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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

Commission File Number: 1-11376

 

 

The Allied Defense Group, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware		04-2281015
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Number)

120 E. Baltimore Street, Suite 2100

Baltimore, MD 21202

(Address of principal executive offices, including zip code)

(410) 385-8155

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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

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

The number of shares of registrant’s Common Stock outstanding as of June 30, 2012 was 8,235,195.

 

 

 

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THE ALLIED DEFENSE GROUP, INC.

INDEX

 

		PAGE NUMBER
PART I. FINANCIAL INFORMATION — UNAUDITED
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Net Assets as of June 30, 2012 and December  31, 2011 (liquidation basis)			2
Consolidated Statement of Changes in Net Assets for the three and six months ended June  30, 2012 (liquidation basis)			3
Notes to Unaudited Condensed Consolidated Financial Statements			4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			9
Item 3. Quantitative and Qualitative Disclosures About Market Risk			14
Item 4. Controls and Procedures			14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			15
Item 1A. Risk Factors			15
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			16
Item 3. Defaults Upon Senior Securities			16
Item 4. Mine Safety Disclosures			16
Item 5. Other Information			16
Item 6. Exhibits			16
Signatures			17

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The Allied Defense Group, Inc.

CONSOLIDATED STATEMENTS OF NET ASSETS (Liquidation Basis)

(Thousands of Dollars, except per share and share data)

 

		June 30,				December 31,
		2012				2011
ASSETS
Cash and cash equivalents		$	3,460			$	640
Short-term investments			27,434				30,872
Prepaid expenses			—				219
Accrued interest receivable			465				428
Funds held in escrow			15,013				15,010
TOTAL ASSETS			46,372				47,169
LIABILITIES
Estimated net costs to be incurred during liquidation			2,245				2,688
Accounts payable			214				57
Other liabilities			95				91
TOTAL LIABILITIES			2,554				2,836
NET ASSETS IN LIQUIDATION		$	43,818			$	44,333
NUMBER OF SHARES OUTSTANDING			8,235,195				8,235,195
NET ASSETS IN LIQUIDATION PER SHARE		$	5.32			$	5.38

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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The Allied Defense Group, Inc.

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS (Liquidation Basis)

(Unaudited)

(Thousands of Dollars)

 

		Three Months				Six Months
		Ended				Ended
		June 30, 2012				June 30, 2012
Net assets on liquidation basis at beginning of period		$	44,032			$	44,333
Changes in fair value of net assets in liquidation
Adjust net assets to fair value			13				(2	)
Increase in estimated net costs to be incurred during liquidation			(203	)			(491	)
Adjust estimated income to be earned during liquidation			(24	)			(22	)
Net assets on liquidation basis at end of period		$	43,818			$	43,818

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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The Allied Defense Group, Inc.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

(Thousands of Dollars)

NOTE 1 — DESCRIPTION OF BUSINESS

Business Operations

The Allied Defense Group Inc. (“Allied” or the “Company”), a Delaware corporation, previously conducted a multinational defense business focused on the manufacture and sale of ammunition and ammunition related products for use by the U.S. and foreign governments. Allied’s business was conducted by its two wholly owned subsidiaries: MECAR sprl, formerly Mecar S.A. (“Mecar”), and ADG Sub USA, Inc., formerly Mecar USA, Inc. (“Mecar USA”).

Plan of Dissolution and Liquidation

On June 24, 2010, the Company signed a definitive purchase and sale agreement (the “Agreement”) with Chemring Group PLC (“Chemring”) pursuant to which Chemring agreed to acquire substantially all of the assets of the Company for $59,560 in cash and the assumption of certain liabilities. On September 1, 2010, the Company completed the asset sale to Chemring contemplated by the Agreement. Pursuant to the Agreement, Chemring acquired all of the capital stock of Mecar for approximately $45,810 in cash, and separately Chemring acquired substantially all of the assets of Mecar USA for $13,750 in cash and the assumption by Chemring of certain specified liabilities of Mecar USA. A portion of the purchase price was paid through the repayment of certain intercompany indebtedness owed to the Company that would otherwise have been cancelled at closing. $15,000 of the proceeds of the sale was deposited into escrow to secure the Company’s indemnification obligations under the Agreement.

In conjunction with the Agreement, the Board of Directors of the Company unanimously approved the dissolution of the Company pursuant to a Plan of Complete Liquidation and Dissolution (“Plan of Dissolution”). The Company’s stockholders approved the Plan of Dissolution on September 30, 2010. In response to concerns of certain of the Company’s stockholders, the Company agreed to delay the filing of a certificate of dissolution with the Delaware Secretary of State. The Company filed a certificate of dissolution with the Delaware Secretary of State on August 31, 2011. In connection with this filing, our stock transfer agent has ceased recording transfers of our stock and our stock is no longer publicly traded.

NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

Liquidation Basis of Accounting

With the authorization of the Plan of Dissolution, the Company adopted the liquidation basis of accounting effective as of the close of business on September 30, 2010. The liquidation basis of accounting will continue to be used by the Company until such time that the plan is terminated and all net assets have been distributed to shareholders.

Under the liquidation basis of accounting, the carrying amounts of assets as of the close of business on September 30, 2010, the date of the authorization of the Plan of Dissolution by the Company, were adjusted to their estimated net realizable values and liabilities, including the estimated costs associated with implementing the Plan of Dissolution, were stated at their estimated settlement amounts. Such value estimates were updated by the Company as of December 31, 2011 and June 30, 2012. The majority of net assets in liquidation at December 31, 2011 and June 30, 2012 were highly liquid and did not require adjustment as their estimated net realizable value approximates their current book value. The exception is the short term investments which are subject to changes in market value.

Consolidated Statements of Net Assets in Liquidation and Changes in Net Assets in Liquidation are the financial statements presented under the liquidation basis of accounting. The valuations of assets at their net realizable values and liabilities at their anticipated settlement amounts represent estimates, based on present facts and circumstances associated with carrying out the Plan of Dissolution based on the assumptions set forth below. The actual values and costs associated with carrying out the Plan of Dissolution are expected to differ from the amounts shown herein because of the inherent uncertainty of the estimates. Such differences may be material. In particular, the estimates of the Company’s liquidation costs will vary with the length of time it operates under the Plan of Dissolution. Accordingly, it is not possible to predict the aggregate amount or timing of future distributions to stockholders, as long as the Plan of Dissolution is in effect and no assurance can be given that the amount of liquidating distributions to be received will equal or exceed the estimate of net assets in liquidation presented in the accompanying Statement of Net Assets in Liquidation.

 

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The Allied Defense Group, Inc.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

(Thousands of Dollars)

 

The estimated net costs to be incurred during liquidation as of June 30, 2012 are as follows:

 

Estimated net costs to be incurred during liquidation
Compensation for remaining employees and directors		$	292
Compliance and other office costs			427
Insurance Fees			421
Professional Fees			1,090
Income Taxes			150
Subtotal			2,380
Less: interest income on cash and investment balances			(135	)
Total net costs to be incurred during liquidation		$	2,245

These estimates are based on assumptions regarding the Company’s ability to settle outstanding obligations to creditors, resolve outstanding litigation, settle remaining leases and the ultimate timing of distributions to its stockholders, but does not include any settlement amounts, fines or penalties, if any, that the Company might incur as a result of the DOJ subpoena or any other legal proceedings. These estimates will be adjusted from time to time as projections and assumptions change.

Principles of Consolidation

As of June 30, 2012, the consolidated financial statements of the Company include the accounts of Allied and its wholly-owned subsidiaries, which are as follows:

 

•

ARC Europe, a Belgian company,

 

•

Allied Research BV (“BV”), a Dutch company,

 

•

Allied Research Cooperative (“Coop”) and,

 

•

ADG Sub USA, Inc. (“Mecar USA”)

Fair Value of Financial Instruments

The Company values its assets and liabilities using the methods of fair-value as described in ASC 820, Fair Value Measurements and Disclosures. In accordance with ASC 820, the Company determines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company generally applies the income approach to determine fair value. This method uses valuation techniques to convert future amounts to a single present amount. The measurement is based on the value indicated by current market expectations about those future amounts.

ASC 820 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to active markets for identical assets and liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). We classify fair value balances based on the observability of those inputs. The three levels of the fair value hierarchy are as follows:

 

•

Level 1 – Observable inputs such as quoted prices in active markets for identical assets or liabilities.

 

•

Level 2 – Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and amounts derived from valuation models where all significant inputs are observable in active markets.

 

•

Level 3 – Unobservable inputs that reflect management’s assumptions.

 

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The Allied Defense Group, Inc.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

(Thousands of Dollars)

 

NOTE 3 — SHORT-TERM INVESTMENTS

Cash in excess of funds required for immediate use by the Company has been invested with the primary goal to preserve capital. As such, the funds are invested in short-term, high-quality, fixed-income securities and are accounted for at fair value. As of June 30, 2012 and December 31, 2011, the fair value of these investments was $27,434 and $30,872, respectively, and was included in short-term investments on the consolidated statements of net assets.

NOTE 4 — FAIR VALUE MEASUREMENTS

For disclosure purposes, assets and liabilities are classified in their entirety in the fair value hierarchy level based on the lowest level of input that is significant to the overall fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the placement within the fair value hierarchy levels.

The following table sets forth the assets and liabilities measured at fair value on a recurring basis, by input level, in the consolidated statement of net assets at June 30, 2012:

 

		Level 1				Level 2				Level 3				Total
Municipal Bonds		$	22,143			$	—			$	—			$	22,143
Certificates of Deposit			5,291				—				—				5,291
Total assets at fair value		$	27,434			$	—			$	—			$	27,434

The following table sets forth the assets and liabilities measured at fair value on a recurring basis, by input level, in the consolidated statement of net assets at December 31, 2011:

 

		Level 1				Level 2				Level 3				Total
Mutual Funds		$	2,977			$	—			$	—			$	2,977
Municipal Bonds			22,892				—				—				22,892
Certificates of Deposit			5,003				—				—				5,003
Total assets at fair value		$	30,872			$	—			$	—			$	30,872

The Company believes the fair value of its financial instruments consisting of cash, cash equivalents, and short-term investments, adjusted to recognize unrealized gains and losses, approximate their carrying values due to the relatively short maturity of these instruments. During 2012, the mutual funds have been converted to money market funds and are now counted as cash and cash equivalents.

NOTE 5 — INDUSTRY SEGMENTS

Prior to September 2010, the Company operated within two operating segments: Mecar and Mecar USA. In September 2010, the Company completed the divesture of Mecar and Mecar USA. As a result, Allied no longer has operating segments. The Company’s continuing operations include only those expenses incurred to support the Company’s corporate headquarters and its non-operating European subsidiaries.

NOTE 6 — PROVISION FOR TAXES

The Company regularly reviews the recoverability of its deferred tax assets and establishes a valuation allowance as deemed appropriate. Realization of deferred tax assets is dependent upon generation of sufficient income by the Company in the jurisdictions in which it has operations and, in some cases, by specific location. Because the Company experienced losses in previous years and continued losses in the current year, management recorded a full valuation allowance against the Company’s net deferred tax asset as of June 30, 2012.

 

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The Allied Defense Group, Inc.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

(Thousands of Dollars)

 

As of June 30, 2012 and December 31, 2011, the Company had no unrecognized tax liabilities. Income taxes are provided based on the liability method for financial reporting purposes. For the three months ended June 30, 2012, there were no interest or penalties recorded.

In Belgium, the Company is still open to examination by the Belgian tax authorities from 2008 forward. In the United States, the Company is still open to examination from 2008 forward, although carryforward tax attributes that were generated prior to 2008 may still be adjusted upon examination by the U.S. tax authorities if they either have been or will be utilized.

As of December 31, 2010, the Company provided for U.S. tax on foreign earnings of approximately $25,475 that is expected to be repatriated. As of June 30, 2012, $13,757 had been successfully repatriated. Income taxes related to repatriation of cash held in foreign countries is not expected to exceed $350. As of June 30, 2012, $200 of income taxes related to the repatriation has been paid and the remainder is expected to be paid in 2013. As of June 30, 2012, the fair value of net deferred tax assets is zero due to full valuation allowance.

The Company may undergo, or may already have undergone, an “ownership change” within the meaning of Section 382 of the Internal Revenue Code, which could affect the Company’s ability to offset gains realized in the asset sale against net operating losses and foreign tax credit carryovers. If it is determined that an ownership change has occurred, this could significantly increase the tax expense incurred from the sale transactions.

NOTE 7 — COMMITMENTS AND CONTINGENCIES

Legal Proceedings

DOJ Subpoena

On January 19, 2010, the Company received a subpoena and communications from the U.S. Department of Justice (“DOJ”) requesting the Company produce documents relating to its dealings with foreign governments. The subpoena stated that it was issued in connection with an ongoing criminal investigation. See Part II – Item 1 for additional information regarding the DOJ proceedings.

Leases

The Company leases domestic office space under an operating lease which expires in early 2013. The lease also includes escalation provisions for taxes and operating costs. In April, 2011, the Company subleased the office space for 2011 and 2012 to offset a portion of the rental obligation owed by the Company.

Indemnification provisions

The Company has sold its SeaSpace, Titan, the VSK Group, GMS and NSM subsidiaries in separate transactions starting with the first transaction closing in 2007. In each transaction, the Company agreed to indemnify the purchaser for periods subsequent to closing for losses arising from breaches of representations, warranties and covenants. Indemnification periods varied based on the particular representation, warranty or covenant covered, the vast majority of which have all expired. As of June 30, 2012, the only remaining indemnification obligations relate to representations and warranties concerning taxes, environmental matters, breaches of title, breaches of authorization and fraud. For SeaSpace, Titan, the VSK Group, GMS and NSM, these indemnification provisions have been capped at $1,000, $950, $6,288 (€5,000), $5,200 and $863, respectively. At June 30, 2012, no amount has been accrued related to these indemnifications as a liability is not deemed probable.

On June 24, 2010, the Company signed a definitive purchase and sale agreement with Chemring Group PLC pursuant to which Chemring agreed to acquire substantially all of the assets of the Company for $59,560 in cash and the assumption of certain liabilities. The purchase and sale agreement contains certain indemnification provisions pursuant to which the Company may be required to indemnify the buyer for a period subsequent to the completion of the sale for any and all losses directly or indirectly based upon, related to, arising out of or in connection with Mecar’s completed contracts, Mecar USA liabilities retained by the Company and any failure by the Company to satisfy all transaction related expenses. The Company’s indemnification liability is limited to, and capped at, the escrowed amount of $15,000 plus the accumulated interest. The Company’s indemnification obligations expire upon the earlier of (i) June 30, 2015 and (ii) the Company’s entry into either a

 

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The Allied Defense Group, Inc.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

(Thousands of Dollars)

 

court or administrative order or a Chemring-approved settlement agreement, in either case, finally resolving the matters relating to the DOJ’s subpoena. In the absence of such final resolution, in certain circumstances, up to 50% of the escrowed funds may be released as early as June 24, 2013. At June 30, 2012, no amount has been accrued related to this indemnification as a liability is not deemed probable.

 

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ITEM 2. MANGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The Allied Defense Group, Inc. (“Allied” or the “Company”) previously conducted a multinational defense business focused on the manufacture and sale of ammunition and ammunition related products for use by the U.S. and foreign governments. Allied’s business was conducted by two wholly-owned subsidiaries: MECAR sprl, formerly MECAR S.A. (“Mecar”), and ADG Sub USA, Inc., formerly MECAR USA, Inc. (“Mecar USA”).

On June 24, 2010, the Company signed a definitive purchase and sale agreement (the “Agreement”) with Chemring Group PLC (“Chemring”) pursuant to which Chemring agreed to acquire substantially all of the assets of the Company for $59.6 million in cash and the assumption of certain liabilities. On September 1, 2010, the Company completed the asset sale to Chemring contemplated by the Agreement. Chemring acquired all of the capital stock of Mecar for $45.8 million in cash, and separately Chemring acquired substantially all of the assets of Mecar USA for $13.8 million in cash and the assumption by Chemring of certain specified liabilities of Mecar USA. A portion of the purchase price was paid through the repayment of certain intercompany indebtedness owed to the Company that would otherwise have been cancelled at closing. $15 million of the proceeds from the sale was deposited into escrow to secure the Company’s indemnification obligations under the Agreement.

In conjunction with the Agreement, the Board of Directors of the Company unanimously approved the dissolution of the Company pursuant to a Plan of Complete Liquidation and Dissolution (“Plan of Dissolution”). The Company’s stockholders approved the Plan of Dissolution on September 30, 2010. In response to concerns of certain of the Company’s stockholders, the Company agreed to delay the filing of a Certificate of Dissolution. The Company filed a Certificate of Dissolution with the Delaware Secretary of State on August 31, 2011. In connection with this filing, our stock transfer agent has ceased recording transfers of our stock and our stock is no longer publicly traded.

In connection with the adoption of the Plan of Dissolution and the anticipated liquidation of the Company, we adopted the liquidation basis of accounting effective the close of business on September 30, 2010, whereby assets are valued at their estimated net realizable cash values and liabilities are stated at their estimated settlement amounts. Uncertainties as to the ultimate amount of our liabilities make it impractical to predict the aggregate net value that may ultimately be distributable to stockholders. Under the liquidation basis of accounting, we accrue for the remaining costs to be incurred during liquidation, including compensation for remaining directors, consultants, insurance costs, costs to settle remaining leases, fees for professional service providers, income taxes, and miscellaneous other costs, partially offset by estimated future interest earnings and sublease payments. Such net costs were estimated to be $2.245 million as of June 30, 2012. Our estimates are based on assumptions regarding our ability to settle outstanding obligations and the ultimate timing of distributions to our stockholders, but do not include any settlement amounts, fines or penalties, if any, that we might incur as a result of the DOJ subpoena or any other legal proceedings.

The Company received a subpoena from the Department of Justice (“DOJ”) on January 19, 2010 requesting that the Company produce documents relating to its dealings with foreign governments. The DOJ initially limited its request of documents to those relating to an indicted former employee of Mecar USA. The DOJ subsequently advised the Company that it is conducting an industry-wide review, and therefore the DOJ’s investigation of the Company will be expanded and ongoing. The Company has also received inquiries from the Securities and Exchange Commission (“SEC”) as to this matter. We cannot predict the settlement amounts, fines or penalties, if any, that we might incur as a result of the foregoing. The period of time required to resolve these matters is uncertain but is expected to take in excess of one year. Furthermore, under the Agreement, the Company has agreed to indemnify Chemring and certain of its related parties from any losses, fines or penalties arising out of, among other things, the completed contracts of Mecar and Mecar USA. We have escrowed $15 million of the cash consideration paid to the Company in the sale to secure our indemnification obligations under the Agreement. These escrowed funds will not be available to the Company for distribution to our stockholders, or otherwise, until released to the Company pursuant to the terms of the Agreement.

Based on advice from our Foreign Corrupt Practices Act (“FCPA”) outside counsel, we are now estimating that we may not be able to conclude the DOJ/SEC inquiries, complete the Delaware dissolution process and make final distribution to stockholders until 2013. As a result, our estimate of net costs to be incurred during liquidation includes our estimate of costs through December 31, 2013.

 

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In February and March, 2012, the DOJ dismissed charges against all individuals indicted in the FCPA sting operation, including the former employee of MECAR USA. Since this time, the Company’s FCPA counsel has had several discussions with the DOJ and SEC regarding the agencies’ respective inquiries. Based upon these discussions, it appears likely that resolution of these inquiries will involve a payment by the Company to at least one of these government agencies in connection with at least one transaction involving the former employee of Mecar USA. At this point, the amount of this payment is undeterminable.

No distributions to stockholders are expected prior to resolution of the DOJ and SEC inquiries and completion of the Delaware dissolution process which includes notice to creditors and publication of the dissolution, followed by a petition to the Delaware courts.

With the completion of the September 2010 sale, Allied no longer has operating segments. The Company is being managed by its two directors who are also serving as the Company’s Chief Executive Officer and Chief Financial Officer. The Company no longer has any full-time employees. Allied no longer conducts any active business operations and is winding-up its affairs as set forth above.

Forward-Looking Statements

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that are based on current expectations, estimates and projections about the Company. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecast in such forward-looking statements. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

Net Assets in Liquidation

Net assets in liquidation at June 30, 2012 are $43.818 million compared to $44.333 million at December 31, 2011. The change in net assets in liquidation is due to: (i) adjustments of assets to fair value, (ii) adjustment to estimated income to be earned on investments, and (iii) adjustments to estimated costs to be incurred during liquidation. The net assets in liquidation per share as of June 30, 2012 has been adjusted to $5.32 as compared to $5.35 as of March 31, 2012, $5.38 as of December 31, 2011, $5.37 as of September 30, 2011, $5.40 as of June 30, 2011 and $5.54 as of March 31, 2011 and December 31, 2010.

We expect to use all of our net assets to complete our Plan of Dissolution, which includes settling existing claims against the Company, including current liabilities and accrued expenses, and making cash liquidating distributions to our shareholders. Net assets available for liquidating distributions to shareholders may vary if we incur greater than estimated operating expenses associated with executing the Plan of Dissolution, any actual settlement costs for existing claims against the Company (as we have not accrued any amounts for resolution of the DOJ/SEC matter or any other existing claim), or if there are existing, but unknown claims made against us in the future.

As of June 30, 2012, cash and cash equivalents decreased from December 31, 2011 by approximately $2.8 million due to funds moved to the short-term investments.

 

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Changes in Net Assets in Liquidation During the Three Months Ended June 30, 2012

The table below summarizes the changes in net assets during the three months ended June 30, 2012:

 

		Three Months Ended June 30, 2012
Net assets on liquidation basis at beginning of period		$	44,032
Changes in fair value of net assets in liquidation
Adjust net assets to fair value			13
Increase in estimated net costs to be incurred during liquidation			(203	)
Adjust estimated income to be earned during liquidation			(24	)
Net assets on liquidation basis at end of period		$	43,818

The change in net assets in liquidation during the three months ended June 30, 2012 is the net effect of valuation changes to the net assets, adjustment to income to be earned on investments, and changes in the estimated net costs to be incurred during liquidation. Adjusting net assets to fair market value increased the net assets in liquidation by $0.013 million. The estimated net costs to be incurred during liquidation increased by $0.203 million. Estimated income to be earned during liquidation decreased by $0.024 million. The net effect was a decrease of $0.214 million in net assets in liquidation for the three months ended June 30, 2012.

The adjustment of assets to fair value is the reduction of short- term investments to fair market value. The unrealized loss associated with the short- term investments is due to the Company’s purchase of financial instruments with interest rates above market and therefore are purchased at a premium to their maturity value with an initial unrealized loss. The unrealized loss will be absorbed against the interest income received as the instruments mature.

The table below reconciles the changes during the quarter ended June 30, 2012, in the estimated net costs to be incurred during liquidation. Actual costs, net of interest income received, incurred during the three months ended June 30, 2012 reduce the remaining estimated net costs to be incurred during liquidation. An update to the estimate of remaining net costs to be incurred during liquidation is reflected in the changes in estimates column.

 

		(in thousands)
Estimated Net Costs to be Incurred During Liquidation		March 31, 2012				Changes in Estimates				(Costs Incurred) Income Received				June 30, 2012
Estimated net costs to be incurred during liquidation
Compensation for remaining employees and directors		$	254			$	74			$	(36	)		$	292
Compliance and other office costs			503				(9	)			(67	)			427
Insurance Fees			302				120				(1	)			421
Professional Fees			1,395				18				(323	)			1,090
Income Taxes			150				—				—				150
Subtotal			2,604				203				(427	)			2,380
Less: interest income on cash and investment balances			(158	)			24				(1	)			(135	)
Total net costs to be incurred during liquidation		$	2,446			$	227			$	(428	)		$	2,245

During the three months ended June 30, 2012, $0.427 million of costs were incurred. The estimate of costs to be incurred during liquidation was increased by $0.203 million. This is the net effect of a $0.074 million increase in compensation for remaining employees and directors principally due to a potential final pay-out to Mecar employees; $0.009 million decrease in compliance and other office costs; $0.120 million increase in insurance fees due to the increase in the estimate for D&O insurance; and $0.018 million increase in professional fees due to amounts accrued not previously included in the estimated net costs to liquidate. As of June 30, 2012, the estimate of remaining costs to be incurred through 2013 is $2.380 million. Future investment income is estimated to be $0.135 million resulting in estimated total net costs to be incurred during liquidation of $2.245 million as of June 30, 2012.

 

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Changes in Net Assets in Liquidation During the Six Months Ended June 30, 2012

The table below summarizes the changes in net assets during the six months ended June 30, 2012:

 

		Six Months Ended June 30, 2012
Net assets on liquidation basis at beginning of period		$	44,333
Changes in fair value of net assets in liquidation
Adjust net assets to fair value			(2	)
Increase in estimated net costs to be incurred during liquidation			(491	)
Adjust estimated income to be earned during liquidation			(22	)
Net assets on liquidation basis at end of period		$	43,818

The change in net assets in liquidation during the six months ended June 30, 2012 is the net effect of valuation changes to the net assets, adjustment to estimated income to be earned on investments, and changes in the estimated net costs to be incurred during liquidation. Adjusting net assets to fair market value decreased the net assets in liquidation by $0.002 million. The estimated net costs to be incurred during liquidation increased by $0.491 million. Estimated income to be earned during liquidation decreased by $0.022 million. The net effect was a decrease of $0.515 million in net assets in liquidation for the six months ended June 30, 2012.

The adjustment of assets to fair value is the reduction of short term investments to fair market value. The unrealized loss associated with the short term investments is due to the Company’s purchase of financial instruments with interest rates above market and therefore are purchased at a premium to their maturity value with an initial unrealized loss. The unrealized loss will be absorbed against the interest income received as the instruments mature.

The table below reconciles the changes during the six months ended June 30, 2012, in the estimated net costs to be incurred during liquidation. Actual costs, net of interest income received, incurred during the six months ended June 30, 2012 reduce the remaining estimated net costs to be incurred during liquidation. An update to the estimate of remaining net costs to be incurred during liquidation is reflected in the changes in estimates column.

 

		(in thousands)
Estimated Net Costs to be Incurred During Liquidation		December 31, 2011				Changes in Estimates				(Costs Incurred) Income Received				June 30, 2012
Estimated net costs to be incurred during liquidation
Compensation for remaining employees and directors		$	297			$	101			$	(106	)		$	292
Compliance and other office costs			564				6				(143	)			427
Insurance Fees			321				344				(244	)			421
Professional Fees			1,556				40				(506	)			1,090
Income Taxes			150				—				—				150
Subtotal			2,888				491				(999	)			2,380
Less: interest income on cash and investment balances			(200	)			22				43				(135	)
Total net costs to be incurred during liquidation		$	2,688			$	513			$	(956	)		$	2,245

As of December 31, 2011, the estimated total net costs to be incurred during liquidation was $2.688 million, consisting of $2.888 million estimated costs offset by $0.200 million of investment income. During the six months ended June 30, 2012, $0.999 million of costs were incurred. The estimate of costs to be incurred during liquidation was increased by $0.491 million.

 

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This is the net effect of a $0.101 million increase in compensation for remaining employees and directors principally due to a final 401k plan contribution and a potential final pay-out to Mecar employees; $0.006 million increase in compliance and other office costs; $0.344 million increase in insurance fees, primarily due to the amortization of prepaid insurance and write-off of the prepaid balance and an increase in the estimate for D&O insurance; and $0.040 million increase in professional fees due to amounts accrued not previously included in the estimated net costs to liquidate. As of June 30, 2012, the estimate of remaining costs to be incurred through 2013 is $2.380 million. Future investment income is estimated to be $0.135 million resulting in estimated total net costs to be incurred during liquidation of $2.245 million as of June 30, 2012.

Critical Accounting Policies

The Company’s discussion and analysis of its financial condition, results of operations and cash flows are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, sales, and expenses, and related disclosure of contingent assets and liabilities. The Company re-evaluates its estimates on an on-going basis. The Company’s estimates and judgments are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates or judgments under different assumptions or conditions.

The Company believes the following are its critical accounting policies which affect its more significant judgments and estimates used in the preparation of its unaudited condensed consolidated financial statements:

 

•

Estimates of the potential liability associated with litigation and government investigations

 

•

Estimates of expenses incurred and interest income received during liquidation. Under the liquidation basis of accounting, the Company accrues for the remaining costs to be incurred during liquidation, including compensation for remaining directors, consultants, insurance costs, costs to settle remaining leases, fees for professional service providers and miscellaneous other costs, partially offset by estimated future interest earnings. These estimates are undiscounted for present value and are based on the assumption that liquidation will occur no later than December 31, 2013.

 

•

Fair Value of financial instruments. The fair values for substantially all of our financial assets and financial liabilities are based on observable prices and inputs and are classified in level 1 of the hierarchy.

A complete discussion of these policies is contained in our Form 10-K filed on March 23, 2012 with the Securities and Exchange Commission for the year ended December 31, 2011. There were no significant changes to the critical accounting policies discussed in the Company’s Form 10-K filed for December 31, 2011.

Commitments and Contingencies

DOJ Subpoena

On January 19, 2010, the Company received a subpoena and communications from the U.S. Department of Justice (“DOJ”) requesting the Company produce documents relating to its dealings with foreign governments. The subpoena stated that it was issued in connection with an ongoing criminal investigation. See Part II – Item 1 for additional information regarding the DOJ matter.

Leases

The Company leases domestic office space under an operating lease which expires in early 2013. The lease also includes escalation provisions for taxes and operating costs. In April, 2011, the Company subleased the office space for 2011 and 2012 to offset a portion of the rental obligation owed by the Company.

Indemnification provisions

The Company has sold its SeaSpace, Titan, the VSK Group, GMS and NSM subsidiaries in separate transactions starting with the first transaction closing in 2007. In each transaction, the Company agreed to indemnify the purchaser for periods

 

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subsequent to closing for losses arising from breaches of representations, warranties and covenants. Indemnification periods varied based on the particular representation, warranty or covenant covered, the vast majority of which have all expired. As of September 30, 2011, the only remaining indemnification obligations relate to representations and warranties concerning taxes, environmental matters, breaches of title, breaches of authorization and fraud. For SeaSpace, Titan, the VSK Group, GMS and NSM, these indemnification provisions have been capped at $1.0 million, $0.950 million, $6.288 million (€5.0 million), $5.2 million and $0.863 million, respectively. At June 30, 2012, no amount has been accrued related to these indemnifications as a liability is not deemed probable.

On June 24, 2010, the Company signed a definitive purchase and sale agreement with Chemring Group PLC pursuant to which Chemring agreed to acquire substantially all of the assets of the Company for $59.560 million in cash and the assumption of certain liabilities. The purchase and sale agreement contains certain indemnification provisions pursuant to which the Company may be required to indemnify the buyer for a period subsequent to the completion of the sale for any and all losses directly or indirectly based upon, related to, arising out of or in connection with Mecar’s completed contracts, Mecar USA liabilities retained by the Company and any failure by the Company to satisfy all transaction related expenses. The Company’s indemnification liability is limited to, and capped at, the escrowed amount of $15 million plus the accumulated interest. The Company’s indemnification obligations expire upon the earlier of (i) June 30, 2015 and (ii) the Company’s entry into either a court or administrative order or a Chemring-approved settlement agreement, in either case, finally resolving the matters relating to the DOJ’s subpoena. In the absence of such final resolution, in certain circumstances, up to 50% of the escrowed funds may be released as early as June 24, 2013. At June 30, 2012, no amount has been accrued related to this indemnification as a liability is not deemed probable.

Future Reporting

The Company filed a Certificate of Dissolution with the State of Delaware on August 31, 2011 and the Company has closed its stock transfer books and instructed its stock transfer agent that no further stock transfers be recognized. Accordingly, the Company’s stock has ceased trading on the OTCQB Marketplace. The Company is required under Delaware law to maintain a quasi-corporate existence for a period of three years for the limited purpose of winding up its affairs and discharging or making provision for the discharge of its liabilities.

Promptly after the filing of the Certificate of Dissolution, the Company requested a no-action letter from the Securities and Exchange Commission to allow the Company to cease filing Forms 10-K and 10-Q. The Securities and Exchange Commission has rejected this request; accordingly, the Company will continue to file all required Forms 10-K and 10-Q.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required for a smaller reporting company.

ITEM 4. CONTROLS AND PROCEDURES

Overview

As a result of the sale of Mecar and Mecar USA and the adoption by the stockholders of the Plan of Dissolution, the Company terminated all employees. The Company’s Officers/Board of Directors continue to oversee and review the Company’s system of financial reporting.

Disclosure Controls and Procedures

Subject to the provisions set forth in the Overview section above, the Company carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 as of the end of the period covered by the report. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective as of June 30, 2012.

 

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Changes in Internal Control Over Financial Reporting

Subject to the provisions set forth in the Overview section above, there were no changes in the Company’s internal control over financial reporting during the period covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

DOJ Subpoena

On January 19, 2010, the Company received a subpoena and communications from the U.S. Department of Justice (“DOJ”) requesting the Company produce documents relating to its dealings with foreign governments. The subpoena stated that it was issued in connection with an ongoing criminal investigation. On the same day, the Company also became aware through a press release issued by the DOJ that an employee of Mecar USA had been indicted by the DOJ for allegedly engaging in schemes to bribe foreign government officials to obtain and retain business. The unsealed indictment of this employee and the DOJ’s press release indicate that the alleged criminal conduct was on behalf of a Decatur, Georgia company which is unrelated to the Company or Mecar USA. Mecar USA’s employment agreement with the employee provided that the employee not actively engage in any other employment, occupation or consulting activity that conflicts with the interests of the Company. In light of the employee’s breach of his employment agreement, Mecar USA terminated his employment on January 20, 2010.

According to the DOJ’s press release, the former employee was arrested on January 19, 2010, along with twenty-one other individuals, after an undercover operation that targeted foreign bribery in the military, and small arms and ammunition industries. The indictments of the twenty-two individuals allege that the defendants conspired to violate the Foreign Corrupt Practices Act (“FCPA”), conspired to engage in money laundering and engaged in substantive violations of the FCPA.

Subsequently, the Company received notice from the DOJ that indicated that it would request additional documents and expand its review beyond matters relating to the indicted former employee of Mecar USA. The Company understood that the DOJ’s expanded review was in connection with an industry-wide review. The Company has also received inquiries from the SEC regarding this matter.

The Company is cooperating with the DOJ and SEC and complying with the DOJ’s subpoena and SEC’s request for information. The Company’s ongoing compliance with these matters is being overseen by the Company’s Board of Directors. The Board of Directors is being assisted in these matters by independent outside counsel. The Company cannot predict the outcome of these matters or the impact, if any, that they may have on our plan to return the net proceeds of the Chemring sale to our stockholders.

Based on advice from our FCPA outside counsel, we have estimated that we may not be able to conclude the DOJ/SEC inquiries, complete the Delaware dissolution process and make final distribution to stockholders until 2013. As a result, our estimate of net costs to be incurred during liquidation includes our estimate of costs through December 31, 2013.

In February and March, 2012, the DOJ dismissed charges against all individuals indicted in the FCPA sting operation, including the former employee of MECAR USA. Since this time, the Company’s FCPA counsel has had several discussions with the DOJ and SEC regarding the agencies’ respective inquiries. Based upon these discussions, it appears likely that resolution of these inquiries will involve a payment by the Company to at least one of these government agencies in connection with at least one transaction involving the former employee of Mecar USA. At this point, the amount of this payment is undeterminable.

No distributions to stockholders are expected prior to resolution of the DOJ and SEC inquiries and completion of the Delaware dissolution process which includes notice to creditors and publication of the dissolution, followed by a petition to the Delaware courts.

Item 1A. Risk Factors

Not required for a smaller reporting company.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable

Item 5. Other Information

None

Item 6. Exhibits

 

Exhibit No.		Description of Exhibits
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32		Certification Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101		The following financial information from our Quarterly Report on Form 10-Q for the second quarter of 2012 filed with the SEC formatted in Extensible Business Reporting Language (XBRL):

(i)		Consolidated Statements of Net Assets as of June 30, 2012 and December 31, 2011 (liquidation basis)
(ii)		Consolidated Statement of Changes in Net Assets for the three and six months ended June 30, 2012 (liquidation basis)

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

		THE ALLIED DEFENSE GROUP, INC.
		/s/ Charles S. Ream
Date: August 13, 2012		Charles S. Ream
		Director and Chief Financial Officer

 

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