Body armor manufacturer DHB Industries (AMEX:DHB) only made the "watchlist" in February's Motley Fool Hidden Gems -- and I think I see why. This gem has some pretty serious flaws, many of which were brought to light in the company's 2003 earnings announcement, released after market close yesterday.

Judging from the release's headlines, DHB had a great year in 2003. Revenues rose 76% to $230 million. Operating income surpassed that slightly, increasing 88% to a record $26 million. Earnings, however, decreased 5% to $0.34 per share. This decline largely stemmed from taxes DHB had to pay in 2003 at a rate of 42% (in contrast to 2002, when DHB received a tax benefit instead). But lowered gross margins also played a part in the earnings decline. (However, it also did not help per-share earnings that the company diluted its existing shareholders by roughly 4.5%.)

All of which begs a couple of questions. First, how did the company rack up such explosive revenue and operating income growth? Second, how did it so completely fail to convert any of this growth into earnings gains?

The answer to both questions: Government contracts.

DHB's primary customers are governments -- federal (the military, DEA, FBI, and other alphabet-soup agencies), state, and local (law enforcement, for the most part). Governments have the ability to place a huge amount of orders in a short period of time. Governments can also apply moral pressure to their suppliers to produce goods immediately, regardless of cost, because "lives are at stake."

But governments are not always big on showing gratitude when suppliers rise to the challenge. If you thought the U.S. government might, for example, grant a tax break to DHB as thanks for it opening a sixth production facility to manufacture the bulletproof vests needed by our soldiers in Iraq, or for paying higher transport costs to expedite shipment of the materials needed to make those vests, well, you would be wrong. For that matter, if you expected the government to so much as pay its bills for these vests in a timely manner -- well, you would be wrong on that one, too. One look at the company's swelling inventories (needed to meet the rising tide of backlogged government orders) and similarly rising accounts receivable, tells the tale.

To make a long story short, DHB's biggest customers may just be its worst enemies.

Rich Smith owns shares in DHB Industries. The Fool has a disclosure policy .