DHB Industries, Inc.
Lessons Learned from DHB

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By steveting
June 13, 2006

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Hi guys,

I've been a shareholder of DHB and like most had front row seat in its roller coaster ride. With the board closing soon, I thought it would be appropriate to make some notes on lessons learned on this investment. This was initially a long write-up with the intention of reviewing the financial statements up to 2005. Unfortunately DHB has not filed any financial statements for a considerable period of time and there are indications that it wont be for a while yet. So let's start on lessons.

Lesson 1
Don't put your hard earned money with crooked management. This is an obvious one and despite the fact that CEO was prosecuted for insider trading, I believed that a good business would negate or turn around a former criminal. I was very wrong on that account. The odds of a crook turning around are worse than a company in receivership trying to turn around. A truism is that a leopard cannot change its spots, but a company can get new competent and honest management to implement the turn around (i.e. think of Alderwoods).

Lesson 2
Avoid companies that have inept and/or complicit Board of Directors, particularly the so-called independent directors. Look at their experience and how relevant is it to the business. Also look at their compensation. At the time when I had invested in DHB, the Board consisted of Messer's Krantz, Nadelman and Chasin. Mr. Chasin was an ex-employee (i.e. good buddy of Mr. Brooks and who's going to say no to your boss?) while the other two had zero experience in the soft body armor industry. Unfortunately these guys sit on the Audit and Compensation committees. So when it came to looking out for the interests of shareholders, the Board of Directors is really in effect the Board of Dummies (thanks to Cowhoney for that nice description). So when the CEO demands more, the Board of Dummies reach out for their rubber stamps and say � "Yes sir!" I failed to see the need of a strong Board that really works for outside shareholders and puts pressure on management to perform/do the right thing.

Lesson 3
When CEO compensation is obscene � run for the hills. The following are objectionable items that the CEO has given to himself and approved by the Board of Dummies.
� The CEO gets a chauffeur and limousine to "deliver" him to various "engagements" because he's incapable of driving there himself.
� Because CEO spends time too much in New York and very little at the company's headquarters in Florida running the business, he "needs" a charted jet to fly himself around the place. Oh by the way, the charted jet just happens to be owned by some family members � a related party transaction.
� While down in Florida pretending to run the company he gets to stay in a multi-million dollar vacation mansion which coincidentally happens to be owned by an old buddy � another related party transaction.
� Also in the 2000 Employment Agreement, the CEO must have thought the time was right to start printing his own money via share options. So in 2000 he granted himself $1 options with 3.75 million shares spread over 5 years. In 2005, he did one better by granting himself an additional 5.25 million shares at the same $1 price tag. The $1 options/warrants contain some extremely generous terms with little risk at all to Mr. Brooks (i.e. vesting immediately if the company is bought out and anti-dilutive provisions).

Below is compensation and share count of CEO taken from the proxy filings, values are in $'000.

Year              1999       2000       2001      2002      2003      2004     2005
Base Pay          $144       $414       $525      $644      $781      $763
Bonus                                             $1,000    $2,000
Perks             $5,065     $3,529     $2,962    $2,116    $1,266    $1,457
                  ------     ------     ------    ------    ------    ------
Total Pay         $5,029     $3,943     $3,487    $2,760    $3,047    $4,220

Options           750        750        775       775       800       800      1,500
Shares owned+opt. 19,276     20,751     20,776    19,669    21,219    16,666   6,963
Share Growth/(Reduct.) 7.65%      0.12%     -5.32%    7.88%    -21.46%  -58.22%

Retained Earnings -$35,222   -$29,215   -$19,082  -$3,447   $11,365   41,440  $21,916*
*Estimated Value � awaiting 2005 10K to confirm

Notice how quickly CEO ownership suddenly decreased in 2004 and 2005? If you account for the excellent timing in which the CEO sold his shares in 2004, his total compensation would some where around $272 million or an average of $38.9 million per year! So what about shareholders then? Let's just say that earnings lagged CEO compensation by a significant margin over the same period, check out the retained earnings numbers. Just from the numbers it's pretty clear the CEO is running the company for himself rather than outside shareholders. The highly objectionable compensation package to the CEO was something I had missed badly.

Lesson 4
Stay well clear of companies whose modus operandi is the following.

(1) Have a business (in a sexy industry) as a going concern to pay for ones' wages;
(2) Get friends and family members involved in the business so they too can share in the spoils, leaving little to the bottom line (i.e. to outside public shareholders) and minimize their tax bill;
(3) Go for the big payoff via the tried and true Hype & Harvest model (this is management's way of the Pump and Dump model favored by penny stock manipulators). Reward yourself with fully vested in the money options/warrants. Make press releases touting large contract wins with record quarterly revenues and earnings. Tell the gullible public about the "feeding frenzy" happening for the company. Sell the company stock at the top; and
(4) Wait till public has amnesia and repeat step (3).

I had failed to see the true nature of this company and how it makes money.

Lesson 5
Don't be afraid to sell for a loss. This is one gargantuan error in emotional investing that will go down in history as the worse mistake ever made by me. The theory was that I wanted to break even, by not accepting a small loss. That was clearly wrong. Eventually I took a much higher loss when selling at a lower price. I failed to see how bad the management truly was and let my emotions (pride?) get the better of me by not recognizing the inevitable at an earlier stage. I wont forget this for a long time.

So those are my lessons learned from DHB. Others may wish to include their own.


(P.S. I no longer hold a position in DHB)

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