##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-Q/A QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended September 30, 2004 Commission File Number: 001-11376   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)   Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ          No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). Yes þ          No Indicate the number of shares outstanding of each of the issuers classes of common stock as of
September 30, 2004: 5,599,617.




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##### 



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




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##### 



THE ALLIED DEFENSE GROUP, INC.
INDEX  PAGENUMBERPART I.
FINANCIAL INFORMATION - UNAUDITEDItem 1. Financial StatementsCondensed Consolidated Balance Sheets
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, 2003Restated andUnauditedASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    20,545
    
    
    $
    43,377Restricted cash
    
    
    10,928
    
    
    
    15,937Accounts receivable
    
    
    35,853
    
    
    
    33,404Costs and accrued earnings on uncompleted contracts
    
    
    68,100
    
    
    
    60,516Inventories
    
    
    15,519
    
    
    
    12,068Deferred tax asset
    
    
    1,990
    
    
    
    1,016Fair value of foreign exchange contracts
    
    
    445
    
    
    
    6,900Prepaid and other current assets
    
    
    8,479
    
    
    
    4,880Total current assets
    
    
    161,859
    
    
    
    178,098PROPERTY, 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$
    206,315
    
    
    $
    220,944LIABILITIES 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
    
    
    10,072
    
    
    
    7,594Customer deposits
    
    
    8,465
    
    
    
    4,938Income taxes
    
    
    4,357
    
    
    
    906Total current liabilities
    
    
    81,347
    
    
    
    88,881LONG-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
    
    
    1,219
    
    
    
    5,5338,489
    
    
    
    13,925STOCKHOLDERS EQUITYPreferred stock, no par value; authorized, 1,000,000 shares; none issued
    
    
    
    
    
    
    Common stock, par value, $.10 per share; authorized 30,000,000 shares;
issued and outstanding 5,599,617 in 2004 and 5,551,373 in 2003
    
    
    560
    
    
    
    555Additional paid-in capital
    
    
    26,568
    
    
    
    25,891Retained earnings
    
    
    74,293
    
    
    
    75,495Accumulated other comprehensive income
    
    
    15,058
    
    
    
    16,197116,479
    
    
    
    118,138$
    206,315
    
    
    $
    220,944
 The accompanying notes are an integral part of these consolidated financial statements. 2




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##### 



The Allied Defense Group, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (Thousands of Dollars, except per share data) (Unaudited)  Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Restated
    
    
    Restated
    
    
    Restated
    
    
    RestatedRevenue
    
    $
    36,137
    
    
    $
    31,421
    
    
    $
    102,233
    
    
    $
    108,479Cost and expensesCost of sales
    
    
    27,300
    
    
    
    25,398
    
    
    
    77,932
    
    
    
    79,796Selling and administrative
    
    
    6,010
    
    
    
    5,259
    
    
    
    18,358
    
    
    
    17,553Research and development
    
    
    2,031
    
    
    
    1,545
    
    
    
    5,408
    
    
    
    3,302Operating income (loss)
    
    
    796
    
    
    
    (781
    )
    
    
    535
    
    
    
    7,828Other 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 (loss) before income taxes
    
    
    (255
    )
    
    
    (1,251
    )
    
    
    (1,754
    )
    
    
    6,307Income tax (benefit) expense
    
    
    (277
    )
    
    
    (875
    )
    
    
    (552
    )
    
    
    2,502NET EARNINGS (LOSS)
    
    $
    22
    
    
    $
    (376
    )
    
    $
    (1,202
    )
    
    $
    3,805Earnings (loss) per shareBasic
    
    $
    
    
    
    $
    (0.07
    )
    
    $
    (0.22
    )
    
    $
    0.69Diluted
    
    $
    
    
    
    $
    (0.07
    )
    
    $
    (0.22
    )
    
    $
    0.68Weighted average number of common shares:Basic
    
    
    5,565,871
    
    
    
    5,504,106
    
    
    
    5,557,623
    
    
    
    5,490,475Diluted
    
    
    5,966,973
    
    
    
    5,504,106
    
    
    
    5,557,623
    
    
    
    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
    
    
    2003Restated
    
    
    RestatedCash flows from operating activitiesNet earnings (loss)
    
    $
    (1,202
    )
    
    $
    3,805Adjustments to reconcile net earnings (loss) to net cash provided by
(used in) operating activitiesDepreciation and amortization
    
    
    3,485
    
    
    
    2,855Unrealized gain (loss) on forward contracts
    
    
    5,564
    
    
    
    (1,253
    )Provision for estimated losses on contracts
    
    
    171
    
    
    
    45Deferred taxes
    
    
    (1,091
    )
    
    
    4805Debt 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
    
    
    (18,267
    )
    
    
    13,468Cash 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
    
    
    (22,245
    )
    
    
    8,892Effects of exchange rate changes on cash and cash equivalents
    
    
    (587
    )
    
    
    1,137NET 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. 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. Restatement.As described in greater detail in the Annual Report on Form 10-K for the period ended
December 31, 2004, the Company has restated its financial statements for certain periods, including
the periods covered by this Form 10-Q/A, since it did not qualify for the use of hedge accounting
under SFAS 133. The Condensed Consolidated Balance Sheet as of September 30, 2004 included in this Form 10-Q/A has
been restated as follows: September 30, 2004As
    
    
    As PreviouslyRestated
    
    
    ReportedAccounts receivable
    
    $
    35,853
    
    
    $
    39,229Cost and accrued earnings on uncompleted contracts
    
    
    68,100
    
    
    
    67,825Fair value of foreign exchange contracts
    
    
    445
    
    
    
    5,249Total current assets
    
    
    161,859
    
    
    
    169,764Total assets
    
    
    206,315
    
    
    
    214,220Accrued liabilities
    
    
    10,072
    
    
    
    15,159Foreign exchange contracts
    
    
    
    
    
    
    5,249Total current liabilities
    
    
    81,347
    
    
    
    91,683Deferred tax liability  non-current
    
    
    1,219
    
    
    
    393Total liabilities
    
    
    89,836
    
    
    
    99,346Accumulated other comprehensive income
    
    
    15,058
    
    
    
    12,428Total liabilities and stockholders equity
    
    
    206,315
    
    
    
    214,220
 The Condensed Consolidated Statements of Earnings for the three and nine months ended September 30,
2004 and 2003 included in this Form 10-Q/A have been restated as follows: September 30, 2004
    
    
    September 30, 2003As
    
    
    As Previously
    
    
    As
    
    
    As PreviouslyThree months ended,
    
    Restated
    
    
    Reported
    
    
    Restated
    
    
    ReportedRevenues
    
    $
    36,137
    
    
    $
    37,142
    
    
    $
    31,421
    
    
    $
    34,871Cost of Sales
    
    
    27,300
    
    
    
    28,062
    
    
    
    25,398
    
    
    
    26,972Operating income (loss)
    
    
    796
    
    
    
    1,039
    
    
    
    (781
    )
    
    
    1,095Earnings (loss) before income taxes
    
    
    (255
    )
    
    
    (12
    )
    
    
    (1,251
    )
    
    
    625Income tax (benefit)
    
    
    (277
    )
    
    
    (194
    )
    
    
    (875
    )
    
    
    (238
    )Net Earnings (loss)
    
    $
    22
    
    
    $
    182
    
    
    $
    (376
    )
    
    $
    863
 5




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The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  September 30, 2004
    
    
    September 30, 2003As
    
    
    As Previously
    
    
    As
    
    
    As PreviouslyNine months ended,
    
    Restated
    
    
    Reported
    
    
    Restated
    
    
    ReportedRevenues
    
    $
    102,233
    
    
    $
    116,837
    
    
    $
    108,479
    
    
    $
    120,251Cost of Sales
    
    
    77,932
    
    
    
    82,909
    
    
    
    79,796
    
    
    
    86,578Operating income
    
    
    535
    
    
    
    10,162
    
    
    
    7,828
    
    
    
    12,818Earnings (loss) before income taxes
    
    
    (1,754
    )
    
    
    7,873
    
    
    
    6,307
    
    
    
    11,297Income tax (benefit) expense
    
    
    (552
    )
    
    
    2,721
    
    
    
    2,502
    
    
    
    4,198Net Earnings (loss)
    
    $
    (1,202
    )
    
    $
    5,152
    
    
    $
    3,805
    
    
    $
    7,099
 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. 6




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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 The Company uses foreign currency futures contracts to minimize the foreign currency exposures that
arise from sales contracts with certain foreign customers. Under the terms of these sales
contracts, the selling price and certain costs are payable in U.S. dollars rather than the Euro,
which is MECARs functional currency. As discussed in Note 1, the Companys accounting for foreign
currency exchange contracts at MECAR did not comply with the guidelines of FAS 133. As such,
gains/losses from settlements of the derivative contracts are reported as a component of revenues
and amounted to gains of $1,137, $208, $1,496 and $9,833 for the three and nine months ended
September 30, 2004 and 2003, respectively. 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. NOTE 6 - ACCOUNTS RECEIVABLE Accounts receivable at September 30, 2004 and December 31, 2003 are comprised as follows: 2004
    
    
    2003RestatedDirect and indirect receivables from foreign governments
    
    $
    15,854
    
    
    $
    19,696Commercial and other receivables, less allowance for doubtful
receivables of $120 in 2004 and $115 in 2003
    
    
    19,999
    
    
    
    13,708$
    35,853
    
    
    $
    33,404
 Receivables from foreign government and government agencies are generally due within 30 days of
shipment, less a 10% hold back provision which is generally due within 90 days. Since these
receivables are supported by letters of credit or other guarantees, no provision for doubtful
accounts is deemed necessary. The Company evaluates its allowance for doubtful accounts on
commercial receivables on an ongoing basis and provides for losses as deemed necessary. 7




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##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  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 $29,349 and $79,786, and $24,868 and $87,860,
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
 NOTE 9  INTANGIBLE ASSETS AND GOODWILL September 30, 2004
    
    
    December 31, 2003Accumulated
    
    
    
    
    
    
    
    
    
    
    AccumulatedGross Amount
    
    
    Amortization
    
    
    Net
    
    
    Gross 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). 8




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  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. 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
    
    $
    1,148
    
    
    $
    Mortgage loan agreements
    
    
    271
    
    
    
    908Capital leases and other
    
    
    6.625
    
    
    
    6,703Total Long-Term Debt
    
    $
    8,044
    
    
    $
    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. 9




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  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
    
    
    1,9912007
    
    
    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. 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 (LOSS) PER SHARE Basic earnings per share exclude dilution and are computed by dividing net earnings by the weighted
average number of common shares outstanding for the period. The computation of diluted earnings
per share includes the effects of stock options, warrants and convertible debenture, if such effect
is dilutive. The table below shows the calculation of basic and diluted earnings per share for the
three and nine months ended September 30, 2004 and September 30, 2003, respectively: 10




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Restated
    
    
    Restated
    
    
    Restated
    
    
    RestatedNet earnings (loss)
    
    $
    22
    
    
    $
    (376
    )
    
    $
    (1,202
    )
    
    $
    3,805Interest on convertible debenture, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    269Net earnings (loss) before interest on
convertible debenture
    
    $
    22
    
    
    $
    (376
    )
    
    $
    (1,202
    )
    
    $
    4,074Weighted average number of basic shares
    
    
    5,565,871
    
    
    
    5,504,106
    
    
    
    5,557,623
    
    
    
    5,490,475Common stock equivalents
    
    
    401,102
    
    
    
    
    
    
    
    
    
    
    
    494,458Weighted average number of diluted shares
    
    
    5,966,973
    
    
    
    5,504,106
    
    
    
    5,557,623
    
    
    
    5,984,933Basic earnings (loss) per share
    
    $
    
    
    
    $
    (0.07
    )
    
    $
    (0.22
    )
    
    $
    0.69Diluted earnings (loss) per share
    
    $
    
    
    
    $
    (0.07
    )
    
    $
    (0.22
    )
    
    $
    0.68
 For the three months ended September 30, 2003
and nine months ended September 30, 2004, the Company has
excluded common stock equivalents of 497,133 and 452,234 since their effect would be anti-dilutive. NOTE 14 - COMPREHENSIVE INCOME (LOSS) A summary of the components of Comprehensive Income (Loss) for the three and nine months ended
September 30, 2004 and 2003 is as follows: Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Restated
    
    
    Restated
    
    
    Restated
    
    
    RestatedNet earnings (loss)
    
    $
    22
    
    
    $
    (376
    )
    
    $
    (1,202
    )
    
    $
    3,805Currency translation adjustment
    
    
    1,691
    
    
    
    997
    
    
    
    (1,139
    )
    
    
    8,778Comprehensive income (loss)
    
    $
    1,713
    
    
    $
    621
    
    
    $
    (2,341
    )
    
    $
    12,583
 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. 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: 11




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(Dollars in thousands, except per share amounts)
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003Restated
    
    
    Restated
    
    
    Restated
    
    
    RestatedReported net earnings (loss)
    
    $
    22
    
    
    $
    (376
    )
    
    $
    (1,202
    )
    
    $
    3,805Stock-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 (loss)
    
    $
    (136
    )
    
    $
    (494
    )
    
    $
    (1,675
    )
    
    $
    3,452Basic earnings (loss) per share:Reported earnings (loss) per share
    
    $
    
    
    
    $
    (0.07
    )
    
    $
    (0.22
    )
    
    $
    0.69Compensation costs, net of tax
    
    
    (0.03
    )
    
    
    (0.02
    )
    
    
    (0.09
    )
    
    
    (0.06
    )Pro forma basic earnings (loss) per share
    
    $
    (0.03
    )
    
    $
    (0.09
    )
    
    $
    (0.31
    )
    
    $
    0.63Diluted earnings (loss) per share:Reported earnings (loss) per share
    
    $
    
    
    
    $
    (0.07
    )
    
    $
    (0.22
    )
    
    $
    0.68Compensation costs, net of tax
    
    
    (0.03
    )
    
    
    (0.02
    )
    
    
    (0.08
    )
    
    
    (0.06
    )Pro forma diluted earnings (loss) per share
    
    $
    (0.03
    )
    
    $
    (0.09
    )
    
    $
    (0.30
    )
    
    $
    0.62
 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 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. 12




---



##### 



The Allied Defense Group, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  NOTE 16 - INDUSTRY SEGMENTS Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Revenues from external customersOrdnance & Manufacturing
    
    $
    22,084
    
    
    $
    22,220
    
    
    $
    63,858
    
    
    $
    79,883Electronic 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$
    36,137
    
    
    $
    31,421
    
    
    $
    102,233
    
    
    $
    108,479Segment profit (loss) before taxesOrdnance & Manufacturing
    
    $
    (330
    )
    
    $
    (1,413
    )
    
    $
    (2,768
    )
    
    $
    7,200Electronic 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
    )$
    (255
    )
    
    $
    (1,251
    )
    
    $
    (1,754
    )
    
    $
    6,307
 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. 13




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  Overview Allied is a strategic portfolio of defense and security businesses, with presence in worldwide
markets, offering both government and commercial customers leading edge products and services.
Allied operates in four (4) segments:  
    Ordnance & Manufacturingsegment consists of MECAR, located in
Belgium, and MECAR USA, located in Marshall, TX. MECAR develops
and produces medium caliber tank, mortar and other ammunition.
MECAR USA will initially pursue contracts from U.S. and foreign
governments for ammunition and pyrotechnics devices. MECAR USA is
expected to be 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 had net profit (loss) of $22 and $(1,202) for the three and nine months ended September 30,
2004, respectively, compared to net profit (loss) of $(376) and $3,805 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. Restatement.As described in greater detail in the Annual Report on Form 10-K for the period ended
December 31, 2004, the Company has restated its financial statements for certain periods, including
the periods covered by this Form 10-Q/A, since it did not qualify for the use of hedge accounting
under SFAS 133. The balance of this Managements Discussion and Analysis of Financial Condition
and Results of Operations gives effect to and is based upon the restated financial statements,
computed using derivative accounting. 14




---



##### 



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
    
    $
    36,137
    
    
    
    100.0
    %
    
    $
    31,421
    
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    27,300
    
    
    
    75.6
    
    
    
    25,398
    
    
    
    80.8Selling and administrative
    
    
    6,010
    
    
    
    16.6
    
    
    
    5,259
    
    
    
    16.7Research and development
    
    
    2,031
    
    
    
    5.6
    
    
    
    1,545
    
    
    
    4,9Operating income (loss)
    
    
    796
    
    
    
    2.2
    
    
    
    (781
    )
    
    
    (2.4
    )Other income (expense)Interest income
    
    
    140
    
    
    
    0.4
    
    
    
    123
    
    
    
    0.4Interest expense
    
    
    (717
    )
    
    
    (2.0
    )
    
    
    (547
    )
    
    
    (1.7
    )Other  net
    
    
    (474
    )
    
    
    (1.3
    )
    
    
    (46
    )
    
    
    (0.2
    )Loss before income taxes
    
    
    (255
    )
    
    
    (0.7
    )
    
    
    (1,251
    )
    
    
    (3.9
    )Income tax benefit
    
    
    (277
    )
    
    
    (0.8
    )
    
    
    (875
    )
    
    
    (2.7
    )Net earnings (loss)
    
    $
    22
    
    
    
    0.1
    %
    
    $
    (376
    )
    
    
    (1.2
    )%
 Revenue.Allied had revenue of $36,137 in the three months ended September 30, 2004, which
was 15% 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
    
    $
    22,084
    
    
    
    61
    %
    
    $
    22,220
    
    
    
    71
    %Electronic Security
    
    
    12,497
    
    
    
    35
    %
    
    
    7,748
    
    
    
    25
    %Environmental Safety & Security
    
    
    1,407
    
    
    
    4
    %
    
    
    1,414
    
    
    
    4
    %Software, Training & Simulation
    
    
    149
    
    
    
    
    %
    
    
    39
    
    
    
    
    %$
    36,137
    
    
    
    100
    %
    
    $
    31,421
    
    
    
    100
    %
 Ordnance & Manufacturing Segment revenue for the third quarter of 2004 decreased by 1% 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. 15




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  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 76% compared with 81% for the same period in 2003. Cost of Sales as Percentage of Sales by Segment Three months endedSeptember 302004
    
    
    2003Ordnance & Manufacturing
    
    
    90
    %
    
    
    84
    %Electronic Security
    
    
    59
    %
    
    
    53
    %Environmental Safety & Security
    
    
    78
    %
    
    
    67
    %Software, Training & Simulation
    
    
    62
    %
    
    
    75
    %Total
    
    
    76
    %
    
    
    81
    %
 Ordnance & Manufacturing Segment cost of sales as a percentage of sales for the three months ended
September 30, 2004 increased over the same period of 2003 as a result of the change in the
accounting for the derivatives. 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. 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 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)  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 (Loss) Pre-Tax Profit (Loss) by Segment Three months endedSeptember 302004
    
    
    2003Ordnance & Manufacturing
    
    $
    (330
    )
    
    $
    (1,413
    )Electronic Security
    
    
    2,021
    
    
    
    640Environmental Safety & Security
    
    
    (1,182
    )
    
    
    (271
    )Software, Training & Simulation
    
    
    (177
    )
    
    
    (167
    )Corporate and other
    
    
    (587
    )
    
    
    (40
    )$
    (255
    )
    
    $
    (1,251
    )
 Ordnance & Manufacturing Segment incurred a pre-tax loss of $330 for the three months ended
September 30, 2004 versus a pre-tax loss of $1,413 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. 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)  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 (Loss).The Company earned a $22 net profit for the three months ended September 30,
2004 compared with $376 net loss in the same period of 2003. The increase in 2004 resulted
principally from the activities at MECAR, SeaSpace and Titan Dynamics. 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 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
    
    $
    102,233
    
    
    
    100.0
    %
    
    $
    108,479
    
    
    
    100.0
    %Cost and expensesCost of sales
    
    
    77,932
    
    
    
    76.2
    
    
    
    79,796
    
    
    
    73.6Selling and administrative
    
    
    18,358
    
    
    
    18.0
    
    
    
    17,553
    
    
    
    16,2Research and development
    
    
    5,408
    
    
    
    5.3
    
    
    
    3,302
    
    
    
    3.0Operating income
    
    
    535
    
    
    
    0.5
    
    
    
    7,828
    
    
    
    7.2Other income (expense)Interest income
    
    
    334
    
    
    
    0.3
    
    
    
    351
    
    
    
    0.3Interest expense
    
    
    (1,715
    )
    
    
    (1.7
    )
    
    
    (1,506
    )
    
    
    (1.4
    )Other  net
    
    
    (908
    )
    
    
    (0.9
    )
    
    
    (366
    )
    
    
    (0.3
    )Earnings (loss) before
income taxes
    
    
    (1754
    )
    
    
    (1.8
    )
    
    
    6,307
    
    
    
    5.8Income tax (benefit) expense
    
    
    (552
    )
    
    
    (0.5
    )
    
    
    2,502
    
    
    
    2.3Net earnings (loss)
    
    $
    (1,202
    )
    
    
    (1.3
    )%
    
    $
    3,805
    
    
    
    3.5
    %
 Revenue. Allied had revenue of $102,233 in the nine months ended September 30, 2004, which was 6% 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
    
    $
    63,858
    
    
    
    62
    %
    
    $
    79,883
    
    
    
    74
    %Electronic Security
    
    
    33,386
    
    
    
    33
    %
    
    
    22,187
    
    
    
    20
    %Environmental Safety & Security
    
    
    4,654
    
    
    
    5
    %
    
    
    5,229
    
    
    
    5
    %Software, Training & Simulation
    
    
    335
    
    
    
    
    %
    
    
    1,180
    
    
    
    1
    %$
    102,233
    
    
    
    100
    %
    
    $
    108,479
    
    
    
    100
    %
 Ordnance & Manufacturing Segment revenue for the nine months ended September 30, 2004 decreased by
20% 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. 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 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)  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 76% compared with 74% for the same period in 2003. Cost of Sales as Percentage of Sales by Segment Nine months endedSeptember 302004
    
    
    2003Ordnance & Manufacturing
    
    
    87
    %
    
    
    79
    %Electronic Security
    
    
    58
    %
    
    
    54
    %Environmental Safety & Security
    
    
    64
    %
    
    
    66
    %Software, Training & Simulation
    
    
    64
    %
    
    
    60
    %Total
    
    
    76
    %
    
    
    74
    %
 Ordnance & Manufacturing Segment cost of sales as a percentage of sales for the nine months ended
September 30, 2004 increased over the same period of 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 Selling and Administrative Expenses.Selling and administrative expenses as a percentage of sales
for the nine months ended September 30, 2004 was approximately 18% compared with 16% 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. 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)  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 (Loss) Pre-Tax Profit (Loss) by Segment Nine months endedSeptember 302004
    
    
    2003Ordnance & Manufacturing
    
    $
    (2,768
    )
    
    $
    7,200Electronic Security
    
    
    5,077
    
    
    
    635Environmental Safety & Security
    
    
    (2,364
    )
    
    
    (608
    )Software, Training & Simulation
    
    
    (517
    )
    
    
    (58
    )Corporate and other
    
    
    (1,182
    )
    
    
    (862
    )$
    (1,754
    )
    
    $
    6,307
 Ordnance & Manufacturing Segment incurred a pre-tax loss for the first nine months of 2004 versus a
pre-tax profit for the comparable period in 2003 due to the change in accounting for the
derivatives, 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. 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 a benefit of 31%
compared to an expense of 40% in the same period of 2003. This occurred primarily from the change
in accounting for the derivatives described above. While the corporate tax rate in Belgium was
reduced from 40.17% to 33.99% effective for tax years beginning January 1, 2003, the reduced tax
rate did not take effect at MECAR and the VSK Group until the second half of 2003. Net Earnings (Loss).The Company incurred a $1,202 net loss for the nine months ended September
30, 2004 compared with $3,805 net profit in the same period of 2003. The decrease in 2004 resulted
from the activities at MECAR, SeaSpace and Titan Dynamics. 21




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  Backlog.As of September 30, 2004, the Companys backlog was $82,500 compared to $115,416 at
December 31, 2003, and $121,674 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
    
    $
    55,467
    
    
    
    67
    %
    
    $
    103,802
    
    
    
    85
    %Electronic Security
    
    
    24,796
    
    
    
    30
    
    
    
    15,582
    
    
    
    13Environmental Safety & Security
    
    
    1,498
    
    
    
    2
    
    
    
    1,632
    
    
    
    1Software, Training & Simulation
    
    
    739
    
    
    
    1
    
    
    
    658
    
    
    
    1$
    82,500
    
    
    
    100
    %
    
    $
    121,674
    
    
    
    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. 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 $80,512 at September 30, 2004, which is a
decrease of $8,705 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 $2,449, or 7% from December 31, 2003, due to
higher shipments in third quarter 2004 versus fourth quarter 2003 and the change in accounting for
the derivatives. Costs and accrued earnings on uncompleted contracts increased by $7,584 from
year-end 2003 primarily as a result of the change in accounting for the derivatives. 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 $445 at September 30, 2004, compared to $6,900 at December 31, 2003.
MECAR uses foreign currency derivative contracts to minimize the foreign currency exposures that
arise from sales contracts with certain foreign customers. 22




---



##### 



The Allied Defense Group, Inc.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
(Thousands of Dollars)
(Unaudited)  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 $1,139. The Euro depreciated by
approximately 2% since the beginning of the year. 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
    
    $
    (18,267
    )
    
    $
    13,468Net 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 $18,267 of cash in its operating activities during the nine
months ended September 30, 2004 whereas it generated $13,468 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. 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)  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. 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. 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)  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. 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 81%
and 78% of condensed consolidated revenue was recognized under the
percentage of completion method during the three and nine months
ended September 30, 2004, respectively. Approximately 79% and 81%
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.
    Derivative Instruments.The Company designates its derivatives
based upon the criteria established by Statement of Financial
Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133), which establishes
accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other
contracts, and for hedging activities. SFAS 133, as amended by
SFAS 138 and SFAS 149, requires that an entity recognize all
derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value.
The accounting for the changes in the fair value of the derivative
depends on the intended use of the derivative and the resulting
designation. For a derivative designated as a fair value hedge,
the gain or loss is recognized in earnings in the period of change
together with the offsetting loss or gain on the risk being
hedged. For a derivative designated as a cash flow hedge, the
effective portion of the derivatives gain or loss is initially
reported as a component of accumulated other comprehensive income
(loss) and is subsequently reclassified to earnings when the hedge
exposure effects earnings. The ineffective portion of the hedge
is reported in earnings immediately. For a derivative that does
not qualify as a fair value hedge or cash flow hedge, the change
in fair value is recognized currently in net income. 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)   
    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;
    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 $31million 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 84% 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 $0.09 million and $0.11 million and $0.01 million and $0.69
million, respectively. DISCLOSURE CONTROLS AND PROCEDURES The following has been amended to reflect the restatement of the Companys consolidated financial
statements as discussed further in the Explanatory Note and in Note 1 of the Notes to Consolidated
Financial Statements.  1.
    Evaluation of disclosure controls and proceduresThe Company maintains disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the reports filed or submitted under the Securities
Exchange Act of 1934, as amended (Exchange Act), is recorded, processed, summarized and
reported within the time periods specified in the Commissions rules and forms. Disclosure
controls and procedures are designed to ensure that information required to be disclosed by the
Company in its Exchange Act reports is accumulated and communicated to the Companys management
including its principal executive and financial officers, as appropriate to allow timely
decisions regarding required disclosure. Under the direction and with the participation of the
Companys management, including the Companys Chief Executive Officer and Chief Financial
Officer, the Company carried out an evaluation of the effectiveness of the design and operation
of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 as of the end of
the period covered by the report. In connection with the annual audit for calendar year 2004,
management concluded that its internal control over financial reporting was ineffective due to
its method of accounting for foreign currency contracts. As a result, the Chief Executive
Officer and the Chief Financial Officer have concluded that the disclosure controls and
procedures were not effective.2.
    Changes in internal controlsExcept as set forth above, there have been no significant changes in our internal controls over
financial reporting or, to our knowledge, in other factors that occurred during the last quarter
that has materially affected, or is reasonably likely to materially affect, our internal control
over financial reporting.   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).10.13
    
    Employee Stock Purchase Plan, as amended (Incorporated by reference from Form 10-Q filed in November 2002).10.14
    
    Lease Agreement, as amended (Incorporated by reference from Form 10-Q filed in November 2002).10.15
    
    Form of Indemnity Agreement for Directors and Executive Officers (Incorporated by reference from Form 10-Q
filed in November 2002).10.16
    
    International Distribution Agreement (Incorporated by reference from Form 10-Q filed in November 2002).10.17
    
    Deferred Compensation Plan for Non-Employee Directors (Incorporated by reference from Form 10-Q filed in August
2004).10.18
    
    Loan and Security Agreement among Wilton Funding, LLC and Allied and certain of its subsidiaries (Incorporated
by reference from Form 8-K filed in June 2004).10.19
    
    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).
 28




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The Allied Defense Group, Inc.
PART II  OTHER INFORMATION
September 30, 2004 Exhibit No.
    
    Description of Exhibits23
    
    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:  April 25, 2005
    Charles A. Hasper,Chief Financial Officer and
Treasurer 30