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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2012

COMMISSION FILE NUMBER 333–89756

 

 

 

LOGO

Alion Science and Technology Corporation

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

DELAWARE

(State or Other Jurisdiction of

Incorporation of Organization)

 

54–2061691

(I.R.S. Employer

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    x  No

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).    x  Yes    ¨  No

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   ¨    Accelerated Filer   ¨
Non-Accelerated Filer   x  (Do not check if a smaller reporting company)    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  ¨    No  x

The number of shares outstanding of Alion Science and Technology Corporation Common Stock as of May 11, 2012 was: Common Stock 6,377,812

 

 

 


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2012

 

PART I — FINANCIAL INFORMATION   
Item 1.   Financial Statements (unaudited)      1   
  Condensed Consolidated Balance Sheets (unaudited)      1   
  Condensed Consolidated Statements of Operations and Comprehensive Loss (unaudited)      2   
  Condensed Consolidated Statements of Cash Flows (unaudited)      3   
  Notes to Condensed Consolidated Financial Statements (unaudited)      4   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      36   
Item 3.   Quantitative and Qualitative Disclosures About Market Risk      47   
Item 4.   Controls and Procedures      48   
PART II — OTHER INFORMATION   
Item 1.   Legal Proceedings      49   
Item 1A.   Risk Factors      49   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      50   
Item 3.   Defaults Upon Senior Securities      50   
Item 4.   Mine Saftey Disclosures      50   
Item 5.   Other Information      50   
Item 6.   Exhibits      51   


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

ALION SCIENCE AND TECHNOLOGY CORPORATION

Condensed Consolidated Balance Sheets (unaudited)

 

     March 31,
2012
    September 30,
2011
 
     (In thousands, except share and
per share information)
 

Current assets:

    

Cash and cash equivalents

   $ 8,758      $ 20,818   

Accounts receivable, net

     183,098        180,364   

Receivable due from ESOP Trust

     1,302        —     

Prepaid expenses and other current assets

     7,545        6,086   
  

 

 

   

 

 

 

Total current assets

     200,703        207,268   

Property, plant and equipment, net

     11,775        10,367   

Intangible assets, net

     8,373        11,734   

Goodwill

     398,921        398,921   

Other assets

     12,314        16,198   
  

 

 

   

 

 

 

Total assets

   $ 632,086      $ 644,488   
  

 

 

   

 

 

 

Current liabilities:

    

Interest payable

   $ 17,525      $ 17,392   

Trade accounts payable

     50,258        52,355   

Accrued liabilities

     45,132        48,435   

Accrued payroll and related liabilities

     36,937        39,738   

Billings in excess of revenue earned

     2,348        2,752   
  

 

 

   

 

 

 

Total current liabilities

     152,200        160,672   

Senior secured notes

     298,729        291,003   

Senior unsecured notes

     242,494        242,064   

Accrued compensation and benefits, excluding current portion

     5,749        5,729   

Non-current portion of lease obligations

     12,548        10,762   

Deferred income taxes

     47,669        44,181   

Commitments and contingencies

     —          —     

Other liabilities

     979        980   

Redeemable common stock, $0.01 par value, 8,000,000 shares authorized, 6,377,812 and 5,658,234 shares issued and outstanding at March 31, 2012 and September 30, 2011

     114,801        126,560   

Common stock warrants

     20,785        20,785   

Accumulated other comprehensive loss

     (123     (123

Accumulated deficit

     (263,745     (258,125
  

 

 

   

 

 

 

Total liabilities, redeemable common stock and accumulated deficit

   $ 632,086      $ 644,488   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

1


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION

Condensed Consolidated Statements of Operations and Comprehensive Loss (unaudited)

 

     Three Months Ended
March 31,
    Six Months Ended
March 31,
 
     2012     2011     2012     2011  
     (In thousands, except share and per share information)  

Contract revenue

   $ 197,112      $ 202,551      $ 387,003      $ 403,319   

Direct contract expense

     150,431        155,002        296,775        310,516   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     46,681        47,549        90,228        92,803   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

     36,517        36,968        72,383        73,625   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     10,164        10,581        17,845        19,178   

Other income (expense):

        

Interest income

     34        10        41        30   

Interest expense

     (18,696     (18,418     (37,337     (36,822

Other

     (4     (97     (117     (158

Gain on debt extinguishment

     —          —          —          460   

Total other income (expense)

     (18,666     (18,505     (37,413     (36,490

Loss before taxes

     (8,502     (7,924     (19,568     (17,312

Income tax expense

     (1,743     (1,743     (3,487     (3,487
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (10,245   $ (9,667   $ (23,055   $ (20,799
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted loss per share

     (1.73     (1.74     (3.86     (3.71
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and weighted average common shares outstanding

     5,915,899        5,540,896        5,977,221        5,598,766   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (10,245   $ (9,667   $ (23,055   $ (20,799

Other comprehensive income

        

Postretirement actuarial gains (losses)

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (10,245   $ (9,667   $ (23,055   $ (20,799
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

2


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION

Condensed Consolidated Statements of Cash Flows (unaudited)

 

     Six Months Ended
March 31,
 
     2012     2011  
     (In thousands)  

Cash flows from operating activities:

  

Net loss

   $ (23,055   $ (20,799

Adjustments to reconcile net loss to net cash used in operating activities:

    

Depreciation and amortization

     5,742        5,839   

Bad debt expense

     302        —     

Paid in kind interest

     3,194        3,134   

Amortization of debt issuance costs

     5,204        5,017   

Incentive and stock-based compensation

     825        1,071   

Gain on debt extinguishment

     —          (460

Deferred income taxes

     3,487        3,487   

Other gains and losses

     (96     24   

Changes in assets and liabilities:

    

Accounts receivable

     (3,036     (4,348

Other assets

     1,829        (1,030

Trade accounts payable

     (2,096     5,801   

Accrued liabilities

     (103     (1,209

Interest payable

     133        96   

Other liabilities

     (196     (104
  

 

 

   

 

 

 

Net cash used in operating activities

     (7,866     (3,481

Cash flows from investing activities:

    

Capital expenditures

     (1,454     (773

Asset sale proceeds

     —          11   
  

 

 

   

 

 

 

Net cash used in investing activities

     (1,454     (762

Cash flows from financing activities:

    

Payment of debt issue costs

     —          (710

Repurchase Senior Unsecured Notes

     —          (1,510

Revolver borrowings

     13,000        —     

Revolver repayments

     (13,000     —     

Loan to ESOP Trust

     (477     (776

ESOP loan repayment

     477        776   

Redeemable common stock purchased from ESOP Trust

     (2,740     (3,209

Redeemable common stock sold to ESOP Trust

     —          3,624   
  

 

 

   

 

 

 

Net cash used in financing activities

     (2,740     (1,805

Net decrease in cash and cash equivalents

     (12,060     (6,048

Cash and cash equivalents at beginning of period

     20,818        26,695   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 8,758      $ 20,647   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

Cash paid for interest

   $ 28,767      $ 28,604   

Cash paid for taxes

     —          —     

Non-cash financing activities:

    

Common stock issued to ESOP Trust in satisfaction of employer contribution liability

   $ 7,114      $ 5,150   

Paid-in-kind notes issued

     3,171        3,108   

See accompanying notes to condensed consolidated financial statements.

 

3


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 the Illinois Institute of Technology (IIT). In December 2002, Alion acquired substantially all of IITRI’s assets and liabilities except 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, 2012 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, 2011.

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.

 

4


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 three types of contracts. Some contracts provide for reimbursement of costs plus fees; others are fixed-price or time-and-material type contracts. We recognize revenue when a contract has been executed, the contract price is fixed or determinable, delivery of services or products has occurred and our ability to collect the contract price is considered reasonably assured. Alion applies the percentage of completion method in Accounting Standards Codification (ASC) Topic 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. We use 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 revenue recognition timing. From time to time, facts develop that require us to revise estimated total costs or expected revenue. We record the cumulative effect of revised estimates in the period when the facts requiring revised estimates become known. We recognize the full amount of anticipated losses on any contract in the period 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 contracts are subject to periodic funding by our contracting agency customers. A customer may fund a contract at inception or incrementally throughout the period of performance as services are provided. If we determine contract funding is not probable, we defer revenue recognition until realization is probable. The federal government can audit Alion’s contract costs and adjust amounts through negotiation. The federal government considers Alion a major contractor and maintains an office on site. DCAA is currently auditing our 2006 and 2007 claimed indirect costs. We are negotiating our 2005 indirect rates and have settled our rates through 2004. We timely submitted our indirect cost proposals for all open fiscal years. We have recorded revenue on federal government contracts in amounts we expect 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 and only to the extent it is probable that it will recover such costs and can reliably estimate the amount it will recover.

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 change as assets or liabilities change from year-to-year. In providing for deferred taxes, Alion considers the tax regulations of the jurisdictions where it operates; estimates of future taxable income; and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies change, the carrying value of deferred tax assets and liabilities may require adjustment.

Alion has a history of operating losses for both tax and financial statement purposes. The Company has recorded valuation allowances equal to deferred tax assets based on the likelihood that it may not be able to realize the value of these assets. Alion recognizes the benefit of a tax position only after determining that the relevant tax authority would “more likely than not” sustain the Company’s position following an audit. For tax positions meeting the “more likely than not” threshold, the Company recognizes the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.

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.

 

5


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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 receivable age. 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 paid to acquire the stock or assets of a business to the net assets acquired based on the estimated fair value of 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. There were no changes to goodwill carrying value this quarter.

The Company accounts for goodwill and other intangible assets in accordance with the provisions of ASC 350, Intangibles, Goodwill and Other. Alion operates in one segment and tests goodwill at the reporting unit level. There are two reporting units. Each year in the fourth quarter we review goodwill for impairment and whenever events or circumstances indicate goodwill might be impaired. Alion is required to recognize an impairment loss to the extent that goodwill carrying amount exceeds fair value. Evaluating goodwill involves significant management estimates. To date, our annual reviews have resulted in no goodwill impairment adjustments. See Note 8 for a detailed discussion of the Company’s goodwill impairment testing process.

Intangible Assets

Alion amortizes intangible assets as it consumes economic benefits over estimated useful lives. As of March 31, 2012, the Company had approximately $8.4 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

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.

 

6


Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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 $17.4 million decline in the fair value of its redeemable common stock this quarter and a corresponding reduction in its accumulated deficit. As of March 31, 2012, Alion’s accumulated deficit included an $851 thousand benefit arising from the Company’s decreased share redemption liability. Outstanding redeemable common stock had an aggregate fair value of approximately $114.8 million as of March 31, 2012.

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

Alion is required to disclose the fair value of its financial instruments, but is not required to record its senior long term debt at fair value. See Note 10 for a discussion of Alion’s long term debt and Note 11 for the related fair value disclosures. The fair value of cash, cash equivalents, accounts payable and accounts receivable is not materially different from carrying value because of the short maturity of those instruments.

Off-Balance Sheet Financing Arrangements

Alion accounts for operating leases entered into in the routine course of business in accordance with ASC 840 Leases. We have no off-balance sheet financing arrangements other than operating leases and letters of credit under our revolving credit agreement. Alion has no relationship with any unconsolidated or special purpose entity and has not issued any guarantees.

Recently Issued Accounting Pronouncements

In December 2010, FASB issued 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. ASU 2010-28 updates ASC 350 – Intangibles – Goodwill and Other (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 December 15, 2010, 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 adopted ASU 2010-28 in the first quarter this year with no effect on Alion’s consolidated financial position or operating results.

In September 2011, the FASB issued Accounting Standards Update 2011-08 (ASU 2011-08), Intangibles Goodwill and Other (Topic 350) – Testing Goodwill for Impairment. ASU 2011-08 permits an entity to first assess qualitative factors including the totality of events and circumstances to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value and therefore whether to test goodwill for impairment. Under ASU 2011-08 an entity may bypass qualitative assessment for any reporting unit in any period and perform a Step One analysis and may resume using qualitative assessment in any subsequent period.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

ASU 2011-08 removes the requirement that an entity calculate the fair value of a reporting unit unless the entity determines it is more likely than not that the reporting unit’s fair value is less than its carrying value. Where an entity is required to test goodwill for impairment, ASU 2011-08 does not change existing guidance on how to test goodwill for impairment. The update improves the examples an entity should consider in determining whether to measure an impairment loss for a reporting unit with negative carrying value. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The Company adopted ASU 2011-08 in the first quarter this year with no effect on Alion’s consolidated financial position or operating results.

In May 2011, the FASB issued Accounting Standards Update 2011-04 (ASU 2011-04) Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ASU 2011-04 provides guidance on how to measure fair value; expands fair value disclosure requirements; and offers guidance on what disclosures to make about fair value measurements. Alion already provides the expanded fair value disclosures that ASU 2011-04 will require for all public companies effective for interim and annual periods beginning after December 15, 2011. The Company does not believe adopting ASU 2011-04 will affect Alion’s consolidated financial position or operating results.

In June 2011, the FASB issued Accounting Standards Update 2011-05 (ASU 2011-05) Comprehensive Income (Topic 220) – Presentation of Comprehensive Income. ASU 2011-05 requires entities to present all non-owner changes in stockholder’s equity either in a continuous, single statement of comprehensive income or in two separate, but consecutive, statements. An entity that presents two statements must present total net income and its components in the first statement followed by a second statement that presents total other comprehensive income and its components, along with total comprehensive income.

ASU 2011-05 does not change how an entity calculates earnings per share; the items to be reported in other comprehensive income; or when items must be reclassified to net income. An entity is still permitted to present components of other comprehensive income net of tax effects or before tax effects with tax effects for all items of other comprehensive income presented in the aggregate. An entity must disclose the tax effects of each item of other comprehensive income in the notes to its financial statements. Alion’s only item of other comprehensive income is amortization of actuarial gains and losses for the Company’s post-retirement medical benefit plan which has no effect on Alion’s provision for income taxes.

ASU 2011-05 is effective for public companies for fiscal years, and interim periods within those years, beginning after December 15, 2011. ASU 2011-05 is to be applied retrospectively; early adoption is permitted. The Company adopted ASU 2011-05 in the first quarter this year with no effect on Alion’s consolidated financial position or 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 established the ESOP Trust. The Plan, a tax qualified retirement plan, includes an ESOP and a 401(k) component. 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, including Plan amendments 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. In June 2011, the Company amended the Plan to eliminate the one year service requirement for employer 401(k) matching contributions; to automatically enroll new hires in the Plan’s 401(k) component; and to designate future profit sharing contributions exclusively in Alion common stock. The Company believes the Plan and the ESOP Trust have been designed and are being operated in compliance with applicable IRC requirements.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(4) Loss Per Share

Basic and diluted loss per share is computed by dividing net 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. In connection with issuing the Senior Secured Notes, the Company issued 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

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 ($18.00 at March 31, 2012). 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.

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.

(6) Accounts Receivable

Accounts receivable at March 31, 2012 and September 30, 2011 consisted of the following:

 

     March 31,
2012
    September 30,
2011
 
     (In thousands)  

Billed receivables and amounts billable as of the balance sheet date

   $ 93,287      $ 85,242   

Unbilled receivables:

    

Amounts billable after the balance sheet date

     34,334        40,621   

Revenues recorded in excess of milestone billings on fixed price contracts

     2,348        2,737   

Revenues recorded in excess of estimated contract value or funding

     35,401        30,759   

Retainages and other amounts billable upon contract completion

     21,375        24,416   

Allowance for doubtful accounts

     (3,647     (3,411
  

 

 

   

 

 

 

Total Accounts Receivable

   $ 183,098      $ 180,364   
  

 

 

   

 

 

 

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Billed accounts receivable include invoices issued to customers for services performed as of the balance sheet date. Unbilled accounts receivable represent revenue recognized as of the balance sheet date for which Alion has yet to issue invoices to customers. Amounts that are currently billable are expected to be invoiced to customers within the next twelve months. Fixed-price contract revenue in excess of milestone billings is not yet contractually billable. Revenue in excess of contract value or funding is billable when Alion receives contractual amendments or modifications. Approximately $137.2 million (74%) and $124.2 million (68%) of contract receivables at March 31, 2012 and September 30, 2011 were from federal government prime contracts.

Alion recognized $93.5 million in revenue in excess of billings on uncompleted contracts as of March 31, 2012, including approximately $35.4 million for customer-requested work for which the Company had not received contracts or contract modifications. At September 30, 2011, Alion had recognized $98.5 million in revenue in excess of billings on uncompleted contracts including approximately $30.8 million for customer-requested work for which the Company had not received contracts or contract modifications.

Retainages and other unbilled amounts are billable upon contract completion or completion of Defense Contract Audit Agency (DCAA) audits. 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. Except for $21.4 million at March 31, 2012, the Company expects to invoice and collect unbilled receivables within the next twelve months.

(7) Property, Plant and Equipment

 

     March 31,
2012
    September 30,
2011
 
     (In thousands)  

Leasehold improvements

   $ 12,425      $ 11,281   

Equipment and software

     34,498        33,373   
  

 

 

   

 

 

 

Total cost

     46,923        44,654   

Less: accumulated depreciation and amortization

     (35,148     (34,287
  

 

 

   

 

 

 

Net Property, Plant and Equipment

   $ 11,775      $ 10,367   
  

 

 

   

 

 

 

Depreciation for fixed assets and leasehold amortization expense was approximately $987 thousand and $1.1 million for the quarters ended March 31, 2012 and 2011 and $1.9 million and $2.3 million for the six months ended March 31, 2012 and 2011.

(8) Goodwill

Alion had approximately $399 million in goodwill as of March 31, 2012. There were no changes to goodwill this quarter, nor were there any significant events this quarter that indicated a potential impairment to goodwill as of March 31, 2012.

Alion operates in one segment and tests goodwill at the reporting unit level. Each of Alion’s two reporting units delivers a similar set of professional engineering services to a wide array of federal government customers, principally within the Department of Defense. Each reporting unit provides the full range of services Alion offers to customers overall. Alion formerly had three and now has two identified reporting units.

Alion’s management has organized reporting units based on managerial responsibility and administrative structure, contract portfolios, and the availability of discrete financial information. Management evaluates reporting unit financial performance based on contract revenue and non-GAAP operating income. Alion does not maintain reporting unit balance sheets and the Company does not track cash flows by reporting unit.

Management identifies reporting units as “sectors” which in turn include lower level business units identified as “groups” consisting of still lower level “operations.” For each business combination, management assigned the goodwill arising from acquisitions to the reporting unit or units expected to benefit from the synergies of each business combination. Coincident with its goodwill determination and purchase price allocation, management assigned assets acquired to reporting units based on the unit or units anticipated to utilize such assets. Management did not allocate to reporting units the liabilities arising from business combinations.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

In 2011, Alion’s reporting units were: the Engineering and Integration Solutions Sector (EISS) and the Technology, Engineering and Operational Solutions Sector (TEOSS). In 2010, Alion’s reporting units were EISS, the Defense Operations Integration Sector (DOIS), and the Engineering and Information Technology Sector (EITS).

In 2011, Alion’s TEOSS reporting unit had $437.0 million in contract revenue; the EISS reporting unit had $357.1 million in contract revenue. In 2010, EISS had $377.4 million in contract revenue; DOIS had $258.0 million in contract revenue; and EITS had $203.7 million in contract revenue. Total contract revenue for all reporting units exceeds Alion’s total reported revenue because reporting unit contract revenue does not include the effects of inter-company eliminations, discounts and GSA industrial funding fees that the Company does not track by reporting unit. These amounts were $6.8 million for fiscal 2011 and $5.1 million for fiscal 2010.

In 2011, management reorganized Alion’s two smaller reporting units, DOIS and EITS, to form the new TEOSS reporting unit. Management undertook the reorganization to optimize Alion’s reporting structure, reduce the number of subsidiary organizations in its reporting units, eliminate duplicative staff and reduce operating expenses. As part of this reorganization, management reduced the number of “groups” within the new sector, and reorganized the remaining groups. Management realigned both contracts and staff at the “group” and “operation” level and re-configured the Company’s financial reporting systems to accumulate information based on Alion’s new structure.

Management established TEOSS as part of Alion’s effort to respond to pricing pressures in the government contracting industry arising from actual and potential federal budget cuts and to improve the Company’s competitive position in the market place. Management also reorganized various administrative functions to change the Company’s cost structure with the goal of winning new contracts with higher negotiated fee rates. Management expects this reorganization will allow the Company to reduce operating costs and better position Alion to win new business in an increasingly price-sensitive, cost-conscious environment.

Establishing the TEOSS reporting unit did not affect the $197 million in goodwill previously allocated to Alion’s other reporting unit, EISS. When management established TEOSS, it assigned $201.9 million in aggregate goodwill to the new reporting unit. Management based its goodwill allocation on historical acquisitions attributable to the newly-formed reporting unit. TEOSS goodwill includes $124.3 million in goodwill previously assigned to DOIS and $77.6 million in goodwill previously assigned to EITS.

Management applied the guidance in ASC Topic 350 Intangibles—Goodwill and Other and the related guidance in ASC Topic 280 Segment Reporting to analyze Alion’s new reporting units to determine the appropriate level at which to test goodwill for potential impairment. Management specifically considered whether the former DOIS and EITS reporting units continued to exist as potential TEOSS components required to be tested separately for impairment. Changes to Alion’s financial information systems to accommodate tracking and reporting for the TEOSS segment preclude management from obtaining discrete financial information for either DOIS or EITS which ceased to exist as separately trackable organizations within the Company. The absence of discrete financial data for the former DOIS and EITS reporting units, and the material changes to them arising from the reorganization led management to conclude that neither DOIS nor EITS was capable of being tested individually for potential impairment to goodwill. Management also concluded that this reorganization did not affect the Company’s determination of estimated fair value or its goodwill impairment analysis at the reporting unit level or in the aggregate.

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 allocates the goodwill related to acquisitions on a specific identification basis consistent with reporting unit structure. The Company’s 2011 reorganization from three into two reporting units is otherwise consistent in structure with goodwill analyses and allocations in prior periods.

The Company performs its own independent analysis to determine whether goodwill is potentially impaired. Management performs a discounted cash flow analysis and uses 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; to assess the probability of future contracts and revenue; and to evaluate the recoverability of goodwill. March 2012 contract backlog was approximately 7.6 times trailing twelve month revenue.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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. However, Management’s sensitivity analyses also incorporated a more conservative range of growth assumptions in addition to assumptions generally consistent with those used by the independent third party to prepare the valuation report for the ESOP Trust. 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 Alion’s most recent impairment testing in 2011, market multiples for trailing twelve month EBITDA for comparable companies (publicly traded professional services government contractors) ranged from a low of 10.9 to a high of 20.8, with a median value of 14.1. Market multiples for trailing twelve month revenue ranged from a low of 1.02 to a high of 2.3, with a median value of 1.36. Management based its valuation on projected revenue and EBITDA and discounted median market multiples by 20-40% to reflect Alion’s recent financial performance and the uncertainties of future financial performance. Management used a weighted average cost of capital rate of 13.0% derived from market-based inputs, the tax-effected interest cost of Alion’s outstanding debt and a hypothetical market participant capital structure. Management estimates future years’ EBITDA based on Alion’s historical adjusted EBITDA as a percentage of revenue. Management based its estimates of future revenue growth on existing contract backlog and recent contract wins. Management analyzed goodwill for impairment using a range of near-term growth values of 5-8% and a range of 0-3% for longer-term out year forecasts.

Prior year market multiples for trailing twelve month EBITDA for comparable professional services government contractors ranged from a low of 7.5 to a high of 11.1 with a median value of 8.1. Prior year 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. 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. Last year management discounted median market multiples by up to 22% to reflect Alion’s lower EBITDA margins compared to its peer group.

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, 2011, would have produced a corresponding approximate 5% decrease or increase in estimated enterprise value. Alion’s enterprise value based on EBITDA multiples from mergers and acquisitions in the market place was approximately 16-18% higher than discounted cash flow enterprise value at September 30, 2011.

Management reviews the Company’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 performs impairment testing on an enterprise value basis as there is no public market for the Company’s common stock.

Management determined that, on an enterprise value basis, Alion’s reporting units have positive carrying value. In reviewing its discounted cash flow analysis prepared for testing goodwill for potential impairment, management considered macroeconomic and other conditions such as:

 

   

the deterioration in general economic conditions arising from federal budget deficits;

 

   

Alion’s recent credit downgrade and the potential for limiting future access to capital;

 

   

An increase in market risks and a higher discount rate for valuing estimated future cash flows;

 

   

Defense and aerospace industry and market concerns about the effects of federal budget deficits on future Department of Defense procurement actions;

 

   

a decline in market-dependent multiples and metrics in both absolute terms and for Alion relative to its peers;

 

   

the decline in Alion’s current year sales compared to last year;

 

   

the Company’s ability to access increased liquidity as a result of its recently-amended larger revolving credit facility; and

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

   

Alion’s success in obtaining $600 million of additional customer contract funding and new contracts from June through September 2011.

Alion completed its most recent goodwill impairment analysis in the fourth quarter of fiscal year 2011 and concluded no goodwill impairment existed as of September 30, 2011. Management determined the totality of events and circumstances would not have supported a decision to roll forward its prior year goodwill impairment analysis and avoid performing a step one goodwill impairment analysis. Management chose to perform a step one analysis which supported a lower enterprise value for Alion as of September 2011 compared to September 2010. September 2011 estimated discounted future cash flows declined 10% compared to September 2010 while the estimated fair value of Alion’s outstanding debt declined less than one percent from September 2010 to September 2011. As a result of changes in Alion’s estimated enterprise fair value, the estimated fair value of Alion’s outstanding common stock declined approximately 22% from September 2010 to September 2011.

As of September 30, 2011, the estimated fair value of each reporting unit substantially exceeded its carrying value and enterprise value. Consistent with prior years’ disclosures, the 10% decline in discounted cash flows for 2011 compared to 2010 did not result in an impairment to goodwill. The results of Alion’s step one impairment testing make it unlikely that a reasonably probable change in assumptions would have triggered an impairment. 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.

The tables below set out for each reporting unit as of September 30, 2011 and 2010: the goodwill assigned to each reporting unit; reporting unit carrying value; reporting unit estimated fair value; and the excess of estimated fair value over carrying value for each reporting unit. The tables present values for EISS and TEOSS for 2011 and for EISS, DOIS and EITS for 2010. Management used the reporting unit estimated fair values presented below in testing goodwill for impairment in the fourth quarter of fiscal year 2011 and 2010.

 

     Goodwill      Carrying
Value
     Estimated
Fair
Value
     Excess of
Estimated Fair
Value over
Carrying Value
 
     at September 30, 2011  

Sector

   (In millions, except percentages)  

TEOSS

   $ 201.9       $ 212.8       $ 295.6       $ 82.8         39

EISS

     197.0         205.9         242.8         36.9         18
  

 

 

    

 

 

    

 

 

    

 

 

    

Total

   $ 398.9       $ 418.7       $ 538.4       $ 119.7         29
  

 

 

    

 

 

    

 

 

    

 

 

    

 

     Goodwill      Carrying
Value
     Estimated
Fair
Value
     Excess of
Estimated Fair
Value over
Carrying Value
 
     at September 30, 2010  

Sector

   (In millions, except percentages)  

DOIS

   $ 124.3       $ 129.3       $ 204.7       $ 75.4         58

EITS

     77.6         81.3         154.5         73.2         90

EISS

     197.0         203.8         284.2         80.4         39
  

 

 

    

 

 

    

 

 

    

 

 

    

Total

   $ 398.9       $ 414.4       $ 643.4       $ 229.0         55
  

 

 

    

 

 

    

 

 

    

 

 

    

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(9) Intangible Assets

Intangible assets consist primarily of contracts acquired through the Anteon and JJMA transactions. The table below shows intangible assets as of March 31, 2012 and September 30, 2011.

 

     March 31, 2012      September 30, 2011  
     Gross      Accumulated
Amortization
    Net      Gross      Accumulated
Amortization
    Net  
     (In thousands)  

Purchased contracts

   $ 111,635       $ (103,975   $ 7,660       $ 111,635       $ (100,864   $ 10,771   

Internal use software and engineering designs

     3,182         (2,469     713         3,182         (2,219     963   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 114,817       $ (106,444   $ 8,373       $ 114,817       $ (103,083   $ 11,734   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

The weighted-average remaining amortization period of intangible assets was approximately three years at March 31, 2012 and September 30, 2011. Amortization expense was approximately $1.7 million and $1.8 million for the quarters ended March 31, 2012 and 2011, and $3.4 million and $3.5 million for the six months ended March 31, 2012 and 2011. Estimated aggregate amortization expense for the next five years and thereafter is as follows.

 

     (In thousands)  

2012 (for the remainder of the fiscal year)

   $ 2,745   

2013

     3,588   

2014

     1,079   

2015

     736   

2016

     141   

2017

     51   

Thereafter

     33   
  

 

 

 
   $ 8,373   
  

 

 

 

(10) Long-Term Debt

Alion’s current debt structure includes a $35 million revolving credit facility, $320.1 million in Secured Notes ($310 million in initial face value plus $10.1 million in PIK interest notes issued) and $245 million of Unsecured Notes. The Company is in compliance with each of the affirmative, negative, financial and other 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 revolving credit facility agreement increasing the credit limit to $35.0 million. In August 2011, Alion and its lenders amended the revolving credit facility agreement to revise the definition of Consolidated EBITDA and increase the Minimum Consolidated EBITDA covenant. The Company can use its 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, 2012, the Company had $3.7 million in outstanding letters of credit and no balance actually drawn.

Security. The Credit Agreement is secured by a first priority security interest in all current and future tangible and intangible property of Alion and its guarantor subsidiaries, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation. In March 2010 Alion and the subsidiary guarantors entered into an Intercreditor Agreement with Wilmington Trust Company and Credit Suisse AG, Cayman Islands Branch to grant Credit Agreement lenders a super priority right of payment with respect to the underlying collateral. Credit Agreement lenders rights are superior to Secured Note holders’ rights.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Guarantees. Alion’s Credit Agreement obligations are guaranteed by its subsidiaries, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation. These subsidiaries also guarantee all the Company’s Secured Note and Unsecured Note obligations (described below).

Interest and Fees. Alion can choose whether the Credit Agreement loans bear interest at one of two floating rates using either a Eurodollar rate or an alternative base rate. The minimum interest rate is 8.5%. The minimum Eurodollar interest rate is 2.5% plus 600 basis points. The minimum alternate base rate is 3.5% plus 500 basis points.

Other Fees and Expenses. Each quarter Alion pays a commitment fee of 175 basis points per year on the prior quarter’s daily unused Credit Agreement balance. The Company paid approximately $139 thousand and $118 thousand in commitment fees for the quarters ended March 31, 2012 and 2011. The Company paid approximately $291 thousand and $230 thousand in commitment fees for the six months ended March 31, 2012 and 2011.

Alion pays letter-of-credit issuance and administrative fees, and 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, 2012. The Company also pays an annual agent’s fee.

Covenants. 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 remaining life of the Credit Agreement.

 

Period

   Minimum Consolidated EBITDA  

October 1, 2011 through September 30, 2012

   $ 60.5 million   

October 1, 2012 through September 30, 2013

   $ 63.0 million   

October 1, 2013 through August 22, 2014

   $ 65.5 million   

The Credit 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;

 

   

employee compensation expense payments invested in Alion common stock;

 

   

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 cash and 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;

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

   

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;

 

   

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 certain 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 uncured defaults under our material contracts;

 

   

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.

Based on current forecasts, management believes Alion will be able to continue to meet the revolving credit agreement Consolidated EBITDA covenant and the various non-financial covenants in Alion’s debt agreements. Federal procurement delays, program cuts, reduced spending levels, government shutdowns, or any of a variety of other disclosed or unknown risk factors could adversely affect Alion’s future revenue and Consolidated EBITDA. If the Company were unable to meet the Consolidated EBITDA covenant, it could seek to amend the revolving credit facility agreement and/or obtain a covenant waiver. Management can provide no assurance that Alion would be able to obtain an amendment or waiver, or if one were available, that terms would favorable.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Senior Secured Notes

In March 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’s 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.

Security. The Secured Notes are secured by a first priority security interest in all current and future tangible and intangible property of Alion and its guarantor subsidiaries, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation. The Secured Notes are senior obligations of Alion and rank pari passu in right of payment with existing and future senior debt, including the Credit Agreement, except to the extent that the Intercreditor Agreement provides Credit Agreement lenders with a super priority right of payment with respect to the underlying collateral.

Guarantees. The Company’s obligations under the Secured Notes are guaranteed by the Company’s subsidiaries, IPS, CATI, METI, JJMA, BMH, WCI, WCGS, MA&D and Alion Canada (US) Corporation.

Interest and Fees. The Secured Notes bear interest at 12% per year; 10% is payable in cash and 2% increases the Secured Note principal (PIK Interest). Interest is payable semi-annually in arrears on May 1 and November 1. Alion pays interest to holders of record as of the immediately preceding April 15 and October 15. The Company must pay interest on overdue principal or interest at 13% per annum to the extent lawful. The Secured Notes mature November 1, 2014.

Covenants. As of March 31, 2012, Alion was in compliance with the covenants set forth in the Indenture governing its 12% Senior Secured Notes (Secured Note Indenture). The Secured Note Indenture does not contain any 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 become liable for any debt unless our ratio of trailing twelve month Adjusted EBITDA to trailing twelve month Consolidated Interest Expense is greater than 2.0 to 1.0. Our ratio of trailing twelve month Adjusted EBITDA to trailing twelve month Consolidated Interest Expense was 0.88 to 1.0 as of March 31, 2012, and 0.86 to 1.0 as of September 30, 2011. Even if trailing twelve month Adjusted EBITDA is not at least two times trailing twelve month 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 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 a business disposition provided liabilities incurred in connection therewith do not exceed the cash and non-cash proceeds received and are not reflected on the Company’s balance sheet;

 

   

certain deferred compensation agreements; and

 

   

certain other debt up to $20 million.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The Secured Note Indenture has a covenant that restricts our ability to declare and pay any cash dividend or other distribution related to any equity interest in Alion, repurchase or redeem any equity interest of Alion, repurchase or redeem the Unsecured Notes or other subordinated debt, or make certain investments. However, within certain limits we may make such payments in limited amounts if Adjusted EBITDA is at least two times Consolidated Interest Expense. Even if Adjusted EBITDA to Consolidated Interest Expense is not greater than 2.0 to 1.0, we may make or pay:

 

   

such payments out of substantially concurrent contributions of equity and substantially concurrent incurrences of permitted debt;

 

   

certain limited and permitted dividends;

 

   

certain repurchases of the Company’s equity securities deemed to occur upon exercise of stock options or warrants;

 

   

cash payments in lieu of the issuance of fractional shares in connection with 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 (as defined in the Secured Note Indenture);

 

   

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.

Events of Default. The Secured Note Indenture contains customary events of default, including:

 

   

payment default on interest obligations when due;

 

   

payment default on principal at maturity;

 

   

uncured covenant breaches;

 

   

default under an acceleration of certain other debt exceeding $30 million;

 

   

bankruptcy and certain insolvency events;

 

   

judgment for payment in excess of $30 million entered against the Company or any material subsidiary that remains outstanding for a period of 60 days and is not discharged, waived or stayed;

 

   

failure of any Secured Note guarantee to be in effect or any subsidiary guarantor’s denial or disaffirmation of its guaranty obligations; and

 

   

failure of any Secured Note security interest to constitute a valid and perfected lien with its applicable priority after a permitted cure period.

Change of Control. Upon a change in control, each Secured Note holder has the right to require Alion 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, (or individuals who were elected or nominated by them, or directors subsequently nominated or elected by them) cease for any reason to constitute a majority of the Company’s board of directors;

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

   

the adoption of a plan relating to Alion’s liquidation or dissolution; and

 

   

subject to certain exceptions, the merger or consolidation of the Company with or into another person or the merger of another person with or into the Company, or the sale of all or substantially all the assets of Alion to another person.

Optional Redemption. Prior to April 1, 2013, not more than once in any twelve month period, we may redeem up to $31 million of Secured Notes at a redemption price of 103% of the principal amount of the Secured Notes redeemed, plus accrued and unpaid interest to the redemption date. Prior to April 1, 2013, the Company may redeem all, but not less than all, of the Secured Notes at a redemption price equal to 100% of the principal amount of the Secured Notes plus accrued and unpaid interest to the redemption date plus an applicable make-whole premium as of the redemption date.

In addition, any time prior to April 1, 2013, subject to certain conditions, the Company may use the proceeds of a qualified equity offering to redeem Unsecured Notes in an aggregate principal amount not to exceed $108.5 million at a redemption price equal to the sum of 112% of the aggregate principal amount of the notes actually redeemed, plus accrued and unpaid interest to the redemption date.

On or after April 1, 2013, the Company may redeem all or a portion of the Secured Notes at the redemption prices set forth below (expressed in percentages of principal amount on the redemption date), plus accrued and unpaid interest to the redemption date, if redeemed during the periods set forth below:

 

Period

   Redemption Price  

April 1, 2013 to September 30, 2013

     105.0

October 1, 2013 to March 31, 2014

     103.0

April 1, 2014 and thereafter

     100.0

Unsecured Notes

In February 2007, Alion issued and sold $250.0 million of its private 10.25% senior 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. In June 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. In November 2010, Alion repurchased $2 million of the Unsecured Notes. In June 2011, Alion repurchased another $3 million of Unsecured Notes.

Interest and Fees. The Senior 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.

Covenants. There are no financial covenants in the Unsecured Note Indenture. As of March 31, 2012, we were in compliance with Unsecured Note Indenture non-financial covenants.

An Unsecured Note Indenture covenant restricts our ability to incur additional debt. Defined terms in the Unsecured 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 debt unless our ratio of trailing twelve month Adjusted EBITDA to trailing twelve month Consolidated Interest Expense is greater than 2.0 to 1.0. Our ratio of trailing twelve month Adjusted EBITDA to trailing twelve month Consolidated Interest Expense was 0.88 to 1.0 as of March 31, 2012, and 0.86 to 1.0 as of September 30, 2011. Even if trailing twelve month Adjusted EBITDA is not at least two times trailing twelve month Consolidated Interest Expense, we may incur other permitted debt including:

 

   

debt pursuant to our now terminated Term B Credit Facility and certain other contracts up to $360 million less principal repayments made under that indebtedness;

 

   

permitted inter-company debt;

 

   

the Unsecured Notes ;

 

   

debt pre-dating the Unsecured Notes;

 

   

permitted debt of acquired subsidiaries;

 

   

permitted refinancing debt;

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

   

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, capital and synthetic leases up to $25 million in the aggregate 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;

 

   

letters of credit reimbursement obligations;

 

   

certain agreements in connection with the disposition of a business provided liabilities incurred in connection therewith do not exceed the cash and non-cash proceeds received and 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 with regard to any equity interest in the Company, make any repurchase or redemption of any equity interest in Alion, repurchase or redeem subordinated debt, and make certain investments. However, within certain limits we may make such payments in limited amounts if Adjusted EBITDA is at least two times Consolidated Interest Expense. Even if Adjusted EBITDA to Consolidated Interest Expense is not greater than 2.0 to 1.0, we may make or pay:

 

   

such payments out of substantially concurrent contributions of equity and substantially concurrent incurrences of permitted debt;

 

   

certain limited and permitted dividends;

 

   

certain repurchases of the Company’s equity securities deemed to occur upon exercise of stock options or warrants;

 

   

cash payments in lieu of the issuance of 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 the Company’s ability to engage in other transactions including restricting our subsidiaries from making distributions and paying dividends to parents, merging or selling all or substantially all our assets, issuing certain subsidiary equity securities, engaging in certain transactions with affiliates, incurring liens, entering into sale lease-back transactions and engaging in business unrelated to our business when we issued the Unsecured Notes.

Events of Default. The Unsecured Note Indenture contains customary events of default, including:

 

   

payment default on interest obligations when due;

 

   

payment default on principal at maturity;

 

   

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 the Company 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 or any subsidiary guarantor’s denial or disaffirmation of its guaranty obligations.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Change of Control. Upon a change in control, each Unsecured Note holder has the right to require Alion 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, (or individuals who were elected or nominated by them, or individuals who were elected or nominated by them) 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.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Optional Redemption. 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  

2012

     102.563

2013 and thereafter

     100.000

Interest Payable

Interest Payable consisted of the following balances:

 

     March 31,
2012
     September 30,
2011
 
     (In thousands)  

Unsecured Notes

   $ 4,188       $ 4,187   

Secured Notes

     13,337         13,205   
  

 

 

    

 

 

 

Total

   $ 17,525       $ 17,392   
  

 

 

    

 

 

 

As of March 31, 2012, Alion must make the following principal repayments (at face amount before debt discount) for its outstanding debt.

 

Fiscal Year:    2012      2013      2014      2015      Total  

Secured Notes and PIK Interest(1)

   $ —         $ —         $ —         $ 339,788       $ 339,788   

Unsecured Notes(2)

     —           —           —           245,000         245,000   

Total Principal Payments

   $ —         $ —         $ —         $ 584,788       $ 584,788   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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, 2012, the $298.7 million carrying value on the face of the balance sheet included $310 million in principal, $10.1 million of PIK notes issued, $2.7 million in accrued PIK interest and is net of $24.1 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 $245 million in principal and $2.5 million in unamortized debt issue costs as of March 31, 2012 (initially $7.1 million).

(11) Fair Value Measurement

Alion applies ASC 820 – Fair Value Measurements and Disclosures in determining the fair value to be disclosed for financial and nonfinancial assets and liabilities on a recurring or nonrecurring basis. The Company has no assets or liabilities, other than its redeemable common stock, which it is required to report at fair value. Valuation techniques utilized in the fair value measurement of assets and liabilities for each period presented were unchanged from previous practice.

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 1inputs 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.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Level 1 primarily consists of financial instruments, such as overnight bank re-purchase agreements or money market mutual funds whose value is based on quoted market prices published by a financial institution, an exchange fund, exchange-traded instruments and listed equities.

Level 2 assets include U.S. Government and agency securities whose valuations are based on market prices from a variety of industry-standard data providers or pricing that considers various assumptions, including time value, yield curve, volatility factors, credit spreads, default rates, loss severity, current market and contractual prices for the underlying instruments, and broker and dealer quotes. All are observable in the market or can be derived principally from or corroborated by observable market data for which the Company can obtain independent external valuation information.

Level 3 consists of unobservable inputs. The Company’s former Subordinated Note warrants were classified as Level 3 liabilities. Assets and liabilities are considered Level 3 when their fair value inputs are unobservable or not available, including situations involving limited market activity, where determination of fair value requires significant judgment or estimation.

The table below sets out the face value, net carrying value and fair value of Alion’s Senior Secured and Senior Unsecured Notes. The fair values disclosed below are based on quoted market prices for Alion’s outstanding notes.

 

     March 31, 2012     September 30, 2011  
     (In thousands)  
     Senior
Secured
Notes
    Senior
Unsecured
Notes
    Senior
Secured
Notes
    Senior
Unsecured
Notes
 

Face value of original notes outstanding

   $ 310,000      $ 245,000      $ 310,000      $ 245,000   

PIK interest notes issued

     10,091        —          6,920        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Face value of outstanding notes

   $ 320,091      $ 245,000      $ 316,920      $ 245,000   

PIK interest notes to be issued

     2,665        —          2,643        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Face value of notes outstanding and notes to be issued

   $ 322,756      $ 245,000      $ 319,563      $ 245,000   

Less: unamortized debt issue costs

     (24,027     (2,506     (28,560     (2,936
  

 

 

   

 

 

   

 

 

   

 

 

 

Carrying value

   $ 298,729      $ 242,494      $ 291,003      $ 242,064   
  

 

 

   

 

 

   

 

 

   

 

 

 

Fair value of outstanding notes

   $ 303,104      $ 138,251      $ 278,727      $ 140,982   
  

 

 

   

 

 

   

 

 

   

 

 

 

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.

(12) Common Stock Warrants

In 2010, Alion issued its Secured Notes and warrants 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. Secured Note warrants are not redeemable for cash. The warrants are exercisable until March 15, 2017.

The Secured Note warrants had an initial fair value of approximately $20.8 million based on Alion’s former share price of $34.50. Alion recognized the value of the warrants as part of the debt issue costs for the Secured Notes and recorded the corresponding credit to equity. The Company accounts for the Secured Note warrants as equity and must reassess this classification each reporting period. The Company identified no required changes in accounting treatment as of March 31, 2012.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(13) Leases

Future minimum lease payments under non-cancelable operating leases for buildings, equipment and automobiles at March 31, 2012 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)  

2012 (for the remainder of fiscal year)

   $ 13,948   

2013

     26,806   

2014

     25,781   

2015

     25,400   

2016

     21,201   

2017

     15,560   

And thereafter

     24,014   
  

 

 

 

Gross lease payments

   $ 152,710   

Less: non-cancelable subtenant receipts

     (625
  

 

 

 

Net lease payments

   $ 152,085   
  

 

 

 

Composition of Total Rent Expense

     For the Six Months Ended
March 31,
 
     2012     2011  
     (In thousands)  

Minimum rentals

   $ 10,320      $ 11,055   

Less: Sublease rental income

     (85     (956
  

 

 

   

 

 

 

Total rent expense, net

   $ 10,235      $ 10,099   
  

 

 

   

 

 

 

(14) ESOP Expense

Alion makes 401(k) matching contributions in shares of its common stock. 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 profit sharing contributions of Alion common stock to the ESOP Trust on the same dates. Through June 2011, Alion contributed 1% of eligible employee compensation in common stock to the ESOP Trust and 1.5% of eligible employee compensation in cash to the 401(k) component. As of July 2011, profit sharing contributions of 2.5% of eligible employee compensation are entirely in shares of Alion common stock. Alion recognized $3.8 million and $7.1 million in Plan expense for the three and six months ended March 31, 2012 based on the value of common stock contributed and to be contributed to the Plan.

Last year, Alion recognized $3.2 million and $6.4 million in Plan expense for the three and six months ended March 31, 2011. Prior year plan expense included common stock and cash contributions. Prior year Plan expense for the quarter ended March 31 included approximately $800 thousand in cash and $2.4 million in stock. Prior year Plan expense for the six months ended March 31 included $1.6 million in cash and $4.8 million in stock.

(15) 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 $446 thousand and $892 thousand in incentive compensation expense for the three and six months ended March 31, 2012. Alion recognized $94 thousand and $925 thousand in incentive compensation expense for the three and six months ended March 31, 2011.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(16) Stock Based Compensation

Alion’s Stock Appreciation Rights (SAR) 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 SAR Plan permits accelerated vesting in the event of death, disability or a change in control of the Company. Approximately 818 thousand SARs were outstanding at March 31, 2012, at a weighted average grant date fair value of $29.91 per share. No outstanding grant has any intrinsic value.

In the second quarter of 2012, Alion recognized a $93 thousand credit to compensation expense. For the six months ended March 31, 2012, the Company recognized a $66 thousand credit to stock based compensation expense. In the second quarter of 2011, Alion recognized $109 thousand in stock based compensation expense. For the six months ended March 31, 2011, stock based compensation expense was $142 thousand.

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, for operating its business.

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.

(17) Segment Information

Alion operates in a single segment, delivering a broad array of scientific and engineering expertise to research and develop technological solutions for problems relating to national defense, public health and safety, and nuclear safety and analysis under contracts with the federal government, state and local governments, and commercial customers. Federal government customers typically exercise independent contracting authority. Federal agency and department offices or divisions may use Alion’s services as a separate customer directly, or through a prime contractor, as long as they have independent decision-making and contracting authority in their organization. Revenue from government prime contracts was approximately 83.3% and 81.9%, of total contract revenue for the six months ended March 31, 2012 and 2011.

(18) 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.

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.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Alion’s effective tax rate for the six months ended March 31, 2012 was -17.8%. As of March 31, 2012 and September 30, 2011 the net deferred tax liability was:

 

     March 31,
2012
    September 30,
2011
 
     (In thousands)  

Current deferred tax asset

   $ 9,244      $ 10,543   

Noncurrent deferred tax asset

     60,279        47,721   

Valuation allowance

     (69,523     (58,264

Noncurrent deferred tax liability

     (47,669     (44,181
  

 

 

   

 

 

 

Net deferred tax liability

   $ (47,669   $ (44,181
  

 

 

   

 

 

 

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 2008 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.

(19) Debt Extinguishment

In November 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. There were no similar transactions in the six months ended March 31, 2012.

(20) Commitments and Contingencies

Legal Proceedings

In February 2011, Alion recognized a $500 thousand liability for an insurance policy deductible related to a civil judgment for a workplace-related injury claim. The Company’s insurer unsuccessfully appealed the judgment. The insurer is considering whether to file an appeal with the Louisiana Supreme Court. We are involved in other routine legal proceedings occurring in the ordinary course of business. We believe these routine legal proceedings are not material to our financial condition, operating results, or cash flows.

As a government contractor, from time to time we may be subject to DCAA audits and federal government inquiries. The federal government may suspend or debar for a period of time any federal contractor it finds has violated the False Claims Act, or who has been indicted or convicted of violations of other federal laws. This could also result in fines or penalties. Given Alion’s dependence on federal government contracts, suspension or debarment could have a material effect on our business, financial condition, operating results, cash flows and our ability to meet our financial obligations. We are not aware of any such pending federal government claims or investigations.

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Government Audits

Federal government cost-reimbursement contract revenues and expenses in the consolidated financial statements are subject to DCAA audit and possible adjustment. Alion is a major contractor and DCAA maintains an office on site to perform various audits throughout the year. The Company has settled indirect rates through 2004 based on completed DCAA audits. All subsequent years are open. Alion has recorded federal government contract revenue based on amounts it expects to realize upon final settlement.

(21) 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, 2012 and September 30, 2011; condensed consolidating statements of operations for the quarters and six months ended March 31, 2012 and 2011; and condensed consolidating statements of cash flows for the six months ended March 31, 2012 and 2011 of Alion, its guarantor subsidiaries and its non-guarantor subsidiaries. Investments include Alion’s investments in its subsidiaries 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, 2012

 

     Parent     Guarantor
Companies
    Non-Guarantor
Companies
    Eliminations     Consolidated  
     (In thousands)  

Current assets:

          

Cash and cash equivalents

   $ 8,889      $ (130   $ (1   $ —        $ 8,758   

Accounts receivable, net

     179,846        2,792        460        —          183,098   

Receivable due from ESOP Trust

     1,302        —          —          —          1,302   

Prepaid expenses and other current assets

     7,447        98        —          —          7,545   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

     197,484        2,760        459        —          200,703   

Property, plant and equipment, net

     11,180        579        16        —          11,775   

Intangible assets, net

     8,373        —          —          —          8,373   

Goodwill

     398,921        —          —          —          398,921   

Investment in subsidiaries

     26,541        —          —          (26,541     —     

Intercompany receivables

     1,584        26,113        —          (27,697     —     

Other assets

     12,310        —          4        —          12,314   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

   $ 656,393      $ 29,452      $ 479      $ (54,238   $ 632,086   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current liabilities:

          

Interest payable

   $ 17,525      $ —        $ —        $ —        $ 17,525   

Trade accounts payable

     50,073        185        —          —          50,258   

Accrued liabilities

     44,795        285        52        —          45,132   

Accrued payroll and related liabilities

     36,194        694        49        —          36,937   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Billings in excess of revenue earned

     2,339        5        4        —          2,348   

Total current liabilities

     150,926        1,169        105        —          152,200   

Intercompany payables

     26,114        —          1,583        (27,697     —     

Senior secured notes

     298,729        —          —          —          298,729   

Senior unsecured notes

     242,494        —          —          —          242,494   

Accrued compensation and benefits, excluding current portion

     5,749        —          —          —          5,749   

Non-current portion of lease obligations

     12,016        532        —          —          12,548   

Deferred income taxes

     47,669        —          —          —          47,669   

Commitments and contingencies

     —          —          —          —          —     

Other liabilities

     979        —          —          —          979   

Redeemable common stock

     114,801        —          —          —          114,801   

Common stock warrants

     20,785        —          —          —          20,785   

Common stock of subsidiaries

     —          4,084        —          (4,084     —     

Accumulated other comprehensive loss

     (123     —          —          —          (123

Accumulated deficit

     (263,746     23,667        (1,209     (22,457     (263,745
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities, redeemable common stock and accumulated deficit

   $ 656,393      $ 29,452      $ 479      $ (54,238   $ 632,086   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Condensed Consolidating Balance Sheet as of September 30, 2011

(In thousands)

 

     Parent     Guarantor
Companies
    Non-Guarantor
Companies
    Eliminations     Consolidated  
     (In thousands)  

Current assets:

          

Cash and cash equivalents

   $ 20,845      $ (27   $ —        $ —        $ 20,818   

Accounts receivable, net

     177,618        2,358        388        —          180,364   

Receivable due from ESOP Trust

     —          —          —            —     

Prepaid expenses and other current assets

     5,991        93        2        —          6,086   

Total current assets

     204,454        2,424        390        —          207,268   

Property, plant and equipment, net

     9,733        614        20        —          10,367   

Intangible assets, net

     11,734        —          —          —          11,734   

Goodwill

     398,921        —          —          —          398,921   

Investment in subsidiaries

     24,566        —          —          (24,566     —     

Intercompany receivables

     1,460        24,675        —          (26,135     —     

Other assets

     16,181        12        5        —          16,198   

Total assets

   $ 667,049      $ 27,725      $ 415      $ (50,701   $ 644,488   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current liabilities:

          

Interest payable

   $ 17,392      $ —        $ —        $ —        $ 17,392   

Trade accounts payable

     52,092        257        6        —          52,355   

Accrued liabilities

     48,087        319        29        —          48,435   

Accrued payroll and related liabilities

     38,766        915        57        —          39,738   

Billings in excess of costs revenue earned

     2,723        5        24        —          2,752   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

     159,060        1,496        116        —          160,672   

Intercompany payables

     24,675        —          1,460        (26,135     —     

Senior secured notes

     291,003        —          —          —          291,003   

Senior unsecured notes

     242,064        —          —          —          242,064   

Accrued compensation and benefits, excluding current portion

     5,729        —          —          —          5,729   

Non-current portion of lease obligations

     10,260        502        —          —          10,762   

Deferred income taxes

     44,181        —          —          —          44,181   

Other liabilities

       —          —          —          980   

Redeemable common stock

     126,560        —          —          —          126,560   

Common stock of subsidiaries

     —          4,084        —          (4,084     —     

Commitments and contingencies

     —          —          —          —          —     

Common stock warrants

     20,785        —          —          —          20,785   

Accumulated other comprehensive loss

     (123     —          —          —          (123

Accumulated deficit

     (258,125     21,643        (1,161     (20,482     (258,125
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities, redeemable common stock and accumulated deficit

   $ 667,049      $ 27,725      $ 415      $ (50,701   $ 644,488   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

29


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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, 2012

 

     Parent     Guarantor
Companies
     Non-Guarantor
Companies
    Eliminations     Consolidated  
     (In thousands)  

Contract revenue

   $ 193,069        3,942         101        —        $ 197,112   

Direct contract expense

     148,323        2,049         59        —          150,431   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Gross profit

     44,746        1,893         42        —          46,681   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Operating expenses

     35,612        823         82        —          36,517   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Operating income

     9,134        1,070         (40     —          10,164   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Other income (expense):

           

Interest income

     34        —           —          —          34   

Interest expense

     (18,696     —           —          —          (18,696

Other

     (4     —           —          —          (4

Equity in net income (loss) of subsidiaries

     1,030           —          (1,030     —     
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total other expenses

     (17,636     —           —          (1,030     (18,666
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

(Loss) income before taxes

     (8,502     1,070         (40     (1,030     (8,502

Income tax expense

     (1,743     —           —          —          (1,743
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ (10,245   $ 1,070       $ (40   $ (1,030   $ (10,245
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Other comprehensive income

           

Postretirement actuarial gains (losses)

     —          —           —          —          —     
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Comprehensive (loss) income

   $ (10,245   $ 1,070       $ (40   $ (1,030   $ (10,245
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

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Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Condensed Consolidating Statement of Operations for the Three Months Ended March 31, 2011

 

     Parent     Guarantor
Companies
     Non-Guarantor
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

     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 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 (loss) income

   $ (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 Six Months Ended March 31, 2012

 

     Parent     Guarantor
Companies
     Non-Guarantor
Companies
    Eliminations     Consolidated  
     (In thousands)  

Contract revenue

   $ 379,091      $ 7,546       $ 366      $ —        $ 387,003   

Direct contract expense

     292,530        4,028         217        —          296,775   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Gross profit

     86,561        3,518         149        —          90,228   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Operating expenses

     70,679        1,507         197        —          72,383   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Operating income

     15,882        2,011         (48     —          17,845   

Other income (expense):

           

Interest income

     41        —           —          —          41   

Interest expense

     (37,337     —           —          —          (37,337

Other

     (129     12         —          —          (117

Gain on debt extinguishment

     —          —           —          —          —     

Equity in net income of subsidiaries

     1,975        —           —          (1,975     —     
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total other expenses

     (35,450     12         —          (1,975     (37,413
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

(Loss) income before taxes

     (19,568     2,023         (48     (1,975     (19,568

Income tax expense

     (3,487     —           —          —          (3,487
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ (23,055   $ 2,023       $ (48   $ (1,975   $ (23,055
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Other comprehensive income

           

Postretirement actuarial gains (losses)

     —          —           —          —          —     
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Comprehensive (loss) income

   $ (23,055   $ 2,023       $ (48   $ (1,975   $ (23,055
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

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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

 

     Parent     Guarantor
Companies
     Non-Guarantor
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

     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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Table of Contents

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Condensed Consolidating Statement of Cash Flows for the Six Months Ended March 31, 2012

 

     Parent     Guarantor
Companies
    Non-Guarantor
Companies
    Consolidated  
     (In thousands)  

Net cash used in operating activities

   $ (7,768   $ (97   $ (1   $ (7,866

Cash flows from investing activities:

        

Capital expenditures

     (1,447     (7     —          (1,454

Asset sale proceeds

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (1,447     (7     —          (1,454

Cash flows from financing activities:

        

Payment of debt issue costs

     —          —          —          —     

Repurchase Senior Unsecured Notes

     —          —          —          —     

Revolver borrowings

     13,000        —          —          13,000   

Revolver payments

     (13,000     —          —          (13,000

Loan to ESOP Trust

     (477     —          —          (477

ESOP loan repayment

     477        —          —          477   

Redeemable common stock purchased from ESOP Trust

     (2,740     —          —          (2,740

Redeemable common stock sold to ESOP Trust

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (2,740     —          —          (2,740

Net decrease in cash and cash equivalents

     (11,955     (104     (1     (12,060

Cash and cash equivalents at beginning of period

     20,845        (27     —          20,818   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 8,890      $ (131   $ (1   $ 8,758   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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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

 

     Parent     Guarantor
Companies
    Non-Guarantor
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

Asset sale proceeds

     11        —          —          11   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (753     —          (9     (762

Cash flows from financing activities:

        

Payment of debt issue costs

     (710     —          —          (710

Payment of Term B Loan

     (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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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of Alion’s financial condition and results of operations should be read together with the condensed consolidated financial statements (unaudited) and the notes to those statements. This updates the information contained in our Annual Report on Form 10-K for the year ended September 30, 2011, 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;

 

   

Threats to network, computer and data security;

 

   

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, 2011 filed with the SEC on December 20, 2011 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 11, 2012. 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.

 

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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 the environment. We principally serve U.S. government departments and agencies and, to a much lesser extent, commercial and international customers.

We expect most of our revenue will continue to be generated from contracts with the U.S. Department of Defense and other federal agencies. We believe we will continue to have some level of commercial, state, local and international revenue. The tables below show our year-to-date revenue by contract type and customer.

 

     For the Six Months Ended March 31,  

Revenue by Contract Type

   2012     2011  
     (In thousands)  

Cost-reimbursement

   $ 320,554         82.8   $ 330,661         82.0

Fixed-price

     26,049         6.7     28,564         7.1

Time-and-material

     40,400         10.5     44,094         10.9
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 387,003         100.0   $ 403,319         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

     For the Six Months Ended March 31,  

Revenue by Customer

   2012     2011  
     (In thousands)  

U. S. Air Force

   $ 92,781         24.0   $ 117,351         29.1

U. S Army

     25,662         6.6     40,983         10.2

U. S Navy

     188,861         48.8     180,267         44.7

Other Department of Defense customers

     47,626         12.3     31,421         7.8

Federal Civilian Agencies and Departments

     22,316         5.8     22,678         5.6

Commercial and International

     9,757         2.5     10,619         2.6
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 387,003         100.0   $ 403,319         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Uncertainty continues to be the order of the day in the federal marketplace, including the professional services government contracting environment. The President and the Secretary of Defense are committed to mandating cost control and achieving savings from both programs and routine Department of Defense operations. Programmatic and budgetary cuts are expected to affect both government spending and defense industry revenues. Many companies have already begun to see revenue declines. Even areas that we formerly believed would survive budgetary pressures and offer a strong demand for our services are showing signs of weakness. While the military is still focused on extending the service life and capabilities of existing systems, Secretary of Defense Panetta has already announced that he expects to achieve cost savings from these activities as well.

Last summer’s budget control act agreement and the subsequent failure of the Congressional Super Committee to reach an agreement, has resulted in the pending sequestration of appropriations beginning next year. The Department of Defense, the largest customer for Alion’s services, has already implemented actions to cut certain programs, and delay or reduce funding for other programs. Alion, like other companies in our industry, has responded to these challenges by reducing costs, reducing headcount for indirect and administrative staff, seeking to reduce office space and in general working to position the Company to serve its customers more effectively and at lower cost. While we continue to believe demand will continue for our higher end technical expertise, declines in quarter over quarter and year over year revenues demonstrate we have not been immune to market pressures. We continue to face challenges in penetrating international markets. We think the Department of Defense’s focus on controlling and reducing costs will help us sell the government the services and technical solutions we offer to improve operating efficiency and effectiveness as we continue to meet the challenges of a changing professional services market place.

 

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The table below sets out our revenue by core business area for the first half of this year and last year.

 

     For the Six Months Ended  
   March 31,  

Core Business Area

   2012     2011  
     (In thousands)  

Naval Architecture and Marine Engineering

   $ 175,103         45.2   $ 163,158         40.5

Defense Operations

     92,478         23.9     105,050         26.0

Modeling and Simulation

     44,849         11.6     80,431         19.9

Technology Design and Other Services

     74,573         19.3     54,680         13.6
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 387,003         100.0   $ 403,319         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, 2012, backlog on existing contracts and executed delivery orders totaled $2.3 billion, of which $369 million was funded. We estimate we have an additional $3.5 billion of unfunded contract ceiling value for an aggregate total backlog of $5.8 billion.

Results of Operations

Quarter Ended March 31, 2012 Compared to Quarter Ended March 31, 2011

 

     Quarter Ended March 31,  
     2012     2011  
     (Dollars in thousands)  
            % of
revenue
           % of
revenue
 

Selected Financial Information

          

Total contract revenue

   $ 197,112         $ 202,551      

Total direct contract costs

     150,431         76.3     155,002         76.5

Direct labor costs

     66,148         33.6     67,520         33.3

Materials, subcontracts and other costs

     84,283         42.8     87,482         43.2

Gross profit

     46,681         23.7     47,549         23.5

Total operating expense

     36,517         18.5     36,968         18.3

Major components of operating expense:

          

Overhead and general and administrative expenses

     25,736         13.1     26,355         13.0

Rental and occupancy expense

     7,905         4.0     7,799         3.9

Depreciation and amortization

     2,876         1.5     2,814         1.4

Income from operations

   $ 10,164         5.2   $ 10,581         5.2

Revenue. Second quarter revenue was down $5.4 million this year compared to last year. Revenue from U.S government customers was down $4.0 million; commercial revenue was off $1.4 million. Air Force contract revenue was down $10.6 million from programmatic changes and budget cuts. Army revenue was down $7.8 million for similar reasons and also because we completed several large, one-off programs last year. Our Navy revenue was up more than $4.9 million compared to last year because of new and follow-on business we won earlier this year. Revenue from other Department of Defense agencies increased by $9.4 million from work we performed on several of our prime contracts.

Naval Architecture and Marine Engineering revenue was up $3.9 million and revenue from Technology and Other Services was up $12.3 million. However, these increases were offset by a $16.0 million fall off in Modeling and Simulation revenue and a $5.6 million decline in Defense Operations revenue.

 

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While our prime contract revenue increased $2.5 million over last year, our work as a subcontractor was down $7.9 million. Revenue from tasking on ID/IQ contracts dropped sharply this quarter, down by $17.6 million. Revenue on three of our Navy multiple award contracts was down $21.9 million in the aggregate; our Modeling and Simulation Information Analysis Center contract was off $12.0 million; and other ID/IQ contracts were down $3.8 million compared to last year. However, activity on our Weapons System Information Analysis Center contract was up $12.7 million and revenue from one of our Seaport-E vehicles was up by $7.4 million.

Cost reimbursement contract revenue was down more than $700 thousand, but it accounted for almost 83% of total revenue this quarter. Fixed prices revenue was down $2.4 million to less than 7% of total revenue. Time-and-material work was down $2.3 million to slightly more than 10% of total revenue. Contract margins on recoverable costs, including rate variance, were moderately better than first quarter performance this year and second quarter performance last year.

Direct Contract Expense and Gross Profit. Second quarter direct contract costs declined $4.6 million compared last year. Our direct labor costs declined $1.4 million; other direct costs, including purchased materials, services and other costs were down $3.2 million. Declines were consistent with lower revenue levels from lower headcount and program and funding delays. Lower costs offset lower revenue, as our gross profit margins improved 20 basis points to 23.7% as we improved our efficiencies. This year’s second quarter gross profit of $46.7 million was more than $800 thousand less than last year’s $47.5 million second quarter performance.

Operating Expenses. Second quarter operating expenses did not change materially compared to last year although we did recognize some operating expense benefits from previously announced reorganizations, staffing changes and other cost reductions. As expected, second quarter charges for amortizing purchased contracts reduced this quarter’s operating expense compared to last year but declines in contract amortization charges were partly offset by increased amortization expenses for intangible assets we deployed late last year and early this year.

Income from Operations. Second quarter operating profit was just over $10 million and 5.2% of revenue. Last year’s operating income was $10.6 million and 5.2% of revenue.

Other Expense. Second quarter 2012 interest expense increased only modestly compared to last year. Interest payable in cash for our senior debt increased because PIK notes increased interest-bearing Secured Note principal. Secured Note debt issue cost amortization was higher due to tracks our higher outstanding principal balance. Unsecured Note cash interest declined as we retired part of this debt last year. We used our revolving credit facility briefly this quarter. We also paid higher letter of credit fees as we replaced cash deposits with landlords with standby letters of credit.

 

     Three Months Ended
March 31,
 
     2012      2011  
     (In thousands)  

Cash Pay Interest

     

Revolver

   $ 203       $ 123   

Secured Notes

     8,002         7,845   

Unsecured Notes

     6,278         6,355   

Other cash pay interest and fees

     26         28   
  

 

 

    

 

 

 

Sub-total cash pay interest

     14,509         14,351   

Deferred and Non-cash Interest

     

Secured Notes PIK interest

     1,601         1,570   

Debt issue costs and other non-cash items

     2,586         2,497   
  

 

 

    

 

 

 

Sub-total non-cash interest

     4,187         4,067   
  

 

 

    

 

 

 

Total interest expense

   $ 18,696       $ 18,418   
  

 

 

    

 

 

 

Income Tax Expense. Alion recognized $1.7 million in second quarter income tax expense this year and last year. Our income tax expense relates to tax-deductible goodwill. This quarter deferred tax assets increased by $5.4 million and were offset by corresponding changes in valuation allowances. Continuing losses make it unlikely Alion will reasonably be able to realize the full value of deferred tax assets.

 

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Net Loss. This quarter, although we cut operating expenses we could only partially offset reduced gross profit from lower overall revenue. Higher interest expense on our long-term debt increased our net loss. This led our second quarter net loss to increase by almost $600 thousand compared to last year.

Six Months Ended March 31, 2012 Compared to Six Months Ended March 31, 2011

 

     Six Months Ended March 31,  
     2012     2011  
     (Dollars in thousands)  
            % of
revenue
           % of
revenue
 

Selected Financial Information

          

Total contract revenue

   $ 387,003         $ 403,319      

Total direct contract costs

     296,775         76.7     310,516         77.0

Direct labor costs

     127,422         32.9     130,119         32.3

Materials, subcontracts and other costs

     169,353         43.8     180,397         44.7

Gross profit

     90,228         23.3     92,803         23.0

Total operating expense

     72,383         18.7     73,625         18.3

Major components of operating expense:

          

Overhead and general and administrative expenses

     50,939         13.2     52,292         13.0

Rental and occupancy expense

     15,714         4.1     15,529         3.9

Depreciation and amortization

     5,730         1.5     5,804         1.4

Income from operations

   $ 17,845         4.6   $ 19,178         4.8

Revenue. Year to date revenue was down $16.3 million in 2012 compared to last year. Revenue from U.S government customers was down $15.5 million; commercial revenue was off approximately $800 thousand. Air Force contract revenue was down $24.6 million because of programmatic changes and budget cuts. Army revenue was down $15.3 million for similar reasons and because last year we completed several large, one-off programs. Our Navy revenue was up $8.6 million compared to last year because of new and follow-on business we won earlier this year. Revenue from other Department of Defense agencies increased by $16.2 million for work we performed on several of our prime contracts.

Naval Architecture and Marine Engineering revenue was up $11.9 million and revenue for Technology and Other Services was up $19.9 million. However, these increases were offset by a $35.6 million fall off in Modeling and Simulation revenue and a $12.6 million decline in Defense Operations revenue.

Our prime contract revenue decreased $5.2 million over last year. Our work as a subcontractor was down $11.1 million. Revenue from tasking on ID/IQ contracts dropped year over year, down by $31.5 million. Some work migrated to several large single award contracts. Revenue on three of our Navy multiple award contracts was down $32.6 million in the aggregate; our Modeling and Simulation Information Analysis Center contract was off $26.8 million; other ID/IQ contracts were down $6.6 million compared to last year. However, activity on our Weapons System Information Analysis Center contract was up $22.7 million and revenue from one of our Seaport-E vehicles increased by $11.8 million.

Cost reimbursement contract revenue was down more $10.1 million but increased to almost 83% of total revenue this year. Fixed prices revenue was down $2.5 million to less than 7% of total revenue. Time-and-material work was down $3.7 million to slightly more than 10% of total revenue. In 2012, contract margins on recoverable costs, including rate variance, were moderately better than year-to-date performance in 2011 leading to a modest increase in gross margin as a percentage of revenue.

Direct Contract Expense and Gross Profit. In 2012, year-to-date direct contract costs declined $13.7 million compared last year. Our direct labor costs declined $2.7 million; other direct costs, including purchased materials, services and other costs were down $11.0 million. Declines were consistent with lower revenue levels from lower headcount and program and funding delays. In 2012, lower costs offset lower revenue driving gross profit margins up approximately 30 basis points. Year-to-date gross profit of $90.2 million was $2.6 million less than last year’s $92.8 million due to the lower revenue volume.

 

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Operating Expenses. Year-to-date operating expenses were down slightly more than $1.2 million compared to last year as we recognized some operating expense benefits from previously announced reorganizations, decrease in indirect and administrative staffing and other cost reductions. As expected, year-to-date charges for amortizing purchased contracts reduced operating expense compared to last year but declines in contract amortization charges were partly offset by increased amortization expenses for intangible assets we deployed late last year and early this year.

Income from Operations. Year-to-date operating income this year declined to $17.8 million compared to $19.2 million last year. While operating expenses were down overall this year, they were a higher percentage (18.7%) of this year’s lower revenues compared to last year (18.3%). Cost reductions could not offset this year’s lower gross margin. In 2012, operating margin was 4.6% of revenues compared to last year’s 4.8% of revenues.

Other Expense. Year-to-date interest expense was over $500 thousand greater than it was last year. Interest payable in cash for our senior debt was higher because PIK notes increased interest-bearing Secured Note principal. Unsecured Note cash interest declined as we retired part of this debt last year. Secured Note PIK interest and debt issue cost amortization were higher due to the higher outstanding principal. We used our revolving credit facility briefly in the second quarter. We also paid higher letter of credit fees as we used standby letters of credit to replace cash deposits with landlords.

 

     Six Months Ended March 31,  
     2012      2011  
     (In thousands)  

Cash Pay Interest

     

Revolver

   $ 365       $ 235   

Secured Notes

     15,978         15,663   

Unsecured Notes

     12,556         12,732   

Other cash pay interest and fees

     40         41   
  

 

 

    

 

 

 

Sub-total cash pay interest

     28,939         28,671   

Deferred and Non-cash Interest

     

Secured Notes PIK interest

     3,194         3,134   

Debt issue costs and other non-cash items

     5,204         5,017   
  

 

 

    

 

 

 

Sub-total non-cash interest

     8,398         8,151   
  

 

 

    

 

 

 

Total interest expense

   $ 37,337       $ 36,822   
  

 

 

    

 

 

 

Debt Extinguishment. In a November 2010 open market transaction, Alion purchased $2.0 million of Senior Unsecured Notes at a discount and recognized a $460 thousand gain. There was no comparable transaction this fiscal year.

Income Tax Expense. Alion recognized $3.5 million in year-to-date income tax expense through March 31, both this year and last year. Income tax expense relates to tax-deductible goodwill. During the first half of the year, deferred tax assets increased by $11.3 million and were offset by corresponding increases in valuation allowances. Continuing losses make it unlikely Alion will reasonably be able to realize the full value of deferred tax assets.

Net Loss. Although we cut operating expenses by more than $1 million this year, we were only able to partially offset $2.6 million in reduced gross profit from lower overall revenue. Higher interest expense on our long-term debt and the absence of any debt extinguishment gain this year, led our 2012 year to date net loss to increase by $2.4 million compared to last year.

 

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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. While Management does not currently estimate the Company will need to use its revolving credit facility to any significant extent, except for letters of credit, Management does forecast that Alion will need to use the revolving credit facility to moderate the effects of interruptions to the collections cycle from contract funding delays.

Cash Flows

Alion used approximately $7.9 million to fund operations this year. We used $6.7 million this quarter and $1.2 million in the first quarter. In 2011, we used $3.5 million to fund operations for the entire first six months of the year. Last year, we generated $4.8 million in operating cash flow during our second quarter. This year’s net loss is $2.3 million greater than last year’s net loss. Net non-cash charges were $700 thousand higher than last year primarily because last year’s results included a significant non-cash debt extinguishment gain. Non-cash paid-in-kind interest and debt issue cost charges were stable year over year. Alion’s income tax expense is a non-cash charge related to tax deductible goodwill. Management does not believe Alion will have any material cash outflows for income taxes for at least several years, and then, only if the Company were to generate net income.

The Company faces significant ongoing cash requirements to fund quarterly interest payments on its senior debt. Growth in accounts receivable, particularly unbilled receivables, continues to tie up cash. As part of management’s ongoing cash flow improvement initiatives, Alion was able to liquidate cash that had previously been tied up for lease-related security deposits. The Company replaced $3.0 million in security deposits with standby letters of credit under the revolving credit facility. This change, coupled with increased receivable collections late in the quarter, enabled us to reduce vendor payables.

Political uncertainties in the budget process and administration demands to reduce Department of Defense spending, adversely affected the contract funding process and Alion’s revenue and cash flows. Many government customers are facing increased workloads and budgetary restrictions that are delaying the process of executing contract modifications. Management is actively engaged in efforts to moderate funding delays so Alion can increase billings to customers for unfunded customer-requested work.

Despite these contract funding challenges, Alion only accessed its revolving credit facility briefly this quarter, and for a limited amount. Delayed collections in the middle of the quarter led the Company to use its revolving credit facility for almost two weeks. The maximum balance drawn was $10 million. The weighted average amount outstanding was $536 thousand. All balances were repaid and no amount was drawn as of March 31, 2012.

Alion collected $199.8 million in receivables this quarter and $387.1 million for the six months through March 31, 2012. Second quarter collections this year, were only $1.6 million less than last year’s second quarter collections. However, our year-to-date collections were off by $22.5 million compared to 2011. This year’s collections are down largely because our sales are down year over year and our unbilled receivables continue at elevated levels, trends which have continued since early last year. Despite these trends, this year’s second quarter collections outpaced revenue by $2.7 million largely because we collected prior year indirect rate variance invoices more quickly than expected.

Days’ sales outstanding (DSO) increased slightly from 86.1 days last quarter to 86.7 days this quarter. DSO is based on trailing twelve month revenue. Management expects DSO levels will improve as the Company begins to realize the benefits of efforts to speed the pace of funding actions, increase amounts billed to customers and reduce unbilled receivables overall. Management is devoting significant time and effort to improve cash flow, but progress so far has been hampered by government delays in issuing contract funding documents.

Year-to-date capital expenditures are higher than they were last year as Alion invested in new software and information technology. This year, certain ESOP transactions occurred on a different timeline than last year. We received cash for mid-year stock sales to the ESOP Trust in April instead of late March. Last year, as is typically the case, the Company received stock sale proceeds in March. Last year, the Company also received cash from the ESOP Trust in October for the preceding September’s stock sale.

 

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This year Alion spent $2.7 million to repurchase stock from ESOP participants. This was $500 thousand less than last year’s $3.2 million in repurchases through March. Lower repurchase outflows were largely the result of a decline in the share price of Alion common stock. Last year Alion spent $710 thousand to increase revolving credit facility capacity by $10 million. We had no comparable expense this year.

We have a long-term revolving credit facility through August 2014. Management expects that Alion will be able to meet the existing debt covenants even though clearance levels may narrow as covenant thresholds increase. Delays in contract funding adversely affect our ability to increase our revenue on the timeline that Management seeks to achieve. However, Management believes the Company can attain the EBITDA levels required in the revolving credit facility despite slower than anticipated contract funding activity.

Meeting our EBITDA covenants will allow Alion to maintain access to its revolving credit facility. We expect to be able to maintain access even though we do not currently forecast needing to borrow significant amounts for extended periods. Management believes the Company may need to use the revolving credit facility for short periods of time based on collections cycles subject to government delays.

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. We retain the ability to restrict or defer certain types of cash payments that in the past caused us to fail to comply with certain prior debt covenants. The Revolving Credit facility also limits our ability to offer and fund certain types of discretionary diversification options that create demands on Alion’s cash flows.

We cannot predict with any degree of accuracy the extent to which re-purchase and diversification demands will increase in future years. As more employees meet statutory and Plan-specific age and length of service requirements, potential diversification demands are likely to increase. These demands can increase further with any increase in the price of a share of Alion common stock. While a drop in our share price could reduce the value of each individual Plan participant’s beneficial interest, such a potential price decline could be offset by increased diversification demands and thus might not reduce the aggregate value of future demands on our cash. Current debt agreements limit our ability to offer discretionary diversification options to ESOP participants and this should reduce future cash flow demands. We try to monitor future potential impacts by relying in part on internal and external financial models that incorporate Plan census data and financial inputs intended to simulate changes in Alion’s share price.

Cash flow effects and risks associated with equity-related obligations

Changes in the price of a share of Alion common stock used to affect warrant-related interest expense. Our outstanding Secured Note warrants have a one penny exercise price and are in the money. They do not have a cash liquidation option and therefore Alion will only recognize interest expense for the debt issue cost associated with the initial fair value of these warrants. We no longer have significant stock-based compensation liabilities as outstanding SARs have little, if 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. Our next regularly scheduled valuation period ends in September 2012. Interest rates, market-based factors and volatility, as well as Alion’s financial results will affect the future value of a share of our common stock.

Certain stock-based compensation grantees can choose to defer their payments by having us deposit funds in a rabbi trust we own. Any such deferrals will not materially affect our planned payments or our overall anticipated cash outflows.

After each semi-annual valuation period, the Plan permits former employees and beneficiaries to request distribution of their vested ESOP account balances. In the coming quarter, we expect we will pay out an as-yet-undetermined amount for distribution requests. Consistent with the terms of the Plan and the IRC, we intend to pay distribution requests in five annual installments and to defer initial payments as permitted. The Plan allows Alion to defer initial installment distributions for five years for former employees who are not disabled, deceased or retired.

Discussion of Debt Structure

Alion’s current debt structure includes a $35 million revolving credit facility with $3.7 million in outstanding letters of credit and no balance actually draw at March 31, 2012; $320.1 million in Secured Notes which include $310 million in original notes at face value plus $10.1 million in PIK interest notes issued; and $245 million of Unsecured Notes. See Note 10 – Long term debt in the accompanying unaudited financial statements elsewhere in this report for a detailed discussion of Alion’s current debt structure.

 

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Senior Secured Note Indenture and Senior Unsecured Note Indenture

See Note 10 – Long-term debt in the accompanying unaudited financial statements elsewhere in this report for a detailed listing of the terms and limitations of our existing long-term debt agreements including our Revolving Credit Agreement, the Secured Note Indenture and the Unsecured Note Indenture. There are no financial covenants in either the Senior Secured Note Indenture or the Senior Unsecured Note Indenture. Certain provisions in the Senior Secured Note Indenture and the Senior Unsecured Note Indenture limit our ability to incur additional debt or pay dividends if our ratio of trailing twelve month Adjusted EBITDA to trailing twelve-month Consolidated Interest Expense is not greater that 2.0 to 1.0. Set out below are our actual ratios as of March 31, 2012 and September 30, 2011.

 

     March 31, 2012      September 30, 2011  

TTM Adjusted EBIDTA

   $  65.6 million       $  63.2 million   

TTM Consolidated Interest Expense

   $ 74.4 million       $ 73.9 million   

Ratio

     0.88 to 1.0         0.86 to 1.0   

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 potential 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 it to exclude certain one-time gains when computing Consolidated EBITDA. The revolving credit agreement requires Alion to have a minimum $60.5 million in Consolidated EBITDA for the twelve months ended March 31, 2012. We had approximately $65.6 million in Consolidated EBITDA for the twelve months ended March 31, 2012 and exceeded the requirement by approximately $5.1 million.

During the rest of this year and for the next three fiscal years the Company expects that at a minimum, it will have to make the estimated interest and principal payments set forth below. Our forecast interest expense for the balance of the current year is based on accessing our revolving credit facility for limited periods of time on an intermittent basis. We estimate the maximum drawn balance will not exceed $10 million on any given day and that our weighted average loan balance will be less than $3.5 million. We do not forecast needing to access the revolving credit facility to any measurable extent beyond the end of the current fiscal year.

 

     (In thousands)  
Fiscal Year:    2012      2013      2014      2015  

Bank revolving credit facility (1)

           

—Interest

   $ 453       $ 621       $ 555       $ —     

Secured Notes (2)

           

—Interest

     16,005         32,491         33,144         16,821   

—Principal and PIK Interest

     —           —           —           339,788   

Unsecured Notes (3)

           

—Interest

     12,556         25,113         25,113         12,556   

—Principal

     —           —           —           245,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cash—pay interest

     29,014         58,225         58,812         29,377   

Total cash—pay principal and PIK Interest

     —           —           —           584,788   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 29,014       $ 58,225       $ 58,812       $ 614,165   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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(1) We expect we will occasionally use our $35.0 million revolving credit facility to meet working capital needs through 2014. After the current fiscal year, 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

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. 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, 2012, Alion had spent a cumulative total of $89.4 million to repurchase shares of its common stock to satisfy ESOP distribution and diversification requests from former employees and Plan beneficiaries. Four years ago, the Company started paying ESOP beneficiaries over the five-year distribution period permitted by ERISA and the terms of the Plan. We intend to continue this practice for the foreseeable future to mitigate some of the cash flow effects of annual employee diversification requests that we expect will 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.

 

Date

   Number of
Shares
Repurchased
     Share
Price
     Total Value
Purchased
 
                   (In thousands)  

December 2010

     119,945       $ 26.65       $ 3,196   

February 2011

     322       $ 26.65         8   

March 2011

     136       $ 26.65         4   

April 2011

     166       $ 27.15         5   

May 2011

     3,677       $ 27.15         100   

June 2011

     87,319       $ 27.15         2,371   

July 2011

     2,300       $ 27.15         62   

August 2011

     292       $ 27.15         8   

September 2011

     289       $ 27.15         8   

November 2011

     1,481       $ 20.95         32   

December 2011

     106,505       $ 20.95