<PAGE>
 
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
 
                      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 3, 1998
 
                        COMMISSION FILE NUMBER 1-14330
 
                              POLYMER GROUP, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
               DELAWARE                              57-1003983
    (STATE OR OTHER JURISDICTION OF     (I.R.S. EMPLOYER IDENTIFICATION NO.)
    INCORPORATION OR ORGANIZATION)
 
          4838 JENKINS AVENUE                           29405
   NORTH CHARLESTON, SOUTH CAROLINA                  (ZIP CODE)
    (ADDRESS OF PRINCIPAL EXECUTIVE
               OFFICES)
 
      REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (803) 566-7293
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<CAPTION>
                  TITLE OF EACH                         NAME OF EACH EXCHANGE
                 CLASS OF STOCK:                        ON WHICH REGISTERED:
                 ---------------                       -----------------------
      <S>                                              <C>
      Common Stock, par value $.01 per share           New York Stock Exchange
</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 18, 1998 was $214,895,061. As of March 18, 1998,
there were 32,000,000 shares of common stock, par value $.01 per share
outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  Notice of 1998 Annual Meeting of Stockholders and Proxy Statement--Part III
 
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<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 industrial and specialty,
reusable wiping, medical and hygiene 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 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 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 and automotive insulation products. 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-one manufacturing facilities located in seven
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, with commercial production expected to
begin in May 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.
 
  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.
 
                                       2
<PAGE>
 
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.
 
  At the time of its formation, PGI 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 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"). 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
transactions 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. In
connection with the IPO, the Company recapitalized its multiple classes of
common stock into a single class of common stock, and split the common stock
at an approximate 19.97 to 1 ratio. 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 the 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, which was financed through borrowings under the Old Credit
Facility, 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, 1996 (as amended, the "Credit Facility"), and
repurchased and retired all of its outstanding 12 1/4% Senior Notes due 2002.
Subsequent to the fiscal year ended January 3, 1998, the Company also
completed an additional offering of $200,000,000 of 8 3/4% Senior Subordinated
Notes due 2008, and acquired the Nonwovens Business (as defined) of Dominion
Textile Inc. and the Oriented Polymer Business (as defined) of a leading North
American manufacturer of polypropylene-based commercial twine and
polyethylene-based specialty knitted products. See "Recent Transactions."
 
                                       3
<PAGE>
 
  Unless otherwise indicated, the information set forth in Items 1 and 2 of
this Annual Report on Form 10-K reflects the inclusion of the Nonwovens
Business and the Oriented Polymer Business.
 
INDUSTRY OVERVIEW
 
  The Company competes primarily in the worldwide market for nonwovens, which
is approximately a $7.5 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 4-5% in each of the next
five years, while the emerging markets are forecasted to grow at a rate of 8-
9% 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
9% per annum from 1988 through 1994. 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, according to industry sources), which is the
category in which the Company primarily competes, or durable (approximately
15% of worldwide consumer sales, according to industry sources). The largest
end uses for disposable nonwovens are for hygiene applications, including
disposable diapers, feminine sanitary protection, baby wipes and 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.
 
  The Company also competes in the North American market for oriented
polyolefin products. Chemical polyolefin products include woven, slit-film
fabrics produced by wearing 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.
 
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
 
                                       4
<PAGE>
 
  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(R) 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.
 
    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 is also undertaking the construction of a unique SMMS
  line at its Waynesboro, Virginia facility, with commercial production
  expected to begin in May 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.
 
    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 12 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. Senior
  management currently owns approximately 23% of the common equity of 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
  until March 2000 and, so long as the Company's prices remain competitive
  with the marketplace, extends through March 2005. 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.
 
                                       5
<PAGE>
 
  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
niche 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
  (as defined) of Dominion Textile Inc. ("Dominion"), 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 (as defined) of a leading North American manufacturer,
  which will expand the Company's product offerings and enhance raw materials
  purchasing opportunities. See "Recent Transactions."
 
    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.
 
    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. Other recent developments include the
  proprietary APEX(R) structural web technology, which is a surface-forming
  process that produces nonwoven fabrics with intricate, three-dimensional
  patterns. The Company believes its next generation nonwovens, produced
  using the APEX(R) structural web technology and marketed under the brand
  name MIRATEC(R), have the potential to replace certain woven and knit
  applications at a lower cost. These advanced nonwovens are currently in
  commercial production for Johnson &
 
                                       6
<PAGE>
 
  Johnson for medical applications such as woven-like gauze and surgical lap-
  pads. The Company is actively developing market opportunities for
  MIRATEC(R) in a variety of other applications, including home furnishings,
  automotive headliners and filtration products.
 
    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 $223 million in 1997. 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 recently
  completed 4.2 meter SMS line at the Mooresville, North Carolina facility.
  The Mooresville facility began commercial production in the fourth quarter
  of 1997 and now has committed capacity utilization in excess of 80%,
  subject to completion of qualifying programs (a process previously
  undergone at the San Luis Potosi facility). Once operating at full capacity
  (which at present is fully committed), the Company believes that the SMMS
  line at Waynesboro, which is expected to begin commercial production in May
  1998, will be the most productive line in the world, producing 1.44 billion
  square yards of nonwovens annually. The Company recently committed to
  install a new, heavyweight APEX(R) line at its Benson, North Carolina
  facility, which is expected to be commercialized in early 1999. 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) by 57%. The expansions include facilities in
  North Bay, Ontario, Portland, Oregon, Vancouver, British Columbia 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 $535.3 million in
1997. Management also achieved an increase in gross margins from 21.9% in 1994
to 24.9% in 1997, and an increase in earnings before interest, taxes,
depreciation and amortization ("EBITDA") from $23.9 million in 1994 to
approximately $99.0 million in 1997. At the same time, the Company has
continued to develop new, proprietary product technologies, to enter new
geographical customer markets and to expand its state-of-the-art manufacturing
facilities in North America, South America and Europe.
 
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.
 
  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
 
                                       7
<PAGE>
 
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
21%, 21% and 22%, or $111.5 million, $107.8 million and $94.0 million, of the
Company's 1997 net sales, 1996 net sales and 1995 net sales, respectively.
Demand for this product category is distributed among hundreds of end-use
applications. Some typical end uses include filtration media, home
furnishings, apparel interlinings, automotive insulation and interior fabrics,
agricultural fabrics, alkaline battery cell separators, cable wrap, electrical
insulation, protective coverings and flexible industrial packaging. 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.
 
  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:
 
    Product                               Application
                                          Alkaline battery cell separators
    Microporous rollgoods                 Liquid filtration
    Kiara(R)                              Automotive insulation
    Key Bak(R)                            Lumberwrap
    Arbrene(R) and Lumber Guard(R)        Housewrap
    Airgard(R)                            Corrugated box reinforcement
    Fab-Strip(TM)                         Protective coverings and laminated
    Fabrene(TM)                            structures
    Agricultural fabric                   Crop covers
    Dust cover                            Furniture and bedding
    Top Swell(TM)                         Water blocking cable wrap
    Bale-lock                             Agricultural twine
 
  The Company's industrial and specialty products are produced primarily using
wetlaid, adhesive bond, through-air fusible fiber bond, spunbond, oriented
polyolefin and lamination technologies. Specialized converting facilities
operated by the Company include a wide-width paper/nonwoven/film
 
                                       8
<PAGE>
 
laminating and printing facility in Portland, Oregon and a thermal and
ultrasonic bonding facility in Vineland, 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 own sales team.
 
 Wiping Products
 
  The wiping products category represented approximately 20%, 17% and 17%, or
$105.2 million, $90.6 million and $73.0 million, of the Company's 1997 net
sales, 1996 net sales and 1995 net sales, respectively. The Company has a
complete line of wiping products used for food service, institutional, light
industrial, janitorial and consumer markets. In 1995, approximately 13%, or
two billion square yards, of North American nonwovens roll goods capacity was
used to produce wiping products. 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 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 North American
volume growth for nonwovens used in disposable wipes will be approximately 7%
per annum through 2000.
 
  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 Colgate-Palmolive'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:
 
                                          Application
    Product
                                          Food service
    Chix(R) and Chix Plus(R)              Heavyweight food service
    Fresh Guy(R)                          Industrial
    Durawipe(R)                           Sanitizing/food service
    Quix(TM)                              Consumer and janitorial
    Worxwell(R)                           Janitorial
    Masslinn(R)                           Janitorial
    Stretch 'N Dust(R)                    Specialized, clean rooms
    Duralace(R)                           Consumer--Europe
    Chifonet(TM)                          Food service--Europe
    Lerette(TM)                           Catering--Europe
    Napkins and tablecloths               Consumer
    Handiwipes(R) and Heavywipes(R)/1/
--------
  /1/Handiwipes(R) and Heavywipes(R) are registered trademarks of Colgate
Palmolive. The Company produces wipes exclusively for Colgate-Palmolive 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
 
                                       9
<PAGE>
 
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. In Europe, the
Company operates its own 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.
 
 Medical Products
 
  The medical products category represented approximately 16%, 18% and 17%, or
$86.7 million, $91.7 million and $73.0 million, of the Company's 1997 net
sales, 1996 net sales and 1995 net sales, 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 almost two
billion square yards consumed annually in the United States. Approximately 40%
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 two years still remain, 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 North American
volume growth rate for nonwovens in medical applications will be approximately
2-4% per annum through 2000, 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(R) structural web technology. A recently developed product
using the APEX(R) 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:
 
      Product                             Application
      Duralace(R)                         Surgical gowns and drapes
      Mirasorb(R)                         Sponges
      Nugauze(R)                          Nonwoven gauze
 
                                      10
<PAGE>
 
 Hygiene Products
 
  The hygiene products category represented approximately 43%, 44% and 45%, or
$231.9 million, $231.2 million and $197.6 million, of the Company's 1997 net
sales, 1996 net sales and 1995 net sales, 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. Today, the Company's customers annually consume over two billion
square yards of nonwoven fabrics for hygiene products. The Company 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 6-8% through 2000,
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 in North
America is expected to be 4-5% annually through 2000.
 
  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
for Johnson & Johnson. 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:
 
      Product                             Application
                                          Coverstock
      Isolite(TM)                         Transfer sublayer
      Multi-Strike(TM)                    Clothlike backsheet
      Soft Touch(TM)                      Leg cuff for diapers
      Dry-Fit(TM)                         Sanitary protection facing
      Reticulon(R)                        Absorbent cores
      Ensorb(R)                           Topsheets
      Novaspun                            Consumer--Europe
      Baby wipes                          Protective apparel (solid barrier)
      Poly-Safe(TM)                       Protective apparel (breathable
      Poly-Breathe(TM)                     barrier)
--------
  /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
 
                                      11
<PAGE>
 
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 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(R), 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(R) structural
web process produces low-cost 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 hygiene and healthcare
applications that are manufactured utilizing the APEX(R) structural web
technology may only be sold to Johnson & Johnson. In all other markets, such
as automotive headliners, home furnishings and filtration products, the
Company may manufacture and freely market products utilizing the APEX(R)
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.
 
  The Company has agreed in collaboration with Los Alamos National
Laboratories ("LANL") to develop and commercialize specific applications of
polymer filtration/metal separations in aqueous, solid and vapor-phase
matrices, which permit removal and recovery of specific metal ions based on
sophisticated polymer chemistry. Initial polymer filtration techniques relate
to the removal and recovery of metal ions from electroplating and metal
finishing process waste streams. Additional polymer filtration/metal
separations applications are being identified by the Company and LANL for
commercialization. These techniques have potential applications in commercial
and large-scale waste site cleanup and disposal. The Company currently markets
this product under the Metal-Set(R) brand name.
 
MARKETING AND SALES
 
  The Company sells to over 1,000 customers in the domestic and international
marketplace. Approximately 58%, 20%, 12% and 10% of the Company's 1997 net
sales were to entities from manufacturing facilities in the United States,
Europe, Canada and Mexico, respectively. Johnson & Johnson, the Company's
largest customer, accounted for 26% of the Company's 1997 net sales while
Procter & Gamble accounted for 16% of net sales for the same period. Sales to
the Company's top 20 customers represented approximately 61% of the Company's
1997 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
 
                                      12
<PAGE>
 
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 16 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.
 
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 (commercial
production expected May 1998), 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
 
                                      13
<PAGE>
 
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.
 
  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. 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: Du Pont, Freudenberg Nonwovens L.P. ("Freudenberg"), Kimberly-
Clark Corporation ("Kimberly-Clark"), Dexter Nonwovens Division, Kuraray Co.,
Ltd., Veratec (a subsidiary of International Paper Co.), Reemay Inc. (a
subsidiary of BBA Group plc), Lohmann GmbH & Company and Lantor International
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-
 
                                      14
<PAGE>
 
Clark. In addition to like-kind products, the Company's wiping products also
compete with used rags and linen. 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
Veratec and FiberWeb Group, Inc. in North America, Corovin GmbH (a subsidiary
of 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. The
Company believes that it is an industry leader in each of these categories.
 
  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 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. See "Risk Factors--Competition in the Company's Markets."
 
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. The Company expects that such price reductions will continue as
incremental capacity continues to be added. In 1996, polypropylene fiber
prices remained stable while resin prices, on average, trended lower.
Polyethylene resin prices were lower in the first half of 1996, but rose in
the second half of the year. Polyester fiber and resin prices experienced
substantial declines worldwide during 1996. Raw materials prices remained
stable to slightly lower in 1997.
 
  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 E.I. Du Pont de Nemours & Co. ("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 Edison Plastics Company, a
 
                                      15
<PAGE>
 
subsidiary of Blessings 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.
 
  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 of material importance 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 40
 
                                      16
<PAGE>
 
registered trademarks and over 75 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.
 
INVENTORY AND BACKLOGS
 
  Unfilled orders, excluding orders on hand not yet released for delivery, as
of January 3, 1998 and December 28, 1996 amounted to approximately $87.2
million and $76.8 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. For the fiscal years ended
January 3, 1998, December 28, 1996 and December 30, 1995, the Company spent
approximately $9.6 million, $6.9 million and $6.4 million on research and
development.
 
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 3, 1998, the Company employed approximately 3,600 persons. Of
this total, approximately 1,600 employees are represented by labor unions or
trade councils that have entered into separate collective bargaining
agreements with the Company. Approximately 31% of the Company's labor force is
covered by collective bargaining agreements which will expire in 1998. The
Company considers its employee relations to be very good.
 
                                      17
<PAGE>
 
                              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.
 
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."
 
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 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.
 
                                      18
<PAGE>
 
  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 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"). The aggregate purchase
price of the assets to be purchased and liabilities to be assumed was
approximately $47.0 million.
 
                                      19
<PAGE>
 
THE JUNE REFINANCING
 
  In the June Refinancing (the "June Refinancing"), the Company (i) refinanced
its outstanding indebtedness under its 12 1/4% Senior Notes by consummating
(a) the June Offering and subsequent September Exchange Offer, and (b) the
Senior Notes Tender Offer and Consent Solicitation, and (ii) entered into the
Credit Facility.
 
The Private Placement and September Exchange Offer
 
  On July 3, 1997, the Company issued $400 million of 9% Senior Subordinated
Notes due 2007 (the "Privately Placed Notes") to Chase in a transaction not
registered under the Securities Act in reliance upon an exemption under the
Securities Act (the "Private Placement") pursuant to an indenture dated as of
July 1, 1997 among the Company, the guarantors named therein and Harris Trust
& Savings Bank, as trustee (the "9% Notes Indenture"). Chase subsequently
placed the Privately Placed Notes with qualified institutional buyers in
reliance under 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 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.
 
  Pursuant to a 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 its 9% Senior
Subordinated Notes due 2007, Series B (the "9% Notes") for each $1,000
principal amount outstanding of the Privately Placed Notes (the "September
Exchange Offer"). The September Exchange Offer was undertaken to comply with
certain Registration Rights granted to holders of the Original Notes in
connection with the Private Placement 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.
 
Senior Notes Tender Offer and Consent Solicitation
 
  In connection with the Private Placement, pursuant to an independent Offer
to Purchase and Consent Solicitation Statement dated June 5, 1997, the Company
offered to repurchase all, but not less than a majority, of its outstanding 12
1/4% Senior Notes due 2002 (the "Senior Notes") at a price equal to $1,103.64
per $1,000 aggregate principal amount of Senior Notes (the "Senior Notes
Tender Offer and Consent Solicitation"). The price was calculated based on (i)
the present value on the payment date of $1,061.25 per $1,000 principal amount
of each Senior Note (the amount payable on July 15, 1998, the first date on
which the Senior Notes were redeemable) plus accrued interest payable through
July 15, 1998, using a discount factor equal to the sum of (x) 5.77% (the
yield on the 8 1/4% U.S. Treasury Note due July 15, 1998 as of 2:00 p.m., New
York City Time, on June 18, 1997, the tenth business day preceding the
expiration date of the offer), plus (y) 75 basis points, minus $10.00 per
$1,000 principal amount of Senior Notes. Each tendering holder also received
accrued and unpaid interest up to, but not including, the date on which
payment for accepted Senior Notes was made.
 
                                      20
<PAGE>
 
  The Company also solicited consents from the tendering holders of Senior
Notes to certain proposed amendments to the Senior Notes indenture which
eliminated substantially all of the protective covenants contained in that
indenture. Holders who timely consented to the proposed amendments received a
consent payment equal to 1% of their principal amount of Senior Notes ($10.00
per $1,000 principal amount). In response to the Senior Notes Tender Offer and
Consent Solicitation, which was consummated on July 3, 1997, the Company
received tenders of, and consents relating to, all of its outstanding Senior
Notes.
 
Credit Facility
 
  As part of the June Refinancing, the Company and certain of its subsidiaries
entered into revolving credit facilities (the "Credit Facility"), dated July
3, 1997, with a group of lenders and with Chase Bank, as administrative agent
(the "Agent"), by amending and restating its original credit facility dated
May 15, 1996 (the "Old Credit Facility"). Prior to the amendment consummated
in connection with the Nonwovens Acquisition, the Credit Facility provided for
aggregate borrowings of up to $325.0 million.
 
THE FNA ACQUISITION
 
  On August 14, 1996, PGI Polymer, a Delaware corporation and wholly owned
subsidiary of the Company, completed the FNA Acquisition by acquiring the
business of PNA Corp., a North Carolina corporation, and its wholly owned
subsidiary FNA Polymer Corp. The acquisition was consummated pursuant to the
terms of a Stock Purchase Agreement dated as of July 15, 1996 among Pertropar
S.A., a corporation incorporated under the laws of the Federal Republic of
Brazil, Alicorno Comercio e Servicios Lda., a corporation incorporated under
the laws of Madeira, and PGI Polymer, and was accounted for using the purchase
method of accounting. Total consideration paid in the transaction was $48
million, as determined in negotiations among the parties to the Stock Purchase
Agreement, and was financed through borrowings under the Company's Old Credit
Facility and working capital.
 
  FNA produced and continues to produce polypropylene fabrics for the
nonwovens industry utilizing spunbond and SMS technologies. Among other assets
acquired in the FNA Acquisition, the Company purchased FNA's modern
manufacturing facility, which was built in 1992 and expanded in 1994. The FNA
Acquisition strengthened the Company's strategic position in the hygiene
materials market and broadened its offering of medical and agricultural
materials.
 
INITIAL PUBLIC OFFERING AND RECAPITALIZATION
 
  In May 1996, the Company completed the Initial Public Offering (the "Initial
Public Offering"), in which the Company offered and sold 11.5 million shares
of Common Stock at a price of $18.00 per share. Net proceeds to the Company
after underwriting fees and discounts approximated $190.8 million. Pursuant to
the Recapitalization Agreement dated May 6, 1996, all of the warrants to
acquire shares of Class C Common Stock were exercised and the outstanding
shares of Class A Common Stock, Class B Common Stock and Class C Common Stock
were converted into a single class of Common Stock concurrently with the
Initial Public Offering. In connection with the Initial Public Offering, the
Company's Board of Directors approved an approximately 19.97 to 1 stock split.
In addition, the Company (i) effectively repaid all outstanding indebtedness
under the FiberTech and Chicopee credit facilities and terminated such credit
facilities, redeemed $50.0 million principal amount of the Senior Notes at
premium of 112.25% plus accrued, but unpaid, interest and entered into the Old
Credit Facility, consisting of a $200.0 million term loan and a $125.0 million
revolving credit facility, (ii) redeemed the preferred stock of Chicopee, Inc.
for approximately $46.9 million, and (iii) redeemed the Company Preferred
Stock for approximately $10.5 million.
 
                                      21
<PAGE>
 
                      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.
 
  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.
 
                                      22
<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
 
                                      23
<PAGE>
 
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 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 require such an offer to be made within 30 days of a change
in control of DT USA or Dominion. The Change of Control Offer expired on March
17, 1998.
 
  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. DT USA currently has $4.4 million aggregate
principal amount of 2003 Notes and $0.5 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. DT USA intends to
exercise its rights under Article IV of the 2003 Notes Indenture and Article
IV of the 2006 Notes Indenture to satisfy and discharge the 2003 Notes and the
2006 Notes at the permitted times described therein.
 
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 September 3, 1997, and Registration Statement on Form
S-1, declared effective on May 9, 1996.
 
                                      24
<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
          --------            -----------           ------------------
<S>                           <C>          <C>
North Little Rock, Arkansas     364,000    Manufacturing
 (Plant 1)..................
North Little Rock, Arkansas     119,000    Manufacturing and Warehousing
 (Plant 2)..................
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
Portland (Clackamas),            30,000    Manufacturing
 Oregon.....................
North Charleston, South           4,500(3) Corporate
 Carolina...................
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
Vancouver, British Columbia.     60,000(1) Manufacturing
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    Warehousing, Manufacturing, Sales,
                                            Marketing, Warehousing and Research
                                            and Development
Tilburg, Netherlands........     29,052    Manufacturing, Marketing, Warehousing
                                            and Administration
Denton, Manchester               12,500    Manufacturing, Warehousing and
 (England)..................                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>
 
                                      25
<PAGE>
 
--------
(1) Leased.
(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
PGH. 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>
                                                                       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
<CAPTION>
                                                                       1996
                                                                   -------------
                                                                    HIGH   LOW
                                                                   ------ ------
      <S>                                                          <C>    <C>
      Second Quarter (a).......................................... $20.50 $17.50
      Third Quarter...............................................  17.38  12.00
      Fourth Quarter..............................................  14.50  12.50
</TABLE>
--------
(a) From May 9, 1996
 
TITLE OF CLASS
 
  Common Stock, $.01 par value
 
  As of April 1, 1998, there were 159 holders of record.
 
                                      26
<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 in
the period ended January 3, 1998 and the balance sheet data as of January 3,
1998, December 28, 1996, December 30, 1995, December 31, 1994 and January 1,
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 3,  DECEMBER 28, DECEMBER 30, DECEMBER 31, JANUARY 1,
                             1998         1996         1995         1994        1994
                          ----------  ------------ ------------ ------------ ----------
                                                     (DOLLARS IN THOUSANDS)
STATEMENT OF OPERATIONS:
<S>                       <C>         <C>          <C>          <C>          <C>        <C> <C> <C> <C>
Net sales...............  $ 535,267     $521,368     $437,638     $165,333    $121,473
Cost of goods sold......    402,058      389,013      333,606      129,071      97,291
                          ---------     --------     --------     --------    --------
 Gross profit...........    133,209      132,355      104,032       36,262      24,182
Selling, general and
 administrative
 expenses...............     74,600       70,207       61,744       20,699      13,022
                          ---------     --------     --------     --------    --------
 Operating income.......     58,609       62,148       42,288       15,563      11,160
Other (income) expense:
 Interest expense, net..     30,499       33,641       37,868       13,216       4,387
 Investment income--
  (gain) on marketable
  securities, net.......    (11,880)          --           --           --          --
 Foreign currency
  transaction (gains)
  losses, net...........       (452)       2,955       22,811       17,332       1,363
 Income taxes...........     13,009       10,730        5,216        3,353       1,970
                          ---------     --------     --------     --------    --------
 Income (loss) before
  extraordinary item....     27,433       14,822      (23,607)     (18,338)      3,440
Extraordinary item,
 (loss) from
 extinguishment of
 debt...................    (12,005)     (13,932)          --       (4,372)         --
                          ---------     --------     --------     --------    --------
Net income (loss).......  $  15,428     $    890     $(23,607)    $(22,710)   $  3,440
Redeemable preferred
 stock dividends and
 accretion..............         --       (3,020)      (4,839)      (1,209)     (2,480)
                          ---------     --------     --------     --------    --------
Net income (loss)
 applicable to common
 stock..................  $  15,428     $ (2,130)    $(28,446)    $(23,919)   $    960
                          =========     ========     ========     ========    ========
Income (loss) before
 extraordinary item per
 common share--basic....  $    0.86     $   0.43     $  (1.39)    $  (0.95)   $   0.05
                          =========     ========     ========     ========    ========
Income (loss) before
 extraordinary item per
 common share--diluted..  $    0.86     $   0.43     $  (1.39)    $  (0.95)   $   0.05
                          =========     ========     ========     ========    ========
Average common shares
 outstanding............     32,000       27,688       20,500       20,500      20,500
                          =========     ========     ========     ========    ========
OPERATING AND OTHER DATA:
Cash provided by
 operating activities...  $  18,362     $ 36,097     $ 11,556     $ 17,386    $  6,888
Cash (used in) investing
 activities.............   (491,901)     (86,422)    (333,208)     (61,375)     (6,958)
Cash provided by (used
 in) financing
 activities.............    485,953       64,391      327,636       58,482      (1,038)
Gross margin (a)........       24.9%        25.4%        23.8%        21.9%       19.9%
EBITDA (b)..............  $  98,921     $ 98,915     $ 72,122     $ 23,864    $ 16,115
EBITDA margin (c).......       18.5%        19.0%        16.5%        14.4%       13.3%
Depreciation and
 amortization...........  $  40,312     $ 36,767     $ 29,834     $  8,348    $  4,955
Capital expenditures....     60,144       26,739       47,842       11,341       6,505
BALANCE SHEET DATA (AT
 END OF PERIOD):
Cash and cash
 equivalents............  $  50,190     $ 37,587     $ 18,088     $ 13,828    $  2,694
Working capital
 (deficit)..............    220,025       93,154       61,558       31,060      (5,786)
Total assets............  1,627,753      708,115      637,981      241,942     103,187
Total debt, excluding
 short-term bridge
 financing..............    745,136      382,242      450,878      190,814      57,562
Minority interest.......     54,730           --           --           --          --
Redeemable preferred
 stock, dividends and
 accretion..............        ---           --       44,339           --      31,603
Shareholders' equity
 (deficit)..............    199,090      195,918       13,752        2,220        (592)
</TABLE>
 
              See Notes to Selected Consolidated Financial Data.
 
                                      27
<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.
 
                                      28
<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>
                                                    YEAR ENDED
                                       ------------------------------------
                                       JANUARY 3, DECEMBER 28, DECEMBER 30,
                                          1998        1996         1995
                                       ---------- ------------ ------------
<S>                                    <C>        <C>          <C>          <C>
Net sales by product category:
Hygiene...............................    43.3%       44.4%        45.1%
Medical...............................    16.2        17.6         16.7
Wiping................................    19.7        17.4         16.7
Industrial and specialty..............    20.8        20.6         21.5
                                         -----       -----        -----
                                         100.0%      100.0%       100.0%
Cost of goods sold....................    75.1        74.6         76.2
                                         -----       -----        -----
  Gross profit........................    24.9        25.4         23.8
Selling, general and administrative
 expenses.............................    13.9        13.4         14.1
                                         -----       -----        -----
Operating income......................    11.0        12.0          9.7
Other (income) expense:
  Interest expense, net...............     5.7         6.5          8.7
  Investment income, (gain) on
   marketable securities, net.........    (2.2)         --           --
  Foreign currency transaction (gains)
   losses, net........................     (.1)        0.5          5.2
                                         -----       -----        -----
Income (loss) before income taxes and
 extraordinary item...................     7.6         5.0         (4.2)
Income taxes..........................     2.5         2.1          1.2
                                         -----       -----        -----
Income (loss) before extraordinary
 item.................................     5.1         2.9         (5.4)
Extraordinary item, net of income tax
 benefit..............................    (2.2)       (2.6)          --
                                         -----       -----        -----
Net income (loss).....................     2.9%        0.3%        (5.4)%
                                         =====       =====        =====
</TABLE>
 
COMPARISON OF YEAR ENDED JANUARY 3, 1998 AND DECEMBER 28, 1996
 
NET SALES
 
  Net sales increased approximately $14.0 million, or 2.7%, from $521.4
million in 1996 to $535.3 million in 1997.
 
  Hygiene product sales increased approximately $0.7 million from $231.2
million in 1996 to $231.9 million in 1997. Net sales increased $8.1 million
primarily as a result of the acquisition of FNA and $9.5 million as a result
of growth in adhesive bond fabric sales and customer contractual obligations.
Net sales in the hygiene category was unfavorably impacted by $16.9 million
due to weaker European foreign currency translation rates and lower thermal
bond product sales as customers converted to spunbond materials faster in 1997
compared to 1996.
 
  Medical product sales decreased 5.4%, or approximately $5.0 million, from
$91.7 million in 1996 to $86.7 million in 1997. This decrease was a result of:
(i) lower net raw material costs passed through to customers in the form of
lower average selling prices, (ii) unfavorable European foreign currency
translation rates, and (iii) other net decreases, including lower exports of
surgical gown and drape fabric, which were partially offset by sales increases
attributable to the acquisition of FNA and customer contractual obligations.
 
  Within the wiping product category, sales increased 16.1%, or $14.6 million,
from $90.6 million in 1996 to $105.2 million in 1997 despite unfavorable
foreign currency translation rates in Europe. Improved sales in this product
category were driven by higher volumes of food service and specialty wiping
products and by growth in rollgood sales and geographic and product line
extensions.
 
                                      29
<PAGE>
 
  Sales in the industrial and specialty product category increased 3.4%, or
$3.7 million, from $107.8 million in 1996 to $111.5 million in 1997. Sales
growth was attributable to the acquisition of FNA and increased sales of woven
slit films offset by unfavorable European foreign currency translation rates
and lower sales of products for home fashions, automotive and apparel
interlining applications.
 
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 thermal bond volume offset
somewhat by 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 the refinancing of the Company's indebtedness in June of 1997.
The Company recorded net investment income related to its gain on marketable
securities of $11.9 million during 1997.
 
  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.
 
                                      30
<PAGE>
 
EXTRAORDINARY ITEM
 
  The Company recorded one-time 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.
 
COMPARISON OF YEAR ENDED DECEMBER 28, 1996 AND DECEMBER 30, 1995
 
NET SALES
 
  Net sales for 1996 were $521.4 million, a 19.1% increase over net sales of
$437.6 million in 1995.
 
  Hygiene product sales increased $33.6 million to $231.2 million in 1996,
from $197.6 million in 1995. Sales of hygiene products made with spunbond and
SMS, adhesive bond and apertured film technologies increased by $28.5 million
in 1996. Driving the internal growth of hygiene products was the SMS expansion
in San Luis Potosi, Mexico and rising demand for apertured film facings,
partially offset by declining thermal bond volume and the discontinuation of
purchased spunbond from a former joint venture partner.
 
  Medical product sales increased $18.7 million to $91.7 million in 1996, from
$73.0 million in 1995. The Company's medical business benefited from a high
level of unit volume growth during the year,
offset by a decrease in average unit selling prices as a result of the pass
through of lower raw material costs. The net increase in total medical sales
between 1996 and 1995 attributable to volume growth was $7.5 million, or
10.2%, offset by price reductions of $5.9 million related to lower material
cost. Growth in medical sales attributable to the acquisition of FNA and
Chicopee were $17.2 million.
 
  Wiping product sales were $90.6 million in 1996, compared to $73.0 million
in 1995, reflecting an increase of $17.6 million. Revenue growth in the wipes
category was principally due to inclusion of a full year of Chicopee
operations.
 
  Sales of industrial and specialty products were $107.8 million in 1996,
compared to $94.1 million in 1995, up 14.6% due primarily to the acquisitions
of FNA and Chicopee. In addition, industrial and specialty product revenue
grew in 1996 as a result of (i) new product introductions such as decal
backings, apparel interlinings, window coverings and landscape fabrics, and
(ii) growth in established product lines such as microporous separators, crop
covers, home furnishings, clean room rollgoods and industrial protective
coverings.
 
GROSS PROFIT
 
  Gross profit was $132.4 million, or 25.4% of net sales, compared to $104.0
million, or 23.8% of net sales in 1995. The improvement in gross profit as a
percentage of sales was largely due to lower raw material costs. Additionally,
the Company increased its gross margins as a result of improvements in
manufacturing efficiencies and material utilization and a mix shift to greater
value added products. The Company has improved material utilization primarily
by reducing waste, controlling weight variation and designing lower basis
weight products. Overhead expenses increased from 19.9% of net sales in 1995
to 20.9% of net sales in 1996 as a result of higher depreciation on completed
capital expenditures and transitional overhead associated with the integration
of value-added production in the hygiene product category.
 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
 
  Selling, general and administrative expenses were $70.2 million in 1996,
compared with $61.7 million in 1995, an increase of $8.5 million primarily due
to the FNA Acquisition in August 1996 and a full year of expenses related to
the Chicopee operations, compared with nine and one half months in
 
                                      31
<PAGE>
 
1995. As a percentage of net sales, selling, general and administrative
expenses decreased to 13.4% in 1996 from 14.1% in 1995. Research and
development expense was $6.9 million in 1996 compared to $6.4 million in 1995.
 
OTHER
 
  Interest expense decreased $4.3 million from $37.9 million in 1995 to $33.6
million in 1996. Interest expense as a percentage of net sales decreased to
6.5% in 1996 from 8.7% in 1995. These decreases are principally due to a lower
average amount of indebtedness outstanding in 1996. Net foreign currency
transaction losses were approximately $3.0 million in 1996 versus $22.8
million in 1995. In 1996, the Company's European operations incurred net
foreign currency transaction losses of $6.2 million which were offset by net
foreign currency transaction gains of $3.3 million within the Company's
Mexican operation. The Initial Public Offering and the recapitalization
consummated concurrently therewith eliminated the majority of the Company's
United States dollar intercompany debt, effectively reducing the Company's
exposure to foreign currency fluctuations.
 
INCOME BEFORE EXTRAORDINARY ITEM
 
  Income before extraordinary item was $14.8 million in 1996 versus a loss
before extraordinary item of $(23.6) million in 1995. Income before
extraordinary item was favorably impacted during 1996 by increased
profitability attributable primarily to volume increases within the hygiene
and industrial and specialty product categories. Offsetting the effects of
improved gross profit were foreign currency transaction losses of
approximately $3.0 million in 1996. The Company provided for income taxes of
$10.7 million during 1996, representing an effective tax rate of approximately
42%. Unfavorably impacting net income in the prior year was a higher effective
tax rate resulting from foreign losses which did not give rise to a
corresponding tax benefit.
 
EXTRAORDINARY ITEM
 
  As a result of the recapitalization effected concurrently with the Initial
Public Offering, the Company recorded one-time charges of approximately $13.9
million, net of taxes, related to the write-off of previously capitalized debt
issue costs and prepayment penalties paid in connection with the repurchase of
$50.0 million in principal of outstanding Senior Notes.
 
                        LIQUIDITY AND CAPITAL RESOURCES
 
OPERATING ACTIVITIES
 
  During 1997, the Company's operations generated $18.4 million of cash. The
Company's working capital increased $126.8 million, from $93.2 million at
December 28, 1996 to $220.0 million at January 3, 1998. Cash and equivalents
were $50.2 million at January 3, 1998 as compared to $37.6 million at December
28, 1996. This increase arose principally from higher net income in 1997.
 
  At December 28, 1996, the Company had $36.1 million of cash, compared to
$11.6 million during 1995, an increase of $24.5 million. This increase was
attributable to a higher level of operating income in 1996 and lower interest
costs due to a lower average amount of indebtedness outstanding in 1996. The
Company's working capital increased $31.6 million, or 51.3%, from $61.6
million in 1995 to $93.2 million in 1996, mainly as a result of increases in
accounts receivable and inventories offset by increased accounts payable and
accrued expenses. Cash and equivalents and marketable securities were $48.5
million at December 28, 1996 as compared to $22.9 million at December 30,
1995, a net increase of $25.6 million.
 
                                      32
<PAGE>
 
INVESTING AND FINANCING ACTIVITIES
 
  Capital expenditures for 1997 totaled $60.1 million, an increase of $33.4
million over 1996 due primarily to expansion of adhesive bond and reticulon
capacity, and a new 4.2 meter wide SMS line at the Company's Mooresville,
North Carolina plant site. Commercialization of this new line was completed
during the fourth quarter of 1997. For fiscal 1998, the Company has budgeted
approximately $31.0 million for sustaining capital expenditures and
approximately $52.0 million 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 one-time 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 $215.9 million of
borrowings under DTA's $600.0 million senior secured credit facilities, and
subordinated advances of $141.0, $69.0, and $25.0 million by Galey, ZB
Holdings and the Company, respectively.
 
  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.
 
  On March 16, 1998, the Company 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 $47.0 million.
 
  On May 15, 1996, the Company completed the Initial Public Offering, in which
it offered and sold 11.5 million shares of common stock at an offering price
of $18.00 per share. Net proceeds to the Company after underwriting fees and
related costs were $190.8 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.
 
                                      33
<PAGE>
 
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 manufactures certain of its products in Germany, Canada, Mexico,
France, England and the Netherlands. The Company accounts for and reports
translation of foreign currency transactions and foreign currency financial
statements in accordance with FAS 52. Since the Company's substantial foreign
operations expose it to the risk of exchange rate fluctuations, if foreign
currency denominated revenues are greater than costs, the translation of
foreign currency denominated costs and revenues into dollars will improve
profitability when the foreign currency strengthens against the dollar and
will reduce profitability when the foreign currency weakens. In addition, the
remeasurements 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. Such products are used only to manage well-defined interest rate and
certain foreign currency risks, as discussed below. Premiums paid for
purchased interest rate cap agreements are charged to expense over the rate
cap period. Charges to expense in 1997 and 1996 related to derivative products
were not significant.
 
  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.
 
NEW ACCOUNTING STANDARDS
 
  In 1997, Statement No. 128, "Earnings Per Share" ("FAS 128") was issued. FAS
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effect of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented, and where appropriate, restated
to conform to the FAS 128 requirements.
 
  In 1997, Statement No. 130, "Reporting Comprehensive Income" ("FAS 130") was
issued. FAS 130 is effective for fiscal years beginning after December 15,
1997 and requires 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 foreign currency translation
adjustments, which prior to adoption were reported separately as a component
of shareholders' equity, to be included in other comprehensive income. The
Company will adopt the new requirements in 1998.
 
  In 1997, Statement No. 131, "Disclosure about Segments of an Enterprise and
Related Information" ("FAS 131"), which is effective for years beginning after
December 15, 1997, was issued. FAS 131 establishes standards for the way that
public business enterprises report information about
 
                                      34
<PAGE>
 
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. The Company will
adopt the new requirements in 1998.
 
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 emission, 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
environmental requirements. The Company is also subject to laws, such as the
Federal Comprehensive Environmental Response, Compensation and Liability Act
of 1980 ("CERCLA"), that may impose liability retroactively and without fault
for 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. 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.
 
YEAR 2000
 
  The Company has made an initial assessment of certain computer systems'
compatibility with the "Year 2000" issue and has determined that it will need
to modify or replace portions of its software so that its computer systems
will function properly with respect to dates in the Year 2000 and beyond. The
Company presently believes that with modifications to existing software and
conversions to new software, the Year 2000 issue will not pose significant
operational problems for its computer systems. The Company will utilize both
internal and external resources to reprogram, or replace, and test the
software for the Year 2000 modifications. Management does not currently expect
the total costs of the year 2000 conversion project to be material to the
financial condition of the Company taken as a whole. The costs of the project
and the date on which the Company believes it will complete the Year 2000
modifications are based on management's best estimates, which were derived
utilizing assumptions of future events, including the continued availability
of certain resources, third party modification plans and other factors.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ from those anticipated. Specific factors that
might cause material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes and similar uncertainties.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
 
  Not applicable.
 
                                      35
<PAGE>
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
<TABLE>
<S>                                                                          <C>
Report of Ernst & Young LLP, Independent Auditors..........................   37
Consolidated Balance Sheets as of January 3, 1998 and December 28, 1996....   38
Consolidated Statements of Operations for the fiscal years ended January 3,
 1998, December 28, 1996 and December 30, 1995.............................   39
Consolidated Statements of Shareholders' Equity for the fiscal years ended
 January 3, 1998, December 28, 1996 and December 30, 1995..................   40
Consolidated Statements of Cash Flows for the fiscal years ended January 3,
 1998, December 28, 1996 and December 30, 1995.............................   41
Notes to Consolidated Financial Statements for the fiscal years ended
 January 3, 1998, December 28, 1996 and December 30, 1995..................   42
</TABLE>
 
 
                                       36
<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 3, 1998 and December 28, 1996 and the related
consolidated statements of operations, shareholders' equity, and cash flows
for each of the three years in the period ended January 3, 1998. Our audits
also included the financial statements 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 3, 1998 and December 28, 1996 and the consolidated
results of its operations and its cash flows for each of the three years in
the period ended January 3, 1998 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.
 
                                          Ernst & Young LLP
 
Greenville, South Carolina
March 25, 1998
 
                                      37
<PAGE>
 
                              POLYMER GROUP, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                                                       JANUARY 3,  DECEMBER 28,
                        ASSETS                            1998         1996
                        ------                         ----------  ------------
<S>                                                    <C>         <C>
Current assets:
  Cash and equivalents................................ $   50,190    $ 37,587
  Marketable securities...............................      7,754      10,892
  Accounts receivable, net............................    107,328      64,752
  Inventories.........................................     94,128      55,637
  Deferred income taxes...............................      4,161       5,172
  Assets held for disposition, net....................    464,524         --
  Other...............................................     26,985      10,387
                                                       ----------    --------
    Total current assets..............................    755,070     184,427
Property, plant and equipment, net....................    606,260     406,527
Intangibles, loan acquisition and organization costs,
 net..................................................    229,391      96,932
Deferred income taxes.................................      9,183      10,741
Other.................................................     27,849       9,488
                                                       ----------    --------
    Total assets...................................... $1,627,753    $708,115
                                                       ==========    ========
<CAPTION>
         LIABILITIES AND SHAREHOLDERS' EQUITY
         ------------------------------------
<S>                                                    <C>         <C>
Current liabilities:
  Accounts payable.................................... $   52,165    $ 36,059
  Accrued liabilities.................................     52,133      33,130
  Income taxes payable................................      1,242       1,196
  Deferred income taxes...............................        284       1,391
  Short-term bridge financing.........................    425,945         --
  Current portion of long-term debt...................      3,276      19,497
                                                       ----------    --------
    Total current liabilities.........................    535,045      91,273
Long-term debt, less current portion..................    741,860     362,745
Deferred income taxes.................................     82,213      52,115
Other noncurrent liabilities..........................     14,815       6,064
Minority interest.....................................     54,730         --
Shareholders' equity:
  Series preferred stock--$.01 par value, 10,000,000
   shares authorized at 1997 and 1996; 0 shares issued
   and outstanding at 1997 and 1996...................        --          --
  Common stock--$.01 par value, 100,000,000 shares
   authorized at 1997 and 1996; 32,000,000 shares
   issued and outstanding at 1997 and 1996............        320         320
  Non-voting common stock--$.01 par value; 3,000,000
   shares authorized at 1997 and 1996; 0 shares issued
   and outstanding at 1997 and 1996...................        --          --
  Additional paid-in capital..........................    243,662     243,662
  (Deficit)...........................................    (39,355)    (54,783)
  Cumulative translation adjustment...................     (5,544)      6,790
  Unrealized holding gain (loss) on marketable
   securities.........................................          7         (71)
                                                       ----------    --------
                                                          199,090     195,918
                                                       ----------    --------
    Total liabilities and shareholders' equity........ $1,627,753    $708,115
                                                       ==========    ========
</TABLE>
 
                            See accompanying notes.
 
                                       38
<PAGE>
 
                              POLYMER GROUP, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                FOR THE FISCAL YEARS ENDED
                                            -----------------------------------
                                            JANUARY
                                               3,     DECEMBER 28, DECEMBER 30,
                                              1998        1996         1995
                                            --------  ------------ ------------
<S>                                         <C>       <C>          <C>
Net sales.................................  $535,267    $521,368     $437,638
Cost of goods sold........................   402,058     389,013      333,606
                                            --------    --------     --------
Gross profit..............................   133,209     132,355      104,032
Selling, general and administrative
 expenses.................................    74,600      70,207       61,744
                                            --------    --------     --------
Operating income..........................    58,609      62,148       42,288
Other (income) expense:
  Interest expense, net...................    30,499      33,641       37,868
  Investment income--(gain) on marketable
   securities, net........................   (11,880)        --           --
  Foreign currency transaction (gains)
   losses, net............................      (452)      2,955       22,811
                                            --------    --------     --------
                                              18,167      36,596       60,679
                                            --------    --------     --------
Income (loss) before income taxes and
 extraordinary item.......................    40,442      25,552      (18,391)
Income taxes..............................    13,009      10,730        5,216
                                            --------    --------     --------
Income (loss) before extraordinary item...    27,433      14,822      (23,607)
Extraordinary item, loss from
 extinguishment of debt, net of income tax
 benefit of $5,959 in 1997 ($7,492 in
 1996)....................................   (12,005)    (13,932)         --
                                            --------    --------     --------
Net income (loss).........................    15,428         890      (23,607)
Redeemable preferred stock dividends and
 accretion................................       --       (3,020)      (4,839)
                                            --------    --------     --------
Net income (loss) applicable to common
 stock....................................  $ 15,428    $ (2,130)    $(28,446)
                                            ========    ========     ========
Net income (loss) per common share:
  Basic:
    Average common shares outstanding.....    32,000      27,688       20,500
    Income (loss) before extraordinary
     item.................................  $    .86    $    .43     $  (1.39)
    Extraordinary item, net of income tax
     benefit..............................      (.38)       (.51)         --
                                            --------    --------     --------
    Net income (loss) per common share--
     basic................................  $    .48    $   (.08)    $  (1.39)
                                            ========    ========     ========
  Diluted:
    Average common shares outstanding.....    32,000      27,688       20,500
    Income per share before extraordinary
     item.................................  $    .86    $    .43     $  (1.39)
    Extraordinary item, net of income tax
     benefit..............................      (.38)       (.51)         --
                                            --------    --------     --------
    Net income (loss) per common share--
     diluted..............................  $    .48    $   (.08)    $  (1.39)
                                            ========    ========     ========
</TABLE>
 
                            See accompanying notes.
 
                                       39
<PAGE>
 
                              POLYMER GROUP, INC.
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 FOR THE FISCAL YEARS ENDED JANUARY 3, 1998, DECEMBER 28, 1996 AND DECEMBER 30,
                                      1995
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                                                                    UNREALIZED
                                                                   HOLDING  GAIN
                                 ADDITIONAL            CUMULATIVE    (LOSS) ON
                          COMMON  PAID-IN              TRANSLATION  MARKETABLE
                          STOCK   CAPITAL   (DEFICIT)  ADJUSTMENT   SECURITIES    TOTAL
                          ------ ---------- ---------  ----------- ------------- --------
<S>                       <C>    <C>        <C>        <C>         <C>           <C>
Balance--December 31,
 1994...................   $ 17   $ 22,626  $(24,207)   $  3,784       $ --      $  2,220
Exchange of Class A and
 B stock (32,959,130
 shares)................    (17)   (22,626)      --          --          --       (22,643)
Issuance of Class A-1
 stock (5,359,615
 shares)................      3     21,155       --          --          --        21,158
Issuance of Class A-2
 stock (698,883 shares).    --       4,015       --          --          --         4,015
Issuance of Class A-3
 stock (2,296,330
 shares)................      1      4,621       --          --          --         4,622
Issuance of Class B
 stock (10,727,437
 shares)................      6     22,843       --          --          --        22,849
Issuance of warrants....    --         500       --          --          --           500
Net loss................    --         --    (23,607)        --          --       (23,607)
Foreign currency
 translation
 adjustments............    --         --        --        9,135         --         9,135
Cumulative dividends on
 redeemable preferred
 stock and discount
 accretion..............    --         --     (4,839)        --          --        (4,839)
Unrealized holding gain
 on marketable
 securities.............    --         --        --          --          342          342
                           ----   --------  --------    --------       -----     --------
Balance--December 30,
 1995...................     10     53,134   (52,653)     12,919         342       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
Net income..............    --         --        890         --          --           890
Foreign currency
 translation
 adjustments............    --         --        --       (6,129)        --        (6,129)
Cumulative dividends on
 redeemable preferred
 stock and discount
 accretion..............    --         --     (3,020)        --          --        (3,020)
Unrealized holding
 (loss) on marketable
 securities.............    --         --        --          --         (413)        (413)
                           ----   --------  --------    --------       -----     --------
Balance--December 28,
 1996...................    320    243,662   (54,783)      6,790         (71)     195,918
Net income..............    --         --     15,428         --          --        15,428
Foreign currency
 translation
 adjustments............    --         --        --      (12,334)        --       (12,334)
Unrealized holding gain
 on marketable
 securities.............    --         --        --          --           78           78
                           ----   --------  --------    --------       -----     --------
Balance--January 3,
 1998...................   $320   $243,662  $(39,355)   $ (5,544)      $   7     $199,090
                           ====   ========  ========    ========       =====     ========
</TABLE>
 
                            See accompanying notes.
 
                                       40
<PAGE>
 
                              POLYMER GROUP, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                                                 FOR THE FISCAL YEARS ENDED
                                            ------------------------------------
                                            JANUARY 3, DECEMBER 28, DECEMBER 30,
                                               1998        1996         1995
                                            ---------- ------------ ------------
<S>                                         <C>        <C>          <C>
Operating activities
  Net income (loss).......................   $ 15,428   $     890    $ (23,607)
  Adjustments to reconcile net income
   (loss) to net cash provided by
   operating activities:
  Extraordinary item, net of income tax
   benefit................................     12,005      13,932          --
  Depreciation and amortization expense...     40,312      36,767       29,834
  Foreign currency transaction (gains)
   losses, net............................       (452)      2,955       22,811
  Gain on marketable securities classified
   as trading, net........................    (11,880)        --           --
  Provision for losses on accounts
   receivable and price concessions.......      7,337       9,060        5,788
  Provision for deferred income taxes.....      5,985       7,831       (1,375)
  Changes in operating assets and
   liabilities, net of effect of
   acquisitions:
    Accounts receivable...................    (19,157)    (11,966)     (16,160)
    Inventories...........................     (6,453)     (6,353)      (7,799)
    Accounts payable and accrued expenses.     (4,304)     (5,860)      (2,666)
    Other, net............................    (20,459)    (11,159)       4,730
                                             --------   ---------    ---------
      Net cash provided by operating
       activities.........................     18,362      36,097       11,556
Investing activities
  Purchases of property, plant and
   equipment..............................    (60,144)    (26,739)     (47,842)
  Purchases of marketable securities
   classified as available for sale.......    (15,251)    (22,879)     (22,521)
  Proceeds from sales of marketable
   securities classified as available for
   sale...................................     17,003      16,713       19,929
  Acquisition of businesses, net of cash
   acquired...............................   (429,559)    (52,466)    (281,358)
  Organization and other costs............     (3,950)     (1,051)      (1,416)
                                             --------   ---------    ---------
      Net cash (used in) investing
       activities.........................   (491,901)    (86,422)    (333,208)
Financing activities
  Issuance of common stock, net of costs
   incurred...............................        --      190,838       30,000
  Proceeds from debt......................    480,846     308,277      273,654
  Proceeds from short-term bridge
   financing..............................    425,945         --           --
  Payments of debt........................   (402,282)   (375,989)     (13,638)
  Issuance of redeemable preferred stock
   and warrants...........................        --       10,000       40,000
  Redemption of preferred stock...........        --      (57,359)         --
  Loan acquisition, debt prepayment and
   other costs, net.......................    (18,556)    (11,376)      (2,380)
                                             --------   ---------    ---------
      Net cash provided by financing
       activities.........................    485,953      64,391      327,636
Effect of exchange rate changes on cash...        189       5,433       (1,724)
                                             --------   ---------    ---------
      Net increase in cash and
       equivalents........................     12,603      19,499        4,260
      Cash and equivalents at beginning of
       year...............................     37,587      18,088       13,828
                                             --------   ---------    ---------
      Cash and equivalents at end of year.   $ 50,190   $  37,587    $  18,088
                                             ========   =========    =========
Noncash investing and financing activities
  Cumulative dividends on redeemable
   preferred stock and accretion..........   $    --    $   3,020    $   4,839
  Approximate 19.97 to 1 stock split......        --          194          --
Supplemental information
  Cash paid for interest..................     40,768      38,111       43,186
  Cash paid for income taxes..............      7,419       6,602        5,027
Acquisition of businesses
  Fair value of assets acquired...........    391,920      61,946      358,814
  Fair value of assets acquired--held for
   disposition............................    464,524         --           --
  Liabilities assumed and incurred........   (426,885)     (9,480)     (77,456)
  Acquisition of businesses, net of cash
   acquired...............................    429,559      52,466      281,358
</TABLE>
 
                            See accompanying notes.
 
                                       41
<PAGE>
 
                              POLYMER GROUP, INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
 
 Description of Business
 
  Polymer Group, Inc. (the "Company") operates in one business segment,
manufacturing and marketing woven and nonwoven polyolefin fabric. The
Company's principal lines of business 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 and England.
 
 Basis of Presentation and Use of Estimates
 
  The accompanying consolidated financial statements of the Company, a
Delaware corporation incorporated on June 16, 1994, 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 Company recorded minority interest in
the consolidated balance sheet of $54.7 million at January 3, 1998. This
minority interest represents the minority shareholders' interest in the
shareholders' equity of Dominion Textile Inc. ("Dominion"). The preparation of
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The
Company's investment in DNS (as defined in "Note 2. Acquisitions") is
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 income approximated $2.4
and $1.9 million during 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 income and
capitalized interest. Interest income was not significant in 1995.
 
 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"). The statement 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 a separate 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. At
January 3, 1998 and December 28, 1996, all securities covered by FAS 115 were
designated as available-for-sale. Accordingly, these securities are stated at
fair value, with unrealized gains and losses reported in a separate component
of shareholders' equity. Realized gains and losses on sales of investments,
 
                                      42
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
as determined on the specific identification basis, are included in the
determination of net income. Marketable securities as of January 3, 1998 and
December 28, 1996 consist of the following:
 
<TABLE>
<CAPTION>
                                                                  1997   1996
                                                                 ------ -------
                                                                 (IN THOUSANDS)
      <S>                                                        <C>    <C>
      Marketable securities (common and preferred stock):
        Cost.................................................... $7,747 $10,963
        Unrealized gains........................................      7     --
        Unrealized (losses).....................................    --      (71)
                                                                 ------ -------
        Gross fair value........................................ $7,754 $10,892
                                                                 ====== =======
</TABLE>
 
 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 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 $5.5 and $3.8 million at
January 3, 1998 and December 28, 1996, 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") accounted for approximately 26% and 16%, respectively, of the
Company's sales in 1997. In 1996, J&J and P&G accounted for approximately 29%
and 14%, respectively, of the Company's sales. In 1995, J&J and P&G accounted
for approximately 28% and 15%, 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 3, 1998 and December 28,
1996, consist of the following:
 
<TABLE>
<CAPTION>
                                                                 1997    1996
                                                                ------- -------
                                                                (IN THOUSANDS)
      <S>                                                       <C>     <C>
      Finished goods........................................... $48,769 $26,809
      Work in process and stores and maintenance parts.........  11,201   3,328
      Raw materials............................................  34,158  25,500
                                                                ------- -------
          Total................................................ $94,128 $55,637
                                                                ======= =======
</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 $1.6, $0.8 and $1.9 million of interest costs during
1997, 1996 and 1995, respectively.
 
                                      43
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
 Intangibles, Loan Acquisition and Organization Costs
 
  In March 1995, the Financial Accounting Standards Board issued Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Assets to be
Disposed Of" ("FAS 121"). FAS 121 requires impairment losses to be recorded on
long-lived assets used in operations when indicators of impairment are present
and the expected future cash flows of those assets are less than the assets'
carrying amount. FAS 121 also addresses the accounting for long-lived assets
that are expected to be sold or discarded. The Company adopted FAS 121 on
December 31, 1995. The effect of adoption was not material to the Company's
financial condition or results of operations.
 
  The excess of cost over the fair value of net assets of companies acquired
is amortized on the straight-line method over an estimated useful life of 40
years. Identified intangible assets consist primarily of costs allocated in
the acquisitions to supply agreements, proprietary technology and other
acquisition-related arrangements. Such costs are amortized on the straight-
line method over periods not exceeding an estimated useful life of ten years.
Capitalized organization costs are amortized over five years on the straight-
line method. Loan acquisition costs relating to long-term debt are amortized
over the term of the related debt. The lives established for these assets are
a composite of many factors; accordingly, the Company evaluates the continued
appropriateness of these lives based upon the latest available economic
factors and circumstances. The carrying value of goodwill is reviewed if the
facts and circumstances suggest that it may be impaired. If this review
indicates that goodwill will not be recoverable, as determined based on the
undiscounted cash flows of the entity acquired over the remaining amortization
period, the Company's carrying value of the goodwill is reduced by the
estimated shortfall of discounted cash flows.
 
 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 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-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 1997, such amount did not exceed 9%. Charges
to expense in 1997 and 1996 related to derivative products were not
significant.
 
  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.
 
 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,
 
                                      44
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
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. 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 3, 1998 and December 28, 1996 was $1.2 billion and
$391.2 million, respectively. During 1997, the Company utilized standby
letters of credit which collateralized the Company's debt obligations to third
parties. Outstanding standby letters of credit totaled approximately $8.7
million at January 3, 1998. The contract amounts of these letters of credit
approximate their fair value.
 
 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.
 
 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 $9.6, $6.9 and
$6.4 million of research and development expense during 1997, 1996 and 1995,
respectively.
 
 Foreign Currency Translation
 
  The assets and liabilities of the Company's Canadian and European
subsidiaries are translated into U.S. dollars at the period end exchange rates
and revenues and expenses are translated at average exchange rates during the
reporting period. At the beginning of fiscal 1997, the Company changed the
functional currency of its Mexican subsidiary to the U.S. dollar. The
cumulative inflation index in Mexico approximated 100% over a three year
period ended December 28, 1996; therefore, Mexico is considered to be a
"highly inflationary" economy in accordance with Statement of Financial
Accounting Standards No. 52, "Foreign Currency Translation" ("FAS 52"). As a
result of this change, the dollar-translated amounts of nonmonetary assets at
the end of fiscal 1996 became the accounting basis for those assets at the
beginning of fiscal 1997 and for subsequent periods. Additionally, the
Mexican-related cumulative translation adjustment accumulated in shareholders'
equity prior to this change in functional currency remains a separate
component of shareholders' equity.
 
 Net Income (Loss) Per Common Share
 
  In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings Per Share" ("FAS 128"). FAS 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share
 
                                      45
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
excludes any dilutive effects of options, warrants and convertible securities.
Diluted earnings per share is very similar to the previously reported fully
diluted earnings per share. All earnings per share amounts for all periods
have been presented, and where appropriate, restated to conform to the FAS 128
requirements. The numerator for both basic and diluted earnings per share is
net income (loss) applicable to common stock. The denominator for both basic
and diluted earnings per share is average common shares outstanding.
 
 Comprehensive Income
 
  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. 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. The Company will adopt the new requirements
retroactively in the first quarter of 1998.
 
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 for Cdn$14.50 per share and
approximately 96% of the outstanding first preferred shares of Dominion for
Cdn$150 per share. The acquisition, which was accounted for using the purchase
method of accounting, was financed with $215.9 million of borrowings under
DTA's $600.0 million senior secured credit facilities, and subordinated
advances of $141.0, $69.0, and $25.0 million by Galey & Lord, Inc. ("Galey"),
ZB Holdings, Inc. ("ZB Holdings") and the Company, respectively. ZB Holdings
is a wholly-owned subsidiary of The InterTech Group, Inc., an affiliate of the
Company.
 
  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 of Dominion 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
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 (the
"Nonwovens Business") for approximately $351.6 million, including fees and
expenses. The Nonwovens Business includes a 50% interest in Argentina-based
Dominion Nonwovens Sudamerica S.A. ("DNS"). DNS manufactures and markets
nonwovens to hygiene markets in South America. 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 9.25%
Guaranteed Senior Notes due 2006 as more fully described in "Note 7. Debt."
Net assets of the apparel business of Dominion have been classified as assets
held for disposition on the Company's consolidated balance sheet at January 3,
1998. Results of operations of Dominion have not been included in the results
of the Company's consolidated financial statements, as their effect is not
considered to be material to the Company's consolidated results of operations.
 
                                      46
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  On August 14, 1996, the Company completed the acquisition (the "FNA
Acquisition") of the business of FNA Polymer Corp. ("FNA") (formerly known as
Fitesa North America) for approximately $48.0 million in a transaction
accounted for by the purchase method of accounting. FNA produces polypropylene
fabrics for the nonwovens industry.
 
  The following pro forma information in the table below is based on
historical financial statements of the Company, FNA and the Nonwovens Business
adjusted to give effect to the Nonwovens Acquisition, the June Refinancing (as
defined in "Note 7. Debt"), the FNA Acquisition, the IPO and the financing
thereof as if such events occurred on December 29, 1996 and December 31, 1995.
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 has been allocated to the underlying assets based on their
respective fair values at the date of the acquisition. Such allocation has
been based on preliminary estimates which may be revised at a later date. The
accompanying pro forma financial information in the table below does not
purport to represent what the Company's results of operations would have been
had the Nonwovens Acquisition, the June Refinancing, the FNA Acquisition, and
the IPO actually occurred at the beginning of the respective periods, or
project the Company's results of operations for any future periods.
 
<TABLE>
<CAPTION>
                                                                 FISCAL YEAR
                                                              -----------------
                                                                1997     1996
                                                              -------- --------
                                                               (IN THOUSANDS)
      <S>                                                     <C>      <C>
      Net sales.............................................. $748,832 $741,088
      Income before extraordinary item.......................   18,247   13,956
      Net income.............................................    6,242       24
      Per share--basic:
        Income before extraordinary item..................... $    .57 $    .44
        Net income...........................................      .19      --
      Per share--diluted:
        Income before extraordinary item..................... $    .57 $    .44
        Net income...........................................      .19      --
</TABLE>
 
NOTE 3. PROPERTY, PLANT AND EQUIPMENT
 
  Property, plant and equipment as of January 3, 1998 and December 28, 1996,
consist of the following:
 
<TABLE>
<CAPTION>
                                                               1997      1996
                                                             --------  --------
                                                              (IN THOUSANDS)
      <S>                                                    <C>       <C>
      Cost:
        Land................................................ $  9,288  $  9,272
        Buildings and land improvements.....................  111,031    84,089
        Machinery, equipment and other......................  527,257   365,464
        Construction in progress............................   50,228    12,915
                                                             --------  --------
                                                              697,804   471,740
      Less accumulated depreciation.........................  (91,544)  (65,213)
                                                             --------  --------
                                                             $606,260  $406,527
                                                             ========  ========
</TABLE>
 
  Depreciation charged to expense was $31.2, $27.2 and $21.0 million during
1997, 1996 and 1995, respectively.
 
                                      47
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 4. INTANGIBLES, LOAN ACQUISITION AND ORGANIZATION COSTS
 
  Intangibles, loan acquisition and organization costs as of January 3, 1998
and December 28, 1996, consist of the following:
 
<TABLE>
<CAPTION>
                                                                1997     1996
                                                              --------  -------
                                                               (IN THOUSANDS)
      <S>                                                     <C>       <C>
      Cost:
        Goodwill............................................. $187,026  $61,801
        Identified intangibles:
          Supply agreement...................................   13,431   13,431
          Proprietary technology.............................   24,100   24,100
          Other..............................................      997      902
        Loan acquisition costs...............................   19,063    8,302
        Organization costs...................................    8,741    6,752
                                                              --------  -------
                                                               253,358  115,288
      Less accumulated amortization..........................  (23,967) (18,356)
                                                              --------  -------
                                                              $229,391  $96,932
                                                              ========  =======
</TABLE>
 
  Amortization charged to expense was $9.2, $9.6 and $8.9 million during 1997,
1996 and 1995, respectively. The approximate $125.2 million increase in
goodwill between 1997 and 1996 results primarily from the acquisition of
Dominion.
 
NOTE 5. ACCRUED LIABILITIES
 
  Accrued liabilities as of January 3, 1998 and December 28, 1996, consist of
the following:
 
<TABLE>
<CAPTION>
                                                                 1997    1996
                                                                ------- -------
                                                                (IN THOUSANDS)
      <S>                                                       <C>     <C>
      Accrued liabilities:
        Interest payable....................................... $ 7,377 $ 6,778
        Salaries, wages and other fringe benefits..............  13,813   7,116
        Restructuring costs....................................   5,484  10,036
        Organization costs.....................................   7,422     --
        Other..................................................  18,037   9,200
                                                                ------- -------
                                                                $52,133 $33,130
                                                                ======= =======
</TABLE>
 
  During 1995, management of the Company 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
1997, 1996, and 1995, the Company charged $6.5, $3.5 and $2.4 million,
respectively, against the accrued restructuring reserve. Substantially all of
the charges against the reserve during 1997 related to the relocation of the
acquiree's corporate offices and certain equipment. Management estimates that
the remainder of the accrued restructuring reserve, $5.5 million, will be
incurred during 1998; therefore, this amount has been recognized as a current
liability in the consolidated balance sheet.
 
                                      48
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
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 $1.7, $2.4 and $2.3 million in 1997, 1996 and
1995, respectively. Rental income approximated $0.6, $2.2 and $2.3 million in
1997, 1996 and 1995, 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 3, 1998 are:
 
<TABLE>
<CAPTION>
                                                      GROSS                NET
                                                     MINIMUM  LEASE AND  MINIMUM
                                                      RENTAL  SUB-LEASE   RENTAL
                                                     PAYMENTS (INCOME)   PAYMENTS
                                                     -------- ---------  --------
                                                           (IN THOUSANDS)
      <S>                                            <C>      <C>        <C>
      1998.......................................... $ 4,595  $ (1,375)   $3,220
      1999..........................................   4,192    (1,275)    2,917
      2000..........................................   4,020    (1,275)    2,745
      2001..........................................   3,797    (1,275)    2,522
      2002..........................................   2,797    (1,275)    1,522
      Thereafter....................................   3,368   (12,219)   (8,851)
                                                     -------  --------    ------
                                                     $22,769  $(18,694)   $4,075
                                                     =======  ========    ======
</TABLE>
 
 Purchase Commitments
 
  At January 3, 1998, the Company had commitments of approximately $74.7,
$9.3, and $1.0 million related to the purchase of raw materials and converting
services, capital projects, and foreign currency, respectively.
 
 Collective Bargaining Agreements
 
  At January 3, 1998, the Company had a total of approximately 3,600 employees
worldwide. Of this total, approximately 1,600 employees are represented by
labor unions or trade councils that have entered into separate collective
bargaining agreements with the Company. Approximately 31% 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. 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
environmental requirements. The Company is also subject to laws, such as the
Federal Comprehensive Environmental Response, Compensation, and Liability Act
of 1980 ("CERCLA"), that may impose liability retroactively and without fault
for 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. As a result, the Company does not currently
anticipate any material adverse effect on its operations, financial condition
or competitive position as a
 
                                      49
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
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.
 
NOTE 7. DEBT
 
  Long-term debt as of January 3, 1998 and December 28, 1996, consists of the
following:
 
<TABLE>
<CAPTION>
                                                               1997      1996
                                                             --------  --------
                                                              (IN THOUSANDS)
<S>                                                          <C>       <C>
Senior Subordinated Notes, due July 2007, interest rate 9%.  $400,000  $    --
Senior Notes, due July 2002, interest rate 12.25%, repaid
 in full in 1997...........................................       --    100,000
Revolving Credit Facility, due July 2003, interest at rates
 ranging from 7.25% to 7.5%................................    61,569    80,894
Term Loans, Facility A, B and C; interest rate 7.25%,
 repaid in full in 1997....................................       --    199,189
DT USA Guaranteed Senior Notes, due April 2006, interest
 rate 9.25%, $124.5 million tendered in January 1998.......   128,052       --
DT USA Guaranteed Senior Note due November 2003, interest
 rate 8.875%, $145.6 million tendered in January 1998......   153,288       --
Other......................................................     8,460     2,159
                                                             --------  --------
                                                              751,369   382,242
Less: Unamortized discount on Senior Subordinated Notes....    (6,233)      --
                                                             --------  --------
                                                              745,136   382,242
Less: Current maturities...................................    (3,276)  (19,497)
                                                             --------  --------
Total......................................................  $741,860  $362,745
                                                             ========  ========
</TABLE>
 
  Long-term debt maturities consist of the following (in thousands):
 
<TABLE>
      <S>                                                                <C>
      1998.............................................................. $ 3,276
      1999..............................................................   2,181
      2000..............................................................   1,010
      2001..............................................................     735
      2002..............................................................     710
      Thereafter........................................................ 737,224
</TABLE>
 
 The June Refinancing
 
  On June 5, 1997, the Company commenced an offer (the "Tender Offer") to
purchase for cash its 12.25% Senior Notes due 2002 (the "Original Notes") and
solicited consents to certain proposed amendments which eliminated
substantially all of the protective covenants. Proceeds from the Privately
Place Notes (as defined below) were used to purchase the Original Notes at a
price equal to $1,103.64 for each Original Note. Holders who tendered in the
Tender Offer prior to the 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 July 3, 1997 the
Company received tenders of, and consents relating to, all of its Original
Notes.
 
  On July 3, 1997, the Company issued $400.0 million of 9% Senior Subordinated
Notes due 2007 (the "Privately Placed Notes") to qualified institutional
buyers pursuant to Rule 144A under the Securities Act. The Company
subsequently registered the Privately Placed Notes with the Securities
 
                                      50
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
Exchange Commission pursuant to a Registration Statement on Form S-4 declared
effective September 3, 1997. The Senior Subordinated Notes are unsecured and
are guaranteed by all of the Company's direct and indirect domestic
subsidiaries. The Senior Subordinated Notes are subject to redemption at any
time on or after July 1, 2002 at the option of the Company based on certain
redemption prices plus accrued interest. As of January 3, 1998, the Company
was in compliance with covenant provisions associated with the Senior
Subordinated Notes which include restrictions on the payment of dividends. If
a change of control occurs at any time, each holder shall have the right to
require that the Company purchase the Senior Subordinated Notes in whole or in
part at an amount equal to 101% of the principal amount held plus accrued
interest.
 
  As part of the June Refinancing, the Company amended its credit facilities.
The amended credit facility provides for secured revolving credit up to $325.0
million, and a portion of the borrowings may be denominated in Dutch guilders
and/or Canadian dollars at the request of the Company. The applicable interest
rates are as follows (plus a margin in each case depending upon certain
leverage ratios):
 
<TABLE>
      <S>                                                   <C>
      U.S. dollar-denominated loans                         LIBOR
      Canadian dollar-denominated loans                     Canadian base rate
      Dutch guilder-denominated loans                       Eurocurrency rate
</TABLE>
 
 
  All indebtedness under the amended credit facility is guaranteed by each of
the direct and indirect domestic subsidiaries of the Company and by Fabrene
Group, Inc., a wholly-owned Canadian subsidiary of the Company. The amended
credit facility is secured by substantially all of the assets of the Company
and pledges of stock and intercompany notes and certain of its subsidiaries.
The amended credit facility contains covenants customary for financings of
this type which the Company is in compliance with as of January 3, 1998.
Commitment fees on the amended credit facility are generally equal to a
percentage of the daily unused average amount of such commitment. At January
28, 1998, unused commitments under the amended credit facility approximated
$254.8 million. Loan acquisition costs, including commitment fees,
approximated $18.6 and 5.3 million in 1997 and 1996, respectively.
 
 DT USA Guaranteed Senior Notes
 
  During 1993, DT USA issued $150.0 million of 8.875% Guaranteed Senior Notes
due 2003 (the "2003 Notes") and during 1996, issued an additional $125.0
million of 9.25% Guaranteed Senior Notes due 2006 (the "2006 Notes"). Both the
2003 Notes and the 2006 Notes are senior indebtedness of DT USA and are
guaranteed by DT USA and Dominion.
 
  On December 23, 1997, following the initial purchase of Dominion shares by
DTA, DT USA made tender offers to purchase the outstanding 2003 Notes and 2006
Notes (the "2003 Tender Offer" and "2006 Tender Offer," respectively), and
solicited consents to certain proposed amendments to facilities which
eliminated substantially all of the protective covenants. The total
consideration paid was $1,065.32 and $1,138.50 for each 2003 Note and 2006
Note, respectively. 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
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,
 
                                      51
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
which require such an offer to be made within 30 days of a change in control
of DT USA or Dominion. The Change of Control Offer expired on March 17, 1998.
 
  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. DT USA intends to exercise its rights to
satisfy and discharge the 2003 Notes and the 2006 Notes at the permitted
times.
 
 Short-term Bridge Financing
 
  The Company received short-term bridge financing to consummate the
acquisition of Dominion as discussed in "Note 2. Acquisitions." Such
indebtedness was either repaid or canceled in January 1998 pursuant to the
disposition of the apparel business of Dominion to Galey. Short-term bridge
financing consisted of the following at January 3,1998 (in thousands):
 
<TABLE>
<S>                                                                    <C>
DTA Credit Facility, original maturity of June 1998, interest rate
 9.5%, repaid in full in January 1998................................. $215,945
Subordinated advance--ZB Holdings, interest rate 9.5%, repaid in full
 in January 1998......................................................   69,000
Subordinated advance--Galey, interest rate imputed at 9.5%, canceled
 in January 1998......................................................  141,000
                                                                       --------
                                                                       $425,945
                                                                       ========
</TABLE>
 
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):
 
 
                                      52
<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 cash
 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, loan
 acquisition and
 organization 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 liabilities 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>
 
 
                                       53
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
                     CONDENSED CONSOLIDATING BALANCE SHEET
                            AS OF DECEMBER 28, 1996
 
<TABLE>
<CAPTION>
                                         COMBINED
                            COMBINED       NON-
                           GUARANTOR    GUARANTOR     THE    RECLASSIFICATIONS
         ASSETS           SUBSIDIARIES SUBSIDIARIES COMPANY  AND ELIMINATIONS  CONSOLIDATED
         ------           ------------ ------------ -------- ----------------- ------------
<S>                       <C>          <C>          <C>      <C>               <C>
Cash and cash
 equivalents............   $   16,329    $ 18,254   $  3,004    $       --       $ 37,587
Marketable securities...          --          --      10,892            --         10,892
Accounts receivable,
 net....................       29,848      34,904        --             --         64,752
Inventories.............       34,088      21,595        --             (46)       55,637
Other...................       12,447       1,902      1,395           (185)       15,559
                           ----------    --------   --------    -----------      --------
    Total current
     assets.............       92,712      76,655     15,291           (231)      184,427
Due from affiliates.....      377,780         671     57,236       (435,687)          --
Investment in
 subsidiaries...........      250,589         --     389,769       (640,358)          --
Property, plant and
 equipment, net.........      266,446     137,942      2,139            --        406,527
Intangibles, loan
 acquisition and
 organization costs,
 net....................       36,743      57,027      1,218          1,944        96,932
Other...................        7,963       6,381      6,143           (258)       20,229
                           ----------    --------   --------    -----------      --------
    Total assets........   $1,032,233    $278,676   $471,796    $(1,074,590)     $708,115
                           ==========    ========   ========    ===========      ========
<CAPTION>
    LIABILITIES AND
  SHAREHOLDERS' EQUITY
  --------------------
<S>                       <C>          <C>          <C>      <C>               <C>
Accounts payable,
 accrued liabilities and
 other..................   $   43,546    $ 22,636   $  5,944    $      (350)     $ 71,776
Current portion of long-
 term debt..............       11,069       6,985      1,443            --         19,497
                           ----------    --------   --------    -----------      --------
    Total current
     liabilities........       54,615      29,621      7,387           (350)       91,273
Due to affiliates.......      301,447      38,450     95,790       (435,687)          --
Long-term debt, less
 current portion........      129,931      69,257    163,557            --        362,745
Deferred income taxes
 and other..............       18,765      31,110      9,144           (840)       58,179
Shareholders' equity....      527,475     110,238    195,918       (637,713)      195,918
                           ----------    --------   --------    -----------      --------
    Total liabilities
     and shareholders'
     equity.............   $1,032,233    $278,676   $471,796    $(1,074,590)     $708,115
                           ==========    ========   ========    ===========      ========
</TABLE>
 
 
                                       54
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
                CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
                   FOR THE FISCAL YEAR ENDED JANUARY 3, 1998
 
<TABLE>
<CAPTION>
                                        COMBINED
                           COMBINED       NON-              RECLASSIFICA-
                          GUARANTOR    GUARANTOR     THE      TIONS AND
                         SUBSIDIARIES SUBSIDIARIES COMPANY  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............       (785)       3,101    10,693         --         13,009
                           --------     --------   -------    --------      --------
    Income 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...........        --           --     15,031     (15,031)          --
                           --------     --------   -------    --------      --------
Net income (loss).......   $  8,651     $ 15,031   $ 6,777    $(15,031)     $ 15,428
                           ========     ========   =======    ========      ========
</TABLE>
 
                CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
                  FOR THE FISCAL YEAR ENDED DECEMBER 28, 1996
 
<TABLE>
<CAPTION>
                                         COMBINED
                            COMBINED       NON-               RECLASSIFICA-
                           GUARANTOR    GUARANTOR     THE       TIONS AND
                          SUBSIDIARIES SUBSIDIARIES COMPANY   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>
 
 
                                       55
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
                CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
                  FOR THE FISCAL YEAR ENDED DECEMBER 30, 1995
 
<TABLE>
<CAPTION>
                            COMBINED     COMBINED
                           GUARANTOR   NON-GUARANTOR   THE     RECLASSIFICATIONS
                          SUBSIDIARIES SUBSIDIARIES  COMPANY   AND ELIMINATIONS  CONSOLIDATED
                          ------------ ------------- --------  ----------------- ------------
<S>                       <C>          <C>           <C>       <C>               <C>
Net sales...............    $287,418     $154,025         --        $(3,805)       $437,638
Cost of goods sold......     230,740      106,670         --         (3,804)        333,606
                            --------     --------    --------       -------        --------
    Gross profit........      56,678       47,355         --             (1)        104,032
Selling, general and
 administrative
 expenses...............      38,502       23,242         --            --           61,744
                            --------     --------    --------       -------        --------
    Operating income....      18,176       24,113         --             (1)         42,288
Other expense, net......      15,733       44,671         275           --           60,679
                            --------     --------    --------       -------        --------
    Income (loss) before
     income taxes.......       2,443      (20,558)       (275)           (1)        (18,391)
Income taxes............         742        1,709       2,765           --            5,216
Equity in earnings
 (loss) of subsidiaries.         --           --      (20,567)       20,567             --
                            --------     --------    --------       -------        --------
Net income (loss).......       1,701      (22,267)    (23,607)       20,566         (23,607)
Redeemable preferred
 stock dividends and
 accretion..............      (4,839)         --       (4,839)        4,839          (4,839)
                            --------     --------    --------       -------        --------
(Loss) applicable to
 common stock...........    $ (3,138)    $(22,267)   $(28,446)      $25,405        $(28,446)
                            ========     ========    ========       =======        ========
</TABLE>
 
 
                                       56
<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      THE     RECLASSIFICATIONS
                         GUARANTOR  NON-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
  Business acquisitions,
   net..................      --      (424,645)     (4,914)           --        (429,559)
  Organization and other
   costs................      --        (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 provided by
 (used in) financing
 activities.............   (9,592)     427,615     (14,678)        82,608        485,953
Effect of exchange rate
 changes on cash........      --           --          189            --             189
                         --------     --------    --------      ---------       --------
Net increase (decrease)
 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>
 
 
 
                                       57
<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
                           GUARANTOR   NON-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...........         --           --      (22,879)           --         (22,879)
  Proceeds from sales of
   marketable
   securities...........         --           --       16,713            --          16,713
  Acquisition of
   businesses, net of
   cash acquired........         --           --      (52,466)           --         (52,466)
  Other costs...........        (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 and
   other costs..........      (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>
 
 
 
                                       58
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
                CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
                  FOR THE FISCAL YEAR ENDED DECEMBER 30, 1995
 
<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.............   $ 33,304     $(8,663)   $(34,302)      $21,217        $ 11,556
Investing activities
  Purchases of property,
   plant and equipment..    (17,951)    (29,891)        --            --          (47,842)
  Purchases of
   marketable
   securities...........        --          --      (22,521)          --          (22,521)
  Proceeds from sales of
   marketable
   securities...........        --          --       19,929           --           19,929
  Acquisition of
   businesses, net of
   cash acquired........        --          --     (281,358)          --         (281,358)
  Other costs...........     (1,416)        --         (399)          399          (1,416)
                           --------     -------    --------       -------        --------
Net cash (used in)
 investing activities...    (19,367)    (29,891)   (284,349)          399        (333,208)
Financing activities
  Issuance of common
   stock, net of costs
   incurred.............     30,000         --          --            --           30,000
  Proceeds from debt....    273,654         --          --            --          273,654
  Payments of debt......    (13,638)        --          --            --          (13,638)
  Issuance of redeemable
   preferred stock......     40,000         --          --            --           40,000
  Intercompany
   transactions, net....   (344,207)     44,046     321,777       (21,616)            --
  Loan acquisition and
   other costs..........     (1,263)        --       (1,117)          --           (2,380)
                           --------     -------    --------       -------        --------
Net cash (used in)
 provided by financing
 activities.............    (15,454)     44,046     320,660       (21,616)        327,636
Effect of exchange rate
 changes on cash........        --          --       (1,724)          --           (1,724)
                           --------     -------    --------       -------        --------
Net (decrease) increase
 in cash and
 equivalents............     (1,517)      5,492         285           --            4,260
Cash and equivalents at
 beginning of year......     10,112       3,715           1           --           13,828
                           --------     -------    --------       -------        --------
Cash and equivalents at
 end of year............   $  8,595     $ 9,207    $    286       $   --         $ 18,088
                           ========     =======    ========       =======        ========
</TABLE>
 
                                       59
<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
                                                      ------------------------
                                                       1997     1996     1995
                                                      -------  -------  ------
                                                          (IN THOUSANDS)
<S>                                                   <C>      <C>      <C>
Current:
  Federal and state.................................. $   315  $   --   $1,461
  Foreign............................................   6,709    2,899   5,130
Deferred:
  Federal and state..................................   7,108    8,324    (826)
  Foreign............................................  (1,123)    (493)   (549)
                                                      -------  -------  ------
Income tax before extraordinary item.................  13,009   10,730   5,216
Income tax benefit from:
  Extraordinary item, loss from early extinguishment
   of debt...........................................  (5,959)  (7,492)    --
                                                      -------  -------  ------
Total income tax expense............................. $ 7,050  $ 3,238  $5,216
                                                      =======  =======  ======
</TABLE>
 
                                       60
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The Company's provision for income taxes in 1997 includes the benefit of
utilizing net operating loss carryforwards of approximately $5.8 million. At
January 3, 1998, the Company had: (i) operating loss carryforwards of
approximately $16.8 million for federal income tax purposes expiring in the
years 2007-2012; (ii) Canadian capital loss carryforwards of approximately
$3.7 million and Canadian operating loss carryforwards of approximately $1.7
million which expire in 2005; and (iii) operating loss carryforwards of
approximately $8.0 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 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 3, 1998 and
December 28, 1996 are as follows:
 
<TABLE>
<CAPTION>
                                                              1997      1996
                                                            --------  --------
                                                             (IN THOUSANDS)
<S>                                                         <C>       <C>
Deferred tax assets:
  Provision for restructuring.............................. $    869  $  2,566
  U.S. net operating loss carryforward.....................    5,883    10,057
  Foreign net operating and capital loss carryforward......    3,603     6,821
  Foreign tax credits......................................    3,359     1,356
  Other....................................................    5,557     9,262
                                                            --------  --------
    Total deferred tax assets..............................   19,271    30,062
Valuation allowance for deferred tax assets................   (5,927)  (14,149)
                                                            --------  --------
Net deferred tax assets....................................   13,344    15,913
Deferred tax liabilities:
  Depreciation and amortization............................  (26,548)  (22,159)
  Basis difference on fixed assets.........................  (52,207)  (23,561)
  Provision for undistributed foreign earnings not
   considered to be retained indefinitely for reinvestment.      --     (3,301)
  Other, net...............................................   (3,742)   (4,485)
                                                            --------  --------
    Total deferred tax liabilities.........................  (82,497)  (53,506)
                                                            --------  --------
    Net deferred taxes..................................... $(69,153) $(37,593)
                                                            ========  ========
</TABLE>
 
  Taxes on income are based on earnings (loss) before taxes as follows:
 
<TABLE>
<CAPTION>
                                                             FISCAL YEAR
                                                       ------------------------
                                                        1997    1996     1995
                                                       ------- ------- --------
                                                            (IN THOUSANDS)
      <S>                                              <C>     <C>     <C>
      Domestic........................................ $18,688 $11,018 $  1,611
      Foreign.........................................  21,754  14,534  (20,002)
                                                       ------- ------- --------
                                                       $40,442 $25,552 $(18,391)
                                                       ======= ======= ========
</TABLE>
 
                                      61
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  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
                                                     ------------------------
                                                      1997     1996    1995
                                                     -------  ------  -------
                                                         (IN THOUSANDS)
      <S>                                            <C>      <C>     <C>
      Computed tax (benefit) expense at the
       statutory rate............................... $14,155  $8,943  $(6,437)
      Valuation allowance...........................  (2,387)    418    7,521
      Withholding taxes.............................     471     964    1,244
      Effect of foreign operations, net.............     314     347    2,375
      Other, net....................................     456      58      513
                                                     -------  ------  -------
      Provision for income taxes before
       extraordinary item...........................  13,009  10,730    5,216
      Income tax benefit related to extraordinary
       item.........................................  (5,959) (7,492)     --
                                                     -------  ------  -------
      Provision for income taxes.................... $ 7,050  $3,238  $ 5,216
                                                     =======  ======  =======
</TABLE>
 
                                       62
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
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
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 two year period ended
January 3, 1998:
 
<TABLE>
<CAPTION>
                                                                        WEIGHTED
                                                                        AVERAGE
                                                              NUMBER OF EXERCISE
                                                               SHARES    PRICE
                                                              --------- --------
      <S>                                                     <C>       <C>
      Unexercised options outstanding--December 30, 1995           --    $  --
        Granted..............................................  130,330    18.00
        Exercised............................................      --       --
        Forfeited............................................      --       --
        Expired/canceled.....................................      --       --
                                                               -------   ------
      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
                                                               =======   ======
      Exercisable options:
        December 30, 1995....................................      --       --
        December 28, 1996....................................      --       --
        January 3, 1998......................................  143,955   $14.90
      Shares available for future grant......................  780,225      --
</TABLE>
 
  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 of each option
grant was determined by using the Black-Scholes option-pricing model with the
following weighted average assumptions used for 1997 and 1996, respectively;
dividend yield of 0.0% both years; expected volatility of 0.56 and 0.55; risk-
free interest rate of 6.1% for both years and weighted average expected lives
of 5 years for both years. Had compensation cost
 
                                      63
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
for the Company's 1996 Plan been determined based on the fair value at the
grant date for such awards in 1997 and 1996 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.
 
<TABLE>
<CAPTION>
                                                                 FISCAL YEAR
                                                               ---------------
                                                                1997    1996
                                                               ------- -------
                                                               (IN THOUSANDS,
                                                                 EXCEPT PER
                                                                 SHARE DATA)
<S>                                                            <C>     <C>
Net income (loss) available to common shareholders--basic:
  As reported................................................. $15,428 $(2,130)
  Pro forma...................................................  15,075  (2,228)
Net income (loss) per common share--basic:
  As reported................................................. $   .48 $  (.08)
  Pro forma...................................................     .47    (.08)
Net income (loss) available to common shareholders--diluted:
  As reported................................................. $15,428 $(2,130)
  Pro forma...................................................  15,075  (2,228)
Net income (loss) per common share--diluted:
  As reported................................................. $   .48 $  (.08)
  Pro forma...................................................     .47    (.08)
Weighted average fair value of options granted under the 1996
 Plan......................................................... $  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 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. Pursuant to a recapitalization agreement, all of
the warrants to acquire shares of Class C common stock were exercised, and the
outstanding shares of Class A common stock, Class B common stock, and Class C
common stock were converted into shares of a single class of common stock. 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
 
                                      64
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
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 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. RETIREMENT PLANS
 
  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 $1.7, $1.7, and $1.6 million
for 1997, 1996 and 1995, respectively. In addition, the Company sponsors
defined benefit retirement plans covering employees at certain of its
subsidiaries. The annual service costs are determined on the basis of an
actuarial valuation by using the projected benefit method. Any realizable
surpluses are amortized on a straight-line basis over the expected average
remaining service lives of the employees in the plan. It is the Company's
policy to fund such plans in accordance with applicable laws and regulations.
At January 3, 1998, the pension plan assets were primarily invested in
separate funds whose values are subject to fluctuation in interest rates and
equity/bond securities markets.
 
  The Company also sponsors, through its Nonwovens Business, a Supplemental
Executive Retirement Plan ("SERP") which provides certain personnel with
supplemental benefits in addition to those available under the Company's
retirement plans. These supplemental retirement benefits are provided by a
nonqualified, noncontributory plan and are based on years of service and
compensation. Contributions are made based upon the estimated requirements of
the plan.
 
  The data presented in the following tables illustrate the funded status for
such plans as of the respective periods, components of pension expense and
assumptions used in accounting for the defined benefit retirement plans.
Information regarding the Company's defined benefit retirement plan for its
Mexican subsidiary is excluded from the following disclosures as such amounts
were not material during 1997, 1996 and 1995.
 
                                      65
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following table sets forth the funded status and amounts recognized in
the consolidated balance sheet as of January 3, 1998 and December 28, 1996:
 
<TABLE>
<CAPTION>
                                          1997                    1996
                                 ----------------------- -----------------------
                                                PLAN                    PLAN
                                 PLAN ASSETS LIABILITIES PLAN ASSETS LIABILITIES
                                 EXCEED PLAN EXCEED PLAN EXCEED PLAN EXCEED PLAN
                                 LIABILITIES   ASSETS    LIABILITIES   ASSETS
                                 ----------- ----------- ----------- -----------
                                                 (IN THOUSANDS)
<S>                              <C>         <C>         <C>         <C>
Accumulated benefit obligation:
  Vested.......................    $36,601     $  --       $21,368      $ 231
  Non-vested...................      1,122        --         1,172        181
                                   -------     ------      -------      -----
                                    37,723        --        22,540        412
Benefits attributable to future
 salaries......................      5,205        --         3,942        --
                                   -------     ------      -------      -----
Projected benefit obligation...     42,928        --        26,482        412
Plan assets at fair value......     57,683        --        34,036        175
                                   -------     ------      -------      -----
Excess (deficit) of plan assets
 over projected benefit
 obligation....................     14,755        --         7,554       (237)
Unrecognized transition net
 asset.........................       (169)       --          (360)       --
Unrecognized net (gain) loss...     (2,412)       --        (1,635)       --
                                   -------     ------      -------      -----
Prepaid pension cost (pension
 liability)....................    $12,174     $  --       $ 5,559      $(237)
                                   =======     ======      =======      =====
</TABLE>
 
  Pension expense included in the determination of net income for 1997, 1996
and 1995 is as follows:
 
<TABLE>
<CAPTION>
                                                            FISCAL YEAR
                                                      -------------------------
                                                       1997     1996     1995
                                                      -------  -------  -------
                                                          (IN THOUSANDS)
   <S>                                                <C>      <C>      <C>
   Current service costs............................. $ 1,566  $ 1,523  $ 1,286
   Interest costs on projected benefit obligation....   1,813    1,673    1,160
   Return on plan assets.............................  (2,659)  (2,158)  (1,400)
   Net amortization of transition obligation.........     (26)     (52)       5
                                                      -------  -------  -------
   Pension expense, net.............................. $   694  $   986  $ 1,051
                                                      =======  =======  =======
</TABLE>
 
  Significant assumptions used in accounting for the defined benefit
retirement plans are as follows:
 
<TABLE>
<CAPTION>
                                                         FISCAL YEAR
                                               -------------------------------
                                                  1997       1996      1995
                                               ---------- ---------- ---------
                                                       (IN THOUSANDS)
   <S>                                         <C>        <C>        <C>
   Return on plan assets:
     U.S. Plan................................  8.0%-9.0%       9.0%      9.0%
     Non U.S. Plans...........................  6.5%-8.5% 6.5%-13.0% 6.5%-8.0%
   Discount rate on projected benefit
    obligations:
     U.S. Plan................................ 7.5%-7.75%       7.5%      7.5%
     Non U.S. Plans...........................  6.0%-8.5%  6.0%-8.5% 6.0%-8.0%
   Salary and wage escalation rate:
     U.S. Plan................................  0.0%-5.0%        --        --
     Non U.S. Plans...........................  3.0%-6.5%  3.0%-4.0% 3.0%-4.0%
</TABLE>
 
                                      66
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 13. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
 
  The Company sponsors several defined benefit postretirement plans covering
certain employees. Accordingly, the Company follows provisions of Statement of
Financial Accounting Standards No. 106, "Employers Accounting for
Postretirement Benefits Other Than Pensions" ("FAS 106"). FAS 106 requires
that the accrual method of accounting for postretirement benefits other than
pensions be used and that the accrual period be based on the period that
employees render the services necessary to earn their postretirement benefits.
The Company currently anticipates funding the plans on a "pay-as-you-go"
basis. The weighted average discount rate used in the calculation of the
accumulated postretirement benefit obligation and the net postretirement
benefit cost for the plans was 6.5% and 7.5%, respectively. The assumed annual
composite rate of increase in the per capita cost of Company provided health
care benefits begins at 9.0% for 1996, gradually decreases to 6.0% by 1999 and
remains at that level thereafter. A 1% increase in these health care cost
trend rates would cause the accumulated obligation to increase by $0.5
million. The effect of such increase on the aggregate of the service and
interest components of the 1997 net postretirement benefit cost is not
significant. During 1997, the Company terminated a defined benefit plan which
was not replaced. The Company recorded approximately $1.7 million in net pre-
tax curtailment gains related to the termination of this plan. Net
postretirement benefit cost included in the determination of net income for
1997, 1996 and 1995 is included in the following table:
 
<TABLE>
<CAPTION>
                                                                  FISCAL YEAR
                                                                 --------------
                                                                 1997 1996 1995
                                                                 ---- ---- ----
                                                                 (IN THOUSANDS)
      <S>                                                        <C>  <C>  <C>
      Service cost--benefits earned during the period........... $107 $169 $109
      Interest costs on accumulated postretirement benefit
       obligation...............................................  203  238  174
                                                                 ---- ---- ----
      Net postretirement benefit cost........................... $310 $407 $283
                                                                 ==== ==== ====
</TABLE>
 
  The following table sets forth the funded status of the Company's obligation
under FAS 106 as of January 3, 1998 and December 28, 1996:
 
<TABLE>
<CAPTION>
                                                                   1997   1996
                                                                  ------ ------
                                                                       (IN
                                                                   THOUSANDS)
      <S>                                                         <C>    <C>
      Accumulated postretirement benefit obligation:
        Retirees................................................. $2,676 $  --
        Fully eligible active plan participants..................  1,054    885
        Other active plan participants...........................  1,831  3,016
                                                                  ------ ------
      Accrued postretirement benefit obligation.................. $5,561 $3,901
                                                                  ====== ======
</TABLE>
 
 
                                      67
<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 3, 1998
Net sales...............................  $128,947  $131,508  $129,711  $145,101
Gross Profit............................    32,585    34,716    31,196    34,712
Income (loss) before extraordinary item.     4,962     6,012     8,948     7,511
Extraordinary item......................       --        --    (12,005)      --
Net income (loss) attributable to common
 stock..................................     4,962     6,012    (3,057)    7,511
  Net income (loss) per common share:
  Basic:
    Income before extraordinary item....  $    .16  $    .19  $    .28  $    .23
    Extraordinary item..................       --        --       (.38)      --
                                          --------  --------  --------  --------
    Net income (loss) per common share--
     basic..............................  $    .16  $    .19  $   (.10) $    .23
                                          ========  ========  ========  ========
  Diluted:
    Income before extraordinary item....  $    .16  $    .19  $    .28  $    .23
    Extraordinary item..................       --        --       (.38)      --
                                          --------  --------  --------  --------
    Net income (loss) per common share--
     diluted............................  $    .16  $    .19  $   (.10) $    .23
                                          ========  ========  ========  ========
FISCAL YEAR ENDED DECEMBER 28, 1996
Net sales...............................  $122,715  $128,593  $135,042  $135,018
Gross profit............................    29,395    32,265    33,834    36,861
Income before extraordinary item........      (483)    2,598     5,531     7,176
Extraordinary item......................       --    (13,932)      --        --
Net income (loss).......................      (483)  (11,334)    5,531     7,176
Redeemable preferred stock dividends and
 accretion..............................    (2,104)     (916)      --        --
Net income (loss) attributable to common
 stock..................................    (2,587)  (12,250)    5,531     7,176
Net income (loss) per common share:
  Basic:
    Income (loss) before extraordinary
     item...............................  $   (.13) $    .06  $    .17  $    .22
    Extraordinary item..................       --       (.53)      --        --
                                          --------  --------  --------  --------
    Net income (loss) per common share--
     basic..............................  $   (.13) $   (.47) $    .17  $    .22
                                          ========  ========  ========  ========
  Diluted:
    Income (loss) before extraordinary
     item...............................  $   (.13) $    .06  $    .17  $    .22
    Extraordinary item..................       --       (.53)      --        --
                                          --------  --------  --------  --------
    Net income (loss) per common share--
     diluted............................  $   (.13) $   (.47) $    .17  $    .22
                                          ========  ========  ========  ========
</TABLE>
 
  During the third quarter of 1997 and second quarter of 1996 the Company
recorded an extraordinary item of $12.0 million (net of tax) and $13.9 million
(net of tax), respectively, for the write-off of previously capitalized debt
issue costs and prepayment premiums related to the refinancing of
indebtedness.
 
                                      68
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
NOTE 15. GEOGRAPHICAL INFORMATION
 
  Geographic data for the Company's operations are presented in the following
table. Intercompany sales and expenses are eliminated in determining results
for each operation. Export sales from the Company's United States operations
to unaffiliated customers approximated $83.0, $43.8, and 16.1 million during
1997, 1996 and 1995, respectively.
 
<TABLE>
<CAPTION>
                                                         FISCAL YEAR
                                                 -----------------------------
                                                    1997       1996     1995
                                                 ----------  -------- --------
                                                        (IN THOUSANDS)
<S>                                              <C>         <C>      <C>
Net sales to unaffiliated customers:
  United States................................. $  311,923  $312,000 $255,296
  Canada........................................     61,747    57,371   59,417
  Europe........................................    109,714   108,563   99,180
  Mexico........................................     51,883    43,434   23,745
                                                 ----------  -------- --------
    Total....................................... $  535,267  $521,368 $437,638
                                                 ==========  ======== ========
Income from operations:
  United States................................. $   34,399  $ 35,625 $ 16,918
  Canada........................................      7,105     9,045   13,485
  Europe........................................      3,327     7,350    4,994
  Mexico........................................     13,778    10,128    6,891
                                                 ----------  -------- --------
    Total.......................................     58,609    62,148   42,288
Other (income) expense, net:
  Interest expense, net.........................     30,499    33,641   37,868
  Investment income--(gain) on marketable
   securities, net..............................    (11,880)      --       --
  Foreign currency transaction (gains) losses,
   net..........................................       (452)    2,955   22,811
                                                 ----------  -------- --------
Income (loss) before income taxes and
 extraordinary item............................. $   40,442  $ 25,552 $(18,391)
                                                 ==========  ======== ========
Identifiable assets:
  United States................................. $  695,042  $388,240 $324,088
  Canada........................................    642,523    92,670   88,100
  Europe........................................    226,117   171,676  180,978
  Mexico........................................     64,071    55,529   44,815
                                                 ----------  -------- --------
    Total....................................... $1,627,753  $708,115 $637,981
                                                 ==========  ======== ========
</TABLE>
 
  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. The Company will adopt the new requirements retroactively in the
first quarter of 1998.
 
 
                                      69
<PAGE>
 
                              POLYMER GROUP, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
NOTE 16. CERTAIN MATTERS
 
  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, $2.1, and $2.3 million
in 1997, 1996, and 1995, respectively. On September 1, 1993, an affiliated
entity of the Company acquired a manufacturing facility in Vineland, New
Jersey for the benefit of a wholly-owned subsidiary of the Company and entered
into a lease of the facility to the subsidiary at a rate which the Company
believes is comparable to similar properties in the area. The lease terminates
on August 31, 2003 and is subject to a fair market value purchase option at
termination. Annual rental expense relating to this lease approximated $0.2
million in 1997, 1996 and 1995, respectively. 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.
 
NOTE 17. SUBSEQUENT EVENTS
 
  On January 29, 1998, the Company (i) acquired all remaining outstanding
shares of Dominion (as described in "Note 2. Acquisitions") and (ii) amended
its credit facility in connection with the acquisition of Dominion. This
amendment provides for a $125.0 million secured term loan and modification of
certain terms of the revolving portion of the credit facility. The Company
borrowed approximately $326.6 million under the amendment to finance the
Nonwovens Acquisition, for which it paid a gross price of approximately $351.6
million, including related fees and expenses. The Company also refinanced its
outstanding indebtedness under the DTA Credit Facility, repaid its
subordinated advance from ZB Holdings and repaid a substantial portion of the
DT USA Guaranteed Senior Notes with borrowings under this facility. Related to
the refinancing of this debt, the Company expects to incur an extraordinary
item for the write-off of loan acquisition costs associated with the DTA
Credit Facility during the first quarter of 1998.
 
  On March 5, 1998, the Company issued $200.0 million of 8.75% Senior
Subordinated Notes due 2008 (the "2008 Notes") to qualified buyers pursuant to
Rule 144A under the Securities Act. Proceeds from the sale of the 2008 Notes
were used to finance the Oriented Polymer Acquisition (as defined) and to
repay existing revolving obligations.
 
  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 $47.0 million.
 
                                      70
<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.
 
  During the two fiscal years prior to the Nonwovens Acquisition, there were
no disagreements with Deloitte & Touche on any matter of accounting principles
or practices, financial statement disclosure or auditing scope or procedure
nor did Deloitte & Touche's reports on the financial statements for such
period contain an adverse opinion or disclaimer of opinion, nor were such
reports qualified or modified as to uncertainty, audit scope or accounting.
 
  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.
 
                                      71
<PAGE>
 
                                   PART III
 
ITEM 10. MANAGEMENT
 
DIRECTORS AND EXECUTIVE OFFICERS
 
  Information regarding directors of the Company required by this Item is
incorporated by reference from the Notice of 1998 Annual Meeting of
Stockholders and Proxy Statement, to be filed with the Commission no later
than 120 days after the fiscal year end (the "Proxy Statement"), under the
caption "Election of Directors". The Company appointed a new officer of the
Company and restructured the responsibilities of certain other officers in
February 1998, following the fiscal year end. The information set forth below
regarding officers of the Company is as of March 1, 1998 and reflects the
current management structure of the Company.
 
<TABLE>
<CAPTION>
             NAME           AGE                    POSITION
             ----           ---                    --------
   <C>                      <C> <S>
   Jerry Zucker............  48 Chairman, President, Chief Executive Officer
                                 and Director
   James G. Boyd...........  53 Executive Vice President, Chief Financial
                                 Officer, Treasurer, Secretary and Director
   S. Grant Reeves.........  42 Vice President--Operational Analysis and Chief
                                 Operating Officer--Oriented Polymer Division
   Thomas E. Phillips......  48 Group Vice President--Sales (Americas),
                                 Finance, Information Technology and Human
                                 Resources, Nonwovens
   James L. Schaeffer......  47 Group Vice President--Operations and General
                                 Manager (Americas), Nonwovens
   Gregg Wilkinson.........  45 Group Vice President--Marketing and
                                 International Business Development, Nonwovens
   Richard L. Ferencz......  53 Group Vice President--Advanced Technology and
                                 Engineering, Nonwovens
   Peter C. Bourgeois......  54 Group Vice President and General Manager,
                                 Fabrene
   Bruce V. Rauner.........  42 Director
   David A. Donnini........  32 Director
   Michael J. McGovern.....  35 Director
   L. Glenn Orr, Jr. ......  57 Director
   John F. ("Jack") Ruffle.  61 Director
</TABLE>
 
  JERRY ZUCKER has served as Chairman, President, Chief Executive Officer and
a Director of the Company since its inception. In addition to his duties with
the Company, Mr. Zucker presently serves as Chairman and Chief Executive
Officer of InterTech, one of the Company's principal stockholders, and has
served in this capacity since 1983.
 
  JAMES G. BOYD has served as Executive Vice President, Chief Financial
Officer, Treasurer, Secretary and a Director of the Company since its
inception. In addition to his duties with the Company, Mr. Boyd serves as
Executive Vice President and Treasurer of InterTech, one of the Company's
principal shareholders, and has served in this capacity since 1986.
 
  S. GRANT REEVES has served as Vice President--Operational Analysis and Chief
Operating Officer--Oriented Polymers Division since February 1998. From June
1994 through February 1998, Mr. Reeves served as a Vice President of the
Company. Mr. Reeves joined lnterTech in 1986, where he served as controller of
Reemay, Inc., a former InterTech affiliate ("Reemay"), and served as General
Manager at Fabrene from 1991 through June 1994.
 
                                      72
<PAGE>
 
  THOMAS E. PHILLIPS has served as Group Vice President--Sales (Americas),
Finance, Information Technology and Human Resources, Nonwovens since February
1998. Mr. Phillips served as Group Vice President--Finance, Systems and
Administration, Nonwovens from March 1995 through February 1998. From 1993
until March 1995, Mr. Phillips served as General Manager and Vice President of
FiberTech. Prior to joining FiberTech, Mr. Phillips served as a Vice President
(1986-1992) and a Senior Vice President (1992-1993) of Reemay, where his
responsibilities included financial, systems, human resources and
administrative functions.
 
  JAMES L. SCHAEFFER has served as Group Vice President--Operations and
General Manager (Americas), Nonwovens since February 1998. Mr. Schaeffer
served as Group Vice President--Operations/Engineering, Nonwovens from March
1995 through February 1998. From 1992 until March 1995, Mr. Schaeffer served
as Vice President--Operations/Engineering of FiberTech. Prior to joining
FiberTech, Mr. Schaeffer served as General Manager for Scott Nonwovens at the
Landisville facility from 1990 to 1992.
 
  GREGG WILKINSON has served as Group Vice President--Marketing and
International Business Development, Nonwovens since February 1998. Mr.
Wilkinson served as Group Vice President--Marketing and Sales, Nonwovens from
March 1995 through February 1998. From July 1994 until March 1995, Mr.
Wilkinson served as Vice President--Marketing, Sales and Technology of
FiberTech and from August 1993 until July 1994, Mr. Wilkinson served as
Director--New Business Development. For the period 1987 to August 1993, Mr.
Wilkinson served in sales and marketing management capacities with Reemay.
 
  RICHARD L. FERENCZ has served as Group Vice President--Advanced Technology
and Engineering, Nonwovens since February 1998. From March 1996 to February
1998, Mr. Ferencz served as Vice President--Advanced Technology and
Engineering of the Company. From 1992 to 1996 Mr. Ferencz served as Vice
President of Engineering of the Company. Prior to joining the Company, Mr.
Ferencz served as Director of Systems of Reemay (1986-1992).
 
  PETER C. BOURGEOIS has served as Group Vice President and General Manager,
Fabrene since February 1998. Mr. Bourgeois served as Vice President, Wovens
from 1993 through February 1998. Mr. Bourgeois served as Vice President--
Marketing and Sales for Fabrene from June 1989 until 1993.
 
  The Board currently consists of seven directors, who are divided into three
classes as nearly equal number as possible, with Messrs. Boyd's and McGovern's
terms expiring in 1998, Messrs. Zucker's and Rauner's terms expiring in 1999,
and Messrs. Donnini's, Orr's and Ruffles's terms expiring in 2000. At each
annual meeting of stockholders, successors to the class of directors whose
term expires at such meeting will be elected to serve for three-year terms or
until their successors are duly elected and qualified. The Board has the power
to appoint the officers of the Company. Each officer will hold office for such
term as may be prescribed by the Board and until such person's successor is
chosen and qualified or until such person's death, resignation or removal.
 
  There are three Committees of the Board: the Compensation Committee, the
1996 Key Employee Stock Option Plan Committee (the "Stock Option Committee")
and the Audit Committee. The Compensation Committee, which is composed of
Messrs. Donnini and Rauner, reviews and makes recommendations to the Board
regarding salaries, compensation and benefits of executive officers and key
employees of the Company. The Stock Option Committee, which is composed of
Messrs. Donnini and Rauner, is empowered to grant options to purchase Common
Stock of the Company to any key employee in accordance with the 1996 Key
Employee Stock Option Plan. The Audit Committee is composed of Messrs.
McGovern, Donnini and Rauner. Among other duties, the Audit Committee reviews
the internal and external financial reporting of the Company, reviews the
scope of the independent audit, considers comments by the auditors regarding
internal controls and accounting procedures and provides the management's
response to the auditors' comments. The Company does not have a nominating
committee.
 
                                      73
<PAGE>
 
EMPLOYMENT AND MANAGEMENT AGREEMENTS
 
  Pursuant to management agreements originally entered into in October, 1992
(the "PGI Management Agreements"), Messrs. Zucker and Boyd (collectively, the
"Executives") have agreed to serve as President and Chief Executive Officer,
and Executive Vice President and Treasurer, respectively, of PGI Polymer.
Pursuant to management agreements entered into in March, 1995 (the "Chicopee
Management Agreements" and, together with the PGI Polymer Management
Agreements, the "Management Agreements"), the Executives have agreed to serve
in the same capacities for Chicopee. The Management Agreements provide that
the Executives' employment thereunder will continue until the Executive's
resignation, permanent disability, death or termination by PGI's or Chicopee's
Board of Directors, as the case may be.
 
  The PGI Management Agreements provide for an annual base salary of $250,000
to be paid to Mr. Zucker and an annual base salary of $150,000 to be paid to
Mr. Boyd, while the Chicopee Management Agreements provide for an annual base
salary of $400,000 to be paid to Mr. Zucker and an annual base salary of
$200,000 to be paid to Mr. Boyd, all of which amounts may be increased as
determined in good faith by the Board of Directors of PGI Polymer and
Chicopee, respectively. The Management Agreements also provide for a bonus to
be paid at the end of each fiscal year to each of the Executives in an amount
determined by PGI Polymer or Chicopee's Board of Directors, as the case may
be, but not to exceed such Executive's base salary.
 
  The Management Agreements provide that upon the termination of either
Executive's employment, such Executive is entitled to receive severance
payments equal to either one-half (in the case of death, disability,
resignation without good reason or termination for cause) or three times (in
all other cases) his annual salary.
 
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."
 
                                      74
<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
 
  On November 12, 1997, the Company filed a Form 8-K relative to DT
Acquisition's offer to purchase any and all outstanding shares of Dominion
Textile Inc.
 
  On February 13, 1998, the Company filed a Form 8-K relative to its
consummation of the acquisition of the Nonwovens Business of Dominion Textile
Inc.
 
                                      75
<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 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
YEAR ENDED DECEMBER 30,
 1995
Allowance for doubtful
 accounts.................   $   496    5,788       674(2)   5,073(1)   $ 1,885
Valuation allowance for
 deferred tax assets......   $10,198    1,594       --         --       $11,792
Restructuring costs.......   $   --       --     17,859(2)   2,406(3)   $15,453
</TABLE>
--------
(1) Uncollectible accounts written off and price concessions.
(2) Reserve established as part of business acquisition.
(3) Charges to reserve.
 
                                       76
<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.
 
                                                   /s/ Jerry Zucker
                                          By: _________________________________
                                                       Jerry Zucker
                                               Chairman, President andChief
                                                     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
               James G. Boyd                  (principal 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/ John F. Ruffle                Director
___________________________________________
              John F. Ruffle
 
</TABLE>
<PAGE>
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
                                                                     SEQUENTIAL
  EXHIBIT                                                               PAGE
  NUMBER                     DOCUMENT DESCRIPTION                      NUMBER
  -------                    --------------------                    ----------
 <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.
 2.3       Operating Agreement, dated December 19, 1997, among
           Polymer Group, Inc., Galey & Lord, Inc. and DT Acquisi-
           tion 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 Octo-
           ber 29, 1997.
 2.5       Notice of Extension and Variation by DT Acquisition
           Inc. in respect of its Offers to Purchase, dated Novem-
           ber 18, 1997.
 2.6       Notice of Extension by DT Acquisition Inc. in respect
           of its Offers to Purchase, dated December 2, 1997.
 2.7       Notice of Extension and Variation by DT Acquisition
           Inc. in respect of its Offers to Purchase, dated Decem-
           ber 8, 1997.
 2.8       Notice of Extension by DT Acquisition Inc. in respect
           of its Offers to Purchase, dated December 17, 1997.
 2.9       Letter Agreement between DTA, PGI and DTI dated Novem-
           ber 16, 1997.
 2.10      Notice of Redemption pursuant to the provisions of Sec-
           tion 206 of the Canada Business Corporations Act in re-
           gard to holders of Common Shares of Dominion Textile
           Inc., dated December 30, 1997.
 2.11      Notice of Redemption pursuant to the provisions of Sec-
           tion 206 of the Canada Business Corporations Act in re-
           gard to holders of First Preferred Shares of Dominion
           Textile Inc., dated December 30, 1997.
 2.12      Notice of Redemption in regard to holders of Second
           Preferred Shares, Series D of Dominion Textile Inc.,
           dated December 23, 1997.
 2.13      Notice of Redemption in regard to holders of Second
           Preferred Shares, Series E of Dominion Textile Inc.,
           dated December 23, 1997.
 2.14      Indenture, winding up Dominion Textile Inc. pursuant to
           the Canada Business Corporations Act, dated January 29,
           1998.
 2.15      Master Separation Agreement, among Polymer Group, Inc.,
           Galey & Lord, Inc. and DT Acquisition Inc., dated Janu-
           ary 29, 1998.(1)*
 3.1(i)    Form of Amended and Restated Certificate of Incorpora-
           tion of the Company.(2)
 3.1(ii)   Certificate of Designation of the Company.(3)
 3.2       Amended and Restated By-laws of the Company.(2)
 4.1       Indenture, dated as of July 1, 1997, among Polymer
           Group, Inc., the Guarantors named therein and Harris
           Trust and Savings Bank, as trustee.(3)
 4.2       Forms of Series A and Series B 9% Senior Subordinated
           Notes due 2007 (contained in Exhibit 4.1 as Exhibit A
           and B thereto, respectively).(3)
 4.3       Form of Guarantee (contained in Exhibit 4.2).(3)
</TABLE>
 
<PAGE>
 
<TABLE>
<CAPTION>
                                                                     SEQUENTIAL
  EXHIBIT                                                               PAGE
  NUMBER                     DOCUMENT DESCRIPTION                      NUMBER
  -------                    --------------------                    ----------
 <C>       <S>                                                       <C>
  4.4      Registration Rights Agreement dated as of July 3, 1997
           among Polymer Group, Inc., the Guarantors named therein
           and Chase Securities Inc.(3)
  4.5      First Supplemental Indenture, dated October 27, 1997,
           between Polymer Group Inc., Harris Trust and Savings
           Bank and Loretex Corporation.
  4.6      Second Supplemental Indenture, dated January 29, 1998,
           between Polymer Group Inc., Harris Trust and Savings
           Bank, DomTex Industries Inc. and Poly-Bond Inc.
  4.7      Amended and Restated 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.(3)
           The Registrant will furnish to the Commission, upon re-
           quest, each instrument defining the rights of holders
           of long-term debt of the Registrant and its subsidiar-
           ies 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.
  9        Voting Agreement, dated May 15, 1996, among the Compa-
           ny, GTC Fund III, Zucker, Boyd, InterTech, FTG, CMIHI
           and Leeway.(4)
 11        Statement of Computation of Per Share Earnings.
 16        Letter of Deloitte & Touche regarding a change in cer-
           tified accountants.
 21        Subsidiaries of the Company.
 23        Consent of Ernst & Young LLP.
 27        Financial Data Schedule.
 99.1      Offer to Purchase and Consent Solicitation Statement
           dated June 5, 1997 to any and all holders of the 12
           1/4% Senior Notes due 2002, relating to the Senior
           Notes Tender Offer and Consent Solicitation.(3)
 99.2      Form of Letter of Transmittal relating to the Senior
           Notes Tender Offer and Consent Solicitation.(3)
 99.3      Form of Notice of Guaranteed Delivery relating to the
           Senior Notes Tender Offer and Consent Solicitation.(3)
 99.4      Form of Letter of Transmittal relating to the Exchange
           Offer.(3)
 99.5      Form of Notice of Guaranteed Delivery relating to the
           Exchange Offer.(3)
 99.6      Form of Tender Instructions relating to the Exchange
           Offer.(3)
 99.7      Offer to Purchase and Consent Solicitation Statement,
           dated December 23, 1997, to any and all holders of Do-
           minion Textile Inc. 8 7/8% Senior Notes due 2003, re-
           lating to the 2003 Tender Offer.
 99.8      Form of Consent and Letter of Transmittal relating to
           the 2003 Tender Offer.
 99.9      Form of Notice of Guaranteed Delivery relating to the
           2003 Tender Offer.
 99.10     Offer to Purchase and Consent Solicitation Statement,
           dated December 23, 1997, to any and all holders of Do-
           minion Textile Inc. 9 1/4% Senior Notes due 2006, re-
           lating to the 2006 Tender Offer.
 99.11     Form of Consent and Letter of Transmittal relating to
           the 2006 Tender Offer.
 99.12     Form of Notice of Guaranteed Delivery relating to the
           2006 Tender Offer.
</TABLE>
<PAGE>
 
--------
  *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
     Registration Statement on Form S-1 (Reg. No. 333-2424).
 (3) Incorporated by reference to the respective exhibit to the Company's
     Registration Statement on Form S-4 (Reg. No. 333-32605).
 (4) Incorporated by reference to the respective exhibit to the Company's
     Form 10-Q, dated August 13, 1996, for the fiscal quarter ended June 29,
     1996, as amended.