DLH Holdings Corp. 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA Consolidated Financial Statements Page Report of Independent Registered Public Accounting Firm (PCAOB ID Number 100 ) 33 Consolidated Statements of Operations for the years ended September 30, 2022 and 2021 36 Consolidated Balance Sheets as of September 30, 2022 and 2021 37 Consolidated Statements of Cash Flows for the years ended September 30, 2022 and 2021 38 Consolidated Statements of Changes in Shareholders' Equity for the years ended September 30, 2022 and 2021 39 Notes to Consolidated Financial Statements 40 32 Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of DLH Holdings Corp. Opinion on the Financial Statements and Internal Control Over Financial Reporting We have audited the accompanying consolidated balance sheets of DLH Holdings Corp. and Subsidiaries (the “Company”) as of September 30, 2022 and 2021, the related consolidated statements of operations, cash flows, and changes in shareholders’ equity for each of the years in the two-year period ended September 30, 2022, and the related notes (collectively referred to as the "consolidated financial statements"). We also have audited the Company’s internal control over financial reporting as of September 30, 2022, based on the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of September 30, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the two-year period ended September 30, 2022, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2022, based on criteria established in Internal Control—Integrated Framework (2013) issued by the COSO. Basis for Opinion The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management’s report on internal control over financial reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that responds to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the 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 financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control Over Financial Reporting A Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. An entity’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the entity; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the entity are being made only in accordance with authorizations of management and directors of the entity; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the entity’s assets that could have a material effect on the financial statements. 33 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. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Revenue Recognition Critical Audit Matter Description As described in Note 4 to the consolidated financial statements, the Company generally recognizes revenue over time as services are provided, as most of its contracts involve a continuous transfer of control to the customer. This continuous transfer of control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay the Company 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, the Company satisfies performance obligations as services are rendered. We identified the Company’s revenue recognition as a critical audit matter because of subjective auditor judgment on the assessment of completion of the contract performance obligations in the contracts that have a continuous transfer of control. Auditing these assumptions involved a degree of judgment and subjectivity as changes in these assumptions could have an impact on the amount of revenue recognized. Response: The following are the primary procedures we performed to address this critical audit matter. To test the recognition of revenue, our audit procedures included among others, testing the internal controls over the proper accumulation of labor costs by contract as well as the approval of monthly and weekly invoices for accuracy and completeness and reviewing key provisions and deliverables within customer contracts. We evaluated management’s application of their revenue recognition policies in the determination of revenue recognition conclusions. We selected a sample of revenue transactions and performed the following procedures: we reviewed the signed contract; we reviewed the recorded timesheet data related to the selected invoices, which corroborated management's assessment towards the completion of the performance obligation; and we reviewed the signed contract related to the selected invoice, noting each task has an agreed upon unit price per contract and the unit price matched what was shown on the invoice. We also tested for proper revenue recognition cut off. Workers' Compensation Claims Liabilities Critical Audit Matter Description The Company uses a combination of insured and self-insurance programs to cover workers’ compensation claims. Workers’ compensation claims liabilities represent management’s estimate of future amounts necessary to pay claims and related expenses with respect to workplace injuries that have occurred as of a given reporting date. The estimated liability of workers’ compensation claims is based on an evaluation of information provided by the Company’s third-party administrators for workers’ compensation claims, coupled with an actuarial estimate of future adverse loss development with respect to reported claims and incurred but not reported claims (together, IBNR). The process of arriving at an estimate of unpaid claims and claims adjustment expense involves a high degree of judgment and is affected by both internal and external events, including the Company's claims experience. The Company’s estimates are based on informed judgment, derived from individual experience and expertise applied to multiple sets of data and analyses. Given the high degree of judgment required to estimate the value of the workers’ compensation claims liabilities, performing audit procedures to evaluate the workers’ compensation claims liabilities recorded as of September 30, 2022 required an increased extent of effort. As a result, we identified the Company’s workers’ compensation claims liabilities as a critical audit matter because of certain significant assumptions management makes when estimating future incurred but not reported claims using both internal and external events to drive the accruals. Auditing these assumptions involved a high degree of judgement and subjectivity as changes in these assumptions could have a significant impact on the accruals recorded to estimate unpaid claims and the related expenses. 34 Response: The following are the primary procedures we performed to address this critical audit matter. We assessed whether there were any changes to the Company’s estimation process during the current year. We assessed whether any changes in the business or environment, including any changes to claims handling practices, were appropriately considered in the reserve setting process as well. We tested the underlying data that served as inputs into the Company’s analysis, including historical claims from third party and claims paid, to evaluate whether inputs and assumptions were reasonable. We compared management’s prior-year assumptions of expected claims development and ultimate loss to actuals incurred during the current year to identify and evaluate potential management bias in the determination of the workers’ compensation claims liabilities. We compared the estimated ultimate loss per each insurance year to prior years estimated ultimate loss by year to reassess the Company’s estimation process. We tested the mathematical accuracy of the accrual as of September 30, 2022. We reviewed supporting vendor documentation related to the current year’s base premiums. We also analyzed the qualifications of the Company’s third-party administrators for their expertise in this area. /s/ WithumSmith+Brown, PC We have served as the Company's auditor since 2007. East Brunswick, New Jersey December 5, 2022 PCAOB ID Number 100 35 DLH HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands except per share amounts) Year Ended September 30, 2022 2021 Revenue $ 395,173 $ 246,094 Cost of Operations Contract costs 322,886 194,614 General and administrative costs 30,730 25,054 Corporate development costs 614 1,088 Depreciation and amortization 7,665 8,115 Total operating costs 361,895 228,871 Income from operations 33,278 17,223 Interest expense 2,215 3,784 Income before provision for income taxes 31,063 13,439 Provision for income taxes 7,775 3,294 Net income $ 23,288 $ 10,145 Net income per share - basic $ 1.82 $ 0.81 Net income per share - diluted $ 1.64 $ 0.75 Weighted average common shares outstanding Basic 12,830 12,549 Diluted 14,179 13,597 The accompanying notes are an integral part of these consolidated financial statements. 36 DLH HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Amounts in thousands except par value of shares) September 30, 2022 September 30, 2021 ASSETS Current assets: Cash $ 228 $ 24,051 Accounts receivable 40,496 33,447 Other current assets 2,878 4,265 Total current assets 43,602 61,763 Equipment and improvements, net 1,704 1,912 Operating lease right-of-use-assets 16,851 19,919 Goodwill 65,643 65,643 Intangible assets, net 40,884 47,469 Other long-term assets 328 464 Total assets $ 169,012 $ 197,170 LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Operating lease liabilities - current $ 2,235 $ 2,261 Accrued payroll 9,444 9,125 Deferred revenue — 22,273 Accounts payable and accrued liabilities 26,862 32,717 Total current liabilities 38,541 66,376 Long-term liabilities: Deferred taxes, net 1,534 1,176 Operating lease liabilities - long-term 16,461 19,374 Debt obligations - long-term, net of deferred financing costs 20,416 44,636 Total long-term liabilities 38,411 65,186 Total liabilities 76,952 131,562 Shareholders' equity: Common stock, $ 0.001 par value; authorized 40,000 shares; issued and outstanding 13,047 and 12,714 at September 30, 2022 and 2021, respectively 13 13 Additional paid-in capital 91,057 87,893 Retained earnings (accumulated deficit) 990 ( 22,298 ) Total shareholders’ equity 92,060 65,608 Total liabilities and shareholders' equity $ 169,012 $ 197,170 The accompanying notes are an integral part of these consolidated financial statements. 37 DLH HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) Year Ended September 30, 2022 2021 Operating activities Net income $ 23,288 $ 10,145 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 7,665 8,115 Amortization of deferred financing costs charged to interest expense 664 792 Stock-based compensation expense 2,608 1,660 Deferred taxes, net 358 1,213 Changes in operating assets and liabilities Accounts receivable ( 7,049 ) ( 906 ) Other current assets 1,387 ( 766 ) Accrued payroll 319 ( 1,486 ) Deferred revenue ( 22,273 ) 22,273 Accounts payable and accrued liabilities ( 5,855 ) 4,139 Other long-term assets and liabilities 131 486 Net cash provided by operating activities 1,243 45,665 Investing activities Business acquisition adjustment — 59 Purchase of equipment and improvements ( 872 ) ( 103 ) Net cash used in investing activities ( 872 ) ( 44 ) Financing activities Proceeds from debt obligations 17,000 30,950 Repayments of debt obligations ( 41,750 ) ( 54,200 ) Payments of deferred financing costs — ( 43 ) Proceeds from issuance of common stock upon exercise of options and warrants 837 366 Payment of tax obligations resulting from net exercise of stock options ( 281 ) — Net cash used in financing activities ( 24,194 ) ( 22,927 ) Net change in cash ( 23,823 ) 22,694 Cash - beginning of year 24,051 1,357 Cash - end of year $ 228 $ 24,051 Supplemental disclosures of cash flow information Cash paid during the year for interest $ 1,528 $ 2,941 Cash paid during the year for income taxes $ 9,282 $ 936 Supplemental disclosures of non-cash activity Common stock surrendered for the exercise of stock options $ 256 $ — Cancellation of common stock $ — $ 68 The accompanying notes are an integral part of these consolidated financial statements. 38 DLH HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the years ended September 30, 2022 and 2021 (Amounts in thousands) Common Stock Additional Paid-In Capital Retained Earnings (Accumulated Deficit) Total Shareholders' Equity Shares Amount Year Ended September 30, 2022 Balance at September 30, 2021 12,714 $ 13 $ 87,893 $ ( 22,298 ) $ 65,608 Expense related to director restricted stock units — — 648 — 648 Expense related to employee stock options — — 1,960 — 1,960 Stock issued for director restricted stock units 53 — — — — Exercise of stock options 257 — 637 — 637 Common stock surrendered for the exercise of stock options ( 31 ) — ( 281 ) — ( 281 ) Exercise of stock warrants 54 — 200 — 200 Net income — — — 23,288 23,288 Balance at September 30, 2022 13,047 $ 13 $ 91,057 $ 990 $ 92,060 Common Stock Additional Paid-In Capital Accumulated Deficit Total Shareholders' Equity Shares Amount Year Ended September 30, 2021 Balance at September 30, 2020 12,404 $ 12 $ 85,868 $ ( 32,443 ) $ 53,437 Expense related to director restricted stock units 141 — 467 — 467 Expense related to employee stock options — — 1,193 — 1,193 Exercise of stock options 175 1 433 — 434 Cancellation of common stock ( 6 ) — ( 68 ) — ( 68 ) Net income — — — 10,145 10,145 Balance at September 30, 2021 12,714 $ 13 $ 87,893 $ ( 22,298 ) $ 65,608 The accompanying notes are an integral part of these consolidated financial statements 39 DLH HOLDINGS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2022 1. Basis of Presentation and Principles of Consolidation 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. Certain amounts reported in our prior year consolidated financial statements have been reclassified to conform to current year presentation. 2. Significant Accounting Policies Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles in the United States (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. The most significant of these estimates and assumptions relate to estimating revenues and costs including overhead and its allocation, estimating progress toward the completion of performance obligations, assessing fair value of acquired assets and liabilities accounted for through business acquisitions, valuing and determining the amortization periods for long-lived intangible assets, interest rate swaps, stock-based compensation, right-of-use assets and leases liabilities, and 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. Revenue The Company's revenues from contracts with customers are derived from offerings that include technology-enabled business process outsourcing, program management solutions, and public health research and analytics, substantially within the U.S. government and its agencies, and to a lesser extent, subcontractors. The Company has various types of contracts of which include time-and-materials contracts, cost-reimbursable contracts, and firm-fixed-price contracts. We consider a contract with a customer to exist when there is a commitment by both parties (customer and Company), payment terms are determinable, there is commercial substance, and collectability is probably in accordance with Accounting Standards Codification ("ASC") No. 606, Revenue from Contracts with Customers ("Topic 606"). We recognize revenue over time when there is a continuous transfer of control to our customer as performance obligations are satisfied. For our U.S. government contracts, this continuous transfer of control to the customer is transferred over time and revenue is recognized based on the extent of progress toward completion of the performance obligation. We consider control to transfer when we have a right to payment. In some instances, the Company commences providing services prior to formal approval to begin work from the customer. The Company considers these factors, the risks associated with commencing work, and legal enforceability in determining whether a contract exists under Topic 606. 40 Contract modification can occur throughout the life of the contract and can affect the transaction price, extend the period of performance, adjust funding, or create new performance obligations. We review each modification to assess the impact of these contract changes to determine if it should be treated as part of the original performance obligation or as a separate contract. 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 service contracts, we satisfy our performance obligations as services are rendered. We use cost-based input and time-based output methods to measure progress based on the contract type. • Time and material - We bill the customer per labor hour and per material, and revenue is recognized in the amount invoiced as the amount corresponds directly to the value of our performance to date. Revenue is recognized to the extent of billable rates times hours delivered plus materials and other reimbursable costs incurred. • Cost reimbursable - We record reimbursable costs as incurred, including an estimated share of the contractual fee earned. • Firm fixed price - We recognize revenue over time using a straight-line measure of progress or percentage of completion method whereby progress toward completion is based on a comparison of actual costs incurred to total estimated costs to be incurred over the contract terms. Contract costs generally include direct costs such as labor, materials, subcontract costs, and indirect costs identifiable with or allocable to a specific contract. Costs are expensed as incurred and include an estimate of the contractual fees earned. Contract costs incurred for U.S. government contracts, including indirect costs, are subject to audit and adjustment by various government audit agencies. Historically, our adjustments have not been material. 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 Accounts receivable, 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 or prepayment for services to be rendered. Contract liabilities are primarily due to contract start-up funding provided under a contract awarded at the end of the fiscal year 2021, for which all performance obligations were completed by March 31, 2022. 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, right-of-use 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. 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. 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. 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. 41 Lease Liabilities 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 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 secured term loan 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. As of September 30, 2022, operating leases for facilities and equipment have remaining lease terms of 0.2 to 8.5 years. Goodwill At September 30, 2022, we performed an internal goodwill impairment evaluation on the year-end carrying value of approximately $ 65.6 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, 2022, 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, 2021. Provision for Income Taxes The Company accounts for income taxes in accordance with the asset and 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, 2022 and 2021. We report interest and penalties as a component of provision for income taxes. For the years ended September 30, 2022 and 2021, 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 Monte Carlo method 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. Compensation Expense 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 method that utilizes various probability factors and other criterion in establishing fair value of the grant. The related compensation expense is recognized over the service period. 42 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. Receivables Receivables include amounts billed and currently due from customers where the right to consideration is unconditional and amounts unbilled. Both billed and unbilled amounts are non-interest bearing, unsecured, and recognized at an estimated realizable value that include costs and fees, and are generally expected to be billed and received within a single year. We evaluate our receivables on a quarterly basis and determine whether an allowance is appropriate based on specific collection issues. No allowance for doubtful accounts was deemed necessary at either September 30, 2022 or September 30, 2021. 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 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, 2022 and 2021, 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, 2022 and 2021, 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 consolidated financial position and the results of its operations, the specific impact is not readily determinable as of the date of these consolidated financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. 3. New Accounting Pronouncements In March 2020 and January 2021, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” and ASU No. 2021-01, “Reference Rate Reform (Topic 848): Scope,” respectively (collectively, “Topic 848”). Topic 848 provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued because of reference rate reform. The optional expedients and exceptions provided by Topic 848 can be applied for all entities 43 as of March 12, 2020 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. 4. Revenue Recognition The following table summarizes the contract balances recognized within the Company's consolidated balance sheets at September 30, 2022 and 2021 (in thousands): 2022 2021 Contract assets $ 7,682 $ 7,307 Contract liabilities $ — $ 22,473 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 presents our revenue disaggregated by these categories: Revenue by customer for the years ended September 30, 2022 and 2021 (in thousands): 2022 2021 Department of Homeland Security $ 126,576 $ 2,485 Department of Veterans Affairs 126,106 110,078 Department of Health and Human Services 102,201 91,543 Department of Defense 33,612 30,930 Other 6,678 11,058 Total Revenue $ 395,173 $ 246,094 Revenue by contract type for the years ended September 30, 2022 and 2021 (in thousands): 2022 2021 Time and Materials $ 308,944 $ 185,656 Cost Reimbursable 46,231 48,101 Firm Fixed Price 39,998 12,337 Total Revenue $ 395,173 $ 246,094 Revenue by whether the Company acts as a prime contractor or a subcontractor for the years ended September 30, 2022 and 2021(in thousands): 2022 2021 Prime Contractor $ 366,571 $ 215,241 Subcontractor 28,602 30,853 Total Revenue $ 395,173 $ 246,094 44 5. Leases The following table summarizes lease balances presented on our consolidated balance sheets at September 30, 2022 and 2021 (in thousands): 2022 2021 Operating lease right-of-use assets $ 16,851 $ 19,919 Operating lease liabilities, current $ 2,235 $ 2,261 Operating lease liabilities, long-term 16,461 19,374 Total operating lease liabilities $ 18,696 $ 21,635 For the years ended September 30, 2022 and 2021, total lease costs for our operating leases are as follows (in thousands): 2022 2021 Operating $ 3,548 $ 3,653 Short-term 114 103 Variable 120 81 Sublease income (a) ( 258 ) ( 302 ) Total lease costs $ 3,524 $ 3,535 (a): 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 term is 5 years and includes two additional 1 year term extension options. The Company's future minimum lease payments as of September 30, 2022 are as follows: For the Fiscal Year Ending September 30, (in thousands) 2023 $ 3,299 2024 3,156 2025 2,995 2026 3,092 2027 2,487 Thereafter 8,513 Total future minimum lease payments 23,542 Less: imputed interest ( 4,846 ) Present value of future minimum lease payments 18,696 Less: current portion of operating lease liabilities ( 2,235 ) Long-term operating lease liabilities $ 16,461 At September 30, 2022, the weighted-average remaining lease term and weighted-average discount rate are 7.5 years and 6.0 %, respectively. The calculation of the weighted-average discount rate was determined based on borrowing terms from our secured term loan. Other information related to our leases is as follows for the years ending September 30, 2022 and 2021 (in thousands): 2022 2021 Cash paid for amounts included in the measurement of lease liabilities $ 3,411 $ 3,306 45 6. Supporting Financial Information Accounts receivable The following table summarizes Accounts receivable presented on our consolidated balance sheets at September 30, 2022 and 2021 (in thousands): 2022 2021 Billed receivables $ 32,814 $ 26,140 Contract assets 7,682 7,307 Allowance for doubtful accounts — — Accounts receivable $ 40,496 $ 33,447 Other current assets The following table summarizes Other current assets presented on our consolidated balance sheets at September 30, 2022 and 2021 (in thousands): 2022 2021 Prepaid insurance and benefits $ 737 $ 655 Other receivables 945 995 Prepaid expenses 1,196 2,615 Other current assets $ 2,878 $ 4,265 Equipment and improvements, net The following table summarizes Equipment and improvements, net presented on our consolidated balance sheets at September 30, 2022 and 2021 (in thousands): 2022 2021 Furniture and equipment $ 893 $ 958 Computer equipment 2,316 1,262 Computer software 4,407 4,353 Leasehold improvements 1,614 1,595 Total equipment and improvements 9,230 8,168 Less: accumulated depreciation and amortization ( 7,526 ) ( 6,256 ) Equipment and improvements, net $ 1,704 $ 1,912 Depreciation and amortization was $ 1.1 million and $ 1.5 million for the years ended September 30, 2022 and 2021, respectively. 46 Intangible assets, net The following table summarizes Intangible assets, net presented on our consolidated balance sheets at September 30, 2022 and 2021 (in thousands): 2022 2021 Intangible assets Customer contracts and related customer relationships $ 62,281 $ 62,281 Covenants-not-to-compete 522 522 Trade names 3,051 3,051 Total intangible assets 65,854 65,854 Less accumulated amortization Customer contracts and related customer relationships ( 23,606 ) ( 17,378 ) Covenants-not-to-compete ( 316 ) ( 264 ) Trade names ( 1,048 ) ( 743 ) Total accumulated amortization ( 24,970 ) ( 18,385 ) Intangible assets, net $ 40,884 $ 47,469 Total amount of amortization expense for each of the years ended September 30, 2022 and 2021 was $ 6.6 million. As of September 30, 2022, the estimated annual amortization expense is as follows: For the Fiscal Year Ending September 30, (in thousands) 2023 $ 6,585 2024 6,585 2025 6,585 2026 5,851 2027 4,823 Thereafter 10,455 Total amortization expense $ 40,884 Accounts payable and accrued liabilities The following table summarizes Accounts payable and accrued liabilities presented on our consolidated balance sheets at September 30, 2022 and 2021 (in thousands): 2022 2021 Accounts payable $ 11,886 $ 16,684 Accrued benefits 3,857 2,916 Accrued bonus and incentive compensation 3,625 2,381 Accrued workers' compensation insurance 4,880 7,014 Other accrued expenses 2,614 3,722 Accounts payable and accrued liabilities $ 26,862 $ 32,717 47 Debt obligations The following table summarizes Debt obligations presented on our consolidated balance sheets at September 30, 2022 and 2021 (in thousands): 2022 2021 Secured term loan $ 22,000 $ 46,750 Less: unamortized deferred financing costs ( 1,584 ) ( 2,114 ) Long-term portion of debt obligations, net of deferred financing costs $ 20,416 $ 44,636 As of September 30, 2022 and 2021, we had no outstanding balance on our secured revolving line of credit and have satisfied mandatory principal payments on our secured term loan for the next twelve months. Interest expense The following table summarizes Interest expense presented on our consolidated statements of operations for the years ending September 30, 2022 and 2021 (in thousands): 2022 2021 Interest expense (a) $ 1,551 $ 2,992 Amortization of deferred financing costs (b) 664 792 Interest expense $ 2,215 $ 3,784 (a): Interest expense on borrowing (b): Amortization of expenses related to secured term loan and secured revolving line of credit. 7. Credit Facilities A summary of our credit facilities as of September 30, 2022 and 2021 is as follows (in millions): 2022 2021 Arrangement Loan Balance Interest Loan Balance Interest Secured term loan (a) due September 30, 2025 $ 22.0 LIBOR* + 2.5 % $ 46.8 LIBOR* + 3.5 % Secured revolving line of credit (b) due September 30, 2025 $ — LIBOR* + 2.5 % $ — LIBOR* + 3.5 % *LIBOR rate as of September 30, 2022 and 2021 was 2.52 % and 0.08 %, respectively. As of September 30, 2022 and 2021, our LIBOR rate is subject to a minimum floor of 0.5 %. (a) Represents the principal amounts payable on our secured term loan, which is secured by liens on substantially all of the assets of the Company. The principal of the secured 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 secured 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. 48 We are required to pay quarterly amortization payments commencing in December 2020 through September 2025. The annual amortization amounts are $ 7.0 million each for fiscal years 2021 and 2022 and $ 8.75 million each for fiscal years 2023 through 2025, with the remaining unpaid loan balance due at maturity in September 2025. The quarterly payments are in equal installments. As of September 30, 2022, the Company made voluntary prepayments of $ 34.0 million, bringing the total amount paid on the secured term loan to $ 48.0 million. As of September 30, 2022, we have satisfied mandatory principal amortization until September 30, 2025. 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. Due to the voluntary prepayment of term debt, there was no excess cash flow payment required. For additional information regarding the schedule of future payment obligations, please refer to Note 10 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 on September 30, 2022 is $ 16.2 million and matures in 2024. The remaining outstanding balance of our secured 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, 2022, interest expense increased by approximately $ 0.2 million. (b) The secured revolving line of credit has a ceiling of up to $ 25.0 million; as of September 30, 2022, we had unused borrowing capacity of $ 23.0 million, which is net of outstanding letters of credit. Borrowing on the secured revolving line of credit is secured by liens on substantially all of the assets of the Company. The Company accessed funds from the secured revolving line of credit during the year, but has no outstanding balance at September 30, 2022. The Company's total borrowing availability, based on eligible accounts receivables at September 30, 2022, was $ 25.0 million. As part of the secured revolving line of credit, the lenders agreed to a sublimit of $ 5 million for letters of credit for the account of the Company, subject to applicable procedures. The secured 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. 8. 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, 2022, there were 1.4 million shares available for grant. Stock-based compensation expense, presented in the table below, is recorded in general and administrative expenses included in our consolidated statements of operations for the years ending September 30, 2022 and 2021 (in thousands): 2022 2021 DLH employees (a) $ 1,960 $ 1,193 Non-employee directors (b) 648 467 Total stock option expense $ 2,608 $ 1,660 49 (a): Included in this amount are equity grants of restricted stock units to Named Executive Officers ("NEO"), which were issued in accordance with the DLH long-term incentive compensation policy, and stock option grants to NEO and non-NEO company employees. The restricted stock units totaled 140,404 restricted stock units issued and outstanding at September 30, 2022. (b): In the first quarter of fiscal year 2022, we issued 53,510 restricted stock units to the Company's non-employee directors, all of which vested as of September 30, 2022. The shares of common stock underlying such restricted stock units were issued on September 30, 2022. Unrecognized stock-based compensation expense Unrecognized stock-based compensation expense is presented in the table below for the years ending September 30, 2022 and 2021 (in thousands): 2022 2021 Unrecognized expense for DLH employees (a) $ 5,214 $ 4,468 (a): On a weighted average basis, this expense is expected to be recognized within the next 4.20 years. Stock option activity for the year ended September 30, 2022: 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 Shares Price Term Value Options outstanding, September 30, 2021 2,374 $ 5.60 5.6 $ 15,899 Granted (a) 275 16.17 — — Exercised ( 257 ) 3.47 — — Options outstanding, September 30, 2022 2,392 $ 7.05 5.4 $ 13,566 (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, 2022, as follows using the Monte Carlo method: Vesting Expected Strike Stock Threshold Term Calculated Grant Date Price Price Price (Years) Fair Value November 8, 2021 $ 16.01 $ 16.01 Service 10 $ 9.68 November 8, 2021 $ 16.01 $ 16.01 $ 24.00 10 $ 9.68 November 8, 2021 $ 16.01 $ 16.01 $ 28.00 10 $ 9.64 November 8, 2021 $ 16.01 $ 16.01 $ 32.00 10 $ 9.58 August 1, 2022 $ 17.77 $ 17.77 $ 23.00 10 $ 9.68 Notes: Results based on 100,000 simulations 50 Stock options shares outstanding, vested and unvested for the years ended September 30, 2022 and 2021 (in thousands): Number of Shares 2022 2021 Vested and exercisable (a) 2,117 1,662 Unvested (b) 275 712 Options outstanding 2,392 2,374 (a): Weighted average exercise price of vested and exercisable shares was $ 5.86 and $ 3.91 at September 30, 2022 and 2021, respectively. Aggregate intrinsic value was approximately $ 13.6 million and $ 13.9 million at September 30, 2022 and 2021, respectively. Weighted average contractual term remaining was 4.9 years and 4.0 years at September 30, 2022 and 2021, respectively. (b): Certain awards vest upon satisfaction of certain performance criteria. 9. 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. Earnings Per Share information is presented in the table below for the years ending September 30, 2022 and 2021 (in thousands except for per share amounts): 2022 2021 Numerator: Net income $ 23,288 $ 10,145 Denominator: Denominator for basic net income per share - weighted-average outstanding shares 12,830 12,549 Effect of dilutive securities: Stock options and restricted stock 1,349 1,048 Denominator for diluted net income per share - weighted-average outstanding shares 14,179 13,597 Net income per share - basic $ 1.82 $ 0.81 Net income per share - diluted $ 1.64 $ 0.75 10. Commitments and Contingencies Contractual Obligations as of September 30, 2022 (in thousands): Payments Due Per Fiscal Year Total 2023 2024 2025 2026 2027 Thereafter Debt obligations $ 22,000 $ — $ — $ 22,000 $ — $ — $ — Facility operating leases 23,407 3,216 3,104 2,995 3,092 2,487 8,513 Equipment operating leases 135 83 52 — — — — Total contractual obligations $ 45,542 $ 3,299 $ 3,156 $ 24,995 $ 3,092 $ 2,487 $ 8,513 51 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, 2022 and September 30, 2021 was approximately $ 4.9 million and $ 7.0 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. 11. Related Party Transactions The Company has determined that for the years ended September 30, 2022 and 2021 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. 12. Provision for Income Taxes The significant components of provision for income taxes from continuing operations are summarized as follows for the years ending September 30, 2022 and 2021 (in thousands): 2022 2021 Current expense $ 7,351 $ 2,081 Deferred expense 424 1,213 Total expense $ 7,775 $ 3,294 The following table presents the significant differences between our income taxes at the federal statutory rate and the Company's effective tax rate for continuing operations for the years ending September 30, 2022 and 2021 (in thousands): 2022 2021 Income taxes at the federal statutory rate $ 6,523 $ 2,822 State taxes, net 1,158 376 Other permanent items 94 96 Total $ 7,775 $ 3,294 52 An analysis of the Company's deferred tax assets and liabilities at September 30, 2022 and 2021 is as follows (in thousands): 2022 2021 Deferred tax assets: Net operating loss carry forwards, net $ 296 $ 318 Stock based compensation 668 508 Accrued compensation 2,108 2,614 Total deferred tax assets 3,072 3,440 Less: valuation allowance ( 262 ) ( 288 ) Total deferred tax assets, net 2,810 3,152 Deferred tax liabilities: Equipment and intangible assets ( 3,833 ) ( 3,507 ) Accrued expenses ( 407 ) ( 671 ) Right of use liability ( 104 ) ( 150 ) Total deferred tax liabilities ( 4,344 ) ( 4,328 ) Net deferred tax liability $ ( 1,534 ) $ ( 1,176 ) 13. Quarterly Financial Data (Unaudited) A summary of quarterly information is as follows (in thousands, except per share data) 2022 Quarters First a Second a Third a Fourth Revenue $ 152,801 $ 108,699 $ 66,440 $ 67,233 Income from operations 11,219 10,254 7,114 4,691 Interest expense ( 672 ) ( 554 ) ( 512 ) ( 477 ) Income before provision for income taxes 10,547 9,700 6,602 4,214 Provision for income taxes 2,743 2,522 1,738 772 Net income $ 7,804 $ 7,178 $ 4,864 $ 3,442 Earnings per share: Basic $ 0.61 $ 0.56 $ 0.38 $ 0.27 Diluted $ 0.55 $ 0.50 $ 0.34 $ 0.24 2021 Quarters First Second Third Fourth Revenue $ 57,852 $ 61,506 $ 61,555 $ 65,182 Income from operations 3,635 4,620 4,939 4,030 Interest expense ( 1,080 ) ( 1,004 ) ( 893 ) ( 808 ) Income before provision for income taxes 2,555 3,616 4,046 3,222 Provision for income taxes 741 1,049 1,166 339 Net income $ 1,814 $ 2,567 $ 2,880 $ 2,883 Earnings per share: Basic $ 0.15 $ 0.20 $ 0.23 $ 0.23 Diluted $ 0.13 $ 0.19 $ 0.21 $ 0.21 a Results for the company’s sustaining business less the FEMA task orders was presented annually in Item 7 and on a quarterly basis within the quarterly report (10Q) for fiscal year 2022's first, second and third quarters. 53 14. Employee Benefit Plans As of September 30, 2022, the Company maintains 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 $ 2.2 million and $ 1.5 million for the years ending September 30, 2022 and 2021. Participants are always fully vested in their elective contributions and vests in Company matching contributions over a four-year period. 15. 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. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.