##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 
 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004. COMMISSION FILE NUMBER 33389756 
 (ALICON LOGO) Alion Science and Technology Corporation   DELAWARE
(State or Other Jurisdiction of
Incorporation of Organization)
10 West 35th Street
    
    542061691
(I.R.S. Employer
Identification No.)
1750 Tysons Boulevard, Suite 1300
 Chicago, IL 60616
(312) 5674000
    
    McLean, VA 22102
(703) 9184480
 (Address, including Zip Code and Telephone Number with
Area Code, of Principal Executive Offices) (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[  ] Yes [X] No Indicate by check mark whether the registrant 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 March 31, 2004, was:
Common Stock 2,923,783




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##### 



ALION SCIENCE AND TECHNOLOGY CORPORATION
FORM 10-Q INDEX
FOR THE QUARTER ENDED MARCH 31, 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
    
    
    31Item 4.
    
    Controls and Procedures
    
    
    31PART II  OTHER INFORMATION
    
    
    32Item 1.
    
    Legal Proceedings
    
    
    32Item 2.
    
    Changes in Securities and Use of Proceeds
    
    
    33Item 3.
    
    Defaults Upon Senior Securities
    
    
    33Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    33Item 5.
    
    Other Information
    
    
    33Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    34




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##### 



PART I  Financial Information
Item 1. Financial Statements ALION SCIENCE AND TECHNOLOGY CORPORATION 
 Consolidated Balance Sheets
 As of March 31, 2004 (Unaudited) and September 30, 2003
 (In thousands, except share information)
 March 31,
    
    September 30,2004
    
    2003AssetsCurrent assets:Cash
    
    $
    136
    
    
    $
    494Restricted cash
    
    
    
    
    
    
    5Accounts receivable, less allowance of $3,041 at March 31, 2004 and $2,484
at September 30, 2003
    
    
    57,826
    
    
    
    42,777Stock subscriptions receivable
    
    
    
    
    
    
    1,246Prepaid expense
    
    
    2,629
    
    
    
    974Other current assets
    
    
    1,219
    
    
    
    987Total current assets
    
    
    61,810
    
    
    
    46,483Fixed assets, net
    
    
    9,538
    
    
    
    8,696Intangible assets, net
    
    
    17,789
    
    
    
    22,788Goodwill
    
    
    84,021
    
    
    
    65,522Other
    
    
    1,385
    
    
    
    97Deferred compensation assets
    
    
    1,555
    
    
    
    1,362Total assets
    
    
    176,098
    
    
    
    144,948Liabilities and Shareholders Equity, Subject to RedemptionCurrent liabilities:Note payable to bank
    
    $
    14,600
    
    
    $
    Current portion of senior note payable
    
    
    5,625
    
    
    
    5,000Acquisition obligations
    
    
    9,186
    
    
    
    2,928Trade accounts payable and accrued liabilities
    
    
    20,192
    
    
    
    9,661Accrued payroll and related liabilities
    
    
    15,499
    
    
    
    14,217Advance payments
    
    
    
    
    
    
    5ESOP liabilities
    
    
    2,165
    
    
    
    320Current portion of lease obligations
    
    
    866
    
    
    
    Billings in excess of costs and estimated earnings on uncompleted contracts
    
    
    981
    
    
    
    409Total current liabilities
    
    
    69,114
    
    
    
    32,540Senior note payable, excluding current portion
    
    
    19,986
    
    
    
    22,903Mezzanine note payable
    
    
    17,244
    
    
    
    17,636Subordinated note payable
    
    
    33,829
    
    
    
    33,437Agreements with officers
    
    
    1,504
    
    
    
    743Deferred compensation liability
    
    
    1,555
    
    
    
    1,362Accrued post-retirement benefit obligation
    
    
    3,409
    
    
    
    3,319Non current portion of lease obligations
    
    
    3,204
    
    
    
    346Redeemable common stock warrants
    
    
    16,818
    
    
    
    14,762Total liabilities
    
    
    166,663
    
    
    
    127,048Shareholders equity, subject to redemption:Common stock (subject to redemption), $0.01 par value, 15,000,000 shares
authorized, 2,973,813 shares and 2,973,813 shares issued and
2,923,782 and 2,973,813 shares outstanding at March 31, 2004 and
September 30, 2003, respectively
    
    
    29
    
    
    
    29Additional paid-in capital
    
    
    30,578
    
    
    
    30,578Treasury stock, at cost (50,031 shares)
    
    
    (736
    )
    
    
    Accumulated deficit
    
    
    (20,436
    )
    
    
    (12,707
    )Total shareholders equity, subject to redemption
    
    
    9,435
    
    
    
    17,900Total liabilities and shareholders equity, subject to redemption
    
    $
    176,098
    
    
    $
    144,948
 See accompanying notes to consolidated financial statements. 3




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##### 



ALION SCIENCE AND TECHNOLOGY CORPORATION 
 Consolidated Statements of Operations
 For the Three Months Ended March 31, 2004 and the Twelve-Week Period Ended March 14, 2003
and for the Six Months Ended March 31, 2004 and the Twenty-Four Week Period Ended March 14, 2003
(In thousands, except share information)
(Unaudited)
 Three Months
    
    Twelve-Week
    
    Six Months
    
    Twenty-Four WeekEnded March 31,
    
    Period Ended
    
    Ended
    
    Period Ended2004
    
    March 14, 2003
    
    March 31, 2004
    
    March 14, 2003Contract revenue
    
    $
    64,712
    
    
    $
    49,005
    
    
    $
    123,303
    
    
    $
    49,005Direct contract expense
    
    
    46,378
    
    
    
    36,031
    
    
    
    88,491
    
    
    
    36,031Gross profit
    
    
    18,334
    
    
    
    12,974
    
    
    
    34,812
    
    
    
    12,974Operating expenses:Indirect contract expense
    
    
    4,665
    
    
    
    2,848
    
    
    
    8,654
    
    
    
    2,848Research and development
    
    
    104
    
    
    
    19
    
    
    
    178
    
    
    
    19General and administrative
    
    
    6,880
    
    
    
    5,432
    
    
    
    14,265
    
    
    
    5,473Non-recurring transaction expense
    
    
    
    
    
    
    388
    
    
    
    
    
    
    
    388Rental and occupancy expense
    
    
    2,495
    
    
    
    2,093
    
    
    
    5,008
    
    
    
    2,093Depreciation and amortization
    
    
    3,267
    
    
    
    2,819
    
    
    
    6,371
    
    
    
    2,819Bad debt expense
    
    
    92
    
    
    
    155
    
    
    
    134
    
    
    
    155Total operating expenses
    
    
    17,503
    
    
    
    13,754
    
    
    
    34,610
    
    
    
    13,795Operating income (loss)
    
    
    831
    
    
    
    (780
    )
    
    
    202
    
    
    
    (821
    )Other income (expense):Interest income
    
    
    7
    
    
    
    3
    
    
    
    9
    
    
    
    3Interest expense
    
    
    (3,677
    )
    
    
    (2,223
    )
    
    
    (6,964
    )
    
    
    (2,223
    )Other
    
    
    (547
    )
    
    
    (75
    )
    
    
    (976
    )
    
    
    (75
    )Loss before income taxes
    
    
    (3,386
    )
    
    
    (3,075
    )
    
    
    (7,729
    )
    
    
    (3,116
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    $
    (3,386
    )
    
    $
    (3,075
    )
    
    $
    (7,729
    )
    
    $
    (3,116
    )Basic and diluted loss per share
    
    $
    (1.16
    )
    
    $
    (1.19
    )
    
    $
    (2.62
    )Basic and diluted weighted average
common shares outstanding
    
    
    2,923,783
    
    
    
    2,575,508
    
    
    
    2,947,294
 See accompanying notes to consolidated financial statements. 4




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##### 



ALION SCIENCE AND TECHNOLOGY CORPORATION 
 Consolidated Statements of Operations
 For the Three Months Ended March 31, 2004, Twelve-Week Period Ended March 14, 2003 and 
Six Months Ended March 31, 2004 and
Pro Forma Consolidated Statement of Operations for the Twenty-Four Week Period Ended March 14, 2003
(In thousands, except share information)
(Unaudited)
 Pro FormaTwenty-FourThree Months
    
    Twelve-Week
    
    
    
    
    
    Week PeriodEnded
    
    Period Ended
    
    Six Months Ended
    
    EndedMarch 31, 2004
    
    March 14, 2003
    
    March 31, 2004
    
    March 14, 2003Contract revenue
    
    $
    64,712
    
    
    $
    49,005
    
    
    $
    123,303
    
    
    $
    96,270Direct contract expenses
    
    
    46,378
    
    
    
    36,031
    
    
    
    88,491
    
    
    
    70,686Gross profit
    
    
    18,334
    
    
    
    12,974
    
    
    
    34,812
    
    
    
    25,584Operating expenses:Indirect contract expense
    
    
    4,665
    
    
    
    2,848
    
    
    
    8,654
    
    
    
    5,416Research and development
    
    
    104
    
    
    
    19
    
    
    
    178
    
    
    
    55General and administrative
    
    
    6,880
    
    
    
    5,432
    
    
    
    14,265
    
    
    
    10,746Non-recurring transaction costs
    
    
    
    
    
    
    388
    
    
    
    
    
    
    
    5,836Rental and occupancy expense
    
    
    2,495
    
    
    
    2,093
    
    
    
    5,008
    
    
    
    4,294Depreciation and amortization
    
    
    3,267
    
    
    
    2,819
    
    
    
    6,371
    
    
    
    5,702Bad debt expense
    
    
    92
    
    
    
    155
    
    
    
    134
    
    
    
    275Total operating expenses
    
    
    17,503
    
    
    
    13,754
    
    
    
    34,610
    
    
    
    32,324Operating income (loss)
    
    
    831
    
    
    
    (780
    )
    
    
    202
    
    
    
    (6,740
    )Other income (expense):Interest income
    
    
    7
    
    
    
    3
    
    
    
    9
    
    
    
    25Interest expense
    
    
    (3,677
    )
    
    
    (2,223
    )
    
    
    (6,964
    )
    
    
    (4,377
    )Other
    
    
    (547
    )
    
    
    (75
    )
    
    
    (976
    )
    
    
    (96
    )Loss before income taxes
    
    
    (3,386
    )
    
    
    (3,075
    )
    
    
    (7,729
    )
    
    
    (11,188
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (27
    )Net loss
    
    $
    (3,386
    )
    
    $
    (3,075
    )
    
    $
    (7,729
    )
    
    $
    (11,215
    )Basic and diluted loss per share
    
    $
    (0.96
    )
    
    $
    (1.19
    )
    
    $
    (2.43
    )Basic and diluted weighted average
common shares outstanding
    
    
    2,923,783
    
    
    
    2,575,508
    
    
    
    2,947,294Pro forma basic and diluted loss per share
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (4.35
    )Pro forma basic and diluted weighted
average common shares outstanding
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,575,508
 See accompanying notes to consolidated financial statements. 5




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ALION SCIENCE AND TECHNOLOGY CORPORATION 
 Consolidated Statements of Cash Flows
 Six Months Ended March 31, 2004
and Twenty-Four Week Period Ended March 14, 2003
(In thousands, except share information)
(Unaudited)
 Six Months
    
    Twenty-Four Week PeriodEnded
    
    EndedMarch 31, 2004
    
    March 14, 2003Cash flows from operating activities:Net loss
    
    $
    (7,729
    )
    
    $
    (3,116
    )Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization
    
    
    6,372
    
    
    
    2,819Accretion of debt to face value
    
    
    760
    
    
    
    307Amortization of debt issuance costs
    
    
    208
    
    
    
    106Decrease in value of interest rate cap agreement
    
    
    50
    
    
    
    Change in fair value of redeemable common stock warrants
    
    
    2,058
    
    
    
    Loss on investments
    
    
    (20
    )
    
    
    9Changes in assets and liabilities, net of effect of acquisitions:Accounts receivable, net
    
    
    (4,605
    )
    
    
    934Other assets
    
    
    (76
    )
    
    
    (1,146
    )Trade accounts payable and accruals
    
    
    4,286
    
    
    
    (472
    )Other liabilities
    
    
    2,271
    
    
    
    2,218Net cash provided by operating activities
    
    
    3,575
    
    
    
    1,659Cash flows from investing activities:Cash paid for acquisitions, net of cash acquired
    
    
    (14,122
    )
    
    
    (58,858
    )Capital expenditures
    
    
    (837
    )
    
    
    (475
    )Purchase of non-marketable securities
    
    
    (1,333
    )
    
    
    Net cash used in investing activities
    
    
    (16,292
    )
    
    
    (59,333
    )Cash flows from financing activities:Proceeds from senior note payable
    
    
    141
    
    
    
    35,000Payment of debt issuance costs
    
    
    
    
    
    
    (1,700
    )Repayment of senior note payable
    
    
    (2,500
    )
    
    
    (1,250
    )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
    
    
    14,600
    
    
    
    7,000Payment of acquisition obligations
    
    
    (18
    )
    
    
    (155
    )Purchase of
50,031 shares of common stock from ESOP Trust
    
    
    (736
    )
    
    
    Payment of stock subscription for common stock issued to ESOP Trust
    
    
    1,247
    
    
    
    25,755Net cash provided by financing activities
    
    
    12,359
    
    
    
    58,465Net increase (decrease) in cash
    
    
    (358
    )
    
    
    791Cash at beginning of period
    
    
    494
    
    
    
    6Cash at end of period
    
    $
    136
    
    
    $
    797Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    2,322
    
    
    $
    427Non-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
    
    
    
    
    
    
    296Bank 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
Six Months Ended March 31, 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 subsidiary Human Factors Applications,
Inc. (HFA) 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 six
months ended March 31, 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 subsidiary HFA 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 has been 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 March 31, 2004, there were 63 available work days (based on a standard
work week of Monday through Friday and excluding designated holidays recognized
by Alion) as compared to 57 available workdays for the twelve-week period ended
March 14, 2003. On a fiscal year-to-date basis, through the six months ended
March 31, 2004 there were 126 available workdays as compared to 114 - 8 -




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##### 



available workdays for the twenty-four week period ended March 14, 2003.
Accordingly, comparisons between the three-month quarter ended March 31, 2004
and the twelve-week period ended March 14, 2003 will need to consider the
differing lengths of time. Comparisons between the six months ended March 31,
2004 and the twenty-four week period ended March 14, 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. In accordance with FSP 106-1, 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
interim period ended March 14, 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 six months ended March 31, 2004, goodwill
increased by $18.5 million, as a result of recording additional obligations of
$6.6 million related to earnout arrangements on historical acquisitions and
approximately $11.9 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 purchased contracts
from IITRI. For the acquisitions described in Note 10, the Company recorded
intangible assets of approximately $0.1 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. - 9 -




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##### 



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 $16.8 million as of March 31, 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 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 who receives a
distribution of common stock 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 March 31,
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
the participants account 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 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
facility consists of a $25.0 million revolving credit facility and a $35.0
million term loan. All principal obligations under the revolving credit
facility are to be repaid in full no later than December 20, 2007. The senior
credit facility is secured by a first priority, perfected security interest in
all of the Companys current and future tangible and intangible property. As of
March 31, 2004, the Company had approximately $14.6 million borrowed under the
revolving credit facility. As of March 31, 2004, the remaining principal repayments (adjusted for
prepayments made through such date) of $26.75 million under the term loan will be 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
    
    $
    8,8752008
    
    $
    250
 - 10 -




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##### 



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 facility 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 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. As a result, interest under the term note was payable at the
prime rate (base rate) plus 200 basis points until February 14, 2003.
Thereafter, the 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 calculated
and reimbursed to the Company semiannually by the senior lender pursuant to the
cap agreement. This cap agreement expires February 3, 2007. As of March 31,
2004, the cap agreement had a fair value of approximately $0.047 million, which
has been recorded in the accompanying consolidated balance sheet. On December 20, 2002, the Company paid $1.7 million to obtain its senior
credit facility that includes a $35.0 million Senior Term Note and a $25.0
million revolving credit 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 six months ended March 31, 2004, the
Company recognized approximately $0.2 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 has 6.0%
as of March 31, 2004. On February 6, 2004, Amendment Number 1 to the Senior Credit Agreement was
entered into, whereby the definition of Borrowing Base (Senior Debt) was
redefined for the fiscal period ended December 31, 2003. As such, the amended
definition increased the Companys borrowing capacity under the Senior Credit
Agreement for the fiscal period ended December 31, 2003. On March 31, 2004, Amendment Number 2 to the Senior Credit Agreement was
entered into, whereby 1) certain cash payments for earn out obligations under
current arrangements are to be excluded in fiscal year 2004 for purposes of
calculating the minimum Fixed Price Charge Coverage Ratio, 2) the effective
period of Borrowing Base Formula for Senior Debt (ii) is to apply for the
fiscal periods ending March 31, 2004, June 30, 2004, and September 30, 2004, 3)
the Borrowing Base Formula Senior Debt (ii) is amended to include an advance
for fifty percent (50%) of the total billed receivables outstanding one-hundred
and twenty-one days (121) or more from the date of original invoice, plus fifty
percent (50%) of the value of the net property and equipment of the Borrower,
and 4) the waiver of the requirement to have the mezzanine (and warrants) that
were purchased from an officer of the Company be repurchased by a member of
Alions senior management team. As such, the adoption of this amendment
potentially increases the Companys borrowing capacity under the Senior Credit
Agreement. In consideration for the aforementioned amendments, the Company was
required to pay a fee of $0.15 million. 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. 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. - 11 -




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##### 



On February 11, 2004, the Company borrowed $750,000 from an officer of the
Company and in exchange will issue a promissory note in the principal amount of
$750,000 to the officer. The promissory note will bear interest at a rate of
15% per year, payable quarterly. The Company will be required to pay the
outstanding principal amount of the promissory note in a lump sum on March 31,
2009. The promissory note will be subordinate to the senior credit facility
and the mezzanine 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. 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. Under the terms of the Senior Credit Facility 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 March 31, 2004, the Company was in compliance with
these financial covenants. - 12 -




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##### 



In summary, for the aforementioned debt agreements, as of March 31, 2004
the remaining fiscal year repayments (at face amount before debt discount) are
as follows: Post-Transaction 8-Year Period Principal payments(in thousands)
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    2010
    
    2011
    
    TotalSenior Term Note
    
    $
    2,500
    
    
    $
    6,875
    
    
    $
    8,250
    
    
    $
    8,875
    
    
    $
    250
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    26,750Mezzanine Note and
Agreements with
Officers
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    21,200
    
    
    
    
    
    
    
    
    
    
    $
    21,200Subordinated Note
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    19,950
    
    
    $
    19,950
    
    
    $
    39,900Total Principal
Payments
    
    $
    2,500
    
    
    $
    6,875
    
    
    $
    8,250
    
    
    $
    8,875
    
    
    $
    250
    
    
    $
    21,200
    
    
    $
    19,950
    
    
    $
    19,950
    
    
    $
    87,850
 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 six months ended March 31, 2004, revenues from services provided
to various agencies of the U.S. Government represented $120.9 million or
approximately 98% of revenues, and $94.6 million or approximately 98% of
revenues for the twenty-four weeks ended March 14, 2003. Contract receivables
from agencies of the U.S. Government represented approximately $57.3 million,
or 95%, of accounts receivable at March 31, 2004 and $47.8 million, or 92%, at
March 14, 2003. During the six months ended March 31, 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 for the six months ended March 31, 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 also 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 provides 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,
the Company has recorded approximately $3.7 million of goodwill as a result of
the acquisition. On February 13, 2004, Alion acquired 100% of outstanding stock of Identix
Public Sector, Inc. (IPS) for $8.0 million in cash. In addition, at closing
the Company reimbursed IPSs parent company $0.9 million for intercompany
payables. Subsequent payments totaling approximately $1.7 million for
intercompany payables will be 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. While the allocation of - 13 -




---



##### 



purchase price is preliminary, the Company has recorded approximately $8.2
million of goodwill as a result of the acquisition. 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 pro forma 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 the first day of each fiscal year presented. This
pro forma information for the twenty-four weeks ended March 31, 2004 also reflects
the pro forma effects of the IITRI acquisition discussed in Note 1.
The pro forma information presented below includes applicable adjustments and covers
differing lengths of time as the IPS acquisition occurred in the middle of an interim
period. Accordingly, period-to-period comparisons should take these differences and
adjustments into account. Future actual financial performance may differ materially from
the pro forma results presented. Three Months Ended March 31, 2004
    
    Twelve Weeks Ended March 14, 2003IPS
    
    Alion
    
    
    
    
    
    IPS
    
    AlionAlion
    
    Pro Forma
    
    Pro Forma
    
    Alion
    
    Pro Forma
    
    Pro FormaPro forma revenue
    
    $
    64,712
    
    
    $
    3,291
    
    
    $
    68,003
    
    
    $
    49,005
    
    
    $
    9,515
    
    
    $
    58,520Pro forma net income (loss)
    
    $
    (3,386
    )
    
    $
    (95)
    
    
    $
    (3,481
    )
    
    $
    (3,075
    )
    
    $
    181
    
    
    $
    (2,894
    )Weighted average shares outstanding
    
    
    2,923,783
    
    
    
    2,923,783
    
    
    
    2,923,783
    
    
    
    2,575,508
    
    
    
    2,575,508
    
    
    
    2,575,508Earnings (loss) per share
    
    $
    (1.16
    )
    
    $
    (0.03
    )
    
    $
    (1.19
    )
    
    $
    (1.19
    )
    
    $
    0.07
    
    
    $
    (1.12
    )
 Six Months Ended March 31, 2004
    
    Twenty-four Weeks Ended March 14, 2003IPS
    
    Alion
    
    
    
    
    
    IPS
    
    AlionAlion
    
    Pro Forma
    
    Pro Forma
    
    Alion
    
    Pro Forma
    
    Pro FormaPro forma revenue
    
    $
    123,303
    
    
    $
    11,291
    
    
    $
    134,594
    
    
    $
    96,270
    
    
    $
    19,994
    
    
    $
    116,264Pro forma net income (loss)
    
    $
    (7,729
    )
    
    $
    (87
    )
    
    $
    (7,816
    )
    
    $
    (11,215
    )
    
    $
    
    
    
    $
    (11,215
    )Weighted average shares outstanding
    
    
    2,947,294
    
    
    
    2,947,294
    
    
    
    2,947,294
    
    
    
    2,575,508
    
    
    
    2,575,508
    
    
    
    2,575,508Earnings (loss) per share
    
    $
    (2.62
    )
    
    $
    (0.03
    )
    
    $
    (2.65
    )
    
    $
    (4.35
    )
    
    $
    
    
    
    $
    (4.35
    )
 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. The lawsuit sought to compel the defendants to submit disputed issues to
an independent accounting firm, in accordance with the terms of the asset
purchase agreement. The Company also sought declaratory judgment that it was
entitled to a downward adjustment to the purchase price and a finding that it
properly computed the earnout required by the asset purchase agreement. 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 - 14 -




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##### 



approximately $0.3 million for potential payments to employees who worked in
the business units subject to this earn out. Through March 31, 2004, the Company recognized approximately $4.5 million
in additional earn out obligations due Messrs. Andrews and Bewley
for the fiscal year ended September 30, 2003 and for the six-month period ended March 31, 2004.
Additionally, the Company recognized approximately $0.3 million for potential payments to employees who worked in
the business units subject to this earn out. As of March 31, 2004, the Company
had paid approximately $0.7 million to Messrs. Andrews and Bewley for earn outs
and purchase price adjustments. The
Company expects to pay Messrs. Andrews and Bewley approximately $3.5
million in the quarter ending June 30, 2004 and approximately $3.3 million in
the quarter ending September 30, 2004. 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 other 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 twenty-four
week period ended March 14, 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 twenty-four week period ended March 14, 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. The Company will issue 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. - 15 -




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##### 



14. Subsequent Event On April 5, 2004, the Company received approximately $2.3 million from the
ESOP Trust in payment for shares to be issued by the Company to the Trust. The
funds received represent employee salary deferrals and rollovers from the qualified
plans of new employees used for the purchase of
beneficial interests in the Companys common stock to be held by the Trust.
As discussed in Note 7, an independent appraiser has determined the fair value of a share of
Alion common stock as of March 31, 2004, the Company will issue shares to the
Trust in exchange for funds already received along with additional shares in
satisfaction of the Companys current ESOP contribution liability based upon this volume. 
 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 May 17, 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. 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. - 16 -




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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. 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 - 17 -




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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 six months ended March 31, 2004, we derived approximately 63%, 23%
and 14% 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. 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 March 31, 2004, the Company has goodwill of approximately $84.0
million, which will be subject to the aforementioned annual impairment review.
As of March 31, 2004, the Company has recorded approximately - 18 -




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$17.8 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. 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 has been 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 March 31, 2004, there were 63 available work days (based on a standard
work week of Monday through Friday and excluding designated holidays recognized
by Alion) as compared to 57 available workdays for the twelve-week period ended
March 14, 2003. On a fiscal year-to-date basis, through the six months ended
March 31, 2004 there were 126 available workdays as compared to 114 available
workdays for the twenty-four week period ended March 14, 2003. Accordingly,
comparisons between the six-months and quarter ended March 31, 2004 and the
twenty-four and twelve week periods ended March 14, 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 six months
ended March 31, 2004 and for the results of operations for the
twelve-week and pro forma twenty-four week periods ended March 14, 2003, assuming that the
IITRI acquisition had been consummated on the first day of the interim period,
October 1, 2002. The following table sets forth, for each period indicated, the percentage
of our revenues derived from each of our major types of customers. Six Months
    
    Twenty-Four WeekEnded
    
    Period EndedMarch 31, 2004
    
    March 14, 2003Department of Defense
    
    
    92.1
    %
    
    
    93.6
    %Federal Civilian Agencies
    
    
    5.6
    
    
    
    4.7Commercial / State / Local
    
    
    2.3
    
    
    
    1.7Total
    
    
    100.0
    %
    
    
    100.0
    %
 Results of Operations Three Months Ended March 31, 2004 Compared to Twelve-Week Period Ended March
14, 2003 Revenues.Revenues increased $15.7 million, or 32.0%, to $64.7 million for
the three months ended March 31, 2004, from $49.0 million for the twelve-week period
ended March 14, 2003. This $15.7 million increase is attributable to the
following:  
    
    For the three months ended March 31, 2004 there were 63 available
workdays (based on a standard five-day work week of Monday through
Friday and excluding designated holidays recognized by Alion) as
compared to 57 for the twelve-week period ended March 14, 2003. The six
day increase in the number of available work days for the three months
ended March 31, 2004 resulted in additional revenue of approximately
$5.7 million of the $15.7 million increase.
    
    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 - 19 -




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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. During the three months ended March 31, 2004, the
revenue generated by the activities of ITSC was approximately $2.8
million.
    
    Alion completed the acquisition and purchase 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.
For the approximately seven weeks from February 14, 2004 to March 31,
2004, the revenue generated by the activities of IPS was approximately
$3.0 million.
    
    Our performance of additional work under contracts that were in
existence during the prior year. 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., accounted for approximately
$1.6 million of increased revenue, while our support to the Department
of Defense Joint Spectrum Center (JSC) accounted for approximately $1.3
million of increased revenue. Additional work in ordinance management
services for the U.S. Navy through a subcontract to Raytheon Technical
Services Corporation contributed approximately $0.6 million of the
revenue increase. On the balance of our contracts, revenue increased approximately $0.7
million for the three months ended March 31, 2004 as compared to the
twelve-week period ended March 14, 2003. Excluding the $5.7 million and $5.8 million increases in revenue
associated with the impact of the additional six working days during the three
months ended March 31, 2004 and the acquisition of ITSC and IPS operations,
respectively, revenue increased approximately $4.2 million, or 8.6%, to $53.2
million (as adjusted) for the three-month period ended March 31, 2004 from
$49.0 million for the twelve-week period ended March 14, 2003. As a component of revenue, material and subcontract (M&S) revenue
increased approximately $3.7 million, or 30.0%, to $16.0 million for the three
months ended March 31, 2004 from $12.3 million for the twelve-week period ended
March 14, 2003. Approximately $1.3 million of the $3.7 million increase is due
to the six-day increase in available workdays for the three-month period ended
March 31, 2004 as compared to the twelve-week period ended March 14, 2003 while
approximately $2.3 million of the $3.7 million increase is related to
activities performed by ITSC and IPS operations. Also, approximately $0.1
million of the $3.7 million increase is associated with M&S activity on the
balance of our contracts. 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 $10.4
million, or 28.9%, to $46.4 million for the three months ended March 31, 2004,
from $36.0 million for the twelve-week period ended March 14, 2003.
Approximately $4.0 million of the $10.4 million increase in direct contract
expenses is due to the impact of the additional six working days in the three
months ended March 31, 2004 while approximately $4.5 million of the $10.4
million increase is attributable to the activities of the ITSC and IPS
operations and approximately $1.9 million of the $10.4 million increase is
attributable to additional work on the contracts referenced above
(see Revenues). As a component of direct contract expenses, direct labor
costs for the three months ended March 31, 2004 increased by $6.5 million or
26.9% to approximately $30.3 million for the three months ended March 31, 2004
from $23.8 million for the twelve-week period ended March 14, 2003.
Approximately $2.7 million of the $6.5 million increase in direct labor cost is
due to the impact of the additional six working days in the three months ended
March 31, 2004 while approximately $2.1 million of the increase in direct labor
cost is attributable to the direct labor performed in connection with the activities of ITSC
and IPS. The remaining $1.7 million increase is attributable to increased
direct labor cost incurred on existing contracts. As a component of direct contract expense, other direct costs (ODCs)
increased by $0.6 million or 35.3% to approximately $2.3 million for the
quarter ended March 31, 2004 from approximately $1.7 million for the
twelve-week period ended March 14, 2003. Approximately $0.1 million of the
$0.6 million increase is due to the additional six working days in the three
months ended March 31, 2004 while approximately $0.1 million of the increase to
ODCs is attributable to the activities of the ITSC and IPS operations. The
remaining $0.4 million increase is attributable to ODCs incurred on existing
contracts. - 20 -




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As a component of direct contract expense, material and subcontract cost
increased approximately $3.4 million, or 32.3%, to $13.9 million for the three
months ended March 31, 2004, compared to $10.5 million for the twelve-week
period ended March 14, 2003. Approximately $1.1 million of the $3.4 million
increase in M&S costs is due to the impact of the additional six working days
that occurred for the three months ended March 31, 2004 while approximately
$2.2 million of the increase in M&S is related to the M&S activities performed
by the ITSC and IPS operations. The remaining increase of approximately $0.1
million is attributable to increased M&S costs incurred on existing contracts
for the twelve-week period ended March 14, 2003. As a percentage of revenue, direct contract expenses decreased to 71.7%
for the three months ended March 31, 2004 from 73.5% for the twelve-week period
ended March 14, 2003. For the twelve-week period ended March 14, 2003, revenue
was reduced by approximately $0.6 million related to certain additional
non-reimbursable contract costs. Absent this
revenue reduction, direct contract expenses, as a percentage of revenue would
have been approximately 72.6% for the twelve-week period ended March 14, 2003. Gross Profit.Gross profit increased $5.3 million, or 40.8%, to $18.3
million for the three months ended March 31, 2004, from $13.0 million for the
twelve-week period ended March 14, 2003. Approximately $1.7 million of the $5.3
million increase is due to the additional gross profit recognized on the
revenue generated during the six additional working days during the three
months ended March 31, 2004 while approximately $1.2 million of the $5.3
million increase is attributable to the gross profit generated by the contracts
performed by the ITSC and IPS operations. The remaining increase comes from additional
profits on existing contracts. Gross profit as a percentage of revenue increased to 28.3% for the three
months ended March 31, 2004, from 26.5% for the twelve-week period ended March
14, 2003. For the twelve-week period ended March 14, 2003, revenue was reduced
by approximately $0.6 million related to certain additional costs on a
fixed-price contract and a non-reimbursement contract. This revenue adjustment
resulted in a corresponding reduction in gross profit. Excluding this revenue
reduction, gross profit, as a percentage of revenue, would have been
approximately 27.4% for the twelve-week period ended March 14, 2003. Operating Expenses.Operating expenses increased $3.7 million, or 26.8% to
$17.5 million for the three months ended March 31, 2004, from $13.8 million for
the twelve-week period ended March 14, 2003. Approximately $1.6 million of the
$3.7 million increase is due to the additional six working days in the three
months ended March 31, 2004 while approximately $0.6 million is attributable to
the activities of the ITSC and IPS operations. Approximately $1.5 million of
the $3.7 million increase is attributable to the increase in infrastructure to
support the revenue growth. 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 $3.7 million, or 35.2%, to $14.2 million for the three months
ended March 31, 2004, from $10.5 million for the twelve-week period ended March
14, 2003. Approximately $1.3 million of the increase in net operating expenses
is due to the impact of the six additional working days during the three months
ended March 31, 2004 as compared to the twelve-week period ended March 14, 2003
while approximately $0.6 million of the $3.7 million increase is attributable
to the operating expenses incurred by the ITSC and IPS operations.
Approximately $1.8 million of the $3.7 million increase is associated with the
additional infrastructure required to support the revenue growth. As a component of operating expenses, overhead expenses for indirect
personnel and facilities costs related to rental and occupancy expenses
increased approximately $2.3 million, or 46.7%, to $7.2 million for the three
months ended March 31, 2004, from $4.9 million for the twelve-week period ended
March 14, 2003. Approximately $0.6 million of the $2.3 million increase is due
to the additional six working days during the three months ended March 31,
2004, and approximately $0.6 million is attributable to indirect personnel and
occupancy costs incurred by the ITSC and IPS operations. The remaining $1.1
million increase is due to infrastructure needs in support of the revenue
growth. - 21 -




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As a second component of our operating expenses, general and
administrative expense increased approximately $1.5 million, or 27.8%, to $6.9
million for the three months ended March 31, 2004, compared to $5.4 million for
the twelve-week period ended March 14, 2003. Approximately $0.7 million of the
$1.5 million increase is due to the impact of the additional six working days.
The remaining $0.8 million increase is due to additional costs to support the
infrastructure. As a percentage of revenue, general and administrative expenses
decreased to 10.6% for the three months ended March 31, 2004, compared to 11.1%
for the twelve-week period ended March 14, 2003. Depreciation and Amortization.Depreciation and amortization expense
increased approximately $0.5 million, or 17.9%, to $3.3 million for the three
months ended March 31, 2004, as compared to $2.8 million for the twelve-week
period ended March 14, 2003. Approximately $0.4 million of the increase is for
additional depreciation on approximately $1.3 million of capital expenditures
incurred during the year ended September 30, 2003. Additionally, amortization
expense associated with the value assigned to the purchased contracts of ITSC
was approximately $0.1 million for the three-month period ended March 31, 2004.
The value to be assigned to the purchased contracts of IPS will be estimated in
the third quarter. For each respective three-month or twelve-week period,
approximately $2.4 million of total amortization expense was incurred
associated with the intangible asset value assigned to purchased customer
contracts of IITRI. Also, for each respective three-month or twelve-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 March 31, 2004,
income from operations was $0.8 million compared to a $0.8 million operating
loss for the twelve-week period ended March 14, 2003. The changes in results
from operations were due to the factors discussed above. Other Income and Expense.Other expenses increased approximately $1.9
million, or 82.6%, to $4.2 million for the three months ended March 31, 2004 as
compared to $2.3 million for the twelve-week period ended March 14, 2003.
Approximately $0.3 million of the $1.9 million increase is due to the amount of
interest expense recognized resulting from the conversion to a three-month
quarter from a twelve-week interim period. The number of interest-bearing days
increased to 92 for the three-month quarter ended March 31, 2004 from 84 days
for the twelve-week period ended March 14, 2003.
However, absent the impact of the eight additional days, approximately $1.4 million of
the $1.9 million increase is associated with the interest expense incurred
related to the debt financing associated with the purchase of the assets from
IITRI. Warrant repurchase liabilities increased as a result of an increase in
the share price of Alions common stock which resulted in additional interest
expense. Approximately $0.4 million of the $1.9 million increase is associated
with an increase in the deferred compensation expense related to Alions stock
appreciation rights and phantom stock plans. For the three months ended March
31, 2004, the deferred compensation expense was approximately $0.5 million
while for the twelve-week period ended March 14, 2003, the deferred
compensation expense was approximately $0.1 million. The remaining $0.1 million
of the $1.9 million increase is associated with interest expense on the
revolving credit facility which included borrowings to fund the February 13,
2004 acquisition of IPS. Income Tax (Expense) Benefit.Alion is a S-corporation and is not subject
to federal and most state income taxes. As of December 20, 2002, our
wholly-owned subsidiary, HFA elected to be a qualified subchapter S subsidiary
and is no longer treated as a taxable corporation for federal income tax
purposes. As a result, HFA recorded no income tax provision for the three
months ended March 31, 2004 or for the twelve-week period ended March 14, 2003. Net Loss.The net loss of $3.4 million for the three months ended March
31, 2004, as compared to net the loss of $3.1 million for the twelve-week period
ended March 14, 2003, was due to the factors discussed above. Six Months Ended March 31, 2004 Compared to the Pro Forma Twenty-Four Week
Period Ended March 14, 2003 Revenues.Revenues increased $27.0 million, or 28.0%, to $123.3 million
for the six months ended March 31, 2004, from $96.3 million for the
twenty-four weeks ended March 14, 2003. This $27.0 million increase is
attributable to the following: - 22 -




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
    
    For the six months ended March 31, 2004 there were 126 available
workdays (based on a standard five-day work week of Monday through
Friday and excluding designated holidays recognized by Alion) as
compared to 114 for the twenty-four week period ended March 14, 2003.
The twelve day increase in the number of available work days for the
six months ended March 31, 2004 resulted in additional revenue of
approximately $11.1 million.
    
    Alion completed the acquisition and purchase of ITSC on October 31,
2003. For the six months ended March 31, 2004, the revenue generated by
the activities of ITSC was approximately $4.2 million.
    
    Alion completed the acquisition and purchase of IPS on February 13,
2004. For the approximately seven weeks from February 14, 2004 to March
31, 2004, the revenue generated by the activities of IPS was
approximately $3.0 million.
    
    Our performance of additional work under contracts that were in
existence during the prior year. 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., accounted for approximately
$2.7 million of increased revenue, while our support to the Department
of Defense Joint Spectrum Center (JSC) accounted for approximately $1.7
million of increased revenue. Additional work in ordnance management
services for the U.S. Navy through a subcontract to Raytheon Technical
Services contributed approximately $1.7 million of the revenue
increase. On the balance of our contracts, revenue increased approximately $2.6
million for the six-month period ended March 31, 2004 as compared to the
twenty-four week period ended March 14, 2003. Excluding the $11.1 million and $7.2 million increases in revenue
associated with the impact of the additional twelve working days during the six
months ended March 31, 2004 and the acquisition of ITSC and IPS operations,
respectively, revenue (as adjusted) increased approximately $8.7 million, or
9.0%, to $105.0 million for the six-month period ended March 31, 2004 from
$96.3 million for the twenty-four week period ended March 14, 2003. As a component of revenue, M&S revenue increased approximately $8.0
million, or 35.2%, to $30.7 million for the six months ended March 31, 2004
from $22.7 million for the twenty-four week period ended March 14, 2003.
Approximately $2.7 million of the $8.0 million increase is due to the
twelve-day increase in available workdays for the six-month period ended March
31, 2004 as compared to the twenty-four week period ended March 14, 2003. Also,
approximately $3.4 million of the $8.0 million increase in M&S revenue is
related to activities performed by ITSC and IPS operations. Approximately $1.9
million of the $8.0 million increase is associated with M&S activity on the
balance of our contracts. 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 $17.8
million, or 25.2%, to $88.5 million for the six months ended March 31, 2004,
from $70.7 million for the twenty-four week period ended March 14, 2003.
Approximately $7.9 million of the $17.8 million increase in direct contract
expense is due to the impact of the additional twelve working days in the six
months ended March 31, 2004 while approximately $5.5 million of $17.8 million
increase is attributable to the activities of the ITSC and IPS operations and
approximately $4.4 million of the $17.8 million increase is attributable to the
additional contract performance referenced above (see Revenues). As a component of direct contract expenses, direct labor costs for the six
months ended March 31, 2004 increased by $10.0 million or 21.2% to $57.2
million for the six months ended March 31, 2004 from $47.2 million for the
twenty-four week period ended March 14, 2003. Approximately $5.2 million of the
$10.0 million increase in direct labor cost is due to the impact of the
additional twelve working days in the six months ended March 31, 2004 while
approximately $2.7 million of the increase in direct labor cost is attributable
to the direct labor related to the activities of the ITSC and IPS operations.
The remaining $2.1 million increase is attributable to increased direct labor
cost incurred on existing contracts. As a component of direct contract expense,
ODCs increased by $1.0 million or 29.4% when compared to the twenty-four week
period ended March 14, 2003. Approximately $0.4 million of the $1.0 million
increase in ODCs is due to the impact of the twelve additional working days in
the six months ended March 31, 2004 while approximately $0.1 of the $1.0
million increase is attributable to the activities - 23 -




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of the ITSC and IPS operations. The remaining $0.5 million increase is
associated with ODCs incurred on the balance of our contracts. As a component of direct contract expense, material and subcontract cost
increased approximately $6.5 million, or 31.9%, to $26.9 million for the six
months ended March 31, 2004, compared to $20.4 million for the twenty-four week
period ended March 14, 2003. Approximately $2.3 million of the $6.5 million
increase in M&S costs is due to the impact of the additional twelve working
days that occurred for the six months ended March 31, 2004 while approximately
$2.6 million of the increase in M&S is related to the M&S activities performed
by the ITSC and IPS operations. The remaining increase of $1.6 million is
attributable to increased M&S cost incurred on existing contracts. As a percentage of revenue, direct contract expenses decreased to 71.8%
for the six months ended March 31, 2004 from 73.4% for the twenty-four week
period ended March 14, 2003. For the twenty-four week period ended March 14,
2003, revenue was reduced by approximately $0.6 million related to certain
additional non-reimbursable contract costs. Absent this revenue reduction,
direct contract expenses as a percentage of revenue, would have been
approximately 73.0% for the twenty-four week period ended March 14, 2003. Gross Profit.Gross profit increased $9.2 million, or 35.9%, to $34.8
million for the six months ended March 31, 2004, from $25.6 million for the
twenty-four week period ended March 14, 2003. Approximately $3.2 million of the
$9.2 million increase is due to the additional gross profit generated during
the twelve additional working days in the six months ended March 31, 2004 while
approximately $1.5 million of the $9.2 million increase is attributable to the
gross profit generated by the contracts performed by the ITSC and IPS
operations. The remaining $4.5 million increase is associated with gross profit
generated on the balance of our contracts. Gross profit as a percentage of revenue increased to 28.2% for the six
months ended March 31, 2004, from 26.5% for the twenty-four week period ended
March 14, 2003. For the twenty-four week period ended March 14, 2003, revenue
was reduced by approximately $0.6 million related to certain additional costs
on a fixed-price contract and a non-reimbursement contract. Absent this revenue
reduction, gross profit as a percentage of revenue would have been
approximately 27.0% for the twenty-four week period ended March 14, 2003. Operating
Expenses.Operating expenses increased $2.3 million, or 7.1% to
$34.6 million for the six months ended March 31, 2004, from $32.3 million for
the twenty-four week period ended March 14, 2003. However, for the twenty-four
week period ended March 14, 2003, there was approximately $5.8 million in
non-recurring, transaction-related expense. There were no such costs incurred
for the six months ended March 31, 2004. As such, the adjusted increase in
operating expense was approximately $8.1 million ($2.3 million plus $5.8
million). On an adjusted basis, approximately $3.2 million of
the $8.1 million
increase is due to the additional twelve working days in the six months ended
March 31, 2004. Approximately $0.9 million of the $8.1 million adjusted
increase is attributable to the activities of the ITSC and IPS operations while
approximately $4.0 million of the adjusted increase is attributable to the
infrastructure costs in support of the revenue growth. Operating expenses, net
of depreciation, amortization, and non-recurring transaction-related expense
increased approximately $7.4 million, or 35.6%, to $28.2 million for the six
months ended March 31, 2004, from $20.8 million for the twenty-four week period
ended March 14, 2003. Approximately $2.7 million of the increase in total
operating expenses is due to the impact of the twelve additional working days
during the six months ended March 31, 2004 as compared to the twenty-four week
period ended March 14, 2003, while approximately $0.9 million of the $7.4
million increase is attributable to the operating expenses incurred by the ITSC
and IPS operations. Approximately $3.8 million of the increase is attributable
to the additional infrastructure required to support the revenue growth. As a component of our operating expenses, overhead expenses for indirect
personnel and facilities costs related to rental and occupancy expenses
increased approximately $4.0 million, or 41.2%, to $13.7 million for the six
months ended March 31, 2004, from $9.7 million for the twenty-four week period
ended March 14, 2003. Approximately $1.3 million of the $4.0 million increase
is due to the additional twelve working days during the six months ended March
31, 2004, and approximately $0.9 million is attributable to facility and
occupancy costs - 24 -




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incurred by ITSC and IPS operations. The remaining $1.8 million increase
was driven by infrastructure needs in support of the revenue growth. As a second component of our operating expenses, general and
administrative expense increased approximately $3.6 million, or 33.6%, to $14.3
million for the six months ended March 31, 2004, compared to $10.7 million for
the twenty-four week period ended March 14, 2003. Approximately $1.4 million of
the $3.6 million increase is due to the impact of the additional twelve working
days. Approximately $0.7 million of the $3.6 million increase was due to
outside legal fees of $0.5 million associated with the AB Technologies
arbitration proceedings and year-end audit fees of approximately $0.2 million.
The remaining $1.5 million increase is due to additional costs to support the
infrastructure. As a percentage of revenues, general and administrative
expenses increased to 11.6% for the six months ended March 31, 2004, compared
to 11.2% for the twenty-four week period ended March 14, 2003. Depreciation and Amortization.Depreciation and amortization expense
increased approximately $0.7 million, or 12.3%, to $6.4 million for the six
months ended March 31, 2004, as compared to $5.7 million for the twenty-four
week period ended March 14, 2003. Approximately $0.6 million of the increase is
due to additional depreciation expense associated with approximately $1.3
million of capital expenditures incurred during the year ended September 30,
2003. As part of the $0.7 million increase, amortization expense associated
with the intangible asset value assigned to the purchased customer contracts of
ITSC was $0.1 million for the six-month period ended March 31, 2004. For each
respective six-month or twenty-four week period, approximately $4.9 million of
total amortization expense was incurred associated with the intangible asset
value assigned to purchased customer contracts of IITRI. Also, for each
respective six-month or twenty-four week period, approximately $0.2 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 six months ended March 31, 2004,
income from operations was $0.2 million compared with $6.7 million operating
loss for the twenty-four-week period ended March 14, 2003. The results from
operations were due to the factors discussed above. Other Income and Expense.Other expenses increased approximately $3.5
million, or 79.5%, to $7.9 million for the six months ended March 31, 2004 as
compared to $4.4 million for the twenty-four week period ended March 14, 2003.
Approximately $0.5 million of the $3.5 million increase is due to the interest
expense recognized resulting from the conversion to a three-month quarter from
a twelve week interim period. The number of days for the six months ended
March 31, 2004 increased to 183 from 168 for the twenty-four week interim
period ended March 14, 2003. However, absent the impact of the fifteen
additional days, approximately $2.4 million of the $3.5 million increase is
associated with the interest expense incurred related to the debt financing
associated with the purchase of the assets from IITRI; specifically, the
warrant repurchase liabilities increased as a result of an increase in the
share price of Alions common stock which resulted in additional interest
expense. Also, approximately $0.8 million of the $3.5 million increase is
associated with an increase in the deferred compensation expense related to
Alions stock appreciation rights and phantom stock plans. For the six months
ended March 31, 2004, the deferred compensation expense was approximately $0.9
million while for the twenty-four-week period ended March 14, 2003, the
deferred compensation expense was $0.1 million. Approximately $0.2 million of
the $3.5 million increase is due to an increase in the interest expense on the
mezzanine and subordinate note resulting from the increase in the number of
days in which interest accrued to 183 days for the six months ended March 31,
2004 from 85 days commencing with the date of issuance (December 20, 2002) to
March 14, 2003. For the six months ended March 31, 2004, interest expense on
the mezzanine note and subordinate note was approximately $2.6 million and for
the twenty-four week period ended March 14, 2003, interest expense on the
mezzanine note and subordinate note was $2.4 million. The remaining $0.1
million of the $3.5 million increase is associated with interest expense on the
revolving credit facility which was used to fund the acquisition of IPS. Income Tax (Expense) Benefit.Our wholly-owned subsidiary, HFA, had
operating income of approximately $0.7 for the six months ended March 31, 2004,
compared to $0.3 million for the twenty-four-week period ended March 14, 2003.
As of December 20, 2002, HFA was elected to be a qualified subchapter S
subsidiary and is no longer treated as a taxable corporation for federal income
tax purposes. As a result, HFA recorded no - 25 -




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income tax provision for the six months ended March 31, 2004 and
approximately $0.03 million for the twenty-four-week period ended March 14,
2003. Net Loss.The net loss of $7.7 million for the six months ended March 31,
2004, as compared to net loss of $11.2 million for the twenty-four week period
ended March 14, 2003, was due to the factors discussed above. 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. In accordance with FSP 106-1, 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
cash provided by operating activities and drawdowns from our revolving credit
facility. The following discussion relates to the cash flow of Alion for the six
months ended March 31, 2004 as compared to the cash flow of Alion for the
twelve-week period ended March 14, 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 provided by operating activities was $3.6 million for the six
months ended March 31, 2004, an increase of $1.9 million from the $1.7 million
provided by operating activities for the twenty-four week period ended March 14, 2003. The primary reason
for this $1.9 million increase in cash provided by operations results from the
increase in the adjustment to the net loss from operating activities of approximately $2.6
million from non-cash interest expense (e.g. accretion of debt to face value,
amortization of debt issuance costs, and the change in fair market value of the
redeemable common stock warrants) associated with the debt structure which
resulted from the Transaction compared to the twenty-four week period ended
March 14, 2003. Net cash used in investing activities was $16.3
million for the six months ended March 31, 2004, and $59.3 million for the
twenty-four week period ended March 14, 2003. Approximately $13.1 million of
the $16.3 million of cash used during the six months ended March 31, 2004 was
for the acquisition and purchase of ITSC and IPS. During the twenty-four week
period ended March 14, 2003, the cash Alion paid for the selected operations of
IITRI was $58.6 million. Cash of $25.8 million was generated from the sale of
Alion common stock to the ESOP Trust, and $32.1 million resulted from net
borrowings under the Senior Term Note. Net cash provided by financing activities was $12.4 million for the six
months ended March 31, 2004, compared to cash provided by financing activities
of $58.5 million for the twenty-four week period ended March 14, 2003. For the
six months ended March 31, 2004, net cash provided by financing activities was
primarily the result of increased borrowings under Alions working capital
bank facility. For the six months ended March 31, 2004, the balance drawn under
the working capital facility was approximately $14.6 million primarily to fund
the acquisition of IPS. For the twenty-four week period ended March 14, 2003,
the balance drawn was approximately $7.0 million. During the twenty-four week
period ended March 14, 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. - 26 -




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Discussion of Debt Structure On December 20, 2002, the Company entered into 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. The new agreement consists of a $25.0 million
revolving credit facility and a $35.0 million term loan to finance, in part,
the IITRI acquisition. Principal repayments under the term loan are payable in
quarterly installments. As of March 31, 2004, the approximate remaining fiscal
year principal repayments (taking into account previous repayments) of $26.8
million under the term loan are as follows: Fiscal Year Ended September 30, 2004
    
    $2.5 millionFiscal Year Ended September 30, 2005
    
    $6.9 millionFiscal Year Ended September 30, 2006
    
    $8.3 millionFiscal Year Ended September 30, 2007
    
    $8.9 millionFiscal Year Ended September 30, 2008
    
    $0.2 million
 The Company must repay all principal obligations under the revolving
credit facility no later than December 20, 2007. The senior credit facility is
secured by a first priority, perfected security interest in all of the
Companys current and future tangible and intangible property. From December 20, 2002 until January 31, 2004, the term note and the
revolving line of credit under the senior credit facility bore interest at
either of two floating rates at the Companys choice: an annual rate equal to
the Eurodollar rate plus 350 basis points, or the LaSalle Bank prime rate plus
200 basis points. After January 31, 2004, the interest rate equals the
Eurodollar rate or the prime rate plus margins which will vary depending upon
the Companys leverage ratio. Leverage ratio is the ratio of total funded debt,
excluding the Subordinated Note (described below), to earnings before interest,
taxes, depreciation, amortization, ESOP repurchase obligations and non-cash
compensation expenses. Revolving Creditand Term Loan
    
    Level I
    
    Level II
    
    Level III
    
    Level IVLeverage ratio
    
    Less than 2.0 to 1.0
    
    Less than 2.5 to
1.0 and greater
than or equal to
2.0 to 1.0
    
    Less than 3.0 to
1.0 and greater
than or equal to
2.5 to 1.0
    
    Greater than or
equal to 3.0 to 1.0Base rate margin
    
    125 basis points
    
    150 basis points
    
    175 basis points
    
    200 basis pointsEurodollar margin
    
    275 basis points
    
    300 basis points
    
    325 basis points
    
    350 basis pointsCommitment fee
(usage less than
40%)
    
    100 basis points
    
    100 basis points
    
    100 basis points
    
    100 basis pointsCommitment fee
(usage greater than
or equal to 40%)
    
    50 basis points
    
    50 basis points
    
    50 basis points
    
    50 basis points
 Interest on the term note was payable at the LaSalle Bank prime rate plus
200 basis points through February 14, 2003. Effective February 14, 2003, the
Company exercised its right to have the term note bear interest at a Eurodollar
rate plus 350 basis points. This did not affect the interest rate on the
revolving line of credit. Thereafter the term note bore interest at the
Eurodollar rate plus 350 basis points. - 27 -




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The Company and one of its senior lenders entered into an interest rate
cap agreement which runs from February 3, 2003 through February 3, 2007. Under
this agreement, the Companys maximum effective interest rate on the first
$25.0 million of the term note principal will not exceed 6%. The senior lender
counterparty to the cap agreement will semiannually calculate and reimburse the
Company for all interest payments in excess of this 6% ceiling. On February 6, 2004, Amendment Number 1 to the Senior Credit Agreement was
executed by and among the parties whereby the definition of Borrowing Base
(Senior Debt) has been redefined for the fiscal period ending December 31,
2003. As such, the amended definition increased the Companys
borrowing capacity under the Senior Credit Agreement for the fiscal period ended
December 31, 2003. On March 31, 2004, Amendment Number 2 to the Senior Credit Agreement was
entered into, whereby 1) certain cash payments for earn out obligations under
current arrangements are to be excluded in fiscal year 2004 for purposes of
calculating the minimum Fixed Price Charge Coverage Ratio, 2) the effective
period of Borrowing Base Formula for Senior Debt (ii) is to apply for the
fiscal periods ending March 31, 2004, June 30, 2004, and September 30, 2004, 3)
the Borrowing Base Formula Senior Debt (ii) is amended to include an advance
for fifty percent (50%) of the total billed receivables outstanding one-hundred
and twenty-one days (121) or more for the date of original invoice, plus fifty
percent (50%) of the value of the net property, and equipment of the Borrower,
and 4) the waiver of the requirement to have the mezzanine (and warrants) that
were purchased from an officer of the Company be repurchased by a member of
Alions senior management team. As such, the adoption of this amendment
potentially increases the Companys borrowing capacity under the Senior Credit
Agreement. On March 31, 2004, the Company had approximately $26.8 million in
borrowings outstanding under the senior term note with approximately $14.6
million outstanding under the revolving credit facility. The revolving credit
facility bears interest at the LaSalle Bank prime rate plus 200 basis points,
which was 6.0% as of March 31, 2004. The approximately $26.8 million balance
remaining under the senior term note bears interest at the Eurodollar rate plus
350 basis points, which was 4.62% as of March 31, 2004. The Company may prepay its borrowings under the senior credit facility 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 any permitted debt or equity
issuance or asset sale. 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. The Company must pay the 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. 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
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. The Company will issue 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 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. 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 - 28 -




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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. 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 warrantholders 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). Under the terms of the senior credit facility, 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 and minimum EBITDAE. EBITDAE is defined in the senior
credit facility as earnings before interest, taxes, depreciation, amortization,
ESOP repurchase obligations and non-cash compensation expenses. The Mezzanine
Note contains financial covenants similar to those contained in the senior
credit facility, but on less onerous terms mutually agreed upon by the Company,
IITRI and the senior lenders. The Subordinated Note includes covenants
customary for deeply subordinated obligations, such as the timely payment of
principal and interest. 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 - 29 -




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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. Through March 31, 2004, the Company recognized approximately $4.5 million
in additional earn out obligations due Messrs. Andrews and Bewley and
approximately $0.3 million for potential payments to employees who worked in
the business units subject to this earn out. As of March 31, 2004, the Company
had paid approximately $0.7 million to Messrs. Andrews and Bewley for earn outs
and purchase price adjustments. The Company expects to pay Messrs. Andrews and
Bewley approximately $3.5 million in the quarter ending June 30, 2004 and
approximately $3.3 million in the quarter ending September 30, 2004. The Companys minimum lease payment obligations under non-cancelable
operating leases for the full fiscal years ending 2004, 2005, 2006, 2007 and 2008 are
$9.8 million, $10.8 million, $8.6 million, $8.7 million and $8.6 million,
respectively. The remaining aggregate obligations on these leases
thereafter are approximately $17.2 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. In December 2003, the Company spent $0.7 million to re-purchase 50,031
shares of its common stock from the ESOP Trust at $14.71 per share to satisfy
obligations to terminated employees. 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 continue 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 2007
through 2010, it expects that it will need to refinance a portion of its
indebtedness at least by fiscal year 2007. 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. - 30 -




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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 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 $1.8 million of the Companys $26.8 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 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. 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. - 31 -




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PART IIOTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS On September 16, 2002, IITRI, Alions predecessor entity, filed a lawsuit
against Clyde Andrews and William Bewley in the U.S. District Court for the
Eastern District of Virginia, which we refer to as the Court. Messrs. Andrews
and Bewley were formerly the shareholders of AB Technologies, Inc. IITRI
acquired substantially all of the assets of AB Technologies in February 2000. The lawsuit sought to compel the defendants to submit disputed issues to
an independent accounting firm, in accordance with the terms of the asset
purchase agreement. The Company also sought declaratory judgment that it is
entitled to a downward adjustment to the purchase price and a finding that it
properly computed the earnout required by the asset purchase agreement. 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. The consolidated federal action was
subsequently dismissed without prejudice. Alion assumed responsibility for and
acquired all claims under both of these lawsuits, and the ensuing arbitration,
as part of its acquisition of IITRIs assets. 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. Through March 31, 2004, the Company recognized approximately $4.5 million
in additional earn out obligations due Messrs. Andrews and Bewley
for the fiscal year ended September 30, 2003 and for the six-month period ended March 31, 2004.
Additionally, the Company recognized approximately $0.3 million for potential payments to employees who worked in
the business units subject to this earn out. As of March 31, 2004, the Company
had paid approximately $0.7 million to Messrs. Andrews and Bewley for earn outs
and purchase price adjustments. The Company expects to pay Messrs. Andrews and
Bewley approximately $3.5 million in the quarter ending June 30, 2004 and
approximately $3.3 million in the quarter ending September 30, 2004. 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 alleges 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; - 32 -




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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. Discovery has commenced and is ongoing. Alion is seeking an injunction
barring the defendants from using Alions trade secrets, as well as exemplary
damages. Other than the foregoing actions, the Company is not involved in any 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 None. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 
 ITEM 5. OTHER INFORMATION None. - 33 -




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##### 



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) ExhibitNo.
    
    Description2.1
    
    Stock Purchase Agreement by and among Identix Public Sector, Inc. Identix
Incorporated and Alion Science and Technology Corporation, dated February 13,
2004.(1)3.1
    
    Second Amended and Restated Certificate of Incorporation of Beagle Holdings, Inc.(2)3.2
    
    Amended and Restated By-laws of Alion Science and Technology Corporation.(3)4.1
    
    Amended and Restated Alion Science and Technology Corporation Employee Ownership,
Savings and Investment Plan.(4)4.2
    
    First Amendment to The Alion Science and Technology Corporation Employee Ownership,
Savings and Investment Plan.(5)4.3
    
    Second Amendment to The Alion Science and Technology Corporation Employee
Ownership, Savings and Investment Plan.(6)4.4
    
    Third Amendment to The Alion Science and Technology Corporation Employee Ownership,
Savings and Investment Plan. (6)4.5
    
    Fourth Amendment to The Alion Science and Technology Corporation Employee
Ownership, Savings and Investment Plan. (6)4.6
    
    Fifth Amendment to The Alion Science and Technology Corporation Employee Ownership,
Savings and Investment Plan. (7)4.7
    
    Sixth Amendment to The Alion Science and Technology Corporation Employee Ownership,
Savings and Investment Plan. (7)4.8
    
    Seventh Amendment to The Alion Science and Technology Corporation Employee
Ownership, Savings and Investment Plan. (7)4.9
    
    Eighth Amendment to The Alion Science and Technology Corporation Employee
Ownership, Savings and Investment Plan. (7)10.29
    
    First Amendment to the Credit Agreement by and among LaSalle Bank National
Association as agent, various lenders and Alion Science and Technology
Corporation.(8)10.30
    
    Second Amendment to the Credit Agreement by and among LaSalle Bank National
Association as agent, various lenders and Alion Science and Technology Corporation.10.31
    
    Employment Agreement between Alion Science and Technology Corporation and James
Fontana.10.32
    
    Employment Agreement between Alion Science and Technology Corporation and Leroy R.
Goff III.31.1
    
    Certification of Chief Executive Officer of Alion Science and Technology
Corporation pursuant to Rule 15d-14(a) promulgated under the Securities Exchange
Act of 1934, as amended.31.2
    
    Certification of Chief Financial Officer of Alion Science and Technology
Corporation pursuant to 15d-14(a) promulgated under the Securities Exchange Act of
1934, as amended.
 - 34 -




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##### 



ExhibitNo.
    
    Description32.1
    
    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 Companys current report on Form 8-K/A, filed with the
Securities and Exchange Commission on March 5, 2004 (File no.
950133-04-000745).(2)
    
    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).(3)
    
    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).(4)
    
    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).(5)
    
    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).(6)
    
    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).(7)
    
    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).(8)
    
    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 December 31, 2003, filed with the Securities and
Exchange Commission on February 17, 2003 (File no. 950133-04-000432). (b) Reports on Form 8-K: The Company filed a Report on Form 8-K on February 13, 2004 with respect
to Item 5. Other Events and Required FD Disclosure and Item 7 Financial
Statements, Pro Forma Financial Information and Exhibits announcing the
acquisition of Identix Public Sector, Inc., dated February 13, 2004. The Company filed an amendment to its Report on Form 8-K on March 5, 2004
with respect to Item 2. Acquisition or Disposition of Assets, Item 5. Other
Events and Required FD Disclosure and Item 7. Financial Statements, Pro Forma
Financial Information and Exhibits announcing the acquisition of Identix Public
Sector, Inc., dated February 13, 2004. The Company filed a Report on Form 8-K on March 8, 2004 with respect to Item
12. Results of Operations and Financial Condition, dated March 8, 2004. - 35 -




---



##### 



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: May 14, 2004
    
    By: /s/ John M. HughesName: John M. HughesTitle: Chief Financial Officer(Principal Financial and Accounting Officerand Duly Authorized Officer)
 - 36 -




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##### 



EXHIBIT INDEX ExhibitNo.
    
    Description2.1
    
    Stock Purchase Agreement by and among Identix Public Sector, Inc. Identix
Incorporated and Alion Science and Technology Corporation, dated February 13,
2004.(1)3.1
    
    Second Amended and Restated Certificate of Incorporation of Beagle Holdings, Inc.(2)3.2
    
    Amended and Restated By-laws of Alion Science and Technology Corporation.(3)4.1
    
    Amended and Restated Alion Science and Technology Corporation Employee Ownership,
Savings and Investment Plan.(4)4.2
    
    First Amendment to The Alion Science and Technology Corporation Employee Ownership,
Savings and Investment Plan.(5)4.3
    
    Second Amendment to The Alion Science and Technology Corporation Employee
Ownership, Savings and Investment Plan.(6)4.4
    
    Third Amendment to The Alion Science and Technology Corporation Employee Ownership,
Savings and Investment Plan. (6)4.5
    
    Fourth Amendment to The Alion Science and Technology Corporation Employee
Ownership, Savings and Investment Plan. (6)4.6
    
    Fifth Amendment to The Alion Science and Technology Corporation Employee Ownership,
Savings and Investment Plan. (7)4.7
    
    Sixth Amendment to The Alion Science and Technology Corporation Employee Ownership,
Savings and Investment Plan. (7)4.8
    
    Seventh Amendment to The Alion Science and Technology Corporation Employee
Ownership, Savings and Investment Plan. (7)4.9
    
    Eighth Amendment to The Alion Science and Technology Corporation Employee
Ownership, Savings and Investment Plan. (7)10.29
    
    First Amendment to the Credit Agreement by and among LaSalle Bank National
Association as agent, various lenders and Alion Science and Technology
Corporation.(8)10.30
    
    Second Amendment to the Credit Agreement by and among LaSalle Bank National
Association as agent, various lenders and Alion Science and Technology Corporation.10.31
    
    Employment Agreement between Alion Science and Technology Corporation and James
Fontana.10.32
    
    Employment Agreement between Alion Science and Technology Corporation and Leroy R.
Goff III.31.1
    
    Certification of Chief Executive Officer of Alion Science and Technology
Corporation pursuant to Rule 15d-14(a) promulgated under the Securities Exchange
Act of 1934, as amended.31.2
    
    Certification of Chief Financial Officer of Alion Science and Technology
Corporation pursuant to 15d-14(a) promulgated under the Securities Exchange Act of
1934, as amended.
 - 37 -




---



##### 



ExhibitNo.
    
    Description32.1
    
    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 Companys current report on Form 8-K/A, filed with the
Securities and Exchange Commission on March 5, 2004 (File no.
950133-04-000745).(2)
    
    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).(3)
    
    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).(4)
    
    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).(5)
    
    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).(6)
    
    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).(7)
    
    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).(8)
    
    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 December 31, 2003, filed with the Securities and
Exchange Commission on February 17, 2003 (File no. 950133-04-000432). - 38 -