10-Q 1 dlhc-2014x10qxq1x123113.htm 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2013
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-18492
DLH HOLDINGS CORP.
(Exact name of registrant as specified in its charter)

New Jersey |  | 22-1899798
(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
1776 Peachtree Street, NW |  |
Atlanta, Georgia |  | 30309
(Address of principal executive offices) |  | (Zip Code)

(866) 952-1647
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o |  | Accelerated filer o
Non-accelerated filer o |  | Smaller Reporting Company x
(Do not check if a smaller reporting company) |  |

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 9,602,773 shares of Common Stock, par value $.001 per share, were outstanding as of January 31, 2014
1

DLH HOLDINGS CORP.
FORM 10-Q
For the Quarter Ended December 31, 2013
Table of Contents

| Page No.
Part I — Financial Information |
Item 1. Financial Statements |
Consolidated Balance Sheets as of December 31, 2013 (Unaudited) and September 30, 201 3 | 3
Consolidated Statements of Operations for the three months ended December 31, 2013 and 2012 (Unaudited) | 5
Consolidated Statements of Cash Flows for the three months ended December 31, 2013 and 2012 (Unaudited) | 6
Notes to Consolidated Financial Statements (Unaudited) | 7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk | 27
Item 4. Controls and Procedures | 27
Part II — Other Information | 28
Item 1. Legal Proceedings | 28
Item 1A. Risk Factors | 28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | 28
Item 3. Defaults Upon Senior Securities | 29
Item 4. Mine Safety Disclosures | 29
Item 5. Other Information | 29
Item 6. Exhibits | 30
Signatures | 31

2

DLH HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)

|  | (unaudited) |  |
|  | December 31, 2013 |  | September 30, 2013
ASSETS |  |  |  |  |  |
CURRENT ASSETS |  |  |  |  |  |
Cash and cash equivalents |  | $ | 2,566 |  |  | $ | 3,408 |
Accounts receivable, net of allowance for doubtful accounts of $0 and $0, including unbilled receivables of $9.7 and $9.5 million, at December 31, 2013 and at September 30, 2013 |  | 13,201 |  |  | 11,943 |
Prepaid workers’ compensation |  | 199 |  |  | 358 |
Other current assets |  | 462 |  |  | 241 |
Total current assets |  | 16,428 |  |  | 15,950 |
EQUIPMENT AND IMPROVEMENTS |  |  |  |  |  |
Furniture and equipment |  | 139 |  |  | 139 |
Computer equipment |  | 126 |  |  | 126 |
Computer software |  | 423 |  |  | 417 |
Leasehold improvements |  | 24 |  |  | 24 |
|  | 712 |  |  | 706 |
Less accumulated depreciation and amortization |  | (577 | ) |  | (550 | )
Equipment and improvements, net |  | 135 |  |  | 156 |
GOODWILL |  | 8,595 |  |  | 8,595 |
OTHER ASSETS |  |  |  |  |  |
Deposit for workers' compensation insurance |  | — |  |  | 1,030 |
Other assets |  | 27 |  |  | 27 |
Total other assets |  | 27 |  |  | 1,057 |
TOTAL ASSETS |  | $ | 25,185 |  |  | $ | 25,758 |

The accompanying notes are an integral part of these consolidated financial statements.
3

DLH HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS EXCEPT PAR VALUE OF SHARES)

|  | (unaudited) |  |
|  | December 31, 2013 |  | September 30, 2013
LIABILITIES AND SHAREHOLDERS’ EQUITY |  |  |  |  |  |
CURRENT LIABILITIES |  |  |  |  |  |
Bank loan payable |  | $ | 940 |  |  | $ | 951 |
Current portion of capital lease obligations |  | 9 |  |  | 22 |
Convertible debenture, net |  | — |  |  | 340 |
Derivative financial instruments, at fair value |  | — |  |  | 160 |
Accrued payroll (including $8.7 million related to unbilled receivables) |  | 10,900 |  |  | 11,138 |
Accounts payable |  | 1,505 |  |  | 370 |
Accrued expenses and other current liabilities |  | 3,377 |  |  | 4,973 |
Total current liabilities |  | 16,731 |  |  | 17,954 |
LONG TERM LIABILITIES |  |  |  |  |  |
Other long term liability |  | 18 |  |  | 20 |
Total long term liabilities |  | 18 |  |  | 20 |
Total liabilities |  | 16,749 |  |  | 17,974 |
COMMITMENTS AND CONTINGENCIES |  |  |  |  |  |
SHAREHOLDERS’ EQUITY |  |  |  |  |  |
Preferred stock, $.10 par value; authorized 5,000 shares, none issued and outstanding |  | — |  |  | — |
Common stock, $.001 par value; authorized 40,000 shares; issued 9,610 at December 31, 2013 and 9,320 at September 30, 2013, outstanding 9,603 at December 31, 2013 and 9,318 at September 30, 2013 |  | 9 |  |  | 9 |
Additional paid-in capital |  | 75,926 |  |  | 75,400 |
Accumulated deficit |  | (67,468 | ) |  | (67,601 | )
Treasury stock, 7 shares at cost at December 31, 2013 and 2 shares at cost at September 30, 2013 |  | (31 | ) |  | (24 | )
Total shareholders’ equity |  | 8,436 |  |  | 7,784 |
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY |  | $ | 25,185 |  |  | $ | 25,758 |

The accompanying notes are an integral part of these consolidated financial statements.
4

DLH HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

|  | (unaudited)
|  | For the Three Months Ended
|  | December 31, |  | December 31,
|  | 2013 |  | 2012
REVENUES |  | $ | 14,477 |  |  | $ | 12,994 |
DIRECT EXPENSES |  | 12,365 |  |  | 11,206 |
GROSS PROFIT |  | 2,112 |  |  | 1,788 |
GENERAL AND ADMINISTRATIVE EXPENSES |  | 2,020 |  |  | 1,849 |
DEPRECIATION AND AMORTIZATION |  | 26 |  |  | 33 |
Income (loss) from operations |  | 66 |  |  | (94 | )
OTHER INCOME (EXPENSE) |  |  |  |  |  |
Interest expense, net |  | (22 | ) |  | (46 | )
Amortization of financing costs |  | (10 | ) |  | (52 | )
Change in fair value of derivative financial instruments |  | 99 |  |  | 61 |
Other income, net |  | — |  |  | 3 |
|  | 67 |  |  | (34 | )
Income (loss) before income taxes |  | 133 |  |  | (128 | )
INCOME TAX EXPENSE |  | — |  |  | — |
NET INCOME (LOSS) |  | $ | 133 |  |  | $ | (128 | )
NET INCOME (LOSS) PER SHARE - BASIC AND DILUTED |  |  |  |  |  |
Net income (loss) per share |  | $ | 0.01 |  |  | $ | (0.01 | )
WEIGHTED AVERAGE BASIC SHARES OUTSTANDING |  | 9,494 |  |  | 9,286 |
WEIGHTED AVERAGE DILUTED SHARES OUTSTANDING |  | 9,549 |  |  | 9,286 |

The accompanying notes are an integral part of these consolidated financial statements
5

DLH HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)

|  | (unaudited)
|  | For the Three Months Ended
|  | December 31, |  | December 31,
|  | 2013 |  | 2012
CASH FLOWS FROM OPERATING ACTIVITIES |  |  |  |  |  |
Net Income (loss) |  | $ | 133 |  |  | $ | (128 | )
Adjustments to reconcile net loss to net cash used in operating activities: |  |  |  |  |  |
Depreciation and amortization including financing costs |  | 36 |  |  | 85 |
Change in fair value of derivative financial instruments |  | (99 | ) |  | (61 | )
Non cash equity grants |  | 217 |  |  | 90 |
Changes in operating assets and liabilities, net of divested business: |  |  |  |  |  |
Accounts receivable |  | (1,258 | ) |  | 931 |
Prepaid workers' compensation and other current assets |  | (62 | ) |  | (224 | )
Other assets |  | 1,030 |  |  | — |
Accounts payable, accrued payroll, accrued expenses and other current liabilities |  | (697 | ) |  | 79 |
Other long term liabilities |  | (2 | ) |  | (41 | )
Net cash (used in)/provided by operating activities |  | (702 | ) |  | 731 |
CASH FLOWS FROM INVESTING ACTIVITIES |  |  |  |  |  |
Purchase of equipment and improvements |  | (6 | ) |  | (9 | )
Net cash used in investing activities |  | (6 | ) |  | (9 | )
CASH FLOWS FROM FINANCING ACTIVITIES |  |  |  |  |  |
Net payments on bank loan payable |  | (11 | ) |  | (547 | )
Rights offering expenses |  | — |  |  | (6 | )
Proceeds from exercise of warrants |  | 52 |  |  | — |
Repayments of capital lease obligations |  | (14 | ) |  | (12 | )
Net repayment on convertible debentures |  | (140 | ) |  | — |
Purchases of treasury stock |  | (21 | ) |  | — |
Cash flows from discontinued operation |  | — |  |  | (7 | )
Net cash used in financing activities |  | (134 | ) |  | (572 | )
Net (decrease)/increase in cash and cash equivalents |  | (842 | ) |  | 150 |
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD |  | 3,408 |  |  | 3,089 |
CASH AND CASH EQUIVALENTS AT END OF PERIOD |  | $ | 2,566 |  |  | $ | 3,239 |
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: |  |  |  |  |  |
Cash paid during the period for interest |  | $ | 92 |  |  | $ | 97 |
Cash paid during the period for income taxes |  | $ | — |  |  | $ | 13 |

The accompanying notes are an integral part of these consolidated financial statements.
6

DLH, HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2013 (UNAUDITED)
(1) ORGANIZATION AND BUSINESS:
For more than 25 years, DLH Holdings Corp. ("DLH"), has provided professional services to the U.S. Government. Headquartered in Atlanta, Georgia, DLH employs over 1,200 skilled technicians, logisticians, engineers, healthcare and support personnel at more than 25 locations around the United States. DLH’s operating subsidiary, DLH Solutions, Inc., is organized into three broad integrated business areas: Healthcare Delivery Solutions, Logistics & Technical Services, and Contingency / Staff Augmentation Services. Our customers, a majority of whom are within the Departments of Defense ("DoD") and Veterans Affairs ("DVA"), benefit from proven leadership processes, technical excellence and differentiation, and cost management. The remaining portion of DLH's business is comprised of customers within the Center for Disease Control and Prevention, Departments of Justice, Agriculture, Interior and Federal Emergency Management Agency, at locations throughout the United States.
DLH Holdings Corp. (together with its subsidiaries, "DLH" or the "Company" and also referred to as "we," "us" and "our") manages its operations from Loganville, Georgia and its principal executive offices are located at 1776 Peachtree Street, Atlanta, Georgia 30309.
Corporate History
DLH Holdings Corp. was originally incorporated in New Jersey in 1969 as a payroll staffing company. Through several strategic transactions over recent decades, the Company has evolved considerably and in early 2010, made the strategic decision to build the Company around its government services entity, DLH Solutions, Inc. The Company is now completely focused on government services both as a prime contractor as well as a partner with other government contractors. The Company's other wholly-owned subsidiaries are not actively operating.
(2) LIQUIDITY AND SIGNIFICANT ACCOUNTING POLICIES:
Liquidity
In recent years, the Company has financed operations and capital expenditures through the sale of equity securities, convertible notes and more recently, through the proceeds from a rights offering. The Company's immediate sources of liquidity include cash and cash equivalents, accounts receivable, unbilled receivables and access to its asset-based credit facility with Presidential Financial Corporation. The Company's operating liabilities are largely predictable and consist of vendor and payroll related obligations. The Company's operations require substantial working capital to fund the future growth of its business model with expanded business development efforts, and planned capital expenditures to support a larger customer base.
At December 31, 2013, the Company had a net working capital deficit of approximately $0.3 million and an accumulated deficit of approximately $67.5 million. For the three months ended December 31, 2013, the Company realized operating income of approximately $66 thousand and net income of approximately $133 thousand.
As described further in Note 5, the Company has a credit facility with Presidential Financial Corporation which provides a maximum amount of $6,000,000 and includes a maximum amount available under the unbilled facility of $1,000,000. However, as described in greater detail in Note 5 below, the Company’s ability to borrow against the increased available credit is subject to the satisfaction of a number of conditions. Presently, the maximum availability under this loan facility is $3,000,000, subject to eligible accounts receivable. At December 31, 2013, the amount of unused availability was approximately $1.1 million. The amount outstanding on the loan facility as of December 31, 2013 was $0.9 million.
Management believes, at present, that: (a) cash and cash equivalents of approximately $2.6 million as of December 31, 2013; b) the amount available under its line of credit (which is limited to the amount of eligible assets); (c) forecasted operating cash flow; (d) certain liabilities not expected to be settled in cash (see Note 3) in fiscal 2014; and (e) effects of cost reduction programs and initiatives should be sufficient to support the Company's operations for twelve months from the date of these financial statements. However, should any of the above- referenced factors not occur substantially as currently expected, there could be a material adverse effect on the Company's ability to access the level of liquidity necessary for it to sustain operations at current levels for the next twelve months. In such an event, management may be forced to make further reductions in spending or seek additional sources of capital to support our operations. If the Company raises additional funds by selling shares of common stock or convertible securities, the ownership of its existing shareholders would be diluted.
7

Presently, the Company derives all of its revenue from agencies of the Federal government. For the fiscal year ended September 30, 2013 and for the three months ended December 31, 2013, the Company derived approximately 96% and 97%, respectively, of its revenue from various contracts awarded by the DVA, the substantial majority of which relate to our provision of healthcare and logistics services to the DVA Consolidated Mail Outpatient Pharmacy (CMOP) program. As of December 31, 2013, these awards from the DVA have anticipated periods of performance ranging from approximately three to up to five years. These agreements are subject to the Federal Acquisition Regulations, and there can be no assurance as to the actual amount of services that the Company will ultimately provide to the DVA under these awards. The Company's results of operations, cash flows and financial condition would be materially adversely affected in the event that we are unable to continue our relationships with the DVA.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of DLH and its subsidiaries, all of which are wholly owned. All significant intercompany balances and transactions have been eliminated in consolidation.
Reclassifications
Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation. These reclassifications had no effect on previously reported results of operations or retained earnings.
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, expected settlement amounts of accounts receivable, measurement of prepaid workers’ compensation, valuation allowances established against accounts receivable and deferred tax assets, measurement of payroll tax contingencies, accounts payable, workers’ compensation claims, and accrued expenses and the valuation of derivative financial instruments associated with debt agreements. In addition, the Company estimates overhead charges and allocates such charges throughout the year. 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.
Revenue Recognition
DLH’s revenue is derived from professional and other specialized service offerings to US Government agencies through a variety of contracts, some of which are fixed-price in nature and/or sourced through Federal Supply Schedules administered by the General Services Administration (“GSA”) at fixed unit rates or hourly arrangements. We generally operate as a prime contractor, but have also entered into contracts as a subcontractor. The recognition of revenue from fixed rates is based upon objective criteria that generally do not require significant estimates that may change over time. DLH recognizes and records revenue on government contracts when it is realized, or realizable, and earned. DLH considers these requirements met when: (a) persuasive evidence of an arrangement exists; (b) the services have been delivered to the customer; (c) the sales price is fixed or determinable and free of contingencies or significant uncertainties; and (d) collectibility is reasonably assured.
Goodwill
In accordance with applicable accounting standards, DLH does not amortize goodwill. DLH continues to review its goodwill 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. At September 30, 2013, we performed a goodwill impairment evaluation. We performed both a qualitative and quantitative 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, 2013. 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. For the three months ended December 31, 2013, the Company determined that no change in business conditions occurred which would have a material adverse effect on the valuation of goodwill. If an impairment write off of all the goodwill became necessary in future periods, a charge of up to $8.6 million would be expensed in the Consolidated Statement of Operations. All remaining goodwill is attributable to the DLH Solutions operating subsidiary.
8

Income Taxes
DLH 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. At December 31, 2013 and 2012, the Company recorded a 100% valuation allowance against its net deferred tax assets.
The Financial Accounting Standards Board (“FASB”) has issued authoritative guidance that clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements and prescribes a recognition threshold of more-likely-than-not to be sustained upon examination. Measurement of the tax uncertainty occurs if the recognition threshold has been met. This interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods and disclosures. The Company conducts business solely in the U.S. and, as a result, also files income taxes in various states and other jurisdictions. Given the substantial net operating losses and the related valuation allowance established against such amounts, the Company has concluded that it does not have any uncertain tax positions. There have been no income tax related interest or penalties for the periods presented in these consolidated financial statements. In the normal course of business, the Company and its subsidiaries are subject to examination by Federal and state taxing authorities. The Company’s income tax returns for years subsequent to fiscal 2010 are currently open, by statute, for review by authorities. However, there are no examinations currently in progress and the Company is not aware of any pending audits.
Stock-Based Compensation
Compensation costs for the portion of equity awards (for which the requisite service has not been rendered) that are outstanding are recognized as the requisite service is rendered. The compensation cost for that portion of awards shall be based on the grant-date fair value of those awards as calculated for recognition purposes under applicable guidance. As of December 31, 2013 and 2012, there was approximately $351 thousand and $208 thousand, respectively, remaining unrecognized compensation expense related to non-vested stock based awards to be recognized in future periods.
Certain awards vest upon satisfaction of certain performance criteria. As permitted, the Company will not recognize expense on the performance based shares until it is probable that these conditions will be achieved. Such charges could be material in future periods.
Stock Options, Warrants and Restricted Stock
For options that vest based on the Company’s common stock achieving certain performance criteria, the Company values these awards with a binomial model that utilizes various probability factors and other criterion in establishing fair value of the grant. The related compensation cost is recognized over the derived service period determined in the valuation.
From time to time, the Company grants restricted stock awards to non-employee directors and employees under existing plans. The Company recognizes non-cash compensation expense over the various vesting periods.
Stock compensation expense totaled $217 thousand for all awards for the three month period ended December 31, 2013 and totaled $90 thousand for all awards for the three months ended December 31, 2012.
On November 8, 2013, the Management Resources and Compensation Committee (the “Committee”) of the Board of Directors approved for the Company’s named executive officers (the “Executive Officers”) equity awards under the Company’s 2006 Long Term Incentive Plan, as amended (the “2006 Plan”) based upon individual and corporate performance during the fiscal year ended September 30, 2013. The stock options (i) have a ten-year term, (ii) have an exercise price equal to the fair market value of the Company’s common stock as determined pursuant to the 2006 Plan, as reported on NASDAQ, on the date of grant ($1.395), and (iii) vest as follows:
(a) 50% of the options granted will vest at such time as the Company’s common stock has a closing price of at least $3.00 per share for ten consecutive trading days; and
(b) 50% of the options granted will vest on the achievement of certain financial and/or business performance objectives as determined by the Committee for the fiscal year ending September 30, 2014.
9

The options were awarded in the following amounts to the Executive Officers: Mr. Parker was granted 100,000 options and each of Ms. JohnBull, Mr. Armstrong and Mr. Wilson were granted 75,000 options. Further, the Management Resources and Compensation Committee allocated a pool of options for distribution to non-executive employees of the Company, subject to the same terms and pursuant to the recommendations of the executive management team. Accordingly, 42,000 additional options were granted to non-executive employees of the Company.
As further described in Note 9, 175,000 options were awarded in connection with extensions of the employment agreements of certain members of the executive management team.
Warrants are issued from time-to-time to non-employee third parties in order to induce then to enter in certain transactions with the Company. The Company recognizes non-cash expense related to such activity over the estimated period of performance.
Effective as of November 25, 2013, the Company granted an aggregate of 80,000 shares of restricted stock to its non-executive directors, consistent with its compensation policy for non-executive directors. These shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. The shares vested immediately and stock expense of $108,800 was recognized in the three months ended December 31, 2013. Additionally, at December 31, 2013, there were 52,500 shares of unvested restricted stock outstanding from prior year grants to non-executive directors. There is $150,000 of unrecognized expense related to these unvested restricted stock awards.
The stock option activity for the three months ended December 31, 2013 is as follows:

|  | Number of Shares |  | Weighted Average Exercise Price |  | Weighted Average Remaining Contractual Term |  | Aggregate Intrinsic Value
Options outstanding, September 30, 2013 |  | 1,612,500 |  |  | $ | 1.15 |  |  | 7.9 |  | $ | 388,000 |
Granted |  | 605,000 |  |  | $ | 1.35 |  |  |  |  |  |
Options outstanding, December 31, 2013 |  | 2,217,500 |  |  | $ | 1.21 |  |  | 8.4 |  | $ | 792,000 |

At December 31, 2013, there were 462,500 options outstanding that were vested and exercisable and an additional 1,755,000 options outstanding that vest to the recipients when the market value of the Company’s stock achieves and maintains defined levels.
The aggregate intrinsic value in the table above 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.
Changes in Shareholders’ Equity
The following are the changes in Shareholders’ Equity for the three months ended December 31, 2013:
(Amounts in Thousands)
10

|  |  |  |  |  | Additional |  |  |  |  |  |  |  | Total
|  | Common Stock |  | Paid-In |  | Accumulated |  | Treasury Stock |  | Shareholders’
|  | Shares |  | Amount |  | Capital |  | Deficit |  | Shares |  | Amount |  | Equity
BALANCE, September 30, 2013 |  | 9,318 |  |  | $ | 9 |  |  | $ | 75,400 |  |  | $ | (67,601 | ) |  | 2 |  |  | $ | (24 | ) |  | $ | 7,784 |
Director restricted stock grants |  | 80 |  |  |  |  |  | 109 |  |  |  |  |  |  |  |  |  |  |  | 109 |
Expense related to employee stock option grants |  |  |  |  |  |  |  | 108 |  |  |  |  |  |  |  |  |  |  |  | 108 |
Exercise of convertible debenture |  | 168 |  |  |  |  | 210 |  |  |  |  |  |  |  |  | 210 |
Exercise of warrants |  | 54 |  |  |  |  | 113 |  |  |  |  |  |  |  |  | 113 |
Repurchase and cancellation of shares |  | (12 | ) |  |  |  | (14 | ) |  |  |  |  |  |  |  | (14 | )
Repurchase of shares |  | (5 | ) |  |  |  |  |  |  |  | 5 |  |  | (7 | ) |  | (7 | )
Net loss |  |  |  |  |  |  |  |  |  |  | 133 |  |  |  |  |  |  |  |  | 133 |
BALANCE, December 31, 2013 |  | 9,603 |  |  | $ | 9 |  |  | $ | 75,926 |  |  | $ | (67,468 | ) |  | 7 |  |  | $ | (31 | ) |  | $ | 8,436 |

On September 18, 2013, we announced that our Board of Directors authorized a stock repurchase program (the Program) under which we could repurchase up to $350,000 of shares of our common stock through open market transactions in compliance with Securities and Exchange Commission Rule 10b-18, privately negotiated transactions, or other means. This repurchase program does not have an expiration date, and we are not obligated to acquire a particular number of shares. Through December 31, 2013, the Company repurchased an aggregate of 17,275 shares of its common stock pursuant to a trading plan entered into by the Company in September 2013 in accordance with Rules 10b5-1 and 10b-18. The average price for all shares repurchased under the program during the quarter ended December 31, 2013 was $1.20 per share. As of December 31, 2013, there is a total of $329,307 remaining for repurchases under the program
Fair Value of Financial Instruments
The Company has financial instruments, principally accounts receivable, accounts payable, loan payable, notes payable, and accrued expense. Due to the short term nature of these instruments, DLH estimates that the fair value of all financial instruments at December 31, 2013 and September 30, 2013 does not differ materially from the aggregate carrying values of these financial instruments recorded in the accompanying consolidated balance sheets. In addition, the Company has historically presented certain common stock warrants and embedded conversion features associated with Convertible Debentures and accounts for such derivative financial instruments at fair value. As further described in Note 6, those convertible debentures matured and the common stock warrants were exercised in the three months ended December 31, 2013.
Earnings (Loss) Per Share
Basic earnings (loss) per share is calculated by dividing income (loss) 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 (loss) per share is calculated by dividing income (loss) available to common shareholders by the weighted average number of basic common shares outstanding, adjusted to reflect potentially dilutive securities.
The effects of common stock equivalents of 2,182,804 and 1,686,346 are anti-dilutive for the three months ended December 31, 2013 and 2012, respectively.
The following table sets forth the calculation of basic and diluted net income (loss) per share (in thousands, except per
share data):
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|  | Three Months Ended
|  | December 31,
|  | 2013 |  | 2012
Numerator: |  |  |  |
Net income (loss) |  | $ | 133 |  |  | $ | (128 | )
Denominator: |  |  |  |
Denominator for basic net income (loss) per share - weighted-average outstanding shares |  | 9,494 |  |  | 9,286 |
Effect of dilutive securities: |  |  |  |
Stock options and restricted stock |  | 55 |  |  | — |
Denominator for diluted net income (loss) per share - weighted-average outstanding shares |  | 9,549 |  |  | 9,286 |
Net income (loss) per share - basic |  | $ | 0.01 |  |  | $ | (0.01 | )
Net income (loss) per share - diluted |  | $ | 0.01 |  |  | $ | (0.01 | )

(3) COMMITMENTS AND CONTINGENCIES:
Potential Contractual Billing Adjustments
Revenues related to retroactive billings in 2008 from an agency of the Federal government were recognized when: (1) the Company developed and calculated an amount for such prior period services and had a contractual right to bill for such amounts under its arrangements, (2) there were no remaining unfulfilled conditions for approval of such billings and (3) collectibility was reasonably assured based on historical practices with, and contractual requirements of, the DVA. Th e related direct costs, principally comprised of salaries and benefits, were accrued to match the recognized reimbursements from the Federal agency; upon approval, wages will be processed for payment to the employees.
During the year ended September 30, 2008, DLH recognized revenues of $10.8 million and direct costs of 10.1 million related to these non-recurring arrangements. At December 31, 2013 and September 30, 2013, the amount of the remaining accounts receivable with the DVA approximated 9.3 million and accrued liabilities for salaries to employees and related benefits totaled 8.7 million. The 9.3 million in accounts receivable was unbilled to the DVA at December 31, 2013 and September 30, 2013.
In April 2012, the Company received formal contract modifications from the DVA concerning the retroactive billing matter for which revenue was accrued in 2008. The contract modifications from the DVA incorporate relevant wage determinations covering largely 2006 and 2007 applying to the Company’s historical contracts with DVA during those periods. These government modifications initiate the procedures whereby the Company may invoice the DVA in accordance with the modified wage determinations and subsequently make timely retroactive payments to employees (active and inactive) covering work performed at the certain locations. The Company expects to follow the process directed by and in conjunction with the Department of Labor and the DVA in generating these invoices. Although the timing cannot be guaranteed, at present, the Company expects to bill and collect such amounts within the next twelve months.
The Company continues to support the Government’s review of the detailed supporting calculations for the retroactive billings and to negotiate an incremental final amount related to indirect costs and fees applied to these retroactive billings. The additional indirect costs and fees are estimated to be between 0.4 million and 0.6 million. The Company has developed these estimates under the same contractual provisions applied to the sites that were settled in 2008. However, because these amounts remain subject to government review, no assurances can be given that any amounts the Company may receive will be within the range specified above.
Payroll Taxes
From 2006 through 2009, DLH received notices from the Internal Revenue Service (“IRS”) claiming taxes, interest and penalties due related to payroll taxes predominantly from its former PEO operations which were sold in fiscal 2003. DLH also received notices from the IRS reporting overpayments of taxes. Management believes that these notices are predominantly the result of misapplication of payroll tax payments between its legal entities. Until the sale of certain assets related to the former PEO operations, DLH operated through 17 subsidiaries, and management believes that the IRS has not correctly identified payments made through certain of the different entities, therefore leading to the notices. Through the fiscal year ended
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September 30, 2009, DLH worked with the IRS to resolve these discrepancies and had certain interest and penalty claims abated. DLH also received notices from the Social Security Administration claiming variances in wage reporting compared to IRS transcripts. DLH believes the notices from the Social Security Administration are directly related to the IRS notices received. DLH believes it has fully responded to the notices issued. DLH believes that after the IRS applies all the funds correctly, any significant interest and penalties will be abated; however, there can be no assurance that each of these matters will be resolved favorably. In settling various years for specific subsidiaries with the IRS, the Company received refunds for those specific periods; however, as the process of settling and concluding on other periods and subsidiaries is not yet completed, the potential exists for related penalties and interest. The remaining liability ($1.4 million at December 31, 2013 and at September 30, 2013) has been recorded in accrued expenses and other current liabilities and includes estimated accrued penalties and interest totaling approximately $600,000.
The Company believes it has accrued for the entire estimated remaining liability, inclusive of interest and penalties through the date of the financial statements. The Company may incur additional interest and may incur possible additional penalties through the future date that this obligation is settled. However, it is not currently possible to estimate what, if any, additional amount(s) may be due in the future, given the uncertain timing and nature of any future settlement negotiations. No payments were made in fiscal 2013 or year to date in fiscal 2014. Management believes that the ultimate resolution of these remaining payroll tax matters will not have a significant adverse effect on its financial position or future results of operations. The Company’s intention is that it will in due course seek to negotiate a mutually satisfactory payment plan with the IRS, but there is no assurance that it would be successful in doing so and the Company’s future cash flows and liquidity could therefore be materially affected by this matter.
Legal Proceedings
As the Company has previously reported, it was advised of a claim by the U.S. Attorney based on an alleged failure to pay certain classes of employees the prevailing wages as required by the Service Contract Act during the years 2003-2010. On December 12, 2013, the Company was further advised by the U.S. Attorney that, after a review of the merits of the complaint, the U.S. Department of Justice declined to intervene and the claim has been dismissed in its entirety.
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. Other than as reported elsewhere in this report, 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.
(4) PREPAID WORKERS’ COMPENSATION:
As part of the Company’s discontinued PEO operations, DLH had a workers’ compensation program with Zurich American Insurance Company (“Zurich”) which covered the period from March 22, 2002 through November 16, 2003, inclusive. Payments for the policy were made to a trust monthly based on projected claims for the policy period. Interest on all assets held in the trust is credited to DLH. Payments for claims and claims expenses are made from the trust. From time-to-time, trust assets have been refunded to the Company based on Zurich’s overall assessment of claims experience and historical and projected settlements. The final amount of trust funds that could be refunded to the Company is subject to a number of uncertainties (e.g. claim settlements and experience, review by the insurer, health care costs, the extended statutory filing periods for such claims); however, based on a third party’s study of claims experience and after giving effect to agreed-upon adjustments, DLH estimates that at December 31, 2013, the remaining prepaid asset of approximately $0.2 million will be received within the next twelve months.
(5) DEBT:
Loan Facility
On July 29, 2010, DLH Solutions entered into a Loan and Security Agreement (the “Loan Agreement”) with Presidential Financial Corporation (the “Lender”). Under the Loan Agreement, the Lender agreed to provide a two (2) year secured loan facility to DLH Solutions in an aggregate amount of up to $1.5 million, upon the further terms and subject to the conditions of the Loan Agreement. In November, 2010, the Lender agreed by means of an amendment to the Loan Agreement to increase the maximum amount available under the facility from $1.5 million to $2.5 million and on February 9, 2011, we entered into a further amendment to the Loan Agreement pursuant to which the Lender agreed to further increase our maximum availability
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under the Loan Agreement from $2.5 million to $3.0 million and to provide an unbilled receivable facility within the limits of the Loan Agreement. The February 2011 amendment also extended the term of the Loan Agreement by 12 months, to July 29, 2013, which will automatically renew annually unless terminated by either party. During the fiscal year ended September 30, 2013, the Agreement was automatically extended to July 29, 2014.
In May 2012, the Company entered into a further amendment to the Loan Agreement (the “Fifth Amendment”) pursuant to which the Lender agreed to increase the available line of credit from $3,000,000 to a maximum amount of $6,000,000 and to increase the maximum amount available under the unbilled accounts facility of the Loan Agreement from $500,000 to $1,000,000. The Company’s ability to borrow against the increased available credit, however, is subject to the satisfaction of certain conditions. The Fifth Amendment provides for an initial sublimit under the maximum loan amount of $3,000,000 (the “Initial Sublimit”) and an adjusted sublimit of $4,000,000 (the “Adjusted Sublimit”). Pursuant to a letter agreement dated May 21, 2013, the sublimit for maximum amounts available on unbilled accounts was increased from $500,000 to $750,000. The Initial Sublimits will remain in effect until the satisfaction of the following conditions: (i) the repayment of the $500,000 over-advance accommodation agreed to by Lender as of May 9, 2012, (ii) the Company's demonstration of the need for the increase, (iii) the Company's continued compliance with the Loan Agreement, and (iv) Lender, in its sole discretion, agrees to increase the Initial Sublimit. In addition, the increased availability under the unbilled accounts facility of the Loan Agreement is subject to the satisfaction of the same conditions that are applicable to Initial Sublimit. Accordingly, until these conditions are satisfied, the current borrowing limits remain in effect.
DLH Solutions’ ability to request loan advances under the Loan Agreement is subject to (i) computation of DLH Solutions’ advance availability limit based on “eligible accounts receivables” (as defined in the Loan Agreement) multiplied by the “Accounts Advance Rate” established by the Lender which initially shall be 85% and may be increased or decreased by the Lender in exercise of its discretion; and (ii) compliance with the covenants and conditions of the loan. An interest rate premium of 2% is payable in respect of any advances secured by unbilled accounts receivable, which are subject to a sub-facility limit of $750,000 and an advance rate of 75%. The loan is secured by a security interest and lien on all of DLH Solutions’ cash accounts, account deposits, letters of credit and investment property, chattel paper, furniture, fixtures and equipment, instruments, investment property, general intangibles, deposit accounts, inventory, other property, all proceeds and products of the foregoing (including proceeds of any insurance policies and claims against third parties for loss of any of the foregoing) and all books and records related thereto.
In December 2013, the Loan Agreement was further modified to permit letters of credit to be issued under the overall credit facility, subject to availability provided by eligible billed and unbilled accounts receivable and further subject to a limit of $1.03 million.
Under the Loan and Security Agreement, interest accrues at the greater of (a) 3.25% or (b) (i) 1.95% above the Wall Street Journal Prime rate on the accounts receivable portion of the credit line and (ii) 3.95% above the Wall Street Journal Prime rate on the unbilled accounts portion. In addition, DLH Solutions will pay certain other related fees and expense reimbursements including a monthly service charge of 0.65% based on the average daily loan balance which shall accrue daily and be due and payable on the last day of each month so long as the Loan Agreement is outstanding. The interest rate on the Accounts Receivable portion of the loan was 5.2% at both December 31, 2013 and 2012. The interest rate on the Unbilled Accounts portion was 7.2% at both December 31, 2013 and 2012. At December 31, 2013, based on current eligible accounts receivable, the amount of the unused availability under the line was $1.1 million. The amount outstanding as of December 31, 2013 was $0.9 million.
The Loan Agreement requires compliance with customary covenants and contains restrictions on the Company’s ability to engage in certain transactions. Among other matters, under the loan agreement we may not, without consent of the Lender, (i) merge or consolidate with another entity, form any new subsidiary or acquire any interest in a third party; (ii) acquire any assets except in the ordinary course of business; (iii) enter into any transaction outside the ordinary course of business; (iv) sell or transfer collateral; (v) make any loans to, or investments in, any affiliate or enter into any transaction with an affiliate other than on an arms-length basis; (vi) incur any debt outside the ordinary course of business; (vii) pay or declare any dividends or other distributions; or (viii) redeem, retire or purchase any of our equity interests exceeding $50,000. Further, without the consent of the Lender, the Company is also restricted from making any payments in respect of other outstanding indebtedness. The Lender agreed to eliminate the tangible net worth covenant as part of the Fifth Amendment. Either party may terminate the Loan Agreement at any time upon 60 days written notice, and the Loan Agreement provides for customary events of default following which the Lender may, at its option, immediately terminate the loan agreement and accelerate the repayment of any amount outstanding. The defined events of default include, among other things, a material adverse change in the Company's circumstances, or if the Lender deems itself insecure in the ability of the Company to repay its obligations, or as to the sufficiency of the collateral. At present, the Company has not experienced, and the financial institution has not declared, an event of default.
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In consideration of the Lender entering into the Fifth Amendment, we agreed to pay a monthly collateral monitoring fee, a documentation fee and at the time that we may borrow amounts in excess of the Initial Sublimit, an origination fee of 1% of the increased availability.
The Company has concurrently executed a Corporate Guaranty Agreement with Lender pursuant to which it has guaranteed all of the obligations of DLH Solutions under the Loan Agreement.
(6) EQUITY AND CONVERTIBLE DEBENTURES FINANCING:
On June 1, 2011, the Company entered into a debenture purchase agreement (the “Debenture Purchase Agreement”) with entities affiliated with Wynnefield Capital, Inc. (the “Debenture Purchasers”), providing for a standby commitment pursuant to which the Debenture Purchasers agreed to purchase convertible debentures (the “Convertible Debentures”) in an aggregate principal amount of up to $350,000 (the “Total Commitment Amount”). In addition, the Company issued the Debenture Purchasers warrants to purchase an aggregate of 53,846 shares of common stock (the “Warrants”) in consideration of their agreement to provide the Total Commitment Amount. The Debenture Purchasers are entities affiliated with Wynnefield Capital, Inc., the Company’s largest shareholder. Mr. Peter Black, a member of the Company’s Board of Directors, is an employee of Wynnefield Capital. On July 28, 2011, the Company drew down the entire amount of the Total Commitment amount available under the Debenture Purchase Agreement and issued the Convertible Debentures in the aggregate principal amount of $350,000 to the Debenture Purchasers.
The Warrants were exercisable at a price of $0.96 until June 2016 and the conversion rate of the convertible debentures was $1.25. In October 2013, Wynnefield Partners Small Cap Value, L.P. I, the holder of a principal amount of $210,000 of convertible debentures elected to convert such debentures in full into 168,000 shares of common stock. The $140,000 balance of the convertible debentures plus accrued interest was paid at maturity on October 28, 2013. In addition, in October 2013, the holders of the Warrants exercised such Warrants in full for 53,846 shares of common stock. A non-recurring gain of $119 thousand was recognized related to the closure of the convertible debt. Additionally, expense of $20 thousand was recorded in the three months ended December 31, 2013, related to fair valuation of the warrants. The accrued liability of $61 thousand with respect to the fair value of the warrants was reflected as additional paid in capital upon their exercise. The shares of the Company’s common stock s issued upon conversion of the debentures were issued in reliance on the exemption from registration provided by Section 3(a)(9) of the Securities Act of 1933, as amended. The shares of the Company’s common stock s issued upon exercise of the Warrants were issued in reliance on the exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933, as amended.
On March 16, 2012, the Company filed a registration statement on Form S-1 with the Securities and Exchange Commission for a rights offering in which existing stockholders of the Company received non-transferable rights to purchase $4.2 million of additional shares of its common stock. Under the terms of the rights offering, the Company distributed, at no charge to the holders of its common stock as of the record date of April 10, 2012, non- transferable subscription rights for each share of common stock owned on the record date. Each subscription right entitled the holder to purchase 0.532 shares of the Company’s common stock at a price of $1.30 per share. The rights offering also includes an over-subscription privilege, which entitled a holder who exercises its basic subscription privilege in full the right to purchase additional shares of common stock that remain unsubscribed at the expiration of the rights offering, subject to the availability and pro rata allocation of shares among persons exercising this over-subscription right.
In connection with the rights offering, on April 30, 2012, the Company entered into a standby purchase agreement with Wynnefield Capital, Inc. (“Wynnefield Capital”), which owned, prior to the rights offering, approximately 21% of the Company’s Common Stock through certain affiliated entities. Pursuant to the standby purchase agreement, Wynnefield Capital (or affiliated assignees) agreed to acquire from us in the rights offering, subject to the satisfactions of specified conditions, the shares of common stock that relate to any rights that remain unexercised at the expiration of the rights offering. We entered into a registration rights agreement with Wynnefield Capital whereby we agreed, at our cost and expense, to register for resale under the Securities Act of 1933, all shares of common stock beneficially owned by Wynnefield Capital, including shares purchased by Wynnefield Capital in the rights offering as well as shares potentially received upon exercise of the conversion feature of the Convertible Debt and upon exercise of the associated warrants. This registration statement was declared effective by the SEC in January 2013.
The Company completed the closing of the rights offering on June 15, 2012 and raised gross proceeds of $4.2 million from the sale of 3,230,769 shares of its common stock. As a result, the total number of shares of the Company’s common stock
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outstanding increased to 9,305,702 shares. Officers and directors purchased an aggregate of 137,678 shares in the rights offering and entities affiliated with Wynnefield Capital purchased a total of 2,840,251 shares of our common stock.
(7) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS AFFECTING THE COMPANY:
In December 2011, the FASB amended disclosure concerning offsetting assets and liabilities. The amendments in the update requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. In January 2013, the FASB issued clarifying guidance related to the amended disclosure requirements concerning offsetting assets and liabilities which had previously been issued in December 2011. The guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this guidance did not have a material effect on the financial statements.
In October 2012, the FASB issued technical corrections and improvements, which include revisions to prior guidance on numerous topics, including Convertible Debentures. The effective date of these revisions is for fiscal years beginning after December 15, 2012. The adoption of this guidance did not have a material effect on the financial statements.
In February 2013, the FASB amended its guidance related to the reporting of amounts reclassified out of accumulated other comprehensive income. The amendments are effective prospectively for reporting periods beginning after December 15, 2012. The adoption of this guidance did not have a material effect on the financial statements.
In July 2013, the FASB updated its guidance with respect to the presentation of unrecognized tax benefits. The guidance is effective for reporting periods beginning after December 15, 2013, with early adoption permitted. The Company has consistently reported in compliance with this updated guidance.
(8) ECONOMIC DEPENDENCY:
A major customer is defined as a customer from whom the Company derives at least 10% of its revenues. In each of the fiscal quarters ended December 31, 2013 and 2012, revenue from the U.S. Government accounted, either directly or indirectly, for 100% of the Company’s total revenue. Within the U.S. Government, our largest customer in the fiscal quarter ended December 31, 2013 continued to be the DVA, accounting for 97% and 96% of revenue in the fiscal quarters ended December 31, 2013 and 2012, respectively, and with whom the Company held over a dozen contracts and/or task orders for logistics, pharmaceutical, and medical services, all subject to the Federal Acquisition Regulations. Accordingly, DLH remains particularly dependent on the continuation of its relationship with the DVA.
(9) EMPLOYMENT AGREEMENTS:
From time to time, we enter into employment agreements with certain key executives which provide for fixed compensation, criterion for earning bonuses and other incentives and, in certain instances, issuance of share based equity grants. These agreements generally continue until terminated by the employee or the Board of Directors or, upon the occurrence of defined certain events or circumstances (including a defined change in control), and provide for salary continuance for specified periods of generally no more than a year and or lump sum payments in the event of a change of control of up to 150% of annual salary.
On October 1, 2013, the Company entered into a new employment agreement with Kevin Wilson, who serves as the President of the Company’s wholly-owned subsidiary DLH Solutions, Inc. The new employment agreement with Mr. Wilson is effective as of October 1, 2013 and will expire September 30, 2015, the terms of which are summarized below. The following description of the amendment agreement is qualified in its entirety by reference to the full text of such agreement.
Mr. Wilson will continue to serve as the President of DLH Solutions, Inc., a wholly-owned subsidiary of DLH. Under the employment agreement, Mr. Wilson will receive a base salary of $210,000 per annum. Mr. Wilson may receive an annual bonus of up to 50% of base salary based on performance targets and other key objectives established by the Management Resources and Compensation Committee of the board of directors. Target bonus will be adjusted by 2% of base salary for every 1% of variance between targets and actual results and no bonus will be awarded if results are less than 90% of target and no bonus will exceed 70% of base salary.
In addition, the Company granted Mr. Wilson options to purchase 100,000 shares of common stock under the Company's 2006 Long Term Incentive Plan, as amended. The options shall vest as follows: 50,000 options vest on the commencement date of the agreement and 50,000 options shall vest on the one year anniversary of the commencement date, provided Mr. Wilson
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remains in the employment of the Company as of such vesting date. The options, to the extent vested, shall be exercisable for a period of ten years at the per share exercise price equal to the fair market value of the Company’s common stock, as determined pursuant to the 2006 Plan, on the date his employment agreement was executed.
On November 29, 2013, the Company entered into a new employment agreement with John F. Armstrong, who serves as the Company’s Executive Vice President. The new employment agreement with Mr. Armstrong is effective as of December 1, 2013 and will expire November 30, 2015. The following description of the amendment agreement is qualified in its entirety by reference to the full text of such agreement.
Mr. Armstrong will continue to serve as DLH’s Executive Vice President for business development of the Company. Under the employment agreement, Mr. Armstrong will receive a base salary of $215,000 per annum. Mr. Armstrong will be entitled to a 5% increase in his base salary in the event that the Company achieves the business development-related performance condition specified in the agreement. Mr. Armstrong may receive an annual bonus of up to 50% of base salary based on performance targets and other key objectives established by the Management Resources and Compensation Committee of the board of directors. Target bonus will be adjusted by 2% of base salary for every 1% of variance between targets and actual results and no bonus will be awarded if results are less than 90% of target and no bonus will exceed 70% of base salary.
In addition, the Company granted Mr. Armstrong options to purchase 75,000 shares of common stock under our 2006 Long Term Incentive Plan (the “2006 Plan”). The options shall vest as follows: 37,500 options vest on the one year anniversary of the commencement date and 37,500 options shall vest if the closing price of the Company’s common stock equals or exceeds $3.00 per share for ten consecutive trading days, provided Mr. Armstrong remains in the employment of the Company as of such vesting dates. The options, to the extent vested, shall be exercisable for a period of ten years at the per share exercise price equal to the fair market value of the Company’s common stock, as determined pursuant to the 2006 Plan, on the date his employment agreement was executed.
(10) SUBSEQUENT EVENTS:
Management has evaluated subsequent events through the date that the Company's financial statements were issued. Based on this evaluation, the Company has determined that no subsequent events have occurred which require disclosure through the date that these financial statements were issued.
ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward Looking and Cautionary Statements
This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “1995 Reform Act”), Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). DLH desires to avail itself of certain “safe harbor” provisions of the 1995 Reform Act and is therefore including this special note to enable DLH to do so. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may” and other similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements included in this report involve known and unknown risks, uncertainties and other factors which could cause DLH’s actual results, performance (financial or operating) or achievements to differ from the future results, performance (financial or operating) or achievements expressed or implied by such forward-looking statements. We based these forward-looking statements on our current expectations and best estimates and projections about future events. Our actual results could differ materially from those discussed in, or implied by, these forward-looking statements. The following factors (among others) could cause our actual results to differ materially from those implied by the forward-looking statements in this report: our ability to secure contract awards, including the ability to secure renewals of contracts under which we currently provide services; our ability to enter into contracts with United States Government facilities and agencies on terms
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attractive to us and to secure orders related to those contracts; changes in the timing of orders for and our placement of professionals and administrative staff; the overall level of demand for the services we provide; the variation in pricing of the contracts under which we place professionals; our ability to manage growth effectively; the performance of our management information and communication systems; the effect of existing or future government legislation and regulation; changes in government and customer priorities and requirements (including changes to respond to the priorities of Congress and the Administration, budgetary constraints, and cost-cutting initiatives, such as the implementation of spending cuts (sequestration) under the Budget Control Act of 2011); economic, business and political conditions domestically (including the impact of uncertainty regarding U.S. debt limits and actions taken related thereto); government contract procurement (such as bid protest, small business set asides, loss of work due to organizational conflicts of interest, etc.) and termination risks; the results of government audits and reviews; the impact of medical malpractice and other claims asserted against us; the disruption or adverse impact to our business as a result of a terrorist attack; the loss of key officers, and management personnel; the competitive environment for our services; the effect of recognition by us of an impairment to goodwill and intangible assets; other tax and regulatory issues and developments; the effect of adjustments by us to accruals for self-insured retentions; our ability to obtain any needed financing; our ability to attract and retain sales and operational personnel; and the effect of other events and important factors disclosed previously and from time to time in DLH’s filings with the U.S. Securities and Exchange Commission. Other factors that could cause actual results to differ from those implied by the forward-looking statements in this Quarterly Report on Form 10-Q are set forth in our Annual Report on Form 10-K for the year ended September 30, 2013, and our other reports filed with the SEC, including this Quarterly Report on Form 10-Q. In light of the significant risks and uncertainties inherent in the forward looking statements included in the Company’s reports, the inclusion of such statements should not be regarded as a representation by or on behalf of the Company that the objectives and plans of the Company will be achieved and you are cautioned not to place undue reliance on forward-looking statements. We undertake no obligation to update any forward-looking statement or statements in this filing to reflect events or circumstances that occur after the date on which the statement is made or to reflect the occurrence of unanticipated events.
Critical Accounting Policies and Estimates
Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from such estimates. These estimates and assumptions are affected by the application of our accounting policies. Critical policies and practices are both most important to the portrayal of a company’s financial condition and results of operations, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain. See Note 2, page F-8 of DLH’s 2013 Annual Report on Form 10-K for the year ended September 30, 2013, as well as “Critical Accounting Policies and Estimates” beginning on page 21 therein for a discussion of our critical accounting policies and estimates. We continually review these estimates and their underlying assumptions to ensure they are appropriate for the circumstances. Changes in the estimates and assumptions we use could have a significant impact on our financial results. We consider the following policies and estimates to be the most critical in understanding the more complex judgments that are involved in preparing our consolidated financial statements and that could impact our results of operations, financial position, and cash flows:
Revenue Recognition
DLH’s revenue is derived from professional and other specialized service offerings to US Government agencies through a variety of contracts, some of which are fixed-price in nature and/or sourced through Federal Supply Schedules administered by the General Services Administration (“GSA”) at fixed unit rates or hourly arrangements. We generally operate as a prime contractor, but have also entered into contracts as a subcontractor. The recognition of revenue from fixed rates is based upon objective criteria that generally do not require significant estimates that may change over time. DLH recognizes and records revenue on government contracts when it is realized, or realizable, and earned. DLH considers these requirements met when: (a) persuasive evidence of an arrangement exists; (b) the services have been delivered to the customer; (c) the sales price is fixed or determinable and free of contingencies or significant uncertainties; and (d) collectibility is reasonably assured.
Goodwill
In accordance with applicable accounting standards, DLH reviews its goodwill 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. At September 30, 2013, we performed a goodwill impairment evaluation. We performed both a qualitative and quantitative 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, 2013. Additional impairment analyses at future dates may be performed to determine if indicators
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of impairment are present, and if so, such amount will be determined and the associated charge will be recorded to the consolidated statement of operations.
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. For the three months ended December 31. 2013, the Company determined that no change in business conditions occurred which would have a material adverse effect on the valuation of goodwill. If an impairment write off of all the goodwill became necessary in future periods, a charge of up to $8.6 million would be expensed in the Consolidated Statement of Operations. All remaining goodwill is attributable to the DLH Solutions operating subsidiary.
Income Taxes
DLH 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. At December 31, 2013 and December 31, 2012, the Company recorded a 100% valuation allowance against its net deferred tax assets.
The Financial Accounting Standards Board (“FASB”) has issued authoritative guidance that clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements and prescribes a recognition threshold of more-likely-than-not to be sustained upon examination. Measurement of the tax uncertainty occurs if the recognition threshold has been met. This interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods and disclosures. The Company conducts business solely in the U.S. and, as a result, also files income taxes in various states and other jurisdictions. Given the substantial net operating losses and the related valuation allowance established against such amounts, the Company has concluded that it does not have any uncertain tax positions. There have been no income tax related interest or penalties for the periods presented in these consolidated financial statements. In the normal course of business, the Company and its subsidiaries are subject to examination by Federal and state taxing authorities. The Company’s income tax returns for years subsequent to fiscal 2010 are currently open, by statute, for review by authorities. However, there are currently no examinations in progress and the Company is not aware of any pending audits.
Overview
Business Description
DLH, Holdings Corp., incorporated in New Jersey, provides healthcare delivery solutions, logistics & technical services, and contingency/staff augmentation services to government agencies including the Department of Veteran Affairs, the Department of Defense, and other clients. The Company principally operates through its wholly-owned subsidiary DLH Solutions, Inc. ("DLH Solutions") and is headquartered in Atlanta, Georgia.
Business Units
As part of our overall strategic planning process, the Company realigned its business into three broad integrated business areas: Healthcare Delivery Solutions, Logistics & Technical Services, and Contingency/Staff Augmentation. This structure enables us to leverage our core competencies and drive towards profitable growth within our focused target markets. We recognize that some business units may grow faster than others as a result of acquisitions or disposition of business. In either case, we intend to enhance our delivery of quality products and services.
Healthcare Delivery Solutions
The Healthcare Delivery Solutions business unit provides a broad continuum of care for our nation's servicemen/women and veterans in various settings and facilities. These include Combat Trauma Centers (CTCs), Military Treatment Facilities (MTFs), Medical Centers, Community-based Outpatient Clinics (CBOCs), and Pharmacy Distribution Centers (including VA Consolidated Mail-order Outpatient Pharmacy). We leverage our network of over 400 active clinicians and other healthcare workers throughout selected regions in the US, applying differentiating tools, databases and technology (including e-PRAT and SPOT-m) to deliver these services. For over a decade, DLH Solutions has been serving the DVA and DoD in providing qualified medical and other professionals in a variety of positions. Healthcare Delivery Solutions is one of our strategic focus areas for growth and a major business area that DLH Solutions services. As more and more Federal and DoD programs increase their performance-based requirements, DLH Solutions' workforce profile of medical talent and credentials (as described above) will help it to compete and differentiate itself in the market place. Our healthcare and medical service new business pipeline
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adds important credentials strategically linked to diversifying and profitably growing our Healthcare Delivery Solutions business base. Professional services have included case management, health and injury assessment, critical care, medical/surgical, emergency room/trauma center, counseling, behavioral health and traumatic brain injury management, medical systems analysis, and medical logistics. While the DVA is its largest customer in this business unit, the Company has focused on leveraging that experience in adjacent healthcare markets within DoD and other federal agencies. For the fiscal year ended September 30, 2013 and the three months ended December 31, 2013, approximately 54% and 53% of our revenue, respectively, was derived from the Healthcare Delivery Solutions business unit.
Logistics & Technical Services
The Logistics & Technical Services business unit draws heavily upon our proven logistics expertise and processes. DLH resources possess expertise covering a wide range of logistics, readiness and project engineering. The experience of DLH Solutions' project personnel is diverse from operational unit level to systems and program office experience. Our core competencies include; supply chain management, performance-based logistics, distribution center and inventory management, statistical process control, packaging/handling/storage & transportation, configuration management, readiness planning, and supply support operations. In addition, we provide program and project management, systems engineering and applicable information technology services, integrated logistics support (including operational systems), readiness assessments, training, equipment maintenance, hazardous material management, facilities and shipyard support services and more. DLH Solutions also provides professional staff to the federal government specializing in logistics, office administration, IT, and facilities/warehouse management.
Through competitively awarded contracts and task orders (including its LOGWORLD contract) DLH Solutions has developed a strong portfolio of logistics processes, personnel and tools to help its clients achieve nationally recognized awards for customer satisfaction. While the DVA is its largest customer in this area, the Company has taken steps to expand in adjacent logistics markets within DoD and other federal agencies. For the fiscal year ended September 30, 2013 and the three months ended December 31, 2013, approximately 45% and 46% of our revenue, respectively, was derived from the Logistics & Technical Services business unit.
Contingency/Staff Augmentation
The Contingency/Staff Augmentation business unit provides disaster and emergency response services and civilian workforce augmentation services. General staffing and selective recruitment process outsourcing are key components of this service area. For both the fiscal year ended September 30, 2013 and the three months ended December 31, 2013, less than 1% of revenue was derived from the Contingency/Staff Augmentation line of service.
Recent Business Trends
The overall Federal government market today continues to be best characterized as "uncertain". This uncertainty has caused both the market and some of our prospective competitors to revisit their strategies with regard to this space. Headlines have been dominated by sequestration, deficit reduction, budget cuts, the debt ceiling, and the like. Nonetheless, DLH continues to see strong bipartisan and Pentagon support for our strategic addressable markets within the DoD and Department of Veterans Affairs. We do not expect significant impacts from sequestration or federal budget cuts to our existing contracts with the Department of Veterans Affairs or the Department of Defense. In addition, we continue to target programs and agencies that we believe are likely to maintain a large addressable long-term market. From an overall budget perspective, it remains likely that government discretionary spending will be constrained for several years to come. The budget agreement reached by the House and Senate in December 2013 provided measured relief from sequestration impacts and precluded the use of continuing resolutions to fund government programs, as has been the recent practice. Nonetheless, substantial budgetary challenges remain for the industry. Although specific funding priorities are subject to change from year to year, we believe that our strategic business alignment around selected military and veterans healthcare & health IT and logistics sustainment services allows us to remain well-placed to expand within what we consider to be top national priority programs and budget areas.
As with other companies operating in the Federal government market, the possibility remains that one or more of our targeted programs could be cut back or terminated as a result of the budget deficit negotiations. Among the marketplace factors that could impact our future results are:

• | federal government budget deficits and the growing U.S. national debt increasing pressure on the U.S. government to reduce federal spending across all federal agencies together with associated uncertainty about the size and timing of those reductions;

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• | cost cutting and efficiency initiatives, current and future budget reductions, continued implementation of Congressionally mandated automatic spending cuts, and other efforts to reduce U.S. government spending, which could cause clients to reduce or delay funding for orders for services;

• | shift to greater use of lowest priced technically acceptable contracting award approaches by governmental agencies resulting in greater pressure on margins;

• | current and continued uncertainty around the timing, extent and nature of Congressional and other U.S. government action to address budgetary constraints; and

• | changes in the relative mix of overall U.S. government spending and areas of spending growth, with lower spending on homeland security, intelligence and defense-related programs as overseas operations end, and continued increased spending on cyber-security, advanced analytics, technology integration and healthcare.

Results of Operations
The following table summarizes, for the periods indicated, selected consolidated statements of operations data expressed as a percentage of revenue:

|  | For the Three Months Ended
|  | December 31, |  | December 31,
Condensed Consolidated Statement of Operations: |  | 2013 |  | 2012
Revenues |  | 100.0 | % |  | 100.0 | %
Direct expenses |  | 85.4 | % |  | 86.2 | %
Gross profit |  | 14.6 | % |  | 13.8 | %
General and administrative |  | 14.0 | % |  | 14.2 | %
Depreciation and amortization expense |  | 0.2 | % |  | 0.3 | %
Income (loss) from operations |  | 0.4 | % |  | (0.7 | )%
Other income (expense) |  | 0.5 | % |  | (0.3 | )%
Income (loss) before income taxes |  | 0.9 | % |  | (1.0 | )%
Income tax expense |  | — | % |  | — | %
Net income (loss) |  | 0.9 | % |  | (1.0 | )%

Revenues
Revenues for the three months ended December 31, 2013 and 2012 were $14.5 million and $13.0 million, respectively, which represents an increase of $1.5 million or 11.4% despite extended government delays in major awards. The increase in revenue is due primarily to new business awarded in 2013 and expansion on current programs.
Direct Expenses
Direct expenses are generally comprised of direct labor (including benefits), direct material, subcontracts, and other direct costs. Direct expenses for the three months ended December 31, 2013 and 2012 were $12.4 million and $11.2 million, respectively, which represent an increase of $1.2 million or 10.3% on higher revenue. As a percentage of revenue, direct expenses for the 2013 and 2012 periods were 85.4% and 86.2%, respectively, with the improvement attributable to favorable contract performance and cost management.
Gross Profit
Gross profit for the three months ended December 31, 2013 and 2012 was $2.1 million and $1.8 million, respectively, which represents an increase of $0.3 million or 18.1%. As a percentage of revenue, gross profit was 14.6% and 13.8%, for the three months ended December 31, 2013 and 2012, respectively. The gross profit rate benefited from new business awarded in 2013 and improved contract performance and cost management.
General and Administrative Expenses
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General and administrative (“G&A”) expenses primarily relate to functions such as operations overhead, corporate management, legal, finance, accounting, contracts administration, human resources, management information systems, and business development.
G&A expenses for the three months ended December 31, 2013 and 2012 were $2.0 million and $1.8 million, respectively, an increase of $0.2 million or 9.2%. Non-cash stock option expense was a significant contributor to the increase in G&A expenses, as those costs were $0.2 million and $0.1 million for the three months ended December 31, 2013 and 2012, respectively.
As a percent of revenue, G&A expenses were 14.0% and 14.2% for the three months ended December 31, 2013 and 2012, respectively.
Depreciation and Amortization
Depreciation and amortization expense was approximately $26 thousand and $33 thousand for the three months ended December 31, 2013 and 2012, respectively.
Income (Loss) from Operations
Income from operations for the three months ended December 31, 2013 was approximately $66 thousand as compared to loss from operations for the three months ended December 31, 2012 of approximately $(94) thousand. The improvement in income from operations results from improved gross profit described above.
Other Income (Expense)
Other income (expense), net was $67 thousand for the three months ended December 31, 2013 as compared to $(34) thousand for the three months ended December 31, 2012. The improvement is due principally to a gain recognized on the maturity of the derivative financial instruments associated with our convertible debentures.
Income Tax
The Company provided a 100% deferred tax valuation allowance because it believes that it cannot be considered more likely than not that it will be able to realize a benefit from its deferred tax asset. The Company determined that negative evidence, including historic and current taxable losses, as well as uncertainties related to the ability to utilize certain Federal and state net loss carry forwards, outweighed any objectively verifiable positive factors, and as such, concluded that a valuation allowance was necessary. In assessing the need for a valuation allowance, the Company historically has considered all positive and negative evidence, including scheduled reversals of deferred tax liabilities, prudent and feasible tax planning strategies and recent financial performance. In the three months ended December 31, 2013 and 2012, the Company recognized no tax expense.
Net Income (Loss)
Net income for the three months ended December 31, 2013 was $133 thousand, or $0.01 per basic and diluted share, as compared to net loss of $(128) thousand or $(0.01) per basic and diluted share for the three months ended December 31, 2012. This improvement is due principally to increased gross profit as described in the preceding paragraphs.
Other Data
Earnings (Loss) Before Interest Tax Depreciation and Amortization (“EBITDA”) adjusted for other non-cash charges (“Adjusted EBITDA”(1)) for the three months ended December 31, 2013 was $309 thousand as compared to $29 thousand for the three months ended December 31, 2012, due principally to the increased gross profit described above.
(1) We present Adjusted EBITDA as a supplemental non-GAAP measure of our performance. We define Adjusted EBITDA as net income (loss) plus (i) interest and other expenses, net, (ii) provision for or benefit from income taxes, if any, (iii) depreciation and amortization, and (iv) G&A expenses — equity grants. This non-GAAP measure of our performance is used by management to conduct and evaluate its business during its regular review of operating results for the periods presented. Management and the Company’s Board utilize this non-GAAP measure to make decisions about the use of the Company’s resources, analyze performance between periods, develop internal projections and measure management performance. We believe that this non-GAAP measure is useful to investors in evaluating the Company’s ongoing operating
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and financial results and understanding how such results compare with the Company’s historical performance. By providing this non-GAAP measure, as a supplement to GAAP information, we believe we are enhancing investors’ understanding of our business and our results of operations. This non-GAAP financial measure is limited in its usefulness and should be considered in addition to, and not in lieu of, US GAAP financial measures. Further, this non-GAAP measure may be unique to the Company, as it may be different from the definition of non-GAAP measures used by other companies. A reconciliation of Adjusted EBITDA with net loss from continuing operations is as follows:

|  | For the three months ended December 31,
|  | 2013 |  | 2012
Net income (loss) |  | $ | 133 |  |  | $ | (128 | )
(i) Interest and other (income) expenses, net |  | (67 | ) |  | 34 |
(ii) Provision for taxes |  | — |  |  | — |
(iii) Depreciation and amortization |  | 26 |  |  | 33 |
(iv) G&A expenses — equity grants |  | 217 |  |  | 90 |
EBITDA adjusted for other non-cash charges |  | $ | 309 |  |  | $ | 29 |

Potential Contractual Billing Adjustments
Revenues related to retroactive billings in 2008 from an agency of the Federal government were recognized when: (1) the Company developed and calculated an amount for such prior period services and had a contractual right to bill for such amounts under its arrangements, (2) there were no remaining unfulfilled conditions for approval of such billings and (3) collectibility was reasonably assured based on historical practices with, and contractual requirements of, the DVA. The related direct costs, principally comprised of salaries and benefits, were accrued to match the recognized reimbursements from the Federal agency; upon approval, wages will be processed for payment to the employees.
During the year ended September 30, 2008, DLH recognized revenues of $10.8 million and direct costs of 10.1 million related to these non-recurring arrangements. At December 31, 2013 and September 30, 2013, the amount of the remaining accounts receivable with the DVA approximated 9.3 million and accrued liabilities for salaries to employees and related benefits totaled 8.7 million. The 9.3 million in accounts receivable was unbilled to the DVA at December 31, 2013 and September 30, 2013.
In April 2012, the Company received formal contract modifications from the DVA concerning the retroactive billing matter for which revenue was accrued in 2008. The contract modifications from the DVA incorporate relevant wage determinations covering largely 2006 and 2007 applying to the Company’s historical contracts with DVA during those periods. These government modifications initiate the procedures whereby the Company may invoice the DVA in accordance with the modified wage determinations and subsequently make timely retroactive payments to employees (active and inactive) covering work performed at the certain locations. The Company expects to follow the process directed by and in conjunction with the Department of Labor and the DVA in generating these invoices. Although the timing cannot be guaranteed, at present, the Company expects to bill and collect such amounts within the next twelve months.
The Company continues to support the Government’s review of the detailed supporting calculations for the retroactive billings and to negotiate an incremental final amount related to indirect costs and fees applied to these retroactive billings. The additional indirect costs and fees are estimated to be between 0.4 million and 0.6 million. The Company has developed these estimates under the same contractual provisions applied to the sites that were settled in 2008. However, because these amounts remain subject to government review, no assurances can be given that any amounts the Company may receive will be within the range specified above.
Liquidity and Capital Resources; Commitments
Liquidity
In recent years, the Company has sought to finance its operations and capital expenditures through the sale of equity securities, convertible notes and more recently, through the receipt of approximately $4.2 million in proceeds from a rights offering. The Company's immediate sources of liquidity include cash and cash equivalents, accounts receivable, unbilled receivables and access to its asset-based credit facility with Presidential Financial Corporation. As described in greater detail below, presently, this credit facility provides us with access of up $3,000,000, with the ability for it to increase to $6,000,000, subject to certain conditions. The Company's operating liabilities are largely predictable and consist of vendor and payroll
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related obligations. The Company's operations require substantial working capital to fund the future growth of its business model with expanded business development efforts, and planned capital expenditures to support a larger customer base.
Certain entities affiliated with Wynnefield Capital, Inc., the Company’s largest stockholder, owned warrants to purchase 53,846 shares of common stock and an aggregate principal amount of $350,000 of convertible debentures, which were due October 28, 2013. The Warrants were exercisable at a price of $0.96 until June 2016 and the conversion rate of the convertible debentures was $1.25. On October 28, 2013, $350,000 of outstanding convertible debentures held by affiliates of Wynnefield Capital, Inc. became due and upon maturity, the principal amount of $210,000 of convertible debentures was converted into 168,000 shares of common stock and the principal amount of $140,000 on the remaining debenture was repaid in full. In addition, in October 2013, the holders of the Warrants exercised such Warrants in full for 53,846 shares of common stock. The shares of the Company’s common stock s issued upon conversion of the debentures were issued in reliance on the exemption from registration provided by Section 3(a)(9) of the Securities Act of 1933, as amended. The shares of the Company’s common stock s issued upon exercise of the Warrants were issued in reliance on the exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933, as amended.
For the three months ended December 31, 2013, the Company generated operating income of $66 thousand and net income of approximately $133 thousand. At December 31, 2013, the Company had $2.6 million in available cash and cash equivalents, $1.1 million loan available on its line of credit, and $0.9 million loan payable on the same line of credit. The Company anticipates that it will continue to rely on operating cash flow and periodic funding, to the extent available from its line of credit, to sustain the operations of the Company. At December 31, 2013, the Company had a net working capital deficit of approximately $0.3 million and an accumulated deficit of approximately $67.5 million.
Management believes, at present, that: (a) cash and cash equivalents of approximately $2.6 million as of December 31, 2013; (b) the amounts available under its line of credit (which is limited to the amount of eligible assets); (c) forecasted operating cash flow; (d) certain liabilities not expected to be settled in cash (see Note 3) in fiscal 2014; and (e) effects of cost reduction programs and initiatives should be sufficient to support the Company's operations for twelve months from the date of these financial statements. However, should any of the above- referenced factors not occur substantially as currently expected, there could be a material adverse effect on the Company's ability to access the level of liquidity necessary for it to sustain operations at current levels for the next twelve months. In such an event, management may be forced to make further reductions in spending or seek additional sources of capital to support our operations. If the Company raises additional funds by selling shares of common stock or convertible securities, the ownership of its existing shareholders would be diluted.
Presently, the Company derives all of its revenue from agencies of the Federal government. For the fiscal year ended September 30, 2013 and for the three months ended December 31, 2013, the Company derived approximately 96% and 97%, respectively, of its revenue from various contracts awarded by the DVA, the substantial majority of which relate to our provision of healthcare and logistics services to the DVA Consolidated Mail Outpatient Pharmacy (CMOP) program. As of December 31, 2013, these awards from the DVA have anticipated periods of performance ranging from approximately three to up to five years. These agreements are subject to the Federal Acquisition Regulations, and there can be no assurance as to the actual amount of services that the Company will ultimately provide to the DVA under these awards. The Company's results of operations, cash flows and financial condition would be materially adversely affected in the event that we are unable to continue our relationships with the DVA.
Repurchase Program
On September 18, 2013, we announced that our Board of Directors authorized a stock repurchase program (the Program) under which we could repurchase up to $350,000 of shares of our common stock through open market transactions in compliance with Securities and Exchange Commission Rule 10b-18, privately negotiated transactions, or other means. During the fiscal quarter ended December 31, 2013, the Company repurchased a total of 17,275 shares of its common stock pursuant to a trading plan entered into by the Company in September 2013 in accordance with Rules 10b5-1 and 10b-18. The average price for all shares repurchased under the program to date was $1.20 per share. As of December 31, 2013, there is a total of $329,307 remaining for repurchases under the program.
Cash from operating activities
Net cash used for operating activities for the three months ended December 31, 2013 was $(702) thousand. The net cash provided by operating activities for the three months ended December 31, 2012 was $731 thousand. The change in cash flow from operations is a function of the timing of collections on our largest contracts at quarter end. For all periods presented, collections on accounts receivable were within terms of the contracts.
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Cash from investing activities
Net cash used in investing activities for the three months ended December 31, 2013 and 2012 was $(6) thousand and $(9) thousand, respectively.
Cash from financing activities
Net cash used in financing activities for the three months ended December 31, 2013 and 2012 was $(134) thousand and $(572) thousand, respectively.
Loan Facility
On July 29, 2010, DLH Solutions entered into a Loan and Security Agreement (the "Loan Agreement") with Presidential Financial Corporation (the "Lender"). Under the Loan Agreement, the Lender agreed to provide a two (2) year secured loan facility to DLH Solutions in an aggregate amount of up to $1.5 million, upon the further terms and subject to the conditions of the Loan Agreement. In November, 2010, the Lender agreed by means of an amendment to the Loan Agreement to increase the maximum amount available under the facility from $1.5 million to $2.5 million and on February 9, 2011, we entered into a further amendment to the Loan Agreement pursuant to which the Lender agreed to further increase our maximum availability under the Loan Agreement from $2.5 million to $3.0 million and to provide an unbilled receivable facility within the limits of the Loan Agreement. The February 2011 amendment also extended the initial term of the Loan Agreement by 12 months, to July 29, 2013, which will automatically renew annually unless terminated by either party. During the fiscal year ended September 30, 2013, the Agreement was automatically extended to July 29, 2014.
In May 2012, the Company entered into a further amendment to the Loan Agreement (the "Fifth Amendment") pursuant to which the Lender agreed to increase the available line of credit from $3,000,000 to a maximum amount of $6,000,000 and to increase the maximum amount available under the unbilled accounts facility of the Loan Agreement from $500,000 to $1,000,000. The Company's ability to borrow against the increased available credit, however, is subject to the satisfaction of certain conditions. The Fifth Amendment provides for an initial sublimit under the maximum loan amount of $3,000,000 (the "Initial Sublimit") and an adjusted sublimit of $4,000,000 (the "Adjusted Sublimit"). Pursuant to a letter agreement dated May 21, 2013, the sublimit for the maximum amount available on unbilled accounts was increased from $500,000 to $750,000. The Initial Sublimits will remain in effect until the satisfaction of the following conditions: (i) the repayment of the $500,000 over-advance accommodation agreed to by Lender as of May 9, 2012, (ii) the Company's demonstration of the need for the increase, (iii) the Company's continued compliance with the Loan Agreement, and (iv) Lender, in its sole discretion, agrees to increase the Initial Sublimit. In addition, the increased availability under the unbilled accounts facility of the Loan Agreement is subject to the satisfaction of the same conditions that are applicable to Initial Sublimit. Accordingly, until these conditions are satisfied, the current borrowing limits remain in effect.
DLH Solutions' ability to request loan advances under the Loan Agreement is subject to (i) computation of DLH Solutions' advance availability limit based on "eligible accounts receivable" (as defined in the Loan Agreement) multiplied by the "Accounts Advance Rate" established by the Lender which initially shall be 85% and may be increased or decreased by the Lender in exercise of its discretion; and (ii) compliance with the covenants and conditions of the loan. An interest rate premium of 2% is payable in respect of any advances secured by unbilled accounts receivable, which are subject to a sub-facility limit of $750,000 and an advance rate of 75%. The loan is secured by a security interest and lien on all of DLH Solutions' cash accounts, account deposits, letters of credit and investment property, chattel paper, furniture, fixtures and equipment, instruments, investment property, general intangibles, deposit accounts, inventory, other property, all proceeds and products of the foregoing (including proceeds of any insurance policies and claims against third parties for loss of any of the foregoing) and all books and records related thereto.
In December 2013, the Loan Agreement was further modified to permit letters of credit to be issued under the overall credit facility, subject to availability, provided by eligible billed and unbilled accounts receivable and further subject to a limit of $1.03 million.
Under the Loan and Security Agreement, interest accrues at the greater of (a) 3.25% or (b) (i) 1.95% above the Wall Street Journal Prime rate on the accounts receivable portion of the credit line and (ii) 3.95% above the Wall Street Journal Prime rate on the unbilled accounts portion. In addition, DLH Solutions will pay certain other related fees and expense reimbursements including a monthly service charge of 0.65% based on the average daily loan balance which shall accrue daily and be due and payable on the last day of each month so long as the Loan Agreement is outstanding. The interest rate on the Accounts Receivable portion of the loan was 5.2% at both December 31, 2013 and 2012. The interest rate on the Unbilled Accounts portion was 7.2% at both December 31, 2013 and 2012. At December 31, 2013, based on current eligible accounts
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receivable, the amount of the unused availability under the line was $1.1 million. The amount outstanding as of December 31, 2013 was $0.9 million.
The Loan Agreement requires compliance with customary covenants and contains restrictions on the Company's ability to engage in certain transactions. Among other matters, under the loan agreement we may not, without consent of the Lender, (i) merge or consolidate with another entity, form any new subsidiary or acquire any interest in a third party; (ii) acquire any assets except in the ordinary course of business; (iii) enter into any transaction outside the ordinary course of business; (iv) sell or transfer collateral; (v) make any loans to, or investments in, any affiliate or enter into any transaction with an affiliate other than on an arms-length basis; (vi) incur any debt outside the ordinary course of business; (vii) pay or declare any dividends or other distributions; or (viii) redeem, retire or purchase any of our equity interests exceeding $50,000. Further, without the consent of the Lender, the Company is also restricted from making any payments in respect of other outstanding indebtedness. The Lender agreed to eliminate the tangible net worth covenant as part of the Fifth Amendment. Either party may terminate the Loan Agreement at any time upon 60 days written notice, and the Loan Agreement provides for customary events of default following which the Lender may, at its option, immediately terminate the loan agreement and accelerate the repayment of any amount outstanding. The defined events of default include, among other things, a material adverse change in the Company's circumstances, or if the Lender deems itself insecure in the ability of the Company to repay its obligations, or as to the sufficiency of the collateral. At present, the Company has not experienced, and the financial institution has not declared, an event of default.
In consideration of the Lender entering into the Fifth Amendment, we agreed to pay a monthly collateral monitoring fee, a documentation fee and at the time that we may borrow amounts in excess of the Initial Sublimit, an origination fee of 1% of the increased availability.
The Company has concurrently executed a Corporate Guaranty Agreement with Lender pursuant to which it has guaranteed all of the obligations of DLH Solutions under the Loan Agreement.
Payroll Taxes
DLH has received notices from the Internal Revenue Service ("IRS") claiming taxes, interest and penalties due related to payroll taxes predominantly from its former PEO operations which were sold in fiscal 2003. DLH has also received notices from the IRS reporting overpayments of taxes. Management believes that these notices are predominantly the result of misapplication of payroll tax payments between its legal entities. If not resolved favorably, the Company may incur interest and penalties. Until the sale of certain assets related to the former PEO operations, DLH operated through 17 subsidiaries, and management believes that the IRS has not correctly identified payments made through certain of the different entities, therefore leading to the notices. To date, DLH worked with the IRS to resolve these discrepancies and has had certain interest and penalty claims abated. DLH has also received notices from the Social Security Administration claiming variances in wage reporting compared to IRS transcripts. DLH believes the notices from the Social Security Administration are directly related to the IRS notices received. DLH believes that after the IRS applies all the funds correctly, any significant interest and penalties will be abated; however, there can be no assurance that each of these matters will be resolved favorably. In settling various years for specific subsidiaries with the IRS, the Company has received refunds for those specific periods; however, as the process of settling and concluding on other periods and subsidiaries is not yet completed, the potential exists for related penalties and interest. The remaining liability ($1.4 million at December 31, 2013 and September 30, 2013) has been recorded in accrued expenses and other current liabilities and includes estimated accrued penalties and interest totaling approximately $0.6 million.
The Company believes it has accrued for the entire estimated remaining liability, inclusive of interest and penalties through the date of the financial statements. The Company may incur additional interest and may incur possible additional penalties through the future date that this obligation is settled, however, it is not currently possible to estimate what, if any, additional amount(s) may be claimed in the future, given the uncertain timing and nature of any future settlement negotiations. No payments were made in fiscal 2014 and 2013. Management believes that the ultimate resolution of these remaining payroll tax matters will not have a significant adverse effect on its financial position or future results of operations. The Company's intention is that it will in due course seek to negotiate a mutually satisfactory payment plan with the IRS, but there is no assurance that it would be successful in doing so and the Company's future cash flows and liquidity could therefore be materially affected by this matter.
Contractual Obligations
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|  |  |  | Payments Due By Period
Obligations |  |  |  | Less than |  | 1-3 |  | 4-5
(Amounts in thousands) |  | Total |  | 1 Year |  | Years |  | Years
Loan Payable (1) |  | $ | 949 |  |  | $ | 949 |  |  | $ | — |  |  | $ | — |
Operating Leases |  | 430 |  |  | 170 |  |  | 208 |  |  | 52 |
Total Obligations |  | $ | 1,379 |  |  | $ | 1,119 |  |  | $ | 208 |  |  | $ | 52 |

(1) Represents the amounts recorded in respect of the loan payable due to Presidential in accordance with the loan agreement and capital lease obligations.
Off-Balance Sheet Arrangements
We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating parts of our business that are not consolidated into our financial statements. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of our capital resources. We have entered into various agreements by which we may be obligated to indemnify the other party with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business under which we customarily agree to hold the indemnified party harmless against losses arising from a breach of representations related to such matters as intellectual property rights. Payments by us under such indemnification clauses are generally conditioned on the other party making a claim. Such claims are generally subject to challenge by us and to dispute resolution procedures specified in the particular contract. Further, our obligations under these arrangements may be limited in terms of time and/or amount and, in some instances, we may have recourse against third parties for certain payments made by us. It is not possible to predict the maximum potential amount of future payments under these indemnification agreements due to the conditional nature of our obligations and the unique facts of each particular agreement. Historically, we have not made any payments under these agreements that have been material individually or in the aggregate. As of our most recent fiscal year end we were not aware of any obligations under such indemnification agreements that would require material payments.
Effects of Inflation
Inflation and changing prices have not had a material effect on DLH’s net revenues and results of operations, as DLH has been able to modify its prices and cost structure to respond to inflation and changing prices.
Recently Issued Accounting Pronouncements Affecting the Company
Refer to Note 7 under Item 1, Financial Statements, for a detailed disclosure regarding Recent Accounting Pronouncements.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DLH does not undertake trading practices in securities or other financial instruments and therefore does not have any material exposure to interest rate risk, foreign currency exchange rate risk, commodity price risk or other similar risks, which might otherwise result from such practices. DLH is not materially subject to fluctuations in foreign exchange rates, commodity prices or other market rates or prices from market sensitive instruments. DLH believes it does not have a material interest rate risk with respect to our prior workers’ compensation programs. In connection with DLH’s prior workers’ compensation programs, prepayments of future claims were deposited into trust funds for possible future payments of these claims in accordance with the policies. The interest income resulting from these prepayments is for the benefit of DLH, and is used to offset workers’ compensation expense. Interest rates payable on these funds have been relatively static and at a level where any further downward rate adjustments would not be expected to result in a material adverse impact on the Company’s exposure to workers’ compensation expense. DLH does not believe the level of exposure to interest rate fluctuations on its debt instruments is material given the amount of debt subject to variable interest rates and the prime rate interest rate floors of at least 3.25% applied by the Lenders.
ITEM 4: 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, has 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.
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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 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.
Changes in Internal Controls
There have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the Company’s fiscal quarter ended December 31, 2013, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Part II — OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
As the Company has previously reported, it was advised of a claim by the U.S. Attorney based on an alleged failure to pay certain classes of employees the prevailing wages as required by the Service Contract Act during the years 2003-2010. On December 12, 2013, the Company was further advised by the U.S. Attorney that, after a review of the merits of the complaint, the U.S. Department of Justice declined to intervene and the claim has been dismissed in its entirety.
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. Other than as reported elsewhere in this report, 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.
ITEM 1A: RISK FACTORS
Our operating results and financial condition have varied in the past and may in the future vary significantly depending on a number of factors. In addition to the other information set forth in this report, you should carefully consider the factors discussed in the “Risk Factors” section in our Annual Report on Form 10-K for the year ended September 30, 2013 and in our other reports filed with the SEC for a discussion of the risks associated with our business, financial condition and results of operations. These factors, among others, could have a material adverse effect upon our business, results of operations, financial condition or liquidity and cause our actual results to differ materially from those contained in statements made in this report and presented elsewhere by management from time to time. The risks identified by DLH in its reports are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently believe are immaterial also may materially adversely affect our business, results of operations, financial condition or liquidity. We believe there have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the period covered by this report, the Company did not issue any securities that were not registered under the Securities Act of 1933, as amended, except as has been reported in previous filings with the SEC or as set forth elsewhere herein.
Registrant Repurchases of Securities
The following table provides certain information with respect to our purchases of shares of our common stock during the three months ended December 31, 2013:
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Period |  | Total Number of Shares Purchased(1) |  | Average Price Paid Per Share | Total Number of Shares Purchased As Part of Publicly Announced Programs |  | Maximum Value of Shares that May Yet Be Purchased Under the Plans or Programs
October 2013 |  | 11,700 |  |  |  |  | $ | 1.1749 |  |  |  | 11,700 |  |  |  | $ | 336,253 |  |
November 2013 |  | 3,725 |  |  |  |  | 1.2638 |  |  |  | 14,975 |  |  | 332,114 |  |
December 2013 |  | 2,300 |  |  |  |  | 1.2205 |  |  |  | 17,275 |  |  | 329,307 |  |
Fiscal quarter ended December 31, 2013 |  | 17,275 |  |  |  |  | $ | 1.1979 |  |  |  | 17,275 |  |  |  | $ | 329,307 |  |
(1) | On September 18, 2013, we announced that our Board of Directors authorized a stock repurchase program (the Program) under which we could repurchase up to $350,000 of shares of our common stock through open market transactions in compliance with Securities and Exchange Commission Rule 10b-18, privately negotiated transactions, or other means. This repurchase program does not have an expiration date. The repurchases included in the above table were repurchased pursuant to a trading plan entered into by the Company in September 2013 in accordance with Rules 10b5-1 and 10b-18.

ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4: MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5: OTHER INFORMATION
None.
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ITEM 6: EXHIBITS
Exhibits to this report which have previously been filed with the Commission are incorporated by reference to the document referenced in the following table. The exhibits designated with a number sign (#) indicate a management contract or compensation plan or arrangement.

Exhibit |  |  |  | Incorporated by Reference |  | Filed
Number |  | Exhibit Description |  | Form |  | Dated |  | Exhibit |  | Herewith
10.1 | # | Employment Agreement with Kevin Wilson |  | 8K |  | 10/3/13 |  | 10.1 |  |
10.2 | # | Form of Option Agreement Granted to Named Executive Officers as of November 8, 2013 |  |  |  |  |  |  |  | X
10.3 | # | Employment Agreement with John F. Armstrong |  | 8K |  | 12/3/13 |  | 10.1 |  |
31.1 |  | Certification of Chief Executive Officer pursuant to Section 17 CFR 240.13a-14(a) or 17 CFR 240.15d-14(a) |  |  |  |  |  |  |  | X
31.2 |  | Certification of Chief Financial Officer pursuant to Section 17 CFR 240.13a-14(a) or 17 CFR 240.15d-14(a) |  |  |  |  |  |  |  | X
32.1 |  | 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 |  |  |  |  |  |  |  | X
101 |  | The following financial information from the DLH Holdings Corp. Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 2013, formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Cash Flows; and, (iv) the Notes to the Consolidated Financial Statements. |  |  |  |  |  |  |  | X

_____________________________________________

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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.
|  | By: | /s/ Zachary C. Parker
|  |  | Zachary C. Parker
|  |  | Chief Executive Officer
|  |  | (Principal Executive Officer)
|  | By: | /s/ Kathryn M. JohnBull
|  |  | Kathryn M. JohnBull
|  |  | Chief Financial Officer
|  |  | (Principal Accounting Officer)
Dated: February 5, 2014 |  |  |

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