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

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

For the fiscal year ended                                 Commission file number
    December 31, 1997                                             0-2545
    -----------------                                             ------

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

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

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

Allied's telephone number, including area code: (703) 847-5268
Securities registered pursuant to Section 12(b) of the Act:  None
                                                             ----

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

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

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                                       1

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                                 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
                                                      ---

         State the aggregate market value of the voting stock held by
non-affiliates of the registrant as of March 11, 1998:

       Common Stock - Par Value $.10                         $57,468,361

The number of shares of registrant's Common Stock outstanding as of March 11,
1998, was 4,703,169.

                                       2

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Item 1.  Business.

General.
--------

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

Description of Business.
------------------------

Allied.
-------

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

MECAR.
------

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

                                       3

<PAGE>

ammunition.

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

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

                  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 COCKERILL Mk II and III and ENGESA EC-90, and DEFA F1
guns. Over 2000 of these guns are standard equipment of light APCs in the Far
East and Sout America alone. In the last three years, these families of
ammunition have been improved to meet the highest standards of safety and
performance.

                  The 90mm KENERGA Weapon System has been jointly developed by
COCKERILL MECHANICAL SYSTEMS ("CMI") and MECAR to provide the modern APC with
anti-tank punch similar to that of tanks equipped with 105mm guns, without
sacrifice to the range, mobility and maintainability of the light APC. In this
partnership CMI is responsible for the weapon and MECAR for the ammunition. The
ammunition family includes the APFSDS, HESH and SMK versions with their
corresponding training rounds. Qualification of this system by the US Army is
anticipated to start in 1998. The system is already under production for other
customers.

                  Tank Ammunition. MECAR produces the entire range of 105mm
rounds of its own design and which perform to NATO requirements, for use in the

                                       4

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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 also produces 100mm APFSDS rounds for friendly pro western clients
in the Far East.

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

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

                  Universal Bullet Trap Rifle Grenades. The universal bullet
         trap rifle grenade is designed to be light, effective, accurate and
         simple to use. It is fitted over the muzzle of any standard military
         rifle with a muzzle outer diameter of 22mm and fired from the shoulder
         in the normal manner. This method of firing a grenade is made possible
         by MECAR's development of the universal bullet trap ("BTU"). The BTU is
         a patented device which can be used with all existing makes of steel
         core or soft core bullets in calibers 7.62mm and 5.56mm, including the
         latest round (SS109) used in the M-16 rifle. The BTU is fitted within
         the tail of the grenade. When the bullet is fired, it lodges in the BTU
         and the expanding gases released by the discharged round propel the
         grenade to its target. MECAR manufactures several different bullet trap
         grenades including high explosive fragmentation, anti-personnel, armour
         piercing, smoke generating, white phosphorus, and parachute flare
         (night illuminating).

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

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

                                       5

<PAGE>


BRI.
----


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

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

Limited.
--------

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

VSK Group.
----------

         The VSK Group engages in the business of developing, manufacturing,
selling, installing and servicing security systems for private industry. The
systems marketed by the VSK Group include intrusion detection, access control
and fire detection systems. The principal products manufactured by the VSK Group
are central control panels; the other components are purchased from other
vendors. In May, 1995, the VSK Group acquired all of the outstanding stock of
IDCS, S.A., which markets an upscale line of security services products
principally in European markets.

                                       6

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Geographic Areas and Industry Segments.
---------------------------------------

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

Market and Customers.
---------------------

         Allied derives the principal portion of its revenues from direct and
indirect sales to foreign governments, U.S. Government agencies and prime
contractors, primarily on fixed price contracts. The addition of the VSK Group
adds a non-military component to company-wide operations. Two agencies of a
foreign government and another foreign government accounted for approximately
64%, 6% and 10% in 1997, 42%, 10% and 19% in 1996, and 31%, 12% and 27% in 1995,
of Allied's revenues. During 1997, 1996 and 1995, Allied derived approximately
5%, 11% and 17%, respectively, of its annual revenue from U.S. Government
agencies and contractors. The VSK Group accounted for approximately 12%, 17% and
28% of Allied's 1997, 1996 and 1995 revenues, respectively.

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

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

                                       7

<PAGE>


         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 1997, MECAR received a foreign military sale contract from the U.S.
Government for the manufacture of ammunition for the benefit of a foreign
government. It is anticipated that MECAR may receive additional foreign military
sales contracts. Such contracts are subject to termination for convenience or
upon default.

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

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

Marketing.
----------

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

         BRI's marketing activities are conducted by its executive and marketing
staff.

                                       8

<PAGE>

In addition, BRI participates in various trade shows and advertises in trade
journals. In 1997, BRI entered into various teaming agreements pursuant to which
BRI will be relying upon the marketing efforts of its teaming partners.

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

Research and Development.
-------------------------

         The development of ammunition and weapon systems requires knowledge and
experience in aerodynamics, mechanical engineering, chemistry, combustion,
materials behavior and ballistics. MECAR maintains an active research and
development staff, including a staff of design engineers, in order to determine
how materials can be used or combined in new ways to improve performance or to
solve new problems. In 1997, 1996 and 1995, MECAR expended $794,370, $857,434
and $1,039,631, 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.

                                       9

<PAGE>



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

         The business of the VSK Group requires continuous investment in
research and development to update and enhance the security systems. The VSK
Group employs a staff of design engineers specialized in the field of both
electronic hardware and software. During 1997, 1996 and 1995 the VSK Group
expended $694,026, $888,885 and $954,363, respectively, on research and
development.

Suppliers and Materials.
------------------------

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

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

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

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

                                       10

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employees of the VSK Group.

Backlog.
--------

         As of December 31, 1997 and December 31, 1996, Allied had backlog
orders believed to be firm, after giving effect to the percentage of completion
method of accounting, of approximately $92.8 million and $79.6 million,
respectively. The backlog of orders as of December 31, 1997 are expected to be
substantially filled in 1998 and the first half of 1999.

Competition.
------------

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

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

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

Personnel.
----------

         As of January 31, 1998, Allied, MECAR, BRI and the VSK Group had 448

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permanent employees as follows:

         ALLIED
         ------
         Salaried employees                            5
         Part-time employees                           1

         MECAR
         -----
         Technical and salaried employees             47
         Hourly workers                              201
         Technical consultants                         3

         BRI
         ---
         Salaried employees                           64
         Hourly employees                             25

         VSK Group
         ---------
         Technical salaried employees                 63
         Hourly workers                               39

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

Patents.
--------

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

Environmental Regulations.
--------------------------

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

                                       12

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Principal Customers.
--------------------

         MECAR has historically received a large percentage of its revenue from
two (2) agencies of a foreign government. Contract awards from these agencies
have generally increased since 1994, although below the levels received in the
1991-1993 timeframe. BRI receives a substantial portion of its business from
and/or through the U.S. Government.

Item 2.  Properties.

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

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

         Throughout 1997, MECAR operated at an average of 85% of productive
capacity of its facility, assuming the operation of 3 shifts. MECAR is currently
operating at full productive capacity including use of some temporary personnel.

         BRI operates from an office and manufacturing building in Arlington
Heights, Illinois. BRI has leased approximately 57,500 square feet of office,
engineering and manufacturing space through July 31, 1999. Assuming one full
shift is maximum capacity, BRI is currently operating at approximately 90% of
the productive capacity of its Arlington Heights facility.

         BRI also operates from leased facilities located in Troy, Michigan and
East Moline, Illinois. The Troy operations are conducted from a leased facility

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

         The VSK Group operates from owned facilities containing approximately
49,400 square feet. Such facilities are currently operating at approximately 80%
of productive capacity.

         Capital expenditure programs for equipment planned in 1998 will require
funding of approximately $1.5 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.

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

         There were no matters submitted to a vote of security holders of Allied
during the fourth quarter of 1997.

                                     PART II

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

Market Information.
-------------------

         Allied's Common Stock has been listed for trading on the American Stock
Exchange ("AMEX") since September 15, 1992. Its AMEX trading symbol is ALR. Its
media listing is under the symbol Allied Rsrch. The table below shows the high
and low sales prices of Allied's Common Stock during 1997 and 1996 (as reported
by AMEX):

         1997                              High             Low
                                           ----             ---

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

         1996                              High             Low
                                           ----             ---

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

Stockholders.
-------------

         There were approximately 1,613 holders of record of the Common Stock of
Allied as of March 11, 1998.

Dividends.
----------

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         Allied paid a 5% stock dividend on November 6, 1992 to holders of
record of its Common Stock on October 15, 1992. Cash was paid in lieu of the
issuance of fractional shares. There have been no dividends declared or paid by
Allied in 1993-1997. The banking agreements of MECAR restrict the ability of
such subsidiary to transfer funds to Allied as described in Management's
Discussion and Analysis of Financial Condition and Results of Operations.

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Item 6.  Selected Financial Data.

         The following selected financial data relates to Allied's consolidated
financial position and results of operations for 1997, 1996, 1995, 1994 and
1993:

                         1997       1996       1995        1994        1993
                         ----       ----       ----        ----        ----

                    (000's omitted except per share amounts)

Revenues               $134,484   $103,660   $ 65,769    $ 69,847    $147,097

Net earnings (loss)       8,565      4,805     (2,013)    (10,941)      7,995

Earnings (loss)
per share:
  Basic                    1.88       1.08       (.46)      (2.49)       1.73
  Diluted                  1.85       1.08       (.46)      (2.49)       1.73

Total assets             99,501     91,948     94,253     107,386     163,591

Long-term debt
obligations and
redeemable preferred
stock                    11,162      7,443     28,435      14,108      19,218

Cash dividends
declared per
common share               --         --         --          --          --

         NOTE: During 1993, Allied changed its method of accounting for income
         taxes as a result of the adoption of FASB 109. This change did not have
         a significant effect on the comparability of the above selected
         financial data. See Notes A and P to the accompanying financial
         statements for Allied. All per share amounts have been restated
         consistent with the provision of FASB 128, which became effective in
         1997.

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

Overview
--------

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

         Allied earned a net profit of $8.56 ($1.88 per share - basic) for 1997
compared to a net profit of $4.81 ($1.08 per share - basic) for 1996 and
compared with a net loss of $2.01 ($.46 per share - basic) for 1995. Diluted
earnings per share were $1.85, $1.08 and ($0.46) in 1997, 1996 and 1995,
respectively. In 1997 and 1996, each of Allied's operating subsidiaries earned a
profit.

Trends In Operations
--------------------

         Allied had one of its most profitable years in 1997, largely fueled by
the continued resurgence of MECAR's overseas military business. Approximately
80% of Allied's 1997 revenues was contributed by MECAR, principally from its
traditional customer base.

         Management's continued attempts to broaden its revenue base was
overshadowed in 1997 by MECAR's extraordinary performance. MECAR experienced a
surge in revenues from its traditional customer base as a result of substantial
orders received in 1996 and 1997, including an $84 order received in early 1997.
Almost all of the new orders received by MECAR in 1997 were for the benefit of
its principal customers. This trend has continued in early 1998 as nearly all of
the $69.5 new orders received to date in 1998 have been for the benefit of such
principal customers.

         The VSK Group continues to supply a steady stream of commercial sector
revenues and earnings. In 1997, the VSK Group contributed approximately $1.1 in
profits and $16.4 in revenues. The 6.8% profit margin achieved by the VSK

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Group in 1997 exceeded the 4.5 % profit margin earned in 1996.

         BRI's profitability was based in large part on revenues from a large
contract for the benefit of a foreign government. In 1997, BRI entered into
several teaming arrangements with U.S.-based firms to pursue both domestic and
international business. It is anticipated that BRI's future prospects will
depend in large part on the success of such teaming arrangements and its ability
to secure other large contracts.

         Allied commenced 1998 with a consolidated backlog of approximately
$92.8 compared with a consolidated backlog at the beginning of 1997 of $79.6.
MECAR began 1998 with a backlog of approximately $65.8 compared with a 1997
beginning backlog of $49.4. VSK began 1998 with a backlog of approximately $12.7
compared with a 1997 beginning backlog of approximately $14.5. BRI's beginning
backlog in 1998 was $14.3 compared with a 1997 beginning backlog of $15.6.

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

         MECAR's core business has been excellent in the past few years. Much of
this business has been for ammunition for MECAR's traditional customers.
Further, such customers have tentatively agreed to purchase two (2) new weapon
systems. MECAR has received and processed an order for training rounds of
ammunition for one of such systems and anticipates receipt of a similar order
for training rounds for the other system. If such systems are fully developed
and acquired by these customers, MECAR should be in a position to receive
substantial orders for ammunition for these systems. However, MECAR has
historically experienced substantial periods during which it has received few or
no orders from these customers. Most of these negative cycles were caused by
customers' budget constraints. Such customers depend heavily on oil sales for
their revenue. The recent drop in oil prices may have the effect of delaying
future MECAR orders or potentially leading to a future negative cycle.

         During the last year, management successfully focused on increasing the
profit margins of the VSK Group's security services business. Management is in

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<PAGE>

the process of examining alternative methods to increase the revenue base of the
VSK Group's business. Such alternatives include but are not limited to expanding
the VSK Group's distributor network and/or growing the VSK Group by acquisition.
Management desires to increase its non-defense business with the twin goals of
having (i) a larger commercial business base to reduce future volatility of the
defense business and (ii) a sufficient commercial component of revenues and
profits to cause the investment community to cease valuing Allied's stock solely
as a defense company.

Trends In Liquidity And Capital Resources
-----------------------------------------

         Allied's liquidity improved in 1996 as a result of the profitable
operations experienced in the last of half of 1995 and throughout 1996, and such
liquidity continued to improve throughout 1997. No liquidity problems are
forecast for 1998 in view of Allied's existing backlog, particularly the backlog
accumulated at MECAR. In the longer term, Allied's liquidity will continue to
depend upon its ability to obtain substantial orders from its traditional
customer base and the success of its efforts to broaden its revenue base.

         The Company has investigated the ability of the parent company and its
subsidiaries to address potential Year 2000 issues. The Company has determined
that its major internal and external systems are or are in the process of being
upgraded to be Year 2000 compliant. The impact of these issues will not have a
material adverse effect on the Company's liquidity or operations.

Liquidity.
----------

         Allied's liquidity increased in 1997, principally as a result of
profitable operations at each operating unit. Working capital was approximately
$25.1 at December 31, 1997, which is an increase of $7.1 from the December 31,
1996 level. Allied's current working capital is required for operations and to
support credit facility agreements.

         Accounts receivable at December 31, 1997 increased from December 31,
1996 by $28.8 due to substantial shipments of products at the end of 1997. Costs
and accrued earnings on uncompleted contracts decreased by $6.9 from 1996 as a
result of shipments at 1997 year-end. Inventory levels and prepaid expenses

                                       20

<PAGE>


were essentially the same at the end of calendar years 1997 and 1996. Current
liabilities decreased slightly from 1996 levels. Accounts payables increased in
1997 over 1996 by $16.1 primarily due to orders completed and shipped at the end
of 1997. Current liabilities decreased slightly from 1996 levels.

         During 1997, 1996 and 1995, Allied funded its operations principally
with internally generated cash and back-up credit facilities required for
foreign government contracts.

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

         MECAR typically obtains relatively large orders for its ammunition and
weapon systems which require credit facilities to provide import letters of
credit, advance payment guarantees and performance bonds. These needs have been
met in the last few years via agreements with a multi-member foreign bank pool,
supplemented by a term loan supplied by some of the bank pool participants (the
"Term Loan") and a partial guarantee by the regional government in Belgium (the
"Walloon Region"). The Term Loan was provided solely to support the Walloon
Region guarantee. Given MECAR's improved financial performance, the Walloon
Region did not extend its guarantee to the credit accommodations required to
support the contracts awarded to MECAR in 1997 and the Term Loan was paid off.

         The current credit facility was revised in 1997 and again in early
1998. As has been the case in recent years, the bank pool must agree to extend
such facility to new orders as they are received by MECAR. While management
believes that it will be able to finance additional MECAR contracts using the
bank pool structure, there can be no assurance that such financing will be
provided.

         The credit facility and other loan agreements continue to impose
certain restrictions on MECAR. MECAR's obligations were collateralized at
December 31, 1997 by base cash deposits of $8.7 and a pledge on MECAR's assets

                                       21

<PAGE>

of $23. The bank agreement further precludes MECAR from making payments to any
company in the Allied group in excess of $2.4 per year until MECAR has
unrestricted cash of not less than $6.7. MECAR's obligations under the bank
agreement are also supported by a guarantee provided by Allied.

         MECAR also has a secured line of credit facility with a maximum
availability of $0.8. Such line of credit was unused at December 31, 1997.

         MECAR has a mortgage loan with a foreign bank which had an outstanding
balance of approximately $3.8 at December 31, 1997. Principal and interest
payments on the mortgage loan extend through January, 2004.

         BRI operated throughout 1997 from cash generated from operations
supplemented by a credit facility. The credit facility consists of a $3.5 line
of credit (which permits advances based upon BRI eligible accounts receivable)
as well as a cash collateralized letter of credit facility. At December 31,
1997, the line of credit had an outstanding balance of $1.7. Allied has
guaranteed BRI's obligations under the above-described credit facility.

         The VSK Group operated throughout 1997 primarily from cash generated
from operations. The VSK Group is obligated on several mortgages and other long
term obligations with December 31, 1997 balances aggregating $2.2.

Capital Resources.
------------------

         Allied spent $1.4 in 1997 on capital equipment as compared with $1.07
in 1996 and $2.92 in 1995, respectively. The expenditures in 1997 were primarily
for facility upgrades and computer equipment. Management currently anticipates
that it will spend approximately $1.5 on capital expenditures in 1998,
principally for additional upgrades to the MECAR facilities and equipment.

Results of Operations.
----------------------

         Allied had revenues of $134.5 in 1997 as compared to $103.7 in 1996 and
$65.8 in 1995, respectively. Allied earned a profit of $8.56 in 1997 compared
with a profit of $4.81 in 1996 and a compared to loss of $2.01 in 1995.

                                       22

<PAGE>


         The following table sets forth, for the years ended December 31, 1997,
1996 and 1995, certain items from Allied's consolidated statements of operations
expressed as a percentage of revenue:

                                        1997         1996         1995
                                        ----         ----         ----

Revenue                                100.0%       100.0%       100.0%

Costs and Expenses
  Cost of sales                         80.9         75.9         75.9
  Selling and administrative            10.7         15.1         24.0
  Research and development               1.1          1.7          3.2
  Restructuring charge                    .7           --           --

           Operating income (loss)       6.6          7.3         (3.1)

Other income (deductions)
  Interest income                         .8          1.9          2.7
  Interest expense                      (1.4)        (3.3)        (4.6)
  Other - net                            1.1         (0.4)         3.0

           Earnings (loss) before
           income taxes                  7.1          5.5         (2.0)
Income taxes                              .7          0.9          1.1

           Net earnings (loss)           6.4          4.6         (3.1)

Revenues
--------

         Revenues for 1997 increased $30.8 or 29.7% as compared to 1996.
Revenues at MECAR increased by approximately 50% over the prior year due to
increased business from MECAR's traditional customer base. The $84 order
received by MECAR in early 1997 included a $44 systems integration component. In
1997, revenues at the VSK Group decreased approximately 8.4% under 1996 levels
primarily due to currency fluctuations (if currency fluctuations are eliminated,
1997 VSK Group revenues increased 6% over 1996 levels). Revenues at BRI
decreased 9.3% from 1996 levels.

                                       23

<PAGE>


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

Cost of Sales
-------------

         Cost of sales as a percentage of sales for 1997 was approximately 81%
compared with 76% for each of 1996 and 1995.

Selling and Administrative Expenses
-----------------------------------

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

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

Research and Development
------------------------

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

         Research and development costs incurred in 1996 decreased by $0.34, or
16.3% under 1995 levels due to lower expenditures at MECAR.

Restructuring Costs
-------------------

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

                                       24

<PAGE>


Interest Income
---------------

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

         Interest income increased in 1996 by $0.15, or 8.9% over 1995 levels
principally due to improved cash flow and corresponding levels of cash.

Interest Expense
----------------

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

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

Other - Net
-----------

         Allied experienced a $1.5 gain in 1997, largely due to net currency
gains.

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

Income Taxes
------------

         The 1997 effective tax rate was 10.1% primarily due to the utilization
of tax loss carryforwards. The balance of the foreign operating loss
carryforwards at MECAR are expected to be utilized in 1998 and it is anticipated
that some 1998 MECAR earnings will become subject to Belgian tax at the 40.7%
statutory rate.

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

Net Earnings (Loss)
-------------------

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

                                       25

<PAGE>


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

                                    PART III

Item 10.  Directors and Executive Officers of Allied.

Directors.
----------

         The following are the directors of Allied:

         J. R. Sculley, age 57, became a director of Allied in 1991. He has
served as president and chief operating officer of Allied since April, 1992, and
was named chairman of the board and chief executive officer in December, 1992.
He is also a director of MECAR, BRI and Limited. Between 1989 and April, 1992,
Mr. Sculley was Director of Advanced Studies and Technologies of Grumman
Corporation, a defense company, and, prior thereto, was Assistant Secretary of
the Army (Research, Development and Acquisition).

         Clifford C. Christ, age 50, became a director of Allied in 1993. He has
been the president and chief executive officer of NavCom Defense Electronics,
Inc., a defense electronics company, since 1988.

         Earl P. Smith, age 59, became a director of Allied in 1993. Mr. Smith
has been a principal of Earl Smith & Associates, a defense consulting firm,
since 1990. During 1990 he was vice president-commercial operations of
Management Services Corporation, a subsidiary of Lear Siegler Corp., and from
1986 to 1990 he was vice president - marketing and contracts of Management
Services Corporation.

         Robert W. Hebel, age 74, became a director of Allied in early 1996.
Throughout the last five years, Mr. Hebel has been a private investor.

         Harry H. Warner, age 62, became a director of Allied in early 1996.
Throughout the last five years, Mr. Warner has been a self-employed financial
consultant, investor and real estate developer. He is also a director of
Chesapeake Corporation and Pulaski Furniture Corporation.

Executive Officers.
-------------------

                                       26

<PAGE>


         The following are the executive officers of Allied:

         J. R. Sculley, age 57, was elected chairman of the board and chief
executive officer of Allied in December, 1992, and has served as Allied's
president and chief operating officer since April, 1992. He served as Director
of Advanced Studies and Technologies of Grumman Corporation, a defense company,
from 1989 to April, 1992, and previously was Assistant Secretary of the Army
(Research, Development and Acquisition). Mr. Sculley also serves as a director
of MECAR, BRI and Limited.

         W. Glenn Yarborough, Jr., age 57, was elected vice president of Allied
in January, 1995. Since February, 1993, Mr. Yarborough has served as vice
president of Services. Previously, he served as director of business development
of Grumman Corporation, a defense company. Mr. Yarborough also serves as a
director of BRI and the VSK Group.

Item 11.  Executive Compensation

Compensation of Directors and Executive Officers
------------------------------------------------

         The following table sets forth information concerning all compensation
paid for services rendered in all capacities to Allied and its subsidiaries
during the years ended December 31, 1997, 1996 and 1995, by the chief executive
officer of Allied and by other executive officers of Allied whose total annual
salary and bonus exceeds $100,000:

                                       27

<PAGE>


                           SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>

                                                                       LONG TERM COMPENSATION
                                                                       ----------------------
                           ANNUAL COMPENSATION                         Awards        Payouts
                    ---------------------------------                -------------------------
                                                          Other                                                 All
Name                                                      Annual     Restricted     Securities                 Other
and                                                       Compen-    Stock          Underlying     LTIP        Compen-
Principal                                                 sation     Award(s)       Options/       Payouts     sation
Position             Year    Salary($)    Bonus($)(1)     ($)        ($)            SARs (#)       ($)         ($)
---------            ----    ---------    --------        -------    ----------     --------       -------     ------
<S><C>
J.R.                 1997    $245,000     $120,000
Sculley,             1996    $245,000     $100,000                                   15,000
Chief                1995    $235,000
Executive
Officer

W. Glenn             1997    $180,500     $108,000
Yarborough,          1996    $168,000     $ 90,000                                   27,600
Jr., Vice            1995    $144,500
President
</TABLE>

                                       29

<PAGE>

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

                                       30

<PAGE>


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

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

                                    Shares Acquired    Value                    Exercisable/              Exercisable/
Name                                on Exercise (#)    Realized ($)             Unexercisable             Unexercisable
----                                ---------------    ------------             -------------             -------------
<S><C>
J.R. Sculley                              4,880          $25,010                22,520/43,600            $94,689/$213,847

W. Glenn Yarborough, Jr.                 19,200          $92,625                14,000/8,400             $58,632/$72,979
</TABLE>

---------------------
(1)   Based on the closing price of the Company's stock of $12.4375 on
      December 31, 1997.

                                       31


<PAGE>


Director Compensation
---------------------

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

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

         In 1991, the Board of Directors of Allied adopted the Allied Research
Corporation Outside Directors Stock Option Plan (the "Directors Option Plan") by
which Allied may grant options for up to 208,000 shares of Allied's Common Stock
to its Outside Directors (which amount includes the 5% stock dividend paid on
November 6, 1992). None of the options granted pursuant to the Directors Option

                                       32

<PAGE>

Plan are intended to qualify as incentive stock options under Sections 422
through 424 of the Internal Revenue Code. The purpose of the Directors Option
Plan is to advance the interests of Allied by providing its Outside Directors
with financial incentives in the form of non-statutory stock options in order to
attract, retain and motivate such Outside Directors. Options for 15,000 shares
each were granted under the Directors Option Plan in 1996 to Messrs. Scott,
Christ, Smith, Hebel and Warner; no such options were awarded in 1997.

Employment Contracts and Change-In-Control Arrangements
-------------------------------------------------------

         J. R. Sculley and Allied have entered into an Employment Agreement (the
"Sculley Agreement") which extends through July 31, 1998. In consideration for
his services as an officer of Allied and as a director of Allied and each of its
subsidiaries, Mr. Sculley is entitled to receive an aggregate sum of not less
than $245,000 per calendar year. The Sculley Agreement further provides that
upon the death or disability of Mr. Sculley, the Company will make installment
payments to or for the benefit of Mr. Sculley in an amount not to exceed
$250,000.

         W. Glenn Yarborough, Jr. and Allied have entered into an Employment
Agreement (the "Yarborough Agreement") which extends through July, 1998, and is
automatically renewable from year to year thereafter unless either Allied or Mr.
Yarborough gives the other timely notice of its or his intent not to renew. Mr.
Yarborough is entitled to receive base compensation of $183,000 per calendar
year. The Yarborough Agreement further provides that in the event Mr. Yarborough
ceases to serve in any capacity as an officer of the Company as a result of a
voluntary or involuntary termination within a period of twelve (12) months
following a change in control, Mr. Yarborough shall be entitled to a lump sum
payment equal to the aggregate amount of compensation payable to Mr. Yarborough
throughout the remaining term of the Yarborough Agreement.

         In June, 1991, the Board of Directors of Allied adopted the Preferred
Share Purchase Rights Agreement (the "Agreement"). The Agreement provides each
stockholder of record on a dividend distribution of one "right" for each
outstanding share of Allied's common stock. Rights become exercisable at the
earlier of ten days following: (1) a public announcement that an acquiror has
purchased or has the right to acquire 10% or more of Allied's common stock, or
(2) the commencement of a tender offer which would result in an offeror
beneficially

                                       33

<PAGE>

owning 30% or more of the outstanding common stock of Allied. All rights held by
an acquiror or offeror expire on the announced acquisition date, and all rights
expire at the close of business on June 20, 2001. Each right entitles a
stockholder to acquire at a stated purchase price, 1/100 of a share of Allied's
preferred stock which carries voting and dividend rights similar to one share of
its common stock. Alternatively, a right holder may elect to purchase for the
stated price an equivalent number of shares of Allied's common stock (or in
certain circumstances, cash, property or other securities of Allied) at a price
per share equal to one-half of the average market price for a specified period.
In lieu of the purchase price, a right holder may elect to acquire one-half of
the common stock available under the second option. The purchase price of the
preferred stock fractional amount is subject to adjustment for certain events as
described in the Agreement. At the discretion of a majority of the Board and
within a specified time period, Allied may redeem all of the rights at a price
of $.01 per right. The Board may also amend any provisions of the Agreement
prior to exercise.

Compensation Committee Interlocks and Insider Participation
-----------------------------------------------------------

         The Compensation Committee of Allied during the fiscal year ended
December 31, 1997 consisted of Messrs. Earl P. Smith, Robert W. Hebel and Harry
H. Warner. None of such individuals has served as an officer or employee of
Allied nor is there any other relationship between any member of the
Compensation Committee and Allied which is required to be disclosed under
applicable regulations.

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

         The following information is furnished as of March 1, 1998, 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:

                                       34

<PAGE>



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

Common            Fidelity Low-Priced       454,000                   9.5%
                  Stock Fund/Fidelity       Owned directly
                  Management &
                  Research Company
                  82 Devonshire Street
                  Boston, MA  02109

Common            Dimensional Fund          270,200                   5.7%
                  Advisors, Inc.(2)         Owned directly(2)
                  1299 Ocean Avenue
                  11th Floor
                  Santa Monica, CA  90401

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

(1)      Based upon 4,649,721 shares of common stock outstanding plus 140,670
         shares which may be acquired within 60 days pursuant to outstanding
         stock options.

(2)      Dimensional Fund Advisors, Inc. ("Dimensional"), a registered
         investment advisor, is deemed to have beneficial ownership of 270,200
         shares, all of which shares are held in portfolios of DFA Investment
         Dimensions Group, Inc., a registered open-end investment company, or in
         series of the DFA Investment Trust Company, a Delaware business trust,
         or the DFA Group Trust and DFA Participation Group Trust, investment
         vehicles for qualified employee benefit plans, all of which Dimensional
         Fund Advisors, Inc. serves as investment manager. Dimensional disclaims
         beneficial ownership of all such shares.

                                       35

<PAGE>



         The following information is furnished as of March 1, 1998, with
respect to the beneficial ownership by management of Allied's Common Stock:

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

Common   Harry H. Warner                    10,000                 *
                                            Owned
                                            directly

Common   Earl P. Smith                      16,110                 *
                                            Owned
                                            directly

Common   Clifford C. Christ                 25,000                 *
                                            Owned
                                            directly

Common   Robert W. Hebel                    17,000                 *
                                            Owned
                                            directly

Common   J. R. Sculley                      122,804               2.6%
                                            Owned
                                            directly

Common   W. Glenn Yarborough, Jr.           58,649                1.3%
                                            Owned
                                            directly

Common   All executive officers             249,563               5.2%
         and directors as a                 Owned
         group (6)                          directly

                                       36

<PAGE>


*Less than 1%

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

(1)   Includes 14,000 shares which may be acquired by Mr. Smith, 18,200
      shares which may be acquired by Mr. Yarborough and 43,720 shares which
      may be acquired by Mr. Sculley within 60 days pursuant to outstanding
      stock options.

(2)   Based upon 4,649,721 shares of common stock outstanding plus 140,270
      shares which may be acquired within 60 days pursuant to outstanding
      stock options.


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

Item 13. Certain Relationships and Related Transactions.

         None.

                                     PART IV

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

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

         Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
Allied of expenses incurred or

                                       37

<PAGE>

paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, Allied will, unless in the opinion of its counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.

(a)(1)   Financial Statements:
         ---------------------

                  Report of Independent Certified Public               F-3
                  Accountants

                  Consolidated Balance Sheets at December 31,          F-4
                  1997 and 1996

                  Consolidated Statements of Operations for            F-6
                  the three years ended December 31, 1997

                  Consolidated Statements of Stockholders'             F-7
                  Equity for the three years ended

                  December 31, 1997

                  Consolidated Statements of Cash Flows                F-8
                  for the three years ended December 31, 1997

                  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, 1997 and 1996
                               and for the three years ended
                               December 31, 1997:

                                       38

<PAGE>


                               Schedule I - Condensed                  F-33
                               Financial Information of
                               Allied

                               Schedule II - Valuation                 F-36
                               and Qualifying Accounts

(a)(3)   Exhibits:
         ---------

                  Exhibit 3 - Certificate of Incorporation,
                                     as amended (Incorporated by
                                     reference from Form 10-K filed
                                     in March, 1992) and Amended and
                                     Restated By-Laws (Incorporated
                                     by reference from Form 8-K filed
                                     in November, 1992)

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

                  Exhibit 10 -

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

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

                  Exhibit 21 - List of Subsidiaries                    E-3


                                       39

<PAGE>



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

(b)      Reports on Form 8-K:
         --------------------

                  No reports on Form 8-K were filed during the fourth quarter of
1997.

                                       40

<PAGE>



                                   SIGNATURES

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

                                       Allied Research Corporation

(Allied) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

                                       /s/ J. R. Sculley

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

Date:  March 24, 1998

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

                                       /s/ J. R. Sculley

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

Date:  March 24, 1998

                                 * * * * * * * *


                                       /s/ J. R. Sculley

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

Date:  March 24, 1998

                                       41

<PAGE>


                                 * * * * * * * *

                                       /s/ Clifford C. Christ

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

Date:  March 24, 1998

                                 * * * * * * * *

                                       /s/ Earl P. Smith

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

Date:  March 24, 1998

                                 * * * * * * * *

                                       /s/ Robert W. Hebel

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

Date:  March 24, 1998

                                 * * * * * * * *

                                       /s/ Harry H. Warner

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

Date:  March 24, 1998

                                 * * * * * * * *

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

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

                                       42


<PAGE>






                       SECURITIES AND EXCHANGE COMMISSION

                            WASHINGTON, D.C.  20549



                       FINANCIAL STATEMENTS AND SCHEDULES

                               DECEMBER 31, 1997



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



                                   FORM 10-K
                                       OF
                          ALLIED RESEARCH CORPORATION


<PAGE>


                          ALLIED RESEARCH CORPORATION

                  INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

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




Consolidated Balance Sheets at December 31, 1997 and 1996                                                   F-4




Consolidated Statements of Operations for the three years ended December 31, 1997                           F-6




Consolidated Statements of Stockholders' Equity for the three years
    ended December 31, 1997                                                                                 F-7




Consolidated Statements of Cash Flows for the three years ended December 31, 1997                           F-8



Notes to Consolidated Financial Statements                                                                  F-10




Schedules as of and for the three years ended December 31, 1997

            Schedule I - Condensed Financial Information of Registrant                                      F-33




            Schedule II -Valuation and Qualifying Accounts                                                  F-36
</TABLE>


<PAGE>

               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors
Allied Research Corporation

We have audited the accompanying consolidated balance sheets of Allied Research
Corporation and subsidiaries as of December 31, 1997 and 1996 and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Allied Research
Corporation and subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended December 31, 1997 in conformity with
generally accepted accounting principles.

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

/s/ GRANT THORNTON LLP
______________________
BALTIMORE, MARYLAND
MARCH 6, 1998


<PAGE>


                          ALLIED RESEARCH CORPORATION

                          CONSOLIDATED BALANCE SHEETS

                                  DECEMBER 31,

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

<TABLE>
<CAPTION>
                                                      ASSETS
                                                                       1997                  1996
                                                                     ----------           ----------
<S><C>
CURRENT ASSETS
   Cash and equivalents, including restricted cash
      (notes A, C and F)                                            $16,420,943          $32,859,478
   Accounts receivable (notes A, D and F)                            40,649,726           11,889,785
   Costs and accrued earnings on
      uncompleted contracts (note A)                                  7,804,344           14,694,117
   Inventories (notes A and F)                                        6,965,666            7,171,007
   Prepaid expenses and deposits                                      4,094,190            3,879,723
                                                                     ----------           ----------

           Total current assets                                      75,934,869           70,494,111



PROPERTY, PLANT AND EQUIPMENT - AT COST
   (notes A and H)
      Buildings and improvements                                     11,714,475           13,231,477
      Machinery and equipment                                        28,778,285           33,030,014
      Leasehold improvements                                            118,927               85,028
                                                                     ----------           ----------
                                                                     40,611,687           46,346,519
      Less accumulated depreciation                                  30,259,311           33,106,026
                                                                     ----------           ----------
                                                                     10,352,376           13,240,493
      Land                                                            1,208,013            1,411,659
                                                                     ----------           ----------
                                                                     11,560,389           14,652,152

OTHER ASSETS
   Deposits (notes C, F and H)                                        6,414,419                    -
   Intangibles, less accumulated amortization of
      $2,783,724 and $1,688,122 in 1997 and 1996,
      respectively (notes A and B)                                    5,028,390            6,123,992
   Other                                                                562,572              677,906
                                                                     ----------           ----------
                                                                     12,005,381            6,801,898
                                                                     ----------           ----------

                                                                    $99,500,639          $91,948,160
                                                                     ==========           ==========
</TABLE>

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

                                      F-4

<PAGE>


                          ALLIED RESEARCH CORPORATION

                    CONSOLIDATED BALANCE SHEETS - CONTINUED

                                  DECEMBER 31,

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

<TABLE>
<CAPTION>
                      LIABILITIES AND STOCKHOLDERS' EQUITY

                                                                       1997                 1996
                                                                     ----------          ----------
<S><C>
CURRENT LIABILITIES
   Notes payable (note E)                                          $  1,720,000        $  3,317,438
   Current maturities of long-term debt                               1,280,736          14,099,171
   Accounts payable                                                  34,656,335          18,571,110
   Accrued liabilities                                                4,747,291           4,311,407
   Accrued losses on contracts (note G)                                 572,279             390,125
   Customer deposits                                                  6,993,756          10,934,488
   Income taxes                                                         847,563             805,970
                                                                     ----------          ----------

           Total current liabilities                                 50,817,960          52,429,709



LONG-TERM DEBT, less current maturities (note H)                      5,311,564           7,443,436


ADVANCE PAYMENTS ON CONTRACTS (note C)                                5,850,000                   -


DEFERRED INCOME TAXES (notes A and P)                                   626,660             628,374


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


STOCKHOLDERS' EQUITY (note L)
   Preferred stock, no par value; authorized, 10,000
      shares; none issued                                                     -                   -
   Common stock, par value, $.10 per share; authorized
      10,000,000 shares; issued and outstanding, 4,608,221
      in 1997 and 4,443,092 in 1996                                     460,822             444,309
   Capital in excess of par value                                    12,100,521          10,846,303
   Retained earnings                                                 26,046,271          17,481,483
   Accumulated other comprehensive income (loss)                     (1,713,159)          2,674,546
                                                                     ----------          ----------
                                                                     36,894,455          31,446,641
                                                                     ----------          ----------

                                                                    $99,500,639         $91,948,160
                                                                     ==========          ==========
</TABLE>

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


                                      F-5


<PAGE>


                          ALLIED RESEARCH CORPORATION

                     CONSOLIDATED STATEMENTS OF OPERATIONS

                            YEARS ENDED DECEMBER 31,

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

<TABLE>
<CAPTION>
                                                        1997               1996                 1995
                                                    -------------    ---------------         -----------
<S><C>
REVENUE (note M)                                     $134,483,750       $103,660,137         $65,768,907

COST AND EXPENSES
   Cost of sales                                      108,775,629         78,658,573          49,896,794
   Selling and administrative                          14,422,923         15,647,951          15,758,673
   Research and development                             1,488,396          1,746,319           2,087,278
   Restructuring costs (note R)                           977,267               -                   -
                                                    -------------    ---------------         -----------
                                                                                -
                                                      125,664,215         96,052,843          67,742,745
                                                    -------------    ---------------         -----------

           Operating income (loss)                      8,819,535          7,607,294          (1,973,838)

OTHER INCOME (DEDUCTIONS)
   Interest income                                      1,033,599          1,921,864           1,770,278
   Interest expense                                    (1,846,697)        (3,451,066)         (3,034,537)
   Other - net (note O)                                 1,519,505           (381,379)          1,968,478
                                                    -------------    ---------------         -----------
                                                          706,407         (1,910,581)            704,219
                                                    -------------    ---------------         -----------

           Earnings (loss) before income taxes          9,525,942          5,696,713          (1,269,619)

INCOME TAXES (NOTES A AND P)                              961,154            891,230             743,652
                                                    -------------    ---------------         -----------

           NET EARNINGS (LOSS)                     $    8,564,788    $     4,805,483         $(2,013,271)
                                                    =============     ==============          ==========

EARNINGS (LOSS) PER SHARE (NOTE S)
   BASIC                                                    $1.88              $1.08               $(.46)
                                                             ====               ====                ====

   DILUTED                                                  $1.85              $1.08               $(.46)
                                                             ====               ====                ====
</TABLE>



The accompanying notes are an integral part of these statements.

                                      F-6

<PAGE>


                          ALLIED RESEARCH CORPORATION

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                  YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

-------------------------------------------------------------------------------
<TABLE>
<CAPTION>



                                                                                         Capital
                                                Preferred stock      Common stock       in excess
                                                 no par value      $.10  par value    of par value   Retained earnings
                                              -----------------  ------------------   ------------   -----------------
<S><C>
BALANCE AT DECEMBER 31, 1994                             -             $439,845        $10,658,174       $14,689,271
  Common stock awards                                    -                  300             10,950                 -
  Employee stock purchase plan purchases                 -                2,061             76,171                 -
  Comprehensive income (loss)
    Net loss for the year                                -                    -                  -       (2,013,271)
    Currency translation adjustment                      -                    -                  -                -
  Total comprehensive income (loss)                      -                    -                  -                -
                                              ------------             --------        -----------      -----------

BALANCE AT DECEMBER 31, 1995                             -              442,206         10,745,295       12,676,000
  Common stock awards                                    -                  903             40,479                -
  Employee stock purchase plan purchases                 -                1,200             60,529                -
  Comprehensive income (loss)
    Net earnings for the year                            -                    -                  -        4,805,483
    Currency translation adjustment                      -                    -                  -                -
  Total comprehensive income (loss)                      -                    -                  -                -
                                              ------------             --------        -----------      -----------

BALANCE AT DECEMBER 31, 1996                             -              444,309         10,846,303       17,481,483
  Common stock awards                                    -                5,275            516,185                -
  Employee stock purchase plan purchases                 -               11,238            738,033                -
  Comprehensive income (loss)
    Net earnings for the year                            -                    -                  -        8,564,788
    Currency translation adjustment                      -                    -                  -                -
  Total comprehensive income (loss)                      -                    -                  -                -
                                              ------------             --------        -----------      -----------

BALANCE AT DECEMBER 31, 1997                             -             $460,822        $12,100,521      $26,046,271
                                              ============              =======         ==========       ==========
</TABLE>

<TABLE>
<CAPTION>
                                                     Accumulated
                                                 other comprehensive
                                                   income (loss)
                                               ----------------------       Total
                                                  foreign currency       stockholders'
                                               translation adjustment       equity
                                               ----------------------    --------------
<S><C>
BALANCE AT DECEMBER 31, 1994                        $ 3,910,384         $29,697,674
  Common stock awards                                         -              11,250
  Employee stock purchase plan purchases                      -              78,232
  Comprehensive income (loss)
    Net loss for the year                                     -                   -
    Currency translation adjustment                     579,699                   -
  Total comprehensive income (loss)                           -          (1,433,572)
                                                    -----------         -----------

BALANCE AT DECEMBER 31, 1995                          4,490,083          28,353,584
  Common stock awards                                         -              41,382
  Employee stock purchase plan purchases                      -              61,729
  Comprehensive income (loss)
    Net earnings for the year                                 -                   -
    Currency translation adjustment                  (1,815,537)                  -
  Total comprehensive income (loss)                           -           2,989,946
                                                    -----------         -----------

BALANCE AT DECEMBER 31, 1996                          2,674,546          31,446,641
  Common stock awards                                         -             521,460
  Employee stock purchase plan purchases                      -             749,271
  Comprehensive income (loss)
    Net earnings for the year                                 -                   -
    Currency translation adjustment                  (4,387,705)                  -
  Total comprehensive income (loss)                           -           4,177,083
                                                    -----------         -----------

BALANCE AT DECEMBER 31, 1997                        $(1,713,159)        $36,894,455
                                                     ==========          ==========
</TABLE>


The accompanying notes are an integral part of these statements.

                                      F-7

<PAGE>

                          ALLIED RESEARCH CORPORATION

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                            YEARS ENDED DECEMBER 31,

--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Increase (decrease) in cash and equivalents                          1997               1996                1995
                                                                -------------      -------------       -------------
<S><C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
   Net earnings (loss) for the year                              $  8,564,788       $  4,805,483        $ (2,013,271)
   Adjustments to reconcile net earnings (loss) to
      net cash from (used in) operating activities
        Depreciation and amortization                               2,645,995          3,093,534           2,751,867
        Loss (gain) on sale of fixed assets                             2,874               (250)             (8,381)
        Deferred income taxes                                       1,148,753           (590,419)            376,550
        Provision for estimated losses on contracts                   (80,012)            (4,036)         (1,178,475)
        Gain on sale of securities                                    (11,684)                 -                   -
        Common stock awards                                           521,460             41,382              11,250
        Changes in assets and liabilities
           Accounts receivable                                    (30,952,448)         7,874,015           2,746,237
           Cost and accrued earnings on
              uncompleted contracts                                 4,937,582        (9,142,340)           2,709,185
           Inventories                                               (803,742)        (1,413,524)           (983,917)
           Prepaid expenses and other assets                         (840,140)        (2,798,161)         (1,451,796)
           Accounts payable and accrued liabilities                18,611,804          2,015,448         (12,291,397)
           Customer deposits                                       (2,458,936)         1,917,475           7,959,923
           Income taxes                                               110,020            441,852            (552,009)
                                                                 ------------       ------------        ------------
                                                                   (7,168,474)         1,434,976              89,037
                                                                 ------------       ------------        ------------

                Net cash provided by (used in)
                   operating activities                             1,396,314          6,240,459          (1,924,234)

CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
   Capital expenditures                                            (1,342,320)        (1,066,889)         (2,920,728)
   Proceeds from sale of fixed assets                                       -                250             183,470
   Purchase of restricted investments                              (8,216,235)                 -                   -
   Proceeds from sale of restricted investments                     1,813,500                  -                   -
   Payments for acquisitions, net of cash acquired                          -                  -          (1,083,571)
                                                                 ------------       ------------        ------------

                Net cash (used in) investing activities            (7,745,055)        (1,066,639)         (3,820,829)
</TABLE>

The accompanying notes are an integral part of these statements.

                                       F-8

<PAGE>


                          ALLIED RESEARCH CORPORATION

               CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

                            YEARS ENDED DECEMBER 31,

--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                                     1997               1996                1995
                                                                -------------      -------------       -------------
<S><C>
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
   Net increase (decrease) in short-term borrowings                (2,717,150)         2,908,978            (114,514)
   Principal payments on long-term debt                           (12,663,855)       (19,009,160)        (23,979,845)
   Proceeds from issuance of long-term debt                         1,908,449         11,762,981          12,252,705
   Net (increase) decrease in long-term deposits                    5,850,000         18,492,000         (12,092,000)
   Proceeds from employee stock purchases                             749,271             61,729              78,232
                                                                 ------------       ------------        ------------

                Net cash (used in) provided by
                   financing activities                            (6,873,285)        14,216,528         (23,855,422)

Effects of exchange rates on cash                                  (3,216,509)        (2,275,015)          1,738,751
                                                                 ------------       ------------        ------------

                Net (decrease) increase in cash
                   and equivalents                                (16,438,535)        17,115,333         (27,861,734)

CASH AND EQUIVALENTS AT BEGINNING OF YEAR                          32,859,478         15,744,145          43,605,879
                                                                 ------------       ------------        ------------

CASH AND EQUIVALENTS AT END OF YEAR                              $ 16,420,943       $ 32,859,478        $ 15,744,145
                                                                 ============       ============        ============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

   Cash paid during the year for
      Interest                                                   $  2,681,569      $   3,088,529       $   4,461,871
      Income taxes                                                  2,140,896          1,245,678           1,638,984
</TABLE>

The accompanying notes are an integral part of these statements.

                                       F-9


<PAGE>


                          ALLIED RESEARCH CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE A - SUMMARY OF ACCOUNTING POLICIES

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

  BASIS OF PRESENTATION

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

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

  I.D.C.S.,  N.V. was acquired on May 9, 1995, was accounted for as a purchase,
  and revenue and results of operations  from the date of acquisition  have been
  consolidated.

  The 1995 consolidated financial statements also included Allied's wholly-owned
  subsidiary ARC Services, Inc. which ceased operations in December, 1995;
  Mecar's wholly-owned subsidiaries Management Export Services, N.V. which was
  liquidated in 1995; and Mecar Immobliere S.A., which merged with Mecar
  effective January 1, 1996; VSK's minority interest in Building Control
  Services, N.V., which was liquidated, and VSK France, which was also
  effectively liquidated in December, 1995. In 1996 and 1997, Classics B.V.B.A.
  and Detectia, N.V. merged into the VSK Group.

  Significant intercompany transactions have been eliminated in consolidation.

  BUSINESS OPERATIONS

  The Companies operate primarily in the United States, Belgium and the United
  Kingdom. During 1997, seventy-two percent of Allied's business activity is in
  the development and production of ammunitions and weapons systems in Belgium
  with sales to customers in Asia, the Middle East and Europe. Seventeen percent
  of the business activity is developing, manufacturing, distributing and
  servicing industrial security products in Belgium with industrial customers
  throughout Europe. Eleven percent of the business activity is providing
  engineering and technical support services in the United States with the
  majority of its sales directly or indirectly to United States Military
  Agencies, other defense contractors foreign governments and industry. A
  description of the business operations of each company follows.

  Allied provides management services to its wholly-owned subsidiaries. Allied
  has no direct domestic operating assets or business activity. Allied is
  currently in the formative steps of establishing a U.S. base for the VSK
  Group's industrial security products.

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

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

                                      F-10

<PAGE>


                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE A - SUMMARY OF ACCOUNTING POLICIES - CONTINUED

  BUSINESS OPERATIONS - CONTINUED

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

  ARCL, which was formerly engaged in the marketing of military hardware on
  behalf of Allied, Mecar and BRI, is currently inactive.

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

  FOREIGN CURRENCY TRANSLATION

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

  REVENUE AND COST RECOGNITION

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

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

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

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

  USE OF ESTIMATES

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

                                      F-11

<PAGE>


                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE A - SUMMARY OF ACCOUNTING POLICIES - CONTINUED

  INVENTORIES

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

  PROPERTY, PLANT AND EQUIPMENT

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

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

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

  INTANGIBLES

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

  DERIVATIVE FINANCIAL INSTRUMENTS

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

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

  STOCK-BASED COMPENSATION

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

  RESEARCH AND DEVELOPMENT

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

  WARRANTIES

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

                                      F-12

<PAGE>


                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE A - SUMMARY OF ACCOUNTING POLICIES - CONTINUED

  INCOME TAXES

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

  EARNINGS PER COMMON SHARE

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

  STATEMENT OF CASH FLOWS

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

  RECLASSIFICATIONS

  Certain items in the 1996 and 1995 financial statements have been reclassified
  to conform to the current presentation.

  NEWLY ISSUED ACCOUNTING STANDARDS

  In June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
  ENTERPRISE AND RELATED INFORMATION (SFAS 131), which is effective for fiscal
  years beginning after December 15, 1997. The statement establishes revised
  standards under which an entity must report business segment information in
  its financial statements. The Company plans to adopt SFAS 131 in the fiscal
  year beginning January 1, 1998 and does not believe its current segment data
  will change significantly under the newly adopted standards, which requires
  reporting on the basis that is used internally for evaluating segment
  performance.

NOTE B - ACQUISITION

  On May 9, 1995 the VSK Group acquired I.D.C.S.,  N.V., a Belgian company for
  approximately  $2,972,000.  I.D.C.S.  manufactures,  distributes and services
  an integrated line of industrial security products.

                                      F-13

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE B - ACQUISITION - CONTINUED

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

                                                          I.D.C.S., N.V.
                                                           May 9, 1995
                                                          --------------

  Fair value of tangible assets acquired                     $2,587,000
  Liabilities assumed                                           855,000
                                                             ----------
  Net assets acquired                                         1,732,000
  Purchase price                                              2,972,000
                                                             ----------

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


NOTE C - RESTRICTED CASH

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

  Cash of $8,727,186  and long-term  cash deposits of $6,414,419 at December 31,
  1997  ($20,116,000  of cash at December 31, 1996) are restricted or pledged as
  collateral for these agreements and other obligations.


NOTE D - ACCOUNTS RECEIVABLE

  Accounts receivable at December 31 are comprised as follows:

<TABLE>
<CAPTION>


                                                                                     1997                  1996
                                                                                  -----------           -----------
<S><C>
        Receivables under U.S. Government contracts and subcontracts
          Amounts billed                                                          $   836,769           $ 1,150,123
          Unbilled amounts due upon completion of contracts,
            recoverable costs and accrued profits                                   3,457,570             2,116,580
                                                                                  -----------           -----------
                                                                                    4,294,339             3,266,703

        Receivables from foreign governments                                       31,322,856             3,154,989
        Commercial and other receivables, less allowance for doubtful
          receivables of $205,350 in 1997 and $364,674 in 1996                      5,032,531             5,468,093
                                                                                  -----------           -----------

                                                                                  $40,649,726           $11,889,785
                                                                                  ===========           ===========
</TABLE>

                                      F-14

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE D - ACCOUNTS RECEIVABLE - CONTINUED

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

NOTE E - NOTES PAYABLE

  In June of 1997, the Company entered into a financing agreement with a
  domestic bank to provide financing for a contract with a foreign government.
  The agreement provides for a $3,500,000 line-of-credit, of which $1,720,000
  was outstanding at December 31, 1997. Borrowings under a similar
  line-of-credit were $250,000 at December 31, 1996. The current line-of-credit
  bears interest at the prime rate (8.5% at December 31, 1997) plus 1.5% and
  expires at the earlier of the contract completion or November, 1999.
  Borrowings under the line-of-credit are limited to BRI's eligible accounts
  receivable, as defined in the agreement.

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

  At December 31, 1996, short-term loans of $3,067,438, were outstanding with
  certain banks.

  The Company has a secured line-of-credit of approximately $800,000 with a
  foreign bank, which was unused at December 31, 1997.

NOTE F - CREDIT FACILITY

  The Company is obligated under various credit agreements (the Agreements) with
  its foreign banking pool and its domestic bank that provided 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 and bonds issued and annual fees of 1.25% - 1.35% of letters of
  credit, bonds and guarantees outstanding. As of December 31, 1997, guarantees
  and performance bonds of $28.6 million remain outstanding.

  Advances under the Agreements are secured by cash of $8,727,186 and long-term
  cash deposits of $6,414,419. Amounts outstanding are also collateralized by
  the letters of credit received under the contracts financed, and a pledge of
  approximately $23 million on Mecar's assets. Certain Agreements provide for
  restrictions on payments or transfers to Allied and ARCL for management fees,
  intercompany loans, loan payments, the maintenance of certain net worth levels
  and other provisions.

NOTE G - ACCRUED LOSSES ON CONTRACTS

  The Company has provided for accrued  losses of $572,279 at December 31, 1997
  ($390,125 at December 31, 1996) in connection  with the  completion of certain
  contracts in progress.  These contracts are expected to be completed in 1998.

                                      F-15


<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE H - LONG-TERM DEBT

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

                                                1997            1996
                                            -----------      -----------

      Term loan agreement                    $    -          $11,413,078
      Mortgage loan agreements                4,678,268        6,299,262
      Notes payable bank                        415,449          660,711
      Note payable - I.D.C.S., N.V.               -              189,162
      Other                                   1,498,583        2,980,394
                                              ---------      -----------
                                              6,592,300       21,542,607
      Less current maturities                 1,280,736       14,099,171
                                              ---------       ----------

                                             $5,311,564      $ 7,443,436
                                             ==========      ===========

  TERM LOAN AGREEMENT

  The Company was obligated under a secured term loan agreement with two of the
  institutions in its foreign banking pool that matured and was paid prior to
  December 31, 1997.

  MORTGAGE LOAN AGREEMENT

  The Company entered into a mortgage loan agreement in 1986, which was amended
  in 1994, to partially finance the construction of Mecar's manufacturing and
  administration facilities in Belgium, which loan has a balance due of
  $3,831,108 at December 31, 1997. The first principal installment was due in
  January, 1996 and the loan matures in January, 2004. As amended, the loan is
  payable in annual principal installments of $512,000 (except for the annual
  principal installment in the year 2000 which is $1,025,000). The loan bears
  interest at 8.75% annually and is collateralized by a mortgage on the
  Company's real estate. The Company is also obligated on several mortgages on
  the VSK Group's buildings which have a total balance due of $847,160 at
  December 31, 1997. The mortgages mature at various dates through 2005 in
  annual installments of approximately $254,000, plus interest at rates ranging
  from 6.6% to 8.5% per year.

  NOTES PAYABLE BANK

  BRI is obligated on a note payable with a balance of $415,449 at December 31,
  1997 which bears interest at the prime rate (8.5% at December 31, 1997) plus
  1.5% and matures in May 2002. The note is payable in monthly installments of
  principal of $5,750 plus accrued interest. The note is secured by the assets
  of BRI and is guaranteed by Allied. The agreement contains covenants requiring
  the maintenance of certain financial ratios, among other matters.

  BRI was obligated on two notes payable of $500,000 each to its bank at
  December 31, 1996, which were repaid on August 14, 1997.

  NOTE PAYABLE  - I.D.C.S., N.V.

  As of December  31, 1996,  the Company was  obligated  to the former  owner of
  I.D.C.S.  in  connection  with the  acquisition  of I.D.C.S.  in the amount of
  $189,162, which was paid at maturity in June, 1997.

                                      F-16

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE H - LONG-TERM DEBT - CONTINUED

  OTHER

  The Company is also obligated on various vehicle, equipment and other
  operating loans. The notes are generally secured by the assets acquired, bear
  interest at rates ranging from 4.4% to 10.75% and mature at various dates
  through 2002.

  Scheduled annual maturities of long-term obligations as of December 31, 1997
  are as follows:

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

            1998                                    $1,280,736
            1999                                     1,233,386
            2000                                     1,180,671
            2001                                       766,779
            2002                                       828,779
            Thereafter                               1,201,841


NOTE I - BENEFIT PLANS

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

  In June, 1992, the Board of Directors approved the Officers Nonqualified
  Deferred Compensation Plan and the Officers Deferred Compensation Grantor
  Trust. Certain officers of the Company are eligible to participate in the
  plan, which permits a deferral of a percentage of future base compensation.
  Amounts deferred will be invested by the Trustee of the Grantor Trust. The
  Company may terminate the plan at any time. No eligible officers had elected
  to participate in the plan as of December 31, 1997.

  The Company instituted a retirement savings plan in 1989 which received a
  favorable determination letter from the Internal Revenue Service.
  Contributions to the Plan are at the discretion of Company's management. In
  1996, the Company began to match participants' contributions at a rate of 25%
  for each participant dollar contributed up to a maximum of 1% of salary.
  Matching contributions in 1997 and 1996 were approximately $47,000 and
  $53,000, respectively. No contributions were made for the year ended December
  31, 1995.

  In 1997, the Company also contributed an additional amount of $35,000 to the
  Plan's profit sharing fund.  Additional  contributions of 25%, up to a maximum
  of 1% of salary will be made in 1998.

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

                                      F-17

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE J - CONTINGENCIES AND COMMITMENTS

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

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

  At December 31, 1997, Mecar has provided for estimated losses on contracts of
  $572,279. In addition, Mecar and BRI recognize revenues under fixed price
  contracts using the percentage of completion method. Estimates of total costs
  at completion are used to determine the amount of revenue earned. It is likely
  that actual costs on these contracts will differ from the Company's estimate
  at completion and losses could exceed the provision established at December
  31, 1997.

  The Company enters into foreign exchange contracts in the normal course of
  business primarily to hedge sales and purchase contracts. These contracts
  typically mature within twelve months, and forward exchange gains and losses
  are recognized upon maturity. Contracts with a notional amount of $20,000,000
  were outstanding as of December 31, 1997. There were no contracts outstanding
  at December 31, 1996.

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

  The Company leases office space, other facilities and equipment under
  operating leases which expire at various dates through 2001. Certain leases
  also include escalation provisions for taxes and operating costs. The
  following is a schedule by year of base rentals due on operating leases that
  have initial or remaining lease terms in excess of one year as of December 31,
  1997.

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

                 1998                                 $427,215
                 1999                                  363,516
                 2000                                  212,458
                 2001                                   17,373

  Total rental expense charged to operations approximated $400,000, $421,000 and
  $444,000, for the years ended December 31, 1997, 1996 and 1995, respectively.

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

                                      F-18

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE K - FAIR VALUE OF FINANCIAL INSTRUMENTS

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

<TABLE>
<CAPTION>
                                                                    1997                             1996
                                                        ----------------------------    ----------------------------
                                                         Carrying         Estimated       Carrying        Estimated
                                                          Amount         Fair Value        Amount        Fair Value
                                                        -----------     ------------    ------------    ------------
<S><C>
      Notes payable                                     $ 1,720,000     $  1,720,000    $  3,317,438    $  3,317,000
      Long-term debt, including current maturities        6,592,300        6,592,300      21,542,607      21,543,000
      Off-balance-sheet instruments
        Guarantees and letters of credit                          -       28,586,000               -      20,283,000
        Foreign exchange contracts                                -       20,000,000               -               -
</TABLE>

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

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

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

  o Estimated fair values for off-balance-sheet instruments (performance bonds,
    advance payment guarantees and letters-of-credit) are reflected at the face
    value of these obligations, since management does not expect to have any
    claims against these obligations based on its past experience. The fair
    value of foreign exchange contracts are based on their notional values,
    since they have short-term maturities at December 31, 1997.

NOTE L - CAPITAL STOCK

  At December 31, 1997,  options to acquire  214,770 shares of the Company
  common stock were  outstanding  and 848,949 shares were reserved for future
  issuance under the following plans:

  1997 INCENTIVE STOCK PLAN

  During 1997, the Board of Directors 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. As of December 31, 1997, no awards had
  been made under the Plan.

                                      F-19

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE L - CAPITAL STOCK - CONTINUED

  1992 ALLIED RESEARCH CORPORATION EMPLOYEE STOCK PURCHASE PLAN

  During 1993, the Board of Directors and shareholders approved and reserved
  525,000 shares for the plan. The plan is voluntary and substantially all
  full-time employees with greater than six months of service are eligible to
  participate through payroll deductions. The purchase price of each share is
  equal to 85% of the closing price of the common stock at the end of each
  calendar quarter. The plan is subject to certain restrictions and the Board
  may amend or terminate it at any time. During 1997, 1996 and 1995 - 16,553,
  12,001 and 20,608 shares, respectively, subject to the plan were issued and
  $31,978, $9,225 and $11,736 was charged to operations.

  1988 INCENTIVE COMPENSATION PLAN

  The Company has reserved 410,900 shares of common stock for key employees of
  the Company and its subsidiaries. The plan authorizes the Board to grant
  incentive stock options, non-statutory stock options, stock appreciation
  rights, stock awards, restricted stock, performance stock rights and cash
  awards. Each type of grant places certain requirements and restrictions upon
  the Company and grantee. As of December 31, 1997, options had been granted for
  276,000 shares, which have all been exercised except for 33,020 at prices of
  $3.75 to $5.125 per share.

  As of December 31, 1997, 94,000 shares of restricted common stock subject to
  the plan have been awarded. These shares were awarded prior to 1993 and the
  value of the incentives were charged to operations in the year they were
  awarded.

  1984 INCENTIVE STOCK OPTION PLAN

  The Company has reserved 315,000 shares of common stock for key employees of
  the Company and its subsidiaries. The plan, which permitted grants through
  March 31, 1994, provided that the purchase price shall be no less than the
  fair market value of a share of common stock of the Company on the date the
  option is granted, except for those options granted to employees who hold in
  excess of 10% of the Company's stock, in which case the option price shall be
  110% of the fair market value on the date of grant. Options granted can be
  exercised two years or later from the date of grant and expire at the earlier
  of thirty days after termination of employment or ten years from the date of
  grant (five years in the case of an Over-Ten-Percent Stockholder). In March
  1995, the Company granted options to two officers and sixteen employees to
  purchase 217,500 shares at $8.25 per share. These options have restrictions
  concerning employment for a two-year period and expire in 2004. At December
  31, 1997, 144,250 of these options remained outstanding.

  1993 ALLIED RESEARCH CORPORATION OUTSIDE DIRECTORS COMPENSATION PLAN

  During 1993, the Board of Directors and shareholders approved a plan whereby
  each director is entitled to receive a cash payment of $1,000 per month and an
  annual grant of 1,000 shares of the Company's common stock while serving as a
  board member. The Company has reserved 52,400 shares of common stock for the
  plan which is subject to certain restrictions. The plan will terminate upon
  the earlier of issuance of all reserved common shares or December 31, 2003. In
  1997, 1996 and 1995, the Company granted 4,000, 5,000 and 3,000 shares of
  common stock subject to the plan and charged $34,000, $26,250 and $11,250,
  respectively, to operations.

                                      F-20

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE L - CAPITAL STOCK - CONTINUED

  1991 OUTSIDE DIRECTORS STOCK OPTION PLAN

  During 1991, the Board of Directors and shareholders approved and reserved
  208,000 shares of common stock for the plan. The Company granted options to
  purchase a total of 40,000 shares at $2.50 to $4.125 per share. All issued
  options have been exercised. During 1996, the Company granted additional
  options to purchase a total of 75,000 shares at $5.125 per share. At December
  31, 1997, 37,500 of the options had been exercised.

  OTHER

  Stock grants for 48,746, 3,035 and 37,260 shares of the Company's common stock
  were made to various employees during 1997, 1996 and 1995. These shares were
  issued outside of any existing plan and their value ($487,460, $12,125 and
  $172,812, respectively) was charged to operations.

  PREFERRED SHARE PURCHASE RIGHTS AGREEMENT

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

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

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

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

                                      F-21

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE L - CAPITAL STOCK - CONTINUED

  THE FOLLOWING TABLE SUMMARIZES OPTION ACTIVITY:

<TABLE>
<CAPTION>
                                                                        1997
                                                            -----------------------------
                                                                         Weighted Average      1996           1995
                                                            Shares        Exercise Price      Shares         Shares
                                                            -------      ----------------     -------        -------
<S><C>
      Options outstanding at beginning of year              313,100           $6.76           227,500        227,500
      Options exercised                                     (95,830)           6.02                 -              -
      Options granted                                             -               -           135,600              -
      Options expired                                        (2,500)           8.25           (50,000)             -
                                                            -------            ----           -------        -------


      Options outstanding at end of year                    214,770           $7.08           313,100        227,500
                                                            =======            ====           =======        =======

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

      Option price range for exercised shares                 $3.75                                 -              -
                                                                 to
                                                              $8.25

      Options available for grant at end of year            115,300                           112,800        238,400

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

  THE FOLLOWING TABLE SUMMARIZES OPTIONS OUTSTANDING AT DECEMBER 31, 1997:

<TABLE>
<CAPTION>
                                                                                  Weighted Average
        Number                                          Weighted Average              Remaining
      Outstanding             Exercise Prices            Exercise Prices          Contractual Life
      -----------             ---------------           ----------------          ----------------
<S><C>
        214,770                $3.75 to $8.25                $7.08                      5.42
</TABLE>

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

                                      F-22

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE L - CAPITAL STOCK - CONTINUED

  The following table presents the pro forma decrease in income that would have
  been recorded had the fair values of options granted in each year after 1994
  been recognized as compensation expense on a straight-line basis over the
  vesting period of the grant.

                                        1997        1996       1995
                                      --------    --------   --------

     Pro forma
       Net earnings                    $80,067    $159,697    $  -
       Earnings per share
         Basic                             .01         .03       -
         Diluted                           .02         .03       -

  There were no options granted in 1995

NOTE M - MAJOR CUSTOMERS

  The Company derives the majority of its revenues from foreign governments,
  direct and indirect sales to U.S. Government agencies and government prime
  contractors, primarily on fixed price contracts. During 1997, 1996 and 1995,
  the Company derived approximately 5%, 11% and 17%, respectively, of its
  revenue from U.S. Government agencies and contractors. Two agencies of a
  foreign government and another foreign government accounted for approximately
  64% , 6% and 10% of revenue in 1997, 42% , 10% , and 19% of revenue in 1996
  and, 31%, 12% and 27% of revenue in 1995.

NOTE N - CONCENTRATIONS OF CREDIT RISK

  Financial instruments and related items which potentially subject the Company
  to concentrations of credit risk consist principally of temporary cash
  investments, trade receivables and costs and accrued earnings on uncompleted
  contracts. The Company places its temporary cash investments with high credit
  quality financial institutions. Credit risk with respect to trade receivables
  and costs and accrued earnings on uncompleted contracts are concentrated due
  to the nature of the Company's customer base. The Company receives guarantees
  and letters of credit from its foreign customers and performs ongoing credit
  evaluations of its other customers' financial condition. The Company's
  provision for doubtful accounts for 1997 and 1996 was not significant.

  The majority of ammunition sales are to two agencies of a foreign government
  and other foreign governments. Mecar's ammunition sales in any given period
  and its backlog at any particular time may be significantly influenced by one
  or a few large orders. In addition, the production period required to fill
  most orders ranges from several months to a year. Accordingly, Mecar's
  business is dependent upon its ability to obtain such large orders and the
  required financing for these orders. As of December 31, 1997 and 1996, backlog
  orders believed to be firm approximated $92.8 and $79.6 million.

  Amounts in foreign banks at December 31, 1997 and 1996 were approximately
  $14.1 million and $31.8 million, respectively. Changes in the value of the
  U.S. dollar and other currencies affect the Company's financial position and
  result of operations since the Company has operations in Belgium and the
  United Kingdom and sells its products on a worldwide basis.

                                      F-23

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE O - OTHER - NET

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

<TABLE>
<CAPTION>
                                                          1997           1996               1995
                                                       ----------      ---------         ----------
<S><C>
      Net currency transaction gains (losses)          $1,328,195      $(836,254)        $1,284,446
      Miscellaneous - net                                 191,310        454,875            684,032
                                                        ---------       ---------         ---------

                                                       $1,519,505      $(381,379)        $1,968,478
                                                        =========       ========          =========
</TABLE>

NOTE P - INCOME TAXES

  The Company has adopted the provisions of Statement of Financial Accounting
  Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"), which
  requires recognition of deferred tax liabilities and assets for the expected
  future tax consequences of events that have been included in the financial
  statements or tax returns. Under this method, deferred tax liabilities and
  assets are determined based on the difference between the financial statement
  and tax basis of assets and liabilities using enacted tax rates in effect for
  the year in which the differences are expected to reverse.

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

                               1997           1996             1995
                           ------------    -----------     -----------

    Domestic               $   (809,173)   $   124,549    $    151,888
    Foreign                  10,335,115      5,572,164      (1,421,507)
                            -----------      ---------      ----------

                           $  9,525,942     $5,696,713     $(1,269,619)
                            ===========      =========      ==========

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

                               1997           1996             1995
                           ------------    -----------     -----------
  Currently payable
    Domestic                 $  46,614    $   197,299        $ 116,692
    Foreign                    921,336      1,323,619          498,696
                              --------      ---------         --------
                               967,950      1,520,918          615,388
  Deferred - net                (6,796)      (629,688)         128,264
                              --------      ---------         --------

                             $ 961,154    $   891,230        $ 743,652
                              ========      =========         ========

                                      F-24

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE P - INCOME TAXES - CONTINUED

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

<TABLE>
<CAPTION>
                                                         1997         1996            1995
                                                       --------      --------       --------
<S><C>
     Taxes at statutory rate                             34.0%         34.0%         (34.0)%
     Benefit of foreign tax credit carryforward             -          (1.2)          (7.4)
     Foreign tax rate differential, loss limitations,
       and net operating loss benefits                  (27.5)        (18.3)          94.3
     Other                                                3.6           1.1            5.7
                                                         ----          -----          ----

                Income taxes                             10.1%         15.6%          58.6%
                                                         ====          =====          ====
</TABLE>

  In 1997, 1996 and 1995, the Company's Belgian subsidiaries utilized
  approximately $8,529,000, $4,232,000 and $47,000, respectively, of foreign
  operating loss carryforwards for tax reporting purposes. Unused net operating
  losses of the Belgian subsidiaries at December 31, 1997 approximate
  $4,220,000, which under Belgian tax law cannot be carried back, but may be
  carried forward indefinitely.

  The Company utilized approximately $67,000, and $94,000 of its foreign tax
  credits in 1996 and 1995, respectively. No foreign tax credits were utilized
  in 1997. At December 31, 1997, foreign tax credit carryforwards of
  approximately $455,000 were available which expire through 2000.

  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
  $28.6 million at December 31, 1997. Determination of the amount of
  unrecognized deferred tax liabilities is not practicable.

                                      F-25

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE P - INCOME TAXES - CONTINUED

  Deferred taxes at December 31, 1997 and 1996 are comprised as follows:

<TABLE>
<CAPTION>
                                                                                     1997              1996
                                                                                  -----------       ------------
<S><C>
    Current
      Unrealized exchange (losses) gain                                          $   (48,880)      $     52,158
      Compensated absences                                                           111,000             96,000
      Deferred income                                                                (52,455)            (8,713)
      Other                                                                           73,000             18,000
                                                                                  -----------       ------------

          Current deferred tax asset/liability                                        82,665            202,669

    Noncurrent
      Foreign tax credit carryforwards                                               676,005            790,017
      Foreign and domestic net operating loss carryforwards                        1,776,435          5,345,510
      Depreciation and amortization                                                  124,455            189,656
      Deferred compensation                                                           25,103             45,224
      Unrealized exchange gain                                                      (577,780)          (599,375)
                                                                                  -----------       ------------

          Noncurrent deferred tax asset/liability                                  2,024,218          5,725,808
                                                                                  -----------       ------------

          Total deferred tax asset before valuation allowances                     2,106,883          5,928,477

    Valuation allowances                                                          (2,236,594)        (6,064,997)
                                                                                  -----------       ------------

          Net deferred tax liability                                             $  (129,711)      $   (136,520)
                                                                                  ==========        ===========
</TABLE>

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

<TABLE>
<CAPTION>
                                                                 1997              1996
                                                              -----------      -------------
<S><C>
    Current (included in "prepaid expenses and deposits")     $   496,949      $     491,854
    Deferred income taxes                                        (626,660)          (628,374)
                                                               ----------        -----------

                                                              $  (129,711)      $   (136,520)
                                                               ==========        ===========
</TABLE>

NOTE Q - EXPLOSION

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

                                      F-26

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE R - RESTRUCTURING COSTS

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


Provisions in 1997                                               $977,267
Cash payments in 1997                                             478,817
                                                                 --------
Restructuring provision at December 31, 1997                     $498,450
                                                                  =======



NOTE S - EARNINGS PER COMMON SHARE

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

<TABLE>
<CAPTION>
                                                                              1997           1996           1995
                                                                           ----------     ----------     -----------
<S><C>
      Basic EPS
        Income (loss) available to common stockholder                      $8,564,788     $4,805,483     $(2,013,271)
                                                                            =========      =========      ==========

        Weighted average number of common shares outstanding                4,543,874      4,432,750       4,408,172

               Basic EPS                                                        $1.88          $1.08          $(0.46)
                                                                                 ====           ====           =====


      Diluted EPS
        Income (loss) available to common stockholders                     $8,564,788     $4,805,483     $(2,013,271)
        Income impact of assumed conversions
                                                                                -              -               -
                                                                            ----------    ----------     -----------
               Income available to common stockholders on a
                 diluted basis                                             $8,564,788     $4,805,483     $(2,013,271)
                                                                            =========      =========      ==========
        Weighted average number of common shares outstanding                4,543,874      4,432,750       4,408,172
        Effect of dilutive securities - stock options                          82,728          5,739           -
                                                                            ----------    ----------     -----------

               Adjusted weighted average number of common
                shares outstanding                                          4,626,602      4,438,489       4,408,172

               Diluted EPS                                                      $1.85          $1.08          $(0.46)
                                                                                 ====           ====           =====

</TABLE>

                                      F-27

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE S - EARNINGS PER COMMON SHARE - CONTINUED

  During 1996, options to purchase 71,950 shares at $8.75 a share were
  outstanding , which were not included in the computation of diluted EPS
  because the options' exercise price was greater than the average market price
  of the common shares. During 1995, options to purchase 227,500 shares at
  prices ranging from $2.75 to $8.25 a share were outstanding, which were not
  included in the computation of diluted EPS since inclusion of such shares
  would be antidilutive.

NOTE T - YEAR 2000 COMPUTER SYSTEMS COMPLIANCE

  The Company has made and will continue to make certain expenditures to ensure
  that its software systems and applications continue to function properly in
  and after 2000. These expenditures have not been and are not anticipated to be
  material to the Company's financial position or results of operations.

NOTE U - GEOGRAPHIC AREAS AND INDUSTRY SEGMENTS

  The Company currently operates in three principal areas: Product sales
  (Mecar), Engineering and Technical (BRI) and Security Systems and Services
  (The VSK Group). Product sales includes the production of ammunitions, weapons
  systems and ordnance products systems integration. Engineering and Technical
  provides support services primarily to United States Military Agencies and
  government contractors. Security Systems and Services includes sales and
  services to industrial and institutional customers of protection, fire and
  access control systems and services.

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


                                      F-28

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE U - GEOGRAPHIC AREAS AND INDUSTRY SEGMENTS - CONTINUED

  Information by geographic area and industry segment is as follows:

<TABLE>
<CAPTION>

    Geographic Area Data                                        1997                 1996               1995
    --------------------                                    -------------         -----------        -----------
    <S><C>
    Net sales to unaffiliated customers
      Belgium (1)                                           $123,916,607        $ 92,023,896         $53,280,097
      France                                                        -                    -             1,054,560
      United States                                           10,567,143          11,636,241          11,434,250
                                                            ------------        ------------         ----------

                                                            $134,483,750        $103,660,137         $65,768,907
                                                             ===========         ===========         ==========

    Operating income (loss)
      Belgium                                               $  8,855,302        $  6,848,251         $  (926,099)
      United Kingdom                                            (212,433)            (91,752)           (626,630)
      France                                                        -                   -               (495,318)
      United States                                              620,453             940,247             598,497
      Corporate                                                 (443,787)            (89,452)           (524,288)
                                                           --------------      --------------        -----------

                                                           $   8,819,535       $   7,607,294         $(1,973,838)
                                                           =============       =============          ==========
    Assets
      Belgium                                              $  83,257,626       $  84,842,298        $84,800,974
      United Kingdom                                             480,608             228,654          1,645,818
      France                                                        -                   -             1,213,227
      United States                                           15,762,405           6,877,208          6,593,254
                                                            ------------       -------------        -----------

                                                           $  99,500,639       $  91,948,160        $94,253,273
                                                            ============        ============         ==========

                                      F-29

</TABLE>


(1) INCLUDES EXPORT SALES PRINCIPALLY TO CUSTOMERS IN ASIA/MIDDLE EAST AND
    EUROPE OF $113,578,000 IN 1997, $72,742,500 IN 1996, $33,212,000 IN 1995.


<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE U - GEOGRAPHIC AREAS AND INDUSTRY SEGMENTS - CONTINUED

<TABLE>
<CAPTION>

    Industry Segment Data                                      1997                   1996            1995
    ---------------------                                   ------------          ------------      -----------
<S><C>

    Net sales to unaffiliated customers
      Product sales                                         $107,533,415          $ 74,109,952      $36,131,894
      Engineering and technical                               10,549,224            11,636,242       11,354,440
      Security systems and service                            16,401,111            17,913,943       18,282,573
                                                           -------------           -----------       ----------

                                                            $134,483,750          $103,660,137      $65,768,907
                                                             ===========           ===========       ==========

    Operating income (loss)
      Product sales                                         $  7,277,898          $  5,373,053      $ (2,686,686)
      Engineering and technical                                  620,453               650,837           912,048
      Security systems and service                             1,364,971             1,672,856           325,088
      Corporate                                                 (443,787)              (89,452)         (524,288)
                                                            -------------         ------------       ------------

                                                            $  8,819,535          $  7,607,294       $(1,973,838)
                                                             ============          ===========        ===========

    Assets
      Product sales                                         $ 18,317,504          $ 81,334,200        $83,468,399
      Engineering and technical                               13,016,075             5,505,577          5,855,840
      Security systems and service                             2,527,051             3,736,752          4,191,620
      Corporate assets                                         2,640,009             1,371,631            737,414
                                                             ------------          -----------       ------------
                                                            $ 99,500,639          $ 91,948,160        $94,253,273
                                                             ============          ============        ==========

    Capital expenditures
      Product sales                                        $   1,043,058          $    696,699        $ 2,179,864
      Engineering and technical                                  163,963               264,915            310,059
      Security systems and service                               135,299               105,275            430,805
                                                             -----------           -----------       ------------

                                                           $   1,342,320         $   1,066,889        $ 2,920,728
                                                             ===========          ============        ===========

    Depreciation and amortization expense
      Product sales                                        $   2,049,204         $   2,488,189        $ 2,310,195
      Engineering and technical                                  446,602               392,497            222,857
      Security systems and service                               150,189               212,848            218,815
                                                            ------------         -------------       ------------

                                                            $  2,645,995        $    3,093,534        $ 2,751,867
                                                             ===========         =============        ===========


                                      F-30

</TABLE>

<PAGE>



                          ALLIED RESEARCH CORPORATION

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

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

NOTE V - QUARTERLY FINANCIAL DATA (UNAUDITED)

<TABLE>
<CAPTION>

                                                         (Amounts in thousands, except per share data)
                                             ----------------------------------------------------------------
                                               First           Second        Third         Fourth      Total
      1997                                    Quarter          Quarter      Quarter        Quarter    For Year
-------------------------------              ---------        ---------    ---------      ---------  ----------
<S><C>
Revenue                                        $29,765          $24,630      $27,774        $52,315    $134,484

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

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

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

</TABLE>
<TABLE>
<CAPTION>

      1996
----------------
<S><C>
Revenue                                        $23,527          $23,004      $17,547        $39,582    $103,660

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

Net earnings                                       636              651          521          2,997       4,805

Per share data:
  Basic                                            .14              .15          .12            .67        1.08
  Diluted                                          .14              .15          .12            .67        1.08



</TABLE>

                                      F-31

<PAGE>


                                                      SCHEDULES


<PAGE>




                          ALLIED RESEARCH CORPORATION

           SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT

                                (PARENT COMPANY)

                                 BALANCE SHEETS

                                  DECEMBER 31,
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------

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



               ASSETS

                                                                                       1997              1996
                                                                                   -----------        -----------
<S><C>
Cash and equivalents                                                               $ 2,342,037        $ 1,039,062
Investments in subsidiaries                                                         41,722,046         34,903,082
Deferred tax asset                                                                      25,103             97,382
Deposits and other                                                                     379,158            235,187
                                                                                   -----------         ----------

         Total assets                                                              $44,468,344        $36,274,713
                                                                                    ==========         ==========


         LIABILITIES

Accounts payable and accrued liabilities                                           $ 1,176,115        $   475,208
Due to subsidiaries                                                                  6,348,894          4,264,263
Deferred tax liability                                                                  48,880              -
Income taxes                                                                             -                 88,601
                                                                                    -----------        ----------

         Total liabilities                                                           7,573,889          4,828,072


STOCKHOLDERS' EQUITY
  Common stock                                                                         460,822            444,309
  Capital in excess of par value                                                    12,100,521         10,846,303
  Retained earnings                                                                 26,046,271         17,481,483
  Accumulated other comprehensive
    (loss) income                                                                   (1,713,159)         2,674,546
                                                                                    -----------        ----------
                                                                                    36,894,455         31,446,641
                                                                                    -----------        ----------
                                                                                   $44,468,344        $36,274,713
                                                                                    ==========         ==========
</TABLE>
                                      F-33



<PAGE>


                          ALLIED RESEARCH CORPORATION

     SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED

                                (PARENT COMPANY)

                            STATEMENTS OF OPERATIONS

                            YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------

                                                                    1997               1996             1995
                                                                 ------------       -----------     -----------
<S><C>
Income
  Intercompany management fees                                   $ 2,684,859        $2,652,889      $ 2,505,222
  Other - net                                                        311,587           (77,412)         266,361
                                                                   ----------        ---------        ----------
                                                                   2,996,446         2,575,477        2,771,583

Costs and expenses
  Administrative and other                                         4,512,176         2,878,746        3,115,475
                                                                   ----------        ---------        ----------

         (Loss) before equity in
           operations of subsidiaries                             (1,515,730)         (303,269)        (343,892)

Equity in operations of subsidiaries                               9,855,491         4,959,035        (1,696,176)
                                                                   ----------        ---------        ----------

         Earnings (loss)  before income taxes                      8,339,761         4,655,766        (2,040,068)

Income taxes (benefit)                                              (225,027)        (149,717)          (26,797)
                                                                   ----------        ---------        ----------

         NET EARNINGS (LOSS)                                     $ 8,564,788        $4,805,483       $(2,013,271)
                                                                   =========         =========        ==========



         Earnings (loss) per common share
           Basic                                                       $1.88             $1.08             $(.46)
                                                                        ====              ====              ====

           Diluted                                                     $1.85             $1.08             $(.46)
                                                                        ====              ====              ====
</TABLE>

                                      F-34


<PAGE>


                          ALLIED RESEARCH CORPORATION

     SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT - CONTINUED

                                (PARENT COMPANY)

                            STATEMENTS OF CASH FLOWS

                            YEAR ENDED DECEMBER 31,

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------


Increase (decrease) in cash and equivalents                         1997              1996              1995
                                                                 -----------      -----------        -----------
<S><C>
Cash flows from (used in) operating activities
  Net (loss) earnings for the year                               $ 8,564,789      $  4,805,483       $(2,013,270)
  Adjustments to reconcile net earnings to net cash from
    (used in) operating activities
      Equity in operations of subsidiaries                        (9,855,489)       (4,959,035)        1,696,176
      Depreciation and amortization                                    6,191              -                 -
      Gain on disposal of property and equipment                        -                 (250)             -
      Deferred income taxes                                          146,262          (127,724)           41,904
      Common stock awards and grants                                 521,460            41,382            11,250
  Changes in assets and liabilities
    Due from subsidiaries                                               -              377,095          (329,697)
    Inventories                                                      (96,059)             -                 -
    Accounts receivable                                              (25,665)             -                 -
    Other assets                                                     (36,298)           85,350           133,830
    Due to subsidiaries                                              733,448              -               26,146
    Accounts payable and accrued liabilities                         700,909           269,066           (61,644)
    Income taxes                                                     (88,601)           38,496            (3,308)
                                                                  ----------       -----------       -----------
                                                                  (7,993,842)       (4,275,620)        1,514,657
                                                                  ----------       -----------       -----------

         Net cash provided by (used in) operating activities         570,947           529,863          (498,613)

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

         Net cash (used in) investing activities                     (17,243)           (7,000)             -

Cash flows from financing activities
  Proceeds from employee stock purchase plan shares                  749,271            61,729            78,232
                                                                  ----------       -----------       -----------

           Net increase (decrease) in cash and equivalents         1,302,975           584,592          (420,381)

Cash and equivalents at beginning of year                          1,039,062           454,470           874,851
                                                                  ----------       -----------       -----------

Cash and equivalents at end of year                              $ 2,342,037      $  1,039,062      $    454,470
                                                                  ==========       ===========       ===========

Supplemental Disclosures of Cash Flow Information
-------------------------------------------------
  Cash paid during the year for
    Income taxes                                                 $   116,692      $    135,000      $    120,000
    Interest                                                            -                 -                 -


</TABLE>

                                      F-35

<PAGE>


                          ALLIED RESEARCH CORPORATION

                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------


                                                             Additions
                                                  -------------------------------
                                  Balance at       Charged to          Charged                       Balance
                                   beginning        costs and          to other                     at end of
Description                        of period        expenses           accounts      Deductions       period
-----------                       ----------      --------------------------------   ----------     ----------
Year ended December 31, 1997
----------------------------
<S><C>
  Estimated losses on
    contracts                    $   390,125      $   572,279       $     -         $    390,125   $   572,279
                                  ==========       ==========        =============   ===========    ==========

  Allowance for doubtful
    receivables                  $   364,674      $   192,837       $     -         $     33,513   $   205,350
                                  ==========       ==========        =============   ===========    ==========

  Valuation allowances on
    deferred tax assets          $ 6,064,997      $        -        $     -         $  3,909,700   $ 2,155,297
                                  ==========       ==========        =============   ===========    ==========

</TABLE>

<TABLE>
<CAPTION>
Year ended December 31, 1996
----------------------------
<S><C>
  Estimated losses on
    contracts                    $   431,215      $   390,125       $     -          $   431,215   $   390,125
                                  ==========       ==========        =============    ==========    ==========

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

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


</TABLE>

<TABLE>
<CAPTION>

Year ended December 31, 1995
----------------------------
<S><C>

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

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

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

</TABLE>




                                      F-36

<PAGE>



                                    EXHIBITS


<PAGE>





                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------

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

<S><C>

 21                        List of Subsidiaries

 23                        Consent of Independent Certified
                              Public Accountants


</TABLE>




                                      E-2