** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-K/A**

 

**AMENDMENT NO. 2**

 

**(Mark One)**

| **ý** | ** ** | **Annual Report Pursuant to Section 13 or  15(d) of the  Securities Exchange Act of 1934**     | ** ** |
|------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| ** ** | ** ** | ** **                                                                                          | ** ** |
| ** ** | ** ** | **For the fiscal year ended December 31, 2003**                                                | ** ** |
|       |       |                                                                                                |       |
|       |       | **OR**                                                                                              |       |
|       |       |                                                                                                |       |
| **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 itscharter)

 

| **Delaware**                                                      | ** ** | **13-3645590**                          |
|-------------------------------------------------------------------|------------|-----------------------------------------|
| (State or other jurisdiction of  incorporation or organization)   |       | (I.R.S. Employer Identification Number) |
|                                                              |       |                                    |
| **13450 STOWE DRIVE, POWAY, CALIFORNIA  92064**              |
| (Address of principal executive offices)                          |
|                                                              |       |                                    |
| **(858) 513-1801**                                                |
| (Registrant’s Telephone No.)  www.aldila.com                 |
|                                                              |       |                                    |
| Securities Registered Pursuant to  Section 12(b) of the Act: |

 

| **Title of each class** | ** ** | **Names of each exchange on which registered** |
|-------------------------|------------|------------------------------------------------|
| None                    |       | None                                           |

 

Securities registered pursuant tosection 12(g) of the Act:

 

| **Common Stock, par value $0.01 per share** |
|---------------------------------------------|
| (Title of Class)                            |

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 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 informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this form 10-K.  ý

 

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

 

The aggregate market valueof the Company’s voting stock held by non-affiliates of the Company as ofJune 30, 2003 was approximately $6.0 million.

 

As of March 23, 2004, there were 4,849,149 shares of the Registrant’scommon stock, par value $0.01 per share, outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the following documents are incorporated into this reportby reference:

 

Part III, Items 10, 11, 12, 13 and 14. The Registrant’s definitive Proxy Statement for the 2003 Annual Meetingof Stockholders to be filed with the Commission within 120 days after the closeof the fiscal year.

 

 

----

 

**EXPLANATORY NOTE:**

** **

**THIS AMENDMENT IS BEING FILED SOLELY TO CORRECT THE FORM OF THECERTIFICATIONS ATTACHED AS EXHIBITS 31.1 AND 31.2.  THIS AMENDMENT MAKES NO OTHER CHANGES TO THEINFORMATION IN THE PREVIOUSLY FILED VERSION OF THIS PERIODIC REPORT.**

 

----

 

**ALDILA, INC.**

 

**Report on Form 10-K**

**For the Fiscal Year Ended December 31,2003**

 

**INDEX**

 
|          |     |                                                                                        |   |
|---------------|----------|---------------------------------------------------------------------------------------------|--------|
| Part I        |     |                                                                                        |   |
|          |     |                                                                                        |   |
|          | Item 1.  | Business                                                                                    |   |
|          | Item 2.  | Properties                                                                                  |   |
|          | Item 3.  | Legal Proceedings                                                                           |   |
|          | Item 4.  | Submission of Matters to a Vote of Security  Holders                                        |   |
|          |     |                                                                                        |   |
| Part II       |     |                                                                                        |   |
|          |     |                                                                                        |   |
|          | Item 5.  | Market for Registrant’s Common Equity and  Related Stockholder Matters                 |   |
|          | Item 6.  | Selected Financial Data                                                                     |   |
|          | Item 7.  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|          | Item 7a. | Quantitative and Qualitative Disclosures  about Market Risk                                 |   |
|          | Item 8.  | Financial Statements and Supplementary Data                                                 |   |
|          | Item 9.  | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure       |   |
|          | Item 9A. | Controls and Procedures                                                                     |   |
|          |     |                                                                                        |   |
| Part  III     |     |                                                                                        |   |
|          |     |                                                                                        |   |
|          | Item 10. | Directors and Executive Officers of the  Registrant                                         |   |
|          | Item 11. | Executive Compensation                                                                      |   |
|          | Item 12. | Security Ownership of Certain Beneficial  Owners and Management                             |   |
|          | Item 13. | Certain Relationships and Related  Transactions                                             |   |
|          | Item 14. | Principal and Accounting Fees and Services                                                  |   |
|          |     |                                                                                        |   |
| Part IV       |     |                                                                                        |   |
|          |     |                                                                                        |   |
|          | Item 15. | Exhibits, Financial Statement Schedules,  and Reports on Form 8-K                           |   |
|          |     |                                                                                        |   |
| Signatures    |     |
| Exhibit Index |     |

 

2

----

 

**PARTI**

 

*This Form 10-K contains forward-lookingstatements within the meaning of the federal securities laws.  These forward-looking statements arenecessarily based on certain assumptions and are subject to significant risks anduncertainties.  These forward-lookingstatements are based on management’s expectations as of the date hereof, andthe Company does not undertake any responsibility to update any of thesestatements in the future.  Actual futureperformance and results could differ from that contained in or suggested bythese forward-looking statements as a result of factors set forth in this Form10-K (including those sections hereof incorporated by reference from otherfilings with the Securities and Exchange Commission), in particular as setforth in “Business Risks” under Item 1 and set forth in the “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” underItem 7.*

 

**Item1.  Business**

 

**General**

 

Aldila, Inc. (“Aldila” or the “Company”) is a leading designer andmanufacturer of high-quality innovative graphite (carbon fiber-based composite)golf shafts in the United States today and has maintained this position forover a decade.  Aldila conducts itsoperations through its subsidiaries, Aldila Golf Corp. (“Aldila Golf”) and AldilaMaterials Technology Corp. Aldila enjoys strong relationships with most majordomestic and many foreign golf club manufacturers including Callaway,TaylorMade-addidas Golf, Ping and Acushnet Company.  Aldila believes that it is one of the fewindependent shaft manufacturers with the technical and production expertiserequired to produce high-quality graphite shafts in quantities sufficient tomeet demand.  The Company’s current golfshaft product lines consist of Aldila branded products designed for custom clubmakers, as well as custom shafts developed in conjunction with its majorcustomers. These product lines are designed to improve the performance of anylevel of golfer from novice to tour professional.

 

In 1994, the Company started production of its principal raw materialfor shafts, graphite prepreg, which consists of sheets of carbon fiberscombined with epoxy resin.  See“Manufacturing—Raw Materials.”  TheCompany now produces substantially all of its graphite prepreg requirementsinternally.

 

In 1998, the Company established a manufacturing facility in Evanston,Wyoming for the production of carbon fiber an effort to further verticallyintegrate its manufacturing operations. On October 29, 1999, SGL Carbon Fibers and Composites, Inc. (“SGL”)purchased a 50% interest in the Company’s carbon fiber manufacturingoperation.  The Company and SGL enteredinto an agreement to operate the facility through a limited liability companywith equal ownership interests between the joint venture partners.  The Company and SGL also entered into supplyagreements with the new entity, Carbon Fiber Technology LLC (“CFT”), for thepurchase of carbon fiber at cost plus an agreed-upon mark-up.  Profits and losses of CFT are shared equallyby the partners.  On February 11,2004, the Company announced that the Company and SGL entered into a non-bindingletter of intent to sell selected assets, including property, plant, equipmentand know-how to an independent third party. If the transaction is completed, the Company and SGL would share equallyin the net proceeds.

 

**Graphite Golf Shafts**

 

The Company was founded in San Diego, California in 1972 and was anearly leader in the design and production of graphite golf shafts.  The Company believes it is well positioned toremain a leader in the market for graphite shafts due to its innovative andhigh quality products, strong customer relationships, design and compositeexpertise and significant manufacturing capabilities.

 

Most golf clubs being sold today have shafts constructed from steel orgraphite, although limited numbers are also manufactured from othermaterials.  Graphite shafts wereintroduced in the early 1970’s as the first major improvement in golf shafttechnology since steel replaced wood in the 1930’s.  The first graphite shafts had significanttorque (twisting force) and appealed primarily to weaker-swinging playersdesiring greater distance.  Graphiteshaft technology has subsequently improved so that shafts can now be designedfor golfers at all skill levels.  Unlikesteel shafts, the design of graphite shafts is easier to alter

 

3

----

 

with respect to weight, flex, flex location and torque to producegreater distance, increased accuracy and reduced club vibration resulting inimproved “feel” to the golfer.  Theimprovements in the design and manufacture of graphite shafts and the growingrecognition of their superior performance characteristics for many golferscompared to steel have resulted in increased demand for graphite shafts bygolfers of all skill levels. The initial acceptance of graphite shafts wasprimarily for use in woods.  Graphitecontinues to dominate  the professionaland consumer wood club market, with over 94% of new woods purchased in 2003including graphite shafts.   Theacceptance of graphite shafts in irons has not achieved the same success aswoods, and acceptance in irons has declined somewhat in recent years.  In 2003, approximately 27% of new ironspurchased were graphite shafted.    Sincemany golfers consider professionals to be “opinion leaders,” increasedacceptance and use of graphite shafts in irons by professionals would helpbroaden the overall graphite market.

 

Initially, graphite shafts were primarily sold for use in premiumclubs, while the value priced segment of the golf club market continued to besupplied with steel shafts.  Today,however, a large percentage of value priced clubs are being sold with graphiteshafts.  As the value priced segment ofthe golf club market converted from steel to graphite shafts, the Company tooksteps to enable it to meet the needs of this market segment, including thedesign of shafts that can be manufactured at prices acceptable to this marketand continued efforts to reduce its overall manufacturing costs.

 

**Products**

 

Aldila offers a broadrange of innovative and high-quality graphite golf shafts designed to maximizethe performance of golfers of every skill level.  The Company manufactures hundreds of uniquegraphite shafts featuring various combinations of performance characteristicssuch as weight, flex, flex point and torque. All of the Company’s shafts are composite structures consistingprincipally of carbon fiber and epoxy resins. The Company’s shafts may also include boron (added to increase shaftstrength) or fiberglass.  The Companyregularly evaluates new composite materials for inclusion in the Company’sshafts and new refinements on designs using current materials.

 

The Company’s shafts, which constituted approximately 89% of net sales inthe year ended December 31, 2003, are designed in partnership with itscustomers (principally golf club manufacturers) to accommodate specific golfclub designs.  The Company’s brandedmodels are typically sold to golf club manufacturers, distributors and golf proand repair shops and are used either to assemble a new custom club fromselected components or as an after market re-shaft of existing clubs.  The Company also helps develop cosmeticdesigns to give the customer’s golf clubs a distinctive look, even when thecustomer does not require a shaft with customized performancecharacteristics.  The prices of Aldilashafts typically range from $3 to $30.

 

The Company introduced an innovative proprietary design, the Aldila“One” shaft during 2002.  The Companybelieves that this is the first shaft design to feature multiple segments, eachwith separate design characteristics, which allows for more precise performanceoptimization than the traditional graphite shaft design, which embodies onlyone set of design characteristics over its entire length.  The One shaft is offered through distributionto the custom club market and possibly directly to consumers. It will also beincluded as a custom option by certain of its golf club manufacturercustomers.  In 2003, the Companyintroduced the NVPrototype at the 2003 PGA Merchandise Show inJanuary 2003 and subsequently changed it to the NVTM.   The NVTM features the Company’sexclusive Micro Laminate Technology – patent pending.

 

Since 1994, the Company has manufactured prepreg material for itsproduction of golf shafts.  In 1998, theCompany began selling prepreg manufactured in its Poway, Californiamanufacturing facility to third parties. Revenues from the sale of prepreg were approximately 5% of net sales in 2003and are not expected to be significant to the Company for several years.  Beginning in 1999, the Company offered forsale large bundle carbon fiber and chopped fiber from its manufacturingfacility in Evanston, Wyoming.  Sales oflarge bundle carbon fiber continued in 1999 through October 29, 1999, thedate that the Company sold a 50% interest in the carbon fiber manufacturingoperation.  All subsequent outside carbonfiber revenues, if any, are attributed to the joint venture.  The Company does not anticipate outside salesof carbon fiber to be significant in 2004 and is currently seeking to sell itsinterest in CFT

 

The Company began themanufacture of composite hockey sticks in 2000, following several months ofdevelopmental work.  The manufacture ofcomposite hockey sticks is similar to that of graphite golf shafts and usessimilar raw materials.  Revenues from thesale of hockey sticks were approximately 6% of net sales in 2003 and are notexpected to be significant to the Company for several years.

 

4

----

 

Carbon fiber composite materials are suited for a diverse range ofapplications based on their distinctive combination of physical and chemicalproperties.  See “Manufacturing – CarbonFiber Manufacturing Process.” Carbon fibers are used as reinforcements incomposite materials that combine fibers with epoxy resins or other matrixmaterials to form a substance with high strength, low weight, stiffness,resistance to corrosion, resistance to fatigue and capacity to dissipate heatand electrical conductivity.  Carbonfiber materials produced by the Company or CFT are used in a variety ofapplications such as molding compounds for the manufacture of electroniccomponents, masts and spars for the marine industry, hockey sticks, fishingrods, industrial products, as well as golf shafts.

 

**Product Design and Development**

 

Aldila is committed to maintaining its reputation as a leader ininnovative shaft design and composite materials technology.  The Company believes that the enhancement andexpansion of its existing product lines and the development of new products arenecessary for the Company’s growth and success. However, while the Company believes that it has generally achievedsuccess in the introduction of its graphite golf shafts, no assurance can begiven that the Company will be able to continue to design and manufactureproducts that meet with market acceptance.

 

Graphite shaft designs and modifications are frequently the directresult of the combined efforts and expertise of the Company and its customersto develop an exclusive shaft for each customer’s clubs.  New golf shaft designs are developed andtested using a CAD/CAE golf shaft analysis program, which evaluates a new shaftdesign with respect to weight, torque, flex point, tip and butt flexibility,swing weight and other critical shaft design criteria.  In addition, the Company researches new andinnovative shaft designs on an independent basis, which has enabled the Companyto produce a variety of new branded shafts as well as generate design ideas forcustomized shafts.  To improve andadvance product designs as they relate to composite technology and shaftprocess manufacturing, the Company’s engineers test new and existing materials,such as boron, kevlar, fiberglass, ceramic, thermoplastic and carbonfiber.  The Company’s design researchalso focuses on improvements in graphite shaft aesthetics since cosmeticappearance has become increasingly important to customers.  The Company’s research and developmentefforts have resulted in the Aldila “One” shaft, which the Company believes tobe the first shaft design featuring multiple segments, each with separatedesign characteristics, and which the Company recently started marketing.  In addition, to the Aldila “One” shaft, theCompany introduced the Aldila NVTM in 2003, featuring the Company’sexclusive Micro Laminate Technology. Although the Company emphasizes these research and developmentactivities, there can be no assurance that Aldila will continue to developcompetitive products or that the Company will be able to utilize new compositematerial technology on a timely or competitive basis, or otherwise respond toemerging market trends.

 

The Company has been one of the leaders in developing the market forlower cost large bundle carbon fiber by successfully converting to this fibertype in some of its products from a more expensive carbon fiber material forthe manufacture of certain of its graphite golf shafts.  The Company has had limited success inproviding large bundle carbon fiber to other manufacturing applications outsideof golf shafts.

 

The Company has applied its composite materials expertise on a limitedbasis to other products in recent years, producing hockey sticks as well asgraphite tubing and other molded parts on a special order basis.

 

**Customers and Customer Relations**

 

The Company believes that its close customerrelationships and responsive service have been significant elements of itssuccess to date, establishing it as a premier graphite shaft company.  Aldila’s golf club manufacturer customersoften work together with the Company’s engineers when developing a new golfclub in order to design a club that maximizes the performance features of theprincipal component parts:  the grip, theclubhead and the Aldila shaft.  TheCompany’s partnership relationship with its customers continues after thedevelopment of clubs containing Aldila’s shafts.  Following the design process, the Companycontinues to provide high levels of customer support and service in areas suchas quality control and assurance, timely and responsive manufacturing, deliveryschedules and education.  The Companybelieves the physical proximity of its headquarter facilities to many of itscustomers has facilitated a high degree of customer interaction andresponsiveness to customer needs.  Whilethe Company has had long-established relationships with most of its customers,it is not the exclusive supplier of graphite shafts to most of them andgenerally does not have long-term supply agreements with its customers

 

5

----

 

For fiscal year 2003, theCompany had approximately 240 golf shaft customers, which includedapproximately 76 golf club manufacturers and more than 40 distributors, withthe balance principally consisting of custom club assemblers, pro shops andrepair shops.  However, the majority ofthe Company’s sales has been and may continue to be concentrated among arelatively small number of customers. Sales to the Company’s top five customers represented approximately 68%,75% and 73% of net sales in 2003, 2002 and 2001, respectively.

 

Historically, Aldila’s principal customers have varied as a result ofgeneral market trends in the golf industry, in particular the prevailingpopularity of the various clubs that contain Aldila’s shafts.  As a result, there typically are changes inthe composition of the list of the Company’s ten most significant customersfrom year to year.  Due to thesubstantial marketplace success of their clubs in recent periods, for the lastseveral years the Company’s largest customers have been Callaway Golf,TaylorMade-addidas Golf, Acushnet Company and Ping.  While the Company believes its relationshipwith each of these major customers is suitable, the Company is not theexclusive supplier to any of them.  TheCompany’s sales to its principal customers have varied substantially from yearto year.

 

| **Customer**            | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|
| Acushnet Company        |       | 26       | %          | 21       | %          | 10       | %          |
| Callaway Golf           |       | 21       | %          | 22       | %          | 22       | %          |
| Ping                    |       | 10       | %          | 9        | %          | 15       | %          |
| TaylorMade-addidas Golf |       | 6        | %          | 13       | %          | 20       | %          |

 

Because of the historic volatility of consumer demand for specificclubs, as well as continued competition from alternative shaft suppliers, salesto a given customer in a prior period may not necessarily be indicative offuture sales and it is often difficult to project the Company’s sales to agiven customer in advance.

 

Although the Company believes that its relationships with its customersare good, the loss of a significant customer or a substantial decrease in salesto a significant customer (whether as a result of diminished sales by thatcustomer or a shaft sourced from other suppliers) could have a material adverseeffect on the Company’s business or operating results.

 

**Marketing and Promotion**

 

The Company’s marketing strategy is designed to encourage golf clubmanufacturers to select and promote Aldila shafts and to increase overallmarket acceptance and use of graphite golf shafts.  The Company utilizes a variety of marketingand promotional channels to increase sales of Aldila brand name shafts throughits network of distributors and to support Aldila’s brand name recognition andreputation among consumers for offering consistently high quality productsdesigned for a wide range of golfers. Although the Company has very limitedsales directly to the end users of its products, the Company believes that itsbrand name recognition contributes to the marketability of its customers’products.  In addition,  Nick Price, Peter Kostis and Rich Beem serveon the Company’s advisory staff and assist in its marketing efforts. Aldila’smarketing and promotion expenditures were approximately $1.9 million, $1.3million and $1.1 million in 2003, 2002 and 2001, respectively.  The Company does not currently incursignificant marketing expenses for its products other than golf shafts.

 

**Sales and Distribution**

 

Within the golf club industry, most companies do not manufacture thethree principal components of the golf club — the grip, the shaft and theclubhead — but, rather, source these components from independent suppliers thatdesign and manufacture components to the club manufacturers’specifications.  As a result, Aldilasells its graphite shafts primarily to golf club manufacturers and, to a lesserextent, distributors, custom club shops, pro shops and repair shops.  Distributors typically resell the Company’sproducts to custom club assemblers, pro and custom club shops, and individuals.  The Company uses its internal sales force inthe marketing and sale of its shafts to golf club manufacturers.  Sales to golf club manufacturers accountedfor approximately 81% of net sales for the year ended December 31, 2003.

 

Prepreg sales and carbon fiber sales are made primarily tomanufacturers of composite products.  TheCompany predominantly has utilized its internal sales force in the marketingand sale of these products to its customers in the past and will continue toutilize its internal sales force for the sales of prepreg in the future.

 

6

----

 

International sales represented 15%, 14%, and 12% of net sales for theyears ended December 31, 2003, 2002 and 2001, respectively.  See Note 15 in the Notes to ConsolidatedFinancial Statements for further breakdown of our international sales andlong-lived assets.

 

**Manufacturing**

 

The Company believes that its manufacturing expertise and productioncapacity differentiate it from many of its competitors and enable Aldila torespond quickly to its customers’ orders and provide sufficient quantities on atimely basis.  The Company today operatesthree golf shaft manufacturing facilities, one prepreg manufacturing facility(in conjunction with one of its shaft manufacturing facilities) and through its50% ownership interest in CFT, one carbon fiber manufacturing facility.  During its 32 years of operation, the Companyhas improved its manufacturing processes and believes it has established areputation as the industry’s leading volume manufacturer of high-performancegraphite shafts.

 

*Shaft Manufacturing Process*.  The process of manufacturing a graphite shafthas several distinct phases.  Differentdesigns of Aldila shafts require variations in both the manufacturing processand the materials used.  In traditionalshaft designs, treated graphite known as “prepreg” is rolled onto metal rodsknown as mandrels.   The graphite is thenbaked at high temperatures to harden the material into a golf shaft.  At the end of the manufacturing process, theshafts are painted and stylized using a variety of colors, patterns anddesigns, including logos and other custom identification.  Through each phase of this process, theCompany performs quality control reviews to ensure continuing high standards ofquality and uniformity and to meet exacting customer specifications.  The Company’s shaft manufacturing facilitiesare located in Poway, California, Tijuana, Mexico, and Zhuhai, China, with anincreasing percentage of its shafts being manufactured in China, in recentyears.

 

*Raw Materials*.  The primary material currently used in all ofthe Company’s graphite shafts is carbon fiber, which is combined with epoxyresin to produce sheets of graphite prepreg. The degree of the heating and stretching the graphite fibers determinesthe tensile strength and modulus (stiffness) of the fiber.  The Company manufacturers graphite prepreg atits Poway, California facility.

 

*Prepreg Manufacturing Process. *InOctober 1994, the Company initiated the internal production of prepreg inits Poway, California facility.  The Companybelieves that by producing a major portion of its prepreg requirementsinternally, it may better control the supply of raw material for shafts and mayreduce the impact of potential future price increases.  The Company now produces substantially all ofits prepreg requirements internally and is dependent on its own prepregproduction operation to support its shaft manufacturing requirements.  The Company is, however, somewhat dependentupon certain domestic prepreg suppliers for types of prepreg that it does notproduce and, therefore, the Company expects to occasionally purchase someprepreg products from outside suppliers in the future.  Although the Company believes that there willcontinue to be alternative third party suppliers of prepreg, there can be noassurance that unforeseen difficulties which could lead to an interruption inthe Company’s internal prepreg production will not occur, which would result inproduction delays.

 

The Company’s prepreg operation is dependent on certain suppliers forcarbon fibers, which along with epoxy resins and release paper constitute theprimary components in prepreg.  Through1997, the Company purchased all of its carbon fibers from outside vendors.  Beginning in 1998, the Company manufacturedcarbon fiber at its Evanston, Wyoming facility for consumption by its golfshaft production operation.  Becauseseveral different forms of carbon fiber are required for golf shaft products,including some not manufactured at the CFT facility, the Company will continueto depend on outside suppliers for a portion of its ongoing carbon fiberneeds.  In 2003, the Company obtained alarge portion of its carbon fiber from CFT but also purchased carbon fiber fromother carbon fiber manufacturers.  Theprices paid by the Company for carbon fiber began to increase at the end of2003 due to capacity constraints in the carbon fiber industry.  If the Company is unable to purchase carbonfiber, other than that produced at CFT, from suppliers, it could result inproduction delays of composite pregreg and golf shafts.

 

*Carbon Fiber Manufacturing Process.* Carbon fiber is produced by processing acrylicfiber through a series of stretching, stabilizing and carbonizing sequencesconverting it into essentially a pure carbon chain fiber exhibiting stiffnessand strength characteristics when made into a composite part similar to steelat significantly less weight.  Thesecarbon fibers combined with various resins are then converted to compositestructures, which have replaced metals in a number of weight criticalaerospace, sporting and industrial applications.  Typically, the composite structure will weigh25 to 50 percent less than the metal structure it has replaced.  Carbon fiber composite structures alsoprovide toughness, resistance to corrosion, resistance to fatigue, capacity to

 

7

----

 

dissipate heat and electrical conductivity.  The carbon fiber industry has grown from itsinception in the late 1950’s into one, which produced approximately 39 millionpounds of carbon fiber in 2003.

 

Carbon fiber usage has grown primarily for consumption by the aerospaceindustry and for sporting goods and industrial applications.  Aerospace grade carbon fibers continue to beutilized for production of commercial and military aerostructures.  The higher-cost, aerospace grade carbonfibers were first used in sporting goods and industrial applications until alower-cost, large bundle carbon fiber was developed as an alternative for usein many sporting goods and industrial applications.  Aldila was a leader in utilizing large bundlecarbon fibers initially purchased from outside vendors, for the manufacture ofgraphite golf shafts.  As such, theCompany completed construction of a 50,000 square foot carbon fiber manufacturingfacility in Evanston, Wyoming, which subsequently became CFT.  The facility produces large bundle carbonfiber material from acrylic fiber through a series of stretching, stabilizingand carbonizing sequences in this facility. This material is now a significant raw material for the Company’sprepreg manufacturing operation to support the manufacture of graphite golfshafts, although the Company still procures certain types of fibers fromoutside vendors for the manufacture of golf shafts.  The Company believes it can purchase the typeof fiber produced by CFT from two outside sources.

 

CFT purchased substantially all of its raw acrylic fibers for thecarbon fiber operation from Toho Carbon Fibers, Inc. for the years 2000 through2003.  Previous to 2000, CourtauldsFibres, Ltd. was also used as a supplier of its raw acrylic fibers.  The Company believes these two vendors willbe able to provide a reliable source of supply for raw materials at theanticipated operating level of CFT. However, CFT will continue to pursue alternate sources of supply forthis material.

 

**Environmental Matters**

 

The Company is subject to various federal, state, local and foreignenvironmental laws and regulations, including those governing the use,discharge and disposal of hazardous materials as the Company uses hazardoussubstances and generates hazardous waste in the ordinary course of itsmanufacturing of graphite golf shafts, other composites, graphite prepreg andcarbon fiber.  The Company believes it isin substantial compliance with applicable laws and regulations and has not todate incurred any material liabilities under environmental laws andregulations; however, there can be no assurance that environmental liabilitieswill not arise in the future which may affect the Company’s business.

 

**Competition**

 

Aldila operates in a highly competitive environment in both the UnitedStates and international markets for the sale of its graphite golf clubshafts.  The Company believes that itcompetes on the basis of its ability to provide a broad range of high quality,performance graphite shafts; its ability to deliver customized products inlarge quantities and on a timely basis to its customers; the acceptance ofgraphite in general, and Aldila shafts in particular, by professional and othergolfers, whose preferences are to some extent subjective; and, finally,price.  Presently, there existssubstantial excess graphite shaft manufacturing capacity both in the UnitedStates and in other countries.  This hashad the effect of decreasing the selling prices of the Company’s shafts.  Management anticipates that this trend hasended.  Until recently, the United Statesmarket for graphite shafts was dominated by a relatively small number of UnitedStates based shaft manufacturers which competed predominantly for the premiumshaft business. However, the Company now competes against United States andforeign-based shaft manufacturers for the premium shaft market and competesprimarily against the foreign-based shaft manufacturers for the value shaftmarket.  This competition has made itmore difficult to retain existing customers, attract new customers and hasplaced increasing pressure on prices for the Company’s premium and valueshafts.  The Company believes that it isthe largest supplier of graphite shafts to the United States club market, whichresults from its ability to establish a premium brand image and reputationamong golf club companies as a value-added supplier with competitive prices.

 

Aldila competes against other shaft manufacturers, both graphite andsteel, and in the past also against golf club companies that produced their ownshafts internally, some of which may have or had greater resources thanAldila.  The Company also faces potentialcompetition from those golf club manufacturers that currently purchase golfshaft components from outside suppliers but that may have, develop or acquirethe ability to manufacture all or a portion of its graphite shaftsinternally.  Should any of the Company’ssignificant customers decide to meet any of its shaft needs internally, itcould have an adverse effect on the Company. The Company also competes against companies who manufacture one or moreof three principal components of the golf club, the grip, the shaft and theclub head, and assemble completed golf clubs for delivery to clubcompanies.  Should any of the Company’ssignificant customers decide to source their golf clubs in this manner where anAldila shaft is not included, it could have an adverse effect on the Company.

 

8

----

 

The Company also competes for sales of prepreg from its prepregfacility and carbon fiber through its 50% interest in CFT with other producersof prepreg and carbon fibers, many of which have substantially greater researchand development, managerial and financial resources than the Company.  Some producers have been producing prepregand carbon fiber for substantially longer periods of time than the Company has,and represent significant competition to the Company.  The Company’s ability to compete in the saleof prepreg and carbon fiber is dependent to some extent on the Company’sability to cause manufacturers and consumers of carbon fiber-based products toutilize large bundle carbon fiber, which is the sole type of carbon fibermanufactured by CFT and a significant portion of the carbon fiber used inAldila’s graphite prepreg, rather than the small bundle, aerospace grade carbonfiber.  In addition, the ability topurchase fiber from an outside source when required in today’s fiber market,limits the Company’s ability to compete in prepreg sales.

 

**Intellectual Property**

 

Aldila utilizes a number of trademarks and logos in connection with thesale and advertising of its products. The Company takes all reasonable measures to ensure that any productbearing an Aldila trademark reflects the consistency and quality associatedwith the Company’s products and intends to continue to protect them to thefullest extent practicable.  As ofDecember 31, 2003 the Company had approximately 58 United States andforeign registered trademarks.

 

**Employees**

 

As of December 31, 2003, Aldila employed 1,180 persons on afull-time basis, including nine in sales and marketing, 20 in research,development and engineering and 1,013 in production. The balance isadministrative and support staff.  Thenumber of full-time employees includes 392 persons who are employed in theCompany’s Mexico facility and 656 who are employed in the Company’s Chinafacility.  Because of seasonal demands,the Company hires a significant number of temporary employees.  As of December 31, 2003, the Companyalso employed an additional 32 temporary employees on a full-time basis.  Aldila considers its employee relations to begood.

 

**Seasonality**

 

Because the Company’s customers have historically built inventory inanticipation of purchases by golfers in the spring and summer, the principalselling season for golf equipment, the Company’s operating results have beenaffected by seasonal demand for golf clubs, which has generally resulted inhighest sales occurring in the first and second quarter.  The timing of customers’ new productintroductions has frequently mitigated the impact of seasonality in recentyears.

 

**Backlog**

 

As of December 31, 2003, the Company had a sales backlog ofapproximately $11.0 million compared to approximately $6.8 million as ofDecember 31, 2002.  The Companybelieves that the dollar volume of its current backlog will be shipped over thenext three months.  Orders can typicallybe cancelled without penalty up to 30 days prior to shipment.  Historically, the Company’s backlog generallyhas been highest in the first and second quarters, due in large part toseasonal factors.  Due to the timing andreceipt of customer orders, backlog is not necessarily indicative of futureoperating results.

 

**Business Risks**

 

*Customer Concentration*.  The Company’s sales have been, and verylikely will continue to be, concentrated among a small number ofcustomers.  In 2003, sales to theCompany’s top five customers represented approximately 68% of net sales.  Aldila’s principal customers havehistorically varied depending largely on the prevailing popularity of thevarious clubs that contain Aldila shafts. In 2003, Callaway Golf accounted for 21% of net sales, Acushnet Companyaccounted for 26% of net sales and Ping accounted for 10% of net sales.  The Company cannot predict the impact thatgeneral market trends in the golf industry, including the fluctuation inpopularity of specific clubs manufactured by customers, will have on its futurebusiness or operating results.

 

While the Company has had long-established relationships with most ofits customers, it is not the exclusive supplier of graphite shafts to most ofthem, and consistent with the industry practice, generally does not havelong-term contracts with its customers. In this regard, Callaway Golf, Acushnet Company and Ping, whocollectively represent in excess of 57% of the Company’s net sales in 2003,each purchased from at least two other graphite shaft suppliers.  In the event Callaway Golf,

 

9

----

 

Acushnet Company, Ping or any other significant customer increasespurchases from its other suppliers or adds additional suppliers, the Companycould be adversely affected.  Althoughthe Company believes that its relationships with its customers are good, theloss of a significant customer or a substantial decrease in sales to asignificant customer could have a material adverse effect on the Company’sbusiness and operating results.  Inaddition, sales by the Company’s major customers are likely to varydramatically from time to time due to fluctuating public demand for golfequipment generally and for their specific products.

 

*Competition*.  Aldila operates in a highly competitiveenvironment for golf equipment sales. The Company believes that it competes principally on the basis of itsability to provide a broad range of high quality, performance graphite shafts;its ability to deliver customized products in large quantities and on a timelybasis; the acceptance of graphite shafts in general, and Aldila shafts inparticular, by professionals and other golfers, whose preferences are to someextent subjective; and finally, price.

 

Aldila competes against both domestic and foreign shaftmanufacturers.  Some of the Company’scurrent and potential competitors may have greater resources than Aldila.  The Company also faces potential competitionfrom those golf club manufacturers that currently purchase golf shaft componentsfrom outside suppliers but that may have, develop or acquire, the ability tomanufacture shafts internally.

 

As the Company further enters into the manufacture and sale of prepregproducts, it competes with other producers of prepregs, many of which havesubstantially greater research and development, managerial and financialresources than the Company and represent significant competition for theCompany.

 

*New Product Introduction*.  The Company believes that the introduction ofnew, innovative golf shafts using graphite or other composite materials will becritical to its future success.  Whilethe Company emphasizes research and development activities in connection withcarbon fiber and other composite material technology, there can be no assurancethat the Company will continue to develop competitive products or that theCompany will be able to develop or utilize new composite material technology ona timely or competitive basis or otherwise respond to emerging market trends.

 

Although the Company believes that it has generally achieved success inthe introduction of its customized graphite golf shafts, specifically, theAldila NVTM, no assurance can be given that the Company will be ableto continue to design and manufacture products that meet with marketacceptance, either on the part of club manufacturers or golfers.  The design of new graphite golf shafts isalso influenced by rules and interpretations of the United States GolfAssociation (“USGA”).  There can be noassurance that any new products will receive USGA approval or that existingUSGA standards will not be altered in ways that adversely affect the sales ofthe Company’s products.

 

*Reliance on Off-Shore ManufacturingFacilities*.  TheCompany operates manufacturing facilities in Tijuana, Mexico and Zhuhai,People’s Republic of China.  The Companypays certain expenses of these facilities in Mexican pesos and Chineserenminbis, respectively, which are subject to fluctuations in currency valueand exchange rates.  The Company operatesa shaft manufacturing facility in Tijuana, Mexico pursuant to the “maquiladora”duty-free program established by the Mexican and United Statesgovernments.  Such program enables theCompany to take advantage of generally lower costs in Mexico, without payingduty on inventory shipped into or out of Mexico.  The Company also operates in the People’sRepublic of China in a special economic zone, which affords special advantagesto companies with regards to income taxes, import and export duties and valueadded taxes.  There can be no assurancethat the governments of Mexico or the People’s Republic of China will continuethe programs currently in place or that the Company will continue to be able tobenefit from these programs.  The loss ofthese benefits could have an adverse effect on the Company’s business.  The Company is also subject to othercustomary risks of doing business outside the United States, includingpolitical instability, other import/export regulations and culturaldifferences.

 

*Raw Material Cost/Availability*.  The Company’s gross profit margins, in part,are dependent on the price paid for carbon fiber purchased from outsidevendors, and more substantially starting in the latter part of 1998, the costof production of carbon fiber at the Evanston, Wyoming facility, including theprice paid for the acrylic fiber used for the manufacture of carbon fiber andthe other costs associated with the operation of the carbon fiber plant.

 

The Company experienced an increase in carbon fiber prices in 1996 and1997 due to the growth experienced in the use of carbon fiber coupled withrelatively little excess capacity.  Theprices paid by the Company for carbon fiber leveled in 1998 and decreasedduring 1999 through 2002, due to the current state of excess-capacity in thecarbon fiber manufacturing industry. However, that trend has begun to reverse itself in the later part of2003.  The Company has begun toexperience increases in certain grades of carbon fiber prices during the laterpart of 2003.  Management is not able topredict the timing or extent of any

 

10

----

 

future price changes for carbon fiber; however, the Company could benegatively impacted if future increases in carbon fiber prices have a negativeimpact on the Company’s gross margins.

 

The Company also has relationships with other outside vendors for itsadditional carbon fiber needs through 2003 and beyond.  Depending on market conditions prevailing atthe time and extent to which production at CFT meets expectations, the Companymay face difficulties in obtaining adequate supplies of carbon fiber fromexternal sources to provide for any carbon fiber needs not met internally.  If it appears that CFT is not likely tosatisfy a significant portion of the Company’s needs or if it appears thatthere will not be adequate availability in the market, the Company may not havemade arrangements in advance for the purchase of material amounts of carbonfiber from alternative sources.

 

In addition, the Company is dependent on its internal production ofgraphite prepreg to support its shaft manufacturing operations and has notsecured adequate additional sources of supply should its production of prepregbe interrupted for any reason.  Theexposure to the Company resulting from its increasing reliance on its owninternal production of the raw materials for its golf shaft business isenhanced because the Company currently operates only one prepreg facility andhas an interest in only one carbon fiber manufacturing facility.  Until recently, there has beenexcess-capacity in these industries.  Inthe past, significant market shortages of both carbon fiber and graphiteprepreg have occurred and if they re-occur, it could have a negative impact onthe Company’s financial statements.

 

*Joint Venture Operating Carbon FiberFacility. * The Company started producing carbon fiber atits Evanston, Wyoming facility in 1998. Since October 1999, this facility has been operated by a jointventure, 50% owned by each of the Company and SGL.  As a result of the operation of this facilitythrough the joint venture, the Company is subject to business and financialrisks, such as the risks that SGL will be unable to meet its obligations to thejoint venture, that there will be operational difficulties resulting from thesplit ownership, raw material supply problems, changes in demand for carbonfiber based products, or that there will be differences of opinion between thejoint venture partners as to future operations leading to an inability to makedecisions when required or to the making of decisions not in the best interestsof both joint venture partners.

 

*Reliance on Carbon Fiber ManufacturingFacility. *Duringthe period in which the Company or the joint venture has operated the Evanston,Wyoming facility, the market for carbon fiber products has been soft, which haslimited the Company’s ability to take full advantage of the opportunity offeredby the vertical integration of its carbon fiber raw material usage in graphitegolf shafts.  In the current carbon fibermarket there may not be a market at attractive prices for any of the type ofcarbon fiber produced at this facility in excess of the needs of the Companyand its venture partner.  If the facilitydoes not produce high quality fiber at the anticipated volumes, either becauseof production shortfalls or limited demand for the facility’s carbon fiber, theper pound cost of the fiber produced will likely be higher due to thesubstantial fixed costs involved in operating a carbon fiber productionfacility.  In addition, if the facilityis not capable of producing carbon fiber at sufficient volumes to satisfy thedemands of both venture partners, the Company would be required to purchaseadditional fiber from third party suppliers, which may not be available insufficient quantities to satisfy its demands and could result in highermarginal costs to the Company than fiber acquired from the joint venture.

 

*Potential Cash Flow Shortages.*  The Company has cash and cash equivalentstotaling $6.9 million as of December 31, 2003.  Management anticipates that these sources offunds when combined with cash flow generated from operations will be sufficientto finance its business operations at least through 2004.  If the Company is not able to generate theexpected cash flows from operations, the Company could be adversely affected.

 

*Shaft Manufacturing by Club Companies andOne-Stop Shops*. Another factor that could have a negative impact in the future on theCompany’s sales to golf club manufacturers would be a decision by one of itscustomers to manufacture all or a portion of their graphite shaft requirements,or to have an increased amount of their requirements filled from one-stop shops(where main components, shaft or head, of the golf club could be purchased andassembled). While the Company has not to date experienced any material declinein its sales for these reasons, should any of the Company’s major customersdecide to meet any significant portion of their shaft needs either internally orthrough one-stop shops, it could have a material adverse impact on the Companyand its financial results.

 

*Utilization of Certain Hazardous Materials*.  In the ordinary course of its manufacturingprocesses, the Company uses hazardous substances and generates hazardouswaste.  The Company has not to dateincurred any material liabilities under environmental laws and regulations andbelieves that it is in substantial compliance with applicable laws andregulations.

 

11

----

 

Nevertheless, no assurance can be given that the Company will notencounter environmental problems or incur environmental liabilities in thefuture, which could adversely affect its business.

 

*Dependence on Discretionary Consumer Spending*.  Sales of golf equipment have historicallybeen dependent on discretionary spending by consumers, which may be adverselyaffected by general economic conditions. The Company believes that golf equipment sales have remained flat inrecent periods and may continue to be so in the future.  A decrease in consumer spending on golfequipment or, in particular, a decrease in demand for golf clubs with graphiteshafts could have an adverse effect on the Company’s business and operatingresults.

 

*Reliance on Key Personnel*.  The success of the Company is dependent uponits senior management team, as well as its ability to attract and retainqualified personnel.  There iscompetition for qualified personnel in the golf shaft industry as well as thecarbon fiber business.  There is noassurance that the Company will be able to retain its existing seniormanagement personnel or to attract additional qualified personnel.

 

*Justice Department Investigation*.  During 1999 the Company received a subpoenafor documents from the Antitrust Division of the U.S. Department of Justice inconnection with the on-going investigation of an alleged price fixingconspiracy in the carbon fiber and graphite prepreg industries.  The Department of Justice has informed theCompany that it is not currently a target of the investigation, although it hasindicated that it has not cleared the Company of any involvement in the allegedconspiracy.  The Company is cooperatingwith the Department of Justice’s investigation.

 

**Item 2.Properties**

 

The Company’s principal executive offices are located in Poway,California (in the San Diego metropolitan area).  The Company’s golf shafts are manufactured atthree separate facilities, one located in Poway, California, one located inTijuana, Mexico and one in the Zhuhai economic development zone of the People’sRepublic of China.  The Company leases a73,000 square foot facility in Poway, California for shaft manufacturingoperations, graphite prepreg production and for its executive offices.  The Mexico facility is also leased andcomprises approximately 31,000 square feet. The China facility is also leased and comprises approximately 88,000square feet.  The Company also may leasewarehousing space in Mexico and China when needed.  Currently, the Company leases warehousingspace in China.  In addition, theCompany’s 50% joint venture, CFT, owns 14 acres of land in Evanston, Wyoming onwhich it operates a 50,000 square foot carbon fiber manufacturing plant.

 

The Company’s principal executive offices were previously located in a33,000 square foot leased facility in Poway, California, with a lease termthrough October 31, 2005.  DuringMarch of 2003, the Company consolidated its principal executive officesinto its manufacturing facility in Poway, California.  The Company has negotiated a sub-lease of itsprevious executive offices with a tenant through October 31, 2005.

 

**Item3.  Legal Proceedings**

 

None.

 

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

 

There were no matters submitted to a vote of security holders duringthe fourth quarter of fiscal 2003.

 

12

----

 

**PART II**

 

**Item5.  Market for Registrant’s Common Equityand Related Stockholder Matters**

 

**COMMON STOCK PERFORMANCE**

 

| ** **     | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
|           |       |     |       |     |       |   |   |   |   |
| First Quarter  |       | $        | 1.76       |     | $          | 1.29 |   | $ | 3.60 |   | $ | 2.52 |   |
|           |       |     |       |     |       |   |   |   |   |
| Second Quarter |       | $        | 1.95       |     | $          | 1.55 |   | $ | 3.24 |   | $ | 1.59 |   |
|           |       |     |       |     |       |   |   |   |   |
| Third Quarter  |       | $        | 2.78       |     | $          | 1.70 |   | $ | 1.87 |   | $ | 1.32 |   |
|           |       |     |       |     |       |   |   |   |   |
| Fourth Quarter |       | $        | 3.73       |     | $          | 2.60 |   | $ | 1.95 |   | $ | 1.10 |   |

 

All the prices above reflect the Company’s one-for-three reverse stocksplit, for shareholders of record at the close of business on June 3,2002.  On March 23, 2004, theclosing common stock price was $5.33, and there were approximately 341****common stockholders of record.  The company believes a significant number ofbeneficial owners also own Aldila stock in “street name.”

 

Aldila, Inc. common stock is traded on the NASDAQ national market,symbol:  ALDA.

 

The Company intends to retain earnings for use in operations and doesnot anticipate paying cash dividends on the common stock in the foreseeablefuture.  Aldila, Inc. is a holdingcompany whose ability to pay dividends depends on the receipt of dividends orother payments from its two principal subsidiaries, Aldila Golf and AldilaMaterials Technology Corp.

 

**EQUITY COMPENSATION PLAN INFORMATION**

 

The following table provides informationregarding securities authorized for issuance under the Company’s equitycompensation plans as of December 31, 2003 (all numbers of securitiesreflect the Company’s one-for-three reverse stock split on June 3, 2002):

 
| **Plan  Category**                                          | ** ** | **Number of securities to be  issued upon exercise of  outstanding options** | ** ** | **Weighted-average exercise  price of outstanding  options** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation plans** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
|                                                        |       |                                                                         |       |                                                         |       |                                                                                                |       |
| Equity  compensation plans approved by security holders     |       | 712,497                                                                      |       | $                                                            | 5.21       |                                                                                                | 638,613    |   |
| 1994 Stock Incentive Plan                                   |       |                                                                         |       |                                                         |       |                                                                                                |       |   |
|                                                        |       |                                                                         |       |                                                         |       |                                                                                                |       |
| Equity  compensation plans not approved by security holders |       | —                                                                       |       |                                                         |       | 20,167                                                                                              |       |
| 1992 Stock Option Plan (1)                                  |       |                                                                         |       |                                                         |       |                                                                                                |       |
| Stock  Option Grant (2)                                     |       | 50,000                                                                       |       | $                                                            | 4.89       |                                                                                                | —     |   |
| Total                                                       |       | 762,497                                                                      |       |                                                         |       | 658,780                                                                                             |       |

 

13

----

 

----

(1) In 1992, the Company adopted the 1992Stock Option Plan to provide equity incentives for the management and directorsof the Company.  The Company has reserved175,431 shares for issuance under this Plan. The Company does not expect to issue additional options under the 1992Plan.

(2) On March 20, 2000, the Company and NickPrice Group entered into a stock option agreement.  The option agreement allows Nick Price topurchase 50,000 shares of Common Stock at a purchase price of $4.89.  The shares are not currently registered underany of the Company’s stock option plans. In return for the shares, the Company is receiving promotional andadvisory services of Nick Price for a guaranteed minimum value of $4.50 pershare, or a minimum aggregate consideration of $225,000.  

 

14

----

 

**Item6.   Selected Financial Data**

 

Theinformation required as to this Item is contained in the following table.

 

**ALDILA, INC.**

**SELECTED FINANCIAL DATA**

**(In thousands, except per share amounts)**

 
| ** **                                              | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Operating Results (Year ended  December 31):       |       |     |       |     |       |     |       |     |       |     |       |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Net sales                                               |       | $        | 37,807     |     | $          | 37,462   |       | $        | 39,561     |     | $          | 55,859 |   | $ | 45,091 |   |
| Cost of sales                                           |       | 30,586   |       | 32,828   |       | 33,304   |       | 42,257   |       | 37,241   |       |
| Gross profit                                            |       | 7,221    |       | 4,634    |       | 6,257    |       | 13,602   |       | 7,850    |       |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Selling, general and administrative                     |       | 6,989    |       | 7,334    |       | 6,851    |       | 7,483    |       | 7,179    |       |
| Impairment of goodwill                                  |       | —   |       | —   |       | 41,932   |       | —   |       | —   |       |
| Impairment of trademarks & patents                  |       | —   |       | —   |       | 12,963   |       | —   |       | —   |       |
| Amortization of goodwill                                |       | —   |       | —   |       | 1,410    |       | 1,428    |       | 1,428    |       |
| Plant consolidation                                     |       | —   |       | 300      |       | 593      |       | (566     | )          | 900      |       |
| Operating income (loss)                                 |       | 232      |       | (3,000   | )          | (57,492  | )          | 5,257    |       | (1,657   | )          |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Interest expense                                        |       | 23       |       | 94       |       | 375      |       | 900      |       | 1,315    |       |
| Other expense (income), net                             |       | 48       |       | 62       |       | 65       |       | (570     | )          | (379     | )          |
| Impairment of investment in joint venture               |       | 2,220    |       | —   |       | —   |       | —   |       | —   |       |
| Equity in earnings of joint venture                     |       | (150     | )          | (269     | )          | (231     | )          | (220     | )          | (12      | )          |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| (Loss) income before income taxes                       |       | (1,909   | )          | (2,887   | )          | (57,701  | )          | 5,147    |       | (2,581   | )          |
| (Benefit) provision for income taxes                    |       | (183     | )          | (43      | )          | (6,282   | )          | 1,930    |       | (476     | )          |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Net (loss) income                                       |       | $        | (1,726     | )        | $          | (2,844   | )          | $        | (51,419    | )        | $          | 3,217 |   | $ | (2,105 | ) |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Net (loss) income per common share-basic:               |       | $        | (0.35      | )        | $          | (0.57    | )          | $        | (10.10     | )        | $          | 0.62 |   | $ | (0.42 | ) |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Net (loss) income per common share,  assuming dilution: |       | $        | (0.35      | )        | $          | (0.57    | )          | $        | (10.10     | )        | $          | 0.62 |   | $ | (0.42 | ) |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Selected Operating Results                              |       |     |       |     |       |     |       |     |       |     |       |
| As a Percentage of Net Sales:                           |       |     |       |     |       |     |       |     |       |     |       |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Gross profit                                            |       | 19.1     | %          | 12.4     | %          | 15.8     | %          | 24.4     | %          | 17.4     | %          |
| Selling, general and administrative                     |       | 18.5     | %          | 19.6     | %          | 17.3     | %          | 13.4     | %          | 15.9     | %          |
| Operating income (loss)                                 |       | 0.6      | %          | (8.0     | )%         | (145.3   | )%         | 9.4      | %          | (3.7     | )%         |
| Net (loss) income                                       |       | (4.6     | )%         | (7.6     | )%         | (130.0   | )%         | 5.8      | %          | (4.7     | )%         |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Financial Position (at December 31):               |       |     |       |     |       |     |       |     |       |     |       |
|                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Working capital                                         |       | $        | 15,181     |     | $          | 13,162   |       | $        | 13,851     |     | $          | 13,387 |   | $ | 15,356 |   |
| Total assets                                            |       | 29,013   |       | 31,159   |       | 34,886   |       | 105,018  |       | 108,889  |       |
| Long-term debt, including current portion               |       | —   |       | —   |       | —   |       | 8,000    |       | 16,000   |       |
| Total stockholders’ equity                         |       | 24,446   |       | 26,353   |       | 29,197   |       | 81,366   |       | 78,149   |       |

 

15

----

 

**Item7.    Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

**Significant Accounting Estimates**

 

We prepare the consolidated financial statements of the Company inconformity with accounting principles generally accepted in the United Statesof America.  As such, we are required tomake certain estimates, judgments and assumptions that we believe arereasonable based upon the information available. These estimates andassumptions affect the reported amounts of assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the periods presented. The significant accounting policies which webelieve are the most critical to aid in fully understanding and evaluating ourreported 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 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 at the time sales are made. The Company believes that shafts returned for breakage will be returned within three years of the initial sale of the shaft.  The Company estimates that 50% will be returned in the first year after sale, 30% in the second year after sale and the remaining 20% in the third year after sale, assuming a mid-year convention.  The Company’s breakage return rate has been between .40% and 1.54% (breakage returns divided by sales dollars) for the past ten years.  The Company has historically utilized a four-year moving average of the breakage return rate to record its estimated liability.  The four-year average utilized in the accrual estimate as of December 31, 2003 is .47%.  The Company’s breakage return rate has declined over the past years as the Company’s sales have decreased.  The highest four-year average over the past four years has been .89%.  If the Company were to use .89% in estimating its liability as of December 31, 2003, it would have the effect of increasing the liability by approximately $366,000, which would be recorded in cost of goods sold.  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.  The Company estimates its allowance for doubtful accounts on a monthly basis, by reviewing all amounts owed to the Company and focusing on those amounts that are greater than 60 days past due.  The Company reviews the customers that have amounts greater than 60 days past due and where appropriate reserves for the receivable amount.  As of December 31, 2003, the Company estimated this amount to be approximately $34,000.  If the Company were to reserve for the total amount greater than 60 days past due, it would increase the allowance by approximately $67,000, which would be recorded in administrative expense.

 

*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.   Management of the Company, including but not limited to, representatives from manufacturing, sales, accounting and officers review the inventory reserve methodology quarterly and when appropriate, establish additional reserves or reduce existing reserves.  The Company’s reserve methodology consists of the following; review on hand inventories of our top customers and compare to their

 

16

----

 

anticipated sales forecast.  A100% reserve is established for all shafts that are deemed to be obsolete.  Raw materials are reviewed based uponestimated future production and when appropriate, reserves areestablished.  Shafts that are designatedfor rework (parts that need additional work) are reviewed and when appropriatereserves are established.  The finalanalysis is to review inactive inventory, and apply reserves to parts that werenot included in the other analyses and have been inactive in the system for aperiod of twelve months.  The Company’saverage reserve percentage compared to gross inventory has been approximately22% for the past five years.  In the pastfive years, the highest reserve percentage was approximately 30% and the lowestreserve percentage was approximately 19%. The Company’s reserve percentage as of December 31, 2003 is21%.   See the estimated impact below tocost of goods sold, utilizing the different reserve rates above:

 

(Amounts below in thousands)

 
| ** **                        | ** ** | **Average** | ** ** | **Highest** | ** ** | **Lowest** | ** ** |
|-----------------------------------|------------|-------------|------------|-------------|------------|------------|------------|
| Gross inventory as of 12/31/03    |       | 9,785       |       | 9,785       |       | 9,785      |       |
| Reserve rate                      |       | 22.4        | %          | 30.3        | %(a)       | 18.7       | %          |
| Estimated reserve                 |       | 2,193       |       | 2,969       |       | 1,830      |       |
| Recorded Reserve as of 12/31/2003 |       | 2,007       |       | 2,007       |       | 2,007      |       |
| Impact to costs of goods sold     |       | 186         |       | 962         |       | (177       | )          |

 

----

(a) This was theCompany’s highest rate, the second highest rate in the past five years was22.1%.

 

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. The Company has worked hard at reducing its inventory in the past years.  Although inventory decreased by only $760,000 in 2003 from 2002, finished goods inventory and work-in-process decreased by approximately $2.0 million and $929,000, respectively in 2003 from 2002.  The decreases of finished goods and work-in-process were partially offset by an increase in raw materials of $2.2 million.  As the Company continues to try and reduce its carrying levels of its work-in-process and finished goods inventory, it should have the effect of further reducing the amount of its inventory reserves.

 

**Overview - Business Conditions**

 

The Company is principally engaged in the business of designing,manufacturing and marketing graphite (carbon fiber based composite) golf clubshafts, with approximately 81% of its net sales resulting from sales to golfclub manufacturers for inclusion in their clubs.  As a result, the Company’s operating resultsare substantially dependent not only on demand by its customers for theCompany’s shafts, but also on demand by consumers for clubs including graphiteshafts such as the Company’s.

 

The graphite shaft market consists of premium shafts, branded shaftsand value shafts.  The Company sellscustomized premium shafts directly to its customers and sells Aldila brandedshafts through the OEM custom fit programs and distributors.  The Company has re-emerged over the pastcouple of years as an innovator in the branded segment of the business, inwhich shafts tend to sell at higher prices and gross margins than the standardshafts sold to club manufacturers.  TheCompany introduced its new and innovative “One” shaft early in 2002, which hasbeen successful in the branded segment and the Company introduced the Aldila NVTM,in 2003, featuring the Company’s exclusive Micro Laminate Technology.  The NVTM has had numerous tourvictories, including the 2003 British Open and is currently the number one newshaft model on tour.   In addition to the“One” and the NVTM shafts, the Company continues to develop otherpremium branded custom shafts.  TheCompany believes that it will continue to be successful in the branded segmentand has focused its marketing and advertising effort in support of thisbusiness. Over the past years the Company has realized substantial sales growthin the value priced segment of the graphite shaft market, although the Companyhas recently seen it sales of value shafts flatten out.  Value shafts sold represent approximately 27%of the total shafts sold, which is down from 37% in 2002.  The Company now competes aggressively withboth United States and foreign-based shaft manufacturers for premium graphiteshafts and also against primarily foreign-based shaft manufacturers for lowerpriced value shaft sales. The Company continues to maintain a broad customerbase in the premium shaft market segment. While the Company’s market share in the value segment is not as great asthe premium segment, the Company has been somewhat successful in securing newcustomers in this segment.  Generally,value shafts have significantly lower selling prices than premium shafts and,as a result, contribute less to gross profit.

 

17

----

 

The pressure on selling prices of both premium and value shafts undercurrent market conditions, and the increased percentage of overall salesrepresented by value shafts has resulted in a reduction of approximately 37% inthe average selling price of the Company’s shafts over the last seven years,although in some cases average selling prices may increase slightly from periodto period depending on the mix of products sold.  In the past five years, the average sellingprice has declined by approximately 9%, however in 2003 it increased byapproximately 11% from 2002, which was primarily attributed to the Company’ssuccess in the premium branded segment. The Company believes that its average selling price will increase if itcontinues to be successful in the premium branded segment of the golf shaftmarket.  In addition, increases in carbonfiber prices passed on to its customers will also have the effect of increasingaverage selling prices in the future.

 

During the 1990’s, the graphite golf shaft industry became increasinglycompetitive, placing extraordinary pressure on the selling prices of theCompany’s golf shafts and adversely affecting its gross profit margins andlevel of profitability.  The Company’sresponse has been to reduce its cost structure, principally by producing itsown prepreg and by shifting the largest portion of its shaft production to itsoffshore facilities, while maintaining high quality and superior customerservice.  The cost saving benefits of itsefforts to vertically integrate its operations, particularly through carbonfiber manufacturing, has not benefited the Company in the last several years.  Recent market prices for golf shaft rawmaterials, which are primarily based on carbon fiber costs, have beenhistorically low with carbon fiber readily available at attractive prices whencompared to the Company’s cost to purchase it from CFT.  In the second half of 2003 the availabilityof carbon fiber began to decline and prices began to increase, which trend theCompany believes will continue at least for the next year or two.  Although the Company’s gross margins andprofitability have continued to be adversely affected through this perioddespite its efforts, management believes that vertical integration through itsprepreg operation has been successful to date and is allowing the Company tomaintain, or in some cases enhance, its competitive position with respect tothe major United States golf club companies that are its principalcustomers.  The Company continues to lookfor opportunities to cut costs and to increase its market share.  In an effort to reduce costs, in 2002 theCompany consolidated its executive offices with its manufacturing facilities inPoway, California.  In addition, theCompany has increased its marketing and advertising spending in support of itsbranded products, principally the Aldila One and the NVTM.

 

The Company’s sales have tended to be concentrated among a limitednumber of major club companies, thus making the Company’s results of operationsdependent on those customers, their continued willingness to purchase asignificant portion of their shafts from the Company, and their success inselling clubs containing the Company’s shafts to their customers.  In 2003, net sales to Callaway Golf, AcushnetCompany and Ping represented 21%, 26% and 10% of the Company’s net sales,respectively, and the Company anticipates that these companies will continue,collectively, to represent the largest portion of its sales in 2004.  Although it is generally difficult to predictin advance the success of any particular club or of any particular manufacturer,the Company believes that it is protected to some extent from normal periodicfluctuations in sales among the various golf club companies by virtue of thebroad range of its club manufacturer customers. Golf club companies regularly introduce new clubs, frequently containinginnovations in design.  Sometimes thesenew clubs achieve dramatic success in the marketplace, thus increasing theoverall volatility of club sales among the major companies.  While the Company seeks to have its shaftsrepresented on as many major product introductions as possible, it can provideno assurance that its shafts will be included in any particular “hot” club orthat sales of a “hot” club that does not include the Company’s shafts will nothave a negative impact on the sales of those clubs that do.  The Company’s sales could also suffer asignificant drop-off from period to period to the extent that they may bedependent in any period on sales of one or more “hot” clubs, which then tailoff in subsequent periods when no other club offers a high level of new salesto replace the lost sales.

 

In 1994, the Company started manufacturing prepreg, the principal rawmaterial in the manufacture of graphite golf shafts, at its facility in Poway,California.  Most of its production ofprepreg is used internally by the Company, with the remainder sold to othercomposite materials manufacturers.   TheCompany continues to look for opportunities to sell its prepreg to othercomposite materials manufacturers and to manufacture other non-golf compositematerials products, such as hockey sticks. Sales of prepreg as a percentage of net revenues increased to 5% in 2003as compared to 3% in 2002 and sales of hockey sticks increased to 6% of netrevenues from 2% in 2002.  Although theCompany has achieved some success in these areas, management continues tobelieve that the growth opportunities in these areas will be limited,especially as it pertains to other composite products, such as hockeysticks.  Management believe that it cancontinue to improve on its sales of composite prepreg, although it does notanticipate it will be material to its results of operations for at leastseveral 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 usedthe material from this facility to satisfy a significant portion of itsinternal demand for carbon fiber in the manufacturing of golf club shafts.  During 1999, the Company also produced andsold

 

18

----

 

carbon fiber from this facility to other unrelated entities for themanufacture of other carbon-based products. On October 29, 1999, SGL purchased a 50% interest in the Company’scarbon fiber manufacturing operation. The Company and SGL entered into an agreement to operate the facility asa limited liability company with equal ownership interests between the venturepartners.  The Company and SGL alsoentered into supply agreements with the new entity, CFT, for the purchase ofcarbon fiber at cost plus an agreed-upon mark-up.  The Company and SGL are each responsible tobear 50% of the fixed costs to operate the facility as a term of this supplyagreement.  Profits and losses of CFT areshared equally by the partners.  Thecarbon fiber from this facility is primarily consumed by the joint venturepartners.   The Company has entered intoa non-binding letter of intent to sell with its partner, selected assets of CFTto a third party.  If the transaction iscompleted, the Company anticipates that it will be consummated  during the second quarter.

 

If the proposed sale of CFT selected assets does not happen and thecarbon fiber facility is not operated at high production levels, either becauseof production difficulties or because there is not enough demand by the jointventure partners to justify that level of production, the cost per unit ofcarbon fiber consumed by the Company (and thus the cost of producing theCompany’s golf shafts and other products) is increased due to spreading thefixed costs of production over smaller volumes. If demand is lower than production capacity, CFT also runs the risk ofbuilding up excess inventory.  Given therelatively low costs historically in the market for carbon fiber and the highlycompetitive market for graphite golf shafts, the failure to operate at highlevels could adversely affect the Company’s gross margins or its ability tomaintain competitive prices for its products. Although selling prices of carbon fiber have been depressed for the pastseveral years based on a surplus of supply in the market for carbon fiber, theCompany is beginning to see increases in prices of some smaller tow carbonfibers and a constriction of supply, which are not manufactured at CFT.  If the prices continue to increase or if thecompany cannot obtain an adequate supply at a reasonable price, it could havean adverse affect on the Company’s business. The Company does not expect third party sales at CFT to have asignificant effect on either its sales or profitability for several years.

 

**Results of Operations**

 

The following table sets forth the operating results for the yearsindicated:

 
| ** **                                        | ** ** | **For the years ended****December 31,** | ** ** | **Period Change** | ** **         |
|---------------------------------------------------|------------|----------------------------------------------|------------|-------------------|--------------------|
| **2003**                                          | ** ** | **2002**                                     | ** ** | **2001**          | **2003 vs.  2002** | ** ** | **2002 vs.  2001** |
| **Results of  Operations**                        | ** ** | ** **                                   | ** ** | ** **        | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Sales                                         |       | $                                            | 37,807     |              | $                  | 37,462 |   | $ | 39,561 |   | 1 | % | -5 | % |
| Cost Of Sales                                     |       | 30,586                                       |       | 32,828            |               | 33,304 |   | -7 | % | -1 | % |
| Gross Profit                                      |       | 7,221                                        |       | 4,634             |               | 6,257 |   | 56 | % | -26 | % |
| Gross Margin                                      |       | 19                                           | %          | 12                | %                  | 16 | % |   |   |   |   |
|                                              |       |                                         |       |              |               |   |   |   |   |   |   |
| Selling, General And Administrative               |       | 6,989                                        |       | 7,334             |               | 6,851 |   | -5 | % | 7 | % |
| Impairment Of Goodwill                            |       | —                                       |       | —            |               | 41,932 |   | — |   | -100 | % |
| Impairment Of Trademarks & Patents            |       | —                                       |       | —            |               | 12,963 |   | — |   | -100 | % |
| Amortization Of Goodwill                          |       | —                                       |       | —            |               | 1,410 |   | — |   | -100 | % |
| Plant Consolidation                               |       | —                                       |       | 300               |               | 593 |   | -100 | % | -49 | % |
| Operating Income (Loss)                           |       | 232                                          |       | (3,000            | )                  | (57,492 | ) | -108 | % | -95 | % |
|                                              |       |                                         |       |              |               |   |   |   |   |   |   |
| Other Expense (Income):                           |       |                                         |       |              |               |   |   |   |   |   |   |
| Interest Expense                                  |       | 23                                           |       | 94                |               | 375 |   | -76 | % | -75 | % |
| Other, Net                                        |       | 48                                           |       | 62                |               | 65 |   | -23 | % | -5 | % |
| Impairment Of Investment In Joint Venture         |       | 2,220                                        |       | —            |               | — |   | — |   | — |   |
| Equity In Earnings Of Joint Venture               |       | (150                                         | )          | (269              | )                  | (231 | ) | -44 | % | 16 | % |
| Loss Before Income Taxes                          |       | (1,909                                       | )          | (2,887            | )                  | (57,701 | ) | -34 | % | -95 | % |
| Benefit For Income Taxes                          |       | (183                                         | )          | (43               | )                  | (6,282 | ) | 326 | % | -99 | % |
| Net Loss                                          |       | $                                            | (1,726     | )                 | $                  | (2,844 | ) | $ | (51,419 | ) | -39 | % | -94 | % |
| Net Loss Per Common Share-Basic                   |       | $                                            | (0.35      | )                 | $                  | (0.57 | ) | $ | (10.10 | ) | -39 | % | -94 | % |
|                                              |       |                                         |       |              |               |   |   |   |   |   |   |
| **Cash Flow Data**                                |       |                                         |       |              |               |   |   |   |   |   |   |
| Cash provided by operating activities             |       | $                                            | 3,997      |              | $                  | 2,473 |   | $ | 688 |   | 62 | % | 259 | % |
| Cash (used for) provided by investing  activities |       | (183                                         | )          | 547               |               | 2,725 |   | -133 | % | -244 | % |
| Cash used for financing activities                |       | (181                                         | )          | —            |               | (8,750 | ) | — |   | -100 | % |

 

19

----

 

*2003 Compared to 2002*

 

*Net Sales. *Net sales increased by $345,000 for 2003 from2002.  Although, sales were relativelyflat year on year, the composition of the Company’s sales changed.  Sales of golf shafts decreased by approximately5%, which was more than offset by increased sales of composite prepreg andother revenues, primarily related to hockey sticks.  The decrease in golf shaft sales wasattributed to decreases in value and OEM premium sales, which were partiallyoffset by increased sales of the Company’s premium branded shafts.  Sales of value shafts and OEM premium shaftsdecreased by 22% and 5%, respectively with sales of the Company’s brandedproduct increasing by 78% as compared to 2002. Shaft unit sales decreased 15% in 2003 compared to 2002 and the averageselling price of shafts sold increased by 11% in 2003, which was primarilyattributed to an increase in premium branded sales in 2003.

 

*Gross Profit.*  Gross profit increased by approximately $2.6million.  The Company’s gross profitmargin increased to 19% in 2003 from 12% in 2002.  The increase in gross profit was attributedto two factors, first, an increase in sales of the Company’s premium brandedproduct, which typically has higher gross margins than that of the Company’sother products and secondly, a decrease in variable costs of productionattributed to fewer units shipped in 2003 when compared to 2002.  In addition, the Company’s gross profit wasnegatively affected by additional inventory related reserves of approximately$669,000 in 2003, versus an increase of $456,000 in 2002.

 

*Operating Income (Loss)*.  Operating income increased by approximately$3.2 million.  The increase was primarilyattributed to the increase in gross profit. In addition to the increase in gross profit, the Company reduced itsselling, general and administrative (“SG&A”) expense by approximately$345,000 in 2003 as compared to 2002. The decrease in SG&A was primarily attributed to decreasedadministrative expenses, attributed to the consolidation of it corporateoffices and the reduction in professional services expenses.  The decrease in SG&A was partially offsetby an increase in spending on advertising and promotion of approximately$553,000.  The Company anticipates thatit will spend approximately the same amount on advertising and promotion insupport of its premium branded product in 2004 that it spent in 2003.  SG&A decreased as a percentage of netsales to 18% in 2003, from 20% in 2002.

 

*Other Expense (Income)*.  The Company recorded an impairment charge ofapproximately $2.2 million related to its investment in its joint venture(CFT).  See - “Notes to ConsolidatedFinancial Statements,” Note 6.  TheCompany believes that the recorded amount of its investment in CFT approximatesfair market value.  Interest expensedecreased to $23,000 in 2003 from $94,000 in 2002.  The decrease is attributed to the repaymentof the Company’s long-term debt in 2001 and the termination of its Line ofCredit in 2003.  As the Companyterminated its Line of Credit it 2003, it will no-longer be subject to anunused line fee.  The Company does notanticipate the need to establish a new Line of Credit in 2004 to support itsoperations.

 

*Income Taxes.*  The Company recorded a benefit for incometaxes in the amount of $183,000 in 2003. The Company’s effective tax rate was 10% in 2003.  At December 31, 2003, the Company had anet deferred tax asset of approximately $2.5 million.  This deferred tax asset represented netoperating loss carryforwards, tax credit carryforwards and other basisdifferences, which give rise to future tax deductions in excess of bookdeductions.  Realization of these taxbenefits is dependent upon the generation of future taxable income.  During the fourth quarter of 2002, managementdetermined that it was no longer more likely than not that the tax benefitsassociated with these deferred tax assets would be realized.  Accordingly, the Company placed a fullvaluation allowance against its net deferred tax asset.  If the Company’s results from operationsshould improve in 2004, the Company would have to determine the appropriatenessof its valuation allowance.

 

*2002 Compared to 2001*

 

*Net Sales. *Net sales decreased $2.1 million, or 5%, to$37.5 million for 2002 from $39.6 million for the prior year.  The decrease in net sales was mainlyattributed to a decrease in average selling prices, which were somewhat offsetby an increase in shaft unit sales. Shaft unit sales increased 11% in 2002 compared to a decrease of 30% in2001 as a result of an increased demand for premium shafts, while the averageselling price of shafts sold in 2002 decreased 15% compared to a decrease of 2%in 2001.

 

20

----

 

*Gross Profit.*  Gross profit decreased $1.6 million, or 26%,to $4.6 million in 2002 from $6.3 million in 2001. The Company’s gross profitmargin decreased to 12% in 2002 from 16% in 2001, which was attributed to twofactors, first, a decrease in net sales, which was a result of the decrease inaverage selling prices of units sold, and secondly, an increase in variablecosts from increased units produced and shipped, which was somewhat mitigatedby the benefit achieved by transferring a larger percentage of our premiumshaft production to China in 2002.  Inaddition, the Company’s gross profit was negatively affected by the increase ininventory related reserves of approximately $456,000 in 2002, which was lessthan the increase of $731,000 in 2001.

 

*Operating Income (Loss)*.  Operating loss decreased $54.5 million to aloss of $3.0 million in 2002 from a loss of $57.5 million in 2001.  The majority of the decrease was attributedto a lack of a charge for the impairment of goodwill, trademarks and patents,which the Company recorded during the fourth quarter of 2001.  The Company wrote-off the remaining balanceof its goodwill, trademarks and patents in accordance with SFAS No. 121“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto be Disposed Of.”  See – “Notes toConsolidated Financial Statements”, Note 5. The total amount of impairment charges recorded in 2001 wasapproximately $54.9 million.

 

Selling, general and administrative (“SG&A”) expense increasedapproximately $483,000, which was mainly attributed to increased advertisingand promotion expenses.  SG&Aincreased as a percentage of net sales to 20% in 2002, from 17% in 2001.  The Company recorded a charge for plantconsolidation during the fourth quarter of 2002 of approximately $300,000related to the consolidation of the Company’s executive offices with theCompany’s manufacturing facilities in Poway compared to $593,000 in 2001related to the closure of two shaft manufacturing facilities in Mexico.  See – “Notes to Consolidated FinancialStatements”, Note 10.

 

*Other Expense (Income)*.  Interest expense decreased approximately$281,000 to $94,000 in 2002 as compared to $375,000 in 2001.  The decrease is primarily attributed to therepayment of the Company’s long-term debt in 2001.  The Company made its final debt principalpayment of $4.0 million on September 30, 2001.  The majority of the Company’s interestexpense in 2002 was attributed to interest and unused borrowing fees related tothe Company’s line of credit in place with a financial institution.

 

*Income Taxes.*  The Company recorded a benefit for incometaxes in the amount of $43,000 in 2002.  The Company’s effective tax rate was 2% in2002.  At December 31, 2002, theCompany had a net deferred tax asset of approximately $1.9 million.  This deferred tax asset represented netoperating loss carryforwards, tax credit carryforwards and other basisdifferences, which give rise to future tax deductions in excess of bookdeductions.  Realization of these taxbenefits is dependent upon the generation of future taxable income.  During the fourth quarter of 2002, managementdetermined that it was no longer more likely than not that the tax benefitsassociated with these deferred tax assets would be realized.  Accordingly, the Company placed a fullvaluation allowance against its net deferred tax asset.  In connection with this determination,management also determined that its reserve of approximately $650,000 forcontingent tax liabilities was no longer appropriate.  As such, this reserve has been eliminated.

 

**Liquidity and Capital Resources**

 

The Company had in place a $12.0 million revolving credit facility froma financial institution, which was secured by substantially all the assets ofAldila Golf and guaranteed by the Company until 2003.  The Company terminated the line of creditduring 2003 and does not anticipate establishing a new line of credit tosupport operations.  Availability forborrowings under the line of credit, based on eligible accounts receivable andinventories, was approximately $2.9 million at December 31, 2002.

 

Cash (including cash equivalents) provided by operating activities in 2003was approximately $4.0 million, compared to approximately $2.5 million in2002.  The increase in cash fromoperations in 2003 was mainly attributed to a smaller net loss and $1.2 millionincome tax refund, which was partially offset by a smaller reduction ininventory than in 2002.  Cash provided byoperating activities was further affected by non-cash charge related to thewrite down of the Company’s investment in joint venture (CFT).  The Company used $699,000 for capitalexpenditures during 2003, with the majority of it applicable to the tenantimprovements placed in service at its manufacturing location to support theconsolidation of the corporate offices. Management anticipates capital expenditures to approximate $600,000 for2004.  The Company received distributionsfrom CFT totaling $500,000 in 2003 compared to $890,000 in 2002.  The Company received a distribution in March2004 in the amount of $750,000.  Futuredistributions must be agreed upon by both joint venture partners prior to anydistribution being made.  The Companyrepurchased 62,499 shares of its stock during 2003, costing it approximately$181,000.  The Company plans to

 

21

----

 

continue to repurchase its stock in accordance with its stock buybackplan through 2004.  The Company believesthat it will have adequate cash resources, including anticipated cash flow andborrowing availability, to meet its obligations at least through 2004.

 

**Off Balance Sheet Arrangements**

 

As of December 31, 2003 and 2002, the Company did not have any OffBalance Sheet Arrangements.

 

**Contractual Obligations**

 
| ** **           | ** ** | **Payments Due by Period (thousands)** | ** ** |
|----------------------|------------|----------------------------------------|------------|
| ** **           | ** ** | **Less Than  1 Year**                  | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than  5 Years** | ** ** | **Total** | ** ** |
| Operating leases (a) |       | $                                      | 1,049      |   | $ | 901 |   | $ | 323 |   | $ | 678 |   | $ | 2,951 |   |
| CFT Fixed Costs (b)  |       | 1,300                                  |       | 2,600 |   | 2,600 |   | — |   | 6,500 |   |
| Total                |       | $                                      | 2,124      |   | $ | 3,308 |   | $ | 2,923 |   | $ | 678 |   | $ | 9,033 |   |

 

----

(a)          We enter into operating leases in the normalcourse of business.  All lease agreementshave fixed payment terms based on the passage of time.  Some lease agreements provide us with theoption to renew the lease.  Our futureoperating lease obligations would change if we exercised these renewal optionsand if we entered into additional operating lease agreements.

(b)         The Company is responsible for 50% of thefixed costs of CFT.  The amountsestimated above are based upon the amount of fixed costs for CFT in 2003.   As the Company is responsible for the fixedcosts until CFT is dissolved, the Company has estimated the amount through year5.  If CFT were to still be in existencepast year 5, the Company is still responsible for 50% of their fixedcosts.  If the proposed sale of assets ofCFT were to go through in 2004, the Company would be responsible for 50% ofCFT’s fixed costs and 50% of CFT’s shutdown costs.  In addition, aspart of the transaction, the Company believes they would be responsible for acarbon fiber supply agreement for a one-year period from the closing date ofthe transaction with the potential acquirer. See – “Notes to the Consolidated Financial Statements”, Note 6.

 

The Company may from time to time consider the acquisition ofbusinesses complementary to the Company’s business.  The Company could require additional debtfinancing if it were to engage in a material acquisition in the future.

 

**Seasonality**

 

Because the Company’s customers have historically built inventory inanticipation of purchases by golfers in the spring and summer, the principalselling season for golf equipment, the Company’s operating results have beenaffected by seasonal demand for golf clubs, which has generally resulted inhighest sales occurring in the second quarter. The timing of customers’ new product introductions has frequentlymitigated the impact of seasonality in recent years.

 

**Item7a.  Quantitative and QualitativeDisclosures about Market Risk**

 

The Company believes that its exposure to market risk relating tointerest rate risk is not material.  TheCompany is exposed to foreign exchange risk to the extent of adverse fluctuationsin the Mexican peso and the Chinese renminbi. Based on historical movements of these currencies, the Company does notbelieve that reasonably possible near-term changes in these currencies willhave a material adverse effect on the Company’s financial position or resultsof operations.  In addition, the Companydoes not engage in hedging activities to protect from this potential risk.  The Company believes that its businessoperations are not exposed to market risk relating to commodity price risk orequity price risk.

 

**“Safe Harbor” Statement Under the Private Securities Litigation ReformAct of 1995**

 

This Annual Report on Form 10-K and certain information incorporatedherein by reference contain forward-looking statements within the “safe harbor”provisions of the Private Securities Litigation Reform Act of 1995.  All statements included or incorporated byreference in this Annual Report on Form 10-K, other than statements that arepurely historical, are forward-looking statements.  Words such as “anticipates,” “expects,”“intends,” “plans,” “believes,” “seeks,” “estimates,” and similar

 

22

----

 

expressions also identify forward-looking statements.  Forward-looking statements are not guaranteesof future performance and are subject to risks and uncertainties that couldcause actual results to differ materially from the results contemplated by theforward-looking statements.  Theseforward-looking statements are based on management’s expectations as of thedate hereof, that necessarily contain certain assumptions and are subject tocertain risks and uncertainties.  TheCompany does not undertake any responsibility to update these statements in thefuture.  The Company’s actual futureperformance and results could differ from that contained in or suggested bythese forward looking statements as a result of the factors set forth in thisManagement’s Discussion and Analysis of Financial Condition and Results ofOperations, the Business Risks described in Item 1 of this Report on Form 10-Kand elsewhere in the Company’s filings with the Securities and ExchangeCommission.

 

**Item8.  Financial Statements andSupplementary Data**

 

The information required as to this Item is incorporated by referencefrom the consolidated financial statements and supplementary data listed inItem 15 of Part IV of this report.

 

**Item9.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

 

On May 20, 2003 the Company changed its accountants from Deloitte &Touche LLP to Peterson & Co., LLP. The change in independent accountants was recommended and approved bythe Company’s Audit Committee.  Duringthe Company’s fiscal years ended December 31, 2001 and December 31,2002, and the subsequent interim periods through May 20, 2003, there were nodisagreements with Deloitte & Touche LLP on any matter of accountingprinciples or practices, financial statement disclosure, or auditing scope orprocedure, which disagreements, if not resolved to the satisfaction of Deloitte& Touche LLP, would have caused Deloitte & Touche LLP to make referencethereto in their report on the financial statements for such years.  See the Company’s Current Report filed onform 8K and later amended on form 8-K/A dated May 20, 2003 and filed on May 29,2003.

 

**Item 9A.Controls and Procedures**

 

(a)          *Evaluation of disclosure controls and procedures.*Asof the end of the period covered by this report, Aldila management, includingthe Chief Executive Officer and Chief Financial Officer, conducted anevaluation of the effectiveness of our disclosure controls and procedurespursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and the ChiefFinancial Officer concluded that such disclosure controls and procedures areeffective in alerting them on a timely basis to material information relatingto Aldila required to be included in Aldila’s periodic filings under theExchange Act.

 

(b)         *Changes in internal control. *There have been no significantchanges in internal controls or in factors that could significantly affectinternal controls, including any corrective actions with regard to significantdeficiencies and material weaknesses, subsequent to the date the ChiefExecutive Officer and Chief Financial Officer completed their evaluation.

 

23

----

 

**PART III**

 

**Item10.  Directors and Executive Officers ofthe Registrant**

 

The information required as to this Item is incorporated by referencefrom the section headed “Election of Directors” in the Company’s ProxyStatement for the 2004 Annual Meeting of Stockholders for the year endedDecember 31, 2003, which will be filed with the Commission within 120 daysof the end of the fiscal year covered by this report (“2004 Proxy Statement”).

 

The Company adopted a Code of Business Conduct and Ethics onDecember 31, 2002 governing its officers, directors and employees,including our principal executive officer, principal financial officer,principal accounting officer or controller, or persons performing similarfunctions.  A copy of the Code of Ethicsis available at the Company’s website, www.aldila.com. See the Code of BusinessConduct and Ethics included herein as Exhibit 14.0 to this Report.

 

**Item11.  Executive Compensation**

 

The information required as to this Item is incorporated herein byreference from the data under the caption “Executive Compensation” in the 2004Proxy Statement.

 

**Item12.  Security Ownership of CertainBeneficial Owners and Management**

 

The information required as to this Item is incorporated herein byreference from the data under the caption “Security Ownership of CertainBeneficial Owners and Management” in the 2004 Proxy Statement.

 

**Item13.  Certain Relationships and RelatedTransactions**

 

There is no information required to be submitted by the Company underthis Item.

 

**Item14.  Principal Accounting Fees andServices**

 

The information required as to this Item isincorporated herein by reference from the data under the caption “IndependentAccountant Fees” in the 2004 Proxy Statement.

 

24

----

 

**PARTIV**

 

**Item 15****.  Exhibits,Financial Statement Schedules, and Reports on Form 8-K**

 

(a)          Documentsincluded as part of this report:

 

1.                                       The consolidatedfinancial statements for the Registrant are included in this report.

 
| Consolidated Balance Sheets at  December 31, 2003 and 2002;                                                   |   |
|---------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                          |   |
| Consolidated Statements of Operations for  the years ended December 31,  2003, 2002 and 2001;                 |   |
|                                                                                                          |   |
| Consolidated Statements of Stockholders’  Equity  for the years ended December 31, 2003,  2002 and 2001; |   |
|                                                                                                          |   |
| Consolidated Statements of Cash Flows  for the years ended December 31,  2003, 2002 and 2001;                 |   |
|                                                                                                          |   |
| Notes to Consolidated Financial Statements                                                                    |   |
|                                                                                                          |   |
| Independent Auditors’ Report.                                                                            |   |

 

2.                                       Schedule IIC Valuationand Qualifying Accounts for the years ended December 31, 2003, 2002 and 2001.

 

All otherschedules are omitted because they are not applicable or the requiredinformation is shown in the consolidated financial statements or the notesthereto.

 

3.                                       See the Index toExhibits on page 47 of this Form 10-K. Financial statements of subsidiaries not consolidated and fifty percentor less owned persons, management contracts or compensatory plans orarrangements required to be filed as exhibits to this report are identified onthe Index to Exhibits.

 

(b)         Reportson Form 8-K:

 

On October 29, 2003, the Company filed a Form 8-K regarding itsfinancial results for the third quarter and nine months period ended September30, 2003.

 

(c)          Exhibitsrequired by Item 601 of Regulation S-K.

 

See item (a) 3above.

 

(d)         Financialstatements required by Regulation S-X which are excluded from the annual reportto shareholders by Rule 14a-3, which include separate financial statements ofsubsidiaries not consolidated and fifty percent or less owned persons.

 

See item (a) 3above.

 

25

----

 

**ALDILA, INC. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEET****S**

**(In thousands, except share data)**

 
| ** **                                                                                                                                                | ** ** | **December 31,  2003** | ** ** | **December 31,  2002** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                                                                |       |                   |       |                   |       |
|                                                                                                                                                      |       |                   |       |                   |       |
| CURRENT ASSETS:                                                                                                                                           |       |                   |       |                   |       |
| Cash and cash equivalents                                                                                                                                 |       | $                      | 6,919      |                   | $          | 3,286 |   |
| Accounts receivable                                                                                                                                       |       | 4,613                  |       | 4,393                  |       |
| Income taxes receivable                                                                                                                                   |       | —                 |       | 1,185                  |       |
| Inventories                                                                                                                                               |       | 7,778                  |       | 8,538                  |       |
| Prepaid expenses and other current assets                                                                                                                 |       | 399                    |       | 497                    |       |
| Total current assets                                                                                                                                      |       | 19,709                 |       | 17,899                 |       |
|                                                                                                                                                      |       |                   |       |                   |       |
| PROPERTY, PLANT AND EQUIPMENT                                                                                                                             |       | 4,776                  |       | 6,167                  |       |
|                                                                                                                                                      |       |                   |       |                   |       |
| INVESTMENT IN JOINT VENTURE                                                                                                                               |       | 4,287                  |       | 6,825                  |       |
|                                                                                                                                                      |       |                   |       |                   |       |
| OTHER ASSETS                                                                                                                                              |       | 241                    |       | 268                    |       |
|                                                                                                                                                      |       |                   |       |                   |       |
| TOTAL ASSETS                                                                                                                                              |       | $                      | 29,013     |                   | $          | 31,159 |   |
|                                                                                                                                                      |       |                   |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                             |       |                   |       |                   |       |
|                                                                                                                                                      |       |                   |       |                   |       |
| CURRENT LIABILITIES:                                                                                                                                      |       |                   |       |                   |       |
| Accounts payable                                                                                                                                          |       | $                      | 3,067      |                   | $          | 2,912 |   |
| Accrued expenses                                                                                                                                          |       | 1,461                  |       | 1,825                  |       |
| Total current liabilities                                                                                                                                 |       | 4,528                  |       | 4,737                  |       |
|                                                                                                                                                      |       |                   |       |                   |       |
| LONG-TERM LIABILITIES:                                                                                                                                    |       |                   |       |                   |       |
| Deferred rent                                                                                                                                             |       | 39                     |       | 69                     |       |
| Total liabilities                                                                                                                                         |       | 4,567                  |       | 4,806                  |       |
|                                                                                                                                                      |       |                   |       |                   |       |
| COMMITMENTS AND CONTINGENCIES (Notes 12, 13  and 14)                                                                                                      |       |                   |       |                   |       |
|                                                                                                                                                      |       |                   |       |                   |       |
| 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 4,885,149 shares in 2003 and 4,947,648 shares in 2002,  respectively |       | 48                     |       | 49                     |       |
| Additional paid-in capital                                                                                                                                |       | 41,803                 |       | 41,983                 |       |
| Accumulated deficit                                                                                                                                       |       | (17,405                | )          | (15,679                | )          |
| Total stockholders’ equity                                                                                                                           |       | 24,446                 |       | 26,353                 |       |
|                                                                                                                                                      |       |                   |       |                   |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                           |       | $                      | 29,013     |                   | $          | 31,159 |   |

 

See notes to consolidated financial statements.

 

26

----

 

**ALDILA, INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data)**

 
| ** **                                                      | ** ** | **Year ended  December 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                      | ** ** | **2003**                     | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                                            |       |                         |       |   |   |   |   |
| NET SALES                                                       |       | $                            | 37,807     |   | $ | 37,462 |   | $ | 39,561 |   |
| COST OF SALES                                                   |       | 30,586                       |       | 32,828 |   | 33,304 |   |
| Gross profit                                                    |       | 7,221                        |       | 4,634 |   | 6,257 |   |
|                                                            |       |                         |       |   |   |   |   |
| SELLING, GENERAL AND ADMINISTRATIVE                             |       | 6,989                        |       | 7,334 |   | 6,851 |   |
| IMPAIRMENT OF GOODWILL                                          |       | —                       |       | — |   | 41,932 |   |
| IMPAIRMENT OF TRADEMARKS & PATENTS                          |       | —                       |       | — |   | 12,963 |   |
| AMORTIZATION OF GOODWILL                                        |       | —                       |       | — |   | 1,410 |   |
| PLANT CONSOLIDATION                                             |       | —                       |       | 300 |   | 593 |   |
| Operating income (loss)                                         |       | 232                          |       | (3,000 | ) | (57,492 | ) |
|                                                            |       |                         |       |   |   |   |   |
| OTHER EXPENSE (INCOME):                                         |       |                         |       |   |   |   |   |
| Interest expense                                                |       | 23                           |       | 94 |   | 375 |   |
| Other, net                                                      |       | 48                           |       | 62 |   | 65 |   |
| Impairment of investment in joint venture                       |       | 2,220                        |       | — |   | — |   |
| Equity in earnings of joint venture                             |       | (150                         | )          | (269 | ) | (231 | ) |
|                                                            |       |                         |       |   |   |   |   |
| LOSS BEFORE INCOME TAXES                                        |       | (1,909                       | )          | (2,887 | ) | (57,701 | ) |
| BENEFIT FOR INCOME TAXES                                        |       | (183                         | )          | (43 | ) | (6,282 | ) |
|                                                            |       |                         |       |   |   |   |   |
| NET LOSS                                                        |       | $                            | (1,726     | ) | $ | (2,844 | ) | $ | (51,419 | ) |
|                                                            |       |                         |       |   |   |   |   |
| NET LOSS PER COMMON SHARE-BASIC                                 |       | $                            | (0.35      | ) | $ | (0.57 | ) | $ | (10.10 | ) |
|                                                            |       |                         |       |   |   |   |   |
| NET LOSS PER COMMON SHARE, ASSUMING  DILUTION                   |       | $                            | (0.35      | ) | $ | (0.57 | ) | $ | (10.10 | ) |
|                                                            |       |                         |       |   |   |   |   |
| WEIGHTED AVERAGE NUMBER OF COMMON SHARES  OUTSTANDING           |       | 4,934                        |       | 4,948 |   | 5,090 |   |
|                                                            |       |                         |       |   |   |   |   |
| WEIGHTED AVERAGE NUMBER OF COMMON AND  COMMON EQUIVALENT SHARES |       | 4,934                        |       | 4,948 |   | 5,090 |   |

 

See notes to consolidated financial statements.

 

27

----

 

**ALDILA, INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY(In thousands)**

 
| ** **                    | ** ** | ** ** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained Earnings  (Accumulated Deficit)** | ** ** | **Total** | ** ** |
|-------------------------------|------------|------------|------------|----------------------------------|------------|----------------------------------------------|------------|-----------|------------|
| **Common Stock**              |
| **Shares**                    | ** ** | **Amount** |
| Balance at January 1, 2001    |       | 5,154      |       | $                                | 51         |                                         | $          | 42,731    |       | $ | 38,584 |   | $ | 81,366 |   |
|                          |       |       |       |                             |       |                                         |       |      |       |   |   |
| Repurchases of common stock   |       | (206       | )          | (2                               | )          | (748                                         | )          |      |       | (750 | ) |
|                          |       |       |       |                             |       |                                         |       |      |       |   |   |
| Net loss                      |       |       |       |                             |       |                                         |       | (51,419   | )          | (51,419 | ) |
|                          |       |       |       |                             |       |                                         |       |      |       |   |   |
| Balance at Deccember 31, 2001 |       | 4,948      |       | 49                               |       | 41,983                                       |       | (12,835   | )          | 29,197 |   |
|                          |       |       |       |                             |       |                                         |       |      |       |   |   |
| Net loss                      |       |       |       |                             |       |                                         |       | (2,844    | )          | (2,844 | ) |
|                          |       |       |       |                             |       |                                         |       |      |       |   |   |
| Balance at December 31, 2002  |       | 4,948      |       | 49                               |       | 41,983                                       |       | (15,679   | )          | 26,353 |   |
|                          |       |       |       |                             |       |                                         |       |      |       |   |   |
| Repurchases of common stock   |       | (63        | )          | (1                               | )          | (180                                         | )          |      |       | (181 | ) |
|                          |       |       |       |                             |       |                                         |       |      |       |   |   |
| Net loss                      |       |       |       |                             |       |                                         |       | (1,726    | )          | (1,726 | ) |
|                          |       |       |       |                             |       |                                         |       |      |       |   |   |
| Balance at December 31, 2003  |       | 4,885      |       | $                                | 48         |                                         | $          | 41,803    |       | $ | (17,405 | ) | $ | 24,446 |   |

 

See notes to consolidated financialstatements.

 

28

----

 

**ALDILA, INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**

 
| ** **                                                                       | ** ** | **Year ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                       | ** ** | **2003**                     | ** ** | **2002** | ** ** | **2001** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                            |       |                         |       |   |   |   |   |
| Net loss                                                                         |       | $                            | (1,726     | ) | $ | (2,844 | ) | $ | (51,419 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |       |                         |       |   |   |   |   |
| Depreciation and amortization                                                    |       | 1,798                        |       | 1,921 |   | 3,840 |   |
| Loss (gain) on disposal of fixed assets                                          |       | 26                           |       | (11 | ) | 363 |   |
| Impairment of investment in joint venture                                        |       | 2,220                        |       | — |   | — |   |
| Impairment of goodwill                                                           |       | —                       |       | — |   | 41,932 |   |
| Impairment of trademarks & patents                                           |       | —                       |       | — |   | 12,963 |   |
| Undistributed income of joint venture, net                                       |       | (182                         | )          | (249 | ) | (192 | ) |
| Changes in assets and liabilities:                                               |       |                         |       |   |   |   |   |
| Accounts receivable                                                              |       | (220                         | )          | (416 | ) | 3,407 |   |
| Inventories                                                                      |       | 760                          |       | 2,934 |   | (471 | ) |
| Deferred tax assets                                                              |       | —                       |       | 2,366 |   | 936 |   |
| Prepaid expenses and other assets                                                |       | 70                           |       | 117 |   | 15 |   |
| Accounts payable                                                                 |       | 155                          |       | (9 | ) | (1,484 | ) |
| Accrued expenses                                                                 |       | (102                         | )          | (802 | ) | (1,717 | ) |
| Income taxes payable/receivable                                                  |       | 1,185                        |       | (462 | ) | (1,588 | ) |
| Deferred tax liabilities                                                         |       | —                       |       | (67 | ) | (5,914 | ) |
| Deferred rent and other long-term  liabilities                                   |       | 13                           |       | (5 | ) | 17 |   |
| Net cash provided by operating activities                                        |       | 3,997                        |       | 2,473 |   | 688 |   |
|                                                                             |       |                         |       |   |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                            |       |                         |       |   |   |   |   |
| Purchases of property, plant and equipment                                       |       | (699                         | )          | (362 | ) | (835 | ) |
| Proceeds from sales of property, plant and  equipment                            |       | 16                           |       | 19 |   | 266 |   |
| Proceeds from sales of marketable  securities                                    |       | —                       |       | — |   | 3,104 |   |
| Distributions from joint venture                                                 |       | 500                          |       | 890 |   | 190 |   |
| Net cash (used for) provided by investing  activities                            |       | (183                         | )          | 547 |   | 2,725 |   |
|                                                                             |       |                         |       |   |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                            |       |                         |       |   |   |   |   |
| Borrowings under line of credit                                                  |       | —                       |       | 887 |   | 750 |   |
| Payments under line of credit                                                    |       | —                       |       | (887 | ) | (750 | ) |
| Principal payments on long-term debt                                             |       | —                       |       | — |   | (8,000 | ) |
| Repurchases of common stock                                                      |       | (181                         | )          | — |   | (750 | ) |
| Net cash used for financing activities                                           |       | (181                         | )          | — |   | (8,750 | ) |
|                                                                             |       |                         |       |   |   |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                            |       | 3,633                        |       | 3,020 |   | (5,337 | ) |
| CASH AND CASH EQUIVALENTS, BEGINNING OF  YEAR                                    |       | 3,286                        |       | 266 |   | 5,603 |   |
| CASH AND CASH EQUIVALENTS, END OF YEAR                                           |       | $                            | 6,919      |   | $ | 3,286 |   | $ | 266 |   |
|                                                                             |       |                         |       |   |   |   |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:                              |       |                         |       |   |   |   |   |
| Cash paid during the year for:                                                   |       |                         |       |   |   |   |   |
| Interest                                                                         |       | $                            | 23         |   | $ | 48 |   | $ | 408 |   |
| Income taxes                                                                     |       | $                            | 183        |   | $ | 251 |   | $ | 618 |   |

 

See notes to consolidated financial statements.

 

29

----

 

**ALDILA, INC. AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL****STATEMENTS**

 

**1.****              SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

*The Company**–***Aldila,Inc. (a Delaware Corporation) (the “Company”) designs, manufacturers andmarkets graphite golf club shafts for sale principally in the UnitedStates.  In addition, the Company sells alimited amount of composite prepregs and hockey sticks.

 

*Principles of Consolidation* – The consolidatedfinancial statements of the Company include the accounts of the Company and itswholly owned subsidiaries, Aldila Materials Technology Corporation (“AMTC”),Aldila Golf, and Aldila Golf’s subsidiaries, Aldila de Mexico, Aldila GraphiteProducts (Zhuhai) Company Ltd. and Aldila Foreign Sales Corporation. Allintercompany transactions and balances have been eliminated in consolidation.  The Company accounts for its joint ventureinvestment in Carbon Fiber Technology (“CFT”) under the equity method ofaccounting.

 

*Use of Estimates* – The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that effect the reported amounts of assets, liabilities,revenues and expenses, as well as the disclosure of contingencies affected bysuch estimates and assumptions.  Actual resultscould differ from these estimates.

 

*Revenue Recognition* – The Company recognizesrevenues from product sales upon transfer of title to the customer at the timeof shipment.  The Company also offersdiscounts to certain customers based on early payment.  Sales to these customers are recognized on agross basis, and sales discounts are recorded at the time the discount is takenby the customer.

 

*Cash Equivalents* – The Company considers allhighly liquid investments purchased with an original maturity of three monthsor less to be cash equivalents.  TheCompany has not historically experienced losses on such investments.

 

*Marketable Securities* – Management determinesthe appropriate classification of marketable debt and equity securities at thetime of purchase.  The Company did nothave any marketable securities at December 31, 2003 and 2002.

 

*Fair Value of Financial Instruments -*The fairvalue of short-term marketable securities, trade accounts receivable andpayable and certain accrued expenses approximate their carrying amounts in thefinancial statements due to the short maturity of such instruments.  The fair value of investments is determinedusing quoted market prices for those securities.

 

*Accounts Receivable* – The Company sellsgraphite golf club shafts primarily to golf club manufacturers and distributorson credit terms.  The Company also sellshockey sticks to one customer and composite prepregs to manufacturers of othercomposite based products on credit terms. Historically, credit losses have been minimal in relation to the creditextended.

 

*Inventories* – Inventories are stated at thelower of first-in, first-out (FIFO) cost or market value.

 

*Property, Plant and Equipment* – Property andequipment are stated at cost.  Repairsand maintenance are charged to expense as incurred.  The Company depreciates its property andequipment using the straight-line method over the estimated useful lives of theassets, as follows:

 
| ** **                     | ** ** | **Years** | ** ** |
|--------------------------------|------------|-----------|------------|
|                           |       |      |       |
| Machinery and equipment        |       | 5-10      |       |
|                           |       |      |       |
| Office furniture and equipment |       | 3-10      |       |

 

Leaseholdimprovements are amortized over the shorter of the asset life or the remainingterm of the related lease.

 

*Trademarks and Patents –*Trademarks andpatents were amortized on a straight-line basis over 40 years and 17 years,respectively.  Amortization expense was$435,000 in 2001.  See *Evaluation of Long-Lived Assets*.

 

30

----

 

*Goodwill* – Goodwill represents the excess ofcost over fair value of net assets acquired and was amortized over 40 years ona straight-line basis.  See *Evaluation of Long-Lived Assets*.

 

*Evaluation of Long-lived Assets*– TheCompany’s policy is to assess potential impairments to its long-lived assetswhen there is evidence that events or changes in circumstances have maderecovery of the assets carrying value unlikely and the carrying amount of theasset exceeds the estimated undiscounted future cash flows.  If such evaluation were to indicate amaterial impairment of these long-lived assets, such impairment would be recognizedby a write down of the applicable asset to its estimated fair value underStatement of Financial Accounting Standards (“SFAS”) No. 144 “Accounting forthe Impairment or Disposal of Long-Lived Assets”.  See Note 5 & Note 6.

 

*Deferred Financing Costs* – Costs associatedwith the issuance of debt are amortized over the life of the related debt usingthe straight-line method.  Suchamortization is included in interest expense.

 

*Warranty Reserve –*The Company provides a warranty to its customers forshaft breakage in the normal course of business.  The Company accrues for the estimatedwarranty based on historical experience at time of sale.  The estimated warranty is calculated basedupon a rolling four-year ratio of breakage returns to sales applied to currentyear sales.

 

*Common Stock and Earnings Per Share (EPS)* –Earnings per share - basic is calculated based upon the weighted average numberof shares outstanding during the year, while diluted also gives effect to allpotential dilutive common shares outstanding during each year such as options,warrants and contingently issuable shares. Options to purchase 712,497 and 737,961 shares of common stock as ofDecember 31, 2003 and December 31, 2002, respectively, at prices ranging from$1.61 to $18.66 per share were not included in the computation of diluted EPSbecause the effect of such options would be anti-dilutive. Such options expireat various dates through December of 2013.

 

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

 

*Income Taxes* - Income taxes are provided utilizingthe liability method.  The liability method requires the recognition of deferredtax assets and liabilities for the expected future tax consequences oftemporary differences between the carrying amounts and tax bases of assets andliabilities.  Valuation allowances are established when necessary toreduce deferred income tax assets to amounts more likely than not to berealized.

 

*Accounting for Stock Based Compensation* – AtDecember 31, 2003, the Company has two stock-based compensation plans, whichare described more fully in Note 12. SFAS No. 123, “Accounting for Stock-Based Compensation,” encourages butdoes not require companies to record compensation cost for stock-based employeecompensation plans at fair value (See SFAS 148 below under *Recently Issued Accounting Pronouncements)*.  The Company has chosen to continue to accountfor stock-based compensation using the intrinsic value method prescribed inAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees,” and related interpretations.  Accordingly, compensation cost for stockoptions is measured as the excess, if any, of the quoted market price of theCompany’s stock at the date of the grant over the amount an employee must payto acquire the stock.  Had compensationcost for the Company’s stock option awards been determined based upon the fairvalue at the grant date for awards from 1995 through 2003 and recognized on astraight-line basis over the related vesting period, in accordance with theprovisions of SFAS No. 123, the Company’s net loss and earnings per share wouldhave been increased to the pro forma amounts indicated below:

 

31

----

 
| ** **                                                                                                                                    | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net loss as reported                                                                                                                          |       | $        | (1,726     | )        | $          | (2,844   | )          | $ | (51,419 | ) |
|                                                                                                                                          |       |     |       |     |       |     |       |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |       | (208     | )          | (380     | )          | (510     | )          |
| Pro forma net loss                                                                                                                            |       | $        | (1,934     | )        | $          | (3,224   | )          | $ | (51,929 | ) |
|                                                                                                                                          |       |     |       |     |       |     |       |
| Earnings per share:                                                                                                                           |       |     |       |     |       |     |       |
| Basic – as reported                                                                                                                      |       | $        | (0.35      | )        | $          | (0.57    | )          | $ | (10.10 | ) |
| Basic – pro forma                                                                                                                        |       | $        | (0.39      | )        | $          | (0.65    | )          | $ | (10.20 | ) |
|                                                                                                                                          |       |     |       |     |       |     |       |
| Diluted – as reported                                                                                                                    |       | $        | (0.35      | )        | $          | (0.57    | )          | $ | (10.10 | ) |
| Diluted – pro forma                                                                                                                      |       | $        | (0.39      | )        | $          | (0.65    | )          | $ | (10.20 | ) |

 

*Recently Issued Accounting Pronouncements*– InJune 2001, the Financial Accounting Standards Board (“FASB”) approved SFAS No.141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other IntangibleAssets.”  SFAS No. 141 prospectivelyprohibits the pooling-of-interests method of accounting for businesscombinations initiated after June 30, 2001. SFAS No. 142 requires companies tocease amortizing goodwill and intangible assets with indefinite useful livesthat existed at June 30, 2001, and any new goodwill resulting from acquisitionscompleted after June 30, 2001 will not be amortized.  SFAS No. 142 also establishes a new method oftesting goodwill and intangible assets with indefinite useful lives forimpairment on an annual basis or on an interim basis if an event occurs orcircumstances change that would reduce the fair value of a reporting unit belowits carrying value.  The Company’sadoption of  SFAS No. 142 on January 1,2002 did not have a material effect on the Company’s financial statements asits goodwill and intangible assets were written off in accordance with SFAS 121“Accounting for the Impairment of Long-Lived Assets to be Disposed Of” in2001.  See Note 5 and Note 6.

 

In August2001, the FASB approved SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets”.  SFAS No.144 establishes a single accounting model, based on the framework of SFAS No.121, “Accounting for the Impairment of Long-Lived Assets and for Long-LivedAssets to be Disposed Of,” for long-lived assets to be disposed by sale,whether previously held and used or newly acquired.  In addition, SFAS No. 144 resolvedsignificant implementation issues related to SFAS No. 121.  The adoption of SFAS 144 did not have amaterial effect on the Company’s financial statements.  See Note 6.

 

In December2002, the FASB issued SFAS No. 148, “Accounting for Stock Based Compensation –Transition and Disclosure, and amendment of FASB Statement No. 123.”  SFAS No. 148 amends SFAS No. 123 to providealternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock-based employee compensation.  In addition, SFAS No. 148 amends thedisclosure requirements of SFAS No. 123 to require prominent disclosures inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.  As the Company still uses theguidance under APB Opinion 25 to account for stock based compensation, theadoption of SFAS 148 will not have a material effect on the Company’s financialstatements.

 

**2.****              ACCOUNTS RECEIVABLE**

 

Accountsreceivable at December 31 consist of the following (in thousands):

 
| ** **                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
|                                         |       |     |       |     |       |
| Trade accounts receivable                    |       | $        | 4,647      |     | $          | 4,415 |   |
| Less:   allowance for doubtful accounts |       | (34      | )          | (22      | )          |
| Accounts receivable                          |       | $        | 4,613      |     | $          | 4,393 |   |

 

32

----

 

**3.****              INVENTORIES**

 

Inventories atDecember 31 consist of the following (in thousands):

 
| ** **      | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------|------------|----------|------------|----------|------------|
|            |       |     |       |     |       |
| Raw materials   |       | $        | 5,420      |     | $          | 3,226 |   |
| Work-in-process |       | 774      |       | 1,703    |       |
| Finished goods  |       | 1,584    |       | 3,609    |       |
| Inventories     |       | $        | 7,778      |     | $          | 8,538 |   |

 

**4.     PROPERTY, PLANT AND EQUIPMENT**

 

Property,plant and equipment at December 31 consists of the following (in thousands):

 
| ** **                                       | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |
| Machinery and equipment                          |       | $        | 14,738     |     | $          | 14,401 |   |
| Office furniture and equipment                   |       | 1,603    |       | 1,804    |       |
| Leasehold improvements                           |       | 8,017    |       | 8,135    |       |
| Property and equipment not yet in service        |       | 31       |       | 38       |       |
|                                             |       | 24,389   |       | 24,378   |       |
| Less: accumulated depreciation and  amortization |       | (19,613  | )          | (18,211  | )          |
| Property, plant and equipment                    |       | $        | 4,776      |     | $          | 6,167 |   |

 

Depreciation andamortization expense were $1.7 million, $1.8 million and $1.8 million in 2003,2002 and 2001, respectively.

 

**5.     GOODWILL, TRADEMARKS AND PATENTS**

 

During the fourth quarter of fiscal year 2001, the Company identified certainconditions including a continued decrease in average selling prices, decliningmargins, an increase in foreign competition and continued volatility in thegolf industry as indicators of asset impairment.  These conditions led to operating results andforecasted future results that were substantially less favorable than had beenpreviously anticipated.  Inaccordance with the Company’s policy and SFAS No. 121, management assessed therecoverability of goodwill and other intangible assets using undiscounted cashflow projections based on the remaining amortization period of goodwill andtrademarks of thirty-one years.  Theseprojections represented the Company’s best estimate as of December 31, 2001 ofthe future undiscounted cash flows using the methodology described above.  Based on these projections, the Companyconcluded that impairment existed as of December 31, 2001.  In determining the amount of the impairmentcharge, the Company utilized an independent valuation, which resulted in awrite-off of all goodwill and intangible assets of approximately $54.9 millionas of December 31, 2001.

 

**6.     INVESTMENT IN JOINT VENTURE**

 

The Companyand SGL each own 50% of CFT in a joint venture to produce carbon fiber.  CFT, which was previously a wholly ownedsubsidiary of AMTC, was formed on October 29, 1999.  AMTC contributed net assets with a book valueof approximately $13.3 million.  SGLpurchased a 50% interest in AMTC’s carbon fiber manufacturing operations forapproximately $7.0 million in cash, which resulted in a gain of approximately$334,000.  Based on the member’srespective ownership interest in the joint venture, profits and losses areallocated equally to each member.  The Amendedand Restated Limited Liability Company Agreement provides that CFT is tocontinue until December 31, 2099 unless it is dissolved earlier, its affairsare wound up and final liquidating distributions are made pursuant to theAmended and Restated  Limited LiabilityCompany Agreement.  The Company’s equityin earnings from the joint venture for the years ended December 31, 2003, 2002

 

33

----

 

and 2001 were approximately$150,000, $269,000 and $231,000, respectively. The Company’s investment includes the unamortized excess of the Company’sinvestment over its equity in the joint venture net assets.  The excess was approximately $84,000 and$104,000 at December 31, 2003 and 2002, respectively, and is being amortized ona straight-line basis over an initial estimated economic useful life ofapproximately 101 months.

 

The Companyand SGL signed a non-binding letter of intent to sell selected assets ofCFT.  The letter is for a purchase priceof $6.0 million, which is comprised of $4.0 million to be paid in cash atclosing and $2.0 million in notes payable, with $1.0 million to be paid on eachof the first and second anniversary of the closing date of the proposedpurchase.  In addition, Aldila and SGLwill each enter into a separate contract to purchase from the proposed acquirerone million pounds of carbon fiber at a price to be determined, in thetwelve-month period following the closing date. Based upon the estimated value of the transaction, the Company recordedan impairment charge against its carrying value of its investment in CFT of approximately$2.2 million in the fourth quarter of 2003.

 

**7.     ACCRUED EXPENSES**

 

Accruedexpenses at December 31 consist of the following (in thousands):

 
| ** **                        | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
|                              |       |     |       |     |       |
| Payroll and employee benefits     |       | $        | 904        |     | $          | 749 |   |
| Warranty reserve [1]              |       | 184      |       | 345      |       |
| Plant consolidation               |       | —   |       | 289      |       |
| Marketing and promotional expense |       | 225      |       | 209      |       |
| Legal and professional fees       |       | 28       |       | 40       |       |
| Interest payable                  |       | —   |       | 3        |       |
| Other                             |       | 120      |       | 190      |       |
| Accrued expenses                  |       | $        | 1,461      |     | $          | 1,825 |   |

 

 
| **[1] Warranty Reserve** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Beginning Balance        |       | $        | 345        |     | $          | 485 |   |
| Settlement of Warranty   |       | (110     | )          | (137     | )          |
| Adjustments to Warranty  |       | (51      | )          | (3       | )          |
| Ending Balance           |       | $        | 184        |     | $          | 345 |   |

 

**8.     LONG-TERM DEBT**

 

*Revolving Credit Agreement* – On July 9, 1999,Aldila Golf, a wholly owned subsidiary of the Company, entered into a Loan andSecurity Agreement (the “Agreement”) with a financial institution whichprovides Aldila Golf with up to $12.0 million in secured financing.  The Agreement had an initial three-year termand was secured by substantially all of the assets of Aldila Golf andguaranteed by the Company.  Advancesunder the Agreement were made based on eligible accounts receivable andinventories of Aldila Golf and bear interest at the Adjusted Eurodollar rate (asdefined) plus 2.5% or at the bank reference rate at the election of the Companysubject to a minimum rate of 7%.  TheAgreement required the Company to maintain a minimum level of tangible networth (as defined).  As of December 31,2002 there were no outstanding borrowings. The Company terminated the line of credit in the current year.

 

*Senior Notes* – The Company placed $20.0million in principal amount of senior notes with an institutional investor onNovember 30, 1993.  The notes boreinterest at 6.13%, payable semi-annually on March 31 and September 30.  The final semi-annual principal payments of$4.0 million were made on March 31 and September 30, 2001.

 

34

----

 

**9.     STOCKHOLDERS’ EQUITY**

 

The Companyannounced on January 17, 2001 that its Board of Directors authorized therepurchase of up to 333,333 shares of the Company’s common stock (or up to 6.5%of the 5,154,068 shares then issued and outstanding).  The Company repurchased 206,267 shares on theopen market, at an approximate cost of $3.63 per share during 2001.  The Company announced on January 22, 2002 anincrease in the number of shares authorized for purchase in its current sharebuyback program from 333,333 to 666,667 shares of the Company’s common stock,which the Company announced on June 27, 2003. The Company repurchased 62,499 shares on the open market, at anapproximate cost of $2.92 per share during 2003.  Subsequent to December 31, 2003 the Companyrepurchased 36,000 shares on the open market at an approximate cost of $5.28.

 

**10.  PLANT CONSOLIDATION**

 

In November of1997, the Company announced its plans to consolidate its United States graphitegolf shaft manufacturing facilities by integrating its operations in RanchoBernardo, California with its operations in Poway, California

 

In the firstquarter ended March 31, 2000, the Company completed a Lease TerminationAgreement (“Termination Agreement”) with the landlord of the Rancho Bernardomanufacturing facility.  The TerminationAgreement allowed the Company to buy itself out of the remaining years of thelease for a sum of $900,000.  TheTermination Agreement was finalized and the payment was made on February 18,2000.  As such, the Company reversedapproximately $566,000 of previously accrued plant consolidation charges.

 

The Companywas informed in April 2001 by one of its major customers that they would liketo have the majority of their shafts manufactured in China.  Based on this request, and the Company’sgeneral strategy of shifting the manufacture of premium product lines from NorthAmerica and Mexico to China, the Company decided to shut down two of itsmanufacturing facilities in Mexico, leaving the Company with one remainingfacility in Mexico.  As a result of thisdecision, the Company laid-off 323 employees and disposed of excess equipmentfrom the two facilities.  The Companyrecorded a plant consolidation charge of $593,000 during 2001.  The charge was comprised of approximately$305,000 in severance and related benefits, $159,000 in write-downs of excessequipment and $129,000 in other related costs, which was all paid by December31, 2001.

 

During thefourth quarter of 2002, management developed a plan to consolidate itsexecutive offices with its U.S. manufacturing operations in an effort to reducecosts.  The Company successfullynegotiated a sub-lease of its executive offices, with the term of the sub-leaseidentical to the term of the Company’s remaining lease obligation throughOctober 31, 2005.  Accordingly, theCompany recorded a plant consolidation charge in the amount of approximately$300,000.  The majority of the charge isrelated to the Company’s leasehold improvements at its executive offices.  There were no severance or related benefitsincluded in the charge.  As of December31, 2003 and 2002, there was approximately $0 and $289,000, respectivelyremaining in the reserve for future obligations.  The components of the reserve in fiscal 2002were as follows:

 
| **Description**                            | ** ** | **Reserve Balance as of  December 31, 2002** | ** ** | **Usage** | ** ** | **Reserve Balance as of  December 31, 2003** | ** ** |
|--------------------------------------------|------------|----------------------------------------------|------------|-----------|------------|----------------------------------------------|------------|
| Leasehold improvements                     |       | $                                            | 305,203    |      | $          | (305,203                                     | )          | $ | — |   |
| Other (including credit for deferred rent) |       | 37,094                                       |       | (37,094   | )          | —                                       |       |
| Lease payments (net of sublease income)    |       | (53,749                                      | )          | 53,749    |       | —                                       |       |
| Total                                      |       | $                                            | 288,548    |      | $          | (288,548                                     | )          | $ | — |   |

 

**11.  INCOME TAXES**

 

The componentsof the provision (benefit) for income taxes are as follows (in thousands):

 
| ** **                           | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current:                             |       |     |       |     |       |     |       |
| Federal                              |       | $        | (211       | )        | $          | (2,317   | )          | $ | (1,370 | ) |
| State                                |       | (58      | )          | (17      | )          | (194     | )          |
| Foreign                              |       | 86       |       | (8       | )          | 260      |       |
| Total                                |       | (183     | )          | (2,342   | )          | (1,304   | )          |
| Deferred:                            |       |     |       |     |       |     |       |
| Federal                              |       | (57      | )          | 1,698    |       | (3,889   | )          |
| State                                |       | 57       |       | 601      |       | (1,089   | )          |
| Total                                |       | —   |       | 2,299    |       | (4,978   | )          |
| Provision (benefit) for income taxes |       | $        | (183       | )        | $          | (43      | )          | $ | (6,282 | ) |

 

35

----

 

Net deferredincome taxes included in current assets in the balance sheet at December 31,consist of the tax effects of temporary differences related to the following(in thousands):

 
| ** **                         | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Inventories                        |       | $        | 1,458      |     | $          | 1,476 |   |
| CFT impairment charge              |       | 882      |       | —   |       |
| Accrued expenses                   |       | 306      |       | 504      |       |
| Allowance for doubtful accounts    |       | 13       |       | 9        |       |
| Deferred expenses                  |       | 18       |       | 37       |       |
| Prepaid expenses                   |       | —   |       | (96      | )          |
| State income taxes                 |       | (201     | )          | (173     | )          |
| Deferred tax assets – current |       | $        | 2,476      |     | $          | 1,757 |   |

 

Net deferredincome taxes included in long-term liabilities in the balance sheet at December31 consist of the tax effects of temporary differences related to the following(in thousands):

 
| ** **                                         | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Property and equipment                             |       | $        | 493        |     | $          | 499 |   |
| Basis in joint venture (CFT)                       |       | (634     | )          | (591     | )          |
| Other                                              |       | 208      |       | 246      |       |
| Deferred tax assets(liabilities) – long  term |       | $        | 67         |     | $          | 154 |   |

 

Total reconciliation of the deferred taxassets and liabilities are below.

 
| ** **                                               | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets – current                       |       | $        | 2,476      |     | $          | 1,757 |   |
| Deferred tax assets (liabilities) – long  term      |       | 67       |       | 154      |       |
| Total net deferred tax asset before  valuation allowance |       | 2,543    |       | 1,911    |       |
| Valuation allowance                                      |       | (2,543   | )          | (1,911   | )          |
| Total deferred tax asset                                 |       | $        | —     |     | $          | — |   |

 

A valuationallowance of approximately $2.5 million has been recorded at December 31, 2003,to offset the net deferred tax assets. Realization of these tax benefits is dependent upon the generation offuture taxable income.  In accordancewith FAS 109, management has determined that it is no longer more likely thannot that the tax benefits associated with the deferred tax assets will berealized.  Differences between thestatutory federal income tax rate and the effective tax rate as a percentage ofincome taxes are summarized below.

 

At December31, 2003, the Company had California net operating loss carryforwards of $1.5million.  The California net operatingloss carryforwards will begin to expire in 2013, unless previouslyutilized.  The Company also has federaland California research and development tax credit carryforwards ofapproximately $43,000 and $49,000, respectively, which will begin to expire in2021 unless previously utilized.

 

36

----

 
| ** **                                      | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                            |       |     |       |     |       |     |       |
| Statutory rate                                  |       | (34.0    | )%         | (34.0    | )%         | (34.0    | )%         |
| State income taxes, net of Federal tax  benefit |       | (4.0     | )          | 1.7      |       | (1.5     | )          |
| Valuation allowance                             |       | 44.7     |       | 66.2     |       | —   |       |
| Goodwill impairment                             |       | —   |       | —   |       | 24.7     |       |
| Non-deductible amortization                     |       | —   |       | —   |       | 0.8      |       |
| Revision of prior years’ tax estimates     |       | (10.3    | )          | (23.4    | )          | —   |       |
| Foreign earnings taxed at different rates       |       | (4.5     | )          | (12.5    | )          | 0.5      |       |
| Other items                                     |       | (1.5     | )          | 0.5      |       | (1.4     | )          |
| Effective rate                                  |       | (9.6     | )%         | (1.5     | )%         | (10.9    | )%         |

 

The Companyhas adopted the position under APB 23 that earnings of its foreign subsidiarieswill be permanently reinvested outside of the United States.  As such, United States deferred taxes havenot been provided for on these earnings.

 

**12.  STOCK OPTION PLAN**

 

In 1992, theCompany adopted a Stock Option Plan for management.  The Company has reserved 175,431 shares forissuance under this Plan.  Options aregranted at the fair market value of the shares at the date of grant, generallybecome fully vested three years after grant, and expire ten years from the dateof grant.

 

In May of1994, the stockholders adopted the 1994 Stock Incentive Plan for employees,directors and consultants of the Company. The Company has reserved 1,366,667 shares for issuance under thisPlan.  Options are granted at the fairmarket value of the shares at the date of grant, generally become fully vestedthree years after grant, and expire ten years from the date of grant.

 

The pro formacompensation costs presented in Note 1 were determined using the weightedaverage fair values of options granted under the Company’s stock option plansduring 2003, 2002 and 2001 were estimated at $1.41, $0.90 and $2.25, respectively, on the date of grant using theBlack-Scholes option-pricing model with the following weighted-averageassumptions: 0% dividend yield, volatility of 49% in 2003, 50% in 2002 and 49%in 2001, risk free rate of return of 2.7% in 2003, 3.3% in 2002 and 5.0% in2001 and expected lives of five years. The estimated fair value of options granted is subject to theassumptions made and if the assumptions changed, the estimated fair valueamounts could be significantly different. A summary of the Company’s fixed stock option plans as of December 31,2003, 2002 and 2001 and activity during the years then ended is presentedbelow:

 
| ** **                 | ** ** | **2003**   | ** ** | **2002**                                   | ** ** | **2001**   | ** ** |
|----------------------------|------------|------------|------------|--------------------------------------------|------------|------------|------------|
| ** **                 | ** ** | **Shares** | ** ** | **Weighted****Average  Exercise****Price** | ** ** | **Shares** | ** ** | **Weighted****Average  Exercise****Price** | ** ** | **Shares** | ** ** | **Weighted****Average  Exercise****Price** | ** ** |
| ** **                 | ** ** | ** ** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Outstanding at January 1   |       | 729,189    |       | $                                          | 5.79       |       | 1,029,323  |   | $ | 10.08 |   | 1,035,547 |   | $ | 12.27 |   |
| Granted                    |       | 90,440     |       | $                                          | 3.03       |       | 108,899    |   | $ | 1.92 |   | 226,271 |   | $ | 4.62 |   |
| Terminated                 |       | (107,132   | )          | $                                          | 7.30       |       | (409,033   | ) | $ | 15.92 |   | (232,495 | ) | $ | 14.55 |   |
| Outstanding at December 31 |       | 712,497    |       | $                                          | 5.21       |       | 729,189    |   | $ | 5.79 |   | 1,029,323 |   | $ | 10.08 |   |

 

37

----

 

The following table summarizesinformation about stock options outstanding and exercisable at December 31,2003:

 
| ** **                         | ** ** | ** **                                     | ** ** | **Options Outstanding**                                    | ** ** | **Options Exercisable**                | ** ** |
|------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------|------------|
| **Range of****Exercise****Prices** | ** ** | **Number  Outstanding  at December 31,  2003** | ** ** | **Weighted  Average  Remaining  Contractual  Life (Yrs.)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number****Exercisable****at December 31,  2003** | ** ** | **Weighted****Average****Exercise  Price** | ** ** |
|                               |       |                                           |       |                                                       |       |                                   |       |   |   |   |   |
| $1.61   - $3.29               |       | 183,166                                        |       | 9.4                                                        |       | $                                      | 2.41       |   | 30,907 |   | $ | 1.81 |   |
| $4.14   - $7.08               |       | 464,237                                        |       | 6.5                                                        |       | $                                      | 4.82       |   | 407,419 |   | $ | 4.85 |   |
| $14.34 - $18.66                    |       | 65,094                                         |       | 2.6                                                        |       | $                                      | 15.82      |   | 65,094 |   | $ | 15.82 |   |
| $1.61 - $18.66                     |       | 712,497                                        |       | 4.5                                                        |       | $                                      | 5.21       |   | 503,420 |   | $ | 6.08 |   |

 

As of December31, 2003, 2002 and 2001, 503,420, 457,258 and 666,662 shares were exercisableunder the Plans at a weighted average exercise price of $6.08, $7.06 and $12.99per share, respectively.

 

As of December31, 2003, an aggregate of 658,780 shares remain available for grant under thePlans.  In addition, during each of 1994and 1993, options covering 8,772 shares were granted to two directors of theCompany apart from the Stock Option Plans. The options were granted at $42.38 and $49.13 per share,respectively.  The terms of these optionsare consistent with those granted under the 1992 Stock Option Plan.

 

On March 20,2000, the Company and Nick Price Group entered into a stock optionagreement.  The option agreement allowsNick Price to purchase 50,000 shares of Common Stock at a purchase price of$4.89 per share.  The shares are notcurrently registered under the Plans.  Inreturn for the shares, the Company is receiving the services of Nick Price at aguaranteed minimum value of $4.50 per share, or a minimum aggregateconsideration of $225,000.  The Companyrecognized compensation expense and a liability of approximately $16,000, $37,000and $66,000 in 2003, 2002 and 2001, respectively.

 

**13. EMPLOYEE BENEFIT PLAN**

 

In 1994, theCompany adopted the Aldila, Inc. 401(k) Savings Plan (the “Plan”) for employeesof the Company and its subsidiaries. This defined contribution plan allows employees who satisfy the age andservice requirements of the Plan to contribute up to 19% of pre-tax wages,limited to the maximum amount permitted under federal law.  The Company matches the first 4% of wagescontributed by employees at a rate of $0.25 for every $1.00.  The Company’s matching contributions vestover four years based on years of service. The Company’s contributions amounted to approximately $48,000, $48,000and $62,000 in 2003, 2002 and 2001, respectively.

 

**14.  COMMITMENTS AND CONTINGENCIES**

 

The Companyleases building space and certain equipment under operating leases.  The Company’s leases for office andmanufacturing space contain rental escalation clauses and renewal options.  Rental expense for the Company was $0.9million, $1.1 million and $1.2 million for 2003, 2002 and 2001,respectively.  As of December 31, 2003,future minimum lease payments for all operating leases are as follows (inthousands):

 
| 2004       |   | $   | 1,049  |   |
|------------|--------|-----|--------|--------|
| 2005       |   | 549 |   |
| 2006       |   | 352 |   |
| 2007       |   | 167 |   |
| 2008       |   | 156 |   |
| Thereafter |   | 678 |   |
|       |   | $   | 2,951  |   |

 

38

----

 

Amountsreceivable from future minimum rental payments due from a sub-lessee for theyears ending December 31, 2004, and 2005 are $245,000 and $211,000,respectively.

 

**15.  SEGMENT INFORMATION**

 

The Companydesigns and manufacturers graphite shafts for golf club manufacturers.  In doing so, the Company also manufacturescarbon fiber and prepreg materials, which are utilized in the manufacture ofgraphite golf shafts.  In accordance withSFAS No. 131 “Disclosures about Segments of an Enterprise and RelatedInformation”, the Company considers its business to consist of one reportableoperating segment.

 

The Companymarkets its products domestically and internationally, with its principalinternational market being Europe.  Thetable below contains information about the geographical areas in which theCompany operates.  Revenues areattributed to countries based on location in which the sale is settled.  Long-lived assets are based on the country ofdomicile.  Sales to a major customerrepresented 21%, 22%, and 21% of net sales in 2003, 2002, and 2001,respectively.  Sales to a second customerrepresented 6%, 13%, and 20% of net sales in 2003, 2002, and 2001,respectively. Sales to a third customer represented 26%, 21% and 10% of net salesin 2003, 2002 and 2001, respectively. Sales to a fourth customer represented 10%, 9% and 15% of net sales in2003, 2002 and 2001, respectively.

 

(in thousands)

 
| **2003**                | ** ** | **Sales** | ** ** | **Long-Lived Assets** | ** ** |
|-------------------------|------------|-----------|------------|-----------------------|------------|
| United States           |       | $         | 32,180     |                  | $          | 6,794 |   |
| Scotland                |       | 53        |       | —                |       |
| England                 |       | 2,855     |       | —                |       |
| China                   |       | 1,057     |       | 2,013                 |       |
| Mexico                  |       | —    |       | 256                   |       |
| Other Foreign Countries |       | 1,662     |       | —                |       |
| Total                   |       | $         | 37,807     |                  | $          | 9,063 |   |
|                    |       |      |       |                  |       |
| **2002**                | ** ** | **Sales** | ** ** | **Long-Lived Assets** | ** ** |
| United States           |       | $         | 32,207     |                  | $          | 10,587 |   |
| Scotland                |       | 189       |       | —                |       |
| England                 |       | 2,165     |       | —                |       |
| China                   |       | 1,023     |       | 2,324                 |       |
| Mexico                  |       | —    |       | 349                   |       |
| Other Foreign Countries |       | 1,878     |       | —                |       |
| Total                   |       | $         | 37,462     |                  | $          | 13,260 |   |
|                    |       |      |       |                  |       |
| **2001**                | ** ** | **Sales** | ** ** | **Long-Lived Assets** | ** ** |
| United States           |       | $         | 34,746     |                  | $          | 12,520 |   |
| Scotland                |       | 167       |       | —                |       |
| England                 |       | 1,792     |       | —                |       |
| China                   |       | 648       |       | 2,607                 |       |
| Mexico                  |       | 74        |       | 360                   |       |
| Other Foreign Countries |       | 2,134     |       | —                |       |
| Total                   |       | $         | 39,561     |                  | $          | 15,487 |   |

 

39

----

 

**16.  QUARTERLY RESULTS OF OPERATIONS (Unaudited)**

 

The followingis a summary of the quarterly results of operations for the two years in theperiod ended December 31, 2003 (in thousands, except per share data):

 
| ** **                                      | ** ** | **Quarter Ended** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|
| ** **                                      | ** ** | **March 31,**     | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                      | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **2003:**                                       |       |              |       |   |   |   |   |   |   |
| Net sales                                       |       | $                 | 10,164     |   | $ | 9,863 |   | $ | 7,995 |   | $ | 9,785 |   |
| Gross profit                                    |       | 1,739             |       | 1,513 |   | 1,893 |   | 2,076 |   |
| Net income(loss)                                |       | (169              | )          | (471 | ) | 189 |   | (1,275 | ) |
| Net income(loss) per common share-basic         |       | $                 | (0.03      | ) | $ | (0.10 | ) | $ | 0.04 |   | $ | (0.26 | ) |
| Net income(loss)  per common share-diluted |       | $                 | (0.03      | ) | $ | (0.10 | ) | $ | 0.04 |   | $ | (0.26 | ) |
|                                            |       |              |       |   |   |   |   |   |   |
| **2002:**                                       |       |              |       |   |   |   |   |   |   |
|                                            |       |              |       |   |   |   |   |   |   |
| Net sales                                       |       | $                 | 11,374     |   | $ | 10,551 |   | $ | 6,450 |   | $ | 9,087 |   |
| Gross profit                                    |       | 1,469             |       | 1,830 |   | 482 |   | 853 |   |
| Net loss                                        |       | (198              | )          | (170 | ) | (699 | ) | (1,777 | ) |
|                                            |       |              |       |   |   |   |   |   |   |
| Net loss per common share-basic                 |       | $                 | (0.04      | ) | $ | (0.03 | ) | $ | (0.14 | ) | $ | (0.36 | ) |
| Net loss per common share-diluted               |       | $                 | (0.04      | ) | $ | (0.03 | ) | $ | (0.14 | ) | $ | (0.36 | ) |

 

Earnings (loss) per share are computed independently for each of thequarters presented and therefore may not sum to the annual amount for the year.

 

**17.  RELATED PARTY TRANSACTIONS**

 

During 1999,the Company entered into a joint venture for the production of carbon fiberwith SGL (see Note 6).  The amount owedto CFT as of December 31, 2003 and 2002 was approximately $64,000 and $205,000,respectively.

 

**18.  SUBSEQUENT EVENTS**

 

The Companyreceived a letter of intent to purchase selected assets of CFT subsequent toyear-end (see Note 6).   The Companyrepurchased its common stock on the open market in accordance with its stockbuyback program (seen Note 9).

 

40

----

 

**ALDILA INC. AND SUBSIDIARIES**

 

**SCHEDULE IIC VALUATION AND QUALIFYINGACCOUNTS**

 

**For the years ended December 31, 2003, 2002and 2001**

 
| ** **                           | ** ** | **Balance at beginning  of year** | ** ** | **Charged to costs and  expenses** | ** ** | **Deductions** | ** ** | **Balance at end  of year** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|----------------|------------|-----------------------------|------------|
| Year ended December 31, 2001         |       |                              |       |                               |       |           |       |                        |       |
| Allowance for uncollectible accounts |       | $                                 | 209,635    |                               | $          | 156,000        |       | $                           | (214,360   | ) | $ | 151,275 |   |
| Warranty reserve                     |       | $                                 | 691,000    |                               | $          | (58,000        | )          | $                           | (148,000   | ) | $ | 485,000 |   |
| Year ended December 31, 2002         |       |                              |       |                               |       |           |       |                        |       |
| Allowance for uncollectible accounts |       | $                                 | 151,275    |                               | $          | (21,899        | )          | $                           | (107,040   | ) | $ | 22,336 |   |
| Warranty reserve                     |       | $                                 | 485,000    |                               | $          | (3,000         | )          | $                           | (137,000   | ) | $ | 345,000 |   |
| Year ended December 31, 2003         |       |                              |       |                               |       |           |       |                        |       |
| Allowance for uncollectible accounts |       | $                                 | 22,336     |                               | $          | 45,000         |       | $                           | (33,260    | ) | $ | 34,076 |   |
| Warranty reserve                     |       | $                                 | 345,000    |                               | $          | (51,000        | )          | $                           | (110,000   | ) | $ | 184,000 |   |

 

41

----

 

**INDEPENDENT AUDITOR****’S REPORT**

 

 

Board of Directors and Stockholders

Aldila, Inc.

 

We have audited the consolidated balance sheet of Aldila, Inc. and itssubsidiaries (“the Company) as of December 31, 2003, and the relatedconsolidated statements of operations, stockholders’ equity, and cash flows forthe year then ended.  These financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audit.  The consolidated financial statements ofAldila, Inc. and its subsidiaries as of December 31, 2002, were audited byother auditors whose report dated February 12, 2003, expressed an unqualifiedopinion on those statements.

 

We conducted out audit in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that out auditprovided a reasonable basis for our opinion.

 

In our opinion, the 2003 consolidated financial statements referred ofabove present fairly, in all material respects, the financial position ofAldila, Inc. and its subsidiaries as of December 31, 2003, and the results ofits operations and its cash flows for the year then ended in conformity withaccounting principles generally accepted in the United States of America.

 
|              | /s/ Peterson & Co., LLP |   |
|-------------------|-----------------------------|--------|
|              | PETERSON & CO., LLP     |
|              |                        |
| February 13, 2004 |                        |

 

42

----

 

**INDEPENDENTAUDITORS’ REPORT**

 

 

Board of Directors andStockholders

Aldila, Inc.

 

We have audited theaccompanying consolidated balance sheet of Aldila, Inc. and its subsidiaries(the “Company”) as of December 31, 2002 and the related consolidatedstatements of operations, stockholders’ equity and cash flows for each of thetwo years in the period ended December 31, 2002.  Our audits also included the 2002 and 2001financial statement schedule listed at Item 15. These financial statements and financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements and financial statement schedule based on our audits.

 

We conducted our audits inaccordance with auditing standards generally accepted in the United States ofAmerica.  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of the Company as of December 31, 2002 and the resultsof its operations and its cash flows for each of the two years in the periodended December 31, 2002 in conformity with accounting principles generallyaccepted in the United States of America. Also, in our opinion, such financial statement schedule, when consideredin relation to the basic consolidated financial statements taken as a whole,presents fairly in all material respects the information set forth therein.

 
| /s/ DELOITTE  & TOUCHE LLP |
|--------------------------------|
|                           |
| San Diego,  California         |
| February 12,  2003        |

 

43

----

 

**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto the signed on its behalf of the undersigned thereunto duly authorised.

 
| Dated:  October 27, 2004 | ALDILA, INC.                                                                                        |
|-------------------------------|-----------------------------------------------------------------------------------------------------|
|                          |                                                                                                |
|                          | /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 |

 

43

----

 

**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Exhibit** |
|---------------------|------------|-------------|
|                |       |        |
|                | 2.1        |        | Agreement of Purchase and Sale, dated as of December 14, 1991, by and  among Aldila Acquisition Corp., Aldila, Inc. and all of the Shareholders of  Aldila, Inc., as amended by the First Amendment dated January 9, 1992 by and  among Aldila Acquisition Corp., Aldila, Inc. and all the Shareholders of  Aldila, Inc. (Filed as Exhibit 2.1 to the Company’s Registration Statement on  Form S-1 (Registration No. 33-61560) and incorporated herein by reference). |
|                |       |        |   |
|                | 3.1        |        | Restated Certificate of Incorporation.  (Filed as Exhibit 3.1 to the Company’s  Registration Statement on Form S-1 (Registration No. 33-70010) and  incorporated herein by reference). |
|                |       |        |   |
|                | 3.2        |        | Restated By-Laws of the Company.   (Filed as Exhibit 3.2 to the Company’s Registration Statement on Form  S-1 (Registration No. 33-61560) and incorporated herein by reference). |
|                |       |        |   |
|                | 4.1        |        | Specimen form of Company’s Common Stock Certificate. (Filed as  Exhibit 4.1 to the Company’s Registration Statement on Form S-1 (Registration  No. 33-61560) and incorporated herein by reference). |
|                |       |        |   |
| *                   | 10.1       |        | 1992 Stock Option Plan of the Company, as amended. (Filed as Exhibit  10.6 to the Company’s Registration Statement on Form S-1 (Registration No.  33-61560) and incorporated herein by reference). |
| ** **          | ** ** | ** **  | ** ** |
| *                   | 10.2       |        | Form of Stock Option Agreement in connection with Stock Option  Plan.  (Filed as Exhibit 10.7 to the  Company’s Registration Statement on Form S-1 (Registration No. 33-61560) and  incorporated herein by reference). |
|                |       |        |   |
| *                   | 10.3       |        | Executive Bonus Plan of the Company.   (Filed as Exhibit 10.2 to the Company’s Report on Form 10-Q for the  quarterly period ended September 30, 1994 and incorporated herein by  reference). |
|                |       |        |   |
|                | 10.4       |        | Form of Indemnification Agreement between the Company and its  directors and executive officers. (Filed as Exhibit 10.13 to the Company’s  Registration Statement on Form S-1 (Registration No. 33-61560) and  incorporated herein by reference). |
|                |       |        |   |
|                | 10.5       |        | Business Park Net Lease dated as of May 29, 1987, |

 

44

----

 
|   |   |   | between the Company and Kaiser Development Company as amended by the  First Amendment to Lease dated as of January 12, 1992, between the Company  and Bedford Development Company. (Filed as Exhibit 10.15 to the Company’s  Registration Statement on Form S-1 (Registration No. 33-61560) and  incorporated herein by reference). |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                     |
|   | 10.6   |   | Lease Agreement dated as of October 15, 1990, between the Company and  Baja del Mar, S.A. de C.V. (Filed as Exhibit 10.16 to the Company’s  Registration Statement on Form S-1 Registration No. 33-61560) and  incorporated herein by reference).                                                                                   |
|   |   |   |                                                                                                                                                                                                                                                                                                                                     |
|   | 10.7   |   | Lease Agreement dated as of August 30, 1993, between the Company and  T.M. Cobb Company.  (Filed as Exhibit  10.16 to the Company’s Registration Statement on Form S-1 (Registration No.  33-70010) and incorporated herein by reference).                                                                                     |
|   |   |   |                                                                                                                                                                                                                                                                                                                                     |
|   | 10.8   |   | First Amendment to Lease Agreement dated as of August 30, 1993,  between the Company and T.M. Cobb Company.   (Filed as Exhibit 10.14 to the Company’s Report on Form 10-K for the  year ended December 31, 1993 and incorporated herein by reference).                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                                                     |
|   | 10.9   |   | Lease Agreement dated as of November 30, 1993, between the Company  and T.M. Cobb Company.  (Filed as  Exhibit 10.15 to the Company’s Report on Form 10-K for the year ended  December 31, 1993 and incorporated herein by reference).                                                                                         |
|   |   |   |                                                                                                                                                                                                                                                                                                                                     |
| *      | 10.10  |   | Form of Stock Option Agreement, dated October 5, 1993, between Marvin  M. Giles, III and the Company. (Filed as Exhibit 10.18 to the Company’s  Registration Statement on Form S-1 (Registration No. 33-70010) and  incorporated herein by reference).                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                     |
|   | 10.11  |   | 1994 Stock Incentive Plan of the Company, as amended. (Filed as  Exhibit A to the Company’s 1997 Proxy Statement dated March 26, 1997 and  incorporated herein by reference).                                                                                                                                                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                     |
|   | 10.12  |   | Form of Stock Option Agreement in connection with the 1994 Stock  Incentive Plan. (Filed as Exhibit 10.1 to the Report on Form 10-Q for the  quarterly period ended September 30, 1994 and incorporated herein by  reference).                                                                                                           |
|   |   |   |                                                                                                                                                                                                                                                                                                                                     |
|   | 10.13  |   | Lease Agreement dated May 15, 1995 between the Company and Desarrollo  Industrial de Tijuana, S.A. de C.V.(Filed as Exhibit 10.1 to the  Company’s Report on Form 10-Q for the quarterly period ended                                                                                                                               |

 

45

----

 
|   |   |   | June 30, 1995 and incorporated herein by reference).                                                                                                                                                                                                                                                                                 |
|--------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                 |
|   | 10.14  |   | Supply Agreement commencing January 1, 1998 between Courtaulds  Fibres, Ltd. And Aldila Materials Technology Corp.  (Filed as Exhibit 10.20 to the Company’s  Report on Form 10-K for the year ended December 31, 1997 and incorporated  herein by reference).                                                             |
|   |   |   |                                                                                                                                                                                                                                                                                                                                 |
|   | 10.15  |   | Loan Agreement dated March 27, 1998 between Aldila, Inc. and Union  Bank of California, N.A. (Filed as Exhibit 10.1 to the Company’s Report on  Form 10-Q for the quarterly period ended March 31, 1998 and incorporated  herein by reference).                                                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                 |
|   | 10.16  |   | First Amendment to Loan Agreement dated March 22, 1999 between the  Company and Union Bank of California, N.A. (Filed as Exhibit 10.16 to the  Company’s Report on Form 10-K for the year ended December 31, 1998 and  incorporated herein by reference).                                                                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                 |
|   | 10.17  |   | Member Interest Purchase Agreement dated as of October 20, 1999 among  SGL Carbon Fibers and Composites, Inc., SGL Technik GmbH, Aldila Materials  Technology Corp. and the Company. (Filed as Exhibit 10.17 to the Company’s  Report on Form 10-K for the year ended December 31, 1999 and incorporated  herein by reference). |
|   |   |   |                                                                                                                                                                                                                                                                                                                                 |
| *      | 10.18  |   | Loan and Security Agreement by and between Aldila Golf Corp. and  Foothill Capital Corporation dated July 9, 1999. (Filed as Exhibit 10.1 to  the Company’s Report on Form 10-Q for the quarterly period ended June 30,  1999 and incorporated herein by reference).                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                 |
| *      | 10.19  |   | Severance Protection Agreement dated March 11, 1999 between the  Company and Gary T. Barbera. (Filed as Exhibit 10.2 to the Company’s Report  on Form 10-Q for the quarterly period ended June 30, 1999 and incorporated  herein by reference).                                                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                 |
| *      | 10.20  |   | Severance Protection Agreement dated March 11, 1999 between the  Company and Peter R. Mathewson. (Filed as Exhibit 10.3 to the Company’s  Report on Form 10-Q for the quarterly period ended June 30, 1999 and  incorporated herein by reference).                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                 |
| *      | 10.21  |   | Severance Protection Agreement dated March 11, 1999 between the  Company and Robert J. Cierzan. (Filed as Exhibit 10.4 to the Company’s Report  on Form 10-Q for the quarterly period ended June 30, 1999 and incorporated  herein by reference).                                                                               |
|   |   |   |                                                                                                                                                                                                                                                                                                                                 |
| *      | 10.22  |   | Severance Protection Agreement dated March 11, 1999 between the  Company and Michael J. Rossi. (Filed as Exhibit 10.5 to the Company’s Report  on Form 10-Q for the quarterly period ended June 30, 1999 and incorporated  herein by reference).                                                                                |

 

46

----

 
|   | 10.23  |   | 1994 Stock Option Plan of the Company, as amended. (Filed as  attachment A-1 in the Company’s 2000 Proxy Statement and registered on the  Company’s Form S-8 (Registration No. 333-57754) and incorporated herein by  reference).                                                                                                         |
|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                |
|   | 10.24  |   | Aldila, Inc. Audit Committee Charter included as Exhibit A in the  Company’s 2001 Proxy dated April 4, 2001 and incorporated herein by  reference.                                                                                                                                                                                             |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                |
|   | 10.25  |   | Carbon Fiber Technology, LLC financial statements as of and for the  years ended December 31, 2002 and 2001 (Filed as exhibit 99.1 in the  Company’s Form 10-K for the year ended December 31, 2002 and incorporated  herein by reference)                                                                                                     |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                |
|   | 11.1   |   | Statement re: Computation of Net Income (Loss) per Common Share  (previously filed as Exhibit 11.1 to the Company’s Amendment No. 1 to Form  10-K/A, for the year ended December 31, 2003 and incorporated by reference).                                                                                                                      |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                |
|   | 14.0   |   | Aldila, Inc.’s Code of Business Conduct and Ethics adopted to  December 31, 2002 (previously filed as Exhibit 14.0 to the Company’s  Amendment No. 1 to Form 10-K/A, for the year ended December 31, 2003 and  incorporated by reference)                                                                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                |
|   | 21.1   |   | Subsidiaries of the Company (previously filed as Exhibit 21.1 to the  Company’s Amendment No. 1 to Form 10-K/A, for the year ended December 31,  2003 and incorporated by reference)                                                                                                                                                           |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                |
|   | 23.1   |   | Independent Auditors’ Consent – Peterson & Co., LLP (previously  filed as Exhibit 23.1 to the Company’s Amendment No. 1 to Form 10-K/A, for  the year ended December 31, 2003 and incorporated by reference)                                                                                                                     |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                |
|   | 23.2   |   | Independent Auditors’ Consent – Deloitte & Touche LLP (previously  filed as Exhibit 23.2 to the Company’s Amendment No. 1 to Form 10-K/A, for  the year ended December 31, 2003 and incorporated by reference)                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                |
|   | 31.1   |   | Certification of Chief Executive Officer                                                                                                                                                                                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                |
|   | 31.2   |   | Certification of Chief Financial Officer                                                                                                                                                                                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                |
|   | 32.1   |   | Certification of Principal Executive Officer and Principal Financial  Officer pursuant 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 (previously filed as Exhibit 32.1 to the  Company’s Amendment No. 1 to Form 10-K/A, for the year ended December 31,  2003 and incorporated by reference). |

 

----

*Indicates management contractsor compensatory plans or arrangements required to be filed as exhibits to thisReport on Form 10-K.

 

47

----