10-K 1 alion201410-k.htm 10-K Alion 2014 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K

 
(Mark One)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 333-89756
 
 
Alion Science and Technology Corporation
(Exact name of registrant as specified in its charter)

 
 
 
 
 
Delaware
 
54-2061691
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
1750 Tysons Boulevard, Suite 1300, McLean, VA 22101
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code (703) 918-4480
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
Title of each class
 
Name of each exchange on which registered
None
 
N/A
Securities registered pursuant to Section 12(g) of the Act:
None
(Title of class)
 
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ¨  Yes    ý  No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ý  Yes    ¨  No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ¨  Yes    ý  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ý  Yes    ¨  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.  ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 
 
 
 
 
 
 
Large accelerated filer
 
¨
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
x  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     ¨  Yes    ý  No
The 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 was: Not Applicable
The number of shares outstanding of Alion Science and Technology Corporation common stock as of December 29, 2014 was 13,103,912.
DOCUMENTS INCORPORATED BY REFERENCE: None


ALION SCIENCE AND TECHNOLOGY CORPORATION
FORM 10-K
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
 
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
 
 
 
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
 
 
 
 
 
Item 15.


PART I
Item 1. Business

Certain information included or incorporated by reference in this annual report on Form 10-K and in press releases, written statements or other documents filed with the United States (U.S.) Securities and Exchange Commission (SEC), and in our investor calls may not address historical fact and thus constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 and other federal securities laws and involve certain known and unknown risks and uncertainties. All statements in this annual report on Form 10-K other than statements of historical fact are statements that could be deemed forward-looking statements, including projections of financial performance, assertions of strategies and objectives, comments on future development, statements concerning future economic performance and projections of our future performance under existing contracts as well as any assumptions underlying any of the foregoing. These forward-looking 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,” “forecast,” “projections,” “could,” “estimate,” “may,” “potential,” “should,” “would” and similar expressions.

Factors that could cause actual results to differ materially from anticipated results include, but are not limited to:
 
•
Our ability to meet current and future debt obligations including covenants
•
U.S. government debt ceiling limitations, sequestration, continuing resolutions, or other similar federal government budgetary or funding issues;
•
Delays in payments from U.S. government customers;
•
U.S. government decisions to reduce funding for projects we support;
•
Failure to retain our existing government contracts, win new business and win re-competed contracts;
•
Failure of government customers to exercise contract options;
•
Limits on financial and operational flexibility given our substantial debt and debt covenants;
•
Government contract bid protest and termination risks;
•
Competitive factors such as pricing pressures and competition to hire and retain employees;
•
Results of current and future legal proceedings and government agency proceedings which may arise from operations and attendant risks of fines, liabilities, penalties, suspension and debarment;
•
Tax law changes that could affect tax liabilities or our effective tax rate;
•
ERISA law changes related to our employee stock ownership plan (ESOP);
•
Any inability to maintain adequate internal control over financial reporting or debt compliance metrics;
•
Changes in accounting standards and Generally Accepted Accounting Principles;
•
Material changes in laws or regulations affecting our businesses;
•
General volatility in the debt and securities markets; and
•
Other risks discussed elsewhere in this annual report, including all risk factors described in the section entitled “Risk Factors.”
Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s view only as of the date of filing of this annual report on Form 10-K. Any such forward-looking statements are not guarantees of future performance, and actual results, developments and business decisions may differ materially from those envisaged by such forward-looking statements. We undertake no obligation to update any of these factors or to publicly announce any change to our forward-looking statements in this annual report on Form 10-K, whether as a result of new information, future events, changes in expectations or otherwise, except as required by law.


1

Overview

Alion Science and Technology Corporation and its subsidiaries (collectively, Alion, the Company, we, or our) is an employee-owned company on basis of its outstanding common stock. We provide advanced engineering, information technology, naval architecture and operational solutions to strengthen national security and drive business results. For customers in defense, civilian government, foreign governments and commercial industries worldwide, Alion’s engineered solutions support smarter decision-making and enhanced readiness in rapidly-changing environments.

Our fiscal 2014 revenue was $805 million, a 5.2% decrease over our fiscal year 2013 revenue of $849 million. For the past three fiscal years, U.S. government contracts accounted for more than 96% of our revenue, with approximately 94% of our revenue derived from Department of Defense contracts. The U.S. Navy is our largest single customer, generating more than 50% of our revenue in each of the last three fiscal years. Cost reimbursable contracts continue to be our predominant contracting method, with approximately 85% of revenue coming from this type of contract.

We provide professional engineering and program management services, and scientific expertise, in a range of specialized core business areas described below. In fiscal 2013, we reorganized our business areas to more closely align our services with the demands of the marketplace. Our revised core business areas track internal resource realignments and consolidations we made to foster greater collaboration across our company. We expect this will improve our efficiency and enhance our ability to provide complete customer solutions. Certain annual revenues for the fiscal years ended 2014, 2013 and 2012 disclosed below differ from amounts previously disclosed due to customers re-defining individual contracts, task orders and programs. While this re-classification may shift reported revenue from one classification to another, our total revenue for the period remains unchanged. Annual revenue by core business area for the past three fiscal years was:
 
 
Revenue by Fiscal Year
Core Business Area
2014
 
2013
 
2012
 
(In millions)
Naval Architecture and Marine Engineering
$
321.9

 
40.0
%
 
$
343.8

 
40.5
%
 
$
354.6

 
43.4
%
Systems Analysis, Design and Engineering
284.2

 
35.3
%
 
285.9

 
33.7
%
 
214.0

 
26.2
%
Modeling, Simulation, Training and Analysis
198.7

 
24.7
%
 
219.3

 
25.8
%
 
248.6

 
30.4
%
Total
$
804.8

 
100.0
%
 
849.0

 
100.0
%
 
$
817.2

 
100.0
%

Naval Architecture and Marine Engineering. We provide technical expertise for ship and systems design as well as acquisition and production supervision, testing, delivery and engineering support to commercial and naval markets, both domestically and internationally.

•
We provide systems engineering/design integration, including mission needs analysis and analysis of alternatives, threat and damage recovery analysis and concept through detail design. Our specialty skills include combat systems engineering, simulation-based design, and systems engineering.
•
We provide operational sustainment and life cycle support, encompassing in-service support as well as lifecycle logistics, including technical data development, contractor advisory services, and interim supply support. We also conduct availability planning, execution and control and provide schedule management and on-site logistics representatives at home ports.
•
We provide acquisition and production management for ships, systems and marine equipment. We also provide waterfront and field engineering support as well as post-shakedown availability planning and execution, damage control audits and shipboard completion inspections.

Systems Analysis, Design and Engineering. We provide services and technologies designed to reduce costs and enhance the performance and safety of complex systems and improve information flow across networks and organizations.

•
We support enterprise networking, databases, and healthcare-related information technologies. We provide requirements engineering, integration of commercial and government off the shelf products and architecture design and development. We also provide full software development lifecycle and help desk support as well as cyber security and information assurance services.

2

•
We support testing and evaluation, including reliability, availability, maintainability, supportability and usability testing. This includes developing detailed plans and requirements and performing data collection and analysis.
•
Our research and development services encompass advanced hardware, software, materials and chemicals. We provide prototyping, initial production and limited fielding of systems. We also provide engineering and analysis services to optimize man-machine interfaces and manpower requirements. Alion develops, designs, prototypes and implements crew stations, floor plans, and virtual interfaces as well as workflow and ergonomic enhancements.
•
We support the planning, procurement, maintenance, distribution and replacement of people or equipment. This includes support to logistical reset, depot level support, tracking systems, Radio-frequency identification, barcoding and other technologies as well as predictive analysis.
•
We provide nuclear safety support to both domestic and international utilities in response to regulatory requirements for appropriate resolution of safety issues.
•
We provide support for environmental protection through risk assessments, organic and inorganic analysis, air quality monitoring and laboratory management.

Modeling, Simulation, Training and Analysis. We use our modeling and simulation expertise to examine event outcomes, identify operational risks, enhance training and predict and improve system operations.

•
We develop and integrate Live/Virtual/Constructive/Gaming technologies to support individual and group training. We produce interactive, immersive training tools and virtual environments using open-source and commercial video game engines. In addition, we develop geospatial databases and products for training and analysis.
•
We provide modeling capabilities for decision support, acquisition, strategy development, transportation systems, program management and production and provide human, social, cultural and behavioral modeling and analysis.
•
We produce training environments and manage the necessary infrastructure. This includes developing architectures and equipment and integrating training systems with command, control and communications systems. We also engage in instructional design and curriculum development, and develop and implement learning management systems.
•
We develop and deliver vulnerability and risk modeling tools and services for the security and protection of structures and vessels.
•
We perform modeling, analysis and management of wireless spectrum and satellite communications and technologies, and provide expertise to support wireless policy development.

We provide support to and analysis of strategic, tactical and weapons systems usage of the wireless spectrum, satellite communications and related technologies.

Corporate History

Alion was organized in October 2001 as a for-profit Delaware corporation to acquire substantially all the assets and liabilities of IIT Research Institute, a not-for-profit Illinois corporation (IITRI). In December 2002, some eligible IITRI employees directed funds from qualifying retirement account balances into an employee stock ownership plan which is now known as The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan (ESOP). In December 2002, State Street Bank and Trust Company (the then and current ESOP Trustee) used those proceeds to purchase Alion common stock on behalf of The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Trust (the ESOP Trust). In December 2002, Alion used those stock sale proceeds plus certain other indebtedness to purchase substantially all of IITRI’s assets. At all times since December 2002, the ESOP Trust has owned substantially all of Alion’s issued and outstanding common stock. Since December 2002, Alion has grown both organically and through acquisitions. From 2004 through 2007 Alion completed a number of levered and unlevered acquisitions. When Alion issued its secured notes in March 2010, the Company also issued common stock warrants constituting a second class of stock under the Internal Revenue Code. As a result, Alion no longer qualified to be treated as an S-corporation for U.S. federal income tax purposes and became a C-corporation.

Completion of Refinancing Transactions

On August 18, 2014, Alion completed a comprehensive refinancing of its outstanding indebtedness. The refinancing was made pursuant to an Amended and Restated Refinancing Support Agreement dated as of May 2, 2014, as amended, between the Company, ASOF II Investments, LLC (ASOF) and Phoenix Investment Adviser, LLC (Phoenix, and collectively, the Supporting Noteholders). The refinancing included the following transactions (the Refinancing Transactions):

•
We exchanged $210,986,000 in aggregate principal amount of our 10.25% Senior Notes due 2015 (the Unsecured Notes), representing 89.78% of the aggregate principal amount of the Unsecured Notes then-outstanding, for, in the aggregate, (i) $208,135,000 in aggregate principal amount of new Third-Lien Senior Secured Notes due 2020 (the

3

Third Lien Notes), (ii) 208,135 warrants to purchase common stock at an exercise price of $0.01 (the “Penny Warrants”) and (iii) $1,710,600 in cash (the Exchange Offer).
•
The proposed amendments contained in the Second Supplemental Indenture relating to the Unsecured Notes, which was executed on May 29, 2014, became operative. The amendments eliminated substantially all of the negative covenants, certain events of default and the covenant restricting mergers and consolidations, modified certain provisions relating to defeasance, and made other technical and conforming changes to the indenture governing the Unsecured Notes.
•
We sold 10 units at a price of $600 per unit, for aggregate proceeds of $6,000 (the Unit Offering). The units in the aggregate consisted of $10,000 principal amount of Third Lien Notes and 10 Penny Warrants.
•
We entered into two new first lien term loan facilities consisting of a Term A Loan in the principal amount of $110.0 million, having a term of four years, and a Term B Loan in the principal amount of $175.0 million having a term of five years (the First Lien Term Loans).
•
We entered into a new $70.0 million second lien term facility having a term of five and one-half years (the Second Lien Term Loan).
•
With the proceeds of the First Lien Term Loans and the Second Lien Term Loan, on September 17, 2014, we redeemed our outstanding 12% Senior Secured Notes due 2014 (the Secured Notes) at a redemption price of 100% of principal amount, plus accrued and unpaid interest to, but not including, the date of redemption, for an aggregate payment of $351,667,904.
•
We replaced our $45.0 million revolving credit facility with a new $65.0 million revolving credit facility (the Revolving Credit Facility).
•
ASOF purchased from Alion in a private placement units consisting of $2,841,000 principal amount of Third Lien Notes and 2,841 Penny Warrants for an aggregate purchase price of $1,704,600 (the ASOF Cash Funding).


The indentures governing the Third Lien Notes and the Unsecured Notes and the agreements governing the First Lien Term Loans, the Second Lien Term Loan and the Revolving Credit Facility are referred to collectively as the “Debt Instruments.”

In addition, as consideration for their funding the Second Lien Term Loan, we issued in a private placement (i) all 70 shares of our new Series A Preferred Stock and (ii) Penny Warrants to purchase 12.5% of our then-outstanding common stock to ASOF and affiliates of Phoenix. The holders of the Series A Preferred Stock have consent rights over certain actions to be taken by Alion and its subsidiaries. With respect to any and all matters on which there is a stockholder vote, the affirmative vote of the majority of the shares of Series A Preferred Stock outstanding is both necessary and sufficient to approve all such matters for all or any classes or series of stockholders of Alion. As a result of its majority ownership of the Series A Preferred Stock, ASOF has the right to appoint a majority of the members of our board of directors, possesses voting control over all matters that require stockholder approval and controls decisions regarding consenting to certain specified actions.

Suspension of Duty to File SEC Reports

On October 30, 2014, Alion filed Forms 15 with the SEC notifying the SEC of the suspension of its duty to file reports under Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Alion’s duty to file periodic, current and other reports with the SEC under the Exchange Act was suspended effective upon filing of the Forms 15 with the SEC. Alion expects that this Annual Report on Form 10-K, including any necessary amendments thereto, will be the final report it files with the SEC.

Although Alion will no longer be filing current and periodic reports with the SEC, pursuant to the indenture governing the Third Lien Notes, Alion is required to post certain information on its website, including annual and quarterly financial statements, a Management’s Discussion and Analysis of Financial Condition and Results of Operations, and current information. Holders of the Debt Instruments will be able to review this information.

The reports, statements and other information the Company has previously submitted to the SEC, including this Annual Report on Form 10-K, may be read and copied at the Public Reference Room of the SEC at 100 F Street NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at (800) SEC-0330. The Company’s SEC filings are also available without charge at the SEC’s web site at http://www.sec.gov.

The Alion ESOP
    

4

The Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan (the Plan), is a KSOP — a qualified retirement plan that includes an ESOP invested in Alion common stock and a non-ESOP component invested in mutual funds. The ESOP Trust owns substantially all issued and outstanding shares of our common stock.

Formerly, eligible employees could use qualified retirement funds to purchase beneficial interests in Alion common. The ESOP Trust used the money employees invested in the ESOP to purchase Alion common stock and allocate ESOP interests to employee accounts according to the Plan’s terms. We make retirement plan contributions to the ESOP component for all eligible employee participants. We also make matching contributions to the ESOP for eligible employees based on their pre-tax salary deferrals.

Except in certain limited circumstances, the ESOP Trustee must vote its shares as directed by the ESOP committee. The ESOP committee consists of four members of Alion’s management team and three other Alion employees; it is responsible for financial management and administration of the ESOP.

By law, Alion is required to value the common stock held in the ESOP component at least once a year. Alion formerly had the ESOP Trustee value the common stock in the ESOP twice a year — as of March 31 and September 30. Beginning in fiscal 2015, the ESOP Trustee will only value the common stock annually as of September 30th. The terms of the KSOP permit the ESOP Trust to use employee-directed funds to purchase shares of Alion common stock at the lesser of the then-current or the immediate prior value of a share of Alion common stock. The ESOP plan administrator has suspended the option for employees to invest in Alion common stock. Currently, all ESOP transactions occur at the redemption value of a share of Alion common stock.
Business Strategy

We plan to grow further by retaining our existing customers, increasing our work for them and seeking out new customers to use our services. We expect to do this through targeted business development efforts and by capitalizing on our skilled work force and our solutions competencies. We have several key strategies.
    
Broaden existing core competencies. We plan to expand our expertise to keep pace with technological developments. We hire skilled employees, engage in business development initiatives and invest in projects to expand our employees’ skill sets. We work to extend our core capabilities to new markets and new customers and focus on enhancing our ability to serve existing customers. We increase our employees’ technological and program management skills through training, internally funded projects and mentoring. We offer our employees non-degree programs in information technology, business, and desktop applications through our “Alion University.” Our Alion University offers programs in engineering, program management, and finance and administration to maintain and enhance our employees’ skills and advance Alion’s reputation in the commercial technology solutions markets.

Expand market share by leveraging experience and reputation. We perform a variety of services for a broad base of more than 206 customers as of September 30, 2014, including Cabinet-level government departments and agencies, and state and foreign governments. We plan to use our advanced technological capabilities and our customer relationships to expand our market presence by offering a broader range of services to our existing customers and by delivering our solutions to new customers. We intend to use our customer relationships and our technology expertise to strategically expand our Department of Homeland Security (DHS) customer base. For over five years, Washington Technology, Defense News and Military Training Technology have continued to rank us among the top professional services government contractors. Additionally for the past four years, Military Times EDGE has voted us a “Best for Vets Employer.” Washington Business Journal continues to rank Alion in its top twenty technology government contractors and government contract awardees.
    
Improve financial performance and increase sales. Federal budget uncertainties and expected lower Department of Defense spending levels have challenged our ability to grow our revenue. Over the past five years our sales have fluctuated from a low of $787 million to a high of $849 million in fiscal 2013. We remain focused on growing our business and striving to achieve operating efficiencies. We intend to strengthen our financial performance by controlling operating costs and growing organically. We believe we can achieve an even more competitive cost structure than we currently have which will enhance our ability to win business and improve operating results. We believe Alion’s size and expertise position us to continue to bid on larger government programs and broaden our customer base.

Market and Industry Background


5

Fiscal pressures on the federal government have prompted increased scrutiny of the Department of Defense’s (DoD’s) budget. Although funding decisions are usually made on an annual basis, near-term decisions about issues such as pay raises, health benefits for military retirees, and the acquisition of weapon systems can have effects on the composition and costs of the nation’s armed forces that last many years.

For fiscal year 2015, DoD requested appropriations totaling $555 billion. Of that amount, $496 billion is for the base budget and $59 billion is for what are termed overseas contingency operations (OCO). The base budget covers programs that constitute the department’s normal activities, such as the development and procurement of weapon systems and the day-to-day operations of the military and civilian workforce. Funding for OCO pays for U.S. involvement in the war in Afghanistan and other nonroutine military activities elsewhere.

The Five Year Defense Plan (FYDP) 2015-2019 describes DoD’s plans for its normal activities and therefore generally corresponds to the base budget. In an effort to reduce costs, the current FYDP includes sizable cuts in the number of military personnel, particularly in the Army.

The Evolution of Modern Warfare: Rising Concern and Pacific Rim Focus (threats from China, Iran and North Korea)
 
Admittedly, the rising concern associated with the Pacific Rim (and Africa) encompassed by Anti-Access/Area Denial (A2/AD) is not the only challenge U.S. forces face in the 21st Century, as the character of modern conflict is extraordinarily complex. While not a new concept, many current wars have recently been defined as “hybrid” in character, with adversaries effectively employing elements of regular and irregular warfare.

It is hybrid warfare, not state actors employing A2AD, which has become the focus of U.S. military efforts since the terrorist attacks of September 11, 2001. This has required creative approaches to address the challenges of fighting insurgents in foreign lands. Additionally, combating irregular warfare has been a top DoD priority since 2008. As such, it has driven the majority of contemporary thought on the conduct of operational warfare.

Many experts agree that hybrid warfare does not replace conventional warfare, or eliminate the need to prepare for it. The DoD advocates the need for balance between conventional and irregular capabilities and highlights the need for superior conventional forces. To successfully operate in the A2/AD environment, the U.S. military must prepare adequately for this evolution of modern warfare by understanding the operational implications presented by modern technology. Planners must use innovative joint planning concepts such as AirSea Battle and effective integration of joint forces to help achieve the desired end state. A2/AD not only increases the dangers of conventional war, but also offers non-state actors worldwide options to increase the effectiveness of irregular or hybrid warfare. The U.S. military continues to prepare for and execute combat operations against modern A2/AD systems that are employed in many places around the world. Similarly, we continue to align our services and solutions to support A2/AD solutions development, training, and operations.

Defense Initiatives

In early fiscal 2015, Secretary Hagel unveiled an ambitious new plan for maintaining the US military technological edge in a time of tightening budgets. Specifically, Secretary Hagel said the new “defense innovation initiative” aims to invest money in “cutting-edge technologies and systems - especially in the fields of robotics, autonomous systems, miniaturization, big data, and advanced manufacturing, including 3-D printing.” He further added that “...by focusing our investments (we) will sharpen our military edge even as we contend with fewer resources.” Hagel calls this initiative the “third offset strategy” and compared it in scale to two past “offset” initiatives, including the nuclear buildup of the 1950s that ultimately helped end the Cold War, as well as the 1970s-era effort that led to the development of precision-guided missiles, stealth aircraft and advanced intelligence, surveillance and reconnaissance platforms.

Additionally, Secretary Hagel and Deputy Secretary of Defense Bob Work will guide the development of this initiative by forming a new Advanced Capability and Deterrence Panel. Work and other Pentagon officials have signaled that the Defense Department is looking for new ways to partner with the defense industry and other institutions to share research and development costs. The new program is not limited to technology research and development. It also calls for a “reinvigorated wargaming (Modeling, Simulation and Experimentation) effort” to “develop and test alternative ways of achieving our strategic objectives and help us think more clearly about the future security environment,” as stated in a recent SECDEF memo. These defense initiatives align with our core competencies including our modeling, simulation, and rapid prototyping capabilities.

6


Offsetting Sequestration

Given the challenges, the defense industrial market is working on how to (i) grow profitably from diminishing DoD budgets and (ii) slash costs for maintaining a satisfactory financial condition.

To that end, the defense contractors (primes and system integrators) are diversifying their businesses into other areas besides defense production to include expansion of professional engineering services. Meanwhile a continued focus on research and development is also helping these companies to develop next generation technologies essential in a climate of fewer programs and reduced budgets.

Defense companies will increasingly be required to come up with next generation intelligence, surveillance and reconnaissance (ISR) technologies. The contractors specializing in space systems will continue to gain from the Pentagon’s increasing focus on its space division to counter emerging security threats as embodied in A2/AD such as a “a day-without-space”.

Achieving new Technological Superior Military Capability: Industry-Government Collaboration

Today the U.S. Armed Forces and their allies possess a military capability advantage over any potential adversary, but that advantage is eroding as potential adversaries invest (with a keen eye on A2/AD) in advanced technology and increase their military force structure. The DoD will need to develop an approach to force planning and desired capabilities, while living within the budgetary caps established by the Budget Control Act of 2011. Enabling technologies that support the development and deployment of operational capabilities that align with the dynamic threat environment must be identified. These operational capabilities must take into account the rise of near-peer competitors and the persistent challenges presented by terrorists and violent extremists.

We are starting to see other nations pursue technological advances to counter U.S. advantages in electronic warfare, longer range air-to-air missiles, radars operating in non-conventional bandwidths, counter-space capabilities, longer range and more accurate ballistic and cruise missiles, improved undersea warfare capabilities, as well as cyber and information operations. This activity has caused DoD researchers and engineering planners to identify challenges known as “hard problems” that must be solved if U.S. Armed Forces are to retain the same overmatch capability that they have sustained in recent years.

The DoD Science and Technology program seeks to provide an appropriate balance between technical capabilities to win the current fight and technical capabilities to prepare for the uncertain future, preventing technological surprise, while ensuring freedom of movement and access for U.S. military forces. Technological superiority has been central to the strategy of the DoD for the past century. The preservation and advancement of technology superiority requires heightened levels of cooperation, coordination, and collaboration between all members of the DoD science & technology community, industry and academia.

Given the restrictions of the Budget Control Act of 2011, the DoD Research Development Test and Evaluation funds available are decreasing, while the complexity and depth of the national security challenges are growing. Finding solutions to these challenges that would prevent the U.S. Armed Forces from fulfilling our national security missions is essential. There is a host of enabling A2/AD technologies and capabilities being developed world-wide that could restrict the U.S. military’s ability to project its armed forces. Specific focus areas include technologies that will be enablers for Electronic warfare (Electronic Attack, Electronic Protection, and Electronic Support); cyber; conventional and non-conventional air and surface detection and tracking systems; flexible and in-depth air and missile defense; alternatives for space based capabilities; and penetrating weapons. Developing enabling technologies and the resulting capabilities will require government and industry collaboration. As such industry possesses an opportunity to present solutions they may already have under development with discretionary funds or Independent Research and Development (IRAD). Meanwhile, DoD will continue to maintain a robust level of funding for its science and technology program, and industry will augment that program through greater organic investment in research and development through its IRAD program. A coordinated effort between both government and industry will ensure the development and accelerated delivery of the right technologies and capabilities for the technological superiority of our Armed Forces.

We are primarily a government contractor.
    

7

For the past three fiscal years, U.S. government contracts accounted for more than 96% of our revenue, with approximately 94% of our revenue derived from Department of Defense contracts. The U.S. Navy is our largest single customer, generating more than 50% of our revenue each of the last three fiscal years.

Our federal government contracts are normally multi-year contracts funded on an annual basis based on Congressional budget authorizations and appropriations. Each year Congress appropriates funds for authorized programs for the coming government fiscal year. Budget delays and uncertainties have continued to push the approval process later into the fiscal year. The annual Congressional appropriations process means a contract is usually only partially funded at the outset of a major program. Normally a procuring agency commits additional money to a contract only as Congress makes appropriations in future fiscal years. The government can modify or discontinue any contract at its discretion or due to contractor default. The government can terminate or modify a contract for any of a variety of reasons, including funding constraints, changing government priorities or changes in program requirements. If the government terminates one of our contracts at its discretion, it typically pays us for all the services we performed and costs we incurred prior to termination, our termination-related costs, and a negotiated contract fee.

As of September 30, 2014, the value of our executed contracts available for funding totaled $2.4 billion. This amount increased from our September 2013 total of $2.2 billion. The increase is due, in part, to the increase in new awards and funding in our Systems Analysis, Design and Engineering core business. Management’s estimated future or expected revenue from our executed contracts, which is discussed in the Backlog section of this report, differs from the value of our executed contracts. Additionally, as stated in the Backlog section of this report, there can be no assurance that our existing contracts will result in actual revenue in any particular period, or at all, or that any contract included in backlog will be profitable.

Contract Types. We have a diverse contract base including many task order and multiple-award contract vehicles (IDIQ—indefinite delivery, indefinite quantity type contracts). Many customers utilize our IDIQ contracts to hire us. Three of our five largest contracts are IDIQ delivery order contracts; they accounted for 53% of fiscal 2014 revenue. Our largest individual contract accounted for 8.5% of our fiscal 2014 revenue. We had a portfolio of 442 stand-alone contracts and delivery/task orders as of September 30, 2014.

We have three contract pricing structure types: cost-reimbursement, fixed-price and time-and-material. Cost-reimbursement contracts allow us to recover expenses for direct labor and materials, a share of indirect expenses, and a fixed or variable fee depending on contract terms. Government contract rules permit us to recover certain, though not all, of our operating expenses (indirect costs). Fixed-price contract customers pay a stated amount intended to cover all direct and indirect costs, and profit. We assume the risk of any cost overruns and receive the benefit of any cost savings on fixed price contracts. Time-and-material contracts have fixed hourly billing rates designed to cover our labor costs, indirect expenses and profit, with cost reimbursable provisions for materials and other direct costs. We have traditional closed-end contracts and multiple award contracts which require sustained post-award effort to realize revenue. The following table summarizes our revenue by contract type for the years ended September 30, 2014, 2013, and 2012.
 
 
Revenue by Fiscal Year
Contract Type
2014
 
2013
 
2012
 
(In millions)
Cost-reimbursement
$
684.0

 
84.9
%
 
$
723.1

 
85.2
%
 
$
675.3

 
82.6
%
Fixed-price
59.2

 
7.4
%
 
74.6

 
8.8
%
 
64.2

 
7.9
%
Time and material
61.6

 
7.7
%
 
51.3

 
6.0
%
 
77.7

 
9.5
%
Total
$
804.8

 
100.0
%
 
$
849.0

 
NaN

 
$
817.2

 
NaN


We sometimes begin providing services before a U.S. government agency has actually signed or funded a contract or task order. We are at risk for costs we incur before a new contract is executed or an existing contract is modified. The practice is customary in our industry, particularly where a company has oral notification of a contract award, but has not received required contract documents. We designed our internal procedures to provide services “at risk” only when we believe funding is highly probable and delays are administrative or technical in nature. In most cases, we get paid for all our costs when a contract is ultimately executed or modified. However, we cannot be certain, when we work at risk, that we will receive an executed contract or that we will be paid for all our costs. As of September 30, 2014, we had approximately $14.7 million in contract revenue at risk; nearly 39% of that amount represents award fees we believe we have earned where we had yet to receive authorization to bill our customers.


8

We compete for key contracts from various U.S. government agencies. Our business development and technical personnel target contract opportunities and analyze each customer’s priorities and overall market dynamics. Depending upon whether a targeted contract is a renewal or a new opportunity, it can take as little as three months and up to three years to develop and execute our strategy before a customer ultimately issues a contract. When we decide to pursue a potential contract, we mobilize a core group of employees with the requisite expertise to lead our bidding and proposal preparation efforts. We supplement our internal capabilities with a network of consultants and other industry experts as necessary. To enhance our prospects of winning a contract, we team with other contractors, frequently our competitors, who have complementary technical strengths.

When we win a contract or task order, we assign a project manager and a task leader to ensure we timely deliver high-quality services. Program managers regularly interface with customers to evaluate our performance and customer satisfaction levels. Managers use our financial management and information systems to compare costs to funding ceilings and measure performance and profitability.

Government Oversight. Federal government auditors and technical specialists regularly review our administrative procedures and our cost accounting policies and practices. Costs on flexibly-priced federal government contracts are subject to Defense Contract Audit Agency (DCAA) and other audits and adjustments. An audit may reveal that some costs charged to a government contract are not allowable, either in whole or in part. In these circumstances, we must repay the federal government any money it paid us for unallowable costs, plus possible interest and possible penalties. The government considers Alion a major contractor and maintains an onsite audit office. The Company has settled indirect rates through 2007 based on completed DCAA audits. All subsequent years are open. We are disputing the government’s claim for penalties and interest for 2005, which in the aggregate are not material. We believe the statute of limitations has expired on any government contractual claims, including any claims for penalties and interest, on our 2005 indirect rate proposal. 

We timely submitted our indirect cost proposals for all open fiscal years and expect to submit fiscal 2014 incurred cost proposal next March as required. We have recorded revenue on federal government contracts in amounts we expect to realize.

Backlog

As of September 30, 2014, management estimates the amount of future revenues to be recognized under our existing contracts to be approximately $1.8 billion, of which, approximately $634 million is funded. Of the $1.8 billion of backlog, the amount not reasonably expected to be filled in fiscal 2015 is approximately $0.9 billion.

All of our existing contracts may have funded backlog and unfunded backlog, each of which is described below. The contract values and management’s estimated revenues do not include any task orders or ceiling value under IDIQ contracts, including Governmentwide Acquisition Contracts (GWACs) and General Services Administration (GSA) schedules, except to the extent that task orders have been awarded to us under those contracts.
 
•
Funded Backlog. Funded backlog represents the estimated revenue value of orders for services under existing contracts for which funding is appropriated or otherwise authorized less revenue previously recognized on these contracts. We expect to recognize a substantial portion of our funded backlog as revenue within the next twelve months.
 
As of September 30,
 
2014
 
2013
 
(In millions)
Funded
$
634.3

 
$
436.9

 
•
Unfunded Backlog. Unfunded backlog represents the estimated revenue value of orders for services under existing contracts for which funding has not been appropriated or otherwise authorized.
 
As of September 30,
 
2014
 
2013
 
(In millions)
Unfunded
$
1,123.3

 
$
1,286.6


In fiscal 2013, management refined the methodology used to determine funded backlog and unfunded backlog, including only estimates of future revenues to be recognized under awarded contracts.

9


There can be no assurance that our existing contracts will result in actual revenue in any particular period, or at all, or that any contract included in backlog will be profitable. There is a higher degree of risk in this regard with respect to unfunded backlog. The actual receipt and timing of any revenue is subject to various contingencies, many of which are beyond our control. The actual recognition of revenue on contracts included in our backlog may never occur or may change because a program schedule could change; the program could be canceled; a contract could be reduced, modified, or terminated early, whether for the convenience of the government or otherwise; or an option that we had assumed would be exercised could not be exercised. The primary risks that could affect our ability to recognize such revenue on a timely basis or at all include: schedule changes, contract modifications, and our ability to assimilate and deploy new staff against funded backlog; cost cutting initiatives and other efforts to reduce U.S. government spending, which could reduce or delay funding for orders for services; and delayed funding of our contracts due to delays in the completion of the U.S. government’s budgeting process and the use of continuing resolutions by the U.S. government to fund its operations, as described under Item 1A Risk Factors of this report. The estimates used to compile remaining contract backlog are based on our experience under our contracts, and we believe the estimates are reasonable.

Corporate Culture, Employees and Recruiting

We strive to create a culture that promotes performance excellence; respects colleagues’ ideas and judgments; and recognizes the value of our professional staff’s unique skills and capabilities. We seek to attract highly qualified and ambitious employees. 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 we have a track record of successfully attracting and retaining 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 offer.

At September 30, 2014, we had 2,818 employees of whom 2,598 were full-time employees. Approximately 28% of our employees have Ph.D.’s or masters degrees, and approximately 73% of our employees have college degrees. Approximately 29% of our employees have Top Secret or higher level security clearances. We believe we have a good relationship with our employees. None of our employees are covered by a collective bargaining agreement.

We view our employees as our most valuable asset. Our success depends in large part on attracting and retaining talented, innovative, experienced professionals at all levels. As an employee owned company, employee ownership is an important aspect of our corporate culture and enhances our ability to attract and retain our employees. Employee ownership provides a platform for our employees to take exceptional pride in their work and supporting our customers that is unique to Alion. 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 technical skills in our core business areas is at times extremely competitive. This makes employee recruiting and retention in these and other specialized areas extremely important. We believe our benefits package, work environment, incentive compensation, and employee-ownership culture will continue to be important in recruiting and retaining highly skilled employees.

Our Customers

We provide scientific, research and development, technical expertise, and operational support to a diverse group of U.S. government customers. We also serve commercial, state, local and international government customers. As of September 30, 2014, we had more than 206 distinct customers, including Cabinet-level government departments and agencies, and state and foreign governments. We have approximately 310 DoD contracts and delivery orders with the U.S. Navy, U.S. Army and U.S. Air Force; the Defense Information Systems Agency (DISA); the Defense Advanced Research Projects Agency (DARPA) and others. Other federal civilian agencies and departments included the National Institute of Environmental Health Sciences, the U.S. Department of Energy and the EPA. Commercial, state and local governments and international customers accounted for the remaining 2.6% of our fiscal 2014 revenue. The table below shows revenue by customer category for our past three fiscal years.
 

10

 
Revenue by Fiscal Year
 
2014
 
2013
 
2012
 
(In millions)
U.S. Department of Defense
$
753.7

 
93.7
%
 
$
790.9

 
93.2
%
 
$
755.6

 
92.4
%
Other Federal Civilian Agencies
29.8

 
3.7
%
 
31.4

 
3.7
%
 
43.2

 
5.3
%
Commercial and International
21.3

 
2.6
%
 
26.7

 
3.1
%
 
18.4

 
2.3
%
Total
$
804.8

 
100.0
%
 
$
849.0

 
100.0
%
 
$
817.2

 
100.0
%

The following five federal government contracts (IDIQ contract vehicles and stand-alone contracts) accounted for more than half of our revenue in fiscal years 2014, 2013 and 2012.

1.
Weapons System Technology Information Analysis Center for the Defense Technical and Information Center (26%, 28%, 17%) (IDIQ contract vehicle);

2.
Seaport-E Multiple Award Contract for the Naval Sea Systems Command (21%, 21%, 20%) (IDIQ contract vehicle);

3.
Technical and Analytical Support for the U.S. Air Force (9%, 8%, 10%) (stand-alone contract);

4.
Naval Sea Systems Command Surface Ships Life Cycle Program Management and Engineering Support (7%, 7%, 6%) (stand-alone contract); and

5.
Software, Networks, Information, Modeling and Simulation - Defense Technical and Information Center (6%, 2%, 0.2%) (IDIQ contract vehicle).

The Weapons System Technology Information Analysis Center for the Defense Technical and Information Center, Seaport-E Multiple Award Contract for the Naval Sea Systems Command and the Software, Networks, Information, Modeling and Simulation for the Defense Technical and Information Center are all IDIQ contract vehicles. Revenues from these IDIQ contract vehicles are comprised of numerous individual task orders. Each task order is separately funded, includes a unique statement of work, period of performance and in some cases, distinct contractual terms and conditions. Termination of these contracts or our inability to renew or replace them when they expire could cause our revenue to decrease and could have a material adverse effect on our business, financial condition, operating results or ability to meet our financial obligations.

Competition

The U.S. government engineering and technology services industries consist of a large number of enterprises ranging from small, niche-oriented companies to multi-billion dollar corporations that serve many U.S. government customers. Competitors frequently form teams to pursue contract opportunities because large contracting initiatives are highly competitive and government customers have diverse requirements. Prime contractors leading large proposal efforts typically select team members based on particular capabilities and experience relevant to each opportunity. Companies that compete on one opportunity may be team members on another opportunity.

We frequently compete against well-known firms in the industry as a prime contractor. Our competitors include Booz Allen Hamilton, BAE, CACI International Inc., SAIC, Leidos Holdings, Inc., Engility Corporation, CSC, ITT, TASC, QinetiQ, ManTech International, URS Corporation, CGI Group Inc. and the services divisions of Lockheed Martin Corporation, General Dynamics Corporation and Northrop Grumman Corporation.

We also compete at the task order level, where knowledge of the customer, its procurement requirements and its environment is often the key to winning business. We have been successful in ensuring our presence on numerous contracts and GSA Schedules, and in competing for tasks under those contracts. The variety of contract vehicles at our disposal, as a prime contractor or subcontractor, allows us to market our services to any U.S. government agency. We have experience providing services to a diverse array of U.S. government departments and agencies. We have first-hand knowledge of our customers and their goals, problems and challenges. Most government contracts we seek are competitive awards. We believe our customers typically consider the following key factors in awarding contracts: technical capabilities and approach; personnel quality and management capabilities; previous successful contract performance; and price.

In our experience, price and technical capabilities are a customer’s two most important considerations in contracts for complex technological programs. We believe our customer knowledge, our government contracting and technical capabilities, and our pricing policies enable us to compete effectively.

11


Business Development and Promotional Activities

We promote our contract research services by meeting face-to-face with current and potential customers, obtaining new work from satisfied customers, and responding to requests for proposals (RFPs) and international tenders. We use our knowledge of and experience with U.S. government procurement procedures, and our relationships with government personnel, to try to maximize our ability to respond timely to RFPs and customer requests. We bid on contracts in our core business areas and related areas where we believe we have a good chance of being awarded the contract. When we bid on a potential contract, we draw on our core business area expertise to display the technical skills we can bring to a particular contract.

Our business developers work face-to-face with customers, are experienced in marketing to government customers, know the services and products they represent, and understand each particular customer’s organization, mission and culture. These professionals possess a working knowledge of rules governing the marketing limitations that are unique to the government arena. They understand government funding systems, conflict of interest restrictions, procurement integrity directives, and the procedural requirements designed to establish a level competitive playing field to ensure appropriate use of public funds.

Our technical staff is an integral part of our promotional efforts. The customer relationships they develop through their work often lead to additional business and new research opportunities. We hold weekly company-wide business development meetings to review proposal opportunities and determine strategy in pursuing these opportunities. We also use independent consultants for promoting business, developing proposal strategies and preparing proposals as necessary.

We focus most of our substantial research and development activities on customer-funded projects and internally-developed capital assets. We believe actively fostering an environment of innovation is critical to our ability to grow our business, allowing us to proactively address issues of national concern in public health, safety and national defense.

Resources

Most of our work relies on computer and laboratory equipment and other supplies readily available from multiple vendors. Disruption in availability from any particular vendor is not likely to materially affect our ability to perform our contracts. Some of our specialized laboratory work depends on special materials and equipment whose unavailability could adversely affect experimental laboratory tasks. However, we believe these kinds of delays or disruptions are not likely to materially affect our overall operations or financial condition.

Patents and Proprietary Information

As a normal course of business, we perform research and development, and engineering activities in support of our customers. Typically these services do not depend on patent protection. In accordance with applicable law, our U.S. government contracts often provide government agencies certain license rights to our inventions and copyright works. Government agencies, and other contractors including our competitors, can obtain the right to utilize our inventions. Similarly, our U.S. government contracts often license to us patents and copyright works owned by third parties. We maintain an active program to track and protect our intellectual property. We routinely enter into intellectual property assignment agreements with our employees to protect our rights to any patents or technologies they develop while employed by us. Costs for internal research and development, patents and intellectual property activities are not material to our financial statements.

We maintain a number of trade secrets that contribute to our success and competitive distinction and endeavor to accord such trade secrets protection adequate to ensure their continuing availability to us. While retaining protection of our trade secrets and vital confidential information is important, we are not materially dependent on maintenance of a specific trade secret.

Seasonality

Although our business is not seasonal, it does fluctuate with the number of working days in each quarter. The first and fourth quarters each year generally have fewer working days for our employees to generate revenue. In the weeks before the federal government’s September fiscal year end, it is not uncommon for government agencies to award additional tasks or complete contract actions to avoid losing unexpended fiscal year funds.

Foreign Operations


12

In each of the past three fiscal years, nearly all our revenue came from contracts with U.S.-based customers. We treat sales to U.S. government customers as domestic sales regardless of where we perform our services. We have seen a modest increase in work for foreign customers which we perform in the U.S.

Company Information Available on the Internet

Our internet address is www.alionscience.com. Information on the Company’s website is not incorporated by reference into this report.

Regulatory Matters

Federal Acquisition Regulation

We are heavily regulated in most of the fields in which we operate. We provide services and products to numerous U.S. government agencies and entities, including the DoD, U.S. Navy, U.S. Army, U.S. Air Force and DHS. When working with these and other U.S. government agencies and entities, we must comply with various laws and regulations relating to the formation, administration and performance of contracts. U.S. government contracts generally are subject to the Federal Acquisition Regulation (FAR), which sets forth policies, procedures and requirements for the acquisition of goods and services by the U.S. government, agency-specific regulations that implement or supplement FAR, such as the DoD’s Defense Federal Acquisition Regulation Supplement (DFARS) and other applicable laws and regulations. These regulations impose a broad range of requirements, many of which are unique to government contracting, including various procurement, import and export, security, contract pricing and cost, contract termination and adjustment, and audit requirements. Among other things, these laws and regulations:

•
require certification and disclosure of all cost and pricing data in connection with certain contract negotiations;
•
define allowable and unallowable costs and otherwise govern our right to reimbursement under various cost-based U.S. government contracts;
•
require reviews by the DCAA, Defense Contract Management Agency (DCMA) and other U.S. government agencies of compliance with government standards for a contractor’s business systems;
•
restrict the use and dissemination of information classified for national security purposes and the export of certain products and technical data; and
•
require us not to compete for work if an organizational conflict of interest, as defined by these laws and regulations, related to such work exists and/or cannot be appropriately mitigated.

The U.S. government may revise its procurement practices or adopt new contract rules and regulations at any time. In order to help ensure compliance with these complex laws and regulations, all of our employees are required to complete ethics training and other compliance training relevant to their position.

Internationally, we are subject to special U.S. government laws and regulations, local government laws and regulations and procurement policies and practices (including laws and regulations relating to bribery of foreign government officials, import-export control, investments, exchange controls and repatriation of earnings) and varying currency, political and economic risks.

Environmental Matters

We are subject to federal, state, local and foreign laws and regulations relating to, among other things, emissions and discharges into the environment, handling and disposal of regulated substances, and contamination by regulated substances and wastes. Some of our operations may require environmental permits and/or controls to prevent or reduce air and water pollution. Issuing authorities can renew, modify, or revoke these permits.

Operating and maintenance costs associated with environmental compliance and preventing contamination at our facilities are a normal, recurring part of our operations. These costs have not been material in the past and are not material to our total operating costs or cash flows. Such costs are usually allowable under government contracts. Based on information presently available to us and on current U.S. government environmental policies relating to allowable costs, all of which are subject to change, we do not expect environmental compliance to materially affect us. We also believe our facilities’ environmental compliance costs will continue to be allowable.

Under existing U.S. environmental laws, potentially responsible parties can be held jointly and severally liable. We could be potentially liable to the government or third parties for the full cost of investigating or remediating contamination at

13

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 remediation of a site, the statutory framework might allow us to pursue rights of contribution from other potentially responsible parties.


Item 1A. Risk Factors

Risks Related to Our Business and Operations

As a highly‑leveraged company, we expect to experience net losses in at least our next four years of operation.
    
We have had a net loss every year since our inception in late 2002. We expect to incur net losses for the foreseeable future. Interest expense on existing debt and future deferred income tax expense are among the most significant factors contributing to our estimated future net losses. The size of future losses and achieving profitability depend on achieving significant revenue growth and controlling expenses. We may not become profitable if revenue grows more slowly than we anticipate, or if operating expenses exceed our expectations. Even if we become profitable, we may not be able to sustain our profitability.

As a highly leveraged company, our ability to meet our financial and other future obligations depends on our future operating results and our ability to service our debt.

Our ability to pay our debt, to comply with financial covenants, and to fund working capital and planned capital expenditures depends on our ability to generate cash flow currently and in the future. We cannot be certain our business strategy will succeed or that we will achieve our anticipated financial results. Our financial and operational performance depends upon a number of factors, many of which are beyond our control. Risk factors include:

•
when and how much of our contract backlog our customers fund;
•
how long our customers take to pay us;
•
when and whether we win new contracts and how we perform on our contracts;
•
whether we can increase our annual revenue and/or operating income;
•
how much we have to spend to repurchase our stock from current and former employees;
•
current economic conditions and conditions in the defense contracting industry;
•
U.S. government spending levels, both generally and by our particular customers;
•
failure by Congress to timely approve budgets for federal departments and agencies we support;
•
operating difficulties, operating costs or pricing pressures;
•
new legislation or regulatory developments that adversely affect us; and
•
any delays in implementing strategic projects.
    
These factors will also affect our ability to meet future ESOP re‑purchase obligations and to pay interest and principal on our outstanding debt as and when amounts come due.
    
Budget issues have been magnified by the 2011 Budget Control Act (the Budget Control Act) which requires billions in automatic cuts in government funding levels. To the extent that federal government spending is delayed or curtailed by government actions, including sequestration and future government shutdowns, our revenues and operating results may be adversely affected.

We face intense competition from many companies that have greater resources than we do. This could cause price reductions, reduced contract profitability, and loss of market share.
    
We operate in highly competitive markets and often encounter intense competition to win contracts. If we are unable to successfully compete for new business, our revenue may not grow and operating margins may decline. Many of our competitors have greater financial, technical, marketing, and public relations resources; have larger client bases; and have greater brand or name recognition than we do. Larger competitors include, but are not limited to, U.S. federal systems integrators such as Booz Allen Hamilton, CSC, CACI International Inc., Leidos, SAIC, Engility Corporation, TASC, URS Corporation, CGI Group Inc., ManTech International, and the services divisions of large defense contractors such as Lockheed Martin Corporation, General Dynamics Corporation and Northrop Grumman Corporation.
        
Our larger competitors may be able to vie 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

14

such as technical qualifications, past performance on large‑scale contracts, geographic presence, price, and availability of key professional personnel. Our competitors have established relationships among themselves or with third parties, including through mergers and acquisitions, to increase their ability to address client needs. They may establish new relationships; new competitors or competitive alliances may emerge.
    
Our ability to compete for desirable contracts will depend on: the effectiveness of our internal and customer‑funded research and development programs; our ability to offer better performance than our competitors at 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, financial condition, results of operations and our ability to meet our financial obligations may be materially compromised.

Historically, a few contracts have provided most of our revenue. If we do not retain or replace these contracts our operations and financial condition will suffer.
    
The following five federal government contracts (contract vehicles and stand‑ alone contracts) accounted for more than half of our revenue in fiscal years 2014, 2013 and 2012.

1.
Weapons System Technology Information Analysis Center for the Defense Technical and Information Center (26%, 28%, 17%) (IDIQ contract vehicle);
2.
Seaport‑E Multiple Award Contract for the Naval Sea Systems Command (21%, 21%, 20%) (IDIQ contract vehicle);
3.
Technical and Analytical Support for the U.S. Air Force (9%, 8%, 10%) (stand‑alone contract);
4.
Naval Sea Systems Command Surface Ships Life Cycle Program Management and Engineering Support (7%, 7%, 6%) (stand‑alone contract); and
5.
Software, Networks, Information, Modeling and Simulation for the Defense Technical and Information Center (6%, 2%, 0.2%) (IDIQ contract vehicle).
    
Termination of these contracts or our inability to renew or replace them when they expire could cause our revenue to decrease and could have a material adverse effect on our business, financial condition, operating results or ability to meet our financial obligations.

As a highly‑leveraged company, if we are unable to achieve or manage growth, our business could be adversely affected.
    
Attempting to achieve long‑term growth has placed significant demands on our management, and on our administrative, operational and financial resources. To achieve and manage growth, we must improve operational, financial and management information systems, and expand, motivate and manage our workforce. If we are unable to achieve and manage growth without compromising our quality of service and our profit margins, or if systems we implement to aid in managing our growth do not produce expected benefits, our business, prospects, financial condition, operating results and ability to meet our financial obligations could be materially adversely affected.

We may lose one or more members of our senior management team or fail to develop new leaders, which could cause the disruption of the management of our business.
    
We believe that the future success of our business and our ability to operate profitably depends on the continued contributions of the members of our senior management and the continued development of new members of senior management. We rely on our senior management to generate business and execute programs successfully. In addition, the relationships and reputation that many members of our senior management team have established and maintain with our clients are important to our business and our ability to identify new business opportunities. The loss of any member of our senior management or our failure to continue to develop new members could impair our ability to identify and secure new contracts, to maintain good client relations, and to otherwise manage our business. We do not maintain key man life insurance policies on any members of management.

Our business could suffer if we fail to attract, train and retain skilled employees.
    
Availability of highly trained and skilled professional, administrative and technical personnel is critical to our future growth and profitability. Even in the current economic climate, competition in our industry for scientists, engineers, technicians, management and professional personnel is intense and competitors aggressively recruit key employees. Competition for experienced personnel, particularly in highly specialized areas, has made it more difficult for us to timely meet all our staffing needs. We cannot be certain we will be able to attract and retain required staff on acceptable terms. Also, due to our highly leveraged capital structure, we may face challenges to recruiting and retaining personnel. Any failure to do so could

15

have a material adverse effect on our business, financial condition, operating results and our ability to meet our financial obligations. Failure to recruit and retain a sufficient number of these employees could adversely affect our ability to maintain or grow our business. Some of our contracts require us to staff a program with personnel the customer considers key to successful performance. If we cannot provide these key personnel or acceptable substitutes, the customer may terminate the contract, and we may not be able to recover our costs.

In order to succeed, we will have to keep up with a variety of rapidly changing technologies. Various factors could affect our ability to keep pace with these changes.

Our success will depend on our ability to keep pace with changing technologies in our core business areas. These technologies can change rapidly. Even if we keep up with the latest developments and available technology, newer services or technologies could negatively affect our business. Integrating our research services’ diverse technologies is complex and often has not been previously attempted. Our success will depend significantly on our ability to develop, integrate and deliver technologically advanced services and solutions at the same or faster pace as our competitors, many of which have greater resources than we do. Our new debt agreements from the Refinancing Transactions limit how much we may spend annually on capital expenditures. Those limitations could restrict our ability to invest in new and developing technologies in one or more of our core business areas. Failure to make the appropriate investment could materially affect our business, financial condition and operating results and ability to meet our financial obligations.

An economic downturn could harm our business.
    
Our business, financial condition, operating results and ability to meet our financial obligations may be affected by various economic factors. Continued unfavorable economic conditions may make it more difficult for us to achieve or maintain revenue growth. In an economic recession, or under other adverse economic conditions which may arise from natural or man‑made events, customers and vendors may be less likely to meet contractual terms and payment or delivery obligations. Continued weakness or further deterioration of economic conditions may have a material adverse effect on our business, financial condition, operating results and ability to meet our financial obligations. We believe that it is possible that an economic downturn could affect our fiscal 2015 results, as well as our results in future periods, due to the combination of a significant reduction in governmental spending as a result of sequestration.

Further adverse changes in market conditions, the stock market, the merger and acquisition environment in our industry or federal government budget constraints could adversely affect the value of our business which could cause us to recognize a goodwill impairment charge in the future.
    
If market conditions were to become more unfavorable, if merger and acquisition activity in our industry were to occur at significantly lower valuations, or we are unable to increase revenue and operating profit, the value of our reporting units could be adversely affected and we might have to recognize an impairment charge to the significant goodwill we have from acquisitions. An impairment charge could have a material adverse effect on our operating results.

Our employees may engage in misconduct or other improper activities, which could harm our business.
    
We are exposed to the risk of employee fraud or other misconduct. Employee misconduct could include intentional failures to comply with U.S. government procurement regulations, unauthorized activities, attempts to obtain reimbursement for improper expenses, or submission of falsified time records. Employee misconduct could also involve 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, financial condition, operating results and our ability to meet our financial obligations.

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

Our operations are subject to U.S. federal, state and local environmental laws and regulations, as well as environmental laws and regulations in the various countries in which we operate. We are also 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, biochemical or other hazardous materials and explosives. We may incur substantial costs in the future because of: modifications to current laws and regulations; new laws and regulations; new guidance or new interpretation of existing laws or regulations; violations of environmental laws or required operating permits; or discovery of previously unknown contamination.


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Our operations involve several risks and hazards, including potential dangers to our employees and to third parties that are inherent in aspects of our business. If we do not adequately insure against these risks, unanticipated losses could materially and adversely affect our financial condition and operating results.

We maintain insurance against risk and potential liabilities related to our operations. We believe we maintain reasonable levels of insurance that limit our likely exposure to unanticipated losses. Our insurance coverage may not be adequate to cover claims or liabilities, and we could be forced to bear significant costs from an accident or incident. Substantial claims in excess of our related insurance coverage could cause our actual results to differ materially and adversely from those anticipated. Due to future claims or liabilities, or to market conditions, our insurance premiums could increase.

Internal system or service failures could disrupt our business and impair our ability to effectively provide our services and products to our customers, which could damage our reputation and adversely affect our revenue, profitability and operating results.

Our information technology systems are subject to systems failures, including network, software or hardware failures, whether caused by us, third‑party service providers, intruders or hackers, computer viruses, natural disasters, power shortages or terrorist attacks. Any such failures could cause loss of data and interruptions or delays in our business, negatively affect our ability to service our clients and perform our contracts, cause us to incur remediation costs, subject us to claims and damage our reputation. Failure or disruption of our communications or utilities could cause us to interrupt or suspend our operations or otherwise adversely affect our business. Any system or service disruptions if not anticipated and appropriately mitigated, could have a material adverse effect on our business including, among other things, an adverse effect on our ability to bill our customers for work performed on our contracts, collect the amounts that have been billed and produce accurate financial statements in a timely manner. Our property and business interruption insurance may be inadequate to compensate us for all losses that may occur as a result of any system or operational failure or disruption and, as a result, our results of operations could be materially and adversely affected.

Security breaches in sensitive U.S. government systems could result in the loss of clients and negative publicity.

Many of the systems we develop, install and maintain involve managing and protecting information involved in intelligence, national security and other sensitive or classified U.S. government functions. A security breach in one of these systems could cause serious harm to our business, damage our reputation and prevent us from being eligible for further work on sensitive or classified systems for U.S. government clients. We could incur losses from such a security breach that could exceed the policy limits under our errors and omissions and product liability insurance. Damage to our reputation or limitations on our eligibility for additional work resulting from a security breach in one of the systems we develop, install and maintain could cause us to incur remediation costs and could materially reduce our revenue. Costs we incur to address security breaches could be material and materially reduce our operating margin.

Our business could be negatively impacted by security threats, including cybersecurity threats, and other disruptions.

As a defense contractor, we face various security threats, including cybersecurity threats to gain unauthorized access to sensitive information; threats to the safety of our employees; threats to the security of our facilities and infrastructure; and threats from terrorist acts. Cybersecurity experts believe that attacks are evolving and include, but are not limited to, malicious software; attempts to gain unauthorized access to data; and other electronic security breaches that could lead to disruptions in mission critical systems, unauthorized release of confidential or otherwise protected information and corruption of data. As a federal government contractor, we are a potential target to those who want to gain unauthorized access to sensitive and classified information of the United States, including officially and non‑officially sponsored acts of other countries and political organizations.
    
We utilize various procedures and controls to monitor these threats and mitigate our exposure to such threats. We are subject to frequent and increasingly sophisticated attempts by unauthorized individuals and/or entities to obtain access to sensitive, protected, and even classified data. We regularly review our systems and cybersecurity protocols. We do not outsource our cybersecurity functions.
    
Several years ago, an unauthorized party was able to gain access to our computer network. Management retained an independent third‑party expert data security firm to assess the nature and extent of unauthorized access, and to recommend remedial actions. We also asked the outside data security expert to recommend additional steps we could take to further enhance our ability to detect, monitor and defend against cybersecurity incidents. We notified government authorities and outside parties based on information obtained from the data security expert’s investigation.
    

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We undertook remedial actions based on the data security expert’s recommendations. We continue to consider additional enhancements to our network security. Our insurance carrier covered our investigation costs subject to our $250,000 policy deductible.
    
There can be no assurance that our remedial actions will be effective against future attacks or that future security breaches will be prevented. Any future security breach could have a material adverse effect on our business, financial condition and results of operations.

Holders of our securities will have limited access to information regarding our business because we have suspended our obligation to file periodic reports with the SEC.
On October 30, 2014, Alion filed a Forms 15 with the SEC, notifying the SEC of the suspension of its duty to file reports under Section 15(d) of the Exchange Act. Alion’s duty to file periodic, current and other reports with the SEC under the Exchange Act was suspended effective upon filing of the Forms 15 with the SEC. Alion expects that this Annual Report on Form 10-K, including any necessary amendments thereto, will be the final report it files with the SEC. Although Alion is required to post certain information on its website, including annual and quarterly financial statements, a Management’s Discussion and Analysis of Financial Condition and Results of Operations, and current information, only holders of the Debt Instruments will be able to review this information. Further, such information is limited and will not include all the information that is required in the reports had Alion been subject to Section 13(a) or Section 15(d) of the Exchange Act. As a result, access to information regarding our business will be limited.
Risks Related to Our Industry

We depend on U.S. government contracts for substantially all of our revenue. Changes in the contracting or fiscal policies of the U.S. government could adversely affect our business, financial condition, results of operations and ability to satisfy our financial obligations.

For the past three fiscal years, U.S. government contracts accounted for more than 96% of our revenue, with approximately 94% of our revenue derived from Department of Defense contracts. The U.S. Navy is our largest single customer, generating more than 50% of our revenue each of the last three fiscal years. Changes in U.S. government contracting policies could directly affect our financial performance. Factors that could materially adversely affect our U.S. government contracting business include:

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budgetary constraints affecting U.S. government spending generally, or specific departments or agencies in particular;
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changes in U.S. government fiscal policies or available funding;
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changes in U.S. government defense and homeland security priorities;
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changes in U.S. government programs or requirements;
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U.S. government curtailment of its use of technology services firms;
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adoption of new laws or regulations;
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technological developments;
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U.S. government shutdowns, threatened shutdowns or budget delays;
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competition and consolidation in our industry; and
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general economic conditions.

These or other factors could cause U.S. government departments or agencies to reduce their purchases under contracts, to exercise their right to terminate contracts or fail to exercise options to renew contracts, any of which could have a material adverse effect on our business, financial condition, operating results and ability to meet our financial obligations.

Many of our U.S. government customers are subject to increasing constraints. We have substantial contracts in place with many U.S. government departments and agencies. Our continuing performance under these contracts, or the possibility of new contracts from these agencies, could be materially adversely affected by agency spending reductions or budget cutbacks. Such reductions or cutbacks could materially adversely affect our business, financial condition, operating results and ability to meet our financial obligations.

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The Budget Control Act of 2011 caused significant delays or reductions in federal government appropriations for our current and future programs and may negatively affect our revenue and materially and adversely affect our financial condition, operating results, cash flows and ability to satisfy our financial obligations. Government shutdowns can delay collection of our accounts receivable.

In August 2011, Congress enacted the Budget Control Act intended to significantly reduce the federal deficit over ten years. The Budget Control Act established discretionary spending caps through 2021 and a Joint Committee of Congress to identify additional deficit reductions. The law’s passage also signaled the end of a decade of defense spending growth. The Joint Committee failed to agree on deficit reductions which triggered the sequestration provision of the Budget Control Act. Sequestration mandates substantial automatic spending cuts to defense and non‑defense programs. The sequestration began on March 1, 2013.

At this time, we cannot predict the effect that either identified or automatic cuts will have on funding for our individual programs. Long‑term funding for certain programs in which we participate is likely to be reduced, delayed or cancelled. These cuts could materially and adversely affect the viability of our prime contractors and our subcontractors, and lead to further revenue reductions.

Although we believe that we may be well‑positioned in areas the DoD has indicated are the focus for future defense spending, the impact of the Budget Control Act remains uncertain and our business and industry could be materially and adversely affected by it. Sequestration could also materially and adversely affect the business of our prime contractors and those with whom we team. Because we derive a material portion of our total revenue from the performance of subcontracts and teaming agreements, sequestration could have not only a direct effect, but also an indirect effect, on our business, financial condition and results of operation were the contracts we perform with prime contractors and teammates reduced.

Management cannot forecast whether sequestration will adversely affect timing of collection of our receivables in the future, but we did experience significant payment delays as a result of the government shutdown that occurred immediately after our fiscal year ended. Earlier in fiscal 2013, the federal government altered some of its accelerated payment practices which affected the overall payment cycle of our invoices. It took us until the fourth quarter of fiscal 2013 to recover from most of the effects of these changes.

We depend heavily on federal government contracts. Delays in the federal budget process, including actions related to the need to raise the debt ceiling, sequestration and any future federal government shutdown, could delay procurement of, and payment for, the products, services and solutions we provide and materially and adversely affect our revenue, gross margin, operating results and cash flow.

We derive a significant portion of our revenue from the federal government and from prime contractors to the federal government. We expect to continue to do so. Funding under those contracts is conditioned upon the continuing availability of Congressional appropriations and agency budgets. Congress usually appropriates funds on a fiscal year basis even though contract performance may extend over many years. The programs in which we participate must compete with other federal government programs and policies for funding during the budget and appropriation process. Concerns about increased deficit spending, along with continued economic challenges, continue to place pressure on federal customer budgets. While we believe that our programs are well aligned with national defense and other priorities, shifts in domestic spending and tax policy, changes in security, defense, and intelligence priorities, the affordability of our products and services, general economic conditions and developments, and other factors may affect a decision to fund or the level of funding for existing programs under which we perform contracts or proposed programs under which we might bid for future work. Even if our contracts are fully funded, full or partial furloughs of government employees may result in delays in our customers approving or paying our invoices.

Congress’s failure to agree on deficit reduction goals and disputes on whether to increase the debt ceiling create constraints on and uncertainties about the level of future federal spending. While specific budgetary decisions for the federal government’s next fiscal year are not yet known, such constraints could delay or cancel key programs in which we are involved and could materially and adversely affect our cash flows, liquidity and operating results. If the federal budget process were to result in a prolonged federal government shutdown, we could incur substantial unreimbursed labor or other costs, or it could delay or cancel key programs, which could materially and adversely affect our operating results, cash flow and liquidity.

In addition, when the U.S. government requires supplemental appropriations to operate or fund specific programs, and legislation to approve any supplemental appropriation bill is delayed, credit markets can react adversely to the uncertainty. In September 2012, Moody’s downgraded our corporate family credit rating from Caa1 to Caa2. Budgetary uncertainties and our

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lower credit rating could materially and adversely affect our access to credit and our overall liquidity. If we were to use our Revolving Credit Facility to a greater extent and for greater amounts than we have in the recent past, this could also increase the cost of credit to us if our floating interest rates were to rise.

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

Each year, Congress must approve budgets for each of the U.S. government departments and agencies we support. When Congress is unable to agree on budget priorities, and is unable to pass the annual budget on a timely basis, it typically enacts a continuing resolution. A continuing resolution allows U.S. government agencies to operate at spending levels equal to or less than levels approved in the prior budget cycle. This can delay funding we expect to receive from clients for work we are already performing. A continuing resolution can delay or even cancel new initiatives which could adversely affect our business, financial condition, operating results, cash flows and our ability to meet our financial obligations.

We may not realize the full amount of our backlog, which could lower future revenue.

The maximum contract value identified in a U.S. government contract does not necessarily determine the revenue we will realize from that contract. Congress normally appropriates funds for a given program each fiscal year, even when actual contract performance may take many years. As a result, U.S. government contracts ordinarily are only partially funded at the time of award. Normally a procuring agency commits additional money to a contract only as Congress makes subsequent year appropriations. Estimates of future revenue attributed to backlog are not necessarily precise. Receipt and timing of any of this revenue is subject to various contingencies such as changed U.S. government spending priorities and government decisions not to exercise existing contract options. Many 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 revenue to be lower than anticipated, and adversely affect our business, financial condition, operating results, cash flows and our ability to meet our financial obligations.

Many of our U.S. government customers procure goods and services through multiple delivery order type contracts under which we must compete for post‑ award orders.

Budgetary pressures and reforms in the procurement process have caused many U.S. government customers to purchase goods and services through IDIQ, GSA Schedule contracts and other multiple award and/or GWAC contract vehicles. These contract vehicles increase competition and pricing pressure requiring us to make sustained post‑award efforts to obtain awards and realize revenue. There can be no assurance that we will maintain or increase revenue or otherwise sell successfully under these contract vehicles. Our failure to compete effectively after an award under any of these types of contracts could harm our business, financial condition, operating results, cash flows and our ability to meet our financial obligations.

U.S. government contracts contain termination provisions that are unfavorable to us.

U.S. government agencies can generally terminate contracts with suppliers at any time without cause under a termination for convenience clause. If a government agency terminates one of our contracts without cause, we are likely to be compensated for services we have provided and costs we have incurred through the termination date, and we may receive payment for termination‑related costs and a negotiated contract fee. However, if the U.S. government terminates a contract because we defaulted under the terms of the contract, we may be liable for any extra costs the U.S. government incurs to procure undelivered services from another company and other potential damages. Termination of any of our large U.S. government contracts could negatively impact our revenue and our ability to win future contracts and adversely affect our business, financial condition, operating results, cash flows and our ability to meet our financial obligations.

If we do not accurately estimate the expenses, time and resources necessary to meet our contractual obligations, our contract profits will be lower than expected.

The total price on a cost‑reimbursement contract is primarily based on allowable costs incurred subject to a contract funding limit. U.S. government regulations require us to notify our customers of any cost overruns or underruns on a cost‑reimbursement contract. We may not be able to recover cost overruns in excess of a contract’s funding limit and may not earn the profit we anticipated from the contract.

In a fixed‑price contract, we estimate project costs and agree to perform services for a predetermined price regardless of our actual costs. We pay for any cost overruns. If we fail to anticipate technical problems, or accurately estimate or control costs, we may face a lower fixed‑price contract profit margin or even a loss. Provisions in our financial statements for estimated contract losses may not be adequate to cover all our actual losses.

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

Based on profit as a percentage of estimated standard costs, cost‑reimbursement contracts are our least profitable type of contract because government regulations limit cost‑reimbursement contract fee levels. Our U.S. government customers typically choose the type of contract they issue. To the extent that in the future cost‑reimbursement contracts increase as a percentage of our contract mix, operating margins and results may suffer.

If our fixed‑price contract revenue were to continue to decline in total or as a proportion of our total business, or if profit rates on these contracts deteriorate, our operating margins and operating results may suffer.

We have historically earned higher profit margins on fixed‑price contracts. If fixed‑price contract revenue were to significantly decrease, or customers shift to other types of contracts, our operating margins and operating results may suffer. We cannot ensure we will be able to maintain our historic profitability levels on fixed‑price contracts overall nor can we ensure that our percentage of total revenue generated from fixed‑price contracts will remain the same or improve.

Our subcontractors’ failure to perform contractual obligations could damage our reputation as a prime contractor and 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 timely perform services satisfactorily could 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. Subcontractor performance deficiencies could result in a government customer terminating our contract for default. A default termination could make us liable for customer re‑procurement costs, and other breach of contract damages, damage our reputation, and hurt our ability to compete for future contracts. Subcontractor work has accounted, and we expect it will continue to account for, a material portion of our work. In fiscal 2014, subcontractor expense, as a percentage of revenue, was 39%.

Because U.S. government contracts are subject to government audits, contract payments are subject to adjustment and repayment which may result in lower than expected or reported contract revenue.

U.S. government contract payments we receive are subject to adjustment and repayment after the government audits our contract costs to the extent that our costs exceed allowable costs and/or obligated contract funding. DCAA is currently auditing our 2007 claimed indirect costs. We have settled our indirect rates through 2005. All subsequent years are open. We are disputing the government’s claim for penalties and interest for 2005. It is our position that the statute of limitations has expired on any government contractual claims, including claims for penalties and interest, on our 2005 indirect rate proposal. We timely submitted our indirect cost proposals for all open fiscal years and expect to submit fiscal 2014 incurred cost proposal next March as required. We have recorded revenue on federal government contracts in amounts we expect to realize. If the estimated reserves in our financial statements are not adequate, future government contract revenue may be lower than expected.

If we fail to recover at‑risk contract revenue, we may have reduced fees or losses.

We are at risk for any revenue we incur before a contract is executed, modified or renewed. A customer may choose not to pay us for these costs. At September 30, 2014 we had approximately $14.7 million in at‑risk revenue. While such revenue is associated with specific anticipated contracts and funding modifications, we cannot be certain that our customers will execute these contracts or contract renewals or that they will pay us for all our related at‑risk costs.

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

U.S. government agencies have conflict of interest policies that may prevent us from bidding on or performing certain contracts. When dealing with U.S. government agencies, 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 design opportunity for the chance of performing the future contract. We have, on occasion, declined to bid on particular projects because of actual or perceived conflicts of interest. We are likely to continue encountering such conflicts of interest in the future. Future conflicts of interest could cause us to be unable to secure key contracts with U.S. government customers.

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As a U.S. 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 U.S. 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/or criminal penalties and administrative sanctions, including contract termination, fines, forfeiture of fees, suspension of payment and suspension or debarment from doing business with U.S. government agencies, any of which could materially and adversely affect our ability to conduct our business.

We derive significant revenue from U.S. government contracts awarded through competitive bidding which is an inherently unpredictable process.

We obtain most of our U.S. government contracts through competitive bidding, including (in many cases) contracts and renewals. We face risks associated with:
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the frequent need to bid on programs in advance of the completion of their design, which can result in unforeseen technological difficulties and/or cost overruns;
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the substantial time and effort, including design, development and promotional activities, required to prepare bids and proposals for contracts we may not win;
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the rapid rate of technological advancement and design complexity of most of our research offerings; and
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the risk of an adverse resolution of bid protest or other award controversy challenging a contract award, a solicitation’s terms and conditions, or the award of significant additional work under an existing contract.

We may not succeed in winning new contract awards or renewals in the future. Our failure to renew or replace existing contracts when they expire or win new contracts, would negatively affect our business, financial condition, operating results, cash flows and our ability to meet our financial obligations.

U.S. government contracts are subject to bid protests by other interested parties that compete with us for new contracts and in re‑competitions. A contract award or a solicitation’s terms and conditions are subject to protest for a variety of reasons, including that a solicitation or competitive bidding process violates law or regulation, or that the government agency has failed to comply with the terms of a solicitation in conducting a procurement. Moreover, changes to an existing contract are subject to protest on the basis that they involve a cardinal change which exceeds the scope of the contract. A bid protest may result in a decision by a Court, the Government Accountability Office, or by the cognizant government agency to cancel a contract award or to take other action that may result in the loss of a contract or in delay in a contract’s start date. Even a bid protest that does not result in such a decision or action may delay the start of contract during the pendency of the protest. Accordingly, bid protests may negatively affect our business, financial condition, operating results, cash flows and our ability to meet our financial obligations.

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

As of September 30, 2014, we had an aggregate of approximately 310 DoD stand‑alone contracts and delivery/task orders and we had facility security clearances at 22 sites. As of September 30, 2014, approximately 80% of our employees held security clearances. Each cleared facility has a Facility Security Officer and Key Management Personnel whom the U.S. Department of Defense-Defense Security Service requires to be cleared to the level of the facility security clearance. Individual employees are selected to be cleared, based on specific classified contract task requirements and each employee’s technical, administrative or management expertise. Once an employee is cleared, he or she may access classified contract information, based on clearance level and a “need‑to‑know.”

Protecting classified information is paramount. Loss of a facility clearance, or an employee’s failure to obtain or maintain a security clearance, could result in a U.S. government customer terminating an existing contract or choosing not to renew a contract. If we cannot maintain or obtain the required security clearances for our facilities and our employees, or cannot obtain these clearances in a timely manner, we may be unable to perform certain U.S. government contracts. Lack of required clearances could also impede our ability to bid on or win new government contracts, which might result in terminating current research activities. This could damage our reputation and our revenue would likely decline, which could materially and adversely affect our business, financial condition, operating results and ability to meet our financial obligations.

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If we fail to establish and maintain important relationships with government entities and agencies, our ability to successfully bid for new business and retain existing business may be adversely affected.

To bid on new business, we rely in part on establishing and maintaining relationships with various government officials. These government relationships help us to better understand government agencies’ needs before we develop a formal proposal. Due to change in personnel at the customer or within our company, we may be unable to maintain our relationships with government entities and agencies; any failure to do so could adversely affect our ability to bid successfully for new business or to retain existing business. This could adversely affect our operating results, cash flow and financial condition and our ability to meet our financial obligations.

Failure to maintain strong relationships with other contractors could result in a decline in our revenue.

Approximately 13% of our fiscal 2014 revenue resulted from our work as a subcontractor and from teaming arrangements with other contractors. As a subcontractor or teammate, we cannot control performance by our prime contractor or other teammates. Poor performance on a given contract could impact our customer relationship, even when we perform as required. We expect to continue to depend on relationships with other contractors for a portion of our revenue for the foreseeable future. Our revenue, operating results, financial position and cash flows could differ materially and adversely from what we anticipate if one or more of our prime contractors or teammates were to rely on one of our competitors or were to directly provide our customers the kind of services we provide.

The federal government’s appropriation process and other factors may delay the collection of our receivables, and our business may be adversely affected if we cannot collect our receivables in a timely manner.

We must collect our receivables to generate cash flow, provide working capital, pay interest and principal on our debt and continue our business operations. If the federal government, or any of our prime contractors fails to pay or delays paying our invoices for any reason, our business and financial condition may be materially and adversely affected. The government may fail to pay outstanding invoices and DCAA could revoke our direct billing privileges, which would adversely affect our ability to timely collect our receivables. Contracting officers can also withhold payment of some portion or all of an outstanding invoice which could also adversely affect our ability to collect our receivables timely.

Government rules could limit our ability to get paid for the work we perform.

Government rules require DoD contracting officers to impose contractual withholdings at no less than certain minimum levels if a contracting officer determines that one or more of a contractor’s business systems have one or more significant deficiencies. If a contracting officer were to impose such a withholding on us or even one of our prime contractors, it would increase the risk we would not be paid in full or paid timely. If we experience difficulties collecting receivables, it could materially and adversely affect our operating results, cash flow and financial condition and our ability to meet our obligations.

The U.S. government may adopt new contract rules and regulations or revise its procurement practices in a manner adverse to us at any time.

The U.S. government may face restrictions or pressure regarding the type and amount of services it may obtain from private contractors. Legislation, regulations and initiatives dealing with procurement reform, environmental responsibility or sustainability, and mitigation of potential conflicts of interest, as well as any resulting shifts in the buying practices of U.S. government agencies could adversely affect us. Such changes could impair our ability to obtain new contracts or win a recompete of an existing contract. Any new contracting requirements or procurement methods could be costly or administratively difficult for us to implement and could materially and adversely affect our operating results, cash flow and financial condition and our ability to meet our obligations.

The U.S. government may prefer minority‑owned, small and small disadvantaged businesses; therefore, we may not win certain contracts on which we bid.

As a result of the Small Business Administration set‑aside program, the U.S. government may decide to restrict certain procurements only to bidders that qualify as minority‑owned, small, or small disadvantaged businesses. As a result, we would not be eligible to perform as a prime contractor on those programs and would be restricted to a maximum of 49% of the work as a subcontractor on those programs. An increase in the amount of procurements under the Small Business

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Administration set‑aside program may impact our ability to bid on new procurements as a prime contractor or restrict our ability to recomplete on incumbent work that is placed in the set‑aside program.

Many of our contracts with the U.S. government are classified or subject to other security restrictions, which may limit investor insight into portions of our business.

For fiscal 2014, we derived a substantial portion of our revenue from contracts with the U.S. government that are classified or subject to security restrictions that preclude the dissemination of certain information. In addition, a significant number of our employees have security clearances which preclude them from providing information regarding certain of our clients and services provided to such clients to other of our employees without security clearances and investors. Because we are limited in our ability to provide information about these contracts and services, the various risks associated with these contracts or services or any dispute or claims relating to such contracts or services, you may not have important information concerning our business, which will limit your insight into a substantial portion of our business and therefore may be less able to fully evaluate the risks related to that portion of our business.

Risks Related to our Debt Structure

We have incurred a significant amount of debt; our debt load may limit our financial and operational flexibility which could prevent us from fulfilling our obligations under the Credit Agreement, the First and Second Term Loans, the Third Lien Notes and our other obligations.
    
Our substantial debt has and could continue to:

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make it more difficult for us to satisfy our debt‑related obligations; any failure to comply with any of our debt instrument obligations, including restrictive and financial covenants, could result in an event of default under our debt agreements, which, if not cured, could permit the holders of that indebtedness to accelerate our indebtedness;
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make it more difficult for us to satisfy our repurchase obligations to ESOP participants;
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increase our vulnerability to general adverse economic and industry conditions and make it more difficult for us to react to changing conditions;
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limit our ability to obtain additional financing for working capital, capital expenditures, acquisitions, other business opportunities, new technologies or other general corporate requirements;
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require a substantial portion of our operating cash flow to pay interest on our debt and thus reduce our ability to use our cash flow for future business needs;
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limit our ability to execute on our business plans;
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limit our flexibility to plan for, or react to changes in our business and the government contracting industry; and
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place us at a competitive disadvantage compared to less leveraged companies.

We may not be able to obtain financing in the future, and the terms of any future financings may limit our ability to manage our business. Difficulties in obtaining financing on favorable terms would have a negative effect on our ability to execute our business strategy.
    
We will need to seek additional capital in the future to refinance or replace existing long‑term debt. We may also need to seek additional capital in the future to meet current or future business plans, meet working capital needs or for other reasons. Based on the significant amount of our existing indebtedness and current market conditions, the availability of financing is, and may continue to be, limited. There can be no assurance that we will be able to obtain future financings on acceptable terms, if at all. If we are unable to obtain alternative or additional financing arrangements in the future, or if we cannot obtain financing on acceptable terms, we may not be able to execute our business strategies. Moreover, the terms of any such additional financing may restrict our financial flexibility, including the debt we may incur in the future, or may restrict our ability to manage our business as we had intended.

After the Refinancing Transaction, Standard & Poor’s raised our corporate family credit rating to B- and Moody’s raised our rating to Caa1 from Caa2. Any future ratings downgrade could increase our cost of capital, or limit any attempt to obtain additional financing in the future. An increase in our cost of capital would adversely affect our results of operations and our financial position.

If we breach our covenants, including financial covenants, we could have to amend the covenants in the Credit Agreement and/or the First and Second Lien Term Loans and Third Lien Notes which could materially affect our ability to finance our future operations, meet our capital needs or satisfy obligations to repurchase our common stock.
    

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The Debt Instruments we executed as part of the August 2014 Refinancing Transactions include a number of covenants, including financial covenants that are tested on a periodic basis. Our Debt Instruments impose other minimum financial performance requirements including a fixed charge coverage test and minimum consolidated EBITDA levels.
    
Events beyond our control can affect our ability to meet these financial performance requirements; we cannot guarantee that we will meet these tests. We have been required to seek waivers of covenants under our debt agreements in the past. For example, various debt agreements contain a financial statement covenant requiring an audit opinion without a “going concern” explanatory note or any similar qualification or exception and without any qualification or exception as to the scope of such audit. If we were to default under any covenants, we could pursue an amendment or waiver with our current lenders, but there can be no assurance that lenders would grant an amendment or waiver.
    
The August 2014 Debt Instruments restrict our operations.
    
The August 2014 Debt Instruments contain, and our future debt agreements may contain, covenants that may restrict our ability to engage in activities that may be in our long‑term best interest, including financing future operations or capital needs or engaging in other business activities. The Credit Agreement, the First and Second Lien Term Loans and Third Lien Notes restrict, among other things, our ability and the ability of our subsidiaries to:

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incur additional debt other than permitted additional debt;
•
pay dividends or distributions on our capital stock;
•
purchase, redeem or retire capital stock or warrants to purchase capital stock other than to satisfy ESOP repurchase obligations;
•
prepay or repurchase certain debt, including the Third‑Lien Notes;
•
pay certain amounts required under our equity‑based and incentive compensation plans;
•
spend amounts on capital assets;
•
make acquisitions and investments other than permitted acquisitions and permitted investments;
•
issue or sell preferred stock of subsidiaries;
•
create liens on our assets;
•
enter into certain transactions with affiliates;
•
merge or consolidate with another company; or
•
transfer or sell assets outside the ordinary course of business.
    
The Credit Agreement and the First and Second Lien Term Loans and Third Lien Notes and related indentures include negative, affirmative and financial covenants that are in some cases more restrictive than our former debt covenants were.
    
From time to time we may require consents or waivers from our lenders or note holders to permit actions prohibited by one or more of the August 2014 Debt Instruments. If, in the future, lenders or note holders refuse to waive restrictive covenants and/or financial level requirements, we could be in default. We could be prohibited from undertaking actions necessary or desirable to maintain or expand our business. There is no guarantee we will be able to obtain additional consents or waivers from our lenders or note holders.

The restrictions set forth in our Series A Preferred Stock limit our operations.
    
Our Series A Preferred Stock contains a number of restrictions in our ability to engage in activities absent the consent of the holders of a majority of the Series A Preferred Stock (which is currently ASOF), including, among other things, our ability to do the following:

•
change the nature of our business;
•
amend our charter, by laws or other organizational documents or those of our Subsidiaries;
•
approve our annual budget;
•
create liens on our assets;
•
transfer or sell assets outside the ordinary course of our business;
•
make any acquisitions and investments other than in the ordinary course of our business;
•
enter into or amend any transaction with affiliates;
•
merge or consolidate with another company;
•
make or pay any dividends or other distributions on account of our common stock (other than ESOP distributions and those permitted under our new Stockholders’ Agreement);
•
authorize certain capital expenditures;

25

•
make optional prepayments on certain of our debt;
•
incur additional debt other than certain permitted debt; and
•
amend our ESOP.

From time to time we may require consents from the holders of a majority of the Series A Preferred Stock to permit actions that require their affirmative consent. If, in the future, the holders refuse to grant requested consent, we could be prohibited from undertaking actions necessary or desirable to maintain or expand our business. There is no guarantee we will be able to obtain consents from the holders of the Series A Preferred Stock.

As the holder of 78.6% of the Series A Preferred Stock, ASOF has the right to appoint a majority of the members of our board of directors and possesses voting control over all matters that require stockholder approval.

All shares of the Series A Preferred Stock are held by the Supporting Noteholders and ASOF owns approximately 78.6% of the Series A Preferred Stock. As a result, ASOF has the right to appoint a majority of the members of our board of directors, possesses voting control over all matters that require stockholder approval and controls decisions regarding consenting to certain specified actions. As of the date of this Annual Report on Form 10-K, ASOF has appointed two members of our board of directors, Lawrence A. First and Daniel H. Clare, both of whom are affiliated with ASOF.

    
Despite our current debt levels, we and our subsidiaries may still be able to incur more debt. This could further increase risks associated with our substantial leverage.
    
Following the Refinancing Transactions, we have the ability to incur additional debt, subject to limitations imposed by covenants in the Debt Instruments and the Series A Preferred Stock. These agreements do not completely prohibit us from incurring additional debt. The more we borrow, the more we, and in turn our security holders, become exposed to the risks described above. We have incurred a significant amount of debt and our debt load may limit our financial and operational flexibility which could prevent us from fulfilling our obligations under our debt agreements. See Note 11-“Long‑Term Debt” in the Notes to the Audited Financial Statements, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Discussion of Debt Structure” for additional information.


Risks Related to our Warrants and Common Stock

Future issuances of equity securities, or securities convertible into common stock, including warrants, issued in connection with a refinancing of our indebtedness, will dilute existing ESOP participants’ beneficial ownership interest in our common stock and could decrease the price of our common stock.

Our financing activities have required us to issue warrants related to our debt, and our future financing activities may require us to issue warrants or other securities convertible into our common stock, which may have a dilutive effect on the ownership interest of ESOP participants and existing warrant holders, and could substantially decrease the price of our common stock. This would dilute the beneficial ownership interests of our existing ESOP participants and could decrease the price of our common stock.

In the Refinancing Transactions we issued penny warrants to purchase 40.0% of our common stock that include anti-dilution protections that could materially dilute the ownership interests of the participants in our ESOP and holders of existing common stock warrants.

Future issuances of our common stock to the ESOP may have a dilutive effect on the beneficial ownership interests of existing participants in the Alion KSOP and could further decrease the price of our common stock.

Issuances of our common stock to the ESOP for employer 401(k) matching and profit sharing contributions will have a dilutive effect on the ownership interests of existing participants in the Alion KSOP and could decrease the price of our common stock. To the extent our stock price declines further, dilution would be greater, as we will be required to issue more shares to satisfy our obligations to the ESOP. The redemption value of our stock has declined over the past four valuations and recently declined from $8.10 as of September 30, 2013 to $2.45 as of August 2014 and September 30, 2014.

The value of our common stock is not based on trading activity in a well-established market. We could conclude a transaction at a stock price that differs from the value of a share of Alion common stock as most recently determined by the ESOP Trustee.

26


As of each September 30 valuation date, the ESOP Trustee receives a valuation report from an independent third party valuation firm. The ESOP Trustee uses the information in the valuation report to determine the price at which the ESOP Trust is willing to buy or sell shares of Alion common stock. The independent third party valuation firm uses various valuation methodologies in assisting the ESOP Trustee to determine the redemption value of a share of Alion common stock. It is possible that we could conclude a transaction with a third party, such as an investment, a merger, a sale of substantially all of our assets, or a change of control transaction, at a stock price that differs from the value ascribed to a share of Alion common stock as of its most recent prior valuation.

If we were to engage in such a transaction, the price per share for Alion common stock in that transaction could be less than the most recent redemption price per share for transactions with the ESOP Trust. There can be no assurance that, with respect to future valuations, the valuation firm, or any other financial adviser that the ESOP Trustee might choose, would utilize the same processes or methodologies in future valuations of our common stock or that such advisor(s) would reach conclusions similar to those contained in the most recent valuation report.
 
There is no established trading market for warrants Alion has issued.

None of our common stock or warrants has a trading market and we cannot assure you that an active trading market will develop. The inability to trade our common stock or warrants may adversely affect their value. We do not intend to apply to list our common stock or warrants on any securities exchange. If no active trading market develops, you may not be able to resell our common stock or warrants at their fair market value or at all. Your lenders may be reluctant to accept common stock or warrants as collateral for loans.

Item 1B. Unresolved Staff Comments
None.


Item 2. Properties

Our headquarters in McLean, Virginia consists of 23,823 square feet of leased office space. We also lease approximately 64 additional office facilities totaling 859,713 square feet. Our largest offices are located in Washington, DC; Fairfax, Alexandria, Vienna, Arlington, Norfolk, Portsmouth, and Newport News, Virginia; Pittsburgh and West Conshohocken, Pennsylvania; Huntsville, Alabama; New London, Connecticut; Annapolis, Annapolis Junction and Lanham, Maryland; Orlando, Florida; Rome, New York; Pascagoula, Mississippi; Fairborn, Ohio; Mt. Clemens, Michigan; Boulder, Colorado; Durham, North Carolina; Bath, Maine; San Diego, California; Albuquerque, New Mexico; and Burr Ridge, Illinois. We lease 18 facilities that contain laboratory space totaling approximately 103,867 square feet, for contract-related research. Our largest laboratories are located in Durham, North Carolina; Chicago and Geneva, Illinois; Annapolis Junction and Lanham, Maryland; West Conshohocken, Pennsylvania;Warren, Michigan and Louisville, Colorado. Lease terms vary in length from one to twelve years, and are generally at market rates.

Aggregate average monthly base rental expense for fiscal 2014, 2013 and 2012 was approximately $1.9 million, $1.8 million and $1.7 million, respectively. We periodically enter into other lease agreements that are, in most cases, directly chargeable to current contracts. Lease obligations are usually either covered by currently available contract funds or cancelable upon termination of the related contracts. We consider our leased space to be adequate for our current and our reasonable anticipated future operations. If sequestration further adversely affects the Company, we may find we have excess leased space. We cannot ensure that if we have excess capacity we will be able to sublease a portion of or assign our leases on terms and conditions favorable to us or at all.


Item 3. Legal Proceedings

We are involved in routine legal proceedings occurring in the ordinary course of business that we believe are not material to our financial condition, operating results, or cash flows. As a government contractor, from time to time we may be subject to DCAA audits and federal government inquiries. The federal government may suspend or debar for a period of time any federal contractor it finds has violated the False Claims Act, and any contractor indicted or convicted of violations of other federal laws. The federal government could also impose fines or penalties.


27

Alion depends on federal government contracts; suspension or debarment could have a material, adverse effect on our business, financial condition, operating results, cash flows and our ability to meet our financial obligations. We are not aware of any such pending federal government claims or investigations.

Item 4. Mine Safety Disclosures
Not applicable.


28

PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

There is no established public trading market for Alion’s common stock.

Holders

As of September 30, 2014, the ESOP Trust held 99.96% of our outstanding common stock. The ESOP Trustee is independent of Alion and its management. Consistent with its fiduciary responsibilities, the ESOP Trustee retains an independent third party valuation firm to assist it in determining the redemption value (share price) at which the Trustee may acquire or dispose of investments in Alion common stock. The last valuation was performed as of September 30, 2014.

Alion’s transactions with the ESOP Trust during the past two years were based on the share prices and dates set out below. The Company did not sell any shares to the ESOP Trust in September 2014.
 
Valuation Date
Share
Price
 
 
September 30, 2014
$
2.45

August 20, 2014
$
2.45

September 30, 2013
$
8.10

March 31, 2013
$
16.25


Dividends

Alion has never declared any cash dividends. We do not expect to pay any dividends in the future, and the terms of our existing debt instruments limit our ability to do so. Although we do not expect to become profitable for the foreseeable future, we currently intend to retain future earnings, if any, to use in operating our business. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend on our operating results, our financial condition, contractual restrictions, applicable law and other factors our Board of Directors determines to be relevant.

29

Item 6. Selected Financial Data

The following table presents selected historical consolidated financial data for Alion for each of the last five fiscal years through September 30, 2014. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes in this annual report. We derived our consolidated operating data for the years ended September 30, 2014, 2013 and 2012 and our September 2014 and 2013 consolidated balance sheet data from our audited consolidated financial statements included in this annual report. We derived our consolidated operating data for the years ended September 30, 2011 and 2010 and our September 2012, 2011 and 2010 consolidated balance sheet data from our consolidated financial statements not included in this annual report. Our historical consolidated financial information may not be indicative of our future performance.
 
 
Alion Science and Technology Corporation
Selected Financial Data
Fiscal Years Ended September 30,
 
2014
 
2013
 
2012
 
2011
 
2010
 
(In thousands)
Consolidated Operating Data:
 
 
 
 
 
 
 
 
 
Contract revenue
$
804,809

 
$
848,972

 
$
817,204

 
$
787,314

 
$
833,988

Direct contract expense
629,311

 
669,504

 
632,831

 
603,481

 
638,000

Total operating expense
129,220

 
137,267

 
143,935

 
148,340

 
157,068

Operating income
46,278

 
42,201

 
40,438

 
35,493

 
38,920

Interest expense (a)
(81,662
)
 
(75,700
)
 
(74,934
)
 
(73,919
)
 
(67,613
)
Net loss
$
(43,996
)
 
$
(36,592
)
 
$
(41,447
)
 
$
(44,384
)
 
$
(15,232
)
Basic and diluted loss per share
$
(0.01
)
 
$
(5.39
)
 
$
(6.74
)
 
$
(7.83
)
 
$
(2.81
)
Basic and diluted weighted-average common shares outstanding
7,952,248

 
6,787,660

 
6,148,438

 
5,671,977

 
5,427,979

Consolidated Balance Sheet
 
 
 
 
 
 
 
 
 
Data at End of Period:
 
 
 
 
 
 
 
 
 
Net accounts receivable
$
171,495

 
$
172,604

 
$
175,293

 
$
180,364

 
$
174,032

Total assets
604,269

 
624,626

 
635,296

 
644,888

 
646,302

Working capital
1,412

 
42,569

 
51,594

 
46,596

 
59,796

Current portion of long-term debt and interest (b)
44,597

 
17,758

 
17,658

 
17,392

 
17,217

Long-term debt, excluding current portion (b)
527,407

 
556,118

 
549,425

 
533,067

 
521,957

Common stock warrant, second lien term loans and third lien notes
6,518

 
—

 
—

 
—

 
—

Redeemable common stock
32,120

 
61,895

 
110,740

 
126,560

 
150,792

Series A preferred stock
2,339

 
—

 
—

 
—

 
—

Common stock warrants, secured notes
20,785

 
20,785

 
20,785

 
20,785

 
20,785

Accumulated deficit
(253,475
)
 
(252,050
)
 
(272,433
)
 
(258,125
)
 
(246,270
)
Other Data:
 
 
 
 
 
 
 
 
 
Depreciation and amortization
$
4,794

 
$
7,363

 
$
11,741

 
$
11,409

 
$
16,777

Cash flows provided by (used in):
 
 
 
 
 
 
 
 
 
Operating activities
$
(23,277
)
 
$
10,783

 
$
12,681

 
$
5,721

 
$
2,396

Investing activities
414

 
(1,869
)
 
(2,731
)
 
(6,291
)
 
(2,147
)
Financing activities
7,982

 
(10,528
)
 
(3,541
)
 
(5,307
)
 
15,261

 
(a)
Interest expense includes interest payable in cash, non-cash expenses for amortizing original issue discount and debt issue costs, and interest accrued for paid-in-kind (PIK) notes to be issued in lieu of cash interest.
(b)
Debt, current and long-term, includes senior and subordinated debt and accrued PIK interest and is net of unamortized debt issue costs and original issue discount.

30

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to assist the reader understand Alion’s business, financial condition, results of operations and liquidity and capital resources. You should read the following discussion in conjunction with the consolidated financial statements and related notes included in this annual report. This discussion contains forward-looking statements about our business and operations that involve risks and uncertainties. Future results may differ materially from those we currently anticipate because of the “Risk Factors” described beginning on page 12 and elsewhere in this annual report.

About This Management’s Discussion and Analysis

Our discussion provides an overview of our business and critical accounting policies, explains year-over-year changes in operating results, describes our liquidity, capital resources and certain other obligations, and discloses certain market and other risks that could affect us.

Overview

With a 75-year legacy, we are an experienced technology solutions company delivering scientific, research and development, engineering and technology expertise and operational support primarily to the DoD, and other U.S. government agencies, and commercial customers. Based in McLean, Virginia, we design, develop, integrate, deliver, maintain and upgrade science and technology solutions, products and tools for national defense, homeland security and other U.S. government programs and to a lesser degree, commercial customers. For example, we design and engineer complete naval vessels and components for naval vessels for the U.S. Navy; we manage and support the implementation of major U.S. Air Force programs by providing financial, procurement and logistics services; we develop and conduct battle simulations for the U.S. Army to prepare soldiers for combat environments; and we assist the DoD in managing the use of the wireless communications spectrum to optimize the efficient transmission of sensitive data. We also provide research and development and engineering support for the DoD and the U.S. Department of Energy and other power generators.

We provide scientific, research and development, technical expertise, and operational support to a diverse group of U.S. government customers. We serve customers in all branches of the U.S. military, a number of Cabinet-level U.S. government agencies, the White House and, to a lesser degree, state and non-U.S. governments. As of September 30, 2014 we had more than 200 distinct customers, including Cabinet-level government departments and agencies and state and foreign governments. As of September 30, 2014, we had approximately 310 DoD stand-alone contracts and delivery/task orders with the U.S. Navy, U.S. Army and U.S. Air Force, the Defense Information Systems Agency, the Defense Advanced Research Projects Agency and others representing approximately 93.7% of our revenue for fiscal 2014. Other federal civilian agencies and departments accounted for 3.7% of our revenue for fiscal 2014, including the National Institute of Environmental Health Sciences, the U.S. Department of Energy and the Environmental Protection Agency. Commercial, state and local governments and international customers accounted for the remaining 2.6% of our revenue for fiscal 2014.

We deliver solutions in the following three core business areas:
•
Naval Architecture and Marine Engineering;
•
Systems Analysis, Design and Engineering; and
•
Modeling, Simulation, Training and Analysis.

Substantially all of our outstanding common stock is owned by the ESOP Trust. There is no established public trading market for our common stock. Consistent with its fiduciary responsibilities, the ESOP Trustee, retains an independent third party valuation firm to assist it in determining the fair market value of our common stock at which the ESOP Trustee may acquire or dispose of investments in our common stock. To assist the ESOP Trustee in determining the fair market value of our common stock, the ESOP Trustee considers such valuation report and its knowledge of our business and the market.

We have had a net loss every year since our inception in December 2002. We expect to incur losses for the foreseeable future. We are a highly leveraged company. Our historic cash interest expense and increasing principal indebtedness through PIK interest on existing debt and future deferred income tax expense are among the most significant factors contributing to our historic net losses and are projected to be among the most significant factors contributing to our estimated future net losses. After we concluded the Refinancing Transactions, Moody's raised our corporate family credit rating to Caal from Caa2 and Standard & Poor's raised our corporate credit rating to B-1 from CC.

We are not exempt from federal government funding and budgetary constraints. Our customers may face constraints on their ability to add funding, or maintain current funding levels to existing contracts and to execute new contracts. As with

31

others in the defense contracting sector, there may be the possibility of significant funding reductions on a number of our contracts and programs.

We have experienced funding delays on several of our programs which has materially adversely affected those programs, which we describe below in our Results of Operations section of this report. Our future financial performance could be materially adversely affected by the risk factors we have identified under "Risk Factors-Risks Related to our Business and Operations elsewhere in this report. Any one of more of these risks could reduce our future revenue and operating income below current or prior year levels and have a material adverse effect on our business, financial condition, results of operations, cash flows and ability to satisfy our financial obligations.

Results of Operations

Year Ended September 30, 2014 Compared to Year Ended September 30, 2013

Despite a challenging U.S. federal government defense market, the Company continues to win new contracts and execute on its existing base of business. Fiscal 2014 year-end revenues decreased 5.2% over fiscal 2013 year-end revenue however, fiscal 2014 operating income increased by 9.7% as compared to fiscal 2013.

The decline in revenue was driven by a number of factors including reductions in defense spending, sequestration, the U.S. Federal Government shutdown and delays in new awards and funding on our existing contracts. Notwithstanding these over-arching market issues, the Company ended fiscal 2014 with the largest funded backlog in the Company’s history and fourth quarter fiscal 2014 revenues that posted an 8.2% increase over fourth quarter fiscal 2013.

The increase in our fiscal 2014 operating income of 9.7% was primarily driven by the Company’s focus to improve contract execution and performance, which produced an increase in contract profitability. In addition, company initiatives to drive efficiencies throughout the business and have reduced overhead expenses by approximately $5.1 million and general and administrative expense reductions of $1.8 million in fiscal 2014 as compared to fiscal 2013.

In fiscal 2014 the Company’s net loss grew by 20.2% as compared to fiscal 2013 as increases in interest expense and costs related to refinancing our debt out-paced our improvements in operating income.
 
Risks related to sequestration, budget reductions, the 2013 government shutdown and other market factors disclosed in this Annual Report on Form 10-K have affected the revenue growth we have experienced in fiscal 2013. In the future these factors could have a material, adverse effect on our business, financial condition, results of operations and cash flows.
 
Fiscal Years Ended September 30,
 
2014
 
2013
 
(In thousands)
Revenue
$
804,809

 
$
848,972

Net loss
$
(43,996
)
 
$
(36,592
)

Revenue

Fiscal 2014 revenue was $804.8 million, down $44.2 million (5.2%) as compared to fiscal 2013 results. This decline was driven primarily by a $37.2 million overall decrease in Department of Defense fiscal 2014 revenue due to funding and award delays. These funding and award delays drove declines of $21.9 million (6.4%)  in our fiscal 2014 Naval Architecture and Marine Engineering revenue which led to a $6.7 million (1.5%) decline in our fiscal 2014 U.S. Navy revenue. In addition, our Modeling, Simulation, Training and Analysis decreased $20.6 million (9.4%) as we realized lower revenues with our U.S. Army and U.S. Air Force customers. The Systems Analysis, Design and Engineering core business area also decreased $1.7 million (0.6%) compared to fiscal 2013 due to funding and new award delays.

The $5.4 million revenue decrease from our commercial and international customers in fiscal 2014 over fiscal 2013 is related to the completed naval architecture and marine engineering work in India. In addition, we also completed several high-end nuclear engineering projects at several international nuclear power plants which also contributed to the decrease in our Commercial and International revenue. Fiscal 2014 other federal agencies revenue also declined $1.6 million compared to fiscal 2013 as tasking in our high-end consulting revenue has decreased due to Federal Government budgetary pressures.


32

Sources of Revenue

The U.S. government continues to be our principal customer. For fiscal years 2014 and 2013, U.S. government contracts accounted for more than 96% of our revenue, with approximately 94% of our revenue derived from Department of Defense contracts. The U.S. Navy is our largest single customer, generating more than 50% of our revenue each of the last two fiscal years. Certain annual revenues for fiscal years 2014 and 2013 disclosed below differ from amounts previously disclosed due to customers re-defining individual contracts, task orders and programs. While this re-classification may shift reported revenue from one classification to another, our total revenue for the period remains unchanged. The table below summarizes our revenue by principal customer for fiscal years 2014 and 2013.
 
Fiscal Years Ended September 30,
Revenue by Customer
2014
 
2013
 
(In millions)
U.S. Air Force
$
123.8

 
15.4
%
 
136.4

 
16.1
%
U.S. Army
122.1

 
15.2
%
 
152.7

 
18.0
%
U.S. Navy
444.9

 
55.3
%
 
451.6

 
53.2
%
Other Department of Defense Customers
62.9

 
7.8
%
 
50.2

 
5.9
%
Sub–total Department of Defense Customers
$
753.7

 
93.7
%
 
$
790.9

 
93.2
%
Other Federal Agencies
29.8

 
3.7
%
 
31.4

 
3.7
%
Sub-total U.S. government customers
$
783.5

 
97.4
%
 
$
822.3

 
96.9
%
Commercial and International customers
21.3

 
2.6
%
 
26.7

 
3.1
%
Total Revenue
$
804.8

 
100.0
%
 
$
849.0

 
100.0
%

We provide professional engineering, program management and information technology services and scientific expertise in a range of specialized core business areas. Our core business areas closely align our services with the demands of the marketplace. We expect our internal resource allocations and cost reductions will improve our efficiency and enhance our ability to provide cost-effective customer solutions. Factors reducing our Naval Architecture and Marine Engineering, Modeling, Simulation, Training and Analysis and Systems Analysis, Design and Engineering core business area revenue are noted in the Revenue section above. The table below summarizes our revenue by core business area for fiscal years 2014 and 2013.
 
 
Fiscal Years Ended September 30,
Core Business Area Revenue
2014
 
2013
 
(In millions)
Naval Architecture and Marine Engineering
$
321.9

 
40.0
%
 
$
343.8

 
40.5
%
Systems Analysis, Design and Engineering
284.2

 
35.3
%
 
285.9

 
33.7
%
Modeling, Simulation, Training and Analysis
198.7

 
24.7
%
 
219.3

 
25.8
%
Total Revenue
$
804.8

 
100.0
%
 
$
849.0

 
100.0
%

Cost-reimbursement contract revenue decreased $39.1 million (5.4%) in fiscal 2014 versus fiscal 2013 and represented 85.0% of fiscal 2014 revenue. Customers, including the Naval Sea Systems Command and the Defense Technical Information Center continued to issue this type of tasking on our IDIQ contract vehicles. Fiscal 2014, fixed price contract revenue was down $15.4 million to 7.3% of annual revenue as compared to fiscal 2013 due, in part, to a decline in our Naval Architecture and Marine Engineering international work and our high-end nuclear engineering and consulting services contracts. Fiscal 2014 time and material contract revenue was up $10.3 million to 7.7% of annual revenue as compared to fiscal 2013. The increase in time and material contract revenue is due, in part, to growth in several core business areas in our U.S. defense and civilian agencies customer base. The table below summarizes our revenue by contract billing type for the fiscal years 2014 and 2013.


33

 
 
Fiscal Years Ended September 30,
Revenue by Contract Billing Type
2014
 
2013
 
(In millions)
Cost Reimbursable contracts
$
684.0

 
85.0
%
 
$
723.1

 
85.2
%
Fixed Price contracts
59.2

 
7.3
%
 
74.6

 
8.8
%
Time and Material contracts
61.6

 
7.7
%
 
51.3

 
6.0
%
Total Revenue
$
804.8

 
100.0
%
 
$
849.0

 
100.0
%

In fiscal 2014, our prime contract revenue decreased by $55.2 million, a 7.3% decrease compared to fiscal 2013. This decline was attributed to delays in new awards and funding on existing programs. Revenue from our work as a subcontractor to other prime contractors was up $11.0 million or 12.0% in fiscal 2014 compared to fiscal 2013. Alion continues to look to increase its presence as a prime contractor on larger, more complex programs where we deliver services to customers by deploying our own staff and by managing the efforts of other contractors.

The table below summarizes our prime and subcontract revenue for fiscal years 2014 and 2013.
 
Fiscal Years Ended September 30,
Prime and Subcontract Revenue
2014
 
2013
 
(In millions)
Prime contracts
$
702.4

 
87.3
%
 
$
757.6

 
89.2
%
Subcontracts from other companies
102.4

 
12.7
%
 
91.4

 
10.8
%
Total Revenue
$
804.8

 
100.0
%
 
$
849.0

 
100.0
%

The trend by our customers to access our services through IDIQ contract vehicles continued in fiscal 2014. Our customers used our Weapons System Information Analysis Center and Seaport-E contracts as well as other IDIQ contract vehicles to obtain Alion’s services. Fiscal 2014, IDIQ contract revenue decreased by 5.3% compared to fiscal 2013. This decline was attributed, in part, to delays in new task orders awards and funding on existing task orders. The table below summarizes our revenue by contract vehicle type for fiscal years 2014 and 2013.
 
Fiscal Years Ended September 30,
Contract Vehicles
2014
 
2013
 
(In millions)
IDIQ Contracts
$
526.7

 
65.4
%
 
$
555.9

 
65.5
%
Individual contracts
278.1

 
34.6
%
 
293.1

 
34.5
%
Total Revenue
$
804.8

 
100.0
%
 
$
849.0

 
100.0
%

Selected Financial Information

The table below summarizes our fiscal 2014 and 2013 revenue and income from operations. Fiscal 2014 full year revenue decreased by $44.2 million and total operating expenses declined by $8.0 million compared to fiscal 2013. The Company benefited from continuing efforts to reduce our cost structure by trimming overhead expenses, general and administrative costs. Our declining contract amortization charges also contributed to the lower fiscal 2014 operating expense. Costs associated with the Company’s refinancing efforts eroded the cost reductions in our general and administrative expenses. The table below presents selected comparative financial information for fiscal years ended September 30, 2014 and 2013. Our discussion and analysis refers to financial information in this table and to Alion’s consolidated financial statements in this Annual Report on Form 10-K.
 

34

Selected Financial Information
Fiscal Years Ended September 30,
 
2014
 
2013
 
 
 
%
Revenue
 
 
 
%
Revenue
 
(In thousands)
Total contract revenue
$
804,809

 
 
 
$
848,972

 
 
Total direct contract costs
629,311

 
78.2
%
 
669,504

 
78.9
%
Direct labor costs
245,068

 
30.5
%
 
248,934

 
29.3
%
Material and subcontract costs
362,408

 
45.0
%
 
402,171

 
47.4
%
Other direct costs
21,835

 
2.7
%
 
18,399

 
2.2
%
Gross profit
175,498

 
21.8
%
 
179,468

 
21.1
%
Total operating expense
129,220

 
16.1
%
 
137,267

 
16.2
%
Major components of operating expense:
 
 
 
 
 
 
 
Overhead and G&A expenses
92,256

 
11.5
%
 
99,381

 
11.7
%
Rental and occupancy expense
32,176

 
4.0
%
 
30,538

 
3.6
%
Depreciation and amortization
4,788

 
0.6
%
 
7,348

 
0.9
%
Operating income
46,278

 
5.8
%
 
42,201

 
5.0
%

Direct Contract Expense and Gross Profit.

Fiscal 2014 direct contract costs were down $40.2 million (6.0%) compared to fiscal 2013, which is in line with lower revenue. As compared to fiscal 2013, fiscal 2014 direct labor costs decreased $3.9 million (1.6%) and third-party costs for materials and subcontracts decreased by $39.8 million (9.9%). Direct labor and Material and subcontract costs decreased, in part, as a result of sequestration, the Congressional continuing resolution and the U.S. federal government shutdown at the beginning of fiscal 2014. Fiscal 2014 other direct costs increased by $3.4 million (18.7%) over fiscal 2013 as the Company required more non-labor goods and travel related costs to service our customers.

Gross profit was down by $4.0 million this year as compared to fiscal 2013 due to the decline in revenue. Our fiscal 2014 gross profit margins increased to 21.8% of revenue as compared to 21.1% of revenue in fiscal 2013. The increase in gross margins, was due, in part, to the Company’s focus to improve contract execution and performance, which produced an increase in contract profitability.

Operating and General and Administrative Expenses.

Fiscal 2014 operating expenses were $8.0 million lower than they were in fiscal 2013. Fiscal 2014, overhead and G&A expenses decreased approximately $7.2 million compared to fiscal 2013 due to ongoing cost reductions and cost avoidance measures. Fiscal 2014 occupancy costs were up $1.6 million over fiscal 2013 due, in part, to opening new office facilities to better serve our new and existing customers. Fiscal 2014 depreciation and amortization expense declined $2.6 million compared to fiscal 2013. Amortization charges for contracts from our 2005 JJMA acquisition continue to decrease over time. Operating expenses continue to trend downward as they have since fiscal 2013.

Operating Income.

Fiscal 2014 operating income rose to $46.3 million for the year, which was a $4.1 million (9.7%) increase over $42.2 million in fiscal 2013. Fiscal 2014 higher operating income was due, in part, to the Company’s focus to improve contract execution and performance, which produced an increase in contract profitability, as well as reductions in overhead and core general and administrative costs. Fiscal 2014 operating income margin was 5.8% up from 5.0% in fiscal 2013.

Other Expense.

Fiscal 2014, total interest expense was approximately $6.0 million higher than fiscal 2013. This increase was a result of our Refinancing Transaction, interest expense on our revolver increased while interest on our Secured and Unsecured notes declined modestly because we retired most of the interest-bearing principal prior to fiscal 2014 year end. Interest expense for our new debt instruments issued in August 2014 also contributed to the increase in total interest expense in fiscal 2014 as compared to fiscal 2013.

35


 
Interest Expense
Fiscal Years Ended September 30,
 
2014
 
2013
 
(In thousands)
Cash Pay Interest
 
 
 
Revolver
$
1,866

 
$
887

First lien term loan, Tranche A
1,051

 
—

First lien term loan, Tranche B
2,299

 
—

Third lien note
1,386

 
—

Secured Notes
32,111

 
32,761

Unsecured Notes
21,504

 
24,861

Other cash pay interest and fees
102

 
69

Sub-total cash pay interest
60,319

 
58,578

Deferred and Non-cash Interest

 
 
Secured Notes PIK interest
6,423

 
6,551

Second lien term loan
1,191

 
—

Third lien note
2,457

 
—

Debt issue costs and other non-cash items
11,272

 
10,571

Sub-total non-cash interest
21,343

 
17,122

Total interest expense
$
81,662

 
$
75,700


Debt Extinguishment and Fair Value Adjustment.

In August 2014, we refinanced our existing debt and recognized a loss of $11.5 million. We extinguished our Secured Notes and exchanged new Third Lien Notes for approximately 90% of our Unsecured Notes. We paid $3.2 million to Unsecured Note holders who participated in the exchange or sold their notes at a discount. We paid ASOF and Phoenix $7.1 million to facilitate the Refinancing Transactions. We recognized a $1.1 million gain for the notes we repurchased. We recognized a loss of $2.1 million in unamortized debt issue costs. In September 2014, we recognized a $9.9 million benefit from the decline in value of the Penny Warrants we issued in the Refinancing Transactions.

Income Tax Expense.

We recognized $7.0 million in income tax expense both fiscal 2014 and fiscal 2013. In fiscal 2014, our deferred tax assets increased by $21.4 million as compared to fiscal 2013. Changes in deferred tax assets which reduce income tax expense were entirely offset by corresponding increases in valuation allowances. Our fiscal 2014 and 2013 income tax expense came almost exclusively from recognizing changes in our deferred tax liability arising from amortizing tax-deductible goodwill.

Net Loss.

The Company posted a net loss of $44.0 million in fiscal 2014 which was a $7.4 million increase over fiscal 2013. Revenue, gross profit and operating expense were all lower while operating income was higher in fiscal 2014 as compared to fiscal 2013. In addition, increased levels of interest expense in fiscal 2014 versus fiscal 2013 led to an increase to our fiscal 2014 net loss.

Results of Operations

Year ended September 30, 2013 Compared to Year ended September 30, 2012

Despite a challenging U.S. federal government defense market, the Company continued to win new contracts and execute on its existing base of business. Fiscal 2013 year-end revenues increased 3.9% over fiscal 2012, and our fiscal 2013 operating income increased by 4.4% compared to fiscal 2012.


36

Fiscal 2013 revenue increases of 3.9% over fiscal 2012 were attributed to growth of our existing base of business with the U.S. Army and other Department of Defense customers related to our Systems Analysis, Design and Engineering core business area.

Increases in fiscal 2013 operating income of 4.4% as compared to fiscal 2012 were impacted by Company initiatives that drove efficiencies throughout the business and reduced overhead expenses by approximately $2.5 million and occupancy costs by $548 thousand as compared to fiscal 2012. Contract amortization charges also declined in fiscal 2013 versus fiscal 2012. Refinancing related expenses off-set other cost reductions in our general and administrative costs and drove an overall increase of $698 thousand in fiscal 2013 compared to fiscal 2012.

The reduction of our fiscal 2013 net loss as compared to fiscal 2012 was due, in part, to the increase in our fiscal 2013 operating income and a fiscal 2013 gain related to the extinguishment of debt.
 
Fiscal Years Ended September 30,
 
2013
 
2012
 
(In thousands)
Revenue
$
848,972

 
$
817,204

Net loss
$
(36,592
)
 
$
(41,447
)

Revenue

Fiscal 2013 revenue was $849.0 million, up $31.8 million (3.9%) over fiscal 2012 results. The Systems Analysis, Design and Engineering core business area provided support for new and existing customers and drove a $35.3 million (4.7%) overall increase in Department of Defense fiscal 2013 revenue. Fiscal 2013 growth was driven primarily by our work in the Systems Analysis, Design and Engineering core business area, which increased $71.9 million (33.6%) compared to fiscal 2012. Reductions in the Modeling, Simulation, Training and Analysis from fiscal 2012 to fiscal 2013 totaling $29.3 million (11.8%) were due, in part to award and funding delays, as well as sequestration related reductions in our customers’ training and travel budgets. Funding delays and reductions related to sequestration and budget reductions led to a $10.8 million (3.0%) decline in our fiscal 2013 Naval Architecture and Marine Engineering revenue. Fiscal 2013 other federal agencies revenue also declined $11.8 million compared to fiscal 2012 as tasking in our high-end consulting revenue has decreased due to Federal Government budgetary pressures.

The $8.3 million revenue increase from our commercial and international customers in fiscal 2013 over fiscal 2012 is related to the Naval Architecture and Marine Engineering work we are performing in India as well as our nuclear engineering work at several international nuclear power plants also contributed to the increase from our Commercial and International revenue.

Sources of Revenue

The U.S. government continued to be our principal customer. For fiscal 2013 and 2012, U.S. government contracts accounted for more than 96% of our revenue, with approximately 92% of our revenue derived from Department of Defense contracts. The U.S. Navy is our largest single customer, generating more than 53% of our revenue in each of fiscal 2013 and 2012. Certain annual revenue for the fiscal years ended 2013 and 2012 disclosed below differs from amounts previously disclosed due to customers re-defining individual contracts, task orders and programs. While this re-classification may shift reported revenue from one classification to another, our total revenue for the period remains unchanged. The table below summarizes our revenue by principal customer for each of the past two fiscal years.

37

 
Fiscal Years Ended September 30,
Revenue by Customer
2013
 
2012
 
(In millions)
U.S. Air Force
$
136.4

 
16.1
%
 
$
138.4

 
16.9
%
U.S. Army
152.7

 
18.0
%
 
119.9

 
14.7
%
U.S. Navy
451.6

 
53.2
%
 
450.9

 
55.1
%
Other Department of Defense Customers
50.2

 
5.9
%
 
46.4

 
5.7
%
Sub–total Department of Defense Customers
$
790.9

 
93.2
%
 
$
755.6

 
92.4
%
Other Federal Agencies
31.4

 
3.7
%
 
43.2

 
5.3
%
Sub-total U.S. government customers
$
822.3

 
96.9
%
 
$
798.8

 
97.7
%
Commercial and International customers
26.7

 
3.1
%
 
18.4

 
2.3
%
Total Revenue
$
849.0

 
100.0
%
 
$
817.2

 
100.0
%

We provided professional engineering, program management and information technology services and scientific expertise in a range of specialized core business areas. Our business areas closely align our services with the demands of the marketplace. As expected our internal resource allocations and cost reductions will improve our efficiency and enhance our ability to provide cost-effective customer solutions. Factors that impacted our core business revenue are noted in the Revenue section above. The table below summarizes our revenue by core business area for fiscal 2013 and 2012.
 
Fiscal Years Ended September 30,
Core Business Area Revenue
2013
 
2012
 
(In millions)
Naval Architecture and Marine Engineering
$
343.8

 
40.5
%
 
$
354.6

 
43.4
%
Systems Analysis, Design and Engineering
285.9

 
33.7
%
 
214.0

 
26.2
%
Modeling, Simulation, Training and Analysis
219.3

 
25.8
%
 
248.6

 
30.4
%
Total Revenue
$
849.0

 
100.0
%
 
$
817.2

 
100.0
%

Cost-reimbursement contract revenue increased $47.8 million (7.1%) in fiscal 2013 versus fiscal 2012 and represented 85.2% of fiscal 2013 revenue. Customers, including the Naval Sea Systems Command and the Defense Technical Information Center continued to issue this type of tasking on our IDIQ contract vehicles. Fiscal 2013 fixed price contract revenue was up $10.4 million to 8.8% of annual revenue as compared to fiscal 2012 from expanded international work in Naval Architecture and Marine Engineering work and high-end nuclear engineering services contracts. Fiscal 2013 time and material contract revenue fell $26.4 million to 6.0% of annual revenue as compared to fiscal 2012, as this reduction in Time and Material contract revenue occurred due to the reduction of our Commercial work within the Washington Consulting group. The table below summarizes our revenue by contract billing type for the past two fiscal years.
 
Fiscal Years Ended September 30,
Revenue by Contract Billing Type
2013
 
2012
 
(In millions)
Cost Reimbursable contracts
$
723.1

 
85.2
%
 
$
675.3

 
82.6
%
Fixed Price contracts
74.6

 
8.8
%
 
64.2

 
7.9
%
Time and Material contracts
51.3

 
6.0
%
 
77.7

 
9.5
%
Total Revenue
$
849.0

 
100.0
%
 
$
817.2

 
100.0
%

In fiscal 2013, our prime contract revenue grew by $58.5 million, an 8.4% increase compared to fiscal 2012. Revenue from our work as a subcontractor to other prime contractors was down $26.7 million or 22.6% in fiscal 2013 compared to fiscal 2012. Alion continued to increase its presence as a prime contractor on larger, more complex programs where we deliver services to customers by deploying our own staff and by managing the efforts of other contractors. Fiscal 2013 prime contract revenue also grew as of a result of increased material procurement activity to support a number of Department of Defense customers that utilized our agile engineering and rapid prototyping support services within our Systems Analysis, Design and Engineering Core Business Area.

Costs for companies that work for us on our prime contracts and costs for materials often generate lower contract fee percentages, which in turn, place downward pressure on our gross margins. The table below summarizes our prime and subcontract revenue for fiscal years 2013 and 2012.

38

 
Fiscal Years Ended September 30,
Prime and Subcontract Revenue
2013
 
2012
 
(In millions)
Prime contracts
$
757.6

 
89.2
%
 
$
699.1

 
85.5
%
Subcontracts from other companies
91.4

 
10.8
%
 
118.1

 
14.5
%
Total Revenue
$
849.0

 
100.0
%
 
$
817.2

 
100.0
%

The trend by our customers to use our services through IDIQ contract vehicles continued in fiscal 2013. IDIQ contract revenue increased by 11.2% compared to fiscal 2012. Our customers used our Weapons System Information Analysis Center and Seaport-E contracts as well as other IDIQ contract vehicles to obtain Alion’s services. The table below summarizes our revenue by contract vehicle type for the past two fiscal years.

 
Fiscal Years Ended September 30,
Contract Vehicles
2013
 
2012
 
(In millions)
IDIQ Contracts
$
555.9

 
65.5
%
 
$
499.7

 
61.1
%
Individual contracts and delivery orders
293.1

 
34.5
%
 
317.5

 
38.9
%
Total Revenue
$
849.0

 
100.0
%
 
$
817.2

 
100.0
%

The table below presents selected comparative financial information for fiscal years ended September 30, 2012 and 2011. Our discussion and analysis refers to financial information in this table and to Alion’s consolidated financial statements in this Annual Report on Form 10-K.
Selected Financial Information
Fiscal Years Ended September 30,
 
2013
 
2012
 
 
 
%
Revenue
 
 
 
%
Revenue
 
(In thousands)
Total contract revenue
$
848,972

 
 
 
$
817,204

 
 
Total direct contract costs
669,504

 
78.9
%
 
632,831

 
77.4
%
Direct labor costs
248,934

 
29.3
%
 
254,949

 
31.2
%
Material and subcontract costs
402,171

 
47.4
%
 
361,367

 
44.2
%
Other direct costs
18,399

 
2.2
%
 
16,515

 
2.0
%
Gross profit
179,468

 
21.1
%
 
184,373

 
22.6
%
Total operating expense
137,267

 
16.2
%
 
143,935

 
17.6
%
Major components of operating expense:
 
 
 
 
 
 
 
Overhead and G&A expense
99,381

 
11.7
%
 
101,133

 
12.4
%
Rental and occupancy expense
30,538

 
3.6
%
 
31,086

 
3.8
%
Depreciation and amortization
7,348

 
0.9
%
 
11,716

 
1.4
%
Operating income
$
42,201

 
5.0
%
 
$
40,438

 
4.9
%

Direct Contract Expense and Gross Profit.

Direct contract costs increased by $36.7 million (5.8%) in fiscal 2013 compared to fiscal 2012 in line with higher fiscal 2013 revenue. Fiscal 2013 direct labor costs decreased $6.0 million (2.4%) year over year while third-party costs for materials and subcontracts grew by $40.8 million (11.3%) compared to fiscal 2012. The decrease in direct labor was driven by reduced level of effort on a number of our contracts. Fiscal 2013 increase in material and subcontractor costs are the result of Alion winning larger, more complex contracts as a prime contractor, that require us to hire and manage other contractors. Fiscal 2013 other direct costs increased by $1.9 million from fiscal 2012. Gross profit was down by $4.9 million in fiscal 2013. The decline in gross profit was due, in part, to the increase in material and subcontractor costs which typically garnered lower contract fees, coupled with the year over year decrease in Alion direct labor.
 

Operating and General and Administrative Expenses.


39

In fiscal 2013, operating expenses were $6.7 million lower than they were in fiscal 2012, declining by 1.4% to 16.2% of revenue. In fiscal 2013, the Company realized $2.5 million in overhead savings as a result of staffing reductions and other non-labor cost reductions and cost avoidance measures. Depreciation expense in fiscal 2013 was down $1.1 million compared to fiscal 2012 as Alion continued to utilize its fully-expensed assets without a charge to operations.

In fiscal 2013, amortization expense for intangibles was down $3.3 million compared to fiscal 2012. Charges for purchased contracts continue to decline over time as the acquired JJMA contract portfolio reaches the end of its useful life for accounting purposes. The useful life was initially established in 2005. As of September 30, 2013, the JJMA contract portfolio had an unamortized carrying value of $1.8 million.

Offsetting some of the benefits from lower fiscal 2013 operating expenses, our general and administrative expenses were up year over year by approximately $698 thousand. This was primarily because of costs associated with Alion’s refinancing efforts.

Operating Income.

Operating income rose to $42.2 million for fiscal 2013, which was a 4.4% increase over fiscal 2012 $40.4 million. The increase in operating income was due, in part, to the increase in revenue as noted in the Sources of Revenue section above. Lower fiscal 2013 operating expenses as compared to fiscal 2012 were due to reductions in overhead and core general and administrative costs that propel the increase and offset lower gross profit margins. This operating income was 5.0% of revenue in fiscal 2013 up from 4.9% in fiscal 2012.

Other Expense.

Fiscal 2013 interest expense was stable compared to fiscal 2012. Secured Note interest was higher in fiscal 2013 because more interest-bearing PIK notes were outstanding. Fiscal 2013 Unsecured Note interest was lower because our outstanding principal was lower. Our fiscal 2013 revolver interest costs were higher as we accessed the revolver more frequently in fiscal 2013 and also had a higher balance of outstanding letters of credit. PIK interest and debt issue cost amortization was also higher in fiscal 2013 than fiscal 2012 because the principal balance increased.
 
Interest Expense
Fiscal Years Ended September 30,
 
2013
 
2012
 
(In thousands)
Cash Pay Interest
 
 
 
Revolver
$
887

 
$
793

Secured Notes
32,761

 
32,116

Unsecured Notes
24,861

 
25,112

Other cash pay interest and fees
69

 
69

Sub-total cash pay interest
58,578

 
58,090

Deferred and Non- cash Interest
 
 
 
Secured Notes PIK interest
6,551

 
6,423

Debt issue costs and other non-cash items
10,571

 
10,421

Sub-total non-cash interest
17,122

 
16,844

Total interest expense
$
75,700

 
$
74,934


Debt Extinguishment.

In fiscal 2013, we repurchased $10 million worth of Unsecured Notes at a discount to face value in a series of open market transactions. We recognized a $3.9 million debt extinguishment gain on these debt repurchase transactions.

Income Tax Expense.

We recognized $7.0 million in income tax expense both in fiscal 2013 and fiscal 2012. In fiscal 2013, our deferred tax assets increased by $18.6 million. Changes in deferred tax assets which reduce income tax expense were entirely offset by corresponding increases in valuation allowances. Our fiscal 2013 and 2012 income tax expense came almost exclusively from recognizing changes in our deferred tax liability arising from amortizing tax-deductible goodwill.
 

40


Net Loss.

The Company posted a net loss of $36.6 million in fiscal 2013 which was a $4.9 million improvement from fiscal 2012. Fiscal 2013 revenue, gross margin and operating income were all higher and operating expenses were lower in fiscal 2013. We benefited from a debt extinguishment gain in fiscal 2013, although continued high levels of interest expense partially offset these improvements.
Liquidity and Capital Resources

The Company is highly leveraged, before and after the refinancing completed in August 2014. As of September 30, 2014, the Company had approximately $629 million of long-term debt outstanding. Over the next year, the interest and principal payments due under our various debt agreements are approximately $43.5 million and $43.2 million, respectively. As of September 30, 2014, the Company has $17.3 million available on its revolving credit facility and has the ability to borrow an additional $6.5 million under that facility.

The Company's high level of debt could have adverse effects on its business and financial condition. Specifically, the Company's high level of debt could have important consequences, including the following:

•
making it more difficult for the Company to satisfy obligations including our repurchase obligations to ESOP participants;
•
limiting the Company's ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions or other general corporate requirements;
•
requiring a substantial portion of the Company's cash flows to be dedicated to debt service payments instead of other purposes;
•
increasing the Company's vulnerability to general adverse economic and industry conditions;
•
limiting the Company's ability to execute on its business plans and flexibility in planning for and reacting to changes in the industry in which the Company competes;
•
placing the Company at a disadvantage compared to other, less leveraged competitors; and
•
increasing the Company's cost of borrowing.

The Company's ability to continue as a going concern and make our scheduled payments depends on and is subject to its financial and operating performance, which in turn is affected by general economic, financial, competitive, business and other factors beyond the Company's control, including the availability of financing in the international banking and capital markets.

The Company has several initiatives designed to increase revenue and profitability through improvement in program execution, cost reductions and avoidance initiatives, improvements that will reduce the Company’s DSO, reductions in our unbilled receivables, and moving in to more profitable business sectors. There can be no assurance, however, that these actions will be successful. If we are unable to generate sufficient funds from operations or raise additional capital, there could be material adverse effects on our liquidity.

Although the Company is significantly leveraged, it expects that the current cash balances, liquidity from its revolver, deferring expenditures, reducing overhead, securing rent abatements, collecting approved award fees related to past periods and cash generated from operations will be sufficient to meet working capital, capital expenditure, debt service, and other cash needs for the next year; however, there can be no assurances that the Company will be able to generate sufficient cash flows to fund its operations and service its debt for the next year.

We use cash primarily to fund operations and service our debt. We had $10.7 million in cash and cash equivalents at September 30, 2014 and had $43 million outstanding under our $65 million revolving credit facility. We were also contingently liable under $3.9 million in outstanding letters of credit which reduced our borrowing capacity. After taking borrowing base limitations into account, the maximum available borrowing capacity under our credit facility at September 30, 2014 was $18.1 million. Our credit facility includes a provision that stipulates a cash dominion condition would occur if our borrowing availability falls below $13 million, including any letters of credit outstanding. A cash dominion condition would not limit the Company’s ability to access the full capacity of the credit facility, but rather require mandatory repayments if the drawn amount on the credit facility exceeds $52 million. In fiscal year 2014 the Company did not meet the conditions requiring cash dominion.


41

At September 30, 2014, we had approximately $631.7 million in outstanding current and noncurrent debt. Please see Note 11to our audited consolidated financial statements in Item 8 to this Annual Report on Form 10-K for detail about our debt instruments. In fiscal year 2015, we are required to make principal payments on Tranche A and Tranche B of our First Lien term loans and to repay $24.0 million in remaining Unsecured Notes. We are also obligated to pay cash interest on outstanding credit agreement balances and our First Lien term loan and Third Lien Notes.

The terms of the new Debt Instruments the Company negotiated in the Refinancing Transactions materially affected Alion’s short and long-term cash obligations and the Company’s interest expense. Current and future interest expense for Alion's Debt Instruments include interest payable in cash, PIK interest, amortization of debt issue costs, amortization of original issue discount and amortization of the fair value of warrants issued to lenders. Fluctuations in our cash flows and liquidity demands required by operations make it necessary for Alion to periodically access the revolving credit facility to meet cash demands.

Cash flows used in operating activities
 
Fiscal Years Ended September 30,
 
2014
 
2013
 
(In thousands)
Net cash flow (used in) provided by operating activities
$
(23,277
)
 
$
10,783


Our operating cash flows are primarily affected by our ability to invoice and collect from our clients in a timely manner, our ability to manage our vendor payments, and the overall profitability of our contracts. We bill most of our customers monthly after services are rendered. Some contracts permit us to bill our customers twice monthly. We used $13.2 million to fund our operations in fiscal 2014 compared to the $10.8 million we generated in fiscal 2013. The $24.0 million year over year change largely explains the revolving credit agreement draw when we closed our refinancing. Current year operating cash flows were affected by:
 
•increased interest payments
•timing of collecting receivables
•timing of vendor payments
•a higher net loss with lower non-cash expenses

We collected approximately $804 million in receivables during the year ended September 30, 2014. In 2013, we collected $857 million. Although we were able to keep collections on pace with revenue, lower current year collections were consistent with reduced fiscal 2014 overall revenue. Revenue and collections were both adversely affected by the government shut down and contract delays earlier in the year.

We compute days’ sales outstanding (DSO) based on trailing twelve-month revenue. Accounts receivable DSO stood at 77.8 days at September 30, 2014 and 74.2 days at September 2013. From July to September 2014, our increasing revenue run rate reduced DSO by almost two days. However, growing receivable balances increased DSO by more than five days, for a net 3.3 day increase in DSO. Year over year our DSO increased by 3.6 days.

Even though Alion was affected by sequestration-related funding delays in fiscal 2014, contract funding outpaced revenue and unfunded contract receivables were stable year over year.

Cash used in investing activities
 
Fiscal Years Ended September 30,
 
2014
 
2013
 
(In thousands)
Net cash provided by (used in) investing activities
$
414

 
$
(1,869
)

We use some of our cash to invest in equipment and software, leasehold improvements and internal projects. Fiscal 2014 expense is net of $1.5 million we received from selling a contract. In fiscal 2013, we invested $1.9 million in capital projects. We expect future investing activities and capital expenditures to continue at comparable levels. Alion’s Debt Instruments limit our capital expenditures.

Cash used in financing activities

42

 
Fiscal Years Ended September 30,
 
2014
 
2013
 
(In thousands)
Net cash provided by (used in) financing activities
$
7,982

 
$
(10,528
)

The Company’s major cash flow events in fiscal 2014 centered on its financing and refinancing activities. Alion received $348.0 million from issuing new debt instruments and another $25.0 million from its revolving credit facility. The Company also exchanged $208.1 million Unsecured Notes for new Third Lien Notes. As part of the Refinancing Transactions we paid $3.2 million to induce Unsecured Note holders to tender their notes for Third Lien Notes or accept less than face value in cash. We also paid $7.1 million in transaction fees to ASOF and Phoenix to facilitate the Refinancing Transactions.

The Company used the majority of its refinancing proceeds to retire its Secured Notes and used $30.5 million to fund debt issue and refinancing transaction costs. This was in addition to the $10.3 million we paid to ASOF, Phoenix and tendering Unsecured Note holders. In the fourth quarter of fiscal 2014, Alion made $4.2 million in First Lien term loan amortization payments as required.

In fiscal 2014, the Company sold $935 thousand of Alion common stock to the ESOP Trust. Alion also repurchased $2.3 million of its common stock from the ESOP Trust to satisfy liquidity demands from former employees. We lent the ESOP Trust $935 thousand for it to fund statutorily required diversification of ESOP participant investments. The ESOP Trust repaid the loan in full.

In fiscal 2013 we used $10.5 million for financing activities. ESOP transactions accounted for $4.5 million of our financing activities and debt repurchases accounted for the remaining $6.0 million of net cash used. In the fourth quarter of fiscal 2013, we also borrowed and repaid an additional $10.0 million on our revolving credit facility to fund operations before our collections recovered from government payment delays. The $10.0 million we borrowed and repaid in the fourth quarter of fiscal 2013 was the highest outstanding revolver balance at any point in fiscal 2013.

In fiscal 2013, we paid out $6.7 million to redeem ESOP shares from former employees. We received $2.2 million for ESOP Trust purchases of Alion common stock from employee salary deferrals for the second half fiscal 2012 and the first half of fiscal 2013. In fiscal 2013, we lent the ESOP Trust $1.9 million for it to fund statutorily required diversification of ESOP participant investments. The ESOP Trust repaid the loan in full prior to March 31, 2013.

In fiscal 2013, as permitted by our debt agreements, we used our swing line facility to borrow and repay the $6.0 million we used to repurchase, at a discount, the $10.0 million of Unsecured Notes we retired. We repurchased the retired Unsecured Notes in a series of open market transactions and prepaid the interest on the notes we repurchased through the date of repurchase. We repaid all borrowed funds we borrowed to purchase Unsecured Notes by July 16, 2013, and the largest repurchase related loan balance outstanding was $3.3 million.

In fiscal 2014, our weighted average revolving credit loan balance increased because of refinancing expenses as well as operating demands. At September 30, 2014 our drawn balance reached $43 million, the maximum for the year. Our weighted average loan balance was $11.5 million for the periods over which we borrowed funds. Our fiscal 2013 weighted average loan balance for the period over which we borrowed funds was $323 thousand. Neither balance includes letters of credit.

Discussion of Debt Structure and Covenant Compliance

See Note 11 to our audited consolidated financial statements in Item 8 of this Annual Report on Form 10-K for a detailed discussion of Alion’s current debt structure and a list of relevant terms and limitations in existing long-term debt agreements.

Alion’s Credit Agreement defines Consolidated EBITDA. Each quarter the Company must achieve $50 million in minimum Consolidated EBITDA (on a trailing twelve-month basis) in order to maintain access to the revolving credit facility and avoid potential cross default under Alion's other debt instruments. Neither EBITDA nor Consolidated EBITDA is a measure of financial performance in accordance with generally accepted accounting principles. The Credit Agreement permits Alion to exclude certain expenses and requires it to exclude certain one-time gains when computing Consolidated EBITDA. Alion had approximately $68.0 million in Consolidated EBITDA for fiscal 2014, and exceeded the requirement by approximately $18.0 million.


43

The Credit Agreement also requires Alion to achieve a one-to-one fixed charge coverage ratio of Adjusted Net Cash Flow (based on Consolidated EBITDA) to fixed charges as defined in the Credit Agreement. Fixed Charges are defined as cash interest and principal payments plus all fees paid to equity sponsors (the Second Lien lenders). The numerator for the Fixed Charge Coverage ratio is Consolidated EBITDA minus: capital expenditures; cash paid for income taxes; and non-recurring charges included in Consolidated EBITDA (Adjusted Net Cash Flow). The Credit Agreement permits certain adjustments related to refinancing transactions. As of September 30, 2014, Alion's fixed charge coverage ratio was $65.2 million in adjusted net cash flow to $64.8 million in adjusted total fixed charges. The company was in compliance with all debt covenants as of fiscal year end.

Capital Resources
 
September 30,
2014
 
September 30,
2013
 
(In thousands)
Available Liquidity
 
Cash and cash equivalents
$
10,732

 
$
25,613

Revolving credit facility
65,000

 
35,000

Less: Outstanding borrowings
(43,000
)
 
—

Less: Letters of Credit
(3,935
)
 
(4,000
)
Net available liquidity
$
28,797

 
$
56,613


We believe our cash balances, investment securities, operating cash flows, and funds available under our credit agreement or from other public or private financing sources, taken together, provide adequate resources to fund ongoing operating and regulatory requirements, acquisitions, future expansion opportunities, and capital expenditures for at least the next twelve months, as well as to meet debt covenants in our existing debt, refinance or repay debt, and repurchase shares pursuant to our obligations under the ESOP.

Short-term Borrowings

From time-to-time, we borrow funds against our revolving credit facility for working capital requirements, to fund operations and for other permitted corporate purposes. Our revolving credit agreement borrowings bear interest at the one-month Eurodollar rate plus 475 basis points (currently 4.90%). The current rate for an alternate base rate loan would be 500 basis points over the 3.5% base rate (8.50%).
Over the Credit Agreement’s life we may use our revolving credit facility or additional sources of borrowings, as needed, to fund our anticipated cash requirements. We currently forecast that we will maintain a balance on the revolving credit facility for extended periods and may need to increase that balance for short periods of time based on collections cycles subject to government payment delays.
If the federal government were to implement further changes to its current payment practices, as a result of sequestration, budget cuts, policy changes, government shut downs, or otherwise, we might have to use our revolving credit facility to a more significant extent than we currently forecast. Delays in the government payment cycle could adversely affect our short-term cash flows and increase our interest expense if we need to use our credit facility to borrow larger amounts more frequently than we have in the past or currently plan to do in the future.
The following table summarizes the activity under our revolving credit facility for fiscal 2014 and fiscal 2013, not including issued and outstanding letters of credit.
 
Fiscal Years Ended September 30,
 
2014
 
2013
 
(In thousands)
Short-term borrowings
 
Aggregate revolving credit facility borrowings
78,000

 
16,461

Aggregate revolving credit facility repayments
(35,000
)
 
(16,461
)
Net change in revolving credit facility balance payable
$
43,000

 
$
—


Cash Management

44


To the extent possible, we invest our available cash in short-term, investment grade securities with the priorities of maintaining the safety of our principal, maintaining the liquidity of our investments, maximizing the yield on our investments and investing our cash to the fullest extent possible. Cash and cash equivalents include cash on hand, amounts due from banks and short term investments with maturity dates of three months or less at the date of purchase.

Cash flow effects and risks associated with equity-related obligations

We cannot accurately predict the extent to which ESOP repurchases and diversification demands may increase in future years. As more employees meet statutory and Plan-specific age and length of service requirements, potential diversification demands are likely to increase. These demands can increase further with any increase in the price of a share of Alion common stock. Declines in our share price, like those we have experienced over the past several years reduce the value of each individual Plan participant’s beneficial interest. Given our current share price it is unlikely increased diversification demands could mitigate or offset the effects of share price declines and give rise to increased demands on Alion's cash flows.

We monitor future potential repurchase liability cash flow demands by relying in part on internal and external financial models that incorporate Plan census data and financial inputs intended to simulate changes in Alion’s share price. Our most recent share price declines have reduced forecast ESOP cash flow demands. We forecast that fiscal 2015 demands will not differ materially from amounts Alion paid out in fiscal 2014.

Changes in the price of a share of Alion common stock do not affect warrant-related interest expense. All outstanding common stock warrants are permanent equity. The warrants have a one penny exercise price and are in the money. They do not have a cash liquidation option and therefore Alion only recognizes interest expense for the debt issue cost associated with the initial fair value of these warrants.

Alion faces no significant stock-based compensation liabilities. Outstanding Stock Appreciation Rights (SARs) have no intrinsic value. Management is unable to forecast the share price the ESOP Trustee will determine in future valuations and therefore cannot predict future cash flow demands that might arise from existing SARs.

Although current financial information includes the effects of the most recent ESOP Trust transactions, future expenses for stock-based compensation are likely to differ from estimates as the price of a share of Alion common stock changes. Our next regularly scheduled ESOP valuation period ends in September 2015. Interest rates, market-based factors and volatility, as well as Alion’s financial results will affect the future value of a share of our common stock. Certain stock-based compensation grantees can choose to defer their payments by having us deposit funds in a rabbi trust we own. Any such deferrals will not materially affect planned payments or overall anticipated cash outflows.

After each valuation period, the Plan permits former employees and beneficiaries to request distribution of their vested ESOP account balances. Consistent with the terms of the Plan, IRC requirements, and our recent business practice, we intend to pay distribution requests in five annual installments and to defer initial payments as permitted. The Plan allows Alion to defer initial installment distributions for six years for former employees who are not disabled, deceased or retired. We plan to meet future distribution demands through operating cash flows, and if necessary, access to Alion’s revolving credit facility.

As a result of the declines in the price of a share of Alion common stock, our existing analyses do not forecast material increases in the level of estimated future share redemption cash outflows as compared with recent years. While we are able to determine the current value of existing demands for future share redemptions based on the current price of a share of Alion common stock, we are only able to forecast cash flow demands for participants who have already commenced redeeming their shares and only for the four years subsequent to their initial share redemption payout. As of September 30, 2014, based on our current $2.45 share price, we estimate we will have to pay out the amounts listed below over the next four fiscal years. This amount declined from prior estimates due to the decline in Alion's share price. We do not yet know the extent to which eligible Plan participants who have yet to request diversification or distribution will place additional demands on the Company's cash flows. Such elections along with any future changes in our share price would impact estimated share redemption payouts.
Estimated Share Redemption Payouts

45

Fiscal Year Ending September 30,
 
Amounts
(in thousands)
2015
$
524

2016
 
420

2017
 
290

2018
 
58

Total estimated pay outs
$
1,292


Cash flow demands from existing debt agreement obligations

From fiscal 2015 through fiscal 2020, we expect we will have to make the estimated interest and principal payments set forth below for Alion’s existing current and long-term debt.

We do not expect Alion will have any tax-related cash obligations for the foreseeable future. We have significant net operating loss deductions available. We do not forecast having taxable income for at least the next five years.

Through December 2015, we believe the Company will be able to generate sufficient operating cash flow to fund business needs and to make interest and principal payments as and when they come due. The following table discloses the estimated interest and principal payments the Company expects to pay on its long term indebtedness in its fiscal years 2015 through 2020.
 
Estimated Future Principal and Interest Payments

 
Fiscal Year
 
2015
2016
2017
2018
2019
2020
Total
 
(Amounts in thousands)
Unsecured Notes not exchanged (1)
 
 
 
 
 
 
 
    Principal
$
24,014

$
—

$
—

$
—

$
—

$
—

$
24,014

    Interest
$
1,235

$
—

$
—

$
—

$
—

$
—

$
1,235

Credit Agreement (2)
 
 
 
 
 
 
 
    Principal
$
—

$
—

$
—

$
—

$
40,000

$
—

$
40,000

    Interest
$
1,960

$
1,960

$
1,960

$
1,960

$
—

$
—

$
7,840

First Lien - Term A (3)
 
 
 
 
 
 
 
    Principal
$
17,500

$
25,000

$
30,000

$
33,750

$
—

$
—

$
106,250

    Interest
$
8,161

$
6,456

$
4,410

$
2,191

$
—

$
—

$
21,218

First Lien - Term B (4)
 
 
 
 
 
 
 
    Principal
$
1,750

$
1,750

$
1,750

$
1,750

$
167,563

$
—

$
174,563

    Interest
$
19,395

$
19,253

$
19,005

$
18,810

$
16,430

$
—

$
92,893

Second Lien (5)
 
 
 
 
 
 
 
    Principal
$
—

$
—

$
—

$
—

$
—

$
70,000

$
70,000

    PIK
$
—

$
—

$
—

$
—

$
—

$
82,603

$
82,603

Third Lien (6)
 
 
 
 
 
 
 
    Principal
$
—

$
—

$
—

$
—

$
—

$
210,986

$
210,986

    PIK
$
—

$
—

$
—

$
—

$
—

$
159,223

$
159,223

    Interest
$
12,702

$
13,589

$
14,948

$
16,485

$
18,219

$
9,211

$
85,154

 
 
 
 
 
 
 
 
Total interest
$
43,453

$
41,258

$
40,323

$
39,446

$
34,649

$
9,211

$
208,340

Total principal and PIK
$
43,264

$
26,750

$
31,750

$
35,500

$
207,563

$
522,812

$
867,639

Total estimated future payments
$
86,717

$
68,008

$
72,073

$
74,946

$
242,212

$
532,023

$
1,075,979


(1)
Unsecured Notes mature February 2015. Interest is payable at 10.25% in arrears.

46


(2)
The Company forecasts the average drawn balance on our revolving credit facility will be $40 million. Interest is at 4.9% per year.

(3)
The $110 million First Lien Term A has a four-year life with quarterly amortization of principal and interest payable in cash at 8.0% per year.

(4)
The $175 million First Lien Term B has a five-year life with quarterly amortization of principal at 1.0% per year and interest payable in cash at 11.0% per year.

(5)
The $70 million Second Lien Term Loan has a five-and-a-half year life with PIK interest at 14.25% per year compounded quarterly.

(6)
The $211.0 million Third Lien Notes has a five-and-a-half year life with cash interest at 5.5% per year. The Third Lien Note has increasing PIK interest that compounds annually accretes quarterly and is due at maturity.

Contingent Obligations

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

Management forecasts that continuing net operating losses for income tax purposes will permit Alion to avoid significant cash outflows for income taxes. Other contingent obligations which will impact our cash flow include:
 
•
ESOP share repurchase and diversification obligations; and
•
Long-term incentive compensation plan obligations.

From December 2002 to September 2014, Alion had spent a cumulative total of $100.5 million to repurchase shares of its common stock to satisfy ESOP distribution and diversification requests from former employees and Plan beneficiaries. Beginning in March 2008, we stopped making lump sum distributions and began paying ESOP beneficiaries over the five-year distribution period permitted by ERISA and the terms of the Plan. Alion intends to continue this practice for the foreseeable future in part to offset the cash flow effects of annual employee diversification requests which are expected to continue for the foreseeable future. Our debt agreements limit our ability to fund certain discretionary ESOP diversification demands on our cash flow. The table below lists current and prior year share repurchases.
Date
Number of
Shares
Repurchased
 
Share
Price
 
Total Value
Purchased
 
 
 
 
 
(In thousands)
November 2012
485

 
$
16.45

 
$
8

December 2012
119,555

 
$
16.45

 
$
1,967

January 2013
759

 
$
16.45

 
$
12

February 2013
5,593

 
$
16.45

 
$
92

March 2013
115,933

 
$
16.45

 
$
1,907

June 2013
164,548

 
$
16.25

 
$
2,674

July 2013
106

 
$
16.25

 
$
2

September 2013
111

 
$
16.25

 
$
2

December 2013
238

 
$
8.10

 
$
2

December 2013
107,717

 
$
8.10

 
$
873

December 2013
7,298

 
$
8.10

 
$
59

March 2014
106,757

 
$
8.10

 
$
864

September 2014
197,737

 
$
2.45

 
$
484

September 2014
256

 
$
10.00

 
$
3

Total
827,093

 
 
 
$
8,949




47

If plans or assumptions change, if assumptions prove inaccurate, if we make additional or larger investments than we currently plan, if we invest in or acquire other companies to a greater extent than we currently plan, if we experience unexpected costs or competitive pressures, or if existing cash and projected cash flow from operations prove insufficient, we may need to obtain additional financing sooner than we expect.

The following table summarizes Alion’s contractual and other long-term debt obligations. The table does not include income tax obligations as we do not expect to have to pay taxes for at least the next five years.
 
 
 
Total
 
2015
 
2016
 
2017
 
2018
 
2019
Thereafter
 
(In thousands)
Contractual Obligations:
 
 
 
 
 
 
 
 
 
 
 
 
Long-term debt including principal and interest
$
1,075,979

 
$
86,717

 
$
68,008

 
$
72,073

 
$
74,946

 
$
242,212

$
532,023

Lease Obligations
$
101,189

 
$
25,800

 
$
21,569

 
18,413

 
15,888

 
6,537

12,982

Total contractual obligations
$
1,177,168

 
$
112,517

 
$
89,577

 
$
90,486

 
$
90,834

 
$
248,749

$
545,005


Off-Balance Sheet Financing Arrangements

Alion accounts for operating leases entered into in the routine course of business in accordance with ASC 840 Leases. Our only off-balance sheet financing arrangements are operating leases and letters of credit under our revolving credit agreement. Alion has no relationship with any unconsolidated or special purpose entity and has not issued any guarantees.
Summary of Critical Accounting Policies

Revenue Recognition
Alion derives its revenue from delivering technology services under three types of contracts. Some contracts provide for reimbursement of costs plus fees; others are fixed-price or time-and-material type contracts. We recognize revenue when a contract has been executed, the contract price is fixed or determinable, delivery of services or products has occurred, and our ability to collect the contract price is considered reasonably assured. Alion applies the percentage-of-completion method in Accounting Standards Codification (ASC) 605 – Revenue Recognition to recognize revenue.
Alion recognizes revenue on cost-reimbursement contracts as it incurs costs and includes estimated fees earned. The Company recognizes time-and-material contract revenue at negotiated, fixed, contractually billable rates as it delivers labor hours and incurs other direct expenses. We use various performance measures under the percentage-of-completion method to recognize revenue for fixed-price contracts. Estimating contract costs at completion and recognizing revenue appropriately involve significant management estimates. Actual costs may differ from estimated costs and affect estimated profitability and revenue recognition timing. From time to time, facts develop that require us to revise estimated total costs or expected revenue. We record the cumulative effect of revised estimates in the period when the facts requiring revised estimates become known. We recognize the full amount of anticipated losses on any contract in the period a loss becomes known. For each of the periods presented, the cumulative effects of revised estimates were immaterial to the Company’s financial performance.
U.S. federal government contracts are subject to periodic funding by our contracting agency customers. A customer may fund a contract at inception or incrementally throughout the period of performance as services are provided. If we determine contract funding is not probable, we defer revenue recognition until realization is probable. The federal government can audit Alion’s contract costs and adjust amounts through negotiation. The federal government considers Alion a major contractor and maintains an office on site. We have settled our rates through 2007. We timely submitted our indirect cost proposals for all open fiscal years. We have recorded revenue on federal government contracts in amounts we expect to realize.
We recognize revenue on unpriced change orders as we incur expenses and only to the extent it is probable we will recover such costs. The Company recognizes revenue in excess of costs on unpriced change orders only when management can also estimate beyond a reasonable doubt the amount of excess and experience provides a sufficient basis for recognition. Alion recognizes revenue on claims as expenses are incurred and only to the extent it is probable we will recover such costs and can reliably estimate the amount we will recover.

Income Taxes

48

Alion accounts for income taxes by applying the provisions in currently enacted tax laws. We determine deferred income taxes based on the estimated future tax effects of differences between the financial statement and tax bases of our assets and liabilities. Deferred income tax provisions and benefits change as assets or liabilities change from year to year. In providing for deferred taxes, Alion considers the tax regulations of the jurisdictions where we operate; estimated future taxable income; and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies change, the carrying value of deferred tax assets and liabilities may require adjustment.
Alion has a history of operating losses for both tax and financial statement purposes. The Company has recorded valuation allowances equal to deferred tax assets based on the likelihood that we may not be able to realize the value of these assets. Alion recognizes the benefit of a tax position only after determining that the relevant tax authority would “more likely than not” sustain our position following an audit. For tax positions meeting the “more likely than not” threshold, we recognize the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.
Cash and Cash Equivalents
The Company considers cash in banks, and deposits with financial institutions with maturities of three months or less at time of purchase which it can liquidate without prior notice or penalty, to be cash and cash equivalents.
Accounts Receivable and Billings in Excess of Revenue Earned
Accounts receivable include billed accounts receivable and unbilled receivables. Unbilled receivables consist of costs and fees which are billable upon occurrence of a specific event, amounts billable after the balance sheet date and revenue in excess of billings on uncompleted contracts (accumulated project expenses and fees which were not billed or were not currently billable as of the date of the consolidated balance sheet). Unbilled accounts receivable include revenue recognized for customer-requested work Alion performed on new and existing contracts for which the Company had not received contracts or contract modifications. Accounts receivable are stated as estimated realized value. The allowance for doubtful accounts is Alion’s best estimate of the amount of probable losses in the Company’s existing billed and unbilled accounts receivable. The Company determines the allowance using specific identification and historical write-off experience based on receivable age. Billings in excess of revenue and advance collections from customers represent amounts received from or billed to customers in excess of project revenue recognized to date.
Property, Plant and Equipment
Leasehold improvements, software and equipment are recorded at cost. Maintenance and repairs that do not add significant value or significantly lengthen an asset’s useful life are charged to current operations. Software and equipment are depreciated on the straight-line method over their estimated useful lives (typically 3 years for software and 5 years for equipment). Leasehold improvements are amortized on the straight-line method over the shorter of the asset’s estimated useful life or the life of the lease. Upon sale or retirement of an asset, costs and related accumulated depreciation are deducted from the accounts, and any gain or loss is recognized in the audited consolidated statements of operations.
Goodwill
Alion assigns the purchase price paid to acquire the stock or assets of a business to the net assets acquired based on the estimated fair value of assets acquired and liabilities assumed. Goodwill is the purchase price in excess of the estimated fair value of the tangible net assets and separately identified intangible assets acquired. There have been no changes to goodwill carrying value in fiscal 2014.

The Company accounts for goodwill and other intangible assets in accordance with the provisions of ASC 350 – Intangibles-Goodwill and Other. Alion operates in one segment and tests goodwill at the reporting unit level. There are two reporting units. We review goodwill for impairment in the fourth quarter each year, and whenever events or circumstances indicate goodwill might be impaired. We are required to recognize an impairment loss to the extent our goodwill carrying value at the reporting unit level exceeds fair value. Evaluating goodwill involves significant management estimates. To date, our annual reviews have resulted in no goodwill impairment adjustments. See Note 9 for a detailed discussion of the Company’s goodwill impairment testing process.

Intangible Assets


49

Alion amortizes intangible assets as it consumes economic benefits over estimated useful lives. As of September 30, 2013, the Company had approximately $2.0 million in net intangible assets, including contracts purchased in the JJMA acquisition and purchased software licenses. The JJMA contract portfolio has a remaining useful life of approximately 1.6 years.

Redeemable Common Stock

Alion has one class of common stock all of which is redeemable. There is no public market for Alion’s redeemable common stock and therefore no observable price for its equity, individually or in the aggregate. The Employee Stock Ownership Plan (ESOP) Trust holds all the Company’s outstanding redeemable common stock. Under certain circumstances, ESOP beneficiaries can require the ESOP Trust to distribute the value of their beneficial interests. The Internal Revenue Code (IRC) and the Employee Retirement Income Security Act (ERISA) require the Company to offer ESOP participants who receive Alion common stock a liquidity put right. The put right requires the Company to purchase distributed shares at their then-current fair market value at any time during two put option periods. Redeemable common stock distributed by the ESOP Trust is subject to a right of first refusal. Prior to any subsequent transfer, shares must first be offered to the Company and then to the ESOP Trust. Eventual redemption of shares of Alion redeemable common stock as a result of distributions is outside the Company’s control. Therefore, Alion classifies its outstanding shares of redeemable common stock as other than permanent equity.

At each reporting date, Alion is required to increase or decrease the reported value of its outstanding redeemable common stock to reflect its estimated redemption value. Management estimates the value of Alion’s obligation to repurchase its outstanding shares of redeemable common stock by considering, in part, the most recent price at which the Company was able to sell shares to the ESOP Trust. The reported value of outstanding redeemable common stock equals the current share price multiplied by total shares issued and outstanding.

In its fiduciary capacity, the ESOP Trustee is independent of the Company and its management. Consistent with its fiduciary responsibilities, the ESOP Trustee retains an independent third party valuation firm to assist it in determining the fair market value (share price) at which the ESOP Trustee may acquire or dispose of investments in Alion common stock. The Audit and Finance Committee of Alion’s Board of Directors reviews the reasonableness of the amount management has determined Alion should recognize for the Company’s obligation to repurchase shares of its outstanding redeemable common stock. The Audit and Finance Committee considers various factors in its review, including, in part, the most recent valuation report prepared for, and the share price selected by the ESOP Trustee.

Alion records changes in the reported value of its outstanding common stock through an offsetting charge or credit to accumulated deficit. The Company recognized a change in the fair value of its redeemable common stock on September 30, 2014. The accumulated deficit at September 30, 2014, included a $110.1 million cumulative benefit for changes in share price which reduced the Company’s aggregate share redemption obligation. Outstanding redeemable common stock had an aggregate fair value of approximately $32.1 million as of September 30, 2014.

Concentration of Credit Risk
    
Alion is subject to credit risk for its cash equivalents and accounts receivable. The Company believes the high credit quality of its cash equivalent investments limits its credit risk with respect to such investments. Alion believes its concentration of credit risk with respect to accounts receivable is limited as the receivables are principally due from the federal government. Approximately 22% of the Company’s receivables are due from commercial customers including other prime contractors.

Fair Value of Financial Instruments

Alion is required to disclose the fair value of its financial instruments, but is not required to record its senior long term debt at fair value. See Note 11 for a discussion of Alion’s long term debt and Note 12 for the related fair value disclosures. The fair value of cash, cash equivalents, accounts payable and accounts receivable is not materially different from carrying value because of the short maturity of those instruments.

Off-Balance Sheet Financing Arrangements

Alion accounts for operating leases entered into in the routine course of business in accordance with ASC 840 Leases. We have no off-balance sheet financing arrangements other than operating leases and letters of credit under our revolving credit facility. Alion has no relationship with any unconsolidated or special purpose entity and has not issued any guarantees.


50

Recently Issued Accounting Pronouncements

In May 2014 the FASB issued Accounting Standards Update 2014-09 (ASU 2014-09), “Revenue from Contracts with Customers” which requires an entity to recognize revenue when a customer obtains control rather than when an entity has transferred substantially all risks and rewards of a good or service. This update is effective for annual reporting periods beginning on or after December 15, 2016 and interim periods therein and requires expanded disclosures. We are currently assessing the impact adopting ASU 2014-09 will have on our operating results, financial position and cash flows.
    
In August 2014, the FASB issued ASU 2014-15 "Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern". ASU 2014-15 defines management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. GAAP-basis financial statements are prepared under the presumption a reporting organization will continue to operate as a going concern. The presumption, commonly called the going concern basis of accounting, establishes the basis for measuring and classifying assets and liabilities.

ASU 2014-15 provides the guidance GAAP currently lacks regarding management’s responsibilities related to going concern analysis and disclosures. It establishes principles and definitions intended to reduce diversity in both timing and content for financial statement disclosures. ASU 2014 -15 is effective for annual periods ending after December 15, 2016, including interim periods within that reporting period. Early application is permitted for annual or interim reporting periods for which financial statements have not been issued. The Company does not believe that adopting ASU 2014-15 will materially affect its operating results, financial position or cash flows.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest rate risk

We face interest rate risk for periodic borrowings on our $65.0 million revolving credit facility under the amended and restated Credit Agreement with Wells Fargo Bank as well as the First Lien term loan. Variable rates increase the risk that interest charges could increase materially if either market interest rates or outstanding balances were to increase.

Credit Agreement balances bear interest at a variable rate based on LIBOR plus 400 basis points. The Credit Agreement interest rate was 4.9% at year end. The Tranche A First Lien term loan bears interest at a minimum 100 basis point LIBOR rate plus 700 basis points. The current interest rate is 8.0%. The Tranche B First Lien term loan bears interest based on the Tranche A rate plus 300 basis points. The Tranche B interest rate is currently 11.0%.

Based on the assumption that Alion would maintain an average drawn balance of $40 million, we estimate that a 100 basis point change in interest rates would cost the Company $400 thousand per year under the Credit Agreement. The same 100 basis point change would cost the Company approximately $2.8 million in additional First Lien term loan interest next fiscal year and approximately $11.1 million in total over the life of the First Lien term loan.

The Second and Third Lien Notes and the Unsecured Notes are fixed-rate obligations. We do not use derivatives for trading purposes. We invest excess cash, if any, in short-term, investment grade, and interest-bearing securities.

Foreign currency risk

Alion does not have a material number of foreign currency based contracts. Most international contract expenses and revenues are U.S. dollar-denominated. Contracts denominated in foreign currency typically are priced to allow for potential adverse foreign exchange impacts and foreign withholdings. Management does not believe Alion's operations are subject to material risks from currency fluctuations.

Risk associated with value of Alion redeemable common stock

Changes in the fair market value of a share of Alion redeemable common stock affect estimated ESOP share repurchase obligations and, potentially, stock appreciation right (SAR) obligations. The number of employees who seek to redeem shares of Alion stock held by the ESOP Trust following termination of employment and the number of shares they seek to redeem affect the timing and amount of the company's repurchase obligations. Declining share prices favorably affect ESOP-related demands on the Company's cash flow .


51

Only the stock appreciation rights granted in fiscal 2014 are outstanding. They were issued at a $8.10 per share strike price and are underwater. Absent a material increase in the price of a share of Alion redeemable common stock, the Company will face little or no cash flow risk related to these outstanding SAR grants.

52

Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

53

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Alion Science and Technology Corporation
McLean, Virginia
We have audited the accompanying consolidated balance sheets of Alion Science and Technology Corporation and subsidiaries (the “Company”) as of September 30, 2014 and 2013, and the related consolidated statements of comprehensive loss, redeemable common stock and stockholders' deficit, and cash flows for each of the three years in the period ended September 30, 2014. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects the financial position of Alion Science and Technology Corporation and subsidiaries as of September 30, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2014, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects the information set forth therein.

/s/ DELOITTE & TOUCHE LLP
McLean, Virginia
December 29, 2014

54

ALION SCIENCE AND TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEETS
 
September 30,
 
2014
 
2013
 
(In thousands, except share and
per share information)
Current assets:
 
 
 
Cash and cash equivalents
$
10,732

 
$
25,613

Accounts receivable, net
171,495

 
172,604

Receivable due from ESOP Trust
—

 
930

Prepaid expenses and other current assets
5,341

 
4,483

Total current assets
187,568

 
203,630

Property, plant and equipment, net
7,066

 
9,668

Intangible assets, net
961

 
2,040

Goodwill
398,921

 
398,921

Other assets
9,753

 
10,367

Total assets
$
604,269

 
$
624,626

Current liabilities:
 
 
 
First lien term loans, current portion:


 


    Tranche A
16,059

 
—

    Tranche B
1,585

 
—

Unsecured notes, current portion
23,977

 
—

Interest payable
2,976

 
17,758

Trade accounts payable
55,533

 
61,622

Accrued liabilities
45,021

 
39,393

Accrued payroll and related liabilities
38,190

 
37,954

Billings in excess of revenue earned
2,815

 
4,334

Total current liabilities
186,156

 
161,061

Revolving credit facility
39,549

 
—

First lien term loans, non-current:
 
 
 
   Tranche A
82,627

 
—

   Tranche B
158,413

 
—

Second lien term loan
56,373

 
—

Third lien notes
190,445

 
—

Secured notes
—

 
322,286

Unsecured notes
—

 
233,832

Accrued compensation and benefits, excluding current portion
5,878

 
5,736

Non-current portion of lease obligations
11,456

 
12,821

Deferred income taxes
65,104

 
58,130

Commitments and contingencies

 

Common stock warrants, second lien term loans and third lien notes
6,518

 
—

Redeemable common stock, $0.01 par value, 24,000,000 shares authorized, 13,110,043 issued and outstanding at September 30, 2014; 20,000,000 shares authorized and 7,641,391 shares issued and outstanding at September 30, 2013 (recorded at redemption value, see Note 5)
32,120

 
61,895

Series A preferred stock
2,339

 
—

Common stock warrants, secured notes
20,785

 
20,785

Accumulated other comprehensive loss (gain)
(19
)
 
130

Accumulated deficit
(253,475
)
 
(252,050
)
Total liabilities, redeemable common stock and stockholders' deficit
$
604,269

 
$
624,626

See accompanying notes to consolidated financial statements.

55

ALION SCIENCE AND TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
 
 
Year Ended September 30,
 
2014
 
2013
 
2012
 
(In thousands, except share and per share
information)
Contract revenue
$
804,809

 
$
848,972

 
$
817,204

Direct contract expense
629,311

 
669,504

 
632,831

Gross profit
175,498

 
179,468

 
184,373

Operating expenses
78,061

 
84,128

 
91,494

General and administrative
51,159

 
53,139

 
52,441

Operating income
46,278

 
42,201

 
40,438

Other income (expense):
 
 
 
 
 
Interest income
55

 
55

 
78

Interest expense
(81,662
)
 
(75,700
)
 
(74,934
)
Other
(123
)
 
(84
)
 
(55
)
Change in warrant value
9,894

 
—

 
—

Gain (loss) on debt extinguishment
(11,458
)
 
3,913

 
—

Total other expenses
(83,294
)
 
(71,816
)
 
(74,911
)
Loss before income taxes
(37,016
)
 
(29,615
)
 
(34,473
)
Income tax expense
(6,980
)
 
(6,977
)
 
(6,974
)
Net loss
$
(43,996
)
 
$
(36,592
)
 
$
(41,447
)
Basic and diluted loss per share
$
(5.53
)
 
$
(5.39
)
 
$
(6.74
)
Basic and diluted weighted average common shares outstanding
7,952,248

 
6,787,660

 
6,148,438

Net loss
$
(43,996
)
 
$
(36,592
)
 
$
(41,447
)
Other comprehensive income:
 
 
 
 
 
Post-retirement actuarial gains (loss)
(149
)
 
279

 
26

Comprehensive loss
$
(44,145
)
 
$
(36,313
)
 
$
(41,421
)
See accompanying notes to consolidated financial statements.


56

ALION SCIENCE AND TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF REDEEMABLE COMMON STOCK,
AND STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED September 30, 2014, 2013, AND 2012
 
 
Redeemable Common
Stock
 
Series A Preferred Stock
 
Common
Stock
Warrants
 
Comprehensive
Loss
 
Accumulated
Deficit
 
Shares
 
Amount
 
Shares
 
Amount
 
 
(In thousands, except share and per share information)
Balance at September 30, 2011
6,041,029

 
$
126,560

 
 
 
 
 
$
20,785

 
 
 
(258,125
)
Redeemable common stock issued
938,492

 
16,162

 
—

 
—

 
—

 


 
—

Redeemable common stock retired
(247,632
)
 
(4,843
)
 
—

 
—

 
—

 


 
—

Change in common stock redemption value
—

 
(27,139
)
 
—

 
—

 
—

 


 
27,139

Post-retirement medical plan actuarial benefit
—

 
—

 
—

 
—

 
—

 
26

 
—

Net loss for year ended September 30, 2012
—

 
—

 
—

 
—

 
—

 
(41,447
)
 
(41,447
)
Comprehensive loss for year ended September 30, 2012
—

 
—

 
—

 
—

 
—

 
(41,421
)
 
—

Balance at September 30, 2012
6,731,889

 
110,740

 
—

 
—

 
20,785

 
 
 
(272,433
)
Redeemable common stock issued
1,316,594

 
14,794

 
—

 
—

 
—

 


 
—

Redeemable common stock retired
(407,092
)
 
(6,664
)
 
—

 
—

 
—

 


 
—

Change in common stock redemption value
—

 
(56,975
)
 
—

 
—

 
—

 


 
56,975

Post-retirement medical plan actuarial benefit
—

 
—

 
—

 
—

 
—

 
279

 
—

Net loss for year ended September 30, 2013
—

 
—

 
—

 
—

 
—

 
(36,592
)
 
(36,592
)
Comprehensive loss for year ended September 30, 2013
—

 
—

 
—

 
—

 
—

 
(36,313
)
 
—

Balance at September 30, 2013
7,641,391

 
61,895

 
—

 
—

 
20,785

 
 
 
(252,050
)
Redeemable common stock issued
5,888,653

 
15,080

 
—

 
—

 
—

 


 
—

Redeemable common stock retired
(420,002
)
 
(2,284
)
 
—

 
—

 
—

 


 
—

Series A preferred stock issued
—

 
—

 
70

 
2,339

 
—

 


 
—

Change in common stock redemption value
—

 
(42,571
)
 
—

 
—

 
—

 


 
42,571

Post-retirement medical plan actuarial expense
—

 
—

 
—

 
—

 
—

 
(149
)
 
—

Net loss for year ended September 30, 2014
—

 
—

 
—

 
—

 
—

 
(43,996
)
 
(43,996
)
Comprehensive loss for year ended September 30, 2014
—

 
—

 
—

 
—

 
—

 
(44,145
)
 
—

Balance at September 30, 2014
13,110,042

 
32,120

 
70

 
$
2,339

 
20,785

 
 
 
(253,475
)
See accompanying notes to consolidated financial statements.


57

ALION SCIENCE AND TECHNOLOGY
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
Year Ended September 30,
 
2014
 
2013
 
2012
 
(In thousands)
Cash flows from operating activities:
 
 
 
 
 
Net loss
$
(43,996
)
 
$
(36,592
)
 
$
(41,447
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
 
Depreciation and amortization
4,794

 
7,363

 
11,741

Paid-in-kind interest
10,072

 
6,551

 
6,423

Bad debt expense
250

 
367

 
802

Amortization of debt issuance costs
11,449

 
10,571

 
10,421

Incentive and stock-based compensation
1,901

 
2,065

 
1,310

Loss (gain) on debt extinguishment
1,244

 
(3,913
)
 
—

Change in warrant fair value
(9,894
)

—


—

Deferred income taxes
6,974

 
6,974

 
6,974

Other gains
(700
)
 
(151
)
 
(95
)
Changes in assets and liabilities:
 
 
 
 
 
Accounts receivable
859

 
2,323

 
4,269

Other assets
(1,568
)
 
733

 
4,122

Trade accounts payable
(6,089
)
 
16,829

 
(7,562
)
Accrued liabilities
19,086

 
(4,122
)
 
16,513

Interest payable
(14,782
)
 
100

 
266

Other liabilities
(2,877
)
 
1,685

 
(1,056
)
Net cash (used in) provided by operating activities
(23,277
)
 
10,783

 
12,681

Cash flows from investing activities:
 
 
 
 
 
Capital expenditures
(1,182
)
 
(1,869
)
 
(2,731
)
Asset sales proceeds
1,596

 
—

 
—

Net cash provided by (used in) investing activities
414

 
(1,869
)
 
(2,731
)
Cash flows from financing activities:
 
 
 
 
 
        Proceeds from sale of first lien term loans:
 
 
 
 
 
   Tranche A
107,800

 
—

 
—

   Tranche B
169,200

 
—

 
—

Proceeds from second lien term loan, sale of preferred shares and common stock warrants
66,150

 
—

 
—

Proceeds from third lien notes
1,711

 
—

 
—

Payment of debt issue costs
(30,505
)
 
—

 
—

Repurchase of secured notes
(338,959
)
 
—

 
—

Repayment of first lien notes
(4,188
)
 
—

 
—

Retirement of unsecured notes
(4,876
)
 
—

 
—

Repurchase of unsecured notes
—

 
(6,030
)
 
—

Revolver borrowings
78,000

 
16,461

 
26,000

Revolver repayments
(35,000
)
 
(16,461
)
 
(26,000
)
Loan to ESOP Trust
(855
)
 
(1,907
)
 
(477
)
ESOP loan repayment
855

 
1,907

 
477

Redeemable common stock purchased from ESOP Trust
(2,285
)
 
(6,664
)
 
(4,843
)
Redeemable common stock sold to ESOP Trust
934

 
2,166

 
1,302

Net cash used in financing activities
7,982

 
(10,528
)
 
(3,541
)
Net increase (decrease) in cash and cash equivalents
(14,881
)
 
(1,614
)
 
6,409

Cash and cash equivalents at beginning of period
25,613

 
27,227

 
20,818

Cash and cash equivalents at end of period
$
10,732

 
$
25,613

 
$
27,227

Supplemental disclosure of cash flow information:
 
 
 
 
 

58

Cash paid for interest
$
75,000

 
$
58,460

 
$
57,755

Cash paid (received) for taxes
11

 
2

 
—

Non-cash investing and financing activities:
 
 
 
 
 
Common stock issued to ESOP Trust in satisfaction of employer contribution liability
$
14,145

 
$
13,757

 
$
13,732

Landlord funded leasehold improvements
$
60

 
$
493

 
$
1,841

Unsecured Notes exchanged for Third Lien Notes
$
208,135

 
$
—

 
$
—

Preferred Stock issued in Refinancing Transaction
$
2,339

 
$
—

 
$
—

Common stock warrant issued in Refinancing Transaction
$
16,412

 
$
—

 
$
—

See accompanying notes to consolidated financial statements.

59

ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Description and Formation of the Business
Alion Science and Technology Corporation and its subsidiaries (collectively, the Company, Alion or we) provide advanced engineering, information technology, naval architecture and operational solutions to strengthen national security and drive business results. For customers in defense, civilian government, foreign governments and commercial industries worldwide, Alion’s engineered solutions support smarter decision-making and enhanced readiness in rapidly-changing environments.
Alion was formed as a for-profit S-Corporation in October 2001, to purchase substantially all of the assets and certain liabilities of IIT Research Institute (IITRI), a not-for-profit corporation controlled by the Illinois Institute of Technology (IIT). In December 2002, Alion acquired substantially all of IITRI’s assets and liabilities except its Life Sciences Operation, for $127.3 million. Prior to that, the Company’s activities were organizational in nature. In 2010, the Company became a C corporation when it ceased to qualify as an S corporation.

(2) Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying audited consolidated financial statements include the accounts of Alion Science and Technology Corporation (a Delaware corporation) and its wholly-owned subsidiaries and have been prepared in accordance with U.S. generally accepted accounting principles on the accrual basis of accounting. The statements include the accounts of Alion and its wholly-owned subsidiaries from date of formation or acquisition. All inter-company accounts have been eliminated in consolidation. The wholly-owned subsidiaries are:
 
•
Innovative Technology Solutions Corporation (ITSC) – acquired October 2003
•
Alion - IPS Corporation (IPS) – acquired February 2004
•
Alion - METI Corporation (METI) – acquired February 2005
•
Alion - CATI Corporation (CATI) – acquired February 2005
•
Alion International Corporation (Alion International) – established February 2005
•
Alion Science and Technology (Canada) Corporation – established February 2005
•
Alion - JJMA Corporation (JJMA) – acquired April 2005
•
Alion - BMH Corporation (BMH) – acquired February 2006
•
Washington Consulting, Inc. (WCI) – acquired February 2006
•
Alion—MA&D Corporation (MA&D) – acquired May 2006
•
Alion Offshore Services, Inc. (Alion Offshore) – established May 2006
•
Washington Consulting Government Services, Inc. (WCGS) – established July 2007
•
Alion Asia Corporation (Alion Asia) – established May 2012
•
Alion Maritime India Private Limited (Alion India) – established May 2013

The accompanying financial statements are prepared on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.  Although our liabilities exceed our assets, we were able to refinance our prior debt and increase our revolving credit borrowing capacity.  Management's current cash flow forecasts indicate that Alion's operating cash flows and sources of liquidity, including the deferment of certain liabilities, will be sufficient to meet debt service payments including cash payable interest and required principal payments for at least the next fifteen months.  In each of the past three fiscal years, Alion generated sufficient cash flow from operations and financing activities to fulfill its financial commitments, including debt service.

            Management’s current forecasts of future results could differ materially due to general economic and Congressional budget uncertainties, sequestration’s effect on future government spending levels, procurement and contract funding delays and other risks associated with future federal government procurement and contracting actions.   Alion depends heavily on federal government prime contracts and subcontracts which account for nearly all the Company’s revenue. Interruptions in the government funding process, whether from federal budget delays, debt ceiling limitations, government shutdowns, sequestration or Department of Defense spending cuts could materially adversely affect  the Company’s future revenue and cash flows.

Fiscal, Quarter and Interim Periods


60
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Use of Estimates

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

The Company is highly leveraged, before and after the refinancing completed in August 2014. As of September 30, 2014, the Company had approximately $629 million of long-term debt outstanding. Over the next year, the interest and principal payments due under our various debt agreements are approximately $43.5 million and $43.2 million, respectively. As of September 30, 2014, the Company has $17.3 million available on its revolving credit facility and has the ability to borrow an additional $6.5 million under that facility.

The Company's high level of debt could have adverse effects on its business and financial condition. Specifically, the Company's high level of debt could have important consequences, including the following:

•
making it more difficult for the Company to satisfy obligations including our repurchase obligations to ESOP participants;
•
limiting the Company's ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions or other general corporate requirements;
•
requiring a substantial portion of the Company's cash flows to be dedicated to debt service payments instead of other purposes;
•
increasing the Company's vulnerability to general adverse economic and industry conditions;
•
limiting the Company's ability to execute on its business plans and flexibility in planning for and reacting to changes in the industry in which the Company competes;
•
placing the Company at a disadvantage compared to other, less leveraged competitors; and
•
increasing the Company's cost of borrowing.

The Company's ability to continue as a going concern and make our scheduled payments depends on and is subject to its financial and operating performance, which in turn is affected by general economic, financial, competitive, business and other factors beyond the Company's control, including the availability of financing in the international banking and capital markets.

The Company has several initiatives designed to increase revenue and profitability through improvement in program execution, cost reductions and avoidance initiatives, improvements that will reduce the Company’s DSO, reductions in our unbilled receivables, and moving in to more profitable business sectors. There can be no assurance, however, that these actions will be successful. If we are unable to generate sufficient funds from operations or raise additional capital, there could be material adverse effects on our liquidity.

Although the Company is significantly leveraged, it expects that the current cash balances, liquidity from its revolver, deferring expenditures, reducing overhead, securing rent abatements, collecting approved award fees related to past periods and cash generated from operations will be sufficient to meet working capital, capital expenditure, debt service, and other cash needs for the next year; however, there can be no assurances that the Company will be able to generate sufficient cash flows to fund its operations and service its debt for the next year.

Summary of Critical Accounting Policies

Revenue Recognition

Alion derives its revenue from delivering technology services under three types of contracts. Some contracts provide for reimbursement of costs plus fees; others are fixed-price or time-and-material type contracts. We recognize revenue when a contract has been executed, the contract price is fixed or determinable, delivery of services or products has occurred, and our

61
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ability to collect the contract price is considered reasonably assured. Alion applies the percentage-of-completion method in Accounting Standards Codification (ASC) 605 – Revenue Recognition to recognize revenue.
 
Alion recognizes revenue on cost-reimbursement contracts as it incurs costs and includes estimated fees earned. The Company recognizes time-and-material contract revenue at negotiated, fixed, contractually billable rates as it delivers labor hours and incurs other direct expenses. We use various performance measures under the percentage-of-completion method to recognize revenue for fixed-price contracts. Estimating contract costs at completion and recognizing revenue appropriately involve significant management estimates. Actual costs may differ from estimated costs and affect estimated profitability and revenue recognition timing. From time to time, facts develop that require us to revise estimated total costs or expected revenue. We record the cumulative effect of revised estimates in the period when the facts requiring revised estimates become known. We recognize the full amount of anticipated losses on any contract in the period a loss becomes known. For each of the periods presented, the cumulative effects of revised estimates were immaterial to the Company’s financial performance.

U.S. federal government contracts are subject to periodic funding by our contracting agency customers. A customer may fund a contract at inception or incrementally throughout the period of performance as services are provided. If we determine contract funding is not probable, we defer revenue recognition until realization is probable. The federal government can audit Alion’s contract costs and adjust amounts through negotiation. The federal government considers Alion a major contractor and maintains an office on site. The Defense Contract Audit Agency (DCAA) is currently auditing our 2008 claimed indirect costs. We have settled our rates through 2007. We timely submitted our indirect cost proposals for all open fiscal years. We have recorded revenue on federal government contracts in amounts we expect to realize.

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

Income Taxes

Alion accounts for income taxes by applying the provisions in currently enacted tax laws. We determine deferred income taxes based on the estimated future tax effects of differences between the financial statement and tax bases of our assets and liabilities. Deferred income tax provisions and benefits change as assets or liabilities change from year to year. In providing for deferred taxes, Alion considers the tax regulations of the jurisdictions where we operate; estimated future taxable income; and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies change, the carrying value of deferred tax assets and liabilities may require adjustment.

Alion has a history of operating losses for both tax and financial statement purposes. The Company has recorded valuation allowances equal to deferred tax assets based on the likelihood that we may not be able to realize the value of these assets. Alion recognizes the benefit of a tax position only after determining that the relevant tax authority would “more likely than not” sustain our position following an audit. For tax positions meeting the “more likely than not” threshold, we recognize the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.

Cash and Cash Equivalents

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

Accounts Receivable and Billings in Excess of Revenue Earned

Accounts receivable include billed accounts receivable and unbilled receivables. Unbilled receivables consist of costs and fees which are billable upon occurrence of a specific event, amounts billable after the balance sheet date and revenue in excess of billings on uncompleted contracts (accumulated project expenses and fees which were not billed or were not currently billable as of the date of the consolidated balance sheet). Unbilled accounts receivable include revenue recognized for customer-requested work Alion performed on new and existing contracts for which the Company had not received contracts or contract modifications. Accounts receivable are stated as estimated realized value. The allowance for doubtful accounts is Alion’s best estimate of the amount of probable losses in the Company’s existing billed and unbilled accounts receivable. The Company determines the allowance using specific identification and historical write-off experience based on receivable age.

62
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Billings in excess of revenue and advance collections from customers represent amounts received from or billed to customers in excess of project revenue recognized to date.
 
Property, Plant and Equipment

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

Goodwill

Alion assigns the purchase price paid to acquire the stock or assets of a business to the net assets acquired based on the estimated fair value of assets acquired and liabilities assumed. Goodwill is the purchase price in excess of the estimated fair value of the tangible net assets and separately identified intangible assets acquired. There have been no changes to goodwill carrying value in fiscal 2014.

The Company accounts for goodwill and other intangible assets in accordance with the provisions of ASC 350 - Intangibles-Goodwill and Other. Alion operates in one segment and tests goodwill at the reporting unit level. There are two reporting units. We do not allocate corporate debt to our reporting units. We treat our corporate debt as part of our capital structure.

We review goodwill for impairment in the fourth quarter each year, and whenever events or circumstances indicate goodwill might be impaired. In the third quarter of fiscal 2014, we determined that our declining revenue and the difficulties Alion had experienced in accessing capital and concluding a refinancing transaction were indicators that goodwill might be impaired. We conducted a full Step One impairment test as of June 30, 2014 and determined goodwill was not impaired. As, discussed in the Goodwill Note, in September 2014, we elected to perform a Step Zero analysis based on favorable changes in Alion's circumstances such as improved fourth quarter financial performance and Alion having successfully concluded its August 2014 Refinancing Transactions.

We are required to recognize an impairment loss to the extent our goodwill carrying value at the reporting unit level exceeds fair value. Evaluating goodwill involves significant management estimates. To date, none of our reviews resulted in a goodwill impairment adjustment. See Note 9 for a detailed discussion of the Company’s goodwill impairment testing process.

Intangible Assets

Alion amortizes intangible assets as it consumes economic benefits over estimated useful lives. As of September 30, 2014, the Company had approximately $1.0 million in net intangible assets, including contracts purchased in the JJMA acquisition and purchased software licenses. The JJMA contract portfolio has a remaining useful life of approximately 1.4 years.

Redeemable Common Stock

There is no public market for Alion’s redeemable common stock and therefore no observable price for its equity, individually or in the aggregate. The Employee Stock Ownership Plan (ESOP) Trust holds all the Company’s outstanding common stock. Under certain circumstances, ESOP beneficiaries can require the ESOP Trust to distribute the value of their beneficial interests. The Internal Revenue Code (IRC) and the Employee Retirement Income Security Act (ERISA) require the Company to offer ESOP participants who receive Alion common stock a liquidity put right. The put right requires the Company to purchase distributed shares at a price per share determined by the ESOP trustee on the most recent valuation date at any time during two put option periods. Common stock distributed by the ESOP Trust is subject to a right of first refusal. Prior to any subsequent transfer, shares must first be offered to the Company and then to the ESOP Trust. Eventual redemption of shares of Alion common stock as a result of distributions is outside the Company’s control. Therefore, Alion classifies its outstanding shares of redeemable common stock as other than permanent equity.

At each reporting date, Alion is required to increase or decrease the reported value of its outstanding common stock to reflect its estimated redemption value. Management estimates the value of Alion’s obligation to repurchase its outstanding shares of redeemable common stock by considering, in part, the most recent price at which the Company was able to sell shares

63
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

to the ESOP Trust. The reported value of outstanding redeemable common stock equals the current share price multiplied by total shares issued and outstanding.

In its fiduciary capacity, the ESOP Trustee is independent of the Company and its management. Consistent with its fiduciary responsibilities, the ESOP Trustee retains an independent third party valuation firm to assist it in determining the value (share price) at which the ESOP Trustee may acquire or dispose of investments in Alion common stock. The Audit and Finance Committee of Alion’s Board of Directors reviews the reasonableness of the amount management has determined Alion should recognize for the Company’s obligation to repurchase shares of its outstanding redeemable common stock. The Audit and Finance Committee considers various factors in its review, including, in part, the most recent valuation report prepared for, and the share price selected by the ESOP Trustee.
 
Alion records changes in the reported value of its outstanding redeemable common stock through an offsetting charge or credit to accumulated deficit. The Company recognized a change in the value as determined by the ESOP trustee of its redeemable common stock in connection with the September 30, 2014 ESOP valuation.

Alion's accumulated deficit at September 30, 2014, includes a $110.1 million cumulative benefit for declines in its share price through September 2014 which reduced the Company's aggregate ESOP share redemption obligation. Outstanding redeemable common stock had an aggregate redemption value of approximately $32.1 million as of September 30, 2014.

Concentration of Credit Risk

Alion is subject to credit risk for its cash equivalents and accounts receivable. The Company believes the high credit quality of its cash equivalent investments limits its credit risk with respect to such investments. Alion believes its concentration of credit risk with respect to accounts receivable is limited as the receivables are principally due from the federal government. Approximately 21% of the Company’s receivables are due from commercial customers including other prime contractors.

Fair Value of Financial Instruments

Alion is required to disclose the fair value of its financial instruments, but is not required to record its senior long term debt at fair value. See Note 11 for a discussion of Alion’s long term debt and Note 12 for the related fair value disclosures. The fair value of cash, cash equivalents, accounts payable and accounts receivable is not materially different from carrying value because of the short maturity of those instruments.

Off-Balance Sheet Financing Arrangements

Alion accounts for operating leases entered into in the routine course of business in accordance with ASC 840 Leases. We have no off-balance sheet financing arrangements other than operating leases and letters of credit under our revolving credit facility. Alion has no relationship with any unconsolidated or special purpose entity and has not issued any guarantees.

Recently Issued Accounting Pronouncements

In May 2014 the FASB issued Accounting Standards Update 2014-09 (ASU 2014-09), “Revenue from Contracts with Customers” which requires an entity to recognize revenue when a customer obtains control rather than when an entity has transferred substantially all risks and rewards of a good or service. This update is effective for annual reporting periods beginning on or after December 15, 2016 and interim periods therein and requires expanded disclosures. We are currently assessing the impact adopting ASU 2014-09 will have on our operating results, financial position and cash flows.
    
In August 2014, the FASB issued Accounting Standards Update 2014-15 ("ASU 2014-15") "Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern". ASU 2014-15 defines management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. GAAP-basis financial statements are prepared under the presumption a reporting organization will continue to operate as a going concern. The presumption, commonly called the going concern basis of accounting, establishes the basis for measuring and classifying assets and liabilities.

ASU 2014-15 provides the guidance GAAP currently lacks regarding management’s responsibilities related to going concern analysis and disclosures. It establishes principles and definitions intended to reduce diversity in both timing and content for financial statement disclosures. ASU 2014 -15 is effective for annual periods ending after December 15, 2016, including interim periods within that reporting period. Early application is permitted for annual or interim reporting periods for

64
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

which financial statements have not been issued. The Company does not believe that adopting ASU 2014-15 will materially affect its operating results, financial position or cash flows.

(3) Employee Stock Ownership Plan (ESOP) and ESOP Trust
    
In December 2001, the Company adopted the Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan (the Plan, the KSOP) and established the ESOP Trust. The Plan, a tax qualified retirement plan, includes an ESOP and a 401(k) component. In September 2013, the Internal Revenue Service (IRS) issued a determination letter that the ESOP Trust and the Plan, as amended and restated effective as of October 1, 2011, qualify under IRC Sections 401(a) and 501(a).
    
In September 2013, Alion adopted Amendment No. 1 to the Plan to eliminate the one-year service requirement for eligibility to receive profit sharing contributions under the Plan. Amendment No.1 was effective October 1, 2013. Also in September 2013, Alion adopted Amendment No. 2 to the Plan to delay transfer to the Company of employee salary deferrals, rollovers and transfers to be invested in the Plan’s ESOP component and to permit Alion to delay its employer contribution to the Plan for the six months ended September 30, 2013. Although Amendment No. 2 permitted delaying Alion’s common stock valuation, the ESOP Trustee and its independent third-party valuation firm completed the September 2013 ESOP valuation in November 2013, a time frame comparable to prior years. Alion did not delay its fiscal 2013 year end employer contribution to the Plan. In December 2013, the ESOP Trustee used employee salary deferrals, rollovers, and transfers from the second half of fiscal 2013 to purchase shares of Alion common stock at $8.10 per share based on the September 2013 ESOP valuation.

In March 2014, Alion adopted Amendments Nos. 3 and 4 to the Plan. Amendment No. 3 closed the Plan to employees covered by the Service Contract Act hired or re-hired after September 30, 2014. Existing Service Contract Act employees covered by the Plan remain in the Plan as grandfathered participants.

Amendment No. 4 permitted delaying the fiscal 2014 mid-year ESOP valuation. In August 2014, after the Company concluded its Refinancing Transactions, the ESOP Trustee and its independent third-party valuation firm completed the fiscal 2014 mid-year Alion common stock valuation. The delayed mid-year valuation established the fair market value of a share of Alion common stock at $2.45. In August 2014, Alion made its mid-year employer contribution based on the $2.45 share price. Also, in August 2014, the ESOP Trustee decided not to invest October 2013 to March 2014 employee salary deferrals, rollovers, and transfers in the Plan’s ESOP component and re-directed employee salary deferrals to their 401(k) investment accounts. The fiscal 2014 year-end ESOP valuation as of September 30, 2014 determined Alion's share price was unchanged at $2.45 per share.

In September 2014, Alion adopted Amendment No. 5 to the Plan effective as of October 1, 2014. Amendment No. 5. eliminated future mid-year valuations and contributions. Beginning October 1, 2014, the Plan's valuation and contribution date will be September 30th of each year. Also in September 2014, the Plan Administrator eliminated the option for employees to invest salary deferrals, rollovers or transfers in the ESOP component of the Plan. The Company believes the Plan and the ESOP Trust have been designed and are being operated in compliance with all applicable IRC requirements.
(4) Loss Per Share
In connection with Alion's August 2014 Refinancing Transactions, the Company issued one new class of in-the-money penny warrants deemed to be participating securities. As a result, the Company is required to use the two-class method to compute earnings per share. The penny warrants Alion issued in March 2010 are not participating securities. Because Alion has had losses each of the past three years, both the new class of warrants issued in fiscal 2014 and the penny warrants issued in March 2010 are anti-dilutive for all periods presented. The warrants are anti-dilutive even after including required adjustments to the earnings per share numerator.
Alion computes basic and diluted loss per share by dividing net loss by the weighted average number of common shares outstanding. If Alion were to become profitable and warrant holders were to exercise their rights to acquire shares of Alion common stock, any such shares issued to warrant holders would dilute future earnings per share. At September 30, 2014, if all warrant holders were to exercise their rights, Alion would have to issue 10,773,816 additional shares.

On August 18, 2014, Alion issued Second Lien lenders a warrant (Second Lien Warrants) with the right to purchase shares equal to 12.5% of Alion's total common stock at a penny-per-share strike price. At the same time, Alion also issued Third Lien penny warrants (Third Lien Warrants) with the right to purchase 27.5% of the Company's total common stock. Both sets of warrants have the same rights and privileges, constitute a single class of warrant, are currently exercisable and expire August 17, 2024. The Second and Third Lien Warrants have anti-dilution protections. At September 30, 2014, the Company

65

had reserved 9,727,040 shares to satisfy potential warrant exercise demands of the Second Lien lenders and Third Lien Note holders.

In March 2010, Alion issued its now-extinguished Secured Notes and accompanying penny warrants (Secured Note Warrants) to purchase 602,614 shares of Alion common stock. As of a result issuing the Second and Third Lien Warrants, anti-dilution protections in the Secured Note Warrants could entitle holders to purchase up to 1,046,776 shares of Alion common stock if Second and Third Lien Warrant holders were to exercise their purchase rights. The Secured Note Warrants are currently exercisable and expire March 15, 2017.
None of the Company's warrants is redeemable or puttable. The 2010 warrants are classified as permanent equity. The Second and Third Lien Warrants are classified as a liability, as they are not considered indexed to the Company’s stock.  As such, the Second and Third Lien Warrants were initially measured at fair value and classified as liabilities on the balance sheet.  Subsequent changes in fair value have been recorded in earnings.

(5) Redeemable Common Stock

The ESOP Trust owns substantially all of Alion’s issued and outstanding common stock, for the benefit of current and former employee participants in the Alion KSOP. The issued and outstanding common stock held by the ESOP represents less than 60% of Alion's total authorized shares. The Company has reserved over 40% of its authorized shares to satisfy the three classes of outstanding penny warrants the Company has issued.

ESOP participants and beneficiaries are entitled to a distribution of the value as determined by the ESOP trustee of their vested account balance upon death, disability, retirement or termination of employment. The Plan permits distributions to be paid over a five-year period commencing the year after a participant’s retirement at age 65, death or disability. Alion can delay distributions to other terminating participants for six years before commencing payment over a subsequent five-year period. The Company intends to pay distribution requests in annual installments and defer initial payments as permitted.

Terminating ESOP participants can hold or immediately sell their distributed shares to the Company. If a participant elects to hold distributed shares, the IRC and ERISA require Alion to offer a put option to allow the recipient to sell stock to Alion at the price per share determined by the ESOP trustee on the most recent valuation date. The Company was able to sell shares to the ESOP Trust was $2.45 at August 20, 2014 and $2.45 at September 30, 2014. The put right requires Alion to purchase distributed shares during two put option periods at the most recent price determined by the ESOP Trustee.

Consistent with its duty of independence from Alion management and its fiduciary responsibilities, the ESOP Trustee retains an independent third party valuation firm to assist it in determining the value (share price) at which the Trustee may acquire or dispose of investments in Alion common stock.

Alion management determines, and the Board of Directors’ Audit and Finance Committee reviews, the reasonableness of Alion’s recorded redeemable common stock liability. The Audit and Finance Committee considers various factors in its review, including in part, the ESOP valuation report and the share price selected by the ESOP Trustee. Management also considers the share price selected by the ESOP Trustee along with other factors in estimating Alion’s aggregate liability for outstanding redeemable common stock.

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

(6) Preferred Stock

On August 18, 2014, Alion issued 70 shares of Series A Preferred Stock to the Second Lien lenders. The Company issued 55 of the 70 shares to ASOF and the balance to Phoenix , the other Second Lien lender. The 70 shares of Series A Preferred Stock are the only preferred stock of the Company. The 70 shares of Series A Preferred Stock have: a penny per share par value; a $10.00 per share liquidation preference; no dividend rights; no conversion rights; rank superior to the common stock of the Company; and are not redeemable by the Company.

Alion executed a Preferred Stock Certificate of Designation that set out the rights of holders of Alion’s Series A Preferred Stock. The holders of a majority of the Series A Preferred Stock have the right, but are not required, to elect a majority of Alion’s directors. The majority of each committee of the Board of Directors must be comprised of directors elected by the holders of the Series A Preferred Stock. Directors elected by the holders of Series A Preferred Stock have supervoting

66

rights as compared to directors elected by Alion’s stockholders generally, and the vote of the majority of the directors elected by the Series A Preferred Stock at a meeting of the Board of Directors or any committee thereof is required for any action to be approved by the Board of Directors or any committee thereof.
A majority vote by holders of the Series A Preferred Stock is deemed to be a majority vote of all of Alion’s voting stock and is necessary and sufficient to approve any and all matters that require a shareholder vote. The Series A Preferred Stock is voted as a block as determined by the holders of a majority of the Series A Preferred Stock, currently ASOF. The consent of the holders of a majority of the Series A Preferred Stock is required for Alion to do, among other things, the following:
•
change the nature of our business;
•
amend our charter, by laws or other organizational documents or those of our Subsidiaries;
•
approve our annual budget;
•
create liens on our assets;
•
transfer or sell assets outside the ordinary course of our business;
•
make any acquisitions and investments other than in the ordinary course of our business;
•
enter into or amend any transaction with affiliates;
•
merge or consolidate with another company;
•
make or pay any dividends or other distributions on account of our common stock (other than ESOP distributions and those permitted under our new Stockholders’ Agreement);
•
authorize certain capital expenditures;
•
make optional prepayments on certain of our debt;
•
incur additional debt other than certain permitted debt; and
•
amend our ESOP.

(7) Accounts Receivable
Accounts receivable at September 30 consisted of the following:
 
September 30,
 
2014
 
2013
 
(In thousands)
Billed receivables and amounts billable as of the balance sheet date
$
105,229

 
$
102,211

Unbilled receivables:
 
 
 
Amounts billable after the balance sheet date
36,691

 
36,693

Revenues recorded in excess of milestone billings on fixed price contracts
2,813

 
3,289

Revenues recorded in excess of estimated contract value or funding
14,652

 
14,605

Retainages and other amounts billable upon contract completion
16,034

 
19,557

Allowance for doubtful accounts
(3,924
)
 
(3,751
)
Total Accounts Receivable
$
171,495

 
$
172,604


Billed accounts receivable include invoices issued to customers for services performed as of the balance sheet date. Unbilled accounts receivable represent revenue recognized as of the balance sheet date for which Alion has yet to issue invoices to customers. Amounts that are currently billable are expected to be invoiced to customers within the next twelve months. Fixed-price contract revenue in excess of milestone billings is not yet contractually billable. Revenue in excess of contract value or funding is billable when Alion receives contract amendments or modifications. Approximately $138.4 million (79)% and $137.5 million (78)% of contract receivables at September 30, 2014 and September 30, 2013 were from federal government prime contracts.

At September 30, 2014, Alion recognized $70.2 million in revenue in excess of billings on uncompleted contracts including approximately $14.7 million for customer-requested work for which the Company had not received contracts or contract modifications. At September 30, 2013, Alion had recognized $74.1 million in revenue in excess of billings on uncompleted contracts including approximately $14.6 million for customer-requested work for which the Company had not received contracts or contract modifications.

Retainages and other unbilled amounts are billable upon contract completion or completion of DCAA audits. In keeping with industry practice, Alion classifies all contract-related accounts receivable as current assets based on contractual

67
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

operating cycles which frequently exceed one year. Except for $16.0 million at September 30, 2014, the Company expects to invoice and collect unbilled receivables within the next twelve months.
(8) Property, Plant and Equipment
 
 
September 30,
 
2014
 
2013
 
(In thousands)
Leasehold improvements
$
12,628

 
$
12,984

Equipment and software
34,343

 
35,203

Total cost
46,971

 
48,187

Less: accumulated depreciation and amortization
(39,905
)
 
(38,519
)
Net Property, Plant and Equipment
$
7,066

 
$
9,668


Depreciation and leasehold amortization expense for fixed assets was approximately $2.8 million, $3.3 million, and $4.3 million for the years ended September 30, 2014, 2013, and 2012.
 
(9) Goodwill

The Company accounts for goodwill and other intangible assets according to ASC 350 Intangibles - Goodwill and Other (ASC 350) which requires that Alion review goodwill at least annually for impairment or more frequently if events or circumstances indicate goodwill might be impaired. The Company performs this review at the end of each fiscal year.

In fiscal 2014, the Company experienced difficulties in accessing the capital markets, delays in its refinancing efforts and declining revenue, all of which indicated to management that as of June 30, 2014 goodwill might be impaired. As a result, management tested goodwill for potential impairment as of June 30, 2014. Management's June 2014 Step One test indicated that Alion's goodwill was not impaired as of June 30, 2014. In September 2014, management elected to perform a qualitative Step Zero analysis of Alion's goodwill to evaluate goodwill for potential impairment.

Since its June 2014 goodwill impairment evaluation, Alion experienced several favorable financial changes. In August 2014 Alion refinanced over 96% of its debt; increased its borrowing capacity and experienced favorable changes in its credit ratings. Fiscal 2014 revenue increased 3.1% over annualized third quarter year-to-date revenue. Revenue increased for the Company and each reporting unit. Fiscal 2014 EBITDA increased 15.6% from June 2014 annualized levels for the Company. Each reporting unit also saw increased EBITDA. At September 2014, executed funded contract backlog reached an all-time high of more than $630 million a 56% increase over last June’s $404 million in funded backlog. Based on stock market performance of publicly-traded government contractors, valuation market multiples appear to have remained stable, if not increased.

As part of its current analysis, management determined that Alion has the cash flow and borrowing capacity to pay its operating expenses, including subcontractors, while managing its debt load and timely paying interest and principal when and as due. Management's cash flow forecast indicates that Alion is expected to have sufficient cash flow to handle loan amortization demands and also repay $24.0 million in remaining Unsecured Notes due February 1, 2015.

As of September 30, 2013 and 2014, Alion had approximately $398.9 million in goodwill. There were no changes to the goodwill carrying amount for the years ended September 30, 2014 and 2013.

Alion operates in one segment and tests goodwill at the reporting unit level. Each of Alion’s two reporting units delivers a similar set of professional engineering, scientific and technical services to a wide array of federal government customers, principally within the Department of Defense. Each reporting unit provides the full range of services Alion offers to customers overall.

Alion’s management has organized reporting units based on managerial responsibility and administrative structure, contract portfolios, and the availability of discrete financial information. Management evaluates reporting unit financial performance based on contract revenue and non-GAAP operating income. Alion does not maintain reporting unit balance sheets and does not track cash flows by reporting unit.

68
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Management identifies reporting units as “sectors” which in turn include lower level business units identified as “groups” consisting of still lower level “operations.” For each business combination, management assigned the goodwill arising from acquisitions to the reporting unit or units expected to benefit from the synergies of that business combination. Coincident with its goodwill determination and purchase price allocation, management assigned assets acquired to reporting units based on the unit or units anticipated to utilize such assets. Management did not allocate to reporting units the liabilities arising from business combinations. Alion’s reporting units are the Engineering and Integration Solutions Sector (EISS) and the Technology, Engineering and Operational Solutions Sector (TEOSS). Management assigned $197.0 million in goodwill to EISS and $201.9 million in goodwill to TEOSS.

In 2013, TEOSS had $477 million in contract revenue and EISS had $371 million in contract revenue. Alion’s reported revenue differs from total reporting unit contract revenue because reporting unit contract revenue did not include $292 thousand in inter-company eliminations, discounts, and GSA industrial funding fees which the Company does not track by reporting unit. In its September 2014 Step Zero analysis, TEOSS and EISS had revenue of $456 million and $350 million for fiscal 2014, with approximately $1.1 million in inter-company eliminations, discounts and GSA industrial funding fees the Company does not track by reporting unit.

Management applied the guidance in ASC 350 and the related guidance in ASC Topic 280 Segment Reporting to analyze Alion’s reporting units to determine the appropriate level at which to test goodwill for potential impairment. The Company employs a reasonable, supportable and consistent method to assign goodwill to reporting units expected to benefit from the synergies arising from acquisitions. Alion determines reporting unit goodwill in a manner similar to the way it determines goodwill in a purchase allocation by using fair value to determine reporting unit purchase price, assets, liabilities and goodwill. Reporting unit residual fair value after this allocation is the implied fair value of reporting unit goodwill. The Company allocates the goodwill related to acquisitions on a specific identification basis consistent with reporting unit structure.

Alion negotiated and executed each of its acquisitions on a cash-free, debt-free basis and therefore did not allocate to its reporting units any of the corporate debt the Company issued to fund its acquisitions. Alion’s debt is part of its capital structure, and therefore this debt has always resided at the corporate level. The Company has consistently applied its accounting policy with regard to assigning assets and liabilities to reporting units and retaining debt at the corporate level. The Company has not allocated its debt to its reporting units either to determine their carrying value or to test reporting unit goodwill for potential impairment.

The Company performs its own independent analysis to determine whether goodwill is potentially impaired. Management performs a discounted cash flow analysis to determine the fair value of each reporting unit. The Company compares the aggregated fair value per the discounted cash flow model to the fair value indicated by the market multiples used in the most recent stock valuation. Management independently determines the rates and assumptions it uses to: perform its goodwill impairment analysis; assess the probability of future contracts and revenue; and evaluate the recoverability of goodwill.

Alion has assigned specific contracts and task orders to each reporting unit which, with goodwill, represent each reporting unit’s principal assets. Although the Company does not maintain complete financial information for its reporting units and therefore is unable to prepare reporting unit balance sheets or statements of cash flows, the Company is able to prepare a discounted cash flow analysis in order to test reporting unit goodwill for potential impairment.

Alion bases its discounted cash flow analysis on each reporting unit’s contract portfolio, anticipated contract revenue stream and historical contract operating margins. Historically, Alion has had minimal interest expense related to operations and low working capital levels which make net contract margins a reliable means of estimating and forecasting reporting unit cash flows.

Cash flow concerns associated with Alion’s current liquidity issues do not materially affect the Company’s goodwill impairment analyses. The Company’s significant interest expense and liquidity demands arise from its various debt instruments, which are part of Alion’s capital structure and thus not allocated to its reporting units. Alion’s operating activities and its reporting units do not face any material interest expense or demands on liquidity that materially affect the Company’s discounted cash flow analysis based on contract portfolios and operating margins.

Alion’s cash flow analysis depends on several significant management inputs and assumptions. Management uses observable inputs, rates and assumptions generally consistent with those used by the independent third party to prepare the

69
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

valuation report for the ESOP Trustee. However, management’s sensitivity analyses also incorporate a more conservative range of growth assumptions in addition to assumptions generally consistent with those used by the independent third party to prepare the valuation report for the ESOP Trust. These sensitivity analyses are designed to stress management’s best estimate of the Company’s financial forecast for purposes of understanding whether a reasonable decline in growth would cause the associated expected discounted cash flows to fall below the reporting units’ carrying value. Management’s cash flow analysis includes the following significant inputs and assumptions: estimated future revenue and revenue growth; estimated future operating margins and EBITDA; observable market multiples for comparable companies; and a discount rate management believes is consistent with a market-based weighted average cost of capital. Management includes EBITDA in its analysis in order to use publicly available valuation data.

In Alion’s fiscal 2013 impairment testing, market multiples for trailing twelve month EBITDA for comparable companies (publicly traded professional services government contractors) ranged from a low of 7.6 to a high of 18.2, with a median value of 13.4. Market multiples for trailing twelve month revenue ranged from a low of 0.30 to a high of 3.01, with a median value of 1.36. Management based its goodwill impairment testing valuation on discounted cash flows, and revenue and EBITDA multiples. Management discounted median market multiples by approximately 30% to reflect Alion’s recent financial performance compared to its peers and the significant uncertainties in the professional services government contracting marketplace likely to adversely affect future financial performance. Management used a weighted average cost of capital rate of 13.0% derived from market-based inputs, the tax-effected interest cost of Alion’s outstanding debt and a hypothetical market participant capital structure. Management estimates future years’ EBITDA based on Alion’s reporting units’ historical adjusted EBITDA as a percentage of revenue. To the extent that management’s analysis included forecasts of future revenue growth, management based such estimates on existing contract backlog, recent contract wins, current year performance and new business opportunities. Management analyzed goodwill for impairment using a range of near-term growth values of 0-4% and a range of 0-4% for longer-term out year forecasts.

There were no changes in fiscal 2014 or fiscal 2013 to the methods used in Step One testing to evaluate goodwill in prior periods. Changes in one or more inputs could materially alter the calculation of Alion’s enterprise fair value and thus the Company’s determination of whether its goodwill is potentially impaired. A hypothetical 10% increase or decrease in the weighted average cost of capital rate at June 30, 2014, would have produced a corresponding 8.6% decrease and 10.5% increase in estimated enterprise value. A similar change in the weighted average cost of capital rate at September 30, 2013, would have produced a corresponding 5.7% decrease and 6.9% increase in estimated enterprise value. Alion’s enterprise value based on discounted cash flows was approximately26% lower at September 30, 2013 than EBITDA multiples from mergers and acquisitions in the government services market place.

Management reviews the Company’s internally-computed enterprise fair value to confirm the reasonableness of the internal analysis and compares the results of its independent analysis with the results of the independent third party valuation report prepared for the ESOP Trustee when such reports are available. Management compares each reporting unit’s carrying amount to its estimated fair value. If a reporting unit’s carrying value exceeds its estimated fair value, the Company compares the reporting unit’s goodwill carrying amount with the corresponding implied fair value of its goodwill. If the carrying amount of reporting unit goodwill exceeds its fair value, the Company recognizes an impairment loss to the extent that the carrying amount of goodwill exceeds implied fair value. Alion performs impairment testing on an enterprise value basis as there is no public market for the Company’s common stock.

Management determined that, on an enterprise value basis, Alion’s reporting units have positive carrying value. Reporting unit carrying values are positive because they do not include any allocation of the corporate debt that is an integral component of the Company’s capital structure. If Alion were to allocate to corporate debt to its reporting units, carrying values would be negative rather than positive.

Alion completed an interim goodwill impairment analysis in the third quarter of fiscal 2014 and concluded no goodwill impairment existed as of June 30, 2014. As of June 30, 2014, the estimated fair value of each reporting unit exceeded its positive carrying value. Consistent with prior disclosures, the decline in estimated discounted cash flows from September 2013 to June 2014 did not result in a goodwill impairment.

The tables below show reporting unit goodwill and carrying value as of September 30, 2014, and goodwill carrying value, estimated fair value, and excess of estimated fair value over carrying value as of September 30, 2013.


70
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
 
 Goodwill
 
Carrying Value
 
at September 30, 2014
Sector
 
(In millions)
TEOSS
 
$
201.9

 
$
184.0

EISS
 
197.0

 
185.4

Total
 
$
398.9

 
$
369.4


 
 
 Goodwill
 
Carrying Value
 
Estimated Fair Value
 
Excess of Estimated Fair Value over Carrying Value
 
at September 30, 2013
Sector
 
(In millions, except percentages)
TEOSS
 
$
201.9

 
$
187.3

 
$
259.2

 
$
71.9

 
38%
EISS
 
197.0

 
184.1

 
222.1

 
38.0

 
21%
Total
 
$
398.9

 
$
371.4

 
$
481.3

 
$
109.9

 
30%
(10) Intangible Assets

The Company accounts for intangible assets according to ASC 350 Intangibles – Goodwill and Other. Intangible assets consist primarily of contracts acquired in the JJMA transaction. The table below shows the intangible assets as of September 30, 2014 and 2013.
 
 
September 30, 2014
 
September 30, 2013
 
Gross
 
Accumulated
Amortization
 
Net
 
Gross
 
Accumulated
Amortization
 
Net
 
(In thousands)
Purchased contracts
$
111,635

 
(110,674
)
 
961

 
$
111,635

 
(109,795
)
 
$
1,840

Internal use software and engineering designs
3,182

 
(3,182
)
 
—

 
3,182

 
(2,982
)
 
200

Total
$
114,817

 
$
(113,856
)

$
961

 
$
114,817

 
$
(112,777
)
 
$
2,040

The weighted-average remaining amortization period of intangible assets was approximately 16 months at September 30, 2014. Amortization expense was approximately $1.1 million, $3.2 million, and $6.5 million, for the years ended September 30, 2014, 2013 and 2012. Estimated aggregate amortization expense for the next four years and thereafter is as follows.
 
Fiscal year ending September 30,
(In thousands)
2015
736

2016
141

2017
51

2018
33

Thereafter
$
—

 
$
961

(11) Long-Term Debt

On August 18, 2014, Alion completed a series of Refinancing Transactions which included:

•
A $65 million amended and restated Credit Agreement with Wells Fargo Bank;
•
$285 million in new First Lien Term Loans; Tranche A for $110 million; and Tranche B for $175 million;
•
A new $70 million Second Lien Term Loan with preferred stock;

71
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

•
$208.1 million in new Third Lien Notes exchanged for approximately 90% of Alion’s Unsecured Notes maturing February 2015 plus $2.9 million in Third Lien Notes issued for cash at a discount;
•
A warrant entitling Second Lien Lenders and Third Lien Note holders to purchase 40.0% of Alion’s total common stock;
•
Extinguishment of $336.4 million in Secured Notes and PIK Notes maturing November 2014; and
•
Eliminating all substantial covenants for $24.0 million in remaining Unsecured Notes due February 2015.

The indentures governing the Third Lien Notes and the Unsecured Notes and the agreements governing the First Lien Term Loans, the Second Lien Term Loan and the Revolving Credit Facility are referred to collectively as the “Debt Instruments.” The tables below present face value and elements of carrying value for Alion’s Debt Instruments as of September 30, 2014 and September 30, 2013.
 
 
At September 30, 2014
 
 
Principal
 
Unamortized Debt Issue Costs
 
 
Description of Debt Instrument
 
Face value
 
PIK Notes Issued and Accrued
 
Original Issue Discount
 
Preferred Stock and Warrants
 
Third Party Costs
 
Net Carrying Value
 
 
(In thousands)
Credit Agreement
 
$
43,000

 
—

 
—

 
—

 
$
(3,451
)
 
$
39,549

 
 
 
 
 
 
 
 
 
 
 
 
 
Unsecured Notes - current
 
$
24,014

 
—

 
—

 
—

 
$
(37
)
 
$
23,977

 
 
 
 
 
 
 
 
 
 
 
 
 
First Lien Term Loan
 
 
 
 
 
 
 
 
 
 
 
 
  Tranche A - current
 
17,500

 
—

 
(345
)
 
—

 
(1,096
)
 
16,059

  Tranche A - noncurrent
 
88,750

 
—

 
(1,751
)
 
—

 
(4,372
)
 
82,627

    Sub-total Tranche A
 
$
106,250

 
—

 
$
(2,096
)
 
—

 
$
(5,468
)
 
$
98,686

 
 
 
 
 
 
 
 
 
 
 
 
 
  Tranche B - current
 
1,750

 
—

 
(57
)
 
—

 
(108
)
 
1,585

  Tranche B - noncurrent
 
172,813

 
—

 
(5,603
)
 
—

 
(8,796
)
 
158,414

    Sub-total Tranche B
 
174,563

 
—

 
(5,660
)
 
—

 
(8,904
)
 
159,999

 
 
 
 
 
 
 
 
 
 
 
 
 
    Sub-total First Lien Loans
 
$
280,813

 
$
—

 
$
(7,756
)
 
$
—

 
$
(14,372
)
 
$
258,685

 
 
 
 
 
 
 
 
 
 
 
 
 
Second Lien Term Loans - noncurrent
 
$
70,000

 
$
1,191

 
$
(3,794
)
 
$
(7,383
)
 
$
(3,640
)
 
$
56,374

 
 
 
 
 
 
 
 
 
 
 
 
 
Third Lien Notes - noncurrent
 
$
210,986

 
$
2,457

 
$
(1,122
)
 
$
(11,073
)
 
$
(10,803
)
 
$
190,445

 
 
 
 
 
 
 
 
 
 
 
 
 
Totals at September 30, 2014
 
$
628,813

 
$
3,648

 
$
(12,672
)
 
$
(18,456
)
 
$
(32,303
)
 
$
569,030



72
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
 
At September 30, 2013
 
 
Principal
 
Unamortized Debt Issue Costs
 
 
Description of Debt Instrument
 
Face value
 
PIK Notes Issued and Accrued
 
OID
 
Preferred Stock and Warrants
 
Third Party Costs
 
Net Carrying Value
 
 
(In thousands)
Credit Agreement - current
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Secured Notes - noncurrent
 
$
310,000

 
$
22,536

 
$
—

 
$
(5,068
)
 
$
(5,182
)
 
$
322,286

 
 
 
 
 
 
 
 
 
 
 
 
 
Unsecured Notes - noncurrent
 
$
235,000

 
$
—

 
$
—

 
$
—

 
$
(1,168
)
 
$
233,832

 
 
 
 
 
 
 
 
 
 
 
 
 
Totals at September 30, 2013
 
$
545,000

 
$
22,536

 
$
—

 
$
(5,068
)
 
$
(6,350
)
 
$
556,118


Debt Instruments

All of Alion’s 100%-owned, domestic subsidiaries jointly, severally, fully and unconditionally guaranteed each Alion debt instrument including: the Credit Agreement; the First Lien Term Loans; the Second Lien Term Loan; the Third Lien Notes; the Unsecured Notes; and the now-extinguished Secured Notes. Each debt instrument is secured by all current and future tangible and intangible property of Alion and its guarantor subsidiaries.

Except for the remaining outstanding Unsecured Notes, each debt instrument includes customary representations and warranties, affirmative covenants and events of default (including payment defaults, breach of representations and warranties, covenant defaults, cross defaults to certain indebtedness, certain bankruptcy and insolvency events, material judgments, certain ERISA and ESOP events, change of control, impairment of security interests in collateral, invalidity of guarantees and intercreditor provisions and certain events with respect to material contracts). If an event of default occurs, lenders are entitled to take certain actions, including, in certain instances, accelerating amounts due.

Intercreditor Agreement

The Company, its subsidiary guarantors and lenders under each of the debt instruments also entered into an Intercreditor Agreement to grant Credit Agreement lenders first priority payment rights and to permit First Lien lenders to acquire revolving credit agreement loans from Credit Agreement lenders. The Intercreditor Agreement governs priority of interests among lenders and restricts the Company’s ability to further encumber its assets.

Credit Agreement

Alion’s Credit Agreement, which includes a revolving credit facility, has repeatedly been amended and restated to extend terms, waive certain covenants, substitute lenders and increase capacity. The Company has frequently incurred fees to obtain waivers and extensions. In connection with its August 2014 Refinancing Transactions, Alion paid $4.3 million in third-party costs to amend, extend and increase the capacity of the current Credit Agreement. The Credit Agreement expires April 30, 2018. Wells Fargo Bank is the administrative agent and sole Credit Agreement lender.

The Credit Agreement permits Alion to borrow, repay and re-borrow up to a maximum of $65 million subject to certain covenants and limitations. Under limited circumstances, Wells Fargo Bank may issue up $6.5 million in extraordinary loans in excess of the $65 million Credit Agreement ceiling. The Credit Agreement contains a $10 million sub-limit for letters of credit.

If Alion’s Credit Agreement borrowing capacity were to fall below $15 million, the Company could lose its ability to borrow funds under the Credit Agreement. The administrative agent could also block Alion’s access to funds in a designated account, and even seize those funds.


73
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Credit Agreement limits Alion’s total borrowing capacity to the lesser of $65 million or a borrowing base. The borrowing base consists of 85% of eligible, outstanding customer receivables plus the lesser of $30 million or 70% of eligible, unbilled receivables, net of certain other adjustments. Existing Credit Agreement loans and outstanding letters of credit reduce Alion’s available borrowing capacity.
  
At September 30, 2014, Alion had borrowed $43 million; had $3.9 million in letters of credit outstanding under the Credit Agreement; and had approximately $18.1 million in remaining maximum borrowing capacity subject to borrowing base limitations. The Company’s borrowing base was $79.7 million. After taking into account borrowing base limitations the available borrowing capacity was $17.4 million at September 30, 2014.

As of September 30, 2013, Alion had approximately $4 million in outstanding letters of credit, no Credit Agreement balance actually drawn, and $31 million in remaining borrowing capacity. At September 30, 2013, the Credit Agreement contained no borrowing base limitation.

Interest Rates and Fees

Credit Agreement interest is payable in cash. The interest rate for Credit Agreement borrowings is daily one-month LIBOR (London Inter-bank Offered Rate) plus 475 basis points. The Company must also pay a 25 basis point unused line fee and a 175 basis point letter of credit fee for any letter of credit that is not cash collateralized. The Credit Agreement imposes a $75 thousand monthly minimum interest charge to the extent that actual interest expense and unused line fees do not exceed that amount. The interest rate on outstanding balances increases by 200 basis points in the event of default.

Events of Default

In addition to the customary events of default described above, the Credit Agreement includes covenants regarding monetary judgments greater than $500 thousand; failure to pay other obligations exceeding $1 million; breaches of loan documents including the Intercreditor Agreement; suspension or debarment, or receipt of notice of suspension or debarment; and termination for default under a material government contract.

Financial Covenants

The Credit Agreement defines several keys terms including Consolidated Net Income, Consolidated EBITDA, Fixed Charges and Fixed Charge Coverage Ratio. The Credit Agreement requires the Company to achieve at least $50 million in trailing four-quarter Consolidated EBITDA measured at the end of each quarter. The Credit Agreement also requires the Company to maintain a minimum one-to-one fixed charge coverage ratio which is also measured on a trailing four-quarter basis at the end of each quarter.

The Credit Agreement defines Consolidated Net income as net income excluding gains or losses from debt extinguishments and asset sales. Consolidated EBITDA includes adjustments to Consolidated Net Income for certain items included in Consolidated Net Income. Principal additions include: interest expense; income tax expense; depreciation and amortization expense; non-recurring expenses accepted by the third-party ESOP valuation company; and non-cash contributions to the ESOP. The principal deductions are cash payments made in respect of amounts previously added back in determining Consolidated EBITDA.

Each of Alion’s debt instruments contains a similar definition of Consolidated Net Income and Consolidated EBITDA as used to determine compliance with each instrument’s financial covenants.

Fixed Charges are defined as cash interest and principal payments plus all fees paid to equity sponsors . The numerator for the Fixed Charge Coverage ratio is Consolidated EBITDA minus: capital expenditures; cash paid for income taxes; and non-recurring charges included in Consolidated EBITDA (Net Cash Flow before Fixed Charges). The Credit Agreement permits certain adjustments related to refinancing transactions.

As of September 30, 2014, Alion had $68.0 million in Consolidated EBITDA and the Fixed Charge Coverage Ratio was 1.01 to 1.0 ($65.2 million in Net Cash Flow before Fixed Charges compared to $64.8 million in Fixed Charges).

First Lien Term Loans


74
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As part of its August 2014 refinancing, Alion executed a $285.0 million First Lien Credit Agreement. The First Lien Credit Agreement includes two terms loans: Tranche A ($110 million) and Tranche B ($175 million). Tranche A matures on August 18, 2018; Tranche B matures August 18, 2019. Tranche A was issued at a $2.2 million discount. Tranche B was issued at $5.8 million discount. Alion also paid $26.1 million in third party costs and loan origination fees for the First Lien Credit Agreement.

Alion must repay $15 million of the Tranche A loan in year one; $25 million in year two, $25 million in year three and $45 million in year four. For the first five years through June 2019, Alion must repay Tranche B principal at 1% per year in quarterly installments. On August 18, 2019, Alion must repay the remaining $166.3 million in Tranche B principal.
 
First lien interest is payable quarterly in arrears in cash. Unless otherwise elected, the interest rate is one-month LIBOR with a floor of 1.00% plus 700 basis points for the Tranche A loan. The Tranche B interest rate is 300 basis points higher than the Tranche A interest rate. In the event of default, interest rates increase by 200 basis points. Alion has the option to use an alternate rate based on the Federal funds rate plus several adjustments. The LIBOR rate is lower than the alternate rate.

The First Lien Credit Agreement limits Alion’s capital expenditures to $2.5 million per year. Beginning at the end of fiscal 2015, the First Lien Credit Agreement requires Alion to use its excess cash flow (as defined in the agreement) to pay down either the outstanding Credit Agreement balance or the First Lien term loans. The First Lien Credit Agreement requires the Company to achieve at least $50 million in trailing four-quarter Consolidated EBITDA measured at the end of each quarter.

Second Lien Term Loan

On August 18, 2014 Alion executed a $70 million Second Lien Credit Agreement with ASOF and JLP Credit Opportunity Master Fund Ltd., an affiliate of Phoenix. The Second Lien term loan was issued at a $3.9 million discount and matures on February 18, 2020. The Company paid $4.5 million third-party costs and fees for the Second Lien Credit Agreement. Alion issued warrants to the Second Lien lenders to acquire Alion common stock at a penny-per-share strike price along with Series A Preferred Stock which gave the lenders as holders of the Series A Preferred Stock the right to elect the majority of the board of directors of the Company. At issuance, the Series A Preferred Stock and the portion of the warrants exercisable by Second Lien lenders had an estimated fair value of $5.9 million.

Second Lien interest is payable entirely in compounding PIK notes. The interest rate is 14.25%. In the event of default, the interest rate is 16.25% and lenders can demand Alion pay default interest in cash rather than by issuing PIK notes.

The Second Lien Credit Agreement requires the Company to achieve at least $45 million in trailing four-quarter Consolidated EBITDA measured at the end of each quarter.

Third Lien Indenture and Third Lien Notes

On August 18, 2014, the Company entered into a Third Lien Indenture and issued approximately $208.1 million new Third Lien Notes in exchange for the same face amount of Unsecured Notes due February 2015. Concurrently with the closing of the exchange offer, the Company also issued an aggregate of $2.9 million in Third Lien Notes at a $1.1 million discount to face value for cash received from Unsecured Note holders who participated in the unit offering and from ASOF who purchased Third Lien Notes and warrants in a private placement. The Third Lien notes mature on February 18, 2020. Interest is payable semi-annually in arrears on March 1 and September 1 of each year to holders of record as of the preceding February 15 and August 15.

The Company paid $13.3 million in third-party costs and fees related to the Third Lien Notes and exchange offer. The warrants Alion issued allow Third Lien Note holders right to acquire common stock at a penny per share. At issuance, the portion of the warrant exercisable by Third Lien Note holders had an estimated fair value of $12.9 million.

One component of Third Lien Note interest is payable in cash at 5.0% from date of issuance through maturity so long as trailing four-quarter Consolidated EBITDA exceeds $54 million measured as of June 30 and December 31 each year. Otherwise all interest is payable only in PIK notes.

In addition to the 5.0% interest potentially payable in cash, Third Lien Note holders are entitled non-cash interest in the form of compounding PIK notes at 9.75% from issuance through August 2018. The PIK note interest rate increases to 10.25% for year five and to 10.75% thereafter. In the event of default, the interest rate increases by 200 basis points and Third

75
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Lien Note holders can demand Alion pay default interest in cash on the entire principal outstanding and on any overdue PIK or cash interest payments.
 
The Third Lien Indenture requires the Company to achieve at least $40 million in trailing four-quarter Consolidated EBITDA measured at the end of each quarter.

Unsecured Notes

In February 2007, Alion issued $250 million in 10.25% Unsecured Notes maturing February 2015. Unsecured Note interest is payable semi-annually in cash in arrears on February 1 and August 1 to holders of record as of the preceding January 15 and July 15.

In fiscal 2011 and fiscal 2013, Alion was able to repurchase at a discount, Unsecured Notes with an aggregate face value of $15 million, recognizing a gain with each transaction. Holders of a majority of outstanding Unsecured Notes agreed to eliminate nearly all the covenants in the Unsecured Note indenture in connection with the exchange offer concluded in August 2014.

As part of Alion’s August 2014 Refinancing Transactions, holders of approximately $211 million in Unsecured Notes exchanged their notes for new Third Lien Notes or cash in the Exchange Offer. The approximately $24.0 million in Unsecured Notes remaining outstanding come due February 1, 2015.

Secured Notes

In March 2010, Alion issued $310 million in 12% Secured Notes maturing November 1, 2014. Secured Note interest was payable semi-annually in arrears at 10% in cash and 2.0% in compounding PIK notes. The Company also issued penny warrants to Secured Note holders conveying the right to purchase 602,614 shares of Alion common stock. The Secured Note warrants, which expire March 15, 2017, have anti-dilution protection. As a result of the August 18, 2014, Refinancing Transactions, Secured Note warrant holders became entitled to purchase 1,041,314 shares of Alion common stock.

On September 16, 2014, Alion used proceeds from its August 18, 2014, Refinancing Transactions to redeem the $310 million in Secured Notes and $26.4 million in outstanding PIK notes. The Company paid $15.3 million in cash interest and accrued PIK interest through the redemption date and recognized a $2.4 million debt extinguishment loss.

As of September 30, 2014, Alion must make the following principal repayments (face value) for its outstanding debt.
Schedule of Principal Payments at face for existing debt instruments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Instrument
 
 FY 2015
 
 FY 2016
 
 FY 2017
 
 FY 2018
 
 FY 2019
 
 FY 2020
 
 Total
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unsecured Notes
 
$
24,014

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
24,014

First Lien - Tranche A
 
$
17,500

 
$
25,000

 
$
25,000

 
$
38,750

 
$
—

 
$
—

 
$
106,250

First Lien - Tranche B
 
$
1,750

 
$
1,750

 
$
1,750

 
$
1,750

 
$
167,563

 
$
—

 
$
174,563

Second Lien Loan
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
70,000

 
$
70,000

Second Lien PIK Notes
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
82,603

 
$
82,603

Third Lien Notes
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
210,986

 
$
210,986

Third Lien PIK Notes
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
159,223

 
$
159,223

Total
 
$
43,264

 
$
26,750

 
$
26,750

 
$
40,500

 
$
167,563

 
$
522,812

 
$
827,639



76
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(12) Fair Value Measurement
Alion applies ASC 820 – Fair Value Measurements and Disclosures in determining the fair value to be disclosed for financial and nonfinancial assets and liabilities. The Company has no assets or liabilities, other than its redeemable common stock and certain common stock warrants, which it is required to remeasure at fair value. Valuation techniques utilized in the fair value measurement of assets and liabilities for each period presented were unchanged from prior practice.
ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. It establishes a fair value hierarchy and a framework which requires categorizing assets and liabilities into one of three levels based on the assumptions (inputs) used in valuing the asset or liability. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. Level 1inputs are unadjusted, quoted market prices in active markets for identical assets or liabilities. Level 2 inputs are observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets. Level 3 inputs include unobservable inputs that are supported by little, infrequent, or no market activity and reflect management’s own assumptions about inputs used in pricing the asset or liability. The Company uses the following valuation techniques to measure fair value.
Level 1 primarily consists of financial instruments, such as overnight bank re-purchase agreements or money market mutual funds whose value is based on quoted market prices published by financial institutions, exchange funds, exchange-traded instruments and listed equities.
Level 2 assets include U.S. government and agency securities whose valuations are based on market prices from a variety of industry-standard data providers or pricing that considers various assumptions, including time value, yield curve, volatility factors, credit spreads, default rates, loss severity, current market and contractual prices for the underlying instruments, and broker and dealer quotes. All are observable in the market or can be derived principally from or corroborated by observable market data for which the Company can obtain independent external valuation information.
Level 3 consists of unobservable inputs. Assets and liabilities are considered Level 3 when their fair value inputs are unobservable or not available, including situations involving limited market activity, where determination of fair value requires significant judgment or estimation.
 
As disclosed in Note 11 above, the Company issued its First and Second Term Loans at a discount to face value. Management believes these discounted values represent fair value for debt instruments issued by an entity with leverage ratios and credit ratings similar to Alion’s. See Note 5 above for Alion's redeemable common stock fair value disclosures and Note 13 below for its common stock warrant fair value disclosures. The table below sets out the face value, net carrying value and fair value of Alion’s Third Lien Notes, Unsecured Notes and Secured Notes. The fair values disclosed below are based on quoted market prices for Alion’s outstanding notes. This is a Level 2 measurement.
 
 
September 30, 2014
 
September 30, 2013
 
(In thousands)
 
Third Lien Notes
 

Unsecured
Notes
 

Secured
Notes
 

Unsecured
Notes
Face value of original notes outstanding
$
210,986


$
24,014

 
$
310,000

 
$
235,000

PIK interest notes issued
—


—

 
19,788

 
—

Face value of outstanding notes
$
210,986


$
24,014

 
$
329,788

 
$
235,000

PIK interest notes to be issued
2,457


—

 
2,748

 
—

Face value of notes outstanding and notes to be issued
$
213,443


$
24,014

 
$
332,536

 
$
235,000

Less: unamortized debt issue costs
(22,998
)

(37
)
 
(10,250
)
 
(1,168
)
Carrying value
$
190,445


$
23,977

 
$
322,286

 
$
233,832

Fair value of outstanding notes
$
163,258


$
23,180

 
$
335,295

 
$
151,928

(13) Common Stock Warrants

Secured Note Warrants


77

In March 2010, when Alion issued its now-extinguished Secured Notes, the Company also issued Secured Note penny warrants that entitled holders to purchase 602,614 shares of Alion common stock. The Secured Note Warrants expire March 15, 2017. They have no dividend rights and are not participating securities.
 
Secured Note Warrants have anti-dilution protection to offset the effect of shares issued below fair value on the date of issuance. On March 31, 2011, Alion issued shares to the ESOP Trust at the September 2010 ESOP valuation share price ($26.65) which was less than the March 2011 ESOP valuation share price ($27.15). As a result, Secured Note warrant holders became entitled to purchase a total of 602,741 shares of Alion common stock.

On August 18, 2014 Alion issued warrants as part of its Refinancing Transactions exercise of which can trigger Secured Note Warrant anti-dilution protections. As of September 30, 2014 the Company has set aside a total of 1,046,776 shares of Alion common stock to meet potential Secured Note Warrant exercise demands.
 
Second and Third Lien Warrants

The Company issued an aggregate of 306,889 warrants in connection with the Refinancing Transactions pursuant to a warrant agreement, dated August 18, 2014, with Wilmington Trust, National Association, as warrant agent. The warrants issued to the Second Lien lenders grant the Second Lien Lenders the right to purchase shares equal to 12.5% of the Company’s then-issued and outstanding common stock at a penny-per-share strike price (Second Lien Warrants). The warrants issued to the Third Lien Note holders grant the Third Lien Note holders the right to purchase shares equal to 27.5% of the Company’s then-issued and outstanding common stock at a penny-per-share strike price (Third Lien Warrants). The Second and Third Lien warrants expire on August 17, 2024 and contain significant anti-dilution protection. Each time the Company contributes shares to the ESOP, its total shares issued and outstanding increase and the Second and Third Lien Warrants become entitled to purchase a proportionately greater number of shares of Alion common stock. Second Lien Warrant holders were initially entitled to purchase 2,313,019 shares of Alion common stock and Third Lien Warrant holders were entitled to purchase 5,088,643 shares of Alion common stock.

As a result of Alion’s September 2014 ESOP contribution, the Company has reserved 3,039,700 shares of common stock to meet Second Lien Warrant potential exercise demands and 6,687,340 shares to meet Third Lien Warrant potential exercise demands. The Second and Third Lien Warrants have dividend rights and therefore are participating securities when determining earnings per share.

Secured Note Warrants - Initial fair value and accounting treatment

None of Alion’s warrants is redeemable for cash. Alion accounts for warrants as permanent equity and reassesses this classification each reporting period. The Company identified no required changes in accounting treatment as of September 30, 2014.

Management used a Black-Scholes-Merton option pricing model to determine that the Secured Note Warrants had an initial fair value of approximately $20.8 million based on Alion’s former share price of $34.50. Alion recognized the value of the Secured Note Warrants as part of the debt issue costs for the Secured Notes and recorded a corresponding credit to equity. The Company has expensed all its Secured Note debt issue costs, including warrant-related costs.

Second Lien and Third Lien Warrants - Initial fair value and accounting treatment

Management used a Black-Scholes-Merton option pricing model and Alion’s $2.45 August 2014 share price as determined by the ESOP Trustee to determine that the Second Lien Warrants had an initial fair value of $5.2 million and the Third Lien Warrants had an initial fair value of $11.3 million. Alion recognized the value of the Second and Third Lien Warrants as part of the debt issue costs for the corresponding debt instruments and recorded an offsetting credit to equity. The anti-dilution protections in the Second and Third Lien Warrants differ materially from the provisions in the Secured Note Warrants. As a result, management determined that the Second and Third Lien Warrants are derivative instruments that qualify for liability treatment and are not permanent equity.
 
The Second and Third Lien Warrants are classified as a liability, as they are not considered indexed to the Company’s stock.  As such, the Second and Third Lien Warrants were initially measured at fair value and classified as liabilities on the balance sheet.  Subsequent changes in fair value have been recorded in earnings.

Because the Second and Third Lien Warrants are liabilities, at each reporting date management is required to fair value these obligations and adjust their carrying value by recognizing a corresponding charge or credit to interest expense.

78

Management uses a Black-Scholes-Merton option pricing model to determine the fair value of the Second and Third Lien Warrants with reference to the estimated fair value of an underlying share of Alion common stock as of each reporting date. For the purpose of its fair value liability accounting, management’s estimate of the fair value of a share of Alion common stock can differ from the share price as determined by the ESOP Trustee based, in part, on a valuation provided to the Trustee by an independent third-party firm.

Management may base its estimate of the fair value of a share of Alion common stock on different variables than those used by the ESOP Trustee and the third-party ESOP valuation firm. Such differences can include estimates of future cash flows, growth rates, market multiples, control premiums, and discount rates, which can produce a wide range of estimated fair values for Alion's common stock. Depending on marketplace variables, management may (or may not) include in its warrant liability estimate, a share price estimated using the Black-Scholes-Merton option pricing model. Including or excluding this option pricing calculation for the estimated fair value of the shares underlying the Second and Third Lien Warrants could materially affect management’s estimate of the share price and the resulting fair value liability the Company is required to recognize. Any difference between management’s estimated share price for determining the Company’s warrant-related fair value liability does not affect the liability the Company recognizes for its outstanding redeemable common stock.

In determining the Company’s warrant-related liability as of September 30, 2014, management estimated the market value of a share of underlying Alion common stock to be $0.68 based on a standard three-factor valuation methodology. Management did not utilize an option pricing model at September 30, 2014 to estimate the price of a share of Alion common stock as an input in its warrant liability calculation. Management determined that the Second and Third Lien Warrants had declined in value from August 18, 2014 to September 30, 2014 as a result, in part, of the Company’s increasing debt load, due to the pay in kind interest embodied in the Second and Third Lien Notes and higher share counts attributable to the anti-dilution provisions of the Second and Third Lien Warrants. The Company recorded a $9.9 million credit to expense for the change in fair value of the Second and Third Lien Warrants from August 18, 2014 through September 30, 2014. Management estimated the fair value of the Second Lien Warrant liability at $2 million and the Third Lien Warrant liability at $4.5 million.

Management’s estimated September 30, 2014 fair value share price reduced the Company’s estimated fair value warrant liability from the amount originally recognized. An estimated share price higher than $2.45 would have increased the estimated fair value of the Company’s warrant-related fair value liability and resulted in a corresponding increase in expense. A ten-percent increase or decrease in the estimated share price management used to determine Alion’s warrant-related liability would have resulted in an $0.7 million increase or decrease in the Company’s fair value warrant-related liability at September 30, 2014 with a corresponding offsetting effect on expense.

(14) Leases

Future minimum lease payments under non-cancelable operating leases for buildings, equipment and automobiles at September 30, 2014 are set out below. Alion subleases some excess capacity to subtenants under non-cancelable operating leases.
 
Lease Payments for Fiscal Years Ending
(In thousands)
2015
$
25,800

2016
21,569

2017
18,413

2018
15,888

2019
6,537

And thereafter
12,982

Gross lease payments
$
101,189

Less: non-cancelable subtenant receipts
(1,650
)
Net lease payments
$
99,539

 
Composition of Total Rent Expense

79
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
September 30,
 
2014
 
2013
 
2012
 
(In thousands)
Minimum rentals
$
22,966

 
$
21,530

 
$
20,639

Less: Sublease rental income
(601
)
 
(600
)
 
(156
)
Total rent expense, net
$
22,365

 
$
20,930

 
$
20,483

(15) Post-retirement Benefits
Alion sponsors a post-retirement plan providing medical, dental, and vision coverage to eligible former employees. The Company is self-insured with a stop-loss limit under an insurance agreement. The plan was closed to new participants in fiscal 2008. It provides benefits until age 65 for employees who met certain age and service requirements. Alion requires most participants to pay the full expected cost of benefits. A limited number of participants, eligible for coverage after age 65, contribute a lesser amount. As of September 30, 2014, the Company had recognized a $491 thousand unfunded plan liability. Alion paid $46 thousand, $39 thousand and $59 thousand in plan benefits for the years ended September 30, 2014, 2013, and 2012. Participants contributed $15 thousand, $14 thousand and $12 thousand for the years ended September 30, 2014, 2013, and 2012.

(16) ESOP Expense

Alion makes 401(k) matching and profit sharing contributions in shares of its redeemable common stock. The Company matches the first 3% and one-half of the next 2% of eligible employee salary deferrals by contributing shares of Alion common stock to the ESOP Trust on March 31 and September 30 each year. The Company also makes profit sharing contributions of 2.5% of eligible employee compensation by contributing shares of Alion common stock to the ESOP Trust on the same dates.

Formerly, through June 2011, Alion profit sharing contributions consisted of 1% of eligible employee compensation in common stock issued to the ESOP Trust and 1.5% of eligible employee compensation in cash to the 401(k) component. Alion recognized $14.2 million, $13.8 million and $13.8 million in Plan expense for the years ended September 30, 2014, 2013 and 2012. In 2012, Plan expense included approximately $1.2 million in cash and approximately $11.0 million in common stock.

In September 2013, Alion amended the ESOP to delay transfer to the Company of employee contributions for investment in the ESOP component of the Plan. In December 2013, the ESOP Trust used employee funds to purchase approximately $930 thousand of Alion common stock at the September 30, 2013 price of $8.10 per share.

The non-cash component of ESOP expense appears in the statement of cash flows supplemental disclosures as “common stock issued in satisfaction of employer contribution liability.” It is included in operating cash flows from changes in accrued liabilities. The Company issued $14.1 million in redeemable common stock for the year ended September 30, 2014.

(17) Long Term Incentive Plan

Alion adopted a long-term cash incentive compensation plan for certain executives in December 2008. The Company amended its incentive compensation plan in January 2010 and amended and restated it in June 2013. The most recent amendment created new change in control provisions that apply to future grants. Individual incentive compensation grants contain specific financial and performance goals and vest over varying periods. Some grants are for a fixed amount; others provide a range of values from a minimum of 50% to a maximum of 150% of initial grant value. The Company periodically evaluates the probability that individuals will achieve stated financial and performance goals.

The August 2014 Refinancing Transactions may have triggered the change in control provisions of the LTI Plan and outstanding grants, including the 2011 LTIPs. While for accounting purposes, the 2011 LTIPs have been treated as if a change in control has occurred and vested at 100% of target value with vested amounts becoming currently payable. The determination of whether the change in control provisions of the LTI Plan and outstanding award apply in connection with the August 2014 Refinancing Transactions and other aspects of the award payments are pending before the Compensation Committee and will be determined at a future time. Non-executive officer LTI grants for November 2014 and November 2015 accelerated and vested at face value on August 18, 2014. Executive officers with grants subject to acceleration that were originally scheduled

80

to vest in November 2015, agreed to defer immediate vesting in exchange for a 10% increase in target value vesting on the normal schedule.
 
Alion recognizes long term incentive compensation expense based on outstanding grants’ stated values, estimated probability of achieving stated goals and estimated probable future grant values. The Company recognized $1.9 million, $2.3 million and $1.4 million and in incentive compensation expense for the years ended September 30, 2014, 2013 and 2012. Fiscal 2014, the Company recognized $173 thousand in additional compensation expense (included in the amount above) related to accelerated vesting and LTI grant agreement modifications.
(18) Stock-based Compensation
Alion initially adopted its Stock Appreciation Rights (SAR) Plan in 2004. The Company amended and restated the SAR Plan in January 2007; amended it in January 2010; and amended and restated the SAR Plan in June 2013. The SAR Plan expires in November 2016. The most recent SAR Plan amendment revised certain change in control provisions.
The chief executive officer may award SARs as he deems appropriate. Awards vest ratably over four years with payment following the grant date fifth anniversary. Grants with no intrinsic value expire on their year-five payment date. The SAR Plan provides for accelerated vesting in the event of death or disability and provides for accelerated vesting of existing grants on a change in control. The August 2014 refinancing constituted a change in control for SARs granted prior to fiscal 2014. All the pre-2014 grants vested with zero value and expired.
The approximately 180 thousand SARs outstanding at September 30, 2014, were issued in fiscal 2014 at a grant date fair value of $8.10 per share. No outstanding grant has any intrinsic value. For the years ended September 30, 2014, 2013 and 2012, the Company recognized credits to compensation expense of $21 thousand, $219 thousand and $90 thousand for the SAR Plan. The Company uses a Black-Scholes-Merton option pricing model based on the fair market value of a share of its common stock to recognize stock –based compensation expense. Alion's aggregate SAR Plan liability was $5 thousand at September 30, 2014.
Phantom Stock Plans
Alion formerly maintained Executive and Director Phantom Stock Plans. In June 2013, the Company amended and restated its Phantom Stock Plan and its Performance Shares and Retention Phantom Stock Plan. No grants are outstanding under either of these plans.
There is no established public trading market for Alion’s common stock. The ESOP Trust owns all outstanding common stock. Alion does not expect to pay any dividends on its common stock and intends to retain future earnings, if any, for operating its business.
(19) Income Taxes
Current Taxes
Alion is subject to income taxes in the U.S., various states, Canada and India. Tax statutes and regulations within each jurisdiction are subject to interpretation requiring management to apply significant judgment. In 2014 and 2013, the Company recognized approximately $6 thousand and $3 thousand in current income tax expense for business operations in India.
Deferred Taxes
Alion recorded approximately $7.0 million in deferred tax expense and liabilities related to tax-basis goodwill amortization in 2014, 2013 and 2012.
Alion was formerly an S corporation and has been a C corporation since March 2010. The Company’s history of losses gives rise to a presumption that it might not be able to realize the full benefit of any deferred tax assets it is required to recognize. Therefore, Alion maintains a valuation allowance equal to the deferred tax assets it is required to recognize each reporting period and in total.
The Company does not expect to pay any income taxes for the foreseeable future. Even though Alion has recorded a full valuation allowance for all deferred tax assets, management believes that if the Company were to become profitable, it should be able to use existing and anticipated net operating loss (NOL) carryforwards to offset taxes that might become due in the future. Alion’s ability to utilize NOL tax benefits will depend upon how much future taxable income it has and may be

81
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

limited under certain circumstances. Alion does not have any NOL tax benefits it can carry back to years prior to becoming a C corporation.
 
The Company offers post-retirement prescription drug coverage to a limited number of retirees and beneficiaries. Alion has not claimed any federal tax credit in prior years. The Affordable Care Act has reduced the value of the federal subsidy for retiree drug coverage. Alion’s tax provision is unaffected by this legislative change. Management will decide whether to seek a subsidy in the future based on its anticipated value and the cost associated with seeking the subsidy.
Tax Uncertainties
ASC Topic 740 Income Taxes prescribes a recognition threshold and a measurement attribute for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The Company may recognize a benefit for that amount which it has a more than 50% chance of realizing. If the Company’s position involves uncertainty, then in order to recognize a benefit, a given tax position must be “more-likely-than-not” to be sustained upon examination by taxing authorities.
Alion periodically assesses its liabilities and contingencies for all periods open to examination by tax authorities, based on the latest available information. Where management believes there is more than a 50 percent chance the Company’s tax position will not be sustained, Alion records its best estimate of the resulting tax liability, including interest. Interest or penalties related to income taxes are reported separately from income tax expense. The Company has analyzed its tax positions and has not recorded any liabilities for tax uncertainties.
The Company has unrecorded tax benefits related to goodwill deductions. If Alion is able to utilize these benefits to reduce taxes payable in the future, it will recognize a reduction in its income tax liability and a corresponding reduction in goodwill carrying value.
Alion may become subject to federal or state income tax examination for tax years ended September 2011 and after. Each of the Company’s open return year returns has given rise to an NOL carryforward. The Company does not expect resolution of tax matters for any open years to materially affect operating results, financial condition, cash flows or its effective tax rate.
As of September 30, 2014 and 2013 deferred tax assets and related valuation allowances were $122.4 million and $97.0 million and deferred tax liabilities were $65.1 million and $58.1 million. Alion’s effective tax rate for fiscal years 2014, 2013 and 2012 was (18.9)%, and (23.6)% and (20.2)%.
The provision for income taxes for the years ended September 30, 2014, 2013 and 2012 was:
 
 
Fiscal Years Ended
September 30,
 
2014
 
2013
 
2012
 
(In thousands)
Current:
 
 
 
 
 
Foreign
$
6

 
$
3

 
$
—

Total current provision
$
6

 
$
3

 
$
—

Deferred:
 
 
 
 
 
Federal
$
5,740

 
5,740

 
$
5,740

State
1,234

 
1,234

 
1,234

Total deferred provision
$
6,974

 
$
6,974

 
$
6,974

Total provision for income taxes
$
6,980

 
$
6,977

 
$
6,974

 
Alion’s income tax provisions at September 30, 2014, 2013 and 2012 include the effects of state income taxes, debt extinguishment and changes in valuation allowances. The provision for income taxes for the years ended September 30, 2014, 2013 and 2012 differ from the amounts computed by applying the statutory U.S. federal income tax rate to income before taxes as a result of the following:
 

82
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
Fiscal Years Ended September 30,
 
2014
 
2013
 
2012
 
(Dollars in thousands)
Expected federal income tax (benefit)
35.0
 %
 
$
(12,956
)
 
35.0
 %
 
$
(10,365
)
 
35.0
 %
 
$
(12,066
)
State income taxes (net of federal benefit)
5.7
 %
 
(2,121
)
 
4.5
 %
 
(1,325
)
 
4.5
 %
 
(1,539
)
Nondeductible expenses
9.0
 %
 
(3,348
)
 
(0.4
)%
 
105

 
(0.5
)%
 
146

Provision to return true-ups
(0.2
)%
 
68

 
(0.1
)%
 
15

 
(0.8
)%
 
286

Tax credits
—
 %
 
—

 
0.3
 %
 
(79
)
 
—
 %
 
—

Changes in valuation allowance
(68.4
)%
 
25,337

 
(62.9
)%
 
18,626

 
(58.4
)%
 
20,147

Income tax expense (benefit)
(18.9
)%
 
$
6,980

 
(23.6
)%
 
$
6,977

 
(20.2
)%
 
$
6,974

At September 30, 2014 and 2013, the Company had $225 million and $156 million in NOL carryforwards that begin to expire in 2025 if not used before then.
At September 30, 2014 and 2013, the components of deferred tax assets and deferred tax liabilities were: 



 
September 30,
 
2014
 
2013
 
(In thousands)
Deferred tax assets:
 
Accrued expenses and reserves
$
9,365

 
$
9,228

Intangible amortization
11,283

 
13,185

Deferred rent
3,374

 
3,680

Deferred wages
4,141

 
4,060

Depreciation and leases
4,485

 
4,375

Carryforwards and tax credits
89,728

 
62,487

Other
—

 
25

Gross deferred tax assets
$
122,376

 
$
97,040

Less Valuation
(122,376
)
 
(97,040
)
Deferred tax liabilities:
 
 
 
Goodwill
(65,104
)
 
(58,130
)
Net deferred tax asset/(liability)
$
(65,104
)
 
$
(58,130
)

(20) Segment Information and Customer Concentration
Alion operates as a single segment, providing advanced engineering, information technology and operational solutions to strengthen national security and drive business results under contracts with the U.S. government, state and local governments, and commercial customers.
U.S. government customers typically exercise independent contracting authority. U.S. government agencies, department offices or divisions may use Alion’s services as a separate customer directly, or through a prime contractor, if they have independent decision-making and contracting authority within their organization. U.S. government prime contracts accounted for approximately 87%, 89%, and 86% of total contract revenue for the years ended September 30, 2014, 2013 and 2012. The following five prime contracts represented over 50% of our revenue for the past three years.
 

83
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
 
 
 
Fiscal Years Ended
September 30,
Government Agency
 
Contract
 
2014
 
2013
 
2012
DoD—Defense Information Analysis Center
 
Weapons System Information Analysis Center for the Defense Technical and Information Center (IDIQ contract vehicle)
 
25.7
%
 
27.6
%
 
17.1
%
DoD—U.S. Navy
 
Seaport-E Multiple Award Contract for the Naval Sea Systems Command (IDIQ contract vehicle)
 
21.4
%
 
20.7
%
 
20.1
%
DoD—U.S. Air Force
 
Technical and Analytical Support for the U.S. Air Force
 
8.5
%
 
8.4
%
 
9.9
%
DoD—U.S. Navy
 
Naval Sea Systems Command Surface Ships Life Cycle Program Management and Engineering Support
 
6.7
%
 
7.2
%
 
5.8
%
DoD—Defense Information Analysis Center
 
Software, Networks, Information, Modeling and Simulation - Defense Technical and Information Center
(IDIQ contract vehicle)
 
6.1
%
 
1.8
%
 
0.2
%
(21) Guarantor/Non-guarantor Condensed Consolidated Financial Information
All of Alion’s 100% owned domestic subsidiaries have jointly, severally, fully and unconditionally guaranteed all of the Company's debt agreements including, the Credit Agreement, the First Lien Term Loans, the Second Lien Term Loan, the Third Lien Notes, the Unsecured Notes and the now-extinguished Secured Notes. All of these instruments are general obligations of the Company.
The following information presents condensed consolidating balance sheets as of September 30, 2014 and September 30, 2013; condensed consolidating statements of operations and comprehensive loss and cash flows for the years ended September 30, 2014, 2013 and 2012 of Alion, its guarantor subsidiaries and its non-guarantor subsidiaries. Investments include Alion’s investments in its subsidiaries presented using the equity method of accounting.

Condensed Consolidating Balance Sheet Information at September 30, 2014

Parent
 
Guarantor Companies
 
Non-Guarantor Companies
 
Eliminations
 
Consolidated
 
(In thousands)
Current assets:

 

 

 

 

Cash and cash equivalents
$
10,757

 
$
(33
)
 
$
8

 
$
—

 
$
10,732

Accounts receivable, net
168,719

 
1,426

 
1,350

 


 
171,495

Receivable due from ESOP Trust
—

 
—

 
—

 
—

 
—

Prepaid expenses and other current assets
5,265

 
47

 
29

 


 
5,341

Total current assets
184,741

 
1,440

 
1,387

 
—

 
187,568

Property, plant and equipment, net
6,697

 
369

 
—

 
—

 
7,066

Intangible assets, net
961

 
—

 
—

 
—

 
961

Goodwill
398,921

 
—

 
—

 
—

 
398,921

Investment in subsidiaries
29,637

 
—

 
—

 
(29,637
)
 
—

Intercompany receivables
2,501

 
30,027

 
33

 
(32,561
)
 
—

Other assets
9,748

 
—

 
5

 
—

 
9,753

Total assets
$
633,206

 
$
31,836

 
$
1,425

 
$
(62,198
)
 
$
604,269


84

Current liabilities:


 

 

 

 

First lien term loans, current portion:


 


 


 


 


    Tranche A
$
16,059

 
$
—

 
$
—

 
$
—

 
$
16,059

    Tranche B
1,585

 
—

 
—

 
—

 
1,585

Unsecured notes, current portion
23,977

 
—

 
—

 
—

 
23,977

Interest payable
2,976

 
—

 
—

 
—

 
2,976

Trade accounts payable
55,476

 
35

 
22

 
—

 
55,533

Accrued liabilities
44,789

 
96

 
136

 
—

 
45,021

Accrued payroll and related liabilities
37,866

 
282

 
42

 
—

 
38,190

Billings in excess of revenue earned
2,685

 
112

 
18

 
—

 
2,815

Total current liabilities
185,413

 
525

 
218

 
—

 
186,156

Intercompany payables
30,061

 
—

 
2,501

 
(32,562
)
 
—

Revolving credit facility
39,549

 
—

 
—

 
—

 
39,549

First lien term loans, non-current:


 


 


 


 


   Tranche A
82,627

 
—

 
—

 
—

 
82,627

   Tranche B
158,413

 
—

 
—

 
—

 
158,413

Second lien term loan
56,373

 
—

 
—

 
—

 
56,373

Third lien notes
190,445

 
—

 
—

 
—

 
190,445

Secured notes
—

 
—

 
—

 
—

 
—

Unsecured notes
—

 
—

 
—

 
—

 
—

Accrued compensation and benefits, excluding current portion
5,878

 
—

 
—

 
—

 
5,878

Non-current portion of lease obligations
11,075

 
381

 
—

 
—

 
11,456

Deferred income taxes
65,104

 
—

 
—

 
—

 
65,104

Commitments and contingencies


 

 

 

 

Common stock warrants, second lien term loans and third lien notes
6,518


—


—


—


6,518

Redeemable common stock
32,120

 
—

 
—

 
—

 
32,120

Series A preferred stock
2,339

 
—

 
—

 
—

 
2,339

Common stock warrants, secured notes
20,785

 
—

 
—

 
—

 
20,785

Common stock of subsidiaries
—

 
4,084

 
8

 
(4,092
)
 
—

Accumulated other comprehensive loss
(19
)
 
—

 
—

 
—

 
(19
)
Accumulated deficit
(253,475
)
 
26,846

 
(1,302
)
 
(25,544
)
 
(253,475
)
Total liabilities, redeemable common stock and stockholders' deficit
$
633,206

 
$
31,836

 
$
1,425

 
$
(62,198
)
 
$
604,269




85

Condensed Consolidating Balance Sheet Information at September 30, 2013

Parent
 
Guarantor Companies
 
Non-Guarantor Companies
 
Eliminations
 
Consolidated

(In thousands)
Current assets:

 

 

 

 

Cash and cash equivalents
$
25,617

 
$
(24
)
 
$
20

 
$
—

 
$
25,613

Accounts receivable, net
169,304

 
2,735

 
565

 
—

 
172,604

Receivable due from ESOP Trust
930

 
—

 
—

 
—

 
930

Prepaid expenses and other current assets
4,449

 
188

 
(154
)
 
—

 
4,483

      Total current assets
200,300

 
2,899

 
431

 
—

 
203,630

Property, plant and equipment, net
9,139

 
525

 
4

 
—

 
9,668

Intangible assets, net
2,040

 
—

 
—

 
—

 
2,040

Goodwill
398,921

 
—

 
—

 
—

 
398,921

Investment in subsidiaries
28,420

 
—

 
—

 
(28,420
)
 
—

Intercompany receivables
1,906

 
27,828

 
—

 
(29,734
)
 
—

Other assets
10,363

 
—

 
4

 
—

 
10,367

      Total assets
$
651,089

 
$
31,252

 
$
439

 
$
(58,154
)
 
$
624,626

Current liabilities:

 

 

 

 

Interest payable
$
17,758

 
$
—

 
$
—

 
$
—

 
$
17,758

Trade accounts payable
61,563

 
58

 
1

 
—

 
61,622

Accrued liabilities
39,169

 
144

 
80

 
—

 
39,393

Accrued payroll and related liabilities
37,404

 
517

 
33

 
—

 
37,954

Billings in excess of costs revenue earned
4,250

 
84

 
—

 
—

 
4,334

      Total current liabilities
160,144

 
803

 
114

 
—

 
161,061

Intercompany payables
27,826

 
153

 
1,754

 
(29,733
)
 
—

Secured Notes
322,286

 
—

 
—

 
—

 
322,286

Unsecured Notes
233,832

 
—

 
—

 
—

 
233,832

Accrued compensation and benefits, excluding current portion
5,736

 
—

 
—

 
—

 
5,736

Non-current portion of lease obligations
12,374

 
447

 
—

 
—

 
12,821

Deferred income taxes
58,130

 
—

 
—

 
—

 
58,130

Commitments and contingencies


 


 


 


 


Redeemable common stock
61,895

 
—

 
—

 
—

 
61,895

Common stock warrants
20,785

 
—

 
—

 
—

 
20,785

Common stock of subsidiaries
—

 
4,084

 
9

 
(4,093
)
 
—

Accumulated other comprehensive loss
130

 
—

 
—

 
—

 
130

Accumulated surplus (deficit)
(252,049
)
 
25,765

 
(1,438
)
 
(24,328
)
 
(252,050
)
      Total liabilities, redeemable common stock and accumulated deficit
$
651,089

 
$
31,252

 
$
439

 
$
(58,154
)
 
$
624,626



86

Condensed Consolidating Statement of Comprehensive Loss











Year Ended September 30, 2014

Parent

Guarantor Companies

Non -Guarantor Companies

Eliminations

Consolidated

(In thousands)
Contract revenue
$
797,104


$
6,547


$
1,158





$
804,809

Direct contract expense
624,940


3,823


548





629,311

Gross profit
172,164


2,724


610





175,498

Operating expenses
76,266


1,398


397


—


78,061

General and administrative
50,847


246


66





51,159

Operating income
45,051


1,080


147


—


46,278

Other income (expense):
—









Interest income
55


—


—


—


55

Interest expense
(81,662
)

—


—


—


(81,662
)
Other
(123
)

—


—


—


(123
)
Change in warrant value
9,894


—


—


—


9,894

Gain on debt extinguishment
(11,458
)

—


—


—


(11,458
)
       Equity in net income of subsidiaries
1,219


—


—


(1,219
)

—

Total other expenses
(82,075
)

—


—


(1,219
)

(83,294
)
Loss before income taxes
(37,024
)

1,080


147


(1,219
)

(37,016
)
Income tax expense
(6,972
)

—


(8
)

—


(6,980
)
Net (loss) income
$
(43,996
)

$
1,080


$
139


$
(1,219
)

$
(43,996
)
Other comprehensive income (expense):










Post-retirement actuarial gains (loss)
(149
)

—


—


—


(149
)
Comprehensive loss
$
(44,145
)

$
1,080


$
139


$
(1,219
)

$
(44,145
)



87

Condensed Consolidating Statement of Comprehensive Loss

 
Year Ended September 30, 2013

 
Parent

Guarantor Companies

Non-Guarantor Companies

Eliminations

Consolidated

 
(In thousands)
Contract revenue
 
839,608

 
8,627

 
737

 
—

 
848,972

Direct contract expenses
 
663,380

 
5,638

 
486

 
—

 
669,504

   Gross profit
 
176,228

 
2,989

 
251

 
—

 
179,468

Operating expenses
 
81,838

 
1,972

 
318

 
—

 
84,128

General and administrative
 
52,491

 
604

 
44

 
—

 
53,139

   Operating income (loss)
 
41,899

 
413

 
(111
)
 
—

 
42,201

Other income (expense):
 
—

 

 

 

 

    Interest income
 
55

 
—

 
—

 
—

 
55

    Interest expense
 
(75,700
)
 
—

 
—

 
—

 
(75,700
)
    Other
 
(200
)
 
116

 
—

 
—

 
(84
)
    Gain on debt extinguishment
 
3,913

 
—

 
—

 
—

 
3,913

    Equity in net income (loss) of subsidiaries
 
418

 
—

 
—

 
(418
)
 
—

Total other income (expense)
 
(71,514
)
 
116

 
—

 
(418
)
 
(71,816
)
    Income (loss) before taxes
 
(29,615
)
 
529

 
(111
)
 
(418
)
 
(29,615
)
    Income tax expense
 
(6,977
)
 
—

 
—

 
—

 
(6,977
)
    Net income (loss)
 
(36,592
)
 
529

 
(111
)
 
(418
)
 
(36,592
)
Other comprehensive income:
 
—

 

 

 

 

    Postretirement actuarial gains
 
279

 
—

 
—

 
—

 
279

Comprehensive income (loss)
 
(36,313
)
 
529

 
(111
)
 
(418
)
 
(36,313
)


88

Condensed Consolidating Statement of Comprehensive Loss

Year Ended September 30, 2012

 
Parent
 
Guarantor Companies
 
Non-Guarantor Companies
 
Eliminations
 
Consolidated
 
 
(In thousands)
Contract revenue
 
$
802,664

 
$
14,015

 
$
525

 
$
—

 
$
817,204

Direct contract expenses
 
624,788

 
7,743

 
300

 
—

 
632,831

   Gross profit
 
177,876

 
6,272

 
225

 
—

 
184,373

Operating expenses
 
88,736

 
2,531

 
227

 
—

 
91,494

General and administrative
 
52,123

 
156

 
162

 
—

 
52,441

   Operating income (loss)
 
37,017

 
3,585

 
(164
)
 
—

 
40,438

Other income (expense):
 

 

 

 

 

    Interest income
 
78

 
—

 
—

 
—

 
78

    Interest expense
 
(74,934
)
 
—

 
—

 
—

 
(74,934
)
    Other
 
(63
)
 
9

 
(1
)
 
—

 
(55
)
    Gain on debt extinguishment
 
—

 
—

 
—

 
—

 
—

    Equity in net income of subsidiaries
 
3,429

 
—

 
—

 
(3,429
)
 
—

Total other income (expense)
 
(71,490
)
 
9

 
(1
)
 
(3,429
)
 
(74,911
)
    Income (loss) before income taxes
 
(34,473
)
 
3,594

 
(165
)
 
(3,429
)
 
(34,473
)
    Income tax (expense) benefit
 
(6,974
)
 
—

 
—

 
—

 
(6,974
)
    Net (loss) income
 
$
(41,447
)
 
$
3,594

 
$
(165
)
 
$
(3,429
)
 
$
(41,447
)
Other comprehensive income:
 


 

 

 

 

    Post retirement actuarial gain
 
26

 
—

 
—

 
—

 
26

Comprehensive loss
 
$
(41,421
)
 
$
3,594

 
$
(165
)
 
$
(3,429
)
 
$
(41,421
)


89

Condensed Consolidating Statement of Cash Flows
Year Ended September 30, 2014
 
Parent

Guarantors

Non-Guarantors

Consolidated
 
(In thousands)
Net cash (used in) provided by operating activities
$
(23,281
)
 
16

 
(12
)
 
$
(23,277
)
Cash flows from investing activities:

 

 

 

Capital expenditures
(1,157
)
 
(25
)
 
—

 
(1,182
)
Asset sales proceeds
1,596

 
—

 
—

 
1,596

Net cash provided by (used in) investing activities
439

 
(25
)
 
—

 
414

Cash flows from financing activities:


 

 

 

        Proceeds from sale of first lien term loans:


 


 


 


   Tranche A
107,800

 
—

 
—

 
107,800

   Tranche B
169,200

 
—

 
—

 
169,200

Proceeds from second lien term loan, sale of preferred shares and common stock warrants
66,150

 
—

 
—

 
66,150

Proceeds from third lien notes
1,711

 
—

 
—

 
1,711

Payment of debt issue costs
(30,505
)
 
—

 
—

 
(30,505
)
Repurchase of secured notes
(338,959
)
 
—

 
—

 
(338,959
)
Repayment of first lien notes
(4,188
)
 
—

 
—

 
(4,188
)
Retirement of unsecured notes
(4,876
)
 
—

 
—

 
(4,876
)
Repurchase of unsecured notes
—

 
—

 
—

 
—

Revolver borrowings
78,000

 
—

 
—

 
78,000

Revolver repayments
(35,000
)
 
—

 
—

 
(35,000
)
Loan to ESOP Trust
(855
)
 
—

 
—

 
(855
)
ESOP loan repayment
855

 
—

 
—

 
855

Redeemable common stock purchased from ESOP Trust
(2,285
)
 
—

 
—

 
(2,285
)
Redeemable common stock sold to ESOP Trust
934

 
—

 
—

 
934

Net cash used in financing activities
7,982

 
—

 
—

 
7,982

Net increase (decrease) in cash and cash equivalents
(14,860
)
 
(9
)
 
(12
)
 
(14,881
)
Cash and cash equivalents at beginning of period
25,617

 
(24
)
 
20

 
25,613

Cash and cash equivalents at end of period
$
10,757

 
$
(33
)
 
$
8

 
$
10,732



 

 

 



90

Condensed Consolidating Statement of Cash Flows
Year Ended September 30, 2013

 

 

 

 


 
Parent
 
Guarantors
 
Non-Guarantors
 
Consolidated

 
(In thousands)
Net cash provided by operating activities
 
$
10,666

 
$
97

 
$
20

 
$
10,783

Cash flows from investing activities:
 

 

 

 

        Capital expenditures
 
(1,792
)
 
(77
)
 
—

 
(1,869
)
Net cash provided by (used in) investing activities
 
(1,792
)
 
(77
)
 
—

 
(1,869
)

 


 

 

 

Cash flows from financing activities:
 


 

 

 

        Repurchase of unsecured notes
 
(6,030
)
 
—

 
—

 
(6,030
)
        Revolver borrowings
 
16,461

 
—

 
—

 
16,461

        Revolver repayments
 
(16,461
)
 
—

 
—

 
(16,461
)
        Loan to ESOP trust
 
(1,907
)
 
—

 
—

 
(1,907
)
        ESOP loan repayment
 
1,907

 
—

 
—

 
1,907

        Redeemable common stock purchased from ESOP trust
 
(6,664
)
 
—

 
—

 
(6,664
)
        Redeemable common stock sold to ESOP Trust
 
2,166

 
—

 
—

 
2,166

Net cash used in financing activities
 
(10,528
)
 
—

 
—

 
(10,528
)
Net increase (decrease) in cash and cash equivalents
 
(1,654
)
 
20

 
20

 
(1,614
)
Cash and cash equivalents at beginning of period
 
27,271

 
(44
)
 
—

 
27,227

Cash and cash equivalents at end of period
 
$
25,617

 
$
(24
)
 
$
20

 
$
25,613



91

Condensed Consolidating Statement of Cash Flows
Year Ended September 30, 2012

 

 

 

 

.
 
Parent
 
Guarantors
 
Non-Guarantors
 
Consolidated

 
(In thousands)
Net cash provided by (used in) operating activities
 
$
12,700

 
$
(19
)
 
$
—

 
$
12,681

Cash flows from investing activities:
 


 

 

 

        Capital expenditures
 
(2,733
)
 
2

 
—

 
(2,731
)
        Proceeds from sale of fixed assets
 
—

 
—

 
—

 
—

Net cash provided by (used in) investing activities
 
(2,733
)
 
2

 
—

 
(2,731
)

 

 

 

 

Cash flows from financing activities:
 

 

 

 

        Revolver borrowings
 
26,000

 
—

 
—

 
26,000

        Revolver repayments
 
(26,000
)
 
—

 
—

 
(26,000
)
        Loan to ESOP trust
 
(477
)
 
—

 
—

 
(477
)
        ESOP loan repayment
 
477

 
—

 
—

 
477

        Redeemable common stock purchased from ESOP trust
 
(4,843
)
 
—

 
—

 
(4,843
)
        Redeemable common stock sold to ESOP Trust
 
1,302

 
—

 
—

 
1,302

Net cash provided by (used in) financing activities
 
(3,541
)
 
—

 
—

 
(3,541
)
Net increase (decrease) in cash and cash equivalents
 
6,426

 
(17
)
 
—

 
6,409

Cash and cash equivalents at beginning of period
 
20,845

 
(27
)
 
—

 
20,818

Cash and cash equivalents at end of period
 
$
27,271

 
$
(44
)
 
$
—

 
$
27,227



(22) Commitments and Contingencies

Government Audits

Federal government cost-reimbursement contract revenues and expenses in the audited consolidated financial statements are subject to DCAA audit and possible adjustment. Alion is a major contractor and DCAA maintains an office on site to perform various audits throughout the year. The Company has settled indirect rates through 2007 based on completed DCAA audits. All subsequent years are open. We are disputing the government’s claim for penalties and interest for 2005, which in the aggregate are not material. We believe the statute of limitations has expired on any government contractual claims, including any claims for penalties and interest, on our 2005 indirect rate proposal. Alion has recorded federal government contract revenue based on amounts it expects to realize upon final settlement.

Legal Proceedings

We are involved in routine legal proceedings occurring in the ordinary course of business that we believe are not material to our financial condition, operating results, or cash flows. As a government contractor, from time to time we may be subject to DCAA audits and federal government inquiries. The federal government may suspend or debar for a period of time any federal contractor it finds has violated the False Claims Act, and any contractor indicted or convicted of violations of other federal laws. The federal government could also impose fines or penalties.

Alion depends on federal government contracts; suspension or debarment could have a material, adverse effect on our business, financial condition, operating results, cash flows and our ability to meet our financial obligations. We are not aware of any such pending federal government claims or investigations.


(23) Interim Period (Unaudited, in thousands except per share information)
 

92
ALION SCIENCE AND TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
2014 Quarters
 
1st
 
2nd
 
3rd
 
4th
Revenue
$
185,380

 
$
192,966

 
$
207,377

 
$
219,086

Gross profit
$
40,105

 
$
43,947

 
$
45,047

 
$
46,399

Net (loss) income
$
(18,462
)
 
$
(16,788
)
 
$
(13,266
)
 
$
4,520

Net loss per share (excluding warrants)
$
(2.41
)
 
$
(2.20
)
 
$
(1.76
)
 
$
0.50

Current assets
$
179,298

 
$
191,759

 
$
189,003

 
$
187,568

Current liabilities
$
474,643

 
$
736,335

 
$
743,602

 
$
186,156

 
2013 Quarters
 
1st
 
2nd
 
3rd
 
4th
Revenue
$
204,329

 
$
221,281

 
$
220,947

 
$
202,415

Gross profit
$
43,694

 
$
46,319

 
$
46,633

 
$
42,822

Net loss
$
(11,021
)
 
$
(9,131
)
 
$
(7,087
)
 
$
(9,353
)
Net loss per share
$
(1.64
)
 
$
(1.39
)
 
$
(1.01
)
 
$
(1.37
)
Current assets
$
203,722

 
$
223,550

 
$
211,464

 
$
203,630

Current liabilities
$
157,168

 
$
171,700

 
$
167,253

 
$
161,061


(24) Related Parties

As a result of the Refinancing Transactions, we issued the Series A Preferred Stock, which confers voting control of Alion’s equity, consent rights over certain actions and the right to appoint a majority of Alion’s directors to the holders of the Series A Preferred Stock. ASOF owns 78.6% of the Series A Preferred Stock and Alion’s Second Lien Term Loan and Third Lien Notes, and the balance of the Series A Preferred Stock is owned by Phoenix. In addition, Lawrence A. First and Daniel H. Clare were elected to serve on Alion’s Board of Directors by ASOF as the holder of a majority of the Series A Preferred Stock. As a result, ASOF and Phoenix may be considered parties related to Alion.
ASOF owns $55.0 million of Second Lien Term Loans and $116.0 million of Third Lien Notes, plus $2.3 million in accrued PIK notes. Phoenix owns $15.0 million of Second Lien Term Loans and $58.9 million of Third Lien Notes, plus $0.9 million in accrued PIK notes. ASOF and Phoenix also own warrants to purchase 6,066,575 and 2,524,241 shares of Alion’s common stock, respectively. ASOF and Phoenix were paid fees in connection with the Refinancing Transactions of $6.8 million and $0.3 million, respectively, plus reimbursement of their professional fees.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.

Item 9A. Controls and Procedures

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

Limitations on the Effectiveness of Controls. Because of their inherent limitations, disclosure controls and procedures and internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and

93

presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures.

Management’s Annual Report on Internal Control Over Financial Reporting. The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 15(d)—15(f) under the Exchange Act). The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.

Management assessed the effectiveness of Alion’s internal control over financial reporting as of September 30, 2014. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework issued in 1992. Based upon the assessments, the Company’s management has concluded that as of September 30, 2014 our internal control over financial reporting was ineffective exclusively due to the one capital transaction discussed below.

Changes in Internal Control Over Financial Reporting. The Company identified a material weakness in the operation of its internal control over financial reporting (as such term is defined in Rule 15(d)-15(f) under the Exchange Act). The material weakness related exclusively to recording elements of the Company’s recent Refinancing Transactions, in particular, the Company’s recently issued Third Lien Notes. The Refinancing Transactions required multiple reviews and analyses of complex accounting principles and interpretations. In its effort to account for the Refinancing Transactions, management relied, in part, on the Company's outside advisors' description and interpretation of some of the newly issued debt instruments. Management did not engage a third party which specializes in the accounting treatment associated with complex capital transactions to analyze the multiple components of the Refinancing Transactions. In the future, management will engage third party specialists to provide assistance and guidance, if and when, the Company executes any future complex capital transactions.

Scope of the Assessment. This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to the exemption provided to issuers that are neither “large accelerated filers” nor “accelerated filers” under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
Item 9B. Other Information
None.

94

PART III
Item 10. Directors, Executive Officers and Corporate Governance

Information Regarding the Directors of the Registrant

The names, ages and positions of our current directors are set forth below:
 
Name
Age
 
Position
 
Term
Expires
 
Director
Since
Bahman Atefi
61
 
President, Chief Executive
Officer, Chairman
 
Not assigned
 
2001
Leslie L. Armitage
46
 
Director
 
2016
 
2002
Daniel H. Clare
43
 
Director
 
2017
 
2014
Lewis Collens
79
 
Director
 
2016
 
2002
Lawrence A. First
51
 
Director
 
2017
 
2014
Admiral Harold W. Gehman, Jr., USN (Ret.)
71
 
Director
 
2016
 
2002
General Michael V. Hayden, USAF (Ret.)
69
 
Director
 
2015
 
2010
General George A. Joulwan, USA (Ret.)
75
 
Director
 
Not assigned
 
2002
General Michael E. Ryan, USAF (Ret.)
72
 
Director
 
Not assigned
 
2002
    
Six of the Company's directors are divided into three classes. Directors Lawrence A. First and Daniel H. Clare have terms expiring on the date of Alion's 2017 annual shareholder meeting. Directors Leslie L. Armitage, Lewis Collens and Harold W. Gehman, Jr. have terms expiring on the date of Alion’s 2016 annual shareholder meeting. Director Michael V. Hayden has a term expiring on the date of Alion's 2015 annual shareholder meeting. Directors Bahman Atefi, George A. Joulwan and Michael E. Ryan are not assigned to a class of directors.
    
The following sets forth the business experience, principal occupations and employment of each of our directors, as well as their specific experience, qualifications, attributes and skills relevant to our business that led to the conclusion that each of these individuals should serve as an Alion director.

Bahman Atefi was appointed chief executive officer of Alion in December 2001 and also as president in 2002. He is also chairman of Alion’s Board of Directors. Dr. Atefi also serves as chairman of the ESOP committee. Dr. Atefi served as president of IITRI from August 1997 and as its chief executive officer from October 2000 until December 20, 2002, when Alion purchased substantially all of IITRI’s assets. From June 1994 to August 1997, Dr. Atefi served as manager of the energy and environmental group at Science Applications International Corporation. In this capacity, he was responsible for a business unit, which provided scientific and engineering support to the U.S. Department of Energy, Nuclear Regulatory Commission, Environmental Protection Agency, Department of Defense, and commercial and international customers. Dr. Atefi is a member of the Board of Directors of The Wolf Trap Foundation for the Performing Arts. Dr. Atefi received a BS in Electrical Engineering from Cornell University, an MS in Nuclear Engineering and a Doctor of Science in Nuclear Engineering from the Massachusetts Institute of Technology.

Dr. Atefi was selected and continues to serve as a director of the Company because of his institutional and operational knowledge of the Company’s business, his financial acumen, his service as the Company’s chief executive officer and his more than twenty-five years of experience in the government contracting professional services market.

Leslie L. Armitage has served as a director of Alion since June 2002. Ms. Armitage currently serves as a Senior Managing Director and Co-Founder of Relativity Capital, a position she has held since January 2006. Ms. Armitage served as a Managing Director and Partner of The Carlyle Group from January 1999 until May 2005 and held various positions at Carlyle from 1990 to 1999. Ms. Armitage has served on the Board of Directors of MHF Services, Inc. since June 2009 and Tactical Micro, Inc. since December 2010. She previously served on the Board of Directors of Vought Aircraft Industries, Inc., Honsel International Technologies, United Components, Inc., Nivisys Industries and Berkshire Manufactured Products.

Ms. Armitage was selected and continues to serve as a director of the Company because of her extensive financial and board experience and acumen developed over the course of more than twenty years in the private equity market, in addition to her familiarity with companies in the government contracting professional services industry.

95

    
Daniel H. Clare is a Managing Director of ASOF and joined the firm in 2010. From 2005 to 2010, Mr. Clare was with Diamond Castle Holdings, LLC, a private equity firm focused on leveraged buyout and growth capital investments in middle market companies, most recently as a Senior Managing Director. From 1999 to 2005, Mr. Clare was an investment professional at CSFB Private Equity/DLJ Merchant Banking Partners. From 1993 to 1997, he was a management consultant at Bain & Company, and in 1998, was a summer associate in the investment banking division at Goldman Sachs & Co. Mr. Clare received a BA from Haverford College in Political Science, and an MBA from Harvard Business School. He also attended the University of Cambridge.

Mr. Clare was selected and continues to serve as a director of the Company because of his extensive experience investing in other companies and serving on the boards of directors of other companies.    

Lewis Collens has served as a director of Alion since June 2002. From 1990 to 2009, Mr. Collens served as president of Illinois Institute of Technology (“IIT”). He is currently President Emeritus and Professor of Law Emeritus at IIT, Chicago-Kent College of Law, a position he has held since August 2009. He also currently serves as Senior Advisor for Charles Dobrusin Associates. Mr. Collens has served as a director of Amsted Industries since February 1991 and as a director and Chairman of Colson Company from March 2002 to March 2012.
    
Mr. Collens was selected and continues to serve as a director of the Company because of his familiarity with the Company’s business from his prior roles as the Chief Executive Officer and Board Chairman of the Company’s predecessor IIT Research Institute, as well as the financial and legal expertise he has developed over his career.

Lawrence A. First is the Chief Investment Officer and Managing Director of ASOF. Mr. First joined the firm in 2008. Prior to joining, Mr. First was a Managing Director and Co‑Portfolio Manager in Merrill Lynch’s Principal Credit Group, a proprietary investing platform for the firm’s capital, where he was responsible for evaluating and managing assets in the team’s North American portfolio, including non‑investment grade bank loans, stressed/distressed fixed income investments and public and private equity. Prior to joining Merrill Lynch in 2003, Mr. First was a senior partner in the Bankruptcy and Restructuring department of the law firm of Fried, Frank, Harris, Shriver & Jacobson, LLP, where he began his legal career in 1987. At Fried Frank, he represented both debtors and creditors in both in‑ court and out‑of court restructurings as well as lenders to, investors in, and potential buyers and sellers of, financially troubled companies. Prior to his joining Fried Frank’s Bankruptcy and Restructuring department, he was a member of its Corporate Department, where he became partner in 1994. Mr. First received a BA from Haverford College in History and Sociology, and a JD from New York University School of Law. He also attended the London School of Economics.

Mr. First was selected and continues to serve as a director of the Company because of his extensive experience investing in other companies and serving on the boards of directors of other companies.

Admiral Harold W. Gehman, Jr., USN (Ret.) has served as a director of Alion since September 2002. Admiral Gehman retired from over 35 years of active duty in the U.S. Navy in October 2000. While in the U.S. Navy, Admiral Gehman served as NATO’s Supreme Allied Commander, Atlantic and as the Commander in Chief of the U.S. Joint Forces Command from September 1997 to September 2000. Since his retirement in November 2000, Admiral Gehman has served as an independent consultant to the U.S. government from October 2000 to present. Admiral Gehman has served on the Boards of Directors of Maersk Lines, Ltd. since April 2001, Transystems Corp since January 2002 and Nivisys Corp. from July 2008 to July 2011. He also served on the board of visitors of Old Dominion University. Admiral Gehman is a senior fellow at the National Defense University and was the chairman of the Governor of Virginia’s Advisory Commission for Veterans Affairs. Admiral Gehman served as co-chairman of the Defense Department’s investigation into the October 2000 attack on the U.S.S. Cole in Aden Harbor, Yemen, as chairman of the Space Shuttle Columbia Accident Investigation Board, and as the Commissioner of the 2005 National Base Realignment and Closure Act.
    
Admiral Gehman was selected and continues to serve as a director of the Company because of his extensive domain expertise developed over the course of his service as a naval officer, as well as his years of leadership in the most senior levels of the U.S. defense establishment.
    
General Michael V. Hayden, USAF (Ret.) has served as a director of Alion since July 2010. General Hayden retired from 39 years of service in the United States Air Force in July 2008. General Hayden served as Director of the Central Intelligence Agency from May 2006 until February 2009, and as Director of the National Security Agency from 1999 until 2005. He entered active duty in 1969 after earning a bachelor’s degree in history in 1967 and a master’s degree in modern American history in 1969, both from Duquesne University. He is a distinguished graduate of Duquesne’s ROTC program. General Hayden served as Commander of the Air Intelligence Agency and as Director of the Joint Command and Control

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Warfare Center. He has also served in senior staff positions at the Pentagon, Headquarters U.S. European Command, National Security Council and the U.S. Embassy to the People’s Republic of Bulgaria. General Hayden served as Deputy Chief of Staff, United Nations Command and U.S. Forces Korea, Yongsan Army Garrison, South Korea. He currently serves as a Distinguished Visiting Professor at George Mason University School of Public Policy and as a Principal at the Chertoff Group. General Hayden has served on the Board of Directors of Motorola Corporation since January 2011, Accenture Federal Services, LLC since May 2012 and Orbis Operations since July 2012. He served on the Board of Directors of National Interest Security Company from April 2009 to March 2010. General Hayden also serves as a Consultant and Advisory Board Member for Cubic Defense Applications, Computer Sciences Corporation, Kaseman LLC, Draper Labs, Next Century Corporation, Accenture, Orbis Operations, IBM, the Commonwealth Bank of Australia and Catapult Technology.
    
General Hayden was selected and continues to serve as a director of the Company because of his extensive domain expertise developed over the course of his service as an Air Force officer, as well as his years of leadership in the senior-most levels of the U.S. defense and intelligence establishments, having served as director both the Central Intelligence Agency and the National Security Agency.

General George A. Joulwan, USA (Ret.) has served as a director of Alion since June 2002. General Joulwan retired from 36 years of service in the military in September 1997. While in the military, General Joulwan served as Commander in Chief for U.S. Southern Command in Panama from 1990-1993 and served as Commander in Chief of the U.S. European Command and NATO Supreme Allied Command from 1993-1997. From 1998 to 2000, General Joulwan served as an Olin Professor at the U.S. Military Academy at West Point. General Joulwan has also served as an adjunct professor at the National Defense University from 2001 to 2002. Since 1998, General Joulwan has served as President of One Team, Inc., a strategic consulting company. General Joulwan currently serves on the Board of Directors of Accenture Federal Services LLC since 2002, IAP Worldwide Services since 2005, Freedom Group, Inc. since 2007 and Emergent Biosolutions since 2013. He also serves on the boards of several charity and non-profit organizations. General Joulwan has previously served on the Board of Directors for General Dynamics Corporation from 1998-2012, TRS-LLC from 2001-2012, and nGrain (Canada) Corporation from 2004-2011.
    
General Joulwan was selected and continues to serve as a director of the Company because of his extensive domain expertise developed over the course of his service as an Army officer, as well as his years of leadership in the senior-most levels of the U.S. defense establishment.
    
General Michael E. Ryan, USAF (Ret.) has served as a director of Alion since June 2002. General Ryan retired from the military in 2001 after 36 years of service. He served his last four years as the 16th Air Force Chief of Staff, responsible for organizing, training and equipping over 700,000 active duty, reserve and civilian members. He is currently president of the consulting firm, Ryan Associates, focusing on national defense issues, a position he has held since January 2001. He is Chairman of the Board of CAE USA, Inc., SELEX Galileo Inc. and the Air Force Village Charitable Foundation. He has served on the Board of Directors of United Services Automobile Association since November 2002, Circadence Corporation since December 2003, VT Services, Inc. from December 2004 to July 2012, CAE USA since August 2002, SELEX Galileo Inc. since June 2005 and Nivisys Industries LLC from July 2008 to July 2011. He is a senior trustee of the Air Force Academy Falcon Foundation.
    
General Ryan was selected and continues to serve as a director of the Company because of his extensive domain expertise developed over the course of his service as an Air Force officer, as well as his years of leadership in the senior-most levels of the U.S. defense establishment, including as a Chief of Staff of the Air Force.

Establishment of Committees

The Board of Directors has established five committees, an Audit and Finance Committee, a Compensation Committee, a Governance and Compliance Committee, a Special Projects Committee and a Refinancing Committee. Each committee currently consists of the following members, which reflects changes made to the members of each committee in August 2014 in connection with the Refinancing Transactions:

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Committee
  
Chairperson
  
Members
Audit and Finance Committee
  
Leslie Armitage
  
Daniel Clare, Lewis Collens, Lawrence First, Harold Gehman, Michael Ryan
Compensation Committee
  
Harold Gehman
  
Leslie Armitage, Daniel Clare, Lewis Collens, Lawrence, First, George Joulwan
Governance and Compliance Committee
  
Michael Ryan
  
Bahman Atefi, Daniel Clare, Lawrence First, Harold Gehman, Michael Hayden, George Joulwan
Special Projects Committee
  
George Joulwan (acting)
  
Daniel Clare, Lawrence First, Michael Ryan
Refinancing Committee
  
Lewis Collens
  
Leslie Armitage, Daniel Clare, Lawrence First,

The Board of Directors has determined that Leslie Armitage qualifies as “audit committee financial expert” as defined in Item 407(d)(5)(ii) of Regulation S-K, and that she is “independent” as independence for audit committee members is defined in the listing standards of the NYSE MKT.

Audit and Finance Committee

The responsibilities of the Audit and Finance Committee are set forth in its charter and include periodically reviewing and making recommendations to the Board of Directors and management of the Company concerning:

•
professional services provided by our independent registered public accounting firm;
•
independence of our independent registered public accounting firm from our management;
•
our quarterly and annual financial statements and our system of internal control over financial reporting;
•
our capital structure, including the issuance of equity and debt securities, the incurrence of indebtedness, and related matters;
•
general financial planning, including cash flow and working capital management, capital budgeting and expenditures, tax planning and compliance and related matters;
•
mergers, acquisitions and strategic transactions;
•
investment policies, financial performance and funding of our employee benefit plans; and
•
other transactions or financial issues that the Board of Directors or management presents to the committee to review.

The Audit and Finance Committee met four times during fiscal 2014.

Compensation Committee

The responsibilities of the Compensation Committee set forth in its charter include:

•
determining the compensation of our Chief Executive Officer and reviewing and approving the compensation of our other executive officers;
•
exercising all rights, authority and functions under our KSOP, retirement and other compensation plans;
•
approving and making recommendations to the Board regarding non-employee director compensation;
•
preparing an annual report on executive compensation for inclusion in our annual report on Form 10-K in accordance with the rules and regulations of the Securities and Exchange Commission;
•
establishing, implementing and monitoring adherence to the Company’s compensation philosophy; and
•
evaluating performance and compensation to ensure that the Company maintains its ability to attract and retain superior employees in key positions and that compensation provided to key employees remains competitive relative to the compensation paid to similarly situated executives of other companies.

The Compensation Committee met three times during fiscal 2014.

Corporate Governance and Compliance Committee
The Corporate Governance and Compliance Committee oversees and reviews nominations for our Board of Directors and evaluates and recommends corporate governance policies and procedures. The Corporate Governance and Compliance Committee is charged with annually assessing the performance of the Board of Directors and its committees. This includes overseeing each committee’s annual self-assessment, including the Corporate Governance and Compliance Committee itself.

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These assessments are intended to monitor the effectiveness of the Board of Directors and each of its committees; gather information regarding the ability of the Board and its committees to fulfill their mandates and responsibilities; and provide a basis to further evaluate and improve policies of the Board and its committees.

The Corporate Governance and Compliance Committee met four times during fiscal 2014.

Special Projects Committee

The Special Projects Committee’s primary purpose and function is to oversee special projects and programs of a significant nature as determined jointly by the Committee and the management of Alion, or by the Board of Directors; and develop, recommend to the Board, and assess policies and procedures with regard to such special projects.

The Special Projects Committee met once during fiscal 2014.

Refinancing Committee

The Refinancing Committee’s primary purpose is to work with management to assess potential strategies and structures for the refinancing of our debt, including the Old Notes, the Existing Secured Notes and our Existing Revolving Credit Facility, as well as to assess proposals we may receive as a result of management’s efforts to explore and solicit potential sources of financing.

The Refinancing Committee met twice during fiscal 2014.

Board of Directors Diversity

Alion’s Corporate Governance and Compliance Committee is charged with recommending director candidates to the full Board of Directors. The Board of Directors nominates directors for election by Alion’s common stockholders. The holders of a majority of the Series A Preferred Stock have the right, but are not required, to elect a majority of our Board of Directors, and any directors not elected by the Series A Preferred Stock are elected by the vote of all holders of Alion common stock. The Governance and Compliance Committee does not have a formal policy regarding diversity when identifying and considering director nominees. In evaluating director nominees, the Governance and Compliance Committee typically considers an individual’s overall experience, subject matter expertise, military service, financial knowledge, and international business and military experience. The Corporate Governance and Compliance Committee is focused on constructing a board with a well-balanced distribution of experience among its members to support the Company’s growth and performance in the government contracting professional services industry.

Registrant Chief Executive Officer and Chairman of the Board

Dr. Atefi was selected to act as both the first CEO and Chairman of the Board of Directors of Alion in 2001 largely because both Illinois Institute of Technology (IIT) and the ESOP Trustee (initially the two largest holders of Alion’s debt and common stock at the time) required him to act as CEO to successfully conclude Alion’s employee buyout of IITRI’s assets. Both IIT and the ESOP Trustee also believed Dr. Atefi was the individual most qualified to serve as Chairman because of his institutional and operational knowledge and his financial acumen. The Company continues to believe this leadership structure remains the most appropriate structure for Alion.

Board of Directors’ Role in Risk Oversight

The Board of Directors oversees potential risks and risk management activities, including discussing Alion’s with management and evaluating such risks at meetings of the Board and its Committees. Members of the Board of Directors also use their independent knowledge and understanding of the risks that Alion and other professional services government contractors face. The Board of Directors reviews Alion’s corporate strategy in light of the evolving nature of the risks the Company faces and adjusts strategy when appropriate.

The Board of Directors has also delegated risk oversight to certain of its standing committees within their areas of responsibility. The Corporate Governance and Compliance Committee and the Audit and Finance Committee assist the Board of Directors in its risk oversight function with regard to internal control over financial reporting, periodic filings, procedures relating to the receipt and treatment of complaints, and policies and procedures designed to ensure adherence to applicable laws and regulations.

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The Board of Directors has delegated to the Corporate Governance and Compliance Committee responsibility for oversight of certain of the Company’s risk oversight and compliance matters, including oversight of (i) material legal proceedings and material contingent liabilities, (ii) the Company’s policies regarding risk assessment and management, (iii) the Company’s compliance programs with respect to legal and regulatory requirements and the Company’s Code of Conduct, and (iv) related party transactions and conflicts of interest.

The Board of Directors has also delegated to the Audit and Finance Committee the responsibility for oversight of certain of the Company’s risk oversight and compliance matters, including reviewing the Company’s accounting policies, practices and disclosure controls and establishing procedures for the receiving and handling of complaints regarding accounting, internal accounting controls and auditing matters.

Information Regarding the Executive Officers of the Registrant

The names, ages and positions of the Company’s current executive officers and the dates from which these positions have been held are set forth below.
Name
 
Age
 
Office
 
Position Since
Bahman Atefi
 
61
 
President, Chief Executive Officer and Chairman of the Board of Directors (1)
 
December 2001
Stacy Mendler
 
51
 
Chief Operating Officer and Executive Vice President (1)
 
September 2006
Kevin Boyle
 
45
 
Senior Vice President, General Counsel and Secretary
 
January 2014
Barry Broadus
 
55
 
Chief Financial Officer, Senior Vice President and Treasurer (1)
 
September 2012
Robert Hirt
 
54
 
Sector Senior Vice President – Technology, Engineering and Operational Solutions Sector
 
July 2011
Rod Riddick
 
64
 
Sector Senior Vice President – Engineering and Integration Solutions Sector
 
November 2013
 
(1)
Member of the ESOP committee.
The following sets forth the business experience, principal occupations and employment of each of the current executive officers who do not serve on the Board of Directors. Please read “Information Regarding the Directors of the Registrant” above for the information with respect to Dr. Atefi.

Stacy Mendler has served as our Chief Operating Officer and Executive Vice President since September 2006. She served as our Executive Vice President and Chief Administrative Officer from September 2005 until September 2006, and as our Senior Vice President and Chief Administrative Officer from May 2002 until September 2005. She is also a member of our ESOP committee. Ms. Mendler served IITRI as Senior Vice President and Director of Administration from October 1997 until December 20, 2002, when we purchased substantially all of IITRI’s assets. As of May 2002, Ms. Mendler was IITRI’s Chief Administrative Officer, as well as Senior Vice President. She also served as IITRI’s Assistant Corporate Secretary from November 1998 through December 2002. From February 1995 to October 1997, Ms. Mendler was Vice President and Group Contracts Manager for the Energy and Environment Group at Science Applications International Corporation where she managed strategy, proposals, contracts, procurements, subcontracts and accounts receivable. She currently serves on the Board of Directors of NVTC, the VA Chamber of Commerce (VCOC) and the Professional Services Council (PCS) and is Vice Chair on the executive committee of VCOC. Ms. Mendler received a BBA in Marketing from James Madison University and a MS in Contracts and Acquisition Management from Florida Institute of Technology.

Kevin Boyle became our Senior Vice President, General Counsel and Secretary on January 6, 2014. Prior to joining us, he served from February 2012 until January 2014 as Senior Vice President, General Counsel and Secretary of MCR, LLC, a privately‑held professional services firm specializing in integrated program management solutions for the Department of Defense. From June 2007 until February 2012, Mr. Boyle served as Senior Vice President, General Counsel & Secretary for Vangent, Inc., a leading provider of information management and business process outsourcing services to the US Federal Government. From 2002 to May 2007, he served as Assistant General Counsel for General Dynamics Information Technology, Inc., following its acquisition of Anteon International Corporation in June 2006. Mr. Boyle also served as Vice President and General Counsel for publicly‑held Interworld Corporation from 2000 to 2002. Prior to 2000, he held similar positions with Visual Networks, Cambridge Technology Partners and BMG Entertainment. Mr. Boyle received his Juris Doctor degree from Tulane Law School and his Bachelor of Arts degree in history from Yale University.    


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Barry Broadus has served as our Chief Financial Officer, Senior Vice President and Treasurer since September 2012. He served as our (Acting) Chief Financial Officer from April 2012 until September 2012 and Director of Financial Planning from September 2008 until April 2012. Prior to joining us, from November 2004 to September 2008, Mr. Broadus served as Vice President and Business Unit Controller at Science Applications International Corporation (SAIC) where he was responsible for the financial oversight of the Energy, Environment & Infrastructure Business Unit. Prior to SAIC, from September 2000 to July 2004 he was the Chief Financial Officer for Brainbench, Inc. Prior to Brainbench, Mr. Broadus served for 12 years at EDS, as the Military Systems Business Unit Controller. He also worked for Andersen Consulting. In his earlier career, he was an Officer in the U.S. Army from 1982 to 1985. Mr. Broadus received a Bachelor of Science in Business Administration with a major in Accounting from the University of Alabama.

Robert Hirt has served as our Senior Sector Vice President for the Technology Engineering and Operational Solutions Sector since July 2011 and the Engineering and Information Technology Sector since March 2011. Mr. Hirt joined us in April of 2009 as the Deputy Sector Manager for the Engineering and Information Technology Sector. Prior to joining us, Mr. Hirt served as a Senior Manager and Chief Technology Officer at SAIC for over 23 years. In this tenure he managed the corporation’s CBRN Weapons Effect, Planning and Simulation Division (DTRA, STRATCOM, NATO), Command and Control Operations (GCCS‑J, M, A, GCSS, NCES) and Logistics Service Operation (Asset Visibility, Repairables Management, RFID, Data Center consolidation, MRAP Joint Logistic Integrator, DEAMS, ECSS). Mr. Hirt received his BA in Economics and Mathematics from the University of California and a MS in Systems Engineering from George Washington University.

Rod Riddick became Sector Senior Vice President and Sector Manager of our Engineering and Integration Solutions Sector (EISS) on November 1, 2013. Mr. Riddick has supported the U.S. Navy in various capacities for over 40 years. He served as Senior Vice President and Deputy Sector Manager of EISS from 2007 to 2013, and as an EISS Group Senior Vice President from 2005 to 2007. He served John J. McMullen Associates, Inc., an internationally regarded ship design and engineering firm, from 1982 to 1985 and from 1990 to 2005 in positions of increasing responsibility, culminating in Senior Vice President of Acquisition Programs from 2000 to 2005. From 1985 to 1990 he was a Program Director with Advanced Technology, Inc. From 1979 to 1982 he worked for Advanced Marine Enterprises, Inc. as Hull Design Section Chief and Program Manager. From 1978 to 1979 he was a Senior Designer at Newport News Shipbuilding & Dry Dock, Inc. From 1977 to 1978 he was a Checker at J.J. Henry Company, Inc. Mr. Riddick began his career as a Designer/Draftsman with Asset, Inc. from 1972 to 1977, after returning from Vietnam as an air traffic controller with the US Air Force.

There is no known family relationship between any director and executive officer.
Code of Ethics
In November 2014, we adopted our revised Code of Ethics that applies to all of our employees and meets the definitional requirements set forth in the rules and regulations of the Securities and Exchange Commission. We provide access to a telephone hotline so our employees can report suspected instances of improper business practices such as fraud, waste, and violations of our Code of Ethics.
A copy of the 2014 Code of Ethics is posted for all of our employees on our internal website and can also be found on our Investor Relations website at: http://www.alionscience.com/en/Investor-Relations/Corporate-Governance-Documents. A printed copy without charge can be obtained from our Secretary upon request.

Item 11. Executive Compensation

Compensation Discussion and Analysis

Objectives of Executive Compensation Program

Our executive compensation program’s primary objective is to attract and retain qualified, energetic employees who are enthusiastic about Alion’s mission and to reward them for their contributions to Alion. Our executive compensation program is designed to create strong financial incentives for our officers to increase revenue, profit, cash flow, operating efficiency and returns, which we expect to lead to increased shareholder value. We strive to promote an ownership mentality in our key leaders and our Board of Directors. We endeavor to ensure that our compensation program is perceived as fundamentally fair to all stakeholders.

The Compensation Committee of the Board of Directors (the “Compensation Committee”) evaluates both performance and compensation to ensure Alion maintains its ability to attract and retain employees in key positions. We seek to

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compensate key employees at levels that are competitive with what our peer group companies pay similarly situated executives. The Compensation Committee believes Alion’s compensation packages for named executives and other officers should include current cash and long-term incentives to reward performance as measured against established goals.

What We Designed Our Compensation Program to Reward

We believe we designed our compensation program to reward each employee’s contribution to Alion. The Compensation Committee considers numerous factors including the Company’s growth and financial performance in measuring named executive officers’ contributions. We refer to the individuals who served as the Company’s Chief Executive Officer and Chief Financial Officer during the current fiscal year, along with the other individuals included in the Summary Compensation Table as “named executive officers.”

Roles and Responsibilities for Our Compensation Program

Role of the Compensation Committee

The Compensation Committee is responsible for establishing, implementing and monitoring adherence to Alion’s compensation philosophy and for setting the individual cash and incentive compensation levels for executive officers. The Compensation Committee’s responsibilities are set forth in its charter and discussed in Item 10 under “Establishment of Committees.”

Role of the Chief Executive Officer

Our Chief Executive Officer makes recommendations to the Compensation Committee in evaluating Alion’s executive officers, including recommending cash and incentive compensation amounts for these individuals. Dr. Atefi relies on his personal experience as Alion’s Chief Executive Officer in evaluating other executive officers and on comparable compensation guidance provided by an outside compensation consultant. Dr. Atefi was not present during Compensation Committee deliberations and voting pertaining to the determination of his own compensation.

Role of the Compensation Consultant

The Compensation Committee annually retains a consultant to provide independent advice on executive compensation matters and to perform specific project-related work. In 2014, we engaged AON Hewitt to review our named executive officers’ compensation packages and to provide the Compensation Committee with competitive data and analysis. AON Hewitt performed no other services for Alion.

Elements of the Company’s Executive Compensation Program

Alion’s compensation program includes several major elements. We pay our named executive officers salaries that are competitive and non-discriminatory to attract, retain, and motivate them. We offer an incentive program designed to encourage exceptional employee performance. We offer our named executive officers fringe benefit, employee morale and wellness programs, and a 401(K) salary deferral program designed to attract and retain both executives and employees.

Base Salary

Alion pays each named executive officer a base salary for services rendered during the fiscal year. This fixed annual amount for performing specific job responsibilities is the minimum income the named executive officer may receive in any given year. The Compensation Committee determines each Alion executive’s base salary based on job responsibilities and performance, and by comparison to peer level compensation. The Compensation Committee establishes the Chief Executive Officer’s base salary, including periodic changes. It considers the Chief Executive Officer’s recommendations when it determines base salaries and changes, for other named executive officers.

Base salaries for our named executive officers as of September 30, 2014 were:
 

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Named Executive Officer
Fiscal 2014 Base Salary
Bahman Atefi
$
750,348

Stacy Mendler
$
440,134

Barry Broadus
$
350,144

Robert Hirt
$
360,168

Rod Riddick
$
320,000


The base salaries set forth above reflect increases of approximately 2.0 - 12.5% for each of the Named Executive Officers, as compared to the base salary levels for fiscal 2013, in part to reflect the market analysis, as described below. Each year, the Compensation Committee utilizes salary survey information provided by its outside compensation consultant for appropriate salary data for Alion’s senior positions.

In reviewing named executive officer base salaries, the Compensation Committee considers:

•
market data from the Company’s outside compensation consultant;
•
each executive’s compensation, individually and relative to other officers;
•
each executive’s individual performance; and
•
Alion’s financial and operating results.

The Compensation Committee and its outside consultant use publicly available data from other professional services government contracting companies to benchmark compensation for Alion’s named executive officers. The benchmark companies include some of the publicly-traded companies Alion uses in its market analyses when testing goodwill for potential impairment. The Compensation Committee compares Alion data to median data for the benchmark group when it evaluates named executive officer total compensation and the individual compensation elements. The Compensation Committee evaluates various factors including base salaries, total cash compensation and various types of long term incentive compensation benchmark companies provide their executives when it decides on compensation levels and elements for Alion’s named executive officers. The Compensation Committee sets total compensation levels to be within the range of the peer companies.

For fiscal 2014, the Compensation Committee reviewed a peer group of companies from the information technology, professional services, and defense and aerospace industries. In its analysis, the Compensation Committee compared current executive compensation levels with selected peer group data and with data from several broader, national compensation surveys. The Compensation Committee updated its list of peer group companies fiscal 2014. The following companies made up the compensation peer group for fiscal 2014.
CIBER Inc.
  
Heico Corp.
  
NCI, Inc.
  
VSE Corp.
Cubic Corp.
  
ICF International, Inc.
  
Orbital Sciences Corp.
  
 
Engility Holdings, Inc.
  
Kratos Defense & Security
  
SRA International Inc.
  
 

The Compensation Committee and its outside consultant used data from industry compensation surveys and proxy statements of peer companies to establish benchmark total compensation ranges (salary, bonus and long term incentive compensation) for each named executive officer. For the Chief Executive Officer and the Chief Financial Officer, the Compensation Committee and its outside consultant gave equal weight to industry compensation survey data and peer group data to establish benchmark compensation ranges. The Compensation Committee and its outside consultant determined benchmark compensation ranges for the Chief Operating Officer based exclusively on industry compensation survey data as the peer group did not include sufficient comparable data for that position. For each sector Senior Vice President, the Compensation Committee and its outside Consultant weighted industry compensation survey data at 75% and peer group data at 25% to establish benchmark compensation ranges. The Compensation Committee then selected the mid-point (50th percentile) of each benchmark compensation range to set the benchmark compensation level for
Each named executive officer.

Total compensation for the Chief Executive Officer and the Chief Operating Officer exceeded the Compensation Committee’s selected benchmark level by approximately 6%. This reflects the long tenure at our company of Dr. Atefi and Ms. Mendler and recognition of their operating and financial acumen. Total compensation levels for the Chief Financial Officer (Mr. Broadus) and a recently appointed sector Senior Vice President (Mr. Riddick) were 46% less than the

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Compensation Committee’s selected benchmark level. Total compensation for Mr. Hirt, our other sector Senior Vice President, was 11% less than the Compensation Committee’s selected benchmark level.

Based on its review for fiscal 2014, the Compensation Committee decided to maintain existing base salaries for all named executive officers next fiscal year.

Annual Bonus

We use annual bonuses in our compensation program to motivate and reward our named executive officers for current, short term performance such as meeting annual financial performance goals, and achieving certain milestones and other non-financial performance goals within a given year. The Compensation Committee believes it is important to encourage and reward both short-term and long-term performance. It has the discretion to set goals and objectives it believes are consistent with creating shareholder value, including financial measures, operating objectives, growth goals and other measures. Objectives may be based upon Alion achieving revenue or operating income targets as well as other financial and business objectives. Revenue growth and operating profitability are weighted as the most significant factors. The Compensation Committee evaluates achievement of objectives following the end of each year and makes annual bonus awards based on this assessment. The Compensation Committee considers individual achievement and also relies on the Chief Executive Officer’s recommendations with respect to other executive officers.

In fiscal 2013, we paid annual bonuses earned in fiscal 2012. In fiscal 2012 and 2011, we paid annual bonuses earned in fiscal 2011 and 2010, respectively. The Compensation Committee determined that named executive officer bonuses relating to fiscal 2013 performance were subject to a further performance condition that the Refinancing Transactions be completed. The Compensation Committee did not apply an additional performance condition to Mr. Fry who stepped down as Sector Senior Vice President in November 2013. Since the Refinancing Transactions were not completed, no annual bonuses were earned by the named executive officers other than Mr. Fry during fiscal 2013.

In the first quarter of fiscal 2014, the Compensation Committee determined that the named executive officers had substantially satisfied the refinancing-related performance condition precedent to earning bonus amounts related to fiscal 2013 performance. The Compensation Committee authorized us to pay the named executive officers these bonus amounts in fiscal 2014, set forth in the Summary Compensation Table.

The Compensation Committee determines annual bonuses based on a retrospective evaluation of each executive’s performance for the current fiscal year and compares its evaluation to the information in the compensation consultant’s report. The Compensation Committee did not establish bonus-specific targets for our named executive officers in fiscal 2013.

The Chief Executive Officer reviews the performance of each of his direct reports with the Compensation Committee and ranks their performance percentile (25th - 50th - 75th) to determine their annual bonuses. The Chief Executive Officer and the Compensation Committee evaluate each executive’s contribution to our year over year overall performance including: revenue growth; operating income performance; contract backlog; new market penetration; DSO; and staff turnover. The Compensation Committee performs a similar review of the Chief Executive Officer’s performance in executive session.

With respect to annual bonus awards attributable to fiscal 2014, the Compensation Committee has not completed its performance review and has not yet determined annual bonus amounts payable to the named executive officers.


Long-term Incentives/Awards

We use our long-term incentives to motivate, retain and reward our named executive officers for both short-term and sustained performance. The Compensation Committee establishes performance-based award opportunities specific to Alion’s financial performance and the specific business unit and/or corporate department an individual leads.

Long-Term Incentive Plan

We established the Alion Science and Technology Corporation Long-Term Incentive Plan (LTIP) in November 2008. LTIP grants provides for award opportunities based on achieving predefined individual performance goals set by the Compensation Committee. Our named executive officers and other key employees are eligible to receive LTIP awards. The Board of Directors has adopted separate forms of LTIP award agreements for named and other executive officers. LTIP awards are paid in cash.

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We established the LTIP to:

•
facilitate recruiting and retaining key employees;
•
provide at-risk awards contingent on achieving predetermined performance criteria over an extended period;
•
provide a meaningful incentive to achieve long-term growth and improve profitability; and
•
provide incentives to selected employees an incentive for excellence in achieving certain Company and business unit or departmental goals.

Under the LTIP, our Compensation Committee is responsible for:

•
selecting which key employees may participate;
•
determining the performance period over which a participant must achieve his or her goals;
•
setting each participant’s award opportunities for a given performance period; and
•
establishing award vesting conditions.

Following consultation with the Compensation Committee’s outside compensation consultant, we determined Alion needed a non-equity based long-term incentive compensation plan to motivate and appropriately reward named executive officers and other key employees. LTIP compensation costs, subject to various Department of Defense limitations, are allowable indirect expenses which can be reimbursed through government contracts. However, we do not expect to recover all LTIP compensation costs.

Three-year LTIP awards have been granted to named executive officers every year between 2008-2013. For fiscal 2014, a new LTIP was not granted, pending a review of the LTIP program and its connection to the Company’s business goals by the Compensation Committee following the Refinancing Transactions.

Named executive officer LTIP grants issued in 2011 vested in 2014. The grants were scheduled to vest in November with payment amounts determined based on evaluation of the relevant performance criteria. A change in control would accelerate the vesting of the 2011 LTIP’s and fix the amount payable to equal the grant’s target amount. If the change in control provisions are not applied, the amount of the award that would be payable under the 2011 LTIPs would be determined based on an evaluation of the relevant performance factors, as described more fully below. The target award amount with respect to the Named Executive Officers under the 2011 LTIPs is approximately $1,850,000 (which is also the amount that would be payable if the change in control provisions were to apply), the minimum amount payable based on performance is approximately $925,000 in the aggregate, and the maximum amount payable based on performance is approximately $2,775,000.

The August 2014 Refinancing Transactions may have triggered the change in control provisions of the LTI Plan and outstanding grants, including the 2011 LTIPs. While for accounting purposes, the 2011 LTIPs have been treated as if a change in control has occurred, the determination of whether the change in control provisions of the LTI Plan and outstanding award apply in connection with the August 2014 Refinancing Transactions and other aspects of the award payments are pending before the Compensation Committee and will be determined at a future time.

In contemplation of the effects of potentially accelerating LTIP grants issued in 2012, the Company and certain named executive officers agreed to modify their 2012 LTIP grant agreements. Certain named executives agreed to waive accelerated vesting in the event of a change in control in exchange for increasing and fixing the amount payable under the 2012 LTIP grants to 110% of the target value. The modified 2012 LTIPs vest in November 2015, if the named executive officer remains employed with the Company as of the vesting date. As discussed above, these awards have been treated for accounting purposes as if a change in control has occurred; however, the Compensation Committee continues to discuss the impact of the August 2014 Refinancing Transactions on the terms of the outstanding awards.
    
Performance goals under LTIP award agreements include, among others, reaching certain company-planned revenue targets; achieving certain levels of Consolidated EBITDA (as determined for our debt covenants); achieving certain levels of reporting unit revenue and operating income; complying with debt covenants; and achieving targeted levels of days’ sales outstanding.

LTIP grants to our named executive officers involve a three-year performance cycle. The Compensation Committee evaluates performance for three-year grants only at the end of each three-year performance cycle. Vesting acceleration can affect the extent to which LTIP grants are subject to performance evaluation.


105

A recipient may receive anywhere from 50% to 150% of the grant target amount at the end of a performance cycle. The actual award amount depends on whether the individual and the Company achieve performance goals, or substantially under- or over-achieve performance goals. The 50% floor was established in order to foster executive retention, while the 150% ceiling is intended to reward outstanding performance. Subject to evaluation on this percentage-based scale, each earned award vests in full on its vesting date, provided that the named executive officer is still employed with us. The Compensation Committee issued no LTIP awards to named executive officers in fiscal 2014.

Stock Appreciation Rights (SAR) Plan

In January 2005, the Board of Directors adopted the Alion Science and Technology Corporation 2004 Stock Appreciation Rights Plan (the SAR Plan). The Compensation Committee, or the administrative committee as delegated, administers the SAR Plan. The Company amended and restated the SAR Plan in January 2007; amended it in January 2010; and amended and restated the SAR Plan in June 2013. The SAR Plan expires in November 2016. The most recent SAR Plan amendment revises certain change in control provisions. The SAR Plan permits grants to Alion directors, officers, employees and consultants. The SAR Plan permits the Chief Executive Officer to award SARs as he deems appropriate. Awards to executive officers are subject to the approval of the administrative committee of the Plan. There were no SAR awards to named executive officers in 2014 and no named executive officers hold outstanding SARs.

Severance/Change in Control and Provisions in Employment Agreements

We maintain employment agreements with certain named executive officers to help ensure they will perform their roles for an extended period of time. These agreements provide for severance payments if an executive’s employment is terminated under certain conditions, such as following a change of control or a termination “without cause” as defined in the agreements.

Change in Control

As part of our normal course of business, we engage in discussions with other companies about possible collaborations and/or other ways to work together to further our respective long-term objectives. Many larger, established companies consider companies at stages of development similar to ours as potential acquisition targets. In certain circumstances, a potential merger, acquisition or material investment could be in the best interests of our shareholders. We provide severance compensation if an executive’s employment is terminated following a change in control transaction.

Termination without Cause

If we terminate the employment of a named executive officer without cause as defined in his or her employment agreement, we are obligated to continue to pay certain amounts as described below under Other Potential Post-Termination Payments. This provides us with flexibility to make a change in senior management if such a change is in the best interests of Alion and its shareholders.

Health and Welfare Benefits and Other Fringe Benefits

Alion provides all its named executive officers a comprehensive, balanced, and flexible fringe benefit program. Our fringe benefit program’s design plays an important role in attracting new employees and retaining our named executive officers. We review industry-wide fringe benefit packages annually to ensure that Alion’s fringe benefit program continues to provide the best value to our named executive officers. Benefits include medical, prescription drug, vision and dental coverage; life insurance; accidental death and dismemberment insurance, short and long-term disability insurance; business travel accident, kidnap and ransom insurance; an employee assistance program and flexible spending accounts for medical expense reimbursement and child care. Alion provides worker’s compensation insurance and unemployment benefits required by law to all employees, including named executive officers. We purchase worker’s compensation and unemployment insurance. Our benefit plans do not discriminate in favor of our named executive officers. Alion provides the major portion of its fringe benefit program as a core package of standard benefits supplemented by a set of employee-selected optional benefits. All eligible employees, including named executive officers contribute to the cost of certain benefits at the same rates and in the same manner. The Company also provides named executive officers a monthly automobile allowance.

KSOP

Alion’s KSOP is a qualified retirement plan that includes an ESOP and a 401(k). The ESOP Trust owns all of the Company’s outstanding shares of common stock. Through June 2011, Alion made retirement plan contributions to both the

106

ESOP and 401(k) components on behalf of all eligible employee KSOP participants. We now make all retirement contributions to the ESOP along with matching contributions based on eligible employee pre-tax salary deferrals. Named executive officers do not receive preferential KSOP benefits.

Compensation Risk Assessment

The Compensation Committee believes that the design and mix of our compensation program appropriately encourages our employees to focus on the creation of long-term shareholder value while also serving to attract, retain and motivate needed talent. We believe our approach to setting company and individual goals with target payouts at multiple performance levels encourages a level of risk-taking behavior appropriate for our business. We also believe we have allocated our compensation among base salary, annual cash incentives and long-term incentive compensation in such a way as not to encourage excessive risk-taking. In its discussions, the Compensation Committee noted the following attributes of our compensation program.

•
There is a balance between short- and long-term financial and strategic objectives, intended to reward managers for continuous improvement in revenue and operating income and growth in shareholder value.
•
A significant portion of management compensation is “at risk” and depends on achieving specific company-wide strategic, operational and financial goals, as well as individual performance goals that can be objectively determined. These corporate goals have pre-established minimum, target and stretch performance levels, with individual metrics and overall maximums.
•
The Compensation Committee considers other qualitative matters in determining annual performance payments and achievement of long term incentive goals.
•
In fiscal 2014, the Compensation Committee did not change named executive officer base salaries for the coming fiscal year, nor did it award any new LTIP grants to named executive officers.

•
Typically, the Compensation Committee issues long term compensation grants to named executive officers that vest over a three year period with performance goals measured only at the end of a three-year period. We believe this encourages our executives to focus on Alion’s long term performance.

Based on this review and currently known facts and circumstances, the Compensation Committee believes Alion’s compensation policies and practices, individually and in the aggregate, do not create known risks that are reasonably likely to materially adversely affect the Company.


107

Summary Compensation Table

The following table sets forth all compensation with respect to our Chief Executive Officer and our other named executive officers for the years ended September 30, 2014, 2013, and 2012.
 
Name and Principal Position
Year
 
Salary
 
Bonus
 
Long-
Term
Incentive
Plan
Awards
 
Non-
Equity
Incentive
Plan
Awards
 
All other
 
Total
Bahman Atefi
2014
 
$
776,378

 
$
—

 
$
—

 
$
750,000

 
$
121,934

 
$
1,648,312

Chief Executive Officer
2013
 
$
771,002

 
$
—

 
$
900,000

 
$
—

 
$
94,445

 
$
1,765,447

and President
2012
 
$
763,929

 
$
—

 
$
900,000

 
$
700,000

 
$
106,612

 
$
2,470,541

Barry Broadus
2014
 
$
356,024

 
$
—

 
$
—

 
$
225,000

 
$
63,187

 
$
644,211

Senior Vice President and
2013
 
$
316,716

 
$
—

 
$
—

 
$
—

 
$
56,641

 
$
373,357

Chief Financial Officer
2012
 
$
272,610

 
$
33,000

 
$
—

 
$
165,000

 
$
49,842

 
$
520,452

Stacy Mendler
2014
 
$
454,200

 
$
—

 
$
—

 
$
300,000

 
$
70,753

 
$
824,953

Chief Operating Officer
2013
 
$
445,081

 
$
—

 
$
315,000

 
$
—

 
$
68,794

 
$
828,875

and Executive Vice President
2012
 
$
441,606

 
$
—

 
$
315,000

 
$
300,000

 
$
74,873

 
$
1,131,479

Robert Hirt
2014
 
$
370,305

 
$
—

 
$
—

 
$
220,000

 
$
66,241

 
$
656,546

Technology, Engineering
2013
 
$
342,997

 
$
35,000

 
$
49,583

 
$
—

 
$
63,328

 
$
490,908

and Operational Solutions
2012
 
$
318,495

 
$
20,000

 
$
28,875

 
$
190,000

 
$
50,150

 
$
607,520

Senior Vice President
 
 
 
 
 
 
 
 
 
 
 
 
 
Rod Riddick
2014
 
$
328,889

 
$
—

 
$
—

 
$
125,000

 
$
65,911

 
$
519,800

Engineering and Integration
2013
 
N/A

 
N/A

 
N/A

 
N/A

 
N/A

 
N/A

Solutions Sector
2012
 
N/A

 
N/A

 
N/A

 
N/A

 
N/A

 
N/A

Senior Vice President
 
 
 
 
 
 
 
 
 
 
 
 
 

Bonuses include non-incentive based cash bonuses, such as special performance bonuses, paid to named executive officers. Non-equity incentive plan compensation includes cash bonuses awarded to our named executive officers for current fiscal year service and, in respect of the reported 2014 amounts, the figures represent cash bonus amounts granted in 2013 but not earned until performance measures were met in fiscal 2014.

Amounts reported for Long Term Incentive Plan awards represent amounts earned by the named executive officers for the three-year performance cycles ending 2013 and 2012. The amounts for the three-year performance cycle ending 2014 have not yet been determined. In 2013, Dr. Atefi, Ms. Mendler and Mr. Fry met the conditions of their 2010 Long Term Incentive Plan grants and the Compensation Committee determined the final value of each named Executive Officer's grant. Mr. Hirt received different category LTIP grants with annual evaluation periods that pre-date his status as a named executive officer. We are reporting LTIP grants earned by Mr. Hirt in the years all performance conditions were satisfied for such grants and amounts became payable. Mr. Hirt's LTIP grants were not subject to evaluation by the Compensation Committee.

Other compensation includes: 401(k) matching and profit sharing contributions under Alion’s KSOP; Company contributions for long and short term disability; amounts paid for life insurance premiums; amounts paid or reimbursed with respect to health and welfare including payroll taxes and the supplemental Medicare tax; amounts paid or reimbursed with respect to social club membership; and amounts paid or reimbursed with respect to leased cars.


108

Detail of All Other Compensation for Fiscal Year 2014, 2013, 2012
Recorded in the Summary Compensation Table
 
Name and Principal Position
Year
 
Company
Matching
Contributions
Under Alion’s
KSOP
 
Health and
Welfare
Benefits
 
Long and
Short Term
Disability
Paid by the
Company
Bahman Atefi
2014
 
$
16,900

 
$
66,280

 
$
4,488

 
2013
 
$
16,575

 
$
39,266

 
$
4,416

 
2012
 
$
16,250

 
$
51,209

 
$
5,250

Barry Broadus
2014
 
$
18,717

 
$
30,183

 
$
2,057

 
2013
 
$
14,758

 
$
27,966

 
$
1,830

 
2012
 
$
20,099

 
$
26,163

 
$
2,419

Stacy Mendler
2014
 
$
16,900

 
$
37,104

 
$
2,625

 
2013
 
$
16,575

 
$
36,576

 
$
2,553

 
2012
 
$
16,250

 
$
35,144

 
$
3,387

Robert Hirt
2014
 
$
17,427

 
$
30,894

 
$
2,140

 
2013
 
$
11,843

 
$
19,161

 
$
2,164

 
2012
 
$
15,842

 
$
18,733

 
$
2,998

Rod Riddick
2014
 
$
19,121

 
$
28,979

 
$
1,831

 
2013
 
N/A

 
N/A

 
N/A

 
2012
 
N/A

 
N/A

 
N/A


Detail of All Other Compensation for Fiscal Year 2014, 2013, 2012
Recorded in the Summary Compensation Table (continued)
 
Name and Principal Position
Year
 
Club
Membership
Fees
 
Term Life
Insurance
Paid by the
Company
 
Leased  Cars
 
Total
Bahman Atefi
2014
 
$
6,130

 
$
300

 
$
27,836

 
$
121,934

 
2013
 
$
6,060

 
$
300

 
$
27,828

 
$
94,445

 
2012
 
$
5,780

 
$
300

 
$
27,823

 
$
106,612

Barry Broadus
2014
 
$
—

 
$
206

 
$
12,024

 
$
63,187

 
2013
 
$
—

 
$
183

 
$
11,904

 
$
56,641

 
2012
 
$
—

 
$
158

 
$
1,002

 
$
49,842

Stacy Mendler
2014
 
$
—

 
$
263

 
$
13,861

 
$
70,753

 
2013
 
$
—

 
$
256

 
$
12,834

 
$
68,794

 
2012
 
$
—

 
$
256

 
$
19,836

 
$
74,873

Robert Hirt
2014
 
$
—

 
$
214

 
$
15,566

 
$
66,241

 
2013
 
$
—

 
$
202

 
$
15,564

 
$
63,328

 
2012
 
$
—

 
$
188

 
$
11,751

 
$
50,150

Rod Riddick
2014
 
$
—

 
$
184

 
$
15,796

 
$
65,911

 
2013
 
N/A

 
N/A

 
N/A

 
N/A

 
2012
 
N/A

 
N/A

 
N/A

 
N/A


109

Summary of Prior Year LTIP Award Agreements
    
In 2011, the Board of Directors issued two separate forms of LTIP award agreements - one for named executive officers and a second for other corporate officers. The 2011 grants to named executive officers had a three-year performance period that was scheduled to end in October 2014 and vest in November 2014, with payment amounts determined based on evaluation of the relevant performance criteria. The August 2014 Refinancing Transactions may have triggered the change in control provisions of the LTI Plan and outstanding grants, including the 2011 LTIPs. While for accounting purposes, the 2011 LTIPs have been treated as if a change in control has occurred, the determination of whether the change in control provisions of the LTI Plan and outstanding award apply in connection with the August 2014 Refinancing Transactions and other aspects of the award payments are pending before the Compensation Committee and will be determined at a future time. These grants remain outstanding while discussions within the Compensation Committee continue.
    
The 2011 LTIP grants to named executive officers contain various performance goals, including, among others,

•
attaining certain company-planned revenue targets;
•
achieving certain levels of Consolidated EBITDA (as determined for our debt covenants);
•
meeting certain levels of reporting unit revenue and operating income;
•
complying with debt covenants; and
•
achieving targeted levels of days’ sales outstanding.

Set out below are the performance goals and actual achievement levels for the 2011 LTIP grants to Dr. Atefi, Ms. Mendler and Mr. Hirt. As discussed above, the Compensation Committee has yet to evaluate progress toward these goals in addition to actual performance and achievement of subjective goals such as maintaining a reputation for excellence and integrity.


110

Dr. Atefi
Target
 
Actual
Three Year Compound Annual Revenue Growth Rate
5.0
%
 
(0.5
)%
Revenue (in millions)
$
914.9

 
$
804.8

Debt Covenant EBITDA (in millions)
$
78.1

 
$
68.0

Total Debt (in millions)
$
545.0

 
$
628.8

Days’ Sales Outstanding
74

 
78

LTIP Grant Value
$
1,200,000

 
 
LTIP Maximum Value
$
1,800,000

 
 
LTIP Minimum Value
$
600,000

 
 
Ms. Mendler
Target
 
Actual
Three Year Compound Annual Revenue Growth Rate
5.0
%
 
(0.5
)%
Revenue (in millions)
$
914.9

 
$
804.8

Debt Covenant EBITDA (in millions)
$
78.1

 
$
68.0

Total Debt (in millions)
$
545.0

 
$
628.8

Days’ Sales Outstanding
74

 
78

LTIP Grant Value
$
400,000

 
 
LTIP Maximum Value
$
600,000

 
 
LTIP Minimum Value
$
200,000

 
 
Mr. Hirt
Target
 
Actual
Three Year Compound Annual Revenue Growth Rate
5.0
%
 
(0.5
)%
Revenue (in millions)
$
914.9

 
$
804.8

Debt Covenant EBITDA (in millions)
$
78.1

 
$
68.0

LTIP Grant Value
$
50,000

 
 
LTIP Maximum Value
$
75,000

 
 
LTIP Minimum Value
$
25,000

 
 
Sector Revenue (in millions)
$
512.5

 
$
455.6

Sector Operating Profit %
6.8
%
 
6.6
 %
Sector Contract Backlog
$
1,130,000

 
$
1,242,115

Sector Days’ Sales Outstanding
64

 
79

Sector LTIP Grant Value
$
150,000

 
 
LTIP Maximum Value
$
225,000

 
 
Sector LTIP Minimum Value
$
75,000

 
 

    
Grants of Plan-Based Awards
    
There were no grants of plan-based awards to named executive officers in 2014.

Deferred Compensation Plans

We maintain two Deferred Compensation Plans. One plan, the Executive Deferred Compensation Plan, covers members of management and other highly compensated officers of the Company. The other plan, the Directors Deferred Compensation Plan, covers members of the Company’s Board of Directors. Neither plan is a qualified plan under the Internal Revenue Code.

Each plan permits an individual to make a qualifying election to forgo current payment and defer a portion of his or her compensation. Officers may defer up to 50% of their annual base salary and up to 100% of bonus and/or stock-based compensation payments. Directors may defer up to 100% of their fees and their stock-based compensation payments.


111

Each Plan permits an individual to defer payment to a specified future date and to specify whether deferrals are to be paid in a lump sum or installments. Under certain limited circumstances, deferrals may be paid out early or further deferred. Typically, individuals may only make one qualifying deferral election per year.

No named executive officer participated in the Executive Deferred Compensation in fiscal 2014.

 
Potential Payments Upon Termination or Change in Control

We have employment agreements with five named executive officers, which provide that if the named executive officer is involuntarily terminated without cause or if the named executive officer is involuntarily terminated or leaves with “good reason” either following or in anticipation of a change in control, he or she will be entitled to receive a lump sum cash payment as set forth in his or her individual agreement. The named executive officers’ employment agreements define “termination for cause,” “good reason” and “change in control” for purposes of determining payments upon termination of employment.

The named executive officer employment agreements provide for salary- and bonus-based severance payments as well as 18 months of company-subsidized health care benefits and a related 40% tax gross up upon an involuntary termination without cause or if the named executive officer is involuntarily terminated or leaves with “good reason” either following or in anticipation of a change in control. In the event of severance related to a change in control, the named executive officers are also eligible for up to $25,000 in outplacement services from a firm selected and paid by Alion. The Company will provide outplacement services up through December 31 of the second calendar year following the calendar year in which the named executive’s employment terminated.

Generally, the LTIP award agreements provide for accelerated vesting upon death or disability. In addition, under the terms of the LTIP awards, a portion of the award vests if the named executive officer is terminated in the second half of the three-year performance period or if there is a change in the named executive officer’s responsibilities. The outstanding LTIP award agreements also provide, in certain cases, for accelerated vesting in the event of a change in control and, in other cases, for accelerated vesting in the event of an involuntary termination or termination by the named executive officer for “good reason” following a change in control.

In order to receive termination-related payments under their employment agreements, named executive officers must execute a release and agree to non-compete, non-interference and non-solicitation covenants that run the same length of time as their salary-based severance. Named executive officers must also agree to a two-year trade-secret non-disclosure covenant and a non-disparagement covenant that runs the life of their agreement.

The tables below set out the estimated payments and benefits that would be provided to each named executive officer as a result of (a) termination without cause; (b) termination on death or disability; (c) termination for cause, voluntary termination or retirement, (d) a change in control, and (e) termination or change in responsibility following a change in control. The calculations in these tables are based on the assumption that termination and/or change in control occurred on September 30, 2014, the last day of the Company’s most-recently completed fiscal year. Amounts in the tables below do not include payments and benefits to the extent they are provided on a non-discriminatory basis to salaried employees generally upon termination of employment.

112

Potential Termination-Related Payments to
Bahman Atefi, Chief Executive Officer
 
 
 
 
 
Unrelated to a Change in Control
 
Change in
Control
Incremental
Compensation and
Benefit Payment
Applicable
Percentage
 
Base
Dollars
 
Termination
without
Cause
 
Death/
Disability
 
Termination
for Cause,
Voluntary
Termination,
Retirement
 
Termination,
Change in
Responsibility
or Other
Good Reason
Salary-based severance
200
%
 
$
750,348

 
$
1,500,696

 
$
—

 
$
—

 
$
1,500,696

Bonus-based severance
200
%
 
$
750,000

 
$
1,500,000

 
$
—

 
$
—

 
$
1,500,000

Health care benefits
 
 
$
10,504

 
$
15,756

 
$
—

 
$
—

 
$
15,756

Tax Gross Up
40
%
 
 
 
$
6,302

 
—

 
—

 
$
6,302

Outplacement services
 
 
$
25,000

 
$
—

 
$
—

 
$
—

 
$
25,000

LTIP Acceleration
 
 
 
 
$
—

 
$
—

 
$
—

 
$
—

Total
 
 
 
 
$
3,022,754

 
$
—

 
$
—

 
$
3,047,754


113

Potential Termination-Related Payments to
Stacy Mendler, Chief Operating Officer
 
 
 
 
 
Unrelated to a Change in Control
 
Change in
Control
Incremental
Compensation and
Benefit Payment
Applicable
Percentage
 
Base
Dollars
 
Termination
without
Cause
 
Death/
Disability
 
Termination
for Cause,
Voluntary
Termination,
Retirement
 
Termination,
Change in
Responsibility
or Other
Good Reason
Salary-based severance
200
%
 
$
440,134

 
$
880,268

 
$
—

 
$
—

 
$
880,268

Bonus-based severance
200
%
 
$
300,000

 
$
450,000

 
$
—

 
$
—

 
$
450,000

Health care benefits
—

 
$
13,813

 
$
20,720

 
$
—

 
$
—

 
$
20,720

Tax Gross Up
40
%
 
 
 
8,288

 
—

 
—

 
$
8,288

Outplacement services
—

 
$
25,000

 
$
—

 
$
—

 
$
—

 
$
25,000

LTIP Acceleration
 
 
 
 
$
—

 
$
—

 
$
—

 
$
—

Total
 
 
 
 
$
1,359,276

 
$
—

 
$
—

 
$
1,384,276

 
Potential Termination-Related Payments to
Barry Broadus, Chief Financial Officer
 
 
 
 
 
Unrelated to a Change in Control
 
Change in
Control
Incremental
Compensation and
Benefit Payment
Applicable
Percentage
 
Base
Dollars
 
Termination
without
Cause
 
Death/
Disability
 
Termination
for Cause,
Voluntary
Termination,
Retirement
 
Termination,
Change in
Responsibility
or Other
Good Reason
Salary-based severance
200
%
 
$
350,144

 
$
700,288

 
$
—

 
$
—

 
$
700,288

Bonus-based severance
200
%
 
$
225,000

 
$
450,000

 
$
—

 
$
—

 
$
450,000

Health care benefits
—

 
$
13,813

 
$
20,720

 
$
—

 
$
—

 
$
20,720

Tax Gross Up
40
%
 
 
 
8,288

 
—

 
—

 
$
8,288

Outplacement services
—

 
$
25,000

 
$
—

 
$
—

 
$
—

 
$
25,000

LTIP Acceleration
 
 
 
 
$
—

 
$
—

 
$
—

 
$
—

Total
 
 
 
 
$
1,179,296

 
$
—

 
$
—

 
$
1,204,296


114

Potential Termination-Related Payments to
Robert Hirt, Sector Senior Vice President
 
 
 
 
 
Unrelated to a Change in Control
 
Change in
Control
Incremental
Compensation and
Benefit Payment
Applicable
Percentage
 
Base
Dollars
 
Termination
without
Cause
 
Death/
Disability
 
Termination
for Cause,
Voluntary
Termination,
Retirement
 
Termination,
Change in
Responsibility
or Other
Good Reason
Salary-based severance
200
%
 
$
360,168

 
$
720,336

 
$
—

 
$
—

 
$
720,336

Bonus-based severance
200
%
 
$
225,000

 
$
450,000

 
$
—

 
$
—

 
$
450,000

Health care benefits
—

 
$
14,212

 
$
21,318

 
$
—

 
$
—

 
$
21,318

Tax Gross Up
40
%
 
 
 
8,527

 
—

 
—

 
$
8,527

Outplacement services
—

 
$
25,000

 
$
—

 
$
—

 
$
—

 
$
25,000

LTIP Acceleration
 
 
 
 
$
—

 
$
—

 
$
—

 
$
—

Total
 
 
 
 
$
1,200,181

 
$
—

 
$
—

 
$
1,225,181

Director Compensation
The following table sets forth certain information regarding the compensation paid to the Company’s non-employee directors for their service during the fiscal year ended September 30, 2014.
 
Name
Fees earned or
paid in cash ($)
(1)
 
All other
compensation ($)
(2)
 
Total
Edward C. (Pete) Aldridge, Jr.
$
92,454

 
$
1,546

 
$
94,000

Leslie Armitage
$
102,500

 
$
—

 
$
102,500

Lewis Collens
$
92,192

 
$
3,558

 
$
95,750

Admiral (Ret.) Harold W. Gehman, Jr.
$
102,000

 
$
—

 
$
102,000

Michael Hayden
$
87,000

 
$
—

 
$
87,000

General (Ret.) George A. Joulwan
$
93,000

 
$
—

 
$
93,000

General (Ret.) Michael E. Ryan
$
92,015

 
$
2,985

 
$
95,000

David Vitale
$
79,293

 
$
5,207

 
$
84,500

 
(1)
This column represents the total fees including the annual retainer fee to non-employee directors. Alion employee directors do not receive any additional compensation for service as a member of the Board of Directors. For the year ended September 30, 2014, Alion’s non-employee directors received an annual retainer and compensation of $70,000, payable in quarterly installments. Each director also receives a fee of $2,500 for in-person attendance or $1,000 for telephone attendance at a Board of Directors meeting. The Audit and Finance Committee chairperson receives $7,500 per year for each year he or she serves in such capacity. Other board committee chairpersons receive $5,000 per year for each year he or she serves in such capacity. Board committee members receive $1,000 per committee meeting when a committee meeting occurs on other than the day of a Board of Directors meeting. Alion reimburses directors for reasonable travel expenses in connection with attendance at Board of Directors and board committee meetings.
(2)
This column represents amounts paid by Alion for travel expenses to attend Board of Directors and board committee meetings.
(3)
On August 18, 2014, David J. Vitale and Edward C. (Pete) Aldridge, Jr. resigned as members of the Board.

Compensation Committee Interlocks and Insider Participation
    
The members of the Compensation Committee are Harold Gehman (Chairman), Leslie Armitage, Lewis Collens, George Joulwan, and Pete Aldridge. None of the members, during the fiscal year, was an Alion officer or employee, formerly an Alion officer, or involved in a related party transaction. Dr. Atefi is the President and Chief Executive Officer of Alion.

During the last completed fiscal year:


115

(A) No executive officer of the Company served as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served on the Compensation Committee of the Company;

(B) No executive officer of the Company served as a director of another entity, one of whose executive officers served on the Compensation Committee of the Company; and

(C) No executive officer of the Company served as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served as a director of the Company.

Compensation Committee Report

The Compensation Committee of the Company has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Annual Report.

THE COMPENSATION COMMITTEE
Harold Gehman, Jr., Chairman
Leslie Armitage, Committee Member
Daniel Clare, Committee Member*
Lewis Collens, Committee Member
Lawrence First, Committee Member*
George Joulwan, Committee Member

*While Mr. First and Mr. Clare are also presently members of the Compensation Committee, because they did not join the Compensation Committee until August 18, 2014, they did not participate in making the recommendation regarding     the inclusion of the Compensation Discussion and Analysis in this filing.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Security Ownership of Certain Beneficial Owners and Management

The following table sets forth certain information as of September 30, 2013, regarding beneficial ownership of Alion common stock by (i) all persons known by the Company that beneficially own more than 5% of the Company’s common stock, (ii) all directors and (iii) all named executive officers, individually and as a group.


116

Name and Address of Beneficial Owner
Title of Class
 
Amount and
Nature of
Beneficial
Ownership
 
 
 
Percentage
of Class (7)(8)
Five Percent Security Holders:
 
 
 
 
 
 
 
 
ASOF II Investments, LLC (1)
Preferred Stock
 
55
 
 
 
78.6
%
Phoenix Investment Adviser, LLC (2)
Preferred Stock
 
15
 
 
 
21.4
%
ASOF II Investments, LLC
Common Stock
 
6,066,575
 
(5)
 
25.4
%
Phoenix Investment Adviser, LLC
Common Stock
 
2,524,241
 
(5)
 
10.6
%
Alion Science and Technology Corporation Employee Ownership, Savings and Investment Trust (3)
Common Stock
 
13,105,361
 
 
 
99.96
%
Directors and Executive Officers (3):
 
 
 
 
 
 
 
 
Daniel Clare (4)
Preferred Stock
 
55
 
 
 
78.6
%
 
Common Stock
 
6,066,575
 
 
 
25.4
%
Lawrence First (4)
Preferred Stock
 
55
 
 
 
78.6
%
 
Common Stock
 
6,066,575
 
 
 
25.4
%
Bahman Atefi
Common Stock
 
57,039
 
(6)
 
0.5
%
Stacy Mendler
Common Stock
 
77,751
 
(6)
 
0.6
%
Barry Broadus
Common Stock
 
3,055
 
(6)
 
0.1
%
Rod Riddick
Common Stock
 
35,376
 
(6)
 
0.3
%
Robert Hirt
Common Stock
 
1,689
 
(6)
 
0.1
%
All Directors and Executive Officers as a Group (13 persons)
Common Stock
 
174,910
 
(6)
 
1.6
%

(1)
The address of ASOF II Investments, LLC is 299 Park Avenue, 34th Floor New York, New York 10171.
(2)
The address of Phoenix Investment Adviser, LLC is 420 Lexington Ave., Suite 2040 New York, New York 10170.
(3)
The address of the ESOP Trust and all directors, other than Messrs. Clare and First, and named executive officers is 1750 Tysons Boulevard, Suite 1300, McLean, Virginia 22101. No directors (other than Dr. Atefi and Messrs. Clare and First) are beneficial owners of our common stock.
(4)
The address of Messrs. Clare and First is 299 Park Avenue, 34th Floor New York, NY 10171. Given their responsibilities at the entity which manages ASOF, Messrs. First and Clare may be deemed beneficial owners of the shares of common stock underlying the Penny Warrants held by ASOF and the Series A Preferred Stock held by ASOF.
(5)
Reflects the beneficial ownership of the shares of common stock underlying Penny Warrants.
(6)
Includes beneficial ownership of shares of Alion’s common stock held by the ESOP Trust.
(7)
Applicable percentages are based on 70 shares of Series A Preferred Stock outstanding on September 30, 2014; 13,110,043 shares of common stock outstanding on September 30, 2014 and are calculated with respect to each person pursuant to Rule 13d-3(d) of the Exchange Act.
(8)
Voting power with respect to all classes of Alion stock is held by ASOF and Phoenix as the only holders of the Series A Preferred Stock. The Series A Preferred Stock votes as a class and its vote controls any vote in which Alion common stock can participate.


Changes in Control

We do not know of any arrangements, the operation of which may at a subsequent date result in a change in control of Alion.

Item 13. Certain Relationships and Related Transactions, and Director Independence

Transactions with related persons

Except as described below, since the beginning of the Company’s last fiscal year, including any currently proposed transactions, no directors, executive officers or immediate family members of such individuals were engaged in transactions with us or any subsidiary involving more than $120,000 other than the August 2014 Refinancing Transactions and arrangements described in the section “Executive Compensation.”


117

ASOF owns $55.0 million of Second Lien Term Loans and $116.0 million of Third Lien Notes, plus $2.3 million million in accrued PIK notes. Phoenix owns $15.0 million of Second Lien Term Loans and $58.9 million of Third Lien Notes, plus $0.9 million in accrued PIK notes. ASOF and Phoenix also own warrants to purchase 6,066,575 and 2,524,241 shares of Alion’s common stock, respectively. ASOF and Phoenix were paid fees in connection with the Refinancing Transactions of $6.8 million and $0.3 million, respectively, plus reimbursement of their professional fees.

Review, approval or ratification of transactions with related persons
    
In accordance the procedures it has established, our Audit and Finance Committee is responsible for reviewing and approving the terms and conditions of all related party transactions. Any material transaction with a director or executive officer of the Company or a member of the immediate family of a director or officer is required to be approved by our Audit and Finance Committee prior to Alion entering into such transaction.

Director Independence

A majority of the Company’s directors meet the test of “independence” as defined by the NYSE Amex rules. The NYSE Amex rules provide that to qualify as an “independent” director, in addition to satisfying certain bright-line criteria, the board of directors must affirmatively determine that a director has no material relationship with the Company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the Company). Our board of directors has determined that Leslie Armitage, Daniel Clare, Lewis Collens, Lawrence First, Harold Gehman, Jr., Michael Hayden, George Joulwan, and Michael Ryan satisfy the bright-line criteria and that none has a relationship with Alion that would interfere with his or her ability to exercise independent judgment as a member of the board. Therefore, we believe that each of these directors is independent under the NYSE Amex rules.

The Audit and Finance Committee currently consists of Leslie Armitage, Daniel Clare, Lewis Collens, Lawrence First, Harold Gehman, Jr., and Michael Ryan. All members of the Audit and Finance Committee are independent in accordance with the NYSE Amex Rules.

The Compensation Committee currently consists of Daniel Clare, Lawrence First, Harold Gehman, Jr., Leslie Armitage, Lewis Collens and George Joulwan. All members of the Compensation Committee are independent in accordance with the NYSE Amex rules.

The Governance and Compliance Committee currently consists of Michael Ryan, Bahman Atefi, Daniel Clare, Lawrence First, Michael Hayden, George Joulwan and Harold Gehman, Jr. All members of the Governance and Compliance Committee, excluding Bahman Atefi, are independent in accordance with the NYSE Amex rules.

The Special Projects Coordination Committee currently consists of Daniel Clare, Lawrence First, Michael Ryan, and George Joulwan.  All members of the Special Projects Coordination Committee are independent in accordance with the NYSE Amex rules.
Item  14. Principal Accountant Fees and Services

Consistent with its charter, the Audit and Finance Committee is responsible for engaging Alion’s independent registered public accounting firm. All audit and permitted non-audit services require advance approval by the Audit and Finance Committee. The full committee approves proposed services and estimated fees for these services. The Audit and Finance Committee approved in advance all services performed by our auditors in fiscal 2014 and 2013.

The following table summarizes the fees that Deloitte & Touche LLP, our independent registered public accounting firm, billed Alion for each of our past two fiscal years for audit services and other services:

Fee Category
 
2014
 
2013
Audit Fees(1)
$
2,251,364

 
$
1,300,000

Audit-Related Fees(2)
—

 
110,000

Tax Fees (3)
144,301

 
134,699

Total Fees
$
2,395,665

 
$
1,544,699

 

118

(1)
Audit fees include fees for auditing Alion’s financial statements, reviewing interim financial statements included in quarterly reports on Form 10-Q, and providing other professional services in connection with statutory and regulatory filings or engagements. This includes comfort letter fees in connection with Alion's registered offering to exchange its Unsecured Notes for new Third Lien Notes.
(2)
Audit-related fees are fees for assurance and similar services for the fiscal 2013 employee benefit plan audit.
(3)
Tax-related fees are fees for preparing the Company’s consolidated federal income tax return, state income tax returns, and foreign income tax returns for foreign subsidiaries. Fees include charges for a statutory tax-return related audit of Alion's Indian subsidiary; advisory services related to transfer pricing and refinancing transactions; and regulatory compliance advice.


119

PART IV
Item 15. Exhibits and Financial Statement Schedules

(a)(1) Financial Statements

Consolidated Financial Statements of Alion Science and Technology Corporation
 

(a)(2) Financial Statement Schedules

Consolidated Financial Statement Schedule
 
Schedule II — Valuation and Qualifying Accounts
 
Allowance for Doubtful
Accounts Receivable
Balance at
Beginning
of Year
 
Additions
Charged to
Costs and
Expenses
 
Deductions
(1)
 
Balance
at End
of Year
 
(In thousands)
Fiscal year ended 2014
$
3,751

 
$
250

 
$
(77
)
 
$
3,924

Fiscal year ended 2013
$
4,145

 
$
(217
)
 
$
(177
)
 
$
3,751

Fiscal year ended 2012
$
3,411

 
$
802

 
$
(68
)
 
$
4,145

 
(1)
Accounts receivable written off against the allowance for doubtful accounts.
Deferred Tax Asset Valuation
Balance at
Beginning
of Year
 
Additions
Charged to
Costs and
Expenses
 
Deductions
 
Balance
at End
of Year
 
(In thousands)
Fiscal year ended 2014
$
97,040

 
$
21,168

 
$
—

 
$
118,208

Fiscal year ended 2013
$
78,414

 
$
18,626

 
$
—

 
$
97,040

Fiscal year ended 2012
$
58,264

 
$
20,150

 
$
—

 
$
78,414




120

(a)(3) Exhibits
 
Exhibit No.
Description
3.1
Fourth Amended and Restated Certificate of Incorporation of Alion Science and Technology Corporation. (1)
3.2
Amendment Number One to the Fourth Amended and Restated Certificate of Incorporation of Alion Science and Technology Corporation. (2)
3.3
Amendment Number Two to the Fourth Amended and Restated Certificate of Incorporation of Alion Science and Technology Corporation. (a)
3.4
Amendment Number Three to the Fourth Amended and Restated Certificate of Incorporation of Alion Science and Technology Corporation. (a)
3.5
Amended and Restated By-laws of Alion Science and Technology Corporation. (3)
3.6
Certificate of Designation of Series A Preferred Stock. (2)
3.7
Amended and Restated Certificate of Designation, Powers, Preferences and Rights of Series A Preferred Stock of Alion Science and Technology. (a)
4.1
Indenture dated as of February 8, 2007, among Alion Science and Technology Corporation, certain subsidiary guarantors and Wilmington Trust Company, as trustee. (4)
4.2
Indenture dated as of August 18, 2014, among Alion Science and Technology Corporation, certain subsidiary guarantors and Wilmington Trust Company, as trustee. (2)
4.3
Form of Third-Lien Senior Secured Note due 2020. (2)
4.4
Form of Warrant. (2)
4.5
Amended and Restated Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (5)
4.6
First Amendment to Amended and Restated Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (6)
4.7
Second Amendment to Amended and Restated Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (7)
4.8
Third Amendment to Amended and Restated Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (8)
4.9
Fourth Amendment to Amended and Restated Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (a)
4.10
Fifth Amendment to Amended and Restated Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan. (16)
4.11
Form of Warrant. (3)
4.12
Form of Unit. (3)
10.1
Employment Agreement, dated as of August 18, 2014 by and between Alion Science and Technology Corporation and Dr. Bahman Atefi. (2)*
10.2
Employment Agreement, dated as of August 18, 2014 by and between Alion Science and Technology Corporation and Stacy Mendler. (2)*
10.3
Employment Agreement, dated as of August 18, 2014 by and between Alion Science and Technology Corporation and Robert Hirt. (2)*
10.4
Employment Agreement, dated as of August 18, 2014 by and between Alion Science and Technology Corporation and Barry Broadus. (2)*
10.5
Alion Science and Technology Corporation Long-Term Incentive Plan (amended and restated as of June, 25, 2013) (9) *
10.6
Form of Alion Science and Technology Corporation Ongoing Long Term Incentive Plan Award Agreement. (10)*
10.7
Alion Science and Technology Corporation 2004 Stock Appreciation Rights Plan (amended and restated as of June, 25, 2013) (9)*
10.8
Alion Science and Technology Corporation Performance Shares and Retention Phantom Stock Plan (amended and restated as of June, 25, 2013) (9)*
10.9
Alion Science and Technology Corporation Phantom Stock Plan (amended and restated as of June, 25, 2013) (9)*
10.10
Alion Science and Technology Director Phantom Stock Plan, as amended and restated effective January 1, 2007. (11)*

121

10.11
First Amendment to Alion Science and Technology Corporation Director Phantom Stock Plan (as amended and restated), dated as of January 22, 2010. (11)*
10.12
Alion Executive Deferred Compensation Plan, as amended and restated effective January 1, 2008. (11)*
10.13
Alion Director Deferred Compensation Plan, as amended and restated effective January 1, 2008. (11)*
10.14
First Supplemental Indenture, dated as February 26, 2010, between Alion-IPS Corporation, Washington Consulting Government Services, Inc., Alion Canada (US) Corporation, Alion Science and Technology Corporation and Wilmington Trust Company, as trustee. (12)
10.15
Warrant Agreement, dated as of August 18, 2014, by and between the Company and Wilmington Trust Company, as warrant agent. (2)
10.16
Amended and Restated Warrant Agreement, dated as of August 18, 2014, and amended as of November 5, 2014, by and between the Company and Wilmington Trust Company, as warrant agent. ( a)
10.17
Stockholders’ Agreement, dated as of August 18, 2014 by and between Alion Science and Technology Corporation and the Alion Science and Technology Corporation Employee Ownership, Savings and Investment Trust. (2)
10.18
Credit Agreement, dated as of August 18, 2014, by and among Alion Science and Technology Corporation, Wells Fargo, National Association and the lenders party thereto. (2)
10.19
First Lien Credit and Guaranty Agreement, dated as of August 18, 2014 by and among Alion Science and Technology Corporation, Goldman Sachs Lending Partners LLC as administrative agent and the lenders party thereto. (2)
10.20
Second Lien Credit and Guaranty Agreement, dated as of August 18, 2014 by and among Alion Science and Technology Corporation, Wilmington Trust, National Association as administrative agent and the lenders party thereto. (2)
10.21
Intercreditor Agreement, dated as of August 18, 2014 by and among the Company, the other grantors party thereto, and Wilmington Trust, National Association, as collateral agent. (2)
10.22
First Lien Pledge and Security Agreement dated as of August 18, 2014, by and among Alion Science and Technology Corporation, certain subsidiaries of the Company and Wilmington Trust, National Association, as collateral agent. (2)
10.23
Second Lien Pledge and Security Agreement, dated as of August 18, 2014, by and among Alion Science and Technology Corporation, certain subsidiaries of the Company and Wilmington Trust, National Association, as collateral agent. (2)
10.24
Third Lien Pledge and Security Agreement dated as of August 18, 2014, by and among Alion Science and Technology Corporation, certain subsidiaries of the Company and Wilmington Trust, National Association, as collateral agent. (2)
10.25
Guaranty Agreement, dated as of August 18, 2014, by and among Alion Science and Technology Corporation, certain subsidiaries of Alion Science and Technology Corporation and Wells Fargo Bank, National Association, as agent. (2)
10.26
Refinancing Support Agreement, dated December 24, 2013, by and among Alion and the Supporting Noteholders. (18)
10.27
Term Sheet, dated as of July 22, 2014, by and among Alion and the Supporting Noteholders. (17)
10.28
Amended and Restated Refinancing Support Letter Agreement, dated October 28, 2014. (a)
10.29
Second Supplemental Indenture, dated as of May 29, 2014, between Alion Science and Technology Corporation, Alion -METI Corporation, Alion - CATI Corporation, Alion - JJMA Corporation, Alion - BMH Corporation, Washington Consulting, Inc., Alion - MA&D Corporation, Alion - IPS Corporation, Alion - International Corporation, Washington Consulting Government Services, Inc. and Wilmington Trust Company, as trustee. (15)
10.30
First Supplemental Indenture, dated as of August 25, 2014, among Alion Science and Technology Corporation, Alion MA&D Corporation, Alion Asia Corporation, Innovative Technology Solutions Corporation, Alion Offshore Services, Inc. and Wilmington Trust, National Association. (a)
10.31
Second Supplemental Indenture dated as of November 5, 2014, among Alion Science and Technology Corporation, the subsidiary guarantors and Wilmington Trust, National Association, as trustee and Wilmington Trust, National Association, as collateral agent. (a)
10.32
2014 Edition of the Alion Code of Ethics, Conduct and Responsibility. (a)
12
Computation of Ratios. (a)
21
Subsidiaries of Alion Science and Technology (a)
31.1
Certification of Chief Executive Officer of Alion Science and Technology Corporation pursuant to Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.(a)
31.2
Certification of Chief Financial Officer of Alion Science and Technology Corporation pursuant to Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended. (a)

122

32.1
Certification of Chief Executive Officer of Alion Science and Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (a)
32.2
Certification of Chief Financial Officer of Alion Science and Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(a)
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document

(1)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on December 21, 2012.
(2)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on August 22, 2014.
(3)
Incorporated by reference from the Company’s Form 8-K/A filed with the SEC on March 25, 2010.
(4)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on February 8, 2007.
(5)
Incorporated by reference from the Company’s Form 10-Q filed with the SEC on May 14, 2013.
(6)
Incorporated by reference from the Company’s Form 10-K filed with the SEC on December 23, 2013.
(7)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on October 2, 2013.
(8)
Incorporated by reference from the Company’s Form 10-Q filed with the SEC on May 15, 2014.
(9)
Incorporated by reference from the Company’s Form 10-Q filed with the SEC on August 8, 2013.
(10)
Incorporated by reference from the Company’s Form 10-K filed with the SEC on December 23, 2008.
(11)
Incorporated by reference from the Company’s Form 10-Q filed with the SEC on May 14, 2010.
(12)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on March 3, 2010.
(13)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on March 16, 2011.
(14)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on August 8, 2011.
(15)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on May 30, 2014.
(16)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on October 6, 2014.
(17)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on July 24, 2014.
(18)
Incorporated by reference from the Company’s Form 8-K filed with the SEC on December 24, 2013.     


(*)
Denotes management contract and/or compensatory plan/arrangement.
(a)
Filed with this Form 10-K for fiscal year 2014.


123

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ALION SCIENCE AND TECHNOLOGY CORPORATION
(Registrant)

Date: December 29, 2014
By: /s/ BAHMAN ATEFI
Bahman Atefi
Chairman, Chief Executive Officer and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 

124

Signature
 
Title
 
Date
/s/ Bahman Atefi
Bahman Atefi
 
Chairman, Chief Executive Officer and Director
 
December 29, 2014
 
 
 
 
 
/s/ Barry M. Broadus
Barry M. Broadus
 
Senior Vice President and
Chief Financial Officer
 
December 29, 2014
 
 
 
 
 
/s/ Jeffrey L. Boyers
Jeffrey L. Boyers
 
Senior Vice President and
Principal Accounting Officer
 
December 29, 2014
 
 
 
 
 
/s/ Leslie Armitage
Leslie Armitage
 
Director
 
December 29, 2014
 
 
 
 
 
/s/ Harold W. Gehman
Harold W. Gehman
 
Director
 
December 27, 2014
 
 
 
 
 
/s/ Michael V. Hayden
Michael V. Hayden
 
Director
 
December 26, 2014
 
 
 
 
 
/s/ George A. Joulwan
George A. Joulwan
 
Director
 
December 27, 2014
 
 
 
 
 
/s/ Michael E. Ryan
Michael E. Ryan
 
Director
 
December 28, 2014
 
 
 
 
 


125

Exhibit Index
 
Exhibit
No.
 
Description
3.3
 
Amendment Number Two to the Fourth Amended and Restated Certificate of Incorporation of Alion Science and Technology Corporation.
3.7
 
Amended and Restated Certificate of Designation, Powers, Preferences and Rights of Series A Preferred Stock of Alion Science and Technology.
4.9
 
Fourth Amendment to Amended and Restated Alion Science and Technology Corporation Employee Ownership, Savings and Investment Plan.
10.16
 
Amended and Restated Warrant Agreement, dated as of August 18, 2014, and amended as of November 5, 2014, by and between the Company and Wilmington Trust Company, as warrant agent. ( a)
10.28
 
Amended and Restated Refinancing Support Letter Agreement, dated October 28, 2014.
10.30
 
First Supplemental Indenture, dated as of August 25, 2014, among Alion Science and Technology Corporation, Alion MA&D Corporation, Alion Asia Corporation, Innovative Technology Solutions Corporation, Alion Offshore Services, Inc. and Wilmington Trust, National Association.
10.31
 
Second Supplemental Indenture dated as of November 5, 2014, among Alion Science and Technology Corporation, the subsidiary guarantors and Wilmington Trust, National Association, as trustee and Wilmington Trust, National Association, as collateral agent.
10.32
 
2014 Edition of Alion Code of Ethics, Conduct and Responsibility.(a)
12
 
Computation of Ratios
21
 
Subsidiaries of Alion Science and Technology Corporation
31.1
 
Certification of Chief Executive Officer of Alion Science and Technology Corporation pursuant to Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
31.2
 
Certification of Chief Financial Officer of Alion Science and Technology Corporation pursuant to Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
32.1
 
Certification of Chief Executive Officer of Alion Science and Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
 
Certification of Chief Financial Officer of Alion Science and Technology Corporation, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS+
 
XBRL Instance Document.
101.SCH+
 
XBRL Taxonomy Extension Schema Document.
101.CAL+
 
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF+
 
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB+
 
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE+
 
XBRL Taxonomy Extension Presentation Linkbase Document.




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