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** **

 

** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-Q**

 

(Mark One)
| **x** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended June 30, 2008**

 

**OR**

 
| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------------------|

 

**For thetransition period from                                         to                                         **

 

**Commission File Number 001-33253**

 

**FORCE PROTECTION, INC.**

(Exact Name of Registrant as Specified in ItsCharter)

 

| **Nevada**                                                       | ** ** | **84-1383888**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization)  |       | (I.R.S. Employer  Identification No.) |
|                                                             |       |                                  |
| **9801 Highway 78, Building No. 1  Ladson, South Carolina** | ** ** | **29456**                             |
| (Address of Principal Executive Offices)                         |       | (Zip Code)                            |

 

**(843) 574-7000**

(Registrant’s Telephone Number, Including AreaCode)

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.         x  Yes         o  No

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 
| Large  accelerated filer  x |   | Accelerated  filer  o |   | Non-accelerated  filer  o(Do not check if a smaller reporting company) |   | Smaller reporting company  o |
|---------------------------------------|--------|---------------------------------|--------|----------------------------------------------------------------------------------|--------|----------------------------------------|

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).    o    Yes     x   No

 

Theregistrant had 68,318,162 shares of common stock outstanding as of September 30,2008.

 

 

 

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Tableof Contents

 

TABLE OF CONTENTS

 
| **PART I — FINANCIAL INFORMATION**                                                             |       |       |
|----------------------------------------------------------------------------------------------------------|------------|------------|
| ** **                                                                                               | ** ** |       |
| Item 1. Financial  Statements                                                                       |       | 1          |
|                                                                                                     |       |       |
| Item 2. Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       | 10         |
|                                                                                                     |       |       |
| Item  3. Quantitative and Qualitative Disclosures About Market Risk                                 |       | 19         |
|                                                                                                     |       |       |
| Item  4. Controls and Procedures                                                                    |       | 19         |
|                                                                                                     |       |       |
| **PART II—OTHER  INFORMATION**                                                                 |       |       |
| ** **                                                                                               | ** ** | ** ** |
| Item 1. Legal  Proceedings                                                                          |       | 21         |
|                                                                                                     |       |       |
| Item 1A. Risk Factors                                                                               |       | 23         |
|                                                                                                     |       |       |
| Item  2. Unregistered Sales Of Equity Securities And Use Of Proceeds                                |       | 23         |
|                                                                                                     |       |       |
| Item  3. Defaults Upon Senior Securities                                                            |       | 23         |
|                                                                                                     |       |       |
| Item  4. Submission of Matters to a Vote of Security Holders                                        |       | 23         |
|                                                                                                     |       |       |
| Item 5.  Other  Information                                                                         |       | 23         |
|                                                                                                     |       |       |
| Item 6. Exhibits                                                                                    |       | 23         |

 

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**Table of Contents**

 

**PART I. FINANCIAL STATEMENTS**

 

**Item 1.**    FinancialStatements 

 

**Force Protection, Inc. and Subsidiaries**

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

 
| ** **                                          | ** ** | **As of  June 30,  2008** | ** ** | **As of  December 31,  2007** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------------|------------|
| ** **                                          | ** ** | **(In Thousands)**             | ** ** |
| **Assets**                                          |       |                                |       |                                    |       |
| **Current assets:**                                 |       |                                |       |                                    |       |
| Cash and cash equivalents                           |       | $                                   | 72,517     |                                    | $          | 90,997 |   |
| Accounts receivable, net                            |       | 131,053                             |       | 118,794                                 |       |
| Inventories                                         |       | 110,091                             |       | 140,639                                 |       |
| Advances to subcontractor                           |       | 10,909                              |       | 25,106                                  |       |
| Deferred income tax assets                          |       | 12,780                              |       | 14,530                                  |       |
| Income taxes receivable                             |       | —                              |       | 6,565                                   |       |
| Other current assets                                |       | 9,771                               |       | 8,481                                   |       |
| Total current assets                                |       | 347,121                             |       | 405,112                                 |       |
| Property and equipment, net                         |       | 64,316                              |       | 66,707                                  |       |
| Intangible assets, net                              |       | 1,005                               |       | 1,355                                   |       |
| Deferred income tax assets                          |       | 1,390                               |       | 1,496                                   |       |
| **Total assets**                                    |       | $                                   | 413,832    |                                    | $          | 474,670 |   |
|                                                |       |                                |       |                                    |       |
| **Liabilities and Shareholders’ Equity**       | ** ** | ** **                          | ** ** | ** **                              | ** ** |
| **Current  liabilities:**                           | ** ** | ** **                          | ** ** | ** **                              | ** ** |
| Accounts payable                                    |       | $                                   | 105,082    |                                    | $          | 146,515 |   |
| Due to United States government                     |       | 19,285                              |       | 18,969                                  |       |
| Other current liabilities                           |       | 18,127                              |       | 20,710                                  |       |
| Advance payments on contracts                       |       | 24,195                              |       | 56,552                                  |       |
| Total current liabilities                           |       | 166,689                             |       | 242,746                                 |       |
|                                                |       |                                |       |                                    |       |
| Other long-term liabilities                         |       | 145                                 |       | 295                                     |       |
|                                                |       | 166,834                             |       | 243,041                                 |       |
|                                                |       |                                |       |                                    |       |
| Commitments and contingencies                       |       |                                |       |                                    |       |
|                                                |       |                                |       |                                    |       |
| **Shareholders’ equity:**                      |       |                                |       |                                    |       |
| Common stock                                        |       | 68                                  |       | 68                                      |       |
| Additional paid-in capital                          |       | 257,225                             |       | 257,160                                 |       |
| Accumulated deficit                                 |       | (10,295                             | )          | (25,599                                 | )          |
| Total shareholders’ equity                     |       | 246,998                             |       | 231,629                                 |       |
| **Total liabilities and shareholders’ equity** |       | $                                   | 413,832    |                                    | $          | 474,670 |   |

 

The accompanying notes to condensed consolidated financial statementsare an integral part of these balance sheets.

 

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**Force Protection, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Operations**

**(Unaudited)**

 
| ** **                                       | ** ** | **For the three months ended  June 30,**  | ** ** | **For the six months ended  June 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                                           | ** ** | **2007**                                                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **(In Thousands, Except Per Share Data)** | ** ** |
| Net sales                                        |       | $                                                                  | 340,917    |                                                            | $          | 138,659 |   | $ | 743,964 |   | $ | 243,484 |   |
| Cost of sales                                    |       | 303,566                                                            |       | 118,090                                                         |       | 668,282 |   | 203,215 |   |
| Gross profit                                     |       | 37,351                                                             |       | 20,569                                                          |       | 75,682 |   | 40,269 |   |
|                                             |       |                                                               |       |                                                            |       |   |   |   |   |
| General and administrative expenses              |       | 21,525                                                             |       | 17,339                                                          |       | 46,150 |   | 34,405 |   |
| Research and development expenses                |       | 3,039                                                              |       | 3,503                                                           |       | 5,899 |   | 8,504 |   |
| Operating income (loss)                          |       | 12,787                                                             |       | (273                                                            | )          | 23,633 |   | (2,640 | ) |
|                                             |       |                                                               |       |                                                            |       |   |   |   |   |
| Other income, net                                |       | 460                                                                |       | 1,106                                                           |       | 971 |   | 2,894 |   |
| Interest expense                                 |       | (98                                                                | )          | (22                                                             | )          | (223 | ) | (31 | ) |
| Income before income tax expense                 |       | 13,149                                                             |       | 811                                                             |       | 24,381 |   | 223 |   |
|                                             |       |                                                               |       |                                                            |       |   |   |   |   |
| Income tax expense                               |       | (4,882                                                             | )          | (148                                                            | )          | (9,077 | ) | (40 | ) |
| Net income                                       |       | $                                                                  | 8,267      |                                                            | $          | 663 |   | $ | 15,304 |   | $ | 183 |   |
| **Earnings  per common share:**                  |       |                                                               |       |                                                            |       |   |   |   |   |
| Basic                                            |       | $                                                                  | 0.12       |                                                            | $          | 0.01 |   | $ | 0.22 |   | $ | 0.00 |   |
| Diluted                                          |       | $                                                                  | 0.12       |                                                            | $          | 0.01 |   | $ | 0.22 |   | $ | 0.00 |   |
| **Weighted  average common shares outstanding:** |       |                                                               |       |                                                            |       |   |   |   |   |
| Basic                                            |       | 68,311                                                             |       | 68,123                                                          |       | 68,304 |   | 67,879 |   |
| Diluted                                          |       | 68,372                                                             |       | 68,555                                                          |       | 68,368 |   | 68,248 |   |

 

The accompanying notes to condensed consolidated financial statementsare an integral part of these statements.

 

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**Force Protection, Inc. and Subsidiaries**

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                           | ** ** | **For the six months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2008**                                                            | ** ** | **2007** | ** ** |
| ** **                                                                           | ** ** | **(In Thousands)**                                             | ** ** |
| **Cash flows from operating activities:**                                            |       |                                                                |       |   |   |
| Net income                                                                           |       | $                                                                   | 15,304     |   | $ | 183 |   |
| Adjustments to reconcile net income to net  cash used in operating activities – |       |                                                                |       |   |   |
| Depreciation and amortization                                                        |       | 6,154                                                               |       | 2,079 |   |
| Deferred income tax provision (benefit)                                              |       | 1,856                                                               |       | (2,810 | ) |
| Income tax benefit realized from stock  options exercised                            |       | —                                                              |       | (2,276 | ) |
| Stock-based compensation                                                             |       | 65                                                                  |       | 1,553 |   |
| Allowance for doubtful accounts                                                      |       | 531                                                                 |       | (45 | ) |
| Provision for asset impairment                                                       |       | 4,947                                                               |       | — |   |
| Provision for inventory obsolescence                                                 |       | 3,837                                                               |       | 3,284 |   |
| Warranty reserve                                                                     |       | 467                                                                 |       | 838 |   |
| (Increase) decrease in assets –                                                 |       |                                                                |       |   |   |
| Accounts receivable                                                                  |       | (12,790                                                             | )          | (65,749 | ) |
| Inventories                                                                          |       | 26,711                                                              |       | (86,197 | ) |
| Advances to subcontractor                                                            |       | 14,197                                                              |       | — |   |
| Income taxes receivable                                                              |       | 6,565                                                               |       | (75 | ) |
| Other current assets                                                                 |       | (1,290                                                              | )          | (9,604 | ) |
| Increase (decrease) in liabilities –                                            |       |                                                                |       |   |   |
| Accounts payable                                                                     |       | (41,433                                                             | )          | 60,882 |   |
| Due to U. S. government                                                              |       | 316                                                                 |       | 5,190 |   |
| Other current liabilities                                                            |       | (2,980                                                              | )          | 6,291 |   |
| Advance payments on contracts                                                        |       | (32,357                                                             | )          | (10,024 | ) |
| Total adjustments                                                                    |       | (25,204                                                             | )          | (96,663 | ) |
| **Net cash used in operating activities**                                            |       | (9,900                                                              | )          | (96,480 | ) |
| **Cash flows from investing activities:**                                            |       |                                                                |       |   |   |
| Capital expenditures                                                                 |       | (8,360                                                              | )          | (25,538 | ) |
| **Net cash used in investing activities**                                            |       | (8,360                                                              | )          | (25,538 | ) |
| **Cash flows from financing activities:**                                            |       |                                                                |       |   |   |
| Proceeds from issuance of common stock                                               |       | —                                                              |       | 1,277 |   |
| Income tax benefit realized from stock  options exercised                            |       | —                                                              |       | 2,276 |   |
| Net (decrease) increase in long-term  liabilities                                    |       | (220                                                                | )          | 20 |   |
| **Net cash (used in) provided by financing  activities**                             |       | (220                                                                | )          | 3,573 |   |
| **Decrease in cash and cash equivalents**                                            |       | (18,480                                                             | )          | (118,445 | ) |
| **Cash and cash equivalents at beginning of  period**                                |       | 90,997                                                              |       | 156,319 |   |
| **Cash and cash equivalents at end of period**                                       |       | $                                                                   | 72,517     |   | $ | 37,874 |   |
| **Supplemental cash flow information:**                                              |       |                                                                |       |   |   |
| Cash paid during the period for                                                      |       |                                                                |       |   |   |
| Interest, net of amounts capitalized                                                 |       | $                                                                   | 238        |   | $ | 31 |   |
| Income taxes                                                                         |       | $                                                                   | 91         |   | $ | 700 |   |
| **Supplemental schedule of noncash investing  and financing activities**             |       |                                                                |       |   |   |
| Note payable, net of discount, issued as  consideration for non-compete agreement    |       | $                                                                   | —     |   | $ | 390 |   |

 

The accompanying notes to condensedconsolidated financial statementsare an integral part of these statements.

 

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**Force Protection, Inc. and Subsidiaries**

**Notes to Condensed Consolidated Financial Statements**

 

**1.**     **Summary of Significant AccountingPolicies**

 

***Organization and Description of the Business***

 

ForceProtection, Inc., reincorporated under the laws of Nevada in 2005, and itssubsidiaries, is an important provider of blast- and ballistic-protectedproducts used to support armed forces and security personnel in harm’sway.  We design, manufacture, test,deliver and support our blast- and ballistic-protected products to increasesurvivability of the users of the products. Our specialty vehicles, which we believe are the forefront of blast- andballistic-protected technology, are designed to protect their occupants fromlandmines, hostile fire, and improvised explosive devices (“IEDs”).  Our primary customer is the United StatesDepartment of Defense (“DoD”) where we service two principal services, the U.S. Army and U. S. Marine Corps.

 

Referencesherein to “Force Protection,” the “Company,” “we,” “our,” or “us” refer toForce Protection, Inc. and its subsidiaries unless otherwise stated orindicated by context.

 

***Basis of Presentation and Consolidation***

 

The accompanying unaudited condensed consolidated financial statementsshould be read in conjunction with our audited consolidated financialstatements included in our Annual Report on Form 10-K for the year ended December 31,2007 filed with the United States Securities and Exchange Commission (“SEC”) onSeptember 15, 2008. These unaudited condensed consolidated financialstatements have been prepared pursuant to Rule 10-01 of Regulation S-X.Certain information and note disclosures normally included in annual financialstatements prepared in accordance with generally accepted accounting principlesin the United States of America (“GAAP”) have been condensed or omittedpursuant to those rules and regulations, although we believe that thedisclosures made herein are adequate to make the information not misleading.

 

The unaudited results of operations for the interim periods shown inthese condensed consolidated financial statements are not necessarilyindicative of operating results for the entire year. In our opinion, theaccompanying unaudited condensed consolidated financial statements recognizeall adjustments of a normal recurring nature considered necessary to fairlystate the financial position, results of operations and cash flows for eachinterim period presented.

 

These unaudited condensed consolidated financial statements include theassets, liabilities, revenues and expenses of our two wholly ownedsubsidiaries, Force Protection Industries, Inc. and Force ProtectionTechnologies, Inc.  We eliminatefrom our financial results all significant intercompany accounts and transactions.

 

***Recent AccountingPronouncements***

 

In May 2008, the Financial Accounting Standards Board (“FASB”)issued FASB Statement No. 162, *TheHierarchy of Generally**AcceptedAccounting Principles*. FASB Statement No. 162 defines the orderin which accounting principles that are generally accepted should be followed.FASB Statement No. 162 is effective for fiscal years beginning after November 15,2008. We have not yet commenced evaluating the potential impact, if any, of theadoption of FASB Statement No. 162 on our consolidated financial position,results of operations, and cash flows.

 

In April 2008, the FASB issued Staff Position (“FSP”) No. FAS 142-3,*Determination of Useful Life of Intangible Assets,*(FSP FAS 142-3). FSP FAS 142-3 amends the factors that should beconsidered in developing the renewal or extension assumptions used to determinethe useful life of a recognized

 

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**Force Protection, Inc. and Subsidiaries**

**Notes to Condensed Consolidated Financial Statements (Continued)**

 

intangibleasset under FASB Statement No. 142, *Goodwill and OtherIntangible Assets*. FSP FAS 142-3 also requires expandeddisclosure related to the determination of intangible asset useful lives. FSPFAS 142-3 is effective for fiscal years beginning after December 15,2008. Earlier adoption is prohibited. We have not yet commenced evaluating thepotential impact, if any, of the adoption of FSP FAS 142-3 on our consolidatedfinancial position, results of operations and cash flows.

 

In March 2008, the FASB issued FASB Statement No. 161, *Disclosures about Derivative**Instruments and Hedging Activities*, anamendment of FASB Statement No. 133, *Accountingfor Derivative Instruments and Hedging Activities*. FASB Statement No. 161changes the disclosure requirements for derivative instruments and hedgingactivities. Entities are required to provide enhanced disclosures about (i) howand why an entity uses derivative instruments, (ii) how derivativeinstruments and related hedged items are accounted for under FASB Statement No. 133,*Accounting for Derivative Instruments andHedging Activities,*and its related interpretations and (iii) howderivative instruments and related hedged items affect an entity’s financialposition, results of operations, and cash flows. FASB Statement No. 161 iseffective for financial statements issued for fiscal years and interim periodsbeginning after November 15, 2008, with early application permitted. FASBStatement No. 161 permits, but does not require, comparative disclosuresfor earlier periods at initial adoption. We have not yet commenced evaluatingthe potential impact, if any, of the adoption of FASB Statement No. 161 onour consolidated financial position, results of operations, cash flows ordisclosures related to derivative instruments and hedging activities.

 

In December 2007, the FASB issued FASB Statement No. 141(revised 2007), *Business Combinations*,which establishes principles and requirements for how the acquirer in abusiness combination (i) recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed, and anycontrolling interest, (ii) recognizes and measures the goodwill acquiredin the business combination or a gain from a bargain purchase, and (iii) determineswhat information to disclose to enable users of the financial statements toevaluate the nature and financial effects of the business combination.  FASB Statement No. 141(R) appliesto fiscal years beginning after December 15, 2008. Earlier adoption isprohibited.

 

InDecember 2007, the FASB issued FASB Statement No. 160, *Noncontrolling Interests in Consolidated FinancialStatements*, which establishes accounting and reporting standardsthat require (i) the ownership interest in subsidiaries held byparties other than the parent to be clearly identified and presented in theconsolidated balance sheet within shareholder’s equity, but separate from theparent’s equity, (ii) the amount of consolidated net incomeattributable to the parent and the noncontrolling interest to be clearlyidentified and presented on the face of the consolidated statement ofoperations, and (iii) changes in a parent’s ownership interest while theparent retains its controlling financial interest in its subsidiary to beaccounted for consistently. FASB Statement No. 160 applies to fiscalyears beginning after December 15, 2008. Earlier adoption is prohibited.

 

InFebruary 2007, the FASB issued FASB Statement No. 159, *The Fair Value Option**for Financial Assets and Financial Liabilities*,which provides companies with an option to report selected financial assets andliabilities at fair value. FASB Statement No. 159 establishes presentationand disclosure requirements designed to facilitate comparisons betweencompanies that choose different measurement attributes for similar types ofassets and liabilities and requires companies to provide additional informationthat will help investors and other users of financial statements to more easilyunderstand the effect of a company’s choice to use fair value on its earnings.FASB Statement No. 159 also requires entities to display the fair value ofthose assets and liabilities for which the company has chosen to use fair valueon the face of the balance sheet. FASB Statement No. 159 does noteliminate disclosure requirements included in other accounting standards,including requirements for disclosures about fair value measurements includedin FASB Statements No. 157, *Fair Value**Measurements*, and No. 107, *Disclosures about Fair Value of FinancialInstruments.* FASB Statement No. 159 is effective as of thebeginning of an entity’s first fiscal year beginning after November 15,2007. We adopted FASB Statement No. 159 on January 1, 2008 and we did notelect the fair value option for any other financial instruments or certainother financial assets and liabilities that were not previously required to bemeasured at fair value.

 

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**Force Protection, Inc. and Subsidiaries**

**Notesto Condensed Consolidated Financial Statements (Continued)**

 

InSeptember 2006, the FASB issued FASB Statement No. 157, *Fair Value**Measurements*, which defines fair value, establishes aframework for measuring fair value under GAAP and expands disclosures aboutfair value measurements. FASB Statement No. 157 applies to otheraccounting pronouncements that require or permit fair value measurements. Thenew guidance is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007, and for interim periods within thosefiscal years. We adopted FASB Statement No. 157 on January 1, 2008and it did not have an impact on our consolidated financial position, resultsof operations and cash flows.

 

Wehave determined that all other recently issued accounting pronouncements willnot have a material impact on our consolidated financial position, results ofoperations and cash flows, or do not apply to our operations.

 

**2.**     **AccountsReceivable**

 

Accounts receivable consists of the following (inthousands):

 
| ** **                            | ** ** | **As of June 30, 2008** | ** ** | **As of December 31,  2007** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| U. S. government                      |       | $                                           | 106,320    |                                        | $          | 106,021 |   |
| Other accounts receivable             |       | 25,587                                      |       | 13,096                                      |       |
|                                  |       | 131,907                                     |       | 119,117                                     |       |
| Less: Allowance for doubtful accounts |       | (854                                        | )          | (323                                        | )          |
| Accounts receivable, net              |       | $                                           | 131,053    |                                        | $          | 118,794 |   |

 

Otheraccounts receivable includes amounts that relate to non-government entities andthe sale of excess raw materials to suppliers. Any gain or loss on the sale of excess raw materials is included in *Other income, net* in the accompanying condensed consolidatedstatement of operations.  As of June 30,2008 and December 31, 2007, our accounts receivable from the U.S. governmentincludes $3.8 million and $8.2 million of earned and unbilled accountsreceivable, respectively.

 

**3.**     **Inventories**

 

Inventories consist of the following (in thousands):

 
| ** **                | ** ** | **As of June 30, 2008** | ** ** | **As of December 31,  2007** | ** ** |
|---------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Raw material and supplies |       | $                                           | 75,096     |                                        | $          | 105,313 |   |
| Work in process           |       | 33,978                                      |       | 35,035                                      |       |
| Finished goods            |       | 1,017                                       |       | 291                                         |       |
| Inventories               |       | $                                           | 110,091    |                                        | $          | 140,639 |   |

 

Dueto excess and obsolete inventory and to account for our inventory at the lowerof cost or market, we reduced the cost basis of our raw material and suppliesand charged to *Cost of Sales* $1.0 and $3.8million during the three- and six-month periods ended June 30, 2008.

 

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**Force Protection, Inc. and Subsidiaries**

**Notesto Condensed Consolidated Financial Statements (Continued)**

 

**4.**     **Property and Equipment**

 

Propertyand equipment consist of the following (in thousands):

 
| ** **                                            | ** ** | **As of June 30, 2008** | ** ** | **As of December 31,  2007** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Land                                                  |       | $                                           | 4,419      |                                        | $          | 4,419 |   |
| Buildings                                             |       | 11,314                                      |       | 5,221                                       |       |
| Leasehold improvements                                |       | 31,940                                      |       | 11,775                                      |       |
| Machinery  and equipment; including tooling and molds |       | 12,999                                      |       | 6,698                                       |       |
| Computer equipment and software                       |       | 7,215                                       |       | 6,750                                       |       |
| Furniture and fixtures                                |       | 4,287                                       |       | 4,454                                       |       |
| Demonstration vehicles                                |       | 1,572                                       |       | 1,531                                       |       |
| Manuals                                               |       | 705                                         |       | 705                                         |       |
| Vehicles                                              |       | 621                                         |       | 576                                         |       |
|                                                  |       | 75,072                                      |       | 42,129                                      |       |
| Less: Accumulated depreciation                        |       | (12,467                                     | )          | (6,714                                      | )          |
|                                                  |       | 62,605                                      |       | 35,415                                      |       |
| Construction in progress                              |       | 1,711                                       |       | 31,292                                      |       |
| Property and equipment, net                           |       | $                                           | 64,316     |                                        | $          | 66,707 |   |

 

InJuly 2007, we purchased land and an approximately 430,000 square footbuilding in Roxboro, North Carolina for $3.5 million in cash, which weoriginally planned to use as a manufacturing plant.  We allocated approximately $0.8 millionto land and $2.7 million to the building.  In March 2008, we decided to suspend the construction of theassembly line at our Roxboro facility and began to develop a plan for analternative use for the facility.  We nowintend to use the Roxboro facility for sustainment and training purposes.  As a result, we charged to operations in thefirst quarter of 2008, as an asset impairment, $2.1 million in deposits on services tobe provided and $2.8 million in design costs that were previouslycapitalized.

 

**5.**     **Advance Payments on Contracts**

 

Advance payments on contracts consist of thefollowing (in thousands):

 
|                                                       |   | **As of June 30, 2008** | ** ** | **As of December 31,  2007** |   |
|------------------------------------------------------------|--------|----------------------------------------|------------|---------------------------------------------|--------|
| Mine Resistant Ambush Protected (“MRAP”) program |   | $22,965                                |       | $53,767                                     |   |
| Iraqi Light Armored Vehicles (“ILAV”)            |   | 1,230                                  |       | 2,785                                       |   |
| Advance payments on contracts                              |   | $24,195                                |       | $56,552                                     |   |

 

Undersome of our U.S. government contracts, we receive performance-based paymentsbased on completion of specific milestones stipulated under the contract (forexample, completion of manufacturing fabrication). We report these payments as *Advance payments on contracts* in our consolidated balancesheet until the final delivery of the products and formal acceptance by theU.S. government as evidenced by an executed Form DD250.

 

**6.**     **IncomeTaxes**

 

Weprovide for income taxes using the liability method in accordance with FASBStatement No. 109,*Accounting forIncome Taxes*. In accordance with APB Opinion No. 28,*Interim Financial Reporting*, and FASBInterpretation No. 18,*Accounting forIncome Taxes in Interim Periods*, the provision for taxes on incomerecognizes our estimate of the effective tax rate expected to be applicable forthe full fiscal year, adjusted for the impact of any discrete events, which arereported in the period in which they occur. Each quarter, we re-evaluate ourestimated tax expense for the year and make adjustments for changes in theestimated tax rate. Additionally, we evaluate the realizability of our deferredtax assets on a quarterly basis. Our evaluation considers all positive andnegative evidence and factors, such as the scheduled reversal of temporarydifferences, historical and projected future taxable income or losses, andprudent and feasible tax planning strategies.

 

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**Force Protection, Inc. and Subsidiaries**

**Notes to Condensed ConsolidatedFinancial Statements (Continued)**

 

The*Income tax expense* for the three and sixmonths ended June 30, 2008 was based on the estimated effective tax ratesapplicable for the fiscal year ending December 31, 2008, after consideringitems specifically related to the interim periods. The *Income tax expense*for the three- and six-monthperiods ended June 30, 2007 was based on the estimated effective tax ratesapplicable for the fiscal year ended December 31, 2007, after consideringitems specifically related to the interim periods.

 

ForceProtection is subject to U.S. federal, state, and local income taxes. *Income**before income taxexpense* is as follows (in thousands):

 
|                             |   | **For the three months ended  June 30,** |       | **For the six months ended  June 30,** |       |
|----------------------------------|--------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
|                             |   | **2008**                                                          | ** ** | **2007**                                                        | ** ** | **2008** | ** ** | **2007** |   |
| Income before income tax expense |   | $                                                                 | 13,149     |                                                            | $          | 811 |   | $ | 24,381 |   | $ | 223 |   |
|                                  |        |                                                                   |            |                                                                 |            |  |  |  |  |  |  |  |  |

 

Areconciliation of statutory federal income tax expense rate to the effectiveincome tax expense rate is as follows:

 
| ** **                                                                                      | ** ** | **For the three months ended  June 30,** | ** ** | **For the six months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2008**                                                          | ** ** | **2007**                                                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Income tax expense at statutory rate                                                            |       | (35.00                                                            | )%         | (35.00                                                          | )%         | (35.00 | )% | (35.00 | )% |
| (Increase) decrease in tax rate resulting  from: State income taxes, net of federal tax benefit |       | (1.93                                                             | )%         | (4.70                                                           | )%         | (1.93 | )% | (4.70 | )% |
| Reversal of other tax accruals no longer  required                                              |       | —                                                            |       | 8.21                                                            |  %    | — |   | 8.21 |  % |
| Research and development credit                                                                 |       | —                                                            |       | 11.63                                                           |  %    | — |   | 11.63 |  % |
| Other permanent differences                                                                     |       | 1.04                                                              |  %    | 2.55                                                            |  %    | 0.94 |  % | 2.55 |  % |
| Nondeductible items                                                                             |       | (1.24                                                             | )%         | (1.05                                                           | )%         | (1.24 | )% | (1.05 | )% |
| Effective income tax rate                                                                       |       | (37.13                                                            | )%         | (18.36                                                          | )%         | (37.23 | )% | (18.36 | )% |

 

Theeffective income tax rate is the provision for income tax expense as a percentof income before income taxes. The 2008 effective rate is higher than theexpected federal statutory rate of 35% primarily due to the state income taxesand permanent differences at statutory rate.

 

Weadopted FASB Interpretation No. 48, on January 1, 2007. FASBInterpretation No. 48 clarifies the accounting for uncertainty in incometaxes recognized in a company’s financial statements in accordance with FASBStatement No. 109, *Accounting for IncomeTaxes*. FASB Statement No. 109 does not prescribe a recognitionthreshold or measurement attribute for the financial statement recognition andmeasurement of a tax position taken in a tax return. FASB Interpretation No. 48clarifies the application of FASB Statement No. 109 by defining acriterion that an individual tax position must meet for any part of the benefitof that position to be recognized in a company’s financial statements.Additionally, FASB Interpretation No. 48 provides guidance on measurement,derecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition. We include interest and penalties relatedto federal and state income taxes, if any, as a component of *Income tax expense* in the accompanying unaudited condensedconsolidated statements of operations.

 

Webelieve that we have appropriate support for the income tax positions taken andto be taken on our income tax returns and that our income tax receivable andaccruals for tax liabilities are adequate for all open years and based on anassessment of many factors including past experience and interpretations of taxlaws applied to the facts of each matter. Accordingly, we have not recognized aliability as a result of applying the guidance in FASB Interpretation No. 48.

 

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**Table of Contents**

 

**Force Protection, Inc. and Subsidiaries**

**Notes to Condensed ConsolidatedFinancial Statements (Continued)**

 

**7.**     **EarningsPer Common Share**

 

Thefollowing table shows the information used in the calculation of basic anddiluted earnings per common share (in thousands, except number of shares andper share amounts):

 
| ** **                                                 | ** ** | **For the three months ended  June 30,** | ** ** | **For the six months ended  June 30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                                          | ** ** | **2007**                                                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Numerator  – Basic and diluted:**                   |       |                                                              |       |                                                            |       |   |   |   |   |
| Net income                                                 |       | $                                                                 | 8,267      |                                                            | $          | 663 |   | $ | 15,304 |   | $ | 183 |   |
| **Denominator:**                                           |       |                                                              |       |                                                            |       |   |   |   |   |
| Weighted  average common shares outstanding – basic   |       | 68,311,399                                                        |       | 68,122,995                                                      |       | 68,304,250 |   | 67,878,655 |   |
| Add:     Stock  options           |       | 26,713                                                            |       | 334,878                                                         |       | 26,868 |   | 280,621 |   |
| Add:     Stock  grants            |       | 34,012                                                            |       | 97,300                                                          |       | 36,544 |   | 88,959 |   |
| Weighted  average common shares outstanding – diluted |       | 68,372,124                                                        |       | 68,555,173                                                      |       | 68,367,662 |   | 68,248,235 |   |
| **Basic  earning per common share:**                       |       |                                                              |       |                                                            |       |   |   |   |   |
| Net income –  basic                                   |       | $                                                                 | 0.12       |                                                            | $          | 0.01 |   | $ | 0.22 |   | $ | 0.00 |   |
| **Diluted  earning per common share:**                     |       |                                                              |       |                                                            |       |   |   |   |   |
| Net income –  diluted                                 |       | $                                                                 | 0.12       |                                                            | $          | 0.01 |   | $ | 0.22 |   | $ | 0.00 |   |

 

Thecalculation of earnings per common share is based on the weighted-averagenumber of our common shares outstanding during the applicable period. Thecalculation for diluted loss per common share recognizes the effect of alldilutive potential common shares that were outstanding during the respectiveperiods, unless their impact would be anti-dilutive.  We use the treasury stock method to calculatethe dilutive effect of stock options and other common stock equivalents(potentially dilutive shares). Diluted earnings per common share recognizes thedilution that would occur if securities or other contracts to issue commonstock were exercised or converted into common stock. These potentially dilutiveshares include stock options and stock grants. 

 

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**Item 2. Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations (“MD&A”)is designed to provide information that is supplemental to, and should be readtogether with our unaudited condensed consolidated financial statements and theaccompanying notes included in this Quarterly Report on Form 10-Q.  Information in this Item 2 is intended toassist the reader in obtaining an understanding of our unaudited consolidatedfinancial statements, the changes in certain key items in those financialstatements from period to period, the primary factors that accounted for thosechanges, and any known trends or uncertainties that we are aware of that mayhave a material effect on our future performance, as well as how certainaccounting principles affect our unaudited condensed consolidated financialstatements. MD&A includes the following sections:

 

·                  Overview

·                  BusinessModel and Key Concepts

·                  KeyChallenges

·                  Strategyand Key Trends

·                  Resultsof Operations — an analysis of our consolidated results of operations, for thethree and six month periods presented in our condensed consolidated financial statements

·                  Liquidityand Capital Resources — an analysis of the effect of our operating,financing and investing activities on our liquidity and capital resources

·                  Off-BalanceSheet Arrangements — a discussion of such commitments and arrangements

·                  Contractual Obligations

·                  CriticalAccounting Policies and Estimates

·                  NewAccounting Pronouncements

 

**SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

This Quarterly Report on Form 10-Q,including the information incorporated by reference herein, contain bothhistorical and forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended (the ‘‘Securities Act’’), and Section 21Eof the United States Securities Exchange Act of 1934, as amended, (“ExchangeAct”).  All statements other thanstatements of historical fact included in this Quarterly Report on Form 10-Qand the documents incorporated by reference in this Quarterly Report on Form 10-Qthat address activities, events or developments that we expect, believe oranticipate will or may occur in the future are forward-looking statementsincluding, in particular, the statements about our plans, objectives,strategies and prospects regarding, among other things, our financial position,results of operations, cash flows and business. We have identified some ofthese forward-looking statements with words like ‘‘believe,’’ ‘‘may,’’ ‘‘will,’’‘‘should,’’ ‘‘expect,’’ ‘‘intend,’’ ‘‘plan,’’ ‘‘predict,’’ ‘‘anticipate,’’ ‘‘estimate’’or ‘‘continue’’ and other words and terms of similar meaning. Theseforward-looking statements include, among other things:

 

·                  statementsregarding the growth of the U.S. and world market for blast- andballistic-protected vehicles and survivability solutions;

 

·                  statements withrespect to our expectation regarding our ability to obtain materials,components and supplies necessary to manufacture our vehicles, our ability toimprove cost efficiencies, including, without limitation, as a result of volumepurchasing, improvements in our manufacturing process and possible futurechanges in the efficiencies in our operations; 

 

·                  statementsregarding any changes in our cost of sales, our general and administrativeexpenses or our research and development expenses as a percentage of net sales;

 

·                  statementsregarding the revenues that may be derived from, and the quantities of vehiclesthat may be purchased or ordered pursuant to, existing or possible futurecontracts or orders by various customers, including statements regarding theestimated value of those orders and contracts and statements about the amountof vehicles in our backlog and the value of our backlog;

 

·                  statementsregarding our ability to utilize net operating loss carry-forwards forincome tax purposes; and

 

·                  statementsregarding the rate at which we and GDLS will produce MRAP vehicles and the dateas of which we will achieve any particular monthly production rate of thesevehicles.

 

Whenused in this Quarterly Report on Form 10-Q, except as specifically notedotherwise, the term “Force Protection, Inc.” refers to Force Protection, Inc.only, and references  to the terms “Company,”“we,” “our,” “ours” and “us” refer to Force Protection, Inc. and itsconsolidated subsidiaries.

 

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**Overview**

 

We design, manufacture, test, deliver and support our blast- andballistic-protected products to increase survivability of the users of ourproducts. These vehicles require ongoing life cycle support in the areas ofspare parts, maintenance, and training. As a consequence, we believe that we have a substantial businessopportunity to provide life cycle support to our existing and future fleet ofvehicles.  In addition, as the fleetages, we have the opportunity to offer upgrades and product improvements forour fleet designed to further enhance the operability and capability of thevehicles.

 

Our specialty vehicles, which we believe are at the forefront of blast-and ballistic-protected technology, are designed to protect their occupantsfrom landmines, hostile fire and improvised explosive devices (“IEDs”). Wecurrently have four vehicle types aimed at fulfilling different operational ormission requirements: the Buffalo, the Cougar, the Cougar Lightweight / CougarRestricted Terrain, and the Cheetah. The Buffalo has six wheels, is our largestvehicle and is designed primarily for use in conducting mine clearanceoperations. The Cougar is a medium-sized vehicle and is available in 4-wheeledand 6-wheeled variants and in a variety of configurations for troop transport,command and control, route reconnaissance, convoy escort and ambulance duty.The Cougar Lightweight / Cougar Restricted Terrain is a new class of vehicledeveloped in response to an urgent request to develop vehicles providingenhanced mobility while maintaining survivability. Although this new class ofvehicle is derived from our successful Cougar platform, it incorporatessignificant amounts of design and technology developed as part of the Cheetahplatform.  On September 5, 2008, theUnited States Marine Corps made a contract award for five of these vehiclesunder the MRAP Competitive Contract, defined below.  The Cheetah is a 4-wheeled vehicle with a curbweight of approximately 8 tons, designed specifically for reconnaissance,forward command and control and urban operations. At present, we have not hadany orders for the Cheetah, although on September 15, 2008, we submitted aresponse to a U.S. Army Tank-Automotive and Armaments Command (“TACOM”) Requestfor Information.

 

We are headquartered, and have manufacturing facilities, in Ladson,South Carolina. In March 2007, we purchased a blast range in Edgefield,South Carolina, and leased a related office building. We use these facilitiesfor our own research and development activities and may also contract withselected governmental and commercial customers to use our facilities. We alsopurchased, in March 2007, a facility in Summerville, South Carolina, forthe intended purpose of expanding research and development operations and tofacilitate our increased customer training requirements of products andapplications. In July 2007, we purchased an additional facility inRoxboro, North Carolina. We intend to use this facility for training andsustainment purposes. In January 2008, we leased a small furnished officespace in Sterling Heights, Michigan, for use as an offsite engineering office.

 

*Business Model and Key Concepts*

 

On September 10, 2007we entered into a subcontract (the ‘‘GDLS Subcontract’’) with General DynamicsLand Systems Inc. (‘‘GDLS’’) pursuant to which GDLS manufactures approximately50% of the Cougar vehicles to be manufactured under, and performs approximately50% of the life cycle support required by, the January 2007 U.S. Marine Corps competitivecontract under the Mine Resistant Ambush Protected (“MRAP”) program for Cougar vehicles(“MRAP Competitive Contract”) based on revenues. We previously entered into ajoint venture with GDLS on December 15, 2006 (the ‘‘Workshare Agreement’’)pursuant to which we and GDLS would fulfill the obligations of the MRAPCompetitive Contract. We formed a Delaware limited liability company, ForceDynamics, LLC (‘‘Force Dynamics’’), to govern the terms of the joint venture.However, the MRAP Competitive Contract was awarded to us and not to ForceDynamics or GDLS. We have attempted to novate this contract to Force Dynamics,although the U.S. government has not yet agreed to the novation. If thecontract is novated, we and GDLS may be required to guarantee payment of allliabilities and performance of all obligations that Force Dynamics will assumeunder the novated contract.

 

Because this contract was awarded to Force Protection and has not yetbeen novated to the joint venture, we include 100% of the revenues from theMRAP Competitive Contract (including revenue from vehicles manufactured byGDLS) in *Net sales* in ourconsolidated statement of operations, and will continue to include them untilsuch time as the MRAP Competitive Contract is novated to Force Dynamics, atwhich point we will recognize revenues only from vehicles subcontracted byForce Dynamics that we actually manufacture. In addition, during the year endedDecember 31, 2007 we include in *Cost ofsales*, an amount equal to 100% of revenues from vehiclesmanufactured by GDLS. Notwithstanding the inclusion of revenues from vehiclesmanufactured by GDLS in *Net sales*,GDLS is entitled to all of the revenue from

 

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vehiclesmanufactured by GDLS. Activities under the GDLS Subcontract continue to evolveand after 2007 certain activities performed by GDLS result in a gross profit tous.

 

To meet the needs of other government contracts, in 2007 wesignificantly expanded our work force and invested heavily in additionalproduction facility capacity. However, beginning at the end of the firstquarter of 2008, we began to scale back our work force to be more in line withcurrent demand. In the future, we intend to utilize partners and subcontractorsto further expand our capacity and capability to fulfill government contracts.This is especially key as U.S. government contracts permit the government toterminate the contract, in whole or in part, without prior notice, at thegovernment’s convenience or for default, usually based on performance.Therefore, if the federal government terminates a contract with us or if wedefault due to our failure or the failure of our partner to perform under thecontract, we would be entitled to recover only our incurred or committed costs,settlement expenses and profit on the work completed prior to the terminationat best or could even be liable for excess costs incurred by the federalgovernment in procuring undelivered items from an alternative source.

 

*Key Challenges*

 

Our rapid growth has come with numerous challenges.Coupled with our reliance on the U.S. military for substantially all of ourbusiness, we have identified the following key challenges to continued success:

 

· being awardedadditional orders or contracts for our vehicles in a volatile marketplace;

· being awardedadditional orders or contracts for spare parts and/or sustainment services; 

· driving abusiness in an environment where U.S. military contracts, which representsubstantially all of our business, may    be terminated in wholeor in part at any time;

· remediatinginternal control weaknesses over financial reporting and disclosure;

· controllinggeneral and administrative expenses; and

· rebalancing thebusiness to contract delivery order requirements.

 

The main uncertainty about our future operations iswhether we will continue to receive additional orders or contracts for ourvehicles. We estimate that orders for MRAP vehicles allow us to continueproduction through the first part of 2009 and for our Buffalo vehicles toextend production until 2012. It is impossible to predict with certaintywhether future orders or contracts will be placed by new or existing customersfor our existing products. If we do not receive future orders or contracts forproduction beyond such dates, it is unlikely that our vehicle business willcontinue and our business will be materially affected.  If we do not receive future orders orcontracts for spare parts and/or sustainment services, our business may bematerially affected.

 

We derive substantially all of our revenue fromcontracts and subcontracts with the U.S. government and its agencies, primarilythe Department of Defense (“DoD”). We expect that U.S. government contracts,particularly with the DoD, will continue to be our primary source of revenuefor the foreseeable future. The continuation and renewal of our existinggovernment contracts and new government contracts are, among other things,contingent upon the availability of adequate funding for various U.S.government agencies, including the DoD. Changes in U.S. government spendingcould directly affect our operating performance and lead to an unexpected lossof revenue. The loss or significant reduction in government funding of a largeprogram in which we participate could also result in a material decrease to ourfuture sales, earnings and cash flows.

 

We have identified material weaknesses in ourinternal control over financial reporting and have concluded that ourdisclosure controls were not effective as of December 31, 2007, andalthough we have taken steps to correct our material weaknesses, we may stillbe subject to risks. If we are unsuccessful in implementing or following ourremediation plan, or fail to update our internal control over financialreporting as our business evolves, we may be unable to report financialinformation timely and accurately or to maintain effective disclosure controlsand procedures. There can be no assurance that, as a result of theseremediation efforts or otherwise, we will not identify other inaccuracies ineither our previous or future financial statements that will require amendmentsand restatements to those financial statements, which could have a materialadverse effect on us and the price of our common stock.

 

We experienced substantial growth in net salesduring the first half of 2008 and during 2007. At the same time, our generaland administrative expenses increased substantially to support the increasedbusiness base and due to the increased use of outside legal, accounting,auditing and consulting resources to address our material weaknesses ininternal controls and internal controls over financial reporting and therestatements of our condensed consolidated financial statements for the first,second and third quarters of 2007. We expect that managing general andadministrative expenses will continue to be a challenge. However, we are unable

 

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topredict whether general and administrative expenses will decrease.

 

During the first six months of 2008, we sought tostabilize our business to match our contract delivery order requirements. Werecognized that our business was changing, and in response, we are attemptingto rebalance our workforce and manufacturing capacity. We may incur costs as aresult of our efforts to recalibrate our business to meet the needs of ourcustomers. In addition, in the past three years we had sought to rapidly expandand develop our operations and production capacity. We have incurred costs andare continuing to incur significant costs associated with our rapid expansionbased on the expectation of future contract revenues. We are still experiencingand may continue to experience certain effects from this rapid growth, such aspayments under severance arrangements and the costs associated with excessmanufacturing capacity and inventory. This growth had placed significantdemands on our management and our administrative, operating, manufacturing andfinancial resources. In addition, our accounting and financial systems need tobe substantially improved in order to accommodate our current and projectedproduction levels and to support our government compliance requirements nowthat we are classified as a large business under applicable federal contractingregulations. We continue to face challenges in improving our administrative,operating, managerial, accounting and financial systems to accommodate ourcurrent and projected production levels.

 

*Strategy and Key Trends*

 

Strategy

 

We plan to leverage our investments in productdevelopment and production facilities. To accomplish this we will:

 

· identify newproducts and markets to meet evolving customer requirements;

· capitalize ondemand for blast- and ballistic-protected vehicles and other survivabilitysolutions;

· expand our serviceand support network;

· focus on corecompetencies; and

· leverage keyrelationships to grow our business.

 

KeyTrends

 

For periods subsequent to 2007, certain factors areexpected to affect our results of operations as compared to results reportedthrough 2007. Some of these factors are:

 

· stabilizing our growth and expansion to match our contract deliveryorder requirements;

· the GDLS Subcontract, under which during 2007 we purchased vehiclesproduced by GDLS from GDLS at the same sales price at which we sold thevehicles to the U.S. military, resulting in a zero gross profit for such sales,and under which after 2007 certain activities performed by GDLS will result ina gross profit to us;

· additional partnering to increase our offerings in designingsurvivability solutions, gaining insight into customer needs and shifting awayfrom manufacturing;

· costs of the Roxboro, North Carolina facility purchased in 2007initially intended to be used to expand our manufacturing capacity that in thefirst quarter of 2008 was determined to be excess capacity and for which webegan to develop a plan for alternative use for the facility and for which weincurred an impairment charge of $4.9 million; and

· potential additional business activities and full year carrying costsrelated to 2007 purchase of blast range and lease of a facility primarily forresearch and development activities and customer training.

 

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**Results of Operations**

 

Thefollowing discussion and analysis is based on our unaudited condensed consolidatedstatements of operations, which reflect our results of operations for the three-and six-month periods ended June 30, 2008 and 2007 as prepared inaccordance with generally accepted accounting principles in the United Statesof America (“GAAP”).

 

Thefollowing table presents our results of operations for the three- and six-monthperiods ended June 30, 2008 and 2007 as well as the percentage change fromyear to year.

 
| ** **                           | ** ** | **For the three months ended June 30,** | ** ** | **For the six months ended June 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                           | ** ** | ** **                                                            | ** ** | ** **                                                          | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **(In Thousands)**              | ** ** | ** **                                                            | **2008**   | ** **                                                          | **2007**   | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| Net sales                            |       | $                                                                     | 340,917    |                                                                | $          | 138,659 |   | 146 % |   |   | $ | 743,964 |   | $ | 243,484 |   | 206 % |   |   |
| Cost of  sales                       |       | 303,566                                                               |       | 118,090                                                             |       | 157 % |   |   | 668,282 |   | 203,215 |   | 229 % |   |   |
| Gross profit                         |       | 37,351                                                                |       | 20,569                                                              |       | 82 % |   |   | 75,682 |   | 40,269 |   | 88 % |   |   |
| General and  administrative expenses |       | 21,525                                                                |       | 17,339                                                              |       | 24 % |   |   | 46,150 |   | 34,405 |   | 34 % |   |   |
| Research and  development expenses   |       | 3,039                                                                 |       | 3,503                                                               |       | (13)% |   |   | 5,899 |   | 8,504 |   | (31) % |   |   |
| Operating  income (loss)             |       | 12,787                                                                |       | (273                                                                | )          | n/m |   |   | 23,633 |   | (2,640 | ) | n/m |   |   |
| Other  income, net                   |       | 460                                                                   |       | 1,106                                                               |       | (58)** **% |   |   | 971 |   | 2,894 |   | (66) % |   |   |
| Interest  expense                    |       | (98                                                                   | )          | (22                                                                 | )          | 345 % |   |   | (223 | ) | (31 | ) | 619 % |   |   |
| Income  before income tax expense    |       | 13,149                                                                |       | 811                                                                 |       | n/m |   |   | 24,381 |   | 223 |   | n/m |   |   |
| Income tax  expense                  |       | (4,882                                                                | )          | (148                                                                | )          | n/m |   |   | (9,077 | ) | (40 | ) | n/m |   |   |
| Net income                           |       | $                                                                     | 8,267      |                                                                | $          | 663 |   | n/m |   |   | $ | 15,304 |   | $ | 183 |   | n/m |   |   |
|                                      |            |                                                                       |            |                                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

n/m– not meaningful

 

***Comparison of Results of Operations for theThree and Six Months Ended June 30, 2008 and 2007***

 

*Units sold*

 

The following table presentsour shipments for the three- and six-month periods ended June 30, 2008 and2007 as well as the percentage change from year to year.

 
| ** **             | ** ** | **For the three months ended June 30,** | ** ** | **For the six months ended June 30,** | ** ** |
|------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **             | ** ** | ** **                                                            | ** ** | ** **                                                          | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **(Units Sold)**       | ** ** | ** **                                                            | **2008**   | ** **                                                          | **2007**   | ** ** | **Change**** ** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| Buffalo                |       | 25                                                                    |       | 17                                                                  |       | 47% |   |   | 49 |   | 35 |   | 40% |   |   |
| Cougar (all  variants) |       | 565                                                                   |       | 212                                                                 |       | 167% |   |   | 1,345 |   | 393 |   | 242% |   |   |
| Total units  sold      |       | 590                                                                   |       | 229                                                                 |       | 158% |   |   | 1,394 |   | 428 |   | 226% |   |   |
|                        |            |                                                                       |            |                                                                     |            |  |  |  |  |  |  |  |  |  |  |  |

 

Theincrease in vehicles sold for the comparative periods is primarily due tovehicles sold pursuant to the contracts (sole source and competitive) awardedto us under the MRAP program.  Of thevehicles sold for the three months ended June 30, 2008 and June 30,2007, the vehicles sold under such contracts represent approximately 93% and76%, respectively, of the total vehicles sold. Of the vehicles sold for the six months ended June 30, 2008 and June 30,2007, the vehicles sold under such contracts represent approximately 95% and48%, respectively, of the total vehicles sold.

 

*Netsales*

 

Theincrease in net sales for the comparative periods is attributable to anincrease in volume of vehicle deliveries, spare parts, and logistics services(field service representatives and technical publications). The mix of vehiclesdelivered and spares parts and logistics sales and the percentage change in thecomparative periods are set forth in the following table:

 

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| ** **                 | ** ** | **For the three months ended June 30,** | ** ** | **For the six months ended June 30,** | ** ** |
|----------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                                            | ** ** | ** **                                                          | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **(In Thousands)**    | ** ** | ** **                                                            | **2008**   | ** **                                                          | **2007**   | ** ** | **Change**** ** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| Buffalo                    |       | $                                                                     | 16,968     |                                                                | $          | 11,820 |   | 44% |   |   | $ | 33,660 |   | $ | 22,816 |   | 47% |   |   |
| Cougar (all  variants)     |       | 269,352                                                               |       | 109,989                                                             |       | 145% |   |   | 632,629 |   | 184,935 |   | 242% |   |   |
| Spare parts  and logistics |       | 54,597                                                                |       | 16,850                                                              |       | 224% |   |   | 77,675 |   | 35,733 |   | 117% |   |   |
|                       |       | $                                                                     | 340,917    |                                                                | $          | 138,659 |   | 146% |   |   | $ | 743,964 |   | $ |  243,484 |   | 206% |   |   |
|                            |            |                                                                       |            |                                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Cost ofsales and Gross profit*

 
| ** **              | ** ** | **For the three months ended June 30,** | ** ** | **For the six months ended June 30,** | ** ** |
|-------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in thousands)**      | ** ** | ** **                                                            | **2008**   | ** **                                                          | **2007**   | ** ** | **2008** | ** ** | **2007** | ** ** |
| Cost of sales           |       | $                                                                     | 303,566    |                                                                | $          | 118,090 |   | $ | 668,282 |   | $ | 203,215 |   |
| Gross margin percentage |       | 11.0                                                                  | %          | 14.8                                                                | %          | 10.2 | % | 16.5 | % |
|                         |            |                                                                       |            |                                                                     |            |  |  |  |  |  |  |  |  |  |

 

Thegross margin percentage decreased by 3.8 and 6.3 percentage points for thethree and six months ended June 30, 2008, respectively, compared to thecomparable 2007 periods primarily as a result of GDLS Subcontract activity,whereby we recognized no gross profit on vehicles sold that were produced byGDLS totaling $143.3 million and $339.6 million for the three and six monthsended June 30, 2008, respectively. We also incurred a write-down of our raw material and supplies to theirnet realizable values in the amount of $1.0 million and $3.8 million forthe three and six months ended June 30, 2008.

 

*General and administrative expenses*

* *
| ** **                   | ** ** | **For the three months ended June 30,** | ** ** | **For the six months ended June 30,** | ** ** |
|------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                   | ** ** | **2008**                                                              | ** ** | **2007**                                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                   | ** ** | ** **                                                            | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| As a percentage of net sales |       | 6.3                                                                   | %          | 12.5                                                                | %          | 6.2 | % | 14.1 | % |

 

Generaland administrative expenses as a percentage of net sales decreased 6.2percentage points and 7.9 percentage points for the three and six months ended June 30,2008, respectively, from the comparable 2007 periods primarily due to asignificant increase in sales volume. The increase in general and administrativeexpenses period over period is related to a $4.9 million charge related to animpairment of certain Roxboro, North Carolina assets, a $1.5 million one-timecontribution to the Medical University of South Carolina Foundation for braintrauma research, higher legal, accounting, auditing, and consulting fees,serverance and higher depreciation. These increases were offset by the absence of a liquated damages charge totaling$1.8 million and $6.7 million incurred in the three-and six-month periods endedJune 30, 2007, respectively, resulting from the delayed registration of aprivate placement of equity.

 

*Researchand development expenses*

 
| ** **                   | ** ** | **For the three months ended June 30,** | ** ** | **For the six months ended June 30,** | ** ** |
|------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                   | ** ** | **2008**                                                              | ** ** | **2007**                                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                   | ** ** | ** **                                                            | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| As a percentage of net sales |       | 0.9                                                                   | %          | 2.5                                                                 | %          | 0.8 | % | 3.5 | % |

 

Researchand development expenses decreased as a percentage of net sales by 1.6percentage points and 2.7 percentage points in the three and six months endedJune 30, 2008, respectively, from the comparable 2007 periods. The decrease inboth periods is primarily due to reduced Cheetah related expenditures and asignificant increase in sales volume. The 2007 Cheetah expenditures includedthe procurement of materials to build a series of vehicles to conduct ongoingtesting.

 

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*Otherincome*

 

Otherincome decreased in the three and six months ended June 30, 2008 compared withthe comparable 2007 periods due to the lower interest income as a result of thedecreased level of funds available for investing and decreased interest rates.

 

*Interestexpense*

 

Interestexpense increased for the three and six months ended June 30, 2008 over thecomparable 2007 periods as a result of commitment fees related to the line ofcredit initially put in place in late 2007 and amended and renewed in the firstand second quarters of 2008.

 

*Incometax expense*

 

Werecorded income tax expense for the three and six months ended June 30,2008 as a result of our pre-tax income. The effective income tax rate for the 2008 periods was approximately 37%compared to approximately 18% for the comparable 2007 periods.  See Note 6, *Income Taxes*,in the accompanying unaudited condensed consolidated financial statements.

 

*Netincome*

 
| ** **                                               | ** ** | **For the three months ended June 30,** | ** ** | **For the six months ended June 30,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in thousands, except per share)** | ** ** | **2008**                                                              | ** ** | **2007**                                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income                                               |       | $                                                                     | 8,267      |                                                                | $          | 663 |   | $ | 15,304 |   | $ | 183 |   |
| Diluted earnings per share                               |       | $                                                                     | 0.12       |                                                                | $          | 0.01 |   | $ | 0.22 |   | $ | 0.00 |   |

 

Net income for the three and six months ended June 30, 2008 increased overthe comparable 2007 periods primarily due to a higher amount of gross profit asa result of a higher volume of sales, partially offset by higher general andadministrative expenses, higher income tax expense and lower interest income.

 

**Backlog**

 

The following table setsforth the number of vehicles included in our backlog as of June 30, 2008,including vehicles to be manufactured by GDLS under the GDLS Subcontract.  The backlog shown in the following table is “funded”backlog, meaning that it reflects vehicles for which we have received ordersand for which funding has been appropriated and authorized for expenditure bythe applicable agency. We cannot assure you that we will deliver or sell all ofthe vehicles included in our backlog. See Part I, Item 1A, Risk Factors,included in our Annual Report on Form 10-K for the year ended December 31,2007.

** **
| ** **                  | ** ** | **Vehicle Funded Backlog  as of June 30, 2008** | ** ** |
|-----------------------------|------------|-------------------------------------------------------------------------------|------------|
| Buffalo                     |       | 22                                                                            |       |
| Cougar MRAP Competitive*    |       | 412                                                                           |       |
| Cougar (all other variants) |       | 329                                                                           |       |
| TOTAL                       |       | 763                                                                           |       |

 

----

*Refers to Cougarvehicles manufactured under the GDLS Subcontract pursuant to which we and GDLSfulfill the MRAP Competitive Agreement.

 

**Liquidity and Capital Resources**

 

Ourliquidity and available capital resources are impacted by operating, financingand investing activities.  Our principalsources of liquidity are cash on hand and cash from operations, primarily fromthe U.S. government.

 

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*Sources and Uses of Cash*

 

Ourprimary sources of funding are cash flows from operations. Our funds were usedprimarily to fund working capital requirements and make capital expenditures.The following chart shows the cash flows provided by or used in operating,investing, and financing activities for the six months ended June 30, 2008and 2007:

 
| ** **                                           | ** ** | **For the six months ended June 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(In thousands)**                              | ** ** | ** **                                                          | **2008**   | ** ** | **2007** | ** ** |
| Net cash used in operating activities                |       | $                                                                   | (9,900     | ) | $ | (96,480 | ) |
| Net cash used in investing activities                |       | (8,360                                                              | )          | (25,538 | ) |
| Net cash (used in) provided by financing  activities |       | (220                                                                | )          | 3,573 |   |
| Increase (decrease) in cash and cash  equivalents    |       | $                                                                   | (18,480    | ) | $ | (118,445 | ) |
|                                                      |            |                                                                     |            |  |  |  |  |  |

 

Asof June 30, 2008 we had $72.5 million of cash and cash equivalents, adecrease from $91.0 million as of December 31, 2007, and an increase from$37.9 million at June 30, 2007.

 

*Cash Flow from Operating Activities*

 

Cashused in operating activities decreased by $86.6 million during the first sixmonths of 2008 compared with the first six months of 2007 primarily due tohigher net income and improved working capital usage.  The cash used in operating activities duringthe first six months of 2007 was primarily due to working capital usageincreases to support the increased MRAP orders.

 

*Cash Flow from Investing Activities*

 

Cashused in investing activities decreased by $17.2 million during the first sixmonths of 2008 compared with the first six months of 2007 primarily due toreduced capital purchases necessary to support existing and future plannedbusiness requirements.  During the firstsix months of 2007, we purchased a research and test facility for $5.5 millionand expended $4.1 million to acquire a logistics training facility. Inaddition, we began construction of a warehouse and an additional assembly lineat our Ladson, South Carolina facility.

 

 *CashFlow from Financing Activities*

 

Cashprovided by financing activities decreased by $3.8 million during the first sixmonths of 2008 compared with the first six months of 2007 primarily due to areduced volume of stock option exercises and a decrease in long-termliabilities.

 

*Current Liquidity and Capital Resources*

 

Duringthe first six months of 2008, we expended approximately $9 million to completethe expansion of our manufacturing capability and capacity and to upgrade ourinformation technology infrastructure. We will continue to expend capital for research and development andbusiness development activities.

 

Theamount of capital that we will require depends on several factors, includingwithout limitation, the extent and timing of sales of our products, performancebased payments, inventory costs, costs of raw materials and components, laborcosts, costs of improving our financial and accounting systems,  thetiming and costs associated with the expansion of our manufacturing,development, engineering and customer support capabilities, the timing and costof our product development and enhancement activities and our operatingresults. We currently estimate that the cash flow that we anticipate will begenerated by our business plus the $30 million available under our line ofcredit and our expected renewal of it will be sufficient to meet our presentlybudgeted capital expenditures and our other presently anticipated cash needsfor the year ending December 31, 2008.  After that time, we expect that we may need toobtain additional sources of capital, which may include borrowings or theissuance of debt or equity securities, including common stock, and there can beno assurance that such financing will be available to us when we need it or, ifavailable, that

 

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theterms of any such financing will be satisfactory to us and not dilutive to ourshareholders. Any failure to obtain necessary capital as and when requiredcould have a material adverse effect on our business, prospects, financialposition, results of operations and cash flows.

 

**Off-Balance Sheet Arrangements**

 

Inaccordance with the definition under SEC rules and regulations, thefollowing qualify as off–balance sheet arrangements:

 

·                  any obligation under certain guarantees orcontracts;

·                  a retained or contingent interest in assetstransferred to an unconsolidated entity or similar entity or similararrangement that serves as credit, liquidity, or market risk support to thatentity for such assets;

·                  any obligation under certain derivativeinstruments; and

·                  any obligation under a material variableinterest held by the registrant in an unconsolidated entity that providesfinancing, liquidity, market risk, or credit risk support to the registrant, orengages in leasing, hedging, or research and development services with theregistrant.

 

Thefollowing discussion addresses each of the above items for the Company.

 

Asof June 30, 2008, we do not have any obligation under certain guaranteesor contracts as defined above.

 

Asof June 30, 2008, we do not have any retained or contingent interest inassets as defined above.

 

Asof June 30, 2008, we do not hold derivative financial instruments, asdefined by FASB Statement No. 133, *Accountingfor Derivative Instruments and Hedging Activities,* as amended.

 

Aspart of our ongoing business, we do not participate in transactions thatgenerate relationships with unconsolidated entities or financial partnerships,such as entities often referred to as structured finance or special purposeentities (“SPEs”), which would have been established for the purpose offacilitating off-balance sheet arrangements or other contractually narrow orlimited purposes. As of June 30, 2008 and December 31, 2007, we werenot involved in any unconsolidated SPE transactions.

 

**ContractualObligations**

 

Wehave future obligations under various contracts relating to debt and interestpayments, operating leases, and purchase obligations.  During the six months ended June 30,2008, there were no significant changes to these obligations as reported in ourAnnual Report on Form 10-K for the year ended December 31, 2007,except that our purchase obligations increased to $144.3 million as of June 30,2008, from $128.3 million at December 31, 2007. The purchase obligations atJune 30, 2008 were primarily comprised of purchase orders related to orders forthe MRAP Competitive Contract and for Cougar Mastiffs and Ridgbacks pursuant tothe DoD’s Foreign Military Sales United Kingdom contract.

 

**Critical Accounting Policies and Estimates**

 

Forthe period ended June 30, 2008, there have been no significant changes incritical accounting policies and estimates from those disclosed in our AnnualReport on Form 10-K for the year ended December 31, 2007 filed withthe SEC on September 15, 2008.

** **

**New AccountingPronouncements**

 

Forthe period ended June 30, 2008, there have been no new accountingpronouncements since those disclosed in our Annual Report on Form 10-K forthe year ended December 31, 2007 filed with the SEC on September 15,2008.

 

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**Item 3. Quantative and QualitativeDisclosures About Market Risk**

 

**Commodity Prices**

 

Weare exposed to market risk from changes in commodity prices. If the price ofsteel increases significantly, the cost of our products could increase. It isunlikely we will be able to pass on this cost under our current contracts. As aresult, if the cost of our raw materials increases, our profitability, if any,could decrease.

 

**Foreign Currency**

 

Themajority of our business is denominated in U.S. dollars and as such, movementin the foreign currency markets will have a minimal direct impact on ourbusiness.

 

**Interest Rates**

 

Wedo not have a trading portfolio and although our current financing is at avariable rate, we do not have any borrowings under the arrangement.  As a result, we are not currently directly atrisk of interest rate fluctuations. As our financing needs change in the future,interest rate risk may become a more significant issue for us.

 

Currently,we do not use any derivative financial instruments for the purpose of reducingour exposure to adverse fluctuations in interest rates, foreign currencyexchange, or commodity prices. We are not a party to leveraged derivatives nordo we hold or issue financial investments for speculative purposes.

 

**Item 4. Controls and Procedures**

 

**Evaluation of Disclosure Controls and Procedures**

 

Disclosurecontrols and procedures are controls and other procedures that are designed toprovide reasonable assurance that the information required to be disclosed inreports filed or submitted under the United States Securities Exchange Act of1934, as amended (“Exchange Act”), is (1) recorded, processed, summarizedand reported within the time periods specified in the rules and forms ofthe SEC and (2) accumulated and communicated to management, including theprincipal executive officer and principal financial officer, as appropriate toallow timely decisions regarding required disclosure.  Our disclosure controls and procedures weredesigned to provide reasonable assurance of achieving their control objectives.

 

Inconnection with the preparation of this Quarterly Report on Form 10-Q forthe period ended June 30, 2008, members of our management, at thedirection (and with the participation) of our chief executive officer andinterim chief financial officer, performed an evaluation of the effectivenessof the design and operation of our disclosure controls and procedures (asdefined in Rule 13a-15(e) under the Exchange Act), as of June 30,2008. Based on that evaluation, the chief executive officer and interim chieffinancial officer, concluded that our disclosure controls and procedures werenot effective at a reasonable assurance level as of June 30, 2008, becauseof the material weaknesses in our internal control over financial reportingdiscussed in the Annual Report on Form 10-K for the year ended December 31,2007 filed with the Securities and Exchange Commission (“SEC”) on September 15,2008. Notwithstanding the material weakness described in the Annual Report on Form 10-Kfor the year ended December 31, 2007, our management has concluded thatour unaudited condensed consolidated financial statements included in thisreport are fairly stated, in all material respects, in accordance withgenerally accepted accounting principles in the United States of America (“GAAP”).

 

**Changes in Internal Control Over Financial Reporting**

 

The changes in our internal control over financial reporting (asdefined in Rule 13a-15(f) under the Exchange Act) during the periodcovered by this report that have materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting arediscussed below.

 

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**Remediation of Material Weaknesses**

 

We have engaged in, and are continuing to engage in, substantialefforts to improve our internal control over financial reporting and disclosurecontrols and procedures related to substantially all areas of our financialstatements and disclosures. These efforts include the following:

 

*Efforts to strengthen accounting and financedepartment through additional professional staff.*  Wehave hired a number of additional professional staff over the past severalmonths with the skills and experience needed for a public company of our sizeand complexity, including an individual with expertise in and responsibilityfor government contract compliance. We will continue to seek to strengthen ouraccounting and finance department and strive to appropriately balance theallocation of full-time staff and consultants. As previously announced, in thesecond quarter of 2008 we hired Charles Mathis as our new Executive VicePresident of Finance. The development of adequate corporate level accountingand finance oversight is still ongoing. We are still recruiting accounting andfinance personnel and do not yet have permanent resources in place sufficientto close our books without significant reliance on third-party contractors.

 

*Use of outside consultants and advisors.*  Whilewe ultimately intend to reduce our reliance on outside consultants, for thenear term we have engaged additional outside consultants and advisors to assistmanagement in oversight and preparation of our financial statements, periodicreports filed with the SEC and related matters. We are also using outsideconsultants to function as our internal audit department and overseeing our Section 404evaluation of internal control over financial reporting, which will includeevaluating and recommending improvements in the existing internal controls atboth the corporate and business group level and establishing a mechanism tomonitor the effectiveness of internal controls on an ongoing basis. As westrengthen our accounting and finance department, we intend to transition moreof these functions to full-time staff.

 

*Increased communication internally and with outsideadvisors.*  We have increased communication by and amongsenior management, external advisors and other third parties relevant to thedisclosure process. Specifically, the chief executive officer meets daily withhis management team to review operational developments. Our board of directorsreceives timely and regular updates on issues of importance. Our chiefexecutive officer also regularly prepares a report to our board of directorshighlighting operational and financial results which is also distributed to hisexecutive team.

 

*Enhanced efforts to identify non-routinetransactions.*  We have initiated daily meetings withexecutive leadership to identify non-routine transactions and their relatedaccounting treatment at an early stage. Certain expenditure transactionsrequire approval of the interim chief financial officer. Additionally, we arein the process of assigning finance professionals within each of the operatingdepartments.

 

*Disclosure controls and procedures improvements.*  Withrespect to the preparation of periodic reports to be filed with the SEC, wehave instituted formal meetings of key personnel involved in the process anddeveloped detailed checklists and timetables with appropriate responsibilitiesand structural processes. In addition, we are utilizing a system of uniformdocument management (e.g., numbering, dating, and red-lining drafts) andimproved coordination of the drafting process with respect to our earningsreleases and periodic reports.

 

Management will consider the design and operating effectiveness ofthese actions and will make additional changes it determines appropriate.

 

The effectiveness of Force Protection’s or any system of disclosurecontrols and procedures and internal control over financial reporting issubject to certain limitations, including the exercise of judgment indesigning, implementing, and evaluating the controls and procedures, theassumptions used in identifying the likelihood of future events, and theinability to eliminate misconduct completely. As a result, our disclosurecontrols and procedures and internal control over financial reporting may notprevent all errors or improper acts or ensure that all material informationwill be made known to appropriate management in a timely fashion.

 

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## ***PART II. OTHER INFORMATION***

## *** ***

**Item 1. Legal Proceedings**

 

*Shareholder Class **Action and Derivative Complaints*

 

On March 10, 2008, the first of ten related class action lawsuitswas filed against us and certain of our former and current board members orofficers in the United States District Court for the District of South CarolinaCharleston Division on behalf of a proposed class of investors who purchased orotherwise acquired our securities during the period between August 14,2006 and February 29, 2008. The complaints seek class certification, andthe allegations include but are not limited to allegations that the defendantsviolated the Exchange Act and made false or misleading public statements and/oromissions concerning our business, internal controls, and financial results.The plaintiffs assert that as a result of the defendants’ allegedly wrongfulacts and omissions, members of the proposed class have suffered significantlosses and damages. The individual class action lawsuits were consolidated on June 10,2008 under caption ‘In Re Force Protection, Inc. Securities Litigation,Action No. 2:08-cv-845-CWH.’ On June 20, 2008 a group of investorsconsisting of the Laborers’ Annuity and Benefit System of Chicago, GaryTrautman, David J. Jager, Bhadra Shah, Panteli Poulikakos, GeorgePoulikakos, and Niki Poulikakos was appointed lead plaintiff.

 

Between March 27, 2008 and May 28, 2008, various allegedshareholders filed derivative lawsuits against former and current officers orboard members wherein the plaintiff shareholders are seeking damages for theCompany. The Company has been named a nominal defendant in each derivative lawsuit.Four (4) derivative lawsuits are pending in the United States DistrictCourt for the District of South Carolina Charleston Division; two (2) derivativelawsuits are pending in Charleston, South Carolina Circuit Court; and one (1) derivativelawsuit is pending in Clark County, Nevada District Court. The plaintiffshareholders’ allegations include and are not limited to allegations of breachof fiduciary duties, abuse of control, gross mismanagement, waste of corporateassets, and unjust enrichment in connection with the Company’s publicstatements regarding its operations and financial results, internal controls,compensation of certain defendants, and alleged insider stock sales by certaindefendants.

 

*Other Disputes*

 

On August 21, 2007, we filed suit against Protected Vehicles, Inc.(“PVI”) and Garth Barrett, Thomas Thebes, and Paul Palmer, three of PVI’semployees (all of whom were former employees of Force Protection) in the UnitedStates District Court for the District of South Carolina. In the complaint, weallege that the named defendants used our confidential information and tradesecrets to create a competing business. We seek injunctive relief, unspecifieddamages, attorneys’ fees and costs. The defendants have answered our complaintand filed counterclaims against us. In their answers and counterclaims, thedefendants allege, among other things, that we and several of our current andformer officers and directors engaged in: certain transactions (includingtransactions with Force Protection) in which such officers and directorsmaintained a financial interest; backdating and certain other improper acts inconnection with certain stock issuances; allegedly wrongful acts with respectto a procurement contract with a foreign government; and other transactionsinvolving alleged self-dealing and engaged in certain allegedly retaliatoryacts in connection with defendants’ prior attempts to bring such activities tothe attention of the Company’s personnel or governmental agencies. Defendantsseek unspecified monetary damages, attorneys’ fees and costs. Defendants filedan amended counterclaim withdrawing three (3) of their causes of action,and have recently indicated they intend to file a second amendedcounterclaim. On January 18, 2008, the district court entered an orderstaying the litigation in light of an involuntary bankruptcy petition filed on January 15,2008, in the United States Bankruptcy Court for the District of South Carolinawith respect to PVI. On February 5, 2008, PVI filed a voluntary Chapter 7petition. On March 28, 2008, the Chapter 7 proceeding was convertedto a Chapter 11 proceeding. On June 20, 2008, the Bankruptcy Courtremanded the litigation back to the District Court, and on September 3,2008, the bulk of PVI’s assets,

 

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includingcertain rights and liabilities with respect to our suit against it, were soldto a third party. On July 31, 2008, we settled our claim against PaulPalmer. Our claims against PVI and the third party (who has now been added as adefendant in the suit) are currently set to be tried in early 2009; thecounterclaims against us have not been set for trial.

 

From February 2007 through April 2008, we received a total of68 complaints from current and former employees filed with the United StatesEqual Employment Opportunity Commission alleging, among other things, raceand/or gender discrimination. We have responded to the complaints as suchresponses have become due, and are investigating the allegations.

 

In early December 2007, we submitted a voluntary disclosure toDDTC regarding the shipment of technical manuals, Cheetah spare parts, armoredvest plates, parts not listed on our license and transfers of technical data toand by our vendors without proper authorization or identification of theappropriate exemption. On January 22, 2008, the DDTC requested additionalinformation and documentation for each specific shipment of these items withinsixty days. In addition, the DDTC directed us to undertake certain specificmeasures, including, but not limited to, that we hire a full time senior exportcontrol compliance officer, implement certain procedures, conduct comprehensiveITAR training, immediately conduct a comprehensive export compliance audit, andinstitute a plan to conduct periodic audits of the export compliance program.On February 11, 2008, we provided DDTC with the job description for theDirector of Export Controls, draft Export Controls Manual, ITAR presentationprovided in new orientation training and the attendance logs for annual ITARtraining provided to executives and other employees having ITARresponsibilities. On March 11, 2008, we provided DDTC with our draft auditplan and on June 2, 2008, we provide the final audit report. On July 14,2008 we provided DDTC with supplemental information to our previous voluntarydisclosure and other information identified in the audit. We have developed andimplemented an Export Control Policies and Procedures Manual and ITAR ProductClassification Guide, established an Export Control Council, and revised ourTechnology Control Plan and Code of Conduct and Ethics. As a result of theexport compliance audit, we have identified additional unauthorized transfersinternally at our facility and in support of U.S. operations in Iraq andAfghanistan as well as issues associated with the execution of our licenses andagreements. We have reported these matters to DDTC.

 

On February 8, 2008, a temporary independent contractor whoseservices we had terminated filed a complaint with OSHA which alleges aviolation under the employee protection provisions of Section 806 of theCorporate and Criminal Fraud Accountability Act of 2002, Title VIII of theSarbanes-Oxley Act of 2002, 18 U.S.C. §1514A. The former independent contractoralleges that we terminated his engagement in retaliation for his allegation ofcertain corporate governance, government contracting, accounting and other irregularities.On April 18, 2008 we responded to the allegations, and are awaiting arecommendation and report from the OSHA investigator. In August 2008 theclaimant submitted a proposed amended complaint which seeks to add additionalclaims and the current and former chief executive officers as defendants.

 

On August 15, 2008, we received a $1.1 million notice ofclaim of lien for the balance of tooling supplied by a vendor to our primecontractor on the Roxboro Facility. We have demanded that the prime contractorresolve this matter with its vendor and indemnify us for this claim of lien.

 

Although we intend to defend ourselves in connection with the foregoinglegal proceedings and claims, there can be no assurance that we will ultimatelyprevail in any of these matters. Moreover, the defense of these claims andproceedings may result in substantial legal expenses and diversion of ourmanagement, and any settlement or adverse judgment may require us to makesubstantial payments, any of which could have a material adverse effect on ourbusiness or financial position, results of operations, or cash flows.

 

In addition, compliance with the directives of the DDTC discussed abovemay result in substantial expenses and diversion of management. Any failure toadequately address the directives of DDTC could result in civil fines and/orsuspension or loss of our export privileges, any of which could have a materialadverse effect on our business or financial position, results of operations, orcash flows.

 

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We are also a party to other litigation which we consider routine andincidental to our business. We may be involved from time to time in otherlitigation that could have a material effect on our operations or finances.Other than the litigation described above, we are not aware of any pending orthreatened litigation against us that could have a material adverse effect on ourbusiness or financial position, results of operations, or cash flows.

 

**Item 1A. Risk Factors**

 

In addition to the other information set forth in this Quarterly Reporton Form 10-Q, you should carefully consider the factors discussed in Part I,“Item 1A. Risk Factors” in our Annual Report on Form 10-K for the yearended December 31, 2007 filed with the SEC on September 15, 2008,which could materially affect our business, financial condition or futureresults. The risks described in our Annual Report on Form 10-K are not theonly risks facing Force Protection. Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also maymaterially adversely affect our business, financial condition, operatingresults or cash flows.

 

**Item 2. Unregistered Sales of Equity Securities and Use ofProceeds**

 

**None**

 

**Item 3. Defaults Upon Senior Securities**

 

**None.**

 

**Item 4. Submission of Matters to a Vote of Security Holders**

 

**None.**

 

**Item 5. Other Information**

 

**None.**

 

# **Item6. Exhibits**

# ** **

**EXHIBIT INDEX**

 
| **NUMBER** | ** ** | **DESCRIPTION** |
|------------|------------|-----------------|
| 2.1        |       |            | Agreement  and Plan of Merger filed as Exhibit 2.1 to the Company’s Annual Report  on Form 10-K filed September 15, 2008, is hereby incorporated by  reference. |
|       |       |            |   |
| 3.1        |       |            | Articles  of Incorporation filed as Exhibit 3.1 in the Company’s Annual Report on  Form 10-K filed September 15, 2008, is hereby incorporated by  reference. |
|       |       |            |   |
| 3.2        |       |            | First  Amended and Restated By-Laws of Force Protection, Inc., filed as  Exhibit 3.1 to the Company’s Current Report on Form 8-K filed  February 26, 2008, is hereby incorporated by reference. |

 

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| 3.3    |   |   | Certificate  of Amendment to Articles of Incorporation filed as Exhibit 3.3 to the  Company’s Annual Report in Form 10-K filed September 15, 2008, is  hereby incorporated by reference.                                                                                                                                                                       |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 4.1    |   |   | Certificate  of Designation for Series D Convertible Preferred Stock, dated  January 19, 2005, filed as Exhibit 4.1 to the Company’s Current  Report on Form 8-K filed January 27, 2005, is hereby incorporated  by reference.                                                                                                                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 4.2    |   |   | Amended  and Restated Certificate of Designation for Series B Convertible  Preferred Stock, filed as Exhibit 4.1 to the Company’s Current Report on  Form 8-K filed February 15, 2005, is hereby incorporated by  reference.                                                                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 4.3    |   |   | Amended  and Restated Certificate of Designation for Series C Convertible  Preferred Stock, filed as Exhibit 4.2 to the Company’s Current Report on  Form 8-K filed February 15, 2005, is hereby incorporated by  reference.                                                                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.1   |   |   | Agreement  between Force Protection, Inc. and Damon Walsh, dated April 4,  2008, filed as Exhibit 10.1 to the Company’s Current Report on  Form 8-K filed April 8, 2008, is hereby incorporated by reference.                                                                                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.2   |   |   | Agreement  between Force Protection, Inc. and Mark Edwards, dated April 4,  2008, filed as Exhibit 10.2 to the Company’s Current Report on  Form 8-K filed April 8, 2008, is hereby incorporated by reference.                                                                                                                                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.3   |   |   | Agreement  between Force Protection, Inc. and Daniel Busher, dated April 4,  2008, filed as Exhibit 10.3 to the Form 8-K filed April 8,  2008, is hereby incorporated by reference.                                                                                                                                                                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.4   |   |   | Agreement  between Force Protection, Inc. and Shelia Boyd, dated April 4,  2008, filed as Exhibit 10.4 to the Company’s Current Report on  Form 8-K filed April 8, 2008, is hereby incorporated by reference.                                                                                                                                        |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.5   |   |   | Agreement  between Force Protection, Inc. and Denise Speaks, dated April 4,  2008, filed as Exhibit 10.5 to the Form 8-K filed April 8,  2008, is hereby incorporated by reference.                                                                                                                                                                       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.6   |   |   | Modification,  dated April 15, 2008, to the Second Amendment to Loan Agreement, dated  February 5, 2008, filed as Exhibit 10.64 to the Company’s Annual  Report on Form 10-K filed September 15, 2008, is hereby  incorporated by reference.                                                                                                         |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.7   |   |   | Amended  and Restated Loan Agreement between Force Protection, Inc. Force  Protection Technologies, Inc., Force Protection Industries, Inc.  and Wachovia Bank, National Association, dated May 6, 2008, filed as  Exhibit 10.1 to the Company’s Current Report on Form 8-K filed  May 9, 2008, is hereby incorporated by reference.       |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.8   |   |   | Promissory  Note between Force Protection, Inc. and Wachovia Bank, National  Association, dated May 6, 2008, filed as Exhibit 10.2 to the  Company’s Current Report on Form 8-K filed May 9, 2008, is hereby  incorporated by reference.                                                                                                             |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.9   |   |   | Amendment  of Solicitation/Modification of Contract under Contract  No. M67854-06-C-5162 between Force Protection Industries, Inc. and  the United States Marine Corps Systems Command, dated May 19, 2008,  filed as Exhibit 10.78 to the Company’s Annual Report on Form 10-K  filed September 15, 2008, is hereby incorporated by reference. |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.10  |   |   | Amendment  of Solicitation/Modification of Contract under Contract  No. M67854-D7-D5031-0003                                                                                                                                                                                                                                                                                  |

 

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|   |   |   | between  Force Protection Industries, Inc. and the United States Marine Corps  Systems Command, dated May 30, 2008, filed as Exhibit 10.79 to the  Company’s Annual Report on Form 10-K filed September 15, 2008, is  hereby incorporated by reference.          |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                           |
| 10.11  |   |   | Agreement  between Force Protection, Inc. and Charles Mathis, dated June 25,  2008, filed as Exhibit 10.1 to the Company’s Current Report on  Form 8-K filed June 27, 2008, is hereby incorporated by reference.                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                           |
| 10.12  |   |   | Second  Extension Amendment to Leases between Force Protection, Inc. and  Aerospace/Defense, Inc., dated June 25, 2008, filed as  Exhibit 10.81 to the Company’s Annual Report on Form 10-K filed  September 15, 2008, is hereby incorporated by reference. |
|   |   |   |                                                                                                                                                                                                                                                                                           |
| 31.1   |   |   | Certification  of the Chief Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 (filed herewith).†                                                                                                                                                          |
|   |   |   |                                                                                                                                                                                                                                                                                           |
| 31.2   |   |   | Certification  of the Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 (filed herewith).†                                                                                                                                                          |
|   |   |   |                                                                                                                                                                                                                                                                                           |
| 32.1   |   |   | Certification  of Officers pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).†                                                                                                                         |

 

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(Exhibitsmarked with a (†) are filed electronically herewith.)

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| ** **                     | **FORCE PROTECTION, INC.***(Registrant)* |
|--------------------------------|------------------------------------------|
| ** **                     | ** **                               |
|                           |                                     |   |
| Date:  September 30, 2008 | By:                                      | /s/ MICHAEL MOODY |
|                           | ** **                               | **Name:    Michael  Moody** |
|                           | ** **                               | **Title:** | **Chief Executive Officer and President** |
|                           | ** **                               | ** ** | **(Principal Executive Officer)** |
|                           | ** **                               | ** ** |
|                           | ** **                               | ** ** |
|                           | ** **                               | ** ** |
| Date:  September 30, 2008 | By:                                      | /s/ FRANCIS E. SCHEUERELL, JR. |
|                           | ** **                               | **Name:    Francis E.  Scheuerell, Jr.** |
|                           | ** **                               | **Title:** | **Interim Chief Financial Officer** |
|                           | ** **                               | ** ** | **(Principal Accounting and Financial Officer)** |
|                           | ** **                               | ** ** |

 

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