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, 1996                                        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, 1996                                        0-2545
    -----------------                                        ------

                          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:  None
                                                             ----

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

                         Common Stock - Par Value $.10
                                (Title of Class)

         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
                                                      ---       ---

         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 III
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 March 14, 1997:

           Common Stock - Par Value $.10                 $43,839,200

The number of shares of  registrant's  Common Stock  outstanding as of March 14,
1997, was 4,521,838.


<PAGE>


Item 1.  Business.

General.

         Allied Research  Corporation  ("Allied") 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 by MECAR 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 weapon
systems.  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 and  manufactures a wide variety of shells,  grenades and
rockets in the  artillery,  anti-tank  and  anti-personnel  categories.  It also
produces two classes of weapons for light  infantry  use. The  following are the
principal products produced and sold by MECAR:



                                       2

<PAGE>



                  105mm Tank - APFSDS-T M1060 (Armour Piercing  Discarding Sabot
         Fin Stabilized Tracer) Round. For use with 105mm tank guns - US M68, UK
         L7 and  French  CN105F1 - this  projectile  is used to  defeat  armored
         targets by means of the kinetic  energy (KE) of its  monobloc  tungsten
         alloy  long  rod  penetrator.  This  model  of KE  round  is a  product
         improvement  of the current in- service MECAR 105mm TK APFSDS-T  M1050.
         Projectiles  consist of a sub-projectile  and sabot. The sub-projectile
         comprises an armour  piercing fin  stabilized  tungsten  alloy long rod
         penetrator,  and aluminum  windshield and a tracer assembled in the fin
         assembly. This is contained within a 3 piece aluminum discarding sabot,
         held in place  with a  plastic  band at the  forward  end and a plastic
         obturating band toward the sabot base. The projectile is crimped to the
         lined   cartridge   case   which   is   loaded   with   cool   burning,
         multi-perforated,  loose  propellant,  and is fitted  with an  electric
         primer. This round is comparable to the US model M833 APFSDS-T round.

                  90mm Anti-tank  APFSDS-T M562 Round.  This shell  developed by
         MECAR  consists of a tungsten  penetrator  weighing  1.7  kilograms,  a
         discardable  sabot of light alloy and a fin with  tracer.  This kinetic
         energy  shell,  weighing 2.8  kilograms  with the sabot,  is fired at a
         muzzle  velocity  of 1460 meters per second  with an  effective  combat
         range of 1800 meters. The penetration  capability of this shell against
         a 120mm thick armour plate  slanted at 60 degrees is achieved at ranges
         in excess of 2,000 meters.  MECAR has  developed  and designed  several
         versions of the 90 mm round which can be used by various  guns in usage
         around the world.

                  25mm APFSDS-T M935 Round.  This  ammunition  round is produced
         for use  against  light  armor  and  support  vehicles  and  was  first
         delivered to customers  starting in 1993.  This round was Mecar's first
         entry into the medium caliber  ammunition  market, and further expanded
         the  customer  base to include  infantry  fighting  and  reconnaissance
         vehicles.

                  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 BTU
         and the expanding gases

                                       3

<PAGE>



         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).

                  Rifle Grenades.  A full range of rifle grenades  utilizing the
         ballistite  cartridge for launching can also be  manufactured by MECAR.
         These  include  anti-personnel,  armour and concrete  piercing,  smoke,
         illumination,  delay and other types. This type of grenade is no longer
         widely used due to the development of the bullet trap grenade.

                  120mm Mortar Round. This round can be fired in both direct and
          indirect  modes.  It has been  developed  for use in new mortar weapon
          systems.

                  60 to 202mm Ammunition. Other ammunition manufactured by MECAR
         for use in various gun systems  includes the kinetic energy  penetrator
         round, high explosive  anti-personnel  fragmentation  round,  anti-tank
         tracer projectile,  smoke tracer projectile,  anti-personnel  canister,
         and training devices.

                  84mm SAKR Recoilless  Rifle.  MECAR has recently  expanded its
         line of  anti-armor  munitions  with the  addition  of their  84mm SAKR
         recoilless  rifle and its  associated  family of  ammunition.  The SAKR
         fills the gap between  rifle  grenades  and the 90mm family of guns and
         ammunition.  Several large orders have already been received.  The SAKR
         ammunition (HEAT, HE-T and HE-TP-T) is also interoperable with existing
         84mm systems which has been sold extensively around the world. MECAR is
         now in a  position  to  provide  ammunition  to  support  the  existing
         inventory of weapons as well as further  expanding the use of this type
         of infantry  weapon with  countries that have already  purchased  MECAR
         rifle grenades.

BRI

         BRI is an  engineering  and  manufacturing  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.

                                       4

<PAGE>




         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.

         On June 1, 1994, MECAR acquired all of the outstanding stock of the 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  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  T  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.  During 1996, 1995 and
1994,  two  agencies  of a foreign  government  and another  foreign  government
accounted for  approximately  10%, 42% and 19% in 1996, 12%, 31% and 27% in 1995
and 5%, 60% and 14% in 1994, of Allied's revenues.  During 1996 and 1995, Allied
derived approximately 11% and 17%, respectively, of its annual revenue from U.S.
Government  agencies and contractors.  The VSK Group accounted for approximately
17% and 28% of Allied's 1996 and 1995 revenues, respectively.

                                       5

<PAGE>




         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.

         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.  sells its products principally
in European markets.



                                       6

<PAGE>



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.

         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.

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 1996, 1995 and 1994, MECAR expended $857,434,  $1,039,631
and  $940,133,  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 1996 and 1995, the VSK Group expended
$888,885 and $954,363,  respectively, on research and development. Prior to 1995
the VSK Group did not separately account for its research and development costs.


                                       7

<PAGE>



Suppliers and Materials.

         Production  of  ammunition  requires  an  ample  supply  of  chemicals,
pyrotechnical  materials  and metal  component  parts and  casings.  During  the
development  phase the  selection  of specific  propellants  and case  materials
includes  consideration  of the availability of raw materials and reliability of
suppliers.  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.

         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, 1996 and  December  31,  1995,  Allied had backlog
orders believed to be firm,  after giving effect to the percentage of completion
method  of  accounting,  of  approximately  $79.6  million  and  $68.1  million,
respectively.  The backlog of orders as of December  31, 1996 are expected to be
substantially filled in 1997 and the first half of 1998.

Competition.

         The  munitions  business is highly  competitive.  MECAR has a number of
competitors throughout the world, including the United

                                       8

<PAGE>



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 representatives. 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.

Personnel.

         As of March  14,  1997,  Allied,  MECAR,  BRI and the VSK Group had 487
permanent employees as follows:

         ALLIED

         Salaried employees                                              5
         Part-time employees                                             1

         MECAR

         Technical and salaried employees                               52
         Hourly workers                                                207
         Technical consultants                                           2

         BRI

         Salaried employees                                             65
         Hourly employees                                               36

         VSK Group

         Technical salaried employees                                   79
         Hourly workers                                                 40

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

Patents.


                                       9

<PAGE>



         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.  In 1991, 1992 and 1993, MECAR and in
1991 and 1992,  Limited had contract  revenue from these  agencies in amounts in
excess of those historically received.  Contract awards from these agencies from
1992 through 1994 were substantially reduced.  Contract awards rebounded in 1995
and 1996, although below the levels received in the 1991-1993 timeframe.

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 also  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  1996,  MECAR  operated  at an average of 85% of  productive
capacity of its facility, assuming the operation of 3 shifts. MECAR is currently
operating at full productive capacity including use of some temporary personnel.

         Capital expenditure programs for equipment planned in 1997 will require
funding of approximately $2.6 million.

         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

                                       10

<PAGE>



July 31,  1999.  Assuming one full shift is maximum  capacity,  BRI is currently
operating  at  approximately  90% 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 80%
of productive capacity.

Item 3.  Legal Proceedings.

         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 1996.



                                       11

<PAGE>



                                    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 Rsrch.  The table below shows the high
and low sales prices of Allied's  Common Stock during 1996 and 1995 (as reported
by AMEX):

         1996                    High            Low
         ----                    ----            ---

         1st Quarter            $5-3/8          $3-1/2
         2nd Quarter             7-1/2           3-1/2
         3rd Quarter             6-1/4           4-1/2
         4th Quarter             6-1/2           4-7/8

         1995                    High            Low
         ----                    ----            ---

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

Stockholders.

         There were approximately 1,644 holders of record of the Common Stock of
Allied as of March 14, 1997.

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 1993-1996.  The banking  agreements  of MECAR  restrict the ability of
such  subsidiary  to  transfer  funds to Allied  as  described  in  Management's
Discussion and Analysis of Financial Condition and Results of Operations.


                                       12

<PAGE>



Item 6.  Selected Financial Data.

         The following selected financial data relates to Allied's  consolidated
financial  position and results of operations  for 1996,  1995,  1994,  1993 and
1992:

<TABLE>
<CAPTION>
                                   1996         1995         1994         1993          1992
                                   ----         ----         ----         ----          ----
<S><C>
                                             (000's omitted except per share amounts)

Revenues                         $103,660      $65,769      $69,847      $147,097     $217,334

Net earnings (loss)                 4,805       (2,013)     (10,941)        7,995       18,040

Per Share:
Net earnings (loss)                  1.08         (.46)       (2.49)         1.73         3.99

Total assets                       91,948       94,253      107,386       163,591      116,236

Long-term debt
obligations and
redeemable preferred
stock                               7,443       28,435       14,108        19,218        6,462

Cash dividends
declared per
common share                            -            -            -             -            -

</TABLE>

NOTE: During 1993, Allied changed its method of accounting for income taxes as a
result of the  adoption  of FASB 109.  This  change  did not have a  significant
effect on the  comparability  of the above selected  financial data. See Notes A
and P to the accompanying financial statements for Allied.

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 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.


                                       13

<PAGE>



                  Allied  earned a net profit of $4.81 ($1.08 per share) for
1996 compared  with a net loss of $2.01  ($.46 per  share) for 1995 and a net
loss of $10.94  ($2.49  per  share)  for  1994.  In  1996,  each of  Allied's
operating subsidiaries earned a profit.

Trends In Operations

                  Allied's  results from  operations  continue to be uneven as a
result of the  volatility  of the  overseas  military  business  of  MECAR.  The
substantial  orders  received by MECAR in 1995 and  throughout  1996 resulted in
profitable  operations  beginning  in the  second  half of 1995  and  continuing
throughout  1996.  Consistent  with  historical  patterns,  these orders were
primarily  from two  agencies  of a  foreign  government.  In order to  continue
profitable operations, MECAR must continue to obtain similar or larger orders on
a timely basis.

                  Management continues to broaden its revenue base in several
respects.  In 1996, MECAR obtained  approximately $17 in new orders from
non-traditional  customers (as opposed to approximately $71 from its traditional
customer base).  Management  believes that MECAR's  expanded  marketing  efforts
should  continue to produce  future orders from  non-traditional  customers.  In
addition, in 1996, the VSK Group contributed approximately $17.9 in revenues and
$0.8 in profits.  Accordingly,  revenues from the commercial  security  services
business   contributed   approximately   17%  of   Allied   revenues   in  1996.
Notwithstanding  these  efforts,  Allied's  results  continue to be  principally
driven by the results of MECAR and more  specifically by the business  generated
from MECAR's traditional customer base.

                  Allied  commenced 1997 with a backlog of  approximately  $79.6
compared with a backlog at the beginning of 1996 of $68.1. MECAR began 1997 with
a backlog of  approximately  $49.4. In the first quarter of 1997, it also
received an $84 contract  from its principal  customer.  VSK began 1997 with a
backlog of approximately $14.5 compared with a 1996 beginning backlog of
approximately $21.1. BRI's beginning backlog in 1997 was $15.6 compared with a
1996 beginning backlog of $12.4.  Approximately  $8.9 of BRI's 1997  backlog is
based on a contract  to manufacture  and deliver a dynamometer  for a foreign
country which is scheduled for  delivery  in mid to  late  1999.  BRI is
negotiating  for  the  additional financing required for this contract.

                  In recent  years,  the  award of  additional  U.S.  government
business to BRI has become less predictable in both amount and timing;  in turn,
BRI has received a  substantial  portion of its revenues from  relatively  large
contracts for the benefit of foreign  governments.  It is anticipated that BRI's
future prospects will continue to be dependent on receipt of such contracts from
or for the benefit of international customers.


                                       14

<PAGE>



Trends In Liquidity And Capital Resources

                  The  substantial  losses  incurred in 1994 caused a decline in
liquidity which decline continued in 1995.  Allied's  liquidity improved in 1996
as a result of the profitable operations experienced in the last of half of 1995
and  throughout  1996.  No  liquidity  problems are forecast for 1997 in view of
Allied's existing backlog, particularly the backlog accumulated at MECAR. In the
longer  term,  Allied's  liquidity  will  continue to depend upon its ability to
obtain substantial orders from it's traditional customer base and the success of
the above-described efforts to broaden its revenue base.

Liquidity.

                  Allied's liquidity increased in 1996,  principally as a result
of  profitable   operations  at  each  operating   unit.   Working  capital  was
approximately  $18.1 at December 31, 1996, which is an increase of $4.1 from the
December  31, 1995  level.  Allied's  current  working  capital is required  for
operations and to support credit facility agreements.

                  Accounts  receivable  at  December  31,  1996  decreased  from
December  31, 1995 by $9.2 due to  substantial  collections  of  receivables  in
December, 1996. Costs and accrued earnings on uncompleted contracts increased by
$8.4  from  1995 as a  result  of  greater  levels  of work in  process  at 1996
year-end. Inventory increased by $0.8 over 1995, generally as a result of longer
production  times.  Prepaid  expenses  and  deposits  increased  $2.8  due to an
increase in new orders.  Current liabilities increased by $15.8 from 1995 levels
inasmuch as the Term Loan (as herein defined) matures in 1997.

                  During  1996,  1995 and 1994,  Allied  funded  its  operations
principally  with  internally  generated  cash  and  back-up  credit  facilities
required for foreign government contracts.

                  Allied  and its  subsidiaries  continued  their  cost  cutting
initiatives in 1996. Allied reduced its general and administrative  expenditures
by approximately 1% on a significantly increased revenue base in 1996.

                  Except for a modest line of credit to support  the  operations
of MECAR  and BRI,  neither  Allied  nor any of its  subsidiaries  has a line of
credit or other  bank  facility  to  provide  liquidity.  Accordingly,  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 is currently dependent principally upon
MECAR's and VSK's operations.

                                       15

<PAGE>




                  MECAR  typically  obtains  relatively  large  orders  for  its
ammunition and weapon systems which require a credit  facility to provide import
letters of credit, advance payment guarantees and performance bonds. These needs
have  been met in the last few  years via an  agreement  with a four (4)  member
foreign bank pool (the "Bank  Agreement"),  supplemented by a term loan supplied
by some of the bank pool  participants (the "Term Loan") and a partial guarantee
by the regional  government  in Belgium (the  "Walloon  Region").  The Term Loan
(which was $11.4 at  December  31,  1996) was  provided  solely to  support  the
Walloon Region  guarantee.  Given MECAR's improved  financial  performance,  the
Walloon  Region  did not  extend  its  guarantee  to the  credit  accommodations
required to support the $84 contract  recently awarded to MECAR. It is currently
anticipated that the Term Loan will be repaid during 1997 and the Walloon Region
guarantee  will be released.  MECAR's  obligations  under the Bank Agreement are
also supported by a $3 guarantee provided by Allied.

                  The credit  facility  was  recently  amended  to  finance  the
substantial  order  received by MECAR from its  principal  customers,  discussed
above.  The credit  facility is now being  provided by a five (5) member foreign
bank pool.  As has been the case in recent  years,  the bank  agreement  must be
further  amended to  provide  appropriate  financing  for 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 Bank  Agreement  and other  loan  agreements  continue  to
impose certain restrictions on MECAR. MECAR's obligations were collateralized at
December 31, 1996 by base cash deposits of $20.1 and a pledge on MECAR's  assets
of $31. As a result,  $20.1 of the cash  balance  reflected  on the December 31,
1996  balance  sheet  is not  available  for  general  corporate  use.  The Bank
Agreement  further  precludes  MECAR from making  payments to any company in the
Allied group in excess of $2 per year.

                  MECAR has a  mortgage  loan with a foreign  bank  which had an
outstanding  balance of approximately  $5.1 at December 31, 1996.  Principal and
interest payments on the mortgage loan extend through January, 2004.

                  BRI  operated   throughout   1996  from  cash  generated  from
operations  supplemented by a credit facility.  The credit facility consisted of
(i) a $.750  line of credit  and (ii) two (2) term  loans  aggregating  $.661 at
December 31, 1996 (repayable in monthly installments  through October,  1998) to
finance capital  expenditures  and  obligations.  In January,  1997, the line of
credit was increased to $1.25.  The line of credit expires in June,  1997 and is
renewable  at the  discretion  of the bank on an  annual  basis  thereafter.  At
December  31,  1996,  the line of credit  had an  outstanding  balance of $.250.
Allied has guaran-

                                       16

<PAGE>



teed BRI's obligations under the above-described  term loans and line of credit.
BRI is in the  process of securing  additional  financing  necessary  to perform
under it's $8.9 dynamometer contract.  While management believes that it will be
able to secure such  financing,  there can be no assurance  that such  financing
will be provided.

                  VSK operated  throughout  1995  primarily  from cash generated
from  operations.  VSK is obligated on several  mortgages with December 31, 1996
balances aggregating $1.2.

                  In May, 1995,  the VSK Group  acquired all of the  outstanding
stock of IDCS, S.A. for a purchase price of $2.97. The purchase price was funded
by a combination of bank and seller financings and thus did not adversely affect
Allied's cash flow.

Capital Resources.

                  Allied  spent $1.07 in 1996 on capital  equipment  as compared
with $2.92 in 1995 and $3.62 in 1994,  respectively.  The  expenditures  in 1996
were  primarily  for  facility  upgrades  and  computer  equipment.   Management
currently   anticipates  that  it  will  spend  approximately  $2.6  on  capital
expenditures  in  1997,   principally  for  additional  upgrades  to  the  MECAR
facilities.

Results of Operations.

                  Allied had  revenues of $103.7 in 1996 as compared to $65.8 in
1995 and  $69.8 in 1994,  respectively.  Allied  earned a profit of $4.81 in
1996 compared to losses of $2.01 in 1995 and $10.94 in 1994, respectively.

                  The following  table sets forth,  for the years ended December
31, 1996, 1995 and 1994, certain items from Allied's consolidated  statements of
operations expressed as a percentage of revenue:

                                            1996          1995          1994
                                            ----          ----          ----

Revenue                                     100%         100.0         100.0%

Costs and Expenses
  Cost of sales                             75.9           75.9          91.6
  Selling and administrative                15.1           24.0          22.4
  Research and development                   1.7            3.2           1.8
  Restructuring charge                      ----           ----            .5

           Operating income (loss)           7.3           (3.1)        (16.3)

Other income (deductions)
  Interest income                            1.9            2.7           5.1
  Interest expense                          (3.3)          (4.6)         (5.4)
  Other - net                               (0.4)           3.0           1.9


                                       17

<PAGE>

                                            1996          1995          1994
                                            ----          ----          ----

           Earnings (loss) before
           income taxes                      5.5           (2.0)        (14.7)

Income taxes                                 0.9            1.1           1.0

           Net earnings (loss)               4.6           (3.1)        (15.7)

Revenues

                  Revenues  for 1996  increased  $37.9 or 57.6% as  compared  to
1995.  Revenues at MECAR increased by approximately 105% over the prior year due
to the  increased  amount of orders  received in the latter  portion of 1995 and
throughout 1996. In 1996,  revenues at the VSK Group decreased  approximately 2%
under 1995  levels  primarily  due to  currency  fluctuations.  Revenues  at BRI
increased 2.5% from 1995 levels. Revenues at Limited were generated largely from
interest  earned on  inter-company  loans  made to MECAR,  which  revenues  were
eliminated in consolidation. In 1996, Limited's intercompany loans to MECAR were
eliminated by conversion thereof to MECAR capital.  Accordingly,  Limited should
have minimal revenues in 1997 and going forward.

                  Revenues for 1995 decreased $4.1, or 5.8% as compared to 1994.
Revenues at MECAR decreased by approximately  41% from the prior year due to the
completion  of several  contracts  and the delay in receipt of  substantial  new
orders.  Further,  MECAR's  1995  revenues  included  a $1.3 net  recovery  from
insurance arising from an explosion at one of the storage bunkers. Such revenues
partially  offset  overhead  and  operating  costs of MECAR  during the shutdown
period.  Revenues at BRI increased 60% from 1994 levels  principally  due to the
receipt  by BRI of a  foreign  military  sales  contract  with an  international
customer. Revenues at the VSK Group increased approximately $11.1, or 156%, over
the seven (7) month period reported for 1994. The 1995 revenue for the VSK Group
included $1.6 revenue  reported by IDCS for the eight (8) month period following
its acquisition in early May, 1995.

Cost of Sales

                  Cost of sales as a percentage  of sales for 1996 and 1995 were
each approximately 76%.

                  Cost of sales as a  percentage  of  sales  for 1995  decreased
15.7% over 1994 due to the product mix manufactured,  the high costs incurred in
1994 due to delays  and loss  provisions  no  longer  required  on a  terminated
contract.

Selling and Administrative Expenses

                  Selling  and  general  administrative  expenses  in 1996  were
slightly less than those incurred in 1995.

                  Selling and general administrative  expenses in 1995 increased
from 1994 levels due to a full year of  operations  at the VSK Group,  and eight
(8) months of operations at IDCS which were

                                       18

<PAGE>



offset by cost containment measures implemented  company-wide.  Further, the VSK
Group  incurred  approximately  $0.8 expenses in 1995 due to a failed attempt to
establish an operation in France.

Research and Development

                  Research and  development  costs  decreased  by $0.34,  or 16%
under 1995 levels due to lower expenditures at MECAR.

                  Research  and  development  costs  increased in 1995 over 1994
levels due to additional  efforts by MECAR in  broadening  its product lines and
VSK's accounting for research and development costs beginning in 1995.

Interest Income

                  Interest income  increased in 1996 by $0.15, or 8.6% over 1995
levels principally due to improved cash flow and corresponding levels of cash.

                  Interest  income  decreased  in  1995  from  1994  due  to the
utilization  of cash for  unprofitable  operations  and  reduced  cash  deposits
associated with the Term Loan agreement.

Interest Expense

                  Interest expense increased in 1996 by $0.42, or 13.7% over the
amount  incurred in 1995 as a result of an increase in the Term Loan and a
change in reporting of bank charges.

                  Interest expense  decreased in 1995 from 1994 as a result of a
decrease in outstanding debt and credit facilities fees.

Other - Net

                  Allied  had a  loss  of  $0.38  in  1996,  largely  due to net
currency losses.

                  Allied  had a  gain  in  1995  of  $2.0  from  other  sources,
principally  consisting  of net currency  gains  occasioned by the weakened U.S.
dollar.

Income Taxes

                  The 1996  effective  tax rate was 15.6%  primarily  due to the
utilization of tax loss carryforwards.

                  The 1995  effective  tax rate was 58.6%  primarily  due to the
losses  incurred at MECAR  (which can only be carried  forward)  and foreign tax
rate differentials in the U.S.


                                       19

<PAGE>



Net Earnings (Loss)

                  The Company had a $4.81  profit in 1996  compared  with a
$2.01 loss in 1995. All operating units earned a profit in 1996.

                  The Company incurred a $2.01 loss in 1995 compared with a loss
of $10.94 in 1994. BRI and the VSK Group operated at a profit in 1995; MECAR and
Services  operated at a loss.  The loss  incurred by MECAR was  minimized due to
approximately  $1.3 attributable to the excess of insurance proceeds received by
MECAR over direct  costs and expenses  incurred as a result of the spring,  1995
explosion.

                                    PART III

Item 10.  Directors and Executive Officers of Allied.

Directors.

         The following are the directors of Allied:

         J. R.  Sculley,  age 56,  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, prior thereto, was Assistant Secretary of
the Army (Research, Development and Acquisition).

         Clifford C. Christ, age 49, 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 58, 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 73,  became a director  of Allied in early 1996.
Throughout the last five years, Mr. Hebel has been a private investor.

         Harry H.  Warner,  age 61,  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

                                       20

<PAGE>



developer.  He is also a director of Chesapeake  Corporation,  Pulaski Furniture
Corporation and American Filtrona Corporation.

Executive Officers.

         The following are the executive officers of Allied:

         J. R.  Sculley,  age 56, 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 56, was elected vice president of Allied
in January,  1995.  Since  February,  1993,  Mr.  Yarborough  has served as vice
president of Services. Previously, he served as director of business development
of Grumman  Corpora- tion, a defense  company.  Mr.  Yarborough also serves as a
direc- tor of BRI and the VSK Group.



                                       21

<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, 1996,  1995 and 1994,  by the
chief  executive  officer of Allied and by other  executive  officers  of Allied
whose total annual salary and bonus exceeds $100,000:

                                       22

<PAGE>



                                           SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
                                                              Long Term Compensation
                                                              ----------------------
                         Annual 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)    ($)(2)       ($)          SARs (#)      ($)       ($)
---------   ----   ---------   -----------    --------     ----------   ----------    -------   -------
<S><C>
J. R.       1996   $245,000    $100,000                                   15,000
Sculley,    1995   $235,000
Chief       1994   $235,000    $103,125       $ 82,763                    56,000
Executive
Officer

W. Glenn    1996   $168,000    $ 90,000                                   27,600
Yarborough, 1995   $144,500
Jr., Vice   1994   $130,000    $ 26,250                                   14,000
President

</TABLE>

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

(1)  Pursuant to Board of Directors' authorization in December, 1996, Messrs.
     Sculley and Yarborough were awarded bonuses of $100,000 and $90,000 for
     1996 performance payable in 1997 in stock and/or cash.  In March, 1997, Mr.
     Sculley was awarded 5,548 shares of stock and a cash bonus of $44,420 and
     Mr. Yarborough was awarded 9,000 shares of Company stock.  These shares had
     a market value of $10.00 per share on the date of grant.  In 1994, Mr.
     Sculley was granted 25,000 shares of Company stock which had a market value
     of $4.125 per share on the date of grant and Mr. Yarborough was granted
     6,000 shares of Company stock which had a market value of $4.375 per share
     on the date of grant.

(2)  In 1994, Mr. Sculley was paid $82,763 in payment of federal and state taxes
     paid as a result of the 1994 stock award.


                                       23

<PAGE>



                     Option/SAR Grants in Last Fiscal Year

<TABLE>
<CAPTION>
                                    Individual Grants                                                  Grant Date Value
                                    -----------------                                                  ----------------

                            Number of
                            Securities         % of Total
                            Underlying         Options/SARs
                            Options/           Granted to           Exercise or                           Grant Date
                            SARs               Employees in         Base Price         Expiration        Present Value
Name                        Granted (#)        Fiscal Year            ($/Sh)           Date                  ($)(2)
----                        -----------        -----------            ------           ----              -------------
<S><C>
J. R. Sculley                  15,000           24.75%               $5.125            10/24/99              32,700

W. G. Yarborough, Jr.          12,600(1)        20.79%               $3.75             3/19/06               20,664

W. G. Yarborough, Jr.          15,000           24.75%               $5.125            10/24/99              32,700

</TABLE>

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

(1)  Options are exercisable 33 1/3% in March, 1997; 66 2/3% in March, 1998; and
     100% in March, 1999.

(2)  The Company used a modified  Black-Scholes model of option valuation to
     determine  grant date present  value.  The Company does not advocate or
     necessarily agree that the Black-Scholes  model can properly  determine the
     value of an option.



                                       24

<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 (#)               FY-End ($)(1)

                                   Shares Acquired              Value                    Exercisable/             Exercisable/
Name                               on Exercise (#)              Realized ($)             Unexercisable            Unexercisable
----                               ---------------              ------------             -------------            -------------
<S><C>
J.R. Sculley                             0                          0                    26,200/44,800            $15,000/$0

W. Glenn Yarborough, Jr.                 0                          0                    22,000/19,600            $15,000/$29,925

</TABLE>

---------------------
(1)  Based on the closing price of the Company's stock of $6.125 on December 31,
     1996




                                       25

<PAGE>



Director Compensation

         Each  director of Allied is  currently  compensated  for  services as a
director, including as a member of committees of the Board, as follows: (i) each
director  who is also an  employee  of Allied is  compensated  in the  amount of
$1,000 per month;  and (ii) each  director who is not also an employee of Allied
("Outside  Director")  is  compensated  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  from 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 to 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  interests 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.

                                       26

<PAGE>



Options for 15,000 shares each were granted  under the Directors  Option Plan in
1996 to Messrs. Scott, Christ, Smith, Hebel and Warner.


Employment Contracts and Change-In-Control Arrangements

         J. R. Sculley and Allied have entered into an Employment Agreement (the
"Sculley  Agreement") which extends through March 31, 1998, and is automatically
renewable from year to year thereafter unless either Allied or Mr. Sculley gives
the other timely notice of its or his intent not to renew. 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 $245,000 per calendar year.  The Sculley  Agreement  further  provides that
upon the death or disability of Mr. Sculley,  the Company will make  installment
payments  to or for the  benefit  of Mr.  Sculley  in an  amount  not to  exceed
$250,000.

         W. Glenn  Yarborough,  Jr. and Allied have entered  into an  Employment
Agreement (the "Yarborough  Agreement") which extends through July, 1997, 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.  In
consideration  for his  services  as an officer  of Allied and as a director  of
certain of its subsidiaries,  Mr. Yarborough is entitled to receive an aggregate
sum of not less  than  $168,000  per  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 to 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

                                       27

<PAGE>



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.

Compensation Committee Interlocks and Insider Participation

         The  Compensation  Committee  of Allied  during the  fiscal  year ended
December  31, 1996  consisted of Messrs.  Charles T. Scott,  Robert W. Hebel and
Earl P. Smith. Upon the retirement from the Board of Directors of Mr. Scott, Mr.
Harry  H.  Warner  was  elected  to the  Compensation  Committee.  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 March 14, 1997,
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:



                                       28

<PAGE>



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

Common      Fidelity Low-Priced       442,610               9.3%
            Stock Fund/Fidelity       Owned directly
            Management & Research
            Company
            82 Devonshire Street
            Boston, MA  02109

Common      Dimensional Fund          269,40                5.7%
            Advisors, Inc.            Owned directly(2)
            1299 Ocean Avenue
            11th Floor
            Santa Monica, CA  90401

--------------------------
(1.)  Based upon 4,521,838  shares of common stock  outstanding  plus 229,100
      shares  which may be acquired  within 60 days  pursuant to  outstanding
      stock options.

(2.)  Dimensional Fund Advisors, Inc. ("Dimensional"), a regis- tered investment
      advisor, is deemed to have beneficial ownership of 269,400 shares, all of
      which shares are held in portfolios of DFA Investment Dimensions Group,
      Inc., a registered open-end investment company, or in series of the DFA
      Investment Trust Company, a Delaware business trust, or the DFA Group
      Grust and DFA Participation Group Trust, investment vehicles for qualified
      employee benefit plans, all of which Dimensional Fund Advisors, Inc.
      serves as investment manager.  Dimensional disclaims beneficial owner-
      ship of all such shares.



                                       29

<PAGE>



                  The following  information  is furnished as of March 14, 1997,
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                17,000                    *
                                      Owned
                                      directly

Common  Earl P. Smith                  17,110                    *
                                      Owned
                                      directly

Common  Clifford C. Christ             24,000                    *
                                      Owned
                                      directly

Common  Robert W. Hebel                16,000                    *
                                      Owned
                                      directly

Common  J. R. Sculley                 111,504                   2.3%
                                      Owned
                                      directly

Common  W. Glenn Yarborough, Jr.       52,904                   1.1%
                                      Owned
                                      directly

Common  All executive officers        238,518                   5.0%
        and directors as a            Owned
            group (6)                 directly


*Less than 1%
-------------------------
(1.)  Includes 15,000 shares which may be acquired by each of Messrs.  Smith,
      Christ and Hebel, 18,200 shares which may be acquired by Mr. Yarborough
      and 37,400 shares which may be acquired by Mr.  Sculley  within 60 days
      pursuant to outstanding stock options.

(2.)  Based upon 4,521,838  shares of common stock  outstanding  plus 229,100
      shares  which may be acquired  within 60 days  pursuant to  outstanding
      stock options.


                                       30

<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 is against public policy as expressed
in the Securities  Act of 1933 and is,  therefore,  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 being  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
                  1996 and 1995

                  Consolidated Statements of Operations for                 F-6
                  the three years ended December 31, 1996



                                       31

<PAGE>



                  Consolidated Statements of Stockholders'                  F-7
                  Equity for the three years ended
                  December 31, 1996

                  Consolidated Statements of Cash Flows                     F-8
                  for the three years ended December 31, 1996

                  Notes to Consolidated Financial Statements                F-10

(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, 1996 and 1995 and for the
                                    three years ended December 31, 1996:

                                            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)
                             and  Amended  and  Restated  By-Laws
                             (Incorporated by reference from Form
                             8-K filed in November, 1992)

                             (a)      Amendment to Amended and Restated
                                      By-Laws adopted by the Board of
                                      Directors in September, 1996

                     Exhibit 10 -

                                  (a)      Executive Employment Agreement
                                           between Allied Research Corporation
                                           and J. R. Sculley (Incorporated by
                                           reference from Form 8-K filed in
                                           April, 1992)

                                  (b)      Executive Employment Agreement
                                           between Allied Research Corporation
                                           and W. Glenn Yarborough, Jr. (In-

                                       32

<PAGE>



                                  corporated by reference from Form
                                  10-K filed in March, 1995.)

                     Exhibit 11 - Computation of
                                  Earnings Per
                                  Common and Common
                                  Equivalent Shares

                     Exhibit 21 - List of Subsidiaries


                     Exhibit 23 - Consent of Independent Certified
                                  Public Accountants

(b)               Reports on Form 8-K:

                           No reports on Form 8-K were filed during the
fourth quarter of 1996.


                                       33

<PAGE>


                       SECURITIES AND EXCHANGE COMMISSION

                            Washington, D.C.  20549





                       FINANCIAL STATEMENTS AND SCHEDULES

                               December 31, 1996





                               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, 1996 and 1995                            F -4

Consolidated Statements of Operations for the three years ended December 31, 1996    F -6

Consolidated Statements of Stockholders' Equity for the three years
    ended December 31, 1996                                                          F -7

Consolidated Statements of Cash Flows for the three years ended December 31, 1996    F -8

Notes to Consolidated Financial Statements                                           F -10

Schedules as of and for the three years ended December 31, 1996

            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, 1996 and 1995 and the related
consolidated  statements of operations,  stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1996.  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,  1996  and  1995,  and  the
consolidated  results of their operations and their  consolidated cash flows for
each of the three years in the period ended December 31, 1996 in conformity with
generally accepted accounting principles.

We have also audited the consolidated  financial  statement  schedules listed on
the accompanying index at Item 14(a)(2). In our opinion, these schedules present
fairly,  in all  material  respects,  the  information  required to be set forth
therein.


Grant Thornton LLP

Baltimore, Maryland
March 10, 1997


<PAGE>



                          Allied Research Corporation

                          CONSOLIDATED BALANCE SHEETS

                                  December 31,

--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                     ASSETS
                                                              1996             1995
                                                           -----------      -----------
<S> <C>
CURRENT ASSETS
   Cash and equivalents, including restricted cash
      (notes A, C and F)                                   $32,859,478      $15,744,145
   Accounts receivable (notes A, D and F)                   11,889,785       21,090,945
   Costs and accrued earnings on
      uncompleted contracts (note A)                        14,694,117        6,311,705
   Inventories (notes A and F)                               7,171,007        6,336,821
   Prepaid expenses and deposits                             3,879,723        1,112,711
                                                            ----------       ----------

           Total current assets                             70,494,111       50,596,327


PROPERTY, PLANT AND EQUIPMENT - AT COST
   (notes A and H)
      Buildings and improvements                            13,316,505       14,247,986
      Machinery and equipment                               33,030,014       35,189,034
                                                            ----------       ----------
                                                            46,346,519       49,437,020
      Less accumulated depreciation                         33,106,026       33,330,357
                                                            ----------       ----------
                                                            13,240,493       16,106,663
      Land                                                   1,411,659        1,544,737
                                                            ----------       ----------
                                                            14,652,152       17,651,400

OTHER ASSETS
   Deposits - restricted cash (notes C, F and H)                     -       18,492,000
   Intangibles, less accumulated amortization of
      $1,688,122 and $1,751,020 in 1996 and 1995,
      respectively (notes A and B)                           6,123,992        7,085,401
   Other                                                       677,906          428,145
                                                            ----------       ----------
                                                             6,801,898       26,005,546
                                                            ----------       ----------

                                                           $91,948,160      $94,253,273
                                                            ==========       ==========
</TABLE>

The accompanying notes are an integral part of these statements.


                                      F-4

<PAGE>


                          Allied Research Corporation

                    CONSOLIDATED BALANCE SHEETS - CONTINUED

                                  December 31,

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


                      LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                              1996               1995
                                                           -----------      -------------
<S> <C>
CURRENT LIABILITIES
   Notes payable (note E)                                  $  3,317,438     $     485,330
   Current maturities of long-term debt                      14,099,171         2,786,383
   Accounts and trade notes payable                          18,571,110        17,786,258
   Accrued liabilities                                        4,311,407         4,857,776
   Accrued losses on contracts (note G)                         390,125           431,215
   Customer deposits                                         10,934,488         9,900,120
   Income taxes                                                 805,970           370,878
                                                             ----------        ----------

           Total current liabilities                         52,429,709        36,617,960



LONG-TERM DEBT, less current maturities (note H)              7,443,436        28,434,776



DEFERRED INCOME TAXES (notes A and P)                           628,374           846,953



CONTINGENCIES AND COMMITMENTS (notes I, J, M 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, 4,443,092
      in 1996 and 4,422,056 in 1995                             444,309           442,206
   Capital in excess of par value                            10,846,303        10,745,295
   Retained earnings                                         17,481,483        12,676,000
   Accumulated foreign currency translation adjustment        2,674,546         4,490,083
                                                             ----------        ----------
                                                             31,446,641        28,353,584
                                                             ----------        ----------

                                                            $91,948,160       $94,253,273
                                                             ==========        ==========
</TABLE>


The accompanying notes are an integral part of these statements.

                                      F-5

<PAGE>


                          Allied Research Corporation

                     CONSOLIDATED STATEMENTS OF OPERATIONS

                            Years ended December 31,

--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                               1996               1995                1994
                                                           ------------        -----------        ------------
<S> <C>
Revenue (note M)                                           $103,660,137        $65,768,907        $ 69,846,845

Cost and expenses
   Cost of sales                                             78,658,573         49,896,794          63,976,951
   Selling and administrative                                15,647,951         15,758,673          15,631,256
   Research and development                                   1,746,319          2,087,278           1,262,333
   Restructuring charge (note R)                                     -                  -              326,831
                                                           ------------        -----------        ------------
                                                             96,052,843         67,742,745          81,197,371
                                                           ------------        -----------        ------------

           Operating income (loss)                            7,607,294         (1,973,838)        (11,350,526)

Other income (deductions)
   Interest income                                            1,921,864          1,770,278           3,539,888
   Interest expenses                                         (3,451,066)        (3,034,537)         (3,768,788)
   Other - net (note O)                                        (381,379)         1,968,478           1,306,083
                                                           ------------        -----------        ------------
                                                             (1,910,581)           704,219           1,077,183
                                                           ------------        -----------        ------------

           Earnings (loss) before income taxes                5,696,713         (1,269,619)        (10,273,343)

Income taxes (notes A and P)                                    891,230            743,652             667,763
                                                           ------------        -----------        ------------

           NET EARNINGS (LOSS)                             $  4,805,483        $(2,013,271)       $(10,941,106)
                                                           ============        ===========        ============

Earnings (loss) per common share (note S)                         $1.08              $(.46)             $(2.49)
                                                                   ====               ====               =====
</TABLE>

The accompanying notes are an integral part of these statements.

                                      F-6

<PAGE>



                          Allied Research Corporation

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                  Years ended December 31, 1996, 1995 and 1994

--------------------------------------------------------------------------------
<TABLE>
<CAPTION
                                                                                   Capital
                                               Preferred stock    Common stock    in excess
                                                no par value     $.10 par value  of par value   Retained earnings
                                               ---------------   --------------  ------------   -----------------
<S> <C>
Balance at December 31, 1993                   $      -             $453,123      $10,800,510      $ 28,597,205
   Common stock awards                                -                7,236          318,014                -
   Employee stock purchase plan purchases             -                1,486           64,186                -
   Purchase and retirement of shares                  -              (22,000)        (524,536)       (2,966,828)
   Currency translation adjustment                    -                   -                -                 -
   Net loss for the year                              -                   -                -        (10,941,106)
                                               ----------           --------      -----------      ------------

Balance at December 31, 1994                          -              439,845       10,658,174        14,689,271
   Common stock awards                                -                  300           10,950                -
   Employee stock purchase plan purchases             -                2,061           76,171                -
   Currency translation adjustment                    -                   -                -                 -
   Net loss for the year                              -                   -                -         (2,013,271)
                                               ----------           --------      -----------      ------------

Balance at December 31, 1995                          -              442,206       10,745,295        12,676,000
   Common stock awards                                -                  903           40,479                -
   Employee stock purchase plan purchases             -                1,200           60,529                -
   Currency translation adjustment                    -                   -                -                 -
   Net earnings for the year                          -                   -                -          4,805,483
                                               ----------           --------      -----------      ------------

Balance at December 31, 1996                          -             $444,309      $10,846,303      $ 17,481,483
                                               ==========           ========      ===========      ============
</TABLE>

<TABLE>
<CAPTION>
                                                             Accumulated               Total
                                                         foreign currency           stockholders'
                                                       translation adjustment          equity
                                                       ----------------------       -------------
<S> <C>
Balance at December 31, 1993                                $ 1,324,060             $ 41,174,898
   Common stock awards                                               -                   325,250
   Employee stock purchase plan purchases                            -                    65,672
   Purchase and retirement of shares                                 -                (3,513,364)
   Currency translation adjustment                            2,586,324                2,586,324
   Net loss for the year                                             -               (10,941,106)
                                                            -----------             ------------

Balance at December 31, 1994                                  3,910,384               29,697,674
   Common stock awards                                               -                    11,250
   Employee stock purchase plan purchases                            -                    78,232
   Currency translation adjustment                              579,699                  579,699
   Net loss for the year                                             -                (2,013,271)
                                                            -----------             ------------

Balance at December 31, 1995                                  4,490,083               28,353,584
   Common stock awards                                               -                    41,382
   Employee stock purchase plan purchases                            -                    61,729
   Currency translation adjustment                           (1,815,537)              (1,815,537)
   Net earnings for the year                                         -                 4,805,483
                                                            -----------             ------------

Balance at December 31, 1996                                $ 2,674,546             $ 31,446,641
                                                            ===========             ============
</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                           1996              1995                1994
                                                                  ------------      -------------       -------------
<S> <C>
Cash flows from (used in) operating activities
   Net earnings (loss) for the year                               $ 4,805,483       $ (2,013,271)       $(10,941,106)
   Adjustments to reconcile net earnings (loss) to
      net cash from (used in) operating activities
        Depreciation and amortization                               3,093,534          2,751,867           2,411,029
        (Gain) loss on sale of fixed assets                              (250)            (8,381)             (2,558)
        Deferred income taxes                                        (590,419)           376,550             390,233
        Provision for estimated losses on contracts                    (4,036)        (1,178,475)            721,937
        Common stock awards                                            41,382             11,250             325,250
        Changes in assets and liabilities
           Accounts receivable                                      7,874,015          2,746,237          48,367,325
           Cost and accrued earnings on
              uncompleted contracts                                (9,142,340)         2,709,185           9,910,050
           Inventories                                             (1,413,524)          (983,917)          1,570,129
           Prepaid expenses and other assets                       (2,798,161)        (1,451,796)          8,832,706
           Accounts payable and accrued liabilities                 2,015,448        (12,291,397)        (34,244,206)
           Customer deposits                                        1,917,475          7,959,923         (20,288,705)
           Income taxes                                               441,852           (552,009)         (4,410,959)
                                                                  -----------       ------------        ------------
                                                                    1,434,976             89,037          13,582,231
                                                                  -----------       ------------        ------------

                Net cash provided by (used in)
                   operating activities                             6,240,459         (1,924,234)          2,641,125

Cash flows from (used in) investing activities
   Capital expenditures                                            (1,066,889)        (2,920,728)         (3,617,518)
   Proceeds from sale of fixed assets                                     250            183,470              16,650
   Payments for acquisitions, net of cash acquired                         -          (1,083,571)         (4,387,925)
                                                                  -----------       ------------        ------------

                Net cash (used in) investing activities           (1,066,639)         (3,820,829)         (7,988,793)
</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>
                                                                      1996              1995                1994
                                                                  ------------      -------------       -------------
<S> <C>
Cash flows from (used in) financing activities
   Net increase (decrease) in short-term borrowings                 2,908,978           (114,514)         (4,011,549)
   Principal payments on long-term debt                           (19,009,160)       (23,979,845)         (9,296,733)
   Proceeds from issuance of long-term debt                        11,762,981         12,252,705           8,533,958
   Net (increase) decrease in long- term deposits                  18,492,000        (12,092,000)          7,467,000
   Proceeds from employee stock purchases                              61,729             78,232              65,672
   Common shares purchased and retired                                     -                  -           (3,513,360)
                                                                  -----------       ------------        ------------

                Net cash provided by (used in)
                   financing activities                            14,216,528        (23,855,422)           (755,012)

Effects of exchange rates on cash                                  (2,275,015)         1,738,751           5,067,494
                                                                  -----------       ------------        ------------

                Net increase (decrease) in cash
                   and equivalents                                 17,115,333        (27,861,734)         (1,035,186)

Cash and equivalents at beginning of year                          15,744,145         43,605,879          44,641,065
                                                                  -----------       ------------        ------------

Cash and equivalents at end of year                              $ 32,859,478       $ 15,744,145        $ 43,605,879
                                                                  ===========        ===========         ===========


Supplemental Disclosures of Cash Flow Information

   Cash paid during the year for
      Interest                                                   $  3,088,529       $  4,461,871        $  4,428,708
      Income taxes                                                  1,245,678          1,638,984           4,784,980
</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.,  a  Belgian  company,  and  Mecar's
  wholly-owned  subsidiaries (Mecar),  Barnes & Reinecke, Inc. (BRI), a Delaware
  corporation and Allied Research  Corporation  Limited (ARCL), a United Kingdom
  company.

  Mecar, S.A.'s wholly owned Belgian subsidiaries include,  Sedachim,  S.I., and
  the VSK Group of companies,  which include Tele Technique Generale,  I.D.C.S.,
  N.V.  and  VSK  Electronics  N.V. and its wholly-owned subsidiaries, Classics,
  B.V.B.A., Detectia, N.V. and Belgian Automation Units, N.V.

  The VSK Group and I.D.C.S.,  N.V were acquired during 1994 and 1995. Both were
  accounted for as a purchases, and revenue and results of operations from their
  dates of acquisition, June 1, 1994 and May 9, 1995, have been consolidated.

  The 1995 and 1994  consolidated  financial  statements also included  Allied's
  wholly-owned   subsidiary  ARC  Services,  Inc.  which  ceased  operations  in
  December, 1995; Mecar's wholly-owned  subsidiaries Management Export Services,
  N.V.  which was liquidated in 1995; and Mecar  Immobliere  S.A.,  which merged
  with Mecar  effective  January 1, 1996;  VSK's  minority  interest in Building
  Control Services,  N.V., which was liquidated,  and VSK France, which was also
  effectively liquidated in December, 1995.

  Significant intercompany transactions have been eliminated in consolidation.

  Business Operations

  The Companies operate  primarily in the United States,  Belgium and the United
  Kingdom.  During 1996,  seventy-two percent of the business activity is in the
  development  and production of ammunitions and weapons systems in Belgium with
  sales to customers in Asia, the Middle East and Europe.  Seventeen  percent of
  the business activity is developing, manufacturing, distributing and servicing
  industrial security products in Belgium with industrial  customers  throughout
  Europe.  Eleven percent of the business activity is providing  engineering and
  technical  support  services  in the  United  States  with sales  directly  or
  indirectly  with the United  States  Military  Agencies and  government  prime
  contractors. A description of the business operations of each company follows.

  Allied provides management services to its wholly-owned  subsidiaries.  Allied
  has no direct domestic operating assets or business activity.

  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.

  BRI provides engineering and technical support services and sells directly and
  indirectly  primarily to United States Military  Agencies and government prime
  contractors.

                                      F-10

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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


NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued

  Business Operations - continued

  ARCL is engaged in the  marketing  of  military  hardware on behalf of Allied,
  Mecar and BRI.

  ARC Services,  Inc. was formed in 1993, and continued until December 31, 1995,
  to market and provide  demilitarization  and environmental  clean-up services.
  Services was involved in certain research and development  projects and had no
  other significant operations since its formation.

  The VSK Group develops, manufacturers,  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 and ARCL 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.

                                      F-11

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued

  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.

  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.

  Research and Development

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

  Warranties

  The Company grants warranties on certain 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.

  Income Taxes

  Income  taxes  are  provided  based  on the  liability  method  for  financial
  reporting  purposes,  in  accordance  with  the  provisions  of  Statement  of
  Financial  Accounting  Standards  No.  109,  "Accounting  for  Income  Taxes".
  Deferred and prepaid  taxes are provided for on items which are  recognized in
  different periods for financial and tax reporting purposes.

  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.

                                      F-12

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued

  Reclassifications

  Certain items in the 1995 and 1994 financial statements have been reclassified
  to conform to the current presentation.

  Newly Issued Accounting Standards

  The Company adopted  Statement of Financial  Accounting  Standards  (SFAS) No.
  123, Accounting for Stock-Based Compensation,  which became effective in 1996.
  As permitted by SFAS No. 123,  the Company has  disclosed  the impact of stock
  based  employee  compensation  on  operations  and will continue to follow the
  accounting  provisions  of Accounting  Principles  Board (APB) Opinion No. 25,
  Accounting  for Stock Issued to Employees,  for applicable  transactions  with
  employees.  The adoption of SFAS No. 123 did not have a material effect on the
  Company's financial statements.

  The  provisions  of  Statement  of  Financial  Accounting  Standard  No.  121,
  Accounting for the Impairment of Long-Lived  Assets and for Long-Lived  Assets
  to be Disposed Of, which is effective for years  beginning  after December 15,
  1995, did not impact the Company's 1996 financial statements.


NOTE B - ACQUISITION

  On May 31, 1994, the Company's wholly-owned  subsidiary,  Mecar S.A., acquired
  the VSK Group, a group of Belgian companies, as well as a minority interest in
  a Belgian company, for approximately  $6,071,900. On May 9, 1995 the VSK Group
  acquired I.D.C.S., N.V., a Belgian company for approximately $2,972,000.

  These  companies  manufacture,  distribute  and service an integrated  line of
  industrial  security  products,  including  devices such as  buildings  access
  control, parking control, intrusion and fire detection and alarms.

  The  acquisitions  have been accounted for as purchases and the purchase price
  in excess of the net assets  acquired has been reflected in  intangibles.  The
  financial  statements  include  the  result  of  operations  since the date of
  acquisition. Pro forma financial data for these acquisitions prior to the date
  of acquisition would not have a material affect on reported results.

                                                 I.D.C.S., N.V.    VSK Group
                                                  May 9, 1995     May 31, 1994
                                                 --------------   ------------

     Fair value of tangible assets acquired        $2,587,000      $7,720,900
     Liabilities assumed                              855,000       6,285,200
                                                    ---------       ---------
     Net assets acquired                            1,732,000       1,435,700
     Purchase price                                 2,972,000       6,071,900
                                                    ---------       ---------

     Excess of cost over assets acquired           $1,240,000      $4,636,200
                                                    =========       =========


                                      F-13

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE C - 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  generally place restrictions on cash deposits and other
  liens on Mecar's assets.  VSK has also pledged certain term deposits to secure
  outstanding bank guarantees.  Cash and long-term deposits at December 31, 1996
  and 1995  restricted or pledged as collateral for various bank  agreements are
  comprised as follows:

<TABLE>
<CAPTION>

                                                                                      1996                 1995
                                                                                  -----------          -----------
<S> <C>
        Cash
           Credit facility and related term loan arrangements                     $18,382,000          $ 7,755,000
           Other bank guarantees and letters of credit                              1,734,000            1,769,000
           Notes payable and line-of-credit                                                -             1,035,000
                                                                                   ----------           ----------
                                                                                   20,116,000           10,559,000
        Deposits restricted cash - long-term
           Credit facility and related term loan arrangements                              -            18,492,000
                                                                                   ----------           ----------

                                                                                  $20,116,000          $29,051,000
                                                                                   ==========           ==========
</TABLE>

NOTE D - ACCOUNTS RECEIVABLE

  Accounts receivable at December 31 are comprised as follows:

<TABLE>
<CAPTION>
                                                                                      1996                 1995
                                                                                  -----------          -----------
<S> <C>
        Receivables under U.S. Government contracts and subcontracts
          Amounts billed                                                          $ 1,150,123          $ 1,715,818
          Unbilled amounts due upon completion of contracts,
            recoverable costs and accrued profits                                   2,116,580            1,670,042
                                                                                   ----------           ----------
                                                                                    3,266,703            3,385,860

        Receivables from foreign governments                                        3,154,989           10,618,736
        Commercial and other receivables, less allowance for doubtful
          receivables of $364,674 in 1996 and $330,077 in 1995                      5,468,093            7,086,349
                                                                                   ----------           ----------
                                                                                  $11,889,785          $21,090,945
                                                                                   ==========           ==========
</TABLE>

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


NOTE E - NOTES PAYABLE

  At December 31, 1996 and 1995, short-term  loans of  $3,067,438  and  $40,330,
  respectively, were outstanding  with certain banks.  Notes payable at December
  31, 1996  bear  an average interest rate of approximately 9%.

                                      F-14

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE E - NOTES PAYABLE - Continued

  The Company is also  obligated  under a  $1,000,000  revolving  line-of-credit
  agreement  which had an  outstanding  balance of $250,000  as of December  31,
  1996.  Borrowings  under a  $750,000  revolving  line-of-credit  agreement  at
  December 31, 1995 were  $445,000.  The current  line bears  interest at prime,
  plus .5% (8.75% at December 31, 1996) and expires in June, 1997. The amount of
  the  line-of-credit was increased to $1,250,000 in January,  1997.  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.

  The Company has a $946,000  secured line of credit with a foreign bank,  which
  was unused at December 31, 1996.


NOTE F - CREDIT FACILITY

  The Company is  obligated  under a credit  agreement  (the  Agreement)  with a
  banking pool that provided credit facilities  primarily for letters of credit,
  bank  guarantees,  performance  bonds and  similar  instruments  required  for
  specific sales contracts.  The Agreement provides for certain bank charges and
  fees as the line is used, plus a fee of approximately 2% of guarantees issued.
  As of December  31,  1996,  the credit  facility  had been fully  utilized and
  guarantees and performance bonds of $18.4 million remain outstanding.

  Advances   under  the  credit   facility  are  secured  by  cash  deposits  of
  $18,382,000.  Amounts  outstanding are also  collateralized  by the letters of
  credit received under the contracts financed and a pledge of approximately $25
  million on Mecar's assets. The Agreement provides 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.

  The deposits  used to secure the  agreement  were  borrowed  under a term loan
  agreement with two of the institutions in the banking pool (see note H).

  The Company is also liable for guarantees and other  instruments issued on its
  behalf by other banks which  approximate $2.8 million,  at December 31,  1996,
  and are collateralized by $1.7 million  of time deposits.


NOTE G - ACCRUED LOSSES ON CONTRACTS

  The Company has provided  for accrued  losses of $390,125 at December 31, 1996
  ($431,215 at December 31, 1995) in connection  with the  completion of certain
  contracts in progress.  These  contracts are expected to be completed in 1997.
  Net  reductions  in the  provision  for  contract  losses  in 1996 and 1995 of
  $124,980 and $1,178,475,  respectively, were credited to operations, primarily
  due to loss provisions no longer required on certain orders.

                                      F-15

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE H - LONG-TERM DEBT

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

                                                1996             1995
                                             -----------      -----------

      Term loan agreement                    $11,413,078      $18,492,000
      Mortgage loan agreements                 6,299,262        8,022,113
      Notes payable bank                         660,711          967,146
      Note payable - I.D.C.S., N.V.              189,162          603,750
      Other                                    2,980,394        3,136,150
                                             -----------      -----------
                                              21,542,607       31,221,159
      Less current maturities                 14,099,171        2,786,383
                                              ----------      -----------

                                             $ 7,443,436      $28,434,776
                                             ===========       ==========

  Term Loan Agreement

  The  Company  is  obligated  under  a  term  loan  agreement  with  two of the
  institutions  in its foreign banking pool. The proceeds were placed in deposit
  accounts as  collateral  for credit  facility  advances  made by the Company's
  foreign banking pool. The note bears interest at 7.5%, payable quarterly.  The
  loan matures on the earlier of December 31, 1997 or upon the expiration of the
  guarantees  issued  under the Credit  Facility  Agreement  with the  Company's
  banking pool. The agreement  provides for the maintenance of certain net worth
  levels and the payment of certain commissions.

  The term loan is  collateralized  by a pledge of approximately  $31 million on
  Mecar's assets and the deposit  accounts,  subject to the priority position of
  the banking pool. The regional  government where Mecar is located (the Walloon
  region)  has  guaranteed  50% of the term credit  subject to certain  priority
  pledges.

  Mortgage Loan Agreement

  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  loan  has a  balance  due  of
  $5,075,000 at December 31, 1996. 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 $599,000  (except for the annual
  principal  installment  in the year 2000  which is  $882,800).  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  $1,224,000  at
  December 31,  1996.  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 two notes payable of $500,000 each to its bank,  which had
  a total balance due of $660,711 at December 31, 1996.  The notes bear interest
  at the  prime  rate plus 2%  (10.25%  at  December  31,  1996)  and  mature in
  September and October, 1998. The two notes are payable in monthly installments
  of $16,383 and $16,400,  respectively,  including principal and interest.  The
  notes are collateralized by the assets of the BRI and Allied's guarantee.  The
  agreement  contains  covenants  requiring  BRI to maintain  certain  financial
  ratios, among other matters.

                                      F-16

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE H - LONG-TERM DEBT - Continued

  Note Payable - I.D.C.S., N.V.

  The Company is obligated to the  former owner of I.D.C.S.  in connection  with
  the acquisition of I.D.C.S.  The note bears interest at 7.5% and is payable in
  monthly installments through June, 1997.

  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, 1996
  are as follows:

                 Year                             Amount
                 ----                          -----------
                 1997                          $14,099,171
                 1998                            1,796,114
                 1999                            1,268,651
                 2000                            1,246,295
                 2001                              805,536
                 Thereafter                      2,326,840


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,  two former directors are receiving  retirement  benefits.  The net
  present  value of  benefits  anticipated  to be payable to current  and former
  directors have been reflected as a charge to earnings.

  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, 1996.

  The Company  instituted  a retirement  savings  plan in 1989 which  received a
  favorable determination letter from the Internal Revenue Service dated January
  12,  1992.  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  1996  were  approximately  $53,000.  No
  contributions were made for the years ended December 31, 1995 and 1994.

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

                                      F-17

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE J - CONTINGENCIES AND COMMITMENTS

  Cost-plus  contracts  and  subcontracts  are subject to  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.

  At December 31, 1996,  Mecar has provided for estimated losses on contracts of
  $390,115.  In addition,  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. It is likely
  that actual costs on these  contracts will differ from the Company's  estimate
  at completion  and losses could exceed the provision  established  at December
  31, 1996.

  The Company  enters into foreign  exchange  contracts in the normal  course of
  business  primarily to hedge sales and  purchase  contracts.  These  contracts
  typically  mature within twelve months,  and forward exchange gains and losses
  are recognized upon maturity. No contracts were outstanding as of December 31,
  1996.

  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.

  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.

  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,
  1996.

                      Year                          Amount
                      ----                         --------
                      1997                         $422,900
                      1998                          395,000
                      1999                          329,400
                      2000                          105,100
                      2001                           12,700

  Total rental expense charged to operations approximated $421,000, $444,000 and
  $660,000, for the years ended December 31, 1996, 1995 and 1994.

  The Company's domestic  operations do not provide post employment  benefits to
  their 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  workforce  reduction  as part of its
  restructuring  charge  (see note R).  After  giving  effect  to the  workforce
  reductions,  current work loads, expected levels of future operations, planned
  redeployment  of workers and severance  policies,  future  severance costs and
  post  employment  benefits  are not  expected to be material to the  Company's
  financial position at this time.

                                      F-18

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

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>
                                                                    1996                            1995
                                                       -----------------------------   -----------------------------
                                                          Carrying        Estimated       Carrying       Estimated
                                                           Amount         Fair Value       Amount        Fair Value
                                                       ------------     ------------   -------------   -------------
<S> <C>
      Notes payable                                    $  3,317,438     $  3,317,000   $     485,330   $     485,000
      Long-term debt, including current maturities       21,542,607       21,543,000      31,221,159      31,221,000
      Off-balance-sheet instruments
        Guarantees and letters of credit                         -        20,283,000              -       20,294,000
        Foreign exchange contracts                               -                -               -               -
</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.

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

   (bullet) 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.

   (bullet) 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.


NOTE L - CAPITAL STOCK

  At December 31, 1996,  options  to  acquire  313,100  shares  of  the  Company
  common  stock  were  outstanding  and 631,949  shares were reserved for future
  issuance under the following plans:

  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 1996,  1995 and 1994 - 12,001,
  20,608 and 14,859  shares,  respectively,  subject to the plan were issued and
  $9,225,  $11,736 and $9,808 was charged to  operations.

                                      F-19

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE L - CAPITAL STOCK - Continued

  1988 Incentive Compensation Plan

  The Company has reserved  410,900  shares of common stock for key employees of
  the  Company  and its  subsidiaries.  The plan  authorizes  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, 1995, options had been granted for
  215,400  shares at prices of $2.125 to $14.875 per share,  which have all been
  exercised  except for 10,000  which expire at the earlier of 30 days after the
  termination of employment of the optionholder or 2003. During 1996, additional
  options to purchase  60,600  shares were issued to four  officers at prices of
  $3.75 to $5.125 per share. These options are exercisable on March 20, 1997 for
  one-third  the number of shares;  and an  additional  one-third in each of the
  following two years.

  During 1994,  30,100  shares were  issued as stock  awards to two officers and
  one  employee.  The value of the awards  charged to  operations  was  $129,937
  in 1994.

  As of December 31, 1996,  94,000 shares of restricted  common stock subject to
  the plan have been  awarded.  These shares were awarded  prior to 1993 and the
  value of the  incentives  were  charged  to  operations  in the year they were
  awarded.  Restricted  stock may be issued to a grantee for an amount less than
  fair market  value and may  require  the  grantee to remain in the  continuous
  employ of the Company for a specified period before such shares can be sold or
  transferred.  At December  31, 1996 there were 10,800  shares  still  reserved
  under the plan.

  1984 Incentive Stock Option Plan

  The Company has 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,  provided  that the  purchase  price shall be no less than the
  fair  market  value of a share of common  stock of the Company on the date the
  option is granted,  except for those options  granted to employees who hold in
  excess of 10% of the Company's  stock, in which case the option price shall be
  110% of the fair  market  value on the date of grant.  Options  granted can be
  exercised  two years or later from the date of grant and expire at the earlier
  of thirty days after  termination  of employment or ten years from the date of
  grant (five years in the case of an  Over-Ten-Percent  Stockholder).  In March
  1994,  the Company  granted  options to two officers and sixteen  employees to
  purchase  217,500 shares at $8.25 per share.  These options have  restrictions
  concerning  employment  for a two-year  period and expire in 2004. At December
  31, 1996, 177,500 of these options remained outstanding.

  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
  1996,  1995 and 1994,  the Company  granted  5,000,  3,000 and 5,000 shares of
  common  stock  subject to the plan and charged  $26,250,  $11,250 and $22,500,
  respectively, to operations.

                                      F-20

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE L - CAPITAL STOCK - Continued

  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. The Company  granted  options to
  purchase a total of 40,000  shares at $2.50 to $4.125  per  share.  All 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, 1996, none of the 1996 issued options had been exercised.

  Other

  Stock grants for 3,035,  37,260 and 5,950 shares of the Company's common stock
  were made to various  employees  during 1996, 1995 and 1994. These shares were
  issued  outside of any existing  plan and their value  ($13,125,  $172,812 and
  $74,375, 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.

  Stock Purchase Agreement

  In April, 1993, the Company agreed to purchase 350,000 shares of the Company's
  common  stock  at a base  price  of $15 per  share  from a  shareholder,  plus
  additional consideration as defined in the agreement. During 1993, the Company
  purchased and retired  130,000 shares for  $2,159,361,  including  $209,361 of
  additional  consideration.  During 1994,  the  remaining  220,000  shares were
  purchased for  $3,513,364  and  additional  consideration  of $213,364 in full
  satisfaction of the agreement.

                                      F-21

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE L - CAPITAL STOCK - Continued

  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 summarizes option activity:

<TABLE>
<CAPTION>
                                                                       1996
                                                            ---------------------------
                                                                       Weighted Average        1995           1994
                                                             Shares     Exercise Price        Shares         Shares
                                                            --------   ----------------       -------       --------
<S> <C>
      Options outstanding at beginning of year              227,500         $7.89             227,500         10,000
      Options exercised                                          -             -                   -              -
      Options granted                                       135,600         $4.81                  -         217,500
      Options Expired                                       (50,000)        $7.63                  -              -
                                                            -------                           -------        -------

      Options outstanding at end of year                    313,100         $6.76             227,500        227,500
                                                            =======                           =======        =======

      Option price range at end of year                       $3.75                             $2.75          $2.75
                                                                to                                to             to
                                                              $8.25                             $8.25          $8.25

      Option price range for exercised shares                    -                                 -              -

      Options available for grant at end of year            112,800                           238,400        238,400

      Weighted-average fair value of options,
          granted during the year                             $2.06
</TABLE>

  The following table summarizes options outstanding at December 31, 1996:

                                                               Weighted Average
      Number                             Weighted Average          Remaining
    Outstanding     Exercise Prices       Exercise Prices      Contractual Life
    -----------     ---------------      ----------------      ----------------
      313,100        $3.75 to $8.25           $6.76               5.91 years

                                      F-22

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE M - MAJOR CUSTOMERS

  The  Company   derives   substantially   all  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 1996,
  1995  and  1994,  the  Company  derived   approximately   11%,  17%  and  12%,
  respectively,  of its revenue from U.S.  Government  agencies and contractors.
  Two agencies of a foreign government and another foreign government  accounted
  for  approximately  10%,  42% and 19% of  revenue in 1996, 12%, 31% and 27% of
  revenue in 1995 and, 5%, 60% and 14% of revenue in 1994.


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 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 1996 and 1995 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, 1996 and 1995, backlog
  orders believed to be firm approximated $79.6 and $68.1 million.

  Amounts in foreign  banks at  December  31,  1996 and 1995 were  approximately
  $31,815,000 and  $15,182,000,  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  operations  in Belgium and the United
  Kingdom and sells its products on a worldwide basis.


NOTE O - OTHER - NET

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

<TABLE>
<CAPTION>

                                                 1996             1995           1994
                                               --------        ---------       ---------
<S> <C>
   Net currency transaction gains (losses)    $(836,254)      $1,284,446      $1,484,651
   Miscellaneous - net                          454,875          684,032        (178,578)
                                               --------        ---------       ---------

                                              $(381,379)      $1,968,478      $1,306,083
                                               ========        =========       =========
</TABLE>

                                      F-23

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE P - INCOME TAXES

  The Company has adopted the  provisions  of Statement of Financial  Accounting
  Standards No. 109,  "Accounting  for Income  Taxes"  ("SFAS No.  109"),  which
  requires  recognition of 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:

<TABLE>
<CAPTION>
                                                              1996              1995             1994
                                                           -----------      ------------     ------------
<S> <C>
      Domestic                                             $   124,549      $   151,888      $ (1,005,790)
      Foreign                                                5,572,164       (1,421,507)       (9,267,553)
                                                             ---------       ----------       -----------

                                                            $5,696,713      $(1,269,619)     $(10,273,343)
                                                             =========       ==========       ===========
</TABLE>

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

<TABLE>
<CAPTION>
                                                              1996              1995             1994
                                                           -----------      ------------     ------------
<S> <C>
      Currently payable
        Domestic                                           $   197,299      $  116,692      $  (65,405)
        Foreign                                              1,323,619         498,696         342,935
                                                            ----------       ---------       ---------
                                                             1,520,918         615,388         277,530
      Deferred - net                                          (629,688)        128,264         390,233
                                                            ----------       ---------       ---------

                                                           $   891,230      $  743,652      $  667,763
                                                            ==========       =========       =========
</TABLE>

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

<TABLE>
<CAPTION>
                                                             1996               1995               1994
                                                            -------            -------            -------
<S> <C>
      Taxes at statutory rate                                34.0 %            (34.0)%            (34.0)%
      Benefit of foreign tax credit carryforward             (1.2)              (7.4)             (14.3)
      Foreign tax rate differential and current
        loss limitations                                    (18.3)              94.3               53.9
      State taxes, net of federal income tax effect            -                  -                  .9
      Other                                                   1.1                5.7                 -
                                                            -----              -----              -----

                 Income taxes                                15.6 %             58.6 %              6.5 %
                                                            =====              =====              =====
</TABLE>

  In  1996,  1995  and  1994,  the  Company's  Belgian   subsidiaries   utilized
  approximately  $4,242,318,  $47,000  and  $50,000,  respectively,  of  foreign
  operating loss carryforwards for tax reporting purposes.  Unused net operating
  losses  of  the  Belgian   subsidiaries  at  December  31,  1996   approximate
  $5,300,000,  which under  Belgian tax law cannot be carried  back,  but may be
  carried forward indefinitely subject to certain annual limitations.

                                      F-24

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE P - INCOME TAXES - Continued

  The Company utilized  approximately  $289,000,  $94,000, and $1,664,000 of its
  foreign tax credits in 1996, 1995 and 1994. At December 31, 1996,  foreign tax
  credit  carryforwards  of  approximately  $747,000 were available which expire
  through 2009.

  Deferred  tax  liabilities  have not been  recognized  for  bases  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
  $18,800,000 at December 31, 1996.  Determination of the amount of unrecognized
  deferred tax liabilities is not practicable.

  Deferred taxes at December 31, 1996 and 1995 are comprised as follows:

<TABLE>
<CAPTION>
                                                                                       1996              1995
                                                                                   ------------      -------------
<S> <C>
      Current
        Unrealized exchange gain (losses)                                          $    52,158       $    (85,970)
        Compensated absences                                                            96,000             96,900
        Deferred income                                                                 (8,713)            (4,185)
        Other                                                                           18,000             14,200
        Deferred compensation                                                           45,224             55,628
                                                                                    ----------        -----------

            Current deferred tax asset/liability                                       202,669             76,573

      Noncurrent
        Foreign tax credit carryforwards                                               790,017          1,099,625
        Foreign and domestic net operating loss carryforwards                        5,345,510          7,708,768
        Depreciation and amortization                                                  189,656            295,881
        Unrealized exchange gain                                                      (599,375)        (1,069,231)
                                                                                    ----------        -----------

            Noncurrent deferred tax asset/liability                                  5,725,808          8,035,043
                                                                                    ----------        -----------

            Total deferred tax asset before valuation allowances                     5,928,477          8,111,616

      Valuation allowances                                                          (6,064,997)        (8,877,811)
                                                                                    ----------        -----------

            Net deferred tax liability                                             $  (136,520)      $   (766,195)
                                                                                    ==========        ===========
</TABLE>


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


<TABLE>
<CAPTION>
                                                                                       1996              1995
                                                                                   ------------      -------------
<S> <C>
         Current (included in "prepaid expenses and deposits")                     $   491,854       $     80,758
         Deferred income taxes                                                        (628,374)          (846,953)
                                                                                    ----------        -----------

                                                                                   $  (136,520)      $   (766,195)
                                                                                    ==========        ===========
</TABLE>

                                      F-25

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE Q - EXPLOSION

  In April,  1995, an explosion damaged Mecar's storage and loading  facilities,
  and caused production to cease for several months. The Company was insured for
  property  damage and business  interruption.  The direct cost of repairing the
  facility  approximating $2.3 million was recovered in addition to $1.3 million
  for business  interruption.  The business interruption portion of the proceeds
  have been classified as revenue in 1995,  which partially  offset overhead and
  operating  costs for the shut down  period.  The $2.3  million  recovery was a
  direct offset against the related costs.


NOTE R - RESTRUCTURING CHARGE

  In  the  fourth  quarter  of  1993,  the  Company   recorded  an  accrual  for
  restructuring  costs totaling  $2,883,289 ($.44 per share after taxes) related
  to its Belgian  manufacturing  operations.  The charge  provided for estimated
  employee   severance,   retraining,   early   retirements  and  related  costs
  attributable  to a planned  workforce  reduction  initiated in late 1993.  The
  Company   anticipated  that  it  would  eliminate  over  the  next  two  years
  approximately  32  permanent  and 120  temporary  factory  and  administrative
  positions. The reductions were the result of efficiencies implemented over the
  past several years,  current backlog levels and anticipated  future  workforce
  requirements for Mecar's core defense operations, as well as those expected to
  be redeployed as part of prospective  diversification  ventures.  During 1994,
  the  Company   increased  the  provision  by  $326,831  to  cover   additional
  terminations. The restructuring was completed in early 1995.


NOTE S - EARNINGS PER COMMON SHARE

  Net earnings per common  share is based upon the  weighted  average  number of
  shares  outstanding of 4,432,750 in 1996,  4,408,172 in 1995, and 4,392,517 in
  1994.  Stock  options  outstanding  have not been  included  in the per  share
  computations since they would not have a material effect on per share amounts.

  The Company  has  adopted  the  disclosure-only  provisions  of  Statement  of
  Financial   Accounting   Standards  No.  123,   "Accounting   for  Stock-Based
  Compensation."  Accordingly,  no compensation cost has been recognized for the
  stock options plans. Had  compensation  cost been determined based on the fair
  value at the grant date for the 1996 awards  consistent with the provisions of
  SFAS No. 123,  the  Company's  net  earnings and earnings per share would have
  been reduced to the pro forma amounts indicated below:

          Net earnings - as reported                   $4,805,483
          Net earnings - pro forma                     $4,645,786
          Earnings per share - as reported                  $1.08
          Earnings per share - pro forma                    $1.05



NOTE T - GEOGRAPHIC AREAS AND INDUSTRY SEGMENTS

  The Company currently operates in three principal areas:  Product sales (Mecar
  and ARCL),  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.  ARC Services  did not have  operating
  revenues in 1995 and 1994.

                                      F-26

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE T - GEOGRAPHIC AREAS AND INDUSTRY SEGMENTS - Continued

  The Company's  foreign  operations  are conducted by Mecar,  the VSK Group and
  ARCL. All material  identifiable assets associated with foreign operations are
  located in Belgium and the United Kingdom.

  Information by geographic area and industry segment is as follows:

<TABLE>
<CAPTION>

    Geographic Area Data                                        1996                1995                1994
    --------------------                                    ------------         -----------        ------------
<S> <C>
    Net sales
      Belgium (1)                                           $ 89,191,742         $53,280,097        $ 61,189,115
      United Kingdom (2)                                              -                   -              332,266
      France                                                   2,832,154           1,054,560                  -
      United States                                           11,636,241          11,434,250           8,325,464
                                                             -----------          ----------         -----------

                                                            $103,660,137         $65,768,907        $ 69,846,845
                                                             ===========          ==========         ===========

    Operating income (loss)
      Belgium                                               $  6,848,251         $  (926,099)       $ (8,954,876)
      United Kingdom                                             (91,752)           (626,630)            (84,007)
      France                                                          -             (495,318)                 -
      United States                                              940,247             598,497          (1,622,714)
      Corporate                                                  (89,452)           (524,288)           (688,929)
                                                             -----------          ----------         -----------

                                                            $  7,607,294         $(1,973,838)       $(11,350,526)
                                                             ===========          ==========         ===========

    Assets
      Belgium                                               $ 84,842,298         $84,800,974        $100,320,904
      United Kingdom                                             228,654           1,645,818           1,647,402
      France                                                          -            1,213,227                  -
      United States                                            6,877,208           6,593,254           5,418,003
                                                             -----------          ----------         -----------

                                                            $ 91,948,160         $94,253,273        $107,386,309
                                                             ===========          ==========         ===========
</TABLE>

    (1) Includes export sales  principally to customers in Asia/Middle  East and
        Europe of $69,910,271 in 1996, $33,212,000 in 1995, $50,457,142 in 1994.

    (2) Includes export  sales  principally  to customers in Asia\Middle East of
        $332,266 in 1994.

                                      F-27

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE T - GEOGRAPHIC AREAS AND INDUSTRY SEGMENTS - Continued

<TABLE>
<CAPTION>

    Industry Segment Data                                         1996                1995               1994
    ---------------------                                     ------------         -----------       ------------
<S> <C>
    Net sales
      Product sales                                           $ 74,109,952         $36,131,894       $ 54,335,591
      Engineering and technical                                 11,636,242          11,354,440          8,325,464
      Security systems and service                              17,913,943          18,282,573          7,185,790
                                                               -----------          ----------        -----------

                                                              $103,660,137         $65,768,907       $ 69,846,845
                                                               ===========          ==========        ===========

    Operating income (loss)
      Product sales                                           $  5,373,053         $(2,686,686)      $ (9,657,051)
      Engineering and technical                                    650,837             912,048           (872,206)
      Security systems and service                               1,672,856             325,088           (132,340)
      Corporate                                                    (89,452)           (524,288)          (688,929)
                                                               -----------          ----------        -----------

                                                              $  7,607,294         $(1,973,838)      $(11,350,526)
                                                               ===========          ==========        ===========

    Assets
      Product sales                                           $ 81,334,200         $83,468,399       $ 94,174,064
      Engineering and technical                                  5,505,577           5,855,840          4,096,033
      Security systems and service                               3,736,752           4,191,620          7,842,496
      Corporate assets                                           1,371,631             737,414          1,273,716
                                                               -----------          ----------        -----------

                                                              $ 91,948,160         $94,253,273       $107,386,309
                                                               ===========          ==========        ===========

    Capital expenditures
      Product sales                                           $    696,699        $  2,179,864       $  2,688,614
      Engineering and technical                                    264,915             310,059            632,922
      Security systems and service                                 105,275             430,805            295,982
                                                               -----------          ----------        -----------

                                                              $  1,066,889        $  2,920,728       $  3,617,518
                                                               ===========          ==========        ===========

    Depreciation and amortization expense
      Product sales                                           $  2,488,189        $  2,310,195       $  1,868,803
      Engineering and technical                                    392,497             222,857            238,725
      Security systems and service                                 212,848             218,815            303,501
                                                               -----------          ----------        -----------

                                                              $  3,093,534        $  2,751,867       $  2,411,029
                                                               ===========          ==========        ===========
</TABLE>

                                      F-28

<PAGE>

                          Allied Research Corporation

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE U - QUARTERLY FINANCIAL DATA (UNAUDITED)

<TABLE>
<CAPTION>
                                    (Amounts in thousands, except per share data)
                            -------------------------------------------------------------
                             First         Second        Third       Fourth       Total
      1996                  Quarter        Quarter       Quarter     Quarter     For Year
-------------------         -------        -------       -------     -------     --------
<S> <C>
Revenue                     $23,527        $23,004       $17,547     $39,582     $103,660

Gross profit                  5,132          5,675         4,341      11,568       26,716

Net earnings                    636            651           521       2,997        4,805

Per share data:
  Net earnings                  .14            .15           .12         .67         1.08


<CAPTION>
      1995
-------------------
Revenue                     $ 9,153        $13,275       $16,530     $26,811     $ 65,769

Gross profit                    103          2,531         2,583      10,655       15,872

Net earnings (loss)          (2,724)        (1,758)          215       2,254       (2,013)

Per share data:
  Net earnings (loss)          (.62)          (.40)          .05         .51         (.46)
</TABLE>

                                      F-29

<PAGE>

                                   SCHEDULES

<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
                                               1996             1995
                                            -----------      -----------

Cash and equivalents                        $ 1,039,062      $   454,470
Due from subsidiaries                                -         3,431,939
Investments in subsidiaries                  34,903,082       31,192,155
Deferred tax asset                               97,382               -
Deposits and other                              235,187          313,287
                                             ----------       ----------

         Total assets                       $36,274,713      $35,391,851
                                             ==========       ==========

                LIABILITIES


Accounts payable and accrued liabilities    $   475,208      $   206,141
Due to subsidiaries                           4,264,263        6,751,678
Income taxes                                     88,601           80,447
                                             ----------       ----------

         Total liabilities                    4,828,072        7,038,266


STOCKHOLDERS' EQUITY
  Common stock                                  444,309          442,206
  Capital in excess of par value             10,846,303       10,745,296
  Retained earnings                          17,481,483       12,676,000
  Accumulated foreign currency
    translation adjustment                    2,674,546        4,490,083
                                             ----------       ----------
                                             31,446,641       28,353,585
                                             ----------       ----------
                                            $36,274,713      $35,391,851
                                             ==========       ==========

                                      F-31

<PAGE>

                          Allied Research Corporation

     SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED

                                (Parent Company)

                            STATEMENTS OF OPERATIONS

                            Year ended December 31,

--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                                     1996             1995             1994
                                                                  ----------       -----------     ------------
<S> <C>
Income
  Management fees - intercompany                                  $2,652,889       $ 2,505,222     $  3,864,152
  Other - net                                                        (77,412)          266,361          202,275
                                                                   ---------        ----------      -----------
                                                                   2,575,477         2,771,583        4,066,427

Costs and expenses
  Administrative and other                                         2,878,746         3,115,475        3,775,141
                                                                   ---------        ----------      -----------

         Earnings (loss) before equity in
           operations of subsidiaries                               (303,269)         (343,892)         291,286

Equity in operations of subsidiaries                               4,959,035        (1,696,176)     (10,965,420)
                                                                   ---------        ----------      -----------

         Earnings (loss)  before income taxes                      4,655,766        (2,040,068)     (10,674,134)

Income taxes (benefit)                                              (149,717)          (26,797)         266,972
                                                                   ---------        -----------     -----------

         NET EARNINGS (LOSS)                                      $4,805,483       $(2,013,271)    $(10,941,106)
                                                                   =========        ==========      ===========



         Net earnings (loss) per common share                          $1.08             $(.46)          $(2.49)
                                                                        ====              ====            =====
</TABLE>

                                      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                          1996                1995            1994
                                                                 ------------        ------------    -------------
<S> <C>
Cash flows from (used in) operating activities
  Net (loss) earnings for the year                               $  4,805,483        $(2,013,270)    $(10,941,106)
  Adjustments to reconcile net earnings to net cash from
    (used in) operating activities
      Equity in operations of subsidiaries                         (4,959,035)         1,696,176       10,965,420
      (Gain) loss on disposal of property and equipment                  (250)                -                -
      Deferred income taxes                                          (127,724)            41,904           41,048
      Common stock awards and grants                                   41,382             11,250          236,473
  Changes in assets and liabilities
    Due from subsidiaries                                             377,095           (329,697)       3,653,332
    Other assets                                                       85,350            133,830         (350,872)
    Due to subsidiaries                                                    -              26,146          316,935
    Accounts payable and accrued liabilities                          269,066            (61,644)         164,350
    Income taxes                                                       38,496             (3,308)         120,000
                                                                  -----------         ----------      -----------
                                                                   (4,275,620)         1,514,657       15,146,686
                                                                  -----------         ----------      -----------

         Net cash provided by (used in) operating activities          529,863           (498,613)       4,205,580

Cash flows from investing activities
  Capital expenditures                                                 (7,250)                -          (213,840)
  Proceeds for sale of property and equipment                             250                 -                -
                                                                  -----------         ----------      -----------

         Net cash (used in) investing activities                       (7,000)                -          (213,846)

Cash flows from financing activities
  Purchase of treasury shares                                              -                  -        (3,513,360)
  Proceeds from employee stock purchase plan shares                    61,729             78,232           65,672
                                                                  -----------         ----------      -----------

           Net cash provided by (used in) financing activities         61,729             78,232       (3,447,688)
                                                                  -----------         ----------      -----------

           Net increase (decrease) in cash and equivalents            584,592           (420,381)         544,052

Cash and equivalents at beginning of year                             454,470            874,851          330,799
                                                                  -----------         ----------      -----------

Cash and equivalents at end of year                              $  1,039,062        $   454,470     $    874,851
                                                                  ===========         ==========      ===========

Supplemental Disclosures of Cash Flow Information

  Cash paid during the year for
    Income taxes                                                 $    135,000        $   120,000     $         -
    Interest                                                               -                  -             3,667
</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>
Year ended December 31, 1996

  Estimated losses on
    contracts                    $   431,215     $   390,125       $     -           $   431,215     $   390,125
                                  ==========      ==========        =======           ==========      ==========

  Allowance for doubtful
    receivables                  $   330,077     $    55,186       $     -           $    20,589     $   364,674
                                  ==========      ==========        =======           ==========      ==========


  Valuation allowances on
    deferred tax assets          $19,923,320     $        -        $     -           $13,858,323     $ 6,064,997
                                  ==========      ==========        =======           ==========      ==========






Year ended December 31, 1995

  Estimated losses on
    contracts                    $ 1,873,008     $(1,178,475)      $     -           $   263,318     $   431,215
                                  ==========      ==========        =======           ==========      ==========

  Allowance for doubtful
    receivables                  $   141,000     $   189,077       $     -           $        -      $   330,077
                                  ==========      ==========        =======           ==========      ==========

  Valuation allowances on
    deferred tax assets          $17,877,228     $ 2,046,092       $     -           $        -      $19,923,320
                                  ==========      ==========        =======          ===========      ==========




Year ended December 31, 1994

  Estimated losses on
    contracts                    $ 3,127,574     $   721,937       $     -           $ 1,976,503     $ 1,873,008
                                  ==========      ==========        =======           ==========      ==========

  Allowance for doubtful
    receivables                  $    21,000     $        -     (a)$120,000          $        -      $   141,000
                                  ==========      ==========        =======           ==========      ==========

  Valuation allowances on
    deferred tax assets          $ 3,384,229     $14,492,999       $     -           $        -      $17,877,228
                                  ==========      ==========        =======           ==========      ==========
</TABLE>

        (a) VSK Group acquisition

                                      F-34


<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) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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

Date:  March 26, 1997

                  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.

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

Date:  March 26, 1997

                                            * * * * * * *

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

Date:  March 26, 1997

                                            * * * * * * *

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

Date:  March 26, 1997

                                            * * * * * * *

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

Date:  March 26, 1997


                                       34

<PAGE>



                                            * * * * * * *

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

Date:  March 26, 1997

                                            * * * * * * *

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

Date:  March 26, 1997

                                            * * * * * * *

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.



                                       35

<PAGE>

                                    EXHIBITS

<PAGE>

                                 EXHIBIT INDEX

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

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



   11            Computation of Earnings
                    per Common and Common
                    Equivalent Shares                             E-3




   21            List of Subsidiaries                             E-4




   23            Consent of Independent Certified
                    Public Accountants                            E-5


                                      E-2