UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2007

OR

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: 001-32240

NEENAH PAPER, INC.

(Exact name of registrant as specified in its charter)

 

(678) 566-6500

(Registrant’s telephone number, including area code)

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 period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x   No o

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o   No x

As of April 30, 2007, there were 14,812,020 shares of the Company’s common stock outstanding.

 

 

TABLE OF CONTENTS

Part I—Financial Information
Item 1.		Financial Statements
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures About Market Risk
Item 4.		Controls and Procedures
Part II—Other Information
Item 1.		Legal Proceedings
Item 1A.		Risk Factors
Item 6.		Exhibits
Signatures

 

Part I—FINANCIAL INFORMATION

Item 1. Financial Statements

NEENAH PAPER, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except share and per share data)
(Unaudited)

		Three Months Ended March 31,
		2007			2006
Net sales		$	224.7		$	132.9
Cost of products sold		181.2			109.4
Gross profit		43.5			23.5
Selling, general and administrative expenses		17.9			15.1
Gain on sale of woodlands		(1.4		)	—
Other income—net		(0.6		)	(1.6		)
Operating income		27.6			10.0
Interest expense—net		6.0			4.5
Income from continuing operations before income taxes		21.6			5.5
Provision for income taxes		6.4			2.1
Income from continuing operations		15.2			3.4
Loss from discontinued operations		(0.5		)	(2.5		)
Net income		$	14.7		$	0.9
Earnings Per Common Share
Basic
Continuing operations		$	1.03		$	0.23
Discontinued operations		(0.04		)	(0.17		)
		$	0.99		$	0.06
Diluted
Continuing operations		$	1.01		$	0.23
Discontinued operations		(0.03		)	(0.17		)
		$	0.98		$	0.06
Weighted Average Common Shares Outstanding (in thousands)
Basic		14,790			14,743
Diluted		15,005			14,796
Cash Dividends Declared Per Share of Common Stock		$	0.10		$	0.10

 

See Notes to Condensed Consolidated Financial Statements

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NEENAH PAPER, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions)
(Unaudited)

		March 31,			December 31,
		2007			2006
ASSETS
Current Assets
Cash and cash equivalents		$	3.5		$	1.6
Restricted cash		10.1			—
Accounts receivable (less allowances of $4.8 and $4.4 million)		148.9			112.5
Inventories		117.0			74.9
Other receivables		13.9			13.6
Prepaid and other current assets		21.1			19.8
Total Current Assets		314.5			222.4
Property, plant and equipment, at cost		801.4			768.1
Less accumulated depreciation		424.1			412.5
Property, plant and equipment—net		377.3			355.6
Deferred Income Taxes		57.5			32.7
Goodwill		94.4			92.0
Intangible Assets, net		33.3			29.5
Other Assets		13.7			12.5
TOTAL ASSETS		$	890.7		$	744.7
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Debt payable within one year		$	4.3		$	1.3
Accounts payable		79.2			74.7
Accrued salaries and employee benefits		25.2			26.6
Accrued income taxes		17.6			10.2
Accrued expenses		29.0			16.7
Total Current Liabilities		155.3			129.5
Long-term Debt		355.6			282.3
Deferred Income Taxes		35.9			35.8
Noncurrent Employee Benefits		127.1			109.2
Other Noncurrent Obligations		13.1			3.0
TOTAL LIABILITIES		687.0			559.8
Commitments and Contingencies (Note 13)
TOTAL STOCKHOLDERS’ EQUITY		203.7			184.9
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	890.7		$	744.7

 

See Notes to Condensed Consolidated Financial Statements

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NEENAH PAPER, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)

		Three Months Ended March 31,
		2007			2006
OPERATING ACTIVITIES
Net income		$	14.7		$	0.9
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		11.0			6.7
Stock-based compensation		1.7			1.4
Deferred income tax benefit		(0.8		)	(0.7		)
Gain on sale of woodlands		(1.4		)	—
Loss on asset dispositions		(0.3		)	0.1
Decrease (increase) in working capital, net of effects of acquisition		(23.6		)	3.5
Pension and other post-employment benefits		(0.8		)	2.8
Other		(0.1		)	1.6
NET CASH PROVIDED BY OPERATING ACTIVITIES		0.4			16.3
INVESTING ACTIVITIES
Capital expenditures		(6.2		)	(3.4		)
Increase in restricted cash		(10.1		)	—
Acquisition cost of Fox River, net of cash acquired		(55.1		)	—
Additional acquisition cost of Neenah Germany		(1.5		)	—
Other		(0.4		)	(0.5		)
NET CASH USED IN INVESTING ACTIVITIES		(73.3		)	(3.9		)
FINANCING ACTIVITIES
Proceeds from issuance of long-term debt		73.3			—
Debt issuance costs		(0.1		)	—
Repayments of long-term debt		(0.4		)	(0.3		)
Short-term borrowings		3.4			0.2
Repayments of short-term debt		—			(0.1		)
Cash dividends paid		(1.5		)	(1.5		)
Other		(0.1		)	—
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		74.6			(1.7		)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		0.2			—
NET INCREASE IN CASH AND CASH EQUIVALENTS		1.9			10.7
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		1.6			12.6
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	3.5		$	23.3
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for interest, net of interest expense capitalized		$	1.5		$	—
Cash paid (received) during period for income taxes		$	0.1		$	(4.6	)
Non-cash investing activities: Liability for equipment acquired		$	1.0		$	0.6

 

See Notes to Condensed Consolidated Financial Statements

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NEENAH PAPER, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in millions, except as noted)

Note 1.  Background and Basis of Presentation

Background

Neenah Paper, Inc. (“Neenah” or the “Company”), a Delaware corporation, was incorporated in April 2004 in contemplation of the spin-off by Kimberly-Clark Corporation (“Kimberly-Clark”) of its fine paper and technical products businesses in the United States and its Canadian pulp business (collectively, the “Pulp and Paper Business”) . In November 2004, Kimberly-Clark completed the distribution of all of the shares of Neenah’s common stock to the stockholders of Kimberly-Clark (the “Spin-Off”). As a result of the Spin-Off, Kimberly-Clark transferred all of the assets and liabilities of the Pulp and Paper Business to Neenah. Following the Spin-Off, Neenah is an independent public company and Kimberly-Clark has no continuing stock ownership.

The fine paper business is a leading producer of premium writing, text, cover and specialty papers. The technical products business is a leading producer of transportation and other filter media, and durable, saturated and coated base papers for a variety of end uses. The pulp business primarily produces northern bleached softwood kraft pulp used by paper mills to manufacturer tissue and printing and writing papers.  At the time of the Spin-Off, the pulp business consisted of pulp mills in Terrace Bay, Ontario and Pictou, Nova Scotia and the related woodlands (including 1,000,000 acres in Nova Scotia).

In June 2006, the Company completed the sale of approximately 500,000 acres of woodlands in Nova Scotia for $139.1 million (proceeds net of transaction costs were $134.8 million). The woodlands sale agreement included a fiber supply agreement to secure a source of fiber for the Company’s Pictou pulp mill. The transaction resulted in a net pretax gain of $131.6 million.  Approximately $9.0 million of such gain was deferred and is being recognized in income pro-rata through December 2007. See Note 6, “Sale of Woodlands.”

In August 2006, the Company’s wholly-owned subsidiary, Neenah Paper Company of Canada (“Neenah Canada”) completed the transfer of the Terrace Bay, Ontario pulp mill and related woodlands operations (“Terrace Bay”) to certain affiliates of Buchanan Forest Products Ltd. (“Buchanan”). Pursuant to the terms of the sale agreement, Buchanan assumed responsibility for substantially all liabilities related to the future operation of Terrace Bay in exchange for a payment of $18.6 million. For the three months ended March 31, 2007, discontinued operations in the condensed consolidated statement of operations primarily reflect costs associated with Terrace Bay’s defined benefit pension.  The condensed consolidated statement of operations for the three months ended March 31, 2006 has been restated to reflect the results of operations of Terrace Bay as discontinued operations. See Note 5, “Discontinued Operations.”

In October 2006, the Company completed the purchase of the stock of FiberMark Services GmbH & Co. KG and the stock of FiberMark Beteiligungs GmbH (collectively “Neenah Germany”).  Neenah Germany was acquired from FiberMark, Inc. (“FiberMark”) and FiberMark International Holdings LLC for approximately million in cash. The transaction was financed from available cash and debt drawn against the Company’s existing revolving credit facility. The assets acquired as a result of the acquisition of Neenah Germany consist of three mills located near Munich and Frankfurt, Germany, that produce a wide range of products, including transportation and other filter media, nonwoven wall coverings, masking and other tapes, abrasive backings, and specialized printing and coating substrates. The results of Neenah Germany are being reported as part of the Company’s Technical Products segment and have been included in the Company’s consolidated financial results since the acquisition date.  See Note 4, “Acquisitions.”

On March 1, 2007, the Company acquired the stock of Fox Valley Corporation and its subsidiary, Fox River Paper Company, LLC (collectively “Fox River”). The Company paid $55.1 million in cash for Fox River (including fees and expenses directly related to the acquisition) and financed the acquisition through a combination of cash and debt drawn against its existing revolving credit facility. The assets acquired as a result of the acquisition of Fox River consist of four U.S. paper mills and various related assets. The results of Fox River are being reported as part of the Company’s Fine Paper segment and have been included in the Company’s consolidated financial results since the acquisition date.  See Note 4, “Acquisitions,” for a summary of the preliminary allocation of the purchase price, selected pro forma financial data and certain mill restructuring activities.

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Basis of Consolidation and Presentation

These statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and, in accordance with those rules and regulations, do not include all information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  Management believes that the disclosures made are adequate for a fair presentation of the Company’s results of operations, financial position and cash flows. In the opinion of management, the condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the results of operations, financial position and cash flows for the interim periods presented herein.  The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make extensive use of estimates and assumptions that affect the reported amounts and disclosures.  Actual results may vary from these estimates.

These condensed consolidated interim financial statements should be read in conjunction with the consolidated and combined financial statements and notes thereto included in the Company’s most recent Annual Report on Form 10-K.  The results of operations for any interim period are not necessarily indicative of the results of operations to be expected for the full year.

The condensed consolidated interim financial statements of Neenah and its subsidiaries included herein are unaudited, except for the December 31, 2006 condensed consolidated balance sheet, which was derived from audited financial statements.  The condensed consolidated financial statements include the financial statements of the Company, and its wholly owned and majority owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Earnings per Share (“EPS”)

Basic earnings per share (“EPS”) was computed by dividing net income by the weighted-average number of shares of common stock outstanding during the three months ended March 31, 2007 and 2006.  Diluted EPS was calculated to give effect to all potentially dilutive common shares using the “Treasury Stock” method. Outstanding stock options, restricted shares, restricted stock units and restricted stock units with performance conditions represent the only potentially dilutive effects on the Company’s weighted-average shares.  For the three months ended March 31, 2007 and 2006, approximately 390,000 and 1,080,000 potentially dilutive options, respectively, were excluded from the computation of dilutive common shares.

The following table presents the computation of basic and diluted shares of common stock used in the computation of EPS (amounts in thousands):

 

Note 2.  Accounting Standard Changes

In January 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes.

Pursuant to the terms of the purchase agreement with FiberMark (see Note 4, “Acquisitions”), the Company is liable for potential additional taxes due for tax returns filed for periods prior to the acquisition.  FiberMark has agreed to indemnify the Company for such additional taxes and a portion of the purchase price has been reserved in an escrow account to fund the indemnification.  The Company believes it is probable that Neenah Germany is liable for approximately $5.5 million in additional taxes.  The Company has also recognized a receivable in an equal amount in Other receivables on the consolidated balance sheet for the value of the indemnification.  The Company does not believe its liability for such taxes is in excess of the escrow amount.

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In addition to the amounts described above, the Company’s adoption of FIN 48 on January 1, 2007 resulted in a $1.0 million increase in its liability for uncertain income tax positions.  As of March 31, 2007, the Company’s liability for uncertain income tax positions was $6.5 million.  If recognized, approximately $0.7 million of such income tax benefits would favorably affect the Company’s effective tax rate in future periods. The Company does not anticipate any changes in its liability for uncertain income tax positions due to the settlement of audits or the expiration of the statute of limitations prior to March 31, 2008.

Tax years 2004 through 2006 are subject to examination by federal and state tax authorities in the United States, federal and provincial tax authorities in Canada and federal and municipal tax authorities in Germany.  Currently the 2004 tax year is being audited by German tax authorities.

The Company recognizes accrued interest and penalties related to uncertain income tax positions in Income tax expense on the condensed consolidated statements of operations.  As of March 31, 2007, the Company had no amounts accrued for interest related to uncertain income tax positions.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. SFAS 157 does not require any new fair value measurements.

The definition of fair value in SFAS 157 retains the exchange price notion in earlier definitions of fair value and emphasizes that fair value is a market-based measurement, not an entity-specific measurement. SFAS 157 expands disclosures about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial recognition.  SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  Adoption of SFAS 157 is not expected to have a material effect on the Company’s financial position, results of operations or cash flows.

 In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115  (“SFAS 159”).  SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Most of the provisions of SFAS 159 apply only to entities that elect the fair value option. However, the amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities.  SFAS 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of FASB Statement No. 157, Fair Value Measurements.  The Company does not expect the adoption of SFAS 159 to have a material effect on its financial position or results of operations.

Note 3.  Comprehensive Income

Comprehensive income includes, in addition to net income, unrealized gains and losses recorded directly into a separate section of stockholders’ equity on the condensed consolidated balance sheets. These unrealized gains and losses are referred to as other comprehensive income items. Accumulated other comprehensive income (loss) consists of unrealized foreign currency translation gains (losses), deferred gains (losses) on cash flow hedges and adjustments to pension and other post-employment benefit obligations. Unrealized foreign currency translation gains (losses) that relate to indefinite investments in international operations are not adjusted for income taxes. As of March 31, 2007 and December 31, 2006, accumulated other comprehensive income was $13.9 million and $9.9 million, respectively.

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The following table presents the components of comprehensive income (loss):

 

Note 4. Acquisitions

Fox River

On March 1, 2007, the Company acquired the stock of Fox River for $55.1 million in cash.  Included in such acquisition costs were amounts for the repayment of debt, the payoff of deferred employee compensation obligations of the acquired companies and approximately $1.8 million for fees and expenses directly related to the acquisition. The Company financed the acquisition through a combination of cash and debt drawn against its existing revolving credit facility. The assets acquired as a result of the acquisition of Fox River consist of four U.S. paper mills and various related assets, producing premium fine papers with well-known brands including STARWHITE®, SUNDANCE®, ESSE® and OXFORD®. The results of Fox River are being reported as part of the Company’s Fine Paper segment and have been included in the Company’s consolidated financial results since the acquisition date.

The total cost of the acquisition has been allocated to the assets acquired and liabilities assumed in accordance with Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS 141”).  Due to the proximity of the Fox River acquisition to March 31, 2007, the values of certain assets and liabilities are based on preliminary valuations and are subject to adjustment as additional information is obtained.  Such additional information includes, but is not limited to, the valuation of property, plant and equipment, intangible assets and the liability for employee severance benefits.  In addition, the allocation of the purchase price to the fair value of assets acquired has not been completed pending payment for certain working capital amounts acquired in the acquisition. The Company has up to 12 months from the closing of the acquisition to finalize its valuations.  Changes to the valuation of assets and liabilities acquired may result in adjustments to the carrying value of property, plant and equipment acquired or goodwill.  The Company has not identified any material unrecorded pre-acquisition contingencies.  Prior to the end of the one-year purchase price allocation period, if information becomes available which would indicate it is probable that such events had occurred as of the acquisition date and the amounts can be reasonably estimated, such items will be included in the final purchase price allocation and may result in an adjustment to the carrying value of property, plant and equipment acquired or goodwill. The Company did not acquire any in-process research and development assets as part of the acquisition.

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The following table summarizes the preliminary allocation of the purchase price to the estimated fair value of the assets acquired and liabilities assumed as of March 1, 2007:

 

In conjunction with the acquisition of Fox River, the Company announced plans to permanently close the Housatonic mill, located near Great Barrington, Massachusetts.  The Housatonic mill, the smallest of the fine paper plants acquired in the Fox River acquisition, has annual production capacity of approximately 15,000 tons and is expected to cease manufacturing operations in the second quarter of 2007. The Housatonic mill was not profitable due to its small size, cost structure and the pricing of many of the grades made there. Closing the mill will allow the Company to eliminate costs and improve margins while still serving the needs of key customers. In addition to the closure of the Housatonic mill, the Company has announced the planned terminations of certain Fox River sales and administrative employees as the business is integrated with the Company’s existing fine paper business.

The preceding table includes approximately $8.2 million for the cost of post-acquisition restructuring activities that the Company recognized in accordance with Emerging Issues Task Force Issue 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination.  Such costs include approximately $4.1 million for severance benefits for approximately 200 affected employees (including $1.4 million for approximately 125 employees at Housatonic), contract termination costs of approximately $2.0 million and approximately $2.1 million for environmental clean-up and monitoring costs.  As of March 31, 2007, termination benefits of approximately $60 thousand had been paid to 4 employees and approximately $4.0 million was accrued but unpaid. The Company expects the payment of termination benefits to be substantially complete by the end of 2007.

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The following selected unaudited pro forma consolidated statement of operations data for the three months ended March 31, 2007 and 2006 was prepared as though the acquisition of Fox River had occurred on January 1, 2007 and 2006 (in millions, except per share data):

                                           

Neenah Germany

In October 2006, the Company completed the purchase of the stock of Neenah Germany.  Neenah Germany was acquired from FiberMark and FiberMark International Holdings LLC for approximately $220 million in cash including $1.5 million paid in the three months ended March 31, 2007 primarily for the adjusted value of working capital at the acquisition date. The Company also incurred approximately $5.1 million of transaction costs directly related to the acquisition of Neenah Germany. The acquisition of Neenah Germany was financed through $160 million of available cash and $58 million of debt drawn against the Company’s revolving credit facility. The primary source of available cash used to finance the acquisition was proceeds from the sale of woodlands in June 2006. See Note 6, “Sale of Woodlands.”  The results of Neenah Germany are being reported as part of the Company’s Technical Products segment and have been included in the Company’s consolidated financial results since the acquisition date.

Note 5.   Discontinued Operations

Transfer of Terrace Bay

Manufacturing operations at Terrace Bay were suspended in February 2006 due to a lack of wood fiber for its operations as the result of a strike initiated in January 2006 by workers employed by the woodlands operations that supplied wood fiber to the mill. Most of the hourly and salaried workers employed at the mill were laid off during the two weeks following the suspension of manufacturing activities.

In August 2006, Neenah Canada transferred Terrace Bay to Buchanan.  Buchanan assumed responsibility for substantially all liabilities related to the future operation of Terrace Bay in exchange for a payment of $18.6 million. At closing, Neenah Canada retained certain working capital amounts, primarily trade accounts receivable, finished goods inventory and trade accounts payable.  In addition, Neenah Canada retained certain long-term disability obligations for current and former mill employees and post-employment medical and life insurance liabilities for current retirees.

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In conjunction with the transfer of Terrace Bay to Buchanan and as a closing condition of the agreement, Neenah Canada initiated plans to curtail and settle its Ontario, Canada defined benefit pension plan (“the Ontario Plan”). In August 2006, Neenah Canada made a payment to the pension trust of approximately $10.8 million for the purchase of annuity contracts to settle its pension liability for current retirees. As a result of the transaction, Neenah Canada recognized a pension curtailment and settlement loss of approximately $26.4 million in the year ended December 31, 2006.  In addition, Neenah Canada expects to record a settlement loss of approximately $40 million related to the future settlement of pension obligations for active employees.  The amount of any funds that Neenah Canada may pay or receive and the timing of recognition of the loss to settle the liability for active employees are dependent upon, among other things, an actuarial determination of the value of the obligations being settled, the cost of annuity contracts, regulatory approval to settle the plan and employee elections.

For the three months ended March 31, 2007, discontinued operations in the condensed consolidated statement of operations primarily reflect costs associated with Terrace Bay’s defined benefit pension plan. The results of operations of Terrace Bay are reflected as discontinued operations in the condensed consolidated statements of operations for the three months ended March 31, 2006. The following table presents the results of discontinued operations:

 

Note 6. Sale of Woodlands

In June 2006, Neenah Canada completed the sale of approximately 500,000 acres of woodlands in Nova Scotia to Atlantic Star Forestry LTD and Nova Star Forestry LTD (collectively, the “Purchaser”) for $139.1 million (proceeds net of transaction costs were $134.8 million). Neenah Canada received the total proceeds from the sale in cash at closing. Neenah Canada also entered into a fiber supply agreement (the “FSA”) with the Purchaser to secure a source of fiber for the Pictou pulp mill. Following the sale, Neenah Canada has approximately 500,000 acres of owned and 200,000 acres of licensed or managed woodlands in Nova Scotia.

Pursuant to the terms of the FSA, the Purchaser is required to make available to the Pictou mill sufficient woodlands acreage to yield 200,000 metric tons of softwood timber annually. The Pictou mill is required to bear all costs associated with harvesting the timber.  Timber purchases under the FSA are at market-based prices subject to semi-annual adjustment. The FSA expires on December 31, 2010 and the Pictou mill has the option to unilaterally extend the contract for an additional five years.  The FSA can be extended for an additional five years upon the mutual agreement of Neenah Canada and the Purchaser.

The sale qualified for gain recognition under the “full accrual method” described in Statement of Financial Accounting Standards No. 66, Accounting for Sales of Real Estate (“SFAS 66”).  The Pictou mill’s commitment to accept acreage offered by the Purchaser to satisfy the timber requirements for the first 18 months of the FSA represents a “constructive obligation.”  As a result, Neenah Canada recognized a net pretax gain on the sale of approximately $122.6 million in June 2006 and deferred approximately $9.0 million, which represents Neenah Canada’s estimated maximum exposure to loss of profit due to the constructive obligation under the FSA.  The deferral related to the constructive obligation will be amortized through December 2007. For the three months ended March 31, 2007, Neenah Canada recognized approximately $1.4 million of such deferred gain.

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Note 7.  Risk Management

The Company is exposed to risks such as changes in foreign currency exchange rates and pulp prices. A variety of practices are employed to manage these risks, including operating and financing activities and, where deemed appropriate, the use of derivative instruments. Derivative instruments are used only for risk management purposes and not for speculation or trading. All foreign currency derivative instruments are either exchange traded or entered into with major financial institutions. Credit risk with respect to the counterparties is considered minimal in view of the financial strength of the counterparties. The notional amounts of the Company’s derivative instruments do not represent amounts exchanged by the parties and, as such, are not a measure of exposure to credit loss.  The amounts exchanged are determined by reference to the notional amounts and the other terms of the contracts.

In accordance with Statement of Financial Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, the Company records all derivative instruments as assets (included in Prepaid and other current assets and Other Assets) or liabilities (included in Accrued expenses or Other Noncurrent Obligations) on the condensed consolidated balance sheet at fair value. Changes in the fair value of derivative instruments are either recorded in income or other comprehensive income, as appropriate.  Unrealized gains or losses from changes in the fair value of highly effective derivatives designated as cash flow hedges are recorded in Accumulated other comprehensive income (loss) in the period that changes in fair value occur and are reclassified to income in the same period that the hedged item affects income.

Pulp Price and Foreign Currency Risk

The operating results, cash flows and financial condition of the Company are subject to pulp price risk. Because the price of pulp is established in U.S. dollars and the Company’s cost of producing pulp is incurred principally in Canadian dollars, the profitability of the Company’s pulp operations is subject to foreign currency risk. The Company uses foreign currency forward contracts to manage its foreign currency risks. In addition, the Company has used, from time-to-time, pulp futures contracts to manage its pulp price risks.  The use of these instruments allows management of this transactional exposure to exchange rate and pulp price fluctuations because the gains or losses incurred on the derivative instruments are intended to offset, in whole or in part, losses or gains on the underlying transactional exposure. (See “Cash Flow Hedges” below). The translation exposure related to the Company’s net investment in its Canadian and German subsidiaries is not hedged.  In addition, the Company’s reported operating results are affected by changes in the Euro exchange rate relative to the U.S. dollar.  The Company’s exposure to such Euro risk is not hedged.

Cash Flow Hedges

As of March 31, 2007, the Company had outstanding foreign currency forward exchange contracts designated as cash flow hedges of U.S. dollar denominated pulp sales in a notional amount of $77 million Canadian dollars. The fair value of the contracts was a current asset of $0.4 million U.S. dollars. The weighted-average exchange rate for the foreign currency contracts at March 31, 2007 was $0.863 U.S. dollars per Canadian dollar. The contracts extend through February 2008 with the highest value of contracts maturing in May 2007.  The Company recorded net pretax gains of $0.6 million and $3.1 million on foreign currency contracts as the forecasted transactions occurred in the three months ended March 31, 2007 and 2006, respectively. Realized gains and losses on foreign currency forward exchange contracts are recorded in Other (income) expense - net on the condensed consolidated statements of operations.  For the three months ended March 31, 2006, gains of $1.6 million on foreign currency forward exchange contracts related to the operations of Terrace Bay were recorded in Loss from discontinued operations.

During 2006 and 2005, the Company entered into a series of pulp futures contracts to hedge fluctuations in pulp prices through December 2006.  Subsequent to December 31, 2006, the Company had no outstanding pulp future contracts.  For the three months ended March 31, 2006, the Company recorded net pretax losses of $1.4 million on pulp futures contracts as the forecasted transactions occurred. Realized gains and losses on pulp derivatives are recorded in Net sales on the condensed consolidated statements of operations.  For the three months ended March 31, 2006, losses of $0.7 million on pulp futures contracts related to the operations of Terrace Bay were recorded in Loss from discontinued operations.

For the three months ended March 31, 2007, changes in the fair value of the Company’s derivative instruments were reflected in other comprehensive income. If future market rates are consistent with the rates assumed at March 31, 2007, a net pretax gain of approximately $0.4 million (or $0.3 million after-tax) is expected to be recognized in earnings during the next 12 months.

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Foreign Currency Transactions

Gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the entity’s functional currency) are included in Other (income)—net in the condensed consolidated statements of operations. Net foreign currency transaction gains (losses) for the three months ended March 31, 2007 and 2006 were $(0.1) million and $0.1 million, respectively.  For the three months ended March 31, 2006, gains of $17 thousand on foreign currency transactions related to the operations of Terrace Bay were recorded in Loss from discontinued operations in the condensed consolidated statements of operations.

Note  8.  Inventories

The following presents inventories by major class:

		March 31,			December 31,
		2007			2006
Summary of Inventories
Inventories by Major Class:
Raw materials		$	27.7		$	24.2
Work in progress		24.3			11.1
Finished goods		68.1			44.5
Supplies and other		5.2			3.4
		125.3			83.2
Excess of FIFO over LIFO cost		(8.3		)	(8.3		)
Total		$	117.0		$	74.9

 

The FIFO values of total inventories valued on the LIFO method were $35.7 million and $37.9 million at March 31, 2007 and December 31, 2006, respectively.

Note  9.  Debt

The following debt was incurred either as a result of or since the Spin-Off. Long-term debt is as follows:

		March 31, 2007			December 31, 2006
Senior Notes (7.375% fixed rate) due 2014		$	225.0		$	225.0
Revolving bank credit facility (variable rates), due 2010		117.2			57.3
Term Loan (variable rates), due 2010		—			—
Third-party financing (7.375% fixed rate) due in quarterly installments through December 2007		0.9			1.3
Neenah Germany project financing (3.8% fixed rate) due in equal semi-annual installments beginning June 2009		13.4			—
Neenah Germany revolving line of credit (variable rates)		3.4			—
Total Debt		359.9			283.6
Less: Debt payable within one year		4.3			1.3
Long-term debt		$	355.6		$	282.3

 

Principal Payments

The following table presents the Company’s required debt payments:

		2007			2008			2009			2010			2011			Thereafter			Total
Debt payments		$	4.3		$	—		$	1.7		$	118.9		$	1.7		$	233.3		$	359.9

 

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Senior Unsecured Notes

In November 2004, the Company completed an underwritten offering of ten-year senior unsecured notes (the “Senior Notes”) at an aggregate face amount of $225 million. The Senior Notes bear interest at a rate of 7.375 percent, payable May 15 and November 15 of each year and mature on November 15, 2014. The Senior Notes are fully and unconditionally guaranteed by all of the Company’s subsidiaries, with the exception of Neenah Germany.

Secured Revolving Credit Facility

On November 30, 2004, the Company entered into a Credit Agreement by and among the Company, certain of its subsidiaries, the lenders listed in the Credit Agreement and JP Morgan Chase Bank, N.A. as agent for the lenders (the “Initial Credit Agreement”). Under the Initial Credit Agreement, the Company had a secured revolving credit facility (the “Revolver”) that provided for borrowings of up to $150 million. Amounts outstanding under the Revolver may be repaid, in whole or in part, at any time without premium or penalty except for specified make-whole payments on LIBOR-based loans.  All principal amounts outstanding under the Revolver are due and payable on the date of termination of the Revolver.

Borrowings under the Initial Credit Agreement were secured by substantially all of the Company’s assets, including the capital stock of its subsidiaries and were guaranteed by Neenah Paper Company of Canada, a wholly-owned subsidiary. The Initial Credit Agreement was scheduled to terminate on November 30, 2008.

The interest rate applicable to borrowings under the Revolver was either (1) the applicable base rate plus 0.25 percent to 0.75 percent or (2) a LIBOR-based rate ranging from LIBOR plus 1.75 percent to LIBOR plus 2.25 percent. Interest was computed based on actual days elapsed in a 360-day year, payable monthly in arrears for base rate loans, or for LIBOR loans, payable monthly in arrears and at the end of the applicable interest period. The commitment was subject to an annual facility fee of 0.375 percent on the average daily unused amount of the commitment.

Both the indenture governing the Senior Notes and the Initial Credit Agreement contain, among other provisions, covenants with which the Company must comply during the term of the agreements. Such covenants restrict the Company’s ability to, among other things, incur certain additional debt, make specified restricted payments and capital expenditures, authorize or issue capital stock, enter into transactions with affiliates, consolidate or merge with or acquire another business, sell certain of its assets or liquidate, dissolve or wind-up. In addition, the terms of the Initial Credit Agreement require the Company to achieve and maintain certain specified financial ratios. As of March 31, 2007 the Company was in compliance with all such covenants.

In October 2006, the Company entered into the Third Amendment (the “Third Amendment”) to the Initial Credit Agreement. Except as generally described herein, the Third Amendment retained the terms of the Initial Credit Agreement described above.  The Third Amendment, among other things, (i) increased the Company’s secured revolving line of credit from $150 million to $165 million, (ii) extended the termination date of the Initial Credit Agreement to November 30, 2010, (iii) set the interest rate under the Revolver to either (A) the Prime Rate (as defined in the Third Amendment) plus a percentage ranging from 0 percent to 0.75 percent, or (B) LIBOR plus a percentage ranging from 1.25 percent to 2.25 percent, (iv) reduced the annual facility fee on the average daily unused amount of the commitment from 0.375 percent to 0.25 percent, and (iv) made other definitional, administrative and covenant modifications to the Initial Credit Agreement.

In the Third Amendment, the lenders also consented to consummation of the Company’s purchase of Neenah Germany.  Neenah Germany is not a borrower or guarantor with respect to the Revolver.  However, the Company pledged 65 percent of its equity interest in Neenah Germany as security for its obligations under the amended Initial Credit Agreement.

In March 2007, the Company entered into the Fourth Amendment (the “Fourth Amendment”) to the Initial Credit Agreement (the Initial Credit Agreement as amended, the “Credit Agreement”). Except as generally described herein, the Fourth Amendment retained the terms of the amended Initial Credit Agreement described above. The Fourth Amendment, among other things, (i) increased the Company’s secured revolving line of credit from $165 million to $180 million and (ii) made other definitional, administrative and covenant modifications to the amended Initial Credit Agreement. Despite the increase in the total commitment to $180 million, the Company’s ability to borrow under the Revolver is currently limited to the lowest of (a) $180 million, (b) the Company’s borrowing base (as determined in accordance with the Credit Agreement), and (c) the applicable cap on the amount of “credit facilities” under the indenture.

The closing of the Fourth Amendment occurred simultaneously with the Company’s consummation of its acquisition of Fox River.  On March 1, 2007, the Company borrowed $54 million in principal under the Credit Agreement as part of the financing for the acquisition of Fox River.  The entities acquired by the Company pursuant to the Fox River acquisition are guarantors with respect to such secured revolving line of credit.  Such entities are also subsidiary guarantors with respect to the Senior Notes; however, the property, plant and equipment acquired in the acquisition of Fox River does not secure the Company’s obligations under the Credit Agreement.

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As of March 31, 2007, the Company’s available borrowing capacity under the Credit Agreement was $180 million and borrowings of $117.2 million were outstanding under the Revolver with a weighted-average interest rate on such borrowings of 7.40 percent per annum. Borrowing availability under the Revolver is reduced by outstanding Letters of Credit and reserves for certain other items as defined in the Credit Agreement. The amount of the borrowing base is subject to change from time to time in accordance with the terms of the Credit Agreement. Availability under the Credit Agreement will fluctuate over time depending on the value of the Company’s inventory, receivables and various capital assets. As of March 31, 2007, the Company had approximately $2.1 million of Letters of Credit outstanding and $60.7 million of borrowing availability under the Revolver.  Interest on amounts borrowed under the Revolver is paid monthly.

The Credit Agreement contains events of default customary for financings of this type, including failure to pay principal or interest, materially false representations or warranties, failure to observe covenants and other terms of the Credit Agreement, cross-defaults to other indebtedness, bankruptcy, insolvency, various ERISA violations, the incurrence of material judgments and changes in control. As of March 31, 2007 no events of default had occured.

Term Loan

On March 30, 2007, the Company entered into an agreement by and among the Company, certain of its subsidiaries and JP Morgan Chase Bank, N.A. (the “Term Loan Agreement”) to borrow $15 million (the “Term Loan”) upon closing in April 2007.  In addition, subject to certain terms and conditions of the Term Loan Agreement, the Company may borrow up to an additional $10 million in a single advance.  The Term Loan is secured by substantially all of the property, plant and equipment acquired by the Company in the acquisition of Fox River and is fully and unconditionally guaranteed by substantially all of the Company’s other subsidiaries, except Neenah Germany.  Principal payments on the Term Loan are due in thirteen equal quarterly installments beginning on November 1, 2007. Amounts outstanding under the Term Loan may be repaid, in whole or in part, at any time without premium or penalty except that LIBOR Borrowings (as defined below) may not be partially repaid such that less than $3.0 million of LIBOR Borrowings are outstanding.  The Term Loan Agreement terminates on November 1, 2010.

At the Company’s option, Term Loan borrowings may be designated as either Alternate Base Rate Borrowings (as defined in the Term Loan Agreement) or London Interbank Offered Rate Borrowings (“LIBOR Borrowings”).  The interest rate on Alternate Base Rate Borrowings is the greater of (i) the Prime Rate (as defined in the Term Loan Agreement) or (ii) the Federal Funds Effective Rate (as defined in the Term Loan Agreement) plus a percentage ranging from 0 percent to 0.75 percent.  The interest rate on LIBOR Borrowings is LIBOR plus a percentage ranging from 1.50 percent to 2.25 percent.  Interest is computed based on actual days elapsed in a 360-day year, payable monthly in arrears for Alternate Base Rate Borrowings, or for LIBOR Borrowings, payable monthly in arrears and at the end of the applicable interest period. As of March 31, 2007, no amounts were outstanding under the Term Loan.

Other Financing

In December 2006, Neenah Germany entered into an agreement with HypoVereinsbank and IKB Deutsche Industriebank AG (the “Lenders”) to provide project financing for the construction of a saturator.  The Lenders agreed to provide €10 million of construction financing secured by the saturator.  The loan matures in December 2016 and principal is repaid in equal semi-annual installments beginning in June 2009.  Principal outstanding under the agreement may be repaid at any time without penalty.  The interest rate on amounts outstanding is 3.8 percent per annum based on actual days elapsed in a 360-day year and is payable semi-annually.  As of March 31, 2007, €10.0 million ($13.4 million) was outstanding under this agreement.  The Company’s use of proceeds under the loan agreement is restricted to the payment of costs incurred pursuant to construction of the saturator.  As of March 31, 2007, Cash and cash equivalents on the consolidated balance sheet included approximately $10.1 million of such restricted cash.

Neenah Germany has an unsecured revolving line of credit (the “Line of Credit”) with HypoVereinsbank that provides for borrowings of up to €15 million for general corporate purposes.  The Line of Credit terminates on November 30, 2007.  Neenah Germany has the ability to borrow in either Euros or U.S. dollars.  Interest on U.S. dollar loans is computed at the rate of 8.5 percent per annum and is computed on Euro loans at EURIBOR plus a margin of 1.5 percent.  Interest is payable quarterly and principal may be repaid at any time without penalty.  As of March 31, 2007, $3.4 million was outstanding under the Line of Credit at a weighted average interest rate of 6.0 percent per annum.

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Note  10.  Pension and Other Post-employment Benefits

Pension Plans

Substantially all active employees of the Company’s U.S. paper operations participate in defined benefit pension plans and defined contribution retirement plans. On November 30, 2004, the Company assumed responsibility for pension and post-employment benefit obligations for active employees of the Pulp and Paper business and former employees of the Canadian pulp operations. In August 2006, Neenah Canada purchased annuity contracts to settle its obligations under the Ontario Plan for former employees of Terrace Bay.  See Note 5 “Discontinued Operations.” Pension and post-employment benefit obligations related to former employees of the U.S. paper operations were retained by Kimberly-Clark. Substantially all of Neenah Germany’s hourly employees participate in defined benefit plans designed to provide a monthly pension upon retirement. There is no legal or governmental obligation to fund Neenah Germany’s benefit plans and as such the plans are currently unfunded.

The following table presents the components of net periodic benefit cost:

Components of Net Periodic Benefit Cost

		Pension Benefits						Post-Employment Benefits Other than Pensions
		Three Months Ended March 31,
		2007			2006 (b)			2007			2006 (c)
Service cost		$	2.0		$	2.5		$	0.6		$	0.6
Interest cost		5.9			5.8			0.5			1.0
Expected return on plan assets(a)		(6.0		)	(7.9		)	—			—
Recognized net actuarial loss		1.2			2.1			0.9			0.4
Amortization of unrecognized transition asset		(0.1		)	(0.1		)	—			—
Amortization of prior service cost		0.4			0.4			(1.5		)	0.1
Net periodic benefit cost (credit)		3.4			2.8			0.5			2.1
Less: Costs related to discontinued operations		0.8			0.6			—			0.9
Net periodic benefit cost related to continuing operations		$	2.6		$	2.2		$	0.5		$	1.2

(a)          The expected return on plan assets is determined by multiplying the fair value of plan assets at the prior year-end (adjusted for estimated current year cash benefit payments and contributions) by the expected long-term rate of return.

(b)         In conjunction with the transfer of Terrace Bay to Buchanan, and as a closing condition of the agreement, Neenah Canada initiated plans to curtail and settle the Ontario Plan.  Pension costs for the Ontario Plan have been classified as Loss from discontinued operations on the condensed consolidated statements of operations.

(c)          Pursuant to the terms of the transfer agreement, Buchanan assumed responsibility for post-employment medical and life insurance benefits for active employees at Terrace Bay.

Based on exchange rates at March 31, 2007, the Company expects to contribute approximately $8 million to its pension trusts in 2007, of which approximately $1.9 million was paid in the three months ended March 31, 2007.  Estimated contributions to the Company’s pension trusts do not include any estimate of amounts necessary to settle the Ontario Plan.  See Note 5, “Discontinued Operations.”

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Note  11.  Stock Compensation Plan

The Company adopted and established the 2004 Omnibus Stock and Incentive Plan (the “Omnibus Plan”) under unanimous written consent of its Board of Directors on December 1, 2004. The Company reserved 3,500,000 shares of $0.01 par value common stock (“Common Stock”) for issuance under the Omnibus Plan. Pursuant to the terms of the Omnibus Plan, the compensation committee of the Company’s Board of Directors may grant various types of equity-based compensation awards, including incentive and nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units (“RSUs”), restricted stock units with performance conditions (“Performance Shares”) and performance units, in addition to certain cash-based awards. All grants under the Omnibus Plan will be made at fair market value and no grant may be repriced. In general, the options expire ten years from the date of grant and vest over a three-year service period. As of March 31, 2007, approximately 1,745,000 shares of Common Stock were reserved for future issuance under the Omnibus Plan.

On January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), Share Based Payment (“SFAS 123R”) using the modified-prospective transition method.  Stock-based compensation cost recognized under SFAS 123R consists of (a) compensation cost for all unvested stock-based grants outstanding as of January 1, 2006, based on the grant date fair value estimated in accordance with the pro forma provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) and (b) compensation cost for all stock-based awards granted subsequent to adoption based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. The amount of stock-based compensation cost recognized is based on the fair value of grants that are ultimately expected to vest and is recognized pro-rata over the requisite service period for the entire award.

SFAS 123R amends Statement of Financial Accounting Standards No. 95, Statement of Cash Flows, to require the reporting of excess tax benefits related to the exercise or vesting of stock-based awards as cash provided by financing activities rather than as a reduction in income taxes paid and reported as cash provided by operations.  The Company did not recognize any excess tax benefits related to the exercise or vesting of stock-based awards for the three months ended March 31, 2007 and 2006.

Valuation and Expense Information Under SFAS 123R

Stock-based compensation expense is recorded in Selling, general and administrative expenses on the condensed consolidated statements of operations.  The following table presents stock-based compensation expense for the three months ended March 31, 2007 and 2006.

		Three Months Ended March 31,
		2007			2006
Stock-based compensation expense		$	1.7		$	1.4
Income tax benefit		(0.6		)	(0.5		)
Stock-based compensation, net of income tax benefit		$	1.1		$	0.9

 

The following table summarizes total compensation costs related to the Company’s equity awards and amounts recognized in the three months ended March 31, 2007.

		Stock Options			Restricted Stock
Unrecognized compensation cost — December 31, 2006		$	3.3		$	2.2
Add: Grant date fair value current year grants		1.2			2.1
Less: Compensation expense recognized		1.2			0.5
Less: Grant date fair value of shares forfeited		—			—
Unrecognized compensation cost — March 31, 2007		$	3.3		$	3.8
Expected amortization period (in years)		1.6			2.4

(a)          The fair value of current year stock option grants includes $0.1 million related to a change in the Company’s estimate for forfeitures.

 

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Stock Options

During the three months ended March 31, 2007, the Company awarded options to Long-Term Incentive Plan (the “LTIP”) participants to purchase 82,500 shares of common stock at a weighted-average exercise price of $36.38 per share. The exercise price of the options was equal to the market price of the Company’s common stock on the date of grant.  The options expire in ten years and one-third vest on each of the first three anniversaries of the date of grant.  The weighted-average grant date fair value for stock options granted during the three months ended March 31, 2007 was $14.22 per share and was estimated using the Black-Scholes option valuation model with the following assumptions:

 

The expected term was estimated based upon historical data for Kimberly-Clark stock option awards and the expected volatility was estimated by reference to the historical stock price performance of a peer group of companies.  The risk-free interest rate was based on the yield on U.S. Treasury bonds with a remaining term approximately equivalent to the expected term of the stock option award.  Forfeitures were estimated at the date of grant.

Performance Shares

During the three months ended March 31, 2007, the Company made a target award of 53,300 Performance Shares to LTIP participants. The measurement period for the Performance Shares is January 1, 2007 through December 31, 2009. Common stock equal to between 30 percent and 250 percent of the performance share target will be awarded based on the Company’s growth in earnings before interest, taxes, depreciation and amortization (“EDITDA”) minus a capital charge and total return to shareholders relative to a peer group of companies and the Russell 2000® Value small cap index. As of March 31, 2007, based on the Company’s expected achievement against performance targets, common stock equal to approximately 103 percent of the Performance Share award will be issued. The weighted-average grant date fair value for the Performance Shares was $36.38 per share and was estimated using a “Monte Carlo” simulation technique. Compensation cost is recognized pro rata over the vesting period.

No stock options were exercised during the three months ended March 31, 2007 and 2006.

For the three months ended March 31, 2007, the aggregate grant date fair value of options vested was $0.6 million.  As of March 31, 2007, certain participants met age and service requirements that allowed their options to qualify for accelerated vesting upon retirement.  As of March 31, 2007, LTIP participants held options to purchase 74,528 shares of common stock that would have been exercisable if they had retired as of such date.  The aggregate grant date fair value of these options, which were subject to accelerated vesting, was $0.9 million.  Stock options subject to accelerated vesting for expense recognition become exercisable according to the contract terms of the stock option grant.

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Note 12.   Goodwill and Other Intangible Assets

The following table presents changes in the carrying amount of goodwill for the three months ended March 31, 2007.  All of such goodwill is reported in the Technical Products segment.

(a)             Primarily reflects payment to FiberMark for actual working capital acquired.

The following table presents the gross carrying amount of intangible assets and the related accumulated amortization for intangible assets subject to amortization.

 

The increase in intangible assets at March 31, 2007 is primarily due to $4.0 million of intangible assets acquired in the Fox River acquisition.  The intangible assets acquired are reported within the Fine Paper segment.  See Note 14, “Segments.”  Of the $4.0 million of acquired intangible assets identified in the preliminary purchase price allocation, $0.3 million was assigned to registered trade names and trademarks with definite lives and is being amortized over a weighted average useful life of 7.5 years.   The remaining balance of intangible assets acquired of $3.7 million was assigned to registered trade names and trademarks with indefinite lives.   Intangible assets at December 31, 2006 were acquired in the acquisition of Neenah Germany.  For the three months ended March 31, 2007, amortization expense related to intangible assets was $0.6 million.  The Company had no amortizable intangible assets for the three months ended March 31, 2006.  Estimated annual amortization expense for each of the next five years is approximately $1.7 million.

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Note 13.  Contingencies and Legal Matters

Litigation

On December 21, 2006, certain retirees of Neenah Canada brought a proposed class action lawsuit against Neenah Canada, the Company and Kimberly-Clark Inc. alleging the wrongful reduction and/or elimination of certain retiree benefits following Neenah Canada’s transfer of the Terrace Bay pulp and woodlands operations to Terrace Bay Pulp Inc. and Eagle Logging Inc.  The purported class has not been certified.  The Company and Neenah Canada believe that the lawsuit is without merit and will vigorously defend the litigation.

In February 2007, certain former employees of Neenah Canada who were previously employed in Neenah Canada’s Longlac woodlands operations brought suit against the Company and Neenah Canada in the Ontario (Canada) Superior Court of Justice for damages the plaintiffs claim to have suffered from an alleged wrongful termination of employment by Neenah Canada occurring on or about August 21, 2006.  Eagle Logging Inc. (the purchaser of Neenah Canada’s Longlac woodlands assets on August 29, 2006), Terrace Bay Pulp Inc. (the purchaser of Neenah Canada’s Terrace Bay pulp mill), Buchanan Forest Products Ltd., Lucky Star Holdings Inc. (each affiliates of Eagle Logging Inc. and Terrace Bay Pulp Inc.), Kimberly-Clark Corporation and Kimberly-Clark Inc. have also been named in the lawsuit.  The lawsuit seeks damages for severance and notice pay under Ontario law, as well as damages for wrongful termination, breach of contract, conspiracy and punitive damages, among other things.  The Company and Neenah Canada believe that the lawsuit is without merit and will vigorously defend the litigation.

The Company is involved in certain other legal actions and claims arising in the ordinary course of business. While the outcome of these legal actions and claims cannot be predicted with certainty, it is the opinion of management that the outcome of any such claim which is pending or threatened, either individually or on a combined basis, will not have a material adverse effect on the consolidated financial condition, results of operations or liquidity of the Company.

Indemnifications

In conjunction with the transfer of Terrace Bay (see Note 5, “Discontinued Operations”), the Company entered into a pulp manufacturing agreement (the “Pulp Manufacturing Agreement”) with Terrace Bay Pulp Inc. (“TBPI”).  Pursuant to the Pulp Manufacturing Agreement, the Company has agreed to sell pulp manufactured by TBPI at Terrace Bay to satisfy the Company’s supply obligations under an amended and restated pulp supply agreement with Kimberly-Clark (as amended and restated, the “Pulp Supply Agreement”). The price paid by the Company under the Pulp Manufacturing Agreement will equal the price paid by Kimberly-Clark pursuant to the Pulp Supply Agreement. TBPI has agreed to perform substantially all of the Company’s obligations under the Pulp Supply Agreement and, together with three of its affiliated companies, to indemnify and hold the Company harmless for any claims arising from Terrace Bay’s failure to so perform.  The Pulp Manufacturing Agreement will terminate on December 31, 2010 or sooner by mutual agreement by the parties or upon the occurrence of certain events (as defined in the Pulp Manufacturing Agreement).  The Company believes that any liability it may have under the Pulp Supply Agreement in excess of TBPI’s indemnification under the Pulp Manufacturing Agreement is immaterial.

 For the three months ended March 31, 2007, the Company did not recognize revenue or cost in its condensed consolidated statement of operations for the pulp manufactured by TBPI at Terrace Bay for sale to Kimberly-Clark.  The Company receives payments from Kimberly-Clark for Kimberly-Clark’s purchases of pulp from TBPI and immediately remits such payments to TBPI.  In general, Kimberly-Clark pays for such pulp purchase in approximately 45 days from receipt of the product.  Due to the lag in payments, at any given time, the Company has equal accounts receivable from Kimberly-Clark and accounts payable to TBPI for such pulp shipments.  As of March 31, 2007, the Company had a receivable from Kimberly-Clark for $21.8 million recorded in Accounts receivable, net on the Consolidated Balance Sheet and an equal payable to TBPI recorded in Accounts payable.

Pursuant to the terms of the purchase agreement with FiberMark (see Note 4, “Acquisitions”), the Company is liable for potential additional taxes due for tax returns filed for periods prior to the Acquisition.  FiberMark has agreed to indemnify the Company for such additional taxes and a portion of the purchase price has been reserved in an escrow account to fund the indemnification.  The Company believes it is probable that Neenah Germany is liable for approximately $5.5 million in additional taxes.  As of March 31, 2007, the Company has recognized a current liability on the consolidated balance sheet for such potential additional taxes.  The Company has also recognized a receivable in an equal amount in prepaid and other current assets on the consolidated balance sheet for the value of the indemnification.  The Company does not believe its liability for such taxes is in excess of the escrow amount.

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Pursuant to the Distribution Agreement, the Pulp Supply Agreement, the Employee Matters Agreement and the Tax Sharing Agreement, the Company has agreed to indemnify Kimberly-Clark for certain liabilities or risks related to the Spin-Off. Many of the potential indemnification liabilities under these agreements are unknown, remote or highly contingent. Furthermore, even in the event that an indemnification claim is asserted, liability for indemnification is subject to determination under the terms of the applicable agreement. For these reasons, the Company is unable to estimate the maximum potential amount of the possible future liability under the indemnity provisions of these agreements. However, the Company accrues for any potentially indemnifiable liability or risk under these agreements for which it believes a future payment is probable and a range of loss can be reasonably estimated. As of March 31, 2007, management believes the Company’s liability under such indemnification obligations was not material to the consolidated financial statements.

Employees and Labor Relations

Hourly employees at the Pictou pulp mill are represented by the Communications, Energy and Paperworkers Union of Canada pursuant to a collective bargaining agreement expiring in May 2009.

Hourly employees at the Neenah, Whiting and Munising paper mills are represented by the United Steelworkers Union (the “USW”). The collective bargaining agreements for the Neenah, Whiting and Munising paper mills expire on February 1, 2009, July 1, 2009 and July 15, 2009, respectively. Additionally, these mills have bargained jointly with the union on pension matters. The agreements on pension matters for these mills expire in June 2007.

Approximately 50 percent of salaried employees and 80 percent of hourly employees of Neenah Germany are eligible to be represented by the Mining, Chemicals and Energy Trade Union, Industriegewerkschaft Bergbau, Chemie and Energie (the “IG BCE”).  Union membership is voluntary, and under German law does not need to be disclosed to the Company. As a result, the number of employees covered by the collective bargaining agreement cannot be determined.  The collective bargaining agreement covering union employees of Neenah Germany is negotiated by the IG BCE and a national trade association representing all employers in the industry.  The collective bargaining agreement between the IG BCE and the national trade association expired on February 28, 2007.  Negotiations on a new contract have begun but the IG BCE and the national trade association have not reached an agreement. The Company believes that expiration of the collective bargaining agreement will not result in a work stoppage.

As of March 31, 2007, Fox River had approximately 500 hourly and 250 salaried regular full-time employees all of whom were located in the United States.  Hourly employees at the Ripon paper mill are represented by a local of the Association of Western Pulp and Paper Workers pursuant to a collective bargaining agreement that expires in April 2010.  Hourly employees at the Appleton, Urbana and Housatonic paper mills and the Appleton distribution center are represented by locals of the USW. The collective bargaining agreements for the Appleton distribution center and the Urbana and Housatonic paper mills expire in November 2008, May 2009 and July 2009, respectively.  The collective bargaining agreement for the Appleton paper mill covering approximately 95 hourly employees expires in May 2007.  Contract negotiations are in process.

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Note 14.  Business Segment Information

The Company reports its operations in three segments: Fine Paper, Technical Products and Pulp. The fine paper business is a leading producer of premium writing, text, cover and specialty papers. The technical products business is a leading producer of filtration media, durable, saturated and coated substrates for a variety of end uses. The pulp business consists of a mill and related timberlands, which produces northern bleached softwood and hardwood kraft pulp. Each segment requires different technologies and marketing strategies. Corporate expenses that are identifiable as directly supporting the operations of the business segments are allocated to the business segments.  General corporate expenses that do not directly support the operations of the business segments are shown as Unallocated corporate costs. Disclosure of segment information is on the same basis that management uses internally for evaluating segment performance and allocating resources.

The following table summarizes the net sales, income before interest and taxes (“Operating income”) and total assets for each of the Company’s business segments.

 

 

 

 

Note 15.  Condensed Consolidating Financial Information

Neenah Paper Michigan, Inc., Neenah Paper Fox River, LLC, Neenah Paper Fox Valley Company, Inc., Neenah Paper Company of Canada, Neenah Paper International Holding Company, LLC and Neenah Paper International, LLC, (the “Guarantor Subsidiaries”) guarantee the Company’s Senior Notes. The Guarantor Subsidiaries are 100 percent owned by the Company and all guarantees are full and unconditional. As of December 31, 2006, Neenah Paper Sales, Inc. which was a subsidiary guarantor was merged into Neenah Paper, Inc. (the parent company and issuer of the Senior Notes).  The following condensed consolidating financial information is presented in lieu of consolidated financial statements for the Guarantor Subsidiaries as of March 31, 2007 and December 31, 2006 and for the three months ended March 31, 2007 and 2006.

 

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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
For the Three Months Ended March 31, 2007

		Neenah Paper, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidating Adjustments			Consolidated Amounts
Net sales		$	55.5		$	103.6		$	65.9		$	(0.3	)	$	224.7
Cost of products sold		37.5			89.7			54.3			(0.3		)	181.2
Gross profit		18.0			13.9			11.6			—			43.5
Selling, general and administrative expenses		8.6			5.3			4.0			—			17.9
Gain on sale of woodlands		—			(1.4		)	—			—			(1.4		)
Other income - net		—			(0.5		)	(0.1		)	—			(0.6		)
Operating income		9.4			10.5			7.7			—			27.6
Equity in earnings of subsidiaries		(11.9		)	—			—			11.9			—
Interest expense-net		5.3			0.6			0.1			—			6.0
Income from continuing operations before income taxes		16.0			9.9			7.6			(11.9		)	21.6
Provision for income taxes		1.3			3.7			1.4						6.4
Income from continuing operations		14.7			6.2			6.2			(11.9		)	15.2
Loss from discontinued operations		—			(0.5		)	—			—			(0.5		)
Net income		$	14.7		$	5.7		$	6.2		$	(11.9	)	$	14.7

 

 

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
For the Three Months Ended March 31, 2006

		Neenah Paper, Inc.			Guarantor Subsidiaries			Consolidating Adjustments			Consolidated Amounts
Net sales		$	23.3		$	134.1		$	(24.5	)	$	132.9
Cost of products sold		18.2			115.7			(24.5		)	109.4
Gross profit		5.1			18.4			—			23.5
Selling, general and administrative expenses		1.6			13.5			—			15.1
Other income - net		—			(1.6		)	—			(1.6		)
Operating income		3.5			6.5			—			10.0
Equity in earnings of subsidiaries		(1.3		)	—			1.3			—
Interest expense-net		4.1			0.4			—			4.5
Income from continuing operations before income taxes		0.7			6.1			(1.3		)	5.5
Provision for income taxes		(0.2		)	2.3			—			2.1
Income from continuing operations		0.9			3.8			(1.3		)	3.4
Loss from discontinued operations		—			(2.5		)	—			(2.5		)
Net income		$	0.9		$	1.3		$	(1.3	)	$	0.9

 

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CONDENSED CONSOLIDATED BALANCE SHEET
As of March 31, 2007

		Neenah Paper, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidating Adjustments			Consolidated Amounts
ASSETS
Current assets
Cash and cash equivalents		$	(2.2	)	$	4.2		$	1.5		$	—		$	3.5
Restricted cash		—			—			10.1			—			10.1
Accounts receivable - net		16.9			88.2			43.8			—			148.9
Inventories		21.1			70.9			25.0			—			117.0
Other receivables		2.5			1.0			10.4			—			13.9
Intercompany amounts receivable		59.9			—			—			(59.9		)	—
Prepaid and other current assets		5.0			13.3			2.8			—			21.1
Total current assets		103.2			177.6			93.6			(59.9		)	314.5
Property, plant and equipment, at cost		244.1			404.8			152.5			—			801.4
Less accumulated depreciation		147.6			271.0			5.5			—			424.1
Property, plant and equipment—net		96.5			133.8			147.0			—			377.3
Investments in subsidiaries		396.6			—			—			(396.6		)	—
Deferred Income Taxes		(2.4		)	59.9			—			—			57.5
Goodwill		—			—			94.4			—			94.4
Intangible Assets, net		—			4.0			29.3			—			33.3
Other Assets		8.9			4.2			0.6			—			13.7
TOTAL ASSETS		$	602.8		$	379.5		$	364.9		$	(456.5	)	$	890.7
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Debt payable within one year		$	0.9		$	—		$	3.4		$	—		$	4.3
Accounts payable		10.9			49.5			18.8			—			79.2
Intercompany amounts payable		—			59.1			0.8			(59.9		)	—
Accrued salaries and employee benefits		5.3			16.0			3.9			—			25.2
Accrued income taxes		3.2			2.4			12.0			—			17.6
Accrued expenses		10.6			18.4			—			—			29.0
Total current liabilities		30.9			145.4			38.9			(59.9		)	155.3
Long-term Debt		342.2			—			13.4			—			355.6
Deferred Income Taxes		—			—			35.9			—			35.9
Noncurrent Employee Benefits		23.9			67.8			35.4			—			127.1
Other Noncurrent Obligations		2.1			10.4			0.6			—			13.1
TOTAL LIABILITIES		399.1			223.6			124.2			(59.9		)	687.0
STOCKHOLDERS’ EQUITY		203.7			155.9			240.7			(396.6		)	203.7
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	602.8		$	379.5		$	364.9		$	(456.5	)	$	890.7

 

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