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                      SECURITIES AND EXCHANGE COMMISSION
                             Washington, DC 20549
 
                                   FORM 10-K
 
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934
 
                   For the fiscal year ended January 2, 1999
 
                        Commission file number 1-14330
 
                              POLYMER GROUP, INC.
            (Exact name of registrant as specified in its charter)
 
<TABLE>
<CAPTION>
                  Delaware                                       57-1003983
<S>                                            <C>
       (State or other jurisdiction of                        (I.R.S. Employer
        incorporation or organization)                      Identification No.)
</TABLE>
 
<TABLE>
<CAPTION>
             4838 Jenkins Avenue                                   29405
      North Charleston, South Carolina                           (Zip Code)
<S>                                            <C>
  (Address of principal executive offices)
</TABLE>
 
      Registrant's telephone number, including area code: (843) 566-7293
 
          Securities registered pursuant to Section 12(b) of the Act:
 
<TABLE>
<CAPTION>
                                                          Name of each exchange on
        Titles of each class of stock:                       which registered:
        ------------------------------                    ------------------------
<S>                                            <C>
           Common Stock, par value                        New York Stock Exchange
                $.01 per share
</TABLE>
 
       Securities registered pursuant to Section 12(g) of the Act: None
 
  Indicate by check mark whether registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the last 90 days. Yes  X  No
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
 
  The aggregate market value of the Company's voting stock held by
nonaffiliates as of March 26, 1999 was $156,848,496. As of March 26, 1999,
there were 32,000,000 shares of common stock, par value $.01 per share
outstanding.
 
                      Documents Incorporated By Reference
 
  Notice of 1999 Annual Meeting of Stockholders and Proxy Statement--Part III
 
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<PAGE>
 
                                    PART 1
 
ITEM 1. BUSINESS
 
General
 
  Polymer Group, Inc. (the "Company") is a leading worldwide manufacturer and
marketer of a broad range of nonwoven and oriented polyolefin products. The
Company's principal lines of business include reusable wiping, medical,
hygiene and industrial and specialty products which include a new family of
Miratec(R) products. The Company believes that it is the third largest
producer of nonwovens as well as the largest producer of spunbond and spunmelt
products in the world and that it employs the most extensive range of
nonwovens technologies of any nonwovens producer, which allows it to supply
products tailored to customers' needs at competitive prices. Nonwovens are
flat, flexible porous sheets produced by interlocking fibers or filaments or
by perforating films. Nonwovens provide certain qualities similar to those of
textiles at a significantly lower cost. The Company also believes that it is
the largest producer of oriented polyethylene materials in North America.
Oriented polyolefin products include woven, slit film fabrics, which are
produced by weaving narrow tapes of slit film and are characterized by high
strength-to-weight ratios, and also include twisted slit film or monofilament
strands.
 
  The Company supplies nonwovens to a number of the largest consumer and
industrial products manufacturers in the world and specifically targets market
niches with high margin, high value-added products. The Company has a global
presence with an established customer base in the three major developed
markets of North America, Europe and Japan, as well as in developing markets
such as South America, China and North Africa. The Company's product offerings
are sold principally to converters that manufacture a wide range of end-use
products, such as hospital surgical gowns and drapes, wound care sponges,
multi-use wiping cloths and towels, flexible industrial packaging, filtration
media, electrical insulation, cable wrap, alkaline battery cell separators,
disposable diapers, feminine hygiene products, automotive insulation products,
apparel, draperies and home furnishings. The Company supplies nonwovens to
customers such as Johnson & Johnson for hygiene related and healthcare
products, including operating room gowns, and The Procter & Gamble Company
("Procter & Gamble") for Pampers(R) and Luvs(R) diapers.
 
  The Company is a leader in nonwovens and extrusion process technologies. The
Company operates twenty-three manufacturing facilities (including its joint
venture in Argentina) located in eight countries and is currently the only
nonwovens producer that utilizes essentially all of the established nonwovens
process technologies. The Company believes that the quality of its
manufacturing operations and the breadth of its nonwovens process technologies
give it a competitive advantage in meeting the current and future needs of its
customers and in leading the development of an expanded range of applications
for nonwovens. The Company continues to make significant investments in
advanced technology in order to increase capacity, improve quality and develop
new low-cost, high-value structures. The Company currently operates four 4.2
meter advanced spunbond/meltblown/ spunbond ("SMS") lines and a unique
spunbond/meltblown/meltblown/spunbond ("SMMS") line at its Waynesboro,
Virginia facility, which began initial commercial production in June 1998.
This advanced technology allows the Company to produce highly uniform
structures with less material than conventional SMS technology. The Company
believes that its broad technological base gives it the capability to design
and manufacture products with optimal cost and functionality. Working as a
developmental partner with its major customers, the Company utilizes its
technological capabilities and depth of research and development resources to
develop and manufacture new products to specifically meet their needs.
 
  In December 1998 the Company completed construction and began commercial
production on its first full-scale APEX(TM) line in Benson, NC. This facility
produces the new Miratec(R) products which open up significant growth
opportunities to the Company.
 
                                       2
<PAGE>
 
  Management has built the Company through a series of capital expansions and
strategic business acquisitions that have broadened the Company's technology
base, increased its product lines and expanded its global presence. The
Company's strategic acquisitions have helped it to establish strong positions
in both the nonwoven and oriented polyolefin markets. Moreover, the Company's
consolidated resources have enabled it to better meet the needs of existing
customers, to reach emerging geographic markets and to exploit niche market
opportunities through customer-driven product development.
 
History of the Company
 
  The Company was organized on June 16, 1994 and, effective June 24, 1994,
acquired a 100% ownership interest in PGI Polymer, Inc. ("PGI Polymer"), which
was incorporated in September 1992 by The InterTech Group, Inc. ("InterTech")
and Golder, Thoma, Cressey, Rauner, Inc. ("Golder, Thoma") to act as a holding
company for entities engaged in the development, manufacturing and marketing
of polyolefin products.
 
  Prior to acquisition by the Company, PGI Polymer acquired from InterTech
approximately 27% of the issued and outstanding shares of stock of Fabrene,
Inc. ("Fabrene"), a leading manufacturer of industrial and commercial oriented
polyolefins. In addition, in October 1992, through its wholly-owned subsidiary
FiberTech Group, Inc. ("FiberTech"), PGI Polymer acquired the Nonwoven
Products Division (the "Predecessor") of Scott Paper Company, a major supplier
of nonwovens for diapers and other hygiene products. Together, Fabrene and
FiberTech offered substantial representation in both the nonwoven and oriented
polyolefin markets.
 
  In connection with the Company's formation (at which point it became the
100% parent owner of PGI Polymer), the Company purchased from Cydsa, S.A. all
of the outstanding shares of Bonlam, S.A. de C.V. ("Bonlam"), the largest
manufacturer of spunbond nonwoven fabrics in Mexico (the "Bonlam Acquisition")
as well as the remaining 73% interest in Fabrene from InterTech. The Bonlam
Acquisition not only presented the opportunity to meet existing customers'
needs in Mexico, but also provided the Company with the additional nonwoven
capacity necessary to meet growing demand in North American and Latin American
markets.
 
  In March 1995, the Company purchased the Johnson & Johnson Advanced Material
Company and Chicopee B.V. (collectively, "Chicopee"), leading manufacturers
and marketers of nonwoven roll and converted products in North America and
Europe (the "Chicopee Acquisition"), and consummated certain other
restructuring and financing transactions. Through the Chicopee Acquisition,
the Company gained substantial manufacturing and technological resources,
consumer market recognition of certain of Chicopee's branded product lines and
a significant presence in the nonwovens markets for wipes and medical
products.
 
  In May 1996, the Company completed its initial public offering (the "IPO")
of 11.5 million shares of Common Stock at a price of $18.00 per share. The
Company also refinanced its outstanding indebtedness by retiring a portion of
its 12 1/4% Senior Notes due 2002 issued in 1994 and establishing its Amended
and Restated Credit Facility, dated May 15, 1996 (the "Old Credit Facility"),
with Chase Manhattan Bank ("Chase Bank").
 
  In August 1996, the Company completed its acquisition of the business of PNA
Corp. and its wholly-owned subsidiary, FNA Polymer Corp. (collectively "FNA"),
a North Carolina based nonwovens producer (the "FNA Acquisition"). The
acquisition strengthened the Company's strategic position in the hygiene
materials market and broadened its offering of medical and agricultural
materials.
 
  On July 3, 1997, the Company consummated its offering of $400,000,000 of 9%
Senior Subordinated Notes due 2007, amended its Amended and Restated Credit
Facility, dated May 15,
 
                                       3
<PAGE>
 
1996 (as amended, the "Credit Facility"), and repurchased and retired all of
its outstanding 12 1/4% Senior Notes due 2002.
 
  On December 19, 1997, DT Acquisition (as defined), a special purpose
subsidiary of the Company, completed the purchase of approximately 98% of the
outstanding common shares of Dominion (as defined) for Cdn $14.50 per share
and 96% of the outstanding preferred shares for Cdn $150 per share.
 
  On January 29, 1998, DT Acquisition acquired all remaining common and
preferred shares of Dominion. Concurrently, the apparel fabrics business of
Dominion was sold to Galey (as defined), pursuant to a Purchase Agreement
dated October 27, 1997, for approximately $464.5 million and the Company
acquired the assets and liabilities which comprised the nonwovens and
industrial fabrics operations for approximately $351.6 million.
 
  On March 5, 1998, the Company consummated its offering of $200,000,000 of 8
3/4% Senior Subordinated Notes due 2008 and on March 16, 1998 completed the
acquisition of a leading North America manufacturer of polypropylene-based
commercial twine and polyethylene-based specialty knitted products. See
"Recent Transactions."
 
Industry Overview
 
  The Company competes primarily in the worldwide market for nonwovens, which
is approximately a $8.2 billion market, according to industry sources. The
nonwovens industry began in the 1950s when paper, textile and chemical
technologies were combined to produce new fabrics and products with the
attributes of textiles but at a significantly lower cost. Today, nonwovens are
used in a wide variety of consumer, industrial and healthcare products as a
result of their superior functionality and relatively low cost.
 
  The nonwovens industry has benefitted from substantial improvements in
technology over the past several years, which have increased the number of new
applications for nonwovens, and therefore increased demand. The Company
believes, based on industry sources, that demand in the developed markets of
North America, Western Europe and Japan will increase 4-6% in each of the next
five years, while the emerging markets are forecasted to grow at a rate of 6-
7% per annum. In the developed markets, growth will be driven primarily by new
applications for nonwovens, while growth in the emerging markets will be
volume driven as per capita income rises in these countries. According to
industry sources, worldwide consumption of nonwovens increased an average of
7% per annum from 1988 through 1998. During 1998, the global growth rate for
nonwovens was adversely affected by lower raw material prices and a weakening
of foreign currencies against the U.S. dollar. The Company also believes that
future growth will depend upon the continuation of improvements in raw
materials and technology, which should result in the development of high-
performance nonwovens, leading to new uses and markets at a lower cost than
alternative materials.
 
  Nonwovens are categorized as either disposable (approximately 85% of
worldwide consumer sales in square yards, according to industry sources),
which is the category in which the Company primarily competes, or durable
(approximately 15% of worldwide consumer sales in square yards, according to
industry sources). The largest end uses for disposable nonwovens are for
hygiene applications, including disposable diapers, feminine sanitary
protection, baby wipes, adult incontinence products, and healthcare
applications, including surgical gowns and drapes and woundcare sponges and
dressings. Other disposable end uses include reusable wipes, filtration media,
protective apparel and fabric softener sheets. Durable end uses include
apparel interlinings, furniture and bedding construction sheeting, cable wrap,
electrical insulation, alkaline battery cell separators, automotive
components, geotextiles, roofing membranes, carpet backing, agricultural
fabrics, durable papers and coated and laminated structures for wallcoverings,
upholstery, shoes and luggage.
 
                                       4
<PAGE>
 
  The Company also competes in the North American market for oriented
polyolefin products. Chemical polyolefin products include woven, slit-film
fabrics produced by weaving narrow tapes of slit film and characterized by
high strength-to-weight ratios, and also include twisted slit film or
monofilament strands. While the broad uncoated oriented polyolefin market is
primarily focused on carpet backing fabric and, to a lesser extent,
geotextiles and bags, the markets in which the Company primarily competes are
made up of a large number of specialized products manufactured for niche
applications. These markets include demanding industrial packaging
applications such as lumberwrap, steel wrap and fiberglass packaging, as well
as high-strength protective coverings and specialized components that are
integrated into a variety of industrial and consumer products.
 
  With its development of the Miratec(R) fabrics using the Company's
proprietary APEX(TM) manufacturing process, the Company believes it can access
new markets for its products. Products that incorporate fabric woven or
knitted using the majority of traditional fibers are potential markets for
Miratec(R). The Company believes that Miratec(R) production requires
substantially less labor than traditional textile manufacturing, requires less
capital investment per unit of output, offers greater design flexibility, and
provides enhanced turnaround times for the end-use customer. Furthermore, the
APEX(TM) process can create unique products which cannot be manufactured
through traditional processes.
 
Competitive Strengths
 
  The Company believes that it has a strong competitive position attributable
to a number of factors, including the following:
 
    Technological Leadership. The Company believes it is a technological
  leader in developing and manufacturing nonwovens and oriented polyolefin
  products. The Company is currently the only nonwovens producer that
  utilizes all of the established nonwoven process technologies and holds
  various patents on yield- and efficiency-enhancing manufacturing processes.
  In addition, the Company enjoys exclusive use of the proprietary APEX(TM)
  structural web technology. The depth and expertise of the Company's
  research and development staff have enabled the Company to develop
  innovative products, frequently in response to specific customer needs. In
  addition, the Company focuses its research and development efforts on
  increasing its production capacity and improving its production processes,
  developing innovative products for new markets based on the Company's
  existing technologies, and developing new process technologies to enhance
  existing business and to enter new markets. The Company's multinational
  presence enables it to globally coordinate advanced production initiatives
  and to co-develop new products directly with international customers. In
  1998, the Company established the Advanced Materials Center in Mooresville,
  NC. The Center brings together scientists, engineers, and project managers
  to develop products based on customers' needs and emerging market demands.
 
    State-of-the-Art Manufacturing Capabilities. The Company believes that it
  has state-of-the-art manufacturing capabilities in both its nonwovens and
  oriented polyolefin product lines. As a result, the Company is one of the
  lowest cost producers in the markets in which it participates. The Company
  currently operates three state-of-the-art SMS lines, located at its
  Waynesboro, Virginia; Mooresville, North Carolina; and San Luis Potosi,
  Mexico facilities, and a fourth is located at the DNS joint venture
  facility. The Company has also completed construction of a unique SMMS line
  at its Waynesboro, Virginia facility, which began initial commercial
  production in June 1998. The Company employs, among others, manufacturing
  technology by Reifenhauser GmbH & Co., the recognized leader in advanced
  SMS commercial equipment. Additionally, the Company continues to enhance
  its production lines with internally developed, proprietary manufacturing
  technologies and has the capability of using multiple polymer/resin
  streams. The December 1998 completion of the first full-scale commercial
  APEX(TM) line in Benson, North Carolina demonstrates the Company's
  commitment to maintaining and developing state-of-the-art manufacturing
  capabilities.
 
                                       5
<PAGE>
 
    Significant Market Share in Primary Markets. The Company has developed
  significant market shares in its primary markets. For example, the Company
  believes that it has a significant share of the noncaptive hygiene market
  and the wipes market and that it is the leading North American manufacturer
  of lumberwrap and oriented uncoated material used for lamination to paper
  for the steel wrap market. The Company also believes that it is the leading
  North American supplier in both the manufactured housing bottom board and
  fiberglass packaging markets, as well as a global leader in the nonwovens
  cable wrap and alkaline battery cell separator markets. The Company
  believes it has been able to secure and maintain its position in these
  markets as a result of its commitment to, and reputation for, innovation
  and quality.
 
    Experienced and Committed Management Team. The Company's senior
  management team has significant experience in the manufacturing and
  marketing of polyolefin products, with an average of 13 years of experience
  in this industry. Management's experience includes acquiring and employing
  assets at a low cost as well as increasing asset utilization and
  productivity. Management also has a successful track record of acquiring,
  improving and integrating complementary businesses into the Company.
 
    Key Customer Relationships. The Company has successfully cultivated long-
  term relationships with key customers, such as Johnson & Johnson and
  Procter & Gamble, who are market leaders in their industries. The Company
  currently works closely as a partner with Procter & Gamble and other
  customers to develop advanced components for next generation disposable
  diapers and other hygiene products. The Company has negotiated a favorable,
  long-term supply agreement with Johnson & Johnson, under which it is the
  exclusive provider of nonwoven fabric requirements for Johnson & Johnson.
  Similarly, the Company enjoys an exclusive, long-term supply contract with
  Bulldog Bag Ltd. for its oriented polyolefin product line. The Company's
  success in developing and strengthening its relationships with these and
  other key customers is attributable to its commitment to product quality,
  dedication to customer technical service and ability to develop innovative
  applications for existing products.
 
  By focusing on the Company's competitive strengths, management has
positioned the Company to address the current and future needs of the
nonwovens and oriented polyolefin markets by providing high value, low cost
products to converters and end-use customers in specialty niche application
markets on a global basis.
 
Business Strategy
 
The Company's goals are to continue to grow its core businesses while
developing new technologies to capitalize on a broad range of new high-margin
product opportunities and expanded geographic markets. The Company intends to
be the leading supplier in its chosen markets by delivering high-quality
products and services at competitive prices. To achieve these goals, the
Company's primary strategy focuses on:
 
    Strategic Acquisitions. The Company continuously evaluates opportunities
  to make acquisitions which complement and expand its core businesses or
  which have the potential to increase market share and distribution
  capability in high-margin complementary products. For example, on January
  29, 1998, the Company completed the acquisition of the Nonwovens Business,
  which served to consolidate the Company's position as the leading supplier
  of spunbond and spunmelt nonwovens in North America, to expand its presence
  in the rapidly growing spunbond nonwovens market in Latin America and to
  develop a significant operating base in the specialty dry-laid nonwovens
  market in Western Europe. The Company believes that as a result of the
  Nonwovens Acquisition, it is now the third largest producer of nonwovens in
  the world as well as the largest producer of spunbond and spunmelt products
  in the world. In addition, on March 16, 1998 the Company acquired the
  Oriented Polymer Business which expanded the Company's product offerings
  and enhanced raw materials purchasing opportunities. See "Recent
  Transactions."
 
                                       6
<PAGE>
 
    Continuous Improvement Aimed at Increasing Product Value and Reducing
  Costs. The Company is committed to continuous improvements throughout its
  business to increase product value and lower costs. The Company's product
  design teams continuously seek to incorporate new materials and operating
  capabilities that enhance or maintain performance specifications while
  lowering the cost of raw materials used in the products. State-of-the-art
  equipment, much of which has been developed internally and is proprietary
  to the Company, has been designed and installed to continuously measure
  process parameters and maintain very narrow tolerances, resulting in higher
  levels of product consistency and reduced waste. The Company also holds
  several patents protecting yield- and efficiency-enhancing manufacturing
  processes developed by its research and development staff. As a result, the
  Company's manufacturing processes utilize less material and produce a
  higher quality finished product than many of its competitors. In addition,
  the Company maintains a human resource program aimed at capturing
  productivity gains through team building, formal training and employee
  empowerment.
 
    Entrance into New Markets with New Products. Through the use of the
  proprietary APEX(TM) technology, the Company is developing a market for its
  Miratec(R) products as a "textile replacement". Miratec(R) fabrics have the
  look, feel, stength and durability of traditional woven or knit textiles,
  but are manufactured with substantially less labor at significantly faster
  speeds, and with far greater design capability. This combination of
  characteristics has led to several joint development agreements with
  leading manufacturers, among them Guilford of Maine (a division of
  Interface, Inc.), The Pillow Factory, WestPoint Stevens, Hunter-Douglas,
  Sommers, Inc. and CMI Enterprises. End-use applications include home
  furnishings, floor coverings, home fashion/decorating, automotive interior
  fabrics, apparel, medical, industrial and specialty uses. The Company's
  strategy for Miratec(R) is one of aggressive expansion. The Company
  installed its first full-scale commercial Miratec(R) line in 1998, and two
  additional lines are scheduled to be installed in 1999. With these
  additional lines, new joint development and supply agreements will be
  sought with a wide variety of leading manufacturers.
 
    Development of High Value-Added Niche Products. The Company is committed
  to investment in the development of products for high value-added niche
  markets. One new offering is its Reticulon(R) brand apertured film, which
  is used as a facing film on feminine hygiene products and in filtration
  applications. The Company also recently introduced a new line of meltblown
  materials for a wide range of wet and dry filtration applications. The
  Company has taken steps to begin commercialization of additional medical
  gown and drape technologies as well as new, high-margin wiping applications
  incorporating antibacterial agents.
 
    Entrance into New Markets with Existing Products. The Company believes
  that it has significant additional market opportunities for its existing
  products. The Company is actively expanding its capabilities to take
  advantage of the penetration and growth of its core products
  internationally, particularly in developing countries. For example, the
  Company has increased sales to Latin America, the Caribbean, New Zealand
  and Australia. The Nonwovens Acquisition further enhanced the Company's
  presence in Western Europe, Latin America, North Africa and the Far East.
  Over the past five years, the Company's sales from manufacturing facilities
  outside the United States have increased from approximately $28 million in
  1993 to approximately $335 million in 1998. In addition, the Company has
  expanded its technical marketing staff to pursue novel applications of its
  current products with new segments of end users. For example, the Company
  has developed a multimillion square meter market in Europe for a new
  hygiene application by introducing a product and technology primarily used
  as a wipe in North America.
 
    Expansion of Capacity through Capital Projects. The Company continuously
  evaluates opportunities to expand its existing production capacity and
  enhance production technologies. Since 1992, the Company has invested in
  capital improvements to debottleneck existing operations and to add new
  capabilities and capacity. The latest of these projects are the state-of-
  the-art SMMS line at the Waynesboro, Virginia facility, and the 4.2 meter
  SMS line at the Mooresville, North Carolina facility. The Waynesboro
  facility SMMS line began initial commercial
 
                                       7
<PAGE>
 
  production in June 1998. The Company believes that the SMMS line is the
  most productive line in the world. The Company recently installed a new,
  heavyweight APEX(TM) line at its Benson, North Carolina facility, which
  began commercial operations in December 1998. In addition, the Company's
  oriented polyolefin business has completed a series of expansions and
  debottlenecking projects since 1990, which have cumulatively increased
  capacity (exclusive of the capacity gained in the Oriented Polymer
  Acquisition). The expansions include facilities in North Bay, Ontario;
  Portland, Oregon; and Albany, New York.
 
  Through the implementation of its business strategy, management has achieved
an increase in net sales from $165.3 million in 1994 to $802.9 million in
1998. Management also achieved an increase in gross margins from 21.9% in 1994
to 25.3% in 1998, and an increase in earnings before interest, taxes,
depreciation and amortization ("EBITDA") from $23.9 million in 1994 to
approximately $164.9 million in 1998.
 
Products
 
  The Company develops, manufactures and sells a broad array of nonwovens,
oriented polyolefin products, conulated/apertured (perforated) films,
laminated composite structures, converted wipes and sorbent products. Sales
are focused in four general product categories that provide opportunities to
leverage the Company's advanced technology and substantial capacity. These
product categories include industrial and specialty, reusable wiping, medical
and hygiene products. (See Note 13 "Segments and Geographic Information" in
accompanying financial statements.)
 
  Marketing and research and development teams are committed to constant
product innovation in conjunction with, or at the request of, the Company's
customers. Close long-term relationships with end-use customers enable the
Company to better understand its customers' needs and have been a significant
factor in the Company's success. In addition, the research and development
teams seek to develop high value-added specialty products using existing
assets in order to leverage the Company's capabilities to produce high-margin
products.
 
 Industrial and Specialty Products
 
  The industrial and specialty products category represented approximately
35%, 21% and 21% or $283.5 million, $111.5 million and $107.8 million, of the
Company's net sales for 1998, 1997 and 1996, respectively. Demand for this
product category is distributed among hundreds of end-use applications. The
Company's strength in engineering and extensive range of process technologies
are well-suited to meet the specialized functionality requirements in this
category. Customers typically have very specific performance and quality
requirements that demand efficient design and process conditions, both of
which are strategic strengths of the Company.
 
  The Company produces a broad range of industrial and specialty products,
including alkaline battery cell separators, cable wrap, electrical insulation,
electronic clean room wipes, manufactured housing bottom board fabric (used to
enclose the underside of a manufactured home), home furnishing dust covers and
mattress pads, window coverings, protective apparel and specialized protective
coverings such as golf green covers, pool covers, salt pile covers, landfill
covers and athletic field covers. The Company also produces a variety of
flexible packaging products utilizing coated and uncoated oriented polyolefin
fabrics such as: Arbrene(R) and Lumber Guard(R) lumberwrap, which are used to
cover high-quality kiln dried lumber for shipping and storage; fiberglass
packaging tubes, which hold batts of insulation under compression for
efficient storage and shipping; balewrap for synthetic and cotton fibers;
steel and aluminum wrap, which are used to cover mill rolls; and coated
oriented bags for animal feed, specialty chemicals and mineral fibers. The
Company is a leading supplier of several of these products, including wetlaid
alkaline battery cell separators, oriented lumberwrap, fiberglass packaging
and bottom board fabric and cable wrap.
 
                                       8
<PAGE>
 
  Included in this business segment is the Company's new Miratec(R) fabrics.
Through the use of the proprietary APEX(TM) technology, the Company is
developing a market for its Miratec(R) products as a "textile replacement".
Miratec(R) fabrics have the look, feel, strength and durability of traditional
woven or knit textiles, but are manufactured with substantially less labor at
significantly faster speeds, and with far greater design capability. This
combination of characteristics has led to several joint development agreements
with leading manufacturers, among them Guilford of Maine (a division of
Interface, Inc.), WestPoint Stevens Inc., The Pillow Factory, Hunter-Douglas,
Sommers, Inc. and CMI Enterprises. End-use applications include home
furnishings, floor coverings, home fashion/decorating, automotive interior
fabrics, apparel, medical, industrial and specialty uses.
 
  The Company also produces a variety of specialized niche products that
further augment the array of end use applications within this product
category. The Company expects that the majority of its long-term growth will
come in the industrial and specialty products category. The Company's current
primary industrial and specialty products and applications are summarized
below:
 
<TABLE>
<CAPTION>
      Product                Application
      -------                -----------
      <S>                    <C>
      Microporous rollgoods  Alkaline battery cell separators
      Kiara(R)               Liquid filtration
      Key Bak(R)             Automotive insulation
      Arbrene(R) and Lumber
       Guard(R)              Lumberwrap
      Airgard(R)             Housewrap
      Fab-Strip(TM)          Corrugated box reinforcement
      Fabrene(TM)            Protective coverings and laminated structures
      Agricultural fabric    Crop covers
      Dust cover             Furniture and bedding
      Top Swell(TM)          Water blocking cable wrap
      Bale-lock              Agricultural twine
      Miratec(R)             Textile replacement
      Miratwill(TM)          Apparel, home fashions and industrial
      Mirastretch(TM)        Apparel and home fashions
      Miraspun(TM)           Apparel, home fashions and industrial
      Miracoat(TM)           Industrial
      Miraguard(TM)          Home fashions, apparel and industrial
      Miralace(TM)           Apparel, home fashions and industrial
      Miracloth(TM)          Industrial
</TABLE>
 
  The Company's industrial and specialty products are produced primarily using
wetlaid, adhesive bond, through-air fusible fiber bond, spunbond, oriented
polyolefin, lamination and APEX(TM) technologies. Specialized converting
facilities operated by the Company include a wide-width paper/nonwoven/film
laminating and printing facility in Portland, Oregon and an ultrasonic bonding
facility in Landisville, New Jersey. The Company sells its industrial products
primarily to converters/distributors, except for alkaline battery cell
separators, fiberglass packaging, cable wrap, electrical insulation, and
lumberwrap in the U.S. Pacific Northwest, which are sold by the Company's
sales team.
 
 Wiping Products
 
  The wiping products category represented approximately 13%, 20% and 17%, or
$107.6 million, $105.2 million and $90.6 million, of the Company's net sales
for 1998, 1997 and 1996, respectively. The Company has a complete line of
wiping products used for food service, institutional, light industrial,
janitorial and consumer markets. Wiping products are categorized as either
"premoistened/wet wipes" or "dry wipes." The Company primarily participates in
the "dry wipes" portion of the market, which the
 
                                       9
<PAGE>
 
Company believes to have greater potential for growth and to contain more
opportunities for value-added, specialty products. Within the "dry wipes"
category, the three general end-use products are food service wipes, consumer
household wipes and industrial and specialty wipes. The Company maintains a
significant market share in the food service and consumer categories and is a
leading producer for the industrial category. Industry sources estimate that
the global volume growth for nonwovens used in disposable wipes will be
approximately 5-6% per annum through 2003.
 
  Products within this category include branded and unbranded light to
heavyweight cloth wipes, towels and aprons marketed under the Chix(R), Chix
Plus(R), Chifonet(TM) and Lerette(TM) trademarks, medium to heavyweight open
weave towels marketed under the Fresh Guy(R) trademark and dry, pretreated,
water activated cleaning and sanitizing wipes for the food service industry,
marketed under the Quix(TM) trademark. Products for the industrial, janitorial
and institutional markets include light to heavy-duty towels and cloths sold
under a variety of trademarks including Worxwell(R), Durawipe(R), Masslinn(R)
and Stretch 'N Dust(R). Specialty wipes consist of products designed to meet
specialized customer requirements and specifications and include clean room
wipes used in the electronics, pharmaceutical and office equipment cleaning
industries, tack cloth used by automotive paint shops, and aerospace wipes for
solvent and sealant wiping, surface preparation and general purposes. The
Company produces multi-use kitchen wipes, including The Clorox Company's
Handiwipes(R) brand pursuant to a long-term supply agreement. The Company also
markets a line of catering products in Europe, including banquet rolls, table
napkins and table cloths. The Company's primary wiping products and
applications are summarized below:
 
<TABLE>
<CAPTION>
      Product                             Application
      -------                             -----------
      <S>                                 <C>
      Chix(R) and Chix Plus(R)            Food service
      Fresh Guy(R)                        Heavyweight food service
      Durawipe(R)                         Industrial
      Quix(TM)                            Sanitizing/food service
      Worxwell(R)                         Consumer and janitorial
      Masslinn(R)                         Janitorial
      Stretch 'N Dust(R)                  Janitorial
      Duralace(R)                         Specialized, clean rooms
      Chifonet(TM)                        Consumer--Europe
      Lerette(TM)                         Food service--Europe
      Napkins and tablecloths             Catering--Europe
      Handiwipes(R) and Heavywipes(R)/1/  Consumer
</TABLE>
 
--------
  /1/Handiwipes(R) and Heavywipes(R) are registered trademarks of The Clorox
Company. The Company produces wipes exclusively for The Clorox Company under a
supply agreement.
 
  The Company utilizes primarily dry form resin bonded and spunlace
technologies to manufacture its wiping products and also maintains dedicated
converting and packaging equipment. In North America, the Company has a long-
term manufacturing and distribution agreement, which extends through 2003,
with Berkley Medical Resources Inc. ("BMR") in Fairfield, Pennsylvania to
convert, warehouse and distribute a wide range of wiping products. The
equipment used in the converting and packaging operations is owned by the
Company and operated solely for its benefit. The Company also operates a
converting operation at San Luis Potosi, Mexico. In Europe, the Company
operates converting and packaging equipment within the Cuijk manufacturing
facility. The Company is a leading manufacturer and marketer of wiping
products as a result of its wide range of products, aggressive sales and
marketing team wide distribution base of dealers and food service distributors
and reputation for excellent customer and technical support, including the
ability to meet specific customer requirements.
 
                                      10
<PAGE>
 
 Medical Products
 
  The medical products category represented approximately 12%, 16% and 18%, or
$92.7 million, $86.7 million and $91.7 million, of the Company's net sales for
1998, 1997 and 1996, respectively. The Company's medical products are used in
the production of wound care sponges and dressings, disposable surgical packs,
apparel such as operating room gowns, drapes for operating rooms and
facemasks, shoecovers and headwear. Medical applications represent the second
largest market for nonwoven fabrics, with over two billion square yards
consumed annually in the United States. Approximately 50% of this demand is
for disposable surgical packs, drapes and gowns, a market in which Johnson &
Johnson has a leading share.
 
  Johnson & Johnson is the Company's primary customer for medical products
pursuant to a long-term supply agreement dated March 15, 1995 (the "Supply
Agreement"). The Supply Agreement grants the Company the exclusive right to
supply Johnson & Johnson with all of its nonwoven fabric requirements,
including those for its entire line of medical products as well as for other
disposable hygiene and wiping applications for a period of five years, and,
provided that the Company's prices remain competitive with the marketplace,
extends for a period of an additional five years. During the first five year
period, of which approximately one year still remains, the Company enjoys
significantly favorable pricing terms. In addition, other preferential terms
continue throughout the duration of the contract.
 
  The Company believes, based on industry sources, that the global growth rate
for nonwovens in medical applications will be approximately 3-4% per annum
through 2003, with much of the growth coming from the expansion of traditional
product lines. A 1992 ruling by the Occupational Safety and Health
Administration ("OSHA") required that employers of healthcare workers supply
personal protective equipment to employees at risk of exposure to infectious
body fluids. Industry sources expect that OSHA rules will continue to
stimulate demand for protective applications for workers, including those in
funeral homes, linen services and law enforcement agencies in addition to
healthcare workers.
 
  Surgical gowns and drapes containing a protective barrier against fluid
strike-through are the largest and fastest growing applications for nonwoven
fabrics in the medical products category. The Company produces Duralace(R)
spunlace fabric for this product group and treats the surface of the fabric to
give it high fluid repellency required for this application. The sponge and
dressing products are produced using spunlace apertured technologies and the
proprietary APEX(TM) structural web technology. A recently developed product
using the APEX(TM) structural web technology, Mirasorb(R), is a nonwoven
sponge that can replace woven gauze in some applications at considerably less
cost. The Company's primary medical products and applications are summarized
below:
 
<TABLE>
<CAPTION>
      Product           Application
      -------           -----------
      <S>               <C>
      Duralace(R)       Surgical gowns and drapes
      Mirasorb(R)(/1/)  Sponges
      Nugauze(R)(/1/)   Nonwoven gauze
</TABLE>
--------
  (/1/) Mirasorb(R) and Nugauze(R) are trademarks of Johnson & Johnson. The
Company furnishes Johnson & Johnson with products used in the manufacture of
these products.
 
 Hygiene Products
 
  The hygiene products category represented approximately 40%, 43% and 44%, or
$319.1 million, $231.9 million and $231.2 million, of the Company's net sales
for 1998, 1997 and 1996, respectively. The Company produces a variety of
nonwoven materials for use in the production of diapers, training pants,
feminine sanitary protection, baby wet wipes and adult incontinence products.
The Company
 
                                      11
<PAGE>
 
believes that it has a significant share of the noncaptive North American
topsheet market. Industry sources estimate that the global growth rate for SMS
and spunbond nonwovens in hygiene applications will average 7-8% through 2003,
primarily due to an increase in the amount of nonwoven fabric per diaper,
increased unit demand from developing countries and the rise in use of adult
incontinence products. Volume growth for nonwovens for use in hygiene
applications globally is expected to be 5-6% annually through 2003.
 
  The Company has a broad product offering and provides customers with a full
range of specialized components for unique or distinctive products, including
the Isolite(TM) topsheet, Multi-Strike(TM) transfer layer, Soft Touch(TM)
backsheet fabric, Dry-Fit(TM) leg cuff fabric, Reticulon(R) sanitary
protection facings, absorbent pads for the Serenity(R)/1/ incontinence guard
and Carefree(R)/1/ panty shield and Ensorb(TM) absorbent cores. The Company
produces a spunlace "wet wipe" product for baby wipe applications in Europe.
This product fills the gap between standard nonwoven wipes and a quality cloth
wipe and has improved thickness and softness over standard airlaid pulp
products. The Company is the only supplier capable of providing all of the
thermal bond, adhesive bond, spunbond, SMS, coextruded apertured films,
through-air bond, spunlace and ultrasonic bond technologies which are required
in the manufacture of these products. The Company's primary hygiene products
and applications are summarized below:
 
<TABLE>
<CAPTION>
      Product           Application
      -------           -----------
      <S>               <C>
      Isolite(TM)       Coverstock
      Multi-Strike(TM)  Transfer sublayer
      Soft Touch(TM)    Clothlike backsheet
      Dry-Fit(TM)       Leg cuff for diapers
      Reticulon(R)      Sanitary protection facing
      Ensorb(R)         Absorbent cores
      Novaspun          Topsheets
      Baby wipes        Consumer--Europe
      Poly-Safe(TM)     Protective apparel (solid barrier)
      Poly-Breathe(TM)  Protective apparel (breathable barrier)
</TABLE>
--------
  /1/Serenity(R) and Carefree(R) are Johnson & Johnson trademarks. The Company
furnishes Johnson & Johnson with products used in the manufacture of these
products.
 
  The Company has a significant relationship with Procter & Gamble and
supplies a full range of products to Procter & Gamble on a global basis. The
Company's marketing and research and development teams work closely as
partners with Procter & Gamble and other customers in the development of next
generation products. The Company believes that this technical support ensures
that the Company's products will continue to be incorporated into such
customers' future product designs. The Company also has significant
relationships with private-label producers of diaper products and is the
primary supplier to Johnson & Johnson Personal Products for its nonwoven
requirements for sanitary protection, tampon and adult incontinence products.
 
New Product Development
 
  The Company continually develops new products that incorporate the Company's
wide variety of technologies. The Company's research and development efforts
have been focused on increasing its production capacity and improving its
production processes, developing products based on the Company's existing
technologies for new markets and developing new process technologies to
enhance existing businesses and allow entry into new businesses. The depth and
expertise of the Company's research and development staff, who work closely
with manufacturing and marketing personnel, have enabled the Company to
develop innovative products, frequently in response to specific customer
needs. In addition, the Company frequently enters into collaborative
partnerships
 
                                      12
<PAGE>
 
with its customers to develop and manufacture next-generation products in
response to its customers' changing needs. The Company believes that these
developmental partnerships enhance customer relationships by ensuring that the
Company's products will continue to be incorporated into its customers' future
products. The Company also utilizes in-plant pilot lines that are installed in
its manufacturing facilities in order to develop new products under real
manufacturing conditions prior to commercialization. The Company currently has
several projects in advanced stages of development that it believes will
present the potential for substantial growth.
 
  APEX(TM), a new surface-forming technology, has the potential to displace
traditional woven textile, knitted and composite products in many applications
because of its favorable price to value ratio. The advanced APEX(TM)
structural web process produces textile replacement fabrics with intricate,
three-dimensional patterns marketed under the name Miratec(R). This
technology, which can be applied to most sheet structures fabricated from
fibers or films, enhances the Company's ability to gain competitive advantages
by increasing manufacturing efficiency and product differentiation. Pursuant
to an agreement with Johnson & Johnson, products for healthcare applications
that are manufactured utilizing the APEX(TM) structural web technology may
only be sold to Johnson & Johnson. In all other markets, such as automotive
headliners, home furnishings, apparel and filtration products, the Company may
manufacture and freely market products utilizing the APEX(TM) structural web
technology.
 
  The Company is at the forefront in the use of new generation resins, which
have the potential to produce stronger and thinner fabrics with advanced
performance characteristics such as elasticity, microporosity and surface
adhesion. The Company believes that its state-of-the-art equipment and
manufacturing processes will provide it with the flexibility to process these
advanced resins and allow it to be a leader in the introduction of these
materials for traditional as well as new end uses.
 
Marketing and Sales
 
  The Company sells to over 1,000 customers in the domestic and international
marketplace. Approximately 58%, 23%, 13% and 6% of the Company's 1998 net
sales were to entities from manufacturing facilities in the United States,
Europe, Canada and Latin America, respectively. Proctor & Gamble and Johnson &
Johnson, the Company's largest customers, each accounted for 17% of the
Company's 1998 net sales. Sales to the Company's top 20 customers represented
approximately 53% of the Company's 1998 net sales.
 
  The Company sells primarily to manufacturers and converters, which
incorporate the Company's products into their finished goods. The Company
employs direct sales representatives, a number of whom are engineers and each
of whom has advanced technical knowledge of the Company's products and the
applications for which they are used. The Company's sales representatives are
active in the Company's new product development efforts and are strategically
located in the major geographic regions in which the Company's products are
utilized. The oriented polyolefin products are sold primarily through a well-
established network of converters and distributors, most of whom have been
doing business with the Company (or its respective predecessors) for more than
17 years. Converters add incremental value to the Company's products and
service the small order size requirements typical of many end users.
 
  In certain new high-margin niche markets, the Company has maintained control
over distribution by dealing directly with the end-use customer through its
sales representatives. The Company offers a broad range of high-quality
products, utilizing multiple technologies and materials, allowing its sales
force to offer customers what the Company believes is the widest range and
variety of nonwoven and oriented polyolefin products available to meet
customers' requirements from a single source. The Company has utilized its
broadened product base to market its products in high-value niche product
areas.
 
                                      13
<PAGE>
 
Manufacturing Processes
 
  General. The Company's competitive strengths include low-cost, high-quality
manufacturing processes and a broad range of process technologies, which allow
the Company to offer its customers the best-suited product for each respective
application. Additionally, the Company has made significant capital
investments in modern technology and has developed proprietary equipment and
manufacturing techniques. The Company believes that it exceeds industry
standards in productivity, reduction of variability and delivery lead time.
The Company has a wide range of manufacturing capabilities (many of which are
patented) that allow it to produce specialized products which, in certain
cases, cannot be reproduced in the market. Substantially all of the Company's
manufacturing sites have plant-wide real time control and monitoring systems
that constantly monitor key process variables using a sophisticated closed
loop system of computers, sensors and custom software.
 
  Nonwovens. The Company believes that it has the most comprehensive array of
nonwoven manufacturing technologies in the industry. The Company has
capabilities spanning the entire spectrum of nonwoven technologies, including
the following manufacturing processes: spunbond, SMS, SMMS, thermal and
adhesive bond, spunlace, wet-laid, dry-laid, film extrusion and aperturing,
through-air bond and ultrasonic bond among other processes.
 
  Nonwoven rollgoods typically have three process steps: web formation, web
consolidation or bonding and finishing. Web formation is the process by which
previously prepared fibers, filaments or films are arranged into loosely held
networks called webs, batts or sheets. In each process, the fiber material is
laid onto a forming or conveying surface, which may be dry, wet or molten. The
dry-laid process utilizes textile fiber processing equipment, called "cards,"
that have been specifically designed for high-capacity nonwoven production.
The carding process converts bales of entangled fibers into uniform oriented
webs that then feed into the bonding process. The wet-laid process utilizes
papermaking technology in which the fibers are suspended in a water slurry and
deposited onto a moving screen, allowing the water to pass through and the
fibers to collect. In a molten polymer-laid process, extrusion technology is
used to transform polymer pellets into filaments, which are laid on a
conveying screen and interlocked by thermal fusion. In this process, the fiber
formation, web formation and web consolidation are generally performed as a
continuous simultaneous operation, making this method very efficient.
 
  Web consolidation is the process by which the fibers or film are bonded
together using either mechanical, thermal, chemical or solvent means. The
bonding method greatly influences the end products' strength, softness, loft
and utility. The principal bonding processes are thermal bond, resin or
adhesive bond, hydroentanglement or spunlace, binder fiber or through-air
bond, calender, spunbond, meltblown, SMS, ultrasonic bond and needlepunch.
Thermal bond utilizes heated calender rolls with embossed patterns to point
bond or fuse the fibers together. In the resin bond process, an adhesive,
typically latex, is pad rolled onto the web to achieve a bond. Spunlace, or
hydroentanglement, uses high pressure water jets to mechanically entangle the
fibers. Through-air bonding takes place through the fusion of bi-component
fibers in a blown hot air drum. Spunbond and meltblown take advantage of the
melt properties of the resins and may use thermal fusion with the aid of
calender rolls. SMS and SMMS are integrated processes of combining spunbond
and meltblown sheets in a laminated structure, creating very strong,
lightweight and uniform fabrics. Ultrasonic bonding utilizes high-frequency
sound waves that heat the bonding sites. Needlepunch is a mechanical process
in which beds of needles are punched through the web, entangling the fibers.
 
  Finishing, or post-treatment, adds value and functionality to the product
and typically includes surface treatments for fluid repellency, aperturing,
embossing, laminating, printing and slitting. Spunlace and resin bond systems
also have a post-treatment drying or curing step. Certain products also go
through an aperturing process in which holes are opened in the fabric,
improving absorbency.
 
                                      14
<PAGE>
 
  Oriented Polyolefins. The oriented/film process begins with plastic resin,
which is extruded into a thin plastic film or into monofilament strands. The
film is slit into narrow tapes. The slit tapes or monofilament strands are
then stretched or "oriented," the process through which it derives its high
strength. The tapes are wound onto spools which feed weaving machines or
twisters. In the finishing process, the product is coated for water or
chemical resistance, ultraviolet stabilization and protection, flame
retardancy, color and other specialized characteristics. In the twisting
process, either oriented slit tapes or monofilament strands are twisted and
packaged on tightly spooled balls for distribution as agricultural and
commercial twine. The Company operates 160-inch and 80-inch coating lines that
have been equipped with the latest technology for gauge control, print
treating, lamination, anti-slip finishes and perforation. The 160-inch line is
one of only two lines of that size in North America. At its Portland, Oregon
facility, the Company extrudes specialized films which are used to laminate
the oriented product to paper and has the additional capability of printing up
to four colors on one of the widest printing presses in North America.
 
  Outside Converting. The Company recently extended its long-term
manufacturing and distribution contract with BMR for an additional five years,
through August 2003. The agreement provides for BMR to convert, warehouse and
distribute a wide range of wiping products. Under the agreement, the Company
sells base fabrics produced at its Benson, North Carolina manufacturing
facility to BMR. BMR then cuts, folds and packages the fabric using Company-
owned machinery in a dedicated facility on behalf of the Company in accordance
with specifications. BMR distributes the products directly to the Company's
customers, while marketing, sales and order processing are the responsibility
of the Company. The Company also operates a converting operation at it's San
Luis Potosi, Mexico location. In Europe, the Company operates its own cutting,
folding and packaging machines at its Cuijk manufacturing facility.
 
Competition
 
  The Company's primary competitors in its industrial and specialty product
markets are: E.I. DuPont de Nemours & Co. ("Du Pont"), Freudenberg Nonwovens
L.P. ("Freudenberg"), Kimberly-Clark Corporation ("Kimberly-Clark"), Dexter
Nonwovens Division, Kuraray Co., Ltd., BBA Group plc, Lohmann GmbH & Company
and Lantor International (an operating unit of IPT Group) for nonwoven
products; and Intertape Polymer Group Inc. and Amoco Fabrics and Fibers Co.
for oriented polymer products. Generally, product innovation and performance,
quality, service and cost are the primary competitive factors, with technical
support being highly valued by the largest customers.
 
  The Company's primary competitors in its wiping product markets are Du Pont
in nonwovens and paper producers such as Fort James Corporation ("Fort
James"), Atlantic Mills Inc. and Kimberly-Clark. Generally, cost, distribution
and utility are the principal factors considered in food service and
janitorial end uses, while product innovation, performance and technical
support are the most important factors for specialty and industrial wiping
products.
 
  The Company's primary competitors in its medical product markets are Du Pont
and FiberWeb Group, Inc. (a subsidiary of BBA Group plc) in the United States
and Freudenberg and Molnlycke AB in Europe. Price, distribution, variety of
product offerings and performance are the chief competitive factors in this
product category.
 
  The Company's primary competitors in its hygiene product categories are BBA
Group plc in North America, BBA Group plc and J.W. Suominen O.Y. in Europe and
Uni-Charm Corp. in Japan. Generally, product cost, technical capacity and
innovation and customer relationships are the most important competitive
factors in these markets.
 
  A number of the Company's niche product applications are sold into select
specialized markets, and the Company believes that the size of such markets,
relative to the amount of capital required for
 
                                      15
<PAGE>
 
entry, as well as the advanced manufacturing processes and technical support
required to service them, present barriers to entry. There can be no
assurance, however, that these specialized markets, particularly as niche
product applications become standardized over time, will not attract
additional competitors that could have greater financial, technological,
manufacturing and marketing resources than the Company.
 
Raw Materials
 
  The primary raw materials used in the manufacture of most of the Company's
products are polypropylene and polyester fiber, polyethylene and polypropylene
resin, and, to a lesser extent, rayon and tissue paper. The prices of
polypropylene and polyethylene are a function of, among other things,
manufacturing capacity, demand and the price of crude oil and natural gas
liquids. Historically, the prices of polypropylene and polyethylene resins
have fluctuated, such as in late 1994 and early 1995 when resin prices
increased by approximately 60%. The sharp increase was primarily due to short-
term interruptions in production capacity and increased demand as a result of
an expanding economy. By mid-1995, supply had increased, thereby reducing
prices. In general, price reductions continued during 1996 and 1997. In 1998,
raw material prices were lower in North America while pricing increased
slightly in Europe.
 
  There can be no assurance that the prices of polypropylene and polyethylene
will not increase in the future or that the Company will be able to pass on
such increases to its customers as it has generally been able to do in the
past. A significant increase in the prices of polyolefin resins that cannot be
passed on to customers could have a material adverse effect on the Company's
results of operations and financial conditions.
 
  The Company's major supplier of polypropylene fiber is FiberVisions L.L.C.,
while its major supplier of polyethylene is Novacor Chemicals Inc. The
Company's major suppliers of rayon fiber are Lenzing Fibers Corp. and
Courtaulds Fibers, Inc., while its major suppliers of polyester are Wellman,
Inc. and Du Pont. The Company primarily purchases its polypropylene resin from
Indelpro, S.A. de C.V., Montell North America Inc. and Exxon Chemical Company,
and purchases its tissue paper from Crown Vantage Inc. As a result of the
Nonwovens Acquisition, the Company is also a purchaser of polyolefin films
from Huntsman Packaging Corporation, polyester fiber from Swicofil A.G.
Textile Services and Du Pont, and polyacrylate powder (SAP) from Elf Atochem.
 
  The Company believes that the loss of any one or more of its suppliers would
not have a long-term material adverse effect on the Company because other
manufacturers with whom the Company conducts business would be able to fulfill
the Company's requirements. However, the loss of the Company's suppliers
could, in the short term, adversely affect the Company's business until
alternative supply arrangements were secured. In addition, there is no
assurance that any new supply arrangements entered into by the Company will
have terms as favorable as those contained in current supply arrangements. The
Company has not experienced any significant disruptions in supply as a result
of shortages in raw materials.
 
Environmental
 
  The Company is subject to a broad range of federal, foreign, state and local
laws and regulations relating to the pollution and protection of the
environment. Among the many environmental requirements applicable to the
Company are laws relating to air emissions, wastewater discharges and the
handling, disposal and release of solid and hazardous substances and wastes.
Based on continuing internal review and advice from independent consultants,
the Company believes that it is currently in substantial compliance with
applicable environmental requirements.
 
 
                                      16
<PAGE>
 
  The Company is also subject to laws, such as CERCLA, that may impose
liability retroactively and without fault for releases or threatened releases
of hazardous substances at on-site or off-site locations. The Company is not
aware of any releases for which it may be liable under CERCLA or any analogous
provision.
 
  Actions by federal, state and local governments in the United States and
abroad concerning environmental matters could result in laws or regulations
that could increase the cost of producing the products manufactured by the
Company or otherwise adversely affect demand for its products. For example,
certain local governments have adopted ordinances prohibiting or restricting
the use or disposal of certain plastic products, such as certain of the
plastic wrapping materials which are produced by the Company. Widespread
adoption of such prohibitions or restrictions could adversely affect demand
for the Company's products and thereby have a material adverse effect upon the
Company. In addition, a decline in consumer preference for plastic products
due to environmental considerations could have a material adverse effect upon
the Company.
 
  Most of the Company's manufacturing processes are mechanical and are
therefore considered to be environmentally benign. The polyolefin resins are
readily recyclable, and the Company maintains a network of recyclers to
receive post-industrial waste for certain of the Company's products. In
addition, each of the Company's manufacturing sites has equipment and
procedures for reclaiming a majority of internally generated scrap, thus
reducing the amount of waste sent to local landfills. As a result, the Company
does not currently anticipate any material adverse effect on its operations,
financial condition or competitive position as a result of its efforts to
comply with environmental requirements. Some risk of environmental liability
is inherent, however, in the nature of the Company's business, and there can
be no assurance that material environmental liabilities will not arise. It is
also possible that future developments in environmental regulation could lead
to material environmental compliance or cleanup costs.
 
Patents and Trademarks
 
  The Company considers its patents, patent licenses and trademarks, in the
aggregate, to be important to its business and seeks to protect this
proprietary know-how in part through United States and foreign patent and
trademark registrations. The Company maintains over 100 registered trademarks
and over 150 patents or patent licenses in the United States. In addition, the
Company maintains certain trade secrets for which, in order to maintain the
confidentiality of such trade secrets, it has not sought patent protection.
From time to time, the Company enters into transactions whereby technology is
licensed or made available to developmental partners within the industry.
 
Inventory and Backlogs
 
  Unfilled orders, excluding orders on hand not yet released for delivery, as
of January 2, 1999 and January 3, 1998 amounted to approximately $103.1
million and $87.2 million, respectively. The Company's unfilled order position
has increased over the past year as a result of the acquisition of the
Nonwovens Business (as defined).
 
Research and Development
 
  The Company continually invests in research and development, focusing its
efforts on increasing production capacity, improving production processes, and
developing new product and process technologies. The Company expanded its
research and development capability by opening its Advanced Material Center in
Mooresville, NC in September of 1998. The Company spent approximately $13.2,
$9.6 and $6.9 million in research and development during 1998, 1997 and 1996,
respectively.
 
                                      17
<PAGE>
 
Seasonality
 
  Use and consumption of the Company's products exhibits some seasonality,
with lighter volumes generally experienced in the first quarter of the fiscal
year.
 
Employees
 
  As of January 2, 1999, the Company employed approximately 3,800 persons. Of
this total, approximately 1,470 employees are represented by labor unions or
trade councils that have entered into separate collective bargaining
agreements with the Company. Approximately 18% of the Company's labor force is
covered by collective bargaining agreements which will expire in 1999. The
Company considers its employee relations to be very good.
 
                              RECENT TRANSACTIONS
 
8 3/4% Notes
 
  On March 5, 1998, the Company issued $200 million of 8 3/4% Senior
Subordinated Notes due 2008 (the "8 3/4% Notes") to Chase Securities Inc.
("Chase") in a transaction not registered under the Securities Act in reliance
upon an exemption under the Securities Act pursuant to an indenture dated as
of March 1, 1998 among the Company, the guarantors named therein and Harris
Trust & Savings Bank, as trustee. Chase subsequently placed the 8 3/4% Notes
with qualified institutional buyers in reliance on Rule 144A under the
Securities Act. The 8 3/4% Notes accrue interest from their original issuance
date at a rate of 8 3/4% per annum, and have customary provisions regarding
redemption, changes in control, ranking, asset sales and other restrictive
covenants. The 8 3/4% Notes are unsecured senior subordinated indebtedness of
the Company and are subordinated in right of payment to all existing and
future senior indebtedness of the Company.
 
  On July 1, 1998, pursuant to its Registration Statement on Form S-4 (Reg.
No. 333-55863) filed with the Commission on June 2, 1998 and declared
effective on July 1, 1998 (the "July 1998 Registration Statement"), the
Company offered to exchange $1,000 principal amount of its 8 3/4% Senior
Subordinated Notes due 2008, Series B (the "March 1998 Notes") for each $1,000
principal amount outstanding of the March 1998 Privately Placed Notes (the
"July 1998 Exchange Offer"). The July 1998 Exchange Offer was undertaken to
comply with certain Registration Rights granted to holders of the March 1998
Privately Placed Notes in connection with the March 1998 Offering pursuant to
the Registration Rights Agreement dated February 27, 1998. The form and terms
of the March 1998 Notes exchanged in the July 1998 Exchange Offer are the same
as the form and terms of the March 1998 Privately Placed Notes (which they
replaced) except that (i) the March 1998 Notes bear a Series B designation,
(ii) the March 1998 Notes have been registered under the Securities Act and,
therefore, do not bear legends restricting the transfer thereof, and (iii) the
holders of the March 1998 Notes are not entitled to any registration rights.
The July 1998 Exchange Offer was consummated on August 7, 1998, with all $200
million principal amount of March 1998 Privately Placed Notes being tendered
for exchange. As a result, the Company currently has $200 million of March
1998 Notes outstanding; no March 1998 Privately Placed Notes remain
outstanding.
 
  The March 1998 Notes Indenture contains several covenants, including:
limitations on indebtedness; limitations on certain restricted payments;
limitations on transactions with affiliates; restrictions on the disposition
of proceeds of asset sales; limitations on liens; limitations on dividend and
other payment restrictions affecting certain subsidiaries; limitations on
guarantees by certain subsidiaries; and limitations on mergers, sales of
assets, etc. Reference is made to the March 1998 Notes Indenture, which was
filed as an Exhibit to the July 1998 Registration Statement, for a complete
description of such covenants.
 
The Nonwovens Transactions
 
  On January 29, 1998, the Company consummated the Nonwovens Acquisition and
the Nonwovens Acquisition Refinancing. The Nonwovens Acquisition and Nonwovens
Acquisition Refinancing are collectively referred to as the "Nonwovens
Transactions."
 
                                      18
<PAGE>
 
The Nonwovens Acquisition
 
  On December 19, 1997, pursuant to the terms of its Offer to Purchase dated
October 29, 1997, as amended (the "Dominion Tender Offer"), DT Acquisition
Inc., a special purpose subsidiary formed by the Company ("DT Acquisition")
completed the purchase of 98% of the outstanding Common Shares of Dominion
Textiles Inc ("Dominion") for Cdn$14.50 per share and 96% of the outstanding
First Preferred Shares of Dominion for Cdn$150 per share. On December 29,
1997, DT Acquisition acquired an additional 331,207 Common Shares. The Company
had previously announced that it had entered into a Purchase Agreement, dated
October 27, 1997, with Galey & Lord, Inc. ("Galey") to sell the denim and
career wear business of Dominion (the "Apparel Fabrics Business") to Galey
following the consummation of the Dominion Tender Offer. The Dominion Tender
Offer was financed with $215 million of borrowings under DT Acquisition's $600
million senior secured credit facilities, and subordinated advances of $141
million, $69 million and $25 million by Galey, ZB Holdings, Inc. ("ZB
Holdings"), and the Company, respectively. ZB Holdings is a wholly-owned
subsidiary of InterTech, an affiliate of the Company wholly-owned by Jerry
Zucker and James G. Boyd.
 
  On January 29, 1998, DT Acquisition acquired the remaining Common Shares and
First Preferred Shares of Dominion in a compulsory acquisition effectuated
pursuant to section 206 of the Canada Business Corporation Act, and acquired
all outstanding Second Preferred Shares pursuant to a notice of redemption
issued December 29, 1997. Dominion then underwent a "winding up" pursuant to
which all assets of Dominion were transferred to DT Acquisition, all
liabilities of Dominion were assumed by DT Acquisition and all of the
outstanding Common Shares and First Preferred Shares held by DT Acquisition
were redeemed. Pursuant to the 2003 Tender Offer and the 2006 Tender Offer
(each as defined), DT USA (as defined), a wholly-owned subsidiary of Dominion
and the issuer of the 2003 Notes and the 2006 Notes, accepted for purchase all
2003 Notes and 2006 Notes validly tendered and not revoked. Immediately
thereafter, the Apparel Fabrics Business was sold to Galey for approximately
$464.5 million, including related fees and expenses, and the Company acquired
(the "Nonwovens Acquisition") the assets and liabilities of Dominion that
comprised the nonwovens and industrial fabrics operations of Dominion (the
"Nonwovens Business"). The Company borrowed approximately $326.6 million under
the Amended Credit Facility to finance the Nonwovens Acquisition, for which it
paid a gross price of approximately $351.6 million, including related fees and
expenses. In connection with the sale of the Apparel Fabrics Business and the
Nonwovens Business, DT Acquisition repaid the subordinated advance from ZB
Holdings in full.
 
  The primary operations of the Nonwovens Business are conducted through Poly-
Bond Inc. ("Poly-Bond"), Nordlys S.A. ("Nordlys"), DIFCO Inc. ("DIFCO"), Geca-
Tapes B.V. ("Geca") and Dominion Nonwovens Sudamerica S.A. ("DNS"). Poly-Bond,
based in Waynesboro, Virginia, is a leading manufacturer of spunbond and
spunmelt composite nonwovens used in disposable diapers, adult incontinence
and feminine hygiene products. Nordlys, based in Bailleul, France,
manufactures dry-laid nonwovens for industrial applications such as cable
wrap, liquid filtration, medical end-uses, and electrical insulation. DIFCO,
based in Magog, Quebec, produces custom designed technical fabrics. Geca,
based in Tilburg, Netherlands, manufactures nonwovens products for industrial
applications such as cable wrap. DNS produces spunbond and spunmelt nonwovens
to serve hygiene markets in countries that are participants in the Mercosur
free trade agreement.
 
The Nonwovens Acquisition Refinancing
 
  On January 29, 1998, in connection with the Nonwovens Acquisition, the
Company amended its Credit Facility to provide for a $125.0 million secured
term loan and to modify certain terms of the revolving portion of the Credit
Facility. The Amended Credit Facility provides for revolving credit facilities
with an aggregate commitment of up to $325.0 million. All indebtedness under
the Amended Credit Facility is guaranteed on a joint and several basis by each
of the Company's direct and indirect domestic subsidiaries. All indebtedness
and related guarantees under the Amended Credit Facility are secured by (i) a
lien on substantially all of the assets of the Company and its domestic
subsidiaries, (ii) a pledge of all or a portion of the stock of the domestic
subsidiaries of the Company and of certain
 
                                      19
<PAGE>
 
non-domestic subsidiaries of the Company, (iii) a lien on substantially all of
the assets of direct foreign borrowers (to secure direct borrowings by such
borrowers), and (iv) a pledge of secured intercompany notes issued to the
Company or one of its subsidiaries by certain non-domestic subsidiaries. See
"Description of Certain Indebtedness--Amended Credit Facility."
 
  Concurrent with the sale of the Apparel Fabrics Business, and pursuant to
the 2003 Tender Offer, DT USA purchased approximately $145.6 million of its
$150.0 million outstanding 8 7/8% Guaranteed Senior Notes due 2003 for total
consideration in cash equal to $1,065.32 per $1,000 principal amount, plus
accrued interest. At the same time, pursuant to the 2006 Tender Offer, DT USA
purchased approximately $124.5 million of its $125.0 million outstanding 9
1/4% Guaranteed Senior Notes due 2006 for total consideration in cash of
$1,138.50 per $1,000 principal amount, plus accrued interest. Pursuant to both
the 2003 Tender Offer and the 2006 Tender Offer (each as defined), DT USA
received the requisite consents from tendering holders to amend the indentures
under which the 2003 Notes and the 2006 Notes were issued to eliminate
substantially all of the covenants contained therein and paid a consent fee,
included in the respective total consideration discussed above, to holders who
tendered their notes and delivered consents prior to the expiration of the
consent solicitations. See "Description of Certain Indebtedness--2003 Notes
and 2006 Notes."
 
  The Company's amendment to the Credit Facility resulting in the Amended
Credit Facility and repurchase of the 2003 Notes and 2006 Notes pursuant to
the 2003 Tender Offer and 2006 Tender Offer are collectively referred to as
the "Nonwovens Acquisition Refinancing."
 
The Oriented Polymer Acquisition
 
  On March 16, 1998, the Company acquired (the "Oriented Polymer Acquisition")
the manufacturing and business assets of a leading North American manufacturer
of polypropylene-based commercial twine and polyethylene-based specialty
knitted products (the "Oriented Polymer Business") for approximately $47.4
million.
 
                      DESCRIPTION OF CERTAIN INDEBTEDNESS
 
Amended Credit Facility
 
  General. In connection with the Nonwovens Acquisition, the Company, the
other "Borrowers" named therein and the "Domestic Non-Borrower Guarantors"
named therein entered into the Amended Credit Facility (the "Amended Credit
Facility") with a group of lenders (the "Lenders") and with Chase Bank, as
Agent, by amending the Credit Facility. The Amended Credit Facility provides
for secured revolving credit borrowings with aggregate commitments of up to
$325,000,000 and a term loan of $125,000,000. Subject to certain terms and
conditions set forth in the Amended Credit Facility, a portion of the Amended
Credit Facility may be used for letters of credit. A portion of the Amended
Credit Facility may be denominated in Dutch guilders and in Canadian dollars.
All indebtedness under the Amended Credit Facility (including any hedging
arrangements provided by a Lender) is guaranteed, on a joint and several
basis, by each and all of the direct and indirect domestic subsidiaries of the
Company.
 
  Security. The Amended Credit Facility and the related guarantees are secured
by (i) a lien on substantially all of the assets of the Company and its
domestic subsidiaries, (ii) a pledge of all or a portion of the stock of the
domestic subsidiaries of the Company and of certain non-domestic subsidiaries
of the Company, (iii) a lien on substantially all of the assets of direct
foreign borrowers (to secure direct borrowings by such borrowers), and (iv) a
pledge of certain secured intercompany notes issued to the Company or one of
its subsidiaries by non-domestic subsidiaries.
 
  Maturity; Prepayment. The revolving credit portion of the Amended Credit
Facility terminates in June 2003. The term loan portion terminates in December
2005. The loans will be subject to mandatory prepayment out of proceeds
received in connection with certain casualty events, asset sales and debt
issuances.
 
                                      20
<PAGE>
 
  Interest Rates. The interest rate applicable to borrowings under the Amended
Credit Facility shall be based on, in the case of U.S. dollar denominated
loans, the Base Rate referred to therein or the Eurocurrency Base Rate
referred to therein for U.S. dollars, at the Company's option, plus a
specified margin. In the event that a portion of the Amended Credit Facility
is denominated in Dutch guilders, the applicable interest rate shall be based
on the applicable Eurocurrency Base Rate referred to therein for Dutch
guilders, plus a specified margin. In the event that a portion of the Amended
Credit Facility is denominated in Canadian dollars, the applicable interest
rate shall be based on the Canadian Base Rate referred to therein (plus a
specified margin) or the Bankers' Acceptance Discount Rate referred to therein
at the Company's option. The applicable margin for loans bearing interest
based on the Base Rate or Canadian Base Rate will range from 0% to 1.25% and
for loans bearing interest on a Eurocurrency Rate will range from 0.75% to
2.50%, based on the Company's ratio of total consolidated indebtedness to
consolidated EBITDA calculated on a rolling four quarter basis.
 
  Covenants; Events of Default. The Amended Credit Facility contains covenants
and events of default customary for financings of this type.
 
8 3/4% Notes
 
  On March 5, 1998, the Company issued $200 million of the 8 3/4% Notes to
Chase in a transaction not registered under the Securities Act in reliance
upon an exemption under the Securities Act pursuant to an indenture dated as
of March 1, 1998 among the Company, the guarantors named therein and Harris
Trust & Savings Bank, as trustee. Chase subsequently placed the 8 3/4% Notes
with qualified institutional buyers in reliance on Rule 144A under the
Securities Act. The 8 3/4% Notes accrue interest from their original issuance
date at a rate of 8 3/4% per annum, and have customary provisions regarding
redemption, changes in control, ranking, asset sales and other restrictive
covenants. The 8 3/4% Notes are unsecured senior subordinated indebtedness of
the Company and are subordinated in right of payment to all existing and
future senior indebtedness of the Company.
 
  On July 1, 1998, pursuant to its Registration Statement on Form S-4 (Reg.
No. 333-55863) filed with the Commission on June 2, 1998 and declared
effective on July 1, 1998 (the "July 1998 Registration Statement"), the
Company offered to exchange $1,000 principal amount of its 8 3/4% Senior
Subordinated Notes due 2008, Series B (the "March 1998 Notes") for each $1,000
principal amount outstanding of the March 1998 Privately Placed Notes (the
"July 1998 Exchange Offer"). The July 1998 Exchange Offer was undertaken to
comply with certain Registration Rights granted to holders of the March 1998
Privately Placed Notes in connection with the March 1998 Offering pursuant to
the Registration Rights Agreement dated February 27, 1998. The form and terms
of the March 1998 Notes exchanged in the July 1998 Exchange Offer are the same
as the form and terms of the March 1998 Privately Placed Notes (which they
replaced) except that (i) the March 1998 Notes bear a Series B designation,
(ii) the March 1998 Notes have been registered under the Securities Act and,
therefore, do not bear legends restricting the transfer thereof, and (iii) the
holders of the March 1998 Notes are not entitled to any registration rights.
The July 1998 Exchange Offer was consummated on August 7, 1998, with all $200
million principal amount of March 1998 Privately Placed Notes being tendered
for exchange. As a result, the Company currently has $200 million of March
1998 Notes outstanding; no March 1998 Privately Placed Notes remain
outstanding.
 
  The March 1998 Notes Indenture contains several covenants, including:
limitations on indebtedness; limitations on certain restricted payments;
limitations on transactions with affiliates; restrictions on the disposition
of proceeds of asset sales; limitations on liens; limitations on dividend and
other payment restrictions affecting certain subsidiaries; limitations on
guarantees by certain subsidiaries; and limitations on mergers, sales of
assets, etc. Reference is made to the March 1998 Notes Indenture, which was
filed as an Exhibit to the July 1998 Registration Statement, for a complete
description of such covenants.
 
 
                                      21
<PAGE>
 
9% Notes
 
  On July 3, 1997, the Company issued the Privately Placed Notes to Chase in a
transaction not registered under the Securities Act in reliance upon an
exemption under the Securities Act pursuant to the 9% Notes Indenture. Chase
subsequently placed the Privately Placed Notes with qualified institutional
buyers in reliance on Rule 144A under the Securities Act. The Privately Placed
Notes accrued interest from their original issuance date at the rate of 9% per
annum, and had substantially similar provisions as the Notes with respect to
redemption (including optional redemption in the first three years in
connection with one or more Public Equity Offerings (as defined herein)),
changes in control, ranking, Asset Sales (as defined herein) and other
restrictive covenants. The Privately Placed Notes were unsecured senior
subordinated obligations of the Company and were subordinated in right of
payment to all existing and future Senior Indebtedness of the Company.
 
  On September 3, 1997, pursuant to Registration Statement on Form S-4 (Reg.
No. 333-32605) filed with the Commission on August 1, 1997 and declared
effective on September 3, 1997 (the Company offered to exchange $1,000
principal amount of the 9% Notes for each $1,000 principal amount outstanding
of the Privately Placed Notes. The September Exchange Offer was undertaken to
comply with certain Registration Rights granted to holders of the Privately
Placed Notes in connection with the June Offering pursuant to the Registration
Rights Agreement dated July 3, 1997. The form and terms of the 9% Notes
offered in the September Exchange Offer are the same as the form and terms of
the Privately Placed Notes (which they replaced) except that (i) the 9% Notes
bear a Series B designation, (ii) the 9% Notes have been registered under the
Securities Act and, therefore, do not bear legends restricting the transfer
thereof, and (iii) the holders of the 9% Notes are not entitled to any
registration rights. The September Exchange Offer was consummated on October
3, 1997, with all $400 million principal amount of Privately Placed Notes
being tendered for exchange. As a result, the Company currently has $400
million of 9% Notes outstanding; no Privately Placed Notes remain outstanding.
 
  The 9% Notes Indenture contains several covenants, including: limitations on
indebtedness; limitations on certain restricted payments; limitations on
transactions with affiliates; restrictions on the disposition of proceeds of
asset sales; limitations on liens; limitations on dividend and other payment
restrictions affecting certain subsidiaries; limitations on guarantees by
certain subsidiaries; and limitations on mergers, sales of assets, etc.
 
2003 Notes and 2006 Notes
 
  On November 1, 1993, Dominion Textile (USA) Inc. ("DT USA"), a subsidiary of
Dominion, issued $150.0 million of 8 7/8% Guaranteed Senior Notes due 2003
(the "2003 Notes") pursuant to an indenture, dated as of November 1, 1993,
among DT USA, Dominion, as the Parent Guarantor, and First Union National
Bank, as successor trustee (the "2003 Notes Indenture"). On April 1, 1996, DT
USA issued an additional $125.0 million of 9 1/4% Guaranteed Senior Notes due
2006 (the "2006 Notes") pursuant to an indenture, dated as of April 1, 1996,
among DT USA, Dominion and First Union National Bank, as successor trustee
(the "2006 Notes Indenture"). Both the 2003 Notes and 2006 Notes are senior
Indebtedness of DT USA and are guaranteed on a joint and several basis by DT
USA and Dominion. DT USA became a wholly-owned subsidiary of Polymer Group,
Inc. in connection with the Nonwovens Acquisition.
 
  On December 23, 1997, following the initial take-up of Dominion shares by DT
Acquisition in the Dominion Tender Offer, DT USA made tender offers to
purchase any and all outstanding 2003 Notes and 2006 Notes (the "2003 Tender
Offer" and "2006 Tender Offer," respectively), and solicited consents to
certain proposed amendments to the 2003 Notes Indenture and 2006 Notes
Indenture. The tender of notes in the 2003 Tender Offer and 2006 Tender Offer
was contingent upon such holder's consent to the proposed amendments to the
2003 Notes Indenture and the 2006 Notes Indenture, until, in each case, such
time that the requisite number of consents to approve the proposed
 
                                      22
<PAGE>
 
amendments had been obtained and a supplemental indenture relating thereto had
been executed. The proposed amendments eliminated substantially all of the
protective covenants in each of the 2003 Notes Indenture and the 2006 Notes
Indenture.
 
  The total consideration offered for each validly tendered 2003 Note and
properly delivered consent was $1,065.32, which was equal to the present value
of $1,043.75 (the amount for which each 2003 Note could be repurchased at
November 1, 1998, its earliest call date) and any interest payments due from
the payment date to such call date, discounted using the yield rate of a
chosen reference security plus a fixed spread. The total consideration offered
for each validly tendered 2006 Note and properly delivered consent was
$1,138.50, which was equal to the present value of $1,046.25 (the amount for
which each 2003 Note could be repurchased at April 1, 2001, its earliest call
date), and any interest payments due from the payment date to such call date,
discounted using the yield rate of a chosen reference security plus a fixed
spread. Holders who tendered in the 2003 Tender Offer and the 2006 Tender
Offer prior to each respective expiration date for consents also received a
consent payment equal to 1% of the outstanding principal amount of notes
tendered (included in the total consideration described above).
 
  On January 16, 1998, DT USA made a separate, unconditional offer to purchase
any and all outstanding 2003 Notes at a price equal to 101% of their aggregate
principal amount (the "Change of Control Offer"). The Change of Control Offer
was made solely for the purpose of satisfying certain provisions of the 2003
Indenture, which required such an offer to be made within 30 days of a change
in control of DT USA or Dominion.
 
  On January 28, 1998, the expiration date for the 2003 Tender Offer and the
2006 Tender Offer, DT USA accepted for repurchase $145.6 million of 2003 Notes
and $124.5 million of 2006 Notes. As of January 2, 1999, DT USA had $4.5
million aggregate principal amount of 2003 Notes and $0.3 million aggregate
principal amount of 2006 Notes outstanding. DT USA accepted for repurchase
$25,000 of the remaining 2003 Notes in the Change of Control Offer.
 
Safe Harbor Statement
 
  This Form 10-K contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. In addition, from time to time,
the Company or its representatives have made or may make forward-looking
statements orally or in writing. Such forward-looking statements may be
included in, but not limited to, various filings made by the Company with the
Securities and Exchange Commission, press releases or oral statements made
with the approval of an authorized executive officer of the Company. Actual
results could differ materially from those projected or suggested in any
forward-looking statements as a result of a variety of factors and conditions.
The following factors could cause actual results to differ materially from
historical results or those anticipated: adverse economic conditions,
competition in the Company's markets, fluctuations in raw material costs, and
other risks detailed in documents filed by the Company with the Securities and
Exchange Commission, including the Company's Registration Statement on Form S-
4, declared effective on July 1, 1998, Registration Statement on Form S-4,
declared effective on September 3, 1997, and Registration Statement on Form S-
1, declared effective on May 9, 1996.
 
                                      23
<PAGE>
 
ITEM 2. PROPERTIES
 
  The Company and its subsidiaries operate the following principal
manufacturing plants and other facilities, all of which are owned, except as
noted. All of the Company's owned properties are subject to liens in favor of
the lenders under the Company's credit facilities.
 
<TABLE>
<CAPTION>
                                      Total
             Location              Square Feet         Principal Function
             --------              -----------         ------------------
 <C>                               <C>          <S>
 North Little Rock, Arkansas
  (Plant 1).......................   364,000    Manufacturing
 North Little Rock, Arkansas
  (Plant 2).......................   119,000    Manufacturing and Warehousing
 Rogers, Arkansas.................   126,000    Manufacturing
 Rogers, Arkansas.................    15,000(1) Warehousing
 Gainesville, Georgia.............   121,000(1) Manufacturing and Warehousing
 Dayton, New Jersey...............    30,000(2) Administration
 Landisville, New Jersey..........   245,000    Manufacturing, Sales, Marketing
                                                and Research and Development
 Vineland, New Jersey.............    83,500(3) Manufacturing
 Benson, North Carolina...........   469,000    Manufacturing, Sales, Marketing
                                                and
                                                Warehousing
 Raleigh, North Carolina..........     5,300(1) Administration
 Mooresville, North Carolina......    73,500    Manufacturing, Sales, Marketing
                                                and
                                                Warehousing
 Mooresville, North Carolina......   356,000    Manufacturing, Warehousing and
                                                Administration
 Portland (Clackamas), Oregon.....    30,000    Manufacturing
 North Charleston, South Carolina.    16,500(3) Corporate
 Waynesboro, Virginia.............   175,000    Manufacturing, Warehousing,
                                                Marketing
                                                and Research and Development
 Waynesboro, Virginia.............   125,500    Warehousing
 Buenos Aires, Argentina..........    79,000(4) Manufacturing, Marketing,
                                                Warehousing and Administration
 Mississauga, Ontario.............     2,900(1) Sales and Marketing
 North Bay, Ontario...............   350,000    Manufacturing
 North Bay, Ontario...............    80,000(1) Warehousing
 Bailleul, France.................   305,584    Manufacturing, Marketing,
                                                Warehousing and Administration
 Neunkirchen, Germany.............   108,000    Manufacturing, Sales and
                                                Marketing
 Guadalajara, Mexico..............     6,200(1) Sales, Marketing and
                                                Warehousing
 Monterrey, Mexico................     2,325(1) Sales, Marketing and
                                                Warehousing
 Mexico City, Mexico..............     9,850(1) Sales, Marketing and
                                                Warehousing
 San Luis Potosi, Mexico..........   100,000    Manufacturing and Marketing
 Cuijk, The Netherlands...........   364,000    Manufacturing, Sales,
                                                Marketing, Warehousing and
                                                Research and Development
 Nijmegan, Netherlands............     3,200    Administration
 Tilburg, Netherlands.............    29,052    Manufacturing, Marketing,
                                                Warehousing and Administration
 Denton, Manchester (England).....    12,500    Manufacturing, Warehousing and
                                                Administration
 Albany, New York.................    60,000    Manufacturing and Warehousing
 Magog, Quebec....................   990,100    Manufacturing, Marketing,
                                                Warehousing and Administration
 Sherbrooke, Quebec...............    16,823    Warehousing
 Kingman, Kansas..................   182,000    Manufacturing, Marketing,
                                                Warehousing and Administration
 Clearfield, Utah.................   100,000    Manufacturing and Warehousing
</TABLE>
--------
(1) Leased.
 
                                      24
<PAGE>
 
(2) The Company owns this 239,200 square foot facility, leasing it to an
    unaffiliated tenant, and subleases 30,000 square feet from such tenant.
    The tenant can terminate the Company's sublease upon 12 months' notice.
(3) Leased from entities affiliated with one of the Company's stockholders.
    See "Certain Relationships and Related Transactions."
(4) Joint venture (DNS) with Sauler Group (50% interest).
 
ITEM 3. LEGAL PROCEEDINGS
 
  The Company is currently a party to various claims and legal actions which
arise in the ordinary course of business. The Company believes such claims and
legal actions, individually and in the aggregate, will not have a material
adverse effect on the business, financial condition or results of operations
of the Company.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  None.
 
                                    PART II
 
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
 
  The Company's common stock is traded on the New York Stock Exchange, symbol
PGI. The Company has never paid or declared a cash dividend on its common
stock, nor does the Company expect to pay any cash dividends in the
foreseeable future. The following table sets forth for the calendar periods
indicated the high and low market prices of the Company's common stock.
 
<TABLE>
<CAPTION>
                                                                       1998
                                                                   -------------
                                                                    High   Low
                                                                   ------ ------
      <S>                                                          <C>    <C>
      First Quarter..............................................  $13.63 $ 9.69
      Second Quarter.............................................   12.88  10.38
      Third Quarter..............................................   12.19   7.75
      Fourth Quarter.............................................   11.50   7.50
 
<CAPTION>
                                                                       1997
                                                                   -------------
                                                                    High   Low
                                                                   ------ ------
      <S>                                                          <C>    <C>
      First Quarter .............................................  $15.88 $13.25
      Second Quarter ............................................   16.13  12.00
      Third Quarter..............................................   16.25  12.75
      Fourth Quarter.............................................   15.25   9.31
</TABLE>
 
Title of Class
 
  Common Stock, $.01 par value
 
  As of March 26, 1999, there were 271 holders of record.
 
                                      25
<PAGE>
 
ITEM 6. SELECTED FINANCIAL DATA
 
  The following table sets forth certain historical financial information of
the Company. The statement of operations data for each of the five years ended
and the balance sheet data as of January 2, 1999, January 3, 1998, December
28, 1996, December 30, 1995 and December 31, 1994 have been derived from
audited financial statements. The table should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the financial statements of the Company and related notes thereto
and other information included elsewhere in this Annual Report on Form 10-K.
 
<TABLE>
<CAPTION>
                                                   Year Ended
                          --------------------------------------------------------------
                          January 2,  January 3,  December 28, December 30, December 31,
                             1999        1998         1996         1995         1994
                          ----------  ----------  ------------ ------------ ------------
                                                 (In Thousands)
<S>                       <C>         <C>         <C>          <C>          <C>
Statement of Operations:
Net sales...............  $ 802,948   $ 535,267    $ 521,368    $ 437,638    $ 165,333
Cost of goods sold......    599,894     402,058      389,013      333,606      129,071
                          ---------   ---------    ---------    ---------    ---------
 Gross profit...........    203,054     133,209      132,355      104,032       36,262
Selling, general and
 administrative
 expenses...............     97,499      74,600       70,207       61,744       20,699
                          ---------   ---------    ---------    ---------    ---------
 Operating income.......    105,555      58,609       62,148       42,288       15,563
Other (income) expense:
 Interest expense, net..     67,444      30,499       33,641       37,868       13,216
 Investment income--
  (gain) on marketable
  securities, net ......       (795)    (11,880)         --           --           --
 Foreign currency and
  other.................        806        (452)       2,955       22,811       17,332
 Income taxes...........     14,157      13,009       10,730        5,216        3,353
                          ---------   ---------    ---------    ---------    ---------
Income (loss) before
 extraordinary item and
 cumulative effect of
 change in accounting
 principle .............     23,943      27,433       14,822      (23,607)     (18,338)
Extraordinary item, net
 of income tax benefit..     (2,728)    (12,005)     (13,932)         --        (4,372)
Cumulative effect of
 change in accounting
 principle, net of
 income tax benefit.....     (1,511)        --           --           --           --
                          ---------   ---------    ---------    ---------    ---------
Net income (loss).......     19,704      15,428          890      (23,607)     (22,710)
Redeemable preferred
 stock dividends and
 accretion..............        --          --        (3,020)      (4,839)      (1,209)
                          ---------   ---------    ---------    ---------    ---------
Net income (loss)
 applicable to common
 stock..................  $  19,704   $  15,428    $  (2,130)   $ (28,446)   $ (23,919)
                          =========   =========    =========    =========    =========
Income (loss) before
 extraordinary item and
 cumulative effect of
 change in accounting
 principle per common
 share--basic and
 diluted ...............  $    0.75   $    0.86    $    0.43    $   (1.39)   $   (0.95)
                          =========   =========    =========    =========    =========
Average common shares
 outstanding............     32,000      32,000       27,688       20,500       20,500
                          =========   =========    =========    =========    =========
Operating and other
 data:
Cash provided by
 operating activities...  $  74,074   $  18,362    $  36,097    $  11,556    $  17,386
Cash provided by (used
 in) investing
 activities.............    131,343    (491,901)     (86,422)    (333,208)     (61,375)
Cash (used in) provided
 by financing
 activities.............   (194,440)    485,953       64,391      327,636       58,482
Gross margin (a)........       25.3%       24.9%        25.4%        23.8%        21.9%
EBITDA (b)..............  $ 164,880   $  98,921    $  98,915    $  72,122    $  23,864
EBITDA margin (c).......       20.5%       18.5%        19.0%        16.5%        14.4%
Depreciation and
 amortization...........  $  59,325   $  40,312    $  36,767    $  29,834    $   8,348
Capital expenditures....     90,096      60,144       26,739       47,842       11,341
Balance sheet data (at
 end of period):
Cash and cash
 equivalents............  $  58,308   $  50,190    $  37,587    $  18,088    $  13,828
Working capital.........    212,456     220,025       93,154       61,558       31,060
Total assets............  1,282,967   1,627,753      708,115      637,981      241,942
Total debt, excluding
 short-term bridge
 financing..............    866,499     745,136      382,242      450,878      190,814
Minority interest.......        --       54,730          --           --           --
Redeemable preferred
 stock, dividends and
 accretion..............        --          --           --        44,339          --
Shareholders' equity....    220,125     199,090      195,918       13,752        2,220
</TABLE>
 
              See Notes to Selected Consolidated Financial Data.
 
                                      26
<PAGE>
 
                 Notes to Selected Consolidated Financial Data
 
(a) Gross margin represents gross profit as a percentage of net sales.
(b) EBITDA is defined as operating income plus depreciation, amortization and
    Mexican statutory employee profit sharing and is presented because it is
    generally accepted as providing useful information regarding a company's
    ability to service and/or incur debt. EBITDA should not be considered in
    isolation from or as a substitute for net income, cash flows from
    operating activities and other consolidated income or cash flow statement
    data prepared in accordance with generally accepted accounting principles
    or as a measure of profitability or liquidity.
(c) EBITDA margin represents EBITDA as a percentage of net sales.
 
                                      27
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
    RESULTS OF OPERATIONS
 
                             Results of Operations
 
  The following table sets forth the percentage relationships to net sales of
certain income statement items.
 
<TABLE>
<CAPTION>
                                                     Fiscal Year Ended
                                             ----------------------------------
                                             January 2, January 3, December 28,
                                                1999       1998        1996
                                             ---------- ---------- ------------
<S>                                          <C>        <C>        <C>
Net sales by product category:
Hygiene....................................     39.8%      43.3%       44.4%
Medical....................................     11.5       16.2        17.6
Wiping.....................................     13.4       19.7        17.4
Industrial and specialty...................     35.3       20.8        20.6
                                               -----      -----       -----
                                               100.0      100.0       100.0
Cost of goods sold.........................     74.7       75.1        74.6
                                               -----      -----       -----
 Gross profit..............................     25.3       24.9        25.4
Selling, general and administrative
 expenses..................................     12.1       13.9        13.4
                                               -----      -----       -----
Operating income...........................     13.2       11.0        12.0
Other (income) expense:
 Interest expense, net.....................      8.4        5.7         6.5
 Investment income, (gain) on marketable
  securities, net..........................     (0.1)      (2.2)        --
 Foreign currency and other................      0.1        (.1)        0.5
                                               -----      -----       -----
Income before income taxes, extraordinary
 item and cumulative effect of change in
 accounting principle......................      4.8        7.6         5.0
Income taxes...............................      1.8        2.5         2.1
                                               -----      -----       -----
Income before extraordinary item and
 cumulative effect of change in accounting
 principle.................................      3.0        5.1         2.9
Extraordinary item, net of income tax
 benefit...................................     (0.3)      (2.2)       (2.6)
Cumulative effect of change in accounting
 principle, net of income tax benefit......     (0.2)       --          --
                                               -----      -----       -----
Net income.................................      2.5%       2.9%        0.3%
                                               =====      =====       =====
</TABLE>
 
Comparison of Year Ended January 2, 1999 and January 3, 1998
 
Net Sales
 
  The following table sets forth components of the Company's net sales by
segment for 1998 and the corresponding increase over 1997:
 
<TABLE>
<CAPTION>
                                                Fiscal Year
                                               -------------
                                                1998   1997  Increase % Increase
                                               ------ ------ -------- ----------
                                                        (In Thousands)
<S>                                            <C>    <C>    <C>      <C>
Net sales by product category:
Hygiene....................................... $319.1 $231.9  $ 87.2     37.6%
Medical.......................................   92.7   86.7     6.0      6.9
Wiping........................................  107.6  105.2     2.4      2.3
Industrial and specialty......................  283.5  111.5   172.0    154.3
                                               ------ ------  ------
                                               $802.9 $535.3  $267.6     50.0%
                                               ====== ======  ======
</TABLE>
 
  Net sales increased approximately $267.6 million, or 50%, from $535.3 million
in 1997 to $802.9 million in 1998. The increase was comprised of $251.5 million
from the Nonwovens Acquisition and the Oriented Polymers Acquisition plus
organic growth offset by raw material cost reductions passed through to
customers and unfavorable foreign currency rates.
 
 
                                       28
<PAGE>
 
Gross Profit
 
  Gross profit increased to $203.1 million in 1998 versus $133.2 million in
1997 as a result of acquisition and organic growth. Raw material costs in 1998
were approximately $330.7 million, or 41.2% of net sales, compared to $236.0
million, or 44.1% of net sales, in 1997. The decline in raw materials costs as
a percentage of net sales reflects the continued trend in lower raw materials
costs versus prior periods. Direct labor costs in 1998 were $65.3 million, or
8.1% of net sales, compared to $42.3 million, or 7.9% of net sales in 1997.
Overhead costs in 1998 were $203.8 million, or 25.4% of net sales, compared to
$123.8 million, or 23.1% of net sales in 1997. The increase in overhead costs
between 1998 and 1997 is due primarily to higher incremental overhead costs
associated with the recent acquisitions.
 
Selling, General and Administrative Expenses
 
  Selling, general and administrative expenses decreased from 13.9% of net
sales in 1997 to 12.1% of net sales in 1998 as a result of synergies
identified since the Nonwovens Acquisition and the Oriented Polymer
Acquisition. Research and development expense was $13.2 million in 1998
compared to $9.6 million in 1997.
 
Other
 
  Interest expense increased $36.9 million, from $30.5 million in 1997 to
$67.4 million in 1998. Interest expense as a percentage of net sales increased
from 5.7% in 1997 to 8.4% in 1998. The increase in interest expense is due to
higher indebtedness outstanding during 1998 primarily as a result of the
recent acquisitions. The Company recorded net investment income related to its
gain on marketable securities of $0.8 million during 1998 and $11.9 million
during 1997.
 
  Net foreign currency transaction losses were approximately $0.8 million in
1998 compared to gains of approximately $0.5 million in 1997.
 
  The Company provided for income taxes of approximately $14.2 million in
1998, representing an effective tax rate of 37.2% before extraordinary item
and cumulative effect of accounting change. The provision for income taxes at
the Company's effective rate differed from the provision for income taxes at
the statutory rate due primarily to higher tax rates in foreign jurisdictions
and to an increase in non-deductible goodwill amortization in 1998. The
Company provided for income taxes of approximately $13.0 million in 1997,
representing an effective tax rate of 32.2% before extraordinary item.
 
Income Before Extraordinary Item and Cumulative Effect of Accounting Change
 
  The Company's income before extraordinary item and cumulative effect of
change in accounting principle was $23.9 million, or $.75 per common share in
1998. The approximate $3.5 million decline between 1998 and 1997 is
attributable to net investment income gains of $11.9 million in 1997 and
higher interest costs recognized in 1998.
 
Extraordinary Item and Cumulative Effect of Change in Accounting Principle
 
  As a result of the Nonwovens Acquisition and refinancing of outstanding
indebtedness, the Company recorded extraordinary charges of $2.7 million, net
of taxes, during the first quarter of 1998 for the write-off of previously
capitalized deferred financing costs.
 
  During 1997 the Company recorded extraordinary charges of $12.0 million, net
of taxes, for the write-off of previously capitalized debt issue costs and
premiums paid in connection with the refinancing of its indebtedness.
 
  In April 1998, the American Institute of Certified Public Accountants issued
SOP 98-5, "Reporting the Costs of Start-Up Activities". The SOP is effective
beginning on January 1, 1999, and requires that start-up/organization costs
capitalized prior to January 1, 1999 be written-off and any future start-up
 
                                      29
<PAGE>
 
costs to be expensed as incurred. During the fourth quarter of 1998, the
Company elected early adoption and wrote off the net book value of start-up
costs as a cumulative effect of an accounting change, as permitted by the SOP.
The after-tax charge for this write-off approximated $1.5 million.
 
Comparison of Year Ended January 3, 1998 and December 28, 1996
 
Net Sales
 
  The following table sets forth components of the Company's net sales by
segment for 1997 and the corresponding increase over 1996:
 
<TABLE>
<CAPTION>
                                              Fiscal Year
                                             -------------
                                                            Increase  % Increase
                                              1997   1996  (Decrease) (Decrease)
                                             ------ ------ ---------  ----------
                                                   (Dollars in thousands)
<S>                                          <C>    <C>    <C>        <C>
Net sales by product category:
Hygiene..................................... $231.9 $231.2   $ 0.7         .3%
Medical.....................................   86.7   91.7    (5.0)      (5.4)
Wiping......................................  105.2   90.6    14.6       16.1
Industrial and specialty....................  111.5  107.9     3.6        3.3
                                             ------ ------   -----
                                             $535.3 $521.4   $13.9        2.7%
                                             ====== ======   =====
</TABLE>
 
  Net sales increased approximately $13.9 million, or 2.7%, from $521.4 million
in 1996 to $535.3 million in 1997. The increase in net sales was comprised
primarily of $19.6 million from the FNA acquisition offset by negative foreign
currency impacts.
 
Gross Profit
 
  Gross profit increased to $133.2 million in 1997 versus $132.4 million in
1996. The approximate $0.8 million increase in gross profit over 1996 reflected
the benefit of the acquisition of FNA offset by volume declines attributable to
unforeseeable delays at two key customers, higher manufacturing costs
associated with program ramp-up delays in Europe and reduced overhead
absorption as a result of lower raw material costs.
 
  Raw material costs in 1997 were approximately $236.0 million, or 44.1% of net
sales, compared to $240.1 million, or 46.1% of net sales, in 1996. This
decrease reflects the continued trend in lower raw material costs, offset
somewhat by higher levels of material usage in North America and Europe. Direct
labor costs were $42.3 million, or 7.9% of net sales in 1997, compared to $39.3
million, or 7.6% of net sales in 1996. Overhead costs were $109.5 million, or
20.9% of net sales, in 1996 versus $123.8 million, or 23.1% of net sales, in
1997. The increase in overhead costs between 1997 and 1996 results from higher
depreciation on completed capital expenditures, incremental overhead associated
with the acquisition of FNA and unfavorable manufacturing costs associated with
program ramp-up delays and lower thermal bond volume.
 
Selling, General and Administrative Expenses
 
  Selling, general and administrative expenses were 13.9% of net sales, or
$74.6 million, in 1997 compared to 13.4% of net sales, or $70.2 million, in
1996. Research and development expense was $9.6 million in 1997 compared to
$6.9 million in 1996.
 
Other
 
  Interest expense in 1997 decreased $3.1 million, from $33.6 million in 1996
to $30.5 million in 1997. Interest expense as a percentage of net sales
decreased from 6.5% in 1996 to 5.7% in 1997. The decrease in interest expense
is principally due to a lower average amount of indebtedness outstanding in
1997 prior to refinancing the Company's indebtedness in June 1997. The Company
recorded net investment income related to its gain on marketable securities of
$11.9 million during 1997.
 
                                       30
<PAGE>
 
  Net foreign currency transaction gains were approximately $0.5 million in
1997 compared to foreign currency losses of approximately $3.0 million in
1996. The Company provided for income taxes of approximately $13.0 million in
1997, representing an effective tax rate of 32.2% before extraordinary item.
The provision for income taxes at the Company's effective rate differed from
the provision for income taxes at the statutory rate due primarily to the
utilization of net operating loss carryforwards and to tax strategies
initiated at the time of the Company's Initial Public Offering in 1996.
 
Income Before Extraordinary Item
 
  The Company's income before extraordinary item was $27.4 million, or $.86
per common share, as compared to $14.8 million, or $.43 per common share in
1996. The approximate $12.6 million increase between 1997 and 1996 is
attributable to net investment income gains of $11.9 million, lower interest
expense and a lower effective tax rate, offset by reduced overhead absorption
due to lower thermal bond volume, offset somewhat by lower raw material costs,
higher manufacturing costs associated with program ramp-up delays in Europe
and volume declines associated with delays at certain key customers.
 
Extraordinary Item
 
  The Company recorded extraordinary charges of $12.0 million, net of taxes,
for the write-off of previously capitalized debt issue costs and premiums paid
in connection with the refinancing of its indebtedness in June of 1997.
 
                        Liquidity and Capital Resources
 
Operating Activities
 
  During 1998, the Company's operations generated $74.1 million of cash. The
Company's working capital decreased $7.5 million, from $220.0 million at
January 3, 1998 to $212.5 million at January 2, 1999. Cash and equivalents
were $58.3 million at January 2, 1999 as compared to $50.2 million at January
3, 1998. This increase arose principally from the conversion of marketable
securities to cash.
 
Investing and Financing Activities
 
  Capital expenditures for 1998 totaled $90.1 million, an increase of $30.0
million over 1997 due primarily to margin-enhancing projects and capacity
expansions. For fiscal 1999, the Company has budgeted approximately $150.0
million primarily for margin-enhancing capital expenditures.
 
  On July 3, 1997, the Company refinanced its outstanding indebtedness by: (i)
consummating the offering of the Privately Placed Notes and the tender offer
and related consent solicitation for its Senior Notes; and (ii) amending and
restating its then existing credit facility. In connection with consummation
of the June Refinancing, the Company recorded extraordinary charges of $12.0
million (net of tax) for the write-off of previously capitalized debt issue
costs and premiums paid with respect to the repurchase of the Senior Notes.
 
  On December 19, 1997, DT Acquisition completed the purchase of approximately
98% of the outstanding common shares of Dominion for Cdn$14.50 per share and
approximately 96% of the outstanding first preferred shares of Dominion for
Cdn$150 per share. Additionally, on December 29, 1997, DT Acquisition acquired
an additional 331,207 common shares. The acquisition, which was accounted for
using the purchase method of accounting, was financed with bridge financing of
$425.9 million.
 
 
                                      31
<PAGE>
 
  On January 29, 1998, DT Acquisition acquired all remaining common and
preferred shares of Dominion which then underwent a "winding up." All assets
of Dominion were transferred to DT Acquisition, all liabilities of Dominion
were assumed by DT Acquisition and all outstanding common shares and first
preferred shares held by DT Acquisition were redeemed. Immediately thereafter,
pursuant to a purchase agreement dated October 27, 1997, and a Master
Separation Agreement dated January 29, 1998, the Apparel Fabrics Business was
sold to Galey for approximately $464.5 million, including related fees and
expenses, and the Company acquired the Nonwovens Business of Dominion for
approximately $351.6 million, including fees and expenses. Concurrently, DT
USA purchased approximately $145.6 million of its $150.0 million outstanding 8
7/8% Guaranteed Senior Notes due 2003. At the same time, DT USA purchased
approximately $124.5 million of its $125.0 million outstanding 9 1/4%
Guaranteed Senior Notes due 2006. In addition, on January 29, 1998 and in
connection with acquisition of the Nonwovens Business, the Company amended its
credit facility to provide a term loan of $125.0 million and a revolving
credit commitment of $325.0 million.
 
  On March 5, 1998 the Company issued $200 million of 8 3/4% Senior
Subordinated Notes due 2008 and on March 16, 1998, acquired the manufacturing
and business assets of a leading North American manufacturer of polypropylene-
based, commercial twine and polyethylene-based specialty knitted products for
approximately $47.4 million.
 
  The Company believes that based on current levels of operations and
anticipated growth, its cash from operations, together with other available
sources of liquidity, including but not limited to, borrowings under the
Amended Credit Facility, will be adequate over the next several years to make
required debt payments, including interest thereon, permit anticipated capital
expenditures and fund the Company's working capital requirements.
 
Effect of Inflation
 
  Inflation generally affects the Company by increasing the cost of labor,
equipment and new materials. The Company does not believe that inflation has
had any material effect on the Company's results of operations.
 
Foreign Currency
 
  The Company accounts for and reports translation of foreign currency
transactions and foreign currency financial statements in accordance with FAS
52. The remeasurement of foreign currency denominated assets and liabilities
into dollars gives rise to foreign exchange gains and losses which are
included in the determination of net income.
 
Derivatives
 
  The Company does not use derivative financial instruments for trading
purposes and may enter into financial instruments, limited in duration and
scope, to manage its exposure to fluctuations of foreign currency rates.
Premiums paid for purchased interest rate cap agreements are charged to
expense over the rate cap period. The Company entered into a London Interbank
Offered Rate-based interest rate cap agreement during 1996. The agreement
provides for a notional amount of $100.0 million which declines ratably over
the rate cap term. If the rate cap exceeds 9% on each quarterly reset date, as
defined in the agreement, the Company is entitled to receive an amount by
which the rate cap exceeds 9%. Over the term of the agreement in 1998, such
amount did not exceed 9%. Charges to income in 1998, 1997 and 1996 related to
derivative products and hedging activities were not significant.
 
                                      32
<PAGE>
 
New Accounting Standards
 
  In 1997, the Financial Accounting Standards Board issued Statement No. 130,
"Reporting Comprehensive Income" ("FAS 130") which is effective for fiscal
years beginning after December 15, 1997. As of January 4, 1998 the Company
adopted FAS 130; however, the adoption of this statement had no impact on the
Company's net income or shareholders' equity. FAS 130 establishes new rules
for the reporting and display of comprehensive income and its components. FAS
130 requires unrealized gains or losses on the Company's available-for-sale
securities and the foreign currency translation adjustments, which prior to
adoption were reported separately in shareholders' equity, to be included in
other comprehensive income. Prior year financial statements have been
reclassified to conform to the requirements of FAS 130.
 
  In 1997, the Financial Accounting Standards Board issued Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("FAS
131") which is effective for years beginning after December 15, 1997. FAS 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. As of January 4, 1998, the Company adopted FAS 131; however, the
adoption of this statement had no impact on the Company's operations and net
income.
 
  In 1998, the Financial Accounting Standards Board issued Statement No. 132,
"Employers' Disclosures about Pensions and Other Post-retirement Benefits"
("FAS 132") which is effective for fiscal years beginning after December 15,
1997. FAS 132 revises and standardizes employers' disclosures for pensions and
other post-retirement benefit plans and it requires additional information
about changes in the benefit obligations and the fair value of plan assets
that are expected to enhance financial analysis. As of January 2, 1999, the
Company adopted FAS 132; however, it does not change the measurement or
recognition standards for these plans.
 
  In 1998, the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("FAS 133")
which is effective for fiscal years beginning after June 15, 1999. FAS 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and
measure those instruments at fair value. FAS 133 contains disclosure
requirements based on the type of hedge and the type of market risk that is
being hedged. The Company has elected to defer the adoption of FAS 133 until
fiscal year 2000. The Company does not believe the adoption of FAS 133 to have
a material impact on the Company's financial position or results of
operations.
 
 Start-Up Activities
 
  In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5, "Reporting the Costs of Start-Up Activities"
("SOP"). The SOP is effective beginning on January 1, 1999, and requires that
start-up/organization costs capitalized prior to January 1, 1999 be written-
off and any future start-up be expensed as incurred. During the fourth quarter
of 1998, the Company elected early adoption and wrote off the net book value
of start-up costs as a cumulative effect of an accounting change, as permitted
by the SOP.
 
Environmental
 
  The Company is subject to a broad range of federal, foreign, state and local
laws governing regulations relating to the pollution and protection of the
environment. The Company believes that it is currently in substantial
compliance with environmental requirements and does not currently anticipate
any material adverse effect on its operations, financial condition or
competitive position as a result of
 
                                      33
<PAGE>
 
its efforts to comply with environmental requirements. Some risk of
environmental liability is inherent, however, in the nature of the Company's
business, and there can be no assurance that material environmental
liabilities will not arise.
 
Year 2000
 
  The Company has commenced global initiatives to assess the Year 2000 issue.
The project encompasses a review of information systems, personal computers,
process systems and ancillary systems and communications with third party
suppliers, vendors and customers. The objective of the Year 2000 assessment is
to minimize the seriousness of any technical failures in order to reduce the
risk of a material impact on the operations and financial condition of the
Company. The following outlines, by key areas, the status of the Company's
Year 2000 assessment, any reasonably expected risks identified during this
process, costs and contingency plans.
 
 Information Systems and Personal Computers
 
  The majority of information systems and personal computers are Year 2000
ready. The information systems at certain facilities in Canada and Europe are
in the final phases of readiness with anticipated completion dates during the
first half of 1999. In most cases, the Company has replaced, or is in the
process of replacing, older software with new programs and systems, rather
than modifying existing systems solely to become Year 2000 ready. Although the
timing of the system replacements is influenced by the Year 2000, in most
cases these systems would have been replaced in the normal course of business.
Management currently does not reasonably expect any risks material to the
operations and financial condition of the Company as a result of information
system and personal computer failures.
 
 Process Systems
 
  The Company has been communicating with vendors and performing physical
tests of the process systems and expects to complete the assessment during the
first half of 1999. Management anticipates the assessment to reveal that
certain systems will not be Year 2000 ready. The results of this assessment,
plans for the final phase, and any necessary contingency plans will be
disclosed at a later date.
 
 Third Party Compliance
 
  The Company continues to learn and evaluate the compliance status of
vendors, suppliers and customers with whom we have a material relationship.
This process includes sending surveys to key suppliers; however, in most
cases, the responses have not been adequate in determining the readiness of
third parties. The Company could face a material financial risk if its
customers or suppliers are unable to complete critical Year 2000 readiness
efforts in a timely manner; however, the evaluation has not revealed any
material risks to date associated with third parties. The Company plans to
have alternate suppliers available in the event a primary supplier has a Year
2000 related production interruption.
 
 Year 2000 Costs
 
  Costs incurred to date have been approximately $0.3 million and currently
management does not expect future costs to exceed $0.7 million. Costs are
being monitored and can be expected to fluctuate during the final phases of
the project; however, total costs are not expected to be material to the
financial results of the Company.
 
Euro Conversion
 
  On January 1, 1999, member countries of the European Monetary Union (EMU)
began a three-year transition from their national currencies to a new common
currency, the "euro". Permanent rates of exchange between members' national
currency and the euro have been established and monetary,
 
                                      34
<PAGE>
 
capital, foreign exchange, and interbank markets have been converted to the
euro. National currencies will continue to exist as legal tender and may
continue to be used in commercial transactions. By January 2002, euro currency
will be issued and by July 2002, the respective national currencies will be
withdrawn. The Company has operations in three of the participating countries
and has successfully transitioned to using both the euro and local currencies
for commercial transactions. The Company continues to address the euro's
impact on information systems, currency exchange rate risk, taxation and
pricing. Costs of the euro conversion have not been material and management
believes the future costs of the euro conversion will not have a material
impact on the results of operations or the financial condition of the Company.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
 
Quantitive and Qualitative Disclosures about Market Risk
 
  The Credit Facility permits the Company to borrow up to $450 million, a
portion of which may be denominated in Dutch guilders and in Canadian dollars.
The variable interest rate applicable to borrowings under the Credit Facility
is based on, in the case of U.S. dollar denominated loans, the Base Rate
referred to therein or the Eurocurrency Base Rate referred to therein for U.S.
dollars, at the Company's option, plus a specified margin. In the event that a
portion of the Credit Facility is denominated in Dutch guilders, the
applicable interest rate is based on the applicable Eurocurrency Base Rate
referred to therein for Dutch guilders, plus a specified margin. In the event
that a portion of the Credit Facility is denominated in Canadian dollars, the
applicable interest rate is based on the Canadian Base Rate referred to
therein (plus a specified margin) of the Bankers' Acceptance Discount Rate
referred to therein, at the Company's option. At January 2, 1999, the Company
had borrowings under the Credit Facility of $260.1 million that were subject
to interest rate risk. Each 1.0% increase in interest rates would impact
pretax earnings by $2.6 million. The Company has an interest rate cap
agreement which limits the amount of interest expense on $100 million of this
debt to a rate of 9%.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
<TABLE>
<S>                                                                         <C>
Report of Ernst & Young LLP, Independent Auditors.........................   36
 
Consolidated Balance Sheets as of January 2, 1999 and January 3, 1998.....   37
 
Consolidated Statements of Operations for the fiscal years ended January
 2, 1999, January 3, 1998 and December 28, 1996...........................   38
 
Consolidated Statements of Shareholders' Equity for the fiscal years ended
 January 2, 1999, January 3, 1998 and December 28, 1996...................   39
 
Consolidated Statements of Cash Flows for the fiscal years ended January
 2, 1999, January 3, 1998 and December 28, 1996...........................   40
 
Notes to Consolidated Financial Statements for the fiscal years ended
 January 2, 1999, January 3, 1998 and December 28, 1996...................   41
</TABLE>
 
                                      35
<PAGE>
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors
Polymer Group, Inc.
 
  We have audited the accompanying consolidated balance sheets of Polymer
Group, Inc. as of January 2, 1999 and January 3, 1998 and the related
consolidated statements of operations, shareholders' equity, and cash flows
for each of the three years in the period ended January 2, 1999. Our audits
also included the financial statement schedule listed in the Index at Item
14(a). These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Polymer
Group, Inc. at January 2, 1999 and January 3, 1998 and the consolidated
results of its operations and its cash flows for each of the three years in
the period ended January 2, 1999 in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken
as a whole, presents fairly in all material respects the information set forth
therein.
 
  As discussed in Note 1 to the consolidated financial statements, in 1998 the
Company changed its method of accounting for the costs of start-up activities.
 
                                          Ernst & Young LLP
 
Greenville, South Carolina
February 25, 1999
 
 
                                      36
<PAGE>
 
                              POLYMER GROUP, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                       (In Thousands, Except Share Data)
 
<TABLE>
<CAPTION>
                                                        January 2,  January 3,
                        ASSETS                             1999        1998
                        ------                          ----------  ----------
<S>                                                     <C>         <C>
Current assets:
  Cash and equivalents................................. $   58,308  $   50,190
  Marketable securities................................        --        7,754
  Accounts receivable, net.............................    103,958     107,328
  Inventories..........................................     98,820      94,128
  Deferred income taxes................................      7,179       4,161
  Assets held for disposition, net.....................        --      464,524
  Other................................................     42,466      26,985
                                                        ----------  ----------
    Total current assets...............................    310,731     755,070
Property, plant and equipment, net.....................    685,009     606,260
Intangibles and loan acquisition costs, net............    253,094     229,391
Deferred income taxes..................................      7,496       9,183
Other..................................................     26,637      27,849
                                                        ----------  ----------
    Total assets....................................... $1,282,967  $1,627,753
                                                        ==========  ==========
         LIABILITIES AND SHAREHOLDERS' EQUITY
         ------------------------------------
Current liabilities:
  Accounts payable..................................... $   53,056  $   52,165
  Accrued liabilities..................................     37,258      52,133
  Income taxes payable.................................      4,469       1,242
  Deferred income taxes................................        422         284
  Short-term bridge financing..........................        --      425,945
  Current portion of long-term debt....................      3,070       3,276
                                                        ----------  ----------
    Total current liabilities..........................     98,275     535,045
Long-term debt, less current portion...................    863,429     741,860
Deferred income taxes..................................     82,876      82,213
Other noncurrent liabilities...........................     18,262      14,815
Minority interest......................................        --       54,730
Shareholders' equity:
  Series preferred stock-$.01 par value, 10,000,000
   shares authorized at 1998 and 1997; 0 shares issued
   and outstanding at 1998 and 1997 ...................        --          --
  Common stock--$.01 par value, 100,000,000 shares
   authorized at 1998 and 1997; 32,000,000 shares
   issued and outstanding at 1998 and 1997.............        320         320
  Non-voting common stock--$.01 par value; 3,000,000
   shares authorized at 1998 and 1997; 0 shares issued
   and outstanding at 1998 and 1997....................        --          --
  Additional paid-in capital...........................    243,662     243,662
  (Deficit)............................................    (19,651)    (39,355)
  Accumulated other comprehensive income...............     (4,206)     (5,537)
                                                        ----------  ----------
                                                           220,125     199,090
                                                        ----------  ----------
    Total liabilities and shareholders' equity......... $1,282,967  $1,627,753
                                                        ==========  ==========
</TABLE>
 
                            See accompanying notes.
 
                                       37
<PAGE>
 
                              POLYMER GROUP, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (In Thousands, Except Per Share Data)
 
<TABLE>
<CAPTION>
                                                  For the Fiscal Years Ended
                                                --------------------------------
                                                January   January
                                                   2,        3,     December 28,
                                                  1999      1998        1996
                                                --------  --------  ------------
<S>                                             <C>       <C>       <C>
Net sales.....................................  $802,948  $535,267    $521,368
Cost of goods sold............................   599,894   402,058     389,013
                                                --------  --------    --------
Gross profit..................................   203,054   133,209     132,355
Selling, general and administrative expenses..    97,499    74,600      70,207
                                                --------  --------    --------
Operating income..............................   105,555    58,609      62,148
Other (income) expense:
  Interest expense, net.......................    67,444    30,499      33,641
  Investment income--(gain) on marketable
   securities, net............................      (795)  (11,880)        --
  Foreign currency and other..................       806      (452)      2,955
                                                --------  --------    --------
                                                  67,455    18,167      36,596
                                                --------  --------    --------
Income before income taxes, extraordinary item
 and cumulative effect of change in accounting
 principle....................................    38,100    40,442      25,552
Income taxes..................................    14,157    13,009      10,730
                                                --------  --------    --------
Income before extraordinary item and
 cumulative effect of change in accounting
 principle....................................    23,943    27,433      14,822
Extraordinary item, net of income tax benefit
 of $0 in 1998, $5,959 in 1997 and $7,492 in
 1996.........................................    (2,728)  (12,005)    (13,932)
Cumulative effect of change in accounting
 principle, net of income tax benefit of $907.    (1,511)      --          --
                                                --------  --------    --------
Net income....................................    19,704    15,428         890
Redeemable preferred stock dividends and
 accretion....................................       --        --       (3,020)
                                                --------  --------    --------
Net income (loss) applicable to common stock..  $ 19,704  $ 15,428    $ (2,130)
                                                ========  ========    ========
Net income (loss) per common share:
  Basic and diluted:
    Average common shares outstanding.........    32,000    32,000      27,688
    Income before extraordinary item and
     cumulative effect of change in accounting
     principle................................  $    .75  $    .86    $    .43
    Extraordinary item, net of tax............      (.08)     (.38)       (.51)
    Cumulative effect of change in accounting
     principle,
     net of tax...............................      (.05)      --           --
                                                --------  --------    --------
    Net income (loss) per common share--basic
     and diluted..............................  $    .62  $    .48    $   (.08)
                                                ========  ========    ========
</TABLE>
 
                            See accompanying notes.
 
                                       38
<PAGE>
 
                              POLYMER GROUP, INC.
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
  For the Fiscal Years Ended January 2, 1999, January 3, 1998 and December 28,
                                      1996
                       (In Thousands, Except Share Data)
 
<TABLE>
<CAPTION>
                                                       Accumulated
                                 Additional               Other
                          Common  Paid-in             Comprehensive           Comprehensive
                          Stock   Capital   (Deficit) Income (Loss)  Total    Income (Loss)
                          ------ ---------- --------  ------------- --------  -------------
<S>                       <C>    <C>        <C>       <C>           <C>       <C>
Balance--December 30,
 1995...................   $ 10   $ 53,134  $(52,653)    $13,261    $ 13,752     $   --
Exercise of warrants
 (1,417,735 shares).....      1         (1)      --          --          --          --
Approximate 19.97 to 1
 stock split............    194       (194)      --          --          --          --
Issuance of stock, net
 of costs incurred
 (11,500,000 shares)....    115    190,723       --          --      190,838         --
Cumulative dividends on
 redeemable preferred
 stock and discount
 accretion..............    --         --     (3,020)        --       (3,020)        --
 
Net income..............    --         --        890         --          890         890
Foreign currency
 translation
 adjustments, net of
 income tax benefit of
 $0.....................    --         --        --       (6,129)     (6,129)     (6,129)
Unrealized holding
 (loss) on marketable
 securities, net of
 income tax benefit of
 $299...................    --         --        --         (413)       (413)       (413)
                           ----   --------  --------     -------    --------     -------
Balance--December 28,
 1996...................    320    243,662   (54,783)      6,719     195,918
Comprehensive (loss) for
 the year ended
 December 28, 1996......                                                         $(5,652)
                                                                                 =======
Net income..............    --         --     15,428         --       15,428     $15,428
Foreign currency
 translation
 adjustments, net of
 income tax benefit of
 $1,467.................    --         --        --      (12,334)    (12,334)    (12,334)
Unrealized holding gain
 on marketable
 securities, net of
 income taxes of ($37)..    --         --        --           78          78          78
                           ----   --------  --------     -------    --------     -------
Balance--January 3,
 1998...................    320    243,662   (39,355)     (5,537)    199,090
Comprehensive income for
 the year ended January
 3, 1998................                                                         $ 3,172
                                                                                 =======
 
Net income..............    --         --     19,704         --       19,704     $19,704
Foreign currency
 translation
 adjustments, net of
 income taxes of $(800).    --         --        --        1,338       1,338       1,338
Unrealized holding
 (loss) on marketable
 securities, net of
 income tax benefit of
 $0.....................    --         --        --           (7)         (7)         (7)
                           ----   --------  --------     -------    --------     -------
Balance--January 2,
 1999...................   $320   $243,662  $(19,651)    $(4,206)   $220,125
                           ====   ========  ========     =======    ========
Comprehensive income for
 the year ended January
 2, 1999................                                                         $21,035
                                                                                 =======
</TABLE>
 
 
                            See accompanying notes.
 
                                       39
<PAGE>
 
                              POLYMER GROUP, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In Thousands)
 
<TABLE>
<CAPTION>
                                                 For the Fiscal Years Ended
                                             ----------------------------------
                                             January 2, January 3, December 28,
                                                1999       1998        1996
                                             ---------- ---------- ------------
<S>                                          <C>        <C>        <C>
Operating activities
 Net income.................................  $ 19,704   $ 15,428    $    890
 Adjustments to reconcile net income to net
  cash
  provided by operating activities:
 Extraordinary item, net of income tax ben-
  efit......................................     2,728     12,005      13,932
 Cumulative effect of change in accounting
  principle, net of
  income tax benefit........................     1,511        --          --
 Depreciation and amortization expense......    59,325     40,312      36,767
 Foreign currency transaction (gains) loss-
  es, net...................................       806       (452)      2,955
 Gain on marketable securities classified
  as trading, net...........................       --     (11,880)        --
 Provision for losses on accounts receiv-
  able and price concessions................     6,860      7,337       9,060
 Provision for deferred income taxes........      (585)     5,985       7,831
 Changes in operating assets and liabili-
  ties, net of effect of acquisitions:
   Accounts receivable......................     4,760    (19,157)    (11,966)
   Inventories..............................       697     (6,453)     (6,353)
   Accounts payable and accrued expenses....   (16,098)    (4,304)     (5,860)
   Other, net...............................    (5,634)   (20,459)    (11,159)
                                              --------   --------    --------
     Net cash provided by operating activi-
      ties..................................    74,074     18,362      36,097
Investing activities
 Purchases of property, plant and equip-
  ment......................................   (90,096)   (60,144)    (26,739)
 Purchases of marketable securities classi-
  fied as available for sale................   (16,672)   (15,251)    (22,879)
 Proceeds from sales of marketable securi-
  ties classified as
  available for sale........................    24,485     17,003      16,713
 Acquisition of businesses, net of cash ac-
  quired....................................   (47,423)  (429,559)    (52,466)
 Proceeds from sale of assets, net of can-
  celed subordinated advance................   323,524        --          --
 Minority interest..........................   (54,730)       --          --
 Other, net.................................    (7,745)    (3,950)     (1,051)
                                              --------   --------    --------
     Net cash provided by (used in) invest-
      ing activities........................   131,343   (491,901)    (86,422)
Financing activities
 Issuance of common stock, net of costs in-
  curred....................................       --         --      190,838
 Proceeds from debt.........................   621,481    906,791     308,277
 Payments of debt...........................  (804,361)  (402,282)   (375,989)
 Issuance of redeemable preferred stock and
  warrants..................................       --         --       10,000
 Redemption of preferred stock..............       --         --      (57,359)
 Loan acquisition costs, net................   (11,560)   (18,556)    (11,376)
                                              --------   --------    --------
     Net cash (used in) provided by financ-
      ing activities........................  (194,440)   485,953      64,391
Effect of exchange rate changes on cash.....    (2,859)       189       5,433
                                              --------   --------    --------
     Net increase in cash and equivalents...     8,118     12,603      19,499
     Cash and equivalents at beginning of
      year..................................    50,190     37,587      18,088
                                              --------   --------    --------
     Cash and equivalents at end of year....  $ 58,308   $ 50,190    $ 37,587
                                              ========   ========    ========
Noncash investing and financing activities
 Cumulative dividends on redeemable pre-
  ferred stock and accretion................  $    --    $    --     $  3,020
 Approximate 19.97 to 1 stock split.........       --         --          194
 Cancellation of subordinated advance.......   141,000        --          --
Supplemental information
 Cash paid for interest, net of amounts
  capitalized...............................    68,725     39,120      37,323
 Cash paid for income taxes.................    13,498      7,419       6,602
Acquisition of businesses
 Fair value of assets acquired..............    48,453    391,920      61,946
 Fair value of assets acquired--held for
  disposition...............................       --     464,524         --
 Liabilities assumed and incurred...........    (1,030)  (426,885)     (9,480)
 Acquisition of businesses, net of cash ac-
  quired....................................    47,423    429,559      52,466
</TABLE>
 
                            See accompanying notes.
 
 
                                       40
<PAGE>
 
                              POLYMER GROUP, INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1. Significant Accounting Policies
 
 Description of Business
 
  Polymer Group, Inc. (the "Company"), a manufacturer and marketer of nonwoven
and oriented polyolefin products, operates in four business segments which
include hygiene, medical, wiping and industrial and specialty products. The
Company operates manufacturing facilities located in the United States,
Canada, Mexico, The Netherlands, France, Germany, England, and a joint venture
in Argentina. The Company's fiscal year end is the Saturday closest to the
last day in December. There were 52 weeks in fiscal year 1998 and 53 weeks in
fiscal year 1997.
 
 Basis of Presentation and Use of Estimates
 
  The accompanying consolidated financial statements of the Company are
prepared on the basis of generally accepted accounting principles and include
the accounts of the Company and its subsidiaries. All material intercompany
accounts are eliminated in consolidation. Certain amounts previously presented
in the consolidated financial statements for prior periods have been
reclassified to conform to current classification. The preparation of
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect
the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates. Investments in 20% to 50%
owned affiliates are accounted for on the equity method.
 
 Revenue Recognition
 
  Revenue from product sales is recognized at the time ownership of goods
transfers to the customer and the earnings process is complete.
 
 Cash Equivalents and Interest Income
 
  Investment securities with maturities of three months or less at the time of
acquisition are considered cash equivalents. Interest and other income
approximated $5.1, $2.4 and $1.9 million during 1998, 1997 and 1996,
respectively, and consists primarily of income from highly liquid investment
sources. Interest expense in the consolidated statements of operations is net
of interest and other income and capitalized interest.
 
 Marketable Securities
 
  The Company accounts for its investments using Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("FAS 115") which requires that certain debt and equity
securities be adjusted to market value at the end of each accounting period.
Market value gains and losses are charged to earnings if the securities are
traded for short-term profit. Otherwise, such gains and losses are charged or
credited to the comprehensive income component of shareholders' equity.
Management determines the proper classifications of investments at the time of
purchase and reevaluates such designation as of each balance sheet date.
Realized gains and losses on sales of investments, as determined on the
specific identification basis, are included in the determination of net
income. As of January 3, 1998, the Company's marketable securities were
invested in equity securities with a market value of approximately $7.8
million, and were designated as available for sale.
 
 Accounts Receivable and Concentration of Credit Risks
 
  Accounts receivable potentially expose the Company to concentration of
credit risk, as defined by Statement of Financial Accounting Standards No.
105, "Disclosure of Information about Financial Instruments with Off-Balance
Sheet Risk and Financial Instruments with Concentration of Credit Risk." The
Company provides credit in the normal course of business and performs ongoing
credit
 
                                      41
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
evaluations on certain of its customers' financial condition, but generally
does not require collateral to support such receivables. The Company also
establishes an allowance for doubtful accounts based upon factors surrounding
the credit risk of specific customers, historical trends and other
information. The allowance for doubtful accounts was $7.6 and $5.5 million at
January 2, 1999 and January 3, 1998, respectively, which management believes
is adequate to provide for credit loss in the normal course of business, as
well as losses for customers who have filed for protection under the
bankruptcy law. Johnson & Johnson ("J&J") and The Procter & Gamble Company
("P&G") each accounted for approximately 17% of the Company's sales in 1998.
In 1997, J&J and P&G accounted for approximately 26% and 16%, respectively, of
the Company's sales. In 1996, J&J and P&G accounted for approximately 29% and
14%, respectively, of the Company's sales.
 
 Inventories
 
  Inventories are stated at the lower of cost or market using the first-in,
first-out method of accounting and, as of January 2, 1999 and January 3, 1998
consist of the following:
 
<TABLE>
<CAPTION>
                                                                 1998    1997
                                                                ------- -------
                                                                (In Thousands)
      <S>                                                       <C>     <C>
      Finished goods........................................... $51,595 $48,769
      Work in process and stores and maintenance parts.........  12,126  11,201
      Raw materials............................................  35,099  34,158
                                                                ------- -------
                                                                $98,820 $94,128
                                                                ======= =======
</TABLE>
 
 Property, Plant and Equipment
 
  Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation is computed for financial reporting purposes on the
straight-line method over the estimated useful lives of the related assets.
The estimated useful lives established for building and land improvements
range from 18 to 33 years, and the estimated useful lives established for
machinery, equipment and other fixed assets range from 3 to 15 years. Costs of
the construction of certain long-term assets include capitalized interest
which is amortized over the estimated useful life of the related asset. The
Company capitalized approximately $4.2, $1.6 and $0.8 million of interest
costs during 1998, 1997 and 1996, respectively.
 
 Intangibles and Loan Acquisition Costs
 
  Intangible assets are amortized using the straight-line method over periods
ranging from 5 to 40 years. Loan acquisition costs relating to long-term debt
are amortized over the term of the related debt. The Company continually
reviews the recoverability of the carrying value of these assets in accordance
with Statement of Financial Accounting Standard No 121 "Accounting for the
Impairment of Long-Lived Assets and for Assets to be Disposed Of" ("FAS 121").
The Company also reviews long-lived assets and the related intangible assets
for impairment whenever events or changes in circumstances indicate the
carrying amount of such assets may not be recoverable. When the future
undiscounted cash flows of the operation to which the assets relate do not
exceed the carrying value of the asset, the intangible assets are written
down, followed by the other long-lived assets, to fair value. FAS 121 write-
downs have not been material to the Company's financial condition or results
of operations.
 
 Derivatives
 
  The Company does not use derivative financial instruments for trading
purposes. Such products are used only to manage well-defined interest rate and
certain foreign currency risks, as discussed
 
                                      42
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
below. Premiums paid for purchased interest rate cap agreements are charged to
expense over the rate cap period. The Company entered into a London Interbank
Offered Rate ("LIBOR")-based interest rate cap agreement during 1996. The
agreement provides for a notional amount of $100.0 million which declines
ratably over the rate cap term. If the rate cap exceeds 9% on each quarterly
reset date, as defined in the agreement, the Company is entitled to receive an
amount by which the rate cap exceeds 9%. Over the term of the agreement in
1998, such amount did not exceed 9%.
 
  The Company may enter into financial instruments, which are limited in
duration and scope, to manage its exposure to fluctuations of foreign currency
rates. These instruments are used for hedging purposes and are employed in
connection with an underlying asset, liability, firm commitment or anticipated
transaction. Gains and losses on hedges of existing assets and liabilities are
included in the carrying amounts of those assets or liabilities and are
ultimately recognized in income as part of those carrying amounts. Gains and
losses related to qualifying hedges of firm commitments or anticipated
transactions are also deferred and recognized in income or as adjustments of
carrying amounts when the hedged transaction occurs. Gains and losses, if any,
on financial instruments that do not qualify as hedges for accounting purposes
are recognized in the determination of net income.
 
  Charges to expense in 1998, 1997 and 1996 related to derivative products
were not significant.
 
  In 1998, the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("FAS 133")
which is effective for fiscal years beginning after June 15, 1999. FAS 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and
measure those instruments at fair value. FAS 133 contains disclosure
requirements based on the type of hedge and the type of market risk that is
being hedged. The Company has elected to defer the adoption of FAS 133 until
fiscal year 2000. The Company does not believe the adoption of FAS 133 to have
a material impact on the Company's financial position or results of
operations.
 
 Fair Value of Financial Instruments
 
  The Company has estimated the fair value amounts of financial instruments as
required by Statement of Financial Accounting Standards No. 107, "Disclosures
about Fair Value of Financial Instruments", using available market information
and appropriate valuation methodologies. However, considerable judgment is
required in interpreting market data to develop the estimates of fair value.
Accordingly, such estimates are not necessarily indicative of the amounts that
the Company would realize in a current market exchange. The carrying amount of
cash and equivalents, marketable securities, accounts receivable, other
assets, accounts payable and derivative financial instruments are reasonable
estimates of their fair values. The contract amounts of outstanding letters of
credit approximate their fair value. Fair value of the Company's long-term
debt was estimated using interest rates at those dates for issuance of such
financial instruments with similar terms and remaining maturities and other
independent valuation methodologies. The estimated fair value of debt at
January 2, 1999 and January 3, 1998 was $860.0 million and $1.2 billion,
respectively.
 
 Income Taxes
 
  The provision for income taxes and corresponding balance sheet accounts are
determined in accordance with Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes" ("FAS 109"). Under FAS 109, the deferred
tax liabilities and assets are determined based upon temporary differences
between the basis of certain assets and liabilities for income tax and
financial reporting purposes. A valuation allowance is recognized if it is
more likely than not that some portion or all of a deferred tax asset will not
be ultimately realized.
 
                                      43
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
 Research and Development
 
  The cost of research and development is charged to expense as incurred and is
included in selling, general and administrative expense in the consolidated
statement of operations. The Company incurred approximately $13.2, $9.6 and
$6.9 million of research and development expense during 1998, 1997 and 1996,
respectively.
 
 Foreign Currency Translation
 
  All assets and liabilities in the balance sheets of foreign subsidiaries
whose functional currency is other than the U.S. dollar are translated at year-
end exchange rates. Translation gains and losses are not included in
determining net income but are accumulated as a separate component of
shareholders' equity. However, subsidiaries considered to be operating in
highly inflationary countries use the U.S. dollar as the functional currency
and translation gains and losses are included in determining net income.
Foreign currency transaction gains and losses are included in determining net
income.
 
 Comprehensive Income
 
  Comprehensive income is reported in accordance with the Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS
130"). FAS 130 establishes new rules for the reporting and display of
comprehensive income and its components. FAS 130 requires unrealized gains or
losses on the Company's available-for-sale securities and the foreign currency
translation adjustments, which prior to adoption were reported separately in
shareholders' equity, to be included in other comprehensive income. Cumulative
foreign currency translation adjustments and unrealized gain (loss) on
marketable securities are as follows:
 
<TABLE>
<CAPTION>
                                                       1998     1997     1996
                                                      -------  -------  ------
                                                          (In Thousands)
<S>                                                   <C>      <C>      <C>
Cumulative foreign currency translation adjustments.. $(4,206) $(5,544) $6,790
Cumulative unrealized gain (loss) on marketable
 securities..........................................     --         7     (71)
                                                      -------  -------  ------
Accumulated other comprehensive income............... $(4,206) $(5,537) $6,719
                                                      =======  =======  ======
</TABLE>
 
 Start-Up Activities
 
  In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5, "Reporting the Costs of Start-Up Activities"
("SOP"). The SOP is effective beginning on January 1, 1999, and requires that
start-up/organization costs capitalized prior to January 1, 1999 be written-off
and any future start-up be expensed as incurred. During the fourth quarter of
1998, the Company elected early adoption and wrote off the net book value of
start-up costs as a cumulative effect of an accounting change, as permitted by
the SOP.
 
Note 2. Acquisitions
 
  On December 19, 1997, DT Acquisition Inc. ("DTA"), a special-purpose
subsidiary of the Company, completed the purchase of approximately 98% of the
outstanding common shares of Dominion Textiles Inc. ("Dominion") for Cdn$14.50
per share and approximately 96% of the outstanding first preferred shares of
Dominion for Cdn$150 per share. The acquisition was accounted for in 1997 using
the purchase method of accounting and was financed with bridge financing of
approximately $425.9 million.
 
                                       44
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  On January 29, 1998, DTA acquired all remaining common and preferred shares,
at which time Dominion underwent a "winding-up". All assets of Dominion were
transferred to DTA, all liabilities were assumed by DTA and all outstanding
common shares and first preferred shares held by DTA were redeemed. Immediately
thereafter, pursuant to a purchase agreement dated October 27, 1997, the
apparel fabrics business of Dominion was sold to Galey & Lord, Inc. for
approximately $464.5 million, and the Company acquired (the "Nonwovens
Acquisition") the assets and liabilities that comprised the nonwovens and
industrial fabrics operations (the "Nonwovens Business") for approximately
$351.6 million, including fees and expenses. Concurrently, Dominion Textile
(USA) Inc. ("DT USA"), a wholly-owned subsidiary of Dominion, purchased
approximately $145.6 million of its $150.0 million outstanding 8.875%
Guaranteed Senior Notes due 2003 and, at the same time, purchased approximately
$124.5 million of its $125.0 million outstanding Guaranteed Senior Notes due
2006. In connection with the Nonwovens Acquisition and related transactions,
the Company also amended its senior secured credit facility to provide for
$125.0 million in term loans. The Company used borrowings under the credit
facility, as amended, to finance the purchase of the Nonwovens Business and
repay the bridge financing indicated above.
 
  Net assets of the apparel business of Dominion were classified as assets held
for disposition on the Company's consolidated balance sheet at January 3, 1998.
No gain or loss was recognized on the sale of the apparel fabrics business and
operating results of this business have been excluded from the Company's
results of operations while results of the Nonwovens Business have been
included in the Company's results for the full year of 1998.
 
  The following pro forma information for fiscal 1997 is based on historical
financial statements of the Company, the Nonwovens Business adjusted to give
effect to the Nonwovens Acquisition and refinancings undertaken during 1997 as
if these events occurred on December 29, 1996. The unaudited pro forma
financial information includes the results of a business acquired by the
Company in the third quarter of 1997, which is not independently significant
for disclosure purposes. In accordance with the purchase method of accounting,
the purchase price for the Nonwovens Acquisition was allocated to the
underlying assets based on their respective fair values at the date of
acquisition. The accompanying pro forma data does not purport to represent what
the Company's results of operations would have been had the Nonwovens
Acquisition and the refinancings consummated in 1997 actually occurred at the
beginning of the respective period, or project the Company's results of
operations for any future periods:
 
<TABLE>
<CAPTION>
                                                                   1997
                                                           ---------------------
                                                           (In Thousands, Except
                                                              Per Share Data)
   <S>                                                     <C>
   Net sales..............................................       $748,832
   Income before extraordinary item.......................         18,247
   Net income.............................................          6,242
   Per share--basic and diluted:
     Income before extraordinary item.....................       $    .57
     Net income...........................................       $    .19
</TABLE>
 
  On March 16, 1998, the Company completed the acquisition (the "Oriented
Polymer Acquisition") of a leading North American manufacturer of
polypropylene-based commercial twine and polyethylene-based specialty knitted
products for approximately $47.4 million in a transaction accounted for by the
purchase method of accounting. Results of this business have been included in
the Company's results of operations since the date of acquisition. Supplemental
pro forma information for the Oriented Polymer Acquisition is not presented
because the acquisition was not material to the consolidated results of
operations.
 
                                       45
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 3. Property, Plant and Equipment
 
  Property, plant and equipment as of January 2, 1999 and January 3, 1998,
consist of the following:
 
<TABLE>
<CAPTION>
                                                               1998      1997
                                                             --------  --------
                                                              (In Thousands)
      <S>                                                    <C>       <C>
      Cost:
        Land................................................ $ 11,687  $  9,288
        Buildings and land improvements.....................  131,453   111,031
        Machinery, equipment and other......................  618,366   527,257
        Construction in progress............................   59,412    50,228
                                                             --------  --------
                                                              820,918   697,804
      Less accumulated depreciation......................... (135,909)  (91,544)
                                                             --------  --------
                                                             $685,009  $606,260
                                                             ========  ========
 
  Depreciation charged to expense was $47.8, $31.2 and $27.2 million during
1998, 1997 and 1996, respectively.
 
Note 4. Intangibles and Loan Acquisition Costs
 
  Intangibles and loan acquisition costs as of January 2, 1999 and January 3,
1998 consist of the following:
 
<CAPTION>
                                                               1998      1997
                                                             --------  --------
                                                              (In Thousands)
      <S>                                                    <C>       <C>
      Cost:
        Goodwill............................................ $217,980  $187,026
        Supply agreement....................................   13,431    13,431
        Proprietary technology..............................   24,100    24,100
        Loan acquisition costs and other....................   30,159    28,801
                                                             --------  --------
                                                              285,670   253,358
      Less accumulated amortization.........................  (32,576)  (23,967)
                                                             --------  --------
                                                             $253,094  $229,391
                                                             ========  ========
 
  Amortization charged to expense was $11.5, $9.2 and $9.6 million during
1998, 1997 and 1996, respectively. The increase in goodwill between 1998 and
1997 results from the Company's recent acquisitions.
 
Note 5. Accrued Liabilities
 
  Accrued liabilities as of January 2, 1999 and January 3, 1998, consist of
the following:
 
<CAPTION>
                                                               1998      1997
                                                             --------  --------
                                                              (In Thousands)
      <S>                                                    <C>       <C>
      Interest payable...................................... $  6,769  $  7,377
      Salaries, wages and other fringe benefits.............   13,965    13,813
      Other.................................................   16,524    30,943
                                                             --------  --------
                                                             $ 37,258  $ 52,133
                                                             ========  ========
</TABLE>
 
                                      46
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  During 1995, management adopted a plan to relocate manufacturing equipment,
corporate offices and certain equipment used in an acquired business' research
and development activities to other sites in the United States. Accordingly,
the Company provided for accrued restructuring costs of approximately $17.9
million at the time of the acquisition. During 1998, the Company completed its
restructuring plan and accordingly at January 2, 1999, no remaining accrual
existed.
 
Note 6. Commitments and Contingencies
 
 Leases
 
  The Company leases certain manufacturing, warehousing and other facilities
and equipment under operating leases. The leases on most of the properties
contain renewal provisions. Rent expense (net of sub-lease income), including
incidental leases, approximated $4.7, $1.7 and $2.4 million in 1998, 1997 and
1996, respectively. Rental income approximated $1.7, $0.6 and $2.2 million in
1998, 1997 and 1996, respectively. The approximate net minimum rental payments
required under operating leases that have initial or remaining non-cancelable
lease terms in excess of one year at January 2, 1999 are:
 
<TABLE>
<CAPTION>
                                                               Lease
                                                      Gross     and       Net
                                                     Minimum    Sub-    Minimum
                                                      Rental   Lease     Rental
                                                     Payments (Income)  Payments
                                                     -------- --------  --------
                                                           (In Thousands)
      <S>                                            <C>      <C>       <C>
      1999.......................................... $ 5,504  $ (1,720)  $3,784
      2000..........................................   4,912    (1,782)   3,130
      2001..........................................   4,545    (1,822)   2,723
      2002..........................................   3,508    (1,710)   1,798
      2003..........................................   2,706    (1,650)   1,056
      Thereafter....................................   2,162   (11,194)  (9,032)
                                                     -------  --------   ------
                                                     $23,337  $(19,878)  $3,459
                                                     =======  ========   ======
</TABLE>
 
 Purchase Commitments
 
  At January 2, 1999, the Company had commitments of approximately $53.8
million related to the purchase of raw materials and converting services and
$18.6 million related to capital projects.
 
 Collective Bargaining Agreements
 
  At January 2, 1999, the Company had a total of approximately 3,800 employees
worldwide. Of this total, approximately 1,470 employees are represented by
labor unions or trade councils that have entered into separate collective
bargaining agreements with the Company. Approximately 18% of the Company's
labor force is covered by collective bargaining agreements which will expire
within one year.
 
 Environmental
 
  The Company is subject to a broad range of federal, foreign, state and local
laws governing regulations relating to the pollution and protection of the
environment. The Company believes that it is currently in substantial
compliance with environmental requirements and does not currently anticipate
any material adverse effect on its operations, financial condition or
competitive position as a result of its efforts to comply with environmental
requirements. Some risk of environmental liability is inherent, however, in
the nature of the Company's business, and there can be no assurance that
material environmental liabilities will not arise.
 
                                      47
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 7. Debt
 
  Long-term debt as of January 2, 1999 and January 3, 1998, consists of the
following (in thousands):
<TABLE>
<CAPTION>
                                                               1998      1997
                                                             --------  --------
<S>                                                          <C>       <C>
Senior subordinated notes, due July 2007,
 interest rate 9%, subject to redemption at
 any time on or after July 1, 2002 at the
 option of the Company based on certain
 redemption prices (a)...................................... $400,000  $400,000
Senior subordinated notes, due March 2008,
 interest rate 8.75%, subject to redemption
 on or after March 1, 2003 at the option of the
 Company based on certain redemption
 prices (a)(c)..............................................  200,000       --
Revolving credit facility, due June 2003, interest
 at rates ranging from 7.88% to 8.75%, interest
 rates for U.S. dollar loans are based on LIBOR;
 Canadian dollar loans are based on Canadian base
 rates and Dutch guilder loans are based on Eurocurrency
 rates (b)(c)...............................................  136,064    61,569
Term loan, due December 2005, interest
 rate 8.13% (b)(c)..........................................  124,000       --
DT USA guaranteed senior notes due
 November 2003, interest rate
 8.875%(d)..................................................    4,505   153,288
DT USA guaranteed senior notes due April
 2006, interest rate 9.25% (d)..............................      337   128,052
Other.......................................................    7,391     8,460
                                                             --------  --------
                                                              872,297   751,369
Less: Unamortized debt discount.............................   (5,798)   (6,233)
                                                             --------  --------
                                                              866,499   745,136
Less: Current maturities ...................................   (3,070)   (3,276)
                                                             --------  --------
                                                             $863,429  $741,860
                                                             ========  ========
</TABLE>
--------
(a) Unsecured obligations guaranteed by all of the Company's direct and
    indirect domestic subsidiaries. If a change in control occurs, the notes
    are subject to redemption at a price equal to 101% of the principal amount
    held at the option of the holder. As of January 2, 1999, the Company was
    in compliance with covenant provisions associated with the senior
    subordinated notes, which includes restrictions on the payment of
    dividends.
(b) The Company's credit facility, amended in January 1998, provides for
    senior revolving credit borrowings with aggregate commitments of up to
    $325.0 million and a term loan of $125.0 million. Subject to certain terms
    and conditions, a portion of the credit facility may be used for letters
    of credit. As of January 2, 1999, the Company had outstanding letters of
    credit of approximately $8.7 million and unused commitments of
    approximately $180.3 million under the credit facility. Commitment fees
    under the credit facility are generally equal to a percentage of the daily
    unused amount of such commitment. The credit facility contains covenants
    customary for financings of this type, which the Company was in compliance
    with as of January 2, 1999.
 
                                      48
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
(c) Loan acquisition costs, including commitment fees, approximated $11.6
    million and $18.6 million in 1998 and 1997, respectively.
(d) In January 1998, DT USA purchased approximately $145.6 million of its
    $150.0 million outstanding 8.875% notes, and at the same time purchased
    approximately $124.5 million of its $125.0 million outstanding 9.25%
    notes. The Company received short-term bridge financing to consummate the
    acquisition of Dominion of approximately $425.9 million, at a weighted
    average interest rate of 9.5%, which was either repaid or canceled in
    January 1998. As part of the short-term bridge financing, $69.0 million
    was received from ZB Holdings, Inc. ("ZB Holdings"), an entity affiliated
    with the Company. This amount, including interest of approximately $0.6
    million, was repaid during January 1998. The Company maintains restricted
    cash of $4.8 million to retire the remaining DT USA notes. This restricted
    cash is classified as part of other noncurrent assets on the Company's
    Consolidated Balance Sheet at January 2, 1999.
 
  Long-term debt maturities consist of the following (in thousands):
 
<TABLE>
      <S>                                                                <C>
      1999.............................................................. $ 3,070
 
      2000..............................................................   2,296
 
      2001..............................................................   2,035
 
      2002..............................................................   2,092
 
      2003.............................................................. 142,595
 
      Thereafter........................................................ 714,411
</TABLE>
 
 
                                      49
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 8. Condensed Consolidating Financial Statements
 
  Payment of the Company's Senior Subordinated Notes is unconditionally
guaranteed, jointly and severally, on a senior subordinated basis by certain
of the Company's wholly-owned subsidiaries. Management has determined that
separate complete financial statements of the guarantor entities would not be
material to users of the financial statements; therefore, the following sets
forth condensed consolidating financial statements (in thousands):
 
                     Condensed Consolidating Balance Sheet
                             As of January 2, 1999
 
<TABLE>
<CAPTION>
                                         Combined
                            Combined       Non-
                           Guarantor    Guarantor      The     Reclassifications
         ASSETS           Subsidiaries Subsidiaries  Company   and Eliminations  Consolidated
         ------           ------------ ------------ ---------- ----------------- ------------
<S>                       <C>          <C>          <C>        <C>               <C>
Cash and equivalents....   $   19,476    $ 31,066   $    7,766    $       --      $   58,308
Accounts receivable,
 net....................       52,118      51,840          --             --         103,958
Inventories.............       47,433      50,568          --             819         98,820
Other...................       26,684       9,215       13,746            --          49,645
                           ----------    --------   ----------    -----------     ----------
    Total current
     assets.............      145,711     142,689       21,512            819        310,731
Due from affiliates.....      823,183       8,021      210,560     (1,041,764)           --
Investment in
 subsidiaries...........      420,485      75,133      777,009     (1,272,627)           --
Property, plant and
 equipment, net.........      476,341     208,346          322            --         685,009
Intangibles and loan
 acquisition costs, net.      156,516      66,861       26,426          3,291        253,094
Other...................       12,600      19,772        2,061           (300)        34,133
                           ----------    --------   ----------    -----------     ----------
    Total assets........   $2,034,836    $520,822   $1,037,890    $(2,310,581)    $1,282,967
                           ==========    ========   ==========    ===========     ==========
    LIABILITIES AND
  SHAREHOLDERS' EQUITY
  ---------------------
Accounts payable,
 accrued liabilities and
 other .................   $   50,110    $ 39,106   $    6,240    $      (251)    $   95,205
Current portion of long-
 term debt..............          899       1,171        1,000            --           3,070
                           ----------    --------   ----------    -----------     ----------
    Total current
     liabilities........       51,009      40,277        7,240           (251)        98,275
Due to affiliates.......      841,138     171,767       28,543     (1,041,448)           --
Long-term debt, less
 current portion........        4,842      33,076      825,511            --         863,429
Deferred income taxes
 and other..............       53,566      40,596        6,679            297        101,138
Shareholders' equity....    1,084,281     235,106      169,917     (1,269,179)       220,125
                           ----------    --------   ----------    -----------     ----------
    Total liabilities
     and
     shareholders' equity  $2,034,836    $520,822   $1,037,890    $(2,310,581)    $1,282,967
                           ==========    ========   ==========    ===========     ==========
</TABLE>
 
                                      50
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
                     Condensed Consolidating Balance Sheet
                             As of January 3, 1998
 
<TABLE>
<CAPTION>
                                         Combined
                            Combined       Non-
                           Guarantor    Guarantor     The    Reclassifications
         ASSETS           Subsidiaries SubsidiarieS Company  and Eliminations  Consolidated
         ------           ------------ ------------ -------- ----------------- ------------
<S>                       <C>          <C>          <C>      <C>               <C>
Cash and equivalents....   $    8,721   $   37,752  $  3,717    $       --      $   50,190
Marketable securities...          --           --      7,754            --           7,754
Accounts receivable,
 net....................       42,281       65,047       --             --         107,328
Inventories.............       40,324       54,164       --            (360)        94,128
Due from affiliates.....           66        2,223       --          (2,289)           --
Assets held for
 disposition, net.......          --       464,524       --             --         464,524
Other...................       22,367        6,004     1,482          1,293         31,146
                           ----------   ----------  --------    -----------     ----------
    Total current
     assets.............      113,759      629,714    12,953         (1,356)       755,070
Due from affiliates.....      436,795        1,884   508,249       (946,928)           --
Investment in
 subsidiaries...........      273,967       11,553   410,893       (684,860)        11,553
Property, plant and
 equipment, net.........      302,905      303,010       --             345        606,260
Intangibles and loan
 acquisition costs, net
 .......................       29,773      180,319    14,767          4,532        229,391
Other...................        7,443       15,066    12,084         (9,114)        25,479
                           ----------   ----------  --------    -----------     ----------
    Total assets........   $1,164,642   $1,141,546  $958,946    $(1,637,381)    $1,627,753
                           ==========   ==========  ========    ===========     ==========
<CAPTION>
    LIABILITIES AND
  SHAREHOLDERS' EQUITY
  --------------------
<S>                       <C>          <C>          <C>      <C>               <C>
Accounts payable,
 accrued labilities and
 other..................   $   44,000   $   65,226  $  8,853    $   (12,255)    $  105,824
Short-term bridge
 financing..............          --       425,945       --             --         425,945
Current portion of long-
 term debt..............          900        1,376     1,000            --           3,276
                           ----------   ----------  --------    -----------     ----------
    Total current
     liabilities........       44,900      492,547     9,853        (12,255)       535,045
Due to affiliates.......      515,331       99,935   307,398       (922,664)           --
Long-term debt, less
 current portion........        1,150      340,944   424,767        (25,001)       741,860
Deferred income taxes
 and other..............       17,182      125,400     9,152             24        151,758
Shareholders' equity....      586,079       82,720   207,776       (677,485)       199,090
                           ----------   ----------  --------    -----------     ----------
    Total liabilities
     and shareholders'
     equity.............   $1,164,642   $1,141,546  $958,946    $(1,637,381)    $1,627,753
                           ==========   ==========  ========    ===========     ==========
</TABLE>
 
 
                                       51
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
                Condensed Consolidating Statement of Operations
                   For the Fiscal Year Ended January 2, 1999
 
<TABLE>
<CAPTION>
                                        Combined
                           Combined       Non-
                          Guarantor     Guarantor    The    Reclassifications
                         Subsidiaries Subsidiaries Company  and Eliminations  Consolidated
                         ------------ ------------ -------  ----------------- ------------
<S>                      <C>          <C>          <C>      <C>               <C>
Net sales...............  $ 513,057     $305,485       --       $(15,594)       $802,948
Cost of goods sold......    390,752      224,906       --        (15,764)        599,894
                          ---------     --------   -------      --------        --------
    Gross profit........    122,305       80,579       --            170         203,054
Selling, general and
 administrative
 expenses...............     58,882       44,141    (5,646)          122          97,499
                          ---------     --------   -------      --------        --------
    Operating income....     63,423       36,438     5,646            48         105,555
Other expense, net......      7,320       16,198    44,082          (145)         67,455
                          ---------     --------   -------      --------        --------
    Income (loss) before
     income taxes,
     extraordinary item
     and cumulative
     effect of change in
     accounting
     principle..........     56,103       20,240   (38,436)          193          38,100
Income taxes............      6,060        7,465       540            92          14,157
                          ---------     --------   -------      --------        --------
    Income before
     extraordinary item
     and cumulative
     effect of change in
     accounting
     principle..........     50,043       12,775   (38,976)          101          23,943
Extraordinary item......        --        (2,728)      --            --           (2,728)
Cumulative effect of
 change in accounting
 principle..............     (2,072)         151       410           --           (1,511)
Equity in earnings of
 subsidiaries...........        --           --     58,270       (58,270)            --
                          ---------     --------   -------      --------        --------
Net income..............  $  47,971     $ 10,198   $19,704      $(58,169)       $ 19,704
                          =========     ========   =======      ========        ========
</TABLE>
 
                Condensed Consolidating Statement of Operations
                   For the Fiscal Year Ended January 3, 1998
 
<TABLE>
<CAPTION>
                                        Combined
                           Combined       Non-
                          Guarantor    Guarantor     The    Reclassifications
                         Subsidiaries Subsidiaries Company  and Eliminations  Consolidated
                         ------------ ------------ -------  ----------------- ------------
<S>                      <C>          <C>          <C>      <C>               <C>
Net sales...............   $354,206     $195,465   $   --       $(14,404)       $535,267
Cost of goods sold......    280,112      136,315        35       (14,404)        402,058
                           --------     --------   -------      --------        --------
    Gross profit........     74,094       59,150       (35)          --          133,209
Selling, general and
 administrative
 expenses...............     47,700       32,967    (6,067)          --           74,600
                           --------     --------   -------      --------        --------
    Operating income....     26,394       26,183     6,032           --           58,609
Other (income) expense,
 net....................     13,941        7,212    (2,986)          --           18,167
                           --------     --------   -------      --------        --------
    Income before income
     taxes and
     extraordinary item.     12,453       18,971     9,018           --           40,442
Income taxes (benefit)..       (785)       3,101    10,693           --           13,009
                           --------     --------   -------      --------        --------
    Income (loss) before
     extraordinary item.     13,238       15,870    (1,675)          --           27,433
Extraordinary item......     (4,587)        (839)   (6,579)          --          (12,005)
Equity in earnings of
 subsidiaries...........        --           --     23,682       (23,682)            --
                           --------     --------   -------      --------        --------
Net income..............   $  8,651     $ 15,031   $15,428      $(23,682)       $ 15,428
                           ========     ========   =======      ========        ========
</TABLE>
 
                                       52
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
                Condensed Consolidating Statement of Operations
                  For the Fiscal Year Ended December 28, 1996
 
<TABLE>
<CAPTION>
                                         Combined
                            Combined       Non-
                           Guarantor    Guarantor     The    Reclassifications
                          Subsidiaries Subsidiaries Company  and Eliminations  Consolidated
                          ------------ ------------ -------  ----------------- ------------
<S>                       <C>          <C>          <C>      <C>               <C>
Net sales...............    $335,477     $187,754   $   --       $ (1,863)       $521,368
Cost of goods sold......     264,027      126,836         1        (1,851)        389,013
                            --------     --------   -------      --------        --------
    Gross profit........      71,450       60,918        (1)          (12)        132,355
Selling, general and
 administrative
 expenses...............      38,281       32,710     (453)         (331)          70,207
                            --------     --------   -------      --------        --------
    Operating income....      33,169       28,208       452           319          62,148
Other expense, net......      11,772       13,806    11,018           --           36,596
                            --------     --------   -------      --------        --------
    Income (loss) before
     income taxes and
     extraordinary item.      21,397       14,402   (10,566)          319          25,552
Income taxes............       4,698        1,659     4,373           --           10,730
                            --------     --------   -------      --------        --------
    Income (loss) before
     extraordinary item.      16,699       12,743   (14,939)          319          14,822
Extraordinary item......     (10,745)         793    (3,980)          --          (13,932)
Equity in earnings of
 subsidiaries...........         --           --     19,809       (19,809)            --
                            --------     --------   -------      --------        --------
Net income..............       5,954       13,536       890       (19,490)            890
Redeemable preferred
 stock dividends and
 accretion..............     (2,551)          --    (3,020)         2,551          (3,020)
                            --------     --------   -------      --------        --------
Income (loss) applicable
 to common stock........    $  3,403     $ 13,536   $(2,130)     $(16,939)       $ (2,130)
                            ========     ========   =======      ========        ========
</TABLE>
 
                                       53
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
                Condensed Consolidating Statement of Cash Flows
                   For the Fiscal Year Ended January 2, 1999
 
<TABLE>
<CAPTION>
                                        Combined
                           Combined       Non-
                          Guarantor    Guarantor      The     Reclassifications
                         Subsidiaries Subsidiaries  Company   and Eliminations  Consolidated
                         ------------ ------------ ---------  ----------------- ------------
<S>                      <C>          <C>          <C>        <C>               <C>
Net cash provided by
 (used by) operating
 activities.............  $ 120,057    $ (18,608)  $ (42,744)     $  15,369      $  74,074
Investing activities
 Purchases of property,
  plant and equipment...    (55,990)     (34,106)        --             --         (90,096)
 Purchases of marketable
  securities classified
  as available for sale.        --           --      (16,672)           --         (16,672)
 Proceeds from sales of
  marketable securities
  classified as
  available for sale....        --           --       24,485            --          24,485
 Proceeds from sale of
  assets, net of
  canceled
  subordinated advance..        --       323,524         --             --         323,524
 Minority interest......        --       (54,730)        --             --         (54,730)
 Acquisition of
  business, net of cash
  acquired..............    (47,423)         --          --             --         (47,423)
 Intercompany
  transactions,net......   (207,033)     (20,662)   (347,282)       574,977            --
 Other, net.............    220,516      366,430      (3,803)      (590,888)        (7,745)
                          ---------    ---------   ---------      ---------      ---------
Net cash (used in)
 provided by investing
 activities.............    (89,930)     580,456    (343,272)       (15,911)       131,343
Financing activities
 Proceeds from debt.....    281,339        4,674     616,808       (281,340)       621,481
 Payments of debt.......   (298,179)    (571,022)   (216,500)       281,340       (804,361)
 Loan acquisition costs,
  net...................        --           --      (11,560)           --         (11,560)
                          ---------    ---------   ---------      ---------      ---------
Net cash (used in)
 provided by financing
 activities.............    (16,840)    (566,348)    388,748            --        (194,440)
Effect of exchange rate
 changes on cash........     (2,532)      (2,186)      1,317            542         (2,859)
                          ---------    ---------   ---------      ---------      ---------
Net increase (decrease)
 in cash and
 equivalents............     10,755       (6,686)      4,049            --           8,118
Cash and equivalents at
 beginning of year......      8,721       37,752       3,717            --          50,190
                          ---------    ---------   ---------      ---------      ---------
Cash and equivalents at
 end of year............  $  19,476    $  31,066   $   7,766      $     --       $  58,308
                          =========    =========   =========      =========      =========
</TABLE>
 
                                       54
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
                Condensed Consolidating Statement of Cash Flows
                   For the Fiscal Year Ended January 3, 1998
 
<TABLE>
<CAPTION>
                                    Combined
                         Combined     Non-       The     Reclassifications
                         Guarantor  Guarantor  Company   and Eliminations  Consolidated
                         ---------  ---------  --------  ----------------- ------------
<S>                      <C>        <C>        <C>       <C>               <C>
Net cash provided by
 operating
 activities............. $ 52,917   $ 29,290   $ 18,763      $(82,608)       $ 18,362
Investing activities
   Purchases of
   property, plant and
    equipment...........  (50,933)    (9,208)        (3)          --          (60,144)
  Purchases of
   marketable securities
   classified as
   available for sale...      --         --     (15,251)          --          (15,251)
  Proceeds from sales of
   marketable securities
   classified as
   available for sale...      --         --      17,003           --           17,003
  Acquisition of
   business, net of cash
   acquired.............      --    (424,645)    (4,914)          --         (429,559)
  Other, net............      --      (3,554)      (396)          --           (3,950)
                         --------   --------   --------      --------        --------
Net cash (used in)
 investing activities...  (50,933)  (437,407)    (3,561)          --         (491,901)
Financing activities
   Proceeds from debt...   19,675     28,478    432,693           --          480,846
  Proceeds from short-
   term bridge
   financing............      --     425,945        --            --          425,945
  Payments of debt...... (160,675)   (69,682)  (171,925)          --         (402,282)
  Intercompany
   transactions, net....  131,425     46,496   (260,529)       82,608             --
  Loan acquisition
   costs, net...........      (17)    (3,622)   (14,917)          --          (18,556)
                         --------   --------   --------      --------        --------
Net cash (used in)
 provided by financing
 activities.............   (9,592)   427,615    (14,678)       82,608         485,953
Effect of exchange rate
 changes on cash........      --         --         189           --              189
                         --------   --------   --------      --------        --------
Net (decrease) increase
 in cash and
 equivalents............   (7,608)    19,498        713           --           12,603
Cash and equivalents at
 beginning of year......   16,329     18,254      3,004           --           37,587
                         --------   --------   --------      --------        --------
Cash and equivalents at
 end of year............ $  8,721   $ 37,752   $  3,717      $    --         $ 50,190
                         ========   ========   ========      ========        ========
</TABLE>
 
                                       55
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
                Condensed Consolidating Statement of Cash Flows
                  For the Fiscal Year Ended December 28, 1996
 
<TABLE>
<CAPTION>
                                         Combined
                            Combined       Non-
                           Guarantor    Guarantor     The    Reclassifications
                          Subsidiaries Subsidiaries Company  and Eliminations  Consolidated
                          ------------ ------------ -------  ----------------- ------------
<S>                       <C>          <C>          <C>      <C>               <C>
Net cash provided by
 operating activities...    $ 31,224     $17,997    $ 3,580      $(16,704)       $ 36,097
Investing activities
  Purchases of property,
   plant and equipment..     (13,029)    (11,569)    (2,141)          --          (26,739)
  Purchases of
   marketable securities
   classified as
   available for sale...         --          --     (22,879)          --          (22,879)
  Proceeds from sales of
   marketable securities
   classified as
   available for sale...         --          --      16,713           --           16,713
  Acquisition of
   businesses, net of
   cash acquired........         --          --     (52,466)          --          (52,466)
  Other, net............        (520)        --        (531)          --           (1,051)
                            --------     -------    -------      --------        --------
Net cash (used in)
 investing activities...     (13,549)    (11,569)   (61,304)          --          (86,422)
Financing activities
  Issuance of common
   stock, net of costs
   incurred.............         --          --     190,838           --          190,838
  Proceeds from debt....     165,900      75,377     67,000           --          308,277
  Payments of debt......    (323,863)       (126)   (52,000)          --         (375,989)
  Issuance of redeemable
   preferred stock......         --          --      10,000           --           10,000
  Redemption of
   preferred stock......         --          --     (57,359)          --          (57,359)
  Intercompany
   transactions, net....     151,691     (71,487)   (96,908)       16,704             --
  Loan acquisition
   costs, net...........      (3,669)     (1,145)    (6,562)          --          (11,376)
                            --------     -------    -------      --------        --------
Net cash (used in)
 provided by financing
 activities.............      (9,941)      2,619     55,009        16,704          64,391
Effect of exchange rate
 changes on cash........         --          --       5,433           --            5,433
                            --------     -------    -------      --------        --------
Net increase in cash and
 equivalents............       7,734       9,047      2,718           --           19,499
Cash and equivalents at
 beginning of year......       8,595       9,207        286           --           18,088
                            --------     -------    -------      --------        --------
Cash and equivalents at
 end of year............    $ 16,329     $18,254    $ 3,004      $    --         $ 37,587
                            ========     =======    =======      ========        ========
</TABLE>
 
                                       56
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 9. Income Taxes
 
  Significant components of the provision for income taxes are as follows:
 
<TABLE>
<CAPTION>
                                                            Fiscal Year
                                                       -----------------------
                                                        1998     1997    1996
                                                       -------  ------  ------
                                                          (In Thousands)
<S>                                                    <C>      <C>     <C>
Current:
  Federal and state .................................. $ 8,864  $  315  $  --
  Foreign.............................................   5,878   6,709   2,899
Deferred:
  Federal and state ..................................  (1,464)  7,108   8,324
  Foreign.............................................     879  (1,123)   (493)
                                                       -------  ------  ------
Income tax before extraordinary item and cumulative
 effect of
 change in accounting principle ......................  14,157  13,009  10,730
Income tax benefit from:
  Cumulative effect of change in accounting principle.    (907)    --      --
  Extraordinary item, loss from early extinguishment
   of debt ...........................................     --   (5,959) (7,492)
                                                       -------  ------  ------
Total income tax expense ............................. $13,250  $7,050  $3,238
                                                       =======  ======  ======
</TABLE>
 
  The Company's provision for income taxes in 1998 includes the benefit of
utilizing net operating loss carryforwards of approximately $5.4 million. At
January 2, 1999, the Company had: (i) operating loss carryforwards of
approximately $0.7 million for federal income tax purposes expiring in the
years 2003-2010; (ii) Canadian capital loss carryforwards of approximately
$3.7 million and Canadian operating loss carryforwards of approximately $9.4
million expiring in the years 2004-2005; (iii) French net operating loss
carryforwards of approximately $0.8 million which expire in 2003; and (iv)
operating loss carryforwards of approximately $1.0 million which begin to
expire in 2002 related to its Mexican operation. No accounting recognition has
been given to the potential income tax benefit related to the U.S., Canadian
and Mexican operating loss carryforwards. The Company has not provided U.S.
income taxes for undistributed earnings of foreign subsidiaries which are
considered to be retained indefinitely for reinvestment. The distribution of
these earnings would result in additional foreign withholding taxes and
additional U.S. federal income taxes to the extent they are not offset by
foreign tax credits, but it is not practicable to estimate the total liability
that would be incurred upon such a distribution. However, in 1996, the Company
provided approximately $3.5 million for income taxes related to the
distribution of earnings from certain of its foreign operations which are not
considered to be retained indefinitely for reinvestment. Significant
components of the Company's deferred tax assets and liabilities as of January
2, 1999 and January 3, 1998 are as follows:
 
<TABLE>
<CAPTION>
                                                                    1998   1997
                                                                   ------ ------
                                                                        (In
                                                                    Thousands)
<S>                                                                <C>    <C>
Deferred tax assets:
  Provision for restructuring..................................... $  917 $  869
  Inventory capitalization and allowances.........................  3,383    --
  U.S. net operating loss carryforward............................    241  5,883
  Foreign net operating loss and capital loss carryforwards.......  3,046  3,603
  Tax credits.....................................................  3,379    --
  Foreign tax credits.............................................  7,459  3,359
  Other...........................................................  1,098  5,557
                                                                   ------ ------
    Total deferred tax assets..................................... 19,523 19,271
</TABLE>
 
                                      57
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
<TABLE>
<CAPTION>
                                                              1998      1997
                                                            --------  --------
                                                             (In Thousands)
<S>                                                         <C>       <C>
  Valuation allowance......................................   (4,848)   (5,927)
                                                            --------  --------
Net deferred tax assets....................................   14,675    13,344
Deferred tax liabilities:
  Depreciation and amortization............................  (51,089)  (26,548)
  Basis difference on fixed assets.........................  (28,667)  (52,207)
  Other, net...............................................   (3,542)   (3,742)
                                                            --------  --------
    Total deferred tax liabilities.........................  (83,298)  (82,497)
                                                            --------  --------
    Net deferred tax liabilities........................... $(68,623) $(69,153)
                                                            ========  ========
</TABLE>
 
  Taxes on income are based on earnings before taxes as follows:
 
<TABLE>
<CAPTION>
                                                               Fiscal Year
                                                         -----------------------
                                                          1998    1997    1996
                                                         ------- ------- -------
                                                             (In Thousands)
      <S>                                                <C>     <C>     <C>
      Domestic.........................................  $16,233 $18,688 $11,018
      Foreign..........................................   21,867  21,754  14,534
                                                         ------- ------- -------
                                                         $38,100 $40,442 $25,552
                                                         ======= ======= =======
</TABLE>
 
  The provision for income taxes at the Company's effective tax rate differed
from the provision for income taxes at the statutory rate as follows:
<TABLE>
<CAPTION>
                                                           Fiscal Year
                                                      ------------------------
                                                       1998     1997     1996
                                                      -------  -------  ------
                                                          (In Thousands)
      <S>                                             <C>      <C>      <C>
      Computed tax expense at statutory rate........  $13,335  $14,155  $8,943
      Goodwill and other............................    2,307      --      --
      Valuation allowance...........................   (1,999)  (2,387)    418
      Withholding taxes.............................      --       471     964
      Effect of foreign operations, net.............      173      314     347
      Other, net....................................      341      456      58
                                                      -------  -------  ------
      Provision for income taxes before
       extraordinary item and cumulative effect of
       change in accounting principle...............   14,157   13,009  10,730
      Income tax benefit related to cumulative
       effect of change in accounting principle and
       extraordinary item...........................     (907)  (5,959) (7,492)
                                                      -------  -------  ------
      Provision for income taxes....................  $13,250  $ 7,050  $3,238
                                                      =======  =======  ======
</TABLE>
 
Note 10. Stock Option and Employee Stock Purchase Plans
 
 Stock Option Plan
 
  In connection with the IPO, the Company adopted the 1996 Key Employee Stock
Option Plan ("1996 Plan"). The 1996 Plan is administered by the Stock Option
Committee, which is composed of non-management members of the Company's Board
who are appointed by the Board. Any person who is a full-time, salaried
employee of the Company (excluding non-management directors) is eligible to
 
                                      58
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
participate in the 1996 Plan. The Stock Option Committee selects the
participants and determines the terms and conditions of the options. The 1996
Plan provides for the issuance of options covering 1,500,000 shares of common
stock, subject to certain adjustments reflecting changes in the Company's
capitalization. Options granted under the 1996 Plan may be either incentive
stock options ("ISOs") or such other forms of non-qualified stock options
("NQOs") as the Stock Option Committee may determine. The 1996 Plan provides
that the option price shall not be less than the fair value of the shares at
the date of grant and that such options vest in equal 20% increments over five
years. The options expire three years after the date that such portion became
vested and exercisable. The options were not considered in the calculation of
diluted earnings per share as their effect was antidilutive; however, these
options could have a dilutive effect in future years. The following table
summarizes the transactions of the 1996 Plan for the three year period ended
January 2,1999:
 
<TABLE>
<CAPTION>
                                                                        Weighted
                                                               Number   Average
                                                                 of     Exercise
                                                               Shares    Price
                                                               -------  --------
<S>                                                            <C>      <C>
Unexercised options outstanding--December 28, 1996............ 130,330  $ 18.00
  Granted..................................................... 595,000    14.25
  Exercised...................................................     --       --
  Forfeited...................................................  (5,555)   18.00
  Expired/canceled............................................     --       --
                                                               -------  -------
Unexercised options outstanding--January 3, 1998.............. 719,775    14.90
  Granted.....................................................     --       --
  Exercised...................................................     --       --
  Forfeited................................................... (65,555)   14.91
  Expired/canceled............................................     --       --
                                                               -------  -------
Unexercised options outstanding--January 2, 1999.............. 654,220  $ 14.90
                                                               =======  =======
Exercisable options:
  December 28, 1996...........................................     --       --
  January 3, 1998............................................. 143,955  $ 14.90
  January 2, 1999............................................. 261,688    14.90
Shares available for future grant............................. 845,780
</TABLE>
 
  At January 2, 1999, the exercise price of the outstanding options ranges
from $14.25 to $18.00 and the weighted average remaining contractual life of
the outstanding options is 3.2 years.
 
  In connection with the IPO, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123"). FAS 123 establishes financial accounting and
reporting standards for stock-based compensation plans. As permitted by FAS
123, the Company elected to account for stock-based compensation awards in
accordance with Accounting Principles Board Opinion No. 25. Accordingly, no
compensation cost has been recognized in the Company's financial statements
for the 1996 Plan. In accordance with FAS 123, the fair value for each option
grant was determined by using the Black-Scholes option-pricing model with the
following weighted average assumptions used for both 1998 and 1997; dividend
yield of 0.0%; expected volatility of 0.56; risk-free interest rate of 6.1%
and weighted average expected lives of 5 years. Had compensation cost for the
Company's 1996 Plan been determined based on the fair value at the grant date
for such awards in 1998, 1997 and 1996, respectively, consistent with the
provisions of FAS 123, the Company's net income available to common
shareholders and net income per common share would have been reduced to the
pro forma amounts indicated below.
 
                                      59
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
<TABLE>
<CAPTION>
                                                     Fiscal year
                                        --------------------------------------
                                            1998         1997         1996
                                        ------------ ------------ ------------
                                        (In Thousands, Except Per Share Data)
<S>                                     <C>          <C>          <C>
Net income (loss) available to common
 shareholders-basic and diluted:
  As reported ......................... $     19,704 $     15,428 $     (2,130)
  Pro forma ...........................       19,033       15,075       (2,228)
Net income (loss) per common share
 basic and diluted:
  As reported.......................... $        .62 $        .48 $       (.08)
  Pro forma ...........................          .59          .47         (.08)
Weighted average fair value per option
 granted under the
 1996 Plan during the respective years
 ...................................... $        --  $       7.79 $       9.72
</TABLE>
 
  The pro forma impact of these options is not likely to be representative of
the effects on reported net income for future years.
 
 Employee Stock Purchase Plan
 
  At the beginning of fiscal 1997, the Company adopted the Stock Purchase Plan
for Employees of Polymer Group, Inc. ("Purchase Plan") which allows employee
participants to purchase common stock of the Company through payroll
deductions. The Purchase Plan is administered by a third party and all
administrative costs of the Purchase Plan are covered by the Company. In
accordance with the Purchase Plan, share purchases by the administrator are
made at the fair value of the Company's common stock on the date of purchase.
The cost of the Purchase Plan was not material during 1998 or 1997.
 
Note 11. Shareholders' Equity
 
  On May 15, 1996, the Company completed the initial public offering ("IPO"),
in which it offered and sold 11.5 million shares of its common stock at a
price of $18.00 per share. In addition, the Company's Board of Directors
("Board") approved an approximate 19.97 to 1 stock split; therefore, all
common shares and warrant data in the consolidated financial statements have
been restated to reflect such stock split.
 
  As a result of the IPO, the Company's authorized capital stock consists of
100,000,000 shares of common stock, par value $0.01 per share, 3,000,000
shares of non-voting common stock, par value $0.01 per share, and 10,000,000
shares of preferred stock, par value $0.01 per share. Subject to certain
regulatory limitations, the non-voting common stock is convertible on a one-
for-one basis into common stock at the option of the holder. The Company's
Board may, without further action by Polymer Group's shareholders, direct the
issuance of shares of preferred stock and may determine the rights,
preferences, conversion features, dividend rate (including whether such
dividend shall be cumulative or noncumulative) and limitations of each issue.
Satisfaction of any dividend preferences of outstanding shares of preferred
stock would reduce the amount of funds available for common dividends. Holders
of shares of preferred stock may be entitled to receive a preference before
any payment is made to common shareholders.
 
  In connection with the IPO, the Company adopted a rights plan ("Rights
Plan"). On April 15, 1996, the Company's Board declared a dividend of one
right for each share of common stock outstanding at the close of business on
June 3, 1996. The holders of additional common stock issued subsequent to such
date and before the occurrence of certain events are entitled to one right for
each such additional share. Each right entitles the registered holder under
certain circumstances to purchase from the
 
                                      60
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
Company one-thousandth of a share of junior preferred stock (series A) at a
price of $80 per one-thousandth share of junior preferred stock, subject to
adjustment. The Company may redeem the rights at $.01 per right prior to the
earlier of the stock acquisition date and the expiration date as defined in
the Rights Plan. Prior to exercise of a right, the holder will have no rights
as a stockholder of the Company, including, without limitation, the right to
vote or to receive dividends or distributions. In addition, the rights have
certain anti-takeover effects. The rights are not issued in separate form and
may not be traded other than with the shares to which they attach. If
unexercised, the rights expire on June 3, 2006. Following the IPO, 100,000
shares of junior preferred stock were reserved for issuance in connection with
the Rights Plan.
 
Note 12. Disclosures about Pension and Postretirement Plans
 
  The Company and its subsidiaries sponsor multiple defined benefit plans and
other postretirement benefit plans that cover substantially all of their non-
union employees. Benefits are based on years of service and the employee's
compensation. It is the Company's policy to fund such plans in accordance with
applicable laws and regulations.
 
<TABLE>
<CAPTION>
                                                               Postretirement
                                           Pension Benefits         Plans
                                           ------------------  ----------------
                                             1998      1997     1998     1997
                                           --------  --------  -------  -------
                                                    (In Thousands)
<S>                                        <C>       <C>       <C>      <C>
Benefit obligation at beginning of year..  $(42,928) $(31,423) $(5,561) $(3,901)
Service costs............................    (1,827)   (1,566)     (72)    (107)
Interest costs...........................    (3,098)   (1,813)    (360)    (203)
Participant contributions................       250       245      --       --
Plan amendments..........................    (1,920)      --       --       --
Actuarial (loss).........................    (1,907)     (396)    (868)     --
Currency translation adjustment and
 other...................................      (665)    5,195      181      --
Acquisition..............................       --    (13,466)     --    (3,197)
Benefit payments.........................     5,663       296      413       23
Curtailments.............................       --        --       --     1,824
Settlements..............................    (1,432)      --       --       --
                                           --------  --------  -------  -------
Benefit obligation at end of year........  $(47,864) $(42,928) $(6,267) $(5,561)
                                           --------  --------  -------  -------
Fair value of plan assets at beginning of
 year....................................  $ 57,683  $ 39,297  $   --   $   --
Actual return on plan assets.............     2,214     3,352      --       --
Acquisition..............................       --     20,149      --       --
Employer contribution....................     2,303     1,448     (413)     (23)
Plan participants' contributions.........       250       245      --       --
Plan amendments..........................       --        --       --       --
Benefit payments.........................    (7,763)     (296)     413       23
Currency translation adjustment and
 other...................................       561    (6,512)     --       --
Divestitures and settlements.............      (672)      --       --       --
                                           --------  --------  -------  -------
Fair value of plan assets at end of year.  $ 54,576  $ 57,683  $   --   $   --
                                           --------  --------  -------  -------
Funded status at year-end................  $  6,712  $ 14,755  $(6,267) $(5,561)
Unrecognized transition net (liability)..       (60)     (169)     --       --
Unrecognized transition net gain/(loss)..     2,814    (2,412)     264      --
Unrecognized prior service cost..........       417       --       --       --
Currency translation adjustment and
 other...................................     1,221       --       --       --
                                           --------  --------  -------  -------
Prepaid (accrued) benefit cost...........  $ 11,104  $ 12,174  $(6,003) $(5,561)
                                           ========  ========  =======  =======
</TABLE>
 
                                      61
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
<TABLE>
<CAPTION>
                               Pension Benefits           Postretirement Plans
                          -----------------------------  -------------------------
                            1998      1997      1996        1998     1997   1996
                          --------  --------  ---------  ----------  ------ ------
                                 (In Thousands, Except Percent Data)
<S>                       <C>       <C>       <C>        <C>         <C>    <C>
Components of net
 periodic benefit cost:
  Current service costs.   $ 1,827   $ 1,566    $ 1,523        $ 72  $ 107  $ 169
  Interest costs on
   projected benefit
   obligation and other.     3,098     1,813      1,673         360    203    238
  Return on plan assets.    (2,943)   (2,659)    (2,158)        --     --     --
  Net amortization of
   transition obligation
   and other............    (1,512)      (26)       (52)        --     --     --
                          --------  --------  ---------  ----------  -----  -----
  Periodic benefit cost,
   net..................   $   470   $   694    $   986        $432  $ 310  $ 407
                          ========  ========  =========  ==========  =====  =====
Weighted average assump-
 tion rates:
  Return on plan assets.   6.5-9.0%  6.5-9.0%  6.5-13.0%        --     --     --
  Discount rate on
   projected benefit
   obligations..........  5.25-9.0%  6.0-8.5%  6.0-8.5%   5.75-7.75%   6.5%   6.5%
  Salary and wage
   escalation rate......   2.5-6.5%  3.0-6.5%  3.0-4.0%         --     --     --
</TABLE>
 
  The assumed annual composite rate of increase in the per capita cost of
Company provided health care benefits are reflected in the following table:
 
<TABLE>
<CAPTION>
                                                       Composite
        Year                                        Rate of Increase
        ----                                        ----------------
        <S>                                         <C>
        1996.......................................          9.0%
        1997.......................................          9.0
        1998.......................................     7.0-10.0
        1999.......................................      6.0-8.0
        2000.......................................      6.0-8.0
        2001.......................................          6.0
        2002.......................................          6.0
        2003 and thereafter........................      5.0-6.0
</TABLE>
 
  A one-percentage point change in assumed health care cost trend rates would
have the following effects:
 
<TABLE>
<CAPTION>
                                               1-Percentage   1-Percentage
                                              Point Increase Point Decrease
                                              -------------- --------------
                                                     (In Thousands)
<S>                                           <C>            <C>
Effect on total of service and interest cost
 components                                        $ 64          $ (60)
Effect on postretirement benefit obligation         612           (555)
</TABLE>
 
  The Company sponsors several defined contribution plans through its domestic
subsidiaries covering employees who meet certain service requirements. The
Company makes contributions to the plans based upon a percentage of the
employees' contribution in the case of its 401(k) plans or upon a percentage
of the employees' salary or hourly wages in the case of its noncontributory
money purchase plans. The cost of the plans was $2.9, $1.7 and $1.7 million
for 1998, 1997 and 1996, respectively.
 
                                      62
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 13. Segments and Geographic Information
 
  The Company has adopted SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information." Operating segments are defined as
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision maker in
deciding how to allocate resources and assessing performance. The Company
defines operating segments around market sectors. Sales to P&G are reported
primarily within the hygiene segment. Sales to J&J are reported primarily in
the hygiene and medical segments. The loss of these sales would have a
material adverse effect on these segments. Generally, the Company's products
can be manufactured on more than one type of asset. Accordingly, certain costs
and assets attributed to each segment of the business were determined on an
allocation basis. Production times have a similar relationship to net sales,
thus the Company believes a reasonable basis for allocating segment assets and
certain costs is the percent of net sales method. Financial data by segment is
as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                          Fiscal Year
                                                 ------------------------------
                                                    1998       1997      1996
                                                 ---------- ---------- --------
<S>                                              <C>        <C>        <C>
Net sales to unaffiliated customers
  Hygiene....................................... $  319,142 $  231,866 $231,218
  Medical.......................................     92,664     86,745   91,728
  Wipes.........................................    107,614    105,195   90,627
  Industrial and specialty......................    283,528    111,461  107,795
                                                 ---------- ---------- --------
                                                 $  802,948 $  535,267 $521,368
                                                 ========== ========== ========
Operating income
  Hygiene....................................... $   44,479 $   18,492 $ 23,820
  Medical.......................................     15,769     11,426    9,451
  Wipes.........................................     15,667     15,672   13,237
  Industrial and specialty......................     29,640     13,019   15,640
                                                 ---------- ---------- --------
                                                 $  105,555 $   58,609 $ 62,148
                                                 ========== ========== ========
Depreciation and amortization
  Hygiene....................................... $   27,263 $   17,346 $ 15,018
  Medical.......................................      7,340      6,992    7,435
  Wipes.........................................      6,794      6,498    6,219
  Industrial and specialty......................     17,928      9,476    8,095
                                                 ---------- ---------- --------
                                                 $   59,325 $   40,312 $ 36,767
                                                 ========== ========== ========
Identifiable assets
  Hygiene....................................... $  479,773 $  460,297 $295,177
  Medical.......................................    139,304    172,205  117,102
  Wipes.........................................    161,779    208,832  126,334
  Industrial and specialty......................    418,530    259,228  144,739
  Assets held for disposition, net..............        --     464,524      --
  Corporate (1).................................     83,581     62,667   24,763
                                                 ---------- ---------- --------
    Total....................................... $1,282,967 $1,627,753 $708,115
                                                 ========== ========== ========
Capital spending
  Hygiene....................................... $   36,589 $   33,493 $ 14,172
  Medical.......................................      2,335      1,665    2,477
  Wipes.........................................      2,712      2,300    4,225
  Industrial and specialty......................     48,460     22,686    5,865
                                                 ---------- ---------- --------
                                                 $   90,096 $   60,144 $ 26,739
                                                 ========== ========== ========
</TABLE>
--------
(1) Consists primarily of cash, marketable securities, loan acquisition costs
    and other corporate related assets.
 
                                      63
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  A reconciliation of operating income shown above to income before income
taxes, extraordinary item and cumulative effect of change in accounting
principle shown in the Consolidated Statements of Operations follows (in
thousands):
<TABLE>
<CAPTION>
                                                         Fiscal Year
                                                --------------------------------
                                                   1998        1997       1996
                                                ----------  ----------  --------
<S>                                             <C>         <C>         <C>
Operating income..............................  $  105,555  $   58,609  $ 62,148
Interest expense, net.........................      67,444      30,499    33,641
Investment (income)--gain on marketable
 securities, net..............................        (795)    (11,880)      --
Foreign currency and other....................         806        (452)    2,955
                                                ----------  ----------  --------
Income before income taxes, extraordinary item
 and cumulative effect of change in accounting
 principle....................................  $   38,100  $   40,442  $ 25,552
                                                ==========  ==========  ========
 
  Geographic data for the Company's operations are presented in the following
table. Export sales from the Company's United States operations to
unaffiliated customers approximated $93.9, $83.0 and $43.8 million during
1998, 1997 and 1996, respectively.
<CAPTION>
                                                         Fiscal Year
                                                --------------------------------
                                                   1998        1997       1996
                                                ----------  ----------  --------
                                                        (In Thousands)
<S>                                             <C>         <C>         <C>
Net sales to unaffiliated customers
  United States...............................  $  467,836  $  311,923  $312,000
  Canada......................................     104,518      61,747    57,371
  Europe......................................     186,656     109,714   108,563
  Asia........................................         --          --        --
  Latin America...............................      43,938      51,883    43,434
                                                ----------  ----------  --------
                                                $  802,948  $  535,267  $521,368
                                                ==========  ==========  ========
Identifiable assets
  United States...............................  $  801,791  $  683,489  $388,240
  Canada......................................     154,070     177,999    92,670
  Europe......................................     240,004     226,117   171,676
  Asia........................................      10,425         --        --
  Latin America...............................      76,677      75,624    55,529
  Assets held for disposition, net............         --      464,524       --
                                                ----------  ----------  --------
                                                $1,282,967  $1,627,753  $708,115
                                                ==========  ==========  ========
</TABLE>
 
                                      64
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
Note 14. Quarterly Results of Operations (Unaudited)
 
<TABLE>
<CAPTION>
                                            First     Second   Third    Fourth
                                           Quarter   Quarter  Quarter  Quarter
                                           --------  -------- -------- --------
                                                     (In Thousands)
<S>                                        <C>       <C>      <C>      <C>
Fiscal year ended January 2, 1999
Net sales................................  $193,336  $206,111 $201,603 $201,898
Gross profit.............................    46,278    51,884   52,541   52,351
Income before extraordinary item and
 cumulative effect of change in
 accounting principle....................     2,295     6,240    6,243    9,166
Extraordinary item.......................    (2,728)      --       --       --
Cumulative effect of change in accounting
 principle, net of tax...................       --        --       --    (1,511)
Net income (loss)........................      (433)    6,240    6,243    7,655
Redeemable preferred stock dividends and
 accretion...............................       --        --       --       --
Net income (loss) attributable to common
 stock...................................      (433)    6,240    6,243    7,655
  Net income (loss) per common share:
  Basic and diluted:
    Income before extraordinary item and
     cumulative effect of change in
     accounting principle................  $    .07  $    .20 $    .20 $    .29
    Extraordinary item...................      (.09)      --       --       --
    Cumulative effect of change in
     accounting principle, net of tax....       --        --       --      (.05)
                                           --------  -------- -------- --------
    Net income (loss) per common share--
     basic and diluted...................  $   (.02) $    .20 $    .20 $    .24
                                           ========  ======== ======== ========
</TABLE>
 
<TABLE>
<S>                                        <C>      <C>      <C>       <C>
Fiscal year ended January 3, 1998
Net sales................................. $128,947 $131,508 $129,711  $145,101
Gross Profit..............................   32,585   34,716   31,196    34,712
Income before extraordinary item..........    4,962    6,012    8,948     7,511
Extraordinary item, net of tax............      --       --   (12,005)      --
Net income (loss) attributable to common
 stock....................................    4,962    6,012   (3,057)    7,511
  Net income (loss) per common share:
  Basic and diluted:
    Income before extraordinary item...... $    .16 $    .19 $    .28  $    .23
    Extraordinary item....................      --       --      (.38)      --
                                           -------- -------- --------  --------
    Net income (loss) per common share--
     basic and diluted.................... $    .16 $    .19 $   (.10) $    .23
                                           ======== ======== ========  ========
</TABLE>
 
During the first quarter of 1998, the Company recorded an extraordinary item
of $2.7 million for the write-off of previously capitalized debt issue costs
related to the acquisition of Dominion. In addition, the Company recorded an
extraordinary item of $12.0 million for the write-off of previously
capitalized debt issue costs and prepayment premiums related to the
refinancing of indebtedness during the third quarter of 1997. During the
fourth quarter of 1998, the Company elected early adoption of SOP 98-5.
"Reporting the Costs of Start-Up Activities," and wrote-off the net book value
($1.5 million, after tax) of start-up costs as a cumulative effect of an
accounting change.
 
                                      65
<PAGE>
 
Note 15. Certain Matters
 
  From time to time, the Company enters into transactions whereby technology
is licensed or made available to developmental partners within the industry.
Amounts recognized for these technology transfers during 1998 were not
material when compared to consolidated net sales. There were no technology
transfers made during 1997 or 1996.
 
  The Company's corporate headquarters are housed in space leased by a
shareholder of the Company from an affiliate of the shareholder. A portion of
the payments and other expenses, primarily insurance and allocated costs, are
charged to the Company. Such amounts approximated $1.8, $1.8, and $2.1 million
in 1998, 1997 and 1996, respectively. The Company leases a manufacturing
facility from an affiliated entity which the Company believes is comparable to
similar properties in the area. Annual rent expense relating to this lease
approximated $0.2 million in 1998, 1997 and 1996. On January 11, 1996, the
Company issued 10,000 shares of 13% Cumulative Redeemable Preferred Stock,
$.01 par value, to an entity affiliated with the Company for $10.0 million.
Such shares were redeemed in connection with the IPO.
 
  In connection with the acquisition of the Nonwovens Business, ZB Holdings
requested consideration from the Company in return for providing a portion of
the financing required to complete the tender offer for the outstanding shares
of Dominion. Independent members of the Board engaged outside legal counsel
and an independent banking firm to evaluate this request. Pursuant to the
review, ZB Holdings received $5.3 million from the Company that was
capitalized as part of the cost of the acquisition.
 
 
                                      66
<PAGE>
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
  In connection with the Nonwovens Acquisition on January 29, 1998, the
Company appointed Ernst & Young LLP, independent auditors, as independent
accountants for the subsidiaries comprising the Nonwovens Business to replace
Deloitte & Touche LLP ("Deloitte & Touche"), chartered accountants, whom the
Company dismissed as of January 29, 1998.
 
  Deloitte & Touche has been provided with a copy of this disclosure and
requested by the Company to furnish a letter addressed to the Commission
stating whether they agree with the above statements. A copy of Deloitte &
Touche's letter to the Commission is filed as an exhibit to this Annual Report
on Form 10-K.
 
                                      67
<PAGE>
 
                                   PART III
 
ITEM 10. MANAGEMENT
 
  Information required under this item is incorporated by reference from the
Proxy Statement under the captions "Election of Directors" and "Executive
Compensation."
 
ITEM 11. EXECUTIVE COMPENSATION
 
  Information required under this Item is incorporated by reference from the
Proxy Statement under the caption "Executive Compensation."
 
ITEM 12. SECURITY OWNERSHIP
 
  Information required under this Item is incorporated by reference from the
Proxy Statement under the caption "Security Ownership."
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  Information required under this Item is incorporated by reference from the
Proxy Statement under the caption "Certain Relationships and Related
Transactions."
 
                                      68
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
Financial Statements and Schedules
 
  (a) The following financial statements and independent auditors report
required by this Item are filed herewith under Item 8.
 
  (i)Consolidated Balance Sheets.
 
  (ii)Consolidated Statements of Operations.
 
  (iii)Consolidated Statements of Shareholders' Equity.
 
  (iv)Consolidated Statements of Cash Flows.
 
  (v)Notes to Consolidated Financial Statements.
 
  (vi)Report of Ernst & Young LLP, Independent Auditors.
 
  (b) Schedule II--Valuation and Qualifying Accounts ("Schedule II").
Supplemental schedules other than Schedule II are omitted because of the
absence of conditions under which they are required or because the required
information is included in the consolidated financial statements or in the
notes thereto.
 
Exhibits
 
  Exhibits required to be filed with this Form 10-K are listed in the
following Exhibit Index.
 
Form 8-K
 
  The Company filed no reports on Form 8-K during the fourth quarter of 1998.
 
                                      69
<PAGE>
 
                              POLYMER GROUP, INC.
 
                 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
                                 (In Thousands)
 
<TABLE>
<CAPTION>
         COLUMN A            COLUMN B      COLUMN C        COLUMN D    COLUMN E
         --------           ---------- ----------------   ----------  ----------
                                          ADDITIONS
                                       ----------------
                            Balance at Charged to                     Balance at
                            Beginning  Costs and          Deductions    End of
        Description         of Period   Expenses  Other   (Describe)    Period
        -----------         ---------- ---------- -----   ----------  ----------
<S>                         <C>        <C>        <C>     <C>         <C>
Year ended January 2, 1999
Allowance for doubtful
 accounts..................  $  5,503    6,860     100(2)   4,860(1)   $  7,603
Valuation allowance for
 deferred tax assets.......  $  5,927      --      --       1,079(3)   $  4,848
Restructuring costs........  $  5,484      --      --       5,484(3)   $    --
Year ended January 3, 1998
Allowance for doubtful
 accounts..................  $  3,848    7,337     503(2)   6,185(1)   $  5,503
Valuation allowance for
 deferred tax assets.......  $ 14,149      --      --       8,222(3)   $  5,927
Restructuring costs........  $ 12,009      --      --       6,525(3)   $  5,484
Year ended December 28,
 1996
Allowance for doubtful
 accounts..................  $  1,885    9,060     114(2)   7,211(1)   $  3,848
Valuation allowance for
 deferred tax assets.......  $ 11,792    2,357     --         --       $ 14,149
Restructuring costs........  $ 15,453      --      --       3,444(3)   $ 12,009
</TABLE>
--------
(1) Uncollectible accounts written off and price concessions.
(2) Reserve established as part of business acquisition.
(3) Charges to reserve.
 
                                       70
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
 
                                          Polymer Group, Inc.
 
                                          By:       /s/ Jerry Zucker
                                            ___________________________________
                                                        Jerry Zucker
                                                Chairman, President and Chief
                                                      Executive Officer
 
  Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this Report has been signed below by the following
persons on behalf of the registrant and in the capabilities and on April 3,
1998.
 
<TABLE>
<CAPTION>
                 Signature                                     Title
                 ---------                                     -----
 
<S>                                         <C>
             /s/ Jerry Zucker               Chairman, Chief Executive Officer,
___________________________________________  President and Director (principal
                Jerry Zucker                 executive officer)
 
             /s/ James G. Boyd              Executive Vice President, Chief Financial
___________________________________________  Officer, Treasurer and Director (principal
                James G. Boyd                financial officer and principal accounting
                                             officer)
 
            /s/ Bruce V. Rauner             Director
___________________________________________
               Bruce V. Rauner
 
          /s/ Michael J. McGovern           Director
___________________________________________
             Michael J. McGovern
 
           /s/ David A. Donnini             Director
___________________________________________
               David A. Donnini
 
           /s/ L. Glenn Orr, Jr.            Director
___________________________________________
              L. Glenn Orr, Jr.
 
        /s/ Duncan M. O'Brien, Jr.          Director
___________________________________________
            Duncan M. O'Brien, Jr.
</TABLE>
 
                                      71
<PAGE>
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
 Exhibit
 Number                        Document Description
 -------                       --------------------                         ---
 <C>     <S>                                                                <C>
 2.1     Agreement dated October 27, 1997, among Polymer Group, Inc.,
         Galey & Lord, Inc. and DT Acquisition Inc.(1)
 2.2     Letter Agreement, dated October 27, 1997, among Polymer Group,
         Inc., Galey & Lord, Inc. and DT Acquisition Inc.(2)
 2.3     Operating Agreement, dated December 19, 1997, among Polymer
         Group, Inc., Galey & Lord, Inc. and DT Acquisition Inc.(1)
 2.4     DT Acquisition Inc. Offers to Purchase Statement for all
         outstanding Common Shares and all outstanding First Preferred
         Shares of Dominion Textile Inc., dated October 29, 1997.(2)
 2.5     Notice of Extension and Variation by DT Acquisition Inc. in
         respect of its Offers to Purchase, dated November 18, 1997.(2)
 2.6     Notice of Extension by DT Acquisition Inc. in respect of its
         Offers to Purchase, dated December 2, 1997.(2)
 2.7     Notice of Extension and Variation by DT Acquisition Inc. in
         respect of its Offers to Purchase, dated December 8, 1997.(2)
 2.8     Notice of Extension by DT Acquisition Inc. in respect of its
         Offers to Purchase, dated December 17, 1997.(2)
 2.9     Letter Agreement between DT Acquisition Inc., PGI and DTI dated
         November 16, 1997.(2)
 2.10    Notice of Redemption pursuant to the provisions of Section 206
         of the Canada Business Corporations Act in regard to holders of
         Common Shares of Dominion Textile Inc., dated December 30,
         1997.(2)
 2.11    Notice of Redemption pursuant to the provisions of Section 206
         of the Canada Business Corporations Act in regard to holders of
         First Preferred Shares of Dominion Textile Inc., dated December
         30, 1997.(2)
 2.12    Notice of Redemption in regard to holders of Second Preferred
         Shares, Series D of Dominion Textile Inc., dated December 23,
         1997.(2)
 2.13    Notice of Redemption in regard to holders of Second Preferred
         Shares, Series E of Dominion Textile Inc., dated December 23,
         1997.(2)
 2.14    Indenture, winding up Dominion Textile Inc. pursuant to the
         Canada Business Corporations Act, dated January 29, 1998.(2)
 2.15    Master Separation Agreement, among Polymer Group, Inc., Galey &
         Lord, Inc. and DT Acquisition Inc., dated January 29, 1998.(3)*
 3.1(i)  Form of Amended and Restated Certificate of Incorporation of the
         Company.(4)
 3.1(ii) Certificate of Designation of the Company.(7)
 3.2     Amended and Restated By-laws of the Company.(4)
 4.1     Indenture dated as of July 1, 1997 among the Company, the
         Guarantors and Harris Trust and Savings Bank, as trustee. (7)
 4.2     Forms of Series A and Series B 9% Senior Subordinated Notes due
         2007.(5)
 4.3     Form of Guarantee.(5)
 4.4     Registration Rights Agreement dated as of July 3, 1997 among the
         Company, the Guarantors and Chase Securities Inc.(7)
 4.5     Indenture, dated as of March 1, 1998 among Polymer Group, Inc.,
         the Guarantors named therein and Harris Trust and Savings Bank,
         as trustee.(5)
</TABLE>
 
 
                                       1
<PAGE>
 
<TABLE>
<CAPTION>
 Exhibit
 Number                        Document Description
 -------                       --------------------                         ---
 <C>     <S>                                                                <C>
 4.6     Forms of Series A and Series B 8 3/4% Senior Subordinated Notes
         due 2008.(5)
 4.7     Form of Guarantee.(5)
 4.8     Registration Rights Agreement dated as of March 5, 1998, among
         Polymer Group, Inc., the Guarantors named therein and Chase
         Securities Inc.(6)
 4.9     Amended and Restated Credit Agreement dated July 3, 1997 by and
         among the Company, the Guarantors named therein, the lenders
         named therein and The Chase Manhattan Bank, as agent.(7)
         The Registrant will furnish to the Commission, upon request,
         each instrument defining the rights of holders of long-term debt
         of the Registrant and its subsidiaries where the amount of such
         debt does not exceed 10 percent of the total assets of the
         Registrant and its subsidiaries on a consolidated basis.
 4.10    First Supplemental Indenture, dated October 27, 1997, between
         Polymer Group Inc., Harris Trust and Savings Bank and Loretex
         Corporation.(2)
 4.11    Second Supplemental Indenture dated January 29, 1998, to
         indenture dated June 30, 1997, among Polymer Group, Inc.,
         Dominion Textile (USA) Inc., with respect to the 9% Senior
         Subordinated Notes due 2008.(2)
 10.1    Purchase Agreement, dated February 27, 1998, by and among
         Polymer Group, Inc., the Guarantors named herein and Chase
         Securities Inc., as Initial Purchaser, with respect to the 8
         3/4% Senior Subordinated Notes due 2008.(6)
 10.2    Amendment No. 2, dated January 29, 1998, to the Amended,
         Restated and Consolidated Credit Agreement dated July 3, 1997 by
         and among Polymer Group, Inc., the Guarantors named therein, the
         lenders named therein and The Chase Manhattan Bank, as agent.(6)
 11      Statement of Computation of Per Share Earnings.
 16      Letter of Deloitte & Touche regarding a change in certified
         accountants.(2)
 21      Subsidiaries of the Company.
 23      Consent of Ernst & Young LLP.
 27      Financial Data Schedule.
</TABLE>
--------
 * Certain portions of the Agreement have been omitted and filed separately
   with the Commission pursuant to an Application for Confidential Treatment.
(1) Incorporated by reference to the respective exhibit to the Company's Form
    8-K, dated February 13, 1998.
(2) Incorporated by reference to the respective exhibit to the Company's Form-
    10K, dated April 3, 1998, for the fiscal year ended January 3, 1998.
(3) Incorporated by reference to the respective exhibit to the Company's Form-
    8K/A, dated April 14, 1998.
(4) Incorporated by reference to the respective exhibit to the Company's
    Registration Statement on Form S-1 (Reg. No. 333-2424).
(5) Incorporated by reference to the respective exhibit to the Company's
    Registration Statement on Form S-4 (Reg. No. 333-55863).
(6) Incorporated by reference to the respective exhibit to the Company's Form
    10-Q, dated May 19, 1998, for the fiscal quarter ended April 4, 1998.
(7) Incorporated by reference to the respective exhibits to the Company's
    Registration Statement on Form S-4 (Reg. No. 333-32605).
 
                                       2