##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-Q/A QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended June 30, 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 þ No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). Yes þ No Indicate the number of shares outstanding of each of the issuers classes of common stock as of
June 30, 2004: 5,558,446.




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##### 



EXPLANATORY NOTE This Form 10-Q/A is being filed to amend The Allied Defense Group, Inc. (the Company) Quarterly
Report on Form 10-Q for the period ended June 30, 2004 in order to reflect the restatement of the
Companys Consolidated Financial Statements and amendments to related disclosures as of June 30,
2004 and for the three and six months ended June 30, 2004 and 2003. The restatement arose from
managements determination that the Companys accounting for foreign currency contracts did not
qualify for the use of hedge accounting under SFAS No. 133 Accounting for Derivative Instruments
and Hedging Activities. See the more complete discussion set forth in the Annual Report on Form
10-K for the period ended December 31, 2004. Generally, no attempt has been made in this Form 10-Q/A to modify or update other disclosures
presented in the original report on Form 10-Q except as required to reflect the effects of the
restatement. This Form 10-Q/A does not reflect events occurring after the filing of the original
Form 10-Q or modify or update those disclosures. Information not affected by the restatement is
unchanged and reflects the disclosure made at the time of the original filing of the Form 10-Q with
the Securities and Exchange Commission on August 9, 2004. The following items have been amended as
a result of the restatement:  
    Part I  Item 1  Financial Statements  
    Part I  Item 2  Managements Discussion and Analysis of Financial Condition and Results of Operations  
    Part I  Item 3  Quantitative and Qualitative Market Risk Disclosure  
    Part I  Item 4  Disclosure Controls and Procedures; and  
    Part II  Item 6  Exhibits and Reports on Form 8-K




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##### 



THE ALLIED DEFENSE GROUP, INC.
INDEX   PAGENUMBERPART I.
FINANCIAL INFORMATION - UNAUDITEDItem 1. Financial StatementsCondensed Consolidated Balance Sheets
June 30, 2004 and December 31, 2003
    
    
    2Condensed Consolidated Statements of Earnings
Three and six months ended June 30, 2004 and 2003
    
    
    3Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 2004 and 2003
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    13Item 3. Quantitative and Qualitative Market Risk Disclosure
    
    
    27Item 4. Disclosure Controls and Procedures
    
    
    27PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    28Item 4. Submission of Matters to a Vote of Security Holders
    
    
    28Item 6. Exhibits and Reports on Form 8-K
    
    
    29Signatures
    
    
    31




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS (Thousands of Dollars, except per share data)   June 30, 2004Restated andUnaudited
    
    
    December 31, 2003ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    22,100
    
    
    $
    43,377Restricted cash
    
    
    10,864
    
    
    
    15,937Accounts receivable
    
    
    34,620
    
    
    
    33,404Costs and accrued earnings on uncompleted contracts
    
    
    82,729
    
    
    
    60,516Inventories
    
    
    14,351
    
    
    
    12,068Deferred tax asset
    
    
    1,707
    
    
    
    1,016Fair value of foreign exchange contracts
    
    
    
    
    
    
    6,900Prepaid and other current assets
    
    
    9,191
    
    
    
    4,880Total current assets
    
    
    175,562
    
    
    
    178,098PROPERTY, PLANT AND EQUIPMENT net of accumulated depreciation
    
    
    25,093
    
    
    
    24,615OTHER ASSETSIntangibles, net of accumulated amortization
    
    
    3,948
    
    
    
    4,135Goodwill
    
    
    13,558
    
    
    
    13,718Other assets
    
    
    525
    
    
    
    37818,031
    
    
    
    18,231$
    218,686
    
    
    $
    220,944LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESNotes payable
    
    $
    10,901
    
    
    $
    14,200Current maturities of long-term debt
    
    
    2,239
    
    
    
    2,709Convertible subordinated debenture, current, less unamortized discount
    
    
    6,693
    
    
    
    5,250Accounts payable
    
    
    43,074
    
    
    
    53,284Accrued liabilities
    
    
    18,225
    
    
    
    7,594Customer deposits
    
    
    9,159
    
    
    
    4,938Foreign exchange contracts
    
    
    3
    
    
    
    Income taxes
    
    
    4,295
    
    
    
    906Total current liabilities
    
    
    94,589
    
    
    
    88,881LONG-TERM OBLIGATIONSLong-term debt, less current maturities and unamortized discount
    
    
    6,057
    
    
    
    4,902Convertible subordinated debenture, less current maturities and
unamortized discount
    
    
    
    
    
    
    2,156Deferred compensation
    
    
    1,705
    
    
    
    1,334Deferred taxes
    
    
    2,045
    
    
    
    5,5339,807
    
    
    
    13,925STOCKHOLDERS 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, 5,558,446 in 2004 and 5,551,373 in 2003
    
    
    556
    
    
    
    555Additional paid-in capital
    
    
    26,096
    
    
    
    25,891Retained earnings
    
    
    74,271
    
    
    
    75,495Accumulated other comprehensive income
    
    
    13,367
    
    
    
    16,197114,290
    
    
    
    118,138$
    218,686
    
    
    $
    220,944
 The accompanying notes are an integral part of these consolidated financial statements. 2




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (Thousands of Dollars, except per share data) (Unaudited)   Three months ended
    
    
    Six months endedJune 30,
    
    
    June 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Restated
    
    
    Restated
    
    
    Restated
    
    
    RestatedRevenue
    
    $
    39,232
    
    
    $
    41,206
    
    
    $
    66,095
    
    
    $
    77,058Cost and expensesCost of sales
    
    
    28,456
    
    
    
    28,777
    
    
    
    50,631
    
    
    
    54,398Selling and administrative
    
    
    5,702
    
    
    
    6,520
    
    
    
    12,349
    
    
    
    12,294Research and development
    
    
    1,816
    
    
    
    906
    
    
    
    3,377
    
    
    
    1,757Operating income (loss)
    
    
    3,258
    
    
    
    5,003
    
    
    
    (262
    )
    
    
    8,609Other income (expense)Interest income
    
    
    93
    
    
    
    131
    
    
    
    195
    
    
    
    228Interest expense
    
    
    (520
    )
    
    
    (524
    )
    
    
    (998
    )
    
    
    (959
    )Other-net
    
    
    (85
    )
    
    
    (348
    )
    
    
    (434
    )
    
    
    (320
    )(512
    )
    
    
    (741
    )
    
    
    (1,237
    )
    
    
    (1,051
    )Earnings (loss) before income taxes
    
    
    2,746
    
    
    
    4,262
    
    
    
    (1,499
    )
    
    
    7,558Income tax expense (benefit)
    
    
    1,105
    
    
    
    1,698
    
    
    
    (275
    )
    
    
    3,377NET EARNINGS (LOSS)
    
    $
    1,641
    
    
    $
    2,564
    
    
    $
    (1,224
    )
    
    $
    4,181Earnings (loss) per shareBasic
    
    $
    0.30
    
    
    $
    0.47
    
    
    $
    (0.22
    )
    
    $
    0.76Diluted
    
    $
    0.28
    
    
    $
    0.45
    
    
    $
    (0.22
    )
    
    $
    0.74Weighted average number of common shares:Basic
    
    
    5,555,509
    
    
    
    5,487,919
    
    
    
    5,553,454
    
    
    
    5,483,546Diluted
    
    
    6,017,500
    
    
    
    5,920,786
    
    
    
    5,553,454
    
    
    
    5,919,666
 The accompanying notes are an integral part of these consolidated financial statements. 3




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands of Dollars) (Unaudited)   Six months ended June 302004
    
    
    2003Restated
    
    
    RestatedCash flows from operating activitiesNet earnings (loss)
    
    $
    (1,224
    )
    
    $
    4,181Adjustments to reconcile net earnings (loss) to net cash provided by
(used in) operating activitiesDepreciation and amortization
    
    
    2,295
    
    
    
    1,810Unrealized losses (gains) on forward contracts
    
    
    5,203
    
    
    
    (3,145
    )Provision for estimated losses on contracts
    
    
    242
    
    
    
    438Deferred taxes
    
    
    18
    
    
    
    5,416Debenture issue costs and conversion feature
    
    
    52
    
    
    
    205Deferred compensation
    
    
    413
    
    
    
    226Common stock award
    
    
    34
    
    
    
    Changes in assets and liabilitiesAccounts receivable
    
    
    (2,887
    )
    
    
    10,224Costs and accrued earnings on uncompleted contracts
    
    
    (21,129
    )
    
    
    (1,742
    )Inventories
    
    
    (2,613
    )
    
    
    (1,656
    )Prepaid and other current assets
    
    
    (5,377
    )
    
    
    (6,437
    )Accounts payable, accrued liabilities and customer deposits
    
    
    1,424
    
    
    
    105Income taxes
    
    
    3,474
    
    
    
    1,513Net cash (used in) provided by operating activities
    
    
    (20,075
    )
    
    
    11,138Cash flows from investing activitiesCapital expenditures
    
    
    (3,476
    )
    
    
    (3,023
    )Net cash used in investing activities
    
    
    (3,476
    )
    
    
    (3,023
    )Cash flows from financing activitiesPrincipal payments on long-term borrowing
    
    
    (2,190
    )
    
    
    (1,166
    )Proceeds from issuance of long-term debt
    
    
    3,305
    
    
    
    1,247Net decrease in short-term borrowings
    
    
    (2,812
    )
    
    
    (153
    )Proceeds from employee stock purchases
    
    
    
    
    
    
    132Option exercises
    
    
    84
    
    
    
    43Restricted cash
    
    
    4,580
    
    
    
    (1,871
    )Net cash provided by (used in) financing activities
    
    
    2,967
    
    
    
    (1,768
    )Net increase (decrease) in cash and cash equivalents
    
    
    (20,584
    )
    
    
    6,347Effects of exchange rate changes on cash and cash equivalents
    
    
    (693
    )
    
    
    846NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    (21,277
    )
    
    
    7,193Cash and cash equivalents at beginning of year
    
    
    43,377
    
    
    
    14,876Cash and cash equivalents at end of period
    
    $
    22,100
    
    
    $
    22,069Supplemental Disclosures of Cash Flow InformationCash paid during the period forInterest
    
    $
    569
    
    
    $
    635Taxes
    
    
    4,983
    
    
    
    8,426Supplemental Disclosures of Non-cash financing activitiesWarrants issued in conjunction with senior secured credit facility
    
    $
    68
    
    
    $
    
 The accompanying notes are an integral part of these consolidated financial statements. 4




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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. The results of operations for the periods ended June 30, 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. Restatement.As described in greater detail in the Annual Report on Form 10-K for the period ended
December 31, 2004, the Company has restated its financial statements for certain periods, including
the periods covered by this Form 10-Q/A, since it did not qualify for the use of hedge accounting
under SFAS 133. The Condensed Consolidated Balance Sheets as of June 30, 2004 included in this Form 10-Q/A has been
restated as follows: June 30, 2004As
    
    
    As PreviouslyRestated
    
    
    ReportedAccounts receivable
    
    $
    34,620
    
    
    $
    31,576Cost and accrued earnings on uncompleted contracts
    
    
    82,729
    
    
    
    86,461Fair value of foreign exchange contracts
    
    
    
    
    
    
    3,811Total current assets
    
    
    175,562
    
    
    
    180,061Total assets
    
    
    218,686
    
    
    
    223,185Accrued liabilities
    
    
    18,225
    
    
    
    21,549Foreign exchange contracts
    
    
    3
    
    
    
    3,811Total current liabilities
    
    
    94,589
    
    
    
    101,721Deferred tax liability  non-current
    
    
    2,045
    
    
    
    1,150Total liabilities
    
    
    104,396
    
    
    
    110,633Accumulated other comprehensive income
    
    
    13,367
    
    
    
    10,764Total liabilities and stockholders equity
    
    
    218,686
    
    
    
    223,185
 The Condensed Consolidated Statements of Earnings for the three and six months ended June 30, 2004
and 2003 included in this Form 10-Q/A have been restated as follows: Three months ended,
    
    June 30, 2004
    
    
    June 30, 2003As
    
    
    As Previously
    
    
    As
    
    
    As PreviouslyRestated
    
    
    Reported
    
    
    Restated
    
    
    ReportedRevenues
    
    $
    39,232
    
    
    $
    45,228
    
    
    $
    41,206
    
    
    $
    42,723Cost of Sales
    
    
    28,456
    
    
    
    30,537
    
    
    
    28,777
    
    
    
    30,691Operating income
    
    
    3,258
    
    
    
    7,173
    
    
    
    5,003
    
    
    
    4,606Earnings before income taxes
    
    
    2,746
    
    
    
    6,661

    
    
    
    4,262
    
    
    
    3,865Income tax expense
    
    
    1,105
    
    
    
    2,435
    
    
    
    1,698
    
    
    
    1,563Net Earnings
    
    $
    1,641
    
    
    $
    4,226
    
    
    $
    2,564
    
    
    $
    2,302
 5




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The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   Six months ended,
    
    June 30, 2004
    
    
    June 30, 2003As
    
    
    As Previously
    
    
    As
    
    
    As PreviouslyRestated
    
    
    Reported
    
    
    Restated
    
    
    ReportedRevenues
    
    $
    66,095
    
    
    $
    79,696
    
    
    $
    77,058
    
    
    $
    85,380Cost of Sales
    
    
    50,631
    
    
    
    54,848
    
    
    
    54,398
    
    
    
    59,606Operating income (loss)
    
    
    (262
    )
    
    
    9,122
    
    
    
    8,609
    
    
    
    11,723Earnings (loss) before income taxes
    
    
    (1,499
    )
    
    
    7,885
    
    
    
    7,558
    
    
    
    10,672Income tax (benefit) expense
    
    
    (275
    )
    
    
    2,915
    
    
    
    3,377
    
    
    
    4,436Net Earnings (loss)
    
    $
    (1,224
    )
    
    $
    4,970
    
    
    $
    4,181
    
    
    $
    6,236
 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. 6




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   NOTE
3 - DERIVATIVE FINANCIAL INSTRUMENTS The Company uses foreign currency futures contracts to minimize the foreign currency exposures that
arise from sales contracts with certain foreign customers. Under the terms of these sales
contracts, the selling price and certain costs are payable in U.S. dollars rather than the Euro,
which is MECARs functional currency. As discussed in Note 1, the Companys accounting for foreign
currency exchange contracts at MECAR did not comply with the guidelines of FAS 133. As such,
gains/losses from settlements of the derivative contracts are reported as a component of revenues
and amounted to losses of $184 and $929 and gains of $4,682 and $8,337 for the three and six months
ended June 31, 2004 and 2003, respectively. 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. $8,739 and $15,812 at June 30, 2004 and December 31, 2003,
respectively, was restricted or pledged as collateral for these agreements. Restricted cash also included $2,000 at June 30, 2004 as a requirement of the senior secured
facility which was completed on May 28, 2004. Restricted cash also included $125 at June 30, 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 June 30, 2004 and December 31, 2003 are comprised as follows: 2004
    
    
    2003RestatedDirect and indirect receivables from foreign governments
    
    $
    22,313
    
    
    $
    19,696Commercial and other receivables, less allowance for doubtful
receivables of $119 in 2004 and $115 in 2003
    
    
    12,307
    
    
    
    13,708$
    34,620
    
    
    $
    33,404
 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 and six
months ended June 30, 2004 and 2003 were $31,346 and $50,437, and $34,121 and $62,992,
respectively. 7




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   NOTE 7  INVENTORIES Inventories at June 30, 2004 and December 31, 2003 are comprised as follows: 2004
    
    
    2003Raw materials
    
    $
    11,824
    
    
    $
    9,852Work in process
    
    
    1,231
    
    
    
    1,017Finished goods, less reserve for obsolescence of
$212 in 2004 and $214 in 2003
    
    
    1,296
    
    
    
    1,199$
    14,351
    
    
    $
    12,068
 NOTE 8  INTANGIBLE ASSETS AND GOODWILL June 30, 2004
    
    
    December 31, 2003Accumulated
    
    
    
    
    
    
    
    
    
    
    AccumulatedGross Amount
    
    
    Amortization
    
    
    Net
    
    
    Gross Amount
    
    
    Amortization
    
    
    NetIntangible assets subject to
amortization:Capitalized Software
    
    $
    1,213
    
    
    $
    367
    
    
    $
    846
    
    
    $
    1,179
    
    
    $
    282
    
    
    $
    897Customer Lists
    
    
    2,248
    
    
    
    449
    
    
    
    1,799
    
    
    
    2,247
    
    
    
    356
    
    
    
    1,891Patents
    
    
    1,494
    
    
    
    191
    
    
    
    1,303
    
    
    
    1,494
    
    
    
    147
    
    
    
    1,347Total
    

    $
    4,955
    
    
    $
    1,007
    
    
    $
    3,948
    
    
    $
    4,920
    
    
    $
    785
    
    
    $
    4,135
 Consolidated amortization expense related to intangible assets, excluding goodwill, for each of the
three and six months ended June 30, 2004 and 2003 were $111 and $222. Estimated future aggregate
annual amortization for intangible assets is as follows: Period
    
    AmountSix months ended December 31, 2004
    
    $
    222Year ended December 31, 2005
    
    
    540Year ended December 31, 2006
    
    
    379Year ended December 31, 2007
    
    
    297Year ended December 31, 2008
    
    
    225Thereafter
    
    
    2,285
 The $13,558 of goodwill at June 30, 2004 is comprised of $7,580 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. The change in goodwill during the six-month period ended
June 30, 2004 was due to the currency translation adjustment. NOTE 9  NOTES PAYABLE AND CREDIT FACILITY Notes Payable At June 30, 2004, MECAR had borrowed $10,827 under its lines of credit with its
lenders. NS Microwave had a note of $74 for machinery and vehicles. At December 31, 2003, MECAR
had 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 weighted average interest
rate for Notes Payable as of June 30, 2004 and December 31, 2003 was 3%. 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 8




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   guarantees issued and quarterly fees at an annual rate of 1.25% of guarantees outstanding. These
fees are charged to interest expense. As of June 30, 2004 and December 31, 2003, guarantees and
performance bonds of approximately $20,563 and $17,233 respectively, were outstanding. Advances under the Agreement are secured by restricted cash at June 30, 2004 and December 31, 2003
of approximately $8,737 and $15,813, respectively. Amounts outstanding are also collateralized by
a pledge of approximately $41,624 of MECARs net assets. The Agreement requires that MECAR
maintain net worth and working capital covenants. NOTE
10 - LONG-TERM DEBT Long-term obligations consist of the following as of June 30, 2004 and December 31, 2003,
respectively: June 30, 2004
    
    
    December 31, 2003Notes payable, less unamortized discount and debt issue costs
    
    $
    1,103
    
    
    $
    Mortgage loan agreements
    
    
    279
    
    
    
    908Capital leases and other
    
    
    6,914
    
    
    
    6,703$
    8,296
    
    
    $
    7,611Less current maturities
    
    
    2,239
    
    
    
    2,709$
    6,057
    
    
    $
    4,902
 Notes payable.On May 28, 2004 the Company obtained a senior loan facility from an accredited
lender under which the Company may borrow up to $18,000 for acquisitions and working capital. At
closing, the Company borrowed $2,000 and deposited $2,000 in a restricted account to secure the
repayment. The facility allows the Company to make additional draws under the facility under
certain conditions through November 28, 2005. All loans under the facility bear interest at the
rate of 11.5% per year payable monthly. Principal is paid in sixty equal monthly payments
commencing in late December 2005. The Company pays a fee on the unused portion of the facility.
Warrants (exercisable at $0.01 per share) to purchase 4,000 shares of the Companys common stock
were issued at closing and were valued at $68. Additional warrants (at the rate of 2,000 for each
$1 million loan) will be issued with future loan advances. The facility includes certain financial
and other covenants. The Company is currently in compliance with those covenants. Mortgage loan agreements.The VSK Group is obligated on a mortgage on its building, which has a
balance of approximately $279 at June 30, 2004. These mortgages are payable in annual installments
of approximately $56 plus interest. Capital leases and other.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 2009. Scheduled annual maturities of long-term obligations as of June 30, 2004 are approximately as
follows: Year
    
    Amount2005
    
    $
    2,2392006
    
    
    2,0012007
    
    
    1,5562008
    
    
    8992009
    
    
    498Thereafter
    
    
    1,103
 9




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   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. Monthly principal payments, in the amount of $750, began 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 (LOSS) 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 and six months ended June 30, 2004 and June 30, 2003, respectively: Three months ended
    
    
    Six months endedJune 30,
    
    
    June 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Restated
    
    
    Restated
    
    
    Restated
    
    
    RestatedNet earnings (loss)
    
    $
    1,641
    
    
    $
    2,564
    
    
    $
    (1,224
    )
    
    $
    4,181Interest on convertible debenture, net of taxes
    
    
    46
    
    
    
    90
    
    
    
    
    
    
    
    179Net earnings (loss) before interest on
convertible
debenture
    
    $
    1,687
    
    
    $
    2,654
    
    
    $
    (1,224
    )
    
    $
    4,360Weighted average number of basic shares
    
    
    5,555,509
    
    
    
    5,487,919
    
    
    
    5,553,454
    
    
    
    5,483,546Common stock equivalents
    
    
    461,991
    
    
    
    432,867
    
    
    
    
    
    
    
    436,120Weighted average number of diluted shares
    
    
    6,017,500
    
    
    
    5,920,786
    
    
    
    5,553,454
    
    
    
    5,919,666Basic earning (loss) per share
    
    $
    0.30
    
    
    $
    0.47
    
    
    $
    (0.22
    )
    
    $
    0.76Diluted earnings (loss) per share
    
    $
    0.28
    
    
    $
    0.45
    
    
    $
    (0.22
    )
    
    $
    0.74
 For the six months ended June 30, 2004, the Company has
excluded common stock equivalents of 478,256 since their effect would be anti-dilutive. NOTE 13 - COMPREHENSIVE INCOME (LOSS) A summary of the components of Comprehensive Income (Loss) for the three and six months ended June
30, 2004 and 2003, is as follows: Three months ended
    
    
    Six months endedJune 30,
    
    
    June 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Restated
    
    
    Restated
    
    
    Restated
    
    
    RestatedNet earnings (loss)
    
    $
    1,641
    
    
    $
    2,564
    
    
    $
    (1,224
    )
    
    $
    4,181Currency translation adjustment
    
    
    (669
    )
    
    
    4,885
    
    
    
    (2,830
    )
    
    
    6,819Comprehensive income (loss)
    
    $
    972
    
    
    $
    7,449
    
    
    $
    (4,054
    )
    
    $
    11,000
 10




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   The currency translation adjustment for the three and six months ended June 30, 2004 resulted from
the depreciation of the Euro during the respective periods. In contrast, the currency translation
adjustment for the comparable periods in 2003 resulted from the appreciation of the Euro during
those periods. 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 and six months ended June 30, 2004 and 2003. The following table presents the pro forma decrease in income for the three and six months ended
June 30, 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 Ended June 30,
    
    
    Six Months Ended June 30,(Dollars in thousands, except per share amounts)
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003Restated
    
    
    Restated
    
    
    Restated
    
    
    RestatedReported net earnings (loss)
    
    $
    1,641
    
    
    $
    2,564
    
    
    $
    (1,224
    )
    
    $
    4,181Stock-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
    
    
    (165
    )
    
    
    (120
    )
    
    
    (331
    )
    
    
    (241
    )Pro forma net earnings (loss)
    
    $
    1,476
    
    
    $
    2,444
    
    
    $
    (1,555
    )
    
    $
    3,940Basic earnings (loss) per share:Reported earnings (loss) per share
    
    $
    0.30
    
    
    $
    0.47
    
    
    $
    (0.22
    )
    
    $
    0.76Compensation costs, net of tax
    
    
    (0.03
    )
    
    
    (0.02
    )
    
    
    (0.06
    )
    
    
    (0.04
    )Pro forma basic earnings (loss) per share
    
    $
    0.27
    
    
    $
    0.45
    
    
    $
    (0.28
    )
    
    $
    0.72Diluted earnings (loss) per share:Reported earnings (loss) per share
    
    $
    0.28
    
    
    $
    0.45
    
    
    $
    (0.22
    )
    
    $
    0.74Compensation costs, net of tax
    
    
    (0.03
    )
    
    
    (0.02
    )
    
    
    (0.05
    )
    
    
    (0.04
    )Pro forma diluted earnings (loss) per share
    
    $
    0.25
    
    
    $
    0.43
    
    
    $
    (0.27
    )
    
    $
    0.70
 Options granted during the three and six months ended June 30, 2004 were 40,000. Options granted
during the three and six months ended June 30, 2003 were 110,000. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes options pricing model. The
weighted-average fair value of each option at the date of grant for the three and six months ended
June 30, 2004 was $7.59. The weighted-average fair value of each option at the date of grant for
the three and six months ended June 30, 2003 was $6.50. The weighted average assumptions used in
the model were as follows: Three Months Ended June 30
    
    
    Six Months Ended June 302004
    
    
    2003
    
    
    2004
    
    
    2003Risk free interest rate
    
    
    2.86
    %
    
    
    2.86
    %
    
    
    2.86
    %
    
    
    2.86
    %Expected volatility rate
    
    
    47.00
    %
    
    
    47.00
    %
    
    
    47.00
    %
    
    
    47.00
    %Expected
lives - years
    
    
    3
    
    
    
    3
    
    
    
    3
    
    
    
    3Divided yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 11




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   The weighted average assumptions were consistent between 2003 and 2004 and will be evaluated prior
to the  publication   of the   next
  Form 10-K. We do not believe that the factors used above have
changed materially over the past twelve months. 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 ended
    
    
    Six months endedJune 30,
    
    
    June 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Restated
    
    
    Restated
    
    
    Restated
    
    
    RestatedRevenues from external customersOrdnance & Manufacturing
    
    $
    26,300
    
    
    $
    31,802
    
    
    $
    41,772
    
    
    $
    57,664Electronic Security
    
    
    11,559
    
    
    
    7,707
    
    
    
    20,890
    
    
    
    14,438Environmental Safety & Security
    
    
    1,223
    
    
    
    1,509
    
    
    
    3,247
    
    
    
    3,815Software, Training & Simulation
    
    
    150
    
    
    
    188
    
    
    
    186
    
    
    
    1,141$
    39,232
    
    
    $
    41,206
    
    
    $
    66,095
    
    
    $
    77,058Segment profit (loss) before taxesOrdnance & Manufacturing
    
    $
    1,752
    
    
    $
    5,305
    
    
    $
    (2,437
    )
    
    $
    8,612Electronic Security
    
    
    2,237
    
    
    
    (63
    )
    
    
    3,057
    
    
    
    (5
    )Environmental Safety & Security
    
    
    (1,046
    )
    
    
    (345
    )
    
    
    (1,182
    )
    
    
    (337
    )Software, Training & Simulation
    
    
    (162
    )
    
    
    (58
    )
    
    
    (341
    )
    
    
    109Corporate and Other
    
    
    (35
    )
    
    
    (577
    )
    
    
    (596
    )
    
    
    (821
    )$
    2,746
    
    
    $
    4,262
    
    
    $
    (1,499
    )
    
    $
    7,558
 NOTE 16  COMMITMENTS AND CONTINGENCIES A suit has been filed against one of the VSK subsidiaries in the Belgian courts alleging a breach
of a non-compete clause within a teaming agreement executed with a claimant in prior years.
Management intends to vigorously defend this suit and believes that it has meritorious defense to
the claim. SeaSpace is in litigation with a former distributor concerning certain aspects of the termination
of the distributor relationship. The former distributor has filed a preliminary injunction action
in Japan concerning the termination. SeaSpace has filed an action for monetary damages in
California and the former distributor has filed a similar action for monetary damages in Japan.
The California court has recently ruled that the matter should be resolved in an international
arbitration proceeding. Management continues to vigorously defend these matters and believes that
it has a meritorious position. NOTE 17 - RECENT ACCOUNTING PRONOUNCEMENTS There were no new accounting pronouncements during the six months ended June 30, 2004 that would
impact the Companys financial reporting. 12




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   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 marginally 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 profit (loss) of $1,641 and $(1,224) for the three and six months
ended June 30, 2004, respectively, compared to net profits of $2,564 and $4,181 for the comparable
periods of 2003. Allied entered 2004 with substantial cash reserves and anticipates no liquidity concerns in 2004.
Allied has secured a senior domestic lending facility for working capital and acquisitions. Restatement.As described in greater detail in the Annual Report on Form 10-K for the period ended
December 31, 2004, the Company has restated its financial statements for certain periods, including
the periods covered by this Form 10-Q/A, since it did not qualify for the use of hedge accounting
under SFAS 133. The balance of this Managements Discussion and Analysis of Financial Condition
and Results of Operations gives effect to and is based upon the restated financial statements,
computed using derivative accounting. 13




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   Results of Operations for the Three Months Ended June 30, 2004 and 2003 The table below shows, for the three months ended June 30, 2004 and 2003, certain items from
Allieds condensed consolidated statements of earnings expressed as a percentage of revenue: Three months ended June 30,2004
    
    
    2003Revenue
    
    $
    39,232
    
    
    
    100.0
    %
    
    $
    41,206
    
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    28,456
    
    
    
    72.5
    
    
    
    28,777
    
    
    
    69.8Selling and administrative
    
    
    5,702
    
    
    
    14.5
    
    
    
    6,520
    
    
    
    15.8Research and development
    
    
    1,816
    
    
    
    4.6
    
    
    
    906
    
    
    
    2.2Operating income
    
    
    3,258
    
    
    
    8.4
    
    
    
    5,003
    
    
    
    12.2Other income (expense)Interest income
    
    
    93
    
    
    
    0.2
    
    
    
    131
    
    
    
    0.3Interest expense
    
    
    (520
    )
    
    
    (1.4
    )
    
    
    (524
    )
    
    
    (1.3
    )Other  net
    
    
    (85
    )
    
    
    (0.2
    )
    
    
    (348
    )
    
    
    (0.9
    )Earnings before income taxes
    
    
    2,746
    
    
    
    7.0
    
    
    
    4,262
    
    
    
    10.3Income tax expense
    
    
    1,105
    
    
    
    2.8
    
    
    
    1,698
    
    
    
    4.1Net earnings
    
    $
    1,641
    
    
    
    4.2
    %
    
    $
    2,564
    
    
    
    6.2
    %
 Revenue.Allied had revenue of $39,232 in the three months ended June 30, 2004, which was
5% lower than its revenue in the same period of 2003. This decrease was principally attributable
to the change in accounting for the derivatives, which was offset by higher distribution sales and
increased activities at the VSK Group and NS Microwave and the increase in the value of the Euro. Revenue by SegmentThree Months Ended
    
    
    Three Months EndedJune 30, 2004
    
    
    June 30, 2003Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    of totalOrdnance & Manufacturing
    
    $
    26,300
    
    
    
    67
    %
    
    $
    31.802
    
    
    
    77
    %Electronic Security
    
    
    11,559
    
    
    
    30
    %
    
    
    7,707
    
    
    
    19
    %Environmental Safety & Security
    
    
    1,223
    
    
    
    3
    %
    
    
    1,509
    
    
    
    4
    %Software, Training & Simulation
    
    
    150
    
    
    
    
    %
    
    
    188
    
    
    
    
    %$
    39,232
    
    
    
    100
    %
    
    $
    41,206
    
    
    
    100
    %
 Ordnance & Manufacturing Segment revenue for the second quarter of 2004 decreased by 17% from the
comparable 2003 period. The entire decrease occurred at MECAR as MECAR USA is not expected to be
fully operational until the latter portion of 2004 or early 2005. The 2003 period was benefited by
substantial activity under the approximately $130,000 Foreign Military Sales (FMS) contract which
is in its final stages and did not provide as much revenue in the current period. While MECAR
continues to meet the ammunition needs of its traditional customers, it is actively seeking to
diversify its customer base. 14




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   Electronic Security Segment revenue for the second quarter of 2004 increased by $3,852, or 50%,
over the 2003 period due to increases at both NS Microwave and the VSK Group. Approximately $3,000
of the increase was from NS Microwave as it has begun to obtain long-awaited orders for its
security products. A substantial portion of NS Microwaves increased revenue was attributable to a
U.S. government contract scheduled for completion in the third quarter of 2004. 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. Environmental Safety & Security Segment revenues for the second quarter of 2004 decreased by $286
from the comparable 2003 period. SeaSpace continues to suffer from increased competition by
domestic and foreign competitors. Further, a substantial project initially forecast for the second
quarter of 2004 has been delayed to the latter portion of 2004. Software, Training & Simulation Segment revenues for the second quarter of 2004 decreased by $38
from the comparable 2003 period. Titan Dynamics sales of its Battle Effects Simulators (BES)
continue to be depressed pending safety certifications expected in late 2004 or early 2005 from the
U.S. Navy/Marine Corps and the U.S. Army. Accordingly, Titan Dynamics revenue is now largely
comprised of cartridge sales for previously sold simulators. Cost of Sales.Cost of sales as a percentage of sales for the three months ended June 30, 2004 was
73% compared with 70% for the same period in 2003. Cost of Sales as Percentage of Sales by Segment Three months endedJune 302004
    
    
    2003Ordnance & Manufacturing
    
    
    80
    %
    
    
    74
    %Electronic Security
    
    
    56
    %
    
    
    55
    %Environmental Safety & Security
    
    
    60
    %
    
    
    71
    %Software, Training & Simulation
    
    
    67
    %
    
    
    43
    %Total
    
    
    73
    %
    
    
    70
    %
 Ordnance & Manufacturing Segment cost of sales as a percentage of sales for the three months ended
June 30, 2004 increased from the same period of 2003 due to the change to derivative accounting
described above. Electronic Security Segment cost of sales as a percentage of sales for the three months ended June
2004 increased over the same period in 2003 due to higher NS Microwave 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 June 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. 15




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   Selling and Administrative Expenses.Selling and administrative expenses as a percentage of sales
for the three months ended June 30, 2004 was approximately 15% compared with 16% for the same
period in 2003. This decrease stemmed from lower administrative costs at NS Microwave and Allied. In 2003, NS Microwaves
administrative costs were burdened with compensation charges associated with production personnel,
which did not recur in 2004. Also in 2003, Allieds administrative costs included the write-off of
funding costs associated with a structured debt financing proposal, which did not recur in 2004.
For the other business units, costs were greater in the second quarter of 2004 due primarily to
increased compensation expenses for administrative personnel. Research and Development.Research and development costs increased for the three months ended June
30, 2004 by 100% over 2003 levels. The increase was attributed to increased research being
conducted at all the business units, except NS Microwave. Expenditures decreased at NS Microwave
as the staff utilized for research and development 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. Interest Income.Interest income decreased for the three months ended June 30, 2004 by 29% from
2003 levels. The total dollar decrease was nominal and was primarily attributed to earnings on
interest bearing cash accounts. Interest Expense.Interest expense for the three months ended June 30, 2004 was materially
consistent with 2003 levels. 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 for the three months
ended June 30, 2004 increased over the comparable 2003 period. Pre-Tax Profit (Loss) Pre-Tax Profit (Loss) by Segment Three months endedJune 302004
    
    
    2003Ordnance & Manufacturing
    
    $
    1,752
    
    
    $
    5,305Electronic Security
    
    
    2,237
    
    
    
    (63
    )Environmental Safety & Security
    
    
    (1,046
    )
    
    
    (345
    )Software, Training & Simulation
    
    
    (162
    )
    
    
    (58
    )Corporate and other
    
    
    (35
    )
    
    
    (577
    )$
    2,746
    
    
    $
    4,262
 Ordnance & Manufacturing Segment pre-tax profit for the three months ended June 30, 2004 decreased
from the comparable period in 2003 principally due to the change to derivative accounting described
above. MECARs profitability for 2004 is expected to be at lower levels than in prior years due to
a lack of substantial high-margin contracts which benefited 2001-2003 results. Electronic Security Segment pre-tax profit for the three months ended June 30, 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 and NS Microwaves increased
business, largely from one U.S. government contract. 16




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   Environmental Safety & Security Segment pre-tax loss resulted from increased competitive pressures,
both at home and abroad, as well as increased development costs associated with new products
expected to be available for sale before year-end and substantial legal expenses associated with an
ongoing dispute with a former sales representative. 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
Navy/Marine Corp certification in the fourth quarter of 2004. Corporate and other Segment pre-tax loss for the three months ended June 30, 2004 decreased from
the 2003 level due to reduced intercompany management fee adjustments and reduced taxes. Income Taxes.The effective income tax rate in the three months ended June 30, 2004 and 2003 was
40%. While the corporate tax rate in Belgium was reduced from 40.17% to 33.99% effective for tax
years beginning January 1, 2003, the reduced tax rate did not take effect at MECAR and the VSK
Group until the second half of 2003. Net Earnings.The Company earned a $1,641 net profit for the three months ended June 30, 2004
compared with $2,564 net profit in the same period of 2003. The decrease in 2004 resulted
principally from the change to derivative accounting described above. 17




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   Results of Operations for the Six Months Ended June 30, 2004 and 2003 The table below shows, for the six months ended June 30, 2004 and 2003, certain items from Allieds
condensed consolidated statements of earnings expressed as a percentage of revenue: Six months ended June 30,2004
    
    
    2003Revenue
    
    $
    66,095
    
    
    
    100.0
    %
    
    $
    77,058
    
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    50,631
    
    
    
    76.6
    
    
    
    54,398
    
    
    
    70.6Selling and administrative
    
    
    12,349
    
    
    
    18.7
    
    
    
    12,294
    
    
    
    16.0Research and development
    
    
    3,377
    
    
    
    5.1
    
    
    
    1,757
    
    
    
    2.3Operating income (loss)
    
    
    (262
    )
    
    
    (0.4
    )
    
    
    8,609
    
    
    
    11.1Other income (expense)Interest income
    
    
    195
    
    
    
    0.3
    
    
    
    228
    
    
    
    0.3Interest expense
    
    
    (998
    )
    
    
    (1.5
    )
    
    
    (959
    )
    
    
    (1.2
    )Other  net
    
    
    (434
    )
    
    
    (0.7
    )
    
    
    (320
    )
    
    
    (0.4
    )Earnings (loss) before income taxes
    
    
    (1,499
    )
    
    
    (2.3
    )
    
    
    7,558
    
    
    
    9.8Income tax expense (benefit)
    
    
    (275
    )
    
    
    (0.4
    )
    
    
    3,377
    
    
    
    4.4Net earnings (loss)
    
    $
    (1,224
    )
    
    
    (1.9
    )%
    
    $
    4,181
    
    
    
    5.4
    %
 Revenue. Allied had revenue of $66,095 in the six months ended June 30, 2004, which was 14% lower than its
revenue in the same period of 2003. This decrease was principally attributable to reduced
production activities at MECAR. Revenue by SegmentSix Months Ended
    
    
    Six Months EndedJune 30, 2004
    
    
    June 30, 2003Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    of totalOrdnance & Manufacturing
    
    $
    41,772
    
    
    
    63
    %
    
    $
    57,664
    
    
    
    75
    %Electronic Security
    
    
    20,890
    
    
    
    32
    %
    
    
    14,438
    
    
    
    19
    %Environmental Safety & Security
    
    
    3,247
    
    
    
    5
    %
    
    
    3,815
    
    
    
    5
    %Software, Training & Simulation
    
    
    186
    
    
    
    
    %
    
    
    1,141
    
    
    
    1
    %$
    66,095
    
    
    
    100
    %
    
    $
    77,058
    
    
    
    100
    %
 Ordnance & Manufacturing Segment revenue for the six months ended June 30, 2004 decreased by 28%
from the comparable period in 2003. The decrease was the result of reduced activity on the large
FMS contract received in February 2002, production delays encountered during the first quarter of
2004, and the change in the accounting gfor the derivatives. Electronic Security Segment revenue for the six months ended June 30, 2004 increased by $6,452 over
the comparable period in 2003. The VSK Group and NS Microwave contributed $2,547 and $3,905 to
this increase, respectively. The increase at the VSK Group is principally the result of continued
expansion of its export sales via 18




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   its European distribution network. NS Microwaves business has improved due to receipt of some
substantial orders in late 2003 and in the first half of 2004. Environmental Safety & Security Segment revenues for the six months ended June 30, 2004 decreased
by $568 from the comparable period in 2003 as a result of increased competition and delayed
projects as noted above. Software, Training & Simulation Segment revenues for the six month ended June 30, 2004 decreased by
$955 from the comparable period in 2003 due to reduced simulator sales. Cost of Sales.Cost of sales as a percentage of sales for the six month periods ended June 30,
2004, was 77% compared with 71% for the same period in 2003. Cost of Sales as Percentage of Sales by Segment Six months endedJune 302004
    
    
    2003Ordnance & Manufacturing
    
    
    88
    %
    
    
    76
    %Electronic Security
    
    
    57
    %
    
    
    55
    %Environmental Safety & Security
    
    
    58
    %
    
    
    65
    %Software, Training & Simulation
    
    
    67
    %
    
    
    59
    %Total
    
    
    77
    %
    
    
    71
    %
 Ordnance & Manufacturing Segment cost of sales as a percentage of sales for the six months ended
June 2004 increased over the same period of 2003 due solely to the change to derivative accounting
described above. Electronic Security Segment cost of sales as a percentage of sales for the six months ended June
2004 increased over the same period of 2003 due to the higher NS Microwave material costs as noted
above. 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 Software, Training & Simulation Segment cost of sales as a percentage of sales for the six months
ended June 30, 2004 increased over 2003 as a result of the change in product mix and higher labor
costs Selling and Administrative Expenses.Selling and administrative expenses as a percentage of sales
for the six months ended June 30, 2004 was approximately 19% compared with 16% for the same period
in 2003. This resulted from higher costs at MECAR, the VSK Group and SeaSpace for increased
compensation expenses for administrative personnel, offset by decreased costs at NS Microwave and
Allied. Research and Development.Research and development costs increased for the six months ended June
30, 2004 by 92% over 2003 levels. This trend of increased research and development is expected to
continue for the remainder of the year. Interest Income.Interest income decreased for the six months ended June 30, 2004 by 14% from 2003
levels. The total dollar decrease was nominal and was primarily attributed to earnings on interest
bearing cash accounts. Interest Expense.Interest expense increased for the six months ended June 30, 2004 by 4% over
2003 levels. The increase was primarily due to the total increase in long-term obligations. 19




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   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 for the six months ended
June 30, 2004 increased over the comparable period of 2003 from currency losses in 2004 on MECARs
U.S. bank accounts. Pre-Tax Profit (Loss) Pre-Tax Profit (Loss) by Segment Six months endedJune 302004
    
    
    2003Ordnance & Manufacturing
    
    $
    (2,438
    )
    
    $
    8,612Electronic Security
    
    
    3,057
    
    
    
    (5
    )Environmental Safety & Security
    
    
    (1,182
    )
    
    
    (337
    )Software, Training & Simulation
    
    
    (341
    )
    
    
    109Corporate and other
    
    
    (595
    )
    
    
    (821
    )$
    (1,499
    )
    
    $
    7,558
 Ordnance & Manufacturing Segment incurred a pre-tax loss for the first half of 2004 and a pre-tax
profit for the same period of 2003 due to reduced work on the FMS contract as well as the required
change to derivative accounting described above. Electronic Security Segment pre-tax profit for the period ended June 30, 2004 increased over 2003
levels due to increased business and increased margins at both the VSK Group and NS Microwave. Environmental Safety & Security Segment pre-tax loss for the six months period ended June 30, 2004
increased over the 2003 loss due to competitive pressures, increased development costs and higher
legal expenses. Software, Training & Simulation Segment pre-tax loss for the period ended June 30, 2004 resulted
from reduced business awaiting necessary safety certifications. Corporate and other Segment pre-tax loss for the six months ended June 30, 2004 was less than the
comparable 2003 period due to reduced taxes. Income Taxes.The effective income tax rate in the first six months of 2004 was a benefit of 18%
compared to an expense of 45% in the same period of 2003. The fluctuation was primarily due to the
reclassification of foreign currency hedge contracts as derivatives. While the corporate tax rate
in Belgium was reduced from 40.17% to 33.99%
effective for tax years beginning January 1, 2003, the reduced tax rate did not take effect at
MECAR and the VSK Group until the second half of 2003. Net Earnings (Loss).The Company incurred a $1,224 net loss for the six months ended June 30, 2004
compared with $4,181 net profit in the same periods of 2003. The decrease in 2004 resulted from
the activities at MECAR, SeaSpace and Titan Dynamics. 20




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   Backlog.As of June 30, 2004, the Companys backlog was $84,899 compared to $115,416 at December
31, 2003, and $124,430 at June 30, 2003. The June 30, 2004 and December 31, 2003 amounts included
unfunded portion of approximately $9,700 from an indefinite delivery, indefinite quantity (IDIQ)
federal contract. Backlog by SegmentJune 30, 2004
    
    
    June 30, 2003Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    Of totalOrdnance & Manufacturing
    
    $
    59,687
    
    
    
    70
    %
    
    $
    110,615
    
    
    
    89
    %Electronic Security
    
    
    23,029
    
    
    
    27
    
    
    
    12,281
    
    
    
    10Environmental Safety & Security
    
    
    1,630
    
    
    
    2
    
    
    
    1,452
    
    
    
    1Software, Training & Simulation
    
    
    553
    
    
    
    1
    
    
    
    82
    
    
    
    $
    84,899
    
    
    
    100
    %
    
    $
    124,430
    
    
    
    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 productive in 2004.
In addition to meeting the ammunition needs of its traditional customers, MECAR has gained new
customers which have contributed 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 $9,700 from an IDIQ federal
contract. Liquidity and Capital Resources Balance Sheet The Companys June 30, 2004 condensed consolidated balance sheet was affected by the value of the
Euro. All European values were converted at the June 30, 2004 and December 31, 2003 conversion
ratios of 1.2085 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 $80,973 at June 30, 2004, which is a decrease
of $8,244 from the December 31, 2003, level. Working capital remains strong due to profitable
operations. Cash at June 30, 2004 decreased by $21,277 from December 31, 2003 as substantial cash was expended
in the first half of 2004 to repay current liabilities including MECARs short-term borrowings.
Restricted cash decreased by $5,073 in the first half of 2004 due to completion of certain
contracts at MECAR. Accounts receivable at June 30, 2004 increased by $1,216, or 4% from December 31, 2003, due to
higher sales in the second quarter 2004 versus the second quarter 2003 and the change in accounting
for the derivatives. Costs and accrued earnings on uncompleted contracts increased by $22,213 from
year-end 2003 primarily as a result of continued work on MECAR contracts and the change in
accounting for the derivatives. Inventories increased $2,283 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 a liability of $3
at June 30, 2004, compared to an asset of $6,900 at December 31, 2003. MECAR uses foreign currency
derivative contracts to minimize the foreign currency exposures that arise from sales contracts
with certain foreign customers. Prepaid and other current assets increased $4,311 primarily from costs on MECARs hedge contract
agreements. 21




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   Property, Plant & Equipment, net of accumulated depreciation, increased primarily from equipment
purchases at the business units during the first six months of 2004. Intangibles decreased
primarily from the amortization of capitalized software, customer lists and patents. Goodwill
decreased solely from the currency translation adjustment. Notes Payable decreased $3,299 from December 31, 2003 as a result of MECAR paying off a short-term
loan. During the first six months of 2004, MECAR used its cash from operations for working capital
needs. Accounts payable decreased $10,210 as a result of lower production costs, primarily at
MECAR, for the six months ended June 30, 2004 compared to the six months ended December 2003. In
contrast, accrued liabilities increased $10,631 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 increased $4,221 primarily at MECAR as a result of
shipments during the period and other new contracts in 2004 requiring deposits. Income taxes
increased $3,389 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 June
30, 2004, and December 31, 2003. The Company has commenced repayment of the debenture. Monthly
payments will continue through March 2005. Stockholders equity as of June 30, 2004, was negatively affected by the reduction in the value of
the Euro versus the U.S. dollar during the first six months of 2004, resulting in a decrease in
accumulated other comprehensive income by $2,830. The Euro depreciated by approximately 4% since
the beginning of the year. Cash Flows The table below provides the cash flow statement data for the periods presented. Six months ended June 302004
    
    
    2003Net cash (used in) provided by operating activities
    
    $
    (20,075
    )
    
    $
    11,138Net cash used in investing activities
    
    
    (3,476
    )
    
    
    (3,023
    )Net cash provided by (used in) financing activities
    
    
    2,967
    
    
    
    (1,768
    )
 Operating Activities.The Company used $20,075 of cash in its operating activities during the six
months ended June 30, 2004 whereas it generated $11,138 of cash during the same period of 2003.
This is attributed primarily to reduction in earnings for the six months ended June 2004 and
increase in costs and accrued earnings on uncompleted contracts. Cash paid for interest was $569
and $635, for the six months ended June 30, 2004 and 2003, respectively. Cash paid for income
taxes was $4,983 and $8,426 for the six months ended June 30, 2004 and 2003, respectively, and
includes federal, international and state taxes. Investing Activities.Net cash used in investing activities increased by 15% between the two
periods. This stemmed from higher 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. Financing Activities.The Company generated $2,967 of cash from its financing activities during
the six months ended June 30, 2004 whereas it used $1,768 of cash during the same period of 2003.
This stemmed from proceeds of long-term debt, in particular the senior secured facility, as well as
a reduction in restricted cash. This was offset by payment of short-term borrowings, which
primarily pertained to MECAR operations. 22




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   Allied.The parent company continues to operate based on fees and dividends received from its
subsidiaries. In the second quarter of 2004, Allied has made cash infusions to NS Microwave, Titan
Dynamics and SeaSpace to support working capital requirements. On May 28, 2004 the Company
obtained a senior loan facility under which the Company may borrow up to $18,000 for acquisitions
and working capital. At closing, the Company borrowed $2,000 and deposited $2,000 in a restricted
account to secure the repayment. The facility allows the Company to make additional draws under
the facility under certain conditions through November 28, 2005. All loans under the facility bear
interest at the rate of 11.5% per year payable monthly. Principal is paid in sixty equal monthly
payments commencing in late December 2005. The Company pays a fee on the unused portion of the
facility. Warrants (exercisable at $0.01 per share) to purchase 4,000 shares of the Companys
common stock were issued at closing and were valued at $68. Additional warrants (at the rate of
2,000 for each $1 million loan) will be issued with future loan advances. The facility includes
certain financial and other covenants. The Company is currently in compliance with those
covenants. 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 June 30, 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 six
months ended June 30, 2004 and does not anticipate repurchasing shares of Company stock during the
remainder of 2004. Future Liquidity.The Company is exploring additional financing in light of its repayment of the
convertible debenture. At times, the Company has utilized the services of an Investment Banker in
an attempt to secure appropriate financing. 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. 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 23




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As
of June 30, 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 80%
and 76%, and 83% and 82%, of condensed consolidated revenue was
recognized under the percentage of completion method during the
three and six months ended June 30, 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 June 30, 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.
    Derivative Instruments.The Company designates its derivatives
based upon the criteria established by Statement of Financial
Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133), which establishes
accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other
contracts, and for hedging activities. SFAS 133, as amended by
SFAS 138 and SFAS 149, requires that an entity recognize all
derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value.
The accounting for the changes in the fair value of the derivative
depends on the intended use of the derivative and the resulting
designation. For a derivative designated as a fair value hedge,
the gain or loss is recognized in earnings in the period of change
together with the offsetting loss or gain on the risk being
hedged. For a derivative designated as a cash flow hedge, the
effective portion of the derivatives gain or loss is initially
reported as a component of accumulated other comprehensive income
(loss) and is subsequently reclassified to earnings when the hedge
exposure effects earnings. The ineffective portion of the hedge
is reported in earnings immediately. For a derivative that does
not qualify as a fair value hedge or cash flow hedge, the change
in fair value is recognized currently in net income.
    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. 24




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
June 30, 2004
(Thousands of Dollars)
(Unaudited)   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. 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. 25




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The Allied Defense Group, Inc. June 30, 2004   QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE At June 30, 2004, Allied had $33 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 and six months ended June 30, 2004 and 2003 by $0.08 million and $0.16 million,
respectively. Approximately 87% and 92% of the Companys revenue for the six months ended June 30, 2004 and 2003,
respectively, were 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 and six months ended June 30,
2004 and 2003 by approximately $0.20 million and $0.03 million and $0.43 million and $0.68 million,
respectively. DISCLOSURE CONTROLS AND PROCEDURES The following has been amended to reflect the restatement of the Companys consolidated financial
statements as discussed further in the Explanatory Note and in Note 1 of the Notes to Consolidated
Financial Statements.  1.
    Evaluation of disclosure controls and proceduresThe Company maintains disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the reports filed or submitted under the Securities
Exchange Act of 1934, as amended (Exchange Act), is recorded, processed, summarized and
reported within the time periods specified in the Commissions rules and forms. Disclosure
controls and procedures are designed to ensure that information required to be disclosed by the
Company in its Exchange Act reports is accumulated and communicated to the Companys management
including its principal executive and financial officers, as appropriate to allow timely
decisions regarding required disclosure. Under 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. In connection with the annual audit for calendar year 2004,
management concluded that its internal control over financial reporting was ineffective due to
its method of accounting for foreign currency contracts. As a result, the Chief Executive
Officer and the Chief Financial Officer have concluded that the disclosure controls and
procedures were not effective.2.
    Changes in internal controlsExcept as set forth above, there have been no significant changes in our internal controls over
financial reporting or, to our knowledge, in other factors that occurred during the last quarter
that has materially affected, or is reasonably likely to materially affect, our internal control
over financial reporting. 26




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The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
June 30, 2004   Item 1 Legal Proceedings See Note 16 to the Condensed Consolidated Financial Statements. Item 4 Submission of Matters to a Vote of Security Holders On June 4, 2004, the Company held its annual meeting of shareholders. The Companys shareholders re-elected J. H. Binford Peay, III, John G. Meyer, Jr., J.R. Sculley,
Clifford C. Christ, Harry H. Warner, Ronald H. Griffith and Gilbert F. Decker as members of the
Board of Directors of the Company. The following votes were cast in connection with the election of directors: Nominee
    
    In Favor
    
    
    WithheldJ. H. Binford Peay, III
    
    
    4,697,196
    
    
    
    215,752John G. Meyer, Jr.
    
    
    4,696,906
    
    
    
    216,042Clifford C. Christ
    
    
    4,809,382
    
    
    
    103,566Ronald H. Griffith
    
    
    4,819,358
    
    
    
    93,590J. R. Sculley
    
    
    4,690,270
    
    
    
    222,678Harry H. Warner
    
    
    4,818,806
    
    
    
    94,142Gilbert F. Decker
    
    
    4,817,806
    
    
    
    95,142
 The Companys shareholders ratified the appointment of
Grant Thornton LLP as the Companys independent auditors
for 2004. The following votes were cast in connection
with such ratification: For
    
    Against
    
    
    Abstain4,868,813
    
    
    36,758
    
    
    
    7,377
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The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
June 30, 2004   Item 6 Exhibits and Reports on Form 8-K  (a)
    Reports on Form 8-KOn April 30, 2004, the Company filed a Form 8-K reporting execution and delivery of a new
employment agreement with Wayne F. C. Hosking, Jr., the Companys Vice President for Corporate
Strategic Development.On May 5, 2004, the Company filed a Form 8-K providing its financial results for the year ended
March 31, 2004.On June 2, 2004, the Company filed a Form 8-K reporting its senior secured financing facility. (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
    
    Amended and Restated By-Laws3.3
    
    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 letter amendments between Allied and John G. Meyer, Jr.10.3
    
    Employment Agreement between Allied and Charles A. Hasper (Incorporated by reference
from Form 8-K filed in August 2001).10.4
    
    Employment Agreement letter amendment between Allied and Charles A. Hasper.10.5
    
    Employment Agreement between Allied and Monte L. Pickens (Incorporated by reference
from Form 8-K filed in April 2003).10.6
    
    Employment Agreement letter amendment between Allied and Monte L. Pickens.10.7
    
    Employment Agreement between Allied and Wayne F. C. Hosking, Jr. (Incorporated by
reference from Form 8-K filed in April 2004).10.8
    
    Employment Agreement between Allied and John J. Marcello10.9
    
    2001 Equity Incentive Plan, as amended (Incorporated by reference from Proxy Statements
filed in April 2001 and April 2002).10.10
    
    8% Convertible Debenture, Series A and related documents (Incorporated by reference
from Form 8-K filed in July 2002).10.11
    
    Credit Agreement for MECAR S.A. (Incorporated by reference from Form 10-Q filed in
August 2002).10.12
    
    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).
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The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
June 30, 2004   (b)
    Exhibit No.
    
    Description of Exhibits10.13
    
    Employee Stock Purchase Plan, as amended (Incorporated by reference from Form 10-Q
filed in November 2002).10.14
    
    Lease Agreement, as amended (Incorporated by reference from Form 10-Q filed in
November 2002).10.15
    
    Form of Indemnity Agreement for Directors and Executive Officers (Incorporated by
reference from Form 10-Q filed in November 2002).10.16
    
    International Distribution Agreement (Incorporated by reference from Form 10-Q filed
in November 2002).10.17
    
    Deferred Compensation Plan for Non-Employee Directors.10.18
    
    Loan and Security Agreement among Wilton Funding, LLC and Allied and certain of its
subsidiaries (Incorporated by reference from Form 8-K filed in June 2004).21
    
    List of Subsidiaries (Incorporated by reference from Form 10-K filed in March 2004)23
    
    Consent of Independent Certified Public Accountants (Incorporated by reference from
Form 10-K filed in March 2004)31.1

    
    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
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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: April 25, 2005
    
    Charles A. Hasper,Chief Financial Officer andTreasurer
 30