**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**Form10-Q**

 

**(Mark One)**

| **x**                                                                                                                                                                                                                                                                         | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                          |
| **FOR THE QUARTERLY PERIOD ENDED  SEPTEMBER 29, 2007**                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                          |
| **OR**                                                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                          |
| **o**                                                                                                                                                                                                                                                                         | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                          |
| **FOR  THE TRANSITION PERIOD FROM                                          TO** |

 

**CommissionFile Number: 333-145355**

 

**VANGENT,INC.**

(Exactname of Registrant as specified in its charter)

 

| **Delaware**                    | ** ** | **20-1961427**      |
|---------------------------------|------------|---------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer    |
| incorporation or organization)  |       | Identification No.) |

 

**4250 North Fairfax Drive**

**Suite 1200**

**Arlington, Virginia 22203**

(Addressof principal executive offices)

 

**(703) 284-5600**

(Registrant’stelephone number, including area code)

 

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 (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days. Yes      o No      x

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated  filer    o | Accelerated  filer    o | Non-accelerated filer    x |
|---------------------------------------------------|---------------------------------------------|------------------------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).Yes   o      No   x

 

The number of shares of the registrant’s common shares, par value $0.01per share, outstanding as of September 29, 2007 was 1,000.

 

 

----

 

**VANGENT,INC.**

**QUARTERLYREPORT ON FORM 10-Q**

**FOR THEQUARTER ENDED SEPTEMBER 29, 2007**

**TABLE OFCONTENTS**

** **
| **PART I—FINANCIAL INFORMATION**                                                                                                                                                                                                                                               | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                                                                                                                                                                                                                                                |       |
| Item 1:  Financial Statements (unaudited)                                                                                                                                                                                                                                      |       |
| Consolidated Balance  Sheets as of December 31, 2006 and September 29, 2007                                                                                                                                                                                                    |       |
| Condensed Consolidated  Statements of Operations for the three and nine months ended September 30,  2006, the Predecessor Period January 1, 2007 to February 14, 2007, and the  Successor Period February 15, 2007 to September 29, 2007 and three months  ended September 29, 2007 |       |
| Condensed  Consolidated Statements of Cash Flows for the nine months ended September 30,  2006, the Predecessor Period January 1, 2007 to February 14, 2007, and the  Successor Period February 15, 2007 to September 29, 2007                                                      |       |
| Consolidated Statements of Owner’s/Stockholder’s  Equity and Comprehensive Income (Loss) for the nine months ended September  30, 2006, the Predecessor Period January 1, 2007 to February 14, 2007, and  the Successor Period February 15, 2007 to September 29, 2007    |       |
| Notes  to Condensed Consolidated Financial Statements                                                                                                                                                                                                                               |       |
|                                                                                                                                                                                                                                                                                |       |
| Item 2:  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                                                                                                                                                                           |       |
| Item 3:  Quantitative and Qualitative Disclosures about Market Risk                                                                                                                                                                                                            |       |
| Item 4:  Controls and Procedures                                                                                                                                                                                                                                               |       |
|                                                                                                                                                                                                                                                                                |       |
| **PART  II—OTHER INFORMATION**                                                                                                                                                                                                                                                 | ** ** |
| Item 1: Legal Proceedings                                                                                                                                                                                                                                                      |       |
| Item 1A: Risk Factors                                                                                                                                                                                                                                                          |       |
| Item 2:  Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                                                                                                                           |       |
| Item 3:  Defaults Upon Senior Securities                                                                                                                                                                                                                                       |       |
| Item 4:  Submission of Matters to a Vote of Security Holders                                                                                                                                                                                                                   |       |
| Item 5: Other  Information                                                                                                                                                                                                                                                     |       |
| Item 6: Exhibits                                                                                                                                                                                                                                                               |       |

 

----

 

**PART I.FINANCIAL INFORMATION**

**ITEM 1.UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Vangent, Inc. (formerly PearsonGovernment Solutions Business)**

**ConsolidatedBalance Sheets**

(in thousands except pershare and share amounts)

(unaudited)

 
| ** **                                                                                             | ** ** | **Predecessor  Entity**     | ** ** | ** ** | **Successor  Entity**   | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------|-------------------------|------------|
| ** **                                                                                             | ** ** | **December 31,  2006** | ** ** | ** ** | **September 29,  2007** | ** ** |
| **Assets**                                                                                             | ** ** | ** **                  | ** ** | ** ** | ** **              | ** ** |
| Current assets                                                                                         |       |                        |       |       |                    |       |
| Cash and cash  equivalents                                                                             |       | $                           | 11,713     |       |                    | $          | 14,996 |   |
| Accounts  receivable, net                                                                              |       | 102,457                     |       |       | 115,501                 |       |
| Inventories                                                                                            |       | 536                         |       |       | 1,401                   |       |
| Deferred loan  fees                                                                                    |       | —                      |       |       | 2,150                   |       |
| Deferred tax  asset                                                                                    |       | 2,948                       |       |       | —                  |       |
| Prepaids and  other assets                                                                             |       | 4,515                       |       |       | 18,661                  |       |
| Total current  assets                                                                                  |       | 122,169                     |       |       | 152,709                 |       |
|                                                                                                   |       |                        |       |       |                    |       |
| Goodwill                                                                                               |       | 442,871                     |       |       | 301,455                 |       |
| Property and  equipment, net                                                                           |       | 30,305                      |       |       | 28,400                  |       |
| Intangible assets,  net                                                                                |       | 682                         |       |       | 203,266                 |       |
| Deferred loan  fees                                                                                    |       | —                      |       |       | 10,867                  |       |
| Other assets                                                                                           |       | 749                         |       |       | 948                     |       |
| Total assets                                                                                           |       | $                           | 596,776    |       |                    | $          | 697,645 |   |
| **Liabilities  and Owner’s /Stockholder’s Equity**                                           |       |                        |       |       |                    |       |
| Current  liabilities                                                                                   |       |                        |       |       |                    |       |
| Current portion  of long-term debt and revolving credit facility                                       |       | $                           | —     |       |                    | $          | 2,400 |   |
| Accounts payable                                                                                       |       | 28,977                      |       |       | 36,464                  |       |
| Accrued expenses                                                                                       |       | 24,067                      |       |       | 30,439                  |       |
| Accrued interest                                                                                       |       | —                      |       |       | 4,686                   |       |
| Advance payments  on contracts                                                                         |       | 8,790                       |       |       | 5,848                   |       |
| Current  maturities on long-term leases                                                                |       | 311                         |       |       | 312                     |       |
| Current portion  of deferred tax liability                                                             |       | —                      |       |       | 852                     |       |
| Total current  liabilities                                                                             |       | 62,145                      |       |       | 81,001                  |       |
|                                                                                                   |       |                        |       |       |                    |       |
| Long-term debt,  net of current portion                                                                |       | —                      |       |       | 426,400                 |       |
| Other long-term  liabilities                                                                           |       | 3,703                       |       |       | 4,140                   |       |
| Deferred tax  liability, net of current portion                                                        |       | 1,844                       |       |       | 3,418                   |       |
| Total liabilities                                                                                      |       | 67,692                      |       |       | 514,959                 |       |
|                                                                                                   |       |                        |       |       |                    |       |
| Commitments and  contingencies (Note 7)                                                                |       |                        |       |       |                    |       |
| Owner’s/stockholder’s  equity                                                                |       |                        |       |       |                    |       |
| Common stock,  $0.01 par value; 1,000 shares authorized, issued and outstanding at September  29, 2007 |       | —                      |       |       | —                  |       |
| Additional  paid-in capital                                                                            |       | —                      |       |       | 203,466                 |       |
| Pearson  intercompany investment in subsidiary                                                         |       | 534,586                     |       |       | —                  |       |
| Accumulated  deficit                                                                                   |       | —                      |       |       | (20,053                 | )          |
| Accumulated  other comprehensive loss                                                                  |       | (5,502                      | )          |       | (727                    | )          |
| Owner’s/stockholder’s  equity                                                                |       | 529,084                     |       |       | 182,686                 |       |
| Total  liabilities and owner’s/stockholder’s equity                                          |       | $                           | 596,776    |       |                    | $          | 697,645 |   |

 

The accompanying notes are an integral partof these unaudited condensed consolidated financial statements.

 

1

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**CondensedConsolidated Statements of Operations**

(in thousands)

(unaudited)

 
| ** **                            | ** ** | **Predecessor  Entity**                               | ** ** | ** ** | **Successor  Entity**                                 | ** ** | **Predecessor Entity**                     | ** ** | ** **                                                   | **Successor  Entity** | ** ** |
|---------------------------------------|------------|-------------------------------------------------------|------------|------------|-------------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------------------|-----------------------|------------|
| ** **                            | ** ** | **Three Months  Ended  September 30, 2006** | ** ** | ** ** | **Three Months  Ended  September 29, 2007** | ** ** | **Nine Months  Ended  September 30, 2006** | ** ** | **Period  January 1, 2007  to  February 14, 2007** | ** **            | ** ** | **Period  February 15, 2007  to  September 29, 2007** | ** ** |
|                                  |       |                                                  |       |       |                                                  |       |                                            |       |                                                         |                  |       |   |   |
| Revenue                               |       | $                                                     | 110,313    |       |                                                  | $          | 129,610                                         |       | $                                                            | 396,479               |       | $ | 58,833 |   |   | $ | 303,656 |   |
| Cost of revenue                       |       | 82,618                                                |       |       | 103,983                                               |       | 315,936                                         |       | 48,187                                                       |                  |       | 254,096 |   |
| Gross profit                          |       | 27,695                                                |       |       | 25,627                                                |       | 80,543                                          |       | 10,646                                                       |                  |       | 49,560 |   |
| General and  administrative expenses  |       | 10,122                                                |       |       | 11,544                                                |       | 29,149                                          |       | 9,383                                                        |                  |       | 29,982 |   |
| Selling and  marketing expenses       |       | 4,821                                                 |       |       | 4,190                                                 |       | 14,878                                          |       | 1,940                                                        |                  |       | 11,039 |   |
| Intangible  amortization              |       | 3                                                     |       |       | —                                                |       | 11                                              |       | —                                                       |                  |       | — |   |
| Operating income  (loss)              |       | 12,749                                                |       |       | 9,893                                                 |       | 36,505                                          |       | (677                                                         | )                     |       | 8,539 |   |
| Interest expense  (income), net       |       | 257                                                   |       |       | 9,731                                                 |       | 482                                             |       | (10                                                          | )                     |       | 24,090 |   |
| Income (loss)  before income taxes    |       | 12,492                                                |       |       | 162                                                   |       | 36,023                                          |       | (667                                                         | )                     |       | (15,551 | ) |
| Provision  (benefit) for income taxes |       | 4,869                                                 |       |       | 1,566                                                 |       | 13,700                                          |       | (292                                                         | )                     |       | 4,502 |   |
| Net income  (loss)                    |       | $                                                     | 7,623      |       |                                                  | $          | (1,404                                          | )          | $                                                            | 22,323                |       | $ | (375 | ) |   | $ | (20,053 | ) |

 

The accompanying notes are an integral part of these unaudited condensedconsolidated financial statements.

 

2

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**ConsolidatedStatements of Owner’s/Stockholder’s Equity and Comprehensive Income (Loss)**

(in thousands, exceptshare amounts)

(unaudited)

 
| ** **                                                   | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Pearson  Intercompany  Investment in** | ** ** | **Accumulated** | ** ** | **Total Owner’s/  Stockholder’s** | ** ** | **Comprehensive** | ** ** |
|--------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|-----------------|------------|--------------------------------------------------|------------|-------------------|------------|
| ** **                                                   | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**                           | ** ** | **(Loss) Income**                        | ** ** | **Subsidiary**  | ** ** | **Deficit**                                      | ** ** | **Equity**        | ** ** | **Income (Loss)** | ** ** |
| ***(Predecessor  Entity)***                                  |       |                  |       |                    |       |                                  |       |                                          |       |            |       |                                             |       |              |       |   |   |
| Balance, December  31, 2005                                  |       | —                |       | $                       | —     |                                  | $          | —                                        |       | $               | (4,930     | )                                                | $          | 496,213           |       | $ | — |   | $ | 491,283 |   | $ | — |   |
| Net income                                                   |       | —                |       | —                  |       | —                                |       | —                                        |       | 22,323          |       | —                                           |       | 22,323            |       | 22,323 |   |
| Pearson equity  transfers and investment                     |       | —                |       | —                  |       | —                                |       | —                                        |       | 17,046          |       | —                                           |       | 17,046            |       | — |   |
| Foreign currency  translation adjustment, net of tax effects |       | —                |       | —                  |       | —                                |       | (815                                          | )          | —          |       | —                                           |       | (815              | )          | (815 | ) |
| Balance,  September 30, 2006                                 |       |                  | —     |                    | $          | —                                |       | $                                             | —     |            | $          | (5,745                                           | )          | $                 | 535,582    |   | $ | — |   | $ | 529,837 |   | $ | 21,508 |   |
|                                                         |       |                  |       |                    |       |                                  |       |                                          |       |            |       |                                             |       |              |       |   |   |
| Balance, December  31, 2006                                  |       |                  | —     |                    | $          | —                                |       | $                                             | —     |            | $          | (5,502                                           | )          | $                 | 534,586    |   | $ | — |   | $ | 529,084 |   | $ | — |   |
| Net loss                                                     |       | —                |       | —                  |       | —                                |       | —                                        |       | (375            | )          | —                                           |       | (375              | )          | (375 | ) |
| Pearson equity  transfers and investment                     |       | —                |       | —                  |       | —                                |       | —                                        |       | 13,310          |       | —                                           |       | 13,310            |       | — |   |
| Foreign currency  translation adjustment, net of tax effects |       | —                |       | —                  |       | —                                |       | (166                                          | )          | —          |       | —                                           |       | (166              | )          | (166 | ) |
| Balance, February  14, 2007                                  |       | —                |       | $                       | —     |                                  | $          | —                                        |       | $               | (5,668     | )                                                | $          | 547,521           |       | $ | — |   | $ | 541,853 |   | $ | (541 | ) |
| *** ***                                                 |       |                  |       |                    |       |                                  |       |                                          |       |            |       |                                             |       |              |       |   |   |
| ***(Successor  Entity)***                                    |       |                  |       |                    |       |                                  |       |                                          |       |            |       |                                             |       |              |       |   |   |
| Balance, February  15, 2007                                  |       | —                |       | $                       | —     |                                  | $          | —                                        |       | $               | —     |                                             | $          | —            |       | $ | — |   | $ | — |   | $ | — |   |
| Net loss                                                     |       | —                |       | —                  |       | —                                |       | —                                        |       | —          |       | (20,053                                          | )          | (20,053           | )          | (20,053 | ) |
| Issuance of  common stock                                    |       | 1,000                 |       | —                  |       | 203,466                               |       | —                                        |       | —          |       | —                                           |       | 203,466           |       | — |   |
| Effect of hedging  activities, net of tax effects            |       | —                |       | —                  |       | —                                |       | (1,040                                        | )          | —          |       | —                                           |       | (1,040            | )          | (1,040 | ) |
| Foreign currency  translation adjustment, net of tax effects |       | —                |       | —                  |       | —                                |       | 313                                           |       | —          |       | —                                           |       | 313               |       | 313 |   |
| Balance,  September 29, 2007                                 |       | 1,000                 |       | $                       | —     |                                  | $          | 203,466                                       |       | $               | (727       | )                                                | $          | —            |       | $ | (20,053 | ) | $ | 182,686 |   | $ | (20,780 | ) |
|                                                              |            |                       |            |                         |            |                                       |            |                                               |            |                 |            |                                                  |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these unaudited condensedconsolidated financial statements.

 

3

----

 

**Vangent, Inc. (formerly PearsonGovernment Solutions Business)**

**CondensedConsolidated Statements of Cash Flows**

(in thousands)

(unaudited)

 
| ** **                                                                                          | ** ** | **Predecessor Entity**                      | ** ** | ** **                                                   | **Successor  Entity** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|-----------------------|------------|
| ** **                                                                                          | ** ** | **Nine  Months  Ended  September 30, 2006** | ** ** | **Period  January 1, 2007  to  February 14, 2007** | ** **            | ** ** | **Period  February 15, 2007  to  September 29, 2007** | ** ** |
| **Cash  flows from operating activities**                                                           |       |                                             |       |                                                         |                  |       |   |   |
| Net income  (loss)                                                                                  |       | $                                                | 22,323     |                                                         | $                     | (375       | ) |   | $ | (20,053 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities |       |                                             |       |                                                         |                  |       |   |   |
| Depreciation and  amortization                                                                      |       | 11,015                                           |       | 2,369                                                        |                  |       | 20,753 |   |
| Stock based  compensation                                                                           |       | 530                                              |       | 1,477                                                        |                  |       | 475 |   |
| Loss on disposal  of property and equipment                                                         |       | 1,464                                            |       | 7                                                            |                  |       | — |   |
| Deferred income  taxes                                                                              |       | 511                                              |       | (19                                                          | )                     |       | 3,749 |   |
| Changes in operating  assets and liabilities, net of effect of acquisition                          |       |                                             |       |                                                         |                  |       |   |   |
| Accounts  receivable                                                                                |       | 23,524                                           |       | (16,445                                                      | )                     |       | 1,255 |   |
| Inventories                                                                                         |       | 382                                              |       | 20                                                           |                  |       | (885 | ) |
| Prepaids and  other assets                                                                          |       | 568                                              |       | 323                                                          |                  |       | (13,601 | ) |
| Accounts payable                                                                                    |       | (43,932                                          | )          | (4,508                                                       | )                     |       | 11,945 |   |
| Accrued expenses  and accrued interest                                                              |       | (2,640                                           | )          | (664                                                         | )                     |       | 13,494 |   |
| Advance payments  on contracts                                                                      |       | (11,415                                          | )          | (1,206                                                       | )                     |       | (1,736 | ) |
| Other long-term  liabilities                                                                        |       | 65                                               |       | 125                                                          |                  |       | 597 |   |
|                                                                                                |       |                                             |       |                                                         |                  |       |   |   |
| Net cash  provided by (used in) operating activities                                                |       | 2,395                                            |       | (18,896                                                      | )                     |       | 15,993 |   |
|                                                                                                |       |                                             |       |                                                         |                  |       |   |   |
| **Cash  flows from investing activities**                                                           |       |                                             |       |                                                         |                  |       |   |   |
| Acquisition of a  business, net of cash acquired                                                    |       | (8,078                                           | )          | —                                                       |                  |       | (629,219 | ) |
| Capital  expenditures for property and equipment                                                    |       | (5,082                                           | )          | (3,727                                                       | )                     |       | (4,412 | ) |
|                                                                                                |       |                                             |       |                                                         |                  |       |   |   |
| Net cash used in  investing activities                                                              |       | (13,160                                          | )          | (3,727                                                       | )                     |       | (633,631 | ) |
|                                                                                                |       |                                             |       |                                                         |                  |       |   |   |
| **Cash  flows from financing activities**                                                           |       |                                             |       |                                                         |                  |       |   |   |
| Capital lease  payments                                                                             |       | (1,150                                           | )          | (39                                                          | )                     |       | (131 | ) |
| Investment from  parent                                                                             |       | 17,037                                           |       | 13,310                                                       |                  |       | — |   |
| Proceeds from  issuance of common stock                                                             |       | —                                           |       | —                                                       |                  |       | 203,466 |   |
| Proceeds from  issuance of long-term debt and revolving credit facility                             |       | —                                           |       | —                                                       |                  |       | 460,000 |   |
| Repayment of  long-term debt and revolving credit facility                                          |       | —                                           |       | —                                                       |                  |       | (31,200 | ) |
|                                                                                                |       |                                             |       |                                                         |                  |       |   |   |
| Net cash  provided by financing activities                                                          |       | 15,887                                           |       | 13,271                                                       |                  |       | 632,135 |   |
|                                                                                                |       |                                             |       |                                                         |                  |       |   |   |
| **Effect  of foreign currency exchange rate changes**                                               |       | (1,885                                           | )          | (166                                                         | )                     |       | 499 |   |
|                                                                                                |       |                                             |       |                                                         |                  |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                               |       | 3,237                                            |       | (9,518                                                       | )                     |       | 14,996 |   |
| Cash and cash  equivalents, beginning of period                                                     |       | 6,338                                            |       | 11,713                                                       |                  |       | — |   |
|                                                                                                |       |                                             |       |                                                         |                  |       |   |   |
| Cash and cash  equivalents, end of period                                                           |       | $                                                | 9,575      |                                                         | $                     | 2,195      |   |   | $ | 14,996 |   |

 

The accompanying notesare an integral part of these unaudited condensed consolidated financialstatements.

 

4

----

 

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**1.****                                      Organizationand Basis of Presentation**

 

**Basis ofPresentation**

 

On February 14, 2007, TheVeritas Capital Fund III, L.P., PGS Holding LLC (“the Buyer Parent”) (currentlyVangent Holding LLC) and PGS Holding Corp. (“the Buyer”) (currently VangentHolding Corp.) consummated a stock purchase agreement with Pearson plc (“Pearson”)and certain other seller entities under which the buyer agreed to acquire allof the equity interests of (i) Pearson Government Solutions, Inc., anindirect wholly-owned subsidiary of Pearson, and (ii) the domestic andinternational affiliates of Pearson Government Solutions, Inc. that areengaged in the consulting, systems integration and business process outsourcingbusiness operated by the “Pearson Government Solutions” operating unit ofPearson and the other seller entities.

 

The accompanying consolidatedfinancial statements after the date of acquisition, February 14, 2007, reflectthe financial statements of Vangent, Inc. (“Successor Entity”), formerly knownas Pearson Government Solutions Business (“Vangent” or “the Company”). Vangent’s subsidiaries include the following legal entities: BlueprintTechnologies, Inc., Pearson Analytic Solutions, Inc., Vangent Canada,Limited, Vangent Mexico, S.A. de C.V., Vangent Servicios de Mexico, S.A. deC.V., Vangent Argentina, S.A., Vangent Venezuela, C.A., Vangent Puerto Rico,Inc., Data Capture UK, Ltd. and Vangent, Ltd.

 

Prior to the date ofacquisition, the carve-out financial statements of the acquired companies (“PredecessorEntity”) include the managed group of entities under Pearson known as PearsonGovernment Solutions Business (“PGS”). PGS included the following legalentities: Pearson Government Solutions, Inc., BlueprintTechnologies, Inc., Pearson Analytic Solutions, Inc., Pearson CanadaSolutions, Limited, Soluciones Pearson Mexico, S.A. de C.V., NCS Servicios deMexico, S.A. de C.V., Pearson Soluciones S.A., NCS Pearson Venezuela, C.A.,Pearson Soluciones, Inc. and Pearson Government Solutions, Ltd. PGS alsocontained certain assets of NCS Pearson Inc., a wholly-owned subsidiary ofPearson representing the Pearson Performance Solutions group and the PGSInternational Headquarters group. The predecessor financial statements wereprepared from Pearson historical accounting records and are presented on acarve-out basis to include the historical financial position, results ofoperations, and cash flows applicable to the business. No direct ownershiprelationship existed amongst all the operations comprising PGS prior to thedate of acquisition. Accordingly, owner’s equity was presented for thePredecessor Entity in lieu of stockholder’s equity.

 

The unauditedconsolidated financial statements presented for the three months and ninemonths ended September 30, 2006 and for the period January 1, 2007 to February14, 2007 represent the Predecessor Entity. The unaudited consolidated financialstatements presented for the period February 15, 2007 to September 29, 2007 andthe three months ended September 29, 2007 represent the Successor Entity. As aresult of the application of purchase accounting (Note 2), the financialstatements of the Predecessor Entity are not comparable with the financialstatements of the Successor Entity, because they are, in effect, those of a newentity.

 

These unauditedconsolidated financial statements have been prepared in accordance withgenerally accepted accounting principles for interim financial information andthe instructions to Rule 10-01 of Regulation S-X. Accordingly, they do notinclude all of the information and footnotes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements. The consolidated financial statements include all normal andrecurring adjustments that management considers necessary to present fairly thefinancial position as of  September 29,2007 (Successor Entity) and the results of operations for the three monthsended September 30, 2006  (PredecessorEntity) and September 29, 2007 (Successor Entity), the nine months endedSeptember 30, 2006 (Predecessor Entity), the period January 1, 2007 to February14, 2007 (Predecessor Entity) and the period February 15, 2007 to September 29,2007 (Successor Entity). The consolidated financial statements also include thecash flows for the nine months ended September 30, 2006 (Predecessor Entity),the period January 1, 2007 to February 14, 2007 (Predecessor Entity) and theperiod February 15, 2007 to September 29, 2007 (Successor Entity).

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the amounts reported in the financial statementsand accompanying notes. Actual results could differ from those estimates.During the third quarter of 2007, the Company identified certain errors relatedto revenue recognized in periods prior to fiscal 2007 and in the second quarterof 2007. The Company has recorded adjustments for these items which increasedrevenue and net income by $378 for the three months ended September 29, 2007and increased revenue by $149, cost of revenue by $926, and reduced net incomeby $777 for the successor period ended September 29, 2007. The Company hasdetermined that the impact of these adjustments was not material to the currentor any prior period and does not believe it will be material to the results forfiscal year 2007.

 

Certain prior yearamounts have been reclassified to conform to the current year presentation.This reclassification had no impact on previously reported net income, owner’sequity or cash flows.

 

**Natureof Operations**

 

Vangent serves clients inthe U.S. Federal Government, international governments, higher education, andthe 

 

5

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

commercial human resourcemanagement sectors. The Company’s primary focus is within U.S. andinternational governmental agencies which utilize third-party providers todesign, build and operate technologically advanced systems. The organizationalstructure focuses on defense, intelligence, homeland security and public healthcare sectors of the government market, as well as civilian agencies. As apercentage of total revenue, two customers represented 49.5% and 16.0% for thethree months ended September 29, 2007, 28.7% and 23.2% for the three monthsended September 30, 2006, 44.0% and 18.4% for the nine months ended September 29,2007, and 40.7% and 18.8% for the nine months ended September 30, 2006. Noother customer represented more than 10% of total revenue in any periodpresented.

 

**2.****                                      VangentAcquisition Transactions (“The Acquisition”)**

 

On February 14, 2007, TheVeritas Capital Fund III, L.P. (“Veritas Capital”) and the Buyer consummated astock purchase agreement with Pearson and certain other seller entities underwhich the Buyer agreed to acquire all of the equity interests of(i) Pearson Government Solutions, Inc. and (ii) the domestic andinternational affiliates of Pearson Government Solutions, Inc. Thepurchase price for the Acquisition was as follows: (i) $560,000 in cash;(ii) $35,000 in Series A preferred stock of the Buyer;(iii) $5,000 in Series B preferred stock of the Buyer; and(iv) 10% of the Class A membership interests of the Buyer Parent. Thecash portion of the purchase price was increased  post-closing by $50, based upon an increasein the net assets of the business at closing as compared to net assets as ofSeptember 30, 2006.

 

In addition to theinvestments discussed above, the Acquisition was funded by:

 

•                  Class A common equity investments in the Buyer Parent of$155,000 by Veritas Capital and Series B preferred stock in the Buyer of $2,000by a third party investor;

 

•                  9 5/8% senior subordinated notes of $190,000 maturing onFebruary 15, 2015; and

 

•                  Borrowings under a senior secured credit facility,consisting of a $240,000 term loan facility at the interest rate of thethree-month LIBOR rate plus 2.25% and $5,000 drawn under a $50,000 revolvingcredit facility at an interest rate of the three-month LIBOR rate plus 2.50%.

 

Under the terms of thepurchase agreement, Pearson plc will pay to Vangent the actuarially determinedunfunded liability (net of tax benefits) of the portion of the Pearson plcpension plan applicable to certain employees of the Company which is estimatedto be $1,828 less an accrued tax benefit payable to Pearson plc of $548 (Note6).

 

The Acquisition wasaccounted for under Emerging Issues Task Force Issue No. 88-16, *Basis in Leveraged Buyout Transactions*(“EITF 88-16”).In accordance with EITF 88-16, the portion of Pearson plc’s (“continuingstockholder”) basis in the Company represented by their 10% residual interestwas assigned to the assets and liabilities acquired. The remainder of theinvestment in the assets and liabilities acquired (the 90%) by the Buyer wasrecorded at fair value. As a result, the assets and liabilities have beenassigned new values, which include part carryover basis and part fair valuebasis. The continuing stockholder’s residual interest in the Company wasapplied to the incremental debt resulting from the Acquisition, and wasaccounted for as a deemed dividend and recognized as a reduction of equity. Athird-party valuation of the assets and liabilities acquired was performed onidentified intangible assets and the newly issued Series A and Series Bpreferred stock and the allocation resulted in new identifiable intangibleassets. Additional purchase accounting adjustments were made in accordance withSFAS No. 141, *Accounting for Business**Combinations,* and related guidance. The excess of thepurchase price over assets acquired and liabilities assumed was allocated togoodwill of the acquired Company.

 

In September 2007, theCompany adjusted its purchase price allocation related to the Acquisition inthe amount of $3,162 which reflects reductions to accounts receivable of $2,146and other current and non-current assets of $418, as well as increases toliabilities assumed of $598 as of the acquisition date with an offsettingincrease to goodwill. The adjusted purchase price allocation is as follows:

 

6

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 
| **Purchase  Consideration:**                         |   |    |    |
|------------------------------------------------------|--------|---------|---------|
| Cash paid to  Pearson                                |   | $       | 560,000 |   |
| Common stock of  Buyer Parent issued to Pearson      |   | 54,185  |    |
| Less deemed dividend                                 |   | (47,697 | )       |
| Series A  preferred stock of Buyer issued to Pearson |   | 35,020  |    |
| Series B  preferred stock of Buyer issued to Pearson |   | 4,958   |    |
| Transaction  costs                                   |   | 32,000  |    |
| Total purchase  consideration                        |   | $       | 638,466 |   |
|                                                 |   |    |    |
| **Allocation  of Purchase Consideration:**           |   |    |    |
| Cash                                                 |   | $       | 2,195   |   |
| Accounts  receivable                                 |   | 116,756 |    |
| Property and  equipment                              |   | 31,007  |    |
| Deferred  financing costs                            |   | 14,013  |    |
| Other current  and non-current assets                |   | 7,864   |    |
| Identifiable  intangible assets                      |   | 216,406 |    |
| Goodwill                                             |   | 301,455 |    |
| Less:  liabilities assumed                           |   | (58,282 | )       |
| Net assets  acquired                                 |   | 631,414 |    |
| Additional cash  received from Buyer                 |   | 7,052   |    |
| Total net assets                                     |   | $       | 638,466 |   |

 

Identifiable intangibleassets were valued by an independent appraiser as of the acquisition date. Inaccordance with EITF 88-16, the 10% residual value of historical intangibleassets was retained and 90% of the appraised value of identifiable intangibleassets was recorded at fair value as shown in the table below:

 
| ** **                     | ** ** | ** ** | ** ** | **Weighted  Average Life** | ** ** |
|--------------------------------|------------|------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **Amount** | ** ** | **(In years)**             | ** ** |
| Customer  relationships        |       | $          | 204,570    |                            | 10.8       |   |
| Intellectual  property         |       | 11,178     |       | Indefinite                      |       |
| Core and  developed technology |       | 603        |       | 4                               |       |
| Other  intangibles assets      |       | 55         |       | 0.5                             |       |
| Total                          |       | $          | 216,406    |                            |       |   |

 

Amortizationof the intangible assets shown above is included in cost of revenue in theconsolidated statements of operations.

 

Thefollowing unaudited pro forma results of operations of Vangent, Inc. assumethat the Acquisition took place on January 1, 2006 for the periods presented:

 

7

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 
| ** ** | ** ** | **Three  Months  Ended  September 30, 2006** | ** ** | **Three  Months  Ended  September 29, 2007** | ** ** | **Nine  Months  Ended  September 30, 2006** | ** ** | **Nine  Months  Ended  September 29, 2007** | ** ** |
|------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** ** | ** ** | ** **                                        | ** ** | ** **                                        | ** ** | ** **                                       | ** ** | ** **                                       | ** ** |
| Revenue    |       | $                                                 | 110,313    |                                              | $          | 129,610                                          |       | $                                                | 396,479    |   | $ | 362,489 |   |
| Net loss   |       | (2,639                                            | )          | (1,404                                            | )          | (13,107                                          | )          | (29,155                                          | )          |
|            |            |                                                   |            |                                                   |            |                                                  |            |                                                  |            |  |  |  |  |

 

Theunaudited pro forma results of operations are being furnished solely forinformational purposes and are not intended to represent or be indicative ofthe consolidated results of operations that the Company would havereported  had these transactions beencompleted as of the dates and for the periods presented, nor are they necessarilyindicative of future results.

 

**3.****                                      Long-TermDebt and Revolving Credit Facility**

 

Thelong-term debt and revolving credit facility consisted of the following:

 
| ** **                                                                                | ** ** | **Predecessor  Entity**                 | ** ** | ** ** | **Successor  Entity**                    | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|------------|------------------------------------------|------------|
| ** **                                                                                | ** ** | **As of  December 31,  2006** | ** ** | ** ** | **As of  September 29,  2007** | ** ** |
| ** **                                                                                | ** ** | ** **                              | ** ** | ** ** | ** **                               | ** ** |
| *Senior  secured credit facilities:*                                                      |       |                                    |       |       |                                     |       |
| Revolving credit  facility, with interest at 9.75% at September 29, 2007                  |       | $                                       | —     |       |                                     | $          | — |   |
| Term loan due  2013 with interest at 7.62% at September 29, 2007                          |       | —                                  |       |       | 238,800                                  |       |
|                                                                                      |       |                                    |       |       |                                     |       |
| *Fixed  rate notes:*                                                                      |       |                                    |       |       |                                     |       |
| 9.625% Notes due  February 15, 2015                                                       |       | —                                  |       |       | 190,000                                  |       |
| Capital lease  obligations                                                                |       | 566                                     |       |       | 503                                      |       |
|                                                                                      |       |                                    |       |       |                                     |       |
| Total long-term  debt and revolving credit facility                                       |       | 566                                     |       |       | 429,303                                  |       |
| Less: current  portion of capital lease obligation                                        |       | (311                                    | )          |       | (312                                     | )          |
| Less: current  portion of long-term debt, revolving credit facility, and short term loans |       | —                                  |       |       | (2,400                                   | )          |
| Total long-term  debt, excluding current portion                                          |       | $                                       | 255        |       |                                     | $          | 426,591 |   |

 

The long-term portion ofcapital lease obligations of $255 and $191 is included in other long-termliabilities in the consolidated balance sheets at December 31, 2006 andSeptember 29, 2007, respectively.

 

8

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

Aggregate futureprincipal maturities of all long term debt as of September 29, 2007 are asfollows:

 
| 2007       |   | $       | 735     |   |
|------------|--------|---------|---------|--------|
| 2008       |   | 2,623   |    |
| 2009       |   | 2,527   |    |
| 2010       |   | 2,418   |    |
| 2011       |   | 2,400   |    |
| Thereafter |   | 418,600 |    |
|       |   | $       | 429,303 |   |

 

The senior secured creditfacilities and fixed rate notes were collateralized as part of the Acquisition(Note 2).

 

**4.****                                      InterestRate Swap**

 

On February 25, 2007, the Company entered into athree-year interest rate swap agreement with Wachovia Bank, N.A. (“Wachovia”)to eliminate the variability of probable cash flows due to fluctuations inLIBOR interest rates on a notional amount of $140,000 of the credit facility. Thenotional amount will amortize down to $120,000 on February 25, 2008 and$110,000 on February 25, 2009 until expiration on February 25, 2010. Under theterms of the swap agreement, the Company exchanged its floating LIBOR interestrate on the credit facility for a fixed interest rate of 5.215% for a period ofthree years.

 

The counterparty to this agreement is a highly ratedfinancial institution. In the unlikely event that the counterparty fails tomeet the terms of the interest rate swap agreement, the Company’s exposure islimited to the interest rate differential on the notional amount at eachquarterly settlement period over the life of the agreement. We do notanticipate non-performance by the counterparty.

 

In accordance with Statement of Financial AccountingStandards No. 133, *Accounting for DerivativeInstruments and Hedging Activities* (“SFAS 133”), the Companydocumented its risk management objective and nature of the risk being hedgedand designated the interest rate swap as a cash flow hedge at the inception ofthe agreement. In accordance with SFAS 133, derivatives that have beendesignated and qualify as cash flow hedging instruments are reported at fairvalue with any gain or loss on the effective portion of the hedge reported as acomponent of other comprehensive income in the Company’s consolidated statementof owner’s/stockholder’s equity. Any ineffective gain or loss is recognizedcurrently in earnings.

 

Pursuant to SFAS 133, we are required to perform aquarterly analysis of the effectiveness of the hedge. Based on the results of the effectiveness analysis performed at September29, 2007, the Company concluded that the hedging relationship was highlyeffective due to the consistency of critical terms of the interest rate swapand related credit facility.  As such, we reported the interestrate swap at its fair value in theconsolidated balance sheet and thecorresponding unrealized loss of $1,040 in accumulated other comprehensiveincome in the consolidated statement of owner’s/stockholder’s equity atSeptember 29, 2007.

 

The Company’s use of derivative financial instrumentsis limited to this interest rate swap, the purpose of which is to hedge thecash flows of variable rate indebtedness. The Company does not hold or issuederivative financial instruments for speculative purposes.

 

**5.****                                      StockBased Compensation**

 

For the three and nine months ended September 30,2006, the Predecessor Entity recorded stock-based compensation expense of $176and $530, respectively,  in accordancewith SFAS 123R. For the period from January 1, 2007 to February 14, 2007all 213 outstanding stock options were vested in full and, accordingly, thePredecessor Entity recorded stock-based compensation expense of $1,477 inaccordance with SFAS 123R. There were no option grants 

 

9

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

by Pearson during the period January 1, 2007 toFebruary 14, 2007. After the date of acquisition and through September 29,2007, the Successor Entity granted no employee stock options.

 

Pearson operated the following equity-settled employeeoption and performance plans until the date of acquisition, February 14, 2007,at which point all such equity based plans ceased to exist and all outstandingoptions became fully vested. Vangent did not replace any of these share basedplans subsequent to the Acquisition.

 

**•****                           Profit Sharing Plan**—Pearsonoperated a profit sharing plan for all employees, the payment of which was atthe discretion of the Pearson Board of Directors and could be made in cash orPearson shares.

** **

**•****                           Save for Shares Plans**—Pearsonoperated a Worldwide Save for Shares Plan and a Save-As-You-Earn plan for UKemployees. Under these plans, employees could save a portion of their monthlysalary over periods of three, five or seven years.

** **

**•****                           Employee Stock Purchase Plan**—Pearsonoperated an Employee Stock Purchase Plan which allowed all employees in theUnited States to save a portion of their monthly salary over six month periods.

** **

•**                           Long-Term Incentive Plan**—Thisplan was introduced in 2001 and consisted of share options and/or restrictedshares, which vested dependent on the following market and non-marketperformance criteria: relative shareholder return, return on invested capitaland a combination of earnings per share and sales growth. The award was splitequally across all three measures.

** **

**•****                           Annual Bonus Share MatchingPlan**—This plan permitted executive directors and senior executives ofPearson to invest up to 50% of any after tax annual bonus in Pearson shares. Ifthese shares were held and Pearson met an earnings per share growth target,Pearson would match them on a gross basis of up to one share for each share heldafter three years and another one for every two shares originally held afterfive years.

 

On June 26, 2007, certain members of management of theCompany and certain outside directors of Vangent Holding Corp. were grantedClass B membership interests in Vangent Holding LLC, the majority shareholderof Vangent Holding Corp. which in turns owns all of the Company’s common stock.Additional shares were granted during July 2007. Vangent Holding LLC conductsno operations and was established solely for the purpose of holding equity inthe Company. At September 29, 2007, the aggregate individual grants of Class Bmembership interests represented approximately 5.3% of the profit interests inVangent Holding LLC. The Class B membership interests are subject to a vestingschedule which vests 20% on each February 14 until February 14, 2012, when suchownership becomes fully vested, or on each anniversary of the date on which aClass B member became a full-time employee or outside director after February14, 2007 until fully vested. The unvested portion of Class B membershipinterests reverts to the holders of Class A interests in the event they areforfeited or reduced in accordance with the terms of the operating agreementgoverning Vangent Holding LLC. Class B membership interests are granted with noexercise price or expiration date. Pursuant to the terms of the operatingagreement governing Vangent Holding LLC, the holders of Class B membershipinterests are entitled to receive their respective proportional interest of alldistributions made by Vangent Holding LLC provided the holders of the Class Amembership interests have received an 8% per annum internal rate of return ontheir invested capital. Additionally, Vangent Holding LLC’s operating agreementlimits Class B membership interests to 7.5% in the aggregate. 

 

The fair value of the interest at the date of grantwas $5,909 based upon the value of the membership interests of Vangent HoldingLLC less a 35% discount for lack of liquidity. The value was determined basedupon the amount paid for 90% of the Class A membership interests of VangentHolding LLC by Veritas Capital on February 14, 2007.

 

In accordance with SFAS No. 123R, the Company recordscompensation expense based on the grant-date fair value on a straight-linebasis over the vesting period for each separate vesting portion of the awards.For the three months ended September 29, 2007 and the period from February 14,2007 through September 29, 2007, the non-cash compensation expense was $475 and$475, respectively.

 

Assuming each Class B membership interest grantoutstanding as of September 29, 2007 vests fully, the Company will recognizeadditional non-cash compensation expense as follows:

 
| 2007  |   | $     | 475    |   |
|-------|--------|-------|--------|--------|
| 2008  |   | 1,266 |   |
| 2009  |   | 1,182 |   |
| 2010  |   | 1,182 |   |
| 2011  |   | 1,182 |   |
| 2012  |   | 147   |   |
| Total |   | $     | 5,434  |   |

 

10

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**6.****                                     ****Retirement Plans**

 

**PensionPlan**

 

Following the completion of the Acquisition, theCompany assumed the responsibility for the portion of certain Pearsondefined benefit and defined contribution pension plans applicable to 75 employeesof the Company in the United Kingdom (“UK”).

 

Vangent was required to exit these Plans on the dateof the Acquisition and was required to establish new plans that were equivalentto the prior plan in order to comply with the terms of the Sale and PurchaseAgreement. After the Acquisition, a successor Vangent Defined Benefit Plan anda successor Vangent Defined Contribution Plan were created for these employees.Thirty-seven UK employees elected to participate in the Vangent Defined BenefitPlan, which is similar to the prior plan held by Pearson. Thirty-eight UKemployees elected to participate in the Vangent Defined Contribution Plan,which will provide benefits substantially similar to their benefits in theprior defined benefit plan.

 

Under the terms of the purchase agreement, Pearson plcwill pay to Vangent the actuarially determined unfunded liability (net of taxbenefits) of the portion of the Pearson plc pension plan applicable to theseemployees of the Company which is estimated to be $1,828, less an accrued taxbenefit payable to Pearson plc of $548. The transfer of unfunded liabilities byPearson plc is expected to be received by year end.

 

Under the Vangent Defined Benefit Plan, employees willreceive a defined benefit upon retirement. Each employee in the plancontributes a determined percentage of their salary and the Company isresponsible for ensuring that the plan is fully funded. There are additionalbenefits in case of death through a spousal pension benefit or due todisability through early retirement benefits associated with such disability.

 

Contributions to the Vangent Defined Benefit Planduring the successor period for the three months ended September 29, 2007 andfrom February 15, 2007 to September 29, 2007 were $58 and $145, respectively. Contributionsto the Vangent Defined Contribution Plan during the successor period for thethree months ended September 29, 2007 and from February 15, 2007 to September29, 2007 were $108 and $276, respectively.

 

**RetirementSavings Plans**

 

Pearson charged thePredecessor Entity for the costs of retirement savings plans through anallocation based on labor costs. Estimated charges included in operations forthe three months ended September 30, 2006, nine months ended September 30, 2006and the periods from January 1, 2007 to February 14, 2007 were $1,801, $5,183and $478, respectively. The following is a brief description of each of theplans:

 

***401(k) Plan***

*** ***

In the United States,Pearson maintained a defined contribution plan under Section 401(k) of the InternalRevenue Code until the Acquisition. At the acquisition date, Vangent initiatedthe Vangent 401(k) Retirement Plan, rolled over existing balances and providedsimilar benefits as the predecessor plan.

*** ***

***Supplemental Deferred Compensation Plan***

*** ***

Pearson operated anon-qualified Supplemental Deferred Compensation Plan whereby employees earning$90 or above could voluntarily defer up to 70% of their base cash compensationand up to 80% of their cash bonus compensation. The compensation deferrals werecontributed to the Supplemental Deferred Compensation Plan, and were notsubject to income taxes until distributed to the participant. Vangent employeeswere no longer eligible to participate in this plan after the Acquisition andVangent did not replace the plan.

 

***Other Plans***

*** ***

In the United Kingdom,Canada, Argentina, Mexico, and Venezuela, employees had access to other Pearsonplans or self-managed local benefit plans depending on the country ofemployment and the local employment laws. To the extent feasible, Vangentreplaced the existing benefit plans with similar plans managed by Vangent.

 

**7.****                                      Commitmentsand Contingencies**

 

The Company is subject to legal proceedings and claimsarising in the ordinary course of business with a portion of the defense and/orsettlement costs being covered by various insurance policies purchased by us.The Company intends to vigorously assert its rights and defend itself in anylitigation that may arise from such claims. While the ultimate outcome andresolution of these matters could affect the results of operations in futureperiods, and while there can be no assurance with respect thereto, managementbelieves after final disposition, any financial impact to the Company would notbe material to the Company’s consolidated financial position, results ofoperations and cash flows. The following matters are noted:

 

**TSA Reserve**

 

On February 29, 2002, the Transportation SecurityAdministration (“TSA”) awarded the Company a contract to assess and recruitpassenger screeners for airports by November 19, 2002, the date mandatedby Congress. The contract expired on December 31, 2002 and the Company wasnot awarded the subsequent contract. During the term of the agreement thecontract was modified multiple times and the contract value increased from anoriginal bid of approximately $100,000 to $742,000. This amount was eventuallyfully funded by TSA.  As of December 31, 2002, the Company had earnedthe maximum allowed under the core contract funding level of $731,000 togetherwith an 

 

11

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

additional $11,000 in connection with the pilotprogram. The pilot program contract ended in 2003.

 

The Department of Homeland Security Inspector General(“DHS/IG”) is investigating the contract in conjunction with the U.S.Department of Justice (“DOJ”). The DOJ’s stated purpose is to determine whetherPGS or its subcontractors violated the Civil False Claims Act. The Sale andPurchase Agreement provides that Pearson will indemnify Vangent, the Buyer andits other affiliates without regard to any time limitation for 50% of any lossesincurred in connection with the investigation up to the aggregate amountof $20,000 and for 100% of any losses in excess of $20,000.

 

Vangent has established a reserve of $5,648representing an estimate of the liability due to the TSA and also has recordeda receivable from Pearson for $2,824 representing 50% of expected losses inaccordance with the Sale and Purchase Agreement.  There are continuingdiscussions between the parties with regard to settlement.  However, any estimateof final settlement amount would be speculative at this time.

 

**Universityof California CASA Contract**

 

In July 2007, the Company received a notice from theUniversity of California (“UC”) that UC deemed the Company to be in breach ofone of its contracts and directed the Company to stop working on that contract.The contract was for the development of a Centralized Admissions andScholarships Application (“CASA”) System. Under this contract, as amended, theCompany was to develop a web-based application and scholarship system to bedeployed in the summer of 2007 and provide managed services and softwaremodifications through June 2010. The development of the web-based applicationand scholarship system is accounted for under Statement of Position 81-1, *Accounting for Performance of Construction-Type andCertain Production-Type Contracts,*and revenue is recorded on apercentage of completion basis. The Company recorded an additional loss of$3,654 in the successor period ended March 31, 2007 associated with the notice.The total loss incurred for the successor period ended September 29, 2007was $4,145 with the additional $491 incurred for general and administrativeexpenses. General and administrative costs are expensed in the period incurredin accordance with Company policy. The Company believes that no additionalshutdown cost will be incurred.

 

UC has asserted a claim for breach of contract.Pursuant to the contract, UC and the Company have entered into discussions tonegotiate a settlement. The Company believes that it is adequately insured withrespect to this action under its professional liability insurance beyond a $500retention. The Company is currently gathering facts and circumstances andcannot reasonably estimate any loss contingency that might arise from thesettlement negotiations.

 

**Loss ofData**

 

In September 2007, the Company became aware of anevent which could lead to the loss of third party confidential information. TheCompany believes that it is adequately insured with respect to this exposureunder its professional liability insurance beyond a $500 retention; howeverthere can be no assurances that this will be the case.

 

**8.****                                      IncomeTaxes**

 

Prior to the Acquisition, PGS’ U.S. entities (“U.S.Entities”) were members of Pearson’s consolidated tax group. As such, theoperating results of the U.S. Entities have been included in Pearson’sconsolidated U.S. federal and state income tax returns for such periods. Theprovision for income taxes, for the periods prior to the Acquisition, has beendetermined on a separate return basis.

 

The U.S. Entities were subject to a tax sharingagreement with Pearson. In general, this agreement requires each of the U.S.Entities to annually reimburse its share of the consolidated tax group’s incometax liabilities. Conversely, each of the U.S. Entities was reimbursed to theextent it provided income tax benefits as a result of its losses included inthe U.S. consolidated tax group. The tax sharing agreement was terminated priorto the Acquisition, and the U.S. Entities will not be affected by the taxsharing agreement post-Acquisition.

 

In connection with the Acquisition, one of the U.S.Entities has made an election under Section 338(h)(10) of the Internal RevenueCode, which for tax purposes will generally allow the entity to “step-up” itsassets to fair market

 

12

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

value, including amortizable assets such as identifiedintangible assets and goodwill.

 

The Acquisition significantly adjusted the balances ofcertain assets and liabilities, from both a financial reporting and taxperspective. As such, the income tax accounting for post-Acquisition periodsmay differ significantly when compared to pre-Acquisition periods.

 

In determining the quarterly provision for incometaxes, management uses an estimated annual effective tax rate which is based onthe expected annual income, statutory tax rates, and tax planning opportunitiesavailable to the Company in the various jurisdictions in which it operates. TheCompany’s effective tax rate differs from the U.S. statutory rate primarily dueto state and local taxes, and differing statutory tax rates applied to the incomeof non-U.S. subsidiaries.

 

The Company adopted the provisions of FASBInterpretation No. 48, *Accounting for Uncertaintyin Income Taxe*s (“FIN 48”), on January 1, 2007 while part of Pearson.The adoption of FIN 48 did not have a material effect on the results ofoperations or financial position of the Company. The Company recognizesinterest and penalties, if any, as part of provision for income taxes. TheCompany currently has no open tax related audits of its federal, state, orlocal tax years.

 

Post-Acquisition, the Company will be indemnified andnot held liable for tax liabilities, if any, relating to pre-Acquisitionperiods. The Company had historical deferred tax assets, prior to the Acquisition,of $1,121. Through purchase accounting, the Company recorded additionaldeferred tax assets of $10,056 and a full valuation allowance of $11,177.

 

The Company is required to assess its deferred taxassets and the need for a valuation allowance. This assessment requiresjudgment on the part of management with respect to benefits that may berealized. The Company has concluded, based upon available evidence, it is morelikely than not that the U.S. federal, state, and local deferred tax assets atSeptember 29, 2007 will not be realizable. Therefore, a valuation allowance hasbeen provided against U.S. deferred tax assets. If this valuation allowance isreduced, subsequently a portion of such reduction will be recorded as anadjustment to goodwill acquired in the Acquisition. If there is no remaininggoodwill, it will be recorded as a reduction to intangible assets acquired andfinally through income tax expense.

 

In accordance with APB No. 23, *Accounting for Income Taxes—Special Areas*, the Company doesnot provide income taxes on undistributed earnings from its non-US.subsidiaries because such earnings are reinvested and in the opinion ofmanagement, will continue to be reinvested indefinitely. In August, the Companydeclared a Venezuelan dividend that is considered a one-time event based on thecountry's deteriorating economic conditions and a pending potentialdevaluation. This unique event does not change the Company's intent to reinvestearnings in the foreign subsidiaries indefinitely.

 

The Company is assessing the upcoming tax law changesin Mexico and will determine the impact, if any, on its business operations inMexico.

 

**9.****                                      RelatedParty Transactions**

 

The accompanyinghistorical financial statements include the accounts of Vangent afterelimination of intercompany accounts and transactions.

 

Included in interestexpense is $194 and $584 for intercompany interest for the three months andnine months ended September 30, 2006, respectively, which is due to interestcharged by Pearson for guaranteeing the Company’s leases and performance bonds.The intercompany balances included in the historical financial statements agreeto the Vangent historical accounting records.

 

13

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

An annual management fee of $1,000 is payable toVeritas Capital. This management fee is paid in quarterly installments and isfor general business management, financial, strategic and consulting services.The amount of the management fee is comparable to the fees charged by thirdparties when performing similar services. Included in purchase consideration(Note 2) is a one-time transaction fee of $10,000 paid to Veritas Capitalat the closing of the Acquisition. This fee was paid as consideration inconnection with planning, structuring and consummating the Acquisition.

 

As described in Notes 5and 6, employees working in Vangent participated in various Pearsonpension, health care, defined contribution and other benefit plans during thepredecessor period.

 

In anticipation of thesale, Vangent negotiated a Transition Services Agreement dated February 9, 2007for Pearson to continue to provide the IT related services, human resourcesservices and other services. These services are invoiced to Vangent on amonthly basis and Vangent pays Pearson as a vendor within the normal accountspayable process.  Within the first twelve months of operations, Vangentwill phase out its use of these services as it negotiates replacement serviceswith its own vendors.

 

Costs allocated for suchsupport services were as follows:

 

 
| ** **                         | ** ** | **Predecessor  Entity**                           | ** ** | ** ** | **Successor  Entity**                             | ** ** | **Predecessor Entity**                      | ** ** | ** **                                                        | **Successor  Entity** | ** ** |
|------------------------------------|------------|---------------------------------------------------|------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------|-----------------------|------------|
| ** **                         | ** ** | **Three  months  ended  September 30, 2006** | ** ** | ** ** | **Three  months  ended  September 29, 2007** | ** ** | **Nine  months  ended  September 30, 2006** | ** ** | **Period  January 1, 2007  through  February 14, 2007** | ** **            | ** ** | **Period  February 15, 2007  through  September 29, 2007** | ** ** |
| ** **                         | ** ** | ** **                                        | ** ** | ** ** | ** **                                        | ** ** | ** **                                       | ** ** | ** **                                                        | ** **            | ** ** | ** ** | ** ** |
| Cost of revenue                    |       | $                                                 | 17,960     |       |                                              | $          | 5,765                                            |       | $                                                                 | 33,022                |       | $ | 3,140 |   |   | $ | 12,882 |   |
| Other operating  expenses          |       | 5,053                                             |       |       | 711                                               |       | 5,137                                            |       | 140                                                               |                  |       | 1,586 |   |
| Total cost and  expenses allocated |       | $                                                 | 23,013     |       |                                              | $          | 6,476                                            |       | $                                                                 | 38,159                |       | $ | 3,280 |   |   | $ | 14,468 |   |

 

**10.****                               RecentlyIssued Accounting Pronouncements**

 

In September 2006,the FASB issued SFAS No. 157, *FairValue Measurements* (“SFAS No. 157”). SFAS No. 157establishes a framework for measuring fair value and requires expandeddisclosures regarding fair value measurements. This accounting standard iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007. The effect, if any, of adopting SFAS No. 157 onthe Company’s financial position and results of operations has not beenfinalized.

 

In September 2006, theFASB issued SFAS No. 158, *Employers’ Accounting forDefined Benefit Pension and Other Postretirement Benefit Obligations*,*an amendment of FASB Statements No. 87, 88, 106,and 132R* (“SFAS No. 158”)  Thestandard requires companies to recognize in their balance sheets any over orunder-funded benefit obligation of each defined benefit pension and otherpostretirement plan. The resulting balance sheet adjustment is offset by acorresponding adjustment to other comprehensive income, net of deferred taxeffects. This change would apply to the Company’s financial statements for theyear ended December 31, 2007. The effect of this adoption is pending thecompletion of an initial actuarial valuation for employees transferred toVangent from Pearson (Note 6). Management does not believe it will have amaterial effect on the Company’s financial position or results of operation.

 

14

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

In February 2007, theFASB issued SFAS No. 159, *TheFair Value Option for Financial Assets and Financial Liabilities - Including anamendment of FASB Statement No. 115*(“SFAS No. 159”). SFAS No. 159 permits entities to choose tomeasure many financial instruments and certain other items at fair value. Thisaccounting standard is effective for financial statements issued for fiscalyears beginning after November 15, 2007. The effect, if any, of adoptingSFAS No. 159 on the Company’s financial position and results of operationshas not been finalized.

 

**11.****                               BusinessSegment, Customer and Geographic Information**

 

**SegmentInformation**

 

Operating segments aredefined as components of an enterprise for which separate financial informationis available and is evaluated regularly by the chief operating decision makerin deciding how to allocate resources and assess performance.

 

The Company reportsoperating results and financial data in three segments: Government group,Commercial group and International group. The Government group assistscivilian, defense and intelligence agencies, as well as, government-relatedentities with the design and execution of information and technology strategy,helps develop and maintain their complex, mission-critical systems and deliversa wide range of business process outsourcing solutions. The Government groupcustomers are primarily U.S. federal agencies. The Commercial group designs andbuilds workforce solutions that automate and improve the recruitment,assessment, selection and development of an organization’s workforce. TheInternational group provides consulting, systems integration and businessprocess outsourcing solutions to both commercial and foreign local and centralgovernment customers. The Company places employees in locations around theworld in support of its clients.

 

The Company evaluates theperformance of its operating segments based on operating income. The Companydoes not measure revenue or operating income by its major service offerings,either for internal management or external financial reporting purposes, as itwould be impractical to do so.

 

The Corporate componentrepresents assets and costs not included in a reporting segment and is primarilycomprised of deferred tax assets and unallocated general corporate costs. Summarizedfinancial information concerning the Company’s reportable segments is shown inthe following tables:

 

15

----

** **

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes to the CondensedConsolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 
| ** **                        | ** ** | **Predecessor  Entity**                    | ** ** | ** ** | **Successor  Entity**                      | ** ** | ** **                                                        | ** ** | ** **                                                       | **Successor ** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|------------|--------------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------------------|---------------------|------------|
| ** **                        | ** ** | **Three**                                  | ** ** | ** ** | **Three**                                  | ** ** | **Predecessor Entity**                                       | ** ** | ** **                                                       | **Entity**          | ** ** |
| ** **                        | ** ** | **months  ended  September 30, 2006** | ** ** | ** ** | **months  ended  September 29, 2007** | ** ** | **Period  January 1, 2006 to  September 30, 2006** | ** ** | **Period  January 1, 2007 to  February 14, 2007** | ** **          | ** ** | **Period  February 15, 2007 to  September 29, 2007** | ** ** |
| Revenue from external  customers: |       |                                       |       |       |                                       |       |                                                              |       |                                                             |                |       |   |   |
| Government group                  |       | $                                          | 86,499     |       |                                       | $          | 102,896                                                           |       | $                                                                | 327,027             |       | $ | 47,011 |   |   | $ | 236,154 |   |
| Commercial group                  |       | 8,579                                      |       |       | 8,555                                      |       | 25,318                                                            |       | 3,302                                                            |                |       | 21,794 |   |
| International  group              |       | 15,235                                     |       |       | 18,159                                     |       | 44,134                                                            |       | 8,520                                                            |                |       | 45,708 |   |
| Total                             |       | $                                          | 110,313    |       |                                       | $          | 129,610                                                           |       | $                                                                | 396,479             |       | $ | 58,833 |   |   | $ | 303,656 |   |
|                              |       |                                       |       |       |                                       |       |                                                              |       |                                                             |                |       |   |   |
| Operating income  (loss):         |       |                                       |       |       |                                       |       |                                                              |       |                                                             |                |       |   |   |
| Government group                  |       | $                                          | 10,352     |       |                                       | 8,996      |                                                              | 31,123     |                                                             | 647                 |       |   | 6,148 |   |
| Commercial group                  |       | 1,085                                      |       |       | 915                                        |       | 2,484                                                             |       | (496                                                             | )                   |       | 1,971 |   |
| International  group              |       | 1,384                                      |       |       | (38                                        | )          | 3,101                                                             |       | (281                                                             | )                   |       | 420 |   |
| Subtotal                          |       | 12,821                                     |       |       | 9,873                                      |       | 36,708                                                            |       | (130                                                             | )                   |       | 8,539 |   |
| Corporate                         |       | (72                                        | )          |       | 20                                         |       | (203                                                              | )          | (547                                                             | )                   |       | — |   |
| Total                             |       | $                                          | 12,749     |       |                                       | $          | 9,893                                                             |       | $                                                                | 36,505              |       | $ | (677 | ) |   | $ | 8,539 |   |
|                              |       |                                       |       |       |                                       |       |                                                              |       |                                                             |                |       |   |   |
| Depreciation and  amortization:   |       |                                       |       |       |                                       |       |                                                              |       |                                                             |                |       |   |   |
| Government group                  |       | $                                          | 1,683      |       |                                       | $          | 6,748                                                             |       | $                                                                | 5,206               |       | $ | 1,352 |   |   | $ | 16,512 |   |
| Commercial group                  |       | 613                                        |       |       | 150                                        |       | 1,735                                                             |       | 447                                                              |                |       | 816 |   |
| International  group              |       | 1,212                                      |       |       | 1,357                                      |       | 4,074                                                             |       | 570                                                              |                |       | 3,425 |   |
| Total                             |       | $                                          | 3,508      |       |                                       | $          | 8,255                                                             |       | $                                                                | 11,015              |       | $ | 2,369 |   |   | $ | 20,753 |   |

 

16

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 
| ** **                    | ** ** | **Predecessor  Entity**                 | ** ** | ** ** | **Successor  Entity**                    | ** ** |
|-------------------------------|------------|-----------------------------------------|------------|------------|------------------------------------------|------------|
| ** **                    | ** ** | **As of  December 31,  2006** | ** ** | ** ** | **As of  September 29,  2007** | ** ** |
| Goodwill:                     |       |                                    |       |       |                                     |       |
| Government group              |       | $                                       | 369,066    |       |                                     | $          | 246,711 |   |
| Commercial group              |       | 45,518                                  |       |       | 19,159                                   |       |
| International  group          |       | 28,287                                  |       |       | 35,585                                   |       |
| Total                         |       | $                                       | 442,871    |       |                                     | $          | 301,455 |   |
|                          |       |                                    |       |       |                                     |       |
| Total long-lived  assets:     |       |                                    |       |       |                                     |       |
| Government group              |       | $                                       | 384,946    |       |                                     | $          | 433,935 |   |
| Commercial group              |       | 47,668                                  |       |       | 40,177                                   |       |
| International  group          |       | 41,993                                  |       |       | 59,957                                   |       |
| Subtotal                      |       | 474,607                                 |       |       | 534,069                                  |       |
| Corporate                     |       | —                                  |       |       | 10,867                                   |       |
| Total                         |       | $                                       | 474,607    |       |                                     | $          | 544,936 |   |
|                          |       |                                    |       |       |                                     |       |
| Total assets:                 |       |                                    |       |       |                                     |       |
| Government group              |       | $                                       | 481,323    |       |                                     | $          | 547,504 |   |
| Commercial group              |       | 52,910                                  |       |       | 54,118                                   |       |
| International  group          |       | 59,595                                  |       |       | 83,006                                   |       |
| Subtotal                      |       | 593,828                                 |       |       | 684,628                                  |       |
| Corporate                     |       | 2,948                                   |       |       | 13,017                                   |       |
| Total                         |       | $                                       | 596,776    |       |                                     | $          | 697,645 |   |
|                          |       |                                    |       |       |                                     |       |
| Property and  equipment, net: |       |                                    |       |       |                                     |       |
| Government group              |       | $                                       | 15,292     |       |                                     | $          | 14,760 |   |
| Commercial group              |       | 1,447                                   |       |       | 2,221                                    |       |
| International  group          |       | 13,566                                  |       |       | 11,419                                   |       |
| Total                         |       | $                                       | 30,305     |       |                                     | $          | 28,400 |   |

 

17

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**Customer****Information**

 

The Company derives themajority of its revenues from departments and agencies of the U.S. FederalGovernment. U.S. Federal Government revenue accounted for 70.3%, 74.7%, 72.7%,68.3%, and 72.7% of the Company’s revenues for the three months ended September30, 2006, the three months ended September 29, 2007, the nine months endedSeptember 30, 2006, the period January 1, 2007 to February 14, 2007 and theperiod February 15, 2007 to September 29, 2007, respectively. Customerscomprising 10% or more of consolidated revenues are as follows:

 
| ** **                 | ** ** | **Predecessor  Entity**                               | ** ** | ** ** | **Successor  Entity**                            | ** ** | **Predecessor Entity**                | ** ** | ** **                                                   | **Successor  Entity** | ** ** |
|----------------------------|------------|-------------------------------------------------------|------------|------------|--------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------------------------|-----------------------|------------|
| ** **                 | ** ** | **Three months  ended  September 30, 2006** | ** ** | ** ** | **Three months  ended  September 29, 2007** | ** ** | **Nine months  ended  September 30, 2006** | ** ** | **Period  January 1, 2007  to  February 14, 2007** | ** **            | ** ** | **Period  February 15, 2007  to  September 29, 2007** | ** ** |
|                       |       |                                                  |       |       |                                             |       |                                       |       |                                                         |                  |       |   |   |
| Health and Human  Services |       | $                                                     | 31,657     |       |                                             | $          | 64,124                                     |       | $                                                            | 161,510               |       | $ | 20,884 |   |   | $ | 138,512 |   |
| Department of  Education   |       | 25,580                                                |       |       | 20,743                                           |       | 74,413                                     |       | 13,684                                                       |                  |       | 52,983 |   |
|                            |            |                                                       |            |            |                                                  |            |                                            |            |                                                              |                       |            |  |  |  |  |  |  |  |

 

18

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**GeographicInformation**

 

The following tablessummarize revenues and long-lived assets, which includes property andequipment, intangible assets, goodwill, deferred taxes and other assets, by thegeographic location of the entity that is performing the service.

 
| ** **     | ** ** | ** **                                        | **Predecessor  Entity** | ** ** | ** **                                        | **Successor  Entity** | ** **                                           | **Predecessor  Entity** | ** **                                                    | ** ** | **Successor  Entity** | ** **                                                     |
|----------------|------------|---------------------------------------------------|-------------------------|------------|---------------------------------------------------|-----------------------|------------------------------------------------------|-------------------------|---------------------------------------------------------------|------------|-----------------------|----------------------------------------------------------------|
| ** **     | ** ** | **Three  months  ended  September 30, 2006** | ** **              | ** ** | **Three  months  ended  September 29, 2007** | ** **            | **Nine months  ended  September 30, 2006** | ** **              | **Period  January 1, 2007   to  February 14, 2007** | ** ** | ** **            | **Period  February 15, 2007 to  September 29, 2007** | ** ** |
| Revenues:      |       |                                              |                    |       |                                              |                  |                                                 |                    |                                                          |       |                  |                                                           |   |
| Domestic       |       | $                                                 | 95,078                  |       |                                              | $                     | 111,451                                              |                    | $                                                             | 352,345    |                  | $                                                              | 50,313 |   |   | $ | 257,948 |   |
| International  |       | 15,235                                            |                    |       | 18,159                                            |                  | 44,134                                               |                    | 8,520                                                         |       |                  | 45,708                                                         |   |
| Total revenues |       | $                                                 | 110,313                 |       |                                              | $                     | 129,610                                              |                    | $                                                             | 396,479    |                  | $                                                              | 58,833 |   |   | $ | 303,656 |   |

 
| ** **                | ** ** | **Predecessor  Entity**                | ** ** | ** ** | **Successor  Entity**                   | ** ** |
|---------------------------|------------|----------------------------------------|------------|------------|-----------------------------------------|------------|
| ** **                | ** ** | **As of  December 31, 2006** | ** ** | ** ** | **As of  September 29, 2007** | ** ** |
| Total long-lived  assets: |       |                                   |       |       |                                    |       |
| Domestic                  |       | $                                      | 432,614    |       |                                    | $          | 484,979 |   |
| International  group      |       | 41,993                                 |       |       | 59,957                                  |       |
| Total long-lived  assets  |       | $                                      | 474,607    |       |                                    | $          | 544,936 |   |

 

**12.          Condensed Guarantor and Non-GuarantorFinancial Information**

 

In connection with theacquisition of the Company by Veritas Capital and the related financing asdiscussed in Note 2, the Company issued $190,000 of senior subordinatednotes due 2015. These notes were sold to qualified institutional buyers underthe provisions of Rule 144A under the Securities Act of 1933 and tonon-U.S. persons under the provisions of Regulation S under the SecuritiesAct of 1933. The notes are general obligations of Vangent, Inc. and will bejointly and severally, irrevocably and unconditionally, guaranteed on a seniorbasis by certain legal entities consisting of Blueprint Technologies, Inc.and Pearson Analytic Solutions, Inc. (the “Guarantors”). Certain legalentities of the Company will not guarantee the notes (the “Non-Guarantors”). These entities include VangentCanada, Limited, Vangent Mexico, S.A. de C.V., Vangent Servicios de Mexico,S.A. de C.V., Vangent Argentina, S.A., Vangent Venezuela, C.A., Vangent PuertoRico, Inc., Data Capture UK, Ltd. and Vangent, Ltd. All entitiesare wholly owned subsidiaries of Vangent.

 

The following informationpresents statements of operations, balance sheets and statements of cash flowsfor the 

 

19

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

Guarantors andNon-Guarantors at December 31, 2006 and September 29, 2007 and for threeand nine months ended  September 30,2006,  the three months ended September29, 2007, the period January 1, 2007 to February 14, 2007 and the periodFebruary 15, 2007 to September 29, 2007.

 

**ConsolidatingStatements of Operations**

**for the threemonths ended September 30, 2006:**

** **
| ** **                           | ** ** | **Issuer and  Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|----------------------|------------|-----------|------------|
| Revenue                              |       | $                               | 95,148     |                 | $          | 15,165    |       | $ | 110,313 |   |
| Cost of revenue                      |       | 70,701                          |       | 11,917               |       | 82,618    |       |
| Gross profit                         |       | 24,447                          |       | 3,248                |       | 27,695    |       |
| General and  administrative expenses |       | 9,404                           |       | 718                  |       | 10,122    |       |
| Selling and  marketing expenses      |       | 3,985                           |       | 836                  |       | 4,821     |       |
| Intangible  amortization             |       | —                          |       | 3                    |       | 3         |       |
| Operating income                     |       | 11,058                          |       | 1,691                |       | 12,749    |       |
| Interest expense,  net               |       | 160                             |       | 97                   |       | 257       |       |
| Income before  income taxes          |       | 10,898                          |       | 1,594                |       | 12,492    |       |
| Provision for  income taxes          |       | 4,284                           |       | 585                  |       | 4,869     |       |
| Net income                           |       | $                               | 6,614      |                 | $          | 1,009     |       | $ | 7,623 |   |

 

**ConsolidatingStatement of Operations**

**for thenine months ended September 30, 2006:**

** **
| ** **                           | ** ** | **Issuer and  Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|----------------------|------------|-----------|------------|
| Revenue                              |       | $                               | 352,565    |                 | $          | 43,914    |       | $ | 396,479 |   |
| Cost of revenue                      |       | 280,211                         |       | 35,725               |       | 315,936   |       |
| Gross profit                         |       | 72,354                          |       | 8,189                |       | 80,543    |       |
| General and  administrative expenses |       | 27,611                          |       | 1,538                |       | 29,149    |       |
| Selling and  marketing expenses      |       | 12,295                          |       | 2,583                |       | 14,878    |       |
| Intangible  amortization             |       | —                          |       | 11                   |       | 11        |       |
| Operating income                     |       | 32,448                          |       | 4,057                |       | 36,505    |       |
| Interest expense  (income), net      |       | 547                             |       | (65                  | )          | 482       |       |
| Income before  income taxes          |       | 31,901                          |       | 4,122                |       | 36,023    |       |
| Provision for  income taxes          |       | 12,473                          |       | 1,227                |       | 13,700    |       |
| Net income                           |       | $                               | 19,428     |                 | $          | 2,895     |       | $ | 22,323 |   |

 

20

----

** **

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes to the CondensedConsolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**ConsolidatedStatements of Operations**

**for the threemonths ended September 29, 2007:**

 
| ** **                           | ** ** | **Issuer and  Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|----------------------|------------|-----------|------------|
| Revenue                              |       | $                               | 111,529    |                 | $          | 18,081    |       | $ | 129,610 |   |
| Cost  of revenue                     |       | 88,469                          |       | 15,514               |       | 103,983   |       |
| Gross  profit                        |       | 23,060                          |       | 2,567                |       | 25,627    |       |
| General  and administrative expenses |       | 10,519                          |       | 1,025                |       | 11,544    |       |
| Selling  and marketing expenses      |       | 3,343                           |       | 847                  |       | 4,190     |       |
| Operating  income                    |       | 9,198                           |       | 695                  |       | 9,893     |       |
| Interest  expense (income), net      |       | 9,759                           |       | (28                  | )          | 9,731     |       |
| (Loss)  income before income taxes   |       | (561                            | )          | 723                  |       | 162       |       |
| Provision  for income taxes          |       | 1,458                           |       | 108                  |       | 1,566     |       |
| Net  (loss) income                   |       | $                               | (2,019     | )                    | $          | 615       |       | $ | (1,404 | ) |

 

**ConsolidatingStatements of Operations**

**for thePredecessor Period January 1, 2007 to February 14, 2007:**

 
| ** **                                 | ** ** | **Issuer and  Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|----------------------|------------|-----------|------------|
| Revenue                                    |       | $                               | 50,349     |                 | $          | 8,484     |       | $ | 58,833 |   |
| Cost of revenue                            |       | 40,437                          |       | 7,750                |       | 48,187    |       |
| Gross profit                               |       | 9,912                           |       | 734                  |       | 10,646    |       |
| General and  administrative expenses       |       | 9,001                           |       | 382                  |       | 9,383     |       |
| Selling and  marketing expenses            |       | 1,590                           |       | 350                  |       | 1,940     |       |
| Operating (loss)  income                   |       | (679                            | )          | 2                    |       | (677      | )          |
| Interest (income)  expense, net            |       | (21                             | )          | 11                   |       | (10       | )          |
| Loss before  income taxes                  |       | (658                            | )          | (9                   | )          | (667      | )          |
| (Benefit from) provision  for income taxes |       | (327                            | )          | 35                   |       | (292      | )          |
| Net loss                                   |       | $                               | (331       | )                    | $          | (44       | )          | $ | (375 | ) |

 

21

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**ConsolidatingStatements of Operations**

**for theSuccessor Period February 15, 2007 to September 29, 2007:**

** **
| ** **                           | ** ** | **Issuer and  Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|----------------------|------------|-----------|------------|
| Revenue                              |       | $                               | 258,163    |                 | $          | 45,493    |       | $ | 303,656 |   |
| Cost of revenue                      |       | 214,881                         |       | 39,215               |       | 254,096   |       |
| Gross profit                         |       | 43,282                          |       | 6,278                |       | 49,560    |       |
| General and  administrative expenses |       | 28,003                          |       | 1,979                |       | 29,982    |       |
| Selling and  marketing expenses      |       | 8,986                           |       | 2,053                |       | 11,039    |       |
| Operating income                     |       | 6,293                           |       | 2,246                |       | 8,539     |       |
| Interest expense  (income), net      |       | 24,144                          |       | (54                  | )          | 24,090    |       |
| (Loss) Income  before income taxes   |       | (17,851                         | )          | 2,300                |       | (15,551   | )          |
| Provision for  income taxes          |       | 3,780                           |       | 722                  |       | 4,502     |       |
| Net (loss) income                    |       | $                               | (21,631    | )                    | $          | 1,578     |       | $ | (20,053 | ) |

 

22

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**CondensedConsolidating Balance Sheets at December 31, 2006:**

** **
| ** **                                     | ** ** | **Issuer and  Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|----------------------|------------|-----------|------------|
| **Assets**                                     |       |                            |       |                 |       |      |       |
| Current assets                                 |       |                            |       |                 |       |      |       |
| Cash and cash  equivalents                     |       | $                               | 8,341      |                 | $          | 3,372     |       | $ | 11,713 |   |
| Accounts  receivable, net                      |       | 90,694                          |       | 11,763               |       | 102,457   |       |
| Inventories                                    |       | 303                             |       | 233                  |       | 536       |       |
| Deferred tax  asset                            |       | 2,948                           |       | —               |       | 2,948     |       |
| Prepaids and  other assets                     |       | 2,075                           |       | 2,440                |       | 4,515     |       |
| Total current  assets                          |       | 104,361                         |       | 17,808               |       | 122,169   |       |
|                                           |       |                            |       |                 |       |      |       |
| Goodwill                                       |       | 414,584                         |       | 28,287               |       | 442,871   |       |
| Property and  equipment, net                   |       | 16,753                          |       | 13,552               |       | 30,305    |       |
| Intangible  assets, net                        |       | 682                             |       | —               |       | 682       |       |
| Other assets                                   |       | 608                             |       | 141                  |       | 749       |       |
| Total assets                                   |       | $                               | 536,988    |                 | $          | 59,788    |       | $ | 596,776 |   |
| **Liabilities  and Owner’s Equity**       |       |                            |       |                 |       |      |       |
| Current  liabilities                           |       |                            |       |                 |       |      |       |
| Accounts payable                               |       | $                               | 21,376     |                 | $          | 7,601     |       | $ | 28,977 |   |
| Accrued expenses                               |       | 17,804                          |       | 6,263                |       | 24,067    |       |
| Advance payments  on contracts                 |       | 3,988                           |       | 4,802                |       | 8,790     |       |
| Current  maturities on long-term leases        |       | 311                             |       | —               |       | 311       |       |
| Total current  liabilities                     |       | 43,479                          |       | 18,666               |       | 62,145    |       |
|                                           |       |                            |       |                 |       |      |       |
| Other long-term  liabilities                   |       | 3,703                           |       | —               |       | 3,703     |       |
| Deferred tax  liability                        |       | 1,319                           |       | 525                  |       | 1,844     |       |
| Total  liabilities                             |       | 48,501                          |       | 19,191               |       | 67,692    |       |
|                                           |       |                            |       |                 |       |      |       |
| Owner’s equity                            |       |                            |       |                 |       |      |       |
| Pearson intercompany  investment in subsidiary |       | 488,487                         |       | 46,099               |       | 534,586   |       |
| Accumulated  other comprehensive (loss) income |       | —                          |       | (5,502               | )          | (5,502    | )          |
| Owner’s equity                            |       | 488,487                         |       | 40,597               |       | 529,084   |       |
| Total  liabilities and owner’s equity     |       | $                               | 536,988    |                 | $          | 59,788    |       | $ | 596,776 |   |
|                                                |            |                                 |            |                      |            |           |            |  |  |  |  |

 

23

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**CondensedConsolidating Balance Sheets at September 29, 2007:**

 
| ** **                                                                      | ** ** | **Issuer and  Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------|------------|----------------------|------------|-----------|------------|
| **Assets**                                                                      |       |                            |       |                 |       |      |       |
| Current assets                                                                  |       |                            |       |                 |       |      |       |
| Cash and cash  equivalents                                                      |       | $                               | 11,534     |                 | $          | 3,462     |       | $ | 14,996 |   |
| Accounts  receivable, net                                                       |       | 102,064                         |       | 13,437               |       | 115,501   |       |
| Inventories                                                                     |       | 1,155                           |       | 246                  |       | 1,401     |       |
| Deferred loan  fees                                                             |       | 2,150                           |       | —               |       | 2,150     |       |
| Prepaids and  other assets                                                      |       | 12,785                          |       | 5,876                |       | 18,661    |       |
| Total current  assets                                                           |       | 129,688                         |       | 23,021               |       | 152,709   |       |
|                                                                            |       |                            |       |                 |       |      |       |
| Goodwill                                                                        |       | 265,870                         |       | 35,585               |       | 301,455   |       |
| Property and  equipment, net                                                    |       | 16,991                          |       | 11,409               |       | 28,400    |       |
| Intangible  assets, net                                                         |       | 203,266                         |       | —               |       | 203,266   |       |
| Deferred loan  fees                                                             |       | 10,867                          |       | —               |       | 10,867    |       |
| Other assets                                                                    |       | 653                             |       | 295                  |       | 948       |       |
| Total assets                                                                    |       | $                               | 627,335    |                 | $          | 70,310    |       | $ | 697,645 |   |
| **Liabilities  and Stockholder’s Equity**                                  |       |                            |       |                 |       |      |       |
| Current  liabilities                                                            |       |                            |       |                 |       |      |       |
| Current portion  of long-term debt and revolving credit facility                |       | $                               | 2,400      |                 | $          | —    |       | $ | 2,400 |   |
| Accounts payable                                                                |       | 33,114                          |       | 3,350                |       | 36,464    |       |
| Accrued expenses                                                                |       | 23,045                          |       | 7,394                |       | 30,439    |       |
| Accrued interest                                                                |       | 4,686                           |       | —               |       | 4,686     |       |
| Advance payments  on contracts                                                  |       | 3,110                           |       | 2,738                |       | 5,848     |       |
| Current  maturities on long-term leases                                         |       | 312                             |       | —               |       | 312       |       |
| Current portion  of deferred tax liability                                      |       | 852                             |       | —               |       | 852       |       |
| Total current  liabilities                                                      |       | 67,519                          |       | 13,482               |       | 81,001    |       |
|                                                                            |       |                            |       |                 |       |      |       |
| Long-term debt,  net of current portion                                         |       | 426,400                         |       | —               |       | 426,400   |       |
| Other long-term  liabilities                                                    |       | 3,055                           |       | 1,085                |       | 4,140     |       |
| Deferred tax  liability, net of current portion                                 |       | 2,928                           |       | 490                  |       | 3,418     |       |
| Total  liabilities                                                              |       | 499,902                         |       | 15,057               |       | 514,959   |       |
|                                                                            |       |                            |       |                 |       |      |       |
| Stockholder’s  equity                                                      |       |                            |       |                 |       |      |       |
| Common stock,  $0.01 par value; 1,000 shares authorized, issued and outstanding |       | —                          |       | —               |       | —    |       |
| Additional  paid-in capital                                                     |       | 203,466                         |       | —               |       | 203,466   |       |
| Vangent  investment in subsidiaries                                             |       | (53,361                         | )          | 53,361               |       | —    |       |
| (Accumulated  deficit) retained earnings                                        |       | (21,631                         | )          | 1,578                |       | (20,053   | )          |
| Accumulated  other comprehensive (loss) income                                  |       | (1,040                          | )          | 313                  |       | (727      | )          |
| Stockholder’s  equity                                                      |       | 127,434                         |       | 55,252               |       | 182,686   |       |
| Total  liabilities and stockholder’s equity                                |       | $                               | 627,336    |                 | $          | 70,309    |       | $ | 697,645 |   |

 

24

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**Condensed ConsolidatingStatements of Cash Flows**

**for the nine months endedSeptember 30, 2006:**

** **
| ** **                                                                                  | ** ** | **Issuer and  Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Total**  | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------------|------------|----------------------|------------|------------|------------|
| **Cash  flows from operating activities**                                                   | ** ** | ** **                      | ** ** | ** **           | ** ** | ** ** | ** ** |
| Net income                                                                                  |       | $                               | 19,428     |                 | $          | 2,895      |       | $ | 22,323 |   |
| Adjustments to  reconcile net income to net cash (used in) provided by operating activities |       |                            |       |                 |       |       |       |
| Depreciation and  amortization                                                              |       | 6,941                           |       | 4,074                |       | 11,015     |       |
| Stock based  compensation                                                                   |       | 530                             |       | —               |       | 530        |       |
| Loss on diposal  of property and equipment                                                  |       | 1,091                           |       | 373                  |       | 1,464      |       |
| Deferred income  taxes                                                                      |       | —                          |       | 511                  |       | 511        |       |
| Changes in  operating assets and liabilities, net of effect of acquisition:                 |       |                            |       |                 |       |       |       |
| Accounts  receivable                                                                        |       | 25,942                          |       | (2,418               | )          | 23,524     |       |
| Inventories                                                                                 |       | 341                             |       | 41                   |       | 382        |       |
| Prepaids and  Other assets                                                                  |       | 683                             |       | (115                 | )          | 568        |       |
| Accounts payable                                                                            |       | (46,683                         | )          | 2,751                |       | (43,932    | )          |
| Accrued expenses                                                                            |       | (2,908                          | )          | 268                  |       | (2,640     | )          |
| Advance payments  on contracts                                                              |       | (8,497                          | )          | (2,918               | )          | (11,415    | )          |
| Other long-term  liabilities                                                                |       | 65                              |       | —               |       | 65         |       |
| Net cash (used  in) provided by operating activities                                        |       | (3,067                          | )          | 5,462                |       | 2,395      |       |
| **Cash  flows from investing activities**                                                   | ** ** | ** **                      | ** ** | ** **           | ** ** | ** ** | ** ** |
| Acquisition of a  business                                                                  |       | (8,078                          | **)**      | **—**           |       | (8,078     | )          |
| Capital  expenditures for property and equipment                                            |       | (1,450                          | )          | (3,632               | )          | (5,082     | )          |
| Net cash used in  investing activities                                                      |       | (9,528                          | )          | (3,632               | )          | (13,160    | )          |
| **Cash  flows from financing activities**                                                   | ** ** | ** **                      | ** ** | ** **           | ** ** | ** ** | ** ** |
| Capital lease  payments                                                                     |       | (249                            | )          | (901                 | )          | (1,150     | )          |
| Investment to  parent                                                                       |       | 15,508                          |       | 1,529                |       | 17,037     |       |
| Net cash  provided by financing activities                                                  |       | 15,259                          |       | 628                  |       | 15,887     |       |
|                                                                                        |       |                            |       |                 |       |       |       |
| **Effect  of foreign currency exchange rate changes**                                       |       | —                          |       | (1,885               | )          | (1,885     | )          |
|                                                                                        |       |                            |       |                 |       |       |       |
| Net increase in  cash and cash equivalents                                                  |       | 2,664                           |       | 573                  |       | 3,237      |       |
| Cash and cash  equivalents, beginning of period                                             |       | 2,617                           |       | 3,721                |       | 6,338      |       |
| Cash and cash  equivalents, end of period                                                   |       | $                               | 5,281      |                 | $          | 4,294      |       | $ | 9,575 |   |

 

25

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**Condensed ConsolidatingStatements of Cash Flows**

**for the Predecessor PeriodJanuary 1, 2007 to February 14, 2007:**

** **
| ** **                                                                  | ** ** | **Issuer and** | ** ** | **Non-**      | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------|------------|---------------|------------|------------|------------|
| ** **                                                                  | ** ** | **Guarantor**       | ** ** | **Guarantor** | ** ** | **Total**  | ** ** |
| **Cash  flows from operating activities**                                   | ** ** | ** **          | ** ** | ** **    | ** ** | ** ** | ** ** |
| Net loss                                                                    |       | $                   | (331       | )             | $          | (44        | )          | $ | (375 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities |       |                |       |          |       |       |       |
| Depreciation and  amortization                                              |       | 1,804               |       | 565           |       | 2,369      |       |
| Stock based  compensation                                                   |       | 1,477               |       | —        |       | 1,477      |       |
| Loss on disposal  of property and equipment                                 |       | —              |       | 7             |       | 7          |       |
| Deferred income  taxes                                                      |       | (19                 | )          | —        |       | (19        | )          |
| Changes in  operating assets and liabilities:                               |       |                |       |          |       |       |       |
| Accounts  receivable                                                        |       | (16,045             | )          | (400          | )          | (16,445    | )          |
| Inventories                                                                 |       | 6                   |       | 14            |       | 20         |       |
| Prepaids and  other assets                                                  |       | 478                 |       | (155          | )          | 323        |       |
| Accounts payable                                                            |       | (462                | )          | (4,046        | )          | (4,508     | )          |
| Accrued expenses  and accrued interest                                      |       | (1,134              | )          | 470           |       | (664       | )          |
| Advance payments  on contracts                                              |       | (137                | )          | (1,069        | )          | (1,206     | )          |
| Other long-term  liabilities                                                |       | 125                 |       | —        |       | 125        |       |
| Net cash used in  operating activities                                      |       | (14,238             | )          | (4,658        | )          | (18,896    | )          |
| **Cash  flows from investing activities**                                   | ** ** | ** **          | ** ** | ** **    | ** ** | ** ** | ** ** |
| Capital  expenditures for property and equipment                            |       | (3,669              | )          | (58           | )          | (3,727     | )          |
| Net cash used in  investing activities                                      |       | (3,669              | )          | (58           | )          | (3,727     | )          |
| **Cash  flows from financing activities**                                   | ** ** | ** **          | ** ** | ** **    | ** ** | ** ** | ** ** |
| Capital lease  payments                                                     |       | (39                 | )          | —        |       | (39        | )          |
| Investment from  parent                                                     |       | 10,068              |       | 3,242         |       | 13,310     |       |
| Net cash  provided by financing activities                                  |       | 10,029              |       | 3,242         |       | 13,271     |       |
|                                                                        |       |                |       |          |       |       |       |
| **Effect  of foreign currency exchange rate changes**                       |       | —              |       | (166          | )          | (166       | )          |
|                                                                        |       |                |       |          |       |       |       |
| Net decrease in  cash and cash equivalents                                  |       | (7,878              | )          | (1,640        | )          | (9,518     | )          |
| Cash and cash  equivalents, beginning of period                             |       | 8,341               |       | 3,372         |       | 11,713     |       |
| Cash and cash  equivalents, end of period                                   |       | $                   | 463        |          | $          | 1,732      |       | $ | 2,195 |   |

 

26

----

 

**Vangent,Inc. (formerly Pearson Government Solutions Business)**

**Notes tothe Condensed Consolidated Financial Statements**

(in thousands, except pershare and share amounts)

(unaudited)

 

**Condensed ConsolidatingStatements of Cash Flows**

**for the Successor Period February15, 2007 to September 29, 2007:**

** **
| ** **                                                                                | ** ** | **Issuer and** | ** ** | **Non-**      | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------|------------|------------|------------|
| ** **                                                                                | ** ** | **Guarantor**       | ** ** | **Guarantor** | ** ** | **Total**  | ** ** |
| **Cash  flows from operating activities**                                                 |       |                |       |          |       |       |       |
| Net loss                                                                                  |       | $                   | (21,631    | )             | $          | 1,578      |       | $ | (20,053 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities |       |                |       |          |       |       |       |
| Depreciation and  amortization                                                            |       | 17,771              |       | 2,982         |       | 20,753     |       |
| Stock based  compensation                                                                 |       | 475                 |       | —        |       | 475        |       |
| Deferred income  taxes                                                                    |       | 3,784               |       | (35           | )          | 3,749      |       |
| Changes in  operating assets and liabilities:                                             |       |                |       |          |       |       |       |
| Accounts  receivable                                                                      |       | 2,490               |       | (1,235        | )          | 1,255      |       |
| Inventories                                                                               |       | (858                | )          | (27           | )          | (885       | )          |
| Prepaids and  Other assets                                                                |       | (10,166             | )          | (3,435        | )          | (13,601    | )          |
| Accounts payable                                                                          |       | 12,150              |       | (205          | )          | 11,945     |       |
| Accrued expenses                                                                          |       | 12,833              |       | 661           |       | 13,494     |       |
| Advance payments  on contracts                                                            |       | (741                | )          | (995          | )          | (1,736     | )          |
| Other long-term  liabilities                                                              |       | 245                 |       | 352           |       | 597        |       |
| Net cash provided  by (used in) operating activities                                      |       | 16,352              |       | (359          | )          | 15,993     |       |
| **Cash  flows from investing activities**                                                 |       |                |       |          |       |       |       |
| Acquisition of a  business, net of cash acquired                                          |       | (633,894            | )          | 4,675         |       | (629,219   | )          |
| Capital  expenditures for property and equipment                                          |       | (3,059              | )          | (1,353        | )          | (4,412     | )          |
| Net cash provided  by (used in) investing activities                                      |       | (636,953            | )          | 3,322         |       | (633,631   | )          |
| **Cash flows  from financing activities**                                                 |       |                |       |          |       |       |       |
| Capital lease  payments                                                                   |       | (131                | )          | —        |       | (131       | )          |
| Proceeds from  issuance of common stock                                                   |       | 203,466             |       | —        |       | 203,466    |       |
| Proceeds from  issuance of long-term debt and revolving credit facility                   |       | 460,000             |       | —        |       | 460,000    |       |
| Repayment of  long-term debt and revolving credit facility                                |       | (31,200             | )          | —        |       | (31,200    | )          |
| Net cash  provided by financing activities                                                |       | 632,135             |       | —        |       | 632,135    |       |
|                                                                                      |       |                |       |          |       |       |       |
| **Effect  of foreign currency exchange rate changes**                                     |       | —              |       | 499           |       | 499        |       |
| ** **                                                                                | ** ** | ** **          | ** ** | ** **    | ** ** | ** ** | ** ** |
| Net increase in  cash and cash equivalents                                                |       | 11,534              |       | 3,462         |       | 14,996     |       |
| Cash and cash  equivalents, beginning of period                                           |       | —              |       | —        |       | —     |       |
| Cash and cash  equivalents, end of period                                                 |       | $                   | 11,534     |          | $          | 3,462      |       | $ | 14,996 |   |
|                                                                                           |            |                     |            |               |            |            |            |  |  |  |  |  |

 

27

----

 

**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Overview**

** **

We are aleading provider of information management and business process outsourcingservices to several U.S. civilian government agencies, as well as select U.S.defense and intelligence agencies, foreign government organizations and privatesector entities. We design, build and operate mission-critical systems andprocesses to seamlessly deliver vital information, services and programs to ourcustomers and their constituents. Most of our revenue is generated fromlong-term contracts that typically have durations of four to six years,including option years. As of September 30, 2007, our total contract backlogwas $1.9 billion.

 

We manage ourbusiness through three segments: the Government Group (“GG”), InternationalGroup (“IG”) and Commercial Group (“CG”).

 

Our GovernmentGroup is our largest segment and has over 30 years of experience in providinginformation management and business process outsourcing to several civilian anddefense agencies of the federal government, including a twenty seven yearhistory with the Department of Education ("DoED"), ten years with theDefense Information Systems Agency and six years with the Centers for Medicareand Medicaid Services ("CMS"). GG is also responsible for thedevelopment, management, analysis and dissemination of healthcare informationto the public sector and is one of the largest non-government providers ofhealth information in the United States. GG accounted for 78.1% of our revenuefor the nine months ended September 29, 2007 and 79.4% for the three monthsended September 29, 2007.

 

OurInternational Group serves local governments, central governments andcommercial customers, primarily in the United Kingdom, Canada and Latin America.This segment provides consulting, systems integration and business processoutsourcing to address a variety of managerial disciplines, including customerinteraction, as well as the management of data, identity, revenue and humancapital. IG accounted for 15.0% of our revenue for the nine months endedSeptember 29, 2007 and 14.0% for the three months ended September 29, 2007.

 

Our CommercialGroup serves the private sector and designs, builds and operates workforcesolutions that automate and improve the recruitment, assessment, selection anddevelopment of a customer’s workforce. For example, we provide solutions thatautomate pre-employment screening, which are designed to improve the qualityand retention of new employees and reduce the cost and time associated withhiring an hourly work force. CG accounted for 6.9% of our revenue for the ninemonths ended September 29, 2007 and 6.6% for the three months ended September29, 2007.

 

***TheTransactions***

*** ***

OnFebruary 14, 2007, the buyer consummated the acquisition of all of theequity interests of (i) Pearson Government Solutions, Inc., anindirect wholly-owned subsidiary of Pearson, and (ii) the domestic andinternational affiliates of Pearson Government Solutions, Inc. that are engagedin the consulting, systems integration and business process outsourcingbusiness operated by the Pearson Government Solutions operating unit of Pearsonand the other seller entities. Upon completion of the Acquisition, all domesticand international affiliates of Pearson Government Solutions, Inc. thatare engaged in such business became our direct or indirect subsidiaries. Inthis section, Pearson and the other seller entities are referred to as the “sellers.”

 

***Closing Price and Purchase Adjustments***

 

Thepurchase price for the Acquisition was as follows: (i) $560.0 millionin cash; (ii) $35.0 million in Series A preferred stock of thebuyer; (iii) $5.0 million in Series B preferred stock of thebuyer; and (iv) 10% of the Class A membership interests of the buyerparent. The cash portion of the purchase price was increased post-closing by$50,000, based upon an increase in the net assets of the business at closing ascompared to net assets as of September 30, 2006.

 

***General.***The stock purchase agreement containscustomary representations, warranties, covenants and indemnities, by and forthe benefit of the buyer and the sellers.

 

28

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***Indemnification.***The sellers’ obligation, which is joint andseveral, to indemnify the buyer and any of its affiliates that is a purchaserentity for breaches of representations and warranties generally survives until12 months after the closing of the Acquisition, except for representationsand warranties relating to tax, employee benefits and broker representations,which will survive until the applicable statute of limitations, and certaincorporate and environmental representations that will survive for three yearsfollowing the closing of the Acquisition. The sellers’ obligations to indemnifythe buyer and its affiliates and the buyer’s obligation to indemnify thesellers for breaches of representations and warranties is, subject to certainexceptions, subject to a $9.0 million deductible, which includes aseparate $1.0 million deductible for certain tax indemnifications, and$50,000 per individual claim. The buyer’s and the sellers’ aggregateindemnification obligations for breaches of representations and warranties aregenerally capped at $60.0 million in the aggregate subject to certainexceptions.

 

Thestock purchase agreement also provides that the sellers will indemnify us, thebuyer and its other affiliates without regard to any time limitation for anylosses incurred by us, our parent and its other affiliates in connection withan investigation by the United States government through the Department ofJustice and the Inspector General of the Department of Homeland Security todetermine whether we and NCS Pearson Inc. violated the Civil False Claims Actor other federal laws in connection with a contract awarded by theTransportation Security Administration to NCS Pearson Inc. in 2002, except thatthe first $20.0 million in losses resulting from such investigation willbe shared equally. Upon closing of the Acquisition, we entered into a jointdefense agreement with one of the sellers, NCS Pearson Inc., pursuant to whichboth parties assumed joint defense with respect to such investigation. 

 

***Additional Covenants.***The stock purchase agreement includescustomary covenants by the sellers to maintain the confidentiality of certainproprietary information about the buyer and its affiliates. In addition, thesellers and certain of their affiliates have agreed not to compete with thebuyer, us and our affiliates with respect to any of our existing contracts orcertain agreed upon future business opportunities for a period of two years andnot to solicit for employment or hire certain of our employees for a period oftwo years after the closing of the Acquisition.

 

***Section 338 Election.***The stock purchase agreement provides thatthe sellers and the buyer make an election under Section 338(h)(10) of theInternal Revenue Code for one of the domestic entities. We believe thiselection will have the effect of significantly increasing the tax basis of ourassets, and increasing our future tax depreciation and amortization. Thesefuture deductions may reduce future cash taxes, if any.

 

***The Transactions.***Inaddition to the equity investments discussed above, the Acquisition was fundedby:

 

•                  Preferredand common equity investments in the buyer of $157.0 million in the aggregateby Veritas Capital and certain third party investors.

 

•                  the9 5/8% senior subordinated notes due 2015; and

 

•                  borrowingsunder our senior secured credit facility, consisting of a $240.0 million termloan facility and $5.0 million drawn under a $50.0 million revolving creditfacility;

 

Allreferences to the “Transactions” refer to (i) the consummation of theAcquisition, (ii) the borrowings under our senior secured credit facilityentered into in connection with the Acquisition and the application of theproceeds therefrom, (iii) the issuance by the buyer of preferred stock toPearson and certain third party investors, (iv) the issuance ofClass A membership interests of the buyer parent to Pearson, (v) theequity investments by Veritas Capital and certain third party investors; and(vi) the issuance of the 9 5/8% senior subordinated notes due 2015 andthe application of the proceeds therefrom.

 

***Basis ofPresentation***

*** ***

Our financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States of America from the historicalaccounting records of Pearson plc, an affiliate of Pearson, and are presentedon a carve-out basis until February 14, 2007, the date of the Acquisition, toinclude the historical financial position, results of operations and cash flowsapplicable to our business. No direct ownership relationship existed among allthe operations comprising our business prior to the Acquisition. Accordingly,owner’s equity is presented in lieu of stockholder’s equity for periods endedFebruary 14, 2007 and prior.

 

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Forpre-Acquisition periods, our financial statements include allocations fromPearson plc for corporate expenses. Pearson plc historically allocated costs tous based on a percentage of revenue or headcount measures compared to theconsolidated organization to cover support and services in the following areas:accounting, financial reporting, insurance, legal, human resources, payroll,tax, business licenses, public relations, charitable contributions and otherservices. We believe these allocations represent a reasonable allocationmethodology. However, these allocations and estimates are not necessarilyindicative of the costs and expenses that would have resulted if we had beenoperating as a stand-alone entity. It is not practical to estimate the costsand expenses that would have resulted on a stand-alone basis.

 

For discussionpurposes only, our fiscal 2007 three months and nine months ended resultsdiscussed below represent the mathematical addition of the historical resultsfor the Predecessor period January 1, 2007 to February 14, 2007 and theSuccessor period February 15, 2007 to September 29, 2007. This approach is notconsistent with generally accepted accounting principles and yields resultsthat are not comparable on a period-to-period basis due to the new basis ofaccounting established at the Acquisition date. However, we believe it is themost meaningful way to comment on the results of operations for the nine monthsended September 29, 2007 compared to the nine months ended September 30, 2006because a discussion of a partial period January 1, 2007 to February 14, 2007(Predecessor) separately from the period February 15, 2007 to September 29,2007 (Successor) compared to the 2006 respective Predecessor periods would notbe meaningful. In addition, the results for the three month periods ended September30, 2006 (Predecessor) and September 29, 2007 (Successor) are not comparable ona period-to-period basis due to the new basis of accounting established at theAcquisition date.

 

***FactorsAffecting Our Future Results of Operations***

*** ***

Our futureresults of operations will be affected by the following factors, which maycause our results of operations to differ from those discussed under “Resultsof Operations.” These are not all of the factors that may affect our futureresults of operations.

 

*Revenuefrom federal government contracts*. Contracts funded byfederal government agencies accounted for 74.7% and 72.0% of our revenue forthe three months and the nine months period ended September  29, 2007, respectively. For the three monthsand the nine months ended September 29, 2007, we derived 90.8% and 90.1%,respectively, of our revenue from contracts in which we acted as the primecontractor. Our business is performed under cost-plus, fixed price and time andmaterials contracts. For the three months ended September 29, 2007, 48.4%, 49.3%and 2.3% of our revenue were derived from cost-plus, fixed price and time andmaterials contracts, respectively. For the nine months ended September 29,2007, 43.0%, 52.0% and 5.0% of our revenue were derived from cost-plus, fixedprice and time and materials contracts, respectively.

 

*Cost ofRevenue*. Our most significant expense is cost ofrevenue, which includes labor expenses, facilities expenses and direct contractexpenses, overhead costs, management and support costs, depreciation andamortization costs related to assets used in revenue generating activities andother costs attributable to serving our customers. Labor expenses consist ofsalaries, wages and related benefits associated with professional and customerservice staff. The Service Contract Act, which covers many of our contracts,requires that hourly employees be paid certain minimum wages for their definedpositions, and requires specific benefit levels. Facilities expenses consist ofcosts relating to our headquarters and other commercial facilities. Otherdirect contract expenses include costs directly attributable to customerengagements, such as travel and living expenses, costs of hardware and softwareand costs of subcontractors. The number and types of personnel, their salaries,and other costs, can have a significant impact on our cost of revenue. Werecord monthly accruals on contracts for costs incurred but not invoiced. Thesecosts typically relate to subcontractor charges and are estimated based on prioractual invoices or other historical vendor information.

 

*General andAdministrative Expenses*. Our general andadministrative expenses include costs not directly associated with performingwork for our customers. These costs include salaries and wages, plus associatedfringe benefits, facilities, depreciation, travel, and insurance. Among thefunctions covered by these expenses are human resources, information systems,accounting, general management, legal, finance, contracts and purchasing. Mostof these costs are allowable costs under the cost accounting standards forcontracting with the federal government and are recoverable under cost-pluscontracts.

 

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*Selling andMarketing Expenses*. Our selling and marketing expensesinclude the costs associated with our sales and business development staff,including salaries, wages and commissions, plus associated fringe benefits,facilities, travel, depreciation and bid and proposal expenses.

 

*PurchaseAccounting Adjustments*. The Acquisition was accounted for under Emerging Issues Task ForceIssue No. 88-16, *Basis in LeveragedBuyout Transactions*(“EITF 88-16”). In accordance withEITF 88-16, the portion of Pearson plc’s (“continuing stockholder”) basisin us represented by its 10% residual interest was assigned to the assets andliabilities acquired. The remainder of the investment in the assets andliabilities acquired (the 90%) by the Buyer was recorded at fair value. As aresult, the assets and liabilities have been assigned new values, which includepart carryover basis and part fair value basis. The continuing stockholder’sresidual interest in the Company was applied to the incremental debt resultingfrom the Acquisition, and was accounted for as a deemed dividend and recognizedas a reduction of equity. A third-party valuation was performed on identifiedintangible assets and the newly issued Series A and Series B preferred stockand the allocation resulted in new identifiable intangible assets. Additional purchaseaccounting adjustments were made in accordance with SFAS No. 141, * Business**Combinations,* and related guidance. The excess of thepurchase price over assets acquired and liabilities assumed was allocated togoodwill of the acquired Company.

 

*Section 338Election*. In connection with the Acquisition, thesellers and the buyer have made an election under Section 338(h)(10) of theInternal Revenue Code for one of the domestic entities. This election will havethe effect of significantly increasing the tax basis of our assets, andincreasing our depreciation and amortization. These future deductions mayreduce future cash taxes, if any.

*** ***

***ContractBacklog***

*** ***

Our totalcontract backlog was approximately $1.9 billion and $1.6 billion as ofSeptember 29, 2007 and September 30, 2006, respectively, and our firm contractbacklog was approximately $445.9 million and $469.1 million as of September 29,2007 and September 30, 2006, respectively. We define total contract backlog asthe amount of revenue we expect to realize over the entire term of the contractincluding the base period and all option years. We do not include contractceiling values under Government-Wide Acquisition Contract ("GWAC") orindefinite delivery, indefinite quantity ("IDIQ") contracts in ourtotal contract backlog calculation. We define firm contract backlog as thevalue of the base period plus all currently exercised options. We believe thatour contract backlog provides us with significant visibility and allows us tobetter manage our business. We review our contract backlog on a periodic basisto determine if any adjustments are necessary. Each year a significant portionof our revenue is derived from our total contract backlog, and a significantportion of our backlog represents work related to the continuation of servicesunder contracts or projects where we are the incumbent provider. A substantialportion of our contracts provide for multiyear revenue. These contractsgenerate revenue over an initial base period, with one or more subsequent optionperiods, which may or may not be exercised by our customers. Most of ourfederal government contracts allow the customer the option of extending theperiod of performance of a contract for a period of one or more years. Typically,options are exercised under our contracts; however the exercise of options isat the sole discretion of the customer. Revenue generated in a base period mayvary from the revenue generated over the remaining option periods.

 

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The followingtable sets forth our contract backlog as of September 30, 2006 and September29, 2007:

 
| ** **           | ** ** | **As of September 30, 2006** | ** ** | **As of September 29, 2007** | ** ** |
|----------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **           | ** ** | **Total Contract  Backlog**                 | ** ** | **Firm Contract  Backlog**                  | ** ** | **Total Contract  Backlog** | ** ** | **Firm Contract  Backlog** | ** ** |
| ** **           | ** ** | **(dollars  in thousands)**                      | ** ** |
| Government Group     |       | $                                                | 1,229,512  |                                             | $          | 214,104 |   | $ | 1,507,481 |   | $ | 211,131 |   |
| International  Group |       | 339,500                                          |       | 238,511                                          |       | 339,954 |   | 223,367 |   |
| Commercial Group     |       | 16,485                                           |       | 16,485                                           |       | 11,442 |   | 11,442 |   |
|                 |       |                                             |       |                                             |       |   |   |   |   |
| Total                |       | $                                                | 1,585,497  |                                             | $          | 469,100 |   | $ | 1,858,877 |   | $ | 445,940 |   |

 

**Critical Accounting Policies**

** **

A number ofour accounting policies require the application of significant judgment by ourmanagement and such judgments are reflected in the amounts reported in ourfinancial statements. In applying these policies, our management uses itsjudgment to determine the appropriate assumptions to be used in thedetermination of estimates. Those estimates are based on our historicalexperience, terms of existing contracts, management’s observation of trends inthe industry, information provided by our customers and information availablefrom other outside sources, as appropriate. On an ongoing basis, we evaluateour estimates and judgments, including those related to revenue recognition,doubtful accounts receivable, goodwill and other intangible assets and othercontingent liabilities. Actual results may differ significantly from theestimates contained in our financial statements. We believe that the followingare our critical accounting policies.

 

***RevenueRecognition and Cost Estimation on Long-Term Contracts***

*** ***

Our revenue isderived primarily from contracts with the federal government. Our contractswith customers are either cost-plus, time and materials, or fixed pricecontracts. We recognize revenue when persuasive evidence of an arrangementexists, services have been rendered, the contract price is fixed ordeterminable, and collectibility is reasonably assured. All contract elements,such as design and early transition services, are separated into multiplecomponents in accordance with EITF 00-21, *Accounting for RevenueArrangements with Multiple Deliverables*. Revenue under cost-pluscontracts are recognized as costs are incurred with applicable profits includedin earnings based on negotiated profit rates. Incentive fees or penalties arerecognized when accepted by the customers and the related contractmodifications are received. Revenue for time-and-materials contracts arerecorded on the basis of allowable labor hours worked multiplied by the contractdefined billing rates, plus the costs of other direct charges used in theperformance of the contract. Profits on time and materials contracts resultfrom the difference between the cost of services performed and the contractdefined billing rates for these services.

 

Servicerevenue for fixed price contracts is recognized when earned, generally as workis performed in accordance with the provisions of the SEC’s Staff AccountingBulletin No. 104, *Revenue Recognition,*or Statementof Position 81-1,*Accounting for Performance of Construction –Type and Certain Production – Type Contracts,*depending on theservices performed. Services performed vary from contract to contract and arenot uniformly performed over the term of the arrangement. Revenue is recognizedon either a proportional performance or a percentage of completion model basedupon the service rendered under the contract. Additionally, customers areobligated to pay as services are performed, and in the event that an agency ofthe federal government cancels the contract, payment for services performedthrough the date of cancellation is negotiated with the customer.

 

Revenuerecognition requires judgment relative to assessing risks, estimating contractrevenue and costs, and making assumptions for schedule and technical issues. Dueto the size and nature of many of our contracts, the estimation of revenue andcosts can be complicated and is subject to many variables. Contract costsinclude labor, subcontracting costs, and other direct costs, as well as anallocation of allowable indirect costs. From time to time, facts develop thatrequire us to revise our estimated total costs and revenue on a contract. Tothe extent that a revised estimate affects contract profit or revenuepreviously recognized, we record the cumulative effect of the revision in theperiod in which the facts requiring the revision become known. Provision forthe full amount of an anticipated loss on the contract is recognized in theperiod in which it becomes probable and can be reasonably estimated.

 

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Invoices tocustomers are prepared in accordance with the terms of the applicable contract,which may not be directly related to the performance of services. Unbilledreceivables are invoiced based upon the achievement of specific events asdefined by each contract including deliverables, timetables, and incurrence ofcertain costs. Unbilled receivables are classified as a current asset. Advancedbillings to customers in excess of revenue earned are recorded as deferredrevenue until the revenue recognition criteria are met. Reimbursements ofout-of-pocket expenses are included in revenue with corresponding costsincurred by us included in cost of revenue.

 

Softwarerevenue is generated from licensing software and providing services, includingmaintenance and technical support, and consulting. We recognize the revenuewhen the license agreement is signed, the license fee is fixed anddeterminable, delivery of the software has occurred, and collectibility of thefee is considered probable. Our software license sales including maintenanceand consulting services are recognized at their fair values when all otherrecognition criteria are met. Service revenue consists of maintenance andtechnical support and is recognized ratably over the service period. Otherservice revenue is recognized as the related services are provided.

 

Revenue fromsales of products is generally recognized upon fulfillment of the order to thecustomer.

 

***Goodwi***l***l***

*** ***

Goodwillrepresents the excess of costs over fair value of assets of businesses acquired.In accordance with SFAS No. 142, *Goodwill and OtherIntangible Assets*, goodwill is evaluated for potential impairment atleast annually by comparing the fair value of a reporting unit, based onestimated future cash flows, to its carrying value including goodwill recordedby the reporting unit. If the carrying value exceeds the fair value, impairmentis measured by comparing the derived fair value of goodwill to its carryingvalue, and any impairment determined is recorded in the current period. Managementcompleted its annual impairment analysis for 2006 and determined that there wasno impairment of goodwill.

 

***Acquired Intangibles***

*** ***

In accordancewith SFAS 142, intangible assets acquired as part of business combinations areamortized over their estimated useful lives unless their useful lives aredetermined to be indefinite. For material business combinations, amountsrecorded related to purchased intangibles are determined from independentvaluations. Our acquired intangibles primarily relate to contracts, programsand customer relationships which are amortized over periods of 20 years orless.

 

***Long-Lived Assets***

*** ***

Generally, thecarrying values of long-lived assets, such as property and equipment andintangible assets with definite lives are reviewed for impairment if events orchanges in the facts and circumstances indicate that their carrying values maynot be recoverable. Purchased intangibles are reviewed for impairment inaccordance with SFAS No. 144, *Accounting for Impairmentor Disposal of Long-Lived Assets*. Any impairment determined isrecorded in the current period and is measured by comparing the fair valuebased on estimated future cash flows of the related asset to its carryingvalue.

 

***Accounting for Contingencies and Litigation***

*** ***

Amountsassociated with litigation and contingencies are recorded as charges toearnings when management, after taking into consideration the facts andcircumstances of each matter including any settlement offers, has determinedthat it is probable that a liability has been incurred and the amount of theloss can be reasonably estimated.

 

***Foreign Currency Translation***

*** ***

For operationsoutside the U.S. with functional currencies other than the U.S. dollar, resultsof operations and cash flows are translated at average exchange rates duringthe period, and assets and liabilities are translated at the year end exchangerates. The cumulative effect of these translation adjustments are reported inaccumulated other comprehensive income in owner’s/stockholder’s equity.

 

***Income Taxes***

*** ***

We account forincome taxes under SFAS No. 109, *Accounting for IncomeTaxes*. Income tax expense and the deferred income tax balances inthe financial statements have been calculated as if we had been taxedseparately and have prepared our own U.S. federal, U.S. state and local andforeign tax returns as a corporation.

 

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Theprovision for income taxes has been determined using the asset and liabilityapproach of accounting for income taxes. Under this approach, deferred taxesrepresent the future tax consequence expected to occur when the reportedamounts of assets and liabilities are recovered or paid. The provision forincome taxes represents income taxes paid or payable for the current year plusthe change in deferred taxes during the year. Deferred taxes result fromdifferences between the financial and tax bases of our assets and ourliabilities and are adjusted for changes in tax rates and tax laws when changesare enacted. Valuation allowances are recorded against deferred tax assets whenit is more likely than not that a tax benefit will not be realized. Provisionhas been made for income taxes on unremitted earnings of subsidiaries andaffiliates, except for subsidiaries in which earnings are deemed to bepermanently reinvested. For periods prior to the Acquisition, our U.S. taxableincome is included in Pearson plc’s consolidated U.S. federal income taxreturn.

 

 We adopted the provisions of FASBInterpretation No. 48 (“FIN 48”), *Accounting for Uncertaintyin Income Taxes (an interpretation of FASB Statement No. 109),*on January 1, 2007. As a result of the implementation of FIN 48, weperformed a comprehensive review of any uncertain tax positions in accordancewith recognition standards established by FIN 48. In this regard, anuncertain tax position represents our expected treatment of a tax positiontaken in a filed tax return, or planned to be taken in a future tax return,that has not been reflected in measuring income tax expense for financialreporting purposes. As a result of this review, we believe we have no uncertaintax positions and accordingly, we did not record any charges. We recognizeinterest and penalties, if any, as part of the provision for income taxes. Wecurrently have no open tax related audits of our federal, state, or local taxyears.

 

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**Results of Operations**

** **

***Company-Wide***

*** ***

The followingtable sets forth our historical results of operations on a company-wide basisfor the three months ended September 30, 2006 and September 29 2007, the ninemonths ended September 30, 2006, and the period January 1, 2007 to February 14,2007 combined with the period February 15, 2007 to September 29, 2007:

 
| ** **                           | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **September 30,  2006**         | ** ** | **September 29,  2007**    | ** ** | **September 30,  2006** | ** ** | **September 29,  2007** | ** ** |
| ** **                           | ** ** | **(dollars in thousands)** | ** ** |
| **Statement  of Operations Data:**   | ** ** | ** **                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                 |       |                                 |       |                            |       |   |   |   |   |
| Revenue                              |       | $                                    | 110,313    |                            | $          | 129,610 |   | $ | 396,479 |   | $ | 362,489 |   |
| Cost of revenue                      |       | 82,618                               |       | 103,983                         |       | 315,936 |   | 302,283 |   |
| Gross profit                         |       | 27,695                               |       | 25,627                          |       | 80,543 |   | 60,206 |   |
| General and  administrative expenses |       | 10,122                               |       | 11,544                          |       | 29,149 |   | 39,365 |   |
| Selling and  marketing expenses      |       | 4,821                                |       | 4,190                           |       | 14,878 |   | 12,979 |   |
| Intangible  amortization             |       | 3                                    |       | —                          |       | 11 |   | — |   |
| Operating income                     |       | 12,749                               |       | 9,893                           |       | 36,505 |   | 7,862 |   |
| Interest  expense, net               |       | 257                                  |       | 9,731                           |       | 482 |   | 24,080 |   |
| Income (loss)  before income taxes   |       | 12,492                               |       | 162                             |       | 36,023 |   | (16,218 | ) |
| Provision for  income taxes          |       | 4,869                                |       | 1,566                           |       | 13,700 |   | 4,210 |   |
| Net income  (loss)                   |       | $                                    | 7,623      |                            | $          | (1,404 | ) | $ | 22,323 |   | $ | (20,428 | ) |

 

***Three MonthsEnded September 29, 2007 Compared to Three Months Ended September 30, 2006***

*** ***

*Revenue.*Revenue for the three months ended September 29, 2007 was $129.6 million,compared to $110.3 million for the three months ended September 30,2006, representing an increase of $19.3 million, or 17.5%. The increase was primarily attributable to anincrease of $31.1 million from higher prescription drug enrollment volume undercontinuing Medicare related outsourcing contracts and increased volume undercertain UK, Mexico, and Venezuela government and commercial contracts, whichcontributed $2.8 million. This is partially offset by a decrease of $5.0million from the completion in 2006 of a DHS contract in our Government Group. Inaddition, we experienced a decrease in revenue from contracts with the DoED andDepartment of Defense ("DoD") of $4.8 million and $2.9 million,respectively.

 

*Cost ofRevenue.*Cost of revenue for the three months ended September 29,2007 was $104.0 million, or 80.2% of revenue, compared to $82.6 million,or 74.9 % of revenue, for the three months ended September 30, 2006, representing anincrease of $21.4 million, or 25.9%. The increase is primarilyattributable to costs associated with the contracts mentioned above, as well asamortization of intangible assets of $5.2 million due to an increase in thevalue of our contract base as a result of the Transaction.

 

*Generaland Administrative Expenses.*General and administrativeexpenses for the three months ended September 29, 2007 were $11.5 million,or 8.9% of revenue, compared to $10.1 million, or 9.2% of revenue, for thethree months ended September 30, 2006, representing an increase of $1.4 million,or 13.9%. The increase was primarily attributable to transition costs of $0.7million, employee bonuses associated with the Transaction of $0.6 million, andcosts associated with the equity ownership incentive plan of $0.5 million,partially offset by lower legal costs of $0.3 million relating to the DOJinvestigation of the TSA matter.

* *

*Sellingand Marketing Expenses.*Selling and marketing expenses forthe three months ended September 29, 2007 were $4.2 million, or 3.2% of revenue,compared to $4.8 million, or 4.4% of revenue, for the three months ended September 30, 2006,representing a decrease of $0.6 million, or 12.5%, due to lower bid andproposal costs.

 

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*OperatingIncome.*Operating income for the three months ended September 29,2007 was $9.9 million, compared to operating income of $12.7 million for thethree months ended September 30, 2006, representing a decrease of $2.8million or 22.0%. The decrease in operating income was attributable to adecrease in gross margin of $2.1 million primarily due to an increase of $5.2million in intangible amortization allocated to cost of revenue, partiallyoffset by an increase due to Medicare contracts growth, and a $1.4 millionincrease in general and administrative expenses.

 

*Out ofPeriod Adjustments*. During the third quarter of 2007, weidentified certain errors related to revenue recognized in periods prior tofiscal 2007 and in the second quarter of 2007. We have recorded adjustments forthese items which increased revenue and net income by $378 for the three monthsended September 29, 2007. We have determined that the impact of theseadjustments was not material to the current or any prior period and do notbelieve it will be material to the results for fiscal year 2007

 

*Provision forIncome Taxes.*The provision for income taxes forthe three months ended September 29, 2007 was $1.6 million compared to aprovision for income taxes of $4.9 million for the three months ended September30, 2006, representing a decrease of $3.3 million, or 67.3%. The effective taxrate was a positive 966.7% and a positive 39.0% for each of the reportingperiods, respectively. The Acquisition significantly adjusted the balances ofcertain assets and liabilities from both a financial reporting and taxperspective. As such, the income tax accounting for post-Acquisition periodsmay differ significantly from pre-Acquisition periods. We are required toassess our deferred tax assets and the need for a valuation allowance. Thisassessment requires judgment on the part of management with respect to benefitsthat may be realized. We have concluded, based upon available evidence, it ismore likely than not that the U.S. federal, state, and local deferred taxassets at September 29, 2007 will not be realizable. Therefore, a valuationallowance has been provided against U.S. deferred tax assets both at theacquisition date and in the successor period. The unusually high effective taxrate in the current period is the result of recording a tax provision for ournon-U.S. subsidiaries and deferred tax expense related to the amortization oftax deductible goodwill while also recording a valuation allowance against ourU.S. deferred tax assets primarily resulting from the net operating loss forthe three months ended September 29, 2007. Our effective tax rate for the threemonths ended September 30, 2006 differs from the U.S. statutory rate primarilydue to state and local taxes, and differing statutory tax rates applied to theincome of non-U.S. subsidiaries.

 

***Nine MonthsEnded September 29, 2007 Compared to Nine Months Ended September 30, 2006***

*** ***

*Revenue.*Revenue for the nine months ended September 29, 2007 was $362.5 million,compared to $396.5 million for the nine months ended September 30,2006, representing a decrease of $34.0 million, or 8.6%. Thedecrease was primarily attributable to a $16.6 million decrease in revenuerelated to a decline in prescription drug enrollment volume under continuingMedicare related outsourcing contracts, a decrease of $16.1 million from thecompletion in 2006 of a DHS contract, and a decrease of $7.7 million from lowerDepartment of Education contracts in our Government Group. These were partiallyoffset by an increase of $9.9 million from increased volume under certain UK,Mexico, and Venezuela government and commercial contracts in our InternationalGroup.

 

*Cost ofRevenue.*Cost of revenue for the nine months ended September 29,2007 was $302.3 million, or 83.4% of revenue, compared to $315.9 million,or 79.7% of revenue, for the nine months ended September 30, 2006, representing adecrease of $13.6 million, or 4.3%. The decrease in cost of revenue wasprimarily attributable to decreased services provided under the contractsdescribed above, offset by an increase in intangible amortization of $13.1million due to an increase in the value of our contract base as a result of theTransaction.

 

*Generaland Administrative Expenses.*General and administrativeexpenses for the nine months ended September 29, 2007 were $39.4 million,or 10.9% of revenue, compared to $29.1 million, or 7.3% of revenue, forthe nine months ended September 30, 2006, representing an increase of $10.3 million,or 35.4%. The increase was primarily attributable to $3.5 million of employeebonuses associated with the Transaction, $2.8 million of transition costs, $1.1million of additional expense due to full vesting of stock options at date ofTransaction, and $0.9 million of management and board fees. The remainingincrease relates to increases in other general and administrative expenses tosupport the standalone company.

 

*Sellingand Marketing Expenses.*Selling and marketing expenses forthe nine months ended September 29, 2007 were $13.0 million, or 3.6% of revenue,compared to $14.9 million, or 3.8% of revenue, for the nine months ended September 30, 2006,representing a decrease of $1.9 million, or 12.8% due to a decrease in bid,proposal and other costs.

 

*OperatingIncome.*Operating income for the nine months ended September 29,2007 was $7.9 million, compared to operating income of $36.5 million forthe nine months ended September 30, 2006, representing a decrease of $28.6 million or78.4%. This decrease in operating income was primarily attributable to generaland administrative expense increases of $10.3 million, and increase inintangible amortization of $13.1 million due to an increase in the value of ourcontract base as a result of the Transaction, a loss of $4.1 million recognizedon the termination of a contract with the University of California, and otherdecreases in revenue and related gross profit as described above.

 

*Out ofPeriod Adjustments.*During the third quarter of 2007, weidentified certain errors related to revenue recognized in periods prior tofiscal 2007. We have recorded adjustments for these items which increasedrevenue by $149, cost of revenue by $926, and reduced net income by $777 forthe successor period ended September 29, 2007. We have determined that theimpact of these adjustments was not material to the current or any period anddo not believe it will be material to the results for fiscal year 2007.

 

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*Provision forIncome Taxes.*The provision for income taxes forthe nine months ended September 29, 2007 was $4.2 million compared to aprovision for income taxes of $13.7 million for the nine months ended September30, 2006, representing a decrease of $9.5 million, or 69.3%. The effective taxrate was a negative 26.0% and a positive 38.0% for each of the reportingperiods, respectively. The nine months ended September 29, 2007 contain periodsboth before and after the acquisition. These periods have discrete effectivetax rates. The Acquisition significantly adjusted the balances of certainassets and liabilities from both a financial reporting and tax perspective. Assuch, the income tax accounting for post-Acquisition periods may differsignificantly from pre-Acquisition periods. We are required to assess our deferredtax assets and the need for a valuation allowance. This assessment requiresjudgment on the part of management with respect to benefits that may berealized. We have concluded, based upon available evidence, it is more likelythan not that the U.S. federal, state, and local deferred tax assets atSeptember 29, 2007 will not be realizable. Therefore, a valuation allowance hasbeen provided against U.S. deferred tax assets both at the acquisition date andin the successor period. The negative effective tax rate in the current periodis the result of recording a tax provision for our non-U.S. subsidiaries anddeferred tax expense related to the amortization of tax deductible goodwillwhile also recording a valuation allowance against our U.S. deferred tax assetsprimarily resulting from the net operating loss for the nine months endedSeptember 29, 2007. Our effective tax rate for the nine months ended September30, 2006 differs from the U.S. statutory rate primarily due to state and localtaxes, and differing statutory tax rates applied to the income of non-U.S.subsidiaries.

 

***Our Segments***

*** ***

***Thefollowing table sets forth our revenue and operating income by segment for thethree months ended September 30, 2006 and September 29, 2007, the nine monthsended September 30, 2006, and the period January 1, 2007 to February 14, 2007combined with the period February 15, 2007 to September 29, 2007:***

 
| ** **              | ** ** | **Three Months Ended**   | ** ** | **Nine Months Ended**    | ** ** |
|-------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| ** **              | ** ** | **September 30,   2006** | ** ** | **September 29,   2007** | ** ** | **September 30,   2006** | ** ** | **September 29,   2007** | ** ** |
| ** **              | ** ** | **(dollars in thousands)**         | ** ** |
| Revenue:                |       |                               |       |                               |       |   |   |   |   |
| Government Group        |       | $                                  | 86,499     |                               | $          | 102,896 |   | $ | 327,027 |   | $ | 283,165 |   |
| International  Group    |       | 15,235                             |       | 18,159                             |       | 44,134 |   | 54,228 |   |
| Commercial Group        |       | 8,579                              |       | 8,555                              |       | 25,318 |   | 25,096 |   |
|                    |       |                               |       |                               |       |   |   |   |   |
| Total revenue           |       | $                                  | 110,313    |                               | $          | 129,610 |   | $ | 396,479 |   | $ | 362,489 |   |
|                    |       |                               |       |                               |       |   |   |   |   |
| Operating  Income:      |       |                               |       |                               |       |   |   |   |   |
| Government Group        |       | $                                  | 10,352     |                               | $          | 8,996 |   | $ | 31,123 |   | $ | 6,795 |   |
| International  Group    |       | 1,384                              |       | (38                                | )          | 3,101 |   | 139 |   |
| Commercial Group        |       | 1,085                              |       | 915                                |       | 2,484 |   | 1,475 |   |
|                    |       |                               |       |                               |       |   |   |   |   |
| Subtotal                |       | 12,821                             |       | 9,873                              |       | 36,708 |   | 8,409 |   |
| Corporate               |       | (72                                | )          | 20                                 |       | (203 | ) | (547 | ) |
|                    |       |                               |       |                               |       |   |   |   |   |
| Total operating  income |       | $                                  | 12,749     |                               | $          | 9,893 |   | $ | 36,505 |   | $ | 7,862 |   |
|                         |            |                                    |            |                                    |            |  |  |  |  |  |  |  |  |  |

*** ***

***Three Months Ended September 29, 2007Compared to Three Months Ended September 30, 2006***

*** ***

***Government Group***

 

*Revenue.*Revenue for the three months ended September 29, 2007 was $102.9million, compared to $86.5 million for the three months ended September30, 2006, representing a increase of $16.4 million, or 19.0%. This increasewas primarily due to increased prescription drug enrollment volume undercontinuing Medicare related outsourcing contracts of $31.1 million. This waspartially offset from the completion of a contract with DHS in 2006 and withthe Department of Veteran's Affairs ("VA") in the first quarter of2007 of $5.0 million and $0.8 million, respectively. In addition, weexperienced a decrease in revenue from contracts with the Department ofEducation and DoD of $4.8 million and $2.9 million, respectively. The remainderis a decrease of revenue from fluctuations across various contracts.

 

37

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*OperatingIncome.*Operating income for the three months ended September29, 2007 was $9.0 million, compared to $10.4 million for the threemonths ended September 30, 2006, a decrease of $1.4 million, or 13.5%.Operating income as a percentage of revenue for the three months endedSeptember 29, 2007 was 8.7% compared to 12.0% for the three months endedSeptember 30, 2006. The decrease in operating income was attributable to lowerprofit from the completion of a contract with DHS in 2006 of approximately $2.3million. Lower prescription drug enrollment volume decreased profit by $1.6million under continuing Medicare related outsourcing contracts. In addition,there were decreases of approximately $4.9 million relating to amortizationassociated with the intangible assets from GG contracts valuation. Thesedecreases were partially offset by increased profit margins from contracts withthe Department of Education, the Equal Employment Opportunity Commission (“EEOC”), DoD, and State agencies ofapproximately $1.9 million, $0.5 million, $1.8 million, and $2.2 million,respectively. The remainder relates to fluctuations in gross profits acrossvarious contracts.

 

***International Group***

 

*Revenue.*Revenue for the three months ended September 29, 2007 was$18.2 million, compared to $15.2 million for the three months endedSeptember 30, 2006 representing an increase of $3.0 million, or 19.7%. Thisincrease was primarily attributable to increased volume under certain UK,Mexico, and Venezuela government and commercial contracts, which contributedapproximately $2.8 million of incremental revenue.

 

*OperatingIncome.*Operating income for the three months ended September29, 2007 was zero, compared to operating income of $1.4 million for thethree months ended September 30, 2006, a decrease of $1.4 million. Operatingincome as a percentage of revenue for the three months ended September 29, 2007was 0.0% compared to 9.2% for the three months ended September 30, 2006. Thedecrease in operating income was attributable to $0.9 million in reducedmargins, which was primarily due the renewal of a contract causing a one-timemargin improvement in Mexico, a $0.7 million increase in general andadministrative expenses, which is related to new corporate allocations of $0.3million and $0.2 million in expenses related to the sale of the Company. Thiswas offset by lower sales and marketing expenses of $0.1 million.

 

***Commercial Group***

 

*Revenue.*Revenue for the three months ended September 29, 2007 was$8.6 million, compared to $8.6 million for the three months ended September 30,2006, representing no change between the two periods. This was primarily due toan increase in services performed under a contract for the Air Force of $0.5million, offset entirely by a decrease in Commercial assessment related revenuefor various commercial clients of $0.4 million and a decrease in trainingservices revenue for several Fortune 500 customers of $0.1 million.

 

*OperatingIncome.*Operating income for the three months ended September29, 2007 was $0.9, compared to $1.1 million for the three months endedSeptember 30, 2006. Operating income as a percentage of revenue for the threemonths ended September 29, 2007 was 10.5% compared to 12.8% for the threemonths ended September 30, 2006. The decrease in operating income was primarilyattributable to an increase in general and administrative expenses of $0.2million as a result of transition-related expenses and an expense of $0.5million under an existing contract in the quarter ended September 29, 2007. Thedecrease in operating income was offset in part by the reduction inamortization of intangible assets related to assessments of $0.2 million and anoverall reduction in operating expenses.

 

***Nine Months Ended September 29, 2007 Comparedto the Nine Months Ended September 30, 2006***

*** ***

***Government Group***

 

*Revenue.*Revenue for the nine months ended September 29, 2007 was$283.2 million, compared to $327.0 million for the nine months endedSeptember 30, 2006, representing a decrease of $43.8 million, or 13.4%.This decrease was primarily attributable to a $16.6 million decrease in revenuerelated to a decline in prescription drug enrollment volume under continuingMedicare related outsourcing contracts. In addition, we experienced a decreaseof approximately $16.1 million due to the completion of a contract with DHS in2006. We also experienced a decrease of volumes on contracts with the Departmentof Education, and DoD of approximately $7.7 million, and $3.5 million,respectively. In addition, we recognized decreased revenue of approximately$2.2 million on the termination of a contract with the University ofCalifornia. These decreases were partially offset by an increase in volume witha contract with EEOC of approximately $1.2 million. The remainder is increasesof revenue across various contracts.

 

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*OperatingIncome.*Operating income for the nine months ended September29, 2007 was $6.8 million, compared to operating income of $31.1 millionfor the nine months ended September 30, 2006, a decrease of $24.3 million,or 78.1%. Operating income as a percentage of revenue for the nine months endedSeptember 29, 2007 was 2.4% compared to 9.5% of operating income as apercentage of revenue for the nine months ended September 30, 2006. Thedecrease in operating income was primarily attributable to lower prescriptiondrug enrollment volume of $11.0 million under continuing Medicare relatedoutsourcing contracts, the completion of a contract with DHS in 2006 ofapproximately $3.4 million, and lower gross margins on contracts with the DoDof approximately $0.8 million. In addition, we recognized a loss of $4.1million on the termination of a contract with the University of California and approximately$12.2 million of amortization of intangible assets associated with the GGcontracts valuation. These decreases were partially offset by increased gross marginsof approximately $3.2 million on our contracts with the Department ofEducation, approximately $0.6 million under our Department of Labor contractand increase gross margins of approximately $0.4 million under our contractwith EEOC. The remainder of the fluctuation in gross profit is across variouscontracts.

 

***International Group***

 

*Revenue.*Revenue for the nine months ended September 29, 2007 was$54.2 million, compared to $44.1 million for the nine months endedSeptember 30, 2006, representing an increase of $10.1 million, or 22.9%.This increase was primarily attributable to increased volume under certain UK,Mexico, and Venezuela government and commercial contracts of $9.9 million.

 

*OperatingIncome.*Operating income for the nine months ended September29, 2007 was $0.1 million, compared to operating income of $3.1 millionfor the nine months ended September 30, 2006, a decrease of $3.0 million, or96.8%. Operating income as a percentage of revenue for the nine months endedSeptember 29, 2007 was 0.2% compared to 7.0% for the nine months endedSeptember 30, 2006. The decrease in operating income was primarily attributableto a one-time foreign exchange gain in 2006 of $0.6 million, and transactionrelated costs of $0.3 million , amortization of intangible assets of $0.4million, increases in general and administrative costs of $1.0 million whichwere related primarily to new corporate allocations and $1.3 million of reducedmargin primarily related to  Mexicocontracts in 2007. Those items were partially offset by reduced spending onsales and marketing of $0.4 million.

 

***Commercial Group***

 

*Revenue.*Revenue for the nine months ended September 29, 2007 was$25.1 million, compared to $25.3 million for the nine months endedSeptember 30, 2006, representing a decrease of $0.2 million, or 0.8%. Thisdecrease was primarily due to the completion of work performed for trainingservices provided under a Medicare-related contract in April 2006, resulting ina reduction of revenue of $0.9 million and a decrease in Commercial assessmentrelated revenue for various commercial clients of $1.5 million. This decreasewas partially offset by an increase in training services revenue for severalFortune 500 customers of $0.9 million and services performed under a contract forthe Air Force of $1.3 million.

 

*OperatingIncome.*Operating income for the nine months ended September29, 2007 was $1.5 million, compared to operating income of $2.5 millionfor the nine months ended  September 30,2006, representing a decrease of $1.0 million, or 40.0%. Operating income as apercentage of revenue for the nine months ended September 29, 2007 was 6.0%compared to 9.9% for the nine months ended September 30, 2006. This decrease in operating income was primarilyattributable to an increase in general and administrative expenses of $0.8million as a result of transition-related expenses and an expense of $0.5million under an existing contract in the quarter ended September 29, 2007. Thedecrease in operating income was offset in part by the reduction inamortization of intangible assets related to assessments of $0.6 million and anoverall reduction in operating expenses.

 

**Liquidity and Capital Resources**

** **

Historically,we financed our capital and working capital requirements through a combinationof cash flows from operating activities and transfers from our former parentcompany.

 

Cash and cashequivalents totaled $15.0 million at September 29, 2007 and $11.7 million atDecember 31, 2006. These amounts are not comparable as certain cash accountswere swept directly into our former parent’s cash accounts prior to theAcquisition. Our cash flow from operations has historically been sufficient tomeet our working capital and capital expenditure requirements.

 

39

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Following theAcquisition, our primary source of liquidity has been cash flow from operationsand borrowings under our senior secured credit facility. Based on our currentlevel of operations, we believe our cash flow from operations and availableborrowings under our revolving credit facility will be adequate to meet ourliquidity needs for at least the next twelve months. Our ability to makescheduled payments of principal, to pay interest or special interest, if any,on or to refinance our indebtedness, or to fund capital expenditures, willdepend on our future performance, which, to a certain extent, is subject tofactors that are beyond our control. There can be no assurance that we will beable to affect any future refinancing of our debt on commercially reasonableterms or at all.

 

Net cash used by operatingactivities was $2.9 million for the nine months ended September 29, 2007compared to cash provided by operating activities of $2.4 million for the ninemonths ended September 30, 2006. The increase of $0.5 million in cash used inoperations was primarily due to increased volumes on the Medicare relatedcontracts, with higher accounts receivable and directly associated higheraccrued costs.

 

Net cash usedin investing activities for the nine months ended September 29, 2007 and 2006was $637.4 million and $13.2 million, respectively. The primary use of cash forthe nine months ended September 29, 2007 was due to the Transaction. The use ofcash for all other periods is due primarily to the purchase of property andequipment for contractual and infrastructure requirements, the acquisition ofBlueprint Technologies, Inc. in April 2006 for $8.1 million and new businessgrowth.

 

Net cash providedby financing activities for the nine months ended September 29, 2007 and 2006was $645.4 million and $15.9 million, respectively. This increase in cashprovided by financing activities of $629.5 million is primarily due to the cashproceeds from the issuance of debt and stock related to the Acquisition.

 

***Debt and Other Obligations***. Concurrentlywith the closing of the offering of the 95/8% seniorsubordinated notes due 2015 on February 14, 2007, and as a condition thereof,we entered into our senior secured credit facility. Our senior secured credit facilityprovides us with up to $50.0 million in available revolving loan borrowings,maturing in 2012, and a $240.0 million term loan, maturing in 2013. We drew$5.0 million under our revolving credit facility to fund a portion of thepurchase price for the Acquisition, which was repaid by June 30, 2007. Inaddition, the Company issued $190.0 million of senior subordinated notes at aninterest rate of 95/8% maturing on February 15, 2015. TheCompany is currently compliant with all debt covenants.

 

Our senior secured creditfacility contains a maximum total leverage ratio. Our senior secured creditfacility is secured by substantially all of our assets, the assets of the buyerand the assets of our domestic subsidiaries, and by a pledge of all of thecapital stock of our domestic subsidiaries, and 66% of the voting capital stockand 100% of the non-voting capital stock of our first tier foreignsubsidiaries.

 

Our senior subordinatednotes are guaranteed on a senior subordinated basis by our existing and futuredomestic subsidiaries that are guarantors under our new senior secured creditfacility. The notes and guarantees are unsecured senior subordinatedobligations ranking equally with our other senior subordinated debt and will besubordinated to all of our and the subsidiary guarantors’ senior debt,including our new senior secured credit facility.

 

***Capital Expenditures***. We spent anaggregate of $8.1 million for capital expenditures during the nine months endedSeptember 29, 2007 primarily related to general infrastructure requirements. Weexpect to spend an aggregate of approximately $12.5 million for capitalexpenditures for the year ended December 31, 2007 primarily relating toanticipated contractual and general infrastructure requirements and newbusiness growth.

 

The followingtable presents, at September 29, 2007, our obligations and commitments to makefuture payments under contracts and contingent commitments:

 

40

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| ** **                       | ** ** | **Payments Due by Period (in millions)** | ** ** |
|----------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                       | ** ** | ** **                                                        | ** ** |
| **Contractual Obligations** | ** ** | **Total**                                                         | ** ** | **Within 1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than 5 Years** | ** ** |
|                             |       |                                                              |       |   |   |   |   |   |   |   |   |
| Senior secured  credit facility  |       |                                                              |       |   |   |   |   |   |   |   |   |
| Revolving credit  facility       |       | $                                                                 | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Term loan  facility              |       | 238.8                                                             |       | 2.4 |   | 4.8 |   | 4.8 |   | 226.8 |   |
| Capital leases                   |       | 0.5                                                               |       | 0.3 |   | 0.2 |   | — |   | — |   |
| Senior  subordinated notes       |       | 190.0                                                             |       | — |   | — |   | — |   | 190.0 |   |
| International  short term loan   |       | 0.2                                                               |       | 0.2 |   | — |   | — |   | — |   |
| Interest  payments due           |       | 233.6                                                             |       | 37.1 |   | 73.2 |   | 72.6 |   | 50.7 |   |
| Total  contractual obligations   |       | $                                                                 | 663.1      |   | $ | 40.0 |   | $ | 78.2 |   | $ | 77.4 |   | $ | 467.5 |   |

** **

**Off-Balance Sheet Arrangements**

** **

As ofSeptember 29, 2007, we had no off-balance sheet arrangements other than regularoperating leases. We do not believe that these leases are reasonably likely tomaterially affect our liquidity or availability of, or requirements for,capital resources.

 

**Recent Accounting Pronouncements**

 

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurements* (“SFASNo. 157”). SFAS No. 157 establishes a framework for measuring fairvalue and requires expanded disclosures regarding fair value measurements. Thisaccounting standard is effective for financial statements issued for fiscalyears beginning after November 15, 2007. The effect, if any, of adoptingSFAS No. 157 on our financial position and results of operations has notbeen finalized.

 

InSeptember 2006, the FASB issued SFAS No. 158, *Employers’ Accounting for Defined Benefit Pension andOther Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106,and 132(R)* (“SFAS No. 158”). SFAS No. 158 requires us torecognize the over funded or under funded status of a defined benefitpostretirement plan as an asset or liability in our balance sheet. Theresulting balance sheet adjustment is offset by a corresponding adjustment to comprehensiveincome, net of deferred tax effects. This change would apply to our financialstatement for the year ended December 31, 2007. The effect of adopting SFASNo. 158 on our financial position and results of operations is pendingfinalization of an initial actuarial valuation. We do not believe it will havea material impact on our financial position.

 

InFebruary 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities, including an amendment of FASB Statement No. 115*(“SFAS 159”). SFAS 159 permits entities to choose to measure manyfinancial instruments and certain other items at fair value that are notcurrently required to be measured at fair value. Unrealized gains and losses onitems for which the fair value option has been elected are reported inearnings. SFAS 159 does not affect any existing accounting literature thatrequires certain assets and liabilities to be carried at fair value.SFAS 159 is effective for fiscal years beginning after November 15,2007. The effect, if any of adopting SFAS 159 on our financial position orresults of operations has not been finalized, but it is not expected to have amaterial impact.

 

**ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

There is no material change in the information reported under “Part I,Item 12—Quantitative and Qualitative Disclosures About Market Risk,” containedin our prospectus filed with the SEC pursuant to Rule 424(b)(4) on October 19,2007.

 

41

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**ITEM 4. CONTROLS AND PROCEDURES**

 

Our management, with the participation of our Chief Executive Officerand our Chief Financial Officer, has evaluated our disclosure controls andprocedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) ofthe Exchange Act). Based on that evaluation, our Chief Executive Officer andChief Financial Officer have concluded that, as of the end of the periodcovered by this report, our disclosure controls and procedures were effectiveto ensure that information required to be disclosed in reports that we file orsubmit under the Exchange Act are: (1) recorded, processed, summarized andreported within the time periods specified in the SEC's rules and forms; and(2) accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

 

**PART II: OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

The information required with respect to this item can be found in Note7 to our unaudited condensed consolidated financial statements and isincorporated by reference herein.

 

**ITEM 1A.RISK FACTORS**

 

There is no material change in the information reported under “Part I.Item 3—Risk Factors” contained in our prospectus filed with the SEC pursuant toRule 424(b)(4) on October 19, 2007.

 

**ITEM 2. UNREGISTERED SALES OFEQUITY SECURITIES AND USE OF PROCEEDS**

 

None

 

**ITEM 3. DEFAULTS UPON SENIORSECURITIES**

 

None

 

**ITEM 4. SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

 

None

 

**ITEM 5. OTHER INFORMATION**

 

None

 

**ITEM 6. EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                      |
|--------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1*                    |       | Certification of Chief Executive Officer Pursuant to Section  302 of the Sarbanes-Oxley Act of 2002.                                                 |
| 31.2*                    |       | Certification of Chief Financial Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                  |
| 32.1*                    |       | Certification of Chief Executive Officer Pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |
| 32.2*                    |       | Certification of Chief Financial Officer Pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |

----

 

*  Filed herewith.

 

42

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**SIGNATURE**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

Date: November 9, 2007 
|   |   | VANGENT, INC. |
|--------|--------|---------------|
|   |   |          |
|   |   | By:           | /s/ CHRISTINE  M. BAILEY |   |
|   |   |          | Christine M. Bailey |
|   |   |          | Chief Financial Officer  (Principal |
|   |   |          | Financial Officer &  Authorized |
|   |   |          | Signatory) |

 

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