##### 



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 March 31, 2006
 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)
 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)
 
 
 þ o
  o þ o
  o þ




---



##### 



THE ALLIED DEFENSE GROUP, INC.
INDEX
 PAGENUMBERPART I. FINANCIAL INFORMATION  UNAUDITEDItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets
March 31, 2006 and December 31, 2005
    
    
    2Condensed Consolidated Statements of Operations
Three months ended March 31, 2006 and 2005
    
    
    3Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 2006 and 2005
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Market Risk Disclosure
    
    
    29Item 4. Disclosure Controls and Procedures
    
    
    29PART II. OTHER INFORMATIONItem 6. Exhibits
    
    
    31Signatures
    
    
    32




---



##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Thousands of Dollars, except per share data)
 March 31, 2006
    
    
    December 31, 2005(a)ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    28,628
    
    
    $
    7,803Restricted cash
    
    
    5,495
    
    
    
    7,428Accounts receivable
    
    
    16,547
    
    
    
    18,547Costs and accrued earnings on uncompleted contracts
    
    
    41,424
    
    
    
    35,178Inventories
    
    
    33,464
    
    
    
    34,300Deferred tax asset
    
    
    2,632
    
    
    
    2,696Fair value of foreign exchange contracts
    
    
    1
    
    
    
    5Prepaid and other current assets
    
    
    7,736
    
    
    
    8,339Total current assets
    
    
    135,927
    
    
    
    114,296PROPERTY, PLANT AND EQUIPMENT net of accumulated depreciation
    
    
    30,475
    
    
    
    29,826OTHER ASSETSIntangibles, net of accumulated amortization
    
    
    13,061
    
    
    
    13,353Goodwill
    
    
    16,776
    
    
    
    16,698Deferred tax asset, non-current
    
    
    6,044
    
    
    
    5,672Other assets
    
    
    2,504
    
    
    
    1,101Total other assets
    
    
    38,385
    
    
    
    36,824TOTAL ASSETS
    
    $
    204,787
    
    
    $
    180,946LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESBank overdraft facility
    
    $
    15,984
    
    
    $
    15,086Current maturities of long-term debt
    
    
    10,798
    
    
    
    4,342Accounts payable
    
    
    20,980
    
    
    
    31,004Accrued liabilities
    
    
    18,608
    
    
    
    15,097Customer deposits
    
    
    19,770
    
    
    
    9,956Fair value of foreign exchange contracts
    
    
    453
    
    
    
    1,161Income taxes
    
    
    1,128
    
    
    
    1,288Total current liabilities
    
    
    87,721
    
    
    
    77,934LONG-TERM OBLIGATIONSShort-term debt, to be refinanced
    
    
    
    
    
    
    13,539Long-term debt, less current maturities and unamortized discount
    
    
    35,137
    
    
    
    7,820Deferred compensation
    
    
    157
    
    
    
    160Derivative instrument
    
    
    1,839
    
    
    
    Total long term liabilities
    
    
    37,133
    
    
    
    21,519TOTAL LIABILITIES
    
    
    124,854
    
    
    
    99,453CONTINGENCIES AND COMMITMENTSSTOCKHOLDERS 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 6,019,485 at March 31, 2006 and 5,982,008 at
December 31, 2005
    
    
    602
    
    
    
    598Additional paid-in capital
    
    
    35,485
    
    
    
    34,354Retained earnings
    
    
    30,755
    
    
    
    34,466Accumulated other comprehensive income
    
    
    13,091
    
    
    
    12,075Total stockholders equity
    
    
    79,933
    
    
    
    81,493TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    204,787
    
    
    $
    180,946
 
 (a)
    
    Condensed consolidated balance sheet as of December 31, 2005, has been derived from audited
consolidated financial statements. The accompanying notes are an integral part of these unaudited condensed consolidated
financial statements.
 2




---



##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Thousands of Dollars, except per share data)
 Three months endedMarch 31,2006
    
    
    2005RESTATEDRevenues
    
    $
    36,168
    
    
    $
    24,018Cost and expensesCost of sales
    
    
    27,409
    
    
    
    19,917Selling and administrative
    
    
    9,467
    
    
    
    7,509Research and development
    
    
    1,730
    
    
    
    1,527Operating loss
    
    
    (2,438
    )
    
    
    (4,935
    )Other income (expense)Interest income
    
    
    124
    
    
    
    189Interest expense
    
    
    (2,315
    )
    
    
    (537
    )Gains on fair value of Senior Convertible notes and warrants
    
    
    567
    
    
    
    Other-net
    
    
    349
    
    
    
    (517
    )(1,275
    )
    
    
    (865
    )Loss before income taxes and cumulative effect of change
in application of accounting principle
    
    
    (3,713
    )
    
    
    (5,800
    )Income tax expense (benefit)
    
    
    (2
    )
    
    
    (2,144
    )Loss before cumulative effect of
change in application of accounting principle
    
    
    (3,711
    )
    
    
    (3,656
    )Cumulative effect of change in application of accounting principle
    
    
    
    
    
    
    (5,577
    )NET LOSS
    
    $
    (3,711
    )
    
    $
    (9,233
    )Earnings (loss) per share:Loss before cumulative effect of change in
application of accounting principle  basic and diluted
    
    $
    (0.62
    )
    
    $
    (0.65
    )Cumulative effect of change in application of accounting principle
    
    
    
    
    
    
    (0.99
    )Net loss  basic and diluted
    
    $
    (0.62
    )
    
    $
    (1.64
    )Weighted average number of common shares:Basic and Diluted
    
    
    6,020,149
    
    
    
    5,620,634
 The accompanying notes are an integral part of these unaudited condensed consolidated
financial statements.
 3




---



##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Thousands of Dollars)
 Three months ended March 31,2006
    
    
    2005RESTATEDCash flows from operating activitiesNet loss
    
    $
    (3,711
    )
    
    $
    (9,233
    )Adjustments to reconcile net loss to net cash provided by operating activitiesCumulative effect of accounting change
    
    
    
    
    
    
    5,577Depreciation and amortization
    
    
    1,677
    
    
    
    1,265Amortization of debt discount and debt issue costs
    
    
    1,247
    
    
    
    63Unrealized (gain) losses on forward contracts
    
    
    (724
    )
    
    
    1,448Gain related to fair value of notes and warrants
    
    
    (567
    )
    
    
    Provision for estimated losses on contracts
    
    
    667
    
    
    
    67Deferred taxes
    
    
    (128
    )
    
    
    (848
    )Common stock and option awards
    
    
    292
    
    
    
    69Deferred director stock awards
    
    
    38
    
    
    
    (Increase) decrease in operating assets and increase (decrease) in liabilities:Restricted cash
    
    
    2,039
    
    
    
    (2,105
    )Accounts receivable
    
    
    2,326
    
    
    
    37,469Costs and accrued earnings on uncompleted contracts
    
    
    (6,223
    )
    
    
    (22,527
    )Inventories
    
    
    1,405
    
    
    
    13,311Prepaid and other current assets
    
    
    744
    
    
    
    (1,369
    )Accounts payable, accrued liabilities and customer deposits
    
    
    2,484
    
    
    
    (16,864
    )Deferred compensation
    
    
    (2
    )
    
    
    20Income taxes
    
    
    (233
    )
    
    
    (480
    )Net cash provided by operating activities
    
    
    1,331
    
    
    
    5,863Cash flows from investing activitiesCapital expenditures
    
    
    (1,070
    )
    
    
    (1,003
    )Net cash used in investing activities
    
    
    (1,070
    )
    
    
    (1,003
    )Cash flows from financing activitiesPrincipal payments on long-term borrowing
    
    
    (13,995
    )
    
    
    (2,968
    )Debt issue costs
    
    
    (1,908
    )
    
    
    Repayment on capital lease obligations
    
    
    (515
    )
    
    
    (659
    )Proceeds from issuance of long-term debt
    
    
    30,000
    
    
    
    728Net increase (decrease) in short-term borrowings
    
    
    5,962
    
    
    
    (4
    )Increase (decrease) in bank overdraft facility
    
    
    447
    
    
    
    (1,538
    )Proceeds from employee stock purchases
    
    
    34
    
    
    
    21Proceeds from option exercises
    
    
    377
    
    
    
    154Net cash provided by (used in) financing activities
    
    
    20,402
    
    
    
    (4,266
    )NET INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    20,663
    
    
    
    594Effects of exchange rate changes on cash
    
    
    162
    
    
    
    (1,587
    )NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    20,825
    
    
    
    (993
    )Cash and cash equivalents at beginning of period
    
    
    7,803
    
    
    
    27,940Cash and cash equivalents at end of period
    
    $
    28,628
    
    
    $
    26,947Supplemental Disclosures of Cash Flow InformationCash paid during the period forInterest
    
    $
    976
    
    
    $
    183Taxes
    
    $
    277
    
    
    
    561Supplemental Disclosures of Non-cash Investing and Financing activitiesWarrants issued in conjunction with senior secured credit facility
    
    $
    2,387
    
    
    $
    Capital leases
    
    $
    497
    
    
    $
    
 The accompanying notes are an integral part of these unaudited condensed
consolidated statements.
 4




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
 NOTE 1  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
     Liquidity and Cash Flows
    5




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
  
    
    The Company intends to have in place, and is in the process of negotiating, a domestic
line of credit that will provide $4,000 to $5,000 of immediate liquidity with a provision
to accordion up to $20,000 based on
financial performance in subsequent periods. This will be contingent on successful
registration of the March 2006 issue of convertible debentures and warrants.
    
    The Company is exploring possible asset backed financing from local banks in Marshall,
TX. This will be contingent on successful registration of the March 2006 convertible
debentures and warrants.
    
    The Company is evaluating the disposition of certain non strategic assets.
    
    The Company has the option of receiving dividends from excess cash from its VSK Group at year end.
    
    The Company may further consolidate its California operations to further reduce operating expenses.
    
    If there are no new sources of cash from financing or investment activities in the
fourth quarter and if certain subsidiaries are not able to return the cash that they have
borrowed for working capital needs the Company could be out of cash to fund headquarters
expenses and to provide operating cost subsidies by year end. The Company does not believe
this is a likely scenario and is working with various parties to manage through this period
of reduced liquidity.
 NOTE 2  PRINCIPLES OF CONSOLIDATION
  
    
    ARC Europe, S.A. (ARC Europe), a Belgian company,
    
    Allied Research Corporation Limited (Limited), an inactive United Kingdom company,
    
    News/Sports Microwave Rental, Inc. (NSM), a California corporation,
    
    Titan Dynamics Systems, Inc. (Titan), a Texas corporation,
    
    SeaSpace Corporation (SeaSpace), a California corporation,
    
    MECAR USA, Inc. (MECAR USA), a Delaware corporation, and
    
    Allied Technology, LLC (Allied Technology), and a Maryland limited liability company,
    
    Global Microwave Systems, Inc (GMS), a California corporation.
   Ammunition & Weapons Effects
 Electronic Security
 6




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
  Other
  Accounting Change
 Restatements of Financial Results Accounting for
Derivative Instruments and Hedging Activities
  7




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
 March 31, 2005
 Selected Consolidated Statements of Earnings Data:
 Impact FromForeign
    
    
    
    
    
    Impact ofCurrency
    
    Impact from
    
    Revenue
    
    As PreviouslyTranslation
    
    Compensation
    
    Recognition
    
    Reported inRESTATED
    
    (1)
    
    Expense (2)
    
    (3)
    
    10-Q/ARevenues
    
    $
    24,018
    
    
    $
    755
    
    
    $
    0
    
    
    $
    2,207
    
    
    $
    21,056Cost of Sales
    
    
    19,917
    
    
    
    (33
    )
    
    
    0
    
    
    
    4,952
    
    
    
    14,998Operating Income (loss)
    
    
    (4,935
    )
    
    
    788
    
    
    
    (36
    )
    
    
    (2,746
    )
    
    
    (2,941
    )Earnings before income
taxes and the cumulative
effect of change in
application of accounting
principle
    
    
    (5,800
    )
    
    
    81
    
    
    
    (36
    )
    
    
    (2,745
    )
    
    
    (3,100
    )Income tax expense (benefit)
    
    
    (2,144
    )
    
    
    (5
    )
    
    
    (12
    )
    
    
    (934
    )
    
    
    (1,193
    )Cumulative effect of
change in the application
of accounting principle
    
    
    (5,577
    )
    
    
    
    
    
    
    
    
    
    
    (5,577
    )
    
    
    Net earnings (loss)
    
    $
    (9,233
    )
    
    $
    86
    
    
    $
    (24
    )
    
    $
    (7,388
    )
    
    $
    (1,907
    )Earnings (loss) per share
 Basic & Diluted:Loss before cumulative
effect of change in the
application of accounting
principle
    
    ($
    0.65
    )
    
    $
    0.01
    
    
    ($
    0.00
    )
    
    ($
    0.32
    )
    
    ($
    0.34
    )Cumulative effect of
change in the application
of accounting principle
    
    ($
    0.99
    )
    
    
    
    
    
    
    
    
    
    ($
    0.99
    )
    
    
    Net income (loss)
    
    ($
    1.64
    )
    
    $
    0.01
    
    
    ($
    0.00
    )
    
    ($
    1.31
    )
    
    ($
    0.34
    )Weighted Average number
of common shares (4):Basic
    
    
    5,620,634
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,609,351Diluted
    
    
    5,620,634
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,609,351
 
 (1)
    
    Impact of correcting for the failure to comply with the documentation requirements of FAS 133,
hedge accounting, for changing the exchange rates to period end spot rates at the Companys MECAR
subsidiary for its foreign currency transactions and other adjustments related to sales contracts.(2)
    
    Impact of correcting the measurement date for options granted in February 2002 by the
Compensation Committee of the Board of Directors of the Company that were subject to subsequent
stockholder approval that was obtained in June 2002.(3)
    
    Impact of change in accounting principle on revenue recognition at the Companys MECAR
subsidiary.(4)
    
    Shares Outstanding for the period were restated to correct for deferred compensation for the
outside directors that was stock based that
had been incorrectly excluded from the earnings per share calculation in the period. 8




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
 Cash Flow Information
  As previouslyRESTATED
    
    ADJUSTMENT
    
    reported in 10-Q/AThree months ended March
31, 2005Cash flows from operations:Accounts payable,
accrued liabilities
and customer deposits
    
    $
    (16,864
    )
    
    $
    1,538
    
    
    $
    (18,402)
    *Cash flows from financing:Borrowings on bank
overdraft
facility
    
    $
    (1,538
    )
    
    $
    (1,538
    )
    
    
    
 
 *
    
    The As previously reported in the 10-Q/A amount has been adjusted for the impact of the foreign
currency translation and other restatement adjustments described above of $5,187. NOTE 3  DERIVATIVE FINANCIAL INSTRUMENTS
 Derivatives and hedging
  Fair value hedges
  Cash flow hedges
  9




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
 Derivatives not designated as hedges
  Counterparty credit risk
  NOTE 4  ACCOUNTS RECEIVABLE AND COSTS AND ACCRUED EARNINGS ON UNCOMPLETED CONTRACTS
  March 31,
    
    
    December 31,2006
    
    
    2005Direct and indirect receivables from foreign governments
    
    $
    4,853
    
    
    $
    1,777Commercial and other receivables, less allowance for doubtful
receivables of $213 in 2006 and $214 in 2005
    
    
    11,694
    
    
    
    16,770$
    16,547
    
    
    $
    18,547
   NOTE 5  INVENTORIES
  March 31, 2006
    
    
    December 31, 2005Raw materials
    
    $
    23,866
    
    
    $
    14,942Work in process
    
    
    9,772
    
    
    
    19,265Finished goods
    
    
    1,573
    
    
    
    1,755Gross inventory
    
    
    35,211
    
    
    
    35,962Less reserves for
obsolescence
    
    
    (1,747
    )
    
    
    (1,662
    )Net inventory
    
    $
    33,464
    
    
    $
    34,300
 10




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
 NOTE 6  GOODWILL
   NOTE 7  LONG-TERM DEBT
  March 31,
    
    
    December 31,2006
    
    
    2005Fair value of Senior subordinated convertible notes
    
    $
    27,594
    
    
    $
    Notes payable, less unamortized discount
    
    
    
    
    
    
    13,539Note related to GMS acquisition, less unamortized discount
    
    
    6,270
    
    
    
    6,173Mortgage loan agreements
    
    
    181
    
    
    
    193Loan for CMS Security Systems acquisition
    
    
    200
    
    
    
    200Other notes payable
    
    
    6,902
    
    
    
    618Capital leases and other
    
    
    4,788
    
    
    
    4,978Total long-term debt
    
    
    45,935
    
    
    
    25,701Less current maturities
    
    
    (10,798
    )
    
    
    (4,342
    )Long-term debt, less current maturities and
unamortized discount, including
short-term debt to be refinanced
    
    $
    35,137
    
    
    $
    21,359
 Senior subordinated convertible notes.
  11




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
   Notes payable.
 Loan for Global Microwave Systems acquisition.
 Mortgage Loan Agreements.
 12




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
 Loan for CMS Security Systems acquisition.
 Other notes payable.
 Capital lease and other.
 Bank Overdraft Credit Facility.
 NOTE 8  LOSS PER SHARE
  Three months endedMarch 31,Restated2006
    
    
    2005Net loss before Cumulative Effect of Change in
Accounting Principle
    
    $
    (3,711
    )
    
    $
    (3,656
    )Cumulative Effect of Change in Accounting Principle
    
    
    
    
    
    
    (5,577
    )Net Loss
    
    $
    (3,711
    )
    
    $
    (9,233
    )Weighted average number of basic shares
    
    
    6,020,149
    
    
    
    5,620,634
 13




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
 Three months endedMarch 31,Restated2006
    
    
    2005Senior Subordinated Convertible Notes
    
    
    
    
    
    
    Warrants
    
    
    
    
    
    
    Stock Options
    
    
    
    
    
    
    Common stock equivalents
    
    
    
    
    
    
    Weighted average number of diluted shares
    
    
    6,020,149
    
    
    
    5,620,634Basic & Diluted loss per share before Cumulative
Effect of Change in Accounting Principle
    
    $
    (0.62
    )
    
    $
    (0.65
    )Cumulative Effect of Change in Accounting Principle
    
    
    
    
    
    
    (.99
    )Net loss per share
    
    $
    (0.62
    )
    
    $
    (1.64
    )
  NOTE 9  COMPREHENSIVE LOSS
  Three months endedMarch 31,2006
    
    
    2005RestatedNet loss
    
    $
    (3,711
    )
    
    $
    (9,233
    )Currency Translation Adjustment
    
    
    1,016
    
    
    
    (6,719
    )Comprehensive loss
    
    $
    (2,695
    )
    
    $
    (15,952
    )
  NOTE 10  SHARE- BASED COMPENSATION
  14




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
         15




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
 ThreeMonthsEndedMarch 31,2005(Dollars in thousands, except per share amounts)
    
    RestatedReported net loss
    
    $
    (9,233
    )Stock-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
    
    
    (72
    )Pro forma net loss
    
    $
    (9,305
    )Basic loss per share:Reported loss per share
    
    $
    (1.64
    )Compensation costs, net of tax
    
    
    (0.01
    )Pro forma basic loss per share
    
    $
    (1.65
    )Diluted loss per share:Reported loss per share
    
    $
    (1.64
    )Compensation costs, net of tax
    
    
    (0.01
    )Pro forma diluted loss per share
    
    $
    (1.65
    )
  Three MonthsEnded March 31,2005Risk free interest rate
    
    
    3.63
    %Expected volatility rate
    
    
    33.90
    %Expected lives  years
    
    
    3Dividend yield
    
    
    
   16




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
  Weighted
    
    
    Weighted AverageAverage
    
    
    RemainingNumber of
    
    
    Exercise
    
    
    Contractual Term
    
    
    AggregateOptions
    
    
    Price
    
    
    (in years)
    
    
    Intrinsic Value*Outstanding-beginning of year
    
    
    507,667
    
    
    $
    16.94Granted
    
    
    
    
    
    
    Exercised
    
    
    29,667
    
    
    
    12.72Forfeited
    
    
    
    
    
    
    Outstanding at March 31, 2006
    
    
    478,000
    
    
    $
    17.21
    
    
    
    4.18
    
    
    $
    2,268Exercisable at March 31, 2006
    
    
    370,000
    
    
    $
    15.89
    
    
    
    4.25
    
    
    $
    2,241
 
 * The intrinsic value of a stock option is the amount by which the market value of the underlying
stock exceeds the exercise price of the option. The market value of our stock was $21.95 at March
31, 2006.
 The following table summarizes options outstanding at March 31, 2006:
 Weighted Average
    
    
    ExercisableNumber
    
    Range of
    
    
    Weighted Average
    
    
    Remaining
    
    
    Number of
    
    
    Weighted AverageOutstanding
    
    Exercise Prices
    
    
    Exercise Prices
    
    
    Contractual Term
    
    
    Options
    
    
    Exercise Prices106,500
    
    $
    8.00 to $8.63
    
    
    $
    8.59
    
    
    3.76 Years
    
    
    106,500
    
    
    $
    8.5940,000
    
    $
    9.01 to $14.90
    
    
    $
    14.90
    
    
    1.33 Years
    
    
    32,000
    
    
    $
    14.90331,500
    
    $
    16.40 to $25.00
    
    
    $
    20.25
    
    
    3.59 Years
    
    
    231,500
    
    
    $
    19.39478,000
    
    $
    8.00 to $25.00
    
    
    $
    17.21
    
    
    
    
    
    
    
    370,000
    
    
    
    
 The following table summarizes restricted stock (nonvested) shares outstanding as of March 31,
2006
 Weighted- Average GrantRestricted Stock
    
    Shares
    
    
    Date Fair ValueRestricted at January 1, 2006
    
    
    51,793
    
    
    $
    22.99Granted
    
    
    6,000
    
    
    $
    21.82Vested
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Restricted shares at March 31, 2006
    
    
    57,793
    
    
    $
    22.87
 17




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
   NOTE 11  INDUSTRY SEGMENTS
 Three months endedMarch 31,2006
    
    
    2005RestatedRevenues from external customersAmmunitions & weapons effects
    
    $
    23,484
    
    
    $
    12,171Electronic security
    
    
    11,221
    
    
    
    10,328Other
    
    
    1,463
    
    
    
    1,519$
    36,168
    
    
    $
    24,018Segment profit (loss) before provision for
income taxes and cumulative effect of change
in accounting principle:Ammunitions & weapons effects
    
    $
    (1,326
    )
    
    $
    (5,451
    )Electronic security
    
    
    295
    
    
    
    662Other
    
    
    (686
    )
    
    
    (511
    )Corporate
    
    
    (1,996
    )
    
    
    (500
    )$
    (3,713
    )
    
    $
    (5,800
    )
 NOTE 12  PROVISION FOR TAXES
    18




---



##### 



The Allied Defense Group, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
(Thousands of Dollars)
 NOTE 13  COMMITMENTS AND CONTINGENCIES
  19




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2006
(Thousands of Dollars)
(Unaudited)
 Overview
  
    
    Ammunition & Weapons Effectssegment consists of MECAR,
located in Belgium, MECAR USA, located in Marshall, TX, and Titan
Dynamics, located in Marshall, TX. MECAR develops and produces
medium caliber, tank, mortar and other ammunition. MECAR USA
became operational in late 2005 and will pursue contracts from
U.S. and foreign governments for ammunition and pyrotechnics
devices with a focus on the 105MM market. Titan designs,
manufactures and sells battlefield effects simulators, minor
pyrotechnics and other training devices.
    
    Electronic Securitysegment consists of the VSK Group, located
in Belgium and California, and NSM and GMS both located in or near
San Diego, California. 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;
VIGITEC S.A., which installs networked video surveillance systems;
and CMS Security Systems which manufactures access control
systems. NSM designs, manufactures, installs and services
industrial and law enforcement surveillance products and
integrated systems for the law enforcement community, agencies of
the Department of Homeland Security and the Department of Defense.
GMS designs and manufactures miniature and sub-miniature FM and
digital transmitters, receivers, and related equipment for
investigative, surveillance, and security applications, and live
TV news/sports/entertainment coverage.
    
    Othersegment consists of the formerly named Environmental Safety
& Security segment and provides products in the area of
environmental monitoring and consists solely of SeaSpace.
SeaSpace designs, manufactures, distributes and services weather
and environmental satellite ground reception systems and
manufactures and markets a line of antenna systems.
    Results of Operations for the Three Months Ended March 31, 2006 and 2005
  20




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2006
(Thousands of Dollars)
(Unaudited)
 Three months ended March 31,2006
    
    
    2005RestatedRevenue
    
    
    100.0
    %
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    75.8
    
    
    
    82.9Selling and administrative
    
    
    23.9
    
    
    
    29.1Research and development
    
    
    4.8
    
    
    
    6.4Depreciation and Amortization
    
    
    2.2
    
    
    
    2.2Operating loss
    
    
    (6.7
    )
    
    
    (20.6
    )Other income (expense)Interest income
    
    
    .3
    
    
    
    0.8Interest expense
    
    
    (6.4
    )
    
    
    (2.2
    )Gain (loss) from fair value of notes and warrants
    
    
    1.6
    
    
    
    Other  net
    
    
    1.0
    
    
    
    (2.2
    )Loss before income taxes
    
    
    (10.2
    )
    
    
    (24.2
    )Income tax expense (benefit)
    
    
    
    
    
    
    (8.9
    )Net loss before
Cumulative Effect of
Change in
Accounting Principle
    
    
    (10.2
    )
    
    
    (15.3
    )Cumulative Effect of
Change in Accounting
Principle
    
    
    
    
    
    
    (23.2
    )Net Loss
    
    
    (10.2
    )%
    
    
    (38.5
    )%
 Revenue.
 Revenue by SegmentThree Months Ended
    
    
    Three Months EndedMarch 31, 2006
    
    
    March 31, 2005Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    of totalRestatedAmmunition & Weapons Effects
    
    $
    23,484
    
    
    
    65
    %
    
    $
    12,171
    
    
    
    51
    %Electronic Security
    
    
    11,221
    
    
    
    31
    %
    
    
    10,328
    
    
    
    43
    %Other
    
    
    1,463
    
    
    
    4
    %
    
    
    1,519
    
    
    
    6
    %$
    36,168
    
    
    
    100
    %
    
    $
    24,018
    
    
    
    100
    %
  21




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2006
(Thousands of Dollars)
(Unaudited)
  Cost of Sales.
 Cost of Sales as Percentage of Sales by Segment
 Three months endedMarch 312006
    
    
    2005RestatedAmmunition & Weapons Effects (AWE)
    
    
    88
    %
    
    
    109
    %Electronic Security (ES)
    
    
    52
    %
    
    
    56
    %Other
    
    
    67
    %
    
    
    57
    %Total
    
    
    76
    %
    
    
    83
    %
    Selling and Administrative Expenses.
   22




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2006
(Thousands of Dollars)
(Unaudited)
  Research and Development.
 Gain on fair value of Senior Subordinated Convertible Notes and warrants.
 Other Income.
 Interest Income.
 Interest Expense.
 Pre-Tax Loss
 Pre-Tax Income (Loss) by Segment Before  the Cumulative Effect of Accounting Change
 Three months endedMarch 31,2006
    
    
    2005RestatedAmmunition & Weapons Effects
    
    $
    (1,326
    )
    
    $
    (5,451
    )Electronic Security
    
    
    295
    
    
    
    662Other
    
    
    (686
    )
    
    
    (511
    )Corporate
    
    
    (1,996
    )
    
    
    (500
    )$
    (3,713
    )
    
    $
    (5,800
    )
   23




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2006
(Thousands of Dollars)
(Unaudited)
   Income Taxes.
 Net Loss.
 Backlog.
 Backlog by SegmentMarch 31, 2006
    
    
    March 31, 2005Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    of totalAmmunition & Weapons Effects
    
    $
    49,949
    
    
    
    66
    %
    
    $
    49,930
    
    
    
    68
    %Electronic Security
    
    
    22,371
    
    
    
    29
    
    
    
    22,324
    
    
    
    31Other
    
    
    3,753
    
    
    
    5
    
    
    
    755
    
    
    
    1$
    76,073
    
    
    
    100
    %
    
    $
    73,009
    
    
    
    100
    %
  Liquidity and Cash Flows
  24




---



##### 





The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2006
(Thousands of Dollars)
(Unaudited)     
    
    The Company intends to have in place, and is in the process of negotiating, a domestic
line of credit that will provide $4,000 to $5,000 of immediate liquidity with a provision
to accordion up to $20,000 based on financial performance in subsequent periods. This will
be contingent on successful registration of the March 2006 issue of convertible debentures
and warrants.
    
    The Company is exploring possible asset backed financing from local banks in Marshall,
TX. This will be contingent on successful registration of the March 2006 convertible
debentures and warrants.
    
    The Company is evaluating the disposition of certain non strategic assets.
    
    The Company has the option of issuing dividends of excess cash from its VSK Group at year end.
    
    The Company may further consolidate its California operations to further reduce operating expenses.
    
    If there are no new sources of cash from financing or investment activities in the
fourth quarter and if certain subsidiaries are not able to return the cash that they have
borrowed for working capital needs the Company could be out of cash to fund headquarters
expenses and to provide operating cost subsidies by year end. The Company does not
believe this is a likely scenario and is working with various parties to manage through
this period of reduced liquidity.
 Balance Sheet
   25




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2006
(Thousands of Dollars)
(Unaudited)
      Cash Flows
  Three months ended March 312006
    
    
    2005RestatedNet cash provided by operating activities
    
    $
    1,331
    
    
    $
    5,863Net cash used in investing activities
    
    $
    (1,070
    )
    
    $
    (1,003
    )Net cash provided by (used in) financing activities
    
    $
    20,402
    
    
    $
    (4,266
    )
 Operating Activities.
 Investing Activities.
 26




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2006
(Thousands of Dollars)
(Unaudited)
 Financing Activities.
 Allied.
 MECAR.
 VSK Group.
 Other Subsidiaries.
 Stock Repurchases.
 Off-Balance Sheet Arrangements.
 Critical Accounting Policies
  27




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2006
(Thousands of Dollars)
(Unaudited)
   
    
    Revenue recognition via the percentage of completion method;
    
    Goodwill and intangible asset valuation;
    
    Inventory reserves and allowance for doubtful accounts;
    
    Derivative instruments;
    
    Valuation of deferred income taxes and income tax reserves.
  Recent Accounting Pronouncements
  Forward-Looking Statements
   
    
    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;
 28




---



##### 



The Allied Defense Group, Inc.
March 31, 2006
 
    
    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;
    
    changes in foreign currency exchange rates and interest rate fluctuation from market conditions;
    
    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.
  QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE
    DISCLOSURE CONTROLS AND PROCEDURES
 Evaluation of disclosure controls and procedures
  29
       The Allied Defense Group, Inc.
March 31, 2006
      Changes in internal controls
  30




---



##### 



The Allied Defense Group, Inc.
March 31, 2006
 PART II. OTHER INFORMATION
 Item 6 Exhibits
 Exhibit No.
    
    Description of Exhibits31.1
    
    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.
 31




---



##### 



The Allied Defense Group, Inc.
 SIGNATURE
  THE ALLIED DEFENSE GROUP, INC./s/ Robert P. DowskiDate: October 18, 2006
    
    Robert P. DowskiChief Financial Officer and Treasurer
 32