##### 



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 period ended March 31, 2004 Commission File Number: 001-11376   The Allied Defense Group, Inc. (Exact name of Registrant as specified in its charter)
 Delaware
    
    04-2281015(State or other jurisdiction of
    
    (I.R.S. Employer Number)incorporation or organization)
 8000 Towers Crescent Drive, Suite 260
Vienna, Virginia 22182(Address of principal executive offices, including zip code) (703) 847-5268(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 is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [X] No [   ] Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of March 31, 2004: 5,553,729.




---



##### 



THE ALLIED DEFENSE GROUP, INC.
INDEX PAGENUMBERPART I. FINANCIAL INFORMATION  UNAUDITEDItem 1. Financial StatementsCondensed Consolidated Balance SheetsMarch 31, 2004 and December 31, 2003
    
    
    2Condensed Consolidated Statements of EarningsThree months ended March 31, 2004 and 2003
    
    
    3Condensed Consolidated Statements of Cash FlowsThree months ended March 31, 2004 and 2003
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    12Item 3. Quantitative and Qualitative Market Risk Disclosure
    
    
    21Item 4. Disclosure Controls and Procedures
    
    
    21PART II. OTHER INFORMATIONItem 6. Exhibits and Reports on Form 8-K
    
    
    22Signatures
    
    
    24




---



##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS (Thousands of Dollars, except per share data) March 31, 2004
    
    December 31, 2003UnauditedASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    26,437
    
    
    $
    43,377Restricted cash
    
    
    4,890
    
    
    
    15,937Accounts receivable
    
    
    25,899
    
    
    
    29,321Costs and accrued earnings on uncompleted contracts
    
    
    71,543
    
    
    
    68,414Inventories
    
    
    13,149
    
    
    
    12,068Deferred tax asset
    
    
    846
    
    
    
    1,016Fair value of foreign exchange contracts
    
    
    2,734
    
    
    
    9,378Prepaid and other current assets
    
    
    5,695
    
    
    
    4,880Total current assets
    
    
    151,193
    
    
    
    184,391PROPERTY, PLANT AND EQUIPMENT net of accumulated depreciation
    
    
    23,759
    
    
    
    24,615OTHER ASSETSIntangibles, net of accumulated amortization
    
    
    4,043
    
    
    
    4,135Goodwill
    
    
    13,590
    
    
    
    13,718Other assets
    
    
    489
    
    
    
    37818,122
    
    
    
    18,231$
    193,074
    
    
    $
    227,237LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESNotes payable
    
    $
    82
    
    
    $
    14,200Current maturities of long-term debt
    
    
    1,975
    
    
    
    2,709Convertible subordinated debenture, current, less unamortized discount
    
    
    7,424
    
    
    
    5,250Accounts payable
    
    
    36,909
    
    
    
    53,284Accrued liabilities
    
    
    22,672
    
    
    
    16,846Customer deposits
    
    
    3,916
    
    
    
    4,938Foreign exchange contracts
    
    
    2,734
    
    
    
    9,378Income taxes
    
    
    1,730
    
    
    
    906Total current liabilities
    
    
    77,442
    
    
    
    107,511LONG-TERM OBLIGATIONSLong-term debt, less current maturities
    
    
    4,305
    
    
    
    4,902Convertible subordinated debenture, less current maturities and
unamortized discount
    
    
    
    
    
    
    2,156Deferred compensation
    
    
    1,745
    
    
    
    1,334Deferred taxes
    
    
    809
    
    
    
    1,3396,859
    
    
    
    9,731STOCKHOLDERS EQUITYPreferred stock, no par value; authorized, 1,000,000 shares; none issued
    
    
    
    
    
    
    Common stock, par value, $.10 per share; authorized 30,000,000 shares;
issued and outstanding, 5,553,729 in 2004 and 5,551,373 in 2003
    
    
    555
    
    
    
    555Additional paid-in capital
    
    
    25,930
    
    
    
    25,891Retained earnings
    
    
    70,910
    
    
    
    70,166Accumulated other comprehensive income
    
    
    11,378
    
    
    
    13,383108,773
    
    
    
    109,995$
    193,074
    
    
    $
    227,237
 The accompanying notes are an integral part of these consolidated financial statements. 2




---



##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (Thousands of Dollars, except per share data) (Unaudited) Three months endedMarch 31,2004
    
    2003Revenue
    
    $
    34,468
    
    
    $
    42,657Cost and expensesCost of sales
    
    
    24,310
    
    
    
    28,914Selling and administrative
    
    
    6,646
    
    
    
    5,774Research and development
    
    
    1,561
    
    
    
    851Operating income
    
    
    1,951
    
    
    
    7,118Other income (expense)Interest income
    
    
    101
    
    
    
    97Interest expense
    
    
    (479
    )
    
    
    (436
    )Other  net
    
    
    (349
    )
    
    
    28(727
    )
    
    
    (311
    )Earnings before income taxes
    
    
    1,224
    
    
    
    6,807Income tax expense
    
    
    480
    
    
    
    2,873NET EARNINGS
    
    $
    744
    
    
    $
    3,934Earnings per shareBasic
    
    $
    .13
    
    
    $
    .72Diluted
    
    $
    .13
    
    
    $
    .68Weighted average number of common shares:Basic
    
    
    5,551,399
    
    
    
    5,479,125Diluted
    
    
    5,744,163
    
    
    
    5,919,028
 The accompanying notes are an integral part of these consolidated financial statements. 3




---



##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands of Dollars) (Unaudited) Three months ended March 312004
    
    2003Cash flows from operating activitiesNet earnings
    
    $
    744
    
    
    $
    3,934Adjustments to reconcile net earnings to net cash provided by (used in) operating activitiesDepreciation and amortization
    
    
    1,160
    
    
    
    1,008Provision for estimated losses on contracts
    
    
    45
    
    
    
    111Deferred taxes
    
    
    (363
    )
    
    
    45Deferred compensation
    
    
    451
    
    
    
    114Changes in assets and liabilitiesAccounts receivable
    
    
    3,029
    
    
    
    5,430Costs and accrued earnings on uncompleted contracts
    
    
    (5,321
    )
    
    
    4,417Inventories
    
    
    (1,351
    )
    
    
    (1,563
    )Prepaid and other current assets
    
    
    (954
    )
    
    
    58Accounts payable, accrued liabilities and customer deposits
    
    
    (9,655
    )
    
    
    606Income taxes
    
    
    882
    
    
    
    2,701Net cash provided by (used in) operating activities
    
    
    (11,333
    )
    
    
    16,861Cash flows from investing activitiesCapital expenditures
    
    
    (888
    )
    
    
    (1,157
    )Net cash used in investing activities
    
    
    (888
    )
    
    
    (1,157
    )Cash flows from financing activitiesPrincipal payments on long-term borrowing
    
    
    (1,100
    )
    
    
    (828
    )Proceeds from issuance of long-term debt
    
    
    
    
    
    
    298Net decrease in short-term borrowings
    
    
    (14,046
    )
    
    
    (2,514
    )Proceeds from employee stock purchases
    
    
    39
    
    
    
    110Option exercises
    
    
    
    
    
    
    43Restricted cash
    
    
    10,843
    
    
    
    110Net cash used in financing activities
    
    
    (4,264
    )
    
    
    (2,781
    )Net increase (decrease) in cash and cash equivalents
    
    
    (16,485
    )
    
    
    12,923Effects of exchange rate changes on cash and cash equivalents
    
    
    (455
    )
    
    
    313NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    (16,940
    )
    
    
    13,236Cash and cash equivalents at beginning of year
    
    
    43,377
    
    
    
    14,876Cash and cash equivalents at end of period
    
    $
    26,437
    
    
    $
    28,112Supplemental Disclosures of Cash Flow InformationCash paid during the period forInterest
    
    $
    148
    
    
    $
    173Taxes
    
    
    1
    
    
    
    55
 The accompanying notes are an integral part of these consolidated financial statements. 4




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(Thousands of Dollars)
(Unaudited) NOTE 1  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The accompanying condensed consolidated financial statements have been prepared
by the Company without audit. In the opinion of management, the accompanying
unaudited condensed consolidated financial statements reflect all necessary
adjustments and reclassifications (all of which are of a normal, recurring
nature) that are necessary for fair presentation for the periods presented. Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted. It is
suggested that these condensed consolidated financial statements be read in
conjunction with the financial statements and notes included in the Companys
December 31, 2003, Form 10-K filed with the Securities and Exchange Commission.
The results of operations for the periods ended March 31, 2004 and 2003 are
not necessarily indicative of the operating results for the full year. Certain reclassifications have been made to the prior periods financial
statements to conform to the current presentation. NOTE 2  PRINCIPLES OF CONSOLIDATION The condensed consolidated financial statements include the accounts of The
Allied Defense Group, Inc. (Allied or the Company), a Delaware corporation,
and its wholly-owned subsidiaries as follows:  
    
    ARC Europe, S.A. (ARC Europe), a Belgian company,  
    
    Allied Research Corporation Limited (Limited), an inactive United Kingdom company,  
    
    News/Sports Microwave Rental, Inc. (NS Microwave), a California corporation,  
    
    Titan Dynamics Systems, Inc. (Titan Dynamics), a Texas corporation,  
    
    SeaSpace Corporation (SeaSpace), a California corporation, and  
    
    MECAR USA, Inc. (MECAR USA), a Delaware corporation ARC Europe includes its wholly-owned subsidiaries MECAR S.A. (MECAR),
Sedachim S.I. S.A., Hendrickx S.A., and the VSK Group. The VSK Group is
comprised of VSK Electronics N.V. and its wholly-owned subsidiaries, Télé
Technique Générale S.A., Intelligent Data Capturing Systems (IDCS) N.V., and
VIGITEC S.A. The Company operates in four (4) segments, which are outlined below:  
    
    Ordnance & Manufacturingsegment
consists of MECAR and MECAR USA. MECAR
develops and produces medium caliber
tank, mortar and other ammunition.
MECAR USA will initially pursue
contracts from the U.S. government and
others for ammunition and pyrotechnics
devices. MECAR USA is expected to be
operational in the latter portion of
2004.  
    
    Electronic Securitysegment consists of
The VSK Group and NS Microwave. VSK
Electronics N.V. manufactures access
control, intrusion protection, fire
detection and video systems; Télé
Technique Générale S.A. installs
security systems; Intelligent Data
Capturing Systems N.V. manufacturers
integrated video systems; and VIGITEC
S.A. installs networked video
surveillance systems. NS Microwave
designs, manufactures, distributes and
services industrial and law enforcement
security products and systems.  
    
    Environmental Safety & Securitysegment
consists of SeaSpace, which designs,
manufactures, distributes and services
weather and environmental satellite
ground reception systems.  
    
    Software, Training & Simulationsegment
consists of Titan Dynamics, which
designs, manufactures and sells
battlefield effects simulators. Allied, the parent company, provides management services to its subsidiaries
and has no operating activities. Significant intercompany transactions have been eliminated in consolidation. 5




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(Thousands of Dollars)
(Unaudited) NOTE 3  DERIVATIVE FINANCIAL INSTRUMENTS As of March 31, 2004 and December 31, 2003, futures contracts designated as
fair value hedges with notional amounts of $69,400 and $50,000 were outstanding
and the fair values of these contracts were $17,078 and $21,966, respectively.
At March 31, 2004 and December 31, 2003, the total fair value was included in
costs and accrued earnings on uncompleted contracts, and fair value of foreign
exchange contracts. Deferred gains on fair value hedges related to multi-year
sales contracts are included in accrued liabilities. NOTE 4  RESTRICTED CASH MECAR is generally required under the terms of its contracts with foreign
governments and its distributor to provide performance bonds and advance
payment guarantees. The credit facility agreements used to provide these
financial guarantees place restrictions on cash deposits and other liens on
MECARs assets. The VSK Group has also pledged certain term deposits to secure
outstanding bank guarantees. $4,765 and $15,812 at March 31, 2004 and December
31, 2003, respectively, was restricted or pledged as collateral for these
agreements. Restricted cash also included $125 at March 31, 2004 and December 31, 2003, as
a result of a deposit which was a requirement of the SeaSpace acquisition
agreement. In 2002, the Company issued a $250 promissory note payable in equal
installments on July 31, 2003 and 2004. Payment is subject to certain
conditions being met as defined in the acquisition agreement. NOTE 5  ACCOUNTS RECEIVABLE Accounts receivable at March 31, 2004 and December 31, 2003 are comprised as
follows: 2004
    
    2003Direct and indirect receivables from foreign governments
    
    $
    14,967
    
    
    $
    15,613Commercial and other receivables, less allowance for doubtful
receivables of $119 in 2004 and $115 in 2003
    
    
    10,932
    
    
    
    13,708$
    25,899
    
    
    $
    29,321
 Receivables from foreign government and government agencies are generally due
within 30 days of shipment, less a 10% hold back provision which is generally
due within 90 days. Since these receivables are supported by letters of credit
or other guarantees, no provision for doubtful accounts is deemed necessary.
The Company evaluates its allowance for doubtful accounts on commercial
receivables on an ongoing basis and provides for losses as deemed necessary. NOTE 6  COSTS AND
ACCRUED EARNINGS ON UNCOMPLETED CONTRACTS Costs and accrued earnings on uncompleted contracts are recognized by MECAR, NS
Microwave and SeaSpace for their fixed priced sales contracts in accordance
with the percentage of completion method of accounting. Under this method,
revenue is recognized as work progresses, based on the relationship between
actual costs incurred during the period and total estimated cost to be incurred
for the total contract. Management reviews these estimates as work progresses
and the effect of any change in cost estimates is reflected in cost of sales in
the period in which the change is identified. The revenue recognized on the
contracts in progress for the three months ended March 31, 2004 and 2003 were
$26,694 and $35,675, respectively. 6




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(Thousands of Dollars)
(Unaudited) NOTE 7  INVENTORIES Inventories at March 31, 2004 and December 31, 2003 are comprised as follows: 2004
    
    2003Raw materials
    
    $
    10,869
    
    
    $
    9,852Work in process
    
    
    1,056
    
    
    
    1,017Finished goods, less reserve for obsolescence of
$212 in 2004 and $214 in 2003
    
    
    1,224
    
    
    
    1,199$
    13,149
    
    
    $
    12,068
 NOTE 8  INTANGIBLE ASSETS AND GOODWILL March 31, 2004
    
    December 31, 2003Accumulated
    
    
    
    
    
    
    
    
    
    AccumulatedGross Amount
    
    Amortization
    
    Net
    
    Gross Amount
    
    Amortization
    
    NetIntangible assets subject to
amortization:Capitalized Software
    
    $
    1,199
    
    
    $
    325
    
    
    $
    874
    
    
    $
    1,179
    
    
    $
    282
    
    
    $
    897Customer Lists
    
    
    2,246
    
    
    
    402
    
    
    
    1,844
    
    
    
    2,247
    
    
    
    356
    
    
    
    1,891Patents
    
    
    1,494
    
    
    
    169
    
    
    
    1,325
    
    
    
    1,494
    
    
    
    147
    
    
    
    1,347Total
    
    $
    4,939
    
    
    $
    896
    
    
    $
    4,043
    
    
    $
    4,920
    
    
    $
    785
    
    
    $
    4,135Goodwill
    
    
    
    
    
    
    
    
    
    $
    13,590
    
    
    
    
    
    
    
    
    
    
    $
    13,718
 Consolidated amortization expense related to intangible assets, excluding
goodwill, for the three months ended March 31, 2004 and 2003 was
$111. The $13,590 of goodwill at March 31, 2004 is comprised of $7,612 related to the
Electronic Security Segment, $4,322 related to the Environmental Safety &
Security Segment and $1,656 related to the Software, Training & Simulation
Segment. Estimated future aggregate annual amortization for intangible assets is as
follows: Period
    
    AmountNine months ended December 31, 2004
    
    $
    576Year ended December 31, 2005
    
    
    540Year ended December 31, 2006
    
    
    379Year ended December 31, 2007
    
    
    297Year ended December 31, 2008
    
    
    225
 7




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(Thousands of Dollars)
(Unaudited) NOTE 9  NOTES PAYABLE AND CREDIT FACILITY Notes Payable  At March 31, 2004, NS Microwave had a note of $82 for machinery
and vehicles. At December 31, 2003 MECAR borrowed $4,322 under its lines of
credit with its lenders. In addition, MECAR borrowed $9,878 under a short-term
loan which was secured by a receivable of $9,878. The line of credit and
short-term loan were paid off during the first quarter of 2004. The weighted
average interest rates for Notes Payable as of March 31, 2004 and December 31,
2003 were 8% and 3%, respectively. Credit Facility  MECAR is obligated under an agreement (the Agreement),
executed March 2002, with its foreign banking syndicate that provides credit
facilities primarily for bank guarantees including performance bonds, letters
of credit and similar instruments required for specific sales contracts as well
as a line-of-credit for tax prepayments and working capital. The Agreement
provides for certain bank charges and fees as the facility is used, plus fees
of 2% of guarantees issued and quarterly fees at an annual rate of 1.25% of
guarantees outstanding. These fees are charged to interest expense. As of
March 31, 2004 and December 31, 2003, guarantees and performance bonds of
approximately $20,631 and $17,233 respectively, were outstanding. Advances under the Agreement are secured by restricted cash at March 31, 2004
and December 31, 2003 of approximately $4,765 and $15,813, respectively.
Amounts outstanding are also collateralized by a pledge of approximately
$41,945 of MECARs net assets. The Agreement requires that MECAR maintain net
worth and working capital covenants. NOTE 10  LONG-TERM DEBT The VSK Group is obligated on a mortgage on its building, which has a balance
of approximately $294 at March 31, 2004. These mortgages are payable in annual
installments of approximately $59 plus interest. The Company and its subsidiaries are also obligated on various vehicle,
equipment, capital lease obligations and other loans. The notes and leases are
generally secured by the assets acquired, bear interest at rates ranging from
3.5% to 8.0% and mature at various dates through 2007. Scheduled annual maturities of long-term obligations as of March 31, 2004 are
approximately as follows: Year
    
    Amount2005
    
    $
    1,9752006
    
    
    1,7302007
    
    
    1,3632008
    
    
    8712009
    
    
    341
 NOTE 11  CONVERTIBLE SUBORDINATED DEBENTURE On June 28, 2002 the Company sold to an accredited investor for $7,500 (i) an
8% subordinated debenture that is convertible into shares of the Companys
common stock at $25.00 per share and (ii) warrants to purchase 15,000 shares of
the Companys common stock at an exercise price of $28.75 per share in cash.
The debenture bears interest at the rate of 8% per year, payable semi-annually.
The Company may elect to pay the principal and/or the interest in cash or in
registered shares of its common stock at a 10% discount to the then current
market price. The warrants to purchase 15,000 shares of the Companys common
stock were valued at $140. 8




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(Thousands of Dollars)
(Unaudited) NOTE 11  CONVERTIBLE SUBORDINATED DEBENTURE  Continued Monthly principal payments, in the amount of $750, are to begin on June 28,
2004 and continue for a period of ten (10) months or until March 28, 2005. The
holder of the debenture may choose to convert all or a portion of the principal
amount outstanding into shares of the Companys common stock at any time before
maturity. The right of the Company to sell and the holders right to purchase
additional debentures expired in August 2003. The Company has registered the
shares of common stock that could be issued in the event the holder elects to
convert the debenture and exercise the warrants. NOTE 12  EARNINGS PER SHARE Basic earnings per share exclude dilution and are computed by dividing net
earnings by the weighted average number of common shares outstanding for the
period. The computation of diluted earnings per share includes the effects of
stock options, warrants and convertible debenture, if such effect is dilutive.
The table below shows the calculation of basic and diluted earnings per share
for the three months ended March 31, 2004 and March 31, 2003, respectively: Three months endedMarch 31,2004
    
    2003Net earnings
    
    $
    744
    
    
    $
    3,934Interest on convertible debenture, net of taxes
    
    
    
    
    
    
    89Net earnings before interest on convertible
debenture
    
    $
    744
    
    
    $
    4,023Weighted average number of basic shares
    
    
    5,551,399
    
    
    
    5,479,125Common stock equivalents
    
    
    192,764
    
    
    
    439,903Weighted average number of diluted shares
    
    
    5,744,163
    
    
    
    5,919,028Basic earning per share
    
    $
    .13
    
    
    $
    .72Diluted earnings per share
    
    $
    .13
    
    
    $
    .68
 9




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(Thousands of Dollars)
(Unaudited) NOTE 13  COMPREHENSIVE INCOME (LOSS) A summary of the components of Comprehensive Income (Loss) for the three months
ended March 31, 2004 and 2003, were as follows: Three months endedMarch 31,2004
    
    2003Net earnings
    
    $
    744
    
    
    $
    3,934Currency translation adjustment
    
    
    (2,005
    )
    
    
    2,569Comprehensive income (loss)
    
    $
    (1,261
    )
    
    $
    6,503
 The currency translation adjustment for the three months ended March 31, 2004
resulted from the depreciation of the Euro during the period. In contrast, the
currency translation adjustment for the comparable period in 2003 resulted from
the appreciation of the Euro during that period. NOTE 14  STOCK BASED COMPENSATION The Company currently accounts for stock options using the intrinsic value
method and is applying APB Opinion No. 25, Accounting for Stock Issued to
Employees.Accordingly, compensation costs for stock options is measured and
recorded as the excess, if any, of the quoted market price of the Companys
stock at the date of grant over the amount an employee must pay to acquire the
stock. Compensation cost for stock awards is recorded based on the quoted
market value of the Companys stock at the time of grant. No compensation cost
has been recognized for the granting of stock options to employees in the three
months ended March 31, 2004 and 2003. The following table presents the pro forma decrease in income for the three
months ended March 31, 2004 and 2003, that would have been recorded had the
fair values of options granted been recognized as compensation expense on a
straight-line basis over the vesting period of the grant: Three Months EndedMarch 31,(Dollars in thousands, except per share amounts)
    
    2004
    
    2003Reported net earnings
    
    $
    744
    
    
    $
    3,934Stock-based compensation costs that would have
been included in the determination of reported
net earnings, if the fair value method was
applied to all awards, net of tax
    
    
    (154
    )
    
    
    (118
    )Pro forma net earnings
    
    $
    590
    
    
    $
    3,816Basic earnings per share:Reported earnings per share
    
    $
    0.13
    
    
    $
    0.72Compensation costs, net of tax
    
    
    (.03
    )
    
    
    (0.02
    )Pro forma basic earnings per share
    
    $
    0.10
    
    
    $
    0.70Diluted earnings per share:Reported earnings per share
    
    $
    0.13
    
    
    $
    0.68Compensation costs, net of tax
    
    
    (.03
    )
    
    
    (0.02
    )Pro forma diluted earnings per share
    
    $
    0.10
    
    
    $
    0.66
 10




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(Thousands of Dollars)
(Unaudited) NOTE 14  STOCK BASED COMPENSATION  Continued No options were granted during the three months ended March 31, 2004, and 2003.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes options pricing model. The weighted average assumptions used in
the model and the weighted-average fair values of each option at the date of
grant were as follows: Three Months Ended March 312004
    
    2003Risk free interest rate
    
    
    2.86
    %
    
    
    2.86
    %Expected volatility rate
    
    
    47.00
    %
    
    
    47.00
    %Expected lives  years
    
    
    3
    
    
    
    3Divided yield
    
    
    
    
    
    
    
 The pro forma amounts may not be representative of future amounts since the
estimated fair value of stock options is amortized to expense over the vesting
period, and additional options may be granted in future periods. NOTE 15  INDUSTRY SEGMENTS Three months endedMarch 31,2004
    
    2003Revenues from external customersOrdnance & Manufacturing
    
    $
    23,078
    
    
    $
    32,667Electronic Security
    
    
    9,330
    
    
    
    6,731Environmental Safety & Security
    
    
    2,024
    
    
    
    2,306Software, Training & Simulation
    
    
    36
    
    
    
    953$
    34,468
    
    
    $
    42,657Segment profit before taxesOrdnance & Manufacturing
    
    $
        1,279
    
    
    $
        6,818Electronic Security
    
    
        820
    
    
    
    58Environmental Safety & Security
    
    
    (136
    )
    
    
    8Software, Training & Simulation
    
    
    (179
    )
    
    
    167Corporate and Other
    
    
        (560
    )
    
    
        (244
    )$
        1,224
    
    
    $
    6,807
 NOTE 16  RECENT ACCOUNTING PRONOUNCEMENTS There were no new accounting pronouncements during the three months ended March
31, 2004 that would impact the Companys financial reporting. 11




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2004
(Thousands of Dollars)
(Unaudited) The following is intended to update the information contained in the Companys
Annual Report on Form 10-K for the year ended December 31, 2003 and presumes
that readers have access to, and will have read, Managements Discussion and
Analysis of Financial Condition and Results of Operations contained in the
Form 10-K. Overview Allied is a strategic portfolio of defense and security businesses, with
presence in worldwide markets, offering both government and commercial
customers leading edge products and services. Allied operates in four (4)
segments:  
    
    Ordnance & Manufacturingsegment consists of MECAR, located in
Belgium, and MECAR USA, located in Marshall, TX. MECAR develops and
produces medium caliber tank, mortar and other ammunition. MECAR USA
will initially pursue contracts from U.S. and foreign governments for
ammunition and pyrotechnics devices. MECAR USA is expected to be
operational in the fourth quarter of 2004.  
    
    Electronic Securitysegment consists of The VSK Group, located in
Belgium, and NS Microwave, located in San Diego, CA. The VSK Group
consists of VSK Electronics N.V. which manufactures access control,
intrusion protection, fire detection and video systems; Télé Technique
Générale S.A. which installs security systems; Intelligent Data
Capturing Systems N.V. which manufacturers integrated video systems;
and VIGITEC S.A. which installs networked video surveillance systems.
NS Microwave designs, manufactures, distributes and services
industrial and law enforcement surveillance products and systems.  
    
    Environmental Safety & Securitysegment consists of SeaSpace, located
in San Diego, CA, which designs, manufactures, distributes and
services weather and environmental satellite ground reception systems.  
    
    Software, Training & Simulationsegment consists of Titan Dynamics,
located in Marshall, TX, which designs, manufactures and sells
battlefield effects simulators, minor pyrotechnics and other training
devices. Allied, the parent company, provides management services to its subsidiaries
and has no operating activities. Allied earned net profits of $744 in the
first quarter of 2004 compared to net profits of $3,934 for the first quarter
of 2003. The reduction in net profits is principally attributed to reduced
profits at MECAR. European results were benefited by a 16% increase in the
value of the Euro versus the U.S. Dollar between the two periods. Allied
entered 2004 with substantial cash reserves and anticipates no liquidity
concerns in 2004. The Company continues to pursue a domestic lending facility
in order to continue its acquisition program. Results of Operations The table below shows, for the three months ended March 31, 2004 and 2003,
certain items from Allieds condensed consolidated statements of earnings
expressed as a percentage of revenue: Three months ended
    
    Three months endedMarch 31, 2004
    
    March 31, 2003Revenue
    
    $
    34,468
    
    
    
    100.0
    %
    
    $
    42,657
    
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    24,310
    
    
    
    70.5
    
    
    
    28,914
    
    
    
    67.8Selling and administrative
    
    
    6,646
    
    
    
    19.3
    
    
    
    5,774
    
    
    
    13.5Research and development
    
    
    1,561
    
    
    
    4.5
    
    
    
    851
    
    
    
    2.0Operating income
    
    
    1,951
    
    
    
    5.7
    
    
    
    7,118
    
    
    
    16.7Other income (expense)Interest income
    
    
    101
    
    
    
    0.3
    
    
    
    97
    
    
    
    0.2Interest expense
    
    
    (479
    )
    
    
    (1.4
    )
    
    
    (436
    )
    
    
    (1.1
    )Other  net
    
    
    (349
    )
    
    
    (1.0
    )
    
    
    28
    
    
    
    0.1
    .Earnings before
income taxes
    
    
    1,224
    
    
    
    3.6
    
    
    
    6,807
    
    
    
    15.9Income tax expense
    
    
    480
    
    
    
    1.4
    
    
    
    2,873
    
    
    
    6.7Net earnings
    
    $
    744
    
    
    
    2.2
    
    
    $
    3,934
    
    
    
    9.2
 12




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations  Continued Revenue.Allied had revenue of $34,468 in the first three months of 2004,
which was 19% lower than its revenue in the first three months of 2003 of
$42,657. This decrease was principally attributable to reduced production
activities at MECAR. Revenue by SegmentThree Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003Percentage
    
    
    
    
    
    PercentageAmount
    
    of total
    
    Amount
    
    of totalOrdnance & Manufacturing
    
    $
    23,078
    
    
    
    67
    %
    
    $
    32,667
    
    
    
    77
    %Electronic Security
    
    
    9,330
    
    
    
    27
    %
    
    
    6,731
    
    
    
    16
    %Environmental Safety & Security
    
    
    2,024
    
    
    
    5
    %
    
    
    2,306
    
    
    
    5
    %Software, Training & Simulation
    
    
    36
    
    
    
    1
    %
    
    
    953
    
    
    
    2
    %$
    34,468
    
    
    
    100
    %
    
    $
    42,657
    
    
    
    100
    %
 Ordnance & Manufacturing Segment revenue in the first three months of 2004
decreased by 29% from the comparable period in 2003. The entire decrease
occurred at MECAR. MECAR USA did not have any sales activity and is not
expected to be operational until the latter portion of 2004. The sales
decrease at MECAR resulted from lower production on the approximately $130,000
Foreign Military Sales (FMS) multi-year contract received in February 2002.
The FMS contract provided approximately 50% of MECARs 2004 year-to-date
revenues. During the first three months of 2004, MECAR encountered production
delays on the FMS contract as a result of design and vendor technical issues.
Those issues are expected to be resolved in the second quarter of 2004. MECAR
has undertaken a customer diversification effort in the past few years, which
continues to be prolific in 2004. In addition to meeting the ammunition needs
of its traditional customers, MECAR has gained new customers, which will
contribute to a majority of its new orders for 2004. Electronic Security Segment revenue increased by $2,599 from the comparable
period in 2003. Revenue increased at the VSK Group by $1,709 and at NS
Microwave by $890. The increase at the VSK Group stemmed from the continued
expansion of its distribution network in Europe, as well as its strong
marketing and business development efforts. In addition, the stronger Euro
represented $1,093 of the increase at the VSK Group. The increase in sales
activity at NS Microwave resulted from work on its strong 2003 year-end
backlog. In 2003 NS Microwaves sales activity was adversely affected by
delays in homeland security appropriations. Environmental Safety & Security Segment revenues decreased by $282 from the
comparable period in 2003 as a result of increased competition by domestic and
foreign competitors. SeaSpaces X band sales made up the majority of 2004
revenues. SeaSpace has undertaken a product and customer diversification
effort to mitigate the increased competition. Software, Training & Simulation Segment revenues decreased by $917 from the
comparable period in 2003 as a result of reduced orders. In the first quarter
of 2004, the sales of cartridges represented the majority of Titan Dynamics
sales. Titan Dynamics major product line of Battle Effects Simulators (BES) is
presently undergoing a U.S. Navy/Marine Corp sponsored safety certification program
scheduled for completion in the fourth quarter 2004. This testing will
be accepted by the US Army, thus allowing Titan Dynamics to better compete in
the US BES market. Certification should also accelerate penetration in foreign
markets. 13




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations  Continued Cost of Sales.Cost of sales as a percentage of sales for the three months
ended March 31, 2004, was 71% compared with 68% for the same period in 2003.
The increase during the three month period was driven by higher costs within
the Ordnance & Manufacturing Segment. Cost of Sales as Percentage of Sales by SegmentThree months endedMarch 312004
    
    2003Ordnance & Manufacturing
    
    
    77
    %
    
    
    71
    %Electronic Security
    
    
    58
    %
    
    
    54
    %Environmental Safety & Security
    
    
    57
    %
    
    
    62
    %Software, Training & Simulation
    
    
    66
    %
    
    
    63
    %Total
    
    
    71
    %
    
    
    68
    %
 Ordnance & Manufacturing Segment cost of sales as a percentage of sales for the
three months ended March 2004 increased over the same period of 2003 because of
lower production activity in 2004 as well as product mix. In addition, MECAR
encountered production delays on the FMS contract as a result of technical
issues, resulting in higher than expected labor and overhead costs. Those
issues are expected to be resolved in the second quarter of 2004. Electronic Security Segment cost of sales as a percentage of sales for the
three months ended March 2004 increased over the same period of 2003 due to the
fact that NS Microwave incurred higher material costs associated with using new
product components to fulfill customer requirements as well as replacing
components which were discontinued by vendors. In contrast, the VSK Group had
consistent cost of sales as a percentage of sales between 2003 and 2004 as it
continues to experience production efficiencies while expanding its
distribution channel throughout Europe. Environmental Safety & Security Segment cost of sales as a percentage of sales
decreased from 2003 as a result of the change in product mix and streamlined
labor costs. SeaSpace has taken efforts to right-size its organization and
reduce its cost of goods sold in light of the competitive environment. Software, Training & Simulation Segment cost of sales as a percentage of sales
for the three months ended March 2004 increased over 2003 as a result of the
change in product mix and higher labor costs. Direct labor as a percentage of
sales was higher in 2004 because the cartridges are more labor intensive than
BES systems and other products. Titan Dynamics BES systems are presently
undergoing a U.S. Navy/Marine Corp sponsored safety certification program
scheduled for completion in the fourth quarter of 2004. Until the safety
certification is obtained, the Company expects the cartridge sales to represent
the majority of total sales. Selling and Administrative Expenses.Selling and administrative expenses as a
percentage of sales for the first three months of 2004 was approximately 19%
compared with 14% for the same period in 2003. This resulted from lower
production activity in 2004 at MECAR. For the other business units, costs were
higher in the first three months of 2004 across each business unit due
primarily to increased compensation expenses for administrative personnel. The
Company expects selling and administrative expense to continue to increase in
proportion to the increase in sales for the remainder of the year. Research and Development.Research and development costs increased in the
first three months of 2004 by 170% over 2003 levels. The total dollar increase
was primarily attributed to increased research being conducted at all the
business units, except NS Microwave. Expenditures decreased at NS Microwave as
the staff utilized for R & D efforts were assigned to production efforts during
the quarter. This trend of increased research and development is expected to
continue for the remainder of the year. 14




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations  Continued Interest Income.Interest income increased in the first three months of 2004
by 4% over 2003 levels. The total dollar increase was nominal and was
primarily attributed to earnings on interest bearing cash accounts. Interest Expense.Interest expense increased in the first three months of 2004
by 10% over 2003 levels due principally to increased charges at MECAR. Other-Net.Other-net primarily represents currency gains/losses, resulting
from foreign currency transactions at MECAR and the VSK Group, as well as bank
charges related to MECARs performance bonds and advance payment guarantees,
which are generally required under the terms of MECARs contracts with foreign
governments and its distributor. Other-net expense was $349 at March 2004,
compared to Other-net income of $28 at March 2003. This resulted primarily
from currency losses in 2004 on MECARs US bank accounts. Pre-Tax Profit Pre-Tax Profit (Loss) by SegmentThree months endedMarch 312004
    
    2003Ordnance & Manufacturing
    
    $
    1,279
    
    
    $
    6,818Electronic Security
    
    
    820
    
    
    
    58Environmental Safety & Security
    
    
    (136
    )
    
    
    8Software, Training & Simulation
    
    
    (179
    )
    
    
    167Corporate and other
    
    
    (560
    )
    
    
    (244
    )$
    1,224
    
    
    $
    6,807
 Ordnance & Manufacturing Segment pre-tax profit for the first three months of
2004 decreased from the comparable period in 2003 principally due to decreased
production activity at MECAR on the FMS contract during the quarter and work on
lower-margin contracts. MECARs profitability for 2004 is expected to be at
lower levels than in prior years due to a lack of high-margin contracts which
benefited 2001-2003 results. Electronic Security Segment pre-tax profit for the first three months of 2004
increased from the comparable period in 2003. Activity at the VSK Group was
favorably impacted by increased sales to non-Belgian customers via the VSK
Groups distribution network. NS Microwaves incurred a lower pre-tax loss as
a result of strong orders in the fourth quarter of 2003. Environmental Safety & Security Segment pre-tax loss resulted from increased
competitive pressures, both at home and abroad, as well as increased
development costs. SeaSpace has taken efforts to right-size its organization
and reduce its cost of goods sold in light of the competitive environment. Software, Training & Simulation Segment pre-tax loss in 2004 results from Titan
Dynamics principal product lacking U.S. Government safety certification.
Titan Dynamics anticipates receipt of Marine Corp certification in the fourth
quarter of 2004. Corporate and other Segment pre-tax loss for the first three months of 2004
increased over 2003 due to reduced intercompany management fee adjustments and
reduced currency gains. Income Taxes.The effective income tax rate in the first three months of 2004
was 39% compared to 42% in the same period of 2003. Income tax expense
decreased in the first three months of 2004 from 2003 levels due to the
decreased pre-tax profits generated. 15




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations  Continued Net Earnings.The Company earned a $744 net profit in the first three months
of 2004 compared with $3,934 net profit in the same period of 2003. The
decrease in 2004 resulted principally from the activities at MECAR. The
Companys 2004 results were negatively impacted by losses at Microwave,
SeaSpace and Titan Dynamics. Backlog.As of March 31,
    2004, the Companys backlog was $112,670 compared to $115,416 at December 31,
    2003, and $130,922 at March 31, 2003. The March 31, 2004 and December 31,
    2003 amounts included unfunded portion of approximately $12,000 from an indefinite
    delivery, indefinite quantity (IDIQ) federal contract. Backlog by SegmentMarch 31, 2004
    
    March 31, 2003Percentage
    
    
    
    
    
    PercentageAmount
    
    of total
    
    Amount
    
    Of totalOrdnance & Manufacturing
    
    $
    86,536
    
    
    
    77
    %
    
    $
    119,704
    
    
    
    91
    %Electronic Security
    
    
    23,971
    
    
    
    21
    %
    
    
    9,977
    
    
    
    8
    %Environmental Safety & Security
    
    
    1,644
    
    
    
    1
    %
    
    
    1,008
    
    
    
    1
    %Software, Training & Simulation
    
    
    519
    
    
    
    1
    %
    
    
    233
    
    
    
    $
    112,670
    
    
    
    100
    %
    
    $
    130,922
    
    
    
    100
    %
 The decrease in backlog is primarily
    the result of MECARs work on the approximately $130,000 FMS multi-year
    contract awarded in February 2002. The backlog associated with this particular
    contract will continue to decrease in accordance with the delivery terms of
    the award. MECAR has undertaken a customer diversification effort in the past
    few years, which continues to be prolific in 2004. In addition to meeting
    the ammunition needs of its traditional customers, MECAR has gained new customers
    which will contribute to a majority of its new orders for 2004. Electronic
    Security backlog increased from new contracts received at the VSK Group and
    NS Microwave. Electronic Security backlog includes an unfunded portion of
    approximately $12,000 from an IDIQ federal contract. Liquidity and Capital Resources Balance Sheet All items on the Companys March 31, 2004 condensed consolidated balance sheet
were affected by the value of the Euro in 2004. All European values were
converted at the March 31, 2004 and December 31, 2003 conversion ratios of
1.2178 and 1.2557, respectively. Historically, the Companys positive cash flow from operations and available
credit facilities have provided adequate liquidity and working capital to fully
fund the Companys operational needs. Working capital, which includes
restricted cash, was $73,751 at March 31, 2004, which is a slight decrease of
$3,129 from the December 31, 2003, level. Working capital remains strong due to
profitable operations. Cash at March 31, 2004 decreased by $16,940 from December 31, 2003 as
substantial cash was expended in the first quarter of 2004 to repay current
liabilities. Restricted cash decreased by $11,047 in the first quarter of 2004
due to completion of certain contracts at MECAR. Accounts receivable at March 31, 2004, decreased $3,422 or 12% from December
31, 2003, due to lower sales in the first quarter 2004 versus the fourth
quarter 2003. Costs and accrued earnings on uncompleted contracts increased
from year-end 2003 primarily as a result of continued work on the FMS contract
at MECAR. Inventories increased $1,081 primarily from higher raw material
purchases. The inventory buildup will give the subsidiaries the ability to
deliver products with the shortest possible lead times. Fair value of foreign
exchange contracts was $2,734 at March 31, 2004, compared to $9,378 at December
31, 2003. MECAR uses foreign currency hedge contracts to minimize the foreign
currency exposures that arise from sales contracts with certain foreign
customers. 16




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2004
(Thousands of Dollars)
(Unaudited) Liquidity and Capital Resources  Continued Prepaid and other current assets increased $937 primarily from capitalized
costs on MECARs hedge contract agreements as well as capitalized funding costs
for a proposed senior debt facility at Corporate. Property, Plant & Equipment, net of accumulated depreciation, decreased
primarily from the lower Euro at March 2004, which affected the balances of
MECAR and the VSK Group. All subsidiaries, except Corporate, purchased
equipment during the first three months of 2004. Goodwill decreased solely
from the lower Euro. Notes Payable decreased $14,118 from December 31, 2003 as a result of MECAR
paying off its line of credit and other indebtedness. During 2004, MECAR used
its cash from operations for working capital needs. The outstanding Notes
Payable balance is from NS Microwave. Accounts payable decreased $16,375 as a
result of lower production costs, primarily at MECAR, for the three months
ended March 2004 compared to the three months ended December 2003. In
contrast, accrued liabilities increased $5,826 due primarily to the costs
associated with deferred gains related to forward exchange contracts at MECAR.
MECAR entered into new foreign exchange contracts during 2004. Customer
deposits decreased $1,022 primarily at MECAR as a result of shipments during
the period and other new contracts in 2004 not requiring deposits. Income
taxes increased $824 due to the tax provisions at MECAR and the VSK Group,
offset by the tax benefits at NS Microwave, SeaSpace, Titan Dynamics and
Corporate. Convertible-subordinated debenture, current and long-term, was materially
unchanged between March 31, 2004, and December 31, 2003. Stockholders equity as of March 31, 2004, was negatively affected by the
reduction in the value of the Euro versus the U.S. dollar during the first
three months of 2004, resulting in a decrease in accumulated other
comprehensive income by $2,005. The Euro depreciated by approximately 3% since
the beginning of the year. Cash Flows The table below provides the cash flow statement data for the periods
presented. Three months ended March 312004
    
    2003Net cash provided by (used in) operating activities
    
    $
    (11,333
    )
    
    $
    16,861Net cash used in investing activities
    
    
    (888
    )
    
    
    (1,157
    )Net cash used in financing activities
    
    
    (4,264
    )
    
    
    (2,781
    )
 Operating Activities.The Company used $11,333 of cash in its operating
activities during the three months ended March 31, 2004 whereas it generated
$16,861 of cash during the same period of 2003. This is attributed primarily
to reduction in earnings for the three months ended March 2004 and payments of
costs and accrued earnings on uncompleted contracts as well as current
liabilities, which are mainly from MECARs and the VSK Groups customer base.
Cash paid for interest was $148 and $173, for the three months ended March 31,
2004 and 2003, respectively. Cash paid for income taxes was $1 and $55 for the
three months ended March 31, 2004 and 2003, respectively, and includes federal,
international and state taxes. Investing Activities.Net cash used in investing activities decreased by $269
between the two periods. This stemmed from lower capital expenditures for
production equipment and leasehold improvements at the Belgian business units.
The Company anticipates that cash generated from operations will be
sufficient to support any further capital expenditures over the remainder of
the year. Future expenditures for the remainder of the year will be primarily
incurred for machinery and equipment. 17




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2004
(Thousands of Dollars)
(Unaudited) Liquidity and Capital Resources  Continued Financing Activities.Net cash used in financing activities decreased by
$1,483 between the two periods. This stemmed from payment of short-term
borrowings offset by increased restricted cash, which primarily pertained to
MECAR operations. Allied.The parent company continues to operate based on fees and dividends
received from its subsidiaries. In the first quarter of 2004, Allied has made
cash infusions to NS Microwave, Titan Dynamics and SeaSpace to support working
capital requirements. MECAR.MECAR continues to operate from internally generated cash and funds
provided by its bank syndicate and financing from capital leases. The bank
syndicate agreement provides (i) lines of credit for tax prepayments and
working capital and (ii) a facility for guarantees/bonds to support customer
contracts. The financial lending terms and fees are denominated in Euros and
the dollar equivalents will fluctuate according to global economic conditions.
The bank agreement imposes two financial covenants requiring MECAR to maintain
minimum net worth and working capital levels. As of March 31, 2004, MECAR was
in compliance with both of these bank covenants. MECARs obligations under the
bank syndicate agreement continue to be collateralized by a pledge of MECARs
assets. The agreement includes Allieds pledge to support MECAR so that it
remains in compliance with its total borrowing obligations. VSK Group.The VSK Group operated solely from cash generated from business
operations. The VSK Group is obligated on several mortgages and other
long-term obligations. Other Subsidiaries.NS Microwave, Titan Dynamics and SeaSpace operated from
cash generated from operations and cash infusions by Allied. Stock Repurchases.The Company did not repurchase any shares of its common
stock during the three months ended March 31, 2004 and does not anticipate
repurchasing shares of Company stock during the remainder of 2004. Future Liquidity.The Company continues to explore alternate methods of
securing the necessary financial capacity to implement its growth plans. At
times, the Company has utilized the services of an Investment Banker in an
attempt to secure a senior credit facility for its U.S. based operations. Funds for the build out of the initial MECAR USA infrastructure are being
provided by the Marshall Economic Development Corporation of Marshall, Texas.
This is a state funded organization with the initial proceeds directed at
creating roads and a manufacturing plant on the grounds. The Companys ability to cover its anticipated future operating and capital
requirements is dependent upon its continued ability to generate positive cash
flow from the operations of its subsidiaries, particularly the operations of
MECAR and the VSK Group, and its ability to successfully integrate its
acquisitions. The Company expects its acquisitions to be accretive to
operations over a period of not longer than 24 months, although this cannot be
assured. This will depend upon many factors including the successful release
of new product offerings, successful research and development efforts, and
increased market share. 18




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2004
(Thousands of Dollars)
(Unaudited) Liquidity and Capital Resources  Continued Off-Balance Sheet Arrangements.As part of our ongoing business, we do not
participate in transactions that generate relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance or special purpose entities (SPEs), which would have been
established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes. As of March 31, 2004, we are
not involved in any material unconsolidated SPE transactions. MECAR is
required to provide performance bonds and advance payment guarantees for
certain contracts, which are provided by MECARs bank syndicate. MECAR is
obligated to repay the bank syndicate any amounts it pays as a result of any
demands on the bonds or guarantees. To date, there have never been any such
demands. Critical Accounting Policies Our significant accounting policies are described in Note A to the consolidated
financial statements included in Item 7 of the Form 10-K for the year ended
December 31, 2003, and are outlined below:  
    
    Revenue recognition via the percentage of completion method.The
percentage of completion method is used by MECAR, NS Microwave and
SeaSpace for their fixed price sales contracts. Approximately 77% and
84% of condensed consolidated revenue was recognized under the
percentage of completion method during the three months ended March
31, 2004 and 2003, respectively.  
    
    Goodwill and intangible asset valuation.The Company completed a
goodwill impairment analysis in the fourth quarter of 2003 and did not
determine that an impairment charge to earnings was required. As
required by the accounting rules, the Company will perform a similar
review each year or earlier if indicators of potential impairment
exist. As of March 31, 2004, there were no indicators of impairment.  
    
    Inventory reserves and allowance for doubtful accounts.The Company
reviews its recorded inventory and estimates a write-down for obsolete
or slow-moving items to their net realizable value. Allowances for
doubtful accounts are evaluated based upon detailed analysis and
assessment of receivables that may not be collected in the normal
course of operations. The inventory reserves and allowance for
doubtful accounts are deemed reasonable.  
    
    Valuation of deferred income taxes and income tax reserves.The
Company is subject to taxation by federal, state and international
jurisdictions. The Company reviews the balances on a quarterly basis
and believes the balances are adequate. Forward-Looking Statements This Managements Discussion and Analysis contains forward-looking statements
that are based on current expectations, estimates and projections about the
Company and the industries in which it operates. In addition, other written or
oral statements which constitute forward-looking statements may be made by or
on behalf of the Company. Words such as expects, anticipates, intends,
plans, believes, seeks, estimates, or variations of such words and
similar expressions are intended to identify such forward-looking statements.
These statements are not guarantees of future performance and involve certain
risks, uncertainties and assumptions (Future Factors) 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. 19




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2004
(Thousands of Dollars)
(Unaudited) Liquidity and Capital Resources  Continued Future Factors include the following:  
    
    substantial reliance on MECARs principal customers to continue to acquire products on a regular basis;  
    
    the cyclical nature of the Companys military business;  
    
    rapid technological developments and changes and the Companys ability to continue to introduce competitive
new products and services on a timely, cost effective basis;  
    
    the ability of the Company to successfully continue to expand its business base;  
    
    the ability of the Companys acquired businesses to mature and meet performance expectations;  
    
    the mix of products/services;  
    
    domestic and foreign governmental fiscal affairs and public policy changes which may affect the level of
purchases made by customers;  
    
    changes in environmental and other domestic and foreign governmental regulations;  
    
    general risks associated with doing business outside the United States, including, without limitation,
import duties, tariffs, quotas and political and economic instability;  
    
    the effects of terrorist actions on business activities, customer orders and cancellations, and the United
States and international governments responses to these terrorist actions;  
    
    changes in government regulations;  
    
    liability and other claims asserted against us;  
    
    the ability to attract and retain qualified personnel; and  
    
    continued availability of financing, financial instruments and financial resources in the amounts, at the
times, and on the terms required to support the Companys future business. We operate in a very competitive and rapidly changing environment. New risk
factors can arise and it is not possible for management to predict all such
risk factors, nor can it assess the impact of all such risk factors on our
business or the extent to which any factor, or combination of factors, may
cause actual results to differ materially from those contained in any
forward-looking statements. Given these risks and uncertainties, investors
should not place undue reliance on forward-looking statements as a prediction
of actual results. 20




---



##### 



The Allied Defense Group, Inc. March 31, 2004 QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE At March 31, 2004, Allied had $31 million of cash (including restricted cash).
Assuming all the cash was available for investment, a 1% change in interest
rates would impact interest income for the three months ended March 31, 2004
and 2003 by less than $0.1 million. Approximately 89% and 72% of the Companys revenue for the three months ended
March 31, 2004 and 2003, respectively, was derived from operations outside the
U.S. Accordingly, exposure exists to potentially adverse movement in foreign
currency rates. It is estimated that a 10% change in the value of the Euro
would impact reported net earnings for the three months ended March 31, 2004
and 2003 by approximately $0.2 million and $0.5 million, respectively. DISCLOSURE CONTROLS AND PROCEDURES  1.
    
    Evaluation of disclosure controls and proceduresUnder the direction and with the participation of the Companys management,
including the Companys Chief Executive Officer and Chief Financial Officer,
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
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Companys disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Exchange Act of 1934 (i) is
recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commissions rules and forms and
(ii) is accumulated and communicated to the Companys senior management to
allow timely decisions regarding required disclosure.  2.
    
    Changes in internal controlsThere have been no significant changes in our internal controls over
financial reporting or, to our knowledge, in other factors that could
significantly affect our internal control over financial reporting
subsequent to the date we conducted the above-described evaluation. We are
currently reviewing the new internal controls documentation and attestation
requirements regarding Rule 404 of the Sarbanes Oxley Act of 2002. We have
retained an independent consulting firm to assist us in evaluating and
improving our internal controls. We are confident that we will fully comply
with such requirements by December 31, 2004. 21




---



##### 



The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
March 31, 2004 Item 6 Exhibits and Reports on Form 8-K  (a)
    
    Reports on Form 8-KOn February 26, 2004, the Company filed a Form 8-K reporting its 2004
outlook from the Chief Executive Officer in a letter to shareholders.On March 2, 2004, the Company filed a Form 8-K providing its financial
results for the year ended December 31, 2003. (b) Exhibit No.
    
    Description of Exhibits3.1
    
    
    Certificate of Incorporation, as amended (Incorporated by reference
from Form 10-Q filed in August 2002).3.2
    
    
    By-Laws (Incorporated by reference from Form 10-Q filed in August
2002).3.3
    
    
    Rights Agreement between Allied and Mellon Investor Services, LLC
(Incorporated by reference from Form 8-K filed in June 2001).10.1
    
    
    Employment Agreement between Allied and John G. Meyer, Jr.
(Incorporated by reference from Form 8-K filed in March 2001 and Form
8-K filed in August 2001).10.2
    
    
    Employment Agreement between Allied and Charles A. Hasper
(Incorporated by reference from Form 8-K filed in August 2001).10.3
    
    
    Employment Agreement between Allied and Monte L. Pickens
(Incorporated by reference from Form 8-K filed in April 2003).10.4
    
    
    2001 Equity Incentive Plan, as amended (Incorporated by reference
from Proxy Statements filed in April 2001 and April 2002).10.5
    
    
    8% Convertible Debenture, Series A and related documents
(Incorporated by reference from Form 8-K filed in July 2002).10.6
    
    
    Credit Agreement for MECAR S.A. (Incorporated by reference from
Form 10-Q filed in August 2002).10.7
    
    
    Award/Contract dated as of March 1, 2002, by and between MECAR S.A.
and U.S. Government (Incorporated by reference from Form 10-Q filed in
August 2002).10.8
    
    
    Employee Stock Purchase Plan, as amended (Incorporated by reference
from Form 10-Q filed in November 2002).10.9
    
    
    Lease Agreement, as amended (Incorporated by reference from Form
10-Q filed in November 2002).10.10
    
    
    Form of Indemnity Agreement for Directors and Executive Officers
(Incorporated by reference from Form 10-Q filed in November 2002).10.11
    
    
    International Distribution Agreement (Incorporated by reference
from Form 10-Q filed in November 2002).
 22




---



##### 



The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
March 31, 2004 (b) Exhibit No.
    
    Description of Exhibits21
    
    
    List of Subsidiaries23
    
    
    Consent of Independent Certified Public Accountants31.1
    
    
    Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 200231.2
    
    
    Certification of Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 200232
    
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 23




---



##### 



The Allied Defense Group, Inc. 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 A. HasperDate: May 10, 2004
    
    Charles A. Hasper,Chief Financial Officer and
Treasurer
 24