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UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF NEW YORK
In re DHB INDUSTRIES, INC. CLASS
ACTION LITIGATION
This Document Relates To:
ALL ACTIONS.
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Civil Action No. 2:05-cv-04296-JS-ETB
CLASS ACTION
CONSOLIDATED CLASS ACTION
COMPLAINT FOR VIOLATION OF THE
FEDERAL SECURITIES LAWS
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TABLE OF CONTENTS
Page
INTRODUCTION ...........................................................................................................................1
OVERVIEW OF THE ACTION .....................................................................................................4
Brooks and DHB Have a Controversial Past .......................................................................4
The Fraudulent Pump-and-Dump Scheme...........................................................................5
DHB’s Vest Programs had Major, Undisclosed Problems ..................................................8
Defendants’ Massive Fraud is Fully Revealed in August 2005.........................................12
JURISDICTION AND VENUE ....................................................................................................24
THE PARTIES...............................................................................................................................24
BACKGROUND TO THE CLASS PERIOD ...............................................................................34
CLASS PERIOD EVENTS ...........................................................................................................42
POST-CLASS PERIOD EVENTS ..............................................................................................103
FALSE FINANCIAL STATEMENTS........................................................................................107
DHB’s Failure to Accrue for Losses Caused by Its Sale of Defective Products
and Improper Accounting for Inventory ..............................................................109
DHB’S INADEQUATE INTERNAL CONTROLS ...................................................................114
ADDITIONAL SCIENTER AND SCHEME ALLEGATIONS.................................................121
DHB’s Insiders’ Long-Standing Knowledge of Problems with Zylon and its
Interceptor Program .............................................................................................131
DHB EXECUTIVES’ INSIDER TRADING, SALARIES AND BONUSES ............................133
DEFENDANTS’ FALSE AND MISLEADING PROXY...........................................................136
LOSS CAUSATION....................................................................................................................138
NO SAFE HARBOR ...................................................................................................................143
APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD-ON-THE-MARKET
DOCTRINE .....................................................................................................................144
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CLASS ACTION ALLEGATIONS ............................................................................................145
COUNT I .....................................................................................................................................146
Violation of §10(b) of the 1934 Act and Rule 10b-5 Promulgated Thereunder
Against All Defendants........................................................................................146
COUNT II ....................................................................................................................................148
Violation of §20(a) of the 1934 Act Against Defendants DHB, Brooks, Hatfield,
Schlegel, Chasin, Krantz, Nadelman and Berkman.............................................148
COUNT III...................................................................................................................................149
For Violation of §20A of the 1934 Act Against All Defendants....................................149
COUNT IV...................................................................................................................................150
Violation of §14(a) of the 1934 Act and Rule 14a-1 Promulgated Thereunder
Against All Defendants........................................................................................150
PRAYER FOR RELIEF ..............................................................................................................154
JURY DEMAND .........................................................................................................................155
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INTRODUCTION
1.
This is a class action on behalf of all purchasers of the publicly traded securities of
DHB Industries, Inc. (“DHB” or the “Company”), between March 24, 2004 and August 29, 2005
(the “Class Period”), against DHB, David H. Brooks (“Brooks” or “David Brooks”), DHB’s
Chairman and Chief Executive Officer (“CEO”) and his wife, Terry Brooks,1 Sandra Hatfield,
DHB’s Chief Operating Officer (“COO”) since December 2000, and Dawn M. Schlegel, its Chief
Financial Officer (“CFO”) since September 1999, and members of DHB’s Board of Directors (Barry
Berkman, Cary Chasin, Jerome Krantz and Gary Nadelman). DHB, through its Point Blank Body
Armor and PACA subsidiaries (collectively, “DHB” or the “Company”), designs, manufactures and
sells body armor products, particularly bulletproof vests. DHB’s bulletproof vest business is divided
into two main product lines – vests produced for the United States military (“Interceptor”-class
vests) and vests produced for domestic law enforcement agencies.
2.
In a classic fraudulent “pump-and-dump” scheme, DHB’s officers and directors
inflated DHB’s stock price by 316% – from $5.46 to $22.70 – through a series of false and
misleading statements and financial reports issued during the Class Period. As the price of DHB
stock spiraled upward, the DHB insiders held their holdings and granted themselves tens of
thousands of options to purchase DHB shares for pennies on the dollar. Then, precisely when the
stock reached peak prices in late 2004, defendants exercised their options and collectively dumped
over 10.2 million shares of stock at $18.57-$20.94 per share, receiving over $200 million in illegal
insider trading proceeds over a thirty day period. Brooks sold 60% of the shares he actually
1
The David H. Brooks’ controlled entities, David Brooks International Inc., Andrew Brooks
Industries, Inc., and Elizabeth Brooks Industries, Inc., through which David and Terry Brooks owned
DHB stock and through which they exercised control of DHB and insider traded, are also
defendants.
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owned, Hatfield sold 100% of the stock she owned and Schlegel sold 84% of the stock she owned.2
Krantz also sold 100% of his stock and Nadelman sold 89% of his shares. Defendants’ illegal
insider sales occurred in two discreet periods. The first wave of selling occurred over a two day
period in late November just after DHB stock reached its then all-time high share price. The second
wave of selling occurred over a five day period in late December just as DHB stock reached its
record all-time high price. In total, defendants’ dumped 22% of DHB’s then outstanding shares in
these two periods of selling. As the chart below demonstrates, defendants’ sales were timed
perfectly to take advantage of the stock price inflation:
2
Even these huge stock sales did not dilute Brooks’ control of DHB. Cleverly, Brooks had
used his control of the Company to cause it to issue to him warrants to purchase millions of shares of
DHB stock at $1 per share. This assured Brooks’ continued control of DHB even as he unloaded
huge amounts of stock, as he could “reload” his stockholdings at a low price to keep control of DHB.
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DHB insiders finished the massive sell-off just after the stock reached its all-time high price and the
Company announced its largest-ever contract, which Brooks said on December 23, 2004 was the
“catalyst that will propel and sustain” DHB “into the future as the clear, preeminent leader in the
design, development and production of technologically superior life-saving body armor systems.”
Over the next four days, as DHB stock climbed to its all-time high share price of $22.70, Brooks
sold more than five million shares for more than $100 million in illegal insider trading proceeds.
3.
Then, only days after DHB’s insiders completed their November-December 2004
stock bail-out, defendants were forced to begin leaking quality problems with DHB’s domestic law
enforcement and military vest programs and disappointing financial results. DHB would later take a
huge $60 million charge against earnings as a result of its concealed widespread use and stockpiling
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of “Zylon,” a ballistics material DHB used extensively. PACA, DHB’s other body-armor subsidiary,
also produced vests containing Zylon. The $60 million charge taken at the end of the Class Period
wiped out over 100% of DHB’s previously reported Class Period profits and almost 50% of its
reported shareholders’ equity! As DHB insiders dumped their stock en masse and the truth about
both DHB’s military and domestic law enforcement vest programs subsequently entered the market,
the price of DHB stock fell precipitously to just $4.48 per share, erasing over $800 million in market
capitalization from the Class Period high and inflicting hundreds of millions of dollars of damages
on public investors who were victimized by defendants’ scheme.
OVERVIEW OF THE ACTION
4.
Prior to the Class Period, in 2000-2001, DHB was a small company with annual sales
of less than $100 million and net income of less than $5-$10 million. DHB has been controlled by
David H. Brooks and his wife, defendant Terry Brooks (collectively, “the Brooks’”), its largest
shareholders, since its inception.
Brooks and DHB Have a Controversial Past
5.
As described fully at ¶31(a), David Brooks and DHB have a checkered past. For
example, Brooks and his brother, Jeffrey Brooks, were fined and barred for five years from brokerdealer activities by the United States Securities and Exchange Commission (“SEC”) in 1992. In
1993, he and his brother entered into a consent agreement with a public Company of which they
were part owners, agreeing to forego involvement with the entity for 10 years after being accused of
stock manipulation. In 1995, the National Association of Securities Dealers (“NASD”) denied
DHB’s application for listing on the NASDAQ Small Cap Market because it “was troubled by
Brooks’ prior misconduct.” The SEC upheld the NASD’s ruling on appeal and expressly concluded
that “We find that the NASD’s concerns as to Brooks are legitimate” because Brooks’ conduct
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“undermines both the regulation of securities firms and its registered representatives, and
protection of investors” and “that Brooks has a history of serious securities law violations.”
6.
DHB’s past is similarly controversial. The Company has a long history of self-
dealing which has illegally enriched Brooks and his immediate family to the tune of tens of millions
of dollars (¶158). The full extent of Brooks’ taking from DHB is still unknown to investors.
Brooks’ high-profile anti-union activities embroiled the Company in labor disputes which threatened
its ability to increase production of its body armor products to meet surging demand and subjected
DHB to shareholder disputes and an SEC investigation, which is still ongoing. DHB also tore
through outside accountants, which changed year after year as a result of DHB’s failure to disclose
large related-party transactions with the Brooks’ and inventory pricing and Audit Committee
weaknesses, among other problems. By the time the Weiser LLP accounting firm resigned in April
2005, DHB had burned through four outside accounting firms since 2002.
The Fraudulent Pump-and-Dump Scheme
7.
Because of DHB’s small size, its limited potential for growth and questions about
Brooks’ past behavior and integrity, DHB’s stock has historically traded at a low price. After the
catastrophic “9/11” terrorist attacks on our country in 2001 and the resulting war on terrorism,
including United States military interventions in Afghanistan and Iraq, the demand for body armor
products to protect domestic law enforcement, security personnel and members of the United States
military skyrocketed amid significant increases in spending for domestic security and national
defense. These events greatly increased the interest of investors in the stocks of companies which
stood to profit from increased “security” spending. Defendants were determined to take advantage
of this anticipated windfall and increased investor interest in companies like DHB provided a perfect
opportunity for Brooks and his cohorts to profit enormously if they could use our national crisis to
pump up DHB’s stock price. But despite increased investor interest in security companies and the
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Company’s own efforts to allay investor concerns about the integrity of its management (such as its
2003 enactment of a Code of Business Conduct & Ethics), DHB’s stock continued to under-perform
and was sold for only $5-$6 per share in the spring of 2004.
8.
By late 2003-early 2004, Brooks and his cohorts realized that in order to pump up
DHB’s stock price to permit them to personally profit from their stock holdings, they had to
convince the market, at least temporarily, that DHB’s business was a tremendous success by causing
DHB to consistently report very strong financial results (i.e., increasing assets, profits, income and
shareholder equity) coupled with credible forecasts of continuing profitable future growth. In the
spring of 2004, DHB resolved the labor difficulties which had been adversely impacting the
Company and secured dismissal of a shareholder derivative suit which had challenged Brook’s’ selfdealing transactions with DHB. With the stage set, DHB’s officers and directors achieved their
fraudulent goals by reporting increasing and large sales of vests to domestic law enforcement
agencies, large supply contracts with the U.S. military and record profits and shareholders’ equity for
the Company. Indeed, during the first three quarters of 2004, DHB reported consistently growing
and “record” sales, net income, EPS and shareholders’ equity, as shown below:
Net Sales
Gross Margin
Net Income
EPS
Shareholders’ Equity
1stQ 04
2ndQ 04
3rdQ 04
$74.40M
27.91%
$6.36M
$0.14
$53M
$86.07M
27.75%
$7.66M
$0.17
$60.7M
$89.41M
27.82%
$8.15M
$0.18
$68.8M
Each time DHB reported “record” results during the Class Period, the Company assured investors
that it had “continue[d] to meet or exceed” all of its financial “operating goals” and the previous
guidance it had given to analysts. It said, for example, that this “surging operating performance and
earnings leverage” created a “future outlook for DHB [that was] exceptionally strong.” Due to
DHB’s significant operating and earning leverage, Brooks told investors, “I can say only this, this is
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just the beginning, the future is ours.” In short, DHB was “in a league of [its] own” with its
“world class products.”
9.
Defendants’ credited DHB’s purported newfound success on soaring sales fueled by
the high quality of the Company’s products (an indispensable element for success of a company
manufacturing body armor products), which DHB repeatedly emphasized exceeded its customers’
requirements and expectations. For example, defendants told investors during the Class Period that
the Company’s market share was “highly dependent upon the quality of its products,” and therefore
management’s “strategic focus is on quality,” which was the “key element[]” of future orders from
“governmental agencies.”
DHB also assured investors that its military contract awards
demonstrated the U.S. Department of Defense’s “continued confidence in [its] ability to deliver
life-saving body armor systems to the armed forces of the United States,” and that its products
“exceed[ed] the requirements and expectations of the United States military.” The Company also
repeatedly assured investors that customer orders showed “confidence of . . . customers in [its]
products,” and that DHB “continue[d] to provide exceptional products . . . that exceed the
requirements and expectations of [its] customers,” the U.S. Military and domestic police forces. In
short, DHB assured investors its “industry leading” products were the result of the “strength of
DHB’s technology” which “strengthen[ed] our capability to manufacture quality products,” that
were the “best that [have] ever been developed.”
10.
While DHB was reporting “record” financial results and its ever strengthening
financial condition, it also assured investors that its internal financial and accounting and SEC
disclosure controls were well-designed, had been tested and were functioning effectively, and thus
complied in all material respects with federal law and regulations. Such assurances were
particularly important given DHB’s track history of changing (through resignation and dismissal) its
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outside accountants annually and investors’ concerns over Brooks’ prior misconduct and integrity.
Each quarter during 2004-2005, Brooks and Schlegel, as the CEO and CFO of DHB, represented
that they had recently evaluated these control systems, that they were effective and that any
previously identified weaknesses had been corrected. Thus, they certified that DHB’s 2004-2005
quarterly reports and financial results were true and correct and that they had disclosed any
deficiencies in the design and/or operation of those control systems and any fraud involving them,
whether or not material. DHB also attached its Code of Business Conduct & Ethics as an exhibit to
its fiscal year 2003 and 2004 10-Ks filed with the SEC.
DHB’s Vest Programs had Major, Undisclosed Problems
11.
Despite statements made by the Company about its “exceptional” and “world-class”
products and record financial results, nothing about DHB’s core lines of business (the production of
bulletproof vests for the military and domestic law enforcement agencies) and financial condition
was what DHB claimed it to be. In fact, defendants were actually concealing serious, known
problems in DHB’s military and domestic law enforcement body armor programs throughout the
Class Period, including persistent failures of ballistic tests, an inability to meet contract performance
requirements and technical specifications and non-performance of a critical quality assurance plan.
Defendants had also failed to disclose, write-off or properly accrue loss contingencies for known
liabilities associated with DHB’s widespread use and stockpiling of a defective material.
12.
DHB’s production of Interceptor-class Outer Tactical Vests (“Interceptor” or
“OTVs”) began in 1999 after the United States Army Natick Soldier Center (“Natick”) awarded
DHB a five-year contract to produce Interceptors for the United States military in 1998. The
Interceptor program itself, and what the military and those involved with the program decisionmaking knew but did not disclose about vest design and quality problems from the program’s
inception, has itself recently came under heavy scrutiny. In 1998, as now, there were a limited
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number of companies capable of successfully bidding on such body armor contracts, body armor and
bullet proof vest-manufacturing being a specialty industry with relatively few producers. There are
also significant barriers to entry to this market. Internal government memoranda made public by The
Marine Times in May 2005 revealed that DHB’s original bid on the Interceptor contract was among
several “technically acceptable” proposals, but “one of the deciding factors” in awarding the contract
to DHB was the Company’s quality assurance plan, for which the military paid DHB an extra $50
per vest. Despite “pleading” from the military, DHB never implemented the plan and failed to
perform these essential quality assurance procedures. DHB also came under scrutiny with regard to
the Interceptor vest contract because it hired Edward Lavigne, a contracting officer at Natick charged
with administering the DHB contract, 2001, in apparent violation of the Procurement Integrity Act
(41 USC §423 et seq.).
13.
The Marine Times’ startling expose, coming only a few months after insiders dumped
over $200 million in DHB stock, detailed extensive problems at the Company which, as explained
herein (¶¶99-101), revealed that the Interceptor program was not what DHB said it was. According
to the expose and supporting documentation (attached hereto as Exs. A and B, respectively), DHB
shipped thousands of defective and non-conforming “Interceptor” vests to the United States Marine
Corps with “critical, life-threatening flaws in the vests” in 2003-2004, which the Marines were then
forced to recall. The expose documented that military and ballistics experts and the Defense
Contract Management Agency had identified thousands of defective DHB vests beginning as early
as January 2003, when a DHB vest first failed a ballistics test, and that DHB vests repeatedly failed
ballistics tests throughout 2003-2004. DHB was indifferent – Hatfield, who was present day-to-day
at the DHB facility, discussed the vest failures with subordinates, some whom then quit in frustration
when she refused to address the issue substantively. The military required DHB officers to
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repeatedly sign “Requests for Deviation/Waivers” which privately admitted major vest deficiencies
throughout 2004. Hatfield in fact signed such a waiver on November 30, 2004, only one day after
massive insider sales by Brooks, Hatfield, Schlegel, Nadelman, Krantz, Chasin and Berkman
resulting in windfall profits of more than $81 million on their sale of 4.3 million shares.
14.
As a result of DHB’s consistent failures to produce quality products and perform
adequate quality control, military officials recommended disciplinary action against DHB. The
military only accepted DHB’s defective vests because it had failed to adequately stock up on body
armor in advance of the ground invasion of Afghanistan and Iraq and, by 2004 when ground fighting
in Afghanistan and Iraq intensified, the military had a dire, urgent need for armor which meant that it
would accept a “sub-par product because it is preferable to none at all.” In total, the military recalled
more than 23,000 DHB vests from use in the field.
15.
The situation with DHB’s vests produced for domestic law enforcement officers was
no better, although defendants successfully concealed the full extent of their problems until August
30, 2005. As explained herein, DHB concealed from investors that, since 2001, the Company had
shipped thousands of vests to domestic law enforcement officers and other security personnel made
with the ballistic material Zylon, which was unsuited for use in bulletproof vests. Point Blank
produced 15 models of vests for use by domestic law enforcement and security personnel, eight of
which were made with Zylon. PACA also produced Zylon vests. Each vest carried a five-year
warranty. But DHB knew prior to the Class Period that Zylon degrades and that its vests could not
meet the Company’s warranty. According to the Arizona Attorney General, in an action commenced
against Second Chance (a DHB competitor), Zylon’s manufacturer, Toyobo Co., Ltd. (“Toyobo”),
conducted tests “and provided [the results] to Second Chance during December 1998 through
January 2003 . . . . Second Chance knew that Zylon rapidly and permanently loses strength when
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exposed to such common conditions as high humidity and heat, fluorescent light, and sunlight.”
State v. Second Chance Body Armor, Inc., No. CV2004-000736 (Maricopa County, Ariz., Super. Ct.,
amended complaint filed 8/13/2004). DHB, along with its competitors who used Zylon in the
manufacturing of bullet proof vests, also received these test results as well as quarterly and semiannual updates from Toyobo regarding Zylon beginning January 1, 2002. Accordingly, DHB
possessed considerable information regarding problems with Zylon prior to and throughout the Class
Period. Rather than act on what defendants knew about Zylon, DHB continued to sell vests made
with Zylon and stockpiled the unusable and unsaleable material, bloating the Company’s Class
Period inventories, which grew by nearly 100% between 3rdQ 04 and 1stQ 05. When questioned
about Zylon and their fast-growing inventories, DHB lied to investors, explaining at first that it was
“stockpiling raw materials” in anticipation of “future shortages,” and later that it had a large number
of finished goods awaiting shipping. DHB also falsely told investors during the Class Period that it
was no longer selling Zylon vests and that there were few Zylon vests in use in the field when it had
actually sold at least 50,000 Zylon vests which were incapable of meeting DHB’s five-year
warranty.
16.
On January 3, 2005 (just days after insiders finished their massive November 2004-
December 2004 sell-off), DHB announced that it had been sued by the Southern States Police
Benevolent Association over its sale of vests containing Zylon. On February 15, 2005, DHB
announced the settlement of the suit, indicating that the Zylon vest problem was settled for $1.5
million – the cost for replacing 2,000 vests – stating, “Zylon itself was not the issue” and “We still
have a high degree of confidence in the vests.” On August 8, 2005, Brooks, Schlegel, Krantz and
Nadelman signed the DHB 2ndQ 05 SEC filing – DHB disclosed therein only that its settlement of
lawsuits regarding Zylon would not have a material adverse impact on the Company.
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Defendants’ Massive Fraud is Fully Revealed in August 2005
17.
On August 30, 2005, DHB suddenly announced a massive $60 million write-off,
revealing that it had “ceased production of all Zylon-containing bullet resistant products,” that it
would be implementing a replacement program for all customers with Zylon body armor and that
these actions would result in a $60 million charge for the replacement costs and Zylon inventory
write-off. The Zylon write-off shocked the market and analysts, as DHB had earlier indicated that it
was no longer producing Zylon vests, that only a small number remained in the field and that its
increasing inventories were due to its stockpiling of raw materials to manufacture valuable products
and finished goods awaiting shipment. This huge $60 million charge wiped out all of DHB’s
reported earnings during the Class Period and eliminated a large part of its net
worth/shareholders’ equity! The write-off revealed that throughout the Class Period, defendants
failed to properly account for its use and stockpiling of Zylon by failing to take write-downs, accrue
liabilities and take the reserves required by GAAP, concealed the scope of DHB’s Zylon usage and
associated liability and mislead investors about the likely impact of the Company’s use and
stockpiling of Zylon on the Company’s financial position. DHB subsequently announced on March
17, 2006 that the Company could not timely file its 2005 10-K because it continued to suffer
inventory pricing problems and needed to reassess the sufficiency of its estimates for the cost of the
Zylon vest replacement program. DHB indicated that it may need to restate its 1stQ 2005-3rdQ
2005 financial results as a result.
18.
As explained in detail herein, (¶¶159-166), DHB’s stock declined significantly after it
reached its all-time high in late December 2004 as the undisclosed truth about DHB began to enter
the market. Although defendants attempted to “walk” DHB’s stock price down slowly to cover their
tracks, DHB shares declined in value as news of the massive insider bail-out, potential and then
actual Zylon liabilities, vest quality issues, and worsening financial results entered into and were
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absorbed by the market. As defendants’ prior misrepresentations and other fraudulent conduct was
revealed, DHB stock declined from its high of $22.70 on December 27, 2004 as the scope of the
insider sell-off become known and reported by the media and, after further revelations, fell all the
way to $4.50 on August 30, 2005 after the announcement of the $60 million Zylon write-off.
Throughout this period, DHB stock experienced large, company-specific stock declines that were not
due to general market movements or industry factors or even company-specific negative information
unrelated to the alleged fraud. The attendant economic loss, i.e. damages, to plaintiffs and other
members of the class was a direct result of defendants’ fraudulent scheme to artificially inflate
DHB’s stock price.
19.
Both the Interceptor vest program and DHB’s models of Zylon vests were large
product lines, crucial to the success of DHB. Zylon was used by Point Blank in half of the models
produced as part of DHB’s domestic law enforcement body armor program and the Interceptor vest
was the lifeblood of DHB’s military armor program. In total, DHB’s sale of body armor products
produced 98% of the Company’s total revenue. These product lines were infected with pervasive
undisclosed problems for a period of years. DHB’s top officers had direct knowledge of these
product lines and the undisclosed problems detailed herein. If the top officers of the Company did
not know about pervasive problems with either the Interceptor or with Zylon, which in fact increased
in magnitude throughout the Class Period, they were grossly reckless in making any public
representations regarding the success of the domestic and military vest lines of business and either
line’s financial impact on DHB. At bottom, the method of accounting for the Company’s Zylon use
and inventories, the performance of DHB’s Interceptor vests sold to the U.S. military are simply not
matters relegated to lower-level managers – these are the very matters which the top executives of
the Company are involved in on a day-to-day basis and with which they must be intimately familiar.
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And, if they are not, then there is absolutely no factual basis for the affirmative and positive
representations they chose to make about the success of DHB’s business and their strong
contribution to DHB’s reported net income/EPS.
20.
As detailed in this Complaint, there were material undisclosed conditions inside
DHB’s business throughout the Class Period which defendants (DHB’s top insiders) knew of, or
were reckless in not knowing of. Defendants knew or were reckless in not knowing that these
conditions would ultimately become public and have a very serious adverse impact on DHB’s
financial results and condition, perceptions as to the quality of its products and DHB’s prospects for
and ability to actually achieve continued profitable growth (as well as the integrity of Brooks and his
DHB management team) and thus cause its stock price to decline sharply. For example, by the
outset of the Class Period, DHB had accumulated a very large inventory of Zylon raw materials
which it used to manufacture body armor products for domestic law enforcement personnel. DHB’s
insiders had become aware through actions and statements of competitors, its Zylon supplier, as well
as DHB’s own experience with its own Zylon body armor products that, due to exposure to light,
heat and moisture, such products deteriorated much more quickly in the field, i.e., in actual service
use, than had been expected or was necessary for DHB’s five-year warranty to be honored, thus
exposing police officers to the risk of serious harm or death and DHB to huge potential product
liability, warranty and recall costs. So serious was this problem with Zylon that certain of DHB’s
competitors had stopped using Zylon to manufacture products and even recalled their own Zylonbased body armor products. DHB, however, took no such action whatsoever and instead falsely told
analysts that it was not still manufacturing Zylon-based products, that there were very few DHB
Zylon vests in use in the field and disclosed only that its settlement of lawsuits regarding Zylon
would not have an adverse material impact on the Company. Unknown to investors, DHB sold at
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least 50,000 Zylon vests during 2001-2005, all of which were still under warranty during the Class
Period. Moreover, DHB continued to manufacture Zylon-based body armor products in the hope of
using up the huge inventory of Zylon materials it had accumulated before the Company was forced
to disclose that its inventory was worthless. In addition, DHB’s insiders knew that the Company
was encountering very serious problems with the quality of its flagship product line, the Interceptor
vest, manufactured for the U.S. military. These vests, of course, were required to meet very
stringent technical specifications and quality standards, as they were to be worn by military
personnel in the field. In order to lower production costs and artificially boost its profits, however,
DHB failed to implement or follow required and necessary manufacturing and quality controls for
which they were being paid. As a result, the DHB Interceptor vest line was plagued by high
numbers of defective vests which did not meet contract requirements or military specifications.
These non-conformities/defects had been detected by Department of Defense procurement and
quality assurance personnel during 2003-2004. These military personnel recommended rejection of
the defective vests and that action be taken against DHB because DHB was producing poor quality,
non-conforming vests and the military had granted DHB huge contracts on the basis of explicit
representations by DHB of the Company’s superior ability to meet technical requirements and
perform quality assurance procedures as compared to its competitors. While DHB was able to get
the military to waive the rejection of these defective products because of the military’s
overwhelmingly urgent need for body armor to protect its soldiers in Afghanistan and Iraq, DHB
knew it was only a matter of time until these defects became publicly known and before the military
stopped accepting delivery of defective vests and likely took action against DHB. And they knew,
of course, that the disclosure of any of the Company’s problems with Zylon and the Interceptor
would have had an immediate negative impact on DHB’s business and its financial results, as it
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would require huge write-offs of inventory, reserves for known contingencies and product
replacement costs which, in turn, would crush DHB’s stock price. Thus, DHB’s insiders lied to
investors to conceal these adverse facts and to inflate the stock so they could profit personally by
pushing the stock up higher, exercising their options and selling off their shares.
21.
DHB’s reported financial results and conditions, as well as the other statements made
between March 24, 2004 and August 29, 2005 concerning DHB’s business, products, financial
condition and future prospects were each false when made and were misleading in failing to disclose
the true financial results and conditions of DHB and adverse facts and conditions concerning DHB’s
business, products, finances and future outlook as set forth below:
(a)
Orders received by DHB from the Department of Defense (“DOD”) were not
an indication of the confidence of the U.S. military in, or satisfaction with, DHB’s products because,
in fact, many thousands of units of DHB’s main military product, the Interceptor vest, shipped to the
U.S. Marines were non-conforming and defective, and orders for vests were being placed and
defective vests were being accepted only because the military was suffering from extreme shortages
of body armor which was desperately necessary for American troops in Afghanistan and Iraq;
(b)
DHB’s products were not “world class,” “exceptional” or “the best that’s ever
been developed” or “technologically superior”; in fact, DHB had, since 2001, shipped at least 50,000
defective and non-conforming Zylon-based body armor products to domestic law enforcement
agencies which did not meet and could not fulfill DHB’s five-year warranty. DHB had also shipped
thousands of defective and non-conforming Interceptor vests to the U.S. Marines which failed to
comply with DOD/U.S. military contract specifications and requirements;
(c)
DHB’s systems of quality control, which were necessary for its successful
operation, were defective and inadequate, which led to the shipment of thousands of defective
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Interceptor vests to the U.S. Marines and also prevented DHB from being able to trace identified
defective vests to specifically identified lots of raw material, a major manufacturing processing and
quality control defect, which contaminated 100% of DHB’s Interceptor vest production;
(d)
DHB had accumulated many millions of dollars of defective and useless
Zylon raw material which its insiders knew could no longer be used to manufacture body armor
products because Zylon degraded rapidly when exposed to heat, light and body perspiration. DHB’s
excessive inventory of useless and unsaleable Zylon materials should have been and would have to
be written off, which would result in a multi-million dollar charge and adversely impact DHB’s
financial condition and results from operations;
(e)
It was not true, as represented by DHB, that there were very few Zylon vests
manufactured by DHB still in use by police departments in the field; on the contrary, there were at
least 50,000 Zylon vests still used in the field and still under warranty, that would have to be
replaced by DHB at a huge cost, which would have a material adverse impact on DHB’s financial
results and condition;
(f)
DHB’s financial reports and statements for the periods ending March 31,
2004-June 20, 2005 were materially false and misleading in overstating the value of DHB’s
inventories, failing to accrue material loss contingencies, i.e., Zylon vest replacement costs, and
overstating DHB’s net income, EPS and shareholders’ equity by material amounts;
(g)
DHB’s top insiders were aware that thousands of DHB Interceptor vests were
defective and did not conform to government standards, even though DHB had been paid an extra
$50 per vest to assure the high quality of such vests, that the DOD/U.S. military’s quality control
assurance personnel had discovered these defects and were recommending rejection of the vests and
disciplinary action against DHB, and that even if DHB was able to persuade the government to
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accept these defective vests because of the government’s urgent need for body armor for U.S. troops,
the U.S. military would, when body armor became more available, curtail its purchases of DHB’s
products;
(h)
DHB’s vests did not meet or exceed the expectations or requirements of
DHB’s domestic law enforcement and U.S. military customers, as thousands of these vests were
defective and non-conforming and its customers had objected to these defects, demanding or taking
remedial actions. Defendants privately acknowledged on multiple occasions throughout 2004,
including as early as February 2004 and, specifically, on November 30, 2004, that its Interceptor
vests did not meet or exceed expectations when officers of the Company signed military “Requests
for Deviation/Waiver” forms indicating major vest defects;
(i)
The reason for the increase in DHB’s inventories during 2004-2005 was not
that DHB was stockpiling raw materials, which were purportedly in short supply so that it would
have those materials to produce armor body products to meet increasing demand as claimed, but
rather, DHB’s inventories were increasing because the Company had accumulated and continued to
carry on its books millions of dollars of Zylon raw materials and Zylon-based vests which were, in
fact, unusable, worthless and should have been written off in accordance with Generally Accepted
Accounting Principles (“GAAP”) standards;
(j)
DHB’s internal financial and accounting and disclosure controls were not
adequately designed, had not been properly tested and, in fact, were defective, which was leading to
material fraud in the presentation of DHB’s financial results and condition. The internal control
deficiencies in DHB’s quality control systems, inventory pricing mechanisms and operations of its
Audit Committee were serious and pervasive and had not been corrected or had been overridden by
management, with the result that DHB had accumulated millions and millions of dollars of excessive
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and worthless inventory of Zylon raw material, was manufacturing and shipping thousands of
defective Interceptor vests to the U.S. military and not properly accounting for or reporting these
matters in its SEC filings and other public statements;
(k)
It was not true that the insider stock sales by DHB’s top officers and directors
were merely due to those individuals wanting to diversify their holdings; but rather, those sales took
place as part of a plan and scheme to inflate DHB’s stock price by false and misleading statements
and then bail out of the stock so that the Individual Defendants could personally profit at the expense
of public investors;
(l)
DHB’s officers and directors were violating multiple provisions of the DHB
Code of Business Conduct & Ethics;
(m)
DHB’s reported multi-hundred million dollar order backlog was false and
misleading because, due to its shipment of defective and non-conforming merchandise to the U.S.
Marines, the U.S. military had the right to cancel or refuse to accept future shipments or to cancel as
yet unfulfilled portions of future orders, and by late 2004, the U.S. Marines had done so; and
(n)
As a result of the foregoing, DHB’s forecasts of continued future profitable
growth and other optimistic statements regarding the future of DHB’s business were completely
false and were known by defendants to be false when made, because the adverse facts and conditions
detailed herein would cause DHB’s business to perform much worse than promised or forecast and
its financial results to be far short of those forecast.
22.
As detailed in ¶¶119-133 (“False Financial Statements”), DHB’s inventories, assets,
net income and EPS were materially inflated during the Class Period. Its shareholders’ equity was
also massively overstated, as the chart below sets forth:
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3/31/04
6/30/04
9/30/04
12/30/04
3/31/05
6/30/05
Shareholders’ equity
as reported
$53,087,000
$60,737,000
$68,795,000
$77,026,000
$85,201,000
$92,799,000
Shareholders’ equity
assuming required
charge* had been
recorded
$15,887,000
$23,537,000
$31,595,000
$39,826,000
$48,001,000
$55,599,000
234%
158%
118%
93%
77%
67%
Overstatement %
* Assumes charge of $60 million, reduced by tax rate of 38%.
23.
Defendants’ “pump-and-dump” scheme was successful. The individual defendants
unloaded huge amounts of stock, as shown below:
Defendant
Berkman
Brooks
Chasin
Hatfield
Krantz
Nadelman
Schlegel
TOTALS:
Shares
Sold
44,620
9,498,025
108,496
269,545
116,226
102,374
149,503
Proceeds
$
864,748
$185,893,751
$ 2,063,127
$ 5,292,041
$ 2,251,557
$ 2,007,554
$ 2,931,754
10,288,789
$201,304,532
This insider selling was unusual in both timing and amount.
- 20 -
% of Actually
Owned Shares
Sold
29.4%
59.7%
100.0%
100.0%
89.0%
58.7%
84.2%
Case 2:05-cv-04296-JS-ETB
24.
Document 80-1
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Page 24 of 162
In addition, defendants’ direct knowledge or reckless disregard of the matters
explained herein and their top executive and directorial positions, which perforce required
defendants’ intimate involvement in the matters central to this suit, defendants’ insider trading
strongly demonstrates their knowledge of the problems alleged herein. (See also ¶¶156-158 “Insider
Trading”). The timing and magnitude of these sales is highly supportive of an inference of
knowledge on the part of Defendants, DHB’s top insiders, of the adverse conditions and problems
existing inside DHB and the accounting manipulations and false statements engaged in to conceal
them. As the table graphs presented in this Complaint demonstrate (¶¶23-24, 31(a)-(g), 157), these
sales were unusual in timing and amount, both individually and in the aggregate. DHB’s top
executives and directors sold, either zero or a relatively small number of shares prior to the
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beginning of the Class Period. Yet, during the Class Period, as their affirmative misrepresentations
pushed DHB’s stock to its all-time high, they unloaded millions of shares of stock. Their market
trading was clearly designed to maximize their personal profits. If, in fact, DHB’s insiders believed
what they were saying about the current period success and future anticipated success of DHB’s
stock, the Individual Defendants would have had no reason to sell off such large portions of their
holdings. If their statements about DHB’s prospects were true, their shares would have been even
more valuable as DHB’s forecasted future successes came to fruition. Their statements were
completely inconsistent with their public representations about DHB’s business, and reported
financial results, but completely consistent with and supportive of the allegations made herein of
their knowledge of the adverse conditions and problems inside DHB’s business and the accounting
manipulations they were engaging in to cover them up, as detailed in the following chart:
- 22 -
tions"
ty to
or."
l
$5.46
1stQ 04 10-Q Internal
financial and accounting and
disclosure controls effective.
Results accurate. No fraud,
material or otherwise.
w orders.
+ million.
gth of DHB's
ts." Products
ts and
omers." DHB
vels of service
15-20% sales growth
"next few years."
come $6.3 million/EPS
million. Inventories
met or exceeded ... all
ed as guidance to
11/29/04-12/29/04 Insiders
sell 10,288,789 shares for
$201,304,532.
10/5-29/04 $54 million in new orders
"substantiate the confidence of ... customers in
... products." "Exceptional products and service
that exceed the requirements and expectations
of ... customers."
8/5/04 "Record" 2ndQ 04 results. Net income $7.6
million/EPS $.17. Shareholder equity $60.7 million.
Inventory $74.3 million. " Met or exceeded all ...
operating goals ... provided as guidance" to
analysts. "Beginning to realize significant ...
earnings leverage." Shareholder equity has
increased by 30% since 12/31/04. "Future outlook
for DHB ... remains exceptionally strong."
Internal financial and accounting and disclosure
controls effective. Results accurate. No fraud,
material or otherwise.
7/14/04 "our facilities ... [here]
allowed us to strengthen our
capability to manufacture
quality products."
1/24/05 Roth Cap Ptnrs.
Attributes stock's activity
to insider selling. Also
group of police officers
claim Zylon vests
defective.
States: "Minimal amount"
in the field.
Class Period
3/24/04 - 8/29/05
3/16/05 4thQ 04
Net income and
refused to provid
conference call o
Inventories incre
scarce raw materi
accounting and di
accurate. No fra
$6.97
8/29/05 DHB will dis
help customers repl
for Zylon inventory
out class period ear
shareholder equity.
5/10/05 1stQ 05 results. Below
expectations. Shareholder
equity $85.2; Inventories
$102.9 million. Growing
inventories due to stockpiling of
scarce raw materials.
10-Q Internal financial and
accounting and disclosure
controls effective. Results
accurate. No fraud, material or
otherwise.
5/9/05 Marine CorpsTimes expos
-- Thousands of DHB Marine Cor
Interceptor vests defective. Quali
control procedures not followed.
Marine Corps recalls thousands o
vests. Marine Corps stopped
purchase of vests.
4/15-16/05 DHB's auditor resign
4 years. Inventory pricing/Audit
weaknesses. Assures analysts n
adjustments required. Inventorie
$85.9 million.
4/9/05 Miami Herald article on in
Speculation of trouble at Compan
spokesperson says "things are go
1/11/05 Newsday -- $200 million insider selling.
Brooks says sellers "just wanted to diversify ...
holdings ... company ... look[s] forward to brilliant
year in 2005 ... insider selling is no reflection of
the business going forward."
2/14/05 Settles Zylon class
action vest suit. Cost $1.5
million. Still have high
degree of confidence in
vests. No material adverse
impact on DHB.
$14.19
$22.70
1/3/05 Class action suit by Southern
States Police Benevolent Ass'n re:
defective Zylon vests.
1/7/05 Roth Cap. Ptnrs -- Shares of DHB weak
due to nervous market after DHB insiders' stock
sales. "Sign of a red flag or bad news."
12/23/04 Huge Army Interceptor vest and Baltimore
Police contracts. "Catalyst that will propel and sustain
us into future." "Preeminent leader in design ... and
production of technologically superior life-saving body
armor" products. "Order demonstrates [DOD's]
confidence in [DHB's] ability to deliver life-saving body
armor." "Puts us in a league of our own as world's
premier provider of protective solutions surpassing our
customers' expectations." "World class products."
11/9/04 Record 3rdQ 04 results.
Net income $8 million/EPS $.18.
Shareholder equity $68.8 million.
Inventories $81.9 million. Continue
"to meet or exceed all ... operating
and performance goals." "Surging
operating performance and earnings
leverage --- this is just the beginning,
the future is ours."
Internal financial and accounting and
disclosure controls effective.
Results accurate. No fraud, material
or otherwise.
9/28/04 DHB refutes
rumor of stock sales by
Brooks.
$15.01
6/9/04 Kudlow & Kramer -- Order "changes the
whole complexion of DHB" -- Interceptor is
"certainly the best that's ever been developed
... it exceded the expectations of what the
military was looking for."
6/8/04 Big US Army contract for
$239 million. Order "a testament
to our industry-leading research
and development efforts."
g
old: 10,288,789
: $201,304,532
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Page 27 of 162
JURISDICTION AND VENUE
25.
The claims asserted in this complaint arise under and pursuant to §§10(b), 14(a),
20(a) and 20A of the 1934 Act [15 U.S.C. §§78j(b) and 78t(a) and 78t-1] and Rules 10b-5 and 14a-1
promulgated thereunder by the SEC [17 C.F.R. §240.10b-5; 17 C.F.R. §240.14a-1 to 240.14a-9].
26.
This Court has jurisdiction over the subject matter of this action pursuant to 28 U.S.C.
§§1331 and 1337, and §27 of the 1934 Act.
27.
Venue is proper in this district pursuant to §27 of the 1934 Act and 28 U.S.C.
§1391(b). Many of the acts and practices complained of herein occurred in substantial part in this
District.
28.
In connection with the acts alleged in this complaint, defendants, directly or
indirectly, used the means and instrumentalities of interstate commerce, including, but not limited to,
the mails, interstate telephone communications and the facilities of the national securities markets.
THE PARTIES
29.
(a)
Plaintiff NECA-IBEW Pension Fund (the Decatur Plan) (“NECA”) purchased
the securities of DHB at artificially inflated prices during the Class Period and suffered damages, as
a result of the artificial inflation coming out of the securities as defendants’ fraud was revealed.
NECA’s transactions are detailed in their certification, which was previously filed with the Court.
NECA is a multi-employer, defined-benefit pension plan headquartered in Decatur, Illinois.
(b)
Plaintiff Dr. George Baciu, Ph.D. (“Mr. Baciu”) purchased the securities of
DHB at artificially inflated prices during the Class Period and suffered damages as a result of the
artificial inflation coming out of the securities as defendants’ fraud was revealed. Mr. Baciu’s
transactions are detailed in the certification, which was previously filed with the Court. Mr. Baciu is
a Canadian citizen resident in Hong Kong where he is a Professor at Hong Kong Polytechnic
University.
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(c)
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Plaintiff Robino Stortini Holdings, LLC (“RS Holdings”) purchased the
securities of DHB at artificially inflated prices during the Class Period and suffered damages as a
result of the artificial inflation coming out of the securities as defendants’ fraud was revealed. RS
Holdings is a limited liability corporation which makes investments on its own behalf. Michael
Stortini is the Principal and Managing Member of RS Holdings. RS Holdings is registered in
Delaware and Michael Stortini is a resident of that state.
30.
Defendant DHB is a public corporation incorporated in Delaware and headquartered
in Westbury, New York. DHB designs and manufactures body armor products which it sells to
police departments and the U.S. military through its Point Blank Body Armor (“Point Blank”) and
PACA subsidiaries. The sale of body armor and associated products provides 98% of DHB’s annual
revenue. DHB and its predecessor-entity, DHB Capital Group, are collectively referred to herein as
“DHB” or the “Company.”
31.
(a)
David H. Brooks was founder, CEO and Chairman of DHB. Defendant Terry
Brooks is David Brooks’ wife and she works cooperatively with him and at his direction with regard
to DHB and the DHB shares they own and/or control individually and through entities they
cooperatively control, including defendants David Brooks International Inc., Andrew Brooks
International Inc., and Elizabeth Brooks International Inc. (the “Brooks Entities”). Brooks sold
millions of shares of DHB stock, personally and by and through the Brooks Entities, during the Class
Period. DHB has also granted millions of “cashless warrants” exercisable into DHB shares to David
and Terry Brooks (collectively, “the Brooks”). Brooks has a long history of securities laws
violations, acknowledged by securities regulators:
(1)
In 1992, Brooks and his brother, Jeffrey Brooks, were implicated by the SEC
in an insider trading scheme at an entity – JBSI – over which Brooks exerted de facto
control. The SEC further charged that David and Jeffrey Brooks aided and abetted
reporting violations at JBSI. Brooks and his brother later settled the litigation by
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accepting a civil fine of $405,000 and consenting to a bar on involvement in any
broker-dealer activities for a period of five years. Before settling with the SEC,
Brooks used JBSI as the placement agent for a private offering of shares in DHB’s
predecessor entity, DHB Capital Group, Inc., and JBSI received considerable
compensation.
(2)
In 1992, David and Jeffrey Brooks purchased over 17% of the shares of
USAT, a small intoxication-testing company. David Brooks served as a consultant to
USAT, while his brother was USAT’s investment banker. In 1993, David and
Jeffrey Brooks entered into a consent decree and injunction with USAT whereby
they severed all ties with the company and were banned from dealing with the
company for 10 years after shareholders accused Brooks of stock manipulation.
(3)
In 1995, the NASD denied an application by DHB to include the company’s
securities on the Nasdaq SmallCap Market, in part because of the SEC’s prior
enforcement action against Brooks and because the NASD was “troubled by Brooks’
prior misconduct.” SEC Release No. 34-37069, 1996 SEC LEXIS 989, *11 (April 5,
1996). Brooks and DHB made an unsuccessful appeal of the ruling to the SEC. The
SEC expressly concluded in the course of denying the company’s appeal of the
NASD ruling that “[W]e find that the NASD’s concerns as to Brooks are legitimate.
. .” because Brooks’ conduct “undermines both the regulation of securities firms
and its registered representatives, and protection of investors. . .” and “that Brooks
has a history of serious securities law violations. . .” Id. at *11-*12.
(4)
In 1998, the NASD agreed to list DHB on the Nasdaq SmallCap Market, but
placed significant restrictions on Brooks, requiring him to resign as CEO and take on
a Co-Chairman (Nadelman assumed the position) through 2000. The replacement
CEO hired by Brooks quit after only weeks on the job because he had concerns about
Brooks’ integrity and his unwillingness to actually relinquish control of DHB’s dayto-day operations, as required by Nasdaq. Nasdaq also implemented measures to
prevent stock manipulation and insider trading by David and Jeffrey Brooks. Nasdaq
required that (1) Brooks place all the shares he beneficially owned into a three year
voting trust administered by an independent trustee required to vote the shares
according to the majority shareholders vote; (2) Brooks be prevented from buying or
selling any shares for a three year period; (3) Brooks resign as a Director of the Audit
Committee; and (4) Jeffrey Brooks lower his ownership of the Company to not more
than 4.9 percent of the outstanding shares, forgo buying any additional shares of the
Company for three years and place all the shares he owned into a Voting Trust. The
Nasdaq restrictions were intended to prevent the exact kind of illegal, fraudulent
activity in which Brooks and his cohorts have now engaged and which are the
subject of this lawsuit.
(5)
In 2003, the SEC began an investigation into a litany of undisclosed or
improperly disclosed self-dealing transactions at DHB which improperly funneled
DHB moneys to Terry Brooks, corporations owned or controlled by the Brooks’
and/or Jeffrey Brooks (collectively, the “Brooks family”). That self-dealing, which
has enriched the Brooks family to the tune of tens of millions of dollars at the
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expense of DHB’s public investors, is set forth in detail herein at ¶149. The SEC
investigation is still ongoing. DHB still has not fully described the nature and extent
of its related-party transactions with David, Terry and Jeffrey Brooks and entities
they own or control.
During the Class Period, Brooks sold 9,498,025 shares of his DHB common stock (59.7% of the
shares he owned) for $185.9 million in insider trading proceeds. These sales were unusual in timing
and amount and are inconsistent with Brooks’ historical DHB stock sales, as the following chart
shows:
Brooks received “other compensation” for 2003 and 2004 of $1 million and $2 million based on
DHB’s apparent business success and false profits. Brooks’ total 2004 compensation, including
options exercised as part of his $186 million stock sale, was $73.3 million. In total, Brooks and
members of his immediate family received $98 million in compensation and payments in 2004
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(described fully herein at ¶149). DHB’s total reported net income in 2004 was $30.44 million and
the Company’s gross profit before expenses was only $94 million. As noted above, the Brooks’
2004-2005 windfall is only their latest illegally-obtained profit-taking at the expense of DHB’s
public investors. (¶149). Brooks also possesses significant knowledge of the accounting rules and
principles abused by himself and others as part of the massive fraud at DHB – he earned a Bachelor
of Science degree in accounting from New York University.
(b)
Sandra Hatfield (“Hatfield”) was COO of DHB since December 2000 and
during the Class Period. From October 1996-December 2000, she was President of the Point Blank
Body Armor subsidiary. Hatfield worked day-to-day in the Oakland Park, Florida facility where
DHB produced Interceptor vests. During the Class Period, Hatfield sold 269,545 shares of DHB
stock (100% of the shares she owned) for $5.3 million in illegal insider trading proceeds. Prior to
the Class Period, Hatfield made no sale of DHB stock. Hatfield’s stock sales were unusual in timing
and amount and out of line with her historical DHB stock sales, as the chart below shows:
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Hatfield received “other compensation” for 2003 and 2004 of $695,000 and $750,000 based on
DHB’s apparent business success and false profits.
(c)
Defendant Dawn Schlegel (“Schlegel”) was the Chief Financial Officer of the
Company during the Class Period since 1999 and throughout the Class Period. During the Class
Period, Schlegel sold 149,503 shares of her DHB common stock, 84.2% of her holdings, for $2.9
million in illegal insider trading proceeds. Prior to the Class Period, Schlegel made no sales of DHB
stock. These sales were unusual in timing and amount and out of line with Schlegel’s historical sales
of DHB stock, as shown by the following graph:
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Schlegel received “other compensation” for 2003 and 2004 of $100,000 and $500,000 based on
DHB’s apparent business success and false profits. Schlegel is also involved in defendant Terry
Brooks’ Tactical Armor Products, Inc., as she is listed as the Company’s “Point of Contact” by the
United States government.
(d)
Defendant Cary Chasin (“Chasin”) was a director of DHB since October 2002
and during the Class Period. He has a longstanding relationship with DHB and Brooks, having been
a high-level employee/consultant of the Company since the late 1990s. Chasin was a member of the
DHB Audit and Compensation Committees. He sold 108,496 shares of his DHB stock, 100% of the
shares he owned, for $2 million in illegal insider trading proceeds. Prior to the Class Period, Chasin
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made no sales of DHB stock. These sales were out of line with his historical sales of DHB stock, as
shown by the following graph:
(e)
Defendant Jerome Krantz (“Krantz”) was a director of DHB since July 2000
and during the Class Period. Krantz was a member of the DHB Audit and Compensation
Committees. He sold 116,226 shares of his DHB stock, 89% of the shares he owned, for $2.2
million in illegal insider trading proceeds. Prior to the Class Period, Krantz sold no shares of DHB
stock. These sales were out of line with his historical sales of DHB stock, as shown by the following
graph:
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(f)
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Defendant Gary Nadelman (“Nadelman”) was a director of DHB since July
2001 and during the Class Period. Nadelman was a business associate of Brooks as far back as 1992
when they, along with Brooks’ brother, Jeffrey Brooks, purchased over 17% of the shares of USAT.
As detailed above (¶31(a)(2)), David and Jeffrey Brooks entered into a consent decree and injunction
with USAT whereby they severed all ties with the company and were banned from dealing with the
company for 10 years. In addition, Nadelman served as one of two directors of Medi Data
International, Inc. (“Medi Data”), a corporation that is 97% owned by David Brooks’ wife,
defendant Terry Brooks, who serves as President and the other director. Medi Data is headquartered
out of the Brooks’ Long Island, New York, residence. Nadelman was also Co-Chairman of DHB
between 1998-2000 when Brooks was required by Nasdaq to share Chairmanship with a purportedly
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independent director. Nadelman was a member of the DHB Audit and Compensation Committees.
He sold 102,374 shares of his DHB stock, 58.7% of the shares he owned, for $2 million in illegal
insider trading proceeds. Prior to the Class Period, Nadelman made no sales of DHB stock. These
sales were out of line with his historical sales of DHB stock, as shown by the following graph:
(g)
Defendant Barry Berkman (“Berkman”) was a director of DHB during the
Class Period. He sold 44,620 shares of his DHB stock, 29.4% of the shares he owned, for $864,748
in illegal insider trading proceeds. Prior to the Class Period, Berkman made no sales of DHB stock.
These sales were out of line with his historical sales of DHB stock, as shown by the following graph:
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32.
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The parties listed in 31(a)-(g) are referred to herein as the “Individual Defendants.”
They are liable for the false statements pleaded herein at ¶51-52, 54-55, 58, 60, 62-64, 66, 69-73, 7778, 83, 85, 87, 91-92, 102-104, 108, and 110, and DHB’s false statements (including, but not limited
to, press releases, financial reports and SEC filings), as those statements were each “group
published” information for which they were collectively responsible.
BACKGROUND TO THE CLASS PERIOD
33.
Defendant DHB is a public corporation. DHB designs and manufactures body armor
products which it sells to police departments and the U.S. military. DHB also owns NDL Products,
Inc. 98% of DHB’s revenue is derived from its sale of body armor and closely associated products.
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34.
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In late 1998, Natick awarded DHB a five-year contract to produce Interceptor OTVs.
Interceptor OTV body armor was designed by a joint Army and Marines development team and
issued to troops beginning in 1999. Then, as now, there were a limited number of companies
capable of successfully bidding on such body armor contracts, body armor and bullet proof vests
being a specialty industry with relatively few producers and, according to DHB, “significant”
barriers to entry. Natick originally awarded the Interceptor contract to DHB in large part because
DHB promised to perform additional quality assurance procedures which its competitors did not
offer. The additional quality assurance procedures separated DHB’s bid from a number of
“technically acceptable proposals.” The military paid DHB $50 a vest extra to perform this quality
assurance program.
35.
Throughout the Class Period, it was known, but undisclosed to investors, that
Interceptor OTV body armor was not as effective as other body armor systems despite claims by
DHB and the military as to the technological superiority of Interceptor vests. In fact, Interceptor
body armor produced by DHB and fielded by troops in Afghanistan and Iraq did not fit correctly,
degraded under use in combat and with age, and left soldiers vulnerable to potentially fatal torso
wounds. As far back as 1996, the military knew of superior body armor, but which had been
developed privately, rather than by the military itself. Instead of supplying troops with the betterconstructed and technologically advanced body armor, bureaucratic entrenchment caused military
officials to contract for and then issue their own inferior vest, the Interceptor, the underlying
technology for which had been developed in the 1970s. Unknown to investors, more modern,
technologically superior body armor is and has been fielded by the United States Secret Service,
among other public and private entities and organizations.
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36.
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In April 2003, three Members of the United States Congress, including Congressman
Neil Abercrombie (D-HI), a member of the Committee on Armed Services, Ranking Member on the
Tactical Air and Land Forces Subcommittee and a member of the Readiness Subcommittee, formally
requested that the Defense Logistics Agency and the Army Material Command investigate whether
DHB violated the Procurement Integrity Act (41 USC §423 et seq.) in connection with the
Interceptor contract because, on January 19, 2001, DHB hired Edward Lavigne as Vice President of
its wholly owned subsidiary, NDL Products. NDL Products manufactures sports products, a
business with which career military officer Lavigne had no experience whatsoever, but which
operates out of the same facility in Oakland Park, Florida where DHB manufactures Interceptor
vests. DHB hired Lavigne away from Natick, where Lavigne had been a contracting officer
administering DHB’s Interceptor contract. The Procurement Integrity Act prohibits contracting
officers from working for companies whose contracts they oversaw in the previous twelve months.
The military’s response was not made public. Lavigne died in 2003.
37.
DHB purchased body armor raw materials from Toyobo Co., Ltd., including synthetic
PBO (poly p-phenylene-2, 6-benzobisoxazole) fiber, commonly referred to as “Zylon,” which it used
to manufacture bulletproof vests sold to domestic law enforcement agencies beginning in 2001.
Eight of the 15 different model vests produced for domestic law enforcement agencies by Point
Blank Body Armor contained Zylon. DHB’s other armor products subsidiary, PACA, also produced
vests containing Zylon. Each model was available in three different “threat levels.” The greater the
“threat level,” the more Zylon DHB used in the construction of the vest.
38.
Zylon first debuted in the body armor industry in the late 90s as a lighter and more
wearable alternative to other armed fabrics, such as Kevlar®. Toyobo is the sole supplier of Zylon
sold to DHB and DHB’s competitors. Zylon is manufactured as continuous filament yarn which is
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converted into fabric by weaving and layering. Prior to and during the Class Period, DHB and
Toyobo were in frequent contact with each other. Beginning in summer 2001, when Toyobo first
obtained conclusive test results indicating that Zylon had significant degradation problems, Toyobo
shared the results of its tests with the body armor industry, including DHB. Beginning January 1,
2002, Toyobo consistently provided the results of its Zylon testing to the body armor industry,
including DHB, on a quarterly and then semi-annual basis. Toyobo was also in frequent contact
with its customers via e-mail and facsimile transmissions and at body armor manufacturers’
meetings.
39.
Testing provided by Toyobo to the body armor industry, including DHB, clearly
indicated problems with Zylon. On or about August 28, 2001, Toyobo reported to Zylon vest
manufacturers, including DHB, test data that showed degradation in Zylon strength in less than 100
days at high temperatures and humidity. On or about September 14, 2001, Toyobo published a
technical bulletin describing Zylon properties under extreme conditions and announcing that there
was a 25%-35% loss of Zylon strength when Zylon was exposed to fluorescent lamps for several
weeks.
40.
In September 2003, ongoing testing of used vests containing Zylon showed
degradation problems with the fiber that shortened the wearable life of the vest. This process, which
is called “hydrolytic degradation,” potentially reduces the efficacy of the protective nature of the
clothing. Based on these tests, a DHB competitor named Second Chance recalled vests made
entirely of Zylon. According to Second Chance, “‘The problems associated with Zylon are not
specific to Second Chance’” – these problems were industry-wide and impacted DHB. Since 2001,
when DHB began selling Zylon vests to police departments, the Company has provided the same
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five-year warranty to police agencies provided by Second Chance Body Armor and other
competitors who sold Zylon vests.
41.
Toyobo tests also showed that the strength of Zylon fiber began to deteriorate rapidly
when exposed to visible and fluorescent light. Prior to the Class Period, Toyobo told DHB and other
body armor industry customers that there was a 23% degradation of Zylon fabric when exposed to a
fluorescent lamp for over 200 hours. In particular, Toyobo made disclosures to Zylon vest
manufacturers in October 2003 concerning Toyobo’s accelerated aging studies on Zylon fabric. The
studies had been performed on Zylon manufactured in May 2000 and tested from June 2001-July
2003 at the Toyobo Research Center. The Toyobo research showed a 25% degradation of Zylon
stored at 104 degrees Fahrenheit and 80% relative humidity. “Hydrolysis” was the failure
mechanism – a form of degradation that inherently occurred in individual Zylon fibers.
42.
DHB internally was very concerned about the Zylon degradation because at least
50,000 Zylon vests were in use in the field and under warranty during the Class Period. DHB
learned that the degradation data from Toyobo was not favorable and that they were concerned about
accelerated degradation. But despite attending manufacturers’ meetings at which Toyobo revealed
test results beginning February 2003 and receiving semi-annual and quarterly test result updates
during 2002-2004 directly from Toyobo, DHB ignored the research provided to it which confirmed
that Zylon degraded quickly and significantly lost tensile strength. DHB continued to manufacture
and sell Zylon bulletproof vests with Zylon provided by Toyobo, knowing that these vests were
defective and that they could not meet DHB’s five-year product warranty.
43.
On or about June 13, 2003, Officer Zeppetella of the Oceanside, California, police
force was killed during a traffic stop while wearing a Second Chance vest made of Zylon. Two
bullets passed through the vest and caused Officer Zeppetella’s death. Ten days later, on June 23,
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2003, Officer Ed Limbacher of Forest Hills, Pennsylvania was shot in the stomach wearing a Second
Chance Zylon vest made less than one year earlier. A bullet pierced his vest leaving him disabled.
In July 2003, Second Chance stopped selling Ultima/Ultimax vests made of Zylon. DHB knew this.
44.
On or about September 8, 2003, Second Chance disclosed to purchasers of its
Ultima/Ultimax vests that Zylon wore out sooner than expected and that there was a potential safety
issue with respect to these vests. Second Chance also initiated a program whereby Zylon vest
purchasers could receive a free “Performance Pac” upgrade to their previously purchased vests, or
participate in a warranty adjustment and vest replacement program, at a discount. DHB also knew of
these actions.
45.
The Association of Police Organizations (“NAPO”) filed a class action in Michigan
state court against Second Chance and Toyobo in March 2004. Other plaintiffs in the suit include
individual police officers in Florida and Michigan, the Fort Myers, Florida, police department, the
Lee County, Florida, sheriff’s office, and the Dermott, Arkansas, police department. The suit sought
reimbursement of the costs of the Zylon-based vests for all officers and agencies that bought them.
Nat’l Ass’n of Police Orgs. v. Second Chance Body Armor, Inc., No. 045-8018-NP (Antrim County,
Mich. Cir. Ct., filed 3/3/2004). DHB was aware of this suit.
46.
In early 2004, DHB reported its 4thQ 03 and fiscal year 2003 results, including net
income and EPS which were lower than analysts had expected and which declined from the 4thQ 02
and 2002 fiscal year results because, without warning, DHB’s executives had caused DHB to pay out
some $3 million in year-end bonuses (mostly to themselves). These bonus payments amounted to an
extraordinary sum given DHB’s size and consumed 50% of DHB’s 4thQ 03 net income and
infuriated analysts. DHB’s total net income in F4 03 was just over $15 million. According to one
analyst, “We were disappointed with the Company’s inability to anticipate the huge bonus outlay,”
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as DHB had forecast higher 4thQ 03 net income and EPS to analysts as recently as November 2003.
Nevertheless, Brooks said “The future outlook for DHB appears outstanding given the continuing
unstable geopolitical environment, the increased need for homeland security, and the continuing
war on terror.”
47.
On March 15, 2004, DHB held a conference call with analysts and stated:
[Brooks:] . . . 2003 was the most successful year in the history of DHB Industries.
The foundation for the company is solid. Now we can aggressively build DHB to
the company I’ve always envisioned. The company posted record results in virtually
every measure of performance. But and I mean but, this is only the beginning for
us. Our goal is to intensify momentum, increase profitability and enhance
shareholder value. Just like night fishing. The lights have been turned on. The
little fish are coming to the light. Now the big fish are coming for the little fish.
It’s like a feeding frenzy.
[Dajel (Schlegel’s deputy):] . . . In recognition of the increased focus on Homeland
Security and the war on terrorism, the number of officers and agents has increased
over the past two years and there has been increased funding to help equip these
officers and agents which has led to increased demand for our product. [Emphasis
added.]
48.
In 2003, DHB enacted its “Code of Business Conduct & Ethics.” DHB attached its
Code of Business Conduct and Ethics as an Exhibit to its 2003 10-K, filed March 16, 2004.
Defendants’ actions throughout the Class Period did not comply with this code. It states, in part:
DHB Industries, Inc. and its subsidiaries (the “Company”) is committed to
the principle of honest and ethical conduct in all aspects of its business. With the
adoption of the Sarbanes-Oxley Act of 2002, and rules adopted by the Securities and
Exchange Commission (the “Commission”), all publicly held companies have been
encouraged to adopt and make available to the public written codes of conduct and
ethics. The following Code of Business Conduct and Ethics (this “Code”) is
intended to be a codification of the business and ethical principles which have been a
part of the Company, and its intended, among other things, to promote:
x
honest and ethical conduct, including the ethical handling of actual or
apparent conflicts of interest between personal and professional
relationships;
x
avoidance of conflicts of interest, including disclosure to an appropriate
person or persons identified in this Code of any material transaction or
relationship that reasonably could be expected to give rise to such a conflict;
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x
full, fair, accurate, timely, and understandable disclosure in reports and
documents that the Company files with, or submits to the Commission and
in other public communications made by the Company;
x
compliance with applicable governmental laws, rules and regulations;
(See also ¶150.)
49.
In mid-March 2004, DHB was forced to reveal that the SEC had been investigating a
series of self-dealing transactions between Brooks and DHB, which had earlier been exposed and
challenged by a shareholder derivative suit. According to the March 18, 2004 Newsday:
DHB Industries . . . said in a federal Securities and Exchange Commission filing that
the regulatory agency is investigating loans made to the company by its founder and
chief executive.
The company . . . said in an SEC filing late Tuesday that David H. Brooks
made millions of dollars in loans to DHB that carried an interest rate of 12 percent a
year.
*
*
*
Some analysts said investors are unhappy with the leadership of Brooks, who
is also DHB’s largest shareholder. Brooks has been a target of complaints by Unite,
the giant Manhattan-based garment workers union, which has been trying to organize
DHB’s manufacturing facilities in Oakland Park, Fla.
*
*
*
In the SEC filing, DHB acknowledged that it also purchased equipment from
Tactical Armor Products Inc., owned by Brooks’ wife, Terry Brooks. DHB also said
it leases office and manufacturing space from a company owned by the Brooks’
children. The transactions were not disclosed in a timely manner as required by SEC
regulations.
DHB said that in 2002 and 2003, it gave David Brooks $7 million to repay
the loans, which carried an interest rate of 12 percent annually. However, the interest
expense recorded on financial statements was $93 for 2003 and $540 for 2002, the
company said.
*
*
*
The financial issues involving DHB were first raised by Unite in February
2003. Unite filed a complaint with the SEC, saying DHB “committed numerous
violations of federal securities regulations.”
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Among the alleged violations, Unite said, was that the company did not
disclose that David Brooks received $12 million in non salary executive
compensation from 1999 to 2001.
*
*
*
Analysts said fourth-quarter earnings were disappointing. Quarterly sales
rose, but earnings were lower. Analysts noted investors were displeased with the
disclosure that the company paid out $2.7 million in bonuses to top executives last
year.
50.
On March 23, 2004, DHB stock traded as low as $5.46 per share.
CLASS PERIOD EVENTS
51.
On March 24, 2004, DHB issued a release announcing a large new DOD contract
headlined and stating:
DHB Industries Awarded $77 Million DOD Contract – Award is the Largest
Contract for Body Armor Ever Issued By the Department of Defense
DHB Industries Inc., the market leader in the rapidly growing protective body
armor industry, announced today that its wholly owned subsidiary, Point Blank Body
Armor, Inc., has been awarded a $77 million contract for body armor for the United
States Military. Point Blank believes this is the largest single contract for body
armor ever awarded by the U.S. Department of Defense.
The Company received the $77 million award for Point Blank’s
“Interceptor” Outer Tactical Vest (OTV). Point Blank is currently the major
supplier of outer tactical vests to the United States Armed Forces.
This brings the total new DOD contacts and purchase orders announced by
DHB Industries over the past four months to $142 million. . . .
Commenting on the announcement, Sandra Hatfield, Chief Operating Officer
of DHB Industries, said, “This contract award demonstrates the U.S. Department of
Defense’s continued confidence in Point Blank’s ability to deliver life-saving body
armor systems to the armed forces of the United States. We will continue to
provide exceptional products that exceed the requirements and expectations of the
United States Military while also providing unmatched service and support.”
[Emphasis added.]
52.
On April 1, 2004, DHB issued a release reporting $12 million in new orders
headlined and stating:
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DHB Industries announces $12 Million in New Orders; Company Reports
Current Backlog of Firm Orders Stands at a Record $203 Million
DHB Industries Inc. . . . announced today that it has received more than $12
million in new purchase and delivery orders within the past week. . . .
Total backlog of firm orders in hand currently stands at a record $203 million,
a 54% increase as compared to total backlog of firm orders in hand of $132 million
on March 1, 2004.
Today’s announcement brings the total new contracts and purchase orders
announced by DHB Industries since November 2003 to $154 million. Last week,
DHB announced that its wholly owned subsidiary, Point Blank Body Armor, Inc.,
had been awarded a $77 million contract from the United States Military for its
“Interceptor” Outer Tactical Vest (OTV). Point Blank believes this is the largest
single contract for body armor ever awarded by the U.S. Department of Defense.
Point Blank is currently the major supplier of outer tactical vests to the United
States Armed Forces.
Commenting on the announcement, Sandra Hatfield, Chief Operating Officer
of DHB Industries, said, “The momentum of new purchase orders coming into
DHB is continuing at a record pace from all market sectors. We believe this is a
result of both strong worldwide demand for protective body armor coupled with
DHB’s proven ability to fulfill this demand with the industry’s leading products
and unparallel[ed] customer service and support.” [Emphasis added.]
Between March 23, 2004 and April 2, 2004, DHB’s stock rose from as low as $5.46 to as high as
$8.18 – an increase of 50% – on exceptionally large trading volume.
53.
On April 20, 2004, DHB announced it had resolved all of its differences with the
UNITE union, settled all litigation with the union and signed a three-year collective bargaining
agreement. DHB also announced the dismissal of a stockholder derivative suit against six of its top
officers, including Brooks.
54.
On April 29, 2004, DHB issued a release announcing more new orders and a record
backlog. The release was headlined and stated:
DHB Industries Announces Record $215+ Million Backlog – Company
Announces $25 Million in New Orders Received Within the Past Week
DHB Industries Inc. . . . announced today that the total backlog of firm orders
in hand currently stands at a record $215+ million. During the past week, DHB’s
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Armor Group has received more than $25 million in new purchase and delivery
orders. Today’s announcement brings the total new contracts and purchase orders
announced by DHB Industries since November 2003 to $179 million.
Commenting on the announcement, Sandra Hatfield, Chief Operating Officer
of DHB Industries, said, “The demand for the Armor Group’s products continues at
an unprecedented pace. We continue to receive new purchase orders from every
market sector, reflecting the strength of DHB’s technology [and] products . . . .
[W]e continue to provide exceptional life-saving products that exceed the
requirements and expectations of our customers while providing unparalleled
levels of service and support.” [Emphasis added.]
55.
On May 6, 2004, DHB reported its 1stQ 04 results via a release headlined and stating:
DHB Industries Announces Record 1st Quarter Revenue of $74.4 Million and
Record Earnings of $0.14 Per Share – First Quarter Net Income Jumps 27% to
$6.3 Million; Revenue Increases 61%
DHB Industries, Inc., the market leader in the rapidly growing body armor
industry, today announced record revenues and earnings for the first quarter ended
March 31, 2004, posting its 17th consecutive year-over-year increase in quarterly
revenues. The current backlog of firm orders in hand has dramatically increased to
an unprecedented $215 million.
First quarter 2004 income available to common stockholders was $6,269,000
or $0.14 per diluted share, as compared to $4,929,000, or $0.12 per diluted share in
the first quarter of 2003.
Gross margins for the first quarter of 2004 were 27.9% versus 28.1% in the
first quarter of 2003. . . . stockholder’s equity. . . Stockholders’ equity rose to a
record $53,087,000 at the end of the first quarter of 2004 . . . .
*
*
*
Dawn Schlegel, CFO of DHB Industries, commented, “The Company met or
exceeded during the first quarter all of its operating goals which it had previously
provided as guidance to the financial community on March 15th. . . . The balance
sheet continued to strengthen as stockholders’ equity increased by $6.3 million in
the quarter.”
*
*
*
Mr. Brooks continued, “Order activity from all four sectors of business –
military, law enforcement, federal agencies and international is expanding at record
levels. We are particularly enthused with the current activity and future growth
prospects in the international markets. [Emphasis added.]
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56.
Document 80-1
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On May 7, 2004, Miller Johnson Steichen Kinnard issued a report on DHB based on
information provided by Schlegel and Hatfield, repeating information provided by them. It stated:
1Q045 SALES AND EPS WERE AHEAD OF EXPECTATIONS;
INCREASING FY04 ESTIMATES AND PRICE TARGET
*
x
*
Strong quarter, both top and bottom lines. Backlog continues to grow.
*
x
*
*
*
*
*
Raising sales and EPS estimates.
*
1Q04 EPS of $0.14 was well ahead of our estimate of $0.11. Gross margin of
27.9% was ahead of our expectations of 27.3%.
57.
On May 10, 2004, Feltl and Company issued a report on DHB based on information
provided by Schlegel and Hatfield, repeating information provided by them. It stated:
Key Points:
x
DHB reported Q1 revenues increased 61% over the prior year to a record level of
$74.4 million on strong demand from the US Military for the Interceptor OTV and
from domestic law enforcement entities.
x
Q1 operating income rose 52% in the quarter over the prior year . . . .
*
*
*
x
Net income for Q1-2004 was $6.3 million or $0.14 per share, compared to $4.9
million and $0.12, respectively, in the prior year. . . .
x
The company’s current backlog remains at an all-time record $215 million.
*
x
*
*
Based on the strong Q1 performance and guidance, we have raised our estimate for
the year to $306.5 million and EPS to $0.54 from $0.46 previously.
*
*
First Quarter Results
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*
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*
This was a solid quarter in all regards . . . [with] solid profit margins and no
unexpected charges or events to detract from the good financial and operating
performance.
*
*
*
Profitability in the quarter was better than our forecast. Gross profit
margin declined slightly to 27.9% from 28.1% a year earlier but up from 27.5% in
Q4-2003.
*
*
*
We think there is potential demand for DHB to grow sales at a rate of 15% to 20%
per year for the next few years. We also expect that earnings can grow faster than
sales as the company realizes further production efficiencies and reduces debt.
58.
On May 10, 2004, DHB filed its 1stQ 04 10-Q report with the SEC signed by Brooks,
Schlegel, Krantz and Nadelman. The 10-Q valued DHB’s inventories as of March 31, 2004 at $62.8
million. The 1stQ 04 10-Q contained the same financial results earlier reported by DHB. The 10-Q
told investors:
The Company’s market share is highly dependent upon the quality of its
products and its ability to deliver its products in a prompt and timely fashion. . . .
Management’s current strategic focus is on quality and delivery, which management
believes are the key elements in obtaining additional and repeat orders under the
Company’s existing procurement contracts with the U.S. military and other
governmental agencies.
It also stated:
Controls and Procedures
The Company carried out an evaluation, as required by Rule 13a-15(b) under
the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the
supervision and with the participation of the Company’s management, including the
Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness
of the design and operation of the Company’s disclosure controls and procedures (as
defined in Rules 13a-14 and 15d-14 of the Exchange Act) as of the end of the period
covered by this report. Based upon that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that the Company’s disclosure controls and
procedures are effective in timely alerting them to material information relating to
the Company (including its consolidated subsidiaries) required to be included in
the Company’s periodic SEC filings. During the period covered by this report, the
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Company has continued to implement certain changes to its internal control over
financial reporting as described below, which have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.
Disclosure controls and procedures are those controls and other procedures
that are designed to ensure that information required to be disclosed by the Company
in the reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the SEC’s rules and
forms. Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the Company’s management, including the
Company’s principal executive officer and principal financial officer, as appropriate
to allow timely decisions regarding required disclosure.
The 1stQ 04 10-Q also included certifications of Brooks and Schlegel as CEO and CFO of DHB
dated May 10, 2004, certifying:
1.
I have reviewed this quarterly report on Form 10-Q of DHB Industries, Inc.;
2.
Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this quarterly report;
3.
Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this quarterly report;
4.
The registrant’s other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
a)
designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b)
evaluated the effectiveness of the registrant’s disclosure controls and
procedures as of a date within 90 days prior to the filing date of this quarterly report
(the “Evaluation Date”); and
c)
presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
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5.
The registrant’s other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent function):
a)
all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant’s ability to record, process,
summarize and report financial data and have identified for the registrant’s auditors
any material weaknesses in internal controls; and
b)
any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officer and I have indicated in this quarterly
report whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
The 1stQ 04 10-Q also contained two other certifications by Brooks and Schlegel stating:
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of DHB Industries, Inc. (the
“Company”) on Form 10-Q for the period ended March 31, 2004 as filed with the
Securities and Exchange Commission on the date hereof (the “Report”), I . . . certify,
pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act
of 2002, that:
(1)
The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2)
The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
59.
DHB’s reported financial results and conditions, as well as the other statements made
between March 24, 2004 and May 10, 2004 concerning DHB’s business, products, financial
condition and future prospects were each false and misleading when made and were misleading in
failing to disclose the true financial results and conditions of DHB and the adverse facts and
conditions concerning DHB’s business, products, finances and future outlook as set forth below:
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(a)
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Orders received by DHB from the DOD were not an indication of the
confidence of the U.S. military in, or satisfaction with, DHB’s products because, in fact, many
thousands of units of DHB’s main military product, the Interceptor vest, shipped to the U.S. Marines
were non-conforming and defective and orders for vests were being placed and defective vests were
being accepted only because the military was suffering from extreme shortages of body armor which
was desperately necessary for American troops in Afghanistan and Iraq;
(b)
DHB’s products were not “exceptional”; in fact, DHB had shipped at least
50,000 Zylon-based body armor products to domestic law enforcement agencies which were
defective and non-conforming and did not meet and could not fulfill DHB’s five-year warranty.
DHB had also shipped thousands of defective and non-conforming Interceptor vests to the U.S.
Marines which failed to comply with DOD/U.S. military contract specifications and requirements;
(c)
DHB’s systems of quality control, which were indispensable for its successful
operation, were defective and inadequate, which led to the shipment of thousands of defective
Interceptor vests to the U.S. Marines and also prevented DHB from being able to trace identified
defective vests to specifically identified lots of raw material, a major manufacturing processing and
quality control defect, which contaminated 100% of DHB’s Interceptor vest production;
(d)
DHB had accumulated many millions of dollars of defective and useless
Zylon raw material which its insiders knew could no longer be used to manufacture body armor
products because Zylon degraded rapidly when exposed to heat, light and body perspiration. DHB’s
excessive inventory of useless and unsaleable Zylon materials should have been and would have to
be written off, which would result in a multi-million dollar charge and adversely impact DHB’s
financial condition and results from operations;
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(e)
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DHB’s financial reports and statements for the period ending March 31, 2004
were materially false and misleading in overstating the value of DHB’s inventories, failing to accrue
material loss contingencies, i.e., Zylon vest replacement costs, and overstating DHB’s net income,
EPS and shareholders’ equity by material amounts;
(f)
DHB’s top insiders were aware that thousands of DHB Interceptor vests were
defective and did not conform to government standards, even though DHB had been paid an extra
$50 per vest to assure the high quality of such vests, that the DOD/U.S. military’s quality control
assurance personnel had discovered these defects and were recommending rejection of the vests and
disciplinary action against DHB, and that even if DHB was able to persuade the government to
accept these defective vests because of the government’s urgent need for body armor for U.S. troops,
the U.S. military would, when body armor became more available, curtail its purchases of DHB’s
products;
(g)
DHB’s vests did not meet or exceed the expectations or requirements of
DHB’s domestic law enforcement and U.S. military customers, as thousands of these vests were
defective and non-conforming and its customers had objected to these defects, demanding or taking
remedial actions. Defendants privately acknowledged on multiple occasions throughout 2004,
including as early as February 2004 and, specifically, on November 30, 2004, that its Interceptor
vests did not meet or exceed expectations when officers of the Company signed government
“Requests for Deviation/Waiver” forms indicating major vest defects;
(h)
DHB’s internal financial and accounting and disclosure controls were not
adequately designed, had not been properly tested and, in fact, were defective, which was leading to
material fraud in the presentation of DHB’s financial results and condition. Due to the internal
control deficiencies in DHB’s quality control systems, inventory pricing mechanisms and the
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operations of its Audit Committee, which were serious and pervasive, DHB had accumulated
millions and millions of dollars of excessive and worthless inventory of Zylon raw material, was
manufacturing and shipping thousands of defective Interceptor vests to the U.S. military and was not
properly accounting for or reporting these matters in its SEC filings and other public statements;
(i)
DHB’s officers and directors were violating multiple provisions of the DHB
Code of Business Conduct & Ethics; and
(j)
As a result of the foregoing, DHB’s forecasts of continued future profitable
growth and other optimistic statements regarding the future of DHB’s business were completely
false and were known by defendants to be false when made, because the adverse facts and conditions
detailed above would cause DHB’s business to perform much worse than promised or forecast and
its financial results to be far short of those forecast.
60.
On June 8, 2004, DHB issued a release announcing a large DOD contract, headlined
and stating:
DHB Industries Announces $239.4 Million Contract; – Award is the Largest
Contract for Armor Ever Issued in the History of Body Armor – Company’s
Backlog Swells to a Record $415 Million
DHB Industries Inc. David Brooks, Chairman and CEO of DHB Industries,
proudly announced today that the Company has been awarded a contract for its
recently developed Dorsal Axillary Protection System (D.A.P.S.) from the U.S.
Army Robert Morris Acquisition Center. The contract value is an astounding
$239,400,000 covering three years.
“This order has an enormous impact on DHB as it marks an entirely new
segment of business and product line to compliment our existing Interceptor Body
Armor sold to the U.S. military and its industry leading soft armor systems sold to
law enforcement and federal agencies. Moreover, the contract provides a substantial
guaranteed base of business for the next three years and will allow for immediate
higher utilization of our recently opened 104,000 sq. ft. Pompano Beach, Florida
manufacturing facility,” stated David Brooks.
Sandra Hatfield, Chief Operating Officer of DHB Industries, commented,
“We are proud of our rapid response to the needs of our customer in designing,
developing and producing this latest addition to the Interceptor Outer Tactical Vest.
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This product is a testament to our industry-leading research and development
efforts.”
*
*
*
Point Blank believes this is the largest single contract for armor ever awarded
in the history of the body armor industry. This brings the total new DOD contracts
and purchase orders announced by DHB Industries over the past eight months to
$381 million and increases the Company’s total current backlog to a record $415
million. [Emphasis added.]
61.
On June 9, 2004, DHB’s stock soared to as high as $13.20 from as low as $9.01 on
June 7, 2004, on exceptionally high volume, a 47% price increase, reaching its highest price in many
months.
62.
On June 9, 2004, Hatfield, DHB’s COO, appeared on CNBC’s “Kudlow & Cramer”:
LARRY KUDLOW, co-host:
It’s the biggest contract ever in the history of body armor: 239.4 million
bucks for bullet-proof vests to protect our soldiers in Iraq. Here with details is
Sandra Hatfield, chief operating officer of DHB Industries. Welcome, Ms. Hatfield.
This is such a great story. A, it’s going to protect our troops in Iraq and, B, it gives
you a leg-up. I like to see companies succeed. Can you just tell us in this new
generation of body armor – you’ve been in the business a while – what’s new? What
are you doing here . . . that has been so successful?
[S. HATFIELD:] Well, I think the biggest thing that’s led to our success is
foreseeing the need of the customer and listening to the customer, and we certainly
have a very good R&D staff that can take an idea and make it into a product quite
rapidly, in fact.
*
*
*
[I]f you want to look at a contract of this size and this magnitude, certainly changes
the whole complexion of the DHB industries.
*
*
*
[T]he facts right now are it’s certainly the best that’s ever been developed. You
know, we never became complacent . . . it does protect against bullets,
fragmentation, and it exceeded the expectations of what the military was looking
for. [Emphasis added.]
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63.
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On July 14, 2004, DHB issued a release announcing additional orders headlined and
stating:
DHB Industries Announces $37 Million in New Orders
DHB Industries Inc., the market leader in the rapidly growing protective body
armor industry, announced today that the Company’s Armor Group has received
approximately $37 million in new purchase and delivery orders since the beginning
of July for a wide variety of products including Point Blank’s “Interceptor Outer
Tactical Vest (OTV)” . . . .
Commenting on the announcement, Sandra Hatfield, Chief Operating Officer
of DHB Industries, said, “As previously stated, we continue to receive new purchase
orders at a staggering rate from all market sectors. As a result of our recent
expansion, we are clearly poised to accommodate and fulfill the needs of our
customers. The planning and positioning of our facilities . . . have allowed us to
strengthen our capability to manufacture quality products . . . .”
64.
On August 5, 2004, DHB issued a release reporting “record” 2ndQ 04 results,
headlined and stating:
DHB Industries Announces Record 2nd Quarter Revenue of $86 Million and
Record Earnings of $0.17 Per Share
– 2nd Quarter Income Available to Shareholders Jumps 91%; Net Revenue
Increases 52%
– Company Ups Guidance For Full-Year 2004 Revenues to Exceed $300 Million
– Company’s Current Backlog Exceeds $393 Million
DHB Industries, Inc., the market leader in the rapidly growing body armor
industry, today announced record revenues and earnings for the second quarter ended
June 30, 2004, posting its 18th consecutive year-over-year increase in quarterly
revenues. The current backlog exceeds $393 million, an 83% increase from the $215
million backlog reported with the Company’s first quarter results on May 6, 2004.
Second quarter 2004 income available to common stockholders was a record
$7,570,000 or $0.17 per diluted share, a 91% increase as compared to $3,961,000, or
$0.09 per diluted share in the second quarter of 2003.
Gross margins for the second quarter of 2004 were 27.7% versus 27.5% in
the second quarter of 2003.
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Income available to common stockholders in the first six months was a record
$13,839,000 or $0.30 per diluted share as compared to $8,890,000, or $0.20 per
diluted share in the first six months of 2003.
Gross margins for the first six months of 2004 were 27.8% versus 27.7% in
the first six months of 2003.
Stockholders’ equity rose to a record $60,737,000 at June 30, 2004, a 30%
increase as compared to $46,738,000 at year-end December 31, 2003.
*
*
*
Dawn Schlegel, CFO of DHB Industries, commented, “During the second
quarter, the Company once again met or exceeded all of its operating goals which
it previously provided as guidance to the financial community on May 6, 2004.
The four income statement items that we deem most important – net sales, gross
margins, selling, general and administrative expenses and operating margins – all
met or exceeded our expectations. We are beginning to realize significant
operating and earnings leverage as our sales increase. Moreover, the balance
sheet continues to strengthen as stockholders’ equity has increased by 30% since
December 31, 2003.”
David Brooks, Chairman and CEO of DHB Industries, added, “DHB
Industries continues to experience extraordinary growth as order activity from all
four sectors of business – military, law enforcement, federal agencies and
international – has been expanding at a rapid pace for more than a year. Over the
past ten months, DHB has announced new contracts and purchase orders totaling
more than $415 million. . . . We believe the future outlook for DHB and its
industry leading soft body armor products remains exceptionally strong.”
[Emphasis added.]
65.
On August 6, 2004, Miller Johnson Steichen Kinnard issued a report on DHB, based
on information provided by Schlegel and Hatfield stating:
x
2Q04 results well ahead of expectations, with strong sales, margins, and
EPS.
*
x
*
*
*
*
Increasing FY04 estimates.
*
We believe orders from domestic law enforcement also gained momentum. DHB
indicated that it has gained new customers in domestic law enforcement as well as
expanding its distribution network to this segment. We believe the Company is
gaining share in the expanding law enforcement market, as attorneys general in
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several states have brought lawsuits against DHB’s competitors due to unreliable
products. [Emphasis added.]
*
*
*
We believe DHB will continue to generate strong sales and earnings results in FY05
....
66.
On August 9, 2004, DHB filed its Form 10-Q report with the SEC for the quarter
ended June 30, 2004. This Form 10-Q report, signed by defendants Brooks, Schlegel, Krantz and
Nadelman, contained the same financial results earlier reported by DHB. The 10-Q valued DHB’s
inventories as of June 30, 2004 at $74.3 million. The 2ndQ 04 10-Q again told investors:
The Company’s market share is highly dependent upon the quality of its
products and its ability to deliver its products in a prompt and timely fashion. . . .
Management’s current strategic focus is on quality and delivery, which management
believes are the key elements in obtaining additional and repeat orders under the
Company’s existing procurement contracts with the U.S. military and other
governmental agencies.
This 10-Q also stated:
Controls and Procedures
The Company carried out an evaluation, as required by Rule 13a-15(b) under
the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the
supervision and with the participation of the Company’s management, including the
Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness
of the design and operation of the Company’s disclosure controls and procedures (as
defined in Rules 13a-14 and 15d-14 of the Exchange Act) as of the end of the period
covered by this report. Based upon that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that the Company’s disclosure controls and
procedures are effective in timely alerting them to material information relating to
the Company (including its consolidated subsidiaries) required to be included in
the Company’s periodic SEC filings. During the period covered by this report, the
Company has continued to implement certain changes to its internal control over
financial reporting as described below, which have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.
Disclosure controls and procedures are those controls and other procedures
that are designed to ensure that information required to be disclosed by the Company
in the reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and
forms. Disclosure controls and procedures include, without limitation, controls and
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procedures designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the Company’s management, including the
Company’s principal executive officer and principal financial officer, as appropriate
to allow timely decisions regarding required disclosure.
The 2ndQ 2004 10-Q also included certifications of Brooks and Schlegel as CEO and CFO of DHB
dated August 5, 2004, certifying:
1.
I have reviewed this quarterly report on Form 10-Q of DHB Industries, Inc.;
2.
Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this quarterly report;
3.
Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this quarterly report;
4.
The registrant’s other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
a)
designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b)
evaluated the effectiveness of the registrant’s disclosure controls and
procedures as of a date within 90 days prior to the filing date of this quarterly report
(the “Evaluation Date”); and
c)
presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5.
The registrant’s other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent function):
a)
all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant’s ability to record, process,
summarize and report financial data and have identified for the registrant’s auditors
any material weaknesses in internal controls; and
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b)
any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officer and I have indicated in this quarterly
report whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
The 2ndQ 04 10-Q also contained two other certifications by Brooks and Schlegel stating:
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of DHB Industries, Inc. (the
“Company”) on Form 10-Q for the period ended June 30, 2004 as filed with the
Securities and Exchange Commission on the date hereof (the “Report”), I . . . certify,
pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act
of 2002, that:
(1)
The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2)
The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
67.
DHB’s reported financial results and conditions, as well as the other statements made
between June 8, 2004 and August 6, 2004 concerning DHB’s business, products, financial condition
and future prospects were each false and misleading when made and were misleading in failing to
disclose the true financial results and conditions of DHB and the adverse facts and conditions
concerning DHB’s business, products, finances and future outlook as set forth below:
(a)
Orders received by DHB from the DOD were not an indication of the
confidence of the U.S. military in, or satisfaction with, DHB’s products because, in fact, many
thousands of units of DHB’s main military product, the Interceptor vest, shipped to the U.S. Marines
were non-conforming and defective, and orders for vests were being placed and defective vests were
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being accepted only because the military was suffering from extreme shortages of body armor which
was desperately necessary for American troops in Afghanistan and Iraq;
(b)
DHB’s products were not “the best that’s ever been developed”; in fact, DHB
had shipped at least 50,000 Zylon-based body armor products to domestic law enforcement agencies
which were defective and non-conforming and did not meet and could not fulfill DHB’s five-year
warranty. DHB had also shipped thousands of defective and non-conforming Interceptor vests to the
U.S. Marines which failed to comply with DOD/U.S. military contract specifications and
requirements;
(c)
DHB’s systems of quality control, which were indispensable for its successful
operation, were defective and inadequate, which led to the shipment of thousands of defective
Interceptor vests to the U.S. Marines and also prevented DHB from being able to trace identified
defective vests to specifically identified lots of raw material, a major manufacturing processing and
quality control defect, which “contaminated 100% of DHB’s Interceptor vest production;
(d)
DHB had accumulated many millions of dollars of defective and useless
Zylon raw material which its insiders knew could no longer be used to manufacture body armor
products because Zylon degraded rapidly when exposed to heat, light and body perspiration. DHB’s
excessive inventory of useless and unsaleable Zylon materials should have been and would have to
be written off, which would result in a multi-million dollar charge and adversely impact DHB’s
financial condition and results from operations;
(e)
DHB’s financial reports and statements for the period ending June 30, 2004
were materially false and misleading in overstating the value of DHB’s inventories, failing to accrue
material loss contingencies, i.e., Zylon vest replacement costs, and overstating DHB’s net income,
EPS and shareholders’ equity by material amounts;
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(f)
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DHB’s top insiders were aware that thousands of DHB Interceptor vests were
defective and did not conform to government standards, even though DHB had been paid an extra
$50 per vest to assure the high quality of such vests, that the DOD/U.S. military’s quality control
assurance personnel had discovered these defects and were recommending rejection of the vests and
disciplinary action against DHB, and that even if DHB was able to persuade the government to
accept these defective vests because of the government’s urgent need for body armor for U.S. troops,
the U.S. military would, when body armor became more available, curtail its purchases of DHB’s
products;
(g)
DHB’s vests did not meet or exceed the expectations or requirements of
DHB’s domestic law enforcement and U.S. military customers, as thousands of these vests were
defective and non-conforming and its customers had objected to these defects, demanding or taking
remedial actions. Defendants privately acknowledged on multiple occasions throughout 2004,
including as early as February 2004 and, specifically, on November 30, 2004, that its Interceptor
vests did not meet or exceed expectations when officers of the Company signed military “Requests
for Deviation/Waiver” forms indicating major vest defects;
(h)
DHB’s internal financial and accounting and disclosure controls were not
adequately designed, had not been properly tested and, in fact, were defective, which was leading to
material fraud in the presentation of DHB’s financial results and condition. Due to internal control
deficiencies in DHB’s quality control systems, inventory pricing mechanisms and the operations of
its Audit Committee, which were serious and pervasive, DHB had accumulated millions and millions
of dollars of excessive and worthless inventory of Zylon raw material, was manufacturing and
shipping thousands of defective Interceptor vests to the U.S. military and was not properly
accounting for or reporting these matters in its SEC filings and other public statements;
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(i)
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DHB’s officers and directors were violating multiple provisions of the DHB
Code of Business Conduct & Ethics; and
(j)
As a result of the foregoing, DHB’s forecasts of continued future profitable
growth and other optimistic statements regarding the future of DHB’s business were completely
false and were known by defendants to be false when made, because the adverse facts and conditions
detailed above would cause DHB’s business to perform much worse than promised or forecast and
its financial results to be far short of those forecast.
68.
On September 24, 2004, Roth Capital Partners issued a report on DHB “initiating
coverage” of the Company. Because this was Roth’s first report on DHB, it was issued only after
extensive discussions with Brooks, Schlegel and Hatfield. The report stated:
x
Recommendation: We are initiating coverage with a STRONG BUY
recommendation . . . .
*
*
*
Posting Record Results
DHB reported Q204 results with revenue increasing to $86.1 million
compared to $56.5 million in Q203 driven by continued strong demand from
shipping OTVs to the U.S. military. . . . Gross margin increased to 27.7% versus
27.5% a year ago. Management also demonstrated its ability to control costs as
SG&A expenses declined to 12.7% of sales compared to 13.8% in Q203. For the
quarter, earnings before interest, taxes, depreciation, and amortization was $13.2
million with net income of $7.6 million, and earnings of $0.17 per share.
69.
In late September 2004, as DHB’s stock moved higher, rumors circulated that Brooks
had filed with the SEC to sell substantial amounts of his DHB stock. Because defendants knew that
information that Brooks was selling large amounts of his stock would be interpreted by market
participants as indicating he knew of adverse undisclosed information about DHB and would thus
negatively impact the stock’s price, DHB issued a release on September 28, 2004 refuting the
rumors:
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DHB Industries Refutes Reported Sales Filing by Executive
DHB Industries Inc., . . . announced today that despite statements from one or more
online services providing access to and analysis of securities filings that David H.
Brooks, Chairman and Chief Executive Officer of DHB, has filed with the Securities
and Exchange Commission to sell substantial amounts of common stock, Mr. Brooks
has made no such filing and has not sold shares of DHB common stock since
December 2003. Mr. Brooks commented, “Although it is not our practice to correct
rumors and incorrect statements regarding DHB and its executive team circulated by
third parties, we have made an exception today in the interest of clear and timely
communication regarding this information to our investors and friends.”
[Emphasis added.]
70.
On October 5, 2004, DHB issued a release announcing new orders, headlined and
stating:
DHB Industries Announces $35+ Million in New Orders
DHB Industries Inc., the market leader in the rapidly growing protective body
armor industry, announced today that its Armor Group has recently received new
purchase and delivery orders for a wide variety of its protective products in excess of
$35 million from various branches of the United States Military, Federal Government
and Domestic Law Enforcement Agencies.
Sandra Hatfield, Chief Operating Officer of DHB Industries commented,
“DHB’s Armor Group continues to experience a strong level of demand for a wide
variety of its superior life-saving products. We are pleased and proud of our
reputation for serving the needs and expectations of our customers. These new
orders substantiate the confidence of our customers in DHB Armor Group’s
products and underscore our focused strategy and continuing opportunities for
growth.” [Emphasis added.]
71.
On October 29, 2004, DHB issued a release announcing new orders, headlined and
stating:
DHB Industries Announces $19 Million in New Orders
DHB Industries Inc., the market leader in the rapidly growing protective body
armor industry, announced today that its Armor Group has recently received new
purchase and delivery orders for a wide variety of its protective products in excess of
$19 million from various branches of the United States Military, Federal Government
and Domestic Law Enforcement Agencies. These new orders follow directly on the
heels of $35+ Million in new orders announced by the Company on October 5, 2004.
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Sandra Hatfield, Chief Operating Officer of DHB Industries commented, “We
continue to provide exceptional products and service that exceed the requirements
and expectations of our customers. These purchase and delivery orders
substantiate the confidence and demand for DHB Armor Group’s products and
underscores our ability to provide unparalleled levels of service and support.”
[Emphasis added.]
72.
On November 9, 2004, DHB reported its 3rdQ 04 results via a release headlined and
stating:
DHB Industries Achieves Record Third Quarter Results – EPS Increases 157%
to Record $0.18 – Revenue Climbs 64% to Record $89.4 Million – Company
Ups Guidance for Full-Year 2004 Revenue to Exceed $330 Million – DHB Has
Announced Over One-Half Billion Dollars in Orders Over Past 12 Months –
DHB Industries, Inc., the market leader in the rapidly growing body armor
industry, announced today record revenues and earnings for the third quarter ended
September 30, 2004, posting its 19th consecutive year-over-year increase in quarterly
revenues. The current backlog of firm orders exceeds $365 million.
Third quarter 2004 income available to common stockholders was a record
$8,058,000 or $0.18 per diluted share, a 157% increase as compared to $0.07 per
diluted share, or $3,160,000 in the third quarter of 2003. . . .
Gross margins for the third quarter of 2004 were 27.8% versus 27.2% in the
third quarter of 2003. . . .
Income available to common stockholders in the first nine months was a
record $21,897,000 or $0.49 per diluted share, an 82% increase as compared to
$12,050,000, or $0.28 per diluted share in the first nine months of 2003. . . .
Gross margins for the first nine months of 2004 were 27.8% versus 27.6% in
the first nine months of 2003. . . .
Stockholders’ equity rose to a record $68,795,000 at September 30, 2004, a
47% increase as compared to $46,738,000 at year-end December 31, 2003.
*
*
*
Sandra Hatfield, COO of DHB Industries, commented, “We continue to meet
or exceed all of our internal operating and performance goals. . . .”
David Brooks, Chairman and CEO of DHB Industries, added, “Our strength,
commitment and leadership position within the body armor industry is extremely
strong. Over the past year, DHB has announced new contracts and purchase
orders totaling more than $525 million. As of September 30, 2004, our Point
Blank subsidiary, providing life-saving protection for our troops, has shipped more
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than 800,000 Interceptor™ Outer Tactical Vests to the US military. The surging
operating performance and earnings leverage of the Company is largely a result of
the significant investments we made over the past three years in R&D, expanding
our manufacturing capacity by opening two new facilities totaling over 150,000
square feet, and significantly increasing our base of versatile employees. As we
look to the future outlook of DHB, I can only say, this is just the beginning, the
future is ours.” [Emphasis added.]
73.
On November 9, 2004, DHB filed its 3rdQ 04 Form 10-Q report with the SEC, signed
by defendants Brooks, Schlegel, Krantz and Nadelman. The 10-Q valued DHB’s inventories as of
September 30, 2004 at $81.9 million. The 3rdQ 2004 10-Q contained the same financial results
earlier reported. The 10-Q report told investors:
The Company’s market share is highly dependent upon the quality of its
products and its ability to deliver its products in a prompt and timely fashion. . . .
Management’s current strategic focus is on quality and delivery, which management
believes are the key elements in obtaining additional and repeat orders under the
Company’s existing procurement contracts with the U.S. military and other
governmental agencies.
The 3rdQ 04 10-Q report also stated:
The Company carried out an evaluation, as required by Rule 13a-15(b) under
the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the
supervision and with the participation of the Company’s management, including the
Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness
of the design and operation of the Company’s disclosure controls and procedures (as
defined in Rules 13a-14 and 15d-14 of the Exchange Act) as of the end of the period
covered by this report. Based upon that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that the Company’s disclosure controls and
procedures are effective in timely alerting them to material information relating to
the Company (including its consolidated subsidiaries) required to be included in
the Company’s periodic SEC filings. During the period covered by this report, the
Company has continued to implement certain changes to its internal control over
financial reporting as described below, which have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.
Disclosure controls and procedures are those controls and other procedures
that are designed to ensure that information required to be disclosed by the Company
in the reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and
forms. Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
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accumulated and communicated to the Company’s management, including the
Company’s principal executive officer and principal financial officer, as appropriate
to allow timely decisions regarding required disclosure.
The 3rdQ 04 10-Q also contained certifications of Brooks as CEO and Schlegel as CFO dated
November 3, 2004, that certified:
1.
I have reviewed this quarterly report on Form 10-Q of DHB Industries, Inc.;
2.
Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this quarterly report;
3.
Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this quarterly report;
4.
The registrant’s other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
a)
designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b)
evaluated the effectiveness of the registrant’s disclosure controls and
procedures as of a date within 90 days prior to the filing date of this quarterly report
(the “Evaluation Date”); and
c)
presented this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5.
The registrant’s other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent function):
a)
all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant’s ability to record, process,
summarize and report financial data and have summarize identified for the
registrant’s auditors any material weaknesses in internal controls; and
b)
any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant’s internal controls; and
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6.
The registrant’s other certifying officer and I have indicated in this quarterly
report whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
*
*
*
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of DHB Industries, Inc. (the
“Company”) on Form 10-Q for the period ended September 30, 2004 as filed with
the Securities and Exchange Commission on the date hereof (the “Report”), I . . .
certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the SarbanesOxley Act of 2002, that:
(1)
The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2)
The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Dated: November 3, 2004 [Emphasis added.]
74.
On November 10, 2004, Roth Capital Partners issued a report on DHB based on
conversations with Schlegel and Hatfield, stating:
DHB Industries Equals Earnings Power, Record Q304 Results
x
DHB Industries came through with record Q304 results of $89.4 million in
sales compared to $54.4 million a year ago, ahead of our estimate of $88.8
and consensus of $88.6 million. EPS was $0.18 compared to $0.07 in Q303.
Results were a penny ahead of our estimate and two cents above Street
estimates.
*
*
*
x
We are only making minor changes to our earnings model to reflect Q304
results and some slight shifting of cost assumptions in FY05. For FY04 our
earnings estimate is $0.66 per share on revenue of $340.6 million. We
estimate sales of $381.2 million and EPS of $0.77 for FY05.
x
We view our estimates for FY05 as conservative . . . .
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*
*
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*
Upcoming Catalyst: OTV Awards
DHB has been the leading supplier of the Interceptor Outer Tactical Vest to
the U.S. Army, Marines, Navy and Air Force for several years, and in our opinion,
the company should continue to dominate the market. [Emphasis added.]
75.
On November 10, 2004, Miller Johnson Steichen Kinnard issued a report on DHB,
stating:
DHB – STRONG 3Q04 RESULTS; VISIBILITY IMPROVING
*
*
x
3Q04 results ahead of expectations.
x
Strong sales, margins, and EPS.
*
x
*
*
*
Increasing FY04 and FY05 estimates.
*
*
*
The Company reported 3Q04 EPS of $0.18, which was well ahead of our
estimate of $0.15 and 157% ahead of 3Q03 EPS of $0.07. Gross margin of 27.8%
was slightly ahead of our assumption of 27.6%. SG&A was 13.0% of sales, which
was better than our assumption of 13.5% of sales. Operating margin of 14.9% was
ahead of our 14.1% estimate. [Emphasis added.]
76.
DHB’s stock soared higher from $10.95 on September 23, 2004 to $15.35 on October
5, 2004 to $19.65 on November 16, 2004, reaching a then all-time high of $21.25 on November 29,
2004. On November 29-November 30, 2004, when DHB hit its then all-time high, Brooks, Hatfield,
Schlegel, Nadelman, Krantz, Chasin and Berkman unloaded 4,401,338 shares of their DHB stock for
$83 million. DHB stock fell from a high of $21.25 on November 29, 2004 to $17.65 on December
1, 2004 and $16.40 by December 8, 2004, as investors became aware of these sales as a result of
SEC filings disclosing their occurrence.
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77.
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On December 23, 2004, DHB issued a release announcing its largest contract award
to date, headlined and stating:
U.S. Army Selects DHB Industries for Prestigious Contract – Interceptor™
OTV Award Marks Significant Milestone For Point Blank Subsidiary
DHB Industries Inc., the market leader in the rapidly growing protective body
armor industry, announced today that its wholly owned subsidiary, Point Blank Body
Armor, Inc., has received notification of a much anticipated, high-profile, three year
contract awarded by the U.S. Army for Point Blank’s Interceptor™ Outer Tactical
Vest (OTV). The Company was also notified that Point Blank was the only
successful offeror for this solicitation. With this announcement, the Company’s total
backlog of orders and contracts now exceeds an unprecedented half-billion dollars.
Commenting on the announcement, David Brooks, Chairman and CEO of
DHB Industries, said, “This major military award is a significant milestone for the
Company representing the catalyst that will propel and sustain us into the future as
the clear, preeminent leader in the design, development and production of
technologically superior life-saving body armor systems. . . . The future outlook
for DHB appears outstanding given the continuing war on terror and the increased
need for homeland security. . . .”
Sandra Hatfield, Chief Operating Officer of DHB Industries, added, “This
contract award is extremely humbling with the knowledge that the Department of
Defense puts this much faith in our Company and its products. . . . The
Interceptor™ OTV award demonstrates the U.S. Department of Defense’s
confidence in Point Blank’s ability to deliver life-saving body armor systems to the
armed forces of the United States. Simply stated, this puts us in a league of our
own as the world’s premier provider of protective solutions surpassing our
customers’ expectations.” [Emphasis added.]
78.
On December 23, 2004, DHB issued another release headlined and stating:
DHB Industries Awarded Contract With City of Baltimore
DHB Industries Inc., the market leader in the rapidly growing protective body
armor industry, announced today that its wholly owned subsidiary, Point Blank Body
Armor, Inc., has been awarded a four year, renewable contract to provide soft body
armor to the City of Baltimore, Maryland. . . .
Sandra Hatfield, Chief Operating Officer of DHB Industries, commented, “In
Point Blank’s 30 year history, this is the first contract with the City of Baltimore and
we welcome the opportunity to provide them with world class products and
unsurpassed customer service.” [Emphasis added.]
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79.
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DHB’s reported financial results and conditions, as well as the other statements made
between September 24, 2004 and December 23, 2004 concerning DHB’s business, products,
financial condition and future prospects were each false and misleading when made and were
misleading in failing to disclose the true financial results and conditions of DHB and the adverse
facts and conditions concerning DHB’s business, products, finances and future outlook as set forth
below:
(a)
Orders received by DHB from the DOD were not an indication of the
confidence of the U.S. military in, or satisfaction with, DHB’s products because, in fact, many
thousands of units of DHB’s main military product, the Interceptor vest, shipped to the U.S. Marines
were non-conforming and defective, and orders for vests were being placed and defective vests were
being accepted only because the military was suffering from extreme shortages of body armor which
was desperately necessary for American troops in Afghanistan and Iraq;
(b)
DHB’s products were not “exceptional” or “technologically superior”; in fact,
DHB had shipped at least 50,000 Zylon-based body armor products to domestic law enforcement
agencies which were defective and non-conforming and did not meet and could not fulfill DHB’s
five-year warranty. DHB had also shipped thousands of defective and non-conforming Interceptor
vests to the U.S. Marines which failed to comply with DOD/U.S. military contract specifications and
requirements;
(c)
DHB’s systems of quality control, which were indispensable for its successful
operation, were defective and inadequate, which led to the shipment of thousands of defective
Interceptor vests to the U.S. Marines and also prevented DHB from being able to trace identified
defective vests to specifically identified lots of raw material, a major manufacturing processing and
quality control defect, which contaminated 100% of DHB’s Interceptor vest production;
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(d)
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DHB had accumulated many millions of dollars of defective and useless
Zylon raw material which its insiders knew could no longer be used to manufacture body armor
products because Zylon degraded rapidly when exposed to heat, light and body perspiration. DHB’s
excessive inventory of useless and unsaleable Zylon materials should have been and would have to
be written off, which would result in a multi-million dollar charge and adversely impact DHB’s
financial condition and results from operations;
(e)
It was not true, as represented by DHB, that there were very few Zylon vests
manufactured by DHB still in use by police departments in the field; on the contrary, there were at
least 50,000 Zylon vests still used in the field and still under warranty, that would have to be
replaced by DHB at a huge cost, which would have a material adverse impact on DHB’s financial
results and condition;
(f)
DHB’s financial reports and statements for the period ending September 30,
2004 were materially false and misleading in overstating the value of DHB’s inventories, failing to
accrue material loss contingencies, i.e., Zylon vest replacement costs, and overstating DHB’s net
income, EPS and shareholders’ equity by material amounts;
(g)
DHB’s top insiders were aware that thousands of DHB Interceptor vests were
defective and did not conform to government standards, even though DHB had been paid an extra
$50 per vest to assure the high quality of such vests, that the DOD/U.S. military’s quality control
assurance personnel had discovered these defects and were recommending rejection of the vests and
disciplinary action against DHB, and that even if DHB was able to persuade the government to
accept these defective vests because of the government’s urgent need for body armor for U.S. troops,
the U.S. military would, when body armor became more available, curtail its purchases of DHB’s
products;
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(h)
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DHB’s vests did not meet or exceed the expectations or requirements of
DHB’s domestic law enforcement and U.S. military customers as thousands of these vests were
defective and non-conforming and its customers had objected to these defects, demanding or taking
remedial actions. Defendants privately acknowledged on multiple occasions throughout 2004,
including as early as February 2004 and, specifically, on November 30, 2004, that its Interceptor
vests did not meet or exceed expectations when officers of the Company signed military “Requests
for Deviation/Waiver” forms indicating major vest defects;
(i)
The reason for the increase in DHB’s inventories during 2004-2005 was not
that DHB was stockpiling raw materials which were in short supply so that it would have those
materials to produce armor body products to meet increasing demand as claimed, but rather, DHB’s
inventories were increasing because DHB had accumulated and continued to carry on its books
millions and millions of dollars of Zylon raw materials which were, in fact, unusable and worthless;
(j)
DHB’s internal financial and accounting and disclosure controls were not
adequately designed, had not been properly tested and, in fact, were defective, which was leading to
material fraud in the presentation of DHB’s financial results and condition. Due to the internal
control deficiencies in DHB’s quality control systems, inventory pricing mechanisms and the
operations of its Audit Committee, which were serious and pervasive, DHB had accumulated
millions and millions of dollars of excessive and worthless inventory of Zylon raw material, was
manufacturing and shipping thousands of defective Interceptor vests to the U.S. military and was not
properly accounting for or reporting these matters in its SEC filings and other public statements;
(k)
DHB’s presented multi-hundred million dollar backlog of orders was
misleading because, due to its shipment of defective and non-conforming merchandise to the U.S.
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Marines, the U.S. military had the right to cancel or refuse to accept future shipments or to cancel as
yet unfulfilled portions of future orders, and in late 2004, the U.S. Marines had done so;
(l)
DHB’s officers and directors were violating multiple provisions of the DHB
Code of Business Conduct & Ethics; and
(m)
As a result of the foregoing, DHB’s forecasts of continued future profitable
growth and other optimistic statements regarding the future of DHB’s business were completely
false and were known by defendants to be false when made, because the adverse facts and conditions
detailed above would cause DHB’s business to perform much worse than promised or forecast and
its financial results to be far short of those forecast.
80.
DHB’s stock surged from as low as $17.84 on December 22, 2004 to reach $22.67
per share on December 23, 2004 and then to its all-time high price of $22.70 on December 27, 2004,
and continued to trade at $19-$20 per share through December 31, 2004. As DHB’s stock again
moved to all-time high levels, Brooks and Hatfield unloaded an additional 5.9 million shares of their
DHB stock for over $117 million in illegal insider trading proceeds. When defendants filed Form
4’s with the SEC disclosing these stock sales, DHB’s stock began to fall sharply from $22.70 to as
low as $15.70 on January 5, 2005 and then to as low as $13.86 on January 12, 2005, a companyspecific stock decline of 40% on extraordinarily heavy trading volume that was not due to general
market movements or industry factors or conditions, or even company-specific adverse information
unrelated to the fraud. However, due to defendants’ continuing misrepresentations and omissions
and failure to make full disclosures, DHB’s stock price remained artificially inflated.
81.
On January 3, 2005, DHB was sued by The Southern States Police Benevolent
Association and seven Ohio Highway Patrol officers for selling defective bullet-resistant vests made
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of Zylon, alleging the vests were completely unsuitable over the five-year period for the intended
uses. The suit was publicly reported by The Miami Herald on January 13, 2005, in an article stating:
Point Blank Faces Lawsuit
Certain models of bullet-resistant vests produced by Broward’s Point Blank
Body Armor don’t live up to their warranties, putting law-enforcement officers at
risk for serious injury or death, a lawsuit filed by a police group alleges.
The Southern States Police Benevolent Association, along with seven Ohio
Highway Patrol officers and a California sheriff’s deputy, last week sued Point Blank
in Broward Circuit Court to force the company to replace the vests.
*
*
*
“My concern is there is a product out there that’s dangerous to our members
and to officers in the rest of the country,” said Jack Roberts, Southern States’
president. The McDonough, Ga., group represents 21,000 officers in the south,
excluding Florida.
*
*
*
ZYLON FLAW
The suit centers on two Point Blank vests, Legacy Premier and Galls
Platinum/Galls Zylon models. . . .
Southern States’ suit against Point Blank alleges that the vests, which sell for
about $1,050 each, are “completely unsuitable for the intended uses over the
warranted five-year period.”
82.
On January 7, 2005, Roth Capital Partners issued a report on DHB stating:
x
Shares of DHB have been weak recently which we attribute to a nervous
market after a significant amount of DHB stock was sold by insiders.
[Emphasis added.]
*
*
*
Insider Selling Puts Pressure on DHB . . . .
. . . Despite the awarding of the Outer Tactical Vest award, shares of DHB
have been weak recently which we attribute to a nervous market viewing recent
insider selling as either a sign of a bad quarter [or] a red flag of other bad news.
83.
On January 11, 2005, Newsday reported on the huge DHB insider selling:
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The chairman and other top executives at DHB Industries Inc. . . . took profits
of more than $200 million in the final weeks of 2004 by selling stakes they owned
that totaled about 25 percent of DHB’s outstanding shares.
The majority of the selling was by chairman and chief executive David H.
Brooks, who sold about $186 million in DHB stock. . . .
All of the selling occurred in about a four-week period, between Nov. 29 and
Dec. 29. DHB’s stock almost quadrupled in the past year but has drifted lower since
late December and now sells at about $16 a share. Analysts attributed the decline to
the large insider sales.
. . . Brooks told Newsday yesterday that he . . . wanted to diversify.
“It became a large portion of their money,” Brooks said of himself and other
DHB executives, including chief financial officer Dawn Schlegel, chief operating
officer Sandra Hatfield and several outside directors. “They just wanted to diversify
some of their holdings. The company continues to look forward to having a
brilliant year in 2005 and the insider selling is no reflection of the business going
forward.”
Brooks’ stock sales during the month of December topped the value of sales
by such business tycoons as Sumner Redstone of Viacom, Lawrence Ellison of
Oracle Corp. and Bill Gates of Microsoft . . . .
*
*
*
Marsha Kramer Mayer, senior vice president of Mera Economic Consulting
in Manhattan, said the insider trading at DHB was not illegal. “It is not necessarily
suspicious, but it is an extraordinarily large amount of selling in a short period of
time,” Mayer said. “The suddenness raises questions.” [Emphasis added.]
84.
On January 24, 2005, Roth Capital Partners issued a report on DHB, stating:
x
We attribute the stock’s activity to insider selling at the end of last year. . . .
[A]n indication either the quarter just completed will disappoint or the
outlook for the company has diminished.
*
x
*
*
A recent complaint filed in the state of Florida alleging a small amount of
defective vests in the field could weigh heavily on shares.
*
*
*
We attribute the pressure on the stock to insider selling of DHB late last
year. . . . We also note a small group of police officers are claiming certain models
of bullet resistant vests manufactured by Point Blank that utilize Zylon fibers are
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defective. These vests are no longer sold with a minimal amount likely in the field.
[Emphasis added.]
85.
On February 15, 2005, DHB announced the settlement of the police officers’ suit over
Zylon vests. The Miami Herald reported:
New vests to cost millions
Point Blank Body Armor on Monday agreed to exchange 2,000 bulletresistant vests containing Zylon to settle a class-action lawsuit claiming the vests
didn’t live up to their warranties.
*
*
*
The reliability of Zylon-based vests has been questioned in recent years. The
strength of Zylon fiber decreases under high temperature and humidity, according to
its manufacturer, Toyobo of Japan.
Zylon itself was not the issue, said Bruce Rubin, a spokesman for Point
Blank.
Rather, it was the high concentration of the Zylon in Point Blank’s Legacy
Premier and Galls Zylon/Platinum vests.
“This was making some of the [police] officers anxious,” Rubin said. “Our
philosophy is that law enforcement officers have enough to worry about without
being concerned about their vests.”
“We still have a high degree of confidence in the vests,” he added.
86.
On March 9, 2005, Feltl and Company issued a report on DHB:
x
DHB stock has dropped 45% since it peaked in late December . . . .
x
Management and insiders sold major portions of their DHB stock holdings
at year-end, triggering the beginning of the sell-off in DHB stock.
[Emphasis added.]
87.
On March 16, 2005, DHB issued a release reporting “record” 4thQ 04 and fiscal year
2004 results:
DHB Industries Posts Record Fourth Quarter Results – Fourth Quarter EPS
Increases 200% to Record $0.18
DHB Industries . . . announced today record revenues and earnings for the
fourth quarter and full-year ended December 31, 2004, posting its 20th consecutive
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year-over-year increase in quarterly revenues. The current backlog of firm orders
exceeds $415 million.
*
*
*
Operating income for the fourth quarter increased 133% to $12,406,000 as
compared to $5,327,000 for 2003. Operating margins in the fourth quarter increased
to 13.8% in 2004 from 7.3% in 2003. Fourth quarter 2004 income available to
common stockholders was $8,178,000 or $0.18 per diluted share, as compared to
$2,762,000, or $0.06 per diluted share in the fourth quarter of 2003.
*
*
*
Operating income for the 2004 full year increased 90.5% to a record
$49,571,000 as compared to $26,016,000 for the 2003 year. Operating margins
increased to 14.6% in 2004 from 11.3% in 2003. Income available to common
stockholders for the full year 2004 increased 103% to $30,075,000 or $0.67 per
diluted share, compared to $14,812,000, or $0.34 per diluted share in 2003.
88.
While DHB claimed its 4thQ 04 results were records and met all of its operating
goals, analysts quickly saw that, in fact, DHB’s revenues and net revenue growth had slowed as its
EPS were flat – less than had been forecast. DHB’s inventories rose to $85.9 million, up
significantly compared to $54.7 million in 4thQ 03 and $81.9 million in 3rdQ 04, and continued the
quarterly inventory growth DHB had reported throughout the Class Period and all of 2004. The
Company said this was due to build-up in uncut fabrics from purchasing and stockpiling raw
materials due to shortages. DHB said its inventories would go down due to strong continuing sales
and as suppliers remedied shortages. On March 17, 2005, DHB had a horrible conference call with
analysts and investors, giving contradictory and inconsistent explanations for the recent huge stock
bail-out and, to make matters worse, now that the bail-out had occurred, defendants refused to give
any earnings guidance or forecasts for 2005 – even though throughout 2004 they had been giving
very positive forecast guidance for 2004 and2005!
89.
On March 17, 2005, Miller Johnson Steichen Kinnard issued a report stating:
DHB – 4Q04 Results below Estimates; Reducing Price
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*
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*
x
4Q04 sales were below expectations.
x
EPS missed by a penny when using a normal tax rate.
*
x
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*
*
*
*
Decreasing FY05 estimates. . . .
*
Operating margin of 13.8% was slightly below our 14.0% estimate and was
significantly ahead of 4Q03 operating margin of 7.3%. DHB’s 4Q04 tax rate was
30.9%, which was lower than our assumption of 38.5%. Had the tax rate been
38.5%, the Company’s EPS would have been $0.16, or a penny shy of our estimate.
[Emphasis added.]
90.
On March 17, 2005, Roth Capital Partners issued a report on DHB:
Truth & Consequence: Record Q404 Results, But Investor Call Fails to Inspire
x
DHB Industries reported Q404 results with sales of approximately $90.2
million (+23.7% y/y) compared to $72.9 million a year ago and just below
our estimate by approximately $500,000. The consensus sales estimate was
at $92.8 million. . . . Sales, however, were constrained mainly due to the
limited supply of raw material, specifically key ballistic fibers which have
become a constraint industry-wide.
*
x
*
*
In light of what appears to be a higher amount of scarcity for key raw inputs
than estimated, we are shifting our sales estimates for FY05 accordingly. For
the year, however, our estimates remain the same at $396.2 million in sales
and EPS of $0.80.
*
*
*
Sales Slightly Below Estimates, Favorable Tax Rate Lifts EPS a Penny Above
Consensus
*
*
*
Inventory Strains Near Term Free Cash Flow
To our consternation, management did not provide any sales or EPS
guidance for either Q105 or FY05 hiding behind legal advice not to do so while the
company works to comply with Sarbanes Oxley. Considering the earful
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management heard on the subject, we would expect to see management provide some
form of sales guidance in the future once the company has completed its audits and
we have moved further into FY05. . . . Cash flow from operations was negative
again this quarter as compared to a positive $2.6 million in Q403 due to . . . mainly
the surge in inventory. While inventory levels continue to rise and stood at $85.9
million exiting September, inventory levels have been historically high for DHB.
We also point out the fabric constraints in the industry are contributing to the
company purchasing and stockpiling raw material when it becomes available and
approximately $31.7 million or 36.7% of the inventory balances are uncut fabrics.
*
*
*
[T]he conference call that followed quickly moved from a discussion of the quarter’s
results to a long, drawn out venting session where frustrated retail and institutional
shareholders alike fixated on the guidance issue (or lack thereof) and investors also
responded angrily to management’s unsatisfactory comments over insider selling in
December. [Emphasis added.]
91.
On March 17, 2005, DHB filed its 2004 Report on Form 10-K, signed by Brooks,
Schlegel, Krantz, Nadelman, Berkman and Chasin. The 10-K reported inventories as of December
31, 2004 at $85.9 million. The 2004 10-K contained the year-end financial results previously
reported by DHB. DHB told investors:
The Company’s market share is highly dependent upon the quality of its
products, and its ability to deliver its products in a prompt and timely fashion. . . .
Management’s current strategic focus is on quality and delivery, which management
believes are the key elements in obtaining additional and repeat orders under the
Company’s existing procurement contracts with the U.S. military and other
governmental agencies.
The 2004 Form 10-K included the DHB Code of Business Conduct & Ethics (set forth in pertinent
part herein at ¶48). The 2004 Form 10-K also stated:
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
Form 10-K. This disclosure controls and procedures evaluation was conducted under
the supervision and with the participation of management, including our CEO and
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 SEC’s rules and forms. 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
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management, including the CEO and CFO, as appropriate to allow timely decisions
regarding required disclosure. Our quarterly evaluation of disclosure controls and
procedures includes an evaluation of some components of our internal control over
financial reporting, and internal control over financial reporting is also separately
evaluated on an annual basis for purposes of providing the management report which
is set forth below.
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 Form 10-K. 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 10K. 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 controls evaluation, our CEO and CFO have concluded
that, as of the end of the period covered by this Form 10-K, 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 SEC’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.
*
*
*
IMPROVEMENTS IN INTERNAL CONTROL
Under the supervision and with the participation of our CEO and CFO, our
management has evaluated changes in our internal controls over financial reporting
that occurred during our last fiscal quarter. Based on that evaluation, our CEO and
CFO did not identify any change in our internal controls over financial reporting
that has materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting.
The 2004 Form 10-K also included certifications signed by Brooks and Schlegel dated March 11,
2005, which stated:
1.
I have reviewed this annual report on Form 10-K of DHB Industries, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the statements made,
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in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and for, the
periods presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in the Exchange Act
Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:
a)
Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during
the period in which this annual report is being prepared;
b)
Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under our supervision, to
provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
c)
Evaluated the effectiveness of the registrant’s disclosure controls and
procedures and presented in this report our conclusions about the effectiveness of the
disclosure controls and procedures, as of the end of the period covered by this report
based on such evaluation; and
d)
Disclosed in this report any change in the registrant’s internal control
over financial reporting that occurred during the registrant’s most recent fiscal
quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant’s
internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the registrant’s
auditors and the audit committee of registrant’s board of directors (or persons
performing the equivalent functions):
a)
all significant deficiencies and material weaknesses in the design or
operation of internal controls over financial reporting which are reasonably likely to
adversely affect the registrant’s ability to record, process, summarize and report
financial information; and
b)
any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant’s internal control over
financial reporting.
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*
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of DHB Industries, Inc. (the
“Company”) on Form 10-K for the year ending December 31, 2004 as filed with the
Securities and Exchange Commission (the “Report”), I . . . certify, pursuant to 18
U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:
92.
(1)
The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2)
The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
the Company. [Emphasis added.]
In DHB’s 2004 10-K, regarding the police officers’ suit against DHB over Zylon
vests, DHB stated:
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, because of concerns regarding the
effectiveness and durability of body armor with high concentrations of Zylon in the
Company’s bullet-resistant soft body armor (vests). In February 2005, we reached a
preliminary settlement with respect to the class action lawsuit filed, subject to final
court approval. The Company does not expect this settlement to have a material
adverse effect on its financial position.
93.
DHB’s stock declined due to concerns over increasing inventories, slowing sales, net
income and EPS growth. DHB’s stock fell from $12.22 on March 16, 2005 to $9.41 on March 21,
2005, two trading days later, a company-specific stock decline not due to general market movements
or industry factors or even company-specific negative information unrelated to the fraud. However,
due to defendants’ continuing misrepresentations and concealments, DHB’s stock continued to trade
at artificially inflated levels.
94.
DHB’s reported financial results and conditions, as well as the other statements made
between January 11, 2005 and March 17, 2005 concerning DHB’s business, products, financial
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condition and future prospects were each false and misleading when made and were misleading in
failing to disclose the true financial results and conditions of DHB and the adverse facts and
conditions concerning DHB’s business, products, finances and future outlook as set forth below:
(a)
Orders received by DHB from the DOD were not an indication of the
confidence of the U.S. military in, or satisfaction with, DHB’s products because, in fact, many
thousands of units of DHB’s main military product, the Interceptor vest, shipped to the U.S. Marines
were non-conforming and defective, and orders for vests were being placed and defective vests were
being accepted only because the military was suffering from extreme shortages of body armor which
was desperately necessary for American troops in Afghanistan and Iraq;
(b)
DHB had shipped at least 50,000 Zylon-based body armor products to
domestic law enforcement agencies which were defective and non-conforming and did not meet and
could not fulfill DHB’s five-year warranty. DHB had also shipped thousands of defective and nonconforming Interceptor vests to the U.S. Marines which failed to comply with DOD/U.S. military
contract specifications and requirements;
(c)
DHB’s systems of quality control, which were indispensable for its successful
operation, were defective and inadequate which led to the shipment of thousands of defective
Interceptor vests to the U.S. Marines and also prevented DHB from being able to trace identified
defective vests to specifically identified lots of raw material, a major manufacturing processing and
quality control defect, which contaminated 100% of DHB’s Interceptor vest production;
(d)
DHB had accumulated many millions of dollars of defective and useless
Zylon raw material which its insiders knew could no longer be used to manufacture body armor
products because Zylon degraded rapidly when exposed to heat, light and body perspiration. DHB’s
excessive inventory of useless and unsaleable Zylon materials should have been and would have to
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be written off, which would result in a multi-million dollar charge and adversely impact DHB’s
financial condition and results from operations;
(e)
It was not true, as represented by DHB, that there were very few Zylon vests
manufactured by DHB still in use by police departments in the field; on the contrary, there were at
least 50,000 Zylon vests still used in the field and still under warranty that vests would have to be
replaced by DHB at a huge cost, which would have a material adverse impact on DHB’s financial
results and condition;
(f)
DHB’s financial reports and statements for the period ending December 31,
2004 were materially false and misleading in overstating the value of DHB’s inventories, failing to
accrue material loss contingencies, i.e., Zylon vest replacement costs, and overstating DHB’s net
income, EPS and shareholders’ equity by material amounts;
(g)
DHB’s top insiders were aware that thousands of DHB Interceptor vests were
defective and did not conform to government standards, even though DHB had been paid an extra
$50 per vest to assure the high quality of such vests, that the DOD/U.S. military’s quality control
assurance personnel had discovered these defects and were recommending rejection of the vests and
disciplinary action against DHB, and that even if DHB was able to persuade the government to
accept these defective vests because of the government’s urgent need for body armor for U.S. troops,
the U.S. military would, when body armor became more available, curtail its purchases of DHB’s
products;
(h)
DHB’s vests did not meet or exceed the expectations or requirements of
DHB’s domestic law enforcement and U.S. military customers, as thousands of these vests were
defective and non-conforming and its customers had objected to these defects, demanding or taking
remedial actions. Defendants privately acknowledged on multiple occasions throughout 2004,
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including as early as February 2004 and, specifically, on November 30, 2004, that its Interceptor
vests did not meet or exceed expectations when officers of the Company signed military “Requests
for Deviation/Waiver” forms indicating major vest defects;
(i)
The reason for the increase in DHB’s inventories during 2004-2005 was not
that DHB was stockpiling raw materials which were in short supply so that it would have those
materials to produce armor body products to meet increasing demand as claimed, but rather, DHB’s
inventories were increasing because DHB had accumulated and continued to carry on its books
millions and millions of dollars of Zylon raw materials and Zylon-containing vests which were, in
fact, unusable and worthless;
(j)
DHB’s internal financial and accounting and disclosure controls were not
adequately designed, had not been properly tested and, in fact, were defective, which was leading to
material fraud in the presentation of DHB’s financial results and condition. Due to internal control
deficiencies in DHB’s quality control systems, inventory pricing mechanisms and the operations of
its Audit Committee, which were serious and pervasive, DHB had accumulated millions and millions
of dollars of excessive and worthless inventory of Zylon raw material, was manufacturing and
shipping thousands of defective Interceptor vests to the U.S. military and was not properly
accounting for or reporting these matters in its SEC filings and other public statements;
(k)
It was not true that the insider stock sales by DHB’s top officers and directors
were merely due to those individuals wanting to diversify their holdings, rather, those sales took
place as part of a plan and scheme to inflate DHB’s stock price by false and misleading statements
and then bail out of the stock so that the Individual Defendants could personally profit at the expense
of public investors;
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DHB’s presented multi-hundred million dollar backlog of orders was
misleading because, due to its shipment of defective and non-conforming merchandise to the U.S.
Marines, the U.S. military had the right to cancel or refuse to accept future shipments or to cancel as
yet unfulfilled portions of future orders, and in late 2004, the U.S. Marines had done so;
(m)
DHB’s officers and directors were violating multiple provisions of the DHB
Code of Business Conduct & Ethics;
(n)
Interceptor OTV body armor was not the best, most technologically advanced
body armor ever developed; and
(o)
As a result of the foregoing, DHB’s forecasts of continued future profitable
growth and other optimistic statements regarding the future of DHB’s business were completely
false and were known by them to be false when made, because the adverse facts and conditions
detailed above would cause DHB’s business to perform much worse than promised or forecast and
its financial results to be far short of those forecast.
95.
On April 1, 2005, Feltl and Company issued a report stating:
x
DHB stock has declined 60% since late December when insiders sold large
blocks of their holdings. . . . Chairman and CEO David Brooks accounted
for most of the sales. . . .
*
*
*
x
The stock has been under heavy selling pressure since large insider sales
were reported late in the year. The selling pressure continued due, we
believe, to the absence of guidance along with the earlier insider sales at
much higher prices. [Emphasis added.]
96.
On April 9, 2005, The Miami Herald reported on the fall in DHB’s stock price:
Almost as quickly as the stock of the parent company of Broward’s Point
Blank Body Armor soared to record heights last year, it has shed those gains this
year.
And there doesn’t seem to be any shortage of explanations for the swoon in
DHB Industries’ market value. Theories from followers of the stock: DHB no longer
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giving earnings guidance; significant insider stock sales; financial issues; and some
chummy deals.
DHB officials declined to discuss what may be behind the drop.
“To comment on why a stock moves in a day, a week or a month, I don’t
think anyone can give an honest answer,” said Manny Rubio, a vice president with
the Westbury, N.Y., company. “Things are going fine.”
*
*
*
The biggest seller was Chairman and Chief Executive David Brooks, who
sold almost 9.5 million shares worth $185.9 million in December. . . . Investors
often perceive huge insider sales as a sign of trouble within a company.
“David Brooks is a controversial guy,” said Dennis Nielsen, an analyst with
Minneapolis-based Feltl & Co. “The huge amount of selling by him and his family
just reinforced whatever concerns people have about him. His ability to pick the
top of the market bothered a lot of people, I think.”
*
*
*
During a conference call last month, DHB said it would no longer provide
investors with earnings guidance. . . .
“I think that compounded the nervousness after all the insider selling,”
Nielsen said.
97.
On April 15, 2005, DHB disclosed that its independent auditor, Weiser & Co., quit
the DHB engagement, requiring DHB to engage its fourth auditing firm in four years. Weiser & Co.
cited deficiencies in DHB’s inventory pricing system, Audit Committee weakness and DHB’s filing
of its 2004 10-K prior to Weiser & Co.’s completion of its audit report as the reasons for its
resignation. Weiser & Co. discussed each issue with the DHB Board of Directors and discussed
DHB’s deficient inventory pricing system and Audit Committee weaknesses with the Audit
Committee as well as the full Board of Directors. DHB’s stock plummeted on this “red flag,” falling
from $8.99 on April 13, 2005 to as low as $6.83 on April 18, 2005, just three days later, a 24%
company-specific stock decline on heavy volume not due to general market movements or industry
factors or forces, or even company-specific factors unrelated to the fraud. However, due to
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defendants’ continuing misrepresentations and omissions and failure to make full disclosures,
DHB’s stock price remained artificially inflated.
98.
On May 4, 2005, Roth Capital Partners issued a report on DHB that stated:
x
404 Audit Completed on Schedule. DHB Industries earlier this week filed an
amended 10-K that completes the 404 Sarbox audit. While a material
weakness in DHB’s systems of inventory valuation was cited among others,
no adjustment or reserve is required.
x
Comfortable with EPS Estimate.
*
*
*
In terms of the balance sheet, we anticipate inventory levels to remain high as DHB
continues to stockpile rolls of ballistic fabrics when these fabrics become available
as constraints on key inputs continue to exist with our expectation the situation
does not see some relief until 2H05. . . .
404 Audit Complete, Material Weakness Does Not Mean A Financial
Restatement
DHB filed an 8-K on April 15th indicating the company’s principal
independent accountant Weiser LLP declined to stand for re-election. . . . While the
situation did raise a red flag as changes in independent auditors may suggest
revenue recognition issues or other accounting problems, there is no restatement
anticipated and we therefore believe the stock is greatly undervalued at these
levels. . . . [N]o adjustment or reserve is required as the total amount for inventory
of $85.9 million is correct. Essentially, some of the input costs were overestimated
while others were underestimated for a wash. . . .
In response to this material weakness, management has already strengthened
the inventory process with a stronger set of checks and balances including the hiring
of an additional inventory manager. [Emphasis added.]
99.
On May 9, 2005, The Marine Corps Times published an exposé (attached hereto as
Ex. A) of major non-conformities in thousands of DHB Interceptor vests sold to the military that
required the recall of 5,000 vests. This article first circulated on May 9, 2005 and was reported by
Newsday on May 10, 2005. The article stated:
The Marines’ flawed body armor
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Corps recalls more than 5,000 vests that experts rejected – but some remain in
the field
The Marine Corps issued to nearly 10,000 troops body armor that government
experts urged the Corps to reject after tests revealed critical, life-threatening flaws
in the vests.
In all, the Marine Corps accepted about 19,000 Interceptor outer tactical vests
from Point Blank Body Armor Inc. that failed government tests due to “multiple
complete penetrations” of 9mm pistol rounds, failing scores on other ballistic or
quality-assurance tests, or a combination of the two.
“Since these are lifesaving pieces of equipment and are being used in support
of the Iraq war, I urge immediate action since this technical office has little
confidence in the performance of the items to provide the contracted levels of
protection as defined in the performance specification,” wrote ballistics expert
James MacKiewicz in a memorandum rejecting two lots of vests on July 19, 2004.
*
*
*
A second government agency, the Defense Contract Management Agency,
backed Natick’s conclusion and also recommended against the waivers.
“Anything less than full compliance for a safety item such as the [Interceptor
body armor] is unacceptable,” DCMA wrote in a 2004 memorandum recommending
that the Corps reject the vests.
But according to documents obtained through the Freedom of Information
Act and interviews with officials at Natick, the Marine Corps and Point Blank, the
service rejected the advice. Instead, the Marine program manager responsible for
fielding the vests, Lt. Col. Gabriel Patricio, and Point Blank’s chief operating
officer, Sandra Hatfield signed waivers that allowed the Corps to buy and
distribute vests that failed to meet the Corps’ minimum standards and
specifications.
Faced with the imminent publication of this story, the result of an eightmonth investigation by Marine Corps Times, the Marine Corps on May 4 issued a
Corpswide message recalling 5,277 Interceptor vests.
Deployment demands
The judgment call fell to Patricio, who over 10 months last year would waive
and accept at least 20 lots of outer tactical vests that didn’t pass muster with
government testers.
Systems Command did not inform field commanders about the waivers when
the equipment was distributed, Reinwald said.
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Patricio said he briefed Catto in February 2004 when the first waivers were
issued, as well as in subsequent meetings on procurement of various types of armor
to protect Marines and their equipment from the growing threat of insurgent attacks
in Iraq.
In his written statement, Catto said he agreed with the decision to issue the
waivers.
“I concurred with the program manager’s decision to waive the 11 lots in
order to rapidly replace the PASGT flaks with a superior, advanced body-armor
system,” Catto said in the statement. “Due to the massive deployment associated
with [Operation Iraqi Freedom], this was considered to be an urgent need, and was
deemed to be in the best interest of deployed Marines at that time.”
*
*
*
“This was one of these situations where they’re screaming for these OTVs
[and] these guys have to get them,” Reinwald said. “At that time, we had the
operation requirement that we didn’t have the schedule to play with.”
*
*
*
“Based on ballistic test data and previously identified quality assurance
failures, I do not recommend acceptance of these lots and do not recommend
acceptance of future lots until this issue is resolved,” MacKiewicz wrote in an
August 24, 2004 memo failing two lots.
The memo is one of many that MacKiewicz drafted from as early as
January 2003, warning of poor ballistic test results and recommending the Marine
Corps solve the problem before shipping any more vests to its troops.
*
*
*
As program manager, it fell to Patricio to purchase more than 190,000
Interceptor vests and armor plates for the Corps.
*
*
*
Facing mounting pressure to acquire body armor quickly because of
upcoming deployments to Iraq and Afghanistan, and armed with the final orders to
close out the Corps’ vest procurement plan, Patricio had little maneuver room on
the vest program.
The first vest failures had come to light in mid-January 2003, as officials
with Point Blank notified Marine contract officers of problems at their Oakland
Park, Fla., test facility.
*
*
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In December 2003, contract officers and testers discovered that multiple
vests from two other lots failed ballistic tests, this time at the Aberdeen facility.
*
*
*
Patricio noted in a memo dated Feb. 2, 2004, that the urgent need for body
armor in the war zone and the time it would take to find out for sure why the vests
were failing outweighed his concerns with the vests.
*
*
*
Natick officials said they pleaded with Point Blank to properly document
and track the materials and manufacture of the vests so they might pinpoint the
problem. But they said Point Blank could not deliver the information they needed.
The Marine Corps contract included a premium of about $50 extra per vest
to cover additional quality assurance procedures at Point Blank, MacKiewicz said.
Among other information that was of interest to Natick testers was which
rolls of woven Kevlar fiber were used, for example, in the assembly of the layered
ballistic vest panels.
“That process was basically broken,” MacKiewicz said. “I could not
distinguish between one roll of material that went into the first 500 or the second 500
or the third 500.
In a series of memorandum written over the summer of 2004, in which
MacKiewicz explained his reasoning for rejecting certain lots delivered by Point
Blank, the testing expert detailed his concerns.
In recommending the rejection of lot 71-12 on July 19, MacKiewicz warned
of “major quality assurance deficiencies” at the company. He recommended
“disciplinary action against the contractor to resolve the issue.”
In a July 21 memorandum to Patricio recommending the rejection of two
more lots, 69-84 and 71-9, MacKiewicz wrote: “One of the significant factors, which
ultimately led to award a contract to Point Blank, was their proposed quality
assurance procedures for eliminating defects and tracking materials. . . . Point
Blank is not compliant with their manufacturing quality control proposal and their
contractual obligation for providing consistent product performance and
reliability.”
*
*
*
No purchases after 2004
The Marine Corps fielded vests from the failed lots through the end of 2004,
documents and interviews show, but stopped taking delivery of Point Blank
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manufactured vests in early 2005. By then, the contract had not been exhausted –
at least 9,000 vests could still have been purchased.
100.
The Marine Core Times exposé documented with internal military memoranda
(attached hereto as Ex. B) that military ballistics experts and the Defense Contract Management
Agency had identified thousands of defective DHB vests beginning in January 2003. Natick
internal memorandum made public by The Marine Times expose stated that DHB vests were failing
ballistics tests and failing to meet performance requirements in December 2003 and throughout
2004. Lt. Col. G.R. Patricio, the Head of Contract, Research, Development & Engineering at
Natick, stated on November 24, 2004 that vests “currently located at the Point Blank production
facility have been completed and are being held in place due to ballistic failures during quality
assurance testing. Therefore the OTVs in the stated lots do not fully comply with the current
Marine Corps performance specifications for the OTV and do not meet existing contractual
requirements.” Patricio eventually took delivery of the vests only because they were “needed by
deploying units that must receive them prior to deployment in the very near future.”
101.
The Marine Corps Times expose further made clear that beginning at least in
February 2004 and continuing throughout 2004, the U.S. military required DHB officers to sign
“Requests for Deviation/Waivers” allowing the military to purchase and distribute vests of
“questionable performance” that failed to meet minimum standards. COO Hatfield signed a
“Request for Deviation/Waiver” on November 30, 2004 indicating “Major” deficiencies and that
DHB would “strive for meeting or exceeding the desired requirements.” The military accepted the
defective vests by waiving the defects because military officials believed that the urgent need meant
that “sub-par product may be preferable to none at all.” According to a July 21, 2004 memorandum
authored by U.S. military official MacKiewicz, DHB was also never “compliant with their
manufacturing quality control proposal and their contractual obligation for providing consistent
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product performance and reliability.” MacKiewicz stated that DHB’s original 1993 proposal to
produce the vests for the military had been among a group of “technically acceptable proposals,” but
that a “significant factor which ultimately led to award a contract to Point Blank, was their proposed
quality assurance procedures for eliminating defects and tracking materials” used in vest
manufacturing. In exchange for these procedures, the military paid DHB an extra fee of $50 per
vest. Despite the $50/vest fee and “pleading” from MacKiewicz and other military officials that
DHB fix a materials tracking process that was “basically broken,” DHB never implemented the plan
and performed the necessary quality assurance procedures. The military considered material
tracking “essential” because “[i]f the tracking history of the material/production cannot be
identified,” the “ballistic quality assurance test has essentially no validity.” MacKiewicz also
stated that crucial tracking identification numbers had been manually “scratched out” and re-marked
on vest labels. MacKiewicz and other Natick officials reiterated these concerns in their entirety in
successive memorandum throughout 2004 after testing other DHB Interceptor vests. MacKiewicz
wrote similar memoranda complaining of DHB’s poor and failed test results and pervasive quality
control problems beginning in early 2003.
102.
On May 10, 2005, DHB issued a release reporting its 1stQ 05 results via a release,
headlined and stating:
DHB Industries Reports First Quarter Results – 1st Quarter Earnings Per
Share Climb 21.4% to $0.17
DHB Industries, Inc., which principally operates in the rapidly growing field
of body armor, announced today results for the first quarter ended March 31, 2005.
DHB posted record first quarter revenues of over $85 million and its 21st
consecutive year-over-year increase in quarterly revenues.
First quarter 2005 income available to common stockholders was $7,619,000,
a 21.5% increase as compared to $6,269,000 in the first quarter of 2004. First
quarter 2005 earnings per share was $0.17 per diluted share, a 21.4% increase as
compared to $0.14 per diluted share in the first quarter of 2004. . . .
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The gross profit margin for the first quarter of 2005 was 27.4% versus 27.9%
in the first quarter of 2004. . . .
Stockholders’ equity rose to a record $85,201,000 at March 31, 2005, a
10.6% increase as compared to $77,026,000 at year-end December 31, 2004.
103.
On May 10, 2005, DHB filed its 1stQ 05 10-Q report with the SEC signed by Brooks
and Schlegel, which reported the same financial results earlier reported by DHB. The 10-Q reported
inventories valued at $102.9 million. According to the 1stQ 05 10-Q:
Our market share is highly dependent upon the quality of our products, and
our ability to deliver our products in a prompt and timely fashion. . . . 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.
DHB’s 1stQ 2005 Form 10-Q also stated:
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 10K. 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,
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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 three months ended March 31, 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 will be effective in addressing the deficiency in internal controls described
above. The attestation report of Weiser LLP also identified what that firm considers
to be two additional weaknesses in internal controls: (1) failure of the Company to
complete consultation with Weiser LLP 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 Weiser LLP has a proper basis for its conclusions, the Company takes Weiser
LLP’s views seriously and intends to explore opportunities to improve the process of
preparing its filings with the Securities and Exchange Commission and the
effectiveness of its Audit Committee.
104.
The 1stQ 05 Form 10-Q also contained certifications from Brooks and Schlegel dated
May 10, 2005 stating:
1.
I have reviewed this quarterly report on Form 10-Q of DHB
Industries, Inc.;
2.
Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
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3.
Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and for, the
periods presented in this report;
4.
The registrant’s other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13(a)-15(f) and 15(d)-15(f)) for the
registrant and have:
a)
Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during
the period in which this report is being prepared;
b)
Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c)
Evaluated the effectiveness of the registrant’s disclosure
controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
d)
Disclosed in this report any change in the registrant’s internal
control over financial reporting that occurred during the registrant’s most recent
fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report)
that has materially affected, or is reasonably likely to materially affect, the
registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of registrant’s board of directors (or
persons performing the equivalent functions):
a)
all significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant’s ability to record, process, summarize and
report financial information; and
b)
any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant’s internal control
over financial reporting.
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*
*
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*
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of DHB Industries, Inc. (the
“Company”) on Form 10-Q for the three months ended March 31, 2005 as filed the
Securities and Exchange Commission (the “Report”), I . . . certify, pursuant to 18
U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the
Company. [Emphasis added.]
105.
On May 11, 2005, Roth Capital Partners issued a report on DHB, based on
information provided by Hatfield and Schlegel, stating:
Inventory levels continued to increase to support the company’s future growth,
reaching $102.9 million versus $86.0 million in Q404. Higher inventory levels
during the quarter were primarily attributable to a higher percentage of finished
goods on the shelves, which may be waiting on accessories to complete assembly of
the product. In addition, the climbing inventory levels are a result of DHB
continuing to stock key ballistic fabrics when these materials are available.
[Emphasis added.]
106.
On May 11, 2005, Miller Johnson Steichen Kinnard issued a report on DHB stating:
1Q05 SALES MISSED . . .
*
*
*
INVESTMENT SUMMARY
DHB reported 1Q05 (ended March) sales of $85.5 million, which was below
our estimate of $90.8 million. . . .
107.
On May 13, 2005, Feltl & Company issued a report on DHB stating:
x
In the absence of guidance, and in light of the flattening revenue trend of
recent quarters, we have reduced our estimate for the year.
108.
On July 28, 2005, DHB issued a release reporting its 2ndQ 05 results, stating:
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DHB Industries Inc., which principally operates in the rapidly growing field of body
armor, announced today results for the second quarter ended June 30, 2005. DHB
posted record second quarter revenues of over $88 million and its 22nd consecutive
year-over-year increase in quarterly revenues.
. . . Income available to common stockholders was $7,598,000 as compared
to $7,570,000 in the second quarter of 2004. Earnings diluted share was $0.17 per
share as compared to $0.17 per diluted share reported in the year-ago period. . . .
The gross profit margin for the second quarter of 2005 was 27.2% versus
27.7% in the comparable year-ago period. . . .
. . . During the second quarter of 2004 . . . [i]ncome available to common
stockholders was a record $15,217,000 or $0.33 per diluted share as compared to
$13,839,000 or $0.30 per diluted share in comparable period last year. . . .
Stockholders’ equity rose to $92,799,000 at June 30, 2005, a 20.5% increase
as compared to $77,026,000 at year-end December 31, 2004 and an increase of 8.9%
as compared to $85,201,000 at March 31, 2005.
109.
On July 29, 2005, Miller Johnson Steichen Kinnard issued a report on DHB:
2Q05 Results Were Slightly Below Expectations
*
x
*
*
EPS in-line, but benefited by a penny due to lower tax rate.
*
*
*
DHB reported 2Q05 (ended June) sales of $88.2 million, which was below
our estimate of $90.4 million and 2.5% ahead of 2Q04 sales of $86.1 million. . . .
The Company reported 2Q05 EPS of $0.17, which was in-line with our
estimate of $0.17 and flat with 2Q04 EPS of $0.17. . . . DHB’s 2Q05 tax rate was
35.5%, which was lower than our assumption of 38.5%. Had the tax rate been
38.5%, the Company’s EPS would have been $0.16, or a penny shy [of] our estimate,
attributable mostly to the sales shortfall.
110.
On August 8, 2005, DHB filed its 2ndQ 05 report on Form 10-Q with the SEC signed
by Brooks, Schlegel, Krantz and Nadelman, which contained the same financial results earlier
reported by DHB. The 10-Q valued DHB’s inventories as of June 30, 2005 at $101.3 million. The
2ndQ 05 10-Q also stated:
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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 10K. 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 six months ended June 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
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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 will be effective in 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 intends to explore opportunities to improve the process of preparing its
filings with the Securities and Exchange Commission and the effectiveness of its
Audit Committee.
The 2ndQ 05 10-Q also contained certifications signed by Brooks and Schlegel dated August 3,
2005, which stated:
1.
I have reviewed this quarterly report on Form 10-Q of DHB Industries, Inc.;
2.
Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this quarterly report;
3.
Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this quarterly report;
4.
The registrant’s other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
a)
designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b)
evaluated the effectiveness of the registrant’s disclosure controls and
procedures as of a date within 90 days prior to the filing date of this quarterly report
(the “Evaluation Date”); and
c)
presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
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5.
The registrant’s other certifying officer and I have disclosed, based on our
recent evaluation, to the registrant’s auditors and the audit committee of registrant’s
board of directors or persons performing the equivalent function):
a)
all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant’s ability to record, process,
summarize and report financial data and have identified for the registrant’s auditors
any material weaknesses in internal controls; and
b)
any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officer and I have indicated in this quarterly
report whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
*
*
*
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of DHB Industries, Inc. (the
“Company”) on Form 10-Q for the period ended June 30, 2004 as filed with the
Securities and Exchange Commission on the date hereof (the “Report”), I . . . certify,
pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act
of 2002, that:
(1)
The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2)
The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
111.
DHB’s reported financial results and conditions, as well as the other statements made
between April 9, 2005 and August 8, 2005 concerning DHB’s business, products, financial condition
and future prospects were each false and misleading when made and were misleading in failing to
disclose the true financial results and conditions of DHB and the adverse facts and conditions
concerning DHB’s business, products, finances and future outlook as set forth below:
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(a)
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Orders received by DHB from the DOD were not an indication of the
confidence of the U.S. military in, or satisfaction with, DHB’s products because, in fact, many
thousands of units of DHB’s main military product, the Interceptor vest, shipped to the U.S. Marines
were non-conforming and defective, and orders for vests were being placed and defective vests were
being accepted only because the military was suffering from extreme shortages of body armor which
was desperately necessary for American troops in Afghanistan and Iraq;
(b)
DHB had shipped at least 50,000 Zylon-based body armor products to
domestic law enforcement agencies which were defective and non-conforming and did not meet and
could not fulfill DHB’s five-year warranty. DHB had also shipped thousands of defective and nonconforming Interceptor vests to the U.S. Marines which failed to comply with DOD/U.S. military
contract specifications and requirements;
(c)
DHB’s systems of quality control, which were indispensable for its successful
operation, were defective and inadequate which led to the shipment of thousands of defective
Interceptor vests to the U.S. Marines and also prevented DHB from being able to trace identified
defective vests to specifically identified lots of raw material, a major manufacturing processing and
quality control defect, which contaminated 100% of DHB’s Interceptor vest production;
(d)
DHB had accumulated many millions of dollars of defective and useless
Zylon raw material which its insiders knew could no longer be used to manufacture body armor
products because Zylon degraded rapidly when exposed to heat, light and body perspiration. DHB’s
excessive inventory of useless and unsaleable Zylon materials should have been and would have to
be written off, which would result in a multi-million dollar charge and adversely impact DHB’s
financial condition and results from operations;
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(e)
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It was not true, as represented by DHB, that there were very few Zylon vests
manufactured by DHB still in use by police departments in the field; on the contrary, there were at
least 50,000 Zylon vests still used in the field and still under warranty, that vests would have to be
replaced by DHB at a huge cost, which would have a material adverse impact on DHB’s financial
results and condition;
(f)
DHB’s financial reports and statements for the periods ending March 31, 2005
and June 30, 2005 were materially false and misleading in overstating the value of DHB’s
inventories, failing to accrue material loss contingencies, i.e., Zylon vest replacement costs, and
overstating DHB’s net income, EPS and shareholders’ equity by material amounts;
(g)
DHB’s top insiders were aware that thousands of DHB Interceptor vests were
defective and did not conform to government standards, even though DHB had been paid an extra
$50 per vest to assure the high quality of such vests, that the DOD/U.S. military’s quality control
assurance personnel had discovered these defects and were recommending rejection of the vests and
disciplinary action against DHB, and that even if DHB was able to persuade the government to
accept these defective vests because of the government’s urgent need for body armor for U.S. troops,
the U.S. military would, when body armor became more available, curtail its purchases of DHB’s
products;
(h)
DHB’s vests did not meet or exceed the expectations or requirements of
DHB’s domestic law enforcement and U.S. military customers, as thousands of these vests were
defective and non-conforming and its customers had objected to these defects, demanding or taking
remedial actions. Defendants privately acknowledged on multiple occasions throughout 2004,
including as early as February 2004 and, specifically, on November 30, 2004, that its Interceptor
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vests did not meet or exceed expectations when officers of the Company signed military “Requests
for Deviation/Waiver” forms indicating major vest defects;
(i)
The reason for the increase in DHB’s inventories during 2004-2005 was not
that DHB was stockpiling raw materials which were purportedly in short supply so that it would
have those materials to produce armor body products to meet increasing demand as claimed, but,
rather, DHB’s inventories were increasing because DHB had accumulated and continued to carry on
its books, millions and millions of dollars of Zylon raw materials and Zylon-containing vests which
were, in fact, unusable and worthless;
(j)
DHB’s internal financial and accounting and disclosure controls were not
adequately designed, had not been properly tested and, in fact, were defective, which was leading to
material fraud in the presentation of DHB’s financial results and condition. Due to internal control
deficiencies in DHB’s quality control systems, inventory pricing mechanisms and the operations of
its Audit Committee, which were serious and pervasive, DHB had accumulated millions and millions
of dollars of excessive and worthless inventory of Zylon raw material, was manufacturing and
shipping thousands of defective Interceptor vests to the U.S. military and not properly accounting for
or reporting these matters in its SEC filings and other public statements;
(k)
DHB’s officers and directors were violating multiple provisions of the DHB
Code of Business Conduct & Ethics; and
(l)
As a result of the foregoing, DHB’s forecasts of continued future profitable
growth and other optimistic statements regarding the future of DHB’s business were completely
false and were known by them to be false when made, because the adverse facts and conditions
detailed above would cause DHB’s business to perform much worse than promised or forecast and
its financial results to be far short of those forecast.
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112.
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On August 24, 2005, the NIJ decertified Zylon as an approved component of bullet-
resistant body armor and bulletproof vests. On August 25, 2005, DHB stock closed at $7.04, up
$.06 from its August 24 closing price and virtually unchanged from its closing price of $7.07 on
August 23. On August 26, 2005, DHB stock reached $7.10, up $.12 from the August 24 closing
price and up $.05 from the August 23 closing price. DHB stock traded at average or below-average
volume on each trading day August 24-26, 2005.
113.
On August 30, 2005, DHB suddenly announced that it had “ceased production of all
Zylon-containing bullet resistant products,” that it would be implementing a replacement program
for all customers with Zylon body armor, and that these actions would result in a $60 million charge
for the relevant cost and Zylon inventory write-off. DHB’s announcement shocked the market and
analysts, as DHB had earlier indicated it was no longer producing Zylon vests, only a small number
remained in the field and that its inventory growth was unrelated to Zylon. This huge charge wiped
out all of DHB’s reported earnings during the Class Period and eliminated a large part of its net
worth/shareholders’ equity. As a result of this full revelation of negative information regarding
DHB’s widespread use and stockpiling of Zylon, DHB’s stock fell sharply from $6.90 on August 29,
2005 to $4.50 on August 31, 2005, a 34% company-specific stock decline on very high volume, not
due to general market movements or industry factors or even company-specific negative factors
unrelated to the fraud.
POST-CLASS PERIOD EVENTS
114.
In November 2005, the Marines and the Army collectively recalled more than 18,000
additional DHB vests.
115.
On November 22, 2005, the military issued a solicitation for interested manufacturers
to bid for the contract to produce an improved Interceptor OTV. The solicitation was posted on the
Federal Business Opportunities website, but the military made no public announcement. Following
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the expectation of the body armor industry that the Interceptor program would be discontinued after
current contracts expired, the United States Army announced the “US Army Next Generation Body
Armor Industry Day” on February 16, 2006, indicating that “[t]he objective of this Industry Day is to
brief interested Force Protection Vendors on the requirements for the US Army’s next generation
body armor system, which will replace the current Interceptor Body Armor.”
116.
In December 2005, Brooks and Terry Brooks held a bat mitzvah for his daughter that
was estimated to cost $10 million. The New York Times reported on the bat mitzvah on January 2,
2006 under the headline “Another Marie Antoinette Moment” and stated that “while 18,000 [] vests
were being recalled by the United States military, some from Iraq, Mr. Brooks was in the midst of
throwing a private party for his daughter and her friends at the Rainbow Room at Rockefeller Center
. . . guests reportedly walk[ed] out carrying gift bags valued at $1,000 each, stocked with digital
cameras and video iPods.” TheMotleyFool.com reported on Brooks and the party under the headline
“DHB: Shades of Tyco?”:
DHB: Shades of Tyco?
*
*
*
Historians tell us that “history repeats itself.” What they don’t tell us is how quickly
it repeats, or how precisely.
Remember Dennis Kozlowski? He of “whizzing Cristal” fame? The ex-CEO was
sentenced to eight to 25 years in prison for his part in pillaging the Tyco (NYSE:
TYC) industrial conglomerate for $600 million worth of salaries, bonuses and perks
earlier this year (in conjunction with ex-CFO Mark Swartz). But what made the man
truly infamous was not the looting, but his profligate spending of the loot on a $2.1
million birthday party for his wife on the island of Sardinia.
In a [MotleyFool.com] column last June, I opined that Kozlowski would be “a hard
act to follow.” As it turns out, it hasn’t been that hard at all.
Kozlowski lives
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Last week, we learned that another infamous CEO, body-armor manufacturer DHB
Industries’ (AMEX: DHB) David H. Brooks, made headlines for actions that seem
borrowed nearly line-for-line from the Dennis Kozlowski playbook.
*
*
*
What’s gotten our attention, mostly, has been Brooks’ pattern of apparent selfenrichment at the expense of his firm’s outside investors. For example, at the tail
end of 2004, as DHB’s stock was flying high on news of strong body armor sales to
the U.S. military in Iraq, Brooks reported to the SEC that he had sold off $186
million worth of stock. DHB’s board of directors subsequently issued him warrants
to buy 5 million more shares at $1 per stub.
Investors naturally wondered why DHB’s CEO was selling off so many shares. Was
the company poised for a fall, or did Brooks just need to raise some cash? As it turns
out, the answer could be “yes” to both questions.
First, the company started changing audit firms faster than some people change their
socks. DHB lost its fifth auditor, Grant Thornton, when that firm resigned in 2003.
Its replacement auditor followed suit in April of this year. Soon after, the firm’s
stock price collapsed on the news that a synthetic fiber used in DHB’s “bulletproof”
vests was defective, and that the firm would need to take up to a $60 million charge
to replace vests already sold.
In addition, it seems Brooks did need the cash. His daughter’s bat mitzvah party was
looming.
50 cents, and a little more
Here’s where the story gets good. (Or sordid. Or both, depending on your
perspective.) Last weekend, Brooks threw a monster coming-of-age party for his
daughter (name suppressed to protect the innocent) at New York’s Rainbow Room,
the self-described pinnacle of “New York style, glamour and sophistication.”
The guest list reportedly included 150 of Brooks’ closest friends and business
associates, and another 150 friends of the young debutante. Nothing too over-the-top
there. Yet Brooks somehow managed to spend a total of $10 million on the fiesta,
which works out to an average of $33,000 per head. At that rate, this party easily
topped the per capita cost of Kozlowski’s wife’s birthday bash. ($2.1 million divided
by 75 guests equals $28,000 per head. Imagine the chewing-out Kozlowski will
receive from the missus when he returns from the Big House. “That little Brooks girl
got $33,000 per, and all I got was a measly . . .”)
As for how Brooks spent all this loot, part went to purchase gift bags for the guests,
stuffed with digital cameras and the trendy gift du jour: Apple (Nasdaq: AAPL)
iPods. But the bulk of the cost went to hire the entertainment, which ranged from the
formerly famous (Don Henley, Stevie Nicks, and Kenny G), to the newly famous (50
Cents and Ciara), to the still pretty well known (Aerosmith and Tom Petty).
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Is the party over?
As with Kozlowski, it’s not the apparent stock profiteering that gets the press in the
Brooks debacle. True, Brooks is being investigated by the SEC, but that doesn’t
make for nearly as compelling a headline as something like “War Profiteer Throws
$10 Million Bat Mitzvah.”
As a result, although throwing a bodacious party is not an indictable offense, DHB
investors can still hope that its publicity will pressure the SEC to develop an actual
prosecution out of its investigation. Even failing that, the bad press garnered from
Brooks’ profligate spending of his capital gains could finally convince DHB’s board
to develop a spine and boot Brooks from the CEO chair.
Either result, one suspects, would give DHB’s stock a boost, and provide some
recompense to investors who – like us – mistakenly lent their trust to this CEO.
[Emphasis added.]
Kozlowski is currently serving up to 25 years in federal prison for the massive fraud that nearly
destroyed Tyco Industries.
117.
On January 9, 2006, Sen. Hillary Clinton (D-NY) formally requested the Senate
Armed Services Committee to investigate reports that Interceptor body armor is inadequate and
inferior, but was nevertheless provided by the military to troops in Afghanistan and Iraq. Senator
Clinton’s letter stated in part:
These reports come in the context of numerous problems that have been reported
during the past year regarding body armor for our troops. In April 2005, the
Government Accountability Office found that there were delays in body armor
acquisition as well as ineffective distribution. In May 2005, the Marine Corps Times
reported that the Corps issued inadequate body armor to nearly 10,000 troops.
Government experts urged the Corps to reject the armor after tests revealed critical,
life-threatening flaws in the vests. In October 2005, it was disclosed that the
Pentagon was not implementing a program to reimburse troops who purchased their
own body armor. Only after public pressure did the Pentagon relent.
With United States troops risking their lives daily in Iraq, Afghanistan and
elsewhere, we owe it to them to make sure they have the best equipment possible.
According to these recent reports, the Pentagon is failing that responsibility.
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118.
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On March 17, 2006, DHB announced that it would not be able to timely file its 2005
10-K and might be required to restate its financial results for 1stQ 2005 -3rdQ 2005. The
Company’s release stated:
The Company did not file its Form 10-K by March 16, 2006 because the Company is
conducting additional analysis of historical information and records to ensure the
reasonableness of estimates and the accuracy of reported inventory levels and
resulting gross profit and income levels for 2005. Our auditors have called our
attention to, and the Company has identified, some inaccurate inventory records.
The net result is not yet known. Based on the foregoing and information that has
become available in the fourth quarter of 2005, the Company is also reassessing its
estimates of the cots of the Voluntary Replacement Program for Zylon(R)-containing
armor products that the Company announced in the third quarter of 2005. We
believe that both of the analyses could result in restatement of the reported results for
one or more of the first three quarters of 2005, including restatement of the amount
of the inventory written off in the third quarter.
FALSE FINANCIAL STATEMENTS
119.
In order to overstate its earnings, assets, inventories and shareholders’ equity in 2004
and the first two quarters of 2005, DHB violated GAAP and SEC rules by failing to accrue for, or
adequately disclose, contingent losses associated with costs it had incurred due to its sale of Zylonrelated products. DHB also failed to properly report the value of its inventory and failed to
adequately write-down these assets to reflect the diminished future economic benefits associated
with the Zylon-containing bullet resistant products it had manufactured and raw materials it had
accumulated. DHB ultimately will take charges exceeding $60 million related to the costs to replace
product already sold and its inventory of Zylon-containing products. This amount exceeded the
entire net income DHB reported during the Class Period and wiped out a large amount of its
shareholders’ equity.
120.
Net Sales
DHB reported the following financial results during the Class Period:
Qtr-end
3/31/04
Qtr-end
6/30/04
Qtr-end
9/30/04
Qtr-end
12/31/04
Qtr-end
3/31/05
Qtr-end
6/30/05
$74.40M
$86.07M
$89.41M
$90.20M
$ 85.46M
$ 88.20M
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Inventories
Gross Margin
Net Income
EPS
Shareholders’
Equity
121.
$62.82M
27.91%
$6.36M
$0.14
$53.09M
Document 80-1
$74.34M
27.75%
$7.66M
$0.17
$60.74M
$81.97M
27.82%
$8.15M
$0.18
$68.80M
Filed 03/20/2006
$85.97M
27.29%
$8.27M
$0.18
$77.03M
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$102.93M
27.36%
$7.71M
$0.17
$85.20M
$101.35M
27.25%
$7.69M
$0.17
$92.80M
DHB later included these results in a Form 10-K and Form 10-Qs which were filed
with the SEC and which documents were reviewed and approved by each of the Individual
Defendants. The Form 10-Qs represented that in the opinion of management, the accompanying
financial statements included all adjustments necessary for a fair presentation. The 2004 Form 10-K
similarly represented that the financial statements were presented in conformity with GAAP, and
represented that with respect to inventories:
Inventories are stated at the lower of cost (determined on the first-in, first-out basis)
or market.
122.
With respect to its liabilities for Zylon and the related litigations, the 2004 10-K
stated only that:
In January 2005, the Company was served with a class action lawsuit by a
police organization and individual police officers, because of concerns regarding the
effectiveness and durability of body armor with high concentrations of Zylon. In
February, the Company reached a preliminary settlement with respect to this lawsuit,
subject to a final court approval. The Company does not expect this settlement to
have a material adverse effect on its financial position.
The Company is subject to other legal proceedings and claims, which have
arisen in the ordinary court of its business and have not been finally adjudicated.
These actions when ultimately concluded and determined will not, in the opinion of
management, have a material adverse effect on the results of operations or the
financial condition of the Company. [Emphasis added.]
DHB’s statement is false and misleading because DHB’s insiders knew that DHB had millions of
dollars of worthless Zylon inventories that would have to be written off and at least 50,000 Zylon
vests in the field under warranty that would have to be replaced, and that the resulting costs would
have a material adverse impact on DHB’s financial condition.
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123.
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DHB’s financial statements and the statements about DHB’s products and inventories
were false and misleading, as such financial information was not prepared in conformity with
GAAP, nor was the financial information “a fair presentation” of the Company’s operations due to
the Company’s failure to accrue losses associated with Zylon and its improper accounting for its
inventory, in violation of GAAP and SEC rules.
124.
GAAP are those principles recognized by the accounting profession as the
conventions, rules and procedures necessary to define accepted accounting practice at a particular
time. Regulation S-X (17 CFR §210.4-01(a)(1)) states that financial statements filed with the SEC
which are not prepared in compliance with GAAP are presumed to be misleading and inaccurate.
Regulation S-X requires that interim financial statements must also comply with GAAP, with the
exception that interim financial statements need not include disclosure which would be duplicative
of disclosures accompanying annual financial statements. 17 C.F.R. §210.10-01(a).
DHB’s Failure to Accrue for Losses Caused by Its Sale of
Defective Products and Improper Accounting for Inventory
125.
GAAP, as set forth in FASB Statements of Financial Accounting Standards (“SFAS”)
No. 5, Accounting for Contingencies, requires that losses for contingencies be recorded as follows:
8.
An estimated loss from a loss contingency (as defined in paragraph 1) shall
be accrued by a charge to income if both of the following conditions are met:
a.
Information available prior to issuance of the financial statements indicates
that it is probable that an asset has been impaired or a liability had been incurred at
the date of the financial statements. It is implicit in this condition that it must be
probable that one or more future events will occur confirming the fact of the loss.
b.
The amount of loss can be reasonably estimated.
(Footnote omitted, emphasis in original.)
126.
SFAS No. 5, 4 and 24 state in part:
4.
Examples of loss contingencies include:
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*
b.
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*
Obligations related to product warranties and product defects.
*
*
*
Obligations Related to Product Warranties and Product Defects
24.
A warranty is an obligation incurred in connection with the sale of goods or
services that may require further performance by the seller after the sale has taken
place. Because of the uncertainty surrounding claims that may be made under
warranties, warranty obligations fall within the definition of a contingency in
paragraph 1. Losses from warranty obligations shall be accrued when the conditions
in paragraph 8 are met. Those conditions may be considered in relation to individual
sales made with warranties or in relation to groups of similar types of sales made
with warranties. If the conditions are met, accrual shall be made even though the
particular parties that will make claims under warranties may not be identifiable.
127.
SFAS No. 5 also requires that adequate disclosures be made for contingent losses.
128.
GAAP, as set forth in Accounting Research Bulletin (“ARB”) No. 43, Chapter 4,
Inventory Pricing, requires that inventories be recorded at the lower of cost or market. ARB No. 43,
Chapter 4, Statement 5 states:
A departure from cost basis of pricing the inventory is required when the
utility of goods is no longer as great as its cost. Where there is evidence that the
utility of goods, in their disposal in the ordinary course of business, will be less than
cost, whether due to physical deterioration, obsolescence, changes in price levels or
other causes, the difference should be recognized as a loss of the current period. This
is generally accomplished by stating such goods at a lower level commonly
designated as market.
(Emphasis in original.)
129.
During the Class Period, as more fully described herein, the Company’s Zylon
products suffered from defects which when uncovered would lead to DHB being unable to sell the
Zylon products on hand and resulting in DHB accumulating millions of dollars worth of excess
inventory, as well as millions of dollars in undisclosed losses on its liability to customers. Pursuant
to GAAP, the Company was required to accrue for probable losses on the costs of complying with
customer warranties on defective products and to evaluate its inventory at each quarter-end and
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record losses for the excessive and unsaleable inventory DHB held. However, in order to meet their
own aggressive earnings estimates and boost DHB’s stock price, the Individual Defendants caused
the Company to not record losses on product liabilities nor to take adequate reserves for excess and
overvalued inventory. As explained in detail elsewhere herein (e.g. ¶¶37-45, 99-101) and also
further detailed in the Additional Scienter and Scheme Allegations section of this Complaint (¶¶152153), defendants were aware of the following factors during the Class Period:
x
Police officers had been complaining about the effectiveness and durability of body
armor with high concentrations of Zylon.
x
Zylon had degradative properties that caused it to be much less effective in a
relatively short time.
x
In early 2005, DHB had to settle a lawsuit filed with respect to the quality of Zylon,
by exchanging 2,000 vests containing Zylon at a cost of $1.5 million. DHB had sold
at least 50,000 Zylon vests.
x
DHB had been accused of selling vests with Zylon which were “completely
unsuitable for the intended use,” over the warranty period.
x
The first vest failures came to light in mid-January 2003 at Point Blank’s own testing
facility. Hatfield subsequently represented falsely to the press that this was due to
improper testing equipment. Additional vest failures occurred throughout 2003. In
December 2003, a separate testing facility found complete penetration of a vest at
less than 14.50 feet per second, a speed at which no vest penetration should occur.
Vest failures continued throughout 2004.
x
DHB vests (produced by the Point Blank subsidiary) had also been found to be
unsuitable by a government ballistics expert.
x
Competing Army supplier of protective vests, Second Chance Body Army, Inc. had
announced it would stop selling Zylon based vests in 2003 due to “potential . . .
safety” issues for police officers, and later it filed for bankruptcy as a result.
x
The manufacturer of Zylon, Toyobo, had been sued for defects in Zylon in body
armor and had been subpoenaed or otherwise investigated by the attorneys general of
28 states and had told DHB Zylon was not suitable for use in vests warranted for five
years.
x
In 2004, DHB had to obtain waivers, and in fact signed such waivers, from the
Marine Corps to continue to use its Interceptor vests after government testers found
the vests did not pass muster and fulfill contractual requirements.
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130.
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Notwithstanding these indicia that DHB had unaccrued and undisclosed liabilities
and/or overstated inventory due to its sale of Zylon products, defendants failed to record adequately
timely charges to account for DHB’s sale of defective product. In fact, when specifically asked
about litigation involving Zylon on the Company’s October 19, 2004 conference call, Robert
Schiller, president of DHB’s Armor division, stated:
We officially settled with the Southern States Police Benefits Association and
that fairness hearing occurred on September 30th and the Judge approved the terms
of our settlement with the plaintiffs. Now we are in the process of working with the
other class action party to bring that suit to a close under the legal principle that
basically says you can’t be tried to the same crime twice. It’s slightly a different
principle but it was all aggregated into one class and since the Southern States
litigation was approved, you know, we are very confident at this stage that the other
lawsuit will be dismissed.
However, neither Schiller nor any of the defendants disclosed the Company’s other liabilities and
problems associated with Zylon.
131.
Ultimately, in the 3rdQ 05, DHB admitted that it will record charges of as much as
$60 million to replace its Zylon containing bullet-resistant products. Had DHB appropriately
accounted for its Zylon-related accrued liabilities and reserved for product warranty claims and for
excess and defective inventory in prior quarters, such a large charge would have been unnecessary.
Had DHB properly reported its inventory and losses in accordance with GAAP, DHB’s gross
margins during the Class Period would have been much lower than 27%.
132.
Due to these accounting improprieties, the Company presented its financial results
and statements in a manner which violated GAAP, including the following fundamental accounting
principles:
(a)
The principle that interim financial reporting should be based upon the same
accounting principles and practices used to prepare annual financial statements (APB No. 28, 10);
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(b)
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The principle that financial reporting should provide information that is useful
to present and potential investors and creditors and other users in making rational investment, credit
and similar decisions was violated (FASB Statement of Concepts No. 1, 34);
(c)
The principle that financial reporting should provide information about the
economic resources of an enterprise, the claims to those resources, and effects of transactions, events
and circumstances that change resources and claims to those resources was violated (FASB
Statement of Concepts No. 1, 40);
(d)
The principle that financial reporting should provide information about how
management of an enterprise has discharged its stewardship responsibility to owners (stockholders)
for the use of enterprise resources entrusted to it was violated. To the extent that management offers
securities of the enterprise to the public, it voluntarily accepts wider responsibilities for
accountability to prospective investors and to the public in general (FASB Statement of Concepts
No. 1, 50);
(e)
The principle that financial reporting should provide information about an
enterprise’s financial performance during a period was violated. Investors and creditors often use
information about the past to help in assessing the prospects of an enterprise. Thus, although
investment and credit decisions reflect investors’ expectations about future enterprise performance,
those expectations are commonly based at least partly on evaluations of past enterprise performance
(FASB Statement of Concepts No. 1, 42);
(f)
The principle that financial reporting should be reliable in that it represents
what it purports to represent was violated. That information should be reliable as well as relevant is
a notion that is central to accounting (FASB Statement of Concepts No. 2, 58-59);
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(g)
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The principle of completeness, which means that nothing is left out of the
information that may be necessary to insure that it validly represents underlying events and
conditions was violated (FASB Statement of Concepts No. 2, 79); and
(h)
The principle that conservatism be used as a prudent reaction to uncertainty to
try to ensure that uncertainties and risks inherent in business situations are adequately considered
was violated. The best way to avoid injury to investors is to try to ensure that what is reported
represents what it purports to represent (FASB Statement of Concepts No. 2, 95, 97).
133.
Further, the undisclosed adverse information concealed by defendants during the
Class Period is the type of information which, because of SEC regulations, regulations of the
national stock exchanges and customary business practice, is expected by investors and securities
analysts to be disclosed and is known by corporate officials and their legal and financial advisors to
be the type of information which is expected to be and must be disclosed.
DHB’S INADEQUATE INTERNAL CONTROLS
134.
Section 13(b)(2) of the 1934 Act requires, in pertinent part, that every reporting
company:
(A)
make and keep books, records, and accounts, which, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of
the issuer;
(B)
devise and maintain a system of internal accounting controls sufficient
to provide reasonable assurances that . . . transactions are recorded as necessary . . .
to permit preparation of financial statements in conformity with [GAAP]. . . .
15 U.S.C. §78m(b)(2).
135.
These provisions require an issuer to employ and supervise reliable personnel, to
maintain reasonable assurances that transactions are executed as authorized, to properly record
transactions on an issuer’s books and, at reasonable intervals, to compare accounting records with
physical assets.
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136.
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The Sarbanes-Oxley Act of 2002 (“SOX”) became effective in July 2002. SOX §302
places responsibility for creating and filing accurate financial reports upon CEOs and CFOs of
public corporations by requiring that they certify that they have evaluated the Company’s internal
control structure to ensure all material information would reach them and be reported to investors
through financial statements that accurately reflected the Company’s financial performance. Section
404 of SOX requires companies to provide a detailed assessment of their internal controls to
shareholders in financial reports. Companies with revenues of more than $70 million for 2004 were
required to file their SOX §404 reports with the SEC 75 days after the end of their fiscal year.
Defendants Brooks and Schlegel repeatedly filed SOX §302 certifications throughout the Class
Period falsely attesting to the adequacy of DHB’s internal controls, when in reality the
Company’s internal controls were acutely defective. For instance, in DHB’s Form 10-Q for the
quarter ended March 31, 2004, the following certifications were attached:
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, David H. Brooks, Chairman and Chief Executive Officer of the Company, certify
that:
1.
I have reviewed this quarterly report on Form 10-Q of DHB Industries, Inc.;
2.
Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this quarterly report;
3.
Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this quarterly report;
4.
The registrant’s other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
a)
designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated subsidiaries,
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is made known to us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b)
evaluated the effectiveness of the registrant’s disclosure controls and
procedures as of a date within 90 days prior to the filing date of this quarterly report
(the “Evaluation Date”); and
c)
presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5.
The registrant’s other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent function):
a)
all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant’s ability to record, process,
summarize and report financial data and have identified for the registrant’s auditors
any material weaknesses in internal controls; and
b)
any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officer and I have indicated in this quarterly
report whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 10, 2004
*
*
*
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Dawn M. Schlegel, Chief Financial Officer of the Company, certify that:
1.
I have reviewed this quarterly report on Form 10-Q of DHB Industries, Inc.;
2.
Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this quarterly report;
3.
Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this quarterly report;
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4.
The registrant’s other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
a)
designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b)
evaluated the effectiveness of the registrant’s disclosure controls and
procedures as of a date within 90 days prior to the filing date of this quarterly report
(the “Evaluation Date”); and
c)
presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5.
The registrant’s other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent function):
a)
all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant’s ability to record, process,
summarize and report financial data and have identified for the registrant’s auditors
any material weaknesses in internal controls; and
b)
any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officer and I have indicated in this quarterly
report whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 10, 2004
*
*
*
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of DHB Industries, Inc. (the
“Company”) on Form 10-Q for the period ended March 31, 2004 as filed with the
Securities and Exchange Commission on the date hereof (the “Report”), I, David H.
Brooks, Chairman and Chief Executive Officer of the Company, certify, pursuant to
18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002,
that:
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(1)
The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2)
The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Dated: May 10, 2004
By: /s/ DAVID H. BROOKS
____________________________________
David H. Brooks
Chairman and Chief Executive Officer
This certification accompanies this Report on Form 10-Q pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by
such Act, be deemed filed by the Company for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended.
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of DHB Industries, Inc. (the
“Company”) on Form 10-Q for the period ended March 31, 2004 as filed with the
Securities and Exchange Commission on the date hereof (the “Report”), I, Dawn M.
Schlegel, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C.
§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:
(1)
The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2)
The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Dated: May 10, 2004
By: /s/ DAWN M. SCHLEGEL
_________________________________
Dawn M. Schlegel
Chief Financial Officer
137.
Defendants Brooks and Schlegel issued similar certifications in subsequent 2004 and
2005 Forms 10-Qs and the Company’s 2004 Form 10-K.
138.
Meanwhile, throughout the Class Period defendants had caused DHB to violate
provisions of SOX and §13(b)(2)(a) of the 1934 Act by failing to maintain accurate records
necessary to accurately present its financial results or to reliably report inventory and contingent
losses. Based upon their access to and/or review of the Company’s accounting and internal controls
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concerning its sales and related matters, each of the defendants was aware that there were serious
deficiencies in multiple areas of the Company’s internal controls, including: (i) data entry; (ii)
expense classification; (iii) financial closing processing; (iv) fixed asset processing; and (v)
inventory processing. In fact, despite knowing the true state of the Company’s unreliable
recordkeeping and defective internal controls, defendants regularly filed financial statements and
issued releases throughout the Class Period that concealed the deficiencies in DHB’s internal
accounting controls.
139.
DHB had previously had problems with internal controls, identified by its former
auditors, Grant Thornton, who considered there to be certain deficiencies in DHB’s internal control
procedures that would be deemed to be a material weakness under standards established by the
American Institute of Certified Public Accountants. In the Company’s 2004 Form 10-K, DHB
represented it had rectified these problems.
140.
As described herein, on August 30, 2005, the market would be shocked to learn in
connection with DHB’s announcement of a huge $60 million charge that while the market was
intensely focused on the Company’s reported financial results, its internal control system, which
defendants Brooks and Schlegel had purportedly designed and evaluated “to ensure that material
information relating to the [Company would be] made known” to them and the market, was in fact
defective.
141.
DHB’s new auditors, Weiser, resigned after identifying more internal control
deficiencies. In May 2005, Weiser reported that:
We have identified the following two material weaknesses that have not been
identified as material weaknesses in management’s assessment:
x
The Company transmitted its annual report on Form 10-K for the year ended
December 31, 2004 for filing via EDGAR with the Securities and Exchange
Commission having been informed by representatives of Weiser LLP, its auditors,
that it had not completed its final review of the last revisions to the Form 10-K and
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accordingly had not yet released its audit report for filing. Despite Weiser’s call, the
2004 Form 10-K was forwarded to the SEC for filing. Subsequently the Company
amended the Form 10-K by filing a Form 10-K/A to include revisions to its financial
statements and certain other changes. Such revisions were to amend certain financial
information including the Note Payable-Bank on the consolidated balance sheet, and
the related footnote, Note 6-Note Payable-Bank, as well as the discussion of the Note
Payable-Bank in Liquidity and Capital Resources, Note 2 Supplemental Cash Flow
Information, Note 9 Stockholders’ Equity, and to correct the omission of the 2004
amount on the line titled “Accounts receivable” under the caption “Cash Flows from
Operating Activities” in the Consolidated Statement of Cash Flows.
x
The conduct of the audit committee did not demonstrate its understanding of
its oversight role of the Company’s external financial reporting and internal control
over financial reporting processes.
These material weaknesses were considered in determining the nature,
timing, and extent of audit tests applied in our audit of the 2004 financial statements,
and this report does not affect our report dated March 6, 2005 (except for Note 6, as
to which the date is March 15, 2005) on those financial statements.
In our opinion, because of the effect of the two material weaknesses
described above on the achievement of the objectives of the control criteria which
were not addressed in management’s assessment, although we believe that
management’s assessment that DHB Industries, Inc. and Subsidiaries did not
maintain effective internal control over financial reporting as of December 31, 2004
is correct, we believe it is not fairly stated, in all material respects, based on criteria
established in Internal Control – Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in that it failed to
cite such two material weaknesses. Also, in our opinion, because of the effect of the
material weaknesses described above on the achievement of the objectives of the
control criteria, and the significant deficiencies in the Company’s systems of
inventory valuation addressed in Management Report On Internal Control Over
Financial Reporting and determined by management to be a material weakness, DHB
Industries, Inc. and Subsidiaries has not maintained effective internal control over
financial reporting as of December 31, 2004, based on criteria established in Internal
Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
142.
Also, in a Form 8-K filed on April 15, 2005, DHB admitted that as of December 31,
2004, there existed certain significant deficiencies in the Company’s systems of inventory valuation
rendering it inadequate to accurately capture cost of materials and labor components of certain work
in progress and finished goods inventory. Accordingly, DHB management determined this control
deficiency constituted a material weakness and therefore the Company did not maintain effective
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internal controls over financial reporting as of December 31, 2004. Yet DHB’s insiders lied in
telling investors these weaknesses had been corrected, when in fact they had not been.
ADDITIONAL SCIENTER AND SCHEME ALLEGATIONS
143.
During the Class Period, the defendants pursued a scheme to defraud, concealing or
recklessly disregarding that DHB was suffering from serious business and operational problems,
including performance defaults and quality control and production problems for its body armor
products and widespread use and stockpiling of Zylon, a defective material. In order to cover up and
conceal these problems, DHB’s top officers engaged in a series of accounting manipulations and
falsifications and other misrepresentations as part of a scheme to inflate the price of DHB’s stock so
they could insider trade and personally profit at the expense of public investors.
144.
In this case, all of the Individual Defendants were in direct control of both DHB’s
accounting policies and practices and the content of its reports to investors regarding DHB’s
business and financial performance. They prepared, approved and/or signed the Company’s
financial statements and related disclosures, its filings with the SEC and its press releases. Brooks,
Schlegel and Hatfield also prepared and/or made statements to investors and analysts in
conversations, conference calls and meetings. This case is unusual in that DHB is a small company,
such that each of the Individual Defendants would have special knowledge regarding both DHB’s
accounting practices and internal financial and accounting controls – matters central to the alleged
fraud in this case, especially after the enactment of SOX with its enhanced control and disclosure
requirements which are the responsibility of top corporate officers and directors.
145.
The Individual Defendants, the three top officers of the Company (including the
Chairman and CEO’s wife and the entities they jointly controlled) and the three members of the
Company’s Audit Committee had unlimited access to the Company’s accounting systems and
controls, as well as its business and financial books and records, had detailed knowledge of the
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Company’s actual business performance, financial condition and results and prospects. Thus, these
Individual Defendants had access to adverse undisclosed information about the actual status of
DHB’s Zylon raw material inventories, sale of Zylon vests and DHB’s U.S. military Interceptor vest
contracts, and knew that the operating, income, EPS and shareholders’ equity of the Company under
GAAP and principles of fair presentation were much less than being publicly reported. The
Individual Defendants knew (or recklessly disregarded) that these adverse facts rendered the
omissions and affirmative representations that they each made, prepared, signed and/or approved
materially false and misleading, and in violation of GAAP and the federal securities laws, as
particularized in this Complaint. By virtue of their positions and authority in the Company, as
described above, the Individual Defendants’ knowing or reckless disregard of these omissions and
affirmative misrepresentations is attributable to defendant DHB.
146.
The named defendants were, during the Class Period, CEO/Chairman, COO and
CFO/Principal Accounting Officer of the Company, as well as members of the Company’s Audit
Committee. These Individual Defendants, as the top officers of DHB, as well as members of the
Company’s Audit Committee, were charged with overseeing and managing DHB’s business
operations, overseeing its system of internal accounting and financial controls, correctly accounting
for its business operations and assuring the accuracy of its SEC filings and other disclosures to
investors. There individuals managed, operated and oversaw DHB’s business as a very close-knit
team, the officers communicating and/or meeting with each other on virtually a daily basis to focus
on the major problems facing DHB’s business – the very items which allegedly were not disclosed –
and attempting to manage and solve them.
147.
Accounting manipulations of the type allegedly engaged in here, i.e., unaccrued
liabilities associated with DHB’s key products and over-valued inventories, could not have happened
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without, and in fact did happened with, the acquiescence and knowledge of these top officers.
Indeed, at one point or another during the Class Period, Brooks, Schlegel, Hatfield, Krantz and
Nadelman signed representations in DHB’s annual reports and quarterly reports accepting
responsibility for the accuracy of DHB’s financial statements and the adequacy of its internal
controls, including reviewing and approving and signing most, if not all, of DHB’s SEC filings.
Brooks also possesses significant knowledge of accounting rules and principles, having earned a
Bachelor of Science degree from New York University in accounting.
148.
DHB is and always has been a small and tightly managed company. David H. Brooks
founded the Company, naming it after his own initials. DHB has never reported more than $90.2
million in net sales in any quarter and the Company’s total reported “record” net income in 2004 was
only $30.44 million. DHB has reported total net income over the previous five years of only $76.7
million and lost $32 million in the prior year. Total shareholders’ equity during the Class Period was
never reported by the Company to be more than $92.8 million and was $77.03 million at the end of
the 4thQ 04. On November 19, 2004, Brooks owned 37% of the only 40,922,416 outstanding shares
and no other investor owned even 1%. Each of the directors who comprise the Audit and
Compensation Committees – defendants Krantz, Nadelman and Chasin – have been employees
and/or directors of the Company since at least 2001. COO Hatfield was President of Point Blank
Body Armor from 1996-2000, becoming COO of DHB in 2000. Defendant Schlegel has been CFO
of DHB since 1999 when she was promoted to CFO from accounting manager. Schlegel has been a
member of the Board since 2000. Schlegel is also involved in Terry Brooks’ Tactical Armor
Products, Inc., which, as explained at ¶31(c) is nothing more than a mechanism by which the
Brooks’ steal money from DHB investors to fund their own personal pursuits, including harness
racing and equine interests.
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David and Terry Brooks have orchestrated a long-running scheme dating at least to
2000, in which Schlegel, Hatfield, Krantz, Nadelman, Berkman and Chasin have participated and
profited from, to use DHB to improperly enrich themselves and their immediate family at the
expense of DHB’s public investors.
(a)
Through DHB’s purchase of “hard armor overweight Small Arms Protective
Inserts, or SAPIs” from Tactical Armor Products, Inc. (“TAP”), David and Terry Brooks have
siphoned tens of millions of dollars from DHB for their own personal benefit. In February 1998,
Brooks made a personal loan to DHB which carried a 12% annual interest rate to finance the
purchase of Lanxide Armor Products (“LAP”), which was a producer of hard armor plates of the
type now produced for DHB by TAP. DHB was bullish about its acquisition of LAP, stating that it
was “a tailor made fit for DHB,” because “simply stated, there are no other companies so vertically
integrated.” In March 1999, DHB said that hard armor “plates are becoming more integral with the
supply of concealable body armor.” DHB continued to extol the benefits of LAP to DHB and the
subsidiary’s potential throughout spring 1999, stating, for example, that LAP allowed DHB to “offer
tangible performance and price advantages on a wide range of hard armor applications.” Despite
LAP’s apparent rosy prospects and benefit to DHB, the Company suddenly shuttered LAP’s New
Jersey operations and divested itself of certain of LAP’s assets in October 1999. DHB then shifted
LAP’s equipment and machinery to its Jacksboro, Tennessee facility. Just a few months later, in
April 2000, Terry Brooks (owner and President) formed TAP “for the purpose of manufacturing
ceramic plates and shields” for body armor. Unknown to investors, Jeffrey Brooks is Director and
Secretary and Dawn Schlegel is TAP’s “Point of Contact” in the government’s Central Contractor
Registry. Moreover, TAP operates entirely out of DHB’s Jacksboro, Tennessee facility. DHB has
never properly disclosed the involvement of Jeffrey Brooks and Dawn Schlegel in TAP and
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concealed TAP’s existence after the Company shutdown LAP by failing to report any of the millions
of dollars DHB was paying to TAP until compelled to do so in 2003 by an SEC investigation. DHB
has still never disclosed that DHB employees are also on the payroll of TAP. Also unknown to
investors, TAP has no customers other than DHB and has never performed any work on any
government contract other than as a subcontractor on DHB’s military contracts. TAP’s addresses are
also DHB addresses, further indication that the two Company’s are not actually separate entities:
x
179 Mine Land, Jacksboro, TN is the location at which both PACA (a DHB
subsidiary) and TAP conduct operations. TAP has no other manufacturing
operations.
x
400 Post Ave., Suite 303, Westbury, NY is the mailing address for TAP and DHB.
x
555 Westbury Ave., Carle Place, NY is the former mailing address for TAP and
DHB.
x
P.O. Box 269, Old Westbury, NY 11568 is the federal government’s Central
Contractor Registry address for TAP; DHB frequently uses the address as its contact
address in advertisements.
In 2004, DHB sold untreated ceramic cores used to make SAPIs to TAP at cost ($6.6 million) and
then purchased SAPIs manufactured by TAP in DHB’s Jacksboro facility with former DHB assets
for $17.6 million, delivering a profit to TAP and cash to the Brooks family. DHB paid Terry and
Jeffrey Brooks’ company $29,243,000 in 2003 and more than $54 million total between 20022004. Total annual payments by DHB to TAP have constituted as much as 13% of DHB’s total
revenue. TAP is nothing more than a reconstituted DHB subsidiary used by the Brooks’ to siphon
money from the Company. The Brooks’ have used TAP to fund their own pursuits, including
equine interests and harness racing out of DHB’s corporate coffers.
(b)
The Compensation Committee (defendants Chasin, Nadelman and Krantz)
approved a “fair rental value payment of $25,000 per month for the cost of renting Mr. Brooks’s
Florida residence.” The residence in question is a 4,947 sq. ft. beachfront condominium at the
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Presidential Palace Condominiums located within the Boca Raton Resort and Club. Unknown to
investors because DHB disclosed only that it made payments to a Brooks “affiliate,” the Florida
residence is owned by Vianel Industries, Inc., a company controlled by Jeffery Brooks. Also
unknown to investors, the President of the Presidential Palace Condominium Association gave its
approval in October 2005 for “David Brooks, Vianel Industries, Inc.” to acquire title to the unit.
Jeffrey Brooks lives in another condominium in the 42-unit oceanfront complex.
(c)
In 2002 and 2003, DHB contracted “stitching work” to U.S. Manufacturing
Corporation, another company wholly-owned by Terry Brooks. In total, DHB paid Terry Brooks’
company more than $600,000 in 2002 and 2003. DHB first disclosed the 2002 and 2003 payments
on March 17, 2005 as part of the fiscal year 2004 10-K. Terry Brooks has since merged U.S.
Manufacturing Corporation into TAP.
(d)
Brooks utilizes a corporate jet owned by one of the Brooks’ minor children for
business and personal travel. DHB purportedly pays rates equivalent to comparable charter flights,
as determined by the Compensation Committee (defendants Chasin, Nadelman and Krantz), to an
entity controlled by the Brooks when David Brooks uses the plane for DHB business. In 2004, DHB
paid $696,000 to “non-affiliated third-party vendors for pilot pay, fuel, and plane maintenance”
purportedly associated with DHB business travel, and paid $161,000 to the Brooks as compensation
for mere use of the plane. In total, Brooks, through his minor children, received more than $850,000
in 2004 alone from DHB to pay for what is in effect his own plane. Brooks, for example, used the
plane to fly superstar musicians to his daughter’s $10 million bat mitzvah. According to the Federal
Aviation Administration, the registered owner of the plane is RSJ Industries LLC. RSJ Industries,
Inc. is a Florida company controlled by David and Terry Brooks, who are its Directors. RSJ
Industries, Inc. is registered to the beachfront condominium purportedly rented by DHB for
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Brooks as a business expense related to his business travel to Florida and title to which was
recently transferred to David Brooks.
(e)
In 2003, Brooks charged $322,000 of personal expenses to DHB credit cards.
Brooks never repaid the money. Instead, DHB determined that it failed to adequately reimburse
Brooks for corporate use of a residence and business use of his minor children’s plane, expenses
which totaled $721,000. Despite Brooks having seemingly been short-changed nearly $400,000 by
DHB, Brooks waived his rights to collect. DHB determined in 2004 that another $2 million in
Brooks personal expenses charged to DHB credit cards was offset by $2.7 million owed by DHB to
Brooks for unpaid expenses incurred by Brooks from 1997-2003. Again, Brooks forewent collection
of the additional $700,000.
(f)
Brooks’ total 2004 compensation, including options exercised as part of his
$186 million stock sale, was $73.3 million. In total, DHB paid approximately $23 million to the
Brooks family (David, Terry, their children and Jeffrey) in salary, bonuses, other compensation and
payments and forgave another $2 million in personal credit card debt in 2004. Thus, DHB paid the
Brooks family more than $93 million in 2004. DHB’s “record” total net income in 2004 was
$30.44 million. DHB’s total reported net income 2002-2004 is less than $70 million.
(g)
Until June 30, 2004, DHB’s Point Blank subsidiary leased its office and
manufacturing space in Oakland Park, Florida from V.A.E. Enterprises LLC (“VAE”). VAE is
controlled by Terry Brooks and beneficially owned by the Brooks’ children. DHB paid total base
rent under the lease to Brooks’ children in excess of $1.2 million in 2002 and 2003. DHB first
leased property in Oakland Park, Florida from V.A.E. Enterprises beginning in 1995.
(h)
DHB borrowed millions of dollars from Brooks throughout the Company’s
corporate history at above-market interest rates as high as 12%. DHB improperly failed to report
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interest paid to Brooks on the loans until required to do so as a result of an ongoing SEC
investigation into the Company.
(i)
David and Terry Brooks and Jeffrey Brooks own or control at least thirty-
eight separate entities registered with Secretaries of State in Delaware, Florida, Nevada, New York
and Tennessee. As detailed above and elsewhere herein, several of the Brooks family’s companies
(e.g., Tactical Armor Products, Inc., U.S. Manufacturing Corp., Vianel Industries, Inc. RSJ
Industries LLC, V.A.E. Enterprises, and defendants Andrew Brooks Industries, Inc., Elizabeth
Brooks Industries, Inc. and David Brooks International, Inc.) are known to conduct business with
DHB, although the full extent of the benefits the Brooks’ receive from DHB are not fully disclosed
or fully knowable without the benefit of discovery.
(j)
David Brooks’ personal office at DHB’s corporate headquarters on Long
Island (a small office at which nothing is manufactured or produced) contains a 60” plasma
television, an electronic closet housing additional electronic equipment, six 150-watt floodlights, and
six to eight 20” flat screen monitors adjacent to even more electronic equipment.
150.
During the Class Period, DHB’s officers and directors, and in particular Brooks,
including by and through Terry Brooks and the Brooks entities, willfully violated DHB’s Code of
Business Conduct & Ethics, including, in particular, the following provisions:
1.
Compliance with Laws, Rules and Regulations
Obeying the law, both in letter and in spirit, is the foundation on which the
Company’s ethical standards are built. All employees must respect and obey the
laws of the cities, states, and countries in which the Company operates. . . .
*
*
*
As a publicly held company, we are subject to significant regulation under the federal
securities laws. Again, an example is our obligation to timely and accurately file all
reports that we are required to file with the Commission, including the accurate filing
of required financial information.
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Our products must meet legal and industry-mandated standards and specifications,
which are designed to promote the effectiveness of our products for various uses.
The Company expects all of its employees to comply with Company practices and
procedures, which are intended to foster compliance with legal and industry
standards.
*
2.
*
*
Financial Information and Dealings with External Auditors
The honest and accurate recording and reporting of financial information is of critical
importance to the Company. This is not only essential in order for senior
management to make informed responsible business decisions, but is also essential to
the Company’s ability to file accurate financial reports with the Securities and
Exchange Commission; to enable the Company to comply with various laws relating
to the maintenance of books and records and financial reporting; to enable the Chief
Executive Officer and Chief Financial Officer of the Company to make their
necessary certifications in connection with the periodic filing by the Company of
financial information; and to inform the stockholders of the Company and the
investing public of accurate financial information of the Company.
No employee shall falsify the books and records of the Company or otherwise
knowingly circumvent or fail to implement the internal accounting controls of the
Company as they now exist or as they may be modified, revised, amended or
supplemented.
The external auditors of the Company play an integral role in the financial reporting
process through their annual examination and report on the Company’s financial
statements and their review of periodic reports of the Company. Open and honest
fair dealings with our external auditors is therefore essential. No employee of the
Company, whether an officer, director or part of the Company’s accounting
department, shall make any false or misleading statement to any external auditor of
the Company in connection with an audit or examination of the financial statements
of the Company or the preparation or filing of any document or report. Similarly, no
employee of the Company shall engage in any conduct to fraudulently influence,
coerce, manipulate or mislead any accountant engaged in the audit or review of any
financial statements of the Company.
3.
Conflicts of Interest
A “conflict of interest” exists when an individual’s private interest interferes in any
way or even appears to conflict with the interests of the Company as a whole. A
conflict situation can arise when an employee, officer or director takes actions or has
interests that may make it difficult to perform his or her work on behalf of the
Company in an objective and effective manner. Conflicts of interest may also arise
when an employee, officer or director, or a member of his or her family, receives
improper personal benefits as a result of his or her position in the Company. Loans
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by the Company to, or guarantees by the Company of obligations of, employees
and/or their family members may create conflicts of interest.
It is almost always a conflict on interest for a Company employee to work
simultaneously for a competitor, customer or supplier. An employee is not allowed
to work for a competitor as a consultant or board member. The best policy is to
avoid any direct or indirect business connection with the Company’s customers,
suppliers or competitors, except on the Company’s behalf.
*
4.
*
*
Insider Trading
Employees who have access to confidential information are not permitted to use or
share that information for stock trading purposes or for any other purpose except the
conduct of the Company’s business. All non-public information about the Company
should be considered confidential information. To use non-public information for
personal financial benefit or to “tip” others who might make an investment decision
on the basis of this information is not only unethical but also illegal. . . .
*
6.
*
*
*
*
Competition and Fair Dealing
*
To maintain the Company’s valuable reputation, compliance with the Company’s
quality processes and safety requirements is essential. In the context of ethics,
quality requires that the Company’s products and services meet reasonable customer
expectations. All inspection and testing documents must be handled in accordance
with all applicable regulations.
*
9.
*
*
Record-Keeping
All of the Company’s books, records, accounts and financial statements must be
maintained in reasonable detail, must appropriately reflect the Company’s
transactions, and must conform both to applicable legal requirements and to the
Company’s system of internal controls. Unrecorded or “off the books” funds or
assets should not be maintained unless permitted by applicable law or regulation.
*
11.
*
*
Protection and Proper Use of Company Assets
All employees, officers and directors should endeavor to protect the Company’s
assets and ensure their efficient use. Theft, carelessness and waste have a direct
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impact on the Company’s profitability. Any suspected incident of fraud or theft
should be immediately reported for investigation. Company assets should be used
for legitimate business purposes and should not be for non-Company business,
though incidental personal use may be permitted.
151.
The Sarbanes-Oxley Act requires that audit committees:
x
be independent and not be affiliated personnel of the company;
x
be directly responsible for appointment, compensation and oversight of
auditors;
x
establish procedures to address complaints about accounting, internal control
and auditing. Defendants Krantz, Nadelman and Chasin comprised DHB’s
Audit Committee during the Class Period.
DHB’s Insiders’ Long-Standing Knowledge of
Problems with Zylon and its Interceptor Program
152.
As explained in detail elsewhere herein (e.g. ¶¶37-45), DHB insiders had long-
standing knowledge of problems with Zylon. Zylon vests produced for domestic law enforcement
agencies were a large product line – eight of Point Blank’s 15 models of vest produced for domestic
law enforcement agencies contained Zylon and PACA also produced vests containing Zylon. The
Company’s widespread use and stockpiling of Zylon created the largest loss – $60 million – in the
Company’s history. If the top officers of the Company do not know about a problem of that
magnitude, since they are charged with the responsibility of attempting to solve it, then they are
grossly reckless and have absolutely no business making any public representations regarding the
state of performance of that line of business, its financial impact on DHB or the Company’s financial
results.
153.
The defects in DHB’s Interceptor vests and DHB’s knowledge of the problems with
the Interceptor vest program and contracts are set forth in The Marine Corps Times article and
internal government memorandum, attached hereto as Exhs. A and B, respectively, and explained in
detail elsewhere herein (e.g. ¶¶99-101). Undertaking the Company’s large U.S. military contracts,
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which involved the Company’s most important product – the Interceptor vest – simply could not
occur without the intimate involvement of the very top executives and financial officials and
directors of the Company. The performance of such contacts is something that is attended to directly
by the top officers of the Company, as they know analysts and investors will demand to know the
status of the contract efforts and whether they are succeeding. Since the Interceptor vest program
and contracts were plagued with major product failures, it is not possible that the COO, CEO and
CFO of the Company did not know of problems involving the most important contracts for DHB.
Indeed, COO Hatfield privately acknowledged the existence of “major” defects at DHB when she
signed a government waiver on November 30, 2004. The waiver stated that DHB would continue to
take “any and all steps to strive for meeting or exceeding the desired requirements.” DHB officers
signed numerous such waivers privately acknowledging such major defects throughout 2004.
154.
At bottom, the method of accounting for Zylon inventories, the performance of
DHB’s Interceptor vests sold to the U.S. military and the performance of the most important
contracts in DHB history are simply not matters relegated to lower-level managers – these are the
very matters which the top executives of the Company are involved in on a day-to-day basis and
with which they must be intimately familiar. And, if they are not, then there is absolutely no factual
basis for the affirmative and positive representations they chose to make about the success of DHB’s
business and their strong contribution to DHB’s reported net income/EPS.
155.
In addition to their top executive and directorial positions, which perforce required
their intimate involvement in the matters central to this suit, the insider trading by the Individual
Defendants is indicative of their knowledge of the problems alleged herein. The timing and
magnitude of these sales is highly supportive of an inference of knowledge on the part of DHB’s top
insiders of the adverse conditions and problems existing insider DHB and the accounting
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manipulations and false statements engaged in to conceal them. As the graphs and tables presented
at ¶¶23-24, 31(a)-(g), 157 demonstrate, these sales were unusual in timing and amount, both
individually and in the aggregate. DHB’s top executives sold, either zero or a relatively small
number of shares prior to the beginning of the Class Period. Yet, during the Class Period, as their
affirmative misrepresentations pushed DHB’s stock higher, they unloaded millions of shares of
stock. And defendants were remarkably clever and effective in timing their sales. All of
defendants’ sales occurred at market peak prices during the Class Period, including selling
millions of shares on the precise day on which DHB stock reached its all-time high share price.
When the stock was most highly inflated during the Class Period, they sold. Their market trading
was clearly designed to maximize their personal profits. If, in fact, DHB’s insiders believed what
they were saying about the current period success and future anticipated success of DHB’s stock,
they would have had no reason to sell the majority of their holdings. If defendants’ public
statements and representations were true, their shares would have been even more valuable as
DHB’s forecasted future successes came to fruition. Thus, their sales were completely inconsistent
with defendants’ public statements and representations about DHB’s business and completely
consistent with and supportive of the allegations made herein of their knowledge of the adverse
conditions and problems inside DHB’s business and the accounting manipulations they were
engaging in to cover them up.
DHB EXECUTIVES’ INSIDER TRADING,
SALARIES AND BONUSES
156.
During the Class Period, defendants had both the motive and opportunity to commit
fraud. While defendants were issuing the fraudulent statements identified herein about DHB’s
financial results and business, DHB’s top insiders took advantage of their knowledge of material
non-public negative information concerning DHB’s business, financials and future prospects by the
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selling of 10.2 million shares of their DHB stock for $201.3 million in illegal insider trading
proceeds. Accordingly, defendants personally profited from the artificial inflation in DHB’s stock
price which their fraudulent scheme created, notwithstanding their duties as officers and directors of
the Company to disclose adverse material facts before trading in DHB stock. Defendants were
remarkably successful in timing their trades. The average price for DHB stock in the 90 days after
defendants’ fraud was fully revealed – August 30, 2005 through November 30, 2005 – was only
$3.86 per share. In contrast, defendants dumped millions of shares at prices as high as $20.94
(including selling millions of shares on the day DHB stock reached its all-time high share price) in
late 2004, and no defendant sold shares during the Class Period at any price lower than $18.60 per
share. The weighted average share price of the Individual Defendants’ Class Period sales is $19.57,
more than 400% greater than the price of DHB stock in the 90-day period after their fraud was fully
revealed. Incredibly, DHB’s market capitalization on August 30, 2005 was only $231 million –
defendants’ insider trading proceeds just eight months earlier totaled $201 million! Both the
timing and volume of defendants’ Class Period sales are highly suspicious.
157.
Defendants’ Class Period sales are set forth below:
Defendant
Berkman
Brooks
Transaction
Date
Shares
Sold
Price
11/29/2004
11/30/2004
Total:
32,120
12,500
44,620
$19.61
$18.79
11/29/2004
12/22/2004
12/23/2004
12/27/2004
12/28/2004
12/29/2004
Total:
3,700,000
400,000
84,100
2,538,744
858,267
1,916,914
9,498,025
$18.90
$18.60
$20.06
$20.94
$19.88
$19.10
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Proceeds
$
$
$
% of Shares
Actually
Owned Sold
629,873
234,875
864,748
29.4%
$ 69,930,000
$ 7,440,000
$ 1,687,046
$ 53,161,299
$ 17,062,348
$ 36,613,057
$185,893,751
59.7%
Case 2:05-cv-04296-JS-ETB
Defendant
Chasin
Transaction
Date
11/29/2004
11/30/2004
Hatfield
Krantz
Nadelman
Schlegel
Shares
Sold
Filed 03/20/2006
Price
46,496
62,000
108,496
$19.61
$18.57
11/29/2004
12/28/2004
12/29/2004
Total:
180,119
24,426
65,000
269,545
$19.61
$19.76
$19.65
11/29/2004
11/30/2004
Total:
85,176
31,050
116,226
$19.61
$18.72
11/29/2004
Total:
102,374
102,374
$19.61
11/29/2004
149,503
149,503
$19.61
TOTALS:
158.
Document 80-1
10,288,789
Proceeds
Page 138 of 162
% of Shares
Actually
Owned Sold
$
911,787
$ 1,151,340
$ 2,063,127
100.0%
$ 3,532,134
$
482,658
$ 1,277,250
$ 5,292,041
100.0%
$ 1,670,301
$
581,256
$ 2,251,557
89.0%
$ 2,007,554
$ 2,007,554
58.7%
$ 2,931,754
$ 2,931,754
84.2%
$201,304,532
The 2003-2004 salaries and “other compensation” of DHB’s top executives are set
forth below:
Name
2003
2004
Total
Brooks
Salary
Bonus
$ 625,000
$1,000,000
$ 675,000
$2,000,000
$1,300,000
$3,000,000
Hatfield
Salary
Bonus
$ 163,068
$ 695,000
$ 225,385
$ 750,000
$ 388,453
$1,445,000
Schlegel
Salary
Bonus
$ 140,625
$ 100,000
$ 200,000
$ 500,000
$ 340,625
$ 600,000
TOTALS:
$2,723,693
$4,350,385
$7,074,078
Brooks’ total 2004 direct compensation, including options exercised as part of his $186 million stock
sale, was $73.3 million. In addition, DHB paid approximately $23 million to the Brooks family
(David, Terry, their children and Jeffrey) in bonuses, indirect and other compensation and payments,
and forgave another $2 million in personal credit card debt. DHB’s total reported net income in
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2004 was $30.44 million and its gross profits before expenses was only $95 million. Thus, Brooks’
immediate family received compensation and other payments from DHB in 2004 totaling more than
three times the Company’s 2004 net income and greater than DHB’s gross profits. Brooks’ salary
in 2004 was only $675,000 – his total 2004 insider trading proceeds ($185,893,751) and bonus
compensation ($2,000,000) was therefore 278 times his salary! Adding in the additional $23 million
DHB paid to the Brooks family and the $2 million in debt forgiven by the Company, their total
compensation from DHB in 2004 rises to 315 times Brooks’ salary. Even the simple value of
Brooks’ 2004 options exercised ($73,300,000) and bonus compensation ($2,000,000) was 112 times
his salary. The total of the other officer-defendants’ trading and bonus compensation also dwarfs
their 2004 salary. Hatfield’s 2004 salary was $388,453 but she collected $6,737,041 in total
($5,292,041 in insider trading proceeds and $1,445,000 in bonus compensation) – 17 times her
salary. Schlegel’s 2004 salary was $340,625, but she collected $3,531,754 total ($2,931,754 in
insider trading proceeds and $600,000 in bonus compensation) – 10 times her salary.
DEFENDANTS’ FALSE AND MISLEADING PROXY
159.
Pursuant to a Definitive Schedule 14A Proxy Statement (the “April Proxy”) issued
under §14(a) of the 1934 Act, dated April 15, 2005 and filed with the SEC on or about April 18,
2005, as amended or supplemented on June 24, 2005, DHB and defendants presented two proposals
(in addition to the appointment of Rachlin Cohen and Holtz LLP as independent auditors for 2005)
for its May 6, 2005 annual meeting of stockholders on which DHB sought its shareholders’ votes
and approval:
(a) Proposal 1: Election of Directors: “ Seven (7) directors will be elected at the
Annual Meeting to serve for terms of approximately one year expiring on the date of
the Annual Meeting in 2006. Each of our directors is elected annually and holds
office until the next annual meeting of stockholders and until his or her successors is
duly elected. . . . All seven (7) nominees are currently directors. Each individual
nominated for election as a director has agreed to serve if elected. . . . Our Board of
Directors has no reason to believe that any of the persons listed as nominees will be
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unable or unwilling to serve. Our Board of Directors has affirmatively determined
that each nominee for the Board of Directors, other than Mr. Brooks and Mrs.
Schlegel, does not have a material relationship with DHB that would interfere with
the exercise of independent judgment and is “independent” under Section 121(A) of
the listing standards of the American Stock Exchange. Our Board of Directors
recommends a huge stockholder vote “FOR” each of the Board of Directors
nominees.”
(b) Proposal 3: The Proposed 2005 Omnibus Equity Incentive Plan: “[W]e have
previously granted options or warrants for substantially all of the shares available
under the 1995 Stock Option Plan, and thus the Board of Directors has adopted a
2005 Omnibus Equity Incentive Plan (the “Plan”) subject to approval by our
stockholders. . . . As indicated in the report of the Compensation Committee, we
believe that it is in our best long-term interest to incentivize employees through
equity-based compensation. . . .”
160.
The April Proxy advocated for the re-election of six of the Individual Defendants,
namely Brooks, Schlegel, Krantz, Naldeman, Chasin and Berkman and listed their qualifications and
purported related professional experience. The only other information about the directors was
contained in a copy of DHB’s 2004 Annual Report on Form 10-K/A, which was included with the
April Proxy. The proxy also reported:
Our entire Board of Directors participates in the identification and evaluation of
qualified nominees to be presented for consideration by our are stockholders and the
designation of those directors who will serve on the Audit and Compensation
Committees. . . . By Board of Directors resolution, our Board of Directors has
determined that in evaluating director candidates, the Board of Directors will
consider the appropriate size of the Board of Directors, our needs, the skills and
experience of our directors and any candidates and a candidate’s familiarity with
accounting standards and our industry. When considering current directors for
nomination for reelection, the Board of Directors considers the member’s prior
performance and contributions. Although the Board of Directors has the authority to
retain a search firm to assist it to identify director candidates, there has to date that no
need to employ a search firm.
161.
At the May 6, 2005 annual meeting of stockholders, the proposal regarding the 2005
Equity Incentive Plan was rejected by stockholders.
162.
The April Proxy was amended and supplemented by a Definitive Schedule 14A Proxy
Statement (the “June Proxy”), dated June 24, 2005 and filed with the SEC on or about June 24, 2005,
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pursuant to which DHB re-submitted the 2005 Omnibus Equity Incentive Plan (“2005 Incentive
Plan”) for approval at a Special Meeting of Stockholders on July 29, 2005, stating:
[W]e have previously granted options or warrants under the 1995 Stock Option Plan.
The 1995 Stock Option Plan will terminate by its terms on September 30, 2005. After
such date the Company will be unable to make equity incentive grants to any of its
existing employees or directors. The Company believes the equity – based
compensation is an important element in motivating and retaining employees.
Accordingly, the Board of Directors has adopted the 2005 Plan, subject to approval
by our stockholders. . . . On May 6, 2005, the Company’s stockholders rejected the
Company’s then proposed 2005 Omnibus Equity Incentive Plan (the “Rejected
Plan”). The Rejected Plan is similar to the 2005 Plan except that the 2005 Plan
provides for grants not to exceed 2,500,000 shares of Common Stock, as opposed to
the 12,000,000 shares provided for in the Rejected Plan. The Company believes that
the 2005 Plan is in our best long-term interest to incentivize and retain our employees
through equity-based compensation.
163.
The June Proxy attached a copy of the 2005 Incentive Plan and provided for the
mailing of a copy of DHB’s 2004 Annual Report on Form 10-K/A, only if requested by the
shareholder.
LOSS CAUSATION
164.
After DHB’s stock reached its all-time high share price of $22.70 on December 27,
2004, the stock declined sharply as the undisclosed truth about DHB began to enter the market. As
the magnitude of defendants’ stock sales became known to market participants via Form 4 filings
with the SEC and the filing of the class action suit by police offers first gave rise to suspicions about
potential Zylon liability, DHB’s stock price fell from $21.25 to $16.40 between November 29, 2004
and December 8, 2004, after the first period of insider selling, and from $22.70 on December 27,
2004 to as low as $13.86 on January 12, 2005, after the second period of insider selling occurred and
was disclosed to the market and the Zylon lawsuit became public. These were very large companyspecific stock declines of 23% and 39%, respectively, that were not due to general market
movements or industry factors or even company-specific negative information unrelated to the
alleged fraud. Meanwhile, the S&P index remained essentially flat.
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165.
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Massive insider stock sales like the defendants’ – far out of line with the insiders’
historic patterns of stock sales – often signify a “red flag” to the investment community that
something is amiss at a company and that insiders know adverse undisclosed information which has
not yet been made public. This was clearly the case with DHB, as defendants’ insider selling was
exacerbated by the fact that investors already had qualms concerning the integrity of Brooks and his
cohorts, and these perfectly-timed gigantic stock sales fit with – indeed reinforced – what was
already perceived as a pattern of dishonest and self-dealing conduct. Also, the Zylon lawsuit
revealed that DHB had sold some defective Zylon vests which were still in the field, contradicting
DHB’s product quality excellence and customer satisfaction statements, and indicated that DHB
could face large and as yet undisclosed warranty and product recall costs or other charges, which
would hurt its earnings. Thus, DHB’s stock fell as investors concluded that DHB’s previously
reported income and profits, assurances of product quality and customer satisfaction and forecasts of
continued profitable growth may have been false. In fact, analysts and members of the financial
media both attributed the sharp decline in DHB’s stock to the massive insider selling and exposure
of its potential liability for Zylon vests:
x
“Shares of DHB have been weak recently which we attribute to a nervous market
after a significant amount of DHB stock was sold by insiders. . . . [A] nervous
market view[ed] recent insider selling as either a sign of a bad quarter [or] a red flag
of other bad news.” Roth Capital Partners, January 7, 2005. [Emphasis added.]
x
“Analysts attributed the [stock price] decline to the large insider sales. . . . ‘[I]t is
an extraordinarily large amount of selling in a short period of time . . . [t]he
suddenness raises questions.’” “Execs get $200M in stock sale,” Newsday, January
11, 2005. [Emphasis added.]
x
“We attribute the stock’s activity to insider selling at the end of last year . . . an
indication either the quarter just completed will disappoint or the outlook for the
company has diminished. . . . A recent complaint . . . alleging . . . defective vests in
the field could weigh heavily on shares.” Roth Capital Partners, January 24, 2005.
[Emphasis added.]
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166.
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Having engaged in a massive, illegal insider bail-out, defendants sought to cover their
tracks – and thus avoid civil suits, an SEC investigation or even criminal indictment – by assuring
investors the sales were not indicative of any undisclosed adverse information about DHB. For
instance, on January 11, 2005, when Newsday published an article on the DHB insider selling,
headlined “Execs get $200M in stock sale,” Brooks tried to assure investors that defendants “‘just
wanted to diversify some of their holdings. The company continues to look forward to having a
brilliant year in 2005 and the insider selling is no reflection of the business going forward.’”
167.
Defendants also continued their fraudulent scheme by attempting to “walk” DHB’s
stock price down slowly to avoid a sudden collapse in the stock price that would attract attention,
including issuing false reassurances and concealments to cushion the impact of their partial negative
disclosures. As a result of these reassurances and the reporting of continued false financial results,
DHB’s stock continued to trade at artificially inflated prices throughout the balance of the Class
Period. As indicated above in DHB’s January 3, 2005 announcement of and subsequent disclosures
regarding the Southern States Policy Benevolent Association Zylon lawsuit and statements
downplaying the impact of the February 15, 2005 settlement of the case were misleading because the
Company’s Zylon liability would ultimately cause a huge loss. On March 16, 2005, DHB reported
its 4thQ 04 and fiscal year 2004 results – its first reporting since the massive insider stock sales.
DHB insiders suddenly, and contrary to their prior practice, refused to provide any earnings
guidance to analysts.
On the same-day conference call, DHB insiders were evasive and
contradictory concerning the sell-off. These events again called into question defendants’ prior
positive statements, financial reports and forecasts. Moreover, DHB trumpeted 4thQ 04 and fiscal
year results as “record” despite sales below guidance, flat EPS and an only slight increase in reported
net income. DHB’s stock fell precipitously again – falling from $12.30 on March 15, 2005 to $10 on
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March 17, 2005 on much higher than normal trading volume, a company-specific 19% stock price
decline not caused by general market movements or industry conditions or even company-specific
negative information unrelated to the fraud.
However, due to defendants’ continuing
misrepresentations and omissions and failure to make full disclosures, DHB’s stock price remained
artificially inflated.
168.
Analysts and the financial media continued to focus on and attribute the fall in DHB’s
stock to the insider selling, financial issues and the issues caused by the police association suit over
DHB’s Zylon vests. According to Feltl and Co., “The stock has been under heavy selling pressure
since large insider sales were reported late in the year. The selling pressure continued due, we
believe, to the absence of guidance. . . .” (April 1, 2005). [Emphasis added.] According to the
Miami Herald, the stock decline was due to “DHB no longer giving earnings guidance; significant
insider stock sales; [and] financial issues. . . . Investors often perceive huge insider sales as a sign
of trouble within a company. ‘David Brooks is a controversial guy’. . . . ‘The huge amount of
selling by him and his family just reinforced whatever concerns people have about him.’”
However, in response to these concerns, DHB’s spokesperson, Manny Rubio, assured investors there
were no undisclosed problems at DHB, saying, “Things are going fine.” (April 9, 2005). [Emphasis
added.]
169.
On April 15, 2005, DHB disclosed that the Company’s third auditor since 2002,
Weiser & Co., resigned. Weiser cited inventory pricing and Audit Committee weaknesses, calling
into question the accuracy of DHB’s Class Period financial reports. DHB’s stock declined from
$8.65 on April 14, 2004 to $6.83 on April 18, 2005, two trading days later, on much heavier-thannormal trading volume, a 20% company-specific stock price decline not due to general market
movements or industry conditions or even company-specific negative information unrelated to the
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fraud. However, DHB insiders assured analysts that despite the internal control weakness identified
by Weiser, DHB’s inventory was properly valued at $85.9 million on December 31, 2004, no
accounting adjustment or write-off was required and DHB’s Audit Committee was functioning
effectively. DHB also assured analysts that its increasing inventory levels3 were due to its deliberate
decision to “stockpile rolls of ballistic fabrics when these fabrics become available as constraints
on key inputs continue to exist.” Thus, DHB’s stock continued to trade at inflated prices.
170.
Coterminous with the May 9, 2005 Marine Times and May 10, 2005 Newsday
reporting on the massive, undisclosed problems with DHB’s Interceptor vest program, DHB reported
its 1stQ 05 results. While reporting increasing shareholders’ equity of $85 million, DHB’s sales
growth, net income and EPS all fell again and its inventories reached a record high. Analysts
commented negatively on DHB’s decline in sales compared to the 4thQ 04, its increasing
inventories and continuing refusal to provide any earnings guidance, contrary to the pre-stock
bailout practice. However, this most recent increase in inventories was due, according to DHB, to a
higher percentage of finished goods on shelves awaiting accessories to complete product assembly
and DHB continuing to stock key ballistic fabrics which were in short supply, when these materials
were available. On August 8, 2005, DHB reported disappointing 2ndQ 05 results, including
declining net income and flat EPS. DHB’s stock fell from $8.66 to $6.92, a company-specific stock
decline of 20%, not due to general market movements or industry conditions, or even companyspecific negative information unrelated to the fraud. DHB made no mention of any potential adverse
3
DHB’s reported inventories increased during the Class Period, as shown below:
2003
4th Q
Inventories $54,753
1st Q
$62,817
2004
2nd Q
3rd Q
$74,342
$81,970
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4th Q
$85,973
2005
1st Q
$102,930
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material impact due to its use of Zylon, and in fact said that Zylon would not have a material adverse
impact on the Company disclosing its settlement of the Zylon lawsuit in February 2005. However,
due to defendants’ continuing misrepresentations and omissions and failure to make full disclosures,
DHB’s stock price remained artificially inflated.
171.
When the National Institute for Justice announced its decertification of Zylon, DHB
stock increased or remained unchanged on average trading volume. That the decertification of Zylon
had no impact on DHB’s stock price reflected the belief of market participants that the Company’s
prior statements regarding its limited use of Zylon and the nature of its inventory build-up were true.
But when DHB announced the massive $60 million write-off due to its apparently widespread use
and stockpiling of Zylon on August 30, 2005, DHB’s stock declined precipitously from $6.90 on
August 29, 2005 to $4.50 on August 31, 2005, a 34% company-specific stock decline on high
volume, not due to general market movements or industry factors or even company-specific negative
factors unrelated to the fraud. DHB’s stock never recovered from full disclosure of the massive
fraud at the Company, and traded at only $3.86 per share during the ninety day period following the
August 30, 2005 write-off. To date, DHB’s stock continues to trade at between $4-$5.
NO SAFE HARBOR
172.
The statutory safe harbor provided for forward-looking statements under certain
circumstances does not apply to any of the allegedly false statements pleaded in this complaint.
Many of the specific statements pleaded in this complaint were not identified as “forward-looking
statements” when made. To the extent there were identified forward-looking statements made, they
were not presented as specific meaningful cautionary statements identifying important factors that
could cause actual results to differ materially from those in the purportedly forward-looking
statements. The Safe Harbor warnings in DHB’s SEC filings and press releases were boilerplate and
did not materially change during the Class Period, even though the economic and business
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conditions in which DHB operated and the risk facing its business did. Alternatively, to the extent
that the statutory Safe Harbor does apply to any forward-looking statements pleaded in this
complaint, defendants are liable for those false forward-looking statements because at the time each
of those forward-looking statements was made, the particular speaker knew that the particular
forward-looking statement was false, and/or the forward-looking statement was authorized and/or
approved by an executive officer of DHB who knew that those statements were false when made.
The Safe Harbor does not apply to DHB’s financial statements.
APPLICABILITY OF PRESUMPTION OF RELIANCE:
FRAUD-ON-THE-MARKET DOCTRINE
173.
At all relevant times, the market for DHB’s securities was an efficient market for the
following reasons, among others:
(a)
DHB’s stock met the requirements for listing, and was listed and actively
traded on the AMEX, a highly efficient and automated market;
(b)
As a regulated issuer, DHB filed periodic public reports with the SEC;
(c)
DHB regularly communicated with public investors via established market
communication mechanisms, including through regular disseminations of press releases on the
national circuits of major newswire services and through wide-ranging public disclosures, such as
communications with the financial press and other similar reporting services; and
(d)
DHB was followed by numerous securities analysts who wrote reports, which
were distributed to the sales force and certain customers of their respective brokerage firms. Each of
those reports was publicly available and entered the public marketplace.
174.
As a result of the foregoing, the market for DHB securities promptly digested current
information regarding DHB from all publicly available sources and reflected such information in
DHB’s stock price. Under these circumstances, all purchasers of DHB’s securities during the Class
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Period suffered similar injury through their purchase of DHB’s securities at artificially inflated
prices and a presumption of reliance applies.
CLASS ACTION ALLEGATIONS
175.
This is a class action on behalf of purchasers of DHB publicly traded securities during
the Class Period, excluding defendants and others as described below (the “Purchaser Class”), and a
sub-class of all persons who were entitled to vote on the proxy statement filed with the SEC by DHB
dated April 15, 2005, as amended or supplemented on June 24, 2005 (“Proxy”), which proposed,
among other things, the re-election of six of the Individual Defendants and approval of the 2005
Omnibus Equity Incentive Plan, and contained numerous materially false and/or misleading
statements and material omissions concerning the merger, (the “Proxy Class”). Collectively the
Proxy Class and Purchaser Class are referred to as the “Class.” Excluded from the Class are
defendants, officers and directors of the Company, subsidiaries and affiliates of the Company, any
entity in which defendants or other excluded persons have a controlling interest, and defendants’ or
other excluded persons’ families. Class members are so numerous that joinder of them is
impracticable.
176.
Common questions of law and fact predominate and include whether defendants: (i)
violated the 1934 Act; (ii) omitted and/or misrepresented material facts; (iii) knew or recklessly
disregarded that their statements were false; and (iv) artificially inflated the price of DHB publicly
traded securities and the extent of and appropriate measure of damages.
177.
Plaintiffs’ claims are typical of those of the Class. Prosecution of individual actions
would create a risk of inconsistent adjudications. Plaintiffs will adequately protect the interests of
the Class. A class action is superior to other available methods for the fair and efficient adjudication
of this controversy.
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COUNT I
Violation of §10(b) of the 1934 Act and Rule 10b-5
Promulgated Thereunder Against All Defendants
178.
Plaintiffs repeat and reallege each and every allegation contained in ¶¶1-177.
179.
During the Class Period, defendants carried out a plan, scheme and course of conduct
which was intended to and, throughout the Class Period, did deceive the investing public, including
plaintiffs and other Class members, as alleged in this complaint and caused plaintiffs and other
members of the Class to purchase DHB stock at artificially inflated prices. In furtherance of this
unlawful scheme and course of conduct, defendants, and each of them, took the actions set forth in
this complaint.
180.
Defendants (a) employed devices, schemes, and artifices to defraud; (b) made untrue
statements of material fact and/or omitted to state material facts necessary to make the statements
made not misleading; and (c) engaged in acts, practices, and a course of business which operated as a
fraud and deceit upon the purchasers of the Company’s common stock in an effort to maintain
artificially high market prices for DHB stock in violation of §10(b) of the 1934 Act and Rule 10b-5.
All defendants are sued as primary participants in the wrongful and illegal conduct and fraudulent
scheme and course of business charged in this complaint.
181.
These defendants employed devices, schemes and artifices to defraud. While in
possession of material adverse non-public information, they engaged in acts, practices, and a scheme
as alleged herein in an effort to assure investors of DHB’s business and financial success and
prospects for continued substantial growth. This included the making of, or the participation in the
making of, untrue statements of material fact and concealing facts necessary in order to make the
statements made, in the light of the circumstances under which they were made, not misleading.
This conduct artificially inflated the price of DHB securities and operated as a fraud and deceit upon
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the purchasers of DHB securities during the Class Period, proximately causing them economic loss
and damage as, through a series of disclosures beginning in early 2005, the price misrepresentations
and other fraudulent conduct of defendants became apparent and the artificial inflation in DHB’s
stock price came out of the stock price as it collapsed to as low as $5.10 per share – a statistically
significant, company-specific stock price decline not due to general stock market movements,
changed economic conditions, changed investor expectations or company-specific negative events or
information unrelated to the alleged misrepresentations and other fraudulent conduct.
182.
The defendants had actual knowledge of the misrepresentations and omissions of
material facts set forth in this Complaint, or acted with reckless disregard of the truth in that they
failed to ascertain and to disclose such facts, even though such facts were available to them.
183.
As a result of the dissemination of the materially false and misleading information
and failure to disclose material facts, as set forth above, the market prices of DHB securities were
artificially inflated during the Class Period. Relying directly or indirectly on the false and
misleading statements made by defendants or upon the integrity of the market in DHB securities,
plaintiffs and the other members of the Class purchased DHB publicly traded securities during the
Class Period at artificially high prices and were damaged thereby.
184.
At the time of defendants’ misrepresentations and omissions, plaintiffs and other
members of the Class were ignorant of their falsity. Had plaintiffs and the other members of the
Class and the market known the truth which was not disclosed by defendants, plaintiffs and other
members of the Class would not have purchased their DHB securities, or, if they had acquired such
securities during the Class Period, they would not have done so at the artificially inflated prices
which they paid.
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185.
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As a direct and proximate result of defendants’ wrongful conduct, plaintiffs and the
other members of the Class suffered damages in connection with their respective purchases and sales
of the Company’s publicly traded securities during the Class Period.
COUNT II
Violation of §20(a) of the 1934 Act
Against Defendants DHB, Brooks, Hatfield, Schlegel,
Chasin, Krantz, Nadelman and Berkman
186.
Plaintiffs repeat and reallege each and every allegation contained in ¶¶1-185.
187.
Individual Defendants Brooks, Hatfield, Schlegel, Chasin, Krantz, Nadelman and
Berkman, acted as controlling persons of DHB within the meaning of §20(a) of the 1934 Act as
alleged in this complaint. By virtue of their high-level executive positions and/or seat on the Board
of Directors, and their ownership and contractual rights, participation in and/or awareness of the
Company’s operations, accounting policies and methods, and/or intimate knowledge of the false
financial statements filed by the Company with the SEC and disseminated to the investing public,
these defendants had the power to influence and control and did influence and control, directly or
indirectly, the decision-making of the Company, including the content and dissemination of the
various statements which plaintiffs contend are false and misleading. These defendants were
provided with or had unlimited access to copies of the Company’s reports, press releases, public
filings and other statements alleged by plaintiffs to be misleading prior to and/or shortly after these
statements were issued and had the ability to prevent the issuance of the statements or cause the
statements to be corrected.
188.
In particular, the defendants named herein had direct and supervisory involvement in
the day-to-day operations, and in the accounting policies and practices of the Company and,
therefore, each is presumed to have had the power to control or influence the particular transactions
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giving rise to the securities violations as alleged in this Complaint, and exercised the same. The
Company controlled all the Individual Defendants and all of its employees.
189.
As set forth above, defendants each violated §10(b) and Rule 10b-5 by their acts and
omissions as alleged in this complaint. By virtue of their positions as controlling persons,
defendants Brooks, Hatfield, Schlegel, Chasin, Krantz, Nadelman, Berkman and DHB are liable
pursuant to §20(a) of the 1934 Act. As a direct and proximate result of defendants’ wrongful
conduct, plaintiffs and other members of the Class suffered damages in connection with their
purchases of the Company’s securities during the Class Period.
COUNT III
For Violation of §20A of the 1934 Act
Against All Defendants
190.
Plaintiffs repeat and reallege each and every allegation contained in ¶¶1-189.
191.
This Count is brought pursuant to §20A of the 1934 Act on behalf of all purchasers of
DHB securities during the Class Period.
192.
Defendant Brooks, by virtue of his position as Chairman and CEO of DHB, and Terry
Brooks and the Brooks Entities, by virtue of their position as affiliates of Brooks and as Brookscontrolled affiliates, had access to, and were in possession of, material non-public information about
DHB at the time they sold millions of shares of DHB common stock during the Class Period.
193.
By virtue of their participation in the scheme to defraud investors described in Count
I and their sale of stock while in possession of material, non-public information about DHB,
defendants violated §10(b) of the 1934 Act and applicable rules and regulations thereunder.
194.
Brooks, Terry Brooks and the Brooks Entities sold shares of DHB common stock
contemporaneous with Lead Plaintiff George Baciu’s purchased of DHB common stock. Brooks
and Terry Brooks, including by and through the Brooks Entities, sold 3,022,844 shares of stock (net
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proceeds of $62,288,345) in trades occurring on December 22 2004, December 23, 2004 and
December 27, 2004. Lead Plaintiff George Baciu purchased 116,000 shares on December 27, 2004.
195.
Plaintiffs and all other members of the Class who purchased shares of DHB common
stock contemporaneously with sales of DHB common stock by defendants: (i) have suffered
substantial damages because, in reliance on the integrity of the market, they paid artificially inflated
prices for DHB common stock as a result of the violations of §10(b) of the 1934 Act and Rule 10b-5
as alleged in Count I; and (ii) would not have purchased DHB securities at the prices they paid, or at
all, if they had been aware that the market prices had been artificially inflated by defendants’ false
and misleading statements and concealment. At the time of the purchases by plaintiffs and the other
members of the Class, the fair and true market value of the DHB securities was substantially less
than the price paid by them.
COUNT IV
Violation of §14(a) of the 1934 Act and Rule 14a-1
Promulgated Thereunder Against All Defendants
196.
Plaintiffs repeat and reallege each and every allegation contained in ¶¶1-195 above as
if fully set forth herein excluding any and all allegations above that contain facts necessary to prove
any element not required to stated at §14(a) claim.
197.
This Cause of Action is asserted under §14(a) of the 1934 Act and Rule 14a-1 to 14a-
9, 17 C.F.R. §§240.14a-1 to 240.14a-9, promulgated thereunder, on behalf of plaintiffs and the
Proxy Class against all Defendants.
198.
The Proxy constituted a proxy statement within the meaning of Section 14(a) of the
1934 Act and Rule 14a-1 to 14a-9, promulgated thereunder. The dissemination of the Proxy, and the
shareholder vote pursuant to the Proxy, were essential in causing the re-election of six of the
Individual Defendants and approval of the 2005 Omnibus Equity Incentive Plan.
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199.
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Defendants violated Section 14(a) and Rule 14a-9, promulgated thereunder, in that
they negligently disseminated a Proxy containing materially false and/or misleading statements and
omissions of material fact regarding: the recommendation and qualification of defendant Brooks,
Schlegel, Krantz, Nadelman, Chasin and Berkman for the position of director; and the
recommendation of the 2005 Incentive Plan.
200.
The Proxy was false and/or misleading in failing to disclose the true financial results
and conditions of DHB, the adverse facts and conditions concerning DHB’s business, products,
finances and future outlook, the six Individual Defendants’ roles in these conditions, the six
Individual Defendants’ self-dealing, and Brooks’ long history of securities laws violations,
acknowledged by securities regulators, as set forth below and herein:
(a)
The U.S. military had lost confidence or satisfaction with
DHB’s products because many thousands of units of DHB’s main
military product, the Interceptor vest, shipped to the U.S. Marines
were non-conforming and defective, and orders for vests were being
placed and defective vests were being accepted only because the
military was suffering from extreme shortages of body armor which
was desperately necessary for American troops in Afghanistan and
Iraq;
(b)
DHB had shipped at least 50,000 Zylon-based body armor
products to domestic law enforcement agencies which were defective
and non-conforming and did not meet and could not fulfill DHB’s
five-year warranty. DHB had also shipped thousands of defective
and non-conforming Interceptor vests to the U.S. Marines which
failed to comply with DOD/U.S. military contract specifications and
requirements;
(c)
DHB’s systems of quality control, which were indispensable
for its successful operation, were defective and inadequate which led
to the shipment of thousands of defective Interceptor vests to the U.S.
Marines and also prevented DHB from being able to trace identified
defective vests to specifically identified lots of raw material, a major
manufacturing processing and quality control defect, which
contaminated 100% of DHB’s Interceptor vest production;
(d)
DHB had accumulated many millions of dollars of defective
and useless Zylon raw material which the six Individual Defendants
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proposed for re-election knew could no longer be used to
manufacture body armor products because Zylon degraded rapidly
when exposed to heat, light and body perspiration. DHB’s excessive
inventory of useless and unsaleable Zylon materials should have been
and would have to be written off, which would result in a multimillion dollar charge and adversely impact DHB’s financial
condition, results from operations, and ability to issue incentive stock
awards;
(e)
Contrary to DHB representations that there were very few
Zylon vests manufactured by DHB still in use by police departments
in the field, there were at least 50,000 Zylon vests still in use in the
field and still under warranty which would have to be replaced by
DHB at a huge cost, which would have a material adverse impact on
DHB’s financial results, condition, and ability to issue incentive stock
awards;
(f)
DHB’s financial reports and statements for the periods ending
December 31, 2004, including the 2004 Report on Form 10-K/A,
were materially false and misleading on overstating the value of
DHB’s inventories, failing to accrue material loss contingencies, i.e.,
Zylon vest replacement costs, and overstating DHB’s net income,
EPS and shareholder’s equity by material amounts;
(g)
DHB’s top insiders, including the six Individual Defendants
seeking re-election, were aware that thousands of DHB Interceptor
vests were defective and did not conform to government standards,
even though DHB had been paid an extra $50 per vest to assure the
high quality of such vests, that the DOD/U.S. military’s quality
control assurance personnel had discovered these defects and were
recommending rejection of the vests and disciplinary action against
DHB, and that even if DHB was able to persuade the government to
accept these defective vests because of the government’s urgent need
for body armor for U.S. troops, the U.S. military would, when body
armor became more available, curtail its purchases of DHB’s
products, which would have a material adverse impact on DHB’s
financial results, condition, and ability to issue incentive stock
awards;
(h)
Defendants privately acknowledged on multiple occasions
throughout 2004, including as early as February 2004 and,
specifically, on November 30, 2004, that its Interceptor vests did not
meet or exceed expectations when officers of the Company signed
military “Request for Deviation/Waiver” forms indicating major vest
defects;
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(i)
The reason for the increase in DHB’s inventories during
2004-2005 was not that DHB was stockpiling raw materials which
were purportedly in short supply so that it would have those materials
to produce armor body products to meet increasing demand as
claimed, but, rather, DHB’s inventories were increasing because
DHB had accumulated and continued to carry on its books, millions
and millions of dollars of Zylon raw materials and Zylon-containing
vests which were, in fact, unusable and worthless;
(j)
DHB’s internal financial and accounting and disclosure
controls were not adequately designed, had not been properly tested
and, in fact were defective, which was leading to material fraud in the
presentation of DHB’s financial results and condition, Due to
internal control deficiencies in DHB’s quality control systems,
inventory pricing mechanisms and the operations of its Audit
Committee, which were serious and pervasive, DHB had accumulated
millions and millions of dollars of excessive and worthless inventory
of Zy7lon raw material, was manufacturing and shipping thousands
of defective Interceptor vests to the U.S. military and not properly
accounting for or reporting these matters in its SEC filings and other
public statements;
(k)
DHB’s officers and directors, including the six seeking reelection, were not performing their duties in accordance with
multiple provisions of the DHB Code of Business Conduct & Ethics;
(l)
DHB’s forecasts of continued future profitable growth and
other optimistic statements regarding the future of DHB’s business
were completely false and were known by defendants, including the
six Individual Defendants seeking re-election, to be false when made,
because the adverse facts and conditions detailed herein would cause
DHB’s business to perform much worse than promised or forecast
and its financial results to be far short of those forecast; and
(m)
The six directors seeking re-election had just unloaded the
majority of their holdings in DHB stock.
201.
The false and/or misleading Proxy was an essential link in causing the Proxy Class to
approve the re-election of the six Individual Defendants and adoption of the 2005 Incentive Plan.
202.
None of the defendants made a reasonable investigation or possessed reasonable
grounds for the belief that the statements made in the Proxy were true, without omissions of any
material facts, and/or not misleading.
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203.
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The defendants caused the Proxy to be disseminated to plaintiffs and the Proxy Class,
were responsible for the contents of the Proxy, allowed their names to be used in connection with the
Proxy and the solicitation of votes, had a substantial financial interest in the outcome of the votes
being sought by the Proxy, solicited votes under the Proxy, and caused the Proxy to be disseminated
through the use of the United States mails and the means and instrumentalities of interstate
commerce.
204.
Each of the misstatements and omissions in the Proxy was material to the
determination by the Proxy Class regarding whether or not to re-elect the six Individual Defendants
and approve the 2005 Incentive Plan, because, under all the circumstances, there is a substantial
likelihood a reasonable shareholder would consider the false and/or misleading statements or omitted
facts important in deciding how to vote on the Proxy or a material part of the mix of information
available to the Proxy Class in deciding how to exercise their voting rights.
PRAYER FOR RELIEF
WHEREFORE, plaintiffs pray for relief and judgment, as follows:
A.
Determining that this action is a proper class action, certifying plaintiffs as class
representatives under Rule 23 of the Federal Rules of Civil Procedure and designating this
Complaint as the operable complaint for class purposes;
B.
Awarding compensatory damages in favor of plaintiffs and the other Class members
against all defendants, jointly and severally, for all damages sustained as a result of defendants’
wrongdoing, in an amount to be proven at trial, including interest thereon;
C.
Awarding extraordinary, equitable and/or injunctive relief as permitted by law, equity
and the federal statutory provisions sued hereunder, pursuant to Rules 64 and 65 and any appropriate
state law remedies to assure that the Class has an effective remedy;
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D.
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Awarding plaintiffs and the Class their costs and expenses incurred in this action,
including counsel fees and expert fees;
E.
Declaring authorizations secured by defendants pursuant to the false and misleading
Proxy null and void, and requiring that any resolution of shareholder votes shall be pursuant to Court
supervision and Court approved Proxy materials; and
F.
Awarding such other and further relief as the Court may deem just and proper.
JURY DEMAND
Plaintiffs demand a trial by jury.
DATED: March 20, 2006
LERACH COUGHLIN STOIA GELLER
RUDMAN & ROBBINS LLP
SAMUEL H. RUDMAN (SR-7957)
/S/ Samuel H. Rudman
SAMUEL H. RUDMAN
58 South Service Road, Suite 200
Melville, NY 11747
Telephone: 631/367-7100
631/367-1173 (fax)
LERACH COUGHLIN STOIA GELLER
RUDMAN & ROBBINS LLP
WILLIAM S. LERACH
THOMAS G. WILHELM
655 West Broadway, Suite 1900
San Diego, CA 92101
Telephone: 619/231-1058
619/231-7423 (fax)
LABATON SUCHAROW & RUDOFF LLP
LYNDA J. GRANT (LG-4784)
NICOLE M. ZEISS (NZ-3894)
100 Park Avenue, 12th Floor
New York, NY 10017-5563
Telephone: 212/907-0700
212/818-0477 (fax)
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Co-Lead Counsel for Plaintiffs
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CERTIFICATE OF SERVICE
I hereby certify that on March 20, 2006, I electronically filed the foregoing with the Clerk of
the Court using the CM/ECF system which will send notification of such filing to the e-mail
addresses denoted on the attached Electronic Mail Notice List, and I hereby certify that I have
mailed the foregoing document or paper via the United States Postal Service to the non-CM/ECF
participants indicated on the attached Manual Notice List.
LERACH COUGHLIN STOIA GELLER
RUDMAN & ROBBINS LLP
s/Samuel H. Rudman
SAMUEL H. RUDMAN
58 South Service Road, Suite 200
Melville, NY 11747
Telephone: 631/367-7100
631/367-1173 (fax)
E-mail: SRudman@lerachlaw.com
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- ---- - ---- - --May 09, 200 5
The Marines' flawed body armo r
Corps recalls more than 5,000 vests that experts rejected - but some
remain in the field
By critn_L_ow
Times staff writer
The Marine Corps issued to nearly 10,000 troops body armor that government experts urged the
Corps to reject after tests revealed critical, life-threatening flaws in the vests .
In all, the Marine Corps accepted about 19,000 Interceptor outer tactical vests from Point Blank
Body Armor Inc . that failed government tests due to "multiple complete penetrations" of 9mm
pistol rounds, failing scores on other ballistic or quality-assurance tests, or a combination of the
two.
"Since these are lifesaving pieces of equipment and are being used in support of the Iraq war, I
urge immediate action since this technical office has little confidence in the performance of the
items to provide the contracted levels of protection as defined in the performance specification,"
wrote ballistics expert James MacKiewicz in a memorandum rejecting two lots of vests on July
19, 2004 .
MacKiewicz is responsible for verifying that each production lot of Marine vests meets
protective requirements and other quality standards . He works at the Army Soldier Systems
Center in Natick, Mass ., and has 18 years of experience with ballistics and armor systems .
A second government agency, the Defense Contract Management Agency, backed Natick's
conclusion and also recommended against the waivers .
"Anything less than full compliance for a safety item such as the [Interceptor body armor] is
unacceptable," DCMA wrote in a2004 memorandum recominendin gthat the Corps reject the
vests .
But according to documents obtained through the Freedom of Information Act and interviews
with officials at Natick, the Marine Corps and Point Blank ., the service rejected that advice .
Instead, the Marine program manager responsible for fielding the vests, Lt . Col . Gabriel
Patricio, and Point Blank's chief operating officer, Sandra Hatfield signed waivers that allowed
the Corps to buy and distribute vests that failed to meet the Corps' minimum standards and
specifications .
Faced with the imminent publication of this story, the result of an eight-month investigation by
Marine Corps Times, the Marine Corps on May 4 issued a Corpswide message, recalling_5 277
Intzrceptor_~:ests ;
Deployment demand s
The judgment call fell to Patricio, who over 10 months last year would waive and accept at least
20 lots of outer tactical vests that didn't pass muster with government testers .
Systems Command did not inform field commanders about the waivers when the equipment was
distributed, Reinwald said .
htti) ://w-,,vtiv .marinetimes .com/print .php?t"=1-292925 .832873 .t,ho
10/31
/7.005
Page 2 of 8
Patricio said he briefed Catto in February 2 0 04 when the first waivers were issued, as well as in
subsequent meetings on procurement of various types of armor to protect Marines and their
equipment from the growing threat of insurgent attacks in Iraq .
In his written statement, Catto said he agreed with the decision to issue the waivers .
"I concurred with the program manager's decision to waive the I I lots in order to rapidly
replace the PASGT Oaks with a superior, advanced body-armor system ," Catto said in the
statement . " Due to the massive deployment associated with [Operation Iraqi Freedom ], this wa s
considered to be an urgent need, and was deemed to be in the best interest of deployed Marines
at that time . "
Both Reinwald and Patricio said the notion of redistributing Interceptor vests already fielded
among deploying forces was considered, but deemed too difficult to execute in time for the
deployments .
"This was one of these situations where they're screaming for these OTVs [and] these guys have
to get them," Reinwald said . "At that time, we had the operational requirement that we didn't
have the schedule to play with . "
The waivers came at a time when U .S . forces were facing increased risk from roadside bombs,
ambushes and intense urban combat . The military rushed to field the Interceptor armor to all its
troops, not just those typically involved in close combat, pushing the vests to the field as quickly
as they were produced .
Systems Command officials responsible for developing and issuing the Interceptor vests argue
that since the vest is worn in concert with the armor insert plates, the combined system offers
more protection than the older personnel armor system for ground troops, or PASGT , that it
replaced.
The Interceptor outer vest protects the wearer against 9mm rounds and shrapnel ; a pair of armor
insert plates offer additional protection against small-arms fire up to 7 .62mm . Interceptor
affords 10 percent greater protection against shrapnel threats than the PASGT vests, according
to Army officials .
All vests stand some chance of failing, but the vests issued to Marines from waivered lots have a
greater chance of being penetrated than vests that met Natick's test criteria, experts there said .
"You have an increased risk of ballistic incident - statistically" with these vests, said Bob
Kinney, director of the individual protection office at Natick . Kinney has worked on individual
protection equipment such as chemical and biological defense suits and body armor at Natick
for more than two decades .
The Marine Corps has been buying its Interceptor body armor vests through the Army's Soldier
Systems Center since 1999. Natick manages the contract and tests random samples of each
production lot at Aberdeen Test Center, Md ., to ensure the vests meet specifications . Aberdeen
is the Army's chartered agency for ballistic quality assurance verification . The Army does not
conduct its testing at Aberdeen, however, instead using commercial labs because of their
independence from the service and the speed with which they deliver test results .
The Marine Corps' assertion that the 19,000 vests meet ballistic specifications is based in part
on results from additional tests conducted at a private test lab, H .P. White of Street, Md .
Systems Command subjected some of the rejected lots ---- a batch comprising about 8,000 vests
---- to additional testing at H .P . White and obtained results that command officials said were
satisfactory .
But the ballistics experts at Natick recommended against fielding any vests until they could
identify and resolve the larger issue behind the vests' declining quality .
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"Based on ballistic test data and previously identified quality assurance failures, I do not
recommend acceptance of these lots and do not recommend acceptance of future lots until this
issue is resolved," MacKiewicz wrote in an Autgust 24 ,,200 _memo . fai,l_ing trio lots .
The memo is one of many that MacKiewicz drafted from as early as January 2003, warning of
poor ballistic test results and recommending the Marine Corps solve the problem before
shipping any more vests to its troops .
It is unclear whether any Marine casualties in Iraq have resulted from shrapnel or bullets that
have penetrated vests distributed from the lots in question . A data sample from the Navy/Marine
Corps Combat Trauma Registry provided by the Marine Corps shows that of 692 Marines
wounded in Iraq between March 2004 and January 2005, eight were struck on the vest, and only
two were penetrated: a fragment from a rocket-propelled grenade and shrapnel from a roadside
bomb .
The Interceptor body armor has been credited across the services with saving thousands of lives .
The Army and Marine Corps fi elded Interceptor body armor in limited quantities during
Operation Enduring Freedom in Afghanistan and ramped up production and fi elding for
Operation Iraqi Freedom and its aftermath . By the time the Iraq war began in March 2003, the
Corps had distributed 131,300 vests and 71 ,000 armor plates . As of November of that year, an
additional 12,200 vests and 12 ,400 plates had been distributed .
One beneficiary of that increased production : Point Blank Body Armor, a subsidiary of New
York-based DHB Industries, which has expanded dramatically to meet the demand . In less than
three months in early 2004, the company opened two new manufacturing plants in Florida,
expanding its operations to meet the Army and Marines' demand for more than I million vests .
Buying vests and armo r
As program manager, it fell to Patricio to purchase more than 190,000 Interceptor vests and
armor plates for the Corps .
During his tenure at Systems Command, the logistics officer handled at least two high-profile
acquisition programs .
Patricia led the development of the new pixel-pattern combat utility uniform that debuted to
rave reviews in January 2002 . Later, he oversaw the pack evaluation process that yielded the
new Individual Load Bearing Equipment rucksack . That pack, the Corps' replacement for the
failed Modular, Lightweight Load-bearing Equipment, or MOLLS, system, was unveiled in
August 2003 . "This is a guy who can get things done," said R .einwald of Patricio .
And that's just what the Corps needed in late 2003 .
Facing mounting pressure to acquire body armor quickly because of upcoming deployments to
Iraq and Afghanistan, and armed with the final orders to close out the Corps' vest procurement
plan, Patricio had little maneuver room on the vest program .
The first vest failures had come to light in mid-January 2003, as officials with Point Blank
notified Marine contract officers of problems at their Oakland Park, Fla ., test facility . Hatfield
told Marine Corps Times the failures stemmed from improper testing equipment at their ballistic
lab .
Over the next year, Natick officials assumed responsibility for testing vests from Point Blank as
they investigated why the original failures occurred .
In December 2003, contract officers and testers discovered that multiple vests from two other
lots failed ballistic tests, this time at the Aberdeen facility .
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Vests from lots 69-9 and 69-12 suffered multiple penetrations of 9mm bullets at speeds below
1,525 feet per second . When gauging performance of a vest against that contract benchmark,
testers expect that rounds will penetrate half of the time .
Those penetrations were of particular concern because previous tests yielded passing results at
an average velocity of 1,620 feet per second, well above the contract benchmark, according to a
document written by Mike Codega, a technical representative at Natick who worked with
MacKiewicz on the Marine vest program . Also a point of concern was the complete penetration
of a vest from lot 69-12 . This one was below 1,450 feet per second, a speed at which no vest
penetration should occur .
"I recommended we do more testing to validate or to confirm or to find out what happened,"
MacKiewicz said in an April 8 interview at Natick . "And as I continued to test, I got more
failures . . . it continued, it didn't stop . Which is strange because we had had about four years of
experience where we had no problem whatsoever."
In further tests of lots 69-9 and 69-12, as well as four additional lots, MacKiewicz and his
colleagues noticed a continued decline in the Point Blank armor's ballistic strength . Some of the
vests were also showing deep indentations - though not penetrations - at speeds that, taken
together with the full penetrations in earlier lots and the fact that the indentations were deeper
than they should have been, prompted testers to raise a red flag .
"It shouldn't have happened . . . because it was a known system for four years and the results
were very high" during previous tests on earlier lots, MacKiewicz said . "To get results that low
was very concerning - it was odd to us ."
When presented with the evidence of failures and the testers' worries, Patricia questioned
Aberdeen's test procedures . In late 2003, in an effort to determine whether testing methodology
there was to blame, Patricio brought in H .P. White, the commercial ballistics testing company,
to review those same lots .
An Aberdeen Test Center spokeswoman declined to comment on doubts about the testing results
and methodology expressed by Point Blank and the Marine Corps .
In reviewing results from both facilities, Patricio wondered why samples from the same lot were
passing at H .P . White and at Point Blank's test site but not at Aberdeen, according to Patricio's
waiv er req uest .for_ lots 69-.9 and 69-12 and other documents .
"H .P . White and the contractor's range have produced passing results for the lots in question
while ATC's data fails the lots," Patricio wrote in a Feb . 2, 2004, memo explaining his waiver
of lots 69-9 and 69-12 . "This matter will not be resolved until the Natick technical
representatives are able to make a determination regarding the underlying factors of the
conflicting data . "
In the memo, Patricio pointed the finger at Aberdeen's test procedures and asked MacKiewicz
and his team to evaluate testing at all three locations to "determine the causes of the
discrepancies and correct the inconsistencies . "
"Failing or passing anything - that's a matter of some testing procedures and interpretations,"
Patricio said in the May 3 interview .
Point Blank officials agree with Patricia, saying the vests did not fail follow-up tests at
independent labs and were therefore safe to field .
Hatfield, however, refused to name any of the sources who she said verified the performance of
the failed lots .
"We see no reason to be concerned that the quality has deteriorated or that the performance has
deteriorated in any fashion," said Hatfield, Point Blank's chief operating officer, in an April 20
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interview at her Pompano Beach production facility in Florida .
Natick officials who investigated the test procedures at Aberdeen and H .P. White found no
differences in the test procedures that would cause such divergent test results .
"No issues . . . relating to instrumentation, test procedure or test facility set-up was found,"
Codega wrote in the memo reviewing the failure of lots 69-9 and 69-12 .
In fact, said H .P . White President Donald Dunn in an interview, in many cases his test facility
fails products that Aberdeen Test Center has previously passed, arguing that his testing
procedures are as stringent, if not more so, than those of Aberdeen . He declined to comment
specifically on any testing of Marine vests that failed at Aberdeen .
Problems with the Point Blank vest design used by the Marine Corps keep cropping up . For
example, as part of the competition for an Army vest contract late last year, that same model of
Point Blank's Interceptor vest failed ballistic tests that simulate shrapnel hits, according to Karl
Masters, the lead engineer for the Army's Interceptor body armor program . That test -- a lower
standard than for 9mm rounds - was conducted by H .P. White .
Masters noted that his comments were in reference to the Army vest program and declined to
specu l ate on the Marine Corps vest issues .
Though the Army awarded Point Blank the contract after all, it bought vests of a different
design than the Marine Corps model, said Army Col . John Norwood, the head of Project
Manager Soldier Equipment, the Army office that oversees development of individual gear .
When asked in an interview whether he suspected any material or manufacturing flaw in the
vests might be to blame for the rejections by government testers, Patricio said only that "we had
the manufacturers involved in the process to the extent that the parties communicated with each
other and attempted to work through the process" of addressing the failures.
Despite the official government waiver forms she signed asking for the ballistic specifications to
be reduced to meet the declining test results, Point Blank's Hatfield said she never considered
the problem to be one that stemmed from a manufacturing or material flaw .
Patricio noted in a memo dated Feb . 2, 2004, that the urgent need for body armor in the war
zone and the time it would take to find out for sure why the vests were failing outweighed his
concerns with the vests .
He therefore would issue a "temporary waiver providing Marines with OTVs of questionable
performance," promising that "if, at a later date , the performance is shown to conclusively not
meet the government ' s performance speci fication , then the issue will be addressed at that time . "
The waiver turned out to be anything but temporary . Over the next year, Patricio went on to
issue waivers for at least 20 lots representing nearly 19,000 vests .
"The OTVs in the stated lots do not fully comply with the current Marine Corps performance
specification for the OTV and do not meet existing contractual requirements ," Patricio wrote in
onewaiver, accepting a ship ment of nine lots ---- about 4,500 vests - that testers at Aberdeen
rejected .
"The OTVs are needed by deploying units that must receive them prior to deployment in the
very near future . I understand and accept the increased risk posed by accepting the reduced
protection against the 9mm threat," he wrote Nov . 24, 2004 .
Patricio said he crafted his waivers using language that was legally required to release the vests
and "put them on the backs of Marines . "
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While shrapnel from homemade bombs and 7 .62mm bullets from AK47 rifles are among the
most common threats in Iraq, 9mm submachine guns are also in common use and a "valid
operational threat," said Masters, the Army engineer .
Material tracking problem s
Natick officials said they pleaded with Point Blank to properly document and track the materials
and manufacture of the vests so they might pinpoint the problem . But they said Point Blank
could not deliver the information they needed ,
The Marine Corps contract included a premium of about $50 extra per vest to cover additional
quality assurance procedures at Point Blank, MacKiewicz said .
Among other information that was of interest to Natick testers was which rolls of woven Kevlar
fiber were used, for example, in the assembly of the layered ballistic vest panels .
"That process was basically broken," MacKiewicz said . "I could not distinguish between one
roll of material that went into the first 500 or the second 500 or the third 500 . "
In a series of memos written over the summer of 2004, in which MacKiewicz explained his
reasoning for rejecting certain lots delivered by Point Blank, the testing expert detailed his
concerns .
In recommending the rejection of lot 71-12 on July 19, MacK ewiczwarned of "major qualify
assurance de .ciencies" at the company . He recommended "disciplinary action against the
contractor to resolve the issue . "
In a July 21 memorandum to Patricio recommending the rejection of two more lots, 69-84 and
71-9, MacKiewicz wrote : "One of the significant factors, which ultimately led to award a
contract to Point Blank, was their proposed quality assurance procedures for eliminating defects
and tracking materials . . . . Point Blank is not compliant with their manufacturing quality control
proposal and their contractual obligation for providing consistent product performance and
reliability. "
Hatfield said she was forthcoming with whatever data contract officials requested, but firmly
rejected government officials' claims that her vests had any kind of material problem, putting
the blame squarely on the tests at Aberdeen .
"We had no evidence that would compel us that we should change anything that we had done
for years," Hatfield said . "I have other sources, and we have compelling evidence that shows no
degradation of performance . "
No purchases after '04
The Marine Corps fielded vests from the failed lots through the end of 2004, documents and
interviews show, but stopped taking delivery of Point Blank manufactured vests in early 2005 .
By then, the contract had not been exhausted - at least 9,000 vests could still have been
purchased.
Neither the Marine Corps nor the company would explain why more vests hadn't been
purchased . But in late December 2004, the Army signed a $190 million contract with Point
Blank to purchase 360,000 vests through 2006 . Point Blank was chosen over I I other bidders
for the contract, the Pentagon said .
The Army, which equips its troops with different versions of the Interceptor body armor system,
has never accepted vests that failed ballistic standards, and the service says it stands by the
manufacturer despite the Corps' vest failures . Army officials in charge of equipping soldiers
with body armor said in an interview that the service has never issued a waiver for ballistic
performance and not one of the more than 680,000 vests fielded since 1998 is from a faile d
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production lot .
The Army versions of the Point Blank vest, dubbed Pathfinder and Pathfinder Plus, differ from
the Marine Corps' "Alpha" package in the weight and number of Kevlar sheets that make up the
armor . To date, the Army has accepted nearly 500, 0 00 vests from the company .
Nonetheless, Point Blank's stock has dropped precipitously this year . In early January, the stock
was riding at $17 .86 before dropping about 61 percent over the first four months of the year .
On May 3, the day before the Corps announced its body armor recall, Point Blank parent
company DHB Industries announced it had named a new president .
The company tapped retired Army Gen . Larry Ellis, who joined the company as a board
member last year after retiring from the service . He led Army Forces Command in Atlanta, Ga .,
before retiring in July .
His appointment follows the hiring of another former Army officer, retired Col . Ishmon Burks,
to be DHB's executive vice president for investor and media relations .
The appointments could help to address DNB's flagging stock value and reputation .
CHECK YOUR VES T
This chart will tell you whether your vest is from one of these lots .
Other documents of interest :
• Defense Contract Mana g ennent_Agencv memorandu m
This DCMA memo recommends against granting a waiver due to the failure of the outer tactical
vests to meet minimum requirements .
• Memorandum from U .S,._Amiy„Robert Morris Acquisition Center
A July 21, 2004, memorandum to the Marine Corps Interceptor Vest contract officer rejecting
two lots of outer tactical vests .
• Memorandum from.,.U .S . Army Robert Morris Acquisition Center
A July 30, 2004, memorandum to the Marine Corps Interceptor Vest contract officer rejecting
one lot of outer tactical vests .
• Test -result resort
This test matrix from the U .S . Army's Aberdeen Test Center shows rejection data for vest
production lot No . 69-96 .
• Test res ult report
This test matrix from the U .S . Army' s Aberdeen Test Center shows rejection data for vest
production lot No . 79-21 .
• Photograph, of test failur e
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'T'his photograph shows the complete penetration of an Interceptor Outer tactical vest during
ballistic testing .
- Matthew Cox covers the Army and contributed to this report .
Back to top
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24
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200 4
U . S . Army Robert Morris Acquisition
SUS,TECTr Ballistic Qual ity A ssurance Test Report for Contract DAA I02- . 9&--D--55006 Delivery order 69-99 and 69-102 .
1 . on 2 0 August 2004 the U . S . ArTny Ab rdeer2 T est Center provided
baili:st ,c quality assjirause results from 'tlhe above stated lots . The
data was provided to the U . S . Army Natick Solder Center , Marine Corp s
S
h ballistic pac kage was identified as the Alph€a : system . U S
Tea
T
epresentatives
ere e c ti . t Pathfinder ballist c
Natick
' s e a ' b~ deb vered . Test results on -, lot 69 yielded aecapta a .a
' on lo t
sa
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tests
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o
.vra ' 1446 fL/set . it t ould be noted that .two of tke :9nri V
s :.
.
s tt i 5 69==99 yielded slightly lower than .nermsl results _, a9 andi t h the is •r tha S ~Tsns . a
his data corpus ned
pr a,vtkst lob fai lures strongly indicate that additional 3 arcs wq, i
9
e :.; ves, s were t ied . _" The .dada g n rat d : at ATC ' a
lower tier
za o V s'' aria . complete
f test result .
Ba3lIsti e ~tre .ieation testing Is designed to Provide one fIn a a
. ~k~a z ed to' mpgart auc taxlce e •
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t d ensure uniformity of each it :, wi thiin Elot _ If the 4 r . . : - :' .g li torsr
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. Th 3 . was=2ep'e?1
°e pen ai y t government evaluators ; so t iat ce a Asa? i _- i ; ._ wa s
= a i d :t ey : k~aa l d have an e~i end caF : is - ta, akai n
t the 'full a xs . ctio a loe ; _c ov rnr, ,t ,. , int 815 is n o
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to by $50 . 0 per v est .
r the ballistic data and '~F~evzousl_f dent i ieri M .1al t y
Baled
s _ €ail .fires ' . do not,- recornc=did a ce take of these nor :: rid d o
i . . c d pta e . o ar~# ut-l .±`e lots uzt i l Leis iss is
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hi ijit ist aid i2 , ' d ' r nue y-. 20U4 , relativ o thy`
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69 9 c3 ' E -12 and' n a nc~ " o accept these risk C
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Clearly an concerned i f subat~ niarr3 a o rn TI c a° a
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echn cal repz eaantati.ve3 are. able to m a c c~ : xrn natz n
regarding the _M rly n factors o the conUU ict i n ' dn-tA 4 . ddit3017d yR
m risk a . 11 lgatr•C h Ct3i1 the L-S .
arm accepted ' . eoto from th coniraot
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t nti l Le tine i ~s~~
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~ 5" thGi .2ro•a Y tn- ar disparity, L i , c p= ssiiig ar_ LS . o
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riu l AU t 1V1~tfLtC Y Kt LALL u r t LLI: i Lll UU i LK ! AL 111:AL V 1 (U E V ) LUI Naga 1 OI L
RECRUITING HQMC UNITS CAREER Marine ONLINE Marine 4 Life NEWS FAMIL Y
PUBLICATIONS LOCAL
MARADMIN 211/0 5
Date signed ., 05/0412005
MARADMIN Number : 211105
Subject: PRECAUTIONARY RECALL OF SELECTED OUTER TACTICAL VEST (OTV)
LOTS
R 0418502 MAY 0 5
FM CMC WASHINGTON DC(UC)
TO AL MARAD14IN (UC)
UNCLASSIFIED//
MARADMIN 211/05
MSGID/GENADMIN/CMC WASHINGTON DC/ I
SUBJ/PRECAUTIONARY RECALL OF SELECTED OUTER TACTICAL VEST (OTV)
/LOTS/ /
POC/DAN FITZGERALD/ -/PM INFANTRY COMBAT EQUIP/ •-/TEL :DSN 378-3334
/TEL :COML (703)432-3334/EMAIL :DANIEL .FITZGERALDAUSMC .MIL//
POC/WENDELL LEIMBACH/MAJ/TM LDR/ -/TEL : DSN 378-322 4
/TEL :COML (703)432-3224/EMAIL :WENDELL .LEIMBACH@USMC .MIL//
GENTEXT/REMARKS/1 . PURPOSE . ANNOUNCE THE PRECAUTIONARY RECALL OF
SELECTED OUTER TACTICAL VEST (OTV) LOTS .
2 . ACTION . THE INFANTRY COMBAT EQUIPMENT PROGRAM MANAGEMENT OFFICE
(PM ICE) OF MARINE CORPS SYSTEMS COMMAND IMMEDIATELY RECALLS ELEVEN
(11) LOTS OF OTVS TOTALING 5277 VESTS THAT WERE FIELDED DURING 2004
IN ORDER TO ENSURE MARINES ARE EQUIPPED WITH THE OPTIMAL LEVEL OF
PERSONAL PROTECTION GEAR .
3 . BACKGROUN D
A . DURING RAPID FIELDING AND EQUIPPING OF FORCES FOR OIF II
ELEVEN {11} LOTS OF OTVS TOTALLING 5277 VESTS WERE FIELDED WITH
WAIVERS THAT ACCOMODATED LOWER THAN CONTRACTED TEST RESULTS FROM A
SPECIFIC TESTING FACILITY- PRIOR TO APPROVING WAIVERS ADDITIONAL
TEST DATA WAS COLLECTED ON THE LOTS IN QUESTION . BALLISTIC
PROTECTION PERFORMANCE OF THE LOTS WAS CONFIRMED AND THEY WERE
SUBSEQUENTLY FIELDED .
B . CONTRACT WAIVERS WERE APPROVED IN ORDER TO EXPEDITE
DELIVERY .
C . CURRENT SITUATION ALLOWS PM ICE TO CONDUCT RECALL OF
WAIVED LOTS WITHOUT ADVERSELY AFFECTING SUPPORT TO THE OPERATING
FORCES .
4 . EXECUTION . ALL COMMANDS POSSESSING OTVS ARE REQUESTED TO
PERFORM AN INVENTORY TO IDENTIFY OTVS FROM LOTS SPECIFIED BELOW
DURING AN APPROPRIATE OPERATIONAL STANDDOWN OR GARRISON PERIOD .
READ IN FIVE COLUMNS ;
LOT SERIAL NUMBERS LOT SIZE DATE DESTINATION
69-09 MC160675-MC161174 490 FEB 04 I & II MEF CIF
69-12
MC161175-MC161674 490 FEB 04 I & II MEF CIF
69-24 MC163205-MC163704 489 JUL 04 IZ MEE CIF,CARDF
69-96 MC177154-MC177653 496 JUL-AUG 04 II MEF CIF
69-102 MC178154-MC178653 391 JUL -AUG 04 lI ME ;" CIF
69-105 MC178654-MC179153 491 JUL-AUG 04 lI MEF CIF
69-111 MC180154-MC180653 496 DEC 04 II MEF CIF
69-117 MC179654-MC180153 496 JUL -AUG 04 II MEP CIF
69-120 MC182654-MC183153 496 DEC 04 II MEF CI F
71-12 MC174204-MC174624 417 JUL -AUG 04 1 MEF CIF
71-2 1
MC176625-MC177153 525
JUL-AUG 04 T MEF CIF
5277 TOTAL
16
http://www.usmc.mil/maradinins/maradinin2O00.nsf/O872a7ac9a4cO8a6852569b9000bc3 fl/... 9/7/2005
I .tV.:.1...C1LJ 12ilLVtii\. 1 I\J. t LL Vd' k31,LL L-.
.C L) ' JU I l:it I t11. I L%.-ttL V LSr) I k%J 1 V) LV 1 0 L agu z- (JL G
A . LOTS CAN ONLY BE IDENTIFIED BY CHECKING THE EIGHT SEPARATE
BALLISTIC PANELS WITHIN THE VEST, GROIN, THROAT, AND COLLAR . OTVS
CAN BE IDENTIFIED BY EITHER LOT NUMBER OR SERIAL NUMBER . NUMBERS
ARE HAND WRITTEN ON THE BALLISTIC PANELS .
B . THE OUTER SHELL OF THE OTV CANNOT BE USED TO IDENTIFY THE LOT OR
SERIAL NUMBER BECAUSE IN MANY CASES THE OUTER SHELLS HAVE BEEN
REPLACED OR EXCHANGED (WOODLAND CAMOUFLAGE TO THE COYOTE BR (YWN) .
C . VESTS IDENTIFIED AS BELONGING TO LOTS ABOVE SHOULD CONTINUE TO
BE WORN UNTIL THEY CAN BE REPLACED . OTVS ARE SERVICEABLE .
5 . OPERATING FORCES . RECORD RESULTS OF INVENTORY THOUGH YOUR CHAIN
OF COMMAND . REQUEST RESULTS BE CONSOLIDATED AT THE MEF LEVEL OR
APPRORIATE MARFOR AND FORWARDED TO PM ICE POC .
6 . LOGCOW (CONSOLIDATE ISSUE FACILITIES (CIF)) . REQUEST IMMEDIATE
INVENTORY TO DETER14INE IF ABOVE LOT NUMBERS ARE ON HAND AND PROVIDE
RESULTS TO PM ICE POC .
7 . MARCORSYCOM, PM ICE WILL COORDINATE ALL ACTIONS CONCERNING THIS
PRECAUTIONARY RECALL AND PROVIDE AMPLIFYING INFORMATION FOR
DISPOSITION OF ANY RECOVERY OF OTVS . . POC INFORMATION . POC FOR
EXECUTION OF THIS PRECAUTIONARY RECALL IS 8 . DAN FITZGERALD, PM,
INFANTRY COMBAT EQUIPMENT, MARCORSYSCOM DSN 378 -3334, COML
(703)432-3334, DANIEL . FITZGERALD@USMC .MI L
< MAILTO :DANIEL . FITZGERAI,D@USMC .MIL > OR MAJ WENDELL LEIMBACH, DSN
378-3224, COML (703)432-3224, WENDELL .LEIMBACH@USMC .MIL
<MA ILTO :WENDELL .LEIMBACH@US MC .MIL >//
17
http://www.usmc. illmaradmi slmaradmin200Q .nsfIO872a7ac9a4cO8a6852 569b900Obc3 fl 1... 9/7/2005
CHECK YOUR VES T
Marine Corps Systems Command is recalling 5,277 Interceptor outer tactical vests from I I lots purchased
and issued last year . In all, the Corps bought about 19,000 vests from at least 20 lots that government
ballistics testers recommended rejecting.
A May 4 Corpswide message, MarAdmin 211/05, ordered commands to inventory their vests in a
"precautionary recall" and determine whether any vests are from the I 1 lots the service is pulling back .
Vests were distributed to Consolidated Issue Facilities for I Marine Expeditionary Force and II MEF, as
well as to the Critical Asset Rapid Distribution Facility at Marine Corps Logistics Base Albany, Ga ., which
distributes equipment for Marine Corps Reserve units .
The following information will tell you whether your vest is from one of these lots :
No . o f
Lot Serial numbers vests Date Destination
69-09 MC160675-MC161174 490 Feb . 2004 I & 11 MEF CIF
69-12 MC161175-MC161674 490 Feb 2004 1 & II MEF CIF
69-24 MC163205-MC163704 489 July 2004 11 MEF CIF, CARDF
69-96 MC177154-MC177653 496 July-Aug . 2004 11 MEF CI F
69-102 MC178154-MC178653 391 July-Aug . 2004 Il MEF CIF
69-105
MC178654-MC179153 491 July-Aug . 2004 IIMEFCIF
69-111 MC180154-MC180653 496 Dec . 2004 11 MEF CIF
69-117 MC179654-MCI80I53 496 July-Aug . 2004 IIMEFCIF
69-120 MC182654-MC183153 496 Dec, 2004 II MEF CIF
71-12 MC174204-MC174624 417 July-Aug, 2004 1 MEP CIF
71-21 MC176625•MC177153 525 July-Aug . 2004 I MEF CI F
** Lots can be identified only by checking the eight separate ballistic panels within the vest, groin , throat
and collar pieces . Vests can be identi fi ed by serial or lot numbers, which are handwritten on the ballistic
panels-
** The outer shell cannot be used to identify the lot or serial number because many outer shells were
replaced or exchanged, most when the Corps switched from woodland camouflage to "coyote brown . "
** If they are identifi ed as being among the recalled lots , Marines are to continue wearing them until they
can be replaced, the message states . "OTVs are serviceable," the message notes.
18