UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549




                                    FORM 10-K




                Annual Report Pursuant to Section 13 or 15(d) of
                       the Securities Exchange Act of 1934




For the fiscal year ended                                 Commission file number
    December 31, 1998                                        0-2545



                           ALLIED RESEARCH CORPORATION
             (Exact name of registrant as specified in its charter)

<PAGE>


                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                    FORM 10-K

                Annual Report Pursuant to Section 13 or 15(d) of
                       the Securities Exchange Act of 1934

For the fiscal year ended                                 Commission file number
    December 31, 1998                                        O-2545
    -----------------                                        ------

                           ALLIED RESEARCH CORPORATION
             (Exact name of registrant as specified in its charter)

Delaware
--------
                                                         04-2281015
(State or other jurisdiction of                       (I.R.S. Employer
incorporation or organization)                       Identification No.)

8000 Towers Crescent Drive
Suite 750
Vienna, Virginia                                          22182
----------------                                          -----
(Address of principal executive offices)               (Zip Code)

Allied's telephone number, including area code: (703) 847-5268

Securities registered pursuant to Section 12(b) of the Act:

        Title of Class                          Name of Exchange
        --------------                          ----------------

        Common Stock,                           American Stock Exchange
        $0.10 Par Value

Securities registered pursuant to Section 12(g) of the Act: None

        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  X     No     


<PAGE>

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part II
of this Form 10-K or any amendment to this Form 10-K. [X]

        State the aggregate market value of the voting stock held by
non-affiliates of the registrant as of February 2, 1999:

       Common Stock - Par Value $.10                 $31,927,427

        The number of shares of registrant's Common Stock outstanding as of
February 2, 1999, was 4,754,210.

<PAGE>

Item 1.  Business.

General.

        Allied Research Corporation ("Allied" or the "Company") was incorporated
in 1962 under the name Allied Research Associates, Inc. Allied changed its
corporate name to Allied Research Corporation in 1988. Allied's business is
primarily conducted through its subsidiaries, MECAR S.A. ("MECAR"), Barnes &
Reinecke, Inc. ("BRI"), Allied Research Corporation Limited ("Limited") as well
as a group of Belgian corporations acquired in 1994 and 1995 lead by VSK
Electronics, S.A., Teletechnique Generale, S.A. and IDCS, S.A. (collectively,
the "VSK Group"). MECAR is located in Petit-Roeulx-lez-Nivelles, Belgium; BRI is
headquartered in Arlington Heights, Illinois and has operations in East Moline,
Illinois and Troy, Michigan; Limited is located in the United Kingdom; and the
VSK Group operates from several different locations in Belgium.

Description of Business.

Allied.

        Allied provides management and marketing services to its subsidiaries.
Allied also provides export licensing and freight forwarding services for its
subsidiaries.

MECAR.

        MECAR develops, designs, manufactures and sells ammunition and light
weapons for infantry use. Substantially all of MECAR's revenues are derived from
the sale of ammunition which is used with weapons that are generally considered
defensive weapons. From time to time, MECAR provides system integration services
pursuant to which it purchases and resells weapon systems and/or ammunition.

        MECAR designs, develops and manufactures a wide variety of ammunition
and grenades in the medium caliber, artillery, anti-tank and anti-personnel
categories. The following are the principal products produced and sold by MECAR:

               Mortar Ammunition. The 81mm family of mortar ammunition has
recently been modernized to compete with the latest generation of this product
line. Production quantities of this latest version have already been
manufactured and delivered to MECAR customers. The 120mm family is a state of
the art ammunition for standard field mortars and for the increased performance
turreted AMS mortar. The current version of this ammunition is presently
undergoing qualification with the US Army, together with the 120mm AMS LAV-M(S)
system. This system is capable of direct as well as indirect fire. The MECAR
ammunition is the only one so far developed that has been designed to perform in
the AMS weapon high pressure and acceleration environment.

                                       3
<PAGE>


               90mm Weapon Systems for Light Armored Vehicles. MECAR has
developed and produces complete families of ammunition that include APFSDS, HE,
SMK and HESH rounds for the COCKERILL Mk II and III and ENGESA EC-90, and DEFA
F1 guns. Over 2000 of these guns are standard equipment on light APCs in the Far
East and South America alone. In the last three years, these families of
ammunition have been improved to meet the highest standards of safety and
performance.

               The 90mm KENERGA Weapon System has been jointly developed by
COCKERILL MECHANICAL SYSTEMS ("CMI") and MECAR to provide the modern APC with
anti-tank punch similar to that of tanks equipped with 105mm guns, without
sacrifice to the range, mobility and maintainability of the light APC. In this
partnership CMI is responsible for the weapon and MECAR for the ammunition. The
ammunition family includes the APFSDS, HESH and SMK versions with their
corresponding training rounds.

               Tank Ammunition. MECAR produces the entire range of 105mm rounds
of its own design and which perform to NATO requirements, for use in the US M68,
UK L7 and French CN105F1 guns. These include the APFSDS, HEAT, HESH and SMK,
with their corresponding training rounds. Additionally, it has produced under
license the US Army M393A2 HEP-T and M724A1 TPDS-T rounds for the Belgian Army.
MECAR has produced 100mm APFSDS rounds for friendly pro western clients in the
Far East.

         Artillery Ammunition. MECAR has produced 155mm HE, SMK(WP) and
ILLUMINATING rounds for various clients. It is currently producing 155mm M107 HE
projectiles for a European client.

         Medium Caliber Round. The 25mm APFSDS-T ammunition round is MECAR's
entry into the medium caliber arena.

        76mm L23 Ammunition. MECAR manufactures HE, HESH and HESH-PRAC
ammunition for the L23 guns, in service with armored vehicles in several
countries in Europe, South America, Africa and the Far East. Even though this is
an established weapon, requirements for this ammunition are expected to continue
for the next several years.

        Universal Bullet Trap Rifle Grenades. The universal bullet trap rifle
grenade is designed to be light, effective, accurate and simple to use. It is
fitted over the muzzle of any standard military rifle with a muzzle outer
diameter of 22mm and fired from the shoulder in the normal manner. This method
of firing a grenade is made possible by MECAR's development of the universal
bullet trap ("BTU"). The BTU is a patented device which can be used with all
existing makes of steel core or soft core bullets in calibers 7.62mm and 5.56mm,
including the latest round (SS109) used in the M-16 rifle. The BTU is fitted
within the tail of the grenade. When the bullet is fired, it lodges in the


                                       4
<PAGE>

BTU and the expanding gases released by the discharged round propel the grenade
to its target. MECAR manufactures several different bullet trap grenades
including high explosive fragmentation, anti-personnel, armour piercing, smoke
generating, white phosphorus, and parachute flare (night illuminating).

        84mm SAKR Recoilless Rifle. MECAR developed and manufactures this
recoilless rifle and its associated family of ammunition. The SAKR fills the gap
between rifle grenades and the 90mm family of guns and ammunition. The SAKR
ammunition (HEAT, HE-T and HE-TP-T) is also interoperable with existing 84mm
systems.

         Hand Grenades. MECAR manufactures the M72 controlled fragmentation hand
grenade.

BRI.

        BRI is an engineering and technical firm that specializes in design,
prototype fabrication, production, test and inspection documentation for
government and industry. The major portion of BRI's business is in military
vehicle technology and technical support of combat and support vehicles. BRI's
capability includes the design of heavy wheeled and tracked vehicles. Military
and commercial technical manuals are prepared, technical data packages are
maintained, and logistic support analysis conducted. BRI is the U.S. Army's
technical support contractor on the M109 self-propelled 155mm Howitzer family of
vehicles, M88 Recovery Vehicle and M551 Sheridan Light Tank.

        BRI's technical publications department provides hard copy and
electronic format documents and manuals for the presentation and support of
products. This includes both commercial and government department of defense
customers.

Limited.

        Limited, a systems integrator in the ammunition industry, was
established by Allied in 1989 to augment its overseas business development
efforts. In 1994, the London office of Limited was closed and the employment of
the relevant employees was terminated. Allied and MECAR continue to attempt to
obtain additional systems integration contracts. If any such contracts are
obtained in the name of Limited, such entity will be appropriately staffed and
supported to carry out the contracts.

VSK Group.

        The VSK Group engages in the business of developing, manufacturing,
selling, installing and servicing security systems for private industry. The
systems marketed by the VSK Group include intrusion detection, access control
and fire detection systems. The principal products manufactured by the VSK Group
are central control panels; the other


                                       5
<PAGE>

components are purchased from other vendors. In May, 1995, the VSK Group
acquired all of the outstanding stock of IDCS, S.A., which markets an upscale
line of security services products principally in European markets.

Geographic Areas and Industry Segments.

        See Note S to Allied's consolidated financial statements for information
concerning the geographic areas and industry segments of Allied which
information is incorporated herein by reference.

Market and Customers.

        Allied derives the principal portion of its revenues from direct and
indirect sales to foreign governments, U.S. Government agencies and prime
contractors, primarily on fixed price contracts. The addition of the VSK Group
adds a non-military component to company-wide operations. Two agencies of a
foreign government and another foreign government accounted for approximately
41%, 20% and 10% in 1998, 64%, 6% and 10% in 1997 and 48%, 10% and 19% in 1996
of Allied's revenues. During 1998, 1997 and 1996, Allied derived approximately
3%, 5% and 11%, respectively, of its annual revenue from U.S. Government
agencies and contractors. The VSK Group accounted for approximately 15%, 12% and
17% of Allied's 1998, 1997 and 1996 revenues, respectively.

        MECAR's products are sold directly or indirectly to the defense
departments of governments. MECAR is regulated by Belgian law regarding the
foreign governments with which it may do business.

        The sales by MECAR in any given period and its backlog at any particular
time may be significantly influenced by one or a few large orders. This is due
to the nature of its business. An order for MECAR's products is typically for a
large quantity and/or a substantial aggregate price, primarily because materials
required for the manufacture of the products cannot be economically purchased in
small quantities and because of the favorable economies of large volume
production. In addition, the production period required to fill most such orders
may range from several months to a year. Accordingly, MECAR's business is
dependent upon its ability to obtain such large orders. MECAR has no continuing
contract with any customer to purchase MECAR's products. MECAR does, of course,
accept smaller orders when it is profitable to do so or when MECAR management
believes that accepting such an order is otherwise in the best interests of
MECAR. MECAR's products are designed for general military use by a variety of
government customers.

        When MECAR obtains a contract for the sale of its products, it generally
receives down payment(s) and/or letter(s) of credit to be applied to the
purchase price upon shipment of the products.

                                       6
<PAGE>

        MECAR has received from time-to-time foreign military sale contracts
from the U.S. Government for the manufacture of ammunition for the benefit of a
foreign government. Such contracts are subject to termination for convenience or
upon default.

        BRI's engineering and technical services are sold directly or indirectly
to the United States Department of Defense, foreign governments and certain
civilian customers. BRI has a number of ongoing design and engineering
assignments with U.S. military agencies, however, BRI has no continuing contract
with any customer to provide products or services. The size of the orders vary
and completion time ranges from several months to a few days. U.S. Government
contracts are subject to termination at the convenience of the U.S.
Government or for default.

        The VSK Group derives substantially all of its revenue from sales and
services to private industry such as banks, hospitals, commercial businesses,
office buildings, etc. The VSK Group also sells its systems to other independent
distributors and resellers. The customers of the VSK Group are located in
Belgium and in neighboring countries. While most of the orders received by the
VSK Group are for work which can be completed within one year, it has received
multi-year orders for its products and services. IDCS sells its products
principally in European markets.

Marketing.

        Most of the marketing activities of MECAR are handled by MECAR's staff
of sales engineers and executive staff. In addition, MECAR advertises in trade
journals and participates in trade shows. MECAR is also represented by marketing
representatives in different markets. MECAR obtains orders from the agencies of
a foreign government which constitute its principal customers through an
independent marketing representative.

        BRI's marketing activities are conducted by its executive and marketing
staff. In addition, BRI participates in various trade shows and advertises in
trade journals. In 1997, BRI entered into various teaming agreements pursuant to
which BRI will be relying upon the marketing efforts of its teaming partners.

        The marketing activities of the VSK Group are handled principally by its
staff of sales personnel. Marketing activities outside of Belgium are conducted
by independent distributors. In addition, the VSK Group advertises in trade
journals and participates in trade shows.


                                       7
<PAGE>

Research and Development.

        The development of ammunition and weapon systems requires knowledge and
experience in aerodynamics, mechanical engineering, chemistry, combustion,
materials behavior and ballistics. MECAR maintains an active research and
development staff, including a staff of design engineers, in order to determine
how materials can be used or combined in new ways to improve performance or to
solve new problems. In 1998, 1997 and 1996, MECAR expended $811,240, $794,370
and $857,434, respectively, for research and development activities. MECAR
designed most of the products which it currently manufactures. MECAR designs and
develops most of its special tooling, fixtures and special explosive loading and
testing systems.

        BRI conducts research and development under contract to both government
and commercial clients. Generally, full-size prototypes are supplied where the
research and development requirement calls for a working model or unit.

        The business of the VSK Group requires continuous investment in research
and development to update and enhance the security systems. The VSK Group
employs a staff of design engineers specialized in the field of both electronic
hardware and software. During 1998, 1997 and 1996 the VSK Group expended
$802,810, $694,026 and $888,885, respectively, on research and development.

Suppliers and Materials.

        Production of ammunition requires an ample supply of chemicals,
pyrotechnical materials and metal component parts and casings. MECAR generally
attempts to ensure that several vendors will be available in the open market to
compete for all supply contracts. However, once the development phase is
complete and the design has been stabilized for certain products, the continued
availability of supplies can become critical to its ability to perform a
particular contract. MECAR seeks to protect itself against shortages and similar
risks by planning alternative means of production, by producing internally, and
by monitoring the availability and sources of supplies.

        Production of weapons requires a continued supply of a variety of
components and materials. MECAR depends upon major suppliers to provide such
components and materials where in-house capability does not exist. It has
generally found such materials and supplies to be readily available.

        For its manufacturing and assembly operations, BRI is dependent on
suppliers of materials and parts, some of which are customer-directed sole
source procurement. BRI has found such supplies and materials to be generally
available.

                                       8
<PAGE>

        The VSK Group relies upon a number of selected subcontractors to supply
the requisite electronic hardware for its security systems. To date, the VSK
Group has found such subcontract materials to be readily available. Assembly of
the central control panels (including all computer software) is performed
internally by employees of the VSK Group.

Backlog.

        As of December 31, 1998 and December 31, 1997, Allied had backlog orders
believed to be firm, after giving effect to the percentage of completion method
of accounting, of approximately $48.0 million and $92.8 million, respectively.
The backlog of orders as of December 31, 1998 are expected to be filled in 1999.


Competition.

        The munitions business is highly competitive. MECAR has a number of
competitors throughout the world, including the United States. Many of its
competitors are substantially larger companies with greater capital resources
and experience. Many of its competitors have existing relationships with
governments and countries in which MECAR markets its products. For example, many
countries will only acquire ammunition and other military items from vendors
located in said countries. In many other countries, it is important to have an
independent marketing representative. Competition is mainly based upon
accessibility of potential markets, technical expertise, quality, capabilities
of the product and price.

        BRI is in a very competitive business and many of its competitors are
larger companies with greater capital resources. As defense spending continues
to decline and the defense industry consolidates, the level of competition will
likely increase. A large portion of BRI's business is obtained through the
competitive bidding process.

        The nature of the competition encountered by the VSK Group depends upon
the segment of the security systems business. In the development and
manufacturing area, there are a number of larger competitors, many with greater
financial resources than the VSK Group. In the installation and services area,
the VSK Group competes with a number of smaller, local competitors.


                                       9
<PAGE>

Personnel.

        As of December 31, 1998, Allied, MECAR, BRI and the VSK Group had 440
full and part-time employees as follows:

        ALLIED
        ------

        Salaried employees                         5
        Part-time employees                        1

        MECAR
        -----

        Technical and salaried employees          46
        Hourly workers                           185
        Technical consultants                      3

        BRI
        ---

        Salaried employees                        59
        Hourly employees                          26
        Part-time employees                        9

        VSK Group
        ---------

        Technical salaried employees              65
        Hourly workers                            41

        The classification of employees noted above for MECAR and the VSK Group
is in accordance with Belgian law.

Patents.

        MECAR holds a number of patents in many countries and with varying
expiration dates covering certain of its products. Allied does not believe there
is a threat of a material loss of revenue with the expiration of any of these
patents.

Environmental Regulations.

        Allied does not anticipate that compliance with any laws or regulations
relating to environmental protection will have a material effect on its capital
expenditures, earnings or competitive position.

Principal Customers.

         MECAR has historically received a large percentage of its revenue from
two (2) agencies of a foreign government. BRI receives a substantial portion of
its business from and/or through the U.S. Government.


                                       10
<PAGE>

Item 2. Properties.

        Allied's principal executive offices are located in Vienna, Virginia,
where it leases approximately 4,300 square feet of office space. The lease
expires in September, 2000.

        MECAR's principal factory is located approximately 25 miles south of
Brussels near Nivelles, Belgium. The factory principally consists of a
manufacturing and administrative complex which was occupied by MECAR in 1989.
The manufacturing area consists of approximately 112,000 square feet and the
administration facilities consist of approximately 28,000 square feet. There are
a number of older buildings on the property that are still used in conjunction
with the new complex. A small test firing range is maintained on this property.
MECAR also owns a 500 acre test range in the vicinity of the Village of Marche
in the Ardennes region of Belgium, which was acquired in 1985.

        Throughout 1998, MECAR operated at an average of 85% of productive
capacity of its facility, assuming the operation of 3 shifts. MECAR is currently
operating at 85% of productive capacity.

        BRI operates from an office and manufacturing building in Arlington
Heights, Illinois. BRI has leased approximately 57,500 square feet of office,
engineering and manufacturing space through July 31, 1999 and has recently
extended the term of this lease through July 31, 2004. Assuming one full shift
is maximum capacity, BRI is currently operating at approximately 85% of the
productive capacity of its Arlington Heights facility.

        BRI also operates from leased facilities located in Troy, Michigan and
East Moline, Illinois. The Troy operations are conducted from a leased facility
consisting of approximately 17,500 square feet of office and engineering space.
The Troy lease expires on January 31, 2000. The East Moline facility contains
1,200 square feet of office and engineering space and is leased on a month to
month basis. Both facilities are used as bases to service Department of Defense
customers in the vicinity. BRI is currently operating at approximately 90% of
the productive capacities of each of its Troy and East Moline facilities.

        The VSK Group operates from owned facilities containing approximately
49,400 square feet. Such facilities are currently operating at approximately 85%
of productive capacity.

        Capital expenditure programs for equipment planned in 1999 will require
funding of approximately $2.5 million.

Item 3. Legal Proceedings.

                                       11
<PAGE>

        There are no material pending legal proceedings, other than ordinary
routine litigation incidental to Allied's business, to which Allied or any of
its subsidiaries is a party or to which any of their property is subject.

Item 4. Submission of Matters to a Vote of Security Holders.

        There were no matters submitted to a vote of security holders of Allied
during the fourth quarter of 1998.

                                     PART II

Item 5.  Market for Stock and Related Security Holder Matters.
Market Information.

        Allied's Common Stock has been listed for trading on the American Stock
Exchange ("AMEX") since September 15, 1992. Its AMEX trading symbol is ALR. Its
media listing is under the symbol Allied Research. The table below shows the
high and low sales prices of Allied's Common Stock during 1998 and 1997 (as
reported by AMEX):

        1998                                              High          Low
        ----                                              ----          ---

        1st Quarter                                     $13-3/16       $   10
        2nd Quarter                                      13-1/16       11-1/4
        3rd Quarter                                       12-1/4        6-3/8
        4th Quarter                                        8-5/8            6

        1997                                               High         Low
        ----                                               ----         ---

        1st Quarter                                      $10-1/2      $ 5-7/8
        2nd Quarter                                       9-9/16        7-1/4
        3rd Quarter                                       13-5/8        8-3/8
        4th Quarter                                     15-13/16       10-5/8

Stockholders.

        There were approximately 1,525 holders of record of the Common Stock of
Allied as of February 18, 1999.

Dividends.

        Allied paid a 5% stock dividend on November 6, 1992 to holders of record
of its Common Stock on October 15, 1992. Cash was paid in lieu of the issuance
of fractional shares. There have been no dividends declared or paid by Allied in
1993-1998. The banking agreements of MECAR restrict the ability of such
subsidiary to transfer funds to


                                       12
<PAGE>

Allied as described in Management's Discussion and Analysis of Financial
Condition and Results of Operations.

Item 6.  Selected Financial Data.

        The following selected financial data relates to Allied's consolidated
financial position and results of operations for 1998, 1997, 1996, 1995 and
1994:

<TABLE>
<CAPTION>
                                      1998           1997             1996         1995           1994
                                      ----           ----             ----         ----           ----
                                                 (000's omitted except per share amounts)

<S>                                 <C>            <C>              <C>           <C>           <C>     
Revenues                            $143,535       $134,484         $103,660      $65,769       $ 69,847

Net earnings (loss)                    9,066          8,565            4,805       (2,013)       (10,941)

Earnings (loss) per share:
  Basic                                 1.92           1.88             1.08         (.46)         (2.49)
  Diluted                               1.90           1.85             1.08         (.46)         (2.49)

Total assets                         113,076         99,501           91,948       94,253        107,386

Long-term debt
obligations and
redeemable preferred
stock                                 10,281         11,162            7,443       28,435         14,108


Cash dividends
declared per
common share                             -              -                 -           -              -
</TABLE>

NOTE: All per share amounts have been restated consistent with the provision of
FASB 128, which became effective in 1997.

Item 7. Management's Discussion and Analysis of Financial Condition and
        Results of Operations.

Overview

         Allied provides management services to its subsidiaries. Allied's
consolidated statements have eliminated all significant intercompany
transactions. The following discussion refers to the financial condition,
liquidity and results of operations of Allied on a consolidated basis unless
otherwise stated. All dollars are in millions except per share amounts.

         Allied operates in three (3) principal segments: the development and
production of ammunitions and weapon systems ("product sales"); the manufacture,
distribution and service of an integrated line of industrial security products
("security systems and services"); and engineering and technical support
services ("engineering and


                                       13
<PAGE>

technical"). Product sales, security systems and services and engineering and
technical are provided solely by MECAR, VSK Group and BRI, respectively.
Accordingly, all references in this Item 7 to (i) MECAR shall refer to the
product sales segment, (ii) VSK Group shall refer to the security systems and
services segment and (iii) BRI shall refer to the engineering and technical
segment. All references herein to Allied or the Company shall refer to Allied
Research Corporation as a whole.

               Allied earned a net profit of $9.07 ($1.92 per share - basic) for
1998 compared to a net profit of $8.56 ($1.88 per share - basic) for 1997 and a
net profit of $4.81 ($1.08 per share - basic) for 1996. Diluted earnings per
share were $1.90, $1.85 and $1.08 in 1998, 1997 and 1996, respectively. In each
of 1998, 1997 and 1996, each of Allied's operating subsidiaries earned a profit.

Forward-Looking Statements

               This Management's Discussion and Analysis of Financial Condition
and Results of Operations 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 increasing competition by foreign and
domestic competitors, including new entrants; substantial reliance on MECAR's
principal customers to continue to acquire MECAR's 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 its transition from a pure
defense firm to a firm with a substantial commercial component; the mix of
products/services; the achievement of lower costs and expenses; 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; 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. The
principal current Future Factor affecting MECAR's business is the continuing
impact of depressed oil prices on its principal customers. These


                                       14
<PAGE>

are representative of the Future Factors that could affect the outcome of the
forward-looking statements. In addition, such statements could be affected by
general industry and market conditions and growth rates, general domestic and
international economic conditions including interest rate and currency exchange
rate fluctuations and other Future Factors.

Trends In Operations

         Allied had one of its most profitable years in 1998.

         MECAR turned in another solid performance in 1998. It contributed
approximately 78% of Allied's 1998 revenues. While the vast majority of such
revenues resulted from products supplied to MECAR's principal customers, MECAR
received a modest contract award ($4.0) from a new customer in 1998 which could
lead to substantial follow-on awards. MECAR has also negotiated the terms of a
contract with another new customer, however this contract has not yet been
awarded.

         MECAR's performance slowed in the fourth quarter of 1998 as a result of
the lack of current orders from MECAR's principal customers. The last
substantial contract received by MECAR from its principal customers was received
in March, 1998. Allied believes that depressed oil prices, which adversely
impact the purchasing power of such customers, is the principal reason for the
delay in receipt of orders from such customers. Notwithstanding the continued
depressed state of oil prices, MECAR has been in active negotiations with the
principal customers for a new contract. MECAR anticipates an award of this
contract in the second quarter of 1999, however there can be no assurance as to 
the receipt of such an award.

         Allied is optimistic that continued orders will be placed by such
principal customers. In addition to follow-on orders for ammunition for various
weapons systems currently owned by such customers, these customers are in the
process of acquiring two new weapons systems via the Foreign Military Sales
program ("FMS"). MECAR has received and completed an initial contract for
ammunition for one of these systems. This ammunition is in the process of being
tested by the U.S. Government and MECAR is in negotiations with the U.S.
Government for a follow-on contract for additional rounds of such ammunition.
MECAR has engaged in preliminary discussions with respect to an initial order
for ammunition for the second new weapons system. It is currently anticipated
that MECAR will receive a contract for such an initial order during 1999 and
anticipates receipt of substantial ammunition orders over a several year period
following successful completion of testing of the ammunition supplied for these
new weapons systems.

         Given the several-month delay in the recognition of revenue from the
time of receipt of a contract (due to the ramp-up time and the delay in


                                       15
<PAGE>

receipt of raw materials following the placement of orders therefor), the
Company anticipates a substantial slow-down in MECAR's revenue beginning at the
end of the first quarter of 1999. If substantial contracts are received in the
near future, the reduced contribution by MECAR may be limited to the next few
quarters. Further, MECAR utilized all of its tax-loss carry forwards in 1998 and
therefore will be subject to Belgian tax on any 1999 earnings.


         The VSK Group had a record year in 1998. It contributed approximately
$21.27 in revenues and $2.54 in profits. Thus, the VSK Group contributed
approximately 28% of Allied's profits on only 14.8% of Allied's revenues. While
all lines of business increased in 1998, the VSK Group's 1998 results were
enhanced by a $4.2 project for an integrated security system installed in a
large hotel complex outside of the VSK Group's traditional service territory.
This project is scheduled for completion in the first quarter of 1999.

         Allied expects the VSK Group to provide another excellent year in 1999,
although it may not reach 1998 levels. In addition to the one-time hotel
project, the VSK Group expects a temporary downturn in its bank business in
1998. One of its principal bank customers is in the process of merging with
another bank and has advised the VSK Group that it will discontinue the
installation of further security systems until the merged entity determines
which bank branches it will continue to operate and which will be closed.
Notwithstanding these matters, the VSK Group has a substantial backlog of orders
and good prospects for additional work.

         In 1998, the VSK Group established dealer relationships in the United
Kingdom and in Germany, two of the fastest growing European markets for security
services and products. The VSK Group expects to continue to expand into these
markets.

         In addition, Allied and the VSK Group are actively seeking to grow the
VSK Group by acquisition. An active acquisition search is in process.

         The internal expansion of the VSK Group's business and its growth by
acquisition are being pursued to further increase Allied's non-defense business
with the twin goals of having (i) a larger commercial business base to reduce
the volatility of Allied's defense business and (ii) a sufficient commercial
component of revenues and profits to cause the investment community to cease
valuing Allied stock solely as a defense company.

         BRI's profitability was based in large part on revenues from a large
contract for the benefit of a foreign government. This contract is scheduled for
completion in mid-1999. In 1997, BRI entered into several teaming arrangements
with U.S.-based firms to pursue both domestic and international business. In
1998, BRI began to receive certain


                                       16
<PAGE>

contract awards from such arrangements. It is anticipated that BRI's future
prospects will depend in large part on the success of such teaming arrangements
and its ability to secure other large contracts.

         Allied commenced 1999 with a consolidated backlog of approximately
$48.0 compared with a consolidated backlog at the beginning of 1998 of $92.8.
MECAR began 1999 with a backlog of approximately $22.0 compared with a 1998
beginning backlog of $65.8. VSK began 1999 with a backlog of approximately $15.0
compared with a 1998 beginning backlog of approximately $12.7. BRI's beginning
backlog in 1999 was $11.0 compared with a 1998 beginning backlog of $14.4.

         The future prospects for Allied depend largely on MECAR's ability to
continue to obtain large orders on a periodic basis and Allied's ability to
successfully continue its expansion of its commercial business.

Trends In Liquidity And Capital Resources

         Allied's liquidity has improved in the last few years as a result of
its profitable operations. No liquidity problems are forecast for 1999. In the
longer term, Allied's liquidity will continue to depend upon its ability to
obtain substantial orders from its traditional customer base and the success of
its efforts to broaden its revenue base.

Year 2000 Issues

         Allied is addressing a broad range of issues associated with the
programming code in existing computer systems as the Year 2000 approaches. The
Year 2000 problem is complex, as many computer systems will be affected in some
way by the rollover of the two-digit year value to 00. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Year 2000 issue creates risks for Allied from unforeseen
problems in its products or its own computer and embedded systems and from third
parties with whom Allied deals on financial and other transactions worldwide.
Failure of Allied's and/or third parties' computer systems could have a material
impact on Allied's ability to conduct its business.

         Allied has commenced a phased program to inventory, assess, remediate,
test, implement and develop contingency plans for all mission-critical
applications and products potentially affected by the Year 2000 issue (the "Y2K
Program"). To accelerate overall completion, activities in each phase are often
concurrent rather than serial, but all phases, except developing contingency
plans, are expected to be completed by mid-1999.

         Allied's current estimate of the aggregate costs to be incurred for the
Y2K Program is less than $.25, which is expected to be funded from operating
cash flows. If Allied encounters significant unforeseen Year 2000 problems,
either in its products or


                                       17
<PAGE>

internal business systems or in relation to third party vendors, manufacturers
or suppliers, actual costs could materially exceed this estimate.

         Allied has substantially completed its inventory of Year 2000 impacted
software and is assessing its centralized computer and embedded systems to
identify any potential Year 2000 issues. Allied has a number of projects
underway to replace or upgrade hardware and software that are known to be Year
2000 non-compliant. Allied currently expects to substantially complete
remediation, validation, and implementation of its internal systems by mid-1999.
However, if implementation of replacement or upgraded systems or software is
delayed, or if significant new non-compliance issues are identified, Allied's
results of operations or financial condition could be materially adversely
affected.

         Allied is also in the process of contacting its critical suppliers,
manufacturers, distributors and other vendors to determine that the operations,
products and services that they provide to Allied are Year 2000 compliant. Where
practicable, Allied will attempt to mitigate its risks with respect to the
failure of third parties to be Year 2000 ready, including developing contingency
plans. However, such failures, including failures of any contingency plan,
remain a possibility and could have a materially adverse impact on Allied's
results of operations or financial condition.

         Allied is in the process of developing contingency plans to address
situations that may result if Allied is unable to achieve Year 2000 readiness of
its critical operations, including operations under the control of third
parties. Additionally, the most reasonably likely "worst case" scenario has not
yet been clearly identified. Completion of such contingency plans is in progress
and is expected to be completed by September 1999. There can be no assurance
that the Company will be able to develop contingency plans that will adequately
address all Year 2000 issues that may arise.

Liquidity.

         Allied's liquidity increased in 1998, principally as a result of
profitable operations at each operating segment. Working capital, which includes
restricted cash, was approximately $35.27 at December 31, 1998, which is an
increase of $10.15 from the December 31, 1997 level. Allied's current working
capital is required for operations and to support credit facility agreements.

         Cash and equivalents at December 31, 1998 increased over year-end 1997
levels largely due to the profitable operations of the operating segments.
Restricted cash increased over year-end 1997 amounts due to an increased level
of work-in-process at MECAR. Accounts receivable at December 31, 1998 decreased
from December 31, 1997 by $11.2 due to unusually large shipments of products at
the end of 1997. Costs and accrued earnings on uncompleted contracts increased
by $13.08 over 1997 as a result of larger amounts of work in progress at the end
of 1998 which is anticipated to be completed


                                       18
<PAGE>

and shipped in the first quarter of 1999. Inventories decreased by $3.54 from
1997 levels due to the increase in contracts in progress and the reduced
backlog. Prepaid expenses increased by $6.0 over 1997 levels corresponding to
the increase in contracts in progress which are scheduled to be shipped in the
first quarter of 1999. Current liabilities increased slightly from 1997 levels.

         During 1998, 1997 and 1996, Allied funded its operations principally
with internally generated cash and back-up credit facilities required for
foreign government contracts.

         Except for modest lines of credit to support certain of its operations,
Allied's ability to cover its anticipated future operating and capital
requirements is dependent upon its ability to generate positive cash flow from
operations. Given the relative size of the operations of its subsidiaries,
Allied's continued ability to generate sufficient cash flow remains dependent
principally upon the operations of MECAR and the VSK Group.

         MECAR typically obtains relatively large orders for its ammunition and
weapon systems which require credit facilities to provide import letters of
credit, advance payment guarantees and performance bonds. These needs have been
met in the last few years via agreements with a multi-member foreign bank pool.

         The current credit facility was revised in 1998. As has been the case
in recent years, the bank pool must agree to extend such facility to new orders
as they are received by MECAR. While management believes that it will be able to
finance additional MECAR contracts using the bank pool structure, there can be
no assurance that such financing will be provided.

         The credit facility and other loan agreements continue to impose
certain restrictions on MECAR. MECAR's obligations were collateralized at
December 31, 1998 by base cash deposits of $13.2 and a pledge on MECAR's assets
of $32. The bank agreement further precludes MECAR from making payments to any
company in the Allied group in excess of $2.4 per year until MECAR has
unrestricted cash of not less than $7.2. MECAR's obligations under the bank
agreement are also supported by a guarantee provided by Allied.

         MECAR has a mortgage loan with a foreign bank which had an outstanding
balance of approximately $3.56 at December 31, 1998. Principal and interest
payments on the mortgage loan extend through January, 2004.

         The VSK Group operated throughout 1998 primarily from cash generated
from operations. The VSK Group is obligated on several mortgages and other
long-term obligations with December 31, 1998 balances aggregating $1.2. It is
also obligated on letters of credit required by a contract with a customer.

                                       19
<PAGE>

         On January 1, 1999, eleven of the fifteen member countries of the
European Union adopted the euro as their common legal currency and established
fixed conversion rates between their existing sovereign currencies and the euro.
The euro trades on currency exchanges and is available for non-cash
transactions. Based on a preliminary assessment, Allied does not believe the
conversion will have a material impact on the competitiveness of its products or
increase the likelihood of contract cancellations. Further, Allied expects that
modifications to comply with euro requirements have been and will continue to be
made in its business operations and systems on a timely basis and does not
believe that the cost of such modifications will have a material adverse impact
on Allied's results of operations or financial condition. There can be no
assurance, however, that Allied will be able to continue to complete such
modifications on a timely basis; any failure to do so could have a material
adverse effect on Allied's results of operations or financial condition. In
addition, Allied faces risks to the extent that suppliers, manufacturers,
distributors and other vendors upon whom Allied relies and their suppliers are
unable to make appropriate modifications to support euro transactions. The
inability of such third parties to support euro transactions could have a
material adverse effect on Allied's results of operations or financial
condition.

         BRI operated throughout 1998 from cash generated from operations
supplemented by a credit facility. The credit facility consisted of a $3.5 line
of credit, which was increased to $4.75 in the latter portion of 1998 as well as
a cash collateralized letter of credit facility. At December 31, 1998, the line
of credit had an outstanding balance of $3.42. Allied has guaranteed BRI's
obligations under the above-described credit facility. Principally in order to
finance BRI's principal contract for the benefit of a foreign government, Allied
advanced approximately $1.4 million to BRI in the third and fourth quarters of
1998 (the "Inter-Company Loan").

         In early 1999, BRI obtained a new credit facility consisting of a $6.0
line of credit (which permits advances based upon BRI eligible accounts
receivable and unbilled work-in-process). BRI has used a portion of its line of
credit to repay a substantial portion of the Inter-Company Loan.

         In September 1998, Allied's Board of Directors authorized the purchase
of up to 200,000 shares of Allied's common stock. To date, the Company has
made very modest repurchases under the share repurchase program. The timing and
size of any future stock repurchases are subject to market conditions, stock
prices Allied's cash position and other cash requirements going forward.

Capital Resources.

         Allied spent $2.4 in 1998 on capital equipment as compared with $1.3 in
1997 and $1.1 in 1996, respectively. The expenditures in 1998 were primarily for
facility


                                       20
<PAGE>

upgrades and computer equipment. Management currently anticipates that it will
spend approximately $2.5 on capital expenditures in 1999, principally for
additional upgrades to the MECAR and VSK facilities and equipment.

Results of Operations.

         Allied had revenues of $143.54 in 1998 as compared to $134.48 in 1997
and $103.66 in 1996, respectively. Allied earned a profit of $9.07 in 1998
compared to profits of $8.56 in 1997 and $4.81 in 1996.


         The following table sets forth, for the years ended December 31, 1998,
1997 and 1996, certain items from Allied's consolidated statements of operations
expressed as a percentage of revenue:

                                      1998              1997          1996
                                      ----              ----          ----

Revenue                              100.0%            100.0%        100.0%

Costs and Expenses
  Cost of sales                       81.3              80.9          75.9
  Selling and administrative           8.8              10.7          15.1
  Research and development             1.1               1.1           1.7
  Restructuring charge                 ---                .7           ---
                                      ----             -----          ----

        Operating income               8.8               6.6           7.3

Other income (deductions)

  Interest income                      1.0                .8           1.9
  Interest expense                    (1.2)             (1.4)         (3.3)
  Other - net                           .6               1.1          (0.4)
                                      ----             -----          ----
        Earnings before
        income taxes                   8.1               7.1           5.5
Income taxes                           1.7                .7           0.9
Net earnings                           6.3               6.4           4.6
                                      ----             -----          ----

        The following discussion of the components of the results of operations
applies to Allied as a whole unless reference is made to a particular segment.

Revenues

        Allied revenues for 1998 increased $9.05, or 6.73%, as compared to 1997.
Revenues for 1997 increased $30.8, or 29.7%, as compared to 1996.

                                       21
<PAGE>

                               Revenues By Segment
                                  ($ Millions)

<TABLE>
<CAPTION>
                                     1998                       1997                     1996
                                     ----                       ----                     ----
                                     % of                       % of                     % of
                        Amount       Total         Amount       Total       Amount       Total
                        ------       -----         ------       -----       ------       -----
<S>                       <C>         <C>          <C>           <C>         <C>         <C>  
         MECAR            $111.8      77.9%        $107.5        80.0%       $74.1       71.5%
         VSK                21.3      14.8%          16.4        12.2%        17.9       17.3%
         BRI                10.5       7.2%          10.5         7.8%        11.6       11.2%
</TABLE>

        Revenues at MECAR for 1998 increased by approximately 4.0% from the
prior year and such revenues increased in 1997 by approximately 45% (net of
currency fluctuations) over the prior year due to increased business from
MECAR's traditional customer base.

        In 1998, revenues at the VSK Group increased approximately 29.9% over
1997 levels primarily due to several large projects including the
previously-described hotel complex project. In 1997, revenues at the VSK Group
decreased approximately 8.4% under 1996 levels primarily due to currency
fluctuations (if currency fluctuations are eliminated, 1997 VSK Group revenues
increased 6% over 1996 levels).

         Revenues at BRI for 1998 decreased by less than 1% from 1997. Revenues
in 1997 decreased 9.3% from 1996 levels.


Cost of Sales

         Cost of sales as a percentage of sales for 1998 was approximately 81%
compared with 81% and 76% for each of 1997 and 1996, respectively.

Selling and Administrative Expenses

         Selling and general administrative expenses in 1998 were $1.8 (or
12.5%) less than those incurred in 1997 as a result of continued cost cutting
efforts.

         Selling and general administrative expenses in 1997 were $1.2 (or 7.8%)
less than those incurred in 1996.


                                       22
<PAGE>

Research and Development

         Research and development costs incurred in 1998 increased by $0.13 (or
8.4%) over 1997 levels.

         Research and development costs incurred in 1997 decreased by $0.26 (or
14.8%) under 1996 levels due to lower expenditures at MECAR.

Restructuring Costs

         Restructuring costs incurred by MECAR, principally comprised of
workforce reductions, of approximately $.98 were incurred in 1997. Such charges
were incurred to reduce employment levels at MECAR.

Interest Income

         Interest income increased in 1998 by $0.47, or 45.4%, over 1997 levels
principally due to increased amounts of cash invested.

         Interest income decreased in 1997 by $.89, or 46% below 1996 levels
principally due to reduced cash levels principally resulting from repayment of a
term loan.

Interest Expense

         Interest expense decreased in 1998 by $0.07, or 4%, under the amount
incurred in 1997 as a result of lesser borrowings during the year.

         Interest expense decreased in 1997 by $1.6, or 46.5%, from the amount
incurred in 1996 as a result of a decrease in bank debt and credit facility
fees.

Other - Net

         Other-net results were a $0.81 loss in 1998 and a gain of $1.52 in
1997, largely due to net currency losses and gains, respectively, at MECAR.


                                       23
<PAGE>

Pre-Tax Profit

                            Pre-Tax Profit By Segment
                                   ($ Million)

                          1998                    1997                 1996
                          ----                    ----                 ----
                          % of                    % of                 % of
                Amount    Total        Amount     Total    Amount      Total

MECAR            $6.9       57%         $8.6       76%      $3.7         66%
VSK               4.5       37%          2.0       18%       1.4         25%
BRI               0.7        6%          0.7        6%       0.5          9%

        MECAR's 1998 pre-tax profit decreased by 20% from 1997 levels
notwithstanding that 1997 pre-tax profits were adversely affected by
approximately $.98 in workforce reduction restructuring costs. MECAR'S results
for 1997 were enhanced by a substantial systems intergration contract. Such
contracts typically provide higher profit margins than traditional contracts.
MECAR'S 1997 pre-tax profit increased by 132% over 1996 pre-tax profits due to a
substantial increase of revenue in 1997 from MECAR's traditional customer base,
including the systems integration contract.

        The VSK Group's 1998 pre-tax profit increased by 125% from its 1997
pre-tax profit principally due to a substantial increase in VSK Group revenue in
1998. The 1997 pre-tax profit of the VSK Group increased by 43% over the 1996
pre-tax profit as a result of higher profit margins and the implementation of
cost containment measures at the VSK Group in 1997.

        BRI's pre-tax profit remained substantially unchanged throughout the
1996-1998 period.

Income Taxes

         The 1998 effective tax rate was 21.7%, primarily due to the utilization
of tax loss carryforwards at MECAR and the reduction of $0.9 in deferred and
accrued tax obligations in the United Kingdom that were favorably resolved in
1998. The foreign operating loss carryforwards at MECAR were fully utilized in
1998 and some 1998 MECAR earnings became subject to Belgian tax at the 40.7%
statutory rate.

         The 1997 effective tax rate was 10.1% primarily due to the utilization
of tax loss carryforwards at MECAR.

                                       24
<PAGE>

Net Earnings 

         The Company had a $9.07 profit in 1998 compared with a $8.56 profit in
1997. All segments earned a profit in 1998.

         The Company had a $8.56 profit in 1997 compared with a $4.81 profit in
1996. All segments earned a profit in 1997.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Sensitivity.

        Allied manages its debt and its available cash considering available
investment opportunities and risks, tax consequences and overall financing
strategies.

        At year-end 1998, Allied had approximately $3.6 million of fixed-rate
indebtedness and approximately $5.6 million of variable-rate indebtedness.
Allied has not entered into any interest rate swaps or other derivatives with
respect to its indebtedness.

        Cash available for investment is typically invested in short term funds,
which generally mature in 30 days or money-market funds. In general, such funds
are not subject to market risk because the interest paid on such funds
fluctuates with the prevailing interest rate. The carrying amounts approximate
market value. It is the Company's practice to hold these investments to
maturity.

        Assuming year-end 1998 variable rate debt and cash available for
investment, a one percent change in interest rates would impact net interest
income by less than $280,000.

Exchange Rate Sensitivity.

         Allied conducts business in several foreign countries and approximately
93%, 92% and 89%, of the Company's revenue for the years ended December 31,
1998, 1997 and 1996, respectively, was derived from Allied's operations outside
the United States. Accordingly, exposure exists to potentially adverse movement
in foreign currency rates. Allied uses foreign exchange forward contracts to
hedge the risk of change in foreign currency exchange rates associated with
some, but not all, of its contracts in which the expenses for providing services
are incurred in currency other than the functional currency of Allied's foreign
subsidiaries or payments on contracts are made by the customer in another
currency. The objective of these contracts is to hedge fixed obligations to
reduce the effect of foreign currency exchange rate fluctuations on Allied's
foreign subsidiaries' operating results.

                                       25
<PAGE>

         Additionally, Allied's consolidated financial statements are
denominated in U.S. dollars and, accordingly, changes in the exchange rates
between the Allied subsidiaries' local currency and the U.S. dollar will affect
the translation of such subsidiaries' financial results into U.S. dollars for
purposes of reporting the consolidated financial results. Allied does not hedge
these matters because cash-flows from international operations are generally
re-invested locally. It is estimated that a 10% change in foreign exchange rates
would impact reported operating profit by less than $1.2 million.

         Allied does not use derivative financial instruments for speculative
trading purposes, nor does Allied hedge its foreign currency exposure in a
manner that entirely offsets the effects of changes in foreign exchange rates.

         Allied regularly reviews its hedging program and may as part of this
review determine at any time to change its hedging program.

Item 8. Financial Statements and Supplementary Data.

         The financial statements required by this item are set forth following
the signature pages hereof.

         See Note T to Allied's consolidated financial statements for
supplementary financial data required by this item.

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures.

         There were no disagreements on any matter of accounting principles,
financial statement disclosure or auditing scope or procedure to be reported
under this item.

                                    PART III

Item 10.  Directors and Executive Officers of Allied.

Directors.

        The following are the directors of Allied:

        J. R. Sculley, age 58, became a director of Allied in 1991. He has
served as president and chief operating officer of Allied since April, 1992, and
was named chairman of the board and chief executive officer in December, 1992.
He is also a director of MECAR, BRI and Limited. Between 1989 and April, 1992,
Mr. Sculley was Director of Advanced Studies and Technologies of Grumman
Corporation, a defense company, and,


                                       26
<PAGE>

prior thereto, was Assistant Secretary of the Army (Research, Development and
Acquisition).

        Clifford C. Christ, age 51, became a director of Allied in 1993. He has
been the president and chief executive officer of NavCom Defense Electronics,
Inc., a defense electronics company, since 1988.

        Earl P. Smith, age 60, became a director of Allied in 1993. Mr. Smith
has been a principal of Earl Smith & Associates, a defense consulting firm,
since 1990. During 1990 he was vice president-commercial operations of
Management Services Corporation, a subsidiary of Lear Siegler Corp., and from
1986 to 1990 he was vice president - marketing and contracts of Management
Services Corporation.

        Robert W. Hebel, age 75, became a director of Allied in early 1996.
Throughout the last five years, Mr. Hebel has been a private investor.

        Harry H. Warner, age 63, became a director of Allied in early 1996.
Throughout the last five years, Mr. Warner has been a self-employed financial
consultant, investor and real estate developer. He is also a director of
Chesapeake Corporation, Pulaski Furniture Corporation and Virginia Management
Investment Corporation.

Executive Officers.

        The following are the executive officers of Allied:

        J. R. Sculley, age 58, was elected chairman of the board and chief
executive officer of Allied in December, 1992, and has served as Allied's
president and chief operating officer since April, 1992. He served as Director
of Advanced Studies and Technologies of Grumman Corporation, a defense company,
from 1989 to April, 1992, and previously was Assistant Secretary of the Army
(Research, Development and Acquisition). Mr. Sculley also serves as a director
of MECAR, BRI and Limited.

        W. Glenn Yarborough, Jr., age 58, was elected president and chief
operating officer in July 1998, and has served as vice president of Allied since
January, 1995 and as Vice President of Services since February, 1993.
Previously, he served as director of business development of Grumman
Corporation, a defense company. Mr. Yarborough also serves as a director of BRI,
Limited and the VSK Group.


                                       27
<PAGE>

Item 11.  Executive Compensation
Compensation of Directors and Executive Officers
        The following table sets forth information concerning all compensation
paid for services rendered in all capacities to Allied and its subsidiaries
during the years ended December 31, 1998, 1997 and 1996, by the chief executive
officer of Allied and by other executive officers of Allied whose total annual
salary and bonus exceeds $100,000:


                                       28
<PAGE>

                                  SUMMARY COMPENSATION TABLE


<TABLE>
<CAPTION>
                  ANNUAL COMPENSATION                               LONG TERM COMPENSATION
                  -------------------                               ----------------------
                                                                     Awards       Payouts   
                                                                     ------       -------   
                                                       Other                                                 All
Name                                                   Annual      Restricted    Securities                 Other
and                                                    Compen-        Stock      Underlying      LTIP      Compen
Principal                                              sation        Award(s)     Options/      Payouts    sation
Position              Year      Salary($)  Bonus($)1     ($)           ($)        SARs (#)        ($)        ($)        
--------              ----      ---------  ---------     ---           ---        --------        ---        ---        
<S>                   <C>       <C>        <C>         <C>         <C>           <C>            <C>        <C>
J.R.                  1998      $275,000   $ 68,125
Sculley,              1997      $245,000   $120,000
Chief                 1996      $245,000   $100,000                                15,000
Executive
Officer
W. Glenn              1998      $197,000   $ 61,312
Yarborough,           1997      $183,000   $108,000
Jr., President and    1996      $168,000   $ 90,000                                27,600
Chief Operating
Officer
</TABLE>

--------------------
(1) Messrs. Sculley and Yarborough were awarded bonuses of (i) $68,125 and
$61,312.50 respectively, for 1998 performance, payable in 1999 in stock and/or
cash, (ii) $120,000 and $108,000, respectively, for 1997 performance, payable in
1998 in stock and/or cash and (iii) $100,000 and $90,000, respectively, for 1996
performance payable in 1997 in stock and/or cash. In each of February 1999, and
March 1998 and 1997, Mr. Sculley was awarded 5,548 shares of stock and cash
bonuses of $30,329, $53,424 and $44,420, respectively. Mr. Yarborough was
awarded 9,000 shares of Company stock in each of February 1999, and March 1998
and 1997. The shares issued in February 1999 had a market value of $6.8125 per
share on the date of grant; the shares issued in 1998 had a market value of
$12.00 per share on the date of grant; and the shares issued in 1997 had a
market value of $10.00 per share on the date of grant. 

                                       29
<PAGE>

               Aggregated Option/SAR Exercises in Last Fiscal Year
                           and FY-End Option/SAR Value

<TABLE>
<CAPTION>
                                                                 Number of
                                                                 Securities           Value of
                                                                 Underlying         Unexercised
                                                                 Unexercised        In-the-Money
                                                                Options/SARS at    Options/SARS at
                                                                 FY-End (#)1         FY-End ($)1
                                                                 -----------         -----------

                         Shares Acquired         Value            Exercisable/      Exercisable/
Name                      on Exercise (#)     Realized ($)       Unexercisable     Unexercisable
----                      ---------------     ------------       -------------     -------------
<S>                          <C>                <C>              <C>                  <C>          
J.R. Sculley                 1,220              $  8,159         42,500/22,400        27,813/0

W. Glenn Yarborough          4,200              $37,980          18,200/0             18,900/0
</TABLE>

-------------------
(1) Based on the Closing price of the Company's stock of $8.25 on December 31,
1998.

                                       30
<PAGE>

Director Compensation

        Directors who are employees of Allied receive no additional compensation
for serving as a director. Each non-employee director (an "Outside Director") is
compensated for services as a director, including as a member of committees of
the Board, in accordance with the Allied Research Corporation Outside Directors
compensation Plan (The "Directors Compensation Plan") by which Allied pays each
of its Outside Directors $1,000 per month during such Outside Director's tenure
and awards 1,000 shares of Allied's Common Stock to each individual who serves
as an Outside Director on each July 1. In addition, Outside Directors are
compensated (a) $1,000 for each Board meeting in excess of four (4) personally
attended during each calendar year, (b) $500 for each committee meeting attended
which is not held in conjunction with a Board meeting, and (c) $250 for each
teleconference Board meeting in excess of two (2) in which a director
participates during each calendar year.

        In 1992, the Board of Directors of Allied adopted the Allied Research
Corporation Outside Directors Retirement Plan (the "Directors Retirement Plan")
to provide retirement benefits for long-standing Outside Directors. Under the
Directors Retirement Plan, Outside Directors are eligible for a retirement
benefit if they retire form the Board and have served as a member of the Board
for a minimum of five (5) years. An eligible Outside Director who retires from
the Board is entitled to receive, commencing on the last day of the first month
following the month in which the director attains age seventy (70), monthly
payments equal to the monthly cash compensation received from Allied at the time
the director terminated service in such capacity. Such payments will cease upon
the earlier of the expiration of a period of time equivalent to the period of
time the director served as a member of the Board or the death of the director.
In the event that a director has breached any fiduciary or legal duty Allied,
the director will forfeit any right to payment of benefits under the Directors
Retirement Plan. The Directors Retirement Plan is administered by the Board of
Directors.

        In 1991, the Board of Directors of Allied adopted the Allied Research
Corporation Outside Directors Stock Option Plan (the "Directors Option Plan") by
which Allied may grant options for up to 208,000 shares of Allied's Common Stock
to its Outside Directors (which amount includes the 5% stock dividend paid on
November 6, 1992). None of the options granted pursuant to the Directors Option
Plan are intended to qualify as incentive stock options under Sections 422
through 424 of the Internal Revenue Code. The purpose of the Directors Option
Plan is to advance the interest of Allied by providing its Outside Directors
with financial incentives in the form of non-statutory stock options in order to
attract, retain and motivate such Outside Directors. Options for an aggregate of
75,000 shares were granted under the Directors Option Plan in 1996 to Allied's
Outside Directors; no such options were awarded in 1997 or 1998.


                                       31
<PAGE>

Employment Contract and Change-In-Control Arrangements

        J.R. Sculley and Allied entered into an Employment Agreement (the
"Sculley Agreement") which expired and is currently being renegotiated by
Allied's Compensation Committee. In consideration for his services as an officer
of Allied and as a director of Allied and each of its subsidiaries, Mr. Sculley
is entitled to receive an aggregate sum of not less than $290,000 per calendar
year.

        W. Glenn Yarborough, Jr. and Allied have entered into an Employment
Agreement (the "Yarborough Agreement") which extends through July, 1999, and is
automatically renewable from year to year thereafter unless either Allied or Mr.
Yarborough gives the other timely notice of its or his intent not to renew. Mr
Yarborough is entitled to receive base compensation or $200,000 per calendar
year. The Yarborough Agreement further provides that in the event Mr. Yarborough
ceases to serve in any capacity as an officer of the Company as a result of a
voluntary or involuntary termination within a period of twelve (12) months
following a change in control, Mr. Yarborough shall be entitled to a lump sum
payment equal to the aggregate amount of compensation payable to Mr. Yarborough
throughout the remaining term of the Yarborough Agreement.

        In June, 1991, the Board of Directors of Allied adopted the Preferred
Share Purchase Rights Agreement (the "Agreement"). The Agreement provides each
stockholder of record on a dividend distribution of one "right" for each
outstanding share of Allied's common stock. Rights become exercisable at the
earlier of ten days following: (1) a public announcement that an acquiror has
purchased or has the right or acquire 10% or more of Allied's common stock, or
(2) the commencement of a tender offer which would result in an offeror
beneficially owning 30% or more of the outstanding common stock of Allied. All
rights held by an acquiror or offeror expire on the announced acquisition date,
and all rights expire at the close of business on June 20, 2001. Each right
entitles a stockholder to acquire at a stated purchase price, 1/100 of a share
of Allied's preferred stock which carries voting and dividend rights similar to
one share of its common stock. Alternatively, a right holder may elect to
purchase for the stated price an equivalent number of shares of Allied's common
stock (or in certain circumstances, cash, property or other securities of
Allied) at a price per share equal to one-half of the average market price for a
specified period. In lieu of the purchase price, a right holder may elect to
acquire one-half of the common stock available under the second option. The
purchase price of the preferred stock fractional amount is subject to adjustment
for certain events as described in the Agreement. At the discretion of a
majority of the Board and within a specified time period, Allied may redeem all
of the rights at a price of $.01 per right. The Board may also amend any
provisions of the Agreement prior to exercise.


                                       32
<PAGE>

Compensation Committee Interlocks and Insider Participation

        The Compensation Committee of Allied during the fiscal year ended
December 31, 1998 consisted of Messrs. Earl P. Smith, Robert W. Hebel and Harry
H. Warner. None of such individuals has served as an officer or employee of
Allied nor is there any other relationship between any member of the
Compensation Committee and Allied which is required to be disclosed under
applicable regulations.

Item 12.  Security Ownership of Certain Beneficial Owners and Management.

         The following information is furnished as of February 2, 1999, with
respect to any person who is known to Allied to be the beneficial owner of more
than five percent (5%) of its Common Stock:

                                               Amount and
Title                                          nature of
of             Name and address of             beneficial          Percent of
class          beneficial owner                ownership           class(1)
-----          ----------------                ---------           ------

Common         Fidelity Low-Priced             473,000              9.7%
               Stock Fund/Fidelity             Owned directly
               Management &
               Research Company
               82 Devonshire Street
               Boston, MA 02109

Common         Lionheart Group, Inc.           319,388             6.6%
               230 Park Avenue                 Owned directly
               Suite 516
               New York, New York 10169

Common         Dimensional Fund                278,000             5.7%
               Advisor, Inc.2                  Owned directly
               1299 Ocean Avenue
               11th Floor
               Santa Monica, CA 90401

-----------------
(1) Based upon 4,754,210 shares of common stock outstanding plus 116,150 shares
which may be acquired within 60 days pursuant to outstanding stock options.
(2) Dimensional Fund Advisors, Inc. ("Dimensional"), a registered investment
advisor, is deemed to have beneficial ownership of 278,000 shares, all of which
shares are owned by advisory clients of Dimensional. Dimensional disclaims
beneficial ownership of all such shares.


                                       33
<PAGE>

        The following information is furnished as of February 2, 1999, with
respect to the beneficial ownership by management of Allied's Common Stock:

                                               Amount and
Title                                          nature of
of             Name of                         beneficial          Percent of
class          beneficial owner                ownership(1)        class(2)
-----          ----------------                ------------        --------

Common         Harry H. Warner                 11,000              *
                                               Owned
                                               directly

Common         Earl P. Smith                   6,110               *
                                               Owned
                                               directly

Common         Clifford C. Christ              26,000              *
                                               Owned
                                               directly

Common         Robert W. Hebel                 8,625               *
                                               Owned
                                               directly

Common         J. R. Sculley                   139,552             2.9%
                                               Owned
                                               directly

Common         W. Glenn Yarborough             73,762              1.5%
                                               Owned
                                               directly

Common         All executive officers          265,049             5.4%
               and directors as a              Owned
               group (6)                       directly

------------------
(1) Includes 18,200 shares which may be acquired by Mr. Yarborough and 53,700
shares which may be acquired by Mr. Sculley within 60 days pursuant to
outstanding stock options.
(2) Based upon 4,754,210 shares of common stock outstanding plus 116,150 shares
which may be acquired within 60 days pursuant to outstanding stock options.


                                       34
<PAGE>


               Allied is aware of no arrangement the operation of which may at a
subsequent date result in a change in control of Allied.

Item 13. Certain Relationships and Related Transactions.

        None.
                                     PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.

        For the purposes of complying with the amendments to the rules governing
Form S-8 under the Securities Act of 1933, the undersigned registrant hereby
undertakes as follows, which undertaking shall be incorporated by reference into
Allied's Registration Statements on Form S-8:

        Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by Allied of
expenses incurred or paid by a director, officer or controlling person of the
registrant in the successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with the
securities bing registered, Allied will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the final
adjudication of such issue.

(a)(1)  Financial Statements:

               Report of Independent Certified Public                       F-3
               Accountants

               Consolidated Balance Sheets at December 31,                  F-4
               1998 and 1997

               Consolidated Statements of Earnings for                      F-6
               the three years ended December 31, 1998

               Consolidated Statements of Stockholders'                     F-7
               Equity for the three years ended
               December 31, 1998

               Consolidated Statements of Cash Flows                        F-8
               for the three years ended December 31, 1998

               Notes to Consolidated Financial Statements                   F-10

                                       35
<PAGE>

(a)(2)  Financial Statement Schedules:

         The following financial statement schedules are included in Part IV of
this report:

               (a)(2)(a)     As of December 31, 1998 and 1997 and for the three
                             years ended December 31, 1998.

                             Schedule I - Condensed                         F-31
                             Financial Information of
                             Allied

                             Schedule II - Valuation                        F-34
                             and Qualifying Accounts

(a)(3)  Exhibits:

               Exhibit 3 - Certificate of Incorporation, as amended
                           (Incorporated by reference from Form 10-K filed
                           in March, 1992); Amended and Restated By-Laws
                           (Incorporated by reference from Form 8-K filed
                           in November, 1992); and Amendment to Amended and
                           Restated By-Laws adopted by the Board of
                           Directors in September, 1996 (Incorporated by
                           reference from Form 10-K filed in March, 1998);
                           and Amendment to Amended and Restated By-Laws
                           adopted by the Board of Directors in February,
                           1999 (Incorporated by reference from Form 8-K
                           filed in February, 1999).

               Exhibit 10 -

                           (a)  Executive Employment Agreement between
                                Allied Research Corporation and W. Glenn
                                Yarborough, Jr. (Incorporated by reference
                                from Form 10-K filed in March, 1995.)

               Exhibit 21 - List of Subsidiaries                             E-3

               Exhibit 23 - Consent of Independent Certified                 E-4
                            Public Accountants

                                    36
<PAGE>

(b) Reports on Form 8-K:

         No reports on Form 8-K were filed during the Fourth quarter of 1998.

Supplemental Information to be Furnished with Reports Filed Pursuant to Section
15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to
Section 12 of the Act.

         No annual report or proxy material has as yet been sent to Allied's
stockholders, although it is expected that an annual report and proxy material
will be furnished to Allied's stockholders subsequent to the filing of this Form
10-K.


                                       37
<PAGE>

                                   SIGNATURES

               Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, Allied has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

                                 Allied Research Corporation
(Allied).........................................................


By (Signature and Title)    /s/ J.R. Sculley                                   
                            -------------------------------------
                            J. R. Sculley, Chief Executive Officer


Date: March 12, 1999

               Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
Allied and in the capacities and on the dates indicated.



By (Signature and Title)   /s/ J.R. Sculley        
                            -------------------------------------
                            J. R. Sculley,
                            Chief Financial Officer


Date:  March 12, 1999

                               * * * * * * *


By (Signature and Title)  /s/ J.R. Sculley                
                            -------------------------------------
                             J. R. Sculley, Director


Date:  March 12, 1999

                               * * * * * * *

                                       38
<PAGE>


By (Signature and Title)   /s/ Clifford C. Christ         
                            -------------------------------------
                             Clifford C. Christ, Director


Date:  March 12, 1999
                                * * * * * * *



By (Signature and Title)     /s/ Earl P. Smith            
                            -------------------------------------
                             Earl P. Smith, Director


Date: March 12, 1999
                                * * * * * * *



By (Signature and Title)      /s/ Robert W. Hebel                
                            -------------------------------------
                             Robert W. Hebel, Director


Date:  March 12, 1999
                                * * * * * * *



By (Signature and Title)     /s/ Harry H. Warner                 
                            -------------------------------------
                             Harry H. Warner, Director


Date:  March 12, 1999
                                * * * * * * *

                                       39
<PAGE>


                       SECURITIES AND EXCHANGE COMMISSION


                             WASHINGTON, D.C. 20549







                       FINANCIAL STATEMENTS AND SCHEDULES

                                DECEMBER 31, 1998








                                FORMING A PART OF
                            ANNUAL REPORT PURSUANT TO
                       THE SECURITIES EXCHANGE ACT OF 1934








                                    FORM 10-K
                                       OF
                           ALLIED RESEARCH CORPORATION


<PAGE>


                           ALLIED RESEARCH CORPORATION

                   INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

--------------------------------------------------------------------------------


<TABLE>
<CAPTION>
                                                                                     Page

<S>                                                                                     <C>
Report of Independent Certified Public Accountants                                    F-3

Consolidated Balance Sheets at December 31, 1998 and 1997                             F-4

Consolidated Statements of Earnings for the three years ended December 31, 1998       F-6

Consolidated Statements of Stockholders' Equity for the three years
    ended December 31, 1998                                                           F-7

Consolidated Statements of Cash Flows for the three years ended December 31, 1998     F-8

Notes to Consolidated Financial Statements                                            F-10

Schedules as of and for the three years ended December 31, 1998

            Schedule I - Condensed Financial Information of Registrant                F-31

            Schedule II -Valuation and Qualifying Accounts                            F-34
</TABLE>

<PAGE>

               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS


Board of Directors
Allied Research Corporation

We have audited the accompanying consolidated balance sheets of Allied Research
Corporation and subsidiaries as of December 31, 1998 and 1997 and the related
consolidated statements of earnings, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Allied Research
Corporation and subsidiaries as of December 31, 1998 and 1997, and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended December 31, 1998 in conformity with
generally accepted accounting principles.

We have also audited Schedules I and II for each of the three years in the
period ended December 31, 1998. In our opinion, these schedules present fairly,
in all material respects, the information required to be set forth therein.

/s/ Grant Thornton LLP
------------------------
BALTIMORE, MARYLAND
FEBRUARY 16, 1999


<PAGE>

                           ALLIED RESEARCH CORPORATION

                           CONSOLIDATED BALANCE SHEETS

                                  DECEMBER 31,

--------------------------------------------------------------------------------

                                     ASSETS
                                                       1998          1997
                                                   ------------  -----------
CURRENT ASSETS
   Cash and equivalents (note A)                    $10,234,653   $7,693,757
   Restricted cash (notes C and F)                   14,013,905    8,727,186
   Accounts receivable (notes A, C and E)            29,445,873   40,649,726
   Costs and accrued earnings on
      uncompleted contracts (note A)                 20,886,607    7,804,344
   Inventories (note D)                               3,422,303    6,965,666
   Prepaid expenses                                  10,093,885    4,094,190
                                                     ----------    ---------

           Total current assets                      88,097,226   75,934,869


PROPERTY, PLANT AND EQUIPMENT - AT COST
   (notes A and H)
      Buildings and improvements                     12,439,745   11,714,475
      Machinery and equipment                        31,775,830   28,778,285
      Leasehold improvements                            118,927      118,927
                                                        -------      -------
                                                     44,334,502   40,611,687
      Less accumulated depreciation                  33,102,833   30,259,311
                                                     ----------   ----------
                                                     11,231,669   10,352,376
      Land                                            1,298,091    1,208,013
                                                      ---------    ---------
                                                     12,529,760   11,560,389

OTHER ASSETS
   Restricted cash deposits (notes B and F)           6,670,289    6,414,419
   Intangibles, less accumulated amortization of
      $3,136,339 and $2,783,724 in 1998 and 1997,
      respectively (note A)                           4,960,537    5,028,390
   Other                                                818,318      562,572
                                                        -------      -------
                                                     12,449,144   12,005,381
                                                     ----------   ----------

                                                   $113,076,130  $99,500,639
                                                    ===========   ==========

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.

                                      F-4
<PAGE>


                           ALLIED RESEARCH CORPORATION

                     CONSOLIDATED BALANCE SHEETS - CONTINUED

                                  DECEMBER 31,

--------------------------------------------------------------------------------

                      LIABILITIES AND STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                               1998           1997
                                                           -------------  -----------
<S>                                                          <C>            <C>
CURRENT LIABILITIES
   Notes payable (note E)                                    $ 3,415,000    $1,720,000
   Current maturities of long-term debt                        1,324,221     1,280,736
   Accounts payable                                           25,377,241    34,656,335
   Accrued liabilities                                         5,043,742     4,747,291
   Accrued losses on contracts (note G)                          786,986       572,279
   Customer deposits                                          16,135,013     6,993,756
   Income taxes                                                  748,795       847,563
                                                                 -------       -------

           Total current liabilities                          52,830,998    50,817,960



LONG-TERM DEBT, less current maturities (note G)               4,431,282     5,311,564


ADVANCE PAYMENTS ON CONTRACTS (note F)                         5,850,000     5,850,000


DEFERRED INCOME TAXES (notes A and P)                                  -       626,660


CONTINGENCIES AND COMMITMENTS (notes I, J, L and N)                    -             -


STOCKHOLDERS' EQUITY (note L)
   Preferred stock, no par value; authorized, 10,000
      shares; none issued                                              -             -
   Common stock, par value, $.10 per share; authorized
      10,000,000 shares; issued and outstanding, 4,757,174
      in 1998 and 4,608,221 in 1997                              475,717       460,822
   Capital in excess of par value                             13,391,099    12,100,521
   Retained earnings                                          35,111,909    26,046,271
   Accumulated other comprehensive income (loss)                 985,125   (1,713,159)
                                                                 -------   ----------
                                                              49,963,850    36,894,455
                                                              ----------    ----------

                                                            $113,076,130   $99,500,639
                                                            ============   ===========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.

                                      F-5
<PAGE>


                           ALLIED RESEARCH CORPORATION

                       CONSOLIDATED STATEMENTS OF EARNINGS

                            YEARS ENDED DECEMBER 31,

--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                1998               1997                1996
                                            ------------       -------------       ------------
<S>                                         <C>                 <C>                <C>
REVENUE (note M)                            $143,535,202        $134,483,750       $103,660,137

COST AND EXPENSES
   Cost of sales                             116,642,893         108,775,629         78,658,573
   Selling and administrative                 12,621,055          14,422,923         15,647,951
   Research and development                    1,614,050           1,488,396          1,746,319
   Restructuring costs (note Q)                     -                977,267               -
                                             -----------         -----------        -----------
                                             130,877,998         125,664,215         96,052,843
                                             -----------         -----------         ----------

           Operating income                   12,657,204           8,819,535          7,607,294

OTHER INCOME (DEDUCTIONS)
   Interest income                             1,503,138           1,033,599          1,921,864
   Interest expense                          (1,772,284)         (1,846,697)        (3,451,066)
   Other - net (note O)                        (812,252)           1,519,505          (381,379)
                                             -----------         -----------        -----------
                                             (1,081,398)             706,407        (1,910,581)
                                             -----------         -----------        -----------

           Earnings before income taxes       11,575,806           9,525,942          5,696,713

INCOME TAXES (NOTES A AND P)                   2,510,168             961,154            891,230
                                             -----------         -----------        -----------

           NET EARNINGS                      $ 9,065,638         $ 8,564,788        $ 4,805,483
                                            ============         ===========        ===========

EARNINGS PER SHARE (NOTE R):
   BASIC                                           $1.92               $1.88              $1.08
                                                    ====                ====               ====

   DILUTED                                         $1.90               $1.85              $1.08
                                                    ====                ====               ====

WEIGHTED AVERAGE NUMBER OF COMMON SHARES:

   BASIC                                       4,722,303           4,543,874          4,432,750
                                               =========           =========          =========

   DILUTED                                     4,765,207           4,626,602          4,438,489
                                               =========           =========          =========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.


                                      F-6
<PAGE>

                           ALLIED RESEARCH CORPORATION

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                          Common                                              Accumulated
                                                          Stock                                           other comprehensive
                                          Preferred  ---------------------     Capital                       income (loss)
                                           stock no                $.10       in excess       Retained     foreign currency
                                          par value  Shares      par value   of par value     earnings  translation adjustment
                                          ---------  ------      ---------   ------------     --------  ----------------------
<S>                                           <C>     <C>          <C>        <C>           <C>                <C>
BALANCE AT DECEMBER 31, 1995                  $  -    4,422,056    $442,206   $10,745,295   $12,676,000        $ 4,490,083
  Common stock awards                            -        9,035         903        40,479             -                  -
  Employee stock purchase plan purchases         -       12,001       1,200        60,529             -                  -
  Comprehensive income (loss)
    Net earnings for the year                    -            -           -             -     4,805,483                  -
    Currency translation adjustment              -            -           -             -             -         (1,815,537)
  Total comprehensive income                     -            -           -             -             -                  -
                                             -----    ---------     -------    ----------    ----------          ---------

BALANCE AT DECEMBER 31, 1996                     -    4,443,092     444,309    10,846,303    17,481,483          2,674,546

  Common stock awards                            -       52,746       5,275       516,185             -                  -
  Employee stock purchase plan purchases         -      112,383      11,238       738,033             -                  -
  Comprehensive income (loss)
    Net earnings for the year                    -            -           -             -     8,564,788                  -
    Currency translation adjustment              -            -           -             -             -         (4,387,705)
  Total comprehensive income                     -            -           -             -             -                  -
                                             -----    ---------     -------    ----------    ----------          ---------

BALANCE AT DECEMBER 31, 1997                     -    4,608,221     460,822    12,100,521    26,046,271        (1,713,159)

  Common stock awards                            -       57,448       5,745       683,631             -                  -
  Employee stock purchase plan
    purchases                                    -       94,505       9,450       628,172             -                  -
  Retirement of common stock                     -       (3,000)       (300)      (21,225)            -                 -
  Comprehensive income
    Net earnings for the year                    -            -           -             -     9,065,638                  -
    Currency translation adjustment              -            -                                                  2,698,284
  Total comprehensive income                     -            -           -             -             -                  -
                                             -----    ---------     -------    ----------    ----------          ---------

BALANCE AT DECEMBER 31, 1998               $     -    4,757,174    $475,717   $13,391,099   $35,111,909       $    985,125
                                           =======    =========    ========   ===========   ===========       ============
</TABLE>

<TABLE>
<CAPTION>



                                             Total
                                          stockholders'
                                          -------------
<S>                                       <C>
BALANCE AT DECEMBER 31, 1995              $28,353,584
  Common stock awards                          41,382
  Employee stock purchase plan purchases       61,729
  Comprehensive income (loss)
    Net earnings for the year                        -
    Currency translation adjustment                  -
  Total comprehensive income                 2,989,946
                                           ----------

BALANCE AT DECEMBER 31, 1996               31,446,641

  Common stock awards                         521,460
  Employee stock purchase plan purchases      749,271
  Comprehensive income (loss)
    Net earnings for the year                       -
    Currency translation adjustment                 -
  Total comprehensive income                4,177,083
                                           ----------

BALANCE AT DECEMBER 31, 1997               36,894,455
  Common stock awards                         689,376
  Employee stock purchase plan
    purchases                                 637,622
  Retirement of common stock                  (21,525)
  Comprehensive income
    Net earnings for the year                       -
    Currency translation adjustment                 -
  Total comprehensive income               11,763,922
                                           ----------

BALANCE AT DECEMBER 31, 1998              $49,963,850
                                          ===========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.

                                      F-7

<PAGE>

                           ALLIED RESEARCH CORPORATION

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                            YEARS ENDED DECEMBER 31,

--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
Increase (decrease) in cash and equivalents                           1998                1997               1996
                                                                 -------------       -------------      -------------
<S>                                                                   <C>                 <C>                <C>
CASH FLOWS FROM OPERATING ACTIVITIES
   Net earnings for the year                                       $ 9,065,638         $ 8,564,788        $ 4,805,483
   Adjustments to reconcile net earnings to net cash
      from operating activities
        Depreciation and amortization                                2,531,777           2,645,995          3,093,534
        Loss (gain) on sale of fixed assets                                  -               2,874              (250)
        Deferred income taxes                                      (1,513,793)           1,148,753          (590,419)
        Provision for estimated losses on contracts                    200,938            (80,012)            (4,036)
        Gain on sale of securities                                           -            (11,684)                  -
        Common stock awards                                            689,376             521,460             41,382
        Changes in assets and liabilities
           Accounts receivable                                      12,859,926        (30,952,448)          7,874,015
           Cost and accrued earnings on
              uncompleted contracts                               (11,922,369)           4,937,582        (9,142,340)
           Inventories                                               3,800,770           (803,742)        (1,413,524)
           Prepaid expenses and other assets                       (5,728,946)           (840,140)        (2,798,161)
           Accounts payable and accrued liabilities               (10,143,759)          18,611,804          2,015,448
           Customer deposits                                         8,229,857         (2,458,936)          1,917,475
           Income taxes                                              (402,161)             110,020            441,852
                                                                   ----------            ---------       -----------
                                                                   (1,398,384)         (7,168,474)          1,434,976
                                                                   ----------            ---------       -----------

                Net cash provided by operating activities            7,667,254           1,396,314          6,240,459

CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
   Capital expenditures                                            (2,381,943)         (1,342,320)        (1,066,889)
   Restricted cash and restricted cash deposits                    (5,542,589)          4,986,079         (9,557,000)
   Proceeds from sale of fixed assets                                       -                    -               250
                                                                   ----------            ---------       -----------
                Net cash (used in) provided by investing
                   activities                                      (7,924,532)           3,643,759       (10,623,639)
                                                                   ==========            =========       ===========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.

                                      F-8
<PAGE>

                           ALLIED RESEARCH CORPORATION

                CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

                            YEARS ENDED DECEMBER 31,

--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                         1998                1997               1996
                                                     -------------       -------------      -------------
<S>                                                         <C>             <C>                 <C>
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
   Net increase (decrease) in short-term borrowings         74,050          (2,717,150)         2,908,978
   Principal payments on long-term debt                 (1,183,821)        (12,663,855)       (19,009,160)
   Proceeds from issuance of long-term debt              1,653,127           1,908,449         11,762,981
   Net decrease in long-term deposits                            -           5,850,000         18,492,000
   Retirement of common stock                             (21,525)                   -                  -
   Proceeds from employee stock purchases                  637,622             749,271             61,729
                                                      ------------       -------------       ------------
                Net cash provided by (used in)
                   financing activities                  1,159,453         (6,873,285)         14,216,528

Effects of exchange rates on cash                        1,638,721         (3,216,509)        (2,275,015)
                                                      ------------       -------------       ------------
                Net increase (decrease) in cash
                   and equivalents                       2,540,896         (5,049,721)          7,558,333

CASH AND EQUIVALENTS AT BEGINNING OF YEAR                7,693,757          12,743,478          5,185,145
                                                      ------------       -------------       ------------

CASH AND EQUIVALENTS AT END OF YEAR                   $ 10,234,653       $   7,693,757       $ 12,743,478
                                                       ===========        ============        ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
--------------------------------------------------
   Cash paid during the year for
      Interest                                         $ 1,352,548          $2,681,569        $ 3,088,529
      Income taxes                                       4,429,842           2,140,896          1,245,678

</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.

                                      F-9
<PAGE>

                           ALLIED RESEARCH CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------

NOTE A - SUMMARY OF ACCOUNTING POLICIES

  A summary of significant accounting policies consistently applied in the
  preparation of the accompanying consolidated financial statements follows.

  BASIS OF PRESENTATION

  The consolidated financial statements of the Company include the accounts of
  Allied Research Corporation (Allied), a Delaware corporation, and its
  wholly-owned subsidiaries, Mecar S.A., (Mecar) a Belgian company, Barnes &
  Reinecke, Inc. (BRI), a Delaware corporation and Allied Research Corporation
  Limited (Limited), a United Kingdom company.

  Mecar includes its wholly owned Belgian subsidiaries, Sedachim, S.I., and the
  VSK Group of companies, comprised of Tele Technique Generale, I.D.C.S., N.V.
  and VSK Electronics N.V. and its wholly-owned subsidiary, Belgian Automation
  Units, N.V.

  In 1996 and 1997, Classics B.V.B.A. and Detectia, N.V. merged into the VSK
  Group.

  Significant intercompany transactions have been eliminated in consolidation.

  BUSINESS OPERATIONS AND SEGMENTS

  The Companies operate primarily in the United States and Belgium. During 1998,
  seventy-eight percent of Allied's business activity was in the development and
  production of ammunitions and weapons systems in Belgium with sales to
  customers in Asia, the Middle East and Europe. Fifteen percent of the business
  activity is developing, manufacturing, distributing and servicing industrial
  security products in Belgium with industrial customers throughout Europe.
  Seven percent of the business activity is providing engineering and technical
  support services in the United States with the majority of its sales directly
  or indirectly to United States Military Agencies, other defense contractors,
  foreign governments and industry. A description of the business segments and
  operations of each company follows.

    CORPORATE

    Allied provides management services to its wholly-owned subsidiaries. Allied
    has no direct domestic operating assets or business activity. Limited, which
    was formerly engaged in the marketing of military hardware, is inactive.

    PRODUCT SALES

    Mecar is primarily engaged in the development and production of ammunitions
    and weapons systems. Mecar derives substantially all of its revenue from
    direct and indirect sales to foreign governments, primarily on fixed price
    contracts.

    ENGINEERING AND TECHNICAL

    BRI provides engineering and technical support services and sells directly
    and indirectly primarily to United States Military Agencies, other defense
    contractors, foreign governments and industry.

                                      F-10
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE A - SUMMARY OF ACCOUNTING POLICIES - CONTINUED

  BUSINESS OPERATIONS AND SEGMENTS - CONTINUED

    SECURITY SYSTEMS AND SERVICES

    The VSK Group develops, manufactures, distributes and services an
    integrated line of industrial security products, including devices such as
    building access control, intrusion detection, fire detection and alarm
    systems.

  FOREIGN CURRENCY TRANSLATION

  The assets and liabilities of Mecar, the VSK Group and Limited are translated
  into U.S. dollars at year-end exchange rates. Resulting translation gains and
  losses are accumulated in a separate component of stockholders' equity. Income
  and expense items are converted into U.S. dollars at average rates of exchange
  prevailing during the year. Foreign currency transaction gains and losses are
  credited or charged directly to operations.

  REVENUE AND COST RECOGNITION

  Revenues under fixed price contracts are recognized on the
  percentage-of-completion method measured by costs incurred to total estimated
  costs. Provision for estimated losses on contracts are recorded when
  identified. Revenues under cost-plus-fixed-fee and time and material contracts
  are recognized on the basis of costs incurred during the period plus the fee
  earned. As contracts extend over one or more years, revisions in costs and
  earnings estimated during the course of the work are reflected in the
  accounting period in which the facts which require the revision become known.

  Recoverable costs plus accrued profits not billed and amounts withheld and due
  upon completion of U.S. Government contracts and subcontracts are carried as
  unbilled receivables. These amounts will be billed on the basis of contract
  terms and are expected to be collected within one year.

  Costs and accrued profits on uncompleted fixed price contracts with foreign
  governments, which are billable upon completion, are carried as costs and
  accrued earnings on uncompleted contracts.

  Revenues from the sale of fire and security systems are recognized when the
  installation is completed, less a provision for anticipated service costs.
  Security system maintenance contract revenues are recognized over the term of
  the contract on a straight-line basis.

  USE OF ESTIMATES

  In preparing financial statements in conformity with generally accepted
  accounting principles, management is required to make estimates and
  assumptions that affect the reported amounts of assets and liabilities and the
  disclosure of contingent assets and liabilities at the date of the financial
  statements and revenue and expenses during the reporting period. Actual
  results could differ from those estimates.

  INVENTORIES

  Inventories which consist primarily of raw materials, are stated principally
  at the lower of cost or market. Cost is determined principally by the
  first-in, first-out method.

                                      F-11
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE A - SUMMARY OF ACCOUNTING POLICIES - CONTINUED

  PROPERTY, PLANT AND EQUIPMENT

  Depreciation is provided for in amounts sufficient to relate the cost of
  depreciable assets to operations over their estimated service lives, primarily
  on a straight-line basis. Accelerated depreciation methods are used for tax
  purposes on certain assets. The estimated service lives used in determining
  depreciation are as follows:

              Buildings                            20 - 30 years
              Machinery and equipment               3 - 10 years

  Maintenance and repairs are charged to expense as incurred; additions and
  betterments are capitalized. Upon retirement or sale, the cost and related
  accumulated depreciation of the disposed assets are removed and any resulting
  gain or loss is credited or charged to operations.

  INTANGIBLES

  Intangibles represent costs in excess of net assets acquired in connection
  with businesses acquired and are being amortized to operations on a
  straight-line basis over twenty years. The recoverability of carrying values
  of intangible assets is evaluated on a recurring basis. The primary indicators
  are current or forecasted profitability of the related business. There have
  been no adjustments to the carrying values of intangible assets resulting from
  these evaluations.

  DERIVATIVE FINANCIAL INSTRUMENTS

  Derivative financial instruments are utilized by the Company to hedge certain
  sales and purchase contracts. The Company does not hold or issue derivative
  financial instruments for trading or speculative purposes.

  Currency gains and losses on contracts designated as hedges of foreign
  currency commitments are deferred and recognized when the measurement of the
  related foreign currency transactions are recognized.

  STOCK-BASED COMPENSATION

  Compensation costs for stock options is measured 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.

  RESEARCH AND DEVELOPMENT

  Costs incurred in research and development activities are charged to
  operations as incurred.

  WARRANTIES

  The Company grants warranties on certain ammunition products for periods
  varying from one to five years. Provision is made for estimated losses arising
  from warranty claims as incurred. Provision is made for estimated warranty
  costs on the sale of security systems at the time of the sale.

                                      F-12
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE A - SUMMARY OF ACCOUNTING POLICIES - CONTINUED

  INCOME TAXES

  Income taxes are provided based on the liability method for financial
  reporting purposes. Deferred and prepaid taxes are provided for on temporary
  differences in the basis of assets and liabilities which are recognized in
  different periods for financial and tax reporting purposes.

  EARNINGS PER COMMON SHARE

  Basic earnings per share amounts have been computed based on the average
  number of common shares outstanding. Diluted earnings per share reflects the
  increase in average common shares outstanding that would result from the
  assumed exercise of outstanding options, calculated using the treasury stock
  method. All prior period per share amounts have been restated to reflect the
  above policy.

  STATEMENT OF CASH FLOWS

  For purposes of the Statement of Cash Flows, the Company considers all highly
  liquid debt instruments purchased with a maturity of three months or less to
  be cash equivalents.

  RECLASSIFICATIONS

  Certain items in the 1997 and 1996 financial statements have been reclassified
  to conform to the current presentation.

  NEWLY ISSUED ACCOUNTING STANDARDS

  In June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
  ENTERPRISE AND RELATED INFORMATION (SFAS 131), which is effective for fiscal
  years beginning after December 15, 1997. The statement establishes revised
  standards under which an entity must report business segment information in
  its financial statements to the basis that is used internally for evaluating
  segment performance. The Company adopted SFAS 131 in the fiscal year beginning
  January 1, 1998 and has restated its prior year segment data to conform to
  this presentation.

  In December 1997, SFAS No. 132, EMPLOYERS' DISCLOSURES ABOUT PENSION AND OTHER
  POSTRETIREMENT BENEFITS, was issued and is effective for the Company's 1998
  fiscal year. The statement revises current disclosure requirements for
  employers' pensions and other retiree benefits. Implementation of this
  disclosure standard did not affect the Company's financial position or results
  of operations.

  In June 1998, SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
  ACTIVITIES, was issued and is effective for all fiscal quarters of fiscal
  years beginning after June 15, 1999. The statement establishes accounting and
  reporting standards for derivative instruments, and for hedging activities.
  Implementation of this standard is not anticipated to have a material effect
  on the Company.

                                      F-13
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------
NOTE B - RESTRICTED CASH

  Mecar is generally required under the terms of its contracts with foreign
  governments to provide performance bonds, advance payment guarantees and
  letters of credit. The credit facility agreements used to provide these
  financial guarantees place restrictions on certain cash deposits and other
  liens on Mecar's assets. BRI is also required under the terms of a contract
  with a foreign government to provide a performance bond and letters of credit.
  The credit facility agreement used to provide these financial guarantees also
  places restrictions on cash deposits. VSK has also pledged certain term
  deposits to secure outstanding bank guarantees.

  Restricted cash of $14,013,905 included in current assets and long-term
  restricted cash deposits of $6,670,289 included in other assets at December
  31, 1998 are restricted or pledged as collateral for these agreements and
  other obligations. The corresponding amounts at December 31, 1997 were
  $8,727,186 and $6,414,419, respectively.


NOTE C - ACCOUNTS RECEIVABLE

  Accounts receivable at December 31 are comprised as follows:

<TABLE>
<CAPTION>
                                                                          1998             1997
                                                                      -----------      ----------
<S>                                                                     <C>              <C>
      Receivables under U.S. Government contracts and subcontracts
        Amounts billed                                                  $ 729,746        $ 836,769
        Unbilled amounts due upon completion of contracts,
          recoverable costs and accrued profits                           526,288        3,457,570
                                                                      -----------      ----------
                                                                        1,256,034        4,294,339

      Receivables from foreign governments                             21,077,888       31,322,856
      Commercial and other receivables, less allowance for doubtful
        receivables of $234,361 in 1998 and $205,350 in 1997            7,111,951        5,032,531
                                                                      -----------      ----------
                                                                      $29,455,873      $40,649,726
                                                                      ===========      ===========
</TABLE>

  Unbilled receivables are comprised of progress billing holdbacks, terminated
  contracts receivable and other unbilled costs and fees.

NOTE D - PREPAID EXPENSES

  Advance payments on contracts in process of approximately $8,271,481 in 1998
  and $2,554,145 in 1997 are included in prepaid expenses.


NOTE E - NOTES PAYABLE

  In November 1998, the Company modified its financing agreement with a domestic
  bank to provide financing for one of its significant contracts. The agreement
  provides for a $4,750,000 line-of-credit, of which $3,415,000 was outstanding
  at December 31, 1998. Borrowings under a similar line-of-credit were
  $1,720,000 at December 31, 1997. The current line-of-credit bears interest at
  the prime rate (7.75% at December 31, 1998) plus 1.5% and expires at the
  earlier of the contract completion or November, 1999. Borrowings under the
  line-of-credit are limited to BRI's eligible accounts receivable, as defined
  in the agreement.

                                      F-14
<PAGE>


                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE E - NOTES PAYABLE - CONTINUED

  Borrowings are secured by BRI's eligible accounts receivable, Allied's
  guarantee and are subject to covenants requiring the maintenance of certain
  financial ratios and other provisions.


NOTE F - CREDIT FACILITY

  The Company is obligated under various credit agreements (the Agreements) with
  its foreign banking pool and its domestic bank that provide credit facilities
  primarily for letters of credit, bank guarantees, performance bonds and
  similar instruments required for specific sales contracts. The Agreements
  provide for certain bank charges and fees as the line is used, plus fees of 2%
  of guarantees issued and annual fees of 1.25% - 1.35% of letters of credit and
  guarantees outstanding. As of December 31, 1998, guarantees and performance
  bonds of $34.1 million remain outstanding.

  Advances under the Agreements are secured by restricted cash of $14,013,905
  and long-term restricted cash deposits of $6,670,289. Long-term restricted 
  cash dposits include $5,850,000 received as an advance payment on contracts. 
  Amounts outstanding are also collateralized by the letters of credit received
  under the contracts financed, and a pledge of approximately $32 million on 
  Mecar's assets. Certain Agreements provide for restrictions on payments or 
  transfers to Allied and ARCL for management fees, intercompany loans, loan 
  payments, the maintenance of certain net worth levels and other provisions.


NOTE G - ACCRUED LOSSES ON CONTRACTS

  The Company has provided for accrued losses of $786,986 at December 31, 1998
  ($572,279 at December 31, 1997) in connection with the completion of certain
  contracts in progress. These contracts are expected to be completed in 1999.


NOTE H - LONG-TERM DEBT

  Long-term obligations as of December 31 consist of the following:

                                                        1998             1997
                                                     -----------     -----------

          Mortgage loan agreements                   $4,710,535      $4,678,268
          Notes payable bank                            346,449         415,449
          Other                                         698,519       1,498,583
                                                        -------       ---------
                                                      5,755,503       6,592,300
          Less current maturities                     1,324,221       1,280,736
                                                      ---------       ---------
                                                     $4,431,282      $5,311,564
                                                     ==========      ==========

                                      F-15

<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------
NOTE H - LONG-TERM DEBT - CONTINUED

  MORTGAGE LOAN AGREEMENTS

  The Company entered into a mortgage loan agreement in 1986, which was amended
  in 1994, to partially finance the construction of Mecar's manufacturing and
  administration facilities in Belgium, which had a balance due of $3,557,998 at
  December 31, 1998. The first principal installment was due in January, 1996
  and the loan matures in January, 2004. As amended, the loan is payable in
  annual principal installments of $550,000 (except for the annual principal
  installment in the year 2000 which is $810,000). The loan bears interest at
  8.75% annually and is collateralized by a mortgage on the Company's real
  estate. The Company is also obligated on several mortgages on the VSK Group's
  buildings which have a total balance due of $1,152,537 at December 31, 1998.
  The mortgages mature at various dates through 2005 in annual installments of
  approximately $254,000, plus interest at rates ranging from 6.6% to 8.5% per
  year.

  NOTES PAYABLE BANK

  BRI is obligated on a note payable with a balance of $346,449 at December 31,
  1998 which bears interest at the prime rate (7.75% at December 31, 1998) plus
  1.5% and matures in May 2002. The note is payable in monthly installments of
  principal of $5,750 plus accrued interest. The note is secured by the assets
  of BRI and is guaranteed by Allied. The agreement contains covenants requiring
  the maintenance of certain financial ratios, among other matters.

  OTHER

  The Company is also obligated on various vehicle, equipment and other
  operating loans. The notes are generally secured by the assets acquired, bear
  interest at rates ranging from 4.4% to 10.75% and mature at various dates
  through 2000.

  Scheduled annual maturities of long-term obligations as of December 31, 1998
are as follows:

                        Year                       Amount
                        ----                       ------

                        1999                      $1,324,221
                        2000                       1,079,359
                        2001                       1,077,596
                        2002                         878,529
                        2003                         594,446
                        Thereafter                   801,352


NOTE I - BENEFIT PLANS

  In June, 1992, the Board of Directors adopted the Allied Research Corporation
  Outside Directors Retirement Plan. The plan provides retirement benefits at
  age 70 to any board member who retires as a director after a minimum of five
  years of service. A retired director is entitled to receive an amount equal to
  the monthly cash compensation received prior to retirement for a period
  equivalent to the time served as a board member. The Board may cease
  retirement payments for cause and modify or terminate the plan at any time.
  Currently, one former director is receiving retirement benefits under the
  plan. The net present value of benefits anticipated to be payable to former
  directors have been previously accrued and reflected as a charge to earnings.

                                      F-16

<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE - I BENEFIT PLANS - CONTINUED

  In June, 1992, the Board of Directors approved the Officers Nonqualified
  Deferred Compensation Plan and the Officers Deferred Compensation Grantor
  Trust. Certain officers of the Company are eligible to participate in the
  plan, which permits a deferral of a percentage of future base compensation.
  Amounts deferred will be invested by the Trustee of the Grantor Trust. The
  Company may terminate the plan at any time. No eligible officers had elected
  to participate in the plan as of December 31, 1998.

  The Company instituted a retirement savings plan in 1989 which received a
  favorable determination letter from the Internal Revenue Service.
  Contributions to the Plan are at the discretion of Company's management. In
  1996, the Company began to match participants' contributions at a rate of 25%
  for each participant dollar contributed up to a maximum of 1% of salary.
  Matching contributions in 1998, 1997 and 1996 were approximately $41,000,
  $47,000 and $43,000, respectively. The Company contributed additional amounts
  of $41,000 and $35,000 to the Plan's profit sharing fund, during 1998 and
  1997, respectively.

  Under the terms of labor agreements at its Belgian subsidiaries, the Company
  contributes to certain governmental and labor organization employee benefit
  and retirement programs.


NOTE J - CONTINGENCIES AND COMMITMENTS

  Cost-plus contracts, subcontracts, and certain other costs are subject to U.S.
  Government audit and review. It is not anticipated that adjustments, if any,
  with respect to determination of reimbursability of costs under cost-plus
  contracts or subcontracts will have a material effect on the Company's
  consolidated results of operations or financial position.

  U.S. Government contracts and subcontracts are by their terms subject to
  termination by the Government or the prime contractor either for convenience
  or for default.

  Mecar and BRI recognize revenues under fixed price contracts using the
  percentage of completion method. Estimates of total costs at completion are
  used to determine the amount of revenue earned. The actual costs on these
  contracts may differ from the Company's estimate at completion and losses
  could exceed the provision of $786,986 established at December 31, 1998.

  The Company enters into foreign exchange contracts in the normal course of
  business primarily to hedge certain sales and purchase contracts. These
  contracts typically mature within twelve months, and forward exchange gains
  and losses are recognized upon final maturity or at the time the related
  foreign currency transaction is recognized. Contracts with a notional amount
  of $22,900,000 were outstanding as of December 31, 1998 ($20,000,000 at
  December 31, 1997).

  In connection with its commitment to provide management services to its
  subsidiaries, the Company has entered into consulting and employment
  agreements with certain management personnel for these subsidiaries. The
  Company has also entered into employment agreements and consulting agreements
  with certain domestic management personnel.

                                      F-17

<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE J - CONTINGENCIES AND COMMITMENTS - CONTINUED

  The Company leases office space, other facilities and equipment under
  operating leases which expire at various dates through 2001. Certain leases
  also include escalation provisions for taxes and operating costs. The
  following is a schedule by year of base rentals due on operating leases that
  have initial or remaining lease terms in excess of one year as of December 31,
  1998.

                            Year                       Amount
                            ----                       ------
                            1999                      $309,198
                            2000                       111,567
                            2001                        21,548
                            2002                         4,705

  Total rental expense charged to operations approximated $398,000, $400,000 and
  $421,000, for the years ended December 31, 1998, 1997 and 1996, respectively.

  The Company's domestic operations do not provide post employment benefits to
  its employees. Under Belgian labor provisions, the Company may be obligated
  for future severance costs for its employees. The Company has provided for
  known severance costs related to its 1997 workforce reduction as part of its
  restructuring charge (see note Q). After giving effect to the workforce
  reductions, current work loads, expected levels of future operations,
  severance policies and future severance costs, post employment benefits are
  not expected to be material to the Company's financial position at this time.


NOTE K - FAIR VALUE OF FINANCIAL INSTRUMENTS

  The estimated fair value of the Company's financial instruments and off
  balance sheet credit obligations are as follows:

<TABLE>
<CAPTION>
                                                                    1998                             1997
                                                          --------------------------       -------------------------
                                                          Carrying        Estimated        Carrying       Estimated
                                                           Amount        Fair Value         Amount        Fair Value
                                                           ------        ----------         ------        ----------
<S>                                                      <C>              <C>             <C>             <C>
    Notes payable                                        $3,415,000       $3,415,000      $1,720,000      $1,720,000
    Long-term debt, including current maturities          5,755,503        5,755,503       6,592,300       6,592,300
    Off-balance-sheet instruments
      Guarantees and letters of credit                            -       34,138,502               -      28,586,000
      Foreign exchange contracts                                  -       22,900,000               -      20,000,000
</TABLE>

  The following methods and assumptions were used to estimate the fair value of
  each class of financial instruments for which it is practicable to estimate
  that value.

  o  The carrying amounts of notes payable approximate their fair value because
     of the short maturity of these obligations.

  o  The fair value of long-term debt is estimated based on approximate market
     prices for the same or similar issues or the current rates offered to the
     Corporation for debt of the same remaining maturities. The Company believes
     the aggregate carrying value approximates fair value.

                                      F-18

<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------


NOTE K - FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED

  o  Estimated fair values for off-balance-sheet instruments (performance bonds,
     advance payment guarantees and letters-of-credit) are reflected at the face
     value of these obligations, since management does not expect to have any
     claims against these obligations based on its past experience. The fair
     value of foreign exchange contracts are based on their notional values,
     since they have short-term maturities at December 31, 1998.

NOTE L - CAPITAL STOCK

  During 1998, the Board of Directors authorized the repurchase of up to 200,000
  shares of the Company's common stock. During 1998, 3,000 shares were
  reacquired and retired.

  At December 31, 1998, options to acquire 127,350 shares of the Company's
  common stock were outstanding and 848,949 shares were reserved for future
  issuance under the following plans:

  1997 INCENTIVE STOCK PLAN

  During 1997, the Board of Directors and shareholders approved and reserved
  225,000 shares of common stock for awards to key employees of the Company and
  its subsidiaries in the form of stock options and stock awards. The Plan is
  administered by the Compensation Committee of the Board of Directors, and
  employees of the Company and its subsidiaries who are deemed to be key
  employees by the Committee are eligible for awards under the Plan.
  In 1998, 53,448 shares were awarded under the Plan.

  1992 ALLIED RESEARCH CORPORATION EMPLOYEE STOCK PURCHASE PLAN

  During 1993, the Board of Directors and shareholders approved and reserved
  525,000 shares for the plan. The plan is voluntary and substantially all
  full-time employees with greater than six months of service are eligible to
  participate through payroll deductions. The purchase price of each share is
  equal to 85% of the closing price of the common stock at the end of each
  calendar quarter. The plan is subject to certain restrictions and the Board
  may amend or terminate it at any time. During 1998, 1997 and 1996 - 7,085,
  16,553 and 12,001 shares, respectively were issued under the plan and $9,314,
  $31,978 and $9,225 was charged to operations.

  1988 INCENTIVE COMPENSATION PLAN

  The Company reserved 410,900 shares of common stock for key employees of the
  Company and its subsidiaries. The plan permitted grants through 1998,
  authorized the Board to grant incentive stock options, non-statutory stock
  options, stock appreciation rights, stock awards, restricted stock,
  performance stock rights and cash awards. Each type of grant places certain
  requirements and restrictions upon the Company and grantee. As of December 31,
  1998, options for 19,100 shares at prices of $3.75 to $5.125 per share remain
  outstanding.

  1984 INCENTIVE STOCK OPTION PLAN

  The Company reserved 315,000 shares of common stock for key employees of the
  Company and its subsidiaries. The plan, which permitted grants through March
  31, 1994. In March 1996, the Company granted options to two officers and
  sixteen employees to purchase 217,500 shares at $8.25 per share. These options
  expire in 2004. At December 31, 1998, 100,750 of these options remained
  outstanding.

                                      F-19


<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE L - CAPITAL STOCK - CONTINUED

  1993 ALLIED RESEARCH CORPORATION OUTSIDE DIRECTORS COMPENSATION PLAN

  During 1993, the Board of Directors and shareholders approved a plan whereby
  each director is entitled to receive a cash payment of $1,000 per month and an
  annual grant of 1,000 shares of the Company's common stock while serving as a
  board member. The Company has reserved 52,400 shares of common stock for the
  plan which is subject to certain restrictions. The plan will terminate upon
  the earlier of issuance of all reserved common shares or December 31, 2003. In
  1998, 1997 and 1996, the Company granted 4,000, 4,000 and 5,000 shares of
  common stock subject to the plan and charged $48,000, $34,000 and $26,250,
  respectively, to operations.

  1991 OUTSIDE DIRECTORS STOCK OPTION PLAN

  During 1991, the Board of Directors and shareholders approved and reserved
  208,000 shares of common stock for the plan. Prior to 1996, the Company
  granted options to purchase a total of 40,000 shares at $2.50 to $4.125 per
  share. All such issued options have been exercised. During 1996, the Company
  granted additional options to purchase a total of 75,000 shares at $5.125 per
  share. At December 31, 1998, 67,500 of the options had been exercised.

  OTHER

  Stock grants for 48,746 and 3,035 shares of the Company's common stock were
  made to various employees during 1997 and 1996, respectively. These shares
  were issued outside of any existing plan and their value ($487,460 and
  $12,125, respectively) was charged to operations.

  PREFERRED SHARE PURCHASE RIGHTS AGREEMENT

  The Board of Directors has adopted an Agreement which provides each
  stockholder of record a dividend distribution of one "right" for each
  outstanding share of common stock. Rights become exercisable the earlier of
  ten days following: (1) a public announcement that an acquiring person has
  purchased or has the right to acquire 10% or more of the Company's common
  stock, or (2) the commencement of a tender offer which would result in an
  offeror beneficially owning 30% or more of the outstanding common stock. All
  rights held by an acquiring person or offeror expire on the announced
  acquisition date and all rights expire at the close of business on June 20,
  2001.

  Each right under the Preferred Share Purchase Rights Agreement entitles a
  stockholder to acquire at a purchase price of $45, one-hundredth of a share of
  preferred stock which carries voting and dividend rights similar to one share
  of common stock. Alternatively, a right holder may elect to purchase for $45
  an equivalent number of common shares (or in certain circumstances, cash,
  property or other securities of the Company) at a price per share equal to
  one-half of the average market price for a specified period. In lieu of the
  purchase price, a right holder may elect to acquire one-half of the common
  shares available under the second option. The purchase price and the preferred
  share fractional amount are subject to adjustment for certain events as
  described in the Agreement.

  Rights also entitle the holder to receive a specified number of shares of an
  acquiring company's common stock in the event that the Company is not the
  surviving corporation in a merger or if 50% or more of the Company's assets
  are sold or transferred.

  At the discretion of a majority of the Board and within a specified time
  period, the Company may redeem all of the rights at a price of $.01 per right.
  The Board may also amend any provisions of the Agreement prior to their
  exercise.

                                      F-20
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE L - CAPITAL STOCK - CONTINUED

  THE FOLLOWING TABLE SUMMARIZES OPTION ACTIVITY:

<TABLE>
<CAPTION>
                                                            1998
                                                -----------------------------
                                                             Weighted Average      1997           1996
                                                Shares       Exercise Price       Shares         Shares
                                                ------       --------------       ------         ------

<S>                                             <C>               <C>             <C>            <C>
    Options outstanding at beginning of year    214,770           $7.08           313,100        227,500
    Options exercised                          (87,420)            6.48          (95,830)              -
    Options granted                                   -               -                 -        135,600
    Options expired                                   -               -           (2,500)       (50,000)
                                                -------           -----           -------        -------
    Options outstanding at end of year          127,350           $7.49           214,770        313,100
                                                =======           =====           =======        =======
    Option price range at end of year             $3.75                             $3.75          $3.75
                                                     to                                to             to
                                                  $8.25                             $8.25          $8.25
    Option price range for exercised shares       $3.75                             $3.75              -
                                                     to                                to
                                                  $8.25                             $8.25
    Options exercisable at end of year           94,750                           115,300        112,800
    Weighted-average fair value of options,
        granted during the year                       -                                 -          $2.06
</TABLE>

  THE FOLLOWING TABLE SUMMARIZES OPTIONS OUTSTANDING AT DECEMBER 31, 1998:

                                                             Weighted Average
      Number                             Weighted Average        Remaining
    Outstanding      Exercise Prices      Exercise Prices    Contractual Life
    -----------      ---------------      ---------------    ----------------

      127,350         $3.75 to $8.25          $7.49                4.78

  The fair value of each option grant is estimated on the date of grant, using
  the Black-Scholes options-pricing model with the following weighted-average
  assumptions used for grants in 1996: risk free interest rates that range from
  5.64% to 5.94%; expected volatility rates that range from 28.91% to 57.98%,
  and expected lives of 1 to 5 years.

  The following table presents the pro forma decrease in income 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.

                                      1998        1997         1996
                                   ----------  ----------  -------
Pro forma
  Net earnings decrease              $59,568     $80,067   $159,697
  Earnings per share decrease
    Basic                                .01         .01        .03
    Diluted                              .01         .02        .03


                                      F-21
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------


NOTE M - MAJOR CUSTOMERS

  The Company derives the majority of its revenues from foreign governments,
  direct and indirect sales to U.S. Government agencies and government prime
  contractors, primarily on fixed price contracts. During 1998, 1997 and 1996,
  the Company derived approximately 3%, 5% and 11%, respectively, of its revenue
  from U.S. Government agencies and contractors. Two agencies of a foreign
  government and another foreign government accounted for approximately 48% ,
  20% and 10% of revenue in 1998, 64%, 6% and 10% of revenue in 1997 and, 42%,
  10%, and 19% of revenue in 1996.


NOTE N - CONCENTRATIONS OF CREDIT RISK

  Financial instruments and related items which potentially subject the Company
  to concentrations of credit risk consist principally of temporary cash
  investments, trade receivables and costs and accrued earnings on uncompleted
  contracts. The Company places its temporary cash investments with high credit
  quality financial institutions. Credit risk with respect to trade receivables
  and costs and accrued earnings on uncompleted contracts are concentrated due
  to the nature of the Company's customer base. The Company generally receives
  guarantees and letters of credit from its foreign customers and performs
  ongoing credit evaluations of its other customers' financial condition. The
  Company's provision for doubtful accounts for 1998 and 1997 was not
  significant.

  The majority of ammunition sales are to two agencies of a foreign government
  and other foreign governments. Mecar's ammunition sales in any given period
  and its backlog at any particular time may be significantly influenced by one
  or a few large orders. In addition, the production period required to fill
  most orders ranges from several months to a year. Accordingly, Mecar's
  business is dependent upon its ability to obtain such large orders and the
  required financing for these orders. As of December 31, 1998 and 1997, backlog
  orders believed to be firm approximated $47.8 and $92.8 million.

  Amounts in foreign banks at December 31, 1998 and 1997 were approximately
  $22.4 million and $14.1 million, respectively. Changes in the value of the
  U.S. dollar and other currencies affect the Company's financial position and
  result of operations since the Company has assets and operations in Belgium
  and sells its products on a worldwide basis.

NOTE O - OTHER - NET

  Other income and expense included in the Company's consolidated statements of
earnings is comprised as follows:

<TABLE>
<CAPTION>
                                                 1998              1997            1996
                                             ------------      ----------      ----------
<S>                                           <C>              <C>             <C>
    Net currency transaction gains (losses)   $(1,093,160)     $1,328,195      $(836,254)
    Miscellaneous - net                           280,908         191,310         454,875
                                            -------------      ----------      ----------
                                            $   (812,252)      $1,519,505      $(381,379)
                                             ===========        =========       ========
</TABLE>


                                      F-22
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------



NOTE P - INCOME TAXES

  The Company recognizes deferred tax liabilities and assets for the expected
  future tax consequences of events that have been included in the financial
  statements or tax returns. Under this method, deferred tax liabilities and
  assets are determined based on the difference between the financial statement
  and tax basis of assets and liabilities using enacted tax rates in effect for
  the year in which the differences are expected to reverse.

  Earnings (loss) before income taxes is comprised as follows:


                              1998            1997              1996
                          ------------    ------------      ----------
Domestic                     $ 213,282     $ (809,173)       $ 124,549
Foreign                     11,362,524      10,335,115       5,572,164
                            ----------      ----------       ---------

                           $11,575,806    $  9,525,942      $5,696,713
                            ==========     ===========       =========

  The Company's provision for income taxes is comprised as follows:


                               1998             1997           1996
                          ------------     -----------    ------------
Currently payable
  Domestic                   $ 669,102        $ 46,614       $ 197,299
  Foreign                    2,945,711         921,336       1,323,619
                           -----------        --------      ----------
                             3,614,813         967,950       1,520,918
Deferred - net             (1,104,645)         (6,796)       (629,688)
                           -----------        --------      ----------
                           $ 2,510,168        $961,154     $   891,230
                            ==========         =======      ==========

  The Company's provision for income taxes differs from the anticipated United
  States federal statutory rate. Differences between the statutory rate and the
  Company's provision are as follows:

                                             1998         1997        1996
                                            --------     -------     -------
Taxes at statutory rate                      34.0 %       34.0 %      34.0 %
Benefit of foreign tax credit carryforward    (1.2)            -       (1.2)
Foreign tax rate differential                (13.4)       (27.5)      (18.3)
Foreign loss limitations                        1.3            -           -
Other                                           1.0          3.6         1.1
                                            --------     -------     -------
           Income taxes                       21.7%       10.1 %      15.6 %
                                            ========     =======     =======

  In 1998, 1997 and 1996, the Company's Belgian subsidiaries utilized
  approximately $3,846,000, $8,529,000 and $4,232,000, respectively, of foreign
  operating loss carryforwards for tax reporting purposes. The Company's Belgian
  subsidiary has used all of its remaining net operating losses at December 31,
  1998. Income tax expense in 1998 was also reduced by approximately $939,000 as
  a result of the favorable resolution of deferred and accrued tax obligations
  in the United Kingdom.


                                      F-23
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE P - INCOME TAXES - CONTINUED

  
  The Company utilized approximately $143,600 and $67,000 of its foreign tax
  credits in 1998 and 1996, respectively. No foreign tax credits were utilized
  in 1997. At December 31, 1998, foreign tax credit carryforwards of
  approximately $764,000 were available which expire through 2001.

  Deferred tax liabilities have not been recognized for basis differences
  related to investments in the Company's Belgian and United Kingdom
  subsidiaries. These differences, which consist primarily of unremitted
  earnings intended to be indefinitely reinvested, aggregated approximately $33
  million at December 31, 1998. Determination of the amount of unrecognized
  deferred tax liabilities is not practicable.

  Deferred taxes at December 31, 1998 and 1997 are comprised as follows:

<TABLE>
<CAPTION>
                                                                                     1998              1997
                                                                                ----------------  -----------------
<S>                                                                              <C>                 <C>
      Current
        Unrealized exchange (losses) gain                                        $       1,594       $    (48,880)
        Compensated absences                                                           132,100            111,000
        Deferred income                                                                   -               (52,455)
        Contract cost provision                                                        249,000               -
        Other                                                                           15,000             73,000
                                                                                   -----------       ------------

            Current deferred tax asset                                                 397,694             82,665

      Noncurrent
        Foreign tax credit carryforwards                                               498,365            676,005
        Foreign and domestic net operating loss carryforwards                             -             1,776,435
        Depreciation and amortization                                                  577,168            124,455
        Deferred compensation                                                           16,607             25,103
        Deferred income                                                                 (5,915)              -
        Other                                                                           26,159               -
        Unrealized exchange gain                                                          -              (577,780)
                                                                                   -----------         -----------

            Noncurrent deferred tax asset                                            1,112,384          2,024,218
                                                                                     ---------         ----------

            Total deferred tax asset before valuation allowances                     1,510,078          2,106,883

      Valuation allowances                                                            (498,365)        (2,236,594)
                                                                                      ---------         ----------

            Net deferred tax asset (liability)                                      $1,011,713        $  (129,711)
                                                                                     =========         ===========

  Deferred tax components are included in the following balance sheet accounts:

                                                                                      1998                1997
                                                                                   -------------      ------------
      Current (included in "prepaid expenses and deposits")                        $   397,694          $ 496,949
      Noncurrent (included in "other" noncurrent assets)                               614,019               -
      Deferred income taxes                                                               -              (626,660)
                                                                                   -------------      ------------
                                                                                    $1,011,713          $(129,711)
                                                                                   =============      ============
</TABLE>


                                      F-24
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------
  
NOTE Q - RESTRUCTURING COSTS

  The Company began implementing a streamlining of its manufacturing,
  administrative processes and personnel during 1993 at its Belgian subsidiary,
  Mecar. The Company has continued to implement additional cost reductions and
  efficiency improvements beyond those initiated in 1993. As a result of changes
  effected in late 1997, the Company recorded a restructuring charge of $977,267
  in the fourth quarter of 1997, principally comprised of workforce reductions,
  termination costs and benefits. The reductions are expected to produce further
  efficiencies and reduce the overall level of core employment.

     Provisions in 1997                               $977,267
     Payments in 1997                                  478,817
                                                      --------
     Payments in 1998                                 $498,450
                                                       =======

NOTE R - EARNINGS PER COMMON SHARE

  The following table reconciles the numerators and denominators of the basic
  and diluted earnings per share (EPS) computations.

<TABLE>
<CAPTION>
                                                                1998           1997            1996
                                                              ----------     ----------      ----------
<S>                                                           <C>            <C>             <C>
    Basic EPS
      Income available to common stockholders                 $9,065,638     $8,564,788      $4,805,483
                                                               =========      =========       =========

      Weighted average number of common shares outstanding     4,722,303      4,543,874       4,432,750
                                                               =========      =========       =========

             Basic EPS                                             $1.92          $1.88           $1.08
                                                                    ====           ====            ====
    Diluted EPS
      Income available to common stockholders                 $9,065,638     $8,564,788      $4,805,483
      Income impact of assumed conversions
                                                                   -              -               -
             Income available to common stockholders on a
               diluted basis                                  $9,065,638     $8,564,788      $4,805,483
                                                               =========      =========       =========

      Weighted average number of common shares outstanding     4,722,303      4,543,874       4,432,750
      Effect of dilutive securities - stock options               42,904         82,728           5,739
                                                               ---------      ---------       ---------
             Adjusted weighted average number of common
               shares outstanding                              4,765,207      4,626,602       4,438,489
                                                               =========      =========       =========
             Diluted EPS                                           $1.90          $1.85           $1.08
                                                                    ====           ====            ====
</TABLE>

                                      F-25
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE R - EARNINGS PER COMMON SHARE - CONTINUED

  During 1996, options to purchase 71,950 shares at $8.75 a share were
  outstanding, which were not included in the computation of diluted EPS because
  the options' exercise price was greater than the average market price of the
  common shares.


NOTE S - GEOGRAPHIC AREAS AND INDUSTRY SEGMENTS

  The Company currently operates in three principal segments: Product sales
  (Mecar), Engineering and Technical (BRI) and Security Systems and Services
  (The VSK Group). Product sales includes the production of ammunitions, weapons
  systems and ordnance products systems integration. Engineering and Technical
  provides support services primarily to United States Military Agencies and
  government contractors. Security Systems and Services includes sales and
  services to industrial and institutional customers of protection, fire and
  access control systems and services. Corporate costs are allocated to each
  segment's operations monthly and are included in the measure of each segments
  profit or loss. Corporate and other includes unallocated corporate cost and
  the former activities of Limited.

  The Company's foreign operations are conducted by Mecar and the VSK Group.

<TABLE>
<CAPTION>
                                         1998             1997              1996
                                     ------------     ------------      ------------
<S>                                  <C>              <C>                <C>
REVENUES FROM EXTERNAL CUSTOMERS
  Product Sales                      $111,804,077     $107,533,415       $74,109,952
  Engineering and Technical            10,457,075       10,549,224        11,636,242
  Security Systems and Service         21,274,050       16,401,111        17,913,943
  Corporate and Other                           -                -                 -
                                     ------------     ------------      ------------
                                     $143,535,202     $134,483,750      $103,660,137
                                      ===========      ===========      ============
INTEREST EXPENSE
  Product Sales                       $ 1,203,361      $ 1,513,363       $ 2,971,325
  Engineering and Technical               419,422          155,206           111,879
  Security Systems and Service            159,284          218,868           361,308
  Corporate and Other                     (9,783)         (40,740)             6,554
                                     ------------     ------------      ------------
                                      $ 1,772,284      $ 1,846,697       $ 3,451,066
                                     ============     ============      ============

INTEREST INCOME
  Product Sales                       $   853,581      $   777,502       $ 1,324,658
  Engineering and Technical               344,127          131,049             5,738
  Security Systems and Service             83,444           51,526           111,405
  Corporate and Other                     221,986           73,522           480,063
                                     ------------     ------------      ------------
                                      $ 1,503,138      $ 1,033,599       $ 1,921,864
                                     ============     ============      ============
</TABLE>

                                      F-26
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE S - GEOGRAPHIC AREAS AND INDUSTRY SEGMENTS - CONTINUED

<TABLE>
<CAPTION>
                                         1998              1997              1996
                                    --------------     ------------      ------------
<S>                                    <C>                <C>               <C>
INCOME TAX EXPENSE (BENEFIT)
  Product Sales                        $ 1,162,865        $   7,038         $  51,569
  Engineering and Technical                308,130          288,200           212,392
  Security Systems and Service           1,909,945          890,943           686,903
  Corporate and Other                    (870,772)        (225,027)          (59,634)
                                    --------------     ------------      ------------
                                    $    2,510,168    $     961,154     $     891,230
                                    ==============     ============      ============
DEPRECIATION AND AMORTIZATION
  Product Sales                        $ 1,474,159       $2,049,204        $2,488,189
  Engineering and Technical                427,407          446,602           392,497
  Security Systems and Service             623,074          150,189           212,848
  Corporate and Other                        7,137             -                 -
                                    --------------     ------------      ------------
                                    $    2,531,777     $  2,645,995      $  3,093,534
                                    ==============     ============      ============
SEGMENT PROFIT (LOSS) BEFORE TAXES
  Product Sales (1)                    $ 6,854,793       $8,609,293        $3,715,666
  Engineering and Technical                744,738          706,558           497,824
  Security Systems and Service           4,452,232        2,003,295         1,442,368
  Corporate and Other                    (475,957)      (1,793,204)            40,855
                                    --------------     ------------      ------------
                                     $  11,575,806     $  9,525,942      $  5,696,713
                                    ==============     ============      ============
SEGMENT ASSETS
  Product Sales                        $80,262,860      $73,593,091       $70,775,112
  Engineering and Technical             16,879,699       13,016,075         5,505,577
  Security Systems and Service          13,567,284        9,664,265        14,067,186
  Corporate and Other (2)                2,366,287        3,227,208         1,600,285
                                    --------------     ------------      ------------
                                      $113,076,130      $99,500,639       $91,948,160
                                    ==============     ============      ============
EXPENDITURE FOR SEGMENT ASSETS
  Product Sales                        $ 1,634,411       $1,043,058         $ 696,699
  Engineering and Technical                170,924          163,963           264,915
  Security Systems and Service             576,608          135,299           105,275
  Corporate and Other                         -                -                 -
                                    --------------     ------------      ------------
                                    $    2,381,943     $  1,342,320      $  1,066,889
                                    ==============     ============      ============
</TABLE>

(1)  UNUSUAL ITEMS - SEGMENT PROFIT ATTRIBUTABLE TO PRODUCT SALES IN 1997
     INCLUDES RESTRUCTURING COSTS OF $977,267, DIRECT CORPORATE COST ALLOCATIONS
     TO OPERATING SEGMENTS INCREASED BY APPROXIMATELY $166,000 IN 1998, 
     CORPORATE AND OTHER IN 1997 INCLUDES $742,000 OF NON-RECURRING COSTS, 
     WHICH AFFECT YEAR-TO-YEAR COMPARABILITY.

(2)  NET OF INTERSEGMENT RECEIVABLES.

                                      F-27
<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE S - GEOGRAPHIC AREAS AND INDUSTRY SEGMENTS - CONTINUED

  The following geographic area data include trade revenues based on product
  shipment destination and property, plant, and equipment based on physical
  location.

<TABLE>
<CAPTION>
                                            Geographic Segment Data
                                  -----------------------------------------------
                                      1998             1997              1996
                                  ------------    -------------     -------------
<S>                                <C>              <C>               <C>
REVENUES FROM EXTERNAL CUSTOMERS
  United States                    $ 7,066,567      $ 7,505,918       $11,634,067
  Belgium                           14,481,788       13,399,143        19,218,820
  Middle East                      105,439,877       94,441,684        68,054,857
  Far East                           3,940,000        3,061,000                 -
  France                             4,096,218        2,934,664         2,832,154
  Other foreign countries            8,510,752       13,141,341         1,860,239
                                  ------------    -------------     -------------
                                  $143,535,202     $134,483,750      $103,600,137
                                  ============    =============     =============
SEGMENT ASSETS
  Belgium                          $93,830,144      $83,257,626       $84,842,298
  United Kingdom                       260,149          480,608           228,654
  United States (1)                 18,985,837       15,762,405         6,877,208
                                  ------------    -------------     -------------
                                  $113,076,130    $  99,500,639     $  91,948,160
                                  ============    =============     =============
</TABLE>

(1)  NET OF INTERSEGMENT RECEIVABLES.


NOTE T - QUARTERLY FINANCIAL DATA (UNAUDITED)

                      (Amounts in thousands, except per share data)
                      ---------------------------------------------
                  First      Second      Third        Fourth        Total
      1998       Quarter     Quarter     Quarter      Quarter     For Year
      ----       -------     -------     -------      -------     --------

Revenue          $35,753     $32,154      $31,001     $44,627     $143,535

Gross profit       6,630       7,380        5,228       7,654       26,892

Net earnings       2,257       2,546        1,780       2,483        9,066

Per share data:
  Basic              .49         .53          .38         .52         1.92
  Diluted            .48         .53          .37         .52         1.90

                                      F-28

<PAGE>

                           ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

--------------------------------------------------------------------------------

NOTE T - QUARTERLY FINANCIAL DATA (UNAUDITED) - CONTINUED

                     (Amounts in thousands, except per share data)
                     ---------------------------------------------
                  First       Second    Third       Fourth      Total
       1997      Quarter     Quarter    Quarter     Quarter    For Year
       ----      -------     -------    -------     -------    --------

Revenue          $29,765     $24,630    $27,774     $52,315    $134,484

Gross profit       5,490       6,618      5,484       7,452      25,044

Net earnings       1,984       2,307      1,896       2,378       8,565

Per share data:
  Basic              .44         .51        .42         .52        1.88
  Diluted            .44         .50        .41         .51        1.85


                                      F-29
<PAGE>

                                    SCHEDULES

                                      F-30
<PAGE>

                           ALLIED RESEARCH CORPORATION

           SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT

                                (PARENT COMPANY)

                                 BALANCE SHEETS

                                  DECEMBER 31,

--------------------------------------------------------------------------------


The condensed balance sheets, statements of operations and cash flows of the
registrant follow.

                 ASSETS
                                                  1998           1997
                                             ---------------------------

Cash and equivalents                         $  1,855,901   $  2,342,037
Investments in subsidiaries                    57,273,612     41,722,046
Deferred tax asset                                 18,201         25,103
Deposits and other                                232,036        379,158
                                              ------------   ------------

         Total assets                         $59,379,750    $44,468,344
                                               ==========     ==========




                LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES
  Accounts payable and accrued liabilities    $1,212,627   $  1,176,115
  Due to subsidiaries                          8,203,273      6,348,894
  Deferred tax liability                           -             48,880
                                             -----------      ----------

         Total liabilities                     9,415,900      7,573,889


STOCKHOLDERS' EQUITY
  Common stock                                   475,717        460,822
  Capital in excess of par value              13,391,099     12,100,521
  Retained earnings                           35,111,909     26,046,271
  Accumulated other comprehensive
    income (loss)                                985,125      (1,713,159)
                                             -----------      ----------
                                              49,963,850     36,894,455
                                             -----------      ----------

                                             $59,379,750    $44,468,344
                                             ===========    ===========
                                      F-31

<PAGE>


                           ALLIED RESEARCH CORPORATION

     SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED

                                (PARENT COMPANY)

                             STATEMENTS OF EARNINGS

                             YEAR ENDED DECEMBER 31,

--------------------------------------------------------------------------------



                                          1998           1997          1996
                                       -----------    -----------    ----------
Income
  Intercompany management fees          $2,850,448    $ 2,684,859    $2,652,889
  Other - net                              463,881        311,587       (77,412)
                                        ----------    -----------     ----------
                                         3,314,329      2,996,446     2,575,477

Costs and expenses
  Administrative and other               3,845,785      4,512,176     2,878,746
                                         ---------     ----------     ---------

         (Loss) before equity in
           operations of subsidiaries     (531,456)    (1,515,730)     (303,269)

Equity in operations of subsidiaries     9,665,490      9,855,491     4,959,035
                                         ---------     ----------     ---------

         Earnings before income taxes    9,134,034      8,339,761     4,655,766

Income taxes (benefit)                      68,396       (225,027)     (149,717)
                                       -----------      ----------   -----------

         NET EARNINGS                   $9,065,638    $ 8,564,788    $4,805,483
                                         =========     ==========     =========

         Earnings per common share
           Basic                             $1.92          $1.88         $1.08
                                              ====           ====          ====

           Diluted                           $1.90          $1.85         $1.08
                                              ====           ====          ====

                                      F-32

<PAGE>


                           ALLIED RESEARCH CORPORATION

     SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED

                                (PARENT COMPANY)

                            STATEMENTS OF CASH FLOWS

                             YEAR ENDED DECEMBER 31,

--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
Increase (decrease) in cash and equivalents                         1998               1997              1996
                                                               ------------------------------------------------
<S>                                                                 <C>                <C>               <C>
Cash flows from (used in) operating activities
  Net earnings for the year                                    $   9,065,638       $ 8,564,789     $  4,805,483
  Adjustments to reconcile net earnings to net cash from
    (used in) operating activities
      Equity in operations of subsidiaries                        (9,665,490)       (9,855,489)      (4,959,035)
      Depreciation and amortization                                    5,307             6,191                -
      Gain on disposal of property and equipment                           -                  -             (250)
      Deferred income taxes                                          (41,978)          146,262         (127,724)
      Common stock awards and grants                                 689,376           521,460           41,382
  Changes in assets and liabilities
    Other assets                                                     141,823          (158,022)          85,350
    Due to subsidiaries                                           (1,333,421)          733,448          377,095
    Accounts payable and accrued liabilities                          36,512           700,909          269,066
    Income taxes                                                           -           (88,601)         38,496
                                                                  -----------       ----------       ----------
                                                                 (10,167,871)       (7,993,842)      (4,275,620)
                                                                 -----------        ----------       ----------

         Net cash (used in) provided by operating activities      (1,102,233)          570,947          529,863

Cash flows from investing activities
  Capital expenditures                                                     -           (17,243)          (7,250)
  Proceeds for sale of property and equipment                              -                 -              250
                                                                 -----------        ----------       ----------
         Net cash (used in) investing activities                           -           (17,243)          (7,000)

Cash flows from financing activities
  Proceeds from employee stock purchase plan shares                  637,622           749,271           61,729
  Retirement of common stock                                         (21,525)                -                -
                                                                 -----------        ----------       ----------

           Net cash provided by financing activities                 616,097           749,271           61,729
                                                                 -----------        ----------       ----------

           Net (decrease) increase in cash and equivalents          (486,136)        1,302,975          584,592

Cash and equivalents at beginning of year                          2,342,037         1,039,062          454,470
                                                                 -----------        ----------       ----------

Cash and equivalents at end of year                            $   1,855,901       $ 2,342,037      $ 1,039,062
                                                               =============       ===========      ===========

Supplemental Disclosures of Cash Flow Information
  Cash paid during the year for:
    Income taxes                                              $      178,000      $    116,692    $     135,000
    Interest                                                               -                 -                -
</TABLE>

                                      F-33
<PAGE>


                           ALLIED RESEARCH CORPORATION

                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                           Additions
                                                   --------------------------
                                Balance at         Charged to        Charged                         Balance
                                 beginning        costs and         to other                        at end of
Description                     of period          expenses          accounts       Deductions       period
-----------                     ---------          --------          --------       ----------       ------
<S>                            <C>                  <C>       <C>               <C>                   <C>
Year ended December 31, 1998
----------------------------
  Estimated losses on
    contracts                   $    572,279       $ 786,986        $      -     $    572,279 (1)    $   786,986
                                ============       =========        ========     ============        ===========
  Allowance for doubtful
    receivables                 $    205,350       $  29,011        $      -     $       -           $   234,361
                                ============       =========        ========     ============        ===========

  Valuation allowances on
    deferred tax assets         $  2,236,594       $       -        $      -     $  1,738,229 (1)    $   498,365
                                ============       =========        ========     ============        ===========

Year ended December 31, 1997
----------------------------
  Estimated losses on
    contracts                   $    390,125       $ 572,279        $      -     $    390,125 (1)    $   572,279
                                ============       =========        ========     ============        ===========
  Allowance for doubtful
    receivables                 $    364,674       $ 192,837        $      -     $     33,513 (2)    $   205,350
                                ============       =========        ========     ============        ===========
  Valuation allowances on
    deferred tax assets         $  6,064,997       $       -        $      -     $  3,828,403 (3)    $ 2,236,594
                                ============       =========        ========     ============        ===========

Year ended December 31, 1996
----------------------------
  Estimated losses on
    contracts                   $    431,215       $ 390,125        $      -     $    431,215 (1)    $   390,125
                                ============       =========        ========     ============        ===========
  Allowance for doubtful
    receivables                 $    330,077       $  55,186        $      -     $     20,589 (2)    $   364,674
                                ============       =========        ========     ============        ===========
  Valuation allowances on
    deferred tax assets         $ 19,923,320       $       -        $      -     $ 13,858,323 (3)    $ 6,064,997
                                ============       =========        ========     ============        ===========
</TABLE>

(1)  REPRESENTS AMOUNT OF RESERVE RELIEVED THROUGH COMPLETION OF CONTRACTS.

(2)  REPRESENTS WRITE-OFF OF RECEIVABLES.

(3)  REDUCTION IN VALUATION ALLOWANCE DUE TO UTILIZATION OF NET OPERATING LOSS
     AND IN 1998 REDUCTION IN DEFERRED TAX OBLIGATIONS.

                                      F-34
<PAGE>

                                    EXHIBITS

<PAGE>

                                  EXHIBIT INDEX

--------------------------------------------------------------------------------

Number              Description of Exhibit                  Page
------              ----------------------                  ----

   21               List of Subsidiaries                    E-3

   23               Consent of Independent Certified
                       Public Accountants                   E-4

                                      E-2