UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended July 3, 2004

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from               to               

Commission file number: 1-14330

POLYMER GROUP, INC.

(Exact name of registrant as specified in its charter)

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

 

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

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

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

Indicate by check mark whether the 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 the distribution of securities under a plan confirmed by a court. Yes x  No o

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

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

 

POLYMER GROUP, INC.

INDEX TO FORM 10-Q

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

 

1

 

IMPORTANT INFORMATION REGARDING THIS FORM 10-Q

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

Safe Harbor-Forward-Looking Statements

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

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

Important factors that could cause actual results to differ materially from those discussed in such forward-looking statements include:

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

·       substantial debt levels and potential inability to maintain sufficient liquidity to finance the Company’s operations and make necessary capital expenditures;

·       inability to meet existing debt covenants;

·       information and technological advances;

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

·       domestic and foreign competition;

·       reliance on major customers and suppliers; and

·       risks relating to operations in foreign jurisdictions.

2

ITEM 1. FINANCIAL STATEMENTS

POLYMER GROUP, INC.
CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Data)

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

 

 

See Accompanying Notes.

3

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

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

(In Thousands, Except Per Share Data)

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

 

See Accompanying Notes.

4

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

Six Months Ended July 3, 2004,

Four Months Ended June 28, 2003 and

Two Months Ended March 1, 2003

(In Thousands, Except Per Share Data)

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

 

See Accompanying Notes.

5

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

EQUITY AND COMPREHENSIVE INCOME (LOSS) (Unaudited)

For the Six Months Ended July 3, 2004

(In Thousands)

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

 

See Accompanying Notes.

6

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

(In Thousands)

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

 

 

See Accompanying Notes.

7

POLYMER GROUP, INC.
Notes to Consolidated Financial Statements

Note 1.   Principles of Consolidation and Financial Statement Information

Principles of Consolidation

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

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

The accompanying unaudited interim consolidated financial statements and related notes should be read in conjunction with the Consolidated Financial Statements of the Company and related notes as contained in the Annual Report on Form 10-K for the period ended January 3, 2004. In the judgment of management, these unaudited interim consolidated financial statements include all adjustments of a normal recurring nature and accruals necessary for a fair presentation of such statements.

Basis of Presentation

After extensive reorganization efforts, the Company and each of its domestic subsidiaries filed voluntary petitions for Chapter 11 reorganization under the United States Bankruptcy Code in the South Carolina Bankruptcy Court on May 11, 2002 (April 25, 2002 as to Bonlam (S.C.), Inc.). In its efforts to emerge from Chapter 11, the Company filed a Modified Plan (as defined) on November 27, 2002 that was approved by the Bankruptcy Court on January 16, 2003 and, accordingly, the Company emerged from Chapter 11 effective March 5, 2003 (the “Effective Date”). For accounting purposes the Company recognized the emergence on March 1, 2003, which was the end of the February 2003 accounting period. The Company adopted “fresh-start accounting” as of March 1, 2003, and the Company’s emergence from Chapter 11 resulted in a new reporting entity. The reorganization value of the Company has been allocated to the underlying assets and liabilities based on their respective fair values at the date of emergence. References to “Predecessor” refer to the old Polymer Group and its subsidiaries on and prior to March 1, 2003, and references to “Successor” refer to Polymer Group and its subsidiaries as of and subsequent to March 2, 2003, after giving effect to the implementation of fresh start accounting. In accordance with financial reporting requirements for companies emerging from Chapter 11, financial information for the three months ended March 29, 2003 is not presented in the consolidated financial statements since such information would combine the results of the Predecessor and Successor.

Reclassification

Certain amounts previously presented in the consolidated financial statements for prior periods have been reclassified to conform with current period classification.

8

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

New Accounting Pronouncements

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

In May 2003, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  SFAS No. 150 requires that certain financial instruments, which under previous guidance could be accounted for as equity, be classified as liabilities in the statement of financial position. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003. The Company has determined that it does not have any financial instruments that are within the scope of SFAS No. 150.

Note 2.   Accounts Receivable and Concentration of Credit Risks

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

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

Note 3.   Inventories

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

		July 3, 2004					January 3,  2004
		(Unaudited)
Finished goods			$	48,787				$	47,288
Work in process			16,820					16,579
Raw materials			35,833					32,646
			$	101,440				$	96,513

 

9

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

 

Note 4.   Business Restructuring

In 2003, the Company implemented a business restructuring initiative. This initiative encompassed a reduction in working capital levels and operating cost reductions through: (i) reducing headcount at both the plant and corporate levels; (ii) improving manufacturing productivity and reducing component costs; (iii) implementing global purchasing initiatives; and (iv) rationalizing certain assets and/or businesses. Approximately 230 positions were eliminated in fiscal 2003.

Accrued costs for restructuring efforts are included in accrued liabilities in the accompanying balance sheet. A summary of the business restructuring activity during the first six months of fiscal 2004 is presented in the following table (in thousands):

Balance accrued at beginning of year		$	4,564
2004 plant realignment costs		1,241
Cash payments		(3,954		)
Adjustments		36
Balance accrued at end of period		$	1,887

 

In December 2003, the Company made the business decision to discontinue one of its production lines in the European operations. Accordingly, in addition to certain costs recorded in 2003, plant realignment costs of $1.2 million, which include severance and other cash costs, were charged to the results of operations in the first six months of 2004.

Note 5.   Intangibles and Loan Acquisition Costs

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

		July 3,					January 3,
		2004					2004
		(Unaudited)
Cost:
Proprietary technology			$	26,536			$	26,533
Loan acquisition costs and other			18,751				13,534
			45,287				40,067
Less accumulated amortization			(8,300		)		(6,507		)
			$	36,987			$	33,560

 

10

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

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

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

 

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

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

Note 6.   Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

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

 

 

11

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

Note 7.   Debt

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

Long-term debt consists of the following (in thousands):

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

 

Senior Secured Bank Facility

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

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

12

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

Company or one or more of its subsidiaries by non-domestic subsidiaries. Commitment fees under the Bank Facility are equal to 0.50% of the daily unused amount of the revolving credit commitment. The Bank Facility contains covenants and events of default customary for financings of this type, including leverage and interest expense coverage covenants. At July 3, 2004, the Company is in compliance with all such covenants and expects to remain in compliance through fiscal 2004. The loans require the Company to use a percentage of proceeds from excess cash flows, as defined by the agreement, to reduce its debt balances.

The interest rate applicable to borrowings under the Bank Facility is based on three-month LIBOR plus a specified margin. The applicable margin for borrowings under the revolving credit facility is 300 basis points, the margin for the first lien term loan is 325 basis points and the margin for the second-lien term loan is 625 basis points. Although not anticipated, the Company may elect to use an alternate base rate for its borrowings under the revolving credit facility ranging from 2.25% to 6.25% with such alternate base rates including a margin based on the Company’s total leverage ratio. The Company had no outstanding borrowings at July 3, 2004 under the revolving credit facility. Average borrowings under the revolving credit facility for the period from April 28, 2004 to July 3, 2004 were $14.7 million at an average rate of 5.80%. The revolving portion of the credit facility matures on April 27, 2009.

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

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

Restructured Credit Facility

Until it was refinanced on April 27, 2004, the Company’s Restructured Credit Facility consisted of secured revolving credit borrowings with aggregate commitments of up to $50.0 million and aggregate term loans and term letters of credit of $435.3 million. All borrowings under the Restructured Credit Facility were U.S. dollar denominated and were guaranteed, on a joint and several basis, by each and all of the direct and indirect domestic subsidiaries of the Company and certain non-domestic subsidiaries of the Company. The Restructured Credit Facility contained covenants and events of default customary for financings of this type, including leverage, senior leverage, interest coverage and adjusted interest coverage. The Company was in compliance with all such covenants through the date of the refinancing. The interest rate applicable to borrowings under the Restructured Credit Facility is based on a specified base rate or a specified Eurodollar base rate, at the Company’s option, plus a specified margin. The effective rate on the term loans was 12.00%, which was the cap on the sum of the interest payable in respect of term loans or term letters of credit plus the senior leverage ratio fee. The Company’s average borrowings under the revolving credit agreement, which had an effective interest rate of 6.75%, were $8.7 million for the period from January 4, 2004 to April 27, 2004.

Convertible Subordinated Notes

In connection with the emergence from Chapter 11, the Company issued $50 million of 10% Convertible Subordinated Notes due 2007 (the “Junior Notes”) pursuant to an indenture dated as of March 5, 2003 (the “Junior Indenture”). The Junior Notes are unsecured subordinated indebtedness of the Company and are subordinated in right of payment to all existing and future indebtedness of the

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

Company which is not, by its terms, expressly junior to, or pari passu with, the Junior Notes. Under the terms of the Junior Notes, the holders may elect to increase the principal amount of the notes in lieu of receiving semi-annual interest payments in cash. The Junior Notes are convertible into shares of Class A Common Stock, at an initial conversion price equal to $7.29 per share. The Junior Indenture contains several covenants, including limitations on: (i) indebtedness; certain restricted payments; liens; transactions with affiliates; dividend and other payment restrictions affecting certain subsidiaries; guarantees by certain subsidiaries; certain transactions including merger and asset sales; and (ii) certain restrictions regarding the disposition of proceeds of asset sales.

During the first quarter of 2004, $2.7 million of the Company’s Junior Notes were converted into approximately 371,500 shares of the Company’s Class A Common Stock.

During the second quarter of 2004, in conjunction with the refinancing of the Company’s long-term debt, the Company’s majority shareholder exchanged an additional $42.6 million in aggregate principal amount of the Company’s Junior Notes it controlled for 42,633 shares of the Company’s 16% Series A Convertible Pay-in-kind Preferred Stock (the “PIK Preferred Shares”). For further discussion of the Company’s PIK Preferred Shares, see Note 11 of the Consolidated Financial Statements.

Subsidiary Indebtedness

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

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

Note 8.   Income Taxes

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

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

Note 9.   Pension Benefits and Postretirement Plans

The Company and its subsidiaries sponsor multiple defined benefit plans and other postretirement benefits that cover certain employees. Benefits are based on years of service and the employee’s compensation. It is the Company’s policy to fund such plans in accordance with applicable laws and regulations. The following disclosures regarding defined benefit plans and other postretirement plans

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

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

Components of net periodic benefit costs for the three and six months ended July 3, 2004 and June 28, 2003 are as follows:

		Pension Benefit Plans
		Three Months Ended						Six Months Ended
		July 3, 2004			June 28, 2003			July 3, 2004			June 28, 2003
Current service costs		$	570		$	656		$	1,160		$	1,276
Interest costs on projected benefit obligation and other		1,218			1,301			2,471			2,535
Return on plan assets		(1,295		)	(1,266		)	(2,629		)	(2,463		)
Amortization of transition obligation and other		(3		)	63			(6		)	122
Periodic benefit cost, net		$	490		$	754		$	996		$	1,470

 

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

 

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

On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was enacted and introduced a prescription drug benefit under Medicare as well as a subsidy to sponsors of retiree health care benefit plans. The Company has elected to defer the recognition of the Act until the authoritative guidance on the accounting for the federal subsidy under the Act is issued. When the guidance is issued, the Company could be required to change previously reported information. Any measure of the periodic benefit cost, benefit obligation and related disclosures for the U.S. and other postretirement benefit plans do not reflect the effect of the Act.

Note 10.   Stock Option Plans

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

The Company elected to account for the 2003 Plan in accordance with the intrinsic value method as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and permitted under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). All options granted under the 2003 Plan had an

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

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

If the Company applied the fair value recognition provision of SFAS No. 123 to stock-based compensation as required by Statement of Financial Accounting Standard No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS No. 148”), the amount of stock-based compensation would have approximately equaled the amount charged to operations. Therefore, no pro forma calculations of net income (loss) and earnings (loss) per common share for the first six months of 2004 are included herein. Since all stock options under plans approved prior to 2003 were canceled as part of the Company’s emergence from Chapter 11, no pro forma information is shown for 2003.

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

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

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

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

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

Note 12.   Derivative and Other Financial Instruments and Hedging Activities

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

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

Activities (an Amendment of SFAS No. 133)” requires the Company to recognize all derivatives on the balance sheet at fair value and establish criteria for designation and effectiveness of hedging relationships.

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

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

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

Note 13.   Segment Information

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

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