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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2002

For the transition period from                      to                     

Commission file number: 0-2545

THE ALLIED DEFENSE GROUP, INC.

(FORMERLY ALLIED RESEARCH CORPORATION)

(Exact name of registrant as specified in its charter)

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  x  NO  ¨

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

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

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

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

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INDEX

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ITEM 1. BUSINESS

General

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

Forward Looking Statements

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

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

Description of Business

Allied

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

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MECAR

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

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

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

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

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

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

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

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

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

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

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a muzzle outer diameter of 22mm and fired from the shoulder in the normal manner. This method of firing a grenade is made possible by MECAR’s development of the universal bullet trap (“BTU”). The BTU is a device which can be used with all existing makes of steel core or soft core bullets in calibers 7.62mm and 5.56mm, including the latest round (SS109) used in the M-16 rifle. The BTU is fitted within the tail of the grenade. When the bullet is fired, it lodges in the BTU and the expanding gases released by the discharged round propel the grenade to its target. MECAR manufactures several different bullet trap grenades including high explosive fragmentation, anti-personnel, armor piercing, smoke generating, white phosphorus, and parachute flare (night illuminating).

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

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

VSK Group

The VSK Group engages in the business of developing, manufacturing, selling, installing and servicing security systems for government and private industry. The systems marketed by the VSK Group include intrusion detection, access control and fire detection systems. The principal products manufactured by the VSK Group are central control panels; the other components are purchased from other vendors. In 1995, the VSK Group acquired all of the outstanding stock of IDCS, S.A., which markets an upscale line of security services products principally in European markets. In late 1999, the VSK Group acquired all of the outstanding stock of VIGITEC, S.A., which markets closed circuit television systems and provides other communications services.

Microwave

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

Titan Dynamics Systems

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

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

SeaSpace

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

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Geographic Areas and Industry Segments

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

Market and Customers

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

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

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

The sales by MECAR in any given period and its backlog at any particular time may be significantly influenced by one or a few large orders. This is due to the normal nature of its business. An order for MECAR’s products is typically for a large quantity and/or a substantial aggregate price, primarily because materials required for the manufacture of the products cannot be economically purchased in small quantities and because of the favorable economies of large volume production. Most of the contracts received by MECAR require delivery in approximately one year. Accordingly, MECAR’s business is dependent upon its ability to obtain such large orders. MECAR frequently accepts smaller orders in an attempt to increase its customer base and efficiently use its manufacturing capacity. MECAR’s products are designed for general military use by a variety of government customers.

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

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

In the Electronic Security segment, the VSK Group derives substantially all of its revenue from sales and services to private industry such as banks, hospitals, commercial businesses, office buildings and to local governments. The VSK Group sells some of its products/services directly to the end users; in other instances it sells its systems to independent distributors and resellers for resale to the end users. The customers of the VSK Group are located in Belgium and in neighboring countries. While most of the orders received by the VSK Group are for work which can be completed within one year, it has received multi-year orders for its products and services. VSK Electronics and IDCS sell their products principally

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

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

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

Marketing

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

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

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

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

Research and Development

In the Ordnance and Manufacturing segment, the development of ammunition and weapon systems requires knowledge and experience in aerodynamics, mechanical engineering, chemistry, combustion, materials behavior and ballistics. MECAR maintains an active research and development staff, including a staff of design engineers, in order to determine how materials can be used or combined in new ways to improve performance or to solve new problems. In 2002, 2001 and 2000, MECAR expended $292,356, $500,904 and $736,764, respectively, for research and development activities. MECAR designed most of the products which it currently manufactures. MECAR designs and develops most of its special tooling, fixtures and special explosive loading and testing systems.

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

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

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Suppliers and Materials

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

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

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

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

Backlog

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

Competition

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

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

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

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

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

Personnel

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

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

Patents

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

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its weapon discharge simulation system (granted in 1993), its electrostatically dischargeable primer (granted in 1999), its electric impulse cartridge (granted in 2001) and an electric gun (granted in 2002). Neither Allied nor any of its other subsidiaries holds any other significant patents.

Environmental Regulations

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

Principal Customers

MECAR has historically received a large percentage of its revenue from two (2) agencies of a foreign government. See Note Q to Allied’s consolidated financial statements. MECAR now receives contracts for the benefit of these customers via the Distributor and has received contracts for the benefit of these customers via the FMS program.

Available Information

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

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

The Allied Defense Group, Inc.

8000 Towers Crescent Drive

Suite 260

Vienna, Virginia 22182

(703) 847-5268

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ITEM 2. PROPERTIES

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

MECAR’s principal factory is located approximately 25 miles south of Brussels near Nivelles, Belgium. The factory principally consists of a manufacturing and administrative complex which was occupied by MECAR in 1989. The manufacturing area is approximately 112,000 square feet and the administration facility is approximately 28,000 square feet. There are a number of older buildings on the property that are still used in conjunction with the new complex. A small test firing range is maintained on this property. MECAR also owns 600 acres in the vicinity of the Village of Marche in the Ardennes region of Belgium, which was previously used as a test range. MECAR ceased its use of the Ardennes firing range in 2001. MECAR is now utilizing other test ranges, including a test range owned by the Belgian Army, although it is also exploring the prospects of securing the use of a new test range.

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

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

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

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

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

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

ITEM 3. LEGAL PROCEEDINGS

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

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

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

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PART II

ITEM 5. MARKET FOR STOCK AND RELATED STOCKHOLDER MATTERS

Market Information

Allied’s Common Stock has been listed for trading on the American Stock Exchange (“AMEX”) since September 15, 1992.

Its AMEX trading symbol is ADG. Its media listing is under the symbol Allied Defense. The table below shows the high and low sales prices of Allied’s Common Stock during 2002 and 2001 (as reported by AMEX):

Stockholders

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

Dividends

Allied paid a 5% stock dividend in November, 1992 to holders of record of its Common Stock on October 15, 1992. Cash was paid in lieu of the issuance of fractional shares. There have been no subsequent dividends declared or paid by Allied.

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

Stock Issuances

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

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

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

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

Equity Compensation Plan Information

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

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

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

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

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

ITEM 6 SELECTED FINANCIAL DATA

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

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Overview

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

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

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

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

Forward-Looking Statements

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

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

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

Critical Accounting Policies

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

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

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

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

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

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

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

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

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

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

Acquisitions

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

Trends In Operations

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

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

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

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

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

Trends In Liquidity And Capital Resources

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

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

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

Liquidity

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Capital Resources

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

Contractual Obligations and Commercial Commitments

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

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

Results of Operations

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

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

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

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

Revenues

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

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

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

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

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

Cost of Sales

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

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

Selling and Administrative Expenses

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

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

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Research and Development

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

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

Interest Income

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

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

Interest Expense

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

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

Other – Net

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

Pre-Tax Profit From Continuing Operations

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

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

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

Income Taxes

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

Net Earnings From Continuing Operations

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

Discontinued Operations

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

Impact of Year 2000

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

Recent Accounting Pronouncements

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

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ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Sensitivity

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

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

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

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

Exchange Rate Sensitivity

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

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

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

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

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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

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

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF ALLIED

Directors

The following are the directors of Allied:

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

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

J. R. Sculley, age 62, became a director of Allied in 1991 and currently serves as Chairman Emeritus. He served as Chairman of the Board and Chief Executive Officer from December, 1992 until September, 1999; from April 1992 until December 1992 he served as President and Chief Operating Officer of Allied. Between 1989 and April, 1992, Mr. Sculley was Director of Advanced Studies and Technologies of Grumman Corporation, a defense company, and, prior thereto, was Assistant Secretary of the Army (Research, Development and Acquisition).

Clifford C. Christ, age 55, became a director of Allied in 1993. He has been the President and Chief Executive Officer of NavCom Defense Electronics, Inc., a defense electronics company, since 1988.

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

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

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

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

Executive Officers

The following are the executive officers of Allied:

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

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

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

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

ITEM 11. EXECUTIVE COMPENSATION

Compensation of Directors and Executive Officers.

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

SUMMARY COMPENSATION TABLE

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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, 2002.

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

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

Director Compensation

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

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

In 1992, the Board of Directors of Allied adopted the Allied Research Corporation Outside Directors Retirement Plan (the “Directors Retirement Plan”) to provide retirement benefits for long-standing Outside Directors. Under the Directors Retirement Plan, Outside Directors are eligible for a retirement benefit if they retire from the Board and have served as a member of the Board for a minimum of five (5) years. An eligible Outside Director who retires from the Board is entitled to receive, commencing on the last day of the first month following the month in which the director attains age seventy (70), monthly payments equal to the monthly cash compensation received from Allied at the time the director terminated service in such capacity. Such payments will cease upon the earlier of the expiration of a period of time equivalent to the period of time the director served as a member of the Board or the death of the director. The Directors Retirement Plan was suspended in 2001. Messrs. Christ, Warner and Sculley are entitled to receive benefits under the Plan upon their retirement from the Board for prior service. No further benefits have accrued or will accrue under the Plan since its suspension in 2001.

In 1991, the Board of Directors of Allied adopted the Outside Directors Stock Option Plan (the “Directors Option Plan”). None of the options granted pursuant to the Directors Option Plan are intended to qualify as incentive stock options under Sections 422 through 424 of the Internal Revenue Code. Options for an aggregate of 26,000 shares were granted under the Directors Option Plan in 2001 to Allied’s Outside Directors. The Directors Option Plan expired in 2001. In 2002, options for an aggregate of 32,500 shares were granted under the 2001 Equity Incentive Plan to Allied’s Outside Directors.

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

Employment Contract and Change-In-Control Arrangements

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

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

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

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

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

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

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of Allied) at a price per share equal to one-half of the average market price for a specified period. In lieu of the purchase price, a right holder may elect to acquire one-half of the common stock available under the second option. The purchase price of the preferred stock fractional amount is subject to adjustment for certain events as described in the Rights Plan. At the discretion of a majority of the Board and within a specified time period, Allied may redeem all of the rights at a price of $.01 per right. The Board may also amend any provisions of the Rights Plan prior to exercise.

Compensation Committee Interlocks and Insider Participation

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

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

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

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

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

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

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

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ITEM 14. DISCLOSURE CONTROLS AND PROCEDURES

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

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

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

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

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

(a)(1) Financial Statements:

(a)(2) Financial Statement Schedules:

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

(a)(2)(a) As of December 31, 2002 and 2001 and for the three years ended December 31, 2002:

(a)(3) Exhibits:

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(b) Reports on Form 8-K:

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

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

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

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SIGNATURES

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

Date: March 26, 2003

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