##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 
 FORM 10-Q
 /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 SECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004. COMMISSION FILE NUMBER 33389756 
 (ALION LOGO) Alion Science and Technology Corporation 
  DELAWARE
(State or Other Jurisdiction of
Incorporation of Organization)
    
    542061691
(I.R.S. Employer
Identification No.)
 10 West 35th Street
Chicago, IL 60616
(312) 5674000
    
    1750 Tysons Boulevard, Suite 1300
McLean, VA 22102
(703) 9184480
 (Address, including Zip Code and Telephone Number with
Area Code, of Principal Executive Offices)      Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days./X/Yes / / No Indicate by check mark whether the registrant is an
accelerated filer (as defined in Rule 12b2 of the Exchange Act).
Yes / / No /X/ The number of shares outstanding of Alion Science and Technology Corporation
common stock as of June 30, 2004, was: Common Stock      3,224,027




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##### 



ALION SCIENCE AND TECHNOLOGY CORPORATION
FORM 10-Q INDEX
FOR THE QUARTER ENDED JUNE 30, 2004 PART I  FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance Sheets
    
    
    3Consolidated Statements of Operations
    
    
    4Consolidated
Statements of Operations and Pro Forma Consolidated Statement of Operations
    
    
    5Consolidated Statements of Cash Flows
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition And Results of Operations
    
    
    16Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    38Item 4. Controls and Procedures
    
    
    38PART II  OTHER INFORMATION
    
    
    39Item 1. Legal Proceedings
    
    
    39Item 2. Changes in Securities and Use of Proceeds
    
    
    40Item 3. Defaults Upon Senior Securities
    
    
    40Item 4. Submission of Matters to a Vote of Security Holders
    
    
    40Item 5. Other Information
    
    
    41Item 6. Exhibits and Reports on Form 8-K
    
    
    42
 2




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##### 



ALION SCIENCE AND TECHNOLOGY CORPORATION
Consolidated Balance Sheets
As of June 30, 2004 (Unaudited) and September 30, 2003
(In thousands, except share information) June 30,
    
    September 30,2004
    
    2003AssetsCurrent assets:Cash
    
    $
    11
    
    
    $
    494Restricted cash
    
    
    
    
    
    
    5Accounts receivable, less allowance of $3,231 at June 30, 2004 and $2,484
at September 30, 2003
    
    
    64,682
    
    
    
    42,777Stock subscriptions receivable
    
    
    
    
    
    
    1,246Receivable from Trust
    
    
    16
    
    
    
    Prepaid expense
    
    
    2,019
    
    
    
    974Other current assets
    
    
    1,922
    
    
    
    987Total current assets
    
    
    68,650
    
    
    
    46,483Fixed assets, net
    
    
    10,787
    
    
    
    8,696Intangible assets, net
    
    
    16,349
    
    
    
    22,788Goodwill
    
    
    81,748
    
    
    
    65,522Other
    
    
    2,108
    
    
    
    97Deferred compensation assets
    
    
    1,688
    
    
    
    1,362Total assets
    
    $
    181,330
    
    
    
    144,948Liabilities and Shareholders Equity, Subject to RedemptionCurrent liabilities:Note payable to bank
    
    $
    500
    
    
    $
    Current portion of senior note payable
    
    
    
    
    
    
    5,000Acquisition obligations
    
    
    5,965
    
    
    
    2,928Trade accounts payable and accrued liabilities
    
    
    19,964
    
    
    
    9,661Accrued payroll and related liabilities
    
    
    15,597
    
    
    
    14,217Advance payments
    
    
    
    
    
    
    5ESOP liabilities
    
    
    1,005
    
    
    
    320Current portion of lease obligations
    
    
    685
    
    
    
    Billings in excess of costs and estimated earnings on uncompleted contracts
    
    
    1,213
    
    
    
    409Total current liabilities
    
    
    44,929
    
    
    
    32,540Senior
note payable, excluding current portion
    
    
    46,746
    
    
    
    22,903Mezzanine note payable
    
    
    17,374
    
    
    
    17,636Subordinated note payable
    
    
    34,038
    
    
    
    33,437Agreements with officers
    
    
    1,509
    
    
    
    743Deferred compensation liability
    
    
    1,684
    
    
    
    1,362Accrued post-retirement benefit obligation
    
    
    3,454
    
    
    
    3,319Non current portion of lease obligations
    
    
    3,391
    
    
    
    346Redeemable common stock warrants
    
    
    16,779
    
    
    
    14,762Total liabilities
    
    
    169,904
    
    
    
    127,048Shareholders equity, subject to redemption:Common stock (subject to redemption), $0.01 par value, 15,000,000 shares
authorized, 3,224,769 shares and 2,973,813 shares issued and
3,224,027 and 2,973,813 shares outstanding at June 30, 2004 and
September 30, 2003, respectively
    
    
    32
    
    
    
    29Additional paid-in capital
    
    
    34,645
    
    
    
    30,578Treasury stock, at cost (743 shares)
    
    
    (12
    )
    
    
    Accumulated deficit
    
    
    (23,239
    )
    
    
    (12,707
    )Total shareholders equity, subject to redemption
    
    
    11,426
    
    
    
    17,900Total liabilities and shareholders equity, subject to redemption
    
    $
    181,330
    
    
    $
    144,948
 See accompanying notes to consolidated financial statements. 3




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##### 



ALION SCIENCE AND TECHNOLOGY CORPORATION
Consolidated Statements of Operations
Three Months Ended June 30, 2004, Sixteen-Week Period Ended July 4, 2003
Nine Months Ended June 30, 2004 and the Forty-Week Period Ended July 4, 2003
(In thousands, except share information)
(Unaudited) Three Months
    
    Sixteen-Week
    
    Nine Months
    
    Forty-Week PeriodEnded
    
    Period Ended
    
    Ended
    
    EndedJune 30, 2004
    
    July 4, 2003
    
    June 30, 2004
    
    July 4, 2003Contract revenue
    
    $
    69,808
    
    
    $
    65,134
    
    
    $
    193,111
    
    
    $
    114,139Direct contract expense
    
    
    50,819
    
    
    
    47,459
    
    
    
    139,310
    
    
    
    83,490Gross profit
    
    
    18,989
    
    
    
    17,675
    
    
    
    53,801
    
    
    
    30,649Operating expenses:Indirect contract expense
    
    
    4,829
    
    
    
    3,588
    
    
    
    13,483
    
    
    
    6,436Research and development
    
    
    65
    
    
    
    50
    
    
    
    243
    
    
    
    69General and administrative
    
    
    6,834
    
    
    
    8,046
    
    
    
    21,099
    
    
    
    13,355Non-recurring transaction expense
    
    
    
    
    
    
    174
    
    
    
    
    
    
    
    726Rental and occupancy expense
    
    
    3,329
    
    
    
    2,541
    
    
    
    8,337
    
    
    
    4,634Depreciation and amortization
    
    
    3,518
    
    
    
    3,797
    
    
    
    9,889
    
    
    
    6,616Bad debt expense (recovery)
    
    
    180
    
    
    
    (700
    )
    
    
    314
    
    
    
    (545
    )Total operating expenses
    
    
    18,755
    
    
    
    17,496
    
    
    
    53,365
    
    
    
    31,291Operating income (loss)
    
    
    234
    
    
    
    179
    
    
    
    436
    
    
    
    (642
    )Other income (expense):Interest income
    
    
    9
    
    
    
    9
    
    
    
    18
    
    
    
    12Interest expense
    
    
    (2,456
    )
    
    
    (2,603
    )
    
    
    (9,420
    )
    
    
    (4,826
    )Other
    
    
    (588
    )
    
    
    (278
    )
    
    
    (1,564
    )
    
    
    (353
    )Loss before income taxes
    
    
    (2,801
    )
    
    
    (2,693
    )
    
    
    (10,530
    )
    
    
    (5,809
    )Income tax expense
    
    
    (4
    )
    
    
    
    
    
    
    (4
    )
    
    
    Net loss
    
    $
    (2,805
    )
    
    $
    (2,693
    )
    
    $
    (10,534
    )
    
    $
    (5,809
    )Basic and diluted loss per share
    
    $
    (0.87
    )
    
    $
    (1.00
    )
    
    $
    (3.47
    )Basic and diluted weighted average
common shares outstanding
    
    
    3,224,704
    
    
    
    2,693,056
    
    
    
    3,038,148
 See accompanying notes to consolidated financial statements. 4




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##### 



ALION SCIENCE AND TECHNOLOGY CORPORATION
Consolidated Statements of Operations
Three Months Ended June 30, 2004, Sixteen-Week Period Ended July 4, 2003 and
Nine Months Ended June 30, 2004 and
Pro Forma Consolidated Statement of Operations for the Forty-Week Period Ended July 4, 2003
(In thousands, except share information)
(Unaudited) Pro FormaThree Months
    
    Sixteen-Week
    
    Nine Months
    
    Forty-WeekEnded
    
    Period Ended
    
    Ended
    
    Period EndedJune 30, 2004
    
    July 4, 2003
    
    June 30, 2004
    
    July 4, 2003Contract revenue
    
    $
    69,808
    
    
    $
    65,134
    
    
    $
    193,111
    
    
    $
    161,404Direct contract expenses
    
    
    50,819
    
    
    
    47,459
    
    
    
    139,310
    
    
    
    118,145Gross profit
    
    
    18,989
    
    
    
    17,675
    
    
    
    53,801
    
    
    
    43,259Operating expenses:Indirect contract expense
    
    
    4,829
    
    
    
    3,588
    
    
    
    13,483
    
    
    
    9,004Research and development
    
    
    65
    
    
    
    50
    
    
    
    243
    
    
    
    105General and administrative
    
    
    6,834
    
    
    
    8,046
    
    
    
    21,099
    
    
    
    18,240Non-recurring transaction costs
    
    
    
    
    
    
    174
    
    
    
    
    
    
    
    6,562Rental and occupancy expense
    
    
    3,329
    
    
    
    2,541
    
    
    
    8,337
    
    
    
    6,835Depreciation and amortization
    
    
    3,518
    
    
    
    3,797
    
    
    
    9,889
    
    
    
    9,499Bad debt expense (recovery)
    
    
    180
    
    
    
    (700
    )
    
    
    314
    
    
    
    (425
    )Total operating expenses
    
    
    18,755
    
    
    
    17,496
    
    
    
    53,365
    
    
    
    49,820Operating income (loss)
    
    
    234
    
    
    
    179
    
    
    
    436
    
    
    
    (6,561
    )Other income (expense):Interest income
    
    
    9
    
    
    
    9
    
    
    
    18
    
    
    
    34Interest expense
    
    
    (2,456
    )
    
    
    (2,603
    )
    
    
    (9,420
    )
    
    
    (6,980
    )Other
    
    
    (588
    )
    
    
    (278
    )
    
    
    (1,564
    )
    
    
    (374
    )Loss before income taxes
    
    
    (2,801
    )
    
    
    (2,693
    )
    
    
    (10,530
    )
    
    
    (13,881
    )Income tax expense
    
    
    (4
    )
    
    
    
    
    
    
    (4
    )
    
    
    (27
    )Net loss
    
    $
    (2,805
    )
    
    $
    (2,693
    )
    
    $
    (10,534
    )
    
    $
    (13,908
    )Basic and diluted loss per share

    
    $
    (0.87
    )
    
    $
    (1.00
    )
    
    $
    (3.47
    )Basic and diluted weighted average
common shares outstanding
    
    
    3,224,704
    
    
    
    2,693,056
    
    
    
    3,038,148Pro forma basic and diluted loss per share
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5.30
    )Pro forma basic and diluted weighted
average common shares outstanding
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,622,527
 See accompanying notes to consolidated financial statements. 5




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##### 



ALION SCIENCE AND TECHNOLOGY CORPORATION
Consolidated Statements of Cash Flows
Nine Months Ended June 30, 2004
and Forty-Week Period Ended July 4, 2003
(In thousands, except share information)
(Unaudited) Nine Months
    
    Forty-Week PeriodEnded
    
    EndedJune 30, 2004
    
    July 4, 2003Cash flows from operating activities:Net loss
    
    $
    (10,534
    )
    
    $
    (5,809
    )Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    9,889
    
    
    
    6,616Accretion of debt to face value
    
    
    1,105
    
    
    
    718Amortization of debt issuance costs
    
    
    310
    
    
    
    247Decrease in value of interest rate cap agreement
    
    
    50
    
    
    
    Change in fair value of redeemable common stock warrants
    
    
    2,018
    
    
    
    (266
    )(Gain) Loss on investments
    
    
    (36
    )
    
    
    (71
    )Changes in assets and liabilities, net of effect of acquisitions:Accounts receivable, net
    
    
    (10,978
    )
    
    
    8,822Other assets
    
    
    (2,529
    )
    
    
    798Trade accounts payable and accruals
    
    
    5,385
    
    
    
    1,121Other liabilities
    
    
    2,674
    
    
    
    (822
    )Net cash provided by (used in) operating activities
    
    
    (2,646
    )
    
    
    11,354Cash flows from investing activities:Cash paid for acquisitions, net of cash acquired
    
    
    (17,715
    )
    
    
    (59,944
    )Capital expenditures
    
    
    (2,786
    )
    
    
    (998
    )Purchase of non-marketable securities
    
    
    (1,333
    )
    
    
    Net cash used in investing activities
    
    
    (21,834
    )
    
    
    (60,942
    )Cash flows from financing activities:Proceeds from senior note payable
    
    
    
    
    
    
    35,000Payment of debt issuance costs
    
    
    
    
    
    
    (1,700
    )Repayment of senior note payable
    
    
    (4,817
    )
    
    
    (1,850
    )Repayment of mezzanine note payable
    
    
    (750
    )
    
    
    Proceeds from agreement with officer
    
    
    750
    
    
    
    Repayments of ITSC revolving credit agreement
    
    
    (375
    )
    
    
    Repayments under IITRI revolving credit agreement
    
    
    
    
    
    
    (6,185
    )Borrowings under revolving credit facility
    
    
    23,850
    
    
    
    Purchase of interest rate cap agreement
    
    
    
    
    
    
    (245
    )Payment of acquisition obligations
    
    
    (18
    )
    
    
    (155
    )Purchase of 50,780 shares of common stock from ESOP Trust
    
    
    (748
    )
    
    
    Stock redemption
    
    
    
    
    
    
    (58
    )Payment of stock subscription for common stock issued to ESOP Trust
    
    
    6,105
    
    
    
    26,489Net cash provided by financing activities
    
    
    23,997
    
    
    
    51,296Net increase (decrease) in cash
    
    
    (483
    )
    
    
    1,708Cash at beginning of period
    
    
    494
    
    
    
    6Cash at end of period
    
    $
    11
    
    
    $
    1,714Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    3,570
    
    
    $
    2,564Non-cash investing and financing activities:Mezzanine note and warrants issued in connection with acquisition of
selected operations of IITRI
    
    
    
    
    
    
    20,343Subordinated note and warrants issued in connection with acquisition of
selected operations of IITRI
    
    
    
    
    
    
    39,900Issuance of 29,637 shares of common stock to ESOP Trust for amount
due to ESOP Trust
    
    
    
    
    
    
    296Common stock issued to ESOP Trust in satisfaction of employer
contribution liability
    
    
    
    
    
    
    1,001Bank debt assumed in connection with the acquisition of selected
operations of IITRI
    
    
    
    
    
    
    6,185IITRI transaction costs assumed in connection with the acquisition of
selected operations of IITRI
    
    
    
    
    
    
    783Additional non-cash consideration paid in connection with acquisition
of selected operations of IITRI
    
    
    
    
    
    
    1,798Deferred compensation arrangement with officer
    
    
    
    
    
    
    857
 See accompanying notes to consolidated financial statements. 6




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##### 



ALION SCIENCE AND TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004 (UNAUDITED) 1. Description and Formation of the Business Alion Science and Technology Corporation (Alion or the Company) provides
scientific and engineering expertise to research and develop technological
solutions for problems relating to national defense, public health and safety,
and nuclear safety and analysis. The Company provides these research services
primarily to agencies of the federal government and, to a lesser extent, to
commercial and international customers. Alion, a for-profit S Corporation, was formed in October 2001 for the
purpose of purchasing substantially all of the assets and certain of the
liabilities of IIT Research Institute (IITRI), a not-for-profit membership
corporation affiliated with and controlled by the Illinois Institute of
Technology. Prior to the acquisition of substantially all of the assets and
liabilities of IITRI (the Transaction), the Companys activities had been
organizational in nature. On December 20, 2002, Alion acquired substantially all of the assets and
liabilities of IITRI (Business), excluding the assets and liabilities of
IITRIs Life Sciences Operation, for aggregate total proceeds of $127.3 million
consisting of (in thousands):  
    
    $58,571 cash, consisting of $56,721 paid to IITRI and $1,517 paid
for certain transaction expenses on behalf of IITRI, and $333 paid for
other transaction expenses;
    
    $39,900 in seller notes to IITRI, with detachable warrants
representing approximately 26% of the outstanding common stock of Alion
(on a fully diluted basis). The seller notes bear interest at an
effective interest rate of 6.71% per annum. See notes 6 and 8;
    
    $20,343 in mezzanine notes to IITRI, with detachable warrants
representing 12% of the outstanding common stock of Alion (on a fully
diluted basis). The mezzanine notes bear interest at 12% per annum. See
notes 6 and 8;
    
    $2,300 in transaction costs less the $1,517 referenced above;
    
    $6,185 in assumed IITRI debt due to its bank; and
    
    $1,520 in additional amounts due to IITRI for purchase price
adjustments related to the Life Sciences Operation. The acquisition was accounted for using the purchase method. The purchase
price has been allocated to the acquired assets and assumed liabilities based
on their estimated fair values at the date of acquisition. As a result of the
Transaction, the Company recorded goodwill of approximately $63.6 million,
which is subject to an annual impairment review, as discussed below. In
addition, the Company recorded intangible assets of approximately $30.6
million, comprised of purchased contracts. The intangible assets have an
estimated useful life of three years and are amortized using the straight-line
method. 7




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##### 



The total purchase consideration of approximately $127.3 million was allocated
to the fair value of the net assets acquired as follows (in thousands): Cash and restricted cash
    
    $
    1,187Accounts receivable
    
    
    47,485Other current assets
    
    
    3,784Acquired contracts
    
    
    30,645Goodwill
    
    
    63,610Fixed assets
    
    
    9,094Liabilities assumed
    
    
    (28,500
    )$
    127,305
 2. Basis of Presentation The accompanying unaudited consolidated financial statements include the
accounts of Alion and its wholly owned subsidiaries Human Factors Applications,
Inc. (HFA), Innovative Technology Solutions Corporation (ITSC), and Identix
Public Sector, Incorporated (IPS) and have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission (SEC) regarding
interim financial information. Certain information and note disclosures
normally included in the annual financial statements, prepared in accordance
with accounting principles generally accepted in the United States of America,
have been condensed or omitted pursuant to those rules and regulations. In the
opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the nine months ended June 30, 2004 are not necessarily
indicative of the results that may be expected for the fiscal year ending
September 30, 2004. For further information, refer to the consolidated
financial statements and notes thereto included in the Post Effective Amendment
No. 4 to the Companys registration statement on Form S-1 (No. 333-89756) filed
with the SEC on January 22, 2004. The preparation of financial statements, in conformity with generally
accepted accounting principles, requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosures of contingencies at the date of the financial statements as well as
the reported amounts of revenues and expenses during the reporting period.
Estimates have been prepared on the basis of the most current and best
available information and actual results could differ from those estimates. 3. Summary of Significant Accounting Policies The consolidated financial statements are prepared on the accrual basis of
accounting and include the accounts of Alion prior to the Transaction and the
accounts of Alion and its wholly owned subsidiaries subsequent to the
Transaction. All significant intercompany accounts have been eliminated in
consolidation. Fiscal, Quarter and Interim Periods The Companys fiscal year ends on September 30. Beginning with the fiscal
year ending September 30, 2004, the Company began operating based on a
three-month quarter, four-quarter fiscal year. For the fiscal year ended
September 30, 2003, the Company operated on a thirteen-period fiscal year that
consisted of three, four-week periods in its first interim period; three,
four-week periods in its second interim period; four, four-week periods in its
third interim period; and the balance of the fiscal year of
approximately three, four-week periods in its fourth interim period. For
the three months ended June 30, 2004, there were 64 available work days (based
on a standard work week of Monday through Friday and 8




---



##### 



excluding designated
holidays recognized by Alion) as compared to 78 available workdays for the
sixteen-week period ended July 4, 2003. On a fiscal year-to-date basis, through
the nine months ended June 30, 2004, there were 192 available workdays as
compared to 194 available workdays for the forty-week period ended July 4,
2003. Accordingly, comparisons between the three-month quarter ended June 30,
2004 and the sixteen-week period ended July 4, 2003 and comparisons between the
nine months ended June 30, 2004 and the forty-week period ended July 4, 2003
will need to consider the differing lengths of time. Reclassifications Where appropriate, certain items relating to prior years have been
reclassified to conform to the current period presentation. Recently Issued Accounting Pronouncements On January 12, 2004, the Financial Accounting Standards Board (FASB)
issued Staff Position No. FAS 106-1 Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003 (FSP 106-1). FSP 106-1 permits employers that sponsor postretirement
benefit plans to defer accounting for any effects of the Medicare Prescription
Drug, Improvement and Modernization Act of 2003 that was signed into law on
December 8, 2003. FSP 106-1 was superseded by FSP FAS 106-2 which is effective beginning July 1, 2004. In accordance with FSP 106-1 and FSP 106-2, neither the accumulated post-retirement
benefit obligation nor the net periodic postretirement benefit costs reflected
in the accompanying financial statements reflects the effect of the Medicare
Prescription Drug Improvement and Modernization Act of 2003 on Alions plan.
Authoritative guidance, when issued, could require the Company to change
previously reported information. 4. Earnings (Loss) Per Share Basic and diluted loss per share is computed by dividing net loss by the
weighted average number of common shares outstanding. For the pro forma
forty-week period ended July 4, 2003, pro forma loss per share has been computed as
though the 2,575,408 shares of common stock sold by the Company to the employee
stock ownership plan (ESOP) component of the Alion Science and Technology
Corporation Employee Ownership, Savings and Investment Plan (KSOP) on December
20, 2002 to fund the Transaction described in Note 1, were outstanding for the
entire period presented. Prior to the sale of shares of common stock to the
ESOP, the Companys capital structure consisted of 100 shares of common stock
issued and outstanding. Accordingly, historical earnings per share information
for periods prior to the Transaction has not been presented as it is not
indicative of the Companys ongoing capital structure. Loss per share excludes the impact of warrants and stock appreciation
rights described herein as the impact of their inclusion would be anti-dilutive
for all periods presented. 5. Goodwill and Intangible Assets The Company accounts for goodwill and other intangible assets in
accordance with the provisions of Statement of Financial Accounting Standards
(SFAS) No. 142, which requires, among other things, the discontinuance of
goodwill amortization. In addition, goodwill is to be reviewed at least
annually for impairment. The Company has elected to perform this review
annually at the end of each fiscal year. The accompanying pro forma statement
of operations excludes historical goodwill amortization expense. During the fiscal year ended September 30, 2003, the Company recorded
goodwill of approximately $65.5 million, which is subject to the aforementioned
annual impairment review. During the
nine months ended June 30, 2004, goodwill increased by approximately $16.2
million primarily as a result 9




---



##### 



of recording additional obligations of $6.5
million related to earnout arrangements for historical acquisitions and
approximately $9.8 million for the acquisitions described in Note 10. In addition, the Company recorded intangible assets of approximately $30.6
million during fiscal year 2003, comprised primarily of contracts purchased
from IITRI. For the acquisitions described in Note 10, as of June 30, 2004, the
Company recorded intangible assets of approximately $1.5 million for purchased
contracts. For the acquisitions described in Note 10, the Companys allocation
of purchase price is preliminary and subject to adjustment. The intangible
assets have an estimated useful life of one to three years and are being
amortized using the straight-line method. Amortization expense was
approximately $7.9 million during the nine months ended
June 30, 2004. Amortization expense is estimated to be
approximately $10.7 million, $2.4 million, and
$0.2 million for fiscal years ending September 30, 2005,
2006, and 2007, respectively. 6. Redeemable Common Stock Warrants In connection with the issuance of the Mezzanine Note, Subordinated Note,
and the Deferred Compensation Agreement described in Note 8, the Company issued
524,229, 1,080,437, and 22,062, respectively, detachable redeemable common
stock warrants (the Warrants) to the holders of those instruments. The Warrants
have an exercise price of $10 per share and are exercisable until December 20,
2008 for the warrants associated with the Mezzanine Note and the Deferred
Compensation Agreement and until December 20, 2010 for the warrants associated
with the Subordinated Note. In addition, the Warrants enable the holders to
sell the warrants back to the Company, at predetermined times, at the then
current fair value of the common stock less the exercise price. Accordingly,
the warrants are classified as debt instruments in accordance with Emerging
Issues Task Force Issue No. 00-19, Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Companys Own Stock. The
estimated fair value of the Warrants of approximately $10.3 million on the date
of issuance was recorded as a discount to the face value of the notes issued
and as a liability in the accompanying consolidated balance sheet. The
estimated fair value of the Warrants was approximately $16.8 million as of June
30, 2004. Changes in the estimated fair value of the Warrants are recorded as
interest expense in the accompanying consolidated statements of operations. 7. Shareholders Equity, Subject to Redemption The Companys outstanding common stock is owned by the Alion Science and
Technology Corporation Employee Ownership, Savings and Investment Trust (the
Trust). The Company provides a put option to any participant or beneficiary
which permits the participant or beneficiary to sell such common stock to the
Company during certain periods, at the then current market value per share,
which was $16.56 per share as of June 30, 2004. Accordingly, all of the
Companys equity is classified as subject to redemption in the accompanying
consolidated balance sheets. The per share market value is determined based
upon a valuation performed by an independent, third-party firm. The Company may
allow the Trust to purchase shares of common stock tendered to the Company
under the put option. Certain participants have the right to sell to the Company their shares
distributed from participant accounts that were acquired on the closing date of
the Transaction at a value per share equal to the greater of the original
purchase price and the then current market value of the common stock. 8. Long-term Debt To
fund the Transaction described in Note 1, the Company entered
into various debt agreements as described below. As described in
Note 14, on August 2, 2004, the Company entered into a new
Senior Credit Facility. The impact of the new facility on the
repayment obligations of the original debt agreements is described in
Note 14. Senior Credit Agreement On December 20, 2002, the Company executed a Senior Credit Agreement among
LaSalle Bank National Association, US Bank, National Cooperative Bank, Orix
Financial Services, Inc. and BB&T Bank to refinance and replace IITRIs prior
credit arrangements and to finance, in part, the Transaction. The Senior Credit
Agreement consists of a $35.0 million Senior Term Note and a $25.0 million
revolving credit facility. All principal obligations under the Senior Credit
Agreement are to be repaid in full no later than December 20, 2007. The Senior
Credit Agreement is secured by a first priority, perfected security interest
in all of the Companys current and future tangible and intangible
property. On December 20, 2002, the 10




---



##### 



Company paid $1.7 million to obtain this
facility which was recorded as debt discount. The Company is using the
effective interest method to accrete the value of long-term debt to its face
value. For the nine months ended June 30, 2004, the Company recognized
approximately $0.3 million of interest expense related to accretion of this
discount. The revolving credit facility bears interest at the LaSalle Bank prime
rate plus 200 basis points, which equaled 6.0% as of June 30, 2004. As of June
30, 2004, the Company had approximately $23.8 million borrowed under the
revolving credit facility. As
of June 30, 2004 and prior to the impact of the new credit
facility described in Note 14, the remaining principal repayments (adjusted for
prepayments made through such date) of $24.4 million under the Senior Term Note
are payable in quarterly installments, yielding remaining fiscal year
repayments in the following amounts: Fiscal Year Ending September 30,
    
    (In thousands)2004
    
    $
    2,5002005
    
    $
    6,8752006
    
    $
    8,2502007
    
    $
    6,808
 For the periods until the receipt of the compliance certificate and
audited financial statements for the fiscal year ended September 30, 2003, the
Companys borrowings under the Senior Credit Agreement were to bear interest at
either of two floating rates: a per year rate equal to the Eurodollar rate plus
350 basis points, or LaSalles prime rate (base rate) plus 200 basis points. Effective February 14, 2003, the Company exercised its right and elected
that the Senior Term Note bear interest at a Eurodollar rate. This election did
not affect the interest rate applicable to amounts borrowed under the revolving
line of credit. Interest under the Senior Term Note was payable at LaSalles
prime rate (base rate) plus 200 basis points until February 14, 2003.
Thereafter, the Senior Term Note bore interest at the Eurodollar rate plus 350
basis points. The Company entered into an interest rate cap agreement effective as of
February 3, 2003 with one of its senior lenders. Under this agreement, the
Companys maximum effective rate of interest payable on the first $25 million
of principal under its term note is not to exceed 6%. Any interest the Company
pays on the first $25 million of principal in excess of 6% will be reimbursed
to the Company semiannually by the senior lender pursuant to the cap agreement.
This cap agreement expires February 3, 2007. As of June 30, 2004, the cap
agreement had a fair value of approximately $0.047 million. 11




---



##### 



Mezzanine Note On December 20, 2002, the Company issued to IITRI a Mezzanine Note
securities purchase agreement (Mezzanine Note) with a face value of
approximately $20.3 million. The Mezzanine Note served as part of the
consideration for the Transaction. The Company is required to pay interest on
the Mezzanine Note at a rate of 12% per year, based on a 360-day year of twelve
30-day months. Interest is payable quarterly in cash. The Company is required
to pay the outstanding principal amount of the Mezzanine Note in a lump sum on
December 20, 2008. The Mezzanine Note is subordinate to the senior credit
facility, but ranks senior to the subordinated note. Under the terms of the Senior Credit Agreement and Mezzanine Note, the
Company is subject to covenants including financial covenants with respect to
minimum fixed charge coverage, maximum total senior leverage, maximum total
leverage, maximum capital expenditures, minimum EBITDAE, as defined, and other
customary covenants. As of June 30, 2004, the Company was in compliance with
these financial covenants. Subordinated Note Also, on December 20, 2002, the Company issued a seller note to IITRI
under a seller note securities purchase agreement (Subordinated Note) with a
face value of $39.9 million. The Subordinated Note served as part of the
consideration for the Transaction. The Subordinated Note bears interest at a
rate of 6% per year through December 2008 payable quarterly by the issuance of
non-interest bearing notes (paid-in-kind notes or PIK notes) maturing at the
same time as the Subordinated Note. The issuance of the PIK notes will have the
effect of deferring the underlying cash interest expense on the Subordinated
Note, but because the PIK notes will not themselves bear interest, they will
not have the effect of compounding any interest on these interest payment
obligations. Commencing December 2008, the Subordinated Note will bear interest
at 16% per year payable quarterly in cash through the time of repayment in full
of the Subordinated Note. Principal on the Subordinated Note will be payable in
equal installments of $19.95 million in December 2009 and December 2010; the
PIK notes are also due in equal installments of $7.2 million on these same
dates. Other Notes and Agreements On December 20, 2002, the Company entered into a deferred compensation
agreement with Dr. Bahman Atefi, its President, CEO and Chairman, as a
condition to completing the Transaction. Under the deferred compensation
agreement, Dr. Atefi is entitled to a payment of approximately $857,000 on
December 20, 2008, plus 12% cash interest per year. On March 28, 2003, an officer of the Company purchased a portion of the
Companys Mezzanine Note owned by IITRI for $750,000, its face value, along
with warrants to purchase 19,327 shares of Alions common stock at an exercise
price of $10.00 per share. On November 12, 2003, the Company purchased the
portion of the Mezzanine Note and warrants from the officer for an aggregate
purchase price of $1,034,020, the estimated fair value of the note
and warrants on that date. On February 11, 2004, the Company borrowed $750,000 from an officer of the
Company. In exchange, on June 7, 2004, the Company issued a promissory note in
the principal amount of $750,000 to the officer. The promissory note bears
interest at a rate of 15% per year, payable quarterly. The annual interest
period was effective beginning February 11, 2004. The Company is required to
pay the outstanding principal amount of the promissory note in a lump sum on
March 31, 2009. The promissory note is subordinate to the Senior Credit
Agreement and the Mezzanine Note. 12




---



##### 



In summary, for the aforementioned debt agreements, as of June 30, 2004
the remaining fiscal year repayments (at face amount before debt discount) are
as follows: Principal Payments (in thousands)2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    2010
    
    2011
    
    TotalSenior Term Note
    
    $
    2,500
    
    
    $
    6,875
    
    
    $
    8,250
    
    
    $
    6,808
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    24,433Mezzanine Note,
Promissory Note,
and Agreement with
Officer
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    21,200
    
    
    
    
    
    
    
    
    
    
    $
    21,200Subordinated Note
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    19,950
    
    
    $
    19,950
    
    
    $
    39,900Subordinated Paid
in Kind Note
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    7,182
    
    
    $
    7,182
    
    
    $
    14,364Total Principal
Payments
    
    $
    2,500
    
    
    $
    6,875
    
    
    $
    8,250
    
    
    $
    6,808
    
    
    $
    
    
    
    $
    21,200
    
    
    $
    27,132
    
    
    $
    27,132
    
    
    $
    99,897
 9. Segment Information and Customer Concentration The Company operates in one segment, delivering a broad array of
scientific and engineering expertise to research and develop technological
solutions for problems relating to national defense, public health and safety,
and nuclear safety and analysis under contracts with the U.S. Government, state
and local governments, and commercial customers. The Companys federal
government customers typically exercise independent contracting authority, and
even offices or divisions within an agency or department may directly, or
through a prime contractor, use the Companys services as a separate customer
so long as that customer has independent decision-making and contracting
authority within its organization. For the nine months ended June 30, 2004, revenues from services provided
to various agencies of the U.S. Government represented $188.7 million or
approximately 98% of revenues, and $158.5 million or approximately 98% of
revenues for the forty-week period ended July 4, 2003. Contract
receivables from agencies of the U.S. Government represented approximately $64.3 million, or 95%
of accounts receivable at June 30, 2004 and $38.0 million, or 92%, at July 4,
2003. During the nine months ended June 30, 2004, there were no sales by Alion
to any customers within a single country (except for the United States) where
the sales accounted for 10% or more of total revenue. The Company treats sales
to U.S. Government customers as sales within the United States regardless of
where the services are performed. Substantially all of the Companys assets
were located within the United States during the nine months ended June 30,
2004. 10. Acquisition of Innovative Technologies Solutions Corporation and Identix
Public Sector, Inc. On October 31, 2003, Alion acquired 100% of the outstanding shares of
Innovative Technologies Solutions Corporation (ITSC) for $4.0 million. The
transaction is subject to an earnout provision not-to-exceed $2.5 million. ITSC
is a New Mexico corporation with approximately 53 employees, the majority of
whom are located in New Mexico. ITSC provided nuclear safety and analysis
services to the U.S. Department of Energy (DOE) as well as to the commercial
nuclear power industry. While the allocation of purchase price is preliminary,
as of June 30, 2004, the Company has recorded approximately $3.6 million of
goodwill and approximately $0.1 million of intangible assets. On February 13, 2004, Alion acquired 100% of the outstanding stock of
Identix Public Sector, Inc. (IPS) for $8.0 million in cash.
At closing, the
Company reimbursed IPSs parent company $0.9 million for 13




---



##### 



intercompany payables. Subsequent payments totaling approximately $1.7
million for intercompany payables were made in the three successive months
following the closing. Per the agreement, a contingent payment of $0.5 million
was placed in escrow and may be due from the Company in the future. The payment
is contingent on the Company having the opportunity to compete or bid for
services on certain government solicitations. While the allocation of purchase
price is preliminary, as of June 30, 2004, the Company has recorded
approximately $5.7 million of goodwill and approximately $1.4 million of
intangible assets. Founded in 1980, IPS is based in Fairfax, Virginia and
provides program and acquisition management, integrated logistics support, and
foreign military support primarily to U.S. Navy customers. IPS, formerly
ANADAC, was a wholly-owned subsidiary of Identix Incorporated. The table below sets out the proforma effects of the IPS acquisition on
the Companys revenue, net income and earnings per share as though the IPS
acquisition had taken place on first day of each period presented. These
pro forma adjustments are in addition to the pro forma effects of the Alion
acquisition of the Selected Operations of IITRI included in the year-to-date
numbers below for the 2003 fiscal year. Three Months Ended June 30, 2004
    
    Sixteen Weeks Ended July 4, 2003Alion
    
    IPS
    
    Pro forma
    
    Alion
    
    IPS
    
    Pro formaPro forma revenue
    
    $
    69,808
    
    
    $
    
    
    
    $
    69,808
    
    
    $
    65,134
    
    
    $
    9,403
    
    
    $
    74,537Pro forma net income (loss)
    
    $
    (2,805
    )
    
    $
    
    
    
    $
    (2,805
    )
    
    $
    (2,693
    )
    
    $
    318
    
    
    $
    (2,375
    )Weighted average
shares outstanding
    
    
    3,224,704
    
    
    
    3,224,704
    
    
    
    3,224,704
    
    
    
    2,693,056
    
    
    
    2,693,056
    
    
    
    2,693,056Earnings per share
    
    $
    (0.87
    )
    
    $
    
    
    
    $
    (0.87
    )
    
    $
    (1.00
    )
    
    $
    0.12
    
    
    $
    (0.88
    )
 Nine Months Ended June 30, 2004
    
    Forty Weeks Ended July 4, 2003Alion
    
    IPS
    
    Pro forma
    
    Alion
    
    IPS
    
    Pro formaPro forma revenue
    
    $
    193,111
    
    
    $
    11,217
    
    
    $
    204,328
    
    
    $
    161,404
    
    
    $
    29,397
    
    
    $
    190,801Pro forma net income (loss)
    
    $
    (10,534
    )
    
    $
    (21
    )
    
    $
    (10,555
    )
    
    $
    (13,908
    )
    
    $
    65
    
    
    $
    (13,843
    )Weighted average
shares outstanding
    
    
    3,038,148
    
    
    
    3,038,148
    
    
    
    3,038,148
    
    
    
    2,622,527
    
    
    
    2,622,527
    
    
    
    2,622,527Earnings per share
    
    $
    (3.47
    )
    
    $
    (0.01
    )
    
    $
    (3.47
    )
    
    $
    (5.30
    )
    
    $
    0.02
    
    
    $
    (5.28
    )
 11. Commitments and Contingencies On September 16, 2002, IITRI filed a lawsuit against Clyde Andrews and
William Bewley, former shareholders of AB Technologies, Inc., in the U.S.
District Court for the Eastern District of Virginia. IITRI acquired
substantially all of the assets of AB Technologies in February 2000. Messrs.
Andrews and Bewley filed a lawsuit against IITRI for breach of the AB
Technologies asset purchase agreement claiming at least $8.2 million in
damages. The Andrews-Bewley lawsuit was removed to federal court and
consolidated into IITRIs lawsuit. The federal court stayed the litigation and
ordered both parties to submit the dispute to the independent accounting firm
of Grant Thornton for arbitration. On January 20, 2004, the arbitrator issued a decision awarding Messrs.
Andrews and Bewley a purchase price adjustment of approximately $0.7 million.
The arbitrators decision reclassified certain overhead expenses as general and
administrative expenses which were capped by the asset purchase agreement. That
decision increased earn out payments due Messrs. Andrews and Bewley by
approximately $3.5 million for the period from the acquisition date through
September 30, 2002. The Company was also required to recognize a liability of
approximately $0.3 million for potential payments to employees who worked in
the business units subject to this earn out from the acquisition date through
September 30, 2002. 14




---



##### 



Through June 30, 2004, the Company recognized approximately $4.9 million
in earn out obligations due Messrs. Andrews and Bewley for the fiscal year
ended September 30, 2003 and for the nine-month period ended June 30, 2004.
Additionally, the Company recognized approximately $0.4 million for potential
payments to employees who worked in the business units subject to this earn
out. As of June 30, 2004, the Company had paid approximately $4.2 million,
excluding interest, to Messrs. Andrews and Bewley for earn outs and purchase
price adjustments. The Company expects to pay Messrs. Andrews and Bewley
approximately $3.3 million, excluding interest, in the quarter ending September
30, 2004, for their earn out related to fiscal year ended September 30, 2003. 12. IITRI Acquisition and Pro Forma Information On December 20, 2002, Alion acquired substantially all of the assets and
certain of the liabilities of IITRI, excluding the assets and liabilities of
IITRIs Life Sciences Operation, for approximately $127.3 million as described
in Note 1. In connection with the acquisition, the Company formed the KSOP,
which has an ESOP component. The ESOP trustee, State Street Bank and Trust
Company, used the proceeds from the ESOP aggregating approximately $25.8
million to acquire approximately 2.58 million shares or 100% of the Companys
outstanding common stock. The Company used the funds from the sale of common
stock to the ESOP and proceeds from the debt instruments described in Note 8,
to fund the Transaction. The acquisition was accounted for using the purchase
method. The acquisition occurred on the last day of the Companys first interim
period in fiscal year 2003, and accordingly, the accompanying consolidated
statements of operations exclude the results of operations of the acquired
business prior to the acquisition. The purchase price has been allocated to the
acquired assets and assumed liabilities based on their estimated fair values at
the date of acquisition. Prior to the Transaction, the Companys activities had
been organizational in nature. The pro forma consolidated statement of operations for the forty-week
period ended July 4, 2003 has been prepared by giving effect to the following
transactions as if those transactions had been consummated on October 1, 2002:  
    
    The incurrence of debt with detachable warrants to purchase common

stock as described in Notes 6 and 8;
    
    The consummation of the Transaction, accounted for using the purchase method; and
    
    The purchase of common stock by the ESOP. For the forty-week period ended July 4, 2003, the pro forma consolidated
statement of operations includes pro forma adjustments to reverse historical
amortization expense related to pre-Transaction goodwill, to record the
amortization of identifiable intangible assets, to record interest expense on
debt issued to finance the Transaction, to record the amortization of debt
issuance costs, and to record the accretion of debt to face value to reflect
the discount for the estimated fair value of warrants issued. The pro forma information does not purport to be indicative of the results
of operations that would have actually been obtained if the transactions had
occurred on the dates indicated or the results of operations that will be
reported in the future. 13. Related Party Transaction On February 11, 2004, the Company borrowed $750,000 from an officer of the
Company and in exchange the Company issued a promissory note in the principal
amount of $750,000 with interest at a rate of 15% per annum, to be paid
quarterly, until March 31, 2009 when the principal amount becomes due. The
annual interest period was effective beginning February 11, 2004. 15




---



##### 



14. Subsequent Event On August 2, 2004, Alion entered into a new Senior Credit Facility
administered by Credit Suisse First Boston consisting of a Senior Secured Term
B Loan in the amount of $100.0 million. The new Senior Credit Facility also
provides for an uncommitted Incremental Term Loan accordion facility in the
amount of $50.0 million. Alion used the initial draw of the new Senior Secured
Term B Loan at the closing date to retire Alions outstanding senior term loan
and revolving credit facility in the approximate amount of $48.2 million
including principal and accrued and unpaid interest and to pay certain
transaction fees associated with the refinancing in the approximate amount of
$2.8 million. Alion intends to use part of the remainder of the Senior Secured
Term B Loan to retire the Companys existing Mezzanine Note in the approximate
principal amount of $19.6 million, pay accrued and unpaid interest and any
prepayment premium the Company may incur at the time under its Mezzanine Note
and pay related fees and expenses. Alion is permitted to use any remaining
portion of the Senior Secured Term B Loan to finance permitted acquisitions.
Alion intends to use that portion of the remaining Senior Secured Revolving
Credit Facility for the Companys working capital needs and other general
corporate purposes, including to finance permitted acquisitions. Alion is
permitted to use any proceeds it might receive in the future from the currently
uncommitted Incremental Term Loan Facility to finance permitted acquisitions
and to make certain put right payments required under the Companys Mezzanine
Warrant, if the put rights are exercised, and for any other purpose permitted
by Incremental Term Loans if and when they are funded. The following table reflects the Companys contractual debt
obligations as of June 30, 2004 and the impact of the
aforementioned Senior Credit Facility entered into on
August 2, 2004. As a result, approximately
$29.5 million of debt previously classified as current has
been reclassified as long-term in the accompanying Consolidated
Balance Sheet as of June 30, 2004. Principal Repayments (in thousands)2004



2005



2006



2007



2008



2009



2010



2011



TOTALSenior Secured Term B Loan



$




$
500



$
500



$
500



$
500



$
48,000



$




$




$
50,000Mezzanine Note



$




$




$




$




$
19,593



$




$




$




$
19,593Seller Subordinated Note


$




$




$




$




$




$






$
19,950



$
19,950



$
39,900Subordinated Paid in Kind Note


$




$




$




$




$




$




$
7,182



$
7,182



$
14,364Sub-total


$




$
500



$
500



$
500



$
20,093



$
48,000



$
27,132



$
27,132



$
123,857Note Payable to bank


$
23,850




$




$




$




$




$




$




$







$
23,850Senior Note Payable



$
23,396




$




$




$




$




$




$




$








$
23,396Proceeds
of Senior Secured Term B Loan



$
(47,246
)


$




$




$




$




$




$




$





$
(47,246
)Total principal payments


$




$
500



$
500



$
500



$
20,093



$
48,000



$
27,132



$
27,132




$
123,857 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS The following discussion of our financial condition and results of
operations should be read together with the consolidated financial statements
and the notes to those statements. This discussion contains forward-looking
statements that involve risks and uncertainties. These statements relate to our
future plans, objectives, expectations and intentions and are for illustrative
purposes only. These statements may be identified by the use of words such as
believe, expect, intend, plan, anticipate, likely, will, pro
forma, forecast, projections, and similar expressions. The factors that could cause actual results to differ materially from
those anticipated include, but are not limited to, the following: changes to
the ERISA laws related to the Companys Employee Ownership, Savings and
Investment Plan; changes to the tax laws relating to the treatment and
deductibility of goodwill, the Companys subchapter S status, or any change in
the Companys effective tax rate; additional costs associated with compliance
with the Sarbanes-Oxley Act of 2002, including any changes in the SECs rules,
and other corporate governance requirements; failure of government customers to
exercise options under contracts; funding decisions relating to U.S. Government
projects; government contract procurement (such as bid protest) and termination
risks; competitive factors such as pricing pressures and/or competition to hire
and retain employees; the results of current and/or future legal proceedings
and government agency proceedings which may arise out of our operations
(including our contracts with government agencies) and the attendant risks of
fines, liabilities, penalties, suspension and/or debarment; undertaking
acquisitions that could increase our costs or liabilities or be disruptive;
failure to adequately integrate acquired businesses; material changes in laws
or regulations applicable to the Companys businesses; as well as other risk
factors discussed in the Companys registration statement on Form S-1 filed
with the SEC on January 22, 2004. Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect managements view only as of August 13, 2004. The
Company undertakes no obligation to update any of the forward-looking
statements made herein, whether as a result of new information, future events,
changes in expectations or otherwise. This discussion addresses only our
continuing operations. 16




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##### 



Critical Accounting Estimates and Policies Our significant accounting policies are described in Note 3 to the
consolidated financial statements included in Post-Effective Amendment No. 4 to
the Companys registration statement on Form S-1 (No. 333-89756) filed with the
SEC on January 22, 2004. Critical accounting policies are defined as those that are reflective of
significant judgments and uncertainties, which potentially result in materially
different results under different assumptions and conditions. Application of
these policies is a critical element in the portrayal of our financial
condition and results of operations. The discussion and analysis of our
financial condition and results of operations are based on our consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these quarterly and interim period consolidated financial statements
requires management to make estimates and judgments that affect the reported
amount of assets, liabilities, revenues and expenses. Actual results may differ
from these estimates under different assumptions or conditions. Our critical accounting policies are set forth below: Revenue Recognition, Cost Estimation and Payment We recognize revenue when persuasive evidence of an arrangement exists,
services have been rendered, the contract price is fixed or determinable, and
collectibility is reasonably assured. We have a standard internal process that
we use to determine whether all required criteria for revenue recognition have
been met. This standard internal process includes a monthly review of contract
revenues and expenses by several levels of management. This review covers,
among other matters, progress against schedule, project staffing and levels of
effort, risks and issues, subcontract management, incurred and estimated costs,
and disposition of prior action items. This monthly internal review is designed
to determine whether the overall progress on a contract is consistent with the
effort expended and revenue recognized to date. Our revenues consist primarily of payments for the work of our employees,
and to a lesser extent, related costs for materials and subcontract efforts
under contracts with our customers. Cost of services consists primarily of
compensation expenses for program personnel, the fringe benefits associated
with this compensation, and other direct expenses incurred to complete
programs, including cost of materials and subcontract efforts. The Companys revenue results from contract research and other services
under a variety of contracts, some of which provide for reimbursement of cost
plus fees and others of which are fixed-price or time-and-material type
contracts. Absent evidence to the contrary, we recognize revenues as follows: Revenue on cost-reimbursement contracts is recognized as costs are
incurred and include an estimate of applicable fees earned. The percentage of completion method is used to recognize revenue on
fixed-price contracts based on various performance measures. From time to time,
facts develop that require the Company to revise its estimated total costs or
revenues expected. The cumulative effect of revised estimates is recorded in
the period in which the facts requiring revisions become known. The full amount
of anticipated losses on any type of contract are recognized in the period in
which they become known. Under time-and-material contracts, labor and related costs are reimbursed
at negotiated, fixed hourly rates. Revenue on time-and-material contracts is
recognized at contractually billable rates as labor hours and direct expenses
are incurred. 17




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##### 



Contracts with agencies of the federal government are subject to periodic
funding by the contracting agency concerned. Funding for a contract may be
provided in full at inception of the contract or ratably throughout the term of
the contract as the services are provided. If funding is not assessed as
probable, revenue recognition is deferred until realization is probable. Contract costs on federal government contracts, including indirect costs,
are subject to audit by the federal government and adjustment pursuant to
negotiations between the Company and government representatives. All of the
Companys federal government contract indirect costs have been audited and
agreed upon through fiscal year 2001. Contract revenues on federal government
contracts have been recorded in amounts that are expected to be realized upon
final settlement. The Company has submitted its fiscal year 2002 indirect cost
submission to its cognizant government audit agency; this submission is
undergoing the audit process at this time. The Company submitted its fiscal
year 2003 indirect cost submission on March 30, 2004. The Company recognizes revenue on unpriced change orders as expenses are
incurred only to the extent that the Company expects it is probable that such
costs will be recovered. The Company recognizes revenue in excess of costs on
unpriced change orders only when management can also reliably estimate the
amount of excess and experience provides a sufficient basis for recognition.
The Company recognizes revenue on claims as expenses are incurred only to the
extent that the Company expects it is probable that such costs will be
recovered and the amount of recovery can be reliably estimated. Contract revenue recognition inherently involves estimation. Examples of
estimates include the contemplated level of effort to accomplish the tasks
under contract, the cost of the effort, and the ongoing assessment of our
progress towards completing the contract. From time to time, as part of our
standard management processes, facts develop that require us to revise our
estimated total costs or revenues. In most cases, these revisions relate to
changes in the contractual scope of our work. To the extent that a revised
estimate affects contract profit or revenue previously recognized, we record
the cumulative effect of the revision in the period in which the facts
requiring the revision become known. Anticipated losses are recognized in the
accounting period in which they are first determined. For the nine months ended June 30, 2004, we derived approximately 60%, 25%
and 15% of our revenues from cost-plus, time-and-material and fixed-price
contracts, respectively. Our most significant expense is our cost of services, which consists
primarily of direct labor costs for program personnel and direct expenses
incurred to complete contracts, including cost of materials and subcontract
efforts. Our ability to accurately predict personnel requirements, salaries and
other costs, as well as to manage personnel levels and successfully redeploy
personnel, can have a significant impact on our cost of services. Overhead
costs consist primarily of indirect costs such as facility lease expenses,
indirect labor expenses, supplies and other office expenses in support of our
direct contract activities. General and administrative expenses consist
primarily of costs associated with our management, finance and administrative
groups; personnel training; sales and marketing expenses which include bid and
proposal efforts; and certain occupancy, travel and other corporate costs. The majority of our revenue is earned under contracts with various
departments and agencies, or prime contractors, of the federal government.
Certain revenues and payments we receive are based on provisional billings and
payments that are subject to adjustment under audit. Federal government
agencies and departments have the right to challenge our cost estimates and
allocations with respect to government contracts. Also, contracts with such
agencies are subject to audit and possible adjustment to account for
unallowable costs under cost-type contracts or other regulatory requirements
that affect both cost-type and fixed-price contracts. 18




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##### 



The following table sets forth, for each period indicated, the percentage
of our revenues derived from each of our major types of customers. Nine months
    
    Forty-Week PeriodEnded
    
    EndedJune 30, 2004
    
    July 4, 2003Department of Defense
    
    
    92.1
    %
    
    
    93.6
    %Federal Civilian Agencies
    
    
    5.7
    %
    
    
    4.6
    %Commercial / State / Local
    
    
    2.2
    %
    
    
    1.8
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
 Goodwill and Identifiable Intangible Assets The Company accounts for goodwill and other intangible assets in
accordance with the provisions of SFAS No. 142, which requires, among other
things, the discontinuance of goodwill amortization. In accordance with the
provisions of SFAS No. 142, the Company no longer amortizes goodwill, however
goodwill is to be reviewed at least annually for impairment. The Company has
elected to perform the annual review at the end of each fiscal year. In
addition, the Company will assess the impairment of goodwill and identifiable
intangible assets whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors considered important to possibly
trigger an impairment review consist of:  
    
    Significant underperformance relative to expected historical or
projected future operating results;
    
    Significant changes in the manner of use of the acquired assets or
the strategy for the overall business;
    
    Significant negative industry or economic trends; and
    
    Significant decline in Alions stock price for a sustained period. When it is determined that the carrying value of intangibles and goodwill
may not be recoverable based upon the existence of one or more of the above
indicators of impairment, management measures any impairment based upon a
projected discounted cash flow method or other measure of fair value including
independent valuation. As of June 30, 2004, the Company has goodwill of approximately $81.7
million, which will be subject to the aforementioned annual impairment review.
As of June 30, 2004, the Company has recorded approximately $32.1 million of
intangible assets comprised primarily of the value assigned to purchased
contracts. The intangible assets have an estimated useful life of one to three
years and are amortized using the straight-line method. As of June 30, 2004,
the value of the intangible assets is $16.3 million. Comparisons of Results of Operations The Companys fiscal year ends on September 30. Beginning with the fiscal
year ending September 30, 2004, the Company began operating based on a
three-month quarter, four-quarter fiscal year whereas for the fiscal year ended
September 30, 2003 the Company operated on a thirteen-period fiscal year that
consisted of three, four-week periods in its first interim period; three,
four-week periods in its second interim period; four, four-week periods in its
third interim period; and the balance of the fiscal year of approximately
three, four-week periods in its fourth interim period. For the three months
ended June 30, 2004, there were 64 available work days (based on a standard
work week of Monday through Friday and excluding designated holidays recognized
by Alion) as compared to 78 available workdays for the sixteen-week period
ended July 4, 2003. On a fiscal year-to-date basis, through the nine months
ended June 30, 2004 there were 192 available workdays as compared to 194
available workdays for the forty-week period 19




---



##### 



ended July 4, 2003. Accordingly, comparisons between the nine months and
quarter ended June 30, 2004 and the forty and sixteen-week periods ended July
4, 2003 will need to take into account the differing lengths of time. As described in the notes to the accompanying consolidated financial
statements, Alion completed the acquisition of substantially all of the assets
and certain of the liabilities of IIT Research Institute on December 20, 2002,
the last day of the Companys first interim period for the fiscal year ended
September 30, 2003. The following discussion and analysis of results of
operations relates to the results of operations for the three and nine months
ended June 30, 2004 and for the sixteen-week and pro forma forty-week periods
ended July 4, 2003, as if the IITRI acquisition had been consummated on the
first day of the interim period, October 1, 2002. Results of Operations Three Months Ended June 30, 2004 Compared to Sixteen-Week Period Ended July 4,
2003 For purposes of comparability, the table below reflects the approximate
impact of the following events and circumstances as they relate to the
financial performance of Alion for the three months ended June 30, 2004
compared to the sixteen-week period ended July 4, 2003. The discussion of the
results of operations will include references to the selected financial
information shown in the table below in conjunction with the consolidated
financial statements of Alion provided elsewhere in this document. The
selected financial information provided in the table is based on estimates from
Alion management.  
    
    For the three months ended June 30, 2004 there were 64
available workdays (based on a standard five-day work week of Monday
through Friday and excluding designated holidays recognized by
Alion) as compared to 78 for the sixteen-week period ended July 4,
2003.
    
    Alion completed the acquisition of Integrated Technology
Solutions Corporation (ITSC) on October 31, 2003. ITSC is a New
Mexico corporation that had approximately 53 employees, the majority
of whom were located in New Mexico. ITSC provided nuclear safety and
analysis services to the U.S. Department of Energy (DOE) as well as
to the commercial nuclear power industry.
    
    Alion completed the acquisition of Identix Public Sector,
Inc. (IPS) on February 13, 2004. IPS is based in Fairfax, Virginia
and provides program and acquisition management, integrated
logistics support, and foreign military support primarily to U.S.
Navy customers. IPS was a wholly-owned subsidiary of Identix
Incorporated. 20




---



##### 



Three Months Ended June 30, 2004
    
    Sixteen Week Period Ended July 4, 2003ConsolidatedAcquired
    
    Operations of
    
    
    
    
    
    
    
    
    
    ConsolidatedConsolidated
    
    
    
    
    
    
    
    
    
    Operations
    
    Alion less the
    
    Consolidated
    
    Fourteen
    
    Operations ofOperations of
    
    ITSC
    
    IPS
    
    (ITSC and
    
    Acquired
    
    Operations of
    
    Work Day
    
    Alion asAlion
    
    Operation*
    
    Operation*
    
    IPS)
    
    Operations
    
    Alion
    
    adjustment
    
    AdjustedTotal revenue
    
    $
    69,808
    
    
    $
    2,789
    
    
    $
    7,807
    
    
    $
    10,596
    
    
    $
    59,212
    
    
    $
    65,134
    
    
    $
    (11,843
    )
    
    $
    53,291Material and subcontract revenue
    
    
    17,781
    
    
    
    948
    
    
    
    4,929
    
    
    
    5,877
    
    
    
    11,904
    
    
    
    13,277
    
    
    
    (2,414
    )
    
    
    10,863Total direct contract expenses
    
    
    50,819
    
    
    
    2,170
    
    
    
    6,518
    
    
    
    8,688
    
    
    
    42,131
    
    
    
    47,459
    
    
    
    (8,629
    )
    
    
    38,830Major components of direct contract expenseDirect labor cost
    
    
    30,939
    
    
    
    1,187
    
    
    
    1,706
    
    
    
    2,893
    
    
    
    28,047
    
    
    
    31,730
    
    
    
    (5,769
    )
    
    
    25,961Other direct cost (ODC)
    
    
    2,616
    
    
    
    63
    
    
    
    27
    
    
    
    90
    
    
    
    2,527
    
    
    
    2,839
    
    
    
    (516
    )
    
    
    2,323Material and subcontract (M&S) cost

    
    
    17,264
    
    
    
    920
    
    
    
    4,786
    
    
    
    5,706
    
    
    
    11,558
    
    
    
    12,890
    
    
    
    (2,344
    )
    
    
    10,546Gross profit
    
    
    18,989
    
    
    
    619
    
    
    
    1,289
    
    
    
    1,908
    
    
    
    17,081
    
    
    
    17,675
    
    
    
    (3,214
    )
    
    
    14,461Total operating expense
    
    
    18,755
    
    
    
    698
    
    
    
    904
    
    
    
    1,602
    
    
    
    17,153
    
    
    
    17,496
    
    
    
    (3,181
    )
    
    
    14,315Major components of operating expenseIndirect personnel and facilities
    
    
    8,158
    
    
    
    408
    
    
    
    334
    
    
    
    742
    
    
    
    7,416
    
    
    
    6,129
    
    
    
    (1,114
    )
    
    
    5,015Non-recurring expense
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    174
    
    
    
    (32
    )
    
    
    142General and administrative
    
    
    6,834
    
    
    
    224
    
    
    
    455
    
    
    
    679
    
    
    
    6,155
    
    
    
    8,046
    
    
    
    (1,463
    )
    
    
    6,583Depreciation and amortization
    
    
    3,518
    
    
    
    66
    
    
    
    116
    
    
    
    182
    
    
    
    3,336
    
    
    
    3,797
    
    
    
    (690
    )
    
    
    3,107Income (loss) from operations
    
    
    234
    
    
    
    (79
    )
    
    
    385
    
    
    
    306
    
    
    
    (72
    )
    
    
    179
    
    
    
    (33
    )
    
    
    146Other income and expense
    
    
    (3,036
    )
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    (3,036
    )
    
    
    (2,872
    )
    
    
    522
    
    
    
    (2,350
    )Income tax benefit / (expense)
    
    
    (4
    )
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    (4
    )
    
    
    0
    
    
    
    0
    
    
    
    0Net income (loss) from operations
    
    
    (2,805
    )
    
    
    (79
    )
    
    
    385
    
    
    
    306
    
    
    
    (3,111
    )
    
    
    (2,693
    )
    
    
    490
    
    
    
    (2,203
    )
 *The operations of the acquired entities, ITSC and IPS, have been fully integrated within Alion on a consolidated basis. The financial information attributed to these entities are the estimates of management. Revenues.Revenues increased $4.7 million, or 7.2%, to $69.8 million for
the three months ended June 30, 2004, from $65.1 million for the sixteen-week
period ended July 4, 2003. The fourteen day increase in the number of
available work days for the sixteen-week period ended July 4, 2003 resulted in
approximately $11.8 million of the $65.1 million of revenue. On an adjusted
basis, the revenue for the sixteen-week period ended July 4, 2003 is
approximately $53.3 million. On this adjusted basis, revenue increased
approximately $16.5 million, or 31.0%, to $69.8 million for the three months
ended June 30, 2004, from $53.3 million (adjusted) for the sixteen-week period
ended July 4, 2003. The $16.5 million adjusted increase is attributable to the
following: 
    
    Revenue generated by the activities of the acquired operations
    $
    10.6 million
    
    Revenue generated by work performed under existing
contracts that were in existence during the prior year
    $

    5.9 millionTotal:
    $

    16.5 million
 For the three months ended June 30, 2004, our performance of additional
work under contracts that were in existence during the prior year includes an
increase in our services under the Modeling and Simulation Information Analysis
Center contract (MSIAC) to the Department of Defense of approximately $2.6
million, an increase in our decommissioning and demilitarization support
services to the U.S. Armys Newport Chemical Agent Disposal Facility (NECDF),
under a subcontract to Parsons Infrastructure and Technology Group, Inc. that
accounted for approximately $1.7 million of increased revenue, while our
support to the Department of Defense Joint Spectrum Center (JSC) accounted for
approximately $0.6 million of increased revenue. On the balance of our
contracts, revenue increased approximately $1.0 million for the three months
ended June 30, 2004 as compared to the sixteen-week period ended July 4, 2003. As a component of revenue, material and subcontract (M&S) revenue
increased approximately $4.5 million, or 33.8%, to $17.8 million for the three
months ended June 30, 2004 from $13.3 million for the sixteen-week period ended
July 4, 2003. The fourteen day increase in the number of available work days
for the sixteen-week period ended July 4, 2003 resulted in approximately $2.4
million of the $13.3 21




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##### 



million of M&S revenue. On an adjusted basis, the M&S
revenue for the sixteen-week period ended July 4, 2003 is approximately $10.9
million. On this adjusted basis, the M&S revenue increased approximately $6.9
million, or 63.3%, to $17.8 million for the three months ended June 30, 2004,
from $10.9 million (adjusted) for the sixteen-week period ended July 4, 2003.
The $6.9 million increase is attributable to the following: 
    
    M&S revenue generated by the activities of the acquired operations
    
    $5.9 million
    
    M&S revenue generated by work performed under existing
contracts that were in existence during the prior year
    
    $1.0 millionTotal:
    
    $6.9 million
 M&S revenues vary in both dollar amount and schedule, which are dependent
on the requirements of the contracts. Direct Contract Expenses.Direct contract expenses increased $3.3 million,
or 7.0%, to $50.8 million for the three months ended June 30, 2004, from $47.5
million for the sixteen-week period ended July 4, 2003. The fourteen day
increase in the number of available work days for the sixteen-week
period ended July 4, 2003 resulted in approximately $8.6 million of the
$47.5 million of direct contract expense. On an adjusted basis, the direct
contract expense for the sixteen-week period ended July 4, 2003 is
approximately $38.8 million. On this adjusted basis, direct contract expense
increased approximately $12.0 million, or 30.9%, to $50.8 million for the three
months ended June 30, 2004, from $38.8 million (adjusted) for the sixteen-week
period ended July 4, 2003. The $12.0 million adjusted increase is attributable
to the following: 
    
    Direct contract expense generated by the activities
of the acquired operations
    
    $8.7 million
    
    Direct contract expense generated by work performed under existing
contracts that were in existence during the prior year
    
    $3.3 millionTotal:
    
    $12.0 million
 As a component of direct contract expenses, direct labor costs for the
three months ended June 30, 2004 decreased by $0.8 million or 2.5% to
approximately $30.9 million for the three months ended June 30, 2004 from $31.7
million for the sixteen-week period ended July 4, 2003. The fourteen day
increase in the number of available work days for the sixteen-week period ended
July 4, 2003 resulted in approximately $5.8 million of the $31.7 million of
direct labor costs. On an adjusted basis, the direct labor cost for the
sixteen-week period ended July 4, 2003 is approximately $26.0 million. On this
adjusted basis, direct labor cost increased approximately $5.0 million, or
19.2%, to $30.9 million for the three months ended June 30, 2004, from $26.0
million (adjusted) for the sixteen-week period ended July 4, 2003. The $5.0
million adjusted increase is attributable to the following: 
    
    Direct labor cost generated by the activities of the acquired operations
    
    $2.9 million
    
    Direct labor cost generated by work performed under existing
contracts that were in existence during the prior year
    
    $2.1 millionTotal:
    
    $5.0 million
 As a component of direct contract expense, other direct costs (ODCs)
decreased by $0.2 million or 7.1% to approximately $2.6 million for the quarter
ended June 30, 2004 from approximately $2.8 million for the sixteen-week period
ended July 4, 2003. The fourteen day increase in the number of available work
days for the sixteen-week period ended July 4, 2003 resulted in approximately
$0.5 million of the $2.8 million of ODC costs. On an adjusted basis, the ODC
cost for the sixteen-week period ended July 4, 2003 is approximately $2.3
million. On this adjusted basis, ODCs increased approximately $0.3 million, or 22




---



##### 



13.0%, to $2.6 million for the three months ended June 30, 2004, from $2.3
million (adjusted) for the sixteen-week period ended July 4, 2003. The $0.3
million adjusted increase is attributable to the following: 
    
    ODCs generated by the activities of the acquired operations
    
    $0.1 million
    
    ODCs generated by work performed under existing
contracts that were in existence during the prior year
    
    $0.2 millionTotal:
    
    $0.3 million
 As a component of direct contract expense, material and subcontract (M&S)
cost increased approximately $4.4 million, or 34.1%, to $17.3 million for the
three months ended June 30, 2004, compared to $12.9 million for the
sixteen-week period ended July 4, 2003. The fourteen day increase in the number
of available work days for the sixteen-week period ended July 4, 2003 resulted
in approximately $2.3 million of the $12.9 million of M&S cost. On an adjusted
basis, the M&S cost for the sixteen-week period ended July 4, 2003 is
approximately $10.6 million. On this adjusted basis, M&S cost increased
approximately $6.8 million, or 64.7%, to $17.3 million for the three months
ended June 30, 2004, from $10.5 million (adjusted) for the sixteen-week period
ended July 4, 2003. The $6.8 million adjusted increase is attributable to the
following: 
    
    M&S cost generated by the activities of the acquired operations
    
    $5.7 million
    
    M&S cost generated by work performed under existing
contracts that were in existence during the prior year
    
    $1.1 millionTotal:
    
    $6.8 million
 On an adjusted basis, as a percentage of revenue, direct contract expenses
were 72.8% for the three months ended June 30, 2004 and for the sixteen-week
period ended July 4, 2003. Gross Profit.Gross profit increased $1.3 million, or 7.3%, to $19.0
million for the three months ended June 30, 2004, from $17.7 million for the
sixteen-week period ended July 4, 2003. The fourteen day increase in the number
of available work days for the sixteen-week period ended July 4, 2003 resulted
in approximately $3.2 million of the $17.7 million of gross profit. On an
adjusted basis, the gross profit for the sixteen-week period ended July 4, 2003
is approximately $14.5 million. On this adjusted basis, gross profit increased
approximately $4.5 million, or 31.0%, to $19.0 million for the three months
ended June 30, 2004, from $14.5 million (adjusted) for the sixteen-week period
ended July 4, 2003. The $4.5 million adjusted increase is attributable to the
following: 
    
    Gross profit generated by the activities of the acquired operations
    
    $1.9 million
    
    Gross profit generated by work performed under existing
contracts that were in existence during the prior year
    
    $2.6 millionTotal:
    
    $4.5 million
 On an adjusted basis, gross profit as a percentage of revenue increased to
27.2% for the three months ended June 30, 2004, from 27.1% (adjusted) for the
sixteen-week period ended July 4, 2003. Operating Expenses.Operating expenses increased $1.3 million, or 7.4% to
$18.8 million for the three months ended June 30, 2004, from $17.5 million for
the sixteen-week period ended July 4, 2003. The fourteen day increase in the
number of available work days for the sixteen-week period ended July 4, 2003
resulted in approximately $3.2 million of the $17.5 million of operating
expense. On an adjusted basis, the operating expense for the sixteen-week
period ended July 4, 2003 is approximately $14.3 million. On this adjusted
basis, operating expense increased approximately $4.5 million, or 31.4%, to
$18.8 million for the three months ended June 30, 2004, from $14.3 million
(adjusted) for the sixteen-week period ended July 4, 2003. The $4.5 million
adjusted increase is attributable to the following: 23




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##### 




    
    Operating expense incurred by the activities of the acquired
operations
    
    $1.6 million
    
    Operating expense incurred for the infrastructure needs in
support of revenue growth of existing operations
    
    $2.9 millionTotal:
    
    $4.5 million
 Operating expenses, net of depreciation and amortization and non-recurring
transaction-related expenses (e.g., third-party legal, accounting, finance,
etc., incurred in connection with the purchase of assets from IITRI) increased
approximately $1.7 million, or 12.6%, to $15.2 million for the three months
ended June 30, 2004, from $13.5 million for the sixteen-week period ended July
4, 2003. The fourteen day increase in the number of available work days for the
sixteen-week period ended July 4, 2003 resulted in approximately
$2.6 million
of the $13.5 million of net operating expense. On an adjusted basis, the net
operating expense for the sixteen-week period ended July 4, 2003 is
approximately $10.9 million. On this adjusted basis, operating expense
increased approximately $4.1 million, or 37.6%, to $15.2 million for the three
months ended June 30, 2004, from $10.9 million (adjusted) for the sixteen-week
period ended July 4, 2003. The $4.1 million adjusted increase is attributable
to the following: 
    
    Net operating expense incurred by the activities of the acquired
operations
    
    $1.6 million
    
    Net operating expense incurred for the infrastructure needs in
support of revenue growth of existing operations
    
    $2.5 millionTotal:
    
    $4.1 million
 As a major component of operating expenses, overhead expenses for indirect
personnel and facilities costs related to rental and occupancy expenses
increased approximately $2.0 million, or 32.8%, to $8.1 million for the three
months ended June 30, 2004, from $6.1 million for the sixteen-week period ended
July 4, 2003. The fourteen day increase in the number of available work days
for the sixteen-week period ended July 4, 2003 resulted in approximately $1.1
million of the $6.1 million of indirect personnel and facility expense. On an
adjusted basis, the indirect personnel and facility for the sixteen-week period
ended July 4, 2003 is approximately $5.0 million. On this adjusted basis,
indirect personnel and facility increased approximately $3.1 million, or 62.0%,
to $8.1 million for the three months ended June 30, 2004, from $5.0 million
(adjusted) for the sixteen-week period ended July 4, 2003. The $3.1 million
adjusted increase is attributable to the following: 
    
    Indirect personnel and facility expense incurred by the activities of the
acquired operations
    
    $0.7 million
    
    Indirect personnel and facility expense incurred to support the growth
of existing operations
    
    $2.4 millionTotal:
    
    $3.1 million
 As a second major component of our operating expenses, general and
administrative (G&A) expense decreased approximately $1.2 million, or 15.0%, to
$6.8 million for the three months ended June 30, 2004, compared to $8.0 million
for the sixteen-week period ended July 4, 2003. The fourteen day increase in
the number of available work days for the sixteen-week period ended July 4,
2003 resulted in approximately $1.4 million of the $8.0 million of G&A expense.
On an adjusted basis, G&A expense for the sixteen-week period ended July 4,
2003 is approximately $6.6 million. On this adjusted basis, G&A expense
increased approximately $0.2 million, or 3.0%, to $6.8 million for the three
months ended June 30, 2004, from $6.6 million (adjusted) for the sixteen-week
period ended July 4, 2003. The $0.2 million adjusted increase is attributable
to the following: 24




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##### 




    
    G&A expense incurred by the activities of the acquired operations
    
    $0.7 million
    
    A decrease in G&A expense incurred in support of the existing
operations
    
    ($0.5) millionTotal:
    
    $0.2 million
 On an adjusted basis, as a percentage of revenues, general and
administrative expenses decreased to 9.8% for the three months ended June 30,
2004, compared to 12.4% for the sixteen-week period ended July 4, 2003. Bad debt expense increased $0.9 million to $0.2 million for the three
months ended June 30, 2004 as compared to a recovery of $0.7 million for the
sixteen-week period ended July 4, 2003. During the sixteen week period ended
July 4, 2003, approximately $0.5 million of the recovery was due to the favorable
resolution of a contractual dispute. For the three months ended June 30, 2004,
the $0.2 million in bad debt expense equates to approximately 0.3% of revenue. Depreciation and Amortization.Depreciation and amortization expense
decreased approximately $0.3 million, or 7.9%, to $3.5 million for the three
months ended June 30, 2004, as compared to $3.8 million for the sixteen-week
period ended July 4, 2003. The fourteen day increase in the number of available
work days for the sixteen-week period ended July 4, 2003 resulted in
approximately $0.7 million of the $3.8 million of depreciation and amortization
expense. On an adjusted basis, depreciation and amortization expense for the
sixteen-week period ended July 4, 2003 is approximately $3.1 million. On this
adjusted basis, depreciation and amortization expense increased approximately
$0.4 million, or 13.0%, to $3.5 million for the three months ended June 30,
2004, from $3.1 million (adjusted) for the sixteen-week period ended July 4,
2003. The $0.4 million adjusted increase is attributable to the following: 
    
    Depreciation and amortization
expense related to the
activities of the acquired operations
    
    $0.2 million
    
    Depreciation and amortization expense related to the
existing operations
    
    $0.2 millionTotal:
    
    $0.4 million
 On an unadjusted basis for the three-month and sixteen-week period,
approximately $2.7 million and $3.4 million, respectively, of total
depreciation and amortization expense of $3.5 million and $3.8 million,
respectively, was incurred associated with the intangible asset value assigned
to purchased customer contracts of IITRI. Also, for each respective three-month
or sixteen-week period, approximately $0.1 million of depreciation expense was
incurred associated with the fair market value assigned to the purchased assets
of IITRI. Income (Loss) from Operations.For the three months ended June 30, 2004,
income from operations was $0.2 million compared to a $0.2 million operating
income for the sixteen-week period ended July 4, 2003. The fourteen day increase in the number of available work days for the
sixteen-week period ended July 4, 2003 resulted in approximately $0.1 million
of the $0.2 million of income from operations. On an adjusted basis, income
from operations for the sixteen-week period ended July 4, 2003 is approximately
$0.1 million. On this adjusted basis, income from operations increased
approximately $0.1 million, to $0.2 million for the three months ended June 30,
2004, from $0.1 million (adjusted) for the sixteen-week period ended July 4,
2003. The $0.1 million adjusted increase is attributable to the following: 25




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##### 




    
    Operating income generated from the activities of the acquired
operations
    
    $0.3 million
    
    Operating (loss) generated from the existing operations
    
    ($0.2) millionTotal:
    
    $0.1 million
 Other Income and Expense.Other expenses increased approximately $0.1
million, or 3.4%, to $3.0 million for the three months ended June 30, 2004 as
compared to $2.9 million for the sixteen-week period ended July 4, 2003. The
fourteen day increase in the number of available work days for the sixteen-week
period ended July 4, 2003 resulted in approximately $0.5 million of the $2.9
million of other expense. On an adjusted basis, other expense for the
sixteen-week period ended July 4, 2003 is approximately $2.4 million. On this
adjusted basis, other expense increased approximately $0.6 million, to $3.0
million for the three months ended June 30, 2004, from $2.4 million (adjusted)
for the sixteen-week period ended July 4, 2003. The $0.6 million adjusted
increase is attributable to the following: 
    
    Interest expense on the balance drawn under the revolving credit
facility resulting from the cash paid for the ITSC and IPS
acquisitions and cash paid for earnout obligations under existing
agreements.
    
    $0.3 million
    
    Interest expense associated with the increase in warrant repurchase
liability related to the increase in share value of Alion stock.
    
    $0.1 million
    
    Interest expense associated with the increase in deferred compensation
expense related to Alions stock appreciation rights and phantom
stock plans.
    
    $0.2 millionTotal:
    
    $0.6 million
 Income Tax (Expense) Benefit.Although HFA became a qualified subchapter
S subsidiary as of December 20, 2002 and is no longer treated as a separate
entity for federal income tax purposes, some states do not recognize this tax
election. Some states do not recognize Alions S-corporation status. As a
result, the Company recorded approximately $0.004 million in state income tax
expense for quarter ended June 30, 2004. The Company recorded no income tax
expense for the sixteen-week period ended July 4, 2003. Net Loss.The net loss increased approximately $0.1 million, or 3.7%, to
$2.8 million for the three months ended June 30, 2004 as compared to $2.7
million for the sixteen-week period ended July 4, 2003. The fourteen day
increase in the number of available work days for the sixteen-week period ended
July 4, 2003 resulted in approximately $0.5 million of the $2.7 million loss.
On an adjusted basis, the loss for the sixteen-week period ended July 4, 2003
is approximately $2.2 million. On this adjusted basis, the loss increased
approximately $0.6 million, or 27.2%, to $2.8 million for the three months
ended June 30, 2004, from $2.2 million (adjusted) for the sixteen-week period
ended July 4, 2003. The $0.6 million adjusted increase is attributable to the
following: 
    
    Income generated by the activities of the acquired operations
    
    $0.3 million
    
    (Loss) generated by existing operations
    
    ($0.9) millionTotal:
    
    ($0.6) million
 The net loss was due to the factors discussed above. Nine months Ended June 30, 2004 Compared to the Pro Forma Forty-Week Period
Ended July 4, 2003 For purposes of comparability, the table below reflects the approximate
impact of the following events and circumstances as they relate to the
financial performance of Alion for the nine months ended 26




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##### 



June 30, 2004 compared to the pro forma forty-week period ended July 4,
2003. As discussed in Note 12, the pro forma information gives
effect to certain transactions, including the acquisition of the
Selected Operations of IITRI, as if such transactions had been
consummated on October 1, 2002. The discussion of the results of operations will include references to
the selected financial information shown in the table below in conjunction with
consolidated financial statements of Alion provided elsewhere in this document.
The selected financial information provided in the table are based on estimates
from Alion management.  
    
    For the nine months ended June 30, 2004 there were 192
available workdays (based on a standard five-day work week of Monday
through Friday and excluding designated holidays recognized by
Alion) as compared to 194 for the forty-week period ended July 4,
2003.
    
    Alion completed the acquisition of Integrated Technology
Solutions Corporation (ITSC) on October 31, 2003. ITSC is a New
Mexico corporation with approximately 53 employees, the majority of
whom are located in New Mexico. ITSC provides nuclear safety and
analysis services to the U.S. Department of Energy (DOE) as well as
to the commercial nuclear power industry.
    
    Alion completed the acquisition of Identix Public Sector,
Inc. (IPS) on February 13, 2004. IPS is based in Fairfax, Virginia
and provides program and acquisition management, integrated
logistics support, and foreign military support primarily to U.S.
Navy customers. IPS was a wholly-owned subsidiary of Identix
Incorporated. Nine Months Ended June 30, 2004
    
    Pro Forma Forty Week-Period Ended July 4, 2003ConsolidatedAcquired
    
    Operations of
    
    
    
    
    
    
    
    
    
    ConsolidatedConsolidated
    
    
    
    
    
    
    
    
    
    Operations
    
    Alion less the
    
    Consolidated
    
    Two Work
    
    Operations ofOperations of
    
    ITSC
    
    IPS
    
    (ITSC
    
    Acquired
    
    Operations of
    
    Day
    
    Alion asAlion
    
    Operation*
    
    Operation*
    
    and IPS)
    
    Operations
    
    Alion
    
    adjustment
    
    AdjustedTotal revenue
    
    $
    193,111
    
    
    $
    6,945
    
    
    $
    10,772
    
    
    $
    17,717
    
    
    $
    175,394
    
    
    $
    161,404
    
    
    $
    (1,690
    )
    
    $
    159,714Material and subcontract revenue
    
    
    45,475
    
    
    
    2,234
    
    
    
    6,442
    
    
    
    8,676
    
    
    
    36,799
    
    
    
    34,044
    
    
    
    (356
    )
    
    
    33,688Total direct contract expenses
    
    
    139,310
    
    
    
    5,384
    
    
    
    8,867
    
    
    
    14,251
    
    
    
    125,059
    
    
    
    118,145
    
    
    
    (1,237
    )
    
    
    116,908Major components of direct contract expenseDirect labor cost
    
    
    88,129
    
    
    
    3,057
    
    
    
    2,584
    
    
    
    5,641
    
    
    
    82,488
    
    
    
    79,387
    
    
    
    (831
    )
    
    
    78,556Other direct cost (ODC)
    
    
    7,029
    
    
    
    157
    
    
    
    29
    
    
    
    187
    
    
    
    6,843
    
    
    
    5,705
    
    
    
    (60
    )
    
    
    5,646Material and subcontract (M&S) cost
    
    
    44,151
    
    
    
    2,169
    
    
    
    6,254
    
    
    
    8,423
    
    
    
    35,728
    
    
    
    33,053
    
    
    
    (346
    )
    
    
    32,707Gross profit
    
    
    53,801
    
    
    
    1,561
    
    
    
    1,905
    
    
    
    3,466
    
    
    
    50,335
    
    
    
    43,259
    
    
    
    (453
    )
    
    
    42,806Total operating expense
    
    
    53,365
    
    
    
    1,801
    
    
    
    1,224
    
    
    
    3,025
    
    
    
    50,340
    
    
    
    49,820
    
    
    
    (522
    )
    
    
    49,298Major components of operating expenseIndirect personnel and facilities
    
    
    21,820
    
    
    
    1,184
    
    
    
    458
    
    
    
    1,642
    
    
    
    20,178
    
    
    
    15,839
    
    
    
    (166
    )
    
    
    15,673Non-recurring expense
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    6,562
    
    
    
    (69
    )
    
    
    6,493General and administrative
    
    
    21,099
    
    
    
    551
    
    
    
    650
    
    
    
    1,201
    
    
    
    19,898
    
    
    
    18,240
    
    
    
    (191
    )
    
    
    18,049Depreciation and amortization
    
    
    9,889
    
    
    
    66
    
    
    
    116
    
    
    
    182
    
    
    
    9,707
    
    
    
    9,499
    
    
    
    (99
    )
    
    
    9,400Income (loss) from operations
    
    
    436
    
    
    

    (240
    )
    
    
    681
    
    
    
    441
    
    
    
    (5
    )
    
    
    (6,561
    )
    
    
    69
    
    
    
    (6,492
    )Other income and expense
    
    
    (10,966
    )
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    (10,966
    )
    
    
    (7,320
    )
    
    
    77
    
    
    
    (7,243
    )Income tax benefit / (expense)
    
    
    (4
    )
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    (4
    )
    
    
    (27
    )
    
    
    0
    
    
    
    (27
    )Net income (loss) from operations
    
    
    (10,534
    )
    
    
    (240
    )
    
    
    681
    
    
    
    442
    
    
    
    (10,976
    )
    
    
    (13,908
    )
    
    
    146
    
    
    
    (13,762
    )
  *
    
    The operations of the acquired entities, ITSC and IPS, have been fully integrated within Alion on a consolidated basis.
The selected financial information attributed to these entities are the estimates of management. Revenues.Revenues increased $31.7 million, or 19.6%, to $193.1 million
for the nine months ended June 30, 2004, from $161.4 million for the forty
weeks ended July 4, 2003. The two day increase in the number of available work
days for the forty-week period ended July 4, 2003 resulted in approximately
$1.7 million of the $161.4 million of revenue. On an adjusted basis, the
revenue for the forty-week period ended July 4, 2003 is approximately $159.7
million. On this adjusted basis, revenue increased approximately $33.4 million,
or 20.9%, to $193.1 million for the nine months ended June 30, 2004, from
$159.7 million (adjusted) for the forty-week period ended July 4, 2003. The
$33.4 million adjusted increase is attributable to the following: 27




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##### 




    
    Revenue generated by the activities of acquired operations
    
    $17.7 million
    
    Revenue generated by work performed under existing
contracts that were in existence during the prior year
    
    $15.7 millionTotal:
    
    $33.4 million
 For the nine months ended June 30, 2004, our performance of additional
work under contracts that were in existence during the prior year includes an
increase in our services under the Modeling and Simulation Information Analysis
Center contract (MSIAC) to the Department of Defense of approximately $8.9
million, an increase in our decommissioning and demilitarization support
services to the U.S. Armys Newport Chemical Agent Disposal Facility (NECDF),
under a subcontract to Parsons Infrastructure and Technology Group, Inc. that
accounted for approximately $3.9 million of increased revenue, while our
support to the Department of Defense Joint Spectrum Center (JSC) accounted for
approximately $2.6 million of increased revenue. On the balance of our
contracts, revenue increased approximately $0.3 million for the nine months
ended June 30, 2004 as compared to the forty-week period ended July 4, 2003. As a component of revenue, M&S revenue increased approximately $11.5
million, or 33.8%, to $45.5 million for the nine months ended June 30, 2004
from $34.0 million for the forty-week period ended July 4, 2003. The two day
increase in the number of available work days for the forty-week period ended
July 4, 2003 resulted in approximately $0.3 million of the $34.0 million of M&S
revenue. On an adjusted basis, the revenue for the forty-week period ended July
4, 2003 is approximately $33.7 million. On this adjusted basis, the M&S revenue
increased approximately $11.8 million, or 35.0%, to $45.5 million for the nine
months ended June 30, 2004, from $33.7 million (adjusted) for the forty-week
period ended July 4, 2003. The $11.8 million adjusted increase is attributable
to the following: 
    
    M&S revenue generated by the activities of the acquired operations
    
    $8.7 million
    
    M&S revenue generated by work performed under existing
contracts that were in existence during the prior year
    
    $3.1 millionTotal:
    
    $11.8 million
 M&S revenues vary in both dollar amount and schedule, which are dependent
on the requirements of the contracts. Direct Contract Expenses.Direct contract expenses increased $21.2
million, or 18.0%, to $139.3 million for the nine months ended June 30, 2004,
from $118.1 million for the forty week period ended July 4, 2003. The two day
increase in the number of available work days for the forty-week period ended
July 4, 2003 resulted in approximately $1.2 million of the $118.1 million of
direct contract expense. On an adjusted basis, the direct contract expense for
the forty-week period ended July 4, 2003 is approximately $116.9 million. On
this adjusted basis, direct contract expense increased approximately $22.4
million, or 19.2%, to $139.3 million for the nine months ended June 30, 2004,
from $116.9 million (adjusted) for the forty-week period ended July 4, 2003.
The $22.4 million adjusted increase is attributable to the following: 
    
    Direct contract expense generated by the activities of the
acquired operations
    
    $14.3 million
    
    Direct contract expense generated by work performed under existing
contracts that were in existence during the prior year
    
    $8.1 millionTotal:
    
    $22.4 million
 28




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As a component of direct contract expenses, direct labor costs for the
nine months ended June 30, 2004 increased by $8.7 million, or 11.0%, to $88.1
million from $79.4 million for the forty-week period ended July 4, 2003. The
two day increase in the number of available work days for the forty-week period
ended July 4, 2003 resulted in approximately $0.8 million of the $79.4 million
of direct labor costs. On an adjusted basis, the direct labor cost for the
forty-week period ended July 4, 2003 is approximately $78.6 million. On this
adjusted basis, direct labor cost increased approximately $9.5 million, or
12.1%, to $88.1 million for the nine months ended June 30, 2004, from $78.6
million (adjusted) for the forty-week period ended July 4, 2003. The $9.5
million adjusted increase is attributable to the following: 
    
    Direct labor cost generated by the activities of the acquired operations
    
    $5.7 million
    
    Direct labor cost generated by work performed under existing
contracts that were in existence during the prior year
    
    $3.8 millionTotal:
    
    $9.5 million
 As a component of direct contract expense, other direct costs (ODC)
increased by $1.3 million, or 22.8%, to $7.0 million for the nine months ended
June 30, 2004 when compared to $5.7 million for the forty week period ended
July 4, 2003. The two day increase in the number of available work days for the
forty-week period ended July 4, 2003 resulted in approximately $0.1 million of
the $5.7 million of ODC costs. On an adjusted basis, the ODC cost for the
forty-week period ended July 4, 2003 is approximately $5.6 million. On this
adjusted basis, ODCs increased approximately $1.4 million, or 25.0%, to $7.0
million for the nine months ended June 30, 2004, from $5.6 million (adjusted)
for the forty-week period ended July 4, 2003. The $1.4 million adjusted
increase is attributable to the following: 
    
    ODCs generated by the activities of the acquired operations
    
    $0.2 million
    
    ODCs generated by work performed under existing
contracts that were in existence during the prior year
    
    $1.2 millionTotal:
    
    $1.4 million
 As a component of direct contract expense, material and subcontract (M&S)
cost increased approximately $11.1 million, or 33.5%, to $44.2 million for the
nine months ended June 30, 2004, compared to $33.1 million for the forty-week
period ended July 4, 2003. The two day increase in the number of available work
days for the forty-week period ended July 4, 2003 resulted in approximately
$0.3 million of the $33.1 million of M&S cost. On an adjusted basis, the M&S
cost for the forty-week period ended July 4, 2003 is approximately $32.8
million. On this adjusted basis, M&S cost increased
approximately $11.5
million, or 35.2%, to $44.2 million for the nine months ended June 30, 2004,
from $32.7 million (adjusted) for the forty-week period ended July 4, 2003.
The $11.5 million adjusted increase is attributable to the following: 
    
    M&S cost generated by the activities of the acquired operations
    
    $8.4 million
    
    M&S cost generated by work performed under existing
contracts that were in existence during the prior year
    
    $3.1 millionTotal:
    
    $11.5 million
 On an adjusted basis, as a percentage of revenue, direct contract expenses
decreased to 72.1% for the nine months ended June 30, 2004 from 73.2% for the
forty-week period ended July 4, 2003. Gross Profit.Gross profit increased $10.5 million, or 24.3%, to $53.8
million for the nine months ended June 30, 2004, from $43.3 million for the
forty-week period ended July 4, 2003. The two day increase in the number of
available work days for the forty-week period ended July 4, 2003 resulted in
approximately $0.5 million of the $43.3 million of gross profit. On an adjusted
basis, the gross profit for the forty-week period ended July 4, 2003 is

approximately $42.8 million. On this adjusted basis, gross 29




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##### 



profit increased approximately $11.0 million, or 25.7%, to $53.8 million
for the nine months ended June 30, 2004, from $42.8 million (adjusted) for the
forty-week period ended July 4, 2003. The $11.0 million adjusted increase is
attributable to the following: 
    
    Gross profit generated by the activities of the acquired operations
    
    $3.5 million
    
    Gross profit generated by work performed under existing
contracts that were in existence during the prior year
    
    $7.5 millionTotal:
    
    $11.0 million
 On an adjusted basis, gross profit as a percentage of revenue increased to
27.9% for the nine months ended June 30, 2004, from 26.8% (adjusted) for the
forty-week period ended July 4, 2003. Operating Expenses.Operating expenses increased $3.6 million, or 7.2% to
$53.4 million for the nine months ended June 30, 2004, from $49.8 million for
the forty week period ended July 4, 2003. However, for the forty-week period
ended July 4, 2003, there was approximately $6.6 million in non-recurring,
transaction-related expense. There were no such costs incurred for the nine
months ended June 30, 2004. As such, the adjusted increase in operating expense
was approximately $10.2 million ($3.6 million plus $6.6 million). Furthermore,
the two day increase in the number of available work days for the forty-week
period ended July 4, 2003 resulted in approximately $0.5 million of the $49.8
million of operating expense. On an adjusted basis, the operating expense for
the forty-week period ended July 4, 2003 is approximately $42.7 million. On
this adjusted basis, operating expense increased approximately $10.7 million,
or 25.1%, to $53.4 million for the nine months ended June 30, 2004, from $42.7
million for the forty-week period ended July 4, 2003. The $10.7 million
adjusted increase is attributable to the following: 
    
    Operating expense incurred by the activities of the acquired operations
    
    $3.0 million
    
    Operating expense incurred for the infrastructure needs in
support of revenue growth of existing operations
    
    $7.7 millionTotal:
    
    $10.7 million
 Operating expenses, net of depreciation, amortization, and non-recurring
transaction-related expense increased approximately $9.7 million, or 28.7%, to
$43.5 million for the nine months ended June 30, 2004, from $33.8 million for
the forty week period ended July 4, 2003. The two day increase in the number of
available work days for the forty-week period ended July 4, 2003 resulted in
approximately $0.4 million of the $33.8 million of net operating expense. On an
adjusted basis, the net operating expense for the forty-week period ended July
4, 2003 is approximately $33.4 million. On this adjusted basis, operating
expense increased approximately $10.1 million, or 30.2%, to $43.5 million for
the nine months ended June 30, 2004, from $33.4 million (adjusted) for the
forty-week period ended July 4, 2003. The $10.1 million adjusted increase is
attributable to the following: 
    
    Net operating expense incurred by the activities of the acquired
operations
    
    $2.8 million
    
    Net operating expense incurred for the infrastructure needs in
support of revenue growth of existing operations
    
    $7.3 millionTotal:
    
    $10.1 million
 As a major component of our operating expenses, overhead expenses for
indirect personnel and facilities costs related to rental and occupancy
expenses increased approximately $6.0 million, or 38.0%, to $21.8 million for
the nine months ended June 30, 2004, from $15.8 million for the forty-week
period ended July 4, 2003. The two day increase in the number of available work
days for the forty-week period ended July 4, 2003 resulted in approximately
$0.2 million of the $15.8 million of indirect personnel and facility expense.
On an adjusted basis, the indirect personnel and facility for the forty-week
period ended July 4, 30




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##### 



2003 is approximately $15.6 million. On this adjusted basis, indirect
personnel and facility increased approximately $6.2 million, or 39.7%, to $21.8
million for the nine months ended June 30, 2004, from $15.6 million (adjusted)
for the forty-week period ended July 4, 2003. The $6.2 million adjusted
increase is attributable to the following: 
    
    Indirect personnel and facility expense incurred by the activities of the
acquired operations
    
    $1.6 million
    
    Indirect personnel and facility expense incurred to support the
growth of existing operations
    
    $4.6 millionTotal:
    
    $6.2 million
 As a second major component of our operating expenses, general and
administrative (G&A) expense increased approximately $2.9 million, or 15.9%, to
$21.1 million for the nine months ended June 30, 2004, compared to $18.2
million for the forty week period ended July 4, 2003. The two day increase in
the number of available work days for the forty-week period ended July 4, 2003
resulted in approximately $0.2 million of the $18.2 million of G&A expense. On
an adjusted basis, G&A expense for the forty-week period ended July 4, 2003 is
approximately $18.0 million. On this adjusted basis, G&A expense increased
approximately $3.1 million, or 17.2%, to $21.1 million for the nine months
ended June 30, 2004, from $18.0 million (adjusted) for the forty-week period
ended July 4, 2003. The $3.1 million adjusted increase is attributable to the
following: 
    
    G&A expense incurred by the activities of the acquired operations
    
    $1.2 million
    
    Legal expense incurred in support of the
AB Technologies arbitration proceedings
    
    $0.5 million
    
    Incremental audit-related expense
    
    $0.2 million
    
    G&A expense incurred to support the growth of the existing operations
    
    $1.2 millionTotal:
    
    $3.1 million
 On an adjusted basis, as a percentage of revenues, general and
administrative expenses decreased to 10.9% for the nine months ended June 30,
2004, compared to 11.3% for the forty-week period ended July 4, 2003. Bad debt expense increased $0.8 million to $0.3 million for the nine
months ended June 30, 2004 as compared to a credit of $0.7 million for the
forty-week period ended July 4, 2003. During the forty- week period ended July
4, 2003, approximately $0.5 million of the credit was due to the favorable
resolution of a contractual dispute. For the nine months ended June 30, 2004,
the $0.3 million in bad debt expense equates to approximately 0.2% of revenue. Depreciation and Amortization.Depreciation and amortization expense
increased approximately $0.4 million, or 4.2%, to $9.9 million for the nine
months ended June 30, 2004, as compared to $9.5 million for the forty week
period ended July 4, 2003. The two day increase in the number of available work
days for the forty-week period ended July 4, 2003 resulted in approximately
$0.1 million of the $9.5 million of depreciation and amortization expense. On
an adjusted basis, depreciation and amortization expense for the forty-week
period ended July 4, 2003 is approximately $9.4 million. On this adjusted
basis, depreciation and amortization expense increased approximately $0.5
million, or 5.3%, to $9.9 million for the nine months ended June 30, 2004, from
$9.4 million (adjusted) for the forty-week period ended July 4, 2003. The $0.5
million adjusted increase is attributable to the following: 31




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##### 




    
    Amortization expense associated with the value assigned to
the purchased contracts of acquired operations $0.2 million
    
    Depreciation and amortization expense associated with the capital
expenditures and intangible assets of the existing operations $0.3 millionTotal: $0.5 million
 For the nine-month and forty-week period, approximately $7.8 million and
$5.5 million, respectively, of total amortization expense was incurred
associated with the intangible asset value assigned to purchase customer
contracts of IITRI. Also, for each respective nine-month or forty week period,
approximately $0.4 million of depreciation expense was incurred associated with
the fair value assigned to the purchased fixed assets of IITRI. Income (Loss) from Operations.For the nine months ended June 30, 2004,
income from operations was $0.4 million compared with $6.6 million operating
loss for the forty-week period ended July 4, 2003. The two day increase in the
number of available work days for the forty-week period ended July 4, 2003
represented approximately $0.1 million of the $6.6 million of loss from
operations. On an adjusted basis, loss from operations for the forty-week
period ended July 4, 2003 is approximately $6.5 million. On this adjusted
basis, income from operations increased approximately $6.9 million, to income
of $0.4 million for the nine months ended June 30, 2004, from a loss of $6.5
million (adjusted) for the forty-week period ended July 4,
2003. The $6.9
million adjusted increase is attributable to the following: 
    
    Operating income generated from the activities of the acquired
operations
    
    $0.4 million
    
    Operating income generated from the existing operations
    
    $6.5 millionTotal:
    
    $6.9 million
 Other Income and Expense.Other expenses increased approximately $3.7
million, or 50.7%, to $11.0 million for the nine months ended June 30, 2004 as
compared to $7.3 million for the forty-week period ended July 4, 2003. The two
day increase in the number of available work days for the forty-week period
ended July 4, 2003 represented approximately $0.1 million of the $7.3
million of other expense. On an adjusted basis, other expense for the
forty-week period ended July 4, 2003 is approximately $7.2 million. On this
adjusted basis, other expense increased approximately $3.8 million, to $11.0
million for the nine months ended June 30, 2004, from $7.2 million (adjusted)
for the forty-week period ended July 4, 2003. The $3.8 million adjusted
increase is attributable to the following: 
    
    Interest expense on the balance drawn under the revolving
credit facility resulting from the cash paid for the ITSC and
IPS acquisitions and cash paid for earnout obligations
under existing agreements.
    
    $0.3 million
    
    Interest expense associated with the increase in warrant repurchase
liability related to the increase in share value of Alion stock.
    
    $0.9 million
    
    Interest expense associated with the increase in deferred compensation
expense related to Alions stock appreciation rights and phantom
stock plans.
    
    $1.1 million
    
    Interest expense associated with the accretion of the debt discount
on the Mezzanine Note and Subordinated Note.
    
    $1.4 million
    
    Various other expenses.
    
    $0.1 millionTotal:
    
    $3.8 million
 32




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##### 



Income Tax (Expense) Benefit.Although HFA became a qualified subchapter S
subsidiary as of December 20, 2002 and is no longer treated as a separate
entity for federal income tax purposes, some states do not recognize this tax
election. In addition, some states do not recognize Alions S-corporation status. As a
result, the Company recorded approximately $0.004 million in state income tax
expense for the nine months ended June 30, 2004. HFA was a
taxable entity from October 1 through December 20, 2002. As a result, the Company
recorded approximately $0.005 million for state income taxes and $0.022 million
for federal income taxes for the forty-week period ended July 4, 2003. Net Loss.The net loss decreased approximately $3.4 million, or 24.5%, to
$10.5 million for the nine months ended June 30, 2004 as compared to $13.9
million for the forty-week period ended July 4, 2003. The two day increase in
the number of available work days for the forty-week period ended July 4, 2003
resulted in approximately $0.1 million of the $13.9 million loss. On an
adjusted basis, the loss for the forty-week period ended July 4, 2003 is
approximately $13.8 million. On this adjusted basis, the loss decreased
approximately $3.3 million, or 23.9%, to $10.5 million for the nine months
ended June 30, 2004, from $13.8 million for the forty-week period ended July 4,
2003. The $3.3 million adjusted decrease is attributable to the following: 
    
    Income generated by the activities of the acquired operations
    
    $0.4 million
    
    Income generated by existing operations
    
    $2.9 millionTotal:
    
    $3.3 million
 Recent Accounting Pronouncements. On January 12, 2004, the Financial Accounting Standards Board (FASB)
issued Staff Position No. FAS 106-1 Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003 (FSP 106-1). FSP 106-1 permits employers that sponsor postretirement
benefit plans to defer accounting for any effects of the Medicare Prescription
Drug Improvement and Modernization Act of 2003 that was signed into law on
December 8, 2003. FSP 106-1 was superseded by FSP FAS 106-2 which is effective beginning July 1, 2004. In accordance with FSP 106-1 and FSP 106-2, neither the accumulated postretirement
benefit obligation nor the net periodic postretirement benefit costs reflected
in the accompanying financial statements reflects the effect of the Medicare
Prescription Drug Improvement and Modernization Act of 2003 on Alions plan.
Authoritative guidance, when issued, could require the Company to change
previously reported information. Liquidity and Capital Resources. Historically, primary sources of liquidity of the business we acquired on
December 20, 2002 have been cash provided by operations and revolving credit
and term-loan facilities. We intend to fund our operations primarily through
the cash provided by operations and drawdowns from our revolving credit
facility. The following discussion relates to the cash flow of Alion for the nine
months ended June 30, 2004 as compared to the cash flow of Alion for the
twenty-eight week period ended July 4, 2003 plus the cash flows of the
operating activities of the business acquired on December 20, 2002 for the
twelve-week period ended December 20, 2002. Net cash used in operating activities was $2.6 million for the nine months
ended June 30, 2004, a decrease of $14.2 million from the $11.4 million
provided by operating activities for the forty-week period ended July 4, 2003.
The primary reason for this $14.2 million decrease in cash provided by
operations results from the increase in approximately
$11.0 million of accounts
receivable associated primarily with the integration of the invoicing and cash
collection processes of the ITSC and IPS operations. 33




---



##### 



Net cash used in investing activities was $21.8 million for the nine
months ended June 30, 2004, and $60.9 million for the forty-week period ended
July 4, 2003. Approximately $17.7 million of the $21.8 million of cash used
during the nine months ended June 30, 2004 was for the acquisition and purchase
of ITSC and IPS. During the forty-week period ended July 4, 2003, the cash
Alion paid for the selected operations of IITRI was $58.6 million, of
which $25.8 million was generated from the sale of Alion common stock to the ESOP
Trust, and $32.1 million was from net borrowings under the Senior Term Note. Net cash provided by financing activities was $24.0 million for the nine
months ended June 30, 2004, compared to cash provided by financing activities
of $51.3 million for the forty-week period ended July 4, 2003. For the nine
months ended June 30, 2004, net cash provided by financing activities was
primarily the result of increased borrowings under Alions revolving credit
facility. For the nine months ended June 30, 2004, the balance drawn under the
revolving credit was approximately $23.8 million primarily used to fund the
acquisitions of ITSC and IPS. For the forty-week period ended July 4, 2003,
there was zero balance on the revolving credit facility. During the forty-week
period ended July 4, 2003, the additional financing required to complete the
purchase of the selected operations of IITRI included a $35.0 million Senior
Term Note, a $20.3 million Mezzanine Note (with warrants), a $39.9 million
Subordinated Note (with warrants), and the sale of $25.8 million of common
stock to the ESOP Trust. Discussion of Debt Structure On August 2, 2004, the Company entered into a new Senior Credit Facility
administered by Credit Suisse First Boston consisting of a $30 million
revolving credit facility, a Senior Secured Term B Loan for $100.0 million, and
a $50 million uncommitted Incremental Term Loan accordion facility. The total
value of the Senior Credit Facility is $180.0 million. At the closing date, the Company used $50 million of the new Senior Secured
Term B Loan to retire its outstanding senior term note and revolving credit
facility under the Senior Credit Agreement with LaSalle Bank National
Association. The Company paid approximately $48.2 million in principal and
accrued and unpaid interest and approximately $2.8 million in transaction fees
associated with the refinancing. The Company intends to use part of the remainder of the Senior Secured Term B
Loan to retire its existing Mezzanine Note in the approximate principal amount
of $19.6 million, to pay accrued and unpaid interest and any prepayment premium
the Company may incur at the time under its Mezzanine Note, and to pay related
fees and expenses. The Company is permitted to use any remaining portion of
the Senior Secured Term B Loan to finance permitted acquisitions. The Company
intends to use the new revolving credit facility to meet working capital needs
and other general corporate purposes, including financing permitted
acquisitions. The Company is permitted to use any future proceeds it might receive from the
currently uncommitted Incremental Term Loan Facility to finance permitted
acquisitions and to make certain put right payments required under the
Companys Mezzanine Warrant, if the put rights are exercised, and for any
other purpose permitted by Incremental Term Loans if and when they are funded. The Company must repay all principal obligations under the Senior Credit
Facility no later than August 5, 2009. The Senior Credit Agreement is secured
by a first priority, perfected security interest in all of the Companys
current and future tangible and intangible property. The Company may prepay its
borrowings under the senior term note in designated minimum amounts without
premium or penalty, other than (i) customary breakage costs related to
repayment of Eurodollar-based loans prior to the end of an interest period, and
(ii) breakage costs associated with the early termination of any interest rate
derivative related to the senior credit facilities. The Company must prepay its
borrowings with a portion of its excess cash flow each year along with proceeds
of permitted debt or equity issuances or asset sales. The Term B Loan and the revolving line of credit under the senior credit
facility bear interest at either of two floating rates both of which vary
according to the Companys leverage ratio: an annual rate equal to the
Eurodollar rate plus 200 to 275 basis points, or the Credit Suisse First Boston
prime rate plus 100 to 175 basis points. Leverage ratio is the ratio of total
funded debt, excluding the Subordinated Note (described below), to 34




---



##### 



earnings before interest, taxes, depreciation, amortization, ESOP repurchase
obligations and non-cash compensation expenses. Under the terms of the Senior
Credit Facility, the Company is subject to covenants including financial
covenants with respect to the interest coverage ratio and maximum leverage
ratio. Revolving Creditand Term Loan
    
    Category I
    
    Category II
    
    Category III
    
    Category IVLeverage Ratio
    
    Greater than or equal to 3.0 to 1.0
    
    Greater than or equal to 2.5 to 1.0
but less than 3.0 to 1.0
    
    Greater than or equal to 2.0 to 1.0
but less than 2.5 to 1.0
    
    Less than 2.0 to 1.0Prime Rate Margin
    
    175 basis points
    
    150 basis points
    
    125 basis points
    
    100 basis pointsEurodollar Margin
    
    275 basis points
    
    250 basis points
    
    225 basis points
    
    200 basis pointsCommitment Fee(on unused balance)
    
    50 basis points
    
    50 basis points
    
    50 basis points
    
    50 basis points
 The table below sets for the Companys anticipated minimum annual debt
repayments based on the retirement of the existing Mezzanine Note from proceeds
of the Senior Credit Facility. Principal Repayments
(in thousands)2004

    
    2005

    
    2006

    
    2007

    
    2008

    
    2009

    
    2010

    
    2011

    
    TOTALSenior
Secured Term B Loan

    
    $
    
    

    
    $
    750
    

    
    $
    750
    

    
    $
    750
    

    
    $
    750
    

    
    $
    72,000
    

    
    $
    
    

    
    $
    
    

    
    $
    75,000Seller
Subordinated Note


    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    


    
    $
    19,950
    

    
    $
    19,950
    

    
    $
    39,900Subordinated
Paid in Kind Note

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    7,182
    

    
    $
    7,182
    

    
    $
    14,364Sub-total

    
    $
    
    

    
    $
    750
    

    
    $
    750
    

    
    $
    750
    

    
    $
    750
    

    
    $
    72,000
    

    
    $
    27,132
    

    
    $
    27,132
    

    
    $
    129,264Note Payable
to bank

    
    $
    23,850
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    



    
    $
    23,850Senior Note
Payable

    
    $
    23,396
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    



    
    $
    23,396Proceeds of
Senior Secured Term B Loan

    
    $
    (47,246
    )

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    
    

    
    $
    (47,246
    )Total
principal payments

    
    $
    
    

    
    $
    750
    

    
    $
    750
    

    
    $
    750
    

    
    $
    750
    

    
    $
    72,000
    

    
    $
    27,132
    

    
    $
    27,132
    

    
    $
    129,264
 On December 20, 2002, the Company issued a Mezzanine Note to IITRI with a
face value of approximately $20.3 million, as part of the consideration for the
IITRI acquisition. The Mezzanine Note is
junior to the senior credit facility, but ranks senior to the Subordinated
Note. If not retired using the proceeds of the Senior Credit Facility as discussed above, the Company must pay the 35




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##### 



outstanding Mezzanine Note principal in a lump
sum on December 20, 2008. Each quarter, the Company must pay interest on the
Mezzanine Note, in cash, at a rate of 12% per year, based on a 360-day year of
twelve 30-day months. The Mezzanine
Note contains financial covenants similar to those contained in the Senior
Credit Agreement, but on less onerous terms mutually agreed upon by the
Company, IITRI and the senior lenders. Also on December 20, 2002, the Company issued the Subordinated Note to
IITRI, with a face value of $39.9 million, as part of the consideration for the
IITRI acquisition. The Subordinated Note bears interest at a rate of 6% per
year through December 2008, payable quarterly by the issuance of non-interest
bearing notes, called paid-in-kind or (PIK) notes, which mature at the same
time as the Subordinated Note. Issuance of the PIK notes will have the effect
of deferring the underlying cash interest expense on the Subordinated Note. The
PIK notes do not bear interest and therefore will not compound any interest on
these payment obligations. Commencing December 2008, the Subordinated Note will
bear interest at 16% per year payable quarterly in cash until the Subordinated
Note has been repaid in full. Principal on the Subordinated Note is payable in
equal installments of $19.95 million in December 2009 and December 2010; the
PIK notes are also due in equal installments of $7.2 million on these same
dates. The Subordinated Note includes covenants
customary for deeply subordinated obligations, such as the timely payment of
principal and interest. On December 20, 2002, the Company entered into a $0.9 million deferred
compensation agreement with Dr. Atefi, with payment terms substantially
equivalent to those of the Mezzanine Note previously described. The Company issued detachable warrants with the Mezzanine Note and the
Subordinated Note. The outstanding warrants associated with the Mezzanine Note
represent the right to buy approximately 12% of the Companys shares of common
stock on a fully diluted basis (assuming the exercise of all warrants
outstanding on September 30, 2003), at an exercise price of $10.00 per share.
These warrants are exercisable until December 20, 2008 and contain a put right
giving the holder the right to require the Company to purchase the warrants
back at the then-current fair value of the Companys common stock, minus the
warrants exercise price. The put right can be exercised within thirty days
after a change in control, or within thirty days prior to December 20, 2008, or
within thirty days after delivery to the current holders of an appraisal of the
per share value of the Companys common stock as of September 30, 2008, if the
ESOP still exists and no public market price exists for the Companys common
stock. The warrants associated with the Subordinated Note represent the right
to buy approximately 26% of the Companys shares of common stock on a fully
diluted basis (assuming the exercise of all warrants outstanding on September
30, 2003), at an exercise price of $10.00 per share. These warrants are
exercisable until December 20, 2010 and also contain a put right giving the
holder the right to require the Company to purchase the warrants back at the
then-current fair value of the Companys common stock, minus the warrants
exercise price. This put right applies to up to 50% of these warrants within
thirty days prior to December 20, 2009 (or within thirty days after delivery to
the warrant holders of an appraisal of the per share value of the Companys
common stock as of September 30, 2009, if the ESOP still exists and no public
market price exists for its common stock), and up to 100% of these warrants
within thirty days prior to December 20, 2010 (or within thirty days after
delivery to the warrant holders of an appraisal of the per share value of its
common stock as of September 30, 2010, if the ESOP still exists and no public
market value exists for its common stock). All put rights terminate upon one or
more underwritten public offerings of Alion common stock resulting in aggregate
gross proceeds of at least $30.0 million to the sellers (excluding proceeds
received from certain affiliates of Alion. On March 28, 2003, an officer of the Company purchased a portion of the
Companys mezzanine note owned by IITRI for $750,000, its face value, along
with warrants to purchase 19,327 shares of Alions 36




---



##### 



common stock at an exercise
price of $10.00 per share. On November 12, 2003, the Company purchased the
portion of the Mezzanine Note and warrants from the officer for an aggregate
purchase price of $1,034,020. On February 11, 2004, the Company borrowed $750,000 from an officer of the
Company. In exchange, on June 7, 2004, the Company issued the officer a
promissory note with interest at a rate of 15% per annum until March 31, 2009.
The annual interest period was effective beginning February 11, 2004. The
agreement essentially replaces a note, which is described above, for the same
sum previously issued to another officer of the Company, the termination of
whose employment relationship resulted in repurchase of the note. The agreement
with the officer is subordinate to the Senior Credit Agreement and the
Mezzanine Note referenced above. The Company has a maximum earnout payment obligation of $11.5 million to
the former shareholders of AB Technologies arising from IITRIs acquisition of
their company. The earnout arrangement applies to results of certain operations
for part of fiscal year 2000, all of fiscal years 2001 through 2004, and part
of fiscal year 2005. Messrs. Andrews and Bewley filed a lawsuit against IITRI
for breach of the AB Technologies asset purchase agreement claiming at least
$8.2 million in damages. The Andrews-Bewley lawsuit was removed to federal
court and consolidated into IITRIs lawsuit. The federal court stayed the
litigation and ordered both parties to submit the dispute to the independent
accounting firm of Grant Thornton for arbitration. On January 20, 2004, the arbitrator issued a decision awarding Messrs.
Andrews and Bewley a purchase price adjustment of approximately $0.7 million.
The arbitrators decision reclassified certain overhead expenses as general and
administrative expenses which were capped by the asset purchase agreement. That
decision increased earn out payments due Messrs. Andrews and Bewley by
approximately $3.5 million for the period from the acquisition date through
September 30, 2002. The Company was also required to recognize a liability of
approximately $0.3 million for potential payments to employees who worked in
the business units subject to this earn out for their earn out related to
fiscal year ended September 30, 2004. Through June 30, 2004, the Company recognized approximately $4.9 million,
excluding interest, in earnout obligations due Messrs. Andrews and Bewley and
approximately $0.4 million for potential payments to employees who worked in
the business units subject to this earn out. As of June 30, 2004, the Company
had paid approximately $4.5 million, excluding interest, to Messrs. Andrews and
Bewley for earn outs and purchase price adjustments. The Company expects to pay
Messrs. Andrews and Bewley approximately $3.3 million,
excluding interest, in
the quarter ending September 30, 2004. The Companys remaining minimum lease payment obligations under
non-cancelable operating leases for the full fiscal years ending 2004, 2005,
2006, 2007, 2008 and 2009 are $2.9 million, $10.9 million, $10.6 million, $10.6
million, $10.5 million and $10.1 million, respectively. The remaining aggregate
obligations on these leases thereafter are approximately $11.5 million.
Commercial facility lease expenses are included in these amounts. These
commercial facility lease obligations are currently reimbursable costs under
the Companys government contracts. Other contingent liabilities which will impact the Companys cash flow relate to:  
    
    Repurchase obligations under the KSOP which may be significant commencing in 2004;
    
    Obligations related to the holders put rights associated with the Mezzanine Note warrants;
    
    Obligations related to the holders put rights associated with the Subordinated Note warrants;
    
    Obligations relating to our stock appreciation rights and phantom stock programs; and
    
    Obligations relating to deferred compensation programs for senior managers. 37




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##### 



To date, the Company has spent the following amounts to repurchase shares
of its common stock from the ESOP Trust to satisfy obligations to terminated
employees. Shares repurchased prior to June 2004 were sold to the ESOP Trust. Number of Shares
    
    
    
    Total ValueDate
    
    Repurchased
    
    Share Price
    
    RepurchasedJune 2003
    
    5,248
    
    $11.13
    
    $58,412July 2003
    
    2,696
    
    $11.13
    
    $30,000December 2003
    
    50,031
    
    $14.71
    
    $735,956June 2004
    
    743
    
    $16.56
    
    $12,297
 The Company believes that cash flow from operations and cash available
under its revolving credit facility will provide it with sufficient capital to
fulfill its current business plan and to fund its working capital needs for at
least the next 36 months. Although the Company expects to have positive cash
flow from operations, it will need to generate significant additional revenues
beyond its current revenue base and to earn net income in order to repay
principal and interest on the indebtedness it assumed to finance the IITRI
acquisition. Additionally, the Companys business plan calls for it to continue to
acquire companies with complementary technologies. If the Company does not have
sufficient cash on hand to fund such acquisitions, it will be required to
obtain financing to do so. Such financing may not be available to us on
favorable terms, if at all. Given the Companys
significant obligations that become due in years 2009
through 2011, it expects that it will need to refinance a portion of its
indebtedness at least by fiscal year 2008. The Companys cash from operations
will be insufficient to satisfy all of its obligations and it cannot be certain
that it will be able to refinance on terms that will be favorable to the
Company, if at all. Moreover, if the Companys plans or assumptions change, if
its assumptions prove inaccurate, if it consummates investments in or
acquisitions of other companies, if it experiences unexpected costs or
competitive pressures, or if its existing cash and projected cash flow from
operations prove insufficient, it may need to obtain greater amounts of
additional financing and sooner than expected. While it is the Companys
intention only to enter into new financing or refinancing that it considers
advantageous, it cannot be certain that such sources of financing will be
available to the Company in the future, or, if available, that financing could
be obtained on terms favorable to the Company. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Companys exposure to interest rate risk is primarily due to the
additional debt it incurred to finance the IITRI, ITSC, and IPS acquisitions.
The Mezzanine Note and Subordinated Note have fixed interest rates, and
therefore present no risk of change to interest charges as a result of an
increase in market interest rates. The balance drawn under the $25.0 million
senior revolving credit facility and $1.2 million of the Companys $24.4
million remaining balance on its senior term note, however, bear interest at
variable rates tied to the Eurodollar rate. Such variable rates increase the
risk that interest charges will increase materially if market interest rates
increase. The Company has reduced, in part, the maximum total amount of
variable interest rate risk by entering into an interest rate cap agreement
which caps at 6% the first $25.0 million of principal borrowed under the senior
term note effective until February 3, 2007. For a description of the
arrangement, refer to Discussion of Debt Structure in Managements
Discussion and Analysis of Financial Condition and Results of Operations. The Company does not use derivatives for trading purposes. It invests its
excess cash in short-term, investment grade, and interest-bearing securities. 38




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Because the Companys expenses and revenues from its international
research contracts are generally denominated in U.S. dollars, the Company does
not believe that its operations are subject to material risks associated with
currency fluctuations. The Companys exposure to change in the fair market value of Alions stock
as the economic basis for the estimate of contingent liabilities relates to:  
    
    Repurchase obligations under the KSOP which may be significant commencing in 2004;
    
    Obligations related to the holders put rights associated with the Mezzanine Note warrants;
    
    Obligations related to the holders put rights associated with the Subordinated Note warrants;
    
    Obligations relating to its stock appreciation rights and phantom stock programs; and
    
    Obligations relating to deferred compensation programs for senior managers. ITEM 4. CONTROLS AND PROCEDURES (a) Disclosure Controls and Procedures.The Companys management, with the
participation of the Companys Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Companys disclosure controls
and procedures (as such term is defined in Rule 15d15(e)under the Securities
Exchange Act of 1934, as amended (the Exchange Act) as of the end of the
period covered by this quarterly report. Based on such evaluation, the
Companys Chief Executive Officer and Chief Financial Officer have concluded
that, as of the end of such period, the Companys disclosure controls and
procedures are effective in recording, processing, summarizing and reporting,
on a timely basis, information required to be disclosed by us in the reports
that the Company file or submit under the Exchange Act. (b) Internal Control Over Financial Reporting.There have not been any changes
in the Companys internal control over financial reporting (as such term is
defined in Rule 15d15(f) under the Exchange Act) during the fiscal quarter to
which this report relates that have materially affected, or are reasonably
likely to materially affect, the Companys internal control over financial
reporting. PART IIOTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On February 28, 2003, Alion filed a lawsuit against Isovac Products,
L.L.C., Inteledatics, Inc., James R. Gauger, George L. Stefanek and Joseph J.
Petrovic in the Circuit Court of Cook County, Illinois, Chancery Division.
Messrs. Gauger, Stefanek and Petrovic were formerly employed by IITRI. Alions complaint alleged that:  
    
    Under contract to the U.S. Army, IITRI developed a mobile rescue
device  an Emergency Personal Isolation and Containment (EPIC®) Pod
 to enable rescuers to safely attend to and support victims of
chemical or biological attacks;
    
    IITRI assembled a team of employees to conceive the device,
including Messrs. Gauger, Stefanek and Petrovic, each of whom executed
an agreement assigning to IITRI all intellectual property rights
arising out of his employment. Messrs. Gauger, Stefanek and Petrovic
also acknowledged receipt of the IITRI Code of Ethics prohibiting
outside activities in conflict with IITRIs interests;
    
    In December 1998, IITRI filed a provisional patent application for
the device; 39




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
    
    In August 1999, Messrs. Gauger, Stefanek and Petrovic and IITRI
employee Robert Mullins jointly filed a patent application, which
assigned the patent to IITRI and that related back to IITRIs December
1998 provisional patent application. The patent was awarded to IITRI in
November 2001;
    
    Messrs. Gauger, Stefanek and Petrovic began a process starting in
March 1999, while they were still IITRI employees, to form companies
that would compete with IITRI using IITRIs trade secrets;
    
    Isovac Products, L.L.C., Inteledatics, Inc., James R. Gauger,
George L. Stefanek and Joseph J. Petrovic, collectively the defendants,
misappropriated IITRIs trade secrets and filed a patent application on
behalf of Isovac Products, L.L.C.;
    
    Mr. Petrovic defamed IITRIs product in an interview with the New
York Times for the defendants pecuniary gain and to cause harm to the
reputation of IITRIs products; and
    
    IITRI assigned to Alion its intellectual property rights in the
EPIC Pod and its rights to claims against the defendants as part of
Alions purchase of substantially all of IITRIs assets. On May 12, 2004, the defendants agreed to settle this case by paying
Alion a royalty on any sales of the technology or of any derivative technology,
and on any services performed that relate to the technology. Defendants also
agreed to mark all of their products that are based on the technology with a
logo that indicates the product is based on Alions intellectual property. The
defendants further agreed to make full and periodic reports of their sales
activities to Alion and to submit to an audit upon demand. Also, defendants
agreed to, and in fact did, issue a written and signed repudiation of
defamatory statements towards Alions technology. Other than the foregoing action, the Company is not involved in any
material legal proceeding other than routine legal proceedings occurring in the
ordinary course of business. As a government contractor, the Company may be subject from time to time
to federal government inquiries relating to our operations and audits of our
accounting procedures by the Defense Contract Audit Agency. Government
contractors who are found to have violated the False Claims Act, or who are
indicted or convicted for violations of other federal laws, may be suspended or
debarred from government contracting for some period. Such an event could also
result in fines or penalties. Given the Companys dependence on federal
government contracts, suspension or debarment could have a material adverse

effect on the Company. The Company is not aware of any such claims or
investigations against it. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS In May 2004, the Company raised approximately $2.5 million in cash through
a private placement of its common stock. The Company sold 97,483 shares to the
ESOP Trust at $14.71 per share and 72,556 shares at $16.56 per share. The
Company issued an additional 130,947 shares to the ESOP Trust, at an average
price per share of $16.56, as a contribution to the KSOP Plan. The shares of
stock were offered pursuant to an exemption from registration under Section
4(2) of the Securities Act of 1933. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 40




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ITEM 5. OTHER INFORMATION None. 41




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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) ExhibitNo.
    
    Description3.1
    
    Second Amended and Restated Certificate of Incorporation of Beagle Holdings, Inc.(1)3.2
    
    Amended and Restated By-laws of Alion Science and Technology Corporation.(2)4.1
    
    Amended and Restated Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan.(3)4.2
    
    First Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan.(4)4.3
    
    Second Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan.(5)4.4
    
    Third Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (5)4.5
    
    Fourth Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (5)4.6
    
    Fifth Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (6)4.7
    
    Sixth Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (6)4.8
    
    Seventh Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (6)4.9
    
    Eighth Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (6)4.10
    
    Ninth Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan.10.33
    
    Third Amendment to the Credit Agreement by and among LaSalle Bank
National Association as agent, various lenders and Alion Science and
Technology Corporation.10.34
    
    Addendum to Employment Agreement between Alion Science and Technology Corporation and James Fontana.10.35
    
    Second Amendment to the Alion Science and Technology Corporation Phantom Stock Plan.31.1
    
    Certification of Chief Executive Officer of Alion Science and
Technology Corporation pursuant to Rule 15d-14(a) promulgated under
the Securities Exchange Act of 1934, as amended.31.2
    
    Certification of Chief Financial Officer of Alion Science and
Technology Corporation
 42




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##### 



pursuant to 15d-14(a) promulgated under the
Securities Exchange Act of 1934, as amended.32.1
    
    Certification of Chief Executive Officer of Alion Science and
Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer of Alion Science and
Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   (1)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys Pre-Effective Amendment No. 2 to the
Registration Statement on Form S-1 filed with the Securities and Exchange
Commission on September 17, 2002 (File no. 950133-2-3224)(2)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys Post-Effective Amendment No. 2 to the
Registration Statement on Form S-1 filed with the Securities and Exchange
Commission on December 9, 2002 (File no. 950133-2-4018).(3)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys Pre-Effective Amendment No. 3 to the
Registration Statement on Form S-1 filed with the Securities and Exchange
Commission on October 7, 2002 (File no. 950133-2-3343).(4)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys Post-Effective Amendment No. 3 to the
Registration Statement on Form S-1 filed with the Securities and Exchange
Commission on March 24, 2003 (File no. 950133-3-862).(5)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys quarterly report on Form 10-Q for the
quarterly period ended July 4, 2003, filed with the Securities and
Exchange Commission on August 15, 2003 (File no. 950133-03-002960).(6)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys Registration Statement on Form S-8 filed
with the Securities and Exchange Commission on April 28, 2004 (File no.
950133-04-001602). (b) Reports on Form 8-K: During the quarter, the Company did not file a Report on Form 8-K. 43




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##### 



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. ALION SCIENCE AND TECHNOLOGY CORPORATION Date: August 13, 2004
    
    By: /s/ John M. HughesName: John M. HughesTitle: Chief Financial Officer(Principal Financial and Accounting Officerand Duly Authorized Officer)
 44




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##### 



EXHIBIT INDEX ExhibitNo.
    
    Description3.1
    
    Second Amended and Restated Certificate of Incorporation of Beagle Holdings, Inc.(1)3.2
    
    Amended and Restated By-laws of Alion Science and Technology Corporation.(2)4.1
    
    Amended and Restated Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan.(3)4.2
    
    First Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan.(4)4.3
    
    Second Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan.(5)4.4
    
    Third Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (5)4.5
    
    Fourth Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (5)4.6
    
    Fifth Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (6)4.7
    
    Sixth Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (6)4.8
    
    Seventh Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (6)4.9
    
    Eighth Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (6)4.10
    
    Ninth Amendment to The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan.10.33
    
    Third Amendment to the Credit Agreement by and among LaSalle Bank
National Association as agent, various lenders and Alion Science and
Technology Corporation.10.34
    
    Addendum to Employment Agreement between Alion Science and Technology Corporation and James Fontana.10.35
    
    Second Amendment to the Alion Science and Technology Corporation Phantom Stock Plan.31.1
    
    Certification of Chief Executive Officer of Alion Science and
Technology Corporation pursuant to Rule 15d-14(a) promulgated under
the Securities Exchange Act of 1934, as amended.
 45




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##### 



31.2
    
    Certification of Chief Financial Officer of Alion Science and
Technology Corporation pursuant to 15d-14(a) promulgated under the
Securities Exchange Act of 1934, as amended.32.1
    
    Certification of Chief Executive Officer of Alion Science and
Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer of Alion Science and
Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   (1)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys Pre-Effective Amendment No. 2 to the
Registration Statement on Form S-1 filed with the Securities and Exchange
Commission on September 17, 2002 (File no. 950133-2-3224).(2)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys Post-Effective Amendment No. 2 to the
Registration Statement on Form S-1 filed with the Securities and Exchange
Commission on December 9, 2002 (File no. 950133-2-4018).(3)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys Pre-Effective Amendment No. 3 to the
Registration Statement on Form S-1 filed with the Securities and Exchange
Commission on October 7, 2002 (File no. 950133-2-3343).(4)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys Post-Effective Amendment No. 3 to the
Registration Statement on Form S-1 filed with the Securities and Exchange
Commission on March 24, 2003 (File no. 950133-3-862).(5)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys quarterly report on Form 10-Q for the
quarterly period ended July 4, 2003, filed with the Securities and
Exchange Commission on August 15, 2003 (File no. 950133-03-002960).(6)
    
    Incorporated by reference to the corresponding exhibit previously filed
as an exhibit to the Companys Registration Statement on Form S-8 filed
with the Securities and Exchange Commission on April 28, 2004 (File no.
950133-04-001602). 46