##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-Q/A
 QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2006
 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)
  o þ
  þ o
  o þ




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##### 




    
    Part I  Item 1  Financial Statements
    
    Part I  Item 2  Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    Part I  Item 3  Quantitative and Qualitative Market Risk Disclosure
    
    Part I  Item 4  Disclosure Controls and Procedures; and
    
    Part II  Item 6  Exhibits and Reports on Form 8-K
  The ALLIED DEFENSE GROUP, INC.Date: March 20, 2007
    /s/ John J. MarcelloJohn J. MarcelloChief Executive Officer and
President




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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, 2006 and December 31, 2005
    
    
    1Condensed Consolidated Statements of Operations Three and nine months ended September 30,
2006 and 2005
    
    
    3Condensed
Consolidated Statements of Stockholders Equity and
Comprehensive Income
    
    
    4Condensed Consolidated Statements of Cash Flows Nine months ended September 30, 2006 and 2005
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3. Quantitative and Qualitative Market Risk Disclosure
    
    
    38Item 4. Disclosure Controls and Procedures
    
    
    38PART II. OTHER INFORMATIONItem 6. Exhibits
    
    
    39Signatures
    
    
    39




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Thousands of Dollars, except per share data)
 September 30,
    
    
    December 31,2006
    
    
    2005 (a)RESTATEDASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    20,024
    
    
    $
    7,803Restricted cash
    
    
    9,526
    
    
    
    7,428Accounts receivable
    
    
    16,248
    
    
    
    18,547Costs and accrued earnings on uncompleted contracts
    
    
    33,209
    
    
    
    35,178Inventories
    
    
    29,458
    
    
    
    34,300Deferred tax asset
    
    
    3,048
    
    
    
    2,696Fair value of foreign exchange contracts
    
    
    
    
    
    
    5Prepaid and other current assets
    
    
    7,936
    
    
    
    8,339Total current assets
    
    
    119,449
    
    
    
    114,296PROPERTY, PLANT AND EQUIPMENT net of accumulated depreciation
    
    
    32,188
    
    
    
    29,826OTHER ASSETSIntangibles, net of accumulated amortization
    
    
    12,267
    
    
    
    13,353Goodwill
    
    
    17,462
    
    
    
    16,698Deferred tax asset, non-current
    
    
    10,058
    
    
    
    5,672Other assets
    
    
    2,146
    
    
    
    1,101Total other assets
    
    
    41,933
    
    
    
    36,824TOTAL ASSETS
    
    $
    193,570
    
    
    $
    180,946
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
 1




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Thousands of Dollars, except per share data)
 September 30,
    
    
    December 31,2006
    
    
    2005RESTATEDLIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESBank overdraft facility
    
    $
    18,133
    
    
    $
    15,086Current maturities of long-term debt
    
    
    10,611
    
    
    
    4,342Accounts payable
    
    
    16,100
    
    
    
    31,004Accrued liabilities
    
    
    16,994
    
    
    
    15,097Customer deposits
    
    
    19,848
    
    
    
    9,956Fair value of foreign exchange contracts
    
    
    3
    
    
    
    1,161Income taxes
    
    
    936
    
    
    
    1,288Total current liabilities
    
    
    82,625
    
    
    
    77,934LONG-TERM OBLIGATIONSShort-term debt, to be refinanced
    
    
    
    
    
    
    13,539Long-term debt, less current maturities and unamortized discount
    
    
    31,030
    
    
    
    7,820Deferred compensation
    
    
    233
    
    
    
    160Derivative instrument
    
    
    687
    
    
    
    Total long term liabilities
    
    
    31,950
    
    
    
    21,519TOTAL LIABILITIES
    
    
    114,575
    
    
    
    99,453CONTINGENCIES AND COMMITMENTSSTOCKHOLDERS EQUITYPreferred stock, no par value; authorized, 1,000,000 shares; none issued
    
    
    
    
    
    
    Common stock, par value, $.10 per share; authorized 30,000,000 shares;
issued and outstanding 6,034,558 at September 30, 2006 and 5,982,008
at December 31, 2005
    
    
    603
    
    
    
    598Additional paid-in capital
    
    
    36,280
    
    
    
    34,354Retained earnings
    
    
    26,214
    
    
    
    34,466Accumulated Other Comprehensive Income
    
    
    15,898
    
    
    
    12,075Total stockholders equity
    
    
    78,995
    
    
    
    81,493TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    193,570
    
    
    $
    180,946
 
 (a)
    
    Condensed consolidated balance sheet as of December 31, 2005, has been derived from audited
consolidated financial statements. The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
 2




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Thousands of Dollars)
 Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005RESTATED
    
    
    
    
    
    
    RESTATEDRevenues
    
    $
    26,152
    
    
    $
    26,819
    
    
    $
    93,616
    
    
    $
    76,995Cost and expensesCost of sales
    
    
    20,433
    
    
    
    26,994
    
    
    
    72,686
    
    
    
    65,165Selling and administrative
    
    
    10,426
    
    
    
    7,232
    
    
    
    29,282
    
    
    
    23,251Research and development
    
    
    2,192
    
    
    
    1,328
    
    
    
    5,916
    
    
    
    4,345Operating loss
    
    
    (6,899
    )
    
    
    (8,735
    )
    
    
    (14,268
    )
    
    
    (15,766
    )Other income (expense)Interest income
    
    
    480
    
    
    
    76
    
    
    
    774
    
    
    
    483Interest expense
    
    
    (1,353
    )
    
    
    (404
    )
    
    
    (5,070
    )
    
    
    (1,441
    )Gain on fair value of Senior Convertible
notes and warrants
    
    
    4,190
    
    
    
    
    
    
    
    5,204
    
    
    
    Other-net
    
    
    (197
    )
    
    
    (61
    )
    
    
    837
    
    
    
    (50
    )3,120
    
    
    
    (389
    )
    
    
    1,745
    
    
    
    (1,008
    )Loss before income taxes
and cumulative effect of
change in application of
accounting principle
    
    
    (3,779
    )
    
    
    (9,124
    )
    
    
    (12,523
    )
    
    
    (16,774
    )Income tax benefit
    
    
    (4,271
    )
    
    
    (2,363
    )
    
    
    (4,271
    )
    
    
    (5,547
    )Earnings (loss) before
cumulative effect of
change in application of
accounting principle
    
    
    492
    
    
    
    (6,761
    )
    
    
    (8,252
    )
    
    
    (11,227
    )Cumulative effect of change in application of
accounting principle
    
    
    
    
    
    
    95
    
    
    
    
    
    
    
    (5,372
    )NET EARNINGS (LOSS)
    
    $
    492
    
    
    $
    (6,666
    )
    
    $
    (8,252
    )
    
    $
    (16,599
    )Earnings (loss) per share:Earnings (loss) before cumulative effect of
change in application of accounting principle
 basic
    
    $
    0.08
    
    
    $
    (1.17
    )
    
    $
    (1.37
    )
    
    $
    (1.98
    )Cumulative effect of
change in application of
accounting principle
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    (0.95
    )Net earnings (loss)  basic
    
    $
    0.08
    
    
    $
    (1.15
    )
    
    $
    (1.37
    )
    
    $
    (2.93
    )Earnings (loss) per share:Earnings (loss) before cumulative effect of
change in application of accounting principle
 diluted
    
    $
    0.08
    
    
    $
    (1.17
    )
    
    $
    (1.37
    )
    
    $
    (1.98
    )Cumulative effect of
change in application of
accounting principle
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    (0.95
    )Net earnings (loss) 
diluted
    
    $
    0.08
    
    
    $
    (1.15
    )
    
    $
    (1.37
    )
    
    $
    (2.93
    )Weighted average number of common shares:Basic
    
    
    6,059,989
    
    
    
    5,798,619
    
    
    
    6,039,940
    
    
    
    5,663,856Diluted
    
    
    6,165,446
    
    
    
    5,798,619
    
    
    
    6,039,940
    
    
    
    5,663,856
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 3




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND
COMPREHENSIVE INCOME
(Unaudited)
(in thousands of dollars, except for share data)
 For the year ended December 31, 2005 and nine months ended September 30, 2006AccumulatedPreferred
    
    
    Common Stock
    
    
    Capital
    
    
    
    
    
    
    other
    
    
    TotalStock, no
    
    
    
    
    
    
    $.10
    
    
    in excess
    
    
    Retained
    
    
    comprehensive
    
    
    Stockholderspar value
    
    
    Shares
    
    
    Par value
    
    
    of par value
    
    
    earnings
    
    
    (loss) income
    
    
    EquityBalance at January 1, 2005
    
    $
    
    
    
    
    5,601,101
    
    
    $
    560
    
    
    $
    27,910
    
    
    $
    73,386
    
    
    $
    23,697
    
    
    $
    125,553Common stock awards
    
    
    
    
    
    
    54,729
    
    
    
    5
    
    
    
    399
    
    
    
    
    
    
    
    
    
    
    
    404Common stock issued with acquisition
    
    
    
    
    
    
    118,072
    
    
    
    11
    
    
    
    2,489
    
    
    
    
    
    
    
    
    
    
    
    2,500Employee stock purchase plan purchases
    
    
    
    
    
    
    5,507
    
    
    
    1
    
    
    
    107
    
    
    
    
    
    
    
    
    
    
    
    108Exercise of stock options
    
    
    
    
    
    
    202,599
    
    
    
    21
    
    
    
    2,671
    
    
    
    
    
    
    
    
    
    
    
    2,692Warrants issued
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    488
    
    
    
    
    
    
    
    
    
    
    
    488Directors deferred stock compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    290
    
    
    
    
    
    
    
    
    
    
    
    290Comprehensive loss:Net loss for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (38,920
    )
    
    
    
    
    
    
    Currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,622
    )
    
    
    Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50,542
    )Balance at December 31, 2005
    
    $
    
    
    
    
    5,982,008
    
    
    $
    598
    
    
    $
    34,354
    
    
    $
    34,466
    
    
    $
    12,075
    
    
    $
    81,493Common stock awards
    
    
    
    
    
    
    10,747
    
    
    
    1
    
    
    
    549
    
    
    
    
    
    
    
    
    
    
    
    550Employee stock purchase plan purchases
    
    
    
    
    
    
    5,636
    
    
    
    1
    
    
    
    110
    
    
    
    
    
    
    
    
    
    
    
    111Exercise of stock options
    
    
    
    
    
    
    36,167
    
    
    
    3
    
    
    
    398
    
    
    
    
    
    
    
    
    
    
    
    401Warrants issued
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    374
    
    
    
    
    
    
    
    
    
    
    
    374Directors deferred stock compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    128
    
    
    
    
    
    
    
    
    
    
    
    128Issue of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    367
    
    
    
    
    
    
    
    
    
    
    
    367Comprehensive loss:Net loss for the nine months ended
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,252
    )
    
    
    
    
    
    
    Currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,823
    
    
    
    Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,429
    )Balance at September 30, 2006, RESTATED
    
    $
    
    
    
    
    6,034,558
    
    
    $
    603
    
    
    $
    36,280
    
    
    $
    26,214
    
    
    $
    15,898
    
    
    $
    78,995
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 4




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Thousands of Dollars)
 Nine Months ended September 30,2006
    
    
    2005RESTATEDCash flows from operating activitiesNet loss
    
    $
    (8,252
    )
    
    $
    (16,599
    )Adjustments to reconcile net loss to net cash used in operating activitiesCumulative effect of accounting change
    
    
    
    
    
    
    5,372Depreciation and amortization
    
    
    5,861
    
    
    
    3,724Amortization of debt discount and debt issue costs
    
    
    1,593
    
    
    
    152Unrealized gain on forward contracts
    
    
    (1,212
    )
    
    
    (1,418
    )Loss on sale of fixed assets
    
    
    412
    
    
    
    Gain related to fair value of notes and warrants
    
    
    (5,204
    )
    
    
    Provision for estimated losses on contracts
    
    
    295
    
    
    
    649Deferred taxes
    
    
    (3,969
    )
    
    
    (2,905
    )Common stock and option awards
    
    
    905
    
    
    
    227Deferred director stock awards
    
    
    128
    
    
    
    (Increase) decrease in operating assets and increase (decrease) in liabilities:Restricted cash
    
    
    (1,644
    )
    
    
    2,314Accounts receivable
    
    
    2,704
    
    
    
    15,675Costs and accrued earnings on uncompleted contracts
    
    
    4,011
    
    
    
    (8,226
    )Inventories
    
    
    5,888
    
    
    
    1,700Prepaid and other current assets
    
    
    2,010
    
    
    
    (3,840
    )Accounts payable, accrued liabilities and customer deposits
    
    
    (6,433
    )
    
    
    (19,143
    )Deferred compensation
    
    
    27
    
    
    
    43Income taxes
    
    
    (457
    )
    
    
    (3,658
    )Net cash used in operating activities
    
    
    (3,337
    )
    
    
    (25,933
    )Cash flows from investing activitiesCapital expenditures
    
    
    (4,503
    )
    
    
    (5,460
    )Acquisitions, final payment
    
    
    (473
    )
    
    
    Net cash used in investing activities
    
    
    (4,976
    )
    
    
    (5,460
    )Cash flows from financing activitiesPrincipal payments on long-term borrowing
    
    
    (14,000
    )
    
    
    (2,250
    )Debt issue costs
    
    
    (1,908
    )
    
    
    Repayment on capital lease obligations
    
    
    (1,324
    )
    
    
    (1,997
    )Proceeds from issuance of long-term debt
    
    
    30,000
    
    
    
    Net increase in short-term borrowings
    
    
    4,715
    
    
    
    2,303Increase in bank overdraft facility
    
    
    1,934
    
    
    
    12,922Proceeds from employee stock purchases
    
    
    95
    
    
    
    64Proceeds from option exercises
    
    
    429
    
    
    
    2,691Net cash provided by financing activities
    
    
    19,941
    
    
    
    13,733NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    11,628
    
    
    
    (17,660
    )Effects of exchange rate changes on cash
    
    
    593
    
    
    
    (2,310
    )NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    12,221
    
    
    
    (19,970
    )Cash and cash equivalents at beginning of period
    
    
    7,803
    
    
    
    27,940Cash and cash equivalents at end of period
    
    $
    20,024
    
    
    $
    7,970
 5




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Thousands of Dollars)
 Nine Months ended September 30,2006
    
    
    2005RESTATEDSupplemental Disclosures of Cash Flow InformationCash paid during the period forInterest
    
    $
    3,300
    
    
    $
    734Taxes
    
    
    1,343
    
    
    
    3,661Supplemental Disclosures of Non-cash Investing and Financing activitiesWarrants issued in conjunction with senior secured credit facility
    
    $
    2,387
    
    
    $
    Capital leases
    
    
    1,281
    
    
    
    1,840
 The accompanying notes are an integral part of these unaudited condensed consolidated financial
statements.
 6




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##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 NOTE 1  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
     Liquidity and Cash Flows
     
    
    The Company intends to have in place, and is in the process of negotiating, a domestic line of credit,
or other facility, that will provide $4,000 to $5,000 of immediate liquidity with a provision to
accordion up to $20,000 based on financial performance in subsequent periods. This will be contingent
on successful registration of the March 2006 issue of convertible debentures and warrants. The Company
filed the S-1 to register these securities on November 7, 2006.
    
    The Company is exploring possible asset backed financing from local banks in Marshall, TX. This will
be contingent on successful registration of the March 2006 convertible debentures and warrants.
 7




---



##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 
    
    The Company is in discussions with the holders of the convertible debentures and other investors on a
potential offering of 5-10M$ of subordinated notes.
    
    The Company is in discussions with the MECAR SA banking group to allow MECAR SA to repay ADG
approximately 5M$ in intercompany loans and 2006 past due management fees.
    
    The Company is evaluating the disposition of certain non strategic assets.
    
    The Company has the option of receiving dividends from excess cash from its VSK Group at year end.
    
    The Company may further consolidate its California operations to continue to reduce operating expenses.
  Restatements of Financial Results
     8




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##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 Selected Consolidated Statements of Earnings Data:
 Three months ended September 30, 2006
 Impact from MECARInventory andAccounts Receivable
    
    
    As PreviouslyRESTATED
    
    
    Adjustment
    
    
    Reported in 10-QRevenues
    
    $
    26,152
    
    
    $
    (1,060
    )
    
    $
    27,212Cost of Sales
    
    
    20,433
    
    
    
    5,948
    
    
    
    14,485Operating income (loss)
    
    
    (6,899
    )
    
    
    (7,008
    )
    
    
    109Earnings (loss) before income taxes
    
    
    (3,779
    )
    
    
    (7,008
    )
    
    
    3,229Income tax (benefit) expense
    
    
    (4,271
    )
    
    
    (5,008
    )
    
    
    737Net earnings
    
    $
    492
    
    
    $
    (2,000
    )
    
    $
    2,492Earnings (loss) per share  Basic & Diluted:Basic
    
    $
    0.08
    
    
    $
    (0.33
    )
    
    $
    0.41Diluted
    
    $
    0.08
    
    
    $
    (0.33
    )
    
    $
    0.40Weighted Average number of common shares:Basic
    
    
    6,059,989
    
    
    
    
    
    
    
    6,059,989Diluted
    
    
    6,165,446
    
    
    
    
    
    
    
    6,165,446
 Nine months ended September 30, 2006
 Impact from MECARInventory andAccounts Receivable
    
    
    As PreviouslyRESTATED
    
    
    Adjustment
    
    
    Reported in 10-QRevenues
    
    $
    93,616
    
    
    $
    (1,060
    )
    
    $
    94,676Cost of Sales
    
    
    72,686
    
    
    
    5,948
    
    
    
    66,738Operating income (loss)
    
    
    (14,268
    )
    
    
    (7,008
    )
    
    
    (7,260
    )Earnings (loss) before income taxes
    
    
    (12,523
    )
    
    
    (7,008
    )
    
    
    (5,515
    )Income tax (benefit) expense
    
    
    (4,271
    )
    
    
    (5,008
    )
    
    
    737Net earnings (loss)
    
    $
    (8,252
    )
    
    $
    (2,000
    )
    
    $
    (6,252
    )Earnings (loss) per share  Basic & Diluted:Basic
    
    $
    (1.37
    )
    
    $
    (0.33
    )
    
    $
    (1.04
    )Diluted
    
    $
    (1.37
    )
    
    $
    (0.33
    )
    
    $
    (1.04
    )Weighted Average number of common shares:Basic
    
    
    6,039,940
    
    
    
    
    
    
    
    6,039,940Diluted
    
    
    6,039,940
    
    
    
    
    
    
    
    6,039,940
 9




---



##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 NOTE 2  PRINCIPLES OF CONSOLIDATION
  
    
    ARC Europe, S.A. (ARC Europe), a Belgian company,
    
    Allied Research Corporation Limited (Limited), an inactive United Kingdom company,
    
    News/Sports Microwave Rental, Inc. (NSM), a California corporation,
    
    Titan Dynamics Systems, Inc. (Titan), a Texas corporation,
    
    SeaSpace Corporation (SeaSpace), a California corporation,
    
    MECAR USA, Inc. (MECAR USA), a Delaware corporation,
    
    Allied Technology, LLC (Allied Technology), a Maryland limited liability company, and
    
    Global Microwave Systems, Inc (GMS), a California corporation.
   Ammunition & Weapons Effects
 Electronic Security
 Other
 Accounting Change
 10




---



##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 NOTE 3  DERIVATIVE FINANCIAL INSTRUMENTS
 Derivatives and hedging
  Fair value hedges
  Cash flow hedges
  Derivatives not designated as hedges
  Counterparty credit risk
  NOTE 4  ACCOUNTS RECEIVABLE AND COSTS AND ACCRUED EARNINGS ON UNCOMPLETED CONTRACTS
  September 30, 2006
    
    
    December 31, 2005(RESTATED)Direct and indirect receivables from governments
    
    $
    5,155
    
    
    $
    1,777Commercial and other receivables
    
    
    11,740
    
    
    
    16,98416,895
    
    
    
    18,761Less allowance for doubtful receivables
    
    
    (647
    )
    
    
    (214
    )$
    16,248
    
    
    $
    18,547
   11




---



##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
  NOTE 5  INVENTORIES
  September 30,
    
    
    December 31,2006
    
    
    2005(RESTATED)Raw materials
    
    $
    16,865
    
    
    $
    14,942Work in process
    
    
    11,412
    
    
    
    19,265Finished goods
    
    
    2,613
    
    
    
    1,755Gross inventory
    
    
    30,890
    
    
    
    35,962Less reserves for obsolescence
    
    
    (1,432
    )
    
    
    (1,662
    )Net inventory
    
    $
    29,458
    
    
    $
    34,300
 NOTE 6  GOODWILL
   NOTE 7  BANK OVERDRAFT CREDIT FACILITY
  12




---



##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 NOTE 8  LONG-TERM DEBT
  September 30, 2006
    
    
    December 31, 2005Fair value of Senior subordinated convertible notes
    
    $
    24,109
    
    
    $
    Short-term debt expected to be refinanced, less unamortized discount
    
    
    
    
    
    
    13,539Note related to GMS acquisition, less unamortized discount
    
    
    6,387
    
    
    
    6,173Mortgage loan agreements
    
    
    164
    
    
    
    193Loan for CMS Security Systems acquisition
    
    
    100
    
    
    
    200Other notes payable
    
    
    7,309
    
    
    
    618Capital leases and other
    
    
    3,572
    
    
    
    4,978Total long-term debt
    
    
    41,641
    
    
    
    25,701Less current maturities
    
    
    (10,611
    )
    
    
    (4,342
    )Long-term debt, less current maturities and unamortized
discount, including short-term debt to be refinanced
    
    $
    31,030
    
    
    $
    21,359
 Senior subordinated convertible notes.
    Notes payable.
 13




---



##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 Classification of Short
Term Obligations Expected to be Refinanced
 Loan for Global Microwave Systems acquisition.
 Mortgage Loan Agreements.
 Loan for CMS Security Systems acquisition.
 Other notes payable.
 Capital lease and other.
 NOTE 9  EARNINGS (LOSS) PER SHARE
  14




---



##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,Restated
    
    
    
    
    
    
    Restated2006
    
    
    2005
    
    
    2006
    
    
    2005Earnings (loss) before Cumulative Effect of Change in
Accounting Principle
    
    $
    492
    
    
    $
    (6,761
    )
    
    $
    (8,252
    )
    
    $
    (11,227
    )Cumulative Effect of Change in Accounting Principle
    
    
    
    
    
    
    95
    
    
    
    
    
    
    
    (5,372
    )Net earnings (loss)
    
    $
    492
    
    
    $
    (6,666
    )
    
    $
    (8,252
    )
    
    $
    (16,599
    )Weighted average number of basic shares
    
    
    6,059,989
    
    
    
    5,798,619
    
    
    
    6,039,940
    
    
    
    5,663,856Warrants
    
    
    31,983
    
    
    
    
    
    
    
    
    
    
    
    Stock Options
    
    
    73,474
    
    
    
    
    
    
    
    
    
    
    
    Weighted average number of diluted shares
    
    
    6,165,446
    
    
    
    5,798,619
    
    
    
    6,039,940
    
    
    
    5,663,856Basic earnings (loss) per share before Cumulative Effect of
Change in Accounting Principle
    
    $
    0.08
    
    
    $
    (1.17
    )
    
    $
    (1.37
    )
    
    $
    (1.98
    )Cumulative Effect of Change in Accounting Principle
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    (0.95
    )Net earnings (loss) per share
    
    $
    0.08
    
    
    $
    (1.15
    )
    
    $
    (1.37
    )
    
    $
    (2.93
    )Diluted loss per share before Cumulative Effect of Change in
Accounting Principle
    
    $
    0.08
    
    
    $
    (1.17
    )
    
    $
    (1.37
    )
    
    $
    (1.98
    )Cumulative Effect of Change in Accounting Principle
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    (0.95
    )Net earnings (loss) per share
    
    $
    0.08
    
    
    $
    (1.15
    )
    
    $
    (1.37
    )
    
    $
    (2.93
    )
  NOTE 10  COMPREHENSIVE INCOME (LOSS)
  Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Restated
    
    
    
    
    
    
    RestatedNet earnings (loss)
    
    $
    492
    
    
    $
    (6,666
    )
    
    $
    (8,252
    )
    
    $
    (16,599
    )Currency Translation Adjustment
    
    
    963
    
    
    
    (3,281
    )
    
    
    3,823
    
    
    
    (13,895
    )Comprehensive income (loss)
    
    $
    1,455
    
    
    $
    (9,947
    )
    
    $
    (4,429
    )
    
    $
    (30,494
    )
  15




---



##### 



The Allied Defense Group, Inc.  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 NOTE 11  SHARE- BASED COMPENSATION
 Share-Based
Payments Accounting for Stock-Based Compensation Statement of Cash Flows
 Accounting for Stock Issued to Employees
        16




---



##### 



The Allied Defense Group, Inc.  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 Three Months
    
    
    Nine MonthsEnded
    
    
    Ended(Dollars in thousands, except per share amounts)
    
    September 30, 2005
    
    
    September 30, 2005Reported net loss
    
    $
    (6,666
    )
    
    $
    (16,599
    )Stock-based compensation costs that would have
been included in the determination of reported
net earnings, if the fair value method was
applied to all awards, net of tax
    
    
    (91
    )
    
    
    (248
    )Pro forma net loss
    
    $
    (6,757
    )
    
    $
    (16,847
    )Basic and diluted loss per share:Reported loss per share
    
    $
    (1.15
    )
    
    $
    (2.93
    )Compensation costs, net of tax
    
    
    (0.02
    )
    
    
    (0.04
    )Pro forma basic loss per share
    
    $
    (1.17
    )
    
    $
    (2.97
    )
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2005
    
    2005Risk free interest rate
    
    
    4.08
    %
    
    
    4.08
    %Expected volatility rate
    
    
    44.62
    %
    
    
    44.62
    %Expected lives  years
    
    
    5
    
    
    
    5Dividend yield
    
    
    
    
    
    
    
    17




---



##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 Weighted
    
    
    Weighted AverageAverage
    
    
    RemainingNumber of
    
    
    Exercise
    
    
    Contractual Term
    
    
    AggregateOptions
    
    
    Price
    
    
    (in years)
    
    
    Intrinsic Value*Outstanding-beginning of year
    
    
    507,667
    
    
    $
    16.94Granted
    
    
    
    
    
    
    Exercised
    
    
    36,167
    
    
    
    11.87Forfeited
    
    
    
    
    
    
    Outstanding at September 30, 2006
    
    
    471,500
    
    
    $
    17.33
    
    
    
    3.74
    
    
    $
    Exercisable at September 30, 2006
    
    
    378,500
    
    
    $
    16.27
    
    
    
    3.83
    
    
    $
    63
 
 *
    
    The intrinsic value of a stock option is the amount by
which the market value of the underlying stock exceeds
the exercise price of the option. The market value of our
stock was $16.44 at September 30, 2006. The following table summarizes options outstanding at September 30, 2006:
 WeightedAverage
    
    
    ExercisableNumber
    
    Range of
    
    
    Weighted Average
    
    
    Remaining
    
    
    Number of
    
    
    Weighted AverageOutstanding
    
    Exercise Prices
    
    
    Exercise Prices
    
    
    Contractual Term
    
    
    Options
    
    
    Exercise Prices100,000
    
    $
    7.88 to $8.63
    
    
    $
    8.63
    
    
    4.25 Years
    
    
    
    100,000
    
    
    $
    8.6340,000
    
    $
    9.01 to $14.90
    
    
    $
    14.90
    
    
    1.58 Years
    
    
    
    32,000
    
    
    $
    14.90331,500
    
    $
    16.40 to $25.00
    
    
    $
    20.25
    
    
    3.84 Years
    
    
    
    246,500
    
    
    $
    20.25471,500
    
    $
    7.88 to $25.00
    
    
    $
    17.33
    
    
    
    
    
    
    
    378,500
    
    
    $
    
 The following table summarizes restricted stock (nonvested) shares outstanding as of September 30, 2006
 Weighted- AverageGrantRestricted Stock
    
    Shares
    
    
    Date Fair ValueRestricted at January 1, 2006
    
    
    51,793
    
    
    $
    22.99Granted
    
    
    8,300
    
    
    $
    21.53Vested
    
    
    (10,997
    )
    
    $
    22.71Forfeited
    
    
    (2,464
    )
    
    $
    22.33Restricted shares at September 30, 2006
    
    
    46,632
    
    
    $
    22.83
   18




---



##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 NOTE 12  INDUSTRY SEGMENTS
 Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Restated
    
    
    
    
    
    
    RestatedRevenues from external customersAmmunitions & weapons effects
    
    $
    13,293
    
    
    $
    16,736
    
    
    $
    55,180
    
    
    $
    44,112Electronic security
    
    
    10,736
    
    
    
    8,071
    
    
    
    33,614
    
    
    
    28,243Other
    
    
    2,123
    
    
    
    2,012
    
    
    
    4,822
    
    
    
    4,640$
    26,152
    
    
    $
    26,819
    
    
    $
    93,616
    
    
    $
    76,995Restated
    
    
    
    
    
    RestatedSegment income (loss) before
provision for income taxes and
cumulative effect of change in
accounting principle:Ammunitions & weapons effects
    
    $
    (5,673
    )
    
    $
    (7,702
    )
    
    $
    (10,035
    )
    
    $
    (14,002
    )Electronic security
    
    
    (294
    )
    
    
    (245
    )
    
    
    (526
    )
    
    
    368Other
    
    
    71
    
    
    
    (345
    )
    
    
    (928
    )
    
    
    (1,528
    )Corporate
    
    
    2,117
    
    
    
    (832
    )
    
    
    (1,034
    )
    
    
    (1,612
    )$
    (3,779
    )
    
    $
    (9,124
    )
    
    $
    (12,523
    )
    
    $
    (16,774
    )
 NOTE 13  PROVISION FOR TAXES
 Interim Financial Reporting
   19




---



##### 



The Allied Defense Group, Inc .  NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Thousands of Dollars)
 NOTE 14  COMMITMENTS AND CONTINGENCIES
  20




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
 Overview
  
    
    Ammunition & Weapons Effectssegment consists of MECAR,
located in Belgium, MECAR USA, located in Marshall, TX,
and Titan Dynamics, located in Marshall, TX. MECAR
develops and produces medium caliber tank, mortar and
other ammunition. MECAR USA became operational in late
2005 and is pursuing contracts from U.S. and foreign
governments for ammunition and pyrotechnics devices with a
focus on the 105MM market. Titan designs, manufactures and
sells battlefield effects simulators, minor pyrotechnics
and other training devices.
    
    Electronic Securitysegment consists of the VSK Group,
located in Belgium and California, and NSM and GMS both
located in or near San Diego, California. The VSK Group
consists of VSK Electronics N.V., which manufactures
access control, intrusion protection, fire detection and
video systems; Télé Technique Générale S.A., which
installs security systems; Intelligent Data Capturing
Systems N.V., which manufacturers integrated video
systems; VIGITEC S.A., which installs networked video
surveillance systems; and CMS Security Systems which
manufactures access control systems. NSM designs,
manufactures, installs and services military surveillance
products and integrated systems for the law enforcement
community, agencies of the Department of Homeland Security
and the Department of Defense. GMS designs and
manufactures miniature and sub-miniature FM and digital
transmitters, receivers, and related equipment for
investigative, surveillance, and security applications,
and live TV news/sports/entertainment coverage.
    
    Othersegment consists of the formerly named Environmental
Safety & Security segment and provides products in the
area of environmental monitoring and consists solely of
SeaSpace. SeaSpace designs, manufactures, distributes and
services weather and environmental satellite ground
reception systems and manufactures and markets a line of
antenna systems.
    Restatements of Financial Results
  21




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
    Three months ended
    
    
    Nine months endedSeptember 30, 2006
    
    
    September 30, 2006As Previously
    
    
    
    
    
    
    As PreviouslyRESTATED
    
    
    Reported in 10-Q
    
    
    RESTATED
    
    
    Reported in 10-QRevenues
    
    $
    26,152
    
    
    $
    27,212
    
    
    $
    93,616
    
    
    $
    94,676Cost of sales
    
    
    20,433
    
    
    
    14,485
    
    
    
    72,686
    
    
    
    66,738Operating income (loss)
    
    
    (6,899
    )
    
    
    109
    
    
    
    (14,268
    )
    
    
    (7,260
    )Earnings (loss) before income taxes
    
    
    (3,779
    )
    
    
    3,229
    
    
    
    (12,523
    )
    
    
    (5,515
    )Income tax expense (benefit)
    
    
    (4,271
    )
    
    
    737
    
    
    
    (4,271
    )
    
    
    737NET EARNINGS (LOSS)
    
    
    492
    
    
    
    2,492
    
    
    
    (8,252
    )
    
    
    (6,252
    )Earnings (loss) per share:Basic
    
    $
    0.08
    
    
    $
    0.41
    
    
    $
    (1.37
    )
    
    $
    (1.04
    )Diluted
    
    $
    0.08
    
    
    $
    0.40
    
    
    $
    (1.37
    )
    
    $
    (1.04
    )
  Three months ended September 30, 2006
 Impact from MECARInventory andAccounts Receivable
    
    
    As PreviouslyRESTATED
    
    
    Adjustment
    
    
    Reported in 10-QRevenues
    
    $
    26,152
    
    
    $
    (1,060
    )
    
    $
    27,212Operating (loss) Income
    
    
    (6,899
    )
    
    
    (7,008
    )
    
    
    109Earnings (loss) before income taxes
    
    
    (3,779
    )
    
    
    (7,008
    )
    
    
    3,229Income tax (benefit) expense
    
    
    (4,271
    )
    
    
    (5,008
    )
    
    
    737Net earnings (loss)
    
    $
    492
    
    
    $
    (2,000
    )
    
    $
    2,492
 22




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
 Nine months ended September 30, 2006
 Impact from MECARInventory andAccounts Receivable
    
    
    As PreviouslyRESTATED
    
    
    Adjustment
    
    
    Reported in 10-QRevenues
    
    $
    93,616
    
    
    $
    (1,060
    )
    
    $
    94,676Operating (loss) Income
    
    
    (14,268
    )
    
    
    (7,008
    )
    
    
    (7,260
    )Earnings (loss) before income taxes
    
    
    (12,523
    )
    
    
    (7,008
    )
    
    
    (5,515
    )Income tax (benefit) expense
    
    
    (4,271
    )
    
    
    (5,008
    )
    
    
    737Net earnings (loss)
    
    $
    (8,252
    )
    
    $
    (2,000
    )
    
    $
    (6,252
    )
 23




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
 Results of Operations for the Three Months Ended September 30, 2006 and 2005
  Three months ended September 30,2006
    
    
    2005Restated$
    %
    $
    %Revenue
    
    $
    26,152
    
    
    
    100
    %
    
    $
    26,819
    
    
    
    100
    %Cost and expensesCost of sales
    
    
    20,433
    
    
    
    78.1
    
    
    
    26,994
    
    
    
    100.7Selling and administrative
    
    
    10,426
    
    
    
    39.9
    
    
    
    7,232
    
    
    
    27.0Research and development
    
    
    2,192
    
    
    
    8.4
    
    
    
    1,328
    
    
    
    4.9Operating loss
    
    
    (6,899
    )
    
    
    (26.4
    )
    
    
    (8,735
    )
    
    
    (32.6
    )Other income (expense)
Interest income
    
    
    480
    
    
    
    1.8
    
    
    
    76
    
    
    
    0.3Interest expense
    
    
    (1,353
    )
    
    
    (5.2
    )
    
    
    (404
    )
    
    
    (1.5
    )Gain (loss) from fair value of notes and
warrants
    
    
    4,190
    
    
    
    16.1
    
    
    
    
    
    
    
    Other  net
    
    
    (197
    )
    
    
    (0.8
    )
    
    
    (61
    )
    
    
    (0.2
    )Loss before income tax benefits
    
    
    (3,779
    )
    
    
    (14.5
    )
    
    
    (9,124
    )
    
    
    (34.0
    )Income tax benefit
    
    
    (4,271
    )
    
    
    (16.3
    )
    
    
    (2,363
    )
    
    
    (8.8
    )Net earnings (loss) before cumulative effect of
change in accounting principle
    
    
    492
    
    
    
    1.8
    
    
    
    (6,761
    )
    
    
    (25.2
    )Cumulative effect of change in accounting
principle
    
    
    
    
    
    
    
    
    
    
    95
    
    
    
    0.4Net earnings (loss)
    
    $
    492
    
    
    
    1.8
    %
    
    $
    (6,666
    )
    
    
    (24.8
    )%
 Revenue.
 Revenue by SegmentThree Months Ended
    
    
    Three Months EndedSeptember 30, 2006
    
    
    September 30, 2005Percentage
    
    
    
    
    
    
    PercentageAmount
    
    of total
    
    Amount
    
    of totalRestatedAmmunition & Weapons
Effects
    
    $
    13,293
    
    
    
    51
    %
    
    $
    16,736
    
    
    
    62
    %Electronic Security
    
    
    10,736
    
    
    
    41
    %
    
    
    8,071
    
    
    
    30
    %Other
    
    
    2,123
    
    
    
    8
    %
    
    
    2,012
    
    
    
    8
    %$
    26,152
    
    
    
    100
    %
    
    $
    26,819
    
    
    
    100
    %
  24




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
   Cost of Sales.
 Cost of Sales by Segment
 Three months endedSeptember 30,2006
    
    
    2005Restated% of Segement
    
    
    
    
    
    
    % of SegementAmount
    
    
    Revenue
    
    
    Amount
    
    
    RevenueAmmunition
& Weapons Effects (AWE)
    
    $
    14,603
    
    
    
    110
    %
    
    $
    20,173
    
    
    
    121
    %Electronic Security (ES)
    
    
    4,889
    
    
    
    46
    %
    
    
    5,595
    
    
    
    69
    %Other
    
    
    941
    
    
    
    44
    %
    
    
    1,226
    
    
    
    61
    %Total
    
    $
    20,433
    
    
    
    78
    %
    
    $
    26,994
    
    
    
    101
    %
   25




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
   Selling and Administrative Expenses.
    Research and Development.
 Gain on fair value of Senior Subordinated Convertible Notes and warrants.
 Other Income (Expense)
 Interest Income.
 Interest Expense.
 26




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
 Pre-Tax Income (Loss
 Pre-Tax Income (Loss) by Segment Before  the Cumulative Effect of Accounting Change
 Three months endedSeptember 30,2006
    
    
    2005RestatedAmmunition & Weapons Effects
    
    $
    (5,673
    )
    
    $
    (7,702
    )Electronic Security
    
    
    (294
    )
    
    
    (245
    )Other
    
    
    71
    
    
    
    (345
    )Corporate
    
    
    2,117
    
    
    
    (832
    )$
    (3,779
    )
    
    $
    (9,124
    )
     Income Taxes. Accounting for Income Taxes in Interim Period
 Net Earnings (Loss).
 27




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
 Results of Operations for the Nine Months Ended September 30, 2006 and 2005
  Nine months ended September 30,2006
    
    
    2005Restated$
    
    
    %
    
    
    $
    
    
    %Revenue
    
    $
    93,616
    
    
    
    100
    %
    
    $
    76,995
    
    
    
    100
    %Cost and expensesCost of sales
    
    
    72,686
    
    
    
    77.6
    
    
    
    65,165
    
    
    
    84.6Selling and administrative
    
    
    29,282
    
    
    
    31.3
    
    
    
    23,251
    
    
    
    30.2Research and development
    
    
    5,916
    
    
    
    6.3
    
    
    
    4,345
    
    
    
    5.6Operating loss
    
    
    (14,268
    )
    
    
    (15.2
    )
    
    
    (15,766
    )
    
    
    (20.4
    )Other income (expense)Interest income
    
    
    774
    
    
    
    0.8
    
    
    
    483
    
    
    
    0.6Interest expense
    
    
    (5,070
    )
    
    
    (5.4
    )
    
    
    (1,441
    )
    
    
    (1.9
    )Gain (loss) from fair
value of notes and
warrants
    
    
    5,204
    
    
    
    5.6
    
    
    
    
    
    
    
    Other  net
    
    
    837
    
    
    
    0.9
    
    
    
    (50
    )
    
    
    (0.1
    )Loss before
income taxes
(benefits)
    
    
    (12,523
    )
    
    
    (13.4
    )
    
    
    (16,774
    )
    
    
    (21.8
    )Income tax expense (benefit)
    
    
    (4,271
    )
    
    
    (4.6
    )
    
    
    (5,547
    )
    
    
    (7.2
    )Net loss before cumulative
effect of change in accounting
principle
    
    
    (8,252
    )
    
    
    (8.8
    )
    
    
    (11,227
    )
    
    
    (14.6
    )Cumulative effect of change in
accounting principle
    
    
    
    
    
    
    
    
    
    
    (5,372
    )
    
    
    (7.0
    )Net loss
    
    $
    (8,252
    )
    
    
    (8.8
    )%
    
    $
    (16,599
    )
    
    
    (21.6
    )%
 Revenue.
 Revenue by SegmentNine Months Ended
    
    
    Nine Months EndedSeptember 30, 2006
    
    
    September 30, 2005RestatedPercentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    of totalRestatedAmmunition &
Weapons Effects
    
    $
    55,180
    
    
    
    59
    %
    
    $
    44,112
    
    
    
    57
    %Electronic Security
    
    
    33,614
    
    
    
    36
    %
    
    
    28,243
    
    
    
    37
    %Other
    
    
    4,822
    
    
    
    5
    %
    
    
    4,640
    
    
    
    6
    %$
    93,616
    
    
    
    100
    %
    
    $
    76,995
    
    
    
    100
    %
  28




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
  Cost of Sales.
 Cost of Sales by Segment
 Nine months endedSeptember 30,2006
    
    2005Restated% of Segment
    
    
    
    
    
    % of SegmentAmount
    
    Revenue
    
    Amount
    
    RevenueAmmunition & Weapons Effects (AWE)
    
    $
    52,960
    
    
    
    96
    %
    
    $
    45,943
    
    
    
    104
    %Electronic Security (ES)
    
    
    17,035
    
    
    
    51
    %
    
    
    16,635
    
    
    
    59
    %Other
    
    
    2,691
    
    
    
    56
    %
    
    
    2,619
    
    
    
    56
    %Corporate
    
    
    
    
    
    
    
    
    
    
    (32
    )
    
    
    0
    %Total
    
    $
    72,686
    
    
    
    78
    %
    
    $
    65,165
    
    
    
    85
    %
    Selling and Administrative Expenses.
 29




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
    Research and Development.
 Gain on fair value of Senior Subordinated Convertible Notes and warrants.
 Other Income.
 Interest Income.
 Interest Expense.
 Pre-Tax Loss
 Pre-Tax Income (Loss) by Segment Before  the Cumulative Effect of Accounting Change
 Nine months endedSeptember 30,2006
    
    
    2005RestatedAmmunition & Weapons Effects
    
    $
    (10,035
    )
    
    $
    (14,002
    )Electronic Security
    
    
    (526
    )
    
    
    368Other
    
    
    (928
    )
    
    
    (1,528
    )Corporate
    
    
    (1,034
    )
    
    
    (1,612
    )$
    (12,523
    )
    
    $
    (16,774
    )
 30




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
     Income Taxes.
 Net Loss.
 Backlog.
 Backlog by SegmentSeptember 30, 2006
    
    
    September 30, 2005Percentage
    
    
    
    
    
    
    PercentageAmount
    
    
    of total
    
    
    Amount
    
    
    of totalAmmunition & Weapons Effects
    
    $
    30,840
    
    
    
    54
    %
    
    $
    78,166
    
    
    
    77
    %Electronic Security
    
    
    23,574
    
    
    
    41
    %
    
    
    20,681
    
    
    
    21
    %Other
    
    
    3,204
    
    
    
    5
    %
    
    
    2,146
    
    
    
    2
    %$
    57,618
    
    
    
    100
    %
    
    $
    100,993
    
    
    
    100
    %
 31




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
  Liquidity and Cash Flows
      32




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
  
    
    The Company intends to have in place, and is in the process of negotiating, a domestic line of
credit or other financing that will provide $4,000 to $5,000 of immediate liquidity with a
provision to accordion up to $20,000 based on financial performance in subsequent periods. This
will be contingent on successful registration of the March 2006 issue of convertible debentures
and warrants.
    
    The Company is exploring possible asset backed financing from local banks in Marshall, TX. This
will be contingent on successful registration of the March 2006 convertible debentures and
warrants.
    
    The Company is in discussions with the holders of the convertible debentures and other investors
on a potential offering of $5,000  $10,000 of subordinated notes.
    
    The Company is in discussions with the MECAR SA banking group to allow MECAR SA to repay ADG
approximately $5,000 in intercompany loans and 2006 past due management fees.
    
    The Company is evaluating the disposition of certain non strategic assets.
    
    The Company has the option of issuing dividends of excess cash from its VSK Group at year end.
    
    The Company may further consolidate its California operations to further reduce operating expenses.
  Balance Sheet
        33




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
 Cash Flows
  Nine months ended September 302006
    
    2005Net cash used in operating activities
    
    $
    (3,337
    )
    
    $
    (25,933
    )Net cash used in investing activities
    
    $
    (4,976
    )
    
    $
    (5,460
    )Net cash provided by financing activities
    
    $
    19,941
    
    
    $
    13,733
 Operating Activities.
 Investing Activities.
 Financing Activities.
 Allied.
 MECAR.
 VSK Group.
 Other Subsidiaries.
 34




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
 Stock Repurchases.
 Off-Balance Sheet Arrangements.
 Trends
 
    
    The Company is focusing on solving its liquidity issues in
late 2006 and early 2007.
    
    The Company expects a substantial rebound in 2007 operations after losses in the past.
    
    The Company expects a significant MECAR order from a principal customer in late 2006 or
early 2007. It is expected to be part of a multi-year (likely three years) substantial
purchase by the customer.
    
    The Company continues to work hard to expand MECARs market and expects further positive
results in 2007 from new customers.
    
    As weapon systems from U.S. and NATO forces, which utilize MECAR munitions, especially the
M393A3 105mm HEP round, are expected to be deployed to operational areas of conflict
during 2007, management expects meaningful orders for that munition in 2007.
    
    The Company has engaged in substantial business development efforts at the U.S.
subsidiaries (including the parent company, Allied). Various proposals for work have been
submitted and the Company is hopeful of some successes in late 2006 and in 2007.
    
    The Company has taken steps to reduce the operating costs of its U.S. operations,
particularly by reducing the break even at the Marshall, Texas facility, and is taking
steps to reduce operating costs in its foreign operations,
    
    Titan is now operational and will continue to attempt to maximize work on its BES contract.
    
    In summary, the Company expects that MECAR will rebound in 2007. The Company further
believes that it has taken the steps in 2006 to greatly improve operating results at its
U.S.-based operations.
 35




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
 Critical Accounting Policies
   
    
    Revenue recognition via the percentage of completion method;
    
    Goodwill and intangible asset valuation;
    
    Inventory reserves and allowance for doubtful accounts;
    
    Derivative instruments;
    
    Valuation of deferred income taxes and income tax reserves.
  Recent Accounting Pronouncements
 Accounting for Uncertainty in
Income Taxes- an interpretation of SFAS No. 109
 Forward-Looking Statements
   
    
    substantial reliance on MECARs principal customers to continue to acquire products on a regular basis;
    
    the cyclical nature of the Companys military business;
 36




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2006
(Thousands of Dollars)
(Unaudited)
 
    
    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;
    
    changes in foreign currency exchange rates and interest rate fluctuation from market conditions;
    
    general risks associated with doing business outside the United States, including, without
limitation, import duties, tariffs, quotas and political and economic instability;
    
    the effects of terrorist actions on business activities, customer orders and cancellations, and
the United States and international governments responses to these terrorist actions;
    
    changes in government regulations;
    
    liability and other claims asserted against the Company;
    
    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.
  37




---



##### 



The Allied Defense Group, Inc.
September 30, 2006
 ITEM 3. QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE
    ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES
 Evaluation of disclosure controls and procedures
    Changes in internal controls
  38




---



##### 



The Allied Defense Group, Inc.
September 30, 2006
 PART II. OTHER INFORMATION
 Item 6 Exhibits
 Exhibit No.
    
    Description of Exhibits31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 SIGNATURE
  THE ALLIED DEFENSE GROUP, INC./s/ Robert P. DowskiDate: March 20, 2007
    Robert P. DowskiChief Financial Officer and
Treasurer 39