**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 September 30, 2006** |
| **or**                                                 |
| **o**                                                  | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

**For thetransition period from               to               **

**Commission file 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.) |
| **9335  Harris Corners Parkway, Suite 300**                 | ** ** | ** **                            |
| **Charlotte,  North Carolina**                                   | ** ** | **28269**                             |
| (Address of principal  executive offices)                        |       | (Zip Code)                            |

 

Registrant’s telephone number,including area code: **(704) 697-5100**

Former name, former address and former fiscal year, if changed fromlast report: **None**

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.   Yes x   No o

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

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

 

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 or15(d) of the Securities Exchange Act of 1934 subsequent to thedistribution of securities under a plan confirmed by a court.   Yes x   No o

OnNovember 6, 2006 there were 19,133,194 shares of Class A commonstock, 137,239 shares of Class B common stock and 24,319 sharesof Class C common stock outstanding. No shares of Class D orClass E common stock were outstanding as of such date. The par value foreach class of common stock 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**                                                                        | ** ** |     | 3          |   |   |
| Item 1.                                   |       | Financial Statements                                                                              |       |     | 3          |   |   |
| Item 2.                                   |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations  |       |     | 31         |   |   |
| Item 3.                                   |       | Quantitative  and Qualitative Disclosures About Market Risk                                       |       |     | 51         |   |   |
| Item 4.                                   |       | Controls and  Procedures                                                                          |       |     | 52         |   |   |
| **PART II.**                              | ** ** | **OTHER  INFORMATION**                                                                            | ** ** |     | 54         |   |   |
| Item 1.                                   |       | Legal Proceedings                                                                                 |       |     | 54         |   |   |
| Item 1A.                                  |       | Risk Factors                                                                                      |       |     | 54         |   |   |
| Item 2.                                   |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                      |       |     | 54         |   |   |
| Item 3.                                   |       | Defaults Upon  Senior Securities                                                                  |       |     | 55         |   |   |
| Item 4.                                   |       | Submission of  Matters To a Vote of Security Holders                                              |       |     | 55         |   |   |
| Item 5.                                   |       | Other Information                                                                                 |       |     | 55         |   |   |
| Item 6.                                   |       | Exhibits                                                                                          |       |     | 55         |   |   |
| Signatures                                     |       |                                                                                              | 56         |     |       |

 

1

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**IMPORTANT INFORMATIONREGARDING 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 product introductions, cost savings, research and developmentactivities and similar matters. The Private Securities Litigation Reform Act of1995 provides a safe harbor for forward-looking statements. Forward-lookingstatements are generally accompanied by words such as “estimate,” “project,” “predict,”“believe,” “expect,” “anticipate” or other words that convey the uncertainty offuture events 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 anyobligation to update these statements and cautions against any undue relianceon them. These forward-looking statements are based on currentexpectations and assumptions about future events. While management considersthese expectations and assumptions to be reasonable, they are inherentlysubject to significant business, economic, competitive, regulatory and otherrisks, contingencies and uncertainties, most of which are difficult to predictand many of which are beyond the Company’s control. See Item 1A. “RiskFactors” to the Company’s Annual Report on Form 10-K. There can beno assurances that these events will occur or that the Company’s results willbe as estimated.

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

·       general economic factorsincluding, but not limited to, changes in interest rates, foreign currencytranslation rates, consumer confidence, trends in disposable income, changes inconsumer demand for goods produced, and cyclical or other downturns;

·       substantial debt levels andpotential inability to maintain sufficient liquidity to finance the Company’soperations and make necessary capital expenditures;

·       inability to meet existingdebt covenants;

·       information andtechnological advances;

·       changes in environmentallaws and regulations;

·       cost and availability ofraw materials, labor and natural and other resources and the inability to passraw material cost increases along to customers;

·       Inability to achievesuccessful start-up on new production lines;

·       domestic and foreigncompetition;

·       delays or difficulties infinding a suitable new Chief Executive Officer;

·       reliance on major customersand suppliers; and

·       risks related to operationsin foreign jurisdictions.

2

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**ITEM 1.**                 FINANCIALSTATEMENTS

**POLYMER GROUP, INC.CONSOLIDATED BALANCE SHEETS (Unaudited)(In Thousands, Except Share Data)**
|                                                                                                                                                                         | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                              | ** ** |                         | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| Current assets:                                                                                                                                                         |       |                         |       |                        |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                               |       |                         | $          | 16,457                      |       |   |   | $ | 30,963 |   |   |
| Accounts receivable, net                                                                                                                                                |       |                         | 129,301    |                        |       |   | 120,668 |   |   |
| Inventories                                                                                                                                                             |       |                         | 130,159    |                        |       |   | 119,663 |   |   |
| Deferred income taxes                                                                                                                                                   |       |                         | 2,155      |                        |       |   | 4,364 |   |   |
| Other current assets                                                                                                                                                    |       |                         | 27,380     |                        |       |   | 23,094 |   |   |
| Total current assets                                                                                                                                                    |       |                         | 305,452    |                        |       |   | 298,752 |   |   |
| Property, plant and equipment, net                                                                                                                                      |       |                         | 438,371    |                        |       |   | 421,997 |   |   |
| Intangibles and loan acquisition costs, net                                                                                                                             |       |                         | 34,546     |                        |       |   | 37,329 |   |   |
| Deferred income taxes                                                                                                                                                   |       |                         | 313        |                        |       |   | 433 |   |   |
| Other assets                                                                                                                                                            |       |                         | 9,650      |                        |       |   | 6,490 |   |   |
| Total assets                                                                                                                                                            |       |                         | $788,332   |                        |       |   | $ | 765,001 |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                           | ** ** |                         | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| Current liabilities:                                                                                                                                                    |       |                         |       |                        |       |   |   |   |   |
| Short-term borrowings                                                                                                                                                   |       |                         | $          | 7,286                       |       |   |   | $ | 5,101 |   |   |
| Accounts payable                                                                                                                                                        |       |                         | 92,369     |                        |       |   | 82,371 |   |   |
| Accrued liabilities                                                                                                                                                     |       |                         | 36,591     |                        |       |   | 32,235 |   |   |
| Income taxes payable                                                                                                                                                    |       |                         | 2,699      |                        |       |   | 1,456 |   |   |
| Current portion of long-term debt                                                                                                                                       |       |                         | 4,157      |                        |       |   | 4,142 |   |   |
| Total current liabilities                                                                                                                                               |       |                         | 143,102    |                        |       |   | 125,305 |   |   |
| Long-term debt                                                                                                                                                          |       |                         | 409,996    |                        |       |   | 405,955 |   |   |
| Deferred income taxes                                                                                                                                                   |       |                         | 65,508     |                        |       |   | 64,692 |   |   |
| Other noncurrent liabilities                                                                                                                                            |       |                         | 24,274     |                        |       |   | 20,956 |   |   |
| Total liabilities                                                                                                                                                       |       |                         | 642,880    |                        |       |   | 616,908 |   |   |
| Minority interests                                                                                                                                                      |       |                         | 17,304     |                        |       |   | 16,611 |   |   |
| 16% Series A convertible pay-in-kind preferred  shares—0 shares issued and outstanding                                |       |                         | —     |                        |       |   | — |   |   |
| Shareholders’ equity:                                                                                                                                              |       |                         |       |                        |       |   |   |   |   |
| Class A common stock—19,139,086 and 18,868,607  shares issued and outstanding at September 30, 2006 and  December 31, 2005, respectively            |       |                         | 191        |                        |       |   | 188 |   |   |
| Class B convertible common stock—137,239 and  153,549 shares issued and outstanding at September 30, 2006 and  December 31, 2005, respectively |       |                         | 2          |                        |       |   | 2 |   |   |
| Class C convertible common stock—24,319 and  31,131 shares issued and outstanding at September 30, 2006 and  December 31, 2005, respectively   |       |                         | —     |                        |       |   | — |   |   |
| Class D convertible common stock—0 shares issued  and outstanding                                                                                             |       |                         | —     |                        |       |   | — |   |   |
| Class E convertible common stock—0 shares issued  and outstanding                                                                                             |       |                         | —     |                        |       |   | — |   |   |
| Additional paid-in capital                                                                                                                                              |       |                         | 169,586    |                        |       |   | 165,652 |   |   |
| Retained earnings (deficit)                                                                                                                                             |       |                         | (70,492    | )                           |       |   | (54,820 | ) |   |
| Accumulated other comprehensive income                                                                                                                                  |       |                         | 28,861     |                        |       |   | 20,460 |   |   |
| Total shareholders’ equity                                                                                                                                         |       |                         | 128,148    |                        |       |   | 131,482 |   |   |
| Total liabilities and  shareholders’ equity                                                                                                                        |       |                         | $788,332   |                        |       |   | $ | 765,001 |   |   |

 

See Accompanying Notes.

3

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**POLYMERGROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

**(InThousands, Except Per Share Data)**

| ** **                                                  | ** ** | **Three Months  Ended  September 30, 2006** | ** ** | **Three Months  Ended  October 1, 2005** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| Net sales                                                   |       |                                                       | $          | 248,586                                                 |       |   |   | $ | 228,220 |   |   |
| Cost of goods sold                                          |       |                                                       | 213,456    |                                                    |       |   | 189,315 |   |   |
| Gross profit                                                |       |                                                       | 35,130     |                                                    |       |   | 38,905 |   |   |
| Selling, general and  administrative expenses               |       |                                                       | 25,311     |                                                    |       |   | 25,431 |   |   |
| Restructuring and  plant realignment costs                  |       |                                                       | 692        |                                                    |       |   | — |   |   |
| Abandoned acquisition  costs                                |       |                                                       | 161        |                                                    |       |   | — |   |   |
| Foreign currency  (gain) loss, net                          |       |                                                       | (1,152     | )                                                       |       |   | 652 |   |   |
| Operating income                                            |       |                                                       | 10,118     |                                                    |       |   | 12,822 |   |   |
| Other expense:                                              |       |                                                       |       |                                                    |       |   |   |   |   |
| Interest expense, net                                       |       |                                                       | 7,479      |                                                    |       |   | 8,161 |   |   |
| Minority interests                                          |       |                                                       | 945        |                                                    |       |   | 1,025 |   |   |
| Foreign currency and other loss, net                        |       |                                                       | 55         |                                                    |       |   | 80 |   |   |
| Income before income  tax expense                           |       |                                                       | 1,639      |                                                    |       |   | 3,556 |   |   |
| Income tax expense                                          |       |                                                       | 3,154      |                                                    |       |   | 3,362 |   |   |
| Net income (loss)                                           |       |                                                       | (1,515     | )                                                       |       |   | 194 |   |   |
| Accrued and  paid-in-kind dividends on PIK preferred shares |       |                                                       | —     |                                                    |       |   | 14,791 |   |   |
| Loss applicable to  common shareholders                     |       |                                                       | $          | (1,515                                                  | )          |   |   | $ | (14,597 | ) |   |
| Loss per common share:                                      |       |                                                       |       |                                                    |       |   |   |   |   |
| Basic                                                       |       |                                                       | $          | (0.08                                                   | )          |   |   | $ | (1.17 | ) |   |
| Diluted                                                     |       |                                                       | $          | (0.08                                                   | )          |   |   | $ | (1.17 | ) |   |

 

See Accompanying Notes.

4

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**POLYMERGROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)**

**(InThousands, Except Per Share Data)**

| ** **                                                  | ** ** | **Nine Months  Ended  September 30, 2006** | ** ** | **Nine Months  Ended  October 1, 2005** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Net sales                                                   |       |                                                      | $          | 757,733                                                |       |   |   | $ | 708,434 |   |   |
| Cost of goods sold                                          |       |                                                      | 642,945    |                                                   |       |   | 583,669 |   |   |
| Gross profit                                                |       |                                                      | 114,788    |                                                   |       |   | 124,765 |   |   |
| Selling, general and  administrative expenses               |       |                                                      | 83,265     |                                                   |       |   | 78,760 |   |   |
| Asset impairment  charges                                   |       |                                                      | 7,856      |                                                   |       |   | — |   |   |
| Restructuring and  plant realignment costs                  |       |                                                      | 5,065      |                                                   |       |   | 9 |   |   |
| Abandoned acquisition  costs                                |       |                                                      | 3,831      |                                                   |       |   | — |   |   |
| Foreign currency  loss, net                                 |       |                                                      | 1,820      |                                                   |       |   | 746 |   |   |
| Operating income                                            |       |                                                      | 12,951     |                                                   |       |   | 45,250 |   |   |
| Other expense (income):                                     |       |                                                      |       |                                                   |       |   |   |   |   |
| Interest expense, net                                       |       |                                                      | 21,075     |                                                   |       |   | 24,195 |   |   |
| Minority interests                                          |       |                                                      | 2,781      |                                                   |       |   | 3,013 |   |   |
| Foreign currency and other (gain) loss, net                 |       |                                                      | 1,110      |                                                   |       |   | (685 | ) |   |
| Income (loss) before  income tax expense                    |       |                                                      | (12,015    | )                                                      |       |   | 18,727 |   |   |
| Income tax expense                                          |       |                                                      | 3,657      |                                                   |       |   | 9,297 |   |   |
| Net income (loss)                                           |       |                                                      | (15,672    | )                                                      |       |   | 9,430 |   |   |
| Accrued and  paid-in-kind dividends on PIK preferred shares |       |                                                      | —     |                                                   |       |   | 27,999 |   |   |
| Loss applicable to  common shareholders                     |       |                                                      | $          | (15,672                                                | )          |   |   | $ | (18,569 | ) |   |
| Loss per common share:                                      |       |                                                      |       |                                                   |       |   |   |   |   |
| Basic                                                       |       |                                                      | $          | (0.81                                                  | )          |   |   | $ | (1.67 | ) |   |
| Diluted                                                     |       |                                                      | $          | (0.81                                                  | )          |   |   | $ | (1.67 | ) |   |

 

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 September 30, 2006(In Thousands)**
|                                                                                            | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings/  (Deficit)** | ** ** | **Accumulated  Other  Comprehensive  Income/  (Loss)** | ** ** | **Total** | ** ** | ** ** | ** ** | **Comprehensive  Income/(Loss)** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------------------|------------|--------------------------------------------------------|------------|-----------|------------|------------|------------|----------------------------------|------------|
| Balance,  December 31, 2005                                                 |       |              | $          | 190                              |       |                               | $          | 165,652                                                |       | $         | (54,820    | )          |       | $                                | 20,460     |   |   | $ | 131,482 |   |   |   |   |   |   |   |
| Net loss                                                                                   |       |              | —     |                             |       | —                             |       | (15,672                                                | )          |      | —     |       |       | (15,672                          | )          |   |   |   | $ | (15,672 | ) |   |
| Currency translation  adjustment, net of tax                                               |       |              | —     |                             |       | —                             |       | —                                                 |       |      | 8,208      |       |       | 8,208                            |       |   |   |   | 8,208 |   |   |
| Cash flow hedge  adjustment, net of reclassification adjustment                            |       |              | —     |                             |       | —                             |       | —                                                 |       |      | (1,399     | )          |       | (1,399                           | )          |   |   |   | (1,399 | ) |   |
| Minimum pension  liability, net of tax                                                |       |              | —     |                             |       | —                             |       | —                                                 |       |      | 1,592      |       |       | 1,592                            |       |   |   |   | 1,592 |   |   |
| Compensation expense  recognized on stock options and restricted stock grants awarded |       |              | 3          |                             |       | 4,929                              |       | —                                                 |       |      | —     |       |       | 4,932                            |       |   |   |   | — |   |   |
| Surrender of shares  to satisfy employee withholding tax obligations                       |       |              | —     |                             |       | (995                               | )          | —                                                 |       |      | —     |       |       | (995                             | )          |   |   |   | — |   |   |
| Balance, September 30,  2006                                                |       |              | $          | 193                              |       |                               | $          | 169,586                                                |       | $         | (70,492    | )          |       | $                                | 28,861     |   |   | $ | 128,148 |   |   |   |   | $ | (7,271 | ) |   |

 

See Accompanying Notes.

6

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**POLYMERGROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOW (Unaudited)**

**(InThousands)**

| ** **                                                                                | ** ** | **Nine Months  Ended  September 30, 2006** | ** ** | **Nine Months  Ended  October 1, 2005** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Operating activities:                                                                     |       |                                                      |       |                                                   |       |   |   |   |   |
| Net income (loss)                                                                         |       |                                                      | $          | (15,672                                                | )          |   |   | $ | 9,430 |   |   |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                                      |       |                                                   |       |   |   |   |   |
| Deferred income taxes                                                                     |       |                                                      | (219       | )                                                      |       |   | 5,957 |   |   |
| Net (gain) on sale of assets                                                              |       |                                                      | (292       | )                                                      |       |   | — |   |   |
| Depreciation and amortization                                                             |       |                                                      | 44,733     |                                                   |       |   | 42,697 |   |   |
| Asset impairment charges                                                                  |       |                                                      | 7,856      |                                                   |       |   | — |   |   |
| Noncash compensation                                                                      |       |                                                      | 5,252      |                                                   |       |   | 1,980 |   |   |
| Changes in operating  assets and liabilities, net of effect of acquisitions:              |       |                                                      |       |                                                   |       |   |   |   |   |
| Accounts receivable, net                                                                  |       |                                                      | (6,425     | )                                                      |       |   | (13,170 | ) |   |
| Inventories                                                                               |       |                                                      | (8,100     | )                                                      |       |   | (7,507 | ) |   |
| Other current assets                                                                      |       |                                                      | (3,529     | )                                                      |       |   | 3,914 |   |   |
| Accounts payable and accrued liabilities                                                  |       |                                                      | 14,103     |                                                   |       |   | 8,811 |   |   |
| Other, net                                                                                |       |                                                      | (1,181     | )                                                      |       |   | (5,027 | ) |   |
| Net cash provided by operating activities                                                 |       |                                                      | 36,526     |                                                   |       |   | 47,085 |   |   |
| Investing activities:                                                                     |       |                                                      |       |                                                   |       |   |   |   |   |
| Purchases of property, plant and equipment                                                |       |                                                      | (63,288    | )                                                      |       |   | (56,861 | ) |   |
| Acquisition of intangibles                                                                |       |                                                      | (407       | )                                                      |       |   | — |   |   |
| Proceeds from sale of assets                                                              |       |                                                      | 2,685      |                                                   |       |   | 354 |   |   |
| Net cash used in investing activities                                                     |       |                                                      | (61,010    | )                                                      |       |   | (56,507 | ) |   |
| Financing activities:                                                                     |       |                                                      |       |                                                   |       |   |   |   |   |
| Proceeds from borrowings                                                                  |       |                                                      | 59,416     |                                                   |       |   | 38,536 |   |   |
| Repayment of borrowings                                                                   |       |                                                      | (53,262    | )                                                      |       |   | (42,110 | ) |   |
| Advances from equipment supplier, net                                                     |       |                                                      | 3,840      |                                                   |       |   | — |   |   |
| Other                                                                                     |       |                                                      | (305       | )                                                      |       |   | (50 | ) |   |
| Net cash provided by (used in) financing  activities                                      |       |                                                      | 9,689      |                                                   |       |   | (3,624 | ) |   |
| Effect of exchange  rate changes on cash                                                  |       |                                                      | 289        |                                                   |       |   | (725 | ) |   |
| Net decrease in cash  and cash equivalents                                                |       |                                                      | (14,506    | )                                                      |       |   | (13,771 | ) |   |
| Cash and cash  equivalents at beginning of period                                         |       |                                                      | 30,963     |                                                   |       |   | 41,296 |   |   |
| Cash and cash equivalents at  end of period                                               |       |                                                      | $          | 16,457                                                 |       |   |   | $ | 27,525 |   |   |

 

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 of Consolidation*

Polymer Group, Inc. (the “Company”)is a publicly-traded, multinational manufacturer, marketer and seller ofnonwoven and oriented polyolefin products. The Company’s main sources ofrevenue are the sales of primary and intermediate products to the medical,hygiene, wipes and industrial and specialty markets.

The accompanying ConsolidatedFinancial Statements include the accounts of Polymer Group, Inc. and allmajority-owned subsidiaries after elimination of all significant intercompanyaccounts and transactions. The accounts of all foreign subsidiaries have beenincluded on the basis of fiscal periods ended three months or less prior to thedates of the 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 December 31, 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 preparation of financial statements in conformityaccounting principles generally accepted in the United States requiresmanagement to make estimates and judgments that affect the amounts reported inthe financial statements and accompanying notes. The accounting estimates thatrequire management’s most significant judgments include the valuation of allowancesfor accounts receivable and inventory, the assessment of recoverability of long-lived assets, the recognitionand measurement of current and deferred income tax assets and liabilities andthe valuation and recognition of share-based compensation. Actual results coulddiffer from those estimates. The Consolidated Balance Sheet data includedherein as of December 31, 2005 has been derived from the audited financialstatements included in the Company’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.

*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 a reduction indetermining revenue in the same period that the revenue is recognized.

*Accumulated Other Comprehensive Income*

Accumulated othercomprehensive income of $28.9 million at September 30, 2006 consistedof $26.4 million of currency translation gains and $2.5 million ofcash flow hedge gains, all net of applicable income tax. Accumulated othercomprehensive income of $20.5 million at December 31, 2005 consistedof $18.2 million of currency translation gains, $1.6 million ofminimum pension liability and $3.9 million of cash flow hedge gains, allnet of applicable income tax.

8

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

*Recent Accounting Standards*

In November 2004, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 151, “Inventory Costs” (“SFAS No. 151”).This statement amends earlier guidance to require that abnormal freight,handling and spoilage costs be recognized as current-period chargesrather than capitalized as an inventory cost. In addition, SFAS No. 151requires that the allocation of fixed production overhead costs be based on thenormal capacity of the production facilities. SFAS No. 151 is effectivefor inventory costs incurred during fiscal years beginning after June 15,2005. The Company has adopted the provisions of SFAS No. 151 effective January 1,2006 and the impact has not been significant to its financial position orresults of operations.

In December 2004,the FASB issued a revision to SFAS No. 123, “Accounting for Stock-BasedCompensation.” The revision, entitled SFAS No. 123(R), “Share-BasedPayment” (“SFAS No. 123(R)”), is effective for all awards granted,modified, repurchased or canceled after June 15, 2005 and requires apublic entity to measure the cost of employee services received in exchange foran award of equity instruments based on the grant-date fair value of the award.The grant date fair value is to be estimated using option-pricing modelsadjusted for the unique characteristics of those instruments. In April 2005,the Securities and Exchange Commission issued a final rule thatregistrants must adopt SFAS No. 123(R)’s fair value method of accountingno later than the beginning of the fiscal year beginning after June 15,2005. Accordingly, the Company adopted SFAS No. 123(R) as of January 1,2006 using the modified prospective transition method. The grant date fairvalue was estimated using the Black-Scholes model. Under the modifiedprospective transition method, all new grants and any unvested portion of priorawards as of January 1, 2006 have been measured based on thefair-value-based method of accounting. The impact of adopting SFAS No. 123(R) hasresulted in marginally lower compensation costs than previously recognizedunder the Company’s historically-used accounting principles. The proformaeffect of utilizing SFAS No. 123(R) on the financial results for thethree and nine months ended October 1, 2005 was as follows (in thousands,except per share data):

9

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

 

| ** **                                                                                                                        | ** ** | **Three Months  Ended  October 1, 2005** | ** ** | **Nine Months  Ended  October 1, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Net income (loss):                                                                                                                |       |                                                    |       |                                                   |       |   |   |   |   |
| As reported                                                                                                                       |       |                                                    | $          | 194                                                    |       |   |   | $ | 9,430 |   |   |
| Add: stock-based employee compensation expense, net of tax, included  in reported net income (loss)                               |       |                                                    | 475        |                                                   |       |   | 1,980 |   |   |
| Deduct: stock-based employee compensation expense, net of tax,  determined under SFAS No. 123(R)                             |       |                                                    | (332       | )                                                      |       |   | (644 | ) |   |
| Pro forma                                                                                                                         |       |                                                    | $          | 337                                                    |       |   |   | $ | 10,766 |   |   |
| Income (loss) applicable to common shareholders:                                                                                  |       |                                                    |       |                                                   |       |   |   |   |   |
| As reported                                                                                                                       |       |                                                    | $          | (14,597                                                | )          |   |   | $ | (18,569 | ) |   |
| Add: stock-based employee compensation expense, net of tax, included  in reported income (loss) applicable to common shareholders |       |                                                    | 475        |                                                   |       |   | 1,980 |   |   |
| Deduct: stock-based employee compensation expense, net of tax,  determined under SFAS No. 123(R)                             |       |                                                    | (332       | )                                                      |       |   | (644 | ) |   |
| Pro forma                                                                                                                         |       |                                                    | $          | (14,454                                                | )          |   |   | $ | (17,233 | ) |   |
| Loss per common share—basic:                                                                                                 |       |                                                    |       |                                                   |       |   |   |   |   |
| As reported                                                                                                                       |       |                                                    | $          | (1.17                                                  | )          |   |   | $ | (1.67 | ) |   |
| Pro forma                                                                                                                         |       |                                                    | (1.16      | )                                                      |       |   | (1.55 | ) |   |
| Loss per common share—diluted:                                                                                               |       |                                                    |       |                                                   |       |   |   |   |   |
| As reported                                                                                                                       |       |                                                    | $          | (1.17                                                  | )          |   |   | $ | (1.67 | ) |   |
| Pro forma                                                                                                                         |       |                                                    | (1.16      | )                                                      |       |   | (1.55 | ) |   |

 

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”).This statement amends earlier guidance and requires retrospective applicationto prior periods’ financial statements of a voluntary change in accountingprinciple unless it is impracticable to determine either the period-specificeffects or the cumulative effects of the change. 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 has completed itsevaluation of the impact that the adoption of SFAS No. 154 could have andhas concluded that such impact is not significant to its financial position orresults of operations.

In July 2006, the FASBissued FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes, an interpretation of FASB Statement No. 109, Accounting for IncomeTaxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in incometaxes recognized in an enterprise’s financial statements. This standardprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken, or expected tobe taken, in a tax return. FIN 48 also provides guidance on other tax-relatedissues and is effective for fiscal years beginning after December 15,2006. The Company is currently analyzing the new guidance.

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”).This statement applies, with certain exceptions, to other accountingpronouncements that either require or permit fair value measurements. Thisstandard creates a fair value hierarchy with assigns types of inputs to eachlevel within the hierarchy. SFAS No. 157 also provides guidance for an 

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

expanded setof disclosure requirements related to fair value and is effective for fiscalyears beginning after November 15, 2007. The Company is currentlyanalyzing the new guidance.

In September 2006, theFASB issued SFAS No. 158, “Employers’ Accounting for Defined BenefitPension and Other Retirement Plans: an amendment of FASB Statements No. 87,88, 106 and 132(R)” (“SFAS No. 158”). SFAS No. 158 requires employersto recognize the funded status of defined benefit postretirement plans in theConsolidated Balance Sheets, with changes in the plan’s funded statusrecognized as an element of other comprehensive income. This standard alsorequires that the measurement of a plan’s funded status be as of the date ofthe employers’ balance sheet. SFAS No. 158 also amends certain of theprevious disclosure requirements related to these plans and is effective forfiscal years ending after December 15, 2006. The Company does not expectthe new guidance to have a significant impact on its financial position orresults of operations.

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

Accounts receivablepotentially expose the Company to concentration of credit risk, as defined bySFAS No. 105, “Disclosure of Information about Financial Instruments withOff-Balance Sheet Risk and Financial Instruments with Concentration of CreditRisk.” The Company provides credit in the normal course of business andperforms ongoing credit evaluations on its customers’ financial condition asdeemed necessary, but generally does not require collateral to support suchreceivables. Customer balances are considered past due based on contractualterms and the Company does not accrue interest on the past due balances. Theprovision for losses on uncollectible accounts is determined principally on thebasis of past collection experience applied to ongoing evaluations ofreceivables and the risk of repayment. The allowance for doubtful accounts was $7.7 millionand $9.6 million at September 30, 2006 and December 31, 2005,respectively, which management believes is adequate to provide for credit lossin 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. Of the $1.9 milliondecrease in the allowance for doubtful accounts, $1.5 million related tothe write-off of specifically identified uncollectible accounts receivable andthe corresponding reserves. Sales to the Procter & Gamble Company (“P&G”)accounted for approximately 13% and 14% of the Company’s sales in the firstnine months of 2006 and 2005, respectively.

On November 15, 2004, theCompany entered into a factoring agreement to sell without recourse, certainU.S. company-based receivables to an unrelated third-party financialinstitution. Under the terms of the factoring agreement, the maximum amount ofoutstanding advances at any one time was $15.0 million, which limitationwas subject to change based on the level of eligible receivables, restrictionson concentrations of receivables and the historical performance of thereceivables sold. In March 2006, the maximum amount of outstandingadvances at any one time was increased to $20.0 million. Additionally, on November 7,2005, the Company’s Latin American operations entered into a factoringagreement to sell without recourse, certain non-U.S. company-based receivablesto an unrelated third-party financial institution. Under the terms of thefactoring agreement, the maximum amount of outstanding advances at any one timeis $10.0 million, which limitation is subject to change based on the levelof eligible receivables, restrictions on concentrations of receivables and thehistorical performance of the receivables sold.

During the first nine monthsof 2006, approximately $140.4 million of receivables had been sold underthe terms of the factoring agreements, compared to approximately$92.4 million during the first 

11

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

nine monthsof fiscal 2005. The sale of these receivables accelerated the collection of theCompany’s cash, reduced credit exposure and lowered the Company’s net borrowingcosts. Sales of accounts receivable are reflected as a reduction of *Accounts receivable, net* in theConsolidated Balance Sheets and any loss recognized on the sale is reflected in*Foreign currency and other (gain) loss, net*in the Consolidated Statements of Operations on such sales, as they meet theapplicable criteria of SFAS No. 140, “Accounting for Transfers andServicing of Financial Assets and Extinguishment of Liabilities” (“SFAS No. 140”).The amount due from the factoring companies, net of advances received from thefactoring companies, was $8.2 million and $6.1 million at September 30,2006 and December 31, 2005, respectively, and is shown in *Other current assets* in the ConsolidatedBalance Sheets. The Company pays factoring fees associated with the sale ofreceivables based on the dollar value of the receivables sold. Such fees areimmaterial and are included in *Foreign currency and other(gain) loss, net* in the Consolidated Statements of Operations.

**Note 3.**   BusinessRestructuring, Asset Impairment and Abandoned Acquisition Costs

TheCompany’s operating income includes various charges resulting fromcorporate-level decisions, such as to consolidate and relocate its corporateoffices, restructure certain operations or pursue certain transactionopportunities. Additionally, the Company evaluates its long-lived assets forimpairment whenever events or changes in circumstances, including thoseaforementioned, indicate that the carrying amounts may not be recoverable. Asummary of such charges is presented in the following table (in thousands):

| ** **                                 | ** ** | **Three Months**  | ** ** | **Three Months** | ** ** | **Nine Months**   | ** ** | **Nine Months** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                 | ** ** | **Ended**              | ** ** | **Ended**             | ** ** | **Ended**              | ** ** | **Ended**            | ** ** |
| ** **                                 | ** ** | **September 30,** | ** ** | **October 1,**   | ** ** | **September 30,** | ** ** | **October 1,**  | ** ** |
| ** **                                 | ** ** | **2006**               | ** ** | **2005**              | ** ** | **2006**               | ** ** | **2005**             | ** ** |
| Asset impairment  charges                  |       |                   | $          | —                |       |                   |       | $                    | —     |   |   |   | $ | 7,856 |   |   |   | $ | — |   |   |
| Restructuring and  plant realignment costs |       |                   | 692        |                  |       |                   | —     |                 |       |   | 5,065 |   |   |   | 9 |   |   |
| Abandoned acquisition costs                |       |                   | 161        |                  |       |                   | —     |                 |       |   | 3,831 |   |   |   | — |   |   |

 

*Asset impairment charges*

During the second quarter offiscal 2006, the Company experienced a continued weakening of earnings and cashflows in certain of its Canadian operations. As a result, the Company evaluatedsuch assets for impairment, consistent with the provisions of Statement ofFinancial Accounting Standards No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets,” and recorded a non-cash charge associatedwith the write-down of such assets to estimated fair value in the amount ofapproximately $5.6 million in the second quarter of 2006.

Additionally, during thesecond quarter of 2006, the Company recorded a non-cash charge in the amount ofapproximately $2.3 million associated with the write-down of assets located inSweden to estimated fair value less costs to sell, as such assets will beremoved from service in 2006 as a result of initiating the Company’s Europeanrestructuring and consolidation strategies, as further described below.

The estimation of fair valuefor the write-down of assets previously noted was based on a combination ofestimated market values and expected present value of future cash flowtechniques.

*Restructuring and plant realignment costs*

Accrued costs for restructuring efforts are includedin *Accrued liabilities* in the ConsolidatedBalance Sheets. These costs generally arise from restructuring initiativesintended to result in lower 

12

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

working capital levels and improved operatingperformance and profitability through: (i) reducing headcount at both theplant and corporate levels; (ii) improving manufacturing productivity andreducing corporate costs; and (iii) rationalizing certain assets,businesses and employee benefit programs. A summary of the businessrestructuring activity during the first nine months of fiscal 2006 is presentedin the following table (in thousands):

| Balance accrued at  beginning of year                  |   | $      | 163    |   |
|--------------------------------------------------------|--------|--------|--------|--------|
| 2006 restructuring  and plant realignment charges, net |   | 5,065  |   |
| Cash payments                                          |   | (3,676 | )      |
| Adjustments                                            |   | 29     |   |
| Balance accrued at end of  period                      |   | $      | 1,581  |   |

 

As further described below,the 2006 restructuring and plant realignment costs are principally associatedwith (a) the Company’s restructuring and consolidation plan for Europe,which included termination benefits provided to an executive officer of theCompany, pursuant to Dutch law, in the amount of $2.1 million, costs associatedwith the planned closure of the Sweden plant and other European consolidationefforts of $0.2 million; (b) costs related to the relocation of thecorporate headquarters to Charlotte, North Carolina in the amount of $2.3million; and (c) downsizing certain Canadian operations resulting inseverance costs of $0.5 million.

*Corporate headquarters relocation*

The Company is accounting forthe Corporate relocation costs in accordance with FASB Statement No. 146 “Accountingfor Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”).

As of July 1, 2006, theCompany had entered into written relocation agreements with 22 employeeswho have agreed to the relocation and to acceptance of benefits offered by theCompany. Such relocation benefits charged to operations of $1.2 million throughthe first nine months of 2006 relate primarily to Company obligations for costsassociated with the employee’s real estate sales process, which process hadbeen substantially completed by the electing employees. Additionally, theCompany has incurred approximately $0.5 million associated with other exitcosts.

The Company expects to incurapproximately $0.6 million in severance costs relating to 21 employees whohave not been offered or who have declined the opportunity to relocate. Suchcosts will be incurred provided that the employee remains in the employ of theCompany through the date of their designated date for corporate relocation.Accordingly, consistent with the provisions of SFAS No. 146, the Companyis accruing the severance cost ratably over the expected service period.

During the first nine monthsof fiscal 2006, the Company has included such restructuring costs in *Restructuring and plant realignment costs* in theConsolidated Statements of Operations. Additional relocation costs are expectedto be recognized pursuant to SFAS No. 146 subsequent to September 30,2006 relating to hiring costs and other employee relocation expenses as suchobligations are incurred.

*European restructuring*

In May 2006, the Companyentered into a termination agreement with an executive officer of the Companythat provided for an aggregate payment of approximately $2.1 million, which wascharged to *Restructuring and plant realignment costs*in the Consolidated Statements of Operations in the 

13

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

secondquarter of fiscal 2006. Additionally, the Company and the executive officerentered certain other consulting and non-compete agreements, which costs willbe charged to operations over future periods.

During the second quarter offiscal 2006, based on the Company’s restructuring and consolidation strategiesnoted above, the Company communicated a plan to affected employees that it wasshutting down its operation located in Sweden. The Company currently expects tocease operations during the fourth quarter of fiscal 2006. As a result of that decisionand other European consolidation efforts, the Company recorded a $0.2 millioncharge to *Restructuring and plant realignment costs*in the Consolidated Statements of Operations to cover the costs of exiting thefacility and severance expected to be paid to terminated employees.

*Canadian restructuring*

During the second quarter offiscal 2006, the Company communicated a plan to affected employees that itplanned to downsize one of its facilities located in Canada. The restructuringplan included the reduction of 19 production and administrative staffpositions. As a result of this decision, the Company recorded a $0.2 millioncharge to *Restructuring and plant realignment costs*in the Consolidated Statements of Operations in the second quarter of fiscal 2006to cover the costs of severance pay due to these employees. During the thirdquarter of fiscal 2006, an additional reduction of seven production andadministrative staff positions was announced and the Company recorded anadditional $0.3 million charge to *Restructuring and plantrealignment costs* in the Consolidated Statements of Operations. As aresult, the total charge for the nine months ended September 30, 2006 was$0.5 million.

Additionally, during the firstquarter of fiscal 2006, as part of its restructuring and related cost reductionmeasures, the Company negotiated certain changes with the union representingthe employees of one of the Company’s Canadian operations, including a partialcurtailment of a defined benefit pension plan. No net gain or loss has beenincurred as a result of the partial curtailment. However, based on electionsmade by plan participants during the second quarter of fiscal 2006, and subjectto approval by Canadian regulatory authorities, the Company may incur a settlementloss associated with employees who have elected to exit the plan. Any lossassociated with the partial settlement of the defined benefit pension plan willbe recognized at such time as the settlement occurs, which is dependent upongovernmental approval and upon fulfillment by the Company of its fundingrequirements associated with the future settlement. On a proforma basis, hadsuch partial settlement occurred as of June 1, 2006, the date of thelatest actuarial estimate, the Company estimates that a settlement loss wouldhave been incurred in the amount of approximately $3.7 million as of thatdate. The Company currently estimates that funding required in connection withthe partial settlement will approximate $2.5 million.

*Abandoned acquisition costs*

During the first five monthsof fiscal 2006, the Company actively pursued a potential acquisition. Inconjunction with this effort, the Company incurred approximately $3.8 millionof costs, which are primarily comprised of third-party professional fees.During the second quarter of fiscal 2006, the negotiations with respect to thepotential acquisition reached an impasse and the Company abandoned its effortsto consummate the acquisition. Accordingly, costs of $3.7 million and $0.1million with respect to the abandoned acquisition were charged to *Abandoned acquisition costs* in the Consolidated Statementsof Operations in the second quarter of fiscal 2006 and the third quarter offiscal 2006, respectively.

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

**Note 4.**   Inventories

Inventories are stated at thelower of cost or market primarily using the first-in, first-out method ofaccounting and consist of the following (in thousands):

| ** **      | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------|------------|------------------------------|------------|-----------------------------|------------|
| Finished goods  |       |                         | $          | 65,686                      |       |   |   | $ | 60,545 |   |   |
| Work in process |       |                         | 19,947     |                        |       |   | 17,724 |   |   |
| Raw materials   |       |                         | 44,526     |                        |       |   | 41,394 |   |   |
|            |       |                         | $          | 130,159                     |       |   |   | $ | 119,663 |   |   |

 

Inventories are net of reserves, primarily forobsolete and slow-moving inventories, of approximately $10.1 million and$9.7 million at September 30, 2006 and December 31, 2005,respectively. Management believes that the reserves are adequate to provide forlosses in the normal course of business.

**Note 5.**   Intangiblesand Loan Acquisition Costs

Intangiblesand loan acquisition costs consist of the following (in thousands):

| ** **                                             | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Cost:                                                  |       |                   |       |                  |       |   |   |   |   |
| Proprietary technology                                 |       |                   | $          | 30,696                |       |   |   | $ | 30,251 |   |   |
| Goodwill (primarily attributable to Nonwovens segment) |       |                   | 10,243     |                  |       |   | 10,243 |   |   |
| Loan acquisition costs                                 |       |                   | 8,895      |                  |       |   | 8,590 |   |   |
| Other                                                  |       |                   | 4,247      |                  |       |   | 3,455 |   |   |
|                                                   |       |                   | 54,081     |                  |       |   | 52,539 |   |   |
| Less accumulated  amortization                         |       |                   | (19,535    | )                     |       |   | (15,210 | ) |   |
|                                                   |       |                   | $          | 34,546                |       |   |   | $ | 37,329 |   |   |

 

In January 2006, the Company acquired thebusiness of Advanced Fiber Solutions, Inc (“AFS”). AFS is a regionaldistribution company located in Alabama that markets and sells syntheticconcrete fibers to the ready mix, stucco and precast segments of theconstruction business, primarily in the southern United States. The aggregatepurchase price of $0.8 million consisted of $0.4 million paid to theseller at closing and $0.4 million to be paid on the first anniversary ofthe transaction, contingent upon the successful transfer of the business to theCompany and other factors. The purchase consisted primarily of customer listsand a covenant not to compete agreement from the seller, and the Companyincluded the aggregate purchase price in *Intangibles and loanacquisition costs, net* in the Consolidated Balance Sheets. Suchcosts will be amortized over the term of the covenant not to compete agreement.In addition, the contingent portion of the purchase price is included in *Accrued liabilities* in the Consolidated Balance Sheets as ofSeptember 30, 2006. Net sales and net income of AFS have been included inthe Company’s Consolidated Financial Statements from the acquisition date of January 9,2006, and do not have a material impact on the Company’s Consolidated Financial

15

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

Statements. Therefore,unaudited pro forma data has not been presented in conjunction with thisacquisition.

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

| ** **                                                                               | ** ** | **Three  Months**      | ** ** | **Three  Months**   | ** ** | **Nine  Months**       | ** ** | **Nine  Months**    | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------------|------------|------------------------|------------|---------------------|------------|
| ** **                                                                               | ** ** | **Ended**              | ** ** | **Ended**           | ** ** | **Ended**              | ** ** | **Ended**           | ** ** |
| ** **                                                                               | ** ** | **September 30,** | ** ** | **October 1,** | ** ** | **September 30,** | ** ** | **October 1,** | ** ** |
| ** **                                                                               | ** ** | **2006**               | ** ** | **2005**            | ** ** | **2006**               | ** ** | **2005**            | ** ** |
| Amortization of:                                                                         |       |                   |       |                |       |                   |       |                |       |   |   |   |   |   |   |   |   |
| Intangibles with finite lives, included in selling, general and  administrative expenses |       |                   | $          | 1,117               |       |                   |       | $                   | 1,068      |   |   |   | $ | 3,319 |   |   |   | $ | 3,186 |   |   |
| Loan acquisition costs included in interest expense, net                                 |       |                   | 333        |                |       |                   | 512        |                |       |   | 1,002 |   |   |   | 1,519 |   |   |
| Total amortization  expense                                                              |       |                   | $          | 1,450               |       |                   |       | $                   | 1,580      |   |   |   | $ | 4,321 |   |   |   | $ | 4,705 |   |   |

 

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 include salaries, wages and other fringe benefitsof $14.3 million and $17.0 million as of September 30, 2006 and December 31,2005, respectively.

**Note 7.**   Debt

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

| ** **                                                                                                                                                                                                                                                                                                                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                      | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Credit Facility, as  defined below, 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 7.57% and 6.77% as of  September 30, 2006 and December 31, 2005, respectively; due in  mandatory quarterly payments of approximately $1.0 million, subject to  additional payments from annual excess cash flows, as defined, with the  balance due November 22, 2012 |       |                   | $          | 406,925               |       |   |   | $ | 410,000 |   |   |
| Revolving Credit Facility—interest at 9.50% as of September 30,  2006; due November 22, 2010                                                                                                                                                                                                                     |       |                   | 6,500      |                  |       |   | — |   |   |
| Other                                                                                                                                                                                                                                                                                                                           |       |                   | 728        |                  |       |   | 97 |   |   |
|                                                                                                                                                                                                                                                                                                                            |       |                   | 414,153    |                  |       |   | 410,097 |   |   |
| Less: Current maturities                                                                                                                                                                                                                                                                                                        |       |                   | (4,157     | )                     |       |   | (4,142 | ) |   |
|                                                                                                                                                                                                                                                                                                                            |       |                   | $          | 409,996               |       |   |   | $ | 405,955 |   |   |

 

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

*Credit Facility*

The Company’s CreditFacility (the “Credit Facility”), which was entered into on November 22,2005, consists of a $45.0 million secured revolving credit facility and a$410.0 million first-lien term loan. The proceeds therefrom were used tofully repay indebtedness under the Company’s previous bank facility and payrelated fees and expenses.

All borrowings under the Credit Facility are U.S.dollar denominated and are guaranteed, on a joint and several basis, by eachand all of the direct and indirect domestic subsidiaries of the Company. TheCredit Facility and the related guarantees are secured by (i) a lien onsubstantially all of the assets of the Company, its domestic subsidiaries andcertain of its non-domestic subsidiaries, (ii) a pledge of all or aportion of the stock of the domestic subsidiaries of the Company and of certainnon-domestic subsidiaries of the Company, and (iii) a pledge of certainsecured intercompany notes. Commitment fees under the Credit Facility are equalto 0.50% of the daily unused amount of the revolving credit commitment. TheCredit Facility limits restricted payments to $5.0 million, including cashdividends, in the aggregate since the effective date of the Credit Facility.The Credit Facility contains covenants and events of default customary forfinancings of this type, including leverage and interest expense coveragecovenants. The Company was in compliance with the debt covenants under thecurrent Credit Facility at September 30, 2006. However, effective with the endof the fiscal quarter ending December 30, 2006, the leverage ratiorequirement, as defined in the Credit Facility, steps down and becomes morerestrictive than the current requirement. Because of the lower-than-expectedlevel of performance, combined with the significant dollars expended on thecapital programs, the restructuring and plant realignment initiatives and theabandoned acquisition, the Company expects increased pressure on the Company’sability to remain in compliance with the leverage ratio requirement for futureperiods. While the Company expects improved operating performance in the fourthquarter of fiscal 2006 and to efficiently manage debt levels at the fiscalyear-end, compliance with the leverage ratio requirement as of December 30,2006 is not assured. The Company’s current estimate of the leverage ratio as ofDecember 30, 2006 approximates the minimum requirement to meet theleverage ratio required under the Credit Facility as of that date without theexistence of significant margin for variance as has been the case in priorperiods. As such, the Company intends to approach its lending group to seek anamendment to certain definitions and covenant levels in its Credit Agreement toprovide additional financial flexibility and mitigate the risk of potential defaultin future periods.

The first-lien term loan requires mandatory paymentsof approximately $1.0 million per quarter and, requires the Company toapply a percentage of proceeds from excess cash flows, as defined by the CreditFacility and determined based on year-end results, to reduce its thenoutstanding balances under the Credit Facility. Excess cash flows required tobe applied to the repayment of the Credit Facility are generally calculated as50.0% of the net amount of the Company’s available cash generated fromoperations adjusted for the cash effects of interest, taxes, capitalexpenditures, changes in working capital and certain other items. Since theamounts of excess cash flows to be applied to the repayment of debt in futureperiods are based on year-end results and not currently determinable, only themandatory payments of approximately $1.0 million per quarter have beenclassified as a current liability. Additionally, no excess cash flow paymentwas required to be made with respect to fiscal 2005 due to the magnitude of themajor capital expenditure projects and any excess cash flow requirement withrespect to fiscal 2006 is not expected to be significant.

17

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

The interest rate applicable to borrowings under theCredit Facility is based on three-month London Interbank Offered Rate (“LIBOR”)plus a specified margin. The applicable margin for borrowings under both thefirst-lien term loan and the revolving credit facility is 225 basis points. TheCompany may, from time to time, elect to use an alternate base rate for itsborrowings under the revolving credit facility based on the bank’s base rateplus a margin of 75 to 125 basis points based on the Company’s total leverageratio. As of September 30, 2006, the Company had $6.5 million ofoutstanding borrowings under the revolving credit facility, and there were nosuch borrowings as of December 31, 2005. As of September 30, 2006,capacity under the revolving credit facility had been reserved for outstandingletters of credit in the amount of $7.1 million, as described below.Average daily borrowings under the revolving credit facility, which werelargely LIBOR-based borrowings, for the period from January 1, 2006 to September 30,2006 were $19.9 million at an average rate of 7.64%.

In accordance with the terms of the Credit Facility,the Company maintained its position in a cash flow hedge agreement originallyentered into in May 2004. This cash flow hedge agreement effectivelyconverts $212.5 million of notional principal amount of debt from avariable LIBOR rate to a fixed LIBOR rate of 3.383%. The cash flow hedgeagreement terminates on May 8, 2007 and is described more fully inNote 12 to the Consolidated Financial Statements.

Subject to certain terms andconditions, a maximum of $25.0 million of the Credit Facility may be usedfor letters of credit. As of September 30, 2006, the Company had$7.1 million of standby and documentary letters of credit outstandingunder the Credit Facility. Letters of credit are in place to provide addedassurance for certain raw material vendors and administrative serviceproviders. None of these letters of credit had been drawn on at September 30,2006.

*Subsidiary Indebtedness*

Nanhai Nanxin Non-woven Co., Ltd (“Nanhai”) has ashort-term credit facility (denominated in U.S. dollars and Chinese renminbi)with a financial institution in China which matures in June 2007. Theamount of outstanding indebtedness under the facility was $3.6 million at September 30,2006 (at an average annual rate of approximately 5.85%) and $5.0 million at December 31,2005 (at an annual average rate of approximately 4.44%). As of September 30,2006, these borrowings are collateralized through the pledge of the Nanhaiassets. Additionally, the Company’s operations in China have also entered intoother short-term credit facilities denominated in Chinese renminbi withfinancial institutions in China. These short-term credit facilities areintended to finance working capital requirements. These facilities have anoutstanding indebtedness of $3.7 million at September 30, 2006 and matureat various dates through June 2007. All of these short-term borrowings inChina are included in *Short-term borrowings*in the Consolidated Balance Sheets.

In March 2006, one of theCompany’s wholly-owned Canadian subsidiaries entered into a term loan totalingapproximately $0.6 million with an agency of the Canadian government,which agency focuses on generating capital investment in the country. Theprincipal of the term loan is due September 1, 2008. Provided that theterm loan is repaid on September 1, 2008, no interest is due. However, ifthe Company elects not to pay the loan on September 1, 2008, the Company,subsequent to that date, will begin making monthly payments of principal andinterest at 6.25% per year.

18

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

**Note 8.**   IncomeTaxes

During the three and nine months ended September 30,2006, the Company recognized an income tax expense of $3.2 million and $3.7million respectively, on consolidated pre-tax income of $1.6 million and aconsolidated pre-tax loss of $12.0 million, respectively. The income tax expenseis significantly different than such expense determined at the U.S. federalstatutory rate primarily due to losses in the U.S. and certain foreignjurisdictions for which no income tax benefits were recognized or whererecognition was limited to the extent of existing deferred tax liabilities.Additionally, the income tax expense was impacted by foreign withholding taxes,for which tax credits are not anticipated, U.S. state income taxes, and foreigntaxes calculated at statutory rates less than the U.S. federal statutory rate.

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 millionand $18.7 million, respectively. This income tax expense is higher than suchexpense determined at the U.S. federal statutory rate partially due to lossesin certain jurisdictions for which no income tax benefits were recognized.Additionally, the income tax expense was impacted by foreign withholding taxes,for which tax credits are not anticipated, U.S. state income taxes and foreigntaxes calculated at statutory rates less than the U.S. federal statutory rate.

Management judgment is required in determining taxprovisions and evaluating tax positions. Although management believes its taxpositions and related provisions reflected in the Consolidated FinancialStatements are fully supportable, it recognizes that these tax positions andrelated provisions may be challenged by various tax authorities. These taxpositions and related provisions are reviewed on an ongoing basis and areadjusted as additional facts and information become available, includingprogress on tax audits, changes in interpretations of tax laws, developments incase law and closing of statutes of limitation. The Company’s tax provisionincludes the impact of recording reserves and any changes thereto. As of September 30,2006, the Company has a number of tax audits in process and has open tax yearswith various taxing jurisdictions that range from 2001 to 2005. Although theresults of current tax audits and reviews related to open tax years have notbeen finalized, management believes that the ultimate outcomes will not have amaterial adverse effect on the Company’s financial position, results ofoperations or cash flows.

Income tax refunds receivablewere $1.6 million at December 31, 2005 and were largely comprised ofamounts due from Latin American tax jurisdictions. These amounts are includedin *Other current assets* on the ConsolidatedBalance Sheets. There were no significant income tax refunds receivable at September 30,2006.

**Note 9.**   Pensionand Postretirement Benefit Plans

The Company and its subsidiaries sponsor multipledefined benefit and other postretirement benefit plans 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.

19

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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 September 30,2006 and October 1, 2005 are as follows (in thousands):

| ** **                                                | ** ** | **Pension Benefit Plans** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended** | ** ** |
| ** **                                                | ** ** | **September 30,  2006**        | ** ** | **October 1,  2005** | ** ** | **September 30,  2006** | ** ** | **October 1,  2005** | ** ** |
| Current service costs                                     |       |                                | $          | 938 |   |   |   | $ | 626 |   |   |   | $ | 2,780 |   |   |   | $ | 1,917 |   |   |
| Interest costs on  projected benefit obligation and other |       |                                | 1,564      |   |   |   | 1,359 |   |   |   | 4,645 |   |   |   | 4,138 |   |   |
| Return on plan assets                                     |       |                                | (1,796     | ) |   |   | (1,486 | ) |   |   | (5,326 | ) |   |   | (4,529 | ) |   |
| Amortization of  transition obligation and other          |       |                                | 111        |   |   |   | 7 |   |   |   | 332 |   |   |   | 20 |   |   |
| Periodic benefit cost, net                                |       |                                | $          | 817 |   |   |   | $ | 506 |   |   |   | $ | 2,431 |   |   |   | $ | 1,546 |   |   |

 

| ** **                                                     | ** ** | **Postretirement Benefit Plans** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                     | ** ** | **Three Months Ended**           | ** ** | **Nine Months Ended** | ** ** |
| ** **                                                     | ** ** | **September 30,  2006**               | ** ** | **October 1,  2005** | ** ** | **September 30,  2006** | ** ** | **October 1,  2005** | ** ** |
| Current service costs                                          |       |                                       | $          | 59 |   |   |   | $ | 46 |   |   |   | $ | 176 |   |   |   | $ | 136 |   |   |
| Interest costs on  projected benefit obligation and other |       |                                       | 133        |   |   |   | 123 |   |   |   | 398 |   |   |   | 366 |   |   |
| Amortization of  transition obligation and other               |       |                                       | (31        | ) |   |   | (29 | ) |   |   | (93 | ) |   |   | (85 | ) |   |
| Periodic benefit cost, net                                     |       |                                       | $          | 161 |   |   |   | $ | 140 |   |   |   | $ | 481 |   |   |   | $ | 417 |   |   |

 

As of September 30, 2006, the Company hadcontributed $6.4 million to its pension and postretirement benefit plansfor the 2006 benefit year. The Company presently anticipates contributing anadditional $1.1 million to fund its plans in 2006, for a total of$7.5 million.

Additionally, during the firstfiscal quarter of 2006, as part of its restructuring and related cost reductionmeasures, the Company negotiated certain changes with the union representingthe employees of one of the Company’s Canadian operations, including a partialcurtailment of a defined benefit pension plan. No net gain or loss has beenincurred as a result of the partial curtailment. However, based on electionsmade by plan participants during the second quarter of fiscal 2006, and subjectto approval by Canadian regulatory authorities, the Company may incur asettlement loss associated with employees who have elected to exit the plan.Any loss associated with the partial settlement of the defined benefit pensionplan will be recognized at such time as the settlement occurs, which is dependentupon governmental approval and upon fulfillment by the Company of its fundingrequirements associated with the future settlement. On a proforma basis, hadsuch partial settlement occurred as of June 1, 2006, the date of thelatest actuarial estimate, the Company estimates that a settlement loss wouldhave been incurred in the amount of approximately $3.7 million as of thatdate. The Company currently estimates that funding required in connection withthe partial settlement will approximate $2.5 million.

20

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

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

*Stock Option Plans*

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, representing 400,000 shares, have a five-year life and vest, based onthe achievement of various service and financial performance criteria, over afour-year period, with the initial awards beginning their vesting terms as of January 4,2004. Vesting of the stock options is accelerated on the occurrence of a changein control. During the first nine months of 2006, 11,250 options wereforfeited. As of September 30, 2006 and December 31, 2005, theCompany had awarded grants of non-qualified stock options to purchase 388,750and 400,000 shares of the Company’s Class A Common Stock,respectively. The awards represent substantially all of the amount reserved forissuance under the 2003 Plan.

Effective January 1, 2006, the Company accountsfor the 2003 Plan in accordance with the methodology defined in SFAS No. 123(R),using the modified prospective transition method. Under the modifiedprospective transition method, the compensation costs related to all new grantsand any unvested portion of prior awards are measured based on the grant-datefair value of the award. Prior to fiscal 2006, the Company elected to accountfor the 2003 Plan in accordance with the intrinsic value method as prescribedby Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees” (“APB No. 25”), which generally measured compensationcost as the excess, if any, of the quoted market price of the stock at the dateof grant over the amount an employee must pay to acquire the stock.Additionally, as a percentage of the options vest based on achievement offinancial performance criteria, compensation costs were recognized over theperformance period when it became probable that such performance criteria wouldbe achieved. The compensation costs related to the 2003 Plan were$0.3 million and $0.8 million for the three and nine months ended September 30,2006, respectively, and were included in *Selling,general and administrative expenses* in the Consolidated Statementsof Operations. For the three and nine months ended October 1, 2005, suchcosts were $0.5 million and $2.0 million, respectively.

The 2005 Stock Option Plan(the “2005 Plan”) was approved by the Company’s Board of Directors andshareholders and was administered by the Compensation Committee of the Board ofDirectors. No awards were granted under the 2005 Plan. On May 23, 2006,the Board of Directors of the Company formally approved the elimination of the2005 Plan.

*Restricted Stock Plans*

In May 2004, the Company’sshareholders approved the 2004 Restricted Stock Plan for Directors (the “RestrictedPlan”), which expires in 2014, for the issuance of restricted shares of theCompany’s Class A Common Stock to Directors of the Company, as defined inthe Restricted Plan. The Restricted Plan approved for issuance 200,000restricted shares and is administered by a committee of the Company’s Board ofDirectors not eligible to receive restricted shares under the Restricted Plan.In the first nine months of fiscal years 2006 and 2005, the Company awarded7,853 and 3,240 restricted shares, respectively, to members of the Company’sBoard of Directors for their Board service to the Company. In addition, 12,500restricted shares were approved for issuance by the Company’s Board ofDirectors in September 2006 to the Company’s Chairman of the Board as acomponent of his compensation for serving as interim Chief Executive Officer.The cost associated with these restricted 

21

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

stockgrants, which vest over periods ranging from immediately to eighteen months,totaled approximately $0.4 million and $0.5 million for the three and ninemonths ended September 30, 2006, respectively, and was included in *Selling, general and administrative expenses*in the Consolidated Statements of Operations. For the three and nine monthsended October 1, 2005, these costs were $10.0 thousand and $30.0 thousand,respectively. As of September 30, 2006, 146,267 shares of theCompany’s Class A Common Stock are available for future grant under theRestricted Plan. This balance does not reflect the decrease for theaforementioned approval to issue 12,500 shares to the Company’s Interim ChiefExecutive Officer, as those shares were not formally issued until October 2006.

In December 2005, theCompany’s 2005 Employee Restricted Stock Plan (the “2005 Stock Plan”) wasapproved by the Company’s Board of Directors and is administered by theCompensation Committee of the Company’s Board of Directors. The 2005 Stock Planwas formally approved by the shareholders of the Company on May 23, 2006at the Annual Shareholders’ Meeting. The 2005 Stock Plan, which expires in2015, approved for issuance 482,000 restricted shares to employees of theCompany. The Compensation Committee may, from time to time, grant shares ofrestricted stock under the 2005 Stock Plan to such employees and in suchamounts and with specified restrictions as it determines appropriate in thecircumstances. Vesting of the restricted shares is accelerated on theoccurrence of a change in control. During the first nine months of fiscal 2006,278,000 restricted shares were awarded to certain employees of the Company.Approximately 100,000 of these shares vested immediately with the balancevesting 25% on each of the grant’s anniversary dates, beginning with January 20,2006 and/or annually based on achievement of certain performance targets. Inaddition, 36,996 shares have been surrendered during fiscal 2006 by employeesto satisfy withholding requirements and 1,500 shares have been forfeited. Thecompensation cost of $0.3 million and $4.0 million related to theserestricted stock grants for the three and nine months ended September 30,2006, respectively, was included in *Selling,general and administrative expenses* in the Consolidated Statementsof Operations. As of September 30, 2006, 242,496 shares of theCompany’s Class A Common Stock are available for future grant under the2005 Stock Plan.

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

In conjunction with the Company’s refinancing in April 2004of its then existing 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 16% Series AConvertible Pay-in-kind Preferred Shares (the “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 inadditional principal amounts of the Junior Notes or in cash. The Junior Notescould be converted, at the option of the holder, into shares of Class ACommon Stock on the same terms as included in the PIK Preferred Shares (aconversion rate of 137.14286 shares of Class A Common Stock per shareof the convertible security, which approximates an initial conversion price ofapproximately $7.29 per share). As the aforementioned exchanges were acomponent of the recapitalization of the Company, involving the majorityshareholder and other common shareholders of the Company and the exchange bythe majority shareholder was a requirement of the then new Bank Facility, theexchanges have been accounted for as a capital transaction and, accordingly, nogain or loss was recognized.

22

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

Dividends on the PIK Preferred Shares accrued at anannual rate of 16.0% and were payable semi-annually in arrears on eachJanuary 1 and July 1, commencing with July 1, 2004. Suchdividends were payable at the option of the Company; (i) through theissuance of additional shares of PIK Preferred Stock; (ii) in cash; or(iii) in a combination thereof. Accordingly, the Company accrued dividendsat the stated rate of 16.0% until such time as the form of the dividend wasdeclared by the Company’s Board of Directors. If the dividend was paid-in-kindthrough the issuance of additional shares of PIK Preferred Stock, the Companyrecognized the dividend at the estimated fair value of the shares issued inexcess of the amounts previously accrued. At any time prior to June 30,2012, the holders of the PIK Preferred Shares could have elected to convert anyor all of their PIK Preferred Shares into shares of the Company’s Class ACommon Stock at an initial conversion rate of 137.14286 shares ofClass A Common Stock per share of PIK Preferred Shares which approximatesan initial conversion price equal to $7.29 per share.

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. The Company accrued dividends at the statedrate of 16.0% on the PIK Preferred Shares during the quarter ended July 2,2005 in the amount of $2.4 million.

On August 3, 2005, the Company’s Board ofDirectors declared that dividends accrued on the PIK Preferred Shares from January 1,2005 through June 30, 2005, in the amount of $4.7 million, would bepaid in the form of PIK Preferred Shares. The Company recorded the value of theadditional PIK Preferred Shares declared as a dividend on August 3, 2005,the date the Board of Directors declared that the accrued dividends were to bepaid in the form of additional PIK Preferred Shares, rather than cash, reducedby the amount of dividends previously recorded at the stated 16.0% rate. Usingthe estimated market value of the Company’s Class A Common Stock of $27.70per share, the fair value of the 4,660 additional PIK Preferred Shares issuedin lieu of cash payment was approximately $17.7 million, which exceededthe amount previously accrued by the Company of $4.7 million, based on thestated rate of 16.0%, by approximately $13.0 million. In addition, theCompany accrued a charge for dividends of $1.8 million for the period fromJuly 2, 2005 through the date that the PIK Preferred Shares were redeemedfor, or converted to, shares of the Company’s Class A Common Stock, asdescribed below. As a result, total accrued and paid-in-kind dividends amountedto approximately $28.0 million in the first nine months of fiscal 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”). In accordance with the terms of the PIK Preferred Shares, the Companywould redeem all PIK Preferred Shares outstanding at the Redemption Date at aredemption rate of 37.26397 shares of Class A Common Stock per PIKPreferred Share. At any time prior to the Redemption Date, holders of PIKPreferred 

23

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

Shares could exercise theirright to convert their PIK Preferred Shares into shares of Class A CommonStock at a conversion rate of 137.14286 shares of Class A CommonStock 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. Also, duringthe first quarter of fiscal 2005, five PIK Preferred Shares were converted into686 shares of Class A Common Stock. As a result of thesetransactions, 8,629,346 additional shares of Class A Common Stock are nowissued and outstanding and no PIK Preferred Shares are currently issued oroutstanding.

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

The Company uses derivative financial instruments tomanage market risks and reduce its exposure to fluctuations in interest ratesand foreign currencies. All hedging transactions are authorized and executedunder clearly defined policies and procedures, which prohibit the use offinancial instruments for trading purposes. FASB Statement No. 133 “Accountingfor Derivative Instruments and Hedging Activities” (“SFAS No. 133”)requires the Company to recognize all derivatives on the balance sheet at fairvalue and establish criteria for designation and effectiveness of hedgingrelationships.

The Company uses interest-rate derivative instrumentsto manage its exposure related to movements in interest rates with respect toits debt instruments. As indicated in Note 7 to the Consolidated FinancialStatements, to mitigate its interest rate exposure as required by the CreditFacility, the Company entered into a pay-fixed, receive-variable interestrate swap, thus effectively converting the variable LIBOR-based interestpayments associated with $212.5 million of the debt to fixed amounts at aLIBOR rate of 3.383%. The notional amount of this contract, which expires on May 8,2007, was $212.5 million at both September 30, 2006 and December 31,2005. Cash settlements are made quarterly and the floating rate is resetquarterly, coinciding with the reset dates of the current Credit Facility.

In accordance with SFASNo. 133, the Company designated the swap as a cash flow hedge of thevariability of interest payments and applied the shortcut method of assessingeffectiveness. The agreement’s terms ensure complete effectiveness inoffsetting the variability of the interest component associated with$212.5 million of first-lien term loan debt. As such, there is noineffectiveness and changes in the fair value of the swap are included in *Accumulated Other Comprehensive Income* in the ConsolidatedBalance Sheets. The fair value of the interest rate swap, based on currentsettlement values, was $2.5 million and $3.9 million as of September 30,2006 and December 31, 2005, respectively. Those amounts are included in *Other noncurrent assets* in theConsolidated Balance Sheets.

The impact of this swap on *Interestexpense, net* in the Consolidated Statements of Operations was adecrease of $1.1 million and $2.6 million for the three and nine monthsended September 30, 2006, respectively. For the three and nine monthsended October 1, 2005, the impact was an decrease of $0.1 million and anincrease of $0.5 million, respectively.

24

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

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

Calculations have not been presented to reconcilebasic income per common share to diluted income per common share for the threeand nine months ended September 30, 2006 or the three and nine monthsended October 1, 2005 as the impact of such calculations areanti-dilutive. Average shares outstanding for the three and nine months ended September 30,2006 were 19,299,589 and 19,291,362, respectively. Average shares outstandingfor the three and nine months ended October 1, 2005 were 12,497,354 and11,113,479, respectively.

As of September 30,2006, the Company’s authorized capital stock consisted of the following classesof stock:

| **Type**                               | ** ** | ** ** | ** ** | **Par Value** | ** ** | **Authorized Shares** | ** ** |
|----------------------------------------|------------|------------|------------|--------------------|------------|----------------------------|------------|
| 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, Class C Common Stock has special rights toannual dividends and all shares of Class B, C, D and E Common Stock may beconverted into an equal number of shares of Class A Common Stock. Theshares of preferred stock may be issued from time to time with suchdesignation, preferences, participation rights and optional or special rights (including,but not limited to, dividend rates, voting rights, maturity dates and the like)as determined by the Board of Directors. See Note 11 to the ConsolidatedFinancial Statements for additional information related to the Company’s PIKPreferred Shares.

**Note 14.**   SegmentInformation

The Company’s reportable segments consist of itsprimary operating divisions—Nonwovens and Oriented Polymers. This reflects howthe overall business is managed on a regular basis by the Company’s seniormanagement and the Board of Directors. Each of these businesses sells todifferent end-use markets, such as hygiene, medical, wipes and industrial andspecialty markets. Sales to P&G accounted for more than 10% of the Company’ssales in each of the periods presented. Sales to this customer are reportedprimarily in the Nonwovens segment and the loss of these sales would have amaterial adverse effect on this segment. The Company recorded charges and/orincome in the Consolidated Statements of Operations during the three and ninemonths ended September 30, 2006 and the three and nine months ended October 1,2005 relating to asset impairment charges, restructuring and plant realignmentcosts, abandoned acquisition costs and foreign currency gain (losses), netwhich have not been allocated to the segment data.

25

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

Financialdata by segment is as follows (in thousands):

| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                         | ** ** | **September 30,  2006**     | ** ** | **October 1,  2005**       | ** ** | **September 30,  2006** | ** ** | **October 1,  2005** | ** ** |
| **Net  sales**                                                     | ** ** |                             | ** ** | ** **                      |       | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| Nonwovens                                                          |       |                             | $          | 210,134                         |       |   | $ | 185,699 |   |   | $ | 624,405 |   |   | $ | 572,405 |   |
| Oriented Polymers                                                  |       |                             | 38,452     |                            |       | 42,521 |   |   | 133,328 |   |   | 136,029 |   |
|                                                               |       |                             | $          | 248,586                         |       |   | $ | 228,220 |   |   | $ | 757,733 |   |   | $ | 708,434 |   |
| **Operating  income (loss)**                                       | ** ** |                             | ** ** | ** **                      |       | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| Nonwovens                                                          |       |                             | $          | 14,211                          |       |   | $ | 18,596 |   |   | $ | 46,159 |   |   | $ | 53,257 |   |
| Oriented Polymers                                                  |       |                             | 703        |                            |       | 790 |   |   | 4,020 |   |   | 9,636 |   |
| Unallocated Corporate                                              |       |                             | (5,095     | )                               |       | (5,912 | ) |   | (18,656 | ) |   | (16,888 | ) |
|                                                               |       |                             | 9,819      |                            |       | 13,474 |   |   | 31,523 |   |   | 46,005 |   |
| Asset impairment charges                                           |       |                             | —     |                            |       | — |   |   | (7,856 | ) |   | — |   |
| Restructuring and plant realignment costs                          |       |                             | (692       | )                               |       | — |   |   | (5,065 | ) |   | (9 | ) |
| Abandoned acquisition costs                                        |       |                             | (161       | )                               |       | — |   |   | (3,831 | ) |   | — |   |
| Foreign currency gain (loss), net                                  |       |                             | 1,152      |                            |       | (652 | ) |   | (1,820 | ) |   | (746 | ) |
|                                                               |       |                             | $          | 10,118                          |       |   | $ | 12,822 |   |   | $ | 12,951 |   |   | $ | 45,250 |   |
| **Depreciation  and amortization expense**                         | ** ** |                             | ** ** | ** **                      |       | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| Nonwovens                                                          |       |                             | $          | 12,426                          |       |   | $ | 10,919 |   |   | $ | 35,887 |   |   | $ | 33,370 |   |
| Oriented Polymers                                                  |       |                             | 2,331      |                            |       | 3,467 |   |   | 7,936 |   |   | 7,924 |   |
| Unallocated Corporate                                              |       |                             | (27        | )                               |       | (37 | ) |   | (92 | ) |   | (116 | ) |
| Depreciation and amortization expense included in operating income |       |                             | 14,730     |                            |       | 14,349 |   |   | 43,731 |   |   | 41,178 |   |
| Amortization of loan acquisition costs                             |       |                             | 333        |                            |       | 512 |   |   | 1,002 |   |   | 1,519 |   |
|                                                               |       |                             | $          | 15,063                          |       |   | $ | 14,861 |   |   | $ | 44,733 |   |   | $ | 42,697 |   |
| **Capital  spending**                                              | ** ** |                             | ** ** | ** **                      |       | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| Nonwovens                                                          |       |                             | $          | 15,777                          |       |   | $ | 21,319 |   |   | $ | 60,419 |   |   | $ | 55,933 |   |
| Oriented Polymers                                                  |       |                             | 785        |                            |       | 713 |   |   | 2,284 |   |   | 928 |   |
| Corporate                                                          |       |                             | 288        |                            |       | — |   |   | 585 |   |   | — |   |
|                                                               |       |                             | $          | 16,850                          |       |   | $ | 22,032 |   |   | $ | 63,288 |   |   | $ | 56,861 |   |

 

| ** **           | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Division  assets** | ** ** |                         | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| Nonwovens            |       |                         | $          | 759,752                     |       |   |   | $ | 715,977 |   |   |
| Oriented Polymers    |       |                         | 128,263    |                        |       |   | 144,477 |   |   |
| Corporate            |       |                         | (1,507     | )                           |       |   | 2,096 |   |   |
| Eliminations         |       |                         | (98,176    | )                           |       |   | (97,549 | ) |   |
|                 |       |                         | $          | 788,332                     |       |   |   | $ | 765,001 |   |   |

 

26

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

*GeographicData:*

Geographicdata for the Company’s operations, based on the geographic region that salesare made from, are presented in the following table (in thousands):

| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                         | ** ** | **September 30,  2006**     | ** ** | **October 1,  2005**       | ** ** | **September 30,  2006** | ** ** | **October 1,  2005** | ** ** |
| **Net sales**                                                      | ** ** |                             | ** ** | ** **                      |       | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| United States                                                      |       |                             | $          | 112,684                         |       |   | $ | 110,721 |   |   | $ | 347,953 |   |   | $ | 331,741 |   |
| Canada                                                             |       |                             | 25,147     |                            |       | 27,724 |   |   | 84,758 |   |   | 86,159 |   |
| Europe                                                             |       |                             | 44,805     |                            |       | 42,799 |   |   | 138,637 |   |   | 142,106 |   |
| Asia                                                               |       |                             | 12,958     |                            |       | 9,794 |   |   | 36,041 |   |   | 31,835 |   |
| Latin America                                                      |       |                             | 52,992     |                            |       | 37,182 |   |   | 150,344 |   |   | 116,593 |   |
|                                                               |       |                             | $          | 248,586                         |       |   | $ | 228,220 |   |   | $ | 757,733 |   |   | $ | 708,434 |   |
| **Operating income (loss)**                                        | ** ** |                             | ** ** | ** **                      |       | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| United States                                                      |       |                             | $          | (2,657                          | )          |   | $ | 254 |   |   | $ | (5,893 | ) |   | $ | 2,103 |   |
| Canada                                                             |       |                             | (532       | )                               |       | (851 | ) |   | (1,130 | ) |   | 3,897 |   |
| Europe                                                             |       |                             | 2,933      |                            |       | 4,055 |   |   | 10,602 |   |   | 12,859 |   |
| Asia                                                               |       |                             | 1,079      |                            |       | 2,012 |   |   | 3,781 |   |   | 4,221 |   |
| Latin America                                                      |       |                             | 8,996      |                            |       | 8,004 |   |   | 24,163 |   |   | 22,925 |   |
|                                                               |       |                             | 9,819      |                            |       | 13,474 |   |   | 31,523 |   |   | 46,005 |   |
| Asset impairment charges                                           |       |                             | —     |                            |       | — |   |   | (7,856 | ) |   | — |   |
| Restructuring and plant realignment costs                          |       |                             | (692       | )                               |       | — |   |   | (5,065 | ) |   | (9 | ) |
| Abandoned acquisition costs                                        |       |                             | (161       | )                               |       | — |   |   | (3,831 | ) |   | — |   |
| Foreign currency gain (loss), net                                  |       |                             | 1,152      |                            |       | (652 | ) |   | (1,820 | ) |   | (746 | ) |
|                                                               |       |                             | $          | 10,118                          |       |   | $ | 12,822 |   |   | $ | 12,951 |   |   | $ | 45,250 |   |
| **Depreciation and amortization  expense**                         | ** ** |                             | ** ** | ** **                      |       | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| United States                                                      |       |                             | $          | 6,746                           |       |   | $ | 6,213 |   |   | $ | 18,718 |   |   | $ | 18,673 |   |
| Canada                                                             |       |                             | 1,800      |                            |       | 2,911 |   |   | 6,239 |   |   | 6,268 |   |
| Europe                                                             |       |                             | 2,169      |                            |       | 2,086 |   |   | 7,035 |   |   | 6,971 |   |
| Asia                                                               |       |                             | 1,115      |                            |       | 1,028 |   |   | 3,207 |   |   | 3,011 |   |
| Latin America                                                      |       |                             | 2,900      |                            |       | 2,111 |   |   | 8,532 |   |   | 6,255 |   |
| Depreciation and amortization expense included in operating income |       |                             | 14,730     |                            |       | 14,349 |   |   | 43,731 |   |   | 41,178 |   |
| Amortization of loan acquisition costs                             |       |                             | 333        |                            |       | 512 |   |   | 1,002 |   |   | 1,519 |   |
|                                                               |       |                             | $          | 15,063                          |       |   | $ | 14,861 |   |   | $ | 44,733 |   |   | $ | 42,697 |   |

 

| ** **                                             | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Identifiable  assets (including intangible assets)** | ** ** |                         | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| United States                                          |       |                         | $          | 325,959                     |       |   |   | $ | 323,596 |   |   |
| Canada                                                 |       |                         | 85,422     |                        |       |   | 94,531 |   |   |
| Europe                                                 |       |                         | 200,644    |                        |       |   | 202,324 |   |   |
| Asia                                                   |       |                         | 90,036     |                        |       |   | 60,267 |   |   |
| Latin America                                          |       |                         | 184,451    |                        |       |   | 181,834 |   |   |
| Eliminations                                           |       |                         | (98,180    | )                           |       |   | (97,551 | ) |   |
|                                                   |       |                         | $          | 788,332                     |       |   |   | $ | 765,001 |   |   |

 

27

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

**Note 15.**   ForeignCurrency (Gain) Loss, Net

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

| ** **                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **September 30,  2006**     | ** ** | **October 1,  2005**       | ** ** | **September 30,  2006** | ** ** | **October 1,  2005** | ** ** |
| Included in operating  income |       |                             | $          | (1,152                          | )          |   |   | $ | 652 |   |   |   | $ | 1,820 |   |   |   | $ | 746 |   |   |
| Included in other,  net       |       |                             | (181       | )                               |       |   | 22 |   |   |   | 602 |   |   |   | (730 | ) |   |
|                          |       |                             | $          | (1,333                          | )          |   |   | $ | 674 |   |   |   | $ | 2,422 |   |   |   | $ | 16 |   |   |

 

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 and liabilities.Gains and losses from the remeasurement of such monetary assets and liabilitiesare reported in *Foreign currency loss, net* in theConsolidated Statements of Operations. Likewise, for international subsidiarieswhich have the local currency as their functional currency, gains and lossesfrom the remeasurement of monetary assets and liabilities not denominated inthe local currency are reported in *Foreign currency loss, net*in the Consolidated Statements of Operations. Additionally, currency gains andlosses have been incurred on intercompany loans between subsidiaries, and tothe extent that such loans are not deemed to be permanently invested, suchcurrency gains and losses are also reflected in *Foreigncurrency and other (gain) loss, net* in the Consolidated Statementsof Operations.

The Company includes gains and losses on receivables, payables andother operating transactions as a component of operating income in *Foreign currency loss, net*. Other foreign currency gains andlosses, primarily related to intercompany loans and debt, are included in *Foreign currency and other (gain) loss, net*.

**Note 16.**   LegalProceedings and Commitments

The Company is not currently a defendant in anymaterial pending legal proceedings other than routine litigation incidental tothe business of the Company. During 2005, the Company was served with a lawsuitby a former customer alleging breach of contract and other charges. Thediscovery phase is continuing and there is not currently enough information toformulate an assessment of the ultimate outcome of the claim. Accordingly,management is not able to estimate the amount of the loss, if any, at thistime. The Company intends to vigorously defend this action and believes that ithas reasonable arguments available in its defense. However, there is apossibility that resolution of this matter, or others that may arise in thenormal course of business, could result in a loss in excess of establishedreserves, if any.

As part of its effortsto enhance its business, the Company, on October 19, 2006, announced thatit had made further commitments to expand its worldwide capacity through theinstallation of a new spunmelt line at the joint venture facility near BuenosAires, Argentina.

In June 2006, one of the Company’s subsidiaries, Fabpro OrientedPolymers, Inc. (“Fabpro”) entered into an asset purchase agreementrelating to the sale of certain assets for $2.3 million and a supply andmarketing rights agreement (“supply agreement”) with an unrelated third party.Under the terms of the supply agreement, which has an initial term of 10 years,Fabpro has committed to purchase a minimum level of product (as defined in thesupply agreement), representing 

28

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

approximately $7.1 million per year, based on currentsales prices, through the year 2012. In the event that Fabpro does not purchasesuch minimum quantities, Fabpro will be obligated to pay a 12.5% penalty on thevalue of the committed amounts not purchased, based on sales prices in effectat that time.

**Note 17.**   SupplementalCash Flow Information

During the first nine months of 2006, noncashinvesting or financing activities included the surrender of 36,996 shares ofthe Company’s Class A Common Stock to the Company by participants in the2005 Stock Plan in the amount of $1.0 million to satisfy employee withholdingtax obligations.

Noncash investing or financing activities in the first nine months of2005 included: (i) the conversion of 62,926 shares of the Company’s PIKPreferred Shares into approximately 8,629,346 shares of the Company’s Class ACommon Stock; (ii) the issuance of 10,200 PIK Preferred Shares aspayment-in-kind, in lieu of cash payment, of approximately $10.3 millionof dividends on the Company’s PIK Preferred Shares, which resulted in anadditional noncash dividend charge of approximately $21.5 million inexcess of the amounts accrued at the stated dividend rate on PIK PreferredShares; and (iii) the accrual of $1.8 million of dividends on the PIKPreferred Shares for dividends from the date of the last dividend declarationdate to the date the PIK Preferred Shares were converted to Class A CommonStock.

**Note 18.**   SettlementAgreements

During June 2006, the Company and an equipmentsupplier negotiated the resolution of a dispute and entered into two settlementagreements, which documented the terms of the resolution. The settlementagreements consisted of (i) an agreement providing that the Company bereimbursed by the equipment supplier, in the amount of 2.5 million Euros($3.2 million), for excess operating costs and expenses and lost profits, whichthe Company had experienced; and (ii) an agreement which provided that theequipment supplier compensate the Company, in the amount of 1.5 millionEuros ($1.9 million), for technical support and services provided by the Companyto the equipment supplier. Under the settlement agreements, the Company agreedto accept the equipment received from the supplier and to release a finalpayment due to the equipment supplier under the original terms of apre-existing contract.

The Company and the AuditCommittee of the Board of Directors of the Company, with assistance fromspecial counsel, have reviewed the settlement agreements and the relationshipof these agreements with equipment purchase contracts and service agreements,which were negotiated between the Company and the equipment supplier in orabout the same time frame. As a result of these reviews, the Company hasconcluded that the economic substance of the aforementioned settlementagreements and the equipment purchase contracts and service agreements aresubstantially interdependent. Accordingly, the accounting treatment applied tothe proceeds from the settlement agreements, which the Company believes reflectsthe economic substance of such agreements in conformity with generally acceptedaccounting principles, reflects approximately $0.6 million of the proceeds fromthe settlement agreements as a reimbursement of excess operating costs with theremaining $4.5 million of such proceeds primarily recognized as a reduction ofthe costs of capital equipment that the Company has agreed to purchase from theequipment supplier.

29

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

**Note 19.**   Other Developments

On September 21, 2006, the Board of Directors ofthe Company asked James L. Schaeffer to resign as Chief Executive Officerand Director of the Company and, pending receipt of his resignation, the Boardrelieved him of his duties as Chief Executive Officer. On October 31,2006, the Company entered into a Severance Agreement with Mr. Schaeffer(the “Severance Agreement”) pursuant to which the Company andMr. Schaeffer agreed that Mr. Schaeffer’s employment with the Companyand services as a Director and officer of the Company ended on October 31,2006 (the “Termination Date”).

In accordance with the Severance Agreement,Mr. Schaeffer is entitled to receive his current base salary through theTermination Date. In addition, as payment of severance, Mr. Schaeffer isentitled to receive (i) an amount equal to his current base salary untilDecember 20, 2006, (ii) the vested portion of his restricted stockawards (less amounts previously withheld for taxes), totaling 30,782 shares ofClass A Common Stock (the “Restricted Shares”), and (iii) the vestedportion of his stock option grants, totaling options to acquire 48,750 sharesof Class A Common Stock (the “Option Shares”). The Restricted Shares andOption Shares will remain subject to the terms and conditions of the Company’s2005 Restricted Stock Plan and 2003 Stock Option Plan, respectively, andaccompanying grant agreements, except for identified provisions requiringforfeiture in the event of certain terminations. All payments under the SeveranceAgreement are subject to applicable tax withholding by the Company.

The Severance Agreement contains customary(a) confidentiality obligations for Mr. Schaeffer with respect toboth Company and third-party confidential information, (b) non-compete andnon-solicitation obligations for Mr. Schaeffer through September 21,2007, and (c) protection of the Company’s intellectual property rights. Inaddition, under the terms of the Company’s 2003 Stock Option Plan,Mr. Schaeffer will continue to be subject to the plan’s non-competeprovisions for so long as the Option Shares remain outstanding. In connectionwith the execution of the Severance Agreement, Mr. Schaeffer also executeda General Release of claims in favor of the Company and certain of its affiliatesand related parties.

Except as provided above, Mr. Schaeffer is notentitled to receive any other payments from the Company related to thetermination of his employment, including without limitation payments pursuantto the Executive Employment Agreement, dated as of March 24, 2006, betweenMr. Schaeffer and the Company, the Change in Control SeveranceCompensation Agreement, dated as of March 24, 2006, betweenMr. Schaeffer and the Company, or the Company’s bonus plan in respect of abonus for the current fiscal year.

The Board of Directorsis currently conducting a search for a new Chief Executive Officer. Until thissearch has been completed, William B. Hewitt, Chairman of the Board ofDirectors, is serving as interim Chief Executive Officer.

30

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

The following discussion and analysis providesinformation which management believes is relevant to an assessment andunderstanding of the Company’s consolidated results of operations and financialcondition. The discussion should be read in conjunction with the consolidatedfinancial statements and notes thereto contained in this Quarterly Report on Form 10-Qand the Annual Report on Form 10-K for the fiscal year ended December 31,2005. In addition, it should be noted that the Company’s gross profit marginsmay not be comparable to other companies since some entities classify shippingand handling costs in cost of goods sold and others, including the Company,include such costs in selling, general and administrative expenses. Similarly,some entities, 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.

During the twenty-one month period ended September 30,2006 the Company was engaged in a major capital expansion program whichincluded adding new spunmelt capacity in Cali, Colombia, in Mooresville, NorthCarolina and in Suzhou, China. Capital expenditures during this period totaled$142.2 million and consisted primarily of the aforementioned three new spunmeltfacilities. The new capacity installations were expected to be the basis of asignificant improvement in sales and profitability and the Company continues tobelieve such improvements will be achieved.

The Cali line, which was installed in the latter partof fiscal 2005, experienced several quarters of suboptimal manufacturingperformance associated with equipment issues which hindered production outputand sales. These issues have been resolved and the Company expects the Caliline to perform at planned levels in the fourth quarter of fiscal 2006.

The Mooresville line initiated production in thelatter part of the second quarter of fiscal 2006 and has performed withinexpected levels since its start up. The Mooresville line was ramping up andcontinuing the qualification process for new sales programs during the thirdquarter of fiscal 2006. The Company expects the Mooresville line to performwell from a productivity and profitability perspective in the fourth quarter offiscal 2006.

The Suzhou line initiated operations in the latterpart of the third quarter of fiscal 2006 and commenced production without anysignificant manufacturing complications. The line will continue to ramp up inthe fourth quarter of 2006 and continue the qualification process for highgrade finished medical fabrics. As such, it the Suzhou line should onlycontribute marginally to sales and profitability during the fourth quarter,with the predominant amount of contribution to be realized in fiscal 2007.

The financial results for the third quarter of fiscal2006 did not improve consistent with the Company’s expectations due, in part,to continued increases in raw material costs, weakness in the Oriented PolymersDivision’s sales and profitability and to the delays in the timing of theprofitability generated by the three spunmelt lines. Additionally, during thefirst nine months of fiscal 2006, the company expended $3.7 million onrestructuring and plant realignment initiatives and $3.8 million associatedwith an abandoned acquisition. The result of the above has had a negativeimpact on the Company’s expected profitability and cash flows from operations.

The Company was in compliancewith the debt covenants under the current Credit Facility at September 30,2006. However, effective with the end of the fiscal quarter ending December 30,2006, the leverage ratio requirement, as defined in the Credit Facility, stepsdown and becomes more restrictive than the current requirement. Because of thelower-than-expected level of performance, combined with the significant dollarsexpended on the capital programs, the restructuring and plant realignmentinitiatives and the abandoned acquisition, the Company expects increasedpressure on the Company’s ability to remain in compliance with the leverageratio requirement for future periods.  

31

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While theCompany expects improved operating performance in the fourth quarter of fiscal2006 and to efficiently manage debt levels at the fiscal year-end, compliancewith the leverage ratio requirement as of December 30, 2006 is notassured. The Company’s current estimate of the leverage ratio as of December 30,2006 approximates the minimum requirement to meet the leverage ratio requiredunder the Credit Facility as of that date without the existence of significantmargin for variance as has been the case in prior periods. As such, the Companyintends to approach its lending group to seek an amendment to certaindefinitions and covenant levels in its Credit Agreement to provide additionalfinancial flexibility and mitigate the risk of potential default in futureperiods.

**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** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                            | ** ** | **September 30,  2006**     | ** ** | **October 1,  2005**       | ** ** | **September 30,  2006** | ** ** | **October 1,  2005** | ** ** |
| Net sales                                                             |       |                             | 100.0      | %                               |       |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |
| Cost of goods sold                                                    |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Materials                                                             |       |                             | 54.7       |                            |       |   | 50.8 |   |   |   | 53.6 |   |   |   | 50.8 |   |   |
| Labor                                                                 |       |                             | 8.2        |                            |       |   | 8.6 |   |   |   | 8.2 |   |   |   | 8.5 |   |   |
| Overhead                                                              |       |                             | 23.0       |                            |       |   | 23.6 |   |   |   | 23.1 |   |   |   | 23.1 |   |   |
|                                                                  |       |                             | 85.9       |                            |       |   | 83.0 |   |   |   | 84.9 |   |   |   | 82.4 |   |   |
| Gross profit                                                          |       |                             | 14.1       |                            |       |   | 17.0 |   |   |   | 15.1 |   |   |   | 17.6 |   |   |
| Selling, general and  administrative expenses                         |       |                             | 10.2       |                            |       |   | 11.1 |   |   |   | 11.0 |   |   |   | 11.1 |   |   |
| Asset impairment  charges                                             |       |                             | —     |                            |       |   | — |   |   |   | 1.0 |   |   |   | — |   |   |
| Restructuring and  plant realignment costs                            |       |                             | 0.3        |                            |       |   | — |   |   |   | 0.7 |   |   |   | 0.0 |   |   |
| Abandoned acquisition  costs                                          |       |                             | 0.0        |                            |       |   | — |   |   |   | 0.5 |   |   |   | — |   |   |
| Foreign currency  (gain) loss, net                                    |       |                             | (0.5       | )                               |       |   | 0.3 |   |   |   | 0.2 |   |   |   | 0.1 |   |   |
| Operating income                                                      |       |                             | 4.1        |                            |       |   | 5.6 |   |   |   | 1.7 |   |   |   | 6.4 |   |   |
| Other expense (income):                                               |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense, net                                                 |       |                             | 3.0        |                            |       |   | 3.6 |   |   |   | 2.8 |   |   |   | 3.4 |   |   |
| Minority interests                                                    |       |                             | 0.4        |                            |       |   | 0.4 |   |   |   | 0.4 |   |   |   | 0.4 |   |   |
| Foreign currency and other loss, net                                  |       |                             | 0.0        |                            |       |   | 0.0 |   |   |   | 0.1 |   |   |   | 0.0 |   |   |
| Income (loss) before  income tax expense                              |       |                             | 0.7        |                            |       |   | 1.6 |   |   |   | (1.6 | ) |   |   | 2.6 |   |   |
| Income tax expense                                                    |       |                             | 1.3        |                            |       |   | 1.5 |   |   |   | 0.5 |   |   |   | 1.3 |   |   |
| Net income (loss)                                                     |       |                             | (0.6       | )                               |       |   | 0.1 |   |   |   | (2.1 | ) |   |   | 1.3 |   |   |
| Accrued and  paid-in-kind dividends on PIK preferred shares |       |                             | —     |                            |       |   | 6.5 |   |   |   | — |   |   |   | 4.0 |   |   |
| Loss applicable to common  shareholders                               |       |                             | (0.6       | )%                              |       |   | (6.4 | )% |   |   | (2.1 | )% |   |   | (2.7 | )% |   |

 

32

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**Comparison of ThreeMonths Ended September 30, 2006 and October 1, 2005**

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 forthcomponents of the Company’s net sales and operating income (loss) by operatingdivision for the three months ended September 30, 2006, the three monthsended October 1, 2005 and the corresponding change (in millions):

| ** **                                 | ** ** | **Three Months  Ended  September 30, 2006** | ** ** | **Three Months  Ended  October 1, 2005** | ** ** | **Change** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------------|------------|---------------------------------------------------------|------------|------------|------------|
| Net sales                                  |       |                                                       |       |                                                    |       |       |       |   |   |   |   |   |   |
| Nonwovens                                  |       |                                                       | $          | 210.1                                                   |       |       |       | $ | 185.7 |   |   |   | $ | 24.4 |   |   |
| Oriented Polymers                          |       |                                                       | 38.5       |                                                    |       |       | 42.5       |   |   |   | (4.0 | ) |   |
| Eliminations                               |       |                                                       | —     |                                                    |       |       | —     |   |   |   | — |   |   |
|                                       |       |                                                       | $          | 248.6                                                   |       |       |       | $ | 228.2 |   |   |   | $ | 20.4 |   |   |
| Operating income  (loss)                   |       |                                                       |       |                                                    |       |       |       |   |   |   |   |   |   |
| Nonwovens                                  |       |                                                       | $          | 14.2                                                    |       |       |       | $ | 18.6 |   |   |   | $ | (4.4 | ) |   |
| Oriented Polymers                          |       |                                                       | 0.7        |                                                    |       |       | 0.8        |   |   |   | (0.1 | ) |   |
| Unallocated Corporate, net of eliminations |       |                                                       | (5.1       | )                                                       |       |       | (5.9       | ) |   |   | 0.8 |   |   |
|                                       |       |                                                       | 9.8        |                                                    |       |       | 13.5       |   |   |   | (3.7 | ) |   |
| Restructuring and plant realignment costs  |       |                                                       | (0.7       | )                                                       |       |       | —     |   |   |   | (0.7 | ) |   |
| Abandoned acquisition costs                |       |                                                       | (0.2       | )                                                       |       |       | —     |   |   |   | (0.2 | ) |   |
| Foreign currency gain (loss), net          |       |                                                       | 1.2        |                                                    |       |       | (0.7       | ) |   |   | 1.9 |   |   |
|                                       |       |                                                       | $          | 10.1                                                    |       |       |       | $ | 12.8 |   |   |   | $ | (2.7 | ) |   |

 

The amounts for restructuringand plant realignment costs, abandoned acquisition costs and foreign currency gain(loss), 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**

Net saleswere $248.6 million for the three months ended September 30, 2006, anincrease of $20.4 million, or 8.9%, over the comparable period of 2005 netsales of $228.2 million. Net sales for 2006 improved in the Nonwovens Divisionover comparable 2005 results by 13.2%, and net sales in 2006 in the OrientedPolymers Division decreased from comparable 2005 results by 9.4%. Areconciliation of the change in net sales between the three months ended October 1,2005 and the three months ended September 30, 2006 is presented in thefollowing table (in millions):

| Net sales—three  months ended October 1, 2005    |   | $      | 228.2  |   |
|------------------------------------------------------------|--------|--------|--------|--------|
| Change in sales due to:                                    |   |   |   |
| Volume                                                     |   | 11.4   |   |
| Price/mix                                                  |   | 6.5    |   |
| Foreign currency translation                               |   | 2.5    |   |
| Net sales—three months ended  September 30, 2006 |   | $      | 248.6  |   |

 

The increase in net sales during the third quarter of2006 was due primarily to volume gains and price/mix improvements. Although allof the nonwovens markets generated volume gains, a 

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substantial portion of that volumegain occurred in the Latin American nonwovens market. The price/mix improvementreflects continued enhancements of the Company’s product offerings as well asthe increases in sales price in an effort to pass along raw material costincreases to customers. Substantially all of the price/mix effect on net salesoccurred in the United States and Latin American nonwovens markets. As rawmaterial costs have increased, the Company has attempted to pass raw materialprices along to its customers, where allowable by contract terms and whereacceptable based on market conditions. In general, with respect to contractedbusiness, there is usually a one-quarter lag between the change in raw materialcost and the change in sales prices.

A significant component of the $11.4 millionincrease in sales in the third quarter of 2006 due to volume growth wasgenerated in the Latin American region with the addition of the spunmelt lineat the Cali, Colombia facility, which initiated operations in the fourthquarter of 2005. The Latin America region’s sales improvement was paced bysignificant year-over-year increases in hygiene and industrial sales. In theCompany’s U.S. nonwovens business, the start-up of the new spunmelt facility inMooresville, North Carolina in the latter part of the second quarter of fiscal2006 and improvements in the medical and wiping markets contributed to theincrease from 2005. Nonwoven sales volumes also increased in Asia, primarilydue to the initial shipments from the Company’s new spunmelt facility inSuzhou, China, which initiated operations in the latter part of the thirdquarter of fiscal 2006. Oriented Polymers’ net sales decreased 9.4% in 2006from the comparable 2005 periods as improvements in price/mix of sales of $2.1million and a favorable foreign currency translation impact were not enough tooffset the $7.1 million decrease in sales volume. Oriented Polymers’ salesvolumes have been negatively impacted in fiscal 2006 by reduced housing startsaffecting their industrial business, imported commodity products affectingprimarily lumberwrap volumes and reduced agricultural sales.

Both the Euro and the Canadiandollar strengthened against the U.S. dollar during the third quarter of2006 compared to 2005. As a result, net sales increased $2.5 million dueto the net favorable foreign currency translation. Further discussion offoreign currency exchange rate risk is contained in “Quantitative andQualitative Disclosures About Market Risk” included in Item 3 of Part Ito this Quarterly Report on Form 10-Q.

**Gross Margin**

Gross margin in the quarterended September 30, 2006 declined to 14.1% from 17.0% in the third quarterof 2005, despite improved sales volumes and product mix, primarily due to theimpact of higher raw materials as a percentage of net sales, the effect of rawmaterial cost increases which were not able to be passed along to the customerand other increased manufacturing costs, including depreciation, during 2006.The raw material component of the cost of goods sold as a percentage of netsales increased from 50.8% in 2005 to 54.7% in 2006.

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**Operating Income**

Areconciliation of the change in operating income between the three months endedOctober 1, 2005 and the three months ended September 30, 2006 ispresented in the following table (in millions):

| Operating income—three  months ended October 1, 2005    |   | $      | 12.8   |   |
|-------------------------------------------------------------------|--------|--------|--------|--------|
| Change in operating  income due to:                               |   |   |   |
| Price/mix                                                         |   | 6.5    |   |
| Higher raw material costs                                         |   | (11.4  | )      |
| Volume                                                            |   | 5.2    |   |
| Higher manufacturing costs                                        |   | (2.8   | )      |
| Foreign currency                                                  |   | 1.9    |   |
| Higher depreciation and amortization expense                      |   | (0.4   | )      |
| Higher restructuring and plant realignment costs                  |   | (0.7   | )      |
| Abandoned acquisition costs                                       |   | (0.2   | )      |
| Higher share-based compensation costs                             |   | (0.4   | )      |
| All other                                                         |   | (0.4   | )      |
| Operating income—three  months ended September 30, 2006 |   | $      | 10.1   |   |

 

Consolidated operating income was $10.1 millionin 2006 as compared to $12.8 million in 2005. The Company experiencedsales volume gains in the nonwovens markets partially offset by volume declinesin the oriented polymer markets, which contributed to improved operatingincome. However, the Company experienced higher raw material costs as rawmaterial costs continued to rise in the third quarter of fiscal 2006, whichwere only partially offset by price/mix improvements as the Company attemptedto pass along raw material cost increases that occurred during the quarter.Operating income was also negatively impacted by higher manufacturing costs,primarily in the Company’s Oriented Polymers Division. The net decline inoperating income was net of the favorable impact of foreign currency gains,which primarily relate to the strengthening of the Colombian and Mexican pesosagainst the U.S. dollar during the current quarter. The net decline inoperating income was negatively impacted by higher restructuring and plantrealignment costs and abandoned acquisition costs. For further details on suchcharges, see Note 3 to the Consolidated Financial Statements included inItem 1 of Part I to this Quarterly Report on Form 10-Q.

During the third quarter of fiscal 2006, restructuringand plant realignment costs are principally associated with (a) costsrelated to the relocation of the corporate headquarters to Charlotte, NorthCarolina in the amount of $0.5 million; and (b) continuing efforts todownsize certain Canadian operations resulting in severance costs of $0.3million. These plans are expected to result in reduced operating costs in thelast quarter of fiscal 2006 and throughout 2007.

Selling, general andadministrative expenses decreased $0.1 million, from $25.4 million in2005 to $25.3 million in 2006.

**Interest and OtherExpense**

Net interest expense decreased $0.7 million, from$8.2 million during the three months ended October 1, 2005 to$7.5 million during the three months ended September 30, 2006. Thedecrease in net interest expense was partially due to the lower interest ratesobtained by refinancing the Company’s long-term debt in November 2005.

Foreign currency and other loss,net for the third quarter of fiscal 2006 remained unchanged from the thirdquarter of fiscal 2005.

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**Income Tax Expense**

During the third quarter offiscal 2006, the Company recognized an income tax expense of $3.2 millionon consolidated pre-tax income of $1.6 million. The income tax expense issignificantly different than such expense determined at the U.S. federalstatutory rate primarily due to losses in the U.S. and certain foreignjurisdictions for which no income tax benefits were recognized. Additionally,the income tax expense was 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. TheCompany recognized income tax expense of $3.4 million for the three monthsended October 1, 2005 on consolidated income before income taxes of$3.6 million for such period. The income tax expense is higher than suchexpense determined at the U.S. federal statutory tax rate partially due to lossesin certain jurisdictions for which no income tax benefits were recognized.Additionally, the income tax expense is impacted by foreign withholding taxes,for which tax credits are not anticipated, U.S. state income taxes and foreigntaxes calculated at statutory rates less than the U.S. federal statutory rate.

**Net Income (Loss)**

As a result of the above, theCompany recognized a net loss of $1.5 million during the three monthsended September 30, 2006 compared to net income of $0.2 million duringthe three months ended October 1, 2005.

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

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 $17.7 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 throughthe date that the PIK Preferred Shares were redeemed for, or converted to,shares of the Company’s Class A Common Stock. As a result, total accruedand paid-in-kind dividends amounted to approximately $14.8 million in the thirdquarter of fiscal 2005. As a result of all of the PIK Preferred Shares beingredeemed for or converted to shares of the Company’s Class A Common Stockby September 15, 2005, no such dividends were recorded in the thirdquarter of 2006.

**Loss Applicable toCommon Shareholders**

As a result of the above, theCompany recognized a loss applicable to common shareholders of $1.5 million,or $0.08 per share, for the three months ended September 30, 2006 comparedto a loss applicable to common shareholders of $14.6 million, or $1.17 pershare, for the three months ended October 1, 2005.

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**Comparison of NineMonths Ended September 30, 2006 and October 1, 2005**

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 Item 1of Part I to this Quarterly Report on Form 10-Q. The followingtable sets forth components of the Company’s net sales and operating income(loss) by operating division for the nine months ended September 30, 2006,the nine months ended October 1, 2005 and the corresponding change(in millions):

| ** **                                 | ** ** | **Nine Months  Ended  September 30, 2006** | ** ** | **Nine Months  Ended  October 1, 2005** | ** ** | **Change** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------------------|------------|------------|------------|
| Net sales                                  |       |                                                      |       |                                                   |       |       |       |   |   |   |   |   |   |
| Nonwovens                                  |       |                                                      | $          | 624.4                                                  |       |       |       | $ | 572.4 |   |   |   | $ | 52.0 |   |   |
| Oriented Polymers                          |       |                                                      | 133.3      |                                                   |       |       | 136.0      |   |   |   | (2.7 | ) |   |
| Eliminations                               |       |                                                      | —     |                                                   |       |       | —     |   |   |   | — |   |   |
|                                       |       |                                                      | $          | 757.7                                                  |       |       |       | $ | 708.4 |   |   |   | $ | 49.3 |   |   |
| Operating income                           |       |                                                      |       |                                                   |       |       |       |   |   |   |   |   |   |
| Nonwovens                                  |       |                                                      | $          | 46.2                                                   |       |       |       | $ | 53.3 |   |   |   | $ | (7.1 | ) |   |
| Oriented Polymers                          |       |                                                      | 4.0        |                                                   |       |       | 9.6        |   |   |   | (5.6 | ) |   |
| Unallocated Corporate, net of eliminations |       |                                                      | (18.7      | )                                                      |       |       | (16.9      | ) |   |   | (1.8 | ) |   |
|                                       |       |                                                      | 31.5       |                                                   |       |       | 46.0       |   |   |   | (14.5 | ) |   |
| Asset impairment charges                   |       |                                                      | (7.9       | )                                                      |       |       | —     |   |   |   | (7.9 | ) |   |
| Restructuring and plant realignment costs  |       |                                                      | (5.1       | )                                                      |       |       | —     |   |   |   | (5.1 | ) |   |
| Abandoned acquisition costs                |       |                                                      | (3.8       | )                                                      |       |       | —     |   |   |   | (3.8 | ) |   |
| Foreign currency loss, net                 |       |                                                      | (1.8       | )                                                      |       |       | (0.7       | ) |   |   | (1.1 | ) |   |
|                                       |       |                                                      | $          | 12.9                                                   |       |       |       | $ | 45.3 |   |   |   | $ | (32.4 | ) |   |

 

The amounts for assetimpairment charges, restructuring and plant realignment costs, abandonedacquisition costs and foreign currency loss, net have not been allocated to theCompany’s reportable business divisions because the Company’s management doesnot evaluate such charges on a division-by-division basis. Division operatingperformance is measured and evaluated before such items.

**Net Sales**

Net saleswere $757.7 million in the first nine months of fiscal 2006, an increaseof $49.3 million, or 7.0%, over net sales for the comparable period of2005 of $708.4 million. Net sales for 2006 improved in the Nonwovens Divisionover comparable 2005 results by 9.1%, and net sales in 2006 in the OrientedPolymers Division decreased 2.0% over 2005 results. A reconciliation of thechange in net sales between the nine months ended October 1, 2005 and thenine months ended September 30, 2006 is presented in the following table(in millions):

| Net sales—nine months  ended October 1, 2005    |   | $      | 708.4  |   |
|-----------------------------------------------------------|--------|--------|--------|--------|
| Change in sales due  to:                                  |   |   |   |
| Volume                                                    |   | 27.0   |   |
| Price/mix                                                 |   | 20.7   |   |
| Foreign currency translation                              |   | 1.6    |   |
| Net sales—nine months ended September 30,  2006 |   | $      | 757.7  |   |

 

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The increase in net sales during the first nine monthsof 2006 was due primarily to volume gains and price/mix improvements.Substantially all of the volume gains occurred in the United States and LatinAmerican nonwovens markets. The price/mix improvement reflects continuedenhancements of the Company’s product offerings as well as the increases in salesprice in an effort to pass along raw material cost increases to customers. Asraw material costs have increased, the Company has attempted to pass rawmaterial costs along to its customers, where allowable by contract terms andwhere acceptable based on market conditions.

A significant component of the $27.0 millionincrease in sales in the first nine months of 2006 due to volume growth wasgenerated in the Latin American region with the addition of the spunmelt lineat the Cali, Colombia facility, which initiated operations in the fourthquarter of fiscal 2005. The Latin America region’s sales improvement was pacedby significant year-over-year increases in hygiene and industrial sales. In theCompany’s U.S. nonwovens business, the start-up of the new spunmelt facility atMooresville, North Carolina in the latter part of the second quarter of fiscal2006 and improvements in the hygiene and consumer markets contributed to theincrease from 2005. The Company believes that the volume growth achieved wasmitigated by reduced purchases by certain customers, primarily during thesecond quarter of fiscal 2006, in response to inventory reduction programs atcertain retail establishments. Nonwovens sales volumes also increased in Europeand Asia, with most of Asia’s increase due to the initial shipments from theCompany’s new spunmelt facility in Suzhou, China, which initiated operations inthe latter part of the third quarter of fiscal 2006. Oriented Polymers’ netsales for 2006 decreased $2.7 million from the 2005 amount, as improvements inprice/mix of sales of $6.4 million and a favorable foreign currency translationimpact were more than offset by sales volume declines affecting net sales by$13.6 million. Oriented Polymers’ sales volumes have been negatively impactedin fiscal 2006 by reduced housing starts affecting their industrial business,imported commodity products affecting, primarily, lumberwrap volumes andreduced agricultural sales.

The Euro was weaker againstthe U.S. dollar during the first nine months of 2006 compared to 2005, butthe Canadian dollar strengthened against the U.S. dollar during the period. Asa result, net sales increased $1.6 million due to the foreign currencytranslation. Further discussion of foreign currency exchange rate risk iscontained in “Quantitative and Qualitative Disclosures About Market Risk”included in Item 3 of Part I to this Quarterly Report on Form 10-Q.

**Gross Margin**

Gross margin in the first nine months of 2006 declinedto 15.1% from 17.6% in the first nine months of 2005, despite improved salesvolumes and product mix, primarily due to the impact of the higher rawmaterials as a percentage of net sales, the effect of raw material costincreases which were not able to be passed along to the customer and otherincreased manufacturing costs including depreciation, during 2006. The rawmaterial component of the cost of goods sold as a percentage of net salesincreased from 50.8% in 2005 to 53.6% in 2006.

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**Operating Income**

Areconciliation of the change in operating income between the nine months ended October 1,2005 and the nine months ended September 30, 2006 is presented in thefollowing table (in millions):

| Operating income—nine  months ended October 1, 2005    |   | $      | 45.3   |   |
|------------------------------------------------------------------|--------|--------|--------|--------|
| Change in operating income due to:                               |   |   |   |
| Price/mix                                                        |   | 20.7   |   |
| Higher raw material costs                                        |   | (26.6  | )      |
| Volume                                                           |   | 9.6    |   |
| Higher manufacturing costs                                       |   | (9.5   | )      |
| Foreign currency                                                 |   | (1.1   | )      |
| Higher depreciation and amortization expense                     |   | (2.6   | )      |
| Asset impairment charges                                         |   | (7.9   | )      |
| Higher restructuring and plant realignment costs                 |   | (5.1   | )      |
| Abandoned acquisition costs                                      |   | (3.8   | )      |
| Higher share-based compensation costs                            |   | (3.3   | )      |
| All other, primarily higher SG&A costs                       |   | (2.8   | )      |
| Operating income—nine months  ended September 30, 2006 |   | $      | 12.9   |   |

 

Consolidated operating income was $12.9 millionin 2006 as compared to $45.3 million in 2005. The Company experiencedhigher raw material costs that were partially offset by price/mix improvements.Operating income was positively impacted by the volume gains in the nonwovensmarkets partially offset by volume declines in the oriented polymers markets,as noted above in the discussion of net sales. The net decline in operatingincome was impacted by higher non-cash compensation costs of $3.3 millionattributable to share-based awards made primarily under the Company’s restrictedstock plans. Other items contributing to the decline in operating income werehigher manufacturing costs, primarily in the Company’s Oriented PolymersDivision, and higher depreciation and amortization charges. The increase indepreciation and amortization charges is primarily related to the installation andstart-up of the new spunmelt production facilities in Latin America and theUnited States. The net decline in operating income was significantly impactedby asset impairment charges, higher restructuring and plant realignment costs,abandoned acquisition costs and foreign currency losses. For further details onsuch charges, see Note 3 to the Consolidated Financial Statements includedin Item 1 of Part I to this Quarterly Report on Form 10-Q.

During the nine months ended September 30, 2006,the Company recognized a charge of $7.9 million associated with the write-downof assets in certain of its Canadian and European operations. Throughout fiscal2006, the Company experienced a continued weakening of earnings and cash flowsin certain of its Canadian operations and evaluated such assets for impairment.Such evaluation resulted in a non-cash charge associated with the write-down ofsuch assets to estimated fair value in the amount of approximately $5.6million. Also, as a result of initiating the Company’s European restructuringand consolidation strategies the Company announced its plans to shut-down itsfacilities in Sweden, with the production of fabric to be consolidated in otherEuropean facilities. This resulted in a non-cash charge of approximately $2.3million associated with the planned disposal of these assets.

The 2006 restructuring and plant realignment costs areprincipally associated with (a) the Company’s restructuring andconsolidation plan for Europe, which included termination benefits provided toan executive officer of the Company, pursuant to Dutch law, in the amount of$2.1 million, costs associated with the planned closure of the Sweden plant andother European consolidation efforts of $0.2 million; (b) costs related tothe relocation of the corporate headquarters to Charlotte, North Carolina inthe amount of $2.3 million; and (c) downsizing certain Canadian operationsresulting 

39

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in severance costs of $0.5million. The plans are expected to result in reduced operating costs in thelast quarter of fiscal 2006 and throughout fiscal 2007.

During the first five months of fiscal 2006, theCompany actively pursued a potential acquisition. In conjunction with thiseffort, the Company incurred approximately $3.8 million of costs, which areprimarily comprised of third-party professional fees. During the second quarterof fiscal 2006, the negotiations with respect to the potential acquisitionreached an impasse and the Company abandoned its efforts to consummate theacquisition. Accordingly, costs of $3.7 million and $0.1 million with respectto the abandoned acquisition were charged to *Abandonedacquisition costs* in the Consolidated Statements of Operations inthe second quarter of fiscal 2006 and the third quarter of fiscal 2006,respectively.

Selling, general andadministrative expenses increased $4.5 million, from $78.8 million in2005 to $83.3 million in 2006, primarily due to the non-cash compensationcosts related to the share-based awards made under the Company’s restrictedstock plans, as well as increased costs due to higher sales volumes, with suchincreased costs partially offset by reduced bonus incentive compensation.Effective January 1, 2006, the Company has elected the modifiedprospective transition method of accounting for share-based awards inaccordance with the provisions of SFAS No. 123(R). Adoption of SFAS No. 123(R) hasresulted in marginally lower compensation costs, with respect to stock options,than previously recognized by the Company under the intrinsic value method asprescribed by APB Opinion No. 25.

**Interest and OtherExpense**

Net interest expense decreased $3.1 million, from$24.2 million during the nine months ended October 1, 2005 to$21.1 million during the nine months ended September 30, 2006. Thedecrease in net interest expense was primarily due to the lower interest ratesobtained by refinancing the Company’s long-term debt in November 2005.Additionally, during the first nine months of 2006, the Company capitalized,with respect to its major capital expenditure projects, interest in the amountof $3.0 million, compared to $1.3 million in the first nine months of2005.

Foreign currency and other(gain) loss, net changed by $1.8 million, from a gain of $0.7 millionin the first nine months of fiscal 2005 to a loss of $1.1 million in thefirst nine months of fiscal 2006. The change was primarily due to foreigncurrency movements on intercompany loan balances, at certain of the Company’sinternational operations, denominated in currencies other than their functionalcurrency, generally the U.S. dollar.

**Income Tax Expense**

During the nine months ended September 30,2006, the Company recognized an income tax expense of $3.7 million on aconsolidated pre-tax loss of $12.0 million. The income tax expense issignificantly different than such expense determined at the U.S. federalstatutory rate primarily due to losses in the U.S. and certain foreignjurisdictions for which no income tax benefits were recognized. Additionally,the income tax expense was 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. TheCompany recognized income tax expense of $9.3 million for the nine monthsended October 1, 2005 on consolidated income before income taxes of$18.7 million for such period. The tax expense is significantly higherthan such expense determined at the U.S. federal statutory tax rate primarilydue to losses in the U.S. and certain foreign tax jurisdictions for which notax benefits were recognized. Additionally, the income tax expense is impactedby foreign withholding taxes, for which tax credits are not anticipated, U.S.state income taxes and foreign taxes calculated at statutory rates less thanthe U.S. federal statutory rate.

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**Net Income (Loss)**

As a result of the above, theCompany recognized a net loss of $15.7 million during the nine monthsended September 30, 2006 compared to net income of $9.4 millionduring the nine months ended October 1, 2005.

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

The Company accrued dividendsat 16% on its PIK Preferred Shares during the quarter ended April 2, 2005in the amount of $2.4 million. Additionally, on January 14, 2005, theCompany’s Board of Directors declared that dividends accrued on the PIKPreferred Shares from the date of issuance through December 31, 2004, inthe amount of $5.6 million, would be paid in the form of PIK PreferredShares. The Company recorded the value of the additional PIK Preferred Sharesdeclared as a dividend on January 14, 2005, the date the Board ofDirectors declared that the accrued dividends were to be paid in the form ofadditional PIK Preferred Shares, rather than cash, reduced by the amount ofdividends previously recorded at the stated 16.0% rate. Using the estimatedmarket value of the Company’s Class A Common Stock of $18.50 per share,the fair value of the 5,540 additional PIK Preferred Shares issued in lieu ofcash payment was approximately $14.1 million, which exceeded the amountpreviously accrued by the Company of $5.6 million, based on the statedrate of 16.0%, by approximately $8.5 million. The Company accrueddividends at 16% on its PIK Preferred Shares during the quarter ended July 2,2005 in the amount of $2.4 million. On August 3, 2005, the Company’sBoard of Directors declared that dividends accrued on the PIK Preferred Sharesfrom January 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 throughthe date that the PIK Preferred Shares were redeemed for, or converted to,shares of the Company’s Class A Common Stock. Accordingly, total accruedand paid-in-kind dividends amounted to $28.0 million in the first ninemonths of fiscal 2005. As a result of all of the PIK Preferred Shares beingredeemed for or converted to shares of the Company’s Class A Common Stockby September 15, 2005, no such dividends were recorded in the first ninemonths of 2006.

**Loss Applicable toCommon Shareholders**

As a result of the above, theCompany recognized a loss applicable to common shareholders of $15.7 million,or $0.81 per share, for the nine months ended September 30, 2006 comparedto a loss applicable to common shareholders of $18.6 million, or $1.67 pershare, for the nine months ended October 1, 2005.

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**LIQUIDITY AND CAPITALRESOURCES**

The Company’s principalsources of liquidity for operations and expansions are funds generated fromoperations and borrowing availabilities under the Credit Facility, consistingof a revolving credit facility with aggregate commitments of $45.0 millionand a first-lien term loan of $410.0 million. The revolving credit portionof the Credit Facility terminates on November 22, 2010 and the remainingbalance (after mandatory annual payments of $4.1 million and additionalpayments, if any, under the excess cash flow provision of the Credit Facility)of the first-lien term loan is due November 22, 2012. The Credit Facilitycontains covenants and events of default customary for financings of this type,including leverage and interest expense coverage covenants. For furtherdiscussion of the terms of the Credit Facility, the Company’s currentcompliance and the Company’s ability to remain in compliance in future periodspursuant to the covenant requirements contained in such agreements, see“Liquidity Summary” below. As of September 30, 2006, the Company had$6.5 million of outstanding borrowings under the revolving creditfacility, and capacity under the revolving credit facility had been reservedfor outstanding letters of credit in the amount of $7.1 million.

| ** **                       | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(In Millions)**       | ** ** |
| **Balance  sheet data:**         | ** ** |                         | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| Cash and cash equivalents        |       |                         | $          | 16.5                        | ** ** |   |   | $ | 31.0 | ** ** |   |
| Working capital                  |       |                         | 162.4      | ** **                  |       |   | 173.4 | ** ** |   |
| Total assets                     |       |                         | 788.3      | ** **                  |       |   | 765.0 | ** ** |   |
| Total debt                       |       |                         | 421.4      | ** **                  |       |   | 415.2 | ** ** |   |
| Total shareholders’  equity |       |                         | 128.1      | ** **                  |       |   | 131.5 | ** ** |   |
|                                  |            |                              |            |                             |            |  |  |  |  |  |  |

 

| ** **                                           | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                           | ** ** | **September 30,  2006**    | ** ** | **October 1,        2005** | ** ** |
| ** **                                           | ** ** | **(In Millions)**          | ** ** |
| **Cash  flow data:**                                 | ** ** |                            | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net cash provided by operating activities            |       |                            | $          | 36.5 |   |   |   | $ | 47.1 |   |   |
| Net cash used in investing activities                |       |                            | (61.0      | ) |   |   | (56.5 | ) |   |
| Net cash provided by  (used in) financing activities |       |                            | 9.7        |   |   |   | (3.6 | ) |   |
|                                                      |            |                                 |            |  |  |  |  |  |  |  |  |

 

**Operating Activities**

Net cash provided by operating activities was $36.5 millionduring 2006, a $10.6 million decrease from the $47.1 million providedby operating activities during 2005. The decrease in cash provided by operatingactivities was primarily attributable to the Company’s reduced gross profitgenerated from sales activities and the cash costs incurred related to therestructuring and plant realignment and the abandoned acquisition costs duringthe first nine months of fiscal 2006 versus the comparable period of 2005. Forfurther details on such charges, see Note 3 to the Consolidated Financial Statementsincluded in Item 1 of Part 1 to this Quarterly Report on Form 10-Q.

The Company had working capital of approximately $162.4 millionat September 30, 2006 compared with $173.4 million at December 31,2005. Accounts receivable at September 30, 2006 was $129.3 million ascompared to $120.7 million at December 31, 2005, an increase of$8.6 million. Accounts receivable represented approximately 47 days ofsales outstanding at September 30, 2006, compared to 46 days of sales at December 31,2005. Inventories at September 30, 2006 were $130.2 million, anincrease of $10.5 million from inventories at December 31, 2005 of$119.7 million. The Company had inventory representing approximately 55days of cost of sales on hand at September 30, 2006, compared to54 days of cost of sales on hand at December 31, 2005. Accountspayable at September 30, 2006 was $92.4 million as compared to$82.4 million at December 31, 2005, 

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an increase of$10.0 million. Accounts payable represented approximately 39 days of costof sales outstanding at September 30, 2006 compared to 37 days ofcost of sales outstanding at December 31, 2005. The dollar increases inaccounts receivable, inventories and accounts payable in 2006 versus 2005 wereprimarily related to the increases in raw material costs and sales volumes.

The Company’s restructuringand plant realignment activities are discussed in Note 3 “BusinessRestructuring” to the Consolidated Financial Statements included in Item 1 of Part Ito this Quarterly Report on Form 10-Q. The 2006 restructuring and plant realignmentcosts are principally associated with (a) the Company’s restructuring andconsolidation plan for Europe, which included termination benefits provided toan executive officer of the Company, pursuant to Dutch law, in the amount of$2.1 million and costs associated with the planned closure of the Sweden plant andother European consolidation efforts of $0.2 million; (b) costs related tothe relocation of the corporate headquarters to Charlotte, North Carolina inthe amount of $2.3 million; and (c) downsizing certain Canadian operationsresulting in severance costs of $0.5 million. Additionally, during thefirst fiscal quarter of 2006, as part of its restructuring and related costreduction measures, the Company negotiated certain changes with the unionrepresenting the employees of one of the Company’s Canadian operations,including a partial curtailment of a defined benefit pension plan. No net gainor loss has been incurred as a result of the partial curtailment. However,based on elections made by plan participants during the second quarter offiscal 2006, and subject to approval by Canadian regulatory authorities, theCompany may incur a settlement loss associated with employees who have electedto exit the plan. Any loss associated with the partial settlement of thedefined benefit pension plan will be recognized at such time as the settlementoccurs, which is dependent upon governmental approval and upon fulfillment bythe Company of its funding requirements associated with the future settlement.On a proforma basis, had such partial settlement occurred as of June 1,2006, the date of the latest actuarial estimate, the Company estimates that asettlement loss would have been incurred in the amount of approximately$3.7 million as of that date. The Company currently estimates that fundingrequired in connection with the partial settlement will approximate $2.5million.

**Investing and FinancingActivities**

Cash used for investing activities amounted to$61.0 million and $56.5 million in the first nine months of 2006 and2005, respectively. Capital expenditures during 2006 totaled$63.3 million, an increase of $6.4 million from capital spending of$56.9 million in 2005. A significant portion of the capital expendituresin 2006 related to the construction of new spunmelt manufacturing facilities inSuzhou, China and Mooresville, North Carolina. In addition, investingactivities during 2006 and 2005 included proceeds from the sale of assets of$2.7 million and $0.4 million, respectively.

Cash provided by financingactivities amounted to $9.7 million in the first nine months of 2006,compared to $3.6 million of cash used in financing activities in the firstnine months of 2005. In 2006, the Company borrowed, on a net basis,$6.2 million of debt whereas the Company repaid, on a net basis,$3.6 million of debt during 2005. Additionally, during the first ninemonths of 2006 the Company received an advance of $3.8 million from anequipment supplier, which proceeds have been designated for specific futurecapital projects. See Note 18 “Settlement Agreements” to the ConsolidatedFinancial Statements included in in Item 1 of Part I to this QuarterlyReport on Form 10-Q for additional information on the advance fromthe supplier.

**Dividends**

The Board of Directors has not declared a dividend onthe Company’s common stock since the first quarter of 2001. The Credit Facilitylimits restricted payments to $5.0 million, including cash dividends, inthe aggregate since the effective date of the Credit Facility. The Company doesnot currently anticipate paying dividends on its common stock in futureperiods.

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On January 14, 2005, theCompany’s Board of Directors declared that dividends accrued on the PIKPreferred Shares from the date of issuance through December 31, 2004, inthe amount of $5.6 million, would be paid in the form of PIK PreferredShares. The Company recorded the value of the additional PIK Preferred Sharesdeclared as a dividend on January 14, 2005, the date the Board ofDirectors declared that the accrued dividends were to be paid in the form ofadditional PIK Preferred Shares, rather than cash, reduced by the amount ofdividends previously recorded at the stated 16.0% rate. Using the estimatedmarket value of the Company’s Class A Common Stock of $18.50 per share,the fair value of the 5,540 additional PIK Preferred Shares issued in lieu ofcash payment was approximately $14.1 million, which exceeded the amountpreviously accrued by the Company of $5.6 million, based on the statedrate of 16.0%, by approximately $8.5 million. The Company accrueddividends at 16% on its PIK Preferred Shares during the quarter endedJuly 2, 2005 in the amount of $2.4 million. On August 3, 2005,the Company’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 $17.7 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 throughthe date that the PIK Preferred Shares were redeemed for, or converted to,shares of the Company’s Class A Common Stock, as described below. As a result,total accrued and paid-in-kind dividends amounted to approximately$28.0 million in the first nine months of fiscal 2005. However, as all PIKPreferred Shares were redeemed for or converted to shares of the Company’sClass A Common Stock by September 15, 2005, no further dividends onthe PIK Preferred Shares will be paid.

**Liquidity Summary**

As discussed more fully in Note 7 to theConsolidated Financial Statements included in Item 1 of Part I to thisQuarterly Report on Form 10-Q, on November 22, 2005, theCompany refinanced its then existing bank facility with a new Credit Facilityconsisting of a $45.0 million secured revolving credit facility maturingin 2010 and a $410.0 million first-lien term loan maturing in 2012. Theproceeds therefrom were used to fully repay indebtedness outstanding under theCompany’s previous bank facility and pay related fees and expenses.

All borrowings under the Credit Facility areU.S. dollar denominated and are guaranteed, on a joint and several basis,by each and all of the direct and indirect domestic subsidiaries of theCompany. The Credit Facility and the related guarantees are secured by(i) a lien on substantially all of the assets of the Company, its domesticsubsidiaries and certain of its non-domestic subsidiaries, (ii) a pledgeof all or a portion of the stock of the domestic subsidiaries of the Companyand of certain non-domestic subsidiaries of the Company, and (iii) apledge of certain secured intercompany notes. Commitment fees under the CreditFacility are equal to 0.50% of the daily unused amount of the revolving creditcommitment. The Credit Facility limits restricted payments to$5.0 million, including cash dividends, in the aggregate since theeffective date of the Credit Facility. The Credit Facility contains covenantsand events of default customary for financings of this type, including leverageand interest expense coverage covenants. The Company was in compliance with thedebt covenants under the current Credit Facility at September 30, 2006. However,effective with the end of the fiscal quarter ending December 30, 2006, theleverage ratio requirement, as defined in the Credit Facility, steps down andbecomes more restrictive than the current requirement. Because of thelower-than-expected level of performance, combined with the significant dollarsexpended on the capital 

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programs, the restructuringand plant realignment initiatives and the abandoned acquisition, the Companyexpects increased pressure on the Company’s ability to remain in compliancewith the leverage ratio requirement for future periods. While the Companyexpects improved operating performance in the fourth quarter of fiscal 2006 andto efficiently manage debt levels at the fiscal year-end, compliance with theleverage ratio requirement as of December 30, 2006 is not assured. TheCompany’s current estimate of the leverage ratio as of December 30, 2006approximates the minimum requirement to meet the leverage ratio required underthe Credit Facility as of that date without the existence of significant marginfor variance as has been the case in prior periods. As such, the Companyintends to approach its lending group to seek an amendment to certain definitionsand covenant levels in its Credit Agreement to provide additional financialflexibility and mitigate the risk of potential default in future periods.

The first-lien term loan requires mandatory paymentsof approximately $1.0 million per quarter and, beginning with fiscal 2006,the first-lien term loan requires the Company to use a percentage of proceedsfrom excess cash flows, as defined by the Credit Facility, and determined basedon year-end results, to reduce its then outstanding balances under the CreditFacility. Excess cash flows required to be applied to the repayment of theCredit Facility are generally calculated as 50.0% of the net amount 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 to be appliedto the repayment of debt in future periods are based on year-end results andnot determinable, only the mandatory payments of approximately$1.0 million per quarter have been classified as a current liability inthe Consolidated Balance Sheet included in Item 1 of Part I to thisQuarterly Report on Form 10-Q. Additionally, no excess cash flowpayment was required to be made with respect to fiscal 2005 due to themagnitude of the major capital expenditure projects and any excess cash flowrequirement with respect to fiscal 2006 is not expected to be significant.

The interest rate applicable to borrowings under theCredit Facility is based on three-month London Interbank Offered Rate (“LIBOR”)plus a specified margin. The applicable margin for borrowings under both thefirst-lien term loan and the revolving credit facility is 225 basispoints. The Company may, from time to time, elect to use an alternate base ratefor its borrowings under the revolving credit facility based on the bank’s baserate plus a margin of 75 to 125 basis points based on the Company’s totalleverage ratio. The Company had $6.5 million of outstanding borrowings atSeptember 30, 2006 under the revolving credit facility. As ofSeptember 30, 2006, capacity under the revolving credit facility had beenreserved for outstanding letters of credit in the amount of $7.1 million.None of these letters of credit have been drawn on at September 30, 2006.Average daily borrowings under the revolving credit facility, which werelargely LIBOR-based borrowings, for the period of January 1, 2006 toSeptember 30, 2006 were $19.9 million at an average rate of 7.64%.

Additionally, in accordance with the terms of theCredit Facility, the Company has maintained a position in 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 has been maintained in accordance with the terms ofthe Credit Facility and it terminates on May 8, 2007.

The Credit Facility entered into during November 2005provided the Company the ability to increase the sale of U.S. basedreceivables and non-U.S. based receivables, under factoring agreements, to$20.0 million and $20.0 million, respectively. Accordingly, theCompany has entered into factoring agreements to sell without recourse, certainU.S. and non-U.S. company-based receivables to unrelated third-party financialinstitutions. Under the terms of the factoring agreement related to the sale ofU.S. company-based receivables, the maximum amount of outstanding advances atany one time is $20.0 million, which limitation is subject to change basedon the level of eligible receivables, restrictions on concentrations ofreceivables and the historical performance of the 

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receivables sold. Under theterms of the factoring agreement related to the sale of non-U.S. company-basedreceivables, the maximum amount of outstanding advances at any one time is$10.0 million, which limitation is subject to change based on the level ofeligible receivables, restrictions on concentrations of receivables and thehistorical performance of the receivables sold. The sale of these receivablesaccelerated the collection of the Company’s cash, reduced credit exposure andlowered the Company’s net borrowing costs.

In June 2006, one of the Company’s subsidiaries,Fabpro Oriented Polymers, Inc. (“Fabpro”) entered into an asset purchaseagreement relating to the sale of certain assets for $2.3 million and asupply and marketing rights agreement (“supply agreement”) with an unrelatedthird party. Under the terms of the supply agreement, which has an initial termof 10 years, Fabpro has committed to purchase a minimum level of product (asdefined in the supply agreement), representing approximately $7.1 millionper year, based on current sales prices, through the year 2012. In the eventthat Fabpro does not purchase such minimum quantities, Fabpro will be obligatedto pay a 12.5% penalty on the value of the committed amounts not purchased,based on sales prices in effect at that time.

The Company continues to evaluate opportunities toconsolidate operations, primarily in the more mature markets of the U.S. andEurope, in an effort to improve the profitability of certain of the Company’solder assets. Such consolidation efforts, if and when approved by the Company,could result in material non-cash charges for the write-offs of assets notretained in the operations. Also, such consolidation efforts could includematerial cash costs related to such restructuring activities.

As discussed in Note 16 to the ConsolidatedFinancial Statements included in Item 1 of Part I to this Quarterly Reporton Form 10-Q,the Company on October 19, 2006 announced that it had made furthercommitments to expand its worldwide capacity through the installation of a newspunmelt line at the joint venture facility near Buenos Aires, Argentina.

The Company relies on itsability to generate positive cash flows from its operations and the financialflexibility provided by the Credit Facility to meet its operating needs, fundits capital expenditures and make all necessary contributions to its retirementplans. In the event that the Company is able to maintain compliance with itsdebt covenants, as described above, the Company believes that such sources offunds are sufficient to meet its long-term needs.

**Off-Balance SheetArrangements**

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 of operationswas minimal during the first nine months of both 2006 and 2005. However, theCompany continues to be impacted significantly by raw material costs. See “Quantitativeand Qualitative Disclosures About Market Risk” included in Item 3 of Part Ito this Quarterly Report on Form 10-Q.

**New AccountingStandards**

In November 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 151, “Inventory Costs” (“SFAS No. 151”). This statement amendsearlier guidance to require that abnormal freight, handling and spoilage costsbe recognized as current-period charges rather than capitalized as aninventory cost. In addition, SFAS No. 151 requires that the allocation offixed production overhead costs be based on the normal capacity of theproduction facilities. SFAS No. 151 is effective for inventory costsincurred during fiscal 

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years beginning after June 15,2005. The Company has adopted the provisions of SFAS No. 151 effective January 1,2006 and the impact has not been significant to its financial position orresults of operations.

In December 2004, the FASB issued a revision toSFAS No. 123, “Accounting for Stock-Based Compensation.” The revision,entitled SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”),is effective for all awards granted, modified, repurchased or canceled after June 15,2005 and requires a public entity to measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award. The grant date fair value is to be estimated usingoption-pricing models adjusted for the unique characteristics of thoseinstruments. In April 2005, the Securities and Exchange Commission issueda final rule that registrants must adopt SFAS No. 123(R)’s fair valuemethod of accounting no later than the beginning of the fiscal year beginningafter June 15, 2005. Accordingly, the Company adopted SFAS No. 123(R) asof January 1, 2006 using the modified prospective transition method. Thegrant date fair value was estimated using the Black-Scholes model. Under themodified prospective transition method, all new grants and any unvested portionof prior awards as of January 1, 2006 have been measured based on thefair-value-based method of accounting. The impact of adopting SFAS No. 123(R) hasresulted in marginally lower compensation costs than previously recognizedunder the Company’s historically-used accounting principles. The proformaeffect of utilizing SFAS No. 123(R) on the financial results for thethree and nine months ended October 1, 2005 is disclosed in Note 1 to theConsolidated Financial Statements included in Item 1 of Part I tothis Quarterly Report on Form 10-Q.

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections” (“SFAS No. 154”). This statement amendsearlier guidance and requires retrospective application to prior periods’financial statements of a voluntary change in accounting principle unless it isimpracticable to determine either the period-specific effects or the cumulativeeffects of the change. In addition, SFAS No. 154 requires that a change inthe method of depreciation or amortization for a long-lived, non-financialasset be accounted for as a change in accounting estimate that is affected by achange in accounting principle. SFAS No. 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005. The Company has completed its evaluation of the impact that the adoptionof SFAS No. 154 could have and has concluded that such impact is not significantto its financial position or results of operations.

In July 2006, the FASB issued FASB InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes, an interpretation ofFASB Statement No. 109, Accounting for Income Taxes” (“FIN 48”). FIN 48clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements. This standard prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken, or expected to be taken, in a tax return.FIN 48 also provides guidance on other tax-related issues and is effective forfiscal years beginning after December 15, 2006. The Company is currentlyanalyzing the new guidance.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements” (“SFAS No. 157”). This statement applies, withcertain exceptions, to other accounting pronouncements that either require orpermit fair value measurements. This standard creates a fair value hierarchywith assigns types of inputs to each level within the hierarchy. SFAS No. 157also provides guidance for an expanded set of disclosure requirements relatedto fair value and is effective for fiscal years beginning after November 15,2007. The Company is currently analyzing the new guidance.

In September 2006, theFASB issued SFAS No. 158, “Employers’ Accounting for Defined BenefitPension and Other Retirement Plans: an amendment of FASB Statements No. 87,88, 106 and 132(R)” (“SFAS No. 158”). SFAS No. 158 requires employersto recognize the funded status of defined benefit postretirement plans in theConsolidated Balance Sheets, with changes in the plan’s funded statusrecognized as an element of other comprehensive income. This standard alsorequires that the 

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measurementof a plan’s funded status be as of the date of the employers’ balance sheet.SFAS No. 158 also amends certain of the previous disclosure requirementsrelated to these plans and is effective for fiscal years ending after December 15,2006. The Company does not expect the new guidance to have a significant impacton its financial position or results of operations.

**Critical AccountingPolicies 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, including the effects of sales returns andallowances and credit risks, convertible securities, inventories, income taxes,and impairment of long-lived assets. Estimates and assumptions are based onhistorical and other factors believed to be reasonable under the circumstances.The impact and any associated risks related to estimates, assumptions, andaccounting policies are discussed within “Management’s Discussion and Analysisof Operations and Financial Condition,” as well as in the Notes to theConsolidated Financial Statements, if applicable, where such estimates,assumptions, and accounting policies affect the Company’s reported and expectedresults.

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:*   In connection with the Company’sChapter 11 reorganization, the Company has applied fresh start accountingto its Consolidated Balance Sheet as of March 1, 2003 in accordance withStatement of Position No. 90-7, “Financial Reporting by Entities inReorganization Under the Bankruptcy Code” as promulgated by the AICPA. Underfresh start accounting, a new reporting entity is considered to be created andthe recorded amounts of assets and liabilities are adjusted to reflect theirestimated fair values at the date fresh start accounting is applied. On March 5,2003, the Company emerged from bankruptcy. For financial reporting purposes, March 1,2003 is considered the emergence date and the effects of the reorganizationhave been reflected in the accompanying financial statements as if theemergence occurred on that date.

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 amounts included in the Consolidated FinancialStatements. Based on the consideration of many factors and various valuationmethods, the Company and its financial advisors determined the reorganizationvalue of the Company to be approximately $73.4 million, as described inthe Modified Plan. The factors and valuation methodologies included the reviewof comparable company market valuations and the recent acquisition values ofcomparable company transactions as well as discounted cash flow models. Thediscounted cash flow models utilized projected free cash flows for four futureyears, with such projected free cash flows discounted at rates approximatingthe expected weighted average cost of capital (11.0% to 13.0%) plus the presentvalue of the Company’s terminal value computed using comparable company exitmultiples. Projected free cash flows were estimated based on projected cashflows from operations, adjusted for the effects of income taxes at an effectiverate of 39.0%, estimated capital expenditures and estimated changes in workingcapital. The calculation of reorganization value of the Company was based on avariety of estimates and 

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assumptions about futurecircumstances and events. Such estimates and assumptions are inherently subjectto significant economic uncertainties. While the Company believes itsjudgments, estimates and valuation methodologies were reasonable, different assumptionscould have materially changed the estimated reorganization value of the Companyas of March 1, 2003.

*RevenueRecognition:*   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. Management bases its estimate of the expense to be recorded eachperiod on historical returns and allowance levels. Management does not believethe likelihood is significant that materially higher deduction levels willresult based on prior experience.

*AccountsReceivable and Concentration of Credit Risks:*   Accountsreceivable potentially expose the Company to a concentration of credit risk, asdefined by Statement of Financial Accounting Standards No. 105, “Disclosureof Information about Financial Instruments with Off-Balance Sheet Risk andFinancial Instruments with Concentration of Credit Risk.” The Company providescredit in the normal course of business and performs ongoing credit evaluationson its customers’ financial condition as deemed necessary, but generally doesnot require collateral to support such receivables. The Company alsoestablishes an allowance for doubtful accounts based upon factors surroundingthe credit risk of specific customers, historical trends and other information.Also, in an effort to reduce its credit exposure to certain customers, as wellas accelerate its cash flows, the Company, beginning in 2004, sold, on a non-recoursebasis, certain of its receivables pursuant to factoring agreements. At September 30,2006, a reserve of $7.7 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 losses could differ significantly from these estimates.

*ConvertibleSecurities:*   The Company recorded the accretionof dividends on the PIK Preferred Shares based on the stated rate of 16.0%. Ifthe Company’s Board of Directors, at the date of any dividend declaration,elected to satisfy the dividend obligation by payment-in-kind, the Companyrecognized an additional dividend charge for the excess, if any, of the fairvalue of the additional PIK Preferred Shares issued, at the dividenddeclaration date, over the amounts previously accrued at the stated rate. Asthe Company’s PIK Preferred Shares were not traded on an active market,determination of the fair value of the securities, at the date of dividenddeclaration, required estimates and judgments, which may have impacted thevaluation of the dividend paid-in-kind. Based on the fact that thePIK Preferred Shares were deep-in-the money, the Company estimated the fairvalue of the PIK Preferred Shares using the number of shares of the Company’s Class ACommon Stock into which the PIK Preferred Shares were convertible at thethen-current share price of the Company’s Class A Common Stock. While theCompany believes its estimates of the fair value of the PIK Preferred Sharesare reasonable, the utilization of different assumptions could producematerially different fair value estimates.

*InventoryReserves:*   The Company maintains reserves forinventories valued using the first in, first out (FIFO) method. Such reservesfor inventories can be specific to certain inventory or general based onjudgments about the overall condition of the inventory. General reserves areestablished based on percentage write-downs applied to inventories agedfor certain time periods, or for inventories that are slow-moving. Specificreserves are established based on a determination of the obsolescence of theinventory and whether the inventory value exceeds amounts to be recoveredthrough the expected sales price of such inventories, less selling costs.Estimating sales prices, 

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establishing markdown percentages and evaluating thecondition of the inventories require judgments and estimates, which may impactthe inventory valuation and gross profits. The actual amount of obsolete orunmarketable inventory has been materially consistent with previouslyestablished reserves. Management believes, based on its prior experience ofmanaging and evaluating the recoverability of its slow moving or obsoleteinventory, that such established reserves are materially adequate. If actualmarket conditions and product sales were less favorable than we have projected,additional inventory writedowns may be necessary.

*IncomeTaxes:*   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 certain foreign subsidiariesthat are considered to be retained indefinitely for reinvestment. Certainjudgments, 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 orbenefit recognized in the Company’s Consolidated Financial Statements.

*Impairmentof Long-Lived Assets:*   Long-lived assets,excluding goodwill, are reviewed for impairment whenever events or changes incircumstances indicate that the carrying amounts may not be recoverable.Goodwill is reviewed annually. For assets held and used, an impairment mayoccur if projected undiscounted cash flows are not adequate to cover thecarrying value of the assets. In such cases, additional analysis is conductedto determine the amount of the loss to be recognized. The impairment loss isdetermined by the difference between the carrying amount of the asset and thefair value measured by future discounted cash flows. The analysis, whenconducted, requires estimates of the amount and timing of projected cash flowsand, where applicable, judgments associated with, among other factors, theappropriate discount rate. Such estimates are critical in determining whetherany impairment charge should be recorded and the amount of such charge if animpairment loss is deemed to be necessary. In addition, future events impactingcash flows for existing assets could render a writedown necessary thatpreviously required no writedown.

For assets held for disposal, an impairment charge isrecognized if the carrying value of the assets exceeds the fair value lesscosts to sell. Estimates are required of fair value, disposal costs and thetime period to dispose of the assets. Such estimates are critical indetermining whether any impairment charge should be recorded and the amount ofsuch charge if an impairment loss is deemed to be necessary. Actual cash flowsreceived or paid could differ from those used in estimating the impairmentloss, which would impact the impairment charge ultimately recognized. As of September 30,2006, based on the Company’s current operating performance, as well as futureexpectations for the business, the Company does not anticipate any materialwritedowns for long-lived asset impairments, including goodwill, in theforeseeable future. However, should current conditions deteriorate, this mayimpact our future cash flow estimates, resulting in an impairment charge thatcould have a material effect on the Company’s Consolidated FinancialStatements.

Additionally, the Company continues to evaluateopportunities to consolidate operations, primarily in the more mature marketsof the U.S. and Europe, in an effort to improve the profitability of certain ofthe Company’s older assets. Such consolidation efforts, if and when approved bythe Company, could result in material non-cash charges for the write-offs ofassets not retained in the operations.

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*Restructuring and plantrealignment costs:*   The Companyaccounts for exit, disposal and relocation costs in accordance with FASBStatement No. 146 “Accounting for Costs Associated with Exit or DisposalActivities” (“SFAS No. 146”). In accordance with SFAS No. 146, the Companyestablishes a liability for a cost associated with an exit or disposal activityat fair value when the liability is incurred, which is when the definition of aliability in FASB Concepts Statement No. 6 “Elements of Financial Statements”,is met. Charges incurred for restructuring and plant realignment costs, as wellas adjustments to, and reversals of, amounts initially established arereflected in *“Restructuring and plant realignment costs”*in the Consolidated Statements of Operations.

**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 of changesin interest rates, foreign exchange rates and raw material pricing arising inour business activities. The Company manages these financial exposures, wherepossible, through operational means and by using various financial instruments.These practices may change as economic conditions change.

**Long-Term Debt andInterest Rate Market Risk**

The Company’s long-termborrowings under the Credit Facility are variable interest rate debt. As such,the Company’s interest expense will increase as interest rates rise anddecrease as interest rates fall. It is the Company’s policy to enter intointerest rate derivative transactions only to meet its stated overallobjective. The Company does not enter into these transactions for speculativepurposes. To that end, as further described in Notes 7 and 12 to theConsolidated Financial Statements included in Item 1 of Part I tothis Quarterly Report on Form 10-Q, the Company entered into aninterest rate swap contract to effectively convert $212.5 million of itsvariable-rate debt to fixed-rate debt. The interest rate swap contract matureson May 8, 2007. 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 million.

**Foreign CurrencyExchange Rate Risk**

The Company manufactures, markets and distributescertain of its products in Europe, Canada, Latin America and Asia. As a result,the Company’s results of operations could be significantly affected by factorssuch as changes in foreign currency rates in the foreign markets in which theCompany maintains a manufacturing or distribution presence. However, suchcurrency fluctuations have much less effect on local operating results becausethe Company, to a significant extent, sells its products within the countriesin which they are manufactured. During the first nine months of both 2006 and2005, certain currencies of countries in which the Company conducts foreigncurrency denominated business moved against the U.S. dollar and had anunfavorable impact on sales and 

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operating income. See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included in Item 2 of Part I to this Quarterly Report on Form 10-Q.

The Company has nothistorically hedged its exposure to foreign currency risk. However, in mostforeign operations, there is a natural currency hedge due to similar amounts ofcosts of materials and production as revenues in such local currencies.However, due to the foreign currency losses sustained in the first nine months offiscal 2006, resulting from the devaluation of the Colombian and Mexican pesosto the U.S. dollar, the Company is reconsidering its hedge strategy withrespect to the Latin American operations. The Company is also subject topolitical risk in certain of its foreign operations and has utilized insuranceprograms in certain circumstances to mitigate its political risk.

**Raw Material and Commodity Risks**

The primary raw materials used in the manufacture ofmost of the Company’s products are polypropylene resin, polyester fiber,polyethylene resin, and, to a lesser extent, rayon, tissue paper and cotton.The prices of polypropylene, polyethylene and polyester are a function of,among other things, manufacturing capacity, demand and the price of crude oiland natural gas liquids. The Company has not historically hedged its exposureto raw material increases, but has attempted to move more customer programs tocontracts with price escalation provisions which would allow the Company topass-through any cost increases in raw materials, although there is often adelay between the time the Company is required to pay the increased rawmaterial cost and the time that the Company is able to pass the increase on toits customers. Raw material costs as a percentage of sales have increased from50.8% in the three months ended October 1, 2005 to 54.7% in the threemonths ended September 30, 2006.

In August and September of 2005, HurricanesKatrina and 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 supplieswere tight in the fourth quarter of 2005, raw materials continued to beavailable to the Company, but at significantly higher prices. The Company,where allowable based on contract terms, had attempted to raise its sellingprices to mitigate the sharp increase in raw materials. Raw material costsdecreased slightly since late December 2005 through the end of the firstquarter of fiscal 2006 as the refineries and chemical processing sites returnedto more normal production levels. In the second and third quarters of fiscal 2006,raw material costs have increased from most of the Company’s suppliers inresponse to certain global economic factors, including the escalating price ofoil. However, the Company currently expects a reduction in raw material costsin the fourth quarter of fiscal 2006.

To the extent the Company isnot able to pass along cost 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 ofexample, if the price of polypropylene were to rise $.01 per pound, and theCompany was not able to pass along any of such increase to its customers, theCompany would realize a decrease of approximately $3.5 million, on an annualizedbasis, in its reported pre-tax operating income. Material increases in rawmaterial prices that cannot be passed on to customers could have a materialadverse effect on the Company’s results of operations and financial condition.See “Management’s Discussion and Analysis of Financial Condition and Results ofOperations” included in Item 2 of Part I to this Quarterly Report on Form 10-Q.

**ITEM 4. CONTROLSAND PROCEDURES**

**A. Evaluation ofDisclosure Controls and Procedures**

Under the direction of our InterimChief Executive Officer and Chief Financial Officer, the Company has evaluatedthe effectiveness of its disclosure controls and procedures, as such item is 

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defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of theend of the period covered by this report. Based on that evaluation, the Company’sInterim Chief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective as of September 30, 2006.

**B. Changes in InternalControl over Financial Reporting**

In our report for the quarterly period ended July 1,2006, management identified a deficiency in the Company’s internal control overfinancial reporting associated with documentation for complex contracts andagreements. Management’s determination resulted from the identification ofcertain contracts and agreements for which adequate documentation was not inplace to support material changes in contract terms, nor to allow for theappropriate consideration of the economic substance of the contracts andagreements. This control deficiency could have resulted in a misstatement ofthe Company’s results of operations that would result in a materialmisstatement to the annual or interim consolidated financial statements thatwould not be prevented or detected. Accordingly, the Company concluded thatthis control deficiency constituted a material weakness. 

During the quarterly period ended September 30, 2006,the Company’s management and Board of Directors have remediated this materialweakness by developing new policies and procedures regarding the documentationof complex contracts, and by implementing a delegation of authority thatrequires a more formal review and approval of documentation for complexcontracts and agreements by experienced accounting and legal personnel.

Other than as described above, there were no changesin the Company’s internal control over financial reporting, as such term isdefined in Exchange Act Rule 13a-15(f), during the quarterly periodended September 30, 2006 that have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.

See Note 18 to the Consolidated Financial Statementsincluded in Item 1 of Part I to this Quarterly Report on Form 10-Q.

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**PART II. OTHERINFORMATION**

**ITEM 1.   LEGALPROCEEDINGS**

Other than as reported in theCompany’s Form 10-K for the period ended December 31, 2005under the caption “Item 3. Legal Proceedings,” the Company is not currently aparty to any material pending legal proceedings. See Note 16 to theConsolidated Financial Statements included in Item 1 of Part I to thisQuarterly Report of Form 10-Q for additional details.

**ITEM 1A.   RISKFACTORS**

The risk factor which was added in our report for thequarterly period ended July 1, 2006, has been removed as the Company has takenthe necessary steps to remediate the material weakness reported therein bydeveloping new policies and procedures regarding the documentation of complexcontracts, and by implementing a delegation of authority that requires a moreformal review and approval of documentation for complex contracts andagreements by experienced accounting and legal personnel.

The risk factor immediately following, which was notincluded in our 2005 Annual Report on Form 10-K, is being included herein toprovide disclosure related to changes in the Company’s risk factors since theCompany filed its 2005 Annual Report on Form 10-K. See the Company’s 2005Annual Report on Form 10-K for an expanded description of other risksfacing the Company.

**Non-compliance withcovenants contained in the Credit Facility, without waiver or amendment fromthe lenders of the Credit Facility, could adversely affect our ability toborrow under the Credit Facility.**

The Company’s Credit Facility contains certainfinancial covenants, including a leverage ratio and an interest expensecoverage ratio. The Company may not be able to satisfy these ratios, especiallyif operating results fall below management’s expectations, which expectationsare that the covenants would be met. See Item 2, “Management’s Discussionand Analysis of Financial Condition and Resultsof Operations—Liquidity and Capital Resources” of Part I of this QuarterlyReport on Form 10-Q for a discussion of the Credit Facility. Abreach of any of these covenants or the Company’s inability to comply with therequired financial ratios could result in a default under the Credit Facility,unless the Company is able to remedy any default within the allotted cureperiod or obtain the necessary waivers or amendments to the Credit Facility. Inthe event of any default not waived, and subject to appropriate cure periods asprovided for in the Credit Agreement, the lenders under the Credit Facilitycould elect to not lend any additional amounts to the Company and could electto declare all outstanding borrowings, together with accrued interest and otherfees, to be immediately due and payable. If the Company is unable to repay theborrowings with respect to our Credit Facility when due, our lenders couldproceed against their collateral, which consists of (i) a lien onsubstantially all of the assets of the Company, its domestic subsidiaries andcertain of its non-domestic subsidiaries, (ii) a pledge of all or aportion of the stock of the domestic subsidiaries of the Company and of certainnon-domestic subsidiaries of the Company, and (iii) a pledge of certainsecured intercompany notes.

See the Company’s 2005 AnnualReport on Form 10-K for an expanded description of other risks facing theCompany.

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

During the third quarter offiscal 2006, 2,194 shares of the Company’s Class B Common Stock wereconverted into 2,194 shares of the Company’s Class A Common Stock.These conversions were exempt from registration based on section 3(a)(9) ofthe Securities Exchange Act of 1933.

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**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** | ** ** |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------|--------------------------|------------|
| 10.1            |       | Severance Agreement dated  October 31, 2006 between James L. Schaeffer and Polymer  Group, Inc.    |
| 10.2            |       | Separation Agreement  dated November 7, 2006 between James Snyder and Polymer Group, Inc.                    |
| 31.1            |       | Certification of Interim  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 Interim  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 thereuntoduly authorized.
|                             | POLYMER GROUP, INC. |
|-----------------------------|--------------------------|
|                        |                     |   |
|                        |                     |   |
|                        |                     |   |
| Date: November 9, 2006 | By:                      | /s/ WILLIAM B. HEWITT |
| * *                    |                     | William B. Hewitt*Interim Chief Executive Officer* |
| * *                    |                     | * * |
| * *                    |                     | * * |
| Date: November 9, 2006 | By:                      | /s/ WILLIS C. MOORE, III |
| * *                    |                     | Willis C.  Moore, III*Chief Financial Officer* |

 

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