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Alion Science & Technology Corp · 10-K · For 9/30/05

Filed On 1/31/06 5:31pm ET · SEC File 333-89756 · Accession Number 950133-6-416

  As Of               Filer                 Filing     As/For/On Docs:Pgs              Issuer               Agent

 1/31/06  Alion Science & Technology Corp   10-K        9/30/05   10:201                                    950133

Annual Report · Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        For, 10-K                                           HTML  1,133K 
 2: EX-3.2      Articles of Incorporation/Organization or By-Laws   HTML     48K 
 3: EX-4.11     Instrument Defining the Rights of Security Holders  HTML     27K 
 4: EX-4.12     Instrument Defining the Rights of Security Holders  HTML     10K 
 5: EX-23.1     Consent of Experts or Counsel                       HTML      6K 
 6: EX-23.2     Consent of Experts or Counsel                       HTML      6K 
 7: EX-31.1     Certification per Sarbanes-Oxley Act (Section 302)  HTML     11K 
 8: EX-31.2     Certification per Sarbanes-Oxley Act (Section 302)  HTML     11K 
 9: EX-32.1     Certification per Sarbanes-Oxley Act (Section 906)  HTML      8K 
10: EX-32.2     Certification per Sarbanes-Oxley Act (Section 906)  HTML      8K

10-K · For, 10-K
Document Table of Contents

Page	(sequential)	\|	(alphabetic)	Top
			Alternative Formats (RTF, XML, et al.) Business Certain Relationships and Related Transactions Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Consolidated Balance Sheets as of September 30, 2002 and 2001 Consolidated Balance Sheets as of September 30, 2005 and 2004 Consolidated Statements of Cash Flows for the years ended September 30, 2002, 2001, and 2000 Consolidated Statements of Cash Flows for the years ended September 30, 2005, 2004 and 2003 Consolidated Statements of Changes in Owner s Net Investment for the years ended September 30, 2002, 2001, and 2000 Consolidated Statements of Income for the years ended September 30, 2002, 2001, and 2000 Consolidated Statements of Operations for the years ended September 30, 2005, 2004 and 2003 Consolidated Statements of Shareholder s Equity (Deficit), Subject to Redemption, for the years ended September 30, 2005, 2004 and 2003 Controls and Procedures Directors and Executive Officers of the Registrant Executive Compensation Exhibits and Financial Statement Schedules Financial Statements and Supplementary Data Item 1 Item 10 Item 11 Item 12 Item 13 Item 14 Item 15 Item 2 Item 3 Item 4 Item 5 Item 6 Item 7 Item 7a Item 8 Item 9 Item 9a Item 9b Legal Proceedings Management s Discussion and Analysis of Financial Condition and Results of Operations Market for Registrant s Common Equity, Related Stockholders Matters and Issuer Purchases of Equity Security Notes to Consolidated Financial Statements Other Information Part I Part Ii Part Iii Part Iv Principal Accountant Fees and Services Properties Quantitative and Qualitative Disclosures About Market Risk Report of Independent Auditors Report Report of Independent Registered Public Accounting Firm Schedule II Valuation and Qualifying Accounts Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters Selected Financial Data Submission of Matters to a Vote of Security Holders
1	1st Page
"	Part I
"	Item 1
"	Business
"	Item 2
"	Properties
"	Item 3
"	Legal Proceedings
"	Item 4
"	Submission of Matters to a Vote of Security Holders
"	Part Ii
"	Item 5
"	Market for Registrant s Common Equity, Related Stockholders Matters and Issuer Purchases of Equity Security
"	Item 6
"	Selected Financial Data
"	Item 7
"	Management s Discussion and Analysis of Financial Condition and Results of Operations
"	Item 7a
"	Quantitative and Qualitative Disclosures About Market Risk
"	Item 8
"	Financial Statements and Supplementary Data
"	Report of Independent Registered Public Accounting Firm
"	Consolidated Balance Sheets as of September 30, 2005 and 2004
"	Consolidated Statements of Operations for the years ended September 30, 2005, 2004 and 2003
"	Consolidated Statements of Shareholder s Equity (Deficit), Subject to Redemption, for the years ended September 30, 2005, 2004 and 2003
"	Consolidated Statements of Cash Flows for the years ended September 30, 2005, 2004 and 2003
"	Notes to Consolidated Financial Statements
"	Schedule II Valuation and Qualifying Accounts
"	Report of Independent Auditors Report
"	Consolidated Balance Sheets as of September 30, 2002 and 2001
"	Consolidated Statements of Income for the years ended September 30, 2002, 2001, and 2000
"	Consolidated Statements of Changes in Owner s Net Investment for the years ended September 30, 2002, 2001, and 2000
"	Consolidated Statements of Cash Flows for the years ended September 30, 2002, 2001, and 2000
"	Item 9
"	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
"	Item 9a
"	Controls and Procedures
"	Item 9b
"	Other Information
"	Part Iii
"	Item 10
"	Directors and Executive Officers of the Registrant
"	Item 11
"	Executive Compensation
"	Item 12
"	Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters
"	Item 13
"	Certain Relationships and Related Transactions
"	Item 14
"	Principal Accountant Fees and Services
"	Part Iv
"	Item 15
"	Exhibits and Financial Statement Schedules

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K


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

		For the fiscal year ended September 30, 2005

Alion Science and Technology Corporation

(Exact name of Registrant as Specified in its Charter)


Delaware	333-89756	54-2061691
(State or Other Jurisdiction of Incorporation or Organization)	(Commission File Number)	(IRS Employer Identification No.)


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

(Address, including Zip Code and Telephone Number, including

Area Code, of Principal Executive Offices)

Securities registered pursuant to Section 12(b) or 12(g) of the Act:

None

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. o Yes þ No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o Yes þ No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). o Yes þ No

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

Aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of the last business day of the registrant’s most recently completed second fiscal quarter: None

The number of shares outstanding of Alion Science and Technology common stock as of September 30, 2005 was 5,149,840.

Documents Incorporated by Reference:

None

EXPLANATORY NOTE

As previously reported, the Company delayed the filing of its Annual Report for the fiscal year ended September 30, 2005 to allow for an independent investigation relating to an anonymous letter received by the Company shortly before the deadline for filing the Annual Report alleging, among other things, that one of the Company’s business units has engaged in illegal activities with respect to certain of its business operations. Consistent with the Company’s Ethics Compliance Program, the Corporate Governance and Compliance Committee of the Registrant’s Board of Directors, in consultation with the Audit and Finance Committee of the Registrant’s Board of Directors, supervised an investigation that was conducted by independent outside legal counsel into the allegations.

The investigation was completed on January 31, 2006. The investigation team did not uncover any evidence of any inappropriate activities of a material nature, as alleged in the anonymous letter. The Audit and Finance Committee of the Board of Directors reviewed the results of the investigation, expressed satisfaction with the scope and thoroughness of the investigation and confirmed that there was no evidence of any inappropriate activities of a material nature, as alleged in the anonymous letter.

ALION SCIENCE AND TECHNOLOGY CORPORATION

FORM 10-K

TABLE OF CONTENTS


PART I
Item 1.	Business	2
Item 2.	Properties	26
Item 3.	Legal Proceedings	27
Item 4.	Submission of Matters to a Vote of Security Holders	28

PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholders Matters and Issuer Purchases of Equity Security	28
Item 6.	Selected Financial Data	29
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 7a.	Quantitative and Qualitative Disclosures About Market Risk	61
Item 8.	Financial Statements and Supplementary Data	63
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	114
Item 9a.	Controls and Procedures	114
Item 9b.	Other Information	114

PART III
Item 10.	Directors and Executive Officers of the Registrant	115
Item 11.	Executive Compensation	120
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters	132
Item 13.	Certain Relationships and Related Transactions	133
Item 14.	Principal Accountant Fees and Services	133

PART IV
Item 15.	Exhibits and Financial Statement Schedules	135

PART I


Item 1.	*Business*

Some of the statements under “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Form 10-K constitute forward-looking statements, which involve known and unknown risks and uncertainties. These statements relate to our future plans, objectives, expectations and intentions and are for illustrative purposes only. These statements may be identified by the use of words such as “believe,” “expect,” “intend,” “plan,” “anticipate,” “likely,” “will,” “pro forma,” “forecast,” “projections,” “could,” “estimate,” “may,” “potential,” “should,” “would” and similar expressions.

The factors that could cause actual results to differ materially from those anticipated include, but are not limited to, the following: changes to the ERISA laws related to the Company’s Employee Ownership, Savings and Investment Plan; changes to the tax laws relating to the treatment and deductibility of goodwill; the Company’s subchapter S status, or any change in the Company’s effective tax rate; additional costs associated with compliance with the Sarbanes-Oxley Act of 2002, including any changes in the SEC’s rules, and other corporate governance requirements; failure of government customers to exercise options under contracts; funding decisions relating to U.S. Government projects; government contract procurement (such as bid protest) and termination risks; competitive factors such as pricing pressures and/or competition to hire and retain employees; the results of current and/or future legal proceedings and government agency proceedings which may arise out of our operations (including our contracts with government agencies) and the attendant risks of fines, liabilities, penalties, suspension and/or debarment; undertaking acquisitions that could increase our costs or liabilities or be disruptive; taking on additional debt to fund acquisitions; failure to adequately integrate acquired businesses; material changes in laws or regulations applicable to the Company’s businesses; as well as other risk factors discussed elsewhere in this annual report.

Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s view only as of January 31, 2006. We undertake no obligation to update any of these factors or to publicly announce any change to our forward-looking statements made herein, whether as a result of new information, future events, changes in expectations or otherwise.


	*Pro Forma Financial Data*

On December 20, 2002, Alion acquired Selected Operations of IIT Research Institute (“IITRI”) in a business combination accounted for using the purchase method (the “Transaction”). Prior to December 20, 2002, Alion was a shell company with limited operating activity. All operating data for the fiscal years ended September 30, 2003 and 2002 are pro forma as it relates to the Transaction described and presented in Item 6, “Selected Financial Data” and assume that this acquisition was completed on October 1, 2001. All pro forma information included in this annual report is based upon the assumptions described in Item 6.

Overview

Alion Science and Technology Corporation (“Alion”, “the Company”, “we”, “our”) is an employee-owned company. We apply our scientific and engineering experience to research and develop technological solutions for problems relating to national defense, homeland security and energy and environmental analysis. We provide our research and development and engineering services primarily to agencies of the federal government, but also to departments of state and local government and foreign governments, as well as commercial customers both in the U.S. and abroad.

Our revenue for fiscal year ended September 30, 2005 was $369.2 million, a 36.8% increase over the prior fiscal year. Federal government contracts accounted for approximately 96% of our revenues in the fiscal year ended September 30, 2005, of which approximately 88% came from the U.S. Department of Defense (DoD) alone. For the fiscal year ended September 30, 2004, federal government contracts accounted for approximately 98% of our revenues and approximately 91% came from the U.S. Department of Defense.

We apply our expertise to a range of specialized fields, which we refer to as core business areas. The core business areas are further described below. The estimated percentage distribution of our annual revenues, by core business area, is provided in the table below.

Estimated Revenue by Fiscal Year*


Core Business Area	2005				2004				2003

	(In millions)
- Defense Operations	$	131	36	%	$	105	39	%	$	84	39	%
- Wireless Communications	$	56	15	%	$	38	14	%	$	45	21	%
- Industrial Technology Solutions	$	52	14	%	$	36	13	%	$	28	13	%
- Naval Architecture/ Marine Engineering	$	51	14	%	$	1	0	%	$	0	0	%
- Modeling and Simulation	$	35	9	%	$	22	8	%	$	13	6	%
- Chemical, Biological, Nuclear, and Environmental Sciences	$	33	9	%	$	33	12	%	$	23	11	%
- Information Technology	$	11	3	%	$	35	13	%	$	20	10	%

	$	369	100	%	$	270	100	%	$	213	100	%


*	Beginning 2005, the descriptions of the Core Business Areas were modified as compared to descriptions used in our Form 10-Ks for 2004 and 2003. The results for 2004 and 2003, have been re-categorized using the modified Core Business Area descriptions. Revenues and percentages are based on management estimates.

Defense Operations. Our defense operations units provide the following services to the U.S. Department of Defense, including individual service components:


	•	Military transformation: we identify and analyze issues and programs of major importance for the Office of the Secretary of Defense (OSD) and related U.S. military services transformation initiatives such as joint warfare experimentation. We also integrate command, control, communication and computer intelligence (C4I) initiatives and develop net-centric initiatives.

	•	Logistics management: we provide support to the U.S. Army on a broad range of requirements including infrastructure assessment, reserve force mobilization, defense industrial base assessment, financial management, cost analysis, and base realignment, from planning to implementation.

	•	Readiness assessments and operational support: we deliver strategic planning and decision-making process improvements by providing technical assistance and decision support tools, such as Full Spectrum Analysis and Distributed Information System Collaboration Architecture (DISCATM).

	•	Training and education services: we assist the U.S. Department of Defense in the development of its department-wide education and training policies. We develop the necessary technology, compile the information to be used in the courseware, and then translate this into an electronic or web-based advanced distant learning medium so that the student can interact with the courseware from a remote location.

	•	Critical infrastructure protection (CIP), risk and vulnerability analysis: we provide techniques, tools, and operational support to assess vulnerabilities and defend infrastructure, including ports, power plants and communications nodes.

	•	Ordnance management: we provide inventory management, inspection and distribution of ordnance for the U.S. Navy.

Wireless Communications. We provide wireless communications research and spectrum engineering services primarily to the U.S. Department of Defense, but also to other agencies of the federal government. To

a lesser extent, we provide wireless communications research and spectrum engineering services to commercial customers and foreign governments. We have expertise in four primary areas:


	•	Wireless and communications-electronics engineering: we perform work for the government “communications-electronics” and commercial wireless communities. The term “communications-electronics” refers to all devices or systems that use the radio frequency spectrum. Our work for the government sector includes such tasks as conducting modeling and simulation of communications networks, testing and evaluating navigational systems, and analyzing radar and space systems performance. For our commercial customers, both foreign and domestic, we determine whether wireless communication networks have the geographic coverage the customers desire, and whether the systems operate free of interference, and we make recommendations designed to improve network performance. We also evaluate and make recommendations for the design of radio transmitters, receivers and antennas for our commercial customers. In the area of net-centric operations, we design next generation wireless networks and devices, including frequency and bandwidth-adaptive systems.

	•	Spectrum management: we perform studies and analyses related to the manner in which the radio frequency spectrum may be utilized without interruption or interference by both new and existing users and technologies. In addition, we assess existing and new technologies for their ability to utilize the radio frequency spectrum efficiently — in other words, to accomplish designated tasks without using too much of the available radio frequency spectrum. Our services, which include providing spectrum policy advice, are used to support decisions of senior government officials in the U.S. and abroad.

	•	C4ISR system engineering: we deliver Command, Control, Communication and Computer Intelligence, Surveillance, and Reconnaissance (C4ISR) engineering and analysis support for radio frequency communications, radar, Identification Friend or Foe (IFF), and navigation systems to the U.S. Department of Defense system developers and integrators. We also develop automated spectrum management software to assign frequencies to multiple users of the radio frequency spectrum in an effort to minimize interference. Our software tool, Spectrum XXI, is the automated spectrum management system used worldwide by the U.S. Department of Defense, and it is now also being used by other agencies of the federal government. We also design, integrate and deploy spectrum monitoring software to locate and track violators of the rules and regulations of spectrum usage.

	•	Electromagnetic environmental effects: we perform studies and analyses to measure and predict electromagnetic environmental effects for both government and commercial customers. Our work has involved building automated tools designed to predict the effects of potential hazards of electromagnetic radiation to ordnance, fuel and personnel. We also analyze electronic components in automotive parts such as brakes and airbags for electromagnetic interference issues on behalf of various commercial customers.

Industrial Technology Solutions. We provide the following services to the U.S. Department of Defense and, to a lesser extent, to commercial customers:


	•	Reliability, material and manufacturing engineering: we apply technology to enhance production, improve performance, reduce cost and extend life of complex engineered products.

	•	Sensor technology development: we develop, evaluate, adapt and integrate sensor technologies and provide support to the U.S. Department of Defense’s Night Vision Electronic Sensors Laboratory.

	•	Facilities engineering/construction management: we provide expertise in engineering, architecture and related disciplines (e.g., construction management, logistics, design oversight and inspection).

	•	Research and analysis center management: we manage numerous U.S. Department of Defense information analysis centers such as the: Advanced Materials and Processes Technology Information Analysis Center (AMPTIAC), Manufacturing Technology Information Analysis Center (MTIAC), Electronic Packaging and Interconnection Technology Center and the DuPage Manufacturing Research Center.


	•	Acoustic engineering: we test and evaluate various components for sound transmission, absorption and intensity; field measurement testing; equipment vibration and isolation; noise abatement; and active silencing.

	•	Aerospace coating production and application: we develop and apply coatings to protect government and commercial satellites as well as the International Space Station.

	•	Innovative manufacturing technologies: we develop and integrate systems for low-volume productivity (e.g., laser cladding of parts), micro-machines and rapid manufacturing systems.

Naval architecture/marine engineering. We provide technical services for ship and systems design from the initial phase of mission analysis and feasibility trade-off studies through contract and detail design, production supervision, testing and logistics support for the commercial and naval markets.


	•	Ship design: we provide total ship design services for military and commercial customers. The services encompass whole ship systems engineering including requirements definition, concept analysis, feasibility studies and contract design, detail design and production support.

	•	Naval architecture: we provide systems engineering/design integration, hull form development and performance analysis, structural design and analysis, weight engineering, and intact and damage stability analysis.

	•	Marine engineering: we design and engineer ship systems including propulsion, electrical, fluids/piping, auxiliary, HVAC, deck machinery, and machinery automation and control systems. We provide expertise for machinery integration, test and trials, failure analysis, modeling and simulation, and integrated logistics support.

	•	Combat systems engineering: we provide services including mission and threat analysis, evaluation of candidate warfare and combat systems, development of specifications and installation drawings for topside and below-deck interface requirements, and ship modernizations.

Modeling and Simulation. Our modeling and simulation operations assist our customers in examining the outcome of events by providing services such as:


	•	Wargaming, experimentation, scenario design and execution: we design and conduct strategic and operations analytic wargames to evaluate future operational concepts and force transformation initiatives, create and implement training scenarios for 2 dimensional and 3 dimensional simulation systems, support Joint Forces Command’s (JFCOM) Millennium Challenge, and we support Joint Conflict and Tactical Simulation (JCATS) scenarios.

	•	C4I integration: for the U.S. Department of Defense, we design and develop policies to enable standard automated interfaces between simulation and Command, Control, Communication and Computer Intelligence systems which support improved planning, training and military operations.

	•	Analysis and visualization: we develop terrain modeling databases and realistic 3D visual systems for flight simulation and other training systems. We manage the Modeling and Simulation Information Analysis Center (MSIAC) for the U.S. Department of Defense (DoD).

	•	Phenomenological modeling: we develop phenomenological models for nuclear, chemical, biological and electromagnetic environments.

	•	Locomotive simulators: we design and build railroad car simulators and complementary training programs for railway carriers to train their employees. Participation in our simulation training is designed to improve safety and to minimize fuel consumption for carriers. Our training tools range from training simulators based on desktop computers to full motion simulators for both electric and diesel-electric locomotives. We have delivered our training tools and services to domestic government and commercial customers and to customers in the U.K., Brazil, Turkey, India, Australia and South Africa.

Chemical, biological, nuclear and environmental sciences. Our chemical, biological, nuclear and environmental sciences operations provide a wide range of research primarily to the U.S. Department of Defense and the U.S. Environmental Protection Agency, but also to other departments of federal, state and local governments, including:


	•	Chemical/biological agent detection, destruction, and decontamination: we develop, test and evaluate safe methods for detection, destruction and chemical decontamination of chemical, biological and other toxic agents; and operate a chemical agent surety laboratory. We provide technical expertise to branches of the U.S. military, the FBI, police departments, hospitals, fire departments, and other federal government and commercial customers to reduce the threat of chemical-biological terrorism. We provide analytical methods to enhance safe handling of chemical substances and design methods to convert harmful chemical and biological materials into harmless materials.

	•	Laboratory support: using our laboratory facilities we analyze materials, wastes and effluents to determine constituents and/or properties; develop and validate analytical methods and instruments; and develop, test and implement methods for measuring air quality.

	•	Life sciences: we provide analysis, testing, operational and laboratory support in the areas of: biotechnology, biomedical sciences, drug development and toxicology.

	•	Detection, recovery and disposal of unexploded ordnance and explosives: we demilitarize conventional, toxic/radioactive and chemical warfare material; decontaminate and demolish buildings and equipment contaminated with explosives. We provide these services through our wholly-owned subsidiary, Human Factors Applications, Inc. (HFA).

	•	Environmental sciences: we provide analysis, operational and laboratory support in: air pollution research, toxicology, ecology and habitat, and quality assurance program support; underwater, airborne and radiated noise analysis; exhaust plume dispersion calculations and modeling; alternative fuels and fuel additives testing; emissions modeling; air and water pollution equipment evaluations; and technology evaluations of waste streams.

	•	Nuclear Safety and Analysis: we provide nuclear safety and analysis services to the U.S. Department of Energy (DOE) and its National Laboratories as well as to the commercial nuclear power industry. Our services include: modeling and simulation in the areas of computational fluid dynamics, structural response, materials behavior, and neutronics; safety and risk performance analysis in the areas of probabilistic safety assessments, accident consequence analysis, and source term dose assessment; design and performance assessment services to nuclear power facilities in the areas of control room habitability, power rate analysis, and license extension; management systems and technical program services in the areas of compliance (e.g., regulatory analysis, policy development, and audits), project management, and training; and regulatory compliance technical support services in the areas of nuclear plant operational readiness reviews and conduct of operations.

Information Technology. Our information technology operations provide the following research primarily to agencies of the federal government, including the U.S. Department of Defense, the Internal Revenue Service and the National Institutes of Health, but also to commercial customers:


	•	Enterprise architecture development and integration: we design, develop and implement enterprise information systems.

	•	Applications development: we develop web-based and stand-alone solutions, as well as decision support tools.

	•	Knowledge management: we deliver solutions for data warehousing/mining, decision support, and information analysis.

	•	Network design and secure network operations: we provide information assurance, business continuity and disaster planning, network planning, call center modeling and re-engineering, and designs for virtual private networks (VPNs).


	•	Independent verification and validation: we implement modeling and simulation, test and evaluation, and database monitoring.

	•	Medical informatics: we develop and integrate technologies for acquisition, storage and use of information, including decision support, in-health and biomedicine.

Software Tools and Technology Products. We have developed a series of software tools and technology products that complement our core business areas. Examples include:


	•	Frequency Assignment & Certification Engineering Tool (FACET^tm): this software tool automates the assignment of radio frequencies, which we refer to as spectrum management, in a way that is designed to minimize interference between multiple users of the radio frequency spectrum.

	•	Advanced Cosite Analysis Tool (ACAT^tm): this software tool is designed to permit co-location of numerous antennas on towers, rooftops and other platforms by predicting interference between the various systems and informing the user how to minimize interference.

	•	Spectrum Monitoring Automatic Reporting and Tracking System (SMART^tm): this system characterizes the frequency usage in a given geographic area, allowing the customer to remotely monitor the spectrum to identify unauthorized users and to look for gaps in the spectrum usage.

	•	X-IG^tm: this software provides 3-D images for managing and displaying visuals of terrain and environment used in flight simulation and other training systems.

	•	MobSim^tm/ SimViewer^tm: this software provides for tracking components across multiple modes of transportation (e.g., air, sea, rail and truck).

	•	Virtual Ocean: this software provides visualization of ship motions based on analytically correct representation of the seaway.

	•	Countermeasures^tm: we provide vulnerability/risk assessment software used to analyze and quantify physical or electronic security.

	•	Cave Dog: this product is a small, remote-controlled hemispherical, multi-spectral vision robot vehicle used for surveillance and reconnaissance.

	•	Real Time Location System (RTLS): this product is designed to enable customers to track thousands of users in a defined area, such as a seaport, a football stadium or an office building, using low cost antennas and badges.

	•	Isis- 3D^tm: we provide fire code software with specific models for weapon thermal hazard response, including aerosol and radiation models.

	•	PRISM^tm: we provide software used for system level failure rate modeling with the ability to model both operating and non-operating failure rates. The system considers non-component failure causes through process assessment.

Corporate History

Alion Science and Technology Corporation, formerly known as Beagle Holdings, Inc., was organized on October 10, 2001, as a for-profit Delaware corporation for the purposes of purchasing substantially all of the assets and assuming certain liabilities of IITRI, a not-for-profit Illinois corporation. Alion is an employee-owned company that is the successor in interest to IITRI, a government contractor in existence for more than sixty years. On December 20, 2002, some of the eligible employees of IITRI directed funds from their eligible retirement account balances into Alion’s Employee Stock Ownership Plan (ESOP). State Street Bank and Trust Company, the ESOP Trustee, used these proceeds, together with funds described elsewhere in this annual report, to purchase substantially all of IITRI’s assets and certain liabilities (hereafter referred to as the “Selected Operations of IITRI”). We refer to this purchase as “the Transaction.” Given the significance of the Transaction, and its effect on Alion’s capital structure, summary descriptions of the acquisition and the related deal terms, the purchase of Alion common stock by the ESOP, and Alion’s ESOP are provided below.


	**The Acquisition and Deal Terms for the Purchase of Assets from IITRI (The “Transaction”)**

Acquired Business. On December 20, 2002, Alion acquired substantially all of the assets, rights and liabilities of IITRI’s business except for, amongst others, those assets, rights and liabilities associated with the Life Sciences Operation (other than its accounts receivable, which Alion did acquire), and IITRI’s real property, some of which we leased upon completion of the acquisition.

Purchase Price. The aggregate purchase price we paid to IITRI for its assets was approximately $127.3 million that included the following components:


• a $57.0 million cash component, which consisted of:
	- approximately $25.8 million from the sale of our common stock to the ESOP;	$25.8 million (approximately)
	- approximately $31.2 million in proceeds from a loan to Alion arranged by LaSalle Bank National Association;	$31.2 million (approximately)
• an approximate $60.2 million debt component, which consisted of:
	- issuance of a promissory note, the mezzanine note, by Alion to IITRI with a face value of approximately $20.3 million;	$20.3 million (approximately)
	- issuance of a promissory note, the subordinated note, by Alion to IITRI with a face value of $39.9 million;	$39.9 million (approximately)
• the payment by Alion at closing of approximately $6.2 million for IITRI’s outstanding bank debt, $2.3 million for IITRI’s cost related to the transaction, and $1.6 million for purchase price adjustments due IITRI;		$10.1 million (approximately)
• warrants issued to IITRI to purchase up to approximately 38% of our common stock, on a fully diluted basis (assuming the exercise of all outstanding warrants), at the closing date.		Warrants

		$127.3 million (approximately)	Plus warrants and the assumption of additional liabilities.

Assumption of Liabilities. Alion assumed substantially all of the liabilities of IITRI’s business, with certain identified exceptions.

Indemnification. IITRI agreed to indemnify us, within limits agreed to by the parties, against any losses resulting from its breach of any of its representations, warranties or covenants and against losses resulting from liabilities retained by IITRI. We, in turn, indemnified IITRI, within limits agreed to by the parties, against losses resulting from our breach of any of our representations, warranties or covenants and against losses resulting from liabilities we assumed.


	*The Purchase of Alion Common Stock by ESOP Trust*

On December 20, 2002, we entered into a stock purchase agreement with the ESOP trust pursuant to which at closing we issued 2,575,408 shares of our common stock at $10 per share, in exchange for the funds our employees directed to be invested in the ESOP component of the KSOP (a “KSOP” is an employee benefit plan that consists of an ESOP and a 401(k) element, which allows employees to have diversified retirement savings in other investments) in the initial one-time ESOP investment election.

Representations and Warranties. Within the stock purchase agreement, we made representations and warranties to the ESOP trust that are customary to transactions of this type, related to, but not limited, to:


	•	Alion’s and HFA’s organization and corporate standing, their authority to enter into the stock purchase agreement and the binding effect of the agreement on us;

	•	the accuracy, compliance with U.S. generally accepted accounting principles and consistency with past practice of the financial statements with respect to the portion of IITRI’s business transferred to Alion; and

	•	our obligation to repurchase any shares of our common stock distributed to ESOP participants.

	•	the ESOP trustee, on behalf of the ESOP trust, made representations and warranties to us, including, but not limited to:


	•	the trustee’s authority to enter into the stock purchase agreement and the binding effect of the agreement on the ESOP trust; and

	•	the investment intent of the ESOP trust.

Covenants. As part of the stock purchase agreement, we agreed with the ESOP trust that:


	•	we will not take any steps without the ESOP trust’s consent to change our status as an S corporation;

	•	we will not enter into any transactions with any of our officers or directors without approval from our board of directors or compensation committee;

	•	we will enforce our obligations under the asset purchase agreement with IITRI and other related agreements;

	•	we will obtain the ESOP trust’s consent before effecting our first public offering of stock to be listed on any securities exchange;

	•	we will not take actions that would prevent the ESOP trust from acquiring any additional shares of our stock under the control share acquisition provisions of the Delaware General Corporation Law;

	•	we will repurchase any shares of common stock distributed to participants in the ESOP component of the KSOP, to the extent required by the ESOP, any ESOP related documents and applicable laws;

	•	we will maintain the KSOP and the ESOP trust so that they will remain in compliance with the qualification and tax exemption requirements under the Internal Revenue Code; and

	•	we will use our best efforts to ensure that the ESOP trust fully enjoys its right to elect a majority of our board of directors and to otherwise control Alion.

Certain of the covenants listed above will lapse if the ESOP trust fails to own or otherwise control at least 20% of the voting power of all our capital stock.

Indemnification. We agreed to indemnify the ESOP trust, within limits agreed to by the parties, against any losses resulting from our breach of any of our representations, warranties or covenants. The ESOP trust will indemnify us, within limits agreed to by the parties, against losses resulting from its breach of any of its representations, warranties or covenants.


	*The Alion ESOP*

The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan, which we refer to as the KSOP, is a qualified retirement plan and is comprised of what we refer to as an ESOP component and a non-ESOP component. The ESOP component of the KSOP owns 100% of the Company’s outstanding shares of common stock.

Eligible employees of the Company can purchase beneficial interests in the Company’s common stock by:


	•	rolling over their eligible retirement account balances into the ESOP component of the KSOP by making an individual one-time ESOP investment election available to new hires; and/or

	•	directing a portion of their pre-tax payroll income to be invested in the ESOP component of the KSOP.

The Company’s ESOP trustee, State Street Bank & Trust Company, uses the monies that eligible employees invest in the ESOP to purchase shares of the Company’s common stock, for allocation to those employees’ ESOP accounts.

The Company makes retirement plan contributions to all of its employees who are eligible participants in the Alion KSOP. These retirement plan contributions are made to eligible employees’ accounts in both the ESOP and the non-ESOP components of the KSOP. The Company also makes matching contributions on behalf of eligible employees, in the ESOP component, based on their pre-tax deferrals of their Alion salary.

The ESOP trustee holds record title to all of the shares of Company common stock allocated to the employees’ ESOP accounts, and except in certain limited circumstances, the ESOP trustee will vote those shares on behalf of the employees at the direction of the ESOP committee. The ESOP committee is comprised of four members of Alion’s management team and three other Alion employees and is responsible for the financial management and administration of the ESOP component.

By law, Alion is required to value the common stock held in the ESOP component at least once a year. Alion has elected to have the common stock in the ESOP component valued by the ESOP trustee twice a year — as of March 31 and September 30. Because all ESOP transactions must occur at the current fair market value of the common stock held in the ESOP trust, having bi-annual valuations affords eligible employees the opportunity to invest in Company common stock and, when applicable, request distributions of their ESOP accounts at the end of each semi-annual period, rather than waiting until the end of each plan year.

Growth Strategy

Our objective is to continue to grow by capitalizing on our highly educated work force, our established position in our core business areas and by synergistic acquisitions. Our strategies for meeting this objective are:


	To build on our experience in wireless communications. We anticipate that U.S. Department of Defense budgets for the next few years will reflect continued emphasis on communications and spectrum issues in which we have established expertise. For example, we expect to play a significant role for the U.S. Department of Defense in the development of Global Electromagnetic Spectrum Information (GEMSIS) as part of the Department of Defense’s move toward net-centric warfare. In addition, civilian agencies of the federal government are interested in the communications solutions we have developed for the U.S. Department of Defense. We also intend to try to expand our communications research base to include more foreign and commercial customers.

	To support the nation in homeland security. Alion has a long history of research and development in defense and destruction of chemical and biological agents. We have also developed a suite of software tools to support first responders in training to deal with potential release of chemical, biological, or nuclear material. We plan to expand our support to the Department of Homeland Security (DHS) and state and local governments in these areas.

	To expand our defense operations research. We will seek to provide new services to the U.S. Department of Defense. We intend to expand our military planning, operations, readiness

assessment, and distance learning services to the Navy; historically, more of our services in the defense arena have been provided to the Army and Air Force. We also intend to use our technical capabilities to develop modeling and simulation systems for all branches of the U.S. armed forces.

      To expand our support to the United States Navy. Through a strategy of internal growth and acquisition, we are a significant support contractor to the United States Navy and its prime contractors. Our support to the U.S. Navy includes both ship design (from conceptual studies to detail design) and programmatic support. Utilizing the depth of our engineering and programmatic talent, we anticipate expanding our support to the U.S. Navy in new ship systems such as DD(x) and LCS.

      To expand our information technology research. We intend to promote our specialized information technology expertise to a broader range of customers, including the civilian agencies of the federal government, primarily by applying technology research and solutions originally developed for military use.

      To develop new software tool and technical products. We will seek to capture some of our intellectual property in the form of stand-alone tools and products to increase revenue. We intend to develop these tools and products to better serve existing customers, and to offer them separately as stand-alone tools and products for new customers.

      To recruit and retain highly skilled employees. We will seek to recruit and retain engineers, scientists, and technical experts with the experience, skills and innovation necessary to design and implement solutions to the complex problems our customers face. We will also seek to attract and retain other motivated professionals who have the qualities necessary to assist us in implementing our future business strategy and meeting our future business goals. As an employee-owned company, we believe we will be able to provide enhanced financial incentives to our employees, and that those incentives will be important recruitment and retention tools.

      To pursue strategic acquisitions and investments. We intend to broaden our customer base and our capabilities in our core research fields by pursuing strategic acquisitions from companies with talent and technologies complementary to our current fields and to our future business goals in order to add new clients and expand our core competencies. During fiscal year 2005, Alion completed the following four acquisitions and one strategic investment:


	•	Countermeasures, Inc. — On October 28, 2004, Alion purchased substantially all of the assets of Countermeasures, Inc. Alion acquired technology and software (e.g. “Buddy System”^tm), used in vulnerability assessment) for identifying, quantifying and managing physical, infrastructure, program and electronic risks. Countermeasures, Inc. had two employees and was located in Hollywood, Maryland.

	•	Mantech Environmental Technology, Inc. (METI) — On February 11, 2005, Alion acquired 100 percent of the outstanding stock of ManTech Environmental Technology, Inc., (now known as Alion — METI Corporation), an environmental and life sciences research and development company. METI had approximately 110 employees and was headquartered in Research Triangle Park, North Carolina.

	•	Carmel Applied Technologies, Inc. (CATI) — On February 25, 2005, Alion acquired 100 percent of the outstanding stock of Carmel Applied Technologies, Inc. (now known as Alion — CATI Corporation), a flight training software and simulator development company. CATI had approximately 55 employees and was headquartered in Seaside, California.

	•	VectorCommand, Ltd — On March 22, 2005, Alion acquired approximately 12.5 percent of the A ordinary shares in VectorCommand Ltd. VectorCommand Ltd., headquartered in the United Kingdom, designs and develops technologies used in training and operations by emergency managers and incident commanders in Australia, Europe, North America and the United Kingdom.

	•	John J. McMullen Associates, Inc. (JJMA) — On April 1, 2005, Alion acquired all of the outstanding stock of John J. McMullen Associates, Inc. (now known as Alion — JJMA Corporation), a provider of ship and systems design from mission analysis and feasibility trade-off studies through contract and

detail design, production supervision, testing and logistics support for the commercial and naval markets. JJMA had approximately 600 employees and was headquartered in Iselin, New Jersey.

Market and Industry Background


	*Trends in government spending likely to affect our business.*

Funding for our federal government contracts is linked to trends in U.S. defense spending. We believe that domestic defense spending will grow over the next several years as a result of the following trends and developments:


	*Department of Defense spending. Congress appropriated $390 billion in defense spending for fiscal year 2006*


	Sustained Spending for National Defense.

The ongoing efforts in Iraq and Afghanistan, in conjunction with global war on terror, reflect the federal government’s continued commitment to strengthen our country’s military, intelligence, and homeland security capabilities. Department of Defense appropriations, excluding military construction and supplemental appropriations to pay for the ongoing efforts in Iraq and Afghanistan, remained constant at approximately $390 billion in federal fiscal year 2006. An additional $50 billion is budgeted for contingency operations related to the global war on terror. In addition, the federal fiscal year 2006 Homeland Security budget proposal totaled approximately $31 billion.


	Sustained interest in procurement and development.

We believe the sustained level of spending for defense and homeland security will result in a growth of our revenues because of the correlation between the areas of projected spending and our core business areas, and the fact that through internal growth and strategic acquisitions, we have increased our technical depth and breadth which we expect will increase our market penetration in the defense and homeland security areas. The following areas of sustained levels of spending for defense and homeland security, as identified in the U.S. Budget for fiscal year 2006, have a direct correlation with our core business areas:


	•	training and training transformation;

	•	modeling and simulation as basis for mission planning and preparation;

	•	the enhancement of defenses against biological, chemical and nuclear attacks;

	•	the use of information technology for national security; and

	•	an overall sustained level of spending for homeland defense.


	*We are primarily a government contractor.*

For fiscal years ended September 30, 2005, 2004, and 2003, revenue that we obtained from federal government contracts was approximately 96%, 98%, and 98% of our total revenue for each respective year. The U.S. Department of Defense is our largest customer. We expect that most of our revenues will continue to result from contracts with the federal government. We perform our government contracts as a prime contractor or as a subcontractor. As a prime contractor, we have direct contact with the applicable government agency. As a subcontractor, we perform work for a prime contractor, which serves as the point of contact with the government agency overseeing the program.

Our federal government contracts are generally multi-year contracts but are funded on an annual basis at the discretion of Congress. Congress usually appropriates funds for a given program on an October 1 fiscal year commencement basis. That means that at the outset of a major program, the contract is usually only partially funded, and normally the procuring agency commits additional monies to the contract only as Congress makes appropriations for future fiscal years. The government can modify or discontinue any contract at its discretion or due to default by the contractor. Termination or modification of a contract at the government’s discretion

may be for any of a variety of reasons, including funding constraints, modified government priorities or changes in program requirements. If one of our contracts is terminated at the government’s discretion, we typically get reimbursed for all of our services performed and costs incurred up to the point of termination, a negotiated amount of the fee on the contract, and termination-related costs we incur.

Contract Types. As of September 30, 2005, we had over 650 active contract engagements, each employing one of three types of price structures: cost-reimbursement, time-and-material, or fixed-price.


	•	Cost-reimbursement contracts allow us to recover our direct labor and allocable indirect costs, plus a fee which may be fixed or variable depending on the contract arrangement. Allocable indirect costs refer to those costs related to operating our business that can be recovered under a contract.

	•	Time-and-material contracts allow us to recover our labor costs, based on negotiated, fixed hourly rates, as well as certain other costs.

	•	Under fixed-price contracts, customers pay us a fixed dollar amount to cover all direct and indirect costs, plus a fee. Under fixed-price contracts, we assume the risk of any cost overruns and receive the benefit of any cost savings.

Our historical contract mix, measured as a percentage of total revenue for the fiscal years ended September 30, 2005, 2004, and 2003, is summarized in the table below.


	For the Year Ended September 30,

Contract Type	2005				2004				2003

Cost-plus	$	216	58	%	$	160	59	%	$	133	62	%
Fixed-price	$	77	21	%	$	44	16	%	$	34	16	%
Time-and-material	$	76	21	%	$	66	25	%	$	46	22	%

Total	$	369	100	%	$	270	100	%	$	213	100	%

Any costs we incur prior to the award of a new contract or prior to modification of an existing contract are at our own risk. This is a practice that is customary in our industry, particularly when a contractor has received verbal advice of a contract award, but has not yet received the authorizing contract documentation. In most cases the contract is later executed or modified and we receive full reimbursement for our costs. We cannot be certain, however, when we commence work prior to authorization of a contract, that the contract will be executed or that we will be reimbursed for our costs. As of September 30, 2005, we had incurred $1.9 million in pre-contract costs at our own risk.

Government Oversight. Our contract administration and cost accounting policies and practices are subject to oversight by federal government inspectors, technical specialists and auditors. All costs associated with a federal government contract are subject to audit by the federal government. An audit may reveal that some of the costs that we may have charged against a government contract are not in fact allowable, either in whole or in part. In these circumstances, we would have to return to the federal government any monies paid to us for non-allowable costs, plus interest and possibly penalties. The federal government has audited all indirect costs for our government contracts through fiscal year 2001, and any impact of these audits is reflected in our financial statements. Government audit of fiscal year 2002 on indirect costs has been completed pending final negotiation of the rates. Audits for fiscal year 2003 and 2004 are in process. We plan to submit our fiscal year 2005 indirect cost claim to the federal government on or about March 31, 2006. The findings of an audit could result in adjustments that may change the financial data reported for fiscal year 2002 and subsequent periods.

Backlog. Contract backlog represents an estimate, as of a specific date, of the remaining future revenues anticipated from our existing contracts. It consists of two elements:


	•	funded backlog, which refers to contracts that have been awarded to us and whose funding has been authorized by the customer, less revenue previously recognized under the same contracts, and


	•	unfunded backlog, which refers to the total estimated value of contracts awarded to us, but whose funding has not yet been authorized by the customer.

Options not yet exercised by a customer for additional years and other extension opportunities included in contracts are included in unfunded backlog. Contract backlog does include pre-negotiated options to continue existing contracts. Changes in our contract backlog calculation result from additions for future revenues as a result of the execution of new contracts or the extension or renewal of existing contracts, reductions as a result of completing contracts, reductions due to early termination of contracts, and adjustments due to changes in estimates of the revenues to be derived from previously included contracts. Estimates of future revenues from contract backlog are by their nature inexact and the receipt and timing of these revenues are subject to various contingencies, many of which are outside of our control. The table below shows the value of our funded and unfunded contract backlog as of September 30, 2005, 2004, and 2003, respectively.


			September 30,

			2005		2004		2003

			(In millions)
Backlog:
		Funded	$	193	$	161	$	107
		Unfunded	$	2,581	$	1,793	$	1,435

	Total		$	2,774	$	1,954	$	1,542

Proposal backlog represents an estimate, as of a specific date, of the proposals we have in process or submitted and for which we are waiting to hear results of the award. It consists of two elements:


	•	in-process backlog, which refers to proposals that we are preparing to submit following a request from a customer, and

	•	submitted backlog, which refers to proposals that we have submitted to a customer and for which we are awaiting an award decision.

The amount of our proposal backlog that ultimately may be realized as revenues depends upon our success in the competitive proposal process, and on the receipt of tasking and associated funding under the ensuing contracts. We will not be successful in winning contract awards for all of the proposals that we submit to potential customers. Our past success rates for winning contract awards from our proposal backlog should not be viewed as an indication of our future success rates. The table below shows the value of our proposal backlog as of September 30, 2005, 2004, and 2003, respectively.


		September 30,

		2005		2004		2003

		(In millions)
In-process		$	276	$	56	$	31
Submitted		$	1,121	$	425	$	392

	Total	$	1,397	$	481	$	423

Seasonality and Cyclicality

We believe that our business may be subject to seasonal fluctuations. The federal government’s fiscal year end (i.e., September 30) can trigger increased purchase requests from our customers for equipment and materials. Any increased purchase requests we receive as a result of the federal government’s fiscal year end would serve to increase our fourth quarter revenues but will generally decrease profit margins for that quarter, as these activities typically are not as profitable as our normal service offerings. In addition, expenditures by our customers tend to vary in cycles that reflect overall economic conditions as well as budgeting and buying patterns. Our revenue has in the past been, and may in the future be materially affected by a decline in the defense budget or in the economy in general. Such future declines could alter our current or prospective customers’ spending priorities or budget cycles which has the affect of extending our sales cycle.

Corporate Culture

Employees and Recruiting. We strive to create organizational culture that promotes excellence in job performance, respect for the ideas and judgment of our colleagues and recognition of the value of the unique skills and capabilities of our professional staff. We seek to attract highly qualified and ambitious staff. We strive to establish an environment in which all employees can make their best personal contribution and have the satisfaction of being part of a unique team. We believe that we have in the past successfully attracted and retained highly skilled employees because of the quality of our work environment, the professional challenges of our assignments, and the financial and career advancement opportunities we make available to our staff.

We view our employees as our most valuable asset. Our success depends in large part on attracting and retaining talented, innovative and experienced professionals at all levels. We rely on the availability of skilled technical and administrative employees to perform our research, development and technological services for our customers. The market for certain skills in areas such as information technology and wireless communications is at times extremely competitive. This makes recruiting and retention of employees in these and other specialized areas extremely important. We recognize that our benefits package, work environment, incentive compensation, and employee-owned culture will be important in recruiting and retaining these highly skilled employees.

As of September 30, 2005, we had 2,508 employees, of whom 2,285 were full-time, 67 half-time, and 156 part-time employees. Over 80% of our employees have federal government security clearances. Approximately 6% of our employees have Ph.D.’s, approximately 40% have master’s degrees, and approximately 70% of our employees have undergraduate degrees. We also use consultants from time to time for technical work, promotional activities, and proposal preparation. We believe that our relationship with our employees is good. None of our employees are covered by a collective bargaining agreement.

Our facilities include laboratory facilities at locations in Chicago and Geneva, Illinois; Annapolis and Lanham, Maryland; West Conshohocken, Pennsylvania; Huntsville, Alabama; Rome, New York; and Albuquerque, New Mexico where we provide our engineers and scientists with advanced tools to research and apply new technologies to issues of national significance.

Our Customers

During the fiscal year ended September 30, 2005, we derived approximately 96% of our revenue from contracts with various agencies or departments of the federal government. Of our total revenue, we derived 88% from contracts with the U.S. Department of Defense. For the fiscal year ended September 30, 2004, approximately 98% of our revenue was from contracts with the federal government, and 91% was derived from contracts with the U.S. Department of Defense. The balance of our revenue was from a variety of commercial customers, U.S. state and local governments and foreign governments. We derived less than 1% of our revenues from international customers in the fiscal years ended September 30, 2005, 2004, and 2003. The table below shows revenues, by customer, for fiscal years ended September 30, 2005, 2004, and 2003, respectively:


		2005				2004				2003

		(In millions)
U.S. Department of Defense (DoD)		$	324	88	%	$	245	91	%	$	202	95	%
Other Federal Civilian Agencies		$	30	8	%	$	19	7	%	$	7	3	%
Commercial and International		$	15	4	%	$	6	2	%	$	4	2	%

	Total	$	369	100	%	$	270	100	%	$	213	100	%

Competition

Our industry is very competitive. In most significant federal government procurements, we compete with much larger, well-established companies, as well as a number of smaller companies. They include Booz-Allen Hamilton, Science Applications International Corporation, Lockheed Martin Corporation, General Dynamics

Corporation, Northrop Grumman Corporation, Anteon International Corporation, CACI International, Inc., and SRA International, Inc. In the commercial arena, we compete most often with smaller, but highly specialized technical companies, as well as a number of larger companies. They include CRIL Technology, Tadiran Communications Ltd., Spectrocan, Orthstar Incorporated, and Elite Electronic Engineering.

In most cases, government contracts for which we compete are awarded based on a competitive process. We believe that in general, the key factors considered in awarding contracts are:


	•	technical capabilities and approach;

	•	quality of the personnel, including management capabilities;

	•	successful past contract performance; and

	•	price.

It is our experience that in awarding contracts to perform complex technological programs, the two most important considerations for a customer are technical capabilities and price.

S Corporation Status

The Internal Revenue Code provides that a corporation that meets certain requirements may elect to be taxed as an S corporation for federal income tax purposes. These requirements provide that an S corporation may only have:


	•	one class of stock;

	•	up to 100 shareholders; and

	•	certain types of shareholders, such as individuals, trusts and some tax-exempt organizations, including ESOPs.

Since the ESOP (which counts as one shareholder for S corporation purposes) is our only stockholder, and we only have one class of stock, we currently meet the requirements to be taxed as an S corporation.

Alion filed an election with the IRS to be treated as an S corporation under the Internal Revenue Code. The election was accepted and became effective on October 11, 2001. An S corporation, unlike a C corporation, generally does not pay federal corporate income tax on its net income. Rather, such income is allocated to the S corporation’s shareholders. Shareholders must take into account their allocable share of income when filing their income tax returns. An ESOP is a tax-exempt entity and does not pay tax on its allocable share of S corporation income. Because neither we nor the ESOP should be required to pay federal corporate income tax, we expect to have substantially more cash available to repay our debt and invest in our operations than we would if Alion were to be taxed as a C corporation.

Many states follow the federal tax treatment of S corporations. In some states, Alion is subject to different tax treatment for state income tax purposes than for federal income tax purposes. The Company and its subsidiaries operate in several states where we are subject to state income taxes. The Company is also subject to other taxes such as franchise and business taxes in certain jurisdictions.

The Company’s wholly-owned operating subsidiaries are qualifying subchapter S subsidiaries. For federal income tax purposes, these subsidiaries are consolidated into Alion’s federal income tax returns.

Under a provision of the Internal Revenue Code, significant penalties can be imposed on a subchapter S employer which maintains an ESOP (i) if the amount of ESOP stock allocated to certain “disqualified persons” exceeds certain statutory limits or (ii) if disqualified persons together own 50% or more of the company’s stock. For this purpose, a “disqualified person” is generally someone who owns 10% or more of the subchapter S employer’s stock (including deemed ownership through stock options, warrants, stock appreciation rights, or SARs, phantom stock, and similar rights). The KSOP, the SAR plan and the phantom stock plan include provisions designed to prohibit allocations in violation of these Internal Revenue Code limits. We expect never to exceed the 50% limit. Apart from the warrants representing approximately 24% of our

common stock that were issued to IITRI at the closing of the Transaction (and subsequently transferred to the Illinois Institute of Technology), no one person is expected to hold ownership interests representing more than 5% of Alion.

Business Development and Promotional Activities

We primarily promote our contract research services by meeting face-to-face with customers or potential customers, by obtaining repeat work from satisfied customers, and by responding to requests for proposals, referred to as RFPs, and international tenders that our customers and prospective customers publish or direct to our attention from time to time. We use our knowledge of and experience with federal government procurement procedures, and relationships with government personnel, to help anticipate the issuance of RFPs or tenders and to maximize our ability to respond effectively and in a timely manner to these requests. We use our resources to respond to RFPs and tenders that we believe we have a good opportunity to win and that represent either our core research fields or logical extensions to those fields for new research. In responding to an RFP or tender, we draw on our expertise in our various business areas to reflect the technical skills we could bring to the performance of that contract.

Our technical staff is an integral part of our promotional efforts. They develop relationships with our customers over the course of contracts that can lead to additional work. They also become aware of new research opportunities in the course of performing tasks on current contracts.

We hold weekly company-wide business development meetings to review specific proposal opportunities and to agree on our strategy in pursuing these opportunities. At times we also use independent consultants for promoting business, developing proposal strategies and preparing proposals.

For internal research and development, we spent approximately $0.5 million, $0.4 million and $0.2 million in fiscal years 2005, 2004 and 2003, respectively. This is in addition to the substantial research and development activities that we have undertaken on projects funded by our customers. We believe that actively fostering an environment of innovation is critical to our future success in that it allows us to be proactive in addressing issues of national concern in public health, safety, and national defense.

Resources

For most of our work, we use computer and laboratory equipment and other supplies that are readily available from multiple vendors. As such, disruption in availability of these types of resources from any particular vendor should not have a material impact on our ability to perform our contracts. In some of the specialized work we perform in a laboratory, we depend on the supply of special materials and equipment whose unavailability could have adverse effects on the experimental tasks performed at the laboratory. However, we believe that the overall impact of these types of delays or disruptions on our total operations and financial condition is likely to be minimal.

Patents and Proprietary Information

Our patent portfolio consists of fourteen issued and active U.S. patents, eleven pending U.S. patents, two active foreign patents and eight pending foreign patents. We routinely enter into intellectual property assignment agreements with our employees to protect our rights to any patents or technologies developed during their employment with us. However, our research and development and engineering services do not depend on patent protection.

Our federal government contracts often provide the federal government with certain rights to our inventions and copyright works, including use of the inventions by government agencies, and a right to exploit these inventions or have them exploited by third-party contractors, including our competitors. Similarly, our federal government contracts often license to us patents and copyright works owned by others.

Foreign Operations

In fiscal years 2005, 2004 and 2003, nearly 100% of the Company’s revenue was derived from services provided under contracts with U.S.-based customers. The Company treats revenues resulting from U.S. government customers as sales within the United States regardless of where the services are performed.

Company Information Available on the Internet

The Company’s internet address is www.alionscience.com. The Company makes available free of charge through its internet site, via a hyperlink to the U.S. Securities and Exchange Commission EDGAR filings web site, its annual report on Form 10-K; quarterly reports on Form 10-Q; current reports on Form 8-K; and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, or the “Exchange Act,” as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission.

Environmental Matters

Our operations are subject to federal, state and local laws and regulations relating to, among other things:


	•	emissions into the air,

	•	discharges into the environment,

	•	handling and disposal of regulated substances, and

	•	contamination by regulated substances.

Operating and maintenance costs associated with environmental compliance and prevention of contamination at our facilities are a normal, recurring part of our operations, are not material relative to our total operating costs or cash flows, and are generally allowable as contract costs under our contracts with the federal government. These costs have not been material in the past and, based on information presently available to us and on federal government environmental policies relating to allowable costs in effect at this time, all of which are subject to change, we do not expect these to have a materially adverse effect on us. Based on historical experience, we expect that a significant percentage of the total environmental compliance costs associated with our facilities will continue to be allowable costs.

Under existing U.S. environmental laws, potentially responsible parties are jointly and severally liable and, therefore, we would be potentially liable to the government or third parties for the full cost of remediating contamination at our sites or at third-party sites in the event contamination is identified and remediation is required. In the unlikely event that we were required to fully fund the remediation of a site, the statutory framework would allow us to pursue rights of contribution from other potentially responsible parties.

Risk Factors


	*Risks Related to Our Business*


	*An economic downturn could harm our business.*

Our business, financial condition and results of operations may be affected by various economic factors. Unfavorable economic conditions may make it more difficult for us to maintain and continue our revenue growth. In an economic recession, or under other adverse economic conditions, customers and vendors may be more likely to be unable to meet contractual terms or their payment obligations. A decline in economic conditions may have a material adverse effect on our business.


	*We face intense competition from many competitors that have greater resources than we do, which could result in price reductions, reduced profitability, and loss of market share.*

We operate in highly competitive markets and generally encounter intense competition to win contracts. If we are unable to successfully compete for new business, our revenue growth and operating margins may

decline. Many of our competitors are larger and have greater financial, technical, marketing, and public relations resources, larger client bases, and greater brand or name recognition than we do. Larger competitors include federal systems integrators such as Booz Allen Hamilton, Science Applications International Corporation, CACI International, Inc., SRA International, Inc., Anteon International Corporation and divisions of large defense contractors such as Lockheed Martin Corporation, General Dynamics Corporation, and Northrop Grumman Corporation. Our larger competitors may be able to compete more effectively for very large-scale government contracts. Our larger competitors also may be able to provide clients with different or greater capabilities or benefits than we can provide in areas such as technical qualifications, past performance on large-scale contracts, geographic presence, price, and the availability of key professional personnel. Our competitors also have established or may establish relationships among themselves or with third parties, including through mergers and acquisitions, to increase their ability to address client needs. Accordingly, it is possible that new competitors or alliances among competitors may emerge.


	We incurred a significant amount of debt in order to complete the IITRI acquisition and through subsequent debt refinancing, which may limit our operational flexibility and negatively affect the value of your investment in the ESOP component.

In order to complete the acquisition of IITRI’s assets and to partially fund our growth through the completion of subsequent acquisitions, we have incurred a substantial amount of indebtedness, including approximately $31.2 million in senior debt, approximately $20.3 million in debt in the form of a mezzanine note issued to IIT and approximately $39.9 million in debt in the form of a subordinate note issued to IIT. The mezzanine note has been redeemed, but the subordinate note remains outstanding. On August 2, 2004, we refinanced the Company’s senior debt and subsequently on April 1, 2005, entered into an incremental term loan and amended our credit facility, which made available approximately $323 million of debt financing to fund acquisitions, refinance existing debt, and provide working capital. As of September 30, 2005, our senior consolidated debt was approximately $143 million. Although we have managed significant amounts of debt since December 2002, we do not have extensive experience in functioning as a highly leveraged company for sustained periods of time.

Our indebtedness could:


	•	limit our ability to obtain additional financing for working capital, capital expenditures, acquisitions and other general corporate activities;

	•	limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

	•	make it more difficult for us to satisfy our obligations to our creditors, including our repurchase obligations to ESOP participants, and, if we fail to comply with the requirements of the indebtedness, may require refinancing on terms unfavorable to us, or if refinancing is not possible, our creditors could accelerate the maturity of our indebtedness, which could cause us to default under other indebtedness, dispose of assets or declare bankruptcy;

	•	limit our ability to successfully withstand a downturn in our business or the economy generally; and

	•	place us at a competitive disadvantage against other less leveraged competitors.


	Our ability to service our debt and meet other future obligations is dependent on our future operating results and we cannot be sure that we will be able to meet these obligations as they come due.

Our ability to meet our payment obligations and to comply with the financial covenants contained in the agreements relating to our indebtedness is subject to a variety of factors, including changes in:


	•	funding of our contract backlog;

	•	the time within which our customers pay our accounts receivable;

	•	new contract awards and our performance under these contracts;


	•	continued increase in revenues on an annual basis;

	•	interest rate levels;

	•	our status as an S corporation for federal income tax purposes; and

	•	general economic conditions.

These factors will also affect our ability in the future to meet our obligations related to the put rights associated with the warrants and to our repurchase obligations under the KSOP. We also are required to pay the principal amounts outstanding under our revolving credit facility and term loan in 2009 and are required to pay fifty percent of the principal amount outstanding, including the amount due under the payment-in-kind notes, under the Seller Note in each of 2009 and 2010.

We may not generate sufficient cash flows to comply with our financial covenants and to meet our payment obligations when they become due. If we are unable to comply with our financial covenants, or if we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make the required payments on our indebtedness, then we may be required to refinance our indebtedness. We cannot be certain that our indebtedness could be refinanced on terms that are favorable to us, if at all. In the absence of a refinancing, our lenders would be able to accelerate the maturity of our indebtedness, which could cause us to default under our other indebtedness, dispose of assets or declare bankruptcy.


	*Risks Related to Our Industry*


	*We are dependent on government contracts for substantially all of our revenues.*

Approximately 96% of our revenues for fiscal year 2005 were derived from contracts with the federal government. Contracts with the U.S. Department of Defense accounted for approximately 88%, and contracts with other government agencies accounted for approximately 8%, of our total revenues in fiscal year 2005. For fiscal year 2004, contracts with the U.S. Department of Defense accounted for approximately 91% of our revenues, and contracts with other government agencies accounted for approximately 7% of our revenues. We expect that government contracts are likely to continue to account for a significant portion of our revenues in the future. A significant decline in government expenditures, or a shift of expenditures away from government programs that we support, could cause a decline in our revenues.


	*The failure by Congress to approve budgets timely for the federal agencies we support could delay or reduce spending and cause us to lose revenue.*

On an annual basis, Congress must approve budgets that govern spending by each of the federal agencies we support. When Congress is unable to agree on budget priorities, and thus is unable to pass the annual budget on a timely basis, then Congress typically enacts a continuing resolution. A continuing resolution allows government agencies to operate at spending levels approved in the previous budget cycle. When government agencies must operate on the basis of a continuing resolution it may delay funding we expect to receive from clients on work we are already performing and will likely result in any new initiatives being delayed, and in some cases being cancelled, both of which may adversely affect our business.


	*Historically, a few contracts have provided us with most of our revenues, and if we do not retain or replace these contracts our operations will suffer.*

The following five large federal government contracts accounted for approximately 48% of our revenues for the fiscal year ended September 30, 2005:


	1.	Modeling and Simulation Information Analysis Center for the U.S. Department of Defense — Defense Information Systems Agency (19%);

	2.	Joint Spectrum Center Engineering Support Services for the U.S. Department of Defense Joint Spectrum Center (12%);


	3.	Information Technology Services for General Services Administration — U.S. Department of Defense (7%);

	4.	Night Vision HighTech Omnibus Contract for the U.S. Department of Army (5%); and

	5.	Engineering, Financial and Program Management Services to the U.S. Department of the Navy’s Virtual SYSCOM (VS) program (5%).

These contracts, some of which are performed for multiple customers, are likely to continue to account for a significant percentage of our revenues in the future. Termination of these contracts or our inability to renew or replace them when they expire could cause our revenues to decrease. During the year ended September 30, 2005, the support services contract to the Joint Spectrum Center underwent a full and open competition for the follow-on support contract that was to commence beginning October 2005. The Company filed a formal bid protest before the Government Accountability Office (GAO) with respect to the JSC contract award. The Company’s principal argument was that the successful bidder had an organizational conflict of interest with respect to its proposed performance of the contract. In its decision dated January 9, 2006, the GAO sustained the protest and recommended that the contracting agency take certain corrective action in order to address the awardee’s organizational conflict of interest. The Company is awaiting further action from the contracting agency. In the meantime, the Company expects to continue to generate revenue from its existing JSC contract until the issues involved in its protest are fully resolved.


	*Government contracts contain termination provisions that are unfavorable to us.*

Generally, government agencies can terminate contracts with their suppliers at any time without cause. If a government agency does terminate one of its contracts with us without cause, we will likely be entitled to receive compensation for the services provided or costs incurred up to the date of termination as well as a negotiated amount of the fee on the contract and termination-related costs we incur. Further, if a government contract is terminated because we defaulted under the terms of the contract, we will likely be entitled to receive compensation for the services provided and accepted up to the date of termination plus a percentage of the fee relating to the provided and accepted services. However, if a default were to occur, we may be liable for excess costs the government incurs in procuring the undelivered portion of the contract from another source. Termination of any of our large government contracts may negatively impact our revenues.


	*Actual or perceived conflicts of interest may prevent us from being able to bid on or perform contracts.*

Government agencies have conflict of interest policies that may prevent us from bidding on or performing certain contracts. Typically, a conflict of interest policy prohibits a contractor that assisted the government agency in the design of a program and/or the associated procurement process from competing to perform the resulting contract. When dealing with government agencies that have conflict of interest policies, we must decide, at times with insufficient information, whether to participate in the design process and lose the chance of performing the contract or to turn down the opportunity to assist in the design process for the chance of performing on the contract. We have, on occasion, declined to bid on particular projects because of actual or perceived conflicts of interest, and we are likely to continue encountering such conflicts of interest in the future, particularly if we acquire other government contractors. Future conflicts of interest could cause us to be unable to secure key research and technology contracts with government customers.


	*We may not receive the full amount of our backlog, which could lower future revenues.*

The maximum contract value specified under a government contract is not necessarily indicative of revenues that we will realize under that contract. Congress normally appropriates funds for a given program on a fiscal year basis, even though actual contract performance may take many years. As a result, contracts ordinarily are only partially funded at the time of award, and normally the procuring agency commits additional monies to the contract only as Congress makes appropriations in subsequent fiscal years. The portion of a government contract which has not yet been performed is referred to as backlog. The original value of a government contract is used in estimating the amount of our backlog. We define backlog to include both funded and unfunded orders for services under existing signed contracts, assuming the exercise of all

options relating to those contracts that have been priced. We define funded backlog to be the portion of backlog for which funding currently is appropriated and obligated to us under a contract or other authorization for payment which an authorized purchasing authority signs, less the amount of revenue we have previously recognized under the contract. We define unfunded backlog as the total estimated value of signed contracts, less funding to date. Unfunded backlog includes all contract options that have been priced but not yet funded. Estimates of future revenues attributed to backlog are not necessarily precise and the receipt and timing of any of these revenues are subject to various contingencies such as changed federal government spending priorities and government decisions not to exercise options on existing contracts. Many of these contingencies are beyond our control. The backlog on a given contract may not ultimately be funded or may only be partially funded, which may cause our revenues to be lower than anticipated.


	Because government contracts are subject to government audits, contract payments are subject to adjustment and repayment which may result in revenues attributed to a contract being lower than expected.

Government contract payments received that are in excess of allowable costs are subject to adjustment and repayment after government audit of the contract payments. Government audits have been completed on indirect costs related to our federal government contracts through fiscal year 2001. Government audit of fiscal year 2002 on indirect costs has been completed pending final negotiation of the rates. Audits for fiscal year 2003 and 2004 are in process. We have included estimated reserves in our financial statements for excess billings and contract losses, which we believe are adequate based on our interpretation of contracting regulations and past experience. These reserves, however, may not be adequate. If our reserves are not adequate, revenues attributed to our contracts may be lower than expected.


	*Our subcontractors’ failure to perform contractual obligations could damage our reputation as a prime contractor and thereby our ability to obtain future business.*

As a prime contractor, we often rely significantly upon other companies as subcontractors to perform work we are obligated to deliver to our customers. A failure by one or more of our subcontractors to satisfactorily perform the agreed-upon services on a timely basis may cause us to be unable to perform our duties as a prime contractor. We have limited involvement in the work our subcontractors perform, and as a result, we may have exposure to problems our subcontractors cause. Performance deficiencies on the part of our subcontractors could result in a government customer terminating our contract for default. A default termination could expose us to liability for the customer’s costs of reprocurement, damage our reputation, and hurt our ability to compete for future contracts.


	*If we fail to recover pre-contract costs, it may result in reduced fees or in losses.*

Any costs we incur before the execution of a contract or contract renewal are incurred at our risk, and it is possible that the customer will not reimburse us for these pre-contract costs. At September 30, 2005, we had pre-contract costs of $1.9 million. While such costs were associated with specific anticipated contracts and we believe their recoverability from such contracts is probable, we cannot be certain that contracts or contract renewals will be executed or that we will recover the related pre-contract costs.


	*If we do not accurately estimate the expenses, time and resources necessary to satisfy our contractual obligations, our profit will be lower than expected.*

Cost-reimbursement contracts provided approximately 58%, 59% and 62% of our revenues for the fiscal years ended September 30, 2005, 2004, 2003, respectively. Fixed-price contracts provided approximately 21%, 16%, and 16% of our revenues for the fiscal years ended September 30, 2005, 2004, and 2003, respectively.

In a cost-reimbursement contract, we are allowed to recover our approved costs plus a negotiated fee. The total price on a cost-reimbursement contract is based primarily on allowable costs incurred, but generally is subject to a maximum contract funding limit. Federal government regulations require us to notify our customers of any cost overruns or underruns on a cost-reimbursement contract. If we incur costs in excess of

the funding limitation specified in the contract, we may not be able to recover those cost overruns. As a result, on a cost-reimbursement contract we may not earn the full amount of the anticipated fee.

In a fixed-price contract, we estimate the costs of the project and agree to deliver the project for a definite, predetermined price regardless of our actual costs to be incurred over the life of the project. We must fully absorb cost overruns. Our failure to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed-price contract may reduce the fee margin of a fixed-price contract or cause a loss. Although we have not historically experienced significant contract losses on fixed-price contracts, the provisions in our financial statements for estimated losses on our fixed-price contracts may not be adequate to cover all actual future losses.


	*Our operating margins and operating results may suffer if cost-reimbursement contracts increase in proportion to our total contract mix.*

In general, cost-reimbursement contracts are the least profitable of our contract types. Our government customers typically determine what type of contract will be awarded to us. Cost-reimbursement contracts accounted for 58%, 59%, and 62% of our revenue for the fiscal years ended September 30, 2005, 2004, and 2003, respectively. To the extent that we enter into more or larger cost-reimbursement contracts in proportion to our total contract mix in the future, our operating margins and operating results may suffer.


	If the volume of services we provide under fixed-price contracts decreases in total or as a proportion of our total business, or if profit rates on these contracts decline, our operating margins and operating results may suffer.

We have historically earned higher relative profits on our fixed-price contracts. Fixed-price contracts accounted for 21%, 16%, and 16% of our revenue for the fiscal years ended September 30, 2005, 2004, and 2003, respectively. If the volume of services we deliver under fixed-price contracts decreases, or shifts to other types of contracts, our operating margins and operating results may suffer. Furthermore, we cannot assure you that we will be able to maintain our historic levels of profitability on fixed-price contracts in general.


	*As a federal government contractor, we must comply with complex procurement laws and regulations and our failure to do so could have a negative impact upon our business.*

We must comply with and are affected by laws and regulations relating to the formation, administration and performance of federal government contracts, which may impose added costs on our business. If a government review or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of fees, suspension of payments, fines and suspension or debarment from doing business with federal government agencies, which may impair our ability to conduct our business. To the knowledge of management, we are not at present the subject of any investigation that may adversely affect our ability to secure future government work.


	*Our failure to obtain and maintain necessary security clearances may limit our ability to carry out confidential work for government customers, which could cause our revenues to decline.*

As of September 30, 2005, we have approximately one hundred thirty five U.S. Department of Defense (DoD) classified contracts that require the Company to maintain facility security clearances at our fifteen sites. Approximately 2,000 of our employees hold security clearances to enable performance on these classified contracts. Each cleared facility has a Facility Security Officer and Key Management Personnel whom the DoD-Defense Security Service requires to be cleared to the level of the facility security clearance. In addition to these clearances, individual employees are selected to be cleared, based on the task requirement of the specific classified contract, for their technical, administrative or management expertise. Once the security clearance is granted, the employee is allowed access to the classified information on the contract based on the clearance and need to know for the information within the contract. Protection of classified information with regard to a classified contract is paramount. Loss of a facility clearance or an employee’s inability to obtain

and/or maintain a security clearance could result in a government customer terminating an existing contract or choosing not to renew a contract upon its expiration. If we cannot maintain or obtain the required security clearances for our facilities or our employees, or if these clearances are not obtained in a timely manner, we may be unable to perform on a contract. Lack of required clearances could also impede our ability to bid on or win new contracts, which may result in the termination of current research activities. Termination of current research activities may damage our reputation and our revenues would likely decline.


	*We derive significant revenues from contracts awarded through a competitive bidding process which is an inherently unpredictable process.*

We obtain most of our government contracts through a competitive bidding process that subjects us to risks associated with:


	•	the frequent need to bid on programs in advance of the completion of their design, which may result in unforeseen technological difficulties and/or cost overruns;

	•	the substantial time and effort, including design, development and promotional activities, required to prepare bids and proposals for contracts that may not be awarded to us; and

	•	the design complexity and rapid rate of technological advancement of most of our research offerings.

Upon expiration, government contracts may be subject to a competitive rebidding process. We may not be successful in winning contract awards or renewals in the future. Our failure to win contract awards, or to renew or replace existing contracts when they expire, would negatively impact our future business and the value of your investment. During the year ended September 30, 2005, the support services contract to the Joint Spectrum Center underwent a full and open competition for the follow-on support contract that was to commence beginning October 2005. In August 2005, we were notified that we were not the successful bidder for these services. The loss of this contract had no material effect on performance for the year ended September 30, 2005. Further discussion of the potential future impact of this contract loss to Alion is provided in the Management Discussion and Analysis section (Item 7) of this annual report.


	*Intense competition in the technology and defense industries could limit our ability to win and retain government contracts.*

We expect to encounter significant competition for government contracts from other companies, especially in our information technology and defense operations units. Some of our competitors will have substantially greater financial, technical and marketing resources than we do.

Our ability to compete for these contracts will depend on:


	•	the effectiveness of our research and development programs;

	•	our ability to offer better performance than our competitors at a lower or comparable cost;

	•	the readiness of our facilities, equipment and personnel to perform the programs for which we compete; and

	•	our ability to attract and retain key personnel.

If we do not continue to compete effectively and win contracts, our future business will be materially compromised.


	*Risks Related To Our Operations*


	*We depend on key management and personnel and may not be able to retain those employees due to competition for their services.*

We believe that our future success will be due, in part, to the continued services of our senior management team. The loss of any one of these individuals could cause our operations to suffer. On

December 20, 2002, we entered into new employment agreements with most of these individuals for five-year terms. We do not, however, maintain key man life insurance policies on any members of management.

In addition, competition for certain employees, such as scientists and engineers, is intense. Our ability to implement our business plan is dependent on our ability to hire and retain these technically skilled professionals. Our failure to recruit and retain qualified scientists and engineers may cause us to be unable to obtain and perform future contracts.


	*Our business could suffer if we fail to attract, train and retain skilled employees.*

The availability of highly trained and skilled professional, administrative and technical personnel is critical to our future growth and profitability. Competition for scientists, engineers, technicians, management and professional personnel is intense and competitors aggressively recruit key employees. Due to our growth and this competition for experienced personnel, particularly in highly specialized areas, it has become more difficult to meet all of our needs for these employees in a timely manner. We intend to continue to devote significant resources to recruit, train and retain qualified employees; however, we cannot be certain that we will be able to attract and retain such employees on acceptable terms. Any failure to do so could have a material adverse effect on our operations. If we are unable to recruit and retain a sufficient number of these employees, our ability to maintain and grow our business could be negatively impacted. In addition, some of our contracts contain provisions requiring us to commit to staff a program with certain personnel the customer considers key to our successful performance under the contract. In the event we are unable to provide these key personnel or acceptable substitutions, the customer may terminate the contract, and we may not be able to recover our costs.


	*Our employees may engage in misconduct or other improper activities, which could harm our business.*

We are exposed to the risk that employee fraud or other misconduct could occur. Misconduct by employees could include intentional failures to comply with federal government procurement regulations, engaging in unauthorized activities, seeking reimbursement for improper expenses or falsifying time records. Employee misconduct could also involve the improper use of our customers’ sensitive or classified information, which could result in regulatory sanctions against us and serious harm to our reputation. It is not always possible to deter employee misconduct, and the precautions we take to prevent and detect this activity may not be effective in controlling unknown or unmanaged risks or losses, which could harm our business.


	*If we are unable to manage our growth, our business could be adversely affected.*

Sustaining our company’s growth has placed significant demands on management, as well as on our administrative, operational and financial resources. To continue to manage our growth, we must continue to improve our operational, financial and management information systems and expand, motivate and manage our workforce. If we are unable to successfully manage our growth without compromising our quality of service and our profit margins, or if new systems we implement to assist in managing our growth do not produce the expected benefits, our business, prospects, financial condition or operating results could be adversely affected.


	*We may undertake acquisitions that could increase our costs or liabilities or be disruptive.*

One of our key operating strategies is to selectively pursue acquisitions. We have made a number of acquisitions in the past, are currently pursuing a number of potential acquisition opportunities, and will consider other acquisitions in the future. We may not be able to consummate the acquisitions we are currently pursuing on favorable terms, or at all. We may not be able to locate other suitable acquisition candidates at prices we consider appropriate or to finance acquisitions on terms that are satisfactory to us. If we do identify an appropriate acquisition candidate, we may not be able to successfully negotiate the terms of an acquisition, finance the acquisition or, if the acquisition occurs, integrate the acquired business into our existing business. Negotiations of potential acquisitions and the integration of acquired business operations could disrupt our business by diverting management away from day-to-day operations. Acquisitions of businesses or other

material operations may require additional debt or equity financing, resulting in additional leverage or dilution of ownership. The difficulties of integration may be increased by the necessity of coordinating geographically dispersed organizations, integrating personnel with disparate business backgrounds and combining different corporate cultures. We also may not realize cost efficiencies or synergies that we anticipated when selecting our acquisition candidates. In addition, we may need to record write-downs from future impairments of intangible assets, which could reduce our future reported earnings. At times, acquisition candidates may have liabilities or adverse operating issues that we fail to discover through due diligence prior to the acquisition, but which we generally assume as part of an acquisition. Such liabilities could have a material adverse effect on our financial condition.


	*Covenants in our credit facility may restrict our financial and operating flexibility.*

Our credit facility contains covenants that limit or restrict, among other things, our ability to borrow money outside of the amounts committed under the credit facility, make other restricted payments, sell or otherwise dispose of assets other than in the ordinary course of business, or make acquisitions, in each case without the prior written consent of our lenders. Our credit facility also requires us to maintain specified financial covenants relating to the interest coverage and maximum debt coverage. Our ability to satisfy these financial ratios can be affected by events beyond our control, and we cannot assure ourselves that we will meet these ratios. Default under our credit facility could allow the lenders to declare all amounts outstanding to be immediately due and payable. We have pledged substantially all of our assets, to secure the debt under our credit facility. If the lenders declare amounts outstanding under the credit facility to be due, the lenders could proceed against those assets. Any event of default, therefore, could have a material adverse effect on our business if the creditors determine to exercise their rights. We also may incur future debt obligations that might subject us to restrictive covenants that could affect our financial and operational flexibility, or subject the company to other events of default. Any such restrictive covenants in any future debt obligations the company incurs could limit our ability to fund our business operations or expand our business.

From time to time we may require consents or waivers from our lenders to permit actions that are prohibited by our credit facility. If, in the future, our lenders refuse to provide waivers of our credit facility’s restrictive covenants and/or financial ratios, then we may be in default under the terms of the credit facility, and we may be prohibited from undertaking actions that are necessary or desirable to maintain and expand its business.


	*Environmental laws and regulations and our use of hazardous materials may subject us to significant liabilities.*

Our operations are subject to federal, state and local environmental laws and regulations, as well as environmental laws and regulations in the various countries in which we operate. In addition, our operations are subject to environmental laws and regulations relating to the discharge, storage, treatment, handling, disposal and remediation of regulated substances and waste products, such as radioactive materials and explosives. The following may require us to incur substantial costs in the future:


	•	modifications to current laws and regulations;

	•	new laws and regulations;

	•	new guidance or new interpretation of existing laws and regulations; or

	•	the discovery of previously unknown contamination.


Item 2.	*Properties*

Our principal operating facilities are located in McLean, Virginia and Chicago, Illinois, and consist of approximately 21,573 square feet and 49,231 square feet of office space, respectively, held under leases. We also lease an additional 62 office facilities totaling approximately 728,639 square feet. Of these, our largest offices are located in Fairfax, Alexandria, Hampton, Newport News, and King George County, Virginia; Washington, DC; West Conshohocken, Pennsylvania; Huntsville, Alabama; Rockville, Annapolis and

Lanham, Maryland; Orlando, Florida; Rome, New York; Iselin, New Jersey; Pascagoula, Mississippi; Fairborn, Ohio; Mt. Clements and Ishpeming, Michigan; San Diego, California; Albuquerque and Los Alamos, New Mexico; Naperville and Warrenville, Illinois.

We lease twelve laboratory facilities totaling 119,707 square feet, for research functions in connection with the performance of our contracts. Of these, our largest laboratories are located in Chicago and Geneva, Illinois; Annapolis and Lanham, Maryland;, West Conshohocken, Pennsylvania; Huntsville, Alabama; Rome, New York; and Albuquerque, New Mexico., The lease terms are annual, varying from one to eight years, and are generally at market rates.

Aggregate average monthly base rental expense for fiscal years 2005 and 2004 was $1,091,594 and $953,120, respectively.

We periodically enter into other lease agreements that are, in most cases, directly chargeable to current contracts. These obligations are usually either covered by currently available contract funds or cancelable upon termination of the related contracts.

All leased space is considered to be adequate for the operation of our business, and no difficulties are foreseen in meeting any future space requirements.


Item 3.	*Legal Proceedings*


	*AB Tech settlement*

On September 12, 2002, the former owners of AB Technologies, Inc. (“AB Tech”) filed a lawsuit (“AB Tech Lawsuit”) against IITRI in Circuit Court for Fairfax County, Virginia. The complaint alleged breach of the AB Tech asset purchase agreement (“Asset Purchase Agreement”), and claims damages of $8.2 million. The former owners of AB Tech (“Former Owners”) asked the court to order an accounting of their earn out.

On September 16, 2002, IITRI filed a lawsuit against the Former Owners which asked the court to compel the Former Owners to submit disputed issues to an independent accounting firm in accordance with the requirements of the Asset Purchase Agreement, make a declaratory judgment concluding that IITRI is entitled to an approximately $1.1 million downward adjustment of the purchase price paid under the Asset Purchase Agreement, and conclude that IITRI properly computed the earnout in accordance with the earnout formula in the Asset Purchase Agreement.

Upon the closing of the Transaction, Alion assumed responsibility for and acquired all claims under these lawsuits.

On July 22, 2005, the Company settled the dispute with the Former Owners. Under the terms of the settlement, the Company paid $3.4 million to the Former Owners, and has a remaining obligation to pay $0.7 million to the Former Owners within fifteen days following the date that the Company’s fiscal 2005 year-end audited financial statement report by the Company’s auditor is issued and made publicly available by the Company.

Joseph Hudert vs. Alion; Frank Stotmeister vs. Alion

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. 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, N.W. in Washington, D.C. Frank Stotmeister and Joseph Hudert died, apparently as a result of the explosion. The deceased were employees of the prime contractor on the site, Grunley-Walsh, and the subcontractor, Cherry Hill Construction Company Inc., respectively. Grunley-Walsh

had a contract with the U.S. General Services Administration (GSA) for construction on 17th Street N.W. 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 currently known to the Company. The Company’s management does not believe that these lawsuits will have a materially adverse effect upon the Company, its operations or its financial condition.

Alion’s primary provider of general liability insurance, St. Paul Travelers, has assumed defense of these lawsuits subject to a reservation of rights to deny coverage. American International Group, the Company’s excess insurance carrier, has also been notified regarding these lawsuits.

Other than the foregoing actions, the Company is not involved in any legal proceeding other than routine legal proceedings occurring in the ordinary course of business. The Company believes that these routine legal proceedings, in the aggregate, are not material to its financial condition and results of operations.

As a government contractor, the Company may be subject from time to time to federal government inquiries relating to its operations and audits by the Defense Contract Audit Agency. Contractors found to have violated the False Claims Act, or which are indicted or convicted of violations of other federal laws, may be suspended or debarred from federal government contracting for some period. Such an event could also result in fines or penalties. Given the Company’s dependence on federal government contracts, suspension or debarment could have a material adverse effect on it. The Company is not aware of any such pending federal government claims or investigations.


Item 4.	*Submission of Matters to a Vote of Security Holders*

No matters were submitted to the vote of security holders for the fourth quarter of the fiscal year ended September 30, 2005.

PART II


Item 5.	*Market for Registrant’s Common Equity, Related Stockholders Matters and Issuer Purchases of Equity Security*

There is no established public trading market for Alion’s common stock. As of September 30, 2005, the ESOP was the only holder of our common stock.

There have been no sales of securities other than sales of securities already reported by the Company in current reports on Form 8-K.


	*Dividend Policy*

Unlike regular C corporations, S corporations do not pay “dividends.” Rather, S corporations make “distributions.” Use of the term “distributions” in this context is unrelated to the term when used in the context of our repurchase obligations under the KSOP. To avoid confusion, when referring to a distribution that would constitute a dividend in a C corporation, we will use the term distribution/dividend. We do not expect to pay any distributions/dividends. We currently intend to retain future earnings, if any, for use in the operation of our business. Any determination to pay cash distributions/dividends in the future will be at the discretion of our board of directors and will be dependent on our results of operations, financial condition, contractual restrictions and other factors our board of directors determines to be relevant, as well as applicable law. The terms of the senior credit facility and the subordinated note prohibit us from paying distributions/dividends without the consent of the respective lenders.


Item 6.	*Selected Financial Data*

The following table presents selected historical and pro forma consolidated financial data for Alion or the Selected Operations of IITRI for each of the fiscal years in the five-year period ended September 30, 2005. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical consolidated financial statements and notes to those statements included elsewhere in this annual report. The consolidated operating data for the fiscal years ended September 30, 2005, 2004 and 2003 and the consolidated balance sheet data as of September 30, 2005 and 2004 are derived from, and are qualified by reference to, the consolidated financial statements of Alion included elsewhere in this annual report. The balance sheet data as of September 30, 2003, are derived from, and are qualified by reference to, the consolidated financial statements of Alion not included in this annual report.

The consolidated operating data for the fiscal years ended September 30, 2002 and 2001, and the consolidated balance sheet data as of September 30, 2002 and 2001 are derived from and are qualified by reference to, the consolidated financial statements of Selected Operations of IITRI, included elsewhere in this annual report. The historical consolidated financial information of Selected Operations of IITRI has been carved out from the consolidated financial statements of IITRI using the historical results of operations and bases of assets and liabilities of the portion of IITRI’s business that was sold and gives effect to allocations of expenses from IITRI.

Alion completed the acquisition of substantially all of the assets and certain of the liabilities of IITRI on December 20, 2002 (the Transaction). The pro forma consolidated data for the fiscal year ended September 30, 2003, assume that the acquisition had been consummated as of October 1, 2001.

Our historical consolidated financial information may not be indicative of our future performance and does not necessarily reflect what our financial position and results of operations would have been had we operated as a separate, stand-alone entity during the periods presented.

Selected Financial Data of Alion Science and Technology Corporation

For Years Ended September 30,


																Pro Forma
	2005(1)			2004(2)			2003(3)			2002(4)			2001(4)			2003(12)

	(In thousands, except share and per share data)
Consolidated Operating Data:
Contract revenue	$	369,231		$	269,940		$	165,917		$	201,738		$	193,152		$	213,182
Direct contract expenses		267,241			196,388			120,559			147,377			140,555			155,214
Operating expenses(5)		104,081			73,703			46,273			48,488			41,726			64,842

Operating income (loss)		(2,091	)		(151	)		(915	)		5,873			10,871			(6,874	)
Other income (expense)(6)		(38,081	)		(14,943	)		(11,701	)		(586	)		(1,072	)		(13,847	)
Income tax (expense) benefit(7)		(66	)		(17	)		—			(589	)		(302	)		(27	)

Net income (loss)(8)	$	(40,238	)	$	(15,111	)	$	(12,616	)	$	4,698		$	9,497		$	(20,748	)

Basic and diluted loss per share	$	(9.50	)	$	(4.91	)	$	(6.05	)
Basic and diluted weighted-average common shares outstanding		4,235,947			3,074,709			2,085,274

Unaudited pro forma as adjusted basic and diluted earnings (loss) per common share(9)																$	(7.83	)


																	Pro Forma
		2005(1)			2004(2)			2003(3)			2002(4)			2001(4)			2003(12)

		(In thousands, except share and per share data)
Consolidated Balance Sheet Data at End of Period:
Net accounts receivable		$	80,898		$	68,949		$	42,775		$	49,051		$	56,095
Total assets			334,249			188,461			144,754			71,096			76,309
Current portion of long-term debt			1,404			468			5,000			3,330			141
Long-term debt, excluding current portion			180,833			99,631			74,719			1,654			11,886
Redeemable common stock warrants			44,590			20,777			14,762			—			—
Long-term deferred gain on sale of building to Illinois Institute of Technology, excluding current portion			—			—			—			3,523			4,054
Other Data:
Depreciation and amortization		$	17,771		$	13,447		$	9,553		$	3,447		$	3,488
Capital expenditures			2,223			3,678			1,329			3,643			1,940
Cash flows provided by (used in):
	Operating activities	$	35,140		$	5,675		$	14,264		$	14,713		$	7,907
	Investing activities		(78,017	)		(23,625	)		(61,428	)		(4,466	)		9,863
	Financing activities		75,938			22,173			47,652			(9,851	)		(17,770	)
Funded contract backlog(10)			193,000			161,000			107,000			72,000			67,000
Unfunded contract backlog(11)			2,581,000			1,793,000			1,435,000			1,431,000			737,000
Number of employees			2,508			1,880			1,604			1,622			1,458


	(1)	During fiscal year 2005, the Company completed four acquisitions and made one strategic investment as described below. The results of operations for the companies acquired are included in Alion’s operations from the dates of the acquisitions. On October 28, 2004, Alion purchased substantially all of the assets of Countermeasures for approximately $2.4 million. Countermeasures had two employees and was located in Hollywood, Maryland. As of September 30, 2005, the Company has recorded approximately $1.4 million in goodwill relating to this acquisition.


		On February 11, 2005, Alion acquired 100 percent of the outstanding stock of METI, an environmental and life sciences research and development company for approximately $7.0 million in cash. METI had approximately 110 employees and was headquartered in Research Triangle Park, North Carolina. As of September 30, 2005, the Company has recorded $5.5 million in goodwill related to this acquisition.

		On February 25, 2005, Alion acquired 100 percent of the outstanding stock of CATI, a flight training software and simulator development company, for approximately $7.3 million in cash. CATI had approximately 55 employees and was headquartered in Seaside, California. The transaction is subject to an earn-out provision not-to-exceed a cumulative amount of $9.0 million based on attaining certain cumulative revenue goals for fiscal years 2005, 2006, and 2007, and a second earn-out provision not-to-exceed $1.5 million for attaining certain revenue goals in the commercial aviation industry. As of September 30, 2005, the Company has recorded approximately $12.9 million in goodwill related to this acquisition.

		On April 1, 2005, the Company acquired 100% of the issued and outstanding stock of JJMA. The Company paid the equity holders of JJMA approximately $51.9 million, issued 1,347,197 shares of Alion common stock to the JJMA Trust valued at approximately $37.3 million, and agreed to make $8.3 million in future payments. Including acquisition costs of $1.1 million, the aggregate purchase price was $99.5 million. As of September 30, 2005, the Company has recorded approximately $61.9 million in goodwill related to the JJMA acquisition.


		On March 22, 2005, Alion acquired approximately 12.5 percent of the A ordinary shares in VectorCommand Ltd. for $1.5 million, which investment is accounted for at cost.


	(2)	During fiscal year 2004, the Company completed two acquisitions as described below. Operating results for these businesses are included in our consolidated totals from the respective dates of acquisitions. On October 31, 2003, Alion acquired 100% of the outstanding stock of Innovative Technology Solutions Corporation (“ITSC”), for $4.0 million. The transaction is subject to an earn out provision not-to-exceed $1.5 million. ITSC is a New Mexico corporation with approximately 53 employees, the majority of whom are located in New Mexico. As of September 30, 2005, the Company has recorded approximately $5.0 million of goodwill relating to this acquisition.


		On February 13, 2004, Alion acquired 100% of the outstanding stock of Identix Public Sector, Inc. (IPS, now known as Alion-IPS Corporation) for $8.0 million in cash. IPS, formerly ANADAC, was a wholly-owned subsidiary of Identix Incorporated. Following the closing, the Company paid Identix approximately $4.3 million for intercompany payables. As of September 30, 2005, the Company has recorded approximately $6.1 million of goodwill relating to this acquisition.


	(3)	For fiscal year 2003 (October 1, 2002 to September 30, 2003), the operations data presented reflects approximately nine months of Alion operations since the Transaction occurred on December 20, 2002, which was at the end of IITRI’s first quarter of operations for fiscal 2003. During the period October 1, 2002 to December 20, 2002, Alion was organizationally a business shell, operationally inactive until the Transaction occurred.

	(4)	Represents consolidated operating and balance sheet data of the Selected Operations of IITRI which was acquired by Alion on December 20, 2002.

	(5)	Operating expenses include (i) non-recurring transaction expenses of approximately $6.7 million and $6.4 million for fiscal years ended September 30, 2003 and 2002, respectively, and (ii) non-recurring, conversion and roll-out expenses of approximately $1.5 million for the fiscal year ended September 30, 2003.

	(6)	For the years ended September 30, 2005, 2004 and 2003, other income (expense) includes approximately $38.7 million, $16.8 million and $13.9 million, respectively, in interest-related expense associated with the debt financing (which includes the related change in warrant valuation associated with the change in the share price of Alion stock) resulting from the Transaction and the acquisitions which were completed in fiscal years 2005 and 2004, as described above. Other income (expense) for the year ended September 30, 2004 includes a gain of approximately $2.1 million on the sale of the Company’s minority interest in Matrics Incorporated.

	(7)	Income tax (expense) benefit primarily relates to income (loss) of our for-profit, wholly-owned subsidiary, HFA prior to HFA becoming a Q-sub beginning on December 21, 2002.

	(8)	The decrease in net income for the year ended September 30, 2002, as compared to the year ended September 30, 2001 is primarily attributable to approximately $6.4 million in non-recurring costs (e.g., outside legal, finance, accounting and audit fees) related to the acquisition of the Selected Operations of IITRI.

	(9)	IITRI operated as a non-stock, not-for-profit corporation since its inception. Therefore, prior to 2003, our historical capital structure is not indicative of our current capital structure and, accordingly, historical earnings per share information has not been presented. Pro forma basic and diluted earnings per common share are computed based upon approximately 2.575 million shares of our stock outstanding after closing of the Transaction and completion of the one-time ESOP investment election being reflected as outstanding for the period prior to the closing of the Transaction. As of September 30, 2003, the pro forma basic and diluted earnings per common share are computed based upon approximately 2.65 million weighted average shares outstanding.


(10)	Funded backlog represents the total amount of contracts that have been awarded and whose funding has been authorized minus the amount of revenue booked under the contracts from their inception to date.

(11)	Unfunded backlog refers to the estimated total value of contracts which have been awarded but whose funding has not yet been authorized for expenditure.

(12)

The unaudited pro forma consolidated statements of operations set forth below should be read in connection with, and are qualified by reference to, our consolidated financial statements and related notes, as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this annual report. We believe that the assumptions used in the preparation of this unaudited pro forma information provide a reasonable basis for presenting the significant effects directly attributable to the transactions discussed below. The unaudited pro forma consolidated operating data are not necessarily indicative of the results that would have been reported had such events actually occurred on the dates described below, nor are they indicative of our future results. The unaudited pro forma consolidated operating data have been prepared to reflect the following adjustments to our historical results of operations and to give effect to the following transactions as if those transactions had been consummated on October 1, 2001:


	•	our incurrence of approximately $96.1 million of debt with detachable warrants to purchase common stock, in connection with the purchase of IITRI’s assets;

	•	the acquisition of IITRI’s assets, which was accounted for under the purchase method of accounting; and

	•	the purchase of our common stock for approximately $25.8 million by the ESOP Trust.

ALION SCIENCE AND TECHNOLOGY CORPORATION

Unaudited Pro Forma Consolidated Statement of Operations

For the Year Ended September 30, 2003


			Year Ended September 30, 2003

			Selected
			Operations of IITRI			Alion			Pro Forma
			Historical			Historical			Adjustments			Pro Forma

			(In thousands, except per share information)
Contract revenue			$	47,265		$	165,917					$	213,182
Direct contract expense				34,655			120,559						155,214

		Gross profit		12,610			45,358						57,968

Operating expenses:
	Indirect contract expense			2,568			8,685						11,253
	Research and development			36			177						213
	General and administrative			4,732			19,909			29	(1)		24,670
	Stock-based and deferred compensation			—			856						856
	Non-recurring transaction expense			6,000			726						6,726
	Rental and occupancy expense			2,089			6,892			112	(2)		9,093
	Depreciation and amortization			886			9,553			(474	)(3)		12,436
										2,471	(4)
	Bad debt expense (recovery)			120			(525	)					(405	)

Total operating expenses				16,431			46,273						64,842

		Operating income (loss)		(3,821	)		(915	)					(6,874	)
Other income (expense):
	Interest income			22			21						43
	Interest expense			(51	)		(11,724	)		(1,685	)(5)		(13,869	)
										(106	)(6)
										(303	)(7)
	Other			(23	)		2						(21	)

		Income (loss) before income taxes		(3,873	)		(12,616	)					(20,721	)
		Income tax expense		(27	)		—						(27	)

		Net income (loss)	$	(3,900	)	$	(12,616	)				$	(20,748	)

Basic and diluted (loss) per share												$	(7.83	)(8)
Basic and diluted weighted average common shares outstanding										2,649	(8)

See accompanying notes to unaudited pro forma consolidated statement of operations.


(1)	Represents Alion board of director expenses and interest expense on the $0.9 million note due to officer under terms of a compensation agreement, net of estimated fair value of detachable warrants.

(2)	Represents the elimination of the amortization of the deferred gain related to the sale of real estate during the year ended September 30, 2001.

(3)	Reversal of IITRI’s historical amortization expense related to pre-acquisition goodwill.

(4)	Under the provisions of SFAS No. 141,“Business Combinations”, the Transaction purchase price was allocated between net tangible assets, the value attributed to identifiable intangible assets (purchased contracts) and goodwill. For purposes of the pro forma consolidated statements of operations, the excess purchase price over the identifiable net assets acquired is considered to be goodwill with an indefinite life

and therefore is not amortizable. The estimated value of $30.6 million attributed to intangible assets has an estimated useful life of three years and has been amortized accordingly using the straight-line method in the pro forma statements of operations. Additionally, an estimated value of approximately $1.5 million was assigned to a single lot of non-capitalized assets (e.g., office furnishings, laptop computers, etc.). This asset has an estimated useful life of three years and has been amortized accordingly using the straight-line method in the pro forma statement of operations.

(5) Represents interest expense on approximately $96.1 million of debt, utilizing a weighted average interest factor of approximately 8.1% per year, issued to finance the Transaction. The senior term note is a variable rate note that is indexed to the prime rate. The prime rate used for the weighted average interest rate calculation was 4.25%.

(6) Represents amortization of debt issuance costs under the effective interest method over the life of the senior term note of five years.

(7) Represents accretion of long-term debt to face value over the term of the debt using the effective interest method. Discount to debt reflects estimated fair value of detachable warrants of $10.3 million.

(8) Our historical capital structure is not indicative of our current structure, and accordingly, historical earnings per share information has not been presented. For the fiscal year ended September 30, 2003, unaudited pro forma basic and diluted loss per share of common stock has been calculated in accordance with the rules for initial public offerings. These rules require that the weighted average share calculation give retroactive effect to any changes in our capital structure. Accordingly, pro forma weighted average shares assume the approximately 2.575 million shares issued by Alion after completion of the initial one-time ESOP investment on December 20, 2002, were outstanding for the entire period presented.


Item 7.	*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 consolidated financial statements and the notes to those statements included elsewhere in this annual report. This discussion contains forward-looking statements about our business and operations that involve risks and uncertainties. Our actual results may differ materially from those we currently anticipate as a result of the “Risk Factors” described beginning on page 26, and elsewhere in this annual report.

About This Management’s Discussion and Analysis

The discussion and analysis that follows is organized to:


	•	provide an overview of our business;

	•	explain the year-over-year trends in our results of operations;

	•	describe our liquidity and capital resources; and,

	•	explain our critical accounting policies.

Overview


	*Pro Forma Comparisons of Results of Operations*

The following discussion and analysis of results of operations relates to the results of operations for the fiscal years ended September 30, 2005 and 2004 and for the pro forma results of operations for the fiscal year ended September 30, 2003. On December 20, 2002, the last day of the Company’s first interim period for the fiscal year ended September 30, 2003, Alion completed the acquisition of substantially all of the assets and certain of the liabilities of IIT Research Institute (the “Transaction”). The pro forma statements reflect adjustments as if the Transaction had been consummated on October 1, 2001.

We apply our scientific and engineering expertise to research and develop technological solutions for problems relating to national defense, public health and safety, and nuclear safety and analysis. We provide our research and development and engineering services primarily to agencies of the federal government, but also to state, local and foreign governments as well as commercial customers both in the U.S. and abroad. Our revenues increased 36.5%, 26.6%, and 5.7% for the fiscal years ended September 30, 2005, 2004, and 2003, respectively, through a combination of internal growth and acquisitions. The following table reflects, for each fiscal year indicated, summary results of operations and contract backlog data:


			For the Years Ended September 30,

			2005			2004			2003

			(In millions)
Revenue			$	369.2		$	269.9		$	213.2

Net loss			$	(40.2	)	$	(15.1	)	$	(20.7	)

Contract Backlog:
		Funded		193.0			161.0			107.0
		Unfunded		2,581.0			1,793.0			1,435.0

	Total		$	2,774.0		$	1,954.0		$	1,542.0

We contract primarily with the federal government. We expect most of our revenues to continue to come from government contracts and we expect that most of these contracts will be with the U.S. Department of Defense. The balance of our revenue comes from a variety of commercial customers, state and local governments, and foreign governments. The following table reflects, for each fiscal year indicated, the percentage of the Company’s revenue derived from each of its major types of customers:


		2005				2004				2003

		(In millions)
U.S. Department of Defense (DoD)		$	324	88	%	$	245	91	%	$	202	95	%
Other Federal Civilian Agencies		$	30	8	%	$	19	7	%	$	7	3	%
Commercial and International		$	15	4	%	$	6	2	%	$	4	2	%

	Total	$	369	100	%	$	270	100	%	$	213	100	%

We intend to continue to expand our research offerings in commercial and international markets; however, the expansion, if any, will be incremental. Revenues from commercial/ state and local government/ international research together amounted to approximately 4% of total revenues in fiscal year 2005 and approximately 2% in each of fiscal years 2004 and 2003. We derive our international revenue primarily from spectrum management research and software tools.

Most of our revenue is generated based on services provided either by our employees or subcontractors. To a lesser degree, the revenue we earn includes reimbursable travel and other items to support the contractual effort. Thus, once we win new business, the key to delivering the revenue is through hiring new employees to meet customer requirements, retaining our employees, and ensuring that we deploy them on direct-billable jobs. Therefore, we closely monitor hiring success, attrition trends, and direct labor utilization. A key challenge in growing our business is to hire enough employees with appropriate security clearances. Since we earn higher profits from the labor services that our employees provide compared with subcontracted efforts and other reimbursable items such as hardware and software purchases for customers, we seek to optimize our labor content on the contracts we win.

The table below provides a summary of annual revenues by significant contracts performed by the Company.

Summary of Annual Revenue by Customer/ Government Agency


		Primary Core		FY05 Annual		FY05 Annual
Sponsor/Government Agency	Title	Business Area*		Revenue		Revenue

				(In millions)
Department of Defense - Defense Modeling and Simulation Information Systems Agency	Information Analysis Center	Modeling and Simulation		$	69		19	%
Department of Defense - Joint Spectrum Center	Joint Spectrum Center Engineering Support Services	Wireless Communications		$	46		12	%
General Services Administration	Information Technology Services - U.S. Department	Information Technology		$	25		7	%
Department of Defense - Army	U.S. Army Night Vision Lab Hightech Omnibus contract		Defense Operations	$	19		5	%
Department of Defense - Navy	Engineering, Financial and Program Management Services to the Virtual SYSCOM program	Naval Architecture and Marine Engineering		$	19		5	%

Subtotal				$	178		48	%
Other Sponsors/ Agencies				$	191		52	%

Total Revenues				$	369		100	%


*	The total annual revenue identified with a sponsor/government agency may include revenue within multiple business areas. The primary core business area is the single largest business area with the sponsor/government agency.

During the year ended September 30, 2005, the support services contract to the Joint Spectrum Center underwent a full and open competition for the follow-on support contract that was to commence beginning October 2005. In August 2005, we were notified that we were not the successful bidder for these services. The JSC contract represented approximately 12%, 18%, and 21% of our revenue for the years ended September 30, 2005, 2004, and 2003, respectively. The Company filed a formal bid protest before the Government Accountability Office (GAO) with respect to the JSC contract award. The Company’s principal argument was that the successful bidder had an organizational conflict of interest with respect to its proposed performance of the contract. In its decision dated January 9, 2006, the GAO sustained the protest and recommended that the contracting agency take certain corrective action in order to address the awardee’s organizational conflict of interest. The Company is awaiting further action from the contracting agency. In the meantime, the Company expects to continue to generate revenue from its existing JSC contract until the issues involved in its protest are fully resolved.

Our revenues and our operating margins are affected by, among other things, our mix of contract types (e.g., cost-reimbursement, fixed-price, and time-and-material). Significant portions of our revenues are generated by services performed on cost-reimbursement contracts under which we are reimbursed for approved costs, plus a fee, which reflects our profit on the work performed. We recognize revenue on cost-reimbursement contracts based on actual costs incurred plus a proportionate share of the fees earned. We also have a number of fixed-price government contracts. We use the percentage-of-completion method to recognize revenue on fixed-price contracts. These contracts involve higher financial risks, and in some cases higher margins, because we must deliver the contracted services for a predetermined price regardless of our

actual costs incurred in the project. Our failure to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed-price contract may reduce the overall fee on the contract or cause a loss. Under time-and-material contracts, labor and related costs are reimbursed at negotiated, fixed hourly rates. Revenue on time-and-material contracts is recognized at contractually billable rates as labor hours and direct expenses are incurred. The following table summarizes the percentage of revenues attributable to each contract type for the periods indicated.


	For the Year Ended September 30,

Contract Type	2005				2004				2003

Cost-plus	$	216	58	%	$	160	59	%	$	133	62	%
Fixed-price	$	77	21	%	$	44	16	%	$	34	16	%
Time-and-material	$	76	21	%	$	66	25	%	$	46	22	%

Total	$	369	100	%	$	270	100	%	$	213	100	%

For the three years ended September 30, 2005, 2004, and 2003, the percentage distribution among these three types of contracts has remained relatively constant. Nonetheless, the percentage distribution reflects, to some extent, the increased use by governmental procuring agencies of General Services Administration Schedules which usually involve an increased number of both time-and-material and fixed-price orders.

Our objective is to continue to grow by capitalizing on our highly educated work force and our established position in our core research fields, and by synergistic acquisitions. From 1998 through September 30, 2005, the Company and its predecessor, IITRI, have completed ten acquisitions. For the year ended September 30, 2005, the following four acquisitions and one strategic investment were completed:


	Countermeasures, Inc. — On October 28, 2004, Alion purchased substantially all of the assets of Countermeasures. Alion acquired technology and software (e.g., “Buddy System^tm” used in vulnerability assessment) for identifying, quantifying and managing physical, infrastructure, program and electronic risks. Countermeasures had two employees and was located in Hollywood, Md.

	Mantech Environmental Technology, Inc. — On February 11, 2005, Alion acquired 100 percent of the outstanding stock of METI, an environmental and life sciences research and development company. METI had approximately 110 employees and was headquartered in Research Triangle Park, NC.

	Carmel Applied Technologies, Inc. — On February 25, 2005, Alion acquired 100 percent of the outstanding stock of CATI, a flight training software and simulator development company. CATI had approximately 55 employees and was headquartered in Seaside, Ca.

	VectorCommand, Ltd — On March 22, 2005, Alion acquired approximately 12.5 percent of the A ordinary shares in VectorCommand Ltd. VectorCommand Ltd., headquartered in the United Kingdom, designs and develops technologies used in training and operations by emergency managers and incident commanders in Australia, Europe, North America and the United Kingdom.

	John J. McMullen Associates, Inc. — On April 1, 2005, Alion acquired all of the outstanding stock of JJMA, a provider of ship and systems design from mission analysis and feasibility trade-off studies through contract and detail design, production supervision, testing and logistics support for the commercial and naval markets. JJMA had approximately 600 employees and was headquartered in Iselin, New Jersey.

We have integrated the acquired entities listed above into our research base and capabilities, enabling us to expand our research offerings for our government and commercial customers. Management believes that synergistic acquisitions like these provide several potential benefits to our organization and the public in that they:


	•	help us expand our research base to include increasingly large and complex programs;

	•	increase our opportunities to exploit the synergies between different research fields in which we work to broaden our offerings to our existing customers;


	•	bring new strengths to our technical capabilities through cross-utilization of research technology and engineering skills; and

	•	increase the overall depth and experience of our management.

Results of Operations

For fiscal years ended September 30, 2005, 2004 and 2003, the Transaction had two significant impacts on net income: first, the value assigned to the purchased contracts are amortized on a straight-line basis over three years resulting in approximately a $10.2 million, non-cash expense per year, and second, there are two additional expense categories that appear on the operating statements: non-recurring third party transaction expenses (e.g. outside legal, finance, accounting and audit fees of approximately $6.7 million for fiscal year 2003) and the interest-related expense associated with the debt financing which includes the related change in warrant valuation associated with change in share price of Alion common stock of approximately $38.7 million, $16.8 million, and $13.9 million for the fiscal years ended September 30, 2005, 2004, and 2003, respectively.


	*Year Ended September 30, 2005 Compared to Year Ended September 30, 2004*

For purposes of comparability, the table below reflects the relative financial impact of the METI, CATI and JJMA acquisitions, which we refer to as the “acquired operations” of Alion, as they relate to the financial performance of Alion for the fiscal year ended September 30, 2005 compared to the financial performance for fiscal year ended September 30, 2004. Significant differences in the results of Alion’s operations for the years September 30, 2005 and 2004, arise from the effects of these acquisitions. The discussion of the results of operations will include references to the financial information shown in the table below in conjunction with the consolidated financial statements of Alion provided elsewhere in this document. The financial information provided in the table is based on estimates from Alion management.


	*Acquisitions Completed in the Year Ended September 30, 2005*


	•	We completed the acquisition of substantially all of the assets Countermeasures on October 28, 2004. Countermeasures had two employees and was located in Hollywood, Maryland. Alion acquired technology and software (e.g. “Buddy System^tm” used in vulnerability assessment) for identifying, quantifying and managing physical, infrastructure, program and electronic risks.

	•	On February 11, 2005, we completed the acquisition of METI, an environmental and life sciences research and development company. METI had approximately 110 employees and was headquartered in Research Triangle Park, North Carolina.

	•	On February 25, 2005, we completed the acquisition of CATI, a provider of flight training software and simulator development systems. CATI had approximately 55 employees and was headquartered in Seaside, California.

	•	On April 1, 2005, we completed the acquisition of JJMA, a provider of ship and systems design from mission analysis and feasibility trade-off studies through contract and detail design, production supervision, testing and logistics support for the commercial and naval markets. JJMA had approximately 600 employees and was headquartered in Iselin, New Jersey.


			Year Ended September 30, 2005								Year Ended September 30, 2004

						Acquired		Consolidated								Consolidated
						Operations		Operations of								Operations of
			Consolidated			(METI,		Alion Less			Consolidated			Acquired		Alion Less
			Operations of			CATI, and		the Acquired			Operations of			Operations		the Acquired
Financial Information			Alion			JJMA)*		Operations			Alion			(ITSC and IPS)*		Operations

			(In millions)
Total revenue			$	369.2		$	65.3	$	303.9		$	269.9		$	28.4	$	241.6
	Material and subcontract revenue			102.7			16.9		85.8			70.3			11.5		58.9
Total direct contract expenses				267.2			46.1		221.1			196.4			19.5		176.9
	Major components of direct contract expense:
		Direct labor cost		152.5			26.6		125.9			120.0			8.1		111.9
		Other direct cost (ODC)		13.7			2.9		10.8			8.1			0.3		7.9
		Material and subcontract (M&S) cost		101.0			16.6		84.4			68.3			11.1		57.1
Gross profit				102.0			19.2		82.8			73.6			5.3		68.3
Total operating expense				104.1			13.1		91.0			73.7			4.4		69.3
	Major components of operating expense:
		Indirect personnel and facilities		41.6			6.9		34.7			28.6			2.2		26.4
		General and administrative		33.0			2.9		30.1			28.1			1.8		26.3
		Depreciation and amortization		17.8			3.2		14.6			13.4			0.3		13.1
		Stock-based compensation		10.6			0.0		10.6			2.5			0.0		2.5
Loss from operations			$	(2.1	)	$	6.1	$	(8.2	)	$	(0.2	)	$	0.9	$	(1.1	)


*	For the years ended September 30, 2005 and 2004, the operations of the acquired entities, Countermeasures, METI, CATI and JJMA, and ITSC and IPS, respectively, have been fully integrated within Alion on a consolidated basis. The financial information attributed to these entities are the estimates of management.

Contract Revenues. Revenues increased $99.3 million, or 36.8%, to $369.2 million for the year ended September 30, 2005, from $269.9 million for the year ended September 30, 2004. This increase is attributable to the following:


•	Revenue generated by the activities of acquired operations	$	65.3 million
•	Revenue generated by the activities of the non-acquired operations	$	34.0 million
	Total:	$	99.3 million

For the year ended September 30, 2005, additional revenue generated by the acquired operations included approximately $49.2 million, $8.0 million and $8.1 million from the activities of JJMA, METI and CATI, respectively. Additional revenue of approximately $33.9 million generated by the non-acquired operations included an increase of approximately $16.5 million in support to the U.S. Army Night Vision Hightech Omnibus contract, an increase of approximately $6.0 million to the Modeling and Simulation Information Analysis Center (MSIAC) contract to the Department of Defense, and an increase of approximately $3.7 million in support of the Weapons Systems Technology Analysis Center contract. On the balance of our contracts performed by the non-acquired operations, revenue increased by approximately $7.7 million.

As a component of revenue, material and subcontract (M&S) revenue increased approximately $32.4 million, or 46.1%, to $102.7 million for the year ended September 30, 2005 from $70.3 million for the year ended September 30, 2004. M&S revenue of the acquired operations was approximately $16.9 million, of which approximately $13.6 million, $1.7 million and $1.6 million was generated by JJMA, CATI and METI, respectively. Approximately $15.5 million of M&S revenue increase was generated by non-acquired operations of which approximately $16.1 million of additional M&S revenue was generated in support to the U.S. Army Night Vision Hightech Omnibus contract and approximately $5.8 million was generated in support of the MSIAC contract. On the balance of our contracts performed by the non-acquired operations, M&S revenue decreased by approximately $6.4 million. As a percentage of revenue, M&S revenue was 27.8% for the fiscal year ended September 30, 2005 as compared to 26.1% for the year ended September 30, 2004. For the year ended September 30, 2005, the M&S revenue content of total revenue performed under contracts of the acquired operations was approximately 25.8% while the M&S content of total revenue performed by the non-acquired operations was approximately 28.2%. The revenue activity of the acquired operations has a higher percentage level of M&S revenue that results from the amount of subcontractor support required.

Direct Contract Expenses. Direct contract expenses increased $70.8 million, or 36.1%, to $267.2 million for the year ended September 30, 2005 from $196.4 million for the year ended September 30, 2004. As a percentage of revenue, direct contract expenses were 72.4% and 72.8% for the years ended September 30, 2005 and 2004, respectively. The changes in specific components of direct contract expenses are:


	•	Direct labor costs for the year ended September 30, 2005 increased by $32.5 million, or 27.1%, to $152.5 million from $120.0 million for the year ended September 30, 2004. As a percentage of revenue, direct labor cost was 41.3% for the year ended September 30, 2005 as compared to 44.5% for the year ended September 30, 2004. The percentage decrease in direct labor cost is directly associated with the relative percentage increase in M&S cost associated with the increase in the percentage of M&S revenue, as described above.

	•	M&S cost increased approximately $32.7 million, or 47.9%, to $101.0 million for the year ended September 30, 2005, compared to $68.3 million for the year ended September 30, 2004. As a percentage of revenue, M&S cost was 27.5% for the year ended September 30, 2005 as compared to 25.3% for the year ended September 30, 2004. The percentage increase in M&S cost is directly associated with the relative percentage increase in M&S cost associated with the contracts, as described above. As a percentage of M&S revenue, M&S cost was approximately 98.3% and 97.2% for the years ended September 30, 2005 and 2004, respectively.

Gross Profit. Gross profit increased $28.4 million, or 38.6%, to $102.0 million for the year ended September 30, 2005, from $73.6 million for the year ended September 30, 2004. The $28.4 million increase is attributable to the following:


•	Gross profit generated by the activities of the acquired operations	$	19.2 million
•	Gross profit generated by the activities of the non-acquired operations	$	9.2 million
	Total:	$	28.4 million

As a percentage of revenue, gross profit was 27.6% for each of the year ended September 30, 2005 and 27.3% for the year ended September 30, 2004. For the year ended September 30, 2005, we experienced an increased proportion of M&S contract revenue, which typically generates lower profit margins; however, we were able to increase our overall gross profit margin due to an increase in profit margins on time-and-materials and fixed price contract work coupled with our ability to sustain our proportionate amount of time-and-material and fixed price contract work.

Operating Expenses. Operating expenses increased $30.4 million, or 41.3%, to $104.1 million for the year ended September 30, 2005, from $73.7 million for the year ended September 30, 2004. The $30.4 million increase is attributable to the following:


•	Operating expense incurred by the activities of the acquired operations	$	13.1 million
•	Operating expense incurred by activities of the non-acquired operations	$	17.3 million
	Total:	$	30.4 million

As a percentage of revenue, operating expenses were 28.3% for the year ended September 30, 2005 as compared to 27.3% for the year ended September 30, 2004. The changes in specific components of operating expenses are:


	•	Stock-based compensation was approximately 2.9 and 0.9 percentage points of revenue for the years ended September 30, 2005 and 2004, respectively. Stock-based compensation and deferred compensation relate primarily to the expense associated with the stock appreciation rights and phantom stock plans. Stock-based compensation increased approximately $8.1 million, or 324% to $10.6 million for the year ended September 30, 2005, from approximately $2.5 million for the year ended September 30, 2004. The increase in stock-based compensation and deferred compensation is a result of the increase in the value of Alion’s common stock and the increase in awards granted.

	•	Operating expenses for indirect personnel and facilities costs related to rental and occupancy expenses increased approximately $13.0 million, or 45.4%, to $41.6 million for the year ended September 30, 2005, from $28.6 million for the year ended September 30, 2004. As a percentage of revenue, operating expenses relating to indirect personnel and facilities expense was 11.3% for the year ended September 30, 2005 as compared to 10.6% for the year ended September 30, 2004. The increase, as a percentage of revenue, is partially attributable to the increase in indirect labor costs associated with the integration activities of the CATI, METI and JJMA acquisitions. Management intends to reduce facility lease costs through efforts to sublet excess space which resulted from additional space acquired through the acquisition process.

	•	General and administrative (G&A) expense increased approximately $4.9 million, or 17.4%, to $33.0 million for the year ended September 30, 2005, compared to $28.1 million for the year ended September 30, 2004. As a percentage of revenues, general and administrative expenses were 9.0% for the year ended September 30, 2005, compared to 10.4% for the year ended September 30, 2004. As a result of integrating the activities of CATI, METI and JJMA, the costs associated with providing G&A activities for the acquired operations have been partially absorbed by the existing G&A infrastructure, resulting in a decrease in expense expressed as a percentage of revenue.

	•	Depreciation and amortization expense increased approximately $4.4 million, or 32.8%, to $17.8 million for the year ended September 30, 2005, as compared to $13.4 million for the year ended September 30, 2004. Depreciation is associated primarily with the value assigned to fixed assets while

amortization expense is associated primarily with the intangible asset value assigned to the purchased contracts of the acquired entities. The $4.4 million increase is primarily attributable to the following:


			Year Ended
			September 30,

			2005		2004

			(In millions)
Depreciation expense			$	4.4	$	2.8
Amortization expense for purchased contracts of:
	- IITRI		$	10.2	$	10.2
	- ITSC		$	0.1		—
	- IPS		$	0.5	$	0.4
	- METI		$	0.3		—
	- JJMA		$	2.2		—
Amortization expense for non-compete agreements			$	0.1		—

		Total	$	17.8	$	13.4

As a percentage of revenue, operating expense relating to depreciation and amortization expense was 4.8% for the year ended September 30, 2005 as compared to 5.0% for the year ended September 30, 2004.

Loss from Operations. For the year ended September 30, 2005, the loss from operations was $2.1 million compared with $0.2 million operating loss for the year ended September 30, 2004. The $1.9 million loss increase is associated with factors discussed above and is attributable to the following:


•	Operating income generated from the acquired operations	$	6.1	million
•	Operating loss generated from the non-acquired operations*	$	(8.0	) million
	Total:	$	(1.9	) million


*	For the year ended September 30, 2005, stock-based compensation expense of approximately $10.6 million was not attributed to the activities of acquired operations.

Other Income and Expense. As a category, other income and expense increased approximately $23.2 million, or 155.7%, to $38.1 million for the year ended September 30, 2005 as compared to $14.9 million for the year ended September 30, 2004. As a component of other income and expense, interest expense increased approximately $21.9 million, or 125.6%, to $38.7 million for the year ended September 30, 2005 from approximately $16.8 million for the year ended September 30, 2004. The $21.9 million increase in interest expense is attributable to the following:


		Year Ended
		September 30,

		2005		2004

		(In millions)
Revolving facility		$	0.2	$	0.8
Senior term loan			6.9		3.1
Mezzanine Note - cash-pay interest			1.8		2.4
- accretion of debt discount			2.2		0.7
Subordinated note - PIK interest			2.3		2.4
- accretion of long-term deferred interest			0.6		0.4
- accretion of debt discount			0.9		0.8
Agreements with officers			0.0		0.2
Accretion of warrants(a)			23.5		5.9
Other			0.3		0.1

	Total	$	38.7	$	16.8


(a)	Reflects change in value assigned to the detachable warrants associated with Mezzanine and Subordinated notes based on the change in the value of Alion common stock.

The remaining increase of approximately $1.3 million is attributable to interest expense and the recognition of a gain of approximately $2.1 million on the sale of our minority interest in Matrics, Inc. For the year ended September 30, 2005, we did not have any significant recognized gains.

Income Tax (Expense) Benefit. The Company has filed qualified subchapter S elections for all of its wholly-owned subsidiaries to treat them as disregarded entities for federal income tax purposes. Some states do not recognize the effect of these elections or Alion’s S corporation status. As a result, the Company recorded approximately $0.07 million and $0.02 million of state income tax expense for the years ended September 30, 2005 and 2004, respectively

Net Loss. The net loss increased approximately $25.1 million, or 166.2%, to $40.2 million for the year ended September 30, 2005 as compared to $15.1 million for the year ended September 30, 2004. The $25.1 million increase is associated with factors discussed above.


	*Year Ended September 30, 2004 Compared to Pro Forma Year Ended September 30, 2003*

For purposes of comparability, the table below reflects the relative financial impact of the ITSC and IPS acquisitions as they relate to the financial performance of Alion for the fiscal year ended September 30, 2004 compared to the pro forma financial performance for fiscal year ended September 30, 2003. The discussion of the results of operations will include references to the financial information shown in the table below in conjunction with the consolidated financial statements of Alion provided elsewhere in this document. The financial information provided in the table is based on estimates from Alion management.


	•	On February 13, 2004, we completed the acquisition of ITSC, a provider of nuclear safety and analysis services to the U.S. Department of Energy (DOE) as well as to the commercial nuclear power industry.


	•	On October 31, 2003, we completed the acquisition of IPS a provider of program and acquisition management, integrated logistics support, and foreign military support primarily to U.S. Navy customers.


											Pro Forma
			Year Ended September 30, 2004								Year Ended
											September 30,
								Consolidated			2003
								Operations of
			Consolidated			Acquired		Alion Less the			Consolidated
			Operations of			Operations		Acquired			Operations of
Financial Information			Alion			(ITSC and IPS)		Operations			Alion

											(In thousands)
			(In thousands)
Total revenue			$	269,940		$	28,359	$	241,581		$	213,182
Material and subcontract revenue				70,328			11,465		58,863			43,391
Total direct contract expenses				196,388			19,488		176,900			155,214
	Major components of direct contract expense:
		Direct labor cost		119,999			8,106		111,894			105,469
		Other direct cost (ODC)		8,109			252		7,857			7,617
		Material and subcontract (M&S) cost		68,280			11,131		57,149			42,128
Gross profit				73,552			5,296		68,256			57,968
Total operating expense				73,703			4,372		69,331			64,842
	Major components of operating expense:
		Indirect personnel and facilities		28,637			2,206		26,431			20,346
		Non-recurring Transaction expense		—			—		—			6,726
		General and administrative		28,116			1,850		26,266			24,670
		Stock-based and deferred compensation		2,513			—		2,513			856
		Depreciation and amortization		13,448			317		13,131			12,436
Income (loss) from operations			$	(151	)	$	924	$	(1,075	)	$	(6,874	)


*	The operations of the acquired entities, ITSC and IPS, have been fully integrated within Alion on a consolidated basis. The financial information attributed to these entities are the estimates of management.

Contract Revenues. Revenues increased $56.7 million, or 26.6%, to $269.9 million for the year ended September 30, 2004, from $213.2 million for the year ended September 30, 2003. The $56.7 million increase is attributable to the following:


•	Revenue generated by the activities of acquired operations	$	28.3 million
•	Revenue generated primarily by work performed under Company contracts that were in existence during the prior year	$	28.4 million
	Total:	$	56.7 million

For the year ended September 30, 2004, our performance of additional work under Company contracts that were in existence during the prior year includes an increase in our decommissioning and demilitarization support services to the U.S. Army’s Newport Chemical Agent Disposal Facility (NECDF) under a subcontract to Parsons Infrastructure and Technology Group, Inc. that accounted for approximately $4.2 million of increased revenue, while our continued support to the Department of Defense Joint Spectrum Center (JSC) accounted for approximately $4.1 million of increased revenue. The Modeling and Simulation Information Analysis Center (MSIAC) contract to the Department of Defense accounted for approximately $3.5 million of the revenue increase.

As a component of revenue, material and subcontract (M&S) revenue increased approximately $26.9 million, or 62.1%, to $70.3 million for the year ended September 30, 2004 from $43.4 million for the year ended September 30, 2003. As a percentage of revenue, M&S revenue was 26.0% for the fiscal year

ended September 30, 2004 as compared to 20.4% for the year ended September 30, 2003. The increase in M&S revenue content can be attributed to two factors: 1) the M&S revenue of the acquired operations was approximately $11.5 million, or 40.5% of total acquired revenue, and 2) the M&S revenue content performed under existing contracts increased to approximately 24.4% of revenue. The revenue activity of the acquired operations has an increased percentage level of M&S revenue that results from the amount of subcontractor support which is provided to the commercial utility customers of the ITSC operation and the increased level of subcontract activity required under our support contracts to the U.S. Navy performed by the IPS operation.

Direct Contract Expenses. Direct contract expenses increased $41.2 million, or 26.5%, to $196.4 million for the year ended September 30, 2004 from $155.2 million for the year ended September 30, 2003. As a percentage of revenue, direct contract expenses were 72.8% for the years ended September 30, 2004 and 2003. The changes in specific components of direct contract expenses are:


	•	Direct labor costs for the year ended September 30, 2004 increased by $14.5 million, or 13.8%, to $120.0 million from $105.5 million for the year ended September 30, 2003. As a percentage of revenue, direct labor cost was 44.5% for the year ended September 30, 2004 as compared to 49.5% for the year ended September 30, 2003. The percentage decrease in direct labor cost is directly associated with the relative percentage increase in M&S cost associated with the M&S revenue of the acquired operations, as described above.

	•	M&S cost increased approximately $26.2 million, or 62.1%, to $68.3 million for the year ended September 30, 2004, compared to $42.1 million for the year ended September 30, 2003. As a percentage of revenue, M&S cost was 25.3% for the year ended September 30, 2004 as compared to 19.8% for the year ended September 30, 2003. The percentage increase in M&S cost is directly associated with the relative percentage increase in M&S cost of the contracts performed by acquired operations, as described above. As a percentage of M&S revenue, M&S cost was approximately 97.1% during the years ended September 30, 2004 and 2003.

Gross Profit. Gross profit increased $15.6 million, or 26.9%, to $73.6 million for the year ended September 30, 2004, from $58.0 million for the year ended September 30, 2003. The $15.6 million increase is attributable to the following:


•	Gross profit generated by the activities of the acquired operations	$	5.3 million
•	Gross profit generated primarily by work performed under Company contracts that were in existence during the prior year	$	10.3 million
	Total:	$	15.6 million

As a percentage of revenue, gross profit was 27.2% for years ended September 30, 2004 and 2003. For the year ended September 30, 2004, we experienced an increased proportion of M&S contract revenue, which typically generates lower profit margins; however, we were able to sustain our overall gross profit margin due to the increase in the proportionate amount of time-and-material and fixed price contract work, which typically generate higher profit margins.

Operating Expenses. Operating expenses increased $8.9 million, or 13.7%, to $73.7 million for the year ended September 30, 2004, from $64.8 million for the year ended September 30, 2003. However, for the year ended September 30, 2003, there was approximately $6.7 million in non-recurring, transaction-related expense associated with Alion’s purchase of the Selected Operations of IITRI. There were no such costs incurred for the year ended September 30, 2004. As such, the adjusted increase in operating expense was approximately $15.6 million ($8.9 million plus $6.7 million). The $15.6 million adjusted increase is attributable to the following:


•	Operating expense incurred by the activities of the acquired operations	$	4.4 million
•	Operating expense incurred for the infrastructure needs in support of revenue growth of existing operations	$	11.2 million
	Total:	$	15.6 million

As a percentage of revenue, operating expense was 27.3% for the year ended September 30, 2004 as compared to 30.4% for the year ended September 30, 2003. For the year ended September 30, 2004, the percentage decrease in operating expense is directly attributable to the absence of Transaction-related expenses. The changes in other specific components of operating expenses are:


	•	Overhead expenses for indirect personnel and facilities costs related to rental and occupancy expenses increased approximately $8.3 million, or 40.8%, to $28.6 million for the year ended September 30, 2004, from $20.3 million for the year ended September 30, 2003. As a percentage of revenue, operating expense relating to indirect personnel and facilities expense was 10.6% for the year ended September 30, 2004 as compared to 9.5% for the year ended September 30, 2003. The increase, as a percentage of revenue, is partially attributable to the increase in indirect labor costs associated with the integration activities of the ITSC and IPS acquisitions.

	•	General and administrative (G&A) expense increased approximately $3.6 million, or 14.1%, to $28.1 million for the year ended September 30, 2004, compared to $24.7 million for the year ended September 30, 2003. As a percentage of revenues, general and administrative expenses were 10.4% for the year ended September 30, 2004, compared to 11.6% for the year ended September 30, 2003. As a result of integrating the activities of ITSC and IPS, the costs associated with providing G&A activities for the acquired operations have been partially absorbed by the existing G&A infrastructure, resulting in a decrease in expense expressed as a percentage of revenue.

	•	Stock-based compensation and deferred compensation relate primarily to the expense associated with the SAR and phantom stock plans. Stock-based compensation increased approximately $1.6 million, or 178% to $2.5 million for year ended September 30, 2004, from approximately $0.9 million for the year ended September 30, 2003. As a percentage of revenue, operating expense relating to stock-based compensation and deferred compensation expense was 0.9% for the year ended September 30, 2004 as compared to 0.4% for the year ended September 30, 2003. The increase in stock-based compensation and deferred compensation is a result of the increase in the value of Alion’s common stock and the increase in awards granted.

	•	Non-recurring Transaction-related expenses (e.g., third party legal, accounting, and finance) was not incurred during the year ended September 30, 2004. For the year ended September 30, 2003, Transaction-related expenses were approximately $6.7 million.

	•	Depreciation and amortization expense increased approximately $1.0 million, or 8.1%, to $13.4 million for the year ended September 30, 2004, as compared to $12.4 million for the year ended September 30, 2003.

For each year ended September 30, 2004 and 2003, approximately $10.2 million of amortization expense was incurred associated with the intangible asset value assigned to purchased customer contracts of IITRI. For the year ended September 30, 2004, approximately $0.3 million of amortization expense was incurred associated with intangible asset value assigned to the purchased contracts of ITSC and IPS. Also, for each respective year ended September 30, 2004 and 2003, approximately $0.5 million of depreciation expense was incurred associated with the fair value assigned to the purchased fixed assets of IITRI. As a percentage of revenue, operating expense relating to depreciation and amortization expense was 5.0% for the year ended September 30, 2004 as compared to 5.8% for the year ended September 30, 2003.


	•	Bad debt expense increased $1.0 million to $0.6 million for the year ended September 30, 2004 as compared to a recovery of $0.4 million for the year ended September 30, 2003. During the year ended September 30, 2003, approximately $0.5 million of cash was received due to the favorable resolution of a contractual dispute. As a percentage of revenue, bad debt expense was 0.2% for the year ended September 30, 2004 as compared to a recovery of 0.2% for the year ended September 30, 2003.

Loss from Operations. For the year ended September 30, 2004, the loss from operations was $0.1 million compared with $6.8 million operating loss for the year ended September 30, 2003. The $6.7 million decrease is associated with factors discussed above and is attributable to the following:


•	Operating income generated from the activities of the acquired operations	$	0.9 million
•	Decrease in operating loss generated from the existing operations	$	5.8 million
	Total:	$	6.7 million

Other Income and Expense. As a category, other income and expense increased approximately $1.2 million, or 8.6%, to $15.1 million for the year ended September 30, 2004 as compared to $13.9 million for the year ended September 30, 2003. As a component of other income and expense, interest expense increased approximately $3.0 million, or 21.6%, to $16.8 million for the year ended September 30, 2004 from approximately $13.9 million for the year ended September 30, 2003. The $3.0 million increase in interest expense is attributable to the following:


		For Year Ended
		September 30,

		2004		2003

		(In millions)
Revolving debt		$	0.8	$	0.3
Senior term note			3.1		2.4
Mezzanine note - stated 12% interest			2.4		2.4
- accretion of debt discount			0.7		1.7
Subordinated note - stated PIK interest			2.4		2.5
- accretion of long term deferred interest			0.4		0.2
- accretion of debt discount			0.8		3.3
Promissory notes with officers			0.2		0.0
Warrants			5.9		0.7
Other			0.1		0.4

	Total	$	16.8	$	13.9


(a)	Reflects change in value assigned to the detachable warrants associated with the change in the value of Alion common stock. The warrants are associated with the Mezzanine and Subordinated notes.

In September 2004, we recognized a gain of approximately $2.1 million on the sale of our minority interest in Matrics, Inc.

Income Tax (Expense) Benefit. Although HFA became a qualified subchapter S subsidiary as of December 20, 2002 and is no longer treated as a separate entity for federal income tax purposes, some states do not recognize this tax election. In addition, some states do not recognize Alion’s S corporation status. As a result, the Company recorded approximately $0.02 million of state income tax expense for the year ended September 30, 2004.

Net Loss. The net loss decreased approximately $5.7 million, or 27.4%, to $15.1 million for the year ended September 30, 2004 as compared to $20.8 million for the year ended September 30, 2003. The $5.7 million decrease is associated with factors discussed above.

Liquidity and Capital Resources

The Company’s primary liquidity requirements are for debt service, working capital, capital expenditures, and acquisitions. The principal working capital need is to fund accounts receivable, which increases with the growth of the business. We are funding our present operations, and we intend to fund future operations, primarily through cash provided by operating activities and through use of our revolving credit facility.

The following discussion relates to the cash flow of Alion for the fiscal years ended September 30, 2005 and 2004.

Operating activities generated approximately $35.1 million and $5.7 million net cash for the years ended September 30, 2005 and 2004, respectively. The $29.4 million increase in cash from operating activities, despite a higher net loss in fiscal year 2005, is primarily attributable to increased non-cash interest expense related to the fair value of common stock warrants, stock-based compensation expense and depreciation and amortization expenses. These amounts were approximately $25.8 million and approximately $4.4 million for the years ended September 30, 2005 and 2004, respectively. The Company also collected approximately $26.3 million more cash on accounts receivable for the year ended September 30, 2005, as compared to the prior year.

Net cash used in investing activities (principally for strategic acquisitions) was approximately $78.0 million for the year ended September 30, 2005. During the year ended September 30, 2005, the Company paid, net of cash acquired, approximately $74.6 million in the aggregate for the acquisitions of CATI, METI, and JJMA and for the assets of Countermeasures and approximately $1.2 million for the investment in VectorCommand. In addition, the Company spent approximately $2.2 million for capital expenditures. During the year ended September 30, 2004, the Company used approximately $21.7 million to make acquisitions and pay earn out obligations. Alion paid approximately $4.0 million for the ITSC acquisition, approximately $10.6 million ($8.0 million in cash at closing plus approximately $2.6 million in subsequent payments for intercompany payables) for the IPS acquisition and $7.1 million in earn out obligations due for the AB Tech acquisition. We spent approximately $3.7 million for capital expenditures and approximately $1.0 million to make a minority investment in Matrics Incorporated. We sold our Matrics investment for $3.1 million in September 2004.

Net cash provided by financing activities was approximately $75.9 million for the year ended September 30, 2005, compared to net cash provided by financing activities of approximately $22.2 million for the year ended September 30, 2004. The most significant components of the Company’s financing activities are: 1) net proceeds from (or repayment of) short term borrowings and 2) net proceeds from (or repayment of) long term debt securities. During the year ended September 30, 2005, Alion borrowed $94.0 million under the Term B Senior Credit Facility. The Company used approximately $58.7 million for the JJMA acquisition, approximately $22.0 million to redeem the Mezzanine Note and approximately $13.3 million to finance the other acquisitions discussed above. In the year ended September 30, 2005, the Company raised approximately $14.5 million from sales of common stock to the ESOP Trust. During the year ended September 30, 2004, Alion borrowed $50.0 million under the Term B Senior Credit Facility to repay the senior term note payable and revolving line credit facility with LaSalle Bank of approximately $29.3 million and $24.0 million, respectively. During the year ended September 30, 2003, the financing was required to complete the purchase of substantially all of the assets of IITRI. Alion generated $25.8 million in cash from the initial sale of the Company’s common stock to the ESOP Trust and another approximately $0.8 million from a subsequent sale of common stock to the ESOP Trust. Alion also obtained $33.3 million from borrowings under the LaSalle Bank senior term note. During the year ended September 30, 2003, Alion repaid approximately $5.7 million of principal on the senior term loan and approximately $6.2 million of principal on LaSalle Bank’s revolving credit facility.


	*Discussion of Debt Structure*

To fund the Transaction, the Company entered into various debt agreements (e.g., Senior Credit Agreement, Mezzanine Note, and Subordinated Note) on December 20, 2002. On August 2, 2004, the Company entered into a new 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. LaSalle Bank National Association serves as syndication agent under the Term B Senior Credit Facility. Proceeds from the Term B Senior Credit Facility were used to extinguish the LaSalle Bank senior term note, the LaSalle Bank revolving credit facility and the Mezzanine Note. On April 1, 2005, the Company entered into an incremental term loan facility and an amendment to the Term B Senior Credit Facility (Amendment One), which added $72 million in term loans to our total indebtedness under the Term

B Senior Credit Facility. Set forth below is a summary of the terms of the Term B Senior Credit Facility, as modified by Amendment One, followed by a description of the remaining debt agreements which were used to fund the Transaction.

Term B Senior Credit Facility. The Term B Senior Credit Facility has a term of five years and consists of:


	•	a senior term loan in the approximate amount of $143.3 million, (which includes the incremental term loan), of which $142.9 million was drawn down as of September 30, 2005;

	•	a senior revolving credit facility, in the amount of $30.0 million, of which approximately $3.0 million was deemed borrowed as of September 30, 2005, through the issuance of letters of credit issued under the Company’s prior senior credit facility which remain outstanding under the Term B Senior Credit Facility and the issuance of additional letters of credit under the Term B Senior Credit Facility; and

	•	an uncommitted incremental term loan “accordion” facility in the amount of $150.0 million.

On the senior term loan, until the quarter ending December 31, 2008, the Company is obligated to pay quarterly installments of principal in the amount of $360,000. On each of December 31, 2008, March 31, 2009, June 30, 2009 and August 2, 2009, the Company is obligated to pay installments of principal in the amount of $34,650,000.

Under the senior revolving credit facility, the Company may request the issuance of up to $5.0 million in letters of credit and may borrow up to $5.0 million in swing line loans, a type of loan customarily used for short-term borrowing needs. All principal obligations under the senior revolving credit facility are to be repaid in full no later than August 2, 2009.

The Company may prepay any of its borrowings under the Term B Senior Credit Facility, in whole or in part, in minimum increments of $1.0 million, in most cases without penalty or premium. The Company is responsible to pay any customary breakage costs related to the repayment of Eurodollar-based loans prior to the end of a designated Eurodollar rate interest period. The Company is required to pay a 1% prepayment premium on the amount of term loans prepaid from future debt proceeds if the interest rate margins of the future debt are lower than applicable interest rate margins then in effect under the Term B Senior Credit Facility and the Company makes the prepayment before April 1, 2006. If, during the term of the Term B Senior Credit Facility, the Company engages in the issuance or incurrence of certain permitted debt or the Company sells, transfers or otherwise disposes of certain of its assets, the Company must use all of the proceeds (net of certain costs, reserves, security interests and taxes) to repay term loan borrowings under the Term B Senior Credit Facility. If the Company engages in certain kinds of issuances of equity or has any excess cash flow for any fiscal year during the term of the Term B Senior Credit Facility, the Company must use 50 percent of the proceeds of the equity issuance (net of certain costs, reserves, security interests and taxes) or 50 percent of excess cash flow for that fiscal year to repay term loan borrowings under the Term B Senior Credit Facility. If the Company’s leverage ratio is less than 2.00 to 1.00 at the applicable time after taking into account the use of the net proceeds (in the case of an equity issuance), then the Company must use 25 percent of those net proceeds or excess cash flow for that fiscal year to repay term loan borrowings under the Term B Senior Credit Facility.

If the Company borrows under the incremental term loan facility and certain economic terms of the incremental term loan, including applicable yields, maturity dates and average life to maturity, are more favorable to the incremental term loan lenders than the comparable economic terms under the senior term loan or the senior revolving credit facility, then the Term B Senior Credit Facility provides that the applicable interest rate spread will be adjusted upward. The upward adjustment will take place if the yield payable under the incremental term loan exceeds the yield under the senior term loan or senior revolving credit facility by more than 50 basis points. The effect of this provision is that an incremental term loan may make our borrowings under the senior term loan and the senior revolving credit facility more expensive.

The Term B Senior Credit Facility requires that the Company’s existing subsidiaries and subsidiaries that the Company acquires during the term of the Term B Senior Credit Facility, other than certain insignificant

subsidiaries, guarantee the Company’s obligations under the Term B Senior Credit Facility. Accordingly, the Term B Senior Credit Facility is guaranteed by the Company subsidiaries, HFA, CATI, METI, and JJMA.

Use of Proceeds. On August 2, 2004, the Company borrowed $50.0 million through the senior term loan under the Term B Senior Credit Facility. The Company used the proceeds to retire its then outstanding senior term loan and revolving credit facility administered by LaSalle Bank in the approximate amount of $47.2 million including principal and accrued and unpaid interest and to pay certain transaction fees associated with the refinancing in the approximate amount of $3.3 million. In October 2004, the Company borrowed approximately $22.0 million of the senior term loan to retire our existing mezzanine note in the approximate principal amount of $19.6 million and to pay accrued and unpaid interest and prepayment premium in the aggregate amount of approximately $2.4 million. On April 1, 2005, the Company borrowed $72 million in an incremental term loan under the Term B Senior Credit Facility. We used approximately $58.7 million of the incremental term loan proceeds to pay a portion of the JJMA acquisition price, and approximately $1.25 million to pay certain transaction fees associated with the incremental term loan. The remaining $12 million has been and will be used for general corporate purposes, which may include financing permitted acquisitions, and funding the Company’s working capital needs, as necessary.

The Term B Senior Credit Facility permits the Company to use the remainder of its senior revolving credit facility for the Company’s working capital needs and other general corporate purposes, including 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 to make certain put right payments required under the Company’s existing mezzanine warrant, if those put rights are exercised, 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, and JJMA.

Interest and Fees. Under the Term B Senior Credit Facility, the senior term loan and the senior revolving credit facility can each bear interest at either of two floating rates. The Company was entitled to elect that interest be payable on the Company’s $143.3 million senior term loan at an annual rate equal to the prime rate charged by CSFB plus 125 basis points or at an annual rate equal to the Eurodollar rate plus 225 basis points. The Company was also entitled to elect that interest be payable on the Company’s senior revolving credit facility at an annual rate that varies depending on the Company’s leverage ratio and whether the borrowing is a Eurodollar borrowing or an alternate base rate (“ABR”) borrowing. Under the Term B Senior Credit Facility, if the Company were to elect a Eurodollar borrowing under its senior revolving credit facility, interest would be payable at an annual rate equal to the Eurodollar rate plus additional basis points as reflected in the table below under the column “Eurodollar Spread” corresponding to the Company’s leverage ratio at the time. Under the Term B Senior Credit Facility, if the Company elects an ABR borrowing under its senior revolving credit facility, the Company may elect an alternate base interest rate based on a federal funds effective rate or based on CSFB’s prime rate, plus additional basis points reflected in the table below under the column “Federal Funds ABR Spread” or “Prime Rate ABR Spread” corresponding to the Company’s leverage ratio at the time.

Eurodollar Prime Rate


		Spread		ABR Spread		ABR Spread
Leverage Ratio		(In basis points)		(In basis points)		(In basis points)

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

On April 1, 2005, the Company elected to have the senior term loan bear interest at the Eurodollar rate and the senior revolving credit facility bear interest at the ABR rate (based on CSFB’s prime rate). As of September 30, 2005, the Eurodollar rate on the senior term loan was 6.45 percent (i.e., 4.20 percent plus 2.25 percent Eurodollar spread) and the ABR rate (based on CSFB’s prime rate) on the senior revolving credit facility was 7.50 percent (i.e., 5.75 percent plus 1.75 percent spread).

Under the Term B Senior Credit Facility, the Company was required to enter into an interest rate hedge agreement acceptable to CSFB to fix or cap the actual interest the Company will pay on no less than 40 percent of the Company’s long-term indebtedness.

On August 16, 2004, the Company entered into an interest rate cap agreement effective as of September 30, 2004 with one of the Company’s senior lenders. Under this agreement, in exchange for the Company’s payment to the senior lender of approximately $319,000, the Company’s maximum effective rate of interest payable with regard to an approximately $37.3 million portion of the outstanding principal balance of the Term B Senior Credit Facility was not to exceed 6.64 percent (i.e., LIBOR 3.89 percent cap plus maximum 2.75 percent Eurodollar spread) for the period September 30, 2004 through September 29, 2005 and was not to exceed 7.41 percent (i.e., LIBOR 4.66 percent cap plus 2.75 percent maximum Eurodollar spread) for the period September 30, 2005 through September 30, 2007.

On April 15, 2005, the Company entered into a second interest rate cap agreement which covers an additional $28.0 million of the Company’s long-term indebtedness. The interest on such portion of the Company’s long-term indebtedness is capped at 7.25 percent (i.e., LIBOR 5.00 percent cap plus 2.25 percent Eurodollar spread). For this second cap agreement, the Company paid a senior lender $117,000. The second interest rate cap agreement terminates on September 30, 2007. Further, the Company’s maximum effective rate of interest payable under the first interest rate cap agreement was reset and capped at a maximum interest rate of 6.91 percent (i.e., LIBOR 4.66 percent cap plus maximum 2.25 percent Eurodollar spread). As of September 30, 2005, approximately $65.3 million, or 45.7 percent, of the $142.9 million drawn under the Term B Senior Credit Facility is at a capped interest rate. The maximum effective interest rate on the $65.3 million that is currently under cap agreements is approximately 7.06 percent. The remaining outstanding aggregate balance under the Term B Senior Credit Facility over $65.3 million, which was approximately $77.6 million as of September 30, 2005, is not subject to any interest rate cap agreements or arrangements.

Subject to certain conditions, the Company may convert a Eurodollar-based loan to a prime rate based loan and the Company may convert a prime rate based loan to a Eurodollar-based loan.

The Company is obligated to pay on a quarterly basis a commitment fee of 0.50 percent per annum on the daily unused amount in the preceding quarter of the commitments made to the Company under the Term B Senior Credit Facility including the unused portion of the senior term loan and the unused portion of the $30.0 million senior revolving credit facility.

For fiscal year 2005, as of September 30, 2005, the Company has paid a 0.5 percent commitment fee of $0.2 million dollars and approximately $0.06 million on the unused amounts of the senior term loan and senior revolving credit facility, respectively. As of September 30, 2005, the unused amounts of the senior term loan and senior revolving credit facility were zero and approximately $30.0 million, respectively.

Each time a letter of credit is issued on the Company’s behalf under the senior revolving credit facility, the Company will pay a fronting fee not in excess of 0.25 percent of the face amount of the letter of credit issued. In addition, the Company will pay quarterly in arrears a letter of credit fee based on the interest rate spread applicable to the revolving credit facility borrowing made to issue the letter of credit. The Company will also pay standard issuance and administrative fees specified from time to time by the bank issuing the letter of credit.

In addition to letter of credit fees, commitment fees and other fees payable under the Term B Senior Credit Facility, the Company will also pay an annual agent’s fee.

Covenants. The Term B Senior Credit Facility requires the Company to meet the following financial tests over the life of the facility:


	•	Leverage Ratio. The Company’s leverage ratio is calculated by dividing the total outstanding amount of all of the Company’s consolidated indebtedness, but excluding the amount owed under the Company’s subordinated note and the aggregate amount of letters of credit issued on the Company’s behalf other than drawings which have not been reimbursed, by the Company’s consolidated EBITDA for the previous four fiscal quarters on a rolling basis. The maximum total leverage ratio is measured as of the end of each of our fiscal quarters. For purposes of determining the Company’s leverage ratio as of or for the quarters ended on September 30, 2004, December 31, 2004 and March 31, 2005, the Term B Senior Credit Facility deems the Company’s consolidated EBITDA to be $7.5 million for the fiscal quarter ended December 31, 2003, $7.0 million for the fiscal quarter ended March 31, 2004, and $7.7 million for the fiscal quarter ended June 30, respectively. For each of the following time periods, the Company is required to maintain a maximum leverage ratio not greater than the following:


Period	Ratio

April 1, 2005 through December 31, 2005		3.75 to 1.00
January 1, 2006 through March 31, 2006		3.50 to 1.00
April 1, 2006 through March 31, 2007		3.25 to 1.00
April 1, 2007 through March 31, 2008		2.75 to 1.00
Thereafter		2.25 to 1.00


	•	Interest Coverage Ratio. The Company’s interest coverage ratio is calculated by dividing the Company’s consolidated EBITDA, less amounts the Company spends attributable to property, plant, equipment and other fixed assets, by the Company’s consolidated interest expense. For purposes of determining the Company’s interest coverage ratio as of or for the quarters ended on September 30, 2004, December 31, 2004 and March 31, 2005, the Term B Senior Credit Facility deems the Company’s consolidated EBITDA to be $7.5 million for the fiscal quarter ended December 31, 2003, $7.0 million for the fiscal quarter ended March 31, 2004, and $7.7 million for the fiscal quarter ended June 30, 2004. The Company is required to maintain a minimum fixed charge coverage ratio of at least the following:


Date or Period	Ratio

August 2, 2004 through September 30, 2005		3.75 to 1.00
Thereafter		4.00 to 1.00

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 50 percent or more of the then outstanding aggregate senior credit facility:


	•	incur additional indebtedness other than permitted additional indebtedness;

	•	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, for the Company to satisfy any put right if exercised by mezzanine warrant holders and for certain payments required under the Company’s equity based incentive plans;

	•	enter into 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 and redeem or repurchase certain equity; 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 be subordinated to the Term B Senior Credit Facility;

	•	failure of the 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;

	•	the Trust is subject to certain taxes in excess of an agreed amount;

	•	final negative determination that the ESOP is not a qualified plan; or

	•	change of control (as defined below).

For purposes of the Term B Senior Credit Facility, a change of control generally occurs when, before the Company lists its common stock to trade on a national securities exchange or the NASDAQ National Market quotation system and obtains net proceeds from an underwritten public offering of at least $30,000,000, the Trust fails to own at least 51 percent of the Company’s outstanding equity interests, or, after the Company has

such a qualified public offering, any person or group other than IIT or the Trust owns more than 37.5 percent of the Company’s outstanding equity interests. A change of control may also occur if a majority of the seats (other than vacant seats) on the Company’s board of directors shall at any time be occupied by persons who were neither nominated by our board nor were appointed by directors so nominated. A change of control may also occur if a change of control occurs under any of the Company’s material indebtedness including the Company’s subordinated note, the warrants issued with the Company’s subordinated note and the warrants issued with the Company’s retired mezzanine note (which warrants remain outstanding).

Senior Credit Agreement. On December 20, 2002, the Company executed a Senior Credit Agreement among LaSalle Bank National Association and other lenders to refinance and replace IITRI’s prior credit arrangements and to finance, in part, the Transaction. The Senior Credit Agreement consisted of a $35.0 million Senior Term Note and a $25.0 million revolving credit facility. All principal obligations under the Senior Credit Agreement were to be repaid in full no later than December 20, 2007. The Senior Credit Agreement was secured by a first priority, perfected security interest in all of the Company’s current and future tangible and intangible property.

Prior to the CSFB refinancing in August 2004, the Company had approximately $47.2 million in borrowings under the Senior Credit Agreement (approximately $24.0 million under the revolving credit facility and approximately $23.2 million under the Senior Term Note), each of which bore interest at either of two floating rates: a per year rate equal to the Eurodollar rate plus 350 basis points, or LaSalle’s prime rate (base rate) plus 200 basis points. Under the Senior Credit Agreement, balances drawn on the revolving credit facility bore interest at the LaSalle Bank prime rate plus 200 basis points.

Effective February 14, 2003, the Company elected that the Senior Term Note bear interest at a Eurodollar rate. This election did not affect the interest rate applicable to amounts borrowed under the revolving line of credit. Interest under the Senior Term Note was payable at LaSalle’s prime rate (base rate) plus 200 basis points until February 14, 2003. Thereafter, the Senior Term Note bore interest at the Eurodollar rate plus 350 basis points.

On August 2, 2004, the revolving credit facility and Senior Term Note were extinguished with proceeds from the Term B Senior Credit Facility. As of August 2, 2004, the Company had approximately $24.0 million borrowed under the revolving credit facility at an interest rate equal to approximately 6.25% (LaSalle Bank prime rate plus 200 basis points).

The Company had entered into an interest rate cap agreement effective as of February 3, 2003 with one of its senior lenders. Under this agreement,


	assessment, and distance learning services to the Navy; historically, more of our services in the defense arena have been provided to the Army and Air Force. We also intend to use our technical capabilities to develop modeling and simulation systems for all branches of the U.S. armed forces.

	To expand our support to the United States Navy. Through a strategy of internal growth and acquisition, we are a significant support contractor to the United States Navy and its prime contractors. Our support to the U.S. Navy includes both ship design (from conceptual studies to detail design) and programmatic support. Utilizing the depth of our engineering and programmatic talent, we anticipate expanding our support to the U.S. Navy in new ship systems such as DD(x) and LCS.

	To expand our information technology research. We intend to promote our specialized information technology expertise to a broader range of customers, including the civilian agencies of the federal government, primarily by applying technology research and solutions originally developed for military use.

	To develop new software tool and technical products. We will seek to capture some of our intellectual property in the form of stand-alone tools and products to increase revenue. We intend to develop these tools and products to better serve existing customers, and to offer them separately as stand-alone tools and products for new customers.

	To recruit and retain highly skilled employees. We will seek to recruit and retain engineers, scientists, and technical experts with the experience, skills and innovation necessary to design and implement solutions to the complex problems our customers face. We will also seek to attract and retain other motivated professionals who have the qualities necessary to assist us in implementing our future business strategy and meeting our future business goals. As an employee-owned company, we believe we will be able to provide enhanced financial incentives to our employees, and that those incentives will be important recruitment and retention tools.

	To pursue strategic acquisitions and investments. We intend to broaden our customer base and our capabilities in our core research fields by pursuing strategic acquisitions from companies with talent and technologies complementary to our current fields and to our future business goals in order to add new clients and expand our core competencies. During fiscal year 2005, Alion completed the following four acquisitions and one strategic investment:


	and therefore is not amortizable. The estimated value of $30.6 million attributed to intangible assets has an estimated useful life of three years and has been amortized accordingly using the straight-line method in the pro forma statements of operations. Additionally, an estimated value of approximately $1.5 million was assigned to a single lot of non-capitalized assets (e.g., office furnishings, laptop computers, etc.). This asset has an estimated useful life of three years and has been amortized accordingly using the straight-line method in the pro forma statement of operations.

(5)	Represents interest expense on approximately $96.1 million of debt, utilizing a weighted average interest factor of approximately 8.1% per year, issued to finance the Transaction. The senior term note is a variable rate note that is indexed to the prime rate. The prime rate used for the weighted average interest rate calculation was 4.25%.

(6)	Represents amortization of debt issuance costs under the effective interest method over the life of the senior term note of five years.

(7)	Represents accretion of long-term debt to face value over the term of the debt using the effective interest method. Discount to debt reflects estimated fair value of detachable warrants of $10.3 million.

(8)	Our historical capital structure is not indicative of our current structure, and accordingly, historical earnings per share information has not been presented. For the fiscal year ended September 30, 2003, unaudited pro forma basic and diluted loss per share of common stock has been calculated in accordance with the rules for initial public offerings. These rules require that the weighted average share calculation give retroactive effect to any changes in our capital structure. Accordingly, pro forma weighted average shares assume the approximately 2.575 million shares issued by Alion after completion of the initial one-time ESOP investment on December 20, 2002, were outstanding for the entire period presented.

Alion Science & Technology Corp · 10-K · For 9/30/05

Filed On 1/31/06 5:31pm ET · SEC File 333-89756 · Accession Number 950133-6-416

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