Attached files

file filename
EX-32.1 - EXHIBIT 32.1 - ALION SCIENCE & TECHNOLOGY CORPc04575exv32w1.htm
EX-31.1 - EXHIBIT 31.1 - ALION SCIENCE & TECHNOLOGY CORPc04575exv31w1.htm
EX-31.2 - EXHIBIT 31.2 - ALION SCIENCE & TECHNOLOGY CORPc04575exv31w2.htm
EX-32.2 - EXHIBIT 32.2 - ALION SCIENCE & TECHNOLOGY CORPc04575exv32w2.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010.
COMMISSION FILE NUMBER 333-89756
 
(ALION LOGO)
Alion Science and Technology Corporation
(Exact Name of Registrant as Specified in Its Charter)
     
DELAWARE   54-2061691
(State or Other Jurisdiction of   (I.R.S. Employer
Incorporation of Organization)   Identification No.)
     
10 West 35th Street   1750 Tysons Boulevard, Suite 1300
Chicago, IL 60616   McLean, VA 22102
(312) 567-4000   (703) 918-4480
(Address, including Zip Code and Telephone Number with Area Code, of Principal Executive Offices)
(Former name, former address and former fiscal year, if changed since last report)
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 o No þ
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large Accelerated Filer o   Accelerated Filer o   Non-Accelerated Filer þ   Smaller Reporting Company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The number of shares outstanding of Alion Science and Technology Corporation Common Stock as of August 10, 2010 was: Common Stock 5,406,092
 
 

 

 


 

ALION SCIENCE AND TECHNOLOGY CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2010
         
 
 
       
    1  
 
       
    1  
 
       
    2  
 
       
    3  
 
       
    5  
 
       
    35  
 
       
    53  
 
       
    53  
 
       
    53  
 
       
 
 
       
    54  
 
       
    54  
 
       
    54  
 
       
    54  
 
       
    54  
 
       
    54  
 
       
    55  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

 


Table of Contents

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
ALION SCIENCE AND TECHNOLOGY CORPORATION
Condensed Consolidated Balance Sheets (unaudited)
As of June 30, 2010 and September 30, 2009
                 
    June 30,     September 30,  
    2010     2009  
    (In thousands, except share  
    and per share information)  
Current assets:
               
Cash and cash equivalents
  $ 24,281     $ 11,185  
Accounts receivable, net
    171,328       180,157  
Prepaid expenses and other current assets
    6,065       3,795  
 
           
Total current assets
    201,674       195,137  
Property, plant and equipment, net
    12,063       14,474  
Intangible assets, net
    20,277       28,680  
Goodwill
    398,921       398,921  
Other assets
    10,651       10,286  
 
           
Total assets
  $ 643,586     $ 647,498  
 
           
Current liabilities:
               
Interest payable
  $ 15,860     $ 9,039  
Current portion, senior term loan payable
          2,389  
Current portion, subordinated note payable
          3,000  
Current portion, acquisition obligations
          50  
Trade accounts payable
    46,586       60,707  
Accrued liabilities
    43,448       45,425  
Accrued payroll and related liabilities
    46,444       43,033  
Billings in excess of revenue earned
    4,629       3,661  
 
           
Total current liabilities
    156,967       167,304  
Senior term loan payable, excluding current portion
          229,221  
Senior secured notes
    272,089        
Senior unsecured notes
    245,905       245,241  
Subordinated note payable
          46,932  
Accrued compensation, excluding current portion
    5,079       5,740  
Accrued postretirement benefit obligations
    752       717  
Non-current portion of lease obligations
    7,873       7,286  
Deferred income taxes
    35,615        
Commitments and contingencies
           
Redeemable common stock warrants
          32,717  
Redeemable common stock, $0.01 par value, 8,000,000 shares authorized, 5,406,237 and 5,424,274 shares issued and outstanding at June 30, 2010 and September 30, 2009
    151,375       187,137  
Common stock warrants
    20,785        
Accumulated other comprehensive loss
    (238 )     (238 )
Accumulated deficit
    (252,616 )     (274,559 )
 
           
Total liabilities, redeemable common stock and accumulated deficit
  $ 643,586     $ 647,498  
 
           
See accompanying notes to condensed consolidated financial statements.

 

1


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
Condensed Consolidated Statements of Operations (unaudited)
                                 
    Three Months Ended     Nine Months Ended  
    June 30,     June 30,  
    2010     2009     2010     2009  
    (In thousands, except share and per share information)  
Contract revenue
  $ 213,309     $ 204,160     $ 622,593     $ 588,385  
Direct contract expense
    164,853       157,666       479,898       452,123  
 
                       
Gross profit
    48,456       46,494       142,695       136,262  
 
                       
Operating expenses:
                               
Indirect contract expense
    10,167       9,443       29,435       27,899  
Research and development
    120       223       690       370  
General and administrative
    19,465       17,253       53,938       40,852  
Rental and occupancy expense
    7,499       8,169       23,783       24,375  
Depreciation and amortization
    4,064       5,156       12,507       14,662  
 
                       
Total operating expenses
    41,315       40,244       120,353       108,158  
 
                       
Operating income
    7,141       6,250       22,342       28,104  
Other income (expense):
                               
Interest income
    16       15       73       63  
Interest expense
    (18,292 )     (15,766 )     (49,275 )     (40,098 )
Other
    (183 )     90       (207 )     (32 )
Gain on sale of non-operating assets
          (19 )           (19 )
Gain on extinguishment of debt
                50,749        
 
                       
Total other income (expense)
    (18,459 )     (15,680 )     1,340       (40,086 )
(Loss) income before taxes
    (11,318 )     (9,430 )     23,682       (11,982 )
Income tax (expense) benefit
    (1,798 )     (7 )     (35,573 )     44  
 
                       
Net loss
  $ (13,116 )   $ (9,437 )   $ (11,891 )   $ (11,938 )
 
                       
 
                               
Basic and diluted loss per share
    (2.40 )     (1.80 )     (2.19 )     (2.27 )
 
                       
Basic and weighted average common shares outstanding
    5,467,797       5,240,778       5,434,436       5,264,762  
 
                       
See accompanying notes to condensed consolidated financial statements.

 

2


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
Condensed Consolidated Statements of Cash Flows (unaudited)
                 
    Nine Months Ended June 30,  
    2010     2009  
    (In thousands)  
Cash flows from operating activities:
               
Net loss
  $ (11,891 )   $ (11,938 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    12,507       14,662  
Bad debt expense
          760  
Accretion of debt to face value
    1,709       1,769  
Amortization of debt issuance costs
    4,712       2,045  
Change in fair value of redeemable common stock warrants
    (160 )     (6,738 )
Incentive and stock-based compensation
    2,645       (5,353 )
Gain on extinguishment of debt
    (50,749 )      
Deferred income taxes
    35,615        
Other gains and losses
    12       37  
Changes in assets and liabilities:
               
Accounts receivable
    8,829       (8,895 )
Other assets
    (1,463 )     (1,214 )
Trade accounts payable
    (14,002 )     (16,310 )
Accrued liabilities
    3,266       16,331  
Interest payable
    6,821       8,869  
Other liabilities
    1,650       5,454  
 
           
Net cash used in operating activities
    (499 )     (521 )
Cash flows from investing activities:
               
Cash paid for acquisition-related obligations
    (50 )     (166 )
Capital expenditures
    (1,639 )     (1,789 )
Proceeds from sale of assets
    5        
 
           
Net cash used in investing activities
    (1,684 )     (1,955 )
Cash flows from financing activities:
               
Cash paid for interest rate swap
          (4,647 )
Sale of Secured Notes
    281,465        
Sale of Common Stock Warrants
    20,785        
Payment of debt issue costs
    (18,177 )      
Repayment of Term B Loan
    (236,596 )     (1,825 )
Repurchase of Subordinated Note and related warrants
    (25,000 )      
Payment of Subordinated Note principal
          (3,000 )
Revolver borrowings
    84,200       349,925  
Revolver repayments
    (84,200 )     (349,925 )
Loan to ESOP Trust
    (5,323 )     (5,936 )
ESOP loan repayment
    5,323       5,936  
Redeemable common stock purchased from ESOP Trust
    (9,326 )     (7,264 )
Redeemable common stock sold to ESOP Trust
    2,128       5,115  
 
           
Net cash provided by (used in) financing activities
    15,279       (11,621 )
Net increase (decrease) in cash and cash equivalents
    13,096       (14,097 )
Cash and cash equivalents at beginning of period
    11,185       16,287  
 
           
Cash and cash equivalents at end of period
  $ 24,281     $ 2,190  
 
           
See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
Condensed Consolidated Statements of Cash Flows (unaudited)
                 
    Nine Months Ended June 30,  
    2010     2009  
    (In thousands)  
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $ 36,230     $ 30,284  
Cash paid (received) for taxes
    34       (104 )
Non-cash financing activities:
               
Common stock issued to ESOP Trust in satisfaction of employer contribution liability
  $ 5,268     $ 5,043  
See accompanying notes to condensed consolidated financial statements.

 

4


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) Description and Formation of the Business
Alion Science and Technology Corporation and its subsidiaries (collectively, the Company or Alion) provide scientific, engineering and information technology expertise to research and develop technological solutions for problems relating to national defense, homeland security, and energy and environmental analysis. Alion provides services to departments and agencies of the federal government and, to a lesser extent, to commercial and international customers.
Alion was established in October 2001 as a for-profit S-Corporation to purchase substantially all of the assets and certain liabilities of IIT Research Institute (IITRI), a not-for-profit corporation controlled by Illinois Institute of Technology (IIT). In December 2002, Alion acquired substantially all of IITRI’s assets and liabilities except for its Life Sciences Operation, for $127.3 million. Prior to that, the Company’s activities were organizational in nature.
On March 22, 2010, the Company became a C-Corporation because it no longer met the Internal Revenue Code S-corporation requirement that it have only a single class of stock. In connection with the sale of the Secured Note Units, Alion issued deep-in-the-money common stock warrants considered to be a second class of stock. See Note 13.
(2) Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements include the accounts of Alion Science and Technology Corporation (a Delaware corporation), and its wholly-owned subsidiaries and have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission. Certain information and note disclosures normally included in the annual financial statements, prepared in accordance with generally accepted accounting principles, have been omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information presented not misleading. The statements are prepared on the accrual basis of accounting and include the accounts of Alion and its wholly-owned subsidiaries from their date of acquisition or formation. All inter-company accounts have been eliminated in consolidation. There were no changes to Alion’s subsidiaries in the current fiscal year.
In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments consisting of normal recurring adjustments and reclassifications that are necessary for fair presentation of the periods presented. The results for the nine months ended June 30, 2010 are not necessarily indicative of the results to be expected for the full fiscal year. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s latest annual report on Form 10-K for the year ended September 30, 2009.
Fiscal, Quarter and Interim Periods
Alion’s fiscal year ends on September 30. The Company operates based on a three-month quarter, four-quarter fiscal year with quarters ending December 31, March 31, June 30, and September 30.
Use of Estimates
Preparing financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported for assets and liabilities, disclosures of contingent assets and liabilities as of financial statement dates and amounts reported for operating results for each period presented. Actual results are likely to differ from those estimates, but management does not believe such differences will materially affect Alion’s financial position, results of operations, or cash flows.
Revenue Recognition
Alion derives its revenue from delivering technology services under a variety of contracts. Some contracts provide for reimbursement of costs plus fees; others are fixed-price or time-and-material type contracts. The Company generally recognizes revenue when a contract has been executed, the contract price is fixed or determinable, delivery of services or products has occurred and collectibility of the contract price is considered reasonably assured.

 

5


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Alion recognizes revenue on cost-reimbursement contracts as it incurs costs and includes estimated fees earned. The Company recognizes time-and-material contract revenue at negotiated, fixed, contractually billable rates as it delivers labor hours and incurs other direct expenses. Alion uses various performance measures under the percentage of completion method to recognize revenue for fixed-price contracts. Estimating contract costs at completion and recognizing revenue appropriately involve significant management estimates. Actual costs may differ from estimated costs and affect estimated profitability and timing of revenue recognition. From time to time, facts develop that require Alion to revise estimated total costs or expected revenue. Alion records the cumulative effect of revised estimates in the period in which the facts requiring revised estimates become known. Alion recognizes the full amount of anticipated losses on any type of contract in the period in which a loss becomes known. For each of the periods presented, the cumulative effects of revised estimates were immaterial to the Company’s financial performance.
Federal government agency contracts are subject to periodic funding. A customer may fund a contract in its entirety at inception or incrementally throughout its period of performance as services are provided. If Alion determines contract funding is not probable, it defers revenue recognition until realization is probable. The federal government can audit Alion’s contract costs and adjust amounts through negotiation. The government considers Alion a major contractor; its auditors maintain an office on site. The government has audited the Company’s claimed costs through fiscal year 2004. The Company negotiated and settled indirect rates through fiscal year 2004 with no material adverse effect on operating results or cash flows. DCAA is currently auditing the Company’s indirect cost proposals for fiscal 2005 and 2006. The Company submitted its fiscal year 2009, 2008 and 2007 indirect cost proposals in March 2010, 2009 and 2008. Alion has recorded federal government contract revenue in amounts it expects to realize.
Alion recognizes revenue on unpriced change orders as it incurs expenses and only to the extent it is probable it will recover such costs. The Company recognizes revenue in excess of costs on unpriced change orders only when management can also estimate beyond a reasonable doubt the amount of excess and experience provides a sufficient basis for recognition. Alion recognizes revenue on claims as expenses are incurred only to the extent it is probable that it will recover such costs and can reliably estimate the amount it will recover.
Alion generates software-related revenue from licensing software and providing services. In general, professional services are essential to the functionality of the solutions the Company sells. Alion applies the percentage of completion method in Accounting Standards Codification (ASC) 605 — Revenue Recognition to recognize revenue.
Income Taxes
From its inception until March 22, 2010, Alion was an S-corporation and was not subject to federal or most state income taxes. As a pass-through entity Alion’s income and losses were allocated to its tax-exempt shareholder, the Alion Science and Technology Corporation Employee Stock Ownership, Savings and Investment Trust (the ESOP Trust). All of Alion’s subsidiaries were qualified S-corporation subsidiaries or disregarded entities included in its consolidated federal tax returns.
On March 22, 2010, Alion issued deep-in-the-money warrants deemed to constitute a second class of stock. Because it was deemed to have two classes of stock, the Company ceased to qualify as an S-corporation and automatically became a C-corporation subject to federal and state income taxes. Some Alion subsidiaries also became subject to separate state income tax and reporting requirements. From its formation, Alion Science and Technology (Canada) Corporation has been subject to Canadian federal and provincial income taxes.
Alion accounts for income taxes by applying the provisions in currently enacted tax laws. The Company determines deferred income taxes based on the estimated future tax effects of differences between the financial statement and tax bases of its assets and liabilities. Deferred income tax provisions and benefits will change as assets or liabilities change from year-to-year. In providing for deferred taxes, Alion considers the tax regulations of the jurisdictions where it operates; estimates of future taxable income; and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies change, the carrying value of deferred tax assets and liabilities may require adjustment.
Alion has a history of operating losses for both tax and financial statement purposes. The Company has recorded valuation allowances equal to deferred tax assets based on the likelihood that it may not be able to realize the value of these assets. Alion recognizes the benefit of a tax position only after determining that the relevant tax authority would “more likely than not” sustain the Company’s position following an audit. For tax positions meeting the “more likely than not” threshold, the Company recognizes the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.

 

6


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Cash and Cash Equivalents
The Company considers cash in banks, and deposits with financial institutions with maturities of three months or less at time of purchase which it can liquidate without prior notice or penalty, to be cash and cash equivalents.
Accounts Receivable and Billings in Excess of Revenue Earned
Accounts receivable include billed accounts receivable, amounts currently billable and revenue in excess of billings on uncompleted contracts that represent accumulated project expenses and fees which have not been billed or are not currently billable as of the date of the consolidated balance sheet. Revenue in excess of billings on uncompleted contracts is stated at estimated realizable value. Unbilled accounts receivable include revenue recognized for customer-related work performed by Alion on new and existing contracts for which the Company had not received contracts or contract modifications. The allowance for doubtful accounts is Alion’s best estimate of the amount of probable losses in the Company’s existing billed and unbilled accounts receivable. The Company determines the allowance using specific identification and historical write-off experience based on age of receivables. Billings in excess of revenue and advance collections from customers represent amounts received from or billed to customers in excess of project revenue recognized to date.
Property, Plant and Equipment
Leasehold improvements, software and equipment are recorded at cost. Maintenance and repairs that do not add significant value or significantly lengthen an asset’s useful life are charged to current operations. Software and equipment are depreciated on the straight-line method over their estimated useful lives (typically 3 years for software and 5 years for equipment). Leasehold improvements are amortized on the straight-line method over the shorter of the asset’s estimated useful life or the life of the lease. Upon sale or retirement of an asset, costs and related accumulated depreciation are deducted from the accounts, and any gain or loss is recognized in the consolidated statements of operations.
Goodwill and Intangible Assets
Alion assigns the purchase price it pays to acquire the stock or assets of an entity to the net assets acquired based on the estimated fair value of the assets acquired. Goodwill is the purchase price in excess of the estimated fair value of the tangible net assets and separately identified intangible assets acquired. Purchase price allocations for acquisitions involve significant estimates and management judgments may be adjusted during the purchase price allocation period. There are no acquisitions with open measurement periods.
The Company accounts for goodwill and other intangible assets in accordance with the provisions of ASC 350 — Intangibles, Goodwill and Other Assets. Alion is required to review goodwill at least annually for impairment or, more frequently if events and circumstances indicate goodwill might be impaired. The Company performs its annual review at the end of each fiscal year. Alion is required to recognize an impairment loss to the extent that its goodwill carrying amount exceeds fair value. Evaluating any impairment to goodwill involves significant management estimates. To date, these annual reviews have resulted in no adjustments.
The Company operates in one segment and tests goodwill at the reporting unit level. Management has identified three reporting units for the purpose of testing goodwill for impairment. The reporting units are based on administrative organizational structure and the availability of discrete financial information. Each reporting unit provides a similar range of scientific, engineering and analytical services to departments and agencies of the U.S. government and commercial customers. The Company employs a reasonable, supportable and consistent method to assign goodwill to reporting units expected to benefit from the synergies arising from acquisitions. Alion determines reporting unit goodwill in a manner similar to the way it determines goodwill in a purchase allocation by using fair value to determine reporting unit “purchase price”, assets, liabilities and goodwill. Reporting unit residual fair value after this allocation is the implied fair value of reporting unit goodwill. The Company’s reporting units remained consistent in structure for all periods presented. The Company allocated changes in goodwill carrying value to reporting units based on acquisitions attributable to each unit’s current structure.

 

7


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company performs its own independent analysis to determine whether goodwill is potentially impaired. The Company performs discounted cash flow and market-multiple-based analyses to estimate the enterprise fair value of Alion and its reporting units and the fair value of reporting unit goodwill in order to test goodwill for potential impairment. Management independently determines the rates and assumptions it uses to perform its goodwill impairment analysis and assesses the probability of future contracts and revenue to evaluate the recoverability of goodwill.
Alion’s cash flow analysis depends on several significant management inputs and assumptions. Management uses observable inputs, rates and assumptions generally consistent with those used by the independent third party to prepare the valuation report for the ESOP Trustee. Management’s cash flow analysis includes the following significant inputs and assumptions: estimated future revenue and revenue growth; estimated future operating margins and EBITDA; observable market multiples for comparable companies; and a discount rate consistent with a market-based weighted average cost of capital. Management includes EBITDA in its analysis in order to use publicly available valuation data.
In the Company’s most recent impairment testing, market multiples for trailing twelve month EBITDA for comparable companies (publicly traded professional services government contractors) ranged from a low of 9.0 to a high of 12.7, with a median value of 10.4. Market multiples for trailing twelve month revenue ranged from a low of 0.76 to a high of 1.22, with a median value of 0.99. Management used median market multiples and a weighted average cost of capital rate of 12.5% derived from market-based inputs, the tax-effected interest cost of Alion’s outstanding debt and a hypothetical market participant capital structure. Management estimates future years’ EBITDA based on Alion’s historical adjusted EBITDA as a percentage of revenue. Management estimated future revenue would grow 7%-10% annually. Prior year market multiples for trailing twelve month EBITDA for comparable professional services government contractors ranged from a low of 9.4 to a high of 16.7, with a median value of 12.4. Prior year market multiples for trailing twelve month revenue ranged from a low of 0.72 to a high of 1.75, with a median value of 1.02. The prior year weighted average cost of capital rate was 12.0% derived from market-based inputs, the tax-effected interest cost of Alion’s outstanding debt and a hypothetical market participant capital structure. There were no changes to the methods used in prior periods to evaluate goodwill. Changes in one or more inputs could materially alter the calculation of Alion’s enterprise fair value and thus the Company’s determination of whether its goodwill is potentially impaired. A hypothetical 10% increase or decrease in the weighted average cost of capital rate at September 30, 2009 would have produced a corresponding approximate 5% decrease or increase in estimated enterprise value. At September 30, 2009, market-multiple based enterprise value exceeded discounted cash flow enterprise value by approximately 7%.
Management reviews the Company’s internally computed enterprise fair value to confirm the reasonableness of the Company’s analysis and compares the results of its independent analysis with the results of the independent third party valuation report prepared for the ESOP Trustee. Management compares each reporting unit’s carrying amount to its estimated fair value. If a reporting unit’s carrying value exceeds its estimated fair value, the Company compares the reporting unit’s goodwill carrying amount with the corresponding implied fair value of its goodwill. If the carrying amount of reporting unit goodwill exceeds its fair value, the Company recognizes an impairment loss to the extent that the carrying amount of goodwill exceeds implied fair value.
Alion completed its most recent goodwill impairment analysis in the fourth quarter of fiscal year 2009 and concluded no goodwill impairment existed as of September 30, 2009. The estimated fair value of each reporting unit substantially exceeded its September 2009 carrying value. A hypothetical 10% decrease in fair value would not have resulted in impairment to goodwill for any reporting unit or triggered the need to perform additional step two analyses for any reporting unit. There were no changes to goodwill in the quarter ended June 30, 2010 nor were there any significant events in the quarter that indicated impairment to goodwill as of June 30, 2010.
Alion amortizes intangible assets as it consumes economic benefits over estimated useful lives. As of June 30, 2010, the Company had a recorded net intangible asset balance of approximately $20.3 million, composed primarily of purchased contracts from the JJMA and Anteon contract acquisitions.
     
Purchased contracts
  1 - 13 years
Internal use software and engineering designs
  2 - 3 years
Non-compete agreements
  3 - 6 years

 

8


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Redeemable Common Stock
There is no public market for Alion’s redeemable common stock and therefore no observable price for its equity, individually or in the aggregate. The ESOP Trust holds all the Company’s outstanding common stock. Under certain circumstances, ESOP beneficiaries can require the ESOP Trust to distribute the value of their beneficial interests. The Internal Revenue Code (IRC) and ERISA require the Company to offer ESOP participants who receive Alion common stock a liquidity put right. The put right requires the Company to purchase distributed shares at any time during two put option periods at the then current fair market value. Common stock distributed by the ESOP Trust is subject to a right of first refusal. Prior to any subsequent transfer, the shares must first be offered to the Company and then to the ESOP Trust. Eventual redemption of shares of Alion common stock as a result of distributions is outside the Company’s control; therefore, Alion classifies its outstanding shares of redeemable common stock as a liability.
At each reporting date, Alion is required to increase or decrease the reported value of its outstanding common stock to reflect its estimated redemption value. Management estimates the value of this liability in part by considering the most recent price at which the Company was able to sell shares to the ESOP Trust (current share price times total shares issued and outstanding). In its fiduciary capacity the ESOP Trustee is independent of the Company and its management. Consistent with its fiduciary responsibilities, the ESOP Trustee retains an independent third party valuation firm to assist it in determining the fair market value (share price) at which the ESOP Trustee may acquire or dispose of investments in Alion common stock. The Audit and Finance Committee of Alion’s Board of Directors reviews the reasonableness of the liability Management has determined is appropriate for the Company to recognize in its financial statements for outstanding redeemable common stock. The Audit and Finance Committee considers various factors in its review, including, in part, the most recent valuation report and the share price selected by the ESOP Trustee.
Alion records changes in the reported value of its outstanding common stock through an offsetting charge or credit to accumulated deficit. There were no fair value adjustments to redeemable common stock in the current quarter. The accumulated deficit at June 30, 2010 included $56.4 million for changes in the Company’s share redemption liability. Outstanding redeemable common stock had an aggregate fair value of approximately $151.4 million as of June 30, 2010.
Concentration of Credit Risk
Alion is subject to credit risk for its cash equivalents and accounts receivable. The Company believes the high credit quality of its cash equivalent investments limits its credit risk with respect to such investments. Alion believes its concentration of credit risk with respect to accounts receivable is limited as the receivables are principally due from the federal government.
Fair Value of Financial Instruments
The Company used the following methods and assumptions to estimate the fair value of each class of financial instruments for which it is practicable to estimate fair value. For each of the following items, the fair value is not materially different than the carrying value.
Cash, cash equivalents, accounts payable and accounts receivable. Carrying amounts approximate fair value because of the short maturity of those instruments.
Senior long-term debt. The carrying amount of the Company’s senior debt approximates fair value, estimated based on current rates offered to the Company for debt of the same remaining maturities, and reflects amounts Alion is contractually required to pay. Senior long-term debt includes the Company’s revolving credit agreement, its Secured Notes and its Unsecured Notes. Senior long-term debt formerly included Alion’s Term B Senior Credit Facility (revolving credit facility and term loan) which the Company extinguished on March 22, 2010.
Subordinated notes and redeemable common stock warrants. Alion used an option pricing model to estimate the fair value of its redeemable common stock warrants. In estimating the Company’s aggregate redeemable common stock warrant liability, Management considered factors such as risk free interest rates; share price volatility of comparable publicly traded companies; information in the valuation report prepared for the ESOP Trustee; and the share price selected by the ESOP Trustee. The only market for the Company’s subordinated debt consisted of principal to principal transactions. The Company carried its subordinated notes at amortized cost. On March 22, 2010, Alion extinguished the Subordinated Note and related warrants. On the same date, the Company issued new warrants when it issued new senior secured notes. The new warrants qualify as equity and are not subject to fair value measurement or reporting.

 

9


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Redeemable Alion common stock. Management estimates the fair value price per share of Alion common stock by considering in part the most recent price at which the Company was able to sell shares to the ESOP Trust as well as information contained in the most recent valuation report that an independent, third-party firm prepares for the ESOP Trustee.
Recently Issued Accounting Pronouncements
Accounting Standards Update 2009-13 (ASU 2009-13) Revenue Recognition — Multiple Deliverable Revenue Arrangements was issued in October 2009 and updates ASC 605 — Revenue Recognition. ASU 2009-13 removes the objective-and-reliable-evidence-of-fair-value criterion from the separation criteria used to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting; replaces references to “fair value” with “selling price” to distinguish from the fair value measurements required under the “Fair Value Measurements and Disclosures” guidance; provides a hierarchy that entities must use to estimate the selling price; eliminates the use of the residual method for allocation; and expands the ongoing disclosure requirements. ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010, and can be applied prospectively or retrospectively. The Company is currently evaluating the effect, if any, that adopting ASU 2009-13 will have on its consolidated financial position and results of operations.
Accounting Standards Update 2009-14 (ASU 2009-14) Certain Revenue Arrangements That Include Software Elements was issued in October 2009 and updates ASC 985 — Software — Revenue Recognition. ASU 2009-14 clarifies which accounting guidance should be used to measure and allocate revenue for arrangements that contain both tangible products and software, where the software is more than incidental to the tangible product as a whole. ASU 2009-14 is effective for fiscal years beginning on or after June 15, 2010 and applies to arrangements entered into or materially modified on or after that date. The Company is currently evaluating the effect, if any, that adopting ASU 2009-14 will have on its consolidated financial position and results of operations.
(3) Employee Stock Ownership Plan (ESOP) and ESOP Trust
In December 2001, the Company adopted the Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan (the Plan) and the ESOP Trust. The Plan, a tax qualified retirement plan, includes ESOP and non-ESOP components. In April 2010, the Internal Revenue Service (IRS) issued a determination letter that the ESOP Trust and the Plan, as amended and restated as of October 1, 2006, and including amendments to the Plan executed in June 2009 and May 2010, qualify under Sections 401(a) and 501(a) of the Internal Revenue Code of 1986 as amended (the IRC). In August 2008, Alion amended the Trust Agreement between the Company and the ESOP Trust. Alion believes that the Plan and the ESOP Trust have been designed and are being operated in compliance with the applicable IRC requirements.
(4) Earnings (Loss) Per Share
Basic and diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding excluding the impact of warrants and phantom stock. Even after including required adjustments to the earnings per share numerator, the warrants and phantom stock are anti-dilutive for all periods presented. The Company’s 1,630,437 Subordinated Note warrants were outstanding for all of 2009 and up through March 22, 2010 when they were extinguished. Also on March 22, 2010, Alion issued 310,000 Units that include the Secured Notes and warrants to purchase 602,614 shares of Alion common stock The Secured Note warrants have a penny per share exercise price, are exercisable beginning March 22, 2011 and expire March 15, 2017. The Secured Note warrants are not redeemable and do not have price protection; they are classified as permanent equity.
(5) Redeemable Common Stock Owned by ESOP Trust
The ESOP Trust owns all of Alion’s issued and outstanding common stock, for the benefit of current and former employee participants in the Alion KSOP. Participants and beneficiaries are entitled to a distribution of the fair value of their vested ESOP account balance upon death, disability, retirement or termination of employment. The Plan permits distributions to be paid over a five year period commencing the year after a participant’s retirement at age 65, death or disability. Alion can delay distributions to other terminating participants for five years before commencing payment over a subsequent five year period.

 

10


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Because Alion is now a C-corporation, terminating ESOP participants have the right to hold or immediately sell their distributed shares to the Company. If a participant elects to hold distributed shares, the IRC and ERISA require that Alion provide a put option to permit a recipient to sell the stock to the Company at the estimated fair value price per share based on the most recent price at which the Company was able to sell shares to the ESOP Trust ($28.00 at March 31, 2010 and $34.50 at September 30, 2009). The put right requires the Company to purchase distributed shares during two put option periods at the then current fair market value. Consistent with its duty of independence from Alion Management and its fiduciary responsibilities, the ESOP Trustee retains an independent third party valuation firm to assist it in determining the fair market value (share price) at which the Trustee may acquire or dispose of investments in Alion common stock. The Audit and Finance Committee of Alion’s Board of Directors reviews the reasonableness of the liability for outstanding redeemable common stock that Management has determined is appropriate for the Company to recognize in its financial statements. The Audit and Finance Committee considers various factors in its review, including in part, the valuation report and the share price selected by the ESOP Trustee. Management considers the share price selected by the ESOP Trustee along with other factors, to assist in estimating Alion’s aggregate liability for outstanding redeemable common stock owned by the ESOP Trust. Certain participants who beneficially acquired shares of Alion common stock on December 20, 2002, have the right to sell such shares distributed from their accounts at the greater of the then current estimated fair value per share or the original $10.00 purchase price.
Although the Company and the ESOP retain the right to delay distributions consistent with the terms of the Plan, and to control the circumstances of future distributions, eventual redemption of shares of Alion common stock is deemed to be outside the Company’s control.
The Company makes 401(k) matching contributions in shares of Alion common stock and discretionary profit-sharing contributions in a combination of Alion common stock and cash. The Company matches the first 3% and one-half of the next 2% of eligible employee salary deferrals by contributing shares of Alion common stock to the ESOP Trust on March 31 and September 30 each year. The Company also makes a profit sharing contribution of Alion common stock to the ESOP Trust on the same dates equal to 1% of eligible employee compensation. Each pay period the Company makes a cash contribution to the non-ESOP component of the KSOP equal to 1.5% of eligible employee compensation. Alion recognized $3.3 million and $3.7 million in compensation expense for the KSOP for the quarters ended June 30, 2010 and 2009, and $10.4 million for the nine months ended June 30, 2010 and 2009.
(6) Accounts Receivable
Accounts receivable at June 30, 2010 and September 30, 2009 consisted of the following:
                 
    June 30,     September 30,  
    2010     2009  
    (In thousands)  
Billed receivables
  $ 91,242     $ 108,566  
Unbilled receivables:
               
Amounts currently billable
    34,429       22,954  
Revenues recorded in excess of milestone billings on fixed price contracts
    4,572       3,757  
Revenues recorded in excess of estimated contract value or funding
    31,867       36,327  
Retainages and other amounts billable upon contract completion
    13,027       12,972  
Allowance for doubtful accounts
    (3,809 )     (4,419 )
 
           
Total Accounts Receivable
  $ 171,328     $ 180,157  
 
           
Revenue recorded in excess of milestone billings on fixed price contracts is not yet contractually billable. Amounts currently billable consist principally of amounts to be billed within the next year. Any remaining unbilled balance including retainage is billable upon contract completion or completion of Defense Contract Audit Agency (DCAA) audits. Revenue recorded in excess of contract value or funding is billable upon receipt of contractual amendments or other modifications. Contract revenue recognized in excess of billings totaled approximately $83.9 million as of June 30, 2010 and included approximately $31.9 million for customer-requested work for which the Company had not received contracts or contract modifications. In keeping with industry practice, Alion classifies all contract-related accounts receivable as current assets based on contractual operating cycles which frequently exceed one year. Unbilled receivables are expected to be billed and collected within one year except for $13.0 million at June 30, 2010.

 

11


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(7) Property, Plant and Equipment
                 
    June 30,     September 30,  
    2010     2009  
    (In thousands)  
Leasehold improvements
  $ 11,034     $ 10,214  
Equipment and software
    33,414       32,807  
 
           
Total cost
    44,448       43,021  
Less: accumulated depreciation and amortization
    (32,385 )     (28,547 )
 
           
Net Property, Plant and Equipment
  $ 12,063     $ 14,474  
 
           
Depreciation and leasehold amortization expense for fixed assets was approximately $1.3 million and $2.0 million for the quarters ended June 30, 2010 and 2009 and $4.1 million and $5.0 million for the nine months ended June 30, 2010 and 2009.
(8) Goodwill and Intangible Assets
As of June 30, 2010, Alion had approximately $398.9 million in goodwill. There were no changes in the goodwill carrying amount during the current quarter.
Intangible assets consist primarily of contracts acquired through the Anteon and JJMA transactions. The table below shows intangible assets as of June 30, 2010 and September 30, 2009.
                                                 
    June 30, 2010     September 30, 2009  
            Accumulated                     Accumulated        
    Gross     Amortization     Net     Gross     Amortization     Net  
 
                                               
Purchased contracts
  $ 111,635     $ (91,700 )   $ 19,935     $ 111,635     $ (83,563 )   $ 28,072  
Internal use software and engineering designs
    2,155       (1,815 )     340       2,155       (1,568 )     587  
Non-compete agreements
    725       (723 )     2       725       (704 )     21  
 
                                   
Total
  $ 114,515     $ (94,238 )   $ 20,277     $ 114,515     $ (85,835 )   $ 28,680  
 
                                   
The weighted-average remaining amortization period of intangible assets was approximately five years at June 30, 2010 and September 30, 2009. Amortization expense was approximately $2.8 million and $3.1 million for the quarters ended June 30, 2010 and 2009 and $8.4 million and $9.7 million for the nine months ended June 30, 2010 and 2009. Estimated aggregate amortization expense for the next five years and thereafter is as follows.
         
    (In thousands)  
For the remaining three months:
       
2010
  $ 2,582  
For the year ending September 30:
       
2011
    6,843  
2012
    5,766  
2013
    3,246  
2014
    879  
2015
    737  
Thereafter
    224  
 
     
 
  $ 20,277  
 
     

 

12


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(9) Long-Term Debt
Alion’s current debt structure includes a $25 million revolving credit facility, the Secured Notes and the Unsecured Notes. On March 22, 2010, the Company retired its Term B Senior Credit Agreement, its Subordinated Note and the Subordinated Note Warrants. The Company is in compliance with each of the affirmative and negative financial and non-financial covenants in its existing debt agreements.
Credit Agreement
On March 22, 2010, the Company entered into a new Credit Agreement (Credit Agreement), which consists of a $25.0 million senior revolving credit facility (Revolver) none of which was actually drawn as of June 30, 2010.
Under the Credit Agreement, Alion may request up to $10.0 million in letters of credit and may borrow up to $5.0 million in swing line loans for short-term borrowing needs. The Company must pay all principal obligations under the Credit Agreement in full no later than August 22, 2014.
The Credit Agreement permits Alion to use the Revolver for working capital, other general corporate purposes, and to finance permitted acquisitions.
Security. The Credit Agreement is secured by a first priority security interest in all current and future tangible and intangible property of Alion and its guarantor subsidiaries, HFA, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation. On March 22, 2010 Alion and the subsidiary guarantors entered into an Intercreditor Agreement with Wilmington Trust Company and Credit Suisse AG, Cayman Islands Branch (Intercreditor Agreement). Under the Intercreditor Agreement, Credit Agreement lenders have a super priority right of payment with respect to the underlying collateral, which is superior to the Secured Note lenders’ rights.
Guarantees. The Company’s obligations under the Credit Agreement are guaranteed by the Company’s subsidiaries, HFA, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation. These subsidiaries also guarantee all of the Company’s obligations under the Secured Notes and Unsecured Notes (each described below). Formerly, only HFA, CATI, METI, JJMA, BMH, WCI and MA&D were guarantors.
Interest and Fees. Alion can choose whether the Revolver bears interest at one of two floating rates using either a Eurodollar rate or an alternative base rate. The minimum interest rate on the Revolver is 9.50%. The Eurodollar interest rate is 600 basis points plus a 3.5% minimum interest rate. The alternate base rate is 500 basis points plus a 4.5% minimum interest rate.
Other Fees and Expenses. Each quarter Alion is required to pay a commitment fee of 175 basis points per year on the prior quarter’s daily unused Revolver balance. The Company paid approximately $112 thousand in commitment fees for the Revolver for the quarter ended June 30, 2010 and $210 thousand this year.
Alion must pay letter-of-credit issuance and administrative fees, and up to a 25 basis point fronting fee. Each quarter Alion must also pay interest in arrears for all outstanding letters of credit. The interest rate is based on the Eurodollar loan rate which was 6.0% as of June 30, 2010. The Credit Agreement also requires the Company to pay an annual agent’s fee.
Covenants. The Credit Agreement requires the Company to achieve the following minimum trailing twelve month Consolidated EBITDA levels for the periods indicated below:
         
Period   Minimum Consolidated EBITDA  
June 30, 2010 through March 31, 2011
  $52.5 million
April 1, 2011 through September 30, 2011
  $55.0 million
October 1, 2011 through September 30, 2012
  $60.0 million
October 1, 2012 through September 30, 2013
  $62.5 million
Thereafter
  $65.0 million

 

13


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Consolidated EBITDA is defined as: (a) net income (or loss), as defined therein; plus (b) the following items, without duplication, to the extent deducted from net income or included in the net loss, the sum of: (i) consolidated interest expense; (ii) provision for income taxes; (iii) depreciation and amortization, including amortization of other intangible assets; (iv) cash contributions to the ESOP in respect of the repurchase liability of the Company under the ESOP Plan; (v) any non-cash charges or expenses including (A) non-cash expenses associated with the recognition of the difference between the fair market value of the (now extinguished Subordinate Note) Warrants and the exercise price of the Warrants, (B) non-cash expenses with respect to the stock appreciation rights and phantom stock plans, and the Warrants and accretion of the Warrants and (C) non-cash contributions to the ESOP; (vi) any extraordinary losses and (vii) any nonrecurring charges and adjustments by third-party valuation firm that prepares valuation reports in connection with the ESOP; minus (c) without duplication, (i) all cash payments made on account of reserves, restructuring charges and other non-cash charges added to net income (or included in net loss) pursuant to clause (b)(v) above in a previous period and (ii) to the extent included in net income (or net loss), any extraordinary gains and all non-cash items of income, in accordance with GAAP.
Secured Notes
On March 22, 2010, Alion issued and sold $310 million of its private units (Units) to Credit Suisse, which informed the Company it had resold most of the units to qualified institutional buyers. Each of the 310,000 Units sold consisted of $1,000 in face value of Alion private 12% senior secured notes (Secured Notes) and a warrant to purchase 1.9439 shares of Alion common stock.
Security. The Secured Notes are secured by a first priority security interest in all current and future tangible and intangible property of Alion and its guarantor subsidiaries, HFA, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation. The Secured Notes are senior obligations of Alion and rank pari passu in right of payment with existing and future senior debt, including the Credit Agreement, except to the extent that the Intercreditor Agreement provides Credit Agreement lenders with a super priority right of payment with respect to the underlying collateral.
Guarantees. The Company’s obligations under the Secured Notes are guaranteed by the Company’s subsidiaries, HFA, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation.
Interest and Fees. The Secured Notes bear interest at 12% per year; 10% is payable in cash and 2% increases the Secured Note principal (PIK Interest). Interest is payable semi-annually in arrears on May 1 and November 1. Alion pays interest to holders of record as of the immediately preceding April 15 and October 15. The Company must pay interest on overdue principal or interest at 13% per annum to the extent lawful. The Secured Notes mature November 1, 2014.
Unsecured Notes
On February 8, 2007, Alion issued and sold $250.0 million of private 10.25% unsecured notes due February 1, 2015 (Unsecured Notes) to Credit Suisse, which informed the Company it had resold most of the notes to qualified institutional buyers. On June 20, 2007, Alion exchanged the private Unsecured Notes for publicly tradable Unsecured Notes with the same terms.
Guarantees. Alion’s obligations under the Unsecured Notes are guaranteed by the Company’s subsidiaries, HFA, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation.
Interest and Fees. The Unsecured Notes bear interest at 10.25% per year, payable semi-annually in arrears on February 1 and August 1. Alion pays interest to holders of record as of the immediately preceding January 15 and July 15. The Company must pay interest on overdue principal or interest at 11.25% per annum to the extent lawful.
Retired Term B Senior Credit Agreement
In August 2004, Alion entered into the Term B Senior Credit Agreement with a syndicate of financial institutions. The Company borrowed and re-paid various sums over the life of the loan. As of March 22, 2010, the Term B Senior Credit Agreement consisted of a $236.0 million senior term loan, a $25.0 million senior revolving credit facility with no balance actually drawn, and approximately $4.0 million in accrued interest payable. On March 22, 2010, the Company used proceeds from issuing the Units to redeem and retire all amounts outstanding under the Term B Senior Credit Agreement including all accrued and unpaid interest. Alion recognized a $6.9 million loss on extinguishing the Term B loans.

 

14


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
As a cost of the consents and waivers the Company obtained from its lenders in September and December 2009, the annual interest rate on the outstanding Term B loan balances increased by 100 basis points on February 1, 2010 and the Company paid the Term B lenders a 100 basis point penalty on March 1, 2010. Management had originally expected to close a re-financing transaction prior to the penalty payment due date and therefore the Company only recorded penalty-related interest when paid.
Retired Subordinated Note
In December 2002, Alion issued a $39.9 million Subordinated Note to IITRI as part of the purchase price for substantially all of IITRI’s assets. In July 2004, IIT acquired the Subordinated Note and related warrant agreement from IITRI. Over the life of the Subordinated Note, IIT and Alion amended its terms to adjust interest accrual rates, timing and payments and to revise the loan amortization schedule.
Through December 2008, Subordinated Note interest was payable quarterly in arrears by issuing paid-in-kind (PIK) notes maturing at the same time as the Subordinated Note. The interest rate was 6.0% from December 2002 through December 2006; approximately 6.4% from December 2006 to December 2007; and approximately 6.7% from December 2007 to December 2008. Beginning December 2008, interest was payable at 10% for PIK notes and 6% in cash with all notes due August 2013. PIK notes deferred most Subordinated Note interest until maturity.
On December 21, 2009, IIT agreed to sell Alion the Subordinated Note and warrants for $25 million and to defer Alion’s January 2010 interest payment to April 2010. On March 22, 2010, the Company used $25 million of the proceeds from issuing the Units to redeem the Subordinated Note and related warrants held by IIT. Alion recognized a $57.6 million gain on retiring the Subordinated Note and warrants. The Subordinated Note had an aggregate carrying value of $50.0 million ($60.1 million of principal, PIK and accrued interest net of $10.1 million in unamortized debt issue and loan modification costs). The warrants had an estimated fair value of $32.6 million. The Company was not required to make the deferred January interest payment and de-recognized the related interest expense.
Interest Payable
Interest Payable consisted of the following balances:
                 
    June 30,     September 30,  
    2010     2009  
    (In thousands)  
Unsecured Notes
  $ 10,677     $ 4,271  
Secured Notes
    5,183        
Senior Term Loan
          3,975  
Subordinated Note Payable
          793  
 
           
Total
  $ 15,860     $ 9,039  
 
           
As of June 30, 2010, Alion must make the following principal repayments (at face amount before debt discount) for its outstanding debt.
                                                         
Fiscal Year:   2010     2011     2012     2013     2014     2015     Total  
 
                                                       
Secured Notes and PIK Interest(1)
  $     $     $     $     $     $ 339,788     $ 339,788  
Unsecured Notes(2)
                                  250,000       250,000  
 
                                         
Total Principal Payments
  $     $     $     $     $     $ 589,788     $ 589,788  
 
                                         
     
1.   The Secured Notes due in 2015 include $310 million of debt issued in March 2010 and an estimated $29.8 million in PIK interest added to principal over the life of the notes. As of June 30, 2010, the $272.1 million carrying value on the face of the balance sheet included $310 million in principal, $1.7 million in accrued PIK interest and is net of $39.6 million in aggregate unamortized debt issue costs. Initial debt issue costs consist of $7.7 million in original issue discount, $13.5 million in third-party costs and $20.8 million for the initial fair value of the new Secured Note warrants.
 
2.   The Unsecured Notes on the face of the balance sheet include $250 million in principal and $4.1 million in unamortized debt issue costs as of June 30, 2010 (initially $7.1 million).

 

15


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(10) Fair Value Measurement
The Company adopted ASC 805 — Fair Value Disclosures in fiscal year 2009 for all financial assets and liabilities recognized or disclosed at fair value in the financial statements. The Company adopted the provisions of ASC 805 for nonfinancial assets and liabilities recognized or disclosed at fair value in the financial statements on a recurring basis; no such assets or liabilities exist at the balance sheet date. The Company implemented ASC 805 this year for all nonfinancial assets and liabilities recognized or disclosed at fair value in the financial statements on a nonrecurring basis. Adopting ASC 805 for items such as goodwill and long lived assets measured at fair value if impaired, did not materially affect the Company’s consolidated financial statements or results of operations.
ASC 805 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. It establishes a fair value hierarchy and a framework which requires categorizing assets and liabilities into one of three levels based on the assumptions (inputs) used in valuing the asset or liability. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. Level 1 inputs are unadjusted, quoted market prices in active markets for identical assets or liabilities. Level 2 inputs are observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets. Level 3 inputs include unobservable inputs that are supported by little, infrequent, or no market activity and reflect management’s own assumptions about inputs used in pricing the asset or liability. The Company uses the following valuation techniques to measure fair value.
Level 1 primarily consists of financial instruments, such as overnight bank re-purchase agreements or money market mutual funds whose value is based on quoted market prices published by a financial institution, an exchange fund, exchange-traded instruments and listed equities.
Level 2 assets include U.S. Government and agency securities whose valuations are based on market prices from a variety of industry-standard data providers or pricing that considers various assumptions, including time value, yield curve, volatility factors, credit spreads, default rates, loss severity, current market and contractual prices for the underlying instruments, and broker and dealer quotes. All are observable in the market or can be derived principally from or corroborated by observable market data for which the Company can obtain independent external valuation information.
Level 3 consists of unobservable inputs. The Company’s former Subordinated Note warrants were classified as Level 3 liabilities. Assets and liabilities are considered Level 3 when their fair value inputs are unobservable or not available, including situations involving limited market activity, where determination of fair value requires significant judgment or estimation.
At March 22, 2010, Alion measured the fair value of the Secured Note warrants at issuance based on the $34.50 underlying estimated fair value of a share of Alion common stock as of September 30, 2009, the then most-recent valuation selected by the ESOP Trustee and presented to the Board of Directors; a 3.39% risk-free U.S. Treasury interest rate for a comparable seven-year investment period and a 36% equity volatility factor based on the historical volatility of the common stock of publicly-traded companies considered to be comparable to Alion. The Secured Note warrants are classified as permanent equity and are carried at the historical date-of-issue fair value. As permanent equity, the value of the Secured Note warrants is not re-measured at future reporting dates.
The Company froze the estimated fair value of its to-be retired Subordinated Note Warrants at their reported value as of December 2009 when IIT agreed to sell the Subordinated Note and Warrants to Alion. On March 22, 2010, the Company de-recognized its December 2009 Subordinated Note Warrant liability when it re-purchased the Subordinated Note and related Warrants from IIT.

 

16


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
At June 30, 2010, the Company had no outstanding assets or liabilities required to be reported at fair value. Valuation techniques utilized in the fair value measurement of assets and liabilities presented on the Company’s balance sheet for each period presented were unchanged from previous practice during the reporting period.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table presents information about the Company’s financial assets and financial liabilities that are measured at fair value on a recurring basis as of September 30, 2009, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value. As of June 30, 2010, the Company had no assets or liabilities it was required to measure at fair value on a recurring basis.
                         
    Level 1     Level 2     Level 3  
Liabilities: as of September 30, 2009
               
Redeemable common stock warrants
                (32,557 )
 
                 
Liabilities: as of September 30, 2009
  $     $     $ (32,557 )
 
                 
The table below provides a summary of the changes in fair value of all financial liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for June 30, 2010 and 2009.
                 
    As of June 30,  
    2010     2009  
    Redeemable Common Stock  
    Warrants  
Balance, beginning of period
  $ (32,557 )   $ (39,996 )
Total realized and unrealized gains and (losses)
    14,724        
Included in interest expense
    (160 )     6,738  
Issuances and settlements
    17,993        
 
           
Balance, end of period
  $     $ (33,258 )
 
           
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The Company’s investment in VectorCommand is tested annually for impairment and is not adjusted to market value at the end of each reporting period. Fair value would only be determined on a nonrecurring basis if this investment were deemed to be other-than-temporarily impaired. The Company has not recorded any other-than-temporary impairments to its VectorCommand investment during the reporting period.
(11) Interest Rate Swap
In January 2008, Alion executed an interest rate swap with one of its lenders to convert floating rate interest payable on a portion of its Senior Term Loan to a fixed rate, and to adjust timing of some Senior Term Loan net interest payments. The swap agreement notional principal was $240 million. The swap expired in November 2008. The Company made its final semi-annual interest payment November 1, 2008. Alion received quarterly floating rate interest payments in February and May at 7.32% and in August and November 2008 at 5.49%. Alion paid interest semi-annually in May and November 2008 at 6.52%. All swap payments were net cash settled.

 

17


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(12) Redeemable Common Stock Warrants
Alion used an option pricing model to estimate the fair value of its now-retired redeemable common stock warrants. Management considered the share price selected by the ESOP Trustee along with other factors, to assist in estimating the Company’s aggregate liability for outstanding redeemable common stock warrants. The Audit and Finance Committee of Alion’s Board of Directors reviewed the reasonableness of the warrant liability Management determined was appropriate for the Company to recognize. The Audit and Finance Committee considered various factors in its review, including risk free interest rates, volatility of the common stock of comparable publicly traded companies, and in part, the valuation report prepared for and the share price selected by the ESOP Trustee.
In December 2002, the Company issued 1,080,437 detachable, redeemable common stock warrants at an exercise price of $10.00 per share. Alion issued the warrants to IITRI in connection with the Subordinated Note. The Company recognized approximately $7.1 million for the initial fair value of the warrants as original issue debt discount to the $39.9 million face value of the Subordinated Note. The Subordinated Note warrants were originally exercisable until December 2010. In June 2004, IITRI transferred the warrants to IIT.
In August 2008, Alion issued an additional 550,000 redeemable common stock warrants at an exercise price of $36.95 per share. The Company issued the second set of warrants to IIT in connection with the Subordinated Note amendment. The Company recognized approximately $10.3 million in debt issue costs for the fair value of the August 2008 warrants and the amendment to the December 2002 warrants. Both sets of warrants were exercisable at the current fair value per share of Alion common stock, less the exercise price. On March 22, 2010, the Company retired the Subordinated Note and the related warrants for the aggregate price of $25 million and recognized a net gain of $57.6 million.
In accordance with ASC 815 — Derivatives, Alion classified the Subordinated Note warrants as debt instruments indexed to and potentially settled in the Company’s own stock and not as equity.
(13) Secured Note Common Stock Warrants
On March 22, 2010, Alion issued 310,000 Units. Each Unit consists of $1,000 of Secured Note face value and a warrant to purchase 1.9439 shares of Alion common stock. The Secured Note warrants entitle holders to purchase a total of 602,614 shares of Alion common stock. Each Secured Note warrant has an exercise price of a penny per share; the Secured Note warrants are not redeemable for cash.
The Company agreed to register the Secured Notes, but is not required to register the warrants. The Units separated into Secured Notes and warrants on June 22, 2010. Each warrant will become exercisable on March 22, 2011 and expires on March 15, 2017.
The Secured Note warrants had an initial fair value of approximately $20.8 million based on Alion’s former share price of $34.50. Alion recognized the value of the warrants as part of the debt issue costs for the Secured Notes and recorded the corresponding credit to equity. The Company accounts for the Secured Note warrants as equity and must reassess this classification each reporting period. The Company identified no required changes in accounting treatment as of June 30, 2010.
(14) Leases
Future minimum lease payments under non-cancelable operating leases for buildings, equipment and automobiles at June 30, 2010 are set out below. Under these operating leases, Alion subleased some excess capacity to subtenants under non-cancelable operating leases. In connection with certain acquisitions, Alion assumed operating leases at above-market rates; recorded loss accruals of approximately $4.9 million based on the estimated fair value of the lease liabilities assumed; and is amortizing these amounts over the lease terms. The remaining unamortized loss related to these acquisitions was $232 thousand at June 30, 2010. Alion also acquired a related sublease pursuant to which it received above-market rates. Based on the estimated fair value of the sublease, Alion recognized an asset of $586 thousand and fully amortized it over the lease term.

 

18


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
         
Lease Payments for Fiscal Years Ending   (In thousands)  
2010 (for the remainder of fiscal year)
  $ 7,062  
2011
    26,718  
2012
    22,804  
2013
    21,321  
2014
    14,835  
2015
    14,688  
And thereafter
    23,872  
 
     
Gross lease payments
  $ 131,300  
Less: non-cancelable subtenant receipts
    (2,891 )
 
     
Net lease payments
  $ 128,409  
 
     
Composition of Total Rent Expense
                 
    June 30,  
    2010     2009  
    (In thousands)  
Minimum rentals
  $ 16,789     $ 19,494  
Less: Sublease rental income
    (1,378 )     (2,189 )
 
           
Total rent expense, net
  $ 15,411     $ 17,305  
 
           
(15) Long Term Incentive Compensation Plan
In December 2008, Alion adopted a long-term incentive compensation plan to provide cash compensation to certain executives. Grants under the plan to individuals contain specific financial and other performance goals and vest over varying time periods. Some grants are for a fixed amount; others contain provisions that provide for a range of compensation from a minimum of 50% to a maximum of 150% of an initial grant amount. The Company periodically evaluates the probability of individuals meeting the financial and other performance goals in grant agreements. Management estimates long term incentive compensation expense based on the stated amounts of outstanding grants, estimated probability of achieving stated performance goals and estimated probable future grant value. The Company recognized $2.3 million in long term incentive compensation expense for the quarter ended June 30, 2010 and $3.5 million year to date. In 2009, Alion recognized long term incentive compensation expense of $924 thousand in the third quarter and $2.8 million year to date.
(16) Stock Appreciation Rights
As of June 30, 2010, Alion had granted 1,445,510 SARs to employees under the 2004 SAR plan. Compensation expense was $26 thousand and $374 thousand for the quarters ended June 30, 2010 and 2009. For the nine months ended June 30, 2010 and 2009, the Company recognized a credit to compensation expense of approximately $853 thousand and $772 thousand.
The ESOP Trustee, consistent with its duty of independence from Alion management and its fiduciary responsibilities, retains an independent third party valuation firm to assist it in determining the fair market value (share price) at which the Trustee may acquire or dispose of investments in Alion common stock. Management considers the share price selected by the ESOP Trustee along with other factors such as risk free interest rates and volatility, to assist in estimating Alion’s aggregate liability for outstanding stock appreciation rights. The Audit and Finance Committee of Alion’s Board of Directors reviews the reasonableness of the liability for outstanding stock appreciation rights that Management has determined is appropriate for the Company to recognize in its financial statements. The Audit and Finance Committee considers risk free interest rates, volatility and various other factors in its review, including in part, the most recent valuation report and the related share price selected by the ESOP Trustee.

 

19


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The table below sets out the disclosures required by ASC 718 — Stock Compensation and the assumptions used to value a share of Alion common stock and the Company’s SAR grants as of June 30, 2010 and September 30, 2010. Alion uses a Black-Scholes-Merton option pricing model to recognize compensation expense. Alion uses the fair market value of a share of its common stock to recognize expense for all grants. There is no established public trading market for Alion’s common stock. The ESOP Trust is the only holder of our common stock. Alion does not expect to pay any dividends on its common stock and intends to retain future earnings, if any, for use in the operation of its business.
Stock-based Compensation Disclosure per ASC 718
Stock Appreciation Rights
As of June 30, 2010
                         
    Shares              
    Granted to     Exercise     Outstanding  
Date of Grant   Employees     Price     at 9/30/09  
February 2005
    165,000     $ 19.94       71,150  
March 2005
    2,000     $ 19.94       2,000  
April 2005
    33,000     $ 29.81       18,000  
June 2005
    2,000     $ 29.81       2,000  
December 2005
    276,675     $ 35.89       175,284  
February 2006
    13,000     $ 35.89       7,750  
February 2006
    7,500     $ 35.89       2,500  
May 2006
    7,000     $ 37.06       6,000  
July 2006
    15,000     $ 37.06       10,000  
October 2006
    2,500     $ 41.02       2,500  
December 2006
    238,350     $ 41.02       171,500  
February 2007
    33,450     $ 41.02       21,700  
May 2007
    2,000     $ 43.37       2,000  
September 2007
    2,000     $ 43.37       2,000  
December 2007
    232,385     $ 40.05       187,740  
April 2008
    2,000     $ 41.00       2,000  
September 2008
    2,000     $ 41.00       2,000  
December 2008
    203,250     $ 38.35       189,875  
April 2009
    1,000     $ 34.30       1,000  
May 2010
    205,400       28.00        
 
                   
 
                       
Total
    1,445,510               876,999  
 
                   
Weighted Average Exercise Price
  $ 34.82             $ 37.07  

 

20


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Stock-based Compensation Disclosures per ASC 718
Stock Appreciation Rights
As of June 30, 2010
                                                 
    Outstanding                             Vested at     Exercisable  
Date of Grant   at 06/30/10     Forfeited     Exercised     Expired     06/30/10     at 06/30/10  
February 2005
                71,150                    
March 2005
                2,000                    
April 2005
                4,000       14,000              
June 2005
                      2,000              
December 2005
    163,584       412       11,288             163,584        
February 2006
    7,750                         7,750        
February 2006
    1,250             1,250             1,250        
May 2006
    6,000                         6,000        
July 2006
    8,000       500       1,500             8,000        
October 2006
    2,500                         1,875        
December 2006
    159,280       3,492       8,728             119,460        
February 2007
    20,300       475       925             15,225        
May 2007
    2,000                         1,500        
September 2007
    2,000                         1,000        
December 2007
    173,240       7,713       6,787             86,620        
April 2008
    2,000                         1,000        
September 2008
    2,000                         500        
December 2008
    174,000       12,631       3,244             43,500        
April 2009
    1,000                         250        
May 2010
    204,400       1,000                              
 
                                   
Total
    929,304       26,223       110,872       16,000       457,514        
 
                                   
 
                                               
Weighted Average Exercise Price
  $ 36.47     $ 38.80     $ 25.94     $ 29.81     $ 38.54        

 

21


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Stock-based Compensation Disclosures per ASC 718
Stock Appreciation Rights
As of June 30, 2010
                                                 
                                    Expected     Remaining  
Date of Grant   Risk Free Interest Rate     Volatility     Life     Life (months)  
February 2005
    3.10 %           3.60 %     45 %   4 yrs      
March 2005
    3.10 %           3.60 %     45 %   4 yrs      
April 2005
    4.10 %           4.20 %     45 %   4 yrs      
June 2005
    4.10 %           4.20 %     45 %   4 yrs      
December 2005
    4.20 %           4.20 %     40 %   4 yrs      
February 2006
    4.20 %           4.20 %     40 %   4 yrs      
February 2006
    4.20 %           4.20 %     40 %   4 yrs      
May 2006
    4.82 %           4.83 %     35 %   4 yrs      
July 2006
    4.82 %           4.83 %     35 %   4 yrs      
October 2006
    4.82 %           4.83 %     35 %   4 yrs     3.8  
December 2006
    4.54 %           4.58 %     35 %   4 yrs     5.8  
February 2007
    4.54 %           4.58 %     35 %   4 yrs     7.8  
May 2007
    4.54 %           4.58 %     35 %   4 yrs     10.7  
September 2007
    4.54 %           4.54 %     35 %   4 yrs     14.1  
December 2007
    4.23 %           4.23 %     35 %   4 yrs     17.8  
April 2008
    4.23 %           4.23 %     35 %   4 yrs     21.9  
September 2008
    4.23 %           4.23 %     35 %   4 yrs     26.5  
December 2008
    4.23 %           4.23 %     35 %   4 yrs     29.8  
April 2009
    4.23 %           4.23 %     35 %   4 yrs     33.4  
May 2010
    4.23 %             4.23 %     35 %   4 yrs     46.4  
 
                                             
Weighted Average Remaining Life (months)
                                            20.5  
(17) Phantom Stock Plans
As of June 30, 2010, Alion had granted 20,779 shares of phantom stock under its Director Phantom Stock Plan. In December 2009, all shares granted but not yet payable under the Initial and Second Phantom Stock Plans were forfeited. The Company recognized approximately $7 thousand and $37 thousand in phantom stock plan compensation expense for the quarters ended June 30, 2010 and 2009. Compensation expense was $21 thousand for the nine months ended June 30, 2010. For the nine months ended June 30, 2009, the Company recognized a $4.6 million credit to compensation expense for phantom stock forfeitures.
The ESOP Trustee, consistent with its duty of independence from Alion management and its fiduciary responsibilities, retains an independent third party valuation firm to assist it in determining the fair market value (share price) at which the Trustee may acquire or dispose of investments in Alion common stock. Management independently estimates the value of a share of common stock by considering, in part, the most recent price at which the Company was able to sell shares to the ESOP Trust. In addition to the share price selected by the ESOP Trustee, Management considers other factors such as risk free interest rates and volatility, to assist in estimating Alion’s aggregate liability for outstanding phantom stock grants that remain subject to share price fluctuations. Only phantom stock grants to non-employee members of Alion’s Board of Directors remain outstanding. No grants to executives remain outstanding.
The Audit and Finance Committee of Alion’s Board of Directors reviews the reasonableness of the liability for outstanding phantom stock grants rights that Management has determined is appropriate for the Company to recognize in its financial statements. The Audit and Finance Committee considers various factors in its review, including in part, the most recent valuation report and the related share price selected by the ESOP Trustee.

 

22


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The table below sets out the disclosures required by ASC 718 — Stock Compensation and the assumptions used to value a share of Alion common stock and the Company’s phantom stock grants as of June 30, 2010 and September 30, 2009. Alion uses a Black Scholes Merton option pricing model to recognize compensation expense. Alion uses the fair market value of a share of its common stock to recognize expense for all grants; therefore no additional disclosures are required for these grants. There is no established public trading market for Alion’s common stock. The ESOP Trust is the only holder of our common stock. Alion does not expect to pay any dividends on its common stock and intends to retain future earnings, if any, for use in the operation of its business.
Stock-based Compensation Disclosure per ASC 718
Director Phantom Stock Plan
as of June 30, 2010
                                 
                    Grant        
            Total     Date        
    Shares     Shares     Share     Outstanding  
Date of Grant   Granted     Granted     Price     at 9/30/09  
 
                               
November 2006
    5,978       5,978       41.02       4,839  
November 2007
    6,993       6,993       40.05       5,994  
 
                         
Total
    12,971       12,971               10,833  
 
                         
 
                               
Weighted Average Grant Date Fair Value Price Per Share
  $ 40.50     $ 40.50             $ 40.48  
Stock-based Compensation Disclosure per ASC 718
Director Phantom Stock Plan
as of June 30, 2010
                                                 
    Outstanding                             Vested at     Exercisable  
Date of Grant   at 06/30/10     Forfeited     Exercised     Expired     6/30/10     at 06/30/10  
 
                                               
November 2006
                4,839                    
November 2007
    4,995             999             2,664       2,664  
 
                                   
Total
    4,995             5,838             2,664       2,664  
 
                                   
 
                                               
Weighted Average Grant Date Fair Value Price Per Share
  $ 40.05     $     $ 40.85     $     $ 40.05     $ 40.05  
Stock-based Compensation Disclosure per ASC 718
Director Phantom Stock Plan
as of June 30, 2010
                             
    Risk Free Interest           Expected     Remaining  
Date of Grant   Rate   Volatility     Life     Life (months)  
 
                           
November 2006
  4.54% – 4.58%     35 %   3 yrs      
November 2007
  4.23% – 4.23%     35 %   3 yrs     4.4  
 
                         
Weighted Average Remaining Life
                        4.4  
(18) Segment Information and Customer Concentration
The Company operates in one segment, delivering a broad array of scientific, engineering and information technology expertise to research and develop technological solutions for problems relating to national defense, homeland security, and energy and environmental analysis. Alion provides services to departments and agencies of the federal government and, to a lesser extent, to commercial and international customers. The Company’s federal government customers typically exercise independent contracting authority. Offices or divisions within an agency or department may directly, or through a prime contractor, use the Company’s services as a separate customer so long as that customer has independent decision-making and contracting authority within its organization.

 

23


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Contract receivables from federal government agencies represented approximately $168.1 million, or 96.4%, and $179.7 million, or 97.4%, of accounts receivable as of June 30, 2010 and September 30, 2009. Contract revenue from federal government departments and agencies represented approximately 97.2% and 96.4%, of total contract revenue for the nine months ended June 30, 2010 and 2009.
(19) Income Taxes
Effective March 22, 2010, the Company automatically ceased to qualify as an S-corporation and became a C-corporation subject to income taxation at the federal and state level. The Company’s subsidiaries also terminated their qualified Subchapter S status and will be subject to separate taxation in states that do not follow IRC consolidated tax return guidelines. In connection with issuing its Secured Notes, Alion issued deep-in-the-money warrants considered to constitute a second class of stock in contravention of IRC requirements that an S-corporation have only a single class of stock.
Alion’s new C-corporation status should allow the Company to use anticipated net operating losses (NOL) to offset taxes that may become due in the future if the Company is able to generate future taxable income. The Company’s ability to utilize NOL tax benefits will depend upon the amount of its future taxable income and may be limited under certain circumstances. All of the Company’s prior income tax gains and losses were allocated to its sole shareholder, the tax-exempt ESOP Trust. Notwithstanding the provisions of the recently enacted Worker, Home Ownership and Business Assistance Act of 2009, the Company does not have any net operating loss tax benefits it is permitted to carry back to prior years.
As a result of its tax status change, Alion recorded a deferred tax liability of $33.8 million, a deferred tax asset of $35.4 million and an offsetting valuation allowance of $35.4 million. The net effect of this was to recognize a $33.8 million charge to current earnings for deferred tax expense. The Company’s history of losses gives rise to a presumption that it might not be able to realize the full benefit of any deferred tax assets it is required to recognize. Therefore, the Company established a valuation allowance equal to the deferred tax assets it was required to recognize on becoming a C-corporation. Alion does not expect it will actually have to pay income taxes for several years. Deferred tax liabilities will continue to increase for tax amortization of goodwill. As of June 30, 2010 deferred tax assets were $36.1 million and deferred tax liabilities were $35.6 million. For the quarter ended June 30, 2010, the Company recognized $739 thousand in deferred tax assets and a corresponding valuation allowance. The Company also recognized $1.8 million in deferred tax liabilities for goodwill amortization in the quarter ended June 30, 2010.
Alion had previously adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” now codified as ASC 740, Income Taxes. ASC 740 prescribes a recognition threshold and a measurement attribute for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The Company may recognize a benefit for that amount which it has a more than 50% chance of realizing. If the Company’s position involves uncertainty, then in order to recognize a benefit, a given tax position must be “more-likely-than-not” to be sustained upon examination by taxing authorities. Alion will continue its existing practice of recognizing tax-related interest and penalties separately from income tax expense.
IRC Section 108(i), allows the Company to elect to defer recognizing until fiscal year 2015, the gain on extinguishing its Subordinated Note. The gain on extinguishing the related warrants is not subject to income taxes. Management is currently evaluating whether an election to defer the extinguishment gain for tax purposes will be beneficial to the Company. Although the Company offers post-retirement prescription drug coverage to a limited number of retirees and beneficiaries, Alion has not claimed any federal tax credit in prior years. The recently enacted health care reform legislation has reduced the value of the federal subsidy for retiree drug coverage. Alion’s tax provision is unaffected by this legislative change. Management will decide whether to seek a subsidy in the future based on its anticipated value and the cost associated with seeking the subsidy.
As a result of Alion’s change in tax status, the Company will file two short-year returns for the current fiscal year. Alion will allocate approximately half of current year results to its period as an S-corporation and approximately half to its period as a C-corporation.

 

24


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Alion may become subject to federal or state income tax examination for tax years ending September 2006 through 2008. The Company’s former status as a pass-through entity owned by a tax-exempt trust makes an examination unlikely and the possibility of an adverse determination remote. Prior to its change in status, the Company was at all times a validly electing S corporation.
The provision for income taxes for the nine months ended June 30, 2010 is as follows:
         
    June 30, 2010  
Current:
       
Federal
  $  
State
    (2 )
Foreign
    (40 )
 
     
Total current provision
    (42 )
 
     
 
       
Deferred:
       
Federal
    29,312  
State
    6,303  
Foreign
     
Total deferred provision/(benefit)
    35,615  
 
     
Total provision for income taxes
  $ 35,573  
 
     
Alion’s tax provision at June 30, 2010 includes the effects of state income taxes, debt extinguishment, converting from an S-corporation to a C-corporation and establishing a valuation allowance. The provision for taxes for the nine months ended June 30, 2010 differs from the amount computed by applying the statutory U.S. federal income tax rate to income before taxes as a result of the following:
                 
    June 30, 2010     June 30, 2010  
 
               
Expected federal income tax (benefit)
    35.0 %   $ 8,289  
State taxes (net of federal benefit)
    17.3 %     4,105  
Nondeductible expenses
    0.6 %     150  
Provision to return true-ups
    0.0 %     (2 )
Tax credits
    -0.2 %     (40 )
Deferred tax assets
    -152.4 %     (36,098 )
Valuation allowance
    152.4 %     36,098  
Deferred tax liabilities
    150.4 %     35,615  
Debt extinguishment and tax status change
    -53.0 %     (12,544 )
 
           
Income tax expense (benefit)
    150.2 %   $ 35,573  
 
           
At June 30, 2010 the components of deferred tax assets and deferred tax liabilities were as follows:
         
    June 30, 2010  
Deferred tax assets:
       
Accrued expenses and reserves
  $ 10,576  
Intangible amortization
    13,191  
Deferred rent
    2,591  
Deferred wages
    3,894  
Depreciation and leases
    2,707  
Carryforwards and tax credits
    3,114  
Other
    25  
 
     
Gross deferred tax assets
  $ 36,098  
 
     
Less Valuation
    36,098  
 
     
Net Deferred Tax Assets
  $  
 
     
Deferred tax liabilities:
       
Goodwill
    (35,615 )
 
     
Net deferred tax asset/(liability)
  $ (35,615 )
 
     

 

25


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(20) Debt Extinguishment
On March 22, 2010, Alion sold $310 million in Secured Note Units and used $240 million of the proceeds to pay outstanding interest and principal on the Term B Senior Credit Agreement and $25 million to retire the Subordinated Note and related warrants at a discount. The Company recognized a net gain of $50.7 million on extinguishing its debt. Alion expensed $16.9 million in unamortized debt issue costs; recognized a $53.1 million gain on retiring the Subordinated Note; and recognized a $14.5 million gain on retiring the warrants.
(21) Commitments and Contingencies
Earn-Out and Hold-Back Commitments
The Company has a $500 thousand maximum earn-out commitment through July 2011 for its LogConGroup acquisition.
Legal Proceedings
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect upon the Company’s business, financial position, operating results or ability to meet its financial obligations.
Government Audits
The amount of federal government contract revenue and expense reflected in the consolidated financial statements attributable to cost reimbursement contracts is subject to audit and possible adjustment by DCAA. The federal government considers the Company a major contractor and DCAA maintains an office on site to perform its various audits throughout the year. All the Company’s federal government contract indirect costs have been audited and indirect rates settled through 2004. The Company has recorded federal government contract revenue in amounts it expects to realize on final settlement.
(22) Guarantor/Non-guarantor Condensed Consolidated Financial Information
Certain of Alion’s 100% owned domestic subsidiaries have jointly, severally, fully and unconditionally guaranteed both the Secured Notes and the Unsecured Notes. Alion’s Unsecured Notes are general obligations of the Company. In March 2010, the Unsecured Note Indenture was amended to include as Unsecured Note guarantors all subsidiaries serving as Secured Note guarantors. The financial information set out below includes the effects of adding additional entities as guarantors of the Unsecured Notes and therefore differs from information the Company previously presented as of September 30, 2009 and for the three and nine months ended June 30, 2009.
The following information presents condensed consolidating balance sheets as of June 30, 2010 and September 30, 2009, condensed consolidating statements of operations for the quarters and nine months ended June 30, 2010 and 2009; and condensed consolidating statements of cash flows for the nine months ended June 30, 2010 and 2009 of the parent company issuer, the guarantor subsidiaries and the non-guarantor subsidiaries. Investments include investments in subsidiaries held by the parent company issuer presented using the equity method of accounting.

 

26


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Balance Sheet as of June 30, 2010
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
    (In thousands)  
Current assets:
                                       
Cash and cash equivalents
  $ 24,034     $ 238     $ 9     $     $ 24,281  
Accounts receivable, net
    166,359       4,949       20             171,328  
Prepaid expenses and other current assets
    5,957       108                   6,065  
 
                             
Total current assets
    196,350       5,295       29             201,674  
Property, plant and equipment, net
    11,968       95                   12,063  
Intangible assets, net
    20,277                         20,277  
Goodwill
    398,921                         398,921  
Investment in subsidiaries
    21,291                   (21,291 )      
Intercompany receivables
    867       20,230             (21,097 )      
Other assets
    10,635       13       3             10,651  
 
                             
Total assets
  $ 660,309     $ 25,633     $ 32     $ (42,388 )   $ 643,586  
 
                             
Current liabilities:
                                       
Book cash overdraft
  $     $     $     $     $  
Interest payable
    15,860                         15,860  
Current portion, senior term loan payable
                             
Current portion of subordinated note payable
                             
Current portion, acquisition obligations
                                 
Trade accounts payable
    45,799       773       14             46,586  
Accrued liabilities
    42,289       1,157       2             43,448  
Accrued payroll and related liabilities
    44,933       1,465       46             46,444  
Billings in excess of revenue earned
    4,629                         4,629  
 
                             
Total current liabilities
    153,510       3,395       62             156,967  
Intercompany payables
    20,231             866       (21,097 )      
Senior term loan payable, excluding current portion
                             
Senior secured notes
    272,089                         272,089  
Senior unsecured notes
    245,905                         245,905  
Subordinated note payable
                             
Accrued compensation, excluding current portion
    5,079                         5,079  
Accrued postretirement benefit obligations
    752                           752  
Non-current portion of lease obligations
    7,822       51                   7,873  
Deferred income taxes
    35,615                         35,615  
Commitments and contingencies
                             
Redeemable common stock warrants
                             
Redeemable common stock
    151,375                         151,375  
Common stock warrants
    20,785                         20,785  
Common stock of subsidiaries
          2,800             (2,800 )      
Accumulated other comprehensive loss
    (238 )                       (238 )
Accumulated deficit
    (252,616 )     19,387       (896 )     (18,491 )     (252,616 )
 
                             
Total liabilities, redeemable common stock and accumulated deficit
  $ 660,309     $ 25,633     $ 32     $ (42,388 )   $ 643,586  
 
                             

 

27


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Balance Sheet as of September 30, 2009
(In thousands)
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
Current assets:
                                       
Cash and cash equivalents
  $ 11,404     $ (215 )   $ (4 )   $     $ 11,185  
Accounts receivable, net
    174,458       5,661       38             180,157  
Prepaid expenses and other current assets
    3,659       133       3             3,795  
 
                             
Total current assets
    189,521       5,579       37             195,137  
Property, plant and equipment, net
    14,346       128                   14,474  
Intangible assets, net
    28,680                         28,680  
Goodwill
    398,921                         398,921  
Investment in subsidiaries
    17,132                   (17,132 )      
Intercompany receivables
    702       15,939             (16,641 )      
Other assets
    10,270       13       3             10,286  
 
                             
Total assets
  $ 659,572     $ 21,659     $ 40     $ (33,773 )   $ 647,498  
 
                             
Interest payable
  $ 9,039     $     $     $     $ 9,039  
Current portion, senior term loan payable
    2,389                         2,389  
Current portion of subordinated note payable
    3,000                         3,000  
Current portion, acquisition obligations
    50                         50  
Trade accounts payable
    59,742       963       2             60,707  
Accrued liabilities
    43,985       1,440                   45,425  
Accrued payroll and related liabilities
    41,643       1,381       9             43,033  
Billings in excess of revenue earned
    3,661                         3,661  
 
                             
Total current liabilities
    163,509       3,784       11             167,304  
Intercompany payables
    15,939             702       (16,641 )      
Senior term loan payable, excluding current portion
    229,221                         229,221  
Senior unsecured notes
    245,241                         245,241  
Subordinated note payable
    46,932                         46,932  
Accrued compensation, excluding current portion
    5,740                         5,740  
Accrued postretirement benefit obligations
    717                           717  
Non-current portion of lease obligations
    7,216       70                   7,286  
Redeemable common stock warrants
    32,717                         32,717  
Redeemable common stock
    187,137                         187,137  
Common stock of subsidiaries
          2,800             (2,800 )      
Accumulated other comprehensive loss
    (238 )                       (238 )
Accumulated deficit
    (274,559 )     15,005       (673 )     (14,332 )     (274,559 )
 
                             
Total liabilities, redeemable common stock and accumulated deficit
  $ 659,572     $ 21,659     $ 40     $ (33,773 )   $ 647,498  
 
                             

 

28


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Operations for the Three Months Ended June 30, 2010
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
    (In thousands)  
Contract revenue
  $ 205,660     $ 7,603     $ 46     $     $ 213,309  
Direct contract expense
    159,764       5,054       35             164,853  
 
                             
Gross profit
    45,896       2,549       11             48,456  
 
                             
Operating expenses:
                                       
Indirect contract expense
    9,286       869       12             10,167  
Research and development
    120                         120  
General and administrative
    19,006       377       82             19,465  
Rental and occupancy expense
    7,339       149       11             7,499  
Depreciation and amortization
    4,050       14                   4,064  
 
                             
Total operating expenses
    39,801       1,409       105             41,315  
 
                             
Operating income
    6,095       1,140       (94 )           7,141  
Other income (expense):
                                       
Interest income
    15       1                   16  
Interest expense
    (18,292 )                       (18,292 )
Other
    (255 )     72                   (183 )
Equity in net income of subsidiaries
    1,119                   (1,119 )      
 
                             
Total other expenses
    (17,413 )     73             (1,119 )     (18,459 )
 
                             
(Loss) income before taxes
    (11,318 )     1,213       (94 )     (1,119 )     (11,318 )
Income tax (expense) benefit
    (1,798 )                       (1,798 )
 
                             
Net income (loss)
  $ (13,116 )   $ 1,213     $ (94 )   $ (1,119 )   $ (13,116 )
 
                             

 

29


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Operations for the Three Months Ended June 30, 2009
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
    (In thousands)  
Contract revenue
  $ 195,465       5,167       3,528           $ 204,160  
Direct contract expense
    151,834       3,205       2,627             157,666  
 
                             
Gross profit
    43,631       1,962       901             46,494  
 
                             
Indirect contract expense
    8,463       755       225             9,443  
Research and development
    223                         223  
General and administrative
    17,005       259       (11 )           17,253  
Rental and occupancy expense
    8,000       80       89             8,169  
Depreciation and amortization
    5,143       6       7             5,156  
 
                             
Total operating expenses
    38,834       1,100       310             40,244  
 
                             
Operating income
    4,797       862       591             6,250  
Other income (expense):
                                       
Interest income
    12             3             15  
Interest expense
    (15,766 )                       (15,766 )
Other
    (96 )     189       (3 )           90  
Gain on sale of non-operating assets
    (19 )                       (19 )
Equity in net income of subsidiaries
    1,642                       (1,642 )      
 
                             
Total other expenses
    (14,227 )     189             (1,642 )     (15,680 )
 
                             
(Loss) income before taxes
    (9,430 )     1,051       591       (1,642 )     (9,430 )
Income tax (expense) benefit
    (7 )                       (7 )
 
                             
Net income (loss)
  $ (9,437 )     1,051       591       (1,642 )   $ (9,437 )
 
                             

 

30


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Operations for the Nine Months Ended June 30, 2010
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
    (In thousands)  
Contract revenue
  $ 598,126     $ 24,351     $ 116     $     $ 622,593  
Direct contract expense
    463,578       16,240       80             479,898  
 
                             
Gross profit
    134,548       8,111       36             142,695  
 
                             
Operating expenses:
                                       
Indirect contract expense
    26,680       2,725       30             29,435  
Research and development
    690                         690  
General and administrative
    52,955       746       237             53,938  
Rental and occupancy expense
    23,307       444       32             23,783  
Depreciation and amortization
    12,468       39                   12,507  
 
                             
Total operating expenses
    116,100       3,954       299             120,353  
 
                             
Operating income
    18,448       4,157       (263 )           22,342  
Other income (expense):
                                       
Interest income
    72       1                   73  
Interest expense
    (49,275 )                       (49,275 )
Other
    (429 )     222                   (207 )
Gain on extinguishment of debt
    50,749                           50,749  
Equity in net income of subsidiaries
    4,159                   (4,159 )      
 
                             
Total other expenses
    5,276       223             (4,159 )     1,340  
 
                             
(Loss) income before taxes
    23,724       4,380       (263 )     (4,159 )     23,682  
Income tax (expense) benefit
    (35,615 )     2       40             (35,573 )
 
                             
 
 
Net income (loss)
  $ (11,891 )   $ 4,382     $ (223 )   $ (4,159 )   $ (11,891 )
 
                             

 

31


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statements of Operations for the Nine Months Ended June 30, 2009
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
    (In thousands)  
Contract revenue
  $ 561,582     $ 16,595     $ 10,208     $     $ 588,385  
Direct contract expense
    433,204       11,239       7,680             452,123  
 
                             
Gross profit
    128,378       5,356       2,528             136,262  
 
                             
Operating expenses:
                                       
Indirect contract expense
    25,097       2,276       526             27,899  
Research and development
    370                         370  
General and administrative
    40,229       613       10             40,852  
Rental and occupancy expense
    23,924       225       226             24,375  
Depreciation and amortization
    14,624       17       21             14,662  
 
                             
Total operating expenses
    104,244       3,131       783             108,158  
 
                             
Operating income
    24,134       2,225       1,745             28,104  
Other income (expense):
                                       
Interest income
    44       16       3             63  
Interest expense
    (40,098 )                       (40,098 )
Other
    (363 )     339       (8 )           (32 )
Gain on sale of non-operating assets
    (19 )                       (19 )
Equity in net income (loss) of subsidiaries
    4,320                   (4,320 )      
 
                             
Total other expenses
    (36,116 )     355       (5 )     (4,320 )     (40,086 )
 
                             
(Loss) income before taxes
    (11,982 )     2,580       1,740       (4,320 )     (11,982 )
Income tax (expense) benefit
    44                         44  
 
                             
 
 
Net income (loss)
  $ (11,938 )   $ 2,580     $ 1,740     $ (4,320 )   $ (11,938 )
 
                             

 

32


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Cash Flows for the Nine Months Ended June 30, 2010
                                 
                    Non-        
            Guarantor     Guarantor        
    Parent     Companies     Companies     Consolidated  
    (In thousands)  
Net cash used in operating activities
  $ (974 )   $ 461     $ 14     $ (499 )
 
                               
Cash flows from investing activities:
                               
Cash paid for acquisitions-related obligations
    (50 )                 (50 )
Capital expenditures
    (1,633 )     (6 )           (1,639 )
Proceeds from sale of assets
    5                   5  
 
                       
Net cash used in investing activities
    (1,678 )     (6 )           (1,684 )
Cash flows from financing activities:
                               
Change in book overdraft
                       
Cash (paid for) received from interest rate swap
                       
Sale of Secured Notes
    281,465                   281,465  
Sale of Common Stock Warrants
    20,785                   20,785  
Payment of debt issue costs
    (18,177 )                 (18,177 )
Payment of Term B Loan
    (236,596 )                 (236,596 )
Repurchase of Subordinated Note and related warrants
    (25,000 )                 (25,000 )
Payment of Subordinated Note
                       
Revolver borrowings
    84,200                   84,200  
Revolver payments
    (84,200 )                 (84,200 )
Loan to ESOP Trust
    (5,323 )                 (5,323 )
ESOP loan repayment
    5,323                   5,323  
Redeemable common stock purchased from ESOP Trust
    (9,326 )                 (9,326 )
Redeemable common stock sold to ESOP Trust
    2,128                   2,128  
 
                       
Net cash (used in) provided by financing activities
    15,279                   15,279  
Net increase (decrease) in cash and cash equivalents
    12,627       455       14       13,096  
Cash and cash equivalents at beginning of period
    11,404       (215 )     (4 )     11,185  
 
                       
Cash and cash equivalents at end of period
  $ 24,031     $ 240     $ 10     $ 24,281  
 
                       

 

33


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Cash Flows for the Nine Months Ended June 30, 2009
                                 
                    Non-        
            Guarantor     Guarantor        
    Parent     Companies     Companies     Consolidated  
    (In thousands)  
Net cash used in operating activities
  $ (597 )   $ 26     $ 50     $ (521 )
 
                               
Cash paid for acquisitions-related obligations
    (166 )                 (166 )
Capital expenditures
    (1,789 )                 (1,789 )
 
                       
Net cash used in investing activities
    (1,955 )                 (1,955 )
Cash flows from financing activities:
                               
Cash (paid for) received from interest rate swap
    (4,647 )                 (4,647 )
Payment of senior term loan principal
    (1,825 )                 (1,825 )
Payment of subordinated note principal
    (3,000 )                 (3,000 )
Revolver borrowings
    349,925                   349,925  
Revolver payments
    (349,925 )                 (349,925 )
Loan to ESOP Trust
    (5,936 )                 (5,936 )
ESOP loan repayment
    5,936                   5,936  
Redeemable common stock purchased from ESOP Trust
    (7,264 )                 (7,264 )
Redeemable common stock sold to ESOP Trust
    5,115                   5,115  
 
                       
Net cash (used in) provided by financing activities
    (11,621 )                 (11,621 )
Net increase (decrease) in cash and cash equivalents
    (14,173 )     26       50       (14,097 )
Cash and cash equivalents at beginning of period
    16,392       (62 )     (43 )     16,287  
 
                       
Cash and cash equivalents at end of period
  $ 2,219     $ (36 )   $ 7     $ 2,190  
 
                       
(23) Subsequent Events
On July 9, 2010, WCGS sold several contracts, primarily with the Office of Naval Research, to MCR Federal LLC. MCR Federal agreed to assume certain liabilities and to pay a total of $5.0 million. WCGS received $4.5 million at closing. The balance is due on contract novation. The Senior Secured Note Indenture requires Alion to either make a tender offer to note holders and use the proceeds to redeem up to $5 million in Senior Secured Note principal at par or re-invest the proceeds in the Company’s business.

 

34


Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of Alion’s financial condition and results of operations should be read together with the condensed consolidated financial statements (unaudited) and the notes to those statements. This updates the information contained in our Annual Report on Form 10-K for the year ended September 30, 2009, and presumes that readers have access to, and will have read, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in that report.
Overview
Alion provides scientific, engineering and information technology expertise to research and develop technological solutions for problems relating to national defense, homeland security and energy and environmental analysis, principally to U.S. government departments and agencies and, to a lesser extent, to commercial and international customers.
The following table summarizes revenue attributable to each contract type for the periods indicated.
                                 
    For the Nine Months Ended June 30,  
Revenue by Contract Type   2010     2009  
    (In thousands)  
Cost-reimbursement
  $ 465,829       74.8 %   $ 419,451       71.3 %
Fixed-price
    71,586       11.5 %     60,553       10.3 %
Time-and-material
    85,178       13.7 %     108,381       18.4 %
 
                       
Total
  $ 622,593       100.0 %   $ 588,385       100.0 %
 
                       
Management expects Alion’s revenue will continue to come from government contracts, mostly from contracts with the U.S. Department of Defense (DoD) and other federal agencies with some revenue from a variety of commercial, state, local and international customers.
                                 
    For the Nine Months Ended June 30,  
Revenue by Customer Type   2010     2009  
    (In thousands)  
U.S. Department of Defense (DoD)
  $ 573,402       92.1 %   $ 538,770       91.6 %
Other Federal Civilian Agencies
    31,869       5.1 %     28,490       4.8 %
Commercial / State / Local and International
    17,322       2.8 %     21,125       3.6 %
 
                       
Total
  $ 622,593       100.0 %   $ 588,385       100.0 %
 
                       
In its first National Security Strategy (NSS) the Obama Administration calls economic revival its top priority and an attack from weapons of mass destruction (WMD) the nation’s top threat. While focusing important attention on the imperative to rebuild America’s economy and to reduce the federal deficit, the NSS lays out broad policy objectives. “We are a nation at war, and the Department of Defense does not expect the defense budget to decline” according to Ashton B. Carter, Under Secretary of Defense for Acquisition, Technology and Logistics. Understanding that a certain amount of growth is needed, President Barack Obama’s defense budget proposal calls for 1 percent real growth each year at a time when the funding curve for all other federal agencies has flattened.
To achieve these budget and program priorities, the Defense Department is taking steps to achieve efficiencies needed to save $100 billion over five years beginning in fiscal 2012. Defense spending is approximately $700 billion per year with approximately $300 billion of those funds spent for internal military and civilian salaries and benefits, operations and sustaining the facilities and infrastructure. The remainder -about $400 billion is spent equally between products (e.g., weapons, electronics, fuel, and facilities) and services (e.g., IT services, knowledge-based services, facilities upkeep, and transportation).
Phasing out time-and-material and sole source ID/IQ contracts, utilizing fixed-price performance-based contracts and fixed-price level of effort or cost-plus-fixed-fee contracts are among the many cornerstones of Under Secretary Carter’s “Do more without more” initiative that seeks savings by providing incentives for greater efficiency in industry service contracting. Reduced internal defense overhead, eliminating unproductive or unneeded programs and activities, and improved contracting efficiencies are expected to yield two-thirds of the savings according to Deputy Secretary of Defense Lynn.

 

35


Table of Contents

Defense Secretary Gates has directed the military services to adopt an expanded set of counterinsurgency (COIN) models and simulation tools to be prepared for the operational, geographic, linguistic and cultural complexities that are confronting military forces. “We must align our training, personal processes and programs to provide deploying units....with language, cultural, tactical and interagency skills required to conduct COIN operations,” according to Gates.
The Defense Department has consistently sought less expensive, but more effective training, in all segments of the training market: Virtual; Live; Constructive/C4ISR; and Education. Spending on training continues with slow but stable growth. Complex missions and increased use of improvised explosive devices have increased the need for high-fidelity mission rehearsal simulations, allowing military personnel to see, hear and act as they would in a real mission with specialized recognition, detection, avoidance and execution mission scenarios for Iraq and Afghanistan. Similarly, redesign and improvement of training ranges and distance learning and modern computer based education continues to remain fairly stable.
The U.S. military has almost “no situational awareness” when a cyber attack is underway on the 7 million computers and 15,000 computer networks it operates, according to Lieutenant General Keith Alexander, the new Commander of the U.S. Cyber Command and Director of the U.S. National Security Agency. The lack of real-time situational awareness puts military forces (and operations) at substantial risk. Situational awareness refers to the ability to understand what’s going on around you. On a battlefield, it means knowing where allied and enemy forces are and what they are doing. In cyberspace, it means understanding who is on particular networks and what they are doing. The Cyber Command is providing technical assistance to the Department of Homeland Security, which is the lead federal agency for defending non-defense government web sites while law enforcement agencies such as the FBI help defend the private sector from cyber crime and intellectual property theft.
Even as the government focuses on changing the procurement environment and contracting activity, Alion’s cost-reimbursable revenue has continued to increase each year. We do not perform inherently governmental functions; we deliver highly sophisticated scientific and engineering research services. As a result, Management believes increased government in-sourcing for acquisition-skilled support services will not materially adversely affect our operations and demand will continue for our higher end technical expertise.
Because Alion is not involved in producing or designing many of the major platforms that are facing budgetary constraints, we do not expect future acquisition program cuts or delays to materially adversely affect us. Although the CG(X) ship acquisition program which we support was cancelled, we believe we have significant opportunities in other ship programs we already support with key waterfront and headquarters roles, such as DDG-51, Littoral Combat Ships and the Joint High Speed Vessel program.
We do not expect other acquisition program cuts or delays to adversely affect us significantly. Rather, we expect to benefit from a focus on extending the service life and capabilities of existing systems across all branches of the Defense Department because we provide these kinds of services. We think cost-containment will help us sell the government services and technical solutions that improve operating efficiency and effectiveness. However, we expect in-sourcing may ultimately reduce some of our future revenue from professional technical services contracts for program management and acquisition management, operations and training support and logistics support.
                                 
    For the Nine Months Ended  
    June 30,  
Core Business Area   2010     2009  
    (In thousands)  
 
                               
Naval Architecture and Marine Engineering
  $ 272,907       43.8 %   $ 268,759       45.8 %
Defense Operations
    151,930       24.4 %     154,322       26.2 %
Modeling and Simulation
    111,140       17.9 %     67,827       11.5 %
Technology Integration
    32,356       5.2 %     36,672       6.2 %
Energy and Environmental Sciences
    29,463       4.7 %     27,786       4.7 %
Information Technology and Wireless Communications
    24,797       4.0 %     33,019       5.6 %
 
                       
 
                               
Total
  $ 622,593       100.0 %   $ 588,385       100.0 %
 
                       

 

36


Table of Contents

Backlog. Contract backlog represents an estimate, as of a specific date, of the future revenue Alion expects from existing contracts. At June 30, 2010, backlog on existing contracts and executed delivery orders totaled $2.8 billion, of which $359 million was funded. We estimate we have an additional $3.8 billion of unfunded contract ceiling value for an aggregate total backlog of $6.6 billion.
Results of Operations
Quarter Ended June 30, 2010 Compared to Quarter Ended June 30, 2009
                                 
    Consolidated Operations of Alion  
    Quarter Ended June 30,  
    2010     2009  
    (Dollars in thousands)  
            % of             % of  
Selected Financial Information           revenue             revenue  
Total contract revenue
  $ 213,309             $ 204,160          
Total direct contract costs
    164,853       77.3 %     157,666       77.2 %
Direct labor costs
    69,471       32.6 %     68,700       33.7 %
Material and subcontract costs
    90,738       42.5 %     81,229       39.8 %
Other direct costs
    4,644       2.2 %     7,737       3.8 %
 
                               
Gross profit
    48,456       22.7 %     46,494       22.8 %
 
                               
Total operating expense
    41,315       19.4 %     40,244       19.7 %
Major components of operating expense:
                               
Indirect expenses including facilities costs
    17,666       8.3 %     17,711       8.7 %
General and administrative
    19,465       9.1 %     17,253       8.5 %
Depreciation and amortization
    4,064       1.9 %     5,156       2.5 %
 
                               
Income from operations
  $ 7,141       3.3 %   $ 6,250       3.1 %
Revenue. Third quarter revenue this year was $213.3 million up $9.1 million and 4.5% over the comparable period last year. Increased cost-reimbursement revenue (up $19.4 million and 12.8%) and fixed price contract revenue (up $1.0 million and 4.9%) were offset in part by an $11.0 million decline in time and material contract revenue (down 31.4%). DoD revenue grew by $9.3 million (5.0%) and overall government contract revenue grew $10.0 million (5.1%) compared to the similar quarter last year.
Modeling and Simulation revenue continued to grow dramatically — up $15.5 million (62.3%) over third quarter 2009 performance. Most of this work came through Alion’s M&S Information Analysis Center contract with the Defense Information Systems Agency. We had continuing growth from our expanded support to the U.S. Army Tank Automotive Research, Development and Engineering Center. Work for the Air Force, principally on Alion’s SAFTAS contract, grew by $17.2 million this quarter, up almost 32% over the similar period last year. Alion delivered increased program management effort for SAFTAS technology upgrades. Naval Architecture and Marine Engineering and Defense Operations remained strong despite a modest 1.6% decline Revenue from other core business areas was down almost $4.0 million (12.6%) compared to third quarter last year, as Alion has yet to see demand in these areas recover to prior levels.
Our prime contract revenue continues to increase with sales up $12.6 million (7.6%) compared to last year. Alion’s revenue from work as a subcontractor to other prime contractors declined $3.5 million to $35.4 million, down 8.9%. Each of these trends is consistent with Alion’s expanded capabilities that enable it to operate as a prime contractor on a greater number of key government programs. Margins on prime contracts and subcontracts both improved (up $1.4 million) to 7.1% overall.
Direct Contract Expense and Gross Profit. Third quarter 2010 direct contract expenses increased $7.2 million (4.6%) to $164.9 million compared to third quarter last year, consistent with year over year growth in revenue. Material and subcontract costs on Alion’s prime contracts increased $9.5 million (11.7%) to 42.5% of quarterly revenue. Direct labor increased by $0.8 million but declined modestly as a percentage of quarterly revenue. Other direct costs also declined in total dollars and as a percentage of revenue. Alion’s prime contract work continues to depend on business partners serving as subcontractors. This can lead to higher levels of subcontract activity compared to Alion staff effort. Management is continuing to focus on improving labor productivity to increase higher-margin, internally-derived revenue. Gross profit for the current quarter at $48.5 million increased by almost $2 million compared to third quarter 2009. Although gross margin growth has not kept pace with revenue growth, this quarter’s gross margin percentage is not materially different from third quarter results last year. This is consistent with increased third-party costs on which Alion typically earns a lower margin.

 

37


Table of Contents

Operating Expenses. Third quarter operating expenses were up $1.1 million overall compared to the same period last year with indirect expenses essentially flat and depreciation and amortization expenses down approximately $1.1 million. Spending on information technology for collaborative technologies, project management and control, and expanded reporting and analytical capabilities increased costs by $727 thousand this quarter compared to 2009 third quarter performance. Incentive compensation expense was $1.4 million higher than it was in the third quarter last year.
Income from Operations. Operating income for the quarter ended June 30, 2010 increased 14% to $7.1 million and 3.3% of quarterly revenue. Additional gross margin dollars were offset by increased compensation expense and costs for information technology efforts.
Other Expense. Net interest income, interest expense and other expense in the aggregate for the quarter ended June 30, 2010 increased materially compared to the third quarter of 2009. Although cash management efforts reduced revolver borrowings and related interest expense by $177 thousand, cash pay interest expense increased. The Senior Secured Notes have a higher interest rate and a higher outstanding principal than our former Term B Senior Credit Facility. This cost the Company more than $2.0 million this quarter compared to last year. However, we also saved $903 thousand in Subordinated Note interest and other fees.
This quarter debt issue cost amortization increased $1.2 million compared to the third quarter last year. Secured Note debt issue costs exceed the expenses we recognized for recently extinguished debt instruments. PIK interest on the Secured Notes increased interest expense by a further $1.6 million. These costs were offset by $1.2 million in savings from extinguishing the Subordinated Note and warrants earlier this year.
                 
    Three Months Ended June 30,  
    2010     2009  
    (In thousands)  
Cash Pay Interest
               
Revolver
  $ 112     $ 289  
Senior Term Loan
          5,711  
Secured Notes
    7,761        
Unsecured Notes
    6,406       6,406  
Subordinated Note
          784  
Other cash pay interest and fees
    (31 )     88  
 
           
Sub-total cash pay interest
    14,248       13,278  
 
               
Deferred and Non-cash Interest
               
Secured Notes PIK interest
    1,554        
Debt issue costs and other non-cash items
    2,490       1,270  
Subordinated Note interest
          1,057  
Subordinated Note warrants
          161  
 
           
Sub-total non-cash interest
    4,044       2,488  
 
           
Total interest expense
  $ 18,292     $ 15,766  
 
           
Income Tax Expense. In the third quarter this year, we recognized deferred tax assets and a related valuation allowance of approximately $739 thousand. We recorded a full valuation allowance for the deferred tax assets we recognized this quarter because our history of losses makes it unlikely that we will reasonably be able to realize the full benefit of our deferred tax assets. We had $1.8 million in deferred tax expense and liabilities related to tax-basis goodwill amortization. For more detail on our tax provision, please see the discussion of our year to date results that follows.
Net Income. Increased interest expense on our long-term debt more than offset our increased operating income and materially contributed to our $13.1 million current quarter loss.

 

38


Table of Contents

Nine Months Ended June 30, 2010 Compared to Nine Months Ended June 30, 2009
                                 
    Consolidated Operations of Alion  
    Nine Months Ended June 30,  
    2010     2009  
    (Dollars in thousands)  
            % of             % of  
Selected Financial Information           revenue             revenue  
Total contract revenue
  $ 622,593             $ 588,385          
Total direct contract costs
    479,898       77.1 %     452,123       76.8 %
Direct labor costs
    205,575       33.0 %     203,287       34.5 %
Material and subcontract costs
    261,305       42.0 %     229,078       38.9 %
Other direct costs
    13,018       2.1 %     19,757       3.4 %
 
                               
Gross profit
    142,695       22.9 %     136,262       23.2 %
 
                               
Total operating expense
    120,353       19.3 %     108,158       18.4 %
Major components of operating expense:
                               
Indirect expenses including facilities costs
    53,218       8.5 %     52,274       8.9 %
General and administrative
    53,938       8.7 %     46,205       7.9 %
Depreciation and amortization
    12,507       2.0 %     14,662       2.5 %
 
                               
Income from operations
  $ 22,342       3.6 %   $ 28,104       4.8 %
Revenue. Our $622.6 million in revenue this year was $34.2 million greater than the $588.4 million for the similar period in 2009. Alion’s Air Force work this year increased $48.8 million (31.9%) over last year largely because of expanded SAFTAS program support for technology upgrades. Other DoD revenue is down $14.2 million (3.7%). Overall, our work for DoD is up $34.6 million (6.4%) over last year. Expanded work for federal departments and agencies outside DoD was up $3.4 million and 11%. This helped offset a continuing decline in commercial sales which were down by $3.8 million compared to last year.
Our 5.8% sales growth was attributable to $46.4 million more cost-reimbursement contract revenue (up 11.1%) and $11.0 million more in fixed price contract sales (up 18.2%). Increases were offset by a $23.2 million drop in time and material (T&M) contract activity (down 21.4%). Our increasing percentage of cost-reimbursable work and a lower level of T&M work continue to place pressure on our contract margins. However, higher margin fixed price work is showing recovery with an $11.0M increase (18.2% growth over prior year). Despite downward pressure from our contract mix, margins increased to $43.4 million (up $3.9 million) representing 7.0% of target cost, up from 6.7% from last year.
Modeling and Simulation revenue, on the Company’s Information Analysis Center contracts and other contracts, grew $43.3 million, a 63.9% increase compared to last year. Revenue continued to grow from providing the U.S. military new capabilities to repair equipment in the field and from offering innovative responses to changing threats to war fighters. Alion is performing research and development to reduce or eliminate the effects of improvised explosive devices used against U.S. and Coalition Forces in Iraq and Afghanistan. We also support the U.S. Navy’s Warfare Development Command. Naval architecture and marine engineering increased 1.5% ($4.1 million) and Defense Operations Support declined 1.5% ($2.4 million) Revenue from other core business areas declined $10.9 million (11.7%). Alion has yet to see its customers for its information technology and telecommunications services recover from the lingering effects of the global recession.
Alion’s prime contract revenue continues to trend upward as a percentage of overall revenue (up $48.1 million and 10.2%) over last year while our revenue from subcontracts with other prime contractors was down $13.9 million or 11.8%. Each of these trends is consistent with expanded capabilities that enable Alion to operate as a prime contractor on a greater number of key government programs. We continue to realize a significant portion of our revenue from contract vehicles on which we compete for task orders. Over 59% of year to date revenue came from ID/IQ contracts. While ID/IQ contract revenue increased modestly as a percentage of overall revenue, ID/IQ revenue grew by $25.2 million, up 7.3% from last year.

 

39


Table of Contents

Direct Contract Expense and Gross Profit. Direct contract expenses increased by $27.8 million to 77.1% of year to date revenue compared to 76.8% of revenue for the comparable period last year. Increasing prime contract activity includes work that Alion shares with its teammates and led to higher material and subcontract cost both in total dollars ($32.2 million) and as a percentage of revenue (up 3.1% to 42.0% of revenue). Direct labor only increased by 1.1% ($2.3 million) while other direct costs declined $6.7 million to 2.1% of revenue. Year to date gross profit at $142.7 million grew $6.4 million (4.7%) compared to $136.3 million for the first nine months of 2009. Alion did not face significant fixed price contract overruns in 2010. In 2009 gross profit was adversely affected by $1.2 million in fixed price contract overruns. In 2010, gross margin as a percentage of revenue declined as the Company saw cost reimbursement revenue increase to almost 75% of revenue. Cost reimbursement contracts typically have lower profit percentages which offset a portion of performance risk.
Operating Expenses. Through June 30, 2010, operating expenses climbed $12.2 million overall compared to last year’s performance and eroded operating profit. The comparative hike in operating expenses comes, in part, from the absence of a $5.8 million credit to stock-based compensation expense recorded last year for phantom stock forfeitures and declines in Alion’s share price. In 2010, expense credits for changes in Alion’s share price were only $0.8 million. Facilities and indirect expenses were up 1.8% over last year ($0.9 million) consistent with salary increases and ordinary building operating expense pass-throughs and offset partially by planned space reductions. Depreciation and amortization declined by $2.2 million principally due to scheduled declines in amortization charges for acquired contracts. G&A expense exclusive of stock-based and long-term incentive compensation charges grew by $6.7 million. We spent almost $2.6 million to re-structure and/or re-finance our former debt. Expanded information technology services for collaborative technologies, project management and control, and expanded reporting and analytical capabilities increased costs $2.2 million compared to 2009 year to date results. Alion saw increased G&A expenses for additional staffing and efforts devoted to business development, cash management and strategic planning.
Income from Operations. Operating income for the nine months ended June 30, 2010 dropped by $5.8 million to $22.3 million compared with $28.1 million for the similar period last year because of our higher operating expenses described above.
Other Expense. Interest income, interest expense and other expense in the aggregate for the nine months ended June 30, 2010 increased by $9.2 million compared to the similar period last year. Higher average investment balances, $24 million in excess cash from the March 2010 re-financing, and a reduced demand on the revolver led to lower interest expense ($0.6 million) and marginally higher interest income ($10 thousand). Despite lower outstanding principal on the Senior Term Loan this year, cash pay interest expense was adversely affected by a 100 basis point interest rate increase for February and March. The biggest hike in cash interest expense was from fees and penalties associated with the September and December 2009 covenant waivers for which Alion ultimately paid more than $3.9 million. Management had expected to close a re-financing transaction prior to March 1, 2010. The new Secured Notes were not issued until March 22, 2010. As a result, Alion was required to pay a $2.6 million fee (100 basis points) to the Term B Lenders on March 1, 2010. Cash interest on the Secured Notes was offset by the absence of Subordinated Note cash interest expense this year. In 2010, non-cash interest expense was $5.3 million higher than it was in 2009. Last year, Alion recognized a $6.7 million benefit for the decline in value of the Subordinated Note warrants offset by $2.8 million in deferred non-cash interest charges. In 2010, the Company only recognized a $160 thousand benefit for a decline in the value of the now-extinguished Subordinated Note warrants and no year-to-date deferred non-cash Subordinated Note interest.

 

40


Table of Contents

                 
    Nine Months Ended June 30,  
    2010     2009  
    (In thousands)  
Cash Pay Interest
               
Revolver
  $ 210     $ 811  
Senior Term Loan
    11,047       17,166  
Secured Notes
    8,536        
Unsecured Notes
    19,219       19,219  
Subordinated Note
          1,655  
Other cash pay interest and fees
    4,002       302  
 
           
Sub-total cash pay interest
    43,014       39,153  
 
               
Deferred and Non-cash Interest
               
Secured Notes PIK interest
    1,709        
Debt issue costs and other non-cash items
    4,712       3,814  
Subordinated Note interest
          3,869  
Subordinated Note warrants
    (160 )     (6,738 )
 
           
Sub-total non-cash interest
    6,261       945  
 
           
Total interest expense
  $ 49,275     $ 40,098  
 
           
Debt Extinguishment. On March 22, 2010, Alion used proceeds from issuing $310 million of Units to retire the then-outstanding Term B Credit Facility loans, the Subordinated Note and related warrants, and to pay debt issue costs. We paid approximately $240 million to retire Term B debt at par plus accrued interest. We recognized a $6.7 million loss on extinguishing this debt by writing off the balance of unamortized Term B-related debt issue costs.
Alion paid $25 million to retire the Subordinated Note and related warrants at a steep discount to both carrying and estimated fair values. We recognized a $67.7 million gain on extinguishing these liabilities offset in part by writing off $10.3 million in unamortized debt issue and debt modification costs. Alion recognized a one-time $50.7 million net benefit from re-financing and debt extinguishment transactions.
Income Tax Expense. Until March 22, 2010, Alion had no material income tax expense as the Company and its subsidiaries were a consolidated pass-through entity whose income was attributable to our sole shareholder, the tax-exempt ESOP Trust. Some states did not recognize Alion’s S corporation status and required the Company and its subsidiaries to file separate state tax returns. Alion’s Canadian subsidiary has always been a taxable entity required to accrue a Canadian tax liability as necessary.
On March 22, 2010, Alion issued 310,000 Units each of which consists of $1,000 in Secured Note face value and a warrant to purchase 1.9439 shares of Alion common stock. The warrants entitle the holders to purchase a total of 602,614 shares of common stock at a penny per share. The fair value of each warrant on the date of issue was approximately $67.05. The warrants are considered to constitute a second class of stock under the IRC. S-corporations are only permitted to have a single class of stock. By issuing the Secured Note warrants, Alion’s S-corporation status automatically terminated and the Company ceased to be a pass-through entity exempt from income taxes. We were required to recognize current income tax expense for the effect of our change in reporting status.
Alion recognized approximately $35.4 million of deferred tax assets related to timing differences for expenses previously recorded that are estimated to generate deductions on future income tax returns. We also recognized a $33.8 million deferred tax liability related to tax-deductible goodwill arising from prior year acquisitions. Prior to establishing a valuation allowance, Alion had a $1.5 million net deferred tax asset arising from conversion to a C-corporation. However, our history of losses makes it unlikely that we will be able to realize the full benefit of our deferred tax assets. We were required to establish a full valuation allowance for deferred tax assets and recognize $33.8 million in deferred tax expense last quarter.
In the third quarter of this year, we recognized additional deferred tax assets and a related valuation allowance of approximately $739 thousand; we recorded $1.8 million in deferred tax liabilities related to goodwill amortization. This year, we recognized $35.6 million in total current tax expense for deferred tax liabilities and $36.1 million for deferred tax assets and valuation allowances.

 

41


Table of Contents

Net Income. Even with a $50.7 million gain on debt extinguishment, interest expense and income tax charges kept Alion in an overall net loss position for the year. Even if one were to exclude our debt extinguishment gain, required tax provisions and debt covenant waiver fees and penalties we paid this year, Alion would still not have been profitable as higher interest expense on long-term debt more than offset increases in operating income.
Liquidity and Capital Resources
Alion requires liquidity to timely pay its vendors and debt obligations, to fund operations while awaiting payment from customers and to invest in capital projects, Accounts receivable require cash when balances increase as business grows or when customers delay contract funding actions. We are funding our current business with cash from operating activities and the cash we have from issuing the Secured Notes. We plan to fund future operations in a similar fashion. We also have access to a $25 million revolving credit facility. Management does not currently estimate Alion will need to use its revolving credit facility to any significant extent.
Cash Flows
Alion’s operations were almost break even year-to-date on a cash flow basis. Although debt extinguishment net of tax provisions contributed $15.1 million to net income, these were non-cash transactions. The cash flow effects of these transactions are reported in our financing activities. We used approximately $0.5 million to fund our operations for the nine months ended June 2010 and 2009 even though we experienced significant fluctuation in both cash activities and non-cash charges. Current year non-cash charges for depreciation, compensation and debt-related expenses were $21.3 million. Last year, charges were only $6.4 million for the similar period. We had an $8.0 million increase in non-cash compensation charges due to last year’s phantom stock forfeiture credits and increased incentive compensation expenses this year. Non-cash debt-related expenses increased $9.1 million, due to higher charges for amortizing the cost of our newly-issued Senior Secured Notes and because we did not benefit from any significant fair value adjustments for our now-extinguished Subordinated Note warrants.
Last year subcontractor and other expense accruals for subcontractor work for which Alion had yet to receive invoices generated $16.9 million more in cash than the $4.9 million they provided this year. While we used approximately $2.3 million to pay invoices, we collected significantly more of our receivables. Last year we funded $8.9 million of billed and unbilled receivables. This year we generated $8.8 million in cash flow — an almost $18 million year over year improvement. Alion’s re-financing transactions materially affected operating cash flow as the Company paid off a $3.9 million Term B interest obligation and $3.9 million in covenant waiver-related fees included in cash paid for interest. Last year interest accruals provided $8.9 million in cash; this year that declined $2.1 million to $6.8 million.
Alion collected $640.1 million in receivables through June 30, 2010, $17.5 million more than the $622.6 million in revenue recognized. Prior year collections were $589.7 million. Our improved collections this quarter led days’ sales outstanding (DSO) to decline from 82.8 days to 74.8 days as of June 30, 2010. (We determine DSO based on trailing twelve month revenue). Both billed and unbilled receivables declined this quarter. Unbilled receivables continue at significant levels despite progress in obtaining previously delayed contract funding. Increased balances from growth in revenue represent currently billable amounts for which we intend to issue invoices next quarter and collect payment within typical time frames. Management expects DSO to track at current levels.
Capital expenditures this year are down less than $300 thousand over the same period last year when we purchased several contract delivery orders from General Dynamics for $116 thousand. ESOP loans were $613 thousand less this year than last year. ESOP share redemptions increased over last year partly as a result of timing differences. We processed share redemption requests in June this year compared to September last year. Sales to the ESOP Trust remained at comparable levels year over year. The higher 2009 cash inflow was the result of receiving 2008 share sale proceeds at the beginning of 2009 rather than in 2008.
Cash management efforts held total year-to-date revolver borrowing activity to $84.2 million. We did not use our revolver at all from April through June 2010. Our year to date borrowing is down $265.7 million from our $349.9 million in year-to-date borrowings through June 2009. Nevertheless, Alion’s re-financing transactions were the most significant non-operating activities this year. On March 22, 2010, Alion issued 310,000 Units for gross proceeds of $302.3 million. We allocated $20.8 million in proceeds to the warrants issued along with the Secured Notes and paid $13.5 million in third-party debt issue costs and $1.3 million in debt issue costs for our current revolving credit agreement. Earlier this year we paid $825 thousand to renew our former revolving credit facility and $2.6 million in Term B Loan fees that we charged directly to interest expense.

 

42


Table of Contents

We used $240 million from selling the 310,000 Units to retire the Term B Loan and pay off accrued interest. Last year we paid $3.0 million in Subordinated Note principal. This year, pursuant to our December 2009 agreement with IIT, we paid $25 million to re-purchase the entire Subordinated Note and related warrants at a significant discount to carrying value. We had approximately $24 million of additional cash on hand after issuing the Secured Notes and retiring the Term B Loan, the Subordinated Note and the related warrants.
We have a long-term revolving credit facility through August 2014 and additional available cash from re-financing activities. Management expects that for the next several years, Alion will be able to meet existing debt covenants which are less stringent and restrictive than previous Term B Loan covenants were. This will allow us to maintain access to our revolving credit facility, even though Management does not foresee needing to draw on it in any material amount or for any extended period. Management believes Alion will have sufficient cash on hand, cash flow from operations and cash available from its $25 million revolving credit facility to continue to meet obligations as they come due notwithstanding an overall increase in interest payments associated with the Secured Notes. We retain the ability to restrict or defer certain types of cash payments that in the past caused us to fail to comply with certain prior debt covenants. The Revolving Credit facility also limits our ability to offer and fund certain types of discretionary diversification options that create demands on Alion’s cash flows.
We cannot predict with any degree of accuracy the extent to which re-purchase and diversification demands will increase in future years. As more employees meet statutory and Plan-specific age and length of service requirements, potential diversification demands are likely to increase. These demands can increase further with any increase in the price of a share of Alion common stock. While a drop in our share price could reduce the value of each individual Plan participant’s beneficial interest, such a potential price decline could be offset by increased diversification demands and thus might not reduce the aggregate value of future demands on our cash. Current debt agreements limit our ability to offer discretionary diversification options to ESOP participants and this should reduce future cash flow demands. We try to monitor future potential impacts by relying in part on internal and external financial models that incorporate Plan census data and financial inputs intended to simulate changes in Alion’s share price.
Cash flow effects and risks associated with equity-related obligations
Changes in the price of a share of Alion common stock used to affect warrant-related interest expense. Our outstanding Secured Note warrants have a one penny exercise price and are in the money. They do not have a cash liquidation option and therefore Alion will only recognize interest expense for the debt issue cost associated with the initial fair value of these warrants. We no longer have significant stock-based compensation liabilities as no outstanding SARs have any intrinsic value; only a modest number of phantom shares remain outstanding. Management is unable to forecast the share price the ESOP Trustee will determine in future valuations.
Although current financial information includes the effects of the most recent ESOP Trust transactions, future expenses for stock-based compensation are likely to differ from estimates as the price of a share of Alion common stock changes. Our next regularly scheduled valuation period ends in September 2010. Interest rates, market-based factors and volatility, as well as Alion’s financial results will affect the future value of a share of our common stock.
Certain SAR and Phantom Stock grantees can make qualifying elections to further defer stock-based compensation payments by having funds deposited into a rabbi trust we own. These elections will not materially affect our planned payments or our overall anticipated cash outflows.
After each semi-annual valuation period, the Plan permits former employees and beneficiaries to request distribution of their vested ESOP account balances. Consistent with the terms of the Plan and the IRC, we intend to pay distribution requests in five annual installments and to defer initial payments as permitted. The Plan allows Alion to defer initial installment distributions for five years for former employees who are not disabled, deceased or retired.
Discussion of Debt Structure
The discussion below describes our current debt structure which includes a $25 million revolving credit facility, the Unsecured Notes and the Secured Notes. On March 22, 2010, we retired the Term B Senior Credit Agreement, the Subordinated Note and the Subordinated Note Warrants.
Credit Agreement
On March 22, 2010, we executed a new Credit Agreement (Credit Agreement), which consists of a $25.0 million senior revolving credit facility (Revolver) none of which was actually drawn as of June 30, 2010. The Credit Agreement lets us request up to $10.0 million in letters of credit and borrow up to $5.0 million in swing line loans for short-term needs. We must pay all Credit Agreement obligations in full by August 22, 2014. Alion can use the Revolver for working capital, permitted acquisitions and other general corporate purposes.

 

43


Table of Contents

Security. The Credit Agreement is secured by a first priority security interest in all current and future tangible and intangible property of Alion and its guarantor subsidiaries, HFA, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation. On March 22, 2010 Alion and its subsidiary guarantors executed an Intercreditor Agreement with Wilmington Trust Company and Credit Suisse AG, Cayman Islands Branch (Intercreditor Agreement) which gives Credit Agreement lenders a super priority right of payment with respect to the underlying collateral. Credit Agreement lender rights are superior to the Secured Note lender rights.
Guarantees. Our subsidiaries, HFA, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation guaranteed our Credit Agreement obligations. They also guaranteed all our Secured and Unsecured Note obligations (each described below).
Interest and Fees. We can choose whether the Revolver bears interest at one of two floating rates using either a Eurodollar rate or an alternative base rate. The minimum interest rate on the Revolver is 9.50%. The Eurodollar interest rate is 600 basis points plus a 3.5% minimum interest rate. The alternate base rate is 500 basis points plus a 4.5% minimum interest rate.
Other Fees and Expenses. Each quarter Alion is required to pay a commitment fee of 175 basis points per year on the prior quarter’s daily unused Revolver balance. As of June 30, 2010, $112 thousand was allocated to outstanding letters of credit. We paid approximately $112 thousand in commitment fees for the Revolver for the quarter ended June 30, 2010 and $179 thousand this year.
Alion must pay letter-of-credit issuance and administrative fees and up to a 25 basis point fronting fee. Each quarter we must also pay interest in arrears for all outstanding letters of credit. The interest rate is based on the Eurodollar loan rate which was 6.0% as of June 30, 2010. The Credit Agreement also requires us to pay an annual agent’s fee.
Covenants. The Credit Agreement requires us to achieve the following minimum trailing twelve month Consolidated EBITDA levels for the periods indicated:
         
Period   Minimum Consolidated EBITDA  
June 30, 2010 through March 31, 2011
  $52.5 million
April 1, 2011 through September 30, 2011
  $55.0 million
October 1, 2011 through September 30, 2012
  $60.0 million
October 1, 2012 through September 30, 2013
  $62.5 million
Thereafter
  $65.0 million
Consolidated EBITDA is defined as: (a) net income (or loss); plus (b) the following items, without duplication, to the extent deducted from net income or included in the net loss, the sum of: (i) consolidated interest expense; (ii) provision for income taxes; (iii) depreciation and amortization, including amortization of other intangible assets; (iv) cash contributions to the ESOP in respect of the repurchase liability of the Company under the ESOP Plan; (v) any non-cash charges or expenses including (A) non-cash expenses associated with the recognition of the difference between the fair market value of the (now extinguished Subordinated Note) Warrants and the exercise price of the Warrants, (B) non-cash expenses with respect to the stock appreciation rights and phantom stock plans, and the Warrants and accretion of the Warrants and (C) non-cash contributions to the ESOP; (vi) any extraordinary losses and (vii) any nonrecurring charges and adjustments by third-party valuation firm that prepares valuation reports in connection with the ESOP; minus (c) without duplication, (i) all cash payments made on account of reserves, restructuring charges and other non-cash charges added to net income (or included in net loss) pursuant to clause (b)(v) above in a previous period and (ii) to the extent included in net income (or net loss), any extraordinary gains and all non-cash items of income, in accordance with GAAP.
The Credit Agreement restricts us from doing any of the following without the prior consent of syndicate bank members that extended more than 50 percent of the aggregate amount of all Credit Agreement loans then outstanding:
    incur additional debt other than permitted additional debt;
    grant certain liens and security interests;
    enter into sale and leaseback transactions;
    make certain loans and investments including acquisitions of businesses, other than permitted acquisitions;
    consolidate, merge or sell all or substantially all our assets;
    pay dividends or distributions other than distributions required by the ESOP Plan or by certain legal requirements;
    enter into certain transactions with our shareholders and affiliates;
    change lines of business;

 

44


Table of Contents

    repay subordinated debt before it is due and redeem or repurchase certain equity;
    enter into certain transactions not permitted under ERISA;
    make more than $8 million in capital expenditures in any fiscal year;
    pay certain earn-outs in connection with permitted acquisitions; or
    change our fiscal year.
Events of Default. The Credit Agreement contains customary events of default including, without limitation:
    breach of representations and warranties;
    payment default;
    uncured covenant breaches;
    default under certain other debt exceeding an agreed amount;
    bankruptcy and insolvency events;
    incurrence of a civil or criminal liability in excess of $5 million of Alion or any subsidiary arising from a government investigation;
    unstayed judgments in excess of an agreed amount;
    failure of any Credit Agreement guarantee to be in effect;
    failure of the security interests to be valid, perfected first priority security interests in the collateral;
    notice of debarment, suspension or termination under a material government contract;
    actual termination of a material contract due to alleged fraud, willful misconduct, negligence, default or any other wrongdoing;
    certain ERISA violations;
    imposition on the ESOP Trust of certain taxes in excess of an agreed amount;
    final determination the ESOP is not a qualified plan;
    so long as any Secured Notes remain outstanding, the Intercreditor Agreement shall fail to be effective; or
    change of control (as defined below).
For purposes of the Credit Agreement, a change of control generally occurs when, before Alion lists its common stock to trade on a national securities exchange and obtains net proceeds from an underwritten public offering of at least $35.0 million, the ESOP Trust fails to own at least 51 percent of Alion’s outstanding equity interests, or, after such a qualified public offering, any person or group other than the ESOP Trust owns more than 37.5 percent of Alion’s outstanding equity interests. A change of control may also occur if a majority of the seats (other than vacant seats) on Alion’s Board of Directors shall at any time be occupied by persons who were neither nominated by the board nor were appointed by directors so nominated. A change of control may also occur if a change of control occurs under any of Alion’s material indebtedness including the Secured and Unsecured Note Indentures.
Secured Notes
On March 22, 2010, Alion issued and sold $310 million of its private units (Units) to Credit Suisse, which informed the Company it resold most of the units to qualified institutional buyers. Each of the 310,000 Units consisted of $1,000 in face value of Alion private senior secured notes (Secured Notes) and a warrant to purchase 1.9439 shares of Alion common stock. On July 30, 2010, the SEC declared effective an Alion registration statement on Form S-4 to effect an exchange offer of the Secured Notes for publicly registered Secured Notes with the same terms. The exchange offer opened August 3, 2010 and will close September 2, 2010.
Security. The Secured Notes are secured by a first priority security interest in all current and future tangible and intangible property of Alion and its guarantor subsidiaries, HFA, IPS, CATI, METI, JJMA, BMH, WCI, WCGS and MA&D. The Secured Notes are senior obligations of Alion and rank parri passu in right of payment with existing and future senior debt, including the Credit Agreement, except to the extent that the Intercreditor agreement provides Credit Agreement lenders with a super priority right of payment with respect to the underlying collateral.
Guarantees. The Company’s obligations under the Secured Notes are guaranteed by the Company’s subsidiaries, HFA, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation.

 

45


Table of Contents

Interest and Fees. The Secured Notes bear interest at 12% per year; 10% is payable in cash and 2% increases the Secured Note principal (PIK Interest). Interest is payable semi-annually in arrears on May 1 and November 1. Alion pays interest to holders of record as of the immediately preceding April 15 and October 15. We must pay interest on overdue principal or interest at 13% per annum to the extent lawful.
Covenants. There are no financial covenants in the Secured Note Indenture. As of June 30, 2010, we were in compliance with Secured Note Indenture non-financial covenants.
A Secured Note Indenture covenant restricts our ability to incur additional debt. Defined terms in the Secured Note Indenture include: Net Available Cash, Total Assets, Restricted Subsidiaries, Indebtedness, Adjusted EBITDA and Consolidated Interest Expense. Alion and its Restricted Subsidiaries may not issue, incur, assume, guarantee, or otherwise becoming liable for any debt unless our Adjusted EBITDA to Consolidated Interest Expense ratio is greater than 2.0 to 1.0. Even if Adjusted EBITDA is not at least two times Consolidated Interest Expense, we may incur other permitted debt including:
    Debt pursuant to certain agreements up to $25 million;
    Permitted inter-company debt;
    The Secured Notes and any public notes exchanged for those notes;
    Debt pre-dating the Secured Notes;
    Permitted debt of acquired subsidiaries;
    Permitted refinancing debt;
    Hedging agreement debt;
    Performance, bid, appeal and surety bonds and completion guarantees;
    Ordinary course insufficient funds coverage;
    Permitted refinancing debt guarantees;
    Working capital debt of non-U.S. subsidiaries;
    Debt for capital expenditures, and capital and synthetic leases up to $25 million in the aggregate $25 million and 2.5% of Alion’s Total Assets;
    Permitted subordinated debt of Alion or any Restricted Subsidiary to finance a permitted acquisition, certain permitted ESOP transactions and refinancing debt of acquired non-U.S. subsidiaries up to $35 million in the aggregate;
    Letter of credit reimbursement obligations;
    Certain agreements in connection with acquiring a business provided liabilities incurred in connection therewith are not reflected on the Company’s balance sheet;
    Certain deferred compensation agreements; and
    Certain other debt up to $20 million.
The Secured Note Indenture has a covenant that restricts our ability to declare and pay any cash dividend or other distribution related to any equity interest in Alion, repurchase or redeem any equity interest of Alion, repurchase or redeem the Unsecured Notes or other subordinated debt, or make certain investments. However, within certain limits we may make such payments in limited amounts if Adjusted EBITDA is at least two times Consolidated Interest Expense. Even if Adjusted EBITDA to Consolidated Interest Expense is not greater than 2.0 to 1.0, we may make or pay:
    Such payments out of substantially concurrent contributions of equity and substantially concurrent incurrences of permitted debt;
    Certain limited and permitted dividends;
    Certain repurchases of the Company’s equity securities deemed to occur upon exercise of stock options or warrants;
    Cash payments in lieu of issuing fractional shares for the exercise of warrants, options or other securities convertible into or exchangeable for our equity securities;
    The required Secured Note premium payable on a change of control;
    Certain permitted inter-company subordinated obligations;
    Certain repurchases and redemptions of subordination obligations of the Company or a Subsidiary Guarantor from Net Available Cash;
    Repurchases of subordinated obligations in connection with an asset sale to the extent required by the Secured Note Indenture;
    Certain permitted ESOP transactions;

 

46


Table of Contents

    Long-term incentive plan payments to our directors, officers and employees, subject to a $3 million annual cap that may increase annually;
    Any purchase, repurchase, redemption, defeasance or other acquisition or retirement for value of the Unsecured Notes, up to an aggregate amount of $10 million; and
    Certain other payments not exceeding $10 million in the aggregate.
The Secured Note Indenture restricts our ability to engage in other transactions including restricting our subsidiaries from making distributions and paying dividends to parents, merging or selling all or substantially all our assets, issuing certain subsidiary equity securities, engaging in certain transactions with affiliates, incurring liens, entering into sale lease-back transactions and engaging in business unrelated to our business when we issued the Secured Notes.
Events of Default. The Secured Note Indenture contains customary events of default, including:
    Payment default;
    Uncured covenant breaches;
    Default under an acceleration of certain other debt exceeding $30 million;
    Certain bankruptcy and insolvency events;
    Judgment for payment in excess of $30 million entered against Alion or any material subsidiary that remains outstanding for a period of 60 days and is not discharged, waived or stayed;
    Failure of any Secured Note guarantee to be in effect or any subsidiary guarantor’s denial or disaffirmation of its guaranty obligations; and
    Failure of any Secured Note security interest to constitute a valid and perfected lien with its applicable priority after a permitted cure period.
Change of Control. Upon a change in control, each Secured Note holder has the right to require Alion to repurchase its notes in cash for 101% of principal plus accrued and unpaid interest. Any of the following events constitutes a change in control:
    Subject to certain exceptions, a person, other than the ESOP Trust, is or becomes the beneficial owner, directly or indirectly, of more than 35% of the total voting power or voting stock of Alion;
    Individuals who constituted Alion’s board of directors on March 22, 2010, cease for any reason to constitute a majority of the Company’s board of directors;
    Adoption of a plan relating to Alion’s liquidation or dissolution; and
    Subject to certain exceptions, Alion’s merger or consolidation with or into another person or the merger of another person with or into Alion, or the sale of all or substantially all our assets to another person.
Optional Redemption. Prior to April 1, 2013, not more than once in any twelve month period, we may redeem up to $31 million of Secured Notes at a redemption price of 103% of the principal amount of the Secured Notes redeemed, plus accrued and unpaid interest to the redemption date.
Prior to April 1, 2013, the Company may redeem all, but not less than all, of the Secured Notes at a redemption price equal to 100% of the principal amount of the Secured Notes plus accrued and unpaid interest to the redemption date plus an applicable make-whole premium as of the redemption date.
In addition, any time prior to April 1, 2013, subject to certain conditions, the Company may use the proceeds of a qualified equity offering to redeem Unsecured Notes in an aggregate principal amount not to exceed $108.5 million at a redemption price equal to the sum of 112% of the aggregate principal amount of the notes actually redeemed, plus accrued and unpaid interest to the redemption date.
On or after April 1, 2013, the Company may redeem all or a portion of the Secured Notes at the redemption prices set forth below (expressed in percentages of principal amount on the redemption date), plus accrued and unpaid interest to the redemption date, if redeemed during the periods set forth below:
         
Period   Redemption Price  
April 1, 2013 to September 30, 2013
    105.0 %
October 1, 2013 to March 31, 2014
    103.0 %
April 1, 2014 and thereafter
    100.0 %

 

47


Table of Contents

Exchange Offer; Registration Rights. On June 18, 2010, we complied with the requirement that we file a registration statement with the SEC offering to exchange the Secured Notes for publicly registered notes with the same terms. The registration statement was declared effective on July 30, 2010. The exchange offer will close September 2, 2010.
Unsecured Notes
On February 8, 2007, we issued and sold $250.0 million of private 10.25% unsecured notes due February 1, 2015 (Unsecured Notes) to Credit Suisse, which informed us it had resold most of the notes to qualified institutional buyers. On June 20, 2007, we exchanged the private Unsecured Notes for publicly tradable Unsecured Notes with the same terms.
Guarantees. Alion’s obligations under the Unsecured Notes are guaranteed by our subsidiaries, HFA, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation.
Interest and Fees. The Unsecured Notes bear interest at 10.25% per year, payable semi-annually in arrears on February 1 and August 1. We pay interest to holders of record as of the immediately preceding January 15 and July 15. We must pay interest on overdue principal or interest at 11.25% per annum to the extent lawful.
Covenants. There are no financial covenants in the Unsecured Note Indenture. As of June 30, 2010, we were in compliance with Unsecured Note Indenture non-financial covenants.
A covenant in the Unsecured Note Indenture restricts our ability to incur additional debt. Defined terms in the Secured Note Indenture include: Net Available Cash, Total Assets, Restricted Subsidiaries, Indebtedness, Adjusted EBITDA and Consolidated Interest Expense. Alion and its Restricted Subsidiaries may not issue, incur, assume, guarantee, or otherwise become liable for any indebtedness unless our Adjusted EBITDA to Consolidated Interest Expense ratio is greater than 2.0 to 1.0. Even if Adjusted EBITDA is not at least two times Consolidated Interest Expense, we may incur other permitted debt including:
    Debt pursuant to our now terminated Term B Senior Credit Facility and certain other contracts up to $360 million less principal repayments made under that debt;
    Permitted inter-company debt;
    The Unsecured Notes;
    Debt pre-dating the Unsecured Notes;
    Permitted debt of acquired subsidiaries;
    Permitted refinancing debt;
    Hedging agreement debt;
    Performance, bid, appeal and surety bonds and completion guarantees;
    Ordinary course insufficient funds coverage;
    Permitted refinancing debt guarantees;
    Working capital debt of non-U.S. subsidiaries;
    Debt for capital expenditures, and capital and synthetic leases up to $25 million in the aggregate $25 million and 2.5% of Alion’s Total Assets;
    Permitted subordinated debt of Alion or any Restricted Subsidiary to finance a permitted acquisition, certain permitted ESOP transactions and refinancing debt of acquired non-U.S. subsidiaries up to $35 million in the aggregate;
    Letter of credit reimbursement obligations;
    Certain agreements in connection with acquiring a business provided liabilities incurred in connection therewith are not reflected on the Company’s balance sheet;
    Certain deferred compensation agreements; and
    Certain other debt up to $35 million.
The Unsecured Note Indenture has a covenant that restricts our ability to declare and pay any cash dividend or other distribution related to any equity interest in Alion, repurchase or redeem any equity interest of Alion, repurchase or redeem subordinated debt, or make certain investments. However, within certain limits we may make such payments in limited amounts if Adjusted EBITDA is at least two times Consolidated Interest Expense. Even if Adjusted EBITDA to Consolidated Interest Expense is not greater than 2.0 to 1.0, we may make or pay:
    Such payments out of substantially concurrent contributions of equity and substantially concurrent incurrences of permitted debt;
    Certain limited and permitted dividends;

 

48


Table of Contents

    Certain repurchases of the Company’s equity securities deemed to occur upon exercise of stock options or warrants;
    Cash payments in lieu of issuing fractional shares for the exercise of warrants, options or other securities convertible into or exchangeable for our equity securities;
    The required Unsecured Note premium payable on a change of control;
    Certain permitted inter-company subordinated obligations;
    Certain repurchases and redemptions of subordination obligations of the Company or a Subsidiary Guarantor from Net Available Cash;
    Repurchases of subordinated obligations in connection with an asset sale to the extent required by the Indenture;
    Repurchase of common stock from former Alion Joint Spectrum Center employees;
    Certain permitted transactions with the ESOP not exceeding $25 million in the aggregate; and
    Certain other payments not exceeding $30 million in the aggregate.
The Unsecured Note Indenture restricts our ability to engage in other transactions including restricting our subsidiaries from making distributions and paying dividends to parents, merging or selling all or substantially all our assets, issuing certain subsidiary equity securities, engaging in certain transactions with affiliates, incurring liens, entering into sale lease-back transactions and engaging in business unrelated to our business when we issued the Unsecured Notes.
Events of Default. The Unsecured Note Indenture contains customary events of default, including:
    Payment default;
    Uncured covenant breaches;
    Default under an acceleration of certain other debt exceeding $30 million;
    Certain bankruptcy and insolvency events;
    Judgment for payment in excess of $30 million entered against Alion or any material subsidiary that remains outstanding for a period of 60 days and is not discharged, waived or stayed; and
    Failure of any Unsecured Note guarantee to be in effect or any subsidiary guarantor’s denial or disaffirmation of its guaranty obligations.
Change of Control. Upon a change in control, each Unsecured Note holder has the right to require Alion to repurchase its notes in cash for 101% of principal plus accrued and unpaid interest. Any of the following events constitutes a change in control:
    Subject to certain exceptions, a person, other than the ESOP Trust, is or becomes the beneficial owner, directly or indirectly, of more than 35% of the total voting power or voting stock of Alion;
    Individuals who constituted Alion’s board of directors on February 8, 2007, cease for any reason to constitute a majority of the Company’s board of directors;
    Adoption of a plan relating to Alion’s liquidation or dissolution; and
    Subject to certain exceptions, Alion’s merger or consolidation with or into another person or the merger of another person with or into Alion, or the sale of all or substantially all our assets to another person.
Optional Redemption. Prior to February 1, 2011, we may redeem all, but not less than all, the Unsecured Notes at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest to the redemption date plus an applicable make-whole premium as of the redemption date.
On or after February 1, 2011, we may redeem all or a portion of the Unsecured Notes at the redemption prices set forth below (expressed in percentages of principal amount on the redemption date), plus accrued and unpaid interest to the redemption date, if redeemed during the 12-month period commencing on February 1 of the years set forth below:
         
Period   Redemption Price  
2011
    105.125 %
2012
    102.563 %
2013 and thereafter
    100.000 %
Exchange Offer; Registration Rights. The Company filed a registration statement with the SEC offering to exchange the Unsecured Notes for publicly registered notes. The registration statement was declared effective May 10, 2007; the exchange offer closed June 20, 2007; all outstanding notes were exchanged for publicly registered notes.

 

49


Table of Contents

Retired Term B Senior Credit Agreement
In August 2004, Alion entered into the Term B Senior Credit Agreement with a syndicate of financial institutions. On March 22, 2010, we used approximately $240 million in proceeds from issuing the Units to redeem and retire all the outstanding Term B loans and pay all unpaid interest accrued to redemption.
Retired Subordinated Note
In December 2002, Alion issued a $39.9 million Subordinated Note to IITRI as part of the purchase price for substantially all of IITRI’s assets. In July 2004, IIT acquired the Subordinated Note and related warrant agreement from IITRI. On March 22, 2010, we used $25 million in proceeds from issuing the Units to redeem the Subordinated Note and the related warrants held by IIT.
Revolving Credit Agreement — Covenant Compliance
Our revolving credit agreement defines Consolidated EBITDA and requires us to achieve certain levels in order to maintain access to our credit facility and avoid cross default on our Senior Secured and Unsecured Notes. Neither EBITDA nor Consolidated EBITDA is a measure of financial performance in accordance with generally accepted accounting principles.
Our revolving credit agreement permits us to exclude certain expenses and requires us to exclude certain one-time gains from Consolidated EBITDA. The revolving credit agreement requires us to have a minimum $52.5 million in Consolidated EBITDA for the twelve months ended June 30, 2010. We had $58.6 million in Consolidated EBITDA for the twelve months ended June 30, 2010 and exceeded the requirement by $6.1 million.
During the rest of this year and the next five fiscal years the Company expects that at a minimum, it will have to make the estimated interest and principal payments set forth below.
                                                 
    ($ In thousands)  
Fiscal Year:   2010     2011     2012     2013     2014     2015  
Bank revolving credit facility(1)
                                               
- Interest
  $ 112     $ 444     $ 445     $ 444     $ 396     $  
Secured Notes(2)
                                               
- Interest
          31,223       31,850       32,490       33,144       16,821  
 
                                               
- Principal and PIK Interest
                                  339,788  
Unsecured Notes(3)
                                               
- Interest
    12,813       25,625       25,625       25,625       25,625       12,813  
 
                                               
- Principal
                                  250,000  
 
                                   
Total cash — pay interest
    12,925       57,292       57,920       58,559       59,165       29,634  
 
                                               
Total cash — pay principal and PIK Interest
                                  589,788  
 
                                   
 
                                               
Total
  $ 12,925     $ 57,292     $ 57,920     $ 58,559     $ 59,165     $ 619,422  
 
                                   
     
(1)   We expect we will occasionally use our $25.0 million revolving credit facility to meet working capital needs through 2014. Management expects the average utilized revolver balance will be immaterial and that interest expense will consist of commitment fees for unused balances. The current facility expires August 22, 2014.
 
(2)   The Secured Notes bear interest at 10% in cash and 2% in PIK. Outstanding principal will increase over time for the 2% compounding PIK interest added to the initial $310 million in principal. The Secured Notes, including $29.8 million in PIK interest, mature November 1, 2014.
 
(3)   The Senior Unsecured Notes bear interest at 10.25% and mature February 1, 2015.

 

50


Table of Contents

Contingent Obligations
Secured Notes registration rights agreement
We entered into a registration rights agreement in connection with the sale of the Units which required us to file a registration statement with the SEC in order to conduct an offer to exchange the Secured Notes for publicly registered Secured Notes with the same terms. We filed a registration statement with the SEC on June 18, 2010 which was declared effective on July 30, 2010.
Earn-outs
Alion has one remaining earn-out commitment arising from our July 2007 LogCon Group acquisition. The maximum potential earn out is $500 thousand though July 2011; $100 thousand has already been earned and paid. Management believes any future LogCon Group earn-outs will not materially affect Alion’s cash flows, financial position or operating results.
Other contingent obligations which will impact the Company’s cash flow
Management forecasts that continuing net operating losses for income tax purposes will permit Alion to avoid significant cash outflows for income taxes. The Senior Secured Note Indenture requires us to either make a tender offer to note holders and use the proceeds of the WCGS ONR contract sale to redeem up to $5 million in Senior Secured Note principal at par, or re-invest the proceeds in our business. Other contingent obligations which will impact our cash flow include:
    ESOP share repurchase and diversification obligations; and
    Long-term incentive compensation plan obligations.
As of June 30, 2010, Alion had spent a cumulative total of $80.9 million to repurchase shares of its common stock to satisfy ESOP distribution and diversification requests from former employees and Plan beneficiaries. In 2008, we changed our prior practice of immediately paying out all distribution requests in full. In March 2008, we began paying ESOP beneficiaries over the five-year distribution period permitted by ERISA and the terms of the Plan. Alion intends to continue this practice for the foreseeable future in part to offset the cash flow effects of annual employee diversification requests that began in fiscal 2008 and which are expected to continue for the foreseeable future. Our debt agreements limit our ability to fund certain discretionary ESOP diversification demands on our cash flow. The table below lists current and prior year share re-purchases.
                         
    Number of                
    Shares             Total Value  
Date   Repurchased     Share Price     Purchased  
                (In thousands)  
December 2008
    233     $ 38.35     $ 9  
March 2009
    189,038     $ 38.35       7,250  
April 2009
    122     $ 34.30       4  
May 2009
    38     $ 34.30       1  
July 2009
    100     $ 34.30       3  
July 2009
    127     $ 38.35       5  
August 2009
    178     $ 34.30       6  
September 2009
    55,282     $ 34.30       1,896  
December 2009
    745     $ 34.50       26  
March 2010
    218,408     $ 34.50       7,535  
April 2010
    52     $ 28.00       1  
May 2010
    108     $ 28.00       3  
June 2010
    62,875     $ 28.00       1,761  
 
                   
Total
    527,306             $ 18,500  
 
                   
Management believes cash on hand, cash flow from operations and cash available under the current revolving credit facility will provide sufficient capital to fulfill current business plans and fund working capital needs for the next two to three years. Alion intends to focus on organic growth and improving processes and margins.
Although we expect to have positive annual operating cash flow eventually, we will need to generate significant additional revenue beyond current levels and earn net income in order to pay interest on the Secured Notes and Unsecured Notes and satisfy ESOP repurchase and diversification obligations.

 

51


Table of Contents

The Secured Indenture, Unsecured Indenture and the revolver allow Alion to make certain permitted acquisitions, and we intend to use available financing to do so. We will ultimately have to refinance the Secured Notes and Unsecured Notes which mature in November 2014 and February 2015 and will require us to pay out more than $600 million over a three-month period. We are uncertain whether, when and under what terms we can refinance these obligations. If we cannot refinance these obligations, we will not have sufficient cash from operations to meet all our obligations.
If plans or assumptions change, if assumptions prove inaccurate, if Alion consummates additional or larger investments in or acquisitions of other companies than are currently planned, if we experience unexpected costs or competitive pressures, or if existing cash and projected cash flows from operations prove insufficient, we may need to obtain additional financing and sooner than expected. We intend to only enter into new financing or refinancing we consider advantageous. However, even with moderately improved conditions in the high-yield credit market, we cannot be certain financing sources will be available in the future, or, if available, that financing terms would be favorable.
Recently Issued Accounting Pronouncements
Accounting Standards Update 2009-13 Revenue Recognition — Multiple Deliverable Revenue Arrangements (ASU 2009-13) was issued in October 2009 and updates Accounting Standards Codification (ASC) 605 — Revenue Recognition. ASU 2009-13 removes the objective-and-reliable-evidence-of-fair-value criterion from the separation criteria used to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting; replaces references to “fair value” with “selling price” to distinguish from the fair value measurements required under the “Fair Value Measurements and Disclosures” guidance; provides a hierarchy that entities must use to estimate the selling price; eliminates the use of the residual method for allocation; and expands the ongoing disclosure requirements. ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010, and can be applied prospectively or retrospectively. We are currently evaluating the effect, if any, that adopting ASU 2009-13 will have on our consolidated financial position and results of operations.
Accounting Standards Update 2009-14 Certain Revenue Arrangements That Include Software Elements (ASU 2009-14) was issued in October 2009 and updates ASC 985 — Software — Revenue Recognition. ASU 2009-14 clarifies which accounting guidance should be used to measure and allocate revenue for arrangements that contain both tangible products and software, where the software is more than incidental to the tangible product as a whole. ASU 2009-14 is effective for fiscal years beginning on or after June 15, 2010 and applies to arrangements entered into or materially modified on or after that date. We are currently evaluating the effect, if any, that adopting ASU 2009-14 will have on our consolidated financial position and results of operations.
Forward Looking Statements
Information included and incorporated by reference in this Form 10-Q may contain forward-looking statements that involve risks and uncertainties. These statements relate to our future plans, objectives, expectations and intentions and are for illustrative purposes only. These statements may be identified by the use of words such as “believe,” “expect,” “intend,” “plan,” “anticipate,” “likely,” “will,” “pro forma,” “forecast,” “projections,” “could,” “estimate,” “may,” “potential,” “should,” “would,” and similar expressions.
Factors that could cause actual results to differ materially from anticipated results include, but are not limited to:
    Any future inability to maintain adequate internal control over financial reporting;
    Limits on our financial and operational flexibility given our substantial debt and debt covenants;
    ERISA law changes related to the KSOP;
    Tax law changes that could affect our tax liabilities or effective tax rate;
    Changes in SEC rules, and other corporate governance requirements;
    Failure of government customers to exercise contract options;
    U.S. government project funding decisions;
    Government contract bid protest and termination risks;
    Competitive factors such as pricing pressures and/or competition to hire and retain employees;
    Results of current and/or future legal proceedings and government agency proceedings which may arise from our operations with attendant risks of fines, liabilities, penalties, suspension and/or debarment;
    Undertaking acquisitions that increase costs or liabilities or are disruptive;
    Taking on additional debt to fund acquisitions;

 

52


Table of Contents

    Failing to adequately integrate acquired businesses;
    Risks from private securities litigation, regulatory proceedings or government enforcement actions relating to prior covenant compliance disclosures;
    Material changes in laws or regulations affecting our businesses; and
    Other risk factors discussed in Alion’s annual report on Form 10-K for the year ended September 30, 2009 filed with the SEC on December 24, 2009 and any subsequent reports.
Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s view only as of August 10, 2010. We undertake no obligation to update any of the forward-looking statements made herein, whether as a result of new information, future events, changes in expectations or otherwise. This discussion addresses only continuing operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest rate risk
Alion’s Secured Notes and Unsecured Notes are fixed-rate debt. We only face interest rate risk for amounts outstanding under the $25 million revolver. Revolver balances bear interest at a 2.50% minimum Eurodollar rate plus 700 basis points (9.50%). If the Eurodollar rate were to exceed 2.50%, our interest expense would increase. However, we currently do not forecast drawing any material balance on the revolver. Therefore, any rate increase is not expected to have a material effect on Alion’s operating results or cash flows for any period from now through August 2014 when the revolver matures. We do not use derivatives for trading purposes. We invest excess cash in short-term, investment grade, and interest-bearing securities.
Foreign currency risk
Expenses and revenues from international contracts are generally denominated in U.S. dollars. Alion does not believe operations are subject to material risks from currency fluctuations.
Risk associated with value of Alion common stock
Changes in the fair market value of Alion’s stock affect our estimated KSOP share repurchase and stock-based compensation obligations. Several factors affect the timing and amount of these obligations, including: the number of employees who seek to redeem shares of Alion stock following termination of employment. Based on our current $28.00 per share price, no outstanding stock appreciation rights have any intrinsic value.
Item 4. Controls and Procedures
Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rule 15d — 15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports it is required to file or submit under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified by the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its Chief Executive and Chief Financial Officers, as appropriate to allow timely decisions regarding required disclosures. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective and timely.
Changes in Internal Control Over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 15d — 15(f) under the Exchange Act) during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 4T. Controls and Procedures
See disclosure under Item 4.

 

53


Table of Contents

PART II — OTHER INFORMATION
Item 1. Legal Proceedings
See Note 21 to the Condensed Consolidated Financial Statements. Other than the actions discussed in the Company’s most recent Annual Report on Form 10-K, the Company is not involved in any legal proceeding other than routine legal proceedings occurring in the ordinary course of business. Alion believes that these routine legal proceedings, in the aggregate, are not material to its financial condition and results of operations.
As a government contractor, Alion may be subject from time to time to federal government inquiries relating to its operations and to DCAA audits. The federal government can suspend or debar, for a period of time, a contractor that is indicted or found to have violated the False Claims Act or other federal laws. Such an event could also result in fines or penalties.
Item 1A. Risk Factors
As of June 30, 2010, the risk factors included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2009 as supplemented by the risk factors included in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010, have not materially changed.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
There were no sales of unregistered securities during the quarter ended June 30, 2010.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Removed and Reserved
Item 5. Other Information
None.

 

54


Table of Contents

Item 6. Exhibits
         
Exhibit    
No.   Description
  31.1    
Certification of Chief Executive Officer of Alion Science and Technology Corporation pursuant to Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
  31.2    
Certification of Chief Financial Officer of Alion Science and Technology Corporation pursuant to 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
  32.1    
Certification of Chief Executive Officer of Alion Science and Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2    
Certification of Chief Financial Officer of Alion Science and Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

55


Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
                 
    ALION SCIENCE AND TECHNOLOGY CORPORATION    
 
               
    By:   /s/ Michael J. Alber    
             
 
      Name:   Michael J. Alber    
 
      Title:   Principal Financial Officer and Duly Authorized Officer    
Date: August 10, 2010
               

 

56