##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended March 31, 2005 Commission File Number: 1-11376   The Allied Defense Group, Inc. (Exact name of Registrant as specified in its charter)
 Delaware
    
    04-2281015(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Number)
 8000 Towers Crescent Drive, Suite 260
Vienna, Virginia 22182(Address of principal executive offices, including zip code) (703) 847-5268(Registrants telephone number, including area code)   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. þ o
 Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). þ o
 Indicate the number of shares outstanding of each of the issuers classes of common stock as of
March 31, 2005: 5,623,030.




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THE ALLIED DEFENSE GROUP, INC.
INDEX   PAGENUMBERPART I. FINANCIAL INFORMATION  UNAUDITEDItem 1. Financial StatementsCondensed Consolidated Balance Sheets March 31, 2005 and December 31, 2004
    
    
    2Condensed
Consolidated Statements of Earnings Three months ended March 31, 2005 and 2004
    
    
    3Condensed
Consolidated Statements of Cash Flows Three months ended March 31, 2005 and 2004
    
    
    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
    
    
    22Item 4. Disclosure Controls and Procedures
    
    
    22PART II. OTHER INFORMATIONItem 6. Exhibits
    
    
    23Signatures
    
    
    25




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The Allied Defense Group, Inc. CONDENSED CONSOLIDATED BALANCE SHEETS
 (Thousands of Dollars, except per share data)   March 31, 2005
    
    
    December 31, 2004UnauditedASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    26,947
    
    
    $
    27,940Restricted cash
    
    
    13,042
    
    
    
    11,757Accounts receivable
    
    
    13,482
    
    
    
    31,946Costs and accrued earnings on uncompleted contracts
    
    
    35,919
    
    
    
    52,745Inventories
    
    
    14,513
    
    
    
    16,063Deferred tax asset
    
    
    2,234
    
    
    
    1,058Fair value of foreign exchange contracts
    
    
    
    
    
    
    1,195Prepaid and other current assets
    
    
    4,235
    
    
    
    4,123Total current assets
    
    
    110,372
    
    
    
    146,827PROPERTY, PLANT AND EQUIPMENT net of accumulated depreciation
    
    
    28,637
    
    
    
    30,294OTHER ASSETSIntangibles, net of accumulated amortization
    
    
    3,627
    
    
    
    3,723Goodwill
    
    
    14,156
    
    
    
    14,401Deferred tax asset, non-current
    
    
    1,419
    
    
    
    485Other assets
    
    
    1,555
    
    
    
    1,62620,757
    
    
    
    20,235$
    159,766
    
    
    $
    197,356LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESNotes payable
    
    $
    50
    
    
    $
    54Current maturities of long-term debt
    
    
    2,387
    
    
    
    2,733Convertible subordinated debenture, current, less unamortized discount
    
    
    
    
    
    
    2,231Accounts payable
    
    
    10,150
    
    
    
    34,933Accrued liabilities
    
    
    8,576
    
    
    
    9,374Customer deposits
    
    
    10,140
    
    
    
    8,708Deferred compensation
    
    
    
    
    
    
    1,612Foreign exchange contracts
    
    
    538
    
    
    
    Income taxes
    
    
    225
    
    
    
    811Total current liabilities
    
    
    32,066
    
    
    
    60,456LONG-TERM OBLIGATIONSLong-term debt, less current maturities and unamortized discount
    
    
    5,766
    
    
    
    6,440Deferred compensation
    
    
    397
    
    
    
    3776,163
    
    
    
    6,817STOCKHOLDERS 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 5,623,030 in 2005 and 5,601,101 in 2004
    
    
    562
    
    
    
    560Additional paid-in capital
    
    
    26,875
    
    
    
    26,669Retained earnings
    
    
    74,620
    
    
    
    78,013Accumulated other comprehensive income
    
    
    19,480
    
    
    
    24,841121,537
    
    
    
    130,083$
    159,766
    
    
    $
    197,356
 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 endedMarch 31,2005
    
    
    2004Revenue
    
    $
    17,899
    
    
    $
    26,864Cost and expensesCost of sales
    
    
    14,421
    
    
    
    22,175Selling and administrative
    
    
    7,472
    
    
    
    6,646Research and development
    
    
    1,527
    
    
    
    1,561Operating loss
    
    
    (5,521
    )
    
    
    (3,518
    )Other income (expense)Interest income
    
    
    189
    
    
    
    101Interest expense
    
    
    (537
    )
    
    
    (479
    )Other-net
    
    
    189
    
    
    
    (349
    )(159
    )
    
    
    (727
    )Loss before income taxes
    
    
    (5,680
    )
    
    
    (4,245
    )Income tax benefit
    
    
    (2,287
    )
    
    
    (1,380
    )NET LOSS
    
    $
    (3,393
    )
    
    $
    (2,865
    )Loss per shareBasic
    
    $
    (0.60
    )
    
    $
    (0.52
    )Diluted
    
    $
    (0.60
    )
    
    $
    (0.52
    )Weighted average number of common shares:Basic
    
    
    5,609,351
    
    
    
    5,551,399Diluted
    
    
    5,609,351
    
    
    
    5,551,399
 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)   Three months ended March 312005
    
    
    2004Cash flows from operating activitiesNet loss
    
    $
    (3,393
    )
    
    $
    (2,865
    )Adjustments to reconcile net earnings to net cash provided by (used in) operating activitiesDepreciation and amortization
    
    
    1,265
    
    
    
    1,141Unrealized losses on forward contracts
    
    
    1,536
    
    
    
    1,264Debt issue costs
    
    
    63
    
    
    
    19Provision for estimated losses on contracts
    
    
    67
    
    
    
    45Deferred taxes
    
    
    (2,000
    )
    
    
    1,892Common stock award
    
    
    33
    
    
    
    Changes in assets and liabilitiesAccounts receivable
    
    
    17,301
    
    
    
    3,029Costs and accrued earnings on uncompleted contracts
    
    
    14,382
    
    
    
    (5,321
    )Inventories
    
    
    987
    
    
    
    (1,351
    )Prepaid and other current assets
    
    
    (313
    )
    
    
    (954
    )Accounts payable, accrued liabilities and customer deposits
    
    
    (23,591
    )
    
    
    (9,655
    )Deferred compensation
    
    
    20
    
    
    
    451Income taxes
    
    
    (450
    )
    
    
    882Net cash provided by (used in) operating activities
    
    
    5,907
    
    
    
    (11,423
    )Cash flows from investing activitiesCapital expenditures
    
    
    (1,003
    )
    
    
    (888
    )Net cash used in investing activities
    
    
    (1,003
    )
    
    
    (888
    )Cash flows from financing activitiesPrincipal payments on long-term borrowing
    
    
    (3,627
    )
    
    
    (1,100
    )Proceeds from issuance of long-term debt
    
    
    728
    
    
    
    Net increase (decrease) in short-term borrowings
    
    
    (4
    )
    
    
    (14,046
    )Proceeds from employee stock purchases
    
    
    21
    
    
    
    39Option exercises
    
    
    154
    
    
    
    Restricted cash
    
    
    (1,834
    )
    
    
    10,843Net cash used in financing activities
    
    
    (4,562
    )
    
    
    (4,264
    )Net increase (decrease) in cash and cash equivalents
    
    
    342
    
    
    
    (16,575
    )Effects of exchange rate changes on cash and cash equivalents
    
    
    (1,335
    )
    
    
    (365
    )NET DECREASE IN CASH AND CASH EQUIVALENTS
    
    
    (993
    )
    
    
    (16,940
    )Cash and cash equivalents at beginning of year
    
    
    27,940
    
    
    
    43,377Cash and cash equivalents at end of period
    
    $
    26,947
    
    
    $
    26,437Supplemental Disclosures of Cash Flow InformationCash paid during the period forInterest
    
    $
    183
    
    
    $
    148Taxes
    
    
    561
    
    
    
    1
 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
March 31, 2005
(Thousands of Dollars)
(Unaudited)   NOTE 1  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The accompanying condensed consolidated financial statements have been prepared by the Company
without audit. In the opinion of management, the accompanying unaudited condensed consolidated
financial statements reflect all necessary adjustments and reclassifications (all of which are of a
normal, recurring nature) that are necessary for fair presentation for the periods presented. Certain information and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of America have been
condensed or omitted. It is suggested that these condensed consolidated financial statements be
read in conjunction with the financial statements and notes included in the Companys December 31,
2004, Form 10-K filed with the Securities and Exchange Commission. The results of operations for
the periods ended March 31, 2005 and 2004 are not necessarily indicative of the operating results
for the full year. Certain reclassifications have been made to the prior periods financial statements to conform to
the current presentation. NOTE 2  PRINCIPLES OF CONSOLIDATION The condensed consolidated financial statements include the accounts of The Allied Defense Group,
Inc. (Allied or the Company), a Delaware corporation, and its wholly-owned subsidiaries as
follows:  
    ARC Europe, S.A. (ARC Europe), a Belgian company,
    Allied Research Corporation Limited (Limited), an inactive United Kingdom company,
    News/Sports Microwave Rental, Inc. (NS Microwave), a California corporation,
    Titan Dynamics Systems, Inc. (Titan Dynamics), a Texas corporation,
    SeaSpace Corporation (SeaSpace), a California corporation,
    MECAR USA, Inc. (MECAR USA), a Delaware corporation, and
    Allied Technology, LLC (Allied Technology), a Maryland 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., VIGITEC S.A. and Control Monitor Systems. 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 mid 2005.
    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. manufactures
integrated video systems; VIGITEC S.A.
installs networked video surveillance
systems; and Control Monitor Systems
manufactures access control 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
Technology was formed in anticipation
of the Battlefield Effects Simulator
(BES) proposal and will subcontract the
work to Titan Dynamics. See additional
discussion of the BES contract award in
Note 17. 5




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The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(Thousands of Dollars)
(Unaudited)   Allied, the parent company, provides management services to its subsidiaries and has no operating
activities. Significant intercompany transactions have been eliminated in consolidation. NOTE 3  DERIVATIVE FINANCIAL INSTRUMENTS The Company uses derivative financial instruments to manage foreign currency exposure. As a matter
of policy, the Company does not enter into speculative hedge contracts or use other derivative
financial instruments. Fair value hedges During 2004, in connection with the acquisition of Control Monitoring Systems, the Company entered
into foreign currency contract designated by the Company as a fair value hedge to minimize the
foreign currency exposures with debt, which is payable in U.S. dollars, rather than the Euro, which is MECARs functional currency. At
March 31, 2005 and December 31, 2004, the contracts notional amount was $300 and the fair value of
the contract was $23 and $38, respectively. The contract was entered into on August 1, 2004 and
expires July 31, 2005. Gains and losses from settlements of derivative contracts are reported as a
component of other income (expense). There were no net gains or losses realized during the periods ended March
31, 2005 and December 31, 2004 from hedge ineffectiveness or from firm commitments that no longer
qualify as fair value hedges. Cash flow hedges 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, net of certain costs, is receivable in U.S. dollars rather than the
Euro, which is MECARs functional currency. At March 31, 2005, MECAR designated foreign currency
futures contracts with a notional amount of $33,000 as cash flow hedges. These contracts had a
negative fair value totaling $538 which is recorded in the accompanying balance sheet as a
liability and a reduction in other comprehensive income, net of
income taxes. Gains and losses from settlements these
contracts are reported as a component of revenues. There were no net gains or losses realized
during the three months ended March 31, 2005 from hedge ineffectiveness. Derivatives not designated as hedges As described in further detail in the Company Form 10-K at December 31, 2004, management concluded
that Allied did not qualify for the use of hedge accounting due to the fact that Allied did not
have the appropriate policies, procedures or documentation to support the use of hedge accounting
for its foreign currency contracts. As such, gains/losses from settlements of the derivative
contracts were recorded to the statement of earnings. For the three months ended March 31, 2005
and 2004, the Company recorded after-tax losses of $1,525 and $3,610 from derivative adjustments.
The Company has taken the steps to comply with the accounting guidelines for future contracts. NOTE 4  RESTRICTED CASH Restricted Cash at March 31, 2005 and December 31, 2004 is comprised as follows: 2005
    
    
    2004Collateralized performance bonds and advance
payment guarantees
    
    $
    11,024
    
    
    $
    9,745Senior secured facility deposit
    
    
    2,000
    
    
    
    2,000Other
    
    
    18
    
    
    
    12$
    13,042
    
    
    $
    11,757
 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. $11,024 and $9,745 at March 31, 2005 and December 31, 2004, respectively,
was restricted or pledged as collateral for these agreements. 6




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The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(Thousands of Dollars)
(Unaudited)   The Company made a security deposit in connection with the senior secured facility as further
described in Note 10. NOTE 5  ACCOUNTS RECEIVABLE Accounts receivable at March 31, 2005 and December 31, 2004 are comprised as follows: 2005
    
    
    2004Direct and indirect receivables from foreign governments
    
    $
    334
    
    
    $
    19,290Commercial and other receivables, less allowance for doubtful
receivables of $154 in 2005 and $143 in 2004
    
    
    13,148
    
    
    
    12,656$
    13,482
    
    
    $
    31,946
 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. The Company allocates its overhead
based on total annual normal production. Management reviews these estimates as work progresses and the
effect of any change in cost estimates is reflected in cost of sales in the period in which the
change is identified. The revenue recognized on the contracts in progress for the three months
ended March 31, 2005 and 2004 were $9,555 and $19,091, respectively. NOTE 7  INVENTORIES Inventories at March 31, 2005 and December 31, 2004 are comprised as follows: 2005
    
    
    2004Raw materials
    
    $
    12,686
    
    
    $
    15,701Work in process
    
    
    4,485
    
    
    
    686Finished goods, less reserve for obsolescence of
$641 in 2005 and $668 in 2004
    
    
    1,123
    
    
    
    774$
    18,294
    
    
    $
    17,161
 NOTE 8  INTANGIBLE ASSETS AND GOODWILL March 31, 2005

    
    
    December 31, 2004Intangible assets
    
    Gross
    
    
    Accumulated
    
    
    
    
    
    
    Gross
    
    
    Accumulatedsubject to amortization:
    
    Amount
    
    
    Amortization
    
    
    Net
    
    
    Amount
    
    
    Amortization
    
    
    NetCapitalized Software
    
    $
    1,184
    
    
    $
    499
    
    
    $
    685
    
    
    $
    1,184
    
    
    $
    477
    
    
    $
    707Customer Lists
    
    
    2,297
    
    
    
    590
    
    
    
    1,707
    
    
    
    2,297
    
    
    
    540
    
    
    
    1,757Patents
    
    
    1,494
    
    
    
    259
    
    
    
    1,235
    
    
    
    1,494
    
    
    
    235
    
    
    
    1,259Total
    
    $
    4,975
    
    
    $
    1,348
    
    
    $
    3,627
    
    
    $
    4,975
    
    
    $
    1,252
    
    
    $
    3,723
 7




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The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(Thousands of Dollars)
(Unaudited)   Consolidated amortization expense related to intangible assets, excluding goodwill, for each of the
three months ended March 31, 2005 and 2004 were $96 and $111. Estimated future aggregate annual
amortization for intangible assets is as follows: Period
    
    AmountNine months ended December 31, 2005
    
    $
    405Year ended December 31, 2006
    
    
    379Year ended December 31, 2007
    
    
    297Year ended December 31, 2008
    
    
    225Year ended December 31, 2009
    
    
    225
 The $14,156 of goodwill at March 31, 2005 is comprised of $8,314 related to the Electronic Security
Segment, $4,447 related to the Environmental Safety & Security Segment and $1,395 related to the
Software, Training & Simulation Segment. The change in goodwill during the three month period
ended March 31, 2005 was due to the currency translation adjustment. Consistent with prior years, the Company conducted its annual impairment test of goodwill during
the fourth quarter of 2004. The fair value of the reporting units was estimated using the expected
present value of future cash flows. Based on the applicable valuations, management determined that
no impairment of goodwill exists. NOTE 9  NOTES PAYABLE AND CREDIT FACILITY Notes Payable At March 31, 2005 and December 31, 2004 NS Microwave had a note of $50 and $54,
respectively, for machinery and vehicles. The weighted average interest rate for Notes Payable
as of March 31, 2005 and December 31, 2004 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 guarantees
issued and quarterly fees at an annual rate of 1.25% of guarantees outstanding. These fees are
charged to interest expense. As of March 31, 2005 and December 31, 2004, guarantees and
performance bonds of approximately $25,076 and $25,779 respectively, were outstanding. Advances under the Agreement are secured by restricted cash at March 31, 2005 and December 31, 2004
of approximately $11,024 and $9,745, respectively. Amounts outstanding are also collateralized by
a pledge of approximately $44,486 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 March 31, 2005 and December 31, 2004,
respectively: 2005
    
    
    2004Notes payable, less unamortized discount and debt issue costs
    
    $
    1,220
    
    
    $
    1,176Mortgage loan agreements
    
    
    255
    
    
    
    284Loan for Control Monitor Systems acquisition
    
    
    300
    
    
    
    300Capital leases and other
    
    
    6,378
    
    
    
    7,413Total Long-Term Debt
    
    $
    8,153
    
    
    $
    9,173Less current maturities
    
    
    2,387
    
    
    
    2,733Long-Term Debt, less current maturities and unamortized
discount
    
    $
    5,766
    
    
    $
    6,440
 8




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(Thousands of Dollars)
(Unaudited)   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 obtained a waiver for the requirement set forth in Section 7.6(a)
of the Loan Agreement requiring the Company to maintain at the end of such fiscal quarter for the
then preceding four fiscal quarters Earnings Before Interest, Taxes, Depreciation & Amortization
(EBITDA) of not less than $15,000. Mortgage loan agreements.The VSK Group is obligated on a mortgage on its building, which has a
balance of approximately $255 at March 31, 2005. The mortgage is payable in annual installments of
approximately $64 plus interest. Loan for Control Monitor Systems acquisition.The VSK Group entered into a $300 loan to fund the
acquisition of Control Monitor Systems. The loan is payable in equal installments on August 1,
2005, 2006 and 2007. 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 2010. Scheduled annual maturities of long-term obligations as of March 31, 2005 are approximately as
follows: Year
    
    Amount2006
    
    $
    2,3872007
    
    
    3,0092008
    
    
    1,0672009
    
    
    3342010
    
    
    1,356
 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 warrants to purchase 15,000 shares of the Companys common stock
were valued at $140. 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. The last payment
on the debenture was made in late March 2005. 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 (loss) per share
for the three months ended March 31, 2005 and March 31, 2004, respectively: 9




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(Thousands of Dollars)
(Unaudited)   Three months endedMarch 31,2005
    
    
    2004Net loss
    
    $
    (3,393
    )
    
    $
    (2,865
    )Weighted average number of basic shares
    
    
    5,609,351
    
    
    
    5,551,399Common stock equivalents
    
    
    
    
    
    
    Weighted average number of diluted shares
    
    
    5,609,351
    
    
    
    5,551,399Basic loss per share
    
    $
    (0.60
    )
    
    $
    (0.52
    )Diluted loss per share
    
    $
    (0.60
    )
    
    $
    (0.52
    )
 At March 31, 2005 and 2004, the Company has excluded common stock equivalents for 288,590 and
192,764, respectively, since their effect would be anti-dilutive. NOTE 13  COMPREHENSIVE LOSS A summary of the components of Comprehensive Loss for the three months ended March 31, 2005 and
2004 are as follows: AccumulatedotherRetained
    
    
    comprehensiveEarnings
    
    
    income
    
    
    TotalDecember 31, 2003
    
    $
    75,495
    
    
    $
    16,197
    
    
    $
    91,692Comprehensive lossNet loss
    
    
    (2,865
    )Currency translation adjustment
    
    
    
    
    
    
    (2,161
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    (5,026
    )March 31, 2004
    
    $
    72,630
    
    
    $
    14,036
    
    
    $
    86,666December 31, 2004
    
    $
    78,013
    
    
    $
    24,841
    
    
    $
    102,854Comprehensive lossNet loss
    
    
    (3,393
    )Currency translation adjustment
    
    
    
    
    
    
    (5,006
    )Change in fair value of cash flow
hedges, net of tax
    
    
    
    
    
    
    (355
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    (8,754
    )March 31, 2005
    
    $
    74,620
    
    
    $
    19,480
    
    
    $
    94,100
 The currency translation adjustment for the three months ended March 31, 2005 and 2004 resulted
from the depreciation of the Euro during the respective 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 months ended March 31, 2005 and 2004. The following table presents the pro forma decrease in income for the three months ended March 31,
2005 and 2004, 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: 10




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(Thousands of Dollars)
(Unaudited)   Three Months EndedMarch 31,(Dollars in thousands, except per share amounts)
    
    2005
    
    
    2004Reported net loss
    
    $
    (3,393
    )
    
    $
    (2,865
    )Stock-based compensation costs that would have been
included in the determination of reported net
earnings, if the fair value method was applied to all
awards, net of tax
    
    
    (72
    )
    
    
    (154
    )Pro forma net loss
    
    $
    (3,465
    )
    
    $
    (3,019
    )Basic loss per share:Reported loss per share
    
    $
    (0.60
    )
    
    $
    (0.52
    )Compensation costs, net of tax
    
    
    (0.01
    )
    
    
    (0.03
    )Pro forma basic loss per share
    
    $
    (0.61
    )
    
    $
    (0.55
    )Diluted loss per share:Reported loss per share
    
    $
    (0.60
    )
    
    $
    (0.52
    )Compensation costs, net of tax
    
    
    (0.01
    )
    
    
    (0.03
    )Pro forma diluted loss per share
    
    $
    (0.61
    )
    
    $
    (0.55
    )
 Options granted during the three months ended March 31, 2005, and 2004 were 40,000 and 0,
respectively. 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 months ended March 31, 2005 was $7.68. The weighted average assumptions used
in the model and the weighted-average fair values of each option at the date of grant were as
follows: Three Months Ended March 312005
    
    
    2004Risk free interest rate
    
    
    3.63
    %
    
    
    2.86
    %Expected volatility rate
    
    
    33.90
    %
    
    
    47.00
    %Expected lives  years
    
    
    3
    
    
    
    3Divided yield
    
    
    
    
    
    
    
 The pro forma amounts may not be representative of future amounts since the estimated fair value of
stock options is amortized to expense over the vesting period, and additional options may be
granted in future periods. NOTE 15  INDUSTRY SEGMENTS Three months endedMarch 31,2005
    
    
    2004Revenues from external customersOrdnance & Manufacturing
    
    $
    5,774
    
    
    $
    15,474Electronic Security
    
    
    10,328
    
    
    
    9,330Environmental Safety & Security
    
    
    1,519
    
    
    
    2,024Software, Training & Simulation
    
    
    278
    
    
    
    36$
    17,899
    
    
    $
    26,864
 11




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(Thousands of Dollars)
(Unaudited)   Three months endedMarch 31,2005
    
    
    2004Segment profit (loss) before taxesOrdnance & Manufacturing
    
    $
    (5,250
    )
    
    $
    (4,190
    )Electronic Security
    
    
    663
    
    
    
    820Environmental Safety & Security
    
    
    (511
    )
    
    
    (136
    )Software, Training & Simulation
    
    
    (86
    )
    
    
    (179
    )Corporate and Other
    
    
    (496
    )
    
    
    (560
    )$
    (5,680
    )
    
    $
    (4,245
    )
 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. A suit was filed against SeaSpace in the Japanese courts. The proceeding related to SeaSpaces
termination of its distributor in Japan and its designation of a new distributor. The suit was
settled in March 2005. NOTE 17  SUBSEQUENT EVENT On April 19, 2005, Allied was awarded a $10,992 firm-fixed price, indefinite-delivery/indefinite
quantity (IDIQ) contract for the procurement of 700 launchers and 1,000,000 cartridges and
associated support for the Battlefield Effects Simulator (BES) training system for the United
States Army. The contract will provide BES in support of target systems for Digital Multi-Purpose
Range Complexes, Digital Multi-Purpose Training Range, and Battlefield Area Complex. Work on the initial
delivery order of $1,500 will be performed in Marshall, Texas, and is expected to be completed in March 2006.
The potential maximum value on this contract is $500 million over its potential 8 year life. NOTE 18  RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the FASB issued revised SFAS No. 123R, Share-Based Payment.SFAS No. 123R
sets accounting requirements for share-based compensation to employees and requires companies to
recognize, in the income statement, the grant-date fair value of stock options and other
equity-based compensation. SFAS No. 123R is effective in annual periods beginning after January 1,
2006. The Company will be required to adopt SFAS No. 123R in 2006. The Company is currently
evaluating the impact of the adoption of SFAS 123R on its financial position and results of
operations, including the valuation methods and support for the assumptions that underlie the
valuation of the awards. 12




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##### 



The Allied Defense Group, Inc. MANAGEMENTS DISCUSSION AND ANALYSIS OF 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 March 31, 2005
(Thousands of Dollars) 
(Unaudited)
 The following is intended to update the information contained in the Companys Annual Report on
Form 10-K for the year ended December 31, 2004 and presumes that readers have access to, and will
have read, Managements Discussion and Analysis of Financial Condition and Results of Operations
contained in those reports. 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 pursue contracts from U.S. and foreign
governments for ammunition and pyrotechnics devices. MECAR USA is
expected to be operational in mid 2005.
    Electronic Securitysegment consists of The VSK Group, located in
Belgium and California, 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
manufactures integrated video systems; VIGITEC S.A. which installs
networked video surveillance systems; and Control Monitor Systems
which manufactures access control 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 Technology was formed in anticipation of
the Battlefield Effects Simulator (BES) proposal and will
subcontract the work to Titan Dynamics. See additional discussion
of BES contract award in Note 17. The parent company provides management services to its subsidiaries and has no operating
activities. Allied incurred a net loss of $3,393 for the three months ended March 31, 2005 compared to a net
loss of $2,865 for the comparable period of 2004. The increased net loss for the three months
ended March 31, 2005 resulted from reduced revenues and the derivative loss in 2005. Allied entered 2005 with substantial cash reserves and anticipates no liquidity concerns in 2005.
Allied has secured a senior domestic lending facility for working capital and acquisitions. 13




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2005
(Thousands of Dollars)
(Unaudited)  Results of Operations for the Three Months Ended March 31, 2005 and 2004 The table below shows, for the three months ended March 31, 2005 and 2004, certain items from
Allieds condensed consolidated statements of earnings expressed as a percentage of revenue: Three months ended March 31,2005
    
    
    2004Revenue
    
    $
    17,899
    
    
    
    100.0
    %
    
    $
    26,864
    
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    14,421
    
    
    
    80.6
    
    
    
    22,175
    
    
    
    82.6Selling and administrative
    
    
    7,472
    
    
    
    41.7
    
    
    
    6,646
    
    
    
    24.7Research and development
    
    
    1,527
    
    
    
    8.5
    
    
    
    1,561
    
    
    
    5.8Operating income
    
    
    (5,521
    )
    
    
    (30.8
    )
    
    
    (3,518
    )
    
    
    (13.1
    )Other income (expense)Interest income
    
    
    189
    
    
    
    1.1
    
    
    
    101
    
    
    
    0.4Interest expense
    
    
    (537
    )
    
    
    (3.1
    )
    
    
    (479
    )
    
    
    (1.8
    )Other  net
    
    
    189
    
    
    
    1.1
    
    
    
    (349
    )
    
    
    (1.3
    )Loss before income taxes
    
    
    (5,680
    )
    
    
    (31.7
    )
    
    
    (4,245
    )
    
    
    (15.8
    )Income tax (benefit)
    
    
    (2,287
    )
    
    
    (12.7
    )
    
    
    (1,380
    )
    
    
    (5.1
    )Net earnings
    
    $
    (3,393
    )
    
    
    (19.0
    )%
    
    $
    (2,865
    )
    
    
    (10.7)
    %
 Revenue.Allied had revenue of $17,899 in the three months ended March 31, 2005, which was
33% lower than its revenue in the same period of 2004. This decrease was principally attributable
to lower sales at MECAR. Revenue by SegmentThree Months Ended
    
    
    Three Months EndedMarch 31, 2005
    
    
    March 31, 2004Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    of totalOrdnance & Manufacturing
    
    $
    5,774
    
    
    
    32
    %
    
    $
    15,474
    
    
    
    58
    %Electronic Security
    
    
    10,328
    
    
    
    58
    %
    
    
    9,330
    
    
    
    35
    %Environmental Safety & Security
    
    
    1,519
    
    
    
    8
    %
    
    
    2,024
    
    
    
    7
    %Software, Training & Simulation
    
    
    278
    
    
    
    2
    %
    
    
    36
    
    
    
    
    %$
    17,899
    
    
    
    100
    %
    
    $
    26,864
    
    
    
    100
    %
 Ordnance & Manufacturing Segment revenue for the first quarter of 2005 decreased by 63% from the
comparable 2004 period. The entire decrease occurred at MECAR and resulted primarily from two
factors. First, MECAR incurred decreased sales activity during the quarter due to completion of
the approximately $130,000 Foreign Military Sales (FMS) contract which was completed during the
first quarter of 2005. The 2004 period benefited by substantial work under the FMS
contract. Second, MECARs revenue was negatively impacted by derivative losses which amounted to $1,324 and
$745 for the three months ended March 31, 2005 and 2004, respectively. MECAR anticipates receipt
of substantial orders in the second quarter which should benefit its results from operations in the
balance of 2005 and beyond. Further, the Company believes that the first quarter of 2005 should be
the last quarter for any substantial adverse impact from derivative accounting. 14




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2005
(Thousands of Dollars)
(Unaudited)  Electronic Security Segment revenue for the first quarter of 2005 increased by 11% over the
comparable 2004 period due to increases at both NS Microwave and the VSK Group. A substantial
portion of NS Microwaves increased revenue was attributable to new U.S. government contracts
received in 2004. Further government orders are expected which should benefit the balance of 2005.
The increase at the VSK Group was due primarily to the increase in the value of the Euro. Environmental Safety & Security Segment revenues for the first quarter of 2005 decreased 25% from
the comparable 2004 period. SeaSpace continues to face pricing pressures. Software, Training & Simulation Segment revenues for the first quarter of 2005 increased from the
comparable 2004 period. Titan Dynamics revenue is largely comprised of cartridge sales for
previously sold simulators and new E-pyro products used for military and law enforcement training.
On April 19, 2005, Allied Technology was awarded a $10,992 firm-fixed price,
indefinite-delivery/indefinite quantity (IDIQ) contract for the procurement of 700 launchers and
1,000,000 cartridges and associated support for the Battlefield Effects Simulator (BES) training
system for the United States Army. The contract will provide BES in support of target systems for
Digital Multi-Purpose Range Complexes, Digital Multi-Purpose Training Range, and Battlefield Area
Complex. Work on the initial delivery order of $1,500 will be performed in Marshall, Texas, and is expected
to be completed in March 2006. This contract was awarded in a very competitive bid against an
incumbent contractor. This demonstrates the strength of the Companys technology and production in
this business segment. This contract has significant growth potential depending on future Army
requirements. Cost of Sales.Cost of sales as a percentage of sales for the three months ended March 31, 2005
was 81% compared with 83% for the same period in 2004. Cost of Sales as Percentage of Sales by Segment Three months endedMarch 312005
    
    
    2004Ordnance & Manufacturing
    
    
    132
    %
    
    
    100
    %Electronic Security
    
    
    56
    %
    
    
    58
    %Environmental Safety & Security
    
    
    57
    %
    
    
    57
    %Software, Training & Simulation
    
    
    60
    %
    
    
    66
    %Total
    
    
    81
    %
    
    
    83
    %
 Ordnance & Manufacturing Segment cost of sales as a percentage of sales for the three months ended
March 31, 2005 increased from the same period of 2004, primarily
from reduced revenue,
derivative losses and customer mix as the majority of the production was for lower-margin products.
In addition, MECAR incurred higher material and labor costs on the products. Electronic Security Segment cost of sales as a percentage of sales for the three months ended March
31, 2005 decreased from the same period in 2004 due to lower NS Microwave material costs associated
with its product components to fulfill customer requirements. Environmental Safety & Security Segment cost of sales as a percentage of sales for the three months
ended March 31, 2005 remained constant with the percentage for the comparable period in 2004. 15




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2005
(Thousands of Dollars)
(Unaudited)  Software, Training & Simulation Segment cost of sales as a percentage of sales for the three months
ended March 31, 2005 decreased from 2004 as a result of the change in product mix and production
efficiencies. Selling and Administrative Expenses.Selling and administrative expenses as a percentage of sales
for the three months ended March 31, 2005 was higher than 2004 levels due to several factors. The
VSK Group, NS Microwave, Titan Dynamics and Corporate incurred higher compensation costs for
administrative personnel. Research and Development.Research and development costs decreased for the three months ended
March 31, 2005 by 2% from 2004 levels. The decrease was attributed to lower research and product
development being conducted at SeaSpace and Titan Dynamics. Interest Income.Interest income increased for the three months ended March 31, 2005 by 86% from
2004 levels. The increase resulted primarily from interest on the parent companys cash account.
As part of the senior loan facility obtained on May 28, 2004, the Company borrowed $2,000 and
deposited that amount in a restricted account to serve as collateral under the entire $18,000 commitment. Interest Expense.Interest expense for the three months ended March 31, 2005 increased by 12% over
2004 levels due to the amortization of debt issue costs associated with the senior loan facility
obtained by the Company on May 28, 2004. 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. The Company had other-net income for the
three months ended March 31, 2005 of $189 compared to expense of $349 for the three months ended
March 31, 2004. Pre-Tax Profit (Loss) Pre-Tax Profit (Loss) by Segment Three months endedMarch 31,2005
    
    
    2004Ordnance & Manufacturing
    
    $
    (5,250
    )
    
    $
    (4,190
    )Electronic Security
    
    
    663
    
    
    
    820Environmental Safety & Security
    
    
    (511
    )
    
    
    (136
    )Software, Training & Simulation
    
    
    (86
    )
    
    
    (179
    )Corporate and other
    
    
    (496
    )
    
    
    (560
    )$
    (5,680
    )
    
    $
    (4,245
    )
 Ordnance & Manufacturing Segment incurred a pre-tax loss of $5,250 for the three months ended March
31, 2005, versus a pre-tax loss of $4,190 for the comparable period in 2004. The increased pre-tax
loss in 2005 was principally due to delayed orders as well as larger derivative losses. MECAR
expects to obtain substantial orders in the balance of the second quarter which will substantially
benefit future periods. Electronic Security Segment pre-tax profit for the three months ended March 31, 2005 decreased from
the comparable period in 2004. The decrease stemmed from lower VSK Groups profits, largely due to
higher selling and administrative and R&D costs. NS Microwaves pre-tax loss was slightly less
than in the first quarter 2004. 16




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2005
(Thousands of Dollars)
(Unaudited)  Environmental Safety & Security Segment pre-tax loss resulted from less business activity in its
core ground-station business and higher development costs associated with new antenna products
expected to be available for sale later in 2005. SeaSpace continues to make efforts to right-size
its organization in light of the competitive environment. Software, Training & Simulation Segment pre-tax loss in 2005 results from Titan Dynamics principal
product lacking U.S. Government safety certification. Titan Dynamics anticipates receipt of
Navy/Marine Corp certification in mid 2005. Corporate and other Segment pre-tax loss for the three months ended March 31, 2005 decreased
slightly from the 2004 level. Income Taxes.The tax benefit for the three months ended March 31, 2005 and 2004 was 40% and 33%,
respectively. Net Earnings.The Company incurred a $3,393 net loss for the three months ended March 31, 2005
compared with $2,865 net loss in the same period of 2004. The higher loss in 2005 resulted
principally from the activities at MECAR and SeaSpace. While the Company also anticipates a weak
second quarter, it anticipates that the third and fourth quarters should be materially higher. Backlog.As of March 31, 2005, the Companys backlog was $73,009 compared to $106,775 at March 31,
2004. The March 31, 2005 and March 31, 2004 amounts included unfunded portion from an indefinite
delivery, indefinite quantity (IDIQ) federal contract. Backlog by SegmentMarch 31, 2005
    
    
    March 31, 2004Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    Of totalOrdnance & Manufacturing
    
    $
    49,856
    
    
    
    68
    %
    
    $
    80,641
    
    
    
    76
    %Electronic Security
    
    
    22,324
    
    
    
    31
    %
    
    
    23,971
    
    
    
    22
    %Environmental Safety & Security
    
    
    755
    
    
    
    1
    %
    
    
    1,644
    
    
    
    2
    %Software, Training & Simulation
    
    
    74
    
    
    
    
    
    
    
    519
    
    
    
    
    %$
    73,009
    
    
    
    100
    %
    
    $
    106,775
    
    
    
    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
was fulfilled in the first quarter of 2005. Electronic Security backlog includes an unfunded
portion of approximately $8,323 and $12,000 at March 31, 2005 and March 31, 2004, respectively,
from an IDIQ federal contract. Liquidity and Capital Resources Balance Sheet
The Companys March 31, 2005 condensed consolidated balance sheet was affected by the value of the
Euro. All European values were converted at the March 31, 2005 and December 31, 2004 conversion
ratios of 1.2916 and 1.3644, 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 $78,306 at March 31, 2005, which is a decrease
of $8,065 from the December 31, 2004, level. 17




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2005
(Thousands of Dollars)
(Unaudited)  Cash at March 31, 2005 decreased slightly from December 31, 2004 as cash was expended
in the first three months of 2005 to repay the convertible debenture as well as current
liabilities. Restricted cash increased in the first three months of 2005 due to the requirements
of certain contracts at MECAR. Accounts receivable at March 31, 2005 decreased from December 31, 2004, due to the cash received on
the final delivery of the FMS contract. Costs and accrued earnings on uncompleted contracts
decreased from year-end 2004 primarily as a result of the completion of the FMS contract.
Inventories decreased primarily from lower raw material purchases. Fair
value of foreign exchange contracts was a liability of $538 at March 31, 2005, compared to an asset
of $1,195 at December 31, 2004. 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 were materially consistent between the two periods. Property, Plant & Equipment, net of accumulated depreciation, decreased primarily from depreciation
in excess of capital expenditures at the business units during the first three months of 2005.
Intangibles decreased primarily from the amortization of capitalized software, customer lists and
patents. Notes Payable was materially consistent between the two periods. Accounts payable and accrued
liabilities decreased as a result of lower production costs at the business units. Customer
deposits increased primarily at MECAR as a result of new contracts in 2005 requiring deposits.
Deferred compensation decreased due to payment of a post-employment obligation to a Company
employee during the first quarter of 2005. Income taxes decreased due to the tax benefit
associated with the new loss for the quarter. Convertible-subordinated debenture, decreased from December 31, 2004 to March 31, 2005 as the
Company made its final payment in March 2005. Stockholders equity as of March 31, 2005, was negatively affected by the reduction in the value
of the Euro versus the U.S. dollar during the first three months of 2005, resulting in a decrease
in accumulated other comprehensive income as well as a $355 reduction in the fair market value of
MECARs cash flow hedges. The Euro depreciated by approximately 5% since the beginning of the
year. Cash Flows The table below provides the summary cash flow data for the periods presented. Three months ended March 312005
    
    
    2004Net cash provided by (used in) operating activities
    
    $
    5,907
    
    
    $
    (11,423
    )Net cash used in investing activities
    
    
    (1,003
    )
    
    
    (888
    )Net cash used in financing activities
    
    
    (4,562
    )
    
    
    (4,264
    )
 Operating Activities.The Company provided $5,907 of cash in its operating activities during the
three months ended March 31, 2005 whereas it used $11,423 of cash during the same period of 2004.
This is attributed primarily to cash received from the final delivery of the FMS
contract at MECAR. Cash paid for interest was $183 and $148 for the three months ended March 31,
2005 and 2004, respectively. Cash paid for income taxes was $561 and $1 for the three months ended
March 31, 2005 and 2004, respectively, and includes federal, international and state taxes. Investing Activities.Net cash used in investing activities increased 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 18




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The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2005
(Thousands of Dollars)
(Unaudited)  over the remainder of the year. Future expenditures for the remainder of the year will be
primarily incurred for machinery and equipment. Financing Activities.Net cash used in financing activities was materially consistent between the
two periods. Allied.The parent company continues to operate based on fees and dividends received from its
subsidiaries. In the first quarter of 2005, Allied has made cash infusions to MECAR USA, Titan
Dynamics and SeaSpace to support working capital requirements. The Company has a senior loan
facility that contains both affirmative and negative financial covenants. The Company obtained a waiver for the requirement set forth
in Section 7.6(a) of the Loan Agreement requiring the Company to maintain at the end of such fiscal
quarter for the then preceding four fiscal quarters Earnings Before Interest, Taxes, Depreciation &
Amortization (EBITDA) of not less than $15,000. MECAR.MECAR continues to operate from internally generated cash and funds provided by its bank
syndicate and financing from capital leases. The bank syndicate agreement provides (i) lines of
credit for tax prepayments and working capital and (ii) a facility for guarantees/bonds to support
customer contracts. The financial lending terms and fees are denominated in Euros and the dollar
equivalents will fluctuate according to global economic conditions. The bank agreement imposes two
financial covenants requiring MECAR to maintain minimum net worth and working capital levels. As
of March 31, 2005, 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, SeaSpace and MECAR, USA operated from cash
generated from operations and cash infusions by Allied. Stock Repurchases.The Company did not repurchase any shares of its common stock during the three
months ended March 31, 2005 and does not anticipate repurchasing shares of Company stock during the
remainder of 2005. 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, the Company does not participate
in transactions that generate relationships with unconsolidated entities or financial partnerships,
such as entities often referred to as structured finance or special purpose entities (SPEs),
which would have been established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes. As of 19




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The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2005
(Thousands of Dollars)
(Unaudited)  March 31, 2005, the Company is 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 been no 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, 2004, 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 53%
and 71% of condensed consolidated revenue was recognized under the
percentage of completion method during the three months ended
March 31, 2005 and 2004, respectively.
    Goodwill and intangible asset valuation.The Company completed a
goodwill impairment analysis in the fourth quarter of 2004 and
determined that an impairment charge to earnings was not required.
    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. 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 20




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The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 2005
(Thousands of Dollars)
(Unaudited)  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. 21




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The Allied Defense Group, Inc. March 31, 2005   QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE Allied is exposed to market risk from foreign currency fluctuations and interest rate changes.
Allied uses derivatives to manage some portion of these risks. Additional information regarding the
derivatives is contained in Note 3. As of March 31, 2005 and December 31, 2004, all of the
derivatives were related to actual or anticipated exposures of the Companys transactions. Approximately 77% and 86% of the Companys revenue for the three months ended March 31, 2005 and
2004, respectively, was derived from operations outside the U.S. Accordingly, exposure exists to
potentially adverse movement in foreign currency rates. It is estimated that a 10% change in the
value of the Euro would impact reported net losses for the three months ended March 31, 2005 and
2004 by approximately $0.3 million and $0.2 million, respectively. At March 31, 2005, Allied had $40 million of cash (including restricted cash). Assuming all the
cash was available for investment, a 1% change in interest rates would impact interest income for
the three months ended March 31, 2005 and 2004 by $0.1 million and $0.08 million, respectively. DISCLOSURE CONTROLS AND PROCEDURES  1.
    Evaluation of disclosure controls and procedures
The 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. As a result, the Chief Executive Officer and the Chief
Financial Officer concluded that the disclosure controls and procedures were effective.2.
    Changes in internal controls
The Company has remediated the material weakness of accounting for foreign currency contracts
that arose in connection with the annual audit for 2004. The Company hired a financial expert
on derivatives to help establish a policy on testing derivatives according to the FAS 133
guidelines. During 2005, all new foreign currency contracts entered into were documented and
tested according to the FAS 133 guidelines. The Company is also in the process of remediating
its significant deficiencies and expects to be completed by the end of 2005. Except 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. 22




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The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
March 31, 2005   Item 6 Exhibits Exhibit No.
    
    
    
    Description of Exhibits}3.1
    
    
    
    
    
    Certificate of Incorporation, as amended (Incorporated by reference from Form 10-Q
filed in August 2002).3.2
    
    
    
    
    
    Amended and Restated By-Laws (Incorporated by reference from Form 10-Q filed in August
2004).3.3
    
    
    
    
    
    Rights Agreement between Allied and Mellon Investor Services, LLC (Incorporated by
reference from Form 8-K filed in June 2001).10.1
    
    
    
    
    
    Employment Agreement between Allied and John G. Meyer, Jr. (Incorporated by reference
from Form 8-K filed in March 2001 and Form 8-K filed in August 2001).10.2
    
    
    
    
    
    Employment Agreement letter amendments between Allied and John G. Meyer, Jr.
(Incorporated by reference from Form 10-Q filed in August 2004).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
(Incorporated by reference from Form 10-Q filed in August 2004).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 (Incorporated
by reference from Form 10-Q filed in August 2004).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. Marcello (Incorporated by reference
from Form 10-Q filed in August 2004).10.9
    
    
    
    
    
    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).10.13
    
    
    
    
    
    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 (Incorporated by reference from
Form 10-Q filed in August 2004).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).10.19
    
    
    
    
    
    Amendment to Loan and Security Agreement among Wilton Funding, LLC and Allied and
certain of its subsidiaries (Incorporated by reference from Form 10-K filed in March 2005)10.20
    
    
    
    
    
    Stock Option Agreement-Employee Form (Incorporated by reference from Form 10-Q filed
in November 2004)10.21
    
    
    
    
    
    Directors Stock Option Agreement-Director Form (Incorporated by reference from Form
10-Q filed in November 2004)10.22
    
    
    
    
    
    Summary of Annual Compensation of Board Members (Incorporated by reference from Form
10-K filed in March 2005)10.23
    
    
    
    
    
    Restricted Stock Agreement
 23




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##### 



The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
March 31, 2005  Exhibit No.
    
    
    
    Description of Exhibits}21
    
    
    
    
    
    List of Subsidiaries (Incorporated by reference from Form 10-K filed in March 2005).23
    
    
    
    
    
    Consent of Independent Registered Public Accounting Firm (Incorporated by reference
from Form 10-K filed in March 2005).31.1
    
    
    
    
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.31.2
    
    
    
    
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.32
    
    
    
    
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
 24




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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.Date: May 10, 2005
    
    /s/ Charles A. HasperCharles A. Hasper,Chief Financial Officer andTreasurer
 25