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EX-32.1 - EXHIBIT 32.1 - ALION SCIENCE & TECHNOLOGY CORPc16024exv32w1.htm
EX-31.1 - EXHIBIT 31.1 - ALION SCIENCE & TECHNOLOGY CORPc16024exv31w1.htm
EX-31.2 - EXHIBIT 31.2 - ALION SCIENCE & TECHNOLOGY CORPc16024exv31w2.htm
EX-32.2 - EXHIBIT 32.2 - ALION SCIENCE & TECHNOLOGY CORPc16024exv32w2.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 MARCH 31, 2011
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.)
1750 Tysons Boulevard, Suite 1300
McLean, VA 22102
(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 May 16, 2011 was: Common Stock 5,792,360
 
 

 

 


 

ALION SCIENCE AND TECHNOLOGY CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2011
         
 
 
       
    1  
 
       
    1  
 
       
    2  
 
       
    3  
 
       
    4  
 
       
    28  
 
       
    44  
 
       
    44  
 
       
 
 
       
    45  
 
       
    45  
 
       
    45  
 
       
    45  
 
       
    45  
 
       
    45  
 
       
    46  
 
       
 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 March 31, 2011 and September 30, 2010
                 
    March 31,     September 30,  
    2011     2010  
    (In thousands, except share  
    and per share information)  
Current assets:
               
Cash and cash equivalents
  $ 20,647     $ 26,695  
Accounts receivable, net
    178,380       174,032  
Receivable due from ESOP Trust
          1,896  
Prepaid expenses and other current assets
    6,563       5,159  
 
           
Total current assets
    205,590       207,782  
Property, plant and equipment, net
    9,249       10,798  
Intangible assets, net
    14,190       17,694  
Goodwill
    398,921       398,921  
Other assets
    11,285       11,107  
 
           
Total assets
  $ 639,235     $ 646,302  
 
           
Current liabilities:
               
Interest payable
  $ 17,313     $ 17,217  
Trade accounts payable
    50,287       44,486  
Accrued liabilities
    41,917       43,145  
Accrued payroll and related liabilities
    35,827       40,221  
Billings in excess of revenue earned
    2,604       2,917  
 
           
Total current liabilities
    147,948       147,986  
Senior secured notes
    283,387       275,831  
Senior unsecured notes
    244,593       246,126  
Accrued compensation and benefits, excluding current portion
    6,538       6,174  
Non-current portion of lease obligations
    8,074       7,848  
Deferred income taxes
    40,694       37,207  
Redeemable common stock, $0.01 par value, 8,000,000 shares authorized, 5,792,360 and 5,658,234 shares issued and outstanding at March 31, 2011 and September 30, 2010
    157,263       150,792  
Common stock warrants
    20,785       20,785  
Accumulated other comprehensive loss
    (177 )     (177 )
Accumulated deficit
    (269,870 )     (246,270 )
 
           
Total liabilities, redeemable common stock and accumulated deficit
  $ 639,235     $ 646,302  
 
           
See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
Condensed Consolidated Statements of Operations (unaudited)
                                 
    Three Months Ended     Six Months Ended  
    March 31,     March 31,  
    2011     2010     2011     2010  
    (In thousands, except share and per share information)  
Contract revenue
  $ 202,551     $ 203,546     $ 403,319     $ 409,284  
Direct contract expense
    155,002       156,049       310,516       315,045  
 
                       
Gross profit
    47,549       47,497       92,803       94,239  
 
                       
Operating expenses:
                               
Indirect contract expense
    10,721       9,982       20,355       19,268  
General and administrative
    15,782       18,775       32,085       35,043  
Rental and occupancy expense
    7,799       8,298       15,529       16,284  
Depreciation and amortization
    2,814       4,212       5,804       8,443  
Loss on sale of subsidiary
    (148 )           (148 )      
 
                       
Total operating expenses
    36,968       41,267       73,625       79,038  
 
                       
Operating income
    10,581       6,230       19,178       15,201  
Other income (expense):
                               
Interest income
    10       12       30       57  
Interest expense
    (18,418 )     (14,097 )     (36,822 )     (30,983 )
Other
    (97 )     87       (158 )     (24 )
Gain on debt extinguishment
          50,749       460       50,749  
 
                       
Total other income (expense)
    (18,505 )     36,751       (36,490 )     19,799  
(Loss) income before taxes
    (7,924 )     42,981       (17,312 )     35,000  
Income tax expense
    (1,743 )     (33,816 )     (3,487 )     (33,776 )
 
                       
Net (loss) income
  $ (9,667 )   $ 9,165     $ (20,799 )   $ 1,224  
 
                       
 
                               
Basic and diluted earnings (loss) per share
    (1.74 )     1.69       (3.71 )     0.23  
 
                       
Basic and weighted average common shares outstanding
    5,540,869       5,411,342       5,598,766       5,417,756  
 
                       
See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
Condensed Consolidated Statements of Cash Flows (unaudited)
                 
    Six Months Ended  
    March 31,  
    2011     2010  
    (In thousands)  
Cash flows from operating activities:
               
Net (loss) income
  $ (20,799 )   $ 1,224  
Adjustments to reconcile net (loss) income to net cash used in operating activities:
               
Depreciation and amortization
    5,804       8,443  
Depreciation charged to direct costs
    35        
Paid in kind interest
    3,134       155  
Amortization of debt issuance costs
    5,017       2,223  
Change in fair value of redeemable common stock warrants
          (160 )
Incentive and stock-based compensation
    1,071       303  
Gain on debt extinguishment
    (460 )     (50,749 )
Deferred income taxes
    3,487       33,818  
Other gains and losses
    24       (1 )
Changes in assets and liabilities:
               
Accounts receivable
    (4,348 )     (7,691 )
Other assets
    (1,030 )     (754 )
Trade accounts payable
    5,801       10,539  
Accrued liabilities
    (1,209 )     5,675  
Interest payable
    96       (3,944 )
Other liabilities
    (104 )     839  
 
           
Net cash used in operating activities
    (3,481 )     (80 )
Cash flows from investing activities:
               
Cash paid for acquisition-related obligations
          (50 )
Capital expenditures
    (773 )     (1,271 )
Asset sale proceeds
    11       5  
 
           
Net cash used in investing activities
    (762 )     (1,316 )
Cash flows from financing activities:
               
Sale of secured notes
          281,465  
Sale of common stock warrants
          20,785  
Payment of debt issue costs
    (710 )     (16,710 )
Repayment of secured notes
    (1,510 )     (236,596 )
Repurchase of Subordinated Note and related warrants
          (25,000 )
Revolver borrowings
          84,200  
Revolver repayments
          (84,200 )
Loan to ESOP Trust
    (776 )     (5,323 )
ESOP loan repayment
    776       5,323  
Redeemable common stock purchased from ESOP Trust
    (3,209 )     (7,561 )
Redeemable common stock sold to ESOP Trust
    3,624       2,128  
 
           
Net cash (used in) provided by financing activities
    (1,805 )     18,511  
Net (decrease) increase in cash and cash equivalents
    (6,048 )     17,115  
Cash and cash equivalents at beginning of period
    26,695       11,185  
 
           
Cash and cash equivalents at end of period
  $ 20,647     $ 28,300  
 
           
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $ 28,604     $ 32,759  
Cash paid for taxes
          (42 )
Non-cash financing activities:
               
Common stock issued to ESOP Trust in satisfaction of employer contribution liability
  $ 5,150     $ 5,268  
See accompanying notes to condensed consolidated financial statements.

 

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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 federal government departments and agencies 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 12.
(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 six months ended March 31, 2011 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, 2010.
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.
Reclassifications
Certain items in the condensed consolidated financial statements have been reclassified to conform to the current presentation.

 

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Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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. Alion applies the percentage of completion method in Accounting Standards Codification (ASC) 605 — Revenue Recognition to recognize revenue.
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 Company timely submitted incurred cost proposals for all open years. The government has audited the Company’s claimed costs through fiscal year 2004. Alion 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. 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.
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.

 

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Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
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
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 or 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.

 

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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 7.5 to a high of 11.1, with a median value of 8.1. Market multiples for trailing twelve month revenue ranged from a low of 0.61 to a high of 0.76, with a median value of 0.71. 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. Consistent with industry norms, 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 9.0 to a high of 12.7, with a median value of 10.4. Prior year 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. The prior year weighted average cost of capital rate was 12.5% 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 to evaluate goodwill in prior periods. 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, 2010 would have produced a corresponding approximate 5% decrease or increase in estimated enterprise value. At September 30, 2010, market-multiple based enterprise value was not materially different from discounted cash flow enterprise value.
Management reviews Alion’s internally computed enterprise fair value to confirm the reasonableness of the internal 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 2010 and concluded no goodwill impairment existed as of September 30, 2010. The estimated fair value of each reporting unit substantially exceeded its September 2010 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 March 31, 2011 nor were there any significant events in the quarter that indicated impairment to goodwill as of March 31, 2011.
Intangible Assets
Alion amortizes intangible assets as it consumes economic benefits over estimated useful lives. As of March 31, 2011, the Company had approximately $14.2 million in net intangible assets, primarily contracts purchased through the JJMA and Anteon contract acquisitions. Alion’s intangible assets have the following estimated useful lives:
         
Purchased contracts
  1 – 13 years
Internal use software and engineering designs
  2 – 3 years
Non-compete agreements
  3 – 6 years

 

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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 the Employee Retirement Income Security Act (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 multiplied by 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 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. The Company recognized a $2.8 million increase in the fair value of its redeemable common stock this quarter. The accumulated deficit at March 31, 2011 included $51.9 million for cumulative changes in the Company’s share redemption liability. Outstanding redeemable common stock had an aggregate fair value of approximately $157.3 million as of March 31, 2011.
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.
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 2010-28 (ASU 2010-28) Goodwill and Other Intangibles — When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts was issued in December 2010 and updates ASC 350 — Goodwill and Other Intangibles (ASC 350). ASU 2010-28 modifies goodwill impairment testing for reporting units with zero or negative carrying amounts.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ASU 2010-28 requires an entity to perform a step two goodwill impairment analysis for reporting units with zero or negative carrying value as part of an annual goodwill impairment analysis; whenever an event occurs or circumstances indicate that a reporting unit’s fair value is more likely than not below its carrying amount; whenever an event occurs or circumstances indicate that a goodwill impairment exists; and upon adoption of the standard.
ASU 2010-28 is effective for fiscal years beginning on or after June 15, 2011, and can only be applied prospectively. Any goodwill impairment recognized on adopting ASU 2010-28 is to be recorded as a cumulative effect adjustment to retained earnings in the period of adoption. Any goodwill impairments occurring subsequent to adoption are to be recognized in current earnings as required by ASC 350. The Company is currently evaluating the effect, if any, that adopting ASU 2010-28 will have on Alion’s consolidated financial position and operating results.
(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 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 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 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 currently exercisable 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.
Terminating ESOP participants can hold or immediately sell their distributed shares to the Company. If a participant elects to hold distributed shares, the IRC and ERISA require Alion to offer a put option to allow the recipient to sell stock to Alion at the estimated fair value share price based on the most recent price at which the Company was able to sell shares to the ESOP Trust ($27.15 at March 31, 2011). The put right requires Alion to purchase distributed shares during two put option periods at 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, in estimating Alion’s aggregate liability for outstanding redeemable common stock owned by the ESOP Trust. A limited number of participants who beneficially acquired shares of Alion common stock on December 20, 2002, can sell such shares distributed from their accounts at the greater of $10.00 or the current estimated fair value share price.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
Alion makes 401(k) matching contributions in shares of its common stock and discretionary profit-sharing contributions in 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 expense for the KSOP for the quarters ended March 31, 2011 and 2010 and $6.4 million and $7.0 million in expense for six months ended March 31, 2011 and 2010.
(6) Accounts Receivable
Accounts receivable at March 31, 2011 and September 30, 2010 consisted of the following:
                 
    March 31,     September 30,  
    2011     2010  
    (In thousands)  
Billed receivables
  $ 85,290     $ 94,662  
Unbilled receivables:
               
Amounts currently billable
    34,728       36,021  
Revenues recorded in excess of milestone billings on fixed price contracts
    2,588       2,917  
Revenues recorded in excess of estimated contract value or funding
    36,779       24,952  
Retainages and other amounts billable upon contract completion
    22,499       19,278  
Allowance for doubtful accounts
    (3,504 )     (3,798 )
 
           
Total Accounts Receivable
  $ 178,380     $ 174,032  
 
           
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 $96.6 million as of March 31, 2011 and included approximately $36.8 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 $22.5 million at March 31, 2011.
(7) Property, Plant and Equipment
                 
    March 31,     September 30,  
    2010     2010  
    (In thousands)  
Leasehold improvements
  $ 10,888     $ 10,862  
Equipment and software
    34,226       33,693  
 
           
Total cost
    45,114       44,555  
Less: accumulated depreciation and amortization
    (35,865 )     (33,757 )
 
           
Net Property, Plant and Equipment
  $ 9,249     $ 10,798  
 
           

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Depreciation and leasehold amortization expense for fixed assets was approximately $1.1 million and $1.4 million for the quarters ended March 31, 2011 and 2010 and $2.3 million and $2.8 million for the six months ended March 31, 2011 and 2010.
(8) Goodwill and Intangible Assets
As of March 31, 2011, Alion had approximately $399 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 March 31, 2011 and September 30, 2010.
                                                 
    March 31, 2011     September 30, 2010  
            Accumulated                     Accumulated        
    Gross     Amortization     Net     Gross     Amortization     Net  
 
                                               
Purchased contracts
  $ 111,635     $ (97,628 )   $ 14,007     $ 111,635     $ (94,228 )   $ 17,407  
Internal use software and engineering designs
    2,155       (1,972 )     183       2,155       (1,868 )     287  
 
                                   
Total
  $ 113,790     $ (99,600 )   $ 14,190     $ 113,790     $ (96,096 )   $ 17,694  
 
                                   
The weighted-average remaining amortization period of intangible assets was approximately 3.5 years at March 31, 2011 and 4.0 years at September 30, 2010. Amortization expense was approximately $1.8 million and $2.8 million for the quarters ended March 31, 2011 and 2010 and $3.5 million and $5.6 million for the six months ended March 31, 2010 and 2011. Estimated aggregate amortization expense for the next five years and thereafter is as follows.
         
    (In thousands)  
 
       
2011 (for the remainder of fiscal year)
  $ 3,338  
2012
    5,766  
2013
    3,246  
2014
    879  
2015
    737  
2016
    141  
Thereafter
    83  
 
     
 
  $ 14,190  
 
     
(9) Long-Term Debt
Alion’s current debt structure includes a $35 million revolving credit facility, $310 million in Secured Notes and $248 million of Unsecured Notes. On March 22, 2010, the Company retired its Term B Senior Credit Agreement, its Subordinated Note and Subordinated Note Warrants. Alion is in compliance with each of the affirmative and negative financial and non-financial covenants in its existing debt agreements.
Credit Agreement
In March 2010, Alion entered into an agreement for a $25.0 million senior revolving credit facility that matures August 2014. In March 2011, Alion and its lenders amended the credit facility agreement to increase the credit limit to $35.0 million. The Company can use the credit facility for working capital, permitted acquisitions and general corporate purposes, including up to $35.0 million in letters of credit and up to $5.0 million in short-term swing line loans. As of March 31, 2011, the Company had $545 thousand in outstanding letters of credit.
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. The Company’s subsidiaries, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation guarantee Alion’s credit agreement obligations, the Secured Notes and the Unsecured Notes. Alion and its subsidiary guarantors executed an agreement with Wilmington Trust Company and Credit Suisse AG, Cayman Islands Branch that grants credit facility lenders a priority payment right superior to the Secured Note lenders’ rights.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Alion can choose either a floating Eurodollar interest rate or a floating alternate base rate to determine credit facility interest expense. The minimum interest rate is 8.50%. The minimum Eurodollar rate is 3.5% plus 500 basis points. The minimum alternate base rate is 4.5% plus 400 basis points.
Each quarter Alion pays a commitment fee on the prior quarter’s daily unused credit facility balance at 1.75% per year. The Company paid $118 thousand and $12 thousand in commitment fees for the quarters ended March 31, 2011 and 2010. The Company paid $230 thousand and $67 thousand in commitment fees for its current and prior credit facilities for the six months ended March 31, 2011 and 2010.
Alion must pay letter-of-credit issuance and administrative fees, up to a 25 basis point fronting fee and interest in arrears each quarter on all outstanding letters of credit. The interest rate is based on the Eurodollar loan rate which was 6.0% as of March 31, 2011. Alion also pays an annual agent’s fee.
The credit agreement requires Alion to achieve minimum trailing twelve month Consolidated EBITDA levels which increase over the life of the agreement. The table below sets out the required minimum for the period 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
October 1, 2013 through August 22, 2014
  $65.0 million
The agreement defines Consolidated EBITDA as net income or loss in accordance with GAAP, plus the following items, without duplication, to the extent deducted from or included in net income or loss:
    consolidated interest expense;
    provision for income taxes;
    depreciation and amortization;
    cash contributed to the ESOP in respect of Alion’s repurchase liability;
    non-cash stock-based and incentive compensation expense;
    non-cash ESOP contributions;
    any extraordinary losses; and
    nonrecurring charges and adjustments included in ESOP valuation reports as prepared by an independent third party.
To the extent included in net income or loss, the following items, without duplication, are deducted in determining Consolidated EBITDA:
    all cash payments on account of reserves, restructuring charges or other non-cash charges added to net income pursuant to the list above in a previous period;
    any extraordinary gains; and
    all non-cash items of income.
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. On September 2, 2010, Alion exchanged the private Secured Notes for publicly tradable Secured Notes with the same terms.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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. The Secured Notes are senior obligations of Alion and rank pari passu in right of payment with existing and future senior debt, except to the extent Credit Agreement lenders have a super priority right of payment with respect to the underlying collateral.
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. IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation guarantee the Unsecured Notes.
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 retired all Term B Senior Credit Agreement interest and principal with proceeds from issuing the Secured Notes and warrants. Alion recognized a $6.9 million loss on extinguishing the Term B loans.
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. 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 related warrants for $25 million and to defer Alion’s January 2010 interest payment to April 2010. On March 22, 2010, the Company retired the Subordinated Note and related warrants for $25 million using proceeds from issuing the Secured Notes and Secured Note warrants. 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.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Interest Payable
Interest Payable consisted of the following balances:
                 
    March 31,     September 30,  
    2011     2010  
    (In thousands)  
Unsecured Notes
  $ 4,239     $ 4,271  
Secured Notes
    13,074       12,946  
 
           
Total
  $ 17,313     $ 17,217  
 
           
As of March 31, 2011, Alion must make the following principal repayments (at face amount before debt discount) for its outstanding debt.
                                                 
Fiscal Year:   2011     2012     2013     2014     2015     Total  
 
                                               
Secured Notes and PIK Interest(1)
  $     $     $     $     $ 339,788     $ 339,788  
Unsecured Notes(2)
                            248,000       248,000  
 
                                   
Total Principal Payments
  $     $     $     $     $ 587,788     $ 587,788  
 
                                   
     
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 March 31, 2011, the $283.4 million carrying value on the face of the balance sheet included $310 million in principal, $6.4 million in accrued PIK interest and is net of $33.0 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 $248 million in principal and $3.4 million in unamortized debt issue costs as of March 31, 2011 (initially $7.1 million).
(10) Fair Value Measurement
The Company adopted ASC 820 — Fair Value Measurements and Disclosures in fiscal year 2010 for all nonfinancial assets and liabilities recognized or disclosed at fair value in the financial statements on a nonrecurring basis. Adopting ASC 820 for items such as goodwill and long lived assets measured at fair value if impaired, did not materially affect the Company’s consolidated financial position or operating results. As of March 31, 2011, the Company has no assets or liabilities it is required to measure at fair value on a recurring basis.
ASC 820 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.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 a fair value determination requires significant judgment or estimation.
On 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 their historical date-of-issue fair value. As permanent equity, the value of the Secured Note warrants is not re-measured at future reporting dates.
Alion 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. The following table provides a summary of the changes in fair value of the now-retired Subordinated Note Warrants which were measured at fair value on a recurring basis using Level 3 inputs. The Company had no other assets or liabilities it was required to measure at fair value on a recurring basis.
                 
    As of March 31  
    2011     2010  
    Redeemable Common Stock  
    Warrants  
Balance, beginning of period
  $     $ (32,557 )
Total realized and unrealized gains and (losses)
          14,724  
Included in interest expense
          (160 )
Issuances and settlements
          17,993  
 
           
Balance, end of period
  $     $  
 
           
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 this period.
(11) 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.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 amending the Subordinated Note. 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.
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.
(12) Secured Note Common Stock Warrants
On March 22, 2010, Alion issued 310,000 Units. Each Unit consisted 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 registered the Secured Notes, but was not required to register the warrants. The Units separated into Secured Notes and warrants on June 22, 2010. Each warrant became exercisable March 22, 2011, and expires 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 a corresponding credit to equity. The Company accounts for the Secured Note warrants as equity and reassesses this classification each reporting period. The Company identified no required changes in accounting treatment as of March 31, 2011.
(13) Leases
Future minimum lease payments under non-cancelable operating leases for buildings, equipment and automobiles at March 31, 2011 are set out below. Alion has subleased some excess capacity to subtenants under non-cancelable operating leases.
         
Lease Payments for Fiscal Years Ending   (In thousands)  
2011 (for the remainder of fiscal year)
  $ 13,886  
2012
    25,643  
2013
    23,893  
2014
    22,723  
2015
    22,674  
2016
    19,185  
And thereafter
    32,282  
 
     
Gross lease payments
  $ 160,286  
Less: non-cancelable subtenant receipts
    (1,652 )
 
     
Net lease payments
  $ 158,634  
 
     
Composition of Total Rent Expense
                 
    March 31,  
    2011     2010  
    (In thousands)  
Minimum rentals
  $ 11,055     $ 11,649  
Less: Sublease rental income
    (956 )     (958 )
 
           
Total rent expense, net
  $ 10,099     $ 10,691  
 
           

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(14) Long Term Incentive Compensation Plan
Alion adopted a long-term cash incentive compensation plan for certain executives in December 2008. Individual grants contain specific financial and performance goals and vest over varying periods. Some grants are for a fixed amount; others provide a range of values from a minimum of 50% to a maximum of 150% of initial grant value. The Company periodically evaluates the probability that individuals will achieve stated financial and performance goals.
Alion recognizes long term incentive compensation expense based on outstanding grants’ stated values, estimated probability of achieving stated goals and estimated probable future grant values. The Company recognized $94 thousand and $925 thousand in incentive compensation expense for the three and six months ended March 31, 2011. Alion recognized $565 thousand and $1.2 million in incentive compensation expense for the three and six month periods ended March 31, 2010.
(15) Stock Based Compensation
SAR Plan
Alion’s Stock Appreciation Rights Plan adopted in 2004 expires in 2014. The chief executive officer may award SARs as he deems appropriate. Awards vest ratably over four years with payment following the grant date fifth anniversary. Grants with no intrinsic value expire on their year-five payment date. The plan permits accelerated vesting in the event of death, disability or a change in control of the Company. Approximately 887 thousand SARs were outstanding at March 31, 2011, at a weighted average grant date fair value of $34.34 per share. Few outstanding SARs have any intrinsic value. For the quarter ended March 31, 2011 the Company recognized compensation expense of $109 thousand and for the quarter ended March 31, 2010, the Company recognized a credit to compensation expense of $893 thousand. For the six months ended March 31, 2011 the Company recognized compensation expense of $142 thousand and for the six months ended 2010 the Company recognized a credit to compensation expense of $879 thousand.
Phantom Stock Plans
Alion formerly maintained Executive and Director Phantom Stock Plans which permitted the Company to issue up to 2 million phantom shares that conveyed no voting or other common stock ownership rights. One grant worth approximately $133 thousand remains outstanding. Alion recognized no expense and $26 thousand in compensation expense for the quarters ended March 31, 2011 and 2010. Compensation expense was $4 and $8 thousand for the six months ended March 31, 2011 and 2010.
The Company uses a Black-Scholes-Merton option pricing model based on the fair market value of a share of its common stock to recognize stock —based compensation expense. There is no established public trading market for Alion’s common stock. The ESOP Trust owns all outstanding common stock. Alion does not expect to pay any dividends on its common stock and intends to retain future earnings, if any, to use in operating its business.
(16) Segment Information and Customer Concentration
Alion operates in a single 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. The Company provides services to federal government departments and agencies and some commercial and international customers. Federal government customers typically exercise independent contracting authority. Federal agency and department offices or divisions may use Alion’s services as separate customers directly, or through a prime contractor, as long as they have independent decision-making and contracting authority in their organization.
Federal government agency prime contract receivables were approximately $117.6 million (65%), and $114.8 million (65%) of aggregate contract receivables as of March 31, 2011 and September 30, 2010. Federal government prime and subcontract revenue was approximately 97.3% and 97.2%, of total contract revenue for the six months ended March 31, 2011 and 2010.
(17) Income Taxes
Deferred Taxes
Alion is subject to income taxes in the U.S., various states and Canada. Tax statutes and regulations within each jurisdiction are subject to interpretation requiring management to apply significant judgment. Alion recorded $1.7 million in deferred tax expense and liabilities related to tax-basis goodwill amortization this quarter and $3.5 million in deferred tax expense for the year.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company expects to be able to use existing and anticipated net operating losses (NOL) to offset taxes that may become due in the future if Alion has future taxable income. Even though Alion recorded a full valuation allowance for all deferred tax assets, the Company does not expect to pay any income taxes for the foreseeable future. Alion’s ability to utilize NOL tax benefits will depend upon how much future taxable income it has and may be limited under certain circumstances. Alion does not have any NOL tax benefits it can carry back to prior years.
Alion’s effective tax rate for the six months ended March 31, 2011 was -20.1%. As of March 31, 2011 and September 30, 2010 the net deferred tax liability was:
                 
    March 31,     September 30,  
    2011     2010  
    (in thousands)  
 
               
Current deferred tax asset
  $ 9,327     $ 11,175  
Noncurrent deferred tax asset
    37,845       25,754  
Valuation allowance
    (47,172 )     (36,929 )
Noncurrent deferred tax liability
    (40,694 )     (37,207 )
Net deferred tax liability
  $ (40,694 )   $ (37,207 )
Tax Uncertainties
Based on the latest available information, Alion periodically assesses its liabilities and contingencies for all periods open to examination by tax authorities. Where management believes there is more than a 50 percent chance the Company’s tax position will not be sustained, Alion records its best estimate of the resulting tax liability, including interest. Any interest or penalties related to income taxes are reported separately from income tax expense. The Company has recorded liabilities for tax uncertainties for all years that remain open to review.
Alion may become subject to federal or state income tax examination for tax years ended September 2007 and forward. Alion’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. The Company does not expect resolution of tax matters for any open years to materially affect operating results, financial condition, cash flows or its effective tax rate.
(18) Debt Extinguishment
On March 22, 2010, Alion sold $310 million in Secured Note Units. The Company used some of the proceeds to pay outstanding interest and principal on its formerly outstanding Term B Senior Credit Agreement and to retire its Subordinated Note and related redeemable common stock warrants at a discount. Alion recognized a net gain of $50.7 million on extinguishing its Term B and subordinated debt. The Company expensed $16.9 million in unamortized debt issue costs; recognized a $53.1 million gain on retiring the Subordinated Note; and recognized a $14.6 million gain on retiring redeemable common stock warrants.
On November 9, 2010, Alion re-purchased $2.0 million of its Senior Unsecured Notes at approximately 25% less than face value and recognized a $460 thousand gain on the transaction.
(19) Commitments and Contingencies
Earn-Out and Hold-Back Commitments
The Company has a maximum remaining $100 thousand earn-out commitment that expires in July 2011 for its LogConGroup acquisition.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Legal Proceedings
On February 16, 2011, a Louisiana civil court entered a $1.9 million judgment against the Company for a workplace-related injury claim. The case was defended by Alion’s insurer which has appealed the judgment. The Company recognized a liability for the $500 thousand policy deductible which is the limit of Alion’s judgment-related exposure in this case.
Alion is involved in various other claims and legal actions arising in the ordinary course of business. Management believes ultimate disposition of these matters will not materially affect the Company’s business, financial position, operating results or ability to meet its financial obligations.
Government Audits
Alion’s cost reimbursement federal government contract revenue and expense is subject to DCAA audit and possible adjustment. Alion is a major federal government contractor. DCAA maintains an on site office to perform various audits. DCAA has audited Alion’s federal government contract costs through 2004. The Company has settled claims through 2004. Alion records federal government contract revenue at the amounts it expects to realize on final settlement.
(20) Guarantor/Non-guarantor Condensed Consolidated Financial Information
Certain of Alion’s wholly-owned domestic subsidiaries have jointly, severally, fully and unconditionally guaranteed both the Secured Notes and the Unsecured Notes which 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 following information presents condensed consolidating balance sheets as of March 31, 2011 and September 30, 2010, condensed consolidating statements of operations for the quarters and six months ended March 31, 2011 and 2010; and condensed consolidating statements of cash flows for the six months ended March 31, 2011 and 2010 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.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Balance Sheet as of March 31, 2011
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
    (In thousands)  
Current assets:
                                       
Cash and cash equivalents
  $ 20,699     $ (69 )   $ 17     $     $ 20,647  
Accounts receivable, net
    175,154       2,935       291             178,380  
Prepaid expenses and other current assets
    6,501       62                   6,563  
 
                             
Total current assets
    202,354       2,928       308             205,590  
Property, plant and equipment, net
    9,204       36       9             9,249  
Intangible assets, net
    14,190                         14,190  
Goodwill
    398,921                         398,921  
Investment in subsidiaries
    21,168                   (21,168 )      
Intercompany receivables
    1,321       20,653             (21,974 )      
Other assets
    11,268       14       3             11,285  
 
                             
Total assets
  $ 658,426     $ 23,631     $ 320     $ (43,142 )   $ 639,235  
 
                             
Current liabilities:
                                       
Interest payable
    17,313                         17,313  
Trade accounts payable
    49,978       308       1             50,287  
Accrued liabilities
    41,694       171       52             41,917  
Accrued payroll and related liabilities
    34,925       857       45             35,827  
Billings in excess of revenue earned
    2,599       5                   2,604  
 
                             
Total current liabilities
    146,509       1,341       98             147,948  
Intercompany payables
    20,653             1,321       (21,974 )      
Senior secured notes
    283,387                         283,387  
Senior unsecured notes
    244,593                         244,593  
Accrued compensation and benefits, excluding current portion
    6,538                         6,538  
Non-current portion of lease obligations
    8,052       22                   8,074  
Deferred income taxes
    40,694                         40,694  
Redeemable common stock
    157,263                         157,263  
Common stock warrants
    20,785                         20,785  
Common stock of subsidiaries
          2,801             (2,801 )      
Accumulated other comprehensive loss
    (177 )                       (177 )
Accumulated deficit
    (269,871 )     19,467       (1,099 )     (18,367 )     (269,870 )
 
                             
Total liabilities, redeemable common stock and accumulated deficit
  $ 658,426     $ 23,631     $ 320     $ (43,142 )   $ 639,235  
 
                             

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Balance Sheet as of September 30, 2010
(In thousands)
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
Current assets:
                                       
Cash and cash equivalents
  $ 26,770     $ (75 )   $     $     $ 26,695  
Accounts receivable, net
    170,676       3,312       44             174,032  
Receivable due from ESOP Trust
    1,896                           1,896  
Prepaid expenses and other current assets
    5,112       47                   5,159  
 
                             
Total current assets
    204,454       3,284       44             207,782  
Property, plant and equipment, net
    10,755       43                   10,798  
Intangible assets, net
    17,694                         17,694  
Goodwill
    398,921                         398,921  
Investment in subsidiaries
    18,844                   (18,844 )      
Intercompany receivables
    1,054       18,235             (19,289 )      
Other assets
    11,091       13       3             11,107  
 
                             
Total assets
  $ 662,813     $ 21,575     $ 47     $ (38,133 )   $ 646,302  
 
                             
Interest payable
  $ 17,217     $     $     $     $ 17,217  
Trade accounts payable
    44,065       421                   44,486  
Accrued liabilities
    42,865       271       9             43,145  
Accrued payroll and related liabilities
    39,277       924       20             40,221  
Billings in excess of revenue earned
    2,882       35                   2,917  
 
                             
Total current liabilities
    146,306       1,651       29             147,986  
Intercompany payables
    18,236             1,053       (19,289 )      
Senior secured notes
    275,831                         275,831  
Senior unsecured notes
    246,126                         246,126  
Accrued compensation and benefits, excluding current portion
    6,174                         6,174  
Non-current portion of lease obligations
    7,805       43                   7,848  
Deferred income taxes
    37,207                         37,207  
Redeemable common stock
    150,792                         150,792  
Common stock of subsidiaries
          2,801             (2,801 )      
Common stock warrants
    20,785                               20,785  
Accumulated other comprehensive loss
    (177 )                       (177 )
Accumulated deficit
    (246,272 )     17,080       (1,035 )     (16,043 )     (246,270 )
 
                             
Total liabilities, redeemable common stock and accumulated deficit
  $ 662,813     $ 21,575     $ 47     $ (38,133 )   $ 646,302  
 
                             

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Operations for the Three Months Ended March 31, 2011
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
    (In thousands)  
Contract revenue
  $ 198,155       4,157       239           $ 202,551  
Direct contract expense
    152,505       2,337       160             155,002  
 
                             
Gross profit
    45,650       1,820       79             47,549  
 
                             
Operating expenses:
                                       
Indirect contract expense
    10,028       674       19             10,721  
General and administrative
    15,585       132       65             15,782  
Rental and occupancy expense
    7,681       106       12             7,799  
Depreciation and amortization
    2,810       4                   2,814  
Loss on sale of subsidiary
    (148 )                       (148 )
 
                             
Total operating expenses
    35,956       916       96             36,968  
 
                             
Operating income
    9,694       904       (17 )           10,581  
Other income (expense):
                                       
Interest income
    10                         10  
Interest expense
    (18,418 )                       (18,418 )
Other
    (224 )     127                   (97 )
Equity in net income (loss) of subsidiaries
    1,014                     (1,014 )      
 
                             
Total other expenses
    (17,618 )     127             (1,014 )     (18,505 )
 
                             
(Loss) income before taxes
    (7,924 )     1,031       (17 )     (1,014 )     (7,924 )
Income tax expense
    (1,743 )                       (1,743 )
 
                             
Net income (loss)
  $ (9,667 )     1,031       (17 )     (1,014 )   $ (9,667 )
 
                             

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Operations for the Three Months Ended March 31, 2010
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
    (In thousands)  
Contract revenue
  $ 195,192     $ 8,322     $ 32     $     $ 203,546  
Direct contract expense
    150,349       5,680       20             156,049  
 
                             
Gross profit
    44,843       2,642       12             47,497  
 
                             
Operating expenses:
                                       
Indirect contract expense
    9,023       949       10             9,982  
General and administrative
    18,481       204       90             18,775  
Rental and occupancy expense
    8,138       149       11             8,298  
Depreciation and amortization
    4,199       13                   4,212  
 
                             
Total operating expenses
    39,841       1,315       111             41,267  
 
                             
Operating income
    5,002       1,327       (99 )           6,230  
Other income (expense):
                                       
Interest income
    12                         12  
Interest expense
    (14,097 )                       (14,097 )
Other
    8       79                   87  
Gain on debt extinguishment
    50,749                         50,749  
Equity in net income of subsidiaries
    1,309                   (1,309 )      
 
                             
Total other expenses
    37,981       79             (1,309 )     36,751  
 
                             
(Loss) income before taxes
    42,983       1,406       (99 )     (1,309 )     42,981  
Income tax (expense) benefit
    (33,818 )     2                   (33,816 )
 
                             
Net income (loss)
  $ 9,165     $ 1,408     $ (99 )   $ (1,309 )   $ 9,165  
 
                             

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Operations for the Six Months Ended March 31, 2011
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
    (In thousands)  
Contract revenue
  $ 393,916     $ 8,973     $ 430     $     $ 403,319  
Direct contract expense
    305,096       5,126       294             310,516  
 
                             
Gross profit
    88,820       3,847       136             92,803  
 
                             
Operating expenses:
                                       
Indirect contract expense
    19,051       1,284       20             20,355  
General and administrative
    31,715       215       155             32,085  
Rental and occupancy expense
    15,308       197       24             15,529  
Depreciation and amortization
    5,797       7                   5,804  
Loss on sale of subsidiary
    (148 )                       (148 )
 
                             
Total operating expenses
    71,723       1,703       199             73,625  
 
                             
Operating income
    17,097       2,144       (63 )           19,178  
Other income (expense):
                                       
Interest income
    30                         30  
Interest expense
    (36,822 )                       (36,822 )
Other
    (400 )     242                   (158 )
Gain on debt extinguishment
    460                         460  
Equity in net income of subsidiaries
    2,323                   (2,323 )      
 
                             
Total other expenses
    (34,409 )     242             (2,323 )     (36,490 )
 
                             
(Loss) income before taxes
    (17,312 )     2,386       (63 )     (2,323 )     (17,312 )
Income tax expense
    (3,487 )                       (3,487 )
 
                             
Net (loss) income
  $ (20,799 )   $ 2,386     $ (63 )   $ (2,323 )   $ (20,799 )
 
                             

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Operations for the Six Months Ended March 31, 2010
                                         
                    Non-              
            Guarantor     Guarantor              
    Parent     Companies     Companies     Eliminations     Consolidated  
    (In thousands)  
Contract revenue
  $ 392,466       16,748       70           $ 409,284  
Direct contract expense
    303,814       11,186       45             315,045  
 
                             
Gross profit
    88,652       5,562       25             94,239  
 
                             
Indirect contract expense
    17,394       1,856       18             19,268  
General and administrative
    34,519       369       155             35,043  
Rental and occupancy expense
    15,968       295       21             16,284  
Depreciation and amortization
    8,418       25                   8,443  
 
                             
Total operating expenses
    76,299       2,545       194             79,038  
 
                             
Operating income
    12,353       3,017       (169 )           15,201  
Other income (expense):
                                       
Interest income
    57                         57  
Interest expense
    (30,983 )                       (30,983 )
Other
    (174 )     150                   (24 )
Gain on debt extinguishment
    50,749                         50,749  
Equity in net income (loss) of subsidiaries
    3,040                     (3,040 )      
 
                             
Total other expenses
    22,689       150             (3,040 )     19,799  
 
                             
Income (loss) before taxes
    35,042       3,167       (169 )     (3,040 )     35,000  
Income tax (expense) benefit
    (33,818 )     2       40             (33,776 )
 
                             
Net income (loss)
  $ 1,224       3,169       (129 )     (3,040 )   $ 1,224  
 
                             

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Cash Flows for the Six Months Ended March 31, 2011
                                 
                    Non-        
            Guarantor     Guarantor        
    Parent     Companies     Companies     Consolidated  
    (In thousands)  
Net cash (used in) provided by operating activities
  $ (3,513 )   $ 6     $ 26     $ (3,481 )
 
                               
Cash flows from investing activities:
                               
Capital expenditures
    (764 )           (9 )     (773 )
Proceeds from sale of assets
    11                   11  
 
                       
Net cash used in investing activities
    (753 )           (9 )     (762 )
Cash flows from financing activities:
                               
Payment of debt issue costs
    (710 )                 (710 )
Repayment of secured notes
    (1,510 )                 (1,510 )
Loan to ESOP Trust
    (776 )                 (776 )
ESOP loan repayment
    776                   776  
Redeemable common stock purchased from ESOP Trust
    (3,209 )                 (3,209 )
Redeemable common stock sold to ESOP Trust
    3,624                   3,624  
 
                       
Net cash used in financing activities
    (1,805 )                 (1,805 )
Net (decrease) increase in cash and cash equivalents
    (6,071 )     6       17       (6,048 )
Cash and cash equivalents at beginning of period
    26,771       (75 )     (1 )     26,695  
 
                       
Cash and cash equivalents at end of period
  $ 20,700     $ (69 )   $ 16     $ 20,647  
 
                       

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Cash Flows for the Six Months Ended March 31, 2010
                                 
                    Non-        
            Guarantor     Guarantor        
    Parent     Companies     Companies     Consolidated  
    (In thousands)  
Net cash (used in) provided by operating activities
  $ (73 )   $ (10 )   $ 3     $ (80 )
 
                               
Cash flows from investing activities:
                               
Cash paid for acquisitions-related obligations
    (50 )                 (50 )
Capital expenditures
    (1,255 )     (16 )           (1,271 )
Asset sale proceeds
    5                   5  
 
                       
Net cash used in investing activities
    (1,300 )     (16 )           (1,316 )
Cash flows from financing activities:
                               
Sale of secured notes
    281,465                   281,465  
Sale of common stock warrants
    20,785                   20,785  
Payment of debt issue costs
    (16,710 )                 (16,710 )
Repayment of secured notes
    (236,596 )                 (236,596 )
Repurchase of subordinated note and related warrants
    (25,000 )                 (25,000 )
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
    (7,561 )                 (7,561 )
Redeemable common stock sold to ESOP Trust
    2,128                   2,128  
 
                       
Net cash provided by financing activities
    18,511                   18,511  
Net increase (decrease) in cash and cash equivalents
    17,138       (26 )     3       17,115  
Cash and cash equivalents at beginning of period
    11,404       (215 )     (4 )     11,185  
 
                       
Cash and cash equivalents at end of period
  $ 28,542     $ (241 )   $ (1 )   $ 28,300  
 
                       

 

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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, 2010, 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.
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 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 financial and operational flexibility given our substantial debt and debt covenants;
    ERISA law changes related to the KSOP;
    Tax law changes that could affect tax liabilities or Alion’s 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;
    U.S. government shutdowns;
    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 operations and 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;
    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, 2010 filed with the SEC on December 14, 2010 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 May 16, 2011. 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.
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.

 

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The following table summarizes revenue attributable to each contract type for the periods indicated.
                                 
    For the Six Months Ended March 31,  
Revenue by Contract Type   2011     2010  
    (In thousands)  
Cost-reimbursement
  $ 327,307       81.1 %   $ 297,478       72.6 %
Fixed-price
    31,008       7.7 %     50,565       12.4 %
Time-and-material
    45,004       11.2 %     61,241       15.0 %
 
                       
Total
  $ 403,319       100.0 %   $ 409,284       100.0 %
 
                       
Management expects most of Alion’s revenue will continue to come from government contracts, primarily from contracts with the U.S. Department of Defense and other federal agencies. Management also expects Alion will continue to generate revenue from a variety of commercial, state, local and international customers.
                                 
    For the Six Months Ended March 31,  
Revenue by Customer Type   2011     2010  
    (In thousands)  
U.S. Department of Defense
  $ 372,032       92.2 %   $ 376,861       92.1 %
Other Federal Civilian Agencies
    18,622       4.6 %     21,036       5.1 %
Commercial / State / Local and International
    12,665       3.1 %     11,387       2.8 %
 
                       
Total
  $ 403,319       100.0 %   $ 409,284       100.0 %
 
                       
In January 2011, Secretary of Defense Gates announced the next major steps in the Obama Administration’s reform agenda focused on eliminating unnecessary spending while protecting the U.S. military’s size and strength. Secretary Gates addressed the Department’s efforts to reduce overhead, invest in high priority programs and reduce defense budget spending growth. The proposed plan focused on steady, sustainable and predictable growth. Despite recent budgetary political turmoil, and the threat of disruptions in government funding, Congress passed and the President signed a 2011 budget that increased Defense Department spending by approximately $5 billion for the current fiscal year.
Defense Department organizational and programmatic changes are intended to eliminate redundancies and duplicative efforts and invest savings in proven programs and systems. Many program cuts affect large procurements or staffing activities in which Alion is not involved. Because we deliver highly sophisticated scientific and engineering research services, we continue to believe demand will persist for our higher end technical expertise. We do not expect other acquisition program cuts or delays to adversely affect us significantly.
Despite the changing procurement environment, our cost-reimbursable revenue is trending upward. We continue to believe budget priorities will limit in-sourcing efforts as the Administration will seek to reduce civilian and military overhead staffing. We expect Alion will 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 designed to improve operating efficiency and effectiveness.
                                 
    For the Six Months Ended March 31,  
Core Business Area   2011     2010  
    (In thousands)  
 
                               
Naval Architecture and Marine Engineering
  $ 167,936       41.7 %   $ 178,599       43.7 %
 
                               
Defense Operations
    98,814       24.5 %     100,865       24.6 %
Modeling and Simulation
    78,376       19.4 %     70,810       17.3 %
Technology Integration
    23,849       5.9 %     23,622       5.8 %
Energy and Environmental Sciences
    17,815       4.4 %     19,303       4.7 %
Information Technology and Wireless Communications
    16,529       4.1 %     16,085       3.9 %
 
                       
 
                               
Total
  $ 403,319       100.0 %   $ 409,284       100.0 %
 
                       
Backlog. Contract backlog represents an estimate, as of a specific date, of the future revenue Alion expects from existing contracts. At March 31, 2011, backlog on existing contracts and executed delivery orders totaled $2.3 billion, of which $338 million was funded. We estimate we have an additional $3.9 billion of unfunded contract ceiling value for an aggregate total backlog of $6.2 billion.

 

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Results of Operations
Quarter Ended March 31, 2011 Compared to Quarter Ended March 31, 2010
                                 
    Consolidated Operations of Alion  
    Quarter Ended March 31,  
    2011     2010  
    (Dollars in thousands)  
            % of             % of  
Selected Financial Information           revenue             revenue  
Total contract revenue
  $ 202,551             $ 203,546          
Total direct contract costs
    155,002       76.5 %     156,049       76.7 %
Direct labor costs
    67,520       33.3 %     68,976       33.9 %
Material and subcontract costs
    83,275       41.1 %     82,424       40.5 %
Other direct costs
    4,207       2.1 %     4,649       2.3 %
 
                               
Gross profit
    47,549       23.5 %     47,497       23.3 %
 
                               
Total operating expense
    36,968       18.3 %     41,267       20.3 %
Major components of operating expense:
                               
Indirect expenses and facilities costs
    18,520       9.1 %     18,280       9.0 %
General and administrative
    15,782       7.8 %     18,775       9.2 %
Depreciation and amortization
    2,814       1.4 %     4,212       2.1 %
 
                               
Income from operations
  $ 10,581       5.2 %   $ 6,230       3.1 %
Revenue. Second quarter sales this year were down almost $1.0 million compared to the second quarter last year. Current quarter sales reflect the effects of last year’s sale of HFA and several ONR contracts which accounted for $4.7 million in second quarter sales last year and a $3.8 million second quarter sales reduction year over year.
Sales to U.S government customers were down $3.1 million; $1.2 million to civilian agencies and $1.9 million to Department of Defense customers. Prime contract sales were down almost $4.6 million consistent with a $14.8 million drop in tasking on ID/IQ contracts. This was partly offset by a $3.6 million increase in subcontract sales. While cost reimbursement contract revenue increased $12.9 million compared to last year’s second quarter results, declines in fixed price sales ($7.5 million) and time-and-material work ($6.4 million) drove overall sales down. Despite overall sales declines, second quarter profit margins on contract costs at target rates increased by almost $1.1 million compared to second quarter results last year.
Despite increased commercial sales, Naval Architecture and Marine Engineering sales were down $2.7 million for the quarter. Contract losses and delayed awards accounted for $3.6 million in reduced second quarter Naval Architecture and Marine Engineering sales compared to last year and were partially offset by new awards and programmatic expansions.
Modeling and Simulation revenue was up $2.1 million for the quarter. Sales from other core business areas in the aggregate were down approximately $400 thousand compared to the second quarter last year.
Direct Contract Expense and Gross Profit. Total direct contract costs declined by slightly more than $1.0 million compared to the second quarter last year. Direct labor costs were down slightly ($1.5 million) while other costs, including purchased materials and services, rose approximately $400 thousand. Fluctuations were consistent with changing revenue levels. Lower costs offset lower revenue; second quarter gross profit dollars at $47.5 million were essentially unchanged from second quarter results last year.
Operating Expenses. Second quarter operating expenses dropped $4.3 million overall compared to the same period last year. Last year, advisory services associated with several re-financing and capital structuring initiatives during the quarter accounted for increased general and administrative operating expenses. Also as expected, decreased charges for amortizing purchased contracts reduced this quarter’s operating expense compared to last year.

 

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Income from Operations. Second quarter operating profit climbed $4.4 million to $10.6 million. This is almost 70% higher than last year’s second quarter results. Last year’s costs were elevated and operating income correspondingly depressed due to several unsuccessful capital structuring efforts prior to the Company’s successful sale of $310 million in Secured Note Units in March 2010.
Other Expense. Interest income, interest expense and other expense in the aggregate for the quarter ended March 31, 2011 changed materially compared to the second quarter of 2010 as non-cash components of interest expense fluctuated significantly. Although cash pay interest expense did not fluctuate materially year over year, this year, interest on Alion’s increased debt load offset the absence of last year’s more than $2.6 million in second quarter fees and interest expense. Last year Alion incurred additional costs as a result of difficulties in meeting some covenants in the former Term B Senior Credit Facility.
Last year, the Company recognized a $1.2 million second quarter benefit from reversing interest expense which Alion was not required to pay when it redeemed the Subordinated Note in March 2010. Paid in kind interest for the Senior Secured Notes issued last year increased this year’s second quarter interest expense by $1.4 million compared to last year. Debt issue cost amortization also increased $1.8 million compared to last year reflecting the continuing cost of last year’s capital re-structuring
                 
    Three Months Ended March 31,  
    2011     2010  
    (In thousands)  
Cash Pay Interest
               
Revolver
  $ 123     $ 94  
Senior Term Loan
          5,308  
Secured Notes
    7,845       775  
Unsecured Notes
    6,355       6,406  
Subordinated Note
          (793 )
Other cash pay interest and fees
    28       2,679  
 
           
Sub-total cash pay interest
    14,351       14,469  
 
               
Deferred and Non-cash Interest
               
Secured Notes PIK interest
    1,570       155  
Debt issue costs and other non-cash items
    2,497       650  
Subordinated Note interest
          (1,177 )
 
           
Sub-total non-cash interest
    4,067       (372 )
 
           
Total interest expense
  $ 18,418     $ 14,097  
 
           
Debt Extinguishment. On March 22, 2010, Alion used proceeds from issuing $310 million of Units to retire its then-outstanding Term B Credit Facility loans, the Subordinated Note and related warrants, and to pay debt issue costs. The Company paid approximately $240 million to retire its Term B debt at par plus accrued interest and 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. The Company recognized a $67.7 million gain on extinguishing these liabilities which was offset in part by writing off $10.2 million in unamortized debt issue and debt modification costs. Alion recognized a one-time $50.7 million net benefit from its re-financing and debt extinguishment transactions. There was no second quarter debt extinguishment activity this year.
Income Tax Expense. Alion recognized $1.7 million in second quarter income tax expense this year. This quarter the Company recognized $4.1 million in deferred tax assets offset by an increase in valuation allowances because continuing losses make it unlikely Alion will reasonably be able to realize the full value of deferred tax assets.
Until March 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 its 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.

 

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In connection with its March 2010 debt refinancing, Alion issued deep-in-the-money warrants considered to constitute a second class of stock under the IRC. This automatically terminated Alion’s S-corporation status and the Company ceased to be a pass-through entity exempt from income taxes. In the second quarter last year, Alion recognized current income tax expense for the effect of its change in reporting status.
Last year, 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. The Company 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, the Company had a $1.5 million net deferred tax asset arising from its conversion to a C-corporation. However, Alion’s history of losses made it unlikely it would be able to realize the full benefit of its deferred tax assets. The Company was required to establish a full valuation allowance for its deferred tax assets and recognize $33.8 million in deferred tax expense in the second quarter last year.
Net Income. Despite improved operating margins this quarter compared to the similar period last year, higher interest expense helped drive a $9.7 million net loss for the quarter. Last year, Alion had $9.2 million in second quarter net income because of a $50.7 million debt extinguishment gain offset by a $33.8 million income tax charge. Without last year’s gain on extinguishment, required tax provision and $2.6 million of debt covenant waiver fees, Alion would have lost $5.1 million in the second quarter.
Six Months Ended March 31, 2011 Compared to Six Months Ended March 31, 2010
                                 
    Consolidated Operations of Alion  
    Six Months Ended March 31,  
    2011     2010  
    (Dollars in thousands)  
            % of             % of  
Selected Financial Information           revenue             revenue  
Total contract revenue
  $ 403,319             $ 409,284          
Total direct contract costs
    310,516       77.0 %     315,045       77.0 %
Direct labor costs
    130,119       32.3 %     136,103       33.3 %
Material and subcontract costs
    171,943       42.6 %     170,567       41.7 %
Other direct costs
    8,454       2.1 %     8,375       2.0 %
 
                               
Gross profit
    92,803       23.0 %     94,239       23.0 %
 
                               
Total operating expense
    73,625       18.3 %     79,038       19.3 %
Major components of operating expense:
                               
Indirect expenses including facilities costs
    35,884       8.9 %     35,552       8.7 %
General and administrative
    32,085       8.0 %     35,043       8.6 %
Depreciation and amortization
    5,804       1.4 %     8,443       2.1 %
 
                               
Income from operations
  $ 19,178       4.8 %   $ 15,201       3.7 %
Revenue. At $403.3 million, Alion’s year to date second quarter revenue for 2011 was down almost $6.0 million compared to last year. Revenue was down across many of the major categories that management tracks. Much of this decline relates to last year’s ONR contract and HFA dispositions. These contracts contributed $9.3 million to last year’s top line and account for more than $7.5 million in year over year sales variance.
This year, federal government sales declined by $7.2 million; Defense Department sales were down $4.8 million; civilian agency sales were down $2.4 million; and prime contract revenue was down $8.1 million. Fixed price and time-and-material contract sales declined $19.6 million and $16.2 million, respectively. Most of those declines came from ID/IQ contracts where sales were off $34.6 million compared to last year. Revenue declined partly due to funding constraints imposed by continuing resolutions and the ongoing threat of a government shut down. Nevertheless, ID/IQ sales still remained a strong percentage of overall revenue accounting for almost 53% of total sales. Cost plus contract revenue increased $29.8 million continuing to increase as a percentage of Alion’s sales mix and mitigating some of the sales decline from higher-margin higher risk contract types.

 

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Among the growth areas in year over year performance, Modeling and Simulation sales were up $7.6 million, as were sales to commercial and international customers ($1.3 million) and revenue from subcontracts ($2.1 million). Sales in all other core business areas were flat or declined. Naval Architecture and Marine Engineering sales were down $10.7 million and Defense Operations sales were down $2.1 million.
Direct Contract Expense and Gross Profit. Total direct contract costs and direct labor declined consistent with lower revenue levels. Direct contract costs dropped $4.5 million. A nearly $6.0 million decline in direct labor was partly offset by a modest $1.4 million increase in subcontract and material costs. Although gross profit dollars were down $1.4 million compared to last year, gross profit remained at 23% of revenue despite higher cost reimbursement revenue which generates lower margins than other kinds of contracts.
Operating Expenses. Year to date operating expenses were down $5.4 million (6.8%) through March 31, 2011 and significantly contributed to increased operating profit. Facilities and indirect expenses were flat. Depreciation and amortization were down $2.6 million as charges for amortizing acquired contracts continued their scheduled decline over time. General and administrative expenses were down $3.0 million. Last year the Company spent almost $2.6 million in its effort to re-structure and/or re-finance its former debt and invested in expanded information technology services and staffing.
Income from Operations. Operating income for the six months ended March 31, 2011 grew $4.0 million compared to last year — a 26% improvement due to lower operating expenses described above.
Other Expense. Year to date interest income, interest expense and other expense in the aggregate for the six months ended March 31, 2011 increased $6.0 million compared to last year. Higher debt load and a higher aggregate, average interest rate led to a $5.8 million increase in interest expense compared to last year. This was despite last year’s $2.6 million second quarter Term B Loan penalty and $3.9 million in Term B covenant waiver fees.
                 
    Six Months Ended March 31,  
    2011     2010  
    (In thousands)  
Cash Pay Interest
               
Revolver
  $ 235     $ 98  
Senior Term Loan
          11,047  
Secured Notes
    15,663       775  
Unsecured Notes
    12,732       12,813  
Other cash pay interest and fees
    41       4,032  
 
           
Sub-total cash pay interest
    28,671       28,765  
 
               
Deferred and Non-cash Interest
               
Secured Notes PIK interest
    3,134       155  
Debt issue costs and other non-cash items
    5,017       2,223  
Subordinated Note warrants
          (160 )
 
           
Sub-total non-cash interest
    8,151       2,218  
 
           
Total interest expense
  $ 36,822     $ 30,983  
 
           
Debt Extinguishment. On March 22, 2010, Alion used proceeds from issuing $310 million of Units to retire its then-outstanding Term B Credit Facility loans, the Subordinated Note and related warrants, and to pay debt issue costs. The Company paid approximately $240 million to retire its Term B debt at par plus accrued interest and 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. The Company recognized a $67.7 million gain on extinguishing these liabilities which was offset in part by writing off $10.2 million in unamortized debt issue and debt modification costs. Alion recognized a one-time $50.7 million net benefit from its re-financing and debt extinguishment transactions.
This year, in November 2010, Alion recognized a $460 thousand gain from repurchasing $2.0 million of Senior Unsecured Notes at a discount in an open market transaction.

 

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Income Tax Expense. Alion recognized $3.5 million in year to date income tax expense this year. The Company recognized an additional $10.2 million in deferred tax assets offset by a $10.2 million increase in related valuation allowances which did not affect income tax expense. Continuing losses make it unlikely Alion will reasonably be able to realize the full value of its $47.2 million in deferred tax assets.
Until March 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 its 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.
In connection with its March 2010 debt refinancing, Alion issued deep-in-the-money warrants considered to constitute a second class of stock under the IRC. This automatically terminated the Company’s S-corporation status. Last year, Alion ceased to be a pass-through entity exempt from income taxes and recognized current income tax expense for the effect of its change in reporting status.
Last year, 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. The Company 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, the Company had a $1.5 million net deferred tax asset arising from its conversion to a C-corporation. However, Alion’s history of losses made it unlikely it would be able to realize the full benefit of its deferred tax assets. The Company was required to establish a full valuation allowance for its deferred tax assets and recognize $33.8 million in deferred tax expense in the second quarter last year.
Net Income. Although this year’s operating income was greater year than last year’s, materially higher interest expense from a higher total debt load led to a higher net loss this year than last year. Last year, debt extinguishment net of taxes contributed approximately $17 million to net income and year to date net income was $1.2 million. Excluding the effects of last year’s $50.7 million debt extinguishment gain, the $33.8 million required income tax charge, and $2.6 million in debt covenant waiver fees and penalties, Alion would have lost $13.0 million for the six months ended March 31, 2010 compared to this year’s $20.8 million loss for the comparable period.
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 or when customers delay contract funding actions. The Company funds its current business with cash from operating activities and cash from financing activities. Management plans to fund future operations in a similar fashion. Alion also has access to a $35 million revolving credit facility. Management does not currently estimate the Company will need to use its revolving credit facility to any significant extent, except for letters of credit. This quarter, management increased Alion’s potential liquidity by raising the existing senior credit facility commitment by $10 million to $35 million. Management was also able to increase the underlying letter of credit limit to $35 million.
Cash Flows
Alion used approximately $3.4 million to fund operations this year. Second quarter operating cash flow was $4.9 million compared to $8.3 million used in the first quarter. This year there’s a year-to-date net loss as opposed to modest net income last year. This year’s loss includes ongoing charges from last year’s restructuring. Non-cash paid-in-kind interest and debt issue cost charges were materially higher than last year. Last year’s results included significant non-cash benefits from debt extinguishment net of income taxes. While Alion continues to face ongoing non-cash income tax expense arising from its change in tax status, the Company’s most significant cash requirements this year have been to fund quarterly interest payments on its senior debt and growth in accounts receivable, particularly unbilled receivables. Political uncertainties in the budget process which led to repeated continuing resolutions and the prospect of a government shutdown adversely affected the contract funding process. Many government customers faced temporary staffing shortages and budgetary restrictions that prevented them from executing contract modifications this quarter. Management expects these logjams will clear and the contract modification process will return to a more normal activity level and allow the Company to increase billings to customers for unfunded work performed at their request.

 

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Alion collected $201.4 million in receivables this quarter and $409.6 million through March 31, 2011, $1.7 million more than last year’s collections through March 31st, but $3.1 million less than we collected in the second quarter last year. Second quarter collections lagged revenue by $1.2 million partly due to the effects of the threatened government shutdown. This quarter’s days’ sales outstanding (DSO) increased 2.4 days to 78.8 days compared to 76.4 days last quarter. DSO is based on trailing twelve month revenue. Management expects DSO levels will improve once customers are able to catch up with delayed contract funding actions.
Although capital expenditures for the quarter and year to date are slightly lower than they were last year, management expects to increase investments in information technology and software in the second half of the year. This year certain ESOP transactions occurred on a different timeline than last year. Share repurchases ($3.2 million) were $4.2 million less than purchases through March 31 last year. Common stock sales to the ESOP Trust at $3.6 million were $1.5 million higher than sales through March 31 last year.
Last year Alion spent $16.7 million for loan modifications and debt issue costs for both former and current senior debt instruments. This year, similar costs were limited to $710 thousand incurred to increase the capacity of the revolving credit facility by $10 million. Despite previously noted contract funding challenges, Alion continued its practice (in place since the March 2010 debt re-financing) of not accessing the revolving credit facility. Last year, the Company used its revolver to a limited extent; prior to the March 2010 re-financing the maximum balance drawn was $3.5 million.
Alion has a long-term revolving credit facility through August 2014 and additional available cash from last year’s re-financing activities. Management expects that for the next several years, the Company will be able to meet existing debt covenants which will allow it to maintain access to its 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 $35 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. Alion retains the ability to restrict or defer certain types of cash payments that in the past caused the Company to fail to comply with certain prior debt covenants.
Management 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 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 Alion’s cash. Current debt agreements limit the Company’s ability to offer discretionary diversification options to ESOP participants and this should reduce future cash flow demands. Management tries 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. The 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. Alion no longer has significant stock-based compensation liabilities as few outstanding SARs have any intrinsic value. 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. The next regularly scheduled valuation period ends in September 2011. Interest rates, market-based factors and volatility, as well as Alion’s financial results will affect the future value of a share of common stock.
Certain stock-based compensation grantees can choose to defer their payments by having Alion deposit funds in a rabbi trust the Company owns. Any such deferrals will not materially affect planned payments or 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, Alion intends 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.

 

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Discussion of Debt Structure
Alion’s current debt structure includes a $35 million revolving credit facility, $310 million in Secured Notes and $248 million of Unsecured Notes. On March 22, 2010, the Company retired its Term B Senior Credit Agreement, its Subordinated Note and Subordinated Note warrants. Alion is in compliance with each of the affirmative and negative financial and non-financial covenants in its existing debt agreements.
Credit Agreement
In March 2010, Alion entered into an agreement for a $25.0 million senior revolving credit facility that matures August 2014. In March 2011, Alion and its lenders agreed to amend the revolving credit facility agreement to increase the credit limit to $35 million. The Company can use the credit facility for working capital, permitted acquisitions and general corporate purposes, including up to $35.0 million in letters of credit and up to $5.0 million in short-term swing line loans. No balance was actually drawn as of March 31, 2011. As of March 31, 2011, the Company had $545 thousand in outstanding letters of credit.
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. The Company’s subsidiaries, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation guarantee Alion’s credit agreement obligations, the Secured Notes and the Unsecured Notes. Alion and its subsidiary guarantors executed an agreement with Wilmington Trust Company representing bondholders and Credit Suisse AG, Cayman Islands Branch representing senior credit lenders, which granted credit facility lenders a priority payment right superior to the Secured Note lenders’ rights.
Alion can choose either a floating Eurodollar interest rate or a floating alternate base rate to determine credit facility interest expense. The minimum interest rate is 8.50%. The minimum Eurodollar rate is 3.5% plus 500 basis points. The minimum alternate base rate is 4.5% plus 400 basis points.
Each quarter Alion pays a commitment fee on the prior quarter’s daily unused credit facility balance at 1.75% per year. The Company paid approximately $118 thousand and $12 thousand in commitment fees for the quarters ended March 31, 2011 and 2010. The Company paid $230 thousand and $67 thousand in commitment fees for its current and prior credit facilities for the six months ended March 31, 2011 and 2010.
Alion must pay letter-of-credit issuance and administrative fees, up to a 25 basis point fronting fee and interest in arrears each quarter on all outstanding letters of credit. The interest rate is based on the Eurodollar loan rate which was 6.0% as of March 31, 2011. Alion also pays an annual agent’s fee.
The credit agreement requires Alion to achieve minimum trailing twelve month Consolidated EBITDA levels which increase over the life of the agreement. The table below sets out the required minimum for the period 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
October 1, 2013 through August 22, 2014
  $65.0 million
The agreement defines Consolidated EBITDA as net income or loss in accordance with GAAP, plus the following items, without duplication, to the extent deducted from or included in net income or loss:
    consolidated interest expense;
    provision for income taxes;
    depreciation and amortization;
    cash contributed to the ESOP in respect of Alion’s repurchase liability
    non-cash stock-based and incentive compensation expense;
    non-cash ESOP contributions;
    any extraordinary losses; and
    nonrecurring charges and adjustments included in ESOP valuation reports as prepared by an independent third party.

 

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To the extent included in net income or loss, the following items, without duplication, are deducted in determining Consolidated EBITDA:
    all cash payments on account of reserves, restructuring charges or other non-cash charges added to net income pursuant to the list above in a previous period;
    any extraordinary gains; and
    all non-cash items of income.
The Credit Agreement restricts us from doing any of the following without the prior consent of syndicate lenders 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;
    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.
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;
    a borrowing which would cause us to exceed a certain cash balance limit, or
    change of control (as defined below).
Under 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 at least $35 million in net proceeds from an underwritten public offering, 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 debt including the Secured and Unsecured Note Indentures.

 

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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. On September 2, 2010, Alion exchanged the private Secured Notes for publicly tradable Secured Notes with the same terms.
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. The Secured Notes are senior obligations of Alion and rank pari passu in right of payment with existing and future senior debt, except to the extent Credit Agreement lenders have a super priority right of payment with respect to the underlying collateral.
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.
There are no financial covenants in the Secured Note Indenture. As of March 31, 2011, 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;

 

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    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;
    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.
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.
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.
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.

 

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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 %
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. IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation guarantee the Unsecured Notes.
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.
There are no financial covenants in the Unsecured Note Indenture. As of March 31, 2011, 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;

 

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    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.
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.
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.
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 %
Revolving Credit Agreement — Covenant Compliance
Alion’s revolving credit agreement defines Consolidated EBITDA and requires the Company to achieve certain levels in order to maintain access to its credit facility and avoid cross default on the Senior Secured and Unsecured Notes. Neither EBITDA nor Consolidated EBITDA is a measure of financial performance in accordance with generally accepted accounting principles.
The revolving credit agreement permits Alion to exclude certain expenses and requires the Company to exclude certain one-time gains from Consolidated EBITDA. The revolving credit agreement requires Alion to have a minimum $52.5 million in Consolidated EBITDA for the twelve months ended March 31, 2011. The Company had $65.1 million in Consolidated EBITDA for the twelve months ended March 31, 2011 and exceeded the requirement by $12.6 million.

 

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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:   2011     2012     2013     2014     2015  
Bank revolving credit facility(1)
                                       
- Interest
  $ 222     $ 445     $ 444     $ 396     $  
Secured Notes(2)
                                       
- Interest
    15,689       31,851       32,491       33,144       16,821  
 
                                       
- Principal and PIK Interest
                            339,788  
Unsecured Notes(3)
                                       
- Interest
    12,710       25,420       25,420       25,420       12,710  
 
                                       
- Principal
                            248,000  
 
                             
Total cash — pay interest
    28,621       57,716       58,355       58,960       29,531  
 
                                       
Total cash — pay principal and PIK Interest
                            587,788  
 
                             
 
                                       
Total
  $ 28,621     $ 57,716     $ 58,355     $ 58,960     $ 617,319  
 
                             
     
(1)   We expect we will occasionally use our $35.0 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.
Contingent Obligations
Earn-outs
Alion has a $100 thousand maximum remaining earn-out commitment arising from the July 2007 LogCon Group acquisition which will not materially affect 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 March 31, 2011, Alion had spent a cumulative total of $84.1 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.

 

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    Number of                
    Shares             Total Value  
Date   Repurchased     Share Price     Purchased  
                (In thousands)  
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       1,760  
July 2010
    145     $ 28.00       4  
August 2010
    89     $ 28.00       2  
September 2010
    209     $ 28.00       6  
December 2010
    119,945     $ 26.65       3,196  
February 2011
    322     $ 26.65       9  
March 2011
    136     $ 26.65       4  
 
                   
Total
    403,034             $ 12,545  
 
                   
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 working capital needs for the next two to three years. Alion intends to focus on trying to achieve organic growth and improve profit margins.
Although it expects to have positive annual operating cash flow eventually, Alion 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.
The Secured Indenture, Unsecured Indenture and the revolving credit facility allow Alion to make certain permitted acquisitions; Management intends to use available financing to do so. Alion will ultimately have to refinance the Secured Notes and Unsecured Notes which mature in November 2014 and February 2015 and will require the Company to pay out more than $600 million over a three-month period. Management is uncertain whether, when and under what terms Alion can refinance these obligations. If Alion cannot refinance these obligations, it will not have sufficient cash from operations to meet all its obligations.
If plans or assumptions change, if assumptions prove inaccurate, if Alion consummates additional or larger investments in or acquisitions of other companies than currently planned, if the Company experiences unexpected costs or competitive pressures, or if existing cash and projected cash operating flows prove insufficient, we may need to obtain additional financing and sooner than expected. Management intends to only enter into new financing or refinancing it considers advantageous. However, even with improving conditions in the high-yield credit market, it is uncertain financing sources will be available in the future, or, if available, that financing terms would be favorable.
Recently Issued Accounting Pronouncements
Accounting Standards Update 2010-28 (ASU 2010-28) Goodwill and Other Intangibles — When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts was issued in December 2010 and updates ASC 350 — Goodwill and Other Intangibles (ASC 350). ASU 2010-28 modifies goodwill impairment testing for reporting units with zero or negative carrying amounts.
ASU 2010-28 requires an entity to perform a step two goodwill impairment analysis for reporting units with zero or negative carrying value as part of an annual goodwill impairment analysis; whenever an event occurs or circumstances indicate that a reporting unit’s fair value is more likely than not below its carrying amount; whenever an event occurs or circumstances indicate that a goodwill impairment exists; and upon adoption of the standard.
ASU 2010-28 is effective for fiscal years beginning on or after June 15, 2011, and can only be applied prospectively. Any goodwill impairment recognized on adopting ASU 2010-28 is to be recorded as a cumulative effect adjustment to retained earnings in the period of adoption. Any goodwill impairments occurring subsequent to adoption are to be recognized in current earnings as required by ASC 350. The Company is currently evaluating the effect, if any, that adopting ASU 2010-28 will have on Alion’s consolidated financial position and operating results.

 

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Item 3.   Quantitative and Qualitative Disclosures About Market Risk
Interest rate risk
We face interest rate risk for periodic borrowings on our $35.0 million senior revolving credit facility. Outstanding balances, if any, bear interest at a variable rate based on Credit Suisse’s prime rate plus a maximum spread of 500 basis points. Variable rates increase the risk that interest charges could increase materially if both market interest rates and outstanding balances were to increase.
We currently do not forecast drawing any material balance on our revolving credit facility. Therefore, any rate increase is not expected to materially affect Alion’s operating results or cash flows for any period from now through August 2014 when our revolving credit facility matures.
Our Senior Secured Notes and Senior Unsecured Notes are fixed-rate obligations. Other than the current revolving credit facility, Alion has currently has no variable rate debt. 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 $27.15 share price, few 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 March 31, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II — OTHER INFORMATION
Item 1.   Legal Proceedings
See Note 19 to the Condensed Consolidated Financial Statements. Other than the actions discussed in the Company’s most recent Annual Report on Form 10-K and Note 19, 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 or operating results.
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 March 31, 2011, although the risk factors included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2010, have not materially changed, other risks, formerly considered to be remotely possible, have materialized. Such other risks include, but are not limited to, the following.
Alion depends heavily on federal government contracts and a delay in the federal budget process or a federal government shutdown may delay procurement of the products, services and solutions the Company provides and adversely affect the Company’s sales and gross margins, operating results and cash flows.
Alion derives a significant portion of its revenue from the federal government and from prime contractors to the federal government. The Company expects to continue to derive significant sales from federal government contracts. Those contracts are conditioned upon the continuing availability of Congressional appropriations. Congress usually appropriates funds on a fiscal year basis even though contract performance may extend over many years. The programs in which Alion participates must compete with other federal government programs and policies for consideration during the budget and appropriation process. Concerns about increased deficit spending, along with continued economic challenges, continue to place pressure on federal customer budgets. While the Company believes that its programs are well aligned with national defense and other priorities, shifts in domestic spending and tax policy, changes in security, defense, and intelligence priorities, the affordability of the Company’s products and services, general economic conditions and developments, and other factors may affect a decision to fund or the level of funding for existing or proposed programs.
When the federal government does not complete its budget process before its September 30 fiscal year end, it typically funds operations through a continuing resolution that authorizes federal government agencies to continue operating, but does not authorize new spending initiatives. When the federal government operates under a continuing resolution, product and service procurement delays can occur.
The federal government’s continuing operations could also be jeopardized if the federal debt ceiling were to be eclipsed. Administration officials have commented that this could occur some time during Alion’s fourth quarter. While the federal debt ceiling historically has not materially affected the Company’s business, if the federal budget process were to result in a prolonged federal government shutdown, it could result in Alion incurring substantial unreimbursed labor or other costs, or delay or cancel key programs, which could materially adversely affect the Company’s cash flows and operating results.
In addition, when the U.S. Government requires supplemental appropriations to operate or fund specific programs, and legislation to approve any supplemental appropriation bill is delayed, credit markets may react adversely to the uncertainty. This in turn, could materially adversely affect Alion’s access to credit and the Company’s liquidity overall.
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
Alion employees directed approximately $1.7 million in salary deferrals and rollovers to the ESOP Trust to purchase beneficial interests in Alion common stock at $26.65 per share. The Company did not use an underwriter and did not pay underwriter discounts or commissions. Alion offered and sold beneficial interests in the KSOP to eligible employees pursuant to Rule 701 under the Securities Act of 1933, as amended.
Item 3.   Defaults Upon Senior Securities
None.
Item 4.   Removed and Reserved
Item 5.   Other Information
None.

 

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Item 6.   Exhibits
         
Exhibit    
No.   Description
  10.33    
Incremental Assumption Agreement and Amendment No. 2 dated as of March 11, 2011, by and among the Company, the lenders party thereto, Credit Suisse AG, Cayman Islands Branch, as administrative agent, Alion — CATI Corporation, Alion — METI Corporation, Alion — JJMA Corporation, Alion — BMH Corporation, Washington Consulting, Inc., Alion — MA&D Corporation, Alion — IPS Corporation, Alion Canada (US) Corporation, and Washington Consulting Government Services, Inc., related to the Credit Agreement and incorporating by reference therein the Amended and Restated Credit Agreement. (1)
  10.34    
Amended and Restated Credit Agreement dated as of March 11, 2011 by and among the Company, the lenders party thereto and Credit Suisse AG, Cayman Islands Branch, as administrative agent. (1)
  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.
     
(1)   Incorporated by reference from the Company’s Form 8-K filed with the SEC on March 16, 2011.

 

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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: May 16, 2011

 

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