10-Q 1 dhb10q.txt FORM 10-Q 09-30-05 ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _________________________ FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED September 30, 2005 Commission File No. 001-13112 DHB INDUSTRIES, INC. (Exact name of Registrant as specified in its charter) DELAWARE 11-3129361 (State or other jurisdiction (I.R.S. Employer of incorporation) Identification No.) 400 POST AVENUE, SUITE 303, WESTBURY, NY 11590 (Address of principal executive offices) Registrant's telephone number: (516) 997-1155 Former name, former address and former fiscal year, if changed since last report: Not applicable Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.) Yes [ X ] No [ ] As of November 7, 2005, there were 45,337,575 shares of Common Stock, $.001 par value, outstanding. ================================================================================ INDEX PART I. FINANCIAL INFORMATION Page ---- Item 1. Financial Statements Condensed Consolidated Balance Sheets as of September 30, 2005 (Unaudited) and December 31, 2004 3 Unaudited Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 2005 and 2004 4 Unaudited Condensed Consolidated Statements of Cash Flows For the Nine Months Ended September 30, 2005 and 2004 5 Notes to Unaudited Condensed Consolidated Financial Statements 6-16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16-22 Item 3. Quantitative and Qualitative Disclosures about Market Risk 23 Item 4. Controls and Procedures 24-25 PART II. OTHER INFORMATION Item 1. Legal Proceedings 25-27 Item 2. Changes in Securities and Use of Proceeds 27 Item 3. Defaults Upon Senior Securities 27 Item 4. Submission of Matters to a Vote of Security Holders 27 Item 5. Other Information 27 Item 6. Exhibits 27 Signatures 28 2
ITEM 1. FINANCIAL STATEMENTS DHB INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data) September 30, December 31, 2005 2004 ------------- ------------ (Unaudited) ASSETS Current assets Cash and cash equivalents $ 5,488 $ 447 Accounts receivable, less allowance for doubtful accounts of $4,695 and $702, respectively 30,953 47,560 Accounts receivable - related party -- 6,583 Inventories 75,944 85,973 Deferred income tax assets 23,231 483 Prepaid expenses and other current assets 2,452 1,220 -------- -------- Total current assets 138,068 142,266 -------- -------- Property and equipment, net 2,370 2,632 -------- -------- Other assets Deferred income tax assets 1,092 593 Deposits and other assets 638 366 -------- -------- Total other assets 1,730 959 -------- -------- Total assets $142,168 $145,857 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Current maturities of term loan payable $ 8,000 $ 4,000 Obligation to repurchase convertible preferred stock 3,000 -- Warranty payable 36,730 -- Accounts payable 7,462 8,014 Accrued expenses and other current liabilities 10,395 8,350 Income taxes payable 8,783 14,816 -------- -------- Total current liabilities 74,370 35,180 -------- -------- Long-term liabilities Notes payable-bank -- 25,634 Term loan payable 7,000 6,500 Other liabilities 1,149 1,086 -------- -------- Total liabilities 82,519 68,400 -------- -------- Commitments and contingencies Minority interest in consolidated subsidiary 297 431 Stockholders' equity Convertible preferred stock, $0.001 par value, 5,000,000 shares authorized, 500,000 shares of Series A, 12% convertible preferred stock issued and outstanding; liquidation preference $3,000 -- 1 Common stock, $0.001 par value, 100,000,000 shares authorized, 45,337,575 and 45,282,536 issued and outstanding 45 45 Additional paid in capital 72,628 35,540 Deferred compensation (28,237) -- Retained earnings 14,916 41,440 -------- -------- Total stockholders' equity 59,352 77,026 -------- -------- Total liabilities and stockholders' equity $142,168 $145,857 ======== ======== (See Notes to Condensed Consolidated Financial Statements)
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DHB INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (In thousands, except share and per share data) For the Three Months Ended For the Nine Months Ended September 30, September 30, 2005 2004 2005 2004 ---------- ---------- ---------- ---------- Net sales $ 90,263 $ 89,410 $ 263,924 $ 249,879 Cost of goods sold (includes related party purchases of $1,999, $6,290, $13,873, and $20,799, respectively) 65,615 64,537 191,859 180,361 ---------- ---------- ---------- ---------- Gross profit 24,648 24,873 72,065 69,518 Selling, general and administrative expenses 25,445 11,591 47,649 32,353 Cost of vest replacement program 60,000 -- 60,000 -- ---------- ---------- ---------- ---------- Income (loss) before other income (expense) (60,797) 13,282 (35,584) 37,165 ---------- ---------- ---------- ---------- Other income (expense) Interest expense (525) (389) (1,714) (1,047) Other income (loss) 6 41 33 55 ---------- ---------- ---------- ---------- Total other income (expense) (519) (348) (1,681) (992) ---------- ---------- ---------- ---------- Income(loss) before income taxes and minority interest (61,316) 12,934 (37,265) 36,173 Income taxes (benefit) expense (19,407) 4,728 (10,877) 13,850 ---------- ---------- ---------- ---------- Income (loss) before minority interest of subsidiary (41,909) 8,206 (26,388) 22,323 Minority interest of subsidiary 258 (58) 134 (156) ---------- ---------- ---------- ---------- Net (loss) income (41,651) 8,148 (26,254) 22,167 Dividend - convertible preferred stock (90) (90) (270) (270) ---------- ---------- ---------- ---------- Income (loss) available to common stockholders $ (41,741) $ 8,058 $ (26,524) $ 21,897 ========== ========== ========== ========== Earnings (loss) per common share: Basic $ (0.92) $ 0.20 $ (0.59) $ 0.54 ========== ========== ========== ========== Diluted $ (0.92) $ 0.18 $ (0.59) $ 0.49 ========== ========== ========== ========== Weighted average shares outstanding: Basic shares 45,312,536 40,891,896 45,302,437 40,814,675 Effect of convertible preferred stock -- 500,000 -- 500,000 Warrants -- 4,570,213 -- 4,299,798 ---------- ---------- ---------- ---------- Diluted shares 45,312,536 45,962,109 45,302,437 45,614,473 ========== ========== ========== ========== (See Notes to Condensed Consolidated Financial Statements)
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DHB INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands, except share and per share data) For the Nine Months Ended September 30, 2005 2004 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ (26,254) $ 22,167 Adjustments to reconcile net income to net cash and cash equivalents provided by (used in) operating activities: Depreciation and amortization 620 708 Amortization of deferred financing costs 18 113 Provision for doubtful accounts (5,397) 49 Minority interest of subsidiary (134) -- Stock issued for services 369 156 Stock compensation expense 11,295 -- Deferred income tax (benefit) expense (23,248) (125) Changes in operating assets and liabilities Accounts receivable 28,587 (19,964) Inventories 10,029 (27,217) Prepaid expenses and other current assets (1,232) 20 Deposits and other assets (290) (31) Warranty payable 36,730 -- Accounts payable (552) 5,135 Income taxes payable (6,033) 5,407 Accrued expenses and other current liabilities 2,045 2,347 Other liabilities 63 431 ---------- ---------- Net cash provided by (used in) operating activities 26,616 (10,804) ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment (358) (1,735) ---------- ---------- Net cash used in investing activities (358) (1,735) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid on preferred stock (270) (270) Payments on notes payable - bank (256,378) (183,862) Proceeds of notes payable - bank 229,744 184,740 Proceeds of term loan 8,500 12,500 Issuance costs of long-term debt -- (83) Payments on long-term debt (3,000) (1,000) Proceeds upon the exercise of warrants 187 160 ---------- ---------- Net cash provided (used) by financing activities (21,217) 12,185 ---------- ---------- Net increase (decrease) in cash and cash equivalents 5,041 (354) Cash and cash equivalents at beginning of the period 447 441 ---------- ---------- Cash and cash equivalents at end of the period $ 5,488 $ 87 ========== ========== (See Notes to Condensed Consolidated Financial Statements)
5 DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements of DHB Industries, Inc. and subsidiaries (collectively "DHB" or the "Company") as of September 30, 2005 and for the three months and nine months ended September 30, 2005 and 2004 have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP"). The unaudited financial statements include all adjustments, consisting only of normal and recurring adjustments, which, in the opinion of management, were necessary for a fair presentation of financial condition, results of operations and cash flows for such periods presented. However, these results of operations are not necessarily indicative of the results for any other interim period or for the full year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been omitted in accordance with published rules and regulations of the Securities and Exchange Commission (the "SEC"). These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Form 10-K and amendments thereto for the year ended December 31, 2004 filed with the SEC on March 17, 2005. The Company received a comment letter from the Securities and Exchange Commission dated August 18, 2005. The Company is in the process of researching the issues raised and drafting an appropriate response. The condensed consolidated financial statements and accompanying footnotes contained in this Form 10-Q do not contain any adjustment, if any, that may result from the resolution of the issues and questions contained in that comment letter. NOTE 2. STOCK BASED COMPENSATION The Company accounts for stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations ("APB No. 25"), and has adopted the disclosure provisions of Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123" ("SFAS No. 148"). Under APB No. 25, compensation expense is only recognized when the market value of the underlying stock at the date of grant exceeds the amount an employee must pay to acquire the stock. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options and warrants which have no vesting restrictions and are fully transferable. In addition, the Black-Scholes option valuation model requires the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock warrants have characteristics significantly different from those of traded warrants and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock warrants. 6 The weighted-average warrant fair values and assumptions used to estimate these values are as follows: DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 2. STOCK BASED COMPENSATION - (Continued) Warrants Issued During 2005 2004 ---- ---- Risk-free interest rate 3.70% 3.12% Expected volatility of common stock 80.14% 93.96% Dividend yield 0.00% 0.00% Expected option term 4.96 years 4.3 years The Company's net income and earnings per share would have been reduced to the pro forma amounts shown below if compensation cost had been determined based on the fair value at the grant dates in accordance with SFAS No. 123 and 148, "Accounting for Stock-Based Compensation."
For the Three Months For the Nine Months Ended September 30, Ended September 30, 2005 2004 2005 2004 -------- ------ -------- ------- Net income (loss) $(41,651) $ 8,148 $(26,524) $22,167 Add: compensation expense included in net income (loss) as reported 11,295 -- 11,295 -- Deduct: compensation determined under fair value based method for all awards, net of related tax effect 12,196 22 12,658 1,630 -------- ------ -------- ------- Net income (loss) pro forma (42,552) 8,126 (27,887) 20,537 Less dividend - preferred stock 90 90 270 270 -------- ------ -------- ------- Income (loss) available to common stockholders, pro forma $(42,642) $ 8,036 $(28,157) $20,267 -------- ------ -------- ------- Basic earnings per common share As reported $ (0.92) $ 0.20 $ (0.59) $ 0.54 Pro forma $ (0.94) $ 0.20 $ (0.62) $ 0.50 Diluted earnings per common share As reported $ (0.92) $ 0.18 $ (0.59) $ 0.49 Pro forma $ (0.94) $ 0.18 $ (0.62) $ 0.45
Pro forma compensation expense may not be indicative of pro forma expense in future years. For purposes of estimating the fair value of each warrant on the date of grant, the Company utilized the Black-Scholes option-valuation model. 7 DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 3. STOCK AND STOCK WARRANTS Warrants As previously disclosed, the CEO and Chairman this year exercised the contractual right under his 2000 employment agreement to extend the agreement for an additional 5-year term, expiring on July 1, 2010. As a result, pursuant to the terms of the 2000 employment agreement, the CEO and Chairman was issued on July 1, 2005 options to purchase 5,250,000 common shares with an exercise price of $1.00 per share vesting 1,500,000 immediately and 750,000 on each anniversary, thereafter. The intrinsic value of the warrants that vested immediately was approximately $11,295 which was included as a non-cash compensation expense during the third quarter ended September 30, 2005. The intrinsic value of the remaining 3,750,000 shares is $28,237 and is recorded as Additional paid in capital and deferred compensation in the equity section of the balance sheet at September 30, 2005. In addition, on July 29, 2005, the shareholders of the Company approved its 2005 Omnibus Stock Option Plan ("the 2005 Plan"). Pursuant to the 2005 Plan, our officers, directors, employees and/or consultants and/or those of our subsidiaries would be able to receive incentive stock options, non-qualified stock options, restricted stock awards, deferred stock awards, bonus stock, stock appreciation rights (SARs), dividend equivalents, and/or other stock-based awards with respect to up to an aggregate of 2,500,000 shares of the Common Stock. In each fiscal year during any part of which the 2005 Plan is in effect, no participant may be granted: (i) options or stock appreciation rights with respect to more than 1,000,000 shares or (ii) restricted stock performance awards and/or other stock-based awards with respect to more than 1,000,000 shares. In addition, the maximum dollar value payable to any one participant with respect to any performance period with respect to any performance awards is $1,000,000 multiplied by the number of full years in the performance period. Pursuant to this plan, the President of DHB was issued 300,000 warrants exercisable at $7.66 per share, vesting 100,000 warrants per annum commencing May 24, 2008, which expire May 24, 2010. Also issued to two key employees in August 2005, were warrants to purchase 30,000 shares each exercisable at $7.11 per share vesting 10,000 warrants per annum, per person August 5, 2006, which expire August 5, 2010. During the quarter ended September 30, 2005, 550,000 of the warrants issued on May 24, 2005 were cancelled. Still outstanding are 200,000 warrants exercisable at $7.66 per share, vesting 100,000 warrants per annum commencing May 24, 2006, which expire May 24, 2009. In addition the warrants issued on June 2, 2005 were cancelled, (600,000 warrants with an exercise price of $7.69 expiring June 2, 2010, and vesting 100,000 warrants on September 2, 2005 and 100,000 warrants on every anniversary date commencing June 2, 2006). During the nine months ended September 30, 2004, the six members of the Company's Board of Directors were issued 50,000 warrants each, exercisable at $5.88 per share for five years. During the nine month periods ended September 30, 2005 and 2004, employees exercised warrants to purchase 30,000 and 80,000 shares, respectively of the Company's unregistered common stock at an average price of $6.26 and $2.00 per share, respectively. 8 DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 3. STOCK WARRANTS - continued During the three and nine months ended September 30, 2005, 525,000 warrants outstanding were not included in the computation of diluted earnings per share because their effect would have been anti-dilutive, since the strike prices were above the average fair market value of DHB's stock price. During the three and nine months ended September 30, 2004 all outstanding warrants were included in the computation of diluted earnings per share. During the nine months ended September 30, 2005, the Company issued 25,040 unregistered shares of its common stock in a non-cash settlement of a lawsuit with a former consultant. The value of this settlement was approximately $369 and is included in selling, general and administrative expenses during the quarter ended March 31, 2005. No unregistered shares were issued during the nine months ended September 30, 2004 other than the stock warrant issuances described above. The following table summarizes information regarding stock warrants outstanding at September 30, 2005.
Weighted Average Weighted Number of Remaining Average Number of Weighted Exercise Price Warrants Contractual Exercise Shares Average Range Outstanding Life Price Exercisable Exercise Price 0 to $1.00 5,250,000 5.00 $1.00 1,500,000 $1.00 $1.01 to $1.50 -- -- $1.41 -- $1.41 $1.51 to $2.00 100,000 1.75 $2.00 100,000 $2.00 $2.01 to $2.50 5,000 3.10 $2.01 -- $2.01 $2.51 to $3.00 -- -- $3.00 -- $3.00 $3.01 and above 932,000 1.73 $6.86 350,000 $5.97 --------- ---- ----- --------- ----- Totals 6,287,000 5.00 $1.83 1,950,000 $1.89 ========= ==== ===== ========= =====
NOTE 4. SUPPLEMENTAL CASH FLOW INFORMATION
For the Nine Months Ended September 30, 2005 2004 ------- ------ Cash paid for: Interest $ 1,706 $ 1,069 Taxes 14,307 9,866 Non-cash financing and investing activities: Revolving credit loan refinanced to long-term debt $ 8,500 $12,500 Obligation to repurchase convertible preferred stock 3,000 --
9 DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 5. INVENTORIES Inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) method and are summarized as follows: September 30 December 31, 2005 2004 ------------ ------------ Raw materials and supplies $24,741 $31,695 Work in process 15,685 18,815 Finished goods 35,518 35,463 ------- ------- $75,944 $85,973 ======= ======= At September 30, 2005 the Company wrote off approximately $19,200,000 in Zylon(R) inventory, as a result of the Company's voluntary Zylon(R) vest replacement program announced in August 2005. NOTE 6. OBLIGATION TO REPURCHASE CONVERTIBLE PREFERRED STOCK. On January 14, 2002, the principal stockholder of the Company exchanged $3,000 of the indebtedness due him for 500,000 shares of Series A, 12% Convertible Preferred Stock. The Series A, 12% Convertible Preferred Stock has a dividend rate of $0.72 per share per annum, an amount equal to the interest that would have been payable on the exchanged indebtedness. The shares of Series A, 12% Convertible Preferred Stock are redeemable at the option of the Company on December 15 of each year. At September 30, 2005, the Board of Directors has approved the redemption of the Convertible Preferred Stock on December 15, 2005. Therefore the convertible Preferred Stock is listed as an obligation under current liabilities at the redemption amount equal to $6 per share, or $3,000. NOTE 7. LONG-TERM DEBT On March 15, 2005, the Company amended its bank credit agreement (the "Credit Agreement"), which increased the total borrowing limits from $45,000 to $55,000. Pursuant to the Credit Agreement, the Company may borrow, on a revolving basis, up to $37,000 on 85% of eligible accounts receivable (the "Credit Facility"), and the Company borrowed a term loan in the principal amount of $18,000 (repaying the $12.5 million dollar term loan), amortizing at the rate of $2,000 per quarter commencing July 2005. This agreement will expire on October 1, 2007. Borrowings under the Credit Agreement bear interest, at the Company's option, at the bank's prime rate (6.75% at September 30, 2005) or LIBOR plus 1.75% per annum on the Credit Facility, and at the bank's prime rate or LIBOR plus 2.25% on the term loan. At September 30, 2005, the Company had a LIBOR loan outstanding on the credit facility at a rate of 6.124%. The borrowings under the Credit Agreement are collateralized by a first security interest in substantially all of the assets of the Company. 10 DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 7. LONG-TERM DEBT - (continued) On November 3, 2005, the Company amended its Credit Agreement, to exclude the non-cash compensation charge and the Zylon(R) replacement charge from the financial covenants calculations and issuing a waiver as of September 30, 2005 for failure to comply with such covenants as a result of the aforementioned charges. The interest rate on the term loan was reduced from LIBOR plus 2.25%, to LIBOR plus 1.75%. The amendment also allows the Company to purchase in the open market in accordance with applicable law up to three million shares of the Company's common stock provided there are no events of default and the share purchase program shall not exceed $9 million to the extent the purchase price is funded through the credit facility. NOTE 8. SEGMENT INFORMATION The Company operates in two principal segments: ballistic-resistant equipment, and protective athletic and sports products. Net sales, income before other income (expense), depreciation and amortization expense, interest expense, income taxes, and identifiable assets for each of the Company's segments are as follows:
For The Three Months For The Nine Months Ended September 30, Ended September 30, ------------------------ ------------------- 2005 2004 2005 2004 -------- -------- -------- -------- NET SALES Ballistic-resistant equipment $ 87,420 $ 87,585 $256,467 $244,528 Protective athletic & sports products 2,843 1,825 7,457 5,351 -------- -------- -------- -------- Consolidated net sales $ 90,263 $ 89,410 $263,924 $249,879 ======== ======== ======== ======== INCOME (LOSS) BEFORE OTHER INCOME (EXPENSE) Ballistic-resistant equipment $(45,494) $ 15,773 $(15,052) $ 45,013 Protective athletic & sports products 176 260 712 879 Corporate and other (1) (15,479) (2,751) (21,244) (8,727) -------- -------- -------- ------- Consolidated income before other income (expense) $(60,797) $ 13,282 $(35,584) $ 37,165 ======== ======== ======== ======== DEPRECIATION AND AMORTIZATION EXPENSE Ballistic-resistant equipment $143 $193 $ 424 $ 474 Protective athletic & sports products 6 33 20 94 Corporate and other 60 55 176 140 -------- -------- -------- -------- Consolidated depreciation and amortization expense $ 209 $ 281 $ 620 $ 708 ======== ======== ======== ======== INTEREST EXPENSE Ballistic-resistant equipment $ 406 $ 386 $ 1,593 $ 1,042 Protective athletic & sports products -- -- -- -- Corporate and other (1) 119 3 121 5 -------- -------- -------- -------- Consolidated interest expense $ 525 $ 389 $ 1,714 $ 1,047 ======== ======== ======== ======== 11 DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 8. SEGMENT INFORMATION - Continued INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST Ballistic-resistant equipment $(49,676) $ 10,590 $(28,586) $ 28,479 Protective athletic & sports products 176 260 713 873 Corporate and other (1) (11,816) 2,084 (9,392) 6,821 -------- -------- -------- -------- Consolidated income before income tax (benefit) expense $(61,316) $ 12,934 $(37,265) $ 36,173 ======== ======== ======== ======== INCOME TAX (BENEFIT) EXPENSE Ballistic-resistant equipment $ 497 $ 935 $ 1,792 $ 2,143 Protective athletic & sports products 75 -- 76 -- Corporate and other (1) (19,979) 3,793 (12,745) 11,707 -------- -------- -------- -------- Consolidated income tax (benefit) expense $(19,407) $ 4,728 $(10,877) $ 13,850 ======== ======== ======== ======== September 30, 2005 December 31, 2004 ------------------ ----------------- IDENTIFIABLE ASSETS Ballistic-resistant equipment $113,153 $138,370 Protective athletic & sports products 6,413 5,018 -------- -------- 119,566 143,388 Corporate and other (2) 22,602 2,469 -------- -------- Consolidated total assets $142,168 $145,857 ======== ======== (1) Corporate and other expenses include corporate general and administrative expenses. (2) Corporate and other assets are principally deferred income tax assets and property and equipment.
NOTE 9. CONTINGENCIES Since September 9, 2005, a number of purported class action lawsuits were filed in the United States District Court for the Eastern District of New York against the Company and certain of the Company's officers and directors. The actions purport to be filed on behalf of purchasers of the Company's publicly traded securities during the period from April 21, 2004 through August 29, 2005. The complaints, which are substantially similar to one another, allege, among other things, that the Company's public disclosures were false or misleading because they did not disclose certain information. The lawsuits allege that DHB's body armor products were defective and failed to meet the standards of its customers, and that these alleged facts should have been publicly disclosed. The Company has been served with a number of these complaints. No class has been certified in the actions. The lawsuits seek compensatory damages plus interest and attorneys' fees. The Company believes that the lawsuits are baseless and intends to vigorously defend against them. Because of their similarity, the Company believes that most or all of the lawsuits will be consolidated into a single action and that the Company will not be required to defend against all of the lawsuits individually. The Company cannot predict the outcome of the lawsuits or whether the Company's financial condition or results of operations may be materially affected as a result of the lawsuits. 12 DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 9. CONTINGENCIES - continued Since September 14, 2005, a number of derivative complaints were filed in the United States District for the Eastern District of New York against certain officers and directors of the Company and, in certain cases, Weiser LLP. The allegations in the complaints are substantially similar and include the Company as a nominal defendant. The complaints allege, among other things, that defendants breached their fiduciary duties and engaged in fraud, misrepresentation, insider trading, misappropriation of corporate information, waste of corporate assets, abuse of control, and unjust enrichment, asserting claims substantially similar to those asserted in the actions described above under "Securities Litigation." The complaints seek monetary damages and various forms of equitable and/or injunctive relief, restitution to the Company and disgorgement of profits earned by defendants, and fees and costs. The Company believes that the lawsuits are baseless and intends to vigorously defend against them. Because of their similarity, the Company believes that most or all of the lawsuits will be coordinated and/or consolidated into a single action. The Company cannot predict the outcome of the lawsuits or whether the Company's financial condition or results of operations may be materially affected as a result of the lawsuits. On or about August 29, 2005, Southern States Police Benevolent Association, Inc., et al. ("Southern States") filed a Class Action Complaint against Protective Apparel Corporation of America, Inc. and Point Blank Body Armor, Inc. ("Defendants"), alleging that the National Institute of Justice ("NIJ") decertified all bullet resistant vests containing Zylon. Southern States further alleged that the test results released by the NIJ demonstrated that all of Defendants' Zylon-containing vests fail to comply with their certifications and warranties. Southern States brought causes of action for breach of warranty on label in vest, breach of warranty in warranty statement, breach of implied warranty of merchantability, breach of implied warranty of fitness for a particular purpose, and for injunctive relief. On or about October 19, 2005, Defendants filed an answer and affirmative defenses denying that Defendants are in breach of any warranty and denying that injunctive relief is proper. On October 20, 2005, the Court entered a Consent Order Certifying Class Action. The certified classes include all law enforcement personnel and organizations, and other individuals, who purchased new ballistic resistant soft body armor containing Zylon from the Defendants, except for federal agencies and any persons who have been physically injured as a result of defects in their vests. The parties are engaged in settlement negotiations. The Company has recorded a $36.7 million reserve for this settlement during the quarter ended September 30, 2005, which is part of the $60 million cost of the vest replacement program. 13 DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 9. CONTINGENCIES - continued On January 3, 2005, a class action lawsuit was filed against us in the Circuit Court of the Seventeenth Judicial Circuit in Broward County, Florida by a police organization and individual police officers, alleging concerns regarding the effectiveness and durability of body armor with high concentrations of Zylon in the Company's bullet-resistant soft body armor (vests). Point Blank Body Armor settled a class action lawsuit involving a total of less than 2,000 vests containing a high concentration of Zylon. Pursuant to the settlement, class members have been exchanging the vests for a choice of four other vests made by the company. Class members have also been receiving two extra carriers, as well as a 10 percent discount certificate. The final date for class members to submit a claim form was August 21, 2005. This settlement did not have a material adverse effect on its financial position. The Company is currently the subject of an investigation by the Securities and Exchange Commission, with respect to certain related party transactions and executive compensation matters regarding the Company and affiliates of Mr. David H. Brooks, the Company's Chief Executive Officer and Chairman. The Company and Mr. Brooks are cooperating with the Securities and Exchange Commission in this investigation. In addition, the Audit Committee periodically monitors the status, terms and performance of related party transactions to assess the benefits to the Company and the related party's compliance with its contractual obligations. The Company is involved in other litigation, none of which it considers to be material or believes would, if adversely determined, have a material adverse effect on its financial condition or operations. NOTE 10. COST OF VEST REPLACEMENT PROGRAM The cost of the vest replacement program is a separate line item under selling, general and administrative expenses, for a total pre-tax charge of $60,000,000, or ($0.76) per diluted share after tax charge, as a result of the Company's voluntary Zylon(R) vest replacement program announced in August 2005. The composition of this charge is as follows: a $36,700,000 reserve for vests containing Zylon(R), the write-off of approximately $19,200,000 in Zylon(R) inventory, and a $4,100,000 increase in the accounts receivable allowance. NOTE 11. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during each reporting period. Actual results could differ from those estimates. 14 DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 12. RECENTLY ISSUED ACCOUNTING STANDARDS In December 2003, the Financial Accounting Standards Board issued FASB Interpretation Number 46-R ("FIN 46-R") "Consolidation of Variable Interest Entities." FIN 46-R, which modifies certain provisions and effective dates of FIN 46, sets forth criteria to be used in determining whether an investment in a variable interest entity should be consolidated. These provisions are based on the general premise that if a company controls another entity through interests other than voting interests, that company should consolidate the controlled entity. The Company believes that currently, it does not have any material arrangements that meet the definition of a variable interest entity, which would require consolidation. In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - An Amendment of ARB No. 43, Chapter 4" (SFAS No. 151). SFAS No. 151 requires all companies to recognize a current-period charge for abnormal amounts of idle facility expense, freight, handling costs and wasted materials. This statement also requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 will be effective for fiscal years beginning after June 15, 2005. The Company does not expect the adoption of this statement to have a material effect on its consolidated financial statements. In December 2004, the FASB issued SFAS No.123(R), "Share-Based Payment" (SFAS No. 123(R). This statement replaces SFAS No. 123 and supersedes APB 25. SFAS 123 (R) requires all stock-based compensation to be recognized as an expense in the financial statements and that such compensation be measured according to the grant-date fair value of stock options. SFAS 123 (R) will be effective for annual periods beginning after June 15, 2005. While the Company currently provides the pro forma disclosures required by SFAS No. 148 on a quarterly basis (see "Note 1 Stock Based Compensation"), and it is currently evaluating the impact this statement will have on its consolidated financial statements, the impact to the financial statements could be material in light of the recent wards of stock warrants and options to employees and the applicable vesting schedules. (See Note 2) In December 2004, the FASB issued SFAS No. 153, "Exchanges on Nonmonetary Assets - An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions" (SFAS 153) SFAS eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, "Accounting for Nonmonetary Transactions," and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of this statement to have a material effect on its consolidated financial statements. 15 DHB INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 12. RECENTLY ISSUED ACCOUNTING STANDARDS - (Continued) In March 2005, the FASB issued Interpretation No. 47 ("FIN 47), "Accounting for Conditional Asset Retirement Obligations", an interpretation of FASB Statement No. 143, "Accounting for Asset Retirement Obligations." The interpretation clarifies that the term conditional asset retirement obligation refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. An entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The effective date of this interpretation is no later than the end of fiscal years ending after December 15, 2005. The Company is currently investigating the effect, if any, that FIN 47 would have on the Company's financial position, cash flows and results of operations. In May 2005, the FASB issued SFAS No. 154, "ACCOUNTING FOR CHANGES AND ERROR CORRECTIONS, A REPLACEMENT OF APB OPINION NO. 20 AND FASB STATEMENT NO. 3" SFAS 154 applies to all voluntary changes in accounting principle and requires retrospective application to prior periods' financial statements of changes in accounting principle. This statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS 154 carries forward without change the guidance contained in Opinion No. 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of this standard to have a material impact on its financial condition, results of operations, or liquidity. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION We are a manufacturer and provider of bullet and projectile-resistant garments, including fragmentation protective vests, and related accessories. Our products are used domestically and internationally by military, law enforcement, security and corrections personnel, as well as other governmental agencies. We also manufacture and distribute protective athletic apparel and equipment, including a wide variety of knee, ankle, elbow, wrist and back supports and braces that assist serious athletes, weekend sports enthusiasts and general consumers in their respective sports and everyday activities. 16 We are a holding company and we conduct our business through subsidiaries in two divisions, the DHB Armor Group and the DHB Sports Group. The Armor Group represented approximately 98%, 97% and 96% of our consolidated revenues during 2004, 2003 and 2002, respectively. The balance of the consolidated revenues is attributable to the Sports Group. The Sports Group represented approximately 3% and 2% of our consolidated revenues during the nine months ended September 30, 2005 and 2004, respectively. Our products are sold both nationally and internationally. Sales to the U.S. military comprise the largest portion of the Armor Group's business, followed by sales to federal, state and local law enforcement agencies, including correctional facilities. Accordingly, any substantial increase or decrease in government spending or any change in emphasis in defense and law enforcement programs would have a material effect on the Armor Group's business. The Sports Group manufactures and markets a variety of sports medicine, protective gear, and health support products under its own labels, private labels and house brands for major retailers. We derive substantially all of our revenues from sales of our products. As indicated in the financial information included in this report, we have experienced substantial increases in our revenues in the past several years, which we attribute primarily to demand from the U.S. military and federal, state and local law enforcement for the products of the Armor Group. Our ability to maintain recent revenue levels will be highly dependent on continued demand for our body armor and projectile-resistant clothing. Although we do not foresee an immediate material reduction in such demand, we have no assurance that government agencies will not refocus their expenditures based on changed circumstances or otherwise, that we will be able to diversify into alternate markets or alternate products, or that we will be able to increase our market share through acquisitions of other businesses. Due to our growth, we have outgrown our small business status under government procurement regulations. Although the loss of our small business status makes us ineligible for certain set-asides under government contracting regulations, we believe that our current size permits us to manage larger orders and credibly bid on major procurement contracts under which small businesses would be our subcontractors. To maintain our ability to deliver quality products in a timely manner, in April 2004, we moved into a new, expanded production facility in Pompano Beach, Florida. Our current strategic focus is on quality and delivery, which we believe are the key elements in obtaining additional and repeat orders under our existing procurement contracts with the U.S. military and other governmental agencies. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2005, COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2004 For the three months ended September 30, 2005, consolidated net sales were approximately $90.3 million, an increase of 1.0% over consolidated net sales of approximately $89.4 million for the three months ended September 30, 2004. Gross profit for the quarter ended September 30, 2005 remained nearly constant at approximately $24.7 million (27.3% of net sales), as compared to approximately $24.9 million (27.8% of net sales) for the quarter ended September 30, 2004. 17 The Company's selling, general and administrative expenses increased significantly to $25.5 million or 28.2% of net sales, during the three months ended September 30, 2005, versus approximately $11.6 million, or 13.0% of net sales for the three months ended September 30, 2004. Selling, general and administrative increased primarily as a result of $11.3 million non-cash compensation expense associated with the warrants issue to the CEO/Chairman on July 1, 2005 pursuant to an extension of his existing employment agreement. Also increasing selling general and administrative expenses during the third quarter of 2005 was a $587,000 increase in commissions as a result of the product mix, increased licenses and fees of approximately $250,000 as a result of increased General Service Administration sales, $547,000 of increased research and development costs, as a result of the opening of our new state of the art ballistic facility in Pompano Beach, and approximately a $800,000 increase in professional and consulting fees as a result of the Zylon(R) replacement program and related legal fees. The cost of the vest replacement program is a separate line item under selling, general and administrative expenses, for a total pre-tax charge of $60,000,000, or ($0.76) per diluted share after tax charge, as a result of the Company's voluntary Zylon(R) vest replacement program announced in August 2005. The composition of this charge is as follows: a $36,700,000 reserve for vests containing Zylon(R), the write-off of approximately $19,200,000 in Zylon(R) inventory, and a $4,100,000 increase in the accounts receivable allowance. Driven primarily by the increase in selling, general and administrative expenses and the cost of the vest replacement program, operating income decreased to a loss of approximately $60.8 million (67% of net sales) for the third quarter of 2005 versus income of approximately $13.3 million (14.9% of net sales) for the third quarter of 2004. Interest expense for the three months ended September 30, 2005 increased 35% to approximately $525,000, compared to approximately $389,000 for the three months ended September 30, 2004. This increase is primarily the result of a $119,000 payment for interest for a line of credit to have funds available for a possible acquisition during the third quarter. Income (loss) before income taxes and minority interest of subsidiary was a loss of approximately $61.3 million for the three months ended September 30, 2005, compared to income before income taxes and minority interest of approximately $12.9 million for the three months ended September 30, 2004. Income benefit for the third quarter of 2005 was approximately $19.4 million while income tax expense for the third quarter of 2004 was approximately $4.7 million. The effective tax rate for the third quarter of 2005 was (31.7%) as compared to 36.6% during the third quarter of 2004. On December 19, 2003, DHB's subsidiary Point Blank Body Armor, Inc. ("Point Blank") issued to Hightower Capital Management, LLC ("Hightower") shares of common stock of Point Blank representing approximately .65% of the outstanding capital stock of Point Blank, in exchange for inventory. The minority interest's share of the consolidated subsidiary's income (loss) was approximately $(258,000) and $58,000 for the three months ended September 30, 2005 and 2004, respectively. 18 After the preferred stock dividends of approximately $90,000 per quarter, the loss available to common stockholders was approximately $41.7 million, or $(0.92) per diluted share for the three months ended September 30, 2005 compared to income available to common stockholders of approximately $8.1 million or $0.18 per diluted share for the three months ended September 30, 2004. The weighted average shares outstanding on a diluted basis for the three months ended September 30, 2005 were 45,312,536, as compared to 45,962,109 for the three months ended September 30, 2004. NINE MONTHS ENDED SEPTEMBER 30, 2005, COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2004 For the nine months ended September 30, 2005, consolidated net sales were approximately $263.9 million, an increase of 5.6% over consolidated net sales of approximately $249.9 million for the nine months ended September 30, 2004. The Armor Group's net sales increased nearly 4.9% from $244.5 million for the nine months ended September 30, 2004 to approximately $256.5 million for the nine months ended September 30, 2005, due primarily to increased shipments to the U.S. Military. The Sports Group's net sales for the nine months ended September 30, 2005 increased 39.4% to approximately $7.5 million, as compared to approximately $5.4 million for the nine months ended September 30, 2004. The primary reason for this increase was a new subcontracting contract for the Sports Group to produce elbow pads for another company. Consolidated gross profit percentage declined slightly to 27.3% for 2005 as compared to approximately 27.8% for 2004. The Company's selling, general and administrative expenses increased significantly to $47.6 million or 18.1% of net sales, during the nine months ended September 30, 2005, versus approximately $32.4 million, or 13.0% of net sales for the nine months ended September 30, 2004. Selling, general and administrative increased primarily as a result of $11.3 million non-cash compensation expense associated with the warrants issue to the CEO/Chairman on July 1, 2005 pursuant to an extension of his existing employment agreement. Also increasing selling, general and administrative expenses was a $4 million increase in research and development costs in the nine months ended September 30, 2005. The cost of the vest replacement program is a separate line item under selling, general and administrative expenses, for a total pre-tax charge of $60,000,000, or ($0.76) per diluted share after tax charge, as a result of the Company's voluntary Zylon(R) vest replacement program announced in August 2005. Driven primarily by the increase in selling, general and administrative expenses and the cost of the vest replacement program, income (loss) before other income (expense) decreased to a loss of approximately $37.3 million (14.1% of net sales) for the nine months ended September 30, 2005 versus income of approximately $36.2 million (14.5% of net sales) for the nine months ended September 30, 2004. Interest expense for the nine months ended September 30, 2005 increased 63.7% to approximately $1.7 million, compared to approximately $1.0 million for the nine months ended September 30, 2004. This increase was primarily the result of increased borrowings under the Company's credit facility and a $119,000 payment for interest for a line of credit to have funds available for a possible acquisition during the third quarter. 19 Income (loss) before income taxes and minority interest was a loss of approximately $37.3 million for the nine months ended September 30, 2005, compared to income before taxes and minority interest of approximately $36.2 million for the nine months ended September 30, 2004. Income tax benefit for the nine months ended September 30, 2005 was approximately $10.9 million while income tax expense for the nine months ended September 30, 2004 was approximately $13.9 million. The effective tax rate for the 2005 was 29.2% as compared to 38.3% for 2004. On December 19, 2003, DHB's subsidiary Point Blank Body Armor, Inc. ("Point Blank") issued to Hightower Capital Management, LLC ("Hightower") shares of common stock of Point Blank representing approximately .65% of the outstanding capital stock of Point Blank, in exchange for inventory. The minority interest's share of the consolidated subsidiary's income (loss) was approximately $(134,000) and $156,000 for the nine months ended September 30, 2005 and 2004, respectively. The total minority interest included in the balance sheet as of September 30, 2005 was approximately $297,000 as compared to approximately $431,000 as of December 31, 2004. After the preferred stock dividends of approximately $270,000 for each of the nine-month periods, income (loss) available to common stockholders was approximately $(26.5) million for the nine months ended September 30, 2005, or $(0.59) per diluted share, as compared with income available to common stockholders of approximately $21.9 million, or $0.49 per diluted share, for the nine months ended September 30, 2004. The weighted average shares outstanding on a diluted basis for the nine months ended September 30, 2005 were 45,302,437, as compared to 45,614,473 for the nine months ended September 30, 2004. LIQUIDITY AND CAPITAL RESOURCES We expect that our primary working capital requirements over the next twelve months will be to assist our subsidiaries in financing their working capital requirements. Our operating subsidiaries sell the majority of their products on 30 to 90-day terms. We need working capital to finance the receivables, manufacturing process and inventory. Working capital at September 30, 2005 was $63.7 million as compared to working capital of $107.1 million at December 31, 2004. The main factor in the decrease in the Company's working capital was the reduction of the inventory as a result of the voluntary Zylon(R) replacement program. However, the Company was able to generate a positive towards cash flow of $26.6 million from operations for the nine months ended September 30, 2005 as compared to cash used in operations $10.8 million for the nine months of September 30, 2004. The primary factor for the improvement in cash provided from operations is the decrease in accounts receivable, as the accounts receivable days outstanding improved to 32 days at September 30, 2005 as compared to 58 days at December 31, 2004. The underlying drivers of operating cash flows are the inflows and outflows of funds. Our cash inflows are principally cash collections from customers. Historically as a result of our growth, we have experienced increases in our accounts receivable, which have caused our cash inflows from operations to lag behind our net sales. However, during the nine months ended September 30, 2005, our cash collections from customers of approximately $286.8 million exceeded our net sales of approximately $263.9 million. As a comparison, for the nine months ended September 30, 2004, our cash collections of approximately $234.3 lagged our net sales of $249.9 million. Our cash outflows are principally 20 manufacturing costs. As a result of our growth, our cash outflows related to manufacturing cost plus increased inventory have outpaced our cost of goods sold. Our cash outflows for manufacturing costs plus inventory buildup were $231.6 million and $220.4 million for the nine months ended September 30, 2005 and 2004, respectively, compared to cost of goods sold of approximately $191.9 million and $180.4 million for such periods, respectively. On March 15, 2005, the Company amended its bank credit agreement (the "Credit Agreement"), which increased the total borrowing limits from $45,000 to $55,000. Pursuant to the Credit Agreement, the Company may borrow, on a revolving basis, up to $37,000 on 85% of eligible accounts receivable (the "Credit Facility"), and the Company borrowed a term loan in the principal amount of $18,000 (repaying the $12.5 million dollar term loan), amortizing at the rate of $2,000 per quarter commencing July 2005. This agreement will expire on October 1, 2007. Borrowings under the Credit Agreement bear interest, at the Company's option, at the bank's prime rate (6.75% at September 30, 2005) or LIBOR plus 1.75% per annum on the Credit Facility, and at the bank's prime rate or LIBOR plus 2.25% on the term loan. At September 30, 2005, the Company had a LIBOR loan outstanding on the credit facility at a rate of 6.124%. The borrowings under the Credit Agreement are collateralized by a first security interest in substantially all of the assets of the Company. On November 3, 2005, the Company amended its Credit Agreement, to exclude the non-cash compensation charge and the Zylon(R) replacement charge from the financial covenants calculations and issuing a waiver as of September 30, 2005 for failure to comply with such covenants as a result of the aforementioned charges. The interest rate on the term loan was reduced from LIBOR plus 2.25%, to LIBOR plus 1.75%. The amendment also allows the Company to purchase in the open market in accordance with applicable law up to three million shares of the Company's common stock provided there are no events of default and the share purchase program shall not exceed $9 million to the extent the purchase price is funded through the credit facility. The Board of Directors approved the redemption of the convertible preferred stock, on December 15, 2005, the annual redemption date. This will eliminate the preferred dividend of $90,000 per quarter from the Company's financial statements. Our credit facility includes both affirmative and negative covenants customary for a financing of this nature. Among other provisions, our credit facility requires us to maintain (1) minimum tangible net worth, (2) a fixed charge coverage ratio, and (3) earnings before interest, taxes, depreciation and amortization. Our credit facility has certain restrictive covenants that limit our ability to pay dividends to our common stockholders or repurchase treasury shares and which limit the total amount of our capital expenditures to $2 million during any year. As described below, we do not anticipate that our capital expenditures will reach this $2 million limit. These restrictive covenants require us to obtain prior approval from the bank before paying common stock dividends or repurchasing shares. As noted above the Company has obtained approval to repurchase up to 3 million shares. We believe that these restrictive covenants do not currently have a material impact on our liquidity and capital resources. Our capital expenditures during the nine months ended September 30, 2005 decreased substantially to $358,000 as compared to $1,735,000 for the nine months ended September 30, 2004. During the nine months ended September 30, 2004, we purchased additional machinery, equipment, furniture and fixtures and 21 leasehold improvements to equip our new warehouse and administrative facility in Florida for our Point Blank subsidiary and a new location for our corporate headquarters. During the remainder of 2005, we currently anticipate spending approximately $800,000 for total capital expenditures. We believe that our existing credit line, together with funds generated from operations, will be adequate to sustain our operations (including projected capital expenditures) for the next 12 months. Historically, we have been successful in obtaining increases in our revolving credit facility, as required, in order to finance the increased working capital needs brought on by the expansion of our business. However, we have no assurance that we will be able to obtain further such increases if needed, and we may be required to explore other potential sources of financing (including the issuance of equity securities and, subject to the consent of our lender, other debt financing) if we continue to experience escalating demand for our products. CASH CONTRACTUAL OBLIGATIONS The following table presents the Company's estimated cash requirements for contractual obligations outstanding as of September 30, 2005:
Payments Due by Period ($ thousands) Less Than More Than 5 1 Year 1-3 Years 4-5 Years Years Total --------- --------- --------- ----------- ------- Contractual Obligations Long-Term Debt $ 8,000 $ 7,000 $ -- $15,000 Employment Contracts 1,450 4,217 1,367 7,034 Consulting Agreements 60 -- -- -- 60 Obligation to purchase convertible preferred stock 3,000 -- -- -- 3,000 ------- Operating Leases 2,048 5,781 3,009 1,880 12,718 ------- ------- ------ ------ ------- Total Contractual Cash Obligations $14,558 $16,998 $4,376 $1,880 $37,812 ======= ======= ====== ====== =======
EFFECT OF INFLATION AND CHANGING PRICES The Company did not experience any measurable increases in raw material prices during the nine months ended September 30, 2005. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements regarding future events and our future results that are based on our current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as "expects," "anticipates," "targets," "goals," "projects," "intends," "plans," "believes," "seeks," "estimates," variations of such words, and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are only predictions that speak as of the date hereof 22 and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form10-K/A for the year ended December 31, 2004 and in other reports that we have filed with the Securities and Exchange Commission. You are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to revise or update publicly any forward-looking statements to reflect any change in the expectations of our management with regard thereto or any change in events, conditions, or circumstances on which any such statements are based. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not issue or invest in financial instruments or their derivatives for trading or speculative purposes. Our market risk is limited to fluctuations in interest rates as it pertains to our borrowings under our $55 million credit facility. We can borrow at either our bank's prime rate of interest or LIBOR plus 1.75%. Any increase in these reference rates could adversely affect our interest expense. The change in the interest rate for 2005 was immaterial. The extent of market rate risk associated with fluctuations in interest rates is not quantifiable or predictable because of the volatility of future interest rates and business financing requirements. However, given the small percentage change in the past, we do not currently expect any changes in the interest rate to have a material effect on our operating results. If interest rates increased 1%, then the interest expense would increase approximately $407,000, annually. Aggregate maturities of our long-term debt are as follows: For the years ending September 30: 2005 $ 5,000,000 2006 8,000,000 2007 2,000,000 ----------- $15,000,000 The Company estimates that the fair value of its long-term debt approximates its carrying value. Our international transactions are predominately denominated in U.S. dollars, mitigating any market risk resulting from foreign currency exchange fluctuations. We do not have any material sales, purchases, assets or liabilities denominated in currencies other than the U.S. Dollar, and as such, we are not subject to material foreign currency exchange rate risk. 23 ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. The disclosure controls and procedures evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO). Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures are also designed to ensure that such information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. The evaluation of our disclosure controls and procedures included a review of the controls' objectives and design, our implementation of the controls and the effect of the controls on the information generated for use in this report. This type of evaluation is performed on a quarterly basis so that the conclusions of management, including the CEO and CFO, concerning the effectiveness of the disclosure controls and procedures can be reported in our periodic reports on Form 10-Q and Form 10-K. The overall goals of our evaluation activities are to monitor our disclosure controls and procedures, and to modify them as necessary. Our intent is to maintain our disclosure controls and procedures as dynamic systems that change as conditions warrant. Based upon the disclosure controls and procedures evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. As mentioned in our filing on Form 8-K dated April 14, 2005, as of December 31, 2004, there existed certain significant deficiencies in our systems of inventory valuation rendering such systems inadequate to accurately capture cost of materials and labor components of certain work in progress and finished goods inventory. During the nine months ended September 30, 2005, we have worked to strengthen our internal controls relating to the matters described above and such efforts include: instituting additional controls, enforcing existing policies and providing oversight with respect to insuring that we accurately capture the cost of materials and labor components of certain work in process and finished good inventory, hiring an additional inventory manager, and continuing to interview candidates with the intention of hiring additional personnel to provide additional support in implementing and improving our system. Our management, including the CEO and the CFO, believes the results of the corrective actions that we have initiated have been and will be effective in 24 addressing the deficiency in internal controls described above. The attestation report of our former auditors also identified what that firm considered to be two additional weaknesses in internal controls: (1) failure of the Company to complete consultation with the auditors prior to filing Form 10-K for the year ended December 31, 2004; and (2) a need to enhance and strengthen the Audit Committee to improve the Committee's effectiveness. Although the Company does not believe that our former auditors had a proper basis for its conclusions, the Company is exploring opportunities to improve the process of preparing its filings with the Securities and Exchange Commission and the effectiveness of its Audit Committee. Except as described above, there have not been any changes in our internal controls over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act during the nine months ended September 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Since September 9, 2005, a number of purported class action lawsuits were filed in the United States District Court for the Eastern District of New York against the Company and certain of the Company's officers and directors. The actions purport to be filed on behalf of purchasers of the Company's publicly traded securities during the period from April 21, 2004 through August 29, 2005. The complaints, which are substantially similar to one another, allege, among other things, that the Company's public disclosures were false or misleading because they did not disclose certain information. The lawsuits allege that DHB's body armor products were defective and failed to meet the standards of its customers, and that these alleged facts should have been publicly disclosed. The Company has been served with a number of these complaints. No class has been certified in the actions. The lawsuits seek compensatory damages plus interest and attorneys' fees. The Company believes that the lawsuits are baseless and intends to vigorously defend against them. Because of their similarity, the Company believes that most or all of the lawsuits will be consolidated into a single action and that the Company will not be required to defend against all of the lawsuits individually. The Company cannot predict the outcome of the lawsuits or whether the Company's financial condition or results of operations may be materially affected as a result of the lawsuits. Since September 14, 2005, a number of derivative complaints were filed in the United States District for the Eastern District of New York against certain officers and directors of the Company and, in certain cases, Weiser LLP, the Company's former auditor. The allegations in the complaints are substantially similar and include the Company as a nominal defendant. The complaints allege, among other things, that defendants breached their fiduciary duties and engaged in fraud, misrepresentation, insider trading, misappropriation of corporate information, waste of corporate assets, abuse of control, and unjust enrichment, asserting claims substantially similar to those asserted in the actions described above under "Securities Litigation." 25 The complaints seek monetary damages and various forms of equitable and/or injunctive relief, restitution to the Company and disgorgement of profits earned by defendants, and fees and costs. The Company believes that the lawsuits are baseless and intends to vigorously defend against them. Because of their similarity, the Company believes that most or all of the lawsuits will be coordinated and/or consolidated into a single action. The Company cannot predict the outcome of the lawsuits or whether the Company's financial condition or results of operations may be materially affected as a result of the lawsuits. On or about August 29, 2005, Southern States Police Benevolent Association, Inc., et al. ("Southern States") filed a Class Action Complaint against Protective Apparel Corporation of America, Inc. and Point Blank Body Armor, Inc. ("Defendants"), alleging that the National Institute of Justice ("NIJ") decertified all bullet resistant vests containing Zylon. Southern States further alleged that the test results released by the NIJ demonstrated that all of Defendants' Zylon-containing vests fail to comply with their certifications and warranties. Southern States brought causes of action for breach of warranty on label in vest, breach of warranty in warranty statement, breach of implied warranty of merchantability, breach of implied warranty of fitness for a particular purpose, and for injunctive relief. On or about October 19, 2005, Defendants filed an answer and affirmative defenses denying that Defendants are in breach of any warranty and denying that injunctive relief is proper. On October 20, 2005, the Court entered a Consent Order Certifying Class Action. The certified classes include all law enforcement personnel and organizations, and other individuals, who purchased new ballistic resistant soft body armor containing Zylon from the Defendants, except for federal agencies and any persons who have been physically injured as a result of defects in their vests. The parties are engaged in settlement negotiations. The Company has recorded a $36.7 million reserve for this settlement during the quarter ended September 30, 2005, which is part of the $60 million cost of the vest replacement program. On January 3, 2005, a class action lawsuit was filed against us in the Circuit Court of the Seventeenth Judicial Circuit in Broward County, Florida by a police organization and individual police officers, alleging concerns regarding the effectiveness and durability of body armor with high concentrations of Zylon in the Company's bullet-resistant soft body armor (vests). Point Blank Body Armor settled a class action lawsuit involving a total of less than 2,000 vests containing a high concentration of Zylon. Pursuant to the settlement, class members have been exchanging the vests for a choice of four other vests made by the company. Class members have also been receiving two extra carriers, as well as a 10 percent discount certificate. The final date for class members to submit a claim form was August 21, 2005. This settlement did not have a material adverse effect on its financial position. We are currently the subject of an investigation by the Securities and Exchange Commission with respect to certain related party transactions and executive compensation matters regarding the Company and affiliates of Mr. David H. Brooks (our Chief Executive Officer and Chairman). The Company and Mr. Brooks are cooperating with the Securities and Exchange Commission in this investigation. In addition, the Audit Committee periodically monitors the status and performance of related party transactions to assess the benefits to the Company and the related party's compliance with its contractual obligations. 26 We are involved in other litigation, none of which we consider to be material to our business or believe would, if adversely determined, have a material adverse effect on our financial condition or operations. ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER REPURCHASES OF EQUITY SECURITIES During the nine month period ended September 30, 2005 and 2004 employees exercised warrants to purchase 30,000 and 80,000 shares, respectively of the Company's unregistered common stock at an average price of $6.26 and $2.00 per share, respectively. ITEM 3. DEFAULTS UPON SENIOR SECURITIES On November 3, 2005, the Company amended its Credit Agreement, to exclude the non-cash compensation charge and the Zylon(R) replacement charge from the financial covenants calculations and issuing a waiver as of September 30, 2005 for failure to comply with such covenants as a result of the afore mentioned charges. Pursuant to the Eight amendment these defaults were waived by LaSalle Business Credit. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the DHB Industries, Inc. Annual Stockholders' Meeting on July 29, 2005, our stockholders approved our 2005 Omnibus Equity Incentive plan. Number of Shares Voted Broker Voted For Against Abstain Non-Votes Proposal 1. To consider and vote upon the Company's proposed 2005 Omnibus Equity Incentive Plan. 11,715,548 8,064,100 152,114 0 ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS 10.18 Lease agreement dated August 22, 2005 between DHB Industries Inc. and A&B Holdings 10.19 Eighth Amendment to Loan and Security Agreement, dated November 3, 2005 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the Chief Executive Officer Pursuant to 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of the Chief Financial Officer Pursuant to 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 27 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned, thereunto duly authorized. Dated: November 9, 2005 DHB INDUSTRIES, INC. (Registrant) Signature Capacity Date Chief Executive Officer November 9, 2005 /s/ David H. Brooks and Chairman of the Board _______________________ Chief Financial Officer, November 9, 2005 /s/ Dawn M. Schlegel Director and Principal _______________________ Accounting Officer /s/ Jerome Krantz Director November 9, 2005 _______________________ /s/ Gary Nadelman Director November 9, 2005 _______________________ 28