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FORM 10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Commission File Number 1-3634

CONE MILLS CORPORATION

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

336-379-6220

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

NONE

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes      X         No            

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes               No      X    

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

Aggregate market value of voting stock held by nonaffiliates of the registrant as of June 30, 2002, Cone’s most recently completed second fiscal quarter, (based on the closing sale price of $2.68 of the registrant’s voting stock, as reported on the New York Stock Exchange Composite Tape on such date) was approximately: $66,342,467.

Number of shares of common stock outstanding as of March 7, 2003: 25,757,544 shares.

FORWARD-LOOKING STATEMENTS AND RISK FACTORS

Except for the historical information presented, the matters disclosed in the following discussion and analysis and other parts of this report, as well as oral statements made from time to time by representatives of Cone, include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933. These statements represent Cone’s current judgment on the future and are subject to risks and uncertainties that could cause actual results to differ materially. These forward-looking statements include statements relating to our anticipated financial performance and business prospects. Statements preceded by, followed by or that include words such as “believe,” “anticipate,” “estimate,” “expect,” “could,” and other similar expressions are to be considered such forward-looking statements. These forward-looking statements speak only as of the date stated and we do not undertake any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, even if experience or future events make it clear that any expected results expressed or implied by these forward-looking statements will not be realized. Although we believe that the expectations reflected in these forward-looking statements are reasonable, these expectations may not prove to be correct or we may not achieve the financial results, savings or other benefits anticipated in the forward-looking statements. These forward-looking statements are necessarily estimates reflecting the best judgment of our senior management and involve a number of risks and uncertainties, some of which may be beyond our control, that could cause actual results to differ materially from those suggested by the forward-looking statements. Such factors include, without limitation:

For a further description of these risks see “Item 1. Business — Competition, — Raw Materials and   — Customers” and “Item 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition — Overview” contained in this Form 10-K. Other risks and uncertainties may be described from time to time in Cone’s other reports and filings with the Securities and Exchange Commission.

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PART I

Founded in 1891 Cone Mills Corporation (“Cone”), incorporated and headquartered in North Carolina, operates in three principal business segments: (1) Denim, (2) Commission Finishing and (3) Decorative Fabrics. Cone believes it is the world’s largest producer of denim fabrics, one of the largest commission printers and finishers of home furnishings in North America and a major producer of decorative wide jacquard fabrics in the United States. Cone competes domestically and internationally on the basis of styling and product development, management experience, versatility and size of manufacturing facilities, competitive prices and the Cone name and reputation.

Cone is engaged in denim production in Mexico through Parras Cone de Mexico, S.A. de C.V. (“Parras Cone”), a joint venture facility with Compañia Industrial de Parras, S.A. de C.V. (“CIPSA”). This facility, Parras Cone, has been producing basic denims and yarn since late 1995. Under a marketing agreement with CIPSA, Cone markets and distributes 100% of the denim production of Parras Cone. Parras Cone’s production capacity was expanded by approximately 9% in 2002 with internally generated funds. The joint venture partners have agreed to an additional 25% expansion. The additional expansion would be financed by internally generated cash flow and debt of Parras Cone. The debt would be nonrecourse to the joint venture partners. Debt financing for the expansion has not been obtained and there can be no assurance that such financing will be available on acceptable terms and conditions.

Cone’s stated strategy has been to grow its denim business by expanding its production capacity in Mexico. Cone has jointly developed the industrial infrastructure to support a denim facility on our site in Altamira, Tamaulipas, Mexico. We believe that the initial denim facility can be completed for a capital investment of less than $70 million. The capital cost for such a facility may be reduced by configuration decisions and the availability of used equipment. As an alternative to building a denim plant on its site in Altamira, Cone is also exploring other opportunities to expand or acquire low-cost denim manufacturing capabilities. The funds required for the Mexico denim expansion will require debt or equity financing and certain modifications to current debt agreements.

On January 16, 2003, Cone entered into a letter of intent with WLR Recovery Fund II, L.P. (“WLR”), a fund managed by W.L. Ross and Company, in which WLR would purchase up to $27 million of convertible notes to support a recapitalization of Cone’s balance sheet. The convertible notes would first be offered to common stockholders. Proceeds realized from the issuance of the convertible notes and modifications of existing lending agreements as part of the recapitalization plan along with anticipated lease financing is expected to provide the funds necessary for Cone to execute its Mexican expansion strategy. The recapitalization plan is subject to a number of contingencies and conditions. See Item 7, Management’s Discussion and Analysis of Results of Operations and Financial Condition.

During 2002, Cone completed the formation of a joint venture in Turkey with Isko, a Turkish denim company. Cone and Isko established a joint venture company, IsKone, (owned 51% by Cone) to sell denim fabrics to Levi Strauss Europe for Levi’s^® jeans. The denim fabrics will be marketed by Cone to Levi Strauss Europe and produced by Isko. The joint venture with Isko was formed to provide denim fabrics for Levi’s^® 501^® jeans in Europe on a tariff friendly basis. The joint venture company, IsKone, began regular commercial operations in the first quarter of 2003.

Cone’s strategy in its home furnishings businesses, Carlisle Finishing and Cone Jacquards, is to concentrate on product development, customer service and quick response to support the fashion focused home furnishings business.

Cone’s stated strategy is to compete only in businesses in which it believes it is a leader and that are competitive in its primary markets. As a part of the process of strategically focusing on these criteria, over the past three years Cone has implemented several reorganization and downsizing initiatives, which resulted in the closing of three manufacturing facilities and in the elimination of over 2,900 jobs.

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Business Segments

Information concerning operating segments for Cone’s 2002, 2001 and 2000 fiscal years are incorporated by reference to Item 7, Management’s Discussion and Analysis of Results of Operations and Financial Condition, Long-Term Strategic Initiatives, and Notes 18 and 22 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report.

Denim

The denim segment represents Cone’s largest segment. We believe that Cone is the world’s largest producer of denim. The vision for Cone Denim is to grow into the most respected provider of denims and associated services to all of our targeted customers. Our preeminence in the Americas will be based upon our constantly broadening expertise creating unmatched value for our customers in the jeanswear production, merchandising and retailing communities.

Cone’s denim fabrics are used primarily in denim bottoms, such as jeans, pants or shorts. Our denim fabrics are primarily designed for customers whose garments are targeted for the middle and upper-middle markets, where styling and quality are important factors. Our customers have traditionally distributed these garments through specialty stores, department stores and national chains.

Cone identifies its denim as “value-added” and “basic.” Sales of value-added denims accounted for approximately two-thirds of Cone’s total denim sales in both 2002 and 2001. Cone places an emphasis on new product development working with our customers to design 150 to 200 new styles of denim each year. Fabric construction, yarn variations, including raw material components, fabric finishes and physical appearance after garment finishing are some of the elements of new product development. Our product development specialists generally work in collaboration with our customers to assure that the fabrics have the proper aesthetics and can be managed efficiently. This collaborative process to product development allows Cone to quickly identify rapidly changing needs.

Cone also sells high-quality basic denim, primarily produced at Parras Cone. These denims are targeted for brand name jeanswear customers where quality and service are important factors. These branded jeans are distributed through the mass-market distribution channel as well as the channels of distribution for Cone’s value-added products. The mass-market channel is the largest and fastest growing retail channel in the United States for denim jeans.

Cone’s largest denim customer is Levi Strauss. Other customers include Gap Inc. (The Gap, Old Navy and Banana Republic), V.F. Corporation (Wrangler, Lee, and others), American Eagle Outfitters, Calvin Klein, the Limited brands (Express, Structure and Victoria’s Secret), Abercrombie & Fitch, Polo Ralph Lauren and JC Penney (Arizona).

Manufacturing.    Cone’s denim facilities are modern and flexible and encompass substantially all manufacturing processes necessary to convert raw fiber or yarn into finished fabrics. Cone’s U.S. dyeing and finishing facilities include a wide range of technologies, with seven indigo long-chain dyeing machines, beam dyeing, continuous overdye machinery and raw cotton dyeing equipment. All of Cone’s U.S. denim weaving facilities were re-loomed in the late 1990s. In order to reduce operating costs and conserve capital that would have been required for equipment modernization, Cone has been outsourcing a significant portion of its yarn production since early 1999. Additionally, in 2001 Cone reconfigured its U.S. denim operations, which reduced costs and U.S. manufacturing capacity.

In addition to its U.S. facilities, Cone has a 50% equity interest in Parras Cone, a low-cost producer of high-quality basic denims located in Mexico. Under a marketing agreement with its partner, Cone markets and distributes 100% of the fabric production of Parras Cone. In 2002, the productive capacity of Parras Cone was expanded by approximately 9%. The joint venture partners plan to expand the productive capacity of Parras Cone by an additional 25% in the future. This expansion will make Parras Cone even more efficient and allow expanded relationships with key customers.

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Denim product and process development is supported by manufacturing development groups, which have specialists located in each facility. These groups work with Cone’s product development specialists and its customers’ designers to produce new products for the marketplace. Cone uses on-line computer-aided design systems to increase styling effectiveness.

Competition.    The denim business is highly competitive. Primary competitive factors include price, product styling and differentiation, customer service, quality and flexibility, with the significance of each factor dependent upon the particular needs of the customer and the product involved.

No single company dominates the United States denim industry. Imports of foreign-made apparel products are a significant source of competition for most sectors of the domestic textile industry. Domestic and foreign competitors range from large integrated enterprises to small niche companies. Competition is in the form of both domestic and foreign piece goods and imported apparel garments from Mexico, Asia and other areas. The migration of garment manufacturing facilities to Mexico and Caribbean countries, the continued growth of finished garment imports from Asia, the strength of the U.S. dollar vis-à-vis Asian currencies and the proliferation of newly styled fabrics competing for fashion acceptance have been factors affecting Cone’s business environment. Cone believes that the financial instability of certain of its domestic competitors is enhancing Cone’s image as an industry leader. Cone’s competitiveness with producers from other countries is influenced by tariffs, transportation costs, the efficiency of the North American supply chain in delivering garments to retailers, the relative value of the U.S. dollar and any foreign subsidies. Any failure of Cone or its supply chain to compete effectively in this environment or to keep pace with changing markets could have a material adverse effect on Cone’s results of operations and financial position.

In recent years, as a result of the competitiveness of the apparel business and the importance of low wage costs for garment producers, Cone has explored a number of international initiatives. Its objectives for expansion into Mexico include seeking access to the Mexican distribution system to sell Cone’s products, as well as access to lower cost cut-and-sew facilities in order to increase market share with private label customers and large branded customers migrating to Mexico. Cone is also seeking to gain production cost advantages while benefiting from its technological expertise. In recent years, jeans producers have migrated much of their garment production sourcing from the United States to Mexico, Central America and the Caribbean. For jeans producers located in Mexico, Cone has benefited from Parras Cone’s cost structure and location, as well as Cone’s U.S. marketing and support infrastructure. Cone’s domestic facilities have benefited from the increase in jeans production in Mexico, Central America and the Caribbean as countries in these regions, with their lower wage rates and favorable trade access to the United States, have maintained competitiveness with garments produced in Asia.

Growth of imported denim bottoms has been rising since the beginning of 1998 with most of the growth coming from Mexico. On an aggregated basis, imports of denim jeans (including denim jeans, shorts and pants) and fabric grew at a rate of approximately 16% in 2002. Mexico and countries under the Caribbean Basin Initiative trade agreement accounted for approximately 60% of the imported denim jeans and fabric into the United States in 2002. The Far East, at approximately 24% of total denim jeans and fabric imports, is another important player. For 2002, the Far East accounted for approximately 40% of the increase in imports of denim jeans and fabric while Mexico and CBI region countries were responsible for approximately 30% of the growth.

Seasonality.    Demand for Cone’s denim and the level of Cone’s sales have become more seasonal in recent years as its customers have come to rely more upon contract sewing and have sought to compress the supply cycle. The strongest part of our denim sales cycle is from March through November as our customers target goods to be sold at retail for the spring, back-to-school and holiday seasons. Cone’s sales are typically four to six months in advance of the retail sale of the denim garment.

Marketing and Sales.    Cone’s marketing focus is the development of strategic relationships with key players in the U.S. Jeanswear supply chain. Styles of Cone’s denim fabrics vary in color, finish, weight and construction, depending upon fashion trends and the needs of the specific customer. Cone’s product development specialists monitor fashion trends throughout the U.S., Europe, Far East and South America, attend fashion and trade shows, meet with garment manufacturers and retailers and conduct market research.

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The denim marketing group is headquartered in Greensboro, North Carolina with sales offices in New York, San Francisco, Los Angeles, Dallas and Brussels to provide a more direct working relationship with the customer. In addition, Cone has sales agents in Europe and Asia. The marketing group maintains support services in trade financing, traffic and transportation in order to support an international presence.

Cone’s denim exports were approximately $171 million, $174 million, and $185 million in 2002, 2001 and 2000, respectively.

Raw Materials.    Cotton is the primary raw material for Cone’s fabric manufacturing operations, its purchased yarn and greige goods (fabrics that have not been dyed or finished). United States agricultural programs affect the cost and supply of cotton in the U.S., and the policies of foreign governments have an effect on worldwide prices and supplies as well. The U.S. Department of Agriculture provides several programs to keep the effective price to cotton purchasers competitive with world levels while protecting the grower. Step 2 of the Federal Agriculture Improvement and Reform Act provided a formula for payments to users of domestically produced cotton when domestic cotton prices exceeded adjusted world prices for a period of time. Funds for these payments were depleted in December 1998. The Step 2 program received additional funding in October 1999. Cone received Step 2 equalization payments during 2002 and 2001. Cone will be eligible for equalization payments in 2003. Although management believes that U.S. companies will continue to be able to acquire adequate cotton supplies at prices competitive with offshore manufacturers, there can be no assurance that these results will always occur. To the extent that effective U.S. cotton prices exceed world prices, Cone’s competitiveness may be materially adversely affected, as Cone cannot always fully pass increased cotton costs on to its customers. See Item 7, Management’s Discussion and Analysis of Results of Operations and Financial Condition, contained in this Form 10-K annual report.

Since cotton is an agricultural product, its supply and quality are subject to the forces of nature. Although Cone has always been able to acquire sufficient supplies of cotton for its operations in the past, any shortage in the cotton supply by reason of weather, disease or other factors could materially adversely affect Cone’s operations. See Item 7, Management’s Discussion and Analysis of Results of Operations and Financial Condition, contained in this Form 10-K annual report.

Cone has an established cotton purchasing program, administered in conformity with policies approved by its Board of Directors, to ensure an uninterrupted supply of appropriate quality and quantities of cotton, to cover committed and anticipated fabric sales and to manage margin risks associated with price fluctuations on anticipated cotton purchases. Cone primarily uses forward purchase contracts and, to a lesser extent, futures and options contracts. Management believes that its cotton purchasing program has resulted in lower overall cotton prices than if cotton were purchased solely on a spot market basis or by solely matching cotton purchases with product sales. Since prices for forward purchase contracts are sometimes fixed in advance of shipment, Cone may benefit from its fixed-price purchases of cotton if prices thereafter rise, or fail to benefit if prices subsequently fall. There can be no assurance the forward purchase contracts and hedging transactions will not result in higher cotton costs to Cone or will protect Cone from price fluctuations.

Cone also purchases yarn, greige goods and dyes and chemicals. Based on Cone’s strategy to limit its investment in yarn manufacturing in the future, it has formed alliances and, in some cases, entered into supply contracts with yarn manufacturers to help ensure adequate supplies at competitive prices. Pursuant to its decision to outsource an increased portion of its yarn manufacturing, Cone entered into a supply agreement with Parkdale America, LLC, during 1999, which expires in 2007. Additional yarn and other materials used by Cone have normally been available in adequate supplies through a number of suppliers.

Commission Finishing

The commission finishing segment provides custom printing and plain-shade dyeing services. Commission printers and dyers process fabrics owned by various customers on a contract fee basis. The customers, primarily referred to in the trade as converters, purchase base fabrics from weaving mills and use either internal or external design staffs to create patterns or color direction. The application of design, color, hand, and finish are the key value adding components of a successful commission printer or dyer.

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Carlisle Finishing.    The Carlisle plant is a modern, highly complex facility comprised of over one million square feet with expertise in rotary screen printing. In recent years, Cone has invested heavily in computerized color-mixing systems, automated process controls, and communication systems using the Internet to support the competitive strategy of focused attention on quality and service.

Markets served by the Carlisle plant are home decorative, specialty apparel and craft fabrics, and plain shade apparel. Cone believes that Carlisle is one of the largest commission printers of home decorative fabrics in the U.S. Key customers in this segment are the Waverly Division of F. Schumacher, P. Kaufmann, Inc. and Covington Fabrics. Key markets for specialty printed products are associated with over-the-counter craft and home sewing, camouflage fabrics for the hunting trade and military apparel, and baby products. Key customers for this segment include Springs Industries and Schott International.

Consumer fashion preference heavily influences the market direction of each of these product groups. Contributing factors to fashion include coloration, texture, and design appeal. In recent years, home furnishings print demand has been affected adversely by alternative products, such as yarn-dyed jacquard fabrics and leather products.

In 1999, Cone restructured the Carlisle operation to reduce cost, improve quality and more aggressively position itself in the market place. These efforts have been successful in returning the operation to profitability. Market competitive forces resulted in the closing of several competitors in 2000, including Carlisle’s largest home decorative competitor. These closings significantly reduced the available number of domestic printers, which Cone believes have benefited Carlisle Finishing.

Raytex Finishing.    In December 2000, Cone announced its intent to cease operations at the Raytex wide print plant and exit those markets. The closing of the Raytex plant was completed in the first quarter of 2001. The first quarter 2001 results were affected negatively by operating inefficiencies associated with closing the Raytex plant.

Decorative Fabrics

The decorative fabrics segment consists of the Cone Jacquards operation. Cone Jacquards focuses on the design, styling and manufacturing of jacquard products primarily for the furniture, top-of-the-bed, outdoor and jobber markets. Customers work side-by-side with Cone professionals on CAD/CAM machines to design and revise fabric specifications, which are then sent electronically to the weaving machines for production.

The manufacturing facility, built in 1995, is a state-of-the-art weaving platform with a mix of wide and narrow weaving equipment. Yarn is procured from multiple sources. Woven fabric, if necessary, is finished at outside finishers. Cone Jacquard’s manufacturing configuration gives it a high degree of flexibility to match production with customer demand.

Fabrics are produced for furniture manufacturers, distributors, specialty product manufacturers, jobbers and retailers. Cone Jacquard fabrics are marketed domestically and internationally, primarily through dedicated sales agents.

In the third quarter of 2001, Cone sold substantially all of the assets, with the exception of outstanding accounts receivable, of the John Wolf converted fabrics business, a component of its decorative fabrics segment, to an unrelated third party and exited the decorative fabrics converting business.

Competition.    The decorative fabrics business is highly competitive and Cone Jacquards competes primarily on the basis of product styling, quality, sales initiative and service. Cone Jacquards competes with a large number of domestic and foreign suppliers.

Seasonality.    Demand for Cone’s jacquards fabrics and the level of Cone’s sales fluctuate moderately during the year with January being a seasonally slow period.

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Other Segment

The “Other” segment consists of miscellaneous ancillary operations.

Trade

The North American Free Trade Agreement (“NAFTA”) created a free-trade zone among Canada, Mexico and the U.S., and phased out all trade restrictions and tariffs on textiles and apparel that meet certain origin criteria among the three countries. NAFTA has been responsible in part for Mexico competing with China as the largest exporter of apparel to the U.S. NAFTA and the Caribbean Basin Initiative program, through favored quota and tariff treatment, have accelerated the shift in production of garments to sources in the western hemisphere, indirectly benefiting U.S. textile producers and Cone. Cone’s Mexican joint venture, Parras Cone, benefits from its access to U.S. markets and has benefited from NAFTA.

The Trade and Development Act of 2000 granted trade benefits to the countries in the Caribbean for certain textile and apparel products. This trade legislation established the Caribbean Basin Initiative (“CBI”) program to allow these countries to cut and sew garments made of United States woven fabric on a duty-free basis. The provisions of the legislation affecting the countries in the Caribbean have resulted in increased shipments of Cone fabric to the area for garment production. This legislation also increased the trade benefits available to the countries in Sub-Saharan Africa for certain apparel products shipped to the U.S. market. The provisions of this legislation benefiting Sub-Saharan Africa nations have led to increased imports from the region. At this time the ultimate impact of the legislation on the U.S. textile and apparel industry and Cone is impossible to predict.

The impact of multilateral agreements intended to liberalize global trade could also significantly affect U.S. textile producers and Cone. The World Trade Organization (“WTO”) is overseeing the phase-out of textile and apparel quotas over a 10-year period through 2004. Tariffs on textile/apparel products are being reduced (but not eliminated) over the same 10-year period. In addition, China’s admission to the WTO will have a significant impact on global textile and apparel trade. By gaining admission to the WTO, China is able to take advantage of the elimination of quota limitations into the U.S. market, and there could be a negative impact on the North American textile industry, including Cone.

The Bush Administration has recently unveiled a proposal to eliminate worldwide tariffs for manufactured goods by 2015. The European Union has also proposed significant reductions in tariffs. These proposals could lead to further reductions in worldwide tariffs. The U.S. government has also engaged in discussions with a number of countries or trade blocs with the intent of further liberalizing trade. “Fast track” authority granted by Congress in 2002 makes new agreements even more likely, as evidenced by recent proposals related to a Free Trade Area of the Americas with the goal of essentially expanding NAFTA to all countries in the western hemisphere, with the exception of Cuba, by January 2005.

In response, Cone continues to focus its operations on the production of fabrics that are less vulnerable to import penetration. Management believes the location of Cone’s U.S. manufacturing facilities in partnership with Mexican and Caribbean garment production, its 50% interest in the Parras Cone plant in Mexico, and its emphasis on shortening production and delivery times allow Cone to respond more quickly than foreign producers to changing fashion trends and to its domestic customers’ demands for precise production schedules and rapid delivery. Cone has invested in technological and process improvements to meet demand for quality and styling.

In instances where Cone finds its products noncompetitive with imports, Cone is pursuing initiatives either to manufacture or source products internationally or to exit the product line.

Trademarks, Copyrights and Patents

Cone owns several registered trademarks containing the “Cone” name and various designs. In addition, Cone holds various other trademarks, trade names, copyrights and patents used in connection with its business and products, both domestically and internationally. Cone believes that the name recognition of Cone and its reputation for quality, service and product development have value in both domestic and international markets.

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Customers

Cone has one customer, Levi Strauss, which accounts for more than 10% of net sales. Sales to this customer accounted for approximately 34%, 37% and 38% of net sales in 2002, 2001 and 2000, respectively. The loss of Levi as a customer, or a significant reduction in its purchases from Cone, would have a material adverse effect on Cone’s financial position and results of operations.

Levi has been a customer of Cone since 1915 and a close, cooperative supplier/customer relationship has evolved through the development of Cone’s proprietary fabrics for use in Levi’s 501® family of jeans. In addition to supplying fabrics for Levi’s 501® family of jeans, Cone sells other denim fabrics to Levi. Because Cone is Levi’s major denim supplier, Levi initiated discussions with Cone in 1989 concerning ways to assure the continuity of this relationship. As a result of these discussions, Cone and Levi entered into an exclusive Supply Agreement as of March 30, 1992, in which the parties agreed that Levi would use only Cone’s proprietary denim fabrics in manufacturing Levi’s 501® family of jeans and that Cone would supply such fabrics solely to Levi. The volume of purchases by Levi and the prices charged by Cone would continue to be subject to customary negotiations between the parties.

On May 13, 2002, Cone and Levi amended the exclusivity and requirements features of their Supply Agreement relating to the denim used worldwide in Levi Strauss’ 501^® jeans. The amendment provides that, after March 30, 2003, Cone may sell these denims to customers in addition to Levi, and Levi may purchase these denims from other suppliers. The amendment also allows Levi to purchase these denims for its European business from non-U.S. sources prior to March 30, 2003, if the European Union implements material tariffs against U.S. produced denim prior to this date. While denim was initially included in the European Union’s list of products for a 30% retaliatory tariff in response to U.S. steel tariffs, it has subsequently been removed from the list. The amendment does not change any other provisions of the Supply Agreement.

A variety of factors, including the inclusion of denim in the initial list of products to be subject to retaliatory tariffs, caused the companies to re-examine the exclusivity relationship. The amendment gives Levi the ability to source denim for its 501^® jeans business in Europe on a more tariff-friendly basis. More broadly, the amendment is consistent with the desire of both companies to manage risks associated with single supplier and single customer relationships on a key product, and reflects changing worldwide trade patterns.

The amendment does not affect Cone’s supply of other products to Levi or its overall close working relationship with Levi in developing new and innovative products. Cone anticipates that orders from Levi for the balance of 2003 and the timing for the end of the contractual exclusivity on fabric supplies for 501® jeans will provide Cone with the time and opportunity to continue to supply a large percentage of the denim for Levi’s 501® jeans in Europe after March 30, 2003. Given the long-term relationship between the parties and Cone’s expectations for Levi orders in 2003, Cone believes that, if it is able to successfully complete a recapitalization including obtaining funding for expansion in Mexico, it will be able to meet successfully changes in sourcing practices for Levi and its other customers in the U.S. and European markets. However, there is no assurance that Cone will be able to compete effectively through the proposed joint venture relationship in Turkey or finance and construct a low-cost denim manufacturing facility in Mexico to supply these or other denims, and the amendment to the Supply Agreement may have a material adverse impact upon Cone’s financial position and results of operations.

Backlog

Cone’s order backlog was approximately $57 million at January 26, 2003, as compared to approximately $68 million at January 27, 2002. Denim accounted for 96% of the order backlog at January 26, 2003. The decrease in Cone’s order backlog is attributable to changes in economic conditions and the shortening of product delivery schedules demanded by Cone’s customers.

Physical deliveries for accepted fabric orders in the apparel industry vary in that some products are ordered for immediate delivery only, while others are ordered for delivery several months in the future. In addition, Cone has an ongoing proprietary program for which orders are issued only for nearby delivery. Therefore, orders on hand are not necessarily indicative of total future revenues. It is expected that substantially all of the orders outstanding at January 26, 2003, will be filled within the first four months of 2003.

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Research and Development

Cone’s research and development activities are directed primarily toward improving the quality, styling and performance of its apparel fabrics and other products and services. Cone also is engaged in the development of computer-aided design and manufacturing systems and other methods of improving the interaction between Cone’s stylists and its customers. These activities are conducted at various facilities, and expenses related to these activities are an immaterial portion of Cone’s overall operating costs.

Governmental Regulation

Federal, state and local regulations relating to the workplace and the discharge of materials into the environment are continually changing; therefore, it is difficult to gauge the total future impact of such regulations on Cone. However, existing government regulations are not expected to have a material effect on Cone’s financial position, operating results or planned capital expenditures.

Employees

At January 31, 2003, Cone employed approximately 3,200 persons, of whom approximately 525 were salaried and approximately 2,675 were hourly employees. Of such hourly employees, approximately 880 are represented by collective bargaining units. Based upon its records relating to the withholding of union dues from employee compensation, Cone believes that approximately 400 of its employees are dues-paying union members of the same local union, which is subject to contract negotiations every three years including wage negotiations. Cone has not suffered any major disruptions in its operations from strikes or similar events for more than a decade and considers its relationship with its employees to be satisfactory.

Item 2. PROPERTY

As of March 2003, Cone’s U.S. manufacturing facilities consist of five plants, four located in North Carolina and one in South Carolina. The denim segment consists of three plants and a distribution center, and each of the commission finishing and the decorative fabrics segments consist of one plant. Internationally, Cone has a 50% interest in a denim manufacturing facility in Parras, Mexico and a 50% interest in an industrial park and water treatment facility in Altamira, Tamaulipas, Mexico.

All such facilities are maintained in good condition and are both adequate and suitable for their respective purposes. Cone’s manufacturing facilities are substantially utilized except for those portions of the facilities formerly used for yarn manufacturing.

All U.S. manufacturing facilities are pledged as security for Cone’s indebtedness under its debt agreements. The Parras Cone denim facility serves as collateral for a portion of the debt of the joint venture company.

Cone leases its executive and administrative offices, located in Greensboro, North Carolina, and other offices, located in various U.S. cities and Brussels, from unrelated third parties.

Over the past three years, Cone has closed its Florence denim plant, located in Forest City, North Carolina, its Raytex plant, located in Marion, South Carolina, and its Salisbury, North Carolina plant. All three facilities are classified as available for sale.

Item 3. LEGAL PROCEEDINGS

Cone and its subsidiaries are involved in legal proceedings and claims arising in the ordinary course of business. Although there can be no assurance as to the ultimate disposition of these matters, management believes that the probable resolution of such contingencies will not have a material adverse effect on the results of operations, financial condition and liquidity of Cone. As of December 29, 2002, no significant litigation existed.

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

Not applicable.

Item 4A. Executive Officers Of The Registrant

All officers of the Registrant are elected or reelected each year at the Annual Meeting of the Board of Directors or at other times as necessary. All officers serve at the pleasure of the Board of Directors and until their successors are elected and qualified.

John L. Bakane joined Cone in 1975. He was named Chief Financial Officer in 1988 and was elected to the Board of Directors in 1989. He was elected Executive Vice President in 1995. In November 1996, he assumed responsibility for management of the Denim Group of Cone and in April 1997 he was appointed President of Cone Apparel Products Group. He was appointed Chief Operating Officer in April 1998, and served in such capacity until elected President and Chief Executive Officer in November 1998.

Gary L. Smith was employed by Cone in 1981 and was serving as Manager of Business Analysis when he was elected Assistant Controller in 1994. He was named Controller in December 1996, Executive Vice President in February 1999 and Chief Financial Officer in November 1999.

Thomas E. McKenna was employed by Cone in 1981. He worked in Cone’s San Francisco, Brussels, and Singapore sales offices prior to being named Vice President, National Sales and Merchandising in June 1997. He was named Senior Vice President, Sales and Marketing in March 1999 and Executive Vice President, Denim Merchandising and Marketing in May 2001.

Michael J. Whisenant was employed by Cone in 1967. He has served in plant management, product development and product quality. He was named Vice President, Technical Services and Product Quality in October 1996 and named Senior Vice President, Operations in March 1999. He was appointed Executive Vice President, Denim Operations in May 2001.

Neil W. Koonce was employed by Cone in 1974. He has been General Counsel since 1987, Vice President since 1989, and Secretary since February 1999.

Michael K. Horrigan was employed by Cone in March 1999 as Vice President, Human Resources. He served as Vice President of Human Resources for the sales and marketing and bed fashions groups at Springs Industries from February 1997 to March 1999. Before joining Springs, he was employed by Sara Lee branded apparel businesses for eight years, including five years as Vice President of Human Resources for Champion Products. For ten years prior to that he worked in human resources for General Electric. On February 28, 2003, he resigned his position as Vice President, Human Resources.

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Terry L. Weatherford was employed by Cone and elected Assistant Secretary in May 1993. He was elected Secretary in December 1993 and served in that capacity until February 1999. In 1995 he also was elected Vice President. From 1999 to March 1, 2003, he served as Assistant Vice President of Human Resources Shared Services. Effective March 1, 2003, he was elected Vice President, Human Resources.

Marvin A. Woolen, Jr. was employed by Cone in July 1995 as Director of Cotton Purchasing. He was elected Vice President in 1997. He has been in the cotton sales, merchandising, purchasing, classing and shipping business since 1971. From 1988 to 1995 he was President of Rollins Company, a cotton shipping firm.

Samir M. Gabriel was employed by Cone in 1988. He has held a variety of positions in Cone’s Finance Department including Manager of Accounting from March 1994 to May 1999, Director of Accounting from June 1999 to May 2000, and Director of Cost Accounting from June 2000 to April 2001. He was appointed Controller in May 2001.

W. Scott Wenhold was appointed Treasurer in January 2001. He served as Director of International Treasury of Johnson Controls, Inc. from September 1999 to December 2000. Prior to joining Johnson Controls, Inc., he was employed by Fort James Corporation where he served as Assistant Treasurer from July 1998 to July 1999, Director of Corporate Finance from August 1997 to July 1998, and Manager of Corporate Finance from April 1994 to August 1997.

PART II

Item 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED

STOCKHOLDERS MATTERS

Cone’s Common Stock has traded on the New York Stock Exchange under the ticker symbol “COE” since June 18, 1992, the date of its public offering. The number of holders of record of Cone’s Common Stock as of January 31, 2003, was 286.

Information required by this Item on the sales prices and dividends of the Common Stock of Cone are incorporated by reference to Note 24 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report.

Equity Compensation Plan Information

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Item 6. SELECTED FINANCIAL DATA

HISTORICAL FINANCIAL REVIEW

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF

OPERATIONS AND FINANCIAL CONDITION

Overview

For the fiscal year 2002, Cone had net sales from continuing operations of $445.6 million as compared with $449.9 million in 2001. The decline in sales is primarily attributable to lower sales in the commission finishing and jacquard segments as both units experienced reduced volume in 2002, as compared with 2001. Denim sales revenue increased in 2002, as a 10% increase in sales volume offset lower sales prices.

We reported our first profitable year since 1994 with net income of $11.4 million or $0.28 per share after preferred dividends. The improvement in operating results was the result of many factors including savings from significant workforce reductions, facility consolidations and cost savings initiatives in 2001 (“2001 Reinvention Plan”) and ongoing profit improvement initiatives in 2002, excellent manufacturing performance as measured against historical internal benchmarks, higher capacity utilization levels of our denim facilities and lower cotton costs. These savings were partially offset by lower denim sales prices, lower sales volume in the commission finishing and jacquards segments and costs associated with redirecting the jacquards business unit.

We believe that one of the most significant factors that can affect operating margins is the overall price of cotton and our cotton costs versus those of our domestic and international competitors. Prices for cotton on the global cotton market, our competitors’ fixed cotton positions and denim supply and demand determine how quickly we must pass on to our customers benefits from lower cotton prices or conversely how quickly we can reflect the increased cost of cotton in our sales prices. In 2002, a significant portion of cotton cost savings were passed along to our customers in the form of lower denim sales prices. We believe that our cotton purchase commitments are at competitive levels for 2003. However, futures prices for cotton have increased significantly in recent months and could adversely affect future results of operations if we are unable to increase denim sales prices. Whether cotton prices are lower or higher long term will depend upon global supply and demand for cotton and the level of equalization payments received under the U.S. government cotton program.

Other significant factors that influence Cone’s operating results and financial condition include general business cycles, consumer fashion preferences, changes in demand for print fabrics, international trade policies and agreements, customer sourcing practices, the relative strength of the U.S. dollar and access to the capital markets at competitive rates.

Long-Term Strategic Initiatives

The textile business is an extremely competitive business on a global basis. Apparel and textile imports into the U.S. continued to grow at double-digit rates in 2002 with the bulk of the growth coming from the Far East. In 2002, on an aggregated basis NAFTA and CBI countries provided approximately 60% of the denim jeans and fabric imports into the U.S. In recent years and since the Asian currency crisis in 1997 many Asian countries, including China, have artificially pegged their currencies to the U.S. dollar, which has helped to keep their goods cheaper thereby boosting their exports. This currency effect, the general global oversupply of apparel and textiles, U.S. retail consolidation and the slowing in consumer spending have resulted in volume and deflationary pricing pressures throughout the apparel and home furnishings markets. These competitive conditions are expected to continue.

Levi has been a customer of Cone since 1915 and a close, cooperative supplier/customer relationship has evolved through the development of Cone’s proprietary fabrics for use in Levi’s 501® family of jeans. In addition to supplying fabrics for Levi’s 501® family of jeans, Cone sells other denim fabrics to Levi. Because Cone is Levi’s major denim supplier, Levi initiated discussions with Cone in 1989 concerning ways to assure the continuity of this relationship. As a result of these discussions, Cone and Levi entered into an exclusive Supply Agreement as of March 30, 1992, in which the parties agreed that Levi would use only Cone’s proprietary denim fabrics in manufacturing Levi’s 501® family of jeans and that Cone would supply such fabrics solely to Levi. The volume of purchases by Levi and the prices charged by Cone would continue to be subject to customary negotiations between the parties.

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On May 13, 2002, Cone and Levi amended the exclusivity and requirements features of their Supply Agreement relating to the denim used worldwide in Levi Strauss’ 501^® jeans. The amendment provides that, after March 30, 2003, Cone may sell these denims to customers in addition to Levi, and Levi may purchase these denims from other suppliers. The amendment also allows Levi to purchase these denims for its European business from non-U.S. sources prior to March 30, 2003, if the European Union implements material tariffs against U.S. produced denim prior to this date. While denim was initially included in the European Union’s list of products for a 30% retaliatory tariff in response to U.S. steel tariffs, it has subsequently been removed from the list. The amendment does not change any other provisions of the Supply Agreement.

A variety of factors, including the inclusion of denim in the initial list of products to be subject to retaliatory tariffs, caused the companies to re-examine the exclusivity relationship. The amendment gives Levi the ability to source denim for its 501^® jeans business in Europe on a more tariff-friendly basis. More broadly, the amendment is consistent with the desire of both companies to manage risks associated with single supplier and single customer relationships on a key product, and reflects changing worldwide trade patterns.

The amendment does not affect Cone’s supply of other products to Levi or its overall close working relationship with Levi in developing new and innovative products. Cone anticipates that orders from Levi for the balance of 2003 and the timing for the end of the contractual exclusivity on fabric supplies for 501^® jeans will provide Cone with the time and opportunity to continue to supply a large percentage of the denim for Levi’s 501^® jeans in Europe after March 30, 2003. Given the long-term relationship between the parties and Cone’s expectations for Levi orders in 2003, Cone believes that, if it is able to successfully complete a recapitalization including obtaining funding for expansion in Mexico, it will be able to meet successfully changes in sourcing practices for Levi and its other customers in the U.S. and European markets. However, there is no assurance that Cone will be able to compete effectively through the proposed joint venture relationship in Turkey or finance and construct a low-cost denim manufacturing facility in Mexico to supply these or other denims, and the amendment to the Supply Agreement may have a material adverse impact upon Cone’s financial position and results of operations.

During 2002, Cone completed the formation of a joint venture in Turkey with Isko, a Turkish denim company, for the purpose of selling denim for Levi Strauss’ 501^® jeans in Europe on a tariff-friendly basis.

Cone’s business strategy is to invest and grow in its core franchises where it is recognized as a market leader. As a result of economic and industry conditions, Cone is focused on four initiatives: (1) engage in businesses in which Cone believes it is an industry leader; (2) retain, attract, motivate and focus a talented and capable management team; (3) migrate to low-cost manufacturing platforms for commodity products; and (4) attract and efficiently invest capital. Our long-term migration strategy is focused on the Americas where free trade agreements, such as NAFTA, are in place or are expected in the near future. We believe that denim jeans produced in these regions will maintain a significant market share of the U.S. retail market because of certain unique product characteristics. Some of the characteristics of denim fabric and jeans that make them more likely to be sourced closer to or in the U.S. include the significant fashion element, especially in women’s jeans, the overall low labor content as compared to other textiles and apparel, the availability of U.S. cotton and certain other supply chain factors.

Cone’s strategy is to grow its denim business by expanding its production capacity in Mexico or other low-cost countries in this hemisphere. The stated plan has been to build a denim plant with an initial capacity of approximately 20 million yards on our site in Altamira, Tamaulipas, Mexico. The infrastructure services, such as roads, water, power and wastewater treatment, for such a facility are complete and would be provided by Altamira Servicios de Infraestructura, S.A. de C.V. (“ASISA”), Cone’s 50/50 joint venture with Guilford Mills. We believe that such a denim facility can be completed for a capital investment of less than $70 million. The capital cost for such a facility may be reduced by configuration decisions and the availability of used equipment when financing for the project is available. As an alternative to building a denim plant on its site in Altamira, Cone is exploring other opportunities to expand or acquire low-cost denim manufacturing capabilities. The funds required for the denim facility will require debt or equity financing and certain modifications to Cone’s current debt structure and lending agreements.

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Parras Cone’s production capacity was expanded by approximately 9% in 2002 with internally generated funds. The joint venture partners have agreed to an additional 25% expansion when financing is available. The additional expansion would be financed by internally generated cash flow and debt of Parras Cone. The debt would be nonrecourse to the joint venture partners. Debt financing for the expansion has not been obtained and there can be no assurance that such financing will be available on acceptable terms and conditions. Cone will continue to market and distribute 100% of the fabric production at Parras Cone.

In Commission Finishing, Cone’s strategy is to utilize the capabilities and versatility of the Carlisle facility to gain market share in the home furnishings business and to gain entrance into selected print apparel markets. Primary competitive focus will be on product development, customer service systems and quality.

For the Decorative Fabrics segment, which consists solely of the jacquards wide weaving operation, the strategic focus is similarly on product development, customer service and quality. In addition, because of its size Cone is able to focus on niche market opportunities. In 2002, Cone management determined that these initiatives were not being effectively executed resulting in the replacement of certain management, sales and product development personnel in late 2002.

Segment Information

Cone operates in three principal business segments: Denim, Commission Finishing and Decorative Fabrics. See Notes 18 and 22 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report.

Results of Operations

Fifty-Two Weeks Ended December 29, 2002 Compared with Fifty-Two Weeks Ended December 30, 2001

Net sales from continuing operations were $445.6 million for the year 2002, as compared with sales of $449.9 million for 2001, a decrease of 1%. Increases in denim segment sales revenue was offset by sales declines in both the commission finishing and jacquard segments.

Gross profit for 2002 increased to 14.2% of sales, as compared with 9.0% for the previous year. The increase in gross profit for 2002 was the result of lower raw material costs, improved denim manufacturing operating schedules, increased efficiencies and quality and the overall focus on cost reduction initiatives.

Denim. Denim segment sales were $365.4 million for the year 2002, an increase of 4% from 2001 sales of $352.0 million. Demand for our denim products recovered strongly in the first quarter of 2002 as retail inventories were replenished following a successful 2001 holiday season for denim jeans, and as fashion trends continued to support denim sales at retail for most of 2002. These factors along with a gain in market share resulted in a 10% increase in sales units in 2002 as compared with 2001. Sales prices continued to decline as competitive pressures within the industry forced us to pass on to our customers a significant portion of our cotton cost savings.

Operating income of the denim segment for 2002 was $38.1 million, as compared to 2001 income of $13.4 million. The improvement in operating income was attributable to cost savings programs, increased sales volume, lower raw material prices, improved capacity utilization and favorable manufacturing variances, all of which were partially offset by lower sales prices. Operating income for the segment includes the equity in earnings from the Parras Cone joint venture plant, which was $3.1 million in 2002 as compared with $0.4 million for 2001. The improvement in Parras Cone’s results is primarily attributable to the same factors that affected Cone’s overall denim performance as well as a 9% capacity expansion that was completed in the third quarter of 2002.

Commission Finishing. Outside sales (total segment sales less intercompany sales) of the commission finishing segment, which consisted entirely of sales from the Carlisle plant in 2002, were $47.8 million for 2002, as compared to 2001 sales of $55.8 million, which consisted of sales from both the Carlisle and Raytex plants.

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Exclusive of Raytex sales of $2.0 million for 2001, outside commission finishing sales decreased 11% from 2001. Outside sales for the commission finishing segment were down in 2002 as compared with 2001 because of depressed market conditions in all market segments, partially offset by increases in market share as a result of competitor consolidations.

Operating income for the commission finishing segment was $2.3 million in both 2002 and 2001. The negative impact of sales volume declines in 2002 was offset by cost savings programs and improved operating efficiencies and quality.

Decorative Fabrics. For 2002, sales of the decorative fabrics segment were $32.1 million, down from $41.8 million in 2001. An overall weakness in the home furnishings market and the lack of successful new product introductions negatively impacted sales in 2002 as compared with 2001. Operating loss for 2002 was $2.9 million, as compared to operating income of $0.8 million in 2001. Operating results were affected by lower sales volume because of poor styling and the continued depressed market conditions in the home furnishings market, increased import penetration of furniture products, costs to realign the product line and changes in business unit management.

Cone’s selling and administrative expenses are primarily fixed expenses and, therefore, do not vary directly with sales. Selling and administrative expenses were $32.5 million or 7.3% of sales in 2002, as compared with $35.8 million or 7.9% of sales in 2001. The reduction in selling and administrative expenses in 2002 was primarily a result of a full year of savings related to the Reinvention Plan, which were partially offset by increased performance-based pay and fees associated with Cone’s financing agreements.

Interest expense for 2002 was $15.8 million, as compared with $17.7 million in 2001. Other expense, which consists of the ongoing expenses of the accounts receivable securitization program, was $1.8 million and $3.0 million in 2002 and 2001, respectively. Benefits from lower borrowings and lower market interest rate levels were partially offset by increases in rates under Cone’s financing agreements.

For 2002 and 2001, the income tax expense (benefit) as a percent of the pre-tax income (loss) from continuing operations was 33% and 34%, respectively. See Note 11 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report.

As discussed under “Denim” above, equity in earnings of Parras Cone, Cone’s joint venture plant in Mexico, was $3.1 million for 2002, as compared with $0.4 million for 2001.

For the year 2002, Cone had net income from continuing operations of $11.4 million, or income of $0.28 per share after preferred dividends. By comparison, Cone reported a net loss from continuing operations in 2001 of $23.1 million, or a loss of $1.07 per share after preferred dividends. In 2001, including losses associated with the exit of the khaki business and the sale of John Wolf, which were accounted for as discontinued operations, Cone reported a net loss of $1.59 per share after preferred dividends.

Fifty-Two Weeks Ended December 30, 2001 Compared with Fifty-Two Weeks Ended December 31, 2000

For 2001, Cone had net sales from continuing operations of $449.9 million, down substantially from continuing operations of $552.6 million in 2000. Sales for the year were negatively impacted by the economic recession, lower prices and retail inventory liquidations that occurred throughout the year.

Based upon economic and industry conditions in January 2001, Cone management began an exhaustive review and benchmarking of operations and staff functions aimed at improving its financial performance. On May 24, 2001, Cone announced the implementation of the first phase of its Reinvention Plan. The objectives of the Reinvention Plan were (1) to produce $30 to $40 million in annual cost savings or improvement in operating results of under-performing businesses and (2) to market actively non-core assets including idle plants, property, equipment and excess inventories with a cash generation target of $15 to $25 million over 18 months.

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The Reinvention Plan initially had four components: (1) workforce reductions; (2) changes in employee pay and benefit practices; (3) streamlining of Cone’s business practices, which included a broad range of items from maintenance scheduling to vendor sourcing practices to the consolidation of denim operations to reduce U.S. capacity; and (4) improvement of the performance of the khaki and John Wolf converted fabrics businesses.

The implementation of the Reinvention Plan resulted in significant workforce reductions, primarily at Cone’s corporate office and the Rutherford County denim facilities, the freezing of benefits for salaried employees in the qualified and nonqualified pension plans, changes in business practices, the consolidation of the Haynes and Florence denim facilities and the sale of the John Wolf converted fabrics business.

Cone sold the John Wolf converted fabrics business in August, 2001 receiving net proceeds of approximately $9 million from the sale including the collection of accounts receivable. The decision to sell was based on the fact that we did not have the size and scale to be able to compete efficiently in this business and in turn were unable to develop a business outlook that would provide an appropriate return on our investment in this operation.

In addition, Cone exited the khaki business in the fourth quarter of 2001. The decision was primarily based on the fact that Cone was not a leader in this category and believed the long-term outlook for khaki produced in North America to be negative. At the end of 2001, the exit of the khaki segment was substantially complete. Cone has accounted for the results of the John Wolf and khaki businesses as discontinued operations under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

Gross profit for 2001 decreased to 9.0% of sales, as compared with 11.6% for the previous year. The decline in gross profit for 2001 was a result of lower sales volume, increased cotton costs to Cone, curtailed manufacturing operating schedules and continued pressure on prices.

Denim. For 2001, denim segment sales were $352.0 million, a decrease of 19% from 2000 sales of $434.6 million. In late 2000, retailers continued to build inventory for the holiday season, which turned out to be disappointing, forcing retailers to liquidate overstocked inventory. This liquidation continued into a downward spiraling economy through most of 2001, which placed further pressure on pricing.

Operating income of the denim segment for 2001 was $13.4 million, as compared to 2000 income of $35.1 million. The decrease in income resulted primarily from lower sales volume and curtailed manufacturing operating schedules after the first quarter of 2001. Operating income for the segment included the equity in earnings from the Parras Cone joint venture plant, which declined from 2000 amounts because of lower sales and curtailed operating schedules in the second half of the year. Parras Cone primarily produces denim for the basic denim market, which was the hardest hit segment of the denim market in 2001.

Commission Finishing. Outside sales (total segment sales less intercompany sales) of the commission finishing segment, which consisted of the Carlisle and Raytex plants, were $55.8 million for 2001, as compared to 2000 sales of $64.2 million. The majority of the sales decline resulted from cessation of operations at Raytex in February 2001. Exclusive of Raytex sales of $2.0 million for 2001 and sales of $16.9 million for 2000, outside commission finishing sales actually increased 13.8% in 2001.

Operating income for the commission finishing segment in 2001 was $2.3 million, as compared to an operating loss of $6.6 million in 2000. Raytex had an operating loss of $0.9 million in 2001, as compared to a loss of $6.7 million in 2000. Carlisle continued its turnaround during the year despite a very difficult economic operating environment. The improvement in operating income was primarily attributable to the closing of Raytex, improved operating efficiencies, increased sales volume and better sales mix.

Decorative Fabrics. For 2001, sales from continuing operations of the decorative fabrics segment were $41.8 million, down from $53.0 million in 2000. A declining home furnishings market primarily affected sales. Operating income for 2001 was $0.8 million, as compared to $2.3 million in 2000. Operating results were affected by lower sales volume partially offset by improved operating efficiencies.

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Cone’s selling and administrative expenses are primarily fixed expenses and, therefore, do not vary directly with sales. Selling and administrative expenses for 2001 were $35.8 million, as compared with $38.4 million in 2000. The lower expenses in 2001 were primarily a result of savings related to the Reinvention Plan, which were partially offset by higher bank and legal fees associated with Cone’s financing agreements.

Interest expense for 2001 was $17.7 million, as compared with $18.4 million in 2000. Other expense of $3.0 million in 2001 includes ongoing expenses of the accounts receivable securitization program, as compared to other expense of $5.3 million in 2000, of which $4.4 million was related to the accounts receivable securitization program in that year.

For 2001 and 2000, the income tax benefit as a percent of the pre-tax loss from continuing operations was 34% and 37%, respectively. See Note 11 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report.

Equity in earnings of Parras Cone, Cone’s joint venture plant in Mexico, was $0.4 million for 2001, as compared with $2.8 million for 2000. In the 2001 period, the plant operated at a lower capacity utilization rate and was impacted negatively by lower selling prices.

For the year 2001, Cone had a net loss from continuing operations of $23.1 million, or a loss of $1.07 per share after preferred dividends. Including losses associated with the exit of the khaki business and the sale of John Wolf, which were accounted for as discontinued operations, Cone reported a net loss of $1.59 per share after preferred dividends for 2001. By comparison, Cone reported a net loss from continuing operations in 2000 of $20.3 million or a loss of $0.94 per share after preferred dividends. Including losses from discontinued operations, Cone reported a net loss of $1.14 per share after preferred dividends. The 2000 results included charges to reflect the closing of the Raytex facility.

Liquidity and Capital Resources

Cone’s principal long-term capital components consist of debt outstanding under its Revolving Credit Facility, Senior Note, 8 ¹/8% Debentures and stockholders’ equity. Primary sources of liquidity are internally generated funds, availability under the Revolving Credit Facility and a $60 million Receivables Purchase and Servicing Agreement (the “A/R Securitization Facility”).

On December 2, 2002, Cone amended agreements with its lenders extending the maturity date of its existing Revolving Credit Facility and Senior Note obligation through May 30, 2003. The amended agreements provided that Cone present a recapitalization proposal to its lenders by January 22, 2003. This recapitalization plan was presented to our lenders prior to the required date and is more fully described below. We were unable to reach an agreement with our lenders to defer the exercise date of certain contingent payment rights. These rights entitle the lenders, upon giving of notice within two years of January 15, 2003, to receive a payment of the greater of $1 million or 10% of the market value of Cone’s outstanding common stock if we have not refinanced the Revolving Credit Facility and Senior Note by January 15, 2003, which did not occur. The lenders have not exercised their rights to date and indicated that they have not made a decision on whether to seek to exercise their rights, pending the resolution of the balance sheet recapitalization. Cone will recognize a current period charge in its income statement for these rights if they are exercised or it is deemed probable that the rights will be exercised as part of the recapitalization plan. If the lenders had notified us that they were exercising their rights as of February 20, 2003, based upon the common stock price for the past 45 days from such date, the indicated payment would have been approximately $4.4 million.

Cone’s financing agreements prohibit it from paying dividends on its Common Stock.

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The following is a summary of primary financing agreements as of December 29, 2002.

At December 29, 2002, Cone had availability under its financing agreements of $31.2 million. Availability under the Revolving Credit Facility and the A/R Securitization Facility is determined by borrowing base calculations, as defined in the respective agreements. During 2002, Cone generated cash from operations of $43.1 million, as compared with cash from operations of $13.7 million in 2001. Other sources of cash flow included $2.3 million in proceeds from sales of property and equipment for 2002, as compared with $4.3 million in 2001. Uses of cash in 2002 included $8.0 million for capital expenditures.

Cone believes that internally generated operating funds and funds available under its Revolving Credit Facility currently in effect are sufficient to meet its needs for working capital and domestic capital spending permitted under the terms of the Revolving Credit Facility. However, its present Revolving Credit Facility and Senior Note obligation mature on May 30, 2003.

On January 16, 2003 Cone entered into a letter of intent with WLR Recovery Fund II, L.P. (“WLR”), a fund managed by W.L. Ross and Company, in which WLR would purchase up to $27.0 million of convertible notes to support a recapitalization of Cone’s balance sheet that would provide funds to allow Cone to execute its Mexican expansion strategy. Funds managed by W.L. Ross and Company currently hold 50% of Cone’s Revolving Credit Facility and a portion of its bonds. The recapitalization plan contemplated by the letter of intent contains the following elements:

This recapitalization plan is subject to a number of contingencies and conditions, including negotiation of a final agreement with WLR, agreement to the proposed changes by Cone’s lenders and bondholders, approval of certain elements of the plan by Cone’s common shareholders, and the effectiveness of certain registration statements to be filed with the Securities and Exchange Commission.

This recapitalization plan was presented to our lenders of the Revolving Credit Facility and Senior Note in January 2003. We have not received a formal response from these lenders regarding our proposal. We are unable to predict whether our lenders will ultimately accept our recapitalization proposal or modifications thereof. Based upon our improved operating results and financial position in 2002, Cone believes that the maturity of the Revolving Credit Facility and Senior Note will be extended as needed to support ongoing operations. However, given the lack of liquidity in the capital markets and the negative perception by lenders regarding the U.S. textile industry, there is no assurance that Cone will be able to refinance or replace its Revolving Credit Facility and its Senior Note or otherwise obtain financing on terms and conditions acceptable to Cone. We will continue to explore alternatives related to financing our business and the expansion of denim capacity in low-cost countries.

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On December 29, 2002, Cone’s long-term capital structure consisted of $145.2 million of long-term debt (including current maturities) and $93.5 million of stockholders’ equity. For comparison, Cone had $173.7 million of long-term debt (including current maturities) and $86.6 million of stockholders’ equity in 2001. In 2002, Cone made principal payments of $29.0 million.

Accounts receivable on December 29, 2002, were $33.0 million, as compared with $28.4 million at December 30, 2001. Receivables, including those sold pursuant to the A/R Securitization Facility, represented 57 days of sales outstanding at December 29, 2002 and 68 days at December 30, 2001. The decrease in days outstanding was primarily the result of the exit from the khaki business and improved business conditions for our denim customers.

Inventories on December 29, 2002, were $48.8 million, down $13.2 million from December 30, 2001. The reduction in inventory levels during 2002 reflects the strength of our denim business as finished goods inventory levels approached historic lows, continued focus on improved processes and lower cotton and other raw material prices.

For 2002, domestic capital spending from continuing operations was $8.0 million compared to $7.0 million for the 2001 period. Domestic capital spending in 2003 is expected to be approximately $11 million financed by internally generated funds.

OTHER MATTERS

EBITDA from continuing operations, which is presented not as an alternative measure of operating results or cash flow from continuing operations (as determined in accordance with accounting principles generally accepted in the United States of America) but because it is a widely accepted financial indicator of the ability to incur and service debt, is used as the basis for certain financial covenants in Cone’s current debt agreements as well as for its incentive compensation plans, and is calculated by Cone as follows (in thousands):

Off-Balance Sheet Financing Arrangements

Cone’s A/R Securitization Facility is its only off-balance sheet financing arrangement. This facility generates funds by the sale of receivables in the U.S. through Cone Receivables II LLC (“CRIILLC”). CRIILLC’s sole business is the ongoing purchase and subsequent resale of certain trade receivables from Cone. CRIILLC sells an undivided 100% ownership interest in these receivables under an agreement with General Electric Capital Corporation (“GECC”). CRIILLC is a separate corporate entity with its own separate creditors who, in the event of its liquidation, will be entitled to be satisfied out of CRIILLC’s assets prior to any value in CRIILLC becoming available to Cone. CRIILLC retains no interests in those receivables transferred to GECC and has not experienced any gains or losses on the transfer of such receivables. Cone believes that minimal counterparty risk exists because of the financial strength of GECC. In addition, the A/R Securitization Facility is essentially asset neutral because of the inverse relationship between the level of accounts receivable and the level of cash proceeds available under the A/R Securitization Facility, subject to funding limits. See Note 2 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report.

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Transactions with Related Parties

Cone has various transactions in the normal course of business with its unconsolidated affiliated companies. Cone purchases denim and yarn from Parras Cone under a transfer pricing arrangement that is a part of the Commercial Agreement between Parras Cone, Cone and its joint venture partner CIPSA. Purchases of denim and yarn from Parras Cone were $63.7 million, $56.6 million and $70.1 million in 2002, 2001 and 2000, respectively. Cone received $1.0 million in management fees from Parras Cone in 2002, 2001 and 2000 for production management, cotton buying, administrative support and engineering services. In addition, Cone sold looms to Parras Cone in 2001 for $2.9 million, the approximate net book value of the equipment at the time of sale. Cone also paid $2.5 million, $2.2 million and $2.7 million in marketing fees to CIPSA in 2002, 2001 and 2000, respectively. At December 29, 2002 and December 30, 2001, Cone had amounts due to Parras Cone recorded in accounts payable of $9.6 million and $9.1 million, respectively.

Critical Accounting Policies

Investments in Unconsolidated Affiliates. Investments in unconsolidated affiliated companies are accounted for by both the equity and cost methods, depending upon ownership levels. See Notes 1 and 4 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report. Cone has an ownership interest in CIPSA, a denim manufacturer in Mexico, which is accounted for under the cost method. Cone and CIPSA formed a company, Parras Cone, to build and operate a denim manufacturing facility in Parras, Mexico. Each shareholder has a 50% interest in Parras Cone. Accordingly, Cone records the equity in earnings of Parras Cone in its consolidated statements of operations in accordance with accounting principles generally accepted in the United States of America.

Cone purchases 100% of the fabric production, markets the production to the end customer, handles production scheduling for the plant, provides financial management and cotton purchasing services and provides customer service on behalf of Parras Cone. However, Cone lacks board of director control and does not have sole discretion over Parras Cone’s management, which prevents Cone from consolidating the entity.

Impairment of Assets. Long-lived assets and certain identifiable intangibles to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, Cone estimates the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows, undiscounted and without interest charges, is less than the carrying amount of the asset, an impairment loss is recognized. Measurement of an impairment loss for long-lived assets and identifiable intangibles that Cone expects to hold and use are based on the difference between the carrying amount and fair value of the asset. Long-lived assets and certain identifiable intangibles to be disposed of are reported at the lower of carrying amount or fair value less cost to sell. Cone has made its best estimate of asset impairments as of December 29, 2002. See Note 22 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report.

Stock Plans. Cone applies Accounting Principles Board Opinion Number 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations in accounting for its stock option plans, which requires compensation expense for Cone’s options to be recognized only if the market price of the underlying stock exceeds the exercise price on the date of grant. Option prices are determined by the last reported sale price on the New York Stock Exchange composite tape on the date of grant. Accordingly, Cone has not recognized compensation expense for any of its options granted. Had SFAS No. 123, “Accounting for Stock Based Compensation,” been used as opposed to APB 25, Cone would have recorded compensation expense using a fair value based accounting model. The effect of using SFAS No. 123 would have decreased the earnings per share after preferred dividends to $0.25 for 2002, or increased the loss per share after preferred dividends to $1.61 and $1.17 for 2001 and 2000, respectively. See Notes 1 and 14 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report.

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Long-Term Debt and Contractual Obligations

Long-Term Debt. Cone’s debt financing consists of its Senior Note, its $57.0 million Revolving Credit Facility and its 8 ¹/8% Debentures. See Note 9 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report.

Contractual Obligations. Cone has various leases accounted for as operating leases. Future contractual obligations required under these lease agreements represent minimum rental payments totaling $15.4 million. These operating leases are primarily related to office space and production equipment leases. See Note 15 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, contained in this Form 10-K annual report.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Cone’s primary market risk exposures are cotton (commodity) price risk and interest rate risk. At December 29, 2002, Cone had no material exchange rate risk on any of its financial instruments. Cone had no financial instruments, derivative financial instruments or derivative commodity instruments held for trading purposes at December 29, 2002. Fair values for cotton derivatives and long-term debt instruments were estimated with reference to market quotes at year-end.

Commodity price risk primarily relates to cotton. Cone has an established cotton purchasing program, administered in conformance with policies approved by the Board of Directors to ensure an uninterrupted supply of appropriate quality and quantities of cotton to cover committed and anticipated fabric sales, and to manage margin risks associated with price fluctuations on anticipated cotton purchases. Cone primarily uses forward contracts and, to a lesser extent, futures and options contracts in its cotton purchasing program.

The following table provides information about Cone’s cotton option contracts that are sensitive to changes in cotton prices. The table presents the number of contracts, the weighted-average strike price and the total dollar contract price by expected maturity dates. Contract amounts are used to calculate the contractual payments and quantity of cotton under option at December 29, 2002 and December 30, 2001.

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Cone’s debt instruments are exposed to interest rate risk. The table presents principal cash flows and related weighted-average interest rates by maturity dates.

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Statement of Responsibility for Financial Statements

The management of Cone Mills is responsible for the preparation and integrity of Cone’s published financial statements. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include management’s best estimates and judgment. Management has also prepared the other information contained in this report and is responsible for its accuracy and consistency with the financial statements.

Cone maintains a system of internal control over financial reporting, which is designed to provide reasonable assurance to Cone’s management and Board of Directors regarding the preparation of reliable published financial statements. The system includes a code of conduct to foster a strong ethical climate, established policies and procedures, internal audit processes, and the employment of qualified personnel. Cone has established formal criteria against which the internal control system over financial reporting is measured and as of December 29, 2002, Cone was in compliance with these criteria.

The Board of Directors, assisted by its Audit Committee, which is composed entirely of directors who are not officers or employees of Cone, provides oversight to the financial reporting process. The Committee meets regularly with management, internal auditors and independent certified public accountants to review the scope and findings of audits, financial reporting issues and the adequacy of the internal control system. To assure complete independence, representatives of McGladrey & Pullen, LLP, Certified Public Accountants, the selection of whom is ratified by the shareholders, have free access to the Audit Committee with or without the presence of management.

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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

McGLADREY & PULLEN, LLP

INDEPENDENT AUDITOR’S REPORT

To the Board of Directors

Cone Mills Corporation

Greensboro, North Carolina

We have audited the accompanying consolidated balance sheets of Cone Mills Corporation and subsidiaries as of December 29, 2002 and December 30, 2001, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 29, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cone Mills Corporation and subsidiaries as of December 29, 2002 and December 30, 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 29, 2002 in conformity with accounting principles generally accepted in the United States of America.

Greensboro, North Carolina

February 14, 2003

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CONE MILLS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 29, 2002, December 30, 2001 and December 31, 2000

See Notes to Consolidated Financial Statements.

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CONE MILLS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 29, 2002 and December 30, 2001