Allied Defense Group: Conversation with the CEO

I spoke with retired Major General John Marcello, who is CEO of Allied Defense Group (ADG) earlier in the week in order to answer some questions that I had in regards to the organization. The focus of the conversation was on the organization over the next 2-3 years rather than on historical events where information is readily available through reading financial statements and conference call transcripts. The conversation was very helpful in allowing me to increase my confidence in the organization and management and in gaining an understanding of the direction of the company going forward. Below, are some highlights from the call:

- Over the past couple of years, the company has undergone (and is to some degree still undergoing) a major transformation where they have sold off non-core operations so that they can concentrate on core assets and on paying down their debt load. At the present time, they owe bondholders about $20M and will likely use money from some of the recent sales to pay this amount down a bit more. The company has also restructured their core MECAR operations as well as NS Microwave.

- Marcello expects the company to operate much more profitably going forward and sees 2008 as being a big year for the company. They are starting off the year very well in terms of revenue and are on track for strong profitability. Much of the revenue in the early part of the year is from ammunition passthrough contracts which offer nice margins for the company. Marcello mentioned that the company now has a larger # of clients and significantly larger amount of backlog then back when the stock was trading well north of $20 per share.

- I asked Marcello what he envisions the company looking like in 2-3 years. He commented that the product mix will likely be very different from what it is today with revenue from the electronics side catching up and surpassing that of the ammunition side of the business (although he still expects ammunition sales to grow on an absolute basis). The company is working on several large initiatives in the Middle East which offer tremendous opportunity to the company in cooperation with Spear for security of ports, petrochemical facilities and potentially large cities within the Middle East. Marcello was also excited about the announced surveillance for the Super Bowl in Glendale.

- The primary reasons behind the recent announcement of the teaming with Alliant is to offset some of the cyclical nature of sales within the Middle East and to increase their exposure within the United States. MECAR USA has recently increased their number of employees and is hitting the ground running in 2008.

- Marcello seemed very intent on continuing to cut costs especially at corporate headquarters and to have more normal cash flows and increasing revenues and earnings at the firm. The company has a strong relationship with Saudi Arabia but is continuing to diversify their country exposure. Continued strength in oil prices and/or weakness in the dollar would be of a net benefit to the company. The threat of Iran should also help the company as cooperation will likely increase across other Middle Eastern countries.

I was very impressed with Marcello and think he is a very capable and knowledgable leader of the company. He seems to be taking the company on the right track by paying off debt, improving the balance sheet, expanding business in terms of both geography and scope and in hopefully guiding the company to increased revenues and profitability going forward. The key risks to the thesis are negative changes in backlog, increased stability in Middle Eastern countries, combination of a significantly higher dollar and weaker oil prices or mismanagement.