ALDILA INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

ý Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

For the quarterly period ended September 30, 2002

o Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

Commission File Number 0-21872

ALDILA, INC.

(Exact name of registrant as specified in its charter)

Delaware		13-3645590
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

12140 Community Road, Poway, California 92064
(Address of principal executive offices)

(858) 513-1801
(Registrant’s Telephone No.)
www.aldila.com

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 ý No o

As of November 13, 2002 there were 4,947,648 shares of the Registrant’s common stock, par value $0.01 per share, outstanding.

ALDILA, INC.

Table of Contents

Form 10-Q for the Quarterly Period

Ended September 30, 2002

PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets at September 30, 2002 and December 31, 2001

	Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and 2001

	Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001

	Notes to Consolidated Financial Statements

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.	Quantitative and Qualitative Disclosures about Market Risk

Item 4.	Controls and Procedures

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings

Item 2.	Changes in Securities

Item 3.	Defaults Upon Senior Securities

Item 4.	Submission of Matters to a Vote of Security Holders

Item 5.	Other Information

Item 6.	Exhibits and Reports on Form 8-K

	Signatures

	Officers’ Certification

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

ALDILA, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

	September 30, 2002			December 31, 2001
	(Unaudited)
ASSETS

CURRENT ASSETS:
Cash and cash equivalents	$	2,360		$	266
Accounts receivable, net	2,878			3,977
Income taxes receivable	1,525			723
Inventories	9,793			11,472
Deferred tax assets	1,957			2,366
Prepaid expenses and other current assets	313			595
Total current assets	18,826			19,399

PROPERTY, PLANT AND EQUIPMENT	6,566			7,634

INVESTMENT IN JOINT VENTURE	7,149			7,466

OTHER ASSETS	286			387

TOTAL ASSETS	$	32,827		$	34,886

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Accounts payable	$	2,159		$	2,921
Accrued expenses	2,457			2,627
Total current liabilities	4,616			5,548

LONG-TERM LIABILITIES:
Deferred rent	71			74
Deferred tax liabilities	10			67
Total liabilities	4,697			5,689

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; authorized 5,000,000 shares; no shares issued
Common stock, $.01 par value; authorized 30,000,000 shares; issued and outstanding 4,947,648 shares	49			49
Additional paid-in capital	41,983			41,983
Accumulated deficit	(13,902		)	(12,835		)
Total stockholders' equity	28,130			29,197

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	32,827		$	34,886

See notes to consolidated financial statements.

ALDILA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED

(In thousands, except per share data)

	Three months ended September 30,						Nine months ended September 30,
	2002			2001			2002			2001

NET SALES	$	6,450		$	6,845		$	28,375		$	31,239
COST OF SALES	5,968			6,133			24,594			24,004
Gross profit	482			712			3,781			7,235

SELLING, GENERAL AND ADMINISTRATIVE	1,897			1,551			5,650			5,351
AMORTIZATION OF GOODWILL	—			350			—			1,061
PLANT CONSOLIDATION	—			—			—			569
Operating income (loss)	(1,415		)	(1,189		)	(1,869		)	254

OTHER EXPENSE (INCOME):
Interest expense	17			92			85			342
Other, net	9			(26		)	45			31
Equity in earnings of joint venture	(52		)	(49		)	(192		)	(160		)

INCOME (LOSS) BEFORE INCOME TAXES	(1,389		)	(1,206		)	(1,807		)	41
PROVISION (BENEFIT) FOR INCOME TAXES	(690		)	(691		)	(740		)	32

NET INCOME (LOSS)	$	(699	)	$	(515	)	$	(1,067	)	$	9


NET INCOME (LOSS) PER COMMON SHARE	$	(0.14	)	$	(0.10	)	$	(0.22	)	$	0.00

NET INCOME (LOSS) PER COMMON SHARE, ASSUMING DILUTION
	$	(0.14	)	$	(0.10	)	$	(0.22	)	$	0.00

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING	4,948			5,087			4,948			5,098

WEIGHTED AVERAGE NUMBER OF COMMON AND COMMON EQUIVALENT SHARES	4,948			5,087			4,948			5,126

See notes to consolidated financial statements.

ALDILA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

(In thousands)

	Nine months ended September 30,
	2002			2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(1,067	)	$	9
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization	1,451			3,023
(Gain) Loss on disposal of fixed assets	(13		)	211
Undistributed income of joint venture, net	(198		)	(164		)
Changes in assets and liabilities:
Accounts receivable	1,099			2,938
Inventories	1,679			(2,116		)
Prepaid expenses and other assets	706			5
Accounts payable	(762		)	(1,473		)
Accrued expenses	(170		)	(1,400		)
Income taxes payable/receivable	(802		)	(681		)
Deferred tax liabilities	(57		)	(131		)
Deferred rent liabilities	(3		)	15
Net cash provided by operating activities	1,863			236

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment	(300		)	(657		)
Proceeds from sales of property, plant and equipment	16			235
Proceeds from sales of marketable securities	—			3,104
Distribution from joint venture	515			190
Net cash provided by investing activities	231			2,872

CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term debt	—			750
Borrowings under line of credit	887			(132		)
Repayments on line of credit	(887		)	(8,000		)
Repurchases of common stock	—			(381		)
Net cash used for financing activities	—			(7,763		)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	2,094			(4,655		)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	266			5,603
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	2,360		$	948

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest	$	34		$	398
Income taxes	$	215		$	608

See notes to consolidated financial statements.

ALDILA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED

1. BASIS OF PRESENTATION

The consolidated balance sheet as of September 30, 2002, the consolidated statements of operations for the three and nine month periods ended September 30, 2002 and 2001 and the consolidated statements of cash flows for the nine month periods ended September 30, 2002 and 2001, are unaudited and reflect all adjustments of a normal recurring nature which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods presented. The consolidated balance sheet as of December 31, 2001 was derived from the Aldila, Inc. and subsidiaries’ (the “Company’s”) audited financial statements. Operating results for the interim periods presented are not necessarily indicative of results to be expected for the fiscal year ending December 31, 2002. These consolidated financial statements should be read in conjunction with the Company’s December 31, 2001 consolidated financial statements and notes thereto.

Certain amounts from the consolidated statements of cash flows for the nine months ended September 30, 2001 have been reclassified to conform to the presentation for the nine months ended September 30, 2002.

On May 15, 2002, the Company’s Board of Directors and stockholders approved a 1-for-3 reverse stock split of the Company’s Class A Common Stock, which became effective on June 3, 2002 for stockholders of record at that date. Stockholders’ equity has been retroactively restated to reflect the reverse stock split for all periods presented by reclassifying the additional paid-in capital, which resulted from the reduction in shares due to the reverse split from common stock to additional paid-in capital. All share data in the accompanying consolidated financial statements and notes to the consolidated financial statements have been retroactively restated to reflect the stock split for all periods presented.

2. INVENTORIES

Inventories consist of the following (in thousands):

	September 30, 2002		December 31, 2001

Raw materials	$	3,070	$	4,100
Work in process	3,017		3,757
Finished goods	3,706		3,615
Inventories	$	9,793	$	11,472

3. REVOLVING CREDIT AGREEMENT

On July 9, 1999, Aldila Golf Corp. (“Aldila Golf”), a wholly owned subsidiary of the Company, entered into a Loan and Security Agreement (the “Agreement”) with a financial institution which provides Aldila Golf with up to $12.0 million in secured financing. The Agreement has a three-year term and is secured by substantially all of the assets of Aldila Golf and guaranteed by the Company. Advances under the Agreement are made based on eligible accounts receivable and inventories of Aldila Golf and bear interest at the Adjusted Eurodollar rate (as defined) plus 2.5% or at the bank reference rate at the election of the Company, subject to a minimum interest rate of 7.0%. As of September 30, 2002 and December 31, 2001, there were no outstanding borrowings. The Agreement renewed automatically for a one-year period on July 9, 2002. The Agreement will terminate on July 9, 2003 if the Company or the lender provides written notification 90 days prior to July 9, 2003 requesting that the Agreement be terminated or at any time if either the Company or the financial institution provides written notification 90 days prior to the date they wish to terminate the Agreement. Availability for borrowings under the line of credit, based on eligible accounts receivable and inventories, was approximately $1.7 million at September 30, 2002 and $3.6 million at December 31, 2001.

4. SUMMARIZED FINANCIAL INFORMATION

Summarized financial information for Carbon Fiber Technology LLC (“CFT”), the Company’s 50% owned joint venture, for the periods ended September 30, 2002 and 2001 is as follows (in thousands):

	Three months ended September 30,				Nine months ended September 30,
	2002		2001		2002		2001
Sales	$	2,083	$	2,248	$	7,494	$	6,957
Cost of sales	1,984		2,139		7,139		6,637
Gross profit	99		108		355		320
Net income	$	104	$	120	$	372	$	295

5. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 146, Accounting for Costs Associated with Disposal or Exit Activities, which nullifies previous financial accounting guidance in Emerging Issues Task Force (“EITF”) 94-3, Liability Recognition of Certain Employee Termination Benefits and Other Costs to Exit and Activity (including Certain Costs Incurred in a Restructuring), and is effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be measured initially at fair value and recognized when the liability is incurred rather than the date a company makes a commitment to an exit plan, which was the guidance under EITF No. 94-3. The Company does not expect adoption of SFAS No. 146 to have a material impact on our consolidated financial position or results of operations.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The Company is principally engaged in the business of designing, manufacturing and marketing graphite (carbon fiber based composite) golf club shafts. In reporting the Company’s results from its operations, the Company relies on several critical accounting policies.

Critical Accounting Policies

We prepare the consolidated financial statements of the Company in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

Revenue Recognition

The Company recognizes revenue from product sales at the time of shipment and passage of title. We also offer certain of our customers the right to return shafts for breakage within a limited time after delivery. We continuously monitor and track such shaft returns and we record a provision for the estimated amount of such future returns, based on historical experience and any notification we receive of pending returns. While such returns have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same return rates that we have in the past. Any significant increase in product failure rates and the resulting returns could have a material adverse impact on our operating results for the period or periods in which such returns materialize.

Accounts Receivable

We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Since our accounts receivable are concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse impact on the collectability of our accounts receivables and our future operating results.

Inventories

We value our inventory at the lower of the actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements for the next twelve months. A significant increase in the demand for our products could result in a short-term increase in the cost of inventory purchases while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. In the future, if our inventory is determined to be overvalued, we would be required to recognize such costs in our cost of goods sold at the time of such determination. Likewise, if our inventory is determined to be undervalued, we may have over-reported our costs of goods sold in previous periods and would be required to recognize such additional operating income at the time of sale. Therefore, although we make every effort to ensure that our forecasts of future product demands are reasonable, any significant unanticipated changes in demand could have a significant impact on the value of our inventory and our reported operating results.

Deferred Taxes

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The Company regularly reviews its deferred tax assets for recoverability and if necessary, establishes a valuation allowance based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. If we continue to operate at a loss or are unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to establish a valuation allowance against all or a significant portion of our deferred tax assets resulting in a substantial increase in our effective tax rate and a material adverse impact on our operating results.

Recently Issued Accounting Pronouncements

The Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 146, Accounting for Costs Associated with Disposal or Exit Activities, which nullifies previous financial accounting guidance in Emerging Issues Task Force (“EITF”) 94-3, Liability Recognition of Certain Employee Termination Benefits and Other Costs to Exit and Activity (including Certain Costs Incurred in a Restructuring), and is effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be measured initially at fair value and recognized when the liability is incurred rather than the date a company makes a commitment to an exit plan, which was the guidance under EITF No. 94-3. The Company does not expect adoption of SFAS No. 146 to have a material impact on our consolidated financial position or results of operations.

Overview - Business Conditions

The Company is principally engaged in the business of designing, manufacturing and marketing graphite (carbon fiber based composite) golf club shafts with approximately 85% of its net sales resulting from sales to golf club manufacturers for inclusion in their clubs. As a result, the Company’s operating results are substantially dependent not only on demand by its customers for the Company’s shafts, but also on demand by consumers for clubs including graphite shafts such as the Company’s.

Until several years ago, graphite shafts were principally offered by manufacturers of higher priced, premium golf clubs, and the Company’s sales were predominantly of premium graphite shafts. However, in recent years the Company has realized substantial sales growth in the value priced segment of the graphite shaft market. The Company now competes aggressively with both United States and foreign-based shaft manufacturers for premium graphite shafts and also against primarily foreign-based shaft manufacturers for lower priced value shafts. The Company continues to maintain a broad customer base in the premium shaft market segment. While the Company’s market share in the value segment is not as great as the premium segment, the Company has advanced rapidly in securing new customers in this segment in recent years. Generally, value shafts have significantly lower selling prices than premium shafts and as a result contribute less to gross profit.

The Company’s sales have tended to be concentrated among a limited number of major club companies, thus making the Company’s results of operations dependent on those customers, their continued willingness to purchase a significant portion of their shafts from the Company, and their success in selling clubs containing the Company’s shafts to their customers. In 2001, net sales to Callaway Golf, TaylorMade-adidas Golf and Ping represented 22%, 20% and 15% of the Company’s net sales, respectively, and the Company anticipates that these companies along with Acushnet Company will continue, collectively, to represent the largest portion of its sales in 2002. Although it is generally difficult to predict in advance the success of any particular club or of any particular manufacturer, the Company believes that it is protected to some extent from normal periodic fluctuations in sales among the various golf club companies by virtue of the broad range of its club manufacturer customers.

Golf club companies regularly introduce new clubs, frequently containing innovations in design. Sometimes these new clubs achieve dramatic success in the marketplace, thus increasing the overall volatility of club sales among the major companies. While the Company seeks to have its shafts represented on as many major product introductions as possible, it can provide no assurance that its shafts will be included in any particular “hot” club or that sales of a “hot” club that does not include the Company’s shafts will not have a negative impact on the sales of those clubs that do. The Company’s sales could also suffer a significant drop-off from period to period to the extent that they may be dependent in any period on sales of one or more “hot” clubs, which then tail off in subsequent periods when no other club offers a high level of new sales to replace the lost sales.

In 1994, the Company started manufacturing prepreg, the principal raw material in the manufacture of graphite golf shafts, at its facility in Poway, California. The Company uses most of its production of prepreg internally, with the remainder sold to other composite materials manufacturers. The Company does not expect third party sales of prepreg to have a significant financial impact on its results of operations for at least the next several years. In 1998, the Company established a manufacturing facility in Evanston, Wyoming for the production of carbon fiber. During 1998 and through the first ten months of 1999, the Company used the material from this facility to satisfy a significant portion of its internal demand for carbon fiber in the manufacturing of golf club shafts. During 1999, the Company also produced and sold carbon fiber from this facility to other unrelated entities for the manufacture of other carbon-based products. On October 29, 1999, SGL Carbon Fibers and Composite, Inc. (“SGL”) purchased a 50% interest in the Company’s carbon fiber manufacturing operation. The Company and SGL entered into an agreement to operate the facility as a limited liability company with equal ownership interests between the venture partners. The Company and SGL also entered into supply agreements with the new entity, CFT, for the purchase of carbon fiber at cost plus an agreed upon mark-up. The Company and SGL are each responsible to bear 50% of the fixed costs to operate the facility as a term of this supply agreement. Profits and losses of CFT are shared equally by the partners. The Company anticipates that the carbon fiber from this facility will primarily be consumed by the joint venture partners; however, any excess carbon fiber produced at this facility could be marketed for sale to unrelated third parties. The Company continues to use its share of the output of this facility to satisfy a significant portion of its internal demand for carbon fiber.

If the carbon fiber facility is not operated at high production levels, either because of production difficulties or because there is not enough demand by the joint venture partners to justify that level of production, the cost per unit of carbon fiber consumed by the Company (and thus the cost of producing the Company’s golf shafts and other products) is increased due to spreading the fixed costs of production over smaller volumes. If demand is lower than production capacity, CFT also runs the risk of building up excess inventory. Given the relatively low selling prices at the present time in the market for carbon fiber and the highly competitive market for graphite golf shafts, the failure to operate at high levels could adversely affect the Company’s gross margins or its ability to maintain competitive prices for its products. Although third party sales of carbon fiber could help justify high production levels and thus help control unit production costs, the weakness of the carbon fiber market and the overall excess capacity in the industry means that third party sales at CFT are not likely to be significant at least until the overall market improves significantly. The Company does not expect third party sales at CFT to have a significant effect on either its sales or profitability for several years.

During the 1990’s, the graphite golf shaft industry became increasingly competitive, placing extraordinary pressure on the selling prices of the Company’s golf shafts and adversely affecting its gross profit margins and level of profitability. The Company’s response has been to reduce its cost structure, principally by producing its own prepreg and by shifting the largest portion of its shaft production to its offshore facilities, while maintaining high quality and superior customer service. The cost saving benefits of its efforts to vertically integrate its operations, particularly

through carbon fiber manufacturing, have been limited somewhat due to historically low market prices for golf shaft raw materials in recent years, which, in some cases, have made carbon fiber available in the market at attractive prices when compared to the Company’s cost to purchase it from CFT. In addition, the Company generally sells shafts manufactured overseas at somewhat lower prices than the same shafts would sell for if manufactured in the United States. Although the Company’s gross margins and profitability have continued to be adversely affected through this period despite its efforts, management believes that these efforts have been successful to date in allowing the Company to maintain, or in some cases enhance, its competitive position with respect to the major United States golf club companies that are its principal customers. The Company continues to look for opportunities to cut costs and to increase its market share.

The pressure on selling prices of both premium and value shafts under current market conditions, and the increased percentage of overall sales represented by value shafts has resulted in a reduction of approximately 57% in the average selling price of the Company’s shafts over the last seven years, although in some cases average selling prices may increase slightly from period to period depending on the mix of products sold. In addition, the percentage of overall golf clubs sold with graphite shafts appears to have leveled off after several decades of significant growth and most major club companies continue to seek multiple sources of supply for their shafts and, thus, are unwilling to commit to one principal graphite shaft supplier. These trends are not likely to reverse themselves under current market conditions. As a result, management does not anticipate meaningful overall improvement in the financial performance of the Company’s golf shaft operations for the foreseeable future. There will continue to be fluctuations in performance on a periodic basis, driven principally by the success of its key customers in selling clubs to consumers, but as selling prices continue to decrease, with increasing pressure on the Company’s margins, increases in unit sales in the future, even to levels comparable to those achieved in 2000, are not likely to generate operating cash flows and net income at the levels achieved in 2000 or in other, similarly successful historical years.

Based on the results of 2001 and the general trends and conditions of the golf industry over the last several years, the Company addressed the issue of impairment of its long-lived assets, specifically, goodwill, trademarks and patents in the fourth quarter of 2001 and concluded that impairment existed. In determining the amount of the impairment charge, the Company utilized an independent valuation, which resulted in a write-off of all the goodwill and intangible assets of approximately $54.9 million in the fourth quarter of 2001.

The Company is responding to the current prospects in its core golf shaft business in a variety of ways. First, the Company has recently introduced its new and innovative Aldila “One” shaft, which management intends to use to capture a portion of the market for premium branded custom shafts, which tend to sell at higher prices and gross margins than the standard shafts sold to club manufacturers. The Company cannot now predict the success of this new shaft in the market, although it anticipates that if it achieves significant market acceptance, the financial benefits are not anticipated to be material until 2003. Second, the Company continues to look for opportunities to sell its prepreg to other composite materials product manufacturers and to manufacture other composite materials products, such as hockey sticks. Although the Company has achieved some success in these areas, management continues to believe that the growth

opportunities in these areas are limited and that sales of prepreg and of other composite materials products will not be material to its results of operations for at least several years. Third, management has concluded that its ownership interest in the joint venture that operates its carbon fiber plant does not offer significant value to the Company and is seeking to sell its interest, either to its joint venture partner, SGL, or, with SGL’s consent, to a third party, so that the capital currently committed to the joint venture could be redeployed more usefully for the Company and its stockholders. At present, the Company is unable to provide any assurances that it will identify and be able to negotiate a sale of its interest in the joint venture. Finally, the Company continues to be receptive to other acquisition opportunities, in areas related to its core business and otherwise, in an effort to add the potential for meaningful growth in its overall profitability. The Company is not actively seeking such opportunities at the present time and is unable to provide any assurance that it will be able to successfully complete any potential acquisitions. Although management anticipates that operating cash flow levels are likely to be measurably lower for at least the next several years than was typical until a few years ago, given the absence of debt currently, the Company should be able to generate cash from operations in excess of its needs for the next several years. This excess operating cash could be used for research and development or marketing activities related to its current core business or to support expansion of its current businesses either internally or through acquisitions.

Results of Operations

Third Quarter 2002 Compared to Third Quarter 2001

Net Sales. Net sales decreased approximately $395,000, or 5.8%, to $6.5 million for the third quarter ended September 30, 2002 (the “2002 Period”) from $6.8 million for the third quarter ended 2001 (the “2001 Period”). The decrease in net sales was primarily attributable to a decrease in shaft unit sales to the Company’s club manufacturer customers with the remaining decrease in net sales attributed to decreases in net sales of prepreg and hockey sticks. Shaft unit sales decreased 3.1% in the 2002 Period as compared to the 2001 Period, and the average selling price of shafts sold increased 0.6%.

Gross Profit. Gross profit decreased approximately $230,000 or 32.3%, to $482,000 for the 2002 Period from $712,000 for the 2001 Period. The Company’s gross profit margin decreased to 7.5% in the 2002 Period compared to 10.4% in the 2001 Period. The decrease was primarily attributed to a charge for inventory reserves in the 2002 Period, of approximately $338,000 versus a $99,000 benefit in the 2001 Period. Without the changes in inventory reserves in the 2002 Period, gross margin would have been 12.7%.

Operating Income (Loss). Operating loss increased $226,000, or 19.0%, to an operating loss of $1.4 million for the 2002 Period from an operating loss of $1.2 million for the 2001 Period. The increase in operating loss during the 2002 Period was primarily attributed to a decrease in gross profit and increased spending on marketing and advertising in support of the Company’s branded product line during the 2002 Period, which was somewhat mitigated by the lack of amortization expense (as a result of the write-off of goodwill and intangibles in the fourth quarter of 2001). The Company anticipates that it will continue its marketing and advertising effort in

support of its branded product, namely the Aldila One shaft. Selling, general and administrative expense increased as a percentage of net sales to 29.4% for the 2002 Period compared to 22.7% for the 2001 Period.

Income (Loss) Before Income Taxes. Loss before income taxes increased $183,000 to a loss of $1.4 million for the 2002 Period from a loss of $1.2 million for the 2001 Period. The majority of the increase is attributed to the increase in loss from operations in the 2002 Period.

Income Tax Expense (Benefit). The Company recorded an income tax benefit of $690,000 in the 2002 Period compared to an income tax benefit of $691,000 in the 2001 Period. The effective tax rate was 49.7% for the 2002 Period compared to 57.3% for the 2001 Period. In addition, the effective tax rate in the 2001 Period was negatively impacted by the Company’s goodwill amortization, which was non-deductible for tax purposes.

Nine Month Period in 2002 Compared to the Nine Month Period in 2001

Net Sales. Net sales decreased $2.9 million, or 9.2%, to $28.4 million for the nine month period ended September 30, 2002 from $31.2 million for the nine month period ended September 30, 2001. The decrease in net sales was attributed to a decrease in the average selling prices of units shipped, which was partially offset by an increase in units shipped. Shaft unit sales increased 11.4% in 2002 compared to 2001, and the average selling price of shafts sold decreased by 18.2% in the 2002, partly as a result of a change in product mix.

Gross Profit. Gross profit decreased $3.5 million, or 47.7%, to $3.8 million in 2002 from $7.2 million in 2001. The decrease in gross profit was primarily attributed to a decrease in net sales. In addition gross profit was negatively impacted by $389,000 for un-utilized carbon fiber capacity and an increase in inventory reserves in of approximately $484,000 in 2002, versus an increase of inventory reserves of approximately $35,000 in 2001. Gross profit margin was 13.3% in 2002 as compared to 23.2% in 2001.

Operating Income (Loss). Operating income decreased $2.1 million, or 835.8%, to an operating loss of $1.9 million in 2002 as compared to operating income of $254,000 in 2001. The decrease in operating income was attributed to a decrease in gross profit and increased spending on marketing and advertising, which was partially mitigated by the lack of amortization expense (as a result of the write-off of goodwill and intangibles in the fourth quarter of 2001) and plant consolidation expenses in 2002 as compared to 2001. The Company anticipates that it will continue its marketing and advertising effort in support of its branded product, namely the Aldila One shaft. Operating income decreased as a percentage of net sales to an operating loss of 6.6% in 2002 from operating income of 0.8% in 2001. Selling, general and administrative expense increased as a percentage of net sales to 19.9% in 2002, from 17.1% in 2001, primarily as a result of the decrease in net sales.

Income (Loss) Before Income Tax. Income before taxes decreased $1.8 million, to a loss before taxes of $1.8 million in 2002 as compared to income of $41,000 in 2001. The majority of the decrease is attributed to the decrease in operating income.

Income Tax Expense (Benefit). The Company recorded an income tax benefit of $740,000 in 2002 as compared to income tax expense of $32,000 in 2001. The Company’s effective rate was 41.0% in 2002 as compared to 78.0% in 2001. The decrease in the effective rate is primarily attributed to the decrease in income before taxes and the lack of goodwill amortization in 2002 as compared to 2001, as the goodwill amortization was not deductible for tax purposes. The Company should continue to realize a reduced effective tax rate to the extent that statutory income tax rates where it has foreign operations are lower than the statutory income tax rates in the United States.

Liquidity and Capital Resources

The Company’s principal source of liquidity to fund its operations in recent years has been cash flow from operations, augmented on occasion by short-term borrowings on its revolving credit facilities. The Company has in place a $12.0 million revolving credit facility from a financial institution, which is secured by substantially all the assets of Aldila Golf and guaranteed by the Company. Borrowings under the line of credit bear interest, at the election of the Company, at the bank reference rate or at the adjusted Eurodollar rate plus 2.5%, with a minimum rate of 7%. Availability for borrowings under the line of credit, based on eligible accounts receivable and inventories, was approximately $1.7 million at September 30, 2002 and $3.6 million at December 31, 2001. The Company borrowed under the line of credit up to a maximum of $887,000 during the first quarter 2002. There were no borrowings during the third quarter of 2002, and as of September 30, 2002 there were no outstanding borrowings under the line of credit. The line of credit renewed effective July 9, 2002 for a one-year term and will automatically renew for one year successive terms unless terminated by either party. Either party may terminate the line of credit agreement by giving the other party 90 days written notice prior to the renewal date. The Company does not plan to terminate this agreement without having another facility in place and is not aware of any intention by the financial institution to terminate the agreement. There are no termination penalties for early termination during the renewal periods. The Company made its final $4.0 million principal payment on its senior notes on September 30, 2001. The senior notes bore interest at 6.13%. Semi-annual principal payments of $4.0 million, plus accrued interest, were made September 30, 1999 through September 30, 2001.

Cash (including cash equivalents) provided by operating activities during the nine month period ended 2002 was $1.9 million compared to $236,000 during the nine month period ended 2001. The increase in cash provided by operations is attributed to the cash provided by working capital items offset by lower net income and depreciation and amortization in the 2002 period. The Company used $300,000 for capital expenditures during the 2002 period. Management anticipates capital expenditures to approximate $500,000 for 2002. The Company may also incur capital expenditures over the next several years to expand and enhance the production capacity of CFT, in order to take advantage of new opportunities brought to CFT and further reduce production costs for the carbon fiber acquired by the Company, in addition to an obligation to support one half of CFT’s fixed annual cost. The Company received a distribution from CFT in the first quarter of 2002 in the amount of $515,000, which was approved by both partners of the

joint venture. Future distributions from CFT, if any, will have to be approved by both partners of the joint venture prior to the distribution. The Company believes that it will have adequate cash resources, including anticipated cash flow and borrowing availability to meet its obligations at least through 2003.

The Company may from time to time consider the acquisition of businesses. The Company could require additional debt financing if it were to engage in a material acquisition in the future.

Seasonality

Because the Company’s customers have historically built inventory in anticipation of purchases by golfers in the spring and summer, the principal selling season for golf equipment, the Company’s operating results have been affected by seasonal demand for golf clubs, which has generally resulted in the highest sales occurring in the second quarter. The timing of customers’ new product introductions has frequently mitigated the impact of seasonality in recent years.

“Safe Harbor” Statement Under the Private Securities Litigation Reform Act of 1995

With the exception of historical information (information relating to the Company’s financial condition and results of operations at historical dates or for historical periods), the matters discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are forward-looking statements that necessarily are based on certain assumptions and are subject to certain risks and uncertainties. These forward-looking statements are based on management’s expectations as of the date hereof, that necessarily contain certain assumptions and are subject to certain risks and uncertainties. The Company does not undertake any responsibility to update these statements in the future. The Company’s actual future performance and results could differ from that contained in or suggested by these forward-looking statements as a result of a variety of factors.

The Company’s Report on Form 10-K for the year ended December 31, 2001 (the “Form 10-K”) presents a more detailed discussion of these and other risks related to the forward-looking statements in this 10-Q, in particular under “Business Risks” in Part I, Item 1 of the Form 10-K and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 7 of the Form 10-K. The forward-looking statements in this 10-Q are particularly subject to the risks that

• we will not maintain or increase our market share at our principal customers;

• demand for clubs manufactured by our principal customers will decline, thereby affecting their demand for our shafts;

• our principal customers will be unwilling to satisfy a significant portion of their demand with shafts manufactured in China in place of either the United States or Mexico;

• new product offerings, including those outside the golf industry, will not achieve success with consumers or OEM customers;

• we will not achieve success marketing shafts to club assemblers based in China;

• our international operations will be adversely affected by political instability, currency fluctuation, export/import regulation and other risks typical of multi-national operations, particularly those operating in less developed countries; and

• CFT will be unsuccessful as a result, for example, of internal operational problems, raw material supply problems, changes in demand for carbon fiber based products, or difficulties in operating a joint venture.

• attractive strategic alternatives will not be available to us on desirable terms, and

• a general decrease in stock market prices would affect the price of our stock.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no significant changes from the information that was disclosed in the Company’s Annual Report for the period ended December 31, 2001 filed on form 10-K.

Item 4. Controls and Procedures

(a) Within the 90 days prior to the date of filing this Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chairman and Chief Executive Officer along with the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company’s Chief Executive Officer along with the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.

(b) There have been no significant changes in the Company’s internal controls or in other factors, which could significantly affect internal controls subsequent to the date the Company carried out its evaluation.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Not applicable.

Item 2. Changes in Securities

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable

Item 5. Other Information

Not applicable.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibit 11.1 - Statement re: Computation of Net Income (Loss) per Common Share

(b) Exhibit 99.1 – Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

During the fiscal quarter for which this report is filed, the Company filed the following report on Form 8-K.

(i) Form 8-K filed July 15, 2002, Item 5 Other events.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated:	ALDILA, INC.


November 13, 2002		/s/ Robert J. Cierzan
		Robert J. Cierzan
		Vice President, Finance Signing both in his capacity as Vice President and as Chief Accounting Officer of the Registrant

Certification Pursuant to Rules 13a-14 and 15d-14
of the 1934 Securities Exchange Act

I certify that:

1. I have reviewed this quarterly report on Form 10-Q of Aldila, Inc. (the registrant);

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of Aldila’s board of directors:

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 13, 2002	/s/ Peter Mathewson
	Peter Mathewson
	Chief Executive Officer

I certify that:

1. I have reviewed this quarterly report on Form 10-Q of Aldila, Inc. (the registrant);

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of Aldila’s board of directors:

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

Date: November 13, 2002	/s/ Robert Cierzan
	Robert Cierzan
	Chief Financial Officer