##### 



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, 2004 Commission File Number: 001-11376   The Allied Defense Group, Inc. (Exact name of Registrant as specified in its charter)
 Delaware
    
    04-2281015(State or other jurisdiction of
    
    (I.R.S. Employer Number)incorporation or organization)
 8000 Towers Crescent Drive, Suite 260
Vienna, Virginia 22182(Address of principal executive offices, including zip code) (703) 847-5268(Registrants telephone number, including area code)   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. x o
 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). x o
 Indicate the number of shares outstanding of each of the issuers classes of
common stock as of September 30, 2004: 5,599,617.




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THE ALLIED DEFENSE GROUP, INC. INDEX
 PAGENUMBERPART I. FINANCIAL INFORMATION  UNAUDITEDItem 1.
    
    Financial StatementsCondensed Consolidated Balance Sheets September 30, 2004 and December 31, 2003
    
    
    2Condensed Consolidated Statements of Earnings Three and nine months ended September 30, 2004 and 2003
    
    
    3Condensed Consolidated Statements of Cash Flows Nine months ended September 30, 2004 and 2003
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3.
    
    Quantitative and Qualitative Market Risk Disclosure
    
    
    27Item 4.
    
    Disclosure Controls and Procedures
    
    
    27PART II. OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    28Item 6.
    
    Exhibits
    
    
    28Signatures
    
    
    30




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The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS (Thousands of Dollars, except per share data) September 30, 2004
    
    December 31, 2003UnauditedASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    20,545
    
    
    $
    43,377Restricted cash
    
    
    10,928
    
    
    
    15,937Accounts receivable
    
    
    39,229
    
    
    
    29,321Costs and accrued earnings on uncompleted contracts
    
    
    67,825
    
    
    
    68,414Inventories
    
    
    15,519
    
    
    
    12,068Deferred tax asset
    
    
    1,990
    
    
    
    1,016Fair value of foreign exchange contracts
    
    
    5,249
    
    
    
    9,378Prepaid and other current assets
    
    
    8,479
    
    
    
    4,880Total current assets
    
    
    169,764
    
    
    
    184,391PROPERTY, PLANT AND EQUIPMENT  net of accumulated depreciation
    
    
    25,844
    
    
    
    24,615OTHER ASSETSIntangibles, net of accumulated amortization
    
    
    3,864
    
    
    
    4,135Goodwill
    
    
    14,226
    
    
    
    13,718Other assets
    
    
    522
    
    
    
    37818,612
    
    
    
    18,231$
    214,220
    
    
    $
    227,237LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESNotes payable
    
    $
    11,688
    
    
    $
    14,200Current maturities of long-term debt
    
    
    2,253
    
    
    
    2,709Convertible subordinated debenture, current, less unamortized discount
    
    
    4,462
    
    
    
    5,250Accounts payable
    
    
    40,050
    
    
    
    53,284Accrued liabilities
    
    
    15,159
    
    
    
    16,846Customer deposits
    
    
    8,465
    
    
    
    4,938Foreign exchange contracts
    
    
    5,249
    
    
    
    9,378Income taxes
    
    
    4,357
    
    
    
    906Total current liabilities
    
    
    91,683
    
    
    
    107,511LONG-TERM OBLIGATIONSLong-term debt, less current maturities and unamortized discount
    
    
    5,791
    
    
    
    4,902Convertible subordinated debenture, less current maturities and
unamortized discount
    
    
    
    
    
    
    2,156Deferred compensation
    
    
    1,479
    
    
    
    1,334Deferred taxes
    
    
    393
    
    
    
    1,3397,663
    
    
    
    9,731STOCKHOLDERS EQUITYPreferred stock, no par value; authorized, 1,000,000 shares; none issued
    
    
    
    
    
    
    Common stock, par value, $.10 per share; authorized 30,000,000 shares;
issued and outstanding 5,599,617 in 2004 and 5,551,373 in 2003
    
    
    560
    
    
    
    555Additional paid-in capital
    
    
    26,568
    
    
    
    25,891Retained earnings
    
    
    75,318
    
    
    
    70,166Accumulated other comprehensive income
    
    
    12,428
    
    
    
    13,383114,874
    
    
    
    109,995$
    214,220
    
    
    $
    227,237
 The accompanying notes are an integral part of these consolidated financial statements. 2




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The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (Thousands of Dollars, except per share data) (Unaudited) Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenue
    
    $
    37,142
    
    
    $
    34,871
    
    
    $
    116,837
    
    
    $
    120,251Cost and expensesCost of sales
    
    
    28,062
    
    
    
    26,972
    
    
    
    82,909
    
    
    
    86,578Selling and administrative
    
    
    6,010
    
    
    
    5,259
    
    
    
    18,358
    
    
    
    17,553Research and development
    
    
    2,031
    
    
    
    1,545
    
    
    
    5,408
    
    
    
    3,302Operating income
    
    
    1,039
    
    
    
    1,095
    
    
    
    10,162
    
    
    
    12,818Other income (expense)Interest income
    
    
    140
    
    
    
    123
    
    
    
    334
    
    
    
    351Interest expense
    
    
    (717
    )
    
    
    (547
    )
    
    
    (1,715
    )
    
    
    (1,506
    )Other-net
    
    
    (474
    )
    
    
    (46
    )
    
    
    (908
    )
    
    
    (366
    )(1,051
    )
    
    
    (470
    )
    
    
    (2,289
    )
    
    
    (1,521
    )Earnings before income taxes
    
    
    (12
    )
    
    
    625
    
    
    
    7,873
    
    
    
    11,297Income tax (benefit) expense
    
    
    (194
    )
    
    
    (238
    )
    
    
    2,721
    
    
    
    4,198NET EARNINGS
    
    $
    182
    
    
    $
    863
    
    
    $
    5,152
    
    
    $
    7,099Earnings per shareBasic
    
    $
    .03
    
    
    $
    .16
    
    
    $
    .93
    
    
    $
    1.29Diluted
    
    $
    .03
    
    
    $
    .16
    
    
    $
    .89
    
    
    $
    1.23Weighted average number of common shares:Basic
    
    
    5,565,871
    
    
    
    5,504,106
    
    
    
    5,557,623
    
    
    
    5,490,475Diluted
    
    
    5,966,973
    
    
    
    6,001,239
    
    
    
    6,009,857
    
    
    
    5,984,933
 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 302004
    
    2003Cash flows from operating activitiesNet earnings
    
    $
    5,152
    
    
    $
    7,099Adjustments to reconcile net earnings to net cash provided by (used in) operating activitiesDepreciation and amortization
    
    
    3,485
    
    
    
    2,855Provision for estimated losses on contracts
    
    
    171
    
    
    
    45Deferred taxes
    
    
    (1,918
    )
    
    
    118Debt issue costs
    
    
    115
    
    
    
    224Deferred compensation
    
    
    159
    
    
    
    340Common stock award
    
    
    106
    
    
    
    111Changes in assets and liabilitiesAccounts receivable
    
    
    (10,106
    )
    
    
    14,852Costs and accrued earnings on uncompleted contracts
    
    
    (631
    )
    
    
    (24,599
    )Inventories
    
    
    (3,576
    )
    
    
    (2,410
    )Prepaid and other current assets
    
    
    (4,267
    )
    
    
    (6,359
    )Accounts payable, accrued liabilities and customer deposits
    
    
    (10,215
    )
    
    
    20,004Income taxes
    
    
    3,221
    
    
    
    1,048Net cash provided by (used in) operating activities
    
    
    (18,304
    )
    
    
    13,328Cash flows from investing activitiesCapital expenditures
    
    
    (4,807
    )
    
    
    (4,454
    )Acquisitions
    
    
    (525
    )
    
    
    Net cash used in investing activities
    
    
    (5,332
    )
    
    
    (4,454
    )Cash flows from financing activitiesPrincipal payments on long-term borrowing
    
    
    (5,072
    )
    
    
    (1,650
    )Proceeds from issuance of long-term debt
    
    
    3,497
    
    
    
    1,517Net increase (decrease) in short-term borrowings
    
    
    (2,245
    )
    
    
    1,507Proceeds from employee stock purchases
    
    
    233
    
    
    
    142Option exercises
    
    
    255
    
    
    
    131Restricted cash
    
    
    4,686
    
    
    
    (1,769
    )Net cash provided by (used in) financing activities
    
    
    1,354
    
    
    
    (122
    )Net increase (decrease) in cash and cash equivalents
    
    
    (22,282
    )
    
    
    8,752Effects of exchange rate changes on cash and cash equivalents
    
    
    (550
    )
    
    
    1,277NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    (22,832
    )
    
    
    10,029Cash and cash equivalents at beginning of year
    
    
    43,377
    
    
    
    14,876Cash and cash equivalents at end of period
    
    $
    20,545
    
    
    $
    24,905Supplemental Disclosures of Cash Flow InformationCash paid during the period forInterest
    
    $
    980
    
    
    $
    896Taxes
    
    
    6,170
    
    
    
    8,957Supplemental Disclosures of Non-cash financing activitiesWarrants issued in conjunction with senior secured credit facility
    
    
    68
    
    
    
    
 The accompanying notes are an integral part of these consolidated financial statements. 4




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The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited) NOTE 1  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The accompanying condensed consolidated financial statements have been prepared
by the Company without audit. In the opinion of management, the accompanying
unaudited condensed consolidated financial statements reflect all necessary
adjustments and reclassifications (all of which are of a normal, recurring
nature) that are necessary for fair presentation for the periods presented. Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted. It is
suggested that these condensed consolidated financial statements be read in
conjunction with the financial statements and notes included in the Companys
December 31, 2003, Form 10-K filed with the Securities and Exchange Commission.
The results of operations for the periods ended September 30, 2004 and 2003
are not necessarily indicative of the operating results for the full year. Certain reclassifications have been made to the prior periods financial
statements to conform to the current presentation. NOTE 2  PRINCIPLES OF CONSOLIDATION The condensed consolidated financial statements include the accounts of The
Allied Defense Group, Inc. (Allied or the Company), a Delaware corporation,
and its wholly-owned subsidiaries as follows:  
    
    ARC Europe, S.A. (ARC Europe), a Belgian company,  
    
    Allied Research Corporation Limited (Limited), an inactive United Kingdom company,  
    
    News/Sports Microwave Rental, Inc. (NS Microwave), a California corporation,  
    
    Titan Dynamics Systems, Inc. (Titan Dynamics), a Texas corporation,  
    
    SeaSpace Corporation (SeaSpace), a California corporation, and  
    
    MECAR USA, Inc. (MECAR USA), a Delaware corporation ARC Europe includes its wholly-owned subsidiaries MECAR S.A. (MECAR),
Sedachim S.I. S.A., Hendrickx S.A., and the VSK Group. The VSK Group is
comprised of VSK Electronics N.V. and its wholly-owned subsidiaries, Télé
Technique Générale S.A., Intelligent Data Capturing Systems (IDCS) N.V.,
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 early 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. manufacturers
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, the parent company, provides management services to its subsidiaries
and has no operating activities. Significant intercompany transactions have
been eliminated in consolidation. 5




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The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited) NOTE 3  ACQUISITION On August 1, 2004, the VSK Group acquired all the common stock of Control
Monitor Systems in a transaction accounted for as a purchase. This acquisition
was undertaken to provide the Company with a position in a high-growth segment
of the North American Electronic Security market. The cost of acquisition was
$400. The results of Control Monitor Systems have been consolidated since its
acquisition on August 1, 2004. The acquired identifiable intangible asset in
this transaction was a Customer List, which had a fair value of $50 and an
indefinite life. Goodwill arising from this transaction was $449 and is not
deductible for tax purposes. NOTE 4  DERIVATIVE FINANCIAL INSTRUMENTS As of September 30, 2004 and December 31, 2003, futures contracts designated as
fair value hedges with notional amounts of $50,200 and $50,000 were outstanding
and the fair values of these contracts were $13,891 and $21,966, respectively.
At September 30, 2004 and December 31, 2003, the total fair value was included
in the following balance accounts: 2004
    
    2003Costs and accrued earnings on uncompleted contracts
    
    $
    8,642
    
    
    $
    12,588Fair value of foreign exchange contracts
    
    
    5,249
    
    
    
    9,378$
    13,891
    
    
    $
    21,966
 Deferred gains on fair value hedges related to multi-year sales contracts are
included in accrued liabilities. NOTE 5  RESTRICTED CASH MECAR is generally required under the terms of its contracts with foreign
governments and its distributor to provide performance bonds and advance
payment guarantees. The credit facility agreements used to provide these
financial guarantees place restrictions on cash deposits and other liens on
MECARs assets. $8,928 and $15,812 at September 30, 2004 and December 31,
2003, respectively, was restricted or pledged as collateral for these
agreements. Restricted cash also included $2,000 at September 30, 2004 as a requirement of
the senior secured facility which was completed on May 28, 2004. Restricted cash also included $125 at December 31, 2003, as a result of a
deposit which was a requirement of the SeaSpace acquisition agreement. In
2002, the Company issued a $250 promissory note which was paid in equal
installments on July 31, 2003 and 2004. The payments were subject to certain
conditions being met as defined in the acquisition agreement. 6




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The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited) NOTE 6  ACCOUNTS RECEIVABLE Accounts receivable at September 30, 2004 and December 31, 2003 are comprised
as follows: 2004
    
    2003Direct and indirect receivables from foreign governments
    
    $
    19,230
    
    
    $
    15,613Commercial and other receivables, less allowance for doubtful
receivables of $120 in 2004 and $115 in 2003
    
    
    19,999
    
    
    
    13,708$
    39,229
    
    
    $
    29,321
 Receivables from foreign government and government agencies are generally due
within 30 days of shipment, less a 10% hold back provision which is generally
due within 90 days. Since these receivables are supported by letters of credit
or other guarantees, no provision for doubtful accounts is deemed necessary.
The Company evaluates its allowance for doubtful accounts on commercial
receivables on an ongoing basis and provides for losses as deemed necessary. NOTE 7  COSTS AND ACCRUED EARNINGS ON UNCOMPLETED CONTRACTS Costs and accrued earnings on uncompleted contracts are recognized by MECAR, NS
Microwave and SeaSpace for their fixed priced sales contracts in accordance
with the percentage of completion method of accounting. Under this method,
revenue is recognized as work progresses, based on the relationship between
actual costs incurred during the period and total estimated cost to be incurred
for the total contract. Management reviews these estimates as work progresses
and the effect of any change in cost estimates is reflected in cost of sales in
the period in which the change is identified. The revenue recognized on the
contracts in progress for the three and nine months ended September 30, 2004
and 2003 were $30,353 and $94,390, and $28,319 and $99,632, respectively. NOTE 8  INVENTORIES Inventories at September 30, 2004 and December 31, 2003 are comprised as
follows: 2004
    
    2003Raw materials
    
    $
    13,465
    
    
    $
    9,852Work in process
    
    
    819
    
    
    
    1,017Finished goods, less reserve for obsolescence of $213
in 2004 and $214 in 2003
    
    
    1,235
    
    
    
    1,199$
    15,519
    
    
    $
    12,068
 7




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The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited) NOTE 9  INTANGIBLE ASSETS AND GOODWILL September 30, 2004
    
    December 31, 2003Gross
    
    Accumulated
    
    
    
    
    
    Gross
    
    AccumulatedAmount
    
    Amortization
    
    Net
    
    Amount
    
    Amortization
    
    NetIntangible assets subject to
amortization:Capitalized Software
    
    $
    1,191
    
    
    $
    411
    
    
    $
    780
    
    
    $
    1,179
    
    
    $
    282
    
    
    $
    897Customer Lists
    
    
    2,297
    
    
    
    494
    
    
    
    1,803
    
    
    
    2,247
    
    
    
    356
    
    
    
    1,891Patents
    
    
    1,494
    
    
    
    213
    
    
    
    1,281
    
    
    
    1,494
    
    
    
    147
    
    
    
    1,347Total
    
    $
    4,982
    
    
    $
    1,118
    
    
    $
    3,864
    
    
    $
    4,920
    
    
    $
    785
    
    
    $
    4,135
 Consolidated amortization expense related to intangible assets, excluding
goodwill, for each of the three and nine months ended September 30, 2004 and
2003 were $111 and $334. Estimated future aggregate annual amortization for
intangible assets is as follows: Period
    
    AmountThree months ended December 31, 2004
    
    $
    111Year ended December 31, 2005
    
    
    540Year ended December 31, 2006
    
    
    379Year ended December 31, 2007
    
    
    297Year ended December 31, 2008
    
    
    225Thereafter
    
    
    2,285
 The $14,226 of goodwill at September 30, 2004 is comprised of $8,123 related to
the Electronic Security Segment, $4,447 related to the Environmental Safety &
Security Segment and $1,656 related to the Software, Training & Simulation
Segment. The change in goodwill during the nine month period ended September
30, 2004 was due to the acquisition of Control Monitor Systems on August 1,
2004 ($449), final payment of the promissory note to SeaSpace according to the
acquisition agreement ($125), offset by the currency translation adjustment
($66). NOTE 10  NOTES PAYABLE AND CREDIT FACILITY Notes Payable At September 30, 2004, MECAR had borrowed $11,624 under its
lines of credit with its lenders. NS Microwave had a note of $64 for machinery
and vehicles. At December 31, 2003, MECAR had borrowed $4,322 under its lines
of credit with its lenders. In addition, MECAR borrowed $9,878 under a
short-term loan which was secured by a receivable of $9,878. The weighted
average interest rate for Notes Payable as of September 30, 2004 and December
31, 2003 was 3%. Credit Facility MECAR is obligated under an agreement (the Agreement),
executed March 2002, with its foreign banking syndicate that provides credit
facilities primarily for bank guarantees including performance bonds, letters
of credit and similar instruments required for specific sales contracts as well
as a line-of-credit for tax prepayments and working capital. The Agreement
provides for certain bank charges and fees as the facility is used, plus fees
of 2% of guarantees issued and quarterly fees at an annual rate of 1.25% of
guarantees outstanding. These fees are charged to interest expense. As of
September 30, 2004 and December 31, 2003, guarantees and performance bonds of
approximately $22,186 and $17,233 respectively, were outstanding. Advances under the Agreement are secured by restricted cash at September 30,
2004 and December 31, 2003 of approximately $8,928 and $15,812, respectively.
Amounts outstanding are also collateralized by a pledge of approximately
$42,472 of MECARs net assets. The Agreement requires that MECAR maintain net
worth and working capital covenants. 8




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The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited) NOTE 11  LONG-TERM DEBT Long-term obligations consist of the following as of September 30, 2004 and
December 31, 2003, respectively: 2004
    
    2003Notes payable, less unamortized discount and debt issue costs
    
    $
    1,147
    
    
    $
    Mortgage loan agreements
    
    
    271
    
    
    
    908Capital leases and other
    
    
    6.625
    
    
    
    6,703Total Long-Term Debt
    
    $
    8,043
    
    
    $
    7,611Less current maturities
    
    
    2,253
    
    
    
    2,709Long-Term Debt, less current maturities and unamortized
discount
    
    $
    5,791
    
    
    $
    4,902
 Notes payable.On May 28, 2004 the Company obtained a senior loan facility
from an accredited lender under which the Company may borrow up to $18,000 for
acquisitions and working capital. At closing, the Company borrowed $2,000 and
deposited $2,000 in a restricted account to secure the repayment. The facility
allows the Company to make additional draws under the facility under certain
conditions through November 28, 2005. All loans under the facility bear
interest at the rate of 11.5% per year payable monthly. Principal is paid in
sixty equal monthly payments commencing in late December 2005. The Company
pays a fee on the unused portion of the facility. Warrants (exercisable at
$0.01 per share) to purchase 4,000 shares of the Companys common stock were
issued at closing and were valued at $68. Additional warrants (at the rate of
2,000 for each $1 million loan) will be issued with future loan advances. The
facility includes certain financial and other covenants. The Company is
currently in compliance with those covenants. Mortgage loan agreements.The VSK Group is obligated on a mortgage on its
building, which has a balance of approximately $271 at September 30, 2004. The
mortgage is payable in annual installments of approximately $54 plus interest. Capital leases and other.The Company and its subsidiaries are also obligated
on various vehicle, equipment, capital lease obligations and other loans. The
notes and leases are generally secured by the assets acquired, bear interest at
rates ranging from 3.5% to 8.0% and mature at various dates through 2009. Scheduled annual maturities of long-term obligations as of September 30, 2004
are approximately as follows: Year
    
    Amount2005
    
    $
    2,2532006
    
    
    1,9902007
    
    
    1,4922008
    
    
    7482009
    
    
    246Thereafter
    
    
    1,314
 NOTE 12  CONVERTIBLE SUBORDINATED DEBENTURE On June 28, 2002 the Company sold to an accredited investor for $7,500 (i) an
8% subordinated debenture that is convertible into shares of the Companys
common stock at $25.00 per share and (ii) warrants to purchase 15,000 shares of
the Companys common stock at an exercise price of $28.75 per share in cash.
The debenture bears interest at the rate of 8% per year, payable semi-annually.
The Company may elect to pay the principal and/or the interest in cash or in
registered shares of its common stock at a 10% discount to the then current
market price. The warrants to purchase 15,000 shares of the Companys common
stock were valued at $140. 9




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited) NOTE 12  CONVERTIBLE SUBORDINATED DEBENTURE  Continued Monthly principal payments, in the amount of $750, began on June 28, 2004 and
continue for a period of ten (10) months or until March 28, 2005. The holder
of the debenture may choose to convert all or a portion of the principal amount
outstanding into shares of the Companys common stock at any time before
maturity. The Company has registered the shares of common stock that could be
issued in the event the holder elects to convert the debenture and exercise the
warrants. NOTE 13  EARNINGS PER SHARE Basic earnings per share exclude dilution and are computed by dividing net
earnings by the weighted average number of common shares outstanding for the
period. The computation of diluted earnings per share includes the effects of
stock options, warrants and convertible debenture, if such effect is dilutive.
The table below shows the calculation of basic and diluted earnings per share
for the three and nine months ended September 30, 2004 and September 30, 2003,
respectively: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net earnings
    
    $
    182
    
    
    $
    863
    
    
    $
    5,152
    
    
    $
    7,099Interest on convertible debenture, net of taxes
    
    
    0
    
    
    
    91
    
    
    
    194
    
    
    
    269Net earnings before interest on convertible debenture
    
    $
    182
    
    
    $
    954
    
    
    $
    5,346
    
    
    $
    7,368Weighted average number of basic shares
    
    
    5,565,871
    
    
    
    5,504,106
    
    
    
    5,557,623
    
    
    
    5,490,475Common stock equivalents
    
    
    401,102
    
    
    
    497,133
    
    
    
    452,234
    
    
    
    494,458Weighted average number of diluted shares
    
    
    5,966,973
    
    
    
    6,001,239
    
    
    
    6,009,857
    
    
    
    5,984,933Basic earning per share
    
    $
    .03
    
    
    $
    .16
    
    
    $
    .93
    
    
    $
    1.29Diluted earnings per share
    
    $
    .03
    
    
    $
    .16
    
    
    $
    .89
    
    
    $
    1.23
 NOTE 14  COMPREHENSIVE INCOME A summary of the components of Comprehensive Income for the three and nine
months ended September 30, 2004 and 2003 are as follows: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net earnings
    
    $
    182
    
    
    $
    863
    
    
    $
    5,152
    
    
    $
    7,099Currency translation adjustment
    
    
    1,664
    
    
    
    895
    
    
    
    (955
    )
    
    
    7,714Comprehensive income
    
    $
    1,846
    
    
    $
    1,758
    
    
    $
    4,197
    
    
    $
    14,813
 The currency translation adjustment for the three months ended September 2004
and the three and nine months ended September 2003 resulted from the
appreciation of the Euro during the respective periods. In contrast, the
currency translation adjustment for the nine months ended September 2004
resulted from the depreciation of the Euro during that period. 10




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited) NOTE 15  STOCK BASED COMPENSATION The Company currently accounts for stock options using the intrinsic value
method and is applying APB Opinion No. 25, Accounting for Stock Issued to
Employees.Accordingly, compensation costs for stock options is measured and
recorded as the excess, if any, of the quoted market price of the Companys
stock at the date of grant over the amount an employee must pay to acquire the
stock. Compensation cost for stock awards is recorded based on the quoted
market value of the Companys stock at the time of grant. No compensation cost
has been recognized for the granting of stock options to employees in the three
and nine months ended September 30, 2004 and 2003. The following table presents the pro forma decrease in income for the three and
nine months ended September 30, 2004 and 2003, that would have been recorded
had the fair values of options granted been recognized as compensation expense
on a straight-line basis over the vesting period of the grant: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(Dollars in thousands, except per share amounts)
    
    2004
    
    2003
    
    2004
    
    2003Reported net earnings
    
    $
    182
    
    
    $
    863
    
    
    $
    5,152
    
    
    $
    7,099Stock-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
    
    
    (158
    )
    
    
    (118
    )
    
    
    (473
    )
    
    
    (353
    )Pro forma net earnings
    
    $
    24
    
    
    $
        745
    
    
    $
    4,679
    
    
    $
    6,746Basic earnings per share:Reported earnings per share
    
    $
    .03
    
    
    $
    .16
    
    
    $
    .93
    
    
    $
    1.29Compensation costs, net of tax
    
    
    (.03
    )
    
    
    (.02
    )
    
    
    (.09
    )
    
    
    (.06
    )Pro forma basic earnings per share
    
    $
    0
    
    
    $
    .14
    
    
    $
    .84
    
    
    $
    1.23Diluted earnings per share:Reported earnings per share
    
    $
    .03
    
    
    $
    .16
    
    
    $
    .89
    
    
    $
    1.23Compensation costs, net of tax
    
    
    (.03
    )
    
    
    (.02
    )
    
    
    (.08
    )
    
    
    (.06
    )Pro forma diluted earnings per share
    
    $
    0
    
    
    $
    .14
    
    
    $
    .81
    
    
    $
    1.17
 Options granted during the three and nine months ended September 30, 2004 were
0 and 40,000, respectively. Options granted during the three and nine months
ended September 30, 2003 were 39,000 and 149,000, 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 and nine months ended September 30, 2004 was $0 and
$7.59, respectively. The weighted-average fair value of each option at the
date of grant for the three and nine months ended September 30, 2003 was $7.37
and $6.72, respectively. The weighted average assumptions used in the model
were as follows: Three Months Ended September 30
    
    Nine Months Ended September 302004
    
    2003
    
    2004
    
    2003Risk free interest rate
    
    
    2.86
    %
    
    
    2.86
    %
    
    
    2.86
    %
    
    
    2.86
    %Expected volatility rate
    
    
    47.00
    %
    
    
    47.00
    %
    
    
    47.00
    %
    
    
    47.00
    %Expected lives  years
    
    
    3
    
    
    
    3
    
    
    
    3
    
    
    
    3Divided yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 11




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited) NOTE 15  STOCK BASED COMPENSATION  Continued The weighted average assumptions were consistent between 2003 and 2004 and will
be evaluated prior to the publication of the next Form 10-K. We do not believe
that the factors used above have changed materially over the past twelve
months. The pro forma amounts may not be representative of future amounts
since the estimated fair value of stock options is amortized to expense over
the vesting period, and additional options may be granted in future periods. NOTE 16  INDUSTRY SEGMENTS Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues from external customersOrdnance & Manufacturing
    
    $
    23,089
    
    
    $
    25,670
    
    
    $
    78,462
    
    
    $
    91,655Electronic Security
    
    
    12,497
    
    
    
    7,748
    
    
    
    33,386
    
    
    
    22,187Environmental Safety & Security
    
    
    1,407
    
    
    
    1,414
    
    
    
    4,654
    
    
    
    5,229Software, Training & Simulation
    
    
    149
    
    
    
    39
    
    
    
    335
    
    
    
    1,180$
    37,142
    
    
    $
    34,871
    
    
    $
    116,837
    
    
    $
    120,251Segment profit before taxesOrdnance & Manufacturing
    
    $
    (87
    )
    
    $
    463
    
    
    $
    6,859
    
    
    $
    12,190Electronic Security
    
    
    2,020
    
    
    
    640
    
    
    
    5,077
    
    
    
    635Environmental Safety & Security
    
    
    (1,182
    )
    
    
    (271
    )
    
    
    (2,364
    )
    
    
    (608
    )Software, Training & Simulation
    
    
    (177
    )
    
    
    (167
    )
    
    
    (517
    )
    
    
    (58
    )Corporate and Other
    
    
    (586
    )
    
    
    (40
    )
    
    
    (1,182
    )
    
    
    (862
    )$
    (12
    )
    
    $
    625
    
    
    $
    7,873
    
    
    $
    11,297
 NOTE 17  COMMITMENTS AND CONTINGENCIES A suit has been filed against one of the VSK subsidiaries in the Belgian courts
alleging a breach of a non-compete clause within a teaming agreement executed
with a claimant in prior years. Management intends to vigorously defend this
suit and believes that it has meritorious defense to the claim. SeaSpace is in litigation with a former distributor concerning certain aspects
of the termination of the distributor relationship. The former distributor has
filed to obtain a preliminary injunction action in Japan concerning the
termination. SeaSpace has filed an action for monetary damages in California
and the former distributor has filed a similar action for monetary damages in
Japan. The California court has recently ruled that the matter should be
resolved in an international arbitration proceeding. Management continues to
vigorously defend these matters and believes that it has a meritorious
position. NOTE 18  RECENT ACCOUNTING PRONOUNCEMENTS There were no new accounting pronouncements during the nine months ended
September 30, 2004 that would impact the Companys financial reporting. 12




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) The following is intended to update the information contained in the Companys
Annual Report on Form 10-K for the year ended December 31, 2003 and the
Companys Quarterly Reports on Form 10-Q for the periods ended March 31, 2004
and June 30, 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 initially pursue contracts from U.S. and foreign governments for
ammunition and pyrotechnics devices. MECAR USA is expected to be
operational in early 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 manufacturers 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. The parent company provides management services to its subsidiaries and has no
operating activities. Allied earned net profits of
$182 and $5,152 for the three and nine months
ended September 30, 2004, respectively, compared to net profits of $863 and
$7,099 for the comparable periods of 2003. The reduction in net profits for
the nine months ended September 30, 2004 resulted from reduced revenues,
Sarbanes Oxley compliance costs  primarily from consulting and associated
costs, and substantial research and development initiatives to expand its
product offerings, increase market share in existing markets, and penetrate new
markets. Allied entered 2004 with substantial cash reserves and anticipates no liquidity
concerns in 2004. Allied has secured a senior domestic lending facility for
working capital and acquisitions. 13




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations for the Three Months Ended September 30, 2004 and 2003 The table below shows, for the three months ended September 30, 2004 and 2003,
certain items from Allieds condensed consolidated statements of earnings
expressed as a percentage of revenue: Three months ended September 30,2004
    
    2003Revenue
    
    $
    37,142
    
    
    
    100.0
    %
    
    $
    34,871
    
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    28,062
    
    
    
    75.6
    
    
    
    26,972
    
    
    
    77.4Selling and administrative
    
    
    6,010
    
    
    
    16.1
    
    
    
    5,259
    
    
    
    15.1Research and development
    
    
    2,031
    
    
    
    5.5
    
    
    
    1,545
    
    
    
    4.4Operating income
    
    
    1,039
    
    
    
    2.8
    
    
    
    1,095
    
    
    
    3.1Other income (expense)Interest income
    
    
    140
    
    
    
    0.4
    
    
    
    123
    
    
    
    0.4Interest expense
    
    
    (717
    )
    
    
    (1.9
    )
    
    
    (547
    )
    
    
    (1.6
    )Other  net
    
    
    (474
    )
    
    
    (1.3
    )
    
    
    (46
    )
    
    
    (0.1
    )Earnings (loss)
before income taxes
    
    
    (12
    )
    
    
    (0.0
    )
    
    
    625
    
    
    
    1.8Income tax (benefit) expense
    
    
    (194
    )
    
    
    (0.5
    )
    
    
    (238
    )
    
    
    (0.7
    )Net earnings
    
    $
    182
    
    
    
    0.5
    %
    
    $
    863
    
    
    
    2.5
    %
 Revenue.Allied had revenue of $37,142 in the three months ended September 30,
2004, which was 7% higher than its revenue in the same period of 2003. This
increase was principally attributable to higher distribution sales and
increased activities at the VSK Group and NS Microwave and the increase in the
value of the Euro. Revenue by SegmentThree Months Ended
    
    Three Months EndedSeptember 30, 2004
    
    September 30, 2003Percentage
    
    
    
    
    
    PercentageAmount
    
    of total
    
    Amount
    
    of totalOrdnance & Manufacturing
    
    $
    23,089
    
    
    
    62
    %
    
    $
    25,670
    
    
    
    74
    %Electronic Security
    
    
    12,497
    
    
    
    34
    %
    
    
    7,748
    
    
    
    22
    %Environmental Safety & Security
    
    
    1,407
    
    
    
    4
    %
    
    
    1,414
    
    
    
    4
    %Software, Training & Simulation
    
    
    149
    
    
    
    
    %
    
    
    39
    
    
    
    
    %$
    37,142
    
    
    
    100
    %
    
    $
    34,871
    
    
    
    100
    %
 Ordnance & Manufacturing Segment revenue for the third quarter of 2004
decreased by 10% from the comparable 2003 period. The entire decrease occurred
at MECAR and resulted primarily from two factors. First, MECAR experienced
raw material delays, which was due in turn to unanticipated increases in order
lead times. MECAR expects to make up the revenue in the fourth quarter.
Second, the 2003 period was benefited by substantial activity under the
approximately $130,000 Foreign Military Sales (FMS) contract which is in its
final stages and did not provide as much revenue in the current period. While
MECAR continues to meet the ammunition needs of its traditional customers, it
is actively seeking to diversify its customer base. 14




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations for the Three Months Ended September 30, 2004 and 2003 -
Continued Electronic Security Segment revenue for the third quarter of 2004 increased by
$4,749, or 61%, over the 2003 period due to increases at both NS Microwave and
the VSK Group. Approximately $4,622 of the increase was from NS Microwave as
it has begun to obtain long-awaited orders for its security products. A
substantial portion of NS Microwaves increased revenue was attributable to new
U.S. government contracts received in 2004. The increase at the VSK Group
stemmed from the continued expansion of its distribution network in Europe, as
well as its strong marketing and business development efforts. Environmental Safety & Security Segment revenues for the third quarter of 2004
decreased slightly from the comparable 2003 period. SeaSpace continues to
suffer from increased competition by domestic and foreign competitors. Software, Training & Simulation Segment revenues for the third quarter of 2004
increased from the comparable 2003 period. Titan Dynamics sales of its Battle
Effects Simulators (BES) continue to be depressed pending safety certifications
expected in late 2004 or early 2005 from the U.S. Navy/Marine Corps and the
U.S. Army. Accordingly, Titan Dynamics revenue is now largely comprised of
cartridge sales for previously sold simulators and new E-pyro products used for
military and law enforcement training. Cost of Sales.Cost of sales as a percentage of sales for the three months
ended September 30, 2004 was 75% compared with 77% for the same period in 2003. Cost of Sales as Percentage of Sales by Segment Three months endedSeptember 302004
    
    2003Ordnance & Manufacturing
    
    
    84
    %
    
    
    84
    %Electronic Security
    
    
    59
    %
    
    
    53
    %Environmental Safety & Security
    
    
    78
    %
    
    
    67
    %Software, Training & Simulation
    
    
    62
    %
    
    
    75
    %Total
    
    
    75
    %
    
    
    77
    %
 Ordnance & Manufacturing Segment cost of sales as a percentage of sales for the
three months ended September 30, 2004 was consistent with the same period of
2003. Electronic Security Segment cost of sales as a percentage of sales for the
three months ended September 30, 2004 increased over the same period in 2003
due to higher NS Microwave material costs associated with using new product
components to fulfill customer requirements as well as replacing components
which were discontinued by certain vendors. In contrast, the VSK Group had
consistent cost of sales as a percentage of sales between 2003 and 2004 as it
continues to experience production efficiencies while expanding its
distribution channel throughout Europe. Environmental Safety & Security Segment cost of sales as a percentage of sales
increased from 2003 as a result of the change in product mix and higher labor
costs. Software, Training & Simulation Segment cost of sales as a percentage of sales
for the three months ended September 30, 2004 decreased from 2003 as a result
of the change in product mix and production efficiencies. 15




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations for the Three Months Ended September 30, 2004 and 2003 -
Continued Selling and Administrative Expenses.Selling and administrative expenses as a
percentage of sales for the three months ended September 30, 2004 was slightly
higher than 2003 levels due to several factors. The parent companys selling
and administrative expenses increased in 2004 primarily as a result of the
Sarbanes Oxley implementation via consulting and associated costs. The Company
will continue to incur Sarbanes Oxley compliance expenses for the remainder of
2004 and into 2005. SeaSpace incurred substantial legal expenses associated
with an ongoing dispute with a former distributor. Management continues to
vigorously defend these matters and believes that it has a meritorious
position. The VSK Group incurred higher compensation costs for administrative
personnel. MECAR, NS Microwave and Titan Dynamics incurred slightly lower
costs in the third quarter of 2004 from the same period in 2003. In
particular, NS Microwaves administrative costs in 2003 were burdened with
compensation charges associated with production personnel, which did not recur
in 2004. Research and Development.Research and development costs increased for the
three months ended September 30, 2004 by 31% over 2003 levels. The increase
was attributed to increased research and product development being conducted at
SeaSpace and Titan Dynamics. SeaSpace has announced that it will begin to
manufacture and sell antennas. This trend of increased research and
development is expected to continue. Interest Income.Interest income increased for the three months ended
September 30, 2004 by 13% from 2003 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 secure the repayment. Interest Expense.Interest expense for the three months ended September 30,
2004 increased by 31% over 2003 levels due to the amortization of debt discount
and 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. Other-net expense for the three months ended
September 30, 2004 increased over the comparable 2003 period primarily from
currency losses at MECAR related to unhedged foreign contracts. Pre-Tax Profit Pre-Tax Profit (Loss) by Segment Three months endedSeptember 302004
    
    2003Ordnance & Manufacturing
    
    $
    (87
    )
    
    $
    463Electronic Security
    
    
    2,021
    
    
    
    640Environmental Safety & Security
    
    
    (1,182
    )
    
    
    (271
    )Software, Training & Simulation
    
    
    (177
    )
    
    
    (167
    )Corporate and other
    
    
    (587
    )
    
    
    (40
    )$
    (12
    )
    
    $
    625
 16




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations for the Three Months Ended September 30, 2004 and 2003 -
Continued Ordnance & Manufacturing Segment incurred a pre-tax loss of $87 for the three
months ended September 30, 2004 versus a pre-tax profit of $463 for the
comparable period in 2003. The pre-tax loss was principally due to production
delays which lowered third quarter revenues and margins. The lower margins did
not cover the operating expenses, even though MECAR took actions to mitigate
the production delays through some costs savings. MECAR expects to make up the
revenues in the fourth quarter. Notwithstanding, MECARs profitability for
2004 is expected to be at lower levels than in prior years due to a lack of
substantially higher margin contracts which benefited 2001-2003 results. Electronic Security Segment pre-tax profit for the three months ended September
30, 2004 increased from the comparable period in 2003. The increase stemmed
from NS Microwaves higher business activity, largely from U.S. government
contracts. The VSK Groups pre-tax profit was materially consistent between
third quarter 2003 and 2004. Environmental Safety & Security Segment pre-tax loss resulted from increased
development costs associated with new antenna products expected to be available
for sale in 2005 and substantial legal expenses associated with an ongoing
dispute with a former distributor. SeaSpace has taken efforts to right-size
its organization in light of the competitive environment. Software, Training & Simulation Segment pre-tax loss in 2004 results from Titan
Dynamics principal product lacking U.S. Government safety certification.
Titan Dynamics anticipates receipt of Navy/Marine Corp certification in the
fourth quarter of 2004 or early 2005. Corporate and other Segment pre-tax loss for the three months ended September
30, 2004 increased from the 2003 level due to Sarbanes Oxley implementation
costs and reduced intercompany management fee adjustments. Income Taxes.The tax benefit for the three months ended September 30, 2004
was substantially greater than the pre-tax loss. Net
Earnings.The Company earned a $182 net profit for the three months ended
September 30, 2004 compared with $863 net profit in the same period of 2003.
The decrease in 2004 resulted principally from the activities at MECAR,
SeaSpace and Titan Dynamics. 17




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations for the Nine Months Ended September 30, 2004 and
2003 The table below shows, for the nine months ended September 30, 2004 and 2003,
certain items from Allieds condensed consolidated statements of earnings
expressed as a percentage of revenue: Nine months ended September 30,2004
    
    2003Revenue
    
    $
    116,837
    
    
    
    100.0
    %
    
    $
    120,251
    
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    82,909
    
    
    
    71.0
    
    
    
    86,578
    
    
    
    72.0Selling and administrative
    
    
    18,358
    
    
    
    15.7
    
    
    
    17,553
    
    
    
    14,6Research and development
    
    
    5,408
    
    
    
    4.6
    
    
    
    3,302
    
    
    
    2.7Operating income
    
    
    10,162
    
    
    
    8.7
    
    
    
    12,818
    
    
    
    10.7Other income (expense)Interest income
    
    
    334
    
    
    
    0.3
    
    
    
    351
    
    
    
    0.3Interest expense
    
    
    (1,715
    )
    
    
    (1.5
    )
    
    
    (1,506
    )
    
    
    (1.3
    )Other  net
    
    
    (908
    )
    
    
    (0.8
    )
    
    
    (366
    )
    
    
    (0.3
    )Earnings before
income taxes
    
    
    7,873
    
    
    
    6.7
    
    
    
    11,297
    
    
    
    9.4Income tax expense
    
    
    2,721
    
    
    
    2.3
    
    
    
    4,198
    
    
    
    3.5Net earnings
    
    $
    5,152
    
    
    
    4.4
    %
    
    $
    7,099
    
    
    
    5.9
    %
 Revenue. Allied had revenue of $116,837 in the nine months ended September 30, 2004,
which was 3% lower than its revenue in the same period of 2003. This decrease
was principally attributable to reduced production activities at MECAR,
SeaSpace and Titan Dynamics, offset by the increase in the value of the Euro. Revenue by SegmentNine Months Ended
    
    Nine Months EndedSeptember 30, 2004
    
    September 30, 2003Percentage
    
    
    
    
    
    PercentageAmount
    
    of total
    
    Amount
    
    of totalOrdnance & Manufacturing
    
    $
    78,462
    
    
    
    67
    %
    
    $
    91,655
    
    
    
    76
    %Electronic Security
    
    
    33,386
    
    
    
    29
    %
    
    
    22,187
    
    
    
    19
    %Environmental Safety & Security
    
    
    4,654
    
    
    
    4
    %
    
    
    5,229
    
    
    
    4
    %Software, Training & Simulation
    
    
    335
    
    
    
    
    %
    
    
    1,180
    
    
    
    1
    %$
    116,837
    
    
    
    100
    %
    
    $
    120,251
    
    
    
    100
    %
 Ordnance & Manufacturing Segment revenue for the nine months ended September
30, 2004 decreased by 14% from the comparable period in 2003. The decrease was
the result of reduced activity on the large FMS contract received in February
2002 and production delays encountered during the third quarter of 2004. 18




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations for the Nine Months Ended September 30, 2004 and
2003 Electronic Security Segment revenue for the nine months ended September 30,
2004 increased by $11,199 over the comparable period in 2003. The VSK Group
and NS Microwave contributed $2,673 and $8,526 to this increase, respectively.
The increase at the VSK Group is principally the result of continued expansion
of its export sales via its European distribution network. NS Microwaves
business has improved due to receipt of some substantial U.S. government orders
in 2004. Environmental Safety & Security Segment revenues for the nine months ended
September 30, 2004 decreased by $575 from the comparable period in 2003 as a
result of increased competition and delayed projects as noted above. Software, Training & Simulation Segment revenues for the nine month ended
September 30, 2004 decreased by $845 from the comparable period in 2003 due to
reduced simulator sales. Cost of Sales.Cost of sales as a percentage of sales for the nine months
period ended September 30, 2004, was 71% compared with 72% for the same period
in 2003. Cost of Sales as Percentage of Sales by Segment Nine months endedSeptember 302004
    
    2003Ordnance & Manufacturing
    
    
    77
    %
    
    
    76
    %Electronic Security
    
    
    58
    %
    
    
    54
    %Environmental Safety & Security
    
    
    64
    %
    
    
    66
    %Software, Training & Simulation
    
    
    64
    %
    
    
    60
    %Total
    
    
    71
    %
    
    
    72
    %
 Ordnance & Manufacturing Segment cost of sales as a percentage of sales was
materially consistent between the nine months ended September 30, 2004 and
2003. Electronic Security Segment cost of sales as a percentage of sales for the nine
months ended September 30, 2004 increased over the same period of 2003 due to
the higher NS Microwave material costs as noted above. Environmental Safety & Security Segment cost of sales as a percentage of sales
decreased from 2003 as a result of the change in product mix and streamlined
labor costs Software, Training & Simulation Segment cost of sales as a percentage of sales
for the nine months ended September 30, 2004 increased over 2003 as a result of
the change in product mix and higher labor costs 19




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations for the Nine Months Ended September 30, 2004 and
2003 Selling and Administrative Expenses.Selling and administrative expenses as a
percentage of sales for the nine months ended September 30, 2004 was
approximately 16% compared with 15% for the same period in 2003. This resulted
from higher costs at Corporate, MECAR, the VSK Group and SeaSpace for Sarbanes
Oxley compliance costs and increased compensation expenses for administrative
personnel. This was offset by decreased costs at NS Microwave. In 2003, NS
Microwave administrative costs were burdened with compensation charges
associated with production personnel, which did not recur in 2004. Research and Development.Research and development costs increased for the
nine months ended September 30, 2004 by 64% over 2003 levels. A substantial
part of this increase relates to SeaSpaces development of antenna products.
This trend of increased research and development is expected to continue. Interest Income.Interest income decreased for the nine months ended September
30, 2004 by 5% from 2003 levels. The total dollar decrease was nominal and was
primarily attributed to earnings on interest bearing cash accounts. Interest Expense.Interest expense increased for the nine months ended
September 30, 2004 by 14% over 2003 levels. The increase was primarily due to
the total increase in long-term obligations. Other-Net.Other-net primarily represents currency gains/losses, resulting
from foreign currency transactions at MECAR and the VSK Group, as well as bank
charges related to MECARs performance bonds and advance payment guarantees,
which are generally required under the terms of MECARs contracts with foreign
governments and its distributor. Other-net expense for the nine months ended
September 30, 2004 increased over the comparable period of 2003 from currency
losses in 2004 at MECAR related to unhedged foreign contracts. Pre-Tax Profit Pre-Tax Profit (Loss) by Segment Nine months endedSeptember 302004
    
    2003Ordnance & Manufacturing
    
    $
    6,859
    
    
    $
    12,190Electronic Security
    
    
    5,077
    
    
    
    635Environmental Safety & Security
    
    
    (2,364
    )
    
    
    (608
    )Software, Training & Simulation
    
    
    (517
    )
    
    
    (58
    )Corporate and other
    
    
    (1,182
    )
    
    
    (862
    )$
    7,873
    
    
    $
    11,297
 Ordnance & Manufacturing Segment pre-tax profit for the first nine months of
2004 decreased from 2003 levels due to reduced work on the FMS contract and
production delays in the third quarter of 2004. Electronic Security Segment pre-tax profit for the period ended September 30,
2004 increased over 2003 levels due to increased business and increased margins
at both the VSK Group and NS Microwave. 20




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Results of Operations for the Nine Months Ended September 30, 2004 and
2003 Environmental Safety & Security Segment pre-tax loss for the nine months period
ended September 30, 2004 increased over the 2003 loss due to increased
development costs and higher legal expenses. Software, Training & Simulation Segment pre-tax loss for the period ended
September 30, 2004 resulted from reduced business awaiting necessary safety
certifications. Corporate and other pre-tax loss for the nine months ended September 30, 2004
was more than the comparable 2003 period due to Sarbanes Oxley compliance costs
and reduce intercompany fees. Income Taxes.The effective income tax rate in the first nine months of 2004
was 33% compared to 37% in the same period of 2003. This decrease occurred at
MECAR and the VSK Group. While the corporate tax rate in Belgium was reduced
from 40.17% to 33.99% effective for tax years beginning January 1, 2003, the
reduced tax rate did not take effect at MECAR and the VSK Group until the
second half of 2003. Net Earnings.The Company earned a $5,152 net profit for the nine months ended
September 30, 2004 compared with $7,099 net profit in the same period of 2003.
The decrease in 2004 resulted from the activities at MECAR, SeaSpace and Titan
Dynamics. Backlog.As of September 30, 2004, the Companys backlog was $83,831 compared
to $115,416 at December 31, 2003, and $108,268 at September 30, 2003. The
September 30, 2004 and December 31, 2003 amounts included unfunded portion from
an indefinite delivery, indefinite quantity (IDIQ) federal contract. Backlog by SegmentSeptember 30, 2004
    
    September 30, 2003Percentage
    
    
    
    
    
    PercentageAmount
    
    of total
    
    Amount
    
    Of totalOrdnance & Manufacturing
    
    $
    56,798
    
    
    
    68
    %
    
    $
    90,396
    
    
    
    83
    %Electronic Security
    
    
    24,796
    
    
    
    29
    
    
    
    15,582
    
    
    
    14Environmental Safety & Security
    
    
    1,498
    
    
    
    2
    
    
    
    1,632
    
    
    
    2Software, Training & Simulation
    
    
    739
    
    
    
    1
    
    
    
    658
    
    
    
    1$
    83,831
    
    
    
    100
    %
    
    $
    108,268
    
    
    
    100
    %
 The decrease in backlog is primarily the result of MECARs work on the
approximately $130,000 FMS multi-year contract awarded in February 2002. The
backlog associated with this particular contract will continue to decrease in
accordance with the delivery terms of the award. MECAR has undertaken a
customer diversification effort in the past few years, which continues to be
productive in 2004. In addition to meeting the ammunition needs of its
traditional customers, MECAR has gained new customers which have contributed to
a majority of its new orders for 2004. Electronic Security backlog increased
from new contracts received at the VSK Group and NS Microwave. Electronic
Securitys September 30, 2004 backlog includes an unfunded portion of
approximately $9,445 from an IDIQ federal contract. 21




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Liquidity and Capital Resources Balance Sheet The Companys September 30, 2004 condensed consolidated balance sheet was
affected by the value of the Euro. All European values were converted at the
September 30, 2004 and December 31, 2003 conversion ratios of 1.2331 and
1.2557, respectively. Historically, the Companys positive cash flow from operations and available
credit facilities have provided adequate liquidity and working capital to fully
fund the Companys operational needs. Working capital, which includes
restricted cash, was $78,081 at September 30, 2004, which is an increase of
$1,201 from the December 31, 2003, level. Working capital remains strong due to
profitable operations. Cash at September 30, 2004 decreased by $22,832 from December 31, 2003 as
substantial cash was expended in the first nine months of 2004 to repay current
liabilities including MECARs short-term borrowings. Restricted cash decreased
by $5,009 in the first nine months of 2004 due to completion of certain
contracts at MECAR, offset by the $2,000 deposit required under the senior loan
facility obtained on May 28, 2004. Accounts receivable at September 30, 2004 increased by $9,908, or 34% from
December 31, 2003, due to higher shipments in third quarter 2004 versus fourth
quarter 2003. Costs and accrued earnings on uncompleted contracts decreased by
$589 from year-end 2003 primarily as a result of continued work on MECAR
contracts. Inventories increased $3,451 primarily from higher raw material
purchases. The inventory buildup will give the subsidiaries the ability to
deliver products with the shortest possible lead times. Fair value of foreign
exchange contracts was $5,249 at September 30, 2004, compared to $9,378 at
December 31, 2003. MECAR uses foreign currency hedge contracts to minimize the
foreign currency exposures that arise from sales contracts with certain foreign
customers. Prepaid and other current assets increased $3,599 primarily from costs on
MECARs hedge contract agreements, as well as prepaid taxes at MECAR in the
second quarter of 2004. Property, Plant & Equipment, net of accumulated depreciation, increased
primarily from equipment purchases at the business units during the first nine
months of 2004. Intangibles decreased primarily from the amortization of
capitalized software, customer lists and patents. Goodwill increased as a
result of the acquisition of Control Monitor Systems on August 1, 2004 as well
as the currency translation adjustment. Notes Payable decreased $2,512 from December 31, 2003 as a result of MECAR
paying off a short-term loan. During the first nine months of 2004, MECAR used
its cash from operations for working capital needs. Accounts payable decreased
$13,234 as a result of lower production costs, primarily at MECAR, for the nine
months ended September 30, 2004 compared to December
2003. Accrued liabilities decreased $1,687 due primarily to the
costs associated with deferred gains related to forward exchange contracts at
MECAR.
Customer deposits increased $3,527 primarily at MECAR as a result of shipments
during the period and other new contracts in 2004 requiring deposits. Income
taxes increased $3,451 due to the tax provisions at MECAR and the VSK Group,
offset by the tax benefits at NS Microwave, SeaSpace, Titan Dynamics and
Corporate. Convertible-subordinated debenture, current and long-term, decreased from
December 31, 2003 to September 30, 2004 as the Company commenced its monthly
principal payments on June 28, 2004. Monthly payments will continue through
March 2005. Stockholders equity as of September 30, 2004, was negatively affected by the
reduction in the value of the Euro versus the U.S. dollar during the first nine
months of 2004, resulting in a decrease in accumulated other comprehensive
income by $955. The Euro depreciated by approximately 2% since the beginning
of the year. 22




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Liquidity and Capital Resources  Continued Cash Flows The table below provides the summary cash flow data for the periods presented. Nine months ended September 302004
    
    2003Net cash provided by (used in) operating activities
    
    $
    (18,304
    )
    
    $
    13,328Net cash used in investing activities
    
    
    (5,332
    )
    
    
    (4,454
    )Net cash provided by (used in) financing activities
    
    
    1,354
    
    
    
    (122
    )
 Operating Activities.The Company used $18,304 of cash in its operating
activities during the nine months ended September 30, 2004 whereas it generated
$13,228 of cash during the same period of 2003. This is attributed primarily
to three factors. First, the Companys earnings were less in 2004 than in
2003. Second, the Company paid short term liabilities, which included Sarbanes
Oxley compliance costs and legal costs associated with an ongoing dispute.
Third, the Company incurred higher accounts receivable from shipments to
customers in 2004 for which cash was not yet received as of September 30, 2004.
Cash paid for interest was $980 and $896, for the nine months ended September
30, 2004 and 2003, respectively. Cash paid for income taxes was $6,170 and
$8,957 for the nine months ended September 30, 2004 and 2003, respectively, and
includes federal, international and state taxes. Investing Activities.Net cash used in investing activities increased by 20%
between the two periods. This stemmed from higher capital expenditures for
production equipment and leasehold improvements at the Belgian business units.
The Company anticipates that cash generated from operations will be sufficient
to support any further capital expenditures over the remainder of the year.
Future expenditures for the remainder of the year will be primarily incurred
for machinery and equipment. Financing Activities.The Company generated $1,354 of cash from its financing
activities during the nine months ended September 30, 2004 whereas it used $122
of cash during the same period of 2003. This stemmed from proceeds of
long-term debt, in particular the senior secured facility, as well as a
decrease in restricted cash. This was offset by payment of short-term
borrowings, which primarily pertained to MECAR operations, and initial
repayments of the convertible debenture. Allied.The parent company continues to operate based on fees and dividends
received from its subsidiaries. In the third quarter of 2004, Allied has made
cash infusions to NS Microwave, Titan Dynamics and SeaSpace to support working
capital requirements. On May 28, 2004 the Company obtained a senior loan
facility under which the Company may borrow up to $18,000 for acquisitions and
working capital. At closing, the Company borrowed $2,000 and deposited $2,000
in a restricted account to secure the repayment. The facility allows the
Company to make additional draws under the facility under certain conditions
through November 28, 2005. All loans under the facility bear interest at the
rate of 11.5% per year payable monthly. Principal is paid in sixty equal
monthly payments commencing in late December 2005. The Company pays a fee on
the unused portion of the facility. Warrants (exercisable at $0.01 per share)
to purchase 4,000 shares of the Companys common stock were issued at closing
and were valued at $68. Additional warrants (at the rate of 2,000 for each $1
million loan) will be issued with future loan advances. The facility includes
certain financial and other covenants. The Company is currently in compliance
with those covenants. 23




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Liquidity and Capital Resources  Continued 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 September 30, 2004, MECAR
was in compliance with both of these bank covenants. MECARs obligations under
the bank syndicate agreement continue to be collateralized by a pledge of
MECARs assets. The agreement includes Allieds pledge to support MECAR so
that it remains in compliance with its total borrowing obligations. VSK Group.The VSK Group operated solely from cash generated from business
operations. The VSK Group is obligated on several mortgages and other
long-term obligations. Other Subsidiaries.NS Microwave, Titan Dynamics and SeaSpace operated from
cash generated from operations and cash infusions by Allied. Stock Repurchases.The Company did not repurchase any shares of its common
stock during the nine months ended September 30, 2004 and does not anticipate
repurchasing shares of Company stock during the remainder of 2004. Future Liquidity.The Company is exploring additional financing in light of
its repayment of the convertible debenture. At times, the Company has utilized
the services of an Investment Banker in an attempt to secure appropriate
financing. Funds for the build-out of the initial MECAR USA infrastructure are being
provided by the Marshall Economic Development Corporation of Marshall, Texas.
This is a state funded organization with the initial proceeds directed at
creating roads and a manufacturing plant on the grounds. The Companys ability to cover its anticipated future operating and capital
requirements is dependent upon its continued ability to generate positive cash
flow from the operations of its subsidiaries, particularly the operations of
MECAR and the VSK Group, and its ability to successfully integrate its
acquisitions. The Company expects its acquisitions to be accretive to
operations over a period of not longer than 24 months, although this cannot be
assured. This will depend upon many factors including the successful release
of new product offerings, successful research and development efforts, and
increased market share. Off-Balance Sheet Arrangements.As part of our ongoing business, we do not
participate in transactions that generate relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance or special purpose entities (SPEs), which would have been
established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes. As of September 30, 2004, we
are not involved in any material unconsolidated SPE transactions. MECAR is
required to provide performance bonds and advance payment guarantees for
certain contracts, which are provided by MECARs bank syndicate. MECAR is
obligated to repay the bank syndicate any amounts it pays as a result of any
demands on the bonds or guarantees. To date, there have never been any such
demands. 24




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited) Critical Accounting Policies Our significant accounting policies are described in Note A to the consolidated
financial statements included in Item 7 of the Form 10-K for the year ended
December 31, 2003, and are outlined below:  
    
    Revenue recognition via the percentage of completion method.The
percentage of completion method is used by MECAR, NS Microwave and
SeaSpace for their fixed price sales contracts. Approximately 82% and
81% of condensed consolidated revenue was recognized under the
percentage of completion method during the three and nine months ended
September 30, 2004, respectively. Approximately 81% and 83% of
condensed consolidated revenue was recognized under the percentage of
completion method during the three and nine months ended September 30,
2003, respectively.
    
    Goodwill and intangible asset valuation.The Company completed a
goodwill impairment analysis in the fourth quarter of 2003 and
determined that an impairment charge to earnings was not required. As
required by the accounting rules, the Company will perform a similar
review in the fourth quarter of 2004.
    
    Inventory reserves and allowance for doubtful accounts.The Company
reviews its recorded inventory and estimates a write-down for obsolete
or slow-moving items to their net realizable value. Allowances for
doubtful accounts are evaluated based upon detailed analysis and
assessment of receivables that may not be collected in the normal
course of operations. The inventory reserves and allowance for
doubtful accounts are deemed reasonable.
    
    Valuation of deferred income taxes and income tax reserves.The
Company is subject to taxation by federal, state and international
jurisdictions. The Company reviews the balances on a quarterly basis
and believes the balances are adequate. Forward-Looking Statements This Managements Discussion and Analysis contains forward-looking statements
that are based on current expectations, estimates and projections about the
Company and the industries in which it operates. In addition, other written or
oral statements which constitute forward-looking statements may be made by or
on behalf of the Company. Words such as expects, anticipates, intends,
plans, believes, seeks, estimates, or variations of such words and
similar expressions are intended to identify such forward-looking statements.
These statements are not guarantees of future performance and involve certain
risks, uncertainties and assumptions (Future Factors) which are difficult to
predict. Therefore, actual outcomes and results may differ materially from
what is expressed or forecast in such forward-looking statements. The Company
undertakes no obligation to update publicly any forward-looking statements,
whether as a result of new information, future events or otherwise. 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; 25




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##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  
    
    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. 26




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##### 



The Allied Defense Group, Inc. September 30, 2004 
 QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE At
September 30, 2004, Allied had $31 million of cash (including restricted
cash). Assuming all the cash was available for investment, a 1% change in
interest rates would impact interest income for the three and nine months ended
September 30, 2004 and 2003 by $0.08 million and $0.24 million and $0.09
million and $0.27, respectively. Approximately 86% and 92% of the Companys revenue for the nine months ended
September 30, 2004 and 2003, respectively, were derived from operations outside
the U.S. Accordingly, exposure exists to potentially adverse movement in
foreign currency rates. It is estimated that a 10% change in the value of the
Euro would impact reported net earnings for the three and nine months ended
September 30, 2004 and 2003 by approximately $0.10 million and $0.75 million
and $0.14 million and $1.02 million, respectively. 
 DISCLOSURE CONTROLS AND PROCEDURES  1.
    
    Evaluation of disclosure controls and proceduresUnder the direction and with the participation of the Companys management,
including the Companys Chief Executive Officer and Chief Financial Officer,
the Company carried out an evaluation of the effectiveness of the design and
operation of its disclosure controls and procedures pursuant to Exchange Act
Rule 13a-15 as of the end of the period covered by the report. Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Companys disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Exchange Act of 1934 (i) is
recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commissions rules and forms and
(ii) is accumulated and communicated to the Companys senior management to
allow timely decisions regarding required disclosure.2.
    
    Changes in internal controlsThere have been no significant changes in our internal controls over
financial reporting or, to our knowledge, in other factors that could
significantly affect our internal control over financial reporting
subsequent to the date we conducted the above-described evaluation. We are
currently reviewing the new internal controls documentation and attestation
requirements regarding Rule 404 of the Sarbanes Oxley Act of 2002. We have
retained an independent consulting firm to assist us in evaluating and
improving our internal controls. We are confident that we will fully comply
with such requirements by December 31, 2004. 27




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##### 



The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
September 30, 2004 
 Item 1 Legal Proceedings See Note 17 to the Condensed Consolidated Financial Statements. 
 Item 6 Exhibits Exhibit No.
    
    Description of Exhibits3.1
    
    Certificate of Incorporation, as amended (Incorporated by reference
from Form 10-Q filed in August 2002).3.2
    
    Amended and Restated By-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).
 28




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The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
September 30, 2004 Exhibit No.
    
    Description of Exhibits10.13
    
    Employee Stock Purchase Plan, as amended (Incorporated by
reference from Form 10-Q filed in November 2002).10.14
    
    Lease Agreement, as amended (Incorporated by reference from Form
10-Q filed in November 2002).10.15
    
    Form of Indemnity Agreement for Directors and Executive Officers
(Incorporated by reference from Form 10-Q filed in November 2002).10.16
    
    International Distribution Agreement (Incorporated by reference
from Form 10-Q filed in November 2002).10.17
    
    Deferred Compensation Plan for Non-Employee Directors
(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
    
    Stock Option Agreement-Employee Form.10.20
    
    Directors Stock Option Agreement-Director Form.21
    
    List of Subsidiaries (Incorporated by reference from Form 10-K filed in March 2004).23
    
    Consent of Independent Certified Public Accountants (Incorporated
by reference from Form 10-K filed in March 2004).31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 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.
 29




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The Allied Defense Group, Inc. 
 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. THE ALLIED DEFENSE GROUP, INC./s/ Charles A. HasperDate:  November 9, 2004
    Charles A. Hasper,Chief Financial Officer and Treasurer 30