LIQUIDITY AND SIGNIFICANT ACCOUNTING POLICIES:

Basis of Presentation

The consolidated interim financial statements included herein have been prepared by DLH, without audit, pursuant to the applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. DLH believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in DLH’s fiscal 2011 Annual Report on Form 10-K which was filed on December 2, 2011. This interim financial information reflects, in the opinion of management, all adjustments necessary (consisting only of normal recurring adjustments and changes in estimates, where appropriate) to present fairly the results for the interim periods. The results of operations and cash flows for such interim periods are not necessarily indicative of the results for the full year.

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. Certain prior period amounts have been reclassified to conform to the current period presentation. The cash flows, and related assets and liabilities of the Company’s previously discontinued TeamStaff Rx subsidiary have been reclassified to a discontinued operation in the accompanying consolidated financial statements from those of continuing businesses for all periods presented.

Goodwill

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, 2011, we performed a goodwill impairment analysis. For the purposes of this analysis, our estimates of fair value are based on the income approach, which estimates the fair value of the DLH Solutions unit based on the future discounted cash flows. Based on the results of the work performed, the Company has concluded that no impairment loss on goodwill was warranted at September 30, 2011. Major assumptions in the valuation study were the estimates of probability weighted future cash flows, the estimated terminal value of the company and the discount factor applied to the estimated future cash flows and terminal value. Estimates of future cash flows were developed by management having regard to current expectations and potential future opportunities. A terminal value for the forecast period was estimated based upon data of public companies that management believes to be similar with respect to the Company’s economics, products and markets. The discount factor used was a cost of capital estimate obtained from a leading third party data provider. The resulting estimated fair value of goodwill exceeded the carrying value at September 30, 2011 by more than 100%, resulting in no impairment charge being taken against goodwill. However, a non-renewal of a major contract (see Note 2—Liquidity) or other substantial changes in the assumptions used in the valuation study 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. DLH has concluded as of June 30, 2012, that there is not any required write off 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 reporting unit.

Income Taxes

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 June 30, 2012, the Company recorded a 100% valuation allowance against its net deferred tax assets of approximately $15.8 million.

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 2008 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 income tax audits.

Changes in Shareholders Equity

Changes in Shareholders’ Equity

The following is the changes in Shareholders’ Equity for the three months ended June 30, 2012:

(AMOUNTS IN THOUSANDS)

				Additional										Total
	Common Stock			Paid-In			Accumulated			Treasury Stock				Shareholders’
	Shares	Amount		Capital			Deficit			Shares	Amount			Equity

BALANCE, March 31, 2012	6,075	$	6	$	71,250		$	(66,520	)	2	$	(24	)	$	4,712

Director restricted stock grants	—			—										—
Exercise of stock options														—
Proceeds from sale of commons stock		3												3
Issuance of shares for services				2										2
Expense related to employee stock option grants				78										78
Fees related to rights offering				(177		)								(177		)
Non employee options				8										8
Warrant expense				(42		)								(42		)
Expense related to employee restricted stock grants				—										—
Rights offering	3,231			4,197										4,197
Net loss							(568		)					(568		)

BALANCE, June 30, 2012	9,306	$	9	$	75,316		$	(67,088	)	2	$	(24	)	$	8,213

The following is the changes in Shareholders’ Equity for the nine months ended June 30, 2012:

(AMOUNTS IN THOUSANDS)

				Additional											Total
	Common Stock			Paid-In			Accumulated			Treasury Stock					Shareholders’
	Shares	Amount		Capital			Deficit			Shares		Amount			Equity

BALANCE, September 30, 2011	6,021	$	6	$	70,988		$	(65,416	)	2		$	(24	)	$	5,554

Director restricted stock grants	54			123											123
Proceeds from sale of commons stock		3													3
Issuance of shares for services				12											12
Expense related to employee stock option grants				145											145
Fees related to rights offering				(184		)									(184		)
Non employee option expense				19											19
Warrant expense				(34		)									(34		)
Expense related to employee restricted stock grants				50											50
Rights offering	3,231			4,197											4,197
Net loss							(1,672		)						(1,672		)

BALANCE, June 30, 2012	9,306	$	9	$	75,316		$	(67,088	)	$	2	$	(24	)	$	8,213

Loss Per Share

Loss Per Share

Loss per share is calculated by dividing 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 loss per share is calculated by dividing the 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 1,462,500 are anti-dilutive for the three and nine months ended June 30, 2012. As such effects are anti-dilutive, there were no differences in the number of weighted average shares outstanding in determining basic and diluted loss per share the three and nine months ended June 30, 2012 and 2011.