QUAKER FABRIC CORP /DE/ - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

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

FOR THE FISCAL YEAR ENDED JANUARY 3, 2004

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
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QUAKER FABRIC CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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DELAWARE 04-1933106
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

941 GRINNELL STREET
FALL RIVER, MASSACHUSETTS 02721
(ADDRESS PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (508) 678-1951

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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock, par value $.01
(TITLE OF CLASS)

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, and (2) has been subject to such filing
requirements for the past 90 days. Yes: X No:
--- ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
---

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes: X No:
--- ---

The aggregate market value of the Registrant's voting stock held by
non-affiliates of the Registrant, computed by reference to the closing sales
price as quoted on NASDAQ on July 3, 2003 was approximately $106.1 million.

As of March 10, 2004, 16,813,368 shares of Registrant's common stock, par
value $0.01 per share, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

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QUAKER FABRIC CORPORATION AND SUBSIDIARIES
FINANCIAL HIGHLIGHTS
(IN THOUSANDS, EXCEPT PER SHARE AND PER YARD AMOUNTS)

i

TO OUR SHAREHOLDERS

During 2003, our overall performance was solid, particularly when viewed
against the backdrop of last year's very challenging macroeconomic and
geopolitical environment, and a number of important investments for the future
were put in place. Net sales for the 52-week fiscal year ended January 3, 2004
were $325.3 million, with net income of $7.9 million and diluted earnings per
share of $0.47; compared to net sales of $365.4 million, net income of $11.6
million and diluted earnings per share of $0.69 for the 53-week fiscal year
ended January 4, 2003. A refund related to the favorable resolution of a foreign
tariff dispute added $1.4 million of non-recurring income to the company's
fiscal 2003 pre-tax income, increasing fully diluted EPS for the year by 5
cents.

Quaker's 2003 results, particularly during the fourth quarter, reflect both
improved operational performance and the positive effect of the strategic and
operating initiatives we have been pursuing. Our gross margin performance for
the fourth quarter and the year demonstrated considerable strength, despite
lower revenues, largely as a result of an increase in our operating
efficiencies, careful management of our raw material and other costs and our
continued focus on the fundamentals of our business. Our operating margin,
however, was down 130 basis points for the year, primarily because of the
ongoing costs associated with the strategic investments we have made over the
past few years to build increased capability in the areas of research and
development, product styling and design, market development, information
technology, supply chain management and the training and development of our
workforce -- all of which are intended to build our competitive strength for the
future.

Our commitment to innovation, technology and new product development allowed
Quaker to introduce a number of new fabric products with margins consistent with
our profitability objectives -- including our newest product entries in the
sueded, laminated, washed, microdenier and high-definition design product
categories. We are particularly pleased by the market's reaction to our newest
collections of sueded fabrics, which we believe provide our customers with a
superior product that they can use to ensure that their own product offerings
bring something distinctly different to the market. It is also important to note
that the development and introduction of these very same products provides us
with the vehicle we needed to compete head-on with less expensive imported
goods.

In addition, during 2003, we reduced inventory, paid our first-ever
dividends, improved our cash flows, and paid down debt -- ending the year with a
net debt to total capitalization ratio of 18.9%, versus 28.7%at the end of 2002.
As a result, we further strengthened our balance sheet, positioning us to
continue responding quickly to new challenges and opportunities as they arise.
The company's financial strength also led to a 20%increase in our dividend for
the fourth quarter.

Looking ahead, we will be continuing to focus on the fundamental elements of
our core business strategy -- providing our customers with the most outstanding
combination of products and service available today -- and we are very focused
on rebuilding volume. Quaker continues to offer the industry's best and most
innovative products, and we believe that core strength gives us the necessary
platform to increase our sales as market conditions improve. We are anticipating
excellent placements at this year's April High Point Furniture Market and our
newest product line, which we expect to be well-represented in High Point, has
already met with an enthusiastic reception at all of the other important
industry trade shows that have taken place so far this year, including the
Showtime Fabric Fair in High Point and the San Francisco Furniture Market in
January, and key international trade shows in Frankfurt and Toronto.

Quaker also remains committed to the export market. While export sales for
both the fourth quarter and last year as a whole were down, we are optimistic
for a rebound during 2004 as a result of a number of strategic moves we made
during the latter part of 2003 and earlier this year. These moves included the
opening of a new sales office and fabric showroom in Germany to capitalize on
the potential of the European market and complement the work already being done
there out of our U.K. sales office, the opening of a sales office in Singapore
and the hiring of an experienced international sales agent to represent us in
South Africa.

We continued to strengthen our presence in the contract market during
2003 -- with key progress made, from both a product development and distribution
standpoint -- and we feel that we have the

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pieces in place to allow that process to maintain its momentum and to fully
establish Quaker as a key player in that arena.

With respect to our yarn sales business, we have worked hard during the past
year to find new markets for our yarn products and strategically reposition that
segment of our business. As a result of this effort, our fourth quarter yarn
sales demonstrated considerable strength, with sales for the quarter of $3.1
million up 11.6%versus the fourth quarter of 2002. And we expect to benefit
further from our strategic repositioning of this aspect of our business during
the balance of this year.

Our efforts to continue improving our cost structure will also remain a
priority, as will the work we are doing to further improve efficiencies
throughout our manufacturing operations -- all without undermining our
commitments to superior product design, innovation and customer service or
compromising the returns anticipated from the targeted strategic investments we
have made in the development of those competencies over the last few years.

We believe that the investments we have made over the last few years have
positioned Quaker well to continue to be a formidable competitor -- in both the
domestic and international markets -- and to deliver solid returns to our
shareholders over time. In fact, that is our commitment and the essence of our
corporate mission and identity.

We appreciate your interest in the company and your continued support.

Sincerely,

Larry A. Liebenow Sangwoo Ahn

Larry A. Liebenow Sangwoo Ahn
President and Chief Executive Officer Chairman of the Board

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PART I

ITEM 1. BUSINESS

OVERVIEW

Quaker Fabric Corporation ('Quaker' or the 'Company') is a leading designer,
manufacturer and worldwide marketer of woven upholstery fabrics primarily for
residential furniture and one of the largest producers of Jacquard upholstery
fabrics in the world. The Company is also a leading developer and manufacturer
of specialty yarns, including a variety of chenille, taslan and spun products,
which Quaker both sells and uses in the production of its fabrics. The Company's
vertically integrated operations provide Quaker with important design, cost and
delivery advantages. The Company's product line is one of the most comprehensive
in the industry and Quaker is well known for its broad range of Jacquard
fabrics, including its soft, velvet-like Jacquard chenilles. The Company's
revenues in 2003 were $325.3 million.

Quaker has been producing upholstery fabric for over fifty-eight years and
is a full-service supplier of Jacquard and plain woven upholstery fabric to the
furniture industry. Quaker's current product line consists of over 5,000
traditional, contemporary, transitional and country fabric patterns intended to
meet the styling and design, color, texture, quality and pricing requirements of
promotional through middle to higher-end furniture manufacturers. Additionally,
the Company introduces over 1,000 new products to the market annually.
Management believes that Jacquard fabrics, with their detailed designs, provide
furniture manufacturers with more product differentiation opportunities than any
other fabric construction on the market.

The Company sells its upholstery fabrics to over 3,000 furniture
manufacturers worldwide, including virtually every significant domestic
manufacturer of upholstered furniture. Quaker also distributes its fabrics
internationally. In 2003, fabric sales outside the United States of $40.6
million represented approximately 12.8%of gross fabric sales.

Quaker uses three tradenames in the marketing of its fabrics -- Whitaker'r',
Quaker'TM' and Davol'TM'. Quaker's Whitaker'r' Collection, a branded line of a
select group of the Company's better-end products, is intended to meet the
design and construction requirements of higher-end furniture manufacturers and
jobbers. In 2001, the Company began marketing certain fabrics intended to meet
the design, construction and pricing needs of its promotional-end customers
under the Company's Davol'TM' brand name. The balance of the Company's fabrics
carry the Quaker'TM' name -- and while there is some price point overlap at the
extreme ends of the Quaker line, most of the fabrics marketed under the Quaker
umbrella are intended to meet the product needs of the Company's high-volume,
middle to higher-end furniture manufacturing customers.

Management estimates that approximately 65% of the Company's fabric sales
are manufactured to customer order.

During the past five years, Quaker has invested $80.6 million in new
manufacturing equipment to expand its yarn and fabric production capacity,
increase productivity, and improve product quality. During 2004, Quaker plans to
spend approximately $14.8 million for new projects consisting principally of new
manufacturing equipment to further its marketing, productivity, quality, service
and financial objectives, and for IT programs.

The Company produces its yarn and fabric products in its ten manufacturing
plants in the greater Fall River, Massachusetts area, where Quaker has nearly
2.0 million square feet of manufacturing and warehousing space. Quaker also
leases warehouse space in Brockton, Massachusetts. In addition to distribution
from the Company's facilities in Fall River, Quaker maintains domestic
distribution centers in High Point, North Carolina, Verona, Mississippi, and
City of Industry, California. To provide better service to its international
customers, the Company also has a distribution center in Mexico and uses a
third-party distribution company to provide warehousing services in Brazil.

The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q,
and all amendments to those reports will be made available free of charge
through the Investor Relations section of the Company's Internet website
(http://www.quakerfabric.com) as soon as practicable after such material is
electronically filed with, or furnished to, the Securities and Exchange
Commission.

1

THE INDUSTRY

Total domestic upholstery fabric sales, exclusive of automotive
applications, are estimated to be in excess of $2.5 billion annually. Management
estimates international fabric sales to be at least twice those of the domestic
market. Due to the capital intensive nature of the fabric manufacturing process
and the importance of economies of scale in the industry, the top 14 upholstery
fabric manufacturers, including Quaker, account for over 80%of the total
domestic sales. Management believes that Quaker is currently the only large U.S.
fabric producer that is continuing to demonstrate its long-term commitment to
the international market by focusing on expanding its export sales.

Within the Jacquard segment, price is a more important competitive factor in
the sale of promotional products than it is in middle to better-end lines, where
fabric styling and design considerations typically play a more important role.

Demand for upholstery fabric is a function of demand for upholstered
furniture. The upholstered furniture market grew from $5.4 billion in 1991 to an
estimated $10.9 billion in 2003. Total upholstered furniture demand is cyclical
and is affected by population growth and demographics, new household formations,
consumer confidence, disposable income, geographic mobility, housing starts, and
home sales.

The upholstery fabric covering a sofa, chair, or other piece of furniture is
one of the most significant factors influencing a furniture buyer's selection.
Purchase decisions are based primarily on the consumer's evaluation of
aesthetics, comfort, durability, quality and price. As a result, the fabric
decisions a furniture manufacturer makes play a critical role in its ability to
gain a product differentiation advantage at the retail level.

Management believes the long-term outlook for the Company's upholstery
fabric sales will be influenced by the following factors:

(i) The furniture industry has been consolidating at both the retail and
manufacturing levels for several years. As a result, fabric suppliers
are required to deal with larger customers that require a broader
range of product choices, shorter delivery lead times,
customer-specific inventory management programs, and additional
information technology-based support services.

(ii) The United States has shifted toward a more casual lifestyle, as
evidenced by product shifts in the apparel and home furnishings
industries. Management believes this has resulted in growing demand
for less formal furniture upholstered with softer, more comfortable
fabric.

(iii) Consumer tastes in upholstered furniture coverings change as new
trends and styles emerge. Leather as a furniture covering has
increased in popularity in recent years, resulting in a reduction in
overall sales of woven upholstery fabric.

(iv) Pushed by consumers demanding immediate product delivery, the
furniture industry has increased its focus on just-in-time
manufacturing methods and shorter delivery lead times.

(v) Advances in the use and application of information technology
throughout the industry supply chain can be anticipated to allow
furniture industry manufacturers, suppliers and customers to share
information more quickly and more effectively, resulting in reduced
cycle times and greater transparency for end consumers who will be
able to determine the status of their orders at each stage of the
manufacturing process. Significant advances in the use of information
technology in the sales and marketing function are also anticipated.

(vi) Both consumers and furniture manufacturers have placed increased
emphasis on product quality, enabling fabric manufacturers with
effective quality control systems to gain a competitive advantage.

(vii) While demand levels over the near term may be adversely affected by
weakness in both the domestic and global economies, a move by the
baby boom generation toward more upscale furniture as they approach
retirement age and additional demand generated by that same group's
purchases of vacation and retirement homes can be expected to provide
favorable longer term demand trends.

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(viii) While at one time most of the largest U.S. fabric producers had
leveraged their size and broad product lines to expand their export
sales, management believes that Quaker alone continues to focus on
international sales as a major strategic initiative.

(ix) In recent years, the lines between the furniture industry's
manufacturers and retailers has begun to blur, with several of the
nation's larger furniture manufacturers opening retail outlets of
their own.

(x) Fabrics entering the United States from China and other low labor cost
countries are resulting in increased price competition in the
promotional and middle ranges of the upholstery fabric and upholstered
furniture markets. In addition, competition in the U.S. domestic market
is likely to further intensify following the January 1, 2005 expiration
of the quotas imposed under the Uruguay Round Agreement on Textiles and
Clothing on textile and apparel products coming into the U.S.

STRATEGY

Quaker's strategy to further its growth and financial performance objectives
includes:

Taking Domestic Market Share. The Company has positioned itself as a
full-service supplier of Jacquard and plain woven fabrics to the promotional
and middle to better end of the market by offering a wide variety of fabric
patterns at prices ranging from $2.40 to $35.00 per yard and by emphasizing
superior customer service.

Expanding International Sales. The Company has made worldwide
distribution of its upholstery fabrics a key component of its strategy.
Quaker has built an international sales and distribution network, dedicated
significant corporate resources to the development of fabrics to meet the
specific styling and design needs of its international customers, and put
programs in place to simplify the purchase of product from Quaker, including
the operation of a distribution facility in Mexico, and the utilization of
the services of a third party distribution company in Brazil. The Company's
international gross sales were $40.6 million in 2003.

Penetrating Related Fabric Segments. Management believes the Company's
styling and design expertise, as well as its ISO 9001-certified operations,
provide opportunities to penetrate the contract and decorative
top-of-the-bed segments, as well as increase Quaker's share of the interior
decorator and recreational vehicle segments. Management believes Quaker's
Ankyra'TM' chenille yarns and fabric finishing abilities will provide the
Company with a product advantage in these segments. As part of these
efforts, during 2002 the Company purchased 24 'double-wide' looms to support
its entry into these segments. During 2003, the Company entered into a
non-exclusive licensing agreement with Hi-Tex, Inc. for the use of its
patented Crypton'r' finish for certain of the Company's contract fabrics.

Maintaining Specialty Yarn Sales. Quaker is a leading producer of
specialty yarns, including chenille, taslan, and spun products.
Approximately 90%of the chenille yarn manufactured by the Company is used in
the production of the Company's fabric. The balance is sold to craft yarn
distributors, upholstery weavers and home fashion accessories firms through
Quaker's yarn sales division, Nortex Yarns. Gross sales of the Company's
specialty yarns were $10.8 million in 2003. The Company's current line of
specialty yarns includes over 50 different varieties of spun and chenille
yarns, and Quaker's yarn design and development staff regularly creates
innovative new specialty yarns for use in the Company's fabrics and sale to
the Company's yarn customers.

Pursuing Strategic Acquisition Opportunities. Although all of Quaker's
growth to date has been the result of internal initiatives, the Company has
evaluated a number of acquisition candidates in the past and plans to pursue
appropriate acquisition opportunities in the future. An ideal acquisition
candidate would either support the Company's new market development
objectives; enhance its international position; permit additional
investments in marketing, new product research and development, design,
information technology and manufacturing; improve Quaker's financial
performance by increasing efficiency and absorption of overhead; or offer a
unique and complementary product, manufacturing or technical capability.

3

COMPETITIVE STRENGTHS

Management believes that the following competitive strengths distinguish
Quaker from its competitors and that these strengths serve as a solid foundation
for the Company's long-term growth strategy:

Product Design, Development and Technological Innovation Capabilities.
Management believes that Quaker's reputation for design excellence, product
leadership and technological development is, and will continue to be, the
Company's most important competitive strength.

Financial Strength. With a strong financial position, including a low
debt to total capital ratio, the Company has the ability to support research
and development and targeted capital investment initiatives, and to continue
responding quickly to new opportunities and challenges as they arise.

Commitment to Customer Service. The Company is committed to offering its
customers the best overall service levels in the industry. Management
believes Quaker's current delivery lead times continue to be among the best
in the industry.

Broad Product Offering. The breadth and depth of Quaker's product line
enables the Company to be a full-service supplier of Jacquard and plain
woven fabrics to virtually every significant domestic manufacturer of
upholstered furniture.

Technological Expertise. Quaker is driven by innovation and is committed
to exploring the development and use of new technology to meet its product
development, customer service, operating and financial objectives.

State-of-the-Art Manufacturing Equipment. Management believes the
Company has one of the most modern, efficient and technologically advanced
manufacturing bases in the industry.

Focus on Jacquard Fabrics. Management believes the detailed, copyrighted
designs of the Company's Jacquard fabrics have enabled it to compete
primarily on the basis of superior styling and design, rather than price.

Vertical Integration. Using Quaker's own specialty yarns in the
production of its fabrics provides the Company with significant design, cost
and delivery advantages.

PRODUCTS

The Company offers a broad assortment of contemporary, traditional,
transitional and country fabrics to manufacturers of both promotional-end and
middle to better-end furniture at prices ranging from $2.40 to $35.00 per yard.
While most of the Company's fabrics have historically been sold under the Quaker
label, the Company began marketing a select group of its middle to better-end
fabrics under its Whitaker'r' label in October 1996. During 2001, the Company
began marketing certain of its fabrics to its promotional-end customers under
its Davol'TM' brand name. In 2003, the Company's promotional-end fabric line and
its middle to better-end fabric line had average gross sales prices of $4.08 per
yard and $6.63 per yard, respectively, compared to $4.00 and $6.43,
respectively, in 2002. The weighted average gross sales price per yard of the
Company's fabrics was $5.66 in 2003, compared to $5.57 in 2002.

Quaker's product line is focused on fabrics with woven designs referred to
in the industry as 'Jacquards,' because of the special Jacquard equipment, or
heads, required to produce them, and also includes a broad assortment of
striped, plaid, and plain fabrics. The vast majority of Quaker's looms are
equipped with Jacquard heads. The use of these heads makes it possible to vary
the pattern, color, and texture of both the filling and warp yarns in a fabric.
While fabrics manufactured on looms without Jacquard heads have a much more
limited range of possible designs, Quaker added thirty-six Dobby looms to its
manufacturing base during 2001 to reduce the cost of manufacturing certain
fabrics that do not require the use of Jacquard heads. During 2002, Quaker added
24 'double-wide' Jacquard looms to support the Company's entry into the
decorative home fashions segment.

Management believes that the Company's newest collections of sueded fabrics
provide Quaker's customers with a superior product that they can use to advance
their efforts to ensure that their own product offerings bring something
distinctive to the market. Management also believes that the

4

development and introduction of these products allows the Company to compete
head-on with less expensive imported goods.

Quaker's product offerings are noted for their use of chenille and other
specialty yarns, which give the fabric a soft, velvet-like appearance and feel.
To take advantage of the trend toward casually styled furniture, and to
capitalize on the growth of the motion furniture segment, Quaker developed a
soft chenille yarn with superior abrasion resistance to compete effectively with
flocks, velvets and tufted fabrics. The Company markets the line of chenille
fabrics it produces using these yarns under its Ankyra'TM' label. Through a
licensing agreement with Solutia (f/k/a Monsanto), a number of the Company's
Ankyra'TM'-based chenille fabrics, as well as certain other fabrics in its line,
have been 'Wear-Dated' by Solutia. Management anticipates that chenille will
remain an important element in the Company's fabric designs and that it will
continue to influence -- and be enhanced by -- Quaker's on-going development and
use of additional new specialty yarns and manufacturing techniques and
processes. In addition, the Company has recently developed a collection of spun
yarn products, including several distinctive boucles that Quaker's design staff
is using to further the Company's styling and design objectives.

Quaker's broad product line enhances the ability of the Company's customers
to meet most of their fabric needs through one full-service supplier while, at
the same time, allowing them to purchase fabrics in a wide enough range of
designs to enable them to differentiate their own new lines of upholstered
furniture from those of their competitors. To generate additional business from
manufacturers of higher-end upholstered furniture, the Company offers a select
group of its middle to better-end products under its Whitaker'r' label, and in
2001 the Company began marketing certain of its promotional-end products under
its Davol'TM' brand name. Gross sales of the Company's middle to better-end
fabrics were $231.1 million, or 72.7%of total gross fabric sales in 2003, with
approximately 42.1%of those sales made under the Whitaker'r' label.

NEW PRODUCT DEVELOPMENT AND DESIGN

Although management believes fashion trends in the upholstery industry do
not change significantly from year to year, consumer tastes in upholstery fabric
and other furniture coverings do change over time. Therefore, it is important to
identify emerging fashion needs and to develop new products responsive to those
needs. Management believes Quaker's design staff has an established reputation
for design excellence and product leadership.

The Company's design department has overall responsibility for the
development of new upholstery fabric patterns for sale by the Company. Although
the Company purchases artwork from independent artists, the Company's staff of
professional designers and designer technicians creates the majority of the
designs on which the Company's fabric patterns are based and also determines the
construction of those patterns. The design department uses state-of-the-art
Computer Aided Design ('CAD') equipment to reduce the length of the Company's
new product development cycle.

The development of each new fabric line requires six months. The first step
in the new product development process is the preparation of a merchandising
plan for the line. The Company's merchandising plans are based on extensive
input from Quaker's sales representatives, senior managers, and major customers
and provide both a broad outline of the number of new products to be included
within each major styling category (e.g., contemporary, traditional,
transitional, and country), as well as the number of new products to be created
for sale at each of the major price points within those styling categories.
Beginning in 2002, the Company enhanced its merchandising practices by including
a number of fabric collections reflecting a common theme in each new line.

In addition, because of the design, cost, and delivery advantages of
Quaker's vertically integrated manufacturing operations, substantial emphasis is
placed on making maximum use of the Company's internally produced yarns during
the fabric development process. In conjuction with development of each new
fabric merchandising plan, members of the Company's fabric design and yarn
development staffs meet to identify the design staff's yarn requirements for the
Company's next fabric line and many of Quaker's proprietary yarns trace their
origins to this design-driven process. Quaker's product development, engineering
and manufacturing staffs also play a key role in the new product development

5

process by reviewing proposed new product constructions to evaluate their impact
on the Company's raw material costs, equipment utilization rates and quality
performance. The Company's product development and engineering staffs also
design and develop new product attributes that add value to Quaker's products
from the consumer's perspective, and their efforts have lead to initiatives such
as the Company's entry into a non-exclusive agreement with Hi-Tex, Inc. for the
use of its patented Crypton'r' finish for certain of the Company's fabrics for
the contract segment.

Although a few plain, striped and plaid fabrics remain in the Company's
product line for ten years or more, a successful product typically has a life of
two to three years. Quaker's design staff also regularly creates custom patterns
for customers seeking to differentiate their products for distribution purposes,
hit a certain price point at the retail level, or meet a particular styling need
in the market they serve. These patterns, which are not part of Quaker's 'open
line,' are known in the industry as 'Specials.'

SALES AND MARKETING

UPHOLSTERY FABRICS

Net fabric sales during 2003 were $314.7 million, or approximately 96.7% of
the Company's net sales. The Company sells its upholstery fabrics to over 3,000
furniture manufacturers worldwide, including substantially all of the largest
domestic manufacturers of upholstered furniture. Fabric sales to the Company's
top 25 customers accounted for approximately 46% of 2003 net sales. None of the
Company's customers accounted for more than 7.9% of net sales during 2003.

The Company uses a direct marketing force of 25 sales representatives, five
of whom are based in Mexico, to market its fabrics in the United States, Canada
and Mexico. All such sales representatives are paid on a commission basis and
represent the Company exclusively. Quaker's fabrics are distributed
internationally through a network of eleven exclusive sales representatives,
working out of sales offices and showrooms in the United Kingdom, the United
Arab Emirates, India, Singapore, and Germany, and four exclusive sales agents in
Brazil, where Quaker maintains a showroom and sales office in Sao Paulo. In
addition, Quaker has appointed 10 independent commissioned sales agents to
represent the Company in the Far East, Australia, New Zealand, the Middle East,
Central and South America, Africa and Asia. All agents located outside the
United States are supervised by Quaker's Vice President -- Sales.

Quaker's United States customers market their products through two annual
national furniture industry trade shows held in April and October in High Point,
North Carolina, as well as through various regional shows. These shows provide
most of Quaker's customers with the opportunity to introduce their new furniture
lines to their major retail customers in a single setting. Quaker's design and
marketing process is closely linked to these trade shows. The Company develops
two major lines for introduction to the Company's customers at the Showtime
Fabric Fairs held in High Point in January and July of each year. Almost all
major U.S. furniture manufacturers attend Showtime to begin selecting fabric for
the new lines of sofas and other upholstered furniture products that they will
exhibit at the April and October High Point Furniture Markets.

Quaker also markets its fabrics at a number of trade shows regularly
attended by its export customers, including shows in Belgium, Dubai, Germany,
Italy, Brazil and Mexico, as well as certain trade shows in the United States
aimed at the international market. Foreign sales of fabric accounted for
approximately 12.8%of Quaker's gross fabric sales during 2003.

In addition to distribution from the Company's facilities in Fall River,
Massachusetts, Quaker maintains five distribution centers from which its
customers may take immediate delivery of selected products. These facilities are
located in City of Industry, California; Verona, Mississippi; High Point, North
Carolina; Sao Paulo, Brazil; and Mexico City, Mexico.

SPECIALTY YARNS

Net yarn sales during 2003 were $10.6 million, or approximately 3.3%of the
Company's net sales. The Company designs, manufactures and markets several types
of specialty yarns, including fancy spun, fancy twisted and chenille. Because of
their soft, velvet-like feel, chenille yarns, and fabrics made out of

6

chenille yarns, are responsive to consumer demand for softer, more casual home
furnishings and accessories. The Company's specialty yarns are sold under the
name of Nortex Yarns to craft yarn distributors and manufacturers of home
furnishings products, principally weavers of upholstery fabric, throws, afghans
and other products. The Company has approximately 45 yarn customers.

Management believes the technical expertise of Quaker's yarn development
staff provides the Company with an important competitive advantage by enabling
Quaker to create and market innovative specialty yarns to meet its customers'
styling and performance criteria. Historically, chenille yarns have had
difficulty meeting the durability standards required for use in fabrics which
are likely to be subjected to heavy wear. To address this problem, Quaker's yarn
development staff created a finished chenille yarn with superior abrasion
resistance, and in 1997 the United States Patent and Trademark Office issued a
patent to protect the Company's Ankyra'TM' process.

MANUFACTURING

The Company operates ten manufacturing facilities in the greater Fall River,
Massachusetts area, and management estimates that approximately 65%of the
Company's fabric sales are manufactured to customer order. Management, in
partnership with key customers, is utilizing forecasting techniques to
significantly reduce delivery lead times. The Company's objective is to operate
its production facilities on a three-shift, five to five and one half-day week
schedule. However, during periods of heaviest demand, Quaker operates some or
all of its production areas on seven-day, three-shift schedules and/or
outsources a portion of its production requirements. During periods of weaker
demand, the Company will decrease its production rates accordingly.

The Company's vertically integrated manufacturing process begins with the
production of specialty yarns, primarily for use in the production of the
Company's fabrics, but also for sale to manufacturers of craft yarns, home
furnishings products and apparel. Although the Company purchases all of its
commodity yarns, most of the Company's weft, or filling, yarn needs are met
through internal production. The next stage of the fabric manufacturing process
involves the preparation of beams of warp yarn. The beams are then sent to the
Company's weave rooms, where looms are used to weave the warp and filling yarns
together. The final steps in the fabric production process include routing the
fabric through various fabric finishing processes to enhance the durability and
performance characteristics of the end product, as well as a stain-resistant
finish upon customer request. Some of the Company's fabrics, including its
Quaker Plush'r', Quaker Suede'TM', Quaker Silk'TM' and Quaker Ultra'TM'
products, and the products it markets under the Crypton'r' brand as a result of
its licensing agreement with Hi-Tex, Inc., benefit from additional chemical and
mechanical finishing processes designed to enhance their appearance, texture or
'hand' and/or performance characteristics. A final product quality inspection is
conducted prior to shipment to the Company's customers.

Since 1988, the United Kingdom has had a flammability standard in place
applicable to all upholstery fabrics sold in the U.K., including products
imported into the U.K. market from other countries. To ensure compliance with
this regulatory standard, the Company devoted considerable resources to the
successful development of fabrics which would meet the performance
specifications set forth in the standard. For the past several years, the United
States Consumer Product Safety Commission has been working on the development of
a similar upholstered furniture flammability standard, and the Company has
played a lead role in the shaping of these proposed regulations. Management
believes the adoption by the CPSC of new regulations in this area, if that were
to occur, would not likely have a material adverse effect on the Company's
results of operations or financial condition and that, prior to the effective
date of such regulations, if any, the Company would be able to make such changes
in its fabric designs and manufacturing processes as would be required to ensure
the Company's compliance.

Quaker has added approximately 400 new looms to its manufacturing base since
1989. The vast majority of the Company's looms are equipped with Jacquard heads,
maximizing the Company's ability to design its products to meet customer needs,
without equipment-related design constraints. During 2000, the mechanical
Jacquard heads on approximately 80 of the Company's older looms were replaced
with electronic Jacquard heads to improve productivity, and another 26
mechanical heads were replaced with electronic heads during 2002. During 2001,
the Company added 36 Dobby looms to reduce the cost

7

of manufacturing certain fabrics not requiring the use of Jacquard heads, and in
2002, 24 'double-wide' Jacquard looms were moved into production to support the
Company's entry into the decorative home fashions segment and add additional
manufacturing capacity.

The Company's fabrics are generally shipped directly to its customers on an
FOB Fall River or FOB warehouse basis. The Company also supplies its
distribution centers with an appropriate selection of fabrics for customers
needing immediate delivery.

During the past five years, the Company placed in service more than $80.6
million of new manufacturing equipment to increase capacity, improve
manufacturing efficiencies, and support the Company's marketing, quality and
delivery objectives.

QUALITY ASSURANCE

Management believes that product quality is a significant competitive factor
in both the domestic and international fabric markets. Quaker's quality
initiatives include:

The use of incentive programs in certain of its production departments to
factor quality into the overall compensation programs in these areas.

Inspection of incoming raw materials to ensure they meet the Company's
product specifications and to provide prompt feedback to vendors when
defects are discovered so that corrective actions may be undertaken
immediately.

A final quality inspection of the Company's yarn and fabric products before
they are released for shipment.

Continuous monitoring of the Company's performance against industry
standards and its own internal quality standards.

ISO 9001 certification of all of the Company's operations. During 2001, the
Company received certification to the new ISO 9000: 2000 Quality Standard
for ISO 9001.

In addition to these measures, the built-in quality control features and
more precise settings on the Company's newer production equipment also support
the Company's efforts to provide defect-free products to its customers.

The Company's quality-related return rate, as a percentage of total yards
shipped, was 0.3% in 2003 and 0.5% in 2002, and the Company's sales of
second-quality fabric were $1.5 million in 2003 and $1.9 million in 2002.

TECHNOLOGY

As part of Quaker's overall strategy to improve productivity and meet its
customers' total service requirments, the Company strives to introduce new
technologies into its operations whenever possible. Quaker's efforts in this
area include: (i) the use of its management information system to provide
computer support to the Company's manufacturing operations; (ii) the use of CAD
equipment to reduce the time required to bring its new products to market,
including the design of 'Specials'; (iii) the use of bar-coding systems for
inventory control purposes and to improve both the efficiency of its own
manufacturing operations and service to its customers; (iv) the use of
electronic Jacquard heads and other production equipment equipped with
microprocessors to improve manufacturing efficiencies and reduce unit costs; (v)
the use of a heuristic advanced planning system to both support Quaker's
delivery lead time objectives and improve productivity levels in Quaker's
manufacturing areas; and (vi) the use of real-time process monitoring control
systems to identify opportunities to improve manufacturing efficiencies.

The Company's CAD equipment is used to develop new fabric designs and to
prepare plastic Jacquard cards for use with the Company's mechanical Jacquard
heads, and computer disks for use with Quaker's electronic Jacquard heads. These
plastic cards and computer disks contain precise instructions about the
construction of the particular fabric pattern to be woven. During 2001, the
Company installed new CAD software, providing all of Quaker's design
professionals with enhanced automated design support directly on their
individual desktop computers.

8

SOURCES AND AVAILABILITY OF RAW MATERIALS

Quaker's raw materials consist principally of polypropylene, polyester,
acrylic, cotton and rayon fibers and yarns for use in its yarn manufacturing and
fabric weaving operations, and latex to backcoat its finished fabrics. In
addition, Quaker purchases commission dyeing services from various dyehouses
which dye, to the Company's specifications, certain fabrics produced by the
Company and certain of the yarns the Company produces internally or purchases
from other manufacturers. Substantially all of the raw materials used by the
Company are purchased from primary producers with manufacturing operations in
the United States, however, certain of the Company's raw material requirements
are purchased from non-U.S. based suppliers. The Company is dependent upon
outside suppliers for its raw material needs, including dyeing services, and is
subject to price increases and delays in receiving these materials and services.
The Company's raw materials are predominantly petrochemical products and their
prices may fluctuate with changes in the underlying market for petrochemicals in
general. In addition, the financial performance and/or condition of some textile
industry suppliers has been hurt by reduced overall demand, increasing the risk
of business failures and/or further consolidations among the Company's supplier
population and the related risk of disruption to Quaker's operations.

Although other sources may be available, the Company currently procures
approximately 59% of its raw material components from two major industry
suppliers, one of which is the sole supplier of a filament yarn used in the
Company's chenille and Taslan air texturizing manufacturing operations.
Generally, Quaker has not experienced any significant difficulty in meeting its
raw material needs, expects that it will be able to obtain adequate amounts to
meet future requirements, and as a matter of corporate policy, attempts to
identify alternate sources for all critical raw material components.

On December 17, 2003, Solutia, Inc., the Company's supplier of acrylic
fiber, filed for reorganization under Chapter 11 of the federal bankruptcy laws.
Approximately 35% of the Company's filling yarns are acrylic and are purchased
from spinners that use fiber from Solutia. While the actions taken by Solutia
have not had an adverse effect on supplies to Quaker, the Company has identified
alternate suppliers and products and is putting in place arrangements to reduce
the risk of price increases or interruptions in raw material flows stemming from
the Solutia bankruptcy filing. In addition, the Company currently purchases
essentially all of its polypropylene yarn, a component used in approximately 60%
of the Company's fabrics, from one domestic supplier. While the Company has
previously evaluated various approaches to dealing with an interruption in its
supply of polypropylene from this supplier, including a hybrid approach
involving the use of both alternate suppliers and an adjustment in the fiber
content and other product specifications of certain fabrics, the Company is
developing, but currently does not have, a firm alternate program in place to
mitigate the risks associated with an interruption in its supply of
polypropylene arising out of an operating, financial or other problem at this
supplier. Further, the Company sources a low melt polymer essential to the
production of Quaker's Ankyra'TM' chenille yarns from a single supplier. While
an alternate source of this polymer is available, it is unlikely that this
source would have the manufacturing capacity to meet all the Company's
requirements for this raw material, at least initially. A shortage or
interruption in the supply of any critical component could have a material
adverse effect on the Company.

The Company's production operations are heavily reliant upon a consistent
supply of energy, including electricity to power the Company's manufacturing
equipment, natural gas to generate the heat used in Quaker's finishing
operations and oil to heat the Company's office areas. A significant shortage or
interruption in the availability of these energy sources would likely have a
material adverse effect on the Company's operations and financial performance.
Beginning in the latter part of 2000, the Company began to experience rising
energy costs. To help provide the Company with greater stability and to reduce
the impact of rising energy costs, during 2001, Quaker entered into a contract
to purchase its electrical power requirements at a fixed price through December
2004.

COMPETITION

The markets for the Company's products are highly competitive. Competitive
factors in the upholstery fabric business include product design, styling,
price, customer service and quality. Price is a more important competitive
factor in the promotional-end of the market than it is in the middle to
better-end of the market, where competition is weighted more heavily toward
fabric styling and design

9

considerations. Cost and other factors may make imported fabrics more
competitive with the Company's products in the future. Recent improvements in
service levels and product design have enhanced the competitive position of
imported products, particularly those coming into the United States from China.
In addition, competition in the U.S. domestic market is likely to further
intensify following the January 1, 2005 expiration of the quotas imposed under
the Uruguay Round Agreement on Textiles and Clothing on textile and apparel
products coming into the U.S. During 2003, the Company's yarn sales business
continued to be adversely affected by diminished demand for products
manufactured by the Company's customers in the home furnishings and apparel
markets. The Company's sales to craft yarn distributors, however, grew somewhat
during 2003, and the Company anticipates additional sales growth in that segment
during 2004.

Several of the companies with which the Company competes may have greater
financial resources than the Company. The Company's products compete with other
upholstery fabrics and furniture coverings, including prints, flocks, tufts,
velvets, suede and leather, with leather furniture enjoying growing popularity
over the past few years, to some extent at the expense of woven fabrics, such as
the Jacquards and other woven fabrics Quaker manufactures.

BACKLOG

As of January 3, 2004, the Company had orders pending for approximately
$26.5 million of fabric and yarn compared to $26.1 million as of January 4,
2003. The Company's backlog position at any given time may not be indicative of
the Company's long-term performance.

TRADEMARKS, PATENTS, COPYRIGHTS

The Company seeks copyright protection for all new fabric designs it
creates, and management believes that the copyrights owned by the Company serve
as a deterrent to those industry participants which might otherwise seek to
replicate the Company's unique fabric designs. In June 1995, the Company
introduced a new collection of fabrics featuring Quaker's proprietary Ankyra'TM'
chenille yarns. In 1997, the United States Patent and Trademark Office issued a
patent to the Company protecting the proprietary manufacturing process developed
by Quaker to produce these yarns. The Company's Whitaker mark, as well as a logo
form of the 'W' mark, is registered with the U.S. Patent and Trademark Office.
During 2000, the Company's Quaker Plush mark also became registered with the
U.S. Patent and Trademark Office. The Company has applications pending, with the
U.S. Patent and Trademark Office to register its Davol mark and its Quaker Ultra
mark. In addition, the Company has filed patent applications with the U.S.
Patent and Trademark Office to protect its intellectual property rights in
several new technologies and processes created by the Company's product
development staff, including certain laminated textured products, Quaker's
Regal'TM' chenilles, a continuous washing and post finishing process, and for
the Company's high-value laminated fabrics. During 2003, the Company also
entered into a non-exclusive licensing agreement with Hi-Tex, Inc. for the use
of its patented Crypton'r' finish for certain of the Company's fabrics for the
contract market.

INSURANCE

The Company maintains general liability and property insurance. The costs of
insurance coverage vary generally and the availability of certain coverages can
change. Following the events of September 11, 2001, the Company experienced
significant increases in the premium rates on certain of its insurance coverages
and certain changes were made in the insurance carriers used by the Company and
in the terms and conditions of some of the Company's insurance policies. While
the Company believes that its present insurance coverage is adequate for its
current operations, there can be no assurance that the coverage is sufficient
for all future claims or will continue to be available in adequate amounts or at
reasonable rates.

EMPLOYEES

The Company is the largest manufacturer, and the largest private sector
employer, in Fall River, Massachusetts. As of January 3, 2004, Quaker employed
2,715 persons, including 2,191 production

10

employees, 180 technical and clerical employees, and 344 exempt employees and
commissioned sales representatives. The Company's employees are not represented
by a labor union, and management believes that employee relations are good. The
Company's operations are heavily dependent on the availability of labor in the
Fall River, Massachusetts area.

ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT (See Item 10 herein)

The executive officers of the Company are as follows:

Larry A. Liebenow. Mr. Liebenow has served as President, Chief Executive
Officer, and a Director of the Company since September 1989. From July 1983
until September 1989, Mr. Liebenow was Chairman of the Board and President of
Nortex International, Inc. ('Nortex International'). From September 1971 to July
1983, Mr. Liebenow served as the Chief Operating Officer of Grupo Pliana, S.A.,
a Mexican yarn and upholstery fabric manufacturing concern.

James A. Dulude. Mr. Dulude has been employed by the Company since May 1986
and has served as Vice President -- Manufacturing since August 1995. Mr. Dulude
served as Vice President -- Purchasing, Planning and MIS from November 1990 to
August 1995. Mr. Dulude served as the Company's Director of Purchasing and
Planning from May 1989 to November 1990, Director of Planning and Scheduling
from July 1988 to May 1989, and Director of Information Systems from May 1986 to
July 1988.

Cynthia L. Gordan. Ms. Gordan has been employed by the Company since March
1988 and has served as Vice President, Secretary, and General Counsel of the
Company since March 1989. Ms. Gordan is also responsible for the Company's Risk
Management, Investor Relations and Human Resources functions. From April 1986 to
November 1987, Ms. Gordan served as a Senior Associate in the Corporate
Department of the Chicago law firm of Katten Muchin & Zavis. From November 1981
to April 1986, Ms. Gordan was employed by The General Electric Company where she
served first as the Vice President and General Counsel of General Electric's
life, property, and casualty insurance affiliates in Providence, Rhode Island,
and later as the strategic planner and acquisition specialist for a division of
General Electric Capital Corporation.

Mark R. Hellwig. Mr. Hellwig has served as Vice President -- Supply Chain
Management since October 1998. From January 1996 until October 1998, Mr. Hellwig
was Director -- Supply Chain Management for Solo Cup Company. From August 1993
to January 1996, Mr. Hellwig was Director -- Logistics at Solo Cup Company. From
1989 to 1993, Mr. Hellwig was with Deloitte and Touche LLP.

Paul J. Kelly. Mr. Kelly has served as Vice President -- Finance, Chief
Financial Officer and Treasurer of the Company since December 1989, and since
November 1993 has also had responsibility for working with industry and
institutional analysts. From January 1988 to December 1989, Mr. Kelly was the
co-founder and President of International Business Brokers and Consultants Ltd.,
a business broker and consulting firm. From December 1977 to December 1987, Mr.
Kelly served as Chief Financial Officer of Ferranti Ocean Research Equipment,
Inc., an international manufacturing concern. From February 1973 to December
1977, he was a certified public accountant with Arthur Andersen & Co.

11

Thomas H. Muzekari. Mr. Muzekari has served as Vice President -- Sales since
March 2003, and was Vice President -- Sales and Marketing from October 1998
until March 2003, and Vice President -- Marketing from March 1996 until October
1998. From September 1989 until February 1996, Mr. Muzekari was the Vice
President -- Marketing for Collins & Aikman's Velvet Division. From 1970 to
September 1989, Mr. Muzekari held various management positions in both sales and
marketing with Milliken and Company.

M. Beatrice Spires. Ms. Spires has been employed by the Company since
September 1995 and has served as Vice President -- Design and Merchandising
since March 2003, and was Vice President -- Styling and Design from March 1996
until March 2003. From September 1995 to March 1996, Ms. Spires served as
Quaker's Director of Design. From July 1992 to September 1995, Ms. Spires was
Vice President -- Merchandising for Collins & Aikman's Velvet Division. From
September 1991 to July 1992, Ms. Spires was Merchandising Manager at Collins &
Aikman.

Norman J. Sturdevant. Mr. Sturdevant has served as Vice President -- Chief
Information Officer since August 2001. From August 1999 to April 2001, Mr.
Sturdevant served as Vice President of Information Technology for Bausch &
Lomb's Europe, Middle East and Africa Region. Prior to that, Mr. Sturdevant
served in various director and manager-level information technology positions
with Bausch & Lomb, Entex Information Services and Electronic Data Systems. Mr.
Sturdevant served as an officer in the U.S. Navy from 1978 to 1984.

Duncan Whitehead. Mr. Whitehead has served as Vice President -- Technology
and Development, and Yarn Sales since August 1995. Mr. Whitehead served as Vice
President -- Yarn Sales and Development from May 1990 to August 1995. From
September 1989 to May 1990, Mr. Whitehead was the Vice President -- Sales and
Marketing for the Company's Nortex Division. From July 1983 to September 1989,
Mr. Whitehead served as Vice President of Sales and Marketing for Nortex
International.

The Company's President, Secretary, and Treasurer are elected annually by
the Board at its first meeting following the annual meeting of stockholders. All
other executive officers hold office until their successors are chosen and
qualified.

12

ITEM 2. PROPERTIES

PROPERTIES

Quaker is headquartered in Fall River, Massachusetts where it currently has
ten facilities, nine of which are used primarily for manufacturing and
warehousing purposes. The tenth facility houses the Company's executive,
administrative and design areas as well as certain manufacturing operations. In
addition, the Company maintains a manufacturing facility in Somerset,
Massachusetts and warehouse space in Brockton, Massachusetts. The Company has
three distribution centers in the United States and one in Mexico. We believe
our facilities are in good condition and are suitable and adequate for our
current and future uses. If we are unable to renew any of the leases that are
due to expire in 2004 and 2005, we believe that suitable replacement properties
are available on commercially reasonable terms. The table below sets forth
certain information relating to the Company's current facilities:

- ---------
(1) Lease expires December 31, 2005
(2) Lease expires July 31, 2007
(3) Lease expires March 29, 2004
(4) Lease expires June 30, 2005
(5) Lease expires May 31, 2004
(6) Lease expires September 30, 2006
(7) Lease expires February 28, 2006
(8) Lease expires July 31, 2004

During 2000, the Company also started to maintain inventory at a third party
warehouse provider in Sao Paulo, Brazil. Quaker has sales offices in Fall River,
Massachusetts; Guadalajara and Mexico City, Mexico; Sharjah, United Arab
Emirates; Hickory and High Point, North Carolina; Chicago, Illinois; Tupelo,
Mississippi; City of Industry, California; and Sao Paulo, Brazil. All of the
Company's sales offices, except the one in Fall River, Massachusetts, are
leased. In addition Quaker has five exclusive sales representatives who lease
and maintain sales offices in Germany, India, Johannesburg, London and
Singapore.

The Company also owns approximately 60 acres of undeveloped land in Fall
River to allow for expansion of its operations.

13

ENVIRONMENTAL MATTERS

The Company's operations are subject to numerous federal, state, and local
laws and regulations pertaining to the discharge of materials into the
environment or otherwise relating to the protection of the environment. The
Company's facilities are located in industrial areas and, therefore, there is
the possibility of incurring environmental liabilities as a result of historic
operations at the Company's sites. Environmental liability can extend to
previously owned or leased properties, properties owned by third parties, and
properties currently owned or leased by the Company. Environmental liabilities
can also be asserted by adjacent landowners or other third parties in toxic tort
litigation. In addition, under the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980, as amended ('CERCLA'), and analogous
state statutes, liability can be imposed for the disposal of waste at sites
targeted for cleanup by federal and state regulatory authorities. Liability
under CERCLA is strict as well as joint and several. Environmental laws and
regulations are subject to change in the future, and any failure by the Company
to comply with present or future laws or regulations could subject it to future
liabilities or interruption of production which could have a material adverse
effect on the Company. In addition, changes in environmental regulations could
restrict the Company's ability to expand its facilities or require the Company
to incur substantial unexpected other expenses to comply with such regulations.

In particular, the Company is aware of soil and groundwater contamination
relating to the use of certain underground fuel oil storage tanks at its Fall
River facilities. During 2001, the Company filed Response Action Outcome
Statements (RAOs) and Activities and Use Limitations (AULs) with the
Commonwealth of Massachusetts with respect to soil and groundwater contamination
at two of its facilities. The AULs are intended to limit human access to the
tainted soil and groundwater, close out the sites and end future regulatory
reporting. During the fourth quarter of 2003, the Company terminated the AUL
with respect to one of these facilities at the direction of the Massachusetts
Department of Environmental Protection in order to complete additional response
actions necessary to support the conclusion that a condition of No Significant
Risk has been achieved at the site. Management anticipates that the Company will
complete the additional response actions and file a new AUL with respect to the
site within two years. In addition, during the fourth quarter of 1993 the
Company removed and encapsulated asbestos at two of its facilities and the
Company has an on-going asbestos management program in place to appropriately
maintain the asbestos that remains present at its facilities. During the fourth
quarter of 1998 and the first quarter of 1999 oil-contaminated soil resulting
from a leak during the mid-1970s from an underground fuel storage tank at the
Company's former facility in Claremont, New Hampshire, was removed and disposed
of at an asphalt batching plant. In January 2003, the New Hampshire Department
of Environmental Services issued a 'no further action required' letter with
respect to this site, and a related escrow account originally established to
cover Quaker's clean up cost indemnification obligations was closed out. The
Company has also agreed to indemnify the purchaser of the Company's former
facility in Leominster, Massachusetts, for certain environmental contingencies.

Quaker has also determined that several localized areas of a sixty-acre
parcel of land in Fall River owned by the Company contain surficial soil
contamination from polyaromatic hydrocarbons ('PAHs') and lead, and are thus
subject to the Massachusetts Superfund law. Over eighty percent of the
contaminated soil exists under high-tension power lines. The site is currently
undeveloped and was purchased by the Company during 1998-1999 to provide a
location for the possible future development of a manufacturing and warehouse
facility. The Company engaged the services of a Licensed Site Professional
('LSP') and filed the appropriate notices and reports with the Massachusetts
Department of Environmental Protection. Following the determination of the
vertical and lateral extent of the contamination and the nature of the soil
contamination by the LSP, it was established that the site could be properly
remediated by covering the contaminated soil with a one-foot depth of clean
soil. This was completed during the second half of 2000. Subsequent soil
sampling and laboratory analyses have confirmed that the areas of contamination
have been properly remediated. Additional environmental assessment and
remediation work at the site is anticipated, the final cost of which is
currently uncertain.

The Company acquired two additional manufacturing facilities during the
second half of 2001. Prior to the Company's purchase, comprehensive
environmental site assessments, including soil and

14

groundwater analyses, were completed at both sites by an LSP. As a result of
these assessments, an AUL has been filed with the Commonwealth of Massachusetts
with respect to one of the sites. Further, although urban fill containing waste
material, including coal and ash, was discovered at the other site, the Company
has determined that the 'urban fill' exemption from the assessment and
remediation requirements of the Massachusetts environmental regulations requires
no further action by the Company with respect to this property.

During 2003, the Company entered into agreements with the Massachusetts
Department of Environmental Protection to install air pollution control
equipment on three of the stacks at one of its manufacturing facilities located
in Fall River. The control equipment is intended to ensure that emissions from
the stacks do not exceed the 0% opacity limit set forth in the Company's
operating permit for air emissions. Management anticipates that the costs
associated with the acquisition and installation of the control equipment will
total approximately $900,000 over a three-year period, which began during 2003.
The equipment itself is scheduled to be fully installed by the end of 2005.

The Company has accrued reserves for environmental matters based on
information presently available. Based on this information and the Company's
established reserves, the Company does not believe that these environmental
matters will have a material adverse effect on either the Company's financial
condition or results of operations. However, there can be no assurance that
these reserves will be adequate or that the costs associated with environmental
matters will not increase in the future.

ITEM 3. LEGAL PROCEEDINGS

The Company is not a party to any legal proceedings other than routine legal
proceedings incidental to its business, which, in the opinion of management, are
immaterial in amount or are expected to be covered by the Company's insurance
carriers.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

15

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

The following summarizes common stock prices for the years ended January 3,
2004 and January 4, 2003.

- ---------

(1) The Company's common stock is traded over the counter and is quoted on the
Nasdaq National Market under the symbol 'QFAB.'

(2) No dividends were paid on the Company's common stock prior to fiscal year
2003. During the first quarter of 2003, the Board of Directors adopted a new
dividend policy. This policy provides for future dividends to be declared at
the discretion of the Board of Directors, based on the Board's quarterly
evaluation of the Company's results of operations, cash requirements,
financial condition and other factors deemed relevant by the Board.

(3) As of March 10, 2004, there were approximately 89 record holders of the
Company's common stock.

(4) The Company's Credit Agreement, Senior Notes, and Series A Notes contain
restrictive covenants which limit the Company's ability to declare and pay
dividends. Under the most restrictive of these covenants, $3.8 million was
available for the payment of dividends as of January 3, 2004. See Note 5 of
Notes to Financial Statements.

16

EQUITY COMPENSATION PLAN INFORMATION

(IN THOUSANDS)
JANUARY 3, 2004

EQUITY COMPENSATION PLANS NOT APPROVED BY SECURITY HOLDERS

Options granted under the 1993 Stock Option Plan for certain Company
officers are fully vested and currently cover 53,000 shares of common stock.
When granted, the exercise price of the shares covered by the 1993 Stock Option
Plan was $2.75 per share as to 60%of the shares granted and $1.37 per share as
to 40%of the shares granted. The Company's 1996 Stock Option Plan for certain
key employees currently covers 891,700 shares of common stock. Options granted
under the 1996 Stock Option Plan vest over a five-year period beginning on the
date of each grant. Options are issued at their fair market value at the date of
grant, and the average exercise price for all options granted is $7.86 per
share. Prior to their participation in the Company's 1997 Stock Option Plan in
2001, the Company's non-employee directors were awarded options pursuant to
individual contracts. These options were issued at their fair market value at
the date of grant, and the average exercise price for all such options granted
is $8.19 per share. All options granted to the Company's non-employee directors
under these contracts are fully vested and currently cover a total of 112,500
shares of common stock.

17

ITEM 6. SELECTED FINANCIAL DATA

QUAKER FABRIC CORPORATION AND SUBSIDIARIES
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AND PER YARD AMOUNTS)

The following table sets forth certain consolidated financial and operating
data of the Company for the periods indicated. This selected financial and
operating data should be read in conjunction with the Consolidated Financial
Statements, the Notes thereto and the other financial information included
herein.

- ---------

(1) The fiscal year ended January 4, 2003 was a 53-week period.

(2) Earnings per share is computed using the weighted average number of common
shares and common share equivalents outstanding during the year.

(3) Net capital expenditures reflects assets acquired by purchase and capital
lease.

(4) In the fiscal year ended January 3, 2004, income resulted from a settlement
of a tariff dispute with the Mexican tax authorities. In the fiscal year
ended December 29, 2001, the charge was for costs incurred related to a
potential acquisition which was not completed. See Note 11 to the
Consolidated Financial Statements.

18

QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

The accompanying notes are an integral part of these consolidated financial
statements.

19

QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

-------------------
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(AMOUNTS IN THOUSANDS)

The accompanying notes are an integral part of these consolidated financial
statements.

20

QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)

The accompanying notes are an integral part of these consolidated financial
statements.

21

QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)

The accompanying notes are an integral part of these consolidated financial
statements.

22

QUAKER FABRIC CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

1. OPERATIONS

Quaker Fabric Corporation and subsidiaries (the 'Company' or 'Quaker')
designs, manufactures and markets woven upholstery fabrics primarily for
residential furniture markets and specialty yarns for use in the production of
its own fabrics and for sale to manufacturers of home furnishings and other
products.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Principles of Consolidation. The accompanying consolidated financial
statements include the accounts of Quaker Fabric Corporation and its wholly
owned subsidiaries. All intercompany balances and transactions have been
eliminated in consolidation.

(b) Fiscal Year. The Company's fiscal year ends on the Saturday nearest to
January 1 of each year. The fiscal years ended December 29, 2001 and January 3,
2004 each contained 52 weeks, while the fiscal year ended January 4, 2003
contained 53 weeks.

(c) Reclassifications. Certain prior year amounts have been reclassified to
conform with the current year's presentation. These reclassifications had no
impact on the Company's financial position or results of operations.

(d) Revenue Recognition. Revenue is recognized from product sales when
earned as required by generally accepted accounting principles and in accordance
with SAB 101, 'Revenue Recognition in Financial Statements.' Revenues are
recognized when product shipment has occurred. At that time, the price is fixed
and determinable and collectability is reasonably assured, title and risk of
loss have transferred and all provisions agreed to in the arrangement necessary
for customer acceptance have been fulfilled.

(e) Cash and cash equivalents. Cash and cash equivalents includes cash on
hand, demand deposits and short-term cash investments which are highly liquid in
nature and have original maturities of three months or less.

(f) Allowance for Doubtful Accounts and Sales Returns and Allowances. The
Company performs ongoing credit evaluations of its customers and adjusts credit
limits based upon payment history and the customer's current creditworthiness,
as determined by management's review of their current credit information. The
Company continuously monitors collections and payments from its customers and
maintains a provision for estimated credit losses based upon historical
experience and any specific customer collection issues identified. While such
credit losses have historically been within expectations and the provisions
established, the Company cannot guarantee that credit loss rates in the future
will be consistent with those experienced in the past. The Company's accounts
receivable are spread among approximately 1,000 customers and no single customer
represents more than 4.3% and 6.0% of the accounts receivable balance at
January 3, 2004 and January 4, 2003, respectively.

Management analyzes historical sales and quality returns, current economic
trends, and the Company's quality performance when evaluating the adequacy of
the reserve for sales returns and allowances. Significant management judgments
and estimates must be made and used in connection with establishing the reserve
for sales returns and allowances in any accounting period. The provision for
sales returns and allowances is recorded as a reduction of sales. Material
differences may result in the amount and timing of net sales for any period if
management makes different judgments or uses different estimates.

(g) Inventories. Inventories are stated at the lower of cost or market and
include materials, labor and overhead. A standard cost system is used and
approximates cost on a FIFO basis. Cost for financial

23

QUAKER FABRIC CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

reporting purposes is determined by the last-in, first-out (LIFO) method.
Inventories consist of the following at January 3, 2004 and January 4, 2003:

LIFO inventory values are higher than FIFO costs because current
manufacturing costs are lower than the older historical costs used to value
inventory on a LIFO basis.

During the year ended January 3, 2004, inventory quantities were reduced.
This reduction resulted in a liquidation of LIFO inventory quantities carried at
higher costs prevailing in prior years as compared with the costs during 2003,
the effect of which increased cost of goods sold by approximately $170 and
decreased net income by approximately $110 or $0.01 per share.

Approximately 65% of finished goods are produced upon receipt of a firm
order. Management, in partnership with key customers, is utilizing forecasting
techniques to significantly reduce delivery lead times. Management regularly
reviews inventory quantities on hand and records a provision for excess and
obsolete inventory based primarily on historical information and estimated
forecasts of product demand and raw material requirements for the next twelve
months.

(h) Property, Plant and Equipment. Property, plant and equipment are stated
at cost. The Company provides for depreciation and amortization on property and
equipment on a straight-line basis over their estimated useful lives as follows:

Buildings and improvements.................................. 32-39 years
Machinery and equipment..................................... 2-20 years
Furniture and fixtures...................................... 5-10 years
Motor vehicles.............................................. 4-5 years
Leasehold improvements...................................... Life of Lease

Maintenance and repairs are charged to operations as incurred. When
equipment and improvements are sold or otherwise disposed of, the asset's cost
and accumulated depreciation are removed from the accounts, and the resulting
gain or loss, if any, is included in the results of operations. Fully
depreciated assets are removed from the accounts when they are no longer in use.

(i) Impairment of Long-Lived Assets. The Company periodically considers
whether there has been a permanent impairment in the value of its long-lived
assets, primarily property and equipment in accordance with Financial Accounting
Standards Board ('FASB') Statement No. 144 ('SFAS No. 144'), 'Accounting for the
Impairment or Disposal of Long-Lived Assets.' The Company evaluates various
factors, including current and projected future operating results and the
undiscounted cash flows for any underperforming long-lived assets. To the extent
that the estimated future undiscounted cash flows are less than the carrying
amount of the asset, the asset is written down to its estimated fair market
value and an impairment loss is recognized. The value of impaired long-lived
assets is adjusted periodically based on changes in these factors. Based on its
review, the Company does not believe that any material impairment of its
long-lived assets has occurred.

(j) Goodwill. Goodwill represents the excess of the purchase price over the
fair value of identifiable net assets acquired. Goodwill was historically
amortized on a straight-line basis over 40 years. In July 2001, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards

24

QUAKER FABRIC CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

(SFAS) No. 142, 'Goodwill and Other Intangible Assets.' The Company has adopted
the requirements of SFAS No. 142 effective December 30, 2001. SFAS No. 142
requires companies to test all goodwill for impairment at least annually and to
cease amortization of this asset. Amortization expense was approximately $193
for the period ended December 29, 2001. At January 3, 2004, the Company was not
required to recognize any impairment.

(k) Income Taxes. The Company accounts for income taxes under SFAS No. 109,
'Accounting for Income Taxes.' This statement requires that the Company
recognize a current tax liability or asset for current taxes payable or
refundable and a deferred tax liability or asset for the estimated future tax
effects of temporary differences and carryforwards to the extent they are
realizable. A valuation allowance is recorded to reduce the Company's deferred
tax assets to the amount that is more likely than not to be realized. While
management has considered future taxable income and ongoing prudent and feasible
tax planning strategies in assessing the need for the valuation allowance, in
the event management were to determine that the Company would be able to realize
deferred tax assets in the future in excess of the net recorded amount, an
adjustment to the deferred tax asset would increase income in the period such
determination was made. In like manner, should management determine that the
Company would not be able to realize all or part of its net deferred tax asset
in the future, an adjustment to the deferred tax asset would be charged to
income in the period such determination was made. The Company does not provide
for United States income taxes on earnings of subsidiaries outside of the United
States. The Company's intention is to reinvest these earnings permanently.
Management believes that United States foreign tax credits would largely
eliminate any United States taxes or offset any foreign withholding taxes.

(l) Earnings Per Common Share. Basic earnings per common share is computed
by dividing net income by the weighted average number of common shares
outstanding during the period. For diluted earnings per share, the denominator
also includes dilutive outstanding stock options determined using the treasury