Allied Defense expects liquidity woes to wane in second half of 2008, considering options to meet put

By Caroline Salls

Pittsburgh, March 26 - Allied Defense Group, Inc. said it expects liquidity challenges it will face in the first half of 2008 to decrease in the second half of the year as its Mecar subsidiary receives payments on its first deliveries from an increased backlog, according to a 10-K filed with the Securities and Exchange Commission.

In addition, the company said it will consider its options, including raising additional capital or the sale of another subsidiary, to put Allied Defense in a position to satisfy a potential put of its senior secured convertible notes, which may be made in December 2008 or January 2009.

Specifically, the company said the senior secured convertible noteholders can put the notes back to the company on Dec. 26, 2008 or Jan. 19, 2009. The put feature requires the noteholders to provide at least 75 days notice of intent to enforce put.

Allied said it encountered serious liquidity difficulties in 2006 and 2007, but its liquidity position improved markedly in the third and fourth quarters of 2007.

According to the 10-K, the serious liquidity challenges Allied faced in 2007 mainly resulted from the reduction of revenues and significant operating losses at Mecar, financing costs associated with registration delay penalties and interest premiums, costs associated with alleged events of default on its convertible notes and with the issuance of new convertible notes, operational restructuring activities and the funding of continuing operating losses at several of the company's smaller U.S.-based subsidiaries.

The company said it managed its initial liquidity issues in 2007 through a combination of a restructuring of its convertible notes and sales of some of its subsidiaries.

Allied Defense restructured its convertible notes in June and July 2007, and, in connection with the restructuring, the noteholders withdrew their allegation of events of default and purchased additional convertible notes.

Also, at the end of 2007, Mecar obtained an additional loan from a Belgian regional agency, and the company sold its SeaSpace and VSK Group subsidiaries in 2007.

Looking ahead to the rest of 2008, Allied Defense said Mecar has begun to work on the substantial backlog it accumulated in the second half of 2007, and it received additional orders in early 2008, including a $43.5 million multiyear contract.

As a result, Allied Defense said it expects to report a profit in 2008.

However, despite its healthy cash position at the end of 2007, the company said it expects liquidity challenges in 2008 as it executes on its backlog. Allied said payments for substantial shipments to be made in the second and third quarter will not be received until the third and fourth quarters.

Based on the timing of purchases and the building of inventory, cash availability is expected to be at its lowest point in May and August of 2008, according to the 10-K.

Mecar refinancing

In the fourth quarter of 2007, Allied Defense said it faced difficulties refinancing Mecar as a result of a tight credit market, political issues associated with financing ammunition manufacturers in Europe and the lack of profitable historical results reported by Mecar before the fourth quarter of 2007.

In January and February, Mecar's banking group notified the subsidiary that it would be held to its commitment to refinance its facility in early 2008.

Allied Defense said a tentative agreement has been reached with the banking group to extend and expand Mecar's credit facility until Nov. 30, 2008.

The completion of the agreement is subject to local government support that will guarantee an additional portion of Mecar's performance bonds and advance payment guarantees from April through November.

Allied Defense said this additional guarantee will reduce the required restricted cash balances at Mecar and allow the company to fund Mecar through it critical working capital expansion period.

In addition to securing the credit facility, Allied Defense said Mecar will require additional cash in the first half of 2008 in order to expand its working capital as it performs on its backlog.

The company said it believes it will be able to finance Mecar's operations, in addition to its other operations, if the credit facility is secured for remainder of 2008 at the current levels.

Allied said its projections show that, if the credit facility is secured until Nov. 30, 2008, it should be able to manage through its liquidity issues and repay Mecar's cash line and debt obligations.

In general, the company said it believes it will be able to find a solution for Mecar's credit facility and fund operations in 2008, as well as to meet the obligations associated with the potential put on its convertible notes based on its current backlog, its history of performing at a profit when backlog is substantial, the ability to raise capital and the ability to sell its subsidiaries.

Allied Defense said its independent audit firm has issued an opinion that expresses doubt about the company's ability to continue as a going concern, but that opinion was mostly based on losses from operations and the uncertainty of the company's ability to refinance the Mecar credit facility.

Based in Vienna, Va., Allied Defense develops ammunition for defense departments and produces electronic and microwave security systems.

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