##### 



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 September 30, 2005
 Commission File Number: 1-11376
 
 The Allied Defense Group, Inc.
 (Exact name of Registrant as specified in its charter)
 Delaware(State or other jurisdiction of
incorporation or organization)
    
    04-2281015(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)
 
 R £
 R £
 £ R




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##### 



THE ALLIED DEFENSE GROUP, INC.
INDEX
 PAGENUMBERPART I. FINANCIAL INFORMATION  UNAUDITEDItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets
September 30, 2005 and December 31, 2004
    
    
    2Condensed Consolidated Statements of Operations
Three and nine months ended September 30, 2005 and 2004
    
    
    3Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 2005 and 2004
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    14Item 3. Quantitative and Qualitative Market Risk Disclosure
    
    
    28Item 4. Disclosure Controls and Procedures
    
    
    29PART II. OTHER INFORMATIONItem 6. Exhibits
    
    
    30Signatures
    
    
    31




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##### 



NOTE




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Thousands of Dollars, except per share data)
 September 30, 2005
    
    
    December 31, 2004ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    7,967
    
    
    $
    27,940Restricted cash
    
    
    6,074
    
    
    
    9,757Accounts receivable
    
    
    16,492
    
    
    
    28,241Costs and accrued earnings on uncompleted contracts
    
    
    29,804
    
    
    
    54,877Inventories
    
    
    25,703
    
    
    
    16,063Deferred tax asset
    
    
    3,768
    
    
    
    1,058Fair value of foreign exchange contracts
    
    
    
    
    
    
    1,195Prepaid and other current assets
    
    
    7,434
    
    
    
    4,123Total current assets
    
    
    97,242
    
    
    
    143,254PROPERTY,
PLANT AND EQUIPMENT net of accumulated depreciation
    
    
    29,741
    
    
    
    30,294OTHER ASSETSRestricted cash
    
    
    2,000
    
    
    
    2,000Intangibles, net of accumulated amortization
    
    
    3,866
    
    
    
    3,723Goodwill
    
    
    13,862
    
    
    
    14,401Deferred tax asset, non-current
    
    
    5,451
    
    
    
    1,020Other assets
    
    
    1,411
    
    
    
    1,62626,590
    
    
    
    22,770$
    153,573
    
    
    $
    196,318LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESNotes payable
    
    $
    2,269
    
    
    $
    54Current maturities of long-term debt
    
    
    3,457
    
    
    
    2,733Convertible subordinated debenture, current, less unamortized discount
    
    
    
    
    
    
    2,231Accounts payable
    
    
    18,694
    
    
    
    34,933Accrued liabilities
    
    
    9,046
    
    
    
    9,374Customer deposits
    
    
    8,522
    
    
    
    8,708Deferred compensation
    
    
    
    
    
    
    1,612Fair value
of foreign exchange contracts
    
    
    2,688
    
    
    
    Income taxes
    
    
    117
    
    
    
    811Total current liabilities
    
    
    44,793
    
    
    
    60,456LONG-TERM OBLIGATIONSLong-term debt, less current maturities and unamortized discount
    
    
    3,062
    
    
    
    6,440Deferred compensation
    
    
    420
    
    
    
    3773,482
    
    
    
    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 5,841,660 in 2005 and 5,601,101 in 2004
    
    
    584
    
    
    
    560Additional paid-in capital
    
    
    30,057
    
    
    
    26,669Retained earnings
    
    
    66,832
    
    
    
    77,605Accumulated other comprehensive income
    
    
    7,825
    
    
    
    24,211105,298
    
    
    
    129,045$
    153,573
    
    
    $
    196,318
 The accompanying notes are an integral part of these consolidated financial statements.
 2




---



##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Thousands of Dollars, except per share data)
 (Unaudited)
 Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Restated
    
    
    
    
    
    
    RestatedRevenue
    
    $
    23,476
    
    
    $
    34,926
    
    
    $
    62,796
    
    
    $
    107,086Cost and expensesCost of sales
    
    
    20,277
    
    
    
    26,982
    
    
    
    50,952
    
    
    
    79,395Selling and administrative
    
    
    7,232
    
    
    
    6,009
    
    
    
    23,216
    
    
    
    18,358Research and development
    
    
    1,327
    
    
    
    2,031
    
    
    
    4,345
    
    
    
    5,408Operating income (loss)
    
    
    (5,360
    )
    
    
    (96
    )
    
    
    (15,717
    )
    
    
    3,925Other income (expense)Interest income
    
    
    76
    
    
    
    140
    
    
    
    483
    
    
    
    334Interest expense
    
    
    (405
    )
    
    
    (717
    )
    
    
    (1,441
    )
    
    
    (1,715
    )Other-net
    
    
    213
    
    
    
    (474
    )
    
    
    514
    
    
    
    (908
    )(116
    )
    
    
    (1,051
    )
    
    
    (444
    )
    
    
    (2,289
    )Income (loss) before income taxes
    
    
    (5,476
    )
    
    
    (1,147
    )
    
    
    (16,161
    )
    
    
    1,636Income tax expense (benefit)
    
    
    (1,184
    )
    
    
    (580
    )
    
    
    (5,388
    )
    
    
    601NET INCOME (LOSS)
    
    $
    (4,292
    )
    
    $
    (567
    )
    
    $
    (10,773
    )
    
    $
    1,035Earnings (loss) per shareBasic
    
    $
    (0.74
    )
    
    $
    (0.10
    )
    
    $
    (1.90
    )
    
    $
    0.19Diluted
    
    $
    (0.74
    )
    
    $
    (0.10
    )
    
    $
    (1.90
    )
    
    $
    0.17Weighted average number of common shares:Basic
    
    
    5,780,911
    
    
    
    5,565,871
    
    
    
    5,674,740
    
    
    
    5,557,623Diluted
    
    
    5,780,911
    
    
    
    5,565,871
    
    
    
    5,674,740
    
    
    
    6,009,857
 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)
 Nine months ended September 302005
    
    
    2004RestatedCash flows from operating activitiesNet (loss) earnings
    
    $
    (10,773
    )
    
    $
    1,035Adjustments to reconcile net (loss) earnings to net cash used in
operating activitiesDepreciation and amortization
    
    
    3,724
    
    
    
    3,485Unrealized losses on forward contracts
    
    
    (1,418
    )
    
    
    78Debenture issue costs and conversion feature
    
    
    152
    
    
    
    115Provision for estimated losses on contracts
    
    
    649
    
    
    
    171Deferred taxes
    
    
    (3,703
    )
    
    
    (1,143
    )Common stock award
    
    
    191
    
    
    
    106Changes in assets and liabilitiesRestricted cash
    
    
    2,669
    
    
    
    6,686Accounts receivable
    
    
    9,449
    
    
    
    (3,524
    )Costs and accrued earnings on uncompleted contracts
    
    
    19,843
    
    
    
    (3,949
    )Inventories
    
    
    (12,513
    )
    
    
    (3,576
    )Prepaid and other current assets
    
    
    (3,840
    )
    
    
    (4,267
    )Accounts payable, accrued liabilities and customer deposits
    
    
    (13,829
    )
    
    
    (10,215
    )Deferred compensation
    
    
    43
    
    
    
    159Income taxes
    
    
    (3,658
    )
    
    
    3,221Net cash used in operating activities
    
    
    (13,014
    )
    
    
    (11,618
    )Cash flows from investing activitiesCapital expenditures
    
    
    (5,460
    )
    
    
    (3,310
    )Acquisitions
    
    
    
    
    
    
    (525
    )Net cash used in investing activities
    
    
    (5,460
    )
    
    
    (3,835
    )Cash flows from financing activitiesPrincipal payments on long-term borrowing
    
    
    (2,250
    )
    
    
    (3,398
    )Repayment on capital lease obligations
    
    
    (1,997
    )
    
    
    (1,674
    )Proceeds from issuance of long-term debt
    
    
    
    
    
    
    2,000Net increase (decrease) in short-term borrowings
    
    
    2,303
    
    
    
    (2,245
    )Proceeds from employee stock purchases
    
    
    64
    
    
    
    233Option exercises
    
    
    2,691
    
    
    
    255Restricted cash
    
    
    
    
    
    
    (2,000
    )Net cash provided by (used in) financing activities
    
    
    811
    
    
    
    (6,829
    )Net decrease in cash and cash equivalents
    
    
    (17,663
    )
    
    
    (22,282
    )Effects of exchange rate changes on cash and cash equivalents
    
    
    (2,310
    )
    
    
    (550
    )NET DECREASE IN CASH AND CASH EQUIVALENTS
    
    
    (19,973
    )
    
    
    (22,832
    )Cash and cash equivalents at beginning of year
    
    
    27,940
    
    
    
    43,377Cash and cash equivalents at end of period
    
    $
    7,967
    
    
    $
    20,545Supplemental Disclosures of Cash Flow InformationCash paid during the period forInterest
    
    $
    734
    
    
    $
    980Taxes
    
    $
    3,661
    
    
    
    6,170Supplemental Disclosures of Non-cash Investing and Financing activitiesWarrants issued in conjunction with senior secured credit facility
    
    $
    
    
    
    $
    68Capital lease
    
    $
    51
    
    
    $
    1,497
 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
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 NOTE 1  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
     Restatement
      5




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
  Selected Consolidated Statements of Earnings Data:
 Impact from using
    
    
    As PreviouslyThree Months Ended September 30, 2004
    
    As Restated
    
    
    Incorrect Rate (1)
    
    
    ReportedRevenues
    
    $
    34,926
    
    
    $
    1,211
    
    
    $
    36,137Cost of sales
    
    
    26,982
    
    
    
    318
    
    
    
    27,300Operating income (loss)
    
    
    (96
    )
    
    
    892
    
    
    
    796Income (loss) before taxes
    
    
    (1,147
    )
    
    
    892
    
    
    
    (255
    )Income tax expense (benefit)
    
    
    (580
    )
    
    
    303
    
    
    
    (277
    )Net income (loss)
    
    
    (567
    )
    
    
    589
    
    
    
    22Earnings (Loss) per shareBasic
    
    $
    (0.10
    )
    
    $
    0.10
    
    
    $
    Diluted
    
    $
    (0.10
    )
    
    $
    0.10
    
    
    $
    
 Impact from using
    
    
    As PreviouslyNine Months Ended September 30, 2004
    
    As Restated
    
    
    Incorrect Rate (1)
    
    
    ReportedRevenues
    
    $
    107,086
    
    
    $
    (4,853
    )
    
    $
    102,233Cost of sales
    
    
    79,395
    
    
    
    (1,463
    )
    
    
    77,932Operating income (loss)
    
    
    3,925
    
    
    
    (3,390
    )
    
    
    535Income (loss) before taxes
    
    
    1,636
    
    
    
    (3,390
    )
    
    
    (1,754
    )Income tax expense (benefit)
    
    
    601
    
    
    
    (1,153
    )
    
    
    (552
    )Net income (loss)
    
    
    1,035
    
    
    
    (2,237
    )
    
    $
    (1,202
    )Earnings (Loss) per shareBasic
    
    $
    0.19
    
    
    $
    (0.41
    )
    
    $
    (0.22
    )Diluted
    
    $
    0.17
    
    
    $
    (0.39
    )
    
    $
    (0.22
    )
 
 (1)
    
    Impact of adjusting the Companys U.S. Dollar
denominated receivables and payables at MECAR valued at the
period end spot rate and not the hedged rate. Selected Consolidated Statements of Cash Flows Data (Reclassification of Restricted Cash):
 As PreviouslyPeriod Ended September 30, 2004
    
    As Restated
    
    
    Adjustment
    
    
    ReportedCash flows from operating activitiesRestricted cash and restricted deposits
    
    $
    6,686
    
    
    $
    (2,000
    )
    
    $
    4,686Cash flows used in financing activitiesRestricted cash and restricted deposits
    
    
    (2,000
    )
    
    
    2,000
    
    
    
    
 Selected Consolidated Statements of Cash Flows Data (Reclassification of Capital
Leases):
 As PreviouslyPeriod Ended September 30, 2004
    
    As Restated
    
    
    Adjustment
    
    
    ReportedCash flows from investing activitiesCapital expenditures
    
    $
    (3,310
    )
    
    $
    (1,497
    )
    
    $
    (4,807
    )Cash flows used in financing activitiesRepayment on capital lease obligations
    
    $
    (1,674
    )
    
    $
    1,674
    
    
    $
    Principal payments on long term debt and debenture
    
    
    (3,398
    )
    
    
    (1,674
    )
    
    
    (5,072
    )Proceeds from issuance of long term debt
    
    
    2,000
    
    
    
    1,497
    
    
    
    3,497Subtotal
    
    
    (3,072
    )
    
    
    1,497
    
    
    
    (1,575
    )
 6




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 Accounting for Derivative Instruments and Hedging Activities
 NOTE 2  PRINCIPLES OF CONSOLIDATION
  
    
    ARC Europe, S.A. (ARC Europe), a Belgian company,
 
    
    Allied Research Corporation Limited (Limited), an inactive United Kingdom company,
 
    
    News/Sports Microwave Rental, Inc. (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 limited liability company.
   
    
    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 became operational
in the third quarter of 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, as well as a
line of antennas.
 
    
    Software, Training & Simulationsegment
consists of Titan Dynamics, which
designs, manufactures and sells
battlefield effects simulators, minor
pyrotechnics, and other training
devices.
  7




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 NOTE 3  DERIVATIVE FINANCIAL INSTRUMENTS
  Fair value hedges
  Derivatives not designated as hedges
 NOTE 4
 ACCOUNTS RECEIVABLE AND COSTS AND ACCRUED EARNINGS ON UNCOMPLETED CONTRACTS
  2005
    
    
    2004Direct and indirect receivables from foreign governments
    
    $
    991
    
    
    $
    15,585Commercial and other receivables, less allowance for doubtful
receivables of $148 in 2005 and $143 in 2004
    
    
    15,501
    
    
    
    12,656$
    16,492
    
    
    $
    28,241
  8




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 NOTE 5
 INVENTORIES
  2005
    
    
    2004Raw materials
    
    $
    13,691
    
    
    $
    14,603Work in process
    
    
    9,032
    
    
    
    686Finished goods, less reserve for obsolescence of $610 in 2005
and $668 in 2004
    
    
    371
    
    
    
    774Precontract costs
    
    
    2,609
    
    
    
    $
    25,703
    
    
    $
    16,063Other AssetsInventories in excess of amounts expected to be sold currently
    
    $
    969
    
    
    $
    1,098
   NOTE 6
 GOODWILL
   NOTE 7  CONVERTIBLE SUBORDINATED DEBENTURE
  9




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 NOTE 8  EARNINGS (LOSS) PER SHARE
  Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,Restated
    
    
    
    
    
    
    Restated2005
    
    
    2004
    
    
    2005
    
    
    2004Net earnings (loss)
    
    $
    (4,292
    )
    
    $
    (567
    )
    
    $
    (10,773
    )
    
    $
    1,035Interest on convertible debenture, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net earnings (loss) before interest on
convertible debenture
    
    $
    (4,292
    )
    
    $
    (567
    )
    
    $
    (10,773
    )
    
    $
    1,035Weighted average number of basic shares
    
    
    5,780,911
    
    
    
    5,565,871
    
    
    
    5,674,740
    
    
    
    5,557,623Common stock equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    452,234Weighted average number of diluted shares
    
    
    5,780,911
    
    
    
    5,565,871
    
    
    
    5,674,740
    
    
    
    6,009,857Basic earning (loss) per share
    
    $
    (0.74
    )
    
    $
    (0.10
    )
    
    $
    (1.90
    )
    
    $
    0.19Diluted earnings (loss) per share
    
    $
    (0.74
    )
    
    $
    (0.10
    )
    
    $
    (1.90
    )
    
    $
    0.17
  NOTE 9  COMPREHENSIVE LOSS
  Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,Restated
    
    
    
    
    
    
    Restated2005
    
    
    2004
    
    
    2005
    
    
    2004Net earnings (loss)
    
    $
    (4,292
    )
    
    $
    (567
    )
    
    $
    (10,773
    )
    
    $
    1,035Currency Translation Adjustment
    
    
    (5,503
    )
    
    
    1,700
    
    
    
    (16,386
    )
    
    
    (1,084
    )Comprehensive income (loss)
    
    $
    (9,795
    )
    
    $
    1,133
    
    
    $
    (27,159
    )
    
    $
    (49
    )
  10




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 NOTE 10  STOCK BASED COMPENSATION
 Accounting for Stock Issued to Employees.
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,Restated
    
    
    
    
    
    
    Restated(Dollars in thousands, except per share amounts)
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004Reported net earnings (loss)
    
    $
    (4,292
    )
    
    $
    (567
    )
    
    $
    (10,773
    )
    
    $
    1,035Stock-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
    
    
    (91
    )
    
    
    (158
    )
    
    
    (288
    )
    
    
    (473
    )Pro forma net earnings (loss)
    
    $
    (4,383
    )
    
    $
    (725
    )
    
    $
    (11,061
    )
    
    $
    562Basic earnings (loss) per share:Reported earnings (loss) per share
    
    $
    (0.74
    )
    
    $
    (0.10
    )
    
    $
    (1.90
    )
    
    $
    0.19Compensation costs, net of tax
    
    
    (0.02
    )
    
    
    (0.03
    )
    
    
    (0.05
    )
    
    
    (0.09
    )Pro forma basic earnings (loss) per share
    
    $
    (0.76
    )
    
    $
    (0.13
    )
    
    $
    (1.95
    )
    
    $
    0.10Diluted earnings (loss) per share:Reported earnings (loss) per share
    
    $
    (0.74
    )
    
    $
    (0.10
    )
    
    $
    (1.90
    )
    
    $
    0.17Compensation costs, net of tax
    
    
    (0.02
    )
    
    
    (0.03
    )
    
    
    (0.05
    )
    
    
    (0.08
    )Pro forma diluted earnings (loss) per share
    
    $
    (0.76
    )
    
    $
    (0.13
    )
    
    $
    (1.95
    )
    
    $
    0.09
  Three Months Ended September 30
    
    Nine Months Ended September 302005
    
    2004
    
    2005
    
    2004Risk free interest rate
    
    
    4.08
    %
    
    
    2.86
    %
    
    
    4.08
    %
    
    
    2.86
    %Expected volatility rate
    
    
    44.62
    %
    
    
    47.00
    %
    
    
    44.62
    %
    
    
    47.00
    %Expected lives  years
    
    
    5
    
    
    
    3
    
    
    
    5
    
    
    
    3Divided yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 11




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
  NOTE 11  INDUSTRY SEGMENTS
 Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Restated
    
    
    
    
    
    
    RestatedRevenues from external customersOrdnance & Manufacturing
    
    $
    12,526
    
    
    $
    20,875
    
    
    $
    28,212
    
    
    $
    68,711Electronic Security
    
    
    8,070
    
    
    
    12,496
    
    
    
    28,242
    
    
    
    33,386Environmental Safety & Security
    
    
    2,012
    
    
    
    1,406
    
    
    
    4,640
    
    
    
    4,654Software, Training & Simulation
    
    
    868
    
    
    
    149
    
    
    
    1,702
    
    
    
    335$
    23,476
    
    
    $
    34,926
    
    
    $
    62,796
    
    
    $
    107,086Segment profit (loss) before taxesOrdnance & Manufacturing
    
    $
    (3,964
    )
    
    $
    (1,222
    )
    
    $
    (13,093
    )
    
    $
    622Electronic Security
    
    
    (245
    )
    
    
    2,021
    
    
    
    369
    
    
    
    5,077Environmental Safety & Security
    
    
    (345
    )
    
    
    (1,182
    )
    
    
    (1,528
    )
    
    
    (2,364
    )Software, Training & Simulation
    
    
    (90
    )
    
    
    (177
    )
    
    
    (299
    )
    
    
    (517
    )Corporate and Other
    
    
    (832
    )
    
    
    (587
    )
    
    
    (1,610
    )
    
    
    (1,182
    )$
    (5,476
    )
    
    $
    (1,147
    )
    
    $
    (16,161
    )
    
    $
    1,636
 NOTE
12  PROVISION FOR TAXES
   NOTE
13  COMMITMENTS AND CONTINGENCIES
  12




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
      13




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 Overview
  
    
    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 became
operational in the third quarter of 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, as well as a line of antennas.
 
    
    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.
   Accounting for Derivative Instruments and Hedging
Activities
  14




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 Results of Operations for the Three Months Ended September 30, 2005 and 2004
  Three months ended September 30,2005
    
    
    2004RestatedRevenue
    
    $
    23,476
    
    
    
    100.0
    %
    
    $
    34,926
    
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    20,277
    
    
    
    86.4
    
    
    
    26,982
    
    
    
    77.3Selling and administrative
    
    
    7,232
    
    
    
    30.8
    
    
    
    6,009
    
    
    
    17.2Research and development
    
    
    1,327
    
    
    
    5.6
    
    
    
    2,031
    
    
    
    5.8Operating loss
    
    
    (5,360
    )
    
    
    (22.8
    )
    
    
    (96
    )
    
    
    (0.3
    )Other income (expense)Interest income
    
    
    76
    
    
    
    .3
    
    
    
    140
    
    
    
    0.4Interest expense
    
    
    (405
    )
    
    
    (1.7
    )
    
    
    (717
    )
    
    
    (2.0
    )Other  net
    
    
    213
    
    
    
    .9
    
    
    
    (474
    )
    
    
    (1.4
    )Loss before income taxes
    
    
    (5,476
    )
    
    
    (23.3
    )
    
    
    (1,147
    )
    
    
    (3.3
    )Income benefit
    
    
    (1,184
    )
    
    
    (5.0
    )
    
    
    (580
    )
    
    
    (1.7
    )Net loss
    
    $
    (4,292
    )
    
    
    (18.3
    )%
    
    $
    (567
    )
    
    
    (1.6
    )%
 Revenue.
 Revenue by SegmentThree Months Ended
    
    
    Three Months EndedSeptember 30, 2005
    
    
    September 30, 2004Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    of totalRestatedOrdnance & Manufacturing
    
    $
    12,526
    
    
    
    53
    %
    
    $
    20,875
    
    
    
    60
    %Electronic Security
    
    
    8,070
    
    
    
    34
    %
    
    
    12,496
    
    
    
    36
    %Environmental Safety & Security
    
    
    2,012
    
    
    
    9
    %
    
    
    1,406
    
    
    
    4
    %Software, Training & Simulation
    
    
    868
    
    
    
    4
    %
    
    
    149
    
    
    
    
    %$
    23,476
    
    
    
    100
    %
    
    $
    34,926
    
    
    
    100
    %
  15




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
     Cost of Sales.
 Cost of Sales as Percentage of Sales by Segment
 Three months endedSeptember 302005
    
    2004RestatedOrdnance & Manufacturing
    
    
    102
    %
    
    
    88
    %Electronic Security
    
    
    69
    %
    
    
    59
    %Environmental Safety & Security
    
    
    61
    %
    
    
    78
    %Software, Training & Simulation
    
    
    72
    %
    
    
    62
    %Total
    
    
    86
    %
    
    
    77
    %
    16




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
  Selling and Administrative Expenses.
 Research and Development.
 Interest Income.
 Interest Expense.
 Other-Net.
 Pre-Tax Loss
 Pre-Tax Loss by Segment
 Three months endedSeptember 30,2005
    
    
    2004RestatedOrdnance & Manufacturing
    
    $
    (3,964
    )
    
    $
    (1,222
    )Electronic Security
    
    
    (245
    )
    
    
    2,021Environmental Safety & Security
    
    
    (345
    )
    
    
    (1,182
    )Software, Training & Simulation
    
    
    (90
    )
    
    
    (177
    )Corporate and other
    
    
    (832
    )
    
    
    (587
    )$
    (5,476
    )
    
    $
    (1,147
    )
  17




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
     Income Taxes.
 Net Loss.
 Results of Operations for the Nine Months Ended September 30, 2005 and 2004
  Nine months ended September 30,2005
    
    
    2004RestatedRevenue
    
    $
    62,796
    
    
    
    100.0
    %
    
    $
    107,086
    
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    50,952
    
    
    
    81.1
    
    
    
    79,395
    
    
    
    74.2Selling and administrative
    
    
    23,216
    
    
    
    37.0
    
    
    
    18,358
    
    
    
    17.1Research and development
    
    
    4,345
    
    
    
    6.9
    
    
    
    5,408
    
    
    
    5.0Operating income (loss)
    
    
    (15,717
    )
    
    
    (25.0
    )
    
    
    3,925
    
    
    
    3.7Other income (expense)Interest income
    
    
    483
    
    
    
    0.8
    
    
    
    334
    
    
    
    0.3Interest expense
    
    
    (1,441
    )
    
    
    (2.3
    )
    
    
    (1,715
    )
    
    
    (1.6
    )Other  net
    
    
    514
    
    
    
    .8
    
    
    
    (908
    )
    
    
    (0.8
    )Earnings (loss) before income taxes
    
    
    (16,161
    )
    
    
    (25.7
    )
    
    
    1,636
    
    
    
    1.6Income tax expense (benefit)
    
    
    (5,388
    )
    
    
    (8.5
    )
    
    
    601
    
    
    
    0.6Net earnings (loss)
    
    $
    (10,773
    )
    
    
    (17.2
    )%
    
    $
    1,035
    
    
    
    1.0
    %
 18




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 Revenue.
  Revenue by SegmentNine Months Ended
    
    
    Nine Months EndedSeptember 30, 2005
    
    
    September 30, 2004Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    of totalRestatedOrdnance & Manufacturing
    
    $
    28,212
    
    
    
    45
    %
    
    $
    68,711
    
    
    
    64
    %Electronic Security
    
    
    28,242
    
    
    
    45
    %
    
    
    33,386
    
    
    
    31
    %Environmental Safety & Security
    
    
    4,640
    
    
    
    7
    %
    
    
    4,654
    
    
    
    4
    %Software, Training & Simulation
    
    
    1,702
    
    
    
    3
    %
    
    
    335
    
    
    
    1
    %$
    62,796
    
    
    
    100
    %
    
    $
    107,086
    
    
    
    100
    %
     Cost of Sales.
 Cost of Sales as Percentage of Sales by Segment
 Nine months endedSeptember 302005
    
    2004RestatedOrdnance & Manufacturing
    
    
    108
    %
    
    
    83
    %Electronic Security
    
    
    59
    %
    
    
    58
    %Environmental Safety & Security
    
    
    56
    %
    
    
    64
    %Software, Training & Simulation
    
    
    70
    %
    
    
    64
    %Total
    
    
    81
    %
    
    
    74
    %
 19




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
     Selling and Administrative Expenses.
 Research and Development.
 Interest Income.
 Interest Expense.
 Other-Net.
 Pre-Tax Profit (Loss)
 Pre-Tax Profit (Loss) by Segment
 Nine months endedSeptember 302005
    
    
    2004RestatedOrdnance & Manufacturing
    
    $
    (13,093
    )
    
    $
    622Electronic Security
    
    
    369
    
    
    
    5,077Environmental Safety & Security
    
    
    (1,528
    )
    
    
    (2,364
    )Software, Training & Simulation
    
    
    (299
    )
    
    
    (517
    )Corporate and other
    
    
    (1,610
    )
    
    
    (1,182
    )$
    (16,161
    )
    
    $
    1,636
 20




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
      Income Taxes.
 Net Earnings (Loss).
 Backlog.
 Backlog by SegmentSeptember 30, 2005
    
    
    September 30, 2004Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    Of totalOrdnance & Manufacturing
    
    $
    75,114
    
    
    
    74
    %
    
    $
    55,467
    
    
    
    67
    %Electronic Security
    
    
    20,682
    
    
    
    21
    
    
    
    24,796
    
    
    
    30Environmental Safety & Security
    
    
    2,144
    
    
    
    2
    
    
    
    1,498
    
    
    
    2Software, Training & Simulation
    
    
    3,053
    
    
    
    3
    
    
    
    739
    
    
    
    1$
    100,993
    
    
    
    100
    %
    
    $
    82,500
    
    
    
    100
    %
  21




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 Liquidity and Capital Resources
 Balance Sheet
         22




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 Cash Flows
  Nine months ended September 302005
    
    2004RestatedNet cash provided by (used in) operating activities
    
    $
    (13,014
    )
    
    $
    (11,618
    )Net cash used in investing activities
    
    
    (5,460
    )
    
    
    (3,835
    )Net cash provided by (used in) financing activities
    
    
    811
    
    
    
    (6,829
    )
 Operating Activities.
 Investing Activities.
 Financing Activities.
 Allied.
 MECAR.
 VSK Group.
 Other Subsidiaries.
 23




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 Stock Repurchases.
 Future Liquidity.
       Off-Balance Sheet Arrangements.
 Critical Accounting Policies
  
    
    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. Under the
percentage of completion method, revenue is recognized on these
contracts as work progresses during the period, based on the
amount of actual cost incurred during the period compared to total
estimated cost to be incurred for the total contract (cost-to-cost
method). 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. If
the contract is projected to create a loss, the entire estimated
loss is charged to operations in the period such loss first
becomes known. Approximately 67% and 61%, and 81% and 79%, of
condensed consolidated revenue was recognized under the percentage
of completion method during the three and nine months ended
September 30, 2005 and 2004, respectively.
    
    Goodwill and intangible asset valuation.The Company completed a
goodwill impairment analysis in the fourth quarter of 2004, which
was recently reviewed, 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
 24




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 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.
 Recent Accounting Pronouncements
  Accounting for Conditional Asset
Retirement Obligations  an interpretation of FASB Statement No. 143 Accounting for Asset Retirement
Obligations,
 25




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
 Share-Based Payment
  Inventory Costs  An Amendment of ARB No. 43, Chapter
4.
 Exchanges of Non-monetary AssetsAn Amendment
of APB Opinion No. 29
 Forward-Looking Statements
  26




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
(Thousands of Dollars)
(Unaudited)
  
    
    material weaknesses in internal controls;
    
    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.
  27




---



##### 



The Allied Defense Group, Inc.
 September 30, 2005
 QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE
    28




---



##### 



The Allied Defense Group, Inc.
 September 30, 2005
 DISCLOSURE CONTROLS AND PROCEDURES
 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. The Company identified a material weakness in its internal
control over financial reporting as outlined below. As a result, the Chief Executive Officer
and the Chief Financial Officer concluded that the disclosure controls and procedures were not
effective as of September 30, 2005. As set forth below, we are in the process of taking the
steps necessary to remediate the material weakness.2.
    
    Changes in internal controlsManagement assessed the effectiveness of the companys internal control over financial reporting
as of September 30, 2005. In making this assessment, it used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission
(COSO) in Internal Control 
Integrated Framework. Based on our assessment we believe that, as of September 30, 2005, the
companys internal control over financial reporting is ineffective based on those criteria as
set forth below.We have become aware of a material weakness in our internal control over financial reporting.
The Public Company Accounting Oversight Boards Auditing Standard No. 2 defines a material
weakness as a significant deficiency, or a combination of significant deficiencies, that results
in there being a more than remote likelihood that a material misstatement of the annual or
interim financial statements will not be prevented or detected. We determined that we had not
met the documentation requirements to qualify for hedge accounting on certain derivative
contracts received in 2005. As a result, the Company must restate its previously reported
financial results for the first and second calendar quarters of 2005. For the third quarter of 2005 and for the first nine months of 2005 all derivatives are
recorded on the balance sheet at fair value. Derivatives which are not designated as hedges for
accounting purposes are adjusted to fair value through earnings, consistent with the requirements
of Statement of Financial
Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS
133).Prior to the filing of this Form 10-Q, we began to take the steps necessary to remediate this
material weaknesses in our internal control over financial reporting. We have engaged a
third-party expert to assist us with our hedge documentation for all new forward contracts
entered into. Accordingly, we believe that we are remediating the material weakness in our
internal controls.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.
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The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
September 30, 2005
 Item 6 Exhibits
 (a) Reports on Form 8-K
 On July 26, 2005, the Company filed a Form 8-K reporting the resignation of its Chief Financial
Officer, Charles A. Hasper.On August 8, 2005, the Company filed a Form 8-K announcing a restatement of certain financial
information previously reported for the years 2002, 2003, 2004, and the first quarter of 2005,
and non-reliance on those previously filed financial statements.On August 10, 2005, the Company filed a Form 8-K/A clarifying the reason for the restatement as
set forth in the Form 8-K filed on August 8, 2005.On August 16, 2005, the Company filed a Form 8-K providing its financial results for the quarter
ended June 30, 2005.On August 23, 2005, the Company filed a Form 8-K reporting the employment of its new Chief
Financial Officer, Robert P. Dowski.
 (b) Exhibit No.
    
    Description of Exhibits10.1
    
    Employment Agreement between Allied and Robert P. Dowski31.1
    
    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.
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The Allied Defense Group, Inc.
 SIGNATURE
  THE ALLIED DEFENSE GROUP, INC./s/ Robert P. DowskiDate:  November 14, 2005
    Robert P. DowskiChief Financial Officer and
Treasurer 31