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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended September 30, 2009
¨ | TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-13112
POINT BLANK SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware | 11-3129361 | |
(State or other jurisdiction of incorporation or organization) |
(IRS Employer Identification Number) | |
2102 SW 2nd St. Pompano Beach, Florida |
33069 | |
(Address of principal executive offices) | (Zip Code) |
Registrants telephone number, including area code: (954) 630-0900
(Former Name, Former Address and Former Fiscal Year if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of November 6, 2009, 51,843,057 shares of the Registrants common stock at $0.001 par value were outstanding.
Table of Contents
TABLE OF CONTENTS
Page | ||||
PART I FINANCIAL INFORMATION | ||||
Item 1. |
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Condensed Consolidated Balance Sheets at September 30, 2009 and December 31, 2008 |
2 | |||
3 | ||||
4 | ||||
5 | ||||
Item 2. |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
13 | ||
Item 3. |
22 | |||
Item 4. |
22 | |||
PART II OTHER INFORMATION | ||||
Item 1. |
22 | |||
Item 1A. |
24 | |||
Item 2. |
26 | |||
Item 3. |
26 | |||
Item 4. |
26 | |||
Item 5. |
27 | |||
Item 6. |
27 | |||
28 | ||||
29 |
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PART IFINANCIAL INFORMATION
Item 1. | FINANCIAL STATEMENTS |
POINT BLANK SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
September 30, 2009 |
December 31, 2008 |
|||||||
(Unaudited) | ||||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash |
$ | 6,878 | $ | 1,707 | ||||
Accounts receivable, less allowance for doubtful accounts of $849 and $279, respectively |
7,246 | 33,620 | ||||||
Inventories, net |
12,729 | 38,700 | ||||||
Income tax receivables |
208 | 11,951 | ||||||
Deferred income taxes |
17,669 | 14,829 | ||||||
Prepaid expenses and other current assets |
2,303 | 2,782 | ||||||
Total current assets |
47,033 | 103,589 | ||||||
Property and equipment, net |
10,373 | 10,742 | ||||||
Other assets: |
||||||||
Deferred income taxes |
10,506 | 10,931 | ||||||
Deposits and other assets |
96 | 113 | ||||||
Total other assets |
10,602 | 11,044 | ||||||
Total assets |
$ | 68,008 | $ | 125,375 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Revolving line of credit |
$ | - | $ | 29,207 | ||||
Term Loan |
6,000 | 10,000 | ||||||
Note payable |
2,973 | 2,950 | ||||||
Income taxes payable |
- | 285 | ||||||
Accounts payable |
10,310 | 23,310 | ||||||
Accrued expenses and other current liabilities |
9,148 | 4,927 | ||||||
Reserve for class action settlement |
4,172 | 4,172 | ||||||
Vest replacement program obligation |
403 | 410 | ||||||
Employment tax withholding obligation |
6,633 | 8,154 | ||||||
Total current liabilities |
39,639 | 83,415 | ||||||
Long term liabilities: |
||||||||
Unrecognized tax benefits |
- | 11,239 | ||||||
Other liabilities |
385 | 418 | ||||||
Total long term liabilities |
385 | 11,657 | ||||||
Total liabilities |
40,024 | 95,072 | ||||||
Commitments and contingencies |
||||||||
Contingently redeemable common stock (related party) |
19,326 | 19,326 | ||||||
Stockholders equity: |
||||||||
Common stock, $0.001 par value, 100,000,000 shares authorized, 51,843,057 shares and 51,446,585 shares issued and outstanding, respectively |
49 | 48 | ||||||
Additional paid in capital |
94,828 | 89,673 | ||||||
Accumulated deficit |
(87,220 | ) | (79,155 | ) | ||||
Total Point Blank Solutions, Inc. stockholders equity |
7,657 | 10,566 | ||||||
Noncontrolling interests |
1,001 | 411 | ||||||
Total stockholders equity |
8,658 | 10,977 | ||||||
Total liabilities and stockholders equity |
$ | 68,008 | $ | 125,375 | ||||
See accompanying notes to condensed consolidated financial statements.
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POINT BLANK SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
For the Three Months Ended | For the Nine Months Ended | |||||||||||||||
September 30, 2009 | September 30, 2008 | September 30, 2009 | September 30, 2008 | |||||||||||||
Net sales |
$ | 19,892 | $ | 30,327 | $ | 129,486 | $ | 91,314 | ||||||||
Cost of goods sold |
20,050 | 26,973 | 122,739 | 79,508 | ||||||||||||
Gross (deficit) profit |
(158 | ) | 3,354 | 6,747 | 11,806 | |||||||||||
Selling, general and administrative expenses |
6,049 | 9,936 | 20,809 | 24,716 | ||||||||||||
Litigation and cost of investigations |
585 | 2,531 | 1,747 | 6,220 | ||||||||||||
Employment tax withholding charge (credit) |
- | 37 | (279 | ) | (26,034 | ) | ||||||||||
Total operating costs |
6,634 | 12,504 | 22,277 | 4,902 | ||||||||||||
Operating (loss) income |
(6,792 | ) | (9,150 | ) | (15,530 | ) | 6,904 | |||||||||
Interest (income) expense, net |
(240 | ) | 281 | (1,160 | ) | 674 | ||||||||||
Other income, net |
(4 | ) | (1 | ) | (226 | ) | (216 | ) | ||||||||
Total other (income) expense |
(244 | ) | 280 | (1,386 | ) | 458 | ||||||||||
(Loss) income before income tax (benefit) expense |
(6,548 | ) | (9,430 | ) | (14,144 | ) | 6,446 | |||||||||
Income tax (benefit) expense |
(2,501 | ) | (3,359 | ) | (6,669 | ) | 3,134 | |||||||||
Net (loss) income |
(4,047 | ) | (6,071 | ) | (7,475 | ) | 3,312 | |||||||||
Net (loss) income attributable to noncontrolling interests |
(236 | ) | (302 | ) | 590 | (564 | ) | |||||||||
Net (loss) income attributable to Point Blank Solutions, Inc. |
$ | (3,811 | ) | $ | (5,769 | ) | $ | (8,065 | ) | $ | 3,876 | |||||
Basic and diluted (loss) earnings per common share |
$ | (0.08 | ) | $ | (0.12 | ) | $ | (0.17 | ) | $ | 0.08 | |||||
Basic and diluted (loss) earnings per contingently redeemable share |
$ | (0.07 | ) | $ | (0.12 | ) | $ | (0.16 | ) | $ | 0.08 | |||||
See accompanying notes to condensed consolidated financial statements.
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POINT BLANK SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
For the Nine Months Ended September 30, |
||||||||
2009 | 2008 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
Net (loss) income |
$ | (7,475 | ) | $ | 3,312 | |||
Adjustments to reconcile net (loss) income to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
1,669 | 940 | ||||||
Amortization of deferred financing costs |
88 | 88 | ||||||
Deferred income tax (benefit) expense |
(9,163 | ) | 3,148 | |||||
Equity-based compensation |
664 | 5,056 | ||||||
Changes in assets and liabilities: |
||||||||
Accounts receivable |
26,374 | 10,359 | ||||||
Inventories |
25,971 | (5,756 | ) | |||||
Income tax receivable |
11,743 | 8,213 | ||||||
Prepaid expenses and other current assets |
391 | 200 | ||||||
Deposits and other assets |
17 | (37 | ) | |||||
Accounts payable |
(13,000 | ) | 2,666 | |||||
Accrued expenses and other current liabilities |
4,221 | 426 | ||||||
Vest replacement program obligation |
(7 | ) | (110 | ) | ||||
Income taxes payable |
(285 | ) | - | |||||
Unrecognized tax benefits |
- | (74 | ) | |||||
Employment tax withholding obligation |
(1,521 | ) | (26,022 | ) | ||||
Other liabilities |
(33 | ) | (104 | ) | ||||
Net cash provided by operating activities |
39,654 | 2,305 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
Proceeds from sale of property and equipment |
- | 4 | ||||||
Purchases of property and equipment |
(1,277 | ) | (3,553 | ) | ||||
Net cash used in investing activities |
(1,277 | ) | (3,549 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
Bank overdraft |
- | (426 | ) | |||||
Contribution from minority owners |
- | 250 | ||||||
Loan to minority owners |
- | 200 | ||||||
Net (repayments) proceeds from credit facility |
(33,207 | ) | 1,252 | |||||
Net proceeds from the issuance of stock options |
1 | - | ||||||
Net proceeds from exercise of stock warrants |
- | 28 | ||||||
Net cash (used in) provided by financing activities |
(33,206 | ) | 1,304 | |||||
Net increase in cash and cash equivalents |
5,171 | 60 | ||||||
Cash at beginning of year |
1,707 | 213 | ||||||
Cash at end of period |
$ | 6,878 | $ | 273 | ||||
Supplemental cash flow information: |
||||||||
Property and equipment acquired by issuing a note payable |
$ | 23 | $ | 2,500 | ||||
See accompanying notes to condensed consolidated financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
Note 1. BASIS OF PRESENTATION
Interim Financial Information
The accompanying unaudited condensed consolidated financial statements of Point Blank Solutions, Inc. (Point Blank) and its subsidiaries (collectively, PBSI or the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The unaudited financial statements include all adjustments, consisting only of normal and recurring adjustments, which, in the opinion of management, were necessary for a fair presentation of financial condition, results of operations and cash flows for such periods presented. The results of operations for the interim periods are not necessarily indicative of the results for any other interim periods or for an entire year.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted in accordance with published rules and regulations of the Securities and Exchange Commission (the SEC). The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes to those financial statements included in the Companys Annual Report on Form 10-K for the year ended December 31, 2008.
Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements include the accounts of Point Blank and its subsidiaries, Point Blank Body Armor, Inc., Protective Apparel Corporation of America and Life Wear Technologies, Inc. All subsidiaries are wholly owned with the exception of a 0.65% interest in Point Blank Body Armor, Inc. held by a third party. The accounts of Lifestone Materials, LLC (Lifestone) are also included in the accompanying condensed consolidated financial statements. Point Blank has a 50% interest and is the primary beneficiary of Lifestone (See Note 8). All intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The Company has prepared the unaudited condensed consolidated financial statements in conformity with GAAP. Such preparation requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates based upon future events. The Company evaluates the estimates on an ongoing basis. In particular, the Company regularly evaluates estimates related to recoverability of accounts receivable and inventory, and accrued liabilities and the realization of deferred tax assets. The estimates are based on historical experience and on various other specific assumptions that the Company believes to be reasonable. Actual results could differ from those estimates based upon future events.
Reclassifications
Certain amounts in the prior year have been reclassified to conform to the current year presentation.
Subsequent Events
The Company has evaluated subsequent events through November 9, 2009, the filing date of this Form 10-Q with the SEC.
Fair Value Measurements
The Companys financial instruments consist primarily of cash, accounts receivable, accounts payable, notes payable and debt. The carrying value of cash, accounts receivable and accounts payable approximates their fair market values due to their short-term nature. The Company believes that the carrying value of its outstanding notes payable and debt approximates fair value.
Recent Accounting Pronouncements
Adoption of New Accounting Standards
In May 2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS 165). This statement establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and whether that date represents the date the financial statements were issued or were available to be issued. The Company adopted SFAS 165 during the second quarter of 2009. The Companys adoption of SFAS 165 did not have a material effect on the Companys financial statements, financial position, or results of operations.
In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification (TM) (Codification) and the Hierarchy of Generally Accepted Accounting PrinciplesA Replacement of FASB Statement No. 162 (SFAS 168). SFAS 168 establishes the Codification as the single source of authoritative GAAP recognized by the FASB to be applied by nongovernmental
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entities. SFAS 168 and the Codification became effective for financial statements issued for interim and annual periods ending after September 15, 2009. As the Codification was not intended to change or alter existing GAAP, its adoption did not have a material effect on the Companys financial statements, financial position or results of operations.
New Accounting Standards Not Yet Adopted
In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167). This statement modifies the way in which a primary beneficiary of a variable interest entity is determined. It is expected that a greater number of variable interest entities will be consolidated following the adoption of SFAS 167. SFAS 167 also expands the disclosures required around significant interests held by a reporting entity in a variable interest entity. SFAS 167 will become effective for the Company on January 1, 2010. The Company is currently evaluating the potential effects of the adoption of SFAS 167 on the Companys financial statements, financial position and results of operations.
In August 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-05, Fair Value Measurements and Disclosures (Topic 820)Measuring Liabilities at Fair Value. This ASU provides guidance on how to measure the fair value of liabilities, including an entitys own debt obligations, when such measurements are required by other U.S. GAAP (e.g., following a business combination). The ASU will become effective for the Company in the fourth quarter of 2009. It is not expected that the adoption of this ASU will have a material effect on the Companys financial statements, financial position or results of operations.
In September 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangementsa consensus of the FASB Emerging Issues Task Force (ASU 2009-13). This ASU amends the existing guidance in U.S. GAAP for determining when individual deliverables in a multiple element arrangement can be accounted for separately. It also provides a different mechanism for allocating arrangement consideration across separable elements. The ASU becomes effective for the Company on January 1, 2011; however, early adoption is permitted as of January 1, 2010. The Company is evaluating this election and the potential effects of the adoption of ASU 2009-13 on the Companys financial statements, financial position and results of operations.
Note 2. INVENTORIES
The components of inventories as of September 30, 2009 and December 31, 2008 are as follows (in thousands):
September 30, 2009 |
December 31, 2008 | |||||
Raw materials |
$ | 7,205 | $ | 24,799 | ||
Work in process |
432 | 90 | ||||
Finished goods |
5,092 | 13,811 | ||||
Total |
$ | 12,729 | $ | 38,700 | ||
Note 3. DEBT
Credit Facility
The Company and its subsidiaries entered into an Amended and Restated Loan and Security Agreement with its lender in 2007 (the Credit Facility). The Credit Facility is available to the Companys subsidiaries (the Borrowers), jointly and severally, and currently provides for (i) a revolving credit line allowing maximum borrowings of $15,000 through January 29, 2010, $10,000 from January 30, 2010 to February 11, 2010, and $5,000 from February 12, 2010 to April 3, 2010 (the Revolving Loan), and (ii) a $10,000 term loan (the Term Loan). Borrowings under the Revolving Loan are available in the form of advances or letters of credit granted or issued against a percentage of the Borrowers eligible accounts receivable and eligible inventory. Borrowings under the Revolving Loan and the Term Loan bear interest at the base rate plus 3.25%, for an effective interest rate of 5.25% as of September 30, 2009. The Revolving Loan and the Term Loan mature, and the Credit Facility expires, in April 2010.
At September 30 2009, there was no indebtedness outstanding under the Revolving Loan and $6,000 principal amount of indebtedness outstanding under the Term Loan.
The Credit Facility contains representations, warranties and covenants that, among other things, limit the Borrowers ability to (i) incur additional indebtedness, (ii) incur liens, (iii) pay dividends or make other restricted payments, (iv) make certain investments; (v) sell or make certain dispositions of assets or engage in sale and leaseback transactions, (vi) engage in certain business activities, (vii) engage in mergers, acquisitions or consolidations, and (viii) enter into certain contractual obligations. The Credit Facility also contains financial covenants that the Borrowers must comply with on a periodic basis, including but not limited to maximum capital expenditure, minimum consolidated earnings before interest, taxes, depreciation, amortization, non-cash compensation (EBITDA), minimum net worth and minimum availability requirements.
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The Borrowers complied with the minimum net worth and maximum capital expenditure covenants under the Credit Facility for the period ended September 30, 2009. However, if the Borrowers are unable to meet their financial covenants or other obligations under the Credit Facility going forward, the Borrowers may need to obtain waivers under and/or enter into amendments to the Credit Facility in order to permit continued compliance with the terms of the Credit Facility. No assurance can be given that the Borrowers will be successful in obtaining such waivers under and/or entering into such amendments to the Credit Facility. If the Borrowers fail to comply with the terms of the Credit Facility, the lender could declare the Borrowers in default, among other possible courses of action.
The Credit Facility is collateralized by substantially all of the Companys assets. The Term Loan also is supported by a third party guarantee (the Guarantee). In connection with the Guarantee, the Borrowers and the Parent Company executed a subordinated note (the Subordinated Note) for the benefit of the guarantor in the amount of the lesser of (i) $10,000, or (ii) such amount as may be advanced by the guarantor to our lender on behalf of the Borrowers and the Company to satisfy their obligations under the Term Loan. The Subordinated Note grants to the guarantor a junior subordinated security interest in specified assets of the Borrowers and the Company for the purpose of securing the payment and performance of the Subordinated Note.
The carrying amount of the Term Loan was $6,000 and $10,000 at September 30, 2009 and December 31, 2008, respectively, and approximates fair value due to the variable interest rate, which is based on current market rates. Certain recent amendments to the Credit Facility are described below:
| On July 30, 2009, the Company and the Borrowers entered into an amendment to the Credit Facility pursuant to which, among other things, the lender agreed not to test the Borrowers compliance with the minimum net worth and minimum EBITDA financial covenants under the Credit Facility for the period ended June 30, 2009. |
| On August 31, 2009, the Company and the Borrowers entered into an amendment to the Credit Facility pursuant to which, among other things, (i) the lender required that the Borrowers make two payments of $500 towards the principal amount of the Term Loan, (ii) the lender agreed not to test compliance with the minimum net worth and minimum EBITDA financial covenants under the Credit Facility for the period ended July 31, 2009, (iii) the lender extended the maturity date of the Term Loan to October 30, 2009, and (iii) the Borrowers agreed they would not have the right to access the Revolving Loan through the close of business on September 30, 2009. In connection with the amendment, the Borrowers paid the lender an amendment fee of $50. |
| On September 30, 2009, the Company and the Borrowers entered into an amendment to the Credit Facility pursuant to which, among other things, (i) the lender agreed not to test compliance with the minimum net worth and minimum EBITDA financial covenants under the Credit Facility for the period ended August 31, 2009, and (ii) the Borrowers agreed to extended the period during which they would not have the right to access the Revolving Loan to November 15, 2009. |
| On October 29, 2009, the Company and the Borrowers entered into an amendment to the Credit Facility pursuant to which the lender agreed to, among other things, (i) permit the Borrowers to resume borrowing under the Revolving Loan, which was amended to provide for maximum borrowings of $15,000 through January 29, 2010, $10,000 from January 30, 2010 to February 11, 2010, and $5,000 from February 12, 2010 to April 3, 2010, its maturity date, and (ii) increase borrowings under the Term Loan from $6,000 to $10,000 and extend its maturity date to April 3, 2010. The amendment also, among other things, (i) restated the Borrowers financial covenants under the Credit Facility, and (ii) increased the interest rate on the Revolving Loan and the Term Loan to the base rate plus 4.00%. In connection with the amendment, the Borrowers paid the lender an amendment fee of $200, and will be obligated to pay the lender an additional $150 fee if certain conditions are not met by the Borrowers and the Credit Facility is not terminated prior to January 31, 2010. |
Note Payable
In March 2008, the partner to Lifestone Materials, LLC (Lifestone, See Note 8) sold property and equipment to Lifestone in exchange for a $2,500 note payable. An additional $450 was advanced to Lifestone during 2008. The note payable balance as of September 30, 2009 was $2,950 and is recorded in the Companys Condensed Consolidated Balance Sheet. This loan bears interest at the prime rate plus 0.25%. Principal and interest are repaid on a quarterly basis from Lifestones available cash as determined by Lifestones partners.
Note 4. COMMITMENTS AND CONTINGENCIES
The Company refers to Item 3 of Part I of our Annual Report on Form 10-K for the year ended December 31, 2008 for disclosures of legal proceedings. Information regarding commitments and contingencies should be read in conjunction with the audited consolidated financial statements and notes to those financial statements included in that Form 10-K.
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SEC Investigation
We are subject to ongoing investigations by the SEC and the U.S. Attorneys Office for the Eastern District of New York into alleged violations of federal securities laws stemming from accounting irregularities and disclosure issues from 2003 through 2005. On August 24, 2009, we received a Wells Notice from the SEC in connection with its investigation. The Wells Notice informed us that the SECs regional staff office conducting the investigation (the Staff) has made a preliminary determination to recommend that the SEC bring a civil injunctive action against us for possible violations of Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 14(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act), and Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13 and 14a-9 thereunder. The recommended action would seek a permanent injunction and a civil penalty.
Under a process established by the SEC, we have the opportunity to submit to the Staff any reasons of law, policy or fact why we believe that the civil action should not be brought (a Wells Submission) before the Staff makes its formal recommendation to the SEC regarding what action, if any, should be brought against us. We are considering making a Wells Submission and will continue to cooperate with the SECs investigation, but there can be no assurance that the SEC will decide not to bring an action against the Company.
We believe that the investigation by the U.S. Attorneys Office is completed now that a grand jury has brought an indictment against Ms. Schlegel and Ms. Hatfield, and a superseding indictment against Mr. Brooks and Ms. Hatfield. The Company cooperated in such investigation and continues to cooperate with the U.S. Attorneys Office as it prepares for the criminal trials of Brooks and Hatfield, which are scheduled to proceed in January 2010. The Company has been engaged in ongoing discussions with the U.S. Attorneys Office concerning a potential non-prosecution agreement for the Company.
Securities Class Action and Shareholder Derivative Action
The securities class action settlement is final except insofar as the derivative action settlement could affect it. One party has appealed the derivative action settlement. The Commercial Litigation Division is not an appealing party, but has filed a court brief in objection to the settlement.
The grounds for the appeal and the issue raised by the Commercial Litigation Division is that the settlement terms involve an indemnification of Mr. Brooks by the Company. The appellant has argued that the SEC is expected to take action against Mr. Brooks that, if successful, would force him and others to pay money back to the Company under the Sarbanes Oxley Act. The appellant has alleged that the amount sought by the SEC could be as much as $180,000. Meanwhile, the settlement agreement has a provision by which the Company has agreed to indemnify Mr. Brooks for any amounts he is ordered to pay back to the Company. In essence, if Mr. Brooks is ordered by the SEC to pay money back to the Company, the money will move in a circle and will leave both Mr. Brooks and the Company in the same position they were in.
In the event the settlement is not finally approved, the settlement fund will be released from escrow as follows:
Mr. Brooks may exercise a sale back option, whereby the Company would have to buy back some or all of the stock he purchased at the per share purchase price, which totals approximately $14,825. The money for this stock buyback would come from the funds escrowed for the settlement. The Company has no obligation to pay Mr. Brooks this amount unless and until he exercises the option and the settlement funds are released from escrow. Mr. Brooks has 90 days from the date that the settlement is rejected to exercise the option.
As for the warrants Mr. Brooks exercised to partially fund the settlement, the Company must pay Mr. Brooks the difference between the exercise price of the warrants under his original warrant agreement and the elevated exercise price for his warrants that he exercised to fund the settlement. This is approximately $4,500. The money for this would come from the funds escrowed for the settlement. The Company has no obligation to pay Mr. Brooks this amount until the funds are released from escrow.
The remaining balance of the escrowed funds will be paid to the Company. Thus, in the event of a total unwinding in which Mr. Brooks is cashed out, the Company will receive approximately $15,875 consisting of the $3,000 balance remaining from the stock transactions and $12,875 of insurance proceeds. These insurance proceeds would be required to be used in any future litigation relating to the derivative and class action claims, and the insurers would have no further obligations to the Company or rights to the money. Under the various agreements, the amount from the escrow account already distributed to the Lead Plaintiffs counsel in the class action is approximately $8,725. In the event the Settlement is not finally approved, then within five days upon receiving notice from the Company or Mr. Brooks, Lead Plaintiffs counsel is required to refund the fees and expenses previously paid, plus accrued interest.
Employment Tax Withholding Obligations
From 2003 through early 2006, the Company paid certain cash bonuses to management and other employees. Members of senior management during that time and other employees also exercised options to purchase shares of the Companys common stock between 2003 and 2006 that had previously been granted to them. The payment of cash bonuses and exercise of options triggered tax withholding obligations by the Company related to the employees share of federal income tax, state income tax and Social Security charges on the compensation associated with the bonuses and options. The Company also had to remit to applicable taxing authorities the employers share of Social Security and other payroll related taxes.
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The Company has determined that income and other payroll related taxes were not withheld and remitted by the Company to the taxing authorities when those bonuses were paid and, with one exception, when the options were exercised. The Company self-reported these apparent violations to the relevant taxing authorities, including the Internal Revenue Service.
As of September 30, 2009 and December 31, 2008, the Company has recognized employment tax withholding obligations, including applicable penalties and interest related to this matter, totaling $6,633 and $8,154, respectively in the accompanying Condensed Consolidated Balance Sheets. The Company has been assessed $2,497 for the employee share of Social Security and Medicare taxes for the years 2004 through 2006 of which $1,521 has been paid as of September 30, 2009. The Company has filed an appeal with the IRS requesting an abatement of all remaining interest and penalties associated with the IRS assessments.
To the extent the Company is required to discharge employee income tax withholding obligations for current and former employees, management is pursuing recovery of those amounts from the affected employees. In July 2006, Mr. Brooks, the former Chief Executive Officer, signed a memorandum of understanding with the Company in which he represented, warranted and covenanted that he has paid (or will pay) all taxes (including, without limitation, federal and state, Social Security, Medicare, FICA or other withholding taxes or similar amounts) attributable to personal income received by him from the Company, including any fines, penalties or back taxes incurred by the Company solely as a result of personal income paid to him. The Company intends to pursue recovery from Mr. Brooks for any of the foregoing amounts ultimately due and payable by the Company to the taxing authorities. At September 30, 2009, the payroll tax withholding obligations that may be recoverable from former executive officers were $7,959.
On April 16, 2008, the statute of limitations for the major portion of the 2004 employment tax withholding obligations expired. Accordingly, the charge and related liability originally recorded during 2004 was reversed during the second quarter of 2008 in the amount of $26,000.
In April 2008, the Company and the Internal Revenue Service agreed to extend the statute of limitations related to federal employment tax withholding obligations for the tax years ended December 31, 2005 and 2006 until December 31, 2010.
Patents
On September 6, 2007, Christopher Van Winkle and David Alan Cox filed an action against the United States in the U.S. Court of Federal Claims alleging patent infringement and seeking compensation for the governments alleged unlicensed use of their patent. The allegedly infringing products were purchased on behalf of the U.S. Army by the General Services Administration (GSA) from Point Blank Body Armor Inc., the Companys subsidiary. The relevant contract with the GSA contains a patent infringement indemnity clause. On September 4, 2008, the United States settled with Christopher Van Winkle and David Alan Cox for $10,250. The Company expects the United States will make a claim for some portion of that amount against the Company and the Company intends to assert appropriate defenses. The Company cannot predict the timing or the outcome of this matter.
Tortious Interference
On April 7, 2008, Point Blank Body Armor filed suit against BAE Systems Specialty Defense Systems of Pennsylvania, Inc. (BAE) and John Norwood in the Southern District of Florida for tortious interference with an advantageous business relationship. The suit alleges that John Norwood used confidential information regarding Point Blank Body Armor that he obtained while working as a program manager for the U. S. Army to the detriment of Point Blank Body Armor and the advantage of his new employer, BAE. In particular, the confidential information was used to interfere with Point Blank Body Armors relationship with one of its suppliers, which in turn interfered with its bid for the production of 230,000 IOTVs pursuant to a request to submit a bid it had received from the U.S. Army. On February 20, 2009, Point Blank, BAE and Norwood entered into a Confidential Settlement Agreement and Release. On March 2, 2009, the litigation was dismissed with prejudice in accordance with the terms of the Settlement Agreement.
Galls Indemnification Claim
Galls, an Aramark Company, LLC (Galls) is one of the Companys distributors that previously purchased body armor containing Zylon from the Company. The Companys contract with Galls that governed the sales of the body armor included language regarding indemnification under certain circumstances. The Company understands that Galls has been cooperating in the Department of Justices (DOJ) False Claims Act investigation regarding all body armor sold that contained Zylon. Galls has also allegedly been informed that the DOJ may assert civil claims against Galls relating to Galls sale of body armor products containing Zylon. On or about May 4, 2009, the Company received, by way of submission of an online filing form, a demand from Galls seeking arbitration of a claim alleging entitlement to indemnification with respect to Galls legal fees associated with the DOJ investigation as well as any civil liability that it may ultimately be found to have regarding the body armor. The claim amount alleged to be in excess of $400 and they claim they may sustain future damages in an unspecified amount. The Company has vigorously defended itself. On October 5, 2009, Galls dismissed its claims against the Company without prejudice.
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Former Chief Executive Officers Termination Agreement
On April 16, 2009, the Board of Directors of the Company terminated the employment of Larry R. Ellis as the Companys President and Chief Executive Officer (the Termination). General Ellis employment was terminated pursuant to Section 8.2 of his Employment Agreement with the Company dated March 29, 2007 (the Employment Agreement). Payments to General Ellis because of the Termination are anticipated to occur in accordance with the terms of the Employment Agreement applicable to a termination not for Cause which, subject to General Ellis continued full performance of certain obligations under the Employment Agreement, is expected to include payment of an amount equal to two times the sum of General Ellis annual Base Salary in effect as of the date of termination plus a Bonus calculated at 100% of Base Salary in effect as of the date of termination (collectively, the Severance Payment), plus certain benefits. The amount of the total severance payment recorded in the second quarter of 2009 was $2,600 plus an additional $100 for vacation and pay in lieu of notification. The vacation and pay in lieu of notification was paid on July 21, 2009. The Severance Payment is to be paid in 24 equal monthly installments, but with the first six installments due on November 1, 2009 (the first business day following the date that is six months from the date of termination), and with each remaining payment due on the first business day of each month commencing with the seventh month following the month in which the termination date occurred. However, the aggregate Severance Payments and benefits may be reduced to take into account the effect of any excess parachute payment (as defined in Section 280G of the Internal Revenue Code of 1986, as amended (the Code)) as more particularly set forth in the Employment Agreement. The Company has not yet commenced the payment of the Severance Payment to General Ellis, and is discussing the terms of the Severance Payment with General Ellis. The full Employment Agreement for General Ellis was filed as Exhibit 10.6 to the Companys Annual Report on Form 10-K for the Year Ended December 31, 2006 (filed on October 1, 2007).
In addition, because of the Termination, the 100,000 units under General Ellis Deferred Stock Award granted in March 2008 immediately vested and 100,000 fully vested shares of the Companys common stock were issued to General Ellis. The form of Deferred Stock Award Agreement was filed as Exhibit 10.1 to the Companys Current Report on Form 8-K filed on March 18, 2008. The fair value of the Deferred Stock Award was being expensed in the accompanying financial statements on a straight-line basis over a three year vesting period. The unamortized value of the Deferred Stock Award of $237 was expensed in the financial statements in the second quarter of 2009.
Letters of Credit
As of September 30, 2009, the Company had open letters of credit for $526.
Note 5. EQUITY AWARDS
A total of 380,657 deferred stock awards were granted to members of the Board of Directors of the Company during the first nine months of 2009. The total equity based compensation cost associated with these awards at grant date was $225. Due to the resignation of three board members during the second quarter of 2009 the revised cost is $207 which has been recognized as of September 30, 2009. The amount of equity based compensation recognized in the third quarter of 2009 relating to these awards was approximately $47.
Note 6. BASIC AND DILUTED LOSS PER COMMON SHARE
For all periods presented, basic and diluted earnings per common share is presented in accordance with, ASC Section 260 Earnings per Share which provides the accounting principles used in the calculation of income per share. Basic income (loss) per common share excludes dilution and is calculated by dividing net income (loss) available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share include the potential dilution from the assumed conversion of all dilutive securities such as stock options and non-vested deferred stock awards using the treasury stock method. When the effect of the dilutive securities is anti-dilutive, such dilutive securities are not included in the calculation of diluted income per common share.
Basic income (loss) per common share calculations is based on the weighted average number of common shares outstanding during each period: 48,774,608 and 48,329,503 shares for the three months ended September 30, 2009 and 2008, respectively, and 48,719,970 and 48,339,503 for the nine months ended September 30, 2009 and 2008 respectively. For the quarters ended September 30, 2009 and 2008, the common stock options are anti-dilutive.
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The computation for basic and diluted loss (income) per common share is as follows:
For the Three Months Ended September 30, |
For the Nine Months Ended September 30, |
|||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Common Shareholders |
||||||||||||||||
Net (loss) income |
$ | (3,811 | ) | $ | (5,769 | ) | $ | (8,065 | ) | $ | 3,876 | |||||
Net (loss) income attributable to contingently redeemable common shares |
221 | 338 | 468 | (227 | ) | |||||||||||
Net (loss) income attributable to common shares |
$ | (3,590 | ) | $ | (5,431 | ) | $ | (7,597 | ) | $ | 3,649 | |||||
Weighted-average shares |
48,774,608 | 48,339,503 | 48,719,970 | 48,339,503 | ||||||||||||
Common stock equivalents - options |
- | - | - | - | ||||||||||||
Weighted-average shares and common stock equivalents |
48,774,608 | 48,339,503 | 48,719,970 | 48,339,503 | ||||||||||||
Basic and diluted (loss) income per common share |
$ | (0.08 | ) | $ | (0.12 | ) | $ | (0.17 | ) | $ | 0.08 | |||||
Contingently redeemable common shares |
||||||||||||||||
Net (loss) income attributed to contingently redeemable shares |
$ | (221 | ) | $ | (338 | ) | $ | (468 | ) | $ | 227 | |||||
Weighted-average shares |
3,007,099 | 3,007,099 | 3,007,099 | 3,007,099 | ||||||||||||
Basic and diluted (loss) income per contingently redeemable share |
$ | (0.07 | ) | $ | (0.12 | ) | $ | (0.16 | ) | $ | 0.08 | |||||
No stock options or deferred stock awards have been included in the computation of earnings per share for the three and nine months ended September 30, 2009, because they are anti-dilutive. A total of 385,558 deferred stock awards (representing 385,558 shares of common stock issued to employees other than executive management) have not been included in the computation of earnings per share for the three and nine months ended September 30, 2008, because they were anti-dilutive.
Note 7. PROVISION FOR INCOME TAXES
The Companys effective tax rate was 45.3% and 48.6% for the nine months ended September 30, 2009 and 2008, respectively. The Companys effective tax rate differs from the statutory rate primarily due to state income taxes and the accounting for uncertain tax positions.
The Company reached a settlement with the Internal Revenue Service related to their examination of its U.S. Corporate Income Tax Returns for the tax years ended December 31, 2003 through 2007, resulting in a refund of $11,300 that was received in the second quarter of 2009. As a result of the IRS settlement, $6,600 of the Companys reserves related to uncertain tax positions were reversed. $1,100 of the decrease in the reserves was credited to the provision for income taxes and impacted the effective tax rate, $4,500 of the reversal relates to equity-based compensation deductions for which the tax benefit was credited to additional paid-in capital. The remaining reserve liability related to uncertain tax positions of $4,737 was reduced to zero as a result of the settlement reached with the IRS regarding certain equity-based compensation deductions and other issues. In addition, the Company recognized $2,200 in interest income related to the final IRS settlement. The Company also settled its examination with the State of New York for the years 2002 through 2004 with no additional tax due.
The tax years 2003 to 2008 remain open to various state taxing jurisdictions and the tax year 2008 remains subject to examination in the United States.
Note 8. LIFESTONE MATERIALS
On March 18, 2008, the Company entered into a strategic alliance with a manufacturer and supplier of technologically advanced lightweight ballistic armor material. Under the terms of the joint venture agreement, an entity Lifestone Materials, LLC (Lifestone) was created which manufactures and sells woven fabric to both partners. Each partner has a 50% equity ownership in Lifestone. Each partner contributed $250 to provide Lifestone with working capital. The venture partner contributed property and equipment valued at $2,500 in exchange for a note payable, and the Company loaned the venture $2,500 to purchase property and equipment (this intercompany payable has been eliminated in consolidation). Lifestone leases a manufacturing facility in Anderson, South Carolina.
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Note 9. RELATED PARTY
Steel Partners II, L.P. and JPS Industries, Inc.
At the Companys 2009 Annual Meeting of Stockholders held on September 9, 2009, the Companys stockholders elected a slate of directors that included two employees of Steel Partners LLC (Steel Partners), the manager of Steel Partners II, L.P. (SP II). SP II reported in its Schedule 13D with respect to its investment in the Company, originally filed with the SEC on February 11, 2008 and subsequently amended, most recently on July 17, 2009, that it owns approximately 4.2% of the Companys outstanding common stock. SP II and its affiliates also own approximately 35% of JPS Industries, Inc. (JPS), a supplier of ballistic materials from whom the Company has historically made and continues to make purchases of materials. For the nine months ended September 30, 2009, the Company made purchases with an aggregate value of approximately $16,300 from JPS. During the period February 1, 2008 through December 31, 2008, the Company made purchases with an aggregate value of approximately $33,000 from JPS. The Company owed JPS approximately $15 and $1,100 as of September 30, 2009 and December 31, 2008, respectively. The transactions between JPS and the Company were not reviewed by the Companys Audit Committee as they were undertaken in the ordinary course of business pursuant to competitive bidding among suppliers.
Management Services Agreement with SP Corporate Services, LLC
Effective as of September 1, 2009, the Company entered into a management services agreement (the Agreement) with SP Corporate Services, LLC (SP Corporate Services). SP Corporate Services is an affiliate of Steel Partners. Mr. Henderson is a Managing Director and operating partner of Steel Partners, and Mr. Gibson, another member of the Board, is a Managing Director of SP Corporate Services.
In accordance with the Agreement, SP Corporate Services will provide the Company with the services of Mr. Henderson as the Companys Chief Executive Officer. Mr. Henderson has been serving as the Companys Chief Executive Officer since his appointment to such position on September 9, 2009. The Company will pay SP Corporate Services $37.5 per month as consideration for Mr. Hendersons services. The Company may pay SP Corporate Services an annual cash bonus pursuant to the Companys annual incentive plan. Additionally, the Company will reimburse SP Corporate Services for certain of Mr. Hendersons reasonable living expenses, including but not limited to his relocation, housing and automobile expenses.
Note 10. RESTRUCTURING CHARGE
The Company is in the process of finalizing a restructuring plan involving the consolidation of its manufacturing facilities. On February 18, 2009, partial implementation of the plan reduced the workforce by 88 employees. Additionally, during the first quarter of 2009, the Company recorded approximately $291 in restructuring costs, primarily related to severance benefits paid to affected employees over the 60 day period commencing with the date of announcement. In the second quarter of 2009, the Company further reduced its workforce by 456 people and recorded approximately $3,338 in restructuring costs, primarily related to severance benefits paid to affected employees which included $2,700 for General Ellis Termination payments, as well as $473 for the present value of future minimum lease payments, less an estimated sublease for both the Deerfield Beach and Washington, DC facilities. The Company did not record any additional restructuring costs during the third quarter of 2009.
The Company did not take a charge for the remaining term of the Oakland Park, FL lease contract, which is approximately 15 months because the facility is still actively being used for the packaging and shipping of product until the restructuring plan is completed.
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Table IReconciles the beginning and ending balances of the restructuring liability (in thousands):
Balance as of January 1, 2009 |
$ | - | ||
Charges |
3,617 | |||
Payments |
(616 | ) | ||
Balance as of September 30, 2009 |
$ | 3,001 | ||
Table IIRestructuring related expenditures presents expenses and their classification in the condensed consolidated statements of operations (in thousands):
For the Nine Months Ended September 30, 2009: | Severance | Leases | Total | ||||||
Cost of sales |
$ | 278 | $ | 387 | $ | 665 | |||
Selling, general, and administrative expense |
2,914 | 38 | 2,952 | ||||||
Total |
$ | 3,192 | $ | 425 | $ | 3,617 | |||
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
Cautionary Note on Forward-Looking Statements
This discussion contains forward-looking statements within the meaning of Section 27A of Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), and the Private Securities Litigation Reform Act of 1995, including statements regarding our expected financial position, business and financing plans. These forward-looking statements generally are identified by the words believe, project, expect, anticipate, estimate, intend, strategy, plan, may, should, will, would, will be, will continue, will likely result, and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of such risks and uncertainties is included in the section titled Risk Factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, as updated by our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2009 and June 30, 2009 and as further updated below. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.
Introduction
The following should be read in conjunction with the Companys unaudited condensed consolidated financial statements, including the respective notes thereto, all of which are included in this Form 10-Q. Unless stated to the contrary, or unless the context otherwise requires, references to PBSI, the Company, we, our or us in this report include Point Blank Solutions, Inc. and subsidiaries.
We are a leading manufacturer and provider of bullet, fragmentation and stab resistant apparel and related ballistic accessories, which are used domestically and internationally by military, law enforcement, security and corrections personnel, as well as governmental agencies. We also manufacture and distribute sports medicine, health support and other products, including a variety of knee, ankle, elbow, wrist and back supports and braces that assist serious athletes, weekend sports enthusiasts and general consumers in their respective sports and everyday activities.
We are organized as a holding company that currently conducts business through three operating subsidiaries. Sales to the U.S. military comprises the largest portion of our business, followed by sales to federal, state and local law enforcement agencies, including correctional facilities. Accordingly, any substantial increase, reduction in or delay in government spending or change in emphasis in defense and law enforcement programs would have a material effect on our business.
We derive substantially all of our revenue from sales of our products. Our ability to maintain recent revenue levels is highly dependent on continued demand for body armor and projectile-resistant clothing. There is no assurance, however, that in the event that governmental agencies refocus their expenditures due to changed circumstances, we will be able to diversify into alternate markets or alternate products, or we will be able to increase market share through acquisitions of other businesses.
Our market share is highly dependent upon the quality of our products and our ability to deliver products in a prompt and timely fashion. Our current strategic focus is on product quality and accelerated delivery, which we believe are the key elements in obtaining additional orders under new as well as existing procurement contracts with the U.S. military and other governmental agencies.
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Critical Accounting Policies
Our management believes that our critical accounting policies include:
Revenue recognitionWe recognize revenue when there is persuasive evidence of an arrangement, delivery of the product has occurred, the price for the goods is fixed or determinable and collectibility is reasonably assured.
We enter into contracts with all of our customers. These contracts specify the material terms and conditions of each sale, including prices and delivery terms for each product sold.
Ballistics apparel and accessory products sold to the U.S. military are manufactured to specifications provided by the U.S. military. Prior to shipment, each manufactured product is inspected by U.S. military representatives. Once the goods pass inspection by the U.S. Government Quality Assurance Specialist (denoted on Form DD 250), the U.S. military immediately accepts risk of ownership associated with those goods.
Non-military contracts specify that customers may return products to us only if such products do not meet agreed upon specifications. Ballistics apparel products sold to other customers besides the U.S. military for use in combat comply with National Institute of Justice (NIJ) standards or in the case of International Sales, the applicable International Standard, and are subjected to internal and external quality control procedures. Because of these internal and external quality control procedures, warranty returns of products sold to law enforcement agencies and to distributors are minimal.
We warrant that our ballistics apparel products will be free from manufacturing defects for a period of five years from the date of purchase. From time to time, individual ballistics apparel products may be returned because they are the incorrect size. In most cases, the product returned for sizing is retailored and reshipped to the customer. Returns for sizing, along with the cost involved in tailoring the units, are minimal.
We do not offer any general rights of return express or implied, associated with any of our military sales or our sports medicine and health support sales. Ballistic resistant apparel and other accessories sold to non-military customers have a 30-day right of return. At the time of sale, the sales transactions meet the conditions of ASC 605 -15-25 Revenue Recognition When Right of Return Exists, and revenue is recognized at the time of sale, net of a provision for estimated returns.
All our contracts specify that products will be shipped FOB shipping point or FOB destination. Shipments to the U.S. military are made FOB shipping point. We recognize revenue for military sales and for those non-military sales sent FOB shipping point when the related products are accepted and shipped. We defer revenue recognition for those sales that are shipped FOB destination until the related goods are received at the customers designated receiving locations.
InventoriesInventories are stated at the lower of cost (determined on the first-in, first-out basis) or market. An allowance for potential non-saleable inventory due to excess stock or obsolescence is based upon a detailed review of inventory components, past history, and expected future usage.
Stock CompensationNew, modified and unvested equity-based payment transactions with employees, such as stock options and deferred stock awards, are recognized in our consolidated financial statements based on their fair value (using appropriate option pricing models where required) and as compensation expense over the appropriate service period.
Income taxesWe use the asset and liability approach to account for income taxes. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the carrying amounts of assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period when the change is enacted. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Accruals for uncertain tax positions are provided for in accordance with the requirements of Accounting for Uncertainty in Income Taxes. Accordingly, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting for uncertainty in income taxes also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our financial position, results of operations, or cash flows.
OtherJudgments and estimates underlying our accounting policies vary based on the nature of the judgment or estimate. We use judgments and estimates to determine our allowance for doubtful accounts, which are determined through analysis of the aging of
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the accounts receivable at the date of the consolidated financial statements, assessments of collectibles based on an evaluation of historic and anticipated trends, the financial condition of customers and an evaluation of the impact of economic conditions. We also use judgments and estimates to determine the valuation allowances on our deferred tax assets to establish reserves for income taxes, each of which relate to our income taxes critical accounting policy. We base these estimates on projections of future earnings, effective tax rates and the impact of economic conditions. These judgments and estimates are based upon empirical data as applied to present facts and circumstances. Judgments and estimates are susceptible to change because the projections that they are based upon do not always turn out to be correct and unanticipated issues may arise that are not considered in our assumptions.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and contingent assets and liabilities in the financial statements and accompanying notes. Significant estimates inherent in the preparation of the accompanying consolidated financial statements include the carrying value of long-lived assets and allowances for receivables and inventories. Actual results could differ from these estimates and the differences could be material.
Results of Operations
The events that occurred during the first nine months of 2009 and for the year ended December 31, 2008 presented a significant challenge to us and our stockholders, vendors, directors, management and our customers. Significant delays in the awarding of U.S. Military and Federal Government soft body armor contracts, uncertainties in the transition of civilian law enforcement body armor certification standards, the continuing and deepening economic challenges facing our country, as well as the crisis in the credit markets, contributed to substantially reduced sales in 2008 and continued to impact our performance in the first nine months of 2009. We believe that these events highlight the value of our strategic vision to build upon our current platform in a way that makes us less dependent on sales of body armor to the military and government.
The nine months of 2009 were particularly difficult in the body armor industry as a whole. Lay-offs, plant closings, and other cost cutting measures were employed industry-wide in an attempt to reduce expenses to offset the downward trend in revenues. We implemented staff reductions and facility consolidations as part of the lean manufacturing transformation of our operations and cost cutting measures. Due to careful and focused management during this difficult economic period, we preserved operating capacity by building rapidly scalable production cells and reducing operating waste. By preserving important capabilities, we believe that we are in position to provide both the law enforcement community and the U.S. Government with sufficient products to meet projected requirements. We also believe that we have sufficient capacity that will enable us to continue to pursue additional business opportunities consistent with our strategic plan.
When reviewing the results of our operations it is important to understand the nature of contracting with the federal government and the possible effect of the federal governments budgeting process on our operating results and production backlog in any given year. Frequently, there may be events surrounding the U.S. and other defense budgets that create fluctuations in our backlog and portfolio of contracts with the federal government. These include availability of year-end monies to accomplish important last minute contracts for supplies and services, enactment of a continuing resolution which limits spending to the previous years level until a budget is signed into law, late approval of a new budget, use and timing of a supplemental appropriation, and several other possible events. These events can significantly affect the amount of orders we have in backlog and the number as well as size of major contracts we have for our products. In fact, during the first nine months of 2009 and the year ended December 31, 2008, requests for proposals and the awarding of contracts continued to be delayed. We believe that it is important for all investors to adequately understand the U.S. governments budget process and its potential impact on our results of operations and production backlog.
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THREE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2008
ANALYSIS OF NET SALES
Three Months Ended September 30, 2009 and 2008
(In thousands)
2009 | 2008 | Dollar Change | ||||||||||||||||
Net sales |
||||||||||||||||||
Military and Federal Government |
$ | 1,352 | 6.8 | % | $ | 9,619 | 31.7 | % | $ | (8,267 | ) | |||||||
Domestic/Distributors |
8,431 | 42.4 | % | 9,375 | 30.9 | % | (944 | ) | ||||||||||
International |
8,459 | 42.5 | % | 9,959 | 32.8 | % | (1,500 | ) | ||||||||||
Sports and Health Products |
1,767 | 8.9 | % | 1,503 | 5.0 | % | 264 | |||||||||||
Total |
20,009 | 100.6 | % | 30,456 | 100.4 | % | (10,447 | ) | ||||||||||
Less Discounts, Returns and Allowances |
(117 | ) | -0.6 | % | (129 | ) | -0.4 | % | 12 | |||||||||
Net Sales |
$ | 19,892 | 100.0 | % | $ | 30,327 | 100.0 | % | $ | (10,435 | ) | |||||||
For the three months ended September 30, 2009, our consolidated net sales were approximately $19.9 million, a decrease of $10.4 million or 34.3% from our consolidated net sales of $30.3 million for the three months ended September 30, 2008. Net sales of soft body armor products decreased $ 10.8 million or 37.2% from $29.0 million for the three months ended September 30, 2008 to $18.2 million for the three months ended September 30, 2009, primarily due to delays in military and other contract awards. These delays have significantly affected our net sales and results of operations.
For the three months ended September 30, 2009, Domestic/Distributor sales were $8.4 million, a decrease of 10.6% from the comparable prior year period of $9.4 million. This decrease was due to the Domestic/Distributor markets reaction to the change in the NIJ standards for soft body armor as well as the economic downturn in the national economy, which continued to have a direct impact on state and local governments spending.
For the three months ended September 30, 2009, International sales were $8.5 million compared to $10.0 million for the comparable period in 2008. The decrease was primarily due to certain one-time contract awards for soft body armor in the third quarter of 2008. International sales help to reduce exposure from U.S. Government contract delays and diversifies our sales mix.
For the three months ended September 30, 2009, Sports and Health Product sales were $1.8 million as compared to $1.5 million in third quarter of 2008, an increase of 20.0% due to increased sales to some of our national retailers.
Gross (deficit) profit for the quarter ended September 30, 2009 was approximately $(0.2) million or (0.1)% of net sales, as compared to approximately $3.4 million for the three months ended September 30, 2008 or 11.2% of net sales. The decrease in gross profit margin as a percentage of net sales quarter-over-quarter is due to the following (1) insufficient sales volume to cover the related manufacturing overhead costs and other variable expenses maintained in order to support future requirements and additional costs incurred from the winding down of certain manufacturing facilities, (2) inventory adjustments totaling $1.4 million as a result of identification of excess and obsolete inventory during the course of the implementation of a restructuring plan which included reducing square footage of our operating facilities and maintaining the appropriate inventory levels on hand in accordance with planned sales, partially offset by $1.0 million recovered by the sale of such inventory; and (3) an expense of $0.3 million due to materials not meeting required rigorous testing procedures.
We expect gross profit and gross profit margins will improve in future periods given the anticipated increase in sales volumes, the reduction in our inventory level from prior periods, our familiarity with new testing protocols and the resulting efficiencies from lean manufacturing. In addition, we are aggressively focusing our sales efforts on increasing the commercial and international business, each provide higher gross margins than our other business lines.
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OPERATING COSTS
Three Months Ended September 30, 2009 and 2008
(In thousands)
2009 | 2008 | Dollar Change |
||||||||
Selling and Marketing |
$ | 1,513 | $ | 2,030 | $ | (517 | ) | |||
Research and Development |
575 | 466 | 109 | |||||||
Equity-Based Compensation |
153 | 3,341 | (3,188 | ) | ||||||
Other General and Administrative |
3,808 | 4,099 | (291 | ) | ||||||
Selling, general and administrative expenses |
6,049 | 9,936 | (3,887 | ) | ||||||
Litigation and Cost of Investigations |
585 | 2,531 | (1,946 | ) | ||||||
Employment Tax Withholding Credit |
- | 37 | (37 | ) | ||||||
Total Operating Costs |
$ | 6,634 | $ | 12,504 | $ | (5,870 | ) | |||
Operating costs were $6.6 million or 33.2%, of net sales for the three months ended September 30, 2009 as compared to $12.5 million or 41.3% of net sales for the three months ended September 30, 2008. The decrease in expenses for the three months ended September 30, 2009 of $5.9 million or 47.2% as compared to the three months ended September 30, 2008 was primarily due to the following:
| Decrease of $3.2 million in equity-based compensation expense. All employee options and Board of Directors deferred stock awards were amortized in the financial statements through August 2008. Due to the change in the majority of the Board of Directors in the third quarter of 2008, all stock options and deferred stock awards (except for deferred stock awards granted to executive management during 2008) vested and the related unrecognized compensation cost was reported as an immediate charge to earnings in the period. |
| Decrease of $1.9 million in litigation and costs of investigations expenses. Although, we will continue to incur costs associated with litigation and cost of investigations, including costs associated with the indemnification of former officers and directors, the associated expense has decreased quarter-over-quarter. Certain of these costs may be recoverable from former officers and directors depending on the outcome of the related litigation and investigations. We cannot predict what the total amount of these costs will be or any recovery of these costs, if applicable. |
| Decrease of $0.5 million in selling and marketing expenses. Due to the reduction in workforce as a result of our restructuring plan, salaries, commission and certain other sales and marketing related expenses decreased. |
Interest income, net for the three months ended September 30, 2009 was approximately $0.2 million as compared to $0.3 million interest expense, net for the comparable period in 2008. The quarter ended September 30, 2009 includes $0.4 million in interest income received from the income tax refund as described in Note 7Provision for Income Taxes in the notes to the Condensed Consolidated Financial Statements included in this Form 10-Q, partially offset by an increase in interest expense attributable to the increase in the contractual rate of interest reflected in the amendments to our credit facility with our lender as well as an increase in the incremental amendment fees.
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NINE MONTHS ENDED SEPTEMBER 30, 2009, COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2008
ANALYSIS OF NET SALES
Nine Months Ended September 30, 2009 and 2008
(In thousands)
2009 | 2008 | Dollar Change | ||||||||||||||||
Net sales |
||||||||||||||||||
Military and Federal Government |
$ | 56,045 | 43.3 | % | $ | 49,912 | 54.7 | % | $ | 6,133 | ||||||||
Domestic/Distributors |
20,735 | 16.0 | % | 26,447 | 29.0 | % | (5,712 | ) | ||||||||||
International |
48,796 | 37.7 | % | 10,940 | 12.0 | % | 37,856 | |||||||||||
Sports and Health Products |
4,114 | 3.2 | % | 4,599 | 5.0 | % | (485 | ) | ||||||||||
Total |
129,690 | 100.2 | % | 91,898 | 100.6 | % | 37,792 | |||||||||||
Less Discounts, Returns and Allowances |
(204 | ) | -0.2 | % | (584 | ) | -0.6 | % | 380 | |||||||||
Net Sales |
$ | 129,486 | 100.0 | % | $ | 91,314 | 100.0 | % | $ | 38,172 | ||||||||
For the nine months ended September 30, 2009, net sales were approximately $129.5 million, an increase of 41.8% from net sales of $91.3 million for the nine months ended September 30, 2008. Net sales of soft body armor products increased from $87.3 million for the nine months ended September 30, 2008 to $125.6 million for the nine months ended September 30, 2009 due primarily to completing two military contracts for Outer Tactical Vests (OTVs) and Improved Outer Tactical Vests (IOTVs) and others for ballistic components.
For the nine months ended September 30, 2009, Domestic/Distributor sales were $20.7 million, a decrease of 21.6% from the comparable prior year period of $26.4 million. This decrease was due to the Domestic/Distributor markets reaction to the change in NIJ standards for soft body armor as well as the economic downturn in the national economy, which continued to have a had a direct impact on state and local governments spending. Shortages of a ballistic material required for one of our vest models also delayed order fulfillment, reducing commercial sales in the first quarter of 2009.
For the nine months ended September 30, 2009, International sales were $48.8 million compared to $10.9 million for the comparable period in 2008. The increase was due to a new contract for IOTVs which was produced in the second and third quarters of 2009. This increase reflects the emphasis placed on expanding our International sales to help reduce the exposure to U.S. Government contract delays and further diversifies our sales mix.
For the nine months ended September 30, 2009, Sports and Health Product sales were $4.1 million, a decrease of 10.9% from the comparable period in 2008. This decrease is primarily due to the loss of one of our retail customers in 2009.
Gross profit for the nine months ended September 30, 2009 was approximately $6.7 million or 5.2% of net sales, as compared to approximately $11.8 million or 12.9% of net sales for the nine months ended September 30, 2008. The decrease in gross profit margin as a percentage of net sales is due to the following: (1) restructuring charges of $0.7 million, including $0.4 million related to the net present value of minimum lease payments for our closed Deerfield Beach facility and $0.3 million related to severance payments as a result of our reduction in workforce; (2) inventory adjustments totaling $3.1 million as a result of identification of excess and obsolete inventory during the course of the implementation of a restructuring plan which included reducing square footage of our operating facilities and maintaining the appropriate inventory levels on hand in accordance with planned sales, partially offset by $2.3 million recovered by the sale of such inventory; (3) an expense of $1.2 million due to materials not meeting required rigorous testing procedures; and (4) completion of contracts that were subject to competitive pricing pressures which led to lower gross profit margins as well as a temporary slow-down in shipments caused by additional testing required by the U.S. military. By targeting expansion in our non-government sales, we are seeking to reduce our U.S. Government contracts as a percentage of our total sales. Our marketing efforts are designed to place additional emphasis on increasing our Domestic and International sales which produce higher gross margins. Additionally, the implementation of greater efficiencies utilizing lean manufacturing principles in our production facilities continues to progress. We believe that the lower production costs realized by the full implementation of our more efficient manufacturing systems combined with a more favorable sales mix will serve to reduce costs while increasing gross margins.
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OPERATING COSTS
Nine Months Ended September 30, 2009 and 2008
(In thousands)
2009 | 2008 | Dollar Change |
||||||||||
Selling and Marketing |
$ | 5,314 | $ | 6,461 | $ | (1,147 | ) | |||||
Research and Development |
1,479 | 1,251 | 228 | |||||||||
Equity-Based Compensation |
664 | 5,056 | (4,392 | ) | ||||||||
Other General and Administrative |
13,352 | 11,948 | 1,404 | |||||||||
Selling, general and administrative expenses |
20,809 | 24,716 | (3,907 | ) | ||||||||
Litigation and Cost of Investigations |
1,747 | 6,220 | (4,473 | ) | ||||||||
Employment Tax Withholding Credit |
(279 | ) | (26,034 | ) | 25,755 | |||||||
Total Operating Costs |
$ | 22,277 | $ | 4,902 | $ | 17,375 | ||||||
Operating costs were $22.3 million or 17.2%, of net sales for the nine months ended September 30, 2009 versus $4.9 million or 5.4% of net sales for the nine months ended September 30, 2008. The increase in expenses for the nine months ended September 30, 2009 of $17.4 million as compared to the nine months ended September 30, 2008 was principally due to the following:
| During the second quarter of 2008, the statute of limitations for the major portion of the 2004 employment tax withholding obligations expired. Accordingly, the charge and related liability originally recorded during 2004, totaling $26.0 million, was reversed during the second quarter of 2008. |
| Higher general and administrative expenses due to $3.0 million in restructuring charges in an effort to reduce overhead costs on a go-forward basis, of which $2.9 million was related to severance payments to former employees (included $2.7 million for General Ellis). |
The increases were partially offset by the following:
| Lower equity-based compensation expense of $4.4 million. All employee options and Board of Directors deferred stock awards were amortized in the financial statements through August 2008. Due to a change in the majority of the Board of Directors of the Company in the third quarter of 2008, all of the options and deferred stock awards (except for the deferred stock awards granted to executive management during 2008) became vested and any unrecognized compensation cost was reported as an immediate charge to earnings in the period. |
| Lower selling and marketing expenses of $1.1 million. Due to the reduction in the workforce as a result of our restructuring plan, salaries, commission and certain other sales and marketing expenses decreased. |
| Lower litigation and costs of investigations expenses of $4.5 million. Although, we will continue to incur costs associated with litigation and cost of investigations, including costs associated with indemnification of former officers and directors our expenses have been decreasing year-over-year. Certain of these costs may be recoverable from former officers and directors depending on the outcome of the related litigation and investigations. We cannot predict what the total amount of these costs will be or any recovery of these costs, if applicable. |
Interest income, net for the nine months ended September 30, 2009 was approximately $1.2 million as compared to $0.7 million interest expense, net for the same period in 2008. This change from the comparable period includes $2.2 million in interest income from the income tax refund, as more fully discussed below, partially offset by increased interest expense attributable to increases in the contractual rate of interest reflected in the amendments to the credit agreement as well as the incremental amendment fees.
Our effective tax rate was 45.3% and 48.6% for the nine months ended September 30, 2009 and 2008, respectively. The effective tax rate differs from the statutory rate primarily due to state income taxes and the accounting for uncertain tax positions.
ASC 740 requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the available evidence, both positive and negative for each respective tax jurisdiction, it is more likely than not that some portion or all of the deferred tax assets will not be realized. At September 30, 2009, management has determined that a valuation allowance of zero is appropriate for our deferred tax assets. We believe the positive evidence consisting of cumulative earnings exclusive of non-recurring charges, projected positive earnings for the next two years and the longevity of the net operating loss carry-forward are greater than the negative evidence of recent losses before non-recurring charges. Therefore, we believe it is more likely than not the net deferred tax assets will be realized and no valuation allowance is necessary.
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We have reached a settlement with the Internal Revenue Service related to its examination of our U.S. Corporate Income Tax Returns for the tax years ended December 31, 2003 through 2007 resulting in a refund of $11.3 million that was received in the second quarter of 2009. As a result of the IRS settlement, $6.6 million of our reserves related to uncertain tax positions were reversed. $1.1 million of the decrease in the reserves was credited to the provision for income taxes and impacted the effective tax rate, $4.5 million of the reversal relates to equity-based compensation deductions for which the tax benefit was credited to additional paid-in capital. The remaining reserve liability related to uncertain tax positions of $4.7 million was reduced to zero as a result of the IRS settlement on equity-based compensation deductions. In addition, we recognized $2.2 million in interest income related to the final IRS settlement. We also settled our examination with the State of New York for the years 2002 through 2004 with no additional tax due.
The tax years 2002 to 2008 remain open to various state taxing jurisdictions and the tax year 2008 remains subject to examination in the United States.
Inflation and Changing Prices
Our profitability is dependent, among other things, on our ability to anticipate and react to changes in the cost of key operating resources, including labor and raw materials. Substantial increases in costs and expenses could impact our operating results to the extent that such increases cannot be passed along to customers. Although we have taken steps to mitigate our risk to rising prices with prudent purchasing practices, inventory management techniques and the Lifestone joint venture, there can be no assurance that future supplies of raw materials and labor will not fluctuate due to market conditions outside of our control.
Certain operating costs such as insurance and other outside services continue to increase at or above the general rate of inflation, and we may be subject to other cost and supply fluctuations outside of our control. Although we have been able to react to most of these cost increases through effective negotiation of increased prices in our sales contracts, efficient purchasing practices and constant management of our raw materials inventory levels, there can be no assurance that we will be able to do so in the future. Additionally, competitive market conditions could limit our ability to pass on cost increases to our customers.
In the current market environment, it is possible that the Company may be exposed to deflationary pricing pressures. This could result in the Company having to offer reduced prices in bids to government authorities and other customers. In this circumstance, the Company would seek to renegotiate lower raw material pricing, and minimize other production costs to the extent possible. However, the Company can provide no assurances that it would be able to maintain its current gross margin in periods of deflation.
Liquidity and Capital Resources
Historically, we have relied on the credit facility provided under our Amended and Restated Loan and Security Agreement with our lender (the Credit Facility), together with funds generated from operations, to sustain working capital and projected capital expenditures. We expect to continue to rely on our existing Credit Facility for the remainder of 2009.
We will need to renew or replace the Credit Facility as it expires or otherwise becomes unavailable, and we may require additional financing in order to fund our operations. Recently, the capital and credit markets have become increasingly tight as a result of adverse economic conditions. If such conditions persist and funds are not readily available, it is likely that our ability to access capital and credit markets will remain limited. To address this, we are taking a number of actions to create additional liquidity. We are employing cash enhancing measures by implementing manufacturing efficiencies to improve productivity, working closely with our vendors and customers and taking cost cutting action such as the closing of our Deerfield Beach and Washington, DC facilities and the eventual closing of the Oakland Park, Florida, manufacturing facility. We also intend to pursue contracting opportunities in accordance with our strategic plan.
As of September 30, 2009, our working capital was approximately $7.4 million, compared to $20.2 million as of December 31, 2008. The decrease in working capital is mainly attributable to a reduction in on-hand inventories, accounts receivable and income taxes receivable. In addition, there was a decrease in our borrowing availability under the Credit Facility, as well as accounts payable due to the receipt of our income tax refund.
We refer to Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2008 for disclosures of contractual obligations over the next five or more years, including severance payments to General Ellis scheduled to begin November 1 2009, as more fully described in Note 4Commitments and Contingencies to our Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. These obligations could have a material adverse impact on our cash flows and liquidity.
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The accounts receivable days outstanding increased to 37 days at September 30, 2009, compared to 31 days at December 31, 2008. This increase is primarily due to a decrease in military receivables as a percentage of our total receivable base. Military receivables typically have a faster payment cycle than commercial receivables.
In order to meet the demands for working capital, we maintain a revolving line of credit with a major financial institution, which is discussed below. The purpose of the revolving line of credit is to provide liquidity when needed, on a short term basis. Our major material suppliers payment terms are normally 7 to 30 days from date of purchase, and our terms with customers range between 30 to 60 days from the date of sale. Any shortfall in working capital may lead us to borrow under our revolving credit line to maintain liquidity.
We and our subsidiaries entered into a Credit Facility with our lender in 2007. The Credit Facility is available to our subsidiaries (the Borrowers), jointly and severally, and currently provides for (i) a revolving credit line allowing maximum borrowings of $15 million through January 29, 2010, $10 million from January 30, 2010 to February 11, 2010, and $5 million from February 12, 2010 to April 3, 2010 (the Revolving Loan), and (ii) a $10 million term loan (the Term Loan). Borrowings under the Revolving Loan are available in the form of advances or letters of credit granted or issued against a percentage of our subsidiaries eligible accounts receivable and eligible inventory. Borrowings under the Revolving Loan and the Term Loan bear interest at the base rate plus 3.25%, for an effective interest rate of 5.25% as of September 30, 2009. The Revolving Loan and Term Loan mature, and the Credit Facility expires, in April 2010.
At September 30, 2009, there was no indebtedness outstanding under the Revolving Loan and $6.0 million principal amount of indebtedness outstanding under the Term Loan.
The Credit Facility contains representations, warranties and covenants that, among other things, limit the Borrowers ability to (i) incur additional indebtedness, (ii) incur liens, (iii) pay dividends or make other restricted payments, (iv) make certain investments; (v) sell or make certain dispositions of assets or engage in sale and leaseback transactions, (vi) engage in certain business activities, (vii) engage in mergers, acquisitions or consolidations, and (viii) enter into certain contractual obligations. The Credit Facility also contains financial covenants that the Borrowers must comply with on a periodic basis, including but not limited to maximum capital expenditure, minimum consolidated earnings before interest, taxes, depreciation, amortization, non-cash compensation (EBITDA), minimum net worth and minimum availability requirements.
The Borrowers complied with the minimum net worth and maximum capital expenditures covenants under the Credit Facility for the period ended September 30, 2009. However, if the Borrowers are unable to meet their financial covenants or other obligations under the Credit Facility going forward, the Borrowers may need to obtain waivers under and/or enter into amendments to the Credit Facility in order to permit continued compliance with the terms of the Credit Facility. No assurance can be given that the Borrowers will be successful in obtaining such waivers under and/or entering into such amendments to the Credit Facility. If the Borrowers fail to comply with the terms of the Credit Facility, the lender could declare the Borrowers in default, among other possible courses of action.
The Credit Facility is collateralized by substantially all of our assets. The Term Loan also is supported by a third party guarantee (the Guarantee). In connection with the Guarantee, the Borrowers and the Company executed a subordinated note (the Subordinated Note) for the benefit of the guarantor in the amount of the lesser of (i) $10 million, or (ii) such amount as may be advanced by the guarantor to our lender on behalf of the Borrowers and the Company to satisfy their obligations under the Term Loan. The Subordinated Note grants to the guarantor a junior subordinated security interest in specified assets of the Borrowers and the Company for the purpose of securing the payment and performance of the Subordinated Note.
The carrying amount of the Term Loan was $6.0 million and $10 million at September 30, 2009 and December 30, 2008, respectively, and approximates fair value due to the variable interest rate, which is based on current market rates. Certain recent amendments to the Credit Facility are described below:
| On July 30, 2009, the Company and the Borrowers entered into an amendment to the Credit Facility pursuant to which, among other things, the lender agreed not to test the Borrowers compliance with the minimum net worth and minimum EBITDA financial covenants under the Credit Facility for the period ended June 30, 2009. |
| On August 31, 2009, the Company and the Borrowers entered into an amendment to the Credit Facility pursuant to which, among other things, (i) the lender required that the Borrowers make two payments of $500,000 towards the principal amount of the Term Loan, (ii) the lender agreed not to test compliance with the minimum net worth and minimum EBITDA financial covenants under the Credit Facility for the period ended July 31, 2009, (iii) the lender extended the maturity date of the Term Loan to October 30, 2009, and (iii) the Borrowers agreed they would not have the right to access the Revolving Loan through the close of business on September 30, 2009. In connection with the amendment, the Borrowers paid the lender an amendment fee of $50,000. |
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| On September 30, 2009, the Company and the Borrowers entered into an amendment to the Credit Facility pursuant to which, among other things, (i) the lender agreed not to test compliance with the minimum net worth and minimum EBITDA financial covenants under the Credit Facility for the period ended August 31, 2009, and (ii) the Borrowers agreed to extended the period during which they would not have the right to access the Revolving Loan to November 15, 2009. |
| On October 29, 2009, the Company and the Borrowers entered into an amendment to the Credit Facility pursuant to which the lender agreed to, among other things, (i) permit the Borrowers to resume borrowing under the Revolving Loan, which was amended to provide for maximum borrowings of $15 million through January 29, 2010, $10 million from January 30, 2010 to February 11, 2010, and $5 million from February 12, 2010 to April 3, 2010, its maturity date, and (ii) increase borrowings under the Term Loan from $6 million to $10 million and extend its maturity date to April 3, 2010. The amendment also, among other things, (i) restated the Borrowers financial covenants under the Credit Facility, and (ii) increased the interest rate on the Revolving Loan and the Term Loan to the base rate plus 4.00%. In connection with the amendment, the Borrowers paid the lender an amendment fee of $200,000, and will be obligated to pay the lender an additional $150,000 fee if certain conditions are not met by the Borrowers and the Credit Facility is not terminated prior to January 31, 2010. |
In March 2008, the partner to Lifestone Materials, LLC (Lifestone) sold property and equipment to Lifestone in exchange for a $2.5 million note payable. An additional $0.5 million was advanced to Lifestone during 2008. The note payable balance as of September 30, 2009 was $3.0 million as reported in our Condensed Consolidated Balance Sheet. This loan bears interest at the prime rate plus .25%. Principal and interest are repaid on a quarterly basis from Lifestones available cash as determined by Lifestones partners.
Our capital expenditures for the nine months ended September 30, 2009 were approximately $1.3 million, compared to $3.6 million (which includes $2.5 million of property and equipment acquired through the Lifestone joint venture) for the nine months ended September 30, 2008. Our capital budget is intended to replace fixed asset equipment as needed and to take advantage of technological improvements that would improve productivity. Beginning in the second quarter of 2007, we increased capital expenditures to improve our systems for inventory control, manufacturing and accounting processes. These expenditures will continue in subsequent periods. We anticipate our capital expenditures for fiscal year 2009 to be approximately $2.0 million.
We believe that borrowings under the Credit Facility, together with funds generated from operations, will be adequate to sustain our operations, including anticipated capital expenditures, for the foreseeable future. There can be no assurance that we will be able to obtain further increases in our credit line if needed. We are exploring other potential sources of financing including the issuance of equity securities and, subject to the consent of our lender, other debt financing. However, there can be no assurance that such sources will be available or, if available, will provide terms satisfactory to us.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
Not applicable.
ITEM 4. | CONTROLS AND PROCEDURES. |
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act , as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2009.
Changes in Internal Control Over Financial Reporting
During the fiscal quarter covered by this report, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS. |
We refer to Item 3 of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, as updated by Part II, Item 1 of our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2009 and June 30, 2009, for a description of legal proceedings outstanding at the time of the filing of that report as to which any material developments that occurred during the three months ended September 30, 2009 are described below.
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SEC Investigation
We are subject to ongoing investigations by the SEC and the U.S. Attorneys Office for the Eastern District of New York into alleged violations of federal securities laws stemming from accounting irregularities and disclosure issues from 2003 through 2005.
On August 24, 2009, we received a Wells Notice from the SEC in connection with its investigation. The Wells Notice informed us that the SECs regional staff office conducting the investigation (the Staff) has made a preliminary determination to recommend that the SEC bring a civil injunctive action against us for possible violations of Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 14(a) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13 and 14a-9 thereunder. The recommended action would seek a permanent injunction and a civil penalty.
Under a process established by the SEC, we have the opportunity to submit to the Staff any reasons of law, policy or fact why we believe that the civil action should not be brought (a Wells Submission) before the Staff makes its formal recommendation to the SEC regarding what action, if any, should be brought against us. We are considering making a Wells Submission and will continue to cooperate with the SECs investigation, but there can be no assurance that the SEC will decide not to bring an action against the Company.
We believe that the investigation by the U.S. Attorneys Office is completed now that a grand jury has brought an indictment against Ms. Schlegel and Ms. Hatfield, and a superseding indictment against Mr. Brooks and Ms. Hatfield. The Company cooperated in such investigation and continues to cooperate with the U.S. Attorneys Office as it prepares for the criminal trials of Brooks and Hatfield, which are scheduled to proceed in January 2010. The Company has been engaged in ongoing discussions with the U.S. Attorneys Office concerning a potential non-prosecution agreement for the Company.
Securities Class Action and Shareholder Derivative Action
The securities class action settlement is final except insofar as the derivative action settlement could affect it. One party has appealed the derivative action settlement. The Commercial Litigation Division is not an appealing party, but has filed a court brief in objection to the settlement.
The grounds for the appeal and the issue raised by the Commercial Litigation Division is that the settlement terms involve an indemnification of Mr. Brooks by the Company. The appellant has argued that the SEC is expected to take action against Mr. Brooks that, if successful, would force him and others to pay money back to the Company under the Sarbanes Oxley Act. The appellant has alleged that the amount sought by the SEC could be as much as $180 million. Meanwhile, the settlement agreement has a provision by which the Company agreed to indemnify Mr. Brooks for any amounts he is ordered to pay back to the Company. In essence, if Mr. Brooks is ordered to the SEC to pay money back to the Company the money will move in a circle and will leave both Mr. Brooks and the Company in the same position they were in.
In the event the settlement is not finally approved, the settlement funds will be released from escrow as follows:
Mr. Brooks may exercise a sale back option whereby the Company would have to buy back some or all of the stock he purchased at the per share purchase price, which totals approximately $14.8 million. The money for this stock buyback would come from the funds escrowed for the settlement. The Company has no obligation to pay Mr. Brooks this amount unless and until he exercises the option and the settlement funds are released from escrow. Mr. Brooks has 90 days from the date that the settlement is rejected to exercise the option.
As for the warrants Mr. Brooks exercised to fund the settlement, the Company must pay Mr. Brooks the difference between the exercise price of the warrants under his original warrant agreement and the elevated exercise price for his warrants that he exercised to fund the settlement. This is approximately $4.5 million. The money for this would come from the funds escrowed for the settlement. The Company has no obligation to pay Mr. Brooks this amount until the funds are released from escrow.
The remaining balance of the escrowed funds will be paid to the Company. Thus, in the event of a total unwinding in which Mr. Brooks is cashed out, the Company will receive approximately $15.9 million consisting of the $3.0 million balance remaining from the stock transactions and $12.9 million of insurance proceeds. These insurance proceeds would be required to be used in any future litigation relating to the derivative and class action claims, and the insurers would have no further obligations to the Company or rights to the money.
Under the various agreements, the escrow has already distributed approximately $8.7 million to the Lead Plaintiffs counsel in the class action. In the event the settlement is not finally approved, then within five days upon receiving notice from the Company or Mr. Brooks, Lead Plaintiffs counsel is required to refund the fees and expenses previously paid, plus accrued interest.
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Patents
On September 6, 2007, Christopher Van Winkle and David Alan Cox filed an action against the United States in the U.S. Court of Federal Claims alleging patent infringement and seeking compensation for the governments alleged unlicensed use of their patent. The allegedly infringing products were purchased on behalf of the U.S. Army by the General Services Administration (GSA) from Point Blank Body Armor Inc., our subsidiary. The relevant contract with the GSA contains a patent infringement indemnity clause. On September 4, 2008, the United States settled with Christopher Van Winkle and David Alan Cox for $10.25 million. We expect the U.S. will make a claim for some portion of that amount against the Company and we intend to assert appropriate defenses. We cannot predict the timing or the outcome of this matter.
Tortious Interference
On April 7, 2008, Point Blank Body Armor filed suit against BAE Systems Specialty Defense Systems of Pennsylvania, Inc (BAE) and John Norwood in the Southern District of Florida for tortious interference with an advantageous business relationship. The suit alleges that John Norwood used confidential information regarding Point Blank Body Armor that he obtained while working as a program manager for the U. S. Army to the detriment of Point Blank Body Armor and the advantage of his new employer, BAE. In particular, the confidential information was used to interfere with Point Blank Body Armors relationship with one of its suppliers, which in turn interfered with its bid for the production of 230,000 IOTVs pursuant to a request to submit a bid it had received from the U.S. Army. On February 20, 2009, Point Blank, BAE and Norwood entered into a Confidential Settlement Agreement and Release. On March 2, 2009, the litigation was dismissed with prejudice in accordance with the terms of the Settlement Agreement.
Galls Indemnification Claim
Galls, an Aramark Company, LLC (Galls) is one of our distributors that previously purchased body armor containing Zylon from us. Our contract with Galls that governed the sales of the body armor included language regarding indemnification under certain circumstances. We understand that Galls has been cooperating in the Department of Justices (DOJ) False Claims Act investigation regarding all body armor sold that contained Zylon. Galls has also allegedly been informed that the DOJ may assert civil claims against Galls relating to Galls sale of body armor products containing Zylon. On or about May 4, 2009, we received, by way of submission of an online filing form, a demand from Galls seeking arbitration of a claim alleging entitlement to indemnification with respect to Galls legal fees associated with the DOJ investigation as well as any civil liability that it may ultimately be found to have regarding the body armor. The claim amount is alleged to be in excess of $400,000 and they claim they may sustain future damages in an unspecified amount. The Company has vigorously defended itself. On October 5, 2009, Galls dismissed its claims against the Company without prejudice.
Item 1A. | RISK FACTORS |
Set out below are material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
We are subject to ongoing investigations, which could require us to pay substantial fines or other penalties or subject us to other sanctions. We cannot predict the outcome or the timing of developments in these matters. We continue to incur significant expenses associated with these investigations.
We are subject to ongoing investigations by the SEC and the U.S. Attorneys Office for the Eastern District of New York into alleged violations of federal securities laws stemming from accounting irregularities and disclosure issues from 2003 through 2005. The existence of and material developments with respect to such investigation have been disclosed in our periodic reports filed with the SEC, and we have been cooperating with the SEC with respect to the investigation.
On August 24, 2009, we received a Wells Notice from the SEC in connection with such investigation. The Wells Notice informed us that the Staff has made a preliminary determination to recommend that the SEC bring a civil injunctive action against us for possible violations of Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 14(a) of the Exchange Act of and Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13 and 14a-9 thereunder. The recommended action would seek a permanent injunction and a civil penalty.
Under a process established by the SEC, we have the opportunity to submit to the Staff any reasons of law, policy or fact why we believe that the civil action should not be brought (a Wells Submission) before the Staff makes its formal recommendation to the SEC regarding what action, if any, should be brought against us. We are considering making a Wells Submission and will continue to cooperate with the SECs investigation, but there can be no assurance that the SEC will decide not to bring an action against the Company.
We are also subject to an industry-wide investigation by the Civil Division of the U.S. Department of Justice into the manufacture and sale of body armor products containing Zylon, a ballistic yarn produced by an unrelated company.
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While we are cooperating fully with the ongoing investigations mentioned above, we cannot predict when the investigations will be completed or the timing of any other developments, nor can we predict what the results of these matters may be.
We are a defendant in a securities class and a shareholder derivative action.
The securities class action settlement is final except insofar as the derivative action settlement could affect it. One party has objected to and appealed the derivative class action settlement.
In the event the settlement is not finally approved, the settlement funds will be released from escrow as follows:
Mr. Brooks may exercise a sale back option whereby the Company would have to buy back some or all of the stock he purchased at the per share purchase price, which totals approximately $14.8 million. The money for this stock buyback would come from the funds escrowed for the settlement. the Company has no obligation to pay Mr. Brooks this amount unless and until he exercises the option and the settlement funds are released from escrow. Mr. Brooks has 90 days from the date that the settlement is rejected to exercise the option.
As for the warrants Mr. Brooks exercised to fund the settlement, the Company must pay Mr. Brooks the difference between the exercise price of the warrants under his original warrant agreement and the elevated exercise price for his warrants that he exercised to fund the settlement. This is approximately $4.5 million. The money for this would come from the funds escrowed for the settlement. The Company has no obligation to pay Mr. Brooks this amount until the funds are released from escrow.
The remaining balance of the escrowed funds will be paid to the Company. Thus, in the event of a total unwinding in which Mr. Brooks is cashed out, the Company will receive approximately $15.9 million consisting of the $3.0 million balance remaining from the stock transactions and $12.9 million of insurance proceeds. These insurance proceeds would be required to be used in any future litigation relating to the Derivative and Class Action claims, and the insurers would have no further obligations to the Company or rights to the money.
Under the various agreements, the escrow has already distributed approximately $8.7 million to the Lead Plaintiffs counsel in the Class Action. In the event the settlement is not finally approved, then within five days upon receiving notice from the Company or Mr. Brooks, Lead Plaintiffs counsel is required to refund the fees and expenses previously paid, plus accrued interest.
We incur significant expenses as a result of our obligation to indemnify former directors and executive officers in ongoing legal proceedings. These expenses have been substantial and are likely to continue to be substantial. This adversely affects our net income and liquidity.
The investigations described in the previous risk factors also involve a number of former directors and executive officers. The former CEO Mr. Brooks, former CFO Ms. Schlegel and former COO Ms. Hatfield have been indicted by a grand jury and are the subject of a civil action initiated by the SEC as a result of these investigations. Under our By-Laws, in certain circumstances, we have obligations to advance expenses for legal fees incurred by these former directors and executive officers. To date, these expenses have been substantial. While we seek to monitor these expenses and to preserve our rights to recover these advances to the extent allowed under law, we will continue to incur expenses associated with our indemnification obligations. This adversely affects our financial position and profitability.
With respect to the advancement of expenses sought by Mr. Brooks, the former CEO, we have contended that we are no longer obligated to advance such expenses based on the conduct of Mr. Brooks in transferring assets out of the United States. Mr. Brooks has initiated litigation in the Chancery Court for the State of Delaware seeking a declaration that he is entitled to continued advancement, in response to which we have filed an answer denying his right to advancement. In addition, we have initiated litigation in the United States District Court for the Eastern District of New York contending that he has forfeited his rights to advancement. The action we commenced in the Eastern District of New York has been stayed in light of Mr. Brooks Delaware action. In the Delaware action, we sought discovery of information from Mr. Brooks, which he has resisted in light of his ongoing criminal prosecution. Mr. Brooks has indicated that he intends to dismiss his Delaware action against us without prejudice, which means that he would retain whatever right he may have to reinstitute his claim at a later date. We cannot predict the outcome of such litigation.
We rely significantly on our Credit Facility for liquidity needs. The available credit under the Credit Facility is linked to a borrowing base, and reductions in eligible receivables and inventory will reduce our ability to draw on the Credit Facility. The terms of the Credit Facility also include various covenants, and failure to meet these covenants could affect our ability to borrow under the Credit Facility. A reduction in our borrowing availability under or failure to remain in compliance with the terms of the Credit Facility could affect our liquidity and require us to seek other sources of financing.
Our liquidity depends on cash generated from operations and the availability of funding under our Credit Facility. Our Credit Facility is comprised of a Revolving Loan and a Term Loan. At September 30, 2009, there was no indebtedness outstanding under the Revolving Loan and $6.0 million principal amount of indebtedness outstanding under the Term Loan.
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The borrowing base under the Revolving Loan is limited based on eligible receivables and inventories, and any reductions in eligible receivables and inventory will reduce our ability to draw on the Revolving Loan.
The continued availability of financing under the Credit Facility also depends on the Borrowers satisfaction of a number of other conditions, including meeting various financial covenants on a periodic basis. If the Borrowers are unable to meet their financial covenants or other obligations under the Credit Facility going forward, the Borrowers may need to obtain waivers under and/or enter into amendments to the Credit Facility in order to permit continued compliance with the terms of the Credit Facility. No assurance can be given that the Borrowers will be successful in obtaining such waivers under and/or entering into such amendments to the Credit Facility.
If the Borrowers fail to comply with the terms of the Credit Facility, our lender could declare us in default, among other possible courses of action, which could affect our liquidity and require us to seek other sources of financing.
We will need to renew or replace our existing Credit Facility and may need to raise additional capital in order to fund our operations, which may be especially difficult in the current economic environment.
Our Credit Facility is comprised of a Revolving Loan and a Term Loan, and is set to expire in April 2010. We will need to renew or replace the Credit Facility as it expires or otherwise becomes unavailable, and we may require additional financing in order to fund our operations. We may be unable to renew the Credit Facility, find a replacement facility, or obtain additional financing on acceptable terms, or at all, which may adversely affect our business and operations.
Recently, the capital and credit markets have become increasingly tight as a result of adverse economic conditions. If such conditions persist and funds are not readily available, it is likely that our ability to access capital and credit markets will remain limited. In addition, if current global economic conditions persist for an extended period of time or worsen substantially, our business may suffer in a manner that could cause us to fail to satisfy the financial and other restrictive covenants to which we are subject under our existing Credit Facility.
Recent and future economic conditions, including turmoil in the financial and credits markets, may adversely affect our business.
Recent economic conditions may adversely affect our business, our customers, our financing and other contractual arrangements. In addition, conditions may remain depressed in the future or may be subject to further deterioration. Recent or future developments in the U.S. and global economies may lead to a reduction in spending on the products we provide, which could have an adverse impact on sales of our products.
Tightening of the credit markets and recent or future turmoil in the financial markets could also make it more difficult for us to refinance our existing indebtedness (if necessary), to enter into agreements for new indebtedness or to obtain funding through the issuance of our securities. Specifically, the tightening of the credit markets and turmoil in the financial markets could make it more difficult or impossible for us to refinance or renew our Credit Facility when it expires in April 2010.
Worsening economic conditions could also result in difficulties for financial institutions (including bank failures) and other parties we may do business with, which could potentially impair our ability to access financing under existing arrangements or to otherwise recover amounts as they become due under our other contractual arrangements.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. |
Not applicable
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES. |
Not applicable
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. |
Our 2009 Annual Meeting of Stockholder (the 2009 Annual Meeting) was held on September 9, 2009. The number of shares of common stock outstanding and eligible to vote as of July 29, 2009, the record date for the 2009 Annual Meeting, was 51,749,297.
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At the 2009 Annual Meeting, our stockholders elected four directors to hold office until the 2010 Annual Meeting of Stockholders or until their respective successors are elected and qualified, by the following votes:
Nominee |
For | Withheld | ||
James R. Henderson |
27,454,348 | 1,336,522 | ||
Robert Chefitz |
27,463,434 | 1,327,436 | ||
Terry R. Gibson |
27,497,826 | 1,293,044 | ||
Merrill A. McPeak |
27,481,492 | 1,309,378 |
At the 2009 Annual Meeting our stockholders also ratified the appointment of Crowe Horwath LLP as our independent registered public accounting firm for the fiscal year ending December 31, 2009, by the following vote:
For |
Against |
Abstain | ||
27,965,546 |
694,204 | 131,119 |
ITEM 5. | OTHER INFORMATION. |
None.
ITEM 6. | EXHIBITS. |
Exhibit |
Description | |
31.1 | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
POINT BLANK SOLUTIONS, INC. | ||
Dated November 9, 2009 | /S/ JAMES R. HENDERSON | |
President and Chief Executive Officer (Principal Executive Officer) | ||
Dated November 9, 2009 | /S/ MICHELLE DOERY | |
Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |
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Exhibit |
Description | |
31.1 | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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