**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**For thequarterly period ended July 1, 2006**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**For thetransition period from               to               **

**Commissionfile number: 1-14330**

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**POLYMER GROUP, INC.**

(Exact name of registrant asspecified in its charter)

| **Delaware**                                                     |   | **57-1003983**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
| **9335  Harris Corners Parkway, Suite 300**                 |   | ** **                            |
| **Charlotte,  North Carolina**                                   |   | **28269**                             |
| (Address of principal  executive offices)                        |   | (Zip Code)                            |

 

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

Former name, former address and former fiscal year, ifchanged from last report:

**4055 Faber Place Drive, Suite 201, North Charleston, SouthCarolina 29405**

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.   Yes x   No o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):

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

 

Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).   Yes o   No x

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

On August 2, 2006 therewere 19,121,229 shares of Class A common stock, 139,433 sharesof Class B common stock and 24,319 shares of Class C commonstock outstanding. No shares of Class D or Class E common stock wereoutstanding as of such date. The par value for each class of common stock is$.01 per share.

 

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**POLYMERGROUP, INC.**

**INDEX TO FORM 10-Q**

|                                                      | **Page**                                                                                    |
|------------------------------------------------------|---------------------------------------------------------------------------------------------|
| IMPORTANT INFORMATION  REGARDING THIS FORM 10-Q |                                                                                        | 2 |   |
| **PART I.**                                     | **FINANCIAL INFORMATION**                                                                   |   |   |   |
| Item 1.                                         | Financial Statements                                                                        |   | 3 |   |
| Item 2.                                         | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |   | 29 |   |
| Item 3.                                         | Quantitative and Qualitative  Disclosures About Market Risk                                 |   | 47 |   |
| Item 4.                                         | Controls and Procedures                                                                     |   | 48 |   |
| **PART II.**                                    | **OTHER INFORMATION**                                                                       |   |   |   |
| Item 1.                                         | Legal Proceedings                                                                           |   | 49 |   |
| Item 1A.                                        | Risk Factors                                                                                |   | 49 |   |
| Item 2.                                         | Unregistered Sales of Equity  Securities and Use of Proceeds                                |   | 50 |   |
| Item 3.                                         | Defaults Upon Senior  Securities                                                            |   | 50 |   |
| Item 4.                                         | Submission of Matters To a  Vote of Security Holders                                        |   | 50 |   |
| Item 5.                                         | Other Information                                                                           |   | 51 |   |
| Item 6.                                         | Exhibits                                                                                    |   | 51 |   |
| Signatures                                           |                                                                                        | 52 |   |

 

1

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**IMPORTANT INFORMATIONREGARDING THIS FORM 10-Q**

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

**SafeHarbor-Forward-Looking Statements**

From time to time, the Company may publish forward-lookingstatements relative to matters such as, including, without limitation,anticipated financial performance, business prospects, technologicaldevelopments, new product introductions, cost savings, research and developmentactivities and similar matters. The Private Securities Litigation Reform Act of1995 provides a safe harbor for forward-looking statements. Forward-lookingstatements are generally accompanied by words such as “estimate,” “project,” “predict,”“believe,” “expect,” “anticipate” or other words that convey the uncertainty offuture events or outcomes.

Various statements contained in this report, includingthose that express a belief, expectation or intention, as well as those thatare not statements of historical fact are, or may be deemed to be, forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. These forward-looking statements speak only as of the date ofthis report. Unless required by law, the Company does not undertake anyobligation to update these statements and cautions against any undue relianceon them. These forward-looking statements are based on currentexpectations and assumptions about future events. While management considersthese expectations and assumptions to be reasonable, they are inherentlysubject to significant business, economic, competitive, regulatory and otherrisks, contingencies and uncertainties, most of which are difficult to predictand many of which are beyond the Company’s control. See Item 1A. “RiskFactors” in the Company’s Annual Report on Form 10-K. There can beno assurances that these events will occur or that the Company’s results willbe as estimated.

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

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

·       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;

·       changesin environmental laws and regulations;

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

·       Inabilityto achieve successful start-up on new production lines;

·       domesticand foreign competition;

·       relianceon major customers and suppliers; and

·       risksrelated to operations in foreign jurisdictions.

2

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**ITEM 1.**                 FINANCIALSTATEMENTS

**POLYMERGROUP, INC.CONSOLIDATED BALANCE SHEETS (Unaudited)(In Thousands, Except Share Data)**

| ** **                                                                                                                                                             | ** ** | **July 1,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                             | ** ** | ** **             | ** ** |                        | ** ** | ** ** |   |
| Current assets:                                                                                                                                                        |       |                   |       |                        |       |   |   |
| Cash and cash  equivalents                                                                                                                                             |       | $                      | 19,523     |                        |       | $ | 30,963 |   |   |
| Accounts receivable,  net                                                                                                                                              |       | 126,297                |       |                        | 120,668    |   |   |
| Inventories                                                                                                                                                            |       | 125,630                |       |                        | 119,663    |   |   |
| Deferred income taxes                                                                                                                                                  |       | 2,921                  |       |                        | 4,364      |   |   |
| Other current assets                                                                                                                                                   |       | 27,248                 |       |                        | 23,094     |   |   |
| Total current assets                                                                                                                                                   |       | 301,619                |       |                        | 298,752    |   |   |
| Property, plant and  equipment, net                                                                                                                                    |       | 438,198                |       |                        | 421,997    |   |   |
| Intangibles and loan  acquisition costs, net                                                                                                                           |       | 35,789                 |       |                        | 37,329     |   |   |
| Deferred income taxes                                                                                                                                                  |       | 348                    |       |                        | 433        |   |   |
| Other assets                                                                                                                                                           |       | 10,250                 |       |                        | 6,490      |   |   |
| Total assets                                                                                                                                                           |       | $                      | 786,204    |                        |       | $ | 765,001 |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                         | ** ** | ** **             | ** ** |                        | ** ** | ** ** |   |
| Current liabilities:                                                                                                                                                   |       |                   |       |                        |       |   |   |
| Short-term borrowings                                                                                                                                                  |       | $                      | 4,878      |                        |       | $ | 5,101 |   |   |
| Accounts payable                                                                                                                                                       |       | 90,385                 |       |                        | 82,371     |   |   |
| Accrued liabilities                                                                                                                                                    |       | 36,716                 |       |                        | 32,235     |   |   |
| Income taxes payable                                                                                                                                                   |       | 1,739                  |       |                        | 1,456      |   |   |
| Current portion of  long-term debt                                                                                                                                     |       | 4,163                  |       |                        | 4,142      |   |   |
| Total current  liabilities                                                                                                                                             |       | 137,881                |       |                        | 125,305    |   |   |
| Long-term debt                                                                                                                                                         |       | 413,536                |       |                        | 405,955    |   |   |
| Deferred income taxes                                                                                                                                                  |       | 65,185                 |       |                        | 64,692     |   |   |
| Other noncurrent  liabilities                                                                                                                                          |       | 20,861                 |       |                        | 20,956     |   |   |
| Total liabilities                                                                                                                                                      |       | 637,463                |       |                        | 616,908    |   |   |
| Minority interests                                                                                                                                                     |       | 16,648                 |       |                        | 16,611     |   |   |
| 16% Series A  convertible pay-in-kind preferred shares—0 shares issued and outstanding                                                                  |       | —                 |       |                        | —     |   |   |
| Shareholders’ equity:                                                                                                                                             |       |                   |       |                        |       |   |   |
| Class A common  stock—19,121,229 and 18,868,607 shares issued and outstanding at July 1,  2006 and December 31, 2005, respectively                 |       | 191                    |       |                        | 188        |   |   |
| Class B  convertible common stock—139,433 and 153,549 shares issued and outstanding  at July 1, 2006 and December 31, 2005, respectively |       | 2                      |       |                        | 2          |   |   |
| Class C  convertible common stock—24,319 and 31,131 shares issued and outstanding  at July 1, 2006 and December 31, 2005, respectively        |       | —                 |       |                        | —     |   |   |
| Class D  convertible common stock—0 shares issued and outstanding                                                                                            |       | —                 |       |                        | —     |   |   |
| Class E  convertible common stock—0 shares issued and outstanding                                                                                            |       | —                 |       |                        | —     |   |   |
| Additional paid-in  capital                                                                                                                                            |       | 169,022                |       |                        | 165,652    |   |   |
| Retained earnings  (deficit)                                                                                                                                           |       | (68,976                | )          |                        | (54,820    | ) |   |
| Accumulated other  comprehensive income                                                                                                                                |       | 31,854                 |       |                        | 20,460     |   |   |
| Total shareholders’  equity                                                                                                                                       |       | 132,093                |       |                        | 131,482    |   |   |
| Total liabilities and  shareholders’ equity                                                                                                                       |       | $                      | 786,204    |                        |       | $ | 765,001 |   |   |

 

See Accompanying Notes.

3

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**POLYMERGROUP, INC.CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)(In Thousands, Except Per Share Data)**

| ** **                                                  | ** ** | **Three Months  Ended  July 1, 2006** | ** ** | **Three Months  Ended  July 2, 2005** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| Net sales                                                   |       |                                                 | $          | 248,706                                              |       |   |   | $ | 235,853 |   |   |
| Cost of goods sold                                          |       |                                                 | 212,253    |                                                 |       |   | 193,910 |   |   |
| Gross profit                                                |       |                                                 | 36,453     |                                                 |       |   | 41,943 |   |   |
| Selling, general and  administrative expenses               |       |                                                 | 25,555     |                                                 |       |   | 25,862 |   |   |
| Asset impairment  charges                                   |       |                                                 | 7,856      |                                                 |       |   | — |   |   |
| Restructuring and  plant realignment costs                  |       |                                                 | 2,740      |                                                 |       |   | 5 |   |   |
| Abandoned acquisition  costs                                |       |                                                 | 3,670      |                                                 |       |   | — |   |   |
| Foreign currency  loss, net                                 |       |                                                 | 2,405      |                                                 |       |   | 70 |   |   |
| Operating income  (loss)                                    |       |                                                 | (5,773     | )                                                    |       |   | 16,006 |   |   |
| Other expense (income):                                     |       |                                                 |       |                                                 |       |   |   |   |   |
| Interest expense, net                                       |       |                                                 | 7,079      |                                                 |       |   | 8,168 |   |   |
| Minority interests                                          |       |                                                 | 952        |                                                 |       |   | 1,054 |   |   |
| Foreign currency and other (gain) loss, net                 |       |                                                 | 564        |                                                 |       |   | (426 | ) |   |
| Income (loss) before  income tax expense (benefit)          |       |                                                 | (14,368    | )                                                    |       |   | 7,210 |   |   |
| Income tax expense  (benefit)                               |       |                                                 | (1,816     | )                                                    |       |   | 3,140 |   |   |
| Net income (loss)                                           |       |                                                 | (12,552    | )                                                    |       |   | 4,070 |   |   |
| Accrued and  paid-in-kind dividends on PIK preferred shares |       |                                                 | —     |                                                 |       |   | 2,357 |   |   |
| Income (loss)  applicable to common shareholders            |       |                                                 | $          | (12,552                                              | )          |   |   | $ | 1,713 |   |   |
| Income (loss) per common share:                             |       |                                                 |       |                                                 |       |   |   |   |   |
| Basic                                                       |       |                                                 | $          | (0.65                                                | )          |   |   | $ | 0.16 |   |   |
| Diluted                                                     |       |                                                 | $          | (0.65                                                | )          |   |   | $ | 0.16 |   |   |

 

See Accompanying Notes.

4

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**POLYMERGROUP, INC.CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)(In Thousands, Except Per Share Data)**

| ** **                                                  | ** ** | **Six Months  Ended  July 1, 2006** | ** ** | **Six Months  Ended  July 2, 2005** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| Net sales                                                   |       |                                               | $          | 509,147                                            |       |   |   | $ | 480,214 |   |   |
| Cost of goods sold                                          |       |                                               | 429,490    |                                               |       |   | 394,354 |   |   |
| Gross profit                                                |       |                                               | 79,657     |                                               |       |   | 85,860 |   |   |
| Selling, general and  administrative expenses               |       |                                               | 57,954     |                                               |       |   | 53,329 |   |   |
| Asset impairment  charges                                   |       |                                               | 7,856      |                                               |       |   | — |   |   |
| Restructuring and  plant realignment costs                  |       |                                               | 4,373      |                                               |       |   | 9 |   |   |
| Abandoned acquisition  costs                                |       |                                               | 3,670      |                                               |       |   | — |   |   |
| Foreign currency  loss, net                                 |       |                                               | 2,972      |                                               |       |   | 94 |   |   |
| Operating income                                            |       |                                               | 2,832      |                                               |       |   | 32,428 |   |   |
| Other expense (income):                                     |       |                                               |       |                                               |       |   |   |   |   |
| Interest expense, net                                       |       |                                               | 13,596     |                                               |       |   | 16,034 |   |   |
| Minority interests                                          |       |                                               | 1,836      |                                               |       |   | 1,988 |   |   |
| Foreign currency and other (gain) loss, net                 |       |                                               | 1,054      |                                               |       |   | (765 | ) |   |
| Income (loss) before  income tax expense                    |       |                                               | (13,654    | )                                                  |       |   | 15,171 |   |   |
| Income tax expense                                          |       |                                               | 502        |                                               |       |   | 5,935 |   |   |
| Net income (loss)                                           |       |                                               | (14,156    | )                                                  |       |   | 9,236 |   |   |
| Accrued and  paid-in-kind dividends on PIK preferred shares |       |                                               | —     |                                               |       |   | 13,208 |   |   |
| Loss applicable to  common shareholders                     |       |                                               | $          | (14,156                                            | )          |   |   | $ | (3,972 | ) |   |
| Loss per common share:                                      |       |                                               |       |                                               |       |   |   |   |   |
| Basic                                                       |       |                                               | $          | (0.73                                              | )          |   |   | $ | (0.38 | ) |   |
| Diluted                                                     |       |                                               | $          | (0.73                                              | )          |   |   | $ | (0.38 | ) |   |

 

See Accompanying Notes.

5

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**POLYMERGROUP, INC.CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS) (Unaudited)For the Six Months Ended July 1, 2006(In Thousands)**

| ** **                                                                         | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings/  (Deficit)** | ** ** | **Accumulated  Other  Comprehensive  Income/  (Loss)** | ** ** | **Total** | ** ** | ** ** | **Comprehensive  Income/(Loss)** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------------------|------------|--------------------------------------------------------|------------|-----------|------------|------------|----------------------------------|------------|
| Balance,  December 31, 2005                                                   |       |              | $          | 190                              |       |                               | $          | 165,652                                                |       | $         | (54,820    | )          |                             | $          | 20,460 |   |   | $ | 131,482 |   |   |   |   |   |   |
| Net loss                                                                           |       |              | —     |                             |       | —                             |       | (14,156                                                | )          |      | —     |       |                             | (14,156    | ) |   |   | $ | (14,156 | ) |   |
| Currency translation  adjustment, net of tax                                       |       |              | —     |                             |       | —                             |       | —                                                 |       |      | 9,765      |       |                             | 9,765      |   |   |   | 9,765 |   |   |
| Cash flow hedge  adjustment, net of reclassification adjustment                    |       |              | —     |                             |       | —                             |       | —                                                 |       |      | 37         |       |                             | 37         |   |   |   | 37 |   |   |
| Minimum pension  liability, net of tax                                        |       |              | —     |                             |       | —                             |       | —                                                 |       |      | 1,592      |       |                             | 1,592      |   |   |   | 1,592 |   |   |
| Compensation expense  recognized on stock options and restricted stock grants |       |              | 3          |                             |       | 4,365                              |       | —                                                 |       |      | —     |       |                             | 4,368      |   |   |   | — |   |   |
| Surrender of shares  to satisfy employee withholding tax obligations               |       |              | —     |                             |       | (995                               | )          | —                                                 |       |      | —     |       |                             | (995       | ) |   |   | — |   |   |
| Balance, July 1, 2006                                                         |       |              | $          | 193                              |       |                               | $          | 169,022                                                |       | $         | (68,976    | )          |                             | $          | 31,854 |   |   | $ | 132,093 |   |   | $ | (2,762 | ) |   |

 

See Accompanying Notes.

6

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

| ** **                                                                                | ** ** | **Six Months  Ended  July 1, 2006** | ** ** | **Six Months  Ended  July 2, 2005** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| Operating activities:                                                                     |       |                                               |       |                                               |       |   |   |   |   |
| Net income (loss)                                                                         |       |                                               | $          | (14,156                                            | )          |   |   | $ | 9,236 |   |   |
| Adjustments to reconcile  net income (loss) to net cash provided by operating activities: |       |                                               |       |                                               |       |   |   |   |   |
| Deferred income taxes                                                                     |       |                                               | (1,677     | )                                                  |       |   | 2,983 |   |   |
| Net (gain) loss on sale of assets                                                         |       |                                               | (40        | )                                                  |       |   | — |   |   |
| Depreciation and amortization                                                             |       |                                               | 29,661     |                                               |       |   | 27,837 |   |   |
| Asset impairment charges                                                                  |       |                                               | 7,856      |                                               |       |   | — |   |   |
| Noncash compensation                                                                      |       |                                               | 4,368      |                                               |       |   | 1,505 |   |   |
| Changes in operating  assets and liabilities, net of effect of acquisitions:              |       |                                               |       |                                               |       |   |   |   |   |
| Accounts receivable, net                                                                  |       |                                               | (3,376     | )                                                  |       |   | (13,331 | ) |   |
| Inventories                                                                               |       |                                               | (3,204     | )                                                  |       |   | (11,085 | ) |   |
| Other current assets                                                                      |       |                                               | (2,247     | )                                                  |       |   | 1,732 |   |   |
| Accounts payable and accrued liabilities                                                  |       |                                               | 10,369     |                                               |       |   | 7,090 |   |   |
| Other, net                                                                                |       |                                               | (933       | )                                                  |       |   | (4,259 | ) |   |
| Net cash provided by operating activities                                                 |       |                                               | 26,621     |                                               |       |   | 21,708 |   |   |
| Investing activities:                                                                     |       |                                               |       |                                               |       |   |   |   |   |
| Purchases of property, plant and equipment                                                |       |                                               | (46,436    | )                                                  |       |   | (34,829 | ) |   |
| Acquisition-related costs                                                                 |       |                                               | (407       | )                                                  |       |   | — |   |   |
| Proceeds from sale of assets                                                              |       |                                               | 1,357      |                                               |       |   | 354 |   |   |
| Net cash used in investing activities                                                     |       |                                               | (45,486    | )                                                  |       |   | (34,475 | ) |   |
| Financing activities:                                                                     |       |                                               |       |                                               |       |   |   |   |   |
| Proceeds from borrowings                                                                  |       |                                               | 44,102     |                                               |       |   | 20,383 |   |   |
| Repayment of borrowings                                                                   |       |                                               | (36,722    | )                                                  |       |   | (22,803 | ) |   |
| Other                                                                                     |       |                                               | (301       | )                                                  |       |   | (51 | ) |   |
| Net cash provided by (used in) financing  activities                                      |       |                                               | 7,079      |                                               |       |   | (2,471 | ) |   |
| Effect of exchange  rate changes on cash                                                  |       |                                               | 346        |                                               |       |   | (836 | ) |   |
| Net decrease in cash  and cash equivalents                                                |       |                                               | (11,440    | )                                                  |       |   | (16,074 | ) |   |
| Cash and cash  equivalents at beginning of period                                         |       |                                               | 30,963     |                                               |       |   | 41,296 |   |   |
| Cash and cash equivalents at  end of period                                               |       |                                               | $          | 19,523                                             |       |   |   | $ | 25,222 |   |   |

 

See Accompanying Notes.

7

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

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

*Principles ofConsolidation*

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

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

The accompanying unauditedinterim Consolidated Financial Statements and related notes should be read inconjunction with the Consolidated Financial Statements of the Company andrelated notes as contained in the Annual Report on Form 10-K for theperiod ended December 31, 2005. In the judgment of management, theseunaudited interim Consolidated Financial Statements include all adjustments ofa normal recurring nature and accruals necessary for a fair presentation ofsuch statements. The Consolidated Balance Sheet data included herein as of December 31,2005 has been derived from the audited financial statements included in theCompany’s Annual Report on Form 10-K.

*Reclassification*

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

*Revenue Recognition*

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

*Accumulated OtherComprehensive Income*

Accumulated othercomprehensive income of $31.9 million at July 1, 2006 consisted of$28.0 million of currency translation gains and $3.9 million of cashflow hedge gains, all net of applicable income tax. Accumulated othercomprehensive income of $20.5 million at December 31, 2005 consistedof $18.2 million of currency translation gains, $1.6 million ofminimum pension liability and $3.9 million of cash flow hedge gains, allnet of applicable income tax.

*Recent AccountingStandards*

In November 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 151, “Inventory Costs” (“SFAS No. 151”). This 

8

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

statement amends earlierguidance to require that abnormal freight, handling and spoilage costs berecognized as current-period charges rather than capitalized as aninventory cost. In addition, SFAS No. 151 requires that the allocation offixed production overhead costs be based on the normal capacity of the productionfacilities. SFAS No. 151 is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. The Company has adopted theprovisions of SFAS No. 151 effective January 1, 2006 and the impacthas not been significant to its financial position or results of operations.

In December 2004, the FASB issued a revision toSFAS No. 123, “Accounting for Stock-Based Compensation.” The revision,entitled SFAS No. 123R, “Share-Based Payment” (“SFAS No. 123R”), iseffective for all awards granted, modified, repurchased or canceled after June 15,2005 and requires a public entity to measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award. The grant date fair value is to be estimated usingoption-pricing models adjusted for the unique characteristics of thoseinstruments. In April 2005, the Securities and Exchange Commission issueda final rule that registrants must adopt SFAS No. 123R’s fair valuemethod of accounting no later than the beginning of the fiscal year beginningafter June 15, 2005. Accordingly, the Company adopted SFAS No. 123Ras of January 1, 2006 using the modified prospective transition method.The grant date fair value was estimated using the Black-Scholes model. Underthe modified prospective transition method, all new grants and any unvestedportion of prior awards as of January 1, 2006 have been measured based onthe fair-value-based method of accounting. The impact of adopting SFAS No. 123Rhas resulted in marginally lower compensation costs than previously recognizedunder the Company’s historically-used accounting principles. The proformaeffect of utilizing SFAS No. 123R on the financial results for the threeand six months ended July 2, 2005 was as follows (in thousands, except pershare data):

9

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

 

| ** **                                                                                                                         | ** ** | **Three Months  Ended  July 2, 2005** | ** ** | **Six Months  Ended  July 2, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| Net income (loss):                                                                                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| As reported                                                                                                                        |       |                                                 | $          | 4,070                                              |       |   |   | $ | 9,236 |   |   |
| Add: stock-based  employee compensation expense, net of tax, included in reported net income  (loss)                               |       |                                                 | 1,094      |                                               |       |   | 1,505 |   |   |
| Deduct: stock-based  employee compensation expense, net of tax, determined under SFAS  No. 123R                               |       |                                                 | (254       | )                                                  |       |   | (312 | ) |   |
| Pro forma                                                                                                                          |       |                                                 | $          | 4,910                                              |       |   |   | $ | 10,429 |   |   |
| Income (loss) applicable to common shareholders:                                                                                   |       |                                                 |       |                                               |       |   |   |   |   |
| As reported                                                                                                                        |       |                                                 | $          | 1,713                                              |       |   |   | $ | (3,972 | ) |   |
| Add: stock-based  employee compensation expense, net of tax, included in reported income (loss)  applicable to common shareholders |       |                                                 | 1,094      |                                               |       |   | 1,505 |   |   |
| Deduct: stock-based  employee compensation expense, net of tax, determined under SFAS  No. 123R                               |       |                                                 | (254       | )                                                  |       |   | (312 | ) |   |
| Pro forma                                                                                                                          |       |                                                 | $          | 2,553                                              |       |   |   | $ | (2,779 | ) |   |
| Income (loss) per share applicable to common  shareholders—basic:                                                             |       |                                                 |       |                                               |       |   |   |   |   |
| As reported                                                                                                                        |       |                                                 | $          | 0.16                                               |       |   |   | $ | (0.38 | ) |   |
| Pro forma                                                                                                                          |       |                                                 | 0.25       |                                               |       |   | (0.27 | ) |   |
| Income (loss) per share applicable to common  shareholders—diluted:                                                           |       |                                                 |       |                                               |       |   |   |   |   |
| As reported                                                                                                                        |       |                                                 | $          | 0.16                                               |       |   |   | $ | (0.38 | ) |   |
| Pro forma                                                                                                                          |       |                                                 | 0.25       |                                               |       |   | (0.27 | ) |   |
| Weighted average exercise price per option granted                                                                                 |       |                                                 | $          | 6.00                                               |       |   |   | $ | 6.00 |   |   |
| Weighted  average fair value per option granted                                                                                    |       |                                                 | $          | 9.76                                               |       |   |   | $ | 7.48 |   |   |

 

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections” (“SFAS No. 154”). This statement amendsearlier guidance and requires retrospective application to prior periods’financial statements of a voluntary change in accounting principle unless it isimpracticable to determine either the period-specific effects or the cumulativeeffects of the change. In addition, SFAS No. 154 requires that a change inthe method of depreciation or amortization for a long-lived, non-financialasset be accounted for as a change in accounting estimate that is affected by achange in accounting principle. SFAS No. 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005. The Company has completed its evaluation of the impact that the adoptionof SFAS No. 154 could have and has concluded that such impact is notexpected to be significant to its financial position or results of operations.

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

10

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

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

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 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. Customer balances areconsidered past due based on contractual terms and the Company does not accrueinterest on the past due balances. The provision for losses on uncollectibleaccounts is determined principally on the basis of past collection experienceapplied to ongoing evaluations of receivables and the risk of repayment. Theallowance for doubtful accounts was approximately $8.7 million and$9.6 million at July 1, 2006 and December 31, 2005,respectively, which management believes is adequate to provide for credit lossin the normal course of business, as well as losses for customers who havefiled for protection under bankruptcy laws. Once management determines that thereceivables are not recoverable, the amounts are removed from the financialrecords along with the corresponding reserve balance. Of the approximate $0.9million decrease in the allowance for doubtful accounts, approximately $0.6 millionrelated to the write-off of specifically identified uncollectible accountsreceivable and the corresponding reserves. Sales to the Procter &Gamble Company (“P&G”) accounted for approximately 12% and 14% of theCompany’s sales in the first six months of 2006 and 2005, respectively.

On November 15, 2004, the Company entered into afactoring agreement to sell without recourse, certain U.S. company-basedreceivables to an unrelated third-party financial institution. Under the termsof the factoring agreement, the maximum amount of outstanding advances at anyone time was $15.0 million, which limitation was subject to change basedon the level of eligible receivables, restrictions on concentrations ofreceivables and the historical performance of the receivables sold. In March 2006,the maximum amount of outstanding advances at one time was increased to$20.0 million. Additionally, on November 7, 2005, the Company’s LatinAmerican operations entered into a factoring agreement to sell withoutrecourse, certain non-U.S. company-based receivables to an unrelated third-partyfinancial institution. Under the terms of the factoring agreement, the maximumamount of outstanding advances at any one time is $10.0 million, whichlimitation is subject to change based on the level of eligible receivables,restrictions on concentrations of receivables and the historical performance ofthe receivables sold. 

During the first six months of2006, approximately $91.3 million of receivables had been sold under theterms of the factoring agreements, compared to approximately $61.5 millionduring the first six months of fiscal 2005. The sale of these receivables acceleratedthe collection of the Company’s cash, reduced credit exposure and lowered theCompany’s net borrowing costs. Sales of accounts receivable are reflected as areduction of *Accounts receivable, net*in the Consolidated Balance Sheets and a gain or loss is reflected in *Foreign currency and other (gain) loss, net* in theConsolidated Statements of Operations on such sales, as they meet theapplicable criteria of SFAS No. 140, “Accounting for Transfers andServicing of Financial Assets and Extinguishment of Liabilities” (“SFAS No. 140”).The amount due from the factoring companies, net of advances received from thefactoring companies, was $5.9 million and $6.1 million at July 1,2006 and December 31, 2005, respectively, and is shown in *Other current assets* in the ConsolidatedBalance Sheets. The Company pays factoring fees associated with the sale ofreceivables based on the dollar value of the receivables sold. Such fees areimmaterial and are included in *Foreign currency and other(gain) loss, net* in the Consolidated Statement of Operations.

11

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

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

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

| ** **                                 | ** ** | **Three Months** | ** ** | **Three Months** | ** ** | **Six Months** | ** ** | **Six Months** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|-----------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                 | ** ** | **Ended**             | ** ** | **Ended**             | ** ** | **Ended**           | ** ** | **Ended**           | ** ** |
| ** **                                 | ** ** | **July 1,**      | ** ** | **July 2,**      | ** ** | **July 1,**    | ** ** | **July 2,**    | ** ** |
| ** **                                 | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2006**            | ** ** | **2005**            | ** ** |
| Asset impairment  charges                  |       |                  | $          | 7,856                 |       |                |       | $                   | —     |   |   |   | $ | 7,856 |   |   |   | $ | — |   |   |
| Restructuring and  plant realignment costs |       |                  | 2,740      |                  |       |                | 5          |                |       |   | 4,373 |   |   |   | 9 |   |   |
| Abandoned acquisition costs                |       |                  | 3,670      |                  |       |                | —     |                |       |   | 3,670 |   |   |   | — |   |   |

 

*Asset impairmentcharges*

During the second quarter of fiscal 2006, the Company experienceda continued weakening of earnings and cash flows in certain of its Canadianoperations. As a result, the Company has evaluated such assets for impairment,consistent with the provisions of Statement of Financial Accounting StandardsNo. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” andhas recorded a non-cash charge associated with the write-down of suchassets to estimated fair value in the amount of approximately $5.6 millionin the second quarter of 2006.

Additionally, during thesecond quarter of 2006, the Company has recorded a non-cash charge in theamount of approximately $2.3 million associated with the write-down of assetslocated in Sweden to estimated fair value less costs to sell, as such assetswill be removed from service in 2006 as a result of initiating the Company’s Europeanrestructuring and consolidation strategies, as further described below.

*Restructuring and plantrealignment costs*

Accrued costs for restructuring efforts are includedin *Accrued liabilities* in the ConsolidatedBalance Sheets. These costs generally arise from restructuring initiativesintended to result in lower working capital levels and improved operating performanceand profitability through: (i) reducing headcount at both the plant andcorporate levels; (ii) improving manufacturing productivity and reducing corporatecosts; and (iii) rationalizing certain assets, businesses and employeebenefit programs. A summary of the business restructuring activity during thefirst six months of fiscal 2006 is presented in the following table (inthousands):

| Balance accrued at  beginning of year           |   | $      | 163    |   |
|-------------------------------------------------|--------|--------|--------|--------|
| 2006 restructuring  and plant realignment costs |   | 4,373  |   |
| Cash payments                                   |   | (563   | )      |
| Adjustments                                     |   | — |   |
| Balance accrued at end of  period               |   | $      | 3,973  |   |

 

12

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

As further described below, the 2006 restructuring andplant realignment costs are principally associated with (a) the Company’srestructuring and consolidation plan for Europe, which included termination benefitsprovided to an executive officer of the Company, pursuant to Dutch law, in theamount of $2.1 million and costs associated with the planned closure of theSweden plant of $0.3 million; (b) costs related to the relocation ofthe corporate headquarters to Charlotte, North Carolina in the amount of $1.8million; and (c) downsizing certain Canadian operations resulting inseverance costs of $0.2 million. 

*Corporate headquarters relocation*

The Company is accounting for the Corporate relocationcosts in accordance with FASB Statement No. 146 “Accounting for CostsAssociated with Exit or Disposal Activities” (“SFAS No. 146”).

As of July 1, 2006, the Company has entered intowritten relocation agreements with 22 employees who have agreed to therelocation and to acceptance of benefits offered by the Company. Suchrelocation benefits charged to operations of $1.2 million through the first sixmonths of 2006 relate primarily to Company obligations for costs associatedwith the employee’s real estate sales process, which process had beensubstantially completed by the electing employees prior to July 1, 2006. Additionally,the Company has incurred approximately $0.2 million associated with otherexit costs.

The Company expects to incur approximately $0.6million in severance costs relating to 21 employees who have not beenoffered or who have declined the opportunity to relocate. Such costs will beincurred provided that the employee remains in the employ of the Companythrough the date of their designated date for corporate relocation. Accordingly,consistent with the provisions of SFAS No. 146, the Company is accruingthe severance cost ratably over the expected future service period.

During the first six months of fiscal 2006, theCompany has included such restructuring costs in *Restructuringand plant realignment costs* in the Consolidated Statement ofOperations. Additional relocation costs are expected to be recognized pursuantto SFAS No. 146 subsequent to July 1, 2006 relating to hiring costsand other employee relocation expenses as such obligations are incurred.

*European restructuring*

In May 2006, the Company entered into atermination agreement with an executive officer of the Company that providedfor an aggregate payment of approximately $2.1 million, which was charged to *Restructuring and plant realignment costs* in theConsolidated Statement of Operations in the second quarter of fiscal 2006. Additionally,the Company and the executive officer entered certain other consulting andnon-compete agreements, which costs will be charged to operations over futureperiods.

During the second quarter of fiscal 2006, based on theCompany’s restructuring and consolidation strategies noted above, the Companycommunicated a plan to affected employees that it was shutting down itsoperation located in Sweden. The Company expects to cease operations during thethird quarter of 2006. As a result of this decision, the Company recorded a$0.3 million charge to *Restructuring and plantrealignment costs* in the Consolidated Statement of Operations in thesecond quarter of fiscal 2006 to cover the costs of exiting the facility andseverance expected to be paid to terminated employees.

13

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

*Canadianrestructuring*

During the second quarter of fiscal 2006, the Companycommunicated a plan to affected employees that it planned to downsize one ofits facilities located in Canada. The restructuring plan included the reductionof 19 production and administrative staff positions. As a result of thisdecision, the Company recorded a $0.2 million charge to *Restructuringand plant realignment costs* in the Consolidated Statement ofOperations in the second quarter of fiscal 2006 to cover the costs of severancepay due to these employees.

Additionally, during the firstfiscal quarter of 2006, as part of its restructuring and related cost reductionmeasures, the Company negotiated certain changes with the union representingthe employees of one of the Company’s Canadian operations, including a partial curtailmentof a defined benefit pension plan. No net gain or loss has been incurred as aresult of the partial curtailment. However, based on elections made by planparticipants during the second quarter of fiscal 2006, and subject to approvalby Canadian regulatory authorities, the Company may incur a settlement lossassociated with employees who have elected to exit the plan. Any lossassociated with the partial settlement of the defined benefit pension plan willbe recognized at such time as the settlement occurs, which is dependent upongovernmental approval and upon fulfillment by the Company of its fundingrequirements associated with the future settlement. On a proforma basis, hadsuch partial settlement occurred as of June 1, 2006, the Company estimatesthat a settlement loss would have been incurred in the amount of approximately$3.7 million as of that date. The Company currently estimates that it willbe required to provide additional funding in connection with the partialsettlement in the amount of approximately $2.5 million.

*Abandoned acquisitioncosts*

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

**Note 4.**   Inventories

Inventoriesare stated at the lower of cost or market primarily using the first-in,first-out method of accounting and consist of the following (in thousands):

| ** **      | ** ** | **July 1,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------|------------|------------------------|------------|-----------------------------|------------|
| Finished goods  |       | $                      | 61,850     |                        |       | $ | 60,545 |   |   |
| Work in process |       | 18,746                 |       |                        | 17,724     |   |   |
| Raw materials   |       | 45,034                 |       |                        | 41,394     |   |   |
|            |       | $                      | 125,630    |                        |       | $ | 119,663 |   |   |

 

Inventories are net ofreserves, primarily for obsolete and slow-moving inventories, of approximately$10.1 million and $9.7 million at July 1, 2006 and December 31,2005, respectively. Management believes that the reserves are adequate toprovide for losses in the normal course of business.

14

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

**Note 5.**   Intangiblesand Loan Acquisition Costs

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

| ** **                                              | ** ** | **July 1,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------|------------|------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **2006**         | ** ** | **2005**              | ** ** |
| Cost:                                                   |       |             |       |                  |       |   |   |
| Proprietary technology                                  |       | $                | 30,489     |                  |       | $ | 30,251 |   |   |
| Goodwill (primarily  attributable to Nonwovens segment) |       | 10,243           |       |                  | 10,243     |   |   |
| Loan acquisition costs and  other                       |       | 13,138           |       |                  | 12,045     |   |   |
|                                                    |       | 53,870           |       |                  | 52,539     |   |   |
| Less accumulated  amortization                          |       | (18,081          | )          |                  | (15,210    | ) |   |
|                                                    |       | $                | 35,789     |                  |       | $ | 37,329 |   |   |

 

In January 2006, theCompany acquired the business of Advanced Fiber Solutions, Inc (“AFS”). AFS isa regional distribution company located in Alabama that markets and sellssynthetic concrete fibers to the ready mix, stucco and precast segments of theconstruction business, primarily in the southern United States. The aggregatepurchase price of $0.8 million consisted of $0.4 million paid to theseller at closing and $0.4 million to be paid on the first anniversary ofthe transaction, contingent upon the successful transfer of the business to theCompany and other factors. The purchase consisted primarily of customer listsand a covenant not to compete agreement from the seller, and the Companyincluded the aggregate purchase price in *Intangibles and loanacquisition costs*. Such costs will be amortized over the term of thecovenant not to compete agreement. In addition, the contingent portion of thepurchase price is included in *Accrued liabilities*as of July 1, 2006. Net sales and net income of AFS have been included inthe the Company’s Consolidated Financial Statements from the acquisition dateof January 9, 2006, and do not have a material impact on the Company’sConsolidated Financial Statements. Therefore, unaudited pro forma data has notbeen presented in conjunction with this acquisition.

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

| ** **                                                                                         | ** ** | **Three Months** | ** ** | **Three Months** | ** ** | **Six Months** | ** ** | **Six Months** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                                                                         | ** ** | **Ended**             | ** ** | **Ended**             | ** ** | **Ended**           | ** ** | **Ended**           | ** ** |
| ** **                                                                                         | ** ** | **July 1,**      | ** ** | **July 2,**      | ** ** | **July 1,**    | ** ** | **July 2,**    | ** ** |
| ** **                                                                                         | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2006**            | ** ** | **2005**            | ** ** |
| Amortization of:                                                                                   |       |                  |       |                  |       |                |       |                |       |   |   |   |   |   |   |   |   |
| Intangibles with finite  lives, included in selling, general and administrative expenses |       |                  | $          | 1,110                 |       |                |       | $                   | 1,061      |   |   |   | $ | 2,202 |   |   |   | $ | 2,118 |   |   |
| Loan acquisition costs  included in interest expense, net                                          |       |                  | 345        |                  |       |                | 503        |                |       |   | 669 |   |   |   | 1,007 |   |   |
| Total amortization expense                                                                         |       |                  | $          | 1,455                 |       |                |       | $                   | 1,564      |   |   |   | $ | 2,871 |   |   |   | $ | 3,125 |   |   |

 

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

15

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

**Note 6.**   AccruedLiabilities

Accrued liabilities in theConsolidated Balance Sheets include salaries, wages and other fringe benefitsof $14.8 million and $17.0 million as of July 1, 2006 andDecember 31, 2005, respectively.

**Note 7.**   Debt

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

| ** **                                                                                                                                                                                                                                                                                                                     | ** ** | **July 1,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                     | ** ** | **2006**         | ** ** | **2005**              | ** ** |
| Credit Facility, as defined below, interest rates  for U.S. dollar borrowings are based on a specified base plus a specified  margin and are subject to certain terms and conditions:                                                                                                                                          |       |             |       |                  |       |   |   |
| First Lien Term Loan—interest at 7.74% and 6.77% as of July 1,  2006 and December 31, 2005, respectively; due in mandatory quarterly  payments of approximately $1.0 million, subject to additional payments  from annual excess cash flows, as defined, with the balance due  November 22, 2012 |       | $                | 407,950    |                  |       | $ | 410,000 |   |   |
| Revolving Credit Facility—interest at 8.25% as of July 1, 2006; due  November 22, 2010                                                                                                                                                                                                                     |       | 9,000            |       |                  | —     |   |   |
| Other                                                                                                                                                                                                                                                                                                                          |       | 749              |       |                  | 97         |   |   |
|                                                                                                                                                                                                                                                                                                                           |       | 417,699          |       |                  | 410,097    |   |   |
| Less: Current  maturities                                                                                                                                                                                                                                                                                                      |       | (4,163           | )          |                  | (4,142     | ) |   |
|                                                                                                                                                                                                                                                                                                                           |       | $                | 413,536    |                  |       | $ | 405,955 |   |   |

 

*Credit Facility*

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

All borrowings under theCredit Facility are U.S. dollar denominated and are guaranteed, on a joint andseveral basis, by each and all of the direct and indirect domestic subsidiariesof the Company. The Credit Facility and the related guarantees are secured by (i) alien on substantially all of the assets of the Company, its domestic subsidiariesand certain of its non-domestic subsidiaries, (ii) a pledge of all or aportion of the stock of the domestic subsidiaries of the Company and of certainnon-domestic subsidiaries of the Company, and (iii) a pledge of certainsecured intercompany notes. Commitment fees under the Credit Facility are equalto 0.50% of the daily unused amount of the revolving credit commitment. TheCredit Facility limits restricted payments to $5.0 million, including cashdividends, in the aggregate since the effective date of the Credit Facility.The Credit Facility contains covenants and events of default customary forfinancings of this type, including leverage and interest expense coveragecovenants. The Company was in compliance with all such covenants at July 1,2006. The first-lien term loan requires mandatory payments of approximately$1.0 million per quarter and, requires the Company to apply a percentageof proceeds from excess cash flows, as defined by the Credit Facility anddetermined based on year-end results, to reduce its then outstanding balancesunder the Credit Facility.

16

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

Excess cash flows required tobe applied to the repayment of the Credit Facility are generally calculated as50.0% of the net amount of the Company’s available cash generated from operationsadjusted for the cash effects of interest, taxes, capital expenditures, changesin working capital and certain other items. Since the amounts of excess cashflows for future periods are based on year-end results and not currentlydeterminable, only the mandatory payments of approximately $1.0 millionper quarter have been classified as a current liability. Additionally, noexcess cash flow payment was required to be made with respect to fiscal 2005due to the magnitude of the major capital expenditure projects and any excesscash flow requirement with respect to fiscal 2006 is not expected to besignificant.

The interest rate applicableto borrowings under the Credit Facility is based on three-month LondonInterbank Offered Rate (“LIBOR”) plus a specified margin. The applicable marginfor borrowings under both the first-lien term loan and the revolving creditfacility is 225 basis points. The Company may, from time to time, elect to usean alternate base rate for its borrowings under the revolving credit facilitybased on the bank’s base rate plus a margin of 75 to 125 basis points based onthe Company’s total leverage ratio. As of July 1, 2006, the Company had$9.0 million of outstanding borrowings under the revolving creditfacility, and there were no such borrowings as of December 31, 2005. As ofJuly 1, 2006, capacity under the revolving credit facility had beenreserved for outstanding letters of credit in the amount of $9.4 million,as described below. Average borrowings under the revolving credit facility,which were largely LIBOR-based borrowings, for the period from January 1,2006 to July 1, 2006 were $22.6 million at an average rate of 7.79%.

In accordance with the termsof the Credit Facility, the Company maintained its position in a cash flow hedgeagreement originally entered into in May 2004. This cash flow hedgeagreement effectively converts $212.5 million of notional principal amountof debt from a variable LIBOR rate to a fixed LIBOR rate of 3.383%. The cashflow hedge agreement terminates on May 8, 2007 and is described more fullyin Note 12 to the Consolidated Financial Statements.

Subject to certain terms andconditions, a maximum of $25.0 million of the Credit Facility may be usedfor revolving letters of credit. As of July 1, 2006, the Company had$9.4 million of standby and documentary letters of credit outstandingunder the Credit Facility. Approximately $2.0 million was related to therequirements of the short-term borrowing arrangements of the Company’s China-basedmajority owned subsidiary (“Nanhai”). Other letters of credit are in place toprovide added assurance for certain raw material vendors and administrativeservice providers. None of these letters of credit had been drawn on at July 1,2006.

*Subsidiary Indebtedness*

Nanhai Nanxin Non-woven Co.,Ltd (“Nanhai”) has a short-term credit facility (denominated in U.S. dollarsand Chinese renminbi) with a financial institution in China which matured in June 2006and was renegotiated, with similar terms and conditions, for an additionaltwelve-month period expiring in June 2007. The amount of outstandingindebtedness under the facility was $3.0 million at July 1, 2006 (atan average annual rate of approximately 5.58%) and $5.0 million at December 31,2005 (at an annual average rate of approximately 4.44%). The Nanhaiindebtedness is supported by a letter of credit issued by the Company’s agentbank and additional collateral was granted through the pledge of the Nanhaiassets. Additionally, in June 2006, PGI Nonwovens Co., Ltd (“Suzhou”)entered a short-term credit facility denominated in Chinese renminbi with afinancial institution in China. The Suzhou indebtedness matures in June 2007and is intended to finance the operation’s initial working capital requirements.The amount of outstanding indebtedness under the credit facility was $1.9 

17

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

million at July 1,2006 (at an annual rate of approximately 5.27%). The Nanhai and Suzhou borrowingsare included in *Short-term borrowings* in theConsolidated Balance Sheets.

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

**Note 8.**   IncomeTaxes

During the three and sixmonths ended July 1, 2006, the Company recognized an income tax benefit of$1.8 million and an income tax expense of $0.5 million respectively, on consolidatedpre-tax losses of $14.4 million and $13.7 million, respectively. Thisincome tax benefit and expense is significantly different than the U.S. federalstatutory rate primarily due to losses in the U.S. and certain foreignjurisdictions for which no income tax benefits were recognized or where recognitionwas limited to the extent of existing deferred tax liabilities. Additionally,the income tax expense was impacted by foreign withholding taxes, for which taxcredits are not anticipated, U.S. state income taxes, and foreign taxescalculated at statutory rates less than the U.S. federal statutory rate.

The Company recognized incometax expense of $3.1 million and $5.9 million for the three and six monthsended July 2, 2005, respectively, on consolidated income before incometaxes of $7.2 million and $15.2 million, respectively. This income taxexpense is marginally higher than the U.S. federal statutory rate partially dueto losses in certain jurisdictions for which no income tax benefits were recognized.Additionally, the income tax expense was impacted by foreign withholding taxes,for which tax credits are not anticipated, U.S. state income taxes and foreigntaxes calculated at statutory rates less than the U.S. federal statutory rate.

Management judgment isrequired in determining tax provisions and evaluating tax positions. Althoughmanagement believes its tax positions and related provisions reflected in theConsolidated Financial Statements are fully supportable, it recognizes that thesetax positions and related provisions may be challenged by various taxauthorities. These tax positions and related provisions are reviewed on anongoing basis and are adjusted as additional facts and information becomeavailable, including progress on tax audits, changes in interpretations of taxlaws, developments in case law and closing of statute of limitations. TheCompany’s tax provision includes the impact of recording reserves and anychanges thereto. As of July 1, 2006, the Company has a number of taxaudits in process and has open tax years with various taxing jurisdictions thatrange from 2001 to 2005. Although the results of current tax audits and reviewsrelated to open tax years have not been finalized, management believes that theultimate outcomes will not have a material adverse effect on the Company’sfinancial position, results of operations or cash flows.

Income tax refunds receivablewere $0.1 million and $1.6 million at July 1, 2006 and December 31,2005, respectively, and are largely comprised of amounts due from LatinAmerican tax jurisdictions. These amounts are included in *Othercurrent assets* on the Consolidated Balance Sheets.

**Note 9.**   Pensionand Postretirement Benefit Plans

The Company and itssubsidiaries sponsor multiple defined benefit plans and other postretirementbenefits that cover certain employees. Benefits are primarily based on years ofservice 

18

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

and theemployee’s compensation. It is the Company’s policy to fund such plans inaccordance with applicable laws and regulations.

Componentsof net periodic benefit costs for the three and six months ended July 1,2006 and July 2, 2005 are as follows (in thousands):

| ** **                                                | ** ** | **Pension Benefit Plans** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                | ** ** | **Three Months Ended**    | ** ** | **Six Months Ended** | ** ** |
| ** **                                                | ** ** | **July 1,  2006**              | ** ** | **July 2,  2005** | ** ** | **July 1,  2006** | ** ** | **July 2,  2005** | ** ** |
| Current service costs                                     |       | $                                   | 929        |   | $ | 635 |   | $ | 1,842 |   | $ | 1,291 |   |
| Interest costs on  projected benefit obligation and other |       | 1,552                               |       | 1,371 |   | 3,081 |   | 2,779 |   |
| Return on plan assets                                     |       | (1,781                              | )          | (1,501 | ) | (3,530 | ) | (3,043 | ) |
| Amortization of  transition obligation and other          |       | 111                                 |       | 7 |   | 221 |   | 13 |   |
| Periodic benefit cost, net                                |       | $                                   | 811        |   | $ | 512 |   | $ | 1,614 |   | $ | 1,040 |   |

 

| ** **                                                     | ** ** | **Postretirement Benefit Plans** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                     | ** ** | **Three Months Ended**           | ** ** | **Six Months Ended** | ** ** |
| ** **                                                     | ** ** | **July 1,  2006**                     | ** ** | **July 2,  2005** | ** ** | **July 1,  2006** | ** ** | **July 2,  2005** | ** ** |
| Current service costs                                          |       | $                                          | 59         |   | $ | 45 |   | $ | 117 |   | $ | 90 |   |
| Interest costs on  projected benefit obligation and other |       | 133                                        |       | 121 |   | 265 |   | 243 |   |
| Amortization of  transition obligation and other               |       | (31                                        | )          | (28 | ) | (62 | ) | (56 | ) |
| Periodic benefit cost, net                                     |       | $                                          | 161        |   | $ | 138 |   | $ | 320 |   | $ | 277 |   |

 

As of July 1, 2006, the Company had contributed$4.6 million to its pension and postretirement benefit plans for the 2006benefit year. The Company presently anticipates contributing an additional$3.6 million to fund its plans in 2006, for a total of $8.2 million.

Additionally, during the first fiscal quarter of 2006,as part of its restructuring and related cost reduction measures, the Companynegotiated certain changes with the union representing the employees of one ofthe Company’s Canadian operations, including a partial curtailment of a definedbenefit pension plan. No net gain or loss has been incurred as a result of the partialcurtailment. However, based on elections made by plan participants during thesecond quarter of fiscal 2006, and subject to approval by Canadian regulatoryauthorities, the Company may incur a settlement loss associated with employeeswho have elected to exit the plan. Any loss associated with the partialsettlement of the defined benefit pension plan will be recognized at such timeas the settlement occurs, which is dependent upon governmental approval andupon fulfillment by the Company of its funding requirements associated with thefuture settlement. On a proforma basis, had such partial settlement occurred asof June 1, 2006, the Company estimates that a settlement loss would havebeen incurred in the amount of approximately $3.7 million as of that date.The Company currently estimates that it will be required to provide additionalfunding in connection with the partial settlement in the amount ofapproximately $2.5 million.

19

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

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

*Stock Option Plans*

The 2003 Stock Option Plan (the “2003 Plan”) wasapproved by the Company’s Board of Directors and shareholders and isadministered by the Compensation Committee of the Board of Directors. The stockoptions, representing 400,000 shares, have a five-year life and vest, based onthe achievement of various service and financial performance criteria, over afour-year period, with the initial awards beginning their vesting terms as of January 4,2004. Vesting of the stock options is accelerated on the occurrence of a changein control. During the second quarter of 2006, 11,250 options were forfeited.As of July 1, 2006 and December 31, 2005, the Company had awardedgrants of non-qualified stock options to purchase 388,750 and 400,000 sharesof the Company’s Class A Common Stock, respectively. The awards representsubstantially all of the amount reserved for issuance under the 2003 Plan.

Effective January 1, 2006, the Company accountsfor the 2003 Plan in accordance with the methodology defined in SFAS No. 123R,using the modified prospective transition method. Under the modifiedprospective transition method, the compensation costs related to all new grantsand any unvested portion of prior awards are measured based on the grant-datefair value of the award. Prior to fiscal 2006, the Company elected to accountfor the 2003 Plan in accordance with the intrinsic value method as prescribedby Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees” (“APB No. 25”), which generally measures compensationcost as the excess, if any, of the quoted market price of the stock at the dateof grant over the amount an employee must pay to acquire the stock. Additionally,as a percentage of the options vest based on achievement of financialperformance criteria, compensation costs were recognized over the performanceperiod when it became probable that such performance criteria will be achieved.The compensation costs related to the 2003 Plan were $0.2 million and$0.5 million for the three and six months ended July 1, 2006,respectively, and were included in *Selling,general and administrative expenses* in the Consolidated Statementsof Operations. For the three and six months ended July 2, 2005, such costswere $1.1 million and $1.5 million, respectively.

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

*Restricted Stock Plans*

In May 2004, the Company’s shareholders approvedthe 2004 Restricted Stock Plan for Directors (the “Restricted Plan”), whichexpires in 2014, for the issuance of restricted shares of the Company’s Class ACommon Stock to Directors of the Company, as defined in the Restricted Plan.The Restricted Plan approved for issuance 200,000 restricted shares and isadministered by a committee of the Company’s Board of Directors not eligible toreceive restricted shares under the Restricted Plan. In the first six months offiscal years 2006 and 2005, the Company awarded 5,660 and 3,240 restrictedshares, respectively, to members of the Company’s Board of Directors for theirBoard service to the Company. The cost associated with these restricted stockgrants, which vest over periods ranging from six to eighteen months, totaledapproximately $45.0 thousand and $90.0 thousand for the three and sixmonths ended July 1, 2006, respectively, and was included in *Selling, general and administrative expenses*in the Consolidated Statement of Operations. For the three and six months 

20

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

ended July 2, 2005, thesecosts were $10.0 thousand and $20.0 thousand, respectively. As of July 1, 2006,148,460 shares of the Company’s Class A Common Stock are availablefor future grant under the Restricted Plan.

In December 2005, theCompany’s 2005 Employee Restricted Stock Plan (the “2005 Stock Plan”) wasapproved by the Company’s Board of Directors and is administered by theCompensation Committee of the Company’s Board of Directors. The 2005 Stock Planwas formally approved by the shareholders of the Company on May 23, 2006at the Annual Shareholders’ Meeting. The 2005 Stock Plan, which expires in2015, approved for issuance 482,000 restricted shares to employees of theCompany. The Compensation Committee may, from time to time, grant shares ofrestricted stock under the 2005 Stock Plan to such employees and in suchamounts and with specified restrictions as it determines appropriate in thecircumstances. Vesting of the restricted shares is accelerated on theoccurrence of a change in control. During the first six months of fiscal 2006,278,000 restricted shares were awarded to certain employees of the Company.Approximately 100,000 of these shares vested immediately with the balancevesting 25% on each of the grant’s anniversary dates, beginning with January 20,2006. In addition, 36,996 shares have been surrendered by employees to satisfywithholding requirements and 750 shares have been forfeited. The compensationcost of $0.3 million and $3.8 million related to these restricted stockgrants for the three and six months ended July 1, 2006, respectively, wasincluded in *Selling, general andadministrative expenses* in the Consolidated Statement of Operations.As of July 1, 2006, 241,746 shares of the Company’s Class ACommon Stock are available for future grant under the 2005 Stock Plan.

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

In conjunction with the Company’s refinancing in April 2004of its then existing credit facility, the Company’s majority shareholderexchanged approximately $42.6 million in aggregate principal amount of10.0% Convertible Subordinated Notes due 2007 (the “Junior Notes”) itcontrolled for 42,633 shares of the Company’s 16% Series AConvertible Pay-in-kind Preferred Shares (the “PIK Preferred Shares”). Also,during the third quarter of fiscal 2004, $10.1 million in aggregateprincipal amount of the Company’s Junior Notes were exchanged for10,083 shares of the Company’s PIK Preferred Shares and 6,719 sharesof the Company’s Class A Common Stock. Such Junior Notes were subordinatedindebtedness of the Company and provided for interest at an annual rate of10.0%, which interest, at the option of the holder, could be received inadditional principal amounts of the Junior Notes or in cash. The Junior Notescould be converted, at the option of the holder, into shares of Class ACommon Stock on the same terms as included in the PIK Preferred Shares (aconversion rate of 137.14286 shares of Class A Common Stock per shareof the convertible security, which approximates an initial conversion price ofapproximately $7.29 per share). As the aforementioned exchanges were acomponent of the recapitalization of the Company, involving the majorityshareholder and other common shareholders of the Company and the exchange bythe majority shareholder was a requirement of the then new Bank Facility, theexchanges have been accounted for as a capital transaction and, accordingly, nogain or loss was recognized.

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

21

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

shares of PIK Preferred Stock,the Company recognized the dividend at the estimated fair value of the sharesissued in excess of the amounts previously accrued. At any time prior to June 30,2012, the holders of the PIK Preferred Shares could have elected to convert anyor all of their PIK Preferred Shares into shares of the Company’s Class ACommon Stock at an initial conversion rate of 137.14286 shares of Class ACommon Stock per share of PIK Preferred Shares which approximates an initialconversion price equal to $7.29 per share.

On January 14, 2005, the Company’s Board ofDirectors declared that dividends accrued on the PIK Preferred Shares from thedate of issuance through December 31, 2004, in the amount of$5.6 million, would be paid in the form of PIK Preferred Shares. TheCompany recorded the value of the additional PIK Preferred Shares declared as adividend on January 14, 2005, the date the Board of Directors declaredthat the accrued dividends were to be paid in the form of additional PIKPreferred Shares, rather than cash, reduced by the amount of dividendspreviously recorded at the stated 16.0% rate. Using the estimated market valueof the Company’s Class A Common Stock of $18.50 per share, the fair valueof the 5,540 additional PIK Preferred Shares issued in lieu of cash payment wasapproximately $14.1 million, which exceeded the amount previously accruedby the Company of $5.6 million, based on the stated rate of 16.0%, byapproximately $8.5 million. The Company accrued dividends at the statedrate of 16.0% on the PIK Preferred Shares during the quarter ended July 2,2005 in the amount of $2.4 million. As a result, total accrued and paid-in-kinddividends amounted to approximately $13.2 million in the first six monthsof fiscal 2005.

On August 3, 2005, the Company’s Board ofDirectors declared that dividends accrued on the PIK Preferred Shares from January 1,2005 through June 30, 2005, in the amount of $4.7 million, would bepaid in the form of PIK Preferred Shares. The Company recorded the value of theadditional PIK Preferred Shares declared as a dividend on August 3, 2005,the date the Board of Directors declared that the accrued dividends were to bepaid in the form of additional PIK Preferred Shares, rather than cash, reducedby the amount of dividends previously recorded at the stated 16.0% rate. Usingthe estimated market value of the Company’s Class A Common Stock of $27.70per share, the fair value of the 4,660 additional PIK Preferred Shares issuedin lieu of cash payment was approximately $17.7 million, which exceededthe amount previously accrued by the Company of $4.7 million, based on thestated rate of 16.0%, by approximately $13.0 million. In addition, theCompany accrued a charge for dividends of $1.8 million for the period fromJuly 2, 2005 through the date that the PIK Preferred Shares were redeemedfor, or converted to, shares of the Company’s Class A Common Stock, asdescribed below.

On July 28, 2005, the Company’s Board ofDirectors authorized the redemption of all of the Company’s PIK PreferredShares on or before September 30, 2005. On August 16, 2005, the Boardof Directors set September 15, 2005 as the redemption date (the “RedemptionDate”). In accordance with the terms of the PIK Preferred Shares, the Companywould redeem all PIK Preferred Shares outstanding at the Redemption Date at aredemption rate of 37.26397 shares of Class A Common Stock per PIKPreferred Share. At any time prior to the Redemption Date, holders of PIKPreferred Shares could exercise their right to convert their PIK PreferredShares into shares of Class A Common Stock at a conversion rate of137.14286 shares of Class A Common Stock per PIK Preferred Share.

As of the close of business onthe Redemption Date, five PIK Preferred Shares had been redeemed by the Companywith the redemption price being paid by the issuance of 187 shares of Class ACommon Stock. Additionally, 62,916 PIK Preferred Shares had been converted byholders into 8,628,473 shares of Class A Common Stock. Also, duringthe first quarter of fiscal 2005, five PIK 

22

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

PreferredShares were converted into 686 shares of Class A Common Stock. As aresult of these transactions, 8,629,346 additional shares of Class ACommon Stock are now issued and outstanding and no PIK Preferred Shares arecurrently issued or outstanding.

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

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

The Company uses interest-rate derivative instrumentsto manage its exposure related to movements in interest rates with respect toits debt instruments. As indicated in Note 7 to the Consolidated FinancialStatements, to mitigate its interest rate exposure as required by the CreditFacility, the Company entered into a pay-fixed, receive-variable interestrate swap, thus effectively converting the variable LIBOR-based interestpayments associated with $212.5 million of the debt to fixed amounts at aLIBOR rate of 3.383%. The notional amount of this contract, which expires on May 8,2007, was $212.5 million at both July 1, 2006 and December 31,2005. Cash settlements are made quarterly and the floating rate is resetquarterly, coinciding with the reset dates of the current Credit Facility.

In accordance with SFAS No. 133, the Companydesignated the swap as a cash flow hedge of the variability of interestpayments and applied the shortcut method of assessing effectiveness. Theagreement’s terms ensure complete effectiveness in offsetting the variabilityof the interest component associated with $212.5 million of first-lienterm loan debt. As such, there is no ineffectiveness and changes in the fairvalue of the swap are recorded to accumulated other comprehensive income (loss)in the Consolidated Balance Sheets. The fair value of the interest rate swap,based on current settlement values, was $3.9 million as of July 1,2006 and December 31, 2005. Those amounts are included in *Other noncurrent assets* in theConsolidated Balance Sheets.

The impact of this swap on *Interest expense, net* in the Consolidated Statements ofOperations was a decrease of $0.9 million and $1.5 million for the threeand six months ended July 1, 2006, respectively. For the three and sixmonths ended July 2, 2005, the impact was an increase of $0.2 million and$0.6 million, respectively.

In May 2005, the Companyentered into a series of foreign exchange forward contracts to manage itsU.S.-dollar exposure on Euro-based obligations for firm commitments related tocertain capital expenditure projects. In accordance with SFAS No. 133, theCompany designated the forward contracts as a fair value hedge. In addition,the forward contracts, which mature through September 15, 2006, are highlyeffective in hedging the Company’s specifically-covered firm commitments,meaning that any change in the foreign currency is offset by a similar changein the firm commitment. At July 1, 2006, the Company had approximately$7.5 million of notional amount in outstanding contracts with athird-party financial institution.

23

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

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

Calculations have not been presented to reconcilebasic income per common share to diluted income per common share for the threeand six months ended July 1, 2006 or July 2, 2005 as the impact ofsuch calculations are anti-dilutive. Average shares outstanding for the threeand six months ended July 1, 2006 were 19,288,746 and 19,280,829,respectively. Average shares outstanding for the three and six months ended July 2,2005 were 10,424,627 and 10,421,542, respectively.

As of July 1,2006, the Company’s authorized capital stock consisted of the following classesof 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 commonstock have similar voting rights. In accordance with the Amended and RestatedCertificate of Incorporation, Class C Common Stock has special rights toannual dividends and all shares of Class B, C, D and E Common Stock may beconverted into an equal number of shares of Class A Common Stock. The sharesof preferred stock may be issued from time to time with such designation,preferences, participation rights and optional or special rights (including,but not limited to, dividend rates, voting rights, maturity dates and the like)as determined by the Board of Directors. See Note 11 to the ConsolidatedFinancial Statements for additional information related to the Company’s PIKPreferred Shares.

**Note 14.**   SegmentInformation

The Company’s reportable segments consist of itsprimary operating divisions—Nonwovens and Oriented Polymers. This reflects howthe overall business is managed on a regular basis by the Company’s seniormanagement and the Board of Directors. Each of these businesses sells todifferent end-use markets, such as hygiene, medical, wipes and industrial andspecialty markets. Sales to P&G accounted for more than 10% of the Company’ssales in each of the periods presented. Sales to this customer are reportedprimarily in the Nonwovens segment and the loss of these sales would have amaterial adverse effect on this segment. The Company recorded charges and/orincome in the Consolidated Statements of Operations during the three and sixmonths ended July 1, 2006 and the three and six months ended July 2,2005 relating to asset impairment charges, restructuring and plant realignmentcosts, abandoned acquisition costs and foreign currency losses, net which havenot been allocated to the segment data.

24

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

Financialdata by segment is as follows (in thousands):

| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **July 1,  2006**           | ** ** | **July 2,  2005**         | ** ** | **July 1,  2006** | ** ** | **July 2,  2005** | ** ** |
| **Net sales**                                                            | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nonwovens                                                                |       | $                                | 203,619    |                           | $          | 192,170 |   | $ | 414,271 |   | $ | 386,706 |   |
| Oriented Polymers                                                        |       | 45,087                           |       | 43,683                         |       | 94,876 |   | 93,508 |   |
|                                                                     |       | $                                | 248,706    |                           | $          | 235,853 |   | $ | 509,147 |   | $ | 480,214 |   |
| **Operating  income (loss)**                                             | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nonwovens                                                                |       | $                                | 14,312     |                           | $          | 17,938 |   | $ | 31,948 |   | $ | 34,661 |   |
| Oriented Polymers                                                        |       | 52                               |       | 3,582                          |       | 3,317 |   | 8,846 |   |
| Unallocated Corporate                                                    |       | (3,466                           | )          | (5,439                         | )          | (13,562 | ) | (10,976 | ) |
|                                                                     |       | 10,898                           |       | 16,081                         |       | 21,703 |   | 32,531 |   |
| Asset impairment charges                                                 |       | (7,856                           | )          | —                         |       | (7,856 | ) | — |   |
| Restructuring and plant realignment costs                                |       | (2,740                           | )          | (5                             | )          | (4,373 | ) | (9 | ) |
| Abandoned acquisition costs                                              |       | (3,670                           | )          | —                         |       | (3,670 | ) | — |   |
| Foreign currency loss, net                                               |       | (2,405                           | )          | (70                            | )          | (2,972 | ) | (94 | ) |
|                                                                     |       | $                                | (5,773     | )                              | $          | 16,006 |   | $ | 2,832 |   | $ | 32,428 |   |
| **Depreciation  and amortization expense**                               | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nonwovens                                                                |       | $                                | 11,759     |                           | $          | 11,353 |   | $ | 23,461 |   | $ | 22,451 |   |
| Oriented Polymers                                                        |       | 2,860                            |       | 2,355                          |       | 5,605 |   | 4,457 |   |
| Unallocated Corporate                                                    |       | (56                              | )          | (37                            | )          | (74 | ) | (78 | ) |
| Depreciation and amortization expense included in operating  income |       | 14,563                           |       | 13,671                         |       | 28,992 |   | 26,830 |   |
| Amortization of loan acquisition costs                                   |       | 345                              |       | 503                            |       | 669 |   | 1,007 |   |
|                                                                     |       | $                                | 14,908     |                           | $          | 14,174 |   | $ | 29,661 |   | $ | 27,837 |   |
| **Capital  spending**                                                    | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nonwovens                                                                |       | $                                | 14,345     |                           | $          | 24,618 |   | $ | 44,640 |   | $ | 34,614 |   |
| Oriented Polymers                                                        |       | 979                              |       | 117                            |       | 1,499 |   | 215 |   |
| Corporate                                                                |       | 267                              |       | —                         |       | 297 |   | — |   |
|                                                                     |       | $                                | 15,591     |                           | $          | 24,735 |   | $ | 46,436 |   | $ | 34,829 |   |

 

| ** **           | ** ** | **July 1,   2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Division  assets** | ** ** | ** **                   | ** ** |                        | ** ** | ** ** |   |
| Nonwovens            |       | $                            | 748,759    |                        |       | $ | 715,977 |   |   |
| Oriented Polymers    |       | 138,738                      |       |                        | 144,477    |   |   |
| Corporate            |       | (335                         | )          |                        | 2,096      |   |   |
| Eliminations         |       | (100,958                     | )          |                        | (97,549    | ) |   |
|                 |       | $                            | 786,204    |                        |       | $ | 765,001 |   |   |

 

25

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

**Geographic Data:**

Geographic data for theCompany’s operations, based on the geographic region that sales are made from,are presented in the following table (in thousands):

| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **July 1,  2006**           | ** ** | **July 2,  2005**         | ** ** | **July 1,  2006** | ** ** | **July 2,  2005** | ** ** |
| **Net sales**                                                            | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States                                                            |       | $                                | 113,681    |                           | $          | 107,598 |   | $ | 235,269 |   | $ | 221,020 |   |
| Canada                                                                   |       | 28,132                           |       | 27,467                         |       | 59,611 |   | 58,435 |   |
| Europe                                                                   |       | 46,803                           |       | 48,623                         |       | 93,832 |   | 99,307 |   |
| Asia                                                                     |       | 11,528                           |       | 11,031                         |       | 23,083 |   | 22,041 |   |
| Latin America                                                            |       | 48,562                           |       | 41,134                         |       | 97,352 |   | 79,411 |   |
|                                                                     |       | $                                | 248,706    |                           | $          | 235,853 |   | $ | 509,147 |   | $ | 480,214 |   |
| **Operating  income (loss)**                                             | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States                                                            |       | $                                | (71        | )                              | $          | 1,150 |   | $ | (3,237 | ) | $ | 1,849 |   |
| Canada                                                                   |       | (1,536                           | )          | 1,617                          |       | (598 | ) | 4,748 |   |
| Europe                                                                   |       | 3,701                            |       | 4,535                          |       | 7,669 |   | 8,804 |   |
| Asia                                                                     |       | 1,317                            |       | 1,344                          |       | 2,702 |   | 2,209 |   |
| Latin America                                                            |       | 7,487                            |       | 7,435                          |       | 15,167 |   | 14,921 |   |
|                                                                     |       | 10,898                           |       | 16,081                         |       | 21,703 |   | 32,531 |   |
| Asset impairment charges                                                 |       | (7,856                           | )          | —                         |       | (7,856 | ) | — |   |
| Restructuring and plant realignment costs                                |       | (2,740                           | )          | (5                             | )          | (4,373 | ) | (9 | ) |
| Abandoned acquisition costs                                              |       | (3,670                           | )          | —                         |       | (3,670 | ) | — |   |
| Foreign currency loss, net                                               |       | (2,405                           | )          | (70                            | )          | (2,972 | ) | (94 | ) |
|                                                                     |       | $                                | (5,773     | )                              | $          | 16,006 |   | $ | 2,832 |   | $ | 32,428 |   |
| **Depreciation  and amortization expense**                               | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States                                                            |       | $                                | 5,941      |                           | $          | 6,398 |   | $ | 11,963 |   | $ | 12,461 |   |
| Canada                                                                   |       | 2,246                            |       | 1,799                          |       | 4,439 |   | 3,357 |   |
| Europe                                                                   |       | 2,494                            |       | 2,385                          |       | 4,866 |   | 4,885 |   |
| Asia                                                                     |       | 1,036                            |       | 986                            |       | 2,092 |   | 1,983 |   |
| Latin America                                                            |       | 2,846                            |       | 2,103                          |       | 5,632 |   | 4,144 |   |
| Depreciation and amortization expense included in operating  income |       | 14,563                           |       | 13,671                         |       | 28,992 |   | 26,830 |   |
| Amortization of loan acquisition costs                                   |       | 345                              |       | 503                            |       | 669 |   | 1,007 |   |
|                                                                     |       | $                                | 14,908     |                           | $          | 14,174 |   | $ | 29,661 |   | $ | 27,837 |   |

 

| ** **                                             | ** ** | **July 1,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| **Identifiable assets (including  intangible assets)** | ** ** | ** **             | ** ** |                        | ** ** | ** ** |   |
| United States                                          |       | $                      | 332,413    |                        |       | $ | 323,596 |   |   |
| Canada                                                 |       | 88,844                 |       |                        | 94,531     |   |   |
| Europe                                                 |       | 205,771                |       |                        | 202,324    |   |   |
| Asia                                                   |       | 79,196                 |       |                        | 60,267     |   |   |
| Latin America                                          |       | 180,942                |       |                        | 181,834    |   |   |
| Eliminations                                           |       | (100,962               | )          |                        | (97,551    | ) |   |
|                                                   |       | $                      | 786,204    |                        |       | $ | 765,001 |   |   |

 

26

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

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

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

| ** **                           | ** ** | **Three Months Ended**                                 | ** ** | **Six Months Ended**                                   | ** ** |
|--------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                           | ** ** | **July 1,      2006   ** | ** ** | **July 2,      2005   ** | ** ** | **July 1,   2006** | ** ** | **July 2,   2005** | ** ** |
| Included in operating  income (loss) |       |                                                             | $          | 2,405                                                            |       |   |   | $ | 70 |   |   | $ | 2,972 |   |   | $ | 94 |   |   |
| Included in other,  net              |       |                                                             | 407        |                                                             |       |   | (306 | ) |   | 783 |   |   | (752 | ) |   |
|                                 |       |                                                             | $          | 2,812                                                            |       |   |   | $ | (236 | ) |   | $ | 3,755 |   |   | $ | (658 | ) |   |

 

For international subsidiarieswhich have the U.S. dollar as their functional currency, local currencytransactions are remeasured into U.S. dollars, using current rates of exchangefor monetary assets and liabilities. Gains and losses from the remeasurement ofsuch monetary assets and liabilities are reported in *Foreigncurrency loss, net* in the Consolidated Statements of Operations.Likewise, for international subsidiaries which have the local currency as theirfunctional currency, gains and losses from the remeasurement of monetary assetsand liabilities not denominated in the local currency are reported in *Foreign currency loss, net* in the Consolidated Statements ofOperations. Additionally, currency gains and losses have been incurred onintercompany loans between subsidiaries, and to the extent that such loans arenot deemed to be permanently invested, such currency gains and losses are alsoreflected in *Foreign currency and other (gain) loss, net*in the Consolidated Statement of Operations.

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

**Note 16.**   LegalProceedings and Commitments

The Company is not currently adefendant in any material pending legal proceedings other than routinelitigation incidental to the business of the Company. During 2005, the Companywas served with a lawsuit by a former customer alleging breach of contract andother charges. The discovery phase has recently begun and there is notcurrently enough information to formulate an assessment of the ultimate outcomeof the claim. Accordingly, management is not able to estimate the amount of theloss, if any, at this time. The Company intends to vigorously defend thisaction and believes that it has reasonable arguments available in its defense.However, there is a possibility that resolution of this matter, or others thatmay arise in the normal course of business, could result in a loss in excess ofestablished reserves, if any.

As part of its efforts toenhance its business, the Company has made commitments to expand its worldwidecapacity. Currently, the Company has several major committed capital projects,including the construction of a new spunmelt manufacturing plant in Suzhou,China and the installation of additional capacity in Mooresville, NorthCarolina and Nanhai, China. Remaining payments due related to these plannedexpansions as of July 1, 2006 totaled approximately $11.0 million andare expected to be expended over the remainder of fiscal 2006 and fiscal 2007.Additionally, the Company has announced plans to install a new spunmelt line atthe joint venture facility near Buenos Aires, Argentina. However, necessaryfinancing and equipment contracts have not yet been executed with respect tothe planned expansion.

In June 2006, one of theCompany’s subsidiaries, Fabpro Oriented Polymers, Inc. (“Fabpro”) entered intoan asset purchase agreement resulting from the sale of certain assets for$2.3 million and a supply and marketing rights agreement (“supplyagreement”) with an unrelated third party. Under the terms of the supply agreement,which has an initial term of 10 years, Fabpro has committed to 

27

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

purchase aminimum level of Product (as defined in the supply agreement), representingapproximately $7.1 million per year, based on current sales prices, through theyear 2012. In the event that Fabpro does not purchase such minimum quantities, Fabprowill be obligated to pay a 12.5% penalty on the value of the committed amountsnot purchased, based on sales prices in effect at that time.

**Note 17.**   SupplementalCash Flow Information

During the first six months of2006, noncash investing or financing activities included the surrender of 36,996shares of the Company’s Class A Common Stock to the Company byparticipants in the 2005 Stock Plan in the amount of $1.0 million to satisfyemployee withholding tax obligations. Also, the Company recorded $1.9 millionof fixed assets, for which payment had not been made as of July 1, 2006,and $2.3 million for proceeds not yet received from the sale of fixed assets.

Noncash investing or financingactivities in the first six months of 2005 included: (i) the conversion of5 shares of the Company’s PIK Preferred Shares into approximately 686 shares ofthe Company’s Class A Common Stock; (ii) the issuance of 5,540 PIKPreferred Shares as payment-in-kind, in lieu of cash payment, of approximately$5.6 million of dividends on the Company’s PIK Preferred Shares, whichresulted in an additional noncash dividend charge of approximately$8.5 million in excess of the amounts accrued at the stated dividend rateon PIK Preferred Shares; and (iii) the accrual of $4.7 million ofdividends on the PIK Preferred Shares.

**Note 18.**   SettlementAgreements

During June 2006, the Companyand an equipment supplier negotiated the resolution of an ongoing dispute andentered into two settlement agreements, which documented the terms of theresolution. The settlement agreements consist of (i) an agreementproviding that the Company be reimbursed by the equipment supplier, in theamount of 2.5 million Euros, for excess operating costs and expenses andlost profits, which the Company has experienced during the past nine months;and (ii) an agreement which provides that the equipment suppliercompensate the Company, in the amount of 1.5 million Euros, for technicalsupport and services provided by the Company to the equipment supplier duringthe aforementioned time frame. Under the settlement agreements, the Companyagreed to accept the equipment received from the supplier and to release a finalpayment due to the equipment supplier under the original terms of apre-existing contract.

In late July and August 2006,the Company reviewed the settlement agreements and the relationship of theseagreements with other services agreed to be purchased by the Company from thisequipment supplier and drafts of other contracts currently being negotiatedwith this equipment supplier. As a result of these reviews, uncertainties havearisen regarding the economic substance of the cash proceeds expected to be receivedunder the terms of the settlement agreements. Accordingly, the Company hasconcluded, based on these uncertainties and currently available information,that the appropriate accounting treatment under generally accepted accountingprinciples is to defer recognition of any and all income associated with thesettlement agreements until such uncertainties are resolved. Therefore, nofinancial statement recognition has been attributed to the settlementagreements by the Company as of and for the three and six month periods endedJuly 1, 2006.

On August 7, 2006, theAudit Committee of the Board of Directors of the Company became aware of issuesrelating to the foregoing transactions. As a result, the Audit Committee beganan internal investigation and has engaged special counsel to assist with theinvestigation of the transactions and related matters. The Company cannotpredict with certainty when the investigation will be completed. See “Controlsand Procedures” included in Item 4 of Part I to this Quarterly Reporton Form 10-Q.

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

The following discussion andanalysis provides information which management believes is relevant to anassessment and understanding of the Company’s consolidated results ofoperations and financial condition. The discussion should be read inconjunction with the consolidated financial statements and notes theretocontained in this Quarterly Report on Form 10-Q and the AnnualReport on Form 10-K for the fiscal year ended December 31,2005. In addition, it should be noted that the Company’s gross profit marginsmay not be comparable to other companies since some entities classify shippingand handling costs in cost of goods sold and others, including the Company,include such costs in selling, general and administrative expenses. Similarly,some entities, including the Company, include foreign currency gains and lossesresulting from operating activities as a component of operating income, andsome entities classify all foreign currency gains and losses outside ofoperating income.

During June 2006, the Company and an equipmentsupplier negotiated the resolution of an ongoing dispute and entered into twosettlement agreements, which documented the terms of the resolution. Thesettlement agreements consist of (i) an agreement providing that the Company bereimbursed by the equipment supplier, in the amount of 2.5 million Euros, forexcess operating costs and expenses and lost profits, which the Company hasexperienced during the past nine months; and (ii) an agreement which providesthat the equipment supplier compensate the Company, in the amount of 1.5million Euros, for technical support and services provided by the Company tothe equipment supplier during the aforementioned time frame.  Under the settlement agreements, the Companyagreed to accept the equipment received from the supplier and to release afinal payment due to the equipment supplier under the original terms of a pre-existingcontract.

In late July and August 2006, the Company reviewed thesettlement agreements and the relationship of these agreements with otherservices agreed to be purchased by the Company from this equipment supplier anddrafts of other contracts currently being negotiated with this equipmentsupplier.  As a result of these reviews,uncertainties have arisen regarding the economic substance of the cash proceedsexpected to be received under the terms of the settlement agreements.  Accordingly, the Company has concluded, basedon these uncertainties and currently available information, that theappropriate accounting treatment under generally accepted accounting principlesis to defer recognition of any and all income associated with the settlementagreements until such uncertainties are resolved.  Therefore, no financial statement recognitionhas been attributed to the settlement agreements by the Company as of and forthe three and six month periods ended July 1, 2006.

On August 7, 2006, the Audit Committee of the Board ofDirectors of the Company became aware of issues relating to the foregoingtransactions.  As a result, the AuditCommittee began an internal investigation and has engaged special counsel toassist with the investigation of the transactions and related matters.  The Company cannot predict with certaintywhen the investigation will be completed. See “Controls and Procedures” included in Item 4 of Part I to thisQuarterly Report on Form 10-Q.

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**Results of Operations**

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

| ** **                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| **   **                                           | ** ** | **July 1,  2006**           | ** ** | **July 2,  2005**         | ** ** | **July 1,  2006** | ** ** | **July 2,  2005** | ** ** |
| Net sales                                                        |       |                             | 100.0      | %                              |       |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |
| Cost of goods sold                                               |       |                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Materials                                                        |       |                             | 53.5       |                           |       |   | 50.6 |   |   |   | 53.0 |   |   |   | 50.8 |   |   |
| Labor                                                            |       |                             | 8.6        |                           |       |   | 8.3 |   |   |   | 8.2 |   |   |   | 8.4 |   |   |
| Overhead                                                         |       |                             | 23.2       |                           |       |   | 23.3 |   |   |   | 23.1 |   |   |   | 22.9 |   |   |
|                                                             |       |                             | 85.3       |                           |       |   | 82.2 |   |   |   | 84.3 |   |   |   | 82.1 |   |   |
| Gross profit                                                     |       |                             | 14.7       |                           |       |   | 17.8 |   |   |   | 15.7 |   |   |   | 17.9 |   |   |
| Selling, general and  administrative expenses                    |       |                             | 10.3       |                           |       |   | 11.0 |   |   |   | 11.4 |   |   |   | 11.1 |   |   |
| Asset impairment  charges                                        |       |                             | 3.1        |                           |       |   | — |   |   |   | 1.5 |   |   |   | — |   |   |
| Restructuring and  plant realignment costs                       |       |                             | 1.1        |                           |       |   | — |   |   |   | 0.9 |   |   |   | — |   |   |
| Abandoned acquisition  costs                                     |       |                             | 1.5        |                           |       |   | — |   |   |   | 0.7 |   |   |   | — |   |   |
| Foreign currency  loss, net                                      |       |                             | 1.0        |                           |       |   | — |   |   |   | 0.6 |   |   |   | — |   |   |
| Operating income  (loss)                                         |       |                             | (2.3       | )                              |       |   | 6.8 |   |   |   | 0.6 |   |   |   | 6.8 |   |   |
| Other expense (income):                                          |       |                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense, net                                            |       |                             | 2.8        |                           |       |   | 3.5 |   |   |   | 2.7 |   |   |   | 3.3 |   |   |
| Minority interests                                               |       |                             | 0.4        |                           |       |   | 0.4 |   |   |   | 0.4 |   |   |   | 0.4 |   |   |
| Foreign currency and other (gain) loss, net                      |       |                             | 0.2        |                           |       |   | (0.1 | ) |   |   | 0.2 |   |   |   | (0.1 | ) |   |
| Income (loss) before  income tax expense (benefit)               |       |                             | (5.7       | )                              |       |   | 3.0 |   |   |   | (2.7 | ) |   |   | 3.2 |   |   |
| Income tax expense  (benefit)                                    |       |                             | (0.7       | )                              |       |   | 1.3 |   |   |   | 0.1 |   |   |   | 1.2 |   |   |
| Net income (loss)                                                |       |                             | (5.0       | )                              |       |   | 1.7 |   |   |   | (2.8 | ) |   |   | 2.0 |   |   |
| Accrued and  paid-in-kind dividends on PIK preferred shares |       |                             | —     |                           |       |   | 1.0 |   |   |   | — |   |   |   | 2.8 |   |   |
| Income (loss) applicable to  common shareholders                 |       |                             | (5.0       | )%                             |       |   | 0.7 | % |   |   | (2.8 | )% |   |   | (0.8 | )% |   |

 

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**Comparison of ThreeMonths Ended July 1, 2006 and July 2, 2005**

The Company’s reportablesegments consist of its two operating divisions, Nonwovens and OrientedPolymers. For additional information regarding segment data, see Note 14 “SegmentInformation” to the Consolidated Financial Statements included in thisQuarterly Report on Form 10-Q. The following table sets forthcomponents of the Company’s net sales and operating income (loss) by operatingdivision for the three months ended July 1, 2006, the three months ended July 2,2005 and the corresponding change (in millions):

| ** **                                      | ** ** | **Three Months  Ended  July 1, 2006** | ** ** | **Three Months  Ended  July 2, 2005** | ** ** | **Change** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|
| Net sales                                       |       |                                                 |       |                                                 |       |       |       |   |   |   |   |   |   |
| Nonwovens                                       |       |                                                 | $          | 203.6                                                |       |       |       | $ | 192.2 |   |   |   | $ | 11.4 |   |   |
| Oriented Polymers                               |       |                                                 | 45.1       |                                                 |       |       | 43.7       |   |   |   | 1.4 |   |   |
| Eliminations                                    |       |                                                 | —     |                                                 |       |       | —     |   |   |   | — |   |   |
|                                            |       |                                                 | $          | 248.7                                                |       |       |       | $ | 235.9 |   |   |   | $ | 12.8 |   |   |
| Operating income (loss)                         |       |                                                 |       |                                                 |       |       |       |   |   |   |   |   |   |
| Nonwovens                                       |       |                                                 | $          | 14.3                                                 |       |       |       | $ | 17.9 |   |   |   | $ | (3.6 | ) |   |
| Oriented Polymers                               |       |                                                 | —     |                                                 |       |       | 3.6        |   |   |   | (3.6 | ) |   |
| Unallocated Corporate, net of eliminations      |       |                                                 | (3.4       | )                                                    |       |       | (5.4       | ) |   |   | 2.0 |   |   |
|                                            |       |                                                 | 10.9       |                                                 |       |       | 16.1       |   |   |   | (5.2 | ) |   |
| Asset impairment charges                        |       |                                                 | (7.9       | )                                                    |       |       | —     |   |   |   | (7.9 | ) |   |
| Restructuring and plant realignment costs  |       |                                                 | (2.7       | )                                                    |       |       | —     |   |   |   | (2.7 | ) |   |
| Abandoned acquisition costs                     |       |                                                 | (3.7       | )                                                    |       |       | —     |   |   |   | (3.7 | ) |   |
| Foreign currency loss, net                      |       |                                                 | (2.4       | )                                                    |       |       | (0.1       | ) |   |   | (2.3 | ) |   |
|                                            |       |                                                 | $          | (5.8                                                 | )          |       |       | $ | 16.0 |   |   |   | $ | (21.8 | ) |   |

 

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

**Net Sales**

Net saleswere $248.7 million for the three months ended July 1, 2006, anincrease of $12.8 million, or 5.4%, over the comparable period of 2005 netsales of $235.9 million. Net sales for 2006 improved in the NonwovensDivision over comparable 2005 results by 5.9%, and net sales in 2006 in theOriented Polymers Division improved over comparable 2005 results by 3.2%. Areconciliation of the change in net sales between the three months ended July 2,2005 and the three months ended July 1, 2006 is presented in the followingtable (in millions):

| Net sales—three  months ended July 2, 2005 |   | $      | 235.9  |   |
|------------------------------------------------------|--------|--------|--------|--------|
| Change in sales due to:                              |   |   |   |
| Volume                                               |   | 5.7    |   |
| Price/mix                                            |   | 5.5    |   |
| Foreign currency translation                         |   | 1.6    |   |
| Net sales—three months ended  July 1, 2006 |   | $      | 248.7  |   |

 

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The increase in net sales during the second quarter of2006 was due primarily to volume gains and price/mix improvements.Substantially all of the volume gains occurred in the United States and LatinAmerican nonwoven markets. The price/mix improvement reflects continuedenhancements of the Company’s product offerings as well as the increases insales price in an effort to pass along raw material cost increases tocustomers. As raw material costs have increased, the Company has attempted topass raw material prices along to its customers, where allowable by contractterms and where acceptable based on market conditions. In general, with respectto contracted business, there is usually a one-quarter lag between the changein raw material cost and the change in sales price.

A significant component of the $5.7 millionincrease in sales in the second quarter of 2006 due to volume growth wasgenerated in the Latin American region with the addition of thenewly-constructed spunmelt line at the Cali, Colombia facility. The LatinAmerica region’s sales improvement was paced by significant year-over-yearincreases in hygiene and industrial sales. In the Company’s U.S. nonwovensbusiness, the industrial and consumer markets contributed to the increase from2005 as new products were introduced into the markets. The Company believesthat the volume growth achieved was mitigated by reduced purchases by certaincustomers in response to inventory reduction programs at certain retailestablishments. Nonwoven sales volumes were essentially flat in Asia anddecreased 2.7% in Europe. Oriented Polymers’ net sales increased 3.2% in 2006from the comparable 2005 periods as improvements in price/mix of sales of $1.6million and a favorable foreign currency translation impact offset the $1.9million decrease in sales volume.

The Euro was stable againstthe U.S. dollar during the second quarter of 2006 compared to 2005, andthe Canadian dollar strengthened against the U.S. dollar during the secondquarter. As a result, net sales increased $1.6 million due to the netfavorable foreign currency translation. Further discussion of foreign currencyexchange rate risk is contained in “Quantitative and Qualitative DisclosuresAbout Market Risk” included in Item 3 of Part I to this Quarterly Reporton Form 10-Q.

**Gross Margin**

Gross margin in the quarterended July 1, 2006 declined to 14.7% from 17.8% in the second quarter of2005, despite improved sales volumes and product mix, primarily due to theimpact of higher raw material and other manufacturing costs, includingdepreciation during 2006. The raw material component of the cost of goods soldas a percentage of net sales increased from 50.6% in 2005 to 53.5% in 2006.

**Operating Income**

A reconciliationof the change in operating income between the three months ended July 2,2005 and the three months ended July 1, 2006 is presented in the followingtable (in millions):

| Operating  income—three months ended July 2, 2005 |   | $      | 16.0   |   |
|-------------------------------------------------------------|--------|--------|--------|--------|
| Change in operating income due to:                          |   |   |   |
| Price/mix                                                   |   | 5.5    |   |
| Higher raw material costs                                   |   | (7.1   | )      |
| Volume                                                      |   | 2.0    |   |
| Higher manufacturing costs                                  |   | (5.1   | )      |
| Foreign currency                                            |   | (2.3   | )      |
| Higher depreciation and amortization expense                |   | (0.9   | )      |
| Asset impairment charges                                    |   | (7.9   | )      |
| Higher restructuring and plant realignment costs            |   | (2.7   | )      |
| Abandoned acquisition costs                                 |   | (3.7   | )      |
| All other                                                   |   | 0.4    |   |
| Operating loss—three months  ended July 1, 2006   |   | $      | (5.8   | )      |

 

32

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The consolidated operatingloss was $5.8 million in 2006 as compared to operating income of$16.0 million in 2005. The Company experienced sales volume gains, whichcontributed to improved operating income. However, the Company experiencedhigher raw material costs,  which were onlypartially offset by price/mix improvements as the Company attempted to passalong raw material price increases that occurred during the quarter. Operating incomewas also negatively impacted by higher manufacturing costs, primarily in theCompany’s Oriented Polymers Division and increased depreciation andamortization charges which higher non-cash charges were primarily associatedwith the installation of the new production line in Latin America. The netdecline in operating income was significantly impacted by asset impairmentcharges, higher restructuring and plant realignment costs, abandonedacquisition costs and foreign currency losses, which currency losses primarilyrelated to the devaluation of the Colombian and Mexican pesos during thequarter. For further details on such charges, see Note 3 to theConsolidated Financial Statements included in Item 1 of Part I of thisQuarterly Report on Form 10-Q.

During the second quarter offiscal 2006, the Company experienced a continued weakening of earnings and cashflows in certain of its Canadian operations. As a result, the Company hasevaluated such assets for impairment, consistent with the provisions ofStatement of Financial Accounting Standards No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” (“SFAS No. 144”) and hasrecorded a non-cash charge associated with the write-down of such assets toestimated fair value in the amount of approximately $5.6 million in the secondquarter of 2006.

Additionally, during thesecond quarter of 2006, the Company has recorded a non-cash charge in theamount of approximately $2.3 million associated with the write-down of assetslocated in Sweden to estimated fair value less costs to sell, as such assetswill be removed from service in 2006 as a result of initiating the Company’sEuropean restructuring and consolidation strategies.

The 2006 restructuring andplant realignment costs are principally associated with (a) the Company’srestructuring and consolidation plan for Europe, which included terminationbenefits provided to an executive officer of the Company, pursuant to Dutchlaw, in the amount of $2.1 million and costs associated with the plannedclosure of the Sweden plant of $0.3 million; (b) costs related to therelocation of the corporate headquarters to Charlotte, North Carolina in theamount of $0.2 million; and (c) downsizing certain Canadian operationsresulting in severance costs of $0.2 million. These plans are expected toresult in reduced operating costs in the latter half of fiscal 2006.

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

Selling, general andadministrative expenses decreased $0.3 million, from $25.9 million in2005 to $25.6 million in 2006.

**Interest and Other Expense**

Net interest expense decreased$1.1 million, from $8.2 million during the three months ended July 2,2005 to $7.1 million during the three months ended July 1, 2006. Thedecrease in net interest expense was partially due to the lower interest ratesobtained by refinancing the Company’s long-term debt in November 2005.Additionally, during the second quarter of 2006, the Company capitalized, withrespect to its major capital expenditure projects, interest in the amount of$1.1 million, compared to $0.5 million in the second quarter of 2005.

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Foreign currency and other(gain) loss, net changed by $1.0 million, from income of $0.4 millionin the second quarter of fiscal 2005 to expense of $0.6 in the second quarterof fiscal 2006.

**Income Tax Expense**

During the three months ended July 1,2006, the Company recognized an income tax benefit of $1.8 million on aconsolidated pre-tax loss of $14.4 million. This income tax benefit issignificantly different than the U.S. federal statutory rate primarily due tolosses in the U.S. and certain foreign jurisdictions for which no income taxbenefits were recognized. Additionally, the income tax benefit was impacted byforeign withholding taxes, for which tax credits are not anticipated, U.S.state income taxes, and foreign taxes calculated at statutory rates less thanthe U.S. federal statutory rate. The Company recognized income tax expense of$3.1 million for the three months ended July 2, 2005 on consolidatedincome before income taxes of $7.2 million for such period. The income taxexpense  is higher than the U.S. federalstatutory tax rate partially due to losses in certain jurisdictions for which noincome tax benefits were recognized. Additionally, the income tax is impactedby foreign withholding taxes, for which tax credits are not anticipated, U.S.state income taxes and foreign taxes calculated at statutory rates less thanthe U.S. federal statutory rate.

**Net Income**

As a result of the above, theCompany recognized a net loss of $12.6 million during the three monthsended July 1, 2006 compared to net income of $4.1 million during thethree months ended July 2, 2005.

**Accrued and Paid-in-Kind Dividends on PIK PreferredShares**

The Company accrued dividendsat 16% on its PIK Preferred Shares during the quarter ended July 2, 2005in the amount of $2.4 million. As a result of all of the PIK PreferredShares being redeemed for or converted to shares of the Company’s Class ACommon Stock by September 15, 2005, no such dividends were recorded in thesecond quarter of 2006.

**Loss Applicable to Common Shareholders**

As a result of the above, theCompany recognized a loss applicable to common shareholders of $12.6 million,or $0.65 per share, for the three months ended July 1, 2006 compared toincome applicable to common shareholders of $1.7 million, or $0.16 pershare, for the three months ended July 2, 2005.

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**Comparison of SixMonths Ended July 1, 2006 and July 2, 2005**

TheCompany’s reportable segments consist of its two operating divisions, Nonwovensand Oriented Polymers. For additional information regarding segment data, seeNote 14 “Segment Information” to the Consolidated Financial Statementsincluded in Item 1 of Part I to this Quarterly Report on Form 10-Q.The following table sets forth components of the Company’s net sales andoperating income (loss) by operating division for the six months ended July 1,2006, the six months ended July 2, 2005 and the corresponding change(in millions):

| ** **                                 | ** ** | **Six Months  Ended  July 1, 2006** | ** ** | **Six Months  Ended  July 2, 2005** | ** ** | **Change** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|------------|------------|
| Net sales                                  |       |                                               |       |                                               |       |       |       |   |   |   |   |   |   |
| Nonwovens                                  |       |                                               | $          | 414.2                                              |       |       |       | $ | 386.7 |   |   |   | $ | 27.5 |   |   |
| Oriented Polymers                          |       |                                               | 94.9       |                                               |       |       | 93.5       |   |   |   | 1.4 |   |   |
| Eliminations                               |       |                                               | —     |                                               |       |       | —     |   |   |   | — |   |   |
|                                       |       |                                               | $          | 509.1                                              |       |       |       | $ | 480.2 |   |   |   | $ | 28.9 |   |   |
| Operating income                           |       |                                               |       |                                               |       |       |       |   |   |   |   |   |   |
| Nonwovens                                  |       |                                               | $          | 31.9                                               |       |       |       | $ | 34.7 |   |   |   | $ | (2.8 | ) |   |
| Oriented Polymers                          |       |                                               | 3.3        |                                               |       |       | 8.8        |   |   |   | (5.5 | ) |   |
| Unallocated Corporate, net of eliminations |       |                                               | (13.5      | )                                                  |       |       | (11.0      | ) |   |   | (2.5 | ) |   |
|                                       |       |                                               | 21.7       |                                               |       |       | 32.5       |   |   |   | (10.8 | ) |   |
| Asset impairment charges                   |       |                                               | (7.9       | )                                                  |       |       | —     |   |   |   | (7.9 | ) |   |
| Restructuring and plant realignment costs  |       |                                               | (4.3       | )                                                  |       |       | —     |   |   |   | (4.3 | ) |   |
| Abandoned acquisition costs                |       |                                               | (3.7       | )                                                  |       |       | —     |   |   |   | (3.7 | ) |   |
| Foreign currency loss, net                 |       |                                               | (3.0       | )                                                  |       |       | (0.1       | ) |   |   | (2.9 | ) |   |
|                                       |       |                                               | $          | 2.8                                                |       |       |       | $ | 32.4 |   |   |   | $ | (29.6 | ) |   |

 

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

**Net Sales**

Net saleswere $509.1 million in the first six months of fiscal 2006, an increase of$28.9 million, or 6.0%, over net sales for the comparable period of 2005of $480.2 million. Net sales for 2006 improved in the Nonwovens Divisionover comparable 2005 results by 7.1%, and net sales in 2006 in the OrientedPolymers Division increased 1.5% over 2005 results. A reconciliation of thechange in net sales between the six months ended July 2, 2005 and the sixmonths ended July 1, 2006 is presented in the following table(in millions):

| Net sales—six months  ended July 2, 2005 |   | $      | 480.2  |   |
|----------------------------------------------------|--------|--------|--------|--------|
| Change in sales due to:                            |   |   |   |
| Volume                                             |   | 15.6   |   |
| Price/mix                                          |   | 14.2   |   |
| Foreign currency translation                       |   | (0.9   | )      |
| Net sales—six months ended  July 1, 2006 |   | $      | 509.1  |   |

 

The increase in net sales during the first six monthsof 2006 was due primarily to volume gains and price/mix improvements.Substantially all of the volume gains occurred in the United States and 

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Latin American nonwoven markets.The price/mix improvement reflects continued enhancements of the Company’sproduct offerings as well as the increases in sales price in an effort to passalong raw material cost increases to customers. As raw material costs haveincreased, the Company has attempted to pass raw material prices along to itscustomers, where allowable by contract terms and where acceptable based onmarket conditions.

A significant component of the $15.6 millionincrease in sales in the first six months of 2006 due to volume growth wasgenerated in the Latin American region with the addition of thenewly-constructed spunmelt line at the Cali, Colombia facility. The LatinAmerica region’s sales improvement was paced by significant year-over-yearincreases in hygiene and industrial sales. In the Company’s U.S. nonwovensbusiness, the hygiene and consumer markets contributed to the increase from2005 as new products were introduced into the markets. The Company believesthat the volume growth achieved was mitigated by reduced purchases by certaincustomers in response to inventory reduction programs at certain retailestablishments. Nonwoven sales volumes were stable in Europe and Asia. OrientedPolymers’ net sales for 2006 approximated the 2005 amount, as improvements inprice/mix of sales of $4.3 million and a favorable foreign currency translationimpact were offset by sales volume declines affecting net sales by $6.5 million.

The Euro was weaker againstthe U.S. dollar during the first six months of 2006 compared to 2005, butthe Canadian dollar strengthened against the U.S. dollar during the period. Asa result, net sales decreased $0.9 million due to the net unfavorableforeign currency translation. Further discussion of foreign currency exchangerate risk is contained in “Quantitative and Qualitative Disclosures AboutMarket Risk” included in Item 3 of Part I to this Quarterly Report on Form 10-Q.

**Gross Margin**

Gross margin in the first sixmonths of 2006 declined to 15.7% from 17.9% in the first six months of 2005,despite improved sales volumes and product mix, primarily due to the impact ofthe raw material price increases during 2006. The raw material component of thecost of goods sold as a percentage of net sales increased from 50.8% in 2005 to53.0% in 2006.

**Operating Income**

A reconciliation of the changein operating income between the six months ended July 2, 2005 and the sixmonths ended July 1, 2006 is presented in the following table(in millions):

| Operating income—six  months ended July 2, 2005 |   | $      | 32.4   |   |
|-----------------------------------------------------------|--------|--------|--------|--------|
| Change in operating income due to:                        |   |   |   |
| Price/mix                                                 |   | 14.2   |   |
| Higher raw material costs                                 |   | (15.2  | )      |
| Volume                                                    |   | 4.4    |   |
| Higher manufacturing costs                                |   | (6.7   | )      |
| Foreign currency                                          |   | (3.4   | )      |
| Higher depreciation and amortization expense              |   | (2.2   | )      |
| Asset impairment charges                                  |   | (7.9   | )      |
| Higher restructuring and plant realignment costs          |   | (4.3   | )      |
| Abandoned acquisition costs                               |   | (3.7   | )      |
| Higher share-based compensation costs                     |   | (2.9   | )      |
| All other, primarily higher SG&A costs                |   | (1.9   | )      |
| Operating income—six months  ended July 1, 2006 |   | $      | 2.8    |   |

 

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Consolidated operating income was $2.8 million in2006 as compared to $32.4 million in 2005. The Company experienced higherraw material costs that were partially offset by price/mix improvements.Operating income was positively impacted by the volume gains noted above in thenet sales discussion. The net decline in operating income was impacted byhigher non-cash compensation costs of $2.9 million attributable to share-basedawards made under the Company’s Stock Option and Restricted Stock plans. Otheritems contributing to the decline in operating income were higher manufacturingcosts, primarily in the Company’s Oriented Polymers Division, and higherdepreciation and amortization charges. The increase in depreciation andamortization charges is primarily related to the installation of the newproduction line in Latin America. The net decline in operating income was significantlyimpacted by asset impairment charges, higher restructuring and plantrealignment costs, abandoned acquisition costs and foreign currency losses,which currency losses primarily related to the devaluation of the Colombian andMexican pesos in the second quarter of 2006. For further details on suchcharges, see Note 3 to the Consolidated Financial Statements included inItem 1 of Part I to this Quarterly Report on Form 10-Q.

During the second quarter of fiscal 2006, the Companyexperienced a continued weakening of earnings and cash flows in certain of itsCanadian operations. As a result, the Company has evaluated such assets forimpairment, consistent with the provisions of SFAS No. 144 and has recorded anon-cash charge associated with the write-down of such assets to estimated fairvalue in the amount of approximately $5.6 million in the second quarter of2006.

Additionally, during the second quarter of 2006, theCompany has recorded a non-cash charge in the amount of approximately $2.3million associated with the write-down of assets located in Sweden to estimatedfair value less costs to sell, as such assets will be removed from service in2006 as a result of initiating the Company’s European restructuring andconsolidation strategies.

The 2006 restructuring and plant realignment costs areprincipally associated with (a) the Company’s restructuring and consolidationplan for Europe, which included termination benefits provided to an executiveofficer of the Company, pursuant to Dutch law, in the amount of $2.1 millionand costs associated with the planned closure of the Sweden plant of $0.3million; (b) costs related to the relocation of the corporate headquarters toCharlotte, North Carolina in the amount of $1.8 million; and (c) downsizingcertain Canadian operations resulting in severance costs of $0.2 million. Theplans are expected to result in reduced operating costs in the latter half offiscal 2006.

During the first five months of fiscal 2006, theCompany actively pursued a potential acquisition. In conjunction with thiseffort, the Company incurred approximately $3.7 million of costs, which areprimarily comprised of third-party professional fees. During the second quarterof fiscal 2006, the negotiations with respect to the potential acquisitionreached an impasse and the Company abandoned its efforts to consummate theacquisition. Accordingly, all costs with respect to the acquisition werecharged to *Abandoned acquisition costs* in theConsolidated Statement of Operations in the second quarter of fiscal 2006.

Selling, general andadministrative expenses increased $4.6 million, from $53.3 million in2005 to $57.9 million in 2006, primarily due to the non-cash compensationcosts related to the share-based awards described above, as well as increasedsales volumes. Effective January 1, 2006, the Company has elected themodified prospective transition method of accounting for share-based awards inaccordance with the provisions of SFAS No. 123R. Adoption of SFAS No. 123Rhas resulted in marginally lower compensation costs, with respect to stockoptions, than previously recognized by the Company under the intrinsic valuemethod as prescribed by APB Opinion No. 25.

**Interest and OtherExpense**

Net interest expense decreased $2.4 million, from$16.0 million during the six months ended July 2, 2005 to$13.6 million during the six months ended July 1, 2006. The decreasein net interest 

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expense was primarily due tothe lower interest rates obtained by refinancing the Company’s long-term debtin November 2005. Additionally, during the first six months of 2006, theCompany capitalized, with respect to its major capital expenditure projects,interest in the amount of $2.2 million, compared to $0.6 million inthe first six months of 2005.

Foreign currency and other(gain) loss, net changed by $1.8 million, from income of $0.7 millionin the first six months of fiscal 2005 to expense of $1.1 million in thefirst six months of fiscal 2006. The change was primarily due to the shift fromforeign currency gains in 2005 to losses in 2006 recognized on intercompanyloan balances denominated in currencies other than their functional currency,generally the U.S. dollar.

**Income Tax Expense**

During the six months ended July 1,2006, the Company recognized an income tax expense of $0.5 million on aconsolidated pre-tax loss of $13.7 million. This income tax expense issignificantly different than the U.S. federal statutory rate primarily due tolosses in the U.S. and certain foreign jurisdictions for which no income taxbenefits were recognized. Additionally, the income tax expense was impacted byforeign withholding taxes, for which tax credits are not anticipated, U.S.state income taxes, and foreign taxes calculated at statutory rates less thanthe U.S. federal statutory rate. The Company recognized income tax expense of$5.9 million for the six months ended July 2, 2005 on consolidatedincome before income taxes of $15.2 million for such period. The taxexpense is marginally higher than the U.S. federal statutory tax rate.Additionally, the income tax is impacted by foreign withholding taxes, forwhich tax credits are not anticipated, U.S. state income taxes and foreigntaxes calculated at statutory rates less than the U.S. federal statutory rate.

**Net Income**

As a result of the above, theCompany recognized a net loss of $14.2 million during the six months endedJuly 1, 2006 compared to net income of $9.2 million during the sixmonths ended July 2, 2005.

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

The Company accrued dividendsat 16% on its PIK Preferred Shares during the quarter ended April 2, 2005in the amount of $2.4 million. Additionally, on January 14, 2005, theCompany’s Board of Directors declared that dividends accrued on the PIKPreferred Shares from the date of issuance through December 31, 2004, inthe amount of $5.6 million, would be paid in the form of PIK PreferredShares. The Company recorded the value of the additional PIK Preferred Sharesdeclared as a dividend on January 14, 2005, the date the Board ofDirectors declared that the accrued dividends were to be paid in the form ofadditional PIK Preferred Shares, rather than cash, reduced by the amount ofdividends previously recorded at the stated 16.0% rate. Using the estimatedmarket value of the Company’s Class A Common Stock of $18.50 per share, thefair value of the 5,540 additional PIK Preferred Shares issued in lieu of cashpayment was approximately $14.1 million, which exceeded the amountpreviously accrued by the Company of $5.6 million, based on the statedrate of 16.0%, by approximately $8.5 million. The Company accrueddividends at 16% on its PIK Preferred Shares during the quarter endedJuly 2, 2005 in the amount of $2.4 million. Accordingly, totalaccrued and paid-in-kind dividends amounted to $13.2 million in the firstsix months of fiscal 2005. As a result of all of the PIK Preferred Shares beingredeemed for or converted to shares of the Company’s Class A Common Stockby September 15, 2005, no such dividends were recorded in the first sixmonths of 2006.

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**Loss Applicable toCommon Shareholders**

As a result of the above, theCompany recognized a loss applicable to common shareholders of $14.2 million,or $0.73 per share, for the six months ended July 1, 2006 compared to aloss applicable to common shareholders of $4.0 million, or $0.38 pershare, for the six months ended July 2, 2005.

**LIQUIDITY AND CAPITALRESOURCES**

TheCompany’s principal sources of liquidity for operations and expansions arefunds generated from operations and borrowing availabilities under the CreditFacility, consisting of a revolving credit facility with aggregate commitmentsof $45.0 million and a first-lien term loan of $410.0 million. Therevolving credit portion of the Credit Facility terminates on November 22,2010 and the remaining balance (after mandatory annual payments of$4.1 million and additional payments, if any, under the excess cash flowprovision of the Credit Facility) of the first-lien term loan is due November 22,2012. The Credit Facility contains covenants and events of default customaryfor financings of this type, including leverage and interest expense coveragecovenants. At July 1, 2006, the Company was in compliance with all suchcovenants. As of July 1, 2006, the Company had $9.0 million ofoutstanding borrowings under the revolving credit facility, and capacity underthe revolving credit facility had been reserved for outstanding letters ofcredit in the amount of $9.4 million.

| ** **                       | ** ** | **July 1,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(In Millions)** | ** ** |
| **Balance sheet data:**          | ** ** | ** **             | ** ** |                        | ** ** | ** ** |   |
| Cash and cash equivalents        |       | $                      | 19.5       |                        |       | $ | 31.0 | ** ** |   |
| Working capital                  |       | 163.7                  |       |                        | 173.4      | ** ** |   |
| Total assets                     |       | 786.2                  |       |                        | 765.0      | ** ** |   |
| Total debt                       |       | 422.6                  |       |                        | 415.2      | ** ** |   |
| Total shareholders’  equity |       | 132.1                  |       |                        | 131.5      | ** ** |   |
|                                  |            |                        |            |                             |            |  |  |  |  |

 

| ** **                                           | ** ** | **Six Months Ended**                                         | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **July 1,      2006    ** | ** ** | **July 2,        2005     ** | ** ** |
| ** **                                           | ** ** | **(In Millions)**                                                 | ** ** |
| **Cash flow data:**                                  | ** ** |                                                                   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net cash provided by operating activities            |       |                                                                   | $          | 26.6 |   |   |   | $ | 21.7 |   |   |
| Net cash used in investing activities                |       |                                                                   | (45.5      | ) |   |   | (34.5 | ) |   |
| Net cash provided by  (used in) financing activities |       |                                                                   | 7.1        |   |   |   | (2.5 | ) |   |
|                                                      |            |                                                                        |            |  |  |  |  |  |  |  |  |

 

**Operating Activities**

Net cash provided by operating activities was $26.6 millionduring 2006, a $4.9 million increase from the $21.7 million providedby operating activities during 2005. The increase in cash provided by operatingactivities was attributable primarily to improvements in working capital duringthe first six months of fiscal 2006 versus the comparable period of 2005offsetting the reductions of cash generated by operating activities, other thanthose associated with changes in working capital, in the first six months of2006 versus the comparable period of 2005.

The Company had working capital of approximately $163.7 millionat July 1, 2006 compared with $173.4 million at December 31, 2005.Accounts receivable at July 1, 2006 was $126.3 million as compared to$120.7 million at December 31, 2005, an increase of$5.6 million. Accounts receivable represented approximately 46 days ofsales outstanding at both July 1, 2006 and December 31, 2005.Inventories at July 1, 2006 were $125.6 million, an increase of $5.9 millionfrom inventories at December 31, 2005 of $119.7 million. The Companyhad inventory representing approximately 54 days of cost of sales on handat both July 1, 2006 and December 31, 2005. Accounts payable at 

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July 1, 2006 was$90.4 million as compared to $82.4 million at December 31, 2005,an increase of $8.0 million. Accounts payable represented approximately 39days of cost of sales outstanding at July 1, 2006 compared to 37 daysof cost of sales outstanding at December 31, 2005. The dollar increases inaccounts receivable, inventories and accounts payable in 2006 versus 2005 wereprimarily related to the increases in raw material prices and higher salesvolumes.

The Company’s restructuring and plant realignmentactivities are discussed in Note 3 “Business Restructuring” to the ConsolidatedFinancial Statements included in Item 1 of Part I to this Quarterly Reporton Form 10-Q. The2006 restructuring and plant realignment costs are principally associated with(a) the Company’s restructuring and consolidation plan for Europe, whichincluded termination benefits provided to an executive officer of the Company,pursuant to Dutch law, in the amount of $2.1 million and costs associated withthe planned closure of the Sweden plant of $0.3 million; (b) costs relatedto the relocation of the corporate headquarters to Charlotte, North Carolina inthe amount of $1.8 million; and (c) downsizing certain Canadian operationsresulting in severance costs of $0.2 million. Additionally, during thefirst fiscal quarter of 2006, as part of its restructuring and related costreduction measures, the Company negotiated certain changes with the unionrepresenting the employees of one of the Company’s Canadian operations,including a partial curtailment of a defined benefit pension plan. No net gainor loss has been incurred as a result of the partial curtailment. However,based on elections made by plan participants during the second quarter offiscal 2006, and subject to approval by Canadian regulatory authorities, theCompany may incur a settlement loss associated with employees who have electedto exit the plan. Any loss associated with the partial settlement of thedefined benefit pension plan will be recognized at such time as the settlementoccurs, which is dependent upon governmental approval and upon fulfillment bythe Company of its funding requirements associated with the future settlement. Ona proforma basis, had such partial settlement occurred as of June 1, 2006, theCompany estimates that a settlement loss would have been incurred in the amountof approximately $3.7 million as of that date. The Company currentlyestimates that it will be required to provide additional funding in connectionwith the partial settlement in the amount of approximately $2.5 million.

**Investing and Financing Activities**

Cash used for investingactivities amounted to $45.5 million and $34.5 million in the firstsix months of 2006 and 2005, respectively. Capital expenditures during 2006totaled $46.4 million, an increase of $11.6 million from capitalspending of $34.8 million in 2005. A significant portion of the capitalexpenditures in 2006 related to the construction of new spunmelt manufacturingfacilities in Suzhou, China and Mooresville, North Carolina. In addition,investing activities during 2006 and 2005 included proceeds from the sale ofassets of $1.4 million and $0.4 million, respectively.

Cash provided by financingactivities amounted to $7.1 million in the first six months of 2006,compared to the $2.5 million used in financing activities in the first sixmonths of 2005. In 2006, the Company borrowed, on a net basis, $7.4 millionof debt whereas the Company repaid, on a net basis, $2.4 million of debtduring 2005.

**Dividends**

The Board of Directors has notdeclared a dividend on the Company’s common stock since the first quarter of2001. The Credit Facility limits restricted payments to $5.0 million,including cash dividends, in the aggregate since the effective date of theCredit Facility. The Company does not currently anticipate paying dividends onits common stock in future periods.

On January 14, 2005, theCompany’s Board of Directors declared that dividends accrued on the PIKPreferred Shares from the date of issuance through December 31, 2004, inthe amount of $5.6 million, would be paid in the form of PIK PreferredShares. The Company recorded the value of the additional PIK Preferred Sharesdeclared as a dividend on January 14, 2005, the date the Board ofDirectors declared that the accrued dividends were to be paid in the form ofadditional PIK Preferred 

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Shares,rather than cash, reduced by the amount of dividends previously recorded at thestated 16.0% rate. Using the estimated market value of the Company’s Class ACommon Stock of $18.50 per share, the fair value of the 5,540 additional PIKPreferred Shares issued in lieu of cash payment was approximately$14.1 million, which exceeded the amount previously accrued by the Companyof $5.6 million, based on the stated rate of 16.0%, by approximately$8.5 million. The Company accrued dividends at 16% on its PIK PreferredShares during the quarter ended July 2, 2005 in the amount of$2.4 million. As a result, total accrued and paid-in-kind dividendsamounted to approximately $13.2 million in the first six months of fiscal2005. However, as all PIK Preferred Shares were redeemed for or converted toshares of the Company’s Class A Common Stock by September 15, 2005,no further dividends on the PIK Preferred Shares will be paid.

**Liquidity Summary**

As discussed more fully inNote 7 to the Consolidated Financial Statements included in Item 1 ofPart I to this Quarterly Report on Form 10-Q, on November 22,2005, the Company refinanced its then existing bank facility with a new CreditFacility consisting of a $45.0 million secured revolving credit facilitymaturing in 2010 and a $410.0 million first-lien term loan maturing in2012. The proceeds therefrom were used to fully repay indebtedness outstandingunder the Company’s previous bank facility and pay related fees and expenses.

All borrowings under theCredit Facility are U.S. dollar denominated and are guaranteed, on a jointand several basis, by each and all of the direct and indirect domestic subsidiariesof the Company. The Credit Facility and the related guarantees are secured by (i) alien on substantially all of the assets of the Company, its domesticsubsidiaries and certain of its non-domestic subsidiaries, (ii) a pledgeof all or a portion of the stock of the domestic subsidiaries of the Companyand of certain non-domestic subsidiaries of the Company, and (iii) apledge of certain secured intercompany notes. Commitment fees under the CreditFacility are equal to 0.50% of the daily unused amount of the revolving creditcommitment. The Credit Facility limits restricted payments to$5.0 million, including cash dividends, in the aggregate since theeffective date of the Credit Facility. The Credit Facility contains covenantsand events of default customary for financings of this type, including leverageand interest expense coverage covenants. At July 1, 2006, the Company wasin compliance with all such covenants. The first-lien term loan requiresmandatory payments of approximately $1.0 million per quarter and,beginning with fiscal 2006, the first-lien term loan requires the Company touse a percentage of proceeds from excess cash flows, as defined by the CreditFacility, and determined based on year-end results, to reduce its thenoutstanding balances under the Credit Facility.

Excess cash flows required tobe applied to the repayment of the Credit Facility are generally calculated as50.0% of the net amount of the Company’s available cash generated fromoperations adjusted for the cash effects of interest, taxes, capitalexpenditures, changes in working capital and certain other items. Since theamounts of excess cash flows for future periods are based on year-end resultsand not determinable, only the mandatory payments of approximately$1.0 million per quarter have been classified as a current liability inthe Consolidated Balance Sheet included in Item 1 of Part I to thisQuarterly Report on Form 10-Q. Additionally, no excess cash flowpayment was required to be made with respect to fiscal 2005 due to themagnitude of the major capital expenditure projects and any excess cash flowrequirement with respect to fiscal 2006 is not expected to be significant.

The interest rate applicableto borrowings under the Credit Facility is based on three-month LondonInterbank Offered Rate (“LIBOR”) plus a specified margin. The applicable marginfor borrowings under both the first-lien term loan and the revolving creditfacility is 225 basis points. The Company may, from time to time, elect touse an alternate base rate for its borrowings under the revolving creditfacility based on the bank’s base rate plus a margin of 75 to 125 basispoints based on the Company’s total leverage ratio. The Company had $9.0 millionof outstanding borrowings at July 1, 2006 under the revolving creditfacility. As of July 1, 2006, capacity under the revolving credit facilityhad been reserved for outstanding letters of credit in the amount of$9.4 million. None of these 

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letters ofcredit have been drawn on at July 1, 2006. Average borrowings under therevolving credit facility, which were largely LIBOR-based borrowings, for theperiod of January 1, 2006 to July 1, 2006 were $22.6 million atan average rate of 7.79%.

Additionally, in accordancewith the terms of the Credit Facility, the Company maintained its position in acash flow hedge agreement, effectively converting $212.5 million ofnotional principal amount of debt from a variable LIBOR rate to a fixed LIBORrate of 3.383%. The cash flow hedge agreement has been maintained in accordancewith the terms of the Credit Facility and it terminates on May 8, 2007.

The Credit Facility enteredinto during November 2005 provided the Company the ability to increase thesale of U.S. based receivables and non-U.S. based receivables, underfactoring agreements, to $20.0 million and $20.0 million,respectively. Accordingly, the Company has entered into factoring agreements tosell without recourse, certain U.S. and non-U.S. company-based receivables tounrelated third-party financial institutions. Under the terms of the factoringagreement related to the sale of U.S. company-based receivables, the maximumamount of outstanding advances at any one time is $20.0 million, whichlimitation is subject to change based on the level of eligible receivables,restrictions on concentrations of receivables and the historical performance ofthe receivables sold. Under the terms of the factoring agreement related to thesale of non-U.S. company-based receivables, the maximum amount of outstandingadvances at any one time is $10.0 million, which limitation is subject tochange based on the level of eligible receivables, restrictions onconcentrations of receivables and the historical performance of the receivablessold. The sale of these receivables accelerated the collection of the Company’scash, reduced credit exposure and lowered the Company’s net borrowing costs.

In June 2006, one of the Company’ssubsidiaries, Fabpro Oriented Polymers, Inc. (“Fabpro”) entered into anasset purchase agreement resulting in the sale of certain assets for$2.3 million and a supply and marketing rights agreement (“supplyagreement”) with an unrelated third party. Under the terms of the supplyagreement, which has an initial term of 10 years, Fabpro has committed topurchase a minimum level of Product (as defined in the supply agreement),representing approximately $7.1 million per year, based on current salesprices, through the year 2012. In the event that Fabpro does not purchase suchminimum quantities, Fabpro will be obligated to pay a 12.5% penalty on thevalue of the committed amounts not purchased, based on sales prices in effectat that time.

As discussed in Note 16to the Consolidated Financial Statements included in Item 1 of Part I tothis Quarterly Report on Form 10-Q,the Company has committed to several major projects to expand its worldwidecapacity, including the construction of a new spunmelt manufacturing facilityin Suzhou, China and the installation of additional capacity in Mooresville,North Carolina and Nanhai, China. Remaining payments due related to theseplanned expansions as of July 1, 2006 totaled approximately $11.0 millionand are expected to be expended over the remainder of fiscal 2006 and fiscal2007. Additionally, the Company has announced plans to install a new spunmeltline at the joint venture facility near Buenos Aires, Argentina. However, necessaryfinancing and equipment contracts have not yet been executed with respect tothe planned expansion.

The Company relies on itsability to generate positive cash flows from its operations and the financialflexibility provided by the Credit Facility to meet its operating needs, fundits capital expenditures and make all necessary contributions to its retirementplans. The Company believes that such sources of funds are sufficient to meetits long-term needs.

**Off-Balance Sheet Arrangements**

The Company does not have anyoff-balance sheet arrangements.

**Effect of Inflation**

Inflation generally affects the Company by increasingthe costs of labor, overhead, and equipment. The impact of inflation on theCompany’s financial position and results of operations was 

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minimal during the firstquarter of both 2006 and 2005. However, the Company continues to be impactedsignificantly by raw material costs. See “Quantitative and QualitativeDisclosures About Market Risk” included in Item 3 of Part I to thisQuarterly Report on Form 10-Q.

**New Accounting Standards**

In November 2004, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 151, “Inventory Costs” (“SFASNo. 151”). This statement amends earlier guidance to require that abnormalfreight, handling and spoilage costs be recognized as current-periodcharges rather than capitalized as an inventory cost. In addition, SFASNo. 151 requires that the allocation of fixed production overhead costs bebased on the normal capacity of the production facilities. SFAS No. 151 iseffective for inventory costs incurred during fiscal years beginning afterJune 15, 2005. The Company has adopted the provisions of SFAS No. 151effective January 1, 2006 and the impact has not been significant to itsfinancial position or results of operations.

In December 2004, theFASB issued a revision to SFAS No. 123, “Accounting for Stock-BasedCompensation.” The revision, entitled SFAS No. 123R, “Share-Based Payment”(“SFAS No. 123R”), is effective for all awards granted, modified,repurchased or canceled after June 15, 2005 and requires a public entityto measure the cost of employee services received in exchange for an award ofequity instruments based on the grant-date fair value of the award. The grantdate fair value is to be estimated using option-pricing models adjusted for theunique characteristics of those instruments. In April 2005, the Securitiesand Exchange Commission issued a final rule that registrants must adopt SFASNo. 123R’s fair value method of accounting no later than the beginning ofthe fiscal year beginning after June 15, 2005. Accordingly, the Companyadopted SFAS No. 123R as of January 1, 2006 using the modifiedprospective transition method. The grant date fair value was estimated usingthe Black-Scholes model. Under the modified prospective transition method, allnew grants and any unvested portion of prior awards as of January 1, 2006have been measured based on the fair-value-based method of accounting. Theimpact of adopting SFAS No. 123R has resulted in marginally lowercompensation costs than previously recognized under the Company’shistorically-used accounting principles. The proforma effect of utilizing SFASNo. 123R on the financial results for the three and six months endedJuly 2, 2005 is disclosed in Note 1 to the Consolidated FinancialStatements included in Item 1 of Part I to this Quarterly Report onForm 10-Q.

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFASNo. 154”). This statement amends earlier guidance and requiresretrospective application to prior periods’ financial statements of a voluntarychange in accounting principle unless it is impracticable to determine eitherthe period-specific effects or the cumulative effects of the change. Inaddition, SFAS No. 154 requires that a change in the method ofdepreciation or amortization for a long-lived, non-financial asset be accountedfor as a change in accounting estimate that is affected by a change inaccounting principle. SFAS No. 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15,2005. The Company has completed its evaluation of the impact that the adoptionof SFAS No. 154 could have and has concluded that such impact is notexpected to be significant to its financial position or results of operations.

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

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**Critical AccountingPolicies And Other Matters**

The Company’s analysis and discussion of its financialposition and results of operations are based upon its consolidated financialstatements that have been prepared in accordance with accounting principlesgenerally accepted in the United States (“U.S. GAAP”). The preparation offinancial statements in conformity with U.S. GAAP requires the appropriateapplication of certain accounting policies, many of which require management tomake estimates and assumptions about future events that may affect the reportedamounts of assets, liabilities, revenues and expenses, and the disclosure ofcontingent assets and liabilities. Since future events and their impact cannotbe determined with certainty, the actual results will inevitably differ from theestimates. The Company evaluates these estimates and assumptions on an ongoingbasis, including but not limited to those related to fresh start accounting,revenue recognition, including the effects of sales returns and allowances andcredit risks, convertible securities, inventories, income taxes, and impairmentof long-lived assets. Estimates and assumptions are based on historical andother factors believed to be reasonable under the circumstances. The impact andany associated risks related to estimates, assumptions, and accounting policiesare discussed within “Management’s Discussion and Analysis of Operations andFinancial Condition,” as well as in the Notes to the Consolidated FinancialStatements, if applicable, where such estimates, assumptions, and accountingpolicies affect the Company’s reported and expected results.

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

*FreshStart Accounting:*   In connection with theCompany’s Chapter 11 reorganization, the Company has applied fresh startaccounting to its Consolidated Balance Sheet as of March 1, 2003 inaccordance with Statement of Position No. 90-7, “Financial Reportingby Entities in Reorganization Under the Bankruptcy Code” as promulgated by theAICPA. Under fresh start accounting, a new reporting entity is considered to becreated and the recorded amounts of assets and liabilities are adjusted toreflect their estimated fair values at the date fresh start accounting isapplied. On March 5, 2003, the Company emerged from bankruptcy. Forfinancial reporting purposes, March 1, 2003 is considered the emergencedate and the effects of the reorganization have been reflected in the accompanyingfinancial statements as if the emergence occurred on that date.

Fresh-start accounting requires that thereorganization value of the Company be allocated to its assets and liabilitiesin conformity with SFAS No. 141, “Business Combinations”. Such allocationshave been reflected in the amounts included in the Consolidated FinancialStatements. Based on the consideration of many factors and various valuationmethods, the Company and its financial advisors determined the reorganizationvalue of the Company to be approximately $73.4 million, as described inthe Modified Plan. The factors and valuation methodologies included the reviewof comparable company market valuations and the recent acquisition values ofcomparable company transactions as well as discounted cash flow models. Thediscounted cash flow models utilized projected free cash flows for four futureyears, with such projected free cash flows discounted at rates approximatingthe expected weighted average cost of capital (11.0% to 13.0%) plus the presentvalue of the Company’s terminal value computed using comparable company exitmultiples. Projected free cash flows were estimated based on projected cashflows from operations, adjusted for the effects of income taxes at an effectiverate of 39.0%, estimated capital expenditures and estimated changes in workingcapital. The calculation of reorganization value of the Company was based on avariety of estimates and assumptions about future circumstances and events.Such estimates and assumptions are inherently subject to significant economicuncertainties. While the Company believes its judgments, estimates andvaluation methodologies were reasonable, different assumptions could havematerially changed the estimated reorganization value of the Company as of March 1,2003.

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*RevenueRecognition:*   Revenue from product sales isrecognized when title and risks of ownership pass to the customer. This isgenerally on the date of shipment to the customer, or upon delivery to a placenamed by the customer, dependent upon contract terms and when collectibility isreasonably assured and pricing is fixed or determinable. Revenue includesamounts billed to customers for shipping and handling. Provision for rebates,promotions, product returns and discounts to customers is recorded as a reductionin determining revenue in the same period that the revenue is recognized.Management bases its estimate of the expense to be recorded each period onhistorical returns and allowance levels. Management does not believe thelikelihood is significant that materially higher deduction levels will resultbased on prior experience.

*AccountsReceivable and Concentration of Credit Risks:*   Accountsreceivable potentially expose the Company to a concentration of credit risk, asdefined by Statement of Financial Accounting Standards No. 105, “Disclosureof Information about Financial Instruments with Off-Balance Sheet Risk andFinancial Instruments with Concentration of Credit Risk.” The Company providescredit in the normal course of business and performs ongoing credit evaluationson its customers’ financial condition as deemed necessary, but generally doesnot require collateral to support such receivables. The Company alsoestablishes an allowance for doubtful accounts based upon factors surroundingthe credit risk of specific customers, historical trends and other information.Also, in an effort to reduce its credit exposure to certain customers, as wellas accelerate its cash flows, the Company, beginning in 2004, sold, on a non-recoursebasis, certain of its receivables pursuant to factoring agreements. At July 1,2006, a reserve of $8.7 million has been recorded as an allowance againsttrade accounts receivable. Management believes that the allowance is adequateto cover potential losses resulting from uncollectible accounts receivable anddeductions resulting from sales returns and allowances. While the Company’scredit losses have historically been within its calculated estimates, it ispossible that future losses could differ significantly from these estimates.

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

*InventoryReserves:*   The Company maintains reserves forinventories valued using the first in, first out (FIFO) method. Such reservesfor inventories can be specific to certain inventory or general based onjudgments about the overall condition of the inventory. General reserves areestablished based on percentage write-downs applied to inventories agedfor certain time periods, or for inventories that are slow-moving. Specificreserves are established based on a determination of the obsolescence of theinventory and whether the inventory value exceeds amounts to be recoveredthrough the expected sales price of such inventories, less selling costs.Estimating sales prices, establishing markdown percentages and evaluating thecondition of the inventories require judgments and estimates, which may impactthe inventory valuation and gross profits. The actual amount of obsolete orunmarketable inventory has been materially consistent with previouslyestablished reserves. Management believes, based on its prior experience ofmanaging and evaluating the 

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recoverability of its slow moving or obsoleteinventory, that such established reserves are materially adequate. If actualmarket conditions and product sales were less favorable than we have projected,additional inventory writedowns may be necessary.

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

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

For assets held for disposal,an impairment charge is recognized if the carrying value of the assets exceedsthe fair value less costs to sell. Estimates are required of fair value,disposal costs and the time period to dispose of the assets. Such estimates arecritical in determining whether any impairment charge should be recorded andthe amount of such charge if an impairment loss is deemed to be necessary.Actual cash flows received or paid could differ from those used in estimatingthe impairment loss, which would impact the impairment charge ultimatelyrecognized. As of July 1, 2006, based on the Company’s current operatingperformance, as well as future expectations for the business, the Company doesnot anticipate any material writedowns for long-lived asset impairments,including goodwill, in the foreseeable future. However, should currentconditions deteriorate, this may impact our future cash flow estimates,resulting in an impairment charge that could have a material effect on theCompany’s Consolidated Financial Statements.

**Environmental**

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

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

The Company is exposed tomarket risks for changes in foreign currency rates and interest rates and hasexposure to commodity price risks, including prices of its primary rawmaterials. The overall objective of the Company’s financial risk managementprogram is to seek a reduction in the potential negative earnings impact ofchanges in interest rates, foreign exchange rates and raw material pricingarising in our business activities. The Company manages these financialexposures, where possible, through operational means and by using variousfinancial instruments. These practices may change as economic conditionschange.

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

The Company’s long-termborrowings under the Credit Facility are variable interest rate debt. As such,the Company’s interest expense will increase as interest rates rise anddecrease as interest rates fall. It is the Company’s policy to enter intointerest rate derivative transactions only to meet its stated overallobjective. The Company does not enter into these transactions for speculativepurposes. To that end, as further described in Notes 7 and 12 to theConsolidated Financial Statements included in Item 1 of Part I tothis Quarterly Report on Form 10-Q, the Company entered into aninterest rate swap contract to effectively convert $212.5 million of itsvariable-rate debt to fixed-rate debt. The interest rate swap contract matureson May 8, 2007. Hypothetically, a 1% change in the interest rate affectingall of the Company’s financial instruments not protected by the interest rateswap contract would change interest expense by approximately $2.1 million.

**Foreign CurrencyExchange Rate Risk**

The Company manufactures, markets and distributescertain of its products in Europe, Canada, Latin America and Asia. As a result,the Company’s results of operations could be significantly affected by factorssuch as changes in foreign currency rates in the foreign markets in which theCompany maintains a manufacturing or distribution presence. However, suchcurrency fluctuations have much less effect on local operating results becausethe Company, to a significant extent, sells its products within the countriesin which they are manufactured. During the six months of both 2006 and 2005,certain currencies of countries in which the Company conducts foreign currencydenominated business moved against the U.S. dollar and had an unfavorableimpact on sales and operating income. See “Management’s Discussion and Analysisof Financial Condition and Results of Operations” included in Item 2 of Part Ito this Quarterly Report on Form 10-Q.

The Company has nothistorically hedged its exposure to foreign currency risk. However, in mostforeign operations, there is a natural currency hedge due to similar amounts ofcosts of materials and production as revenues in such local currencies. However,due to the foreign currency losses sustained in the second quarter of fiscal2006, resulting from the devaluation of the Colombian and Mexican pesos to theU.S. dollar, the Company is reconsidering its hedge strategy with respect tothe Latin American operations. The Company, in May 2005, entered intoforeign currency forward contracts to manage (effectively fixing) its U.S.dollar exposure on certain Euro-based obligations for firm commitments relatedto certain capital expenditure projects. The Company is also subject topolitical risk in certain of its foreign operations and has utilized insuranceprograms in certain circumstances to mitigate its political risk.

**Raw Material andCommodity Risks**

The primary raw materials used in the manufacture ofmost of the Company’s products are polypropylene resin, polyester fiber,polyethylene resin, and, to a lesser extent, rayon, tissue paper and cotton.The prices of polypropylene, polyethylene and polyester are a function of,among other things, manufacturing capacity, demand and the price of crude oiland natural gas liquids. The 

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Company has not historicallyhedged its exposure to raw material increases, but has attempted to move morecustomer programs to contracts with price escalation provisions which wouldallow the Company to pass-through any cost increases in raw materials, althoughthere is often a delay between the time the Company is required to pay theincreased raw material price and the time that the Company is able to pass theincrease on to its customers. Raw material prices as a percentage of sales haveincreased from 50.6% in the three months ended July 2, 2005 to 53.5% inthe three months ended July 2, 2006.

In August and September of 2005, HurricanesKatrina and Rita hit the Gulf Coast area, temporarily shutting down a number ofrefineries and chemical processing sites of certain raw material suppliers forthe Company’s North and South American operations. As a result, while supplieswere tight in the fourth quarter of 2005, raw materials continued to beavailable to the Company, but at significantly higher prices. The Company,where allowable based on contract terms, has attempted to raise its sellingprices to mitigate the sharp increase in raw materials. Raw material pricesdecreased slightly since late December 2005 through the end of the firstquarter of fiscal 2006 as the refineries and chemical processing sites returnedto more normal production levels. However, in the second quarter of fiscal 2006,raw material prices have increased from most of the Company’s suppliers inresponse to certain global economic factors, including the escalating price ofoil.

To the extent the Company isnot able to pass along price increases of raw materials, or to the extent anysuch price increases are delayed, the Company’s cost of goods sold wouldincrease and its operating profit would correspondingly decrease. By way ofexample, if the price of polypropylene were to rise $.01 per pound, and theCompany was not able to pass along any of such increase to its customers, theCompany would realize a decrease of approximately $3.0 million, on anannualized basis, in its reported pre-tax operating income. Material increasesin raw material prices that cannot be passed on to customers could have amaterial adverse effect on the Company’s results of operations and financialcondition. See “Management’s Discussion and Analysis of Financial Condition andResults of Operations” included in Item 2 of Part I to this QuarterlyReport on Form 10-Q.

**ITEM 4.**                 CONTROLSAND PROCEDURES

**A. Evaluation ofDisclosure Controls and Procedures**

Under the direction of theChief Executive Officer and the Chief Financial Officer, the Company hasevaluated the effectiveness of its disclosure controls and procedures, as suchitem is defined in Rule 13a-15(e) under the Securities Exchange Act of1934, as amended (the “Exchange Act”), as of the end of the period covered bythis report. Based on that evaluation, the Company’s Chief Executive Officerand Chief Financial Officer concluded that our disclosure controls andprocedures were not effective at the reasonable assurance level because of thematerial weakness in the Company’s internal control over financial reportingdescribed below. Notwithstanding the existence of this material weakness, theCompany’s management believes that the consolidated financial statements andother financial information included in this report fairly present in allmaterial respects the Company’s financial condition, results of operations andcash flows as of, and for, the periods presented. 

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

Management is responsible for establishing andmaintaining effective internal control over financial reporting for the Companyas such term is defined in Rule 13a-15(f) of the Exchange Act. Internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with accountingprinciples generally accepted in the United States. Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect 

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misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

A material weakness is a control deficiency, orcombination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. As of the end of the periodcovered by this report, management identified a deficiency in the Company’sinternal control over financial reporting associated with documentation forcomplex contracts and agreements. Management’s determination resulted from theidentification of certain contracts and agreements for which adequatedocumentation was not in place to support material changes in contract terms,nor to allow for the appropriate consideration of the economic substance of thecontracts and agreements. This control deficiency could result in a misstatementof the Company’s results of operations that would result in a materialmisstatement to the annual or interim consolidated financial statements thatwould not be prevented or detected. Accordingly, the Company has concluded thatthis control deficiency constitutes a material weakness. 

The Company’s management and Board of Directors is inthe process of remediating this material weakness by implementing a delegationof authority that requires a more formal review and approval of documentationfor complex contracts and agreements by experienced accounting and legalpersonnel.

On August 7, 2006, the Audit Committee of the Board ofDirectors of the Company became aware of issues relating to certaintransactions that occurred in the quarter ended July 1, 2006 that createduncertainty regarding the appropriate accounting treatment for, and theeconomic substance of, those transactions, including whether income should berecognized in the second quarter of fiscal 2006 in connection with thetransactions.  As a result, the AuditCommittee began an internal investigation and has engaged special counsel toassist with the investigation of the transactions and related matters.  The Company cannot predict with certaintywhen the investigation will be completed. 

Other than as described above, there were no changesin the Company’s internal control over financial reporting, as such term isdefined in Exchange Act Rule 13a-15(f), during the quarter ended July 1, 2006that have materially affected, or are reasonably likely to materially affect,the Company’s internal control over financial reporting.

See Note 18 to theConsolidated Financial Statements included in Item 1 of Part I to thisQuarterly Report on Form 10-Q.

**PART II. OTHERINFORMATION**

**ITEM 1.**                 LEGALPROCEEDINGS

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

**ITEM 1A.**        RISKFACTORS

The risk factor immediatelyfollowing, which was not included in our 2005 Annual Report on Form 10-K,is being included herein to provide disclosure related to changes in theCompany’s risk factors since the Company filed its 2005 Annual Report onForm 10-K. See the Company’s 2005 Annual Report on Form 10-K for anexpanded description of other risks facing the Company.

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**If the Company is unable to design and implementprocedures to properly remediate any material weakness in internal control overfinancial reporting, a material misstatement to the annual or interimconsolidated financial statements could occur.**

Management identified a deficiency in the Company’sinternal control over financial reporting associated with documentation forcomplex contracts and agreements. Management’s determination resulted from theidentification of certain contracts and agreements for which adequatedocumentation was not in place to support material changes in contract terms,nor to allow for the appropriate consideration of the economic substance of thecontracts and agreements. This control deficiency could result in amisstatement of the Company’s results of operations that would result in amaterial misstatement to the annual or interim consolidated financialstatements that would not be prevented or detected. Accordingly, the Companyhas concluded that this control deficiency constitutes a material weakness. 

The Company’s management and Board of Directors is inthe process of remediating this material weakness by implementing a delegationof authority that requires a more formal review and approval of documentationfor complex contracts and agreements by experienced accounting and legalpersonnel.  Remediation of thisdeficiency is necessary to ensure that the Company’s system of internal controlover financial reporting is operating effectively.

On August 7, 2006, the AuditCommittee of the Board of Directors of the Company became aware of issuesrelating to certain transactions that occurred in the quarter ended July 1,2006 that created uncertainty regarding the appropriate accounting treatmentfor, and the economic substance of, those transactions, including whetherincome should be recognized in the second quarter of fiscal 2006 in connectionwith the transactions.  As a result, theAudit Committee began an internal investigation and has engaged special counselto assist with the investigation of the transactions and related matters.  The Company cannot predict with certaintywhen the investigation will be completed. 

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

During the second quarter offiscal 2006, 8,497 shares of the Company’s Class B Common Stock wereconverted into 8,497 shares of the Company’s Class A Common Stock.These conversions were exempt from registration based on section 3(a)(9) ofthe Securities Exchange Act of 1933.

**ITEM 3.**                 DEFAULTSUPON SENIOR SECURITIES

Not applicable.

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

The Shareholders of the Company at the their AnnualMeeting held on May 23, 2006, considered and voted to adopt and approvethe following matters (the numbers below represent shares of Class A, Band C Common Stock):

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Theelection of nine (9) directors for one-year terms or until theirsuccessors are duly elected and qualified the following:

| **Name of Director** | ** ** | ** ** | ** ** | **Votes in Favor** | ** ** | **Votes Withheld** | ** ** |
|--------------------------------|------------|------------|------------|------------------------------|------------|-------------------------|------------|
| Pedro A. Arias                 |       |       | 18,298,666 |                         |       |                    | 60,833     |   |   |
| Ramon Betolaza                 |       |       | 17,798,144 |                         |       |                    | 561,355    |   |   |
| Lap Wai Chan                   |       |       | 17,798,146 |                         |       |                    | 561,353    |   |   |
| William B. Hewitt              |       |       | 17,798,114 |                         |       |                    | 561,385    |   |   |
| Eugene Linden                  |       |       | 18,302,768 |                         |       |                    | 56,731     |   |   |
| James A. Ovenden               |       |       | 18,306,872 |                         |       |                    | 52,627     |   |   |
| James L. Schaeffer             |       |       | 17,798,163 |                         |       |                    | 561,336    |   |   |
| Charles E. Volpe               |       |       | 18,306,858 |                         |       |                    | 52,641     |   |   |
| Michael Watzky                 |       |       | 17,798,146 |                         |       |                    | 561,353    |   |   |

 

Theapproval of the 2005 Employee Restricted Stock Plan (the “2005 Stock Plan”) forcertain of the Company’s employees. The 2005 Stock Plan provides for grants ofrestricted shares of the Company’s Common Stock to eligible employees of theCompany. The purpose of the 2005 Stock Plan is to provide these individualswith incentives to maximize corporate performance and shareholder value andotherwise contribute to the success of the Company and to enable the Company toattract, retain and reward the best available persons for positions ofresponsibility. The 2005 Stock Plan replaces the Company’s 2005 Stock OptionPlan, which was terminated in conjunction with the approval of the 2005 StockPlan. No grants were made under the 2005 Stock Option Plan.

| **Votes in Favor** | ** ** | **Votes Against** | ** ** | **Votes Abstaining** | ** ** | **Broker Non Votes** | ** ** |
|------------------------------|------------|------------------------|------------|---------------------------|------------|--------------------------------|------------|
| 16,222,757                   |       |                   | 853,665    |                      |       |                           | 10,140     |   |   |   | 1,272,937 |   |   |
|                              |            |                        |            |                           |            |                                |            |  |  |  |  |  |  |

 

**ITEM 5.**                 OTHERINFORMATION

Not applicable.

**ITEM 6.**                 EXHIBITS

Exhibitsrequired to be filed with this Form 10-Q are listed below:
| Exhibit  Number | ** ** | ** **                                                                                                        | **Document Description** | ** ** |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------|--------------------------|------------|
| 10.1            |       | Termination Agreement  dated May 8, 2006 between PGI Nonwovens B.V. and  Mr. R. Altdorf. |
| 10.2            |       | Consulting Agreement  dated May 8, 2006 between Polymer Group, Inc. and  Mr. R. Altdorf.      |
| 31.1            |       | Certification of  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002         |
| 31.2            |       | Certification of  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002         |
| 32.1            |       | Certification by the  Chief Executive Officer pursuant to 18 U.S.C. Section 1350                             |
| 32.2            |       | Certification by the Chief  Financial Officer pursuant to 18 U.S.C. Section 1350                             |

 

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                            | POLYMER GROUP, INC. |
|----------------------------|--------------------------|
| Date: August 15, 2006 | By:                      | /s/ JAMES L. SCHAEFFER |
| * *                   | * *                 | James L.  Schaeffer*Chief Executive Officer* |
| Date: August 15, 2006 | By:                      | /s/ WILLIS C. MOORE, III |
| * *                   | * *                 | Willis C.  Moore, III*Chief Financial Officer* |

 

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