** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K/A**

** **

**Amendment No. 1**

**(Mark One)**

 

| **x**      | **Annual Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**     |
|------------|---------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                              |
| ** ** | **For the  fiscal year ended December 31, 2006**                                                   |
| ** ** | ** **                                                                                              |
| ** ** | **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 its charter)

 

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

 

**13450STOWE DRIVE, POWAY, CALIFORNIA 92064**

(Address ofprincipal executive offices)

 

Registrant’s telephonenumber, including area code     **858-513-1801**

 

Securities RegisteredPursuant to Section 12(b) of the Act:

 
| **Title of  each class**                 | ** ** | **Names of  each exchange on which registered** |
|------------------------------------------|------------|-------------------------------------------------|
| Common Stock, par value  $0.01 per share |       | The NASDAQ Stock  Market, LLC                   |

 

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

 

**None**

(Title of Class)

 

Indicateby check mark if the registrant is well-known seasoned issuer, as defined in Rule 405of the Securities Act.        Yes oNo x

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act. Yes o No x

 

Indicateby check mark whether the registrant(1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.     Yes x No o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this form 10-K.  o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer o |   | Accelerated filer x |   | Non-accelerated filer o    |   | Smaller reporting company o |
|---------------------------|--------|---------------------|--------|----------------------------|--------|-----------------------------|
|                      |   |                |   | (Do not check if a         |   |                        |
|                      |   |                |   | smaller reporting company) |   |                        |

 

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

 

Aggregatemarket value of voting stock held by non-affiliates as of June 30, 2006was - $135.8 million.

 

Commonshares outstanding as of March 9, 2007 was — 5,524,250

 

DOCUMENTSINCORPORATED BY REFERENCE

Portionsof the following documents are incorporated into this report by reference:

 

Part III,Items 10, 11, 12, 13 and 14.  TheRegistrant’s definitive Proxy Statement for the 2007 Annual Meeting ofStockholders to be filed with the Commission within 120 days after the close ofthe fiscal year.

 

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** **

**EXPLANATORYNOTE:**

 

Asfurther discussed in Note 15 to the Consolidated Financial Statements, “Restatementof Previously Issued Consolidated Financial Statements”, this Annual Report on Form 10-K/A-1is being filed to revise the Company’s previously filed Consolidated BalanceSheets as of December 31, 2006 and 2005 to reclassify marketablesecurities that were previously reported as cash and cash equivalents, and torevise the Company’s previously filed Consolidated Statements of Cash Flows forthe years ended December 31, 2006 and 2005 to report investing cash flowsrelated to the sales and purchases of marketable securities.  For additional information, see the Company’sForm 8-K filed on March 17, 2008. The revisedinterim results set forth in Note 13 to the Consolidated Financial Statements, “QuarterlyResults of Operations”, supersede the information in our Form 8-K filed March17, 2008.  Such revisions did not affectpreviously reported results of operations, earnings per common share, workingcapital or total stockholders’ equity.

 

TheCompany has not attempted to modify or update subsequent events occurring afterthe date of filing the original December 31, 2006 Annual Report on Form 10-K.

 

Thefollowing items in the Company’s December 31, 2006 Annual Report on Form 10-Khave also been restated to reflect the reclassification of marketable securities.

 

Part II— Item 7 — Management’s Discussion and Analysis of Financial Condition andResults of Operations — Liquidity and Capital Resources section.

Part II  — Item 9A Controls and Procedures

Part IV— Item 15 — Exhibits and Financial Statement Schedules

 

 

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** **

**ALDILA, INC.**

 

**Report on Form 10-K**

**Amendment No. 1****For the Fiscal Year Ended December 31, 2006**

 

**INDEX**

 
| Part I        |   |      |   |                                                                                                                |   |
|--------------------|--------|-----------|--------|---------------------------------------------------------------------------------------------------------------------|--------|
|               |   |      |   |                                                                                                                |   |
|               |   | Item  1.  |   | Business                                                                                                            |   |
|               |   | Item  1A. |   | Risk  Factors                                                                                                       |   |
|               |   | Item 1B.  |   | Unresolved Staff  Comments                                                                                          |   |
|               |   | 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, Related Stockholder Matters and Issuer Purchases  of Equity Securities |   |
|               |   | 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                                                                                            |   |
|               |   | Item 9B.  |   | Other Information                                                                                                   |   |
|               |   |      |   |                                                                                                                |   |
| 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 and Related Stockholder Matters                     |   |
|               |   | Item 13.  |   | Certain  Relationships and Related Transactions, and Director Independence                                          |   |
|               |   | 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 |   |      |   |

 

 

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**PART I**

 

*This Form 10-K/A-1 contains forward-looking statements within themeaning of the federal securities laws. These forward-looking statements are necessarily based on certainassumptions and are subject to significant risks and uncertainties.  These forward-looking statements are based onmanagement’s expectations as of the date hereof, and the Company does notundertake any responsibility to update any of these statements in thefuture.  Actual future performance andresults could differ from that contained in or suggested by theseforward-looking statements as a result of factors set forth in this Form 10-K/A-1(including those sections hereof incorporated by reference from other filingswith the Securities and Exchange Commission), in particular as set forth in “BusinessRisks” under Item 1 and set forth in the “Management’s Discussion and Analysisof Financial Condition and Results of Operations” under Item 7.*

 

**Item 1.  Business**

 

**General**

 

Aldila, Inc.(“Aldila” or the “Company”) is a leading designer and manufacturer ofhigh-quality innovative graphite (carbon fiber-based composite) golf shafts inthe United States today.  Aldila conductsits operations through its subsidiaries, Aldila Golf Corp. (“Aldila Golf”) andAldila Materials Technology Corp.  Aldilaenjoys strong relationships with most major domestic and many foreign golf clubmanufacturers including Callaway Golf, TaylorMade-adidas Golf, Ping andAcushnet Company.  Aldila believes thatit is one of the few independent shaft manufacturers with the technical andproduction expertise required to produce high-quality graphite shafts inquantities sufficient to meet demand. The Company’s current golf shaft product lines consist of Aldila brandedand co-branded products designed for its major customers and 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.

 

In1994, the Company started production of its principal raw material for shafts,graphite prepreg, which consists of carbon fibers combined with epoxy resin insheet form.  See “Manufacturing—RawMaterials.”  The Company now producessubstantially all of its graphite prepreg requirements internally and alsosells prepreg externally.

 

In1998, the Company established a manufacturing facility in Evanston, Wyoming forthe production of carbon fiber, in an effort to further vertically integrateits manufacturing operations.  On October 29,1999, SGL Carbon Fibers and Composites, Inc. (“SGL”) purchased a 50%interest in the Company’s carbon fiber manufacturing operation.  The Company and SGL entered into an agreementto operate the facility through a limited liability company with equalownership interests between the joint venture members.  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.

 

**GraphiteGolf Shafts**

 

TheCompany was founded in San Diego, California in 1972 and was an early leader inthe 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.

 

Mostgolf clubs being sold today have shafts constructed from steel or graphite,although limited numbers are also manufactured from other materials.  Graphite shafts were introduced in the early1970’s as the first major improvement in golf shaft technology since steelreplaced wood in the 1930’s.  The firstgraphite shafts had significant torque (twisting force) and appealed primarilyto weaker-swinging players desiring greater distance.  Graphite shaft technology has subsequentlyimproved so that shafts can now be designed for golfers at all skill levels.

 

Unlikesteel shafts, the design of graphite shafts is easier to alter with respect toweight, flex, flex location and torque to produce greater distance, increasedaccuracy and reduced club vibration resulting in improved “feel” to thegolfer.  The improvements in the designand manufacture of graphite shafts and the growing recognition of theirsuperior performance characteristics for many golfers compared to steel haveresulted in increased demand for graphite shafts by golfers of all skilllevels. The initial acceptance of graphite shafts was primarily for use inwoods.  According to the 2006 U.S.National Consumer Survey conducted by The Darrell Survey Company, graphitecontinues to dominate the professional and consumer wood club market, with over98**%** of new drivers purchased in 2006including graphite shafts.   In Hybridclubs, 76% of the new clubs purchased had graphite shafts up from 65% theprevious year.  The acceptance ofgraphite shafts

 

 

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inirons has not achieved the same success as in woods.  While acceptance in irons did increase in2006, it still lags well behind with only 26% of new irons purchased havinggraphite shafts. However, with the introduction of Hybrid clubs into themarket, players golf bags do not have the traditional amount of irons in theirbags as the Hybrid clubs typically replace the harder to hit long irons,usually the lower numbered irons in a golfers bag.  This results in players having more graphiteshafted clubs in their bags now than prior to the introduction of Hybrid clubs.

 

**Products**

 

*GolfShafts*

 

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.

 

TheCompany’s shafts, which constituted approximately 85% of net sales in the yearended December 31, 2006, are designed in partnership with its customers(principally golf club manufacturers) to accommodate specific golf clubdesigns.  In addition, the Companyresearches new and innovative shaft designs on an independent basis, which hasenabled the Company to produce a variety of new branded shafts as well asgenerate design ideas for customized shafts. The Company’s branded and co-branded models are typically sold to golfclub manufacturers, distributors and golf pro and repair shops and are usedeither to assemble a new custom club from selected components or as an aftermarket re-shaft of existing clubs.  TheCompany also helps develop cosmetic designs to give the customer’s golf clubs adistinctive look, even when the customer does not require a shaft withcustomized performance characteristics. The prices of Aldila shafts typically range from $6 to $199.

 

TheCompany introduced the NV Prototype at the 2003 PGA Merchandise Show in January 2003and subsequently changed it to the NVTM.   The NVTM went on to become the most successful newproduct launch in the Company’s history and returned Aldila to the forefront ofthe composite shaft industry.  The NVTM features the Company’s exclusive MicroLaminate Technology TM (“MLT”). The Company followed up the NVTM with theintroduction of the NVS, NV ProtoPypeTM, NVTM Hybrid, NVSHybrid family of shafts and the GamerTMshaft in 2004. The NVS shaft is geared toward the player who requires a shaft thatpromotes a higher initial launch angle, and one that makes it easier to turnthe ball right to left.  The NV ProtoPypeTM promotes a lower, more controlled launchangle, with reduced spin, along with very low torque to provide extremely tightdispersion.  Hybrid clubs (also known asutility clubs and driving irons) are currently the fastest growing segment ofthe golf industry.  They are designed toreplace long irons by providing a club that is easier to hit and much moreforgiving for average as well as very skilled players.  The Company offers a full range of shafts tofit hybrid clubs, including the VS ProtoTM Hybrid, NVTM Hybrid, NVS Hybrid and GamerTM.  In the spring of 2006, Aldila began shipmentsof our two newest shaft offerings — the VS ProtoTM and the VSProtoTM Hybrid. The VS Proto has quickly become one of Aldila’s single most popularshaft models on Tour.  Both are high-end,high performance shafts featuring carbon nanotubes as well as aerospace carbonfibers and Aldila’s exclusive high performance resin system.  The Company believes that it will continue tobe successful in the branded segment for the foreseeable future and has focusedits engineering, marketing and advertising effort in support of this business.

 

*Other Products*

 

Since 1994, the Company has manufactured prepregmaterial for its production of golf shafts. In 1998, the Company began selling prepreg manufactured in its Poway,California manufacturing facility to third parties.  Net sales of prepreg were approximately 12%of the Company’s net sales in 2006.  The Company began the manufacture ofcomposite hockey sticks in 2000.  Themanufacture of composite hockey sticks is similar to that of graphite golfshafts and uses similar raw materials. Revenues from the sale of hockey sticks were approximately 3% of netsales in 2006 and are not expected to be significant to the Company.

 

The Company offers carbon fiber for sale through itsjoint venture, CFT, however, the Company does not anticipate outside sales ofcarbon fiber to be significant for the foreseeable future.  Carbon fiber composite materials are suitedfor a diverse range of applications based on their distinctive combination ofphysical and chemical properties.  See “Manufacturing— Carbon Fiber Manufacturing Process.” Carbon fibers are used as reinforcements in composite materials thatcombine fibers with epoxy resins or other matrix materials to form a substancewith high strength, low weight, stiffness, resistance to corrosion, resistanceto fatigue and capacity to dissipate heat and electrical conductivity.  Carbon fiber materials produced by

 

 

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the Company or CFT are used in a variety of applications such asmolding compounds for the manufacture of electronic components, masts and sparsfor the marine industry, hockey sticks, fishing rods, industrial products, aswell as golf shafts.

 

**ProductDesign and Development**

 

Aldilais committed to maintaining its reputation as a leader in innovative shaftdesign and composite materials technology. The Company believes that the enhancement and expansion of its existingproduct lines and the development of new products are necessary for the Company’sgrowth and success.  However, while theCompany believes that it has generally achieved success in the introduction ofits graphite golf shafts, no assurance can be given that the Company will beable to continue to design and manufacture products that meet with marketacceptance.

 

Graphiteshaft designs and modifications are frequently the direct result of thecombined efforts and expertise of the Company and its customers to develop anexclusive shaft for each customer’s clubs. New golf shaft designs are developed and tested using a CAD/CAE golfshaft analysis program, which evaluates a new shaft design with respect toweight, torque, flex point, tip and butt flexibility, swing weight and othercritical shaft design criteria.  Inaddition, the Company researches new and innovative shaft designs on an independentbasis, which has enabled the Company to produce a variety of new branded shaftsas well as generate design ideas for customized shafts.  To improve and advance product designs asthey relate to composite technology and shaft process manufacturing, theCompany’s engineers have experience with existing materials, such as boron,kevlar, fiberglass, ceramic, thermoplastic and carbon fiber.  The Company’s engineers also look to newer,more advanced materials such as carbon nanotubes.  Nanotechnology is a fast growing field ofresearch that has good potential for structures such as composite golfshafts.  The Company believes it is thefirst major shaft company to employ carbon nanotubes in shaft design, and is atthe forefront of utilizing this emerging technology in golf shaftdevelopment.  The Company’s designresearch also focuses on improvements in graphite shaft aesthetics sincecosmetic appearance has become increasingly important to customers.  The Company’s research and developmentefforts have resulted in the Aldila “One” shaft, Aldila NVTM, NVS, NV ProtoPypeTM, NVTM Xtreme, NVTM Hybrid, NVSHybrid, GamerTM shafts, and the VS Proto and VS ProtoHybrid.  All of the NVTM family of shafts feature the Company’sexclusive MLT.  Although the Company emphasizesthese research and development activities, there can be no assurance thatAldila will continue to develop competitive products or that the Company willbe able to utilize new composite material technology on a timely or competitivebasis, or otherwise respond to emerging market trends.

 

TheCompany has been one of the leaders in developing the market for lower costlarge bundle carbon fiber by successfully converting to this fiber type in someof its products from a more expensive carbon fiber material for the manufactureof certain of its graphite golf shafts. The Company has had some success in providing large bundle carbon fiberto other manufacturing applications outside of golf shafts.

 

TheCompany has applied its composite materials expertise on a limited basis toother products in recent years, producing hockey sticks as well as graphitetubing and other molded parts on a special order basis.

 

**Customersand Customer Relations**

 

TheCompany believes that its close customer relationships and responsive servicehave been significant elements of its success to date, establishing it as apremier graphite shaft company.  Aldila’sgolf club manufacturer customers often work together with the Company’sengineers when developing a new golf club in order to design a club thatmaximizes the performance features of the principal component parts:  the grip, the clubhead and the Aldilashaft.  The Company’s partnershiprelationship with its customers continues after the development of clubscontaining Aldila’s shafts.  Followingthe design process, the Company continues to provide high levels of customersupport and service in areas such as quality control and assurance, timely andresponsive manufacturing, delivery schedules and education.  The Company believes the physical proximityof its headquarter facilities to many of its customers has facilitated a highdegree of customer interaction and responsiveness to customer needs.  While the Company has had long-establishedrelationships with most of its customers, it is not the exclusive supplier ofgraphite shafts to most of them and generally does not have long-term supplyagreements with its customers.

 

For fiscal year 2006, theCompany had approximately 670 golf shaft customers, which includedapproximately 120 golf club manufacturers and more than 150 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 a relativelysmall number of customers.  Sales to theCompany’s top five customers represented approximately 62%, 62% and 57% of netsales in 2006, 2005 and 2004, respectively.

 

Historically,Aldila’s principal customers have varied as a result of general market trendsin the golf industry, in

 

 

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particularthe prevailing popularity of the various clubs that contain Aldila’sshafts.  As a result, there typically arechanges in the composition of the list of the Company’s ten most significantcustomers from 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 Acushnet Company,Callaway Golf, and Ping.  While theCompany believes its relationship with each of these major customers is good,the Company is not the exclusive supplier to any of them.  The Company’s sales to its principalcustomers have varied substantially from year to year.

 

| **Customer**     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------|------------|----------|------------|----------|------------|----------|------------|
| Ping             |       | 18       | %          | 19       | %          | 9        | %          |
| Acushnet Company |       | 17       | %          | 19       | %          | 22       | %          |
| Callaway Golf    |       | 15       | %          | 18       | %          | 17       | %          |

 

Becauseof the historic volatility of consumer demand for specific clubs, as well ascontinued competition from alternative shaft suppliers, sales to a given customerin a prior period may not necessarily be indicative of future sales and it isoften difficult to project the Company’s sales to a given customer in advance.

 

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 (whether as a result of diminished sales by that customeror a shaft sourced from other suppliers) could have a material adverse effecton the Company’s business or operating results.

 

**Marketing,Advertising and Promotion**

 

TheCompany’s marketing strategy is designed to encourage golf club manufacturersto select and promote Aldila shafts and to increase overall market acceptanceand use of graphite golf shafts.  TheCompany utilizes a variety of marketing and promotional channels to increasesales of Aldila brand name shafts through its network of distributors and tosupport Aldila’s brand name recognition and reputation among consumers foroffering consistently high quality products designed for a wide range ofgolfers. Although the Company has very limited sales directly to the end usersof its products, the Company believes that its brand name recognitioncontributes to the marketability of its customers’ products.  In addition, Nick Price, Gary McCord andPaula Creamer serve on the Company’s advisory staff and assist in its marketingefforts. Aldila’s marketing and promotion expenditures were approximately $3.2million, $2.3 million and $2.2 million in 2006, 2005 and 2004,respectively.  The Company does notcurrently incur significant marketing expenses for its products other than golfshafts.

 

**Salesand Distribution**

 

Withinthe golf club industry, most companies do not manufacture the three principalcomponents of the golf club — the grip, the shaft and the clubhead — but rathersource these components from independent suppliers that design and manufacturecomponents to the club manufacturers’ specifications.  As a result, Aldila sells its graphite shaftsprimarily to golf club manufacturers and, to a lesser extent, distributors,custom club shops, pro shops and repair shops. Distributors typically resell the Company’s products to custom clubassemblers, 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 anddistributors.  Sales to golf clubmanufacturers accounted for approximately 77% of net sales for the year ended December 31,2006 as compared to 81% for the previous year.

 

Prepregsales, which represented 12% of the Company’s 2006 net sales, and carbon fibersales (through the Company’s joint venture, CFT) 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.

 

Internationalsales represented 28%, 23%, and 18% of net sales for the years ended December 31,2006, 2005 and 2004, respectively.  TheCompany’s international sales have increased from 18% in 2004 to 28% in2006.  A large portion of the increasewas attributed to increased sales to customers in China.  The majority of the customers are assemblersin China, with the end product usually being shipped back to the United Statesor Europe.  See Note 12 in the Notes toConsolidated Financial Statements for further breakdown of our internationalsales and long-lived assets.

 

 

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**Manufacturing**

 

TheCompany believes that its manufacturing expertise and production capacitydifferentiate it from many of its competitors and enable Aldila to respondquickly to its customers’ orders and provide sufficient quantities on a timelybasis.  The Company today operates threegolf shaft manufacturing facilities, one prepreg manufacturing facility (inconjunction with one of its shaft manufacturing facilities) and through its 50%ownership interest in CFT, one carbon fiber manufacturing facility.  The Company is constructing another shaftmanufacturing facility, which will be operational and producing shafts duringthe first quarter of 2007.  During its 34years of operation, the Company has improved its manufacturing processes andbelieves it has established a reputation as the industry’s leading volumemanufacturer of high performance graphite 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” (See Prepreg ManufacturingProcess) is rolled onto metal rods known as mandrels.   The graphite is then baked at hightemperatures 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 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.  The Company is currentlyconstructing a facility in Ho Chi Minh City, Vietnam, which will be operationaland producing shafts in the first quarter of 2007.

 

*Shaft Manufacturing Raw Materials*.  The primary materials currently used in theCompany’s graphite shafts are prepreg, paints, inks and heat transfer decals.

 

*Prepreg Manufacturing Process. *In October 1994,the Company initiated the internal production of prepreg in its 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 and for itsoutside sales of prepreg material.  TheCompany is, however, somewhat dependent upon certain domestic prepreg suppliersfor types of prepreg that it does not produce and, therefore, the Companyexpects to occasionally purchase some prepreg products from outside suppliersin the future.  Although the Companybelieves that there will continue to be alternative third party suppliers ofprepreg, there can be no assurance that unforeseen difficulties which couldlead to an interruption in the Company’s internal prepreg production will notoccur, which would result in production delays.

 

TheCompany’s prepreg operation is dependent on certain suppliers for carbonfibers, which along with epoxy resins and release paper constitute the primarycomponents used to manufacture prepreg. Through 1997, the Company purchased all of its carbon fibers fromoutside vendors.  Beginning in 1998, theCompany manufactured carbon fiber at its 50% owned Evanston, Wyoming facility,CFT, to provide fiber for its prepreg manufacturing process for consumption byits golf shaft production operation. Because several different forms of carbon fiber are required for golfshaft products, including some not manufactured at the CFT facility, the Companywill continue to depend on outside suppliers for a portion of its ongoingcarbon fiber needs.  In 2006, the Companyobtained a large portion of its carbon fiber from CFT but also purchased carbonfiber from other carbon fiber manufacturers. The prices paid by the Company for carbon fiber not produced at CFTbegan to increase at the end of 2003 and throughout 2005, due to risingmanufacturing costs and capacity constraints in the carbon fiber industry.  However, after an initial price increase inearly 2006, the prices remained level with no apparent changes in capacityconstraints.  If the Company is unable topurchase carbon fiber from suppliers, other than that produced at CFT, it couldresult in production delays of composite prepreg 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.  The degreeof the heating and stretching of the graphite fibers determines the tensilestrength and modulus (stiffness) of the fiber. These carbon fibers combined with various resins are then converted tocomposite structures, which have replaced metals in a number of weight criticalaerospace, sporting and industrial applications.

 

Typically,the composite structure will weigh 25 to 50 percent less than the metalstructure it has replaced.  Carbon fiber compositestructures also provide toughness, resistance to corrosion, resistance tofatigue, capacity to dissipate heat and electrical conductivity.  The carbon fiber industry has grown from itsinception in the late 1950’s, into one which produced approximately 50 millionpounds of carbon fiber in 2005.

 

 

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Carbonfiber usage has grown primarily for consumption by the aerospace industry andfor sporting goods and industrial applications. Aerospace grade carbon fibers continue to be utilized for production ofcommercial and military aerostructures. The higher cost, aerospace grade carbon fibers were first used insporting goods and industrial applications until a lower cost, large bundlecarbon fiber was developed as an alternative for use in many sporting goods andindustrial applications.  Aldila was aleader in utilizing large bundle carbon fibers initially purchased from outsidevendors for the production of prepreg, which is used in the manufacture of graphitegolf shafts.  In 1998 the Companycompleted construction of a 50,000 square foot carbon fiber manufacturingfacility in Evanston, Wyoming, which subsequently became CFT.  CFT produces large bundle carbon fibermaterial from acrylic fiber through a series of stretching, stabilizing andcarbonizing sequences in this facility. Carbon fiber that has more than 24,000 (24K) filaments is considered tobe large tow carbon fiber.  During 2004,CFT began producing a smaller tow (24K), which yields better properties and canbe used in more applications.  CFT nowproduces two different tow sizes of carbon fibers.  These materials are significant raw materialsused in the Company’s prepreg manufacturing operation to support themanufacture of graphite golf shafts, although the Company still procurescertain types of fibers from outside vendors for the manufacture of golfshafts.  The Company believes it canpurchase the type of fibers produced by CFT from at least two outside sources.

 

CFTpurchased substantially all of its raw acrylic fibers for the carbon fiberoperation from one supplier for the years 2000 through 2006.  Previous to 2000, the Company purchased rawacrylic fibers from another supplier who in May 2005, filed bankruptcy andannounced its intention to cease producing acrylic fibers, which left CFT in atrue sole source position.  The assets ofthis previous supplier are now owned by China Bluestar who continues to operatethe business.  There is no certainty thatChina Bluestar will be successful.  CFTis continuing to pursue alternate sources of supply for this material and hasrun several trials with results that are encouraging.  However, if the current supplier is unable todeliver and CFT cannot qualify and source material from a new supplier prior tothis event, it could have a material adverse effect on the Company’s business.

 

**EnvironmentalMatters**

 

TheCompany is subject to various federal, state, local and foreign environmentallaws and regulations, including those governing the use, discharge and disposalof hazardous materials as the Company uses hazardous substances and generateshazardous waste in the ordinary course of its manufacturing of graphite golfshafts, other composites, graphite prepreg and carbon fiber.  The Company believes it is in substantialcompliance with applicable laws and regulations and has not to date incurredany material liabilities under environmental laws and regulations; however,there can be no assurance that environmental liabilities will not arise in thefuture which may affect the Company’s business.

 

**Competition**

 

Aldilaoperates in a highly competitive environment in both the United States andinternational markets for the sale of its graphite golf club shafts.  The Company believes that it competes on thebasis of its ability to provide a broad range of high quality, performancegraphite shafts, its ability to deliver customized products in large quantitiesand on a timely basis to its customers, the acceptance of graphite shafts ingeneral, and Aldila shafts in particular, by professional and other golfers,whose preferences are to some extent subjective, and finally, price.  Until recently, the United States market forgraphite shafts was dominated by a relatively small number of United Statesbased shaft manufacturers which competed predominantly for the business oflarger original equipment manufacturers (“OEMs”).  However, the Company now competes againstUnited States and foreign-based shaft manufacturers for the OEM shaft market.This competition has made it more difficult to retain existing customers,attract new customers and has placed increasing pressure on prices for OEMshafts.  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 competitiveprices.  Aldila competes against othershaft manufacturers, both graphite and steel, and in the past also against golfclub companies that produced their own shafts internally, some of which mayhave or had greater resources than Aldila. The Company also faces potential competition from those golf clubmanufacturers that currently purchase golf shaft components from outside suppliersbut that may have, develop or acquire the ability to manufacture all or aportion of its graphite shafts internally. Should any of the Company’s significant customers decide to meet any ofits shaft needs internally, it could have an adverse effect on theCompany.  The Company also competesagainst companies who manufacture one or more of three principal components ofthe golf club, the grip, the shaft and the club head, and assemble completedgolf clubs for delivery to club companies. Should any of the Company’s significant customers decide to source theirgolf clubs in this manner where an Aldila shaft is not included, it could havean adverse effect on the Company. Presently, there exists substantial excess graphite shaft manufacturingcapacity both in the United States and in other countries, however, this excessmanufacturing capacity has somewhat been mitigated by carbon fiber supplyconstraints.

 

 

8

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TheCompany also competes for sales of prepreg from its prepreg facility and carbonfiber through its 50% interest in CFT with other producers of prepreg andcarbon fibers, many of which have substantially greater research anddevelopment, 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 the types of carbon fiber manufactured by CFT, which is a significantportion of the carbon fiber used in Aldila’s graphite prepreg.  In addition, the ability to purchase fiberfrom an outside source when required in today’s fiber market, limits theCompany’s ability to compete in prepreg sales.

 

**IntellectualProperty**

 

Aldilautilizes a number of trademarks and logos in connection with the sale andadvertising of its products.  The Companytakes all reasonable measures to ensure that any product bearing an Aldilatrademark reflects the consistency and quality associated with the Company’sproducts and intends to continue to protect them to the fullest extentpracticable.  As of December 31,2006 the Company had approximately 55 United States and foreign registeredtrademarks.

 

**Employees**

 

Asof December 31, 2006, Aldila employed 1,366 persons on a full-time basis,including 11 in sales and marketing, 18 in research, development andengineering and 1,143 in production. The balance of employees areadministrative and support staff.  Thenumber of full-time employees includes 467 persons who are employed in theCompany’s Mexico facility, 692 who are employed in the Company’s China facilityand nine persons who are employed in the Company’s Vietnam facility.  Because of seasonal demands, the Companyhires a significant number of temporary employees.  As of December 31, 2006, the Companyalso employed 32 temporary employees. Aldila considers its employee relationsto be good.

 

**Seasonality**

 

Becausethe Company’s customers have historically built inventory in anticipation ofpurchases by golfers in the spring and summer, the principal selling season forgolf equipment, the Company’s operating results have been affected by seasonaldemand for golf clubs, which has generally resulted in highest sales occurringin the first and second quarter.  Thetiming of customers’ new product introductions has frequently mitigated theimpact of seasonality in recent years.

 

**Backlog**

 

Asof December 31, 2006, the Company had a sales backlog of approximately$12.5 million compared to approximately $11.4 million as of December 31,2005.  The Company believes that the dollarvolume of its current backlog will be shipped over the next three months.  Orders can typically be cancelled withoutpenalty up to 30 days prior to shipment. Historically, the Company’s backlog generally has been highest in thefirst and fourth quarters, due in large part to seasonal factors.  Due to the timing and receipt of customerorders, backlog is not necessarily indicative of future operating results.

 

**Item 1A.  Risk Factors**

 

**Customer Concentration**

 

TheCompany’s sales have been, and very likely will continue to be, concentratedamong a small number of customers.  In2006, sales to the Company’s top five customers represented approximately 62%of net sales.  Aldila’s principalcustomers have historically varied depending largely on the prevailingpopularity of the various clubs that contain Aldila shafts.  In 2006, Ping accounted for 18% of net sales,Acushnet Company accounted for 17% of net sales and Callaway Golf accounted for15% of net sales.  The Company cannotpredict the impact that general market trends in the golf industry, includingthe fluctuation in popularity of specific clubs manufactured by customers, willhave on its future business or operating results.

 

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, andconsistent with the industry practice, generally does not have long-termcontracts with its customers.  In thisregard, Ping, Acushnet Company and Callaway Golf, who collectively representapproximately 51%

 

 

9

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ofthe Company’s net sales in 2006, each purchased from at least two othergraphite shaft suppliers.  In the eventPing, Acushnet Company and Callaway Golf or any other significant customerincreases purchases from its other suppliers or adds additional suppliers, theCompany could be adversely affected. 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 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**

 

Aldilaoperates in a highly competitive environment for golf equipment sales.  The Company believes that it competesprincipally on the basis of its ability to provide a broad range of highquality, performance graphite shafts, its ability to deliver customizedproducts in large quantities and on a timely basis, the acceptance of graphiteshafts in general, and Aldila shafts in particular, by professionals and othergolfers, whose preferences are to some extent subjective, and finally, price.

 

Aldilacompetes against both domestic and foreign shaft manufacturers.  Some of the Company’s current and potentialcompetitors may have greater resources than Aldila.  The Company also faces potential competitionfrom those golf club manufacturers that currently purchase golf shaftcomponents from outside suppliers but that may have, develop or acquire, theability to manufacture shafts internally.

 

Asthe Company further enters into the manufacture and sale of prepreg products,it competes with other producers of prepregs, many of which have substantiallygreater research and development, managerial and financial resources than theCompany and represent significant competition for the Company.

 

**New Product Introduction**

 

TheCompany believes that the introduction of new, innovative golf shafts usinggraphite or other composite materials will be critical to its futuresuccess.  While the Company emphasizesresearch and development activities in connection with carbon fiber and othercomposite material technology, there can be no assurance that the Company willcontinue to develop competitive products or that the Company will be able todevelop or utilize new composite material technology on a timely or competitivebasis or otherwise respond to emerging market trends.

 

Althoughthe Company believes that it has generally achieved success in the introductionof its customized graphite golf shafts, specifically, the Aldila NVTM line of golf shafts, no assurance can be giventhat the Company will be able to continue to design and manufacture productsthat meet with market acceptance, either on the part of club manufacturers orgolfers.  The design of new graphite golfshafts is also influenced by rules and interpretations of the UnitedStates Golf Association (“USGA”).  Therecan be no assurance that any new products will receive USGA approval or thatexisting USGA standards will not be altered in ways that adversely affect thesales of the Company’s products.

 

**Reliance on Offshore Manufacturing Facilities**

 

* *The Company operatesmanufacturing facilities in Tijuana, Mexico and Zhuhai, People’s Republic ofChina and is currently constructing a plant in Ho Chi Minh City, Vietnam.  The Company pays certain expenses of thesefacilities in Mexican pesos, Chinese renminbis and Vietnam dong, respectively,which are subject to fluctuations in currency value and exchange rates.  The facility in Tijuana, Mexico operatespursuant to the “maquiladora” duty-free program established by the Mexican andUnited States governments.  Such programenables the Company to take advantage of generally lower costs in Mexico,without paying duty 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. The operation in Vietnam also will enjoy advantages in regards to incometaxes.  There can be no assurance that thegovernments of Mexico, the People’s Republic of China or Vietnam 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**

 

TheCompany’s gross profit margins, in part, are dependent on the price paid forcarbon fiber purchased from outside vendors, and more substantially starting inthe latter part of 1998, the cost of production of carbon fiber at theEvanston, Wyoming facility, CFT, including the price paid for the acrylic fiberused for the manufacture of carbon fiber and the other costs associated withthe operation of the carbon fiber plant.

 

TheCompany experienced an increase in carbon fiber prices in 1996 and 1997 due tothe growth experienced in the use of carbon fiber coupled with relativelylittle excess capacity.  The prices paidby the Company for carbon fiber leveled in

 

 

10

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1998and decreased during 1999 through 2002, due to excess capacity in the carbonfiber manufacturing industry.  However,that trend reversed itself in the later part of 2003.  The Company experienced carbon fiber priceincreases in certain grades of carbon fiber prices during the later part of2003 and through 2005, however, prices have not changed since early 2006.  Management is not able to predict the timingor extent of any future price changes for carbon fiber; however, the Companycould be negatively impacted if carbon fiber prices continue to increase andthe Company is not able to pass along these increases to its customers due tocompetition.

 

TheCompany also has relationships with other outside vendors for its additionalcarbon fiber needs through 2006 and beyond. Depending on market conditions prevailing at the time and extent towhich production at CFT meets expectations, the Company may face difficultiesin obtaining adequate supplies of carbon fiber from external sources to providefor any carbon fiber needs not met internally. If it appears that CFT is not likely to satisfy a significant portion ofthe Company’s needs or if it appears that there will not be adequateavailability in the market, the Company may not have made arrangements inadvance for the purchase of material amounts of carbon fiber from alternativesources.

 

Inaddition, the Company is dependent on its internal production of graphiteprepreg to support its shaft manufacturing operations and has not securedadequate additional sources of supply should its production of prepreg be interruptedfor any reason.  The exposure to theCompany resulting from its increasing reliance on its own internal productionof the raw materials for its golf shaft business is enhanced because theCompany currently operates only one prepreg facility and has an interest inonly one carbon fiber manufacturing facility. Until recently, there has been excess-capacity in these industries.  In the past, significant market shortages ofboth carbon fiber and graphite prepreg have occurred and if they re-occur, itcould have a negative impact on the Company’s financial statements.

 

**Joint Venture Operating Carbon Fiber Facility**

 

TheCompany started producing carbon fiber at its Evanston, Wyoming facility in1998.  Since October 1999, thisfacility has been operated as a joint venture, 50% owned by each of the Companyand SGL.  As a result of the operation ofthis facility through the joint venture, the Company is subject to business andfinancial risks, such as the risks that SGL will be unable to meet itsobligations to the joint venture, that there will be operational difficultiesresulting from the split ownership, raw material supply problems, changes indemand for carbon fiber based products, or that there will be differences ofopinion between the joint venture partners as to future operations leading toan inability to make decisions when required, or to the making of decisions notin the best interests of both joint venture partners.

 

**Reliance on Carbon Fiber Manufacturing Facility**

 

Untilrecently, during the period in which the Company or the joint venture hasoperated the Evanston, Wyoming facility, the market for carbon fiber productshas been soft, which has limited the Company’s ability to take full advantageof the opportunity offered by the vertical integration of its carbon fiber rawmaterial usage in graphite golf shafts. If the facility does not produce high quality fiber at the anticipatedvolumes, either because of production shortfalls or limited demand for thefacility’s carbon fiber, the per pound cost of the fiber produced will likelybe higher due to the substantial fixed costs involved in operating a carbonfiber production facility.  In addition,if the facility is not capable of producing carbon fiber at sufficient volumesto satisfy the demands of both venture partners, the Company would be requiredto purchase additional fiber from third party suppliers, which may not beavailable in sufficient quantities to satisfy its demands and could result inhigher marginal costs to the Company than fiber acquired from the jointventure.  In addition, if CFT is unableto obtain precursor, the significant raw material consumed in the carbon fibermanufacturing process, it could have a material adverse effect on the Company’sbusiness.

 

**Potential Cash Flow Shortages**

 

TheCompany has cash, cash equivalents and marketable securities totaling $15.2million as of December 31, 2006. Management anticipates that these sources of funds, when combined withcash flow generated from operations, will be sufficient to finance its businessoperations at least through 2007.  If theCompany is not able to generate the expected cash flows from operations, theCompany could be adversely affected.

 

**Shaft Manufacturing by Club Companies and One-Stop Shops**

 

Anotherfactor that could have a negative impact in the future on the Company’s salesto golf club manufacturers would be a decision by one of its customers tomanufacture all or a portion of their graphite shaft requirements, or to havean increased amount of their requirements filled from one-stop shops (wheremain 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

 

 

11

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reasons,should any of the Company’s major customers decide to meet any significantportion of their shaft needs either internally or through one-stop shops, itcould have a material adverse impact on the Company and its financial results.

 

**Utilization of Certain Hazardous Materials**

 

Inthe ordinary course of its manufacturing processes, the Company uses hazardoussubstances and generates hazardous waste. The Company has not to date incurred any material liabilities underenvironmental laws and regulations and believes that it is in substantialcompliance with applicable laws and regulations.  Nevertheless, no assurance can be given thatthe Company will not encounter environmental problems or incur environmentalliabilities in the future, which could adversely affect its business.

 

**Dependence on Discretionary Consumer Spending**

 

Salesof golf equipment have historically been dependent on discretionary spending byconsumers, which may be adversely affected by general economic conditions.  The Company believes that golf equipmentsales have remained flat in recent periods and may continue to be so in thefuture.  A decrease in consumer spendingon golf equipment or, in particular, a decrease in demand for golf clubs withgraphite shafts could have an adverse effect on the Company’s business andoperating results.

 

**Reliance on Key Personnel**

 

Thesuccess of the Company is dependent upon its senior management team, as well asits ability to attract and retain qualified personnel.  There is competition for qualified personnelin the golf shaft industry as well as the carbon fiber business.  There is no assurance that the Company willbe able to retain its existing senior management personnel or to attractadditional qualified personnel.

 

**Justice Department Investigation**

 

During1999 the Company received a subpoena for documents from the Antitrust Divisionof the U.S. Department of Justice in connection with the on-going investigationof an alleged price fixing conspiracy in the carbon fiber and graphite prepregindustries.  The Department of Justicehas informed the Company that it is not currently a target of theinvestigation, although it has indicated that it has not cleared the Company ofany involvement in the alleged conspiracy. The Company is cooperating with the Department of Justice’sinvestigation.

 

**Item 1B. Unresolved Staff Comments**

 

None.

 

**Item 2. Properties**

 

TheCompany’s principal executive offices are located in Poway, California (in theSan Diego metropolitan area).  TheCompany’s golf shafts are manufactured at four separate facilities; one locatedin Poway, California, one located in Tijuana, Mexico, one in the Zhuhaieconomic development zone of the People’s Republic of China and one that iscurrently being built in Ho Chi Minh City, Vietnam.  The Company leases a 73,000 square footfacility in Poway, California for shaft manufacturing operations, graphiteprepreg production and for its executive offices.  The Company also has leased an additional52,000 square foot facility in Poway, California and plans to move its golfoperations, executive offices and warehouse into this facility in 2007.  This would leave the graphite prepregproduction at the original Poway facility and provide room for expansion.  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 Vietnam facility wasbuilt by the Company and operates under a 54 year land lease. The land isapproximately 10,000 square meters and the building is comprised ofapproximately 64,000 square feet. The Company also may lease warehousing spacewhen needed.  Currently, the Companyleases warehousing space in the United States and in China. ** **Inaddition, the Company’s 50% joint venture, CFT, owns 14 acres of land inEvanston, Wyoming on which it operates a 50,000 square foot carbon fibermanufacturing plant.

 

 

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**Item 3.  Legal Proceedings**

 

None.

 

**Item 4.  Submission of Matters toa Vote of Security Holders**

 

Therewere no matters submitted to a vote of security holders during the fourthquarter of fiscal 2006.

 

 

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** **

**PART II**

 

**Item 5.  Market for Registrant’sCommon Equity and Related Stockholder Matters**

 

**COMMONSTOCK PERFORMANCE**

 

| ** **     | ** ** | **2006**      | ** ** | **2005**   | ** ** |
|----------------|------------|---------------|------------|------------|------------|
| ** **     | ** ** | **Dividends** | ** ** | ** ** | ** ** | ** ** | ** ** | **Dividends** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **Declared**  | ** ** | **High**   | ** ** | **Low** | ** ** | **Declared** | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $             | 0.15       |       | $          | 33.20 |   | $ | 25.80 |   | $ | 0.05 |   | $ | 18.71 |   | $ | 13.16 |   |
|           |       |          |       |       |       |   |   |   |   |   |   |   |   |
| Second Quarter |       | $             | 0.15       |       | $          | 35.16 |   | $ | 25.25 |   | $ | 1.10 |   | $ | 24.06 |   | $ | 17.52 |   |
|           |       |          |       |       |       |   |   |   |   |   |   |   |   |
| Third Quarter  |       | $             | 0.15       |       | $          | 25.49 |   | $ | 13.79 |   | $ | 0.15 |   | $ | 27.83 |   | $ | 19.79 |   |
|           |       |          |       |       |       |   |   |   |   |   |   |   |   |
| Fourth Quarter |       | $             | 0.15       |       | $          | 16.48 |   | $ | 14.31 |   | $ | 1.15 |   | $ | 25.50 |   | $ | 21.21 |   |

 

Allthe prices above reflect the Company’s one-for-three reverse stock split, forshareholders of record at the close of business on June 3, 2002.  On March 9, 2007, the closing commonstock price was **$**16.15**,** and there were approximately 167****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 Global Market, symbol:  ALDA.

 

TheCompany intends to retain earnings for use in operations and payments of cashdividends on its common stock.  Cashdividends are discussed by the Company’s Board of Directors and management ateach quarterly Board Meeting, and if approved, cash dividends areannounced.  Aldila, Inc. is aholding company whose ability to pay dividends depends on the receipt ofdividends or other payments from its two principal subsidiaries, Aldila Golfand Aldila Materials Technology Corp.

 

TheCompany announced on July 28, 2006 that its Board of Directors authorizedthe repurchase of up to $5.0 million of the Company’s common stock.  Theshares will be repurchased from time to time in open market transactions at theCompany’s discretion, subject to market conditions and other factors,including  imposed “black-out periods” during which the Company and itsinsiders are prohibited from trading in the Company’s common stock.  During the year, the Company used cash ofapproximately $1.2 million purchasing 75,596 shares of its common stock, withan average price paid of $16.11; however, the Company did not repurchase anyshares during the fourth quarter of 2006.  The Company has approximately $3.8 million remaining under its currentstock repurchase plan.

 

**TOTALRETURN GRAPH**

 

The graph below matches the cumulative 5-year total return of holdersof Aldila, Inc.’s common stock with the cumulative total returns of theNASDAQ Composite index, and a peer group of seventeen NASDAQ listed companiesin SIC Codes 3940-3949 listed in footnote 1 below. The graph assumes that thevalue of the investment in the Company’s common stock, in the peer group, andthe index (including reinvestment of dividends) was $100 on 12/31/2001 andtracks it through 12/31/2006. The information was provided by the Research DataGroup, Inc.

 

 

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**COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN***

Among Aldila, Inc., The NASDAQ Composite IndexAnd A Peer Group

 

 

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*$100invested on 12/31/01 in stock or index-including reinvestment of dividends.

Fiscalyear ending December 31.

 

| ** **            | ** ** | **12/01**  | ** ** | **12/02**  | ** ** | **12/03**  | ** ** | **12/04**  | ** ** | **12/05**  | ** ** | **12/06**  | ** ** |
|-----------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Aldila, Inc.** | ** ** | **100.00** | ** ** | **48.29**  | ** ** | **113.05** | ** ** | **489.48** | ** ** | **904.75** | ** ** | **545.56** | ** ** |
| **NASDAQ Composite**  | ** ** | **100.00** | ** ** | **69.66**  | ** ** | **99.71**  | ** ** | **113.79** | ** ** | **114.47** | ** ** | **124.20** | ** ** |
| **Peer Group**        | ** ** | **100.00** | ** ** | **85.19**  | ** ** | **112.70** | ** ** | **167.17** | ** ** | **163.51** | ** ** | **189.68** | ** ** |

 

*The stock price performance included in this graph is not necessarilyindicative of future stock price performance*

 

(1.)The seventeen companies included in the peer group (SIC Codes 3940-3949) are:Action Products International Inc, Aldila, American Sports Development GroupInc, BP International Inc, Ecom Ecom.com Inc, Escalade Inc, Gametech InternationalInc, Gaming Partners International Corp., Golfgear International Inc, Jakks PacificInc, LEW Corp., Marx Toys & Entertainment Corp., Natural Golf Corp.,RC2 Corp., Simon Worldwide Inc, Sport-Haley Inc and Sports Arenas Inc.

 

 

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**EQUITYCOMPENSATION PLAN INFORMATION**

 

The following table provides information regardingsecurities authorized for issuance under the Company’s equity compensationplans as of December 31, 2006 (all numbers of securities reflect theCompany’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 to  be issued  upon vesting  of restricted  stock** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                                                          |       |                                                                                                     |       |                                                                      |       |                                                                                                 |       |                                                                                                                                    |       |
| Equity compensation plans  approved by security holders — 1994 Stock Incentive Plan      |       | 161,630                                                                                                  |       | $                                                                         | 13.41      |                                                                                                 | 28,473     |                                                                                                                                    | 439,446    |   |
|                                                                                          |       |                                                                                                     |       |                                                                      |       |                                                                                                 |       |                                                                                                                                    |       |
| Equity compensation plans  not approved by security holders — 1992 Stock Option Plan (1) |       | —                                                                                                   |       |                                                                      |       | —                                                                                               |       | 20,167                                                                                                                                  |       |
| Total                                                                                         |       | 161,630                                                                                                  |       |                                                                      |       | 28,473                                                                                               |       | 459,613                                                                                                                                 |       |
|                                                                                               |            |                                                                                                          |            |                                                                           |            |                                                                                                      |            |                                                                                                                                         |            |  |

 

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

 

 

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**Item 6.  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)**

 
| ** **                                             | ** **               | **2006**   | ** **               | **2005**   | ** **               | **2004**   | ** **               | **2003**   | ** **               | **2002**   | ** **               |
|--------------------------------------------------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|
| Operating Results (Year  ended December 31):      |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
|                                                   |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| Net sales                                              |                     | $          | 72,370                   |       | $                        | 76,978     |                     | $          | 52,762                   |       | $                        | 37,807 |   | $ | 37,462 |   |
| Cost of sales                                          |                     | 48,087     |                     | 47,368     |                     | 34,786     |                     | 30,586     |                     | 32,828     |                     |
| Gross profit                                           |                     | 24,283     |                     | 29,610     |                     | 17,976     |                     | 7,221      |                     | 4,634      |                     |
|                                                   |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| Selling, general and administrative                    |                     | 10,731     |                     | 9,741      |                     | 8,237      |                     | 6,989      |                     | 7,334      |                     |
| Plant consolidation                                    |                     | —     |                     | —     |                     | —     |                     | —     |                     | 300        |                     |
| Operating income (loss)                                |                     | 13,552     |                     | 19,869     |                     | 9,739      |                     | 232        |                     | (3,000     | )                        |
|                                                   |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| Interest (expense)                                     |                     | —     |                     | —     |                     | —     |                     | (23        | )                        | (94        | )                        |
| Interest income                                        |      | 714        |      | 639        |      | 148        |      | 46         |      | 22         |      |
| Other income (expense), net                            |                     | 2,148      |                     | (53        | )                        | (88        | )                        | (94        | )                        | (84        | )                        |
| Impairment of investment in joint venture              |                     | —     |                     | —     |                     | —     |                     | (2,220     | )                        | —     |                     |
| Equity in earnings of joint venture                    |                     | 407        |                     | 236        |                     | 246        |                     | 150        |                     | 269        |                     |
|                                                   |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| Income (loss) before income taxes                      |                     | 16,821     |                     | 20,691     |                     | 10,045     |                     | (1,909     | )                        | (2,887     | )                        |
| Provision (benefit) for income taxes                   |                     | 5,585      |                     | 7,287      |                     | 725        |                     | (183       | )                        | (43        | )                        |
|                                                   |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| Net income (loss)                                      |                     | $          | 11,236                   |       | $                        | 13,404     |                     | $          | 9,320                    |       | $                        | (1,726 | ) | $ | (2,844 | ) |
|                                                   |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| Net income (loss) per common share-basic:              |                     | $          | 2.04                     |       | $                        | 2.54       |                     | $          | 1.85                     |       | $                        | (0.35 | ) | $ | (0.57 | ) |
|                                                   |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| Net income (loss) per common share, assuming dilution: |                     | $          | 2.01                     |       | $                        | 2.46       |                     | $          | 1.77                     |       | $                        | (0.35 | ) | $ | (0.57 | ) |
|                                                   |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| Selected Operating Results                             |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| As a Percentage of Net  Sales:                         |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
|                                                   |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| Gross profit                                           |                     | 33.6       | %                        | 38.5       | %                        | 34.1       | %                        | 19.1       | %                        | 12.4       | %                        |
| Selling, general and administrative                    |                     | 14.8       | %                        | 12.7       | %                        | 15.6       | %                        | 18.5       | %                        | 19.6       | %                        |
| Operating income                                       |                     | 18.7       | %                        | 25.8       | %                        | 18.5       | %                        | 0.6        | %                        | 8.0        | %                        |
| Net income (loss)                                      |                     | 15.5       | %                        | 17.4       | %                        | 17.7       | %                        | (4.6       | )%                       | (7.6       | )%                       |
| ** **                                             | ** **               | ** ** | ** **               | ** ** | ** **               | ** ** | ** **               | ** ** | ** **               | ** ** | ** **               |
| Financial Position (at  December 31):             |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
|                                                   |                     |       |                     |       |                     |       |                     |       |                     |       |                     |
| Working capital                                        |                     | $          | 36,050                   |       | $                        | 28,805     |                     | $          | 25,977                   |       | $                        | 15,181 |   | $ | 13,162 |   |
| Total assets                                           |                     | 55,896     |                     | 48,089     |                     | 42,075     |                     | 29,013     |                     | 31,159     |                     |
| Total stockholders’ equity                        |                     | 49,326     |                     | 38,551     |                     | 35,061     |                     | 24,446     |                     | 26,353     |                     |

 

 

17

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**Item 7.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations (“MD&A”)**

 

TheCompany’s MD&A is comprised of significant accounting estimates made in thenormal course of its operations, overview of the Company’s business conditions,results of operations, liquidity and capital resources and contractualobligations.  The Company did not haveany off balance sheet arrangements as of December 31, 2006 and 2005.  The Company’s significant accountingestimates identified are, revenue recognition, accounts receivables andinventory valuation.  The Company isdisclosing segment information for two segments.  The Company has historically considered itsoperations to be comprised of one business segment. However, due to thesignificance of its external sales of prepreg in the first quarter of 2006, atrend which management believes will continue, the Company believes itsbusiness to be comprised of two operating segments, Composite Products andComposite Materials.  The Company beganreporting two segments for the first quarter of 2006.  Composite Products is comprised sales of golfshafts, hockey sticks and other composite products. Composite Materials iscomprised of external sales of prepreg products in the forms of uni-tapes,fabrics and film adhesives along with contributions from its interest in CFT.

 

**Significant Accounting Estimates**

 

Theconsolidated financial statements of the Company are prepared in conformitywith accounting principles generally accepted in the United States ofAmerica.  As such, the Company isrequired to make certain estimates, judgments and assumptions that we believeare reasonable based upon the information available.  These estimates and assumptions affect thereported amounts of assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during the periodspresented.  The significant accountingpolicies, which the Company believes are the most critical to aid in fullyunderstanding and evaluating our reported financial results, include thefollowing:

 

*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 any shafts returned for breakage will be returned within three years of the initial sale of the shaft.  The Company estimates in regards to total actual returns, 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 .17% and 1.09% (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, 2006 is .24%.   The Company’s breakage return rate has declined over the past years.  The highest four-year average over the past ten years has been 1.01%.  If the Company were to use 1.01% in estimating its liability as of December 31, 2006, it would have the effect of increasing the liability by approximately $1.2 million, 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 receivable 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, 2006, the Company estimated this amount to be approximately $36,000.  If the Company were to reserve for the total amount greater than 60 days past due, it would increase the allowance by approximately $161,000, which would be recorded in administrative expense.

 

 

18

 

 

*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: reviewing on hand inventories of our top customers and comparing inventories to historical sales trends and anticipated sales forecasts.  A 100% reserve is established for all shafts that are deemed to be obsolete.  Raw materials are reviewed based upon estimated future production and when appropriate, reserves are established.  Shafts that are designated for rework (parts that need additional work) are reviewed and when appropriate reserves are established.  The final analysis is to review inactive inventory, and apply reserves to parts that were not included in the other analyses and have been inactive in the system for a period of twelve months.  The Company’s average reserve percentage compared to gross inventory has been approximately 16% for the past five years.  In the past five years, the highest reserve percentage was approximately 30% and the lowest reserve percentage was approximately 8%.  The Company’s reserve percentage as of December 31, 2006 is 9%.   See the estimated impact below to cost of goods sold, utilizing the different reserve rates above:

 

(Amounts below in thousands)

 
| ** **                       | ** **         | **Highest** | ** ** | **Average** | ** ** | **Lowest** | ** **                     |
|----------------------------------|--------------------|-------------|------------|-------------|------------|------------|--------------------------------|
| Gross inventory as of  12/31/06  |     | $           | 15,061     |        | $          | 15,061     |       | $ | 15,061 |   |
| Reserve rate                     |               | 30          | %(a)       | 16          | %          | 8          | %                              |
| Estimated reserve                |               | 4,568       |       | 2,410       |       | 1,161      |                           |
| Recorded Reserve as of  12/31/06 |               | 1,370       |       | 1,370       |       | 1,370      |                           |
| Impact to costs of goods  sold   |               | $           | 3,198      |        | $          | 1,040      |                           | $ | (209 | ) |

 

----

(a) This was the Company’shighest rate; the second highest rate in the past five years was 21%.

 

In the future, if our inventory were 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 increase in inventory in the current year was attributed to an increase in finished goods, with the majority of that increase being Aldila branded shafts.  However, the Company’s reserve percentage as compared to gross inventories has remained consistent with prior year.  The Company continues to look at ways of minimizing its inventory levels and to be more efficient.  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**

 

*CompositeProducts*

 

TheComposite Products segment is mainly comprised of graphite golf shafts and, toa lesser extent, hockey sticks.  Thegraphite shaft market consists of customized OEM production shafts, bothpremium and value and Aldila branded and co-branded shafts.  The Company sells customized OEM productionand co-branded shafts directly to its OEM customers and sells Aldila brandedshafts through the OEM custom stock and custom fit programs and todistributors.  The Company has re-emergedover the past couple of years as an innovator in the branded segment of thebusiness, in which shafts tend to sell at higher prices and gross margins thanthe customized OEM production shafts sold to club manufacturers.  The Company introduced the Aldila NVTM in 2003, featuring the Company’s exclusiveMicro Laminate Technologyä.  The NVTM has hadnumerous Tour victories.  The Companyintroduced NVä lineextensions in 2004, including the NVSä, NV ProtoPypeä, Pink NVä, NVä Irons and NVä Hybridshafts.  The Company began shipping itsnewest shaft offering — the VS ProtoTM and the VSProtoTM Hybrid in 2006.  The VS ProtoTM was used bythe winner of the 2006 U.S. Open and is

 

 

19

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quicklybecoming Aldila’s single most popular shaft model on Tour.  As with the NV ProtoPypeTM, the VS ProtoTM is a high performance shaft featuring carbonnanotubes as well as aerospace carbon fibers and Aldila’s exclusive high performanceresin system.  In addition, the Companyunveiled the new VS ProtoTM Hybrid shaft for high-end hybridclubs.  The Company’s sales of the VSProtoTM shaft line have exceeded the first year salesof our NVTM shaft line over a comparable period of time.   In 2006, PGA Tour, LPGA Tour and NationwideTour professionals using Aldila NVTM or VS ProtoTM shafts in their clubs have won a total of 32Tour events.  The Aldila VS ProtoTM and NVTM Hybrid shaftscombined have been the number one hybrid shafts at every event this year on thePGA Tour, according to the Darrell Survey Company.  In addition, Aldila Hybrid shafts won theAnnual Golf Magazine Club Test for 2006. Forty club testers evaluated hybrid clubs for Golf Magazine and clubsfeaturing Aldila Hybrid shafts received the highest rating in every categoryfor hybrid clubs. Overall the Aldila shafts helped give the testers the bestfeel, playability, forgiveness and distance with their hybrids compared to thecompetition.  As the 2007 PGA Tour hasbegan, Aldila was once again the leading shaft manufacturer represented at theMercedes Championship, winning both the wood and hybrid shaft count.  The Company also recorded its first win ofthe year at the recent Sony Open with the winner using an Aldila NVTM shafted driver.  Paula Creamer, who is a member of the Aldilaadvisory staff, won the SBS Open playing her customary pink NVTM.  The Company believes that it will continue tobe successful in the branded segment and has focused its marketing andadvertising effort in support of this business.

 

TheCompany continues to maintain a broad customer base in both the OEM productionshaft and branded shaft market segments and competes aggressively with bothUnited States and foreign-based shaft manufacturers for OEM production shaftsand branded shafts.  However, the Company’ssales have tended to be concentrated among a limited number of major clubcompanies, thus making the Company’s results of operations dependent on thosecustomers, their continued willingness to purchase a significant portion oftheir shafts from the Company, and their success in selling clubs containingthe Company’s shafts to their customers. In 2006, net sales to Ping, Acushnet Company and Callaway Golfrepresented 18%, 17% and 15% of the Company’s net sales, respectively, and theCompany anticipates that these companies will continue, collectively, torepresent the largest portion of its sales in 2007.  Although it is generally difficult to predictin advance the success of any particular club or of any particularmanufacturer, the Company believes that it is protected to some extent fromnormal periodic fluctuations in sales among the various golf club companies byvirtue of the broad range of its club manufacturer customers.  Golf club companies regularly introduce newclubs, frequently containing innovations in design.  Sometimes these new clubs achieve dramaticsuccess in the marketplace, thus increasing the overall volatility of clubsales among the major companies.  Whilethe Company seeks to have its shafts represented on as many major productintroductions as possible, it can provide no assurance that its shafts will beincluded in any particular “hot” club or that sales of a “hot” club that doesnot include the Company’s shafts will not have a negative impact on the salesof those clubs that do.  The Company’ssales could also suffer a significant drop-off from period to period to theextent that they may be dependent in any period on sales of one or more “hot”clubs, which then tail off in subsequent periods when no other club offers ahigh level of new sales to replace the lost sales.

 

Duringthe 1990’s, the graphite golf shaft industry became increasingly competitive,placing extraordinary pressure on the selling prices of the Company’s golfshafts and adversely affecting its gross profit margins and level ofprofitability.  The Company’s averageselling price decreased by 64% from December 31, 1990 through December 31,2002.  The pressure was mainly attributedto the increased competition for OEM production shafts, and a shift of ourcustomers away from branded shafts to customized OEM production shafts.  Beginning in 2003, the Company was able toachieve higher average selling prices as it enjoyed increasing success in thebranded segment of the business.  In late2004, the Company began to see its OEM customers choose co-branded shafts fortheir stock offerings.  The introductionof co-branded shafts and the continued success in the branded segment had theeffect of increasing the Company’s average selling prices over the last fewyears.  The Company’s average sellingprice increased by approximately 70% for the year ended December 31, 2006as compared to the comparable period in 2002. However, the Company’s average selling price decreased by 6% for theyear ended December 31, 2006 as compared to the comparable period in2005.  The percentage of the totalbranded and co-branded shaft revenue to total Composite Products revenuedecreased to 46% for the year ended December 31, 2006 as compared to 58%for the year ended December 31, 2005. As the Company’s branded and co-branded shafts typically sell at higherselling prices than OEM production shafts, a significant change in product mixin any one period will have the effect of increasing or decreasing the averageselling price of shafts sold.  Inaddition, increases in carbon fiber prices passed on to its customers will alsohave the effect of increasing average selling prices in the future.

 

  The Company’s response to the pricingpressure it faced during the 1990’s, and continues to face in the OEMproduction shaft segment, has been to vertically integrate, reduce its coststructure and to focus on continued penetration of the branded and co-brandedshaft segments.  The vertical integrationbegan in 1994 when the Company started manufacturing prepreg, the principal rawmaterial in the manufacture of graphite golf shafts, at its facility in Poway,California.  See Composite Materials.  In addition to the Company’s efforts toreduce its costs through vertical integration, the Company also reduced itscost structure by shifting more of its shaft production to lower cost labormarkets, such as Mexico, China and in 2007, Vietnam.

 

 

20

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Inaddition to golf shafts, the Company also manufactures hockey sticks for onecustomer.  The Company beganmanufacturing and selling hockey sticks in 2002.  The Company has not seen a significantincrease in sales of hockey sticks and is not satisfied with current status ofits hockey business.  The Company doesnot see the hockey business as being material to the Company in thefuture.  The percentage of hockey shaftrevenue to total Composite Products revenue was 3% for the year ended December 31,2006 as compared to 2% for the year ended December 31, 2005.

 

*CompositeMaterials*

 

TheComposite Materials segment is comprised of external sales of prepreg, filmadhesives, fabrics and other materials and the contribution provided by theCompany’s 50% owned interest in CFT.  TheCompany has never tracked inter-segment sales and has always looked at thecontribution provided by Composite Materials based upon the external sales ofmaterials.  The Company records allshared cost to Composite Products and allocates certain costs for segmentreporting, such as shipping, purchasing and other administrative costs basedupon the net revenues of each segment. Costs that are specific to one segment are charged directly to therespective segment.

 

TheCompany began the manufacture of composite materials in 1994.  Initially, the prepreg produced was mainlyconsumed by the Composite Products segment. The Company’s external sales of prepreg and other materials haveincreased over the past several years. Sales of prepreg as a percentage of net sales were 12% year ended December 31,2006 as compared to 10% for 2005.  In thesecond half of 2005, the Company purchased a second resin filmer.  The addition of a second resin filmerprovides additional supply of resin film, which is one of the key raw materialsin the production of prepreg.  Theincrease in resin film capacity enables the Company to add additional capacityto the Company’s prepreg composite manufacturing operations as well as provideincreased capacity for film products.  Inaddition, it provides capacity protection should the Company encounter problemswith its other resin filmer.  The Companyhas completed the installation of its sixth prepreg tape line, which enables itto support anticipated growth for shaft and prepreg sales.   In addition, an additional wide prepreg tapeline will be installed late this year to add further capacity to supportanticipated growth in this business segment.

 

TheCompany continues to look for opportunities to sell its prepreg and filmadhesive products to other fabricators of products manufactured from compositematerials.  The Company has achieved somesuccess in these areas and management believes that growth opportunities inthese areas will continue to exist. In addition, management believes thatvertical integration through its prepreg operation has been successful to dateand is allowing the Company to maintain, or in some cases enhance, itscompetitive position with respect to the major United States golf clubcompanies that are its principal customers.

 

Inaddition to vertical integration through prepreg, the Company established amanufacturing facility in Evanston, Wyoming for the production of carbon fiberin 1998, which is a significant raw material used in the prepreg productionprocess.  During 1998 and through thefirst ten months of 1999, the Company used the material from this facility tosatisfy a significant portion of its internal demand for carbon fiber in themanufacturing of prepreg used for graphite shaft production. During 1999, theCompany also produced and sold carbon fiber from this facility to otherunrelated entities for the manufacture of other carbon-based products.  On October 29, 1999, SGL purchased a 50%interest in the Company’s carbon fiber manufacturing operation.

 

TheCompany and SGL entered into an agreement to operate the facility as a limitedliability company with equal ownership interests between the venturemembers.  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.  The partners share profitsand losses of CFT equally.  The jointventure partners primarily consume the carbon fiber manufactured from thisfacility.

 

Ifthe carbon fiber facility is not operated at high production levels, eitherbecause of production difficulties or because there is not enough demand by thejoint venture owners 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 profitable competitive prices for its products.  Although selling prices of carbon fiber hadbeen depressed for the 1998 through mid 2003 period based on a surplus ofsupply in the market for carbon

 

 

21

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fiber,in the second half of 2003 the Company began to see increases in carbon fiberprices and a constriction of supply of all types of carbon fiber notmanufactured at CFT.  If the pricescontinue to increase or if the company cannot obtain an adequate supply at areasonable price, it could have an adverse effect on the Company’sbusiness.  The Company does not expectthird party sales at CFT to have a significant effect on either the Company’sprofitability.

 

CFTpurchased substantially all of its raw acrylic fibers for the carbon fiberoperation from one supplier for the years 2000 through 2006.  Previous to 2000, the Company purchased rawacrylic fibers from another supplier who in May 2005, filed bankruptcy andannounced its intention to cease producing acrylic fibers, which left CFT in atrue sole source position.  The assets ofthis previous supplier are now owned by China Bluestar who continues to operatethe business.  There is no certainty thatChina Bluestar will be successful.  CFTis continuing to pursue alternate sources of supply for this material and hasrun several trials with results that are encouraging.  The current supplier of precursor hasrecently notified CFT that it does not intend to continue to supply precursorbeyond late October 2007.  CFTmanagement projects that precursor in inventory when supply ends from thecurrent supplier should carry the operation through the first half of2008.  However, if the current supplieris unable to deliver and CFT cannot qualify and source material from a newsupplier prior to this event, it could have a material adverse effect on theCompany’s business.

 

Untilrecently, the Company believed that the cost saving benefits of its efforts tovertically integrate through the manufacture of carbon fiber had not benefitedthe Company.   Market prices for golfshaft raw materials, 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.  The Company’s gross margins and profitabilitywere adversely affected when the market prices of carbon fiber were low.  However, in the second half of 2003, theavailability of carbon fiber began to tighten and prices began to increase. Theshortage of carbon fiber in the world markets today is real and appears to belong term. The Company believes that CFT is now a valuable strategic asset.

 

**Resultsof Operations**

 

***2006 Compared to 2005***

 

*NetSales*

 

| ** **          | ** **         | **2006** | ** ** | **2005**           | ** ** | **Chg** | ** **         | **% Chg** | ** ** |
|---------------------|--------------------|----------|------------|--------------------|------------|---------|--------------------|----------------|------------|
| Composite Products  |     | $        | 63,479     |     | $          | 69,561  |     | $              | (6,082     | )    | (9 | )% |
| Composite Materials |               | 8,891    |       | 7,417              |       | 1,474   |               | 20             | %          |
| Total Net Sales     |               | $        | 72,370     |               | $          | 76,978  |               | $              | (4,608     | ) | (6 | )% |

 

Netsales decreased by $4.6 million for 2006 from 2005.  The decrease in sales was attributed to adecrease in Composite Product sales, which were partially offset by an increasein Composite Materials sales.  Thedecrease in the Composite Product sales is mainly attributed to a change inproduct mix in 2006 as compared to 2005. The Company’s average selling price of golf shaft sales decreased by 6%for the year and overall units declined by 4%. There were decreases in sales ofbranded and co-branded products, which were partially offset by increases inOEM products.  Branded golf shaft salesdeclined by 19% and co-branded golf shaft sales declined by 44%, which werepartially offset by an increase in OEM stock type shaft sales of 16%.  Branded and co-branded golf shaft salesdeclined to 46% of Composite Products sales in 2006 from 58% in 2005.  The decreases in branded and co-branded wereattributed to a relatively weak demand of driver club units, which representthe best opportunities for branded and co-branded products.  Composite Materials sales increased by $1.5million, or a 20% increase.  CompositeMaterials have increased to approximately 12% of the Company’s consolidated netrevenues.  The Company believes thatthese sales will continue to increase and is installing an additional wideprepreg tape line at the end of 2007 to support this anticipated growth.

 

*GrossProfit*

 

| ** **          | ** ** | **2006** | ** ** | **2005** | ** **         | **Chg** | ** ** | **% Chg**     | ** ** |
|---------------------|------------|----------|------------|----------|--------------------|---------|------------|--------------------|------------|
| Composite Products  |       | $        | 20,577     |     |     | $       | 27,271     |     | $          | (6,694 | )   | (25 | )% |
| Composite Materials |       | 3,706    |       | 2,339    |               | 1,367   |       | 58                 | %          |
| Total Gross Profit  |       | $        | 24,283     |     | $                  | 29,610  |       | $                  | (5,327     | ) | (18 | )% |
|                     |            |          |            |          |                    |         |            |                    |            |  |  |  |  |

 

Totalgross profit decreased by approximately $5.3 million, or 18% in 2006 ascompared to 2005.  The decrease in grossprofit was primarily attributed to a decrease in gross profit of CompositeProducts, which was partially offset by an increase in gross profit ofComposite Materials.  The decrease inComposite Products gross profit was mainly attributed to

 

 

22

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thedecrease in branded and co-branded sales in 2006 as compared to 2005.  Composite Products gross margin decreased to32% for 2006 as compared to 39% for 2005. The Composite Materials gross profit increased by approximately $1.4million, or 58%, in 2006 as compared to 2005. The increase is mainly attributed to an increase in contributionprovided by the operations of CFT and the increase in gross profit provided bythe sales of external materials.  TheCompany’s gross profit was negatively affected by additional inventory reservesof $811,000 in 2006 as compared to $710,000 in 2005.  The increase in reserves in 2006 and 2005were offset by the sales of product that was fully reserved for of $22,000 in2006 and $147,000 in 2005.  The neteffect of the inventory reserve adjustments was a decrease in gross profit of$789,000 in 2006 and a decrease in gross profit of $563,000 in 2005.

 

*OperatingIncome*

 

| ** **                                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **Chg** | ** ** | **% Chg** | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|----------|------------|---------|------------|----------------|------------|
| Gross profit                                                         |       | $        | 24,283     |     | $          | 29,610  |       | $              | (5,327     | ) | (18 | )% |
|                                                                 |       |     |       |     |       |    |       |           |       |
| Selling,  General & Administrative (“SG&A) Expense |       |     |       |     |       |    |       |           |       |
| Composite Products                                                   |       | 10,104   |       | 9,127    |       | 977     |       | 11             | %          |
| Composite Materials                                                  |       | 627      |       | 614      |       | 13      |       | 2              | %          |
| Total SG&A                                                       |       | 10,731   |       | 9,741    |       | 990     |       | 10             | %          |
|                                                                 |       |     |       |     |       |    |       |           |       |
| Operating Income                                                     |       |     |       |     |       |    |       |           |       |
| Composite Products                                                   |       | 10,474   |       | 18,144   |       | (7,671  | )          | (42            | )%         |
| Composite Materials                                                  |       | 3,078    |       | 1,725    |       | 1,354   |       | 78             | %          |
| Operating Income                                                     |       | $        | 13,552     |     | $          | 19,869  |       | $              | (6,317     | ) | (32 | )% |
| Operating Margin                                                     |       | 19       | %          | 26       | %          | (7      | )%         |           |       |

 

Operatingincome decreased by approximately $6.3 million, or 32%, in 2006 as compared to2005.  The decrease was attributed to adecrease in gross profit and an increase in SG&A.  The Company’s SG&A expenses increased byapproximately $990,000 in 2006 as compared to 2005.  SG&A increased as a percentage ofrevenues to 15% in 2006 as compared to 13% for 2005.  The increase was primarily attributed to theincreased costs in selling, advertising, marketing and tour support of theCompany’s branded and co-branded product. Such costs increased by 35% in 2006 as compared to 2005.  The Company anticipates that this spendingwill remain flat in 2007.  In addition,other administrative expense increased by 14% in 2006 as compared to 2005.  The Company anticipates these costs mayincrease slightly in 2007 due to having a full years worth of operations inVietnam.  These increases in SG&A werepartially offset by a decrease in the Company’s incentive expenses, which iscomprised of bonuses, employee benefits and stock-based compensation expense.Incentive expenses decreased by approximately 65% in 2006 as compared to2005.  The Company’s stock-basedcompensation expense was $255,000 in 2006 as compared to $0 in 2005.  Although incentive expenses decreased in2006, the Company anticipates that stock-based compensation expense willincrease in the future to the extent that the Company’s Board of Directorsapproves additional grants of equity awards to employees and directors of theCompany.  In addition, each May thereis an automatic grant of options to the external directors of the Company.  The Company’s corporate costs increased by21% in the current year, although the Company’s Sarbanes-Oxley section 404 (“SOX”)compliance work decreased slightly in the year. The Company spent $498,000 on SOX in 2006 as compared to $603,000 in2005.  The Company has established aninternal audit department in 2006 and hopes to use more internal resources in2007 to complete the SOX compliance work. Such compliance costs are ongoing and the Company anticipates spendingbetween $300,000 to $400,000 in 2007 for its SOX compliance efforts.

 

*OtherIncome*

 

| ** **                           | ** ** | **2006** | ** ** | **2005** | ** ** | **Chg** | ** ** | **% Chg** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|---------|------------|----------------|------------|
|                                 |       |     |       |     |       |    |       |           |       |
| Operating income                     |       | $        | 13,552     |     | $          | 19,869  |       | $              | (6,317     | ) | (32 | )% |
|                                 |       |     |       |     |       |    |       |           |       |
| Interest income                      |       | 714      |       | 639      |       | 75      |       | 12             | %          |
| Other, net                           |       | 2,148    |       | (53      | )          | 2,201   |       | 4,153          | %          |
| Equity in earnings of  joint venture |       | 407      |       | 236      |       | 171     |       | 72             | %          |
| Total other income                   |       | 3,269    |       | 822      |       | 2,447   |       | 298            | %          |
| Income before income taxes           |       | $        | 16,821     |     | $          | 20,691  |       | $              | (3,870     | ) | 19 | % |

 

 

23

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OtherIncome increased by approximately $2.5 million for 2006, or 298%, as comparedto 2005.  The Company benefited from asettlement as a class member in a civil suit against certain carbon fiberproducers in the amount of $2.2 million, which is recorded in other, net.  In addition, the Company benefited from anincrease in earnings from its equity investment in CFT.

 

*Income Taxes*

 

| ** **                 | ** ** | **2006** | ** ** | **2005** | ** ** | **Chg** | ** ** | **% Chg** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|---------|------------|----------------|------------|
| Income before income taxes |       | $        | 16,821     |     | $          | 20,691  |       | $              | (3,870     | ) | 19 | % |
| Provision for income taxes |       | 5,585    |       | 7,287    |       | (1,702  | )          | (23            | )%         |
| Net income                 |       | $        | 11,236     |     | $          | 13,404  |       | $              | (2,168     | ) | (16 | )% |
| Effective tax rate         |       | 33       | %          | 35       | %          | 2       | %          |           |       |
| Profit margin              |       | 16       | %          | 17       | %          | (1      | )%         |           |       |

 

TheCompany recorded a provision for income taxes in the amount of $5.6 million in2006 as compared to $7.3 for 2005.  TheCompany’s effective tax rate was 33% in 2006 as compared to 35% in 2005.  The Company’s decrease in its effective taxrate was primarily attributed to research and developmental (“R&D”) taxcredits that were taken in the fourth quarter. The Company undertook a project, with the assistance of consultants whospecialize in R&D tax credits, during the year to review the past creditstaken and the methodology used to compute them. The Company in recent years has increased its R&D efforts in material,resin and graphite shaft technology.  Theincrease in efforts has had the effect of increasing the Company’s R&D taxcredits.  The benefit to the effectivetax rate was approximately 2% in the current year.  The Company does not anticipate this benefitto be as significant going forward. The Company estimates that its effectivetax rate going forward will be between 35% and 38%.

 

***2005 Compared to 2004***

 

*NetSales*

 

| ** **          | ** ** | **2005** | ** ** | **2004**           | ** ** | **Chg** | ** **         | **% Chg** | ** ** |
|---------------------|------------|----------|------------|--------------------|------------|---------|--------------------|----------------|------------|
| Composite Products  |       | $        | 69,561     |               | $          | 48,312  |               | $              | 21,249     |   | 44 | % |
| Composite Materials |       | 7,417    |       | 4,450              |       | 2,967   |               | 67             | %          |
| Total Net Sales     |       | $        | 76,978     |     | $          | 52,762  |     | $              | 24,216     |     | 46 | % |

 

Netsales increased by $24.2 million for 2005 from 2004.  The increase was mainly attributed to a $21.2million increase in Composite Products sales, and to a lesser extent anincrease in Composite Materials sales of $3.0 million.  The increase in Composite Products sales wasattributed to increases in sales of branded and co-branded golf shafts.  Branded golf shaft sales increased 73% in2005 as compared to 2004, which was mainly attributed to the success of theCompany’s NVTM family of shafts. Co-branded golf shaft sales increased 1,387% in 2005 as compared to2004.  The increased branded andco-branded sales are mainly attributed to demand from first and second tierclub companies to these shafts in their driver, fairway and hybrid clubmodels.  Total golf shaft unit salesincreased by approximately 13% for 2005 from 2004.  The average selling price of shafts soldincreased by approximately 33% for 2005 from 2004, which was attributed to theincreased branded and co-branded shaft sales in the product mix.  Composite Material sales increased byapproximately 67% in 2005 from 2004 and represented 10% of the Company’s netsales for 2005.  The Company added a newresin filmer, which was operational in the first quarter of 2006.

 

*GrossProfit*

 

| ** **          | ** ** | **2005** | ** ** | **2004** | ** ** | **Chg** | ** ** | **% Chg** | ** ** |
|---------------------|------------|----------|------------|----------|------------|---------|------------|----------------|------------|
| Composite Products  |       | $        | 27,271     |     | $          | 17,505  |       | $              | 9,766      |   | 56 | % |
| Composite Materials |       | 2,339    |       | 471      |       | 1,868   |       | 397            | %          |
| Total Gross Profit  |       | $        | 29,610     |     | $          | 17,976  |       | $              | 11,634     |   | 65 | % |

 

Grossprofit increased by approximately $11.6 million for 2005 from 2004.  The Company’s gross profit margin

 

 

24

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increasedto 38% in 2005 from 34% in 2004.  Theincrease in gross profit was mainly attributed to the increased gross profitcontributed by Composite Products and to a lesser extent a gross profitincreased provided by Composite Materials. The increase in sales of the Company’s branded and co-branded products,which typically have higher gross margins than that of the Company’s otherComposite Products, were the reason for the increased gross profit in CompositeProducts.  In addition, the Company’sgross profit was negatively affected by additional inventory related reservesof approximately $710,000 in 2005, versus an increase of  $97,000 in 2004.  The increase in reserves in 2005 and 2004were offset by the sales of product that was fully reserved for of $147,000 in2005 and $285,000 in 2004.  The neteffect of the inventory reserve adjustments was a decrease in gross profit of$563,000 in 2005 and an increase in gross profit of $186,000 in 2004.

 

*OperatingIncome*

 

| ** **                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **Chg** | ** ** | **% Chg** | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|----------|------------|---------|------------|----------------|------------|
| Gross profit                                                         |       | $        | 29,610     |     | $          | 17,976  |       | $              | 11,634     |   | 65 | % |
|                                                                 |       |     |       |     |       |    |       |           |       |
| Selling,  General & Administrative (“SG&A) Expense |       |     |       |     |       |    |       |           |       |
| Composite Products                                                   |       | 9,127    |       | 7,796    |       | 1,331   |       | 17             | %          |
| Composite Materials                                                  |       | 614      |       | 441      |       | 173     |       | 39             | %          |
| Total SG&A                                                       |       | 9,741    |       | 8,237    |       | 1,504   |       | 18             | %          |
|                                                                 |       |     |       |     |       |    |       |           |       |
| Operating Income                                                     |       |     |       |     |       |    |       |           |       |
| Composite Products                                                   |       | 18,144   |       | 9,709    |       | 8,435   |       | 87             | %          |
| Composite Materials                                                  |       | 1,725    |       | 30       |       | 1,695   |       | 5662           | %          |
| Operating Income                                                     |       | $        | 19,869     |     | $          | 9,739   |       | $              | 10,130     |   | 104 | % |
| Operating Margin                                                     |       | 26       | %          | 18       | %          | 8       | %          |           |       |

 

Operatingincome increased by approximately $10.1 million for 2005 from 2004.  The increase was primarily attributed to theincrease in gross profit.  The Company’sselling, general and administrative (“SG&A”) expenses increased byapproximately $1.5 million in 2005 as compared to 2004.  The increase was primarily attributed to theincreased costs associated with being a publicly traded company.  The Company’s corporate costs increased by130%, with the majority of the increase attributed to Sarbanes-Oxley section404 (“SOX”) compliance work, which was being performed with the assistance ofoutside consultants.  The Company spentapproximately $603,000 in 2005 for its SOX compliance efforts.  In addition to the increase in corporateexpenses, the Company had higher SG&A costs related to incentive expensesand sales and marketing expenses. SG&A decreased as a percentage of net sales to 13% in 2005, from 16%in 2004.

 

*OtherIncome*

 

| ** **                           | ** ** | **2005** | ** ** | **2004** | ** ** | **Chg** | ** ** | **% Chg** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|---------|------------|----------------|------------|
|                                 |       |     |       |     |       |    |       |           |       |
| Operating income                     |       | $        | 19,869     |     | $          | 9,739   |       | $              | 10,130     |   | 104 | % |
|                                 |       |     |       |     |       |    |       |           |       |
| Interest income                      |       | 586      |       | 60       |       | 526     |       | 877            | %          |
| Equity in earnings of  joint venture |       | 236      |       | 246      |       | (10     | )          | (4             | )%         |
| Total other income                   |       | 822      |       | 306      |       | 516     |       | 169            | %          |
| Income before income taxes           |       | $        | 20,691     |     | $          | 10,045  |       | $              | 10,646     |   | 106 | % |

 

OtherIncome increased by approximately $516,000 for 2005 from 2004.  The increase was attributed to the interestincome the Company realized on its invested cash balances.

 

*IncomeTaxes*

 

| ** **                 | ** ** | **2005** | ** ** | **2004**                             | ** ** | **Chg** | ** **                           | **% Chg** | ** ** |
|----------------------------|------------|----------|------------|--------------------------------------|------------|---------|--------------------------------------|----------------|------------|
| Income before income taxes |       | $        | 20,691     |                                 | $          | 10,045  |                                 | $              | 10,646     |   | 106 | % |
| Provision for income taxes |       | 7,287    |       | 725                                  |       | 6,562   |                                 | 905            | %          |
| Net income                 |       | $        | 13,404     |        | $          | 9,320   |        | $              | 4,084      |        | 44 | % |
| Effective tax rate         |       | 35       | %          | 7                                    | %          | 28      | %                                    |           |       |
| Profit margin              |       | 17       | %          | 18                                   | %          | (1      | )%                                   |           |       |

 

 

25

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TheCompany recorded a provision for income taxes in the amount of $7.3 million in2005 as compared to approximately $725,000 for 2004.  The Company’s effective tax rate was 35% in2005 as compared to 7% in 2004.  Thedifference in the effective tax rates was related to a change in the Company’svaluation allowance during 2004.

 

AtDecember 31, 2004, the Company had a net deferred tax asset ofapproximately $2.2 million.  Thisdeferred tax asset represented net operating loss carryforwards, tax creditcarryforwards and other basis differences, which give rise to future taxdeductions in excess of book deductions. Realization of these tax benefits is dependent upon the generation offuture taxable income. During the fourth quarter of 2002, management determinedthat based on its then current outlook and existing circumstances that it wasnot likely that the tax benefits associated with its deferred tax assets wouldbe realized.  Accordingly, the Companyplaced a full valuation allowance against its net deferred tax asset as of December 31,2002.  Based upon the Company’s resultsin 2004, the Company re-addressed the appropriateness of its valuationallowance and the circumstances that led to the establishment of its valuationallowance.  The Company determined thatthere had been a change in circumstances, and that its deferred tax assetswould be realized in future years and accordingly reduced its valuationallowance against the related deferred tax assets to zero as of December 31,2004.

 

**Liquidityand Capital Resources**

 

Cash,cash equivalents and marketable securities (“cash”) decreased by approximately$639,000 for 2006 as compared to 2005. The decrease in cash was attributed to changes in working capital,capital spending, dividend payments and repurchases of common stock, which werepartially offset by net income, issuance of common stock, depreciation andamortization and benefit from the exercise of stock options.  The majority of the cash used for workingcapital was attributed to an increase in restricted cash of $1.4 million,increases in accounts receivable of $1.6 million and inventories of $1.3million and decreases in accounts payable and accrued expenses of $3.0 million.

 

Therestricted cash is associated with cash on deposit in China for customs dutiesand taxes based upon raw materials imported. The Company’s custom status was downgraded during 2006.  The Company anticipates that it will regainits previous status in the second half of 2007, however, their can be noguarantee the Company will regain its previous customs status.  The Company’s average days outstanding of itsaccounts receivable increased to 45 days in 2006 as compared to 36 in2005.  The increase is mainly attributedto the timing of sales in 2006 as compared to 2005 and to a slower payingcustomer mix in 2006 as compared to 2005. The Company does not anticipate any problems in collecting its accountsreceivable balance as of December 31, 2006.  The increase in inventories was mainlyattributed to increases of the Company’s branded products in finishedgoods.  Cash provided by operatingactivities in 2006 was approximately $4.5 million, compared to approximately$10.4 million in 2005.

 

TheCompany used $4.6 million for capital expenditures during 2006.  Composite Products capital expenditures were$3.2 million in 2006, with the majority of that being attributed to theexpansion in Vietnam.  CompositeMaterials capital expenditures were $1.4 million in 2006.  The capital expenditures in CompositeMaterials was attributed to the remaining payments on the resin filmerinstalled in the first quarter of 2006 and sixth prepreg tape line installed atthe end of 2006.  The capitalexpenditures of the Composite Materials segment also support the CompositeProducts segment. Management anticipates capital expenditures will approximatebetween $4.0 million and $6.0 million for 2007. The increase in capital spending will be used to support the Company’sgrowth in the Composite Materials business, finish the expansion in Vietnam andrelocate the Company’s corporate offices, warehousing and other departmentsinto one building.  The Company used $11.0 million in cashfor investing activities to purchase marketable securities in 2006 as comparedto $38.0 million in 2005. The purchases in 2006 and 2005 of marketablesecurities were comprised of Auction Rate Securities (“ARS”), see Note 15 tothe Consolidated Financial Statements. The Company had sales of marketablesecurities of $13.6 million in 2006 and $29.1 million in 2005, of which $21.6million were ARS and the remaining was certificates of deposit and commercialpaper which matured in 2005.  The Companyreceived income tax distributions from CFT totaling $169,000 in 2006 comparedto $400,000 in 2005.  Futuredistributions from CFT must be agreed upon by both joint venture partners priorto any distribution being made.

 

TheCompany paid $3.3 million in dividend payments in 2006 as compared to $13.1million in 2005.  The Company declaredand paid four $0.15 per share quarterly dividends in 2006.  The Company declared and paid two special$1.00 per-share dividends in 2005, which were not paid in 2006.  In addition, the Company repurchased 75,596shares of its common stock in the open market during 2006, which resulted in ause of cash of $1.2 million.  The Company’sdividend policy and stock repurchase policy are discussed quarterly during theCompany’s board of directors meetings and subject to board approval.  The Company has $3.8 million remaining thatcan be repurchased against its current approved stock buyback plan.

 

 

26

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**ContractualObligations**

 

| ** **           | ** ** | **Payments Due by Period (thousands)** | ** ** |
|----------------------|------------|------------------------------------------------------------|------------|
| ** **           | ** ** | **Less Than  1 Year**                            | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than  5 Years** | ** ** | **Total** |   |
| Operating leases (a) |       | $                                                          | 1,348      |   | $ | 3,015 |   | $ | 1,116 |   | $ | 180 |   | $ | 5,659 |   |
| CFT Fixed Costs (b)  |       | 1,600                                                      |       | 3,200 |   | 3,200 |   | — |   | 8,000 |   |
| Total                |       | $                                                          | 2,948      |   | $ | 6,215 |   | $ | 4,316 |   | $ | 180 |   | $ | 13,659 |   |

 

----

(a)          We enter into operating leases in the normal courseof business.  All lease agreements havefixed 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 the fixedcosts of CFT.  The amounts estimatedabove are based upon the amount of fixed costs for CFT in 2005.   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 fixed costs.  The Company does not currently have a fixed orminimum quantity of carbon fiber that it is required to purchase from CFT.

 

TheCompany may from time to time consider the acquisition of businessescomplimentary to the Company’s business. The Company could require additional debt financing if it were to engagein a material acquisition in the future.

 

**Seasonality**

 

Becausethe Company’s customers have historically built inventory in anticipation ofpurchases by golfers in the spring and summer, the principal selling season forgolf equipment, the Company’s operating results have been affected by seasonaldemand for golf clubs, which has generally resulted in highest sales occurringin the second quarter.  The timing ofcustomers’ new product introductions has frequently mitigated the impact ofseasonality in recent years.

 

**“SafeHarbor” Statement Under the Private Securities Litigation Reform Act of 1995**

 

ThisAnnual Report on Form 10-K/A-1 and certain information incorporated hereinby 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/A-1, other than statementsthat are purely historical, are forward-looking statements.

 

Wordssuch as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,”and similar 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-K/A-1and elsewhere in the Company’s filings with the Securities and ExchangeCommission.

 

**Item 7a.  Quantitative andQualitative Disclosures about Market Risk**

 

TheCompany believes that its exposure to market risk relating to interest raterisk is not material.  The Company isexposed to foreign exchange risk to the extent of adverse fluctuations in theMexican peso, the Chinese renminbi and the Vietnamese dong.  Based on historical movements of thesecurrencies, the Company does not believe that reasonably possible near-termchanges in these currencies will have a material adverse effect on the Company’sfinancial position or results of operations. In addition, the Company does not engage in hedging activities toprotect from this potential risk.  TheCompany believes that its business operations are not exposed to market riskrelating to commodity price risk or equity price risk.

 

**Item 8.  Financial Statements andSupplementary Data**

 

Theinformation required as to this Item is incorporated by reference from theconsolidated financial statements and supplementary data listed in Item 15 of Part IVof this report.

 

 

27

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**Item 9.  Changes in andDisagreements with Accountants on Accounting and Financial Disclosure**

 

None.

 

**Item 9A. Controls and Procedures**

 

**Evaluation of Disclosure Controls and Procedures(Restated)**

 

The Company’s management,including its Chief Executive Officer and Chief Financial Officer, conducted anevaluation of the effectiveness of its disclosure controls and procedurespursuant to Exchange Act Rule 13a–15 in connection with filing our originalForm 10-K as of December 31, 2006.  In connection with filing this Form10-K/A-1 the Company’s Chief Executive Officer and Chief Financial Officerre-evaluated the effectiveness of our disclosure controls and procedures inplace as of December 31, 2006 and determined that, solely as a result of thematerial weakness in our internal control over financial reporting discussedbelow, our disclosure controls and procedures then in place were not effectivein alerting them on a timely basis to material information required to beincluded in our periodic filings under the Exchange Act. Management has takensteps to correct these disclosure controls and procedures. As of the date offiling this Form 10-K/A-1 the Company’s Chief Executive Officer and ChiefFinancial Officer have evaluated the effectiveness of our disclosure controlsand procedures pursuant to Exchange Act Rule 13a-15 and believe such disclosurecontrols now are effective in alerting them on a timely basis to materialinformation relating to Aldila required to be included in Aldila’s periodicfilings under the Exchange Act.

** **

**Management’s Report on InternalControl over Financial Reporting (Restated)**

 

The Company’s managementis responsible for establishing and maintaining effective internal control overfinancial reporting (as defined in Rule 13a-15(f) of the Securities ExchangeAct). Management assessed the effectiveness of the Company’s internal controlover financial reporting as of December 31, 2006. In making this assessment,management used the criteria set forth by the Committee of SponsoringOrganizations of the Treadway Commission (“COSO”) in its report entitledInternal Control – Integrated Framework. In connection with this Form 10-K/A-1,management re-evaluated the effectiveness of the design and operation of ourdisclosure controls and procedures as of the end of the period covered by thisreport. This evaluation was performed under the supervision and withparticipation of the Company’s CEO and CFO. A material weakness is a controldeficiency, or combination of control deficiencies, such that there is areasonable possibility that a material misstatement of the Company’s financialstatements will not be prevented or detected on a timely basis. Based on thisre-evaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures were not effective as ofDecember 31, 2006, due to the following material weakness.

 

Management has determined that a material weakness ininternal control over financial reporting existed as of December 31, 2006,which resulted in errors and subsequent restatement of the 2006 financialstatements included in this Form 10-K/A-1. Specifically, management determinedthat the Company’s controls over the accounting for cash and cash equivalentsand investments in marketable securities were not designed and did not operate effectively toappropriately identify marketable securities and determine that such marketable securities were presented in accordance withgenerally accepted accounting principles in the Company’s consolidatedfinancial statements. Management has taken steps to correct the identifiedweakness in the Company’s internal controls over financial reporting. As of thedate of filing this Form 10-K/A-1 the Company’s Chief Executive Officer andChief Financial Officer have evaluated the effectiveness of our internal controlsover financial reporting pursuant to Exchange Act Rule 13a-15 and believe suchinternal controls over financial reporting now provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements in all material respects in accordance with generallyaccepted accounting principles as used in the United States of America.

 

28

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REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROLOVER FINANCIAL REPORTING

 

To the Board of Directors and Stockholders of 

Aldila, Inc. 

Poway, California 

 

We have audited management’s assessment (as restated), included in theaccompanying Management’s Report on Internal Control over Financial Reporting,that Aldila, Inc. and subsidiaries (the "Company," or "Aldila,Inc.") did not maintain effective internal control over financialreporting as of December 31, 2006, based on criteria established in *Internal Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission("COSO").  Aldila, Inc.’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit. 

 

We conducted our audit in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion. 

 

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

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate. 

 

A material weakness is a control deficiency, or a combination ofcontrol deficiencies, that results in more than a remote likelihood that amaterial misstatement of the annual or interim financial statements will not beprevented or detected.  The materialweakness described in the following sentence has been identified and includedin management's assessment.  Controlsover the accounting for cash and cash equivalents and marketable securitieswere not designed and did not operate effectively to appropriately identifyauction-rate-securities and determine that such securities were presented inaccordance with generally accepted accounting principles in the Company’sconsolidated financial statements.  Thismaterial weakness was considered in determining the nature, timing, and extentof audit tests applied in our audit of the restatement of the applicableDecember 31, 2006 consolidated financial statements of the Company, and thisreport does not affect our report dated March 9, 2007 (except for Notes 13, 15,and the Cash Equivalents and Marketable Securities section of Note 1 and thefifth and sixth paragraphs of such report, as to which the date is March 28,2008) on those financial statements. 

 

In our opinion, management's assessment (as restated) that the Companydid not maintain effective internal control over financial reporting as ofDecember 31, 2006 is fairly stated, in all material respects, based on thecriteria established in Internal Control - Integrated Framework issued by theCOSO.  Also, in our opinion, because ofthe effect of the material weakness described above on the achievement of theobjectives of the aforementioned control criteria, the Company had notmaintained effective internal control over financial reporting as of December31, 2006, based on the criteria established in Internal Control - IntegratedFramework issued by the COSO.  

 

We have also audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the December 31, 2006 and2005 consolidated balance sheets and the related consolidated statements ofincome, stockholders’ equity, and cash flows for each of the years in thethree-year period ended December 31, 2006 of Aldila, Inc., and our report datedMarch 9, 2007 (except for Notes 13, 15, and the Cash Equivalents and MarketableSecurities section of Note 1 to those financial statements, and the fifth andsixth paragraphs of such report, as to which the date is March 28, 2008)expressed an unqualified opinion thereon. 

 

 
| /s/ Squar, Milner, Peterson, Miranda &  Williamson, LLP                                                              |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                     |   |
| San Diego, California                                                                                                    |   |
| March 9, 2007 (except for the first, fifth and sixth  paragraphs of this report, as to which the date is March 28, 2008) |

 

*Changesin internal control. *Therehave been no significant changes in internal controls or in factors that couldsignificantly affect internal controls, including any corrective actions withregard to significant deficiencies and material weaknesses, during the fiscalquarter ended December 31, 2006.

 

**Item 9B. Other Information**

 

None.

 

29

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##### **PART III**

#####  

**Item 10.  Directors and ExecutiveOfficers of the Registrant**

 

Theinformation required as to this Item is incorporated by reference from thesection headed “Election of Directors” in the Company’s Proxy Statementfor the 2007 Annual Meeting of Stockholders for the year ended December 31,2006, which will be filed with the Commission within 120 days of the end of thefiscal year covered by this report (“2007 Proxy Statement”).

 

TheCompany adopted a Code of Business Conduct and Ethics on December 31, 2002governing its officers, directors and employees, including our principalexecutive officer, principal financial officer, principal accounting officer orcontroller, or persons performing similar functions.  A copy of the Code of Ethics is available atthe Company’s website, www.aldila.com. See the Code of Business Conduct andEthics included herein as Exhibit 14.0 to this Report.

 

**Item 11.  Executive Compensation**

 

Theinformation required as to this Item is incorporated herein by reference fromthe data under the caption “Executive Compensation” in the 2007 ProxyStatement.

 

**Item 12.  Security Ownership ofCertain Beneficial Owners and Management**

 

Theinformation required as to this Item is incorporated herein by reference fromthe data under the caption “Security Ownership of Certain Beneficial Owners andManagement” in the 2007 Proxy Statement.

 

**Item 13.  Certain Relationshipsand Related Transactions, and Director Independence**

 

Theinformation required as to this Item as it pertains to Director Independence isincorporated by reference from the section headed “Election of Directors”in the 2007 Company’s Proxy Statement.

 

**Item 14.  Principal AccountingFees and Services**

 

Theinformation required as to this Item is incorporated herein by reference fromthe data under the caption “Independent Accountant Fees” in the 2007 ProxyStatement.

 

 

30

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**PART IV**

 

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

 

(a)          Documents included as part of this report:

 

1.                                       Theconsolidated financial statements for the Registrant are included in thisreport.

 
|   |   | Consolidated  Balance Sheets at December 31, 2006 and 2005;                                                 |
|--------|--------|------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                             |
|   |   | Consolidated  Statements of Operations for the years ended December 31, 2006, 2005 and  2004;               |
|   |   |                                                                                                             |
|   |   | Consolidated Statements of Stockholders’ Equity for  the years ended December 31, 2006, 2005 and 2004; |
|   |   |                                                                                                             |
|   |   | Consolidated Statements of Cash Flows for the years  ended December 31, 2006, 2005 and 2004;                |
|   |   |                                                                                                             |
|   |   | Notes to Consolidated Financial Statements                                                                       |
|   |   |                                                                                                             |
|   |   | Reports of Independent Registered Public Accounting  Firm                                                        |

 

2.                                       Schedule IICValuation and Qualifying Accounts for the years ended December 31, 2006,2005 and 2004.

 

Allother schedules 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 54 of this Form 10-K.  Financial statements of subsidiaries notconsolidated and fifty percent or less owned persons, management contracts orcompensatory plans or arrangements required to be filed as exhibits to thisreport are identified on the Index to Exhibits.

 

(b)         Exhibits required by Item 601 of Regulation S-K.

 

Seeitem (a) 3 above.

 

(c)          Financial statements required by Regulation S-Xwhich are excluded from the annual report to shareholders by Rule 14a-3,which include separate financial statements of subsidiaries not consolidatedand fifty percent or less owned persons.

 

Seeitem (a) 3 above.

 

 

31

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**ALDILA, INC. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                           | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                           | ** ** | **As  Restated**      | ** ** | **As  Restated**      | ** ** |
| ** **                                                                                                                                                                           | ** ** | **(Note  15)**        | ** ** | **(Note  15)**        | ** ** |
| **ASSETS**                                                                                                                                                                           | ** ** | ** **            | ** ** | ** **            | ** ** |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| CURRENT ASSETS:                                                                                                                                                                      |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                                                                                            |       | $                     | 3,882      |                  | $          | 1,921 |   |
| Marketable securities                                                                                                                                                                |       | 11,300                |       | 13,900                |       |
| Restricted cash                                                                                                                                                                      |       | 1,444                 |       | —                |       |
| Accounts receivable                                                                                                                                                                  |       | 8,862                 |       | 7,233                 |       |
| Income taxes receivable                                                                                                                                                              |       | 1,237                 |       | 895                   |       |
| Inventories                                                                                                                                                                          |       | 13,691                |       | 12,387                |       |
| Deferred tax assets                                                                                                                                                                  |       | 1,360                 |       | 1,352                 |       |
| Prepaid expenses and other current assets                                                                                                                                            |       | 795                   |       | 625                   |       |
| Total current assets                                                                                                                                                                 |       | 42,571                |       | 38,313                |       |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| PROPERTY, PLANT AND  EQUIPMENT                                                                                                                                                       |       | 8,794                 |       | 5,570                 |       |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| INVESTMENT IN JOINT  VENTURE                                                                                                                                                         |       | 3,091                 |       | 2,895                 |       |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| DEFERRED TAXES                                                                                                                                                                       |       | 1,144                 |       | 1,051                 |       |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| OTHER NON-CURRENT ASSETS                                                                                                                                                             |       | 296                   |       | 260                   |       |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| TOTAL ASSETS                                                                                                                                                                         |       | $                     | 55,896     |                  | $          | 48,089 |   |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                       | ** ** | ** **            | ** ** | ** **            | ** ** |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| CURRENT LIABILITIES:                                                                                                                                                                 |       |                  |       |                  |       |
| Accounts payable                                                                                                                                                                     |       | $                     | 4,479      |                  | $          | 6,294 |   |
| Accrued expenses                                                                                                                                                                     |       | 2,042                 |       | 3,214                 |       |
| Total current liabilities                                                                                                                                                            |       | 6,521                 |       | 9,508                 |       |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| LONG-TERM LIABILITIES:                                                                                                                                                               |       |                  |       |                  |       |
| Deferred rent and other long-term liabilities                                                                                                                                        |       | 49                    |       | 30                    |       |
| Total liabilities                                                                                                                                                                    |       | 6,570                 |       | 9,538                 |       |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                                       |       |                  |       |                  |       |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                           |       |                  |       |                  |       |
| Preferred stock, $.01 par value; authorized 5,000,000 shares; no  shares issued                                                                                                      |       | —                |       | —                |       |
| Common stock, $.01 par value; authorized 30,000,000 shares; issued and  outstanding 5,524,250 shares as of December 31, 2006 and 5,395,523  shares as of December 31, 2005 |       | 55                    |       | 54                    |       |
| Additional paid-in capital                                                                                                                                                           |       | 49,903                |       | 47,041                |       |
| Accumulated deficit                                                                                                                                                                  |       | (632                  | )          | (8,544                | )          |
| Total stockholders’ equity                                                                                                                                                      |       | 49,326                |       | 38,551                |       |
|                                                                                                                                                                                 |       |                  |       |                  |       |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                     |       | $                     | 55,896     |                  | $          | 48,089 |   |

 

See notes to consolidated financial statements.

 

 

32

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**ALDILA, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

 
| ** **                                                     | ** ** | **Year ended**   | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                     | ** ** | **December 31,** | ** ** |
| ** **                                                     | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                     | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| NET SALES                                                      |       | $                     | 72,370     |   | $ | 76,978 |   | $ | 52,762 |   |
| COST OF SALES                                                  |       | 48,087                |       | 47,368 |   | 34,786 |   |
| Gross profit                                                   |       | 24,283                |       | 29,610 |   | 17,976 |   |
|                                                           |       |                  |       |   |   |   |   |
| SELLING, GENERAL AND  ADMINISTRATIVE                           |       | 10,731                |       | 9,741 |   | 8,237 |   |
| Operating income                                               |       | 13,552                |       | 19,869 |   | 9,739 |   |
|                                                           |       |                  |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                                        |       |                  |       |   |   |   |   |
| Interest income                                                |       | 714                   |       | 639 |   | 148 |   |
| Other, net                                                     |       | 2,148                 |       | (53 | ) | (88 | ) |
| Equity in earnings of joint venture                            |       | 407                   |       | 236 |   | 246 |   |
|                                                           |       |                  |       |   |   |   |   |
| INCOME BEFORE INCOME TAXES                                     |       | 16,821                |       | 20,691 |   | 10,045 |   |
| PROVISION FOR INCOME TAXES                                     |       | 5,585                 |       | 7,287 |   | 725 |   |
|                                                           |       |                  |       |   |   |   |   |
| NET INCOME                                                     |       | $                     | 11,236     |   | $ | 13,404 |   | $ | 9,320 |   |
|                                                           |       |                  |       |   |   |   |   |
| NET INCOME PER COMMON  SHARE, BASIC                            |       | $                     | 2.04       |   | $ | 2.54 |   | $ | 1.85 |   |
|                                                           |       |                  |       |   |   |   |   |
| NET INCOME PER COMMON  SHARE, ASSUMING DILUTION                |       | $                     | 2.01       |   | $ | 2.46 |   | $ | 1.77 |   |
|                                                           |       |                  |       |   |   |   |   |
| WEIGHTED AVERAGE NUMBER OF  COMMON SHARES OUTSTANDING          |       | 5,518                 |       | 5,273 |   | 5,027 |   |
|                                                           |       |                  |       |   |   |   |   |
| WEIGHTED AVERAGE NUMBER OF COMMON AND COMMON EQUIVALENT SHARES |       | 5,591                 |       | 5,457 |   | 5,255 |   |

 

See notes to consolidated financial statements.

 

 

33

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**ALDILA, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**(In thousands)**

 
| ** **                                                                                | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **  | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|-------------|------------|------------|------------|
| ** **                                                                                | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | ** **  | ** ** |
| ** **                                                                                | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit** | ** ** | **Total**  | ** ** |
| Balance at January 1, 2004                                                           |       | 4,885                 |       | $           | 48         |            | $          | 41,803      |       | $          | (17,405    | ) | $ | 24,446 |   |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Repurchases of common stock                                                               |       | (55                   | )          | —      |       | (295            | )          | —      |       | (295       | )          |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Common stock issued upon stock option exercises, including income tax  benefits of $917   |       | 297                   |       | 3           |       | 2,356           |       | —      |       | 2,359      |       |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Dividend payments                                                                         |       | —                |       | —      |       | —          |       | (769        | )          | (769       | )          |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Net income                                                                                |       | —                |       | —      |       | —          |       | 9,320       |       | 9,320      |       |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Balance at Deccember 31, 2004                                                             |       | 5,127                 |       | 51          |       | 43,864          |       | (8,854      | )          | 35,061     |       |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Common stock issued upon stock option exercises, including income tax  benefits of $1,799 |       | 268                   |       | 3           |       | 3,177           |       | —      |       | 3,180      |       |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Dividend payments                                                                         |       | —                |       | —      |       | —          |       | (13,094     | )          | (13,094    | )          |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Net income                                                                                |       | —                |       | —      |       | —          |       | 13,404      |       | 13,404     |       |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Balance at December 31, 2005                                                         |       | 5,395                 |       | 54          |       | 47,041          |       | (8,544      | )          | 38,551     |       |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Repurchases of common stock                                                               |       | (75                   | )          | (1          | )          | (1,210          | )          | —      |       | (1,211     | )          |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Stock-based compensation                                                                  |       | —                |       | —      |       | 255             |       | —      |       | 255        |       |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Common stock issued upon stock option exercises, including income tax  benefits of $1,549 |       | 204                   |       | 2           |       | 3,817           |       | —      |       | 3,819      |       |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Dividend payments                                                                         |       | —                |       | —      |       | —          |       | (3,324      | )          | (3,324     | )          |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Net income                                                                                |       | —                |       | —      |       | —          |       | 11,236      |       | 11,236     |       |
|                                                                                      |       |                  |       |        |       |            |       |        |       |       |       |
| Balance at December 31, 2006                                                         |       | 5,524                 |       | $           | 55         |            | $          | 49,903      |       | $          | (632       | ) | $ | 49,326 |   |

 

See notes to consolidated financial statements.

 

 

34

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**ALDILA, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                         | ** ** | **Year ended**   | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **December 31,** | ** ** |
| ** **                                                                         | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                         | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                               |       | **As  Restated**      |       | **As  Restated** |   |   |   |
|                                                                               |       | **(Note  15)**        |       | **(Note  15)** |   |   |   |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                             |       |                  |       |   |   |   |   |
| Net income                                                                         |       | $                     | 11,236     |   | $ | 13,404 |   | $ | 9,320 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                  |       |   |   |   |   |
| Depreciation and amortization                                                      |       | 1,322                 |       | 1,275 |   | 1,422 |   |
| Stock-based compensation                                                           |       | 255                   |       | — |   | — |   |
| Loss (gain) on disposal of fixed assets                                            |       | 43                    |       | (5 | ) | 32 |   |
| Undistributed income of joint venture, net                                         |       | (365                  | )          | (223 | ) | (285 | ) |
| Changes in assets and liabilities:                                                 |       |                  |       |   |   |   |   |
| Restricted cash                                                                    |       | (1,444                | )          | — |   | — |   |
| Accounts receivable                                                                |       | (1,629                | )          | (2,019 | ) | (601 | ) |
| Inventories                                                                        |       | (1,304                | )          | (4,095 | ) | (514 | ) |
| Deferred tax assets                                                                |       | (101                  | )          | (199 | ) | (2,204 | ) |
| Prepaid expenses and other assets                                                  |       | (227                  | )          | (392 | ) | 52 |   |
| Accounts payable                                                                   |       | (1,815                | )          | 2,081 |   | 1,146 |   |
| Accrued expenses                                                                   |       | (1,172                | )          | 433 |   | 1,320 |   |
| Income taxes payable/receivable                                                    |       | (342                  | )          | 118 |   | (1,013 | ) |
| Deferred rent and other long-term liabilities                                      |       | 19                    |       | 10 |   | (19 | ) |
| Net cash provided by operating activities                                          |       | 4,476                 |       | 10,388 |   | 8,656 |   |
|                                                                               |       |                  |       |   |   |   |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                             |       |                  |       |   |   |   |   |
| Purchases of property, plant and equipment                                         |       | (4,570                | )          | (1,565 | ) | (1,871 | ) |
| Proceeds from sales of property, plant and equipment                               |       | 2                     |       | 10 |   | 3 |   |
| Purchases of marketable securities                                                 |       | (11,000               | )          | (38,029 | ) | (4,971 | ) |
| Proceeds from sales of marketable securities                                       |       | 13,600                |       | 29,100 |   | — |   |
| Distributions from joint venture                                                   |       | 169                   |       | 400 |   | 1,500 |   |
| Net cash (used for) provided by investing activities                               |       | (1,799                | )          | (10,084 | ) | (5,339 | ) |
|                                                                               |       |                  |       |   |   |   |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                             |       |                  |       |   |   |   |   |
| Repurchases of common stock                                                        |       | (1,211                | )          | — |   | (295 | ) |
| Benefit from exercise of stock options                                             |       | 1,549                 |       | 1,799 |   | 917 |   |
| Proceeds from issuance of common stock                                             |       | 2,270                 |       | 1,381 |   | 1,442 |   |
| Dividend payments                                                                  |       | (3,324                | )          | (13,094 | ) | (769 | ) |
| Net cash (used for) provided by financing activities                               |       | (716                  | )          | (9,914 | ) | 1,295 |   |
|                                                                               |       |                  |       |   |   |   |   |
| NET (INCREASE) DECREASE IN  CASH AND CASH EQUIVALENTS                              |       | 1,961                 |       | (9,610 | ) | 4,612 |   |
| CASH AND CASH EQUIVALENTS,  BEGINNING OF YEAR                                      |       | 1,921                 |       | 11,531 |   | 6,919 |   |
| CASH AND CASH EQUIVALENTS,  END OF YEAR                                            |       | $                     | 3,882      |   | $ | 1,921 |   | $ | 11,531 |   |
|                                                                               |       |                  |       |   |   |   |   |
| SUPPLEMENTAL DISCLOSURES  OF CASH FLOW INFORMATION:                                |       |                  |       |   |   |   |   |
| Cash paid during the year for:                                                     |       |                  |       |   |   |   |   |
| Income taxes                                                                       |       | $                     | 4,480      |   | $ | 5,813 |   | $ | 3,095 |   |

 

See notes to consolidated financial statements.

 

 

35

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**ALDILA, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**1.****             ****SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

*The Company**—***Aldila, Inc.(a Delaware Corporation) (the “Company”) designs, manufacturers and marketsgraphite golf club shafts for sale principally in the United States.  In addition, the Company sells compositeprepregs and other related materials and a limited amount of 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 CarbonFiber Products Company Ltd and Aldila Composite Products Company Ltd.   All intercompany transactions and balanceshave been eliminated in consolidation. The Company accounts for its joint venture investment in Carbon FiberTechnology LLC (“CFT”) under the equity method of accounting.

 

*Use of Estimates* — The preparation of financial statements inconformity with accounting principles generally accepted in the United States ofAmerica requires management to make estimates and assumptions that affect thereported amounts of assets, liabilities, revenues and expenses, as well as thedisclosure of contingencies affected by such estimates and assumptions.  Actual results could differ from theseestimates.

 

*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.  Recording revenue netof discounts would not have a significant effect on net sales or on the netrealizable value of accounts receivable. Sales discounts for the years ended December 31, 2006, 2005 and2004 were $303,000, $554,000 and $328,000, respectively, representing less than1% of gross revenues.  The Companymonitors the significance of these amounts.

 

*Cash Equivalents  and MarketableSecurities* — The Company considers all highly liquidinvestments purchased with an original maturity of three months or less to becash equivalents. All short-term, highly liquid investments having originalmaturities greater than ninety days are considered to be marketablesecurities.  Management determines theappropriate classification of marketable debt and equity securities at the timeof purchase and reevaluates such designation as of each balance sheet date.Marketable securities at December 31, 2006 and 2005 were comprised of auctionrate securities that were generally liquidated in either 7 days or 28 days,and  were classified asavailable-for-sale securities in accordance with Statements of FinancialAccounting Standard (“SFAS”) No. 115, “Accounting for Certain Investments inDebt and Equity Securities.” The carrying value of marketable securities atDecember 31, 2006 and 2005, respectively, approximated fair value and no unrealized gains or losses have beenincurred. The auction rate securities were originally reported in the December31, 2006 and 2005 financial statements as cash and cash equivalents.   The balance of auction rate securities as ofDecember 31, 2006 and 2005 was $11.3 million and $13.9 million,respectively.  See Note 15 to theconsolidated financial statements.

 

*Restricted Cash *—* *The Company hadrestricted cash in the amount of $1.4 million as of December 31, 2006, allof which is classified as current.  The$1.4 million is foreign restricted currency maintained in a separate bankaccount at the Bank of China, under the name of its Chinese subsidiary tosupport the import and export activities in China.  The restriction requirement occurred due tocustoms infractions during inspections carried out by the local customs officein Zhuhai that resulted in the Company’s custom import status being downgradedduring the second quarter of 2006.  Thedowngrade is not necessarily permanent and the Company believes that it will beable to apply for a status review during the second quarter of 2007.

 

*Fair Value of Financial Instruments*—**Thefair value 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. The Company provides an allowance for doubtful accounts equal to theestimated uncollectible amounts.  TheCompany’s estimate is based on historical collection experience and a monthlyreview of the current status of outstanding customer balances.  Historically, credit losses have been minimalin relation to the credit extended.

 

*Inventories* — Inventories are stated at the lower of first-in,first-out (FIFO) cost or market value. The inventory balance, which includes material, labor and manufacturingoverhead costs, is recorded net of an estimated allowance for obsolete orunmarketable inventory. The estimated allowance for obsolete or unmarketableinventory is based upon management’s understanding of market conditions andforecasts of future product demand, all of which are subject to change. Ifactual

 

 

36

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chargesfor obsolescence or unmarketable inventory significantly exceed the estimatedallowance, the Company’s operating results would be significantly adverselyaffected.

 

*Property, Plant and Equipment* — Property and equipmentare stated at cost.  Repairs andmaintenance are charged to expense as incurred. The Company depreciates its property and equipment using thestraight-line method over the estimated useful lives of the assets, 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.

 

*Joint Venture —* The Company’s 50% investment in CFT isaccounted for under the equity method. (See Note 5).

 

*Evaluation of Long-lived Assets —* The Company’s policy is toassess potential impairments to its long-lived assets when there is evidencethat events or changes in circumstances have made recovery of the assetscarrying value unlikely and the carrying amount of the asset exceeds theestimated undiscounted future cash flows. If such evaluation were to indicate a material impairment of theselong-lived assets, such impairment would be recognized by a write down of theapplicable asset to its estimated fair value under Statement of FinancialAccounting Standards (“SFAS”) No. 144 “Accounting for the Impairment orDisposal of Long-Lived Assets”.

 

Warranty Reserve *—*The Company provides a warranty to its customers for shaft breakage inthe normal course of business.  TheCompany accrues for the estimated warranty based on historical experience attime of sale.  The estimated warranty iscalculated based upon a rolling four-year ratio of breakage returns to salesapplied to current year sales. (See Note 6).

 

*Advertising**—* The Companyadvertises primarily through print media. The Company’s policy is to expenseadvertising costs, including production costs, as incurred. Advertisingexpenses for 2006, 2005 and 2004 were $1.4 million, $1.2 million and $1.2million, respectively.

 

*Shipping and Handling Costs*—**Shippingand handling costs are classified as cost of sales.

 

*Research & Development (“R&D”)**—* The Company performs internal research and developmentefforts. Research and development expenses were approximately $2.5 million,$2.4 million and $1.7 million for 2006, 2005 and 2004, respectively.

 

*Foreign Currency Translation —*TheCompany’s foreign subsidiaries are a direct and integral component or extensionof the parent company’s operation.  Thedaily operations of foreign subsidiaries are dependent on the economicenvironment of the parent’s currency.  Inaddition, the changes in the foreign subsidiary’s individual assets andliabilities directly affect the cash flow of the parent company.  The functional currency of foreignsubsidiaries is the US dollar.  During theyears ended December 31, 2006, 2005 and 2004, net foreign currencytransaction gains and losses included in the Company’s Statements of Operationswere insignificant.

 

*Common Stock and Earnings Per Share (“EPS”)**—* Earnings per share - basic is calculated based upon theweighted average number of shares outstanding during the year, while dilutedalso gives effect to all potential dilutive common shares outstanding duringeach year such as options, restricted stock, warrants and other contingentlyissuable shares.

 

*IncomeTaxes* — Incometaxes are provided utilizing the asset and liability method.  The assetand liability method requires the recognition of deferred tax assets andliabilities for the expected future tax consequences of temporary differencesbetween the carrying amounts and tax bases of assets and liabilities. Valuation allowances are established when necessary to reduce deferred incometax assets to amounts more likely than not to be realized.

 

*Accounting for Stock Based Compensation —*At December 31,2006, the Company has two stock-based compensation plans, which are describedmore fully in Note 8. Beginning in fiscal year 2006, the Company accounts forshare-based compensation arrangements in accordance with the provisions ofStatement of Financial Accounting Standards No. 123R (“SFAS 123R”) “Share-BasedPayment,” which requires the measurement and recognition of compensationexpense for all

 

 

37

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share-basedpayment awards to employees and directors based on estimated fair values. TheCompany uses the Black-Scholes option valuation model to estimate the fairvalue of its stock options at the date of grant. The Black-Scholes optionvaluation model requires the input of subjective assumptions to calculate thevalue of stock options. The Company uses historical data among otherinformation to estimate the expected price volatility, the expected option lifeand the expected forfeiture rate.  Inaccordance with SFAS 123R, the Company records compensation expense forRestricted Stock Awards based on the estimated fair value of the award on thedate of grant. The estimated fairvalue is determined based onthe closing price of the Company’s Common Stock on the award date multiplied bythe number of awards expected to vest. The number of awards expected to vest isbased on the number of awards granted adjusted by estimated forfeiture rates.The total compensation cost is then recognized ratably over the vesting period.

 

*Concentration Risk*— The Company maintains someof its cash in bank deposit accounts which may be uninsured or exceed thefederally insured limits.  No losses have been experienced related to suchaccounts.  The Company believes it places its cash with quality financialinstitutions and is not exposed to any significant concentration of credit riskon cash.

 

*Recently Issued Accounting Pronouncements*—**In September 2006, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 108, “FinancialStatements *—* Considering the Effects of Prior YearMisstatements When Quantifying Misstatements in Current Year FinancialStatements” (“SAB 108”). This new guidance addresses how a registrant shouldquantify the effect of errors on the financial statements based on their impactto both the balance sheet and the income statement in order to determinemateriality. The interpretations in this SAB 108 are being issued to addressdiversity in practice in quantifying financial statement misstatements and thepotential under current practice for the build up of improper amounts on thebalance sheet.  The guidance provides fora one-time cumulative effect adjustment to correct for misstatements and errorsthat were not deemed material under a prior approach but are material under theSAB 108 approach. The application of SAB 108 did not have an effecton the Company’s consolidated financial position or results of operations.

 

InSeptember 2006, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 157, “Fair Value Measurements” (“SFAS 157”). This new standardprovides guidance for using fair value to measure assets and liabilities andinformation about the extent to which companies measure assets and liabilitiesat fair value, the information used to measure fair value, and the effect offair value measurements on earnings. This framework is intended to provideincreased consistency in how fair value determinations are made under variousexisting accounting standards which permit, or in some cases require, estimatesof fair market value. SFAS 157 also expands financial statement disclosurerequirements about a company’s use of fair value measurements, including theeffect of such measures on earnings. The provisions of SFAS 157 are effectivefor financial statements issued for fiscal years beginning after November 15,2007. The Company has not assessed the impact on its consolidated financialstatements, if any.

 

In July 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes” (“FIN 48”) which clarifies the accounting for uncertainty inincome taxes recognized in the financial statements in accordance with FASBStatement No. 109, “Accounting for Income Taxes”. This pronouncementprescribes a recognition threshold and measurement process for recording in thefinancial statements uncertain tax positions taken or expected to be taken inthe Company’s tax return. FIN 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods anddisclosure requirements for uncertain tax positions. The accounting provisionsof FIN 48 are effective for the Company beginning January 1, 2007. Thecumulative effect of initially adopting FIN 48 will be recorded as an adjustmentto opening retained earnings in the year of adoption and will be presentedseparately. The Company is in the process of evaluating the effect, if any, theadoption of FIN 48 will have on its financial statements.

 

*Reclassifications**—* Certainreclassifications have been made to prior years’ disclosures to conform tocurrent year classifications.

 

**2.****             ****ACCOUNTSRECEIVABLE**

 

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

 

| ** **                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
|                                   |       |     |       |     |       |
| Trade accounts receivable              |       | $        | 8,898      |     | $          | 7,251 |   |
| Less: allowance for  doubtful accounts |       | (36      | )          | (18      | )          |
| Accounts receivable                    |       | $        | 8,862      |     | $          | 7,233 |   |

 

 

38

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**3.     INVENTORIES**

 

Inventoriesat December 31 consist of the following (in thousands):

 

| ** **      | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------|------------|----------|------------|----------|------------|
|            |       |     |       |     |       |
| Raw materials   |       | $        | 8,364      |     | $          | 8,447 |   |
| Work-in-process |       | 1,204    |       | 1,279    |       |
| Finished goods  |       | 4,123    |       | 2,661    |       |
| Inventories     |       | $        | 13,691     |     | $          | 12,387 |   |

 

**4.     PROPERTY, PLANT ANDEQUIPMENT**

 

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

 

| ** **                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |
| Machinery and equipment                          |       | $        | 17,712     |     | $          | 15,437 |   |
| Office furniture and  equipment                  |       | 1,730    |       | 1,655    |       |
| Leasehold improvements                           |       | 9,362    |       | 8,881    |       |
| Property and equipment not  yet in service       |       | 2,431    |       | 954      |       |
|                                             |       | 31,235   |       | 26,927   |       |
| Less: accumulated  depreciation and amortization |       | (22,441  | )          | (21,357  | )          |
| Property, plant and equipment                    |       | $        | 8,794      |     | $          | 5,570 |   |

 

Depreciation andamortization expense were $1.3 million, $1.3 million and $1.4 million in 2006,2005 and 2004, respectively.

 

**5.     INVESTMENT IN JOINT VENTURE**

 

TheCompany and SGL Carbon and Composites, Inc. (“SGL”) each own 50% of CFT ina joint venture to produce carbon fiber. CFT, which was previously a wholly owned subsidiary of AMTC, was formedon October 29, 1999.  AMTCcontributed net assets with a book value of approximately $13.3 million toCFT.  SGL purchased a 50% interest inAMTC’s carbon fiber manufacturing operations for approximately $7.0 million incash.  The Amended and Restated LimitedLiability Company Agreement provides that CFT is to continue until December 31,2099 unless it is dissolved earlier, its affairs are wound up and finalliquidating distributions are made pursuant to the agreement.

 

TheCompany’s 50% investment in CFT is accounted for under the equity method.  Based on the member’s respective ownershipinterest in the joint venture, profits and losses are allocated equally to eachmember.  Each partner is responsible for50% of the fixed costs of the facility regardless on the amount of fiber thatis purchased from the joint venture.  In2006, CFT’s sales to the Company and its partner were $6.9 million and $6.6million, respectively.  The amount ofconsolidated retained earnings of the Company represented by undistributedearnings of CFT was an accumulated deficit of approximately $4.1 million as of December 31,2006.  The Company’s equity in earningsfrom the joint venture for the years ended December 31, 2006, 2005 and2004 was approximately $407,000, $236,000 and $246,000, respectively.  The Company’s investment includes theunamortized excess of the Company’s original investment over its equity in thejoint venture net assets.  The excess wasapproximately $25,000 and $45,000 at December 31, 2006 and 2005,respectively, and is being amortized on a straight-line basis over an initialestimated economic useful life of approximately 101 months.

 

**6.     ACCRUED EXPENSES**

 

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

 

| ** **                     | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
|                           |       |     |       |     |       |
| Payroll and employee  benefits |       | $        | 1,490      |     | $          | 2,653 |   |
| Warranty reserve [1]           |       | 157      |       | 180      |       |
| Legal and professional  fees   |       | 12       |       | 67       |       |
| Plant consolidation            |       | 81       |       | —   |       |
| Other                          |       | 302      |       | 314      |       |
| Accrued expenses               |       | $        | 2,042      |     | $          | 3,214 |   |

 

39

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| **[1] Warranty Reserve** | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Beginning Balance                  |       | $        | 180        |     | $          | 176 |   |
| Settlement of Warranty             |       | (119     | )          | (106     | )          |
| Adjustments to Warranty            |       | 96       |       | 110      |       |
| Ending Balance                     |       | $        | 157        |     | $          | 180 |   |

 

**7.     STOCKHOLDERS’ EQUITY**

** **

TheCompany announced on July 28, 2006 that its Board of Directors authorizedthe repurchase of up to $5.0 million of the Company’s common stock.  Theshares will be repurchased from time to time in open market transactions at theCompany’s discretion, subject to market conditions and other factors,including  imposed “black-out periods” during which the Company and itsinsiders are prohibited from trading in the Company’s common stock.  Whilethe Company typically allows insiders to trade in its stock for thirty daysbeginning the third day after its quarterly earnings announcement, the Companymay impose a black-out period at any time without advance public notice. During the year, the Company used cash of approximately $1.2 million purchasing75,596 shares of its common stock, with an average price paid of $16.11.  The Company has approximately $3.8 millionremaining under its current stock repurchase plan.  The Company also announced that all prior stockrepurchase plans have been cancelled. Prior to the announcement, the Company had adopted previous stockrepurchase plans, but had not repurchased any shares under those plans since August 2004.  The Company repurchased 54,989 shares in 2004at an approximate cost of $295,000.  TheBoard of Directors discusses stock buyback levels at each of the Company’squarterly board meetings.  All sharesthat have been repurchased under the Company’s stock buyback programs have beenretired.

 

TheCompany declared and paid four quarterly dividends in the amount of $0.15 pershare to holders of its common stock during 2006, which resulted in dividendpayments totaling $3.3 million.  TheCompany declared and paid dividends during 2005, including two $1.00 specialdividends.  The Company paid dividendstotaling $2.45 per share in 2005, which resulted in dividend payments of $13.0million to holders of the Company’s common stock.  The Company also paid approximately $769,000in dividends during 2004, which was the first year the Company began payingdividends to holders of its common stock.

 

**8.     ACCOUNTING FOR STOCK BASEDCOMPENSATION**

 

OnJanuary 1, 2006 the Company adopted Statement of Financial AccountingStandards (“SFAS”) No.123R (Revised 2004), “Share Based Payment,” (“SFAS 123R”),using the modified prospective method. In accordance with SFAS No. 123R, the Company measures the cost ofemployee services received in exchange for an award of equity instruments basedon the grant-date fair value of the award. That cost is recognized over the period during which an employee isrequired to provide service in exchange for the award — the requisite serviceperiod.  The Company determines thegrant-date fair value of employee share options using the Black-Scholesoption-pricing model. On December 19, 2005 the Compensation Committee ofthe Company’s Board of Directors approved a plan to accelerate the vesting ofapproximately 150,000 stock options granted to employees in 2004 and 2005,including options held by executive officers of the Company.  The Board took this action with the beliefthat it was in the best interests of the stockholders, as it will reduce theCompany’s reported compensation expense associated with those options in futureperiods compared to the expense that otherwise would have been recorded inconnection with the implementation of SFAS No.123R.

 

In1992, the Company 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 of 1994, thestockholders adopted the 1994 Stock Incentive Plan (“Plan”) for employees,directors and consultants of the Company. The Company has reserved 1,366,667 shares for issuance under thisPlan.  Equity incentive programs coveredunder the Plan, include incentive stock options, non-qualified stock optionsand restricted stock awards.  Stock optionsand restricted stock awards are granted at the fair market value of the sharesat the date of grant, generally become fully vested over three years aftergrant, and expire ten years from the date of grant.

 

Therewere no capitalized stock-based compensation costs at December 31,2006.  There were no modifications tostock options awards during 2006.  TheCompany recognizes stock-based compensation expense using the straight lineattribution method.  The remainingunrecognized compensation cost related to unvested awards at December 31,2006 is approximately

 

40

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$675,000,which is expected to be recognized over a weighted average period of 7.5years.  This amount does not include thecost of any additional options or restricted stock awards that may be awardedin future periods nor any changes in the Company’s forfeiture rate.

 

Inaccordance with the modified prospective method, the Company’s ConsolidatedFinancial Statements for prior periods have not been restated to reflect, anddo not include, the impact of SFAS No. 123R.  The following table summarizes compensationcosts related to the Company’s stock-based compensation plans for the twelvemonth period ended December 31, 2006 (in thousands):

 

| ** **                               | ** ** | **Twelve month** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **period ended** | ** ** |
| ** **                               | ** ** | **December**          | ** ** |
| ** **                               | ** ** | **31, 2006**     | ** ** |
| Cost of sales                            | ** ** | $                     | —     | ** ** |
| Selling, general and administrative      | ** ** | 255                   | ** ** |
| Pre-tax stock-based compensation expense | ** ** | 255                   | ** ** |
| Income tax benefit                       |       | 85                    |       |
|                                     |       |                  |       |
| Net stock-based  compensation expense    |       | $                     | 170        |   |

 

***Stock Option Activity***

 

SFASNo.123R requires the Company to reflect income tax benefits resulting from taxdeductions in excess of expense as a financing cash flow in its ConsolidatedStatement of Cash Flow rather than as an operating cash flow as in priorperiods.  Cash proceeds, tax benefits andintrinsic value of related total stock options exercised during the twelvemonth period ended December 31, 2006 are as follows (in thousands):

 

| ** **                                      | ** ** | **Twelve month** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **period ended** | ** ** |
| ** **                                      | ** ** | **December**          | ** ** |
| ** **                                      | ** ** | **31, 2006**     | ** ** |
| Proceeds from stock  options exercised          |       | $                     | 2,270      |   |
| Tax benefit related to  stock options exercised |       | $                     | 1,549      |   |
| Intrinsic value of stock  options exercised     |       | $                     | 4,347      |   |

 

Thefair value of stock options at date of grant was estimated using theBlack-Scholes model.  The expected lifeof employee stock options is determined using historical data of employeeexercises and represents the period of time that stock options are expected tobe outstanding.  The risk free interestrate is based on the U.S. Treasury constant maturity for the expected life ofthe stock option.  Expected volatility isbased on the historical volatilities of the Company’s common stock.  Below is the information for the grantsissued for 2006, 2005 and 2004.

 

| ** **                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected life (years)                           |       | 6        |       | 5        |       | 5        |       |
| Risk-free interest rate                         |       | 5.0      | %          | 3.8      | %          | 3.5      | %          |
| Expected volatility                             |       | 72.3     | %          | 54.5     | %          | 59.0     | %          |
| Expected dividend yield                         |       | 1.9      | %          | 1.5      | %          | 1.0      | %          |
| Weighted average fair  value of options granted |       | $        | 18.84      |     | $          | 11.28    |       | $ | 5.06 |   |
|                                                 |            |          |            |          |            |          |            |  |  |  |

 

Thefollowing table summarizes the stock option transactions during the twelvemonth period ended December 31, 2006:

 

| ** **                      | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**        | ** ** | ** **    | ** ** |
|---------------------------------|------------|------------|------------|--------------|------------|---------------------|------------|---------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** **   | ** ** | **average**         | ** ** | ** **    | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Weighted** | ** ** | **remaining**       | ** ** | ** **    | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **average**  | ** ** | **contractual**     | ** ** | **Aggregate** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **exercise** | ** ** | **life**            | ** ** | **Intrinsic** | ** ** |
| ** **                      | ** ** | **Shares** | ** ** | **price**    | ** ** | **(in years)** | ** ** | **Value**     | ** ** |
| Options outstanding  1/1/2006   |       | 353,311    |       | $            | 11.36      |                |       |          |       |   |
| Options granted                 |       | 13,336     |       | 32.01        |       |                |       |          |       |
| Options exercised               |       | 204,323    |       | 11.11        |       |                |       |          |       |
| Options terminated              |       | 694        |       | 17.11        |       |                |       |          |       |
| Options outstanding  12/31/2006 |       | 161,630    |       | $            | 13.41      |                | 7.5        |          | $          | 6.48 |   |
| Options exercisable  12/31/2006 |       | 133,142    |       | $            | 10.86      |                | 7.2        |          | $          | 4.95 |   |

 

41

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Thetotal intrinsic value of options exercised during the twelve month periodsended December 31, 2006, 2005 and 2004 was approximately $4.3, $4.0million and $2.4 million, respectively. The total fair value of shares vested during the period ended December 31,2006 was approximately $388,000.  Asummary of the status of the Company’s nonvested shares as of December 31,2006 and changes during the twelve month period ended December 31, 2006 ispresented below.

 

| ** **                | ** ** | ** **            | ** ** | ** **          | ** ** |
|---------------------------|------------|-----------------------|------------|---------------------|------------|
| ** **                | ** ** | ** **            | ** ** | **Weighted**        | ** ** |
| ** **                | ** ** | ** **            | ** ** | **Average**         | ** ** |
| ** **                | ** ** | ** **            | ** ** | **Grant-Date**      | ** ** |
| **Nonvested Shares** | ** ** | **Shares (000)** | ** ** | **Fair Value** | ** ** |
| Nonvested at 1/1/2006     |       | 56                    |       | $                   | 4.81       |   |
| Granted                   |       | 13                    |       | 18.84               |       |
| Vested                    |       | 41                    |       | 3.24                |       |
| Forfeited                 |       | —                |       | —              |       |
| Nonvested at 12/31/2006   |       | 28                    |       | $                   | 13.63      |   |

 

***Restricted Stock Activity***

 

Restrictedstock awards were issued to employees under the Company’s Plan.  Restricted stock awards vest over three yearsand are subject to the employees’ continuing service to the Company. The costof restricted stock awards is determined using the fair value of the Company’scommon stock on the date of the grant. The compensation expense is recognizedratably over the vesting period.    A summary of the status of andchanges in restricted stock units granted under the Company’s Plan as of andduring the twelve months ended December 31, 2006 is presented below:

 

| ** **                               | ** ** | **December 31, 2006** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | ** **                      | ** ** | **Weighted** | ** ** |
| ** **                               | ** ** | ** **                      | ** ** | **average** | ** ** |
| ** **                               | ** ** | ** **                      | ** ** | **exercise** | ** ** |
| ** **                               | ** ** | **Shares**                      | ** ** | **price** | ** ** |
| Restricted stock  outstanding 1/1/2006   |       | —                          |       | — |   |
| Restricted stock awarded                 |       | 28,473                          |       | $ | 15.70 |   |
| Restricted stock  terminated             |       | —                          |       | — |   |
| Restricted stock  outstanding 12/31/2006 |       | 28,473                          |       | $ | 15.70 |   |

 

***Pro forma Information for PeriodsPrior to the Adoption of FAS 123R***

 

Ifcompensation cost for the Company’s stock-based compensation plans had beenrecognized in the twelve month periods ended December 31, 2005 and 2004under the provisions of FAS No. 123R, the Company’s net income and EPSwould have been reduced to the following pro forma amounts:

 

| ** **                                                                                                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net income as reported                                                                                                                       |       | $        | 13,404     |     | $          | 9,320 |   |
|                                                                                                                                         |       |     |       |     |       |
| Add back:                                                                                                                                    |       |     |       |     |       |
| Option charge from  accelerated vesting of options                                                                                           |       | 19       |       |     |       |
|                                                                                                                                         |       |     |       |     |       |
| Deduct: Total stock-based employee compensation expense determined under  fair value based method for all awards, net of related tax effects |       | (1,378   | )          | (202     | )          |
| Pro forma net income                                                                                                                         |       | $        | 12,045     |     | $          | 9,118 |   |
|                                                                                                                                         |       |     |       |     |       |
| Earnings per share:                                                                                                                          |       |     |       |     |       |
| Basic — as reported                                                                                                                     |       | $        | 2.54       |     | $          | 1.85 |   |
| Basic — pro forma                                                                                                                       |       | $        | 2.28       |     | $          | 1.81 |   |
|                                                                                                                                         |       |     |       |     |       |
| Diluted — as reported                                                                                                                   |       | $        | 2.46       |     | $          | 1.77 |   |
| Diluted — pro forma                                                                                                                     |       | $        | 2.21       |     | $          | 1.74 |   |

 

42

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**9.     INCOME TAXES**

 

During the year ended December 31,2006, the Company completed an R&D project, which resulted in the Companybenefiting from increased R&D credits in the current year.  Where appropriate, the Company amended pastincome tax returns.  The R&D creditshad the effect of reducing the Company’s income tax expense in the current yearfor Federal and State income taxes by approximately $289,000 and $444,000,respectively.

 

During the year ended December 31,2004, the Company addressed the appropriateness of its valuation allowance andthe circumstances that led to the establishment of its valuation allowance inaccordance with SFAS 109.  The Companybelieved there had been a change in circumstances, and that its deferred taxassets would be realized in future years and accordingly reduced its valuationallowance against the related deferred tax assets to zero as of December 31,2004.  The recorded amount of thevaluation allowance as of December 31, 2003 was $2.5 million, which wasreduced to zero during 2004.

 

*Income tax provision for the years ended Decembers 31, is as follows(in thousands):*

 

|                       |   | **2006** |   | **2005** |   | **2004** |   |
|----------------------------|--------|----------|--------|----------|--------|----------|--------|
| Current:                   |   |     |   |     |   |     |   |
| Federal                    |   | $        | 4,706  |     | $      | 6,273    |   | $ | 2,256 |   |
| State                      |   | 627      |   | 1,101    |   | 455      |   |
| Foreign                    |   | 356      |   | 114      |   | 217      |   |
| Total                      |   | 5,689    |   | 7,487    |   | 2,928    |   |
| Deferred:                  |   |     |   |     |   |     |   |
| Federal                    |   | (99      | )      | (202     | )      | (2,352   | )      |
| State                      |   | (5       | )      | 2        |   | 149      |   |
| Total                      |   | (104     | )      | (200     | )      | (2,203   | )      |
| Provision for income taxes |   | $        | 5,585  |     | $      | 7,287    |   | $ | 725 |   |

 

*Rate reconciliations for the years ended December 31, are asfollows:*

 

| ** **                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Statutory rate                                  |       | 35.0     | %          | 35.0     | %          | 34.0     | %          |
| State income taxes, net of  Federal tax benefit |       | 2.4      |       | 3.5      |       | 4.0      |       |
| Valuation allowance                             |       | —   |       | —   |       | (26.9    | )          |
| R&D tax credits                             |       | (2.1     | )          | —   |       | —   |       |
| Foreign earnings taxed at  different rates      |       | (1.8     | )          | (2.3     | )          | (4.0     | )          |
| Other items                                     |       | (.3      | )          | (1.0     | )          | .1       |       |
| Effective rate                                  |       | 33.2     | %          | 35.2     | %          | 7.2      | %          |

 

*Net deferred income taxes  as of December 31,are as follows (in thousands):*

 

Netdeferred income taxes included in current and long-term assets in the balancesheet at December 31, consist of the tax effects of temporary differencesrelated to the following:

 

| **Deferred tax assets-net, current** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
| Inventories                                         |       | $        | 1,056      |     | $          | 943 |   |
| Accrued expenses                                    |       | 322      |       | 258      |       |
| Allowance for doubtful  accounts                    |       | 15       |       | 7        |       |
| Deferred expenses (capital  losses)                 |       | 20       |       | 4        |       |
| State income taxes                                  |       | 25       |       | 140      |       |
| Other                                               |       | (78      | )          | —   |       |
| Deferred tax assets — current                  |       | $        | 1,360      |     | $          | 1,352 |   |

 

43

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| **Deferred tax assets-net, long-term** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------|------------|----------|------------|----------|------------|
| Property and equipment                                |       | $        | 488        |     | $          | 543 |   |
| Basis in joint venture  (CFT)                         |       | (341     | )          | (418     | )          |
| CFT impairment charge                                 |       | 898      |       | 904      |       |
| Other                                                 |       | 99       |       | 22       |       |
| Deferred tax assets — long term                  |       | $        | 1,144      |     | $          | 1,051 |   |

 

| **Reconciliation of deferred tax assets** | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets —  current                           |       | $        | 1,360      |     | $          | 1,352 |   |
| Deferred tax assets — long  term                         |       | 1,144    |       | 1,051    |       |
| Total net deferred tax  asset before valuation allowance      |       | 2,504    |       | 2,403    |       |
| Valuation allowance                                           |       | —   |       | —   |       |
| Total deferred tax asset                                      |       | $        | 2,504      |     | $          | 2,403 |   |

 

TheCompany has adopted the position under APB 23 that earnings of its foreignsubsidiaries will be permanently reinvested outside of the United States.  As such, United States deferred taxes havenot been provided for on these earnings.

 

**10.  EMPLOYEE BENEFITPLAN**

 

In1994, the Company adopted the Aldila, Inc. 401(k) Savings Plan (the “Plan”)for employees of the Company and its subsidiaries.  This defined contribution plan allowsemployees who satisfy the age and service requirements of the Plan tocontribute up to 19% of pre-tax wages, limited to the maximum amount permittedunder federal law.  The Company matchesthe first 4% of wages contributed by employees at a rate of $0.50 for every$1.00.  The Company’s matchingcontributions vest over four years based on years of service.  The Company’s contributions amounted toapproximately $137,000, $58,000 and $48,000 in 2006, 2005 and 2004,respectively.

 

**11.  COMMITMENTS AND CONTINGENCIES**

 

TheCompany leases building space and certain equipment under operatingleases.  The Company’s leases for officeand manufacturing space contain rental escalation clauses and renewaloptions.  Rental expense for the Companywas $1.1 million, $1.1 million and $900,000 for 2006, 2005 and 2004,respectively.  As of December 31,2006, future minimum lease payments for all operating leases are as follows (inthousands):

 

| 2007       |   | $     | 1,348  |   |
|------------|--------|-------|--------|--------|
| 2008       |   | 1,522 |   |
| 2009       |   | 1,493 |   |
| 2010       |   | 583   |   |
| 2011       |   | 533   |   |
| Thereafter |   | 180   |   |
|       |   | $     | 5,659  |   |

 

**12.  SEGMENT INFORMATION**

 

TheCompany classifies its business into two segments based on products offered;Composite Products and Composite Materials. The Composite Products segment is primarily comprised of sales ofgraphite golf shafts and hockey sticks. The Composite Materials segment is comprised of external sales ofprepreg uni-tapes, fabrics, film adhesives and the Company’s 50% interest inCFT.  The Company reported one segment inits Annual Report filed on Form 10-K for the year ended December 31,2005.  Historically, the Company’sexternal sales of Composite Materials have not been significant; however, theyhave increased as a percentage of net sales in the last couple of yearsalthough never exceeding 10% of consolidated net sales prior to 2006.  Composite Materials net sales was 12% ofconsolidated net sales for the twelve month period ended December 31,2006, and the Company believes that this trend will continue for theforeseeable future.  The Companyevaluates performance based on profit or loss from operations.  The Company does not evaluate inter-segmentsales and has never tracked such sales. The Composite Materials segment produces the majority of its materialsfor the Composite Products segment. Certain SG&A costs and other shared support costs are recordedinitially in the Composite Products segment and allocated for segmentreporting.

 

44

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*SegmentOperating Results*

 

| ** **                        | ** ** | **Twelve months ended December 31, 2006** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                        | ** ** | **Composite**                                                      | ** ** | **Composite** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | **Products**                                                       | ** ** | **Materials** | ** ** | **Total** | ** ** |
| Revenues from external  customers |       | $                                                                  | 63,479     |   | $ | 8,891 |   | $ | 72,370 |   |
| Operating income                  |       | $                                                                  | 10,474     |   | $ | 3,078 |   | $ | 13,552 |   |
| Income before income taxes        |       | $                                                                  | 12,686     |   | $ | 4,135 |   | $ | 16,821 |   |

 

| ** **                        | ** ** | **Twelve months ended December 31, 2005** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                        | ** ** | **Composite**                                                      | ** ** | **Composite** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | **Products**                                                       | ** ** | **Materials** | ** ** | **Total** | ** ** |
| Revenues from external  customers |       | $                                                                  | 69,561     |   | $ | 7,417 |   | $ | 76,978 |   |
| Operating income                  |       | $                                                                  | 18,144     |   | $ | 1,725 |   | $ | 19,869 |   |
| Income before income taxes        |       | $                                                                  | 18,680     |   | $ | 2,011 |   | $ | 20,691 |   |

 

| ** **                        | ** ** | **Twelve months ended December 31, 2004** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                        | ** ** | **Composite**                                                      | ** ** | **Composite** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | **Products**                                                       | ** ** | **Materials** | ** ** | **Total** | ** ** |
| Revenues from external  customers |       | $                                                                  | 48,312     |   | $ | 4,450 |   | $ | 52,762 |   |
| Operating income                  |       | $                                                                  | 9,709      |   | $ | 30 |   | $ | 9,739 |   |
| Income before income taxes        |       | $                                                                  | 9,769      |   | $ | 276 |   | $ | 10,045 |   |

 

*SegmentLong-Lived Assets*

 

| ** **                           | ** ** | **As of December 31,** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|
| ** **                           | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| Property, Plant and  Equipment       |       |                                  |       |   |   |
| Composite Products                   |       | $                                     | 5,082      |   | $ | 2,979 |   |
| Composite Materials (1)              |       | $                                     | 3,712      |   | $ | 2,591 |   |
| Total Property, Plant and  Equipment |       | $                                     | 8,794      |   | $ | 5,570 |   |
|                                 |       |                                  |       |   |   |
| Investment in Joint  Venture         |       |                                  |       |   |   |
| Composite Materials                  |       | $                                     | 3,091      |   | $ | 2,895 |   |
| Total Investment in Joint  Venture   |       | $                                     | 3,091      |   | $ | 2,895 |   |
|                                 |       |                                  |       |   |   |
| Total Long-Lived Assets              |       |                                  |       |   |   |
| Composite Products                   |       | $                                     | 5,082      |   | $ | 2,979 |   |
| Composite Materials                  |       | $                                     | 6,803      |   | $ | 5,486 |   |
| Total Long-Lived Assets              |       | $                                     | 11,885     |   | $ | 8,465 |   |

 

----

Notes

 

(1) Theseassets also support the Composite Products segment as the Composite Materialssegment manufactures the majority of the materials consumed by the CompositeProducts segment.

 

45

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*Informationabout Geographic Areas*

 

TheCompany markets its products domestically and internationally, with itsprincipal international market being Europe. The table below contains information about the geographical areas inwhich the Company operates.  Revenues areattributed to countries based on location in which the sale is settled.  Long-lived assets are based on the country ofdomicile.  Although sales to China haveincreased over the years, the majority of those shafts being sold in China arebeing assembled and sent either back to the United States or to Europe.  The majority of the international sales areattributed to the Composite Products segment. Composite Materials international sales are immaterial.

 

| **(in thousands)**      | ** ** | ** ** | ** ** | ** **                 | ** ** |
|-------------------------|------------|------------|------------|----------------------------|------------|
| **2006**                | ** ** | **Sales**  | ** ** | **Long-Lived Assets** | ** ** |
| United States           |       | $          | 51,928     |                       | $          | 8,329 |   |
| England                 |       | 7,453      |       | —                     |       |
| China                   |       | 9,006      |       | 1,553                      |       |
| Canada                  |       | 2,461      |       | —                     |       |
| Australia               |       | 570        |       | —                     |       |
| Mexico                  |       | —     |       | 482                        |       |
| Vietnam                 |       | —     |       | 1,521                      |       |
| Other Foreign Countries |       | 952        |       | —                     |       |
| Total                   |       | $          | 72,370     |                       | $          | 11,885 |   |

 

| **2005**                | ** ** | **Sales** | ** ** | **Long-Lived Assets** | ** ** |
|-------------------------|------------|-----------|------------|----------------------------|------------|
| United States           |       | $         | 59,523     |                       | $          | 6,415 |   |
| England                 |       | 7,524     |       | —                     |       |
| China                   |       | 6,908     |       | 1,813                      |       |
| Canada                  |       | 959       |       | —                     |       |
| Australia               |       | 800       |       | —                     |       |
| Mexico                  |       | —    |       | 237                        |       |
| Other Foreign Countries |       | 1,264     |       | —                     |       |
| Total                   |       | $         | 76,978     |                       | $          | 8,465 |   |

 

| **2004**                | ** ** | **Sales** | ** ** | **Long-Lived Assets** | ** ** |
|-------------------------|------------|-----------|------------|----------------------------|------------|
| United States           |       | $         | 43,277     |                       | $          | 6,134 |   |
| Scotland                |       | —    |       | —                     |       |
| England                 |       | 3,510     |       | —                     |       |
| China                   |       | 4,356     |       | 1,887                      |       |
| Mexico                  |       | —    |       | 296                        |       |
| Other Foreign Countries |       | 1,619     |       | —                     |       |
| Total                   |       | $         | 52,762     |                       | $          | 8,317 |   |

 

*Informationabout Major Customers*

 

Historically,Aldila’s principal customers have varied as a result of general market trendsin the golf industry, in particular the prevailing popularity of the variousclubs that contain Aldila’s shafts.  As aresult, there typically are changes in the composition of the list of theCompany’s ten most significant customers from year to year.  Due to the substantial marketplace success oftheir clubs in recent periods, for the last several years the Company’s largestcustomers have been Acushnet Company, Callaway Golf, and Ping.

 

| **Major Customers** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Ping                     |       | 18       | %          | 19       | %          | 9        | %          |
| Acushnet Company         |       | 17       | %          | 19       | %          | 22       | %          |
| Callaway Golf            |       | 15       | %          | 18       | %          | 17       | %          |

 

46

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**13.  QUARTERLY RESULTS OFOPERATIONS (Unaudited)**

 

Thefollowing is a summary of the quarterly results of operations for the two yearsin the period ended December 31, 2006 (in thousands, except per sharedata):

 
| ** **                                  | ** ** | **Quarter Ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|
| ** **                                  | ** ** | **March 31,**     | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                  | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **2006:**                                   | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                   |       | $                      | 20,770     |   | $ | 17,397 |   | $ | 16,329 |   | $ | 17,874 |   |
| Gross profit                                |       | 9,668                  |       | 6,186 |   | 4,113 |   | 4,316 |   |
| Net income                                  |       | 4,342                  |       | 2,685 |   | 2,861 |   | 1,348 |   |
|                                        |       |                   |       |   |   |   |   |   |   |
| Net income per common  share-basic          |       | $                      | 0.80       |   | $ | 0.48 |   | $ | 0.51 |   | $ | 0.24 |   |
| Net income per common  share-diluted        |       | $                      | 0.78       |   | $ | 0.47 |   | $ | 0.51 |   | $ | 0.24 |   |
|                                        |       |                   |       |   |   |   |   |   |   |
| **2005:**                                   | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                   |       | $                      | 17,808     |   | $ | 21,821 |   | $ | 19,327 |   | $ | 18,022 |   |
| Gross profit                                |       | 7,435                  |       | 8,118 |   | 7,866 |   | 6,191 |   |
| Net income (loss)                           |       | 3,309                  |       | 3,644 |   | 3,761 |   | 2,690 |   |
|                                        |       |                   |       |   |   |   |   |   |   |
| Net income (loss) per  common share-basic   |       | $                      | 0.64       |   | $ | 0.70 |   | $ | 0.71 |   | $ | 0.50 |   |
| Net income (loss) per  common share-diluted |       | $                      | 0.61       |   | $ | 0.66 |   | $ | 0.68 |   | $ | 0.48 |   |

 

Earnings(loss) per share are computed independently for each of the quarters presentedand therefore may not sum to the annual amount for the year.  The Company benefited from a $2.2 millionpre-tax settlement of a class action lawsuit that it was a party to during thethird quarter ended September 30, 2006.

 

Asdisclosed in Footnote 15, the Company restated its Consolidated Balance Sheetsas of December 31, 2006 and 2005 and the Consolidated Statements of CashFlows for the years ended December 31, 2006 and 2005.  Below are the effects of the restatements toas filed interim financial statements for the quarters ended March 31,2005 through September 30, 2006.

** **

**Scheduleof Consolidated Balance Sheets Line Item Reclassifications**

 
| *** ***              | *** *** | **As of September 30, 2006**  | *** *** |
|---------------------------|--------------|------------------------------------|--------------|
| *** ***              | *** *** | **As Reported**                    | ** **   | **Reclassification** | ** ** | **As Restated** | *** *** |
|                      |         |                               |         |   |   |   |   |
| Cash and cash equivalents |         | $                                  | 12,627       |   | $ | (10,300 | ) | $ | 2,327 |   |
| Marketable securities     |         | —                             |         | 10,300 |   | 10,300 |   |
|                      |         |                               |         |   |   |   |   |
|                      | *** *** | **As of  June 30, 2006**      | *** *** |
|                      | *** *** | **As  Reported**                   | ** **   | **Reclassification** | ** ** | **As  Restated** | *** *** |
|                      |         |                               |         |   |   |   |   |
| Cash and cash equivalents |         | $                                  | 16,292       |   | $ | (13,100 | ) | $ | 3,192 |   |
| Marketable securities     |         | —                             |         | 13,100 |   | 13,100 |   |
|                      |         |                               |         |   |   |   |   |
|                      | ** **   | **As of  March 31, 2006**     | ** **   |
|                      | ** **   | **As  Reported**                   | ** **   | **Reclassification** | ** ** | **As  Restated** | ** ** |
|                      |         |                               |         |   |   |   |   |
| Cash and cash equivalents |         | $                                  | 16,708       |   | $ | (13,400 | ) | $ | 3,308 |   |
| Marketable securities     |         | —                             |         | 13,400 |   | 13,400 |   |
|                      |         |                               |         |   |   |   |   |
|                      | ** **   | **As of  September 30, 2005** | ** **   |
|                      | ** **   | **As  Reported**                   | ** **   | **Reclassification** | ** ** | **As  Restated** | ** ** |
|                      |         |                               |         |   |   |   |   |
| Cash and cash equivalents |         | $                                  | 19,429       |   | $ | (18,300 | ) | $ | 1,129 |   |
| Marketable securities     |         | —                             |         | 18,300 |   | 18,300 |   |
|                      |         |                               |         |   |   |   |   |
|                      | ** **   | **As of  June 30, 2005**      | ** **   |
|                      | ** **   | **As  Reported**                   | ** **   | **Reclassification** | ** ** | **As  Restated** | ** ** |
|                      |         |                               |         |   |   |   |   |
| Cash and cash equivalents |         | $                                  | 16,666       |   | $ | (15,498 | ) | $ | 1,168 |   |
| Marketable securities     |         | —                             |         | 15,498 |   | 15,498 |   |
|                      |         |                               |         |   |   |   |   |
|                      | ** **   | **As of  March 31, 2005**     | ** **   |
|                      | ** **   | **As  Reported**                   | ** **   | **Reclassification** | ** ** | **As  Restated** | ** ** |
|                      |         |                               |         |   |   |   |   |
| Cash and cash equivalents |         | $                                  | 15,123       |   | $ | (12,996 | ) | $ | 2,127 |   |
| Marketable securities     |         | 2,491                              |         | 12,996 |   | 15,487 |   |

 

 

47

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**Scheduleof****Consolidated****Statements of Cash Flow Line ItemReclassifications**

 
|                                                     | ** ** | **For the  nine month period ended September 30, 2006** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------|------------|
|                                                     | ** ** | **As  Reported**                                             | ** ** | **Reclassification** | ** ** | **As  Restated** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash used for operating activities                   |       | (372                                                         | )          | — |   | (372 | ) |
|                                                     |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of marketable securities                        |       | —                                                       |       | (6,400 | ) | (6,400 | ) |
| Proceeds from the sale of marketable securities          |       | —                                                       |       | 10,000 |   | 10,000 |   |
| Net cash provided by (used for) investing activities     |       | (3,064                                                       | )          | 3,600 |   | 536 |   |
|                                                     |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by financing activities                |       | 242                                                          |       | — |   | 242 |   |
|                                                     |       |                                                         |       |   |   |   |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS** |       | (3,194                                                       | )          | 3,600 |   | 406 |   |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**      |       | 15,821                                                       |       | (13,900 | ) | 1,921 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**            |       | 12,627                                                       |       | (10,300 | ) | 2,327 |   |
|                                                     |       |                                                         |       |   |   |   |   |
|                                                     | ** ** | **For the  six month period ended June 30, 2006**       | ** ** |
|                                                     | ** ** | **As  Reported**                                             | ** ** | **Reclassification** | ** ** | **As  Restated** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash used for operating activities                   |       | (7                                                           | )          | — |   | (7 | ) |
|                                                     |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of marketable securities                        |       | —                                                       |       | (4,300 | ) | (4,300 | ) |
| Proceeds from the sale of marketable securities          |       | —                                                       |       | 5,100 |   | 5,100 |   |
| Net cash provided by (used for) investing activities     |       | (1,807                                                       | )          | 800 |   | (1,007 | ) |
|                                                     |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by financing activities                |       | 2,285                                                        |       | — |   | 2,285 |   |
|                                                     |       |                                                         |       |   |   |   |   |
| **NET INCREASE IN CASH AND CASH  EQUIVALENTS**           |       | 471                                                          |       | 800 |   | 1,271 |   |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**      |       | 15,821                                                       |       | (13,900 | ) | 1,921 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**            |       | 16,292                                                       |       | (13,100 | ) | 3,192 |   |
|                                                     |       |                                                         |       |   |   |   |   |
|                                                     | ** ** | **For the  three month period ended March 31, 2006**    |       |
|                                                     | ** ** | **As  Reported**                                             | ** ** | **Reclassification** | ** ** | **As  Restated** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by operating activities                |       | 195                                                          |       | — |   | 195 |   |
|                                                     |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of marketable securities                        |       | —                                                       |       | (1,800 | ) | (1,800 | ) |
| Proceeds from the sale of marketable securities          |       | —                                                       |       | 2,300 |   | 2,300 |   |
| Net cash provided by (used for) investing activities     |       | (741                                                         | )          | 500 |   | (241 | ) |
|                                                     |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by financing activities                |       | 1,433                                                        |       | — |   | 1,433 |   |
|                                                     |       |                                                         |       |   |   |   |   |
| **NET INCREASE IN CASH AND CASH  EQUIVALENTS**           |       | 887                                                          |       | 500 |   | 1,387 |   |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**      |       | 15,821                                                       |       | (13,900 | ) | 1,921 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**            |       | 16,708                                                       |       | (13,400 | ) | 3,308 |   |
| ** **                                               | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |

 

48

----

 
|                                                      | ** ** | **For the  nine month period ended September 30, 2005** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------------------------|------------|
|                                                      | ** ** | **As  Reported**                                             | ** ** | **Reclassification** | ** ** | **As  Restated** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                 | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by operating activities                 |       | 8,741                                                        |       | — |   | 8,741 |   |
|                                                      |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                 | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of marketable securities                         |       | —                                                       |       | (33,429 | ) | (33,429 | ) |
| Proceeds from the sale of marketable securities           |       | 4,971                                                        |       | 15,129 |   | 20,100 |   |
| Net cash provided by (used for) investing activities      |       | 3,755                                                        |       | (18,300 | ) | (14,545 | ) |
|                                                      |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                 | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash used for financing activities                    |       | (4,598                                                       | )          | — |   | (4,598 | ) |
|                                                      |       |                                                         |       |   |   |   |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS** |       | 7,898                                                        |       | (18,300 | ) | (10,402 | ) |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**       |       | 11,531                                                       |       | — |   | 11,531 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**             |       | 19,429                                                       |       | (18,300 | ) | 1,129 |   |
|                                                      |       |                                                         |       |   |   |   |   |
|                                                      | ** ** | **For the  six month period ended June 30, 2005**       | ** ** |
|                                                      | ** ** | **As  Reported**                                             | ** ** | **Reclassification** | ** ** | **As  Restated** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                 | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by operating activities                 |       | 5,770                                                        |       | — |   | 5,770 |   |
|                                                      |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                 | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of marketable securities                         |       | —                                                       |       | (25,227 | ) | (25,227 | ) |
| Proceeds from the sale of marketable securities           |       | 4,971                                                        |       | 9,729 |   | 14,700 |   |
| Net cash provided by (used for) investing activities      |       | 4,346                                                        |       | (15,498 | ) | (11,152 | ) |
|                                                      |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                 | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash used for financing activities                    |       | (4,981                                                       | )          | — |   | (4,981 | ) |
|                                                      |       |                                                         |       |   |   |   |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS** |       | 5,135                                                        |       | (15,498 | ) | (10,363 | ) |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**       |       | 11,531                                                       |       | — |   | 11,531 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**             |       | 16,666                                                       |       | (15,498 | ) | 1,168 |   |
|                                                      |       |                                                         |       |   |   |   |   |
|                                                      | ** ** | **For the  three month period ended March 31, 2005**    | ** ** |
|                                                      | ** ** | **As  Reported**                                             | ** ** | **Reclassification** | ** ** | **As  Restated** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                 | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by operating activities                 |       | 760                                                          |       | — |   | 760 |   |
|                                                      |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                 | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of marketable securities                         |       | —                                                       |       | (10,516 | ) | (10,516 | ) |
| Proceeds from the sale of marketable securities           |       | 2,480                                                        |       | (2,480 | ) | — |   |
| Net cash provided by (used for) investing activities      |       | 2,325                                                        |       | (12,996 | ) | (10,671 | ) |
|                                                      |       |                                                         |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                 | ** ** | ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by  financing activities                |       | 507                                                          |       | — |   | 507 |   |
|                                                      |       |                                                         |       |   |   |   |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS** |       | 3,592                                                        |       | (12,996 | ) | (9,404 | ) |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**       |       | 11,531                                                       |       | — |   | 11,531 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**             |       | 15,123                                                       |       | (12,996 | ) | 2,127 |   |

 

49

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**14.  RELATED PARTY TRANSACTIONS**

 

Thedollar amount of transactions with related parties, primarily attributed topurchases of carbon fiber from CFT, was approximately $6.9, $4.8 and $4.7million for the years ended December 31, 2006, 2005 and 2004,respectively.  Amounts owed to CFT as of December 31,2006 and 2005 were approximately $156,000 and $255,000, respectively.

 

**15.  Restatement of Previously Issued ConsolidatedFinancial Statements**

 

Subsequentto filing the Company’s Form 10-K for the fiscal year ended December 31,2006, the Company determined that its previously issued Consolidated BalanceSheets had marketable securities incorrectly identified and reported with cashand cash equivalents and as a result, the Consolidated Statements of Cash Flowsdid not reflect the purchases and sales activity of the marketablesecurities.  The effects of therestatement on Consolidated Balance Sheets as of December 31, 2006 and2005, and Consolidated Statements of Cash Flows for the years ended December 31,2006 and 2005 are reflected in the following tables:

 

**Scheduleof Consolidated Balance Sheets Line Item Reclassifications**

 
| ** **                                                                        | ** ** | **As of December 31, 2006**                              | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **As Reported**                                               | ** ** | **Reclassification** | ** ** | **As Restated** | ** ** |
|                                                                              |       |                                                          |       |   |   |   |   |
| Cash and cash equivalents                                                         |       | $                                                             | 15,182     |   | $ | (11,300 | ) | $ | 3,882 |   |
| Marketable securities                                                             |       | —                                                        |       | 11,300 |   | 11,300 |   |
|                                                                              |       |                                                          |       |   |   |   |   |
|                                                                              | ** ** | **As of  December 31, 2005**                             | ** ** |
|                                                                              | ** ** | **As  Reported**                                              | ** ** | **Reclassification** | ** ** | **As  Restated** | ** ** |
|                                                                              |       |                                                          |       |   |   |   |   |
| Cash and cash equivalents                                                         |       | $                                                             | 15,821     |   | $ | (13,900 | ) | $ | 1,921 |   |
| Marketable securities                                                             |       | —                                                        |       | 13,900 |   | 13,900 |   |
|                                                                              |       |                                                          |       |   |   |   |   |
| **Schedule of Consolidated  Statements of Cash Flow Line Item Reclassifications** |       |                                                          |       |   |   |
| ** **                                                                        |       |                                                          |       |   |   |   |   |
|                                                                              | ** ** | **For the  twelve month period ended December 31, 2006** | ** ** |
|                                                                              | ** ** | **As  Reported**                                              | ** ** | **Reclassification** | ** ** | **As  Restated** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                         | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by operating activities                                         |       | 4,476                                                         |       | — |   | 4,476 |   |
|                                                                              |       |                                                          |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                                         | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of marketable securities                                                 |       | —                                                        |       | (11,000 | ) | (11,000 | ) |
| Proceeds from the sale of marketable securities                                   |       | —                                                        |       | 13,600 |   | 13,600 |   |
| Net cash provided by (used for) investing activities                              |       | (4,399                                                        | )          | 2,600 |   | (1,799 | ) |
|                                                                              |       |                                                          |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                                         | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash used for financing activities                                            |       | (716                                                          | )          | — |   | (716 | ) |
|                                                                              |       |                                                          |       |   |   |   |   |
| **NET INCREASE (DECREASE) IN CASH  AND CASH EQUIVALENTS**                         |       | (639                                                          | )          | 2,600 |   | 1,961 |   |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**                               |       | 15,821                                                        |       | (13,900 | ) | 1,921 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**                                     |       | 15,182                                                        |       | (11,300 | ) | 3,882 |   |
|                                                                              |       |                                                          |       |   |   |   |   |
|                                                                              | ** ** | **For the  twelve month period ended December 31, 2005** | ** ** |
|                                                                              | ** ** | **As  Reported**                                              | ** ** | **Reclassification** | ** ** | **As  Restated** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                         | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by operating activities                                         |       | 10,388                                                        |       | — |   | 10,388 |   |
|                                                                              |       |                                                          |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                                         | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of marketable securities                                                 |       | —                                                        |       | (38,029 | ) | (38,029 | ) |
| Proceeds from the sale of marketable securities                                   |       | 4,971                                                         |       | 24,129 |   | 29,100 |   |
| Net cash provided by (used for) investing activities                              |       | 3,816                                                         |       | (13,900 | ) | (10,084 | ) |
|                                                                              |       |                                                          |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                                         | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash used for financing activities                                            |       | (9,914                                                        | )          | — |   | (9,914 | ) |
|                                                                              |       |                                                          |       |   |   |   |   |
| **NET INCREASE (DECREASE) IN CASH  AND CASH EQUIVALENTS**                         |       | 4,290                                                         |       | (13,900 | ) | (9,610 | ) |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF PERIOD**                               |       | 11,531                                                        |       | — |   | 11,531 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**                                     |       | 15,821                                                        |       | (13,900 | ) | 1,921 |   |

 

 

50

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**ALDILA INC. AND SUBSIDIARIES**

 

**SCHEDULE IIC VALUATION AND QUALIFYING ACCOUNTS**

 

**For the years ended December 31, 2006, 2005 and2004**

 
| ** **                            | ** ** | **Balance at beginning** | ** ** | **Charged to costs and** | ** ** | ** **     | ** ** | **Balance at end** | ** ** |
|---------------------------------------|------------|--------------------------|------------|--------------------------|------------|----------------|------------|--------------------|------------|
| ** **                            | ** ** | **of year**         | ** ** | **expenses**             | ** ** | **Deductions** | ** ** | **of year**   | ** ** |
| Year ended  December 31, 2004    |       |                     |       |                     |       |           |       |               |       |
| Allowance for uncollectible  accounts |       | $                        | 34,000     |                     | $          | 60,000         |       | $                  | (69,000    | ) | $ | 25,000 |   |
| Inventory Reserves                    |       | $                        | 2,007,000  |                     | $          | 97,000         |       | $                  | (1,143,000 | ) | $ | 961,000 |   |
| Warranty reserve                      |       | $                        | 184,000    |                     | $          | 69,000         |       | $                  | (77,000    | ) | $ | 176,000 |   |
|                                  |       |                     |       |                     |       |           |       |               |       |
| Year ended  December 31, 2005    |       |                     |       |                     |       |           |       |               |       |
| Allowance for uncollectible  accounts |       | $                        | 25,000     |                     | $          | 2,000          |       | $                  | (9,000     | ) | $ | 18,000 |   |
| Inventory Reserves                    |       | $                        | 961,000    |                     | $          | 710,000        |       | $                  | (636,000   | ) | $ | 1,035,000 |   |
| Warranty reserve                      |       | $                        | 176,000    |                     | $          | 110,000        |       | $                  | (106,000   | ) | $ | 180,000 |   |
|                                  |       |                     |       |                     |       |           |       |               |       |
| Year ended  December 31, 2006    |       |                     |       |                     |       |           |       |               |       |
| Allowance for  uncollectible accounts |       | $                        | 18,000     |                     | $          | 34,000         |       | $                  | (16,000    | ) | $ | 36,000 |   |
| Inventory Reserves                    |       | $                        | 1,035,000  |                     | $          | 811,000        |       | $                  | (476,000   | ) | $ | 1,370,000 |   |
| Warranty reserve                      |       | $                        | 180,000    |                     | $          | 96,000         |       | $                  | (119,000   | ) | $ | 157,000 |   |

 

 

51

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directorsand Stockholders of Aldila, Inc. Poway, California 

 

We have audited theaccompanying consolidated balance sheets of Aldila, Inc. and subsidiaries (the"Company," or "Aldila, Inc.") as of December 31, 2006 and2005, and the related consolidated statements of income, stockholders’ equityand cash flows for each of the years in the three-year period ended December31, 2006.  In connection with our auditsof the consolidated financial statements, we have also audited the accompanyingfinancial statement schedule listed in Item 15(a) 2 for each of the years inthe three year period ended December 31, 2006.  These financial statements and the financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits. 

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion. 

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Aldila, Inc. as ofDecember 31, 2006 and 2005, and the consolidated results of their operationsand their cash flows for each of the years in the three-year period endedDecember 31, 2006 in conformity with accounting principles generally acceptedin the United States of America.  Also,in our opinion, the related financial statement schedule for each of the yearsin the three year period ended December 31, 2006, when considered in relationto the basic consolidated financial statements taken as a whole, presentsfairly, in all material respects, the information set forth therein. 

 

As discussed in Note 1 tothe consolidated financial statements, the Company changed its method ofaccounting for stock-based compensation, effective January 1, 2006, as a resultof the adoption of Statement of Financial Accounting Standards No. 123R, *Share-Based Payments.*

 

As more fully explainedin Notes 13, 15, and the Cash Equivalents and Marketable Securities section ofNote 1 to the accompanying financial statements, the Company has restated itsconsolidated balance sheets as of December 31, 2006 and 2005, and itsconsolidated statements of cash flows for the years ended December 31, 2006 and2005.

 

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of Aldila, Inc.’s internal control overfinancial reporting as of December 31, 2006, based on criteria established inInternal Control—Integrated Framework issued by the  Committee of Sponsoring Organizations of theTreadway Commission ("COSO"). Our report dated March 9, 2007 (except for the first, fifth and sixthparagraphs of such report, as to which the date is March 28, 2008) expressed anunqualified opinion on management’s assessment (as restated) that the Companydid not maintain effective internal control over financial reporting as ofDecember 31, 2006 because of the effect of a material weakness relating to alack of internal control over the accounting for cash and cash equivalents andmarketable securities based on the aforementioned COSO criteria.  Our report referenced in the precedingsentence also expressed an opinion that the Company had not maintainedeffective internal control over financial reporting as of December 31, 2006based on the aforementioned COSO criteria. 

 

 
| /s/ Squar, Milner, Peterson, Miranda &  Williamson, LLP                                                                                                                                                |   |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                                                                                                                       |   |   |
| San Diego, California                                                                                                                                                                                      |   |   |
| March 9, 2007 (except for  Notes 13, 15, and the Cash Equivalents and Marketable Securities section of  Note 1 and the fifth and sixth paragraphs of this report, as to which the  date is March 28, 2008) |

 

 

52

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.

 
|                      | ALDILA, INC. |
|---------------------------|--------------|
|                      |         |
| Date: March 28, 2008 | By:          | /s/ Peter R. Mathewson |
|                      |         | Peter R. Mathewson |
|                      |         | Chairman of the Board, |
|                      |         | Chief Executive Officer |

 

 

53

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**EXHIBIT INDEX**
| **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        |       | 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).                                                                                                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.6        |       | 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).                                                                                                                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.7        |       | 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).                                                                                                                                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.8        |       | 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).                                                                                                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.9        |       | 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).                                                                                                                                                                                                                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.10       |       | 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).                                                                                                                                                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.11       |       | Lease Agreement  dated May 15, 1995 between the Company and Desarrollo Industrial de  Tijuana, S.A. de                                                                                                                                                                                                                                                                                                                                                                                                                |

 

 

54

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|    |   | C.V.(Filed as  Exhibit 10.1 to the Company’s Report on Form 10-Q for the quarterly  period ended June 30, 1995 and incorporated herein by reference).                                                                                                                                                                                      |
|---------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.12   |   | 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). |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| * 10.13 |   | 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).                                                                                   |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| * 10.14 |   | 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).                                                                                    |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| * 10.15 |   | 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).                                                                                     |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.16   |   | 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).                                                                                                          |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.17   |   | Aldila, Inc.  Audit Committee Charter included as Exhibit A in the Company’s 2001  Proxy dated April 4, 2001 and incorporated herein by reference.                                                                                                                                                                                         |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 10.18   |   | Aldila, Inc.’s  Code of Business Conduct and Ethics adopted on December 31, 2002 (Filed  as Exhibit 14.0 in the Company’s Report on Form 10-K for the year  ended December 31, 2003)                                                                                                                                        |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 11.1    |   | Statement re:  Computation of Net Income (Loss) per Common Share.                                                                                                                                                                                                                                                                                              |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 21.1    |   | Subsidiaries of  the Company.                                                                                                                                                                                                                                                                                                                                  |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 23.1    |   | Consent of  Independent Registered Public Accounting Firm — Squar, Milner, Peterson,  Miranda & Williamson, LLP                                                                                                                                                                                                                                  |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 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 to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                           |
| 99.1    |   | Carbon Fiber  Technology, LLC financial statements as of and for the years ended  December 31, 2004 and 2003 (filed as Exhibit 99.1 in the Company’s  Report on Form 10-K for the year ended December 31, 2004 and  incorporated herein by reference)                                                                                 |

 

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*Indicatesmanagement contracts or compensatory plans or arrangements required to be filedas exhibits to this Report on Form 10-K.

 

 

55

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