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DHB Industries, Inc.
Some thoughts about DHB

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By Naicinvestorz
June 23, 2005

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Recently spoke to Ishmon Burks (new IR), about DHB's future. In this note we will give his comments and some of our thoughts.

While DHB has been a consistent grower over the last 5 years (its sales and earnings have increased for 21 consecutive quarters) its stock price is a true roller coaster ride. Here are some of the more important issues regarding our investment in DHB.

Inventory:
One of the factors that has dragged down DHB in recent months is concern about its increasing inventory levels. Talking to Burks it is clear that the inventory build up is NOT a result of no demand for their products but because an acute shortage of raw materials. Basically vests are waiting to be shipped but some raw materials �like Dupont's Kevlar- are missing so DHB can't ship out these vests as they aren't 100% complete. It is well documented that DuPont is building another factory to meet strong demand for Kevlar and the new plant should be fully operational by the 4th quarter of 2005.
In January 2005 COO Hatfield had said she hoped to see some relief by May/June of this year but according to Burks this might have been a little too optimistic. DHB will get a pre-set percentage of Kevlar as soon as it is available from DuPont.

Supplemental:
Two months ago President Bush approved a $82 billion military supplemental. $3.3 billion is destined to improve army force protection. DHB should be a beneficiary of this. According to Burks what might have held the US military back was the fact that there was no money approved and no new contracts could be signed. With the new bill signed by Bush this obstacle should be out of the way and if the need for additional body armor was apparent this could now be addressed.

Replacement cycle:
Vests have a shelf life of about 6-7 years and a replacement cycle of about 4 months in combat. In combat meaning a soldier in Iraq or Afghanistan not someone patrolling borders on a US army base. According to Burks the big question is what you believe the US will do in Iraq and Afghanistan: will they pull out this year? '06-'07-'08... A question that no one knows for sure but it is quite easy to see that if Bush keeps his word and will not pull out of Iraq anytime soon there will be a real need for replacement vests. This could be positive going forward according to Burks. Also the fact that most vests have been shipped to "urgent" locations such as Iraq mean that there are still many US soldiers who aren't well equipped in potential future hot zones such as South Korea.

International
Burks believes international potential is significant but admitted that their Washington DC office has to get staffed better before they can fully pursue the international arena. DHB is currently doing research to enter the international arena. It is looking for countries that are generally friendly to the US, have large defense budgets and don't make their own body armor. He mentioned countries like Pakistan, Turkey as potential candidates.

Cash/Debt situation
Related to build up of inventory and continued investment in operations. At the same time DHB is sure to get its money from the government as they eventually do deliver but are considered slow payers. As the inventory situation improves later this year cash levels should improve and debt will go down according to Burks.

M&A and SEC
DHB recently hired a former M&A director of Deutsche Bank to strengthen its management team. It is believed he has joined DHB to look for potential interesting acquisitions. It would be unclear where DHB would do an acquisition (supply chain, or enhance product line) and how it would finance it (equity, debt, shares). Burks had no real comment.
SEC investigation continues to go on but no real news over last 6 months.

Resignation of auditor
In April DHB announced that its current auditor Weiser LLP declined to stand for re-election. While a resignation of an auditor certainly raises a big red flag there are no restatements anticipated. As implied by Brooks the change in auditor will most likely result in more rapid filing of DHB's 10-Q's and 10-K filings. DHB also passed the Sarbanes Oxley requirements but did have a "control deficiency" that constituted a weakness in the way DHB used to value its inventories but this was mainly an issue of timing (recognizing inventory in one quarter over another). DHB has recently added a new internal person to make sure inventory levels are accounted for correctly in the future.
While this is a "material weakness" it is not material "fraud". A big report by the big four accounting firms titled Perspectives on Internal Control Reporting (December '04) stated that fast growing companies in immature industries were more susceptible to material weaknesses in the way they account for their inventory. DHB grew sales by 40% in 2001, 33% in 2002, 76.5% in 2003 and 48% in 2004. During this entire period of rapid growth the company had virtually no additions to its internal audit team so some minor mistakes were almost inevitable.

New management, Nasdaq listing, coverage on Wall Street
Quite surprisingly Burks said there were no more plans to list on Nasdaq. This had been said to be "in progress" before but seems to be a non-issue for the moment. Burks said that new management had only been there for about 40 days and when it was ready and felt comfortable enough to go on the road (as of September) would go out to conferences and meet with more investors and potentially get more coverage by analysts.
Burks said that Brooks has clearly understood that DHB needed more people than just himself, Hatfield and Schlegel and the additions of Ellis as President, Burks as VP of Communications, Rubio for Strategic Planning and Dien for M&A are a sign of this. Day-to-day management has been shifted away from Brooks into the hands of retired General Ellis. Asked if the addition of Ellis wouldn't create a potential conflict of interest Burks said that both Ellis and the army are used to dealing with situations like this (were a private person gets out of the army to go work for army related businesses). Burks referred to Cheney who was in government, went to Halliburton and back into government.

Guidance:
Simple answer: no. No guidance should be expected anytime in the near future. Results will speak for themselves. Burks did say that future financial results might come sooner than before (before DHB always reported on last day allowed by SEC). DHB is planning to announce 2Q05 earnings in last week of July.

DHB backlog (products that have been ordered but not yet delivered) stands at $400M. Revenues in 2004 were $340 million.

Opinion:
Continue to believe DHB is currently undervalued by Mr. Market. DHB is trading at about 11 times earnings and less than 1 times sales. Investors should also keep in mind that DHB has grown 100% organically and has very high ROA, ROE.
Due to raw material constraints the company's growth rate has slowed somewhat (revenues were up 15% in 1st quarter of 2005 and earnings were up 21%) but are still respectable. Recently we actually saw some insider buying at DHB with General Ellis picking up 1,000 shares at $7.7. Insignificant, but maybe a start to a new trend?

Believe the new management additions are positive for DHB.


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