| ALDILA INC Item 1A Risk Factors Customer Concentration The Company’s sales have been, and very likely will continue to be, concentrated among a small number of customers |
| In 2005, sales to the Company’s top five customers represented approximately 62prca of net sales |
| Aldila’s principal customers have historically varied depending largely on the prevailing popularity of the various clubs that contain Aldila shafts |
| In 2005, Acushnet Company accounted for 19prca of net sales, Ping accounted for 19prca of net sales and Callaway Golf accounted for 18prca of net sales |
| The Company cannot predict the impact that general market trends in the golf industry, including the fluctuation in popularity of specific clubs manufactured by customers, will have on its future business or operating results |
| While the Company has had long-established relationships with most of its customers, it is not the exclusive supplier of graphite shafts to most of them, and consistent with the industry practice, generally does not have long-term contracts with its customers |
| In this regard, Acushnet Company, Ping and Callaway Golf, who collectively represent approximately of 56prca of the Company’s net sales in 2005, each purchased from at least two other graphite shaft suppliers |
| In the event Acushnet Company, Ping, and Callaway Golf or any other significant customer increases purchases from its other suppliers or adds additional suppliers, the Company could be adversely affected |
| Although the Company believes that its relationships with its customers are good, the loss of a significant customer or a substantial decrease in sales to a significant customer could have a material adverse effect on the Company’s business and operating results |
| In addition, sales by the Company’s major customers are likely to vary dramatically from time to time due to fluctuating public demand for golf equipment generally and for their specific products |
| Competition Aldila operates in a highly competitive environment for golf equipment sales |
| The Company believes that it 9 ______________________________________________________________________ competes principally on the basis of its ability to provide a broad range of high quality, performance graphite shafts, its ability to deliver customized products in large quantities and on a timely basis, the acceptance of graphite shafts in general, and Aldila shafts in particular, by professionals and other golfers, whose preferences are to some extent subjective, and finally, price |
| Aldila competes against both domestic and foreign shaft manufacturers |
| Some of the Company’s current and potential competitors may have greater resources than Aldila |
| The Company also faces potential competition from those golf club manufacturers that currently purchase golf shaft components from outside suppliers but that may have, develop or acquire, the ability to manufacture shafts internally |
| As the Company further enters into the manufacture and sale of prepreg products, it competes with other producers of prepregs, many of which have substantially greater research and development, managerial and financial resources than the Company and represent significant competition for the Company |
| New Product Introduction The Company believes that the introduction of new, innovative golf shafts using graphite or other composite materials will be critical to its future success |
| While the Company emphasizes research and development activities in connection with carbon fiber and other composite material technology, there can be no assurance that the Company will continue to develop competitive products or that the Company will be able to develop or utilize new composite material technology on a timely or competitive basis or otherwise respond to emerging market trends |
| Although the Company believes that it has generally achieved success in the introduction of its customized graphite golf shafts, specifically, the Aldila NV^TM line of golf shafts, no assurance can be given that the Company will be able to continue to design and manufacture products that meet with market acceptance, either on the part of club manufacturers or golfers |
| The design of new graphite golf shafts is also influenced by rules and interpretations of the United States Golf Association (“USGA”) |
| There can be no assurance that any new products will receive USGA approval or that existing USGA standards will not be altered in ways that adversely affect the sales of the Company’s products |
| Reliance on Offshore Manufacturing Facilities The Company operates manufacturing facilities in Tijuana, Mexico and Zhuhai, People’s Republic of China |
| The Company pays certain expenses of these facilities in Mexican pesos and Chinese renminbis, respectively, which are subject to fluctuations in currency value and exchange rates |
| The facility in Tijuana, Mexico operates pursuant to the “maquiladora” duty-free program established by the Mexican and United States governments |
| Such program enables 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’s Republic of China in a special economic zone, which affords special advantages to companies with regards to income taxes, import and export duties and value added taxes |
| There can be no assurance that the governments of Mexico or the People’s Republic of China will continue the programs currently in place or that the Company will continue to be able to benefit from these programs |
| The loss of these benefits could have an adverse effect on the Company’s business |
| The Company is also subject to other customary risks of doing business outside the United States, including political instability, other import/export regulations and cultural differences |
| Raw Material Cost/Availability The Company’s gross profit margins, in part, are dependent on the price paid for carbon fiber purchased from outside vendors, and more substantially starting in the latter part of 1998, the cost of production of carbon fiber at the Evanston, Wyoming facility, CFT, including the price paid for the acrylic fiber used for the manufacture of carbon fiber and the other costs associated with the operation of the carbon fiber plant |
| The Company experienced an increase in carbon fiber prices in 1996 and 1997 due to the growth experienced in the use of carbon fiber coupled with relatively little excess capacity |
| The prices paid by the Company for carbon fiber leveled in 1998 and decreased during 1999 through 2002, due to excess capacity in the carbon fiber manufacturing industry |
| However, that trend reversed itself in the later part of 2003 |
| The Company experienced carbon fiber price increases in certain grades of carbon fiber prices during the later part of 2003 and through 2005 |
| Management is not able to predict the timing or extent of any future price changes for carbon fiber; however, the Company could be negatively impacted if carbon fiber prices continue to increase and the Company is not able to pass along these increases to its customers due to competition |
| The Company also has relationships with other outside vendors for its additional carbon fiber needs through 2005 and beyond |
| Depending on market conditions prevailing at the time and extent to which production at CFT meets expectations, the Company may face difficulties in obtaining adequate supplies of carbon fiber from external sources to provide for any carbon fiber needs not met internally |
| If it appears that CFT is not likely to satisfy a significant portion of the Company’s needs or if it appears that there will not be adequate availability in the market, the Company may not have made arrangements in advance for the purchase of material amounts of carbon fiber from alternative sources |
| 10 ______________________________________________________________________ In addition, the Company is dependent on its internal production of graphite prepreg to support its shaft manufacturing operations and has not secured adequate additional sources of supply should its production of prepreg be interrupted for any reason |
| The exposure to the Company resulting from its increasing reliance on its own internal production of the raw materials for its golf shaft business is enhanced because the Company currently operates only one prepreg facility and has an interest in only one carbon fiber manufacturing facility |
| Until recently, there has been excess-capacity in these industries |
| In the past, significant market shortages of both carbon fiber and graphite prepreg have occurred and if they re-occur, it could have a negative impact on the Company’s financial statements |
| Joint Venture Operating Carbon Fiber Facility The Company started producing carbon fiber at its Evanston, Wyoming facility in 1998 |
| Since October 1999, this facility has been operated by a joint venture, 50prca owned by each of the Company and SGL As a result of the operation of this facility through the joint venture, the Company is subject to business and financial risks, such as the risks that SGL will be unable to meet its obligations to the joint venture, that there will be operational difficulties resulting from the split ownership, raw material supply problems, changes in demand for carbon fiber based products, or that there will be differences of opinion between the joint venture partners as to future operations leading to an inability to make decisions when required or to the making of decisions not in the best interests of both joint venture partners |
| Reliance on Carbon Fiber Manufacturing Facility Until recently, during the period in which the Company or the joint venture has operated the Evanston, Wyoming facility, the market for carbon fiber products has been soft, which has limited the Company’s ability to take full advantage of the opportunity offered by the vertical integration of its carbon fiber raw material usage in graphite golf shafts |
| If the facility does not produce high quality fiber at the anticipated volumes, either because of production shortfalls or limited demand for the facility’s carbon fiber, the per pound cost of the fiber produced will likely be higher due to the substantial fixed costs involved in operating a carbon fiber production facility |
| In addition, if the facility is not capable of producing carbon fiber at sufficient volumes to satisfy the demands of both venture partners, the Company would be required to purchase additional fiber from third party suppliers, which may not be available in sufficient quantities to satisfy its demands and could result in higher marginal costs to the Company than fiber acquired from the joint venture |
| In addition, if CFT is unable to obtain precursor, the significant raw material consumed in the carbon fiber manufacturing process, it could have a material adverse effect on the Company’s business |
| Potential Cash Flow Shortages The Company has cash, cash equivalents and marketable securities totaling dlra15dtta8 million as of December 31, 2005 |
| Management anticipates that these sources of funds, when combined with cash flow generated from operations, will be sufficient to finance its business operations at least through 2006 |
| If the Company is not able to generate the expected cash flows from operations, the Company could be adversely affected |
| Shaft Manufacturing by Club Companies and One-Stop Shops Another factor that could have a negative impact in the future on the Company’s sales to golf club manufacturers would be a decision by one of its customers to manufacture all or a portion of their graphite shaft requirements, or to have an increased amount of their requirements filled from one-stop shops (where main components, shaft or head, of the golf club could be purchased and assembled) |
| While the Company has not to date experienced any material decline in its sales for these reasons, should any of the Company’s major customers decide to meet any significant portion of their shaft needs either internally or through one-stop shops, it could have a material adverse impact on the Company and its financial results |
| Utilization of Certain Hazardous Materials In the ordinary course of its manufacturing processes, the Company uses hazardous substances and generates hazardous waste |
| The Company has not to date incurred any material liabilities under environmental laws and regulations and believes that it is in substantial compliance with applicable laws and regulations |
| Nevertheless, no assurance can be given that the Company will not encounter environmental problems or incur environmental liabilities in the future, which could adversely affect its business |
| 11 ______________________________________________________________________ Dependence on Discretionary Consumer Spending Sales of golf equipment have historically been dependent on discretionary spending by consumers, which may be adversely affected by general economic conditions |
| The Company believes that golf equipment sales have remained flat in recent periods and may continue to be so in the future |
| A decrease in consumer spending on golf equipment or, in particular, a decrease in demand for golf clubs with graphite shafts could have an adverse effect on the Company’s business and operating results |
| Reliance on Key Personnel The success of the Company is dependent upon its senior management team, as well as its ability to attract and retain qualified personnel |
| There is competition for qualified personnel in the golf shaft industry as well as the carbon fiber business |
| There is no assurance that the Company will be able to retain its existing senior management personnel or to attract additional qualified personnel |
| Justice Department Investigation During 1999 the Company received a subpoena for documents from the Antitrust Division of the US Department of Justice in connection with the on-going investigation of an alleged price fixing conspiracy in the carbon fiber and graphite prepreg industries |
| The Department of Justice has informed the Company that it is not currently a target of the investigation, although it has indicated that it has not cleared the Company of any involvement in the alleged conspiracy |
| The Company is cooperating with the Department of Justice’s investigation |