QUAKER FABRIC CORP /DE/, ARS, 1998-04-15

QUAKER FABRIC CORP /DE/
ARS, 1998-04-15
BROADWOVEN FABRIC MILLS, MAN MADE FIBER & SILK

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<PAGE>

FINANCIAL HIGHLIGHTS

QUAKER FABRIC CORPORATION AND SUBSIDIARIES

Quaker Fabric Corporation is a leading manufacturer of woven upholstery fabrics
for residential furniture markets in the United States and abroad. The company's
broad product line includes over 3,000 individual patterns, and Quaker's
manufacturing operations are vertically integrated, beginning with the
production of yarns for use in the manufacture of its fabrics and continuing
through fabric weaving and finishing. The company also sells a portion of the
yarn it produces to manufacturers of home furnishings products and apparel
throughout the United States.

<TABLE>
<CAPTION>
(Dollars in thousands,
except per share data)
------------------------------------------
Fiscal Fiscal Percent
1997 1996 Change
-------------------------------------------
<S> <C> <C> <C>
Net sales ......................... $219,174 $198,856 10.2%
Operating income .................. 19,462 16,948 14.8%
Net income ........................ 11,113 8,562 29.8%
Earnings per common share-diluted.. 1.28 1.03 24.3%
Working capital ................... 42,634 32,620 30.7%
Funded debt ....................... 54,934 44,718 22.8%
Shareholders'equity ............... 82,313 66,572 23.6%
</TABLE>

[GRAPH]

<PAGE>

TO OUR SHAREHOLDERS

Our 1997 financial performance reflects significant gains over 1996. Net sales
increased to almost $220.0 million, up 10.2%. Operating income increased to
$19.5 million, up 14.8%. Net income increased to $11.1 million, up 29.8%.
Diluted earnings per share increased to $1.28, up 24.3%. And basic earnings per
share increased to $1.34, up 25.2%.

In addition to record revenues and net income, 1997 was a year of
important accomplishments and important investments in the future. We
significantly strengthened our product leadership position, developed and
successfully introduced our new line of Quaker Plush'tm' fabrics, achieved ISO
9001 certification on a company-wide basis, and absorbed a significant portion
of the front-end costs of two critically important ongoing strategic initiatives
- -- penetration of the office furniture market and implementation of an
aggressive, two-year, $66.0 million capacity expansion program needed to respond
to strong and growing demand for our products. This year promises to be equally
significant as we continue to build Quaker's long-term value by making the most
of the extraordinary opportunities we have created.

From a product line and distribution standpoint, we are in excellent
shape. Record order rates for our fabrics and yarns during the second half of
last year, and continuing into this year, indicate that we are offering both our
domestic and export customers precisely what they are looking for, when it comes
to product styling and design. The uniqueness of our new Quaker Plush products
has made them an enormous success. And all of our fabrics, from our Quaker'tm'
label products to our better-end Whitaker Collection'tm' fabrics, are selling
well.

Unprecedented demand for our products confirms our status as the
industry standard setter when it comes to product innovation, but it has
presented two major challenges for us. First, capacity constraints have caused
our production backlog to increase by more than 80% when compared to this time
last year. As a result, our delivery lead times are now considerably longer than
we like to see them. While our customers have evidenced a willingness to make
the "product/delivery tradeoff" required over the short-term, moving the new
equipment included in our capacity expansion plan into production as quickly as
our equipment suppliers can manufacture it has become our number one priority.
Second, the costs associated with building our capacity and keeping our
customers as happy as possible in the meantime have put, and are continuing to
put, pressure on our margins. Although still high by industry standards, our
margins declined during the second half of last year -- with the cost of
preparing for the arrival of new equipment, heavy hiring, training and overtime
costs, and some deterioration in our manufacturing efficiencies as our newest
employees moved through their learning curves all taking their toll. We
anticipate that these same factors, as well as the cost of temporarily
outsourcing a small amount of our manufacturing requirements to provide better
service to our customers, will continue to put pressure on our profitability
indices over the near term.

Implementation of our capacity expansion plan began early last year and
is essentially on schedule. This program is the largest in the history of the
company and the first time we have had to not only add a significant number of
new people to our organization but also fold

<PAGE>

additional facilities into our operations. Most of the yarn manufacturing
equipment included in the plan was in place by year end -- restoring the balance
for the foreseeable future between our yarn manufacturing and fabric weaving
areas. And the critical weaving equipment needed to significantly ramp up our
fabric production rates began arriving in January of this year and will all be
in production by the end of the first half.

During the balance of this year, in addition to building our production
capacity, we will continue to focus on consolidating our leadership position in
the new product design and development area, further strengthening our marketing
programs and domestic and international distribution systems, and improving our
operating and financial performance.

In addition, this July, we will be converting to a new Enterprise
Resource Planning system which will both provide additional computerized support
to our operations and address the Year 2000 issue. This new software system, in
combination with our ISO 9001 program, will play an important role in the
overall effort we are making to reduce our delivery lead times, achieve our
productivity and quality goals and forge more effective partnerships with our
customers and suppliers.

Temporary growing pains aside, we have made significant improvements in
the company's financial performance and are building an integrated, cohesive
organization with the vision needed to see new business opportunities -- and the
skills needed to capitalize on them. Given the enormous opportunities our
products and distribution systems have created for us -- around the world -- we
believe we must continue to move aggressively -- to seize the moment. And that
is precisely what we are doing.

Sincerely,

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

<PAGE>

THE COMPANY

Quaker makes upholstery fabric -- exciting and different upholstery fabric. In
fact, we are one of the largest and most successful upholstery fabric
manufacturers in the United States. We are also the world's largest producer of
chenille yarn -- a soft, velvet-like yarn which has become increasingly
important in our industry over the past several years -- largely because of how
we have used it to develop and style our fabrics. Our operations are vertically
integrated -- from specialty yarn manufacturing through fabric weaving and
finishing -- providing us with important design, cost and delivery advantages.
Last year, we sold almost $220.0 million of fabric and yarn -- giving us a
compound annual growth rate of 10.3% over the last four years.

We have positioned ourselves as a supplier of choice to virtually every
significant furniture manufacturer in America. Our export operations are also a
key component of our strategy, and over 20% of our 1997 fabric sales were made
outside the United States. We've invested more than $66.0 million in Quaker's
manufacturing base over the past five years to support our growth -- respond to
strong demand for our products -- and reduce our manufacturing costs, giving us
one of the most modern, vertically integrated manufacturing operations in the
industry.

Our strategy has enabled us to more than double our sales between 1991
and 1997 -- achieve one of the highest gross margins in this business -- and
generate strong cash flows. But, most important, the Quaker story is about
growth -- the company's dramatic growth over the past few years -- and the new
markets we have entered, the new products we have introduced and the worldwide
distribution system we have developed which we believe will result in further
growth for us in the future.

PRODUCTS

Product drives our business, and Jacquard fabrics form the core of our product
line. If you look closely at the photographs included in this annual report,
you can see that the detailed design features of our fabrics are woven right
into them. This is the distinguishing feature of Jacquards. Every one of
our Jacquard designs is unique and copyrighted. That's why our fabrics are not
commodities and why our copyrights are one of our most important assets.

Our product line is very broad. We have over 3,000 fabric patterns in
our line -- covering all of the important price points and styles, including a
significant number of plain fabrics to complement our Jacquard designs -- and we
introduce over 700 new fabric designs to the market every year.

Our Whitaker Collection'tm' fabrics offer our higher-end customers a
differentiated product. Some of our Whitaker Collection fabrics feature our
Ankyra'tm' chenille yarns. These yarns represent just one of the advantages of
vertical integration. With them, we've been able to construct durable,
abrasion-resistant chenille fabrics -- opening up new opportunities for us --
and for our customers.

<PAGE>

[PHOTO PAGE]

<PAGE>

[PHOTO PAGE]

<PAGE>

THE COMPANY (CONTINUED)

The new line of Quaker Plush'tm' fabrics we introduced last year also
brought something distinctly different to the market -- affordable fabrics which
were rich in appearance -- durable -- and extraordinarily soft. Their uniqueness
has resulted in enormous demand.

The innovative, specialty yarns we design and make contribute to the
distinctive look of our products, and we produce almost all of the specialty
yarns we need to weave our fabrics. In addition, we have taken our yarn
expertise and turned it into a business of its own by marketing our specialty
yarns to manufacturers of home furnishings and apparel products throughout the
United States. Like our fabrics, our yarns compete primarily on their styling
and performance, contributing to our strong margin and profit performance.

VERTICAL INTEGRATION

Vertical integration plays a major role in our ability to maintain our status as
a design leader on the fabric side of our business. And using our own specialty
yarns to produce our fabrics provides us with cost and delivery advantages as
well.

The company is also vertically integrated in terms of its fabric
finishing operations. Finishing our own fabrics not only allows us to control
the quality of the process -- but also provides us with additional design, cost
and delivery advantages. Our Quaker Plush products are a good example of this.
The unique look and softer feel of these products come from the technical
expertise we brought to bear on the development of a special finishing process
for them.

CUSTOMERS

Our long list of customers reflects who we are as a company and the work we have
done to identify new markets for our products. Our customer base includes
virtually every significant domestic furniture manufacturer. We have also made a
commitment to the international market -- and a significant part of our growth
over the past few years is attributable to the work we've done to make Quaker a
truly global player.

CUSTOMER SERVICE AND PRODUCT QUALITY

Our customers want a total package from us that includes not only outstanding
designs but also quality products and superior service. One of the things we do
for our key customers is create special designs exclusively for them. We also
have a comprehensive quality control program in place to build quality directly
into our products -- and, last December, we achieved ISO 9001 certification on a
company-wide basis, from new product design to product shipment.

Prompt delivery is important to our customers. They can have immediate
delivery on any of the products we have in inventory at our distribution centers
in North Carolina, Mississippi, California, and Mexico. Our objective is to get
the rest of our products to our customers within four to six weeks. However,
capacity constraints and unprecedented

<PAGE>

THE COMPANY (CONTINUED)

demand for our products have caused our production backlog to increase to record
levels, and our delivery lead times are now longer than we like to see them. We
are working to address this problem by moving the new equipment included in our
capacity expansion plan into production as quickly as our equipment suppliers
can deliver it to us.

COMPETITIVE STRENGTHS

Product excellence and vertical integration are Quaker's two most important
competitive strengths. It is our expertise in the new product development area
- -- including our technical expertise -- which has allowed us to differentiate
our products -- develop the broad product line needed to be a full service
supplier to our customers -- and grow faster than our competitors.

But our vertically integrated operations are also absolutely critical.
They give our designers unique tools to style with. And our modern, efficient
manufacturing base gives us the productivity levels and unit cost advantages we
need to offer our products at competitive prices.

Each of these strengths is just as important to us in the international
market as it is in the United States -- and we've built a worldwide distribution
system over the last several years to take full advantage of that. And all of
these strengths, taken together, make us a superior performer in this industry
- -- have resulted in industry-leading margins and value to our customers in the
past -- and promise exciting growth opportunities for us in the future.

GROWTH STRATEGY

Quaker's growth strategy is intended to produce sustained, superior growth over
the long term by taking full advantage of our competitive strengths. The key
components of our strategy include:

INCREASING SALES TO THE MIDDLE- TO BETTER-END SEGMENT In 1990, we decided
to begin designing fabrics for the middle- to better-end of the market,
without giving up our strong position with our high volume, promotional-end
customers. Our objective was to reposition Quaker as a full service
supplier to the entire domestic residential fabric market. Sales of
Quaker's middle- to better-end fabrics have increased rapidly, from about
$66.0 million in 1992 -- to almost $133.0 million last year, for a compound
annual growth rate of almost 15%. Without neglecting our promotional-end
customers -- who continue to demand large volumes of "fashion forward"
Quaker fabrics at value prices -- the new products we have introduced for
the middle- to better-end of the market have moved us into a leadership
position in that segment as well.

EXPANDING INTERNATIONAL SALES Just as we did with the expansion of our
sales to the middle- and better-end of the market, we decided to leverage
our design and manufacturing strengths to begin penetrating promising
markets around the globe. The advantages were clear -- diversifying market
risks and gaining the opportunity for increased

<PAGE>

THE COMPANY (CONTINUED)

sales, at higher margins. Last year we sold almost $40.0 million of fabric
outside the United States, and we remain convinced that the export market
offers significant revenue and profit potential for us.

CAPITALIZING ON CASUAL FURNITURE GROWTH Today's consumers are looking for
soft, comfortable, livable furniture -- resulting in tremendous growth in
casual furniture sales over the past few years. Quaker is well positioned
to benefit from the rapid growth of this furniture segment -- where soft,
durable, distinctive fabrics, such as Quaker's Ankyra and Quaker Plush
chenilles, are in strong demand.

PENETRATING RELATED MARKETS The superior styling and performance of our
fabrics and yarns provide opportunities to penetrate markets closely
related to our core residential fabric business. Our Whitaker Collection
and Quaker Plush products have been well received in the jobber market. The
company's Ankyra yarns are opening up exciting new opportunities for us in
the office furniture market, where durability and abrasion resistance are
critical. And there are other markets out there that are a natural fit for
a company like Quaker.

GROWING SPECIALTY YARN SALES We also plan to continue growing our specialty
yarn business. Our outside yarn sales have increased from about $10.0
million in 1993 to almost $33.0 million last year, a CAGR of almost 35%.
We're convinced that our position as the largest chenille yarn producer in
the world, combined with our broad range of novelty spun yarns, will enable
us to continue developing new markets and applications for all of our yarn
products.

CONSIDERING ACQUISITION OPPORTUNITIES Although our growth to date has been
the result of internal initiatives, we are alert to acquisition
opportunities which would either support our new market development
objectives -- or bring some unique and complementary product, manufacturing
or technical capability to Quaker.

TAKING CARE OF TODAY -- PREPARING FOR TOMORROW

Our operating strategy last year was to take care of today and prepare for
tomorrow as efficiently and profitably as possible. "Taking care of today" meant
that we needed to make and ship as much product as we could to respond to order
rates that were more than 15% ahead of 1996 during 1997 as a whole -- more than
40% ahead during the fourth quarter. And we needed to move the new manufacturing
equipment included in our capacity expansion plan into production fast -- to
support our long-term growth. Our challenge this year is to capture the
opportunities our strong product line and worldwide distribution system have
given us by using our increased capacity to generate additional sales and
profits -- because we believe no other company in our industry today is as well
positioned as Quaker to continue growing and prosperi ng over the long-term.

<PAGE>

[PHOTO PAGE]

<PAGE>

[PHOTO PAGE]

<PAGE>

SELECTED FINANCIAL DATA

(In thousands, except per share and per yard data)

QUAKER FABRIC CORPORATION AND SUBSIDIARIES

The following table sets forth certain consolidated financial and operating data
of the Company for the periods indicated, which data has been derived from the
Consolidated Financial Statements of the Company and the Notes thereto, which
have been audited by Arthur Andersen LLP, independent public accountants. 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.

<TABLE>
<CAPTION>
Fiscal Year Ended
--------------------------------------------------------------------
January 3, January 4, December 30, December 31, January 1,
1998 1997(1) 1995 1994 1994
--------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net sales ..................................... $ 219,174 $ 198,856 $ 173,487 $ 180,842 $ 147,867
Cost of products sold ......................... 167,401 152,787 137,083 133,168 110,753
--------------------------------------------------------------------
Gross margin .................................. 51,773 46,069 36,404 47,674 37,114
Selling, general and
administrative expenses...................... 32,311 29,121 26,176 27,560 22,292
--------------------------------------------------------------------
Operating income .............................. 19,462 16,948 10,228 20,114 14,822
Interest expense, net ......................... 3,700 4,092 3,898 3,863 4,936
Other expenses, net ........................... 65 77 98 34 299
--------------------------------------------------------------------
Income before provision
for income taxes and
extraordinary item .......................... 15,697 12,779 6,232 16,217 9,587
Provision for income taxes .................... 4,584 4,217 712 6,691 4,218
--------------------------------------------------------------------
Income before
extraordinary item .......................... 11,113 8,562 5,520 9,526 5,369
Extraordinary item: loss on
extinguishment of debt ...................... -- -- -- -- (2,550)
Net income .................................... 11,113 8,562 5,520 9,526 2,819
Preferred stock dividends ..................... -- -- -- -- 70
--------------------------------------------------------------------
Net income applicable to
common stock ................................ $ 11,113 $ 8,562 $ 5,520 $ 9,526 $ 2,749
Earnings per common share
before extraordinary item(2)--diluted ....... $ 1.28 $ 1.03 $ 0.67 $ 1.15 $ 0.75
Extraordinary item ............................ -- -- -- -- (0.30)
--------------------------------------------------------------------
Earnings per common share(2)--diluted ......... $ 1.28 $ 1.03 $ 0.67 $ 1.15 $ 0.45
--------------------------------------------------------------------
Weighted average shares outstanding(2)......... 8,681 8,332 8,293 8,301 8,536
--------------------------------------------------------------------
Earnings per common share--basic(2)............ $ 1.34 $ 1.07 $ 0.69 $ 1.19 $ 0.34
--------------------------------------------------------------------
Weighted average shares
outstanding-basic(2)........................... 8,274 8,021 8,021 8,010 8,010
--------------------------------------------------------------------
ELECTED OPERATING DATA:
EBITDA(3)...................................... $ 28,479 $ 24,569 $ 16,821 $ 25,920 $ 19,710
Depreciation and amortization ................. 8,511 7,437 6,462 5,603 5,019
Net capital expenditures(4).................... 25,484 11,979 13,165 18,727 10,558
Unit volume (in yards) ........................ 44,976 43,552 40,761 41,641 36,289
Average gross sales price per yard ............ $ 4.23 $ 4.05 $ 3.88 $ 4.06 $ 3.87

BALANCE SHEET DATA:
Working capital ............................... $ 42,634 $ 32,620 $ 30,780 $ 30,994 $ 25,915
Total assets .................................. 178,088 148,832 138,117 130,476 109,908
Long-term debt, net of current
portion, and capital leases .................. 52,772 42,235 45,118 43,845 35,172
Stockholders' equity .......................... 82,313 66,572 57,850 52,589 43,574
</TABLE>

(1) The fiscal year ended January 4, 1997 was a 53-week period.

(2) Earnings per share for Fiscal 1994, 1995, 1996 and 1997 is computed using
the weighted average number of common shares and common share equivalents
outstanding during the year. Earnings per share for Fiscal 1993 gives effect to
the 1993 Recapitalization and the use of proceeds from the 1993 Offering as if
both events had occurred at the beginning of 1993.

(3) Represents income from continuing operations before extraordinary items plus
interest, taxes, depreciation, amortization and other non-cash expenses.
Although the Company has measured EBITDA consistently between the periods
presented, EBITDA as a measure of liquidity is not governed by GAAP and, as
such, may not be comparable to other similarly titled measures of other
companies. The Company believes that EBITDA, while providing useful information,
should not be considered in isolation or as an alternative to either (i)
operating income determined in accordance with GAAP as an indicator of operating
performance or (ii) cash flows from operating activities determined in
accordance with GAAP as a measure of liquidity.

(4) Net capital expenditures reflect assets acquired by purchase and capital
lease.

<PAGE>

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

QUAKER FABRIC CORPORATION AND SUBSIDIARIES

<TABLE>
<CAPTION>
January 3, January 4,
1998 1997
--------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash ..................................................................... $ 234 $ 385
Accounts receivable, less allowances of $1,479 and $2,052 at
January 3, 1998 and January 4, 1997, respectively,
for doubtful accounts and sales returns and allowances ................ 32,996 26,261
Inventories .............................................................. 32,176 26,957
Prepaid income taxes ..................................................... 25 694
Prepaid expenses and other current assets ................................ 4,688 3,617
--------------------------
Total current assets ................................................. 70,119 57,914
Property, plant and equipment, net of depreciation and amortization ............ 101,307 84,045
Other assets:
Goodwill, net of amortization ............................................ 6,204 6,397
Deferred financing costs ................................................. 251 322
Other assets ............................................................. 207 154
--------------------------
Total assets ......................................................... $ 178,088 $ 148,832
==========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of debt .................................................. $ 995 $ 951
Current portion of capital lease obligations ............................. 1,167 1,532
Accounts payable ......................................................... 18,203 14,384
Accrued expenses and taxes ............................................... 7,120 8,427
--------------------------
Total current liabilities ............................................ 27,485 25,294
Long-term debt, less current portion ........................................... 47,436 35,731
Capital lease obligations, less current portion ................................ 5,336 6,504
Deferred income taxes .......................................................... 13,771 11,649
Other long-term liabilities .................................................... 1,747 3,082
Commitments and contingencies
Redeemable preferred stock:
Series A convertible, $.01 par value per share, liquidation
preference $1,000 per share, 50,000 shares authorized, none issued -- --
Stockholders' equity:
Common stock, $.01 par value per share, 20,000,000 shares authorized;
8,400,684 and 8,021,097 shares issued and outstanding at January 3
1998 and January 4, 1997, respectively ..................... 84 80
Additional paid-in capital ............................................... 46,572 41,948
Retained earnings ........................................................ 37,072 25,959
Cumulative translation adjustment ........................................ (1,415) (1,415)
--------------------------
Total stockholders' equity ........................................ 82,313 66,572
--------------------------
Total liabilities and stockholders' equity ........................ $ 178,088 $ 148,832
==========================

</TABLE>

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

<PAGE>

CONSOLIDATED STATEMENTS OF INCOME

(Amounts in thousands, except per share amounts)

QUAKER FABRIC CORPORATION AND SUBSIDIARIES

<TABLE>
<CAPTION>
Fiscal Year Ended
-----------------------------------
January 3, January 4, December 30,
1998 1997 1995
-----------------------------------
<S> <C> <C> <C>
Net sales ...................................................... $219,174 $198,856 $173,487
Cost of products sold .......................................... 167,401 152,787 137,083
-----------------------------------
Gross margin ................................................... 51,773 46,069 36,404
Selling, general and administrative expenses ................... 32,311 29,121 26,176
-----------------------------------
Operating income ............................................... 19,462 16,948 10,228

Other expenses:
Interest expense, net ........................................ 3,700 4,092 3,898
Other, net ................................................... 65 77 98
-----------------------------------
Income before provision for income taxes ....................... 15,697 12,779 6,232
Provision for income taxes ..................................... 4,584 4,217 712
-----------------------------------
Net income ..................................................... 11,113 8,562 5,520
-----------------------------------
Earnings per common share - basic .............................. $ 1.34 $ 1.07 $ 0.69
-----------------------------------
Earnings per common share - diluted ............................ $ 1.28 $ 1.03 $ 0.67
-----------------------------------
Weighted average shares outstanding - basic .................... 8,274 8,021 8,021
-----------------------------------
Weighted average shares outstanding - diluted .................. 8,681 8,332 8,293
-----------------------------------
</TABLE>

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

<PAGE>

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

(Dollars in thousands, except share amounts)

QUAKER FABRIC CORPORATION AND SUBSIDIARIES

<TABLE>
<CAPTION>
Additional Cumulative Total
Common Paid-in Retained Translation Stockholders'
Stock Capital Earnings Adjustment Equity
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1994 .................... $ 80 $41,380 $11,877 (748) $ 52,589
Stock option compensation expense ....... -- 229 -- -- 229
Net income .............................. -- -- 5,520 -- 5,520
Issuance of 10,618 shares of common stock
under stock option plan ......... -- 78 -- -- 78
Foreign currency translation adjustment . -- -- -- (566) (566)
--------------------------------------------------------------
Balance, December 30, 1995 .................... $ 80 $41,687 $17,397 $ (1,314) $ 57,850)
Stock option compensation expense ....... -- 261 -- -- 261
Net income .............................. -- -- 8,562 -- 8,562
Foreign currency translation adjustment . -- -- -- (101) (101)
--------------------------------------------------------------
Balance, January 4, 1997 ...................... $ 80 $41,948 $25,959 $(1,415) $ 66,572
Stock option compensation expense ....... -- 571 -- -- 571
Net income .............................. -- -- 11,113 -- 11,113
Proceeds from sale of 300,000 shares
of common stock, net of expenses....... 3 3,264 -- -- 3,267
Proceeds from stock options exercised,
including tax benefits ............... 1 789 -- -- 790
--------------------------------------------------------------
BALANCE, JANUARY 3, 1998 ...................... $ 84 $46,572 $37,072 $(1,415) $ 82,313
===============================================================
</TABLE>

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

<PAGE>

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

QUAKER FABRIC CORPORATION AND SUBSIDIARIES

<TABLE>
<CAPTION>
Fiscal Year Ended
------------------------------------------------
January 3, January 4, December 30,
1998 1997 1995
------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income ....................................................... $11,113 $8,562 $ 5,520
Adjustments to reconcile net income to
net cash provided by operating activities--
Depreciation and amortization .................................. 8,511 7,437 6,462
Stock option compensation expense .............................. 571 261 229
Deferred income taxes .......................................... 1,570 1,134 (200)
Changes in operating assets and liabilities--
Accounts receivable ............................................ (6,735) (2,050) 1,398
Inventories .................................................... (5,219) (4,581) (871)
Prepaid expenses and other current assets ...................... (455) 657 (1,374)
Accounts payable and accrued expenses .......................... 2,512 4,078 1,158
Deferred income taxes .......................................... 552 (8) (53)
Other long-term liabilities .................................... (1,335) (684) (245)
------------------------------------------------
Net cash provided by operating activities ................ 11,085 14,806 12,024
------------------------------------------------
Cash flows from investing activities:
Purchases of property, plant and equipment ....................... (25,484) (11,979) (13,165)
Sale of equipment ................................................ -- -- 212
------------------------------------------------
Net cash used for investing activities ................... (25,484) (11,979) (12,953)
------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of short-term and long-term debt .......... 45,000 -- 34,500
Repayments of debt ............................................... (33,251) (1,278) (31,912)
Repayments of capital leases ..................................... (1,533) (1,249) (1,171)
Capitalization of financing costs ................................ (25) (14) (135)
Proceeds from issuance of common stock, net of
offering expenses ............................................. 3,267 -- --
Proceeds from exercise of common stock options ................... 790 -- 78
------------------------------------------------
Net cash provided (used) by financing activities ......... 14,248 (2,541) 1,360
Effect of exchange rates on cash ....................................... -- (101) (566)
------------------------------------------------
Net increase (decrease) in cash and cash equivalents ................... (151) 185 (135)
Cash and cash equivalents, beginning of period ......................... 385 200 335
------------------------------------------------
Cash and cash equivalents, end of period ............................... $ 234 $ 385 $ 200
================================================
Supplemental disclosure of cash flow information:
Cash paid for--
Interest ................................................... $ 3,108 $ 3,916 $ 4,043
Income taxes ............................................... $ 3,648 $ 829 $ 1,881
</TABLE>

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

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands except per share amounts)

QUAKER FABRIC CORPORATION AND SUBSIDIARIES

1. OPERATIONS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(A) PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of
Quaker Fabric Corporation and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated.

(B) FISCAL YEAR

The Company's fiscal year ends on the Saturday nearest to January 1 of each
year. The fiscal years ended January 3, 1998 and December 30, 1995 contained 52
weeks while the fiscal year ended January 4, 1997 contained 53 weeks.

Inventories are stated at the lower of cost or market and include materials,
labor and overhead. Cost is determined by the last-in, first-out (LIFO) method.
Inventories consist of the following at January 3, 1998 and January 4, 1997:

<TABLE>
<CAPTION>
January 3, January 4,
1998 1997
-----------------------
<S> <C> <C>
Raw materials ............ $14,430 $11,127
Work-in-process .......... 9,917 8,421
Finished goods ........... 8,092 7,500
-----------------------
Inventory at FIFO....... 32,439 27,048
LIFO reserve.............. 263 91
-----------------------
Inventory at LIFO....... $32,176 $26,957
=======================
</TABLE>

(D) PROPERTY, PLANT AND EQUIPMENT

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

<TABLE>

<S> <C>
Buildings and improvements............ 32-39 years
Machinery and equipment............... 3-20 years
Furniture and fixtures................ 10 years
Motor vehicles ....................... 4-5 years
</TABLE>

Leasehold improvements are amortized on a straight-line basis over the shorter
of the estimated life of the assets or the remaining lease term.

(E) GOODWILL

Goodwill represents the excess of the purchase price over the fair value of
identifiable net assets acquired. Goodwill is amortized on a straight-line basis
over 40 years. Accumulated amortization is $1,507 and $1,314 at January 3, 1998
and January 4, 1997, respectively. Amortization expense was approximately $193
for both years. The Company's policy is to evaluate annually whether the useful
life of goodwill should be revised or whether the remaining balance has been
impaired. When evaluating impairment, the Company uses an estimate of future
operating income over the remaining goodwill life to measure whether the
goodwill is recoverable.

(F) INCOME TAXES

Deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax basis of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse.

(G) DEFERRED FINANCING COSTS

Financing costs related to certain loans and capital leases have been
capitalized and are being amortized over the life of the related loan or capital
lease. Accumulated amortization was $409 and $313 as of January 3, 1998 and
January 4, 1997, respectively.

<PAGE>

(H) EARNINGS PER COMMON SHARE

The Company has adopted Statement of Financial Accounting Standards (SFAS) No.
128, "Earnings per Share," effective December 15, 1997. Basic income per common
share is computed by dividing net income by the weighted average number of
common shares outstanding during the period. For diluted income per share, the
denominator also includes dilutive outstanding stock options determined using
the treasury stock method. The following table reconciles weighted average
common shares outstanding to weighted average shares outstanding and dilutive
potential common shares.

<TABLE>
<CAPTION>
-----------------------------------------
January 3, January 4, December 30,
1998 1997 1995
-----------------------------------------
<S> <C> <C> <C>
Weighted average common shares outstanding ....... 8,274 8,021 8,021
Dilutive potential common shares ................. 407 311 272
-----------------------------------------
Weighted average common shares outstanding
and dilutive potential common shares ............ 8,681 8,332 8,293
-----------------------------------------
</TABLE>

(I) FOREIGN CURRENCY TRANSLATION

The assets and liabilities of the Company's Mexican operations are translated at
period-end exchange rates, and statement of income accounts are translated at
weighted average exchange rates. Prior to 1997, the resulting translation
adjustments are included in the consolidated balance sheet as a separate
component of equity, "Cumulative Translation Adjustment," and foreign currency
transaction gains and losses are included in the consolidated statements of
income. In 1997, Mexico was designated a "highly inflationary country" and
accordingly, the Company recorded translation gains and losses in the income
statement rather than as a separate component of equity. In accordance with SFAS
No. 52, Foreign Currency Translation, the translation adjustments for periods
prior to Fiscal 1997 remain as a separate component of equity.

(J) IMPAIRMENT OF LONG-LIVED ASSETS

The Company periodically assesses the realizability of its long-lived assets in
accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of." Based on its review, the
Company does not believe that any material impairment of its long-lived assets
has occurred.

(K) USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

The presentation 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 disclosures of
contingent assets and liabilities as of the date of the financial statements and
the reported amounts of income and expenses during the reporting periods.
Operating results in the future could vary from the amounts derived from
management's estimates and assumptions.

(L) FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company's financial instruments consist mainly of cash and cash equivalents,
accounts receivable, current maturities of long term debt, accounts payable, and
long term debt. The carrying amount of these financial instruments as of January
3, 1998 approximates fair value due to the short term nature and terms of these
instruments.

(M) RECLASSIFICATIONS

Certain reclassifications have been made to the prior years' financial
statements to conform with the presentation of the Fiscal 1997 Financial
Statements.

<PAGE>

3. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following:

<TABLE>
<CAPTION>
January 3, January 4,
1998 1997
----------------------
<S> <C> <C>
Land ................................................. $ 236 $ 236
Buildings and improvements ........................... 18,408 17,559
Leasehold improvements ............................... 485 309
Machinery and equipment .............................. 112,927 94,541
Furniture and fixtures ............................... 1,428 1,292
Motor vehicles ....................................... 331 330
Construction in progress ............................. 5,201 1,899
----------------------
139,016 116,166
Less-- Accumulated depreciation and amortization ..... 37,709 32,121
----------------------
$101,307 $ 84,045
======================
</TABLE>

Included in machinery and equipment is equipment under capital lease of $11,419
as of January 3, 1998 and $12,644 as of January 4, 1997. The Company is
depreciating the equipment over economic useful lives of 15 to 20 years, which
is greater than the lease terms, because the Company intends to exercise its
option to purchase the equipment at the end of the initial lease terms at fair
market value.

4. ACCRUED EXPENSES AND TAXES

Accrued expenses and taxes consisted of the following:

<TABLE>
<CAPTION>
January 3, January 4,
1998 1997
----------------------
<S> <C> <C>
Accrued workers' compensation .................... $1,300 $1,500
Accrued medical insurance ........................ 1,492 1,766
Accrued other, including taxes ................... 4,328 5,161
----------------------
$7,120 $8,427
======================
</TABLE>

5. DEBT

Debt consisted of the following:

<TABLE>
<CAPTION>
January 3, January 4,
1998 1997
-----------------------
<C> <C> <C>
7.18% Senior Notes due October 10, 2007 ............................ $30,000 $ --
7.09% Senior Notes due October 10, 2005 ............................ 15,000 --
6.81% Series A Notes due December 15, 2002 ......................... -- 30,000
Unsecured credit facility payable to several banks ................. 1,700 4,000
9.73% Note payable in monthly principal and
interest installments of $81 through August
1999, secured by certain equipment .............................. 1,498 2,287
Notes payable in monthly principal installments of $13 plus interest
until July 1998 and $6 plus interest from August 1998 to
July 2000, interest at prime plus 1% (9.50% at January 3, 1998
and 9.25% at January 4, 1997), secured by certain equipment ..... 233 395
-----------------------
48,431 36,682
Less-- Current portion ............................................. 995 951
-----------------------
$47,436 $35,731
========================
</TABLE>

<PAGE>

On October 10, 1997, the Company issued $30,000 of 7.18% Senior Notes and
$15,000 of 7.09% Senior Notes (the "Senior Notes"). The Senior Notes were issued
as part of a revision to the 6.81% Series A Note Agreement that increased the
Company's borrowings by $15,000 and replaced the 6.81% Series A Notes with the
Senior Notes. The Senior Notes are unsecured and bear interest at a fixed rate
of 7.18% and 7.09%, payable semiannually. The Senior Notes may be prepaid in
whole or in part prior to maturity, at the Company's option, subject to a yield
maintenance premium, as defined. Required principal payments of the Senior Notes
are as follows:

<TABLE>
<CAPTION>
7.18% Note 7.09% Note
<S> <C> <C>
October 10, 2003......... $ -- $ 5,000
October 10, 2004......... -- 5,000
October 10, 2005......... -- 5,000
October 10, 2006......... 15,000 --
October 10, 2007......... 15,000 --
-----------------------
$30,000 $15,000
=======================
</TABLE>

Under the terms of the unsecured credit facility (the "Credit Agreement"), the
Company may borrow up to $50,000 through December 31, 2002. Advances made under
the Credit Agreement bear interest at either the prime rate or the Eurodollar
(Libor) rate plus an "Applicable Margin." The Applicable Margin on advances is
adjusted quarterly based on the Company's Leverage Ratio as defined in the
Credit Agreement. The Applicable Margin for Eurodollar (Libor) advances may
range from 0.625% to 1.5%. The Company is also required to pay certain fees
including a commitment fee which will vary based on the Company's Leverage
Ratio. As of January 3, 1998, the commitment fee is 0.375% of the unused portion
of the Credit Agreement which was $48,027, net of $273 of outstanding letters of
credit. As of January 3, 1998, the Company had $1,700 outstanding under the
Credit Agreement at an effective interest rate of 8.5%. As of January 4, 1997,
the Company had $4,000 outstanding under the Credit Agreement at an effective
interest rate of 7.0%.

The Company is required to comply with a number of affirmative and negative
covenants under the Credit Agreement and the Senior Notes. Among other things,
the Credit Agreement and the Senior Notes require the Company to satisfy certain
financial tests and ratios (including interest coverage ratios, leverage ratios,
and net worth requirements.) The Credit Agreement and the Senior Notes also
impose limitations on the Company's ability to incur additional indebtedness,
create certain liens, incur capital lease obligations, declare and pay
dividends, make certain investments, make capital expenditures, and purchase,
merge or consolidate with or into any other corporation. As of January 3, 1998,
the Company is in compliance with all debt covenants.

As of January 3, 1998, debt principal payments for each of the next five fiscal
years and thereafter are as follows:

<TABLE>

<S> <C>
1998............... $ 995
1999............... 700
2000............... 1,736
2001............... --
2002............... --
Thereafter......... 45,000
---------
$48,431
==========
</TABLE>

6. INCOME TAXES

Income before provision for income taxes consists of:
<TABLE>
<CAPTION>
Fiscal Year Ended
------------------------------------------
January 3, January 4, December 30,
1998 1997 1995
------------------------------------------
<S> <C> <C> <C>
Domestic...................... $14,471 $12,200 $ 6,184
Foreign ...................... 1,226 579 48
------------------------------------------
$15,697 $12,779 $ 6,232
==========================================
</TABLE>

<PAGE>

The following is a summary of the provision (benefit) for income taxes:

<TABLE>
<CAPTION>
Fiscal Year Ended
----------------------------------------
January 3, January 4, December 30,
1998 1997 1995
----------------------------------------
<S> <C> <C> <C>
Federal
Current ........................ $ 2,544 $ 2,510 $ 725
Deferred ....................... 1,341 1,300 1,703
----------------------------------------
$ 3,885 $ 3,810 $ 2,428
----------------------------------------
State
Current ........................ $ 410 $ 573 $ 187
Deferred ......,,,,,............ (195) (166) (1,903)
----------------------------------------
$ 215 $ 407 $(1,716)
----------------------------------------
Foreign
Current ........................ $ 60 $ -- $ --
Deferred ....................... 424 -- --
----------------------------------------
$ 484 $ -- $ --
----------------------------------------
$ 4,584 $ 4,217 $ 712
========================================
</TABLE>

A reconciliation between the provision for income taxes before extraordinary
item computed at U.S. federal statutory rates and the amount reflected in the
accompanying consolidated statements of income is as follows:

<TABLE>
<CAPTION>
Fiscal Year Ended
--------------------------------------------
January 3, January 4, December 30,
1998 1997 1995
--------------------------------------------
<S> <C> <C> <C>
Computed expected tax provision ................................ $ 5,494 $ 4,345 $ 2,119
Increase in taxes resulting from:
Amortization of goodwill .............................. 67 67 67
State and foreign income taxes, net
of federal benefit .................................. 893 583 385
Decrease in taxes resulting from:
State investment tax credits,
net of federal provision ............................ (1,075) (319) (452)
Reversal of state deferred taxes due
to change in tax law, net of federal provision....... -- -- (1,050)
Reversal of tax reserves no longer required..... ...... (1,081) (308) (48)
Foreign sales corporation benefit ..................... (485) (245) (270)
Valuation allowance ................................... 750 -- --
Other ................................................. 21 94 (39)
--------------------------------------------
$ 4,584 $ 4,217 $ 712
============================================
</TABLE>

At January 3, 1998, the Company had net operating loss carryforwards of
approximately $1,712 for federal income tax purposes available to offset future
taxable income which have been benefitted for financial reporting purposes.
These carryforwards expire from 2001 to 2005. Additionally, the Company has
available for use $951 of federal tax credit carryforwards, of which
approximately $696 expire from 1999 to 2005. The remaining tax credit
carryforwards have no expiration dates. The timing and use of the net operating
loss carryforwards and the tax credit carryforwards are limited under federal
income tax legislation. In addition, the Company has approximately $2,000
of state investment tax credits. These tax credits have no expiration date;
however, the timing and use of these credits is limited under the applicable
state income tax legislation.

In November 1995, the Massachusetts legislature amended the apportionment
formula for corporate income tax purposes and adopted a single sales factor
formula. The effect of this new apportionment formula will be phased in over a
five year period beginning in 1996. In accordance with SFAS 109, the Company has
recorded the effect of this tax law change on deferred taxes as a reduction of
state deferred tax liability of $1,050, net of federal taxes, as of December 30,
1995.

<PAGE>

The significant items comprising the domestic deferred tax asset/liability are
as follows:

<TABLE>
<CAPTION>
January 3, 1998 January 4, 1997
-------------------------------------------------------------------
Current Long-term Current Long-term
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Net operating loss carryforwards .......................... $ 270 $ 355 $ 259 $ 599
Tax credit carryforwards .................................. 192 2,817 191 951
Receivable reserves ....................................... 197 -- 718 --
Other ............................................... 1,112 1,245 1,311 1,123
------------------------------------------------------------------
Total assets ........................................ $ 1,771 $ 4,417 $ 2,479 $ 2,673
Valuation allowance ................................. -- (750) -- --
------------------------------------------------------------------
Total assets, net of valuation allowance .................. $ 1,771 $ 3,667 $ 2,479 $ 2,673
------------------------------------------------------------------
Liabilities:
Property basis differences ............................... $ -- $(17,582) $ -- $(14,832)
Inventory basis differences .............................. (1,177) -- (1,292) --
------------------------------------------------------------------
Total liabilities ................................. $ (1,177) $(17,582) $ (1,292) $(14,832)
------------------------------------------------------------------
Net assets (liabilities) ....................... $ 594 $(13,915) $ (1,187) $(12,159)
==================================================================
</TABLE>

The Company has provided a valuation allowance for a portion of certain state
tax credits that may not be realized. The significant items comprising the
foreign deferred tax asset/liability are as follows:

<TABLE>
<CAPTION>
January 3, 1998 January 4, 1997
----------------------------------------------------------
Current Long-term Current Long-term
----------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Net operating loss carryforwards ............... $-- $ 144 $-- $ 510
Liabilities:
Inventory ...................................... $(569) $-- $(506) $ --
-----------------------------------------------------------
Net assets (liabilities) ............... $(569) $ 144 $(506) $ 510
===========================================================
</TABLE>

7. COMMITMENTS AND CONTINGENCIES

(A) LITIGATION AND ENVIRONMENTAL CLEANUP MATTERS

The Company is engaged in certain routine environmental cleanup matters. In the
opinion of management, the costs associated with these cleanup matters are not
expected to materially affect the Company's financial condition, results of
operations or liquidity.

(B) LEASES

The Company leases certain facilities and equipment under operating lease
agreements and capital lease agreements that expire at various dates from the
current year to the year 2002. As of January 3, 1998, the aggregate minimum
future commitments under leases are as follows:
<TABLE>
<CAPTION>
Capital Operating Total
Leases Leases Leases
------------------------------------------
<S> <C> <C> <C>
1998............................ $ 1,651 $ 937 $ 2,588
1999............................ 2,240 703 2,943
2000............................ 1,094 443 1,537
2001............................ 2,080 343 2,423
2002............................ 725 155 880
Thereafter...................... -- 39 39
---------------------------------------
$ 7,790 $ 2,620 $10,410
-----------------------
Less -- Amount representing
interest................... 1,287
---------
$ 6,503
Less-- Current portion.......... 1,167
---------
$ 5,336
---------
</TABLE>

Rent expense for operating leases for the years ended January 3, 1998, January
4, 1997 and December 30, 1995 was $953, $1,276 and $1,561, respectively.

In the normal course of its business activities, the Company is required under
certain contracts to provide letters of credit which may be drawn down in the
event the Company fails to perform under the contracts. As of January 3, 1998
and January 4, 1997, the Company has issued or agreed to issue letters of credit
totaling $273 and $472, respectively.

<PAGE>

(D) EMPLOYMENT CONTRACT

In 1997, the Company's Board of Directors approved an amendment to the President
and Chief Executive Officer's Employment Agreement (the "Employment Agreement").
The Employment Agreement provides for Mr. Liebenow to continue to serve as
President and Chief Executive Officer of the Company on a full-time basis
through March 12, 2002, subject to an automatic three-year extension, unless
terminated by the Company upon one year's prior notice. The Employment Agreement
provides for an initial base salary of $600, subject to such annual increases as
may be determined by the Board of Directors, as well as certain benefits and
reimbursement of expenses. If the Employment Agreement had terminated as of
January 3, 1998, Mr. Liebenow would have been entitled to receive $1,980 (in the
event of a voluntary termination, termination for cause or for any other
reason).

8. STOCK OPTIONS

In 1993, the Company adopted the 1993 Stock Option Plan for Company officers,
and options to purchase a total of 635,795 shares of common stock were granted
to certain officers that year. The difference of $1,186 between the fair market
value at the grant date and the exercise price of these options was charged to
compensation expense over five years. During 1996, additional options to
purchase 94,000 shares of common stock were granted to certain officers under
the 1993 Stock Option Plan. The difference of $348 between the fair market value
at the grant date and the exercise price of these options was charged to
compensation expense over five years. The 1993 Stock Option Plan provided that
all options granted under the plan would vest over five years and be exercisable
for ten years except in the event of a change in control, in which case all
outstanding options granted pursuant to the plan would vest immediately. Upon
the consummation of the Company's public offering of common stock in 1997, all
previously unvested options granted under the 1993 Stock Option Plan became
immediately exercisable in full, and the amount of unamortized compensation
expense of $480 was recorded as a charge to the statement of income at that
time.

During 1996, the Company adopted the 1996 Stock Option Plan for key middle
managment employees. Options are granted at not less than fair market value,
vest over a five year period, and are exercisable for ten years. A total of
100,000 shares are reserved under this plan, and options to purchase 87,300
shares have been granted.

During 1997, the Company adopted the 1997 Stock Option Plan. Options to purchase
330,000 shares of common stock were granted to certain officers under the 1997
Stock Option Plan. These options vest over five years, and are exercisable for
ten years. A total of 500,000 shares are reserved under this plan.

During 1995, options to purchase 5,000 shares of common stock were granted to a
director of the Company. These options vest over three years and are exercisable
for ten years. During 1997, options to purchase an aggregate of 10,000 shares of
common stock were granted to two directors of the Company. These options vest
over three years and are exercisable for ten years.

During 1997, the Company recorded $571 as stock option compensation expense.

PRO FORMA STOCK-BASED COMPENSATION EXPENSE

In October 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation," which sets forth a fair-value-based
method of recognizing stock-based compensation expense. As permitted under SFAS
No. 123, the Company has elected to continue to apply APB No. 25 to account for
its stock-based compensation plans. Had compensation cost for awards granted in
Fiscal 1997 and Fiscal 1996 under the Company's stock-based compensation plans
been determined based on the fair value at the grant dates consistent with the
method set forth in SFAS No. 123, the effect on the Company's net income and
earnings per common share would have been as follows:

<TABLE>
<CAPTION>
1997 1996 1995
------------------------------------
<S> <C> <C> <C>
Net income
As reported ....................................... $11,113 $8,562 $5,520
Pro forma ......................................... $10,787 $8,500 $5,513
Earnings per common share - diluted
As reported ....................................... $ 1.28 $ 1.03 $ 0.67
Pro forma ......................................... $ 1.24 $ 1.02 $ 0.67
</TABLE>

Compensation expense for options is reflected over the vesting period;
therefore, future compensation expense may be greater as additional options are
granted.

<PAGE>

The fair value of each option grant was estimated on the grant date using the
Black-Scholes option pricing model with the following weighted average
assumptions:

<TABLE>
<CAPTION>
1997 1996 1995
------------------------------
<S> <C> <C> <C>
Volatility ............................. 44.83% 60.13% 60.13%
Risk-free interest rate................. 6.69% 6.44% 7.25%
Expected life of options................ 6.48 years 10 years 10 years
</TABLE>

The Black-Scholes option pricing model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option pricing models require the input of highly
subjective assumptions, including expected stock price volatility. Because the
Company's stock options have characteristics significantly different from those
of traded options and because changes in the subjective input assumptions used
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options.

STOCK OPTION ACTIVITY

A summary of the Company's stock option activity is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------------------------------------------------------------
Weighted Weighted Weighted
Number Avg. Exercise Number Avg. Exercise Number Avg. Exercise
of Shares Price of Shares Price of Shares Price
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
beginning of year .............. 728,207 $ 2.60 587,707 $2.04 593,325 $ 2.00
Granted ........................... 391,000 $14.96 142,000 $4.97 5,000 $ 11.00
Exercised ......................... (79,587) $ 4.25 -- -- (10,618) $ 4.12
Forfeited ......................... (7,700) $ 8.87 (1,500) $8.25 -- --
Expired ........................... -- -- -- -- -- --
Options outstanding,
end of year .................... 1,031,920 $ 7.11 728,207 $2.60 587,707 $ 2.04
Options exercisable ............... 608,470 $ 2.00 351,284 $2.01 233,083 $ 1.96
Options available for grant ....... 180,200 -- 53,400 -- 94,000 --
Weighted average fair value
per share of options granted.... -- $ 8.25 -- $ 6.07 -- $ 6.24
</TABLE>

A summary of the status of the Company's stock options as of January 3, 1998 is
as follows:

<TABLE>
<CAPTION>
-------------------------------------------------------------------
Range of Weighted Avg. Weighted Avg.
Exercise Number of Remaining Exercise
Prices Shares Contractual Life Price
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
1993 Plan................. $ 1.20- 4.12 599,620 5.70 $ 1.89
1996 Plan ................ $ 8.25-13.00 87,300 8.90 $10.97
1997 Plan................. 15.25 330,000 9.40 $15.25
Directors................. $11.00-15.25 15,000 8.80 $13.83
</TABLE>

9. EXPORT SALES

Export sales from the United States to unaffiliated customers by major
geographical area were as follows:

<TABLE>
<CAPTION>
Fiscal Year Ended
------------------------------------------
January 3, January 4, December 30,
1998 1997 1995
------------------------------------------
<S> <C> <C> <C>
North America (excluding USA) ....... $11,900 $ 9,900 $ 8,500
Middle East ......................... 11,300 13,000 5,800
South America ....................... 1,800 700 200
Europe .............................. 2,900 2,500 1,800
All other areas ..................... 4,600 4,000 3,200
------------------------------------------
$32,500 $30,100 $19,500
==========================================
</TABLE>

10. 401(k) PLAN

The Company has established a 401(k) plan (the "401(k) Plan") for eligible
employees of the Company who may contribute up to 15% of their annual salaries
(up to $9,500) to the 401(k) Plan. All contributions made by an employee are
fully vested and are not subject to forfeiture. Each year the Company
contributes on behalf of each participating employee an amount equal to 100% of
the first $200 contributed by each employee and 25% of the next $800 contributed
by such employee, for a maximum annual Company contribution of $400 per
employee. An employee is fully vested in the contributions made by the Company
upon his or her completion of five years of participation in the 401(k) Plan.

<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

TO QUAKER FABRIC CORPORATION:

We have audited the accompanying consolidated balance sheets of Quaker Fabric
Corporation (a Delaware corporation) and subsidiaries as of January 3, 1998 and
January 4, 1997, and the related statements of income, changes in stockholders'
equity and cash flows for each of the three years ended January 3, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Quaker Fabric
Corporation and subsidiaries as of January 3, 1998 and January 4, 1997, and the
results of their operations and their cash flows for each of the three years
ended January 3, 1998, in conformity with generally accepted accounting
principles.

/s/ Arthur Anderson LLP

Boston, Massachusetts
February 10, 1998

<PAGE>

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 has been producing upholstery fabrics for the residential furniture
market for more than 50 years. Today, 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 apparel and
home furnishings products throughout the United St ates. Over the last five
years, Quaker has achieved sales and net income (excluding extraordinary items)
growth in every year except 1995. Net sales and net income have grown from
$147.9 million and $2.8 million, respectively, in 1993, to $219.2 million and
$11.1 million, respectively, in 1997.

During 1995, the Company reported a decrease in net sales and lower gross,
operating and net margins as a result of a convergence of economic, industry and
Company-specific factors. These factors caused the Company's net sales to
decline $7.3 million, to $173.5 million from $180.8 million in 1994. The Company
encountered poor market conditions in Mexico, Canada and the Middle East, each
of which is an important export market for the Company. As a result, 1995
foreign sales decreased by $10.7 million, or 31.6% below 1994 foreign sales
levels. This decline was partially offset by a $2.9 million increase in net yarn
sales, with domestic fabric sales essentially flat.

Also, in early 1995, significant price increases were announced by several of
the Company's most important raw material suppliers. Such price increases
adversely affected the Company's gross margin, particularly during the latter
part of the year as the Company was unable to fully pass along these cost
increases to customers during 1995.

Finally, during 1995, the Company experienced a number of sharp changes in its
order rates which required several significant adjustments in the Company's
production rates. These adjustments adversely affected equipment utilization
rates, quality performance and overtime costs, contributing to the deterioration
in the Company's 1995 gross margin.

In response to the challenges encountered during 1995, management developed a
comprehensive performance improvement plan designed to increase margins and
earnings by growing sales, reducing raw material costs and improving
manufacturing efficiencies. Following management's implementation of this plan,
the Company's sales and profitability improved in comparison to prior periods in
each of the last three quarters of 1996 and during the first three quarters of
1997.

However, during the second half of 1997, record order rates for the Company's
fabric and yarn products caused the Company's production backlog and delivery
lead times to increase significantly. To respond to this strong and growing
demand for the Company's products and to support its new market development
efforts, during the third quarter of 1997 Quaker began implementing an
aggressive capacity expansion plan involving the installation of more than $50.0
million of new manufacturing equipment between the beginning of the third
quarter of 1997 and the end of the second quarter of 1998.

Period costs associated with the implementation of this plan, including the cost
of identifying and preparing the space needed to house the new equipment
included in the plan, costs related to the hiring and training of the more than
350 new employees needed to run this new equipment, and some deterioration in
the Company's productivity and internal quality performance resulting from the
addition of these new employees adversely affected the Company's margin
performance during the third and fourth quarters of 1997. In addition, heavy
overtime expenses associated with operating almost all of the Company's
manufacturing areas on a six and one-half day per week schedule, to meet
customer demand despite existing capacity constraints, also put pressure on the
Company's margins during the second half of 1997. As a result, the Company's
gross margin percentages fell to 23.0% and 22.3% during the third and fourth
quarters of 1997, respectively, compared to 23.2% and 25.3%, respectively,
during the comparable periods of 1996. These cost factors, as well as costs
associated with the Company's decision to temporarily outsource a small amount
of its manufacturing requirements until all of the equipment included in the
Company's capacity expansion plan is moved into production, are expected to
continue to exert downward pressure on the Company's margins over the near-term.

Externally, current market conditions are generally favorable both domestically
and in the major foreign markets important to the Company. There do not appear
to be any significant raw material price increases on the horizon, and the
economies of most of the countries Quaker is currently exporting to are stable
or growing. The Company has not

<PAGE>

done much business in the Far East historically, so the economic problems
currently occurring there are not a direct threat -- and there is no indication
that alternative competitive product is coming into the United States market. On
the domestic front, management believes that a strong economy characterized by
low interest and unemployment rates, high consumer confidence levels, modest
inflation rates and a general uptick in housing starts underpins the strong
specific demand for Quaker's products.

QUARTERLY OPERATING RESULTS

The following table sets forth certain condensed unaudited consolidated
statements of income data for the eight fiscal quarters ended January 3, 1998,
as well as certain data expressed as a percentage of the Company's total net
sales for the periods indicated:

<TABLE>
<CAPTION>
Fiscal 1997(1) Fiscal 1996(1)
-------------------------------------------------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
-------------------------------------------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales ......................... $53,198 $ 52,475 $55,130 $58,371 $43,254 $51,025 $46,436 $58,141
Gross margin ...................... 13,099 13,006 12,656 13,012 9,297 11,312 10,751 14,709
Gross margin
percentage ...................... 24.6% 24.8% 23.0% 22.3% 21.5% 22.2% 23.2% 25.3%
Operating income .................. 4,631 5,020 4,873 4,938 2,673 4,014 4,053 6,208
Operating income
percentage ...................... 8.7% 9.6% 8.8% 8.5% 6.2% 7.9% 8.7% 10.7%
Income before
provision for
income taxes .................... $3,747 $ 4,181 $ 3,925 $ 3,844 $ 1,696 $ 2,972 $ 2,984 $ 5,127
-------------------------------------------------------------------------
Net income ........................ $2,510 $ 2,801 $ 3,080 $ 2,722 $ 1,136 $ 1,992 $ 1,999 $ 3,435
-------------------------------------------------------------------------
Earnings per common
share-basic ...................... $ 0.31 $ 0.34 $ 0.37 $ 0.32 $ 0.14 $ 0.25 $ 0.25 $ 0.43
-------------------------------------------------------------------------
Earnings per common
share-diluted ................... $ 0.30 $ 0.32 $0.35 $ 0.31 $ 0.14 $ 0.24 $ 0.24 $ 0.41
-------------------------------------------------------------------------
</TABLE>

(1) 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.

The Company follows industry practice by closing its operating facilities for a
one-to-two week period during July of each year. In 1995 and 1996, this shutdown
period, and the resulting effect on sales, occurred in the third fiscal quarter.
In 1997, the first week of the annual shutdown period occurred in the second
fiscal quarter.

PRODUCT MIX

Over the past several years, Quaker has taken steps to expand both the breadth
and depth of the Company's product line by increasing the number of higher
margin, middle to better-end fabrics in its line and by expanding the number of
fabrics it offers at each price point and in each styling category. As a result,
the Company has added new manufacturers of higher-end furniture to its customer
base and positioned itself as a full service supplier of Jacquard and plain
woven fabrics to all of its customers. The following table sets forth certain
information relating to the changes that have occurred in the Company's product
mix and the average gross sales price of its fabrics since 1995:

<TABLE>
<CAPTION>
Fiscal Year
------------------------------------------------------------------------------
1997 1996 1995
------------------------------------------------------------------------------
Percent Percent Percent
of of of
Amount Sales Amount Sales Amount Sales
------------------------------------------------------------------------------
(in thousands, except per yard data)
<S> <C> <C> <C> <C> <C> <C>
Gross fabric sales (dollars):
Promotional-end fabrics .......... $ 57,395 30.2% $54,716 31.0% $ 57,023 36.0%
Middle to better-end fabrics ..... 132,788 69.8 121,702 69.0 101,201 64.0
------------------------------------------------------------------------------
Gross fabric sales ............. $190,183 100.0% $176,418 100.0% $158,224 100.0%
------------------------------------------------------------------------------
Gross fabric sales (yards):
Promotional-end fabrics .......... 16,822 37.4% 16,074 36.9% 17,042 41.8%
Middle to better-end fabrics ..... 28,154 62.6 27,478 63.1 23,719 58.2
------------------------------------------------------------------------------
Gross fabric sales ............. 44,976 100.0% 43,552 100.0% 40,761 100.0%
------------------------------------------------------------------------------
Average gross sales price per yard:
Promotional-end fabrics .......... $ 3.41 $ 3.40 $ 3.35
Middle to better-end fabrics ..... 4.72 4.43 4.27
Average per yard-- all fabrics . 4.23 4.05 3.88
</TABLE>

<PAGE>

GEOGRAPHIC DISTRIBUTION OF 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 sales from its Mexico City, Mexico distribution center. The
Company's 1997 foreign sales were up by $4.0 million, or 11.1% above 1996. The
following table sets forth certain information about the changes which have
occurred in the geographic distribution of the Company's gross fabric sales
since 1995:

<TABLE>
<CAPTION>
Fiscal Year
---------------------------------------------------------------
1997 1996 1995
---------------------------------------------------------------
Percent Percent Percent
of of of
Amount Sales Amount Sales Amount Sales
---------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Gross fabric sales:
Domestic sales ........... $150,525 79.1% $140,717 79.8% $135,037 85.3%
Foreign sales(1).......... 39,658 20.9 35,701 20.2 23,187 14.7
---------------------------------------------------------------
Gross fabric sales..... $190,183 100.0% $176,418 100.0% $158,224 100.0%
---------------------------------------------------------------
</TABLE>

(1) Foreign sales consists of both direct exports from the United States as well
as sales from the Company's Mexico City distribution center.

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the percentages of
the Company's net sales represented by certain income and expense items in the
Company's consolidated statements of income:

Fiscal Year
-------------------------
1997 1996 1995
-------------------------
<S> <C> <C> <C>
Net sales ........................................ 100.0% 100.0% 100.0%
Cost of products sold ............................ 76.4 76.8 79.0
-------------------------
Gross margin ..................................... 23.6 23.2 21.0
Selling, general and administrative expenses ..... 14.7 14.7 15.1
-------------------------
Operating income ................................. 8.9 8.5 5.9
Interest expense, net ............................ 1.7 2.1 2.2
Other expenses, net .............................. -- -- 0.1
-------------------------
Income before provisions for income taxes ........ 7.2 6.4 3.6
Provisions for income taxes ...................... 2.1 2.1 0.4
-------------------------
Net income ....................................... 5.1% 4.3% 3.2%
-------------------------
</TABLE>

FISCAL 1997 COMPARED TO FISCAL 1996

Net Sales. Net sales for 1997 increased $20.3 million, or 10.2%, to $219.2
million from $198.9 million in 1996. Both gross fabric sales and gross yarn
sales were higher during the period. Gross fabric sales increased due to
increases in both domestic and foreign fabric sales. Gross fabric sales within
the United States increased 7.0%, to $150.5 million in 1997 from $140.7 million
in 1996. Foreign sales increased 11.1%, to $39.7 million in 1997 from $35.7
million in 1996. This increase was due to improved sales in Mexico and Canada as
well as increased penetration of other international markets. Gross yarn sales
increased 23.3%, to $33.0 million in 1997 from $26.8 million in 1996.

The gross volume of fabric sold increased 3.3%, to 45.0 million yards in 1997
from 43.6 million yards in 1996. The average gross sales price per yard
increased 4.4%, to $4.23 in 1997 from $4.05 in 1996. The increase was
principally due to a product shift to more middle to better-end fabrics. The
Company sold 2.5% more yards of middle to better-end fabrics and 4.7% more yards
of promotional-end fabrics in 1997 than in 1996. The average gross sales price
per yard of middle to better-end fabrics increased by 6.5%, to $4.72 in 1997
from $4.43 in 1996. The average gross sales price per yard of promotional-end
fabrics increased by 0.3%, to $3.41 in 1997 from $3.40 in 1996.

Gross Margin. The gross margin percentage for the first half of 1997 increased
to 24.7% as compared to 21.9% for the first half of 1996. The increase in the
gross margin percentage was due to 1.) increased sales volume in the
higher-margin middle to better-end and foreign/export fabric categories, 2.)
lower manufacturing costs resulting from improved manufacturing efficiencies,
and 3.) improved manufacturing quality performance resulting in a decrease in
sales of second quality fabric. For the second half of 1997, the gross margin
percentage was 22.6% as compared to 24.3% in 1996. This decrease is attributable
to the effects of the capacity expansion program initiated during the third
quarter of 1997. The adverse effects on gross margin included higher training
costs, reorganization of manufacturing facilities and operations, internal
quality slippage, and higher overtime.

<PAGE>

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $32.3 million in 1997 from $29.1 million in
1996 due to increases in sales commissions, labor and fringes, and freight
expenses associated with the Company's higher net sales for the period. Selling,
general and administrative expenses as a percentage of net sales were 14.7% in
1997 and 1996.

Interest Expense, Net. Interest expense decreased to $3.7 million in 1997 from
$4.1 million in 1996. Lower capital loans and term debt obligations and lower
fees were the primary reasons for this decrease.

Effective Tax Rate. The effective tax rate decreased to 29.2% in 1997 from 33.0%
in 1996. The decrease in the effective tax rate was due to the reversal of tax
reserves no longer required and the increase in the foreign sales corporation
benefit partiallly offset by an increase in state and foreign income taxes. See
Note 6 of Notes to Consolidated Financial Statements included elsewhere in this
report.

FISCAL 1996 COMPARED TO FISCAL 1995 NET SALES.

Net Sales. Net sales for 1996 increased $25.4 million, or 14.6%, to $198.9
million from $173.5 million in 1995. Both gross fabric sales and gross yarn
sales were higher during the period. Gross fabric sales increased due to
increases in both domestic and foreign fabric sales. Gross fabric sales within
the United States increased 4.2%, to $140.7 million in 1996 from $135.0 million
in 1995. Foreign sales increased 54.0%, to $35.7 million in 1996 from $23.2
million in 1995. This increase was due to improved sales in Mexico, Canada
and the Middle East as well as increased penetration of other international
markets. Gross yarn sales increased 42.0%, to $26.8 million in 1996 from
$18.8 million in 1995.

The gross volume of fabric sold increased 6.8%, to 43.6 million yards in 1996
from 40.8 million yards in 1995. The average gross sales price per yard
increased 4.4%, to $4.05 in 1996 from $3.88 in 1995. The increase was
principally due to a product shift to more middle to better-end fabrics. The
Company sold 15.8% more yards of middle to better-end fabrics and 5.7% fewer
yards of promotional-end fabrics in 1996 than in 1995. The average gross sales
price per yard of middle to better-end fabrics increased by 3.7%, to $4.43 in
1996 from $4.27 in 1995. The average gross sales price per yard of
promotional-end fabrics increased by 1.5%, to $3.40 in 1996 from $3.35 in 1995.

Gross Margin. The gross margin percentage for 1996 increased to 23.2% from 21.0%
for 1995. This increase was primarily attributable to the Company's performance
improvement plan which resulted in increased domestic and international sales of
higher-margin, middle to better-end fabrics, improved manufacturing efficiencies
related to the acquisition of newer, more efficient manufacturing equipment and
more efficient use of the Company's existing equipment, improved quality
performance, decreased raw material costs, and the effect of spreading overhead
over a higher sales base.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $29.1 million in 1996 from $26.2 million in
1995 due to increases in sales commissions, labor and fringes, and sampling
expenses associated with the Company's higher net sales for the period. Selling,
general and administrative expenses as a percentage of net sales decreased to
14.7% in 1996 from 15.1% in 1995 due to a significant increase in net sales
without a corresponding increase in overhead.

Interest Expense, Net. Interest expense increased to $4.1 million in 1996 from
$3.9 million in 1995. Lower debt levels were offset by higher commitment fees
associated with increased borrowing availability and other financing charges.

Effective Tax Rate. The effective tax rate increased to 33.0% in 1996 from 11.4%
in 1995. The reduced tax rate for 1995 reflects an adjustment recorded during
the fourth quarter as a result of tax law changes in Massachusetts enacted in
November 1995 which reduced the Company's future deferred tax liability. See
Note 6 of Notes to Consolidated Financial Statements included elsewhere in this
report.

LIQUIDITY AND CAPITAL RESOURCES

The Company historically has financed its operations and capital requirements
through a combination of internally generated funds, borrowings, and equipment
leasing. The Company's capital requirements have arisen principally in
connection with the purchase of equipment to expand production capacity and
improve the Company's quality and productivity performance and with an increase
in the Company's working capital needs related to its sales growth.

The primary source of the Company's liquidity and capital resources has been
operating cash flow. The Company's net cash provided by operating activities was
$12.0 million, $14.8 million and $11.1 million in 1995, 1996 and 1997,
respectively. The Company has supplemented its operating cash flow with
borrowings. Net borrowings (repayments) were $1.3 million in 1995, ($2.5)
million in 1996 and $10.2 million in 1997. The Company also raised $3.3 million
from the offering of 300,000 new shares in 1997.

<PAGE>

Over the last five years, the Company has placed in service new manufacturing
equipment with an aggregate cost of $66.0 million. Capital expenditures in 1996
and 1997 were $12.0 million and $25.5 million, respectively. Capital
expenditures during 1997 were funded by operating cash flow, borrowings and
proceeds from the 1997 Offering. Management anticipates that capital
expenditures will total approximately $54.0 million in 1998, consisting of $45.0
million primarily for new production equipment to expand chenille yarn capacity,
increase weaving capacity, and support the Company's marketing, productivity,
quality, service and financial performance objectives. Management believes that
operating income and borrowings under the Credit Agreement, will provide
sufficient funding for the Company's capital expenditures and working capital
needs for the foreseeable future.

During 1997, the Company began implementation of a major computer system
upgrade. Full conversion to the new Enterprise Resource Planning system is
expected during 1998. The total project cost is approximately $4.5 million. See
"Year 2000" below.

As discussed in Note 5 of Notes to Consolidated Financial Statements, the
Company issued $45.0 million of Senior Notes due October 2005 and 2007 (the
"Senior Notes") during 1997. Proceeds from the Senior Notes were used to replace
the 6.81% Series A Notes and reduce borrowings under the Credit Agreement. The
Senior Notes bear interest at a fixed rate of 7.09% on $15.0 million and 7.18%
on $30.0 million. Annual principal payments begin on October 10, 2003 with a
final payment due October 10, 2007.

The Company also has a $50.0 million Credit Agreement with a bank which expires
December 31, 2002. As of January 3, 1998, the Company had $1.7 million
outstanding under the Credit Agreement and unused availability of $48.0 million,
net of outstanding letters of credit.

The Company is required to comply with a number of affirmative and negative
covenants under the Credit Agreement and the Senior Notes, including, but not
limited to, maintenance of certain financial tests and ratios (including
interest coverage ratios, net worth related ratios, and net worth requirements);
limitations on certain business activities of the Company; restrictions on the
Company's ability to declare and pay dividends, incur additional indebtedness,
create certain liens, incur capital lease obligations, make certain investments,
engage in certain transactions with stockholders and affiliates, make capital
expenditures in excess of certain specified amounts, and purchase, merge, or
consolidate with or into any other corporation. The Company is currently in
compliance with all of the affirmative and negative covenants in the Credit
Agreement and the Senior Notes and management believes the Company's continued
compliance will not prevent the Company from operating in the normal course of
business.

INFLATION

The Company does not believe that inflation has had a significant impact on the
Company's results of operations for the periods presented. Historically, the
Company believes it has been able to minimize the effects of inflation by
improving its manufacturing and purchasing efficiency, by increasing employee
productivity, by reflecting the effects of inflation in the selling prices of
the new products it introduces each year and, to a lesser degree, by increasing
the selling prices of those products which have been included in the Company's
product line for more than one year.

FOREIGN CURRENCY TRANSLATION

All of the Company's sales are denominated in U.S. dollars except sales through
the Company's Mexico City distribution center. These sales are denominated in
pesos and are, therefore, subject to currency fluctuations. Accounts receivable
in pesos at January 3, 1998 were $2.4 million.

Mexico has been designated as a "highly inflationary country" for purposes of
applying Statement of Financial Standards No. 52, Foreign Currency Translation.
Accordingly, in 1997 the Company recorded translation gains and losses in
the income statement rather than as a separate component of equity. See
Note 2(i) of Notes to Consolidated Financial Statements included elsewhere in
this report.

YEAR 2000

During 1996, the Company began a project to review all of its computer systems.
Among the considerations at that time was what impact, if any, would the year
2000 have on computer systems. In late 1996, the Company made a commitment to
purchase and install a new computer system to meet its current and projected
needs. In addition to providing new systems applications, the software complies
with the year 2000 requirement.

The process of implementing the new software package began in 1997 and is
expected to be completed during 1998. Management believes that subject to the
successful implementation of this new software package, the year 2000 issue will
not have a material adverse impact on the Company's operations.

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

<PAGE>

SUMMARY QUARTERLY FINANCIAL DATA

(Unaudited)

The following is a summary of the results of operations for each of the quarters
within the years ended January 3, 1998 and January 4, 1997.

In thousands, except per share data

First Second Third Fourth
1997 Quarter Quarter Quarter Quarter
- -----------------------------------------------------------------------------
NET SALES ......................... $53,198 $52,475 $55,130 $58,371
GROSS MARGIN ...................... 13,099 13,006 12,656 13,012
OPERATING INCOME .................. 4,631 5,020 4,873 4,938
NET INCOME (LOSS) ................. $ 2,510 $ 2,801 $ 3,080 $ 2,722
EARNINGS PER COMMON SHARE-BASIC ... $ 0.31 $ 0.34 $ 0.37 $ 0.32
EARNINGS PER COMMON SHARE-DILUTED.. $ 0.30 $ 0.32 $ 0.35 $ 0.31

First Second Third Fourth
1996 Quarter Quarter Quarter Quarter
- -----------------------------------------------------------------------------
Net sales ......................... $43,254 $51,025 $46,436 $58,141
Gross margin ...................... 9,297 11,312 10,751 14,709
Operating income .................. 2,673 4,014 4,053 6,208
Net income (loss) ................. $ 1,136 $ 1,992 $ 1,999 $ 3,435
Earnings per common share-basic.... $ 0.14 $ 0.25 $ 0.25 $ 0.43
Earnings per common share-diluted.. $ 0.14 $ 0.24 $ 0.24 $ 0.41

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

The following summarizes common stock prices for the years ended January 3,
1998 and January 4, 1997.

Price per Share
1997 High Low
- ---------------------------------------------------------------------
FIRST QUARTER ............................ $18.50 $13.00
SECOND QUARTER ........................... $17.00 $13.00
THIRD QUARTER ............................ $23.88 $15.00
FOURTH QUARTER ........................... $24.25 $17.00

Price per Share
1997 High Low
- ---------------------------------------------------------------------
First Quarter ............................ $ 9.50 $ 5.69
Second Quarter ........................... $ 9.75 $ 7.25
Third Quarter ............................ $10.63 $ 7.00
Fourth Quarter ........................... $14.50 $ 9.25

(1) The Company's common stock is traded over the counter and is quoted on the
Nasdaq National Market under the symbol "QFAB."
(2) No dividends have been paid on the Company's common stock.
(3) As of March 17, 1998, there were approximately 49 record holders of common
stock.
(4) The Company's Credit Agreement and Senior Notes contain restrictive
covenants which limit the Company's ability to declare and pay dividends. Under
the most restrictive of these covenants, $17.5 million was available for the
payment of dividends as of January 3, 1998.

<PAGE>

GENERAL INFORMATION

DIRECTORS
- -------------------------------------------------------------------------------
SANGWOO AHN, Chairman DR. JERRY I. PORRAS
Partner Lane Professor of Organizational
Morgan Lewis Githens & Ahn Behavior and Change
Stanford University Graduate
LARRY A. LIEBENOW School of Business
President and CEO
Quaker Fabric Corporation ERIBERTO R. SCOCIMARA
President and Chief Executive Officer
Hungarian-American Enterprise Fund

COMMITTEES
- --------------------------------------------------------------------------------
AUDIT COMMITTEE COMPENSATION COMMITTEE
Sangwoo Ahn Sangwoo Ahn
Eriberto R. Scocimara Larry A. Liebenow
Jerry I. Porras
STOCK OPTION COMMITTEE
Sangwoo Ahn
Jerry I. Porras

OFFICERS
- -------------------------------------------------------------------------------
LARRY A. LIEBENOW PAUL J. KELLY
President and Chief Vice President - Finance,
Executive Officer Treasurer and Chief Financial Officer

ANTHONY DEGOMES THOMAS MUZEKARI
Vice President Vice President
New Business Development Marketing

JAMES A. DULUDE BEATRICE SPIRES
Vice President Vice President
Manufacturing Styling and Design

THOMAS J. FINNERAN J. DUNCAN WHITEHEAD
Vice President Vice President
Sales Technology and Development,
and Yarn Sales
CYNTHIA L. GORDAN
Vice President, Secretary
and General Counsel

CORPORATE DATA
- --------------------------------------------------------------------------------
CORPORATE OFFICE INDEPENDENT AUDITORS
Quaker Fabric Corporation Arthur Andersen LLP
941 Grinnell Street 225 Franklin Street
Fall River, Massachusetts 02721 Boston, Massachusetts 02110
(508) 678-1951
LEGAL COUNSEL
ANNUAL MEETING Proskauer Rose Goetz & Mendelsohn LLP
11:00 a.m., May 28, 1998 1585 Broadway
Bank of Boston New York, New York 10036
100 Federal Street
Boston, Massachusetts 02105 FORM 10-K
The Company's Form 10-K Report,
TRANSFER AGENT AND REGISTRAR as filed with the Securities and
First National Bank of Boston Exchange Commission, is available
150 Royall Street to stockholders without charge
Canton, Massachusetts 02021 upon request to the Corporate Office,
(781) 575-3170 Attn: Corporate Secretary.

NASDAQ (National Market System)
Trading Symbol - QFAB

32
STATEMENT OF DIFFERENCES
------------------------

The trademark symbol shall be expressed as............................ 'tm'

<PAGE>