**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 July 3,2004
| o | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|---|------------|--------------------------------------------------------------------------------------------------------------------|

 

For the transition period from               to               

**Commissionfile number: 1-14330**

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POLYMERGROUP, INC.

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

 

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

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter periods that the registrant was required to file such reports),and (2) has been subject to the filing requirements for the past90 days. Yes x  No o

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

Indicate by check mark whether the registrant 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

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.

On August 10,2004 there were 10,042,800 shares of Class A common stock,274,291 shares of Class B common stock and 54,251 shares of Class Ccommon stock outstanding. No shares of Class D or Class E wereoutstanding as of such date. The par value for each class of common shares is$.01 per share.

 

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**POLYMER GROUP, INC.**

**INDEX TO FORM 10-Q**
|                                                      | ** ** | ** **                                                                                  | ** ** | **Page** |
|------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|----------|
| IMPORTANT  INFORMATION REGARDING THIS FORM 10-Q |       | 2                                                                                           |       |
| **PART I. FINANCIAL INFORMATION**               |       |                                                                                        |       |
| Item 1.                                              |       | Financial Statements                                                                        |       | 3        |   |
| Item  2.                                             |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       | 23       |   |
| Item  3.                                             |       | Quantitative  and Qualitative Disclosures About Market Risk                                 |       | 34       |   |
| Item 4.                                              |       | Controls and Procedures                                                                     |       | 35       |   |
| **PART II. OTHER INFORMATION**                  |       |                                                                                        |       |
| Item 1.                                              |       | Legal Proceedings                                                                           |       | 35       |   |
| Item 2.                                              |       | Changes in Securities                                                                       |       | 36       |   |
| Item 3.                                              |       | Defaults Upon  Senior Securities                                                            |       | 36       |   |
| Item  4.                                             |       | Submission  of Matters To a Vote of Security Holders                                        |       | 36       |   |
| Item 5.                                              |       | Other Information                                                                           |       | 37       |   |
| Item 6.                                              |       | Exhibits  and Reports on Form 8-K                                                      |       | 37       |   |
| Signatures                                           |       | 38                                                                                          |       |

 

1

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

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

**Safe Harbor-Forward-Looking Statements**

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

Various statements contained in this report, includingthose that express a belief, expectation or intention, as well as those thatare not statements of historical fact are, or may be deemed to be, forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933and Section 21E of the Securities Exchange Act of 1934. These forward-lookingstatements speak only as of the date of this report. Unless required by law,the Company does not undertake any obligation to update these statements andcautions against any undue reliance on them. These forward-lookingstatements are based on current expectations and assumptions about futureevents. While management considers these expectations and assumptions to bereasonable, they are inherently subject to significant business, economic,competitive, regulatory and other risks, contingencies and uncertainties, mostof which are difficult to predict and many of which are beyond the Company’scontrol.

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

·       generaleconomic factors including, but not limited to, changes in interest rates,foreign currency translation rates, consumer confidence, trends in disposable income,changes in consumer demand for goods produced, and cyclical or other downturns;

·       substantialdebt levels and potential inability to maintain sufficient liquidity to financethe Company’s operations and make necessary capital expenditures;

·       inabilityto meet existing debt covenants;

·       informationand technological advances;

·       costand availability of raw materials, labor and natural and other resources;

·       domesticand foreign competition;

·       relianceon major customers and suppliers; and

·       risksrelating to operations in foreign jurisdictions.

2

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**ITEM 1. FINANCIAL STATEMENTS**

**POLYMER GROUP, INC.CONSOLIDATED BALANCE SHEETS**

**(In Thousands, Except Share Data)**
| ** **                                                                                                                                                 | ** ** | **July 3,  2004** | ** ** | ** January 3,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                 | ** ** | **(Unaudited)**        | ** ** | ** **                      | ** ** |
| **ASSETS**                                                                                                                                                 |       |                   |       |                            |       |   |   |   |   |
| Current assets:                                                                                                                                            |       |                   |       |                            |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                  |       |                   | $          | 20,852                          |       |   |   | $ | 21,336 |   |   |
| Accounts receivable, net                                                                                                                                   |       |                   | 126,993    |                            |       |   | 121,146 |   |   |
| Inventories                                                                                                                                                |       |                   | 101,440    |                            |       |   | 96,513 |   |   |
| Deferred income taxes                                                                                                                                      |       |                   | 141        |                            |       |   | 143 |   |   |
| Other current assets                                                                                                                                       |       |                   | 23,134     |                            |       |   | 20,554 |   |   |
| Total current assets                                                                                                                                       |       |                   | 272,560    |                            |       |   | 259,692 |   |   |
| Property, plant and  equipment, net                                                                                                                        |       |                   | 397,602    |                            |       |   | 416,508 |   |   |
| Intangibles and loan  acquisition costs, net                                                                                                               |       |                   | 36,987     |                            |       |   | 33,560 |   |   |
| Deferred income taxes                                                                                                                                      |       |                   | 2,348      |                            |       |   | 2,335 |   |   |
| Other assets                                                                                                                                               |       |                   | 4,125      |                            |       |   | 9,215 |   |   |
| Total assets                                                                                                                                               |       |                   | $          | 713,622                         |       |   |   | $ | 721,310 |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                              |       |                   |       |                            |       |   |   |   |   |
| Current liabilities:                                                                                                                                       |       |                   |       |                            |       |   |   |   |   |
| Short-term borrowings                                                                                                                                      |       |                   | $          | 5,831                           |       |   |   | $ | 8,454 |   |   |
| Accounts payable                                                                                                                                           |       |                   | 58,053     |                            |       |   | 57,091 |   |   |
| Accrued liabilities                                                                                                                                        |       |                   | 38,851     |                            |       |   | 39,850 |   |   |
| Income taxes payable                                                                                                                                       |       |                   | 1,256      |                            |       |   | 1,190 |   |   |
| Current portion of long-term debt                                                                                                                          |       |                   | 5,144      |                            |       |   | 34,001 |   |   |
| Total current liabilities                                                                                                                                  |       |                   | 109,135    |                            |       |   | 140,586 |   |   |
| Long-term debt, less  current portion                                                                                                                      |       |                   | 432,181    |                            |       |   | 440,992 |   |   |
| Deferred income taxes                                                                                                                                      |       |                   | 26,077     |                            |       |   | 28,711 |   |   |
| Other noncurrent  liabilities                                                                                                                              |       |                   | 33,478     |                            |       |   | 37,670 |   |   |
| Total liabilities                                                                                                                                          |       |                   | 600,871    |                            |       |   | 647,959 |   |   |
| Minority interests                                                                                                                                         |       |                   | 15,216     |                            |       |   | 14,151 |   |   |
| 16% Series A convertible  pay-in-kind preferred shares—42,633 shares issued and outstanding at  July 3, 2004                                |       |                   | 43,908     |                            |       |   | — |   |   |
| Shareholders’ equity:                                                                                                                                 |       |                   |       |                            |       |   |   |   |   |
| Class A common stock—10,042,800 and 8,228,425 shares issued and  outstanding at July 3, 2004 and January 3, 2004, respectively         |       |                   | 100        |                            |       |   | 82 |   |   |
| Class B convertible common stock—274,291 and 389,977 shares  issued and outstanding at July 3, 2004 and January 3, 2004,  respectively |       |                   | 3          |                            |       |   | 4 |   |   |
| Class C convertible common stock—54,251 and 34,892 shares issued  and outstanding at July 3, 2004 and January 3, 2004, respectively    |       |                   | 1          |                            |       |   | — |   |   |
| Class D convertible common stock—0 shares issued and outstanding                                                                                 |       |                   | —     |                            |       |   | — |   |   |
| Class E convertible common stock—0 shares issued and outstanding                                                                                 |       |                   | —     |                            |       |   | — |   |   |
| Additional paid in capital                                                                                                                                 |       |                   | 76,338     |                            |       |   | 73,304 |   |   |
| Retained earnings (deficit)                                                                                                                                |       |                   | (37,305    | )                               |       |   | (32,986 | ) |   |
| Accumulated other comprehensive income                                                                                                                     |       |                   | 14,490     |                            |       |   | 18,796 |   |   |
| Total shareholders’ equity                                                                                                                            |       |                   | 53,627     |                            |       |   | 59,200 |   |   |
| Total liabilities and  shareholders’ equity                                                                                                           |       |                   | $          | 713,622                         |       |   |   | $ | 721,310 |   |   |

 

 

See Accompanying Notes.

3

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**POLYMER GROUP, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)**

**Three Months Ended July 3, 2004 and June 28,2003**

**(In Thousands, Except Per Share Data)**
| ** **                                           | ** ** | **Successor**                                        | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **Three Months  Ended  July 3, 2004** | ** ** | **Three Months  Ended  June 28, 2003** | ** ** |
| Net sales                                            |       |                                                 | $          | 210,591 |   |   |   | $ | 198,757 |   |   |
| Cost of goods sold                                   |       |                                                 | 173,626    |   |   |   | 165,041 |   |   |
| Gross profit                                         |       |                                                 | 36,965     |   |   |   | 33,716 |   |   |
| Selling, general and  administrative expenses        |       |                                                 | 24,627     |   |   |   | 24,686 |   |   |
| Plant realignment costs                              |       |                                                 | 656        |   |   |   | 2,408 |   |   |
| Arbitration settlement,  net                         |       |                                                 | (13,394    | ) |   |   | — |   |   |
| Operating income                                     |       |                                                 | 25,076     |   |   |   | 6,622 |   |   |
| Other expense (income):                              |       |                                                 |       |   |   |   |   |   |   |
| Interest expense, net                                |       |                                                 | 9,357      |   |   |   | 14,962 |   |   |
| Minority interests                                   |       |                                                 | 624        |   |   |   | 539 |   |   |
| Foreign currency and other                           |       |                                                 | 5,732      |   |   |   | (619 | ) |   |
|                                                 |       |                                                 | 15,713     |   |   |   | 14,882 |   |   |
| Income (loss) before income  tax expense             |       |                                                 | 9,363      |   |   |   | (8,260 | ) |   |
| Income tax expense                                   |       |                                                 | 3,640      |   |   |   | 2,855 |   |   |
| Net income (loss)                                    |       |                                                 | 5,723      |   |   |   | (11,115 | ) |   |
| Accrued dividends on PIK  preferred shares           |       |                                                 | 1,271      |   |   |   | — |   |   |
| Earnings (losses)  available for common shareholders |       |                                                 | $          | 4,452 |   |   |   | $ | (11,115 | ) |   |
| Net earnings (losses) available per common share:    |       |                                                 |       |   |   |   |   |   |   |
| Basic                                                |       |                                                 | $          | 0.45 |   |   |   | $ | (1.29 | ) |   |
| Diluted                                              |       |                                                 | $          | 0.36 |   |   |   | $ | (1.29 | ) |   |

 

See Accompanying Notes.

4

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**POLYMER GROUP, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)**

**Six Months Ended July 3, 2004,**

**Four Months Ended June 28, 2003 and**

**Two Months Ended March 1, 2003**

**(In Thousands, Except Per Share Data)**
| ** **                                                                                           | ** ** | **Successor**                                                  | ** ** | **Predecessor**                                      | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **Six Months  Ended   July 3, 2004 ** | ** ** | **Four Months  Ended  June 28, 2003** | ** ** | **Two Months  Ended  March 1, 2003** | ** ** |
| Net sales                                                                                            |       |                                                           | $          | 417,334                                              |       |   |   | $ | 262,824 |   |   |   | $ | 132,909 |   |   |
| Cost of goods sold                                                                                   |       |                                                           | 341,889    |                                                 |       |   | 217,670 |   |   |   | 111,075 |   |   |
| Gross profit                                                                                         |       |                                                           | 75,445     |                                                 |       |   | 45,154 |   |   |   | 21,834 |   |   |
| Selling, general and  administrative expenses                                                        |       |                                                           | 51,762     |                                                 |       |   | 32,865 |   |   |   | 16,004 |   |   |
| Plant realignment costs                                                                              |       |                                                           | 1,241      |                                                 |       |   | 2,416 |   |   |   | 4 |   |   |
| Arbitration settlement,  net                                                                         |       |                                                           | (13,394    | )                                                    |       |   | — |   |   |   | — |   |   |
| Operating income                                                                                     |       |                                                           | 35,836     |                                                 |       |   | 9,873 |   |   |   | 5,826 |   |   |
| Other expense (income):                                                                              |       |                                                           |       |                                                 |       |   |   |   |   |   |   |   |   |
| Interest expense, net (contractual interest of $20,306 for the two  months ended March 1, 2003) |       |                                                           | 24,534     |                                                 |       |   | 18,722 |   |   |   | 10,665 |   |   |
| Investment gain, net                                                                                 |       |                                                           | —     |                                                 |       |   | — |   |   |   | (291 | ) |   |
| Minority interests                                                                                   |       |                                                           | 1,107      |                                                 |       |   | 739 |   |   |   | 441 |   |   |
| Foreign currency and other                                                                           |       |                                                           | 7,118      |                                                 |       |   | (850 | ) |   |   | 1,434 |   |   |
|                                                                                                 |       |                                                           | 32,759     |                                                 |       |   | 18,611 |   |   |   | 12,249 |   |   |
| Income (loss) before  reorganization items and income taxes                                          |       |                                                           | 3,077      |                                                 |       |   | (8,738 | ) |   |   | (6,423 | ) |   |
| Reorganization items,  net gain                                                                      |       |                                                           | —     |                                                 |       |   | — |   |   |   | (540,479 | ) |   |
| Income (loss) before  income tax expense                                                             |       |                                                           | 3,077      |                                                 |       |   | (8,738 | ) |   |   | 534,056 |   |   |
| Income tax expense                                                                                   |       |                                                           | 6,125      |                                                 |       |   | 3,726 |   |   |   | 1,692 |   |   |
| Net income (loss)                                                                                    |       |                                                           | (3,048     | )                                                    |       |   | (12,464 | ) |   |   | 532,364 |   |   |
| Accrued dividends on PIK  preferred shares                                                           |       |                                                           | 1,271      |                                                 |       |   | — |   |   |   | — |   |   |
| Earnings (losses)  available for common shareholders                                                 |       |                                                           | $          | (4,319                                               | )          |   |   | $ | (12,464 | ) |   |   | $ | 532,364 |   |   |
| Net earnings (losses) available per common share:                                                    |       |                                                           |       |                                                 |       |   |   |   |   |   |   |   |   |
| Basic                                                                                                |       |                                                           | $          | (0.46                                                | )          |   |   | $ | (1.44 | ) |   |   | $ | 16.63 |   |   |
| Diluted                                                                                              |       |                                                           | $          | (0.46                                                | )          |   |   | $ | (1.44 | ) |   |   | $ | 16.63 |   |   |

 

See Accompanying Notes.

5

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**POLYMER GROUP, INC.CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’**

**EQUITY AND COMPREHENSIVEINCOME (LOSS)**(Unaudited)

**For the Six Months EndedJuly 3, 2004**

**(In Thousands)**
| ** **                                                                                       | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **    | ** ** | **Accumulated**   | ** ** | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------|------------|----------------------------|------------|---------------|------------|-------------------|------------|------------|------------|------------|-------------------|------------|
| ** **                                                                                       | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **    | ** ** | **Other**         | ** ** | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                                                                       | ** ** | ** ** | ** ** | ** Additional ** | ** ** | **Retained**  | ** ** | **Comprehensive** | ** ** | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                                                                       | ** ** | **Common** | ** ** | **Paid-in**                | ** ** | **Earnings/** | ** ** | **Income/**       | ** ** | ** ** | ** ** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                                       | ** ** | **Stock**  | ** ** | **Capital**                | ** ** | **(Deficit)** | ** ** | **(Loss)**        | ** ** | **Total**  | ** ** | ** ** | **Income/(Loss)** | ** ** |
| Balance, January 3, 2004, audited                                                           |       |       | $          | 86                         |       |          |       | $                 | 73,304     |       |       | $          | (32,986           | )          |   | $ | 18,796 |   |   | $ | 59,200 |   |   |   |   |   |   |
| Net income (loss)                                                                                |       |       | —     |                       |       |          | —     |              |       | (3,048     | )          |       | —            |       |   | (3,048 | ) |   |   | $ | (3,048 | ) |   |
| Accrued dividends on PIK preferred shares                                                        |       |       | —     |                       |       |          | —     |              |       | (1,271     | )          |       | —            |       |   | (1,271 | ) |   |   | — |   |   |
| Currency translation adjustment                                                                  |       |       | —     |                       |       |          | —     |              |       | —     |       |       | (3,707            | )          |   | (3,707 | ) |   |   | (3,707 | ) |   |
| Cash flow hedge adjustment, net of reclassification  adjustment                                  |       |       | —     |                       |       |          | —     |              |       | —     |       |       | (599              | )          |   | (599 | ) |   |   | (599 | ) |   |
| Compensation recognized on stock options and  restricted stock grants                            |       |       | —     |                       |       |          | 345        |              |       | —     |       |       | —            |       |   | 345 |   |   |   | — |   |   |
| Class A and Class C common stock issued  under order of United States Bankruptcy Court |       |       | 14         |                       |       |          | (14        | )                 |       | —     |       |       | —            |       |   | — |   |   |   | — |   |   |
| Conversion of junior notes to Class A common  stock                                         |       |       | 4          |                       |       |          | 2,703      |              |       | —     |       |       | —            |       |   | 2,707 |   |   |   | — |   |   |
| Balance, July 3,  2004                                                                      |       |       | $          | 104                        |       |          |       | $                 | 76,338     |       |       | $          | (37,305           | )          |   | $ | 14,490 |   |   | $ | 53,627 |   |   |   | $ | (7,354 | ) |   |

 

See Accompanying Notes.

6

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

**(In Thousands)**
| ** **                                                                                          | ** ** | **Successor**                                      | ** ** | **Predecessor**                                     | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **Six Months  Ended  July 3, 2004** | ** ** | **Four Month  Ended  June 28, 2003** | ** ** | **Two Months  Ended  March 1, 2003** | ** ** |
| Operating activities:                                                                               |       |                                               |       |                                                |       |   |   |   |   |   |   |
| Net income (loss)                                                                                   |       | $                                                  | (3,048     | )                                                   |       | $ | (12,464 | ) |   |   | $ | 532,364 |   |   |
| Adjustments to reconcile  net income (loss) to net cash provided by (used in) operating activities: |       |                                               |       |                                                |       |   |   |   |   |   |   |
| Gain on investments                                                                                 |       | —                                             |       |                                                | —     |   |   |   | (291 | ) |   |
| Gain on cancellation of prepetition indebtedness                                                    |       | —                                             |       |                                                | —     |   |   |   | (619,913 | ) |   |
| Deferred income taxes                                                                               |       | (2,634                                             | )          |                                                | —     |   |   |   | 3,010 |   |   |
| Fresh start adjustments                                                                             |       | —                                             |       |                                                | —     |   |   |   | 47,460 |   |   |
| Write-off of loan acquisition costs                                                                 |       | 5,022                                              |       |                                                | —     |   |   |   | 10,217 |   |   |
| Depreciation and amortization                                                                       |       | 26,467                                             |       |                                                | 16,818     |   |   |   | 8,812 |   |   |
| Noncash interest and compensation                                                                   |       | 2,104                                              |       |                                                | 1,368      |   |   |   | — |   |   |
| Changes in operating  assets and liabilities, net of effect of acquisitions:                        |       |                                               |       |                                                |       |   |   |   |   |   |   |
| Accounts receivable, net                                                                            |       | (7,409                                             | )          |                                                | (9,210     | ) |   |   | (8,195 | ) |   |
| Inventories                                                                                         |       | (6,268                                             | )          |                                                | 2,683      |   |   |   | (887 | ) |   |
| Current and other assets                                                                            |       | 2,510                                              |       |                                                | (1,526     | ) |   |   | 6,675 |   |   |
| Accounts payable and accrued liabilities                                                            |       | 1,200                                              |       |                                                | 1,745      |   |   |   | 13,027 |   |   |
| Other, net                                                                                          |       | (1,121                                             | )          |                                                | 5,147      |   |   |   | (5,180 | ) |   |
| Net cash provided by (used in) operating activities                                                 |       | 16,823                                             |       |                                                | 4,561      |   |   |   | (12,901 | ) |   |
| Investing activities:                                                                               |       |                                               |       |                                                |       |   |   |   |   |   |   |
| Purchases of property, plant and equipment                                                          |       | (8,854                                             | )          |                                                | (11,542    | ) |   |   | (3,062 | ) |   |
| Proceeds from sale of marketable securities                                                         |       | —                                             |       |                                                | —     |   |   |   | 11,867 |   |   |
| Proceeds from sale of other assets                                                                  |       | 783                                                |       |                                                | —     |   |   |   | — |   |   |
| Other, net                                                                                          |       | —                                             |       |                                                | —     |   |   |   | 15 |   |   |
| Net cash provided by (used in) investing activities                                                 |       | (8,071                                             | )          |                                                | (11,542    | ) |   |   | 8,820 |   |   |
| Financing activities:                                                                               |       |                                               |       |                                                |       |   |   |   |   |   |   |
| Proceeds from issuance of debt                                                                      |       | 485,217                                            |       |                                                | —     |   |   |   | 535,310 |   |   |
| Repayment of debt                                                                                   |       | (481,922                                           | )          |                                                | (1,308     | ) |   |   | (549,031 | ) |   |
| Loan acquisition costs and other                                                                    |       | (12,306                                            | )          |                                                | (743       | ) |   |   | (948 | ) |   |
| Net cash provided by (used in) financing activities                                                 |       | (9,011                                             | )          |                                                | (2,051     | ) |   |   | (14,669 | ) |   |
| Effect of exchange rate  change on cash                                                             |       | (225                                               | )          |                                                | 3,317      |   |   |   | 4,632 |   |   |
| Net increase (decrease)  in cash and cash equivalents                                               |       | (484                                               | )          |                                                | (5,715     | ) |   |   | (14,118 | ) |   |
| Cash and cash  equivalents at beginning of period                                                   |       | 21,336                                             |       |                                                | 31,783     |   |   |   | 45,901 |   |   |
| Cash and cash equivalents at  end of period                                                         |       | $                                                  | 20,852     |                                                |       | $ | 26,068 |   |   |   | $ | 31,783 |   |   |

 

 

See Accompanying Notes.

7

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**POLYMER GROUP, INC. Notes to Consolidated Financial Statements**

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

*Principles ofConsolidation*

Polymer Group, Inc. (which together with itssubsidiaries is referred to herein as the Company) is a publicly-traded,multinational manufacturer, marketer and seller of nonwoven and orientedpolyolefin products. The Company’s main sources of revenue are the sales ofprimary and intermediate products to the Consumer and Industrial &Specialty segments.

The accompanying consolidated financial statementsinclude the accounts of Polymer Group, Inc. and all majority-ownedsubsidiaries after elimination of all significant intercompany accounts andtransactions. The accounts of all foreign subsidiaries have been included onthe basis of fiscal periods ended three months or less prior to the dates ofthe consolidated balance sheets. All amounts are presented in U.S. dollars,unless otherwise noted. Investments in 20% to 50% owned affiliates where theCompany is able to exercise significant influence, but not control, areaccounted for by the equity method and, accordingly, the consolidated resultsof operations include the Company’s share of the affiliates’ income or loss.

The accompanying unauditedinterim consolidated financial statements and related notes should be read inconjunction with the Consolidated Financial Statements of the Company andrelated notes as contained in the Annual Report on Form 10-K for theperiod ended January 3, 2004. 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.

*Basis of Presentation*

After extensive reorganization efforts,the Company and each of its domestic subsidiaries filed voluntary petitions forChapter 11 reorganization under the United States Bankruptcy Code in the SouthCarolina Bankruptcy Court on May 11, 2002 (April 25, 2002 as toBonlam (S.C.), Inc.). In its efforts to emerge from Chapter 11, theCompany filed a Modified Plan (as defined) on November 27, 2002 that wasapproved by the Bankruptcy Court on January 16, 2003 and, accordingly, theCompany emerged from Chapter 11 effective March 5, 2003 (the “EffectiveDate”). For accounting purposes the Company recognized the emergence on March 1,2003, which was the end of the February 2003 accounting period. TheCompany adopted “fresh-start accounting” as of March 1, 2003, andthe Company’s emergence from Chapter 11 resulted in a new reporting entity. Thereorganization value of the Company has been allocated to the underlying assetsand liabilities based on their respective fair values at the date of emergence.References to “Predecessor” refer to the old Polymer Group and its subsidiarieson and prior to March 1, 2003, and references to “Successor” refer toPolymer Group and its subsidiaries as of and subsequent to March 2, 2003,after giving effect to the implementation of fresh start accounting. Inaccordance with financial reporting requirements for companies emerging from Chapter 11,financial information for the three months ended March 29, 2003 is notpresented in the consolidated financial statements since such information wouldcombine the results of the Predecessor and Successor.

*Reclassification*

Certain amounts previouslypresented in the consolidated financial statements for prior periods have beenreclassified to conform with current period classification.

8

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

*New AccountingPronouncements*

In January 2003, the Financial AccountingStandards Board (“FASB”) released Interpretation No. 46, “Consolidation ofVariable Interest Entities (revised December 2003)” (“FIN 46”). FIN 46requires that all primary beneficiaries of variable interest entities (VIEs)consolidate that entity. The provisions of FIN 46 related to VIEs created oracquired after January 31, 2003 were effective and adopted by the Companyin fiscal year 2003. The provisions of FIN 46 related to VIE’s in which anenterprise holds an interest it acquired before February 1, 2003 wereeffective for the Company in the first quarter of fiscal 2004. The Company hasdetermined that it does not have any relationships or contracts that constitutea variable interest.

In May 2003, the FASB issuedStatement of Financial Accounting Standards (“SFAS”) No. 150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity.”  SFAS No. 150 requires thatcertain financial instruments, which under previous guidance could be accountedfor as equity, be classified as liabilities in the statement of financialposition. SFAS No. 150 is effective for financial instruments entered intoor modified after May 31, 2003. The Company has determined that it doesnot have any financial instruments that are within the scope of SFAS No. 150.

**Note 2.**   AccountsReceivable and Concentration of Credit Risks

Accounts receivable potentially expose the Company toconcentration of credit risk, as defined by SFAS No. 105, “Disclosure ofInformation about Financial Instruments with Off-Balance Sheet Risk and FinancialInstruments with Concentration of Credit Risk.” The Company provides credit inthe normal course of business and performs ongoing credit evaluations on itscustomers’ financial condition as deemed necessary, but generally does notrequire collateral to support such receivables. Customer balances areconsidered past due based on contractual terms and the Company does not accrueinterest on the past due balances. Once management determines that thereceivables are not recoverable, the amounts are removed from the financialrecords along with the corresponding reserve balance. The allowance fordoubtful accounts was approximately $12.5 million and $13.6 million at July 3,2004 and January 3, 2004, respectively, which management believes isadequate to provide for credit loss in the normal course of business, as wellas losses for customers who have filed for protection under bankruptcy laws.Several of the individual customer balances specifically provided for in theallowance for doubtful accounts have improved their payment trend and reportedimproving financial results. Accordingly, the Company recorded a reduction inthe provision for doubtful accounts of $1.1 million during the second quarterof 2004.

In the first six months of 2004and 2003, The Procter & Gamble Company (“P&G”) accounted forapproximately 12% and 13%, respectively, of the Company’s sales.

**Note 3.**   Inventories

Inventoriesare stated at the lower of cost or market using the first-in, first-out methodof accounting and consist of the following (in thousands):
| ** **      | ** ** | **July 3,  2004**      | ** ** | **January 3,   2004** | ** ** |
|-----------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **      | ** ** | ** (Unaudited) ** | ** ** | ** **                      | ** ** |
| Finished goods  |       |                        | $          | 48,787                          |       |   |   | $ | 47,288 |   |   |
| Work in process |       |                        | 16,820     |                            |       |   | 16,579 |   |   |
| Raw materials   |       |                        | 35,833     |                            |       |   | 32,646 |   |   |
|            |       |                        | $          | 101,440                         |       |   |   | $ | 96,513 |   |   |

 

9

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

 

**Note 4.**   BusinessRestructuring

In 2003, the Company implemented a businessrestructuring initiative. This initiative encompassed a reduction in workingcapital levels and operating cost reductions through: (i) reducingheadcount at both the plant and corporate levels; (ii) improvingmanufacturing productivity and reducing component costs; (iii) implementingglobal purchasing initiatives; and (iv) rationalizing certain assetsand/or businesses. Approximately 230 positions were eliminated in fiscal 2003.

Accrued costsfor restructuring efforts are included in accrued liabilities in theaccompanying balance sheet. A summary of the business restructuring activityduring the first six months of fiscal 2004 is presented in the following table(in thousands):
| Balance accrued at  beginning of year |   | $      | 4,564  |   |
|---------------------------------------|--------|--------|--------|--------|
| 2004 plant realignment costs          |   | 1,241  |   |
| Cash payments                         |   | (3,954 | )      |
| Adjustments                           |   | 36     |   |
| Balance accrued at end of  period     |   | $      | 1,887  |   |

 

In December 2003, theCompany made the business decision to discontinue one of its production linesin the European operations. Accordingly, in addition to certain costs recordedin 2003, plant realignment costs of $1.2 million, which include severance andother cash costs, were charged to the results of operations in the first sixmonths of 2004.

**Note 5.**   Intangiblesand Loan Acquisition Costs

Intangiblesand loan acquisition costs consist of the following (in thousands):
| ** **                       | ** ** | **July 3,** | ** ** | **January 3,** | ** ** |
|----------------------------------|------------|------------------|------------|---------------------|------------|
| ** **                       | ** ** | **2004**         | ** ** | **2004**            | ** ** |
| ** **                       | ** ** | **(Unaudited)**  | ** ** | ** **          | ** ** |
| Cost:                            |       |             |       |                |       |   |   |
| Proprietary technology           |       |             | $          | 26,536              |       |   | $ | 26,533 |   |
| Loan acquisition costs and other |       |             | 18,751     |                |       | 13,534 |   |
|                             |       |             | 45,287     |                |       | 40,067 |   |
| Less accumulated  amortization   |       |             | (8,300     | )                   |       | (6,507 | ) |
|                             |       |             | $          | 36,987              |       |   | $ | 33,560 |   |

 

10

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

Components ofamortization expense are shown in the table below (in thousands):
| ** **                                                                               | ** ** | **Successor**                                        | ** ** | **Predecessor**                                       | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **Three Months  Ended  July 3, 2004** | ** ** | **Three Months  Ended  June 28, 2003** | ** ** | **Six Months  Ended  July 3, 2004** | ** ** | **Four Months  Ended  June 28, 2003** | ** ** | **Two Months  Ended  March 1, 2003** | ** ** |
| Amortization of:                                                                         |       |                                                 |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Intangibles with finite lives, included in selling, general and  administrative expenses |       |                                                 | $          | 1,433                                                 |       |   |   | $ | 1,446 |   |   |   | $ | 2,885 |   |   |   | $ | 1,973 |   |   |   | $ | 220 |   |   |
| Loan acquisition costs included in interest expense, net                                 |       |                                                 | 490        |                                                  |       |   | 473 |   |   |   | 969 |   |   |   | 631 |   |   |   | 1,425 |   |   |
| Total amortization  expense                                                              |       |                                                 | $          | 1,923                                                 |       |   |   | $ | 1,919 |   |   |   | $ | 3,854 |   |   |   | $ | 2,604 |   |   |   | $ | 1,645 |   |   |

 

Intangibles are amortized over periods ranging from 2to 7 years. Loan acquisition costs are amortized over the life of therelated debt.

In conjunction with therefinancing of the Restructured Credit Facility on April 27, 2004, theCompany charged the unamortized balance of the loan acquisition costs relatedto that debt of $5.0 million to *Foreign currency and other*in April 2004. Additionally, with the issuance of the new Senior SecuredBank Facility, the Company capitalized approximately $12.2 million of loanacquisition costs, which were primarily bank arrangement and legal fees.

**Note 6.**   AccruedLiabilities

Accruedliabilities consist of the following (in thousands):
| ** **                           | ** ** | **July 3,** | ** ** | **January 3,** | ** ** |
|--------------------------------------|------------|------------------|------------|---------------------|------------|
| ** **                           | ** ** | **2004**         | ** ** | **2004**            | ** ** |
| ** **                           | ** ** | **(Unaudited)**  | ** ** | ** **          | ** ** |
| Salaries, wages and  fringe benefits |       |             | $          | 17,507              |       |   | $ | 15,443 |   |
| Restructuring                        |       |             | 1,887      |                |       | 4,564 |   |
| Interest                             |       |             | 784        |                |       | 1,877 |   |
| Sales commissions and  promotions    |       |             | 2,094      |                |       | 2,070 |   |
| Professional fees                    |       |             | 1,480      |                |       | 4,074 |   |
| Other                                |       |             | 15,099     |                |       | 11,822 |   |
|                                 |       |             | $          | 38,851              |       |   | $ | 39,850 |   |

 

 

11

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

**Note 7.**   Debt

The Company had outstandingshort-term borrowings denominated in U.S. dollars and Chinese rmb of $5.8million (at an average annual interest rate of approximately 4.49%) and $8.5million (at an average annual interest rate of approximately 5.31%) as of July3, 2004 and January 3, 2004, respectively.

Long-termdebt consists of the following (in thousands):
| ** **                                                                                                                                                                                                                                     | ** ** | **July 3,**            | ** ** | **January 3,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------|------------|
| ** **                                                                                                                                                                                                                                     | ** ** | **2004**                    | ** ** | **2004**            | ** ** |
| ** **                                                                                                                                                                                                                                     | ** ** | ** (Unaudited) ** | ** ** | ** **          | ** ** |
| Senior Secured Bank Facility, interest rates for  U.S. dollar borrowings are based on a specified base plus a specified margin  and are subject to certain terms and conditions:                                                               |       |                        |       |                |       |   |   |
| First Lien Term Loan—interest at 4.35% as of July 3, 2004; due  in quarterly payments of $750 thousand beginning in September 2004  with the balance due April 27, 2010                                               |       |                        | $          | 300,000             |       |   | — |   |
| Second Lien Term Loan—interest at 7.35% as of July 3, 2004; due  April 27, 2011                                                                                                                                                 |       |                        | 125,000    |                |       | — |   |
| Restructured Credit Facility, interest rates for  U.S. dollar borrowings are based on a specified base plus a specified margin,  are capped at 12.00% and are subject to certain terms and conditions;  terminating on December 31, 2006: |       |                        |       |                |       |   |   |
| Term Loans—interest at 12.00%; due December 31, 2006                                                                                                                                                                                 |       |                        | —     |                |       | $ | 416,834 |   |
| Junior Notes—interest at  10.00%; due December 31, 2007                                                                                                                                                                         |       |                        | 10,132     |                |       | 53,717 |   |
| Other                                                                                                                                                                                                                                          |       |                        | 2,193      |                |       | 4,442 |   |
|                                                                                                                                                                                                                                           |       |                        | 437,325    |                |       | 474,993 |   |
| Less: Current maturities                                                                                                                                                                                                                       |       |                        | (5,144     | )                   |       | (34,001 | ) |
|                                                                                                                                                                                                                                           |       |                        | $          | 432,181             |       |   | $ | 440,992 |   |

 

*Senior Secured Bank Facility*

The Company’s Senior Secured BankFacility (the “Bank Facility”), which was entered into on April 27, 2004,consists of a $50.0 million secured revolving credit facility, a $300.0 millionsenior secured first lien term loan and a $125.0 million senior secured second lienterm loan. The proceeds therefrom were used to fully repay indebtedness underthe Company’s previous Restructured Credit Facility and pay related fees andexpenses.

All borrowings under the BankFacility are U.S. dollar denominated and are guaranteed, on a joint and severalbasis, by each and all of the direct and indirect domestic subsidiaries of theCompany and supported by the pledge of stock of certain non-domesticsubsidiaries of the Company. The Bank Facility and the related guarantees aresecured by (i) a lien on substantially all of the assets of the Company,its domestic subsidiaries and certain of its non-domestic subsidiaries, (ii) apledge of all or a portion of the stock of the domestic subsidiaries of theCompany and of certain non-domestic subsidiaries of the Company, and (iii) apledge of certain secured intercompany notes issued to the 

12

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

Company or oneor more of its subsidiaries by non-domestic subsidiaries. Commitment fees underthe Bank Facility are equal to 0.50% of the daily unused amount of therevolving credit commitment. The Bank Facility contains covenants and events ofdefault customary for financings of this type, including leverage and interestexpense coverage covenants. At July 3, 2004, the Company is in compliancewith all such covenants and expects to remain in compliance through fiscal2004. The loans require the Company to use a percentage of proceeds from excesscash flows, as defined by the agreement, to reduce its debt balances.

The interest rate applicable toborrowings under the Bank Facility is based on three-month LIBOR plus aspecified margin. The applicable margin for borrowings under the revolvingcredit facility is 300 basis points, the margin for the first lien term loan is325 basis points and the margin for the second-lien term loan is 625 basis points.Although not anticipated, the Company may elect to use an alternate base rate forits borrowings under the revolving credit facility ranging from 2.25% to 6.25%with such alternate base rates including a margin based on the Company’s totalleverage ratio. The Company had no outstanding borrowings at July 3, 2004under the revolving credit facility. Average borrowings under the revolvingcredit facility for the period from April 28, 2004 to July 3, 2004were $14.7 million at an average rate of 5.80%. The revolving portion ofthe credit facility matures on April 27, 2009.

In accordance with the terms ofthe Bank Facility, the Company entered a cash flow hedge agreement, effectivelyconverting $212.5 million of notional principal amount of debt from a variableLIBOR rate to a fixed LIBOR rate of 3.383%. The cash flow hedge agreementterminates on May 8, 2007 and is described more fully in Note 12 of theConsolidated Financial Statements.

Subject to certain terms andconditions, a portion of the Bank Facility may be used for revolving letters ofcredit. As of July 3, 2004, the Company had $7.9 million of standbyletters of credit outstanding under this facility, which related primarily tothe short-term borrowings of the Company’s China-based majority ownedsubsidiary (“Nanhai”).

*Restructured Credit Facility*

Until it was refinanced on April 27,2004, the Company’s Restructured Credit Facility consisted of secured revolvingcredit borrowings with aggregate commitments of up to $50.0 million andaggregate term loans and term letters of credit of $435.3 million. Allborrowings under the Restructured Credit Facility were U.S. dollar denominatedand were guaranteed, on a joint and several basis, by each and all of thedirect and indirect domestic subsidiaries of the Company and certainnon-domestic subsidiaries of the Company. The Restructured Credit Facilitycontained covenants and events of default customary for financings of thistype, including leverage, senior leverage, interest coverage and adjustedinterest coverage. The Company was in compliance with all such covenantsthrough the date of the refinancing. The interest rate applicable to borrowingsunder the Restructured Credit Facility is based on a specified base rate or aspecified Eurodollar base rate, at the Company’s option, plus a specifiedmargin. The effective rate on the term loans was 12.00%, which was the cap onthe sum of the interest payable in respect of term loans or term letters ofcredit plus the senior leverage ratio fee. The Company’s average borrowingsunder the revolving credit agreement, which had an effective interest rate of6.75%, were $8.7 million for the period from January 4, 2004 to April 27,2004.

*Convertible Subordinated Notes*

In connection with the emergencefrom Chapter 11, the Company issued $50 million of 10% ConvertibleSubordinated Notes due 2007 (the “Junior Notes”) pursuant to an indenture datedas of March 5, 2003 (the “Junior Indenture”). The Junior Notes areunsecured subordinated indebtedness of the Company and are subordinated inright of payment to all existing and future indebtedness of the 

13

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

Company whichis not, by its terms, expressly junior to, or *paripassu* with, the Junior Notes. Under the terms of the Junior Notes,the holders may elect to increase the principal amount of the notes in lieu ofreceiving semi-annual interest payments in cash. The Junior Notes areconvertible into shares of Class A Common Stock, at an initial conversionprice equal to $7.29 per share. The Junior Indenture contains severalcovenants, including limitations on: (i) indebtedness; certain restrictedpayments; liens; transactions with affiliates; dividend and other paymentrestrictions affecting certain subsidiaries; guarantees by certainsubsidiaries; certain transactions including merger and asset sales; and (ii) certainrestrictions regarding the disposition of proceeds of asset sales.

During the first quarter of 2004,$2.7 million of the Company’s Junior Notes were converted into approximately371,500 shares of the Company’s Class A Common Stock.

During the second quarter of2004, in conjunction with the refinancing of the Company’s long-term debt, theCompany’s majority shareholder exchanged an additional $42.6 million inaggregate principal amount of the Company’s Junior Notes it controlled for42,633 shares of the Company’s 16% Series A Convertible Pay-in-kindPreferred Stock (the “PIK Preferred Shares”). For further discussion of theCompany’s PIK Preferred Shares, see Note 11 of the Consolidated FinancialStatements.

*Subsidiary Indebtedness*

Nanhai has a credit facility witha financial institution in China which is scheduled to mature in June 2005.The amount of outstanding indebtedness under the facility was $5.8 millionand $8.5 million at July 3, 2004 and January 3, 2004,respectively. The Nanhai indebtedness is guaranteed 100% by the Company and tosupport this guarantee, a letter of credit has been issued by the Company’sagent bank in the amount of $7.1 million.

The Company’s Argentina-basedmajority owned subsidiary (“DNS”) has two credit facilities denominated in U.S.dollars totaling approximately $1.8 million (all with current maturities)at July 3, 2004 and $3.4 million (with current maturities ofapproximately $3.1 million) at January 3, 2004, respectively.

**Note 8.**   IncomeTaxes

The Company recognized income taxexpense of $6.1 million for the six months ended July 3, 2004 on consolidatedincome before income taxes of $3.1 million for such period. This tax expense inexcess of income before income tax expense primarily resulted from income taxesattributable to the earnings generated by foreign operations as well as stateincome taxes in the United States, with no federal income tax benefit beingrecognized for the pre-tax losses incurred in the United States. During the sixmonths ended June 28, 2003, the Company recognized an income tax expenseof approximately $5.4 million.

The Company recognized income taxexpense of $3.6 million and $2.9 million during the quarters ended July 3,2004 and June 28, 2003, respectively. The income tax expense in 2003 wasin excess of statutory rates as no federal income tax benefit was recognizedfor the combined pre-tax losses incurred in the United States.

**Note 9.**   Pension Benefits and PostretirementPlans

The Company and its subsidiariessponsor multiple defined benefit plans and other postretirement benefits thatcover certain employees. Benefits are based on years of service and theemployee’s compensation. It is the Company’s policy to fund such plans inaccordance with applicable laws and regulations. The following disclosuresregarding defined benefit plans and other postretirement plans 

14

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

for the fiscal2003 period reflect the combined data of the Successor for the four monthsended June 28, 2003 with that of the Predecessor for the two months ended March 1,2003.

Components ofnet periodic benefit costs for the three and six months ended July 3, 2004and June 28, 2003 are as follows:
| ** **                                                | ** ** | **Pension Benefit Plans** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                | ** ** | **Three Months  Ended**   | ** ** | **Six Months  Ended** | ** ** |
| ** **                                                | ** ** | **July 3,  2004**         | ** ** | **June 28,  2003** | ** ** | **July 3,  2004** | ** ** | **June 28,  2003** | ** ** |
| Current service costs                                     |       | $                              | 570        |   | $ | 656 |   | $ | 1,160 |   | $ | 1,276 |   |
| Interest costs on  projected benefit obligation and other |       | 1,218                          |       | 1,301 |   | 2,471 |   | 2,535 |   |
| Return on plan assets                                     |       | (1,295                         | )          | (1,266 | ) | (2,629 | ) | (2,463 | ) |
| Amortization of  transition obligation and other          |       | (3                             | )          | 63 |   | (6 | ) | 122 |   |
| Periodic benefit cost, net                                |       | $                              | 490        |   | $ | 754 |   | $ | 996 |   | $ | 1,470 |   |

 
| ** **                                                | ** ** | **Postretirement Benefit Plans**   | ** ** |
|-----------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                | ** ** | **Three Months  Ended**       | ** ** | **Six Months  Ended** | ** ** |
| ** **                                                | ** ** | ** July 3,   2004** | ** ** | **June 28,  2003** | ** ** | ** July 3,   2004** | ** ** | **June 28,  2003** | ** ** |
| Current service costs                                     |       |                               | $          | 101 |   |   |   | $ | 98 |   |   |   | $ | 202 |   |   |   | $ | 196 |   |   |
| Interest costs on  projected benefit obligation and other |       |                               | 213        |   |   |   | 236 |   |   |   | 428 |   |   |   | 464 |   |   |
| Periodic benefit cost, net                                |       |                               | $          | 314 |   |   |   | $ | 334 |   |   |   | $ | 630 |   |   |   | $ | 660 |   |   |

 

As of July 3, 2004, theCompany contributed $4.1 million to its pension plans for the 2004 benefityear. The Company presently anticipates contributing an additional $2.3 millionto fund its pension plans in 2004 for a total of $6.4 million.

On December 8, 2003, theMedicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”)was enacted and introduced a prescription drug benefit under Medicare as wellas a subsidy to sponsors of retiree health care benefit plans. The Company haselected to defer the recognition of the Act until the authoritative guidance onthe accounting for the federal subsidy under the Act is issued. When theguidance is issued, the Company could be required to change previously reportedinformation. Any measure of the periodic benefit cost, benefit obligation andrelated disclosures for the U.S. and other postretirement benefit plans do notreflect the effect of the Act.

**Note 10.**   Stock Option Plans

On December 11, 2003, theCompany awarded the initial non-qualified stock options under the 2003 StockOption Plan (the “2003 Plan”). The 2003 Plan was approved by the Company’sBoard of Directors and is administered by the Compensation Committee of the Boardof Directors. The options have a ten-year life and vest, based on theachievement of various service and financial performance criteria, over afive-year period beginning January 1, 2004. As of  July 3, 2004, 400,000 shares of theCompany’s Class A common stock were reserved for issuance under the 2003Plan, of which 160,000 shares are available for future grants.

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” and permitted under Statement of Financial AccountingStandards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”).All options granted under the 2003 Plan had an 

15

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

exercise priceequal to the market value of the underlying common stock on the date of grant.However, as a percentage of the options vest based on achievement of financialperformance criteria, compensation costs will be recognized when it becomesprobable that such performance criteria will be achieved. Accordingly, duringthe three months and six months ended July 3, 2004, the Company recognizedcompensation expense associated with such plans of $180,000.

If the Company applied the fairvalue recognition provision of SFAS No. 123 to stock-based compensation asrequired by Statement of Financial Accounting Standard No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure” (“SFAS No. 148”),the amount of stock-based compensation would have approximately equaled theamount charged to operations. Therefore, no pro forma calculations of netincome (loss) and earnings (loss) per common share for the first six months of2004 are included herein. Since all stock options under plans approved prior to2003 were canceled as part of the Company’s emergence from Chapter 11, no proforma information is shown for 2003.

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

In conjunction with the Company’srefinancing of the Restructured Credit Facility, the Company’s majorityshareholder exchanged approximately $42.6 million in aggregate principal amountof the Junior Notes it controlled for 42,633 shares of the Company’s PIKPreferred Shares. The dividends on the PIK Preferred Shares accrue at an annualrate of 16% and are payable semi-annually in arrears on each January 1 andJuly 1, commencing with July 1, 2004, at the option of the Company, (i) throughthe issuance of additional shares of preferred stock; (ii) in cash; or (iii) ina combination thereof. Dividends are cumulative and accrue from the most recentdividend payment date to which dividends have been paid or, if no dividendshave been paid, from the date of original issuance.

On June 30, 2012, theCompany must redeem all of the PIK Preferred Shares then outstanding at a priceequal to $1,000 per share plus $1,000 per share for all unpaid dividendsthereon whether or not declared, which amount will be payable by the Company, (i) incash; (ii) through the issuance of shares of Class A Common Stock; or(iii) through a combination thereof. If paid in stock, the number ofshares to be delivered by the Company will be the mandatory redemption price(as defined earlier) divided by the then market price of a share of Class ACommon Stock.

At any time prior to to June 30,2012, the holders of the PIK Preferred Shares may elect to convert any or allof their PIK Preferred Shares into shares of the Company’s Class A CommonStock at a conversion price equal to $7.29 per share. Also, at any time prior toJune 30, 2012, provided certain conditions have been met, the Company mayelect to redeem the shares, which redemption price may be paid by the Company,(i) in cash; (ii) through the issuance of shares of Class A Common Stock; or(iii) through a combination thereof. If paid in stock, the number of shares tobe delivered by the Company will be the optional redemption price (as definedby the preferred stock agreement) divided by the then market price of a shareof Class A Common Stock.

As of July 3, 2004, theCompany accrued a dividend of approximately $1.3 million which is expected tobe settled in the form of additional PIK Preferred Shares.

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

The Company uses derivativefinancial instruments to manage market risks and reduce its exposure fromfluctuations in interest rates. All hedging transactions are authorized andexecuted under clearly defined policies and procedures, which prohibit the useof financial instruments for trading purposes. SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” as amended by SFAS No. 138,“Accounting for Certain Derivative Instruments and Certain Hedging 

16

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

Activities (anAmendment of SFAS No. 133)” requires the Company to recognize allderivatives on the balance sheet at fair value and establish criteria fordesignation and effectiveness of hedging relationships.

The Company uses interest-ratederivative instruments to manage its exposure on its debt instruments. Asindicated in Note 7 to the Consolidated Financial Statements, to mitigate itsinterest rate exposure as required by the Bank Facility, the Company enteredinto a pay-fixed, receive-variable interest rate swap, thus effectivelyconverting the interest payments associated with approximately 50% of the debtto fixed amounts at a LIBOR rate of 3.383%. As of July 3, 2004, thenotional amount of these contracts, which expire on May 8, 2007, was$212.5 million. Cash settlements are made quarterly and the floating rate isreset quarterly, coinciding with the reset dates of the Bank Facility debt.

In accordance with SFAS No. 133,the Company designated the swap as a cash flow hedge of the variability ofpayments under the senior secured term loans and applied the shortcut method ofassessing effectiveness. The agreement’s terms ensure complete effectiveness inoffsetting the interest component associated with the Bank Facility. As such,there is no ineffectiveness and changes in the fair value of the swap arerecorded to accumulated other comprehensive income (loss). The fair value ofthe interest rate swap as of July 3, 2004 of $0.6 million was based oncurrent settlement values and was recorded in *Othernoncurrent liabilities* on the Consolidated Balance Sheet.

The impact of the settlement ofthese swaps on *interest expense, net* for the three and six months ended July 3,2004 was an increase of $0.6 million.

**Note 13.**   SegmentInformation

The Company’s reportable marketsegments consist of Consumer and Industrial & Specialty reflecting themanagement of the Company’s business based on product sales. The Company alsomanages the business’ profitability based upon the Company’s primary operatingdivisions. Therefore, disclosures for the operating divisions have also beenpresented in the following table. Sales to P&G account for more than 10% ofthe Company’s sales in each of the periods presented. Sales to this customer arereported primarily in the Consumer market segment and the loss of these saleswould have a material adverse effect on this segment. Generally, the Company’snonwoven products can be manufactured on more than one type of production line.Accordingly, certain costs attributed to each segment of the business weredetermined on an allocation basis. Production times have a similar relationshipto net sales and the Company believes a reasonable basis for allocating certaincosts is the percent of net sales method for market segment data. During thethree and six months ended July 3, 2004, the three and four months ended June 28,2003 and the two months ended March 1, 2003, the Company recorded plantrealignment costs which have not been allocated to the segment data.Additionally, the arbitration settlement, net has not been allocated to thesegment data.

17

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

Financialdata by market segment is as follows (in thousands):
| ** **                                                               | ** ** | **Successor**                          | ** ** | **Predecessor**             | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|
| ** **                                                               | ** ** | **Three Months  Ended**           | ** ** | **Six Months  Ended**  | ** ** | **Four Months  Ended** | ** ** | **Two months  Ended** | ** ** |
| ** **                                                               | ** ** | ** July 3, 2004 ** | ** ** | **June 28, 2003** | ** ** | **July 3, 2004** | ** ** | **June 28, 2003** | ** ** | **March 1, 2003** | ** ** |
| **Net sales:**                                                           |       |                                   |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer                                                                 |       |                                   | $          | 110,496                     |       |   |   | $ | 108,637 |   |   |   | $ | 221,455 |   |   |   | $ | 143,681 |   |   |   | $ | 74,956 |   |   |
| Industrial & specialty                                          |       |                                   | 100,095    |                        |       |   | 90,120 |   |   |   | 195,879 |   |   |   | 119,143 |   |   |   | 57,953 |   |   |
|                                                                     |       |                                   | $          | 210,591                     |       |   |   | $ | 198,757 |   |   |   | $ | 417,334 |   |   |   | $ | 262,824 |   |   |   | $ | 132,909 |   |   |
| **Operating  income:**                                                   |       |                                   |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer                                                                 |       |                                   | $          | 3,590                       |       |   |   | $ | 3,514 |   |   |   | $ | 7,645 |   |   |   | $ | 5,184 |   |   |   | $ | 3,105 |   |   |
| Industrial & specialty                                          |       |                                   | 8,748      |                        |       |   | 5,516 |   |   |   | 16,038 |   |   |   | 7,105 |   |   |   | 2,725 |   |   |
|                                                                     |       |                                   | 12,338     |                        |       |   | 9,030 |   |   |   | 23,683 |   |   |   | 12,289 |   |   |   | 5,830 |   |   |
| Plant realignment costs                                                  |       |                                   | (656       | )                           |       |   | (2,408 | ) |   |   | (1,241 | ) |   |   | (2,416 | ) |   |   | (4 | ) |   |
| Arbitration settlement, net                                              |       |                                   | 13,394     |                        |       |   | — |   |   |   | 13,394 |   |   |   | — |   |   |   | — |   |   |
|                                                                     |       |                                   | $          | 25,076                      |       |   |   | $ | 6,622 |   |   |   | $ | 35,836 |   |   |   | $ | 9,873 |   |   |   | $ | 5,826 |   |   |
| **Depreciation  and amortization expense included in operating income:** |       |                                   |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer                                                                 |       |                                   | $          | 7,792                       |       |   |   | $ | 7,394 |   |   |   | $ | 15,401 |   |   |   | $ | 10,082 |   |   |   | $ | 4,375 |   |   |
| Industrial & specialty                                          |       |                                   | 5,030      |                        |       |   | 4,854 |   |   |   | 10,098 |   |   |   | 6,037 |   |   |   | 3,012 |   |   |
|                                                                     |       |                                   | $          | 12,822                      |       |   |   | $ | 12,248 |   |   |   | $ | 25,499 |   |   |   | $ | 16,119 |   |   |   | $ | 7,387 |   |   |
| ** **                                                               | ** ** | ** **                             | ** ** | ** **                  | ** ** | ** July 3, 2004 ** | ** ** | **January 3, 2004** | ** ** | ** ** | ** ** |
| **Identifiable assets (including intangible  assets):**                  |       |                                   |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer                                                                 |       |                                   |       |                        |       |   |   |   |   |   | $ | 375,920 |   |   |   | $ | 392,419 |   |   |   |   |   |   |
| Industrial & specialty                                          |       |                                   |       |                        |       |   |   |   |   |   | 332,507 |   |   |   | 321,851 |   |   |   |   |   |   |
| Corporate                                                                |       |                                   |       |                        |       |   |   |   |   |   | 5,195 |   |   |   | 7,040 |   |   |   |   |   |   |
|                                                                     |       |                                   |       |                        |       |   |   |   |   |   | $ | 713,622 |   |   |   | $ | 721,310 |   |   |   |   |   |   |

 

18

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

Financialdata by operating division is as follows (in thousands):
| ** **                                                              | ** ** | **Successor**                          | ** ** | **Predecessor**             | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|
| ** **                                                              | ** ** | **Three Months  Ended**           | ** ** | **Six Months  Ended**  | ** ** | **Four Months  Ended** | ** ** | **Two months  Ended** | ** ** |
| ** **                                                              | ** ** | ** July 3, 2004 ** | ** ** | **June 28, 2003** | ** ** | **July 3, 2004** | ** ** | **June 28, 2003** | ** ** | **March 1, 2003** | ** ** |
| **Net sales:**                                                          |       |                                   |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Nonwovens                                                               |       |                                   | $          | 164,257                     |       |   |   | $ | 158,320 |   |   | $ | 328,471 |   |   | $ | 208,395 |   |   |   | $ | 108,373 |   |   |
| Oriented Polymers                                                       |       |                                   | 46,442     |                        |       |   | 40,437 |   |   | 89,091 |   |   | 54,429 |   |   |   | 24,536 |   |   |
| Eliminations                                                            |       |                                   | (108       | )                           |       |   | — |   |   | (228 | ) |   | — |   |   |   | — |   |   |
|                                                                    |       |                                   | $          | 210,591                     |       |   |   | $ | 198,757 |   |   | $ | 417,334 |   |   | $ | 262,824 |   |   |   | $ | 132,909 |   |   |
| **Operating income:**                                                   |       |                                   |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Nonwovens                                                               |       |                                   | $          | 11,839                      |       |   |   | $ | 10,810 |   |   | $ | 23,774 |   |   | $ | 14,167 |   |   |   | $ | 7,852 |   |   |
| Oriented Polymers                                                       |       |                                   | 4,688      |                        |       |   | 2,739 |   |   | 8,226 |   |   | 3,797 |   |   |   | 1,461 |   |   |
| Unallocated Corporate                                                   |       |                                   | (4,231     | )                           |       |   | (4,483 | ) |   | (8,707 | ) |   | (5,511 | ) |   |   | (3,598 | ) |   |
| Eliminations                                                            |       |                                   | 42         |                        |       |   | (36 | ) |   | 390 |   |   | (164 | ) |   |   | 115 |   |   |
|                                                                    |       |                                   | 12,338     |                        |       |   | 9,030 |   |   | 23,683 |   |   | 12,289 |   |   |   | 5,830 |   |   |
| Plant realignment costs                                                 |       |                                   | (656       | )                           |       |   | (2,408 | ) |   | (1,241 | ) |   | (2,416 | ) |   |   | (4 | ) |   |
| Arbitration settlement, net                                             |       |                                   | 13,394     |                        |       |   | — |   |   | 13,394 |   |   | — |   |   |   | — |   |   |
|                                                                    |       |                                   | $          | 25,076                      |       |   |   | $ | 6,622 |   |   | $ | 35,836 |   |   | $ | 9,873 |   |   |   | $ | 5,826 |   |   |
| **Depreciation and amortization expense included in operating income:** |       |                                   |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Nonwovens                                                               |       |                                   | $          | 10,501                      |       |   |   | $ | 10,133 |   |   | $ | 21,073 |   |   | $ | 13,610 |   |   |   | $ | 5,766 |   |   |
| Oriented Polymers                                                       |       |                                   | 1,998      |                        |       |   | 2,077 |   |   | 4,072 |   |   | 2,743 |   |   |   | 1,349 |   |   |
| Unallocated Corporate                                                   |       |                                   | 387        |                        |       |   | — |   |   | 764 |   |   | (272 | ) |   |   | 272 |   |   |
| Eliminations                                                            |       |                                   | (64        | )                           |       |   | 38 |   |   | (410 | ) |   | 38 |   |   |   | — |   |   |
|                                                                    |       |                                   | $          | 12,822                      |       |   |   | $ | 12,248 |   |   | $ | 25,499 |   |   | $ | 16,119 |   |   |   | $ | 7,387 |   |   |
| ** **                                                              | ** ** | ** **                             | ** ** | ** **                  | ** ** | **July 3, 2004** | ** ** | ** January 3, 2004 ** | ** ** | ** ** | ** ** |
| **Identifiable  assets (including intangible assets):**                 |       |                                   |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Nonwovens                                                               |       |                                   |       |                        |       |   |   |   |   | $ | 683,905 |   |   | $ | 708,595 |   |   |   |   |   |   |
| Oriented Polymers                                                       |       |                                   |       |                        |       |   |   |   |   | 145,097 |   |   | 147,075 |   |   |   |   |   |   |
| Corporate                                                               |       |                                   |       |                        |       |   |   |   |   | 5,195 |   |   | 7,040 |   |   |   |   |   |   |
| Eliminations                                                            |       |                                   |       |                        |       |   |   |   |   | (120,575 | ) |   | (141,400 | ) |   |   |   |   |   |
|                                                                    |       |                                   |       |                        |       |   |   |   |   | $ | 713,622 |   |   | $ | 721,310 |   |   |   |   |   |   |

 

19

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

Geographic Data:

Geographicdata for the Company’s operations is presented in the following table (inthousands):
| ** **                                                                      | ** ** | **Successor**                    | ** ** | **Predecessor**                   | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|-----------------------------------|------------|
| ** **                                                                      | ** ** | **Three Months  Ended**     | ** ** | **Six Months  Ended**        | ** ** | **Four Months  Ended** | ** ** | **Two months  Ended** | ** ** |
| ** **                                                                      | ** ** | ** July 3, 2004** | ** ** | ** June 28, 2003** | ** ** | **July 3, 2004** | ** ** | **June 28, 2003** | ** ** | **March 1, 2003** | ** ** |
| **Net sales:**                                                             |       |                             |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States                                                                   |       |                             | $          | 93,698                            |       |   |   | $ | 83,737 |   |   |   | $ | 184,044 |   |   |   | $ | 111,878 |   |   |   | $ | 58,992 |   |   |
| Canada                                                                          |       |                             | 27,723     |                              |       |   | 26,781 |   |   |   | 56,315 |   |   |   | 35,815 |   |   |   | 16,416 |   |   |
| Europe                                                                          |       |                             | 49,225     |                              |       |   | 53,348 |   |   |   | 100,695 |   |   |   | 69,177 |   |   |   | 33,936 |   |   |
| Asia                                                                            |       |                             | 8,803      |                              |       |   | 7,880 |   |   |   | 15,621 |   |   |   | 10,020 |   |   |   | 4,773 |   |   |
| Latin America                                                                   |       |                             | 31,142     |                              |       |   | 27,011 |   |   |   | 60,659 |   |   |   | 35,934 |   |   |   | 18,792 |   |   |
|                                                                            |       |                             | $          | 210,591                           |       |   |   | $ | 198,757 |   |   |   | $ | 417,334 |   |   |   | $ | 262,824 |   |   |   | $ | 132,909 |   |   |
| **Operating  income (loss):**                                                   |       |                             |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States                                                                   |       |                             | $          | 126                               |       |   |   | $ | (2,324 | ) |   |   | $ | (649 | ) |   |   | $ | (3,073 | ) |   |   | $ | (1,582 | ) |   |
| Canada                                                                          |       |                             | 2,104      |                              |       |   | 1,365 |   |   |   | 4,029 |   |   |   | 2,182 |   |   |   | 1,233 |   |   |
| Europe                                                                          |       |                             | 3,965      |                              |       |   | 5,558 |   |   |   | 8,410 |   |   |   | 6,635 |   |   |   | 2,330 |   |   |
| Asia                                                                            |       |                             | 1,056      |                              |       |   | 832 |   |   |   | 1,600 |   |   |   | 1,081 |   |   |   | 848 |   |   |
| Latin America                                                                   |       |                             | 5,087      |                              |       |   | 3,599 |   |   |   | 10,293 |   |   |   | 5,464 |   |   |   | 3,001 |   |   |
|                                                                            |       |                             | 12,338     |                              |       |   | 9,030 |   |   |   | 23,683 |   |   |   | 12,289 |   |   |   | 5,830 |   |   |
| Plant realignment costs                                                         |       |                             | (656       | )                                 |       |   | (2,408 | ) |   |   | (1,241 | ) |   |   | (2,416 | ) |   |   | (4 | ) |   |
| Arbitration settlement, net                                                     |       |                             | 13,394     |                              |       |   | — |   |   |   | 13,394 |   |   |   | — |   |   |   | — |   |   |
|                                                                            |       |                             | $          | 25,076                            |       |   |   | $ | 6,622 |   |   |   | $ | 35,836 |   |   |   | $ | 9,873 |   |   |   | $ | 5,826 |   |   |
| **Depreciation  and amortization expense included in operating income (loss):** |       |                             |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States                                                                   |       |                             | $          | 6,093                             |       |   |   | $ | 6,164 |   |   |   | $ | 11,917 |   |   |   | $ | 8,155 |   |   |   | $ | 3,658 |   |   |
| Canada                                                                          |       |                             | 1,454      |                              |       |   | 1,510 |   |   |   | 2,957 |   |   |   | 1,978 |   |   |   | 950 |   |   |
| Europe                                                                          |       |                             | 2,252      |                              |       |   | 2,180 |   |   |   | 4,595 |   |   |   | 2,839 |   |   |   | 1,166 |   |   |
| Asia                                                                            |       |                             | 998        |                              |       |   | 903 |   |   |   | 1,992 |   |   |   | 1,178 |   |   |   | 628 |   |   |
| Latin America                                                                   |       |                             | 2,025      |                              |       |   | 1,491 |   |   |   | 4,038 |   |   |   | 1,969 |   |   |   | 985 |   |   |
|                                                                            |       |                             | $          | 12,822                            |       |   |   | $ | 12,248 |   |   |   | $ | 25,499 |   |   |   | $ | 16,119 |   |   |   | $ | 7,387 |   |   |
| ** **                                                                      | ** ** | ** **                       | ** ** | ** **                        | ** ** | ** July 3, 2004 ** | ** ** | **January 3, 2004** | ** ** | ** ** | ** ** |
| **Identifiable assets (including intangible  assets):**                         |       |                             |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States                                                                   |       |                             |       |                              |       |   |   |   |   |   | $ | 171,435 |   |   |   | $ | 155,685 |   |   |   |   |   |   |
| Canada                                                                          |       |                             |       |                              |       |   |   |   |   |   | 98,708 |   |   |   | 106,428 |   |   |   |   |   |   |
| Europe                                                                          |       |                             |       |                              |       |   |   |   |   |   | 265,547 |   |   |   | 279,269 |   |   |   |   |   |   |
| Asia                                                                            |       |                             |       |                              |       |   |   |   |   |   | 35,415 |   |   |   | 37,987 |   |   |   |   |   |   |
| Latin America                                                                   |       |                             |       |                              |       |   |   |   |   |   | 142,517 |   |   |   | 141,941 |   |   |   |   |   |   |
|                                                                            |       |                             |       |                              |       |   |   |   |   |   | $ | 713,622 |   |   |   | $ | 721,310 |   |   |   |   |   |   |

 

20

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

**Note 14.**   ForeignCurrency and Other

Components of foreign currency and other are shown in the table below(in thousands):
| ** **                                                                   | ** ** | **Successor**                                        | ** ** | **Predecessor**                                       | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **Three Months  Ended  July 3, 2004** | ** ** | **Three Months  Ended  June 28, 2003** | ** ** | **Six Months  Ended  July 3, 2004** | ** ** | **Four Months  Ended  June 28, 2003** | ** ** | **Two Months  Ended  March 1, 2003** | ** ** |
| Foreign currency loss (gain)                                                 |       |                                                 | $          | 740                                                   |       |   |   | $ | (648 | ) |   |   | $ | 2,017 |   |   |   | $ | (847 | ) |   |   | $ | 1,814 |   |   |
| Write-off of loan  acquisition costs related to Restructured Credit Facility |       |                                                 | 5,022      |                                                  |       |   | — |   |   |   | 5,022 |   |   |   | — |   |   |   | — |   |   |
| Other, net                                                                   |       |                                                 | (30        | )                                                     |       |   | 29 |   |   |   | 79 |   |   |   | (3 | ) |   |   | (380 | ) |   |
|                                                                         |       |                                                 | $          | 5,732                                                 |       |   |   | $ | (619 | ) |   |   | $ | 7,118 |   |   |   | $ | (850 | ) |   |   | $ | 1,434 |   |   |

 

**Note 15.**   Earnings Per Share and Shareholders’Equity

The following is a reconciliation of basic netearnings per common share to diluted net earnings per common share for thequarter ended July 3, 2004 (in thousands, except per share data):
| ** **                                                           | ** ** | **Earnings Available  to Common  Shareholders  (EPS Numerator)** | ** ** | **Average Shares  Outstanding  (EPS Denominator)** | ** ** | **Earnings Per  Common Share** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|------------------------------------------|------------|
| Basic                                                                |       |                                                                            | $          | 4,452                                                        |       |                                     |       | 9,823.8 |   |   |   | $ | 0.45 |   |   |
| Adjustments:                                                         | ** ** |                                                                            |       |                                                         |       |                                     |       |   |   |   |   |   |   |
| Convertible debt and PIK  preferred shares                           |       |                                                                            | 1,754      |                                                         |       |                                     | 7,303.7    |   |   |   |   |   |   |
| Potential shares  exercisable under stock option plans               |       |                                                                            |       |                                                         |       |                                     | 241.6      |   |   |   |   |   |   |
| Less: shares which could  be repurchased under treasury stock method |       |                                                                            |       |                                                         |       |                                     | (226.7     | ) |   |   |   |   |   |
| Diluted                                                              |       |                                                                            | $          | 6,206                                                        |       |                                     |       | 17,142.4 |   |   |   | $ | 0.36 |   |   |

 

No calculations have been presented for the six monthsended July 3, 2004, the four months ended June 28, 2003 or the threemonths ended June 28, 2003 as the impact of such calculations would beanti-dilutive. Average shares outstanding were 9,305,423, 8,644,973 and8,645,650 for each of those periods, respectively. No calculation has beenpresented for the two months ended March 1, 2003 as there were noconvertible or potentially dilutive securities in existence during that period.Average shares outstanding were 32,004,000 for the two months ended March 1,2003.

As of July 3, 2004, theCompany’s authorized capital stock consisted of the following classes of stock:
| **Type**                               | ** ** | **Par Value** | ** ** | **Authorized Shares** | ** ** |
|----------------------------------------|------------|--------------------|------------|----------------------------|------------|
| PIK Preferred stock                    |       |               | $          | .01                        |       |   |   | 173,000 |   |   |
| Class A common  stock             |       |               | $          | .01                        |       |   |   | 39,200,000 |   |   |
| Class B convertible  common stock |       |               | $          | .01                        |       |   |   | 800,000 |   |   |
| Class C convertible  common stock |       |               | $          | .01                        |       |   |   | 118,453 |   |   |
| Class D convertible  common stock |       |               | $          | .01                        |       |   |   | 498,688 |   |   |
| Class E convertible common  stock |       |               | $          | .01                        |       |   |   | 523,557 |   |   |

 

All classes of the common stock have similar votingrights. In accordance with the Amended and Restated Certificate of Incorporation,Class C common stock has special rights to annual dividends 

21

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

and all shares of Class B, C, Dand E common stock may be converted into an equal number of shares of Class Acommon stock. See Note 11 for additional information related to the Company’sPIK Preferred Stock.

In April 2004, the United States Bankruptcy Courtfor the District of South Carolina resolved certain pending claims filed againstthe Company in connection with the Modified Plan and, as a result, approved theissuance of 1,327,177 shares of the Company’s Class A Common Stock and19,359 shares of the Company’s Class C Common Stock which were issued on apro rata basis to holders of the Predecessor Company’s Class 4 GeneralUnsecured Claims per the Predecessor Company’s Chapter 11 Plan ofReorganization. If these shares had been outstanding for all Successor periodspresented, the pro forma earnings (losses) available per common share would be$0.41 (basic) and $0.34 (diluted) for the three months ended July 3, 2004and $(1.11) (basic and diluted) for the three months ended June 28, 2003.If these shares had been outstanding for all Successor periods presented, thepro forma net loss per common share for the six months ended July 3, 2004and the four months ended June 28, 2003 would have been $(0.42) per shareand $(1.25) per share, respectively.

**Note 16.**   Legal Proceedings

On August 18, 2003 an affiliate (“Affiliate”) ofthe former Chief Executive Officer of the Company filed a claim seeking damagesassociated with a lease agreement and an alleged services agreement, betweenthe Company and the Affiliate, associated with the lease by the Company of itsformer corporate headquarters and the provision of shared administrativeservices. The damages sought in the complaint total $7.7 million, plusattorney’s fees. The Company believes that the ultimate outcome will not have amaterial adverse effect on its financial position or results of operations.

On April 23, 2002, the Company filed a demand forarbitration against Johnson & Johnson (J&J). The primary issue inthe arbitration was the Company’s assertion that J&J breached a supplyagreement when J&J and certain of its affiliates failed to purchase certainproducts from the Company and to allow the Company a reasonable opportunity tocompete for certain sales. On June 28, 2004, the Company entered into anew supply agreement with a subsidiary of J&J. The Company also ended thearbitration and received approximately $17.0 million from J&J as settlementof the arbitration issues. Net settlement proceeds of $13.4 million, afterproviding for $3.6 million of costs and expenses associated with thearbitration, were included in *Operating income*in the three months ended July 3, 2004.

**Note 17.**   Supplemental Cash Flow Information

Noncash transactions in the first six months of 2004included the issuance of 1,327,177 shares of the Company’s Class A CommonStock and 19,359 shares of the Company’s Class C Common Stock inaccordance with the ruling of the United States Bankruptcy Court for theDistrict of South Carolina, the conversion of $2.7 million of the Company’sJunior Notes into approximately 371,500 shares of the Company’s Class ACommon Stock, the exchange of $42.6 million of the Company’s Junior Notes intoapproximately 42,633 shares of the Company’s PIK Preferred Shares and theaccrual of $1.3 million of dividends on the PIK Preferred Shares.

**Note 18.**   SubsequentEvent

On June 4, 2004, the Company commenced an offerto exchange PIK Preferred Shares for its remaining Junior Notes. Through July 13,2004, which is the date that the exchange offer concluded, approximately $10.1million of the Junior Notes were tendered in exchange for PIK Preferred Shares.

22

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL 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 period ended January 3,2004.

For accounting purposes, theCompany recognized the emergence from Chapter 11 on March 1, 2003, whichwas the end of the February accounting period. For purposes of discussionof results of operations, the four months ended June 28, 2003 (Successor)has been combined with two months ended March 1, 2003 (Predecessor).

**Results of Operations**

The followingtable sets forth the percentage relationships to net sales of certain incomestatement items.
| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                  | ** ** | **July 3,  2004**           | ** ** | **June 28,  2003**        | ** ** | **July 3,  2004** | ** ** | **June 28,  2003** | ** ** |
| Net sales                                                   |       | 100.0                            | %          |                           | 100.0      | % |   | 100.0 | % |   | 100.0 | % |   |
| Cost of goods sold                                          |       |                             |       |                           |       |   |   |   |   |   |   |   |   |
| Materials                                                   |       | 48.3                             |       |                           | 47.1       |   |   | 47.4 |   |   | 46.9 |   |   |
| Labor                                                       |       | 9.8                              |       |                           | 10.1       |   |   | 9.9 |   |   | 10.2 |   |   |
| Overhead                                                    |       | 24.4                             |       |                           | 25.9       |   |   | 24.6 |   |   | 26.0 |   |   |
|                                                        |       | 82.5                             |       |                           | 83.1       |   |   | 81.9 |   |   | 83.1 |   |   |
| Gross profit                                                |       | 17.5                             |       |                           | 16.9       |   |   | 18.1 |   |   | 16.9 |   |   |
| Selling, general and  administrative expenses               |       | 11.7                             |       |                           | 12.4       |   |   | 12.4 |   |   | 12.3 |   |   |
| Plant realignment costs                                     |       | 0.3                              |       |                           | 1.2        |   |   | 0.3 |   |   | 0.6 |   |   |
| Arbitration settlement,  net                                |       | (6.4                             | )          |                           | —     |   |   | (3.2 | ) |   | — |   |   |
| Operating income                                            |       | 11.9                             |       |                           | 3.3        |   |   | 8.6 |   |   | 4.0 |   |   |
| Other expense (income):                                     |       |                             |       |                           |       |   |   |   |   |   |   |   |   |
| Interest expense, net                                       |       | 4.5                              |       |                           | 7.5        |   |   | 5.9 |   |   | 7.4 |   |   |
| Minority interests                                          |       | 0.3                              |       |                           | 0.3        |   |   | 0.3 |   |   | 0.3 |   |   |
| Foreign currency and other                                  |       | 2.7                              |       |                           | (0.3       | ) |   | 1.7 |   |   | 0.1 |   |   |
|                                                        |       | 7.5                              |       |                           | 7.5        |   |   | 7.9 |   |   | 7.8 |   |   |
| Income (loss) before  reorganization items and income taxes |       | 4.4                              |       |                           | (4.2       | ) |   | 0.7 |   |   | (3.8 | ) |   |
| Reorganization items                                        |       | —                           |       |                           | —     |   |   | — |   |   | 136.6 |   |   |
| Income (loss) before  income tax expense                    |       | 4.4                              |       |                           | (4.2       | ) |   | 0.7 |   |   | 132.8 |   |   |
| Income tax expense                                          |       | 1.7                              |       |                           | 1.4        |   |   | 1.4 |   |   | 1.4 |   |   |
| Net income (loss)                                           |       | 2.7                              |       |                           | (5.6       | ) |   | (0.7 | ) |   | 131.4 |   |   |
| Accrued dividends on PIK  preferred shares                  |       | 0.6                              |       |                           | —     |   |   | 0.3 |   |   | — |   |   |
| Earnings (losses) available for  common shareholders        |       | 2.1                              | %          |                           | (5.6       | )% |   | (1.0 | )% |   | 131.4 | % |   |

 

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**Comparison of Three Months Ended July 3, 2004 andJune 28, 2003**

The followingtable sets forth components of the Company’s net sales and operating income bymarket segment and operating division for the three months ended July 3,2004 and the corresponding change over the comparable period in 2003 (in millions):
| ** **                      | ** ** | **Three Months Ended** | ** ** | ** **              | ** ** |
|---------------------------------|------------|----------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **July 3,  2004**           | ** ** | **June 28,  2003** | ** ** | ** Change ** | ** ** |
| Market Segments:                |       |                             |       |                    |       |   |   |   |   |
| Net Sales                       |       |                             |       |                    |       |   |   |   |   |
| Consumer                        |       | $                                | 110.5      |                    | $          | 108.6 |   |   | $ | 1.9 |   |   |
| Industrial & Specialty |       | 100.1                            |       | 90.2                    |       |   | 9.9 |   |   |
|                            |       | $                                | 210.6      |                    | $          | 198.8 |   |   | $ | 11.8 |   |   |
| Operating Income                |       |                             |       |                    |       |   |   |   |   |
| Consumer                        |       | $                                | 3.6        |                    | $          | 3.5 |   |   | $ | 0.1 |   |   |
| Industrial & Specialty |       | 8.7                              |       | 5.5                     |       |   | 3.2 |   |   |
|                            |       | 12.3                             |       | 9.0                     |       |   | 3.3 |   |   |
| Plant realignment costs         |       | (0.6                             | )          | (2.4                    | )          |   | 1.8 |   |   |
| Arbitration settlement, net     |       | 13.4                             |       | —                  |       |   | 13.4 |   |   |
|                            |       | $                                | 25.1       |                    | $          | 6.6 |   |   | $ | 18.5 |   |   |
| Operating Divisions:            |       |                             |       |                    |       |   |   |   |   |
| Net Sales                       |       |                             |       |                    |       |   |   |   |   |
| Nonwovens                       |       | $                                | 164.3      |                    | $          | 158.3 |   |   | $ | 6.0 |   |   |
| Oriented Polymers               |       | 46.4                             |       | 40.5                    |       |   | $ | 5.9 |   |   |
| Eliminations                    |       | (0.1                             | )          | —                  |       |   | (0.1 | ) |   |
|                            |       | $                                | 210.6      |                    | $          | 198.8 |   |   | $ | 11.8 |   |   |
| Operating Income                |       |                             |       |                    |       |   |   |   |   |
| Nonwovens                       |       | $                                | 11.8       |                    | $          | 10.8 |   |   | $ | 1.0 |   |   |
| Oriented Polymers               |       | 4.7                              |       | 2.7                     |       |   | 2.0 |   |   |
| Unallocated Corporate           |       | (4.2                             | )          | (4.5                    | )          |   | 0.3 |   |   |
| Eliminations                    |       | —                           |       | —                  |       |   | — |   |   |
|                            |       | 12.3                             |       | 9.0                     |       |   | 3.3 |   |   |
| Plant realignment costs         |       | (0.6                             | )          | (2.4                    | )          |   | 1.8 |   |   |
| Arbitration settlement, net     |       | 13.4                             |       | —                  |       |   | 13.4 |   |   |
|                            |       | $                                | 25.1       |                    | $          | 6.6 |   |   | $ | 18.5 |   |   |

 

The amounts for plant realignmentcosts and arbitration settlement, net have not been allocated to the Company’sreportable business segments, for reporting purposes, because the Company’smanagement does not evaluate such charges or income on a segment-by-segmentbasis. Segment operating performance is measured and evaluated before unusualor special items.

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**Net Sales**

Areconciliation of the change in net sales between the three months ended July 3,2004 and the three months ended June 28, 2003 is presented in the followingtable (in millions):
| Net sales—three months  ended June 28, 2003 |   | $      | 198.8  |   |
|-------------------------------------------------------|--------|--------|--------|--------|
| Change in sales due to:                               |   |   |   |
| Volume                                                |   | 8.2    |   |
| Price/mix                                             |   | 4.2    |   |
| Foreign currency                                      |   | 3.0    |   |
| Businesses sold/exited                                |   | (3.6   | )      |
| Net sales—three months ended  July 3, 2004  |   | $      | 210.6  |   |

 

Consolidated net sales were approximately$210.6 million for the three months ended July 3, 2004, an increaseof $11.8 million or 5.9% over the prior year comparable period. The increase innet sales was due primarily to increased sales volume, especially in the UnitedStates and Latin America, improvement in sales price/mix due partially tohigher material costs as well as the strengthening of foreign currencies,predominantly the Euro and the Canadian dollar, versus the U.S. dollar. Theseincreases were partially offset by decreases associated with businesses exitedor sold.

Consumer net sales were $110.5 million in thethree months ended July 3, 2004 compared to $108.6 million in 2003,an increase of $1.9 million or 1.8%. This segment’s sales were positivelyimpacted by increased volumes in the United States and Latin America, offset bydecreased volumes in Europe. Industrial & Specialty net sales were$100.1 million for the three months ended July 3, 2004 compared to$90.2 million in the comparable period of 2003, an increase of$9.9 million or 11.0%. The largest drivers of the quarter-to-quarterincrease were increased volumes and an improved mix of sales, especially inOriented Polymers.

Nonwovens net sales were $164.3 million in the threemonths ended July 3, 2004 compared to $158.3 million in 2003, an increaseof $6.0 million or 3.8%. Within the nonwovens business, higher sales volume inthe U.S. hygiene and the Latin American hygiene and industrial markets wereoffset by volume losses in Asian hygiene and U.S. medical. The 2004 nonwovenssales were also favorably impacted by the strengthening of the Euro versus theU.S. dollar. Oriented Polymers net sales increased $5.9 million in thequarter-to-quarter comparison and benefited from higher volumes, an improved price/mixof sales and the strengthening of the Canadian dollar versus the U.S. dollar.

**OperatingIncome**

Areconciliation of the change in operating income between the three months endedJuly 3, 2004 and June 28, 2003 is presented in the following table(in millions):
| Operating income—three  months ended June 28, 2003 |   | $      | 6.6    |   |
|--------------------------------------------------------------|--------|--------|--------|--------|
| Change in operating income due to:                           |   |   |   |
| Arbitration settlement, net                                  |   | 13.4   |   |
| Price/mix                                                    |   | 4.2    |   |
| Volume                                                       |   | 2.3    |   |
| Lower plant realignment costs                                |   | 1.8    |   |
| Lower manufacturing costs                                    |   | 0.3    |   |
| Foreign currency                                             |   | 0.2    |   |
| Businesses sold/exited                                       |   | — |   |
| Higher raw material costs                                    |   | (3.4   | )      |
| Higher depreciation and amortization                         |   | (0.6   | )      |
| All other, primarily SG&A costs                          |   | 0.3    |   |
| Operating income—three months  ended July 3, 2004  |   | $      | 25.1   |   |

 

25

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Consolidated operating income was$25.1 million in the three months ended July 3, 2004 as compared to$6.6 million in 2003. The improvement in operating income in the currentquarter was positively impacted by the $17.0 million arbitration settlementwhich was received during the quarter and reported as operating income net of$3.6 million of legal and other associated arbitration costs. An improved price/mixas well as increased volumes also contributed favorably to operating income inthe second quarter of 2004. Although the Company charged to operating income$0.6 million of plant realignment costs during the second quarter of 2004, thatamount was $1.8 million lower than the $2.4 million in the second quarter of2003. Offsetting these favorable impacts were higher raw material costs of$3.4 million, predominantly in the U.S. and Canadian businesses and higherdepreciation and amortization charges due to the expansion efforts in 2003.

**Interest Expense and Other**

Interest expense decreased$5.6 million from $15.0 million during the three months ended June 28,2003 to $9.4 million during the same period in 2004. The decrease isprimarily due to the lower interest rates obtained by refinancing the Company’sprevious Restructured Credit Facility with the new Senior Secured Bank Facility(“Bank Facility”), effective April 27, 2004. In conjunction with theCompany’s refinancing, the Company’s majority shareholder exchanged on April 27,2004 approximately $42.6 million in aggregate principal amount of the 10%Convertible Subordinated Notes due 2007 (the “Junior Notes”) for 42,633 sharesof the Company’s 16% Series A Convertible Pay-in-kind Preferred Stock (the“PIK Preferred Shares”), which also contributed to lower interest costs duringthe period. If the refinancing and the exchange occurred at the beginning ofthe current quarter, the Company would have realized an approximate $1.8million reduction in interest expense. Foreign currency and other expenseincreased approximately $6.3 million, from $(0.6) million during thethree months ended June 28, 2003 to $5.7 million for the comparableperiod in 2004, primarily due to the $5.0 million write-off of loan acquisitioncosts related to the refinancing of the Company’s previous Restructured CreditFacility.

**Income Taxes**

The Company recognized income taxexpense of $3.6 million for the three months ended July 3, 2004 onconsolidated income before income taxes of $9.4 million for such period. Thiseffective rate of 38.9% resulted from income taxes accrued on the earningsgenerated by foreign operations as well as state income taxes recognized onsuch taxable income in the United States. During the three months ended June 28,2003, the Company recognized an income tax expense of approximately $2.9million.

**Net Income(Loss)**

The Company’s net income duringthe three months ended July 3, 2004 was approximately $5.7 million asa result of the factors described above, as compared to a net loss of$11.1 million during the comparable period in 2003.

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**Comparison of Six Months Ended July 3, 2004 and June 28,2003**

The followingtable sets forth components of the Company’s net sales and operating income bymarket segment and operating division for the six months ended July 3,2004 and the corresponding change over the comparable period in 2003 (inmillions):
| ** **                      | ** ** | **Six Months Ended** | ** ** | ** **              | ** ** |
|---------------------------------|------------|--------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **July 3,  2004**         | ** ** | **June 28,  2003** | ** ** | **Change** | ** ** |
| Market Segments:                |       |                           |       |                    |       |   |   |
| Net Sales                       |       |                           |       |                    |       |   |   |
| Consumer                        |       | $                              | 221.4      |                    | $          | 218.6 |   | $ | 2.8 |   |
| Industrial & Specialty |       | 195.9                          |       | 177.1                   |       | 18.8 |   |
|                            |       | $                              | 417.3      |                    | $          | 395.7 |   | $ | 21.6 |   |
| Operating Income                |       |                           |       |                    |       |   |   |
| Consumer                        |       | $                              | 7.6        |                    | $          | 8.3 |   | $ | (0.7 | ) |
| Industrial & Specialty |       | 16.0                           |       | 9.8                     |       | 6.2 |   |
|                            |       | 23.6                           |       | 18.1                    |       | 5.5 |   |
| Plant realignment costs         |       | (1.2                           | )          | (2.4                    | )          | 1.2 |   |
| Arbitration settlement, net     |       | 13.4                           |       | —                  |       | 13.4 |   |
|                            |       | $                              | 35.8       |                    | $          | 15.7 |   | $ | 20.1 |   |
| Operating Divisions:            |       |                           |       |                    |       |   |   |
| Net Sales                       |       |                           |       |                    |       |   |   |
| Nonwovens                       |       | $                              | 328.5      |                    | $          | 316.8 |   | $ | 11.7 |   |
| Oriented Polymers               |       | 89.1                           |       | 78.9                    |       | 10.2 |   |
| Eliminations                    |       | (0.3                           | )          | —                  |       | (0.3 | ) |
|                            |       | $                              | 417.3      |                    | $          | 395.7 |   | $ | 21.6 |   |
| Operating Income                |       |                           |       |                    |       |   |   |
| Nonwovens                       |       | $                              | 23.8       |                    | $          | 22.0 |   | $ | 1.8 |   |
| Oriented Polymers               |       | 8.2                            |       | 5.2                     |       | 3.0 |   |
| Unallocated Corporate           |       | (8.7                           | )          | (9.1                    | )          | 0.4 |   |
| Eliminations                    |       | 0.3                            |       | —                  |       | 0.3 |   |
|                            |       | 23.6                           |       | 18.1                    |       | 5.5 |   |
| Plant realignment costs         |       | (1.2                           | )          | (2.4                    | )          | 1.2 |   |
| Arbitration settlement, net     |       | 13.4                           |       | —                  |       | 13.4 |   |
|                            |       | $                              | 35.8       |                    | $          | 15.7 |   | $ | 20.1 |   |

 

The amounts for plant realignmentcosts and arbitration settlement, net have not been allocated to the Company’sreportable business segments, for reporting purposes, because the Company’smanagement does not evaluate such charges or income on a segment-by-segmentbasis. Segment operating performance is measured and evaluated before unusualor special items.

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**Net Sales**

Areconciliation of the change in net sales between the six months ended July 3,2004 and the six months ended June 28, 2003 is presented in the followingtable (in millions):
| Net sales—six months ended  June 28, 2003 |   | $      | 395.7  |   |
|-----------------------------------------------------|--------|--------|--------|--------|
| Change in sales due to:                             |   |   |   |
| Foreign currency                                    |   | 13.9   |   |
| Volume                                              |   | 10.7   |   |
| Price/mix                                           |   | 4.5    |   |
| Businesses sold/exited                              |   | (7.5   | )      |
| Net sales—six months ended  July 3, 2004  |   | $      | 417.3  |   |

 

Consolidated net sales were approximately$417.3 million for the six months ended July 3, 2004, an increase of$21.6 million or 5.5% over the prior year comparable period. The increase innet sales was due primarily to the strengthening of foreign currencies, predominantlythe Euro and the Canadian dollar, versus the U.S. dollar and increased salesvolume, partially offset by decreases associated with businesses exited orsold.

Consumer net sales were $221.4 million in thefirst six months of 2004 compared to $218.6 million in 2003, an increaseof $2.8 million or 1.3%. This segment’s sales were positively impacted byforeign currencies, predominantly in Europe, where the Euro was strongeragainst the U.S. dollar during 2004 compared to 2003. Increased sales volumes inLatin America and the U.S. were offset by declines in Europe. Industrial &Specialty net sales were $195.9 million in the first six months of 2004compared to $177.1 million in the first six months of 2003, an increase of$18.8 million or 10.6%. The year-to-year increase was due to volumeincreases and the strengthening of the Euro and the Canadian dollar compared tothe U.S. dollar.

Nonwovens net sales were $328.5million in the first six months of 2004 compared to $316.8 million in 2003, anincrease of $11.7 million or 3.7%. Within the nonwovens business, higher salesvolume in the U.S. hygiene and Latin American medical and hygiene markets wereoffset by volume losses in Asian hygiene and U.S. medical. The 2004 nonwovenssales were also favorably impacted by the strengthening of the Euro versus theU.S. dollar. Oriented Polymers net sales increased $10.2 million due to salesvolume increases, improved price/mix as well as the strengthening of theCanadian dollar versus the U.S. dollar.

**OperatingIncome**

Areconciliation of the change in operating income between the six months ended July 3,2004 and June 28, 2003 is presented in the following table (in millions):
| Operating income—six  months ended June 28, 2003 |   | $      | 15.7   |   |
|------------------------------------------------------------|--------|--------|--------|--------|
| Change in operating income due to:                         |   |   |   |
| Arbitration settlement, net                                |   | 13.4   |   |
| Lower manufacturing costs                                  |   | 6.1    |   |
| Price/mix                                                  |   | 4.5    |   |
| Volume                                                     |   | 3.2    |   |
| Foreign currency                                           |   | 1.2    |   |
| Lower plant realignment costs                              |   | 1.2    |   |
| Businesses sold/exited                                     |   | 0.1    |   |
| Higher raw material costs                                  |   | (6.7   | )      |
| Higher depreciation and amortization                       |   | (2.0   | )      |
| All other, primarily SG&A costs                        |   | (0.9   | )      |
| Operating income—six months  ended July 3, 2004  |   | $      | 35.8   |   |

 

28

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Consolidated operating income was$35.8 million in the first six months of 2004 as compared to$15.7 million in the first six months of 2003. The improvement inoperating income in the first six months was positively impacted by the $17.0million arbitration settlement which was received during the second quarter andreported as operating income net of $3.6 million of legal and other associatedarbitration costs. The improvement to operating income due to lowermanufacturing costs reflects the benefit of the Company’s ongoing efforts toreduce spending and improve operating efficiency. Increased volumes, the strengtheningof foreign currencies versus the U.S. dollar and lower plant realignmentcharges also contributed favorably to operating income in the first six monthsof 2004. Offsetting these favorable impacts were higher raw material costs of$6.7 million, predominantly in the U.S. and Canadian businesses, higherdepreciation and amortization charges due to the expansion efforts in 2003 andincreased selling, general and administrative expenses, which were primarilyrelated to first quarter year-over-year spending.

**Interest Expense and Other**

Interest expense decreased$4.9 million from $29.4 million during the six months ended June 28,2003 to $24.5 million during the same period in 2004. The decrease isprimarily due to the lower interest rates obtained by refinancing the Company’sprevious Restructured Credit Facility with the new Bank Facility, effective April 27,2004. In conjunction with the Company’s refinancing, the Company’s majorityshareholder exchanged on April 27, 2004 approximately $42.6 million inaggregate principal amount of the Junior Notes for 42,633 shares of PIKPreferred Shares, which also contributed to lower interest costs during theperiod. If the refinancing and the exchange occurred at the beginning of thecurrent fiscal year, the Company would have realized an approximate $8.6 millionreduction in interest expense. Foreign currency and other expense increasedapproximately $6.5 million, from $0.6 million during the six monthsended June 28, 2003 to $7.1 million for the comparable period in 2004.Approximately $5.0 million of the increase in foreign currency and otherexpense was due to the write-off of the loan acquisition costs related to therefinancing of the Company’s previous Restructured Credit Facility.

**Chapter 11 Reorganization Items**

The Company recognized a net gainof $540.5 million from reorganization items upon its emergence from Chapter 11during the first six months of 2003. These reorganization items primarilyincluded gains on cancellation of prepetition indebtedness of $619.9 million,offset by fresh start adjustments of $47.5 million and other costs associatedwith the reorganization of $31.9 million.

**Income Taxes**

The Company recognized income taxexpense of $6.1 million for the six months ended July 3, 2004 onconsolidated income before income taxes of $3.1 million for such period. Theincome tax expense in excess of income before income taxes primarily resultedfrom income taxes accrued on the earnings generated by foreign operations as wellas state income taxes in the United States, with no federal income tax benefitbeing recognized for the pre-tax losses incurred in the United States. Duringthe six months ended June 28, 2003, the Company recognized an income taxexpense of approximately $5.4 million.

**Net Income(Loss)**

The Company’s net loss during thesix months ended July 3, 2004 was approximately $3.0 million as aresult of the factors described above, as compared to a net income of$519.9 million during the comparable period in 2003.

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**Liquidity and Capital Resources**

The Company’s principal sourcesof liquidity for operations and expansions are funds generated internally andborrowings under the Company’s Bank Facility which provides for securedrevolving credit borrowings with aggregate commitments of up to $50.0 millionand aggregate term loans of $425.0 million. 
| ** **                                                                | ** ** | **July 3,  2004** | ** ** | **January 3,  2004** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                | ** ** | **(In Millions)** | ** ** |
| Balance sheet data:                                                       |       |                   |       |                      |       |   |   |
| Cash and cash equivalents                                                 |       | $                      | 20.9       |                      |       | $ | 21.3 |   |   |
| Working capital                                                           |       | 163.4                  |       |                      | 119.1      |   |   |
| Working capital, excluding current portion of long-term debt              |       | 168.6                  |       |                      | 153.1      |   |   |
| Total assets                                                              |       | 713.6                  |       |                      | 721.3      |   |   |
| Total debt                                                                |       | 443.2                  |       |                      | 483.4      |   |   |
| PIK Preferred Shares, expected to be settled with shares of common  stock |       | 43.9                   |       |                      | —     |   |   |
| Shareholders’ equity                                                 |       | 53.6                   |       |                      | 59.2       |   |   |
|                                                                           |            |                        |            |                           |            |  |  |  |  |

 
| ** **                                          | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------|------------|--------------------------------|------------|
| ** **                                          | ** ** | **July 3,  2004**         | ** ** | **June 28,  2003** | ** ** |
| ** **                                          | ** ** | **(In Millions)**         | ** ** |
| Cash flow data:                                     |       |                           |       |   |   |   |   |
| Net cash provided by (used in) operating activities |       | $                              | 16.8       |   |   | $ | (8.3 | ) |   |
| Net cash used in investing activities               |       | (8.1                           | )          |   | (2.7 | ) |   |
| Net cash used in  financing activities              |       | (9.0                           | )          |   | (16.7 | ) |   |
|                                                     |            |                                |            |  |  |  |  |  |  |

 

**Operating Activities**

Net cash provided by operating activities was$16.8 million during the six months ended July 3, 2004, anapproximate $25.1 million improvement from the $8.3 million used in operatingactivities during the six months ended June 28, 2003. The currentsix-month period was positively impacted by improved operating results and thenet arbitration settlement of $13.4 million, with such impacts being partiallyoffset by increases in working capital. The Company continues to have access toa $50.0 million revolving credit facility to help it to meet short-term cashrequirements. Generally, the Company strives to keep borrowings under itsrevolving credit facility at a minimum.

The Company had working capital,excluding the current portion of long-term debt, of $168.6 million at July 3,2004, compared to $153.1 million at January 3, 2004. Accounts receivableon July 3, 2004 were $127.0 million as compared to$121.1 million on January 3, 2004, an increase of $5.9 million,primarily due to higher sales during the quarter. Accounts receivablerepresented approximately 55 days of sales outstanding at July 3,2004 versus approximately 60 days of sales outstanding on January 3,2004. Inventories at July 3, 2004 were approximately $101.4 million,an increase of $4.9 million from inventories at January 3, 2004 of$96.5 million. The Company had inventory representing approximately53 days of cost of sales on hand at July 3, 2004 versus approximately59 days of cost of sales on hand at January 3, 2004. Accounts payable at July 3,2004 was $58.1 million as compared to $57.1 million on January 3, 2004, anincrease of $1.0 million. The Company had accounts payable representingapproximately 31 days of cost of sales outstanding at July 3, 2004,compared to approximately 35 days of cost of sales outstanding at January 3,2004.

**Investing and Financing Activities**

Cash used in investing activities amounted to $8.1 millionduring the six months ended July 3, 2004, compared to the $2.7 millionduring the six months ended June 28, 2003. Capital expenditures 

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during the first six months of2004 totaled $8.9 million, a decrease of $5.7 million from capitalspending of $14.6 million during the same period in fiscal 2003. Investingactivities during the first six months of 2004 and 2003 included proceeds fromthe sale of assets of $0.8 million and $11.9 million, respectively.

Cash used in financing activitiesamounted to $9.0 million during the six months ended July 3, 2004,compared to the $16.7 million during the six months ended June 28, 2003.During the first six months of 2004, the Company received net proceeds of $3.3million under its credit facilities, whereas the Company used $15.0 million ofcash to pay down its debt during the comparable period of 2003. In addition,the Company paid $12.2 million of loan acquisition costs during the six monthsended July 3, 2004, compared to $1.7 million during the same period of2003.

**LiquiditySummary**

As discussed in Note 7 to the Consolidated FinancialStatements, on April 27, 2004, the Company entered into its Bank Facilityconsisting of a $50.0 million revolving credit facility maturing in 2009, a$300.0 million senior secured first lien term loan that matures in 2010 and a$125.0 million senior secured second-lien term loan maturing in 2011. Theproceeds therefrom were used to fully repay indebtedness outstanding under theCompany’s previous Restructured Credit Facility and pay related fees andexpenses. The senior secured first lien term loan requires quarterly paymentsof $750,000 beginning in September 2004 and accrues interest at LIBOR plus325 basis points. The senior secured second lien term loan accrues interest atLIBOR plus 625 basis points. The revolving credit facility initially bearsinterest at LIBOR plus 300 basis points. The Bank Facility provides the Companywith increased flexibility in terms of cash availability, less stringentrequirements for covenant compliance, extended maturity dates and substantiallyreduced net cash interest costs.

The Bank Facility contains covenants and events ofdefault customary in financings of this type, including leverage and interestexpense coverage. The Bank Facility requires the Company to use a percentage ofproceeds from excess cash flows, as defined by the agreement, to reduce itsdebt balances. Additionally, in accordance with the terms of the Bank facility,the Company entered a cash flow hedge agreement, effectively converting$212.5 million of notional principal amount of debt from a variable LIBORrate to a fixed LIBOR rate of 3.383%. The cash flow hedge agreement terminateson May 8, 2007.

In conjunction with the Company’s refinancing of theRestructured Credit Facility, the Company’s majority shareholder exchangedapproximately $42.6 million in aggregate principal amount of the Junior Notesit controlled for 42,633 shares of the Company’s PIK Preferred Shares. Thedividends on the PIK Preferred Shares accrue at an annual rate of 16% and arepayable semi-annually in arrears on each January 1 and July 1,commencing with July 1, 2004, at the option of the Company, (i) throughthe issuance of additional shares of preferred stock; (ii) in cash; or (iii) ina combination thereof. Dividends are cumulative and accrue from the most recentdividend payment date to which dividends have been paid or, if no dividendshave been paid, from the date of original issuance.

On June 30, 2012, the Company must redeem all ofthe PIK Preferred Shares then outstanding at a price equal to $1,000 per shareplus $1,000 per share for all unpaid dividends thereon whether or not declared,which amount will be payable by the Company, (i) in cash; (ii) throughthe issuance of shares of Class A Common Stock; or (iii) through acombination thereof. If paid in stock, the number of shares to be delivered bythe Company will be the mandatory redemption price (as defined earlier) dividedby the then market price of a share of Class A Common Stock.

At any time prior to to June 30, 2012, theholders of the PIK Preferred Shares may elect to convert any or all of theirPIK Prefereed Shares into shares of the Company’s Class A Common Stock ata conversion price equal to $7.29 per share. Also, at any time prior to June 30,2012, provided certain conditions have been met, the Company may elect toredeem the shares, which redemption price may be paid by the Company, (i) incash; (ii) through the issuance of shares of Class A Common Stock; or 

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(iii) through a combinationthereof. If paid in stock, the number of shares to be delivered by the Companywill be the optional redemption price (as defined by the preferred stockagreement) divided by the then market price of a share of Class A Common Stock.The Company currently expects to settle the mandatory or optional redemptionwith the issuance of shares of Class A Common Stock.

Based on the ability to generateworking capital through its operations and the improved financial flexibilityprovided by the Bank Facility, the Company believes that it has the financialresources necessary to meet its operating needs, fund its capital expendituresand make all necessary contributions to its retirement plans. Additionally,based on the the refinancing of its debt and the exchange of its Junior Notesto PIK Preferred Shares, the Company believes that it has significantly reducedits cash interest costs, improved its financial flexibility and strengthenedits financial position.

**Effect ofInflation**

Inflation generally affects theCompany by increasing the cost of labor, overhead and equipment. The impact ofinflation on the Company’s financial position and results of operations wasminimal during the first six months of 2003 and 2004.

**Critical Accounting Policies And Other Matters**

The Company’s analysis and discussion of its financialposition and results of operations are based upon its consolidated financialstatements that have been prepared in accordance with generally acceptedaccounting principles 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 sales returnsand allowances and credit risks, inventories, income taxes, impairment of long-livedassets, pension and other post retirement benefits and contingencies. Estimatesand assumptions are based on historical and other factors believed to bereasonable under the circumstances. The impact and any associated risks relatedto estimates, assumptions, and accounting policies are discussed withinManagement’s Discussion and Analysis of Operations and Financial Condition, aswell as in the Notes to the Consolidated Financial Statements, if applicable,where such estimates, assumptions, and accounting policies affect the Company’sreported and expected results.

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

*Fresh Start Accounting:**  *Inconnection with the Company’s Chapter 11 reorganization, the Company hasapplied Fresh Start Accounting (as defined herein) to its consolidated balancesheet as of March 1, 2003 in accordance with Statement of Position No. 90-7,“Financial Reporting by Entities in Reorganization Under the Bankruptcy Code”as promulgated by the AICPA. Under Fresh Start Reporting, a new reportingentity is considered to be created and the recorded amounts of assets andliabilities are adjusted to reflect their estimated fair values at the dateFresh Start Accounting is applied. On March 5, 2003, the Company emergedfrom bankruptcy. For financial reporting purposes, March 1, 2003 isconsidered the emergence date and the effects of the reorganization have beenreflected in the accompanying financial statements as if the emergence occurredon that date.

The reorganization value of the Company’s new commonequity at March 1, 2003 of approximately $73.4 million was determinedbased on an independent valuation by financial specialists after considerationof multiple factors and by using various valuation methodologies and evaluatingother relevant industry information. The reorganization value of the Companywas allocated to the 

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various assets and liabilitiesbased on their respective fair values pursuant to Fresh Start Accountingprinciples. The calculated reorganization value of the Company was based on avariety of estimates and assumptions about future circumstances and events.Such estimates and assumptions are inherently subject to significant economicuncertainties.

*Revenue Recognition:**  *Revenuefrom product sales is recognized at the time ownership of goods transfers tothe customer and the earnings process is complete in accordance with StaffAccounting Bulletin (“SAB”) No. 101, “Revenue Recognition in FinancialStatements”, as updated by SAB No. 104, “Revenue Recognition.” Sales returnsand allowances, a component of net sales, are recorded in the period in whichthe related sales are recorded. Management bases its estimate of the expense tobe recorded each period on historical returns and allowance levels. Managementdoes not believe the likelihood is significant that materially higher deductionlevels will result based on prior experience.

*Accounts Receivable and Concentration of Credit Risks:**   Accounts*receivable 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.At July 3, 2004, a reserve of $12.5 million has been recorded as anallowance against trade accounts receivable. Management believes that theallowance is adequate to cover potential losses resulting from uncollectibleaccounts receivable and deductions resulting from sales returns and allowances.

*Inventory Reserves:**  *TheCompany maintains reserves for inventories valued using the first in, first out(FIFO) method. Such reserves for inventories can be specific to certaininventory or general based on judgments about the overall condition of theinventory. General reserves are established based on percentage write-downsapplied to inventories aged for certain time periods. Specific reserves areestablished based on a determination of the obsolescence of the inventory andwhether the inventory value exceeds amounts to be recovered through expectedsales price, less selling costs. Estimating sales prices, establishing markdownpercentages and evaluating the condition of the inventories require judgmentsand estimates, which may impact the inventory valuation and gross margins.Management believes based on its prior experience of managing and evaluatingthe recoverability of its slow moving or obsolete inventory that suchestablished reserves are materially adequate.

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

For assets held for disposal, an impairment charge 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 

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impairment loss, which wouldimpact the impairment charge ultimately recognized and the Company’s cashflows.

*Benefit Plans:**  *TheCompany has pension and post retirement costs and obligations which aredependent on assumptions used by actuaries in calculating such amounts. Theseassumptions include discount rates, inflation, salary growth, long-term returnon plan assets, retirement rates, mortality rates and other factors. While theCompany believes that the assumptions used are appropriate, significantdifferences in actual experience or significant changes in assumptions wouldaffect its pension costs and obligations.

*IncomeTaxes:**  *TheCompany records an income tax valuation allowance when the realization ofcertain deferred tax assets, net operating losses and capital loss carryforwards is not likely. These deferred tax items represent expenses recognizedfor financial reporting purposes, which will result in tax deductions overvarying future periods. The Company has not provided U.S. income taxes forundistributed earnings of foreign subsidiaries that are considered to beretained indefinitely for reinvestment. Certain judgments, assumptions andestimates may affect the carrying value of the valuation allowance and deferredincome tax expense in the Company’s consolidated financial statements.

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

The overall objective of theCompany’s financial risk management program is to seek a reduction in thepotential negative earnings impact of changes in interest rates, foreignexchange and raw material pricing arising in our business activities. TheCompany manages these financial exposures through operational means and byusing various financial instruments. These practices may change as economicconditions change.

**Long-Term Debt and Interest Rate Market Risk**

The Company’s long-termborrowings are variable interest rate debt. As such, the Company’s interestexpense will increase as interest rates rise and decrease as interest ratesfall. It is the Company’s policy to enter into interest rate derivativetransactions only to meet its stated overall objective. The Company does notenter into these transactions for speculative purposes. To that end, theCompany entered into an interest rate swap contract to convert $212.5 millionof its variable-rate debt to fixed-rate debt. In addition, the Company includesshort-term borrowings in its debt portfolio, especially in foreign countries,in an effort to minimize interest rate risk. Hypothetically, a 1% change in theinterest rate affecting all of the Company’s financial instruments notprotected by the interest rate swap contract would change interest expense byapproximately $2.3 million.

**Foreign Currency Exchange Rate Risk**

The Company manufactures, markets and distributescertain of its products in Europe, Canada, Latin America and the Far East. As aresult, the Company’s financial statements could be significantly affected byfactors such as changes in foreign currency rates in the foreign markets inwhich the Company maintains a manufacturing or distribution presence. However,such currency fluctuations have much less effect on local operating resultsbecause the Company, to a significant extent, sells its products within thecountries in which they are manufactured. During 2003 and the first six monthsof 2004, certain currencies of countries in which the Company conducts foreigncurrency denominated business strengthened against the U.S. dollar and had asignificant impact on sales and operating income. See “Management’s Discussionand Analysis of Financial Condition and Results of Operations” included in Item2 of Part 1 of this Quarterly Report on Form 10-Q.

The Company has not historicallyhedged its exposure to foreign currency risk, although it has mitigated itsrisk of currency losses on foreign monetary assets by sometimes borrowing inforeign 

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currencies as anatural hedge. The Company is also subject to political risk in certain of itsforeign operations.

**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 and polyethylene are a function of, among otherthings, manufacturing capacity, demand and the price of crude oil and naturalgas liquids. The Company has not historically hedged its exposure to rawmaterial increases, but has attempted to move more customer programs tocost-plus type contracts, which would allow the Company to pass-throughany cost increases in raw materials. Raw material prices as a percentage ofsales have increased slightly from 46.9% in the first six months of 2003 to47.4% for the comparable period of 2004.

To the extent the Company is notable to pass along price increases of raw materials, or to the extent any suchprice increases are delayed, the Company’s cost of goods sold would increaseand its operating profit would correspondingly decrease. By way of example, ifthe price of polypropylene were to rise $.01 per pound, and the Company was notable to pass along any of such increase to its customers, the Company wouldrealize a decrease of approximately $2.0 million, on an annualized basis,in its reported operating income. Material increases in raw material pricesthat cannot be passed on to customers could have a material adverse effect onthe Company’s results of operations and financial condition. See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included in Item 2 of Part 1 of this Quarterly Report on Form 10-Q.

**ITEM 4. CONTROLS AND PROCEDURES**

Under the direction of our Chief Executive Officer andChief Financial Officer, the Company evaluated its disclosure controls andprocedures as of the end of the period covered by this report. Based on thatevaluation, the Chief Executive Officer and Chief Financial Officer haveconcluded that these disclosure controls and procedures were effective as of July 3,2004.

There were no changes in theCompany’s internal controls over financial reporting during the quarter ended July 3,2004 that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal controls over financial reporting.

**PART II. OTHER INFORMATION**

**ITEM 1. LEGAL PROCEEDINGS**

On August 18, 2003 an affiliate (“Affiliate”) ofthe former Chief Executive Officer of the Company filed a claim seeking damagesassociated with a lease agreement and an alleged services agreement, betweenthe Company and the Affiliate, associated with the lease by the Company of itsformer corporate headquarters and the provision of shared administrativeservices. The damages sought in the complaint total $7.7 million, plusattorney’s fees. The Company believes that the ultimate outcome will not have amaterial adverse effect on its financial position or results of operations.

On April 23, 2002, theCompany filed a demand for arbitration against J&J. The primary issue inthe arbitration was the Company’s assertion that J&J breached a supplyagreement when J&J and certain of its affiliates failed to purchase certainproducts from the Company and to allow the Company a reasonable opportunity tocompete for certain sales. On June 28, 2004, the Company entered into anew supply agreement with a subsidiary of J&J. The Company also ended thearbitration and received approximately $17.0 million from J&J as settlementof the arbitration issues. Net settlement proceeds of $13.4 million, afterproviding for $3.6 million of costs and expenses associated with thearbitration, were included in *Operating income*in the three months ended July 3, 2004.

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**ITEM 2. CHANGES IN SECURITIES**

During the first six months of fiscal2004, $2.7 million of the Company’s Junior Notes were converted intoapproximately 371,500 shares of the Company’s Class A Common Stock at theconversion rate of 137.14286 shares per $1,000 of Junior Notes. In addition,$42.6 million of the Company’s Junior Notes were exchanged for approximately42,633 shares of the Company’s PIK Preferred Shares. Also, 1,327,177 shares ofthe Company’s Class A Common Stock and 19,359 shares of the Company’s Class CCommon Stock were issued in accordance with the ruling from the United StatesBankruptcy Court for the District of South Carolina.

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

Not applicable.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

The Shareholders of theCompany at their Annual Meeting held on May 5, 2004, considered and votedto adopt and approve the following matters:

·       Theelection of 7 directors for one year terms or until their successors are dulyelected and qualified (“Proposal 1”).
| **Name of Director** | ** ** | ** ** | ** ** | **Votes in Favor** | ** ** | **Votes Withheld** | ** ** |
|--------------------------------|------------|------------|------------|------------------------------|------------|-------------------------|------------|
| Pedro Arias                    |       |       | 6,685,240  |                         |       |                    | 63,932     |   |   |
| Ramon Betolaza                 |       |       | 6,685,240  |                         |       |                    | 63,932     |   |   |
| Lap Wai Chan                   |       |       | 6,685,240  |                         |       |                    | 63,932     |   |   |
| William B. Hewitt              |       |       | 6,685,240  |                         |       |                    | 63,932     |   |   |
| Eugene Linden                  |       |       | 6,685,240  |                         |       |                    | 63,932     |   |   |
| James Ovenden                  |       |       | 6,685,240  |                         |       |                    | 63,932     |   |   |
| Michael Watzky                 |       |       | 6,685,240  |                         |       |                    | 63,932     |   |   |

 

·       Theapproval of the 2003 Employee Stock Option Plan (“Proposal 2”). The stockoption plan provides for grants of stock options to eligible officers and otheremployees of the Company. The purpose of the stock option plan is to providethese individuals with incentives to maximize shareholder value and otherwisecontribute to the success of the Company and to enable the Company to attract,retain and reward the best available persons for positions of responsibility.
| ** ** | **Votes in Favor** | ** ** | ** ** | ** ** | **Votes Against** | ** ** | ** ** | ** ** | **Votes Abstaining** | ** ** | ** ** |
|------------|------------------------------|------------|------------|------------|------------------------|------------|------------|------------|---------------------------|------------|------------|
| 6,732,240  |                         | 16,854     |       | 68         |                   |

 

·       Theapproval of the 2004 Restricted Stock Plan for the Company’s directors (“Proposal3”). The restricted stock plan provides for grants of restricted stock optionsto eligible Directors of the Company. The purpose of the restricted stock planis to provide these individuals with incentives to maximize shareholder valueand otherwise contribute to the success of the Company and to enable theCompany to attract, retain and reward the best available persons to serve asDirectors.
| ** ** | **Votes in Favor** | ** ** | ** ** | ** ** | **Votes Against** | ** ** | ** ** | ** ** | **Votes Abstaining** | ** ** | ** ** |
|------------|------------------------------|------------|------------|------------|------------------------|------------|------------|------------|---------------------------|------------|------------|
| 6,732,320  |                         | 16,789     |       | 53         |                   |

 

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**ITEM 5. OTHER INFORMATION**

Notapplicable.

**ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K**

**(a)****           Exhibits**

Exhibitsrequired to be filed with this Form 10-Q are listed below:
| **Exhibit  Number** | ** ** | **Document Description**                                                                                 |
|---------------------|------------|----------------------------------------------------------------------------------------------------------|
| 31.1                |       | Certification of Chief Executive Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 |
| 31.2                |       | Certification of Chief Financial Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 |
| 32.1                |       | Certification by the Chief Executive Officer pursuant to 18 U.S.C.  Section 1350                    |
| 32.2                |       | Certification by the Chief Financial Officer pursuant to 18 U.S.C.  Section 1350                    |

 

**(b)****          Reportson Form 8-K During the Quarter Ended July 3, 2004**

On April 30, 2004, the Company filed a report on Form 8-Krelated to the new senior secured bank facility consisting of a $50.0 millionrevolving credit facility maturing in 2009, a $300.0 million senior securedfirst-lien term loan that matures in 2010 and a $125.0 million senior securedsecond-lien term loan maturing in 2011. In conjunction with the refinancing,the Company’s majority shareholder exchanged approximately $42.6 million inaggregate principal amount of the Company’s 10% Convertible Subordinated Notesdue 2007 (together with accrued interest thereon) for 42,633 shares of theCompany’s 16% Series A Convertible Pay-in-kind Preferred Stock.

On May 11, 2004, the Company filed a report on Form 8-K,which included the press release for the period ended April 3, 2004. Alsoincluded in this filing are the condensed consolidated balance sheet and theconsolidated statement of operations for the fiscal first quarter ended April 3,2004, the one month ended March 29, 2003 and the two months ended March 1,2003.

On June 4, 2004, the Company filed a report on Form 8-Krelated to the offer to exchange all of its 10% Convertible Notes due 2007, inthe aggregate outstanding principal amount of $9.7 million, for 9,707 shares ofthe Company’s Series A Preferred Stock.

On June 29, 2004, the Company filed a report on Form 8-Krelated to the commencement of a new supply agreement, which will terminate on March 31,2007, with Johnson & Johnson Consumer Products Company, Inc. andthe settlement of the arbitration that was initiated by the Company againstJohnson & Johnson (“J&J”). The Company received a payment ofapproximately $17.0 million, which was used by the Company to pay certain costsand expenses associated with the arbitration, with the balance used for generalcorporate purposes, which may include the repayment of outstandingindebtedness.

 

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**SIGNATURES**

Pursuant tothe requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                            | Polymer Group, Inc. |
|----------------------------|--------------------------|
|                       |                     |   |
| Date: August 16, 2004 | By:                      | /s/ James L. Schaeffer |
|                       | * *                 | James L. Schaeffer*Chief Executive Officer* |
| * *                   | * *                 | * * |
| Date: August 16, 2004 | By:                      | /s/ Willis C. Moore III |
|                       | * *                 | Willis C. Moore III*Chief Financial Officer* |
| * *                   | * *                 | * * |

 

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