DLH Holdings Corp. 10-K

ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our CEO and President and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Exchange Act) as of the end of the period covered by this report, have concluded that, based on the evaluation of these controls and procedures, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our CEO and President and Chief Financial Officer, to allow timely decisions regarding required disclosure. Our management, including our CEO and President and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. Our 30 management, however, believes our disclosure controls and procedures are in fact effective to provide reasonable assurance that the objectives of the control system are met. Management’s Report on Internal Control over Financial Reporting Our management, under the supervision of our Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The Company's internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. Management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting as of September 30, 2020. In making this evaluation, management used the 2013 framework on Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the COSO framework, our management has concluded that our internal control over financial reporting was effective as of September 30, 2020. This annual report does not include an attestation report of our independent registered public accounting firm regarding our internal control over financial reporting. Management's report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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 that the degree of compliance with the policies or procedures may deteriorate. Changes in Internal Controls over Financial Reporting There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) identified in connection with the evaluation of our internal control that occurred during the fourth quarter of our fiscal year ended September 30, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B. OTHER INFORMATION None. PART III The Information required by Items 10, 11, 12, 13 and 14 of Part III of Form 10-K has been omitted in reliance on General Instruction G(3) and is incorporated herein by reference to our proxy statement to be filed with the SEC pursuant to Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended, as set forth below: 31 ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE The information required by this Item with respect to our executive officers, directors, board committees, and corporate governance matters will be set forth in our definitive Proxy Statement under the captions "Executive Officers," "Election of Directors," and "Corporate Governance" of the Proxy Statement, to be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, and is incorporated herein by reference to our Proxy Statement. We have adopted a written code of business conduct and ethics, which applies to our principal executive officer, principal financial or accounting officer or person serving similar functions and all of our other employees and members of our board of directors. We did not waive any provisions of the code of business ethics during the year ended September 30, 2020. Our code of business conduct and ethics is posted in the investor relations - corporate governance section of our website at www.dlhcorp.com. If we amend, or grant a waiver under, our code of business ethics that applies to our principal executive officer, principal financial or accounting officer, or persons performing similar functions, we intend to post information about such amendment or waiver on our website. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item will be set forth in our definitive Proxy Statement, to be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, and is incorporated herein by reference to our Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by this Item will be set forth in our definitive Proxy Statement, to be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, and is incorporated herein by reference to our Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE The information required by this Item will be set forth in our definitive Proxy Statement, to be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, and is incorporated herein by reference to our Proxy Statement. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this Item will be set forth in our definitive Proxy Statement under the caption "Independent Registered Public Accounting Firm", to be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, and is incorporated herein by reference to our Proxy Statement. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) (1) Financial Statements The financial statements and schedules of the Company are included in Part II, Item 8 of this report beginning on page F-1. (a) (2) Financial Statement Schedule All schedules have been omitted since the required information is not applicable or because the information required is included in the Consolidated Financial Statements or the notes thereto. (a) (3) Exhibits The exhibits designated with an asterisk (*) are filed herewith. All other exhibits have been previously filed with the Commission and, pursuant to 17 C.F.R. Secs. 20l.24 and 240.12b-32, are incorporated by reference to the document referenced in brackets following the descriptions of such exhibits. The exhibits designated with a number sign (#) indicate a management contract or compensation plan or arrangement. 32 Exhibit No. Description 2.1 Stock Purchase Agreement among the Company, Social & Scientific Systems, Inc., and Social & Scientific Systems, Inc. Employee Stock Ownership Trust (filed as Exhibit 2.1 to Current Report on Form 8-K filed June 13, 2019). 2.2 Equity Purchase Agreement among DLH Holdings Corp., Irving Burton Associates, LLC, Project Insight Holdings, Inc., the Owners of the Seller and Anna L. Ryan as the Sellers' Representative (filed as Exhibit 2.1 to Current Report on Form 8-K filed October 6, 2020). 3.1 Amended and Restated Certificate of Incorporation (filed as Exhibit A to Definitive Proxy Statement dated May 1, 2000 as filed with the Securities and Exchange Commission). 3.2 Amended and Restated By-Laws of Registrant adopted as of August 27, 2020 (filed as Exhibit 3.1 to the Current Report on Form 8-K filed August 31, 2020). 3.3 Amendment to Amended and Restated Certificate of Incorporation of the Company (filed as Exhibit B to Definitive Proxy Statement dated March 13, 2008 as filed with the Securities and Exchange Commission) . 3.4 Amendment to Amended and Restated Certificate of Incorporation of the Company filed June 25, 2012 (filed as Exhibit 3.1 to Current Report on Form 8-K filed on June 26, 2012). 3.5 Amendment to Amended and Restated Certificate of Incorporation filed February 12, 2015 (filed as Annex A to the Company’s Proxy Statement dated December 31, 2014). 4.1 Specimen of the Common Stock Certificate (filed as Exhibit 4.1 to Annual Report on Form 10-K for the fiscal year ended September 30,2017.) 4.2 Form of Warrant issued to Subordinated Lenders (filed as Exhibit 4.4 to Current Report on Form 8-K filed May 6, 2016). 4.3 * Description of Securities. 10.1 # Form of Stock Option Award under 2006 Long Term Incentive Plan (filed as Exhibit 10.6 to Quarterly Report on Form 10-Q filed on February 16, 2010). 10.2 # Employment Agreement between the Company and Kevin Wilson (filed as Exhibit 10.1 to Current Report on Form 8-K dated October 3, 2013). 10.3 # 2006 Long Term Incentive Plan, as amended (filed as Annex A to the Company’s Proxy Statement dated January 3, 2014). 10.4 Lease Agreement dated April 27, 2015 between DLH Holdings Corp. and Piedmont Center, 1-4 LLC (filed as Exhibit 10.1 to Quarterly Report on Form 10-Q filed on August 5, 2015) 10.5 # Amendment to Employment Agreement with Kevin Wilson (filed as Exhibit 10.1 to Current Report on Form 8-K filed October 2, 2015). 10.6 # 2016 Omnibus Equity Incentive Plan, as amended (incorporated by reference to Appendix A to the Company’s definitive Proxy Statement dated December 29, 2017). 10.7 # Form of Stock Option Award Agreement under the 2016 Omnibus Equity Incentive Plan (filed as Exhibit 10.8 to Quarterly Report on Form 10-Q filed May 16, 2016). 10.8 Registration Rights Agreement dated September 29, 2016 (filed as Exhibit 10.2 to Current Report on 8-K filed on October 4, 2016). 10.9 # Change in Control, Severance and Covenant Agreement with Helene Fisher, dated June 4, 2018 (filed as Exhibit 10.2 to Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2018, filed August 6, 2018). 10.10 Credit Agreement among DLH Holdings Corp., DLH Solutions, Inc., Danya International, LLC, Social & Scientific Systems, Inc., First National Bank of Pennsylvania, as Administrative Agent and other lenders party thereto (filed as Exhibit 10.1 to Current Report on Form 8-K filed on June 13, 2019). 10.11 First Amendment to Credit Agreement among DLH Holdings Corp., DLH Solutions, Inc., Danya International, LLC, Social & Scientific Systems, Inc., First National Bank of Pennsylvania, as Administrative Agent and other lenders party thereto (filed as Exhibit 10.1 to Current Report on Form 8-K filed on September 12, 2019). 10.12 Amended and Restated Credit Agreement among DLH Holdings Corp., DLH Solutions, Inc., Danya International, LLC, Social & Scientific Systems, Inc., Irving Burton Associates, LLC, First National Bank of Pennsylvania, as Administrative Agent and other lenders party thereto (filed as Exhibit 10.1 to Current Report on Form 8-K filed October 6, 2020). 10.13 # Employment Agreement between the Company and Zachary C. Parker dated October 11, 2019 (filed as Exhibit 10.1 to Current Report on 8-K filed on October 17, 2019). 10.14 # Employment Offer Letter with Kevin Beverly dated October 18, 2019 (filed as Exhibit 10.1 to Current Report on 8-K filed on October 22, 2019). 33 10.15 # Change in Control, Severance and Covenant Agreement with Kevin Beverly dated October 18, 2019 (filed as Exhibit 10.2 to Current Report on 8-K filed on October 22, 2019). 10.16 # Form of Restricted Stock Unit for non-employee directors under the 2016 Omnibus Equity Incentive Plan. 10.17 # Employment Offer Letter between the Company and Jeanine M. Christian (filed as Exhibit 10.1 to Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2020, filed August 5, 2020). 10.18 # Employment Offer Letter between the Company and Jacqueline S. Everett (filed as Exhibit 10.2 to Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2020, filed August 5, 2020). 10.19 # Change in Control, Severance and Covenant Agreement between the Company and Jeanine M. Christian (filed as Exhibit 10.3 to Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2020, filed August 5, 2020). 10.20 # Change in Control, Severance and Covenant Agreement between the Company and Jacqueline S. Everett (filed as Exhibit 10.4 to Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2020, filed August 5, 2020). 10.21 # Letter Agreement dated July 15, 2020 between the Company and Kevin H. Beverly (filed as Exhibit 10.5 to Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2020, filed August 5, 2020). 10.22 # Employment agreement between the Company and Kathryn M JohnBull dated September 14, 2020 (filed as Exhibit 10.1 to Current Report on Form 8-K filed on September 15, 2020) 21.00 * Subsidiaries of Registrants. 23.10 * Consent of WithumSmith+Brown, PC 31.10 * Certification of Chief Executive Officer pursuant to Section 17 CFR 240.13a-14(a) or 17 CFR 240.15d-14(a). 31.20 * Certification of Chief Financial Officer pursuant to Section 17 CFR 240.13a-14(a) or 17 CFR 240.15d-14(a). 32.10 * Certification of Chief Executive Officer and Chief Financial Officer pursuant to 17 CFR 240.13a-14(b) or 17 CFR 240.15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code. 101.0 The following financial information from the DLH Holdings Corp. Annual Report on Form 10-K for the fiscal year ended September 30, 2020, formatted in iXBRL (Inline eXtensible Business Reporting Language) and filed electronically herewith: (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Cash Flows; (iv) the Consolidated Statements of Changes in Shareholders' Equity and, (v) the Notes to the Consolidated Financial Statements. Filed electronically herewith. 34 ITEM 16. FORM 10-K SUMMARY None 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. DLH HOLDINGS CORP. /s/ KATHRYN M. JOHNBULL By: Kathryn M. JohnBull Chief Financial Officer (Principal Accounting Officer) Dated: December 7, 2020 ______________________________________________________________________________________________________ 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: Signature Capacity Date /s/ FREDERICK G. WASSERMAN Chairman of the Board December 7, 2020 Frederick G. Wasserman /s/ AUSTIN J. YERKS III Director December 7, 2020 Austin J. Yerks III /s/ ELDER GRANGER Director December 7, 2020 Elder Granger /s/ FRANCES MURPHY Director December 7, 2020 Frances Murphy /s/ JAMES P. ALLEN Director December 7, 2020 James P. Allen /s/ MARTIN J. DELANEY Director December 7, 2020 Martin J. Delaney /s/ STEPHEN J. ZELKOWICZ Director December 7, 2020 Stephen J. Zelkowicz /s/ ZACHARY C. PARKER Chief Executive Officer, President and Director December 7, 2020 Zachary C. Parker /s/ KATHRYN M. JOHNBULL Chief Financial Officer and Principal Accounting Officer December 7, 2020 Kathryn M. JohnBull 35 DLH Holdings Corp. and Subsidiaries Index to Consolidated Financial Statements Page Report of Independent Registered Public Accounting Firm F-2 Consolidated Statements of Operations for the years ended September 30, 2020 and 2019 F-3 Consolidated Balance Sheets as of September 30, 2020 and 2019 F-4 Consolidated Statements of Cash Flows for the years ended September 30, 2020 and 2019 F-5 Consolidated Statements of Changes in Shareholders' Equity for the years ended September 30, 2020 and 2019 F-6 Notes to Consolidated Financial Statements F-7 F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of DLH Holdings Corp. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of DLH Holdings Corp. and Subsidiaries (the “Company”) as of September 30, 2020 and 2019, the related consolidated statements of operations, cash flows, and shareholders’ equity, for each of the two years in the period ended September 30, 2020, and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of September 30, 2020 and 2019, and the consolidated results of its operations and its cash flows for each of the two years in the period ended September 30, 2020, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ WithumSmith+Brown, PC We have served as the Company's auditor since 2007. Whippany, New Jersey December 06, 2020 F-2 DLH HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands except per share amounts) Year Ended September 30, 2020 2019 Revenue $ 209,185 $ 160,391 Cost of Operations Contract costs 163,596 124,551 General and administrative costs 24,195 20,525 Acquisition costs 930 1,391 Depreciation and amortization 7,003 3,956 Total operating costs 195,724 150,423 Income from operations 13,461 9,968 Interest expense, net 3,441 2,473 Income before income taxes 10,020 7,495 Income tax expense 2,906 2,171 Net income $ 7,114 $ 5,324 Net income per share - basic $ 0.58 $ 0.44 Net income per share - diluted $ 0.54 $ 0.41 Weighted average common shares outstanding Basic 12,282 12,018 Diluted 13,105 13,041 The accompanying notes are an integral part of these consolidated financial statements. F-3 DLH HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Amounts in thousands except par value of shares) September 30, 2020 September 30, 2019 ASSETS Current assets: Cash and cash equivalents $ 1,357 $ 1,790 Accounts receivable 32,541 23,226 Other current assets 3,499 1,831 Total current assets 37,397 26,847 Equipment and improvements, net 3,339 5,343 Operating leases right-of-use-assets 22,427 — Deferred taxes, net 37 2,345 Goodwill 67,144 52,758 Intangible assets, net 52,612 41,208 Other long-term assets 606 757 Total assets $ 183,562 $ 129,258 LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Debt obligations - current, net of deferred financing costs $ 6,727 $ — Operating lease liabilities - current 2,045 — Accrued payroll 10,611 8,852 Accounts payable, accrued expenses, and other current liabilities 28,578 20,633 Total current liabilities 47,961 29,485 Long-term liabilities: Operating lease liabilities - long-term 21,620 — Debt obligations - long term, net of deferred financing costs 60,544 53,629 Other long-term liabilities — 573 Total long-term liabilities 82,164 54,202 Total liabilities 130,125 83,687 Shareholders' equity: Common stock, $ 0.001 par value; authorized 40,000 shares; issued and outstanding 12,404 and 12,036 at September 30, 2020 and 2019, respectively 12 12 Additional paid-in capital 85,868 85,114 Accumulated deficit ( 32,443 ) ( 39,555 ) Total shareholders’ equity 53,437 45,571 Total liabilities and shareholders' equity $ 183,562 $ 129,258 The accompanying notes are an integral part of these consolidated financial statements. F-4 DLH HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) Year Ended September 30, 2020 2019 Operating activities Net income $ 7,114 $ 5,324 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization expense 7,003 3,956 Amortization of deferred financing costs 721 982 Stock based compensation expense 910 790 Deferred taxes, net 2,308 1,792 Non-cash gain from lease modification ( 121 ) — Changes in operating assets and liabilities Accounts receivable ( 5,408 ) 617 Other current assets ( 1,592 ) ( 57 ) Accrued payroll 489 178 Accounts payable, accrued expenses, and other current liabilities 7,188 5,262 Other long-term assets/liabilities 839 ( 805 ) Net cash provided by operating activities 19,451 18,039 Investing activities Business acquisition, net of cash acquired ( 32,678 ) ( 67,079 ) Purchase of equipment and improvements ( 152 ) ( 405 ) Net cash used in investing activities ( 32,830 ) ( 67,484 ) Financing activities Borrowing on senior debt 33,000 70,000 Repayments of senior debt ( 19,000 ) ( 21,708 ) Repurchase of common stock ( 211 ) — Payment of deferred financing costs ( 898 ) ( 3,451 ) Proceeds from issuance of common stock upon exercise of options 55 39 Net cash provided by financing activities 12,946 44,880 Net change in cash and cash equivalents ( 433 ) ( 4,565 ) Cash and cash equivalents at beginning of year 1,790 6,355 Cash and cash equivalents at end of year $ 1,357 $ 1,790 Supplemental disclosures of cash flow information Cash paid during the year for interest $ 2,806 $ 1,502 Cash paid during the year for income taxes $ 917 $ 543 The accompanying notes are an integral part of these consolidated financial statements. F-5 DLH HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the years ended September 30, 2020 and 2019 (Amounts in thousands) Common Stock Treasury Stock Additional Paid-In Capital Accumulated Deficit Total Shareholders' Equity Shares Amount Shares Amount Year Ended September 30, 2020 Balance at September 30, 2019 12,036 $ 12 — $ — $ 85,114 $ ( 39,555 ) $ 45,571 Cumulative-effect adjustment for adoption of ASC 842 — — — — — ( 2 ) ( 2 ) Expense related to director restricted stock unit 90 — — — 347 — 347 Expense related to employee stock options — — — — 563 — 563 Exercise of stock options 395 — — — 55 — 55 Repurchase of common stock — — 28 ( 113 ) — — ( 113 ) Cancellation of common stock ( 117 ) — ( 28 ) 113 ( 211 ) — ( 98 ) Net income — — — — — 7,114 7,114 Balance at September 30, 2020 12,404 $ 12 — $ — $ 85,868 $ ( 32,443 ) $ 53,437 Common Stock Treasury Stock Additional Paid-In Capital Accumulated Deficit Total Shareholders' Equity Shares Amount Shares Amount Year Ended September 30, 2019 Balance at September 30, 2018 11,899 $ 12 — $ — $ 84,285 $ ( 44,879 ) $ 39,418 Expense related to director restricted stock unit 102 — — — 527 — 527 Expense related to employee stock options — — — — 263 — 263 Exercise of stock options 35 — — — 39 — 39 Net income — — — — — 5,324 5,324 Balance at September 30, 2019 12,036 $ 12 — $ — $ 85,114 $ ( 39,555 ) $ 45,571 The accompanying notes are an integral part of these consolidated financial statements F-6 DLH HOLDINGS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2020 1. Basis of Presentation The accompanying consolidated financial statements include the accounts of DLH Holdings Corp. and its subsidiaries (together with its subsidiaries, "DLH" or the "Company" and also referred to as "we," "us," and "our"), all of which are wholly owned. All significant intercompany balances and transactions have been eliminated in consolidation. The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") and with the instructions to Form 10-K, Regulation S-X, and Regulation S-K. 2. Business Overview The Company is a full-service provider of technology-enabled health and human services, providing solutions to three market focus areas: Defense and Veterans' Health Solutions, Human Solutions and Services, and Public Health and Life Sciences. We deliver domain-specific expertise, industry best-practices and innovations to customers across these markets leveraging seven core competencies: secure data analytics, clinical trials and laboratory services, case management, performance evaluation, system modernization, operational logistics and readiness, and strategic digital communications. The Company manages its operations from its principal executive offices in Atlanta, Georgia, and we have a complementary headquarters office in Silver Spring, Maryland. We employ over 2,200 skilled employees working in more than 30 locations throughout the United States and one location overseas. At present, the Company derives 98 % of its revenue from agencies of the Federal government, primarily as a prime contractor but also as a subcontractor to other Federal prime contractors. A major customer is defined as a customer from whom the Company derives at least 10% of its revenues. Our two largest customers are the Department of Veteran Affairs ("VA") and the Department of Health and Human Services ("HHS"). The VA comprised approximately 48 % and 57 % of revenue for the years ended September 30, 2020 and 2019, respectively, and HHS comprised approximately 45 % and 39 % of revenue for the years ended September 30, 2020 and 2019, respectively. 3. New Accounting Pronouncements In February 2016, the FASB issued new accounting guidance included in Accounting Standard Codification ("ASC") 842 related to leases. This new accounting guidance is intended to improve financial reporting about leasing transactions. This accounting standard will require organizations that lease assets, referred to as “Lessees”, to recognize on the balance sheet the assets and liabilities. Per ASU 2016-02, Leases (Topic 842), we determine if a contract contains a lease by identifying an asset and determining if we have the right to control the use of the identified asset for a period of time in exchange for consideration. A contract conveys the right to control the use of an identified asset when the lessee has the right to direct the use of the identified asset and obtain substantially all economic benefits from its use, throughout the period of its use. We also determine if a lease qualifies as an operating or finance lease. All Company leases at adoption were operating leases. The ASU also requires lessees to identify and separate lease and non-lease components. Per a practical expedient provided in the ASU, the Company elected not to separate lease and non-lease components. Upon lease commencement, the lease liability and right-of-use asset are recorded on the balance sheet. The lease liability is measured as the present value of future minimum lease payments, including all probable renewals, to be made during the lease term. The right-of-use asset is measured as the present value of future minimum lease payments to be made during the lease term, including all probable renewals, plus lease payments made to the lessor before or at lease commencement and indirect costs paid less incentives received. DLH adopted this standard on October 1, 2019 and recognized initial right of use assets and lease liabilities of $ 17.4 million and $ 18.0 million, respectively. At adoption, the Company elected several practical expediencies to facilitate the implementation of the new standard and did not recast comparative prior year information. As such, we did not reassess and include initial direct costs in the measurement of right-of-use assets, capitalize leases with terms of 12 months or less, nor reassess lease classification of existing leases. In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which requires companies to record an allowance for expected credit losses over the contractual term of certain financial assets, including short-term trade receivables and contract assets. Additionally, it expands disclosure requirements for credit quality of financial assets. ASU 2016-13 F-7 becomes effective for the Company in the first quarter of fiscal year 2021. We do not expect a material impact to our operating results, financial position, or cash flows as a result of adopting this new standard. In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies the accounting for goodwill impairments by eliminating step two from the goodwill impairment test. Instead, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. ASU 2017-04 also clarifies that an entity should consider income tax effects from any tax-deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The new standard is effective for fiscal years beginning after December 15, 2019 for both interim and annual reporting periods. The Company adopted this standard in the first quarter of fiscal 2020 and adoption did not have an impact on the Company's consolidated financial statements. In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848), which provides optional expedients and exceptions for the application of U.S. GAAP to contracts, hedging relationships, and other transactions that reference the London Interbank Offered Rate ("LIBOR") and other references rates expected to be discontinued due to reference rate reform. ASU 2020-04 became effective on March 12, 2020 for all entities meeting certain criteria. The Company may elect to apply the amendments using a prospective approach through December 31, 2022. The Company is currently assessing the impact of electing this standard on its consolidated financial statements and related disclosures and does not expect the impact to be material. In August 2020, the FASB issued ASU 2020-06, which amends the measurement and disclosure of convertible instruments, contracts in an entity's own equity, and EPS guidance. The guidance can be adopted using a modified retrospective method or a fully retrospective method. The amendments are effective for fiscal years beginning after December 15, 2021 for public entities, excluding those that are smaller reporting companies. For all other entities the amendments are effective for fiscal years beginning after December 15, 2023. The Company does not expect the update to have a material impact on its consolidated financial statements and related disclosures . 4. Significant Accounting Policies Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include valuation of goodwill and intangible assets, interest rate swaps, stock-based compensation, right-of-use assets, and liabilities, valuation allowances established against accounts receivable and deferred tax assets, and measurement of loss development on workers' compensation claims. We evaluate these estimates and judgments on an ongoing basis and base our estimates on historical experience, current and expected future outcomes, third-party evaluations, and various other assumptions that we believe are reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities as well as identifying and assessing the accounting treatment with respect to commitments and contingencies. We revise material accounting estimates if changes occur, such as more experience is acquired, additional information is obtained, or there is new information on which an estimate was or can be based. Actual results could differ from those estimates. In particular, a material reduction in the fair value of goodwill would have a material adverse effect on the Company’s financial position and results of operations. We account for the effect of a change in accounting estimate during the period in which the change occurs. Fair Value of Financial Instruments The carrying amounts of the Company's cash and cash equivalents, accounts receivable, contract assets, accrued expenses, and accounts payable approximate fair value due to the short-term nature of these instruments. The fair values of the Company's debt instruments approximate fair value because the underlying interest rates approximate market rates that the Company could obtain for similar instruments at the balance sheet dates. Long-Lived Assets Our long-lived assets include equipment and improvements, intangible assets, and goodwill. The Company continues to review its long-lived assets for possible impairment or loss of value at least annually or more frequently upon the occurrence of an event or when circumstances indicate that a reporting unit’s carrying amount is greater than its fair value. F-8 Equipment and improvements are stated at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful asset lives ( 3 to 7 years) and the shorter of the initial lease term or estimated useful life for leasehold improvements. Intangible assets (other than goodwill) are originally recorded at fair value and are amortized on a straight-line basis over their estimated useful lives of 10 years. Maintenance and repair costs are expensed as incurred. Leases Right-of-use assets are measured at the present value of future minimum lease payments, including all probable renewals, plus lease payments made to the lessor before or at lease commencement and indirect costs paid, less incentives received. Our right-of-use assets include long-term leases for facilities and equipment and are amortized over their respective lease terms. Goodwill At September 30, 2020, we performed a goodwill impairment evaluation on the year-end carrying value of approximately $ 67.1 million. We performed a qualitative assessment of factors to determine whether it was necessary to perform the goodwill impairment test. Based on the results of the work performed, the Company has concluded that no impairment loss was warranted at September 30, 2020, as no change in business conditions occurred which would have a material adverse effect on the valuation of goodwill. Our assessment incorporated effects of the COVID-19 pandemic, which is not expected to have a meaningful impact on our financial results. Notwithstanding this evaluation, factors including non-renewal of a major contract or other substantial changes in business conditions could have a material adverse effect on the valuation of goodwill in future periods and the resulting charge could be material to future periods’ results of operations. Similarly, there were no impairments during the prior year ended September 30, 2019. Income Taxes The Company accounts for income taxes in accordance with the liability method, whereby deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reflected on the consolidated balance sheet when it is determined that it is more likely than not that the asset will be realized. This guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized. We account for uncertain tax positions by recognizing the financial statement effects of a tax position only when, based upon the technical merits, it is "more-likely-than-not" that the position will be sustained upon examination. We had no uncertain tax positions at either September 30, 2020 and 2019. We report interest and penalties as a component of income tax expense. For the years ended September 30, 2020 and 2019, we recognized no interest and no penalties related to income taxes. Stock-based Equity Compensation The Company uses the fair value-based method for stock-based equity compensation. Options issued are designated as either an incentive stock or a non-statutory stock option. No option may be granted with a term of more than 10 years from the date of grant. Option awards may depend on achievement of certain performance measures determined by the Compensation Committee of our Board. Shares issued upon option exercise are newly issued common shares. All awards to employees and non-employees are recorded at fair value on the date of the grant and expensed over the period of vesting. The Company uses a binomial and Black Scholes option pricing model to estimate the fair value of each stock option at the date of grant. Any consideration paid by the option holders to purchase shares is credited to capital stock. Cash and Cash Equivalents We consider all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. We maintain cash balances at financial institutions that are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $ 250,000 . Deposits held with financial institutions may exceed the $ 250,000 limit. Earnings per Share Basic earnings per share is calculated by dividing income available to common shareholders by the weighted average number of common stock outstanding and restricted stock grants that vested or are likely to vest during the period. Diluted earnings per share is calculated by dividing income available to common shareholders by the weighted average number of basic common F-9 shares outstanding, adjusted to reflect potentially dilutive securities. Diluted earnings per share is calculated using the treasury stock method. Treasury Stock The Company periodically purchases its own common stock that is traded on public markets as part of announced stock repurchase programs. The repurchased common stock is classified as treasury stock on the consolidated balance sheets and held at cost. As of September 30, 2020, the Company did no t hold any treasury stock. Preferred Stock Our certificate of incorporation authorizes the issuance of "blank check" preferred stock with such designations, rights and preferences as may be determined from time to time by our board of directors up to an aggregate of 5,000,000 shares of preferred stock. As of September 30, 2020, the Company has no t issued any preferred stock. Interest Rate Swap The Company uses derivative financial instruments to manage interest rate risk associated with its variable debt. The Company's objective in using these interest rate derivatives is to manage its exposure to interest rate movements and reduce volatility of interest expense. The gains and losses due to changes in the fair value of the interest rate swap agreements completely offset changes in the fair value of the hedged portion of the underlying debt. Offsetting changes in fair value of both the interest rate swaps and the hedged portion of the underlying debt are recognized in interest expense in the Consolidated Statements of Operations. The Company does not hold or issue any derivative instrument for trading or speculative purposes. Risks & Uncertainties Management continues to evaluate the impact of the COVID-19 pandemic on the industry and has concluded that while it is reasonably possible that the virus could have a negative effect on the Company’s financial position and the results of its operations, the specific impact is not readily determinable as of the date of these financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. 5. Revenue Recognition We recognize revenue over time when there is a continuous transfer of control to our customer. For our U.S. government contracts, this continuous transfer of control to the customer is supported by clauses in the contract that allow the U.S. government to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. When control is transferred over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. For services contracts, we satisfy our performance obligations as services are rendered. We use a cost-based input method to measure progress. Contract costs include labor, material and allocable indirect expenses. For time-and-material contracts, we bill the customer per labor hour and per material, and revenue is recognized in the amount invoiced since the amount corresponds directly to the value of our performance to date. We consider control to transfer when we have a present right to payment. Essentially, all of our contracts satisfy their performance obligations over time. Contracts are often modified to account for changes in contract specifications and requirements. Contract modifications impact performance obligations when the modification either creates new or changes the existing enforceable rights and obligations. The effect of a contract modification on the transaction price and our measure of progress for the performance obligation to which it relates is recognized as an adjustment to revenue and profit cumulatively. Furthermore, a significant change in one or more estimates could affect the profitability of our contracts. We recognize adjustments in estimated profit on contracts in the period identified. For time-and-materials contracts, revenue is recognized to the extent of billable rates times hours delivered plus materials and other reimbursable costs incurred. Revenue for cost-reimbursable contracts is recorded as reimbursable costs are incurred, including an estimated share of the applicable contractual fees earned. Contract costs are expensed as incurred. Estimated losses are recognized when identified. Contract assets - Amounts are invoiced as work progresses in accordance with agreed-upon contractual terms. In part, revenue recognition occurs before we have the right to bill, resulting in contract assets. These contract assets are reported within F-10 receivables, net on our consolidated balance sheets and are invoiced in accordance with payment terms defined in each contract. Period end balances will vary from period to period due to agreed-upon contractual terms. Contract liabilities - Amounts are a result of billings in excess of costs incurred. The following table summarizes the contract balances recognized within the Company's consolidated balance sheets: (in thousands) September 30, September 30, September 30, 2020 2019 2018 Contract assets $ 7,943 $ 4,302 $ 214 Contract liabilities $ 200 $ 92 $ — The increase in contract assets and contract liabilities is primarily due to the acquisitions of Social & Scientific Systems, Inc ("S3") on June 7, 2019 and Irving Burton Associates, LLC. ("IBA") on September 30, 2020. Disaggregation of revenue from contracts with customers We disaggregate our revenue from contracts with customers by customer, contract type, as well as whether the Company acts as prime contractor or subcontractor. We believe these categories best depict how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors. The following series of tables present our revenue disaggregated by these categories: Revenue by customer: (in thousands) Year Ended September 30, 2020 2019 Department of Veterans Affairs $ 100,204 $ 91,949 Department of Health and Human Services 95,026 62,000 Other 13,955 6,442 Total revenue $ 209,185 $ 160,391 Revenue by contract type: (in thousands) Year Ended September 30, 2020 2019 Time and materials $ 147,509 $ 134,136 Cost reimbursable 58,091 23,200 Firm fixed price 3,585 3,055 Total revenue $ 209,185 $ 160,391 F-11 Revenue by whether the Company acts as a prime contractor or a subcontractor: (in thousands) Year Ended September 30, 2020 2019 Prime contractor $ 193,448 $ 154,207 Subcontractor 15,737 6,184 Total revenue $ 209,185 $ 160,391 6. Leases We have leases for facilities and office equipment. Our lease liabilities are recognized as the present value of the future minimum lease payments over the lease term. Our right-of-use assets are recognized as the present value of the future minimum lease payments over the lease term less unamortized lease incentives and the balance remaining in deferred rent liability under ASC 840. Our lease payments consist of fixed and in-substance fixed amounts attributable to the use of the underlying asset over the lease term. Variable lease payments that do not depend on an index rate or are not in-substance fixed payments are excluded in the measurement of right-of-use assets and lease liabilities and are expensed in the period incurred. The incremental borrowing rate on our credit facility is used in determining the present value of future minimum lease payments. Some of our lease agreements include options to extend the lease term or terminate the lease. These options are accounted for in our right-of-use assets and lease liabilities when it is reasonably certain that the Company will extend the lease term or terminate the lease. The Company does not have any finance leases. Upon the adoption of ASC 842, we recorded operating lease right-of-use assets of $ 17.4 million, current and long-term operating lease liabilities of $ 3.6 million and $ 14.4 million, and a $ 2 thousand cumulative adjustment to accumulated deficit. The impact of adopting the standard on our consolidated balance sheet at October 1, 2019 is as follows: (in thousands) Ref September 30, 2019 ASC 842 Adjustments October 1, 2019 Long-term assets: Operating leases right-of-use assets $ — $ 17,398 $ 17,398 Current liabilities: Deferred rent liability - short-term (a) 44 ( 44 ) — Operating leases liabilities - current — 3,645 3,645 Long-term liabilities: Deferred rent liability - long-term (b) 276 ( 276 ) — Unamortized tenant improvement allowance (c) 297 ( 297 ) — Operating leases liabilities - long-term — 14,372 14,372 Shareholders' equity: Accumulated deficit ( 39,555 ) ( 2 ) ( 39,557 ) Ref (a): The balance of short-term deferred rent liability presented in our annual 10K report within accounts payable, accrued expenses, and other accrued liabilities on our consolidated balance sheet at September 30, 2019. Ref (b): The balance of long-term deferred rent liability presented in our annual 10K report within other long-term liabilities on our consolidated balance sheet at September 30, 2019. F-12 Ref (c): The balance of unamortized tenant improvement allowance presented in our annual 10K report within other long-term liabilities on our consolidated balance sheet at September 30, 2019. The Company executed a modification of a lease during the fiscal quarter ending December 31, 2019 and recognized adjustments to the right-of-use asset and lease liabilities in accordance with ASC 842. As a result of the modification, a gain of $ 0.1 million was recognized. The gain represents the difference between the change in values of the right-of-use-asset and lease liabilities, which were $ 7.3 million and $ 7.2 million, respectively. For the year ended September 30, 2020, the increase to right-of-use assets and lease liabilities related to the modification was $ 24.7 million and $ 25.2 million, respectively. For more information, refer to Note 7. Supporting Financial Information . As of September 30, 2020, operating leases for facilities and equipment have remaining lease terms of 0.6 to 10.5 years. The following table summarizes lease balances in our consolidated balance sheet at September 30, 2020: (in thousands) September 30, 2020 Operating lease right-of-use assets $ 22,427 Operating lease liabilities, current $ 2,045 Operating lease liabilities - long-term 21,620 Total operating lease liabilities $ 23,665 The Company subleases a portion of one of its leased facilities. The sublease is classified as an operating lease with respect to the underlying asset. The sublease was assumed from the acquisition in fiscal 2019. During the year ended September 30, 2020, the sublease was amended with the new terms commencing in July 2020. The sublease term is 5 years with two additional 1 year term extension options. The Company's lease costs are included within general and administrative costs in our Consolidated Statements of Operations. For the year ended September 30, 2020, total lease costs for our operating leases are as follows: (in thousands) Year Ended September 30, 2020 Operating $ 4,236 Short-term 155 Variable 63 Sublease income ( 271 ) Total lease costs $ 4,183 Other information related to our leases are as follows: Ref September 30, 2020 Weighted-average remaining lease term 9.1 years Weighted-average discount rate (a) 5.99 % Ref (a): Calculation based off of borrowing terms from senior credit facility. (in thousands) Year Ended September 30, 2020 Cash paid for amounts included in the measurement of lease liabilities $ 3,586 Lease liabilities arising from obtaining right-of-use-assets $ 229 F-13 The Company's future minimum lease payments as of September 30, 2020 are as follows: For the Fiscal Year Ending September 30, (in thousands) 2021 $ 3,408 2022 3,501 2023 3,375 2024 3,251 2025 3,092 Thereafter 14,684 Total future minimum lease payments 31,311 Less: imputed interest ( 7,646 ) Present value of future minimum lease payments 23,665 Less: current portion of operating lease liabilities ( 2,045 ) Long-term operating lease liabilities $ 21,620 Under ASC 840, the Company's future minimum lease payments for the prior fiscal year ended September 30, 2019 were as follows: For the Fiscal Year Ending September 30, (in thousands) 2020 $ 3,484 2021 3,051 2022 3,136 2023 3,166 2024 3,100 Thereafter 16,945 Total future minimum lease payments $ 32,882 7. Supporting Financial Information Accounts receivable (in thousands) September 30, September 30, Ref 2020 2019 Billed receivables $ 24,598 $ 18,924 Contract assets 7,943 4,302 Total accounts receivable 32,541 23,226 Less: Allowance for doubtful accounts (a) — — Accounts receivable, net $ 32,541 $ 23,226 Ref (a): Accounts receivable are non-interest bearing, unsecured and carried at net realizable value. We evaluate our receivables on a quarterly basis and determine whether an allowance is appropriate based on specific collection issues. 0 No allowance for doubtful accounts was deemed necessary at either September 30, 2020 or September 30, 2019. F-14 Other current assets (in thousands) September 30, September 30, 2020 2019 Prepaid insurance and benefits $ 665 $ 495 Other receivables 1,363 301 Prepaid expenses 1,471 1,035 Other current assets $ 3,499 $ 1,831 Equipment and improvements, net (in thousands) September 30, September 30, Ref 2020 2019 Furniture and equipment $ 958 $ 1,262 Computer equipment 1,171 1,043 Computer software 4,341 3,985 Leasehold improvements 1,595 1,595 Total equipment and improvements 8,065 7,885 Less accumulated depreciation and amortization ( 4,726 ) ( 2,542 ) Equipment and improvements, net (a) $ 3,339 $ 5,343 Ref (a): Depreciation and amortization was $ 2.2 million and $ 1.2 million for the years ended September 30, 2020 and 2019, respectively. Intangible assets, net (in thousands) September 30, September 30, Ref 2020 2019 Intangible assets (a) Customer contracts and related customer relationships $ 45,600 $ 45,600 Covenants not to compete 480 480 Trade name 2,109 2,109 Acquired intangibles - IBA acquisition (b) 16,223 — Total intangible assets 64,412 48,189 Less accumulated amortization Customer contracts and related customer relationships ( 11,150 ) ( 6,590 ) Covenants not to compete ( 212 ) ( 164 ) Trade name ( 438 ) ( 227 ) Total accumulated amortization ( 11,800 ) ( 6,981 ) Intangible assets, net $ 52,612 $ 41,208 Ref (a): Total amount of amortization expense for the year ended September 30, 2020 and 2019 was $ 4.8 million and $ 2.7 million, respectively. Ref (b): The Company is currently valuing the acquired intangible assets from the IBA acquisition. The balances provided are an estimate and subject to revision. Please refer to Note 16 for more information. F-15 Estimated amortization expense for future years: (in thousands) Fiscal 2021 $ 6,441 Fiscal 2022 6,441 Fiscal 2023 6,441 Fiscal 2024 6,441 Fiscal 2025 6,441 Thereafter 20,407 Total amortization expense $ 52,612 Goodwill The changes in the carrying amount of goodwill for the years ended September 30, 2020 and 2019 are as follows: (in thousands) Ref Total Balance at September 30, 2018 $ 25,989 Increase from S3 acquisition 26,769 Balance at September 30, 2019 52,758 Preliminary increase from IBA acquisition (a) 14,386 Balance at September 30, 2020 $ 67,144 Ref (a): The Company is currently valuing the goodwill from the IBA acquisition. The balance provided is an estimate and subject to revision. Please refer to Note 16 for more information. Accounts payable, accrued expenses, and other current liabilities (in thousands) September 30, September 30, 2020 2019 Accounts payable $ 14,645 $ 10,054 Accrued benefits 2,833 2,252 Accrued bonus and incentive compensation 2,340 1,951 Accrued workers' compensation insurance 5,529 4,007 Other accrued expenses 3,231 2,369 Accounts payable, accrued expenses, and other current liabilities $ 28,578 $ 20,633 Debt Obligations (in thousands) September 30, September 30, 2020 2019 Bank term loan $ 70,000 $ 56,000 Less unamortized deferred financing cost ( 2,729 ) ( 2,371 ) Net bank debt obligation 67,271 53,629 Less current portion of term loan debt obligations ( 6,727 ) — Long-term portion of bank debt obligation $ 60,544 $ 53,629 F-16 Interest expense (in thousands) Year Ended September 30, Ref 2020 2019 Interest expense (a) $ ( 2,841 ) $ ( 1,512 ) Amortization of deferred financing costs (b) ( 721 ) ( 982 ) Other income (expense), net (c) 121 21 Interest expense, net $ ( 3,441 ) $ ( 2,473 ) Ref (a): Interest expense on borrowing Ref (b): Amortization of expenses related to term loan and revolving line of credit. For 2019, amortization included write-off of remaining deferred financing costs related to prior loan agreement that was terminated early. Ref (c): Gain on lease modification due to a lease amendment F-17 8. Credit Facilities A summary of our loan facility as of September 30, 2020 is as follows: ($ in Millions) As of September 30, 2020 Lender Arrangement Loan Balance Interest Maturity Date First National Bank of Pennsylvania Secured term loan (a) $ 70.0 LIBOR* + 3.5 % 09/30/25 First National Bank of Pennsylvania Secured revolving line of credit (b) $ — LIBOR* + 3.5 % 09/30/25 *LIBOR rate as of September 30, 2020 was 0.16 %. As of September 30, 2020, our LIBOR rate is subject to a minimum floor of 0.5 %. The floor affects interest payments for the periods after September 30, 2020 (a) Represents the principal amounts payable on our secured term loan. The $ 70.0 million secured term loan is secured by liens on substantially all of the assets of the Company. The principal of the term loan is payable in quarterly installments with the remaining balance due on September 30, 2025. The Credit Agreement requires compliance with a number of financial covenants and contains restrictions on our ability to engage in certain transactions. Among other matters, we must comply with limitations on: granting liens; incurring other indebtedness; maintenance of assets; investments in other entities and extensions of credit; mergers and consolidations; and changes in nature of business. The loan agreement also requires us to comply with certain quarterly financial covenants including: (i) a minimum fixed charge coverage ratio of at least 1.25 to 1.00, and (ii) a Funded Indebtedness to Adjusted EBITDA ratio not exceeding the ratio of 3.75 :1.0 to 2.75 :1.0 through maturity. Adjusted EBITDA ratio is calculated by dividing the Company's total interest-bearing debt by net income adjusted to exclude (i) interest and other expenses, (ii) provision for or benefit from income taxes, if any, (iii) depreciation and amortization, and (iv) non-recurring charges, losses or expenses to include transaction and non-cash equity expense. The term loan has an interest rate spread range from 2.5 % to 4.5 % depending on the funded indebtedness to adjusted EBITDA ratio. We are in compliance with all loan covenants and restrictions. We are required to pay quarterly amortization payments commencing in December 2020 through September 2025. The annual amount of principal amortization is based on a percentage of the loan balance at September 30, 2020. The annual amortization amounts are $ 7.0 million for fiscal years 2021 and 2022 and $ 8.75 million each for fiscal years 2023 - 2025. The quarterly payments are in equal installments. In addition to quarterly payments of the outstanding indebtedness, the loan agreement also requires annual payments of a percentage of excess cash flow, as defined in the loan agreement. The loan agreement states that an excess cash flow recapture payment must be made equal to (a) 75 % of the excess cash flow for the immediately preceding fiscal year in which indebtedness to consolidated EBITDA ratio is greater than or equal to 2.50 :1.0; (b) 50 % of the excess cash flow for the immediately preceding fiscal year in which the funded indebtedness to consolidated EBITDA Ratio is less than 2.50 :1.0 but greater than or equal to 1.5 :1.0; or (c) 0 % of the excess cash flow for the immediately preceding fiscal year in which the funded indebtedness to consolidated EBITDA Ratio is less than 1.5 :1.0. In addition, the Company must make additional mandatory prepayment of amounts outstanding based on proceeds received from asset sales and sales of certain equity securities or other indebtedness. For additional information regarding the schedule of future payment obligations, please refer to Note 11 Commitments and Contingencies . On September 30, 2019, we executed a floating-to-fixed interest rate swap with First National Bank ("FNB") as counter party. The notional amount in the floating-to-fixed interest rate swap is $ 36 million that matures in 2024. The remaining outstanding balance of our term loan is subject to interest rate fluctuations and the minimum LIBOR floor. On the notional amount, the Company pays a base fixed rate of 1.61 %, plus applicable credit spread. As a result, for the year ended September 30, 2020, interest expense increased by less than $ 0.2 million. (b) The secured revolving line of credit has a ceiling of up to $ 25.0 million. Borrowing on the line of credit is secured by liens on substantially all of the assets of the Company. The Company accessed funds from the revolving credit facility during the year, but has no outstanding balance at September 30, 2020. F-18 The Company's total borrowing availability, based on eligible accounts receivables at September 30, 2020, was $ 24.8 million. As part of the revolving credit facility, the lenders agreed to a sublimit of $ 5 million for letters of credit for the account of the Company, subject to applicable procedures. The revolving line of credit has a maturity date of September 30, 2025 and is subject to loan covenants as described above. The Company is fully compliant with those covenants. 9. Stock-based Compensation and Equity Grants Stock-based compensation expense Options issued under equity incentive plans were designated as either an incentive stock or a non-statutory stock option. No option was granted with a term of more than 10 years from the date of grant. Exercisability of option awards may depend on achievement of certain performance measures determined by the Compensation Committee of our Board. Shares issued upon option exercise are newly issued shares. As of September 30, 2020, there were 0.9 million shares available for grant. Stock-based compensation expense, shown in the table below, is recorded in general and administrative expenses included in our Consolidated Statements of Operations: (in thousands) Year Ended Ref September 30, 2020 2019 DLH employees $ 563 $ 263 Non-employee directors (a) 347 527 Total stock option expense $ 910 $ 790 Ref (a): In the first quarter of fiscal 2019, we issued 90,000 restricted stock units to the Company's non-employee directors, all of which vested as of September 30, 2020. The shares of common stock underlying such restricted stock units were issued on October 5, 2020. Equity grants of restricted stock units, in accordance with DLH compensation policy for non-employee directors, were made in the first quarter of fiscal 2020 totaling 63,177 restricted stock units. The restricted stock units were granted on October 1, 2020. Unrecognized stock-based compensation expense (in thousands) Year Ended September 30, Ref 2020 2019 Unrecognized expense for DLH employees (a) $ 2,633 $ 631 Ref (a): Compensation expense for the portion of equity awards for which the requisite service has not been rendered is recognized as the requisite service is rendered. The compensation expense for that portion of awards has been based on the grant-date fair value of those awards as calculated for recognition purposes under applicable guidance. For options that vest based on the Company’s common stock achieving and maintaining defined market prices, the Company values the awards with a Monte Carlo binomial model that utilizes various probability factors and other criterion in establishing fair value of the grant. The related compensation expense is recognized over the derived service period determined in the valuation. On a weighted average basis, this expense is expected to be recognized within the next 4.58 years. F-19 Stock option activity for the year ended September 30, 2020: The aggregate intrinsic value in the table below represents the total pretax intrinsic value (i.e., the difference between the Company’s closing stock price on the last trading day of the period and the exercise price, times the number of shares) that would have been received by the option holders had all option holders exercised their in the money options on those dates. This amount will change based on the fair market value of the Company’s stock. (in years) Weighted Weighted Average (in thousands) (in thousands) Average Remaining Aggregate Number of Exercise Contractual Intrinsic Ref Shares Price Term Value Options outstanding, September 30, 2019 2,134 $ 4.36 5.9 $ 4,815 Granted (a) 750 $ 6.74 — — Exercised ( 395 ) $ 0.99 — — Cancelled ( 360 ) $ 2.89 — — Options outstanding, September 30, 2020 2,129 — 7.4 $ 6,583 Ref (a): Utilizing a volatility of 50 % along with assumptions of a 10-year term and the aforementioned 10-day stock price threshold results in an indicated range of value of the Options granted during the year ended September 30, 2020, as follows using the Monte Carlo and Black Scholes methods. Volatility 50 % Vesting Expected Strike Stock Threshold Term Calculated Grant Date Ref Price Price Price (Years) Fair Value July 13, 2020 (a) $ 8.02 $ 8.02 Service 10 $ 4.69 July 13, 2020 $ 8.02 $ 8.02 $ 12.00 10 $ 4.79 July 13, 2020 $ 8.02 $ 8.02 $ 14.00 10 $ 4.76 July 13, 2020 $ 8.02 $ 8.02 $ 16.00 10 $ 4.76 Notes: Results based on 100,000 simulations Ref (a): Options granted vest after completion of a one-year service period. Stock options shares outstanding, vested and unvested for the years ended: (in thousands) Number of Shares September 30, Ref 2020 2019 Vested and exercisable (a) 1,213 1,300 Unvested (b) 916 834 Options outstanding 2,129 2,134 Ref (a): Weighted average exercise price of vested and exercisable shares was $ 2.25 and $ 1.51 at September 30, 2020 and 2019, respectively. Aggregate intrinsic value was approximately $ 6.1 million and $ 3.9 million at September 30, 2020 and 2019, respectively. Weighted average contractual term remaining was 4.6 years and 3.8 years at September 30, 2020 and 2019, respectively. F-20 Ref (b): Certain awards vest upon satisfaction of certain performance criteria. 10. Earnings Per Share Basic earnings per share is calculated by dividing income available to common shareholders by the weighted average number of common shares outstanding and restricted stock grants that vested or are likely to vest during the period. Diluted earnings per share is calculated by dividing income available to common shareholders by the weighted average number of basic common shares outstanding, adjusted to reflect potentially dilutive securities. Diluted earnings per share is calculated using the treasury stock method. (in thousands) Year Ended September 30, 2020 2019 Numerator: Net income $ 7,114 $ 5,324 Denominator: Denominator for basic net income per share - weighted-average outstanding shares 12,282 12,018 Effect of dilutive securities: Stock options and restricted stock 823 1,023 Denominator for diluted net income per share - weighted-average outstanding shares 13,105 13,041 Net income per share - basic $ 0.58 $ 0.44 Net income per share - diluted $ 0.54 $ 0.41 11. Commitments and Contingencies Contractual Obligations as of September 30, 2020: Payments Due Per Fiscal Year Contractual obligations (Amounts in thousands) Total 2021 2022 2023 2024 2025 Thereafter Debt obligations $ 70,000 $ 7,000 $ 7,000 $ 8,750 $ 8,750 $ 38,500 $ — Facility leases 31,002 3,317 3,418 3,292 3,199 3,092 14,684 Equipment operating leases 309 91 83 83 52 — — Total Contractual Obligations $ 101,311 $ 10,408 $ 10,501 $ 12,125 $ 12,001 $ 41,592 $ 14,684 Workers' Compensation We accrue workers' compensation expense based on claims submitted, applying actuarial loss development factors to estimate the costs incurred but not yet recorded. Our accrued liability for claims development as of September 30, 2020 and September 30, 2019 was approximately $ 5.5 million and $ 4.0 million, respectively. Legal Proceedings As a commercial enterprise and employer, the Company is subject to various claims and legal actions in the ordinary course of business. These matters can include professional liability, employment-relations issues, workers’ compensation, tax, payroll and employee-related matters, other commercial disputes arising in the course of its business, and inquiries and investigations by governmental agencies regarding our employment practices or other matters. The Company is not aware of any pending or threatened litigation that it believes is reasonably likely to have a material adverse effect on its results of operations, financial position or cash flows. F-21 12. Related Party Transactions The Company has determined that for the years ended September 30, 2020 and 2019 and through the filing date of this report, there were no significant related party transactions that have occurred which require disclosure through the date that these consolidated financial statements were issued. 13. Income Taxes The Company accounts for income taxes in accordance with the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reflected on the balance sheet when it is determined that it is more likely than not that the asset will be realized. This guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized. We will also set up a valuation allowance, reducing the carrying value of deferred tax assets if it is more likely than not that some or all of the deferred tax asset will not be realized, based on estimated future taxable income. Presently, the Company has no deferred tax asset valuation allowances. At September 30, 2020 and 2019, respectively, the Company had federal net operating losses of approximately $ 7.4 million and $ 18.9 million. The Company utilized approximately $ 11.5 million of federal net operating losses to offset taxes otherwise currently due in 2020. The federal NOLs begin to expire in 2030 and continue to expire through 2033. The Company has no material state net operating losses carryforward. However, the Coronavirus Aid, Relief, and Economic Security (CARES) Act modifies the credit for prior-year minimum tax liability of corporations, including to accelerate the recovery of remaining minimum tax credits of a corporation for its 2019 taxable year from its 2021 taxable year and to permit a corporation to elect instead to recover 100 percent of any of its remaining minimum tax credits in its 2018 taxable year. The Company has AMT credits of $ 366 thousand as of the year ended September 30, 2020, of which 100 percent has been established as an income tax receivable in current assets. An analysis of the Company's deferred tax assets and liabilities is as follows: Year Ended September 30, (amounts in thousands) 2020 2019 Deferred income tax assets: Net operating loss carry forwards $ 1,554 $ 3,926 AMT credit carryforward — 183 Stock based compensation 140 140 Accrued expenses 1,698 1,666 Other items, net 258 45 Total deferred tax asset 3,650 5,960 Deferred tax liability: Equipment and intangible assets ( 3,613 ) ( 3,615 ) Net deferred tax asset $ 37 $ 2,345 F-22 The significant components of income tax expense for income taxes from continuing operations are summarized as follows: Year Ended September 30, (amounts in thousands) 2020 2019 Current expense $ 598 $ 379 Deferred expense 2,308 1,792 Total expense $ 2,906 $ 2,171 The following table indicates the significant differences between our income taxes at the federal statutory rate and the Company's effective tax rate for continuing operations: Year Ended September 30, (amounts in thousands) Ref 2020 2019 Federal statutory rate $ 2,104 $ 1,574 State taxes, net 554 407 Other permanent items 160 91 Deferred tax estimate adjustment 88 99 Total $ 2,906 $ 2,171 We file income tax returns in the U.S. federal jurisdiction and in various state jurisdictions. We are no longer subject to income tax examinations for years before 2015. F-23 14. Quarterly Financial Data (Unaudited) A summary of quarterly information is as follows (in thousands, except per share data) 2020 Quarters Ref First Second Third Fourth Revenue $ 52,238 $ 54,798 $ 51,459 $ 50,691 Income from operations 3,126 3,837 3,800 2,698 Interest expense, net ( 941 ) ( 906 ) ( 813 ) ( 781 ) Income before income taxes 2,185 2,931 2,987 1,917 Income tax expense 634 855 863 554 Net income $ 1,551 $ 2,076 $ 2,124 $ 1,363 Earnings per share: Basic $ 0.13 $ 0.17 $ 0.17 $ 0.11 Diluted $ 0.12 $ 0.16 $ 0.16 $ 0.10 2019 Quarters Ref First Second Third Fourth Revenue (a) $ 33,752 $ 33,756 $ 38,700 $ 54,183 Income from operations 2,557 2,327 1,690 3,394 Interest expense, net ( 177 ) ( 545 ) ( 562 ) ( 1,190 ) Income before income taxes 2,380 1,782 1,128 2,204 Income tax expense 690 517 325 639 Net income (loss) $ 1,690 $ 1,265 $ 803 $ 1,565 Earnings (loss) per share: Basic $ 0.14 $ 0.11 $ 0.07 $ 0.13 Diluted $ 0.13 $ 0.10 $ 0.06 $ 0.12 Ref (a): The inclusion of S3 for Fiscal 2019 impacts part of quarter three and all of quarter four versus the full year for Fiscal 2020. 15. Employee Benefit Plans As of September 30, 2020, the Company and its subsidiaries maintain a 401(k) Plan (the "401(k) Plan"), a defined contribution and supplemental pension plan for the benefit of its eligible employees. The Company may provide a discretionary matching contribution of a participant's elective contributions under the 401 (k) Plan. The Company recorded related expense of $ 1.2 million in fiscal 2020 and $ 577 thousand in fiscal year 2019. The increase was primarily due to headcount growth from the S3 acquisition. A participant is always fully vested in his or her elective contributions and vests in Company matching contributions over a four year period. 16. Business Combinations: Acquisition of Irving Burton Associates, LLC On September 30, 2020, the Company acquired 100 % of the equity interests of IBA for a net preliminary purchase price of $ 32.7 million, inclusive of the preliminary working capital adjustment. The acquisition was financed through a combination of: • borrowings of $ 33 million under the Company’s amended senior credit facility • cash on hand to pay transaction expenses and financings costs of $ 1.8 million The acquisition of IBA is consistent with the Company’s growth strategy, as it provided contract diversification, addition of key capabilities and increased presence in the military health market. The estimated goodwill derived from this transaction is primarily due to these attributes. F-24 We have used the acquisition method of accounting for this transaction, whereby the assets acquired and liabilities assumed are recognized based upon their estimated fair values at the acquisition date. The preliminary base purchase price for IBA was $ 32 million adjusted to reflect acquired cash, assumed liabilities and preliminary net working capital adjustments. Subject to certain limitations and conditions, the Company will be indemnified by the seller for damages resulting from breaches or inaccuracies of the representations, warranties, and covenants of the seller and IBA as set forth in the Purchase Agreement. The Purchase Agreement further provides that escrow funds of an aggregate amount of approximately $ 0.4 million were established at closing. The Company does not expect to draw on these funds as both the buyer and seller have agreed on the final purchase price. A representations and warranties insurance policy has been purchased by the Company in connection with the Purchase Agreement, under which the Company may seek recourse for breaches of the seller’s representations and warranties to supplement the indemnity escrow. The representations and warranties insurance policy is subject to certain customary exclusions and a deductible. In accordance with ASU 2017-01, which was previously adopted, the Company is accounting for this transaction as an acquisition of a business. We have not completed the process of allocating the acquisition price to the fair value of the assets and liabilities of IBA at the acquisition date. We are awaiting the fair values of the intangibles assets from the third party valuation firm. The preliminary purchase price and its allocation are shown below. Based on the unaudited financial statements of IBA on September 30, 2020, we accounted for the total acquisition consideration and allocation of fair value to the related assets and liabilities on a preliminary basis as follows: (Amounts in thousands) Preliminary purchase price for IBA $ 32,706 Net assets acquired Cash and cash equivalents $ 28 Accounts receivable 3,907 Other current assets 124 Total current assets 4,059 Accounts payable and accrued expenses ( 758 ) Payroll liabilities ( 1,269 ) Other current liabilities ( 177 ) Net working capital 1,855 Equipment and improvements, net 28 Other long-term assets/liabilities 214 Net identifiable assets acquired 2,097 Goodwill and other identifiable intangible assets 30,609 Net assets acquired $ 32,706 All operating units are aggregated into a single reportable segment. The acquisition of IBA did not create an additional reportable segment as all operations report to a single Chief Operating Decision Maker (CODM), serve a similar customer base, and provide similar services within a common regulatory environment. The goodwill represents intellectual capital and the acquired workforce, of which both do not qualify as a separate intangible asset. The tax deductible goodwill is in the process of being calculated. The following table presents certain results for the years ended September 30, 2019 as though the acquisition of IBA had occurred on October 1, 2018. The unaudited pro forma information is presented for informational purposes only and is not necessarily indicative of our results if the acquisition had taken place on that date. The pro forma information was prepared by combining our reported historical results with the historical results of IBA for the pre-acquisition periods. In addition, the reported historical amounts were adjusted for the following items, net of associated tax effects: • The impact of acquisition financing. • The removal of certain IBA operations due to completed and nonrecurring contracts. • The impact of recording IBA's intangible asset amortization. F-25 • The impact of interest expense for the new credit facility. • The removal of transaction costs incurred by IBA for the acquisition. (unaudited) (in thousands) Year ended Year ended September 30, September 30, Pro forma results 2020 2019 Revenue $ 234,443 $ 228,117 Net income (loss) 7,170 2,464 Number of shares outstanding - basic 12,282 12,018 Number of shares outstanding - diluted 13,105 13,041 Basic earnings per share (loss) $ 0.58 $ 0.21 Diluted earnings per share (loss) $ 0.55 $ 0.19 17. Subsequent Events Management has evaluated subsequent events through the date that the Company's consolidated financial statements were issued. Based on this evaluation, the Company has determined that no further subsequent events have occurred which require disclosure through the date that these consolidated financial statements were issued. F-26