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 1, 2005

[ ] 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, 2004 was approximately $111.6 million.

As of March 14, 2005, 16,826,218 shares of Registrant's common stock, par
value $0.01 per share, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

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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 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. The Company's revenues in 2004 were $289.1 million.

Quaker has been producing upholstery fabric for almost sixty 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. Quaker also distributes its fabrics internationally. In
2004, net fabric sales outside the United States of $35.9 million represented
approximately 13.4% of net fabric sales.

Quaker uses three tradenames in the marketing of its fabrics -- Whitaker'r',
Quaker'TM' and Davol'r'. 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'r' 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 60% of the Company's fabric sales are manufactured to
customer order.

During the past five years, Quaker has invested $78.2 million in new
manufacturing equipment to expand its yarn and fabric production capacity,
increase productivity, and improve product quality. During 2005, Quaker plans to
spend approximately $7.6 million for new projects consisting principally of
facilities maintenance expenditures, modifications needed at the 540,000 square
foot manufacturing and warehousing facility leased by the Company in December
2004 and a modest amount of new equipment needed to support the expansion of the
Company's craft yarn sales.

The Company's yarn and fabric manufacturing and warehousing operations are
conducted at its ten manufacturing plants in the greater Fall River,
Massachusetts area, where Quaker has approximately 2.2 million square feet of
manufacturing and warehousing space. Quaker also leases 217,000 square feet of
warehousing space in Brockton, Massachusetts. During the fourth quarter of 2004,
the Company entered into a long-term lease on 540,000 square feet of
manufacturing and warehousing space in Fall River. During 2005, the Company
plans to consolidate operations currently conducted in four of its leased
facilities, including its leased Brockton facility, into this new plant. 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

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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.

THE INDUSTRY

Total domestic upholstery fabric sales, exclusive of automotive
applications, are estimated to be approximately $1.6 billion annually, with
sales of imported fabrics, in both roll and 'kit' form, representing
approximately 42% of total U.S. fabric sales during 2004, up from 29% in 2003
and 11% in 2002. Management estimates international fabric sales to be at least
twice those of the domestic market. The top ten upholstery fabric manufacturers,
including Quaker, account for approximately 57% of 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. U.S. retail upholstered furniture sales grew from $20.3 billion in
1999 to an estimated $23.9 billion in 2004. 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. Historically, the U.S. furniture market has been
characterized by relatively slow growth, with compounded annual growth rates
typically in the 2.5% to 3.5% range.

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
capture retail floor space, thereby generating increased sales by attracting
consumer attention.

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

(iii) Fabrics, leather and faux suede microdenier products entering the
United States from Asia in both roll and 'kit' form are resulting in
increased competition in the upholstery fabric and upholstered
furniture markets and are capturing an increasing share of the
domestic furniture market. Economic factors affecting purchasing
decisions made by U.S. furniture manufacturers to source furniture
coverings domestically or in the international market are expected to
cause this trend to accelerate. In addition, recent increases in
imported furniture coverings and an increase in imports of fully
upholstered furniture into the U.S. can be anticipated to have a
deflationary effect on pricing throughout the distribution chain.
Competition in the U.S. domestic market may also intensify further
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.

(iv) 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.

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

(vi) 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.

(vii) 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.

(viii) 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.

(ix) 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.

(x) 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.

STRATEGY

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

Maintaining its Leadership Position in the Domestic Residential Fabric
Market. 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 net fabric sales
were $35.9 million in 2004.

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 outdoor segments, as well as
increase Quaker's share of the interior decorator and recreational vehicle
segments. Management believes Quaker's fabric finishing and post-finishing
abilities will provide the Company with a product advantage in these segments.

Maintaining Specialty Yarn Sales. Quaker is a leading producer of specialty
yarns, including chenille, taslan, and spun products. Approximately 82% of the
chenille and spun yarns manufactured by the Company are used in the production
of the Company's fabric. The balance is sold to craft yarn distributors,
upholstery weavers and home fashion accessories firms. The Company's yarn
styling and yarn technology has allowed the development of a number of unique
yarns for the craft yarn sector. These new yarns, many of which are patented,
have met with considerable success in the craft yarn sector. To support further
penetration of this sector and to provide improved product aesthetics on retail
store shelves, during the fourth quarter of 2004, the Company invested in yarn
'balling' and packaging equipment. Net sales for this division increased by
91.9% to $20.4 million in 2004 from $10.7 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.

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Considering Strategic Acquisition Opportunities. 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.

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 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.

Commitment to Customer Service. The Company is committed to offering its
customers the best overall service levels 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 the domestic and international furniture market.

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 support its efforts to compete 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'r' brand name. In 2004, the Company's promotional-end fabric line and
its middle to better-end fabric line had average gross sales prices of $4.05 per
yard and $6.80 per yard, respectively, compared to $4.08 and $6.63,
respectively, in 2003. The weighted average gross sales price per yard of the
Company's fabrics was $5.74 in 2004, compared to $5.66 in 2003.

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 also
added 24 'double-wide' Jacquard looms to its manufacturing base. 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

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ensure that their own product offerings bring something distinctive to the
market. Management also believes that the development and introduction of these
products allows the Company to compete with less expensive imported goods on the
basis of styling and performance rather than price.

Quaker's product offerings are noted for their use of the chenille and other
specialty yarns manufactured by the Company. These yarns give the fabric a soft
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. The
Company markets the line of chenille fabrics it produces using these yarns under
its Ankyra'TM' label. Management anticipates that chenille and the other
specialty yarns produced by the Company will remain an important element in the
Company's fabric designs and that they 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 is intended to allow 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'r' brand name. Gross sales of the Company's middle to better-end
fabrics were $197.2 million, or 72.8% of total gross fabric sales in 2004, with
approximately 30.7% 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 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 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 conjunction with the 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
process by reviewing proposed new product constructions to evaluate their impact
on the Company's

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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
market.

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' and have become increasingly
important to the Company's overall marketing efforts in recent years.

In addition, within the past several years, Quaker has entered into a number
of licensing agreements with various designers, including Todd Oldham
(La-Z-Boy), Alexander Julian, and Jaclyn Smith, pursuant to which Quaker has
been granted the exclusive right to manufacture upholstery fabrics incorporating
the copyrighted fabric patterns created by those designers.

SALES AND MARKETING

UPHOLSTERY FABRICS

Net fabric sales during 2004 were $268.7 million, or approximately 92.9% of
the Company's net sales. The Company sells its upholstery fabrics to over 3,000
furniture manufacturers worldwide. Fabric sales to the Company's top 25
customers accounted for approximately 41% of 2004 net sales. None of the
Company's customers accounted for more than 7.5% of net sales during 2004.

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, customer service center 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 every
major U.S. furniture manufacturer attends 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. Beginning in
December 2005, these semi-annual Showtime Fabric Fairs will be held in December
and June.

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. Net foreign sales of fabric accounted for
approximately 13.4% of Quaker's net fabric sales during 2004.

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.

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SPECIALTY YARNS

Net yarn sales during 2004 were $20.4 million, or approximately 7.1% 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 softness, the specialty yarns produced by the Company and the fabrics made
out of them are intended to be 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 70 yarn customers,
with recent sales into the craft yarn market reflecting significant growth, and
sales to one customer representing more than 50% of the Company's yarn sales.

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 60% of the
Company's fabric sales are manufactured to customer order. Management, in
partnership with key customers, uses forecasting techniques to significantly
reduce delivery lead times to its key customers. The Company's objective is to
operate its production facilities on a three-shift, five to five and one
half-day per 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 and post-finishing processes to enhance
the durability and performance characteristics of the end product. Some of the
Company's fabrics, including its Quaker Plush'r', Quaker Suede'TM', Quaker
Silk'TM' and Quaker Ultra'r' 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.

Over the past two years Quaker has introduced 'lean manufacturing'
principles in two of its newest plants. These principles involve more training
for the Company's hourly workforce, plant layouts designed to ensure a smooth
continuous flow of product through the manufacturing process and an emphasis on
inventory reduction. These two plants have proven to be the most effective in
terms of utilization of assets, overall conversion costs and quality. The lean
initiative is now being aggressively introduced in Quaker's beaming, weaving and
yarn producing areas.

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

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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 its manufacturing base to reduce the cost of
manufacturing certain fabrics not requiring the use of Jacquard heads, and in
2002, 24 'double-wide' Jacquard looms were moved into production.

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 approximately
$78.2 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:

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 0.35% in 2004 and 0.30% in 2003, and the Company's sales of
second-quality fabric were $1.3 million in 2004 and $1.5 million in 2003.

TECHNOLOGY

As part of Quaker's overall strategy to improve productivity and meet its
customers' total service requirements, 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

8

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; (vi) the use of real-time process monitoring
control systems to identify opportunities to improve manufacturing efficiencies;
(vii) the implementation of a web portal to provide Quaker's customers with
secure, on-line access to product and order shipment information; and
(viii) the introduction of KANBAN scheduling practices in some production areas.

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.

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. While the Company purchases its raw material
requirements from both U.S. and non-U.S. based suppliers, in 2004, Quaker
sourced over 95% of its raw materials from suppliers in North America. 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 typically fluctuate with
changes in the underlying market for petrochemicals in general. In addition, the
financial performance and/or condition of a number of textile industry suppliers
has been hurt by recent reductions in the overall size of the U.S. textile
industry, 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 81% of its raw material components from four 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.
Approximately 36% of the Company's filling yarns are acrylic and are purchased
from spinners that use acrylic fiber from Solutia, Inc. ('Solutia'.) On December
17, 2003, Solutia, the Company's supplier of acrylic fiber, filed for
reorganization under Chapter 11 of the federal bankruptcy laws and on January
25, 2005, Solutia announced that it would be exiting the acrylic business, with
operations at Solutia's acrylic manufacturing facilities expected to cease in
early to mid-April 2005. With the closure of Solutia, Quaker will source acrylic
from two primary offshore producers. To maintain customer service levels, the
longer lead times associated with offshore sourcing will require the Company to
hold additional component safety stock inventory at both the spinners used by
the Company and at Quaker.

In addition, the Company currently purchases essentially all of its
polypropylene yarn, a component used in approximately 12% 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.

In addition, Quaker was notified that, on January 25, 2005, an interim
receiver was appointed to hold and control the estate of Les Textiles Du-Re Ltee
('Du-Re') and to operate Du-Re's business on a temporary basis pursuant to the
provisions of Section 47 of the Canadian Bankruptcy and Insolvency

9

Act. Du-Re is a spinner that supplies Quaker with a number of acrylic spun yarns
made with Solutia fiber and included in a number of the fabrics manufactured and
sold by Quaker. Quaker is working with Du-Re's receiver and Regitex Inc.,
another Canadian yarn manufacturer with which Quaker has worked in the past, to
arrange for a continuous flow of these raw materials.

Although Quaker expects that it will be able to obtain adequate amounts of
raw materials to meet its future requirements, and as a matter of corporate
policy, attempts to identify alternate sources for all critical raw material
components, an increase in the price of or 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. Upon expiration of this agreement, the Company began purchasing 60% of its
electricity requirements at the default rate and the balance at an 'hour to
hour' rate. The Company expects to experience a significant increase in its
energy costs during 2005.

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 considerations. Recently, cost and other factors have
made imported fabrics more competitive with the Company's products. Imported
furniture coverings, including leather, fabric in both roll and 'kit' form and
faux suede products, are currently estimated to represent approximately 42% of
sales into the U.S. fabric market, up from 29% in 2003 and 11% in 2002. This
percentage can be expected to increase in the absence of a change in U.S. trade
policy or other international developments. In addition, competition in the U.S.
domestic market may further intensify as a result of 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 2004,
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. Recently, the Company's sales to the craft
yarn market grew significantly, with sales to one craft yarn customer
representing more than 50% of the Company's yarn sales. The Company anticipates
additional sales growth during 2005 in the craft yarn market.

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, faux suede and plain furniture
coverings enjoying growing popularity over the past few years, primarily at the
expense of woven fabrics, such as the Jacquards and other woven fabrics Quaker
manufactures.

BACKLOG

As of January 1, 2005, the Company had orders pending for approximately
$14.6 million of fabric and yarn compared to $26.5 million as of January 3,
2004. 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

10

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
Davol'r', Quaker Ultra'r' and Whitaker'r' marks, as well as a logo form of the
'W'r' mark, are registered with the U.S. Patent and Trademark Office. 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.
Although premium rates for most coverages purchased by the Company have dropped
since the significant increases experienced during the first round of
post-September 11 renewals, most rates have still not decreased to their pre-
September 11 levels. 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

As of January 1, 2005, Quaker employed 2,509 persons, including 2,020
production employees, 175 technical and clerical employees, and 314 exempt
employees and commissioned sales representatives. As a result of a reduction in
force during the first quarter of 2005, the Company employed approximately 2,200
persons as of March 14, 2005. 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.

11

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.

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.

12

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.

13

ITEM 2. PROPERTIES

PROPERTIES

Quaker is headquartered in Fall River, Massachusetts where it currently has
eleven facilities, ten of which are used primarily for manufacturing and
warehousing purposes. The eleventh 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. During the fourth quarter of 2004, the Company entered
into a long-term lease on 540,000 square feet of manufacturing and warehousing
space in Fall River. During 2005, the Company plans to consolidate operations
currently conducted in four of its leased facilities, including its leased
Brockton facility, into this new plant. The table below sets forth certain
information relating to the Company's current facilities:

- ---------
(1) Lease expires December 31, 2005 -- Management plans to move operations at
this facility to the Company's Commerce Drive plant during 2005.
(2) Lease expires December 31, 2015
(3) Lease expires July 31, 2007
(4) Month-to-month lease -- Management plans to move operations at this facility
to the Company's Commerce Drive plant during 2005.
(5) Lease expires June 30, 2005 -- Management plans to move operations at this
facility to the Company's Commerce Drive plant during 2005.
(6) Month-to-month lease -- Management plans to move operations at this facility
to the Company's Commerce Drive plant during 2005.
(7) Lease expires September 30, 2006
(8) Lease expires February 28, 2006
(9) Lease expires July 31, 2006

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

14

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, Massachusetts which was purchased in 1998 to allow for expansion of its
operations. The Company's December 2004 decision to enter into a long-term lease
on an additional 540,000 square feet of manufacturing and warehousing space in
Fall River led the Company to reevaluate its interest in developing this land as
a manufacturing location. The net book value of this land is approximately $4.0
million, and the Company intends to market it for sale or development.

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

15

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 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.

16

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

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

As of March 14, 2005, there were approximately 83 record holders of the
Company's common stock.

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. The Company's Credit Agreement,
Senior Notes, and Series A Notes (the 'Loan Documents') contain restrictive
covenants which restrict the Company's ability to pay dividends. In accordance
with amendments made to the Loan Documents during the second half of 2004, the
Company suspended dividend payments during the third quarter of 2004 and no
dividends have been declared or paid since that time. See Note 5 of Notes to
Consolidated Financial Statements.

MARKET INFORMATION

The following summarizes the high and low sales prices for a share of the
Company's common stock as reported by NASDAQ and cash dividends paid per share
for each of the quarters in the years ended January 1, 2005 and January 3, 2004.

17

EQUITY COMPENSATION PLAN INFORMATION

(IN THOUSANDS)
JANUARY 1, 2005

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.

PURCHASES OF EQUITY SECURITIES BY THE COMPANY

During the fourth quarter of 2004 the Company did not purchase any of its
equity securities.

18

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

(4) Favorable settlement of the Company's claim for certain federal research and
development tax credits added approximately $2,000 or $0.12 per share, to
the Company's results of operations for fiscal 2004. See Note 6 to the
Consolidated Financial Statements.

19

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following analysis of the financial condition and results of operations
of the Company should be read in conjunction with the Company's Consolidated
Financial Statements and the Notes thereto included elsewhere in this report.

GENERAL

Overview. Quaker is a leading designer, manufacturer and worldwide marketer
of woven upholstery fabrics and one of the largest producers of Jacquard
upholstery fabrics in the world. The Company also manufactures specialty yarns,
most of which are used in the production of the Company's fabric products. The
balance is sold to manufacturers of craft yarns, home furnishings and other
products.

Overall demand levels in the upholstery fabric sector are a function of
overall demand for household furniture, which is, in turn, affected by general
economic conditions, population demographics, new household formations, consumer
confidence and disposable income levels, sales of new and existing homes and
interest rates.

Competition in the industry is intense, from both domestic fabric mills and
fabric mills located outside the U.S. manufacturing products for sale into the
U.S. market. In addition, there has been a recent and significant increase in
imports of both furniture coverings and fully upholstered furniture into the
U.S. market, with industry data indicating that sales of imported fabrics in
both roll and 'kit' form represented approximately 42% of total U.S. fabric
sales during 2004, up from 29% in 2003 and 11% in 2002. Competition in the U.S.
domestic market may further intensify as a result of 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.

The Company's fabric products compete with other furniture coverings,
including leather, suede, microdenier 'faux suede', prints, tufts, flocks and
velvets, for consumer acceptance. Consumer tastes in upholstered furniture
coverings are somewhat cyclical and do change over time, with various coverings
gaining or losing share depending on changes in home furnishing trends and the
amount of retail floor space allocated to various upholstered furniture product
categories at any given time. For example, leather furniture and furniture
covered with microdenier faux suede products, primarily imported in roll and
'kit' form from low labor cost countries, particularly China, have enjoyed
growing popularity over the past few years, primarily at the expense of woven
fabrics, such as the Jacquards and other woven fabrics Quaker manufactures, and
in some retail furniture stores, these products may occupy as much as 50% of the
floor space allocated to upholstered furniture products.

Quaker's 2002 revenues of $365.4 million and net income of $11.6 million
both set new company records. During the first half of 2002, Quaker's revenues
were running at an annualized rate of approximately $400.0 million, however,
global economic conditions deteriorated as the year progressed, ultimately
resulting in a weak fourth quarter, with domestic fabric sales down 8.9% for the
quarter and yarn sales off significantly. The Company's backlog position was
also down considerably, from $43.0 million at the end of 2001 to $26.1 million
at the end of 2002, due to both significant reductions Quaker achieved in its
delivery lead times and weakness in the Company's fourth quarter order rate.
During 2002, Quaker also further strengthened its balance sheet, with the
Company generating approximately $13.0 million of free cash flow during the
fourth quarter, thereby allowing Quaker to reduce funded debt by approximately
$13.3 million during the quarter.

Net sales for the 52-week fiscal year ended January 3, 2004 of $325.3
million were down 11%, with net income of $7.9 million, down 31.3%, and diluted
earnings per share of $0.47. A refund related to the favorable resolution of a
foreign tariff dispute added $1.4 million of non-recurring income to fiscal 2003
pre-tax income, increasing diluted earnings per share for the year by $0.05.

Uncertainty surrounding the global economic and geopolitical environment
continued to put pressure on the Company's fabric sales during 2003, with 2003
domestic net fabric sales down 9.0% and net export sales down 16.5% versus 2002.
While the Company's 2003 yarn revenues were also down 32.1%, yarn sales for the
fourth quarter of $3.0 million were up 12.0% versus the comparable period of
2002, primarily as a result of the steps taken during the year to strategically
reposition that segment of the Company's business. Despite a drop of a little
over $40.0 million in Quaker's 52-week revenues for

20

2003 compared to 2002's 53-week fiscal year, the Company's gross margin declined
only 30 basis points, showing particular improvement in the fourth quarter.
Quaker's operating margin, however, was down 130 basis points for the year,
largely because of the ongoing costs associated with the strategic investments
the Company has made to build competitive advantage, particularly in the areas
of research and development, product styling and design, and information and
supply chain management. The 11% year-over-year decrease in the Company's
revenues caused those investments to push up Quaker's 'SG&A as a percentage of
revenues' results for the year and kept the Company from achieving its 'SG&A as
a percentage of revenues' objectives.

In addition, during 2003, Quaker reduced inventory, paid dividends for the
first time, generated improved 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, further strengthening the Company's balance sheet.

RECENT DEVELOPMENTS

Fiscal 2004 started out reasonably strong, but the Company's financial
performance deteriorated as the year progressed, particularly during the second
half. Because of the significant investments Quaker has made in machinery and
equipment over the years, the Company's fixed costs are relatively high --
causing any shortfall at the top line to quickly erode Quaker's margins and
bottom line profitability.

Net sales of $289.1 million for 2004 were down 11.1% versus 2003 -- with net
sales into the domestic residential market of $232.8 million for the year and
$53.8 million for the fourth quarter, down 15.3% and 17.8%, respectively -- and
international fabric sales of $35.9 million for the year and $10.5 million for
the fourth quarter, down 10.2% and 12.2%, respectively. Yarn sales, however,
showed consistent strength throughout the year, with total 2004 sales into that
market of $20.4 million, up 92% over 2003 and reflecting the strategic
repositioning of that aspect of Quaker's business.

From a profitability standpoint, the Company's performance during the first
quarter of 2004 was solid, with net income of $2.4 million -- but the Company
recorded a small loss in the second quarter, a ($2.1) million loss in the third
quarter and a ($1.9) million loss in the fourth quarter -- leading to a loss of
($2.0) million for the year as a whole, with favorable settlement of a Company
claim for certain federal research and development tax credits adding
approximately $2.0 million, or $0.12 per share, to the Company's results for the
fourth quarter and for the year.

The $41.9 million drop in Quaker's net sales into the domestic residential
furniture market in 2004 compared to 2003 was the single most important factor
affecting the Company's financial performance during 2004. This decline reflects
a continuation of intense competition in the domestic market, including
competition and pricing pressure from leather, faux suede and other furniture
coverings coming into the U.S. from Asia. The current popularity of faux suede
at the promotional end of the market and leather at the middle and upper-end has
reduced the size of the market for the woven Jacquard and plain fabrics Quaker
makes.

Last year's lower revenues resulted in a significant deterioration in
Quaker's margin performance, pushed SG&A expense as a percentage of sales up to
19.1% for the year, and 20.2% for the fourth quarter -- and generally hurt the
Company's financial performance resulting in losses at the bottom line in every
quarter except the first. The problems created by 2004's revenue shortfall were
exacerbated by a number of other factors, including higher energy and raw
material prices and the more than $0.7 million of professional fees Quaker
incurred in connection with its Sarbanes-Oxley Act compliance efforts.

The deterioration in the Company's financial results led to violations of
several of the financial covenants in Quaker's principal loan documents and the
Company sought and received waivers from its two major financing sources to deal
with this. Quaker is continuing to work with its lenders to put new loan
agreements in place that are consistent with the Company's current operating and
financing needs. This process is expected to be completed during the second
quarter of 2005. Last year's cash flow from operations was $19.8 million, with
capital expenditures of $14.9 million -- compared to cash flow from operations
of $34.4 million in 2003, with capital expenditures of $7.9 million in that
year.

The Company took aggressive action during the second half of 2004 to reduce
its operating costs. These actions included staffing reductions intended to
reduce overhead and bring production rates in

21

line with demand, and the temporary idling of certain yarn manufacturing
equipment as well as the execution of a long-term lease on 540,000 square feet
of additional manufacturing and warehousing space in Fall River. In addition,
during the first quarter of 2005, the Company began implementing further
company-wide cost cutting measures intended to reduce annual fixed operating
costs by approximately $6.0 million, and reduced employment levels at the
Company by an additional 275 production staff employees.

New fabric orders during the fourth quarter of 2004 were down approximately
17% versus the comparable period of 2003, and 2004 ended with a total production
backlog valued at approximately $14.6 million, down 45.1% in comparison to $26.5
million at the end of 2003. This drop in the backlog reflects both lower orders
during the fourth quarter of last year and Quaker's continued efforts to reduce
delivery lead times.

In January 2005, an important raw material supplier announced its decision
to exit the acrylic business. Over the short term, dealing with this development
will increase Quaker's raw material costs, put additional pressure on the
Company's margins and also involve some significant opportunity costs. The
Company has placed orders with this supplier to build a safety stock of acrylic
inventory at Quaker sufficient to cover its manufacturing requirements until raw
materials from the new suppliers enter the Company's supply chain. Quaker has
also moved ahead with some adjustments in its pricing to deal with the pressure
placed on the Company's margins by the significant raw material and other cost
increases affecting its business.

Management believes that domestic market conditions are likely to remain
both challenging and highly dynamic, with problems at the Company's suppliers
just one symptom of the broader challenges arising out of the changes taking
place in the furniture industry as a whole. These challenges -- including rapid
changes in the competitive landscape, a significant increase in fabric imports,
the emergence of new industry participants, consolidation in the furniture
retailing and manufacturing sectors and changes in the kind of furniture
consumers want to purchase and in how they want to purchase it -- will make
building the kind of sales volume the Company needs a difficult task. These
challenges also place additional importance on the wisdom of Quaker's corporate
and marketing strategies and the effectiveness of their execution.

In late 2004, Quaker arranged to have an in-depth market study performed to
serve as the basis of a refinement of the Company's strategy going forward so
that the core competencies the Company has developed in the design, technology,
supply chain and new product development areas can be used to best advantage to
further the Company's revenue and profitability objectives.

In the meantime, the Company is moving aggressively to build sales in both
the domestic and international residential fabric markets. Quaker is also
continuing its efforts to grow sales into the contract and specialty yarn
markets and is working on a new line of products for the outdoor furniture
segment, where the product and service advantages Quaker has already developed
can be leveraged to generate additional sales.

In addition, Quaker intends to begin bringing fabrics into the U.S. market
that the Company does not have the equipment to make, as a complement to
Quaker's existing product offerings.

22

Quarterly Operating Results. The following table sets forth certain
unaudited condensed consolidated statements of operations data for the eight
fiscal quarters ended January 1, 2005, as well as certain data expressed as a
percentage of the Company's total net sales for the periods indicated:

- ---------

The data reflected in this table has been derived from unaudited financial
statements that, in the opinion of management, include all adjustments
(consisting only of normal recurring adjustments) necessary for the fair
presentation of such information when read in conjunction with the Company's
Consolidated Financial Statements and the Notes thereto contained elsewhere in
this report. Fiscal years 2004 and 2003 contained 52 weeks.

-------------------

The Company follows industry practice by closing its operating facilities
for a one-to-two week period during July of each year. In 2003, this shutdown
period, and the resulting effect on sales, was split between the second and
third fiscal quarters. In 2004, the shutdown period, and the resulting effect on
sales, occured in the third fiscal quarter.

Product Mix. By offering a broad assortment of fabrics at each price point
and in each styling category, the Company has positioned itself as a full
service supplier of Jacquard and plain woven fabrics to the upholstered
furniture segment. While Quaker offers a full range of fabrics to its
promotional-end customers, the Company's primary focus is on the development of
products for the middle to upper-end of the market, where Quaker's design,
technology and manufacturing expertise provide the Company with the greatest
competitive advantage. Quaker's product line is divided into three distinct
branded collections, with its Davol'TM', Quaker'TM', and Whitaker'r' Collections
intended to meet the styling, design, quality and pricing needs of the
promotional, middle to better, and better to upper ends of the market,
respectively.

Geographic Distribution of Fabric Sales. To develop markets for upholstery
fabric outside the United States, the Company has placed substantial emphasis on
building both direct exports from the United States as well as on sales from its
distribution centers in Mexico and Brazil. The following table sets forth
certain information about the changes which have occurred in the geographic
distribution of the Company's net fabric sales since 2002:

23

- ---------

(1) Foreign sales consists of both direct exports from the United States as well
as sales from the Company's distribution centers in Mexico and Brazil.

CRITICAL ACCOUNTING POLICIES

The following is a brief discussion of the more significant accounting
estimates used by the Company.

GENERAL

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. The most significant estimates and assumptions relate to
accounts receivable reserves, inventory valuation and inventory reserves,
self-insurance reserves, property, plant and equipment and income taxes. Actual
amounts could differ significantly from these estimates.

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 more than 1,000 customers and no single
customer represented more than 4.4% and 4.3% of the accounts receivable balance
at January 1, 2005 and January 3, 2004, 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. Material differences
may result in the amount and timing of the Company's net sales for any period if
management makes different judgments or uses different estimates.

INVENTORIES

Inventory is valued using the last-in, first-out (LIFO) method.
Approximately 60% 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. A significant increase in demand for the Company's products

24

could result in a short-term increase in manufacturing costs, including but not
limited to overtime and other costs related to capacity constraints in certain
areas of the Company. A significant decrease in demand could result in an
increase in the amount of excess inventory quantities on hand. Additionally,
assumptions used in determining management's estimates of future product demand
may prove to be incorrect, in which case the provision required for excess and
obsolete inventory would have to be adjusted in the future. If inventory is
determined to be overvalued, the Company would be required to recognize such
costs as cost of goods sold at the time of such determination. Therefore,
although every effort is made to ensure the accuracy of management's forecasts
of future product demand, any significant unanticipated changes in demand could
have a significant impact on the value of the Company's inventory and the
Company's reported operating results.

SELF-INSURANCE RESERVES

The Company is self-insured for workers' compensation and medical insurance.
Quaker has purchased stop loss coverage for both types of risks in order to
minimize the effect of a catastrophic level of claims. At the end of each
accounting period, the reserves for incurred but not reported claims are
evaluated. Management evaluates claims experience on a regular basis in
consultation with the Company's insurance advisors and makes adjustments to
these reserves. Significant management judgments and estimates must be made and
used in connection with evaluating the adequacy of self-insurance reserves.
Material differences may result in the amount and timing of these costs for any
period if management makes different judgments or uses different estimates.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment is depreciated over the estimated useful
lives. Useful lives are based on management's estimates of the period that the
assets will generate revenue. These assets are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying value of an asset
may not be recoverable. Reductions in the useful lives of the Company's fixed
assets would have an adverse impact on the Company's financial results.

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. Likewise, 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.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board (FASB) issued a
revised Statement of Financial Accounting Standards (SFAS) No. 123, 'Share Based
Payment.' The revised SFAS No. 123 requires that the fair value of stock options
be recorded in the results of operations beginning no later than July 1, 2005.
Upon adoption of the revised standard, prior awards are charged to expense under
the prior rules, and awards after adoption are charged to expense under the
revised rules. The

25

Company has not determined the effect of the new standard on its earnings,
however, expense under the new standard will likely be somewhat higher. The
effect of adopting the new rules on reported diluted earnings per share is
dependent on the number of options granted in the future, the terms of those
awards and their fair values and, therefore, the effect on diluted earnings per
share could change. The Company will adopt the revised rules on July 1, 2005,
but has not determined whether it would adopt prospectively, or retrospectively
to January 1, 2005.

In November 2004, the FASB issued SFAS No. 151, 'Inventory Costs.' This
statement clarifies the accounting for the abnormal amount of idle facilities
expense, freight, handling costs and wasted material. This statement requires
that those items be recognized as current-period expense. In addition the
statement requires that allocation of fixed overhead to the cost of conversion
be based on the normal capacity of the production facilities. This statement is
effective for inventory costs incurred after December 31, 2005. Adoption of this
statement will not have a material effect on the financial statements of the
Company.

On December 17, 2003, the SEC issued SEC Staff Accounting Bulletin No. 104,
'Revenue Recognition' ('SAB 104'), which supersedes a portion of SEC Staff
Accounting Bulletin No. 101, 'Revenue Recognition in Financial Statements'
('SAB 101'). The primary purpose of SAB 104 is to rescind accounting guidance
contained in SAB 101 related to multiple element revenue arrangements, which was
superseded as a result of the issuance of Emerging Issues Task Force 00-21,
'Accounting for Revenue Arrangements with Multiple Deliverables' ('EITF
No. 00-21'). While the wording of SAB 104 has changes to reflect the issuance of
EITF No. 00-21, the revenue recognition principles of SAB 101 remain largely
unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have an
impact on the Company's consolidated results of operations, financial position
or cash flows.

RESULTS OF OPERATIONS

FISCAL 2004 COMPARED TO FISCAL 2003

Net Sales. Net sales for 2004 decreased $36.2 million, or 11.1%, to $289.1
million from $325.3 million in 2003. Net fabric sales decreased due to decreases
in both domestic and foreign fabric sales. Net fabric sales within the United
States decreased 15.3%, to $232.8 million in 2004 from $274.7 million in 2003,
as a result of increased competition from leather, microdenier faux suede and
other furniture coverings being imported into the U.S. in roll and 'kit' form,
primarily from low labor cost countries in Asia. Net foreign sales decreased
10.2%, to $35.9 million in 2004 from $40.0 million in 2003. This decrease in
foreign sales was due primarily to lower sales in Mexico, Canada and the Middle
East. In Mexico, the Company competes primarily with Mexican weavers which
typically offer their products at prices lower than the Company's. As a result,
the Company has lost some market share to lower cost local mills. In Canada,
where furniture manufacturers sell furniture into both the United States and
Canadian markets, competition from faux suede fabrics and leather increased
during 2004 and contributed to a more difficult competitive environment. The
political climate in the Middle East continued to have a negative impact on
sales into that region during 2004. Net yarn sales increased 91.9%, to $20.4
million in 2004 from $10.7 million in 2003, primarily as a result of the effort
made by the Company to penetrate the craft yarn sector.

The gross volume of fabric sold decreased 15.9%, to 47.2 million yards in
2004 from 56.1 million yards in 2003. The weighted average gross sales price per
yard increased 1.4%, to $5.74 in 2004 from $5.66 in 2003 as a result of product
mix changes. The Company sold 16.9% fewer yards of middle to better-end fabrics
and 14.4% fewer yards of promotional-end fabrics in 2004 than in 2003. The
average gross sales price per yard of middle to better-end fabrics increased by
2.6%, to $6.80 in 2004 from $6.63 in 2003. The average gross sales price per
yard of promotional-end fabrics decreased by 0.7%, to $4.05 in 2004 from $4.08
in 2003.

Gross Margin. The gross margin percentage for 2004 decreased to 18.3% as
compared to 21.6% for 2003. Total fixed costs increased by approximately $0.8
million due primarily to higher payroll taxes and fringe benefits in 2004
compared to 2003. The gross profit margin also was negatively affected by higher
raw material costs in 2004 versus 2003, primarily due to increased petrochemical
costs and higher

26

variable labor and overhead costs caused by inefficiencies in the Company's
manufacturing operations as demand and production rates declined.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $55.3 million in 2004 and 2003. Selling, general
and administrative expenses as a percentage of net sales were 19.1% and 17.0% in
2004 and 2003, respectively. Lower variable costs in 2004, such as sales
commissions, resulting from lower sales were offset by higher sampling expenses
and $0.7 million of costs incurred in connection with the Company's
Sarbanes-Oxley compliance efforts. Selling, general and administrative expenses
were higher as a percentage of net sales due to lower sales.

Interest Expense, Net. Interest expense decreased to $3.3 million in 2004
from $3.9 million in 2003. Lower average levels of senior debt was the primary
reason for the decrease.

Effective Tax Rate. The Company's effective tax rate was a benefit of 65% in
2004 compared to a provision of 35.4% in 2003. The tax benefit rate in 2004 was
increased to 65% principally due to the $2.0 million favorable settlement of
certain claims for federal research and development tax credits.

The Company is currently challenging tax assessments from the Massachusetts
Department of Revenue (MDOR) for the years 1993-1998. During the third quarter
of 2003, the Company filed amended tax returns with the MDOR claiming
approximately $1.4 million of research and development tax credits for the years
1993-2001. Also, additional credits of $0.7 million were claimed on the
originally filed tax returns for 2002 and 2003. The MDOR is currently reviewing
the amended tax returns. There is significant uncertainty surrounding the
amount, if any, and timing of the benefit that will be ultimately realized. The
Company believes that it has a supportable basis for claiming these research and
development tax credits, but the amounts are subject to an ongoing audit.
Accordingly, the Company has not reflected the potential benefits of these
credits in its financial statements for these or subsequent years. No benefit
will be recognized in the financial statements until these gain contingencies
are resolved through the eventual disposition with the tax authorities.

FISCAL 2003 COMPARED TO FISCAL 2002

Net Sales. Net sales for 2003 decreased $40.1 million, or 11.0%, to $325.3
million from $365.4 million in 2002. Net fabric sales decreased due to decreases
in both domestic and foreign fabric sales. Net fabric sales within the United
States decreased 9.0%, to $274.7 million in 2003 from $301.8 million in 2002, as
a result of increased competition from leather and poor macroeconomic conditions
for much of the year, particularly in the furniture sector. Net foreign sales
decreased 16.5%, to $40.0 million in 2003 from $47.9 million in 2002. This
decrease in foreign sales was due primarily to lower sales in Mexico, Canada and
the Middle East. In Mexico, where the Company competes primarily with Mexican
fabric mills, weakness in the Mexican peso versus the U.S. dollar caused the
Company to be at a competitive disadvantage vis a vis Mexican domestic mills for
much of 2003. A significant portion of furniture manufactured in Canada is
actually sold in the United States. As a result of a strong Canadian dollar
during 2003, Canadian furniture sales into the United States declined, reducing
demand for the Company's upholstery fabric in Canada. The political climate in
the Middle East during 2003 negatively impacted sales into that region. Net yarn
sales decreased 32.1%, to $10.7 million in 2003 from $15.7 million in 2002.

The gross v