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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

For the fiscal year ended December 31, 2003

Commission file number: 001-11376

The Allied Defense Group, Inc.

8000 Towers Crescent Drive, Suite 260

(703) 847-5268

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

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

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

      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.     Yes þ

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

      State the aggregate market value of the voting stock of the registrant held by non-affiliates as of June 30, 2003, the last day of the registrant’s most recently completed second fiscal quarter (For purposes of this determination, only our directors and executive officers have been deemed affiliates):

      The number of shares of registrant’s Common Stock outstanding as of March 1, 2004, was 5,551,373.

INDEX

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PART I

Item 1.     Business

      The Allied Defense Group, Inc. (“Allied” or the “Company”) owns and manages a strategic portfolio of defense and security businesses, with presence in worldwide markets.

      Allied was incorporated as a Delaware corporation in 1961 under the name Allied Research Associates, Inc. Allied changed its corporate name to Allied Research Corporation in 1988 and subsequently changed its name to The Allied Defense Group, Inc. effective January 2, 2003. Allied’s strategic defense and security businesses are conducted through MECAR S.A. (“MECAR”), a group of Belgian corporations acquired in 1994, 1995 and 1999 consisting of VSK Electronics N.V., Télé Technique Générale, S.A., Intelligent Data Capturing Systems, S.A. and VIGITEC, S.A. (collectively, the “VSK Group”), News/ Sports Microwave Rental Inc. (“NS Microwave”), Titan Dynamics Systems, Inc. (“Titan Dynamics”), and SeaSpace Corporation (“SeaSpace”). In late 2003, the Company organized MECAR USA, Inc., a Delaware corporation (“MECAR USA”).

      The following table summarizes the Company’s significant acquisitions and divestitures:

      In order to continue building a strong worldwide strategic portfolio of defense and security businesses and to improve profitability, Allied has adopted a growth strategy that focuses on the following objectives:

	•	Strategic acquisitions that complement existing operating divisions
	•	Organic growth by expanding product offerings, increasing market share in existing markets, and penetrating new markets
	•	Enhance marketing and business development efforts between each subsidiary to increase sales and backlog
	•	Successfully integrate new subsidiaries to ensure profitability and accretion

Description of Business

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

      MECAR. MECAR develops, designs, manufactures and sells ammunition and light weapons for military use. Substantially all of MECAR’s revenues are derived from the sale of ammunition which is used with weapons that are generally considered defensive weapons. From time to time, MECAR provides system integration services pursuant to which it purchases and resells weapon systems and/or ammunition manufactured by others. MECAR designs, develops and manufactures a wide variety of ammunition and grenades in the medium caliber, artillery, anti-tank and anti-personnel categories. The following are the principal products produced and sold by MECAR:

      Mortar Ammunition The 120mm family is state of the art ammunition for standard field mortars and for the increased performance turreted Automatic Mortar System (AMS). The current version of this ammunition has successfully completed qualification with the U.S. Army, together with the 120mm AMS LAV-M(S) system. This system is capable of direct as well as indirect fire. The MECAR ammunition is the only one so far developed that has been qualified in the AMS weapon high pressure and acceleration environment. The 81mm family of mortar

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      90mm Ammunition MECAR has developed and produces complete families of ammunition that include Armor Piercing Fin Stabilized Discarding Sabot (APFSDS), High Explosive (HE), Smoke (SMK) and High Explosive Squash Head (HESH) rounds for the COCKERILL Mk II and III and ENGESA EC-90, and DEFA F1 guns. Over 2,000 of these guns are standard equipment on light Armored Personnel Carriers (APCs) in the Far East and South America alone. In the last five years, these families of ammunition have been improved to meet the highest standards of safety and performance. The 90mm KENERGA Weapon System has been jointly developed by Cockerill Mechanical Systems (“CMI”) and MECAR to provide the modern A..P..C.. (APC) with anti-tank punch similar to that of tanks equipped with 105mm guns, without sacrifice to the range, mobility and maintainability of the light APC. In this partnership, CMI is responsible for the weapon and MECAR for the ammunition. The ammunition family includes the APFSDS, HESH and SMK versions with their corresponding training rounds. This system is currently completing its final phase of qualification by the U.S. Army.

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

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

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

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

      84mm SAKR Recoilless Rifle MECAR develops 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.

      Grenades MECAR manufactures two types of grenades: the M72 controlled fragmentation hand grenade and the universal bullet trap rifle grenade. 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. MECAR manufactures several different bullet trap grenades including high explosive fragmentation, anti-personnel, armor piercing, smoke generating, white phosphorus, and parachute flare (night illuminating).

      VSK Group. The VSK Group designs, manufactures, sells, installs and services security systems for government and private industry. The VSK Group consists of four firms: VSK Electronics, N.V., Télé Technique Générale, S.A., Intelligent Data Capturing Systems (IDCS) S.A., and VIGITEC S.A. VSK Electronics, N.V. manufactures access control and fire detection systems; Télé Technique Générale, S.A. installs security systems; IDCS S.A. manufacturers integrated video systems; and VIGITEC S.A. installs networked video surveillance systems. These firms combine to create a wealth of technical knowledge in hardware and software development and closed circuit monitoring, along with the latest trends in data transmission and communication protocols for a host of protection and detection security systems. The VSK Group’s systems offer total integration with all aspects of data collection and management, surveillance, protection and detection with either direct and/or remote programming options for maximum control. The latest technological systems include biometric verification, asset tracking and digital closed circuit television distribution.

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

      Titan Dynamics. Titan Dynamics designs, manufactures and sells an extensive line of battlefield effects simulators. These systems provide military personnel with real time, thermal, audio/visual battlefield effects commonly experienced in wartime to enhance training realism. The simulators fire pyrotechnic cartridges that simulate the flash, smoke and sound of fired or exploding ammunition and ordnance systems. Titan Dynamics’ principal product lines are Omega 36/ B2 and Omega 60/ B1 battlefield effects simulators (BES), the Multi Air Defense Simulator System (MADSS), the Rocket Propelled Grenade System (RPGS) and the E-Pryo Simulator devices. The Omega 36/ B2 and the Omega 60/ B1 BES are 36 shot and 60 shot programmable dispensers which discharge multiple Titan-produced cartridges that produce various pyrotechnic effects such as flash/bang, colored smokes, air burst, star clusters and missile firing signatures. The MADSS and the RPGS are multi-spectrum training systems used to simulate aircrew’s and ground crew’s internal attack warning systems while also providing the real-time thermal/audio/visual battlefield effects related to the attack. The company’s focus for the future is to design and manufacture innovative new products for the military training environment and exploit its revolutionary patented initiation technologies to a wide variety of applicable commercial fields.

      SeaSpace. SeaSpace designs, manufactures, distributes and services weather and environmental satellite ground reception systems. Its proprietary TeraScan® software processes earth remote sensing satellite data for mission-critical applications requiring timely and accurate weather and environmental information. Founded in 1982, SeaSpace pioneered the development of cost-effective, easily deployed systems, and has built a worldwide base of over 450 military, commercial, and academic customers. SeaSpace has also established market leadership in development and deployment of ground stations supporting the newest generation of “X-Band” satellites being launched by NASA and other organizations.

      MECAR USA. MECAR USA will initially pursue contracts from the U. S. Government and others for ammunition and pyrotechnics devices. MECAR USA is expected to be operational in the latter portion of 2004.

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. The Company operates in four principal segments: the Ordnance & Manufacturing segment which consists of MECAR; the Electronic Security segment which consists of the VSK Group and NS Microwave; the Environmental Safety & Security segment which consists of SeaSpace; the Software, Training & Simulation segment which consists of Titan Dynamics.

Market and Customers

      Allied derives the principal portion of its revenue in the Ordnance and Manufacturing segment from direct and indirect sales to foreign governments and prime contractors, primarily on fixed price contracts. Two foreign governments accounted for approximately 56% and 4% in 2003, 65% and 1% in 2002, and 77% and 1% in 2001, of Allied’s revenue as detailed in Note P to Allied’s consolidated financial statements, the provisions of which are incorporated herein. Ordnance and Manufacturing sales to its principal foreign government customers are made via an independent marketing representative. Commencing in early 2000, MECAR designated an affiliate of this representative as its independent distributor/value added reseller (the “Distributor”). The Distributor obtains a contract from the end user customer and subcontracts a portion of the work to MECAR. The products that MECAR produces are sold to the Distributor for resale to the foreign government agencies end users.

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      Ordnance and Manufacturing products are sold either directly or indirectly to the defense departments of governments. MECAR is regulated by Belgian law regarding the foreign governments with which it may do business. The sales by MECAR in any given period and its backlog at any particular time may be significantly influenced by one or a few large orders. An order for MECAR’s products is typically for a large quantity and/or a substantial aggregate price, primarily because materials required for the manufacture of the products cannot be economically purchased in small quantities and because of the favorable economies of large volume production. Most of the contracts received by MECAR require delivery in approximately one year. Accordingly, MECAR’s business is dependent upon its ability to obtain such large orders. MECAR frequently accepts smaller orders in an attempt to increase its customer base and efficiently use its manufacturing capacity.

      When MECAR obtains a contract for the sale of its products, it generally receives down payment(s) and/or letter(s) of credit to be applied to the purchase price upon shipment of the products. In such cases, MECAR is generally required to provide advance payment guarantees and performance bonds issued by its bank syndicate.

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

      In the Electronic Security segment, the VSK Group derives substantially all of its revenue from sales and services to private industry such as banks, hospitals, commercial businesses, office buildings and to local governments. The VSK Group sells some of its products/services directly to the end users; in other instances it sells its systems to independent distributors and resellers for resale to the end users. The customers of the VSK Group are located in Belgium and in neighboring countries. While most of the orders received by the VSK Group are for work which can be completed within one year, it has received multi-year orders for its products and services. VSK Electronics and IDCS sell their products principally in European markets. VIGITEC and Télé Technique Générale sell their products in Belgium and in other European markets. NS Microwave’s customers include U.S. Government agencies as well as state and local law enforcement agencies. The U.S. Government agencies have historically accounted for a majority of NS Microwave’s revenues. The Electronic Security segment is not dependent upon any single customer or a few customers.

      In the Environmental Safety and Security segment, customers include numerous users with need for mission-critical weather and environmental information, including scientists/researchers, universities, military forces and commercial users. The Environmental Safety and Security segment is not dependent upon any single customer or a few customers.

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

Principal Customers

      MECAR has historically received a large percentage of its revenue from agencies of a foreign government. See Note P to Allied’s consolidated financial statements. MECAR receives contracts for the benefit of this customer via the Distributor and has received contracts for the benefit of these customers via the FMS program.

Raw Materials and Suppliers

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

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

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

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

      Prolonged disruptions in the supply of any of the Company’s raw materials, difficulty completing qualification of new sources of supply, or implementing use of replacement materials or new sources of supply could have a material adverse effect on the Company’s business, financial condition, or results of operations.

Marketing

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

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

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

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

Research and Development

      In the Ordnance and Manufacturing segment, the development of ammunition and weapon systems requires knowledge and experience in aerodynamics, mechanical engineering, chemistry, combustion, materials behavior and ballistics. MECAR maintains an active research and development staff, including a staff of design engineers, in order to determine how materials can be used or combined in new ways to improve performance or to solve new problems. In 2003, 2002, and 2001, MECAR expended $1,075, $292, and $501, respectively, for research and development activities. MECAR designed most of the products which it currently manufactures. MECAR designs and develops most of its special tooling, fixtures and special explosive loading and testing systems.

      The Electronic Security business requires continuous investment in research and development to update and enhance its security systems. The VSK Group and NS Microwave employ staffs of design engineers specialized in the field of both electronic hardware and software. During 2003, 2002, and 2001, the Electronic Security segment expended $2,452, $1,329 and $1,003, respectively, on research and development.

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

Backlog

      As of December 31, 2003 and December 31, 2002, Allied had backlog orders believed to be firm, after giving effect to the percentage of completion method of accounting, of approximately $115.4 million and

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      Electronic Security backlog includes an unfunded portion of $12 million from a federal contract.

Competition

      The munitions business is highly competitive. MECAR has a number of competitors throughout the world, including the United States. Many of its competitors are substantially larger companies with greater capital resources and experience. Many of its competitors have existing relationships with governments and countries in which MECAR markets its products. For example, many countries will only acquire ammunition and other military items from vendors located in said countries. In many other countries, it is important to have an independent marketing representative. Competition is mainly based upon accessibility to potential markets, technical expertise, quality, capabilities of the product, price and ability to meet delivery schedules. The downsizing of the munitions industrial base has resulted in a reduction in the number of competitors through consolidations and departures from the industry. This has reduced the number of competitors in some programs, but has strengthened the capabilities of some of the remaining competitors. In addition, it is possible that there will be increasing competition from the remaining competitors in business areas area they do not currently compete.

      The nature of the competition encountered by the Electronic Security segment depends upon the sub-segment of the security systems business. In the development and manufacturing area, there are a number of larger competitors, many with greater financial resources than the VSK Group. In the installation and services area, the VSK Group competes with a number of smaller, local competitors. NS Microwave competes with niche suppliers of specialized security products as well as much larger companies with substantially greater financial and other resources.

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

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

Seasonal Nature of Business

      The Company’s business in general is not seasonal, although the summer and winter holiday seasons affect Company revenue because of the impact of holidays and vacations on the Company’s product and service sales by the Company’s international operations. Variations in the Company’s business may also occur at the expiration of major contracts until such contracts are renewed or new businesses obtained.

      The U.S. Government’s fiscal year ends on September 30 of each year. It is not uncommon for government agencies to award extra tasks or complete other contract actions in the weeks before the end of the fiscal year in order to avoid the loss of unexpected fiscal year funds. Moreover, in the years when the U.S. Government does not complete its budget process before the end of its fiscal year, government operations typically are funded pursuant to a “continuous resolution” that authorizes agencies of the government to continue to operate but traditionally does not authorize new spending initiatives. When the government operates pursuant to a continuing

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Personnel

      As of December 31, 2003, Allied, MECAR, the VSK Group, NS Microwave, SeaSpace and, Titan Dynamics had 577 full and part-time employees as follows:

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

Patents and Trademarks

      NS Microwave holds a patent on a mechanical mast that is a key component of certain security systems it supplies to law enforcement agencies. The patent was granted in 1997. Titan holds patents on its weapon discharge simulation system (granted in 1993), its electrostatically dischargeable primer (granted in 1999), its electric impulse cartridge (granted in 2001) and an electric gun (granted in 2002). SeaSpace has the TERASCAN and SEASPACE trademarks. Neither Allied nor any of its other subsidiaries holds any other significant patents and trademarks. The Company’s operations are not dependent to any significant extent upon its patents or trademarks.

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.

Available Information

      Our principal Internet address is www.allieddefensegroup.com. We make available free of charge on www.allieddefensegroup.com our annual, quarterly and current reports, and amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. In addition, you may request a copy of these filings (excluding exhibits) at no cost by writing or telephoning us at the following address or telephone number:

	The Allied Defense Group, Inc.
	8000 Towers Crescent Drive
	Suite 260
	Vienna, Virginia 22182
	(703) 847-5268

Item 2.     Properties

      Allied’s principal executive offices are located in Vienna, Virginia, where it leases approximately 3,900 square feet of office space. The lease expires in September, 2007.

      MECAR’s principal factory is located approximately 25 miles south of Brussels near Nivelles, Belgium. The factory principally consists of a manufacturing and administrative complex which was occupied by MECAR in

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

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

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

      Titan Dynamics operates from a leased office and manufacturing facility consisting of approx 3,800 square feet in Marshall, TX. The facility is currently operating at approximately 80% of productive capacity.

      MECAR USA will operate from a leased facility in Marshall, Texas, which is being constructed by the local development authority.

      Capital expenditure programs for facilities and equipment planned in 2004 will require funding of approximately $3.8 million.

Item 3.     Legal Proceedings

      There are no material pending legal proceedings, other than ordinary routine litigation incidental to Allied’s business, to which Allied or any of its subsidiaries is a party or to which any of their property is subject. See Note L to Allied’s consolidated financial statements for a description of one pending suit against the VSK Group and one pending suit against SeaSpace.

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

      No matter was submitted to a vote of security holders during the fourth quarter of 2003, through the solicitation of proxies or otherwise.

PART II

Item 5.     Market for Stock and Related Stockholder Matters

      Market Information. Allied’s Common Stock has been listed for trading on the American Stock Exchange (“AMEX”) since September 15, 1992. Its AMEX trading symbol is ADG. Its media listing is under the symbol Allied Defense. The table below shows the high and low sales prices of Allied’s Common Stock during 2003 and 2002 (as reported by AMEX):

      Stockholders. The number of holders of record of the Common Stock at March 1, 2004 was 1,119.

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      Dividends. Allied paid a 5% stock dividend in November, 1992 to holders of record of its Common Stock on October 15, 1992. Cash was paid in lieu of the issuance of fractional shares. There have been no subsequent dividends declared or paid by Allied. The payment of dividends is within the discretion of Allied’s Board of Directors and any decision to pay dividends in the future will depend upon an evaluation of a number of factors, including earnings, capital requirements, operating and financial condition, and any contractual limitation then in effect. In this regard, MECAR’s bank syndicate agreement requires the maintenance by MECAR of minimum financial covenants, which effectively restricts the amount of dividends we may pay from MECAR’s assets.

Item 6.     Selected Financial Data

      The selected consolidated financial data below have been derived from our audited financial statements. You should read the following table in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and notes thereto included elsewhere in the annual report on Form 10-K. The historical results presented below are not indicative of any future results. The following selected financial data relates to Allied’s consolidated financial position and results of operations for 2003, 2002, 2001, 2000, and 1999:

Overview

      Allied is a strategic portfolio of defense and security businesses, with presence in worldwide markets, offering both government and commercial customers leading edge products and services. Allied operates in four principal segments: MECAR’s development and production of ammunition and weapon systems (“Ordnance & Manufacturing”); VSK Group’s and NS Microwave’s manufacture, distribution and service of industrial security products (“Electronic Security”); Titan Dynamics’ development and sale of Battlefield Effects Simulators (“Software, Training & Simulation”); and SeaSpace’s production and sale of weather and environmental satellite ground reception systems (“Environmental Safety & Security”).

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      Due to the historic volatility in MECAR’s business, in the mid-1990’s Allied acquired the VSK Group with a goal of attempting to diversify its operations. The Company continued its diversification efforts in late 2001 and into mid-2002 with the acquisitions of NS Microwave, Titan Dynamics and SeaSpace.

      In 2003, MECAR and the VSK Group continued to provide excellent revenues and net profits. MECAR achieved above-average net profits due in large part to continued work on a large FMS contract for the benefit of one of its principal customers. The VSK Group reported record revenues and net profits based on increased export sales of its security services products via its distribution system. The excellent European results were amplified by the increased value of the Euro versus the U.S. Dollar but offset by losses incurred by the most recent domestic acquisitions.

      Allied earned net profits of $8,821 ($1.60 per share — basic and $1.54 per share-diluted) in 2003 compared to net profits of $10,672 ($2.01 per share — basic and $1.92 per share-diluted) in 2002 and net profits of $10,367 ($2.11 per share-basic and $2.10 per share — diluted) in 2001.

      Allied anticipates that 2004 will be another profitable year. The European subsidiaries have healthy backlogs and are expected to deliver substantial profits, although perhaps not at the same levels as in recent years. Allied anticipates that its domestic subsidiaries should perform considerably better in 2004 than in 2003.

      In late 2003, Allied organized MECAR USA, INC., a Delaware corporation, to pursue ammunition and related opportunities from U.S. and other markets. MECAR USA will initially focus on contracts for ammunition and pyrotechnics devices. MECAR USA will operate from Marshall, Texas. It will commence operations in the fourth quarter of 2004.

      Allied enters 2004 with substantial cash reserves and anticipates no liquidity concerns in 2004. The Company continues to pursue a domestic lending facility in order to continue its acquisitions program.

Results of Operations

      The following table sets forth, for the years ended December 31, 2003, 2002 and 2001, certain items from Allied’s consolidated statements of operations expressed as a percentage of revenue:

      Revenues. Allied’s consolidated revenues for 2003 increased $40,541, or 31%, over the prior year principally due to higher production activities at MECAR and the VSK Group. Revenues for 2002 increased $33,919, or 35%, over 2001 revenues, again based upon increased activity at MECAR and the VSK Group during the period.

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      Ordinance & Manufacturing segment revenues increased in 2003 due to continued performance of the multi-year FMS contract as well as work on additional orders secured from non-traditional customers. Notwithstanding MECAR’s success in obtaining orders from new customers, approximately 60% of 2003 revenues were derived from MECAR’s traditional customer base.

      The positive fluctuation in 2002 over 2001 Ordnance & Manufacturing segment revenues was caused by work on the FMS contract awarded in early 2002.

      Electronic Security segment revenue increased by 7% in 2003, although the mix was substantially different. The VSK Group contributed $27,234, a 29% increase over 2002, largely due to increased sales to non-Belgian customers. The VSK Group makes sales to such customers via independent sales distributors. NS Microwave’s 2003 revenues decreased to $6,069. Many of NS Microwave’s traditional U.S. Government agency customers were reorganized into the Department of Homeland Security. The organization and startup of the Department of Homeland Security was marked by a delay in award of contracts by these agencies. While NS Microwave began to receive some orders in the fourth quarter of 2003, it was too late to realize meaningful revenues from some of these orders in 2003.

      Electronic Security segment revenues increased by $11,426 in 2002. NS Microwave was added to the Electronic Security segment in 2002 and contributed $10,248 to this amount.

      In each of 2003 and 2002, Ordnance & Manufacturing and Electronic Security segment revenues were positively impacted by the stronger Euro. In 2003 and 2002, these revenues were so benefited by approximately 20% and 6%, respectively.

      Environmental Safety & Security segment revenue increased in 2003 over 2002 revenues as a result of only five months of activity in 2002. This segment’s revenue in 2003 was less than expected due to increased competition by domestic and foreign competitors.

      Software, Training & Simulation segment revenues increased in 2003 inasmuch as 2002 revenues included only six (6) months of operations following the June, 2002 acquisition of Titan Dynamics. Revenues continue to be constrained due to the lack of safety certification for the OMEGA 36/ B2 battlefield effects simulator. Testing by the Marine Corps is substantially complete and Titan Dynamics is optimistic that it will receive Marine Corps certification of this product by the end of the third quarter of 2004. Certification should also accelerate penetration in foreign markets. Further, Marine Corps certification should facilitate and accelerate certification by the U.S. Army. In 2003, the sales of cartridges represented the majority of Titan Dynamics’ sales.

      Cost of Sales. Cost of sales as a percentage of revenue for 2003 was approximately 73% compared with 70% in 2002. The increase during 2003 was driven by higher costs within the Ordnance and Manufacturing Segment. The costs were primarily related to the FMS contract which dominated the production process in the current year. Additionally, MECAR incurred higher than anticipated labor costs due to production delays surrounding a 90MM production order. The delay has been resolved and should not affect activity in future periods. Electronic Security segment cost of sales decreased from 2002 primarily due to the VSK Group’s production efficiencies realized as it expanded its distribution channel throughout Europe. In particular, the VSK Group incurred lower material costs on its export sales to its distributors. Environmental Safety & Security Segment cost of sales increased over 2002 as a result of higher X band sales, which traditionally have lower margins. Over the past twelve months, the X band market has become much more competitive. While selling

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      Cost of sales as a percentage of revenue for 2002 was approximately 70% compared with 65% for 2001. The increase in production costs relative to those incurred in 2001 was primarily the result of a very favorable development contract in 2001 with above-average margins. The majority of the margins generated by this one contract were recognized during the third and fourth quarters of 2001.

      Selling and Administrative Expenses. Selling and administrative expenses as a percentage of sales for 2003 was slightly higher than 2002. The Ordnance & Manufacturing segment incurred higher administrative compensation costs. In the Electronic Security segment, the VSK Group also incurred higher costs that were driven by the increased sales volume. NS Microwave was affected by the funding issues surrounding homeland security spending by the federal government. Administrative costs were also burdened with compensation charges associated with production personnel who had been reassigned to administrative support functions since the beginning of the year. Additionally, the consolidated results were affected by full year contributions by Titan Dynamics and SeaSpace. The Company expects Selling and administrative expense to continue to increase in proportion to the increase in sales.

      Selling and administrative expenses in 2002 increased by $5,388 from the prior year. The increase was due primarily to the additions of NS Microwave, Titan Dynamics and SeaSpace. Administrative costs at MECAR and VSK only increased by approximately $400 from 2001. NS Microwave was consolidated on a full-year basis while Titan Dynamics and SeaSpace were second and third quarter 2002 additions.

      Research and Development. Research and development costs increased between 2001 and 2003. The total dollar increases were primarily attributed to increased research conducted at MECAR, the VSK Group and NS Microwave. This trend is expected to continue.

      Interest Income. Interest income decreased between 2001 and 2003. Income earned on interest bearing accounts throughout the Company has been affected by the lower interest rates being earned on such accounts.

      Interest expense. Interest expense increased between 2001 and 2003 due principally to the costs associated with a convertible debenture issued in the second quarter of 2002. The interest charges on that debenture will continue, on a monthly basis, until the earlier of the instrument being converted into common stock or until the debenture is liquidated. The debenture is repayable in ten monthly payments commencing on June 28, 2004, and terminating on March 28, 2005.

      Other — Net. Other-Net income for 2003 decreased by $1,045 from 2002, while Other-Net income for 2002 increased by $1,616 over 2001. The fluctuations stemmed primarily from the currency fluctuations at MECAR and the VSK Group. In particular, MECAR had currency gains in 2002 on its U.S. bank accounts. Subsequently, MECAR incurred currency losses in 2003 on its U.S. bank accounts due the strength of the Euro over the past twelve months. Other expense includes bank charges related to MECAR’s performance bonds and advance payment guarantees.

      Pre-Tax Profit.

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      MECAR has enjoyed several consecutive years of above-average profitability. In 2003, MECAR continued to reap the benefits of a large multi-year FMS contract for the benefit of one of its principal customers. This contract was also a prime contributor to MECAR’s 2002 profits. While some work remains on this FMS contract, it is not expected to be a substantial contributor to 2004 profits. In 2001, a substantial portion of MECAR’s profits was earned on a high margin product development contract. While MECAR has a substantial backlog of orders for 2004, it does not have any above-average margin contracts similar to those enjoyed in 2001 – 2003. Accordingly, MECAR’s profitability for 2004 will likely be less than the amounts earned in the preceding time periods.

      2003 profits within the Electronic Security segment decreased from 2002 levels despite record performance by the VSK Group. The VSK Group reported $5,519 of pre-tax profits, which amount was favorably impacted by increased sales to non-Belgian customers via the VSK Group’s distribution network. NS Microwave’s performance suffered due to continuing delays in award of orders caused in part by the organization of the Department of Homeland Security. Some orders began to be received in the fourth quarter of 2003. NS Microwave has right-sized its workforce for its 2004 operations.

      The Environmental Safety & Security segment results in 2003 were disappointing due to increased competitive pressures, both home and abroad. The Company has appointed a new President at SeaSpace and SeaSpace has taken efforts to right-size its organization and reduce its cost of goods sold in light of the competitive environment.

      Titan Dynamics continues to be adversely impacted since its principal product lacks U.S. Government safety certification. Titan Dynamics anticipates receipt of Marine Corps certification in the second or third quarter of 2004.

      The losses incurred by the Corporate and Other segment increased in 2003 due to increased taxes, intercompany management fee adjustments and reduced currency gains.

      Income Taxes. The effective income tax expense in 2003, 2002 and 2001 was 46%, 46% and 45%, respectively, primarily due to foreign rate differentials and permanent tax differences. In 2003, the statutory tax rate for the European subsidiaries was reduced by the Belgium parliament from 40.17% to 33.99%. The 2003 effective tax rate was adversely affected as a result of increased permanent differences and benefits impacted by the repatriation of dividends by Allied from its foreign subsidiaries.

      Net Earnings. 2003 net earnings of $8,821 decreased from 2002 levels due to losses incurred by Allied’s domestic subsidiaries.

Liquidity and Capital Resources

Balance Sheet. All items on the Company’s December 31, 2003 consolidated balance sheet were positively affected by the increased value of the Euro in 2003. All European values were converted at the December 31, 2003 and 2002 conversion ratios of 1.2557 and 1.0483 U.S. Dollar to 1 Euro, respectively. The following sets forth additional reasons for the fluctuations in the balance sheet items from December 31, 2002 to December 31, 2003.

      Historically, the Company’s positive cash flow from operations and available credit facilities have provided adequate liquidity and working capital to fully fund the Company’s operational needs. Working capital, which includes restricted cash, was $76,880 at December 31, 2003, which is an increase of $16,698 over the December 31, 2002, level. Working capital has remained strong since 2002 due to profitable operations and the $7,500 convertible debenture issued by the Company on June 28, 2002.

      Cash (including restricted cash) increased by $36,386 in 2003 due to profitable operations and cash collections by MECAR and the VSK Group, borrowings from short-term debt and improved cash flow from operations. Accounts receivable at December 31, 2003, was consistent with the amount at December 31, 2002. Costs and accrued earnings on uncompleted contracts increased from year-end 2002 primarily as a result of work on the FMS contract at MECAR. Inventories increased $2,659 primarily from higher raw material purchases. The inventory buildup will give the subsidiaries the ability to deliver products with the shortest possible lead times. Fair value of foreign exchange contracts was $9,378 at December 31, 2003, compared to $13,595 at

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      Property, Plant & Equipment, net of accumulated depreciation, increased primarily from equipment purchases at MECAR and the VSK Group. Intangibles and Goodwill, net of accumulated amortization, increased primarily from the strength of the Euro and adjustment of deferred tax related to intangibles purchased in 2002.

      Notes Payable increased $7,683 over 2002 as a result of MECAR funding its working capital needs. Accounts payable increased $22,318 over 2002 which is related to the increase in costs on uncompleted contracts. Accrued liabilities increased $8,627 due primarily to the costs associated with higher production levels and deferred gains related to forward exchange contracts at MECAR. Customer deposits decreased $154 primarily at MECAR as a result of shipments during the period and other new contracts in 2003 not requiring deposits. Income taxes decreased $1,772 due to the tax benefits at NS Microwave, SeaSpace, Titan Dynamics and Corporate, offset by the tax provisions at MECAR and the VSK Group.

      Convertible-subordinated debenture, current and long-term, was only impacted by amortization between December 31, 2003 and December 31, 2002. However, the current and long-term allocations changed. The initial terms called for monthly principal payments, in the amount of $750, to begin on June 28, 2003, and continue for a period of ten (10) months or until March 28, 2004. Additionally, the monthly principal payments were to include interest on the outstanding note balance. On June 27, 2003, the lender exercised its right to extend the terms of the debenture by twelve (12) months, which impacted the Company’s current maturity schedule.

      Stockholders’ equity at December 31, 2003, was positively affected by 2003 profits and increase in the value of the Euro versus the U.S. dollar during the year 2003 by approximately 20%, resulting in accumulated other comprehensive income of $13,383 at December 31, 2003.

Cash Flows. The table below highlights Allied’s cash flows for the periods listed:

      The increase in cash provided by operating activities between 2003 and 2002 is attributed primarily to growth in earnings, collection of receivables and decreased cash outlays for cost and accrued earnings on uncompleted contracts, which are mainly from MECAR’s and the VSK Group’s customer base. The decrease in cash provided by operating activities between 2002 and 2001 stems primarily from the expenditures for work related to the FMS contract which was awarded in early 2002. Cash paid for interest was $1,492, $535 and $1,692 for the years ended December 31, 2003, 2002 and 2001, respectively. Cash paid for income taxes was $9,455, $9,510 and $6,939 for the years ended December 31, 2003, 2002 and 2001, respectively, and includes federal, international and state taxes.

      Cash used in investing activities decreased by $3,758 between 2003 and 2002. This stemmed from cash paid for the Titan Dynamics and SeaSpace acquisitions in 2002, with no related acquisition activity in 2003. This decrease was offset by a slight increase in capital expenditures due primarily to higher outlays for production equipment and leasehold improvements at the Belgian business units. The 2002 acquisitions were the main reason for the $6,565 increase in cash used in investing activities between 2002 and 2001. In addition, capital expenditures were higher in 2002. The Company anticipates that cash generated from operations and capital leases will be sufficient to support any further capital expenditures in the foreseeable future. Future expenditures will be primarily incurred at MECAR for machinery and equipment.

      Cash provided by financing activities decreased between 2003 and 2002 and increased between 2002 and 2001. During 2002, the primary source of cash provided by financing activities was the $7,500 proceeds realized from the sale of the convertible debenture and warrant.

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      Allied. The parent company continues to operate based on fees and dividends received from its subsidiaries. Allied has made cash infusions to NS Microwave and Titan to support working capital requirements. To implement its acquisition program, Allied has secured dividends from its subsidiaries and in 2002 sold a $7.5 million convertible debenture. The debenture is repayable in ten (10) monthly installments commencing in June 2004. The Company anticipates repayment of the debenture from existing cash reserves.

      MECAR. MECAR continues to operate from internally generated cash and funds provided by its bank syndicate and financing from capital leases. MECAR typically obtains orders for its ammunition and weapon systems that require credit facilities to provide import letters of credit, advance payment guarantees and performance bonds. These needs have been met in the last few years via agreements with a five member international bank syndicate of which the lead bank is based in Belgium. While the bank syndicate agreement provides that MECAR is responsible to repay the syndicate for amounts paid by the banks pursuant to the guarantees/bonds, the financial terms stipulate that all such obligations be secured, in part, by a cash pledge.

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

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

      The revised bank agreement, as executed in March 2002, eliminates most restrictions on cash transfers by MECAR to Allied or other Allied group companies. However, the agreement imposes two financial covenants requiring MECAR to maintain minimum net worth and working capital levels. As of December 31, 2003, MECAR was in compliance with both of these bank covenants. MECAR’s obligations under the bank syndicate agreement continue to be collateralized by a pledge of MECAR’s assets and a mortgage on MECAR’s facility. The agreement includes Allied’s pledge to support MECAR so that it remains in compliance with its total borrowing obligations.

      VSK Group. The VSK Group operated throughout 2003 solely from cash generated from business operations. The VSK Group is obligated on several mortgages and other long-term obligations.

      Other Subsidiaries. NS Microwave and Titan Dynamics operated in 2003 from cash generated from operations and cash infusions by Allied. SeaSpace operated in 2003 from cash generated from operations and cash reserves.

      Stock Repurchases. The Company did not repurchase any shares of its common stock in 2003, 2002 or 2001 and does not anticipate repurchasing shares of Company stock in calendar year 2004.

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

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      The following table identifies material contractual obligations as of December 31, 2003:

      Future Liquidity. The Company continues to explore alternate methods of securing the necessary financial capacity to implement its growth plans. At times, the Company has utilized the services of an investment banker in an attempt to secure a senior credit facility for its U.S. based operations.

      Funds for the build out of the initial MECAR USA infrastructure are being provided by the Marshall Economic Development Corporation of Marshall, Texas. This is a state funded organization with the initial proceeds directed at creating roads and a manufacturing plant on the grounds.

      The Company’s ability to cover its anticipated future operating and capital requirements is dependent upon its continued ability to generate positive cash flow from the operations of its subsidiaries, particularly the operations of MECAR and the VSK Group, and its ability to successfully integrate its acquisitions. The Company expects its acquisitions to be accretive to operations within 24 months, although this cannot be assured. This will depend upon many factors including the successful release of new product offerings, successful research and development efforts, and increased market share. There is no assurance that this goal will be achieved.

      Completed Acquisitions. See Note B to Allied’s consolidated financial statements for a discussion of completed acquisitions which have affected our liquidity.

      Off-Balance Sheet Arrangements. As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2003, we are not involved in any material unconsolidated SPE transactions. MECAR is required to provide performance bonds and advance payment guarantees for certain contracts, which are provided by MECAR’s bank syndicate. At December 31, 2003, MECAR’s bank syndicate had provided $18,079 of such bonds/ guarantees. MECAR is obligated to repay the bank syndicate any amounts it pays as a result of any demands on the bonds or guarantees. To date, there have never been any such demands.

      Recent Accounting Pronouncements. See Note A to Allied’s consolidated financial statements for a description of recently issued accounting pronouncements. Allied does not anticipate that any of such pronouncements will have a material impact on its financial results.

Critical Accounting Policies

      The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, sales, and expenses, and related disclosure of contingent assets and liabilities. The Company re-evaluates its estimates on an on-going basis. The Company’s estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

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      The Company believes the following are its critical accounting policies which affect its more significant judgments and estimates used in the preparation of its consolidated financial statements:

	•	Revenue recognition via the percentage of completion method
	•	Goodwill and intangible asset valuation
	•	Inventory reserves and allowance for doubtful accounts
	•	Valuation of deferred income taxes and income tax reserves.

      Revenue Recognition via the Percentage of Completion Method.  We believe our most critical accounting policies include revenue recognition and cost estimation on fixed price contracts for which we use the percentage of completion method of accounting. The percentage of completion method is used by MECAR, NS Microwave, and SeaSpace for substantially all of their fixed price sales contracts. Approximately 83%, 92% and 80% of consolidated revenue was recognized under the percentage of completion method during 2003, 2002, and 2001, respectively.

      Under the percentage of completion method, revenue is recognized on these contracts as work progresses during the period, based on the amount of actual cost incurred during the period compared to total estimated cost to be incurred for the total contract (cost-to-cost method). Management reviews these estimates as work progresses and the effect of any change in cost estimates is reflected in cost of sales in the period in which the change is identified. If the contract is projected to create a loss, the entire estimated loss is charged to operations in the period such loss first becomes known.

      Accounting for the profit on a contract requires estimates of (1) the total contract value, (2) the total costs at completion, which is equal to the sum of the actual incurred costs to date on the contract and the estimated costs to complete the contract’s scope of work, and (3) the measurement of progress towards completion. The estimated profit or loss on a contract is equal to the difference between the contract value and the estimated total cost at completion. Adjustments to original estimates are often required as work progresses under a contract, as experience is gained and as more information is obtained, even though the scope of work required under the contract may not change, or if contract modifications occur. A number of internal and external factors affect our cost of sales estimates, including labor rates and efficiency variances, material usage variances, revised estimates of warranty costs, delivery schedules and testing requirements. Additionally, as inventory items increase in age, obsolete and excess items are charged to cost of sales if the economic conditions of the future sales potential of that inventory warrant a charge. While we believe that the systems and procedures used by the subsidiaries, coupled with the experience of their management teams, provide a sound basis for our estimates, actual result will differ from management’s estimates. The complexity of the estimation process and issues related to the assumptions, risks and uncertainties inherent with the application of the percentage of completion method affect the amounts reported in our financial statements.

      Goodwill and intangible asset valuation. The Company adopted the Financial Accounting Standards Board (“FASB”) Statements of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets” on accounting for business combinations and goodwill as of the beginning of fiscal year 2002. Accordingly, the Company no longer amortizes goodwill from acquisitions, but continues to amortize other acquisition-related intangibles with definitive lives and other costs. As of December 31, 2003, the Company has $13.8 million of goodwill recorded in Other assets on the Consolidated Balance Sheet.

      In conjunction with the implementation of the new accounting rules for goodwill, the Company completed a goodwill impairment analysis in the fourth quarter of 2003 and did not determine that an impairment charge to earnings was required. As required by the new rules, the Company will perform a similar review each year, or earlier if indicators of potential impairment exist. The impairment review is based on a discounted cash flow approach that uses estimates of future cash flows discounted at the Company’s weighted average cost of capital. The estimates used are consistent with the plans and estimates that the Company uses to manage the underlying businesses. If market conditions in these business units fail to meet expectations, it could negatively impact revenue or cost, and could result in charges for the impairment of goodwill in future periods.

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      For intangible assets with definitive lives, the Company amortizes the cost over the estimated useful life and assesses any impairment by estimating the future cash flow from the associated asset. As of December 31, 2003, the Company had $4.1 million of intangible assets with definitive lives recorded in “Other assets,” which includes patents, customer lists, trademarks, etc. If the estimated undiscounted cash flow related to these assets decreases in the future or the useful life is shorter than originally estimated, the Company may incur charges to reflect the impairment of these assets. Impairment could also result if the underlying technology fails to gain market acceptance, if the products fail to gain expected market acceptance or if the market conditions in the related businesses are unfavorable.

      Inventory reserves and allowance for doubtful accounts.  Inventories are stated at the lower of cost or market. Cost is determined based on a first-in, first-out basis. The Company’s inventory includes raw materials, work-in process and finished goods of $12.1 million as of December 31, 2003. The Company reviews its recorded inventory and estimates a write-down for obsolete or slow-moving items to their net realizable value. The write-down is based on current and forecasted demand and the age of the item, and therefore, if actual demand and market conditions are less favorable than those projected by management, additional write-downs may be required. Allowances for doubtful accounts are evaluated based upon detailed analysis and assessment of receivables that may not be collected in the normal course of operations.

      Valuation of deferred income taxes and income tax reserves.  The Company is subject to taxation by federal, state and international jurisdictions. The Company’s annual provision for income taxes and the determination of the resulting deferred tax assets and liabilities involve a significant amount of management judgment and are based on the best information available at the time. The Company believes that it has recorded adequate liabilities and reviews those balances on a quarterly basis.

      Judgment is also applied in determining whether deferred tax assets will be realized in full or in part. When it is more likely than not that all or some portion of specific deferred tax assets such as foreign tax credit carryovers will not be realized, a valuation allowance is established for the amount of the deferred tax assets that are determined not to be realizable.

Forward-Looking Statements

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

      Future Factors include substantial reliance on MECAR’s principal customers to continue to acquire MECAR’s products on a regular basis; the cyclical nature of the Company’s military business; rapid technological developments and changes and the Company’s ability to continue to introduce competitive new products and services on a timely, cost effective basis; the ability of the Company to successfully continue to expand its business base; the mix of products/services; domestic and foreign governmental fiscal affairs and public policy changes which may affect the level of purchases made by customers; changes in environmental and other domestic and foreign governmental regulations; general risks associated with doing business outside the United States including, without limitation, import duties, tariffs, quotas and political and economic instability, the effects of terrorist actions on business activities, customer orders and cancellations, and the United States and international governments’ responses to these terrorist actions; changes in government regulations; liability and other claims assorted against us; the ability to attract and retain qualified personnel; and continued availability of financing, financial instruments and financial resources in the amounts, at the times and on the terms required to support the Company’s future business. These are representative of the Future Factors that could affect the outcome of the forward-looking statements. In addition, such statements could be affected by general industry and market conditions and growth rates; general domestic and international economic conditions including

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Item 7A.     Quantitative and Qualitative Disclosures About Market Risk

      In the normal course of business, we are exposed to market risk, including foreign currency fluctuations and interest rates changes. From time to time, we use derivatives to manage some portion of these risks. Our derivatives are agreements with independent third parties that provide for payments based on a notional amount. As of December 31, 2003 and 2002, all of the derivatives were related to actual or anticipated exposures of our transactions. We are exposed to credit risk in the event of non-performance by counterparties to derivatives. However, we monitor our derivative positions by regularly evaluating our positions and the creditworthiness of the counterparties, all of whom we either consider credit worthy, or who have issued letters of credit to support their performance.

      We have performed sensitivity analyses to determine how market rate changes might affect the fair value of our market risk sensitive derivatives and related positions. This analysis is inherently limited because it represents a singular, hypothetical set of assumptions. Actual market movements may vary significantly from our assumptions. The effects of market movements may also directly or indirectly affect our assumptions and rights and obligations not covered by sensitivity analysis. Fair value sensitivity is not necessarily indicative of the ultimate cash flow or the earnings effect from the assumed market rate movements.

      Interest Rate Sensitivity. Allied manages its debt and its available cash considering available investment opportunities and risks, tax consequences and overall financing strategies. At December 31, 2003, Allied had approximately $15.0 million of fixed-rate indebtedness. Allied has not entered into any interest rate swaps or other derivatives with respect to its indebtedness. Cash available for investment is typically invested in short term funds, which generally mature in 30 days or money-market funds. In general, such funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate. The carrying amounts approximate market value. It is the Company’s practice to hold these investments to maturity. Assuming year-end cash available for investment (including restricted cash), a 1% change in interest rates would impact net interest income for the years ended December 31, 2003 and 2002 by $0.4 million and less than $0.1 million, respectively.

      Exchange Rate Sensitivity. Allied maintains operations in several foreign countries. Approximately 92% of the Company’s revenue was derived from operations outside the United States. Accordingly, exposure exists to potentially adverse movement in foreign currency rates. Allied uses foreign exchange forward contracts to hedge the risk of change in foreign currency exchange rates associated with some, but not all, of its contracts in which the expenses for providing services are incurred in currency other than the functional currency of Allied’s foreign subsidiaries or payments on contracts are made by the customer in another currency. The objective of these contracts is to hedge fixed obligations to reduce the effect of foreign currency exchange rate fluctuations on Allied’s foreign subsidiaries’ operating results. The notional value of foreign exchange forward contracts outstanding at December 31, 2003 and 2002 was $50 million and $93 million, respectively. A 10% change in the exchange rate of the currencies hedged would change the fair market value of the contracts by approximately $7.2 million and $11.2 million as of December 31, 2003 and 2002, respectively.

      Additionally, Allied’s consolidated financial statements are denominated in U.S. dollars and, accordingly, changes in the exchange rates between the Allied subsidiaries’ local currency and the U.S. dollar will affect the translation of such subsidiaries’ financial results into U.S. dollars for purposes of reporting the consolidated financial results. Allied does not hedge these matters because cash-flows from international operations are generally re-invested locally. It is estimated that a 10% change in the value of the Euro would impact reported net earnings for the years ending December 31, 2003 and 2002 by approximately $1.4 million and $1.2 million, respectively. See Note N to the financial statements for more information on financial instruments.

      Allied does not use derivative financial instruments for speculative trading purposes, nor does Allied hedge its foreign currency exposure in a manner that entirely offsets the effects of changes in foreign exchange rates. Allied regularly reviews its hedging program and may as part of this review determine at any time to change its hedging program.

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

      See Note V to Allied’s consolidated financial statements for supplementary quarterly financial data required by this item.

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

      Under the direction and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 as of the end of the period covered by the report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) is accumulated and communicated to the Company’s senior management to allow timely decisions regarding required disclosure.

      There have been no significant changes in our internal controls over financial reporting or, to our knowledge, in other factors that could significantly affect our internal control over financial reporting subsequent to the date we conducted the above-described evaluation. We are currently reviewing the new internal controls documentation and attestation requirements regarding Rule 404 of the Sarbanes Oxley Act of 2002. We have retained an independent consulting firm to assist us in evaluating and improving our internal controls. We are confident that we will fully comply with such requirements by December 31, 2004.

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PART III

Item 10.     Directors and Executive Officers of Allied

Directors. The following are the directors of Allied:

      J. H. Binford Peay, III, age 64, became a director in April, 2000 and was elected Chairman of the Board, President and Chief Executive Officer in January, 2001. General Peay retired in 1997 as Commander in Chief, United States Central Command, with responsibility for operations in some 20 countries throughout Africa, the Middle East, Persian Gulf and South Asia. Previously, he was Vice Chief of Staff, U.S. Army. General Peay is currently a director of United Defense Industries, Inc., and a Trustee of the National Defense University. Previously, he had also been a trustee of Virginia Military Institute Foundation and the George C. Marshall Foundation. General Peay resigned as Chief Executive Officer as of June 1, 2003 to become Superintendent of the Virginia Military Institute. He remains the Chairman of the Board.

      John G. Meyer, Jr., age 59, became a director in January, 2003 when he was also elected as President of the Company. He succeeded General Peay as the CEO on June 1, 2003. He previously served as Executive Vice President and Chief Operating Officer since January, 2001. Mr. Meyer previously retired from the U.S. Army having served as its most senior Public Affairs Officer during his last four (4) years of military service.

      J. R. Sculley, age 63, became a director of Allied in 1991 and currently serves as Chairman Emeritus. He served as Chairman of the Board and Chief Executive Officer from December, 1992 until September, 1999; from April 1992 until December 1992 he served as President and Chief Operating Officer of Allied. Between 1989 and April, 1992, Mr. Sculley was Director of Advanced Studies and Technologies of Grumman Corporation, a defense company, and, prior thereto, was Assistant Secretary of the Army (Research, Development and Acquisition).

      Clifford C. Christ, age 56, became a director of Allied in 1993. He has been the President and Chief Executive Officer of NavCom Defense Electronics, Inc., a defense electronics company, since 1988.

      Harry H. Warner, age 68, became a director of Allied in early 1996. He is president of the George C. Marshall Foundation and is also a director of Chesapeake Corporation and Virginia Management Investment Corporation, a registered investment advisor. Throughout the last five years, Mr. Warner has been a self-employed financial consultant, investor and real estate developer.

      Ronald H. Griffith, age 65, became a director of Allied in April, 2000. Mr. Griffith is Executive Vice President and Chief Operating Officer of MPRI, Inc., a professional services company, since 1998. Formerly, he served as Vice Chief of Staff of the U.S. Army.

      Gilbert F. Decker, age 66, became a director of Allied in June, 2002. Mr. Decker is a consultant to companies in the defense and aerospace industries. He previously served as Executive Vice President of Engineering and Production at Walt Disney Imagineering as well as Assistant Secretary of the Army for Research, Development and Acquisitions. Mr. Decker is currently on the board of directors of Alliant Techsystems, Inc. and Anteon International Corporation.

Executive Officers. The following are the executive officers of Allied:

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

      Monte Pickens was elected Executive Vice President and Chief Operating Officer in May 2003. Previously, Mr. Pickens was the Vice President of T. Marzetti Company. Mr. Pickens retired from the U.S. Army as a Colonel in 1992.

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

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      Audit Committee Financial Expert. The Board of Directors of Allied has determined that each of Clifford C. Christ and Gilbert F. Decker is an audit committee financial expert as defined by Item 401(h) of Regulation S-K of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and is independent within the meaning of Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act.

      Audit Committee. Allied has a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The members of the Audit Committee are Clifford C. Christ, Harry H. Warner, Ronald H. Griffith and Gilbert F. Decker.

      Code of Ethics. Allied has adopted a code of business conduct and ethics for directors, officers (including Allied’s principal executive officer, principal financial officer and controller) and employees. The code of ethics is available on the Company’s website at http://www.allieddefensegroup.com. Stockholders may request a free copy of the code of ethics from:

	Allied Defense Group, Inc.
	8000 Towers Crescent Drive, Suite 260
	Vienna, Virginia 22182
	(703) 847-5268
	Attn: Investor Relations

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Item 11.     Executive Compensation

Compensation of Directors and Executive Officers.

      The following table sets forth information concerning all compensation accrued for services rendered in all capacities to the Company and its subsidiaries during the years ended December 31, 2003, 2002 and 2001, to the chief executive officer of Allied and to other executive officers of Allied whose total annual salary and bonus exceed $100,000:

Summary Compensation Table

(1)	Mr. Peay’s salary includes compensation as Chief Executive Officer through June 1, 2003. Mr. Peay resigned as the Chief Executive Officer but remains the Chairman of the Board and his salary includes $14,000 paid to him in that capacity in 2003.
(2)	Cash and stock bonuses approved, on an annual basis, by the Compensation Committee. My Peay was awarded a stock grant in 2002 in the amount of $33,450. In 2001, the Compensation Committee awarded Messrs. Meyer, Waddell and Hasper with a stock grant based on performance objectives issued during the year of $20,000. Stock grants were not awarded to these same officers in 2003 or 2002 as part of the annual bonus program.
(3)	The costs include premiums on life insurance policies and a one-time payment to Mr. Peay upon his resignation as Chief Executive Officer.
(4)	Stock grants were awarded to Messrs. Peay, Meyer, Waddell and Hasper as part of the employment agreements each executed in 2001.
(5)	Mr. Waddell resigned as Vice President for Strategic Planning and Corporate Development of the Company effective December 1, 2003, when he accepted the position of President of SeaSpace Corporation, a wholly-owned subsidiary of the Company.

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Options Grants in Last Fiscal Year

      The following table contains information concerning the stock option grants made to each of the named executive officers for the fiscal year ended December 31, 2003.

(1)

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

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

      The following table sets forth information concerning option exercises and option holdings by each of the named executive officers for the fiscal year ended December 31, 2003.

(1)	Represents the closing price per share on the date the option was exercised less the option exercise price multiplied by the number of shares acquired upon exercise.
(2)	Represents the closing price per share of the underlying shares on the last day of the fiscal year less the option exercise price multiplied by the number of shares. The closing price per share was $23.91 on the last trading day of the fiscal year as reported on the AMEX.

Director Compensation

      Directors who are employees of Allied receive no additional compensation for serving as a director. Each non-employee director (an “Outside Director”) is compensated for service as a director, including as a member of committees of the Board, at the rate of $1,000 per month; an award of 1,000 shares of Common Stock on each July 1; and an award as of each July 1 of an option to acquire 6,500 shares of common stock (commencing in 2000). As Chairman Emeritus, Mr. Sculley is entitled to an additional $500 per month. As Chairman of the Board, General Peay is entitled to the same cash and stock based compensation as paid to non-employee members of the Board of Directors plus (i) an additional $1,000 per month and (ii) reimbursement of annual premiums on a $1 million life insurance policy, together with all applicable income taxes.

      In 1992, the Board of Directors of Allied adopted the 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

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      In 2003, Mr. Sculley was paid approximately $80,000 in satisfaction of his post-employment severance entitlement. Mr. Sculley is entitled to annual payments of $80,000 through 2005.

Employment Contract and Change-In-Control Arrangements

      Mr. Meyer’s employment agreement provides for an annual salary of $270,000 and the potential to earn an annual bonus up to 50% of the annual salary upon satisfaction of certain performance standards. Upon certain terminations of Mr. Meyer’s employment, he will be entitled to receive his annual salary for up to three (3) years following such termination. Further, if the termination of employment occurs within twelve (12) months of a change of control, the payments may be accelerated into a lump sum payment at the election of Mr. Meyer.

      Mr. Pickens’ employment agreement provides for an annual salary of $185,000 and the potential to earn an annual bonus up to 35% of the annual salary upon satisfaction of certain performance standards. Upon certain terminations of Mr. Pickens’ employment, he will be entitled to receive his annual salary for one year following such termination. Further, if the termination of employment occurs within twelve (12) months of a change of control, the payments may be accelerated into a lump sum payment at the election of Mr. Pickens.

      Mr. Hasper’s employment agreement provides for an annual salary of $180,000 and the potential to earn an annual bonus up to 35% of the annual salary upon satisfaction of certain performance standards. Upon certain terminations of Mr. Hasper’s employment, he will be entitled to receive his annual salary for one year following such termination. Further, if the termination of employment occurs within twelve (12) months of a change of control, the payments may be accelerated into a lump sum payment at the election of Mr. Hasper.

      Mr. Waddell’s employment agreement provides for an annual salary of $163,500 and the potential to earn an annual bonus up to 35% of the annual salary upon satisfaction of certain performance standards. For periods commencing in 2004, the performance standards will relate to Mr. Waddell’s responsibilities as President of SeaSpace Corporation. Upon certain terminations of Mr. Waddell’s employment, he will be entitled to receive his annual salary for one year following such termination. Further, if the termination of employment occurs within twelve (12) months of a change of control, the payments may be accelerated into a lump sum payment at the election of Mr. Waddell.

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

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

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Compensation Committee Interlocks and Insider Participation

      The Compensation Committee of Allied consists of Messrs. Harry H. Warner and Ronald H. Griffith. J.R. Sculley, a former Chairman of the Board and President of Allied, also served on the Compensation Committee in 2003.

      The following information is furnished with respect to any person who is known to Allied to be the beneficial owner of more than five percent (5%) of its Common Stock and is based upon the most recent filings made by the undersigned with the Securities and Exchange Commission:

(1)	Based upon 5,551,373 shares of common stock outstanding plus 427,998 shares which may be acquired within sixty (60) days pursuant to outstanding stock options plus 315,000 shares which may be issued within sixty (60) days pursuant to a convertible debenture and stock purchase warrant.
(2)	Bricoleur Capital Management, LLC (“Bricoleur”) filed an amended Schedule 13G with the SEC on February 9, 2004. This Schedule 13G states that Bricoleur beneficially owned 460,200 shares of Common Stock as of December 31, 2003.
(3)	FMR Corp. and its wholly-owned subsidiary, Fidelity Management & Research Company (“Fidelity”), Edward C. Johnson, 3rd and Abigail P. Johnson, jointly filed an amended Schedule 13G with the SEC on February 17, 2004. This Schedule 13G states that Fidelity Low-Priced Stock Fund owned 475,000 shares of Common Stock as of December 31, 2003.
(4)	Dimensional Fund Advisors, Inc. (“Dimensional”), a registered investment advisor, filed an amended Schedule 13G with the SEC on February 6, 2004. This Schedule 13G states that Dimensional is deemed to have beneficial ownership of 307,230 shares, all of which shares are owned by advisory clients of Dimensional. Dimensional disclaims beneficial ownership of all such shares.
(5)	Riverview Group, LLC has the right to acquire up to 315,000 shares within sixty (60) days pursuant to its convertible debenture and stock purchase warrant.
(6)	Heartland Advisors, Inc. and William J. Nasgovitz filed a Schedule 13G with the SEC on February 12, 2004. This Schedule 13G states that The Heartland Value Fund owns 300,000 shares of common stock.
(7)	Berno, Gambal & Barbee, Inc. filed an amendment to its Schedule 13G with the SEC on February 13, 2004. This amendment states that Berno, Gambal & Barbee owns 291,400 shares of the common stock.