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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



(Mark One)

|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ------------------------------------------------------------------------------------



For the fiscal year ended December 31, 2002



| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | -----------------------------------------------------------------------------------------



For the transition period from
 to



Commission file number: 0-2545



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THE ALLIED
DEFENSE GROUP, INC.

(FORMERLY ALLIED RESEARCH CORPORATION)

(Exact name of registrant as specified in its charter)



|Delaware                 |  | 04-2281015                          
|------------------------ |  | ------------------------------------
|(State of incorporation) |  | (I.R.S. Employer Identification No.)



|8000 Towers Crescent Drive Suite 260 Vienna, Virginia 22182  |  | (703) 847-5268                                      
|------------------------------------------------------------ |  | ----------------------------------------------------
|(Address of principal executive offices, including zip code) |  | (Registrants telephone number, including area code)



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



|Title of Class                |  | Name of Exchange       
|----------------------------- |  | -----------------------
|Common Stock, $0.10 Par Value |  | American Stock Exchange



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



None



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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
II of this Form 10-K or any amendment to this Form 10-K.  x



Indicated by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Act).  YES  x  NO ̈



State the aggregate market value of the voting stock of the
registrant held by non-affiliates as of June 28, 2002, the last day of the registrants most recently completed second fiscal quarter (For purposes of this determination, only our directors and executive officers have been deemed affiliates):



|Common Stock  Par Value $.10 |  | $129,824,510
|----------------------------- |  | ------------



The
number of shares of registrants Common Stock outstanding as of March 1, 2003, was 5,474,813.



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INDEX



|          
|----------
|PART I    
|          
|Item 1.   
|          
|Item 2.   
|          
|Item 3.   
|          
|Item 4    
|          
|PART II   
|          
|Item 5.   
|          
|Item 6.   
|          
|Item 7.   
|          
|Item 7A.  
|          
|Item 8.   
|          
|Item 9.   
|          
|PART III  
|          
|Item 10.  
|          
|Item 11.  
|          
|Item 12.  
|          
|Item 13.  
|          
|Item 14.  
|          
|PART IV   
|          
|Item 15.  
|          
|SIGNATURES





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ITEM 1. BUSINESS



General



The Allied Defense Group, Inc. (Allied or the
Company) was incorporated in 1961 under the name Allied Research Associates, Inc. Allied changed its corporate name to Allied Research Corporation in 1988 and subsequently changed its name to The Allied Defense Group, Inc. effective
January 2, 2003. Allieds strategic defense and security businesses are conducted through MECAR S.A. (MECAR), a group of Belgian corporations acquired in 1994, 1995 and 1999 consisting of VSK Electronics, S.A., Tele Technique
Generale, S.A., IDCS, S.A. and VIGITEC, S.A. (collectively, the VSK Group), News/Sports Microwave Rental. Inc. (Microwave), Titan Dynamics Systems, Inc. (Titan Dynamics Systems) and SeaSpace Corporation
(SeaSpace). MECAR is located in Petit-Roeulx-lez-Nivelles, Belgium. The VSK Group operates from several different locations in Belgium. Microwave was acquired on December 31, 2001 and is located in Spring Valley, California. Titan was
acquired on June 6, 2002 and is located in Marshall, Texas. SeaSpace was acquired on July 31, 2002 and is located in Poway, California.



Forward Looking Statements



Certain information included in this report or in other materials Allied has filed or will file with the Securities and Exchange Commission
(SEC) contains or may contain forward-looking statements. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They contain words like anticipate,
estimate, expect, project, intend, plan, believe, may, can, could, might and other words or phrases of similar meaning in
connection with any discussion of future operating or financial performance. Such statements include information relating to anticipated operating results, financial resources, changes in revenues, change in profitability, interest expense, growth
and expansion, the ability to produce the liquidity and capital necessary to expand and take advantage of opportunities in the future, and stock market valuations. From time to time, forward-looking statements also are included in Allieds
other periodic reports on Forms 10-Q and 8-K, in press releases and in other material released to the public.



Any or all of the forward-looking statements included in this report and in any other reports or public statements made by the Company may turn out to be inaccurate. This can occur as a result of
incorrect assumptions or as a consequence of known or unknown risks and uncertainties. Many factors mentioned in this report or in other reports or public statements made by the Company will be important in determining our future performance.
Consequently, actual results may differ materially from those that might be anticipated from our forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future
events or otherwise. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995, and all of our forward-looking statements are expressly qualified in their entirety by the cautionary statements contained or
referenced in this section.



Description of Business



Allied



Allied provides management, marketing services
and government relations for its subsidiaries. In addition, Allied also provides export licensing, procurement and logistic support services for its subsidiaries.



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MECAR



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



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



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



90mm
Weapon Systems for Light Armored Vehicles MECAR has developed and produces complete families of ammunition that include APFSDS, HE, SMK and HESH rounds for the COCKERILL Mk II and III and ENGESA EC-90, and DEFA F1 guns. Over 2,000 of these guns
are standard equipment on light APCs in the Far East and South America alone. In the last five years, these families of ammunition have been improved to meet the highest standards of safety and performance.



The 90mm KENERGA Weapon System has been jointly
developed by Cockerill Mechanical Systems (CMI) and MECAR to provide the modern APC with anti-tank punch similar to that of tanks equipped with 105mm guns, without sacrifice to the range, mobility and maintainability of the light APC. In
this partnership, CMI is responsible for the weapon and MECAR for the ammunition. The ammunition family includes the APFSDS, HESH and SMK versions with their corresponding training rounds. This system is currently completing its final phase of
qualification by the U.S. Army.



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



Artillery Ammunition MECAR has produced 155mm HE,
SMK(WP) and ILLUMINATING rounds for various customers.



Medium Caliber Round The 25mm APFSDS-T ammunition round is MECARs entry into the medium caliber arena.



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



Universal Bullet Trap Rifle Grenades The universal
bullet trap rifle grenade is designed to be light, effective, accurate and simple to use. It is fitted over the muzzle of any standard military rifle with



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



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



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



VSK Group



The VSK Group engages in the business of developing, manufacturing, selling, installing and servicing security systems for government and
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 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. In late 1999, the VSK Group acquired all of the outstanding stock
of VIGITEC, S.A., which markets closed circuit television systems and provides other communications services.



Microwave



Microwave engages in the development of sophisticated microwave surveillance systems used in law enforcement, port security, border
security, airport security, high-end commercial security, and citywide surveillance applications. The companys products and services are used for gathering, transmitting, receiving and processing multiple signals from remote locations. The
company develops, assembles and sells electronic technology products and systems for users to operate through the companys proprietary hardware, software and communication links. Microwaves systems and products include cameras,
command/control systems, video concealments, microwave link solutions, and other sensors. Microwave offers fixed observation/transmit surveillance installations in addition to mobile command centers and airborne camera/tracking/transmit packages.



Titan Dynamics Systems



Titan Dynamics Systems engages in the design,
manufacture and sale of battlefield effects simulators. These systems provide soldiers with real time, thermal, audio/visual battlefield effects commonly experienced in wartime to enhance training realism.



Titan Dynamics Systems principal product is its Omega
36/B2 battlefield effects simulator. This 36 shot programmable dispenser discharges multiple Titan-produced cartridges that produce various pyrotechnic effects such as flash/bang, colored smokes, air burst, star clusters and missile firing
signatures.



SeaSpace



SeaSpace Corporation engages in the design,
manufacture, distribution and service of weather and environmental satellite ground reception systems.



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Geographic Areas and
Industry Segments



See Note V 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 revenue in the Ordnance and Manufacturing segment from direct and indirect sales to foreign
governments and prime contractors, primarily on fixed price contracts. Two agencies of a foreign government and another foreign government accounted for approximately 65%, 1% and 1% in 2002, 47%, 30% and 1% in 2001, and 54%, 23% and 4% in 2000, of
Allieds revenue as detailed in Note Q to Allieds consolidated financial statements, the provisions of which are incorporated herein.



Ordnance and Manufacturing sales to its principal foreign government customers have historically been made with the assistance of an
independent marketing representative. Commencing in early 2000, MECAR designated an affiliate of this representative as its independent distributor/value added reseller (the Distributor). The Distributor obtains a contract from the end
user customer and subcontracts a portion of the work to MECAR. The products that MECAR produces are sold to the Distributor for resale to the foreign government agencies end users.



Ordnance and Manufacturing products are sold either 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 normal 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. Most of the contracts received by MECAR require delivery in approximately one year. Accordingly, MECARs business is dependent upon
its ability to obtain such large orders. MECAR frequently accepts smaller orders in an attempt to increase its customer base and efficiently use its manufacturing capacity. 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. In such cases, MECAR is generally required to provide advance payment
guarantees and performance bonds issued by its bank syndicate.



MECAR has from time-to-time received foreign military sale (FMS) contracts from the U.S. Government for the manufacture of ammunition for the benefit of a foreign government customer. Such contracts may be terminated for
convenience by the government or upon default by the manufacturer. The contracts received by MECAR through the FMS system do not require down payments, letters of credit, advance payment guarantees or performance bonds.



In the Electronic Security segment, the VSK Group derives
substantially all of its revenue from sales and services to private industry such as banks, hospitals, commercial businesses, office buildings and to local governments. The VSK Group sells some of its products/services directly to the end users; in
other instances it sells its systems to independent distributors and resellers for resale to the end users. 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. VSK Electronics and IDCS sell their products principally



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in European markets. VIGITEC
and Tele Technique Generale sell their products principally in Belgium. Microwaves customers include U.S. Government agencies as well as state and local law enforcement agencies. The U.S. Government agencies have historically accounted for a
majority of Microwaves revenues.



The
Environmental Safety and Security segments customers include numerous users with need for mission-critical weather and environmental information, including scientists/researchers, universities, military forces and commercial users.



In the Software, Training & Simulation
segment, customers include a number of Army, National Guard and Marine Corps ranges and training centers.



Marketing



Most of the marketing activities of the Ordnance and Manufacturing segment are handled by MECARs staff of sales engineers and executive personnel. In addition, MECAR advertises in trade journals and participates in
trade shows. MECAR is also represented by marketing representatives in different markets and has designated a Distributor for indirect sales to its principal end user customers.



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



Environmental
Safety & Security markets its products in the United States principally through its executive management and its sales personnel. Marketing activities outside of the United States are conducted by independent distributors, supported by SeaSpace
executive management and sales personnel.



Software, Training & Simulation markets its products principally through its executive management.



Research and Development



In the Ordnance and Manufacturing segment, 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 2002, 2001 and 2000, MECAR expended $292,356, $500,904 and $736,764, 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.



The Electronic Security business requires continuous investment in research and development to update and enhance its security systems.
The VSK Group and Microwave employ staffs of design engineers specialized in the field of both electronic hardware and software. During 2002, 2001 and 2000, the Electronic Security segment expended $1,328,748, $1,003,358 and $846,307, respectively,
on research and development.



The Environmental
Safety & Security and Software, Training & Simulation Segments expended minimal amounts for research and development.



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Suppliers and
Materials



In the Ordnance and
Manufacturing segment, production of ammunition requires an ample supply of chemicals, pyrotechnic materials, metal component parts and casings. MECAR generally attempts to ensure that several vendors will be available in the open market to compete
for all supply contracts. However, once the development phase is complete and the design has been stabilized for certain products, the continued availability of supplies can become critical to its ability to perform a particular contract. MECAR
seeks to protect itself against shortages and similar risks by planning alternative means of production, by producing internally, and by monitoring the availability and sources of supplies. MECAR depends upon major suppliers to provide a continuous
flow of such components and materials where in-house capability does not exist, and has generally found such materials and supplies to be readily available.



In the Electronic Security segment, each of the VSK Group and Microwave relies upon a number of select subcontractors to supply the
requisite electronic hardware for its security systems. To date, each entity has found such subcontract materials to be readily available.



In the Environmental Safety & Security segment, SeaSpace uses a variety of high quality vendors to produce various hardware components
and subsystems. Adequate numbers of vendors exist for all significant components and subsystems. Software is developed in-house with existing technical staff.



The Software, Training & Simulation segment, Titan has adequate numbers of suppliers for most components. If a vendor change or
addition is required, additional time and funds may be required to evaluate and certify vendors prior to use. In the past, this has not been a critical problem.



Backlog



As of December 31, 2002 and December 31, 2001, Allied had backlog orders believed to be firm, after giving effect to the percentage of
completion method of accounting, of approximately $156.8 million and $56.0 million, respectively. A substantial portion of the backlog of orders as of December31, 2002 is expected to be filled in 2003. The December 31, 2002 backlog was as follows:



|Ordnance and Manufacturing      |  | - |  | $ | 143.0 million
|------------------------------- |  | - |  | - | -------------
|Electronic Security             |  | - |  |   | 10.6 million 
|Environmental Safety & Security |  | - |  |   | 2.0 million  
|Software, Training & Simulation |  | - |  |   | 1.2 million  



Competition



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



The nature of the competition encountered by the Electronic
Security segment depends upon the sub-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.



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Microwave competes with niche
suppliers of specialized security products as well as much larger companies with substantially greater financial and other resources.



Competition in the Environmental Safety & Security segment is vigorous but usually limited to fewer than a dozen suppliers, some of
which are substantially larger than SeaSpace. Barriers to entry are significant and competition often hinges on customer satisfaction, risk associated with trying a new supplier on mission-critical applications, technical capability and price.



The U. S. battlefield effects simulator market
where Titan competes is relatively small and served by an entrenched, substantially larger competitor. Historically, the market does not attract new entrants. Titan has superior technology that should permit it to gain a substantially larger share
once required government testing and certification is completed. That testing is underway. Certification should also accelerate penetration in foreign markets.



Personnel



As of December31, 2002, Allied, MECAR, the VSK Group, Microwave, SeaSpace and Titan had 579 full and part-time employees as follows:



|ALLIED                           |  |    
|-------------------------------- |  | ---
|Salaried employees               |  | 8  
|                                
|MECAR                            |  |    
|Technical and salaried employees |  | 50 
|Hourly workers                   |  | 265
|Technical consultants            |  | 2  
|                                
|VSK GROUP                        |  |    
|Technical salaried employees     |  | 120
|Hourly workers                   |  | 23 
|Part-time employees              |  | 5  
|                                
|MICROWAVE                        |  |    
|Salaried employees               |  | 35 
|Hourly workers                   |  | 23 
|                                
|SEASPACE                         |  |    
|Salaried employees               |  | 32 
|Hourly workers                   |  | 6  
|                                
|TITAN                            |  |    
|Salaried employees               |  | 2  
|Hourly workers                   |  | 8  



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



Patents



Microwave holds a patent on a mechanical mast that is a key component of certain security systems it supplies to law enforcement agencies. The patent was granted in 1997. Titan holds patents on



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its weapon discharge
simulation system (granted in 1993), its electrostatically dischargeable primer (granted in 1999), its electric impulse cartridge (granted in 2001) and an electric gun (granted in 2002). Neither Allied nor any of its other subsidiaries holds any
other significant 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. See Note Q to
Allieds consolidated financial statements. MECAR now receives contracts for the benefit of these customers via the Distributor and has received contracts for the benefit of these customers via the FMS program.



Available Information



Our principal Internet address is
www.allieddefensegroup.com. We make available free of charge on www.allieddefensegroup.com our annual, quarterly and current reports, and amendments to those reports, as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the SEC.



In
addition, you may request a copy of these filings (excluding exhibits) at no cost by writing or telephoning us at the following address or telephone number:



The Allied Defense Group, Inc.

8000 Towers Crescent Drive

Suite 260

Vienna, Virginia 22182

(703) 847-5268



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ITEM 2. PROPERTIES



Allieds principal executive offices are located in Vienna, Virginia, where it leases approximately 3,700 square feet of office space. The lease expires in September, 2007.



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 is approximately 112,000 square feet and the administration
facility is approximately 28,000 square feet. There are a number of older buildings on the property that are still used in conjunction with the new complex. A small test firing range is maintained on this property. MECAR also owns 600 acres in the
vicinity of the Village of Marche in the Ardennes region of Belgium, which was previously used as a test range. MECAR ceased its use of the Ardennes firing range in 2001. MECAR is now utilizing other test ranges, including a test range owned by the
Belgian Army, although it is also exploring the prospects of securing the use of a new test range.



Throughout 2002, MECAR operated using one full and two partial shifts. MECAR is currently operating near its productive capacity.



The VSK Group operates from owned facilities
containing approximately 49,400 square feet. Such facilities are currently operating at approximately 75% of productive capacity.



Microwave operates from a leased office, production and warehouse facility consisting of approximately 8,400 square feet in Spring Valley,
California. The facility is leased on a month to month basis and is currently operating at approximately 80% of productive capacity.



SeaSpace operates from a leased office consisting of 14,000 square feet in Poway, CA. The lease expires in June, 2009 and the facility is
currently operating at approximately 70% of production capacity.



Titan Dynamics Systems operates from a leased office and manufacturing facility consisting of approx 3,800 square feet in Marshall, TX. The facility is currently operating at approximately 50% of productive capacity.



Capital expenditure programs for facilities and equipment
planned in 2003 will require funding of approximately $2.3 million.



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. See
Note M to Allieds consolidated financial statements for a description of one pending suit against the VSK Group.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



On November 22, 2002, the Company held a special meeting of stockholders. At the meeting, the Companys stockholders approved an amendment to the Companys Certificate of Incorporation, as
amended, to change the name of the Company to The Allied Defense Group, Inc. The following votes were cast in connection with such approval:



|For       |  | Against |  | Abstain
|--------- |  | ------- |  | -------
|4,574,704 |  | 8,836   |  | 4,391  



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PART II



ITEM 5. MARKET FOR STOCK AND RELATED STOCKHOLDER 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 ADG. Its media listing is under the symbol Allied Defense. The table below shows the high and low sales prices
of Allieds Common Stock during 2002 and 2001 (as reported by AMEX):



|2002        |  | High   |  | Low   
|----------- |  | ------ |  | ------
|1st Quarter |  | $24.99 |  | $13.58
|2nd Quarter |  | $28.04 |  | $19.55
|3rd Quarter |  | $25.37 |  | $18.60
|4th Quarter |  | $20.75 |  | $14.20



|2001        |  | High    |  | Low    
|----------- |  | ------- |  | -------
|1st Quarter |  | $  8.94 |  | $  6.15
|2nd Quarter |  | $  9.31 |  | $  7.30
|3rd Quarter |  | $16.59  |  | $  7.80
|4th Quarter |  | $19.70  |  | $11.20 



Stockholders



There were approximately 1,167 holders of
record of the Common Stock of Allied as of March 1, 2003.



Dividends



Allied
paid a 5% stock dividend in November, 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 subsequent dividends declared or paid by Allied.



The payment of dividends is within the discretion of
Allieds Board of Directors and any decision to pay dividends in the future will depend upon an evaluation of a number of factors, including earnings, capital requirements, operating and financial condition, and any contractual limitation then
in effect. In this regard, MECARs bank syndicate agreement requires the maintenance by MECAR of minimum financial covenants, which effectively restricts the amount of dividends we may pay from MECARs assets.



Stock Issuances



On June 6, 2002, Allied acquired all of the outstanding
capital stock of Titan Dynamics Systems in exchange for consideration which included 28,889 shares of unregistered Common Stock. The Company issued another 55,556 unregistered shares of its Common Stock in satisfaction of an obligation of Titan
Dynamics Systems.



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In late June
2002, the Company issued to a single institutional investor for $7.5 million a debenture convertible into shares of its Common Stock and a stock purchase warrant as further discussed under Equity Compensation Plan Information below.



On July 31, 2002, Allied acquired all of the outstanding
capital stock of SeaSpace in exchange for consideration which included 197,731 shares of unregistered Common Stock. The Company issued another 10,894 unregistered shares of its Common Stock in satisfaction of an obligation of SeaSpace.



All shares issued in these transactions were exempt from
registration pursuant to Section 4(2) of the Securities Act. Allied has registered the shares issued in the Microwave and SeaSpace acquisitions as well as the shares issuable to the institutional investor in the convertible debenture issuance for
resale by such stockholders.



Equity Compensation Plan
Information



The following table
provides information about the Companys Common Stock that may be issued upon the exercise of options and rights under all of the Companys existing equity compensation plans as of December 31, 2002, including the 2001 Equity Incentive
Plan, the 1997 Incentive Stock Plan, the 1992 Employee Stock Purchase Plan, the 1984 Incentive Stock Option Plan and the 1991 Outside Directors Stock Option Plan (all of which have been approved by the Companys stockholders), as well as rights
to acquire shares of the Companys Common Stock granted to an unaffiliated institutional investor in connection with a $7.5 million convertible debenture issued by the Company to the investor.



|Plan Category                                                |  | Number of securities to be issued upon exercise of outstanding options, warrants and rights |  | Weighted average exercise price of outstanding options, warrants and
rights |       | Number of securities remaining
available for future issuance under equity compensation plans (excluding securities reflected in column
|------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------- | ----- | --------------------------------------------------------------------------------------------------------------------------------------
|Equity compensation plans approved by security holders       |  | 531,000                                                                                     |  | $                                                                           | 12.81 |                                                                                                                                       
|Equity compensation plans not approved by securities holders |  | 315,000                                                                                     |  | $                                                                           | 25.18 |                                                                                                                                       
|                                                             |  |                                                                                             |  |                                                                             |       |                                                                                                                                       
|Total                                                        |  | 846,000                                                                                     |  | $                                                                           | 17.42 |                                                                                                                                       
|                                                             |  |                                                                                             |  |                                                                             |       |                                                                                                                                       



The
following paragraphs describe the material features of the potential 315,000 share issuance described above.



In late June, 2002, the Company sold for $7.5 million a convertible debenture and a stock purchase warrant to a single institutional
investor. The debenture bears interest at the rate of eight percent (8%) per year, payable on January 1 and July 1 of each year. The debenture matures in ten (10) equal monthly principal installments of $750,000 commencing June 28, 2003. The Company
can elect to pay principal and/or interest in cash and/or in registered shares of Common Stock at a ten percent (10%) discount to the market price at the time(s) of the payments.



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The investor
can choose to convert all or a portion of the principal amount outstanding into shares of Common Stock at any time before maturity. The debenture is convertible into 300,000 shares of common stock at a fixed conversion price of $25.00 per share. In
the event that the Company sells shares of Common Stock at a price less than $25.00 per share, the fixed conversion price of the debenture generally shall be reduced based on a weighted average adjustment (subject to certain exceptions). The
debenture also contains anti-dilution provisions for stock dividends, stock splits or combinations and reclassifications. Further, Allied can elect to pay principal and and/or interest in registered shares of Common Stock at a ten percent (10%)
discount to the then current market price of the Common Stock. In any of these events, the number of shares of Common Stock available to the institutional investor may exceed 300,000 shares.



The warrant is exercisable for a total of 15,000 shares of
Common Stock at an exercise price of $28.75 payable in cash. The warrant is exercisable until June 28, 2006. The number of shares issuable upon exercise and the exercise price are subject to adjustment in the event of stock dividends, stock splits,
combinations or reclassifications of Common Stock as well as sales of shares of Common Stock at less than $25.00 per share (subject to exceptions).



ITEM 6 SELECTED FINANCIAL DATA



The selected consolidated financial data below have been derived from our audited financial statements. You should read the following table in conjunction with Managements Discussion and Analysis of Financial Condition and
Results of Operations and our consolidated financial statements and notes thereto included elsewhere in the annual report on Form 10-K. The historical results presented below are not indicative of any future results. The following selected financial
data relates to Allieds consolidated financial position and results of operations for 2002, 2001, 2000, 1999 and 1998:



|                          |  | 2002                                     |         | 2001 |   | 2000   |  | 1999 |         |  | 1998
|------------------------- |  | ---------------------------------------- | ------- | ---- | - | ------ |  | ---- | ------- |  | ----
|                          |  | (000s omitted except per share amounts)
|Revenues                  |  | $                                        | 130,866 |      | $ | 96,947 |  | $    | 107,743 |  | $   
|Earnings (loss) from      |  |                                          |         |      |   |        |  |      |         |  |     
|  continuing operations  |  |                                          | 10,672  |      |   | 10,367 |  |      | 8,705   |  |     
|  discontinued operation |  |                                          |        |      |   |       |  |      | 517     |  |     
|                          |  |                                          |         |      |   |        |  |      |         |  |     
|Net earnings (loss)       |  |                                          | 10,672  |      |   | 10,367 |  |      | 9,222   |  |     
|                          |  |                                          |         |      |   |        |  |      |         |  |     
|Earnings (loss) per share |  |                                          |         |      |   |        |  |      |         |  |     
|Basic:                    |  |                                          |         |      |   |        |  |      |         |  |     
|  continuing operations  |  |                                          | 2.01    |      |   | 2.11   |  |      | 1.79    |  |     
|  discontinued operation |  |                                          |        |      |   |       |  |      | 0.11    |  |     
|                          |  |                                          |         |      |   |        |  |      |         |  |     
|Net income (loss)         |  |                                          | 2.01    |      |   | 2.11   |  |      | 1.90    |  |     
|                          |  |                                          |         |      |   |        |  |      |         |  |     
|Diluted:                  |  |                                          |         |      |   |        |  |      |         |  |     
|  continuing operations  |  |                                          | 1.92    |      |   | 2.10   |  |      | 1.79    |  |     
|  discontinued operation |  |                                          |        |      |   |       |  |      | 0.11    |  |     
|                          |  |                                          |         |      |   |        |  |      |         |  |     
|Net income (loss)         |  |                                          | 1.92    |      |   | 2.10   |  |      | 1.90    |  |     
|                          |  |                                          |         |      |   |        |  |      |         |  |     
|Total assets              |  |                                          | 168,168 |      |   | 86,784 |  |      | 87,636  |  |     



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|                                                          |  | 2002                                     |  | 2001  |  | 2000  |  | 1999  |  | 1998 
|--------------------------------------------------------- |  | ---------------------------------------- |  | ----- |  | ----- |  | ----- |  | -----
|                                                          |  | (000s omitted except per share amounts)
|Long-term debt obligations and redeemable preferred stock |  | 7,272                                    |  | 3,110 |  | 3,529 |  | 3,081 |  | 4,154
|Cash dividends declared per common share                  |  |                                         |  |      |  |      |  |      |  |     



|ITEM 7 |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------ |  | -------------------------------------------------------------------------------------



Overview



Allied provides management services to its subsidiaries.
Allieds consolidated statements have eliminated all significant intercompany transactions. The following discussion refers to the financial condition, liquidity and results of operations of Allied on a consolidated basis unless otherwise
stated.



Allied operates in four (4) principal
segments  MECARs development and production of ammunition and weapon systems (Ordnance & Manufacturing); the manufacture, distribution and service of industrial security products conducted by the VSK Group and Microwave
(Electronic Security), Titan Dynamics Systems development and sale of Battlefield Effects Simulators (Software, Training & Simulation) and SeaSpaces production and sale of weather and environmental satellite
ground reception systems (Environmental Safety & Security).



In 1999, Allied reorganized its European holdings. A Belgium holding company, ARC Europe, S.A., now owns all of the capital stock of each of MECAR and the VSK Group. In March, 2000, Allied sold all of
the stock of Barnes & Reinecke, Inc. (BRI).



Allied earned net profits of $ 10.7 million ($2.01 per share  basic and $1.92 per share-diluted) in 2002 compared to net profits of $10.4 million ($2.11 per share-basic and $2.10 per sharediluted) in 2001 and net profits
from continuing operations of $8.7 million ($1.79 per share-basic and diluted) in 2000.



Forward-Looking Statements



As set forth in Item 1 of this report, this Managements Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that are based on current expectations, estimates and
projections about the Company and the industries in which it operates. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (Future Factors) which are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is expressed or forecast in such forward-looking statements. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new
information, future events or otherwise.



Future
Factors include substantial reliance on MECARs principal customers to continue to acquire MECARs products on a regular basis; the cyclical nature of the Companys military business; rapid technological developments and changes and
the Companys ability to continue to introduce competitive new products and services on a timely, cost effective basis; the ability of the Company to successfully continue to expand its business base; the mix of products/services; domestic and
foreign



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governmental fiscal affairs
and public policy changes which may affect the level of purchases made by customers; changes in environmental and other domestic and foreign governmental regulations; general risks associated with doing business outside the United States including,
without limitation, import duties, tariffs, quotas and political and economic instability, the effects of terrorist actions on business activities, customer orders and cancellations, and the United States and international governments
responses to these terrorist actions; changes in government regulations; liability and other claims assorted against us; the ability to attract and retain qualified personnel; and continued availability of financing, financial instruments and
financial resources in the amounts, at the times and on the terms required to support the Companys future business. These are representative of the Future Factors that could affect the outcome of the forward-looking statements. In addition,
such statements could be affected by general industry and market conditions and growth rates; general domestic and international economic conditions including interest rate and currency exchange rate fluctuations; increasing competition by foreign
and domestic competitors, including new entrants; and other Future Factors.



Critical Accounting Policies



Our significant accounting policies are described in Note A to the consolidated financial statements included in Item 8 of this Form 10-K. Management has identified the Companys critical accounting estimates which
are those that are most important to the portrayal of the financial condition and operating results of the Company and require subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.
Significant estimates underlying the accompanying consolidated financial statements and the reported amount of net sales and expenses include revenue recognition via the percentage of completion method, goodwill and intangible asset valuation,
inventory valuation and the assessment of the valuation of deferred income taxes and income tax reserves.



We believe our most critical accounting policies include revenue recognition and cost estimation on fixed price contracts for which we use
the percentage of completion method of accounting. This method is used by MECAR, Microwave, and SeaSpace for substantially all of their sales contracts. Approximately 92%, 80% and 81% of consolidated revenue was recognized under the percentage of
completion method during 2002, 2001 and 2000, respectively. The value of contracts in process at December 31, 2002 and 2001 were $56.7 million and $30.6 million and the gross margin recognized on these contracts through December 31, 2002 and 2001
were approximately $10.3 million and $11.1 million, respectively.



Under the percentage of completion method revenue is recognized on these contracts as work progresses during the period, based on the amount of actual cost incurred during the period compared to total estimated cost to be
incurred for the total contract. Management reviews these estimates on at least a quarterly basis and the effect of any change in cost estimates are reflected in cost of sales in the period in which the change is identified. If the contract is
projected to create a loss, the entire estimated loss is charged to operations in the period such loss first becomes known. A number of internal and external factors affect our cost of sales estimates, including labor rates and efficiency variances,
material usage variances, delivery schedules and testing requirements. Additionally, as inventory items increase in age, obsolete and excess items are charged to cost of sales if the economic conditions of the future sales potential of that
inventory warrant a charge. While we believe that the systems and procedures used by



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the subsidiaries, coupled with
the experience of their management teams, provide a sound basis for our estimates, actual result will differ from managements estimates. The complexity of the estimation process and issues related to the assumptions, risks and uncertainties
inherent with the application of the percentage of completion method affect the amounts reported in our financial statements.



The company adopted the Financial Accounting Standards Board (FASB) Statements of Financial Accounting Standards
(SFAS) No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets on accounting for business combinations and goodwill as of the beginning of fiscal year 2002. Accordingly, the Company
no longer amortizes goodwill from acquisitions, but continues to amortize other acquisition-related intangibles with definitive lives and other costs. As of December 31, 2002, the Company has $10.6 million of goodwill recorded in Other
assets on the Condensed Consolidated Balance Sheet.



In conjunction with the implementation of the new accounting rules for goodwill, the Company completed a goodwill impairment analysis in the 4thquarter of 2002 and did not determine that an impairment charge to earnings was required. As required by the new rules, the Company will perform a similar review each year, or earlier if indicators of
potential impairment exist. The impairment review is based on a discounted cash flow approach that uses estimates of future cash flows discounted at the Companys weighted average cost of capital. The estimates used are consistent with the
plans and estimates that the Company uses to manage the underlying businesses. If market conditions in the Companys related businesses fail to meet expectations, if they become unfavorable, if it causes the entities business model to
negatively change or if it negatively impacts revenue or cost, the Company may incur charges for the impairment of goodwill in future periods.



For intangible assets with definitive lives, the Company amortizes the cost over the estimated useful life and assesses any impairment by
estimating the future cash flow from the associated asset in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. As of December 31, 2002, the Company had $4.1 million of intangible assets with
definitive lives recorded in Other assets, which includes patents, customer lists, trademarks, etc. If the estimated undiscounted cash flow related to these assets decreases in the future or the useful life is shorter than originally
estimated, the Company may incur charges to reflect the impairment of these assets. The impairment is based on the estimated discounted cash flow associated with the assets or the related business segment. Impairment could result if the underlying
technology fails to gain market acceptance, if the products fail to gain expected market acceptance or if the market conditions in the related businesses are unfavorable.



Inventories are stated at the lower of cost or market. Cost is determined based on a first-in, first-out
basis. The Companys inventory includes raw materials, work-in process and finished goods of $9.4 million as of December 31, 2002. The Company reviews its recorded inventory and estimates a write-down for obsolete or slow-moving items to their
net realizable value. The write-down is based on current and forecasted demand and the age of the item, and therefore, if actual demand and market conditions are less favorable than those projected by management, additional write-downs may be
required.



The Company is subject to taxation by
federal, state and international jurisdictions. The Companys annual provision for income taxes and the determination of the resulting deferred tax assets and liabilities involve a significant amount of management judgment and are based on the
best information available at the time. The actual income tax liabilities to the jurisdictions with respect to any fiscal year are normally determined within nine months after the financial statements have been published. The Company believes that
it has recorded adequate liabilities and reviews those balances on a quarterly basis.



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Judgment is
also applied in determining whether deferred tax assets will be realized in full or in part. When it is more likely than not that all or some portion of specific deferred tax assets such as foreign tax credit carryovers will not be realized, a
valuation allowance is established for the amount of the deferred tax assets that are determined not to be realizable. Accordingly, if the Companys prospects or financial results were to change thereby impacting the likelihood of realizing the
deferred tax assets, judgment will be applied to determine changes to the amount of the valuation allowance required to be in place on the financial statements in any given period. The Company continually evaluates strategies that could allow the
future utilization of its deferred tax assets.



Acquisitions



In
June and July, 2002, Allied acquired all of the outstanding capital stock of Titan and SeaSpace in exchange for aggregate consideration of 293,070 shares of Common Stock and cash of $5.0 million. Allied used the purchase method of accounting to
account for these acquisitions. Accordingly, the results of Titan and SeaSpace are included in the Companys consolidated financial statements since the date of each acquisition. The purchase price for each acquisition was apportioned to the
acquired assets and liabilities at fair value. The excess purchase price over estimated fair value of the net assets acquired was recorded as goodwill. In accordance with the transition provisions of SFAS 142, goodwill related to these acquisitions
is not being amortized. Other intangible assets acquired in these acquisitions were recorded at fair value and are being amortized over their useful lives.



Trends In Operations



The Ordnance & Manufacturing and Electronic Security segments continued to be the major contributors to the profitability of the
Company in 2002. The Environmental Safety & Security and Software, Training & Simulation segments were added in the second and third quarters of the current year and had a minor positive impact on the profits generated during 2002. The
Company is evaluating further expansion in each segment via strategic acquisitions.



MECAR operated its facilities throughout 2002 without any operational capacity issues, although continued growth could require MECAR to seek additional capacity in both plant and labor. The majority of
MECARs revenues resulted from orders from its traditional customer base. The unit was awarded a United States Foreign Military Sales contract for the benefit of one of their customers that will continue to have an impact on revenue and profit
over the next 24 months. MECARs gross margin declined in 2002 from the record levels achieved in 2001 due to a one-time development contract which had a very favorable impact on 2001 results.



The VSK Group recorded another profitable year in 2002. The
business unit contributed approximately $21.1 million in revenue and $2.1 million in net income to consolidated activity.



Three new units impacted operations during the year. Microwave was acquired by the Company on December 31, 2001 and produced a full
years worth of activity in 2002. The unit generated $10 million in revenue and $0.2 million in net income during the first year of full operations. Microwave anticipates significant growth over the next several years as the demand for its
integrated surveillance solutions accelerates to meet the needs of national, state and local law enforcement agencies and for homeland defense. Titan and SeaSpace were acquired in June and July, respectively, in 2002 and combined contributed
slightly over $4 million in revenue and $0.2 million in net income. Orders activity within Microwave is heavily dependent on the timeliness of the Department of Homeland Security reorganization as well as the congressional budget approval process
which authorizes operational funds for that particular department. During the fourth quarter of 2002, Microwave experienced a softening of orders attributed to the above-mentioned Homeland Security reorganization. The company expects that the
congressional funding process for Homeland Security will be completed during 2003 and Microwave will be an active participant on government contracts issued by agencies within the Department.



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In future
periods, Allieds operations will continue to be materially impacted by MECARs ability to obtain orders from its current customer base, by MECARs ability to expand into other international markets, by Allieds ability to
successfully diversify into other strategic business segments.



Trends In Liquidity And Capital Resources



In June 2002, the Company sold a convertible debenture and stock purchase warrant for $7.5 million. Approximately $5 million of the proceeds were used by the Company to complete the Titan and SeaSpace acquisitions with a
portion of the remaining funds directed to support the working capital needs of Microwave and Titan. The debenture is repayable in ten (10) monthly installments beginning in mid-2003 and is expected to be repaid from Allied cash and/or dividends
received from MECAR and/or the VSK Group.



Future
cash flow will be generated from internal operations and financial support from the European bank syndicate. SeaSpace has access to a Working Line of Credit in the amount of $1.5 million that is available to sustain short term working capital needs.
Allied has made additional investments in Microwave to support its working capital as a result of the delay in receipt of Homeland Security orders. The parent company is financially supported by management fees received by each subsidiary and by
dividends primarily from MECAR and VSK. Allied received approximately $9.1 million in fees and dividends from it operating subsidiaries in 2002.



For the long term, the generation of positive cash flow from core operations will depend upon MECARs ability to continue to receive
orders from its traditional customer base, the ability of MECAR to maintain positive operating margins and the ability of Allied to strategically expand its business segments.



Liquidity



Working capital, which includes restricted cash, was approximately $60 million at December 31, 2002, which is an increase of $18.8 million
from the December 31, 2001 level. The increase in working capital is attributed to the sale of the $7.5 million convertible subordinated debenture and the Companys profitable operations in 2002. The Companys current working capital is
required for operations, to support credit facility agreements, to fulfill contractual obligations related to orders, and to continue to implement the Companys growth plans.



During 2002 and 2001, Allied funded its operations principally with internally generated cash, with the
issuance of a convertible debenture and a European credit facility that was renewed in the first quarter of 2002 that gave MECAR access to approximately $50 million of short term credit and bank guarantees.



On June 28, 2002, the Company sold to an accredited investor
$7.5 million of an 8% subordinated debenture convertible into shares of the Companys common stock at $25.00 per share. The investor also acquired warrants to purchase 15,000 shares of the Companys common stock at an exercise price of
$28.75 per share.



Accounts receivable at
December 31, 2002 increased over 2001 levels by $8.9 million principally due to higher sales in the fourth quarter of 2002, which included activity from Microwave, Titan and SeaSpace. Accounts receivable of Microwave, Titan and SeaSpace totaled $4.5
million at the end of 2002. Costs and accrued earnings on uncompleted contracts increased by $36.4 million from year-end 2001 levels as a result of increased amounts of work-in-progress at the end of 2002. Inventories increased by $3.2 million from
2001 levels, primarily from the additions of Microwave, Titan and SeaSpace. Fair value of foreign exchange contracts increased primarily as a result of the larger nominal amounts of hedge contracts outstanding in 2002 and the stronger Euro in
relation to the U.S. dollar. The asset is offset by an identical deferred credit in current liabilities. Intangibles increased from 2001 levels due to the Titan and SeaSpace acquisitions.



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MECAR
typically obtains orders for its ammunition and weapon systems that require credit facilities to provide import letters of credit, advance payment guarantees and performance bonds. These needs have been met in the last few years via agreements with
a five member international bank syndicate of which the lead bank is based in Belgium. While the bank syndicate agreement provides that MECAR is responsible to repay the syndicate for amounts paid by the banks pursuant to the guarantees/bonds, the
financial terms stipulate that all such obligations be secured, in part, by a cash pledge. At December 31, 2002, MECARs lenders had issued $18.3 million of guarantees/performance bonds and MECAR had pledged $7.4 million of cash.



The bank syndicate agreement provides the banks the right to
review and approve each proposed MECAR contract before agreeing to provide the necessary letters of credit, guarantee and/or bond. While management believes that it will be able to finance additional MECAR contracts using the bank syndicate
structure, there can be no assurance that such financing will be unconditionally and permanently provided.



The bank syndicate agreement provides (i) lines of credit aggregating $13.2 million for tax prepayments and working capital and (ii) a
facility for guarantees/bonds to support customer contracts of $38.6 million. The financial lending terms and fees are denominated in Euros and the dollar equivalents will fluctuate according to global economic conditions.



The revised bank agreement, as executed in March of 2002,
eliminates most restrictions on cash transfers by MECAR to Allied or other Allied group companies. However, the new agreement imposes two new financial covenants requiring MECAR to maintain minimum net worth and working capital levels. As of
December 31, 2002, MECAR was not in violation of either of these two bank covenants. MECARs obligations under the bank syndicate agreement continue to be collateralized by a pledge of MECARs assets and add a second mortgage on
MECARs facility. The agreement includes Allieds pledge to support MECAR so that it remains in compliance with its total borrowing obligations.



MECAR has a mortgage loan with one member of its bank pool and this loan is guaranteed by a foreign government agency. The outstanding
balance was approximately $1.0 million at December 31, 2002. Principal and interest payments on the mortgage loan extend through January, 2004, and the loan includes a prepayment penalty clause.



The VSK Group operated throughout 2002 solely from cash
generated from normal business activity. The VSK Group is obligated on several mortgages and other long-term obligations with December 31, 2002 balance aggregating $0.8 million.



Microwave & Titan operated in 2002 from cash generated from operations and cash infusions by Allied.
SeaSpace operated in 2002 from cash generated from operations.



On January 1, 1999, eleven member countries of the European Union adopted the Euro as their common legal currency and established fixed conversion rates between their existing sovereign currencies and the Euro. Commencing January 1,
2002, the participating countries introduced Euro notes and coins and began to withdraw all other existing currencies from circulation.



Allied will continue to evaluate all issues involving the introduction of the Euro as further accounting, tax and governmental legal and
regulatory guidance becomes available. Based on current information and Allieds current assessment, Allied does not expect that the Euro conversion will have a material and adverse effect on its business or financial condition.



In September 1998, Allieds Board of Directors authorized
the purchase of up to 200,000 shares of Allieds common stock. During 2000 and 1999, Allied repurchased 75,688 and 22,600 shares of its common stock in market transactions. The Company did not repurchase shares in 2002 or 2001 and does not
anticipate repurchasing shares of Company stock in calendar year 2003.





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Allieds
ability to cover its anticipated future operating, debt servicing and capital requirements is dependent upon its ability to generate positive cash flow from the operations of its subsidiaries and to be able to dividend a portion of available cash
back to the parent company.



Capital Resources



Allied spent $6.3 million in 2002 on
capital equipment as compared with $3.1 million in 2001 and $3.9 million in 2000, respectively. The expenditures in 2002 were primarily for operating machinery and building upgrades. Management currently anticipates that it will spend approximately
$2.3 million, across all the operations, on capital expenditures in 2003 for additional upgrades to its facilities and equipment. A majority of the capital expenditures for 2003 are planned for MECAR and will be spent on production equipment. The
planned capital additions will be denominated in Euros and will be financed by the existing credit facility or new lease facilities negotiated by each business unit.



Contractual Obligations and Commercial Commitments



As described herein and in the notes to the consolidated
financial statements, Allied has contractual obligations and commercial commitments that may affect its financial condition. However, based on managements assessment of the underlying provisions and circumstances of the material contractual
obligations and commercial commitments of Allied, there is no known trend, demand, commitment, event or uncertainty that is reasonably likely to occur which would have a material adverse effect on Allieds financial condition or results of
operations.



The following table identifies
material contractual obligations as of December 31, 2002:



|Contractual Obligations            |  | Payments due by period
|---------------------------------- |  | ----------------------
|                                   |  | Total                 
|Long-Term Debt                     |  | $                     
|Capital Lease Obligations          |  |                       
|Convertible Debenture              |  |                       
|Operating Leases                   |  |                       
|Unconditional Purchase Obligations |  |                       
|                                   |  |                       
|Total Contractual Obligations      |  | $                     
|                                   |  |                       



Results of
Operations



Allied had revenues from
continuing operations of $130.9 million in 2002 compared to $96.9 million in 2001 and to $107.7 million in 2000, respectively. Allied earned profits from continuing operations of $10.7 million in 2002, $10.4 million in 2001 and $8.7 million in 2000.



The following table sets forth, for the years
ended December 31, 2002, 2001 and 2000, certain items from Allieds consolidated statements of operations expressed as a percentage of revenue:



|                           |  | 2002  |   |  | 2001  |   |  | 2000  |  
|-------------------------- |  | ----- | - |  | ----- | - |  | ----- | -
|Revenue                    |  | 100.0 | % |  | 100.0 | % |  | 100.0 | %
|Cost and expenses          |  |       |   |  |       |   |  |       |  
|Cost of sales              |  | 69.9  |   |  | 65.2  |   |  | 74.2  |  
|Selling and administrative |  | 13.9  |   |  | 12.5  |   |  | 10.0  |  
|Research and development   |  | 1.2   |   |  | 1.6   |   |  | 1.5   |  
|                           |  |       |   |  |       |   |  |       |  
|Operating income           |  | 15.0  |   |  | 20.7  |   |  | 14.3  |  



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|                                                        |  | 2002 |   |  | 2001 |   |  | 2000 |  
|------------------------------------------------------- |  | ---- | - |  | ---- | - |  | ---- | -
|Other income (deductions)                               |  |      |   |  |      |   |  |      |  
|Interest income                                         |  | 0.4  |   |  | 0.7  |   |  | 0.6  |  
|Interest expense                                        |  | (1.1 | ) |  | (1.7 | ) |  | (1.4 | )
|Other  net                                             |  | 1.0  |   |  | (0.3 | ) |  | 0.4  |  
|                                                        |  |      |   |  |      |   |  |      |  
|Earnings before discontinued operation and income taxes |  | 15.3 |   |  | 19.3 |   |  | 13.9 |  
|Income tax expense                                      |  | 7.1  |   |  | 8.6  |   |  | 5.8  |  
|                                                        |  |      |   |  |      |   |  |      |  
|Earnings from continuing operations                     |  | 8.2  |   |  | 10.7 |   |  | 8.1  |  
|Discontinued operation                                  |  |     |   |  |     |   |  | 0.5  |  
|                                                        |  |      |   |  |      |   |  |      |  
|Net earnings                                            |  | 8.2  |   |  | 10.7 |   |  | 8.6  |  
|                                                        |  |      |   |  |      |   |  |      |  



The
Companys operating results are exposed to foreign exchange rate fluctuations as financial results of its European subsidiaries are translated from Euros into U.S. Dollars upon consolidation. As exchange rates vary, revenues and other operating
results, when translated by the Company, may differ materially from comparable operating results for prior periods.



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



Revenues



Allieds consolidated revenues from continuing
operations for 2002 increased $33.9 million, or 35%, from the prior year. Revenues from continuing operations for 2001 decreased $10.8 million, or 10%, from 2000 revenues.



|                                |  | Revenues By Segment |     
|------------------------------- |  | ------------------- | ----
|                                |  | 2002                |     
|                                |  | Amount              |     
|                                |  | ($ Millions)        |     
|Ordnance & Manufacturing        |  | $                   | 95.3
|Electronic Security             |  |                     | 31.3
|Environmental Safety & Security |  |                     | 4.0 
|Software, Training & Simulation |  |                     | 0.3 



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The positive
fluctuation within the Ordnance & Manufacturing segment was solely the result of increased activity within MECAR. This included work on the U.S. Foreign Military Sales contract awarded in early 2002. Revenue was slightly affected by a stronger
Euro relative to the U.S. Dollar which positively benefited the segments results by approximately 6%.



The fluctuation in MECARs 2001 revenues from the amount realized in 2000 results principally from a change in MECARs revenue
base. In 2000, MECAR began to receive subcontracts from a Distributor (as opposed to direct contracts from the end user customer). As a result, in 2001 the majority of non-FMS revenue was through the Distributor subcontracts. These subcontracts
generally have lower revenue value than MECARs traditional direct end user sales contracts; however, this subcontract arrangement does not reduce the Companys gross margins since MECARs cost of sales is reduced as a result of its
agreement with the Distributor.



Electronic
Security segment revenues increased by $11.4 million in 2002 and, like the impact within Ordnance & Manufacturing, were affected by the stronger Euro. Microwave was added to the Electronic Security segment in 2002 and contributed $10.3 million
to the segment activity.



Revenues for the
Environmental Safety & Security and the Software, Training & Simulation segments constitute sales generated by Titan and SeaSpace, respectively. These two units were consolidated into the operations as of June 6 and July 31 respectively and
posted a combined $4.3 million in sales for these segments.



Cost of Sales



Cost of goods sold as a percentage of sales for 2002 was approximately 70% compared with 65% for 2001 and 74% for 2000. The increase in production costs relative to those incurred in 2001 was primarily the result of a very favorable
development contract in 2001 with above-average margins. A majority of the margins generated by this one contract were recognized during the third and fourth quarters of 2001. The remaining profit on that contract was recognized by MECAR in the
first quarter of 2002 and had a small impact on the overall margin activity for the year.



The relative improvement in the cost of sales for goods sold in 2001 compared to 2000 resulted primarily from productivity improvements and the increase in the subcontracts awarded via the Distributor
as explained under Revenues  both within Mecar. Certain fees, selling expenses and other customer related expenses in connection with direct sales to customers are not incurred on Distributor subcontracts.



Selling and Administrative Expenses



Selling and administrative expenses increased by $6.1 million
from the prior year. The increase was due primarily to the additions of Microwave, Titan and SeaSpace. Administrative costs at MECAR and VSK only increased $0.4 million from 2001. Microwave was consolidated on a full-year basis while Titan and
SeaSpace were second and third quarter 2002 additions. The effect of the elimination of goodwill amortization, as a result of the implementation of SFAS 141, was immaterial to consolidated activities during the year. In prior years, the amortization
costs were associated with goodwill balances maintained by ARC Europe and VSK.



Selling and administrative expenses increased by 12% in 2001 over expenses incurred in 2000. The increase was due to increased employment related charges at the parent company and increased costs
associated with the review of acquisition opportunities.



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Research and
Development



Research and development
costs increased by $0.1 million from 2001, primarily due to a full-year of activity of Microwave. The costs incurred by Titan and SeaSpace were immaterial to the overall results. However, the Company expects that costs will increase at a modest rate
for Microwave, Titan and SeaSpace in future periods.



Research and development costs incurred in 2001 decreased by 5% from the 2000 level as a result of a portion of the Mecar R & D staff being diverted to work on production projects.



Interest Income



Interest income decreased in the current year by $0.1
million. The decrease was a result of lower rates and less interest earned on cash principally at Mecar.



Interest income was essentially unchanged during the periods 2000 through 2001.



Interest Expense



Interest expense was lower in the current year by $0.3
million. The decrease was a result of lower interest charges on outstanding bank debt at Mecar, offset by interest costs associated with the convertible debenture issued in June.



Interest expenses incurred in 2001 increased by approximately 9% compared to the amount incurred in 2000 and
were largely due to increased borrowings at MECAR.



Other
 Net



Other-Net results were $1.3
million in 2002 (gain) and $0.3 in 2001 (loss). The 2002 results primarily included currency gains based on the strength of the Euro within the European community over the past fifteen months. The Euro is the base currency for the European operating
units.



Pre-Tax Profit From Continuing Operations



|                                |  | Pre-Tax Profit (Loss) By Segment |     
|------------------------------- |  | -------------------------------- | ----
|                                |  | 2002                             |     
|                                |  | ($ Millions)                     |     
|Ordnance & Manufacturing        |  | $                                | 16.4
|Electronic Security             |  |                                  | 3.9 
|Environmental Safety & Security |  |                                  | 0.5 
|Software, Training & Simulation |  |                                  | (0.2
|Corporate and Other             |  |                                  | (0.6



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As described
above, MECARs pre-tax profit was affected by the lack of a similar development contract in 2002 to replace the effect that contract had on operations in 2001. Approximately 95% of the revenue and profits on that development contract were
recorded in 2001.



The net profits for 2002
within the Electronic Security Segment were slightly higher in the current period compared to the prior year. A portion of the improvement was due to lower production costs and the effects of a favorable exchange rate. Profits at Microwave also
contributed to the increase. Electronic Securitys pre-tax profit increase in 2001 from its 2000 level was due to increased operating margins at the VSK Group as a result of production efficiencies and lower administrative expenses.



Pre-tax profit (loss) for the Environmental
Safety & Security segment and the Software, Training & Simulation segment are comprised of pre-tax profit (loss) from operations of SeaSpace and Titan, respectively, from their dates of acquisition. The activities from the two segments had
an immaterial impact on pre-tax profits in 2002. The results for these two segments should show improvement in subsequent quarters at a modest rate of growth.



Income Taxes



The effective income tax expense attributable to continuing operations in 2002, 2001 and 2000 was 46%, 45% and 42%, respectively,
primarily due to foreign rate differentials and permanent tax differences. The statutory tax rate for the European subsidiaries is expected to be reduced by the Belgium parliament from 40.17% to 33.99% and should become effective for 2003.



Net Earnings From Continuing Operations



The Company earned profits of $10.7
million, $10.4 million and $8.7 million in 2002, 2001 and 2000, respectively, from continuing operations.



Discontinued Operations



All results from discontinued operations reported by Allied relate to the operations of BRI and have been reported net of income tax expense or benefits. The Companys 2000 profit of $0.5 million
from discontinued operations is principally comprised of gain on the sale of BRI.



Impact of Year 2000



Through March 1, 2003, the Company has not experienced any significant problems related to the Y2K issue.



Recent Accounting Pronouncements



See Note A to Allieds consolidated financial statements for a description of recently issued accounting pronouncements. Except for
the elimination of periodic amortization of goodwill and the substitution therefore of periodic goodwill impairment testing, Allied does not anticipate that any of such pronouncements will have a material impact on its financial results.



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ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Interest Rate Sensitivity



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



At year-end 2002, Allied had approximately $14.2 million of
fixed-rate indebtedness. Allied has not entered into any interest rate swaps or other derivatives with respect to its indebtedness.



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



Assuming year-end 2002 variable rate
debt and cash available for investment, a one percent change in interest rates would impact net interest income by less than $0.1 million.



Exchange Rate Sensitivity



Allied maintains operations in several foreign countries. Approximately 89% of the Companys revenue from continuing operations was
derived from operations outside the United States. Accordingly, exposure exists to potentially adverse movement in foreign currency rates. Allied uses foreign exchange forward contracts to hedge the risk of change in foreign currency exchange rates
associated with some, but not all, of its contracts in which the expenses for providing services are incurred in currency other than the functional currency of Allieds foreign subsidiaries or payments on contracts are made by the customer in
another currency. The objective of these contracts is to hedge fixed obligations to reduce the effect of foreign currency exchange rate fluctuations on Allieds foreign subsidiaries operating results.



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



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



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



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



The financial statements and supplementary financial information and data required by this Item are set forth in the pages indicated in Item 15(a) (1) and (2).



(See Note U to Allieds consolidated financial statements
for supplementary quarterly financial data required by this item.



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|ITEM 9. |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
|------- |  | -------------------------------------------------------------------------------------



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



PART III



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF ALLIED



Directors



The
following are the directors of Allied:



J. H.
Binford Peay, III, age 63, became a director in April, 2000 and was elected Chairman of the Board, President and Chief Executive Officer in January, 2001. General Peay retired in 1997 as Commander in Chief, United States Central Command, with
responsibility for operations in some 20 countries throughout Africa, the Middle East, Persian Gulf and South Asia. Previously, he was Vice Chief of Staff, U.S. Army. General Peay is currently a director of United Defense Industries, Inc., and a
Trustee of the National Defense University. Previously, he had also been a trustee of Virginia Military Institute Foundation and the George C. Marshall Foundation. General Peay has resigned as Chief Executive Officer as of June 1, 2003 to become
Superintendent of the Virginia Military Institute. He will remain as Chairman of the Board.



John G. Meyer, Jr., age 58, became a director in January, 2003 when he was also elected as President of the Company. He served as Executive Vice President and Chief Operating Officer since January,
2001. He will succeed General Peay as the CEO on June 1, 2003. Mr. Meyer previously retired from the U.S. Army having served as its most senior Public Affairs Officer during his last four (4) years of military service.



J. R. Sculley, age 62, became a director of Allied in 1991 and
currently serves as Chairman Emeritus. He served as Chairman of the Board and Chief Executive Officer from December, 1992 until September, 1999; from April 1992 until December 1992 he served as President and Chief Operating Officer of Allied.
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 55, 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.



Harry H. Warner, age 67, became a director of Allied in early 1996. Throughout the last five years, Mr. Warner has been a self-employed
financial consultant, investor and real estate developer. He is president of the George C. Marshall Foundation and is also a director of Chesapeake Corporation and Virginia Management Investment Corporation, a registered investment advisor.



Ronald H. Griffith, age 64, became a director of
Allied in April, 2000. Mr. Griffith is Executive Vice President and Chief Operating Officer of MPRI, Inc., a professional services company, since 1998. Formerly, he served as Vice Chief of Staff of the U.S. Army.



Gilbert F. Decker, age 65, became a director of Allied in
June, 2002. Mr. Decker is a consultant to companies in the defense and aerospace industries. He previously served as Executive Vice President



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of Engineering and Production
at Walt Disney Imagineering as well as Assistant Secretary of the Army for Research, Development and Acquisitions. Mr. Decker is currently on the board of directors of Alliant Techsystems, Inc. and Anteon International Corporation.



Executive Officers



The following are the executive officers of Allied:



J. H. Binford Peay, III serves as Chairman of
the Board and Chief Executive Officer.



John G.
Meyer, Jr. was elected President in January, 2003 and previously served as Executive Vice President and Chief Operating Officer.



Bruce W. Waddell, age 56, was elected Vice President for Strategic Planning and Corporate Development in January, 2001. He served as a
director of Allied from April, 2000 through mid-January, 2001. Previously, Mr. Waddell was President of The Stonebridge Group, Inc., a management consulting firm specializing in strategy and business development. He previously held management
positions with Avery Dennison and in General Electrics defense and lighting businesses.



Charles A. Hasper, age 48, was elected Treasurer and Chief Financial Officer in August, 2001. Previously, Mr. Hasper served as a partner in CK Capital Partners, an investment banking firm.



ITEM 11. EXECUTIVE COMPENSATION



Compensation of Directors and Executive Officers.



The following table sets forth information concerning all compensation accrued for services rendered in all capacities to the Company and its subsidiaries during the years ended December 31, 2002, 2001
and 2000, to the chief executive officer of Allied and to other executive officers of Allied whose total annual salary and bonus exceeds $100,000:



SUMMARY COMPENSATION TABLE



|                                                             |  | Annual Compensation |  | Long-Term Compensation Awards |         |       
|------------------------------------------------------------ |  | ------------------- |  | ----------------------------- | ------- | ------
|Name and Principal Position                                  |  | Year                |  | Salary                        |         | Bonus1
|                                                             |  |                     |  |                               |        
|                                                             |  |                     |  |                               |        
|                                                             |  |                     |  |                               |        
|J. H. Binford Peay, III,                                     |  | 2002                |  | $                             | 312,500 |       
|Chairman of the Board, President and Chief Executive Officer |  | 2001                |  | $                             | 300,000 |       

---

|1 |  | Cash and stock bonuses approved, on an annual basis, by the Compensation Committee. Mr. Peay was awarded a stock grant in 2002 in the amount of $33,450. In 2001, the
Compensation Committee awarded Messrs. Meyer, Waddell and Hasper with stock grants based on performance objectives issued during the year of $20,000. Stock grants were not awarded to these same officers in 2002.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2 |  | The costs include premiums on life insurance policies. The Company compensated Mr. Peay in the amounts of $69,007 and $67,685, in 2002 and 2001 respectively, for a
$1 million life insurance policy.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3 |  | Stock grants were awarded to Messrs. Peay, Meyer, Waddell and Hasper as part of the employment agreements each executed in 2001.
|- |  | --------------------------------------------------------------------------------------------------------------------------------



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|                                                                |  | Annual Compensation |  | Long-Term Compensation Awards |         |       
|--------------------------------------------------------------- |  | ------------------- |  | ----------------------------- | ------- | ------
|Name and Principal Position                                     |  | Year                |  | Salary                        |         | Bonus1
|John G. Meyer, Jr., Executive                                   |  | 2002                |  | $                             | 196,667 |       
|Vice President and Chief Operating Officer                      |  | 2001                |  | $                             | 160,000 |       
|                                                               
|Bruce W. Waddell,                                               |  | 2002                |  | $                             | 158,750 |       
|Vice President for Strategic Planning and Corporate Development |  | 2001                |  | $                             | 145,000 |       
|                                                               
|Charles A. Hasper, Treasurer                                    |  | 2002                |  | $                             | 160,000 |       
|and Chief Financial Officer                                     |  | 2001                |  | $                             | 66,667  |       



Options Grants in
Last Fiscal Year



The following table
contains information concerning the stock option grants made to each of the named executive officers for the fiscal year ended December 31, 2002.



|                        |  | Individual Grants                               |  | Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term (1)
|----------------------- |  | ----------------------------------------------- |  | --------------------------------------------------------------------------------------------------
|Name                    |  | Number of Securities Underlying Options Granted |  | % of Total Options Granted to Employees in Fiscal Year                                            
|J. H. Binford Peay, III |  | 100,000                                         |  | 46                                                                                                
|John G. Meyer, Jr.      |  | 40,000                                          |  | 18                                                                                                
|Bruce W. Waddell        |  | 40,000                                          |  | 18                                                                                                
|Charles A. Hasper       |  | 40,000                                          |  | 18                                                                                                



|(1) |  | Potential gains are net of exercise price, but before taxes associated with exercise. These amounts represent certain assumed rates of appreciation only, in
accordance with the SECs rule. Actual gains, if any, on stock option exercises are dependent on the future performance of the Common Stock, overall market conditions and the option holders continued employment through the vesting period.
The amounts reflected in this table may not necessarily be achieved
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





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Aggregated Options
Exercised in Last Fiscal Year and Fiscal Year-End Values



The following table sets forth information concerning option exercises and option holdings by each of the named executive officers for the fiscal year ended December 31, 2002.



|Name                    |  | Shares Acquired on Exercise (#) |                 | Value Realized |                   | Number of Securities Underlying/ Unexercised Options /SARsValue |             | Value of Unexercised In-the-Money Options/SARs at FY-End ($) (1)
|----------------------- |  | ------------------------------- | --------------- | -------------- | ----------------- | --------------------------------------------------------------- | ----------- | ----------------------------------------------------------------
|                        |  |                                 | Exercisable (#) |                | Unexercisable (#) |                                                                 | Exercisable |                                                                 
|J. H. Binford Peay, III |  |                                |                 |               |                   | 46,500                                                          |             | 160,000                                                         
|John G. Meyer, Jr.      |  |                                |                 |               |                   | 16,000                                                          |             | 64,000                                                          
|Bruce W. Waddell        |  |                                |                 |               |                   | 16,000                                                          |             | 64,000                                                          
|Charles A. Hasper       |  |                                |                 |               |                   | 16,000                                                          |             | 64,000                                                          



|(1) |  | Represents the closing price per share of the underlying shares on the last day of the fiscal year less the option exercise price multiplied by the number of shares.
The closing price per share was $18.55 on the last trading day of the fiscal year as reported on the AMEX.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Director Compensation



Directors who are employees of Allied receive no additional compensation for serving as a director.



Each non-employee director (an Outside Director)
is compensated for service as a director, including as a member of committees of the Board, at the rate of $1,000 per month; an award of 1,000 shares of Common Stock on each July 1 and an award as of each July 1 of an option to acquire 6,500 shares
of common stock (commencing in 2000). As Chairman Emeritus, Mr. Sculley is entitled to an additional $500 per month.



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. The Directors Retirement Plan was suspended in 2001. Messrs. Christ, Warner and Sculley are entitled to receive benefits under the Plan upon their retirement from the Board for prior
service. No further benefits have accrued or will accrue under the Plan since its suspension in 2001.



In 1991, the Board of Directors of Allied adopted the Outside Directors Stock Option Plan (the Directors Option Plan). 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. Options for an aggregate of 26,000 shares were granted under the Directors
Option Plan in 2001 to Allieds Outside Directors. The Directors Option Plan expired in 2001. In 2002, options for an aggregate of 32,500 shares were granted under the 2001 Equity Incentive Plan to Allieds Outside Directors.



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In 2002, Mr.
Sculley was paid approximately $80,000 in satisfaction of his post-employment severance entitlement. Mr. Sculley is entitled to annual payments of $80,000 through 2005.



Employment Contract and Change-In-Control Arrangements



General Peays employment agreement provides for an
annual salary of $325,000 and the potential to earn an annual bonus up to 50% of the annual salary upon satisfaction of certain performance standards. Upon certain terminations of General Peays employment, he will be entitled to receive his
annual salary, bonus and benefits for a period of up to three (3) years following the termination of employment. Further, if the termination of employment occurs within twelve (12) months of a change of control, the payments may be accelerated into
a lump sum payment at the election of General Peay. General Peay has resigned his position as Chief Executive Officer as of June 1, 2003.



Mr. Meyers employment agreement provides for an annual salary of $200,000 and the potential to earn an annual bonus up to 35% of the
annual salary upon satisfaction of certain performance standards. Upon certain terminations of Mr. Meyers employment, he will be entitled to receive his annual salary for one year following such termination. Further, if the termination of
employment occurs within twelve (12) months of a change of control, the payments may be accelerated into a lump sum payment at the election of Mr. Meyer.



Mr. Waddells employment agreement provides for an annual salary of $160,000 and the potential to earn an annual bonus up to 35% of
the annual salary upon satisfaction of certain performance standards. Upon certain terminations of Mr. Waddells employment, he will be entitled to receive his annual salary for one year following such termination. Further, if the termination
of employment occurs within twelve (12) months of a change of control, the payments may be accelerated into a lump sum payment at the election of Mr. Waddell.



Mr. Haspers employment agreement provides for an annual salary of $160,000 and the potential to earn an annual bonus up to 35% of
the annual salary upon satisfaction of certain performance standards. Upon certain terminations of Mr. Haspers employment, he will be entitled to receive his annual salary for one year following such termination. Further, if the termination of
employment occurs within twelve (12) months of a change of control, the payments may be accelerated into a lump sum payment at the election of Mr. Hasper.



Mr. Sculleys employment with Allied terminated in September, 1999. He is entitled to post-employment payments of $80,000 per year
through 2005. Such amounts are subject to acceleration upon a change of control of Allied.



In June, 2001, the Board of Directors of Allied adopted a new shareholder rights plan (the Rights Plan). The Rights Plan provides each stockholder of record on a dividend distribution 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 acquirer has purchased or has the right to acquire 15% or more of
Allieds common stock, or (2) the commencement of a tender offer which would result in an offeror beneficially owning 15% or more of the outstanding common stock of Allied. All rights held by an acquirer or offeror expire on the announced
acquisition date, and all rights expire at the close of business on May 31, 2011. Each right entitles a stockholder to acquire at a stated purchase price, 1/100 of a share of Allieds preferred stock which carries voting and dividend rights
similar to one share of its common stock. Alternatively, a right holder may elect to purchase for the stated price an equivalent number of shares of Allieds common stock (or in certain circumstances, cash, property or other securities



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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 Rights Plan. 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 Rights Plan prior to exercise.



Compensation Committee Interlocks and Insider Participation



The Compensation Committee of Allied consists of Messrs. Harry H. Warner, Ronald H. Griffith and J. R. Sculley. Mr. Sculley was formerly Chairman of the Board and President of Allied.



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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS



The following information is furnished 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 and is based upon the most recent filings made by the undersigned with the Securities and Exchange Commission:



|Title of Class |  | Name and Address of Beneficial Owner                                                 |  | Amount and Nature of Beneficial Ownership |  | Percent of Class1
|-------------- |  | ------------------------------------------------------------------------------------ |  | ----------------------------------------- |  | -----------------
|Common         |  | Bricoleur Capital Management, LLC2 12230 El Camino Rd., Ste. 100 San Diego, CA 92130 |  | 512,900 Owned directly                    |  | 8.9%             
|Common         |  | FMR Corp.3 82 Devonshire Street Boston, MA 02109                                     |  | 445,000 Owned directly                    |  | 8.4%             
|Common         |  | Dimensional Fund Advisors, Inc.4 1299 Ocean Ave., 11thFloor Santa Monica, CA 90401   |  | 310,400 Owned directly                    |  | 5.4%             
|Common         |  | Riverview Group, LLC5 666 Fifth Avenue New York, New York 10103                      |  | 315,000 Owned directly                    |  | 5.0%             

---

|1 |  | Based upon 5,474,813 shares of common stock outstanding plus 283,332 shares which may be acquired within sixty (60) days pursuant to outstanding stock options plus
315,000 shares which may be issued within sixty (60) days pursuant to a convertible debenture and stock purchase warrant.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2 |  | Bricoleur Capital Management, LLC (Bricoleur) filed an amended Schedule 13G with
the SEC on February 13, 2003. This Schedule 13G states that Bricoleur beneficially owned 512,900 shares of Common Stock as of December 31, 2002.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3 |  | FMR Corp. and its wholly-owned subsidiary, Fidelity Management & Research Company
(Fidelity), Edward C. Johnson, 3rd and Abigail P. Johnson, jointly filed an amended Schedule 13G with the SEC on February 13, 2002. This Schedule 13G states that Fidelity Low-Priced Stock Fund owned 445,000 shares of Common Stock as of
December 31, 2001.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4 |  | Dimensional Fund Advisors, Inc. (Dimensional), a registered investment advisor,
filed an amended Schedule 13G with the SEC on February 10, 2003. This Schedule 13G states that Dimensional is deemed to have beneficial ownership of 310,400 shares, all of which shares are owned by advisory clients of Dimensional. Dimensional
disclaims beneficial ownership of all such shares.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|5 |  | Riverview Group, LLC has the right to acquire up to 315,000 shares within sixty (60) days
pursuant to its convertible debenture and stock purchase warrant
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



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The following
information is furnished as of March 1, 2003, with respect to the beneficial ownership by management of Allieds Common Stock:



|Title of Class |  | Name and Address of Beneficial Owner                |  | Amount and Nature of Beneficial Ownership |  | Percent of Class1
|-------------- |  | --------------------------------------------------- |  | ----------------------------------------- |  | -----------------
|Common         |  | J. H. Binford Peay, III                             |  | 128,4212 Owned directly                   |  | 2.1%             
|Common         |  | John G. Meyer, Jr.                                  |  | 46,8793 Owned directly                    |  | *                
|Common         |  | Harry H. Warner                                     |  | 38,5004 Owned directly                    |  | *                
|Common         |  | Clifford C. Christ                                  |  | 31,5005 Owned directly                    |  | *                
|Common         |  | J. R. Sculley                                       |  | 64,9004 Owned directly                    |  | 1.1%             
|Common         |  | Ronald H. Griffith                                  |  | 22,5004 Owned directly                    |  | *                
|Common         |  | Gilbert F. Decker                                   |  | 7,5005                                    |  | *                
|Common         |  | All executive officers and directors as a group (9) |  | 406,0826 Owned directly                   |  | 6.7%             



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.



Mr. Sculleys employment with the Company terminated in September, 1999. During 2002 and 2001, the Company paid Mr. Sculley approximately $80,000 and $100,000, respectively, in satisfaction of his
post-employment severance entitlement. He is entitled to post-employment payments of $80,000 per year through 2005. Such amounts are subject to acceleration upon a change of control of the Company.



---

|1 |  | Based upon 5,474,813 shares of common stock outstanding plus 283,332 shares which may be acquired within sixty (60) days pursuant to outstanding stock options plus
315,000 shares which may be issued within sixty (60) days pursuant to a convertible debenture and stock purchase warrant.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2 |  | Includes stock options for 99,833 shares which may be exercised within sixty (60) days.
|- |  | ---------------------------------------------------------------------------------------

|3 |  | Includes stock options for 37,333 shares which may be exercised within sixty (60) days.
|- |  | ---------------------------------------------------------------------------------------

|4 |  | Includes stock options for 19,500 shares which may be exercised within sixty (60) days.
|- |  | ---------------------------------------------------------------------------------------

|5 |  | Includes stock options for 6,500 shares which may be exercised within sixty (60) days.
|- |  | --------------------------------------------------------------------------------------

|6 |  | Includes stock options for 270,332 shares which may be exercised within sixty (60) days.
|- |  | ----------------------------------------------------------------------------------------

|* |  | Less than 1%
|- |  | ------------



32



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ITEM 14. DISCLOSURE CONTROLS AND PROCEDURES



Within the ninety (90) days prior to the date of this report, our chief executive officer and our chief financial officer evaluated the effectiveness of the Companys disclosure controls and procedures. Based on that
evaluation, our chief executive officer and our chief financial officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits
under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.



There were no significant changes in our internal controls or, to our knowledge, in other factors that could
significantly affect our disclosure controls and procedures subsequent to the date we conducted the evaluation.



33



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##### Table of Contents



PART IV



ITEM 15. 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 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 Accountants                                                               |  | F-3 
|---------------------------------------------------------------------------------------------------------------- |  | ----
|Consolidated Balance Sheets at December 31, 2002 and 2001                                                        |  | F-4 
|Consolidated Statements of Operations for each of the three years in the period ended
December 31, 2002          |  | F-6 
|Consolidated Statements of StockholdersEquity for each of the three years in the
period ended December 31, 2002 |  | F-7 
|Consolidated Statements of Cash Flows for each of the three years in the period ended
December 31, 2002          |  | F-8 
|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, 2002 and 2001 and for the three years ended December 31, 2002:



|Schedule I  Condensed Financial Information of Allied |  | F-36
|------------------------------------------------------ |  | ----
|Schedule II  Valuation and Qualifying Accounts        |  | F-39



(a)(3) Exhibits:



34



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##### Table of Contents



|Exhibit No. |  | Description of Exhibits                                                                                                                                         
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1         |  | Certificate of Incorporation, as amended (Incorporated by reference from Form 10-Q filed in August
2002).                                                       
|           
|3.2         |  | By-Laws (Incorporated by reference from Form 10-Q filed in August 2002).                                                                                        
|           
|3.3         |  | Rights Agreement between Allied and Mellon Investor Services, LLC (Incorporated by reference from Form 8-K filed in
June 2001).                                 
|           
|10.1        |  | Employment Agreement between Allied and J. H. Binford Peay, III (Incorporated by reference from Form 8-K filed in
March 2001 and Form 8-K filed in August 2001).
|           
|10.2        |  | Employment Agreement between Allied and John G. Meyer, Jr. (Incorporated by reference from Form 8-K filed in March
2001 and Form 8-K filed in August 2001).     
|           
|10.3        |  | Employment Agreement between Allied and Bruce W. Waddell (Incorporated by reference from Form 8-K filed in March 2001
and Form 8-K filed in August 2001).       
|           
|10.4        |  | Employment Agreement between Allied and Charles A. Hasper (Incorporated by reference from Form 8-K filed in August
2001).                                       
|           
|10.5        |  | 2001 Equity Incentive Plan, as amended (Incorporated by reference from Proxy Statements filed in April 2001 and April
2002).                                    
|           
|10.6        |  | 8% Convertible Debenture, Series A and related documents (Incorporated by reference from Form 8-K filed in July
2002).                                          
|           
|10.7        |  | Credit Agreement for MECAR S.A. (Incorporated by reference from Form 10-Q filed in August 2002).                                                                
|           
|10.8        |  | Award/Contract dated as of March 1, 2002, by and between MECAR S.A. and U.S. Government (Incorporated by reference
from Form 10-Q filed in August 2002).        
|           
|10.9        |  | Employee Stock Purchase Plan, as amended (Incorporated by reference from Form 10-Q filed in November
2002).                                                     
|           
|10.10       |  | Lease Agreement, as amended (Incorporated by reference from Form 10-Q filed in November 2002).                                                                  
|           
|10.11       |  | Form of Indemnity Agreement for Directors and Executive Officers (Incorporated by reference from Form 10-Q filed in
November 2002).                             
|           
|10.12       |  | International Distribution Agreement (Incorporated by reference from Form 10-Q filed in November
2002).                                                         
|           
|21          |  | List of Subsidiaries                                                                                                                                            





35



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##### Table of Contents



|23   |  | Consent of Independent Certified Public Accountants
|---- |  | ---------------------------------------------------
|    
|99.1 |  | Certificate Pursuant to U.S.C. Section 1350        



(b) Reports on Form
8-K:



No reports on Form 8-K were filed
during the fourth quarter of 2002.



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.



36



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##### Table of Contents



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.



| |  |  |  |  |  | THE ALLIED DEFENSE
GROUP, INC.
| |  |  |  |  |  | ------------------------------
|
| |  |  |  |  |  |                               
| |  |  |  |  |  |                               
| |  |  |  |  |  |                               



Date: March 26, 2003



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



|      |  |                |  |  |  | By: |  | /s/    JOHN G. MEYER,
JR.                                
|----- |  | -------------- |  |  |  | --- |  | ---------------------------------------------------------
|      |  |                |  |  |  |     |  | John G. Meyer, Jr., President and Chief Operating Officer
|Date: |  | March 26, 2003 |  |  |  |     |  |                                                          
|     
|      |  |                |  |  |  | By: |  | /s/    CHARLES A.
HASPER                                 
|      |  |                |  |  |  |     |  | Charles A. Hasper, Treasurer and Chief Financial Officer 
|Date: |  | March 26, 2003 |  |  |  |     |  |                                                          
|     
|      |  |                |  |  |  | By: |  | /s/    GRESFORD B.
GRAY                                  
|      |  |                |  |  |  |     |  | Gresford B. Gray, Director of Accounting                 
|Date: |  | March 26, 2003 |  |  |  |     |  |                                                          
|      |  |                |  |  |  |     |  | **********                                               
|     
|      |  |                |  |  |  |     |  | /s/    J. R.
SCULLEY                                     
|      |  |                |  |  |  |     |  | J. R. Sculley, Director                                  
|Date: |  | March 26, 2003 |  |  |  |     |  |                                                          
|     
|      |  |                |  |  |  |     |  | /s/    CLIFFORD C.
CHRIST                                
|      |  |                |  |  |  |     |  | Clifford C. Christ, Director                             
|Date: |  | March 26, 2003 |  |  |  |     |  |                                                          
|     
|      |  |                |  |  |  |     |  | /s/    HARRY H.
WARNER                                   
|      |  |                |  |  |  |     |  | Harry H. Warner, Director                                
|Date: |  | March 26, 2003 |  |  |  |     |  |                                                          
|     
|      |  |                |  |  |  |     |  | /s/    RONALD H.
GRIFFITH                                
|      |  |                |  |  |  |     |  | Ronald H. Griffith, Director                             
|Date: |  | March 26, 2003 |  |  |  |     |  |                                                          
|     
|      |  |                |  |  |  |     |  | /s/    Gilbert F.
Decker                                 
|      |  |                |  |  |  |     |  | Gilbert F. Decker, Director                              
|Date: |  | March 26, 2003 |  |  |  |     |  |                                                          



37



---

##### Table of Contents



CERTIFICATION



I,
J. H. Binford Peay, III, certify that:



|1. |  | I have reviewed this annual report on Form 10-K of The Allied Defense Group, Inc.
|-- |  | ---------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this annual report is being prepared;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within ninety (90) days prior to the filing date of this annual
report (the Evaluation Date); and
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) |  | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                     |  |  |  |                                                                            |  | /s/    J. H. BINFORD PEAY,
III
|-------------------- |  |  |  | -------------------------------------------------------------------------- |  | ------------------------------
|Date: March 26, 2003 |  |  |  | J. H. Binford Peay, III, Chairman of the Board and Chief Executive Officer



38



---

##### Table of Contents



CERTIFICATION



I,
John G. Meyer, Jr., certify that:



|1. |  | I have reviewed this annual report on Form 10-K of The Allied Defense Group, Inc.
|-- |  | ---------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this annual report is being prepared;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within ninety (90) days prior to the filing date of this annual
report (the Evaluation Date); and
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) |  | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                     |  |  |  |                                                           |  | /s/    JOHN G. MEYER,
JR.
|-------------------- |  |  |  | --------------------------------------------------------- |  | -------------------------
|Date: March 26, 2003 |  |  |  | John G. Meyer, Jr., President and Chief Operating Officer



39



---

##### Table of Contents



CERTIFICATION



I,
Charles A. Hasper, certify that:



|1. |  | I have reviewed this annual report on Form 10-K of The Allied Defense Group, Inc.
|-- |  | ---------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this annual report is being prepared;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within ninety (90) days prior to the filing date of this annual
report (the Evaluation Date); and
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) |  | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                     |  |  |  |                                            |  | /s/    CHARLES A. HASPER
|-------------------- |  |  |  | ------------------------------------------ |  | ------------------------
|Date: March 26, 2003 |  |  |  | Charles A. Hasper, Chief Financial Officer



40



---

##### Table of Contents



SECURITIES
AND EXCHANGE COMMISSION

Washington, D.C. 20549



FINANCIAL STATEMENTS AND SCHEDULES



December 31, 2002



FORMING A PART OF

ANNUAL REPORT PURSUANT TO

THE SECURITIES EXCHANGE ACT OF 1934



FORM 10-K

OF

The Allied Defense Group Inc.

(Formerly Allied Research Corporation)





F-1



---

##### Table of Contents

The Allied Defense Group Inc.

(Formerly Allied Research Corporation)



INDEX TO FINANCIAL STATEMENTS AND SCHEDULES



|                                                                                                                  |  | Page
|----------------------------------------------------------------------------------------------------------------- |  | ----
|Report of Independent Certified Public Accountants                                                                |  | F-3 
|                                                                                                                 
|Consolidated Balance Sheets at December 31, 2002 and 2001                                                         |  | F-4 
|                                                                                                                 
|Consolidated Statements of Operations for each of the three years in the period ended December 31, 2002           |  | F-6 
|                                                                                                                 
|Consolidated Statements of Stockholders Equity for each of the three years in the period ended December 31, 2002 |  | F-7 
|                                                                                                                 
|Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2002           |  | F-8 
|                                                                                                                 
|Notes to Consolidated Financial Statements                                                                        |  | F-10
|                                                                                                                 
|Schedules as of and for the three years ended December 31, 2002                                                   |  |     
|                                                                                                                 
|Schedule I  Condensed Financial Information of Registrant                                                        |  | F-36
|                                                                                                                 
|Schedule II  Valuation and Qualifying Accounts                                                                   |  | F-39





F-2



---

##### Table of Contents



REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS



Board of Directors

The Allied Defense Group, Inc.



We have audited the accompanying consolidated balance sheets of The Allied Defense Group, Inc. (formerly Allied Research Corporation) and subsidiaries as of December 31, 2002 and 2001 and the related consolidated statements of
operations, stockholders equity and cash flows for each of the three years in the period ended December 31, 2002. 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 auditing standards generally accepted in the United States of America. 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 The Allied
Defense Group, Inc. and subsidiaries as of December 31, 2002 and 2001, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America.



As discussed in Note A to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill and other intangible assets.



We have also audited Schedules I and II for each of the three years in the period ended December 31, 2002. In our opinion,
these schedules present fairly, in all material respects, the information required to be set forth therein.



/s/ Grant Thornton LLP



Baltimore, Maryland

February 7, 2003



F-3



---

##### Table of Contents



The Allied
Defense Group, Inc.

(Formerly Allied Research Corporation)



CONSOLIDATED BALANCE SHEETS



December 31,



|                                                                                        |  | 2002 |             | 2001
|--------------------------------------------------------------------------------------- |  | ---- | ----------- | ----
|ASSETS                                                                                  |  |      |             |     
|CURRENT ASSETS                                                                          |  |      |             |     
|Cash and equivalents                                                                    |  | $    | 14,876,018  |     
|Restricted cash                                                                         |  |      | 8,051,916   |     
|Accounts receivable                                                                     |  |      | 28,564,530  |     
|Costs and accrued earnings on uncompleted contracts                                     |  |      | 56,728,176  |     
|Inventories                                                                             |  |      | 9,408,739   |     
|Deferred tax asset                                                                      |  |      | 305,041     |     
|Fair value of foreign exchange contracts                                                |  |      | 13,594,789  |     
|Prepaid and other current assets                                                        |  |      | 2,885,453   |     
|                                                                                        |  |      |             |     
|Total current assets                                                                    |  |      | 134,414,662 |     
|PROPERTY, PLANT AND EQUIPMENT  AT COST                                                 |  |      |             |     
|Buildings and improvements                                                              |  |      | 15,155,667  |     
|Machinery and equipment                                                                 |  |      | 40,415,265  |     
|                                                                                        |  |      |             |     
|                                                                                        |  |      | 55,570,932  |     
|Less accumulated depreciation                                                           |  |      | 38,181,356  |     
|                                                                                        |  |      |             |     
|                                                                                        |  |      | 17,389,576  |     
|Land                                                                                    |  |      | 1,254,262   |     
|                                                                                        |  |      |             |     
|                                                                                        |  |      | 18,643,838  |     
|OTHER ASSETS                                                                            |  |      |             |     
|Intangibles, less accumulated amortization of $3,109,110 in 2002 and $2,768,998 in
2001 |  |      | 14,717,746  |     
|Deferred tax asset                                                                      |  |      |            |     
|Other assets                                                                            |  |      | 392,169     |     
|                                                                                        |  |      |             |     
|                                                                                        |  |      | 15,109,915  |     
|                                                                                        |  |      |             |     
|                                                                                        |  | $    | 168,168,415 |     
|                                                                                        |  |      |             |     



The
accompanying notes are an integral part of these consolidated financial statements.



F-4



---

##### Table of Contents



The Allied
Defense Group, Inc.

(Formerly Allied Research Corporation)



CONSOLIDATED BALANCE SHEETS  CONTINUED



December 31,



|                                                                                                                                       |  | 2002 |             |   | 2001 |  
|-------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | -
|LIABILITIES AND STOCKHOLDERS
EQUITY                                                                                                   |  |      |             |   |      |  
|CURRENT LIABILITIES                                                                                                                    |  |      |             |   |      |  
|Notes payable                                                                                                                          |  | $    | 6,517,499   |   |      | $
|Current maturities of long-term debt                                                                                                   |  |      | 1,915,167   |   |      |  
|Convertible subordinated debenture, current                                                                                            |  |      | 5,250,000   |   |      |  
|Accounts payable                                                                                                                       |  |      | 30,964,273  |   |      |  
|Accrued liabilities                                                                                                                    |  |      | 7,826,222   |   |      |  
|Customer deposits                                                                                                                      |  |      | 5,092,375   |   |      |  
|Foreign exchange contracts                                                                                                             |  |      | 13,594,789  |   |      |  
|Income taxes                                                                                                                           |  |      | 3,222,121   |   |      |  
|                                                                                                                                       |  |      |             |   |      |  
|Total current liabilities                                                                                                              |  |      | 74,382,446  |   |      |  
|LONG-TERM OBLIGATIONS                                                                                                                  |  |      |             |   |      |  
|Long-term debt, less current maturities                                                                                                |  |      | 4,737,790   |   |      |  
|Convertible subordinated debenture, less current maturities and unamortized
discount                                                   |  |      | 2,028,928   |   |      |  
|Deferred compensation                                                                                                                  |  |      | 394,147     |   |      |  
|Deferred taxes                                                                                                                         |  |      | 110,671     |   |      |  
|                                                                                                                                       |  |      |             |   |      |  
|                                                                                                                                       |  |      | 7,271,536   |   |      |  
|CONTINGENCIES AND COMMITMENTS                                                                                                          |  |      |            |   |      |  
|STOCKHOLDERS EQUITY                                                                                                                   |  |      |             |   |      |  
|Preferred stock, no par value; authorized, 1,000,000 shares; none issued                                                               |  |      |            |   |      |  
|Common stock, par value, $.10 per share; authorized 30,000,000 shares; issued and
outstanding, 5,474,813 in 2002 and 5,129,179 in 2001 |  |      | 547,481     |   |      |  
|Capital in excess of par value                                                                                                         |  |      | 24,870,742  |   |      |  
|Retained earnings                                                                                                                      |  |      | 61,344,989  |   |      |  
|Accumulated other comprehensive loss                                                                                                   |  |      | (248,779    | ) |      |  
|                                                                                                                                       |  |      |             |   |      |  
|                                                                                                                                       |  |      | 86,514,433  |   |      |  
|                                                                                                                                       |  |      |             |   |      |  
|                                                                                                                                       |  | $    | 168,168,415 |   |      | $
|                                                                                                                                       |  |      |             |   |      |  



The
accompanying notes are an integral part of these consolidated financial statements.



F-5



---

##### Table of Contents



The Allied
Defense Group, Inc.

(Formerly Allied Research Corporation)



CONSOLIDATED STATEMENTS OF OPERATIONS



Years ended December 31,



|                                                           |  | 2002 |             |   | 2001 |   |            | 2000 | 
|---------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ---------- | ---- | 
|Revenue                                                    |  | $    | 130,865,817 |   |      | $ | 96,947,263 |      | 
|Cost and expenses                                          |  |      |             |   |      |   |            |      | 
|Cost of sales                                              |  |      | 91,509,072  |   |      |   | 63,253,073 |      | 
|Selling and administrative                                 |  |      | 18,193,843  |   |      |   | 12,108,778 |      | 
|Research and development                                   |  |      | 1,628,535   |   |      |   | 1,504,262  |      | 
|                                                           |  |      |             |   |      |   |            |      | 
|                                                           |  |      | 111,331,450 |   |      |   | 76,866,113 |      | 
|                                                           |  |      |             |   |      |   |            |      | 
|Operating income                                           |  |      | 19,534,367  |   |      |   | 20,081,150 |      | 
|Other income (deductions)                                  |  |      |             |   |      |   |            |      | 
|Interest income                                            |  |      | 506,091     |   |      |   | 644,093    |      | 
|Interest expense                                           |  |      | (1,390,721  | ) |      |   | (1,666,068 | )    | 
|Other  net                                                |  |      | 1,300,383   |   |      |   | (315,592   | )    | 
|                                                           |  |      |             |   |      |   |            |      | 
|                                                           |  |      | 415,753     |   |      |   | (1,337,567 | )    | 
|                                                           |  |      |             |   |      |   |            |      | 
|Earnings before discontinued operation and income taxes    |  |      | 19,950,120  |   |      |   | 18,743,583 |      | 
|Income tax expense                                         |  |      | 9,277,655   |   |      |   | 8,377,004  |      | 
|                                                           |  |      |             |   |      |   |            |      | 
|Earnings from continuing operations                        |  |      | 10,672,465  |   |      |   | 10,366,579 |      | 
|Discontinued operation  engineering and technical segment |  |      |            |   |      |   |           |      | 
|                                                           |  |      |             |   |      |   |            |      | 
|NET EARNINGS                                               |  | $    | 10,672,465  |   |      | $ | 10,366,579 |      | 
|                                                           |  |      |             |   |      |   |            |      | 
|Earnings per share                                         |  |      |             |   |      |   |            |      | 
|Basic                                                      |  |      |             |   |      |   |            |      | 
|Continuing operations                                      |  | $    | 2.01        |   |      | $ | 2.11       |      | 
|Discontinued operation                                     |  |      |            |   |      |   |           |      | 
|                                                           |  |      |             |   |      |   |            |      | 
|Net income                                                 |  | $    | 2.01        |   |      | $ | 2.11       |      | 
|                                                           |  |      |             |   |      |   |            |      | 
|Diluted                                                    |  |      |             |   |      |   |            |      | 
|Continuing operations                                      |  | $    | 1.92        |   |      | $ | 2.10       |      | 
|Discontinued operation                                     |  |      |            |   |      |   |           |      | 
|                                                           |  |      |             |   |      |   |            |      | 
|Net income                                                 |  | $    | 1.92        |   |      | $ | 2.10       |      | 
|                                                           |  |      |             |   |      |   |            |      | 
|Weighted average number of common shares:                  |  |      |             |   |      |   |            |      | 
|Basic                                                      |  |      | 5,304,998   |   |      |   | 4,905,114  |      | 
|                                                           |  |      |             |   |      |   |            |      | 
|Diluted                                                    |  |      | 5,658,274   |   |      |   | 4,947,260  |      | 
|                                                           |  |      |             |   |      |   |            |      | 



The
accompanying notes are an integral part of these consolidated financial statements.



F-6



---

##### Table of Contents



The Allied
Defense Group, Inc.

(Formerly Allied Research Corporation)



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY



Years ended December 31, 2002, 2001 and 2000



|                                       |  | Preferred Stock, no par value |   | Common Stock |                |   | Capital in excess of par value |   |         | Retained earnings |  | Accumulated other comprehensive (loss) income |            |   | Total stockholders equity |  
|-------------------------------------- |  | ----------------------------- | - | ------------ | -------------- | - | ------------------------------ | - | ------- | ----------------- |  | --------------------------------------------- | ---------- | - | -------------------------- | -
|                                       |  | Shares                        |   |              | $.10 par value |   |                                |   |         |                  
|                                       |  |                               |   |              |                |  
|Balance at January 1, 2000             |  | $                             |  |              | 4,836,722      |   |                                | $ | 483,672 |                   |  | $                                             | 13,906,739 |   |                            | $
|Common stock awards                    |  |                               |  |              | 17,000         |   |                                |   | 1,700   |                   |  |                                               | 139,550    |   |                            |  
|Employee stock purchase plan purchases |  |                               |  |              | 16,930         |   |                                |   | 1,693   |                   |  |                                               | 126,821    |   |                            |  
|Exercise stock options                 |  |                               |  |              | 17,500         |   |                                |   | 1,750   |                   |  |                                               | 126,875    |   |                            |  
|Retirement of common stock             |  |                               |  |              | (75,688        | ) |                                |   | (7,569  | )                 |  |                                               | (610,932   | ) |                            |  
|Comprehensive income                   |  |                               |   |              |                |   |                                |   |         |                   |  |                                               |            |   |                            |  
|Net earnings for the year              |  |                               |  |              |               |   |                                |   |        |                   |  |                                               |           |   |                            |  
|Currency translation adjustment        |  |                               |  |              |               |   |                                |   |        |                   |  |                                               |           |   |                            |  
|Total comprehensive income             |  |                               |  |              |               |   |                                |   |        |                   |  |                                               |           |   |                            |  
|                                       |  |                               |   |              |                |   |                                |   |         |                   |  |                                               |            |   |                            |  
|Balance at December 31, 2000           |  | $                             |  |              | 4,812,464      |   |                                | $ | 481,246 |                   |  | $                                             | 13,689,053 |   |                            | $
|Common stock awards                    |  |                               |  |              | 71,400         |   |                                |   | 7,140   |                   |  |                                               | 575,170    |   |                            |  
|Common stock issued                    |  |                               |  |              | 184,777        |   |                                |   | 18,478  |                   |  |                                               | 2,428,522  |   |                            |  
|Employee stock purchase plan purchases |  |                               |  |              | 38,538         |   |                                |   | 3,854   |                   |  |                                               | 281,993    |   |                            |  
|Exercise stock options                 |  |                               |  |              | 22,000         |   |                                |   | 2,200   |                   |  |                                               | 298,430    |   |                            |  
|Comprehensive income                   |  |                               |   |              |                |   |                                |   |         |                   |  |                                               |            |   |                            |  
|Net earnings for the year              |  |                               |  |              |               |   |                                |   |        |                   |  |                                               |           |   |                            |  
|Currency translation adjustment        |  |                               |  |              |               |   |                                |   |        |                   |  |                                               |           |   |                            |  
|Total comprehensive income             |  |                               |  |              |               |   |                                |   |        |                   |  |                                               |           |   |                            |  
|                                       |  |                               |   |              |                |   |                                |   |         |                   |  |                                               |            |   |                            |  
|Balance at December 31, 2001           |  | $                             |  |              | 5,129,179      |   |                                | $ | 512,918 |                   |  | $                                             | 17,273,168 |   |                            | $
|Common stock awards                    |  |                               |  |              | 35,964         |   |                                |   | 3,596   |                   |  |                                               | 784,977    |   |                            |  
|Common stock issued                    |  |                               |  |              | 293,070        |   |                                |   | 29,307  |                   |  |                                               | 6,443,567  |   |                            |  
|Employee stock purchase plan purchases |  |                               |  |              | 9,100          |   |                                |   | 910     |                   |  |                                               | 168,404    |   |                            |  
|Exercise stock options                 |  |                               |  |              | 7,500          |   |                                |   | 750     |                   |  |                                               | 61,125     |   |                            |  
|Warrants issued Comprehensive income   |  |                               |  |              |               |   |                                |   |        |                   |  |                                               | 139,501    |   |                            |  
|Net earnings for the year              |  |                               |  |              |               |   |                                |   |        |                   |  |                                               |           |   |                            |  
|Currency translation adjustment        |  |                               |  |              |               |   |                                |   |        |                   |  |                                               |           |   |                            |  
|Total comprehensive income             |  |                               |  |              |               |   |                                |   |        |                   |  |                                               |           |   |                            |  
|                                       |  |                               |   |              |                |   |                                |   |         |                   |  |                                               |            |   |                            |  
|Balance at December 31, 2002           |  | $                             |  |              | 5,474,813      |   |                                | $ | 547,481 |                   |  | $                                             | 24,870,742 |   |                            | $
|                                       |  |                               |   |              |                |   |                                |   |         |                   |  |                                               |            |   |                            |  



The
accompanying notes are an integral part of these consolidated financial statements.



F-7



---

##### Table of Contents



The Allied
Defense Group, Inc.

(Formerly Allied Research Corporation)



CONSOLIDATED STATEMENTS OF CASH FLOWS



Years ended December 31,



|                                                                                                 |  | 2002 |             |   | 2001 |   |             | 2000 | 
|------------------------------------------------------------------------------------------------ |  | ---- | ----------- | - | ---- | - | ----------- | ---- | 
|Cash flows from (used in) operating activities                                                   |  |      |             |   |      |   |             |      | 
|Net earnings for the year                                                                        |  | $    | 10,672,465  |   |      | $ | 10,366,579  |      | 
|Adjustments to reconcile net earnings to net cash from (used in) continuing operating
activities |  |      |             |   |      |   |             |      | 
|Depreciation and amortization                                                                    |  |      | 3,322,178   |   |      |   | 2,224,844   |      | 
|Gain on sale of subsidiary                                                                       |  |      |            |   |      |   |            |      | 
|(Income) loss from discontinued operation                                                        |  |      |            |   |      |   |            |      | 
|Gain on sale of fixed assets                                                                     |  |      |            |   |      |   |            |      | 
|Deferred income taxes                                                                            |  |      | 793,157     |   |      |   | (702,243    | )    | 
|Provision for estimated losses on contracts                                                      |  |      |             |   |      |   | (329,691    | )    | 
|Common stock awards                                                                              |  |      | 650,573     |   |      |   | 582,310     |      | 
|Changes in assets and liabilities                                                                |  |      |             |   |      |   |             |      | 
|Accounts receivable                                                                              |  |      | (2,572,251  | ) |      |   | (494,411    | )    | 
|Cost and accrued earnings on Uncompleted contracts                                               |  |      | (29,288,574 | ) |      |   | 12,324,767  |      | 
|Inventories                                                                                      |  |      | (3,309,175  | ) |      |   | 1,002,068   |      | 
|Prepaid expenses and other assets                                                                |  |      | 531,489     |   |      |   | 992,182     |      | 
|Accounts payable and accrued liabilities                                                         |  |      | 18,801,433  |   |      |   | (10,633,608 | )    | 
|Customer deposits                                                                                |  |      | 992,784     |   |      |   | (3,489,764  | )    | 
|Income taxes                                                                                     |  |      | 455,488     |   |      |   | 1,688,021   |      | 
|                                                                                                 |  |      |             |   |      |   |             |      | 
|                                                                                                 |  |      | (9,622,898  | ) |      |   | 3,164,475   |      | 
|                                                                                                 |  |      |             |   |      |   |             |      | 
|Net cash provided by (used in) continuing operating activities                                   |  |      | 1,049,567   |   |      |   | 13,531,054  |      | 
|Cash flows from (used in) investing activities                                                   |  |      |             |   |      |   |             |      | 
|Capital expenditures                                                                             |  |      | (6,289,857  | ) |      |   | (3,108,281  | )    | 
|Acquisitions, net of cash acquired                                                               |  |      | (3,810,510  | ) |      |   | (556,181    | )    | 
|Proceeds from sale of discontinued operations                                                    |  |      |            |   |      |   |            |      | 
|Proceeds from sale of fixed assets                                                               |  |      |            |   |      |   | 129,848     |      | 
|                                                                                                 |  |      |             |   |      |   |             |      | 
|Net cash used in investing activities                                                            |  |      | (10,100,367 | ) |      |   | (3,534,614  | )    | 



The
accompanying notes are an integral part of these consolidated financial statements.



F-8



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##### Table of Contents



The Allied
Defense Group, Inc.

(Formerly Allied Research Corporation)



CONSOLIDATED STATEMENTS OF CASH FLOWSCONTINUED



Years ended December 31,



|                                                                       |  | 2002 |            |   | 2001 |   |            | 2000 | 
|---------------------------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | ---- | 
|Cash flows from (used in) financing activities                         |  |      |            |   |      |   |            |      | 
|Net (decrease) increase in short-term borrowings                       |  |      | 3,244,627  |   |      |   | (1,058,481 | )    | 
|Deferred Compensation                                                  |  |      | 299,609    |   |      |   |           |      | 
|Proceeds from convertible subordinated debenture                       |  |      | 7,500,000  |   |      |   |           |      | 
|Debenture issue costs                                                  |  |      | (157,500   | ) |      |   |           |      | 
|Principal payments on long-term debt                                   |  |      | (1,485,855 | ) |      |   | (3,883,738 | )    | 
|Proceeds from issuance of long-term debt                               |  |      | 2,795,674  |   |      |   | 1,307,430  |      | 
|Retirement of common stock                                             |  |      |           |   |      |   |           |      | 
|Proceeds from stock purchases                                          |  |      | 169,315    |   |      |   | 586,577    |      | 
|Option exercises                                                       |  |      | 61,875     |   |      |   |           |      | 
|Restricted cash and restricted deposits                                |  |      | (774,835   | ) |      |   | (3,201,724 | )    | 
|                                                                       |  |      |            |   |      |   |            |      | 
|Net cash provided by (used in) financing activities                    |  |      | 11,652,910 |   |      |   | (6,249,936 | )    | 
|Effects of exchange rates on cash                                      |  |      | 1,352,284  |   |      |   | (395,238   | )    | 
|                                                                       |  |      |            |   |      |   |            |      | 
|Net increase in cash and equivalents                                   |  |      | 3,954,394  |   |      |   | 3,351,266  |      | 
|Cash and equivalents at beginning of year                              |  |      | 10,921,624 |   |      |   | 7,570,358  |      | 
|                                                                       |  |      |            |   |      |   |            |      | 
|Cash and equivalents at end of year                                    |  | $    | 14,876,018 |   |      | $ | 10,921,624 |      | 
|                                                                       |  |      |            |   |      |   |            |      | 
|Supplemental Disclosures of Cash Flow Information:                     |  |      |            |   |      |   |            |      | 
|Cash paid during the year for                                          |  |      |            |   |      |   |            |      | 
|Interest                                                               |  | $    | 534,516    |   |      | $ | 1,691,880  |      | 
|Income taxes                                                           |  |      | 9,509,528  |   |      |   | 6,939,330  |      | 
|Supplemental of Non-Cash Investing and Financing
Activities:           |  |      |            |   |      |   |            |      | 
|Non-cash consideration in connection with business acquisition         |  | $    | 6,473,000  |   |      | $ | 6,833,311  |      | 
|Warrants issued in conjunction with convertible subordinated debenture |  |      | 139,500    |   |      |   |           |      | 
|Convertible debenture beneficial conversion feature                    |  |      | 138,000    |   |      |   |           |      | 



The
accompanying notes are an integral part of these consolidated financial statements.



F-9



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##### Table of Contents



The Allied
Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE A  SUMMARY OF SIGNIFICANT 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 The Allied Defense Group Inc. (Allied), a
Delaware corporation, and its wholly-owned subsidiaries, ARC Europe, S. A. (ARC Europe), a Belgian company, Allied Research Corporation Limited (Limited), an inactive United Kingdom company, News/Sports Microwave Rental, Inc. (Microwave), a
California corporation, Titan Dynamics Systems, Inc., (Titan Dynamics Systems), a Texas corporation, and SeaSpace Corporation (SeaSpace), a California corporation. Microwave, Titan Dynamics Systems and SeaSpace were acquired on December 31, 2001,
June 6, 2002 and July 31, 2002, respectively. The results of operations of Microwave, Titan and SeaSpace are included in the consolidated statements of operations subsequent to their respective acquisition dates. The operations of a former
subsidiary, Barnes & Reinecke, Inc. (BRI), a Delaware corporation, are classified as discontinued operations.



ARC Europe includes its wholly-owned subsidiaries MECAR S.A. (MECAR), Sedachim, S.I. (Sedachim) and the VSK Group. The VSK Group is comprised of VSK
Electronics N.V. and its wholly-owned subsidiaries, Tele Technique Generale, S.A., I.D.C.S., N.V., Belgian Automation Units, N.V. and Vigitec S.A. (Vigitec).



The Company operates in four (4) principal segments. MECAR engages principally in the development and production of medium caliber tank ammunition and
mortars (Ordnance & Manufacturing Segment, formerly the Product Sales Segment). The VSK Group and Microwave engage in the design, manufacture, distribution and service of industrial and law enforcement security products and systems (Electronic
Security Segment, formerly the Security Systems & Services Segment). Titan Dynamics Systems engages in the design, manufacture and sale of battlefield effects simulators (Software, Training & Simulation Segment). SeaSpace Corporation engages
in the design, manufacture, distribution and service of weather and environmental satellite ground reception systems (Environmental Safety & Security Segment). ARC Europe has no operating activities. Allied, the parent company, that provides
management services to its subsidiaries, has no operating activities.



Significant intercompany transactions have been eliminated in the consolidation.



Foreign Currency Translation



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



Revenue and Cost Recognition



Revenues under fixed price contracts are recognized on the
percentage-of-completion method measured by costs incurred to total estimated costs at completion. Provision for estimated losses and penalties 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.



F-10



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE A  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIESContinued



Costs and
accrued profits on uncompleted direct and indirect fixed price contracts with foreign governments, direct and indirect U.S. Government foreign military sales contracts, and custom designed domestic security and weather systems, which are billable
upon completion, are carried as costs and accrued earnings on uncompleted contracts.



Revenues from the sale of traditional 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. Revenues from service work rendered are recorded when performed.



In the normal course of the Companys business, it does not bill shipping and handling costs to customers. Shipping and handling costs are included
in cost of sales.



Use of Estimates



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



Inventories



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



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 goodwill and other intangibles acquired in connection
with businesses acquired. The cost of intangibles other than goodwill is amortized to operations on a straight-line basis over their expected lives of three to twenty years. Goodwill acquired prior to July 1, 2001 was amortized through December 31,
2001. Subsequent to such date, and for goodwill acquired subsequent to June 30, 2001, goodwill is not amortized, but is subject to an annual impairment test along with other intangibles, pursuant to the provisions of Statement of Financial
Accounting Standards (SFAS) Nos. 141 and 142. SFAS No. 142 was adopted effective January 1, 2002. The recoverability of carrying values of intangible assets is evaluated on a recurring basis. The primary indicators are current and forecasted
profitability and cash flow of the related business. There have been no adjustments to the carrying values of intangible assets resulting from these impairment tests.



F-11



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE A  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIESContinued



The
following provides comparable effects of adoption of SFAS No. 142 for the years ended December 31, 2002, 2001 and 2000:



|                                                        |  | 2002 |            | 2001 |   | 2000      
|------------------------------------------------------- |  | ---- | ---------- | ---- | - | ----------
|Earnings from continuing operations, as reported        |  | $    | 10,672,465 |      | $ | 10,366,579
|Add back goodwill amortization (net of income taxes)    |  |      |           |      |   | 137,582   
|                                                        |  |      |            |      |   |           
|Adjusted earnings from continuing operations            |  | $    | 10,672,465 |      | $ | 10,504,161
|                                                        |  |      |            |      |   |           
|Earnings from continuing operations per share  basic   |  | $    | 2.01       |      | $ | 2.11      
|Add back goodwill amortization (net of income taxes)    |  |      |           |      |   | .03       
|                                                        |  |      |            |      |   |           
|Adjusted earnings from continuing operations  basic    |  | $    | 2.01       |      | $ | 2.14      
|                                                        |  |      |            |      |   |           
|Earnings from continuing operations per share  diluted |  | $    | 1.92       |      | $ | 2,10      
|Add back goodwill amortization (net of income taxes)    |  |      |           |      |   | .03       
|                                                        |  |      |            |      |   |           
|Adjusted earnings from continuing operations  diluted  |  | $    | 1.92       |      | $ | 2.13      
|                                                        |  |      |            |      |   |           



Derivative
Financial Instruments



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



The Company recognizes the fair value of hedge contracts to which it is a party on its balance sheet. Currency gains and
losses on contracts designated as hedges of foreign currency commitments are deferred and recognized when the measurement of the related foreign currency transactions are recognized as a component of revenue or cost of sales in accordance with
criteria established by SFAS No. 133 and SFAS No. 138.



Stock-Based Compensation



Compensation costs for stock options is measured as the excess, if any, of the quoted market price of the Companys stock at the date of grant over the amount an employee must pay to acquire the stock. Compensation cost for
stock awards is recorded based on the quoted market value of the Companys stock at the time of grant.



The following table presents the pro forma decrease in income that would have been recorded had the fair values of options granted been recognized as compensation expense on a straight-line basis over
the vesting period of the grant:



|                            |  | 2002 |         | 2001 |   | 2000   
|--------------------------- |  | ---- | ------- | ---- | - | -------
|Pro forma                   |  |      |         |      |   |        
|Net earnings decrease       |  | $    | 371,363 |      | $ | 142,062
|Earnings per share decrease |  |      |         |      |   |        
|Basic                       |  |      | .07     |      |   | .03    
|Diluted                     |  |      | .06     |      |   | .03    



F-12



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE A  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIESContinued



The fair
value of each option grant is estimated on the date of grant using the Black-Scholes options pricing model. The weighted average assumptions used in the model were as follows.



|                         |  | 2002  |   |  | 2001  |  
|------------------------ |  | ----- | - |  | ----- | -
|Risk free interest rate  |  | 1.82  | % |  | 4.54  | %
|Expected volatility rate |  | 44.00 | % |  | 40.00 | %
|Expected lives  years   |  | 3     |   |  | 3     |  
|Divided yield            |  |      |   |  |      |  



The pro forma amounts
may not be representative of future amounts since the estimated fair value of stock options is amortized to expense over the vesting period, and additional options may be granted in future periods.



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 on ammunition products as incurred. Provision is made for estimated warranty costs on the sale of security, weather and environmental satellite systems at the
time of the sale.



Income Taxes



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



Earnings Per Common Share



Basic earnings per share amounts have been computed based on the weighted
average number of common shares outstanding. Diluted earnings per share reflects the increase in weighted average common shares outstanding that would result from the assumed exercise of outstanding options, warrants, and convertible debt calculated
using the treasury stock method, unless they are anti-dilutive.



Statement of Cash Flows



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



Reclassifications



Certain items in the 2002 and 2001 financial statements have been reclassified to conform to the current presentation.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE A  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIESContinued



Newly Issued Accounting Standards



In July, 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets
and the associated asset retirement costs. This Statement applies to all entities. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal
operation of a long-lived asset, except for certain obligations of lessees. This Statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company does not anticipate any impact from the adoption of
SFAS No. 143 based on current business activity.



In August 2001,
the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes FASB Statement No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The provisions of the statement are effective for financial statements issued for fiscal years beginning after December 15, 2001. To date, there
has been no impact on current business activity.



In April 2002,
the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 145, Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement 13, and Technical Corrections. SFAS 145 is effective May
15, 2002, except the rescission of SFAS 4 which is effective in fiscal years beginning after May 15, 2002. SFAS 145 rescinds SFAS 4, Reporting Gains and Losses from Extinguishment of Debt, and SFAS 64, Extinguishment of Debt Made to
Satisfy Sinking-Fund Requirements. Accordingly, a gain or loss from a debt extinguishment should not be classified as an extraordinary item unless it meets the criteria for extraordinary item classification in APB Opinion 30, Reporting the
Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring Events and Transactions. SFAS 145 also rescinds SFAS 44, Accounting for Intangible
Assets of Motor Carriers, because transition to the Motor Carrier Act of 1980 is complete and intrastate operating rights have been deregulated.



In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated with Exit on Disposal Activities. SFAS 146 is effective for exits or
disposal activities initiated after December 31, 2002. SFAS 146 provides financial accounting and reporting guidance for costs associated with exit or disposal activities, including one-time termination benefits, contract termination costs other
than for a capital lease, and costs to consolidate facilities or relocate employees. Currently, the Company does not anticipate disposal activity and therefore does not expect any impact from SFAS 146 at this time.



In December 2002, the FASB issued SFAS 148, Accounting for Stock-Based
CompensationTransition and Disclosure: an amendment of FASB Statement No. 123. SFAS 148 allows several methods for an entity to report a voluntary change to the fair value based method of accounting for stock-based employee compensation.
SFAS 148 is effective for fiscal years ending after December 15, 2002. The Company is evaluating the transition methods allowed under this standard and accordingly, cannot determine the impact of adoption at this time.



The FASB issued FASB Interpretation (FIN) 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others: an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34. FIN 45 requires guarantors to recognize a
liability for the obligation undertaken in issuing certain guarantees. FIN 45s initial recognition and measurement provisions are effective for guarantees issued or modified after December 31, 2002 and disclosure requirements are effective for
interim or annual periods ending after December 15, 2002. The Company does not anticipate any impact from the adoption of FIN 45 based on current business activity.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE A  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIESContinued



In
January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities: an interpretation of ARB No. 51. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements (AC Section
C51), for certain entities (known as variable interest entities) that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do
not have the characteristics of a controlling financial interest. Variable interest entities are required to be consolidated by their primary beneficiary. The primary beneficiary is the party that absorbs a majority of the entitys expected
losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. A
public enterprise applies FIN 46 to variable interest entities in which the enterprise holds a variable interest that it acquired before February 1, 2003 in the first fiscal year or interim period beginning after June 15, 2003. For nonpublic
enterprises, FIN 46 applies to variable interests in a VIE created before February 1, 2003 no later than the end of the first annual reporting period beginning after June 15, 2003. The Company does not anticipate any impact from the adoption of FIN
46 based on current business activity.



NOTE B 
ACQUISITIONS



Microwave



On December 31, 2001, the
Company acquired all the common stock of Microwave in a transaction accounted for as a purchase. This acquisition was undertaken to provide Allied with a strong position in a high-growth segment of the North American Electronic Security market.



The assets acquired in the acquisition of Microwave are
summarized below:



|Current assets         |  | $ | 2,919,000
|---------------------- |  | - | ---------
|Property and equipment |  |   | 194,000  
|Goodwill               |  |   | 3,068,000
|Intangibles            |  |   | 1,065,000
|Other assets           |  |   | 228,000  
|                       |  |   |          
|Cost of acquisition    |  | $ | 7,474,000
|                       |  |   |          



The cost of acquisition
included cash and expenses of $641,000, a note for $70,000, assumption of $4,316,000 of liabilities, and shares of Allied common stock valued at $2,447,000, based on the market price of the shares. The results of Microwaves operations have
been consolidated since its acquisition on December 31, 2001.



Titan Dynamics Systems



On June 6, 2002, the Company acquired all the common stock of Titan Dynamics Systems in a transaction accounted for as a purchase. This acquisition was undertaken to provide Allied with a strong position in a high-growth segment of
the North American Software, Training & Simulation market.



The assets acquired in the acquisition of Titan Dynamics Systems are summarized below:



|Current assets         |  | $ | 92,000   
|---------------------- |  | - | ---------
|Property and equipment |  |   | 64,000   
|Goodwill               |  |   | 1,345,000
|Intangibles            |  |   | 894,000  
|                       |  |   |          
|Cost of acquisition    |  | $ | 2,395,000
|                       |  |   |          



The cost of acquisition
included cash and expenses of $144,000, assumption of $368,000 of liabilities, and shares of Allied common stock valued at $1,883,000, based on the market price of the shares. The results of Titan Dynamics Systems operations have been
consolidated since its acquisition on June 6, 2002.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE B 
ACQUISITIONSContinued



SeaSpace Corporation



On July 31, 2002,
the Company acquired all the common stock of SeaSpace Corporation in a transaction accounted for as a purchase. This acquisition was undertaken to provide Allied with a strong position in a high-growth segment of the North America Environmental
Safety & Security market.



The assets acquired in the
acquisition of SeaSpace are summarized below:



|Current assets         |  | $ | 4,245,000 
|---------------------- |  | - | ----------
|Property and equipment |  |   | 725,000   
|Goodwill               |  |   | 3,323,000 
|Intangibles            |  |   | 2,495,000 
|Other assets           |  |   | 153,000   
|                       |  |   |           
|Cost of acquisition    |  | $ | 10,941,000
|                       |  |   |           



The cost of acquisition
included cash of $4,500,000 (including a $250,000 holdback provision), expenses of approximately $51,000, assumption of $1,800,000 of liabilities and shares of Allied common stock valued at $4,590,000, based on the market price of the shares. The
results of SeaSpaces operations have been consolidated since its acquisition on July 31, 2002.



Goodwill arising from these transactions are related to the Software, Training & Simulation and Environmental Safety & Security Segments and are not deductible for tax purposes. The costs of
acquisition are subject to adjustments in the event certain contractual provisions are breached.



NOTE C  DISCONTINUED OPERATION



On March 6, 2000, the Company sold the stock of BRI, the engineering and technical segment of its business. Summarized data relating to the discontinued operation of the engineering and technical
segment for the year ended December 31, 2000 is as follows:



|                                      |  | 2000
|------------------------------------- |  | ----
|Results of operations                 |  |     
|Revenue                               |  | $   
|Income before taxes                   |  |     
|Income taxes                          |  |     
|Net income                            |  |     
|Net gain from discontinued operations |  |     
|Gain on sale, net of taxes            |  | $   
|Net income                            |  |     
|                                      |  |     
|                                      |  | $   
|                                      |  |     



NOTE D 
RESTRICTED CASH



MECAR is generally required under the terms
of its contracts for direct and indirect sales to foreign governments to provide performance bonds, advance payment guarantees and letters of credit. The credit facility agreements used to provide these financial guarantees place restrictions on
certain cash deposits and other liens on MECARs assets. VSK has also pledged certain term deposits to secure outstanding bank guarantees.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE D 
RESTRICTED CASHContinued



Restricted cash of
$8,051,916 and $6,211,977 included in current assets at December 31, 2002 and 2001, respectively, was restricted or pledged as collateral for these agreements and other obligations.



NOTE E  ACCOUNTS RECEIVABLE



Accounts receivable at December 31 are comprised as follows:



|                                                                                                                   |  | 2002 |            | 2001
|------------------------------------------------------------------------------------------------------------------ |  | ---- | ---------- | ----
|Direct and indirect receivables from foreign governments                                                           |  | $    | 15,784,591 |     
|Commercial and other receivables, less allowance for doubtful receivables of $232,156 in
2002 and $106,601 in 2001 |  |      | 12,779,939 |     
|                                                                                                                   |  |      |            |     
|                                                                                                                   |  | $    | 28,564,530 |     
|                                                                                                                   |  |      |            |     



NOTE F  PREPAID
AND OTHER CURRENT ASSETS



Advance payments on contracts in
process in 2002 and 2001 of approximately $818,107 and $1,000,440, respectively, were included in prepaid and other current assets.



NOTE G  INTANGIBLE ASSETS



Intangible assets at December 31 are comprised as follows:



|                                          |  | December 31, 2002 |            | December 31, 2001       
|----------------------------------------- |  | ----------------- | ---------- | ------------------------
|Intangible assets subject to amortization |  | Gross Amount      |            | Accumulated Amortization
|Capitalized Software                      |  | $                 | 713,027    |                         
|Customer Lists                            |  |                   | 2,247,000  |                         
|Patents                                   |  |                   | 1,494,000  |                         
|                                          |  |                   |            |                         
|Total                                     |  | $                 | 4,454,027  |                         
|Goodwill                                  |  |                   | 13,372,829 |                         
|                                          |  |                   |            |                         
|Total                                     |  | $                 | 17,826,856 |                         
|                                          |  |                   |            |                         



Consolidated
amortization expense related to intangible assets, excluding goodwill, for 2002 and 2001 was $340,112 and $0, respectively. Intangible assets are being amortized over lives ranging from 3 to 17 years for a weighted average life of 12 years.



The goodwill, net of amortization of $10,603,831 at December 31,
2002 is comprised of $5,936,073 related to the Electronic Security Segment, $3,322,525 related to the Environmental Safety & Security Segment and $1,345,233 related to the Software, Training & Simulation Segment.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE H  CREDIT
FACILITY



The Company is obligated under various credit
agreements (the Agreements) with Mecars foreign bank syndicate that provide credit facilities primarily for letters of credit, bank guarantees, performance bonds and similar instruments required for specific sales contracts. The Agreements
provide for certain bank charges and fees as the line is used, plus fees of 2% of guarantees issued and annual fees of 1.25% based on bonds and guarantees outstanding. These fees are charged to interest expense. As of December 31, 2002, guarantees
and performance bonds of approximately $18 million remain outstanding.



Advances under the Agreements are secured by restricted cash of approximately $8.1 million at December 31, 2002. Amounts outstanding are also collateralized by the letters of credit received under the contracts financed, and a pledge
of approximately $24 million on MECARs assets. Certain Agreements provide for the maintenance of certain net worth levels and other provisions.



NOTE I  ACCRUED LOSSES ON CONTRACTS



The Company provided for accrued losses of $312,716 at December 31, 2002 in connection with the completion of certain contracts in progress. These
contracts are scheduled to be completed in 2003. Accrued contract losses at December 2001 were $382,385. These amounts are included in accrued liabilities.



NOTE J  LONG-TERM DEBT



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



|                         |  | 2002 |           | 2001
|------------------------ |  | ---- | --------- | ----
|Mortgage loan agreements |  | $    | 1,295,263 |     
|Other                    |  |      | 5,357,694 |     
|                         |  |      |           |     
|                         |  |      | 6,652,957 |     
|Less current maturities  |  |      | 1,915,167 |     
|                         |  |      |           |     
|                         |  | $    | 4,737,790 |     
|                         |  |      |           |     



Mortgage Loan
Agreements



The Company entered into a mortgage loan
agreement in 1986, which was amended in 1994, to partially finance the construction of MECARs manufacturing and administration facilities in Belgium, which had a balance due of $987,494 at December 31, 2002. The loan matures in January, 2004.
As amended, the loan is payable in annual principal installments of $493,747. The loan bears interest at rates ranging from 5.60% to 6.95% per year, is collateralized by a mortgage on the Companys real estate and includes a prepayment penalty.
The Company is also obligated on several mortgages on the VSK Groups buildings which have a total balance due of $307,769 at December 31, 2002. The mortgages mature at various dates through 2005 in annual installments of approximately $45,000,
plus interest at rates ranging from 3.9% to 4.5% per year.



Other



The Company is also
obligated on various vehicle, equipment, capital lease obligations and other loans. The notes and leases are generally secured by the assets acquired, bear interest at rates ranging from 3.50% to 8.00% and mature at various dates through 2007.



Scheduled annual maturities of long-term obligations as of
December 31, 2002 are as follows:



|Year |  | Amount    
|---- |  | ----------
|2003 |  | $1,915,167
|2004 |  | 1,950,433 
|2005 |  | 1,201,644 
|2006 |  | 865,717   
|2007 |  | 719,996   





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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE K  CONVERTIBLE SUBORDINATED DEBENTURE



On June 28, 2002 the Company sold to an accredited investor for $7,500,000
(i) an 8% subordinated debenture that is convertible into shares of the Companys common stock at $25.00 per share, subject to adjustment in the event of certain dilutive events, and (ii) warrants to purchase 15,000 shares of the Companys
common stock at an exercise price of $28.75 per share in cash. The debenture bears interest at the rate of 8% per year, payable semi-annually commencing January 1, 2003. The Company may elect to pay the interest in cash or in registered shares of
its common stock. The debenture matures in ten (10) equal monthly principal installments of $750,000 commencing June 28, 2003.



The holder of the debenture may choose to convert all or a portion of the principal amount outstanding into shares of the Companys common stock at
any time before maturity. The Company has registered the shares of common stock issuable in the event the holder elects to convert the debenture and exercise of the warrants. The Company has the option to sell to the issuer up to $3.75 million of
additional debentures and the holder has the right to purchase up to $3.75 million of additional debentures under certain circumstances.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE L  BENEFIT PLANS



The Company instituted a simplified employee pension plan in 2000 for its domestic staff. Contributions to the plan in 2002,
2001 and 2000 were approximately $105,000, $104,000 and $78,000, respectively.



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



NOTE M  CONTINGENCIES AND COMMITMENTS



A suit has been filed against one of the VSK subsidiaries in the Belgian
courts alleging a breach of a non-compete clause within a teaming agreement executed with a claimant in prior years. The suit demands damages of approximately $770,000. Management intends to vigorously defend this suit and believes that it has
meritorious defense to the claim, and therefore no loss provision has been established.



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. U.S. Government sponsored foreign military sales contracts
are subject to U.S. Government review. It is not anticipated that adjustments, if any, with respect to determination of costs under these direct contracts or subcontracts will have a material effect on the Companys consolidated results of
operations or financial position.



MECAR, Microwave and SeaSpace
recognize revenues under fixed price contracts using the percentage of completion method. Estimates of total costs at completion are used to determine the amount of revenue earned. The actual costs on these contracts may differ from the
Companys estimate at completion.



The Company enters into
foreign exchange contracts in the normal course of business to hedge certain sales contracts. These contracts typically mature within twelve months, and forward exchange gains and losses are recognized upon final maturity or at the time the related
foreign currency transaction is recognized. Contracts with a notional amount of $93 million were outstanding as of December 31, 2002 ($32 million at December 31, 2001).



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. Certain of these agreements provide for
severance payments in the event of termination under certain conditions.



The Company leases domestic office space and equipment under operating leases which expire at various dates through 2007. 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, 2002:



|Year |  | Amount  
|---- |  | --------
|2003 |  | $337,200
|2004 |  | 337,200 
|2005 |  | 337,200 
|2006 |  | 337,200 
|2007 |  | 337,200 



Total rental expense
charged to operations approximated $214,000, $136,000 and $137,000, for the years ended December 31, 2002, 2001 and 2000, respectively.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE M  CONTINGENCIES AND COMMITMENTSContinued



The Companys domestic operations do not provide post employment
benefits to its employees. Under Belgian labor provisions, the Company may be obligated for future severance costs for its employees. The Company has provided for known severance costs related to its workforce reductions. After giving effect to
prior workforce reductions, current workloads, expected levels of future operations, severance policies and future severance costs, post employment benefits are not expected to be material to the Companys financial position.



NOTE N  FAIR VALUE OF FINANCIAL INSTRUMENTS



At December 31, 2002 and 2001, the Companys financial instruments
include cash, cash equivalents, receivables, accounts payable, borrowings, forward exchange contracts, guarantees and performance bonds. The face value of cash, cash equivalents, receivables and payables approximate their carrying values because of
the short-term nature of the instruments. The estimated fair value of the other financial instruments and off-balance-sheet credit obligations are as follows:



|                                                                      |  | 2002            |            | 2001                
|--------------------------------------------------------------------- |  | --------------- | ---------- | --------------------
|                                                                      |  | Carrying Amount |            | Estimated Fair Value
|Notes payable and long-term obligations, including current maturities |  | $               | 20,843,531 |                     
|Foreign exchange contracts                                            |  |                 | 18,832,768 |                     
|Off-balance-sheet instruments                                         |  |                 |            |                     
|Guarantees and performance bonds                                      |  |                 |           |                     
|Standby letters of credit                                             |  |                 |           |                     



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.



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



| |  | The fair value of foreign exchange contracts is based on quoted market prices for the same or similar instruments. At December 31, 2002 ,the total fair value was
included in accounts receivable, costs and accrued earnings on uncompleted contracts, and fair value of foreign exchange contracts. At December 31, 2001, the fair value was included in fair value of foreign exchange contracts.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Estimated fair values for off-balance-sheet instruments, which include performance bonds and advance payment guarantees 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.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE O  DERIVATIVE FINANCIAL INSTRUMENTS



In the second quarter of 2001, the Company adopted Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), which establishes accounting and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. SFAS 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The
accounting for the changes in the fair value of the derivative depends on the intended use of the derivative and the resulting designation.



The Company designates its derivatives based upon the criteria established by SFAS 133. For a derivative designated as a fair value hedge, the gain or
loss is recognized in earnings in the period of change together with the offsetting loss or gain on the risk being hedged. For a derivative designated as a cash flow hedge, the effective portion of the derivatives gain or loss is initially
reported as a component of accumulated other comprehensive income (loss) and is subsequently reclassified to earnings when the hedge exposure effects earnings. The ineffective portion of the hedge is reported in earnings immediately.



The Company uses foreign currency future contracts to minimize the foreign
currency exposures that arise from sales contracts with certain foreign customers. Under the terms of these sales contracts, the selling price and certain costs are payable in U.S. dollars rather than the Euro, which is MECARs functional
currency. These futures contracts are designated as fair value hedges since they are designed to lock in the net Euros that will be realized when the amounts due under the sales agreement are received. As a matter of policy, the Company does not
enter into speculative hedge contracts or use other derivative financial instruments. As of December 31, 2002 futures contracts designated as fair value hedges with a $93 million notional amount were outstanding and the fair value of these contracts
was $18.8 million. The Company estimates the fair value of outstanding hedge contracts based on quotes obtained for the derivative contracts. The Company recognizes the fair value of hedge contracts that expire in less than one year as current
assets or liabilities. Those that expire in more than one year are recognized as long-term assets or liabilities.



Gains and losses from settlements of derivative contracts are reported as a component of other income. Net changes in the fair value of derivative
contracts prior to settlement are also reported as a component of other income. There were no net gains or losses realized during the year ended December 31, 2002 from hedge ineffectiveness, from firm commitments that no longer qualifies as fair
value hedges, nor were any amounts excluded from the assessment of hedge effectiveness.



The Companys foreign exchange forward and option contracts expose the Company to credit risks to the extent that the counter parties may be unable to meet the terms of the agreement. The company minimizes such risk by
using major financial institutions as its counterparties. Management does not expect any material loss as result of default by counterparties.



NOTE P  CAPITAL STOCK



During 1998, the Board of Directors authorized the repurchase of up to 200,000 shares of the Companys common stock. During 2000 and 1999, 75,688 and
22,600 shares were reacquired and retired, respectively. No shares were reacquired in 2001 or 2002.



The Company may grant stock options, appreciation rights, incentive options, performance shares and other awards to key executives, management, directors and employees under various plans at prices
equal to or in excess of the market price at the date of the grant. The options for common shares generally are exercisable over a five to ten year period and expire up to ten years from the date of grant. At December 31, 2002, options to acquire
531,000 shares of the Companys common stock were outstanding and 459,187 additional shares were reserved for future issuance under the following plans:



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE P  CAPITAL STOCKContinued



2001 Equity Incentive Plan



During 2001, the Board of Directors and shareholders approved and reserved
240,000 shares of common stock for awards to key employees of the Company and its subsidiaries. In 2002, the Board of Directors and the shareholders authorized the plan to be increased by 250,000 shares. The plan authorized the Compensation
Committee of the Board of Directors to grant stock options, stock appreciation rights, restricted stock, performance shares and cash awards. Each type of grant places certain requirements and restrictions upon the Company and grantee. In 2002,
options to acquire 252,500 shares were granted (135,496 in 2001) and 1,500 shares (1,800 in 2001) were also awarded under the plan. As of December 31, 2002 options to acquire 387,996 shares have been granted. The plan expires in December 2010.



1997 Incentive Stock Plan



During 1997, the Board of Directors and shareholders approved and reserved
225,000 shares of common stock for awards to key employees of the Company and its subsidiaries in the form of stock options and stock awards. The Plan is administered by the Compensation Committee of the Board of Directors, and employees of the
Company and its subsidiaries who are deemed to be key employees by the Committee are eligible for awards under the Plan. At December 31, 2002, a total of 224,805 options and shares had been issued under the plan, including 1,205 and 98,104 shares in
2002 and 2001, respectively.



1992 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 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 2002, 2001 and 2000 9,100 38,538 and 16,930 shares, respectively were issued under
the Plan and $29,879 $48,410 and $21,822 were charged to operations, respectively. A total of 169,112 shares have been issued under the Plan.



1984 Incentive Stock Option Plan



The Company reserved 315,000 shares of common stock for key employees of the Company and its subsidiaries. The plan permitted option grants through March
31, 1994. At December 31, 2002, options for 13,000 shares remain outstanding.



1993 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
2002, 2001 and 2000, the Company granted 5,000, 4,000 and 7,000 shares of common stock subject to the plan and charged $125,000 $32,360 and $52,500 , respectively, to operations. To date, 48,000 shares have been under the plan.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE P  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. During 2001, the Company granted options to purchase a total of 26,000 shares at $7.88 per share. This plan expired in 2001; therefore, no further grants can be made. At
December 31, 2002, options for 45,500 shares remained outstanding.



Other



Stock grants for 52,000 and
48,746 shares of the Companys common stock were made to various employees during 2001 and 1999, respectively. These shares were issued outside of any existing plan and their value of $416,000 and $487,460, respectively, was charged to
operations.



Preferred Share Purchase Rights Agreement



The Board of Directors has adopted a new Preferred Stock
Purchase Rights Agreement in 2001. The Agreement 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 15% or more of the Companys common stock, or (2) the commencement of a tender offer which would result in an offeror beneficially owning 15% 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 May 31, 2011.



Each right under the Preferred Share Purchase Rights Agreement entitles a stockholder to acquire at a purchase price of $50,
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 $50 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 provision of the Agreement prior to exercise of the rights.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE P  CAPITAL STOCKContinued



The following table summarizes option activity:



|                                                                |  | 2002   |                 | 2001 |          | 2000
|--------------------------------------------------------------- |  | ------ | --------------- | ---- | -------- | ----
|                                                                |  |        |                 |      | Weighted |     
|                                                                |  |        |                 |      | Average  |     
|                                                                |  |        |                 |      | Exercise |     
|                                                                |  | Shares |                 |      | Price    |     
|Options outstanding at beginning of year                        |  |        | 286,000         |      |          | $   
|Options granted                                                 |  |        | 252,500         |      |          |     
|Options exercised                                               |  |        | (7,500          | )    |          |     
|Options forfeited                                               |  |        |                |      |          |     
|Options expired                                                 |  |        |                |      |          |     
|                                                                |  |        |                 |      |          |     
|Options outstanding at end of year                              |  |        | 531,000         |      |          | $   
|                                                                |  |        |                 |      |          |     
|Option price range at end of year                               |  | $      | 7.88 to $25.00  |      |          |     
|Option price range for exercised shares                         |  | $      | 8.25 to $  8.25 |      |          |     
|Options exercisable at end of year                              |  |        | 179,000         |      |          |     
|Weighted-average fair value of options, granted during the year |  | $      | 7.10            |      |          |     



The
following table summarizes options outstanding at December 31, 2002:



|Number Outstanding |  | Exercise Prices |               | Weighted Average Exercise Prices |   | Weighted Average Remaining Contractual Life
|------------------ |  | --------------- | ------------- | -------------------------------- | - | -------------------------------------------
|                   |  |                
|278,500            |  | $               | 7.88 to $9.01 |                                  | $ | 8.55                                       
|220,000            |  | $               | 16.40         |                                  | $ | 16.40                                      
|32,500             |  | $               | 25.00         |                                  | $ | 25.00                                      



NOTE Q  MAJOR
CUSTOMERS



The Company derives the majority of its revenues
directly or indirectly from foreign governments (some of which are through the U.S. government via the Foreign Military Sales program), primarily on fixed price contracts. Direct and indirect sales to two agencies of The Kingdom of Saudi Arabia and
Belgium accounted for approximately 65%, 1% and 1% of revenue in 2002, 47%, 30% and 1% of revenue in 2001, and 54%, 23% and 4% of revenue in 2000.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE R  CONCENTRATIONS OF CREDIT RISK



Financial instruments and related items which potentially subject the Company
to concentrations of credit risk consist principally of temporary cash investments, trade receivables and costs and accrued earnings on uncompleted contracts. The Company places its temporary cash investments with high credit quality financial
institutions. Credit risk with respect to trade receivables and costs and accrued earnings on uncompleted contracts are concentrated due to the nature of the Companys customer base. The Company generally receives guarantees and letters of
credit from its foreign customers and performs ongoing credit evaluations of its other customers financial condition. The Companys provision for doubtful accounts for 2001 and 2000 was not significant.



The majority of ammunition sales are to or for the benefit of two agencies of
The Kingdom of Saudi Arabia 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, 2002 and 2001, backlog
orders, believed to be firm, from continuing operations, approximated $156.8 million and $56.0 million, respectively.



Amounts in foreign banks at December 31, 2002 and 2001 were approximately $14.8 million and $14.4 million, respectively. Changes in the value of the U.S.
dollar and other currencies affect the Companys financial position and results of operations since the Company has assets and operations in Belgium and sells its products on a worldwide basis.



NOTE S  OTHER  NET



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



|                                        |  | 2002 |           | 2001 |   |          | 2000 | 
|--------------------------------------- |  | ---- | --------- | ---- | - | -------- | ---- | 
|Net currency transaction gains (losses) |  | $    | 872,463   |      | $ | (436,612 | )    | 
|Miscellaneous  net                     |  |      | 427,920   |      |   | 121,020  |      | 
|                                        |  |      |           |      |   |          |      | 
|                                        |  | $    | 1,300,383 |      | $ | (315,592 | )    | 
|                                        |  |      |           |      |   |          |      | 



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE T  INCOME TAXES



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



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



|         |  | 2002 |            |   | 2001 |   |            | 2000 | 
|-------- |  | ---- | ---------- | - | ---- | - | ---------- | ---- | 
|Domestic |  | $    | (92,852    | ) |      | $ | (1,975,063 | )    | 
|Foreign  |  |      | 20,042,972 |   |      |   | 20,718,646 |      | 
|         |  |      |            |   |      |   |            |      | 
|         |  | $    | 19,950,120 |   |      | $ | 18,743,583 |      | 
|         |  |      |            |   |      |   |            |      | 

|
|

|The |  | Companys provision for income taxes is comprised as follows:
|--- |  | -------------------------------------------------------------



|                                            |  | 2002 |            |   | 2001 |   |           | 2000 | 
|------------------------------------------- |  | ---- | ---------- | - | ---- | - | --------- | ---- | 
|Currently (refundable) payable              |  |      |            |   |      |   |           |      | 
|Domestic                                    |  | $    | 1,781,227  |   |      | $ | 158,644   |      | 
|Foreign                                     |  |      | 8,289,585  |   |      |   | 8,920,896 |      | 
|                                            |  |      |            |   |      |   |           |      | 
|                                            |  |      | 10,070,812 |   |      |   | 9,079,540 |      | 
|Deferred  net                              |  |      | (793,157   | ) |      |   | (702,536  | )    | 
|                                            |  |      |            |   |      |   |           |      | 
|Total attributable to continuing operations |  | $    | 9,277,655  |   |      | $ | 8,377,004 |      | 
|Taxes related to discontinued operation     |  |      |           |   |      |   |          |      | 
|                                            |  |      |            |   |      |   |           |      | 
|Total tax provision                         |  | $    | 9,277,655  |   |      | $ | 8,377,004 |      | 
|                                            |  |      |            |   |      |   |           |      | 



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE T  INCOME TAXESContinued



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



|                              |  | 2002 |   |  | 2001 |   |  | 2000 |  
|----------------------------- |  | ---- | - |  | ---- | - |  | ---- | -
|Taxes at statutory rate       |  | 34.0 | % |  | 34.0 | % |  | 34.0 | %
|Foreign tax rate differential |  | 6.9  |   |  | 6.8  |   |  | 6.3  |  
|Permanent differences         |  |     |   |  | 2.8  |   |  |     |  
|Amortization of intangibles   |  | 1.2  |   |  | 0.3  |   |  | 1.1  |  
|Other                         |  | 4.4  |   |  | 0.8  |   |  | (0.9 | )
|                              |  |      |   |  |      |   |  |      |  
|Income taxes                  |  | 46.5 | % |  | 44.7 | % |  | 40.5 | %
|                              |  |      |   |  |      |   |  |      |  



Foreign loss
carryforwards of $6.6 million were utilized in 2000 for tax reporting purposes.



Foreign tax credit carryforwards of approximately $1,243,000 were available at December 31, 2002, which expire at various dates through 2007.



Deferred tax liabilities have not been recognized for basis differences related to investments in the Companys Belgian and United Kingdom
subsidiaries. These differences, which consist primarily of unremitted earnings intended to be indefinitely reinvested, aggregated approximately $57 million at December 31, 2002. Determination of the amount of unrecognized deferred tax liabilities
attributable to these unremitted earnings is not practicable.



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE T  INCOME TAXES  Continued



Deferred taxes at December 31, 2002 and 2001 are comprised as follows:



|                                                      |  | 2002 |            |   | 2001 |  
|----------------------------------------------------- |  | ---- | ---------- | - | ---- | -
|Current deferred tax asset                            |  |      |            |   |      |  
|Inventory                                             |  | $    | 15,709     |   |      | $
|Compensation Accruals                                 |  |      | 171,341    |   |      |  
|Valuation adjustments                                 |  |      | 165,707    |   |      |  
|Net unrealized exchange loss                          |  |      |           |   |      |  
|Other                                                 |  |      | (47,716    | ) |      |  
|                                                      |  |      |            |   |      |  
|                                                      |  |      | 305,041    |   |      |  
|Noncurrent deferred tax asset (liability)             |  |      |            |   |      |  
|Foreign tax credit carryforwards                      |  |      | 1,243,333  |   |      |  
|Foreign and domestic net operating loss carryforwards |  |      |           |   |      |  
|Depreciation and amortization                         |  |      | (2,348     | ) |      |  
|Deferred Compensation                                 |  |      | 88,695     |   |      |  
|Deferred income                                       |  |      | (239,128   | ) |      |  
|Valuation adjustments                                 |  |      | 42,110     |   |      |  
|                                                      |  |      |            |   |      |  
|Noncurrent deferred tax asset                         |  |      | 1,132,662  |   |      |  
|Valuation allowance                                   |  |      | (1,243,333 | ) |      |  
|                                                      |  |      |            |   |      |  
|Net non-current deferred tax (liability) asset        |  |      | (110,671   | ) |      |  
|                                                      |  |      |            |   |      |  
|Net deferred tax asset                                |  | $    | 194,370    |   |      | $
|                                                      |  |      |            |   |      |  



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



|                                          |  | 2002 |          |   | 2001
|----------------------------------------- |  | ---- | -------- | - | ----
|Prepaid expenses and other current assets |  | $    |         |   |     
|Current deferred tax asset                |  |      | 305,041  |   |     
|Noncurrent deferred tax asset             |  |      |          |   |     
|Noncurrent deferred tax liability         |  |      | (110,671 | ) |     
|                                          |  |      |          |   |     
|                                          |  | $    | 194,370  |   |     
|                                          |  |      |          |   |     



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE U  EARNINGS PER COMMON SHARE



The average outstanding common shares and the stock options used in the basic
and diluted earnings per share (EPS) computations are as follows:



|                                                                   |  | 2002                              |  | 2001       |  | 2000                             
|------------------------------------------------------------------ |  | --------------------------------- |  | ---------- |  | ---------------------------------
|                                                                   |  | Income from continuing operations |  | Net income |  | Income from continuing operations
|Basic EPS                                                          |  |                                   |  |            |  |                                  
|Weighted average number of common shares outstanding               |  | 5,304,998                         |  | 5,304,998  |  | 4,905,114                        
|                                                                   |  |                                   |  |            |  |                                  
|Diluted EPS                                                        |  |                                   |  |            |  |                                  
|Weighted average number of common shares outstanding               |  | 5,304,998                         |  | 5,304,998  |  | 4,905,114                        
|Effect of dilutive securities  stock options and convertible debt |  | 353,748                           |  | 353,748    |  | 42,146                           
|                                                                   |  |                                   |  |            |  |                                  
|Adjusted weighted average number of common shares outstanding      |  | 5,658,746                         |  | 5,658,746  |  | 4,947,260                        
|                                                                   |  |                                   |  |            |  |                                  



The incremental shares
from assumed conversions of options, totaling 32,500 and 20,500 in 2002 and 2000, respectively, are not included in computing the diluted per share amounts, since inclusion of such shares would be anti-dilutive. In 2002, interest expense net of
taxes, of $184,438, was added to net earnings for purpose of computing diluted EPS.



NOTE V  GEOGRAPHIC AREAS AND INDUSTRY SEGMENTS



The Company operates in four (4) principal segments. MECAR engages principally in the development and production of medium caliber tank ammunition and mortars (Ordnance & Manufacturing Segment, formerly the Product Sales
Segment). The VSK Group and Microwave engage in the design, manufacture, distribution and service of industrial and law enforcement security products and systems (Electronic Security Segment, formerly the Security Systems & Services Segment).
Titan Dynamics Systems engages in the design, manufacture and sale of battlefield effects simulators (Software, Training & Simulation Segment). SeaSpace Corporation engages in the design, manufacture, distribution and service of weather and
environmental satellite ground reception systems (Environmental Safety & Security Segment).



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED



NOTE V  GEOGRAPHIC AREAS AND INDUSTRY SEGMENTSContinued



|The |  | Companys foreign operations are conducted by MECAR and the VSK Group.
|--- |  | ----------------------------------------------------------------------



|                                                             |  | 2002 |             |   | 2001 |   |            | 2000 | 
|------------------------------------------------------------ |  | ---- | ----------- | - | ---- | - | ---------- | ---- | 
|Revenues from external customers, from continuing operations |  |      |             |   |      |   |            |      | 
|Ordnance & Manufacturing                                     |  | $    | 95,278,706  |   |      | $ | 77,071,290 |      | 
|Electronic Security                                          |  |      | 31,302,231  |   |      |   | 19,875,973 |      | 
|Environmental Safety & Security                              |  |      | 4,031,756   |   |      |   |           |      | 
|Software Training & Simulation                               |  |      | 253,124     |   |      |   |           |      | 
|                                                             |  |      |             |   |      |   |            |      | 
|                                                             |  | $    | 130,865,817 |   |      | $ | 96,947,263 |      | 
|                                                             |  |      |             |   |      |   |            |      | 
|Interest expense                                             |  |      |             |   |      |   |            |      | 
|Ordnance & Manufacturing                                     |  | $    | 940,868     |   |      | $ | 1,574,002  |      | 
|Electronic Security                                          |  |      | 52,320      |   |      |   | 91,911     |      | 
|Environmental Safety & Security                              |  |      | 948         |   |      |   |           |      | 
|Software Training & Simulation                               |  |      |            |   |      |   |           |      | 
|Corporate and Other                                          |  |      | 396,585     |   |      |   | 155        |      | 
|                                                             |  |      |             |   |      |   |            |      | 
|                                                             |  | $    | 1,390,721   |   |      | $ | 1,666,068  |      | 
|                                                             |  |      |             |   |      |   |            |      | 
|Interest income                                              |  |      |             |   |      |   |            |      | 
|Ordnance & Manufacturing                                     |  | $    | 232,036     |   |      | $ | 321,853    |      | 
|Electronic Security                                          |  |      | 192,687     |   |      |   | 184,742    |      | 
|Environmental Safety & Security                              |  |      | 10,882      |   |      |   |           |      | 
|Software Training & Simulation                               |  |      |            |   |      |   |           |      | 
|Corporate and Other                                          |  |      | 70,486      |   |      |   | 137,498    |      | 
|                                                             |  |      |             |   |      |   |            |      | 
|                                                             |  | $    | 506,091     |   |      | $ | 644,093    |      | 
|                                                             |  |      |             |   |      |   |            |      | 
|Income tax expense (benefit)                                 |  |      |             |   |      |   |            |      | 
|Ordnance & Manufacturing                                     |  | $    | 6,648,355   |   |      | $ | 7,347,311  |      | 
|Electronic Security                                          |  |      | 1,638,207   |   |      |   | 1,431,554  |      | 
|Environmental Safety & Security                              |  |      | 211,578     |   |      |   |           |      | 
|Software Training & Simulation                               |  |      | (47,630     | ) |      |   |           |      | 
|Corporate and Other                                          |  |      | 827,145     |   |      |   | (401,861   | )    | 
|                                                             |  |      |             |   |      |   |            |      | 
|                                                             |  | $    | 9,277,655   |   |      | $ | 8,377,004  |      | 
|                                                             |  |      |             |   |      |   |            |      | 
|Depreciation and amortization                                |  |      |             |   |      |   |            |      | 
|Ordnance & Manufacturing                                     |  | $    | 1,767,603   |   |      | $ | 1,297,356  |      | 
|Electronic Security                                          |  |      | 1,009,532   |   |      |   | 912,879    |      | 
|Environmental Safety & Security                              |  |      | 205,839     |   |      |   |           |      | 
|Software Training & Simulation                               |  |      | 42,678      |   |      |   |           |      | 
|Corporate and Other                                          |  |      | 296,526     |   |      |   | 14,609     |      | 
|                                                             |  |      |             |   |      |   |            |      | 
|                                                             |  | $    | 3,322,178   |   |      | $ | 2,224,844  |      | 
|                                                             |  |      |             |   |      |   |            |      | 



F-31



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE VGEOGRAPHIC
AREAS AND INDUSTRY SEGMENTSContinued



|                                                               |  | 2002 |             |   | 2001 |   |            | 2000 | 
|-------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ---------- | ---- | 
|Segment profit (loss), from continuing operations before taxes |  |      |             |   |      |   |            |      | 
|Ordnance & Manufacturing                                       |  | $    | 16,439,507  |   |      | $ | 17,378,954 |      | 
|Electronic Security                                            |  |      | 3,902,933   |   |      |   | 3,497,515  |      | 
|Environmental Safety & Security                                |  |      | 549,988     |   |      |   |           |      | 
|Software Training & Simulation                                 |  |      | (181,072    | ) |      |   |           |      | 
|Corporate and Other                                            |  |      | (761,236    | ) |      |   | (2,132,886 | )    | 
|                                                               |  |      |             |   |      |   |            |      | 
|                                                               |  | $    | 19,950,120  |   |      | $ | 18,743,583 |      | 
|                                                               |  |      |             |   |      |   |            |      | 
|Segment assets                                                 |  |      |             |   |      |   |            |      | 
|Ordnance & Manufacturing                                       |  | $    | 118,064,985 |   |      | $ | 59,264,836 |      | 
|Electronic Security                                            |  |      | 28,640,795  |   |      |   | 25,797,810 |      | 
|Environmental Safety & Security                                |  |      | 10,832,813  |   |      |   |           |      | 
|Software Training & Simulation                                 |  |      | 2,882,769   |   |      |   |           |      | 
|Corporate and Other(1)                                         |  |      | 7,747,053   |   |      |   | 1,721,186  |      | 
|                                                               |  |      |             |   |      |   |            |      | 
|                                                               |  | $    | 168,168,415 |   |      | $ | 86,783,832 |      | 
|                                                               |  |      |             |   |      |   |            |      | 
|Capital Expenditure for Segment assets                         |  |      |             |   |      |   |            |      | 
|Ordnance & Manufacturing                                       |  | $    | 4,249,674   |   |      | $ | 2,170,480  |      | 
|Electronic Security                                            |  |      | 1,504,120   |   |      |   | 937,801    |      | 
|Environmental Safety & Security                                |  |      | 158,609     |   |      |   |           |      | 
|Software Training & Simulation                                 |  |      | 49,334      |   |      |   |           |      | 
|Corporate and Other                                            |  |      | 328,120     |   |      |   |           |      | 
|                                                               |  |      |             |   |      |   |            |      | 
|                                                               |  | $    | 6,289,857   |   |      | $ | 3,108,281  |      | 
|                                                               |  |      |             |   |      |   |            |      | 



| | (1) |  | Net of intersegment receivables.
| | --- |  | --------------------------------



The following geographic area data includes trade revenues based on customer location and assets based on physical location.



|                                 |  | Geographic Segment Data
|-------------------------------- |  | -----------------------
|                                 |  | 2002                   
|Revenues from external customers |  |                        
|Saudi Arabia                     |  | $                      
|United States(1)                 |  |                        
|Belgium                          |  |                        
|Canada(1)                        |  |                        
|France                           |  |                        
|Other foreign countries          |  |                        
|                                 |  |                        
|                                 |  | $                      
|                                 |  |                        



| | (1) |  | Includes foreign military sales for the benefit of Saudi Arabia.
| | --- |  | ----------------------------------------------------------------



F-32



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##### Table of Contents

The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE VGEOGRAPHIC
AREAS AND INDUSTRY SEGMENTSContinued



|                 |  | Geographic Segment Data
|---------------- |  | -----------------------
|                 |  | 2002                   
|Segment assets   |  |                        
|Belgium          |  | $                      
|United Kingdom   |  |                        
|United States(1) |  |                        
|                 |  |                        
|                 |  | $                      
|                 |  |                        



| | (1) |  | Net of intersegment receivables and investments.
| | --- |  | ------------------------------------------------



|                       |  | 2002 |            | 2001 |   | 2000      
|---------------------- |  | ---- | ---------- | ---- | - | ----------
|Property and equipment |  |      |            |      |   |           
|Belgium                |  | $    | 17,201,500 |      | $ | 12,067,047
|United States          |  |      | 1,442,338  |      |   | 231,657   
|                       |  |      |            |      |   |           
|                       |  | $    | 18,643,838 |      | $ | 12,298,704
|                       |  |      |            |      |   |           



NOTE
WQUARTERLY FINANCIAL DATA (UNAUDITED)



|2002            |  | First Quarter                                 |        | Second Quarter |   | Third Quarter |  | Fourth Quarter |        | Total For Year
|--------------- |  | --------------------------------------------- | ------ | -------------- | - | ------------- |  | -------------- | ------ | --------------
|                |  | (Amounts in thousands, except per share data)
|Revenue         |  | $                                             | 16,928 |                | $ | 27,396        |  | $              | 30,806 |               
|Gross profit    |  |                                               | 5,230  |                |   | 8,278         |  |                | 7,699  |               
|Net earnings    |  |                                               | 1,173  |                |   | 2,151         |  |                | 673    |               
|Per share data: |  |                                               |        |                |   |               |  |                |        |               
|Basic           |  | $                                             | .23    |                | $ | .41           |  | $              | .13    |               
|                |  |                                               |        |                |   |               |  |                |        |               
|Diluted         |  | $                                             | .23    |                | $ | .41           |  | $              | .12    |               
|                |  |                                               |        |                |   |               |  |                |        |               



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The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCONTINUED





NOTE WQUARTERLY
FINANCIAL DATA (UNAUDITED)Continued



|                |  | First Quarter                                 |        | Second Quarter |   | Third Quarter |  | Fourth Quarter |        | Total For Year
|--------------- |  | --------------------------------------------- | ------ | -------------- | - | ------------- |  | -------------- | ------ | --------------
|2001            |  |                                               |        |                |  
|                |  | (Amounts in thousands, except per share data)
|Revenue         |  | $                                             | 17,010 |                | $ | 25,837        |  | $              | 26,847 |               
|Gross profit    |  |                                               | 4,988  |                |   | 7,410         |  |                | 10,043 |               
|Net earnings    |  |                                               | 1,143  |                |   | 2,022         |  |                | 3,203  |               
|Per share data: |  |                                               |        |                |   |               |  |                |        |               
|Basic           |  | $                                             | .23    |                | $ | .41           |  | $              | .65    |               
|                |  |                                               |        |                |   |               |  |                |        |               
|Diluted         |  | $                                             | .23    |                | $ | .41           |  | $              | .65    |               
|                |  |                                               |        |                |   |               |  |                |        |               





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SCHEDULES



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##### Table of Contents



SCHEDULE I
 CONDENSED FINANCIAL INFORMATION OF REGISTRANT



The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)

(Parent Company)



BALANCE SHEETS



December 31,



|                                         |  | 2002 |            |   | 2001 |  
|---------------------------------------- |  | ---- | ---------- | - | ---- | -
|ASSETS                                   |  |      |            |   |      |  
|Cash and equivalents                     |  | $    | 6,157,452  |   |      | $
|Restricted cash                          |  |      | 250,000    |   |      |  
|Investment in subsidiaries               |  |      | 81,759,662 |   |      |  
|Due from subsidiaries                    |  |      | 5,377,804  |   |      |  
|Income tax recoverable                   |  |      | 118,118    |   |      |  
|Deferred taxes                           |  |      | 188,791    |   |      |  
|Deposits and other                       |  |      | 1,054,301  |   |      |  
|                                         |  |      |            |   |      |  
|Total assets                             |  | $    | 94,906,128 |   |      | $
|                                         |  |      |            |   |      |  
|LIABILITIES AND STOCKHOLDERS EQUITY     |  |      |            |   |      |  
|LIABILITIES                              |  |      |            |   |      |  
|Accounts payable and accrued liabilities |  | $    | 904,426    |   |      | $
|Income taxes payable                     |  |      |           |   |      |  
|Deferred tax liability                   |  |      | 146,238    |   |      |  
|Deferred Compensation                    |  |      | 62,104     |   |      |  
|Convertible Debenture                    |  |      | 7,278,928  |   |      |  
|                                         |  |      |            |   |      |  
|Total liabilities                        |  |      | 8,391,696  |   |      |  
|STOCKHOLDERS EQUITY                     |  |      |            |   |      |  
|Common stock                             |  |      | 547,481    |   |      |  
|Capital in excess of par value           |  |      | 24,870,741 |   |      |  
|Retained earnings                        |  |      | 61,344,989 |   |      |  
|Accumulated other comprehensive loss     |  |      | (248,779   | ) |      |  
|                                         |  |      |            |   |      |  
|                                         |  |      | 86,514,432 |   |      |  
|                                         |  |      |            |   |      |  
|                                         |  | $    | 94,906,128 |   |      | $
|                                         |  |      |            |   |      |  



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SCHEDULE I  CONDENSED FINANCIAL INFORMATION OF REGISTRANTCONTINUED



The Allied Defense Group, Inc.

(Formerly
Allied Research Corporation)

(Parent Company)



STATEMENTS OF OPERATIONS



Year ended December 31,



|                                                              |  | 2002 |            | 2001 |   |            | 2000 | 
|------------------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | ---- | 
|Income                                                        |  |      |            |      |   |            |      | 
|Intercompany management fees                                  |  | $    | 3,859,067  |      | $ | 2,870,627  |      | 
|Dividend from subsidiary                                      |  |      | 4,882,855  |      |   |           |      | 
|Other  net                                                   |  |      | 59,874     |      |   | 491,258    |      | 
|                                                              |  |      |            |      |   |            |      | 
|                                                              |  |      | 8,801,796  |      |   | 3,361,885  |      | 
|Costs and expenses                                            |  |      |            |      |   |            |      | 
|Administrative and other                                      |  |      | 4,687,277  |      |   | 5,336,948  |      | 
|                                                              |  |      |            |      |   |            |      | 
|Earnings (loss) before equity in operations of subsidiaries   |  |      | 4,114,519  |      |   | (1,975,063 | )    | 
|Equity in operations of subsidiaries, less dividends received |  |      | 7,349,750  |      |   | 11,779,241 |      | 
|                                                              |  |      |            |      |   |            |      | 
|Earnings before income taxes                                  |  |      | 11,464,269 |      |   | 9,804,178  |      | 
|Income taxes (benefit)                                        |  |      | 791,804    |      |   | (562,401   | )    | 
|                                                              |  |      |            |      |   |            |      | 
|NET EARNINGS                                                  |  | $    | 10,672,465 |      | $ | 10,366,579 |      | 
|                                                              |  |      |            |      |   |            |      | 
|Earnings per common share                                     |  |      |            |      |   |            |      | 
|Basic                                                         |  | $    | 2.01       |      | $ | 2.11       |      | 
|                                                              |  |      |            |      |   |            |      | 
|Diluted                                                       |  | $    | 1.92       |      | $ | 2.10       |      | 
|                                                              |  |      |            |      |   |            |      | 



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SCHEDULE I
 CONDENSED FINANCIAL INFORMATION OF REGISTRANTCONTINUED



The Allied Defense Group, Inc.

(Formerly Allied Research Corporation)

(Parent Company)



STATEMENTS OF CASH FLOWS



Year ended December 31,



|                                                                                      |  | 2002 |             |   | 2001 |   |             | 2000 | 
|------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | ---- | 
|Cash flows from (used in) operating activities                                        |  |      |             |   |      |   |             |      | 
|Net earnings for the year                                                             |  | $    | 10,672,465  |   |      | $ | 10,366,579  |      | 
|Adjustments to reconcile net earnings to net cash from (used in) operating
activities |  |      |             |   |      |   |             |      | 
|Equity in operations of subsidiaries                                                  |  |      | (12,232,605 | ) |      |   | (11,779,241 | )    | 
|Dividend from subsidiary                                                              |  |      | 4,882,855   |   |      |   |            |      | 
|Depreciation and amortization                                                         |  |      | 296,526     |   |      |   | 14,609      |      | 
|Deferred taxes                                                                        |  |      | 952,750     |   |      |   | (721,045    | )    | 
|Common stock awards and grants                                                        |  |      | 650,573     |   |      |   | 582,310     |      | 
|Changes in assets and liabilities                                                     |  |      |             |   |      |   |             |      | 
|Other assets                                                                          |  |      | 341,748     |   |      |   | 844,685     |      | 
|Due to subsidiaries                                                                   |  |      | (2,503,480  | ) |      |   | 1,552,209   |      | 
|Accounts payable and accrued liabilities                                              |  |      | (1,488,974  | ) |      |   | 185,577     |      | 
|Income taxes                                                                          |  |      | (238,118    | ) |      |   | 120,000     |      | 
|                                                                                      |  |      |             |   |      |   |             |      | 
|                                                                                      |  |      | (9,338,725  | ) |      |   | (9,200,896  | )    | 
|                                                                                      |  |      |             |   |      |   |             |      | 
|Net cash provided by (used in) operating activities                                   |  |      | 1,333,740   |   |      |   | 1,165,683   |      | 
|Cash flows from investing activities                                                  |  |      |             |   |      |   |             |      | 
|Capital expenditures                                                                  |  |      | (328,121    | ) |      |   |            |      | 
|Acquisitions                                                                          |  |      | (4,895,000  | ) |      |   | (556,181    | )    | 
|Proceeds from sale of subsidiary                                                      |  |      |            |   |      |   |            |      | 
|                                                                                      |  |      |             |   |      |   |             |      | 
|Net cash (used in) provided by investing activities                                   |  |      | (5,223,121  | ) |      |   | (556,181    | )    | 
|Cash flows from financing activities                                                  |  |      |             |   |      |   |             |      | 
|Proceeds from convertible subordinated debenture                                      |  |      | 7,500,000   |   |      |   |            |      | 
|Debenture issue costs                                                                 |  |      | (157,500    | ) |      |   |            |      | 
|Proceeds from employee stock purchase plan shares                                     |  |      | 169,315     |   |      |   | 586,577     |      | 
|Option exercises                                                                      |  |      | 61,875      |   |      |   |            |      | 
|Restricted cash                                                                       |  |      | (250,000    | ) |      |   |            |      | 
|                                                                                      |  |      |             |   |      |   |             |      | 
|Net cash provided by (used in) financing activities                                   |  |      | 7,323,690   |   |      |   | 586,577     |      | 
|                                                                                      |  |      |             |   |      |   |             |      | 
|Net increase (decrease) in cash and equivalents                                       |  |      | 3,434,309   |   |      |   | 1,196,079   |      | 
|Cash and equivalents at beginning of year                                             |  |      | 2,723,143   |   |      |   | 1,527,064   |      | 
|                                                                                      |  |      |             |   |      |   |             |      | 
|Cash and equivalents at end of year                                                   |  | $    | 6,157,452   |   |      | $ | 2,723,143   |      | 
|                                                                                      |  |      |             |   |      |   |             |      | 
|Supplemental Disclosures of Cash Flow Information:                                    |  |      |             |   |      |   |             |      | 
|Cash paid during the year for:                                                        |  |      |             |   |      |   |             |      | 
|Income taxes                                                                          |  | $    | 360,070     |   |      | $ | 44,367      |      | 
|Interest                                                                              |  |      | 36,415      |   |      |   | 155         |      | 
|Supplemental of Non-Cash Investing and Financing Activities:                          |  |      |             |   |      |   |             |      | 
|Non-cash consideration in connection with business acquisition                        |  | $    | 6,473,000   |   |      | $ | 6,833,311   |      | 
|Warrants issued in conjunction with convertible debenture                             |  |      | 139,500     |   |      |   |            |      | 
|Convertible debenture beneficial conversion feature                                   |  |      | 138,000     |   |      |   |            |      | 



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SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS



The Allied Defense Group, Inc.

(Formerly Allied Research
Corporation)



Valuation and Qualifying
Accounts



Years ended December 31, 2002,
2001 and 2000



|                                            |  |                                |           | Additions                     |   |                           |  |            |  
|------------------------------------------- |  | ------------------------------ | --------- | ----------------------------- | - | ------------------------- |  | ---------- | -
|Description                                 |  | Balance at beginning of period |           | Charged to costs and expenses |   | Charged to other accounts |  | Deductions |  
|Year ended December 31, 2002                |  |                                |           |                               |   |                           |  |            |  
|Estimated losses on contracts               |  | $                              | 382,385   |                               | $ | 312,716                   |  | $          | 
|                                            |  |                                |           |                               |   |                           |  |            |  
|Allowance for doubtful receivables          |  | $                              | 106,601   |                               | $ | 125,555                   |  | $          | 
|                                            |  |                                |           |                               |   |                           |  |            |  
|Valuation allowance on inventory            |  | $                              | 150,000   |                               | $ | 50,000                    |  | $          | 
|                                            |  |                                |           |                               |   |                           |  |            |  
|Valuation allowances on deferred tax assets |  | $                              | 270,661   |                               | $ | 972,672                   |  | $          | 
|                                            |  |                                |           |                               |   |                           |  |            |  
|Year ended December 31, 2001                |  |                                |           |                               |   |                           |  |            |  
|Estimated losses on contracts               |  | $                              | 712,076   |                               | $ | 382,385                   |  | $          | 
|                                            |  |                                |           |                               |   |                           |  |            |  
|Allowance for doubtful receivables          |  | $                              | 153,840   |                               | $ |                          |  | $          | 
|                                            |  |                                |           |                               |   |                           |  |            |  
|Valuation allowances on deferred tax assets |  | $                              | 288,399   |                               | $ |                          |  | $          | 
|                                            |  |                                |           |                               |   |                           |  |            |  
|Year ended December 31, 2000                |  |                                |           |                               |   |                           |  |            |  
|Estimated losses on contracts               |  | $                              | 172,572   |                               | $ | 712,076                   |  | $          | 
|                                            |  |                                |           |                               |   |                           |  |            |  
|Allowance for doubtful receivables          |  | $                              | 168,682   |                               | $ |                          |  | $          | 
|                                            |  |                                |           |                               |   |                           |  |            |  
|Valuation allowances on deferred tax assets |  | $                              | 1,379,239 |                               | $ |                          |  | $          | 
|                                            |  |                                |           |                               |   |                           |  |            |  



|(1) |  | Represents amount of reserve relieved through completion of contracts.
|--- |  | ----------------------------------------------------------------------

|(2) |  | Represents write-off of receivables.
|--- |  | ------------------------------------

|(3) |  | Reductions in deferred tax valuation allowance requirements in 2000.
|--- |  | --------------------------------------------------------------------



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EXHIBITS




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##### Table of Contents

EXHIBIT INDEX

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

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



  21                List of Subsidiaries                                    E-3




  23                Consent of Independent Certified
                     Public Accountants                                     E-4

                                      E-2