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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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 October 31, 2008, there were 14,592,824 shares of the Company’s common stock outstanding.

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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)

See Notes to Condensed Consolidated Financial Statements

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NEENAH PAPER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions)

(Unaudited)

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)

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.  Following the Spin-Off, management began executing a strategy to exit the pulp business and transform the Company into a manufacturer of specialty papers.

The fine paper business is a leading producer of premium writing, text, cover and specialty papers used in corporate identity packages, corporate annual reports, invitations, personal stationery and high-end packaging for point of sale advertising. The technical products business is a leading producer of transportation and other filter media; durable, saturated and coated substrates for a variety of end uses; and nonwoven wall coverings.

In June 2006, the Company’s wholly owned subsidiary, Neenah Paper Company of Canada (“Neenah Canada”) sold approximately 500,000 acres of woodlands in Nova Scotia for proceeds of $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. See Note 5, “Discontinued Operations—Sale of Woodlands.”

In August 2006, Neenah Canada transferred the Terrace Bay, Ontario pulp mill and related woodlands operations (“Terrace Bay”) to certain affiliates of Buchanan Forest Products Ltd. (“Buchanan”). Buchanan acquired substantially all of the assets of Terrace Bay and assumed responsibility for substantially all of the liabilities related to its future operation.  The results of operations of Terrace Bay are reported as discontinued operations on the condensed consolidated statements of operations for the three and nine months ended September 30, 2008 and 2007.  See Note 5, “Discontinued Operations—Transfer of Terrace Bay.”

In October 2006, the Company purchased 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 $220.1 million in cash (net of cash acquired). The transaction was financed from available cash and debt drawn against the Company’s existing revolving credit facility. The Neenah Germany assets consist of two mills located near Munich, Germany and a third mill near 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.

In March 2007, the Company acquired the stock of Fox Valley Corporation and its subsidiary, Fox River Paper Company, LLC (collectively, “Fox River”) for approximately $54.7 million in cash (net of cash acquired). The transaction was financed from available cash and debt drawn against the Company’s existing revolving credit facility. At the time of the acquisition, the Fox River assets consisted 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 allocation of the purchase price to the fair value of assets acquired and liabilities assumed, and a description of certain post-acquisition restructuring activities.

In February 2008, the Company committed to a plan to sell its pulp mill in Pictou, Nova Scotia (the “Pictou Mill”) and approximately 500,000 acres of woodland assets in Nova Scotia (the “Woodlands”).  In June 2008, Neenah Canada completed the sale of the Pictou Mill to Northern Pulp Nova Scotia Corporation (“Northern Pulp”), a new operating company jointly owned by Atlas Holdings LLC and Blue Wolf Capital Management LLC.  In connection with the transfer of the Pictou Mill, Neenah Canada made payments of approximately $10.3 million to Northern Pulp. In addition, the Company incurred transaction costs of approximately $3.3 million. Pursuant to the terms of the transaction, Northern Pulp assumed all of the assets and liabilities associated with the Pictou Mill, as well as existing customer contracts, supply agreements, labor agreements and pension obligations. The sale did not include the Woodlands.

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Management believes it is probable that the sale of the Woodlands will be completed within 12 months.  As of September 30, 2008, the assets and liabilities of the Woodlands are reported as assets held for sale—discontinued operations and liabilities related to discontinued operations, respectively, on the condensed consolidated balance sheet.  For the three and nine months ended September 30, 2008, the results of operations of the Pictou Mill and the Woodlands and the loss on disposal of the Pictou Mill are reported as discontinued operations in the condensed consolidated statements of operations. The consolidated results of operations for all prior periods have been restated to reflect the results of operations of the Pictou Mill and the Woodlands as discontinued operations.  See Note 5, “Discontinued Operations—Sale of the Pictou Mill and the Woodlands.”

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 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, 2007 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 from the consolidated financial statements.

Earnings (Loss) per Share (“EPS”)

Basic earnings (loss) per share (“EPS”) was computed by dividing net income (loss) by the weighted-average number of shares of common stock outstanding during the three and nine months ended September 30, 2008 and 2007.  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 and nine months ended September 30, 2008, approximately 1,565,000 and 1,470,000 potentially dilutive stock-based compensation awards, respectively, were excluded from the computation of dilutive common shares.  For the three and nine months ended September 30, 2007, approximately 310,000 and 260,000 potentially dilutive stock-based compensation awards, respectively, were excluded from the computation of dilutive common shares.

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

(a)        The reduction in weighted-average basic shares outstanding is primarily due to the execution of a reverse/forward split of the issued and outstanding shares of common stock.  See Note 13, “Stockholders’ Equity.”

Note 2.  Accounting Standard Changes

In April 2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”).  FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets.”  FSP 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited.  The Company is reviewing FSP 142-3 and is unable to estimate the impact on its financial position, results of operations or cash flows.

Note 3.  Comprehensive Income (Loss)

Comprehensive income (loss) includes, in addition to net income (loss), gains and losses recorded directly into stockholders’ equity on the condensed consolidated balance sheet. These gains and losses are referred to as other comprehensive income items. Accumulated other comprehensive income (loss) consists of foreign currency translation gains and (losses), deferred gains and (losses) on cash flow hedges, and adjustments related to pensions and other post-employment benefits. Income taxes are not provided for foreign currency translation adjustments because they relate to indefinite investments in Neenah Germany. The Company also does not provide income taxes for foreign currency translation adjustments for its Canadian operations.  For the three and nine months ended September 30, 2008, the Company did not record deferred taxes related to future funds expected to be repatriated upon the sale of the Woodlands because there are no expected tax consequences considering the anticipated proceeds from the disposal of the Woodlands.  As of September 30, 2008 and December 31, 2007, accumulated other comprehensive income was $117.1 million and $98.5 million, respectively.

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

(a)        In connection with the sale of the Pictou Mill, Northern Pulp assumed responsibility for Neenah Canada’s Nova Scotia, Canada defined benefit pension plan (the “Nova Scotia Plan”).  For the nine months ended September 30, 2008, the Company reclassified approximately $53.7 million ($33.2 million after income taxes) in deferred pension and other post-employment benefit adjustments related to the transfer of the Nova Scotia Plan to Northern Pulp to loss from discontinued operations on the condensed consolidated statement of operations.  See Note 5, “Discontinued Operations—Sale of the Pictou Mill and the Woodlands.”

Note 4.  Acquisitions

In March 2007, the Company acquired the stock of Fox River for $54.7 million in cash (net of cash acquired). Included in the cost of the acquisition were amounts for the repayment of debt, the payment of deferred employee compensation obligations of the acquired companies and fees and expenses directly related to the acquisition. The transaction was financed from available cash and debt drawn against the Company’s existing revolving credit facility. At the time of the acquisition, the Fox River assets consisted 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 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.

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The total cost of the Fox River acquisition has been allocated to the assets acquired and liabilities assumed by the Company in accordance with Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS 141”). The Company did not acquire any in-process research and development assets as part of the acquisition.  The following table summarizes the final allocation of the purchase price to the estimated fair value of the Fox River assets acquired and liabilities assumed at March 1, 2007:

In May 2007, the Company closed the former Fox River fine paper mill located in Housatonic, Massachusetts (the “Housatonic Mill”). In September 2007, the Company ceased manufacturing operations at the former Fox River fine paper mill located in Urbana, Ohio (the “Urbana Mill”). Converting operations at the Urbana Mill were phased out during the first quarter of 2008. The Company also closed a Fox River converting and distribution center located in Appleton, Wisconsin during the second quarter of 2008. The closures of the Housatonic Mill and the Urbana Mill allowed the Company to maximize cost efficiencies by shifting fine paper manufacturing to utilize available capacity at its other fine paper mills.

Following the closures, the Company began a process to sell the surplus equipment and facilities. For the three and nine months ended September 30, 2008, the Company recognized a gain of approximately $3.6 million and $6.6 million, respectively, from the sale of the Fox River converting and distribution center, land and buildings at the Urbana Mill and the Housatonic Mill and all related equipment.  For the three and nine months ended September 30, 2008, proceeds from such asset sales were $10.4 million and $13.6 million, respectively. Assets held for sale are valued at the lower of cost (which was fair value at acquisition for the Fox River assets) or fair value less cost to sell.  As of September 30, 2008, the Company had disposed of substantially all of the Fox River assets held for sale.  As of December 31, 2007, only the Housatonic Mill ($2.2 million) was recorded as assets held for sale and reported on the condensed consolidated balance sheet as prepaid and other current assets.

As of September 30, 2008, the Company had also substantially completed the process of terminating certain Fox River sales and administrative employees whose jobs were eliminated as the acquired Fox River business was integrated with the Company’s existing fine paper business. Severance benefits were paid to approximately 320 former hourly and salaried employees at the Housatonic Mill and the Urbana Mill, and Fox River sales and administrative employees in conjunction with the previously described closure and integration activities.  All the previously described integration activities were components of the Company’s plan to exit certain activities of the acquired Fox River business and were accounted for in accordance with Emerging Issues Task Force Issue 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination (“EITF 95-3”).

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The liabilities in the preceding table include approximately $12.5 million for the cost of post-acquisition exit activities that the Company recognized in accordance with EITF 95-3. As of September 30, 2008, approximately $5.4 million in severance benefits had been paid to former Fox River employees.  The severance benefits for former Fox River employees include benefits that will be paid over a period of 18 to 36 months from the date of acquisition pursuant to the terms of employment agreements with certain former Fox River executives. As of September 30, 2008, approximately $1.5 million had been paid under such agreements and approximately $0.8 million remained to be paid. As of September 30, 2008, the payment of all other severance benefits had been substantially completed. The following table presents the status of post-acquisition restructuring liabilities as of and for the nine months ended September 30, 2008:

Note 5.  Discontinued Operations

Sale of the Pictou Mill and the Woodlands

In February 2008, the Company committed to a plan to sell the Pictou Mill and the Woodlands.  In June 2008, Neenah Canada completed the sale of the Pictou Mill to Northern Pulp, a new operating company jointly owned by Atlas Holdings LLC and Blue Wolf Capital Management LLC.  In connection with the transfer of the Pictou Mill, Neenah Canada made payments of approximately $10.3 million to Northern Pulp. In addition, the Company incurred transaction costs of approximately $3.3 million. Pursuant to the terms of the transaction, Northern Pulp assumed all of the assets and liabilities associated with the Pictou Mill, as well as existing customer contracts, supply agreements (including the Pulp Supply Agreement, as defined below, with Kimberly-Clark), labor agreements and pension obligations. The sale did not include the Woodlands.

In conjunction with the sale of the Pictou Mill, the Company entered into a stumpage agreement (the “Stumpage Agreement”) which allows Northern Pulp to harvest an average of approximately 400,000 metric tons of softwood timber annually from the Woodlands. The Stumpage Agreement is for a term of ten years and Northern Pulp has the option to extend the agreement for an additional three years.  For calendar year 2008, Northern Pulp will pay a nominal amount for approximately 236,000 metric tons of softwood timber harvested under the Stumpage Agreement.  As a result, the Company recorded $2.8 million in deferred revenue for the estimated fair value of the timber to be harvested by Northern Pulp in calendar 2008.  The loss on transfer of the Pictou Mill was increased by an amount equal to such deferred revenue.  For the three and nine months ended September 30, 2008, the Company recognized approximately $2.0 million of such deferred revenue. For timber purchases during calendar year 2009, Northern Pulp has agreed to pay the then current stumpage rate charged by the Nova Scotia provincial government for harvesting on government licensed lands. The price paid for timber purchases during the remainder of the Stumpage Agreement will be based on an agreed upon index.   The Company believes the Stumpage Agreement prices for calendar year 2009 and beyond represent market rates.  Northern Pulp has agreed to pay all costs associated with maintaining the Woodlands and harvesting the timber.  An agreement to sell the Woodlands will require the buyer to assume the Stumpage Agreement.

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During the first quarter of 2008, the Company determined that the estimated value it would receive from a sale of the Pictou Mill indicated that it would not recover the carrying value of the mill’s long-lived assets. As a result, for the nine months ended September 30, 2008, the Company recognized non-cash, pre-tax impairment charges of $91.2 million to write-off the carrying value of the Pictou Mill’s long-lived assets. In addition, for the nine months ended September 30, 2008, the Company recorded a pre-tax loss of $29.3 million to recognize the loss on disposal of the Pictou Mill.

In conjunction with the sale of the Pictou Mill, Northern Pulp assumed responsibility for all pension and other post-employment benefit obligations for active and retired employees of the mill. The Company accounted for the transfer of these liabilities as a settlement of post-employment benefit obligations pursuant to Statement of Financial Accounting Standards No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits.” For the nine months ended September 30, 2008, the Company recognized a non-cash, pre-tax settlement loss of $53.7 million due to the reclassification of deferred pension and other post-employment benefit adjustments related to the transfer of the Nova Scotia Plan to Northern Pulp from accumulated other comprehensive income to loss from discontinued operations in the condensed consolidated statement of operations.

Management believes that it is probable that the sale of the Woodlands will be completed within 12 months.  As of September 30, 2008, the assets and liabilities of the Woodlands are reported as assets held for sale—discontinued operations and liabilities related to discontinued operations, respectively, on the condensed consolidated balance sheet. For the three and nine months ended September 30, 2008, the results of operations of the Pictou Mill and the Woodlands and the loss on disposal of the Pictou Mill are reported as discontinued operations in the condensed consolidated statements of operations. The consolidated results of operations for all prior periods have been restated to reflect the results of operations of the Pictou Mill and the Woodlands as discontinued operations. Assets held for sale are valued at the lower of cost or fair value less cost to sell. As of September 30, 2008, the assets of the Woodlands are reported at their historic book cost of $3.8 million.

Transfer of Terrace Bay

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. As a closing condition of the agreement to transfer Terrace Bay to Buchanan, Neenah Canada initiated plans to curtail and settle its Ontario, Canada defined benefit pension plan (the “Ontario Plan”). In December 2007, the Ontario Plan was terminated and all outstanding pension obligations for active employees were settled through the purchase of annuity contracts or lump-sum payments pursuant to participant elections.

At closing, Neenah Canada retained pension and long-term disability obligations for current and former mill employees and post-employment medical and life insurance obligations for current retirees. During the first quarter of 2008, Neenah Canada paid approximately $5.0 million to settle litigation related to the reduction and/or elimination of certain retiree benefits following Neenah Canada’s transfer of Terrace Bay to Buchanan.  In conjunction with the settlement, Neenah Canada agreed to continue certain retiree life insurance benefits at a reduced rate in the future.  As a result of the settlement, for the nine months ended September 30, 2008, Neenah Canada recorded a curtailment gain of approximately $4.3 million which is recorded in other income-net on the condensed consolidated statement of operations.

In conjunction with the transfer of Terrace Bay, 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 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 was equal to the price paid by Kimberly-Clark pursuant to the Pulp Supply Agreement. TBPI 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 TBPI’s failure to so perform.

For the three and nine months ended September 30, 2008 and 2007, the Company did not recognize revenue or cost in its condensed consolidated statement of operations for pulp manufactured by TBPI 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 purchases in approximately 45 days from receipt of the product.  As of September 30, 2008, there were no amounts receivable from Kimberly-Clark or payable to TBPI on the condensed consolidated balance sheet pursuant to the Pulp Manufacturing Agreement.  As of December 31, 2007, the Company had a receivable from Kimberly-Clark for $17.7 million recorded in accounts receivable, net, $1.7 million of cash received from Kimberly-Clark that had not been remitted to Buchanan recorded in cash and cash equivalents and a $19.4 million payable to TBPI recorded in accounts payable on the condensed consolidated balance sheet.

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In June 2007, the Company notified Kimberly-Clark of its intention to terminate its obligation to supply pulp from Terrace Bay under the Pulp Supply Agreement effective June 2008.  The Pulp Manufacturing Agreement was terminated contemporaneously with the Terrace Bay portion of the Pulp Supply Agreement in June 2008.

The results of operations of the Pictou Mill, the Woodlands and Terrace Bay and the loss on sale of the Pictou Mill are reported as discontinued operations in the condensed consolidated statements of operations for each period presented. The following table summarizes the results of discontinued operations:

(a)        Represent net sales of the Pictou Mill and the Woodlands only.

(b)        For the nine months ended September 30, 2008, the loss from operations includes non-cash, pre-tax impairment charges of $91.2 million to write-off the carrying value of the Pictou Mill’s long-lived assets.

The following table summarizes assets held for sale and liabilities related to discontinued operations:

As of September 30, 2008, the deferred tax consequences related to the Woodlands are reported as current deferred income taxes on the condensed consolidated balance sheet to conform to the classification of the assets and liabilities of discontinued operations as current assets and liabilities. In general, such amounts were classified as noncurrent deferred income taxes as of December 31, 2007.

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Sale of Woodlands in 2006

In June 2006, Neenah Canada sold approximately 500,000 acres of woodlands in Nova Scotia to Atlantic Star Forestry LTD and Nova Star Forestry LTD (collectively, the “Purchaser”) for proceeds of $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 Mill. Following the sale, Neenah Canada had approximately 500,000 acres of owned and 200,000 acres of licensed or managed woodlands in Nova Scotia, Canada. Neenah Canada transferred the FSA to Northern Pulp in conjunction with the sale of the Pictou Mill. Neenah Canada’s rights to harvest timber on the 200,000 acres of licensed or managed lands in Nova Scotia were also transferred to Northern Pulp as part of the sale.

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”).  Neenah Canada’s commitment to accept acreage offered by the Purchaser to satisfy the timber requirements for the first 18 months of the FSA represented a “constructive obligation.”  As a result, Neenah Canada deferred approximately $9.1 million of the gain on sale, which represented Neenah Canada’s estimated maximum exposure to loss of profit due to the constructive obligation under the FSA. For the three and nine months ended September 30, 2007, Neenah Canada recognized approximately $1.6 million and $4.5 million, respectively, of such deferred gain.  As of December 31, 2007, the deferred gain related to the constructive obligation was fully amortized and no amounts of such deferred gain were recognized for the three and nine months ended September 30, 2008.

Note 6. Other Income - Net

The following table presents the components of “Other income – net” on the condensed consolidated statement of operations:

Note 7. Risk Management

The Company is exposed to risks such as changes in foreign currency exchange rates and pulp prices. The Company has, from time-to-time, employed a variety of practices to manage these risks, including operating and financing activities and, where deemed appropriate, the use of derivative instruments. The Company has used derivative instruments only for risk management purposes and not for speculation or trading. All foreign currency derivative instruments were either exchange traded or entered into with major financial institutions. The notional amounts of the Company’s derivative instruments did not represent amounts exchanged by the parties and, as such, were not a measure of exposure to credit loss. The amounts exchanged were 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 recorded 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 were 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 were recorded in accumulated other comprehensive income (loss) in the period that changes in fair value occurred and were reclassified to income in the same period that the hedged item affected income. As of September 30, 2008, the Company does not have any outstanding derivative instruments.

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Pulp Price and Foreign Currency Risk

The operating results, cash flows and financial condition of the Company are subject to pulp price risk. The profitability of the Company’s pulp operations was subject to foreign currency risk because the price of pulp is established in U.S. dollars and the Company’s cost of producing pulp was incurred principally in Canadian dollars. Prior to the sale of the Pictou Mill, the Company used foreign currency forward contracts to manage its foreign currency risks. In addition, the Company used pulp futures contracts to manage its pulp price risks. The use of these instruments allowed management of this transactional exposure to exchange rate and pulp price fluctuations because the gains or losses incurred on the derivative instruments were 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. The Company’s reported operating results are also affected by changes in the Euro exchange rate relative to the U.S. dollar.  The Company’s exposure to such currency translation risk is not hedged.

Cash Flow Hedges

As of September 30, 2008, the Company had no outstanding foreign currency forward exchange contracts. As of December 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 $3.4 million Canadian dollars. The fair value of the contracts was a current asset of $0.5 million U.S. dollars. For the nine months ended September 30, 2008 and for the three and nine months ended September 30, 2007, all realized gains and losses on foreign currency forward exchange contracts were related to the operations of the Pictou Mill and were recorded in loss from discontinued operations on the condensed consolidated statements of operations. As of September 30, 2008 and December 31, 2007, the Company had no outstanding pulp future contracts.

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.

The following table presents gains (losses) from the Company’s risk management activities:

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Note 8. Inventories

The following presents inventories by major class:

The FIFO values of total inventories valued on the LIFO method were $77.9 million and $75.3 million at September 30, 2008 and December 31, 2007, respectively.

Note 9. Debt

Long-term debt consisted of the following:

Principal Payments

The following table presents the Company’s required debt payments by respective calendar year:

(a)        Represents required debt payments for the period October 1, 2008 through December 31, 2008.

(b)        Includes principal payments on the Company’s revolving bank credit facility and remaining outstanding term loan of $109.6 million and $2.2 million, respectively.

(c)         Includes principal payments on the Senior Notes of $225.0 million.

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.

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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 that provided for borrowings of up to $150 million. The Initial Credit Agreement was secured by substantially all of the Company’s assets, including the capital stock of its subsidiaries and was guaranteed by Neenah Canada. The Company has subsequently amended the Initial Credit Agreement primarily to (i) increase the secured revolving line of credit, (ii) extend the termination date of the Initial Credit Agreement, (iii) set the interest rate under the secured revolving line of credit to either (A) the Prime Rate (as defined in the amended credit agreement) plus a percentage, or (B) London Interbank Offered Rate Borrowings (“LIBOR”) plus a percentage, (iv) reduce the annual facility fee on the average daily unused amount of the commitment from 0.375 percent, and (iv) make other definitional, administrative and covenant modifications.

In May 2008, the Company entered into the Sixth Amendment to the Initial Credit Agreement (the “Sixth Amendment”). In the Sixth Amendment, the Lenders consented to consummation of the sale of the Pictou Mill. As of September 30, 2008, the Initial Credit Agreement (as amended the “Amended Credit Agreement”) provides for a secured revolving credit facility (the “Revolver”) to provide for borrowings of up to $210 million. The Company’s ability to borrow under the Revolver is limited to the lowest of (a) $210 million, (b) the Company’s borrowing base (as determined in accordance with the Amended Credit Agreement), and (c) the applicable cap on the amount of “credit facilities” under the indenture for the Senior Notes. The Amended Credit Agreement is currently scheduled to terminate on November 30, 2010.

As of September 30, 2008, the interest rate applicable to borrowings under the Revolver will be either (1) the Prime Rate plus a percentage ranging from 0 percent to 2.00 percent or (2) LIBOR plus a percentage ranging from 1.25 percent to 3.50 percent. Interest is 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 is subject to an annual facility fee of 0.25 percent on the average daily unused amount of the commitment.

The Amended Credit Agreement is secured by substantially all of the assets of the Company and the subsidiary borrowers, including the capital stock of such subsidiaries, and is guaranteed by Neenah Canada. Neenah Canada’s guarantee is secured by substantially all of that subsidiary’s assets.

In the Third Amendment to the Initial Credit Agreement, the lenders consented to 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 the obligations of the Company and its subsidiaries under the Amended Credit Agreement.

The weighted-average interest rate on outstanding Revolver borrowings as of September 30, 2008 and December 31, 2007 was 4.7 percent per annum and 6.4 percent per annum, respectively. Interest on amounts borrowed under the Revolver is paid monthly. 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 Amended Credit Agreement. Borrowing availability under the Revolver is reduced by outstanding letters of credit and reserves for certain other items as defined in the Amended Credit Agreement. Availability under the Amended Credit Agreement will fluctuate over time depending on the value of the Company’s inventory, receivables and various capital assets. As of September 30, 2008, the Company had approximately $1.6 million of letters of credit outstanding and $60.1 million of borrowing availability under the Revolver.

The Amended 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 Amended Credit Agreement, cross-defaults to other indebtedness, bankruptcy, insolvency, various ERISA violations, the incurrence of material judgments and changes in control. As of September 30, 2008, no events of default had occurred.

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Term Loan

In March 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 up to $25 million (the “Term Loan”). The weighted-average interest rate on outstanding Term Loan borrowings as of September 30, 2008 and December 31, 2007, was 4.0 percent per annum and 6.7 percent per annum, respectively. Borrowings under the Term Loan are being repaid in equal quarterly installments which began in November 2007.  Term Loan borrowings were used to repay outstanding Revolver borrowings. 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.  During the three and nine months ended September 30, 2008, the Company prepaid approximately $6.3 million and $9.5 million, respectively, in Term Loan borrowings.  In June 2008, the Company entered into the First Amendment (the “First Amendment”) to the Term Loan.  The First Amendment reduced required amortization payments to $1.25 million per quarter.  Any remaining amounts outstanding under the Term Loan are due and payable upon termination of the Term Loan Agreement, currently scheduled to occur in November 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 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. 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) may not be partially repaid such that less than $3.0 million of LIBOR Borrowings are outstanding.

Other Financing

In December 2006, Neenah Germany entered into an agreement with HypoVereinsbank and IKB Deutsche Industriebank AG (the “Lenders”) to provide €10.0 million of project financing for the construction of a saturator and the financing matures in December 2016.  Principal outstanding under the agreement may be repaid at any time without penalty.  Interest on amounts outstanding is based on actual days elapsed in a 360-day year and is payable semi-annually. As of September 30, 2008, €10.0 million ($14.2 million, based on exchange rates at September 30, 2008) was outstanding under this agreement.

Neenah Germany has an unsecured revolving line of credit (the “Line of Credit”) with HypoVereinsbank that provides for borrowings of up to 15 million Euros for general corporate purposes.  The Line of Credit matures on November 30, 2008.  Neenah Germany has the ability to borrow in either Euros or U.S. dollars.  Interest is computed on U.S. dollars loans at the rate of 8.5 percent per annum and 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. The weighted-average interest rate on outstanding Line of Credit borrowings as of September 30, 2008 and December 31, 2007 was 6.4 percent and 6.5 percent per annum, respectively.  As of September 30, 2008, €11.8 million ($16.7 million, based on exchange rates at September 30, 2008) was outstanding under the Line of Credit.

Note 10.  Pension and Other Post-employment Benefits

Pension Plans

Substantially all active employees of the Company’s U.S. paper operations and its former Canadian pulp operations participate in defined benefit pension plans and/or defined contribution retirement plans. Neenah Germany has defined benefit plans designed to provide a monthly pension upon retirement for all its employees in Germany. There is no legal or governmental obligation to fund Neenah Germany’s benefit plans and as such the plans are currently unfunded.

In June 2008, in conjunction with the sale of the Pictou Mill, Northern Pulp assumed responsibility for the Nova Scotia Plan and all other post-employment benefit obligations for active and retired employees of the Pictou Mill.  See Note 5, “Discontinued Operations.”

In December 2007, the Company terminated the Ontario Plan and all outstanding pension obligations for active employees were settled through the purchase of annuity contracts or lump-sum payments pursuant to participant elections.  See Note 5, “Discontinued Operations.”

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In November 2007, the Company amended the Fox River defined benefit pension plan to freeze the vested pension benefit for salaried employees born after December 31, 1957.  The affected employees were transferred to the Company’s defined contribution retirement plan. The pension benefit for salaried employees of Fox River born on or before December 31, 1957 was unaffected.

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

Components of Net Periodic Benefit Cost

(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)        As a closing condition of the agreement to the transfer Terrace Bay to Buchanan, 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.

(d)        Pension and other post-employment benefit costs for the Pictou Mill and the Woodlands are reported as results of discontinued operations on the condensed consolidated statements of operations

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The Company expects to make pension contributions of approximately $9 million in 2008. For the nine months ended September 30, 2008, the Company made pension contributions of approximately $6.5 million, including approximately $2.4 million related to the Pictou Mill and the Woodlands.  The Company will not make any future pension contributions for the Pictou Mill and the Woodlands. In addition, Neenah Germany expects to pay approximately $1.7 million (based on exchange rates at September 30, 2008) for pension benefits in 2008. Neenah Germany made approximately $1.2 million of such pension benefit payments during the nine months ended September 30, 2008.

Note 11.  Stock Compensation Plan

The Company established the 2004 Omnibus Stock and Incentive Plan (the “Omnibus Plan”) in December 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 September 30, 2008, approximately 1,520,000 shares of Common Stock were reserved for future issuance under the Omnibus Plan.  The Company accounts for stock-based compensation pursuant to the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”).

Valuation and Expense Information

Substantially all stock-based compensation expense is recorded in selling, general and administrative expenses on the condensed consolidated statements of operations.  The following table summarizes stock-based compensation expense and related income tax benefits for the three and nine months ended September 30, 2008 and 2007.

The following table summarizes total compensation costs related to the Company’s equity awards and amounts recognized in the nine months ended September 30, 2008.