UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission file number 1-10542

Unifi, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(336) 294-4410

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 þ          No o

      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.     þ

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes þ          No o

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     Yes o          No þ

      As of December 24, 2004, the aggregate market value of the registrant’s voting common stock held by non-affiliates of the registrant was $193,287,518. The Registrant has no non-voting stock.

      As of September 21, 2005, the number of shares of the Registrant’s common stock outstanding was 52,145,434.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the Annual Meeting of Shareholders of Unifi, Inc., to be held on October 19, 2005, are incorporated by reference into Part III. (With the exception of those portions which are specifically incorporated by reference in this Form 10-K, the Proxy Statement is not deemed to be filed or incorporated by reference as part of this report.)

PART I

      Unifi, Inc., a New York corporation formed in 1969, together with its subsidiaries, hereinafter set forth, (the “Company” or “Unifi”), is a diversified producer and processor of multi-filament polyester and nylon textured yarns with manufacturing operations in the U.S. and South America. The Company is primarily engaged in the processing of synthetic yarns in two business segments, polyester and nylon. The polyester segment is comprised of textured, dyed, twisted and beamed yarns with sales to knitters and weavers that produce fabrics for the apparel, automotive and furniture upholstery, home furnishings, industrial and other end use markets. The nylon segment is comprised of textured nylon and covered spandex products with sales to knitters and weavers that produce fabrics for the apparel, hosiery, sock and other end use markets.

      On September 30, 2004, the Company completed its acquisition of the INVISTA polyester filament manufacturing assets located in Kinston, North Carolina which the Company acquired from INVISTA S.a.r.l. (“INVISTA”), a subsidiary of Koch Industries, Inc. (“Koch”). During fiscal year 2005, Unifi completed the liquidation of its dyed operations in the U.K., and made significant progress in liquidating its Irish manufacturing operations.

      During the third quarter of fiscal 2004, the Company formalized its initiative to develop a sourcing business. While the sourcing business contributed to the Company’s business initiatives, management decided in July 2005 to discontinue this business segment and to focus solely on its successful downstream marketing efforts. The sourcing business is currently completing and delivering existing programs and expects to be substantially wound up by the end of the third quarter of fiscal year 2006.

      See Note 7 “Business Segments, Foreign Operations and Concentrations of Credit Risk” of this Report for further information regarding the financial information about these segments.

      The Company manufactures partially oriented yarn (“POY”) and processes synthetic polyester and nylon yarns. POY is made from petroleum based chemicals that are reacted to form a polymer which is melted and extruded through microscopic holes to form a collection of filaments which are combined to form a yarn. The texturing process, which is common to both polyester and nylon, involves the processing of POY, which is either natural or solution dyed raw polyester or natural nylon filament fiber. Texturing POY involves the use of high-speed machines to draw, heat, and twist the POY to produce yarn having various physical characteristics, depending on its ultimate end use. This process gives the yarn greater bulk, strength, stretch, consistent dye ability and a softer feel, thereby making it suitable for use in knitting and weaving of fabrics. The polyester and nylon yarns produced by the Company can be sold externally or further processed internally. Additional processing for our polyester segment includes package dyeing, twisting and beaming. Package dyeing allows the Company to match customer specific color requirements for yarns sold into the automotive, home furnishings and apparel markets. Twisting incorporates real twist into the filament yarns, which can be sold for such uses as sewing thread, home furnishings and apparel. Beaming places both textured yarn on beams to be used by customers in knitting and weaving applications. Warp drawing converts POY into flat yarn, also packaged on beams. Further processing for the nylon segment mostly includes covering, which involves the wrapping or air entangling of filament or spun yarn around a core yarn. This process enhances a fabric’s ability to stretch, recover its original shape, and resist wrinkles.

      Sources and Availability of Raw Materials: The primary raw material suppliers to the Company’s polyester segment are Nanya Plastics Corp. of America (“Nanya”) for polyester polymer beads (“chip”), DAK Americas LLC for terephthalic acid (“TPA”) and E.I. DuPont de Nemours and Company (“DuPont”) for mono-ethylene glycol (“MEG”). The production of POY is comprised of two primary

processes, polymerisation (performed at the Company’s Kinston facility) and spinning (performed at the Company’s Yadkinville and Kinston facilities). The polymerisation process is the production of polymer by a chemical reaction involving TPA and MEG, which are combined to form chip. The spinning process involves the extrusion of molten polymer, directly from polymerization or using chip, into POY. The molten polymer is extruded through spinnerettes to form continuous multi-filament raw yarn.

      The primary suppliers of POY to the Company’s nylon segment are U.N.F. Industries Ltd (“UNF”), Universal Premier Fibers, LLC (formerly Cookson Fibers, Inc.) and Sara Lee Nilit Fibers, Ltd. UNF is a 50/50 joint venture between Unifi and Nilit Ltd., located in Israel. The joint venture produces nylon POY at Nilit’s manufacturing facility in Migdal Ha — Emek, Israel. The nylon POY production is being utilized in the Company’s domestic nylon texturing and covering operations.

      Although the Company is heavily dependent upon a limited number of suppliers, the Company has not had and does not anticipate having any significant difficulty in obtaining its raw nylon POY or chemical and other raw materials used to manufacture polyester POY.

      Patents, Trademarks and Licenses: The Company currently has a limited number of patents and approximately 20 registered trademarks, none of which it considers material to any reporting segment or its business taken as a whole.

      Working Capital Commitments, Sales Return Policies and Customer Payment Terms: The Company does not currently provide a raw yarn consignment arrangement to any customers.

      Sales return practices are typically developed and enforced by the Company or segment management and generally provide for the return of yarn that is off-quality or subsequently deemed not suitable for a particular end use. In addition, rebates may be offered to specific large volume customers for purchasing certain quantities of yarn over a prescribed time period. The Company provides for allowances associated with rebates in the same accounting period the sales are recognized in income. Allowances for rebates are calculated based on sales to customers with negotiated rebate agreements with the Company.

      Customer payment terms are generally consistent for both the polyester and nylon reporting segments and are usually based on prevailing industry practices for the sale of yarn domestically or internationally. In certain cases, payment terms are subject to further negotiation between the Company and individual customers based on specific circumstances impacting the customer. This may entail the extension of payment terms or negotiation of situation specific payment plans. The Company does not believe that any such deviations from normal payment terms are significant to either reporting segment or to the Company taken as a whole.

      Customers: In the fiscal year ended June 26, 2005, the Company sold its polyester yarns to approximately 800 customers and its nylon yarns to approximately 200 customers. Neither the polyester reporting segment nor the nylon reporting segment had sales to any one customer in fiscal year 2005 either individually or combined (for shared customers) in excess of 10% of the Company’s consolidated revenues. However, there is one nylon reporting segment customer that exceeds 10% of the nylon segment’s net sales to external customers.

      Due to the additional raw material and manufacturing costs incurred to produce certain yarns and the stringent quality and time sensitivity of the end-use markets of these certain yarns (for example, dyed yarns used in the automotive and furniture markets), sales prices are higher, on average, for these items than for other polyester products used in different end-use applications. Gross margins generally compare favorably for these items absent any significant quality claims which are more prevalent in automotive and home furnishings end uses. Consequently, the loss of customers that purchase significant volumes of dyed yarns could have a significant effect on the operating income of the polyester segment and the consolidated Company.

      Backlog and Seasonality of Business: The Company generally sells its products on an order-by-order basis for both the polyester and nylon reporting segments. Changes in economic indicators and consumer confidence levels can have a significant impact on sales at retail. Deviations between expected sales and actual consumer demand result in significant adjustments to desired inventory levels and, in turn, replenishment

orders placed with suppliers. This changing demand ultimately works its way through the supply chain and impacts the Company. The end result is typically the absence of long-term sales contracts between the Company and its customers even in situations where yarn with unique characteristics is sold to one or very few customers. For substantially all customer orders including those involving more customized yarns, the Company manufactures and ships yarn in accordance with firm orders received from customers specifying yarn type and delivery dates. As a result, the Company does not track unfilled orders for purposes of determining backlog but rather to routinely reconfirm or update the status of potential orders. Consequently, backlog is generally not applicable to the Company. In addition, the Company does not consider its products to be of a seasonal nature.

      Competitive Conditions: The textile industry in which the Company currently operates is competitive. The Company processes and sells both high-volume commodity products and more specialized yarns both domestically and internationally into many end-use markets. Pricing is highly competitive with innovation, product quality and customer service being essential for differentiating the competitors within the industry. Product innovation gives our customers competitive advantages, while product quality is an important factor for improving our customers’ manufacturing efficiencies. The Company’s polyester and nylon segments compete in a worldwide market with a number of other foreign and domestic producers of such yarns. In the sale of polyester filament yarns, major domestic competitors are Nanya, Dillon Yarn Company, Inc., O’Mara, Inc., Spectrum Dyed Yarns, Inc., KOSA and AKRA, S.A. de C.V.; and in the sale of nylon yarns, major domestic competitors are Sapona Manufacturing Company, Inc., McMichael Mills, Inc. and Worldtex, Inc. Additionally, there are numerous foreign competitors that not only sell polyester and nylon yarns in the United States but also import foreign sourced fabric and apparel into the United States and other countries in which the Company does business which adversely impacts the sale of Company polyester and nylon yarns. General economic conditions, such as raw material prices, interest rates, currency exchange rates and inflation rates that exist in different countries have a significant impact on the Company’s competitiveness, as do various country-to-country trade agreements and restrictions.

      Research and Development: The Company spent approximately $1.8 million, $1.9 million and $2.3 million for fiscal years 2005, 2004 and 2003, respectively, on company-sponsored research and development activities. There was no customer-sponsored research and development during the last three fiscal years.

      Compliance with Government Environmental Regulations: Management believes that the operation of the Company’s production facilities and the disposal of waste materials are substantially in compliance with applicable federal, state and local laws and regulations and that there are no material ongoing or anticipated capital expenditures associated with environmental control facilities necessary to remain in compliance with such provisions. The Company incurs normal operating costs associated with the discharge of materials into the environment but does not believe that these costs are material or inconsistent with other domestic competitors.

      Employees: The Company currently employs approximately 3,900 full-time active employees.

      See Note 7 “Business Segments, Foreign Operations and Concentrations of Credit Risk” of the Consolidated Financial Statements of this Report for further information regarding the financial information about geographic areas.

      The Company’s Internet address is: www.unifi.com. Copies of the Company’s reports, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, that the Company files with or furnishes to the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and beneficial ownership reports on Forms 3, 4, and 5, are available as soon as practicable after such material is electronically filed with or furnished to the SEC and maybe obtained without charge by accessing the Company’s web site or by writing Mr. William M. Lowe, Jr. at Unifi, Inc. P.O. Box 19109 Greensboro, North Carolina 27419-9109.

      Following is a summary of principal properties owned or leased by the Company:

      Polyester Segment Properties

      Domestic:

      Foreign:

      Nylon Segment Properties

      Domestic:

      Foreign:

      In addition to the above properties, the corporate administrative office for each of its segments is located at 7201 West Friendly Ave. in Greensboro, North Carolina. Such property consists of a building containing approximately 100,000 square feet located on a tract of land containing approximately 9 acres. This property was purchased at fair market value from the Unifi, Inc. Retirement Savings Plan (the “Plan”) in August 2002, prior to which, the Company leased this property from the Plan.

      All of the above facilities are owned in fee simple, with the exception of a plant in Mayodan, North Carolina which is leased from a financial institution pursuant to a Sale-leaseback Agreement entered into on May 20, 1997, as amended; one warehouse in Kinston, North Carolina, one plant in Bogota, Colombia, one sales office in New York, and one office in Sao Paulo, Brazil. Management believes all the properties are well maintained and in good condition. On July 28, 2004, the Company announced the closure of the European Division, and as of June 30, 2005, the Company had completed the sale of the real property located in Ireland and had substantially completed the sales of all the manufacturing equipment. The Company also terminated the lease relating to two warehouses in Carrickfergus, Ireland. In fiscal year 2005, the Company’s manufacturing plants in the U.S. operated below capacity while the plants in South America operated at or near full capacity. Accordingly, management does not perceive any capacity constraints in the foreseeable future.

      As a result of the Company’s consolidation efforts, the Company has closed or is in the process of closing its sales offices in Germany, France, U.K. and Hong Kong.

      The Company also leases three manufacturing facilities to other manufactures, one of which is leased to UNIFI-SANS Technical Fibers, LLC (“USTF”), a joint venture in which the Company is a 50% owner.

      There are no pending legal proceedings, other than ordinary routine litigation incidental to our business, to which we are a party or of which any of our property is the subject.

      The Company and Dupont entered into a manufacturing Alliance (the “Alliance”) in June 2000 to produce partially oriented polyester filament yarn at its facility at Kinston, North Carolina (the “Kinston Site”). Dupont and the Company have had discussions regarding the Alliance and each party alleged that the other was in breach of material terms of their agreement. Certain of these difference were finally resolved by an Arbitration Panel in June 2003. However, Dupont continued to pursue collection of its claims that the Company had breached its “Transition Period” purchasing obligation from Dupont, which the Arbitration Panel had previously dismissed as it held the Transition Period claims were not properly before it. On April 30, 2004, Dupont sold substantially all of the assets of its textiles and interiors businesses, which were owned by its wholly owned subsidiary, Invista, Inc., to subsidiaries of Koch Industries, Inc. of Wichita, Kansas. Effective September 30, 2004, the Company completed the acquisition of the INVISTA polyester POY manufacturing assets which resulted in the termination of the Alliance Master Agreement, and the release of all claims relating to Alliance disputes among the parties.

      The Company maintains a 34% interest in Parkdale America, LLC (“PAL”), a private company, which produces cotton and synthetic yarns for sale to the textile and apparel industries primarily within North America. PAL is a joint venture with Parkdale Mills, Inc., which manages the PAL operations. The Company accounts for its investment in PAL on the equity method of accounting and as of June 26, 2005, the Company’s carrying investment in PAL (including goodwill value) was $138.8 million.

      The Company was informed by PAL of its participation in activities with competitors in the markets for open-end and air jet spun cotton and polycotton yarns used in the manufacture of hosiery and other garments that may have resulted in violations of US antitrust laws (the “PAL Activities”). PAL informed the Company that it voluntarily disclosed the activities to the U.S. Department of Justice Antitrust Division (the “DOJ”), and that the DOJ has launched an investigation of the activities. PAL informed the Company that it is cooperating fully with the DOJ. The Company believes that it had no involvement whatsoever in the activities at issue and believes it has no liability arising out of such activities or for PAL’s actions.

      The Company has been named in various federal class action lawsuits and a demand for relief under Massachusetts law related to the PAL Activities. The Company has denied all the allegations against it in these claims and intends to vigorously defend itself. The aforementioned federal class action lawsuits have been consolidated into one action in the United States District Court for the Middle District of North Carolina Greensboro Division (the “Court”) under the caption “In Re Cotton Yarn Antitrust Litigation” (the “Consolidated Action”). On January 14, 2005 with the consent of the plaintiffs, the Judge in the case signed a “Notice and Order of Dismissal Without Prejudice and Stipulation for Tolling of Statute of Limitations and Tolling Agreement” (the “Dismissal”). The Dismissal provides, among other things, that the claims against the Company in the litigation are dismissed without prejudice; that the applicable statute of limitations with respect to the claims of the plaintiffs shall be tolled during the pendency of the litigation; that if the plaintiffs’ counsel elect to rename the Company as a defendant in the litigation, for purposes of the statute of limitations, the refiling shall relate back to the date of the filing of the initial complaint in the litigation; and that the Company agrees to provide discovery in the litigation as though it was a party to the litigation, including responding to interrogatories, requests for production of documents, and notices of deposition.

      Effective August 16, 2005, Parkdale Mills, Inc. and PAL signed a Settlement Agreement with the “Class Representatives” and “Class Members” (hereinafter collectively referred to as the “Settlement Class”) in the Consolidated Action agreeing to settle this litigation. Under the terms of the Settlement Agreement, Parkdale Mills, Inc., PAL and their “joint venture partners (with particular reference to Unifi, Inc.)” are released upon final Court approval of the settlement. This settlement must be approved by the Court before it is effective. It is believed that it will take quite some time before the settlement is finally approved. Until the Settlement Agreement is finally approved by the Court, the Company remains unable to determine the level of damages for which PAL may be liable or the impact of such liability on the Company, which impact could be material.

      On September 7, 2005, the Company and Parkdale Mills, Inc. signed an Amendment to the PAL Operating Agreement that provides that the burden of any portion of the settlement amount contemplated in

the Settlement Agreement that is to be borne by PAL will be allocated to and borne by Parkdale Mills, Inc. as a Member of PAL.

      No matters were submitted to a vote of security holders during the fourth quarter for the fiscal year ended June 26, 2005.

      The following list contains the name, age, position and offices held, and the period served in such position or offices for each of the executive officers of the Company.

      BRIAN R. PARKE Mr. Parke is 57 and had been the Manager or President of the Company’s Irish subsidiary (Unifi Textured Yarns Europe Limited) from its acquisition by the Company in 1984 to January 20, 1999, when he was elected President and Chief Operating Officer of the Company. On January 26, 2000, Mr. Parke was elected Chief Executive Officer of the Company. Additionally, Mr. Parke had been a Vice President of the Company since October 21, 1993 and was elected to the Company’s Board of Directors in July 1999. In April 2004, Mr. Parke was elected Chairman of the Board of Directors.

      THOMAS H. CAUDLE, JR. Mr. Caudle is 54 and has been an employee of the Company since 1982. On January 20, 1999, Mr. Caudle was elected as a Vice President of Manufacturing Services of the Company and on July 26, 2000 he was elected as a Senior Vice President in charge of Manufacturing for the Company. In April 2003, Mr. Caudle was elected Vice President of Global Operations.

      BENNY L. HOLDER Mr. Holder is 43 and has been an employee of the Company since January 1995. Prior to coming to the Company, Mr. Holder held various management positions in the Information Technology departments within Memorex Telex from 1990 until 1994 and at Revlon, Inc. from 1994 until 1995. Mr. Holder has held various management positions within the Information Technology area of the Company since joining the Company overseeing all of the Company’s IT operations as Managing Director from June 1999 until January 2001 when he was appointed Vice President and Chief Information Officer.

      WILLIAM M. LOWE, JR. Mr. Lowe is 52 and joined the Company as Vice President and Chief Financial Officer effective January 5, 2004. Prior to being employed by the Company, Mr. Lowe was Executive Vice President and Chief Financial Officer at Metaldyne Corporation an automotive component and systems manufacturer from 2001 to 2003. From 1991 to 2001 Mr. Lowe held various financial positions at Arvinmeritor, Inc. a diversified manufacturer of automotive components and systems. In April 2004, Mr. Lowe was appointed Vice President, Chief Operating Officer and Chief Financial Officer.

      CHARLES F. MCCOY Mr. McCoy is 41, and has been an employee of the Company since January 2000, when he joined the Company as its Assistant Secretary and General Counsel. Mr. McCoy was an Associate Attorney with the law firm of Frazier, Frazier & Mahler, LLP, the firm serving as General Counsel for the Company since 1971, from 1989 until 1993 and a Partner of the firm from 1994 until December 1999. In October 2000, Mr. McCoy was elected as Vice President, Secretary and General Counsel of the Company and Corporate Compliance Officer in 2002.

      These executive officers, unless otherwise noted, were elected by the Board of Directors of the Registrant at the Annual Meeting of the Board of Directors held on October 21, 2004. Each executive officer was elected to serve until the next Annual Meeting of the Board of Directors or until his successor was elected and qualified. No executive officer has a family relationship as close as first cousin with any other executive officer or director.

PART II

      The Company’s common stock is listed for trading on the New York Stock Exchange (“NYSE”) under the symbol “UFI”. The following table sets forth the high and low sales prices of Unifi’s common stock as reported on the NYSE Composite Tape.

      As of September 21, 2005 there were 552 record holders of the Company’s common stock. A significant number of the outstanding shares of common stock which are beneficially owned by individuals and entities are registered in the name of Cede & Co. Cede & Co. is a nominee of The Depository Trust Company, a securities depository for banks and brokerage firms. The Company estimates that there are 4,500 beneficial owners of its common stock.

      No dividends have been paid in the past seven fiscal years and none are expected to be paid in the foreseeable future.

      The following table presents a summary of share repurchases made by Unifi during the fiscal quarter ended June 26, 2005.

      On April 25, 2003, the Company announced that its Board of Directors had reinstituted the Company’s previously authorized stock repurchase plan at its meeting on April 24, 2003. The plan was originally announced by the Company on July 26, 2000 and authorized the Company to repurchase of up to 10.0 million shares of its common stock. During fiscal years 2004 and 2003, the Company repurchased approximately 1.3 million and 0.5 million shares, respectively. The repurchase program was suspended in November 2003 and the Company has no immediate plans to reinstitute the program. There is remaining authority for the Company to repurchase approximately 6.8 million shares of its common stock under the repurchase plan. The repurchase plan has no stated expiration or termination date.

      For information regarding the Company’s equity compensation plans, see Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

      The following discussion of management’s views on the financial condition and results of operations of the Company should be read in conjunction with the Consolidated Financial Statements and Notes included elsewhere in this Annual Report on Form 10-K. The discussion contains forward-looking statements that reflect management’s current expectations, estimates and projections. Actual results for the Company could differ materially from those discussed in the forward-looking statements. Factors that could cause such differences are discussed in “Forward-Looking Statements” below in this section and elsewhere in this Annual Report on Form 10-K.

      The Company conducts its business through three reporting segments, Polyester, Nylon and Sourcing, each of which operates on a global basis. The polyester segment primarily manufactures its products in Brazil, South America and the United States, which has the largest operations and number of locations. The Nylon segment consists of operations in the United States and Colombia, South America. The Sourcing segment operates out of Unifi’s corporate office in Greensboro, North Carolina. Management recently announced that

the Sourcing segment will be closed after completing and delivering all existing programs which is expected to occur during the third quarter of fiscal year 2006.

      The textile industry in the United States continues to remain challenging primarily due to the importation of garments and fabrics from lower wage-based countries and over capacity throughout the world. These two factors have resulted in a declining market for the Company domestically and overseas, which has resulted in lower net sales, gross profits and net income for both the polyester and nylon segments. In addition, the domestic demand for sheer hosiery products continues to decline which also unfavorably impacts the nylon segment. Because of these general industry trends, the Company’s net sales, gross profits and net income have been trending downward for the past several years. These challenges continue to impact the Company and we expect that they will continue to impact the Company for the foreseeable future. The Company’s success going forward continues to be primarily based on its ability to pass along raw material price increases to its customers and to improve the mix of product offerings to more premium and value-added products, and to implement cost saving strategies which will improve our operating efficiencies. The Company is also highly committed and dedicated to identifying strategic opportunities to participate in the Asian textile market, specifically China, where the growth rate is estimated to be within a range of 7% to 9%, which is much higher than the U.S. market.

      The Company’s primary objective is to return to profitability. During fiscal 2005, the Company focused on reducing costs throughout its operations and continuing to improve working capital. The dyed facility located in Manchester, England was closed in June 2004. On July 28, 2004, the Company announced management’s decision to close the European manufacturing operations and associated sales offices (the “Division”). The manufacturing operations in Ireland ceased October 31, 2004. As a result of these plant closings, the financial results of both the U.K. and Ireland facilities have been re-classified as “discontinued operations” for all periods presented in the Consolidated Statements of Operations.

      On September 30, 2004, the Company completed its acquisition of the INVISTA polyester filament manufacturing assets located in Kinston, North Carolina, including inventories, valued at approximately $24.4 million which was seller financed. The acquisition resulted in the termination of the Alliance Master Agreement which eliminated the Put and Call provisions of that agreement and released all claims relating to Alliance disputes among the parties. In the second quarter of fiscal year 2005, the Company announced that it would curtail two production lines and downsize the Kinston facility which was successfully completed in the third quarter of fiscal 2005.

      The Company has sought to expand its presence in various foreign markets, including China. On October 21, 2004, the Company announced that Unifi and Sinopec Yizheng Chemical Fiber Co., Ltd. (“YCFC”) have signed a non-binding letter of intent to form a joint venture to manufacture, process and market polyester filament yarn in YCFC’s facilities in Yizheng, Jiangsu Province, Peoples Republic of China. On or about June 10, 2005, Unifi and YCFC entered into an Equity Joint Venture Contract (the “JV Contract”), which provided several closing conditions, including Governmental and Regulatory approval of the transaction. Under the terms of the JV Contract, each company owns a 50% equity interest in the joint venture company, which will be called Yihua Unifi Fibre Company Limited (“YUFI”). The Company will ultimately invest $30 million in cash in YUFI for its 50% equity interest. This commitment is expected to be funded by the proceeds of capital asset sales relating to the closure of the European manufacturing operations. The joint venture transaction closed on or about August 3, 2005 and on or about August 4, 2005, the Company contributed its initial capital contribution of $15 million in cash to YUFI. The Company expects to transfer an additional $15 million to YUFI during first quarter of fiscal 2006.

      The following table set forth the loss from continuing operations components for each of the Company’s business segments for fiscal year 2005 and fiscal year 2004. The table also sets forth each of the segments’ net sales as a percent to total net sales, the net income components as a percent to total net sales and the percentage increase or decrease of such components over the prior year:

      For the year ended June 26, 2005, the Company recognized a $34.9 million loss from continuing operations before income taxes which was a $35.2 million improvement from the prior year. The improvement in continuing operations were primarily attributable to $38.7 million in charges for asset write downs and a goodwill impairment included in the prior fiscal year. During the fiscal year 2005, raw material prices declined slightly while selling prices continued to increase in an effort to increase gross margin. The primary drivers to the fiscal year 2005 LIFO adjustments were increases in nylon raw material prices and higher values due to the product mix for the nylon inventories whereas in the prior fiscal year both polyester and nylon raw material pricing remained comparable.

      Consolidated net sales from continuing operations increased from $667.8 million to $799.4 million, or 19.7%, for the fiscal year. Included in the current fiscal year net sales amounts are $117.7 million related to revenue generated from the newly acquired POY business in Kinston, NC. Unit volume from continuing operations increased 19.6% for the year, while average net selling prices increased by 0.2%. The primary driver of the increase in unit volumes is the acquisition of the Kinston manufacturing facility from INVISTA. The increase in net selling price was reduced by 10.5% due to the Kinston POY plant acquisition which sells lower priced commodity products. See the Polyester discussion below for further analysis including the effects of the acquisition of the Kinston facility on the current fiscal year.

      At the segment level, polyester dollar net sales accounted for 73.4% in the current fiscal year compared to 72.2% in fiscal year 2004. Nylon accounted for 25.9% of dollar net sales for the current fiscal year compared to 27.6% for the prior fiscal year. Sourcing accounted for 0.7% and 0.2% of dollar net sales for the current fiscal year and prior fiscal year, respectively.

      Gross profit from continuing operations decreased $9.5 million to $30.7 million, for the current fiscal year. This decrease is primarily attributable to higher volumes and lower average selling prices for both the polyester and nylon segments and is also a result of a delay in passing increased fiber prices to the Company’s customers during the first half of the fiscal year. Also, the Company recognized, as a reduction of cost of sales, cost savings and other benefits from the Alliance of $8.4 million in fiscal year 2005 compared to $38.2 million in fiscal year 2004. In addition, the Company sold off inventory during the fourth quarter that was slow moving at below cost in order to reduce its inventories and improve its working capital position.

      Selling, general, and administrative expenses decreased by 6.9% or $3.2 million for the year. The decrease in selling, general, and administrative expenses is due to downsizing of corporate departments and their related costs. During the current fiscal year the Company incurred approximately $1.1 million in professional fees associated with its efforts in becoming compliant with the Sarbanes-Oxley Act of 2002.

      For the year ended June 26, 2005, the Company recorded a $13.5 million provision for bad debts. This compares to $2.6 million recorded in the prior fiscal year. The increase relates to the domestic operations and is primarily due to the write off of one customer who filed bankruptcy in May 2005 resulting in $8.2 million in additional bad debt expense. Fiscal year 2005 continued to be a challenging year for the U.S. textile industry, particularly in the apparel sector while the financial viability of certain customers continues to require close management scrutiny in these difficult economic and industry conditions. Management believes that its reserve for uncollectible accounts receivable is adequate.

      Interest expense increased from $18.7 million in fiscal year 2004 to $20.6 million in fiscal year 2005. The increase in interest expense is primarily due to the purchase of the Kinston POY manufacturing facility from INVISTA, which was 100% seller financed. The Company had no outstanding borrowings on its domestic bank line at June 26, 2005 and June 27, 2004, and has had no borrowings on the credit facility since October 3, 2002. The weighted average interest rate of Company debt outstanding at June 26, 2005 and June 27, 2004 was 6.7% and 6.4%, respectively. Interest income decreased from $2.4 million in fiscal year 2004 to $2.3 million in fiscal year 2005.

      Other income/expense changed from $2.6 million of income in fiscal year 2004 to $2.3 million of income in fiscal year 2005. Fiscal year 2004 income included net gains from the sale of property and equipment of $3.3 million offset by other expenses of $0.7 million. The current fiscal year income includes net gains from

the sale of property and equipment of $1.8 million and net unrealized gains on hedging contracts of $1.7 million; offset by charges relating to currency translations and other expenses of $0.9 million.

      Equity in the net profits of our equity affiliates, PAL, USTF and UNF totaled $6.8 million in fiscal year 2005 compared to equity in net loss of $7.1 million in fiscal year 2004. The Company’s share of PAL’s earnings improved from a $6.9 million loss in fiscal year 2004 to $6.4 million of income in fiscal year 2005. The increase in earnings is primarily attributable to PAL which realized a higher operating profit due primarily to lower cotton prices and also realized net gains on cotton futures contracts. PAL realized gains on future contracts of $1.4 million in fiscal year 2005 compared to realized net losses of $4.7 million on future contracts for cotton purchases in fiscal year 2004. PAL is forecasting a profitable calendar year 2005 and the Company expects to continue to receive cash distributions from PAL.

      The Company recorded minority interest income of $0.5 million for fiscal year 2005 compared to minority interest income of $6.4 million in the prior fiscal year. Minority interest recorded in the Consolidated Statements of Operations primarily relates to the minority owner’s share of the earnings of Unifi Textured Polyester, LLC (“UTP”). Unifi had an 85.4% ownership interest and Burlington Industries, Inc., now known as International Textile Group, LLC (“ITG”), had a 14.6% interest in UTP. In April 2005, the Company acquired ITG’s ownership interest for $0.9 million in cash.

      In the fourth quarter of fiscal year 2005, the Company’s nylon segment recorded a $0.6 million charge to write down to fair value less cost to sell 166 textile machines that are held for sale.

      The Company has established a valuation allowance against its deferred tax assets relating primarily to North Carolina income tax credits. The valuation allowance decreased $2.2 million in fiscal year 2005 compared to an increase of $2.6 million in fiscal year 2004. The gross decrease of $3.0 million in fiscal year 2005 consisted of the expiration of unused North Carolina income tax credits ($2.2 million) and the expiration of a long-term capital carryforward ($0.8 million). Due to lower estimates of future state taxable income, the portion of the valuation allowance that relates to North Carolina income tax credits increased $0.8 million and $2.6 million in fiscal years 2005 and 2004, respectively. In fiscal year 2004, the increase to the reserve also included $0.8 million that related to a long-term capital loss carryforward that the Company did not expect to utilize before it was scheduled to expire in fiscal year 2005. The net impact of changes in the valuation allowance to the effective tax rate reconciliation for fiscal years 2005 and 2004 were 2.4% and 5.0%, respectively. The percentage decrease from fiscal year 2005 to fiscal year 2004 is primarily attributable to the stabilization of forecasted state taxable income.

      The Company recognized an income tax benefit in the current fiscal year, at a 40.5% effective tax rate compared to an income tax benefit, at a 36.3% effective tax rate in fiscal year 2004. The current fiscal year effective rate was positively impacted by a reduction in the change to the valuation allowance, an increase in the utilization of state tax losses, and a change in the tax status of a subsidiary. The current fiscal year effective rate was also positively impacted by the recording of a deferred tax asset for a foreign subsidiary that should have been previously recognized. The Company recorded this deferred tax asset of $1.2 million in the fourth quarter. The Company evaluated the effect of the adjustment and determined that the differences were not material for any of the periods presented in the Consolidated Financial Statements. The current fiscal year effective tax rate was negatively impacted by the accrual required by management’s decision to repatriate approximately $15.0 million from controlled foreign corporations under the provisions of the American Jobs Act of 2004 (the “Act”).

      The Act creates a temporary incentive for U.S. multinational corporations to repatriate accumulated income earned outside the U.S. by providing an 85% dividend received deduction for certain dividends from controlled foreign corporations. According to the Act, the amount of eligible repatriation is limited to $500 million or the amount described as permanently reinvested earnings outside the U.S. in the most recent audited financial statements filed with the Securities and Exchange Commission (the “SEC”) on or before June 30, 2003. As a result of liquidating Unifi’s European manufacturing operations, the Company expects to repatriate any excess cash that remains after re-investing approximately $30.0 million in a joint venture located in China. At this time, Unifi expects to repatriate approximately $15.0 million. The Company has not made any changes to its position on the reinvestment of other foreign earnings.

      As a result of the above and after restating the prior fiscal year for discontinued operations, the Company realized during the fiscal year 2005 a net loss from continuing operations of $20.8 million or $(0.40) per share, a loss from discontinued operations — net of tax of $21.6 million or $(0.41) per share an, an extraordinary gain — net of taxes of $0 of $1.2 million or $0.02 per share for a net loss of $41.2 million or $(0.79) per share compared to a fiscal year 2004 net loss from continuing operations of $44.7 million or $(0.86) per share and a loss from discontinued operations — net of tax of $25.1 million or $(0.48) per share for a net loss of $69.8 million or $(1.34) per share.

      The following table sets forth the segment operating loss components for the polyester segment for fiscal year 2005 and fiscal year 2004. The table also sets forth the percent to net sales and the percentage increase or decrease over the prior year:

      Fiscal year 2005 polyester net sales increased $105.1 million, or 21.8% compared to fiscal year 2004. The Company’s polyester segment sales volumes and average unit prices increased approximately 21.3% and 0.5%, respectively. The increase was due mainly to the acquisition of the Kinston, North Carolina POY manufacturing facility on September 30, 2004 and increased sales prices that were realized in the second half of the fiscal year.

      The percentages reflected in the column “Consolidated without Kinston Acquisition” in the table below are non-GAAP financial measures used by management in evaluating the business which management believes provides investors with a more accurate picture of the trends relating to price and volume of the processed polyester yarn manufactured and sold by the Company. The Kinston POY sales represent sales of a relatively high volume and lower priced commodity used in the production of processed polyester yarn. The table below displays a percentage comparison of the polyester segment sales and volume data to the corresponding prior fiscal year:

      The 11.0% increase in average selling prices (Consolidated without Kinston Acquisition) reflects the Company’s success in raising its textured polyester prices during fiscal year 2005 against an economic period of rising raw material prices. Domestically, Unifi’s polyester sales volumes increased 28.3% while average unit prices declined approximately 4.5%. Sales from our Brazilian texturing operation, on a local currency basis, increased 3.7% over the prior fiscal year due primarily to sales price adjustments for changes in the inflation

index which were significant during the fiscal year. The impact on net sales from this operation on a U.S. dollar basis as a result of the change in currency exchange rate was an increase of $6.1 million. Other than the Brazilian operations, the Company does not have any other significant foreign operations where movements in currency exchange rates are material.

      Gross profit on sales for our polyester operations decreased $4.2 million, or 12.9%, over fiscal year 2004, while gross margin (gross profit as a percentage of net sales) declined from 6.8% in fiscal year 2004 to 4.9% in fiscal year 2005. The reduction from the prior year is primarily attributable to an increase in fixed and variable manufacturing costs which were 38.4% of net sales in fiscal year 2005 compared to 37.5% of net sales in fiscal year 2004. In addition to the increase in fixed and variable manufacturing costs, fiber cost increased as a percent of net sales from 52.6% in fiscal year 2004 to 54.8% in fiscal year 2005. In addition, the Company recognized, as a reduction of cost of sales, cost savings and other benefits from the Alliance of $8.4 million and $38.2 million for the fiscal years ended June 26, 2005 and June 27, 2004, respectively. After completing the acquisition of the POY manufacturing facility in Kinston, North Carolina from INVISTA, the Alliance payments to Unifi ended.

      Selling, general and administrative expenses for this segment decreased $4.5 million from fiscal years 2004 to 2005. While the methodology to allocate domestic selling, general and administrative costs remained consistent between fiscal year 2004 and fiscal year 2005, the percentage of such costs allocated to each segment are determined at the beginning of every year based on specific cost drivers. The polyester segment’s share of these costs for fiscal year 2005 were lower compared with fiscal year 2004 due to increases in the nylon segment’s share based on the cost drivers.

      The polyester segment net sales, gross profit and selling, general and administrative expenses for fiscal year 2005 were 73.4%, 92.8% and 70.2%, respectively, of consolidated amounts compared to 72.2%, 81.3% and 75.2%, respectively for fiscal 2004.

      Our international polyester pre-tax results of operations for the polyester segment’s Brazilian location declined $4.6 million in fiscal year 2005 over fiscal year 2004. This decline is primarily due to a 4.8% increase in the cost of fiber, a 4.5% decrease in volume and a $0.5 million increase in selling, general and administrative costs.

      The following table sets forth the segment operating loss components for the nylon segment for fiscal year 2005 and fiscal year 2004. The table also sets forth the percent to net sales and the percentage increase or decrease over the prior year:

      The nylon segment net sales increased $22.3 million, or 12.1% in fiscal year 2005 compared to fiscal year 2004. Unit volumes for fiscal year 2005 increased 5.9% while the average selling price increased 6.2%. The increase in sales volume and price continue to be primarily attributable to higher sales at retail resulting from the Sara Lee Branded Apparel supply agreement (“Sara Lee Agreement”) which started in July 2004. These incremental sales were offset by erosion in our U.S. customer base due primarily to an increase in the importation of socks into the domestic market and a decline in domestic demand for sheer hosiery products.

      Nylon gross profit decreased $5.1 million, or 66.5% in fiscal year 2005 and gross margin decreased from 4.2% in fiscal year 2004 to 1.2% in fiscal year 2005. This was primarily attributable to reductions in per unit sales prices in excess of reduced unit costs for raw materials. Fiber costs increased from 62.0% of net sales in fiscal year 2004 to 64.5% of net sales in fiscal year 2005 due to the incremental change in product mix driven by the Sara Lee Agreement. Fixed and variable manufacturing costs decreased as a percentage of sales from 30.9% in fiscal year 2004 to 30.6% in fiscal year 2005.

      Selling, general and administrative expense for the nylon segment increased $0.8 million in fiscal year 2005. This increase is due to a significantly larger allocation of selling, general and administrative expenses based on cost drivers which were affected by increased sales volumes directly related to the Sara Lee Agreement. The increase in volumes attributable to the Sara Lee Agreement more than offset the overall reduction of selling, general and administrative expense that the Company realized.

      The nylon segment net sales, gross profit and selling general and administrative expenses for fiscal year 2005 were 25.9%, 8.4% and 27.6%, respectively, of consolidated amounts compared to 27.6%, 19.1% and 24.0%, respectively, for fiscal year 2004.

      The following table sets forth the segment operating loss components for the sourcing segment for fiscal year 2005 and fiscal year 2004. The table also sets forth the percent to net sales and the percentage increase or decrease over the prior year:

      Sourcing was formalized and commenced operations during January 2004. During fiscal year 2005 the business generated a loss of $1.3 million compared to a loss of $0.5 million in fiscal year 2004. Selling, general and administrative expenses are all direct charges; the business unit does not incur any allocated expenses. In July 2005, the Company announced its plan to phase out the sourcing segment during the first half of fiscal year 2006.

      The following table set forth the loss from continuing operations components for each of the Company’s business segments for fiscal year 2004 and fiscal year 2003. The table also sets forth each of the segments net sales as a percent to total net sales, the net income components as a percent to total to net sales and the percentage increase or decrease of such components over the prior year:

      For the year ended June 26, 2004, the Company recognized a $70.1 million loss from continuing operations which was a $51.4 million increase from the prior fiscal year. The increase in the loss from continuing operations was primarily attributable to $25.2 million in charges for asset write downs and $13.5 million for goodwill impairments. The decline in income was offset by a decrease of $1.5 million in

LIFO reserves during fiscal year 2004. The primary drivers to the fiscal year 2004 LIFO adjustments were decreases in polyester raw material pricing over fiscal year 2003.

      Consolidated net sales from continuing operations decreased from $747.7 million to $667.8 million, or 10.7%, for the 2004 fiscal year. Unit volumes from continuing operations decreased 7.5% for fiscal year 2004, while average net selling prices declined by 3.2%. These decreases were primarily due to the effects of the weak economy and the reduced consumer spending which impacted textile and apparel manufacturers. Additionally, the importation of fabric and apparel primarily from Asia into the domestic market continued to erode the business of the Company’s U.S. based customers causing the Company to lose more of its market share.

      At the segment level, polyester dollar net sales accounted for 72.2% in fiscal year 2004 compared to 72.4% in fiscal year 2003. Nylon accounted for 27.6% of dollar net sales for fiscal year 2004 compared to 27.6% for the prior year period. Sourcing was formalized and commenced operations during January 2004. The first six months of operations clearly reflected that the business was in its start-up phase. For the period January through June 2004, the business generated $1.4 million in dollar net sales.

      Gross profit decreased $31.6 million to $40.3 million during fiscal year 2004. The reduction over the prior year was primarily attributable to an increase in fixed and variable manufacturing costs as a result of lower volumes and a deferral in the benefits from restructuring that were realized later in the fiscal year.

      Selling, general, and administrative expenses decreased by 3.8% or $1.8 million for the fiscal year. The decrease in selling, general, and administrative expenses was primarily due to the Company’s efforts through restructuring to reduce corporate departments and their related costs. During the fiscal year ended June 27, 2004, the Company incurred $0.7 million in consulting charges associated with its effort in becoming compliant with the Sarbanes-Oxley Act of 2002.

      For the year ended June 27, 2004, the Company recorded a $2.6 million provision for bad debts. This compared to $3.8 million recorded in the fiscal year 2003. Fiscal year 2004 continued to be a challenging year for the U.S. textile industry, particularly in the apparel sector while the financial viability of certain customers continues to require close management scrutiny in these difficult economic and industry conditions.

      Interest expense decreased from $19.7 million in fiscal year 2003 to $18.7 million in fiscal year 2004. The decrease in interest expense was a function of both lower levels of debt and lower weighted average interest rates throughout fiscal year 2004 compared to the fiscal year 2003. The Company had no outstanding borrowings on its domestic bank line at June 27, 2004 and June 29, 2003, and has had no borrowings on the credit facility since October 3, 2002. The weighted average interest rate of Company debt outstanding at June 27, 2004 and June 29, 2003 was 6.4% and 6.3%, respectively. Interest income increased from $1.5 million in fiscal year 2003 to $2.4 million in fiscal year 2004 due primarily to an increase in the interest rate earned by the Brazilian operation on its bank deposits.

      Other income/expense changed from $0.1 million of income in fiscal year 2003 to $2.6 million of income in fiscal year 2004. Fiscal year 2003 included the recognition in income of non-refundable fees collected in the amount of $1.0 million associated with our technology license agreement with Tuntex (Thailand). Fiscal year 2004 income included net gains from the sale of property and equipment of $3.3 million offset by other expenses of $0.7 million.

      Equity in the net losses, to the extent recognized, of our equity affiliates, PAL, USTF and UNF totaled $7.1 million in fiscal year 2004 compared to equity in net income of $10.6 million in fiscal year 2003. The decrease in net income primarily related to our investment in PAL. The Company’s share of PAL’s net losses in fiscal year 2004 was $6.9 million compared to net income of $11.7 million in fiscal year 2003. PAL’s earnings from operations decreased primarily due to increased cotton prices that it was unable to pass on to its customers due to sales contract commitments. In addition, PAL realized $4.7 million of net losses on futures contracts for cotton purchases in the Company’s 2004 fiscal year compared to $3.0 million in net gains on futures contracts in the Company’s 2003 fiscal year.

      The Company recorded minority interest income of $6.4 million for fiscal year 2004 compared to an expense of $4.8 million in the fiscal year 2003. Minority interest recorded in the Consolidated Statements of Operations primarily related to the minority owner’s share of the earnings and cash flows of UTP. UTP was formed with Burlington Industries, Inc., which is now known as ITG, on May 29, 1998, whereby Unifi has an 85.4% ownership interest and ITG has a 14.6% interest. For the first five years, ITG was entitled to the first $9.4 million of annual net earnings and the first $12.0 million of UTP’s cash flows on an annual basis, less the amount of UTP net earnings. Subsequent to June 2, 2003, earnings and cash flows of UTP are allocated based on ownership percentages.

      The Company, after discontinued operations reclassifications, recorded restructuring charges in fiscal years 2004 and 2003 of $8.2 million and $10.6 million, respectively. Due to the challenging business conditions over the past two fiscal years, the Company found it necessary to implement restructuring plans in both years. The fiscal year 2003 restructuring plan consisted primarily of employee severance and related costs for 680 management and production level workers, $2.4 million of domestic severance, $5.4 million of lease costs associated with the closure of an air jet texturing plant in Altamahaw, North Carolina, and $0.2 million in other related restructuring charges.

      In June 2000 the Company and Dupont formed an Alliance to integrate each company’s polyester POY manufacturing facilities into a single production unit to enable each company to match production with the best assets available, significantly improving product quality and yields. On April 4, 2001, DuPont shut its Cape Fear POY facility allowing for the acceleration of the benefits of the Alliance by shutting down older filament manufacturing operations and transferring production to lower cost, more modern and flexible assets. As a result of DuPont shutting down the Cape Fear facility, the Company recognized, in the fourth quarter of 2001, a $15.0 million charge for its 50% share of the severance and costs to dismantle the facility. As of March 28, 2004, the project was completed and the Company’s actual share of the severance and dismantlement costs was $11.3 million. Accordingly, the Company in fiscal years 2004 and 2003 reflected reductions of previously recorded amounts of $0.2 million and $3.5 million, respectively, in the Consolidated Statements of Operations.

      The Company concluded its Arbitration proceedings with Dupont regarding the Alliance in June 2003. The award owed by Unifi to Dupont as a result of the Arbitration panel ruling was paid in June 2003. In addition, the line item “Arbitration costs and expenses” in the Consolidated Statements of Operations includes professional fees incurred throughout the applicable fiscal year. In fiscal year 2004, only $0.2 million of legal fees were related to Dupont’s claim.

      In fiscal year 2004, the Company recorded a goodwill impairment charge of $13.5 million in the polyester segment. In addition, the Company was also required to record an impairment charge of $25.2 million relating to its long-lived domestic polyester assets. For further discussion, see Note 14 “Impairment Charges” in the Consolidated Financial Statements.

      The Company has established a valuation allowance against its deferred tax assets relating primarily to North Carolina income tax credits and a long term capital loss carryforward. The valuation allowance increased $2.6 million in fiscal year 2004 compared to an increase of $2.7 million in fiscal year 2003. The gross increase of $3.5 million in fiscal year 2004 was partially offset by a $0.8 million deduction to the valuation allowance due to the expiration of unused North Carolina income tax credits, which were written off in fiscal year 2004. Due to lower estimates of future state taxable income, the portion of the valuation allowance that relates to North Carolina income tax credits increased $2.6 million and $2.7 million in fiscal years 2004 and 2003, respectively. In fiscal year 2004, the increase to the reserve also included $0.8 million that related to a long-term capital loss carryforward that the Company did not expect to utilize before it was scheduled to expire in fiscal year 2005. The net impact of changes in the valuation allowance to the effective tax rate reconciliation for fiscal years 2004 and 2003 was 5.0% and 14.6%, respectively. The percentage decrease from fiscal year 2004 to fiscal year 2003 is primarily attributable to the larger pre-tax loss in fiscal year 2004 compared to fiscal year 2003.

      The Company recognized a tax benefit in fiscal year 2004, at a 36.3% effective tax rate compared to a tax benefit, at a 13.9% effective tax rate in fiscal year 2003. A primary reason for the difference between the

statutory and effective tax rate in both fiscal years 2004 and 2003 is due to changes to the deferred tax asset valuation allowance relating primarily to North Carolina income tax credits. The fiscal year 2004 effective tax rate was positively impacted by a decrease in gains realized from surrendering of life insurance policies, a reduction in the change to the valuation allowance, and an increase in the utilization of state tax losses. In fiscal year 2003, the effective tax rate was negatively impacted due to an increase in the valuation allowance relating primarily to North Carolina income tax credits. Additionally, due to a change in the legal entity structure, a deferred tax asset associated with a state net operating loss carryforward was written off in fiscal year 2003. The combined effect of the above items in fiscal years 2004 and 2003 was partially offset by the earnings of certain foreign operations, which were taxed at lower effective tax rates than the US statutory rate.

      As a result of the above and after restating the financial results for discontinued operations, the Company realized during the fiscal year 2004 a net loss from continuing operations of $44.7 million or $(0.86) per share and a loss from discontinued operations — net of tax of $25.1 million or $(0.48) per share for a net loss of $69.8 million or $(1.34) per share compared to a fiscal year 2003 net loss from continuing operations of $16.1 million or $(0.30) per share and a loss from discontinued operations — net of tax of $11.1 million or $(0.21) per share for a net loss of $27.2 million or $(0.51) per share.

      The following table sets forth the segment operating profit components for the polyester segment for fiscal year 2004 and fiscal year 2003. The table also sets forth the percent to net sales and the percentage increase or decrease over the prior year:

      Fiscal year 2004 polyester segment net sales decreased $59.5 million, or 11.0% compared to fiscal year 2003. The decrease from fiscal year 2003 was primarily attributable to a continuing reduction of average unit prices and volumes as the effects of the weak economy and reduced consumer spending impacted textile and apparel manufacturers. Additionally, the importation of fabric and apparel primarily from Asia into the domestic market continued to erode the business of our U.S. based customers. For fiscal year 2004, the Company’s polyester segment’s sales volumes and average unit prices declined approximately 8.4% and 2.6%, respectively. Domestically, Unifi’s polyester sales volumes declined 12.50% while average unit prices declined approximately 3.1%. Sales from our Brazilian texturing operation, on a local currency basis, increased 6.7% over fiscal year 2003 due primarily to sales price adjustments for changes in the inflation index which were significant during fiscal year 2004 and due to a 10.9% increase in volumes. The impact on net sales from this operation on a U.S. dollar basis as a result of the change in currency exchange rate was an increase of $8.9 million.

      Gross profit on sales for our polyester operations decreased $28.2 million, or 46.3%, over fiscal year 2003, while gross margin (gross profit as a percentage of net sales) declined from 11.3% in fiscal year 2003 to 6.8% in fiscal year 2004. The reduction over the prior year was primarily attributable to an increase in fixed and

variable manufacturing costs which were 37.5% of net sales in fiscal year 2004 compared to 31.0% of net sales in fiscal year 2003 as a result of lower volumes. In addition, the Company recognized, as a reduction of cost of sales, cost savings and other benefits from the Alliance of $38.2 million and $34.6 million for the fiscal years ended June 27, 2004 and June 29, 2003, respectively.

      Selling, general and administrative expenses for this segment decreased $1.9 million from fiscal year 2003 to 2004. This decrease was primarily due to reductions of salaries and benefits as a result of restructuring in fiscal year 2004. While the methodology to allocate domestic selling, general and administrative costs remained consistent between fiscal year 2003 and fiscal year 2004, the percentage of such costs allocated to each segment was determined at the beginning of every year based on specific cost drivers. The polyester segment’s share of such costs for fiscal year 2004 was consistent with fiscal year 2003.

      Pre-tax results of operations for the polyester segment’s Brazilian location improved $0.4 million in fiscal year 2004 over fiscal year 2003. This improvement in the Brazilian operations reflected improved manufacturing efficiencies, an expanded customer base and continued efforts to increase sales of value-added products.

      The Polyester segment net sales, gross profit and selling general and administrative expenses for fiscal year 2004 were 72.2%, 81.3% and 75.2%, respectively, of consolidated amounts compared to 72.4%, 84.8% and 76.3%, respectively, for fiscal year 2003.

      The following table sets forth the segment operating loss components for the nylon segment for fiscal year 2004 and fiscal year 2003. The table also sets forth the percent to net sales and the percentage increase or decrease over the prior year:

      Nylon segment net sales decreased $21.8 million, or 10.6% in fiscal year 2004 compared to fiscal year 2003. Unit volumes for fiscal year 2004 decreased by 0.1%, while average sales prices, based on product mix, decreased 10.5%. The reductions in sales volume and price continued to be primarily attributable to slower sales at retail resulting from the uncertain economy and consumer spending. Additionally, importation of fabric and apparel into the domestic market continued to erode the business of our U.S. based customers.

      Nylon gross profit decreased $3.2 million, or 29.7% in fiscal year 2004 and gross margin decreased from 5.3% in fiscal year 2003 to 4.2% in 2004. This was primarily attributable to reductions in per unit sales prices in excess of reduced unit costs for raw materials. Fixed and variable manufacturing costs increased as a percentage of sales from 30.5% in fiscal year 2003 to 30.9% in fiscal year 2004.

      Selling, general and administrative expense for the nylon segment decreased $0.3 million in fiscal year 2004 compared to fiscal year 2003. This decrease was similar to the decrease realized in the polyester segment. See further discussion on selling, general and administrative expenses under the polyester segment above for further explanation.

      The Nylon segment net sales, gross profit and selling general and administrative expenses for fiscal year 2004 were 27.6%, 19.1% and 24.0%, respectively, of consolidated amounts compared to 27.6%, 15.2% and 23.7%, respectively, for fiscal year 2003.

      The following table sets forth the segment operating loss components for the sourcing segment for fiscal year 2004. The table also sets forth the percent to net sales:

      Sourcing was formalized and commenced operations during January 2004. The first six months of operations clearly reflected that the business was in its start-up phase. For the period January through June 2004, the business generated a negative gross margin of $0.1 million. Selling general and administrative expenses were all direct charges; the business unit did not incur any allocated expenses.

      The textile industry in the United States continues to remain challenging primarily due to the importation of garments and fabrics from lower wage-based countries and over capacity throughout the world. These two factors have resulted in a declining market for the Company domestically and overseas, which has resulted in lower net sales, gross profits and net income for both the polyester and nylon segments. In addition, the domestic demand for sheer hosiery products continues to decline which also unfavorably impacts the nylon segment. Because of these general industry trends, the Company’s net sales, gross profits and net income have been trending downward for the past several years. These challenges continue to impact the Company and we expect that they will continue to impact the Company for the foreseeable future. The Company’s success going forward continues to be primarily based on its ability to pass along raw material price increases to its customers and to improve the mix of product offerings to more premium and value-added products, and to implement cost saving strategies which will improve our operating efficiencies. The Company is also highly committed and dedicated to identifying strategic opportunities to participate in the Asian textile market, specifically China, where the growth rate is much higher than within the U.S. market.

      On August 2, 2005, President Bush signed into law the U.S.-Dominican Republic — Central America Free Trade Agreement (“CAFTA”) which is a permanent agreement with no ending date that provides for duty free treatment of most apparel and textile products. The agreement includes a number of measures that will affect textile and apparel trade between the seven signatory countries which include the United States, Dominican Republic, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua. Due to the passage of this agreement, the Company will continue its focus on marketing and sales opportunities to increase its share of business in the CAFTA and Andean regions which are continuing to be steady in their supply to the U.S.

      The World Trade Organization, as part of a staged quota removal, has eliminated all remaining textile and apparel quotas effective January 1, 2005 and the U.S. and the European Union have subsequently called for safe-guard provisions against China which would cause uncertainty in the Company’s global markets. Recent media coverage regarding the growth of imports from China has tainted the outlook for the textile industries in the U.S. The Company, through strategic initiatives, plans to participate in the growing China markets through its investment in YUFI. In addition, the Company will focus on marketing and sales opportunities to increase its share of business in the Caribbean Basin Initiative and Andean regions which are continuing to be steady in their supply to the U.S.

      As a result of Hurricane Katrina, prices of paraxylene, a feedstock used in polymer production, have increased sharply. The Company has passed this raw material price increase along to all of its customers. Unifi believes that the price increase will be temporary, and accordingly, the Company expects to be able to reduce this surcharge in the near future. As a result of Unifi’s decision to pass along the raw material price increases

to its customers, the Company could lose a moderate portion of its business. The impact on raw material prices and supply as a result of Hurricane Rita cannot be determined as of September 23, 2005.

Liquidity and Capital Resources

      While the Company operated at a loss in fiscal year 2005, non-cash charges of depreciation and amortization of $52.9 million, the provision for bad debt and quality claims of $13.5 million, noncurrent assets of $4.1 million, income taxes of $1.1 million and asset impairment charges of $0.6 million resulted in the generation of $53.4 million as compared to $21.4 million for fiscal year 2004. Other significant sources of cash from continuing operations were lower inventories and accounts receivable of $35.3 million and $8.3 million, respectively. Continuing operations cash uses include the loss from operations of $20.8 million, reductions in accounts payable and accrued expenses of $15.6 million, decreases in deferred taxes of $19.8 million, gains from the sale of capital assets of $1.8 million, income from unconsolidated equity affiliates of $2.4 million, other amounts of $1.8 million and recoveries of restructuring charges of $0.3 million. The prevailing items effecting deferred taxes were depreciation in excess of federal tax depreciation, increases in reserves for accounts receivables and severance, and increases in net operating losses which reduced the deferred tax obligation by $10.0 million, $3.6 million, and $4.1 million, respectively. The line item “Other” in the cash provided by continuing operating activities section of the Consolidated Statements of Cash Flows primarily includes minority interest and an increase in cash surrender value of life insurance policies. Working capital changes have been adjusted to exclude the effects of acquisitions and currency translation for all years presented, where applicable. Net working capital at June 26, 2005 was $221.1 million.

      The Company utilized a net $4.5 million for net investing activities which included uses of $9.4 million for capital expenditures, $2.3 million for acquisition related costs, and $2.7 million for a deposit of restricted cash; offset by increases to investing activities include $6.1 million for return of capital on investments from equity affiliates, $3.2 million for proceeds from the sales of capital assets and $0.5 million, net for other investing activities. The Company had a $0.1 million increase from financing activities due to the issuance common of stock relating to the exercise of stock options. Since October 3, 2002, the Company has had no amounts outstanding under its bank credit facility.

      The Company is not committed for any significant capital expenditures but expects to spend within a range of $10.0 to $15.0 million for capital expenditures during fiscal year 2006.

      The Company periodically evaluates the carrying value of its polyester and nylon segments long-lived assets, including property, plant and equipment and intangibles, to determine if such assets are impaired whenever events or changes in circumstances indicate that a potential impairment has occurred. The importation of fiber, fabric and apparel has continued to adversely impact sales volumes and margins for these operations and has negatively impacted the U.S. textile and apparel industry in general. See “Goodwill and Other Intangible Assets” and “Long-Lived Assets” under Note 1 “Significant Accounting Policies and Financial Statement Information” for further information regarding the accounting guidance applicable to these assets.

      On February 5, 1998, the Company issued $250 million of senior, unsecured debt securities (the “Notes”) which bear a coupon rate of 6.5% and mature on February 1, 2008. The estimated fair value of the notes, based on quoted market prices, at June 26, 2005, and June 27, 2004, was approximately $210.0 million and $190.0 million, respectively. The Company makes semi-annual interest payments of $8.1 million on the first business day of February and August.

      Effective July 26, 2000, the Board of Directors increased the Company’s remaining authorization to repurchase up to 10.0 million shares of the Company’s common stock. The Company purchased 1.4 million shares in fiscal year 2001 for a total of $16.6 million. There were no significant stock repurchases in fiscal year 2002. Effective April 24, 2003, the Board of Directors re-instituted the stock repurchase program. Accordingly, the Company purchased 0.5 million shares in fiscal year 2003 and 1.3 million shares in fiscal year 2004. At June 26, 2005, there was remaining authority for the Company to repurchase approximately 6.8 million shares of its common stock under the repurchase plan. The repurchase program was suspended in November 2003 and the Company has no immediate plans to reinstitute the program.

      On December 7, 2001, the Company refinanced its $150 million revolving bank credit facility, as amended, and its $100 million accounts receivable securitization, which were entered into on December 20, 2000, with a new five-year $150 million asset based revolving credit agreement (the “Credit Agreement”) which terminates on December 7, 2006. On October 29, 2002 the Company notified its lender of a $50.0 million permanent reduction of the total facility amount, resulting in a total facility amount of $100.0 million effective January 1, 2003. The Credit Agreement is secured by substantially all U.S. assets excluding manufacturing facilities and manufacturing equipment and all the assets of Unifi Kinston, LLC. Borrowing availability is based on eligible domestic accounts receivable and inventory. As of June 26, 2005, the Company had no outstanding borrowings and availability of $55.2 million under the terms of the Credit Agreement.

      Effective March 1, 2003, borrowings under the Credit Agreement bear interest at rates selected periodically by the Company of LIBOR plus 1.75% to 3.00% and/or prime plus 0.25% to 1.50%. The interest rate matrix is based on the Company’s leverage ratio of funded debt to EBITDA, as defined by the Credit Agreement. The interest rate in effect at June 26, 2005 was 6.3%. Under the terms of the Credit Agreement, the Company pays an unused line fee ranging from 0.25% to 0.50% per annum on the unused portion of the commitment which is included in interest expense. In connection with the refinancing, the Company incurred fees and expenses aggregating $2.0 million, which are being amortized over the term of the Credit Agreement.

      The Credit Agreement contains customary covenants for asset based loans that restrict future borrowings and capital spending. In addition, if borrowing capacity is less than $25.0 million at any time during the quarter, covenants include a required minimum fixed charge coverage ratio of 1.1 to 1.0 and a required maximum leverage ratio of 5.0 to 1.0. At June 26, 2005, the Company was in compliance with all covenants under the Credit Agreement as it had availability in excess of $25.0 million.

      On September 30, 2004, the Company completed its acquisition of the INVISTA polyester filament manufacturing assets located in Kinston, North Carolina, including inventories, valued at approximately $24.4 million which was seller financed. The acquisition resulted in the termination of the Alliance Master Agreement which eliminated the Put and Call provisions of that agreement

      On October 19, 2004, the Company announced that it planned to curtail two production lines and downsize its recently acquired facility in Kinston, North Carolina. During the December 2004 quarter, the Company recorded a severance reserve of $10.7 million for approximately 500 production level employees and a restructuring reserve of $0.4 million for the cancellation of certain warehouse leases. The entire $10.9 million restructuring reserve was recorded as assumed liabilities in purchase accounting; and accordingly, the $10.9 million was not recorded as a restructuring expense in the Consolidated Statements of Operations. During the third quarter of fiscal year 2005, management completed the curtailment of both production lines as scheduled which resulted in an actual reduction of 388 production level employees and a reduction to the initial restructuring reserve. Since no long-term assets or intangible assets were recorded in purchase accounting, the net reduction of $1.2 million was recorded as an extraordinary gain — net of taxes of $0 in the accompanying Consolidated Statements of Operations.

      As part of the acquisition of the Kinston facility from INVISTA and upon finalizing the quantities and value of the acquired inventory, Unifi Kinston, LLC, a subsidiary of the Company, entered into a $24.4 million five-year Loan Agreement (the “Kinston Loan”). The loan, which calls for interest only payments for the first two years, bears interest at 10% per annum and is payable in arrears each quarter commencing December 31, 2004 until paid in full. Quarterly principal payments of approximately $2.0 million are due beginning December 31, 2006 with the final payment due September 30, 2009. The Loan Agreement contains customary covenants for asset based loans including a required minimum collateral value ratio of 1.0 to 1.0 and a pre-defined maximum leverage ratio. The loan is secured by all of the business assets held by Unifi Kinston, LLC. On July 25, 2005, the Company made a $24.4 million pre-payment, plus accrued interest, paying off the Kinston Loan in full.

      The land associated with this site (the “Kinston Site”) is leased pursuant to a 99 year ground lease (“Ground Lease”) with Dupont. Since 1993, Dupont has been investigating and cleaning up the Kinston Site under the supervision of the United States Environmental Protection Agency (“EPA”) and the

North Carolina Department of Environment and Natural Resources pursuant to the Resource Conservation and Recovery Act Corrective Action program. The Corrective Action Program requires Dupont to identify all potential areas of environmental concern (“AOCs”), assess the extent of contamination at the identified AOCs and clean them up to applicable regulatory standards. Under the terms of the Ground Lease, upon completion by Dupont of required remedial action, ownership of the Kinston Site will pass to the Company. Thereafter, the Company will have responsibility for future remediation requirements, if any, at the AOCs previously addressed by Dupont. At this time the Company has no basis to determine if and when it will have any responsibility or obligation with respect to the AOCs or the extent of any potential liability for the same.

      On October 21, 2004, the Company announced that Unifi and Sinopec Yizheng Chemical Fiber Co., Ltd. (“YCFC”) have signed a non-binding letter of intent to form a joint venture to manufacture, process and market polyester filament yarn in YCFC’s facilities in Yizheng, Jiangsu Province, Peoples Republic of China. On or about June 10, 2005, Unifi and YCFC entered into an Equity Joint Venture Contract (the “JV Contract”), which provided several closing conditions, including Governmental and Regulatory approval of the transaction. Under the terms of the JV Contract, each company owns a 50% equity interest in the joint venture company, which will be called Yihua Unifi Fibre Company Limited (“YUFI”). The Company will ultimately invest $30 million in cash in YUFI for its 50% equity interest. This commitment is expected to be funded by the proceeds of capital asset sales relating to the closure of the European manufacturing operations. The joint venture transaction closed on or about August 3, 2005 and on or about August 4, 2005, the Company contributed its initial capital contribution of $15 million in cash to YUFI. The Company expects to transfer an additional $15 million to YUFI during first quarter of fiscal 2006.

Contractual Obligations

      The Company’s significant long-term obligations as of June 26, 2005 are as follows:

Recent Accounting Pronouncements

      In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4”. (“SFAS No. 151”) clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company continues to evaluate the provisions of SFAS No. 151 and does not expect that the adoption will have a material impact on the Company’s consolidated financial position or results of operations.

      In December 2004, the FASB finalized SFAS No. 123(R) “Shared-Based Payment” (“SFAS No. 123R”) which, after the SEC amended the compliance dates on April 15, 2005, will be effective for the Company’s fiscal year beginning June 27, 2005. The new standard will require the Company to record compensation expense for stock options using a fair value method. On March 29, 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), which provides the Staff’s views regarding interactions between SFAS No. 123R and certain SEC rules and regulations and provides interpretation of the valuation of share-based payments for public companies.

      The Company is currently evaluating SFAS No. 123R and SAB No. 107 to determine the fair value method to measure compensation expense, the appropriate assumptions to include in the fair value model and the transition method to use upon adoption. Two methods are available upon adoption of SFAS No. 123R. Under the Modified — Prospective Transition Method compensation cost is recognized for share-based payments based on the grant date fair value from the beginning of the fiscal period in which the recognition provisions are first applied. Under the Modified — Retrospective Transition method companies are allowed to restate prior periods by recognizing compensation cost in the amounts previously reported in the pro forma Note disclosure. The impact of the adoption of SFAS No. 123R is not known at this time due to these factors as well as the unknown level of options granted in future years. The effect on the Company’s results of operations of expensing stock options using the Black – Scholes model is presented in the table above.

      In December 2004, the FASB issued SFAS No. 153, “Exchange of Nonmonetary Assets” which eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS No. 153 will be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does not expect that the adoption of SFAS No. 153 will have a material impact on its financial position and results of operations.

      In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations”. This is an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations” which applies to all entities and addresses the legal obligations with the retirement of tangible long-lived assets that result from the acquisition, construction, development or normal operation of a long-lived asset. The SFAS requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. Interpretation No. 47 further clarifies what the term “conditional asset retirement obligation” means with respect to recording the asset retirement obligation discussed in SFAS No. 143. The effective date is for fiscal years ending after December 15, 2005. The Company does not expect that the adoption of this interpretation will have a material impact on its financial position and results of operations.

      In May 2005, the FASB issued SFAS No. 154, “Accounting Changes, and Error Correction — a replacement of APB Opinion No. 20 and FASB No. 3”. SFAS No. 154 requires restatement of prior period financial statements, unless impracticable, for changes in accounting principle. The retroactive application of a change in accounting principle should be limited to the direct effects of the change. Changes in depreciation, amortization or depletion methods should be accounted for as a change in an accounting estimate. Corrections of accounting errors will be accounted for under the guidance contained in APB Opinion 20. The effective date of this new pronouncement is for fiscal years beginning after December 15, 2005 and prospective application is required. The Company does not expect that the adoption of this statement will have a material impact on its financial position and results of operations.

Off Balance Sheet Arrangements

      The Company is not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies

      The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The SEC has defined a Company’s most critical accounting policies as those involving accounting estimates that require management to make assumptions about matters that are highly uncertain at the time and where different reasonable estimates or changes in the accounting estimate from quarter to quarter could materially impact the presentation of the financial statements. The following discussion provides further information about accounting policies critical to the Company and should be read in conjunction with Note 1, “Significant Accounting Policies and Financial Statement Information” of this Report.

      Allowance for Doubtful Accounts: An allowance for losses is provided for known and potential losses arising from yarn quality claims and for amounts owed by customers. Reserves for yarn quality claims are based on historical claim experience and known pending claims. The collectability of accounts receivable is based on a combination of factors including the aging of accounts receivable, historical write-off experience, present economic conditions such as chapter 11 bankruptcy filings within the industry and the financial health of specific customers and market sectors. Since losses depend to a large degree on future economic conditions, and the health of the textile industry, a significant level of judgment is required to arrive at the allowance for doubtful accounts. Accounts are written off when they are no longer deemed to be collectible. The reserve for bad debts is established based on certain percentages applied to accounts receivables aged for certain periods of time and are supplemented by specific reserves for certain customer accounts where collection is no longer certain. The Company’s exposure to losses at fiscal year end 2005 on accounts receivable was $120.9 million against which an allowance for losses of $14.0 million was provided. Establishing reserves for yarn claims and bad debts requires management judgment and estimates, which may impact the ending accounts receivable valuation, gross margins (for yarn claims) and the provision for bad debts.

      Inventory Reserves: The Company maintains reserves for inventories valued utilizing the FIFO method and may provide for additional reserves over and above the LIFO reserve for inventories valued at LIFO. Such reserves for both FIFO and LIFO valued inventories can be specific to certain inventory or general based on judgments about the overall condition of the inventory. Reserves are established based on percentage markdowns applied to inventories aged for certain time periods. Specific reserves are established based on a determination of the obsolescence of the inventory and whether the inventory value exceeds amounts to be recovered through expected sales prices, less selling costs; and, for inventory subject to LIFO (raw materials only), the amount of existing LIFO reserves. Due to declining prices of raw materials over the past several years and lower inventory levels, the available LIFO reserve has been depleted significantly requiring that supplemental reserves be established. The LIFO reserve at fiscal year end was $3.7 million. Estimating sales prices, establishing markdown percentages and evaluating the condition of the inventories require judgments and estimates, which may impact the ending inventory valuation and gross margins.

      Impairment of Long-Lived Assets: Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. For assets held and used, an impairment may occur if projected undiscounted cash flows are not adequate to cover the carrying value of the assets. In such cases, additional analysis is conducted to determine the amount of loss to be recognized. The impairment loss is determined by the difference between the carrying amount of the asset and the fair value measured by future discounted cash flows. The analysis requires estimates of the amount and timing of projected cash flows and, where applicable, judgments associated with, among other factors, the appropriate discount rate. Such estimates are critical in determining whether any impairment charge should be recorded and the amount of such charge if an impairment loss is deemed to be necessary. During the third quarter of fiscal 2004, the Company performed impairment testing on its domestic polyester texturing segment’s long-lived assets and determined that a write down was required. Based on the poor historical financial performance of the segment and the uncertainty of the moderate forecasted cash flows, the Company estimated the fair value of assets using a market value of $73.7 million. Management determined that the assets were in fact impaired because the carrying value was $98.9 million. This resulted in the segment recording an impairment charge of $25.2 million. The Company also tested for impairment the entire domestic polyester segment and domestic nylon segment both of which passed. Future events impacting cash flows for existing assets could render a write down necessary that previously required no such write down.

      For assets held for disposal, an impairment charge is recognized if the carrying value of the assets exceeds the fair value less costs to sell. Estimates are required of fair value, disposal costs and the time period to dispose of the assets. Such estimates are critical in determining whether any impairment charge should be recorded and the amount of such charge if an impairment loss is deemed to be necessary. Actual cash flows received or paid could differ from those used in estimating the impairment loss, which would impact the impairment charge ultimately recognized and the Company’s cash flows.

      Accruals for Costs Related to Severance of Employees: From time to time, the Company establishes accruals associated with employee severance or other cost reduction initiatives. Such accruals require that estimates be made about the future payout of various costs, including, for example, health care claims. The Company uses historical claims data and other available information about expected future health care costs to estimate its projected liability. Such costs are subject to change due to a number of factors including the incidence rate for health care claims, prevailing health care costs, and the nature of the claims submitted, among others. Consequently, actual expenses could differ from those expected at the time the provision was estimated, which may impact the valuation of accrued liabilities and results of operations. The Company’s estimates have been materially accurate in the past; and accordingly, at this time management expects to continue to utilize the present estimation processes.

      Valuation Allowance for Deferred Tax Assets: The Company established a valuation allowance against its deferred tax assets in accordance with SFAS No. 109, “Accounting for Income Taxes”. The specifically identified deferred tax assets which may not be recoverable are primarily state income tax credits. The realization of some of our deferred tax assets is based on future taxable income within a certain time period and is therefore uncertain. On a quarterly basis, the Company reviews its estimates for future taxable income over a period of years to assess if the need for a valuation allowance exists. To forecast future taxable income, the Company uses historical profit before tax amounts which may be adjusted upward or downward depending on various factors, including perceived trends, and then applies the expected change in rates to deferred tax assets and liabilities based on when they reverse in the future. At June 26, 2005, the Company had a gross deferred tax liability of approximately $10.0 million relating specifically to depreciation. The reversal of this deferred tax liability is the primary item generating future taxable income. Actual future taxable income may vary significantly from management’s projections due to the many complex judgments and significant estimations involved, which may result in adjustments to the valuation allowance which may impact the net deferred tax liability and provision for income taxes.

      Management and the Company’s audit committee discussed the development, selection and disclosure of all of the critical accounting estimates described above.

      Certain statements included herein contain forward-looking statements within the meaning of federal security laws about Unifi, Inc.’s (the “Company”) financial condition and results of operations that are based on management’s current expectations, estimates and projections about the markets in which the Company operates, management’s beliefs and assumptions made by management. Words such as “expects,” “anticipates,” “believes,” “estimates,” variations of such words and other similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in, or implied by, such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s judgment only as of the date hereof. The Company undertakes no obligation to update publicly any of these forward-looking statements to reflect new information, future events or otherwise.

      Factors that may cause actual outcome and results to differ materially from those expressed in, or implied by, these forward-looking statements include, but are not necessarily limited to, availability, sourcing and pricing of raw materials, pressures on sales prices and volumes due to competition and economic conditions, reliance on and financial viability of significant customers, operating performance of joint ventures, alliances and other equity investments, technological advancements, employee relations, changes in construction spending, capital expenditures and long-term investments (including those related to unforeseen acquisition opportunities), continued availability of financial resources through financing arrangements and operations, outcomes of pending or threatened legal proceedings or governmental investigations or proceedings (including environmental related claims), negotiation of new or modifications of existing contracts for asset management and for property and equipment construction and acquisition, regulations governing tax laws, other governmental and authoritative bodies’ policies and legislation, the continuation and magnitude of the Company’s common stock repurchase program and proceeds received from the sale of assets held for disposal. In addition to these representative factors, forward-looking statements could be impacted by general domestic and international economic and industry conditions in the markets where the Company competes, such as changes in currency exchange rates, interest and inflation rates, recession and other economic and political factors over which the Company has no control. Other risks and uncertainties may be described from time to time in the Company’s other reports and filings with the Securities and Exchange Commission.

      The Company is exposed to market risks associated with changes in interest rates and currency fluctuation rates, which may adversely affect its financial position, results of operations and cash flows. In addition, the Company is also exposed to other risks in the operation of its business.

      Interest Rate Risk: The Company is exposed to interest rate risk through its borrowing activities, which are further described in Note 2 “Long Term Debt and Other Liabilities.” The majority of the Company’s borrowings are in long-term fixed rate bonds. Therefore, the market rate risk associated with a 100 basis point change in interest rates would not be material to the Company at the present time.

      Currency Exchange Rate Risk: The Company conducts its business in various foreign currencies. As a result, it is subject to the transaction exposure that arises from foreign exchange rate movements between the dates that foreign currency transactions are recorded (export sales and purchases commitments) and the dates they are consummated (cash receipts and cash disbursements in foreign currencies). The Company utilizes some natural hedging to mitigate these transaction exposures. The Company also enters into foreign currency forward contracts for the purchase and sale of European and North American currencies to hedge balance sheet and income statement currency exposures. These contracts are principally entered into for the purchase of inventory and equipment and the sale of Company products into export markets. Counter-parties for these instruments are major financial institutions. If the derivative is a hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings. The Company does not enter into derivative financial instruments for trading purposes nor is it a party to any leveraged financial instruments.

      Currency forward contracts are used to hedge exposure for sales in foreign currencies based on specific sales orders with customers or for anticipated sales activity for a future time period. Generally, 60-80% of the sales value of these orders is covered by forward contracts. Maturity dates of the forward contracts are intended to match anticipated receivable collections. The Company marks the outstanding accounts receivable and forward contracts to market at month end and any realized and unrealized gains or losses are recorded as other income and expense. The Company also enters currency forward contracts for committed or anticipated equipment and inventory purchases. Generally 50-75% of the asset cost is covered by forward contracts although 100% of the asset cost may be covered by contracts in certain instances. Effective February 14, 2005, the Company entered into a contract to sell the European facility in Ireland and received a $2.8 million non-refundable deposit from the purchaser. In addition to the deposit, the contract calls for a partial payment of 16.0 million Euros on June 30, 2005 and a final payment of 2.1 million Euros on September 30, 2005. On February 22, 2005, the Company entered into a forward exchange contract for 15.0 million Euros. The Company was required by the financial institution to deposit $2.8 million in an interest bearing collateral account to secure the financial institution’s maximum exposure on the hedge contract. This cash deposit has been reclassified as “Restricted cash” and is included in current assets on the balance sheet. On July 15, 2005, the Company settled the forward exchange contract for 15.0 million Euros. Forward contracts are matched with the anticipated date of delivery of the assets and gains and losses are recorded as a component of the asset cost for purchase transactions the Company is firmly committed. The latest maturity for all outstanding purchase and sales foreign currency forward contracts are September 2005 and January 2006, respectively.

      The dollar equivalent of these forward currency contracts and their related fair values are detailed below:

      The fair values of the foreign exchange forward contracts at the respective year-end dates are based on discounted year-end forward currency rates. The total impact of foreign currency related items that are reported on the line item other (income) expense, net in the Consolidated Statements of Operations, including transactions that were hedged and those that were not hedged, was a pre-tax gain of $1.1 million for the fiscal year ended June 26, 2005, and a pre-tax loss of $0.5 million for the fiscal year ended June 27, 2004 and no effect for the fiscal year ended June 29, 2003.

      Inflation and Other Risks: The inflation rate in most countries the Company conducts business has been low in recent years and the impact on the Company’s cost structure has not been significant. The Company is also exposed to political risk, including changing laws and regulations governing international trade such as quotas and tariffs and tax laws. The degree of impact and the frequency of these events cannot be predicted.

Management’s Report on Internal Control over Financial Reporting

      Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based upon the criteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on that evaluation, management believes that the Company maintained effective internal control over financial reporting as of June 26, 2005.

      Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal controls over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

      Ernst and Young, LLP, the Company’s independent registered public accounting firm, has issued an attestation report on the assessment performed by the Company’s management with respect to the Company’s internal control over financial reporting, which begins on page 32 of this report.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of Unifi, Inc.,

      We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Unifi, Inc. maintained effective internal control over financial reporting as of June 26, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Criteria”). Unifi, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

      We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

      A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

      Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

      In our opinion, management’s assessment that Unifi, Inc. maintained effective internal control over financial reporting as of June 26, 2005, is fairly stated, in all material respects, based on the COSO Criteria. Also, in our opinion, Unifi, Inc. maintained, in all material respects, effective internal control over financial reporting as of June 26, 2005, based on the COSO Criteria.

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Unifi, Inc. as of June 26, 2005 and June 27, 2004, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended June 26, 2005 of Unifi, Inc. and our report dated August 26, 2005, expressed an unqualified opinion thereon.

Greensboro, North Carolina

August 26, 2005

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of Unifi, Inc.

      We have audited the accompanying consolidated balance sheets of Unifi, Inc. as of June 26, 2005, and June 27, 2004, and the related consolidated statements of operations, changes in shareholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended June 26, 2005. Our audits also included the Valuation and Qualifying Accounts financial statement schedule listed in the index at Item 15(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 the standards of the Public Company Accounting Oversight Board (United States). 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 Unifi, Inc. at June 26, 2005 and June 27, 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 26, 2005, in conformity with U.S. 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.

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Unifi, Inc.’s internal control over financial reporting as of June 26, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 26, 2005, expressed an unqualified opinion thereon.

Greensboro, North Carolina

August 26, 2005

CONSOLIDATED BALANCE SHEETS