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Aldila 10-Q 2008
UNITED STATES Washington, D.C. 20549
FORM 10-Q
ALDILA, INC. (Exact name of registrant as specified in its charter)
14145 DANIELSON ST. SUITE B, POWAY, CALIFORNIA 92064 (Address of principal executive offices)
Registrant’s telephone number, including area code – 858-513-1801
Registrant’s website – www.aldila.com
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
Common shares outstanding as of November 7, 2008 was — 5,174,183
ALDILA, INC. Form 10-Q for the Quarterly Period Ended September 30, 2008
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ALDILA, INC. AND SUBSIDIARIES (In thousands, except share data)
See notes to consolidated financial statements.
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ALDILA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED (In thousands, except per share data)
See notes to consolidated financial statements.
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ALDILA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED (In thousands)
See notes to consolidated financial statements.
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ALDILA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
1. Basis of Presentation
The consolidated balance sheet as of September 30, 2008 and the consolidated statements of operations for the three and nine month periods ended September 30, 2008 and 2007 and the consolidated statements of cash flows for the nine month periods ended September 30, 2008 and 2007, are unaudited and reflect all adjustments of a normal recurring nature which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The consolidated balance sheet as of December 31, 2007 was derived from the Aldila, Inc. and subsidiaries’ (the “Company’s”) audited financial statements. Operating results for the interim periods presented are not necessarily indicative of results to be expected for the fiscal year ending December 31, 2008. These consolidated financial statements should be read in conjunction with the Company’s December 31, 2007 consolidated financial statements and notes thereto included in the Company’s Annual Report and filed on Form 10-K with the Securities and Exchange Commission.
Recent Accounting Pronouncements
Effective January 1, 2008, we adopted Statement of Financial Accounting Standards (“FAS”) No. 157, Fair Value Measurements (“FAS 157”). In February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position FAS 157-2, Effective Date of FASB Statement No. 157, which delayed the effective date of FAS 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until January 1, 2009. We have not yet determined the impact that the implementation of FAS 157-2 will have on our non-financial assets and liabilities which are not recognized on a recurring basis; however, we do not anticipate the adoption to significantly impact our consolidated financial statements. The adoption of FAS 157 did not have a material effect on the Company’s results of operations.
2. Restatement of Previously Issued Consolidated Financial Statements
The Company’s consolidated statement of cash flows for the nine month period ended September 30, 2007 has been restated from the statement of cash flows that was originally included in the Company’s quarterly report filed on Form 10-Q for the period ended September 30, 2007. The Company restated its quarterly information in Note 13 of the Company’s notes to consolidated financial statements included in the Company’s 2007 Annual Report and filed on Form 10-K. The restatement affected cash flows from operating and investing activities for the period ended September 30, 2007.
3. Inventories
Inventories consist of the following (in thousands):
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4. Property, Plant and Equipment
Property, plant and equipment consist of the following (in thousands):
5. Accrued Expenses
Accrued expenses consist of the following (in thousands):
(1) Warranty reserve rollforward
6. Debt
The Company entered into a Credit and Security Agreement (“Credit Facility”) with KeyBank National Association (“Key Bank”) effective February 8, 2008. The Credit Facility is comprised of a Term Loan Commitment (“Term Loan”) of $5.0 million and a Maximum Revolving Amount (“Revolver”) of $10.0 million, for a total Credit Facility of $15.0 million. The Credit Facility is for a term of 5 years, terminating on February 8, 2013. The Company’s assets serve as collateral for the Credit Facility. The interest rate of borrowing against the Credit Facility can be either at a Base Rate or Eurodollar Rate. Base Rate is defined as a rate per annum equal to the greater of (a) the Prime Rate or (b) one-half of one percent (.50%) in excess of the Federal Funds Effective Rate. Eurodollar Rate is a LIBOR rate plus 1.75%. The Company must maintain certain Financial Covenants (“Covenants”) in accordance with the Credit Facility, which are as follows; a Leverage Ratio which cannot exceed 2.0 to 1.0, a Fixed Charge Coverage Ratio not to be less than 1.2 to 1.0 and the Company must maintain a Minimum Cash Balance equal to or greater than $5.0 million. As of September 30, 2008, the Company was in compliance with all Covenants. The Credit Facility was filed as exhibit 10.24 in the Company’s 2007 Annual Report filed on Form 10-K.
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Short term debt
Long term debt
Revolver – The Company has borrowed $4.0 million against the Revolver as of September 30, 2008, with $2.5 million maturing on October 30, 2008 at an interest rate of 5.45% and $1.5 million maturing on November 30, 2008 at an interest rate of 5.47%. The weighted average interest rate of the Company’s short term borrowings is 5.46%. The Company must pay a .25% commitment fee for the average unused portion of the Revolver for any given period. On October 30, 2008, the Company paid the $2.5 million of the Revolver, which matured on such date. As of November 1, 2008 the Company had a remaining balance of $1.5 million outstanding against the Revolver.
Term Loan – The Company borrowed $5.0 million during the first quarter of 2008 against the Term Loan. The interest rate of the Term Loan is LIBOR plus 1.75% and adjusts each month. As of September 30, 2008, the interest rate was 4.33%. The Company must make monthly payments of $83,333 plus interest. The Company has paid $667,000 against the Term Loan in 2008.
7. Stockholders’ Equity
On February 11, 2008, the Company announced a $5.00 special cash dividend payable to shareholders of record on February 25, 2008. The special dividend qualifies as a change in capitalization in accordance with the 1994 Stock Option Plan. On October 7, 2008, the Compensation Committee of the Company’s Board of Directors modified all outstanding stock options issued prior to May 30, 2008, subject to the Internal Revenue Service Code regulations for the incentive stock options that were modified.
The Company paid $25.8 million for the aforementioned special cash dividend to shareholders during the first quarter period ended March 31, 2008. The Company also paid two $0.15 quarterly dividends per share during the first half of 2008; however, the Company did not declare any dividends relative to the third quarter. On August 21, 2008, the Company announced that it was discontinuing its quarterly dividend of $.15 per share.
8. Accounting for Stock-Based Compensation
On January 1, 2006 the Company adopted FAS No.123R (Revised 2004), “Share Based Payment,” (“FAS 123R”), using the modified prospective method. In accordance with FAS No. 123R, the Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award — the requisite service period. The Company determines the grant-date fair value of employee share options using the Black-Scholes option-pricing model.
There were no capitalized stock-based compensation costs as of September 30, 2008 and 2007, respectively. The Company granted 10,002 non-qualified stock options on May 30, 2008 to its Board of Directors in accordance with the Company’s stock option plan. The Company issued 28,980 shares of restricted stock awards to employees during the period ended September 30, 2008. As noted in Note 7, the Compensation Committee of the Company’s Board of Directors modified all outstanding stock options issued prior to May 30, 2008. The modification will result in additional compensation expense of approximately $100,000, which the Company will begin recording during the fourth quarter of 2008. The Company recognizes stock-based compensation expense using the straight line attribution method. The remaining
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unrecognized compensation cost related to unvested awards at September 30, 2008 was approximately $681,000; such expense will be recognized over a weighted average period of 1.8 years. This amount does not include the cost of any additional options or restricted stock awards that may be awarded in future periods nor any changes in the Company’s forfeiture rate. The Company’s FAS123R expense was $123,000 and $210,000 for the nine month periods ended September 30, 2008 and 2007, respectively.
Stock Option Activity
Cash proceeds, tax benefits and intrinsic value of related total stock options exercised during the three and nine month periods ended September 30, 2008 and 2007, respectively, are as follows (in thousands):
The following table summarizes the stock option transactions during the nine month period ended September 30, 2008:
The fair value of stock options at date of grant was estimated using the Black-Scholes model. The Company had utilized the short cut method of determining the expected life of stock options in the past, in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 107 (“SAB 107”). SAB 107 allowed the short cut method to be used for stock option grants through December 31, 2007. As such, the Company has estimated the expected life of its grants in 2008 based upon historical exercise data. The risk free interest rate is based on the U.S. Treasury constant maturity for the expected life of the stock option. Expected volatility is based on the historical volatilities of the Company’s common stock. The Company determined in August 2008 to suspend dividend payments so going forward expected dividend yield will be nil. Below is the information for the stock option grants for 2008 and 2007.
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Restricted Stock Activity
Restricted stock awards were issued to employees under the Company’s Plan. Restricted stock awards vest over three years and are subject to the employees’ continuing service to the Company. The cost of restricted stock awards is determined using the fair value of the Company’s common stock on the date of the grant. The compensation expense is recognized ratably over the vesting period. A summary of the status of and changes in restricted stock units granted under the Company’s Plan as of and during the nine month period ended September 30, 2008 is presented below:
9. Segment Reporting
The Company classifies its business into two segments based on products offered; Composite Products and Composite Materials. The Composite Products segment is primarily comprised of sales of graphite golf shafts for the 2008 period and sales of graphite golf shafts and hockey sticks for the 2007 period. The Company discontinued its hockey product line during the second quarter of 2007. The Composite Materials segment is comprised of external sales of prepreg uni-tapes, fabrics, film adhesives and the Company’s formerly 50% interest in Carbon Fiber Technology LLC (“CFT”). The Company sold its 50% interest in CFT to its joint venture partner during the fourth quarter ended December 31, 2007. As such, the Composite Materials numbers reported for 2008 does not reflect the benefit of owning CFT. The Company evaluates performance based on profit or loss from operations. The Company does not evaluate inter-segment sales and historically has not tracked such sales. The Composite Materials segment produces the majority of its materials for the Composite Products segment. Certain SG&A costs and other shared support costs are recorded initially in the Composite Products segment and allocated for segment reporting. Segment long-lived assets are comprised of property, plant and equipment. The long-lived assets of the Composite Materials segment also support the Composite Products segment as the Composite Materials segment manufactures the majority of the raw material prepreg consumed by the Composite Products segment.
Segment Operating Results
Three Month Periods Ended September 30, 2008 and 2007
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Nine Month Periods Ended September 30, 2008 and 2007
Segment Long-Lived Assets
10. Income Taxes
The Company adopted the provisions of FIN 48 on January 1, 2007, and has analyzed filing positions in all of the federal, state, and foreign jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. As of the date of adoption, the Company had approximately $754,000 of unrecognized tax benefits including interest. For the period ended December 31, 2007, the Company recorded an additional unrecognized tax benefit of $210,000 including interest.
If the Company were to recognize these tax benefits, it would favorably affect the annual effective income tax rate. Prior to the adoption of FIN 48, the Company had recorded its liability for unrecognized tax benefits in its income taxes payable/receivable line item on the face of the Company’s balance sheet. In accordance with FIN 48, the unrecognized tax benefits that do not relate to temporary differences should be classified as either a current or non-current liability. As such, the Company has recorded an other current liability of $137,000 and an other long term liability of $827,000 as of December 31, 2007. As of September 30, 2008, such amounts were $137,000 and $1.4 million, respectively. The changes to Company’s unrecognized tax benefits during the third quarter ended September 30, 2008 are as follows:
Notes [1] The increase in the reserve is associated with R&D credits taken for California for the tax years 2001-2007. The Company has been under audit from the California Franchise Tax Board (“FTB”) since 2007 for the 2001-2004 taxable years and received the preliminary results of the audit, disallowing a portion of the credit. The Company is still appealing the decision as the audit has not been finalized. However, it appears more than likely than not that some of the credit will be disallowed. As such, the Company is reserving for it in the current period.
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The Company does not anticipate material changes to the Company’s unrecognized tax positions that it has taken during the period. However, as noted above, the Company is in the appeal process with the FTB. If the Company has a positive outcome during the appeal process, it may be able to recognize the tax position related to the FTB audit. The Company’s practice is to recognize interest related to income tax matters in income tax expense. During the nine month period ended September 30, 2008, the Company recognized approximately $56,000 of additional interest associated with uncertain tax positions. As of September 30, 2008 and December 31, 2007, the Company had approximately $129,000 and $73,000, respectively, accrued for interest.
Item 2. Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations
The Company’s MD&A is comprised of significant accounting estimates made in the normal course of its operations, overview of the Company’s business conditions, results of operations, liquidity and capital resources and contractual obligations. The Company is disclosing segment information for two segments. Composite Products is comprised of sales of golf shafts, hockey sticks and other composite products. The Company discontinued the sale of hockey sticks as of the second quarter ended June 30, 2007. As such, there are no sales of hockey sticks reflected in the Composite Products sales for 2008. Composite Materials is comprised of external sales of prepreg products in the forms of uni-tapes, fabrics and film adhesives along with contributions from its interest in Carbon Fiber Technology LLC (“CFT”). The Company sold its interest in CFT during the fourth quarter ended December 31, 2007 to its joint venture partner. As such, the Composite Materials numbers reported for 2008 do not reflect the benefit from owning CFT.
Significant Accounting Estimates
We prepared the consolidated financial statements of the Company in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented.
We have several significant accounting estimates, such as; revenue recognition, accounts receivable and inventories, which were discussed in the 2007 Annual Report filed on Form 10-K, that are both important to the portrayal of our financial condition and results of operations and require management’s most difficult, subjective and complex judgments. Typically, the circumstances that make these judgments complex and difficult involve making estimates about the effect of matters that are inherently uncertain. During the nine months ended September 30, 2008, there where not any significant changes related to the aforementioned significant accounting estimates previously made that would have a material impact on our consolidated financial position, results of operations, cash flows or our ability to conduct business. However, during the three months ended September 30, 2008, The Company increased its liability for uncertain tax positions during the three month period ended September 30, 2008. The change was attributed to a change in prior year estimates and additional tax positions taken. The change in prior year estimates is associated with R&D credits taken for California for the tax years 2001-2007. The Company has been under audit from the California Franchise Tax Board since 2007 for the 2001-2004 taxable years and received the preliminary results of the audit, disallowing a portion of the credit. The Company is still appealing this decision as the audit has not been finalized. The Company does not anticipate that these amounts will change materially during the next twelve months, however, should the Company win their appeal the accrual will change in that future period.
Overview - Business ConditionsComposite Products
The Composite Products segment is mainly comprised of graphite golf shafts and, to a lesser extent, hockey sticks, (see discussion below regarding the Company’s decision to exit the hockey business). The graphite shaft market consists of customized OEM production shafts, both premium and value and Aldila branded and co-branded shafts. The Company sells customized OEM production and co-branded shafts directly to its OEM customers and sells Aldila branded shafts through the OEM custom stock and custom fit programs and to distributors. In 2003, the Company re-emerged as an innovator in the branded segment of the business, in which shafts tend to sell at higher prices and have higher gross margins than the customized OEM production shafts sold to club manufacturers. The Company’s recent branded shaft offerings are as follows:
Branded Shaft Offerings
· Aldila NVÒ and NVÒ Line extensions.
· Introduced in 2003, featuring the Company’s exclusive Micro Laminate TechnologyÒ. · Has had numerous Tour victories
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· The Company introduced NVÒ line extensions in 2004, including the NVSä, NV ProtoPypeÒ, Pink NVÒ, NVÒ Irons and NVÒ Hybrid shafts. · The Aldila NVÒ can be considered one of the most successful shaft introductions ever.
· VS ProtoTM and the VS ProtoTM Hybrid
· Introduced and began shipping in 2006 · High performance shaft featuring carbon nanotubes as well as aerospace carbon fibers and the Company’s exclusive high performance resin systems. · Used by the winner of the 2006 U.S. Open.
· DVS® and DVS® Hybrid
· Introduced late in the fourth quarter 2007. · Features carbon nanotubes and an innovative tip design for extra kick at impact - with optimum launch. · Used by Aldila advisory staff member, Paula Creamer, for 4 LPGA wins to date in 2008.
· VooDoo
· Initially introduced on Tour only. · Becoming one of the most popular shafts on the PGA Tour. · Already used to win 8 events since its introduction. · Began shipping to customers in the third quarter of 2008.
Hybrid shafts are included in branded shafts. The Company’s branded hybrid shafts have been the most popular hybrid shafts on Tour for the last several years, often times outpacing the nearest competitor at a two to one margin. The Company’s success in Branded Shafts has led to tremendous success on Tour over the past several years.
Tour Play
· 2006 Tour Play
· PGA, LPGA and Nationwide Tour professionals using Aldila shafts won a total of 32 Tour events.
· 2007 Tour Play
· Tour professionals using Aldila shafts won 19 events on the PGA Tour and nearly fifty percent of all the events on the Nationwide Tour. · Aldila shafts were also the most popular shafts for woods and hybrid clubs at every Major Championship on the PGA Tour. · Aldila shafts were used by the winner of the Masters and the U.S. Open as well as the winner of the World Golf Championship-Accenture Match Play Championship. · Aldila advisory staff member, Paula Creamer, won the SBS Open and led the U.S. Women’s team to victory in the Solheim Cup playing her Pink NV® woods. · Aldila was also the shaft of choice for the majority of players in both woods and hybrids at the 2007 PGA Club Professional Championship. · At the 2007 U.S. Men’s Amateur, Aldila was the leading shaft choice for hybrids. · During the U.S. Public Links Championship, Aldila was the most popular wood and hybrid shaft. · Aldila was also the leading shaft at the NCAA Division 1 Men’s Championship in both woods and hybrids and the leading driver shaft at the NCAA Women’s Championship. · Aldila shafts were included on the Golf Digest Hot List and won Golf Tips Magazine’s Technology Award.
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· 2008 Tour Play
· Aldila has enjoyed a great start to the 2008 Tour season. · On the PGA Tour, players using Aldila shafts have won 12 events including the World Golf Championship-CA Championship and the Verizon Heritage by Aldila advisory staff member, Boo Weekley. · Players using Aldila shafts have also won 12 events on the Nationwide Tour and 12 events on the Champions Tour. · On the LPGA Tour we have won 17, and Paula Creamer, an Aldila advisory staff member, has won four events.
Our entire high performance line has done well with Tour players winning using our NV®, VS Proto™, DVS®, MOI Proto and VooDoo shafts.
Competition
The Company tries to maintain a broad customer base in both the OEM production shaft and branded shaft market segments and competes aggressively with foreign-based shaft manufacturers for OEM production shafts and branded shafts. However, the Company’s sales have tended to be concentrated among a limited number of major club companies, thus making the Company’s results of operations dependent on those customers, their continued willingness to purchase a significant portion of their shafts from the Company, and their success in selling clubs containing the Company’s shafts to their customers. In 2007, net sales to Acushnet Company, Ping and Callaway Golf, represented 21%, 18% and 13% of the Company’s net sales, respectively, and the Company anticipates that these companies will continue, collectively, to represent the largest portion of its sales in 2008.
Although it is generally difficult to predict in advance the success of any particular club or of any particular manufacturer, the Company believes that it is protected to some extent from normal periodic fluctuations in sales among the various golf club companies by virtue of the broad depth and range of its customer base. Golf club companies regularly introduce new clubs, frequently containing innovations in design. Sometimes these new clubs achieve dramatic success in the marketplace, thus increasing the overall volatility of club sales among the major companies. While the Company seeks to have its shafts represented on as many major product introductions as possible, it can provide no assurance that its shafts will be included in any particular “hot” club or that sales of a “hot” club that does not include the Company’s shafts will not have a negative impact on the sales of those clubs that do. The Company’s sales could also suffer a significant drop-off from period to period to the extent that they may be dependent in any period on sales of one or more “hot” clubs, which then tail off in subsequent periods and at the same time, new offerings fail to achieve a high level of new sales sufficient to exceed or replace the previous sales levels of “hot” clubs.
During the 1990’s, the graphite golf shaft industry became increasingly competitive, placing extraordinary pressure on the selling prices of the Company’s golf shafts and adversely affecting its gross profit margins and level of profitability. The competition on OEM production stock offerings was very tough, with selling price often times being the most critical factor. This had the effect of reducing the Company’s average selling prices during the 1990s. Customers shifted away from branded shafts to customized OEM production shafts. As the Company re-emerged in 2003 in the branded shaft segment, the Company was able to achieve higher average selling prices. In late 2004, the Company began to offer its OEM customers co-branded shafts for their stock offerings. The introduction of co-branded shafts and the continued success in the branded segment had the effect of increasing the Company’s net sales and average selling prices over prior years. The competition in the branded segment of the business has increased as there are a lot of good branded shafts in the marketplace, with the Company’s considered amongst the best. The Company’s average selling price decreased by approximately 10% for the nine month period ended September 30, 2008 as compared to the comparable period for 2007. The majority of this is attributed to a shift away from branded and co-branded shafts in the Company’s mix of shafts. As the Company’s branded and co-branded shafts typically sell at higher selling prices than OEM production shafts, a significant change in product mix in any one period will have the effect of increasing or decreasing the average selling price of shafts sold. In addition, increases and decreases in carbon fiber prices passed on to its customers could also have the effect of increasing or decreasing average selling prices in the future. If the Company is unable to pass along carbon fiber prices to its customers, it could have an adverse impact on the Company’s gross margin.
The Company’s response to the pricing pressure it faced during the 1990’s, and continues to face, has been to vertically integrate, reduce its cost structure and to focus on continued penetration of the branded and co-branded shaft segments. The vertical integration began in 1994 when the Company started manufacturing prepreg, the principal raw material in the manufacture of graphite golf shafts, at its facility in Poway, California. (See Composite Materials). In
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addition to the Company’s efforts to reduce its costs through vertical integration, the Company also reduced its cost structure by shifting more of its shaft production to lower cost labor markets, such as Mexico, China and in 2007, Vietnam.
In addition to golf shafts, the Company also manufactured hockey sticks for one customer. The Company began manufacturing and selling hockey sticks in 2002. The Company had not seen a significant increase in sales of hockey sticks and was not satisfied with the status of its hockey business during 2007 and discontinued this product line in the second quarter of 2007.
Composite Materials
The Composite Materials segment is comprised of external sales of prepreg, film adhesives, fabrics and other materials and in 2007 the contribution provided by the Company’s 50% owned interest in CFT. The Company sold its 50% interest in CFT to its joint venture partner on November 30, 2007. As such, the Composite Materials segment will not benefit from contributions from CFT after that date. The Company historically has not tracked inter-segment sales and has always looked at the contribution provided by Composite Materials based upon the external sales of materials. The Company records all shared costs to Composite Products and allocates certain costs for segment reporting, such as shipping, purchasing and other administrative costs based upon the net revenues of each segment. Costs that are specific to one segment are charged directly to the respective segment.
The Company began to manufacture composite materials in 1994. Initially, the prepreg produced was mainly consumed by the Composite Products segment. Until the current year, 2008, the Company’s external sales of prepreg and other materials had increased over the past several years. Sales of prepreg as a percentage of net sales were 15% for the nine month period ended September 30, 2008 versus 15% for the nine month period ended September 30, 2007. The Company has spent a significant amount of money over the past several years to increase the capacity of its prepreg operations in support of its external sales of prepreg and Composite Products operations. Over the last several years, the Company has put in place two prepreg production lines, a second resin filmer and completed the installation of a wide prepreg tape line during the first quarter of 2008. The prepreg lines add to the Company’s capacity of prepreg to support both the Composite Materials and Composite Products segments. The additional resin filmer will support the Company’s wide tape line and provide redundancy as the Company had previously only one resin filmer. In addition, the wide tape line will allow the Company to enter some markets it has previously not been able to get into.
The Company continues to look for opportunities to sell its prepreg and film adhesive products to other fabricators of products manufactured from composite materials. The Company has achieved some success in these areas and management believes that growth opportunities in these areas will continue to exist. In addition, management believes that vertical integration through its prepreg operation has been successful to date and is allowing the Company to maintain, or in some cases enhance, its competitive position with respect to the major United States golf club companies that are its principal customers.
In addition to vertical integration through prepreg, in 1998 the Company established a manufacturing facility in Evanston, Wyoming for the production of carbon fiber , which is a significant raw material used in the prepreg production process. On October 29, 1999, SGL Carbon Fibers and Composites, Inc. (“SGL”) purchased a 50% interest in the Company’s carbon fiber manufacturing operation. On November 30, 2007, SGL purchased the remaining 50% of CFT from the Company. As part of the sale, the Company signed a five year supply agreement with CFT, which allows but does not require the Company to purchase up to 900,000 pounds of carbon fiber in year 1 and 996,000 pounds of carbon fiber in years 2-5.
Results of Operations
Third Quarter 2008 Compared to Third Quarter 2007
Net Sales
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Net sales decreased by $1.4 million, or 11%, for the three month period ended September 30, 2008 (“2008 Quarter”) as compared to the three month period ended September 30, 2007 (“2007 Quarter”). The decrease in sales was attributed to decreases in Composite Products and Composite Materials sales. The decrease in the Composite Products sales of $591,000 is mainly attributed to a change in product mix in 2008 as compared to 2007 and to a lesser extent a 3% decrease in shaft unit sales. The Company’s average selling price of golf shaft sales decreased by 2% in the 2008 Quarter as compared to the 2007 Quarter. There were decreases in sales of branded and OEM products, which were partially offset by an increase in sales of co-branded products. A weak economy and decreased industry retail sales compared to last year negatively impacted our sales. Our sales continued to be hurt by slowing sales of second selling season OEM shaft programs. New shaft programs slowly began to ship during the end of the 2008 Quarter. Branded golf and co-branded shaft sales decreased to 33% of Composite Products sales for the 2008 Quarter as compared to 35% for the 2007 Quarter. Composite Materials sales decreased by $846,000, or a 38% decrease. The majority of our Composite Materials business is to customers in the recreational products industry. Our customers businesses have been impacted by the weak economy similar to what is impacting the Composite Products segment. We believe this to be temporary and our investments made in terms of capacity and personnel will resume their momentum as economic factors improve for our customer base. Composite Materials have decreased to approximately 12% of the Company’s consolidated net revenues for the 2008 Quarter as compared to 17% for the 2007 Quarter.
Gross Profit
Total gross profit decreased by approximately $2.3 million, or 69% in the 2008 Quarter as compared to the 2007 Quarter. The decrease was attributed to a decrease in Composite Products gross profit of $1.6 million and a decrease in Composite Materials gross profit of $737,000. The decrease in Composite Products gross profit was mainly attributed to increased manufacturing costs attributed to lower volumes of Composite Products and Composite Materials and a change in manufacturing mix, with a larger percentage of shafts manufactured in Mexico in the 2008 Quarter as compared to the 2007 Quarter and to a lesser extent a shift in product mix sold during the quarter. Branded and co-branded shafts typically sell at higher selling prices and contribute more to gross profit. Composite Products gross margin decreased to 8% for the 2008 Quarter as compared to 22% for the 2007 Quarter. The Company’s Vietnam factory continues to ramp up as new shaft programs are being qualified and its production should increase in the fourth quarter of 2008. As the Company moves more of its manufacturing to Vietnam, it should help to offset the rising costs in China and the higher costs associated with Mexico, which should improve the Company’s gross profit in the future. The Company recorded $139,000 for inventory reserves in the 2008 Quarter as compared to $77,000 for the 2007 Quarter. The Composite Materials gross profit decreased by approximately $737,000, or 74%, in the 2008 Quarter as compared to the 2007 Quarter. The decrease was mainly attributed to a decrease in sales of Composite Materials and to a lesser extent the loss of contribution provided by the operations of CFT in 2008 versus 2007. The Company sold its remaining 50% interest in CFT to its joint venture partner during the fourth quarter of 2007, as such, the Composite Materials segment will not benefit from CFT during 2008 as compared to 2007.
Operating (Loss)Income
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Operating income decreased by approximately $2.5 million, or 355%, in the 2008 Quarter as compared to the 2007 Quarter. The decrease was attributed to a decrease in gross profit of $2.3 million and an increase in SG&A of $132,000. SG&A increased as a percentage of revenues to 24% in the 2008 Quarter as compared to 21% for the 2007 Quarter. SG&A expenses increased by $132,000 in the 2008 Quarter as compared to the 2007 Quarter, all of which is attributed to an increase in advertising and promotion in support of the Company’s branded shafts. SG&A expense, excluding advertising and promotion, decreased by approximately 2% for the 2008 Quarter as compared to the 2007 Quarter.
Other Income (Expense)
Other Income decreased by approximately $315,000, or 90%, for the 2008 Quarter as compared to the 2007 Quarter. The majority of the decrease was attributed to the decrease in interest income, a decrease in equity in earnings of joint venture and an increase in interest expense. The decrease in interest income is attributed to having less cash invested during the 2008 Quarter as compared to the 2007 Quarter. The increase in interest expense is attributed to interest associated with the Company’s credit facility it established during the first quarter of 2008.
Income Taxes
The Company recorded a benefit for income taxes in the amount of $643,000 in the 2008 Quarter as compared to a provision for income taxes of $359,000 for the 2007 Quarter. The Company records its provision for income taxes in interim periods based upon its estimated annual effective rate. The Company also records interest expense for its unrecognized tax benefits in the provision for income taxes. The amount of expense for the 2008 Quarter and 2007 Quarter was approximately $31,000 and $13,000, respectively. The Company had an increase in its accrual for unrecognized tax benefits of $630,000 during the 2008 Quarter. The increase was attributed to a revision of prior year estimates and tax positions taken during the 2008 Quarter. The revision of prior year estimates is associated with the California R&D credit for the tax years 2001-2007. The Company has been under audit from the California Franchise Tax Board (“FTB”) since 2007 for the taxable years 2001-2004 and received a preliminary finding during the quarter. The FTB is disallowing a portion of the Company’s R&D credits taken. The Company is currently appealing the finding.
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Nine Month Period Ended September 30, 2008 compared to the Nine Month Period Ended September 30, 2007
Net Sales
Net sales decreased by $9.4 million, or 18%, for the nine month period ended September 30, 2008 (“2008 Period”) as compared to the nine month period ended September 30, 2007 (“2007 Period”). The decrease in sales was attributed to decreases in Composite Products and Composite Materials sales. The decrease in the Composite Products sales of $7.8 million was mainly attributed to decreases in branded and co-branded shaft sales, which were partially offset by an increase in OEM shaft sales. The Company’s average selling price of golf shaft sales decreased by 10% in the 2008 Period as compared to the 2007 Period on a 5% decline in unit sales. A weak economy and decreased industry retail sales compared to last year impacted our sales. Our sales continued to be hurt by slowing sales of second selling season OEM shaft programs. New shaft programs began delivery in the late third quarter of the 2008 Period. Branded golf and co-branded shaft sales decreased to 33% of Composite Products sales for the 2008 Period as compared to 47% for the 2007 Period. In addition, the 2007 Period benefited from $1.7 million of hockey stick sales as compared to zero for the 2008 Period. Composite Materials sales decreased by $1.6 million, or a 21% decrease. The majority of our Composite Materials business is to customers in the recreational products industry. Our customers businesses have been impacted by the weak economy similar to what is impacting the Composite Products segment. We believe this to be temporary and our investments made in terms of capacity and personnel will resume their momentum as economic factors improve for our customer base. Composite Materials sales was approximately 15% of the Company’s consolidated net revenues for the 2008 Period and the 2007 Period. The Company completed the installation of a wide prepreg tape line in the first quarter of 2008 and anticipates that this will enable the Company to get into different composite material markets in the future.
Gross Profit
Total gross profit decreased by approximately $8.3 million, or 50% in 2008 Period as compared to the 2007 Period. The decrease was attributed to decrease in Composite Products and Composite Materials gross profit. The decrease in Composite Products gross profit was mainly attributed to the decrease in branded and co-branded sales in the 2008 Period as compared to 2007 Period. In addition, the Composite Products gross profit in the 2007 Period benefited from approximately $250,000 in gross profit from hockey stick sales in the 2007 Period. As noted before, the Company discontinued its hockey stick sales during the second quarter of 2007. In addition, the 2008 Period has been impacted by increased manufacturing costs attributed to lower manufacturing volumes of Composite Products and Composite Materials. Composite Products gross margin decreased to 19% for the 2008 Period as compared to 29% for the 2007 Period. The Company’s Vietnam factory is ramping up and many of the Company’s customers have toured this facility and have come away impressed. The Company plans to continue to move more of its manufacturing to Vietnam, which should help to offset the rising costs in China and improve the Company’s gross profit in the future. The Company recorded additional inventory reserves of $355,000 in the 2008 Period as compared to $436,000 for the 2007 Period. The Composite Materials gross profit decreased by approximately $2.1 million, or 56% in the 2008 Period as compared to the 2007 Period. The decrease was mainly attributed to a decrease in contribution provided by the operations of CFT and to a lesser extent, gross profit provided by composite materials sales. The Company sold its remaining 50% interest in CFT to its joint venture partner during the fourth quarter of 2007. As such, the Composite Materials segment did not benefit from CFT during the 2008 Period.
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Operating (Loss) Income
Operating income decreased by approximately $8.8 million, or 130%, in the 2008 Period as compared to the 2007 Period. The decrease was mainly attributed to a decrease in gross profit of $8.3 million and an increase in SG&A of $529,000. SG&A increased as a percentage of revenues to 24% in the 2008 Period as compared to 19% for the 2007 Period. SG&A expenses were higher in the current period, which was primarily driven by front-loaded marketing programs, in support of the DVS® shaft and launch of the VooDoo shaft, and increases in selling expenses. The Company anticipates that its advertising and promotion expenses will be higher for the year ended December 31, 2008 as compared to the same period in 2007. In the 2008 Period, advertising and promotion expenses were 30% higher than the 2007 Period. Excluding the increases in advertising and promotion expenses, SG&A decreased by 4% in the 2008 Period as compared to the 2007 Period. That decrease was attributed to lower incentive expenses in the 2008 Period as compared to the 2007 Period, which was partially offset by an increase in professional fees associated with the Company’s establishment of a credit facility and restatement of its previously issued financial statements during the first quarter of 2008.
Other Income (Expense)
Other Income decreased by approximately $775,000, or 78%, for the 2008 Period as compared to the 2007 Period. The majority of the decrease was attributed to the decrease in interest income, a decrease in equity in earnings of joint venture and an increase in interest expense. The decrease in interest income is attributed to having less cash invested during the 2008 Period as compared to the 2007 Period. The decrease in cash invested was attributed to the special dividend the Company paid out during the first quarter of 2008. The increase in interest expense is attributed to interest associated with the Company’s credit facility it established during the first quarter of 2008.
Income Taxes
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The Company recorded a benefit for income taxes in the amount of $637,000 in the 2008 Period as compared to a provision for income taxes of $2.8 million for the 2007 Period. The Company’s effective tax rate was 36% for the 2008 Period as compared to 35% for the 2007 Period. The Company records its provision for income taxes in interim periods based upon it estimated annual effective rate. The Company also records interest expense for its unrecognized tax benefits in the provision for income taxes. The amount of expense for the 2008 Period and 2007 Period was approximately $56,000 and $39,000, respectively. The Company had an increase in its accrual for unrecognized tax benefits of $630,000 during the 2008 Period. The increase was attributed to a revision of prior year estimates and tax positions taken during the 2008 Period. The revision of prior year estimates is associated with the California R&D credit for the tax years 2001-2007. The Company has been under audit from the California Franchise Tax Board (“FTB”) since 2007 for the taxable years 2001-2004 and received a preliminary finding during the quarter. The FTB is disallowing a portion of the Company’s R&D credits taken. The Company is currently appealing the finding.
Liquidity and Capital Resources
Cash and cash equivalents (“cash”) decreased by approximately $22.4 million as of September 30, 2008 as compared to December 31, 2007. The decrease in cash was mainly attributed to dividend payments of $27.3 million, capital spending of approximately $1.2 million and income tax payments of $4.8 million, which was partially offset by net borrowings of $8.3 million under the Company’s credit facility with Key Bank. The Company entered into the credit facility with Key Bank on February 8, 2008. (See note 6 to the consolidated financial statements.)
The Company used approximately $1.2 million for capital expenditures during the 2008 Period as compared to $5.1 million during the 2007 Period. The majority of the capital expenditures in 2008 were attributed to investment in the Composite Products segment. The Company has spent approximately $900,000 in support of Composite Products and $346,000 for Composite Materials, which was attributed to the aforementioned final installation of the wide tape line. Management anticipates that capital expenditures will not exceed $1.5 million for 2008.
The Company declared and paid a special $5.00 cash dividend to shareholders during the 2008 Period. The special dividend payments to shareholders totaled $25.8 million. In addition to the special dividend, the Company paid two $0.15 per share quarterly dividends during the 2008 Period. The Company’s dividend policy is reviewed quarterly during the Company’s Board of Directors meetings and subject to Board approval. The Company announced on August 21, 2008 that it was discontinuing its quarterly dividend. The Company borrowed $12.0 million from Key Bank during the 2008 Period to help support the special dividend paid and paid back $3.7 million during the 2008 Period. The borrowing is comprised of a term loan and a revolving line of credit. The Company borrowed $5.0 million against the term loan, which is payable over a five year period. The Company makes monthly principal payments of $83,333 plus interest to Key Bank against the term loan. The Company borrowed $7.0 million against the revolving line of credit during the 2008 Period and the Company paid back $3.0 million during the 2008 Period. The Company made $667,000 in principal payments against its term loan.
We believe that our cash available from future operating and financing activities will be adequate to meet our anticipated requirements for working capital, capital expenditures, debt service and the payment of any future dividends, if granted by the Company’s Board of Directors. There can be no assurance, however, that our business will continue to generate cash flows at current levels. If we are unable to generate sufficient cash flow from operations, we may be required to sell assets, reduce capital expenditures or obtain additional financing and there is no assurance we will be able to do so on a timely basis or on satisfactory terms.
Recent Accounting Pronouncements
Effective January 1, 2008, we adopted Statement of Financial Accounting Standards (“FAS”) No. 157, Fair Value Measurements (“FAS 157”). In February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position FAS 157-2, Effective Date of FASB Statement No. 157, which delayed the effective date of FAS 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until January 1, 2009. We have not yet determined the impact that the implementation of FAS 157-2 will have on our non-financial assets and liabilities which are not recognized on a recurring basis; however, we do not anticipate adoption to significantly impact our consolidated financial statements. The adoption of FAS 157 did not have a material effect on the Company’s results of operations.
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Seasonality
Because the Company’s customers have historically built inventory in anticipation of purchases by golfers in the spring and summer, the principal retail selling season for golf equipment, the Company’s operating results have been affected by seasonal demand for golf clubs, which has generally resulted in the Company’s highest sales occurring in the first and second quarter. The timing of customers’ new product introductions has frequently mitigated the impact of seasonality in recent years.
Backlog
As of September 30, 2008, the Company had a sales backlog of approximately $9.7 million compared to approximately $12.2 million as of September 30, 2007. The Company believes that the dollar volume of its current backlog will be shipped over the next three months. Orders can typically be cancelled without penalty up to 30 days prior to shipment. Historically, the Company’s backlog generally has been highest in the first and second quarters, due in large part to seasonal factors. Due to the timing and receipt of customer orders, backlog is not necessarily indicative of future operating results.
“Safe Harbor” Statement Under the Private Securities Litigation Reform Act of 1995
With the exception of historical information (information relating to the Company’s financial condition and results of operations at historical dates or for historical periods), the matters discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations may contain forward-looking statements that necessarily are based on certain assumptions and are subject to certain risks and uncertainties. These forward-looking statements are based on management’s expectations as of the date hereof, that necessarily contain certain assumptions and are subject to certain risks and uncertainties. The Company does not undertake any responsibility to update these statements in the future. The Company’s actual future performance and results could differ from that contained in or suggested by these forward-looking statements as a result of a variety of factors.
The Company’s Report on Form 10-K for the year ended December 31, 2007 (the “Form 10-K”) presents a more detailed discussion of these and other risks related to the forward-looking statements in this 10-Q, in particular under “Risk Factors” in Part I, Item 1A of the Form 10-K and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 7 of the Form 10-K. The forward-looking statements in this 10-Q are particularly subject to the risks that:
· our product offerings, including the NV®, VS Proto™, DVS®, VooDoo shaft lines and product offerings outside the golf industry, will not achieve or maintain success with consumers or customers; · we will not maintain or increase our market share at our principal customers; · demand for clubs manufactured by our principal customers will decline, thereby affecting their demand for our shafts; · demand for composite materials by our principal customers will decline; · the market for graphite shafts will continue to be extremely competitive, affecting selling prices and profitability; · our international operations will be adversely affected by political instability, currency fluctuations, export/import regulations or other risks typical of multi-national operations, particularly those in less developed countries; · the Company will not be able to acquire adequate supplies of carbon fiber at reasonable market prices; · acts of terrorism, natural disasters, or disease pandemics interfere with our manufacturing operations or our ability to ship our finished products.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
There have been no material changes from the information that was disclosed in the Company’s Annual Report for the period ended December 31, 2007 filed on Form 10-K.
Item 4. Controls and Procedures
(a) As of the end of the period covered by this report, Aldila management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that as of June 30, 2008 such disclosure controls and procedures were effective in alerting them on a timely basis to material information relating to Aldila required to be included in Aldila’s periodic filings under the Exchange Act.
(b) There have been no material changes in the Company’s internal controls over financial reporting, which could significantly affect internal controls subsequent to the date the Company carried out its evaluation.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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