Form 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

Form 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2008.

COMMISSION FILE NUMBER 333-89756

Alion Science and Technology Corporation

(Exact Name of Registrant as Specified in Its Charter)


DELAWARE (State or Other Jurisdiction of Incorporation of Organization)		54-2061691 (I.R.S. Employer Identification No.)

10 West 35^th Street Chicago, IL 60616 (312) 567-4000		1750 Tysons Boulevard, Suite 1300 McLean, VA 22102 (703) 918-4480

(Address, including Zip Code and Telephone Number with Area Code, of Principal Executive Offices)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer o	Accelerated filer o	Non-accelerated filer þ	Smaller reporting company o

(Do not check if a smaller reporting company)

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

The number of shares outstanding of Alion Science and Technology Corporation Common Stock as of February 12, 2009, was: Common Stock 5,229,523

PART I — FINANCIAL INFORMATION


Item 1.	*Financial Statements (unaudited)*

ALION SCIENCE AND TECHNOLOGY CORPORATION

Condensed Consolidated Balance Sheets (unaudited)

As of December 31, 2008 and September 30, 2008


	December 31,			September 30,
	2008			2008
	(In thousands, except share
	and per share information)

Current assets:
Cash and cash equivalents		4,830		$	16,287
Accounts receivable, net		174,518			168,451
Stock subscriptions receivable		—			2,669
Prepaid expenses and other current assets		3,927			3,135

Total current assets		183,275			190,542
Property, plant and equipment, net		17,602			18,601
Intangible assets, net		37,862			41,248
Goodwill		398,871			398,871
Other assets		6,080			6,684

Total assets	$	643,690		$	655,946

Current liabilities:
Interest payable	$	14,705		$	6,543
Current portion, Term B senior term loan payable		2,389			2,389
Interest rate swap liability		—			4,629
Current portion of subordinated note payable		3,000			3,000
Current portion, acquisition obligations		—			50
Trade accounts payable		51,445			57,164
Accrued liabilities		33,878			39,227
Accrued payroll and related liabilities		45,508			41,557
Billings in excess of costs and estimated earnings on uncompleted contracts		3,141			2,708

Total current liabilities		154,066			157,267
Term B senior term loan payable, excluding current portion		229,684			229,831
Senior unsecured notes		244,577			244,355
Subordinated note payable		41,992			42,656
Accrued compensation, excluding current portion		6,803			11,305
Accrued postretirement benefit obligations		636			627
Non-current portion of lease obligations		6,290			6,260
Redeemable common stock warrants		38,542			39,996
Redeemable common stock, $0.01 par value, 8,000,000 shares authorized, 5,229,523 and 5,229,756 shares issued and outstanding at December 31, 2008 and September 30, 2008		200,552			200,561
Accumulated other comprehensive loss		(36	)		(36	)
Accumulated deficit		(279,416	)		(276,876	)

Total liabilities, redeemable common stock and accumulated deficit	$	643,690		$	655,946

See accompanying notes to condensed consolidated financial statements.

ALION SCIENCE AND TECHNOLOGY CORPORATION

Condensed Consolidated Statements of Operations (unaudited)


	Quarter Ended
	December 31,
	2008			2007
	(In thousands, except share and per share information)

Contract revenue	$	188,796		$	183,145
Direct contract expense		145,322			140,382

Gross profit		43,474			42,763

Operating expenses:
Indirect contract expense		9,124			9,883
Research and development		69			161
General and administrative		10,173			15,741
Rental and occupancy expense		7,738			7,671
Depreciation and amortization		4,806			5,027

Total operating expenses		31,910			38,483

Operating income		11,564			4,280
Other income (expense):
Interest income		23			155
Interest expense		(14,088	)		(13,276	)
Other		(35	)		146

Total other expenses		(14,100	)		(12,975	)
Loss before income taxes		(2,536	)		(8,695	)
Income tax expense		(4	)		(11	)

Net loss	$	(2,540	)	$	(8,706	)

Basic and diluted loss per share	$	(0.49	)	$	(1.74	)

Basic and diluted weighted average common shares outstanding		5,229,523			5,012,838

See accompanying notes to condensed consolidated financial statements.

ALION SCIENCE AND TECHNOLOGY CORPORATION

Condensed Consolidated Statements of Cash Flows (unaudited)


	Quarter Ended December 31,
	2008			2007
	(In thousands)

Cash flows from operating activities:
Net loss	$	(2,540	)	$	(8,706	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		4,806			5,027
Accretion of debt to face value		590			246
Amortization of debt issuance costs		683			442
Change in fair value of redeemable common stock warrants		(1,454	)		(104	)
Stock-based compensation		(4,603	)		2,046
Loss on interest rate swap		18			—
Changes in assets and liabilities:
Accounts receivable, net		(6,066	)		(39,274	)
Other assets		(188	)		(1,480	)
Trade accounts payable		(5,719	)		3,285
Accrued liabilities		(1,197	)		3,148
Interest payable		8,162			1,713
Other liabilities		2,219			1,681

Net cash used in operating activities		(5,289	)		(31,976	)
Cash flows from investing activities:
Cash paid for acquisitions-related obligations		(166	)		—
Capital expenditures		(407	)		(1,223	)

Net cash used in investing activities		(573	)		(1,223	)
Cash flows from financing activities:
Change in book overdraft		—			2,065
Cash paid under interest rate swap		(4,647	)		—
Payment of Term B Credit Facility principal		(608	)		(618	)
Payment of subordinated note principal		(3,000	)		—
Revolving credit facility borrowings		97,600			113,880
Revolving credit facility payments		(97,600	)		(96,580	)
Purchase of redeemable common stock from ESOP Trust		(9	)		(12	)
Cash received from issuance of redeemable common stock to Trust		2,669			3,377

Net cash (used in) provided by financing activities		(5,595	)		22,112
Net decrease in cash and cash equivalents		(11,457	)		(11,087	)
Cash and cash equivalents at beginning of period		16,287			11,684

Cash and cash equivalents at end of period	$	4,830		$	597

Supplemental disclosure of cash flow information:
Cash paid for interest	$	4,282		$	10,086
Cash paid for taxes		4			11

See accompanying notes to condensed consolidated financial statements.

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


(1)	Description and Formation of the Business

Alion Science and Technology Corporation and its subsidiaries (collectively, the Company or Alion) provide scientific, engineering and information technology expertise to research and develop technological solutions for problems relating to national defense, homeland security, and energy and environmental analysis. Alion provides services to departments and agencies of the federal government and, to a lesser extent, to commercial and international customers.

Alion is a for-profit S-Corporation formed in October 2001 to purchase substantially all of the assets and certain liabilities of IIT Research Institute (IITRI), a not-for-profit corporation controlled by Illinois Institute of Technology (IIT). In December 2002, Alion acquired substantially all of IITRI’s assets and liabilities for aggregate total proceeds of $127.3 million. Prior to that time, the Company’s activities were organizational in nature.


(2)	Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC) regarding interim financial reporting. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the audited consolidated financial statements included in Alion’s Annual Report on Form 10-K for the year ended September 30, 2008.

The statements are prepared on the accrual basis of accounting and include the accounts of Alion and its wholly-owned subsidiaries from their date of acquisition or formation. All inter-company accounts have been eliminated in consolidation. There were no changes to Alion’s subsidiaries in the current fiscal year.

Fiscal, Quarter and Interim Periods

Alion’s fiscal year ends on September 30. The Company operates based on a three-month quarter, four-quarter fiscal year with quarters ending December 31, March 31, June 30, and September 30.

Use of Estimates

Preparing financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported for assets and liabilities, disclosures of contingent assets and liabilities as of financial statement dates and amounts reported for operating results for each period presented. Actual results are likely to differ from those estimates, but the Company’s management does not believe such differences will materially affect Alion’s financial position, results of operations, or cash flows.

Reclassifications

Certain items in the condensed consolidated financial statements have been reclassified to conform to the current presentation.

Revenue Recognition

Alion derives its revenue from delivering technology services under a variety of contracts. Some contracts provide for reimbursement of costs plus fees; others are fixed-price or time-and-material type contracts. The Company generally recognizes revenue when a contract has been executed, the contract price is fixed or determinable, delivery of services or products has occurred and collectibility of the contract price is considered reasonably assured.

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Alion recognizes revenue on cost-reimbursement contracts as it incurs costs and includes estimated fees earned. The Company recognizes time-and-material contract revenue at negotiated, fixed, contractually billable rates as it delivers labor hours and incurs other direct expenses. Alion uses various performance measures under the percentage of completion method to recognize revenue for fixed-price contract revenue. Estimating contract costs at completion and recognizing revenue appropriately involve significant management estimates. Actual costs may differ from estimated costs and affect estimated profitability and the timing of revenue recognition. From time to time, facts develop that require the Company to revise its estimated total costs or expected revenues. The Company records the cumulative effect of revised estimates in the period in which the facts requiring revised estimates become known. Alion recognizes the full amount of anticipated losses on any type of contract in the period in which the loss becomes known. For each of the periods presented, the cumulative effects of revised estimates were immaterial to the Company’s financial performance. Revised estimates did not generate any material anticipated losses for any period presented. There were no cost overruns on fixed price contracts that materially affected financial performance in any of the periods presented.

Contracts with federal departments and agencies are subject to periodic funding. A customer may fully fund a contract at inception or fund it periodically as services are provided. If contract funding is not probable, the Company defers revenue recognition until realization is probable.

Government contract costs are subject to federal government audit and to adjustment through negotiations between Alion and government representatives. The government considers Alion a major contractor and maintains an office on site to perform various audits. The Company has negotiated and settled its indirect rates through fiscal year 2003 with no material adverse effect on its results of operations or cash flows. The government has audited the Company’s government contract indirect costs through fiscal year 2004. Alion submitted its fiscal year 2005, 2006, and 2007 indirect expense rates in March 2006, 2007, and 2008. The Company expects to submit its fiscal year 2008 indirect expense rates in March 2009. Alion has recorded federal government contract revenue in amounts it expects to realize.

Alion recognizes revenue on unpriced change orders as it incurs expenses and only to the extent it is probable the Company will recover such costs. The Company recognizes revenue in excess of costs on unpriced change orders only when management can also estimate beyond a reasonable doubt the amount of excess and experience provides a sufficient basis for recognition. The Company recognizes revenue on claims as expenses are incurred only to the extent it is probable Alion will recover such costs and can reliably estimate the amount it will recover.

Alion generates software revenue from licensing software and providing services. In general, professional services are essential to the functionality of the solution sold and the Company applies the percentage of completion method, as prescribed by AICPA SOP 81-1, Accounting for Performance on Construction-Type and Certain Production-Type Contracts, to recognize revenue.

Income Taxes

Alion is an S-corporation under the provisions of the Internal Revenue Code of 1986, as amended. For federal and certain state income tax purposes, the Company is not subject to tax on its income. Alion’s income is allocated to its sole shareholder, the Alion Science and Technology Corporation Employee Ownership, Savings and Investment Trust (the Trust). Alion may be subject to state income taxes in those states that do not recognize S corporations. The Company is subject to franchise and business taxes. All of Alion’s wholly-owned operating subsidiaries are qualified subchapter S or disregarded entities which are included in the Company’s consolidated federal income tax returns. Alion’s Canadian subsidiary is subject to income taxation in Canada at the federal and provincial level.

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Cash and Cash Equivalents

The Company considers cash in banks, and deposits with financial institutions with maturities of three months or less at time of purchase which it can liquidate without prior notice or penalty, to be cash and cash equivalents.

Accounts Receivable and Billings in Excess of Costs and Estimated Earnings on Uncompleted Contracts

Accounts receivable include billed accounts receivable, amounts currently billable and costs and estimated earnings in excess of billings on uncompleted contracts that represent accumulated project expenses and fees which have not been billed or are not currently billable as of the date of the consolidated balance sheet. The costs and estimated earnings in excess of billings on uncompleted contracts are stated at estimated realizable value. Unbilled accounts receivable include revenue recognized for customer-requested work performed by Alion on new and existing contracts for which the Company had not received contracts or contract modifications. The allowance for doubtful accounts is Alion’s best estimate of the amount of probable losses in the Company’s existing billed and unbilled accounts receivable. The Company determines the allowance using specific identification and historical write-off experience based on age of receivables. Billings in excess of costs and estimated earnings and advance collections from customers represent amounts received from or billed to customers in excess of project revenue recognized to date.

Property, Plant and Equipment

Leasehold improvements, software and equipment are recorded at cost. Maintenance and repairs that do not add significant value or significantly lengthen an asset’s useful life are charged to current operations. Software and equipment are depreciated on the straight-line method over their estimated useful lives (typically 3 years for software and 5 years for equipment). Leasehold improvements are amortized on the straight-line method over the shorter of the asset’s estimated useful life or the life of the lease. Upon sale or retirement of an asset, costs and related accumulated depreciation are deducted from the accounts, and any gain or loss is recognized in the consolidated statements of operations.

Goodwill and Other Intangibles

As required by SFAS 142, Goodwill and Other Intangible Assets, Alion reviews goodwill annually for impairment at the end of each fiscal year or if events or circumstances indicate potential impairment. The Company must recognize an impairment loss if, and to the extent that, goodwill exceeds fair value. Alion completed its most recent goodwill impairment analysis in the fourth quarter of fiscal year 2008 and concluded no goodwill impairment existed as of September 30, 2008. There were no significant events in the three months ended December 31, 2008, that indicated impairment to goodwill as of December 31, 2008. The Company operates in one segment and tests goodwill at the reporting unit level. Intangible assets are amortized as economic benefits are consumed over their estimated useful lives.


Purchased contracts			1-13 years
Internal use software and engineering designs			2-3 years
Non-compete agreements			3-6 years

Postretirement Benefits

Alion accounts for postretirement benefits other than pension in accordance with SFAS No. 106 Employers’ Accounting for Postretirement Benefits Other Than Pension and SFAS No. 158 Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. SFAS 106 requires the Company to accrue the cost of providing postretirement benefits over employees’ periods of active service. Costs are determined on an actuarial basis. SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize in income, the effects of

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

any changes in funded status in the year in which the changes occur. Alion curtailed its postretirement benefits plan at the end of fiscal year 2007. See Note 4 for further discussion.

Redeemable Common Stock

Alion’s outstanding shares of common stock are redeemable equity securities because eventual redemption of shares of Alion common stock is outside the Company’s control. Alion is required to increase or decrease the reported value of its outstanding common stock to reflect the estimated redemption value at each reporting date based on management’s estimated fair value price per share. Alion records changes in the reported value of its outstanding common stock through an offsetting charge or credit to accumulated deficit, based on the change, if any, in the estimated fair value of a share of Alion common stock and the total shares outstanding at each reporting date. Management used a valuation prepared by an independent, third party appraiser selected by the ESOP Trustee to estimate the fair value price per share of Alion common stock in determining outstanding redeemable common stock had an aggregate fair value of approximately $200.6 million as of December 31, 2008.

Concentration of Credit Risk

Financial instruments that potentially subject Alion to credit risk consist primarily of cash equivalents and accounts receivable. The Company believes the high credit quality of its cash equivalent investments limits its credit risk with respect to such investments. Alion believes its concentrations of credit risk with respect to accounts receivable are limited as these are primarily receivables due from the federal government.

Fair Value of Financial Instruments

The carrying amount of cash, cash equivalents, accounts receivable and accounts payable approximate fair value because of the short maturity of these instruments. Alion uses an option pricing model to estimate the fair value of its redeemable common stock warrants. The value of the warrants depends in part on the fair value price per share of Alion common stock which management estimates based on a valuation performed for the ESOP Trustee by an independent, third-party firm. It is impracticable for the Company to estimate the fair value of its subordinated debt because the only market for financial instruments with similar terms consists of principal to principal transactions. The Company carries this instrument at amortized cost.

Recently Issued Accounting Pronouncements

In December 2007, FASB issued SFAS No. 141 (revised 2007), “Business Combinations,” (SFAS 141R) effective for fiscal years beginning after December 15, 2008. The new standard is based on a fair value model and requires an acquirer to measure all assets acquired and liabilities assumed at their respective fair values at the date of acquisition. This includes measuring noncontrolling (minority) interests at fair value. SFAS 141R establishes principles and requirements for recognizing and measuring goodwill arising from a business combination, and any gain from a bargain purchase. SFAS 141R establishes new disclosure standards and significantly alters the accounting for contingent consideration, pre-acquisition contingencies, in-process research and development and restructuring costs. It requires expensing of acquisition-related costs as incurred. Transactions consummated after the effective date of SFAS 141R apply the new standard prospectively. Existing guidance in SFAS 141 applies to business combinations consummated prior to the effective date of SFAS 141R.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” (SFAS 160) which amends Accounting Research Bulletin No. 51 and provides accounting and reporting standards for noncontrolling (minority) interests in a subsidiary and deconsolidation of a subsidiary. SFAS 160 requires noncontrolling interests to be presented separately within equity in the consolidated statement of financial position. Consolidated net income attributable to the parent and noncontrolling interests are to be separately presented on the face of the statement of operations. A change in ownership that does not affect control of a subsidiary is to be accounted for as an equity transaction. A change in ownership that affects control results in

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

recognition of a gain or loss and remeasurement at fair value of any remaining noncontrolling interest. Because SFAS 160 requires that a noncontrolling interest continue to be attributed to its share of losses, a noncontrolling interest could have a negative carrying balance.

SFAS 160 is effective for fiscal years beginning after December 15, 2008. In the year of adoption, presentation and disclosure requirements will apply retrospectively to all periods presented. The Company does not expect adopting SFAS 160 will materially affect its consolidated financial statements or results of operations.

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities,” (SFAS 161) which amends SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). SFAS 161 requires enhanced disclosures about how and why an entity uses derivatives, how the entity accounts for derivatives under SFAS 133 and how derivatives and related hedged items affect an entity’s financial position, results of operations and cash flows. SFAS 161 is effective for fiscal years beginning after November 15, 2008. Alion does not expect adopting SFAS 161 will materially affect its consolidated financial statements or results of operations.


(3)	Employee Stock Ownership Plan (ESOP) and Stock Ownership Trust

In December 2001, the Company adopted the Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan (the Plan) and the Trust. The Plan, a tax qualified retirement plan, includes ESOP and non-ESOP components. In August 2005, the Internal Revenue Service (IRS) issued a determination letter that the Trust and the Plan, as amended through the Plan’s Ninth Amendment, qualify under Sections 401(a) and 501(a) of the Internal Revenue Code of 1986 as amended (the Code). In January 2007, Alion amended and restated the Plan effective as of October 1, 2006, and filed a determination letter request with the IRS. In July and September 2007, the Company adopted the first and second amendments to the amended and restated Plan. Alion believes that the Plan and the Trust have been designed and are being operated in compliance with the applicable requirements of the Code.


(4)	Postretirement Benefits

Alion sponsors a medical benefits plan providing medical, dental, and vision coverage to eligible former employees who met certain age and service requirements. The Company effectively amended the plan in September 2007 to eliminate benefits for individuals retiring after December 2007 and closed the plan to new participants. Alion is self-insured with a stop-loss limit under an insurance agreement. The plan provides benefits until age 65 and beginning January 2009 requires employees to pay 100% of expected health care premiums. A small, closed group of employees eligible for coverage after age 65 contributes a smaller fixed share of their health care premiums. Retiree contributions for fiscal year 2009 are estimated to be approximately $426 thousand. There were no plan assets as of December 31, 2008 or September 30, 2008. Alion uses a September 30 measurement date.


(5)	Loss Per Share

Basic and diluted loss per share is computed by dividing net loss by the weighted average number of common shares outstanding excluding the impact of warrants, phantom stock and stock appreciation rights described herein as this impact would be anti-dilutive for all periods presented.


(6)	Redeemable Common Stock Owned by ESOP Trust

The ESOP Trust owns all of the Company’s common stock, for the benefit of current and former employee participants in the Alion KSOP. Participants and beneficiaries are entitled to a distribution of the fair value of their vested ESOP account balance upon death, disability, retirement or termination of employment. The ESOP permits distributions to be paid over a five year period commencing the year after a participant’s retirement at age 65, death

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

or disability. Alion can delay distributions to other terminating participants for five years before commencing payment over a subsequent five year period.

The Company can choose whether to make a distribution in cash or shares of Alion common stock. The IRC and ERISA require that if Alion distributes common stock to a participant or beneficiary, it must provide a put option to permit the recipient to sell the stock back to the Company at the estimated fair value price per share, which was $38.35 at December 31, 2008 and September 30, 2008. Alion estimates the fair value per share of its common stock based on a valuation performed by an independent, third-party firm selected by the ESOP Trustee. Certain participants who beneficially acquired shares of Alion common stock on December 20, 2002, have the right to sell such shares distributed from their accounts at the greater of the then current estimated fair value per share or the original $10.00 purchase price.

Although the Company and the ESOP retain the right to delay distributions consistent with the terms of the Alion KSOP and to control the circumstances of future distributions, eventual redemption of shares of Alion common stock is deemed to be outside the Company’s control.


(7)	Accounts Receivable

Accounts receivable at December 31, 2008 and September 30, 2008 consisted of the following:


	December 31,			September 30,
	2008			2008
	(In thousands)

Billed receivables	$	102,415		$	99,794
Unbilled receivables:
Amounts currently billable		30,716			37,883
Revenues recorded in excess of milestone billings on fixed price contracts		3,084			2,651
Revenues recorded in excess of estimated contract value or funding		30,415			18,925
Retainages and other amounts billable upon contract completion		12,104			13,160
Allowance for doubtful accounts		(4,216	)		(3,962	)

Total Accounts Receivable	$	174,518		$	168,451

Revenues recorded in excess of milestone billings on fixed price contracts are not yet contractually billable. Amounts currently billable consist principally of amounts to be billed within the next year. Any remaining unbilled balance including retainage is billable upon contract completion or completion of Defense Contract Audit Agency audits. Revenue recorded in excess of contract value or funding is billable upon receipt of contractual amendments or other modifications. Costs and estimated earnings in excess of billings on uncompleted contracts totaled approximately $76.3 million as of December 31, 2008 and included approximately $30.4 million for customer-requested work for which the Company had not received contracts or contract modifications. In keeping with industry practice, Alion classifies all contract-related accounts receivable as current assets based on contractual operating cycles which frequently exceed one year. Unbilled receivables are expected to be billed and collected within one year except for $12.1 million at December 31, 2008.

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(8)	Property, Plant and Equipment


	December 31,		September 30,
	2008		2008
	(In thousands)

Leasehold improvements	$	9,451	$	9,451
Equipment and software		31,800		31,393

Total cost		41,251		40,844
Less: accumulated depreciation and amortization		23,649		22,243

Net Property, Plant and Equipment	$	17,602	$	18,601

Depreciation and leasehold amortization expense for fixed assets was approximately $1.4 million and $1.3 million for the quarters ended December 31, 2008 and 2007.


(9)	Goodwill and Intangible Assets

As of December 31, 2008, Alion has recorded goodwill of approximately $398.9 million. There were no changes in the carrying amount of goodwill during the quarter ended December 31, 2008.

Intangible assets consist primarily of contracts purchased from Anteon Corporation and obtained through the JJMA, BMH, WCI and MA&D acquisitions. Intangible assets as of December 31, 2008 and September 30, 2008 are as follows.


	December 31, 2008									September 30, 2008
								Weighted									Weighted
								Average									Average
								Remaining									Remaining
			Accumulated					Amortization				Accumulated					Amortization
	Gross		Amortization			Net		Period		Gross		Amortization			Net		Period

Purchased contracts	$	111,635	$	(74,692	)	$	36,943		6.1 yrs	$	111,635	$	(71,410	)	$	40,225		6.3 yrs
Internal use software and engineering designs		2,155		(1,276	)		879		2.7 yrs		2,155		(1,178	)		977		2.9 yrs
Non-compete agreements		725		(685	)		40		1.6 yrs		725		(679	)		46		1.8 yrs

Total	$	114,515	$	(76,653	)	$	37,862		6.0 yrs	$	114,515	$	(73,267	)	$	41,248		6.0 yrs

Amortization expense was approximately $3.4 million and $3.7 million for the quarters ended December 31, 2008 and 2007. Estimated aggregate amortization expense for the next five years and thereafter is as follows.


	(In thousands)

For the remaining nine months:
2009		9,181
For the year ending September 30:
2010		10,985
2011		6,843
2012		5,767
2013		3,246
2014		879
Thereafter		961

		37,862

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(10)	Long-Term Debt

Term B Senior Credit Facility

In December 2002, Alion entered into various debt agreements including a subordinated note and warrant agreement to fund acquisition of substantially all of IITRI’s assets. In August 2004, Alion entered into a Term B senior secured credit facility (the Term B Senior Credit Facility) with a syndicate of financial institutions for which Credit Suisse serves as arranger, administrative agent and collateral agent, and for which Bank of America serves as syndication agent. The Term B Senior Credit Facility has been amended several times to increase the senior term loan principal to approximately $238.4 million, extend its maturity to February 2013 and increase the revolving credit facility to $50 million. The Term B Senior Credit Facility also includes a $110 million uncommitted incremental “accordion” facility under which loans may be permitted subject to satisfying a leverage based incurrence test.

In September 2008, the fifth and most recent amendment revised certain financial covenants to provide Alion flexibility through September 30, 2009 and made other changes to the Term B Senior Credit Facility. Interest rates increased to a minimum 3.50% Eurodollar rate plus 600 basis points, and a minimum 4.50% alternate base rate plus 500 basis points. The senior term loan interest rate spread will increase if the Company refinances, replaces or extends the maturity of its existing revolving line of credit at an interest rate spread more than 50 basis points higher than the then-current interest rate spread. The senior term loan spread will increase by the difference in the higher revolving credit facility rate spread less 50 basis points. Alion must use all (formerly half) of excess annual cash flow to prepay outstanding senior term loans. The Company must meet certain conditions before it may pay the CEO or COO for previously awarded shares of phantom stock. Subject to certain conditions, Alion may incur additional second lien debt.

Interest and Fees. The Term B Senior Credit Facility term loan and revolving credit facility can each bear interest at either of the two floating rates discussed above. The senior term loan bears interest at the Eurodollar rate and the revolving credit facility bears interest at the alternate base rate based on Credit Suisse’s prime rate. As of December 31, 2008, the minimum interest rate on the term loan and the revolving credit facility is 9.50% for both Eurodollar and alternate base rate loans. The interest rate no longer depends on the Company’s leverage ratio. Through September 30, 2008, the Eurodollar rate on the senior term loan was 5.49 percent (2.99 percent plus 250 basis point spread) and the alternate base rate was 6.75 percent (5.00 percent plus 175 basis point spread).

Other Fees and Expenses. Each quarter, Alion is required to pay a commitment fee of 50 basis points per year on the prior quarter’s daily, unused revolving credit facility and senior term loan commitment. As of December 31, 2008, only the $3.5 million allocated to letters of credit was outstanding on the revolving credit facility; the senior term loan was fully utilized. For the quarter ended December 31, 2008, the Company paid no commitment fee for the senior term loan and approximately $53 thousand for the revolving credit facility.

Alion is required to pay issuance and administrative fees, and a fronting fee of up to 25 basis points for each letter of credit issued under the revolving credit facility. Each quarter Alion is required to pay interest in arrears at the revolving credit facility rate for all outstanding letters of credit. The Company is also required to pay an annual agent’s fee under the Term B Senior Credit Facility.

Financial Covenants. As of December 31, 2008, the Company was in compliance with the Term B Senior Credit Facility financial covenants.

Senior Unsecured Notes

In February 2007, the Company issued and sold $250.0 million of private 10.25% senior unsecured notes due February 2015 (Senior Unsecured Notes) to Credit Suisse, which informed Alion that it resold most of the notes to qualified institutional buyers. In June 2007, Alion exchanged the private Senior Unsecured Notes for publicly tradable Senior Unsecured Notes with the same terms.

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Interest and Fees. The Senior Unsecured Notes bear interest at 10.25% per year, payable semi-annually in arrears on February 1 and August 1. The Company pays interest to holders of record as of the immediately preceding January 15 and July 15. The Company must pay interest on overdue principal at 11.25% per annum and, to the extent lawful, will pay interest on overdue semi-annual interest installments at 11.25% per annum.

Interest Payable

Interest Payable consisted of the following balances:


	December 31,		September 30,
	2008		2008
	(In thousands)

Senior Unsecured Notes	$	10,677	$	4,271
Term B Senior Credit Facility Note Payable		3,933		2,272
Subordinated Note Payable		95

Total	$	14,705	$	6,543

Subordinated Note

In December 2002, Alion issued a $39.9 million Subordinated Note to IITRI as part of the purchase price for substantially all of IITRI’s assets. In July 2004, IIT acquired the Subordinated Note and related warrant agreement from IITRI. In June 2006, the Company and IIT increased the interest rate on the Subordinated Note for two years from December 2006 through December 2008. In August 2008, the Company and IIT amended the Subordinated Note to: extend the maturity date to August 2013; require Alion to pay $3.0 million in principal in November 2008, 2009 and 2010, and $2.0 million in November 2011; and require Alion to pay cash interest at 6% rather than 16%, along with 10% in non-cash interest to be added to principal. The amended Subordinated Note agreement prohibits Alion from redeeming vested phantom stock held by the Chief Executive Officer and Chief Operating Officer unless the Company timely makes its scheduled principal payment each year. The Company paid IIT a $0.5 million amendment fee.

Up to and including December 2008, interest on the Subordinated Note was payable quarterly in arrears by issuing paid-in-kind (PIK) notes maturing at the same time as the Subordinated Note. The interest rate was 6.0% from December 2002 through December 2006; approximately 6.4% from December 2006 to December 2007; and approximately 6.7% from December 2007 to December 2008. After December 2008, interest is still payable quarterly in arrears, 6% to be paid in cash and 10% to be paid in PIK notes due August 2013. Existing and future PIK notes defer related cash interest expense on the Subordinated Note. Over the term of the Subordinated Note, Alion expects to issue approximately $41.4 million in PIK notes. In addition to the principal payments required each November from 2008 through 2011, Alion is required to pay a total of $70.3 million in principal and PIK notes in August 2013.

As of December 31, 2008, the remaining fiscal year principal repayments (at face amount before debt discount) for outstanding indebtedness are as follows:


	2009		2010		2011		2012		2013		2014		2015		Total
	(In thousands)

Senior Secured Term B Loan(1)	$	1,825	$	2,433	$	2,433	$	2,433	$	229,297	$	—	$	—	$	238,421
Senior Unsecured Notes(2)		—		—		—		—		—		—		250,000		250,000
Subordinated Seller Note(3)		—		3,000		3,000		2,000		70,311		—		—		78,311

Total Principal Payments	$	1,825	$	5,433	$	5,433	$	4,433	$	299,608	$	—	$	250,000	$	566,732


(1)		The table does not include any Term B Senior Credit Facility principal pre-payments. The timing and amount of such payments is uncertain. The total on the face of the balance sheet for the Term B Senior Term Loan includes

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


		approximately $238.4 million in principal and $6.3 million in unamortized debt issue costs as of December 31, 2008. Debt issue costs for the original loan and subsequent modifications totaled $12.5 million. The Company anticipates that it will need to refinance the Term B Senior Credit Facility before it matures.

(2)		The Senior Unsecured Notes on the face of the balance sheet include $250 million in principal and $5.4 million in unamortized debt issue costs as of December 31, 2008 (originally $7.1 million).

(3)		The Subordinated Note on the face of the balance sheet includes approximately $11.9 million of unamortized original issue discount for the fair value of the detachable warrants Alion issued in December 2002 and the warrants Alion issued for the September 2008 amendment. The first set of warrants had an initial fair value of approximately $7.1 million The amendment to the first set of warrants had an initial fair value of $1.3 million and the additional warrants had an initial fair value of approximately $9.0 million. The Company recognized original issue discount for the fair value of the warrants in accordance with Emerging Issues Task Force Issue 00-19 Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in, a Company’s Own Stock.


(11)	Fair Value Measurement

The Company adopted SFAS 157, as amended by FSP 157-1, FSP 157-2, and FSP 157-3 (together referred to as SFAS 157), on October 1, 2008, for all financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis or on a nonrecurring basis during the reporting period. While the Company adopted the provisions of SFAS 157 for nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis, no such assets or liabilities exist at the balance sheet date. The Company, in accordance with FSP 157-2, delayed implementation of SFAS 157 for all nonfinancial assets and liabilities recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The Company intends to adopt FSP SFAS 157-2 in fiscal year 2010. The Company does not expect adopting FSP SFAS 157-2 will materially affect its consolidated financial statements or results of operations. Nonfinancial assets and liabilities measured on a nonrecurring basis included on the Company’s balance sheet include items such as goodwill and long lived assets that are measured at fair value resulting from an impairment charge, if deemed necessary.

SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. SFAS 157 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs when measuring fair value. The fair value framework requires the categorization of assets and liabilities into one of three levels based on the assumptions (inputs) used in valuing the asset or liability. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. Level 1 inputs are unadjusted, quoted market prices in active markets for identical assets or liabilities. Level 2 inputs are observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets. Level 3 inputs include unobservable inputs that are supported by little, infrequent, or no market activity and reflect management’s own assumptions about inputs used in pricing the asset or liability. The following valuation techniques are used to measure fair value.

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

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

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Level 3 is comprised of unobservable inputs. The Company’s warrants are classified as a Level 3 liability. Assets and liabilities are considered Level 3 when their fair value inputs are unobservable or not available, including situations involving limited market activity, where determination of fair value requires significant judgment or estimation. At December 31, 2008, the warrants were measured at fair value based on the underlying estimated fair value of a share of Alion common stock as of the valuation most recently performed for the ESOP Trustee, risk-free U.S. Treasury interest rates for comparable investment periods and an equity volatility factor based on the historical volatility of the common stock of publicly-traded companies considered to be comparable to Alion. Valuations techniques utilized in the fair value measurement of assets and liabilities presented on the Company’s balance sheet were not changed from previous practice during the reporting period.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents information about the Company’s financial assets and financial liabilities that are measured at fair value on a recurring basis as of December, 2008, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.


	Level 1		Level 2		Level 3

Liabilities:

Redeemable common stock warrants	$	—	$	—	$	(38,542	)

The table below provides a summary of the changes in fair value of all financial liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarter ended December 31, 2008.


	Quarter Ended
	December 31, 2008
	Redeemable Common
	Stock Warrants

Balance, beginning of period	$	(39,996	)
Total realized and unrealized gains and (losses)
Included in interest expense		1,454
Included in other comprehensive income (loss)		—
Issuances and settlements		—
Transfers in (out)		—

Balance, end of period	$	(38,542	)

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company’s investment in VectorCommand is tested annually for impairment and is not adjusted to market value at the end of each reporting period. Fair value would only be determined on a nonrecurring basis if this investment were deemed to be other-than-temporarily impaired. The Company has not recorded any other-than-temporary impairments to its VectorCommand investment during the reporting period.


(12)	Interest Rate Swap

In January 2008, Alion executed an interest rate swap with one of its lenders to convert the floating rate interest payable on a portion of its Term B senior term loan to a fixed rate, and to adjust the timing of some net interest payments related to its Term B senior term loan. The swap agreement had a notional principal of $240 million and expired on November 1, 2008. The Company made its final semi-annual interest payment November 1, 2008. Alion received quarterly floating rate interest payments in February and May at 7.32% and in August and November 2008 at 5.49%. Alion paid interest semi-annually in May and November 2008 at 6.52%. All swap payments were net cash settled.

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(13)	Redeemable Common Stock Warrants

In December 2002, the Company issued 1,080,437 detachable, redeemable common stock warrants at an exercise price of $10.00 per share. Alion issued the warrants to IITRI in connection with the Subordinated Note. The Company recognized approximately $7.1 million for the initial fair value of the warrants as original issue discount to the $39.9 million face value of the Subordinated Note. The Subordinated Note warrants were originally exercisable until December 2010. In June 2004, IITRI transferred the warrants to IIT.

In August 2008, Alion issued an additional 550,000 redeemable common stock warrants at an exercise price of $36.95 per share. The Company issued the second set of warrants to IIT in connection with the amendment of the Subordinated Note. The December 2002 warrants are currently exercisable and the August 2008 warrants are exercisable as of April 2009 at the then current fair value per share of Alion common stock, less the exercise price. The Company recognized approximately $10.3 million in debt issue costs for the fair value of the September 2008 warrants and the amendment to the December 2002 warrants.

Alion has classified the warrants as debt instruments and not as equity, in accordance with Emerging Issues Task Force Issue 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’ Own Stock. The Company recognizes interest expense for changes in the fair value of the warrants which had an aggregate estimated fair value of $38.5 million as of December 31, 2008.


(14)	Leases

Future minimum lease payments under non-cancelable operating leases for buildings, equipment and automobiles at December 31, 2008 are set out below. Under these operating leases, Alion subleased some excess capacity to subtenants under non-cancelable operating leases. In connection with certain acquisitions, Alion assumed operating leases at above-market rates; recorded loss accruals of approximately $4.9 million based on the estimated fair value of the lease liabilities assumed; and is amortizing these losses over the lease terms. The remaining unamortized loss related to these acquisitions was $0.6 million at December 31, 2008. In connection with an acquisition, Alion also acquired a related sub-lease pursuant to which it receives above-market rates. Based on the estimated fair value of the sublease, Alion recognized an asset of $586 thousand which is being amortized over the lease term. The remaining asset value was $20 thousand at December 31, 2008.


Lease Payments for Fiscal Years Ending	(In thousands)

2009 (for the remainder of fiscal year)	$	18,635
2010		21,328
2011		18,917
2012		14,982
2013		13,773
2014		7,399
And thereafter		20,900

Gross lease payments	$	115,934
Less: non-cancelable subtenant receipts		(6,052	)

Net lease payments	$	109,882

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Composition of Total Rent Expense


	December 31,
	2008			2007
	(In thousands)

Minimum rentals	$	6,183		$	6,356
Less: Sublease rental income		(743	)		(835	)

Total rent expense, net	$	5,440		$	5,521


(15)	Long Term Incentive Compensation Plan

In December 2008, Alion adopted a long-term incentive compensation plan to provide cash compensation to certain executives. Grants under the plan to individuals contain specific financial and other performance goals and vest over varying time periods. Some grants are for a fixed amount; others contain provisions that provide for a range of compensation from a minimum of 50% to a maximum of 150% of an initial grant amount. The Company periodically evaluates the probability of individuals meeting the financial and other performance goals in grant agreements. Management estimates long term incentive compensation expense based on the stated amounts of outstanding grants, estimates of probable achievement of stated performance goals and estimates of probable future grant value. The Company recognized $924 thousand in long term incentive compensation expense during the first quarter of fiscal 2009.


(16)	Stock Appreciation Rights

As of December 31, 2008, Alion had granted 1,289,000 SARs to directors and employees under the 2002 and 2004 SAR Plans. For the quarters ended December 31, 2008 and 2007, the Company recognized approximately $84 thousand and $512 thousand in compensation expense associated with the two SAR plans.

The table below sets out the disclosures and the assumptions used to value a share of Alion common stock and the Company’s grants of stock appreciation rights as of December 31, 2008 and September 30, 2008. For grants issued prior to October 1, 2006, the Company uses the intrinsic value method to recognize compensation expense. For grants issued on or after October 1, 2006, Alion uses a Black-Scholes-Merton option pricing model to recognize compensation expense pursuant to SFAS 123(R) Share-Based Payment. Alion uses the fair market value of a share of its common stock to recognize expense for all grants; therefore no additional disclosures are required for these grants. There is no established public trading market for Alion’s common stock. The Trust is the only holder of the Company’s common stock. Management estimates the fair value price per share of Alion common stock based on a valuation performed by an independent, third-party firm selected by the ESOP Trustee. Alion does not expect to pay any dividends on its common stock. The terms of the Term B Senior Credit Facility, the Indenture and the Subordinated Note impose certain limitations on the payment of dividends. The Company currently intends to retain future earnings, if any, for use in the operation of its business.

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock-based Compensation Disclosures per FAS 123 and FAS 123R
Stock Appreciation Rights
As of December 31, 2008


	Shares
	Granted to		Exercise		Outstanding		Outstanding								Vested		Exercisable
Date of Grant	Employees		Price		at 9/30/08		at 12/31/08		Forfeited		Exercised		Expired		at 12/31/08		at 12/31/08

November 2003		129,550	$	14.71		68,335		63,235		540		4,560		—		63,235		6,277
February 2004		2,000	$	14.71		2,000		2,000		—		—		—		1,600		—
February 2005		164,750	$	19.94		89,162		87,837		1,325		—		—		62,663		—
March 2005		2,000	$	19.94		2,000		2,000		—		—		—		1,500		—
April 2005		33,000	$	29.81		20,250		20,250		—		—		—		13,500		—
June 2005		2,000	$	29.81		2,000		2,000		—		—		—		1,500		—
December 2005		276,675	$	35.89		203,774		200,329		3,445		—		—		151,700		—
February 2006		13,000	$	35.89		7,750		7,750		—		—		—		3,875		—
February 2006		7,500	$	35.89		3,750		3,125		625		—		—		1,875		—
May 2006		7,000	$	37.06		6,000		6,000		—		—		—		3,000		—
July 2006		15,000	$	37.06		10,500		10,500		—		—		—		5,500		—
October 2006		2,500	$	41.02		2,500		2,500		—		—		—		1,250		—
December 2006		239,290	$	41.02		201,083		191,783		9,300		—		—		46,168		—
February 2007		33,450	$	41.02		24,700		24,700		—		—		—		6,738		—
May 2007		2,000	$	43.37		2,000		2,000		—		—		—		500		—
September 2007		2,000	$	43.37		2,000		2,000		—		—		—		500		—
December 2007		232,385	$	40.05		210,310		206,060		4,250		—		—		51,515		—
April 2008		2,000	$	41.00		2,000		2,000		—		—		—		—		—
September 2008		2,000	$	41.00		2,000		2,000		—		—		—		—		—

Total		1,168,100				862,114		838,069		19,485		4,560		—		416,619		6,277

Wtd Avg Exercise Price	$	33.15			$	34.77	$	34.82	$	37.57	$	14.71	$	—	$	31.14	$	14.71

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock-based Compensation Disclosures per FAS 123 and 123R
Stock Appreciation Rights
As of December 31, 2008


	Risk Free			Remaining Life
Date of Grant	Interest Rate	Volatility	Expected Life	(Months)

November 2003	4.06% - 4.49%	60%	3 yrs	—
February 2004	4.06% - 4.49%	60%	5 yrs	1.6
February 2005	3.10% - 3.60%	45%	4 yrs	1.0
March 2005	3.10% - 3.60%	45%	4 yrs	2.1
April 2005	4.10% - 4.20%	45%	4 yrs	3.0
June 2005	4.10% - 4.20%	45%	4 yrs	5.2
December 2005	4.20% - 4.20%	40%	4 yrs	11.7
February 2006	4.20% - 4.20%	40%	4 yrs	13.3
February 2006	4.20% - 4.20%	40%	4 yrs	13.8
May 2006	4.82% - 4.83%	35%	4 yrs	16.6
July 2006	4.82% - 4.83%	35%	4 yrs	18.0
October 2006	4.82% - 4.83%	35%	4 yrs	21.8
December 2006	4.54% - 4.58%	35%	4 yrs	23.7
February 2007	4.54% - 4.58%	35%	4 yrs	25.7
May 2007	4.54% - 4.58%	35%	4 yrs	28.6
September 2007	4.54% - 4.54%	35%	4 yrs	32.1
December 2007	4.23% - 4.23%	35%	4 yrs	35.7
April 2008	4.23% - 4.23%	35%	4 yrs	39.9
September 2008	4.23% - 4.23%	35%	4 yrs	44.5
Wtd Avg Remaining Life (months)				18.9


(17)	Phantom Stock Plans

As of December 31, 2008, under the Initial Phantom Stock Plan, Alion had granted 223,685 shares of phantom stock. Under the Second Phantom Stock Plan, Alion had granted 340,312 shares of retention phantom stock and 213,215 shares of performance phantom stock. Under the Director Phantom Stock Plan, Alion had granted 20,779 shares of phantom stock. In the quarter ended December 31, 2008, Alion recognized a $4.7 million credit to compensation expense for forfeited grants. The Company recognized approximately $1.5 million in compensation expense in the comparable period in fiscal year 2008.

The table below sets out the disclosures required by SFAS 123(R) and the assumptions used to value a share of Alion common stock and the Company’s grants of phantom stock as of December 31, 2008 and September 30, 2008. For grants issued prior to October 1, 2006, the Company uses the intrinsic value method to recognize stock-based compensation expense for its phantom stock plans. For grants issued on or after October 1, 2006, Alion uses a Black Scholes Merton option pricing model to recognize compensation expense pursuant to SFAS 123(R) Share-Based Payment. Alion uses the fair market value of a share of its common stock to recognize expense for all grants; therefore no additional disclosures are required for these grants. There is no established public trading market for Alion’s common stock. The ESOP Trust is the only holder of the Company’s common stock. Management estimates the fair value price per share of Alion common stock based on a valuation performed by an independent, third-party firm selected by the ESOP Trustee. The terms of the Term B Senior Credit Facility, the Indenture and the Subordinated Note impose certain limitations on the payment of dividends. The Company intends to retain future earnings, if any, for use in the business.

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock-based Compensation Disclosures per FAS 123 and FAS 123R
Phantom Stock
as of December 31, 2008


							Grant
	Shares		Shares		Total		Date
	Granted to		Granted to		Shares		Price		Outstanding		Outstanding								Vested		Exercisable
Date of Grant	Employees		Directors		Granted		per Share		at 9/30/08		at 12/31/08		Forfeited		Exercised		Expired		at 12/31/08		at 12/31/08

November 2003		52,685		—		52,685	$	14.71		11,897		5,098		—		6,799		—		5,098		5,098
February 2005		213,215		—		213,215	$	19.94		66,436		30,287		10,328		25,821		—		30,287		30,287
February 2005		98,399		—		98,399	$	19.94		16,696		16,696		—		—		—		16,696		16,696
February 2005		5,015		—		5,015	$	19.94		5,015		—		2,558		2,457		—		—		—
August 2005		2,960		—		2,960	$	33.78		2,960		—		2,960		—		—		—		—
November 2005		66,592		—		66,592	$	35.89		51,268		—		43,188		8,080		—		—		—
November 2005		—		7,808		7,808	$	35.89		5,531		5,531		—		—		—		5,531		5,531
November 2005		55,726		—		55,726	$	35.89		41,795		—		41,795		—		—		—		—
November 2006		—		5,978		5,978	$	41.02		5,409		5,409		—		—		—		3,416		3,416
November 2006		65,456		—		65,456	$	41.02		50,341		—		46,684		3,657		—		—		—
November 2007		—		6,993		6,993	$	40.05		6,993		6,993		—		—		—		2,331		1,665
November 2007		42,447		—		42,447	$	40.05		39,950		—		34,956		4,994		—		—		—
January 2008		2,497		—		2,497	$	40.05		2,497		—		2,497		—		—		—		—
May 2008		1,220		—		1,220	$	41.00		1,220		—		1,220		—		—		—		—

Total		606,212		20,779		626,991				308,006		70,014		186,186		51,808		—		63,359		62,693

Wtd Avg Grant Date Fair Value Price per Share	$	26.58	$	38.77	$	26.98			$	32.10	$	39.06	$	36.91	$	25.17		—	$	22.79	$	22.60

Stock-based Compensation Disclosures per FAS 123 and FAS 123R
Phantom Stock
as of December 31, 2008


	Risk Free			Remaining Life
Date of Grant	Interest Rate	Volatility	Expected Life	(Months)

November 2003	4.06% - 4.49%	60%	5 yrs	—
February 2005	3.10% - 3.60%	45%	3 yrs	—
February 2005	3.10% - 3.60%	45%	3 yrs	—
February 2005	3.10% - 3.60%	45%	4 yrs	1.0
August 2005	3.72% - 3.77%	45%	3 yrs	—
November 2005	4.20% - 4.20%	40%	3 yrs	—
November 2005	4.20% - 4.20%	40%	3 yrs	—
November 2005	4.20% - 4.20%	40%	5 yrs	22.3
November 2006	4.54% - 4.58%	35%	3 yrs	10.4
November 2006	4.54% - 4.58%	35%	3 yrs	10.4
November 2007	4.23% - 4.23%	35%	3 yrs	22.4
November 2007	4.23% - 4.23%	35%	3 yrs	22.4
January 2008	4.23% - 4.23%	35%	3 yrs	24.4
May 2008	4.23% - 4.23%	35%	3 yrs	28.4
Wtd Avg Remaining Life (months)				11.9


(18)	Segment Information and Customer Concentration

The Company operates in one segment, delivering a broad array of scientific, engineering and information technology expertise to research and develop technological solutions for problems relating to national defense, homeland security, and energy and environmental analysis. Alion provides services to departments and agencies of

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the federal government and, to a lesser extent, to commercial and international customers. The Company’s federal government customers typically exercise independent contracting authority. 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.

Contract receivables from agencies of the federal government represented approximately $171.1 million, or 96.1%, and $210.0 million, or 90.9%, of accounts receivable at December 31, 2008 and 2007. Contract revenue from departments and agencies of the federal government represented approximately 95.5% and 92.0%, of total contract revenue during the quarters ended December 31, 2008 and 2007.


(19)	Guarantor/Non-guarantor Condensed Consolidated Financial Information

Alion’s Senior Unsecured Notes are unsecured general obligations of the Company. Certain of Alion’s 100% owned domestic subsidiaries have jointly, severally, fully and unconditionally guaranteed the Senior Unsecured Notes. The following information presents condensed consolidating balance sheets as of December 31, 2008 and September 30, 2008, condensed consolidating statements of operations for the three months ended December 31, 2008 and 2007; and condensed consolidating statements of cash flows for the three months ended December 31, 2008 and 2007 of the parent company issuer, the guarantor subsidiaries and the non-guarantor subsidiaries. Investments include investments in subsidiaries held by the parent company issuer and have been presented using the equity method of accounting.

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Balance Sheet Information at December 31, 2008


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

Current assets:
Cash and cash equivalents	$	4,912		$	(77	)	$	(5	)	$	—		$	4,830
Accounts receivable		165,274			4,776			4,468			—			174,518
Prepaid expenses and other current assets		3,820			40			67			—			3,927

Total current assets		174,006			4,739			4,530			—			183,275
Property, plant and equipment, net		17,456			68			78			—			17,602
Intangible assets, net		37,862			—			—			—			37,862
Goodwill		398,871			—			—			—			398,871
Investment in subsidiaries		11,902			—			—			(11,902	)		—
Intercompany receivables		—			8,155			—			(8,155	)		—
Other assets		6,067			13			—			—			6,080

Total assets	$	646,164		$	12,975		$	4,608		$	(20,057	)	$	643,690

Current liabilities:
Interest payable		14,705			—			—			—			14,705
Current portion, Term B Senior Credit Facility note payable		2,389			—			—			—			2,389
Current portion, subordinated note payable		3,000			—			—			—			3,000
Trade accounts payable		50,024			668			753			—			51,445
Accrued liabilities		32,244			1,085			549			—			33,878
Accrued payroll and related liabilities		44,103			866			539			—			45,508
Billings in excess of costs and estimated earnings on uncompleted contracts		3,141			—			—			—			3,141

Total current liabilities		149,606			2,619			1,841			—			154,066
Intercompany payables		7,012			—			1,143			(8,155	)		—
Term B Senior Credit Facility note payable, excluding current portion		229,684			—			—			—			229,684
Senior Unsecured Notes		244,577			—			—			—			244,577
Subordinated note payable		41,992			—			—			—			41,992
Accrued compensation, excluding current portion		6,803			—			—			—			6,803
Accrued postretirement benefit obligations		636			—			—			—			636
Non-current portion of lease obligations		6,212			59			19			—			6,290
Redeemable common stock warrants		38,542			—			—			—			38,542
Common stock of subsidiaries		—			2,799			(1	)		(2,800	)		—
Redeemable common stock		200,552			—			—			—			200,552
Accumulated other comprehensive loss		(36	)		—			—			—			(36	)
Accumulated surplus (deficit)		(279,416	)		7,498			1,604			(9,012	)		(279,416	)

Total liabilities, redeemable common stock and accumulated deficit	$	646,164		$	12,975		$	4,608		$	(20,057	)	$	643,690

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Balance Sheet Information at September 30, 2008


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

Current assets:
Cash and cash equivalents	$	16,392		$	(62	)	$	(43	)	$	—		$	16,287
Accounts receivable		161,519			3,872			3,060			—			168,451
Stock subscriptions receivable		2,669			—			—			—			2,669
Prepaid expenses and other current assets		3,024			47			64			—			3,135

Total current assets		183,604			3,857			3,081			—			190,542
Property, plant and equipment, net		18,419			97			85			—			18,601
Intangible assets, net		41,248			—			—			—			41,248
Goodwill		398,871			—			—			—			398,871
Investment in subsidiaries		10,831			—			—			(10,831	)		—
Intercompany receivables		—			8,038			72			(8,110	)		—
Other assets		6,668			16			—			—			6,684

Total assets	$	659,641		$	12,008		$	3,238		$	(18,941	)	$	655,946

Current liabilities:
Interest payable	$	6,543		$	—		$	—		$	—		$	6,543
Interest rate swap liability		4,629			—			—			—			4,629
Current portion, Term B Senior Credit Facility note payable		2,389			—			—			—			2,389
Current portion, subordinated note payable		3,000			—			—			—			3,000
Current portion, acquisition obligations		50			—			—			—			50
Trade accounts payable		55,933			467			765			—			57,164
Accrued liabilities		37,678			1,007			542			—			39,227
Accrued payroll and related liabilities		40,569			696			292			—			41,557
Billings in excess of costs and estimated earnings on uncompleted contracts		2,708			—			—			—			2,708

Total current liabilities		153,498			2,170			1,599			—			157,267
Intercompany payables		7,543			—			567			(8,110	)		—
Term B Senior Credit Facility note payable, excluding current portion		229,831			—			—			—			229,831
Senior Unsecured Notes		244,355			—			—			—			244,355
Subordinated note payable		42,656			—			—			—			42,656
Accrued compensation, excluding current portion		11,305			—			—			—			11,305
Accrued postretirement benefit obligations		627			—			—			—			627
Non-current portion of lease obligations		6,181			62			17			—			6,260
Redeemable common stock warrants		39,996			—			—			—			39,996
Common stock of subsidiaries		—			2,799			1			(2,800	)		—
Redeemable common stock		200,561			—			—			—			200,561
Accumulated other comprehensive loss		(36	)		—			—			—			(36	)
Accumulated surplus (deficit)		(276,876	)		6,977			1,054			(8,031	)		(276,876	)

Total liabilities, redeemable common stock and accumulated deficit	$	659,641		$	12,008		$	3,238		$	(18,941	)	$	655,946

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Statement of Operations for the Three Months Ended December 31, 2008


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

Contract revenue	$	179,964		$	5,650	$	3,182		$	—		$	188,796
Direct contract expense		138,720			4,168		2,434			—			145,322

Gross profit		41,244			1,482		748			—			43,474

Operating expenses:
Indirect contract expense		8,154			842		128			—			9,124
Research and development		69			—		—			—			69
General and administrative		10,062			111		—			—			10,173
Rental and occupancy expense		7,613			64		61			—			7,738
Depreciation and amortization		4,794			5		7			—			4,806

Total operating expenses		30,692			1,022		196			—			31,910

Operating income		10,552			460		552			—			11,564
Other income (expense):
Interest income		23			—		—			—			23
Interest expense		(14,088	)		—		—			—			(14,088	)
Other		(94	)		61		(2	)		—			(35	)
Equity in net income (loss) of subsidiaries		1,071			—		—			(1,071	)		—

Income (loss) before income taxes		(2,536	)		521		550			(1,071	)		(2,536	)
Income tax expense		(4	)		—		—			—			(4	)

Net income (loss)	$	(2,540	)	$	521	$	550		$	(1,071	)	$	(2,540	)

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Statement of Operations for the Three Months Ended December 31, 2007


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

Contract revenue	$	175,001		$	6,349	$	1,795		$	—		$	183,145
Direct contract expense		134,569			4,549		1,264			—			140,382

Gross profit		40,432			1,800		531			—			42,763

Operating expenses:
Indirect contract expense		8,517			1,191		175			—			9,883
Research and development		161			—		—			—			161
General and administrative		15,457			264		20			—			15,741
Rental and occupancy expense		7,509			77		85			—			7,671
Depreciation and amortization		5,003			21		3			—			5,027

Total operating expenses		36,647			1,553		283			—			38,483

Operating income		3,785			247		248			—			4,280
Other income (expense):
Interest income		155			—		—			—			155
Interest expense		(13,276	)		—		—			—			(13,276	)
Other		63			84		(1	)		—			146
Equity in net income (loss) of subsidiaries		578			—		—			(578	)		—

Income (loss) before income taxes		(8,695	)		331		247			(578	)		(8,695	)
Income tax expense		(11	)		—		—			—			(11	)

Net income (loss)	$	(8,706	)	$	331	$	247		$	(578	)	$	(8,706	)

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Statement of Cash Flows
Three Months Ended December 31, 2008


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

Net cash (used in) provided by operating activities	$	(5,288	)	$	(39	)	$	38		$	(5,289	)
Cash flows from investing activities:
Cash paid for acquisitions		(166	)		—			—			(166	)
Capital expenditures		(431	)		24			—			(407	)

Net cash (used in) provided by investing activities		(597	)		24			—			(573	)
Cash flows from financing activities:
Change in book overdraft
Net cash paid from interest rate swap		(4,647	)		—			—			(4,647	)
Repayment of Term B Credit Facility note payable		(608	)		—			—			(608	)
Repayment of subordinated note payable		(3,000	)		—			—			(3,000	)
Net borrowings under revolving credit facility		97,600			—			—			97,600
Repayment under revolving credit facility		(97,600	)		—			—			(97,600	)
Purchase of common stock from ESOP Trust		(9	)		—			—			(9	)
Cash received from sale of common stock to ESOP Trust		2,669			—			—			2,669

Net cash used in financing activities		(5,595	)		—			—			(5,595	)
Net increase (decrease) in cash and cash equivalents		(11,480	)		(15	)		38			(11,457	)
Cash and cash equivalents at beginning of period		16,392			(62	)		(43	)		16,287

Cash and cash equivalents at end of period	$	4,912		$	(77	)	$	(5	)	$	4,830

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Statement of Cash Flows
Three Months Ended December 31, 2007


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

Net cash (used in) provided by operating activities	$	(31,530	)	$	(456	)	$	10		$	(31,976	)
Cash flows from investing activities:
Capital expenditures		(1,156	)		(12	)		(55	)		(1,223	)

Net cash used in investing activities		(1,156	)		(12	)		(55	)		(1,223	)
Cash flows from financing activities:
Change in book overdraft		2,065			—			—			2,065
Repayment of Term B Credit Facility note payable		(618	)		—			—			(618	)
Revolving credit facility borrowings		113,880									113,880
Revolving credit facility payments		(96,580	)		—			—			(96,580	)
Purchase of common stock from ESOP Trust		(12	)		—			—			(12	)
Cash received from sale of common stock to ESOP Trust		3,377			—			—			3,377

Net cash provided by financing activities		22,112			—			—			22,112
Net decrease in cash and cash equivalents		(10,574	)		(468	)		(45	)		(11,087	)
Cash and cash equivalents at beginning of period		11,718			(33	)		(1	)		11,684

Cash and cash equivalents at end of period	$	1,144		$	(501	)	$	(46	)	$	597


(20)	Commitments and Contingencies

Earn-Out Commitments

Alion’s LogConGroup earn-out obligation continues through September 2013. The earn-out cannot exceed $900 thousand based on revenue from potential logistics contracts. In the three months ended December 31, 2008, Alion recognized no LogConGroup earn-out. Management believes realization of this earn-out will not have a material effect on Alion’s financial position, results of operations, or liquidity. No other acquisition related earn-out obligations remain. The Company paid $50 thousand in LogConGroup earn-outs in the quarter ended December 31, 2008.

Legal Proceedings

Estate of Joseph Hudert vs. Alion Science and Technology Corporation; Estate of Frank Stotmeister vs. Alion Science and Technology Corporation.

On December 23, 2004, the estate of Joseph Hudert filed an action against Grunley-Walsh Joint Venture, L.L.C. (Grunley-Walsh) and the Company in the District of Columbia Superior Court for damages in excess of $80 million. On January 6, 2005, the estate of Frank Stotmeister filed an action against the Company in the same court on six counts, some of which are duplicate causes of action, claiming $30 million for each count. The Hudert case has been removed to the United States District Court for the District of Columbia. Several other potential defendants may be added to these actions in the future.

The suits arose in connection with a steam pipe explosion that occurred on or about April 23, 2004 on a construction site at 17th Street, NW in Washington, D.C. The plaintiffs died, apparently as a result of the explosion. They were employees of the prime contractor on the site, Grunley-Walsh, and the subcontractor, Cherry Hill

ALION SCIENCE AND TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Construction Company Inc., respectively. Grunley-Walsh had a contract with the U.S. General Services Administration (GSA) for construction on 17th Street NW near the Old Executive Office Building in Washington, D.C. Sometime after the award of Grunley-Walsh’s construction contract, Alion was awarded a separate contract by GSA. Alion’s responsibilities on this contract were non-supervisory monitoring of Grunley-Walsh’s activities and reporting to GSA of any deviations from contract requirements.

The Company intends to defend these lawsuits vigorously. Based on the facts underlying the lawsuits known to the Company at this time, and the Company’s non-supervisory monitoring role at the project site, the Company’s management believes that the potential for Alion to incur a material loss as a result of the lawsuits is remote. Therefore, the Company’s management does not believe that these lawsuits will have a material adverse effect upon the Company, its operations, its financial condition or its cash flows.

Alion’s primary provider of general liability insurance, St. Paul Travelers, has assumed defense of these lawsuits. However, since there is some uncertainty as to whether St. Paul Travelers received timely notice of a potential claim by Alion in connection with these lawsuits under its general liability insurance policy, St. Paul Travelers indicated when it assumed defense of the lawsuits, that it was doing so subject to a reservation of rights to deny coverage. Nevertheless, even if St. Paul Travelers is ultimately able to properly deny coverage as a result of late notice of the lawsuits, the Company’s management does not believe that the lawsuits will have a materially adverse effect upon the Company, its operations, its financial condition or its cash flows. American International Group, the Company’s excess insurance carrier, has also been notified regarding these lawsuits.

The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect upon the Company’s business, financial position, operating results or ability to meet its financial obligations.

Government Audits

Federal government cost reimbursement contract revenue and expenses reflected in the consolidated financial statements are subject to audit and possible adjustment by the Defense Contract Audit Agency (DCAA). DCAA considers Alion a major contractor and maintains an office on site to perform its various audits throughout the year. The Company’s federal government contract costs have been audited through 2004. Indirect rates have been negotiated through fiscal year 2003. Federal government contract revenue has been recorded in amounts that the Company expects to realize upon final settlement.


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

The following discussion of Alion’s financial condition and results of operations should be read together with the condensed consolidated financial statements (unaudited) and the notes to those statements. This updates the information contained in the Company’s Annual Report on Form 10-K for the year ended September 30, 2008, and presumes that readers have access to, and will have read, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in that report.

Overview

Alion provides scientific, engineering and information technology expertise to research and develop technological solutions for problems relating to national defense, homeland security and energy and environmental analysis, principally to federal departments and agencies and, to a lesser extent, to commercial and international customers.

The following table summarizes the percentage of revenues attributable to each contract type for the periods indicated.


	For the Three Months Ended December 31,
Revenue by Contract Type	2008				2007
	(In thousands)

Cost-reimbursement		134,068	71.0	%	$	128,303	70.1	%
Fixed-price		18,850	10.0	%		20,221	11.0	%
Time-and-material		35,878	19.0	%		34,620	18.9	%

Total	$	188,796	100.0	%	$	183,145	100.0	%

Alion expects most of its revenue will continue to come from government contracts, mostly from contracts with the U.S. Department of Defense (DoD) with the balance continuing to come from a variety of commercial, state, local and foreign government customers.


	For the Three Months Ended December 31,
Revenue by Customer Type	2008				2007
	(In thousands)

U.S. Department of Defense (DoD)		172,360	91.3	%	$	156,111	85.3	%
Other Federal Civilian Agencies		7,868	4.2	%		11,939	6.5	%
Commercial/State/Local and International		8,568	4.5	%		15,095	8.2	%

Total	$	188,796	100.0	%	$	183,145	100.0	%

The Company has reduced the number of core business areas it tracks and re-categorized data presented for prior periods to be consistent with its current presentation.


	For the Three Months Ended December 31,
Core Business Area	2008				2007
	(In thousands)

Naval Architecture and Marine Engineering	$	85,641	45.4	%	$	77,584	42.4	%
Defense Operations Support		33,285	17.6	%		40,929	22.3	%
Industrial Technology Solutions		28,708	15.2	%		26,703	14.6	%
Modeling and Simulation		21,440	11.4	%		15,834	8.6	%
Chemical, Biological, Nuclear and Environmental Sciences		13,496	7.1	%		13,466	7.4	%
Information Technology		6,226	3.3	%		8,629	4.7	%

Total	$	188,796	100.0	%	$	183,145	100.0	%

Backlog. Our contract backlog represents an estimate, as of a specific date, of the remaining future revenue we anticipate from existing contracts. At December 31, 2008, backlog on existing contracts and executed delivery orders totaled $2,521 million, of which $365 million was funded. The Company estimates it has an additional $2,941 million of unfunded contract ceiling value for an aggregate total backlog of $5,462 million.

Results of Operations

Quarter Ended December 31, 2008 Compared to Quarter Ended December 31, 2007


	Consolidated Operations of Alion
	Quarter Ended December 31,
	2008						2007
				%					%
				Revenue					Revenue
	(Dollars in thousands)

Selected Financial Information
Total contract revenue	$	188,796					$	183,145
Alion labor-related revenue		113,593			60.2	%		103,644		56.6	%
Material and subcontract revenue		75,203			39.8	%		79,501		43.4	%
Total direct contract costs		145,322			77.0	%		140,382		76.7	%
Direct labor costs		66,829			35.4	%		58,601		32.0	%
Material and subcontract costs		72,464			38.4	%		76,561		41.8	%
Other direct costs		6,029			3.2	%		5,220		2.9	%
Gross profit		43,474			23.0	%		42,763		23.3	%
Total operating expense		31,910			16.9	%		38,483		21.0	%
Major components of operating expense
Indirect expenses including facilities costs		16,862			8.9	%		17,554		9.6	%
General and administrative (excluding stock-based compensation)		14,776			7.8	%		13,695		7.5	%
Stock-based compensation		(4,603	)		(2.4	)%		2,046		1.1	%
Depreciation and amortization		4,806			2.5	%		5,027		2.7	%
Income from operations	$	11,564			6.1	%	$	4,280		2.3	%

Revenue, Direct Contract Expense and Gross Profit. Fiscal 2009 first quarter revenue of $188.8 million was $5.7 million more than the comparable period in 2008, a 3.1% increase attributable to greater cost-reimbursement contract revenue. A $16.2 million increase in DoD revenue offset a $6.5 million decline in commercial revenue and a $4.1 million decline in civilian agency activity. Naval architecture and marine engineering increased $8.1 million compared to first quarter 2008 performance and modeling and simulation work increased by $5.6 million as well. These increases were offset by a $7.6 million decline in support for defense operations. Alion’s revenue from subcontractors and materials declined by nearly $4.3 million while internally-delivered revenue increased nearly $10.0 million compared with the first quarter of fiscal 2008.

Direct contract expenses increased by $4.9 million (3.5%) to 77.0% of quarterly revenue. Less profitable material and subcontract costs declined by $4.1 million while direct labor increased by $8.2 million (14%) and other direct costs increased by $0.8 million (15.5%). Increased direct labor resulted from higher head count, reduced overhead staffing and higher labor productivity, partially offsetting prior quarters’ lower direct labor levels. Increased direct labor helped mitigate differences in profitability between employee and subcontractor labor. However, lower overall profitability on material and subcontract costs led to modestly lower overall contract profitability. Gross profit at $43.5 million increased slightly compared to $42.8 million and declined slightly as a percentage of revenue.

Operating Expenses. First quarter operating expenses declined by $6.6 million overall compared to the same period last year significantly improving operating profit. The drop in operating expenses comes, in part, from a $4.7 million current year credit to stock-based compensation expense for forfeitures of previously awarded

phantom shares. Facility and indirect costs declined by a net $0.7 million; depreciation and amortization declined by $0.2 million; and general and administrative (G&A) expense exclusive of stock-based and long-term incentive compensation charges declined by $1.0 million. However, G&A expenses increased by approximately $0.9 million for period costs associated with Alion’s recently implemented long term incentive compensation plan. Alion continued efforts initiated last year to trim overhead staff, and optimize office space through consolidating locations and eliminating excess space.

Income from Operations. Operating income for the quarter ended December 31, 2008 increased by $7.3 million to $11.6 million compared with $4.3 million for the quarter ended December 31, 2007, as a result of $0.8 million in reduced indirect expenses and $1.0 million in reduced G&A expenses and $4.7 million in credits to stock-based compensation expense for phantom stock plan forfeitures.

Other Expense. Interest income, interest expense and other expense in the aggregate for the quarter ended December 31, 2008 increased by $1.1 million compared to first quarter 2008. Interest income declined due to lower market rates and lower average investment balances. Despite the lower outstanding principal balance on the senior term loan compared to the first quarter of 2008, cash pay interest increased by $1.1 million for the first quarter of 2009 because the September 2008 amendment to the Term B Senior Credit Facility increased Alion’s minimum interest rate by 350 basis points to 9.50% for both the senior term loan and the revolving credit facility. Despite the higher rate on the revolving credit facility, lower outstanding balances helped reduce interest expense for the revolver by $0.5 million for the current quarter compared to first quarter 2008.

First quarter 2009 debt issue cost amortization increased $0.6 million compared to the comparable period in 2008 as a result of fees paid and warrants issued to amend Alion’s senior secured and subordinated debt at the end of last fiscal year. The higher interest rate on the Subordinated Note increased expense by $0.9 million compared to last year. However, Alion also recognized a $1.5 million benefit in the current quarter from a reduction in warrant value due to a decline in the risk free interest rate used to estimate the fair value of the outstanding warrants.


	Quarter Ended December 31,
	2008			2007
	(In thousands)

Cash Pay Interest
Term B Revolving Credit Facility	$	132		$	644
Term B Senior Loan		5,793			4,692
Senior Unsecured Notes		6,406			6,406
Subordinated Note		95			—
Other cash pay interest and fees		98			98

Sub-total cash pay interest		12,524			11,840
Deferred and Non- cash Interest
Debt issue costs and other non-cash items		1,272			688
Subordinated Note interest		1,746			852
Redeemable warrants		(1,454	)		(104	)

Sub-total non-cash interest		1,564			1,436

Total interest expense	$	14,088		$	13,276

Income Tax Expense. Income tax expense was immaterial for the current quarter and the similar period last year because Alion and its subsidiaries are a consolidated S corporation whose income is attributable to the ESOP Trust, a tax exempt entity. Some states do not recognize Alion’s S corporation status. Alion’s Canadian subsidiary accrues a Canadian tax liability, as required.

Net Loss. The net loss decreased approximately $6.2 million, or 71.3%, to $2.5 million for the quarter ended December 31, 2008 as compared to $8.7 million for the quarter ended December 31, 2007.

Liquidity and Capital Resources

Alion requires liquidity primarily for working capital and debt service. The Company uses its revolving line of credit to fund accounts receivable, which can increase as revenue increases or when contract funding is delayed. Alion is funding its current business with cash from operating activities and by accessing its revolving credit facility. The Company intends to fund future operations in a similar fashion.

Cash Flows

The following narrative discusses Alion’s cash flows for the quarters ended December 31, 2008 and 2007.

Although Alion lost $6.2 million less in the first quarter of fiscal 2009 than it did in the first quarter of fiscal 2008, operating activities nonetheless consumed $5.3 million this quarter. This contrasts favorably with the first quarter of 2008 when Alion used $32.0 million for operating activities, largely to fund accounts receivable and a related increase in days’ sales outstanding (DSO) as of December 31, 2007. Although the Company used $6.3 million this quarter to fund growth in assets, principally accounts receivable, this was a $34.5 million improvement over the comparable quarter last year. Alion collected $186.4 million of accounts receivable in the first quarter of fiscal 2009. The current quarter’s growth in receivables was mostly due to delays in contract funding that increased unbilled accounts receivable. At December 31, 2008, the Company’s DSO stood at 85.5 based on net accounts receivable and trailing twelve month revenue.

Alion’s first quarter performance benefited from a $10.4 million increase in unpaid interest accruals and other liabilities, approximately $7.0 million more than the comparable quarter last year. This year however, Alion used $6.9 million to reduce accounts payable and accrued expenses. In the comparable period last year, the Company benefitted from a $6.4 million increase in payables and accruals.

In the first quarter of fiscal 2008 Alion invested $1.2 million in new capital equipment during the first quarter. In the first quarter of fiscal 2009 the Company only spent one-third as much on capital assets and spent less than $0.2 million to pay for contracts acquired last year.

In the quarter ended December 31, 2008, Alion reduced its total debt-related liabilities by paying off $3.0 million of Subordinated Note principal and $4.6 million in interest rate swap obligations. The Company received $2.7 million in cash from stock sales to the ESOP Trust during the current quarter. In the first quarter of fiscal 2008, Alion increased its total debt and liabilities obtaining $19.4 million by utilizing its revolving credit facility and book cash overdrafts. The Company received $3.4 million from stock sales to the ESOP Trust during the first quarter of fiscal 2008.

Cash flow effects and risks associated with equity-related obligations

Changes in the price of a share of Alion common stock affect stock-based compensation expense, operating income and warrant-related interest expense. Because management is unable to forecast the share price to be determined by the ESOP Trustee for the March 2009 valuation period and because that future price may differ from the September 2008 share price the Company cannot forecast the non-cash expense it is likely to recognize in future periods for already-issued Phantom Stock and SAR plan grants. Alion expects to recognize non-cash interest expense related to outstanding Warrants as the current share price, interest rates, assumed volatility, and time to time expiration change. The carrying value of the warrants exceeds their current net cash value by approximately $7.1 million which represents the time value of the underlying options, primarily associated with the warrants issued in September 2008.

Actual expenses for stock-based compensation and warrant-related interest are likely to differ from estimates as the price of a share of Alion common stock changes. The next valuation period ends March 2009. Interest rates, market-based factors and volatility, as well as the Company’s financial results will affect the future value of a share of Alion common stock.

Certain grantees of SARs and Phantom Stock are permitted to make qualifying elections to further defer stock-based compensation payments by having funds deposited into a rabbi trust owned by the Company. These elections will not have a material effect on either Alion’s planned payments or its overall anticipated cash outflows.

After each semi-annual valuation period, the ESOP Plan permits former employees and beneficiaries to request distribution of their vested ESOP account balances. Consistent with the terms of the Plan, the Company intends to pay distribution requests in five annual installments and to defer initial payments as permitted. The Plan allows the Company to defer initial installment payments for five years for former employees who are not disabled, deceased or retired.

Alion has not paid any distribution requests this year, but will have to fund distribution requests resulting from the most recent valuation prior to March 2009. The Company estimates that it will have to pay approximately $5.4 million in the second quarter to satisfy diversification and distribution requests

Discussion of Debt Structure

The discussion below describes the Term B Senior Credit Facility, as modified by Amendments One through Five and Increments Four and Five; the Subordinated Note as subsequently amended and; the Senior Unsecured Notes issued and sold by the Company.

Term B Senior Credit Facility

As of December 31, 2008, the Term B Senior Credit Facility consisted of:


	•	a senior term loan in the approximate amount of $238.4 million;

	•	a $50.0 million senior revolving credit facility approximately $3.5 million of which was allocated to letters of credit and deemed borrowed, but none of which was actually drawn as of December 31, 2008; and

	•	a $110.0 million uncommitted incremental term loan “accordion” facility which the Company may be able to access in future subject to satisfying a leverage-based incurrence test.

In August 2004, Alion entered into the Term B Senior Credit Facility with a syndicate of financial institutions for which Credit Suisse serves as arranger, administrative agent and collateral agent, and for which Bank of America serves as syndication agent.


	•	In April 2005, the first amendment made certain changes and added $72.0 million in senior term loans to the total Term B Senior Credit Facility debt.

	•	In March 2006, the second amendment made certain changes, increased the senior term loan commitment by $68.0 million (drawn in full) and increased the revolving credit commitment from $30.0 million to $50.0 million.

	•	In June 2006, the third amendment made certain changes and added $50.0 million in senior term loans to the total Term B Senior Credit Facility debt.

	•	In January 2007, the fourth increment added $15.0 million in senior term loans to the total Term B Senior Credit Facility debt.

	•	In February 2007, the fourth amendment made certain changes, extended the senior term loan maturity date to February 6, 2013, adjusted the principal repayment schedule to require a balloon principal payment at maturity, and added an incurrence test as an additional condition precedent to Alion’s ability to borrow additional funds.

	•	In July 2007, the fifth increment added $25.0 million in senior term loans to the Term B Senior Credit Facility.

In September 2008, the fifth amendment revised certain financial covenants to provide Alion flexibility through September 2009 and made other changes to the Term B Senior Credit Facility. Interest rates increased to a minimum 3.50% Eurodollar rate plus 600 basis points, and a minimum 4.50% alternate base rate plus 500 basis points. The senior term loan interest rate spread will increase if the Company refinances, replaces or extends the maturity of its existing revolving line of credit at an interest rate spread more than 50 basis points higher than the then-current interest rate spread. The senior term loan spread will increase by the difference in the higher revolving credit facility rate spread less 50 basis points. Alion must now use all (formerly half) of annual excess cash flow to

prepay outstanding senior term loans. The Company must meet certain conditions before it may pay the CEO or COO for previously awarded shares of phantom stock. Subject to certain conditions, Alion may now incur additional second lien debt.

The Term B Senior Credit Facility requires the Company to repay one percent of the principal balance of the senior term loan during each of the next five fiscal years in equal quarterly installments of approximately $0.6 million through December 31, 2012 and to repay the remaining outstanding balance of approximately $229.3 million on February 6, 2013.

Under the senior revolving credit facility, Alion may request up to $40.0 million in letters of credit and may borrow up to $5.0 million in swing line loans for short-term borrowing needs. The Company must pay all principal obligations under the senior revolving credit facility in full no later than August 2, 2009.

Interest and Fees. The Term B Senior Credit Facility term loan and revolving credit facility can each bear interest at either of the two floating rates discussed above. The senior term loan bears interest at the Eurodollar rate and the revolving credit facility bears interest at the alternate base rate based on Credit Suisse’s prime rate. As of September 30, 2008, 9.50% is the minimum interest rate on the term loan and the revolving credit facility for both Eurodollar and alternate base rate loans. The interest rate no longer depends on the Company’s leverage ratio. Through September 30, 2008, the Eurodollar rate was 5.49 percent (2.99 percent plus 250 basis point spread) and the alternate base rate was 6.75 percent (5.00 percent plus 175 basis point spread).

Alion may prepay all or any portion of its Term B debt in minimum increments of $1 million, generally without penalty or premium, except for customary breakage costs associated with pre-payment of Eurodollar-based loans. If the Company issues certain permitted debt, or sells, transfers or disposes of certain assets, it must use all net proceeds to repay any Term B loan amounts outstanding. To the extent Alion has excess cash flow for any fiscal year, as defined in the Term B Senior Credit Facility, it must use all of it to repay Term B loan amounts outstanding.

If the Company enters into an additional term loan, including an incremental term loan, and certain terms of such loan are more favorable to the new lenders than existing terms under the Term B Senior Credit Facility, the applicable interest rate spread on the senior term loans can increase. As a result, additional term loans could increase the Company’s interest expense under its existing term loans. Certain of the Company’s subsidiaries (HFA, CATI, METI, JJMA, BMH, WCI, WCGS and MA&D) guaranteed the Company’s obligations under the Company’s Term B Senior Credit Facility.

Use of Proceeds. In August 2004, the Company borrowed $50.0 million through the senior term loan under the Term B Senior Credit Facility. Alion used approximately $47.2 million to retire its prior senior term loan and revolving credit facility and paid approximately $2.8 million in transaction fees. In October 2004, the Company borrowed approximately $22.0 million under the senior term loan to retire its existing $19.6 million mezzanine note and to pay approximately $2.4 million in accrued unpaid interest and prepayment premium. In April 2005, the Company borrowed $72.0 million in an incremental term loan under the Term B Senior Credit Facility. Alion used approximately $58.7 million of the proceeds to pay part of the JJMA acquisition price, and approximately $1.3 million for term loan transaction fees. The Company used approximately $12.0 million for part of the BMH acquisition price. In March 2006, Amendment Two made $68.0 million of term loans available to the Company. Alion used approximately $16.5 million of these term loan proceeds to pay part of the WCI acquisition price, and approximately $13.6 million to redeem mezzanine warrants held by IIT and the CEO. In May 2006, the Company used $15.0 million of Amendment Two incremental term loan proceeds for part of the MA&D acquisition price. In June 2006, the Company borrowed $21.0 million in Amendment Two incremental term loans and $50.0 million in Amendment Three incremental term loans to pay part of the Anteon Contracts acquisition price. In January 2007, Alion paid a $0.3 million fee to borrow $15.0 million under Increment Four to pay down part of its outstanding senior revolving credit facility balance. In July 2007, Alion paid a $0.5 million fee to borrow $25.0 million under Increment Five to pay down part of its outstanding senior revolving credit facility balance.

The Term B Senior Credit Facility permits the Company to use the remainder of its senior revolving credit facility for working capital needs, other general corporate purposes, and to finance permitted acquisitions. The Term B Senior Credit Facility permits the Company to use any proceeds from the uncommitted incremental term loan facility to finance permitted acquisitions and for any other purpose permitted by any future incremental term loan.

Security. The Term B Senior Credit Facility is secured by a security interest in all of the Company’s current and future tangible and intangible property, as well as all of the current and future tangible and intangible property of the Company’s subsidiaries, HFA, CATI, METI, JJMA, BMH, WCI, WCGS and MA&D.

During fiscal year 2008, the senior term loans bore interest at the Eurodollar rate and the senior revolving credit facility bore interest at the alternate base rate. From October 1, 2007 through September 29, 2008, the interest rate on Alion’s revolving credit facility depended on the Company’s leverage ratio and whether the Company chose a Eurodollar or alternate base rate loan. The table below sets out the leverage-based interest rate spreads for Alion’s Term B loans.


			Federal Funds ABR
			Spread		Prime Rate ABR
Leverage Ratio	Eurodollar Spread		(in Basis Points)		Spread

Category 1		275		225		175
Greater than or equal to 3.00 to 1.00
Category 2		250		200		150
Greater than or equal to 2.50 to 1.00 but less than 3.00 to 1.00
Category 3		225		175		125
Greater than or equal to 2.00 to 1.00 but less than 2.50 to 1.00
Category 4		200		150		100
Less than 2.00 to 1.00

As of September 30, 2008, the minimum interest rate on Alion’s term loan and revolving credit facility is 9.50% and no longer depends on the Company’s leverage ratio. The Eurodollar rate interest rate is 600 basis points plus a 3.5% minimum interest rate. The alternate base rate is 500 basis points plus a 4.5% minimum interest rate.

Interest Rate Swap. In January 2008, Alion executed an interest rate swap with one of its lenders to convert the floating rate interest payable on a portion of its Term B senior term loan to a fixed rate, and to adjust the timing of some net interest payments related to its Term B senior term loan. The swap agreement had a notional principal amount of $240 million and expired on November 1, 2008. The Company made its final semi-annual interest payment November 1, 2008. Alion received quarterly floating rate interest payments in February and May 2008 at 7.32% and in August and November 2008 at 5.49%. Alion paid interest semi-annually in May and November 2008 at 6.52%. All swap payments were net cash settled.

Financial Covenants. As of December 31, 2008, the Company was in compliance with the Term B Senior Credit Facility financial covenants.

The Term B Senior Credit Facility includes covenants which, among other things, restrict the Company’s ability to do the following without the prior consent of syndicate bank members that have extended more than 50 percent of the aggregate amount of all loans then outstanding under the Term B Senior Credit Facility:


	•	incur additional indebtedness other than permitted additional indebtedness after satisfying a leverage-based incurrence test;

	•	consolidate, merge or sell all or substantially all of the Company’s assets;


	•	make certain loans and investments including acquisitions of businesses, other than permitted acquisitions;

	•	pay dividends or distributions other than distributions needed for the ESOP to satisfy its repurchase obligations and certain payments required under the Company’s equity based incentive plans;

	•	enter into certain transactions with the Company’s shareholders and affiliates;

	•	enter into certain transactions not permitted under ERISA;

	•	grant certain liens and security interests;

	•	enter into sale and leaseback transactions;

	•	change lines of business;

	•	repay subordinated indebtedness before it is due and redeem or repurchase certain equity;

	•	pay certain earn-outs in connection with permitted acquisitions;

	•	make payments to directors, officers, and employees of the Company or its subsidiaries in connection with warrants, stock appreciation rights, phantom stock plans or similar incentives or equity-based incentives in excess of $20 million in the aggregate; or

	•	use the proceeds of the Company’s borrowings other than as permitted by the Term B Senior Credit Facility.

Events of Default. The Term B Senior Credit Facility contains customary events of default including, without limitation:


	•	payment default;

	•	breach of representations and warranties;

	•	uncured covenant breaches;

	•	default under certain other debt exceeding an agreed amount;

	•	bankruptcy and insolvency events;

	•	notice of debarment, suspension or termination under a material government contract;

	•	certain ERISA violations;

	•	unstayed judgments in excess of an agreed amount;

	•	failure of the subordinated note to remain subordinated to the Term B Senior Credit Facility;

	•	failure of any guarantee of the Term B Senior Credit Facility to be in effect;

	•	failure of the security interests to be valid, perfected first priority security interests in the collateral;

	•	failure of the Company to remain an S-corporation;

	•	imposition on the ESOP Trust of certain taxes in excess of an agreed amount;

	•	final determination the ESOP is not a qualified plan;

	•	incurrence of a civil or criminal liability in excess of $5 million of the Company or any subsidiary arising from a government investigation;

	•	actual termination of a material contract due to alleged fraud, willful misconduct, negligence, default or any other wrongdoing; or

	•	change of control (as defined below).

For purposes of the Term B Senior Credit Facility, a change of control generally occurs when, before Alion lists its common stock to trade on a national securities exchange and the Company obtains net proceeds from an underwritten public offering of at least $30.0 million, the ESOP Trust fails to own at least 51 percent of the

Company’s outstanding equity or voting interests, or, after the Company has such a qualified public offering, any person or group other than IIT or the ESOP Trust owns more than 37.5 percent of the Company’s outstanding equity or voting interests. A change of control may also occur if a majority of the seats (other than vacant seats) on Alion’s Board of Directors shall at any time be occupied by persons who were neither nominated by the board nor were appointed by directors so nominated. A change of control may also occur if a change of control occurs under any of Alion’s material indebtedness including the Company’s Indenture or under Alion’s subordinated note related warrants.

Subordinated Note — Redeemable Common Stock Warrants

In August 2008, Alion amended and restated the original warrants and issued an additional 550,000 redeemable common stock warrants at an exercise price of $36.95 per share. The Company issued the second set of warrants to IIT in connection with the amendment of the Subordinated Note. The new warrants are exercisable from April 2009 to September 2013 at the then-current fair value per share of Alion common stock, less the exercise price. The original warrants are exercisable currently and through September 2013. The Company recognized approximately $10.3 million in debt issue costs for the fair value of the September 2008 warrants and the amendment to the December 2002 warrants.

Alion has classified the warrants as debt instruments and not equity, in accordance with EITF Issue 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’ Own Stock. The Company recognizes interest expense for changes in the fair value of the warrants which had an aggregate estimated fair value of $38.5 million as of September 30, 2008.

Senior Unsecured Notes

On February 8, 2007, Alion issued and sold $250.0 million of its private 10.25% senior unsecured notes due February 1, 2015 (Senior Unsecured Notes) to Credit Suisse, which informed the Company it had resold most of the notes to qualified institutional buyers. On June 20, 2007, Alion exchanged its private Senior Unsecured Notes for publicly tradable Senior Unsecured Notes with the same terms.

Interest and Fees. The Senior Unsecured Notes bear interest at 10.25% per year, payable semi-annually in arrears on February 1 and August 1. Alion makes interest payments to holders of record as of the immediately preceding January 15 and July 15. The Company must pay interest on overdue principal or interest at 11.25% per annum to the extent lawful.

Covenants. The Indenture governing the Senior Unsecured Notes contains covenants that, among other things, limit Alion’s ability and the ability of certain of its subsidiaries to:


	•	incur or guarantee additional indebtedness;

	•	pay dividends on capital stock or redeem, repurchase or retire capital stock or subordinated indebtedness, except in certain circumstances for the junior subordinated notes and junior warrants;

	•	repurchase or redeem shares of Company stock in connection with distributions and diversifications from the ESOP component of the KSOP;

	•	transfer or sell assets including shares of stock of certain subsidiaries outside the ordinary course of business;

	•	make investments other than certain permitted investments;

	•	engage in business unrelated to Alion’s existing business;

	•	incur certain liens and enter into sale/leaseback transactions;

	•	enter into certain transactions with affiliates;

	•	pay dividends and make distributions and loans to the Company; and

	•	merge or consolidate with other companies.

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


	•	payment default;

	•	uncured covenant breaches;

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

	•	certain bankruptcy and insolvency events;

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

	•	failure of any guarantee of the Senior Unsecured Notes to be in effect or the denial or disaffirmation by any subsidiary guarantor of its guaranty obligations.

Change of Control. Upon a change in control, each Senior Unsecured Note holder has the right to require Alion to repurchase its notes in cash for 101% of the principal amount of such holder’s notes plus accrued and unpaid interest. Any of the following events constitutes a change in control:


	•	subject to certain exceptions, a person, other than the ESOP Trust, is or becomes the beneficial owner, directly or indirectly, of more than 35% of the total voting power or voting stock of Alion;

	•	individuals who constituted Alion’s board of directors on the date the Senior Unsecured Notes were issued, cease for any reason to constitute a majority of the Company’s board of directors;

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

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

Optional Redemption. Prior to February 1, 2011, the Company may redeem all, but not less than all, of the Senior Unsecured Notes at a redemption price equal to 100% of the principal amount of the Senior Unsecured Notes

plus accrued and unpaid interest to the redemption date plus an applicable make-whole premium as of the redemption date.

In addition, any time prior to February 1, 2010, subject to certain conditions, the Company may use the proceeds of a qualified equity offering to redeem Senior Unsecured Notes in an aggregate principal amount not to exceed $87.5 million at a redemption price equal to the sum of 110.25% of the aggregate principal amount of the notes actually redeemed, plus accrued and unpaid interest to the redemption date.

On or after February 1, 2011, the Company may redeem all or a portion of the Senior Unsecured Notes at the redemption prices set forth below (expressed in percentages of principal amount on the redemption date), plus accrued and unpaid interest to the redemption date, if redeemed during the 12-month period commencing on February 1 of the years set forth below:


	Redemption
Period	Price

2011		105.125	%
2012		102.563	%
2013 and thereafter		100.000	%

During the remainder of fiscal year 2009 and the next six fiscal years the Company expects that at a minimum, it will have to make the estimated interest and principal payments set forth below.


	7-Fiscal Year Period
	2009*		2010		2011		2012		2013		2014		2015
	($ in thousands)

Bank revolving credit facility
— Interest(1)	$	872	$	983	$	710	$	483	$	482	$	253	$	253
Senior Term Loan
— Interest(2)		17,161		22,759		22,525		22,352		7,820		—		—
— Principal(3)		1,825		2,433		2,433		2,433		229,297		—		—
Senior Unsecured Notes
— Interest		25,625		25,625		25,625		25,625		25,625		25,625		12,813
— Principal		—		—		—		—		—		—		250,000
Subordinated Note
— Interest		2,353		3,223		3,369		3,594		3,332		—		—
— Principal		—		3,000		3,000		2,000		70,311		—		—

Total cash — pay interest		46,011		52,590		52,229		52,054		37,259		25,878		13,066
Total cash — pay principal		1,825		5,433		5,433		4,433		299,608		—		250,000

Total	$	47,836	$	58,023	$	57,662	$	56,487	$	336,867	$	25,878	$	263,066


*		Estimated interest and principal payments for the remainder of fiscal year 2009.

(1)		Alion anticipates regularly accessing a $50.0 million revolving credit facility to finance working capital needs. The present revolving credit facility matures in August 2009. The Company expects to replace it with a similar facility for working capital needs at least through 2013. Alion estimates the average revolver balance will be $10.0 million for fiscal year 2009; $8.0 million for fiscal year 2010, $5.0 million for 2011, $2.5 million for 2012 and 2013 and minimal thereafter. Interest expense includes estimated fees for the unused balance of a $50.0 million revolving credit facility. The Company estimates the effective average cash-pay interest rate, excluding fees for the unused balance on the revolver, will be 9.5% for all periods presented.

(2)		Alion estimates the average annual senior term loan balance under the Term B Senior Credit Facility will be: $238.1 million, $235.7 million, $233.3 million, $230.8 million, and $81.0 million for fiscal years 2009 through 2013. The senior term loan matures February 2013. The Company expects it will need to refinance the senior


		term loan before it matures and forecasts interest expense to continue at levels similar to prior years based on Alion’s current minimum interest rate of 9.5%.

(3)		The Term B Senior Credit Facility requires Alion to repay approximately 1.0% of the principal balance outstanding under the senior term loan annually. On a cumulative basis, Alion is required to pay approximately 4.3% of the principal through the first quarter of fiscal year 2013. The remaining principal balance is due on February 6, 2013, the senior term loan maturity date. The table reflects the balance drawn of $238.4 million as of December 31, 2008, resulting in approximately $2.4 million in principal payments each fiscal year from 2009 through 2012, approximately $0.6 million for the first quarter of fiscal year 2013, and the remaining principal balance of approximately $228.7 million on February 6, 2013. If Alion generates certain excess cash flow in a given fiscal year, issues or incurs certain debt or sells certain assets, the Term B Senior Credit Facility requires the Company to prepay a portion of the principal. As of December 31, 2008, no mandatory prepayments are due.

Contingent Obligations

Earn-outs

Alion’s LogConGroup earn-out obligation continues through September 2013. The earn-out cannot exceed $900 thousand based on revenue from potential logistics contracts. In the three months ended December 31, 2008, Alion recognized no LogConGroup earn out. Management believes realization of this earn-out will not have a material effect on Alion’s financial position, results of operations, or liquidity. No other acquisition related earn-out obligations remain. The Company paid $50 thousand in LogConGroup earn-outs in the quarter ended December 31, 2008.

Other Contingent obligations which will impact the Company’s cash flow

Other contingent obligations which will impact Alion’s cash flow include:


	•	IIT’s Subordinated Note warrant put rights;

	•	Stock-based and long-term incentive compensation plan obligations; and

	•	KSOP share repurchases and diversification options.

As of December 31, 2008, Alion had spent a cumulative total of $62.4 million to repurchase shares of its common stock to satisfy ESOP distribution requests from former employees and Plan beneficiaries. In 2008, the Company changed its prior practice of immediately paying out all distribution requests in full. In March 2008, Alion began paying ESOP beneficiaries over the five-year distribution period permitted by ERISA and the terms of the Plan. Alion intends to continue this practice for the foreseeable future in part to offset the cash flow effects of annual employee diversification requests that began in fiscal 2008 and which are expected to continue for the foreseeable future.


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

June 2003		5,248	$	11.13	$	58
July 2003		2,696	$	11.13		30
December 2003		50,031	$	14.71		736
May 2004		117	$	16.56		2
June 2004		727	$	16.56		12
June 2004		743	$	16.56		12
July 2004		48,309	$	16.56		800
December 2004		46,816	$	19.94		934
March 2005		5,691	$	19.94		113
June 2005		45,846	$	29.81		1,367
August 2005		1,090	$	33.78		37


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

September 2005		170,657	$	33.78		5,765
December 2005		211,537	$	35.89		7,592
June 2006		273,800	$	37.06		10,147
July 2005		32,420	$	37.06		1,202
August 2006		1,747	$	37.06		65
December 2006		2,243	$	41.02		92
January 2007		14	$	41.02		1
February 2007		157,320	$	41.02		6,453
March 2007		73	$	41.02		3
May 2007		238	$	43.37		10
June 2007		152	$	43.37		7
July 2007		276,877	$	43.37		12,008
August 2007		251,248	$	43.37		10,897
September 2007		15	$	43.37		1
October 2007		90	$	40.05		4
December 2007		210	$	40.05		8
February 2008		648	$	40.05		26
March 2008		19,961	$	40.05		799
March 2008		10,011	$	41.00		410
April 2008		60	$	40.05		2
July 2008		306	$	41.00		13
September 2008		68,009	$	41.00		2,788
December 2008		233	$	38.35		9

Total		1,685,183			$	62,403

Alion believes cash flow from operations and cash available under current and anticipated revolving credit facilities will provide sufficient capital to fulfill current business plans and fund working capital needs for at least the next 24 months. The Company intends to focus on organic growth, margin improvement and process improvement and expects to continue improving cash flow from operations through more frequent electronic invoicing. Although Alion expects to have positive annual cash flow from operations, it will need to generate significant additional revenue beyond current levels and earn net income in order to repay principal and interest on the Term B Senior Credit Facility, the Senior Unsecured Notes, the Subordinated Note and Warrants, and to meet ESOP repurchase and diversification obligations.

The Term B Senior Credit Facility and the Indenture governing the Senior Unsecured Notes allow Alion to make certain permitted acquisitions, and the Company intends to use financing available under the Term B Senior Credit Facility to do so. Alion will need to replace its existing revolving credit facility prior to August 2009, and plans to refinance the Term B senior term loan and the subordinated note before they mature. The Company is uncertain whether it will be able to refinance these obligations or if refinancing terms will be favorable. If Alion is unable to refinance the revolving credit facility prior to August 2009, it may not have sufficient cash from operations to satisfy all of its obligations. If Alion is unable to refinance the Term B senior term loan, it will not have sufficient cash from operations to satisfy all of its obligations. If plans or assumptions change, if assumptions prove inaccurate, if Alion consummates additional or larger investments in or acquisitions of other companies than are currently planned, if the Company experiences unexpected costs or competitive pressures, or if existing cash and projected cash flow from operations prove insufficient, the Company may need to obtain greater amounts of additional financing and sooner than expected. While Alion intends only to enter into new financing or refinancing

it considers advantageous, given the current state of the credit markets, the Company cannot be certain sources of financing will be available in the future, or, if available, that financing terms would be favorable.

Recently Issued Accounting Pronouncements

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities,” (SFAS 161) which amends SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). SFAS 161 requires enhanced disclosures about how and why an entity uses derivatives, how the entity accounts for derivatives under SFAS 133 and how derivatives and related hedged items affect an entity’s financial position, results of operations and cash flows. SFAS 161 is effective for fiscal years beginning after November 15, 2008. The Company does not expect adopting SFAS 161 will materially affect its consolidated financial statements or results of operations.

Forward Looking Statements

This discussion contains forward-looking statements that involve risks and uncertainties. These statements relate to the Company’s future plans, objectives, expectations and intentions and are for illustrative purposes only. These statements may be identified by the use of words such as “believe,” “expect,” “intend,” “plan,” “anticipate,” “likely,” “will,” “pro forma,” “forecast,” “projections,” “could,” “estimate,” “may,” “potential,” “should,” “would,” and similar expressions.

Factors that could cause actual results to differ materially from those anticipated include, but are not limited to, the following:


	•	changes to the ERISA laws related to the KSOP;

	•	changes to Alion’s subchapter S status, or any change in Alion’s effective tax rate;

	•	additional costs associated with complying 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;

	•	results of current and/or future legal proceedings and government agency proceedings which may arise out of Alion’s operations and the attendant risks of fines, liabilities, penalties, suspension and/or debarment;

	•	undertaking acquisitions that could increase costs or liabilities or be disruptive;

	•	taking on additional debt to fund acquisitions;

	•	failure to adequately integrate acquired businesses;

	•	material changes in laws or regulations applicable to Alion’s businesses;

	•	other risk factors discussed in the Company’s annual report on Form 10-K for the year ended September 30, 2008 filed with the SEC on December 23, 2008.

Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s view only as of February 13, 2009. 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 continuing operations.


Item 3.	*Quantitative and Qualitative Disclosures About Market Risk*

Interest rate risk

The Company is exposed to interest rate risk principally for debt incurred to finance its acquisitions, its periodic borrowings and related debt amendments and re-financings. The balance on the $50.0 million senior revolving credit facility bears interest at variable rates currently based on Credit Suisse’s (CS) prime rate (with a minimum of 4.5%) plus a maximum spread of 500 basis points. The balance on the Senior Secured Term B Loan bears interest at variable rates currently tied to the Eurodollar rate (with a minimum of 3.5%) plus 600 basis points. Such variable rates increase the risk that interest charges will increase materially if market interest rates increase. The current interest rate spreads exceed the spreads that were in effect in fiscal year 2008. The approximate impact of a 1% increase in the interest rate, as applied to principal balances drawn under the Senior Secured Term B Credit Facility would be $1.8 million, $2.4 million, $2.3 million, $2.3 million, and $1.1 million for the balance of fiscal year 2009 and fiscal years ending 2010 through 2013.

The Company does not use derivatives for trading purposes. It invests its excess cash in short-term, investment grade, and interest-bearing securities.

Foreign currency risk

Expenses and revenues from international contracts are generally denominated in U.S. dollars. Alion does not believe operations are subject to material risks from currency fluctuations.

Risk associated with value of Alion common stock

Changes in the fair market value of Alion’s common stock affect the economic basis for the Company’s estimated warrant liability. The value of Alion’s warrant liability would increase by approximately $5.6 million if the price of the Company’s stock were to increase by 10% and would decrease by approximately $5.5 million if the price of the Company’s stock were to decrease by 10%. Such changes would be reflected in interest expense in Alion’s consolidated statements of operations.

Changes in the fair market value of Alion’s stock also affect the Company’s estimated KSOP share repurchase obligations and stock-based compensation obligations under existing phantom stock and stock appreciation rights plans. Several factors affect the timing and amount of these obligations, including: the number of employees who

seek to redeem shares of Alion stock following termination of employment, and the number of employees who exercise their rights under the stock appreciation and phantom stock programs during any particular time period.


Item 4.	*Controls and Procedures*

Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rule 15d — 15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports it is required to file or submit under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified by the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its Chief Executive and Chief Financial Officers, as appropriate to allow timely decisions regarding required disclosures. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective and timely.

Limitations on the Effectiveness of Controls. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures.

Changes in Internal Control Over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 15d — 15(f) under the Exchange Act) during the first fiscal quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


Item 4T.	*Controls and Procedures*

See disclosure under Item 4.

PART II — OTHER INFORMATION


Item 1.	*Legal Proceedings*

See Note 20 to the Condensed Consolidated Financial Statements. Other than the actions discussed in Note 20, the Company is not involved in any legal proceeding other than routine legal proceedings occurring in the ordinary course of business. Alion believes that these routine legal proceedings, in the aggregate, are not material to its financial condition and results of operations.

As a government contractor, Alion may be subject from time to time to federal government inquiries relating to its operations and to DCAA audits. The federal government can suspend or debar, for a period of time, a contractor that is indicted or found to have violated the False Claims Act or other federal laws. Such an event could also result in fines or penalties.


Item 1A.	*Risk Factors*

There have been no material changes to the risk factors Alion disclosed in its Annual Report Form 10-K for the year ended September 30, 2008.


Item 2.	*Unregistered Sales of Equity 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.


Item 6.	*Exhibits*


Exhibit
No.			Description

	31	.1	Certification of Chief Executive Officer of Alion Science and Technology Corporation pursuant to Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
	31	.2	Certification of Chief Financial Officer of Alion Science and Technology Corporation pursuant to 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
	32	.1	Certification of Chief Executive Officer of Alion Science and Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32	.2	Certification of Chief Financial Officer of Alion Science and Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


PART I — FINANCIAL INFORMATION			3
	Item 1.	Financial Statements (unaudited)	3
		Condensed Consolidated Balance Sheets (unaudited)	3
		Condensed Consolidated Statements of Operations (unaudited)	4
		Condensed Consolidated Statements of Cash Flows (unaudited)	5
		Notes to Condensed Consolidated Financial Statements (unaudited)	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44
	Item 4.	Controls and Procedures	45
	Item 4T.	Controls and Procedures	45

PART II — OTHER INFORMATION			45
	Item 1.	Legal Proceedings	45
	Item 1A.	Risk Factors	45
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
	Item 3.	Defaults Upon Senior Securities	46
	Item 4.	Submission of Matters to a Vote of Security Holders	46
	Item 5.	Other Information	46
	Item 6.	Exhibits	46


	Title:	Principal Financial Officer and Duly Authorized Officer