**FORM 10-K**

 

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

**ANNUAL REPORT PURSUANT TOSECTION 13 OR 15(d) ofthe SECURITIES EXCHANGE ACT OF 1934**

** **

**For the fiscalyear ended June 30, 2005**

** **

**Commissionfile number 1-10875**

 

**J. L.HALSEY CORPORATION**

(exact name of registrant as specified in its charter)

 
| **DELAWARE**                                        | ** ** | **01-0579490**                       |
|-----------------------------------------------------|------------|--------------------------------------|
| (State of incorporation)                            |       | (I.R.S. Employer Identification No.) |
|                                                |       |                                 |
| **103 Foulk Rd, Suite 205Q****Wilmington, DE** | ** ** | **19803**                            |
| (Address of principal executive office)             |       | (Zip Code)                           |

 

Registrant’stelephone number, including area code:  **(302) 691-6189**

 

Securitiesregistered pursuant to Section 12(g) of the Act:

 

**CommonStock, Par Value $.01 Per Share**(Title of class)

 

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes    ý      No    o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

 

Indicate by checkmark whether the Registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

 

Yes    o      No    ý

 

Asof December 31, 2004, the aggregate market value of the shares of commonstock held by non-affiliates was approximately $16,796,816.  (Determination of stock ownership bynon-affiliates was made solely for the purpose of responding to thisrequirement and the Registrant is not bound by this determination for any otherpurpose.)

 

Therewere 82,966,396 shares of the Registrant’s common stock outstanding as of September 12,2005.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None

 

 

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**J. L. HALSEY CORPORATION AND SUBSIDIARIES**

** **

**FORM 10-K – FISCAL YEAR ENDED JUNE 30, 2005**

 

**Contentsand Cross Reference SheetFurnished Pursuant to General Instruction G(4) of Form 10-K**

 
| **Item No.** | ** ** | **Description**                                                                             | ** ** | **Page  Number** |
|--------------|------------|---------------------------------------------------------------------------------------------|------------|------------------|
|         |       |                                                                                        |       |             |
|         |       | PART I                                                                                 |       |             |
|         |       |                                                                                        |       |             |
| Item 1.      |       | Business                                                                                    |       | 1                |
| Item 2.      |       | Properties                                                                                  |       | 17               |
| Item 3.      |       | Legal  Proceedings                                                                          |       | 18               |
| Item 4.      |       | Submission of  Matters to a Vote of Security Holders                                        |       | 18               |
|         |       |                                                                                        |       |             |
|         |       | PART II                                                                                |       |             |
|         |       |                                                                                        |       |             |
| Item 5.      |       | Market for  Registrant’s Common Equity and Related Stockholder Matters                 |       | 20               |
| Item 6.      |       | Selected  Financial Data                                                                    |       | 21               |
| Item 7.      |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       | 22               |
| Item 7A.     |       | Quantitative  and Qualitative Disclosures about Market Risk                                 |       | 31               |
| Item  8.     |       | Financial  Statements and Supplementary Data                                                |       | 32               |
| Item  9.     |       | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosures      |       | 52               |
| Item  9A.    |       | Controls  and Procedures                                                                    |       | 52               |
| Item 9B.     |       | Other Information                                                                           |       | 52               |
|         |       |                                                                                        |       |             |
|         |       | PART III                                                                               |       |             |
|         |       |                                                                                        |       |             |
| Item  10.    |       | Directors  and Executive Officers of the Registrant                                         |       | 53               |
| Item  11.    |       | Executive  Compensation                                                                     |       | 54               |
| Item  12.    |       | Security  Ownership of Certain Beneficial Owners                                            |       | 57               |
| Item  13.    |       | Certain  Relationships and Related Transactions                                             |       | 58               |
| Item  14.    |       | Principal  Accountant Fees and Services                                                     |       | 58               |
|         |       |                                                                                        |       |             |
|         |       | PART IV                                                                                |       |             |
|         |       |                                                                                        |       |             |
| Item  15.    |       | Exhibits,  Financial Statement Schedules                                                    |       | 59               |
|         |       |                                                                                        |       |             |
| Signatures   |       | 63                                                                                          |
|              |            |                                                                                             |            |                  |  |

 

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**PART I**

** **

**Forward-Looking Information**

 

***ThisAnnual Report includes forward-looking statements related to future events andour future performance within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, and Section 21E of the Securities and ExchangeAct of 1934, as amended. All statements other than statements of historicalfact, including statements regarding industry prospects and future results ofoperations or financial position, made in this Annual Report are forwardlooking. We use words such as “anticipates,” “believes,” “expects,” “future”and “intends” and similar expressions to identify forward-looking statements.Forward-looking statements reflect management’s current expectations, plans orprojections and are inherently uncertain. Our actual results may differsignificantly from management’s expectations, plans or projections. Readers arecautioned not to place undue reliance on these forward-looking statements,which speak only as of the date hereof. Certain risks and uncertainties thatcould cause our actual results to differ significantly from management’sexpectations are described in the section entitled “Business — RiskFactors” This section, along with other sections of this Annual Report,describes some, but not all, of the factors that could cause actual results todiffer significantly from management’s expectations and have a material adverseeffect on the business, financial condition and common stock of the Company. Weundertake no obligation to publicly release any revisions to theseforward-looking statements that may be made to reflect events or circumstancesafter the date hereof or to reflect the occurrence of unanticipated events.Readers are urged, however, to review the factors set forth in reports that wefile from time to time with the Securities and Exchange Commission. Unless thecontext requires otherwise in this Annual Report the terms “Halsey,” the “Company,”“we,” “us” and “our” refer to J.L Halsey Corporation and its subsidiaries.***

 

**ITEM 1.**                             BUSINESS

 

***Overview***

* *

J. L. Halsey Corporation, through its wholly-owned subsidiary, LyrisTechnologies, Inc. (“Lyris”), is a leading email marketing firm.  Lyris’ email marketing software and servicesprovide clients with leading solutions for creating, managing and deliveringonline permission-based direct marketing programs, newsletters, discussiongroups and other digital communications to clients’ whose email lists requirespecialized technology in order to effectively communicate with their membersand customers.  Lyris offers its emailsolutions in two forms:  as software thatis downloaded and installed on a customer’s computers; and as a hosted solutionin which the customer uses Lyris’ software through an internet connection.

 

***Our Products and Services***

 

***ListManager***. Corporations, governments, not-for-profit organizations, politicalcampaigns, athletic teams, and schools have large lists of people with whomthey want to communicate by email.  Theselists can range from hundreds to thousands to millions of email addresses.  For the past ten years, Lyris has developedand licensed software, called *ListManager*,which can manage these email address lists. This software enables customers todevelop, send and monitor complex email mailings reliably.   The software also permits organizations todesign email campaigns that are customized to their members’ preferences.Customers can obtain the benefits of the *ListManager*functionality in two ways: first by installing software on their corporatenetwork; or second, by logging onto Lyris’ servers via the internet on aso-called “hosted basis.”

 

Lyris offers hosted email marketing solutions based on the *ListManager*platform under two brands: *ListHosting*and*SparkList*.  These services enable clients to create, sendand monitor email campaigns with only a web browser and without the need fortheir own engineering and equipment support. For these clients, email administration and security are outsourced andthey can manage mailing lists, as well as direct marketing campaigns,newsletters and discussion groups while supported by Lyris’ data facility andtechnical staff.

 

Over ninety percent (90%) of Lyris’ revenues come from the licensing of*ListManager* software, the sale ofsupport and maintenance services for *ListManager*software and from the sale of the use of *ListManager* ona “hosted” basis.

 

***Other Products***. In November 2004, Lyris acquired PiperSoftware Company and its *EmailAdvisor*product.  With this acquisition, Lyrisacquired another product that is sold on a hosted basis.   *EmailAdvisor* isa deliverability monitoring tool which helps facilitate the delivery oflegitimate email while taking into account the complexity of different email

 

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programs.   With the tremendous increase in spam (see “GovernmentRegulation” below), many ISPs (internet service providers), networkadministrators and individuals have begun deploying anti-spam filters toprevent spam from entering their email inboxes. Many of these anti-spam filters unfortunately block legitimate emailsthat people want to receive.  *EmailAdvisor* helps email senders minimize the chance thatlegitimate email which a member wants to receive is wrongly blocked.

 

Lyris also sells email security and antispam software.  This product, called *MailShield*,is a server-based email filtering application that allows organizations toproactively manage and prevent unauthorized inbound and outbound email.  *MailShield* isused at the enterprise level to block spam and email viruses, prevent relayabuse, by which spammers exploit servers to send their mail, and also filtercontent contained in outbound mail

 

Finally, Lyris offers another software product called *MailEngine*.  *MailEngine* is an SMTP Mail Transfer Agent (“MTA”).  This is the software that actually sends theemail out through the internet’s mail system. Companies partner *MailEngine* withtheir own internal systems to send high volumes of email.

 

***Customers***

 

 Over 4,000 customers havepurchased *ListManager* software and more than 1,000customers use our software on a hosted basis. Our customers include several departments of the U.S. government, nationalpolitical campaigns, local governments and political campaigns, Fortune 500 andsmaller companies, including many top software companies, and some of thelargest and most reputable academic organizations, charitable organizations andathletic teams.

 

***Strategy***

 

Our primary goal is to create value for our shareholders by creatingand delivering efficiently a leading set of products to our customers.    We hope to sell products and services atquality and price points that deliver value for our customers.  To accomplish these goals and objectives wehope to continue as a leader in the email marketing communications market byattracting new customers and deepening our relationships with existingcustomers.  We intend to achieve thisobjective by improving and diversifying our current product offerings throughresearch and development as well as through strategic acquisitions. BecauseLyris operates in a fragmented market, characterized by a large number of smallcompetitors and a handful of medium-sized competitors, we believe there may bean opportunity to create shareholder value by acquiring competing andcomplementary businesses.  Throughacquisitions, we may be able to expand Lyris’ customer base and diversify anddeepen our technology offerings. We are currently seeking acquisitions.

 

***Sales and Marketing***

 

Lyris’ sales and marketing activities are based in its Berkeley,California headquarters.  The sales teamis structured by product, with one team focused exclusively on software and theother on hosted solutions.  As of September 15,2005, Lyris’ sales and marketing organization consisted of 11 employees.   Historically, Lyris’ marketing efforts haveconsisted of trade shows and limited print advertising.

 

***Customer Service and Support***

 

 We believe that customer serviceand support are important components in successfully selling software andhosting.  Lyris provides customer serviceand support in three levels.  First, all *ListManager* customers receive “included support” whichprovides free web access to our online support databases and thirty days ofemail assistance.    Second, customersmay purchase two levels of paid support. The first level, referred to as Essential Support, provides emailassistance and free access to minor upgrades during the term of the supportcontract.  Customers also have the optionof purchasing Comprehensive Support, which includes email and telephone support(subject to certain limits) and free access to minor and major upgrades for aperiod of one year.

 

For *SparkList* and Lyris *ListHosting*,we offer free access to our online support databases as well as web seminars onthe fundamentals of our hosted products as well as on the basics of emailmarketing and communication.

 

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***Technology***

 

Lyris’products are written in several computing languages, including C, C++, C#, andTCL, among others. *ListManager* isdesigned to run in conjunction with a number of different commercial databaseservers, including Microsoft SQL Server and Oracle.

 

Ourscalable platform is designed to handle hundreds of thousands of emails perhour, while emphasizing reliability, availability and security.  *ListManager*automatically handles bounces due to invalid email addresses, and tracks useractivity after reception of emails, such as open detection, clickthroughtracking and purchase tracking. The information gathered from user activitiesis digested into reports, and can be used for initiating further emailcampaigns.

 

Oursecurity systems control access to internal systems and data via the Internet.Internally, log-ins and passwords are maintained for all systems, with accesscontrol granted on an individual basis to only the required areas for which therecipient is responsible.   Firewallsprevent unauthorized access from outside or access to confidential data on theinside.  We rely on certain encryptionand authentication technologies licensed from third parties to provide securetransmission of confidential information.

 

***Research and Development***

 

Because we compete in technology markets, we must try to continuallyinnovate as fast or faster than our competition. We are committed to supportingand updating our core technology and to expanding our product offerings tooffer a leading set of products which meet the needs of our customers.  We invest our resources in productdevelopment.   Historically, Lyris hasreleased major upgrades to its flagship product, *ListManager*,every 12 to 16 months and has augmented these offerings with periodic minorupgrades.  As of June 30, 2005, wehave approximately 15 engineers who are engaged in researching, developing,testing and deploying new versions of *ListManager*, *EmailAdvisor*, *MailShield*, and*MailEngine*.

 

***Operations***

 

Continuous data center operations are crucial to oursuccess. We currently lease space and services in a secure co-location datafacility in Fremont, CA.  We also leasespace in a secure co-location data facility in Novato, California. Thesefacilities have redundant electrical generators and UPS power supplies thatprotect the facilities, fire suppression systems, and 24x7 physicalsecurity.  All data center locations arecurrently processing outbound email.

 

Our network software constantly monitors our systems and notifiessystems engineers if any unexpected conditions arise.

 

***Competition***

 

***General***.  Weoperate in an extremely competitive technology market.  Many of our competitors have significantlygreater resources (financial, technical, marketing, human capital and otherresources) than we do.  We must continueto innovate as well and as fast or faster than our competitors or we may beleft behind in the competition for customers.  In general, the barriers to entry in software and hosting markets areconsidered to be low.  New competitorscan and will enter the markets in which we compete.  We believe the following factors areimportant or may become important in the competition for customers:

 

•                  Product feature set;

 

•                  Ease of use of the products;

 

•                  Ability to integrate with other applicationsthat our clients use to interact with their customers such as CRM, EMM, Webanalytics, ERP packages and consumer and business databases;

 

•                  Performance and scalability;

 

•                  Price and total cost of ownership;

 

•                  Stability and reliability;

 

•                  Quality of the customer service and support,and

 

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•                  Brand name and reputation.

 

***Email Marketing Markets***

 

We have several types of competitors in the email market.  The market for email marketing software andhosted email marketing services is fragmented with many participants.  Some of these competitors offer an on-premisesoftware solution, others offer a hosted service, and still others offer both,as we do.

 

There are many small, privately-held competitors, particularly on the hostedside.  Many competitors price theirproducts below our prices.  At the higherend of the email marketing market, there are a number of large companies thatcompete with either an integrated offering or that compete with large staffs ofpeople who help customize the applications for their customers’ needs.   Among the companies that include emailmarketing in an integrated offering are CRM (Customer Relationship Management)software vendors such as Siebel, EMM (enterprise marketing management) softwarevendors such as Unica, outsourced e-commerce solution providers such as DigitalRiver, database marketers such as Experian (which owns CheetahMail), Axciom(which owns Digital Impact) and Harte Hanks (which owns PostFuture).  BigFoot Interactive was recently purchased byAlliance Data Systems’ Epsilon division which will enable them to sell anintegrated solution.   Other competitorsinclude Silverpop, Responsys, Exact Target, Constant Contact, SubscriberMail,and DoubleClick’s DartMail business.

 

***Email Security and Anti-Spam Markets***

 

In the email security and anti-spam markets, there are a number of verylarge competitors and several well-funded start-up competitors.  Large companies who operate in this marketinclude Symantec, McAfee, Microsoft, Tumbleweed and Trend Micro.  Additionally, many other privately heldcompanies compete in this space, many of whom have raised significant fundingfrom private investors.  Some of the largerprivately-held companies include IronPort, Proofpoint, MXLogic, Sophos, KasperskyLabs, and Cloudmark.  Other competitorsprovide enabling anti-spam technology rather than an end-user solution.  Examples of such companies include Mailshell,Commtouch and MailFrontier.  Emailsecurity and anti-spam markets are among the most competitive of all technologymarkets.

 

***Intellectual Property***

 

We have filed one patent application that covers some of the technologydeveloped for *EmailAdvisor*.  We enter into confidentiality and proprietaryrights agreements with our employees, consultants, and other third parties inorder to try to protect our trade secrets and intellectual property.  In recent years, many software companies havefiled patents covering their technologies. Many of these patents have yet to be litigated.  We are aware of one patent application whoseowner claims that our software infringes at least one claim in thatpatent.  Although this patent iscurrently being litigated by a number of defendants in the email marketingbusiness, we have elected to license this patent in lieu of litigation. Othersmay develop technologies that are similar or superior to our technology and mayreceive and enforce patents on such technology.

 

***U.S. and Foreign Government Regulation***

 

Email has been the subjectof regulation by local, state, federal and foreign governments.  In 2003, the US Congress passed the CAN-SPAMAct.  The CAN-SPAM Act of 2003establishes the United States’ first national standards for the sending ofcommercial email and requires the Federal Trade Commission (FTC) to enforce itsprovisions.

 

CAN-SPAM defines spam as “anyelectronic mail message the primary purpose of which is the commercialadvertisement or promotion of a commercial product or service (includingcontent on an Internet website operated for a commercial purpose).” It exempts “transactionalor relationship messages.” The bill permits email marketers to send unsolicitedcommercial email as long as it contains all of the following: an opt-outmechanism; a valid subject line and header (routing) information; and thelegitimate physical address of the mailer, among other requirements.

 

If a user opts out, a senderhas ten days to remove the address. The legislation also prohibits the sale orother transfer of an email address after an opt-out request.

 

We believe strongly that emailers should send email only to those whohave requested or given permission (twice) for email to be sent.   Lyris does not permit any of its hostedcustomers to send SPAM, and requires by contract that our

 

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software purchasers and hostedclients comply with CAN-SPAM. Additionally, Lyris sells an anti-spam solution, called *MailShield*.

 

***Corporate Background***

 

***Acquisition of Lyris***

 

On May 12, 2005, Halsey acquired all ofthe outstanding capital stock of Lyris. The purchase price was $30.7 million, which included cash payments of$25.1 million (including acquisition costs and working capital adjustments of$1.2 million) and $5.6 million in the form of a promissory note payable,subject to Lyris’ achieving specified revenue targets, on the secondanniversary of the closing date with interest equal to 10% per annum. With thisacquisition, Halsey has become a leading email marketing company with over5,000 customers worldwide.

 

The financial information listed below is based on the auditedfinancial statements of Lyris Technologies, Inc. for their past threefiscal years prior to the acquisition by Halsey. Prior to the acquisition byHalsey on May 12, 2005, Lyris was incorporated under Subchapter S of theInternal Revenue Code in Delaware, therefore, no federal income tax expense wasreported in Lyris’ statement of operations. A summary of Lyris’ auditedstatement of operations for the three years ended December 31, are asfollows:

 
| ** **                        | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                           |       | $          | 11,993,428 |       | $          | 10,914,412 |       | $ | 7,622,384 |   |
|                              |       |       |       |       |       |       |       |
| Operating  expenses               |       | 6,176,236  |       | 5,856,331  |       | 4,228,320  |       |
|                              |       |       |       |       |       |       |       |
| Income from  operations           |       | 5,817,192  |       | 5,058,081  |       | 3,394,064  |       |
|                              |       |       |       |       |       |       |       |
| Other income (expense)            |       | 5,741      |       | 2,820      |       | (4,603     | )          |
|                              |       |       |       |       |       |       |       |
| Income  before state income taxes |       | 5,822,933  |       | 5,060,901  |       | 3,389,461  |       |
|                              |       |       |       |       |       |       |       |
| State income tax provision        |       | 91,159     |       | 86,555     |       | 58,452     |       |
|                              |       |       |       |       |       |       |       |
| Net income                        |       | $          | 5,731,774  |       | $          | 4,974,346  |       | $ | 3,331,009 |   |

 

***Discontinuedoperations***

 

Halsey is the successorto NovaCare, Inc. (“NovaCare”), which was a national leader in physicalrehabilitation services, orthotics and prosthetics and employee services. Thechanges to Medicare reimbursement in the late 1990’s had deleterious effects onNovaCare and its competitors and customers.   The prior operating business most affected by the Medicare changes wasthe long-term care services segment in which NovaCare provided therapists toskilled nursing facilities.  Thisbusiness was disposed of in fiscal 1999 with the shutdown of certain of itsoperations in the Western United States during the third fiscal quarter and thesale of the remaining operations on June 1, 1999. NovaCare’s formeroutpatient services segment was disposed of through the sales of its orthotics andprosthetics (O&P) and physical rehabilitation and occupational health(PROH) businesses. The O&P business was sold to Hangar Orthopedic Group, Inc.in July of 1999 and the PROH business was sold to Select MedicalCorporation in November of 1999. The Company’s former employee services segment was disposed of throughNovaCare’s sale of its interest in NovaCare Employee Services (“NCES”) in October of1999 to a subsidiary of Plato Holdings, Inc. as part of a tender offer byPlato for all of NCES’s outstanding shares. With cash raised from the sales of its businesses, the Company repaidall of its bank debt in the summer of 1999, and in January of 2000, theCompany retired its publicly-traded subordinated debt.

 

NovaCare sold its name aspart of the sale of the PROH business and subsequently changed its name to NAHC, Inc.(“NAHC”).  On June 18, 2002, in atransaction approved by NAHC’s stockholders at a special meeting, NAHC mergedwith and into Halsey, its wholly-owned subsidiary. The purpose of the mergerbetween NAHC and Halsey was to implement transfer restrictions on the Company’scommon stock in order to preserve the Company’s net operating losses.

 

Prior to the Lyris acquisition, the Company hasspent the past several years maximizing the assets that it has retained,including old accounts receivable, Medicare receivables and appeals, and taxitems and to minimize liabilities

 

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retained after the sales of theoperating businesses.  The Company hasmade significant progress on these matters. The Company has collected virtually all of its receivables other thanamounts which are the subject of litigation or arbitration or that have beenwritten off. A subsidiary of the Company has retained four****employeesand two consultants to carry out the general and administrative functionsspecified above. These resources have been supplemented with outside financial,tax, legal and systems resources when required by management and the board.  No members of the current board were membersprior to, or at the time of the Company selling its healthcare operatingbusinesses in 1999.

 

**Risk Factors**

 

*An investment in our common stock involves a high degree ofrisk. You should consider carefully the risks and uncertainties described belowand all the other information contained in this Form 10-K before youdecide whether to purchase our common stock. The risks described below are not the only risks facing our company.Additional risks not currently known to us or that we currently deem immaterialmay also impair our business operations. Our business, financial condition orresults of operations could be materially adversely affected by any of theserisks.  This report also contains forward-lookingstatements that involve risks and uncertainties. Our actual results coulddiffer materially from those anticipated in these forward-looking statements asa result of certain factors, including the risks faced by us described belowand elsewhere in this report. The market price of our common stock coulddecline due to any of these risks and uncertainties, or for other reasons, andyou may lose part or all of your investment.*

 

***Risks Related to Our Business and Industry***

 

***Our business is substantially dependent on the market for email marketing.***

 

Over ninety percent (90%) of our revenues come from the email marketingmarket – from the licensing of *ListManager*software, the sale of support and maintenance contracts related to *ListManager*, and from the sale of the hosted use of *ListManager*.  Themarket for email marketing software is relatively new and still evolving.  There is no certainty regarding how orwhether this market will develop, or whether it will experience anycontractions.

 

***Seasonal trends may cause our quarterly operatingresults to fluctuate, which may adversely affect the market price of our commonstock.***

 

The traditional directmarketing industry has typically generated lower revenues during the summermonths and higher revenues during the calendar year-end months. We believe ourbusiness is affected by similar revenue fluctuations, but our limited operatinghistory is insufficient to isolate and predict the magnitude of these effects.Because we may experience these effects, investors (and, possibly, securitiesanalysts) may not be able to predict our quarterly or annual operating results.If we fail to meet expectations of securities analysts and investors, our stockprice could decline.

 

***If businesses and consumers fail to accept onlinedirect marketing as a means to attract new customers, demand for our servicesmay not develop and the price of our stock could decline.***

 

The market for online directmarketing services is relatively new and rapidly evolving and our business maybe harmed if sufficient demand for our services does not develop. Our currentand planned services are very different from the traditional methods that manyof our clients have historically used to attract new customers and maintaincustomer relationships.

 

***Ourresults depend on consumer use of email and the Internet.  If consumers do not continue to use email andthe Internet, demand for our services may not develop and the price of ourstock could decline.***

 

Our current and plannedservices enable customers to use email to increase revenue and traffic fromtheir online audiences, customers and members. Our ability to serve thesecustomers therefore depends on their audiences continuing to use both email andthe Internet as communications media.  Ifconsumer adoption of either technology declines, demand for our services maynot develop or may decline.

 

***The growth of the email marketing market depends on the continuedgrowth and effectiveness of anti-spam products***

 

Adoption of email as a communications medium dependson the ability to prevent junk mail, or “spam”, from overwhelming a subscriber’selectronic mailbox.  In recent years,many companies have evolved to address this issue and

 

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filter unwanted messages beforethey reach customers’ mailboxes.  In response,spammers have become more sophisticated and have also begun using junk messagesas a means for fraud.  Email protectioncompanies in turn have evolved to address this new threat.  However, if their products fail to beeffective against spam, adoption of email as a communications tool willdecline, which would adversely affect the market for our services.

 

***The online direct marketing industry is highlycompetitive, and if we are unable to compete effectively, the demand for, orthe prices of, our services may decline.***

 

The market for online directmarketing is highly competitive, rapidly evolving and experiencing rapidtechnological change. Intense competition may result in price reductions,reduced sales, gross margins and operating margins, and loss of market share.Our principal competitors include providers of online direct marketingsolutions such as DoubleClick, Responsys, Experian, Silverpop, BigfootInteractive and InfoUSA, as well as the in-house information technologydepartments of our existing and prospective clients. The loss of a client dueto service quality or technology problems could result in reputational harm tous and, as a result, increase the effect of competition and negatively impactour ability to attract new clients.

 

Many of these potentialcompetitors have broad distribution channels and they may bundle complementaryproducts or services. Such bundled products include but are not limited to, webanalytics, data mining, customer relationship management (CRM) systems andprofessional services.  If we are notable to bundle complementary services or continue to expand our distributioncapabilities, our results may suffer.

 

In addition, we expectcompetition to persist and intensify in the future, which could harm ourability to increase sales and maintain our prices. In the future, we mayexperience competition from Internet service providers, advertising and directmarketing agencies and other large established businesses possessing large,existing customer bases, substantial financial resources and establisheddistribution channels and these businesses could develop, market or resell anumber of online direct marketing solutions. These potential competitors mayalso choose to enter, or have already entered, the market for online directmarketing by acquiring one of our existing competitors or by forming strategicalliances with a competitor. As a result of future competition, the demand forour services could substantially decline. Any of these occurrences could harmour ability to compete effectively.

 

***The email security business is highly competitive,and if we are unable to compete effectively, the demand for, or the prices of,our services may decline.***

 

Lyris’ email securitybusiness faces competition from businesses that develop their own anti-spam andother messaging security technology. These competitors vary, from enterprise software vendors such as Oracleand SAP to online service providers who develop or bundle anti-spam, anti-virusand other messaging security technology with their other products such asSymantec and Network Associates.  Lyrisalso faces competition from large enterprise network infrastructure andsoftware vendors such as Cisco Systems and Microsoft as they diversify theirproduct offerings.   Many of thesecompetitors have broad distribution channels and can bundle competing productsor services. This competition poses a significant risk for Lyris.

 

***If we fail to respond to rapidly changing technology or evolvingindustry standards, our products and services may become obsolete or lesscompetitive.***

 

The markets for our products and services are characterized by rapidtechnological advances, changes in client requirements, changes in protocolsand evolving industry standards.  If weare unable to develop enhancements to, and new features for, our existingproducts and services, or develop entirely new products and services, ourproducts and services may become obsolete, less marketable, or less competitiveand our business will be harmed.  Theability to add new enhancements, new features and new services depends onseveral factors, including having sufficient financial, technical and humanresources, and on completing such work in a timely fashion.  Failure to produce timely acceptable newfeatures will significantly impair our ability to retain existing revenue andearn new revenue.

 

***If we fail to market new features and migrate customers to new versionsof our system, our products and services may become obsolete or lesscompetitive.***

 

The development of proprietarytechnology and service enhancements and the migration of customers to newtechnology entail significant technical and business risks and requiresubstantial expenditures and lead-time. Lyris might

 

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not be successful in marketingand supporting recently released versions of its technology and services on atimely or cost-effective basis. In addition, even if new technology andservices are developed and released, they might not achieve market acceptance.Also, if Lyris is not successful in a smooth migration of customers to new orenhanced technology and services, Lyris could lose customers.

 

***Weface significant threats from new entrants to our business***

 

Barriers to entry insoftware markets are low.  Privately-backedand public companies could choose to enter our space and compete directly withus, or indirectly by offering substitute solutions.   The result could be decreased demand orpricing for our services, longer sales cycles, or a requirement to makesignificant incremental investments in research and development to match theseentrants’ new technologies.  If any ofthese happens, it could cause us to suffer a decline in revenues andprofitability.

 

***The majority ofour services are sold pursuant to short-term subscription agreements, and ifour customers elect not to renew these agreements, our revenues may decrease.***

 

Typically, our hostedservices are sold pursuant to short-term subscription agreements, which aregenerally six months to one year in length, with no obligation to renew theseagreements. Our renewal rates may decline due to a variety of factors,including the services and prices offered by our competitors, new technologiesoffered by others, consolidation in our customer base or if some of ourcustomers cease their operations. If our renewal rates are low or decline forany reason, or if customers renew on less favorable terms, our revenues maydecrease, which could adversely affect our stock price.

 

***Defects in Lyris’ products could diminish demandfor its products and services and cause it to lose customers.***

 

Because Lyris’ productsand services are complex, they may have errors or defects that users identifyafter they begin using them, which could harm Lyris’ reputation and business.  In particular, Lyris’ anti-spam products mayidentify some legitimate emails as unwanted or unsolicited spam, or Lyris maynot be able to filter out a sufficiently high percentage of unsolicited orunwanted messages sent to the email accounts of customers.  Complex software products like Lyris’frequently contain undetected errors when first introduced or when new versionsor enhancements are released.  Inaddition, Lyris may be unable to respond in a prompt manner, or at all, to newmethods of attacking a messaging system, such as new spamming techniques.  Lyris has from time to time found defects inproducts and errors in existing products may be detected in the future.  Any such errors, defects or other performanceproblems could impact the perceived reliability of Lyris’ products and servicesand hurt Lyris’ reputation.  If thatoccurs, customers could elect not to renew or terminate their subscriptions andfuture sales could be lost.

 

***If the delivery of Lyris’ email messages is limited or blocked, thenthe amount Lyris may be able to charge clients for producing and sending theircampaigns may be reduced and clients may discontinue their use of Lyris’services.***

 

Internet serviceproviders are able to block messages from reaching their users. Recent releasesof Internet service provider software and the implementation of stringent newpolicies by Internet service providers make it more difficult to deliver emailson behalf of customers. Lyris continually improves its own technology and workswith Internet service providers to improve its ability to successfully deliveremails. However, if Internet service providers materially limit or halt thedelivery of Lyris’ emails, or if Lyris fails to deliver emails in such a way asto be compatible with these companies’ email handling or authenticationtechnologies, then the amount Lyris may be able to charge clients for producingand sending their online direct marketing campaigns may be reduced and clientsmay discontinue their use of Lyris’ services. In addition, the effectiveness of email marketing may decrease as aresult of increased customer resistance to email marketing in general.

 

***Lyris’ facilities and systems are vulnerable to natural disasters andother unexpected events and any of these events could result in an interruptionof Lyris’ ability to execute clients’ online direct marketing campaigns.***

 

Lyrisdepends on the efficient and uninterrupted operations of its data center andhardware systems. The data center and hardware systems are located in California,an area susceptible to earthquakes. The data center and hardware systems arealso vulnerable to damage from fire, floods, power loss, telecommunicationsfailures, and similar events. If any of these events results in damage to thedata center or systems, Lyris may be unable to execute clients’ hosted onlinedirect

 

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marketing campaigns until thedamage is repaired, and may accordingly lose clients and revenues. In addition,subject to applicable insurance coverage, we may incur substantial costs inrepairing any damage.

 

***System failures could reduce theattractiveness of our service offerings.***

 

We provide email marketing and delivery services toour clients and end-users through our proprietary technology and clientmanagement systems. The satisfactory performance, reliability and availabilityof the technology and the underlying network infrastructure are critical to ouroperations, level of client service, reputation and ability to attract andretain clients. We have experienced periodic interruptions, affecting all or aportion of our systems, which we believe will continue to occur from time totime. Any systems damage or interruption that impairs our ability to accept andfill client orders could result in an immediate loss of revenue to us, andcould cause some clients to purchase services offered by our competitors. Inaddition, frequent systems failures could harm our reputation.  Some factors that could lead to interruptionsin customer service include:  operator negligence, improper operation by, or supervision of,employees, physical and electronic break-ins, misappropriation, computerviruses and similar events; power loss, computer systems failures, andInternet and telecommunications failures. We do not carry sufficient businessinterruption insurance to fully compensate us for losses that may occur.

 

***If we are unable to safeguard theconfidential information in our data warehouse, our reputation may be harmedand we may be exposed to liability****.*

 

We currently storeconfidential customer information in a secure data warehouse owned by a thirdparty. We cannot be certain, however, that we will be able to preventunauthorized individuals from gaining access to this data warehouse. If anycompromise or breach of security were to occur, it could harm our reputationand expose us to possible liability. Any unauthorized access to our serverscould result in the misappropriation of confidential customer information orcause interruptions in our services. It is also possible that one of ouremployees could attempt to misuse confidential customer information, exposingus to liability. In addition, our reputation may be harmed if we lose customerinformation maintained in our data warehouse due to systems interruptions orother reasons.

 

***If we are unable to protect our intellectual property or if thirdparties develop superior intellectual property, third parties could use ourintellectual property without our consent and prevent us from using theirtechnology.***

 

Our ability tosuccessfully compete is substantially dependent upon internally developedtechnology and intellectual property, which we protect through a combination ofpatent, copyright, trade secret and trademark law, as well as contractualobligations. We may not be able to protect our proprietary rights. Unauthorizedparties may attempt to obtain and use our proprietary information. Policingunauthorized use of our proprietary information is difficult, and we cannot becertain that the steps we have taken will prevent misappropriation,particularly in foreign countries where the laws may not protect ourproprietary rights as fully as in the United States.

 

Lyris is one of severalcompanies rapidly building new technologies in its industry.  It is possible that a third party could beawarded a patent that applies to some portion of Lyris’ business.  If this occurs, we may be required to incursubstantial legal fees, cease using the technology or pay significant licensingfees for such use.

 

***We rely uponthird parties for technology that is critical to our products, and if we areunable to continue to use this technology and future technology, our ability tosell or continue to support subscriptions to our products and services would belimited and our operating results could be harmed.***

 

We rely on non-exclusivesoftware license rights from third parties in technologies that areincorporated into and necessary for the operation and functionality of ourproducts. Our licenses often require the payment of royalties or otherconsideration to third parties. Our success will depend in part on ourcontinued ability to have access to these technologies, and we do not knowwhether these third-party technologies will continue to be licensed to us oncommercially reasonable terms or at all. Our loss of license to, or theinability to support, maintain and enhance, software products we license fromthird parties could result in our customers having to upgrade their Lyrisproducts. In addition, a loss of license from third parties could lead toincreased costs and delays or reductions in our product development, sales andsupport until we are able to develop functionally equivalent software oridentify and obtain licenses to alternative third party software with comparablefunctionality, which we may be unable to do. As a result, our margins, marketshare and operating results could be significantly harmed. If any of theseevents occurs, our business and operating results could be harmed.

 

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***If a third partyasserts that we are infringing its intellectual property, whether successful ornot, it could subject us to costly and time-consuming litigation or expensivelicenses, and our business may be harmed.***

 

The software and Internetindustries are characterized by the existence of a large number of patents,trademarks and copyrights and by frequent litigation based on allegations ofinfringement or other violations of intellectual property rights. Third partiesmay assert patent and other intellectual property infringement claims againstus in the form of lawsuits, letters or other forms of communication. If a thirdparty successfully asserts a claim that we are infringing their proprietaryrights, royalty or licensing agreements might not be available on terms we findacceptable or at all. Because currently pending patent applications are notpublicly available for certain periods of time, we cannot anticipate all suchclaims or know with certainty whether our technology infringes the intellectualproperty rights of third parties.  As ageneral matter, we do not search patent office files for patents or patentapplications that we may possibly infringe.

 

From time to time we may benamed as a defendant in lawsuits claiming that we have, in some way, violatedthe intellectual property rights of others. Existing lawsuits in this area, aswell as any future assertions or prosecutions of claims like these, couldrequire us to expend significant financial and managerial resources. Thedefense of any claims, with or without merit, could be time-consuming, resultin costly litigation and diversion of technical and management personnel, causeproduct enhancement delays or require that we develop non-infringing technologyor enter into royalty or licensing agreements.

 

We expect that the number ofinfringement claims in our market will increase as the number of services andcompetitors in our industry grows. These claims, whether or not successful,could:

 

•                  divert management’s attention;

 

•                  result in costly and time-consuminglitigation;

 

•                  require us to enter into royalty or licensingagreements, which may not be available on acceptable terms, or at all; or

 

•                  require us to redesign our software andservices to avoid infringement.

 

As a result, any third-partyintellectual property claims against us could increase our expenses andadversely affect our business. In addition, many of our subscription agreementsrequire us to indemnify our customers for third-party intellectual propertyinfringement claims, which would increase the cost to us resulting from anadverse ruling in any such claim. Even if we have not infringed any thirdparties’ intellectual property rights, we cannot be sure our legal defenseswill be successful, and even if we are successful in defending against suchclaims, our legal defense could require significant financial resources andmanagement time.

 

***Activities of clients could damage Lyris’ reputation or give rise tolegal claims against us.***

 

Clients’ promotion oftheir products and services may not comply with federal, state and local laws.We cannot predict whether Lyris’ role in facilitating these marketingactivities would expose us to liability under these laws. Any claims madeagainst us could be costly and time-consuming to defend. If we are exposed tothis kind of liability, we could be required to pay fines or penalties,redesign business methods, discontinue some services or otherwise expendresources to avoid liability.

 

Lyris’ services involvethe transmission of information through the Internet. These services could beused to transmit harmful applications, negative messages, unauthorizedreproduction of copyrighted material, inaccurate data or computer viruses toend-users in the course of delivery. Any transmission of this kind could damageLyris’ reputation or could give rise to legal claims against us. We could spenda significant amount of time and money defending against these legal claims.

 

***New regulation of, and uncertainties regarding the application ofexisting laws and regulations to, online direct marketing and the Internetcould prohibit, limit or increase the cost of, our business.***

 

In December 2003,Congress enacted the CAN-SPAM Act of 2003, legislation that regulates thesending of commercial email.  Thislegislation pre-empts state laws regulating commercial email.  The effect of this legislation on

 

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marketers is difficult topredict.  We cannot assure you that thisor future legislation regarding commercial email will not harm ourbusiness.  In addition, many states havepassed laws that are significantly more punitive and harder to comply with thanCAN-SPAM, particularly Utah and Michigan. It is not clear to what extent these state laws will in fact bepreempted by CAN-SPAM.

 

Our business could benegatively impacted by new laws or regulations applicable to online directmarketing or the Internet or the application of existing laws and regulationsto online direct marketing or the Internet. There is a growing body of laws andregulations applicable to access to, or commerce on, the Internet. Moreover,the applicability to the Internet of existing laws is uncertain and may takeyears to resolve. Due to the increasing popularity and use of the Internet, itis likely that additional laws and regulations will be adopted covering issuessuch as privacy, pricing, content, copyrights, distribution, taxation,antitrust, characteristics and quality of services and consumer protection. Theadoption of any additional laws or regulations may impair the growth of theInternet or online direct marketing, which could, in turn, decrease the demandfor Lyris’ services and prohibit, limit or increase the cost of our doingbusiness.

 

***We may expandthrough acquisitions of, or investments in, other companies or through businessrelationships, all of which may divert our management’s attention, resulting inadditional dilution to our stockholders and consumption of resources that arenecessary to sustain our business.***

 

One of our businessstrategies is to acquire competing or complementary services, technologies orbusinesses. We also may enter into relationships with other businesses in orderto expand our service offerings, which could involve preferred or exclusive licenses,additional channels of distribution or discount pricing or investments in othercompanies.

 

An acquisition, investmentor business relationship may result in unforeseen operating difficulties andexpenditures. In particular, we may encounter difficulties assimilating orintegrating the acquired businesses, technologies, products, personnel oroperations of the acquired companies, particularly if the key personnel of theacquired company choose not to work for us, and we may have difficulty retainingthe customers of any acquired business due to changes in management andownership. Acquisitions may also disrupt our ongoing business, divert ourresources and require significant management attention that would otherwise beavailable for ongoing development of our business. Moreover, we cannot assureyou that the anticipated benefits of any acquisition, investment or businessrelationship would be realized or that we would not be exposed to unknownliabilities, nor can we assure you that we will be able to complete anyacquisitions on favorable terms or at all. In connection with one or more ofthose transactions, we may:

 

•                  issue additional equity securities that woulddilute our stockholders;

 

•                  use cash that we may need in the future tooperate our business;

 

•                  incur debt on terms unfavorable to us or thatwe are unable to repay;

 

•                  incur large charges or substantialliabilities;

 

•                  encounter difficulties retaining keyemployees of the acquired company or integrating diverse business cultures; and

 

•                  become subject to adverse tax consequences,substantial depreciation or deferred compensation charges.

 

***Failure toproperly manage and sustain our expansion efforts could strain our managementand other resources.***

 

Our ability to successfullyoffer services and implement our business plan in a rapidly evolving marketrequires an effective planning and management process. We may try to rapidlyand significantly expand the depth and breadth of our service offerings.Failure to properly manage this expansion could place a significant strain onour managerial, operational and financial resources. To manage expansion, weare required to continually:

 

•                  improve existing and implement newoperational, financial and management controls, reporting systems andprocedures;

 

•                  install new management information systems;and

 

•                  train, motivate, retain and manage ouremployees.

 

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We may be unable to install management informationand control systems in an efficient and timely manner, and our current orplanned personnel, systems, procedures and controls may be inadequate tosupport our operations

 

***Because competition for our targetemployees is intense, we may not be able to attract and retain the highlyskilled employees we need to support our planned growth.***

 

To continue to execute our growth plan, we mustattract and retain highly qualified personnel. Competition for these personnelis intense, especially for engineers with high levels of experience indesigning and developing software and Internet-related services. We may not besuccessful in attracting and retaining qualified personnel. We have from timeto time in the past experienced, and we expect to continue to experience in thefuture, difficulty in hiring and retaining highly skilled employees withappropriate qualifications. Many of the companies with which we compete forexperienced personnel have greater resources than we have. In addition, inmaking employment decisions, particularly in the Internet and high-technologyindustries, job candidates often consider the value of the stock options theyare to receive in connection with their employment. Volatility in the price ofour stock may, therefore, adversely affect our ability to attract or retain keyemployees. Furthermore, the new requirement to expense stock options maydiscourage us from granting the size or type of stock options awards that jobcandidates require to join our company. If we fail to attract new personnel orfail to retain and motivate our current personnel, our business and futuregrowth prospects could be severely harmed.

 

***Any failure toadequately expand our direct sales force will impede our growth.***

 

We expect to besubstantially dependent on our direct sales force to obtain new customers andto manage our customer relationships. We believe that there is significantcompetition for direct sales personnel with the advanced sales skills andtechnical knowledge we need. Our ability to achieve significant growth inrevenue in the future will depend, in large part, on our success in recruiting,training and retaining sufficient direct sales personnel. New hires requiresignificant training and may, in some cases, take more than a year before theyachieve full productivity. Our recent hires and planned hires may not become asproductive as we would like, and we may be unable to hire sufficient numbers ofqualified individuals in the future in the markets where we do business. If weare unable to hire and develop sufficient numbers of productive sales personnel,sales of our service will suffer.

 

***If we fail todevelop our brand cost-effectively, our business may suffer.***

 

We believe that developingand maintaining awareness of the Lyris brand in a cost-effective manner iscritical to achieving widespread acceptance of our current and future servicesand is an important element in attracting new customers. Furthermore, webelieve that the importance of brand recognition will increase as competitionin our market develops. Successful promotion of our brand will depend largelyon the effectiveness of our marketing efforts and on our ability to providereliable and useful services at competitive prices. Brand promotion activitiesmay not yield increased revenue, and even if they do, any increased revenue maynot offset the expenses we incur in building our brand. If we fail tosuccessfully promote and maintain our brand, or incur substantial expenses inan unsuccessful attempt to promote and maintain our brand, we may fail toattract enough new customers or retain our existing customers to the extentnecessary to realize a sufficient return on our brand-building efforts, and ourbusiness and results of operations could suffer.

 

***Widespreadblocking or erasing of cookies or limitations on our ability to use cookies mayimpede our ability to collect information with our technology and reduce thevalue of that data.***

 

Our technology currentlyuses cookies, which are small files of information placed on an Internet user’scomputer, to collect information about the user’s visits to the websites of ourcustomers. Third-party software and our own technology make it easy for usersto block or delete our cookies. Several software programs, sometimes marketedas ad-ware or spyware detectors, block our cookies by default or prompt usersto delete or block our cookies. If a large proportion, such as a majority, ofusers delete or block our cookies, this could undermine the value of the datathat we collect for our customers and could negatively impact our ability todeliver accurate reports to our customers, which would harm our business.

 

Changes in web browsers mayalso encourage users to block our cookies. Microsoft, for example, frequentlymodifies its Internet Explorer web browser. Some modifications by Microsoftcould substantially impair our ability to use cookies for data collectionpurposes. If that happens and we are unable to adapt our technology andpractices adequately in response to changes in Microsoft’s technology, then thevalue of our services will be substantially impaired. Additionally,

 

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other technologies could bedeveloped that impede the operation of our services. These developments couldprevent us from providing our services to our customers or reduce the value ofour services.

 

In addition, laws regulatingthe use of cookies by us and our customers could also prevent us from providingour services to our customers or require us to employ alternative technology. AEuropean Union Directive currently being implemented by member countriesrequires us to tell users about cookies placed on their computers, describe howwe and our customers will use the information collected and offer users theright to refuse a cookie. Although no European country currently requires consentprior to delivery of a cookie, one or more European countries may do so in thefuture. If we were required to obtain consent before delivering a cookie or ifthe use or effectiveness of cookies is limited, we would be required to switchto alternative technologies to collect user profile information, which may notbe done on a timely basis, at a reasonable cost, or at all.

 

***We may not realize expected benefits from our acquisition of Lyris.***

 

We expect our acquisitionof Lyris to result in additional net revenues for the Company.  Achieving the benefits of our acquisition ofLyris will depend in part on our integration of its operations and personnel,and our demonstration to customers that the acquisition will not result inadverse changes in client service standards.

 

With respect to theintegration of personnel, despite our efforts to retain the key employees ofLyris, we may not be successful, as competition for qualified management andtechnical employees in Lyris’ industry is intense.  We may also be perceived to have a differentcorporate culture and these key employees may not want to work for a larger,publicly-traded company.  In addition,competitors may recruit these key employees during the integrationprocess.  As a result, these key employeescould leave with little or no prior notice, which could impede the integrationprocess and harm our business, financial condition and operating results.  In connection with the acquisition certainkey employees have entered into employment agreements that will restrict theirability to compete with us if they leave. We cannot assure you of theenforceability of these non-competition agreements or that these employees willcontinue to work with us under their employment agreements.

 

***Lyrisis a relatively young company with a limited history of operating results****.*

 

Lyris is a relativelyyoung company with no long-term history of developing its internal managementand administration processes.  If itcannot continue to develop these internal processes, its long-term results maysuffer.

 

***We may need toraise additional capital to achieve our business objectives, which could resultin dilution to existing investors or increase our debt obligations.***

 

We require working capitalto fund our business. If capital requirements vary materially from thosecurrently planned, we may require additional financing sooner than anticipated.Our capital requirements depend on several factors, including the rate ofmarket acceptance of our products, the ability to expand our client base andthe growth of sales and marketing. Additional financing may not be availablewhen needed, on terms favorable to us or at all. If adequate funds are notavailable or are not available on acceptable terms, we may be unable to developor enhance our services, take advantage of future opportunities or respond tocompetitive pressures, which would harm our operating results and adverselyaffect our ability to sustain profitability.

 

**Risks related to ourCompany and Investment in our Common Stock**

 

***Internet-related stock prices areespecially volatile and this volatility may depress our stock price or cause itto fluctuate significantly.***

 

The stock market and the trading prices ofInternet-related companies in particular, have been notably volatile. Thisvolatility is likely to continue in the short-term and is not necessarilyrelated to the operating performance of affected companies. This broad marketand industry volatility could significantly reduce the price of our commonstock at any time, without regard to our operating performance. Factors thatcould cause our stock price in particular to fluctuate include, but are notlimited to:

 

•       actualor anticipated variations in quarterly operating results;

 

•       announcementsof technological innovations by others or us;

 

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•       acceptanceby consumers of technologies of companies other than us;

 

•       theability to sign new clients and the retention of existing clients;

 

•       newproducts or services that we offer;

 

•       competitivedevelopments including new products or services, or new relationships by ourcompetitors;

 

•       changesthat affect our clients or the viability of their product lines;

 

•       changesin financial estimates by securities analysts;

 

•       conditionsor trends in the Internet and online commerce industries;

 

•       globalunrest and terrorist activities;

 

•       changesin the economic performance and/or market valuations of other Internet oronline e-commerce companies;

 

•       requiredchanges in generally accepted accounting principles and disclosures;

 

•       ourannouncement of significant acquisitions, strategic partnerships, jointventures or capital commitments or results of operations or other developmentsrelated to those acquisitions;

 

•       additionsor departures of key personnel; and

 

•       sales orother transactions involving our common stock.

 

***Our executive officers and directors havecontrol over our affairs.***

 

As of June 30, 2005 our executive officers anddirectors and entities affiliated with them beneficially own, in the aggregate,approximately 39% of our common stock. As a group they will likely be able to control our business. Thesestockholders will have the ability to exert substantial influence over allmatters requiring approval by our stockholders, including the election andremoval of directors and any merger, consolidation or sale of all orsubstantially all of our assets. This concentration of ownership could have theeffect of delaying, deferring or preventing a change of control or impeding amerger or consolidation, takeover or other business combination.

 

***We are a small company withoutsecurities analyst coverage at the present time and there is limited trading ofour stock.***

 

Trading markets for common stock rely in part on theresearch and reports that industry or financial analysts would publish about usor our business. Currently, no securities analysts cover our stock.  As a result, we lack visibility in themarket.  In addition, if one or more ofthe analysts does initiate coverage with an unattractive rating our stock pricewould likely decline rapidly.  There isalso little liquidity in the trading of our stock and therefore it may be moredifficult for investors to sell common stock in our company.  Sales of large blocks of stock may have asignificantly greater negative impact because of the lack of liquidity.

 

***The stock transfer restrictions implemented in the merger of NAHC, Inc.and J. L. Halsey Corporation may delay or prevent takeover bids by thirdparties and may delay or frustrate any attempt by stockholders to replace orremove the current management.***

 

The shares of common stock issued by the Company in the merger are subject to the transfer restrictions that, in general, prevent any individual stockholder or group of stockholders from acquiring in excess of 5% of the outstanding common stock of the Company. The types of acquisition transactions that the Company may undertake therefore will be limited unless the board of directors waives the transfer restrictions. The transfer restrictions also may make it more difficult for stockholders to replace current management because no single stockholder may cast votes for more than 5% of the Company’s outstanding shares of common stock, unless that stockholder held more than 5% of our common stock before the merger.

 

***The Company may not be able to realize the benefits of our NOL carryforwards.***

 

Our ability to use our potential tax benefits in future years will depend upon the amount of our otherwise taxable income. If Lyris generates insufficient taxable income in future years, the NOLs will not be needed or used and therefore will provide no benefit to the Company. If the Company experiences a change of ownership within the meaning of Section

 

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382 of the Internal RevenueCode, the Company will not be able to realize the benefit of its net operatingloss, capital loss and tax credit carryforwards.

 

***There are uncertainties related to legacyassets and liabilities.***

 

The Company continues to manage arelatively small number of legacy assets and liabilities remaining from theperiod prior to the sale of its operating businesses in 1999.   These remaining legacy assets consist ofrestricted cash, old receivables that are the subject of litigation or arbitration,and appeals of Medicare related claims. The Company has established significant reserves against these assetsbecause of the uncertainty regarding their collectability.

 

The Company is defending tworemaining suits against us. Our management believes that we should prevail oneach of these claims against us. However, there is uncertainty and cost related to the claims.   The outcome of these matters is not possibleto predict and the current reserves include only estimates of the costs oflitigating, but do not reflect the possibility of a settlement, an adverseruling or a judgment against the Company. For more information regarding theselawsuits, please see Note 12 to our consolidated financial statements.

 

***Provisions in our certificate of incorporationand bylaws might discourage, delay or prevent a change of control of ourcompany or changes in our management and, therefore, depress the trading priceof our common stock.***

 

Our amended and restated certificate ofincorporation and bylaws contain provisions that could depress the tradingprice of our common stock by acting to discourage, delay or prevent a change ofcontrol of our company or changes in our management that the stockholders ofour company may deem advantageous. These provisions:

 

•                  establish a classified board of directors sothat not all members of our board are elected at one time;

•                  provide that directors may only be removed “forcause” and only with the approval of 66 2/3% of our stockholders;

•                  require super-majority voting to amend someprovisions in our amended and restated certificate of incorporation;

•                  authorize the issuance of “blank check”preferred stock that our board of directors could issue to increase the numberof outstanding shares to discourage a takeover attempt;

•                  provide that the board of directors isexpressly authorized to make, alter or repeal our bylaws; and

•                  establish advance notice requirements fornominations for elections to our board or for proposing matters that can beacted upon by stockholders at stockholder meetings.

 

***We will incur significant costs as a resultof being a public company****.*

 

As a public company, we will incur significantlegal, accounting and other expenses that Lyris did not incur as a privatecompany. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules implementedby the Securities and Exchange Commission, require changes in corporategovernance practices of public companies. We expect these new rules andregulations to significantly increase Lyris’ legal and financial costs.

 

***New accountingstandards or interpretations of existing accounting standards could adverselyaffect our operating results****.*

 

Generally acceptedaccounting principles in the United States are subject to interpretation by theFinancial Accounting Standards Board, the American Institute of CertifiedPublic Accountants, the SEC and various bodies formed to promulgate andinterpret appropriate accounting principles. A change in these principles orinterpretations could have a significant effect on our reported financialresults, and could affect the reporting of transactions completed before theannouncement of a change.

 

For example, we recognizesoftware license revenue in accordance with Statement of Position, or SOP 97-2,*Software Revenue Recognition,* asamended by SOP 98-9, *Software RevenueRecognition with Respect to Certain Transactions*. The AmericanInstitute of Certified Public Accountants and the SEC continue to issueinterpretations and guidance for applying the relevant accounting standards toa wide range of sales contract terms and business arrangements that areprevalent in software licensing arrangements. As a result of futureinterpretations or applications of existing accounting standards, includingSOP 97-2 and SOP 98-9, by regulators or our internal or independentaccountants, we could be required to delay revenue recognition into futureperiods, which would adversely affect our operating results.

 

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Certain factors have in thepast and may in the future cause us to defer recognition for license feesbeyond delivery. Because of these factors and other specific requirements underaccounting principles generally accepted in the United States for softwarerevenue recognition, we must have very precise terms in our softwarearrangements in order to recognize revenue when we initially deliver softwareor perform services. Negotiation of mutually acceptable terms and conditionscan extend our sales cycle, and we may accept terms and conditions that do notpermit revenue recognition at the time of delivery.

 

In May 2005,the Financial Accounting Standards Board (FASB) issued SFAS No. 154, *Accounting Changes and Error Corrections. *SFAS No. 154 establishes newstandards on accounting for changes in accounting principles.  Pursuant to the new rules, all such changesmust be accounted for by retrospective application to the financial statementsof prior periods unless it is impracticable to do so.  SFAS No. 143 supersedes AccountingPrinciples Bulletin (APB) Opinion 2, *Accounting for Changes*andSFAS No. 3, *Reporting Accounting Changes in InterimFinancial Statements,*though it carries forward the guidance ofthose pronouncements with respect to amounting for changes in estimates,changes in the reporting entity, and error corrections.  This statement is effective for accountingchanges and effort corrections made in years beginning after December 15,2005, with early adoption permitted for changes and corrections made in yearsbeginning after May 2005.  The Companydoes not expect adoption of SFAS No. 154 to have a material impact on theCompany’s financial statements.

 

In March 2005,the SEC issued SAB No. 107 which offers guidance on SFAS No. 123(R).  SAB No. 107 was issued to assistpreparers by simplifying some of the implementation challenges of SFAS No. 123(R)while enhancing the information that investors receive.  SAB No. 107 creates a framework that ispremised on two overarching themes: (a) considerable judgment will berequired by preparers to successfully implement SFAS No. 123(R),specifically when valuing employee stock options; and (b) reasonableindividuals, acting in good faith, may conclude differently on the fair valueof employee stock options.  Key topicscovered by SAB No. 107 include valuation models, expected volatility andexpected term.  The Company expects toapply the principles of SAB No. 107 in conjunction with the adoption ofSFAS No. 123(R).

 

In December 2004,the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123R), *Share-Based Payment. *SFASNo. 123(R) replaces SFAS No. 123, *Accounting for Stock-BasedCompensation*and supersedes APB Opinion No. 25.  Generally, the approach in SFAS No. 123(R)is similar to the approach described in SFAS No. 123 for fair value.However, SFAS No. 123(R) requires all share-based payments to employees,including grants of employee stock options, to be recognized in the financialstatements based on their fair values and prohibits pro forma disclosure as analternative to financial statement recognition. SFAS No. 123(R) is effective for the Company beginning in the firstquarter of fiscal 2006.  The Companyexpects the adoption of SFAS 123(R) to have an impact on our financialstatements.

 

In December 2004,the FASB issued SFAS No. 153 *Exchange of Non-monetaryAssets—An Amendment of APB Opinion No. 29. *The provisions of this statement are effective for nonmonetary asset exchanges occurring in periods beginning after June 15,2005.  This statement eliminates theexception to fair value for exchanges of similar productive assets and replacesit with a general exception for exchange transactions that do not havecommercial substance—that is, transactions that are not expected to result insignificant changes in the cash flows of the reporting entity.  The Company does not expect the adoption ofSFAS No. 153 to have a significant impact on its consolidated financialstatements.

 

In November 2004,FASB issued SFAS No. 151, *Inventory Costs*thatamends the guidance in Accounting Research Bulletin (ARB) No. 43, Chapter4, *Inventory Pricing,* (ARB No. 43) toclarify the accounting for abnormal amounts of idle facility expense, freight,handling costs, and wasted material (spoilage). In addition, this statement requires that an allocation of fixedproduction overheads to the costs of conversion be based on the normal capacityof the production facilities.  SFAS No. 151is effective for inventory costs incurred during years beginning after June 15,2005.  The Company does not expect theadoption of SFAS No. 151 to have an impact on its consolidated financialstatements.

 

In July 2002,*The Public Company Accounting Reform and InvestorProtection Act of 2002*(the Sarbanes-Oxley Act) was enacted.  Section 404 of the Sarbanes-Oxley Actstipulates that public companies must take responsibility for maintaining aneffective system of internal control. The act requires public companies to report on the effectiveness oftheir control over financial reporting and obtain an attestation report fromtheir independent registered public accounting firm about management’sreport.  The act requires most publiccompanies (accelerated filers) to report on the company’s internal control overfinancial reporting for years ending on or after November 15, 2004.  Other public companies (non-acceleratedfilers) must begin to comply with the new requirements related to internalcontrol over financial reporting for their first year ending on or after July 15,2007 under the latest extension granted by the SEC.  J.L. Halsey Corporation is a non-acceleratedfiler and therefore expects to comply with the regulations of Section 404for its reporting period ending June 30, 2008.

 

16

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**Intellectual Property**

 

**We havefiled one patent application that covers some of the technology developed forEmailAdvisor.  We enter intoconfidentiality and proprietary rights agreements with our employees,consultants, and other third parties in order to try to protect our trade secretsand intellectual property.  In recentyears, many software companies have filed patents covering theirtechnologies.  Many of these patents haveyet to be litigated.  We are aware of onepatent application whose owner claims that our software infringes at least oneclaim in that patent.  We have obtained alicense to this patent instead of litigating it. This patent is currently beinglitigated by a number of defendants in the email marketing business. Others maydevelop technologies that are similar or superior to our technology and may receiveand enforce patents on such technology.**

** **

**Insurance**

** **

The Company currentlypurchases insurance policies to cover the ongoing liability and property risksarising out of the current operations.

 

Although the Companypurchased professional liability tail coverage insurance for periods prior tothe sales of its previous healthcare businesses, the insurer, PHICO InsuranceCompany, has been declared insolvent and is no longer able to pay claims onbehalf of the Company (see “Legal Proceedings”).

 

**Employees**

** **

At June 30, 2005, the Company had 48employees, of which 44 were employed by Lyris and 4 were employed by othersubsidiaries of the Company. The Company’s employees are not represented by anylabor union and the Company is not aware of any current activity to organizeany of its employees.

 

**ITEM 2.**                             PROPERTIES

 

Halsey’s principal office is located at 103 FoulkRd, Suite 205Q, Wilmington, DE19803 where Halsey leasesapproximately112 square feet of office space. Our subsidiaries lease office space inCalifornia, Delaware, Pennsylvania and Nevada.

 

A summary of our significant leased officefacilities are as follows:

 
| **Location**                         | ** ** | **Approximate Number of  Square Feet Leased** | ** ** | **Expiration of Lease** | ** ** |
|--------------------------------------|------------|-----------------------------------------------|------------|-------------------------|------------|
|                                 |       |                                          |       |                    |       |
| Berkeley,  California                |       | 11,900                                        |       | December 2005      |       |
| King of  Prussia, Pennsylvania       |       | 2,600                                         |       | January 2006       |       |
| Loveland,  Colorado                  |       | 945                                           |       | November 2006      |       |
| Simi Valley,  California             |       | 640                                           |       | November 2005      |       |
| North  Andover, Massachusetts        |       | 400                                           |       | September 2005     |       |
| Wilmington,  Delaware (Headquarters) |       | 112                                           |       | September 2005     |       |

 

17

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Our remaining leaseobligations as of June 30, 2005 for all of our facilities are $214,445.

 

**ITEM 3.**                             LEGALPROCEEDINGS

 

Walmsleyand Sullivan v. NAHC, Inc. et. al.  Duringthe third quarter of fiscal 2002, this action was filed in the Court of CommonPleas for the County of Philadelphia, PA by Walmsley and Sullivan, two formeremployees against the Company and its officer and directors.  The suit seeks damages in excess of $3million as a result of alleged breaches of contracts to pay certain bonuses,and other claims.  The Company stronglydisagrees with the allegations in the complaint and intends to vigorouslydefend this action.  The Company has suedboth Walmsley and Sullivan in federal court in Arizona.  This suit claims damages related to bonusespaid to Walmsley and Sullivan. During the third quarter of fiscal 2004 severaldepositions were completed in this case and more are expected in the nearfuture. **The Company receivednotice on May 6, 2005, that the presiding judge issued an ordertransferring the matter from the District of Arizona to the Eastern District ofPennsylvania for the convenience of the witnesses. In addition, the orderdenied the Company’s partial motion for summary judgment on its fraud, negligent misrepresentationand breach of fiduciary duty claim against Walmsley and Sullivan due to amaterial issue of fact to be resolved at trial. Halsey believes, at present,that it is likely**that this case will settle inthe second quarter. The Company believes that it has adequately accrued for thecosts to defend this case as of June 30, 2005.

 

NovaCare v. Stratford Nursing Home.  The Company filed this collection lawsuitover three years ago to collect on a receivable of approximately $145,000, whichthe Company has fully reserved. Stratford counter-claimed with numerous theories asserting that theCompany instead owed Stratford money. Although Stratford’s principal claims were dismissed by the court,Stratford, in the last quarter of fiscal year 2003, has quantified itsremaining counter-claims at approximately $1 million.  The Company believes that the theories onwhich these damages are based are inconsistent with the contract between theparties and with the conduct of each party. As of June 30, 2005, this case is pending in the U.S. District Court forthe Southern District of New Jersey (Camden). The outcome of this action is not possible to predict and the Companyhas reserved an estimate of the cost of litigating this action, but this estimatedoes not reflect the possibility of an adverse ruling or a judgment against theCompany or a settlement.

 

Uninsured Professional Liability Claims.**The Company is a defendant in two professional liabilityclaims and had previously purchased professional liability insurance policiesfrom PHICO Insurance Company.  On February 2,2002, a Pennsylvania court authorized state insurance regulators to liquidatethe insolvent PHICO Insurance Company, which had provided professionalliability insurance policies to the Company. As a result, PHICO will not bepermitted to pay any claims on behalf of the Company.  The Company believes, however, that stateinsurance guaranty funds will pay most of the amounts due on the remaining claimson the Company’s behalf.  Based on itsdiscussion with the state guaranty funds and its review of claims during thethird quarter of 2004, the Company now believes that a payment may be requiredto settle one professional liability claim that may exceed the amount availableto the Company under the applicable state guaranty fund limits.  The Company recorded an accrual and relatedexpense in the third quarter of 2004 equal to the estimated cost to settle thatclaim less the amount that would be paid by the state guaranty fund. TheCompany believes that the other claim will not exceed the amount available tothe Company under the applicable state guaranty fund limit. There is noassurance, however, that each of the claims will settle within those limits andthere is no excess insurance policy in place that would pay settlements orawards in excess of those limits. Therefore, in the event that the Company’s current assessment isincorrect, and the amounts required to pay on these claims are in excess of anyamounts paid by guaranty funds, the Company will be required to fund theseclaims.

 

**ITEM 4.****                             SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

At the Annual Meeting ofthe Company’s stockholders held on April 7, 2005, (the “Annual Meeting”),the following nominee was elected to serve on Halsey’s Board of Directors as a Class IIIDirector until the Annual Meeting of the Company’s Stockholders in 2007 oruntil his earlier death, resignation or removal from office.

 

18

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| **Name**                      | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** | **Abstentions** | ** ** | **Broker Non-Votes** | ** ** |
|-------------------------------|------------|---------------|------------|--------------------|------------|-----------------|------------|----------------------|------------|
|                          |       |          |       |               |       |            |       |                 |       |
| William T.  Comfort, III |       | 60,266,784    |       | 259,024            |       | 0               |       | 943,826              |       |

 

In addition to Mr. Comfort, David R.Burt, Andrew Richard Blair and Nicholas DeSantis Cuadra continued as directorsafter the Annual Meeting.

 

19

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**PART II**

 
| **ITEM 5.** | **MARKET  FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER  PURCHASES OF EQUITY SECURITIES** |
|-------------|-------------------------------------------------------------------------------------------------------------------------|

 

The Company’s commonstock is traded on the Over-the-Counter Bulletin Board (“OTCBB”) under thesymbol JLHY.  Trading of the Company’scommon stock on OTCBB commenced on December 3, 1999.  The Company’s common stock was traded on theNew York Stock Exchange (the “NYSE”) under the symbol NOV until November 22,1999.  The Company’s common stock tradedon the OTCBB under the symbol NAHC until June 17, 2002.  On August 29, 2005 there were 1,266holders of record of common stock.

 

The following table setsforth the high and low bids per share of common stock on the OTCBB for therelevant periods, and reflect inter-dealer prices, without retail mark-up,mark-down or commission and thus may not necessarily represent actualtransactions.

 
| ** **                          | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------|------------|----------|------------|---------|------------|
|                                |       |     |       |    |       |
| **Year  Ended June 30, 2005:** |       |     |       |    |       |
| First  Quarter                      |       | $        | 0.35       |    | $          | 0.25 |   |
| Second Quarter                      |       | 0.38     |       | 0.29    |       |
| Third  Quarter                      |       | 0.35     |       | 0.30    |       |
| Fourth  Quarter                     |       | 0.68     |       | 0.27    |       |
|                                |       |     |       |    |       |
| **Year  Ended June 30, 2004:** |       |     |       |    |       |
| First  Quarter                      |       | $        | 0.20       |    | $          | 0.11 |   |
| Second  Quarter                     |       | 0.29     |       | 0.16    |       |
| Third  Quarter                      |       | 0.31     |       | 0.19    |       |
| Fourth  Quarter                     |       | 0.44     |       | 0.26    |       |

 

With the exception of 2-for-1stock splits of common stock affected in the form of stock dividends in June 1987and July 1991, no other dividends have been paid or declared on commonstock since the Company’s initial public offering on November 5,1986.  The Company does not expect todeclare any cash dividends on common stock in the foreseeable future.

 

On May 6, 2005, theCompany sold 773,333 shares of its own common stock held in treasury to certainemployees of the Company and Lyris at the then current market price of thestock of $.30 per share.  No underwriterswere used in the sale.  The sale wasexempt from registration in reliance on Regulation D promulgated under theSecurities Act of 1933, as amended, based on the fact that the amount of theoffering did not exceed five million dollars, that there were no more thanthirty-five purchasers (excluding accredited investors), and that no generalsolicitation occurred.  Notice of thesale was filed on Form D on May 26, 2005.

 

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**ITEM 6.**                             SELECTEDFINANCIAL DATA

 

The following selectedfinancial data should be read in conjunction with the Company’s consolidatedfinancial statements and the accompanying notes presented elsewhere herein.

 

The Company had disposedof its previous healthcare operating segments in 1999.  From that time period until May 11,2005, the Company’s activities had consisted of managing the legal proceedingsagainst it, attempting to realize its assets, general administrative mattersand searching for potential acquisition candidates.

 

Our results of operationsfor the year ended June 30, 2005 includes the results of the acquisitionof Lyris on May 12, 2005. The selected financial data below includes dataof Lyris from May 12, 2005 through the end of our fiscal year of June 30,2005 only. Accordingly, the accompanying selected financial data for periodsprior to May 12, 2005 does not include Lyris and reflects the Company’sassets and liabilities and results of operations as discontinued operationsexcept for its remaining general and administrative activities which weretreated as continuing operations. See Note 3 of our consolidated financialstatements as of and for the year ended June 30, 2005 for pro formafinancial information as if this acquisition had occurred on July 1, 2004and 2003.

 

**J. L. HALSEY CORPORATION AND SUBSIDIARIESFIVE YEAR FINANCIAL SUMMARY**

 
| ** **                                                               | ** ** | **Years  Ended June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **2005  (1)**                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                                                     |       |                           |       |   |   |   |   |   |   |   |   |
| **Statement of Operations Data:**                                        |       |                           |       |   |   |   |   |   |   |   |   |
| Revenue                                                                  |       | $                              | 2,207,099  |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Gross Profit                                                             |       | 1,760,183                      |       | — |   | — |   | — |   | — |   |
| Loss from continuing operations                                          |       | (434,492                       | )          | (2,186,248 | ) | (3,189,160 | ) | (3,065,542 | ) | (4,575,864 | ) |
| Gain on disposal of discontinued  operations, net of tax                 |       | 281,030                        |       | 4,940,828 |   | 4,066,677 |   | 21,254,826 |   | 3,744,466 |   |
| Income tax provision                                                     |       | (76,781                        | )          | — |   | — |   | — |   | — |   |
| Net (loss) income                                                        |       | (230,243                       | )          | 2,754,580 |   | 877,517 |   | 18,189,284 |   | (831,398 | ) |
| Loss per share from continuing operations                                |       |                           |       |   |   |   |   |   |   |   |   |
| Basic and diluted                                                        |       | (0.01                          | )          | (0.03 | ) | (0.04 | ) | (0.05 | ) | (0.07 | ) |
| Net (loss) income per share:                                             |       |                           |       |   |   |   |   |   |   |   |   |
| Basic and diluted                                                        |       | (0.00                          | )          | 0.03 |   | 0.01 |   | 0.28 |   | (0.01 | ) |
| Weighted average shares used in basic and  diluted per share calculation |       | 82,296,880                     |       | 82,193,063 |   | 83,097,263 |   | 65,306,280 |   | 63,364,280 |   |
|                                                                          |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                | ** ** | **As  of June 30,** | ** ** |
|---------------------------|------------|--------------------------|------------|
| ** **                | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|                      |       |                     |       |   |   |   |   |   |   |   |   |
| **Balance Sheet Data:**   |       |                     |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents |       | $                        | 3,101,511  |   | $ | 28,880,201 |   | $ | 23,219,618 |   | $ | 11,631,692 |   | $ | 5,686,950 |   |
| Total assets              |       | 38,823,407               |       | 31,643,479 |   | 29,142,504 |   | 34,502,039 |   | 25,225,715 |   |
| Long term debt (2)        |       | 5,600,000                |       | — |   | — |   | — |   | — |   |
| Shareholders’ equity |       | 27,081,768               |       | 27,080,011 |   | 24,325,431 |   | 23,114,144 |   | 4,872,735 |   |
|                           |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)                                  Includesinformation from Lyris Technologies Inc. as of the acquisition date of May 12,2005 through June 30, 2005. Amounts in previous years do not includeamounts from Lyris.

 

(2)                                  Representscontingent note payable incurred as part of the acquisition of LyrisTechnologies on May 12, 2005.  (SeeNote 5).

 

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| **ITEM 7.** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|-------------------------------------------------------------------------------------------------|

 

***Thefollowing discussion contains forward-looking statements that involve risks anduncertainties. Our actual results could differ materially from those discussedbelow. Additional factors that could cause or contribute to such differencesinclude, but are not limited to, those identified below, and those discussed inthe section entitled “Risk Factors”, included elsewhere in this report.When used in this document, the words “believes,” “expects,” “anticipates,” “intends,”“plans” and similar expressions, are intended to identify certain of theseforward-looking statements. However, these words are not the exclusive means ofidentifying such statements. In addition, any statements that refer toexpectations, projections or other characterizations of future events orcircumstances are forward-looking statements. The cautionary statements made inthis document should be read as being applicable to all related forward-lookingstatements wherever they appear in this document. You should read the followingdiscussion in conjunction with our Consolidated Financial Statements andrelated notes.***

 

*Overview*

* *

Halsey, through its wholly-owned subsidiary, Lyris is a leading emailmarketing firm.  Lyris’ email marketingsoftware and services provide clients with leading solutions for creating,managing and delivering online permission-based direct marketing programs,newsletters, discussion groups and other digital communications to clients’whose email lists require specialized technology in order to effectivelycommunicate with their members and customers. Lyris offers its email solutions in two forms:  as software that is downloaded and installedon a customer’s computers; and as a hosted solution in which the customer usesLyris’ software through an internet connection.

 

On May 12, 2005, Halsey acquired all of theoutstanding capital stock of Lyris for $30.7 million in cash, which included cashpayments of $25.1 million (including acquisition costs and workingcapital adjustments of $1.2million) and $5.6 million in the form of a promissory note payable, subject toLyris’ achieving specified revenue targets, on the second anniversary of the closingdate with interest equal to 10% per annum. With this acquisition, Halsey has become a leading email marketingcompany with over 5,000 customers worldwide.

 

Halsey is the successorto NovaCare, which was a national leader in physical rehabilitation services,orthotics and prosthetics and employee services. The changes to Medicarereimbursement in the late 1990’s had deleterious effects on NovaCare and itscompetitors and customers.    The prioroperating business most affected by the Medicare changes was the long-term careservices segment in which NovaCare provided therapists to skilled nursingfacilities.  This business was disposedof in fiscal 1999 with the shutdown of certain of its operations in the WesternUnited States during the third fiscal quarter and the sale of the remainingoperations on June 1, 1999. NovaCare’s former outpatient services segmentwas disposed of through the sales of its orthotics and prosthetics (O&P)and physical rehabilitation and occupational health (PROH) businesses. TheO&P business was sold to Hangar Orthopedic Group, Inc. in July of1999 and the PROH business was sold to Select Medical Corporation in November of1999.  The Company’s former employeeservices segment was disposed of through NovaCare’s sale of its interest inNovaCare Employee Services (“NCES”) in October of 1999 to a subsidiary ofPlato Holdings, Inc. as part of a tender offer by Plato for all of NCES’soutstanding shares.  With cash raisedfrom the sales of its businesses, the Company repaid all of its bank debt inthe summer of 1999, and in January of 2000, the Company retired itspublicly-traded subordinated debt.

 

NovaCare sold its name aspart of the sale of the PROH business and subsequently changed its name to NAHC, Inc.  On June 18, 2002, in a transactionapproved by NAHC’s stockholders at a special meeting, NAHC merged with and intoHalsey, its wholly-owned subsidiary.  The purpose of the merger between NAHC and Halsey was to implementtransfer restrictions on the Company’s common stock in order to preserve theCompany’s net operating losses.

 

Prior to the Lyris acquisition, the Company hasspent the past several years maximizing the assets that it had retained,including old accounts receivable, Medicare receivables and appeals, and taxitems and to minimize liabilities retained after the sales of the operatingbusinesses.  The Company has madesignificant progress on these matters. The Company has collected virtually all of its receivables other thanamounts which are the subject of litigation or arbitration or that have beenwritten off. A subsidiary of the Company has retained four****employeesand two consultants to carry out the general and administrative functionsspecified above. These resources have been supplemented with outside financial,tax, legal and systems resources when required by management and theboard.  No members of the current boardwere members prior to the Company selling its operating businesses.

 

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**Our Products and Services**

 

***ListManager***. Corporations, governments, not-for-profit organizations, politicalcampaigns, athletic teams, and schools have large lists of people with whomthey want to communicate by email.  Theselists can range from hundreds to thousands to millions of email addresses.  For the past ten years, Lyris has developedand licensed software, called *ListManager*,which can manage these email address lists. This software enables customers todevelop, send and monitor complex email mailings reliably.   The software also permits organizations todesign email campaigns that are customized to their members’ preferences.Customers can obtain the benefits of the *ListManager*functionality in two ways: first by installing software on their corporatenetwork; or second, by logging onto Lyris’ servers via the internet on aso-called “hosted basis.”

 

Lyris offers hosted email marketing solutions based on the *ListManager*platform under two brands: *ListHosting*and*SparkList*.  These services enable clients to create, sendand monitor email campaigns with only a web browser and without the need fortheir own engineering and equipment support. For these clients, email administration and security are outsourced andthey can manage mailing lists, as well as direct marketing campaigns,newsletters and discussion groups while supported by Lyris’ data facility andtechnical staff.

 

Over ninety percent (90%) of Lyris’ revenues come from the licensing of*ListManager* software, the sale ofsupport and maintenance services for *ListManager* softwareand from the licensing of the use of *ListManager* ona “hosted” basis.

 

***Other Products***. In November 2004, Lyris acquired PiperSoftware company and its *EmailAdvisor*product.  With this acquisition, Lyrisacquired another product that is licensed on a hosted basis.   *EmailAdvisor* isa deliverability monitoring tool which helps facilitate the delivery oflegitimate email while taking into account the complexity of different emailprograms.   With the tremendous increasein spam (see “Government Regulation” below), many ISPs (internet serviceproviders), network administrators and individuals have begun deployinganti-spam filters to prevent spam from entering their email inboxes.  Many of these anti-spam filters unfortunatelyblock legitimate emails that people want to receive.  *EmailAdvisor*helps email senders minimize the chance that legitimate email which a memberwants to receive is wrongly blocked.

 

Lyris also sells email security and antispam software.  This product, called *MailShield*,is a server-based email filtering application that allows organizations toproactively manage and prevent unauthorized inbound and outbound email.  *MailShield* isused at the enterprise level to block spam and email viruses, prevent relayabuse, by which spammers exploit servers to send their mail, and also filtercontent contained in outbound mail

 

Finally, Lyris offers another software product called *MailEngine*.  *MailEngine* is an SMTP Mail Transfer Agent (“MTA”).  This is the software that actually sends theemail out through the internet’s mail system. Companies partner *MailEngine* withtheir own internal systems to send high volumes of email.

 

*Acquisitionof Lyris and Comparability of Operations*

 

Our results of operationsfor the year ended June 30, 2005 includes the results of the acquisitionof Lyris on May 12, 2005. The results of this acquisition must be factoredinto any comparison of our 2005 results to the results of 2004 and 2003. Seenote 3 of our consolidated financial statements as of and for the year ended June 30,2005 for pro forma financial information as if this acquisition had occurred onJuly 1, 2004 and 2003.

 

*CriticalAccounting Policies and Use of Estimates*

 

Ourfinancial statements are prepared in accordance with accountingprinciples generally accepted in the United States, or GAAP.  The application of GAAP requires that we makeestimates that affect our reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period.  We base our estimateson historical experience and on various other assumptions that we believe to bereasonable under the circumstances.  Weevaluate our estimates and assumptions on an ongoing basis.  Our actual results may differ significantlyfrom these estimates.

 

We believe that of oursignificant accounting policies, which are described in Note 2 to our financialstatements, the following accounting policies involve a greater degree ofjudgment and complexity. Accordingly, these are the policies we believe are themost critical to aid in fully understanding and evaluating our financialcondition and results of operations.

 

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•                  revenuerecognition

•                  valuationallowances and reserves

•                  losscontingencies

•                  accountingfor acquisitions

•                  accountingfor stock-based compensation

•                  accountingfor goodwill, long-lived assets and other intangible assets

•                  accountingfor income taxes

 

**Revenue Recognition**

 

Lyris recognizes revenue from the following primarysources:  (1) licensing softwareproducts; (2) providing customer technical support; and (3) hostedsoftware products.

 

The Companygenerally recognizes revenue when all of the following conditions aresatisfied: (1) there is persuasive evidence of an arrangement; (2) theservice has been provided to the customer (in the case of software licenses,revenue is recognized when the customer is given electronic access to thelicensed software); (3) the amount of fees to be paid by the customer isfixed or determinable; and (4) the collection of fees is probable.

 

The Companyrecognizes software license revenue in accordance with the provisions of SOP 97-2,*Software Revenue Recognition*, andSOP 98-9 *Modification of SOP 97-2, SoftwareRevenue Recognition with Respect to Certain Transactions*.  The Company generally has multiple elementarrangements for its software revenue including software licenses andmaintenance. The Company allocates the arrangement fee to each of the elementsbased on the residual method utilizing vendor specific objective evidence(VSOE) for the undelivered elements, regardless of any separate prices statedwithin the contract for each element. VSOE for maintenance is generally basedon the price the customer would be required to pay when it is sold separately.Fair value for the delivered elements, primarily software licenses andupgrades, is based on the residual amount of the total arrangement fees afterdeducting the VSOE for the undelivered elements. Maintenance revenues,including revenues included in multiple element arrangements, are deferred andrecognized ratably over the related contract period, generally twelve months.

 

Hosting revenue is recognized monthly based on the usagedefined in the agreement.  Excess usageis billed and recognized as revenue as incurred.

 

# **Deferred Revenue**

# ** **

Deferred revenue represents customer billings madein advance for annual support contracts. Maintenance is typically billed on aper annum basis in advance and revenue is recognized ratably over themaintenance period.

 

**Allowance for Doubtful Accounts**

** **

The Company’s policies for allowances for doubtful accounts for itscurrent operations (Lyris) and its previous healthcare discontinued operationsare as follows:

 

Continuing operations

 

We regularly assess our ability to collect outstanding customerinvoices and in so doing must make estimates of the collectibility of accountsreceivable.  We provide an allowance fordoubtful accounts when we determine that the collection of an outstandingcustomer receivable is not probable.  Wespecifically analyze accounts receivable and historical bad debts experience,and changes in our customer payment history when evaluating the adequacy of theallowance for doubtful accounts.  If anyof these factors change, our estimates may also change, which could affect thelevel of our future provision for doubtful accounts.

 

Discontinued operations

 

The Company maintainsallowances for the collection of its receivables remaining from discontinuedoperations.  These allowances are theresult of the inability or unwillingness of many of the Company’s formerhealthcare customers to make payments. Several of the key industries in which the Company previously operatedwere severely impacted by the Balanced Budget Act of 1997.  As a result of the provisions of this Act,many of the Company’s former customers went bankrupt and many are nearlyinsolvent. Currently, the Company has outstanding receivables from a few ofthese customers and has recorded 100% allowances against these receivables. TheCompany is pursuing collection from two of its former customers throughlitigation.

 

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On a quarterly basis, theCompany reviews the value of the reserves and adjusts the net value of thereceivables to the estimated amount that management expects to realize. Whenfacts and circumstances indicate that an account has been impaired below itscurrent carrying value, the Company will adjust the reserve accordingly.  When a customer files for bankruptcy or otherfacts and circumstances dictate that the associated receivable will not becollectible at any future period, the Company fully reserves the receivable.  Generally when there has been a significantchange in facts or circumstances and it is reasonably assured collectibility ofa receivable, the Company will release the associated reserves to support theCompany’s change in estimate.

 

There are a few accountsthat make up the Company’s receivables remaining from discontinued operations,all of which are fully reserved because it is highly unlikely that we willcollect the money that it is owed.  As aresult it is inherently difficult to estimate the amount that the Company willrealize upon collection.

 

***Loss Contingencies***

* *

**The Company records estimated loss contingencieswhen information is available that indicates that it is probable that an assethas been impaired or a liability has been incurred and the amount of the losscan be reasonably estimated.  When noaccrual is made for a loss contingency because one or both of these conditionsare not met, or if an exposure to loss exists in excess of the amount accrued,the Company discloses such contingencies when there is at least a reasonable possibilitythat a loss or an additional loss may have been incurred.  Determining the likelihood of incurring aliability and estimating the amount of the liability involves significantjudgment.  If we had used differentassumptions, the amount of loss contingencies recorded could have differedmaterially.  In particular, the Companyhas estimated that the Walmsley case will not result in a judgment against theCompany.  If the outcome of thelitigation is more adverse to the Company than management currently expects,then the Company may have to record additional charges in the future and suchcharges could be significant.**

 

**Accounting for Acquisitions**

 

Significant judgment isrequired to estimate the fair value of purchased assets and liabilities at thedate of acquisition, including estimating future cash flows from the acquiredbusiness, determining appropriate discount rates, asset lives and otherassumptions. Our process to determine the fair value of the non-competeagreements, customer relationships and developed technology includes the use ofestimates including: the potential impact on operating results if thenon-compete agreements were not in place; revenue estimates for customersacquired through the acquisition based on an assumed customer attrition rate;estimated costs to be incurred to purchase the capabilities gained through thedeveloped technology model; and appropriate discount rates based on theparticular business’s weighted average cost of capital. Our estimates of anentity’s growth and costs are based on historical data, various internalestimates and a variety of external sources, and are developed as part of ourroutine long-range planning process.

 

**Stock-Based Compensation**

** **

We have granted stock options at exercise prices that equaled the fairvalue of our common stock as estimated by our board of directors as of the dateof grant.

 

**Goodwill, Long-Lived Assets and OtherIntangible Assets**

** **

We assess the impairment ofidentified intangibles, long-lived assets and goodwill at least annually andwhenever events or a change in circumstances indicate the carrying value maynot be recoverable. Factors we consider important which could trigger animpairment review include the following:

 

•                  significant underperformance relative tohistorical or expected projected future operating results;

•                  significant changes in the manner of our useof the acquired assets or the strategy for our overall business;

•                  significant negative industry or economictrends;

•                  significant decline in our stock price for asustained period of time; and

•                  our market capitalization relative to netbook value

 

Whenwe determine that the carrying value of intangible assets, long-lived assets orgoodwill may not be recoverable based upon the existence of one or more of theabove indicators of impairment, we measure any potential impairment based on aprojected discounted cash flow method using a discount rate determined by ourmanagement to be commensurate with the risk inherent in our current businessmodel.

 

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**Income Taxes**

 

The Company accounts for income taxes in accordance with SFAS No. 109,“Accounting for Income Taxes.” The objectives of accounting for income taxesare to recognize the amount of taxes payable for the current year and deferredtax assets and liabilities for future tax consequences of events that have beenrecognized in the Company’s financial statements or tax returns. The Companyperforms periodic evaluations of recorded tax assets and liabilities andmaintains a valuation allowance if deemed necessary. The determination of taxespayable for the current year includes estimates. In the event that actualresults differ materially from management’s expectations, the estimated taxespayable could materially change, directly impacting the Company’s financialposition or results of operations.

 

**The Company has net operating losscarryforwards.  The realization of anybenefit of these loss carryforwards is dependent on future results and theactual amount of these loss carryforwards may change over time.  The Company does not recognize any benefit onits financial statements for any previously incurred losses and will not untilit determines that it is more likely than not that it will have taxable incometo realize these benefits. Although the Company has reported net income infiscal years 2004 and 2003 it has not generated taxable income since 1996.**

 

**Year Ended June 30, 2005 Compared with the Year Ended June 30,2004**

 

*Revenue*

* *

*Total revenue was approximately $2,207,000for the year ended June 30, 2005 compared to none for the year ended June 30,2004.  All of the revenue for the fiscalyear ended June 30, 2005 represents revenue attributable to Lyris for theperiod May 12, 2005 (acquisition date) through June 30, 2005. TheCompany had no revenue in fiscal 2004.*

 

*Cost of revenue*

* *

*Cost of revenue was $446,916 for the yearended June 30, 2005 compared to none for the year ended June 30,2004. All of the Cost of revenue is a result of the acquisition of Lyris on May 12,2005. Cost of revenue primarily includes salary and personnel costsattributable to our support services and hosting business. Other costsallocated to cost of revenue include amortization of intangibles of $103,225related to developed technology and computer and internet bandwith costsassociated with providing our support and hosting services to our customers.*

* *

*Sales and marketing*

* *

Sales and marketing expenses consist primarily ofsalaries and related expenses for personnel dedicated entirely to the sales andmarketing efforts of the Company. Other sales and marketing costs include costsassociated with exhibits and tradeshows. Sales and marketing expenses were$290,542 for the year ended June 30, 2005 compared to none for the year ended June 30, 2004. All salesand marketing expenses were incurred by Lyris. The Company had no sales andmarketing expenses in fiscal 2004.

 

*General and administrative*

* *

General and administrative expenses consistprimarily of compensation for personnel, professional services, which includeconsultants, legal fees and accounting, audit and tax fees, and administrativeexpenses associated with operating as a public company. General andadministrative expenses were $2,223,179 for the year ended June 30, 2005compared to $2,424,307 for the prior year. The primary reason for the decrease of approximately $201,000 includedincreases of $327,000 in general and administrative expenses for LyrisTechnologies from the acquisition date of May 12, 2005 through June 30,2005, offset by decreases in operating expenses by the parent company ofapproximately $528,000 primarily as a

 

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result of decreases inprofessional and consulting fees, legal fees, insurance expense and otheradministrative operating expenses.

 

*Amortization of intangibles*

* *

Amortization of intangibles was $197,637 in fiscalyear 2005 and none in theprevious year. The increase reflects amortization expense related to intangibleassets of customer relations and non-compete agreements that are recorded asintangible assets on our balance sheet. The as a result of the acquisition of Lyrison May 12, 2005. See Note 4 for details on intangible assets.

 

*Provision for income taxes*

 

During theyear ended June 30, 2005, the Company recorded an income tax provision forthe year ended June 30, 2005 of $76,781 which consists of state incometaxes on the earnings of one of our subsidiaries. The company has not recordeda provision for federal income taxes due to our federal net operating loss carryforwardsof approximately $184 million. See Note 11 for more details regarding our taxcarryforwards.

 

*Net income (loss)*

 

Net income (loss) was ($230,243) for the year ended June 30,2005 compared to $2,754,580 for the previous year. The net loss in 2005includes net income from Lyris Technologies of $704,000 and a net loss fromJ.L. Halsey of ($934,000). The net income in fiscal year 2004 of $2,754,580 wasprimarily the result of a large federal income tax refund received by theCompany in July of 2003.

 

*Discontinued Operations*

* *

*Discontinued Operations**.* Discontinued operations consist of gains or losses as a result ofadjustments to the $374.1 million loss on disposal of discontinued operationswhich was originally recorded in fiscal year 2000.  Gains primarily include amounts received inexcess of book value for trade accounts receivable and Medicare relatedindemnification receivables which were owed to the Company prior to thedisposition of the Company’s long-term care services business in 1999 as wellas gains related to federal income tax refunds. Losses primarily includeexpenses incurred or adjustments to liabilities which were owed by the Companyprior to the disposition of the Company’s long-term care services business infiscal year 2000.

 

The gain ondisposal of discontinued operations was $281,030 compared to $4,940,828 for theprior year. These gains reflect adjustments to the $374.1 million loss ondisposal of discontinued operations that was recorded in fiscal year 2000.  The gain in fiscal year 2005 of $281,030primarily relates to the collection of previously reserved receivables in theamount of $460,000 and the collection of a federal income tax refund of$400,000, offset by increases in expense accruals of $579,000, to reflectadditional legal costs, collection costs and to adjust other liabilitiesremaining from discontinued operations. The gain in fiscal year 2004 of $4.9million, primarily relates to income tax related refunds totaling $6 millionand decreases in reserves for certain receivables totaling $600,000 principallydue to recovery of previously reserved receivables offset by increases inexpense accruals of $1.7 million, to reflect additional legal costs, collectioncosts, and to adjust other liabilities remaining from our discontinuedoperations. The $6 million of income tax refunds consist of Federal Income taxcarryback claims filed by the Company in July 2003 for the tax years endedJune 1993 and 1996 as a result of the amendment of our 2001 tax yearreturn. The Company received the tax refunds in the fourth quarter of thefiscal year 2004.

 

**Year Ended June 30, 2004 Compared with the Year Ended June 30,2003**

 

*Continuing Operations*

* *

*ContinuingOperations*.  Continuing operations consist of general andadministrative expenses and interest income. General and administrativeexpenses consist primarily of compensation for personnel, professionalservices, which include consultants, legal fees and accounting, audit and taxfees, and administrative expenses associated with operating as a publiccompany.

 

The loss before incometaxes from continuing operations was $2,186,248 for the year ended June 30,2004 compared to $3,189,160 for the prior year. The primary reason for the decrease in the loss was a decrease ingeneral and administrative costs of approximately $1.1 million, offset by areduction in interest and other income of approximately $100,000.  The decrease in general and administrativeexpenses include reductions in salaries and wages of $637,000, document storagerelated costs of $137,000, legal expenses of $481,000, office rent of $50,000and professional and consulting fees of $48,000 offset by a $250,000 recoveryof legal fees from the Company’s directors and officers insurance carrier. Thedecrease in salaries and wages includes a reduction of $574,000 of non-cashcompensation that was recorded in fiscal year 2003. The decrease in general andadministrative costs was primarily due to the settlement of legal matters and

 

27

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the general reduction of coststo operate the Company. The non-cash compensation charge was the result of atransaction between a principal stockholder and an officer of the Company.

 

There is no provision foror benefit from income taxes for the years ended June 30, 2004 and 2003,as the Company could not utilize, for financial reporting or income taxpurposes, the loss incurred in the periods. The Company has NOLs of approximately $184 million as of June 30,2004.  The ultimate amount of the NOLsthat may be utilized is dependent on future results and it is reasonablypossible that the actual amount may differ from the amount noted above.  The Company will not recognize an incomestatement benefit for any previously incurred or future operating losses orfuture tax deductions until such time as management believes it is more likelythan not that the Company’s future operations will generate sufficient taxableincome to be able to realize such benefits. Accordingly, the Company has provided a full valuation allowance againstthe net deferred tax assets at June 30, 2004.

 

*Discontinued Operations*

* *

*Discontinued Operations**.* Discontinued operations consist of gains or losses as a result ofadjustments to the $374.1 million loss on disposal of discontinued operationswhich was originally recorded in fiscal year 2000.  Gains primarily include amounts received inexcess of book value for trade accounts receivable and Medicare relatedindemnification receivables which were owed to the Company prior to thedisposition of the Company’s long-term care services business in 1999 as wellas gains related to federal income tax refunds. Losses primarily includeexpenses incurred or adjustments to liabilities which were owed by the Companyprior to the disposition of the Company’s long-term care services business infiscal year 2000.

 

The gain on disposal ofdiscontinued operations was $4,940,828, compared to $4,066,677 for the prioryear. These gains reflect adjustments to the $374.1 million loss on disposal ofdiscontinued operations that was recorded in fiscal year 2000. The gain infiscal year 2004 of $4.9 million, primarily relates to income tax relatedrefunds totaling $6.0 million and decreases in reserves for certain receivablestotaling $600,000 principally due to recovery of previously reservedreceivables offset by increases in expense accruals of $1.7 million, to reflectadditional legal costs, collection costs, and to adjust other liabilitiesremaining from our discontinued operations. The $6 million of income tax refundsconsist of Federal Income tax carryback claims filed by the Company in July 2003for the tax years ended June 1993 and 1996 as a result of the amendment ofour 2001 tax year return. The Company received the tax refunds in the fourthquarter of the fiscal year 2004. The gain in fiscal year 2003 of $4.1 million,primarily relates to the realization of certain receivables in excess of bookvalue totaling $2.7 million and the reversal of accruals of $1.4 million, net,to reflect the settlement of tax claims, lawsuits and to adjust otherliabilities remaining from our discontinued operations.

 

**Quarterly Financial Information (unaudited)**

 
| ** **                                                                    | ** ** | **First****Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| **Year Ended June 30, 2005:**                                            |       |                 |       |                |       |               |       |                |       |
| Revenue                                                                       |       | $                    | —     |                | $          | —             |       | $                   | —     |   | $ | 2,207,099 |   |
| Cost of revenue                                                               |       | —               |       | —              |       | —             |       | 446,916             |       |
| Gross Profit                                                                  |       | —               |       | —              |       | —             |       | 1,760,183           |       |
| (Loss) Income from continuing operations                                      |       | (297,033             | )          | (257,156            | )          | (320,380           | )          | 440,077             |       |
| Gain (loss) on disposal of discontinued  operations, net of tax               |       | 141,782              |       | 116,981             |       | (296,735           | )          | 319,002             |       |
| Income tax provision                                                          |       | —               |       | —              |       | —             |       | 76,781              |       |
| Net (loss) income                                                             |       | $                    | (155,251   | )                   | $          | (140,175           | )          | $                   | (617,115   | ) | $ | 682,298 |   |
| (Loss) gain per share from continuing  operations basic and diluted           |       | $                    | (0.00      | )                   | $          | (0.00              | )          | $                   | (0.00      | ) | $ | 0.01 |   |
| Gain (loss) per share on the disposal of  discontinued operations, net of tax |       | $                    | 0.00       |                | $          | 0.00               |       | $                   | (0.00      | ) | $ | 0.00 |   |
| Net (loss) income per share – basic and  diluted                         |       | $                    | (0.00      | )                   | $          | (0.00              | )          | $                   | (0.01      | ) | $ | 0.01 |   |

 
| ** **                                                                    | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| **Year Ended June 30, 2004:**                                            |       |               |       |                |       |               |       |                |       |
| Loss from continuing operations                                               |       | $                  | (643,275   | )                   | $          | (489,971           | )          | $                   | (606,284   | ) | $ | (446,718 | ) |
| Gain (loss) on disposal of discontinued  operations, net of tax               |       | 618,039            |       | 234,444             |       | 4,769,150          |       | (680,805            | )          |
| Net (loss) income                                                             |       | $                  | (25,236    | )                   | $          | (255,527           | )          | $                   | 4,162,866  |   | $ | (1,127,523 | ) |
| Loss per share from continuing operations  basic and diluted                  |       | $                  | (0.01      | )                   | $          | (0.01              | )          | $                   | (0.01      | ) | $ | (0.00 | ) |
| Gain (loss) per share on the disposal of  discontinued operations, net of tax |       | $                  | 0.01       |                | $          | 0.01               |       | $                   | 0.06       |   | $ | (0.02 | ) |
| Net (loss) income per share – basic and  diluted                         |       | $                  | (0.00      | )                   | $          | (0.00              | )          | $                   | 0.05       |   | $ | (0.02 | ) |

 

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**Liquidity and Capital Resources**

** **

*Liquidity and Cash Flows*

* *

***Cash and cash equivalents***

* *

At June 30, 2005, cash and cashequivalents totaled approximately $3.1 million compared to approximately $28.9million at June 30, 2004. The decrease in cash was mainly attributable tothe Company’s acquisition of Lyris Technologies, Inc. on May 12,2005.  Cash paid for the acquisition asof June 30, 2005 was $24,706,227, which includes acquisition costs paid asof June 30, 2005 of $806,227.

 

In fiscal year 2005, the Company sold 773,333shares of its own common stock held in treasury to certain employees of theCompany and Lyris at the current market price of the stock of $.30 per share.This resulted in a cash inflow to the Company in the amount of $232,000 whichwas recorded as a reduction to Treasury Stock in the equity section of theCompany’s balance sheet. In fiscal year 2003, the Company purchased 2 millionshares of its own common stock at $0.12 per share and 200 shares at $0.11 pershare for a total purchase price of $240,022. Both stock purchases by theCompany were made at fair market value at the time of each transaction. Thisamount has been recorded as Treasury Stock in the equity section of theCompany’s balance sheet.

 

***Net Cash Flow from OperatingActivities***

 

Net Cash Flow from Operating Activities was approximately($657,000) for the year ended June 30, 2005. This amount includes apositive cash flow from operations from our Lyris subsidiary of $813,000 forthe period May12, 2005 – June 30, 2005, offset by a negative cash flowfrom operations from the parent company of ($1,470,000). The net cash usedresulted from a net loss of ($230,000), changes in working capital assets andliabilities of ($382,000), add-back of gain on disposal of discontinuedoperations of ($281,000), offset by-non cash items of $236,000 related todepreciation and amortization.

 

Net Cash Flow from Operating Activities was approximately($2,355,000) for the year ended June 30, 2004. The net cash used resultedfrom net income of $2,754,000, changes in working capital assets andliabilities of $7,000, add-back of gain on disposal of discontinued operationsof ($4,940,000), reversal of income tax payable of ($187,000), offset by-noncash items of $11,000.

 

Net Cash Flow from Operating Activities was approximately($4,683,000) for the year ended June 30, 2003. The net cash used resultedfrom net income of $877,000, changes in working capital assets and liabilitiesof ($38,000), add-back of gain on disposal of discontinued operations of($4,067,000), reversal of income tax payable of ($2,031,000), offset by-non cashitems of $576,000.

 

***Net Cash Flow from InvestingActivities***

 

Net Cash Flow used in Investing Activitieswas approximately $24,640,000, for the year ended June 30, 2005, whichrepresented cash paid for the acquisition of Lyris of $24,620,000 and thepurchase of property and equipment of $20,000. Net Cash Flow used in InvestingActivities was approximately $6,000 for the year ended June 30, 2004,which represented the purchase of property and equipment. Net Cash Flowprovided by Investing Activities was approximately $2,003,000 for the yearended June 30, 2003, which represented cash received as a result of therelease of restricted cash held by the Company’s former workers compensationinsurance carrier in the amount of $2,020,000, offset by the purchase of propertyand equipment of $17,000.

 

***Net Cash Flow from FinancingActivities***

 

Net Cash Flow provided by FinancingActivities was $232,000, for the year ended June 30, 2005, whichrepresented cash received as the result of the sale of 773,333 shares of the Company’scommon stock held in treasury. Net

 

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Cash Flow used in FinancingActivities was ($240,000), for the year ended June 30, 2003, whichrepresented cash paid for the purchase of the Company’s own common stock.

 

We expect our current cash and cash generated as aresult of operations by Lyris will fund our current operations for theforeseeable future. In the event that we decide to purchase additionalbusinesses, our capital requirements may exceed our current resources. In sucha case, we would have to seek additional debt or equity financing from privateor public sources. To the extent we raise additional capital by issuing equitysecurities, ownership dilution to existing stockholders will result, and futureinvestors may be granted rights superior to those of existing stockholders. Tothe extent that we borrow funds, the lenders of such funds will have claims toour assets before there can be any distribution to our stockholders. There canbe no assurance, however, that additional financing, either debt or equity,will be available from any source or, if available, will be available on termsacceptable to us.

 

In July 2004,the Company received notification that a former customer had filed for Bankruptcyprotection under the U.S. Bankruptcy Code Chapter 11.  The Company may or may not have to returnsome or all of the amounts that it has collected from this former customer overthe two years ended June 30, 2004. The total amount collected by the Companyover that time was $2 million. The Company has not recorded a liability at thistime since it is not possible to determine if a potential liability is probablebased on the information available to us at this time. If in fact the Companyis notified in the future by the Bankruptcy Court that an amount must be repaidto the former customer, we believe that we may have legal defenses to supportthe retention of payments collected from our former customer.

 

*Legal Claims*

* *

*The Company is currently defending twolawsuits (Walmsley and Sullivan v. NAHC, Inc. and NovaCare v. Stratford,see Item 3) and management believes the Company will prevail in both instances.The Company has accrued for the potential costs of litigating these claims, butthe Company does not, and has not, accrued for the payments that could resultfrom an adverse ruling, judgment or a settlement of these claims until theCompany believes that it is probable that such a payment will be made.*

 

*Off-BalanceSheet Arrangements*

 

The Companyhas no off-balance sheet arrangements.

 

*Long-TermContractual Obligations*

 

As of June 30,2005, the Company had contractual obligations related to operating leases foroffice space. The following are our contractual commitments and obligations asof June 30, 2005:

* *
| ** **                   | ** ** | **Payments due by period** | ** ** |
|------------------------------|------------|----------------------------|------------|
| **Contractual Obligations**  | ** ** | **Total**                  | ** ** | **Less than 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5 years** | ** ** |
| Operating  Lease Obligations |       | $                          | 214,445    |   | $ | 207,445 |   | $ | 7,000 |   | $ | — |   | $ | — |   |
|                              |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

* *

Uninsured Professional Liability Claims

 

The Company is a defendantin two professional liability claims and had previously purchased professionalliability insurance policies from PHICO Insurance Company.  On February 2, 2002, a Pennsylvaniacourt authorized state insurance regulators to liquidate the insolvent PHICOInsurance Company, which had provided professional liability insurance policiesto the Company. As a result, PHICO will not be permitted to pay any claims onbehalf of the Company.  The Companybelieves, however, that state insurance guaranty funds will pay most of theamounts due on the remaining claims on the Company’s behalf.  Based on its discussion with the stateguaranty funds and its review of claims during the third quarter of 2004, theCompany now believes that a payment may be required to settle one professionalliability claim that may exceed the amount available to the Company under theapplicable state guaranty fund limits. The Company recorded an accrual and related expense in the third quarterof 2004 equal to the estimated cost to settle that claim less the amount thatwould be paid by the state guaranty fund. The Company believes that the otherclaim will not exceed the amount available to the Company under the applicablestate guaranty fund limit. There is no assurance, however, that each of theclaims will settle within those limits and there is no excess insurance policyin place that would pay settlements or awards in excess of those limits.  Therefore, in the event that the Company’scurrent assessment is incorrect, and the

 

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amounts required to pay onthese claims are in excess of any amounts paid by guaranty funds, the Companywill be required to fund these claims.

 

*Workers’ Compensation Loss Payments*

* *

*During the first quarter of fiscal year 2003,the NovaCare workers’ compensation insurance carrier notified the Company thatthe purchaser of NCES (“the Purchaser”) who is responsible for making certainclaim payments required by NovaCare’s insurance policy deductibles haddefaulted on those payment obligations. The Purchaser has funds that have been prepaid to this insurance carrierfor claim payments under deductibles on the NovaCare policies as well as otherunrelated workers’ compensation policies of the Purchaser.  In management’s opinion, the deposits held bythe insurance carrier are sufficient to pay deductible obligations on theNovaCare policies as well as the unrelated workers’ compensation policies.*

* *

**Cautionary Statement**

** **

Except for historicalinformation, matters discussed above including, but not limited to, statementsconcerning litigation against the Company, are forward-looking statements thatare based on management’s estimates, assumptions and projections.  Important factors that could cause results todiffer materially from those expected by management include the outcome andcosts of pending legal actions against the Company, and the Company’s abilityto identify potential acquisition targets and to successfully completepotential acquisitions.

 

**Recent Accounting Pronouncements**

** **

In May 2005,the Financial Accounting Standards Board (FASB) issued SFAS No. 154, *Accounting Changes and Error Corrections*.  SFAS No. 154 establishes new standards onaccounting for changes in accounting principles.  Pursuant to the new rules, all such changesmust be accounted for by retrospective application to the financial statementsof prior periods unless it is impracticable to do so.  SFAS No. 143 supersedes Accounting PrinciplesBulletin (APB) Opinion 2, *Accounting for Changes*and SFAS No. 3, *Reporting Accounting Changes in InterimFinancial Statements*, though it carries forward the guidance ofthose pronouncements with respect to amounting for changes in estimates,changes in the reporting entity, and error corrections.  This statement is effective for accountingchanges and effort corrections made in years beginning after December 15, 2005,with early adoption permitted for changes and corrections made in yearsbeginning after May 2005.  The Companydoes not expect adoption of SFAS No. 154 to have a material impact on theCompany’s financial statements.

 

In March 2005,the SEC issued SAB No. 107 which offers guidance on SFAS No. 123(R).  SAB No. 107 was issued to assist preparers bysimplifying some of the implementation challenges of SFAS No. 123(R) whileenhancing the information that investors receive.  SAB No. 107 creates a framework that ispremised on two overarching themes: (a) considerable judgment will be requiredby preparers to successfully implement SFAS No. 123(R), specifically whenvaluing employee stock options; and (b) reasonable individuals, acting in goodfaith, may conclude differently on the fair value of employee stockoptions.  Key topics covered by SAB No.107 include valuation models, expected volatility and expected term.  The Company expects to apply the principlesof SAB No. 107 in conjunction with the adoption of SFAS No. 123(R).

 

In December2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123R), *Share-Based Payment*. SFAS No.123 (R) replaces SFAS No. 123, *Accounting for Stock-BasedCompensation* and supersedes APB Opinion No. 25.  Generally, the approach in SFAS No. 123(R) issimilar to the approach described in SFAS No. 123 for fair value. However, SFASNo. 123(R) requires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the financial statements based ontheir fair values and prohibits pro forma disclosure as an alternative tofinancial statement recognition.  SFASNo. 123(R) is effective for the Company beginning in the first quarter offiscal 2006.  The Company expects theadoption of SFAS 123(R) to have an impact on our financial statements.

 

In December2004, the FASB issued SFAS No. 153 *Exchange of Non-monetaryAssets—An Amendment of APB Opinion No. 29*.  The provisions of this statement areeffective for non monetary asset exchanges occurring in periods beginning afterJune 15, 2005.  This statement eliminatesthe exception to fair value for exchanges of similar productive assets andreplaces it with a general exception for exchange transactions that do not havecommercial substance—that is, transactions that are not expected to result insignificant changes in the cash flows of the reporting entity.  The Company does not expect the adoption of SFASNo. 153 to have a significant impact on its consolidated financial statements.

 

In November2004, FASB issued SFAS No. 151, *Inventory Costs*that amends the guidance in Accounting Research Bulletin (ARB) No. 43, Chapter4, *Inventory Pricing*, (ARB No. 43) toclarify the accounting for abnormal amounts of idle facility expense, freight,handling costs, and wasted material (spoilage). In addition, this statement requires that an allocation of fixedproduction overheads to the costs of conversion be based on the normal capacityof the production facilities.  SFAS No.151 is effective for inventory costs incurred during years beginning after June15, 2005.  The Company does not expectthe adoption of SFAS No. 151 to have an impact on its consolidated financialstatements.

 

In July 2002, *The Public Company Accounting Reform and Investor Protection Act of2002* (the Sarbanes-Oxley Act) was enacted.  Section 404 of the Sarbanes-Oxley Actstipulates that public companies must take responsibility for maintaining aneffective system of internal control. The act requires public companies to report on the effectiveness oftheir control over financial reporting and obtain an attestation report fromtheir independent registered public accounting firm about management's report.  The act requires most public companies(accelerated filers) to report on the company’s internal control over financialreporting for years ending on or after November 15, 2004.  Other public companies (non-acceleratedfilers) must begin to comply with the new requirements related to internalcontrol over financial reporting for their first year ending on or after July15, 2007 under the latest extension granted by the SEC.  J.L. Halsey Corporation is a non-acceleratedfiler and therefore expects to comply with the regulations of Section 404 forits reporting period ending June 30, 2008.

 

**ITEM 7A.**                    QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

The Company does notengage in trading market risk sensitive instruments and does not purchase asinvestments, as hedges or for purposes “other than trading,” instruments thatare likely to expose the Company to market risk, whether it be from interestrate, foreign currency exchange, or commodity price risk. The Company hasentered into no forward or futures contracts, purchased no options and enteredinto no swap arrangements.

 

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**ITEM 8.**                             FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

 
| **Index to Consolidated Financial Statements**                                                                   |   |
|------------------------------------------------------------------------------------------------------------------|--------|
| ** **                                                                                                       |   |
| Report of Independent Registered Public Accounting  Firm – Burr, Pilger & Mayer LLP                |   |
|                                                                                                             |   |
| Report of Independent  Registered Public Accounting Firm – PricewaterhouseCoopers LLP                       |   |
|                                                                                                             |   |
| Consolidated  Balance Sheets as of June 30, 2005 and 2004                                                   |   |
|                                                                                                             |   |
| Consolidated Statements of Operations for the years  ended June 30, 2005, 2004 and 2003                |   |
|                                                                                                             |   |
| Consolidated Statements of Stockholders’ Equity for  the years ended June 30, 2005, 2004 and 2003 |   |
|                                                                                                             |   |
| Consolidated Statements of Cash Flows for the years  ended June 30, 2005, 2004 and 2003                |   |
|                                                                                                             |   |
| Notes to Consolidated Financial Statements                                                                       |   |

 

32

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**Report of Independent Registered Public Accounting Firm**

 

Tothe Board of Directors and Stockholders of J.L. Halsey Corporation:

 

Wehave audited the accompanying consolidated balance sheet of J.L. HalseyCorporation and Subsidiaries as of June 30, 2005 and the related consolidatedstatements of operations, stockholders’ equity and cash flows for the year thenended.  These consolidated financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditprovide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of J.L. HalseyCorporation and Subsidiaries as of June 30, 2005, and the results of theiroperations and cash flows for the year then ended, in conformity withaccounting principles generally accepted in the United States of America.

 
| /s/ Burr, Pilger & Mayer LLP |   |
|---------------------------------------|--------|
|                                  |
| San Francisco, California             |
| September 26, 2005               |

 

33

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### **REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

 

To****the Board of Directors and Stockholdersof J.L. Halsey Corporation:

 

In our opinion, the accompanying consolidated balance sheet and therelated consolidated statements of income, stockholder’s equity and cash flowspresent fairly, in all material respects, the financial position of J.L. HalseyCorporation and its subsidiaries at June 30, 2004, and the results oftheir operations and their cash flows for each of the two years in the periodended June 30, 2004 in conformity with accounting principles generallyaccepted in the United States of America. These financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these financial statements based on our audits.  We conducted our audits of these statementsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements,assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 
| /s/ PRICEWATERHOUSECOOPERS LLP |   |
|--------------------------------|--------|
|                           |
|                           |
| Boston, Massachusetts          |
| September 8, 2004         |

 

34

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**J. L. HALSEYCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                             | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                             | ** ** | **2005**          | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                             |       |              |       |   |   |
| Current  assets:                                                                                                       |       |              |       |   |   |
| Cash and  cash equivalents                                                                                             |       | $                 | 3,101,511  |   | $ | 28,880,201 |   |
| Accounts  receivable, net of allowances of $9,715 in 2005                                                              |       | 1,878,343         |       | — |   |
| Prepaid  expenses                                                                                                      |       | 231,250           |       | 57,233 |   |
| Deferred  income taxes                                                                                                 |       | 94,663            |       | 93,562 |   |
| Prepaid  expenses related to discontinued operations                                                                   |       | 269,975           |       | 216,625 |   |
| Total  current assets                                                                                                  |       | 5,575,742         |       | 29,247,621 |   |
| Restricted  cash related to discontinued operations                                                                    |       | 2,234,383         |       | 2,385,844 |   |
| Fixed  assets, net                                                                                                     |       | 550,992           |       | 10,014 |   |
| Intangible  assets, net                                                                                                |       | 12,713,750        |       | — |   |
| Goodwill                                                                                                               |       | 17,748,540        |       | — |   |
| Total assets                                                                                                           |       | $                 | 38,823,407 |   | $ | 31,643,479 |   |
|                                                                                                                   |       |              |       |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                          |       |              |       |   |   |
| Current  liabilities:                                                                                                  |       |              |       |   |   |
| Accounts  payable and accrued expenses                                                                                 |       | $                 | 1,093,146  |   | $ | 264,174 |   |
| Income taxes  payable                                                                                                  |       | 76,781            |       | — |   |
| Accrued  expenses remaining from discontinued operations                                                               |       | 3,112,781         |       | 4,205,732 |   |
| Deferred  revenue                                                                                                      |       | 1,687,556         |       | — |   |
| Total  current liabilities                                                                                             |       | 5,970,264         |       | 4,469,906 |   |
| Note payable                                                                                                           |       | 5,600,000         |       | — |   |
| Accrued  interest                                                                                                      |       | 76,712            |       | — |   |
| Deferred  income taxes                                                                                                 |       | 94,663            |       | 93,562 |   |
| Total  liabilities                                                                                                     |       | 11,741,639        |       | 4,563,468 |   |
| Commitments  and contingencies (Note 13)                                                                               |       |              |       |   |   |
| Stockholders’  equity:                                                                                            |       |              |       |   |   |
| Common  stock, $.01 par value; authorized 200,000,000 shares; issued 89,522,280  shares at June 30, 2005 and 2004 |       | 895,223           |       | 895,223 |   |
| Additional  paid-in capital                                                                                            |       | 275,063,911       |       | 275,063,911 |   |
| Accumulated  deficit                                                                                                   |       | (210,495,561      | )          | (205,965,587 | ) |
| Treasury  stock (at cost), 6,555,884 and 7,329,217 shares respectively, at June 30,  2005 and 2004                |       | (38,381,805       | )          | (42,913,536 | ) |
| Total  stockholders’ equity                                                                                       |       | 27,081,768        |       | 27,080,011 |   |
| Total  liabilities and stockholders’ equity                                                                       |       | $                 | 38,823,407 |   | $ | 31,643,479 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

35

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**J. L. HALSEYCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
| ** **                                                              | ** ** | **Years Ended June 30,** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                              | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                    |       |                          |       |   |   |   |   |
| Revenues                                                                |       | $                             | 2,207,099  |   | $ | — |   | $ | — |   |
| Cost of  revenue:                                                       |       |                          |       |   |   |   |   |
| Software and  services                                                  |       | 343,691                       |       | — |   | — |   |
| Amortization  of intangibles                                            |       | 103,225                       |       | — |   | — |   |
| Total cost  of revenue                                                  |       | 446,916                       |       | — |   | — |   |
| Gross profit                                                            |       | 1,760,183                     |       | — |   | — |   |
| Operating  expenses:                                                    |       |                          |       |   |   |   |   |
| General and  administrative expenses                                    |       | 2,223,179                     |       | 2,424,307 |   | 3,532,588 |   |
| Sales &  marketing                                             |       | 290,542                       |       | — |   | — |   |
| Amortization  of intangibles                                            |       | 94,412                        |       | — |   | — |   |
| Loss from  operations                                                   |       | (847,950                      | )          | (2,424,307 | ) | (3,532,588 | ) |
| Interest  income                                                        |       | 490,170                       |       | 238,059 |   | 322,956 |   |
| Interest  expense                                                       |       | (76,712                       | )          | — |   | — |   |
| Other income                                                            |       | —                        |       | — |   | 20,472 |   |
| Loss from  continuing operations                                        |       | (434,492                      | )          | (2,186,248 | ) | (3,189,160 | ) |
| Gain on  disposal of discontinued operations                            |       | 281,030                       |       | 4,940,828 |   | 4,066,677 |   |
| Net (loss) income  before income taxes                                  |       | (153,462                      | )          | 2,754,580 |   | 877,517 |   |
| Income tax  provision                                                   |       | 76,781                        |       | — |   | — |   |
| Net (loss) income                                                       |       | $                             | (230,243   | ) | $ | 2,754,580 |   | $ | 877,517 |   |
| Loss per  share from continuing operations - basic and diluted          |       | $                             | (0.01      | ) | $ | (0.03 | ) | $ | (0.04 | ) |
| Net (loss) income  per share - basic and diluted                        |       | $                             | (0.00      | ) | $ | 0.03 |   | $ | 0.01 |   |
| Weighted  average number of shares outstanding – basic and diluted |       | 82,296,880                    |       | 82,193,063 |   | 83,097,263 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

36

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**J. L. HALSEYCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

 
| ** **                     | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated** | ** ** | **Treasury Stock** | ** ** | **Total Stockholders’** | ** **   |
|--------------------------------|------------|------------------|------------|-------------------------|------------|-----------------|------------|--------------------|------------|------------------------------|--------------|
| ** **                     | ** ** | **Shares**       | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Deficit**        | ** ** | **Shares**                   | ** **   | **Amount** | ** ** | **Equity** | ** ** |
|                           |       |             |       |                    |       |            |       |               |       |                         |         |   |   |   |   |
| Balance at June 30,  2002 |       | 89,522,280       |       | $                       | 895,223    |            | $          | 274,490,119        |       | $                            | (209,597,684 | ) | (5,329,017 | ) | $ | (42,673,514 | ) | $ | 23,114,144 |   |
|                           |       |             |       |                    |       |            |       |               |       |                         |         |   |   |   |   |
| Treasury  stock purchase       |       | —           |       | —                  |       | —          |       | —             |       | (2,000,200                   | )            | (240,022 | ) | (240,022 | ) |
|                           |       |             |       |                    |       |            |       |               |       |                         |         |   |   |   |   |
| Stock based  compensation      |       | —           |       | —                  |       | 573,792         |       | —             |       | —                       |         | — |   | 573,792 |   |
|                           |       |             |       |                    |       |            |       |               |       |                         |         |   |   |   |   |
| Net income                     |       | —           |       | —                  |       | —          |       | 877,517            |       | —                       |         | — |   | 877,517 |   |
|                           |       |             |       |                    |       |            |       |               |       |                         |         |   |   |   |   |
| Balance at June 30,  2003 |       | 89,522,280       |       | 895,223                 |       | 275,063,911     |       | (208,720,167       | )          | (7,329,217                   | )            | (42,913,536 | ) | 24,325,431 |   |
|                           |       |             |       |                    |       |            |       |               |       |                         |         |   |   |   |   |
| Net income                     |       | —           |       | —                  |       | —          |       | 2,754,580          |       | —                       |         | — |   | 2,754,580 |   |
|                           |       |             |       |                    |       |            |       |               |       |                         |         |   |   |   |   |
| Balance at June 30,  2004 |       | 89,522,280       |       | 895,223                 |       | 275,063,911     |       | (205,965,587       | )          | (7,329,217                   | )            | (42,913,536 | ) | 27,080,011 |   |
|                           |       |             |       |                    |       |            |       |               |       |                         |         |   |   |   |   |
| Treasury  stock sale           |       | —           |       | —                  |       | —          |       | (4,299,731         | )          | 773,333                      |         | 4,531,731 |   | 232,000 |   |
|                           |       |             |       |                    |       |            |       |               |       |                         |         |   |   |   |   |
| Net loss                       |       | —           |       | —                  |       | —          |       | (230,243           | )          | —                       |         | — |   | (230,243 | ) |
|                           |       |             |       |                    |       |            |       |               |       |                         |         |   |   |   |   |
| Balance at June 30,  2005 |       | 89,522,280       |       | $                       | 895,223    |            | $          | 275,063,911        |       | $                            | (210,495,561 | ) | (6,555,884 | ) | $ | (38,381,805 | ) | $ | 27,081,768 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

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**J. L. HALSEYCORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                                                                         | ** ** | **For the Years Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                         | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Cash Flow from Operating Activities:**                                                                           |       |                                  |       |   |   |   |   |
| Net (loss)  income                                                                                                 |       | $                                     | (230,243   | ) | $ | 2,754,580 |   | $ | 877,517 |   |
| Adjustments  to reconcile net (loss) income to net cash flows from operating activities of  continuing operations: |       |                                  |       |   |   |   |   |
| Gain on  disposal of discontinued operations, net of tax                                                           |       | (281,030                              | )          | (4,940,828 | ) | (4,066,677 | ) |
| Stock based  compensation                                                                                          |       | —                                |       | — |   | 573,792 |   |
| Depreciation  and amortization                                                                                     |       | 236,285                               |       | 10,702 |   | 2,218 |   |
| Reversal of  income tax payable                                                                                    |       | —                                |       | (187,000 | ) | (2,031,399 | ) |
| Changes in  assets and liabilities, net of effects from acquisitions and dispositions:                             |       |                                  |       |   |   |   |   |
| Accounts  receivable                                                                                               |       | (526,115                              | )          | — |   | — |   |
| Prepaid expenses                                                                                                   |       | (125,462                              | )          | 46,304 |   | 715,732 |   |
| Accounts  payable and accrued expenses                                                                             |       | 156,883                               |       | (39,155 | ) | (753,983 | ) |
| Accrued  interest                                                                                                  |       | 76,712                                |       | — |   | — |   |
| Deferred  revenue                                                                                                  |       | (40,397                               | )          | — |   | — |   |
| Income taxes  payable                                                                                              |       | 76,781                                |       | — |   | — |   |
| Net cash  flows used in continuing operations                                                                      |       | (656,586                              | )          | (2,355,397 | ) | (4,682,800 | ) |
| Net cash  flows (used in) provided by discontinued operations                                                      |       | (713,810                              | )          | 8,022,099 |   | 14,507,668 |   |
| Net cash  flows (used in) provided by operating activities                                                         |       | (1,370,396                            | )          | 5,666,702 |   | 9,824,868 |   |
| **Cash Flows from Investing Activities:**                                                                          |       |                                  |       |   |   |   |   |
| Continuing  operations:                                                                                            |       |                                  |       |   |   |   |   |
| Additions to  property and equipment                                                                               |       | (20,368                               | )          | (6,119 | ) | (16,815 | ) |
| Payment for  business acquired, net of cash acquired                                                               |       | (24,619,926                           | )          | — |   | — |   |
| Discontinued  operations:                                                                                          |       |                                  |       |   |   |   |   |
| Release of  restricted cash                                                                                        |       | —                                |       | — |   | 2,019,895 |   |
| Net cash  flows (used in) provided by investing activities                                                         |       | (24,640,294                           | )          | (6,119 | ) | 2,003,080 |   |
| **Cash Flows from Financing Activities:**                                                                          |       |                                  |       |   |   |   |   |
| Continuing  operations:                                                                                            |       |                                  |       |   |   |   |   |
| Payment for  sale (purchase) of treasury stock                                                                     |       | 232,000                               |       | — |   | (240,022 | ) |
| Net cash  flows provided by (used in) financing activities                                                         |       | 232,000                               |       | — |   | (240,022 | ) |
| Net  (decrease) increase in cash and cash equivalents                                                              |       | (25,778,690                           | )          | 5,660,583 |   | 11,587,926 |   |
| Cash and  cash equivalents, beginning of year                                                                      |       | 28,880,201                            |       | 23,219,618 |   | 11,631,692 |   |
| Cash and  cash equivalents, end of year                                                                            |       | $                                     | 3,101,511  |   | $ | 28,880,201 |   | $ | 23,219,618 |   |

 

**Supplementaldisclosure of cash flow information:**

No cashpayments were made for income tax or interest in any of the years ended June30, 2005, 2004 and 2003.

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

38

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**J. L. HALSEYCORPORATION AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**June 30,2005**

 

**1.****              The Company**

 

Halsey, through its wholly owned subsidiary, Lyris is a leading emailmarketing firm.  Lyris’ email marketingsoftware and services provide clients with leading solutions for creating,managing and delivering online permission-based direct marketing programs,newsletters, discussion groups and other digital communications to clients’whose email lists require specialized technology in order to effectivelycommunicate with their members and customers. Lyris offers its email solutions in two forms: as software that isdownloaded and installed on a customer’s computers; and as a hosted solution inwhich the customer uses Lyris’ software through an internet connection.

 

On May 12, 2005, Halsey acquired all of the outstanding capitalstock of Lyris for $30.7 million, which included cash payments of $25.1million (including acquisition costs and working capital adjustments of $1.2million) and $5.6 million in theform of a promissory note payable, subject to Lyris’ achieving specifiedrevenue targets, on the second anniversary of the closing date with interestequal to 10% per annum.  Halseybelieves that it is probable that the specified revenue targets stated in thepromissory note will be attained on or before the second anniversary of theclosing date. As a result, we have recorded the note payable of $5.6 million asa non-current liability on our Balance Sheet as of June 30, 2005. With this acquisition, Halsey has become aleading email marketing company with over 5,000 customers worldwide.

 

Halsey is the successorto NovaCare, which was a national leader in physical rehabilitation services,orthotics and prosthetics and employee services.  The changes to Medicare reimbursement in thelate 1990’s had deleterious effects on NovaCare and its competitors andcustomers.  The prior operating businessmost affected by the Medicare changes was the long-term care services segmentin which NovaCare provided therapists to skilled nursing facilities.  This business was disposed of in fiscal 1999with the shutdown of certain of its operations in the Western United Statesduring the third fiscal quarter and the sale of the remaining operations on June 1,1999. NovaCare’s former outpatient services segment was disposed of through thesales of its orthotics and prosthetics (O&P) and physicalrehabilitation and occupational health (PROH) businesses. The O&P businesswas sold to Hangar Orthopedic Group, Inc. in July of 1999 and thePROH business was sold to Select Medical Corporation in November of1999.  The Company’s former employeeservices segment was disposed of through NovaCare’s sale of its interest inNovaCare Employee Services (“NCES”) in October of 1999 to a subsidiary ofPlato Holdings, Inc. as part of a tender offer by Plato for all of NCES’soutstanding shares.  With cash raisedfrom the sales of its businesses, the Company repaid all of its bank debt inthe summer of 1999, and in January of 2000, the Company retired itspublicly-traded subordinated debt.

 

NovaCare sold its name aspart of the sale of the PROH business and subsequently changed its name to NAHC, Inc..  On June 18, 2002, in a transactionapproved by NAHC’s stockholders at a special meeting, NAHC merged with and intoHalsey, its wholly-owned subsidiary.  The purpose of the merger between NAHC and Halsey was to implementtransfer restrictions on the Company’s common stock in order to preserve theCompany’s net operating losses.

 

Prior to the Lyris acquisition, the Company has spent the past severalyears maximizing the assets that it had retained, including old accountsreceivable, Medicare receivables and appeals, and tax items and to minimizeliabilities retained after the sales of the operating businesses.  The Company has made significant progress onthese matters.  The Company has collectedvirtually all of its receivables other than amounts which are the subject oflitigation or arbitration or that have been written off. A subsidiary of theCompany has retained four****employees andtwo consultants to carry out the general and administrative functions specifiedabove. These resources have been supplemented with outside financial, tax,legal and systems resources when required by management and the board.  No members of the current board were membersprior to the Company selling its operating businesses.

 

**2.****              Summary ofSignificant Accounting Policies**

 

*Principles ofConsolidation*: The consolidated financial statements include the accounts of theCompany and its wholly-owned subsidiaries. All significant intercompany accountsand transactions have been eliminated.

 

*Use of Estimates*:  The preparation of financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the reported amounts of assets andliabilities

 

39

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and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of expenses during the reporting period. Actual resultscould differ from those estimates. Management also uses estimates to reportassets and liabilities remaining from discontinued operations. The Companyestimates reserves against potential assets from discontinued operations aswell as in the reporting of potential liabilities from discontinued operations.The Company adjusts these estimates as facts and circumstances require.

 

*Cash and Cash Equivalents*:The Company’s holdings consist of cash in banks. These holdings are recorded onthe Company’s balance sheet at current value, which includes cost plus earnedinterest.  The Company maintains cashbalances with banks in excess of FDIC insured limits. The Company limits creditrisk by maintaining accounts with financial institutions of high creditstanding.

 

*Restricted Cash*

 

The Company’s restricted cash balances consist of the following:

 
| ** **                                                                | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| Cash balance  in support of self-insured workers compensation liabilities |       | $                      | 2,234,383  |                   | $          | 2,385,844 |   |
|                                                                           |            |                        |            |                        |            |  |  |

 

The restrictedcash accounts are a result of an agreement between Halsey and its previousworkers compensation insurance carriers from our previous healthcarediscontinued operations and are restricted at the discretion of the insurancecarriers. The Company has been working with the insurance carriers to settlethe seven remaining workers compensation claims. The change in the restrictedcash balance represents a release of the restricted cash that was received bythe Company in fiscal year 2005 in the amount of $176,277 offset by interestincome of $24,816.

 

# ***Property and Equipment***

 

Property and equipment are stated at cost, lessaccumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line methodover the shorter of the estimated useful lives of the assets, generally twoyears to seven years, or the lease term, if applicable. Repair and maintenancecosts are expensed in the period incurred.

 

# ***Revenue Recognition***

 

Lyris recognizes revenue from the following primarysources:  (1) licensing softwareproducts; (2) providing customer technical support; and (3) hostedsoftware products.

 

The Companygenerally recognizes revenue when all of the following conditions aresatisfied: (1) there is persuasive evidence of an arrangement; (2) theservice has been provided to the customer (in the case of software licenses,revenue is recognized when the customer is given electronic access to thelicensed software); (3) the amount of fees to be paid by the customer isfixed or determinable; and (4) the collection of fees is probable.

 

The Companyrecognizes software license revenue in accordance with the provisions of SOP 97-2,*Software Revenue Recognition*, andSOP 98-9 *Modification of SOP 97-2, SoftwareRevenue Recognition with Respect to Certain Transactions*.  The Company generally has multiple elementarrangements for its software revenue including software licenses andmaintenance. The Company allocates the arrangement fee to each of the elementsbased on the residual method utilizing vendor specific objective evidence (VSOE)for the undelivered elements, regardless of any separate prices stated withinthe contract for each element. VSOE for maintenance is generally based on theprice the customer would be required to pay when it is sold separately. Fairvalue for the delivered elements, primarily software licenses and upgrades, isbased on the residual amount of the total arrangement fees after deducting theVSOE for the undelivered elements. Maintenance revenues, including revenuesincluded in multiple element arrangements, are deferred and recognized ratablyover the related contract period, generally twelve months.

 

Hosting revenue is recognized monthly based on theusage defined in the agreement.  Excessusage is billed and recognized as revenue as incurred.

 

# ***Deferred Revenue***

# ** **

Deferred revenue represents customer billings madein advance for annual support contracts. Maintenance is typically billed on aper annum basis in advance and revenue is recognized ratably over themaintenance period.

 

*Segment Reporting*

 

In June 1997, theFinancial Accounting Standards Board (“FASB”) issued Statement No. 131, *Disclosures about Segments of an Enterprise andRelated Information* (“SFAS No. 131”). SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information, establishesstandards for reporting information regarding operating segments in annualfinancial statements and requires selected information of those segments to bepresented in interim financial reports issued to stockholders. Operatingsegments are identified as components of an enterprise about which separatediscrete financial information is available for evaluation by the chiefoperating decision-maker, or decision-making group, in making decisions on howto allocate resources and assess performance. We are not organized by multipleoperating segments for the purpose of making operating decisions or assessingperformance. Accordingly, we operate as one operating segment and reportapplicable enterprise-wide disclosures.

 

***Allowance for Doubtful Accounts***

 

The Company’s policies for allowances for doubtful accounts for itscurrent operations (Lyris) and its previous healthcare discontinued operationsare as follows:

 

Continuing operations

 

We regularly assess our ability to collect outstanding customerinvoices and in so doing must make estimates of the collectibility of accountsreceivable.  We provide an allowance fordoubtful accounts when we determine that the collection of an outstandingcustomer receivable is not probable.  Wespecifically analyze accounts receivable and historical bad debts experience,and changes in our customer payment history when evaluating the adequacy of theallowance for doubtful accounts.  If anyof these factors change, our estimates may also change, which could affect thelevel of our future provision for doubtful accounts.

 

40

----

 

Discontinued operations

 

The Company maintainsallowances for the collection of its receivables remaining from discontinuedoperations.  These allowances are the resultof the inability or unwillingness of many of the Company’s former healthcarecustomers to make payments.  Several ofthe key industries in which the Company previously operated were severelyimpacted by the Balanced Budget Act of 1997. As a result of the provisions of this Act, many of the Company’s formercustomers went bankrupt and many are nearly insolvent. Currently, the Companyhas outstanding receivables from a few of these customers and has recorded 100%allowances against these receivables. The Company is pursuing collection fromtwo of its former customers through litigation.

 

On a quarterly basis, theCompany reviews the value of the reserves and adjusts the net value of thereceivables to the estimated amount that management expects to realize. Whenfacts and circumstances indicate that an account has been impaired below itscurrent carrying value, the Company will adjust the reserve accordingly.  When a customer files for bankruptcy or otherfacts and circumstances dictate that the associated receivable will not becollectible at any future period, the Company fully reserves thereceivable.  Generally when there hasbeen a significant change in facts or circumstances and it is reasonablyassured collectibility of a receivable, the Company will release the associatedreserves to support the Company’s change in estimate.

 

There are a few accountsthat make up the Company’s receivables remaining from discontinued operations,all of which are fully reserved because it is highly unlikely that we willcollect the money that it is owed.  As aresult it is inherently difficult to estimate the amount that the Company willrealize upon collection.  In the fourthquarter of fiscal year 2005, the Company collected $410,000 from a previouscustomer.  The Company also wrote offfully reserved receivables totaling $169,317. 

 

***LossContingencies*****:********The Company recordsestimated loss contingencies when information is available that indicates thatit is probable that an asset has been impaired or a liability has been incurredand the amount of the loss can be reasonably estimated.  When no accrual is made for a losscontingency because one or both of these conditions are not met, or if anexposure to loss exists in excess of the amount accrued, the Company disclosessuch contingencies when there is at least a reasonable possibility that a lossor an additional loss may have been incurred. Determining the likelihood of incurring a liability and estimating theamount of the liability involves significant judgment.  If we had used different assumptions, theamount of loss contingencies recorded could have differed materially.  In particular, the Company has estimated thatthe Walmsley case will not result in a judgment against the Company.  If the outcome of the litigation is moreadverse to the Company than management currently expects, then the Company mayhave to record additional charges in the future and such charges could besignificant.  See Note 13 for details oncontingencies.**

 

***Accounting for Acquisitions:*******Significantjudgment is required to estimate the fair value of purchased assets andliabilities at the date of acquisition, including estimating future cash flowsfrom the acquired business, determining appropriate discount rates, asset livesand other assumptions. Our process to determine the fair value of thenon-compete agreements, customer relationships and developed technologyincludes the use of estimates including: the potential impact on operatingresults if the non-compete agreements were not in place; revenue estimates forcustomers acquired through the acquisition based on an assumed customerattrition rate; estimated costs to be incurred to purchase the capabilitiesgained through the developed technology model; and appropriate discount ratesbased on the particular business’s weighted average cost of capital. Ourestimates of an entity’s growth and costs are based on historical data, variousinternal estimates and a variety of external sources, and are developed as partof our routine long-range planning process.

 

***Stock-Based Compensation:***Statement of FinancialAccounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”)requires that companies either recognize compensation expense for grants ofstock, stock options, and other equity instruments based on fair value, orprovide pro forma disclosure of net income or loss and earnings or loss pershare in the notes to the financial statements. The Company follows thedisclosure provisions of SFAS 123 and applies APB Opinion 25 and relatedinterpretations in accounting for its plans. Accordingly, no compensation costhas been recognized for its stock option plans since all options issued werefor a fixed number of shares and had fixed exercise prices equal to the fairmarket value of the common stock on the grant date. The effects of applyingSFAS 123 in this pro forma disclosure are not likely to be representativeof the effects on reported income or loss for future years. Had compensationcost for the Company’s stock-based compensation plans been determined based onthe fair value at the grant dates as calculated in accordance withSFAS 123, the Company’s net loss and loss per share for theyear ended June 30,2005 would have been increased to the pro forma amounts indicated below:

 

41

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| ** **                                    | ** ** | **Year ended  June 30, 2005** | ** ** |
|-----------------------------------------------|------------|------------------------------------|------------|
| Net income  (loss):                           |       |                               |       |
| As reported                                   |       | $                                  | (230,243   | ) |
| Deduct: Pro  forma stock compensation expense |       | (39,891                            | )          |
| Pro forma                                     |       | $                                  | (270,134   | ) |
| Net income  (loss) per share—basic       |       |                               |       |
| As reported                                   |       | $                                  | (0.00      | ) |
| Pro forma                                     |       | (0.00                              | )          |
| Net income  (loss) per share—diluted     |       |                               |       |
| As reported                                   |       | $                                  | (0.00      | ) |
| Pro forma                                     |       | (0.00                              | )          |

 

The Company’s board of directors approved the J.L.Halsey Corporation 2005 Equity Based Compensation Plan on May 6, 2005.The plan provides for 13,200,000 shares to be made available to employees,directors and consultants of the Company. See Note 12 for more informationregarding the Equity Based Compensation Plan.

 

The fair value of each stock option was estimated on the date of grantusing the Black-Scholes option-pricing model with the following assumptions:

 
| Expected  Life                            |   | 5 years |   |
|-------------------------------------------|--------|---------|--------|
| Expected  Volatility                      |   | 97%     |   |
| Dividend  Yield                           |   | 0%      |   |
| Weighted  Average Risk-free Interest Rate |   | 3.57%   |   |

 

***Goodwill, Long-Lived Assets and OtherIntangible Assets:***We assess the impairment of identified intangibles,long-lived assets and goodwill at least annually and whenever events or achange in circumstances indicate the carrying value may not be recoverable.Factors we consider important which could trigger an impairment review includethe following:

 

•                  significantunderperformance relative to historical or expected projected future operatingresults;

•                  significantchanges in the manner of our use of the acquired assets or the strategy for ouroverall business;

•                  significantnegative industry or economic trends;

•                  significantdecline in our stock price for a sustained period of time; and

•                  our market capitalization relative to netbook value

 

When we determine that thecarrying value of intangible assets, long-lived assets or goodwill may not berecoverable based upon the existence of one or more of the above indicators ofimpairment, we measure any potential impairment based on a projected discountedcash flow method using a discount rate determined by our management to becommensurate with the risk inherent in our current business model.

 

*Accounts and NotesReceivables Remaining from Discontinued Operations*: AtJune 30, 2005, the accounts and notes receivables remaining fromdiscontinued operations primarily consist of trade accounts receivable andMedicare related receivables which were owed to the Company prior to thedisposition of the Company’s healthcare operating segments in 1999.  The Company has reserved these receivables at100% to reduce these assets to their net realizable value of zero as theCompany believes that it is not likely to collect any of these amounts.Adjustments to reserves are charged or credited to gain (loss) on discontinuedoperations, net of tax.

 

*Accrued Expenses Remaining from Discontinued Operations*:At June 30, 2005, the accrued expenses remaining from discontinuedoperations primarily consist of liabilities which arose prior to or as a resultof the disposition transactions. These liabilities include workerscompensation, uninsured professional liability claims and credit and collectionexpenses. The Company adjusts these accrual amounts based on currentinformation available to management and these adjustments are charged orcredited to gain (loss) on discontinued operations, net of tax.

 

42

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*Income Taxes*:  The Company records deferred tax assets andliabilities for the expected future tax consequences of events that have beenrecognized in the Company’s financial statements or tax returns.  Valuation allowances are provided againstdeferred tax assets which are unlikely to be realized as of the end of relevantreporting period.

 

*Net Income (Loss) PerShare*:  Basicnet income (loss) per share (“EPS”) is calculated using the weighted averagenumber of common shares outstanding during each period. Diluted net income(loss) per share is calculated using basic EPS adjusted for the effects ofstock options and convertible debt if such instruments are dilutive.

 

The dilutedloss per common share calculated for the year ended June 30, 2005, excludes theeffects of 6,370,000 options outstanding. This amount was excluded since its inclusion would beanti-dilutive.  The Company had nooutstanding options as of June 30, 2004 or 2003.

 

*Comprehensive Income(Loss)*: For fiscal years 2005, 2004 and 2003 theCompany’s comprehensive income or loss consists only of net income or loss.

 

**3.  Acquisition of Lyris Technologies, Inc.**

 

As discussed in Note 1, on May 12, 2005 the Company acquired Lyris Technologies, Inc. The acquisition was accounted for as a purchase and, accordingly, the results of operations of Lyris have been included in the consolidated financial statements commencing on the date of acquisition. In connection with the acquisition, the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition were as follows:

 
| **Description**                        | ** ** | **May 12, 2005** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| Assets:                                |       |                  |       |
| Cash                                   |       | $                     | 86,301     |   |
| Trade  receivables                     |       | 1,038,898             |       |
| Other  current assets                  |       | 361,885               |       |
| Property and  equipment                |       | 559,258               |       |
| Goodwill                               |       | 17,748,540            |       |
| Trademarks  and intangible assets      |       | 12,911,387            |       |
| Total assets  acquired                 |       | 32,706,269            |       |
| Liabilities:                           |       |                  |       |
| Accounts  payable and accrued expenses |       | 320,065               |       |
| Deferred  revenue                      |       | 1,727,953             |       |
| Total  liabilities                     |       | 2,048,018             |       |
| Net assets  acquired                   |       | $                     | 30,658,251 |   |
|                                   |       |                  |       |
| Represented  by:                       |       |                  |       |
| Cash paid at  closing                  |       | $                     | 23,900,000 |   |
| Acquisition  costs                     |       | 1,023,430             |       |
| Working  capital adjustment            |       | 134,821               |       |
| Note payable                           |       | 5,600,000             |       |
|                                   |       | $                     | 30,658,251 |   |

 

The following tablerepresents pro-forma financial information as if the acquisition took place onthe first day of the fiscal year in which the acquisition occurred and thefirst day of the fiscal year prior to the actual fiscal year of acquisition.

 
| ** **                           | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|--------------------------------------|------------|-----------|------------|-----------|------------|
| Total  revenue                       |       | $         | 12,562,157 |      | $          | 10,815,171 |   |
| Net income  (loss)                   |       | 1,656,969 |       | 4,495,244 |       |
| Basic net  income (loss) per share   |       | $         | 0.02       |      | $          | 0.05 |   |
| Diluted net  income (loss) per share |       | $         | 0.02       |      | $          | 0.05 |   |

 

43

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**4.****              IntangibleAssets**

 

Intangible assets consist of the following at June 30: 

 
| ** **                      | ** ** | **2005**  | ** ** |
|---------------------------------|------------|-----------|------------|
| Customer  relations             |       | $         | 4,113,161  |   |
| Developed  technology           |       | 4,078,226 |       |
|                            |       | 8,191,387 |       |
| Less:  accumulated amortization |       | (197,637  | )          |
|                            |       | 7,993,750 |       |
| Trade names                     |       | 4,720,000 |       |
| Total  intangible assets        |       | $         | 12,713,750 |   |

 

The following table outlinesthe Company’s intangible assets, by acquisition, as of June 30, 2005:

 
| ** **              | ** ** | **Gross amount** | ** ** | **Accumulated  amortization** | ** ** | **Balance at  June 30, 2005** | ** ** |
|-------------------------|------------|------------------|------------|-------------------------------|------------|------------------------------------|------------|
| Lyris  Technologies:    |       |             |       |                          |       |                               |       |
| Customer  relationships |       | $                | 3,900,000  |                          | $          | (81,251                            | )          | $ | 3,818,749 |   |
| Developed  technology   |       | 3,800,000        |       | (94,999                       | )          | 3,705,001                          |       |
| Tradenames              |       | 4,400,000        |       | —                        |       | 4,400,000                          |       |
| Subtotal                |       | 12,100,000       |       | (176,250                      | )          | 11,923,750                         |       |
|                    |       |             |       |                          |       |                               |       |
| Piper  Software:        |       |             |       |                          |       |                               |       |
| Developed  technology   |       | 278,226          |       | (8,226                        | )          | 270,000                            |       |
| Subtotal                |       | 278,226          |       | (8,226                        | )          | 270,000                            |       |
|                    |       |             |       |                          |       |                               |       |
| Sparklist:              |       |             |       |                          |       |                               |       |
| Customer  relationships |       | 213,161          |       | (13,161                       | )          | 200,000                            |       |
| Tradenames              |       | 320,000          |       | —                        |       | 320,000                            |       |
| Subtotal                |       | 533,161          |       | (13,161                       | )          | 520,000                            |       |
|                    |       |             |       |                          |       |                               |       |
| Grand Total             |       | $                | 12,911,387 |                          | $          | (197,637                           | )          | $ | 12,713,750 |   |

 

Amortization expense for the year ended June 30,2005 was $197,637. Duringthe year ended June 30, 2005, $103,225 of amortization expense wasclassified as cost of revenue and relates to the amortization of developedtechnology.

 

The estimated future amortization expense related tointangible assets, assuming no future impairment of the underlying assets as ofJune 30, 2005 is as follows:

 

| **Fiscal  Year** | ** ** | **Customer relationships,  and trade names** | ** ** | **Developed  Technology** | ** ** | **Total** | ** ** |
|------------------|------------|----------------------------------------------|------------|---------------------------|------------|-----------|------------|
| 2006             |       | $                                            | 746,004    |                      | $          | 819,996   |       | $ | 1,566,000 |   |
| 2007             |       | 746,004                                      |       | 819,996                   |       | 1,566,000 |       |
| 2008             |       | 658,004                                      |       | 819,996                   |       | 1,478,000 |       |
| 2009             |       | 650,004                                      |       | 819,996                   |       | 1,470,000 |       |
| 2010             |       | 650,004                                      |       | 695,017                   |       | 1,345,021 |       |
| 2011             |       | 568,729                                      |       | —                    |       | 568,729   |       |
| Total            |       | $                                            | 4,018,749  |                      | $          | 3,975,001 |       | $ | 7,993,750 |   |
|                  |            |                                              |            |                           |            |           |            |  |  |  |  |  |

 

44

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The following table outlines the Company’s goodwill,by acquisition, as of June 30, 2005:

 
| **Description**     | ** ** | **Goodwill  Amount** | ** ** |
|---------------------|------------|----------------------|------------|
|                |       |                 |       |
| Lyris  Technologies |       | 16,763,460           |       |
| Piper  Software     |       | 985,080              |       |
|                |       |                 |       |
| Total               |       | $                    | 17,748,540 |   |
|                     |            |                      |            |  |

 

**5.****              NotePayable**

 

**CommodoreResources, (Nevada) Inc, a wholly-owned subsidiary of the Company, executed apromissory note with The John Buckman and Jan Hanford Trust in the amount of$5.6 million as part of the acquisition of Lyris Technologies on May 12,2005.  The note bears interest at therate of 10% per annum. The note and accrued interest become due on May 12,2007 subject to the following conditions:**

 

**•****                 ****Total Revenue of Lyris Technologiesfor the twelve month periods ended March 31, 2006 and 2007, taken in theaggregate, must be equal to or greater than $24 million.**

 

**•****                 ****If total revenues for the twelve monthperiods ended March 31, 2006 and 2007, taken in the aggregate, are lessthan $24 million but greater than or equal to $16 million, then the interestand principal due shall be ratably reduced.**

 

**•****                 ****If total revenues for the twelve monthperiods ended March 31, 2006 and 2007, taken in the aggregate, are lessthan $16 million, then no amounts of interest and principal shall be due underthe terms of this note.**

 

**•****                 ****The amount due on this note shall alsobe reduced for any royalty payments that the Company is required to make underthe terms of the License Agreement between the Company and Digital Impact, Inc.**

 

**•****                 ****The Company has accrued $76,712 ofinterest owed on this note as of June 30, 2005 and recorded this amount asinterest expense in the statement of operations for the year ending June 30,2005.**

 

**6.****              Discontinued Operations**

 

**At June 30,2005 and 2004, assets and liabilities from discontinued operations consistedof:**

 
| ** **                                                              | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| Restricted  cash in support of workers compensation liabilities         |       | $                      | 2,234,383  |                   | $          | 2,385,844 |   |
| Prepaid  expenses pertaining to insurance deposits                      |       | 269,975                |       | 216,625                |       |
| Accounts  receivable remaining from discontinued operations             |       | 1,109,296              |       | 1,688,613              |       |
| Allowance  for doubtful accounts remaining from discontinued operations |       | (1,109,296             | )          | (1,688,613             | )          |
| Total assets  related to discontinued operations                        |       | $                      | 2,504,358  |                   | $          | 2,602,469 |   |
|                                                                    |       |                   |       |                   |       |
| Accrued  expenses remaining from discontinued operations                |       | 3,112,781              |       | 4,205,732              |       |
| Taxes  payable related to discontinued operations                       |       | —                 |       | —                 |       |
| Total  liabilities related to discontinued operations                   |       | $                      | 3,112,781  |                   | $          | 4,205,732 |   |
|                                                                         |            |                        |            |                        |            |  |  |  |  |

 

The accounts receivablesremaining from discontinued operations as of June 30, 2005 consistedprimarily of trade accounts receivable and Medicare related receivables whichwere owed to the Company prior to the disposition of the Company’s long-termcare services business in 1999. At June 30, 2005, the Company believesthat the probability of collecting these receivables is low and the Companywill most likely cease its collection efforts in the next few quarters,therefore the Company has fully reserved these receivables to reduce their netrealizable value to zero. If any of these receivables are collected, theCompany will record a gain in the period of collection.

 

The decreasein accounts receivable remaining from discontinued operations from $1,688,613to $1,109,296 is the result of a collection of a fully reserved receivable froma former customer in the amount of $410,000 as well as the write off of fullyreserved receivables totaling $169,317.

 

The accrued expensesremaining from discontinued operations primarily consist of liabilities, whicharose prior to or as a result of the disposition transactions.  These liabilities include costs forlitigation, workers compensation claims, professional liability claims, andother liabilities.

 

45

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The Company accrues anestimate of the legal costs necessary to defend itself against legal claimsrelated to its discontinued operations. The costs of litigation are difficultto estimate because of the high variability of possible outcomes. As a result,the actual costs could differ significantly from these estimates.

 

The $281,000 gain ondisposal of discontinued operations recorded in fiscal year 2005 relates toadjustments to the $374.1 million loss on disposal of discontinued operationswhich was originally recorded in fiscal year 2000.  The adjustments consist of decreases inreserves for certain receivables totaling $460,000 and income tax refundstotaling $400,000, offset by increases in expense accruals of $579,000, toreflect additional costs related to collections, legal costs, lawsuits (seeNote 13), and to adjust other liabilities remaining from discontinuedoperations.

 

The $4.9 million gain ondisposal of discontinued operations recorded in fiscal year 2004 relates toadjustments to the $374.1 million loss on disposal of discontinued operationswhich was originally recorded in fiscal year 2000. The adjustments consist ofincome tax related refunds totaling $6 million and decreases in reserves forcertain receivables totaling $600,000 principally due to recovery of previouslyreserved receivables, offset by increases in expense accruals of $1.7 million,to reflect additional costs related to collections, legal costs, lawsuits (SeeNote 12), and to adjust other liabilities remaining from our discontinuedoperations. The $6 million of income tax refunds consist of federal income taxcarryback claims filed by the Company in July 2003 for the tax years endedJune 1993 and 1996 as a result of the amendment of our 2001 tax yearreturn. The Company received the tax refunds in the fourth quarter of thefiscal year 2004.

 

The $4.1 million gain on disposal of discontinuedoperations recorded in fiscal year 2003 relates to adjustments to the $374.1million loss on disposal of discontinued operations which was originallyrecorded in fiscal year 2000. The adjustments consist of the realization ofcertain receivables in excess of book value totaling $2.7 million and thereversal of accruals of $1.4 million, net, to reflect the settlement oflawsuits, tax claims, and to adjust other liabilities remaining from ourdiscontinued operations.

 

**7.  Net (Loss) Income Per Share**

 

The following table sets forth thecomputation and reconciliation of net income per share-basic and net income pershare-diluted:

 
| ** **                                                                            | ** ** | **Years Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenue**                                                                           |       | $                             | 2,207,099  |   | $ | — |   | $ | — |   |
| **Cost  of revenue**                                                                  |       | 446,916                       |       | — |   | — |   |
| **Gross  profit**                                                                     |       | 1,760,183                     |       | — |   | — |   |
| **Loss  from continuing operations**                                                  |       | (434,492                      | )          | (2,186,248 | ) | (3,189,160 | ) |
| **Gain  on disposal of discontinued operations**                                      |       | 281,030                       |       | 4,940,828 |   | 4,066,677 |   |
| **Provision  for income taxes**                                                       |       | (76,781                       | )          | — |   | — |   |
| **Net  (loss) income**                                                                |       | $                             | (230,243   | ) | $ | 2,754,580 |   | $ | 877,517 |   |
|                                                                                  |       |                          |       |   |   |   |   |
| **Weighted  average shares outstanding:**                                             |       |                          |       |   |   |   |   |
| **basic  and diluted**                                                                |       | 82,296,880                    |       | 82,193,063 |   | 83,097,263 |   |
| **Loss  per share from continuing operations –**** ****basic and diluted**  |       | $                             | (0.01      | ) | $ | (0.03 | ) | $ | (0.04 | ) |
| **Income  per share on disposal of discontinued operations – basic and diluted** |       | 0.01                          |       | 0.06 |   | 0.05 |   |
| **Net  (loss) income per share – basic and diluted**                             |       | $                             | (0.00      | ) | $ | 0.03 |   | $ | 0.01 |   |

 

The diluted loss per common share calculatedfor the year ended June 30, 2005 excludes the effects of 6,370,000 optionsoutstanding.  This amount was excludedsince its inclusion would be anti-dilutive. The Company had no outstanding options as of June 30, 2004 or 2003.

 

**8.****              Property and Equipment**

 

Fixed assets consist of the following at June 30: 

 
| ** **                      | ** ** | **As of June 30,** | ** ** |
|---------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **2005**                | ** ** | **2004** | ** ** |
| Computers                       |       | $                       | 502,241    |   | $ | 22,934 |   |
| Furniture  and fixtures         |       | 15,726                  |       | — |   |
| Leasehold  improvements         |       | 5,887                   |       | — |   |
| Software                        |       | 60,872                  |       | — |   |
| Other  equipment                |       | 17,834                  |       | — |   |
| Total Cost                      |       | 602,560                 |       | 22,934 |   |
| Less:  accumulated depreciation |       | (51,568                 | )          | (12,920 | ) |
| Net property  and equipment     |       | $                       | 550,992    |   | $ | 10,014 |   |

 

46

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The increase in property and equipment is the directresult of the acquisition of Lyris on May 12, 2005. Depreciation expensefor the years ended June 30, 2005, 2004 and 2003 was $38,648, $10,702, and$2,218, respectively.  Property andequipment are stated at cost, less accumulated depreciation andamortization.  Depreciation andamortization is computed using the straight-line method over the shorter of theestimated useful lives of the assets, generally two years to seven years, orthe lease term, if applicable. Repair and maintenance costs are expensed in theperiod incurred.

 

**9.    Accounts Payable and Accrued Expenses**

 

Accounts payable andaccrued expenses are summarized as follows:

 
| ** **                         | ** ** | **As of June 30,** | ** ** |
|------------------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **2005**                | ** ** | **2004** | ** ** |
| Accounts  payable                  |       | $                       | 826,785    |   | $ | 222,721 |   |
| Accrued  compensation and benefits |       | 266,361                 |       | 41,453 |   |
| Total                              |       | $                       | 1,093,146  |   | $ | 264,174 |   |
|                                    |            |                         |            |  |  |  |  |  |

** **

**10.  Operating Leases**

 

TheCompany has various non-cancelable operating leases for office space thatexpire at various times through 2007.

 
| 2006  |   | $ | 207,445 |   |
|-------|--------|---|---------|--------|
| 2007  |   | $ | 7,000   |   |
| Total |   | $ | 214,445 |   |

 

Total rent expensecharged to operations was $147,211, $96,227 and $146,176 in fiscal 2005, 2004and 2003, respectively.

 

**11.   Income Taxes**

 

The components offederal and state income tax expense as of June 30, 2005, 2004 and 2003 were asfollows:

 
| ** **                | ** ** | **Years ended June 30,** | ** ** |
|---------------------------|------------|--------------------------|------------|
| ** **                | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Current                   |       |                     |       |   |   |   |   |
| Federal                   |       | $                        | —     |   | $ | — |   | $ | — |   |
| State                     |       | 110,832                  |       | — |   | — |   |
|                      |       |                     |       |   |   |   |   |
| Deferred                  |       | —                   |       | — |   |   |   |
| Federal                   |       | —                   |       | — |   | — |   |
| State                     |       | (34,051                  | )          | — |   | — |   |
|                      |       |                     |       |   |   |   |   |
| Total income  tax expense |       | $                        | 76,781     |   | $ | — |   | $ | — |   |
|                           |            |                          |            |  |  |  |  |  |  |  |  |  |  |

 

The components of netdeferred tax assets (liabilities) as of June 30, 2005 and 2004 were asfollows:

 
| ** **                                                       | ** ** | **As of June 30,** | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                       | ** ** | **2005**                | ** ** | **2004** | ** ** |
| Accruals and  reserves not currently deductible for tax purposes |       | $                       | 1,867,162  |   | $ | 2,322,282 |   |
| Net  operating loss, capital loss and tax credit carryforwards   |       | 72,942,040              |       | 87,221,106 |   |
| Gross  deferred tax assets                                       |       | 74,809,202              |       | 89,543,388 |   |
| Valuation  allowance                                             |       | (74,714,539             | )          | (89,449,826 | ) |
| Net deferred  tax assets                                         |       | 94,663                  |       | 93,562 |   |
| Other, net                                                       |       | (94,663                 | )          | (93,562 | ) |
| Gross  deferred tax liabilities                                  |       | (94,663                 | )          | (93,562 | ) |
| Net deferred  tax asset (liability)                              |       | $                       | —     |   | $ | — |   |

 

The Company has recordeda valuation allowance to reflect the estimated amount of deferred tax assetswhich relate to federal and state net operating loss carry forwards, in excessof amounts carried back to prior years, and tax credit carryforwards that maynot be realized.

 

The Company has federal net operating loss carryforwards ofapproximately $184 million and a capital loss carryforward of approximately $11million to offset future taxable income and taxable gains.  The net operating loss carryforwards expireprincipally in 2018. The capital loss carryforwards expire in 2007 and 2008. Inaddition, the Company has state net operating loss carryforwards ofapproximately $10 million, which begin to expire in 2018. The change in thevaluation allowance was an increase of $1,101 for the year ended June 30, 2005and there was no change in the valuation allowance for the year ended June 30,2004. The increase in 2005 is a result of the Company adjusting its deferredtax asset and respective valuation allowance to eliminate state net operatingloss carryforwards that are no longer available to the Company. If the Companyexperiences a change of ownership within the meaning of Section 382 of theInternal Revenue Code, the Company will not be able to realize the benefit ofits net operating loss, capital loss and tax credit carryforwards.

 

 

47

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of the InternalRevenue Code, the Company will not be able to realize the benefit of its netoperating loss, capital loss and tax credit carryforwards.

 

The reconciliation of theexpected tax (benefit) expense (for income from continuing operations beforeincome taxes) to actual tax (benefit) expense was as follows:

 
| ** **                                                           | ** ** | **Years Ended June 30,** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                           | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                 |       |                          |       |   |   |   |   |
| **Expected  federal income tax expense (benefit) at statutory rate** |       | $                             | (92,211    | ) | $ | (765,187 | ) | $ | (1,116,206 | ) |
| **State  income taxes, net of federal benefit**                      |       | 76,781                        |       | (56,777 | ) | (156,922 | ) |
| **Expiration  of capital loss carryover**                            |       | (12,762,623                   | )          | — |   | — |   |
| **Reduction  in state NOL carryover**                                |       | (1,296,315                    | )          | — |   | — |   |
| **Nondeductible  stock-based compensation**                          |       | —                        |       | — |   | 200,827 |   |
| **Effect  of valuation allowance on current year losses**            |       | 14,734,186                    |       | 821,964 |   | 1,072,301 |   |
| **Amortization  of intangible assets**                               |       | 81,031                        |       | — |   | — |   |
| **Refund  of federal income tax**                                    |       | (150,898                      | )          | — |   | — |   |
| **Other,  net**                                                      |       | (513,170                      | )          | — |   | — |   |
|                                                                 |       | $                             | 76,781     |   | $ | — |   | $ | — |   |

 

The amount of incometaxes refunded during fiscal 2005, 2004 and 2003 amounted to $368,045,$5,865,651, and $13,374,065 respectively. The amount of income taxes paidduring fiscal 2005, 2004 and 2003 totaled $11,980, $38,040 and $45,300respectively.

 

**12. Benefit Plans**

 

*Stock Option Plan*

 

The Company established the J.L. Halsey Corporation2005 Equity Based Compensation Plan (“Equity Based Compensation Plan”) on May 6,2005. The Equity Based Compensation Plan provides for grants of stock optionsand stock-based awards to employees, directors, and consultants of the Company.Stock options issued in connection with the Equity Based Compensation Plan aregranted with an exercise price per share equal to the fair market value of ashare of Company common stock at the date of grant. All stock options haveten-year maximum terms and vest, either quarterly, or annually and all withinfour years of grant date. The total number of shares of common stock issuableunder the Equity Based Compensation Plan is 13,200,000. At June 30, 2005,there were 6,830,000 shares available for grant under the Equity BasedCompensation Plan.

 

The Company’s previousstock option plans were terminated by the Company’s Board of Directors on April 17,2003.

 

The following summarizesthe activity of the stock option plan:

 

| *** ***                       | *** *** | **Shares** | ** ** | **Weighted Average  Option Price** | ** ** |
|------------------------------------|--------------|------------|------------|------------------------------------|------------|
|                               |         |       |       |                               |       |
| Outstanding  at June 30, 2004 |         | —     |       | $                                  | —     |   |
| Granted                            |         | 6,370,000  |       | 0.31                               |       |
| Exercised                          |         | —     |       | —                             |       |
| Canceled                           |         | —     |       | —                             |       |
| Outstanding  at June 30, 2005 |         | 6,370,000  |       | 0.31                               |       |
| Exercisable  at June 30, 2005 |         | —     |       | $                                  | —     |   |

 

Thefollowing table summarizes information about stock options outstanding at June 30,2005:

 
| **Options Outstanding**       | ** **   | **Options Exercisable** | ** ** |
|-------------------------------|--------------|-------------------------|------------|
| **Range of  Exercise Prices** | ** **   | **Number  Outstanding** | ** ** | **Weighted-Average  Remaining  Contractual Life** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
| $                             | 0.00 to 0.30 |                    |       | 6,125,000 |   | 9.85 years |   | $ | 0.30 |   | — |   | $ | — |   |
| $                             | 0.31 to 0.46 |                    |       | 245,000 |   | 9.93 years |   | $ | 0.46 |   | — |   | $ | — |   |
| $                             | 0.00 to 0.46 |                    |       | 6,370,000 |   |   |   | $ | 0.31 |   | — |   | $ | — |   |

 

48

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In September 2002, an officer and principalstockholder of the Company granted an option to a director and principalstockholder of the Company to purchase 4,170,000 shares of common stock of theJ.L Halsey Corporation from the officer for $0.04 per share.  Under theguidance provided by the American Institute of Certified Public Accountants (“AICPA”)Accounting Interpretation No. 1 to Accounting Principles Board (“APB”) 25,such transaction is viewed to be a transaction of the Company and would requirethe Company to record a charge for the excess, if any, of the market price ofthe shares over the exercise price of the options.  At the time of thegrant, the exercise price of the options equaled the market price of the sharesand, therefore this transaction had no effect on the Company’s results ofoperations.

 

In January 2003, the same two individualsentered into a transaction whereby the director directly purchased 4,170,000shares of common stock from an officer and principal stockholder of theCompany. Pursuant to Interpretation No. 1 to APB 25, this is treated as atransaction of the Company and, as a result, the excess of the purchase priceover the market value, as measured by the quoted market price on the date oftransaction, is recorded as stock-based compensation expense. On the date ofthe transaction, the Company’s market price per share was $0.13 per share andthe officer paid $0.2676 per share. Accordingly, the Company recorded $574,000of non-cash, stock-based compensation expense and a corresponding increase inadditional paid-in capital for this transaction.

 

*Retirement Plans*

 

The Company has a definedcontribution 401(k) plan covering substantially all of its employees. TheCompany does not provide any matching contributions under the terms of theplan.

 

**13.  Commitments and Contingencies**

 

Walmsleyand Sullivan v. NAHC, Inc. et. al.  Duringthe third quarter of fiscal 2002, this action was filed in the Court of CommonPleas for the County of Philadelphia, PA by Walmsley and Sullivan, two formeremployees against the Company and its officer and directors.  The suit seeks damages in excess of $3million as a result of alleged breaches of contracts to pay certain bonuses,and other claims.  The Company stronglydisagrees with the allegations in the complaint and intends to vigorouslydefend this action.  The Company has suedboth Walmsley and Sullivan in federal court in Arizona.  This suit claims damages related to bonusespaid to Walmsley and Sullivan. During the third quarter of fiscal 2004 severaldepositions were completed in this case and more are expected in the nearfuture. **The Company receivednotice on May 6, 2005, that the presiding judge issued an ordertransferring the matter from the District of Arizona to the Eastern District ofPennsylvania for the convenience of the witnesses. In addition, the orderdenied the Company’s partial motion for summary judgment on its fraud,negligent misrepresentation and breach of fiduciary duty claim againstWalmsley and Sullivan due to a material issue of fact to be resolved at trial. Halseybelieves, at present, that it is likely**that this casewill settle in the second quarter.  TheCompany believes that it has adequately accured for the costs to defend thiscase as of June 30, 2005.

 

NovaCare v. Stratford Nursing Home.  The Company filed this collection lawsuitover three years ago to collect on a receivable of approximately $145,000,which the Company has fully reserved. Stratford counter-claimed with numerous theories asserting that theCompany instead owed Stratford money. Although Stratford’s principal claims were dismissed by the court,Stratford, in the last quarter of fiscal year 2003, has quantified itsremaining counter-claims at approximately $1 million.  The Company believes that the theories onwhich these damages are based are inconsistent with the contract between theparties and with the conduct of each party. As of June 30, 2005, this case is pending in the U.S. District Court forthe Southern District of New Jersey (Camden). The outcome of this action is not possible to predict and the Companyhas reserved an estimate of the cost of litigating this action, but thisestimate does not reflect the possibility of an adverse ruling or a judgmentagainst the Company or a settlement.

 

*Other Miscellaneous Cases andClaims*

 

Miscellaneous Claims.The Company has recorded reserves to pay several dozen small claims (most willbe $50,000 or less) that it has identified related to two of its previousoperating businesses.

 

Uninsured Professional Liability Claims.**The Company is a defendant in two professional liabilityclaims and had previously purchased professional liability insurance policiesfrom PHICO Insurance Company.  On February 2,2002, a

 

49

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Pennsylvania courtauthorized state insurance regulators to liquidate the insolvent PHICOInsurance Company, which had provided professional liability insurance policiesto the Company. As a result, PHICO will not be permitted to pay any claims onbehalf of the Company.  The Companybelieves, however, that state insurance guaranty funds will pay most of theamounts due on the remaining claims on the Company’s behalf.  Based on its discussion with the stateguaranty funds and its review of claims during the third quarter of 2004, theCompany now believes that a payment may be required to settle one professionalliability claim that may exceed the amount available to the Company under theapplicable state guaranty fund limits. The Company recorded an accrual and related expense in the third quarterof 2004 equal to the estimated cost to settle that claim less the amount thatwould be paid by the state guaranty fund. The Company believes that the otherclaim will not exceed the amount available to the Company under the applicablestate guaranty fund limit. There is no assurance, however, that each of theclaims will settle within those limits and there is no excess insurance policyin place that would pay settlements or awards in excess of those limits.  Therefore, in the event that the Company’scurrent assessment is incorrect, and the amounts required to pay on theseclaims are in excess of any amounts paid by guaranty funds, the Company will berequired to fund these claims.

 

*Workers’ Compensation Loss Payments*

 

During the first quarterof fiscal year 2003, the NovaCare workers’ compensation insurance carriernotified the Company that the purchaser of NCES (“the Purchaser”) who isresponsible for making certain claim payments required by NovaCare’s insurancepolicy deductibles had defaulted on those payment obligations.  The Purchaser has funds that have beenprepaid to this insurance carrier for claim payments under deductibles on theNovaCare policies as well as other unrelated workers’ compensation policies ofthe Purchaser.  In management’s opinion,the deposits held by the insurance carrier are sufficient to pay deductibleobligations on the NovaCare policies as well as the unrelated workers’compensation policies. 

 

**EmploymentAgreements**

 

Effective as of May 5,2000, the Company entered into an employment agreement with David R. Burt, toserve as the Company’s Chief Executive Officer. The original term of the agreement expired on May 5, 2005, and wassubsequently extended for one year though May 5, 2006.  Pursuant to the agreement, Mr. Burtreceives an annual base salary of $250,000 and an annual performance bonus ofnot less than $20,000.  The agreementrequires Mr. Burt to devote at least 50% of his business time andattention to the performance of the duties and responsibilities of ChiefExecutive Officer, in as much as Mr. Burt also served, until December 2003,as president, chief executive officer and a director of Ergo ScienceCorporation.  Mr. Burt resigned fromall positions with Ergo in December 2003 and now devotes all of hisbusiness time to his duties as an officer and director of the Company.

 

EffectiveMay 12, 2005, Lyris entered into an employment agreement with Luis A.Rivera, to serve as President and Chief Executive Officer. The term of theagreement is for five years and expires on May 12, 2010. Pursuant to theagreement, Mr. Rivera receives an annual base salary of $200,000 and willbe eligible to receive a quarterly performance bonus based on the profitabilityof the Company. In addition, Mr. Rivera received an award of 3,600,000Company stock options, which will vest ratably over four years on a quarterlybasis.  The terms of Mr. Rivera employment are contained in anemployment agreement between Lyris and Mr. Rivera dated May 12, 2005.

 

OnAugust 29, 2005, Joseph Lambert joined the Company as Vice President andController and Lyris, as Financial Controller.  Mr. Lambert willreceive an annual base salary of $125,000 and will be eligible to receive anannual merit bonus of up to 25% of his base salary.  In addition, Mr. Lambertwill receive an award of 250,000 Company stock options, which will vest ratablyover four years.  The terms of Mr. Lambert’s employment are containedin an offer letter, dated August 2, 2005 from Lyris, and an employmentagreement between Lyris and Mr. Lambert dated August 29, 2005.

 

**14.  Quarterly Results (Unaudited)**

 

The following table sets forth unauditedselected financial information for the periods indicated. This information hasbeen derived from unaudited consolidated financial statements, which, in theopinion of management, include all adjustments (consisting only of normalrecurring adjustments) necessary for a fair presentation of such information.The results of operations for any quarter are not necessarily indicative of theresults to be expected for any future period.

 

50

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| ** **                                                                    | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter (1)** | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|-------------------------|------------|
| **Year Ended June 30, 2005:**                                            |       |               |       |                |       |               |       |                    |       |
| Revenue                                                                       |       | $                  | —     |                | $          | —             |       | $                       | —     |   | $ | 2,207,099 |   |
| Cost of  revenue                                                              |       | —             |       | —              |       | —             |       | 446,916                 |       |
| Gross Profit                                                                  |       | —             |       | —              |       | —             |       | 1,760,183               |       |
| (Loss)  Income from continuing operations                                     |       | (297,033           | )          | (257,156            | )          | (320,380           | )          | 440,077                 |       |
| Gain (loss)  on disposal of discontinued operations, net of tax               |       | 141,782            |       | 116,981             |       | (296,735           | )          | 319,002                 |       |
| Income tax  provision                                                         |       | —             |       | —              |       | —             |       | 76,781                  |       |
| Net (loss)  income                                                            |       | $                  | (155,251   | )                   | $          | (140,175           | )          | $                       | (617,115   | ) | $ | 682,298 |   |
| (Loss)  income per share from continuing operations basic and diluted         |       | $                  | (0.00      | )                   | $          | (0.00              | )          | $                       | (0.00      | ) | $ | 0.01 |   |
| Gain (loss)  per share on the disposal of discontinued operations, net of tax |       | $                  | 0.00       |                | $          | 0.00               |       | $                       | (0.00      | ) | $ | 0.00 |   |
| Net (loss)  income per share – basic and diluted                         |       | $                  | (0.00      | )                   | $          | (0.00              | )          | $                       | (0.01      | ) | $ | 0.01 |   |

 
| ** **                                                                    | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter (2)** | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|-------------------------|------------|
| **Year Ended June 30, 2004:**                                            |       |               |       |                |       |               |       |                    |       |
| Loss from  continuing operations                                              |       | $                  | (643,275   | )                   | $          | (489,971           | )          | $                       | (606,284   | ) | $ | (446,718 | ) |
| Gain (loss)  on disposal of discontinued operations, net of tax               |       | 618,039            |       | 234,444             |       | 4,769,150          |       | (680,805                | )          |
| Net (loss)  income                                                            |       | $                  | (25,236    | )                   | $          | (255,527           | )          | $                       | 4,162,866  |   | $ | (1,127,523 | ) |
| Loss per  share from continuing operations basic and diluted                  |       | $                  | (0.01      | )                   | $          | (0.01              | )          | $                       | (0.01      | ) | $ | (0.00 | ) |
| Gain (loss)  per share on the disposal of discontinued operations, net of tax |       | $                  | 0.01       |                | $          | 0.01               |       | $                       | 0.06       |   | $ | (0.02 | ) |
| Net (loss)  income per share – basic and diluted                         |       | $                  | (0.00      | )                   | $          | (0.00              | )          | $                       | 0.05       |   | $ | (0.02 | ) |

 

----

(1)          Includes fourth quarter2005 gains (losses) on disposal of discontinued operations of:

 

•                  $425,000 to reducereserves for collection of receivables

•                  $8,000 to reduceliability accruals pertaining to the Company’s professional liability insuranceliabilities.

•                  $(44,000) toincrease liability accruals pertaining to costs associated with lawsuits.

•                  $(30,000) toincrease accruals pertaining to the Company’s workers compensation liability.

•                  $(13,000) toincrease liability accruals pertaining to the Company’s collection relatedcosts.

•                  $(27,000)relating to other miscellaneous expenses.

 

(2)          Includes fourth quarter2004 gains (losses) on disposal of discontinued operations of:

 

•                  $(80,000) toincrease liability accruals pertaining to the Company’s collection relatedcosts.

•                  $(765,000) toincrease liability accruals pertaining to costs associated with lawsuits.

•                  $(10,000) toincrease accruals pertaining to the Company’s workers compensation liability.

•                  $109,000 toadjust the reserves against some of the Company’s accounts and notesreceivables to reflect revised expectations of collectibility

•                  $65,000 to reduceaccruals pertaining to the Company’s professional liability insuranceliabilities.

 

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**15.****  VALUATIONAND QUALIFYING ACCOUNTSYears Ended June 30, 2005, 2004 and 2003**

 
| **Description**                      | ** ** | **Balance  At  Beginning of  Period** | ** ** | **Charged  To  Costs and  Expenses** | ** ** | **Other** | ** ** | **Deductions** | ** ** | **Balance  At End  of Period** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|-----------|------------|----------------|------------|--------------------------------|------------|
|                                 |       |                                  |       |                                 |       |      |       |           |       |                           |       |
| Year ended June 30, 2005:       |       |                                  |       |                                 |       |      |       |           |       |                           |       |
| Allowance for uncollectible accounts |       | $                                     | 1,688,613  |                                 | $          | 12,320    |       | $              | (400,285   | )(1)                           | $          | (181,637 | )(3) | $ | 1,119,011 | (4) |
|                                 |       |                                  |       |                                 |       |      |       |           |       |                           |       |
| Year ended June 30, 2004:       |       |                                  |       |                                 |       |      |       |           |       |                           |       |
| Allowance for uncollectible accounts |       | $                                     | 2,386,252  |                                 | —     |      | $          | (553,477       | )(2)       | $                              | (144,162   | )(3) | $ | 1,688,613 |   |
|                                 |       |                                  |       |                                 |       |      |       |           |       |                           |       |
| Year ended June 30, 2003:       |       |                                  |       |                                 |       |      |       |           |       |                           |       |
| Allowance for uncollectible accounts |       | $                                     | 8,479,118  |                                 | —     |      | $          | (1,924,011     | )(2)       | $                              | (4,168,855 | )(3) | $ | 2,386,252 |   |
|                                      |            |                                       |            |                                      |            |           |            |                |            |                                |            |  |  |  |  |  |

 

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(1)                                  Primarilythe collection of previously reserved amounts.(2)                                  Primarilyrelated to changes in reserve estimates for receivables remaining fromdiscontinued operations.

(3)                                  Primarilywrite-offs.

(4)                                  Includesallowances for uncollectible accounts for Lyris of $9,715 and for the Halseydiscontinued operations of $1,109,296.

 

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| **ITEM 9.** | ** ** | **CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES** |
|-------------|------------|--------------------------------------------------------------------------------------------|

 

On June 8,2005, the Audit Committee of the Board of Directors of Halsey announced that ithad appointed Burr, Pilger & Mayer LLP as its new independentregistered accounting firm to audit its financial statements for the yearending June 30, 2005.

 

Also on June 8,2005, the Audit Committee of the Board of Directors of Halsey dismissedPricewaterhouseCoopers LLP as its independent registered accounting firm.PricewaterhouseCoopers LLP has audited our financial statements for the fiscalyear ended June 30, 2004 and for the preceding five fiscal years.

 

The reportsissued by PricewaterhouseCoopers LLP on Halsey’s financial statements for thepast two fiscal years ended June 30, 2004 and 2003 did not contain any adverseopinion or a disclaimer of opinion, or any qualification or modification as touncertainty, audit scope or accounting principles.

 

As reported inthe Company’s Report on Form 8-K filed on June 14, 2005, duringHalsey’s fiscal years ended June 30, 2004 and 2003 and through June 8,2005, there were no disagreements with PricewaterhouseCoopers LLP on any matterof accounting principles or practices, financial statement disclosure, orauditing scope or procedure, which, if not resolved to the satisfaction ofPricewaterhouseCoopers LLP, would have caused PricewaterhouseCoopers LLP tomake reference to the subject matter of the disagreement in connection with itsreports.

 

The Registrant has had nochanges in or disagreements with its independent accountants.

 

**ITEM 9A.**                    CONTROLS ANDPROCEDURES

 

*Evaluation of disclosure controls and procedures*

 

Based on an evaluation as of the end of the periodcovered by this annual report on Form 10-K, the Company’s principalexecutive officer and acting principal financial officer has concluded that theCompany’s disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”) areeffective in timely providing management with material information required tobe disclosed by the Company in its filings under the Exchange Act.

 

*Changes in internal controls*

 

There have been no significant changes in theCompany’s internal controls or in other factors that have materially affected,or are reasonably likely to materially affect, its internal controls during thefourth quarter, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

**ITEM 9B.       OTHER INFORMATION**

 

None

 

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**PART III**

 

**ITEM 10.**                      DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

 

The directors and executive officers of theCompany are as follows:

 
| **Name**                     | ** ** | **Position**                                                                                           | ** ** | **Age** | ** ** |
|------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------|------------|
| William T. Comfort, III |       | Chairman of the Board of Directors and  Director                                                       |       | 39      |       |
| David R. Burt                |       | Chief Executive Officer, President, Acting  Chief Financial Officer, Secretary, Treasurer and Director |       | 42      |       |
| Andrew Richard Blair         |       | Director                                                                                               |       | 72      |       |
| Nicolas DeSantis Cuadra      |       | Director                                                                                               |       | 39      |       |
| Luis A. Rivera               |       | Chief Operating Officer                                                                                |       | 34      |       |
| Joseph Lambert               |       | Vice President, Controller                                                                             |       | 44      |       |

 

No family relationshipsexist among any of the directors or executive officer of the Company.  Executive officers serve at the discretion ofthe Company’s Board of Directors.

 

*WilliamT. Comfort, III* has served as a director of the Company since June 2002, andChairman of the Board since November 12, 2002.  Mr. Comfort was a private equityinvestor with CVC Capital Partners, a leading private equity firm based inLondon, England, from February 1995 until December 2000.  From February 2001 to February 2003he served as a consultant to Citicorp Venture Capital (“CVC”).  He is now principal of Conversion CapitalPartners Limited, an investment fund headquartered in London, England.  Mr. Comfort has served as a member of theboard of directors of Ergo Science Corporation since January 2001. Mr. Comfortalso served as a director of numerous public and private companies as arepresentative of CVC Capital Partners and CVC from which he has resigned.  Mr. Comfort received his J.D. and L.L.M.in tax from New York University School of Law.

 

*DavidR. Burt* hasbeen Chief Executive Officer, President and Secretary of the Company and itspredecessor since May 4, 2000, Treasurer since January 14, 2002, anda director since June 7, 2000.  Mr. Burtpreviously served as a Class III director of the Company until January 31,2004, when he resigned that position and was reappointed as a Class IIdirector to fill the vacancy on the Board of Directors created by theresignation of Charles E. Finelli.  Mr. Burtwas also President, Chief Executive Officer, Secretary, and a director of ErgoScience Corporation, a biopharmaceutical company, until his resignation in December 2003.  Mr. Burt had served in variouscapacities with Ergo since joining that company in March 1993.  Mr. Burt received a B.A. in governmentfrom Dartmouth College and a J.D. from the University of Maryland LawSchool.  Before attending law school, Mr. Burtworked on the staff of United States Senator Paul S. Sarbanes.

 

*AndrewRichard Blair*has been a director of the Company since November 12, 2002.  He is a founder of Freimark Blair &Company, Inc., a broker-dealer research boutique.  Mr. Blair has served as President, ChiefExecutive Officer, Chief Financial Officer and as a director of Freimark Blairsince January 1983.  Mr. Blairreceived his B.S. in Science and Business Administration from Wake ForestUniversity.

 

*NicolasDeSantis Cuadra*has been a director of the Company since January 16, 2003.  Mr. DeSantis has served since January 2003as the Chief Executive Officer of London-based Twelve Stars Communications, aninternational brand business consulting firm, which Mr. DeSantis foundedin 1994.  He previously served as theChief Executive Officer of Twelve Star from 1994 until December 1998.  From December 2000 until January 2003,Mr. DeSantis served as the marketing director of OPODO Ltd., an onlinetravel portal owned by several European-based airlines.  From January 1999 until December 2000Mr. DeSantis served as Senior Vice President and Chief Marketing Officerof Beenz.com.  Mr. DeSantis receiveda degree in economics from Kensington University of Los Angeles, California, in1988.

 

*Luis A. Rivera*was elected to the office of Chief Operating Officer of the Company effective asof our acquisition of Lyris in May 2005. At the same time, Mr. Rivera was named President and ChiefExecutive Officer of Lyris.  From May 2003through May 2005, Mr. Rivera was the General Manager of Lyris.  From May 2001 through April 2003, Mr. Riverawas the Director of Sales of Lyris.  FromNovember 1999 through May 2001, Mr. Rivera served as Director ofInternational Sales of Turbolinx, an open source technology company.  Mr. Rivera is a graduate of ClaremontMcKenna College.

 

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*Joseph Lambert* joined the Company on August 29, 2005as Vice President and Controller.  Priorto joining the Company, Mr. Lambert served as Director of OperationalAccounting for Dreyer’s Grand Ice Cream, Inc. from December 2001 to August 2005. From March 2001 through June 2001, Mr. Lambert was a consultantand served as Interim Controller of Equilibrium Technologies.  From June 2001through October 2001, Mr. Lambert was employed by New Boston SelectGroup, Inc., in which capacity he continued to serve as Interim Controllerof Equilibrium Technologies.  Prior to his work with EquilibriumTechnologies, Mr. Lambert served as Controller of 1stUp.com Corporationfrom 1999 to 2001.  Mr. Lambert holds a B.A. in Economics from theUniversity of California Los Angeles.

 

**Section 16(a) Beneficial Ownership Reporting Compliance**

 

Section 16(a) ofthe Exchange Act requires the Company’s directors, executive officers andholders of more than 10% of its shares of common stock to file with the SECinitial reports of ownership of shares of common stock and reports of changesin such ownership. The SEC’s rules require such persons to furnish theCompany with copies of all Section 16(a) reports that they file.  Based on a review of these reports and onwritten representations from the reporting persons that no other reports wererequired, the Company believes that the applicable Section 16(a) reportingrequirements were complied with for all transactions which occurred in thefiscal year ended June 30, 2005.

 

**Code of Ethics**

 

 On September 25, 2003, the Company adopted a Code of Conductapplicable to all employees, including the principal executive officer,principal financial officer and principal accounting officer. A copy of theCode of Conduct was included as an exhibit in the Company’s 2003 Form 10-Kas filed with the Securities and Exchange Commission and is incorporated byreference.

 

**Audit Committee Members and Financial Expert**

 

The audit committee ofthe board of directors is comprised of Andrew Richard Blair, who serves aschairman and Nicholas DeSantis Cuadra. The Audit Committee does not include a financial expert within themeaning of the applicable rules of the Securities and Exchange Commission.The board of birectors has not appointed a financial expert to the AuditCommittee because of the Company’s current size, its current lack of operationsand the difficulty and expense of locating a person with such expertise who iswilling to join the board of directors.

 

**Shareholder Nomination**

 

There have been nomaterial changes to the procedures by which shareholders may recommend nomineesto the board of directors, since the disclosure in the Company’s last proxystatement.

 

**ITEM 11.**                      EXECUTIVECOMPENSATION

 

The following table setsforth certain information for the fiscal years ended June 30, 2005, 2004and 2003 concerning the compensation of the Company’s Chief Executive Officerand certain other executive officers. These individuals are referred to herein as “Named Executive Officers.”

 

54

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**Summary Compensation Table**

 
| ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                      | ** ** | **Long-Term Compensation**    | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                      | ** ** | **Awards**                    | ** ** | **Payouts** | ** ** | ** ** | ** ** |
| **Name and Principal  Position** | ** ** | **Year**   | ** ** | **Salary** | ** ** | **Bonus**  | ** ** | **Other  Annual  Compensation** | ** ** | **Restricted  Stock  Awards** | ** ** | **Securities  Underlying  Options/  SARs(#)** | ** ** | **LTIP  Payouts** | ** ** | **All Other  Compensation** | ** ** |
| David R. Burt                    |       | 2005       |       | 250,000    |       | 20,000     | (1)        | —                          |       | —                        |       | — |   | — |   | — |   |
| Chief  Executive                 |       | 2004       |       | 250,000    |       | 20,000     | (2)        | —                          |       | —                        |       | — |   | — |   | — |   |
| Officer,  President,             |       | 2003       |       | 250,000    |       | 178,701    | (3)        |                            |       |                          |       |   |   |   |   |   |   |
| Secretary,  Treasurer            |       |       |       |       |       |       |       |                            |       |                          |       |   |   |   |   |   |   |
| and Director                     |       |       |       |       |       |       |       |                            |       |                          |       |   |   |   |   |   |   |
| Luis A. Rivera                   |       | 2005       |       | 25,875     |       | 34,341     | (4)        | —                          |       | —                        |       | — |   | — |   | — |   |
| Chief  Operating                 |       |       |       |       |       |       |       |                            |       |                          |       |   |   |   |   |   |   |
| Officer of  JL Halsey            |       |       |       |       |       |       |       |                            |       |                          |       |   |   |   |   |   |   |
| and  President and               |       |       |       |       |       |       |       |                            |       |                          |       |   |   |   |   |   |   |
| Chief  Executive                 |       |       |       |       |       |       |       |                            |       |                          |       |   |   |   |   |   |   |
| Officer of  Lyris.               |       |       |       |       |       |       |       |                            |       |                          |       |   |   |   |   |   |   |
| Joseph Lambert, VP Controller    |       | 2005       |       | —     | (5)        | —     |       | —                          |       | —                        |       | — |   | — |   | — |   |

 

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(1)          This amount represents the amount earned and paid in fiscal year 2005.

 

(2)          Thisamount represents the amount earned andpaid in fiscal year 2004.

 

(3)          Thisamount represents the amount earned in fiscal year 2003, of which $20,000 waspaid in fiscal year 2003. The remaining amount has been accrued. The bonuses in2002 and 2003 were paid or accrued pursuant to different formulas in accordancewith the executive’s employment contract. No bonuses remain to be accrued undersuch formulas.

 

(4)          Mr. Riverabecame an officer of the Company on May 12, 2005 when the Company acquiredLyris Technologies, Inc. Salary and bonus only includes amounts earnedfrom the period May 12, 2005 – June 30, 2005. Bonus amount was earnedin fiscal year 2005 and paid in fiscal year 2006.

 

(5)          Mr. Lambertjoined the Company on August 28, 2005 and therefore did not receive anycompensation in fiscal year 2005.

 

**Option GrantsIn Last Fiscal Year**

 

During fiscal 2005, we granted to Mr. Riveraoptions to purchase 3,600,000 shares of common stock at an exercise price of$0.30. These options vest on a quarterly basis over a four year period. As of June 30,2005, none of Mr. Rivera’s options had vested and accordingly, none wereexercised.

 

The Company terminatedits previous stock option plan in fiscal year 2003, therefore, no options weregranted to any Named Executive Officer during the fiscal year ended June 30,2003 or 2004.

 

**Aggregate Option Exercises in Last Fiscal Yearand Fiscal Year End Option Values**

 
| ** **     | ** ** | **Shares**   | ** ** | ** **            | ** ** | **Number of Securities Underlying** | ** ** | **Value of the Unexercised** | ** ** |
|----------------|------------|--------------|------------|-----------------------|------------|-------------------------------------|------------|------------------------------|------------|
| ** **     | ** ** | **Acquired** | ** ** | ** **            | ** ** | **Unexercised Options**             | ** ** | **In-The-Money Options**     | ** ** |
| ** **     | ** ** | **on**       | ** ** | **Value**             | ** ** | **At Fiscal Year-End**              | ** ** | **at Fiscal Year-End (2)**   | ** ** |
| **Name**       | ** ** | **Exercise** | ** ** | **Realized (1)** | ** ** | **Exercisable**                     | ** ** | **Unexercisable**            | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Luis A. Rivera |       | —       |       | $                     | —     |                                | —     |                         | 3,600,000  |   | $ | — |   | $ | 756,000 |   |
|                |            |              |            |                       |            |                                     |            |                              |            |  |  |  |  |  |  |  |

 

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(1)                                  Amounts shown in this column do notnecessarily represent actual value realized from the sale of the sharesacquired upon exercise of the option because in many cases the shares are notsold on exercise but have continued to be held by the executive officerexercising the option. The amounts shown represent the difference between theoption exercise price and the market price on the date of exercise, which isthe amount that would have been realized if the shares had been soldimmediately upon exercise.

 

(2)                                  The value of unexercised in-the-money optionsat fiscal year end assumes a fair market value for our common stock of $0.51,the closing sale price per share of our common stock as reported in the OTCBulletin Board on Thursday, June 30, 2005. The $756,000 is calculatedbased on the difference between the market price of our stock at June 30,2005 and the exercise price to the officer of $0.30.

 

55

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No options were exercisedduring, and no options were held by, any Named Executive Officer at the end ofthe fiscal year ended June 30, 2003 or 2004.

 

**Compensationof Directors of Halsey**

 

The Company provides eachnon-employee director with an annual retainer of $25,000.  Each director receives a fee of $1,000 permeeting attended, plus out-of-pocket expenses. In addition, members of board committees receive a fee of $1,000, plusout-of-pocket expenses, for each non-telephonic committee meeting attended thatis not scheduled in conjunction with a meeting of the full board, and a fee of$500, plus out-of-pocket expenses, for each non-telephonic committee meeting attendedin conjunction with a meeting of the full board and for each telephonic meetingof any committee of the board.  Executiveofficers of the Company do not receive additional compensation for serving onthe board of directors. William T. Comfort, III, the Company’s Chairman ofthe Board has waived all retainers and fees for his services.

 

**EmploymentAgreements**

 

Effective as of May 5,2000, the Company entered into an employment agreement with David R. Burt, toserve as the Company’s Chief Executive Officer. The original term of theagreement expired on May 5, 2005, and was subsequently extended for oneyear though May 5, 2006.  Pursuantto the agreement, Mr. Burt receives an annual base salary of $250,000 andan annual performance bonus of not less than $20,000.  The agreement requires Mr. Burt todevote at least 50% of his business time and attention to the performance ofthe duties and responsibilities of Chief Executive Officer, in as much as Mr. Burtalso served, until December 2003, as president, chief executive officerand a director of Ergo Science Corporation. Mr. Burt resigned from all positions with Ergo in December 2003and now devotes all of his business time to his duties as an officer anddirector of the Company. As consideration for, among other things, his effortsin obtaining settlements on certain disputes in July 2000, the Companygranted Mr. Burt a convertible promissory note in the principal amount of$60,000. Mr. Burt subsequently transferred the note to a family limitedpartnership controlled by him.  On orabout May 28, 2002, the holder of the note converted $52,125 of principalon the note into 20,850,000 shares of Common Stock.  The remaining $7,875 in principal and $9,500in accrued interest were redeemed by the Company.  On September 19, 2002, the familylimited partnership granted an option to purchase 4,170,000 shares of theCommon Stock acquired upon conversion of the note to Mr. William T.Comfort III, a director of the Company, at $0.04 per share which was laterexercised.  On January 8, 2003, thepartnership sold an additional 4,170,000 shares to LDN Stuyvie Partnership, ofwhich Mr. Comfort is the sole general partner, for $0.2676 per share. Mr. Burt’semployment agreement also provides him certain registration rights with respectto the shares acquired upon conversion of the note. Because the exercise priceof the options and the selling price of the shares were at or above marketprice in effect at the time of the transactions, there was no effect on theCompany’s results of operations.

 

EffectiveMay 12, 2005, Lyris entered into an employment agreement with Luis A.Rivera, to serve as President and Chief Executive Officer. The term of theagreement is for five years and expires on May 12, 2010. Pursuant to theagreement, Mr. Rivera receives an annual base salary of $200,000 and willbe eligible to receive a quarterly performance bonus based on the profitabilityof the Company. In addition, Mr. Rivera received an award of 3,600,000Company stock options, which will vest ratably over four years on a quarterlybasis.  The terms of Mr. Rivera employment are contained in anemployment agreement between Lyris and Mr. Rivera dated May 12, 2005.

 

OnAugust 29, 2005, Joseph Lambert, 44, joined the Company as Vice Presidentand Controller and Lyris, as Financial Controller.  Mr. Lambert willreceive an annual base salary of $125,000 and will be eligible to receive anannual merit bonus of up to 25% of his base salary.  In addition, Mr. Lambertwill receive an award of 250,000 Company stock options, which will vest ratablyover four years.  The terms of Mr. Lambert’s employment are containedin an offer letter, dated August 2, 2005 from Lyris, and an employmentagreement between Lyris and Mr. Lambert dated August 29, 2005.

 

The Company and James T.Walmsley, our former Vice President, are currently engaged in litigation withrespect to (i) the Company’s claim that Mr. Walmsley received amountshe was not entitled to and (ii) amounts that Mr. Walmsley claims theCompany owes to him. See Note 12.

 

**CompensationCommittee Interlocks and Insider Participation**

 

The CompensationCommittee of the Company during 2005 consisted of William T. Comfort, III.No executive officer of the Company serves as a member of the compensationcommittee or board of directors of another company of which an executiveofficer serves on the Compensation Committee of the Company.

 

56

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**ITEM 12.**                      SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS

 

The following table setsforth information with respect to the beneficial ownership of the Company’scommon stock as of September 2, 2005 by:

 

•                                          eachstockholder known by the Company to beneficially own more than five percent ofthe common stock;

 

•                                          eachof the Company’s directors;

 

•                                          eachof the Company’s named executive officers; and

 

•                                          alldirectors and executive officers as a group.

 

The Company hasdetermined beneficial ownership in accordance with the rules of theSecurities and Exchange Commission. Unless otherwise indicated, the persons included in this table have solevoting and investment power with respect to all the shares of common stockbeneficially owned by them, subject to applicable community property laws.  The Company has no options outstanding forinclusion in the calculation of beneficial ownership.

 
| **Name of Beneficial Owner (a)**               | ** ** | **Amount and Nature of  Beneficial Ownership** | ** ** | **Percentage of  Outstanding Shares** | ** ** |
|------------------------------------------------|------------|------------------------------------------------|------------|---------------------------------------|------------|
|                                           |       |                                           |       |                                  |       |
| LDN Stuyvie Partnership                        |       | 15,216,955                                     | (b)        | 18.3                                  | %          |
| William T. Comfort III                         |       | 19,386,955                                     | (c)        | 23.4                                  | %          |
| David R. Burt                                  |       | 12,510,000                                     | (d)        | 15.1                                  | %          |
| Luis A. Rivera                                 |       | 620,000                                        | (e)        |                                  | *          |
| Joseph Lambert                                 |       | —                                         | (f)        | —                                | ** ** |
| Andrew Richard Blair                           |       | —                                         | ** ** | —                                | ** ** |
| Nicolas De Santis Cuadra                       | ** ** | —                                         | ** ** | —                                | ** ** |
| Directors and Officers as a group (6  persons) |       | 32,516,955                                     |       | 38.7                                  | %          |

 

----

*                      Represents beneficial ownership of less than1% of the Company’s outstanding shares of common stock.

 

(a)               Information as tothe interests of the directors and officers has been furnished in part bythem.  The inclusion of informationconcerning shares held by or for their spouses or children or by corporationsor other entities in which they have an interest does not constitute anadmission by such persons of beneficial ownership thereof.  Unless otherwise indicated, the address ofeach director and officer listed is 103 Foulk Rd. Suite 205Q, Wilmington,DE 89119. Unless otherwise indicated, all persons have sole voting anddispositive power as to all shares they are shown as owning.

 

(b)              LDN StuyviePartnership is a limited partnership, the sole general partner of which isWilliam T. Comfort III, the Company’s Chairman of the Board. The address of LDNStuyvie Partnership is 30 Cheyne Walk, SW3 5HH London, UNITED KINGDOM.

 

(c)               Includes the sharesheld by LDN Stuyvie Partnership, of which Mr. Comfort is the sole generalpartner.

 

(d)              Consists entirely ofshares held by a family limited partnership, the general partner of which iscontrolled by Mr. Burt.

 

(e)               Includes 450,000shares of common stock subject to stock options held by Mr. Rivera on September 12,2005 and exercisable within 60 days thereafter.

 

(f)                 Mr. Lambertjoined the Company on August 29, 2005. As of the filing of this Form 10-K,none of the options granted to Mr. Lambert are currently exercisable orexercisable within 60 days thereafter.

 

57

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## ***Equity Compensation PlanInformation***

## *** ***

The following table furnishes information withrespect to compensation plans under which equity securities of the Company areauthorized for issuance as of June 30, 2005.

 
| **Plan category**                                           | ** ** | **Number of securities to be  issued upon exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average exercise  price of outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  issuance under equity  compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**                                                                                            | ** ** | **(b)**                                                                           | ** ** | **(c)**                                                                                                                                       | ** ** |
|                                                        |       |                                                                                               |       |                                                                              |       |                                                                                                                                          |       |
| Equity  compensation plans approved by security holders     |       |                                                                                               |       |                                                                              |       |                                                                                                                                          |       |
| Equity  compensation plans not approved by security holders |       | 6,370,000                                                                                          |       | $                                                                                 | 0.31       |                                                                                                                                          | 6,830,000  |   |
| Total                                                       |       | 6,370,000                                                                                          |       | $                                                                                 | 0.31       |                                                                                                                                          | 6,830,000  |   |

 

The Company establishedthe Equity Based Compensation Plan on May 6, 2005.****The Equity Based Compensation Planprovides for grants of stock options and stock-based awards to employees,directors, and consultants of the Company. Stock options issued in connectionwith the Equity Based Compensation Plan are granted with an exercise price pershare equal to the fair market value of a share of Company common stock at thedate of grant. All stock options have ten-year maximum terms and vest, eitherquarterly, or annually and all within four years of grant date. The totalnumber of shares of common stock issuable under the Equity Based CompensationPlan is 13,200,000. At June 30, 2005, there were 6,830,000 sharesavailable for grant under the Equity Based Compensation Plan.

 

**ITEM 13.****                                              CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

On or about May 28,2002, a family limited partnership controlled by David Burt, our ChiefExecutive Officer, converted $52,125 of the $60,000 note originally issued to Mr. Burtin September 2000 for 20,850,000 shares of Common Stock.  The remaining $7,875 of principal and $9,500of interest accrued on the note was redeemed by the Company at the time of theconversion.  On September 19, 2002,the family limited partnership granted an option to purchase 4,170,000 sharesof the Common Stock acquired upon conversion of the note to Mr. William T.Comfort III, a director of the Company, at $0.04 per share, which was laterexercised. On January 8, 2003, the partnership sold an additional 4,170,000shares to LDN Stuyvie Partnership, of which Mr. Comfort is the solegeneral partner, for $0.2676 per share.

 

**ITEM 14.**                      PRINCIPALACCOUNTANT FEES AND SERVICES

 

| **Fee Type**       | ** ** | **Fiscal Year  2005** | ** ** | **Fiscal Year  2004** | ** ** |
|--------------------|------------|-----------------------|------------|-----------------------|------------|
|               |       |                  |       |                  |       |
| Audit fees (1)     |       | $                     | 164,000    |                  | $          | 165,974 |   |
| Audit-related fees |       | —                |       | —                |       |
| Tax fees           |       | —                |       | —                |       |
| All other fees (2) |       | $                     | 116,660    |                  | $          | 21,580 |   |
| Total (3)          |       | $                     | 280,660    |                  | $          | 187,554 |   |

 

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**(1)**          Includes fees forprofessional services rendered in connection with the audit of the Company’sfinancial statements and the review of the Company’s financial statementsincluded in the Company’s quarterly reports on Form 10Q for each fiscalyear.

 

(2)          Includes fees for professional services rendered related to income taxmatters in Fiscal Year 2004 and fees for professional services rendered inconnection with the acquisition of Lyris Technologies in Fiscal Year 2005.

 

(3)                                  All audit and other principal accountant feeswere approved by the Company’s Audit Committee.

 

*Boardof Directors Pre-Approval Policy:*

 

**Our Audit Committeehas adopted a policy to pre-approve all audit, audit-related, tax and otherservices proposed to be provided by our independent auditor prior to engagingthe auditor for that purpose. Consideration and approval of such services generally will occur at theAudit Committee’s regularly scheduled quarterly meetings.**

 

58

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**PART IV**

 

**ITEM 15.**                      EXHIBITS,FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

 

(a) See Item 8 in Part II of this AnnualReport on Form 10-K, Financial Statements and Supplementary Data, for anindex to the consolidated financial statements and supplementary financialinformation filed on this Form 10-K.

 

(b) During the three months ended June 30,2005, we filed the following reports on Form 8-K:

 

•                     On May 12 2005, we filed a CurrentReport on Form 8-K reporting Item 1, in connection with the announcementof entering into a Stock Purchase Agreement with Lyris Technologies, Inc.and the adoption by our Board of Directors of the J.L. Halsey 2005 Equity BasedCompensation Plan.

 

•                     On May 16 2005, we filed a CurrentReport on Form 8-K reporting Item 2, in connection with the completion ofa Stock Purchase Agreement with Lyris Technologies, Inc., Item 5, inconnection with the appointment of Luis A. Rivera as the Company’s new ChiefOperating Officer, and item 9, the filing of audited financial statements ofthe newly acquired Lyris Technologies, Inc.

 

•                     On June 14, 2005 we filed a CurrentReport on Form 8-K reporting Item 4, in connection with the change in ourindependent Registered Public Accounting Firm.

 

**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                     | ** ** | ** ** |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                |       |       |
| 2(a)(i)              |       | Stock Purchase Agreement dated as of April 2, 1999 by and among  NovaCare, Inc., NC Resources, Inc., Hanger Orthopedic Group, Inc.  and HPO Acquisition Corp. (incorporated by reference to Exhibit 2(a) to  the Company’s Current Report on Form 8-K dated July 1, 1999).                             |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                |       |       |
| 2(a)(ii)             |       | Amendment No. 1 to Stock Purchase Agreement made as of May 19,  1999 by and among NovaCare, Inc., NC Resources, Inc., Hanger  Orthopedic Group, Inc. and HPO Acquisition Corp. (incorporated by  reference to the Exhibit 2 (b) to the Company’s Current Report on Form 8-K  dated July 1, 1999). |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                |       |       |
| 2(a)(iii)            |       | Amendment No. 2 to Stock Purchase Agreement made as of June 30,  1999 by and among NovaCare, Inc., NC Resources, Inc., Hanger  Orthopedic Group, Inc. and HPO Acquisition Corp. (incorporated by  reference to Exhibit 2(c) to the Company’s Current Report on Form 8-K  dated July 1, 1999).     |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                |       |       |
| 2(b)(i)              |       | Stock Purchase Agreement dated as of June 1, 1999 by and among  NovaCare, Inc., NC Resources, Inc. and Chance Murphy, Inc.  (incorporated by reference to Exhibit 2(a) to the Company’s Current  Report on Form 8-K dated June 1, 1999).                                                               |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                |       |       |
| 2(b)(ii)             |       | Amendment No. 1 to Stock Purchase Agreement made as of June 1,  1999 by and among NovaCare, Inc., NC Resources, Inc. and Chance  Murphy, Inc. (incorporated by reference to Exhibit 2(b) to the  Company’s Current Report on Form 8-K dated June 1, 1999).                                        |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                |       |       |
| 2(c)                 |       | Stockholder Agreement dated as of September 8, 1999 among Plato  Holdings, Inc., New Plato Acquisition, Inc., NC Resources, Inc.  and NovaCare, Inc. (incorporated by reference to Exhibit 2((a) to  the Company’s Current Report on Form 8-K dated October 14, 1999).                            |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                |       |       |
| 2(d)(i)              |       | Stock Purchase Agreement dated as of October 1, 1999 by and  among NovaCare, Inc. NC Resources, Inc. and Select Medical  Corporation (incorporated by reference to Exhibit 2(b) to the  Company’s Current Report on Form 8-K dated October 14, 1999).                                                       |       | —     |

 

59

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | ** ** |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 2(d)(ii)             |       | First Amendment dated November 19, 1999 to the Stock Purchase  Agreement dated October 1, 1999 among NovaCare, Inc., NC Resources, Inc.  and Select Medical Corporation (incorporated by reference to Exhibit 2(b) to  the Company’s Current Report on Form 8-K dated December 6, 1999).                                                             |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 2(d)(iii)            |       | Opinion of Warburg Dillon Read LLC dated as of October 1, 1999  (incorporated by reference to Exhibit 99(a) to the Company’s  Current Report on Form 8-K dated October 14, 1999).                                                                                                                                                                                   |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 2(e)                 |       | Stock Purchase Agreement by and among Commodore Resources, Inc.,  Lyris Technologies, Inc., John Buckman, Jan Hanford, The John Buckman  and Jan Hanford Trust and the Company, for certain limited purposes contained  therein, dated May 6, 2005 (incorporated by reference to Exhibit 2.1  to the Company’s Current Report on Form 8-K dated May 12, 2005). |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 3(a)(i)              |       | Certificate of Incorporation of the Company, as amended (incorporated  by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-4  filed with the Securities and Exchange Commission on February 5, 2002,  file no. 333-82154).                                                                                                                          |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 3(a)(ii)             |       | Certificate of Ownership and Merger of NAHC, Inc. with and into  J. L. Halsey Corporation (incorporated by reference to Exhibit 2.1 to  the Company’s Registration Statement on Form S-4 filed with the  Securities and Exchange Commission on February 5, 2002, file no. 333-82154).                                                                                    |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 3(b)                 |       | First Amended and Restated Bylaws of the Company (incorporated by  reference to Exhibit 3(b) to the Company’s Annual Report on Form 10-K  for the year ended June 30, 2002).                                                                                                                                                                                             |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 4(a)(ii)             |       | Amendment No. 2 to 1986 Stock Option Plan (incorporated by  reference to Exhibit 4(a)(ii) to the Company’s Annual Report on Form 10-K  for the year ended June 30, 2002).                                                                                                                                                                                           |       |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 4 (b)*               |       | Form of Indenture dated as of January 15, 1993 between the  Company and Pittsburgh National Bank relating to 51/2% Convertible  Subordinated Debentures Due 2000 (incorporated by reference to Exhibit 4  to Registration Statement on Form S-3 No. 33-55710).                                                                                                           |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 4(c)(i)              |       | 1998 Stock Option Plan (incorporated by reference to Exhibit 4  to Registration Statement Form S-8 filed with the Securities and  Exchange Commission on January 15, 1999, File No. 333-70653).                                                                                                                                                                               |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 4(c)(ii)             |       | Amendment No. 1 to 1998 Stock Option Plan (incorporated by  reference to Exhibit 4(c)(ii) to the Company’s Annual Report on Form 10-K  for the year ended June 30, 2002).                                                                                                                                                                                           |       |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 4(d)                 |       | J. L. Halsey Corporation Executive Stock Option Plan (incorporated by  reference to Exhibit 4(d) to the Company’s Annual Report on Form 10-K  for the year ended June 30, 2002).                                                                                                                                                                                         |       |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 4(e)                 |       | J. L. Halsey Corporation 2005 Equity-Based Compensation Plan (incorporated  by reference to Exhibit 10.1 to the Company’s current report on Form 8-K  dated May 12, 2005).                                                                                                                                                                                                    |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(a)                |       | Stock Purchase Agreement dated as of May 1, 1997 between  NovaCare Employee Services, Inc. and James W. McLane (incorporated by  reference to Exhibit 10(i) to the Company’s Annual Report on Form 10-K  for the year ended June 30, 1998).                                                                                                                    |       | —     |

 

60

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                   | ** ** | ** ** |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(b)                |       | Subscriber Services Agreement dated as of July 1, 1999 between NovaCare, Inc.  and NovaCare Employee Services, Inc. (incorporated by reference to Exhibit 10(b) to  the Company’s Current Report on Form 8-K dated November 2, 1999).                                                                                                     |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(c)                |       | Amended and Restated Employment Agreement dated as of September 27,  2000 between the Company and David R. Burt (incorporated by reference to Exhibit 10(k)(i) to  the Company’s Annual Report on Form 10-K for the year ended June 30,  2000).                                                                                                     |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(d)                |       | Convertible Subordinated Note dated as of September 27, 2000  issued by the Company to David R. Burt (incorporated by reference to Exhibit 10(k)(ii) to  the Company’s Annual Report on Form 10-K for the year ended June 30,  2000).                                                                                                          |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(f)(i)             |       | Indemnification Agreement, dated May 4, 2000, by and between  NAHC, Inc. and David R. Burt (the “Burt Indemnification Agreement”)  (incorporated by reference to Exhibit 10(f)(i) to the Company’s  Annual Report on Form 10-K for the year ended June 30, 2002).                                                               |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(f)(ii)            |       | Assignment and Assumption Agreement, dated as of June 1, 2002,  by and between NAHC, Inc. and J. L. Halsey Corporation, assigning the  obligations of NAHC under the Burt Indemnification Agreement to Halsey  (incorporated by reference to Exhibit 10(f)(ii) to the Company’s  Annual Report on Form 10-K for the year ended June 30, 2002). |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(g)                |       | Form of Indemnification Agreement entered into by and between  the Company and each of Charles E. Finelli, William T. Comfort, III,  Andrew Richard Blair and Nicolas DeSantis Cuadra (incorporated by reference  to Exhibit 10(g) to the Company’s Annual Report on Form 10-K  for the year ended June 30, 2002).                   |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(h)                |       | Stock Purchase Agreement by and between the Company and the  University of Chicago Law School.                                                                                                                                                                                                                                                                                    |       |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(i)                |       | Form of Nonstatutory Stock Option Agreement under the J. L.  Halsey Corporation 2005 Equity-Based Compensation Plan (incorporated by  reference to Exhibit 10.2 to the Company’s current report on Form 8-K  dated May 12, 2005).                                                                                                                        |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(j)                |       | Promissory Note, from Commodore Resources, Inc., a subsidiary of  the Company, to The John Buckman and Jan Hanford Trust dated May 12,  2005.                                                                                                                                                                                                                           |       |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(k)                |       | Guaranty, entered into by the Company on May 12, 2005, to  guaranteeing the payment by Commodore Resources, Inc., a subsidiary of  the Company, to The John Buckman and Jan Hanford Trust of the amount  specified in the Promissory Note dated May 12, 2005.                                                                                                      |       |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(l)                |       | Employment Agreement effective May 12, 2005 between Lyris and Luis A.  Rivera.                                                                                                                                                                                                                                                                                                    |       |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 10(m)                |       | Employment Agreement dated as of August 29, 2005 between Lyris and  Joseph Lambert.                                                                                                                                                                                                                                                                                               |       |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 14                   |       | Code of Business Conduct and Ethics, adopted by the Company on September 25,  2003 (incorporated by reference to Exhibit 14 to the Company’s Annual  Report on Form 10-K for the year ended June 30, 2002).                                                                                                                                              |       |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 21                   |       | Subsidiaries of the Company.                                                                                                                                                                                                                                                                                                                                                      |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 24                   |       | Power of Attorney (see “Power of Attorney” in Form 10-K)                                                                                                                                                                                                                                                                                                           |       | —     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 31.1                 |       | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                                                                                                                  |       |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| 32.1                 |       | Section 1350  Certification                                                                                                                                                                                                                                                                                                                                                  |       |       |

 

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Copies of the exhibitsfiled with this Annual Report on Form 10-K or incorporated by referenceherein do not accompany copies hereof for distribution to stockholders of theCompany. The Company will furnish a copy of any of such exhibits to anystockholder requesting the same.

 

Exhibit denoted byan asterisk was filed prior to the Company’s adoption of filing via EDGAR.

 

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| Dated: September 28, 2005 |                           |
|--------------------------------|--------------------------------|
|                           | J. L. HALSEY CORPORATION, INC. |
|                           |                           |   |
|                           | By:                            | /s/ David R.  Burt |   |
|                           |                           | DAVID R. BURT |
|                           |                           | Chief Executive Officer, President, Secretary and Principal  Financial Officer |
|                                |                                |  |  |  |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.

 
| **Signature**                    | ** ** | **Title**                                 | ** **                                | **Date** |
|----------------------------------|------------|-------------------------------------------|-------------------------------------------|----------|
|                             |       |                                      |                                      |     |
| /S/ William T. Comfort, III |       |                                      | Chairman of the Board and Director        |     | September 28, 2005 |
| (WILLIAM T. COMFORT, III)   |       |                                      |                                      |     |
|                             |       |                                      |                                      |     |
| /S/ David R. Burt                |       |                                      | Chief Executive Officer, President,       |     | September 28, 2005 |
| (DAVID R. BURT)                  |       | Secretary and Principal Financial Officer |                                      |     |
|                             |       |                                      |                                      |     |
| /S/ Andrew Richard Blair         |       |                                      | Director                                  |     | September 28, 2005 |
| (ANDREW RICHARD BLAIR)           |       |                                      |                                      |     |
|                             |       |                                      |                                      |     |
| /S/ Nicolas DeSantis Cuadra      |       |                                      | Director                                  |     | September 28, 2005 |
| (NICOLAS DESANTIS CUADRA)        |       |                                      |                                      |     |
|                             |       |                                      |                                      |     |
| /S/ Joseph Lambert               |       |                                      | Vice President and Controller, (Principal |     | September 28, 2005 |
| (JOSEPH LAMBERT)                 |       | Accounting Officer)                       |                                      |     |
|                                  |            |                                           |                                           |          |  |  |  |  |

 

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