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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 

**ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) of**

**theSECURITIES EXCHANGE ACT OF 1934**

 

**Forthe fiscal year ended June 30, 2008**

 

**Commissionfile number 1-10875**

 

**Lyris, Inc.**

 (exact name of registrant as specified in itscharter)

 

| **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)

 

Indicate by check mark ifthe Registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.

Yes   o   No   x

 

Indicated by check markif the Registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.

Yes   o   No   x

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes   x   No   o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

 

Indicate by checkmark whetherthe Registrant is a larger accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeraccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)

 

| Large Accelerated  filer  o |   | Non-accelerated  filer  o     |
|---------------------------------------|--------|-----------------------------------------|
| Accelerated  filer  o       |   | Smaller reporting  company  x |

 

Indicated by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).Yes   o   No   x

 

As of December 31,2007, the aggregate market value of the shares of common stock held bynon-affiliates was approximately $68,090,106 (Determination of stock ownershipby non-affiliates was made solely for the purpose of responding to thisrequirement and the Registrant is not bound by this determination for any otherpurpose.)

 

There were 103,221,882shares of the Registrant’s common stock outstanding as of September 5,2008.

 

 

 

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**LYRIS,INC. AND SUBSIDIARIES**

**FORM 10-K – FISCAL YEARENDED JUNE 30, 2008**

 

**Contents and Cross ReferenceSheetFurnished Pursuant to General Instruction G(4) of Form 10-K**

 
| **Item No.** | ** ** | **Description**                                                                             | ** ** | **Page  Number** |
|-------------------|------------|---------------------------------------------------------------------------------------------|------------|------------------|
|              |       |                                                                                        |       |             |
|              |       | PART I                                                                                 |       |             |
|              |       |                                                                                        |       |             |
| Item 1.           |       | Business                                                                                    |       | 3                |
| Item 1A.          |       | Risk Factors                                                                                |       | 9                |
| Item 1B.          |       | Unresolved  Staff Comments                                                                  |       | 18               |
| Item 2.           |       | Properties                                                                                  |       | 19               |
| Item 3.           |       | Legal Proceedings                                                                           |       | 19               |
| Item 4.           |       | Submission  of Matters to a Vote of Security Holders                                        |       | 19               |
|              |       |                                                                                        |       |             |
|              |       | PART II                                                                                |       |             |
|              |       |                                                                                        |       |             |
| Item 5.           |       | Market for  Registrant’s Common Equity and Related Stockholder Matters                 |       | 20               |
| Item 6.           |       | Selected  Financial Data                                                                    |       | 22               |
| Item 7.           |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       | 23               |
| Item 7A.          |       | Quantitative  and Qualitative Disclosures about Market Risk                                 |       | 37               |
| Item 8.           |       | Financial  Statements and Supplementary Data                                                |       | 38               |
| Item 9.           |       | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosures      |       | 72               |
| Item 9A.          |       | Controls and  Procedures                                                                    |       | 72               |
| Item 9B.          |       | Other Information                                                                           |       | 73               |
|              |       |                                                                                        |       |             |
|              |       | PART III                                                                               |       |             |
|              |       |                                                                                        |       |             |
| Item 10.          |       | Directors and  Executive Officers of the Registrant                                         |       | 74               |
| Item 11.          |       | Executive  Compensation                                                                     |       | 77               |
| Item 12.          |       | Security  Ownership of Certain Beneficial Owners                                            |       | 84               |
| Item 13.          |       | Certain  Relationships and Related Transactions                                             |       | 86               |
| Item 14.          |       | Principal  Accountant Fees and Services                                                     |       | 89               |
|              |       |                                                                                        |       |             |
|              |       | PART IV                                                                                |       |             |
|              |       |                                                                                        |       |             |
| Item 15.          |       | Exhibits,  Financial Statement Schedules                                                    |       | 90               |
|              |       |                                                                                        |       |             |
| Signatures        |       |                                                                                        |       | 95               |

 

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**PART I**

 

**Forward-Looking Information**

 

*ThisAnnual Report on Form 10-K includes forward-looking statements related tofuture events and our future performance within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities and Exchange Act of 1934, as amended. All statements other thanstatements of historical fact, including statements regarding industryprospects and future results of operations or financial position, made in thisAnnual Report are forward looking. We use words such as “anticipates,” “believes,”“expects,” “future” and “intends” and similar expressions to identifyforward-looking statements. Forward-looking statements reflect management’scurrent expectations, plans or projections and are inherently uncertain. Ouractual results may differ significantly from management’s expectations, plansor projections. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date hereof. Certainrisks and uncertainties that could cause our actual results to differsignificantly from management’s expectations are described in the sectionentitled “Business — Risk Factors” This section, along with other sectionsof this Annual Report, describe some, but not all, of the factors that couldcause actual results to differ significantly from management’s expectations andhave a material adverse effect on our business, financial condition and resultsof operations as well as the value of our common stock. We undertake noobligation to publicly release any revisions to these forward-lookingstatements that may be made to reflect events or circumstances after the datehereof or to reflect the occurrence of unanticipated events. Readers are urged,however, to review the factors set forth in reports that we file from time totime with the Securities and Exchange Commission. Unless the context requiresotherwise in this Annual Report the terms “we,” “us” and “our” refer to Lyris, Inc.and its subsidiaries.*

 

**ITEM 1.  BUSINESS**

 

**Overview**

 

Lyris, Inc., (“Lyris”or the “Company”), formerly J.L. Halsey Corporation, is a leading digitalmarketing technology and services firm.  Ourdigital marketing software and services provide clients with solutions forcreating, delivering and managing online, permission-based direct marketingprograms and other communications to clients who use the Internet tocommunicate with their customers and members. Our technology solutions include email marketing software, whichprovides clients with tools to create, deliver and manage email marketingprograms, newsletters, discussion groups and other digital communications; Webanalytics software, which provides clients with tools to analyze the behaviorof visitors to their websites and also manage pay-per-click (PPC) campaigns andWeb content management software, which is used by clients to manage a website,landing page or email content creation. We offer our software solutions in two forms: as licensed software thatis purchased by clients and downloaded and installed on those clients’computers, and as a hosted solution in which customers use our software on asubscription basis through an Internet connection.

 

On October 31, 2007,we changed our corporate name from J.L. Halsey Corporation to Lyris, Inc.  We made the corporate name change to promotevisibility of our current operation as a provider of integrated marketingtechnology solutions.

 

Prior to August 2006,Lyris was a provider of hosted and licensed email marketing software throughits wholly owned subsidiaries, Lyris Technologies, Inc. and Uptilt, Inc.(d/b/a” EmailLabs”).  On August 18,2006, we acquired ClickTracks Analytics, Inc. (“ClickTracks”) and HotBanana Software, Inc., (“Hot Banana”). ClickTracks was a Web analytics provider and Hot Banana was ane-marketing Web content management company. Both EmailLabs and ClickTracks were merged into Lyris Technologies, Inc.in late 2007.

 

In November 2007,Lyris introduced *Lyris HQ*, online marketingsoftware platform that is offered only on a hosted basis and combines a suiteof marketing technologies within a single sign-on interface. The *Lyris HQ* platform has combined technologies from ouracquisitions to give clients the ability to schedule and manage emailcampaigns, coordinate Web content management, and review analytics results inorder to optimize those campaigns.  Inaddition, with *Lyris HQ*, we introduced a newlydeveloped Web-based search keyword campaign management system called *BidHero* as part of the platform to let advertisers overseeand update pay-per-click (PPC) keyword bidding on Google, Yahoo and othersearch ad platforms.

 

Although we provide an ondemand Web-based marketing platform that brings together a suite of marketingtechnologies into one, we continue to offer the following separate individualonline marketing solutions: *Lyris List Manager,*our licensed software product for email marketing; *EmailLabs,*ourbrand for hosted email marketing software; and *EmailAdvisor,*our deliverability monitoring tool. In addition, we continue to offer our Web Analytics Software: *ClickTracks,*our Web analytics product and *Lyris Hot Banana,*our software that enables customers tomanage content across their different Web properties.

 

We expect to spend themajority of our resources on research and development, and sales and marketing,to strengthen our products and service offerings.

 

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**Our Products and Services**

 

***Lyris HQ***

 

*Lyris HQ* is an on demand Web-based marketing platformthat brings together a suite of marketing technologies into one, single,integrated user experience.  *Lyris HQ* gives clients a centralizedonline site from which to conduct email marketing, Web analytics, Web contentmanagement and PPC keyword bidding. Introduced in November 2007, this service allows users to developand manage email campaigns, coordinate the supporting Web content, oversee andupdate PPC keyword bidding, access reports analyzing various key performanceindicators and make adjustments to their campaigns in real time.  Other features include a calendar totrack schedules across applications and marketing team members, a message boardfor communicating with team members and a resource center (available atLyrisHQ.com), where customers can access blogs and whitepapers that shares bestpractices and tips on how to improve the performance of their campaigns.  *Lyris HQ* isprimarily targeting small and mid-sized businesses (“SMB”) and mid-marketcompanies that use the Internet to market and sell their goods and services. The affordableprice of *Lyris HQ*, starting at$299/month, puts a comprehensive on-demand toolset into the hands of everydaymarketers to simplify their processes, unify their marketing efforts andimprove a campaign’s return on investment.

 

***EmailMarketing Software***

 

***Lyris ListManager*****is our emailmarketing licensed software product*.*  *LyrisListManager* provides IT and marketing departments with atime-tested, powerful email marketing engine to manage and executecampaigns.  Lyris *ListManager*gives IT managers a secure, trustworthy, on-premise platform to deliver areliable, cost-effective solution for marketing teams.  And for marketers, *LyrisListManager* delivers a platform to create high-volume, customizedemail campaigns that ensure the timely delivery of messages to the appropriateemail recipients.  *LyrisListManager* is the industry’s most robust, secure on-premisesoftware solution for email delivery, backed by know-how and best industrypractices.  For IT managers, *Lyris ListManager* delivers software that can be integratedinto other enterprise software solutions. *Lyris ListManager’s* open architectureenables IT managers to modify, configure and integrate the application quicklyand easily.  It cost-effectively helpsmarketers nurture their customer base and convert prospects, while smoothlyintegrating with other applications and solutions.  *Lyris ListManager’s*powerfuldelivery engine which has proven to be effective in diverse industries, allowsusers to the functionality to conduct massive email campaigns ranging in sizefrom small to very large scale.  Therelease of *Lyris ListManager* version 10.0, on June 30,2008, proves Lyris’ dedication to its current and future customers that requiresuch solution.

 

***EmailLabs*****is our brand of hosted email marketing software,which also manages email campaigns and communications.  *EmailLabs*ismarketed to the online marketers and to advertising or marketing agencies as aproduct that they can offer to their clients under that agency’s brand.  *EmailLabs* isonly offered on a hosted basis and traditionally has been our premium emailoffering because of its capabilities, functionality and appeal to users.  *EmailLabs*isthe email marketing software that is integrated into the *Lyris HQ*platform and provides the email campaign capabilities within this integratedsoftware suite.

 

***EmailAdvisor***is our deliverabilitymonitoring tool that helps facilitate the delivery of legitimate email whiletaking into account the complexity of different email viewingapplications.  With the email difficultiesthat can be caused by spam (see “U.S. and Foreign Government Regulation”below), many ISPs (Internet service providers), network administrators andothers now deploy anti-spam filters to prevent spam from entering their emailinbox.  Many of these anti-spam filtersunfortunately block legitimate emails that people want to receive.*   EmailAdvisor* helps email sendersdesign their messages and campaigns to minimize the chance that legitimateemail is wrongly blocked.  *EmailAdvisor*is**also integratedinto *Lyris HQ*and provides its emaildeliverability monitoring capability.

 

***Web Analytics Software***

 

***ClickTracks***is our Web analytics product, which is offered as licensed software or as ahosted application. Web analytics software uses cookies and simple java-scriptto track and report on the activity of visitors to a website or landing page.This software then allows the user to analyze the behavior of those visitorsand report on basic statistics about this behavior.  Lyris sells the *ClickTracks*hosted and licensed software and related services primarily to SMB’s that usethe Internet to market and sell their goods and services*.*  *Clicktracks* isalso sold to agencies and ISPs, which run the software on behalf of othercustomers.  *ClickTracks*is also integrated into the *Lyris HQ*platform and provides the Web analytics capabilities within the integratedapplication.

 

***Web Content Management Software***

 

***Lyris’HotBanana*** software enables customers to manage contentacross their different Web properties more easily, including corporatewebsites, intranets, extranets, landing pages and micro marketingsites.  Hot Banana assists clients tooptimize 

 

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their sites in a mannerthat allows search engines to find relevant content more easily and increasetraffic to their site. *HotBanana* isboth hosted and licensed software that is sold primarily to SMBs that use theInternet to market and sell their goods and services.  Lyris also provides professional services forthe Hot Banana offering, including creative design, content creation, and otherwebsite development services.  *HotBanana* software is**integratedinto *Lyris HQ*and provides the Web contentmanagement capabilities within the suite.

 

**Customers**

 

At June 30, 2008,approximately, 3,783 customers have purchased**our softwareproducts and approximately 187 customers currently use our software on a hostedbasis.  While the majority of ourcustomers are marketing businesses, that use the Internet to sell their goodsand services, our customers also span many other industries including severaldepartments of the U.S. government, national and local political campaigns,Fortune 500 companies, and some of the largest and most reputable academicorganizations, charitable organizations and athletic teams.  We sell to a wide and diversified group ofcustomers and no single customer represents 10% or more of our annual revenues

 

**Sales and Marketing**

 

Our primary goal for sales and marketing isdesigned to raise customer awareness of *LyrisHQ* and *Lyris ListManager*products,establish the company’s executives as thought leaders and to become a go-toresource for all media, analysts and bloggers in the email and integratedmarketing industries.  The February 2008launch of LyrisHQ.com was a major step in that direction.   With aplethora of resources to back these efforts, Lyris, Inc. is poised tobecome the world’s leading provider of integrated online marketing applicationsfor marketers in small-to-medium sized teams who need to manage a wide array ofonline marketing tools.

 

Our sales and marketingactivities are based in our Emeryville, California operating headquarters withadditional personnel in San Jose, California and in Barrie, Ontario.  The sales team is divided into two maingroups, dedicated to (1) selling licensed software, primarily *Lyris ListManager*, and (2) selling *LyrisHQ. *Moreover, the *Lyris HQ* sales team also responds to inquiries relating toour single point email marketing, Web analytics or Web content managementofferings*.* Sales teams also incorporate a group of account managers who focus onretention of existing customers and developing additional business from ourlargest clients.

 

We continue to utilizethe best practices in integrated marketing campaigns that combine the Internetand offline media.  Our marketingstrategy includes attending periodic trade shows and events and seekingpromotional partners through business development activities includingtechnology, agency and referral partnerships. As part of our marketing strategy, we use cross-media advertingmethodology which includes limited print advertising, and significant Internetadvertising including “pay-per-click” (PPC) marketing on major search enginessuch as Google and Yahoo.

 

**Customer Service, Support and Operations**

 

Our hosted serviceofferings include free access to our online support databases and Web seminarson the fundamentals of our hosted products and the basics of online marketingand communication.  Clients receiveautomatic upgrades since the service is hosted on our servers.  Lyris’ standard contract allows for telephonesupport (6 am- 6 pm PDT) and 24/7 telephone support for system emergencies.  In addition, each client is given a standardone to two-hour training session.  Lyrisprovides additional fee-based customized training sessions for a charge.

 

We also offer accountmanagement to clients that are looking for additional support in deployingtheir marketing initiatives.  AccountManagement focuses on increasing customer satisfaction and customerloyalty.  Account Managers work closelywith clients to understanding their online marketing goals and objectives; aswell as providing guidance and best practice recommendations to ensure clientsuccess when using our products and services. Account Managers are also responsible for developing new businessopportunities from our existing customer base.

 

For our licensed softwareclients, we provide customer service and support in differing levels dependingon the product purchased.  Softwarecustomers receive “included support,” which provides free Web access to ouronline support databases and thirty days of online and telephone support.  Customers may also purchase two levels ofpaid support. The first level, referred to as Essential Support, providesonline assistance, telephone support (6 am- 6 pm PST) and free access to minorupgrades during the term of the support contract. The second level, referred toas Comprehensive Support, includes online assistance and telephone support (6am- 6 pm PST) and free access to minor and major upgrades for one year.

 

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As of June 30, 2008,our customer service and support organization had 80 employees.

 

**Professional services**

 

We also offer a widearray of Professional and Consulting Services to better serve our customers.  Service focus areas include implementations,custom development, best practices workshops, and on-demand professionalservices and consulting expertise.  Ourservices team help our customers launch new email marketing campaigns, analyzetheir messaging and design, measure Marketing ROI, and advise on ways tooptimize deliverability.  Customers maypurchase our Professional and Consulting Services a-la carte, or take advantageof comprehensive service offerings which bundle these services into packages.

 

**Operations**

 

We believe thatcontinuous data center operations are crucial to our success in selling hostedservices.  We currently lease space andservices in secure co-location data facilities in Fremont, Novato, Sunnyvaleand Emeryville, California.  These facilitieshouse the servers that our hosted customers use to access our services.  In addition, these facilities have redundantelectrical generators and UPS power supplies, fire suppression systems, and24x7 physical securities that protect the facilities.

 

We continuously monitorthe performance of our service.  Ourmonitoring features include centralized performance consoles, automated loaddistribution tools and various self-diagnostic tools and programs that constantlymonitor our systems and notify systems engineers if any unexpected conditionsarise.  Those system engineers and ourdedicated Operations team are committed to ensuring our clients are up on ourhosted network to enable delivery of marketing solutions on a real time basis.

 

**Technology**

 

*Lyris HQ,*our flagship product, is written in Adobe Flex and delivered as a Web-basedFlash application. This allows us to provide a Rich Internet Application (RIA)to our clients. *Lyris HQ* is the new integrateduser front-end for our individual point applications backends.*  Lyris HQ*communicates and integrates with the individual point applications using aRESTful XML API library.

 

Our independent pointapplications are written in several computing languages, including Flex, ColdFusion, C, C++, C#, and TCL, among others.  They are designed to run inconjunction with a number of different commercial database servers, includingmySQL, Microsoft SQL Server and Oracle.  Lyris’ and EmailLabs’ platformsare designed to handle hundreds of thousands of emails per hour, whileemphasizing reliability, availability and security.  They automaticallyhandle bounces due to invalid email addresses and track user activity afterreceipt of the emails, such as open detection, clickthrough tracking andpurchase tracking.  The information gathered from user activities isdigested into reports and can be used for initiating further email campaigns.

 

Our security systemscontrol access to internal systems and data via the Internet. Internally,log-ins and passwords are maintained for all systems, with access controlgranted on an individual basis to only the required areas for which therecipient is responsible.  Firewalls prevent unauthorized access fromoutside or access to confidential data on the inside.  Certain encryptionand authentication technologies licensed from third parties combined with ourown technologies to provide secure transmission of confidential information.

 

**Research and Development**

 

We believe thatinvestment in research and development is a critical factor in strengtheningour products offerings.  Accordingly, weare continually reinvesting resources in product development.  To succeed in technology markets, our broadfocus is on innovation and long-term approach to new markets.  Additionally, we are committed to supportingand updating our core technology and to expanding our product offerings toprovide a leading set of products that meet the needs of our customers.   As wecontinue to build out our services platform, we will bring a broad range of newproducts and service offerings to market that target the needs of small andmedium-sized businesses, as well as large enterprises.

 

Historically, we havereleased major upgrades to our flagship products every 12 to 16 months. We areimplementing an Agile/SCRUM methodology for our releases which will allow forshorter development cycles and faster releases. As of June 30, 2008, we have approximately 65 engineers who areengaged in maintaining our current products and researching, developing,testing and deploying new versions of our software.  We are investing resources for significantnew research and development to build out the Lyris HQ RIA and integrate andextend out our individual point applications backends.  In addition to this work, features are constantlybeing added or enhanced within our existing applications.  Our main research and development facilitiesare located in Emeryville and San Jose, California.

 

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Duringfiscal years 2008, 2007, and 2006, research and development expense was $2.3million, $1.4 million, and $.2 million, respectively.  We plan to continue to make significantinvestments in a broad range of research and product development efforts tofurther our product and service offerings.

 

**Competition**

 

***General*****.**  We operate inextremely competitive technology markets. Many of our competitors have significantly greater resources (financial,technical, marketing, human capital and other resources) than we do.  In general, the barriers to entry in softwareand hosting markets are considered to be low. New competitors can and will enter the markets in which we compete. Webelieve the following factors are important or may become important in thecompetition for customers:

 

·                 Productfeature set;

·                 Easeof use of the products;

·                 Abilityto integrate with other applications that our clients use to interact withtheir customers such as Customer Relationship Management (“CRM”), enterprisemarketing management (“EMM”), Web analytics, Enterprise Resource Planningpackages and consumer and business databases;

·                 Acompetitors’ introduction of an integrated digital marketing software suite tocompete directly with *Lyris HQ*in*,*performance and scalability;

·                 Priceand total cost of ownership;

·                 Stabilityand reliability;

·                 Qualityof customer service and support;

·                 Brandname and reputation; and

·                 Abilityto provide services in a secure environment and maintain the confidentiality ofcustomer data.

 

***Integrated Software Suite*.**  We arenot currently aware of a competitor that is marketing an integrated suite ofdigital marketing tools that include email, Web analytics and Web contentmanagement suitable for mid-size or larger companies. While some integration ofthese services is occurring among our competitors, the integration of theseservices through custom software, varies from application to application.  However, we do believe that in the futureother companies will develop and market integrated suites of digital marketingtools that could include the full suite of integrated marketing tools that weoffer and possibly additional digital marketing tools.

 

***Email Marketing Markets****. *The market for email marketingsoftware and hosted email marketing services is fragmented and includes manyparticipants.  We have several types ofcompetitors, some of whom offer an on-premise licensed software solution, whileothers offer a hosted service.

 

At the higher end of theemail marketing market, generally referred to as enterprise, there are a numberof large companies that compete by offering professional services withtechnology to help customize the applications for their customers’ needs aswell as digital marketing consulting services. Additionally, some larger competitors provide some integration ofservices as part of their email marketing solutions.  There are companies that include emailmarketing in an integrated offering such as CRM software vendors, EMM softwarevendors, and database marketers.

 

Our competitors alsoinclude many small, privately-held, companies that compete with us on thehosted side, as well as in the SMB marketplace. Our larger competitors in this marketplace include Silverpop, Responsys,Exact Target and SubscriberMail, who typically offer only an email solution andnot an integrated suite.

 

Finally, severalcompanies of our competitors focus on providing email services to very smallusers who do not require either the volume or functionality needed by larger ormore sophisticated users.  Although we dohave many smaller customers, Constant Contact and Vertical Response are thelarger providers to this market.

 

***Web Analytics Market***.  In the Web analytics market, there are anumber of large competitors and several well-funded start-up competitors.  Large companies who operate in this marketinclude WebTrends, Omniture, Visual Sciences (recently acquired by Omniture),CoreMetrics, IndexTools (owned by Yahoo), and Urchin (owned by Google).Additionally, many smaller, privately held companies compete in this space,including OneStat, and Manticore Technology. The Web analytics market is amongthe most competitive of all technology markets.

 

***Web Content Management Market*****.**  In the Web contentmanagement market, there are a number of very large competitors and severalwell-funded start-up competitors.  Large companies who operate in thismarket include EMC (through its Documentum subsidiary), Interwoven, Silver LakeSoftware, Hummingbird, and Vignette Software.  Additionally, many smallerprivately held companies compete in this space, including CrownPeak,Clickability, Ektron, PaperThin, and FatWire.

 

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We believe our productscompete effectively with these vendors based on our strategy and our newcomprehensive on-demand marketing platform that consolidates our full suite ofdigital marketing technologies into a single sign-on dashboard interface.

 

**Intellectual Property**

 

We have filed severalpatent applications.  One applicationcovers certain technology developed for*EmailAdvisor*, and fourother applications are related to technology and processes developed forClickTracks. We were recently awarded a patent on ClickTracks technologythat covers the display of statistical data overlaid on the website as well asthe automatic parameter masking used to define relevant page identifyingURLs.  This technology displays metricsabout website visitors directly onto the site itself, allowing easy analysisand interpretation.

 

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 recent years, manysoftware companies have filed applications for patents covering theirtechnologies.  Many of these patents haveyet to be litigated.  Other competitorsmay develop technologies that are similar or superior to our technology and mayreceive and enforce patents on such technology. We are not aware of any issued or pending patents that may be assertedagainst us.

 

**Employees**

 

At June 30, 2008, wehad 250 employees. Our employees are not represented by any labor union and weare not aware of any current activity to organize any of our employees.

 

**Insurance**

 

We currently purchaseinsurance policies to cover the ongoing liability and property risks arisingout of our current operations.

 

Although we purchased professionalliability tail coverage insurance for periods prior to the sales of ourprevious healthcare businesses, the insurer, PHICO Insurance Company, has beendeclared insolvent and is no longer able to pay claims on our behalf (see “LegalProceedings”).

 

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

 

Email has been thesubject of regulation by local, state, federal and foreign governments. In 2003, the CAN-SPAM Act of 2003 (“CAN-SPAM”) was enacted as United Statesfederal law, CAN-SPAN established national standards for the sending ofcommercial email.  The Federal TradeCommission (FTC) enforces its provisions.

 

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).” CAN-SPAMexempts “transactional or relationship messages.” The provision permits emailmarketers to send unsolicited commercial email that contain, among other requirements,the following: an opt-out mechanism; a valid subject line and header (routing)information; and the legitimate physical address of the mailer.

 

Under CAN-SPAM, if arecipient of permitted email marketing opts out, a sender has ten days to removethe address. The legislation also prohibits the sale or other transfer of anemail 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.  We donot permit any of our hosted customers to send spam, and we require by contractthat our software purchasers and hosted clients comply with CAN-SPAM. Additionally, Lyris sells an anti-spam solution, called*MailShield*.

 

***Available Information***

 

We are subject to theinformation requirements of the Securities Exchange Act of 1934, or theExchange Act. Therefore, we file periodic reports, proxy statements and otherinformation with the Securities and Exchange Commission, or SEC. Such reports,proxy statements and other information may be obtained by visiting the PublicReference Room of the SEC at 100 F Street, NE, Washington, DC 20549 or bycalling the SEC at 1-800-SEC-0330, by sending an electronic message to the SECat 

 

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publicinfo@sec.gov or bysending a fax to the SEC at 1-202-772-9295. In addition, the SEC maintains awebsite (www.sec.gov) that contains reports, proxy and information statements,and other information regarding issuers that file electronically.

 

We make our annual reporton Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-Kand all amendments to such reports filed or furnished pursuant to Section 13(a) or15(d) of the Exchange Act, available (free of charge) on or through theinvestor relations section our website located at www.lyris.com, as soon asreasonably practicable after they are filed with or furnished to the SEC. Informationcontained on or accessible through our website or contained on other websitesis not deemed to be part of this report on Form 10-K.

 

**ITEM1A.  RISK FACTORS**

 

*Thefollowing section describes risks and uncertainties that we believe mayadversely affect our business, financial condition or results ofoperations.  The risks described below are not the only risks facing us.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 Annual Report is qualified in its entirety by theserisks.  This Annual Report also contains forward-looking statements thatinvolve risks and uncertainties. Our actual results could differ materiallyfrom those anticipated in these forward-looking statements as a result ofcertain factors, including the risks faced by us described below and elsewherein this report.  The market price of ourcommon stock could decline due to any of these risks and uncertainties, or forother reasons, and you may lose part or all of your investment.*

 

**RisksRelated to Our Business and Industry**

 

***Our business is substantially dependent on the market foremail marketing.***

 

More than 90% of ourrevenue comes from email marketing — from the licensing of software, the saleof support and maintenance contracts related to our software, and from the saleof hosted services.  The markets for digital marketing, including emailmarketing, Web analytics, marketing content management and related services arerelatively new and still evolving.  There can be no certainty regardinghow or whether these markets will develop, or whether they will experience anycontractions.

 

***Seasonal trends may cause our quarterly operating results tofluctuate, which may adversely affect the market price of our common stock.***

 

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 also affected by similar revenue fluctuations, but our limitedoperating history and the impact of our acquisitions and the integration ofthose acquisitions make it difficult to 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 online directmarketing as a means to attract and retain new customers, demand for ourservices may not develop and the price of our stock could decline.***

 

Our current and plannedservices are relatively new, rapidly evolving, and are very different from thetraditional methods that many of our clients have historically used to attractnew customers and maintain customer relationships.  As a result, customersand potential customers may be reticent to try new technologies and newsolutions, and the demand for our services may not develop or may decline,which could cause our stock price to decline.

 

***Our results depend on consumer use of email and theInternet.  If consumers do not continue to use email and the Internet,demand for our services may not develop and the price of our stock coulddecline.***

 

Our current and plannedservices enable customers to use email and the Internet to increase revenue andtraffic from, and communication with, their online audiences, customers andmembers. Our ability to serve these customers therefore depends on theiraudiences continuing to use both email and the Internet as communicationsmedia.  If consumer adoption of either technology declines, demand for ourservices may not develop or may decline.

 

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

 

Adoption of email as acommunications medium depends on the ability to prevent junk mail, or “spam,”from overwhelming a subscriber’s electronic mailbox.  In recent years,many companies have evolved to address this issue and filter 

 

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unwanted messages beforethey reach customers’ mailboxes.  In response, spammers have become moresophisticated and have also begun using junk messages as a means forfraud.  Email protection companies in turn have evolved to address thisnew threat.  However, if their products fail to be effective against spam,adoption of email as a communications tool will decline, which would adverselyaffect the market for our services.

 

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

 

The market for onlinedirect marketing is highly competitive and experiencing rapid technologicalchange. Intense competition may result in price reductions, reduced sales,reduced gross margins and operating margins, and loss of market share. Ourprincipal competitors include providers of online direct marketing solutionssuch as DoubleClick (owned by Google), Responsys, Experian, Silverpop, BigfootInteractive, Exact Target, Constant Contact and InfoUSA, Web analyticsproviders such as Omniture, Core Metrics, Urchin (owned by Google), Web contentmanagement providers such as Interwoven and Vignette Software, Silver LakeSoftware and many other smaller privately held companies, including Indextools,OneStat, and Manticore Technology. The loss of a client due to service qualityor technology problems could result in reputational harm to us and, as aresult, increase the effect of competition and negatively impact our ability toattract new clients.

 

Many of these potentialcompetitors have broad distribution channels and may bundle complementaryproducts or services. Such bundled products include, but are not limited to,Web analytics, data mining, customer relationship management (CRM) systems andprofessional services.  If we are not able to bundle complementaryservices or continue to expand our distribution capabilities, our results maysuffer.

 

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.  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.

 

***If we fail to respond to rapidly changing technology orevolving industry standards, our products and services may become obsolete orless competitive.***

 

The market for our productsand services is characterized by rapid technological advances, changes inclient requirements, changes in protocols and evolving industrystandards.  If we are unable to develop enhancements to, and new featuresfor, our existing products and services, or develop entirely new products andservices, our products and services may become obsolete, less marketable orless competitive, and our business will be harmed.  The ability to add newenhancements, new features and new services depends on several factors,including having sufficient financial, technical and human resources andcompleting such work in a timely fashion.  Failure to produce timelyacceptable new features will significantly impair our ability to retainexisting revenue and earn new revenue.

 

***If we fail to market new features and migrate customers tonew versions of our system, our products and services may become obsolete orless competitive.***

 

The development ofproprietary technology (e.g. *Lyris HQ*) andservice enhancements and the migration of customers to new technology entailsignificant technical and business risks and require substantial expendituresand lead-time. We might not be successful in marketing and supporting recentlyreleased versions of our technology and services on a timely or cost-effectivebasis. In addition, even if new technology and services are developed andreleased, they might not achieve market acceptance. Also, if we are notsuccessful in a smooth migration of customers to new or enhanced technology andservices, we could lose customers.

 

***We face significant threats from new entrants to ourbusiness.***

 

Barriers to entry insoftware markets are low.  Privately-backed and public companies couldchoose to enter our space and compete directly with us, or indirectly byoffering substitute solutions.  The result could be decreased demandor pricing for our services, longer sales cycles, or a requirement to makesignificant incremental investments in research and development to match theseentrants’ new technologies.  If any of these happens, it could cause us tosuffer a decline in revenues and profitability.

 

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***The majority of our hosted services are sold pursuant toshort-term subscription agreements, and if our customers elect not to renewthese agreements, our revenues may decrease.***

 

Typically, our hostedservices are sold pursuant to short-term subscription agreements, which aregenerally nine 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 our products could diminish demand for ourproducts and services and cause us to lose customers.***

 

Because our products andservices are complex, they may have errors or defects that users identify afterthey begin using them, which could harm our reputation and business.  Inparticular, our anti-spam products may identify some legitimate emails asunwanted or unsolicited spam, or we may not be able to filter out asufficiently high percentage of unsolicited or unwanted messages sent to theemail accounts of customers.  Complex software products like oursfrequently contain undetected errors when first introduced or when new versionsor enhancements are released.  In addition, we may be unable to respond ina prompt manner, or at all, to new methods of attacking a messaging system,such as new spamming techniques.  We have from time to time found defectsin products, and errors in existing products may be detected in thefuture.  Any such errors, defects or other performance problems couldimpact the perceived reliability of our products and services and hurt ourreputation.  If that occurs, customers could elect not to renew orterminate their subscriptions and future sales could be lost.

 

***If the delivery of our email messages is limited or blocked,then the amount we may be able to charge clients for producing and sendingtheir campaigns may be reduced and clients may discontinue their use of ourservices.***

 

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. We continually improve our own technology and work withInternet service providers to improve our ability to successfully deliveremails. However, if Internet service providers materially limit or halt the deliveryof our emails, or if we fail to deliver emails in such a way as to becompatible with these companies’ email handling or authentication technologies,then the amount we may be able to charge clients for producing and sendingtheir online direct marketing campaigns may be reduced and clients maydiscontinue their use of our services.  In addition, the effectiveness ofemail marketing may decrease as a result of increased customer resistance toemail marketing in general.

 

***Our facilities and systems are vulnerable to naturaldisasters and other unexpected events and any of these events could result inan interruption of our ability to execute clients’ online direct marketingcampaigns.***

 

We depend on theefficient and uninterrupted operations of our data centers and hardwaresystems. The data centers and hardware systems are located in California, anarea susceptible to earthquakes. The data centers and hardware systems are alsovulnerable to damage from fire, floods, power loss, telecommunications failuresand similar events. If any of these events results in damage to our datacenters or systems, we may be unable to execute clients’ hosted online directmarketing campaigns until the damage is repaired, and may accordingly loseclients and revenues. In addition, subject to applicable insurance coverage, wemay incur substantial costs in repairing any damage.

 

***System failures could reduce the attractiveness of ourservice offerings.***

 

We provide emailmarketing and delivery services to our clients and end-users through ourproprietary technology and client management systems. The satisfactoryperformance, reliability and availability of the technology and the underlyingnetwork infrastructure are critical to our operations, level of client service,reputation and ability to attract and retain clients. We have experiencedperiodic interruptions, affecting all or a portion of our systems, which webelieve will continue to occur from time to time. Any systems damage orinterruption that impairs our ability to accept and fill client orders couldresult in an immediate loss of revenue to us, and could cause some clients topurchase services offered by our competitors. In addition, frequent systemsfailures could harm our reputation.  Some factors that could lead to interruptionsin customer service include:  operatornegligence; improper operation by, or supervision of, employees; physical andelectronic break-ins; misappropriation; computer viruses and similarevents; power loss; computer systems failures; and Internet andtelecommunications failures. We do not carry sufficient business interruptioninsurance to fully compensate us for losses that may occur.

 

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***A rapid expansion of our network and systems could cause ournetwork or systems to fail or cause our network to lose data.***

 

In the future, we mayneed to expand our network and systems at a more rapid pace than we have in thepast. We may suddenly require additional bandwidth for which we have notadequately planned. We may secure an extremely large customer, group ofcustomers, or experience demands for growth by an existing customer or set ofcustomers that would require significant system resources. Our network orsystems may not be capable of meeting the demand for increased capacity, or wemay incur additional unanticipated expenses to accommodate such capacityconstraints. In addition, we may lose valuable data or our network maytemporarily shut down if we fail to expand our network to meet futurerequirements. Any disruption in our network processing or loss of data maydamage our reputation and result in the loss of customers.

 

***If we are unable to safeguard the confidential informationin our data warehouse, our reputation may be harmed and we may be exposed toliability****.*

 

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 servers couldresult in the misappropriation of confidential customer information or causeinterruptions in our services. It is also possible that one of our employeescould attempt to misuse confidential customer information, exposing us toliability. 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 ifthird parties develop superior intellectual property, third parties could useour intellectual 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. Policing unauthorizeduse of our proprietary information is difficult, and we cannot be certain thatthe steps we have taken will prevent misappropriation, particularly in foreigncountries where the laws may not protect our proprietary rights as fully as inthe United States.

 

We are one of severalcompanies rapidly building new technologies in this industry.  It ispossible that a third party could be awarded a patent that applies to someportion of our business.  If this occurs, we may be required to incursubstantial legal fees, cease using the technology or pay significant licensingfees for such use.  We are aware of several patents that may be assertedagainst us.

 

***We rely upon third parties for technology that is criticalto our products, and if we are unable to continue to use this technology andfuture technology, our ability to sell or continue to support subscriptions toour products and services would be limited and our operating results could beharmed.***

 

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 depends in part on our continuedability to have access to these technologies, and we do not know whether thesethird-party technologies will continue to be licensed to us on commerciallyreasonable terms or at all. Our loss of rights to use, or the inability tosupport, maintain and enhance, software products we license from third partiescould result in our customers having to upgrade their purchased softwareproducts. 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 withcomparable functionality, which we may be unable to do. As a result, our margins,market share and operating results could be significantly harmed. If any ofthese events occurs, our business and operating results could be harmed.

 

***If a third party asserts that we are infringing itsintellectual property, whether successful or not, it could subject us to costlyand time-consuming litigation or expensive licenses, and our business may beadversely affected.***

 

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 a general matter, we do not searchpatent office files for patents or patent applications that we may possiblyinfringe.  We are aware of several patents for which patent infringement 

 

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potentially may beasserted against us.

 

From time to time we maybe named as a defendant in lawsuits claiming that we have, in some way,violated the intellectual property rights of others. Existing lawsuits againstothers in this industry, as well as any future assertions or prosecutions ofclaims like these, could require us to expend significant financial andmanagerial resources. The defense of any claims, with or without merit, couldbe time-consuming, result in costly litigation and diversion of technical andmanagement personnel, cause product enhancement delays or require that wedevelop non-infringing technology or enter into royalty or licensingagreements.

 

We expect that the numberof infringement claims in our market will increase as the number of servicesand competitors in our industry grows. These claims, whether or not successful,could:

 

·divert management’s attention;

 

·result in costly and time-consuming litigation;

 

·require us to enter into royalty or licensing agreements, which may not beavailable on acceptable terms, or at all; or

 

·require us to redesign our software and services to avoid infringement.

 

As a result, anythird-party intellectual property claims against us could increase our expensesand adversely affect our business. In addition, many of our subscriptionagreements require us to indemnify our customers for third-party intellectualproperty infringement claims, which would increase the cost to us resultingfrom an adverse ruling in any such claim. Even if we have not infringed anythird parties’ intellectual property rights, we cannot be sure our legaldefenses will be successful, and even if we are successful in defending againstsuch claims, our legal defense could require significant financial resourcesand management time.

 

***Activities of clients could damage our reputation or giverise to legal claims against us.***

 

Clients’ promotion oftheir products and services may not comply with federal, state and local laws.We cannot predict whether our role in facilitating these marketing activitieswould expose us to liability under these laws. Any claims made against us couldbe costly and time-consuming to defend. If we are exposed to this kind ofliability, we could be required to pay fines or penalties, redesign businessmethods, discontinue some services or otherwise expend resources to avoidliability.

 

Our services involve thetransmission of information through the Internet. These services could be usedto transmit harmful applications, negative messages, and unauthorizedreproduction of copyrighted material, inaccurate data or computer viruses toend-users in the course of delivery. Any transmission of this kind could damageour reputation or could give rise to legal claims against us. We could spend asignificant amount of time and money defending against these legal claims.

 

***U.S. federal legislation entitled Controlling the Assault ofNon-Solicited Pornography and Marketing Act of 2003 imposes certain obligationson the senders of commercial emails, which could minimize the effectiveness ofour email marketing product, and establishes financial penalties for non-compliance,which could increase the costs of our business.***

 

In December 2003,Congress enacted the Controlling the Assault of Non-Solicited Pornography andMarketing Act of 2003, or the CAN-SPAM Act, which establishes certainrequirements for commercial email messages and specifies penalties for thetransmission of commercial email messages that are intended to deceive therecipient as to source or content. The CAN-SPAM Act, among other things,obligates the sender of commercial emails to provide recipients with theability to opt out of receiving future emails from the sender. In addition,some states have passed laws regulating commercial email practices that aresignificantly more punitive and difficult to comply with than the CAN-SPAM Act,particularly Utah and Michigan, which have enacted do-not-email registrieslisting minors who do not wish to receive unsolicited commercial email thatmarkets certain covered content, such as adult or other harmful products. Someportions of these state laws may not be preempted by the CAN-SPAM Act. Theability of our customers’ constituents to opt out of receiving commercialemails may minimize the effectiveness of our email marketing product. Moreover,non-compliance with the CAN-SPAM Act carries significant financial penalties.If we were found to be in violation of the CAN-SPAM Act, applicable state lawsnot preempted by the CAN-SPAM Act, or foreign laws regulating the distributionof commercial email, whether as a result of violations by our customers or ifwe were deemed to be directly subject to and in violation of theserequirements, we could be required to pay penalties, which would adverselyaffect our financial performance and significantly harm our business. We alsomay be required to change one or more aspects of the way we operate ourbusiness, which could impair our ability to attract and retain customers orincrease our operating costs.

 

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***We have acquired all of our operating businesses since May 2005,and we may continue to expand through acquisitions of, or investments in, othercompanies or through business relationships, all of which may divert ourmanagement’s attention, resulting in additional dilution to our stockholdersand consumption of resources that are necessary 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 exclusivelicenses, additional channels of distribution or discount pricing orinvestments in other companies.

 

Our completed acquisitionsand any future acquisition, investment or business relationship may result inunforeseen operating difficulties and expenditures. In particular, we mayencounter difficulties assimilating or integrating the acquired businesses,technologies, products, personnel or operations of the acquired companies,particularly if the key personnel of the acquired company choose not to workfor us and we may have difficulty retaining the customers of any acquiredbusiness due to changes in management and ownership. Acquisitions may alsodisrupt our ongoing business, divert our resources and require significantmanagement attention that would otherwise be available for ongoing developmentof our business. Moreover, we cannot assure you that the anticipated benefits ofany acquisition, investment or business relationship would be realized or thatwe would not be exposed to unknown liabilities, nor can we assure you that wewill be able to complete any acquisitions on favorable terms or at all. Inconnection with one or more of those transactions, we may:

 

·issue additional equity securities that would dilute our stockholders;

 

·use cash that we may need in the future to operate our business;

 

·incur debt on terms unfavorable to us or that we are unable to repay;

 

·incur large charges or substantial liabilities;

 

·encounter difficulties retaining key employees of the acquired company orintegrating diverse business cultures;

 

·become subject to adverse tax consequences, substantial depreciation ordeferred compensation charges; and

 

·encounter unfavorable reactions from investment banking market analysts whodisapprove of our completed acquisitions.

 

***Failure to properly manage and sustain our expansion effortscould strain our management and other resources.***

 

Our ability tosuccessfully offer services and implement our business plan in a rapidlyevolving market requires an effective planning and management process. We maytry to rapidly and significantly expand the depth and breadth of our serviceofferings. Failure to properly manage this expansion could place a significantstrain on our managerial, operational and financial resources. To manageexpansion, we are required to continually:

 

·improve existing and implement new operational, financial and managementcontrols, reporting systems and procedures;

 

·install new management information systems; and

 

·train, motivate, retain and manage our employees.

 

We may be unable toinstall management information and control systems in an efficient and timelymanner, and our current or planned personnel, systems, procedures and controlsmay be inadequate to support our operations.

 

***Because competition for our target employees is intense, wemay not be able to attract and retain the highly skilled employees we need tosupport our planned growth.***

 

To continue to executeour growth plan, we must attract and retain highly qualified personnel.Competition for these personnel is intense, especially for engineers with highlevels of experience in designing and developing software and Internet-relatedservices. We may not be successful in attracting and retaining qualifiedpersonnel. We have from time to time in the past experienced, and we expect tocontinue to experience in the future, difficulty in hiring and retaining highlyskilled employees with appropriate qualifications. Many of the companies withwhich we compete for experienced personnel have greater resources than 

 

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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 requirement to expense stock options may discourageus from granting the size or type of stock option awards that job candidatesrequire in order to join us. If we fail to attract new personnel or fail toretain and motivate our current personnel, our business and future growthprospects could be severely harmed.

 

***Any failure to adequately expand our direct sales force willimpede our growth.***

 

We currently are, and inthe future expect to continue to be, substantially dependent on our directsales force to obtain new customers and to manage our customer relationships.We believe that there is significant competition for direct sales personnelwith the advanced sales skills and technical knowledge we need. Our ability toachieve significant growth in revenue in the future will depend in large parton our success in recruiting, training and retaining sufficient direct salespersonnel. New hires require significant training and may, in some cases, takemore than a year before they achieve full productivity. Our recent hires andplanned hires may not become as productive as we would like, and we may beunable to hire sufficient numbers of qualified individuals in the future in themarkets where we do business. If we are unable to hire and develop sufficientnumbers of productive sales personnel, sales of our service will suffer.

 

***If we fail to develop our brands cost-effectively, ourbusiness may be adversely affected.***

 

We believe thatdeveloping and maintaining awareness of our brands in a cost-effective manneris critical to achieving widespread acceptance of our current and futureservices and is an important element in attracting new customers. Furthermore,we believe that the importance of brand recognition will increase ascompetition in our market develops. Successful promotion of our brands willdepend largely on the effectiveness of our marketing efforts and on our abilityto provide reliable and useful services at competitive prices. Brand promotionactivities may not yield increased revenue, and even if they do, any increasedrevenue may not offset the expenses we incur in building our brands. If we failto successfully promote and maintain our brands, or incur substantial expensesin an unsuccessful attempt to promote and maintain our brands, 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.

 

***Widespread blocking or erasing of cookies or limitations onour ability to use cookies may impede our ability to collect information withour technology and may reduce the value of the data that we do collect.***

 

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 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, othertechnologies could be developed that impede the operation of our services.These developments could prevent us from providing our services to ourcustomers or reduce the value of our services.

 

In addition, lawsregulating the use of cookies by us and our customers could also prevent usfrom providing our services to our customers or require us to employalternative technology. A European Union Directive currently being implementedby member countries requires us to tell users about cookies placed on theircomputers, describe how we and our customers will use the information collectedand offer users the right to refuse a cookie. Although no European countrycurrently requires consent prior to delivery of a cookie, one or more Europeancountries may do so in the future. If we were required to obtain consent beforedelivering a cookie or if the use or effectiveness of cookies is limited, wewould be required to switch to alternative technologies to collect user profileinformation, which may not be done on a timely basis, at a reasonable cost orat all.

 

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***We have not realized expected benefits from ouracquisitions.***

 

While we expect ouracquisitions to result in additional net revenues for us, we cannot guaranteethat will be the case.

 

With respect to theintegration of personnel, despite our efforts to retain the key employees ofacquired businesses, we may not be successful, as competition for qualifiedmanagement and technical employees in our industry is intense.  We mayalso be perceived to have a different corporate culture and these key employeesmay not want to work for a larger, publicly-traded company.  In addition,competitors may recruit these key employees.  As a result, these keyemployees could leave with little or no prior notice, which could impede theintegration process and harm our business, financial condition and operatingresults.  In connection with these acquisitions certain key employees haveentered into employment agreements or consulting and non-competition agreementsthat will restrict their ability to compete with us if they leave or at theconclusion of their consulting term. We cannot assure you of the enforceabilityof these non-competition agreements or that these employees or consultants willcontinue to work with us under their employment or consulting agreements.  We have already seen significant decreases inrevenue and profitability due to the fact that neither ClickTracks nor HotBanana has generated the revenues anticipated at acquisition.

 

***We may need to raise additional capital to achieve ourbusiness objectives, which could result in dilution to existing investors orincrease our debt obligations.***

 

Our capital requirementsdepend on several factors, including the rate of market acceptance of ourproducts, the ability to expand our client base and the growth of sales andmarketing.  In addition, under the termsof the agreements governing certain of our acquisitions, we are required to makeadditional payments to the sellers of the businesses.  Our cash on hand,cash flow and borrowing capacity under our credit facility currently areinsufficient to pay these amounts.  We have a current accountdeficit.  There is no certainty that we will be able to raise additionalequity or other capital, or the terms on which such capital may be raised willbe favorable to us.  The terms of any new capital may be superior to, ordilutive to, the existing common shareholders.

 

***Restrictions in the agreements with our lenders may inhibitour ability to grow.***

 

We borrowed money topurchase EmailLabs and Hot Banana.  Our agreement with Comerica Bank (“Comerica”the “Bank”), our senior lender, places certain restrictions on us, includingrestrictions on our total borrowings, our debt to EBITDA and other financialratios, and our ability to buy additional businesses, among other restrictions.

 

**Risksrelated to us and Investment in our Common Stock**

 

***Internet-related stock prices are especially volatile, andthis volatility may depress our stock price or cause it to fluctuatesignificantly.***

 

The stock market, and thetrading prices of Internet-related companies in particular, have been notablyvolatile. This volatility is likely to continue in the short-term and is notnecessarily related to the operating performance of affected companies.  This broad market and industry volatilitycould significantly reduce the price of our common stock at any time, withoutregard to our operating performance. Factors that could cause our stock pricein particular to fluctuate include, but are not limited to:

 

·actual or anticipated variations in quarterly operating results;

 

·announcements of technological innovations by others or us;

 

·acceptance by consumers of technologies of companies other than us;

 

·the ability to sign new clients and the retention of existing clients;

 

·new products or services that we offer;

 

·competitive developments including new products or services, or newrelationships by our competitors;

 

·changes that affect our clients or the viability of their product lines;

 

·conditions or trends in the Internet and online commerce industries;

 

·global unrest and terrorist activities;

 

·changes in the economic performance and/or market valuations of other Internetor online e-commerce companies;

 

·required changes in generally accepted accounting principles and disclosures;

 

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·our announcement of significant acquisitions, strategic partnerships, jointventures or capital commitments or results of operations or other developmentsrelated to those acquisitions;

 

·additions or departures of key personnel; and

 

·sales or other transactions involving our common stock.

 

***Our executive officers and directors beneficially own asignificant amount of our common stock.***

 

As of September 2,2008, our executive officers and directors and entities affiliated with thembeneficially own or have options exercisable within 60 days to purchase, in theaggregate, approximately 52% of our common stock.  The chairman of our board of directors (the “Board”or “Board of Directors”), Mr. William T. Comfort, III, as controllingpartner of LDN Stuyvie Partnership beneficially owns 39.5% of our commonstock.  These stockholders together have, and Mr. Comfort himselfhas, the ability to exert substantial influence over all matters requiringapproval by our stockholders, including the election and removal of directorsand any merger, consolidation or sale of all or substantially all of ourassets. This concentration of ownership could have the effect of delaying,deferring or preventing a change of control or impeding a merger orconsolidation, takeover or other business combination.

 

***We are a small company without securities analyst coverageat the present time and there is limited trading of our stock.***

 

Trading markets forcommon stock rely in part on the research and reports that industry orfinancial analysts would publish about us or our business. Currently, nosecurities analysts cover our stock.  As a result, we lack visibility inthe market.  In addition, if one or more analysts initiate coverage withan unattractive rating, our stock price would likely decline rapidly. There is also little liquidity in the trading of our stock and therefore it maybe more difficult for investors to sell our common stock.  Sales of largeblocks of stock may have a significantly greater negative impact because of thelack of liquidity.

 

***The transfer restrictions on our common stock may delay orprevent takeover bids by third parties and may delay or frustrate any attemptby stockholders to replace or remove the current management.***

 

The shares of commonstock issued by us in the merger with our former parent company, NAHC, Inc.,are subject to transfer restrictions that, in general, prevent any individualstockholder or group of stockholders from acquiring in excess of 5% of ouroutstanding common stock. The types of acquisition transactions that we mayundertake will be limited unless our board of directors waives the transferrestrictions. The transfer restrictions also may make it more difficult forstockholders to replace current management because no single stockholder maycast votes for more than 5% of our outstanding shares of common stock, unlessthat stockholder held more than 5% of our common stock before the merger or ourboard of directors specifically authorizes the acquisition of more than 5% ofour common stock.

 

***We may not be able to realize the benefits of our NOLcarryforwards.***

 

Our ability to use ourpotential tax benefits derived from our net operating loss carryforwards infuture years will depend upon the amount of our otherwise taxable income. If wegenerate insufficient taxable income in future years, the NOLs will not beneeded or used and therefore will provide no benefit to us. If we experience achange of ownership within the meaning of Section 382 of the InternalRevenue Code, we will not be able to realize the benefit of our net operatingloss, capital loss and tax credit carryforwards.

 

***There are uncertainties related to legacy assets andliabilities.***

 

We continue to manage arelatively small number of legacy assets and liabilities remaining from theperiod prior to the sale of our operating businesses in 1999.  These remaining legacy assets consist of oldreceivables that are the subject of litigation or arbitration, and appeals ofMedicare related claims.  We have established 100% reserves against theseassets because of the uncertainty regarding our ability to collect them.

 

We are defending oneremaining lawsuit against us. Our management believes that we should prevail inthis case.  However, there is uncertainty and cost related to the claim.  The outcome of this matter is not possible topredict 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 us. For more information regarding this lawsuit,please see Note 12 to our Consolidated Financial Statements.

 

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***Provisions in our certificate of incorporation and bylawsmight discourage, delay or prevent a change of control of us or changes in ourmanagement and, therefore, depress the trading price of our common stock.***

 

In addition to theprovisions to protect our NOLs, 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 us fromhaving a change of control or changes in our management that our stockholdersmay deem advantageous. These provisions:

 

·establish a classified board of directors so that not all members of our boardare elected at one time;

 

·provide that directors may only be removed “for cause” and only with theapproval of 66 2/3% of our stockholders;

 

·require super-majority voting to amend some provisions in our amended andrestated certificate of incorporation;

 

·authorize the issuance of “blank check” preferred stock that our board ofdirectors could issue to increase the number of outstanding shares todiscourage a takeover attempt;

 

·provide that the board of directors is expressly authorized to make, alter orrepeal our bylaws; and

 

·establish advance notice requirements for nominations for elections to ourboard or for proposing matters that can be acted upon by stockholders atstockholder meetings.

 

**ITEM 1B.  UNRESOLVED STAFF COMMENTS**

 

None

 

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**ITEM 2.    PROPERTIES**

 

Our principal office islocated at 103 Foulk Rd, Suite 205Q, Wilmington, DE 19803, where we leaseapproximately 112 square feet of office space. Our subsidiaries lease officespace in California, Delaware, Pennsylvania, Nevada and Ontario, Canada.

 

A summary of oursignificant leased office facilities at June 30, 2008 are as follows:

 

| **Location**            | ** ** | **Square Feet** | ** ** | **Type of Possession** | ** ** | **Lease Expiration Date** | ** ** |
|-------------------------|------------|----------------------|------------|----------------------------------|------------|-------------------------------------|------------|
| ** **              | ** ** | ** **           | ** ** | ** **                       | ** ** | ** **                          | ** ** |
| Emeryville,  California |       | 19,500               |       | Lease                            |       | October 2009                   |       |
|                    |       |                 |       |                             |       |                                |       |
| San Jose,  California   |       | 17,120               |       | Lease                            |       | September 2012                 |       |
|                    |       |                 |       |                             |       |                                |       |
| Santa Cruz,  California |       | 11,000               |       | Lease                            |       | December 2009                  |       |
|                    |       |                 |       |                             |       |                                |       |
| Barrie, Ontario         |       | 6,400                |       | Lease                            |       | May 2010                       |       |
|                    |       |                 |       |                             |       |                                |       |
| Boston,  Massachusetts  |       | 125                  |       | Lease                            |       | May 2009                       |       |
|                    |       |                 |       |                             |       |                                |       |
| Wayne,  Pennsylvania    |       | 837                  |       | Lease                            |       | September 2008                 |       |
|                    |       |                 |       |                             |       |                                |       |
| Wilmington,  Delaware   |       | 112                  |       | Lease                            |       | September 2008                 |       |

 

Our remaining leaseobligation as of June 30, 2008 for all of our facilities is $2.6 million.

 

**ITEM 3.    LEGALPROCEEDINGS**

 

*NovaCarev. Stratford Nursing Home. * We filed this collection lawsuit in August, 1999 tocollect on a receivable of approximately $146 thousand, which we have fullyreserved.  Stratford counter-claimed with numerous theories asserting thatwe instead owed Stratford money.  Although Stratford’s principal claimswere dismissed by the court, Stratford, in the last quarter of fiscal year2003, had quantified its remaining counter-claims at approximately $1.0million.  We believe that the theories on which these damages are basedare inconsistent with the contract between the parties and with the conduct ofeach party.  As of June 30, 2008, this case is pending in the U.S.District Court for the Southern District of New Jersey (Camden).  Theoutcome of this action is not possible to predict and we have reserved anestimate of the cost of litigating this action; however, this estimate does notreflect the possibility of an adverse ruling or a judgment against us or asettlement.

 

***Other Cases and Claims***

 

*O’Learyv. Joyner Sports Medicine. *We are a defendantin one professional liability claim and had previously purchased professionalliability insurance policies from 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 us. As a result, PHICO will not be permitted topay any claims on our behalf; however, the remaining claims were transferred tovarious state guaranty funds.  Since 2002, state insurance guaranty fundshave paid the amounts due for liability claims settlements on our behalf. Based on our discussion with the state guaranty funds and a review of claimsduring the third quarter of 2004, we now believe that a payment may be requiredto settle the professional liability claim that may exceed the amount availableto us under the applicable state guaranty fund limits.  We recorded anaccrual and related expense in the third quarter of 2004 equal to the estimatedcost to settle that claim less the amount that would be paid by the stateguaranty fund.  We are undertaking negotiations to settle our liability onthis claim and have recently increased our reserve for this liabilityclaim.  There is no insurance policy in place that would pay anysettlement or award for this claim; therefore, in the event that our currentreserve assessment is incorrect, we will be required to fund any amount inexcess of the reserve amount.

 

**ITEM4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

**                     **No matters were submitted to our stockholdersduring the fourth quarter of 2008 fiscal year.

 

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**PART II**

 

**ITEM 5.   MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES**

 

Our common stock istraded on the Over-the-Counter Bulletin Board (“OTCBB”) under the symbolLYRI.OB.  Trading of our common stock on OTCBB commenced on December 3,1999.  Our common stock was previouslytraded on the New York Stock Exchange (the “NYSE”) under the symbol NOV until November 22,1999. Our common stock traded on the OTCBB under the symbol NAHC until June 17,2002 and as JLHY.OB until November 15, 2007.  On June 30, 2008there were 524 holders 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, 2008** | ** ** | ** ** | ** ** | ** ** | ** ** |
| First quarter                                    |       | $          | 1.41       |       | $          | 0.80 |   |
| Second quarter                                   |       | 1.74       |       | 1.05       |       |
| Third quarter                                    |       | 1.30       |       | 0.80       |       |
| Fourth quarter                                   |       | 0.90       |       | 0.50       |       |
|                                                  |            |            |            |            |            |  |  |

 
| **Year Ended June 20, 2007** |   |   |   |   |   |
|--------------------------------------------------|--------|--------|--------|--------|--------|
| First quarter                                    |   | 1.13   |   | 0.77   |   |
| Second quarter                                   |   | 0.91   |   | 0.66   |   |
| Third quarter                                    |   | 0.84   |   | 0.70   |   |
| Fourth quarter                                   |   | $      | 0.91   |   | $      | 0.70 |   |
|                                                  |        |        |        |        |        |  |  |

 

With the exception of2-for-1 stock splits of common stock affected in the form of stock dividends inJune 1987 and July 1991, no other dividends have been paid ordeclared on common stock since our initial public offering on November 5,1986.  We do not expect to declare any cash dividends on common stock inthe foreseeable future.

 

See disclosure under theheading entitled “Equity Compensation Plan Information” in Item 12 – SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters – for disclosure related to the securities authorized for issuanceunder the Company’s equity compensation plans.

 

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**PerformanceGraph**

** **

The followingperformance graph compares the cumulative total return on our Common Stockduring the last five fiscal years to the NASDAQ Composite and NASDAQ Computerindices for the period from June 30, 2003 through June 30, 2008. Thegraph assumes that $100 was invested in each of the Company’s Common Stock, theNASDAQ Composite Index and the companies listed on the NASDAQ Computer Index onJune 30, 2003 and that any dividends were reinvested.

 
| ** ** | ** ** | **J. L. Halsey** | ** ** | **NASDAQ Composite** | ** ** | **NASDAQ Computer** | ** ** |
|------------|------------|----------------------------|------------|---------------------------|------------|--------------------------|------------|
| 6/30/03    |       | $                          | 100        |                      | $          | 100                      |       | $ | 100 |   |
| 6/30/04    |       | $                          | 283        |                      | $          | 126                      |       | $ | 125 |   |
| 6/30/05    |       | $                          | 425        |                      | $          | 127                      |       | $ | 124 |   |
| 6/30/06    |       | $                          | 767        |                      | $          | 134                      |       | $ | 123 |   |
| 6/30/07    |       | $                          | 692        |                      | $          | 160                      |       | $ | 154 |   |
| 6/30/08    |       | $                          | 558        |                      | $          | 141                      |       | $ | 144 |   |

 

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**ITEM 6.  SELECTED FINANCIALDATA**

 

The following selectedfinancial data for the five years ended June 30, 2008, have been derivedfrom our audited consolidated financial statements and should be read inconjunction with Item 7 – Management’s Discussion and Analysis of FinancialCondition and the Results of Operations and Notes to the Consolidated FinancialStatements in this report.

 
| ** **                                                     | ** ** | **Years Ended June 30,**                            | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **2008**                                                           | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                     | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated  Statements of Operations Data:**               |       |                                                               |       |   |   |   |   |   |   |   |   |
| Software  revenues                                             |       | $                                                                  | 5,947      |   | $ | 8,045 |   | $ | 5,331 |   | $ | 796 |   | $ | — |   |
| Services  revenues                                             |       | 37,253                                                             |       | 30,960 |   | 19,022 |   | 1,411 |   | — |   |
| Gross Profit                                                   |       | 25,601                                                             |       | 26,965 |   | 17,597 |   | 1,760 |   | — |   |
| (Loss) income  from operations                                 |       | (5,091                                                             | )          | (775 | ) | 2,986 |   | (434 | ) | (2,186 | ) |
| Income tax  provision                                          |       | 440                                                                |       | 544 |   | 827 |   | 77 |   | — |   |
| Gain on disposal  of discontinued operations, net of tax       |       | 29                                                                 |       | 1,670 |   | 407 |   | 281 |   | 4,941 |   |
| Net (loss)  income                                             |       | $                                                                  | (5,502     | ) | $ | 351 |   | $ | 2,566 |   | $ | (230 | ) | $ | 2,755 |   |
|                                                           |       |                                                               |       |   |   |   |   |   |   |   |   |
| (Loss) gain per  share from continuing operations:             |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic and  diluted                                             |       | (0.06                                                              | )          | (0.01 | ) | 0.03 |   | (0.01 | ) | (0.03 | ) |
| Net income  (loss) per common share:                           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic and  diluted                                             |       | (0.06                                                              | )          | 0.00 |   | 0.03 |   | 0.00 |   | 0.03 |   |
| Weighted average  shares used in basic per share calculation   |       | 98,604                                                             |       | 90,706 |   | 83,127 |   | 82,297 |   | 82,193 |   |
| Weighted average  shares used in diluted per share calculation |       | 98,604                                                             |       | 92,904 |   | 84,485 |   | 82,297 |   | 82,193 |   |

 
| ** **                            | ** ** | **As of June,**                                          | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                            | ** ** | **2008**                                                           | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                            | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated  Balance Sheet Data:** |       |                                                               |       |   |   |   |   |   |   |   |   |
| Cash, cash equivalents                |       | $                                                                  | 151        |   | $ | 659 |   | $ | 255 |   | $ | 3,102 |   | $ | 28,880 |   |
| Intangibles, net  of amortization     |       | 14,614                                                             |       | 22,414 |   | 19,776 |   | 12,714 |   | — |   |
| Goodwill                              |       | 35,924                                                             |       | 36,021 |   | 273,960 |   | 17,749 |   | — |   |
| Total assets                          |       | 63,467                                                             |       | 70,191 |   | 57,719 |   | 38,824 |   | 31,643 |   |
| Long-term debt                        |       | 9,375                                                              |       | 13,494 |   | 11,592 |   | 5,600 |   | — |   |
| Stockholders’  Equity            |       | $                                                                  | 45,652     |   | $ | 45,806 |   | $ | 30,066 |   | $ | 27,082 |   | $ | 27,080 |   |

 
| ** **                                            | ** ** | **As of June,**                                          | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2008**                                                           | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                            | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated  Statements Cash Flows Data:**         |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net cash  provided by (used in) operating activities  |       | $                                                                  | 2,901      |   | $ | 4,568 |   | $ | 5,163 |   | $ | (1,370 | ) | $ | 5,667 |   |
| Net cash  provided by (used in) investing activities  |       | (3,791                                                             | )          | (13,451 | ) | (17,840 | ) | (24,640 | ) | (6 | ) |
| Net cash  provided by (used in) financing activities  |       | 332                                                                |       | 9,279 |   | 9,830 |   | 232 |   | — |   |
| Effect of  exchange rate changes on cash              |       | 50                                                                 |       | 8 |   | — |   | — |   | — |   |
| Net (decrease)  increase in cash and cash equivalents |       | $                                                                  | (508       | ) | $ | 404 |   | $ | (2,847 | ) | $ | (25,778 | ) | $ | 5,661 |   |

 

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**ITEM7.   MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

***Overview***

* *

*The discussion and analysis below includes certainforward-looking statements that are subject to risks, uncertainties and otherfactors, as described in “Risk Factors” and elsewhere in this Annual Report on Form 10-K,that could cause our actual growth, results of operations, performance, financialposition and business prospects and opportunities for this quarter and theperiods that follow to differ materially from those expressed in, or impliedby, those forward-looking statements.*

* *

*The following Management’sDiscussion and Analysis (“MD&A”) is intended to help the reader understandthe results of operations and our financial condition and should be read inconjunction with our Condensed Consolidated Financial Statements and the notesto Consolidated Financial Statements included in Part II, Item 8 of thisAnnual Report on Form10-K. This overview summarizes the MD&A, whichincludes the following sections:*

* *

***Our Business –***a general description of our business, ourofferings and services; our business strategy; our acquisitions anddiscontinued operations.

* *

***Critical Accounting Policies andEstimates –***a discussion of our critical accounting policies that require criticaljudgments, assumptions and estimates.

* *

***Results of Operations –***analysis of our Company’s consolidatedresults of operations for the three years presented in our consolidatedfinancial statements.  We present ourdiscussion in the MD&A on a consolidated basis and in conjunction with ourCondensed Consolidated Financial Statements and the notes to those statementsincluded in Part II, Item 8 of this Annual Report on Form 10-K.

* *

***Liquidity, Capital Resources andFinancial Position –***analysis of cash flows; legal claims; off-balance sheet arrangements;long-term aggregate contractual obligations; future payments on acquisitions;and revolving line of credit.

* *

**Our Business**

 

***General***

 

Lyris, Inc.,formerly J.L. Halsey Corporation, is a leading digital marketing technology andservices firm. Our digital marketing software and services provide clients withsolutions for creating, delivering and managing online, permission-based directmarketing programs and other communications to clients who use the Internet tocommunicate with their customers and members.  Our technology solutions include email marketing software, whichprovides clients with tools to create, deliver and manage email marketingprograms, newsletters, discussion groups and other digital communications; Webanalytics software, which provides clients with tools to analyze the behaviorof visitors to their websites and also manage pay-per-click (PPC) campaigns andWeb content management software, which is used by clients to manage a website,landing page or email content creation.  We offer our software solutions in two forms: as licensed software thatis purchased by clients and downloaded and installed on those clients’computers and servers, and as a hosted solution in which customers use oursoftware on a subscription basis through an Internet connection.

 

In November 2007, webegan to offer our new on-demand marketing platform that consolidates our fullsuite of digital marketing technologies into a single sign-on dashboardinterface.   In this new comprehensiveon-demand marketing platform, we have implemented a new pricing model for the offeringthat is a full, seat-base pricing model. It includes unlimited search engine keyword management, Web analytics,Web content management, pay-per-click (“PPC”) management and emaildeliverability solutions for the price of a single seat.  At the end of our fiscal year, June 30,2008, we had approximately 187 Lyris HQ customers.   As part of our offerings, we continue tooffer software-as-a-service (“SaaS”) through our individual software brands:Hot Banana (“HB”); List Manager (“LM”); ClickTracks; and EmailLabs.

 

***Business Strategy***

 

Our primary goal is toachieve long-term sustainable growth and create value for our stockholders bycreating and delivering efficiently and profitably a leading set of softwareand service products to our customers.  Our vision to achieve this goal includes:

 

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| · |   | Quality products: Selling products and services at  quality and price points that deliver value for our customers. In  November 2007, we began to offer our new on-demand marketing platform  that consolidates our full suite of digital marketing technologies into a  single sign-on dashboard interface. *Lyris HQ* is a  major strategic undertaking and we intend to continue to invest in the  ongoing development of the *Lyris HQ*  integrated digital marketing suite. The digital marketplace is still evolving  and we believe that we are still early in taking advantage of an opportunity  to provide an integrated suite of digital marketing services to this  marketplace. We operate in a fragmented market, characterized by a large  number of small competitors and a handful of medium-sized competitors and  believe that *Lyris HQ* substantially  differentiates us from those competitors. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |   |
| · |   | Being a leader in digital marketing technology and  related services: Becoming a leader in developing and selling technology  solutions for digital marketers, primarily focused on small and mid-size  organizations, or departments/business units of larger organizations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |   |
| · |   | People: Continuing to create a great place to work  where people are inspired to be the best they can be.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |   |
| · |   | Partners: Continuing to nurture a winning network of  partners and building mutual trust and loyalty.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |   |
| · |   | Profit: Maximizing return to shareholders and  simultaneously mindful of our overall financial responsibilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

 

***Acquisitions***

 

***2005Acquisitions***

 

***Lyris Technologies Acquisition***.  On May 12, 2005, we acquired all of theoutstanding capital stock of Lyris Technologies for $30.7 million, whichincluded cash payments of $25.1 million (including acquisition costs andworking capital adjustments of $1.2 million) and $5.6 million in the form of apromissory note payable, subject to Lyris Technologies achieving specifiedrevenue, on May 12, 2007, with interest accruing at 10% per annum and dueat the maturity date.  The specified revenue targets stated in the promissorynote were attained.  As of March 31, 2007, principal on thepromissory note had been reduced to approximately $5.4 million, and the notewas amended and restated (“Amended and Restated Note” to require the followingpayments (constituting both principal and interest): (a) $1.0 million due May 12,2007; (b) $1.5 million due February 12, 2008; and (c) $4.7million due November 12, 2008.  We paid the $1.0 million on May 14,2007.

 

On January 23, 2008,LDN Stuyvie Partnership (“LDN Stuyvie”), which is controlled by thenon-executive chairman of our board of directors, William T. Comfort III,purchased the Amended and Restated Note from the Trust, from the sellers ofLyris Technologies, at a discount of 10% for a total purchase price of $5.2million.  On February 12, 2008, the Amended and Restated Note wasamended to extend the due date of the next payment thereunder to November 12,2008, the maturity date of the Amended and Restated Note.

 

On March 5, 2008, weentered into a Subscription Agreement (the “LDN Stuyvie Subscription Agreement”)with LDN Stuyvie. Pursuant to the LDN Stuyvie Subscription Agreement, LDNStuyvie purchased 6,520,374 shares of our common stock at a purchase price of$1.05 per share or $6.8 million in the aggregate. The aggregate purchase pricewas satisfied by LDN Stuyvie as follows: (a) payment of $1.0 million incash, and (b) termination of our obligations under the Amended andRestated Note.

 

***EmailLabs Acquisition*****.**  On October 11, 2005, weacquired all of the outstanding capital stock of EmailLabs for $24.5 million(including acquisition costs and working capital adjustments of $612). The acquisition of EmailLabs also called for two contingent payments of $1.7million each subject to EmailLabs achieving specified revenue targets by thefirst and second anniversary of the closing date.  Additionally, $500 thousand was held backfrom the former stockholders of EmailLabs subject to EmailLabs meetingspecified working capital requirements.  We made the first $1.7 millionpayment to the former EmailLabs’ stockholders on October 13, 2006, and wemade the second $1.7 million payment to the former EmailLabs’ stockholders on October 11,2007.  The $500 thousand holdback and the working capital adjustment werepaid in January 2006.   The former stockholders of EmailLabsalso received the proceeds of tax refunds related to the period prior to theclosing date.   These refunds were paid in September 2006.

 

***2006Acquisitions***

 

***ClickTracks Acquisition***.  On August 18, 2006, weacquired all of the outstanding capital stock of ClickTracks for approximately$8.5 million in cash, $2.8 million of our common stock (2,799,636 shares)issued to certain security holders of ClickTracks and $337 thousand ofacquisition costs.  The acquisition originally called for additionalcontingent payments totaling approximately $3.8 million in the eventClickTracks achieved future revenue targets.   Pursuant to ouragreements with John

 

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Marshall, dated March 13,2007, and June 8, 2007, respectively, Mr. Marshall (acting in hiscapacity as the representative of the former stockholders of ClickTracks)acknowledged and agreed that the initial targets would not be met and waivedall rights to any future payments under the purchase agreement.

 

***Hot Banana Acquisition*****.**  On August 18, 2006, we alsoacquired all of the outstanding capital stock of Hot Banana for approximately$1.9 million Canadian ($1.8 million U.S. based on the then-applicable exchangerate), with additional installments of up to $750 thousand Canadian if HotBanana achieved specified revenue and technology integration targets, and up toan additional $500 thousand Canadian payable subject to working capital andother adjustments.  In March 2007, we paid $94 Canadian ($81 U.S.)for the first phase of the technology integration, in addition to $336 thousandCanadian ($299 thousand U.S.) for the working capital adjustment in April 2007.   Additionally, we paid $94 thousand Canadian($86 thousand U.S.) for the second phase of the technology integration in May 2007.

 

On October 4, 2007,we paid $375 thousand Canadian ($377 thousand U.S.) to the former owners of HotBanana for the first installment of the revenue earnouts.

 

DuringJune 30, 2008, Hot Banana did not meet the specified revenue target of$1.8 million.    Accordingly, we reversedthe unpaid accrued deferred merger consideration.

 

***Discontinued operations***

 

We are the successor toNovaCare, Inc (“NovaCare”), which was a national leader in physicalrehabilitation services, orthotics and prosthetics and employee services.Changes to Medicare reimbursement in the late 1990’s had deleterious effects onus and our competitors and customers.  The prior operating businessmost affected by the Medicare changes was the long-term care services segmentin which NovaCare provided therapists to skilled nursing facilities.  Wedisposed of this business in fiscal 1999 with the shutdown of certainoperations in the Western United States during the third fiscal quarter and thesale of the remaining operations on June 1, 1999.  NovaCare’s former outpatient services segmentwas disposed of through the sales of the 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.  NovaCare’s former employee services segment was disposed of throughthe sale of NovaCare’s 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 thesales of these businesses, we repaid all of NovaCare’s bank debt in the summerof 1999, and in January of 2000 we retired NovaCare’s publicly-tradedsubordinated debt.

 

We sold the NovaCare nameas part of the sale of the PROH business and subsequently changed our name toNAHC, Inc. (“NAHC”).  On June 18,2002, in a transaction approved by our stockholders at a special meeting, NAHCmerged with and into J.L Halsey Corporation, its wholly-ownedsubsidiary.   The purpose of the merger between NAHC and J. L. Halseywas to implement transfer restrictions on our common stock in order to preserveour federal income tax net operating losses. We spent several years maximizing remaining NovaCare assets, includingold accounts receivable, Medicare receivables and appeals, and tax items, andminimizing liabilities retained after the sales of the NovaCare operatingbusinesses.  We collected virtually all of the receivables, other thanamounts which are the subject of litigation or arbitration or that have beenwritten off, and also resolved all but one litigation matter remaining fromthese prior operations. None of our current executives or directors wereassociated with us prior to, or at the time of, the sale of the NovaCarehealthcare operating businesses in 1999.

 

***Critical Accounting Policies and Use of Estimates***

 

Our financial statementsare prepared in accordance with accounting principles generally accepted in theUnited States, or GAAP, which require management to make estimates, judgmentsand assumptions that affect our reported amounts in the consolidated financialstatements and accompanying notes.  Webase our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances.  We evaluate ourestimates and assumptions on an ongoing basis.  Our actual results maydiffer significantly from these estimates. We believe that our most critical accounting policies and estimatesrelate to the following:

 

·      revenue recognition

·      deferred revenue

·      allowance for doubtful accounts

·      loss contingencies

·      accounting for acquisitions

·      accounting for stock-based compensation

·      accounting for goodwill, long-lived assetsand other intangible assets

·      accounting for income taxes

 

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***RevenueRecognition***

 

We recognize revenue fromproviding services and licensing our software products to our customers.

 

We generally recognizerevenue when all of the following conditions are satisfied:  (1) thereis persuasive evidence of an arrangement; (2) the service has beenprovided to the customer (in case of software licenses, revenue is recognizedwhen the customer is given electronic access to the licensed software); (3) theamount of fees to be paid by the customer is fixed or determinable; and (4) thecollection of fees is probable.

 

***Services Revenue***

 

Services revenueis derived from hosting software for use by customers and providingprofessional consulting and technical support (maintenance) services.

 

Our hostedsoftware arrangements are considered service arrangements in accordance withEmerging Issues Task Force (“EITF”) Issue No. 00-3,*“Application of AICPA Statement of Position 97-2,Software Revenue Recognition, to Arrangements That Include the Right to UseSoftware Stored on Another Entity’s Hardware,”* and may includemultiple deliverables under EITF 00-21,*“Accountingfor Revenue Arrangements with Multiple Deliverables.”*  Inaddition, because we provide our applications as a service, we follow theprovisions of Securities and Exchange Commission Staff Accounting Bulletin No. 104,*“Revenue Recognition.”*  Hostingrevenue is recognized monthly based on the usage defined in theagreement.  Excess usage is billed and recognized as revenue whenincurred.

 

 Professional services sold with our hostedsoftware arrangements are accounted for separately when these services havevalue to the customer on a standalone basis and there is objective and reliableevidence of fair value for each deliverable. When accounted for separately, professional services revenue isrecognized as the services are performed. If professional services do not qualify for separate accounting, revenueis recognized ratably over the remaining term of the hosted softwarearrangement.

 

Technical support(maintenance) revenue, including revenue that is part of a multiple elementarrangement, is deferred and recognized ratably over the term of the agreement,generally one year.

 

***Software Revenue***

 

###### *We recognize software licenserevenue in accordance with the provisions of*Statements of Positions (“SOP”) No. 97-2, “Software Revenue Recognition”, and SOP 98-9, “Modificationof SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions”. We enter into certain revenue arrangements for which we are obligatedto deliver multiple products and/or services (multiple elements).  Forthese arrangements, which generally include software products and maintenance,we allocate and defer revenue for the undelivered elements based on theirvendor-specific objective evidence of fair value (“VSOE”).  VSOE exists (delivered and undelivered) forthe majority of our elements.  Weallocate total earned revenue under the agreement among the various elementsbased on their relative fair value.  Inthe event that VSOE does not exist for all elements, revenue for the deliveredelements is recognized  (softwarelicenses) as the difference between the total arrangement fee and the totalVSOE of the undelivered elements.

###### * *

Under the guidanceof SOP 97-2, we determine VSOE of fair value based on actual prices charged forstandalone sales of maintenance.  Toaccomplish this we track sales for the maintenance product when sold on a standalonebasis for a one year term and compare to sales of the associated licensedsoftware product.

 

We perform aquarterly analysis of the actual sales for standalone maintenance and licensedsoftware to establish the percentage of sales relationships for each level ofmaintenance and licensed software.  Theresult of this analysis is historically a tight range of percentage of salesrelationships centered on a mid-point which is then used as VSOE of fair valueof the maintenance element.  Thispercentage is also used to determine maintenance revenue in bundled softwaresales that is recognized ratably over the maintenance period.

 

We recognizerevenue from our professional services at the time of delivery of the softwarelicense in accordance with the guidance in of SOP 97-2.  We established professional services VSOEbased on the use of a consistent rate per hour when similar services are soldseparately on a time-and-material basis. In cases where VSOE has not been established, the full value of the arrangementis deferred and recognized ratably over the term of the agreement.

 

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***DeferredRevenue***

 

Deferred revenuerepresents customer billings made in advance for annual support or hostingcontracts, professional consulting services to be delivered in the future, andbulk purchases of emails to be delivered in the future.    Maintenance is typically billed on a perannum basis in advance for software and the revenue is recognized ratably overthe maintenance period.  Bulk purchases are typically billed in advance,ranging from monthly to annually, and the revenue is recognized in the periodsin which emails are delivered.

 

***ValuationAllowances and Reserves***

 

We record trade accountsreceivable at net realizable value. This value includes an appropriateallowance for estimated uncollectible accounts to reflect any loss anticipatedon the trade accounts receivable balances and charged to the provision fordoubtful accounts.

 

We provide an allowancefor doubtful accounts equal to the estimated uncollectible amounts.  Our estimate is based on historicalcollection experience, changes in our customer payment history and a review ofthe current status of trade accounts receivable.  If any of these factors change, it isreasonably possible that our estimate of the allowance for doubtful accountswill change.   Accounts receivable arepresented in our consolidated balance sheet, net of an allowance for doubtfulaccounts of $450 and $365 at June 30, 2008 and June 30, 2007,respectively.

 

***LossContingencies***

 

We record estimated losscontingencies when information is available that indicates that it is probablethat a material loss has been incurred or an asset has been impaired and theamount of the loss can be reasonably estimated.  We disclose if theassessment indicates that a potentially material loss contingency is notprobable but is reasonably possible, or is probable but cannot be estimated, orif an exposure to loss exists in excess of the amount accrued.  Loss contingencies considered remote aregenerally not disclosed unless they arise from guarantees, in which case theguarantees would be disclosed. Determining the likelihood of incurring a liability and estimating theamount of the liability involves an exercise of judgment.   If the outcomeof the litigation is more adverse to us than management currently expects, thenwe may have to record additional charges in the future.  See Note 19 to our Consolidated FinancialStatements for details on commitments and contingencies.

 

***Accountingfor 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 determinethe fair value of the non-compete agreements, customer relationships anddeveloped technology includes the use of estimates including: the potentialimpact on operating results if the non-compete agreements were not in place;revenue estimates for customers acquired through the acquisition based on anassumed customer attrition rate; estimated costs to be incurred to purchase thecapabilities gained through the developed technology model; and appropriatediscount rates based on the particular business’s weighted average cost ofcapital.  Our estimates of an entity’sgrowth and costs are based on historical data, various internal estimates and avariety of external sources, and are developed as part of our planningprocess.  See Note 4 to our ConsolidatedFinancial Statements for details on acquisitions.

 

***Stock-BasedCompensation***

 

Effective July 1,2005, we adopted the provisions of Statement of Financial Accounting Standards(“SFAS”) No. 123 (Revised 2004), “*Shared-Based Payments*”(“SFAS No. 123(R)”), and selected the modified prospective method toinitially report stock-based compensation amounts in the consolidated financialstatements.  Under the fair valuerecognition provisions of this statement, share-based compensation cost ismeasured at the grant date based on the fair value of the award and isrecognized as expense over the applicable vesting period of the stock award(generally  four years) using thestraight-line method.

 

Prior to adoption of SFASNo. 123(R), we provided the disclosures required under SFAS No. 123, “*Accounting for Stock-Based Compensation*,” as amended by SFASNo. 148, “*Accounting for Stock-Based Compensation —Transition and Disclosures*.”  Under this method, we recordedcompensation expense only if the market price of the underlying stock on thedate of grant exceeded the exercise price.   Previously reported amounts have not beenrestated.

 

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***Goodwill,Long-lived Assets and Other Intangible Assets***

 

We classify ourintangible assets into three categories: (1) intangible assets withdefinite lives subject to amortization, (2) intangible assets withindefinite lives not subject to amortization, and (3) goodwill.

 

We evaluate our fixedassets and intangible assets with definite lives in accordance with SFAS No. 144,“*Accounting for the Impairment or Disposal ofLong-lived Assets,”*for impairment. Under SFAS 144, if the carrying amount of an asset or asset group (inuse or under development) is evaluated and found not to be recoverable(carrying amount exceeds the gross, undiscounted cash flows from use anddisposition), then an impairment loss must be recognized.  The impairment loss is measured as the excessof the carrying amount over the assets’ fair value.  In addition, the potential impairment offinite life intangibles is assessed whenever events or a change incircumstances indicate the carrying value may not be recoverable.

 

We test goodwill and ourintangible with indefinite lives not subject to amortization under the provisionof SFAS No. 142, “*Goodwill and OtherIntangible Assets.*” for annual impairment testing.  In addition, we consider the followingsignificant factors that could trigger an impairment review prior to annualtesting:

 

a.     asignificant underperformance relative to historical or expected projectedfuture operating results;

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

c.     significantnegative industry or economic trends;

d.     asignificant decline in our stock price for a sustained period of time;

e.     our marketcapitalization relative to net book value; and

f.      asignificant adverse change in legal factors or in the business climate thatcould affect the value of the asset.

 

When we determine thatthe carrying value of intangible assets, long-lived assets or goodwill may notbe recoverable based upon the existence of one or more of the above indicatorsof impairment, we measure any potential impairment based on a projecteddiscounted cash flow method using a discount rate determined by our managementto be commensurate with the risk inherent in our current business model.

 

During fiscal year 2008,we determined that the carrying value of some our intangibles with definitelives might not be recoverable due to the second quarter unexpected revenuereduction and projected lower operating results from some of our softwarerevenues.  Accordingly, we performed animpairment testing of our intangible assets related to the ClickTracks and HotBanana acquisitions.  As are result, weincurred $4.1 million impairment loss. See Note 5, Intangible Assets.

 

During the fourth quarterof fiscal year 2008, we completed the annual impairment test for our goodwill,intangibles with definite lives and intangibles with indefinite lives.  We determined that the carrying amount of ourgoodwill and intangibles with indefinite lives were not impaired.   See Note 5 and 6 to our ConsolidatedFinancial Statements for details on intangibles and goodwill.

 

***Accounting forIncome Taxes***

 

We account for incometaxes under the provisions of SFAS No. 109,*“Accounting for Income Taxes.” *Under this method, deferred taxassets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases.  Deferred tax assets, including tax loss andcredit carryforwards, and liabilities are measured using enacted tax rates expectedto apply to taxable income in the years in which those temporary differencesare expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in taxrates is recognized in income in the period that includes the enactmentdate.   Deferred income tax expenserepresents the change during the period in the deferred tax assets and deferredtax liabilities.   The components of thedeferred tax assets and liabilities are individually classified as current andnon-current based on their characteristics.  Deferred tax assets are reduced by a valuation allowance when, in theopinion of management, it is more likely than not that some portion or all ofthe deferred tax assets will not be realized.  See Note 14 to our Consolidated Financial Statements for details onincome taxes.

 

We utilize certaintax strategies to lower taxable income.  We believe that we will be ableto establish with state tax authorities that we are entitled to all or most ofthe benefits from these strategies.  However, these tax strategies aresubject to certain assumptions and interpretations of the relevant legislationand judicial history that may or may not be accepted by the taxauthorities.  Based on our assessment on any challenges from state taxauthorities, we recognize a liability on uncertain tax positions.

 

On July 1, 2007, weadopted the provisions of FASB Interpretation No. 48, “*Accounting for Uncertainty in Income Taxes,*” (FIN 48).   FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial

 

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statements in accordancewith SFAS No. 109, “*Accounting forIncome Taxes*,” (SFAS 109).   FIN 48 prescribes a recognition threshold and measurement attributefor the financial statement recognition and measurement of a tax position takenor expected to be taken in a tax return. Interpretation No. 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition.   In addition,FIN 48 prescribes a two-step process to determine the amount of tax benefit tobe recognized.   First, the tax positionmust be evaluated to determine the likelihood that it will be sustained uponexternal examination. If the tax position is deemed “more-likely-than-not” tobe sustained, the tax position is then assessed to determine the amount ofbenefit to recognize in the financial statements.  The amount of the benefit that may berecognized is the largest amount that has a greater than 50% likelihood ofbeing realized upon ultimate settlement.  Refer to Note 14, Income Taxes.

 

**Results of Operations for Fiscal Years 2008, 2007, and 2006**

 
| ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change  2008 vs. 2007** | ** ** | **Change  2007 vs. 2006** | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| **(In thousands, except percentages** | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **$**                               | ** ** | **%**                               | ** ** | **$** | ** ** | **%** | ** ** |
| Software revenue                                     |       | $          | 5,947      |       | $          | 8,045      |       | $                                   | 5,331      |                                | $          | (2,098 | ) | -26 | % | $ | 2,714 |   | 51 | % |
| Services revenue                                     |       |       |       |       |       |       |       |                                |       |                                |       |   |   |   |   |
| Hosted revenue                                       |       | 30,204     |       | 25,006     |       | 14,975     |       | 5,198                               |       | 21                                  | %          | 10,031 |   | 67 | % |
| Support &  maintenance revenue              |       | 5,465      |       | 4,862      |       | 3,618      |       | 603                                 |       | 12                                  | %          | 1,244 |   | 34 | % |
| Professional  services revenue                       |       | 1,584      |       | 1,092      |       | 429        |       | 492                                 |       | 45                                  | %          | 663 |   | 155 | % |
| Total Services  revenue                              |       | 37,253     |       | 30,960     |       | 19,022     |       | 6,293                               |       | 20                                  | %          | 11,938 |   | 63 | % |
| **Total  revenues**                                  | ** ** | **$**      | **43,200** | ** ** | **$**      | **39,005** | ** ** | **$**                               | **24,353** | ** **                          | **$**      | **4,195** |   | 11 | % | **$** | **14,652** |   | 60 | % |

 

***Fiscal year 2008 compared withfiscal year 2007***

 

***SoftwareRevenue***

 

Software revenuedecreased approximately by $2.1 million or 26% in fiscal year 2008, comparedwith fiscal year 2007.  The decline wasprimarily attributable to market shift and management’s focus from softwarelicense sales to a hosted revenue model.  Currently, our customers have shown a preference for hosted solutions,thus we intend to focus our resources on this market.  However, we will continue to provide varioussoftware product solutions to our wide range of customers.

 

***Service Revenue***

 

Service revenue increasedapproximately by $6.3 million or 20% in fiscal year 2008, compared with fiscalyear 2007.    Increase in service revenuewas driven primarily by hosted revenue growth of $5.2 million or 21% in 2008compared with 2007, due to significant *Lyris HQ* customerincrease.  In addition, our professionalservices revenue reflects an increase of $492 thousand or 45% in 2008, comparedwith 2007.  This increase was associatedwith hosted revenue growth driven primarily by an increase in *Lyris HQ*contracts.

 

***Fiscal year 2007 compared withfiscal year 2006***

 

***SoftwareRevenue***

 

Software revenueincreased approximately by $2.7 million or 25% in fiscal year 2007, comparedwith fiscal year 2006.  This increase wasdriven primarily by our acquisitions that generated more software productsavailable for sale.

 

***Service Revenue***

 

Service revenue increasedapproximately by $11.9 million or 63% in fiscal year 2007 compared with fiscalyear 2006.  The main driver of thisgrowth was the approximately $10.0 million or 67% increase in hostedrevenue.  The overall growth ofapproximately $11.9 million or 63% in service revenue in fiscal year 2007 wasdue to our acquisitions, which contributed to higher service offerings in 2007.

 

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***Cost of revenue***

*** ***
| **(In thousands, except percentages** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change  2008 vs. 2007** | ** ** | **Change  2007 vs. 2006** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Cost of revenue                                      |       | $        | 17,599     |     | $          | 12,040   |       | $                                   | 6,756      |                                | $          | 5,559 |   | $ | 5,284 |   |
| As percent of  revenue                               |       | 41       | %          | 31       | %          | 28       | %          | 10                                  | %          | 3                                   | %          |
|                                                      |            |          |            |          |            |          |            |                                     |            |                                     |            |  |  |  |  |  |

 

Cost of revenues includesexpenses primarily related to engineering employee costs, support and hostingour services, the data center costs, amortization of developed technology,depreciation of computer equipment, website development costs and overheadallocated costs.

 

Cost of revenue increasedapproximately by $5.6 million in fiscal year 2008, compared with fiscal year2007, mainly due to a one-time charge of $4.1 million amortization andimpairment expense of developed technology (See Note 5 to our ConsolidatedFinancial Statements) and an increase in data center and hosting costs.  Our business continues to grow in hostedservices which contribute to that related costs.

 

Cost of revenuesincreased approximately by $5.2 million in fiscal year 2007 due to $2.3 millionamortization of our developed technology and our acquisitions of EmailLabs,ClickTracks and Hot Banana.

 

***General andadministrative***

 
| **(****In thousands, except percentages** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change  2008 vs. 2007** | ** ** | **Change  2007 vs. 2006** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------------|------------|-------------------------------------|------------|
| General and  administrative                              |       | $        | 11,857     |     | $          | 11,087   |       | $                                   | 6,901      |                                | $          | 770 |   | $ | 4,186 |   |
| As percent of  revenue                                   |       | 27       | %          | 28       | %          | 28       | %          | -1                                  | %          | 0                                   | %          |
|                                                          |            |          |            |          |            |          |            |                                     |            |                                     |            |  |  |  |  |  |

 

General andadministrative expenses consists primarily of compensation and benefits foradministrative personnel, professional services which include consultants,legal fees, and accounting, audit and tax fees, and cost related to corporateoperations including stock-based compensation and other corporate developmentcosts.

 

General andadministrative expenses reflected a slight increase of $770 thousand in fiscalyear 2008, compared with fiscal year 2007. We intend to continue to improve our margins through increasedefficiency in operating expenses.

 

General and administrativeexpenses increased approximately by $4.2 million in fiscal year 2007, comparedwith fiscal year 2006.   The primaryreason for this increase was due to our acquisitions of EmailLabs, ClickTracksand Hot Banana.  Increases were driven byprofessional and consulting fees, legal fees, accounting fees, merger andacquisition related costs and other administrative operating expensesassociated with integrating the newly-acquired companies.

 

***Research anddevelopment***

*** ***
| **(In thousands, except percentages** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change  2008 vs. 2007** | ** ** | **Change  2007 vs. 2006** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Research and  development                            |       | $        | 2,334      |     | $          | 1,448    |       | $                                   | 210        |                                | $          | 886 |   | $ | 1,238 |   |
| As percent of  revenue                               |       | 5        | %          | 4        | %          | 1        | %          | 1                                   | %          | 3                                   | %          |
|                                                      |            |          |            |          |            |          |            |                                     |            |                                     |            |  |  |  |  |  |

 

Researchand development expenses include payroll, employee benefits, stock-basedcompensation and other headcount related expenses associated with productdevelopment.

 

Research and developmentexpenses increased $886 thousand in fiscal year 2008 compared with fiscal year2007 primarily related to an increase in headcount related costs which weredirectly associated to build out the *Lyris HQ*offering.

 

In fiscal year 2007,research development increased approximately by $1.2 million.  This increase was also mainly due toemployee-related costs to initially develop the new e-marketing technologyplatform, *Lyris HQ*.  After our acquisitions, our primary focus wason integrating the point application solutions.

 

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***Sales andmarketing***

 
| **(In thousands, except percentages** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change  2008 vs. 2007** | ** ** | **Change  2007 vs. 2006** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Sales and  marketing                                 |       | $        | 12,566     |     | $          | 10,539   |       | $                                   | 5,097      |                                | $          | 2,027 |   | $ | 5,442 |   |
| As percent of  revenue                               |       | 29       | %          | 27       | %          | 21       | %          | 2                                   | %          | 6                                   | %          |
|                                                      |            |          |            |          |            |          |            |                                     |            |                                     |            |  |  |  |  |  |

 

Sales and marketingexpenses include payroll, employee benefits, stock-based compensation, andother headcount-related expenses associated with advertising, promotions, tradeshows, seminars, and other programs.

 

Sales and marketingincreased approximately by $2.0 million during fiscal year 2008, primarilyreflecting increased corporate marketing and advertising campaigns associatedwith the initial release of *Lyris HQ*in November 2007.  In addition, other headcount-relatedexpenses, increased by 14% during fiscal year 2008 compared with fiscal year2007.  Our headcount-related expenses aremainly related to salary and compensation benefits.

 

Sales and marketingexpenses increased approximately by $524 thousand for fiscal year 2007 comparedwith fiscal year 2006.   This increasewas primarily due to our acquisitions of EmailLabs, ClickTracks and Hot Banana.

 

***Amortization ofcustomer relationships***

*** ***
| **(In thousands, except percentages**              | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change  2008 vs. 2007** | ** ** | **Change  2007 vs. 2006** | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Amortization and  impairment of customer relationship trade names |       | $        | 3,742      |     | $          | 1,741    |       | $                                   | 1,217      |                                | $          | 2,001 |   | $ | 524 |   |
| As percent of  revenue                                            |       | 9        | %          | 4        | %          | 5        | %          | 4                                   | %          | -1                                  | %          |
|                                                                   |            |          |            |          |            |          |            |                                     |            |                                     |            |  |  |  |  |  |

 

Amortization andimpairment of customer relationships tradenames (ClickTracks and Hot Banana)increased by $2.0 million for fiscal year 2008 compared with fiscal year 2007,reflecting a $2.1 million recorded impairment during fiscal year 2008.  See Note 5 to our Consolidated FinancialStatements for detail information.

 

Amortization andimpairment of customer relationship tradenames increased approximately by $524 thousandin fiscal year 2007 compared with fiscal year 2006.  The increase primarily driven by amortizationexpense related to intangible assets of customer relationships that arerecorded as intangible assets on our balance sheet as a result of theacquisition of EmailLabs on October 11, 2005, and the acquisitions ofClickTracks and Hot Banana on August 18, 2006.

 

If we determinethat the carrying value of intangible assets or long-lived assets 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.  Refer to Critical Accounting Policies andEstimates above in this Item 7 in this report.

 

***Interestexpense***

 
| **(In thousands, except percentages** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change  2008 vs. 2007** | ** ** | **Change  2007 vs. 2006** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Interest expense                                     |       | $        | 1,084      |     | $          | 3,130    |       | $                                   | 1,268      |                                | $          | (2,046 | ) | $ | 1,862 |   |
| As percent of  revenue                               |       | 3        | %          | 8        | %          | 5        | %          | -6                                  | %          | 3                                   | %          |
|                                                      |            |          |            |          |            |          |            |                                     |            |                                     |            |  |  |  |  |  |

 

Interest expensedecreased approximately by $2.0 million in fiscal year 2008 compared withfiscal year 2007.   The decrease wasprimarily due to the debt extinguishment, a noncash transaction of debtconversion to equity.  This event isrelated to LDN Stuyvie note, with our largest stockholder.  Pursuant to the Backstop Agreement on thisnote, the Company granted to LDN Stuyvie the exclusive right to purchase anadditional $10 million of common stock. See Note 10 to our Consolidated Financial Statements for detailinformation.

 

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Interestexpense increased in fiscal year 2007 of $1.8 million compared with fiscal year2006 mainly due to $1.3 million amortization, as non-cash interest expense,related to the $10.0 million promissory note issued to LDN Stuyvie Partnershipon August 16, 2006, in addition to interest incurred in our revolving lineof credit with Comerica.

 

***Gain (loss) ondebt extinguishment***

 

Gainon debt extinguishment was $919 thousand for the fiscal year ended June 30,2008, compared with $0 for the fiscal year ended June 30, 2007. Thisincrease was due to a net gain on debt extinguishment noncash conversion fromdebt to equity, related to Stuyvie Subscription Agreement dated March 5,2008.  See Note 9 to our ConsolidatedFinancial Statements.

 

***Provision forincome taxes***

 

During the fiscal yearended June 30, 2008, we recorded an income tax provision of approximately$440 thousand which consisted primarily of a provision for state income taxeson the earnings of three of our subsidiaries in the amount of $322 thousand anda provision for federal income taxes of $118 thousand.

 

During the fiscal yearended June 30, 2006, we recorded an income tax provision of approximately$544 thousand which consisted primarily of a provision for state income taxeson the earnings of two of our subsidiaries in the amount of $425 thousand and aprovision for federal income taxes of $119 thousand.  See Note 14 of our Consolidated FinancialStatements for detail on income taxes.

 

***DiscontinuedOperations***

 

Discontinued operationsconsist of gains or losses as a result of adjustments to the $374.1 millionloss on disposal of discontinued healthcare operations which was originallyrecorded 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 us prior to the disposition ofNovaCare’s long-term care services business in 1999, as well as gains relatedto federal income tax refunds. Losses primarily include expenses incurred oradjustments to liabilities which were owed by NovaCare prior to the dispositionof NovaCare’s long-term care services business in fiscal year 2000.  See Note 12 of our Consolidated FinancialStatements for detail information.

 

**Liquidity,Capital Resources and Financial Condition**

 

**Cash andcash equivalents**

 

Our primary source ofcash during 2008 was cash received from the collection of accounts receivablebalances generated from sales and cash collected on fully reserved receivablesfrom discontinued operation, in addition to the available line of credit fromComerica to support our operations.   Asof June 30, 2008 our cash equivalents totaled $151 thousand compared to$659 thousand at fiscal year ended June 30, 2007.

 

We anticipate that wewill continue to improve our cash flow from operations.  We expect that we will maintain increasinglong-term sustaining growth in our hosted revenue offerings, particularly withour product, *Lyris HQ,*combined with increasedefficiency within our operating expenses that will generate available cash tosatisfy our capital needs and debt obligations.

 

***Fiscalyear 2008 compared with fiscal year 2007***

 

**Cash flows**

 
| **(In thousands, except percentages** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change  2008 vs. 2007** | ** ** | **Change  2007 vs. 2006** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Net cash  provided by operating activities           |       | $        | 2,901      |     | $          | 4,568    |       | $                                   | 5,163      |                                | $          | (1,667 | ) | $ | (595 | ) |
| Net cash used in  investing activities               |       | (3,791   | )          | (13,451  | )          | (17,840  | )          | 9,660                               |       | 4,389                               |       |
| Net cash  provided by financing activities           |       | 332      |       | 9,279    |       | 9,830    |       | (8,947                              | )          | (551                                | )          |
| Effect of  exchange rate changes on cash             |       | 50       |       | 8        |       | —   |       | 42                                  |       | 8                                   |       |
| **Increase  in cash and cash equivalents**           |       | $        | (508       | )        | $          | 404      |       | $                                   | (2,847     | )                                   | (912       | ) | $ | 3,251 |   |
|                                                      |            |          |            |          |            |          |            |                                     |            |                                     |            |  |  |  |  |  |

 

Net cash flows fromoperations decreased approximately by $1.7 million in fiscal year 2008 comparedwith fiscal year 2007.  This decrease wasprimarily attributable to a $5.5 million net loss from continuing operations infiscal year 2008, compared with 

 

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net income of $351thousand in fiscal year 2007.  The netloss from continuing operations was primarily caused by a non-cash item of $4.1million of impairment costs recorded during fiscal year 2008.  In addition, we experienced higher operatingcosts related to headcount expenses, compensation and benefits; headcountincreased from approximately 162 in 2007 to 250 employees in 2008.  The increase in headcount is part of ourlong-term strategic goals to develop a qualified and high performing team tomeet our business vision and strategy.

 

 Net cash used in investing activitiesdecreased approximately by $9.7 million in fiscal year 2008 compared withfiscal year 2007.  This decrease wasprimarily related to larger payments for business acquisitions, Hot Banana andClickTracks, during fiscal year 2007.  In 2008 and 2007, capital expenditures were $1.9 million and $1.5million, respectively.  We estimate thatfuture capital expenditures will be primarily for developing new products andpurchases to upgrade our information technology capabilities.

 

***Fiscalyear 2007 compared with fiscal year 2006***

 

Net cash from operatingactivities decreased approximately by $595 thousand in fiscal year 2007compared with fiscal year 2006.

 

Net cash used ininvesting activities decreased approximately by $4.4 million in fiscal year2007 compared with fiscal year 2006, primarily due to lower acquisition costsin 2007 than 2006.  In 2007, we used $1.5million for capital expenditures.

 

**Cash flows from FinancingActivities**

** **
| **(In thousands, except percentages** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **Change  2008 vs. 2007** | ** ** | **Change  2007 vs. 2006** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Proceeds from  sale of stock                         |       | $        | 1,000      |     | $          | 87       |       | $                                   | 75         |                                | $          | 913 |   | $ | 12 |   |
| Proceeds from  exercise of stock options             |       | 206      |       | —   |       | —   |       | 206                                 |       | —                              |       |
| Payment for  purchase of treasury stock              |       | (1,670   | )          | —   |       | —   |       | (1,670                              | )          | —                              |       |
| Financing fees                                       |       | —   |       | (75      | )          | (112     | )          | 75                                  |       | 37                                  |       |
| Proceeds from  debit and credit arrangements         |       | 22,923   |       | 27,453   |       | 22,384   |       | (4,530                              | )          | 5,069                               |       |
| Payment of debt  and credit arrangements             |       | (22,127  | )          | (28,186  | )          | (12,517  | )          | 6,059                               |       | (15,669                             | )          |
| Proceeds from  convertible debt from related party   |       | —   |       | 10,000   |       | —   |       | (10,000                             | )          | 10,000                              |       |
| **Net  cash provided by financing activities**       |       | $        | 332        |     | $          | 9,279    |       | $                                   | 9,830      |                                | (8,947     | ) | $ | (551 | ) |
|                                                      |            |          |            |          |            |          |            |                                     |            |                                     |            |  |  |  |  |  |

 

***Fiscalyear 2008 compared with fiscal year 2007***

 

Net cash provided byfinancing activities decreased approximately by $8.9 million in fiscal year2008, compared with fiscal year 2007.  The decrease was attributed to $10.0 million in proceeds received infiscal year 2007 which was related to convertible debt from a related party,LDN Stuyvie Partnership.   In addition, a$1.7 million payment for purchase of treasury stock occurred in fiscal year2008.  These were repurchased shares fromJohn Marshall, the former president of ClickTracks, in accordance with anagreement that was entered into between us and Mr. Marshall on June 8,2007.

 

In fiscal year 2008,there was an approximately $796 thousand net cash inflow from our revolvingline of credit with Comerica.  As of June 30,2008, we have $11.9 million revolving line of credit facility, less $9.9million outstanding balance, and $240 thousand used for letters of credit.  Accordingly, the availability under thisrevolving line of credit was $1.7 million at the end of fiscal year 2008.  See Note 11 to our Consolidated FinancialStatements for detail information of our revolving line of credit withComerica.

 

***Fiscalyear 2007 compared with fiscal year 2006***

 

Net cash provided byfinancing activities decreased approximately by $551 thousand in fiscal year2007, compared with fiscal year 2006.  The decrease was due to $10.0 million in proceeds related to LDN StuyvieConvertible note in fiscal year 2007, offset by approximately $10.6 net cashoutflow from our revolving line of credit with Comerica.

 

***Legal Claims***

 

*NovaCarev. Stratford Nursing Home**.** * We filed this collection lawsuit inAugust, 1999 to collect on a receivable of approximately $146,000, which wehave fully reserved.  Stratford counter-claimed with numerous theoriesasserting that we instead owed Stratford money.  Although Stratford’sprincipal claims were dismissed by the court, Stratford, in the last quarter of

 

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fiscal year 2003, hadquantified its remaining counter-claims at approximately $1 million.  Webelieve that the theories on which these damages are based are inconsistentwith the contract between the parties and with the conduct of each party. As of June 30, 2008, this case is pending in the U.S. District Court forthe Southern District of New Jersey (Camden).  The outcome of this actionis not possible to predict and we have reserved an estimate of the cost oflitigating this action; however, this estimate does not reflect the possibilityof an adverse ruling or a judgment against us or a settlement.

 

***Other Cases and Claims***

 

*O’Learyv. Joyner Sports Medicine.** *We are a defendant in one professionalliability claim and had previously purchased professional liability insurancepolicies from PHICO Insurance Company.  On February 2, 2002, aPennsylvania court authorized state insurance regulators to liquidate theinsolvent PHICO Insurance Company, which had provided professional liabilityinsurance policies to us. As a result, PHICO will not be permitted to pay anyclaims on our behalf; however, the remaining claims were transferred to variousstate guaranty funds.  Since 2002, state insurance guaranty funds havepaid the amounts due for liability claims settlements on our behalf. Based on our discussion with the state guaranty funds and a review of claimsduring the third quarter of 2004, we now believe that a payment may be requiredto settle the professional liability claim that may exceed the amount availableto us under the applicable state guaranty fund limits.  We recorded anaccrual and related expense in the third quarter of 2004 equal to the estimatedcost to settle that claim less the amount that would be paid by the stateguaranty fund.  We are undertaking negotiations to settle our liability onthis claim and have recently increased our reserve for this liabilityclaim.  There is no insurance policy in place that would pay anysettlement or award for this claim; therefore, in the event that our currentreserve assessment is incorrect, we will be required to fund any amount inexcess of the reserve amount.

 

***Off-BalanceSheet Arrangements***

 

Inaccordance with the definition under SEC rules, the following qualify asoff-balance sheet arrangements:

 

We currently have$240 thousand in irrevocable letter of credits (“LOC”) issued by Comerica Bank,consisting of a $200 thousand LOC in favor of the Hartford Insurance Company,and a $40 thousand LOC in favor of Legacy Partners I SJ North Second, LLC.

 

The HartfordInsurance LOC replaces a cash deposit previously held by the Hartford InsuranceCompany as collateral for deductible payments that may be due under acompensation insurance policy. We received the $200 thousand deposit previouslyheld by the Hartford in October 2007. Under the terms of the LOC, anyamount drawn down by the Hartford on this LOC would be added to our existingdebt as part of our Line of Credit with Comerica.  The LOC expires on September 1, 2009,and will automatically renew annually unless we are notified by Comerica 30days prior to the annual expiration date that they have chosen not to extendthe LOC for the next year. As of the date of this report there have been nodraw downs on this LOC by Hartford.

 

The LegacyPartners I SJ North Second, LLC, LOC is in connection with our office leasedated January 31, 2008, in San Jose, California.   This LOC shall expire on April 30,2009.  As of the date of this report,there have been no drawings by the Legacy Partners.

 

***Long-TermContractual Obligations***

 

The following tablesummarizes by period the payments due for contractual obligations estimated asof June 30, 2008:

 
| ** **                      | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|
| **(In thousands)**         | ** ** | **Total**                                 | ** ** | **Less Than 1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **More Than 5 Years** | ** ** |
| Long-term debt  obligations(1)  |       | $                                         | 9,930      |   | $ | 555 |   | $ | 5,000 |   | $ | 4,375 |   | $ | 0 |   |
| Operating lease  obligations(2) |       | $                                         | 2,646      |   | $ | 927 |   | $ | 1,133 |   | $ | 586 |   | $ | 0 |   |
|                            |       |                                      |       |   |   |   |   |   |   |   |   |
| Total                           |       | $                                         | 12,576     |   | $ | 1,482 |   | $ | 6,133 |   | $ | 4,961 |   | $ | 0 |   |

 

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(1)  Revolvingline of credit with Comerica

(2)  Variousproperty leases

 

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***Revolving Line of Credit***

 

On October 11, 2005,we entered into a Loan and Security Agreement with Comerica Bank, (the “Loanand Security Agreement”), an asset-based revolving line of credit.  Theinitial borrowings under the Loan and Security Agreement were used toconsummate the acquisition of EmailLabs and for general corporatepurposes.  Under the original Loan and Security Agreement, interest onoutstanding balances was charged at a floating rate equal to Comerica’s baserate plus 0.75% or Comerica’s LIBOR rate plus 3.75%.  The original amount available to us was $18.5million and that amount was reduced monthly beginning October 31,2005.  Monthly reductions were $250 thousand through September 30,2007 and $347 thousand, thereafter through the maturity date.  Inaddition, the Loan and Security Agreement contains certain financial covenantsand requires us to maintain certain financial ratios.  Failure to meetthese financial covenants and ratios constitute an event of default.

 

From April 2006through January 2007, we entered into four amendments to the Security andLoan Agreement.  These amendmentsadjusted Comerica’s lending commitment, adjusted the rate at which outstandingborrowings bear interest and revised existing financial and other covenants.

 

Effective March 31,2007, we entered into a Fifth Amendment to the Loan and Security Agreement (the“Fifth Amendment”) with Comerica.  TheFifth Amendment increased the amounts available under the revolving line ofcredit to fifteen million dollars ($15.0 million), extended the term to fiveyears from the date of the Fifth Amendment and provided that the amountsavailable under the line are reduced in equal monthly installments of $208thousand.  The Amendment modified thedefinition of EBITDA to allow for adjustments related to discontinuedoperations, subject to certain limitations, and also modified the financialcovenants.

 

On March 6,2008, we entered into an Amended and Restated Loan and Security Agreement (the “NewCredit Agreement”) with Comerica Bank. The New Credit Agreement amends and restates in its entirety the Loanand Security Agreement. The Bank’s commitment and interest rate under the NewCredit Agreement are essentially unchanged. The revolving line of credit is in the amount of approximately $12.7million as of March 6, 2008, which is reduced on the last day of each ofthe following months as follows: (i) $208 thousand per month for eachmonth from April 2008 through July 2008, (ii) $312 thousand for December 2008,(iii) $417 thousand per month for each month from January 2009through March 2009, (iv) $312 thousand for April 2009, and (v) $208thousand per month for each month from May 2009 through March 31,2012, the maturity date.  The New CreditAgreement contains certain financial covenants and requires us to maintain certainfinancial ratios.  Failure to meet these financial covenants and ratiosconstitutes an event of default.  The commitment is secured by essentiallyall of the assets of the Company and its subsidiaries including intellectualproperty.

 

The financial covenantrequirements, measured on a monthly basis, are as follows: (a) fixedcharge coverage of at least 1.25 to 1.00 (except for the period September 1,2008, to November 3, 2008, when it is 1:15:1.00), calculated as the ratioof annualized rolling three-month EBITDA minus cash taxes and capitalizedexpenditures to the sum of cash interest expense plus the current portion ofall indebtedness to Comerica; (b) minimum EBITDA, on a rolling three-monthbasis, of at least (i) $800 thousand for the three-month period ended March 31,2008,  (ii) $0 for the three-monthperiod ending June 30, 2008 (iii) $250 thousand for the three monthsending September 30, 2008, (iv) $1.5 million for each three-monthperiod ending December 31, 2008 through February 28, 2009 and (v) $2.0million for the three month period ending March 1, 2009 and thereafter; (c) ratioof senior debt to EBITDA, calculated on an annualized rolling three-monthbasis, of not greater than: (i) 2.50 to 1.00 for the measuring periodsthrough June 30, 2008, (ii) 3.25:1.00 for the measuring periods July 1,2008 to November 30, 2008 and (iii) 2.00 to 1.00 at all timesthereafter; (d) Liquidity, defined as cash held at Comerica plusavailability under the revolving line, of not less than (i) $500 thousandfor the measuring periods ended March 31, 2008, and (ii) $250thousand for the measuring periods April 1, 2008 through June 30,2008.

 

The New Credit Agreementcontains customary events of default provisions giving the Bank the right todemand immediate payment of all principal, interest and other obligationsoutstanding thereunder in the event of certain occurrences, and typicalnegative covenants preventing or restricting our ability to take certainactions, including, without limitation, changing our principal executiveoffices, changing our names, disposing of property or other assets, andincurring additional indebtedness.

 

As of June 30, 2008,we have $11.9 million revolving line of credit facility, less $9.9 millionoutstanding balance, and $240 thousand used for letters of credit.  Accordingly, the availability under thisrevolving line of credit was $1.7 million at the end of fiscal year 2008.

 

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**Theaggregate maturities of line of credit by fiscal year as of June 30, 2008are as follows:**

 
| **Fiscal Year Ended June 30,** | ** ** | **Amount**              | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **(in thousands)** | ** ** |
| 2009                                               |       | $                       | 555        |   |
| 2010                                               |       | 2,500                   |       |
| 2011                                               |       | 2,500                   |       |
| 2012                                               |       | 4,375                   |       |
| Total                                              |       | $                       | 9,930      |   |

 

On July 30, 2008, weentered into First Amendment to Amended and Restated Loan Security Agreementwith Comerica Bank.

 

During the course of theCompany’s year-end audit, our independent auditors requested and we agreed tomake certain accounting entries to reverse a previously recognized softwarelicense sale of approximately $73 thousand. The effect was to reduce our EBITDA to a negative $-478 thousand whichwas below the amount required by the financial covenant with Comerica, for thequarterly measurement period ending June 30, 2008.  On September 12, 2008, we obtained awaiver for this quarterly measurement period requirement.  See Note 21 to our Consolidated FinancialStatements for Subsequent Events related to our revolving line of credit with Comerica.

 

**RecentAccounting Pronouncements**

 

Refer to Note 2 toour Consolidated Financial Statements for a discussion of recent accountstandards and pronouncements.

 

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**ITEM7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

***Foreign Currency Exchange***

 

We record assets,liabilities and results of our operations outside of the United States based ontheir functional currency.   Onconsolidation, we translate all assets and liabilities in effect on the balancesheet date.  We translate revenues andexpenses at the average of the monthly exchange rates, were in effect duringthe period.   We recognize the resultingadjustments as a separate component of equity in other comprehensive loss orgain.   Foreign currency transactiongains and losses are included in income as incurred, for that period.

 

One of our entities, HotBanana is subject to opportunities and risks relating to foreign currencyfluctuation.   We will continue to manageits foreign currency exposure to mitigate, over time, a portion of the impactof exchange rate changes on net income and earnings per share.  The fluctuation in the exchange ratesresulted in foreign currency translation losses reflected as a component ofcomprehensive gain in stockholders’ equity of $162 thousand at June 30,2008.

 

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**ITEM 8. FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 
| **Index  to Consolidated Financial Statements**                                                                                            | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                 | ** ** |
| Report of Independent Registered  Public Accounting Firm – Burr, Pilger & Mayer LLP                                          |       |
|                                                                                                                                       |       |
| Consolidated Balance Sheets as of June 30, 2008  and 2007                                                                             |       |
|                                                                                                                                       |       |
| Consolidated Statements of Operations for the years ended  June 30, 2008, 2007 and 2006                                          |       |
|                                                                                                                                       |       |
| Consolidated Statements of Stockholders’ Equity and  Comprehensive Income for the years ended June 30, 2008, 2007  and 2006 |       |
|                                                                                                                                       |       |
| Consolidated Statements of Cash Flows for the years  ended June 30, 2008, 2007 and 2006                                          |       |
|                                                                                                                                       |       |
| Notes to Consolidated Financial Statements                                                                                                 |       |

 

Schedule II:  Appendix A - Valuation and QualifyingAccounts

 

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**Reportof Independent Registered Public Accounting Firm**

 

To the Board of Directorsand Stockholders of Lyris, Inc:

 

We have auditedthe accompanying consolidated balance sheets of Lyris, Inc. andSubsidiaries (the “Company”) as of June 30, 2008 and 2007 and the relatedstatements of operations, stockholders’ equity and comprehensive income, andcash flows for each of the years in the three-year period ended June 30,2008. Our audits also included the financial statement schedules listed in item15(b).  These consolidated financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

 

We conducted ouraudits in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. The company is not required to have, nor were we engaged to perform, anaudit of the company’s internal control over financial reporting.  An audit also includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Lyris, Inc. and Subsidiariesas of June 30, 2008 and 2007, and the results of their operations andtheir cash flows for each of the years in the three-year period ended June 30,2008, in conformity with accounting principles generally accepted in the UnitedStates of America.  Also, in our opinion,the related financial statement schedule, when considered in relation to theconsolidated financial statements taken as a whole, presents fairly, in allmaterial respects, the information set forth therein.

 

 

Burr,Pilger & Mayer, LLP

SanFrancisco, California

September 16,2008

 

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**LYRIS,INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except per share data)**

** **
| ** **                                                                                                                 | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                 | ** ** | **2008**          | ** ** | **2007** | ** ** |
| **ASSETS**                                                                                                                 | ** ** | ** **        | ** ** | ** ** | ** ** |
| Current assets:                                                                                                            |       |              |       |   |   |
| Cash and cash  equivalents                                                                                                 |       | $                 | 151        |   | $ | 659 |   |
| Accounts receivable,  less allowances of $450 and $365, respectively                                                       |       | 7,660             |       | 6,903 |   |
| Prepaid expenses  and other current assets                                                                                 |       | 1,051             |       | 713 |   |
| Deferred income  taxes                                                                                                     |       | 619               |       | 580 |   |
| Deferred  financing fees                                                                                                   |       | 116               |       | 147 |   |
| Prepaid expenses  related to discontinued operations                                                                       |       | 6                 |       | 6 |   |
| Total current  assets                                                                                                      |       | 9,603             |       | 9,008 |   |
| Property and  equipment, net                                                                                               |       | 3,326             |       | 2,452 |   |
| Restricted cash  related to discontinued operations                                                                        |       | —            |       | 200 |   |
| Restricted cash                                                                                                            |       | —            |       | 96 |   |
| Intangible assets,  net                                                                                                    |       | 14,614            |       | 22,414 |   |
| Goodwill                                                                                                                   |       | 35,924            |       | 36,021 |   |
| TOTAL ASSETS                                                                                                               |       | $                 | 63,467     |   | $ | 70,191 |   |
|                                                                                                                       |       |              |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                             |       |              |       |   |   |
| Current  liabilities:                                                                                                      |       |              |       |   |   |
| Accounts payable  and accrued expenses                                                                                     |       | $                 | 2,722      |   | $ | 2,580 |   |
| Revolving line of  credit - short-term                                                                                     |       | 555               |       | — |   |
| Contingent  acquisition consideration - short-term                                                                         |       | —            |       | 2,050 |   |
| Note payable -  short-term                                                                                                 |       | —            |       | 1,049 |   |
| Accrued interest                                                                                                           |       | —            |       | 70 |   |
| Income taxes  payable                                                                                                      |       | 24                |       | 218 |   |
| Accrued expenses  remaining from discontinued operations                                                                   |       | 471               |       | 722 |   |
| Deferred revenue                                                                                                           |       | 4,417             |       | 3,893 |   |
| Total current  liabilities                                                                                                 |       | 8,189             |       | 10,582 |   |
| Revolving line  of credit                                                                                                  |       | 9,375             |       | 9,134 |   |
| Note payable -  long-term                                                                                                  |       | —            |       | 4,360 |   |
| Contingent  acquisition consideration - long-term                                                                          |       | —            |       | 163 |   |
| Other long-term  liabilities                                                                                               |       | 251               |       | 146 |   |
| TOTAL  LIABILITIES                                                                                                         |       | 17,815            |       | 24,385 |   |
| Stockholders’  equity:                                                                                                |       |              |       |   |   |
| Common stock,  $0.01 par value; authorized 200,000 shares; issued and outstanding 103,217  and 98,431 shares, respectively |       | 1,032             |       | 984 |   |
| Additional  paid-in capital                                                                                                |       | 257,310           |       | 252,172 |   |
| Accumulated  deficit                                                                                                       |       | (213,080          | )          | (207,578 | ) |
| Cumulative  foreign currency translation adjustment                                                                        |       | 390               |       | 228 |   |
| Total  stockholders’ equity                                                                                           |       | 45,652            |       | 45,806 |   |
| TOTAL  LIABILITIES AND STOCKSHOLDERS’ EQUITY                                                                          |       | $                 | 63,467     |   | $ | 70,191 |   |

 

See accompanyingNotes to Consolidated Financial Statements.

 

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**LYRIS, INC.AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Inthousands, except per share data)**

 
| ** **                                                                                                               | ** ** | **Years Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                               | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues:                                                                                                                |       |                                    |       |   |   |   |   |
| Software  revenues                                                                                                       |       | $                                       | 5,947      |   | $ | 8,045 |   | $ | 5,331 |   |
| Services  revenues                                                                                                       |       | 37,253                                  |       | 30,960 |   | 19,022 |   |
| Total revenues                                                                                                           |       | 43,200                                  |       | 39,005 |   | 24,353 |   |
| Cost of  revenues:                                                                                                       |       |                                    |       |   |   |   |   |
| Software and  services                                                                                                   |       | 13,451                                  |       | 9,739 |   | 5,346 |   |
| Amortization of  developed technology                                                                                    |       | 4,148                                   |       | 2,301 |   | 1,410 |   |
| Total cost of  revenues                                                                                                  |       | 17,599                                  |       | 12,040 |   | 6,756 |   |
| Gross profit                                                                                                             |       | 25,601                                  |       | 26,965 |   | 17,597 |   |
| Operating  expenses:                                                                                                     |       |                                    |       |   |   |   |   |
| General and  administrative                                                                                              |       | 11,857                                  |       | 11,087 |   | 6,901 |   |
| Research and  development                                                                                                |       | 2,334                                   |       | 1,448 |   | 210 |   |
| Sales and  marketing                                                                                                     |       | 12,566                                  |       | 10,539 |   | 5,097 |   |
| Amortization and  impairment of customer relationship trade names                                                        |       | 3,742                                   |       | 1,741 |   | 1,217 |   |
| Income (loss)  from operations                                                                                           |       | (4,898                                  | )          | 2,150 |   | 4,172 |   |
| Interest income                                                                                                          |       | 5                                       |       | 24 |   | 98 |   |
| Interest expense                                                                                                         |       | (1,084                                  | )          | (3,130 | ) | (1,268 | ) |
| Other income                                                                                                             |       | 9                                       |       | 181 |   | — |   |
| Gain on debt  extinguishment                                                                                             |       | 919                                     |       | — |   | — |   |
| Loss on sale of  assets                                                                                                  |       | (42                                     | )          | — |   | (16 | ) |
| (Loss) income  from continuing operations before income taxes                                                            |       | (5,091                                  | )          | (775 | ) | 2,986 |   |
| Income tax  provision                                                                                                    |       | 440                                     |       | 544 |   | 827 |   |
| (Loss) income  from continuing operations                                                                                |       | (5,531                                  | )          | (1,319 | ) | 2,159 |   |
| Gain on disposal  of discontinued operations, net of income tax benefit (expense) of ($1), $125  and ($25), respectively |       | 29                                      |       | 1,670 |   | 407 |   |
| Net (loss)  income                                                                                                       |       | $                                       | (5,502     | ) | $ | 351 |   | $ | 2,566 |   |
| **Basic:**                                                                                                               |       |                                    |       |   |   |   |   |
| (Loss) income  per share from continuing operations                                                                      |       | $                                       | (0.06      | ) | $ | (0.01 | ) | $ | 0.03 |   |
| Gain on disposal  of discontinued operations, net of income tax benefit (expense) per share                              |       | $                                       | 0.00       |   | $ | 0.02 |   | $ | 0.00 |   |
| Net income  (loss) per share                                                                                             |       | $                                       | (0.06      | ) | $ | 0.00 |   | $ | 0.03 |   |
| **Diluted:**                                                                                                             |       |                                    |       |   |   |   |   |
| (Loss) income  per share from continuing operations                                                                      |       | $                                       | (0.06      | ) | $ | (0.01 | ) | $ | 0.03 |   |
| Gain on disposal  of discontinued operations, net of income tax benefit (expense) per share                              |       | $                                       | 0.00       |   | $ | 0.02 |   | $ | 0.00 |   |
| Net income  (loss) per share                                                                                             |       | $                                       | (0.06      | ) | $ | 0.00 |   | $ | 0.03 |   |
| Weighted average  shares used in calculating net (loss) income per common share:                                         |       |                                    |       |   |   |   |   |
| Basic                                                                                                                    |       | 98,604                                  |       | 90,706 |   | 83,127 |   |
| Diluted                                                                                                                  |       | 98,604                                  |       | 92,904 |   | 84,486 |   |

 

 See accompanying Notes to ConsolidatedFinancial Statements.

 

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**LYRIS,INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME**

**(Inthousands, except per share data)**

 
| ** **                                                    | ** ** | **Common Stock** | ** ** | **Treasury Stock**   | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|---------------------------|------------|
| ** **                                                    | ** ** | ** **            | ** ** | **Accumu-  lated  Other** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                                    | ** ** | **Shares**            | ** ** | **Amount**                | ** ** | **Additional  Paid-In  Capital** | ** ** | **(Accumulated  Deficit)** | ** ** | **Compre-  hensive  Income** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Stock-  holders’  Equity** | ** ** |
| **Balances  at June 30, 2005**                           | ** ** | **89,522**            | ** ** | **$**                     | **895**    | ** ** | **$** | **275,064** | ** ** | **$** | **(210,495** | **)** | **$** | **—** | ** ** | **(6,555** | **)** | **$** | **(38,382** | **)** | **$** | **27,082** | ** ** |
| Treasury stock  sale                                          |       | —                |       | —                    |       | (1,343 | ) | — |   | — |   | 241 |   | 1,418 |   | 75 |   |
| Stock-Based  Compensation                                     |       | —                |       | —                    |       | 343 |   | — |   | — |   | — |   | — |   | 343 |   |
| Comprehensive  income, net of tax:                            |       |                  |       |                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cumulative  translation adjustment                            |       | —                |       | —                    |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Net income                                                    |       |                  |       |                      |       | — |   | 2,566 |   | — |   | — |   | — |   | 2,566 |   |
| **Total  comprehensive income**                               | ** ** | **—**            | ** ** | **—**                | ** ** | **—** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2,566** | ** ** |
| **Balances  at June 30, 2006**                           | ** ** | **89,522**            | ** ** | **895**                   | ** ** | **274,064** | ** ** | **(207,929** | **)** | **—** | ** ** | **(6,313** | **)** | **(36,964** | **)** | **30,066** | ** ** |
| Stock issued for  exercise of stock options                   |       | 112                   |       | 1                         |       | (97 | ) | — |   | — |   | 31 |   | 183 |   | 87 |   |
| Stock issued for  acquisition of ClickTracks                  |       | —                |       | —                    |       | (13,653 | ) | — |   | — |   | 2,799 |   | 16,406 |   | 2,753 |   |
| Stock issued for  related party promissory note               |       | 8,797                 |       | 88                        |       | (10,130 | ) | — |   | — |   | 3,483 |   | 20,375 |   | 10,333 |   |
| Stock-Based  Compensation                                     |       | —                |       | —                    |       | 694 |   | — |   | — |   | — |   | — |   | 694 |   |
| Beneficial  conversion feature of convertible promissory note |       |                  |       |                      |       | 1,294 |   | — |   | — |   | — |   | — |   | 1,294 |   |
| Comprehensive  income, net of tax:                            |       |                  |       |                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cumulative  translation adjustment                            |       | —                |       | —                    |       | — |   |   |   | 228 |   | — |   | — |   | 228 |   |
| Net income                                                    |       |                  |       |                      |       | — |   | 351 |   | — |   | — |   | — |   | 351 |   |
| **Total  comprehensive income**                               | ** ** | **—**            | ** ** | **—**                | ** ** | **—** | ** ** | **—** | ** ** | **—** | ** ** | **—** | ** ** | **—** | ** ** | **579** | ** ** |
| **Balances  at June 30, 2007**                           | ** ** | **98,431**            | ** ** | **984**                   | ** ** | **252,172** | ** ** | **(207,578** | **)** | **228** | ** ** | **—** | ** ** | **—** | ** ** | **45,806** | ** ** |
| Purchase of  treasury shares                                  |       | —                |       | —                    |       | — |   | — |   | — |   | (2,226 | ) | (1,670 | ) | (1,670 | ) |
| Common stock sale                                             |       | 952                   |       | 10                        |       | 990 |   | — |   | — |   | — |   | — |   | 1,000 |   |
| Stock issued for  exercise of stock options                   |       | 5                     |       | —                    |       | (159 | ) | — |   | — |   | 487 |   | 365 |   | 206 |   |
| Stock issued for  related party promissory note               |       | 3,829                 |       | 38                        |       | 3,557 |   |   |   |   |   | 1,739 |   | 1,305 |   | 4,900 |   |
| Stock-Based  Compensation                                     |       |                  |       |                      |       | 750 |   |   |   |   |   |   |   |   |   | 750 |   |
| Comprehensive  loss, net of tax:                              |       |                  |       |                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cumulative  translation adjustment                            |       | —                |       | —                    |       | — |   |   |   | 162 |   | — |   | — |   | 162 |   |
| Net loss                                                      |       | —                |       | —                    |       | — |   | (5,502 | ) | — |   | — |   | — |   | (5,502 | ) |
| **Total  comprehensive loss**                                 | ** ** | **—**            | ** ** | **—**                | ** ** | **—** | ** ** | **—** | ** ** | **—** | ** ** | **—** | ** ** | **—** | ** ** | **(5,340** | **)** |
| **Balances  at June 30, 2008**                           | ** ** | **103,217**           | ** ** | **$**                     | **1,032**  | ** ** | **$** | **257,310** | ** ** | **$** | **(213,080** | **)** | **$** | **390** | ** ** | **$** | **—** | ** ** | **$** | **—** | ** ** | **$** | **45,652** | ** ** |
|                                                               |            |                       |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanyingNotes to Consolidated Financial Statements

 

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**LYRIS, INC.AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

 
| ** **                                                                                                 | ** ** | **Year Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2008**                               | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                                                       |       |                                   |       |   |   |   |   |
| **Cash  Flow from Operating Activities:**                                                                  |       |                                   |       |   |   |   |   |
| Net income  (loss)                                                                                         | ** ** | **$**                                  | **(5,502** | **)** | **$** | **351** | ** ** | **$** | **2,566** | ** ** |
| Adjustments to  reconcile net loss to net cash provided by operating activities of continuing  operations: |       |                                   |       |   |   |   |   |
| Gain on disposal  of discontinued operations, net of tax                                                   |       | (29                                    | )          | (1,670 | ) | (407 | ) |
| Stock-based  compensation expense                                                                          |       | 750                                    |       | 694 |   | 343 |   |
| Depreciation,  and amortization and impairment of purchased intangibles                                    |       | 8,895                                  |       | 4,852 |   | 3,045 |   |
| Provision for  bad debt                                                                                    |       | 580                                    |       | 638 |   | 328 |   |
| Deferred income  tax benefit                                                                               |       | (39                                    | )          | (156 | ) | (102 | ) |
| Loss on sale of  assets                                                                                    |       | 42                                     |       | — |   | 16 |   |
| Interest on  related party promissory note                                                                 |       | 368                                    |       | 437 |   | — |   |
| Gain on debt  restructuring                                                                                |       | (947                                   | )          | — |   | — |   |
| Beneficial  conversion feature of convertible promissory note                                              |       | —                                 |       | 1,294 |   | — |   |
| Changes in  assets and liabilities:                                                                        |       |                                   |       |   |   |   |   |
| Accounts  receivable                                                                                       |       | (1,337                                 | )          | (2,473 | ) | (1,739 | ) |
| Prepaid expenses  and other current assets                                                                 |       | (307                                   | )          | (79 | ) | (328 | ) |
| Accounts payable  and accrued expenses                                                                     |       | 267                                    |       | (7 | ) | 176 |   |
| Accrued interest                                                                                           |       | —                                 |       | (457 | ) | 557 |   |
| Deferred revenue                                                                                           |       | 537                                    |       | 879 |   | 679 |   |
| Income taxes  payable                                                                                      |       | (155                                   | )          | (182 | ) | 409 |   |
| Net cash flows  provided by continuing operations                                                          |       | 3,123                                  |       | 4,121 |   | 5,543 |   |
| Net cash flows  (used in) provided by discontinued operations                                              |       | (222                                   | )          | 447 |   | (380 | ) |
| Net cash  provided by operating activities                                                                 | ** ** | **2,901**                              | ** ** | **4,568** | ** ** | **5,163** | ** ** |
| **Cash  Flows from Investing Activities:**                                                                 |       |                                   |       |   |   |   |   |
| Continuing  operations:                                                                                    |       |                                   |       |   |   |   |   |
| Acquisition  costs                                                                                         |       | —                                 |       | — |   | (32 | ) |
| Reduction of  note payable                                                                                 |       | —                                 |       | (195 | ) | (104 | ) |
| Purchases of  property and equipment                                                                       |       | (1,917                                 | )          | (1,523 | ) | (854 | ) |
| Payments for  business acquired, net of cash acquired                                                      |       | (2,170                                 | )          | (13,051 | ) | (17,450 | ) |
| Release of  restricted cash                                                                                |       | 96                                     |       | — |   | — |   |
| Discontinued  operations:                                                                                  |       | —                                 |       |   |   |   |   |
| Release of  restricted cash                                                                                |       | 200                                    |       | 1,318 |   | 600 |   |
| Net cash used in  investing activities                                                                     | ** ** | **(3,791**                             | **)**      | **(13,451** | **)** | **(17,840** | **)** |
| **Cash  Flows from Financing Activities:**                                                                 |       |                                   |       |   |   |   |   |
| Proceeds from  sale of stock                                                                               |       | 1,000                                  |       | 87 |   | 75 |   |
| Proceeds from  exercise of stock options                                                                   |       | 206                                    |       | — |   | — |   |
| Payment for  purchase of treasury stock                                                                    |       | (1,670                                 | )          | — |   | — |   |
| Financing fees                                                                                             |       | —                                 |       | (75 | ) | (112 | ) |
| Proceeds from  debt and credit arrangements                                                                |       | 22,923                                 |       | 27,453 |   | 22,384 |   |
| Proceeds from  convertible debt from related party                                                         |       | —                                 |       | 10,000 |   | — |   |
| Payment of debt  and credit arrangements                                                                   |       | (22,127                                | )          | (28,186 | ) | (12,517 | ) |
| Net cash  provided by financing activities                                                                 | ** ** | **332**                                | ** ** | **9,279** | ** ** | **9,830** | ** ** |
| Effect of  exchange rate changes on cash and cash equivalents                                              |       | 50                                     |       | 8 |   | — |   |
| Net (decrease)  increase in cash and cash equivalents                                                      | ** ** | **(508**                               | **)**      | **404** | ** ** | **(2,847** | **)** |
| Cash and cash  equivalents, beginning of period                                                            |       | 659                                    |       | 255 |   | 3,102 |   |
| Cash and cash equivalents,  end of period                                                                  | ** ** | **$**                                  | **151**    | ** ** | **$** | **659** | ** ** | **$** | **255** | ** ** |
| ** **                                                                                                 | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Supplemental  cash flow information:                                                                       |       |                                   |       |   |   |   |   |
| Cash paid for  interest                                                                                    |       | $                                      | 786        |   | $ | 1,786 |   | $ | 709 |   |
| Cash paid for  taxes                                                                                       |       | $                                      | 699        |   | $ | 862 |   | $ | 565 |   |
| Supplemental  disclosure of non-cash transactions:                                                         |       |                                   |       |   |   |   |   |
| Extinguishment  of promissory note                                                                         |       | $                                      | 5,847      |   | $ | — |   | $ | — |   |
| Stock issued for  acquisition of ClickTracks                                                               |       | $                                      | —     |   | $ | 2,753 |   | $ | — |   |
| Stock issued for  related party promissory note                                                            |       | $                                      | 4,900      |   | $ | 10,333 |   |   |   |   |
| Conversion of  convertible debt and accrued interest to equity                                             |       | $                                      | —     |   | $ | 10,437 |   | $ | — |   |
| Gain on debt  restructuring                                                                                |       | $                                      | 947        |   | $ | — |   | $ | — |   |
| Beneficial  conversion feature of convertible promissory note                                              |       | $                                      | —     |   | $ | 1,294 |   | $ | — |   |

 

See accompanyingNotes to Consolidated Financial Statements.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

**1.****                   Description ofBusiness**

 

Lyris Inc. (the “Company”)provides hosted and installed software solutions to marketers forsmall-to-medium business.  In November 2007,we began to offer our new on-demand marketing platform that consolidates ourfull suite of digital marketing technologies into a single sign-on dashboardinterface.  In this new comprehensiveon-demand marketing platform, we have implemented a new pricing model for theoffering that is a full, seat-base model. It includes unlimited search engine keyword management, Web analytics,Web content management, pay-per-click (“PPC”) management and emaildeliverability solutions for the price of a single seat.  For the fiscal year ended, June 30,2008, we have approximately 187 Lyris HQ customers.  As part of our offerings, we continue tooffer software-as-a-service (“SaaS”) through our software brands: Hot Banana (“HB”);List Manager (“LM”); ClickTracks; and EmailLabs.

 

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

 

***Fiscal Year***

 

Our fiscal year ends on June 30.  References to fiscal 2008, for example, referto the fiscal year ending June 30, 2008.

 

***Basis ofPresentation and Consolidation***

 

We prepare ourconsolidated financial statements in accordance with accounting principlesgenerally accepted in the United States. Our consolidated financial statements include our accounts and accountsof our subsidiaries.  We eliminate fromour financial results all significant intercompany transactions.  Certain prior year amounts have beenreclassified to conform to the current year presentation.

 

***SegmentReporting***

 

SFAS No. 131,*“Disclosure about Segments of an Enterprise andRelated Information*,*”*establishes standards for the reporting by business enterprises of informationabout operating segments, products and services, geographic areas and major customers. The method for determining what information to report is based on the way thatmanagement organizes our operations for making operational decisions andassessments of financial performance.

 

Our chief executiveofficer (“CEO”) is considered to be the chief operating decision-maker. The CEO reviews financial information presented on a consolidated basis forpurposes of making operating decisions and assessing financialperformance.  We have determined that we operate in a single operatingsegment, specifically, e-marketing technology and services.

 

***Use ofEstimates and Assumptions***

 

In accordance with U.S.generally accepted accounting principles, we make estimates and assumptionsthat affect the reported amounts of assets, liabilities, revenues and expensesand the disclosure of contingent assets and liabilities in our consolidatedfinancial statements and accompanying notes. These estimates are based on the analysis of historical and expectationof future trends, which can require extended periods of time to resolve, andare subject to change from period to period. Accordingly, the actual results may ultimately differ from estimates andassumptions.  Our accounting estimatesthat require most significant and subjective judgments include, but not limitedto, the accounting for doubtful accounts, amortization and depreciation(estimated useful lives used), goodwill and intangible assets valuation,discontinued operations, valuation and recognition of stock-based compensation,current and deferred taxes, and contingencies.

 

***Foreign currency translation***

 

We record assets,liabilities and results of operations at the operating entity outside of theUnited States based on their functional currency.  Oneof our operating entities – Hot Banana – uses the Canadian dollar as itsfunctional currency.  On consolidation,we translate all assets and liabilities denominated in a foreign currency intoU.S. dollars at the exchange rate in effect on the balance sheet date.  We translate revenues and expenses at the averageexchange rate during the period.  Wetranslate equity transactions using historical exchange rates.  We recognize the resulting translationadjustments within other comprehensive income, as a separate component ofshareholders’ equity.  Foreign currencytransaction gains and losses are included in net income as incurred, for theperiod.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

***Certain Risks and Uncertainties***

 

We operate in a highlycompetitive and dynamic market, accordingly there are factors that couldadversely impact the Company’s current and future operations or financialresults include, but are not limited to, the following:  ability to obtain rights to or protect ourintellectual property; changes in regulations; ability to develop new productsaccepted in the marketplace; future impairments charges; competition including,but not limited to, pricing and products or product features and services;litigation or claims against us; and the hiring, training and retention of keyemployees.

 

Financial instrumentsthat potentially subject us to a concentration of credit risk consist primarilyof cash and trade receivables.  We sell our products primarily tocustomers throughout the United States.  We monitor the credit status ofour customers on an ongoing basis and we do not require our customers toprovide collateral for purchases on credit.  No sales to an individualcustomer accounted for more than 10% of revenue for fiscal years ended 2008,2007 and 2006.  Moreover, there was nosingle customer or supplier accounted for more than 10% of our tradereceivables for fiscal years 2008, 2007 and 2006.

 

***Fair Value ofFinancial Instruments***

 

The carrying amounts ofcertain financial instruments, including cash and cash equivalents, restrictedcash, accounts receivable and accounts payable, and certain other accruedliabilities, approximate their fair values due to their short maturities.

 

***Cash and CashEquivalents***

 

We consider all highlyliquid investments purchased with an original maturity of three months or lessto be cash equivalents.  Cash and cash equivalent, primarily consists ofcash on deposit with banks and money market funds, are stated at cost, whichapproximates fair value.  We maintaincash balances with banks in excess of FDIC insured limits.  We limit credit risk by maintaining accountswith financial institutions of high credit standing.

 

***Property andEquipment***

 

Property and equipmentare stated at cost, less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method overthe shorter of the estimated useful lives of the assets, generally two years toseven years, or the lease term including any lease term extensions that we havethe right and intention to execute, if applicable.  Repair and maintenance costs are expensed inthe period incurred.

 

***RevenueRecognition***

 

We recognize revenue fromproviding services and licensing our software products to our customers.

 

We generally recognizerevenue when all of the following conditions are satisfied:  (1) thereis persuasive evidence of an arrangement; (2) the service has beenprovided to the customer (in case of software licenses, revenue is recognizedwhen the customer is given electronic access to the licensed software); (3) theamount of fees to be paid by the customer is fixed or determinable; and (4) thecollection of fees is probable.

 

***Services Revenue***

 

Services revenue isderived from hosting software for use by customers and providing professionalconsulting and technical support (maintenance) services.

 

Our hosted softwarearrangements are considered service arrangements in accordance with EmergingIssues Task Force (“EITF”) Issue No. 00-3,*“Application of AICPA Statement of Position 97-2, Software Revenue Recognition,to Arrangements That Include the Right to Use Software Stored on Another Entity’sHardware,”* and may include multiple deliverables under EITF 00-21,*“Accounting for Revenue Arrangements with MultipleDeliverables.”*  In addition, because we provide ourapplications as a service, we follow the provisions of Securities and ExchangeCommission Staff Accounting Bulletin No. 104,*“Revenue Recognition.”*  Hosting revenue is recognizedmonthly based on the usage defined in the agreement.  Excess usage isbilled and recognized as revenue when incurred.

 

Professional servicessold with our hosted software arrangements are accounted for separately whenthese services have value to the customer on a standalone basis and there isobjective and reliable evidence of fair value for each deliverable.  When 

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

accounted for separately,professional services revenue is recognized as the services are performed.  If professional services do not qualify forseparate accounting, revenue is recognized ratably over the remaining term ofthe hosted software arrangement.

 

Technical support(maintenance) revenue, including revenue that is part of a multiple elementarrangement, is deferred and recognized ratably over the term of the agreement,generally one year.

 

***Software Revenue***

 

###### *Werecognize software license revenue in accordance with the provisions of*SOP 97-2, “SoftwareRevenue Recognition”, and SOP 98-9,“Modification of SOP 97-2, Software Revenue Recognition with Respect toCertain Transactions”. We enterinto certain revenue arrangements for which we are obligated to delivermultiple products and/or services (multiple elements).  For thesearrangements, which generally include software products and maintenance, weallocate and defer revenue for the undelivered elements based on theirvendor-specific objective evidence of fair value (“VSOE”).  VSOE exists (delivered and undelivered) forthe majority of our elements.  Weallocate total earned revenue under the agreement among the various elementsbased on their relative fair value.  Inthe event that VSOE does not exist for all elements, revenue for the deliveredelements is recognized (software licenses) as the difference between the totalarrangement fee and the total VSOE of the undelivered elements.

###### * *

Under the guidance of SOP97-2, we determine VSOE of fair value based on actual prices charged forstandalone sales of maintenance.  Toaccomplish this we track sales for the maintenance product when sold on astandalone basis for a one year term and compare to sales of the associatedlicensed software product.

 

We perform a quarterlyanalysis of the actual sales for standalone maintenance and licensed softwareto establish percentage of sales relationships for each level of maintenanceand licensed software.  The result of thisanalysis is historically a tight range of percentage of sales relationshipscentered on a mid-point which is then used as VSOE of fair value of themaintenance element.  This percentage isalso used to determine maintenance revenue in bundled software sales that isrecognized ratably over the maintenance period.

 

We recognize revenue fromour professional services at the time of delivery of the software license inaccordance with the guidance in of SOP 97-2. We established professional services VSOE based on the use of a consistentrate per hour when similar services are sold separately on a time-and-materialbasis.  In cases where VSOE has not beenestablished, the full value of the arrangement is deferred and recognizedratably over the term of the agreement.

 

***DeferredRevenue***

 

Deferred revenuerepresents customer billings made in advance for annual support or hostingcontracts, professional consulting services to be delivered in the future, andbulk purchases of emails to be delivered in the future. Maintenance istypically billed on a per annum basis in advance for software and the revenueis recognized ratably over the maintenance period.  Bulk purchases aretypically billed in advance, ranging from monthly to annually, and the revenueis recognized in the periods in which emails are delivered.

 

***AdvertisingCosts***

 

Advertising costs areexpensed as incurred or the first time the advertising takes place. During fiscal years 2008, 2007, and 2006, advertising costs were $4,133,$3,233, and $1,524, respectively.

 

***Research andDevelopment Costs***

 

Research and developmentcosts are expensed as incurred.  Research and development costs for thefiscal years ended June 30, 2008, 2007 and 2006 were approximately $2,334,$1,448 and $210, respectively.

 

***Allowance forDoubtful Accounts***

 

We record trade accountsreceivable at net realizable value. This value includes an appropriateallowance for estimated uncollectible accounts to reflect any loss anticipatedon the trade accounts receivable balances and charged to the provision fordoubtful accounts.

 

We provide an allowancefor doubtful accounts equal to the estimated uncollectible amounts.  Our estimate is based on historicalcollection experience, changes in our customer payment history and a review ofthe current status of trade accounts 

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

receivable.  If any of these factors change, it isreasonably possible that our estimate of the allowance for doubtful accountswill change.  Accounts receivable arepresented in our consolidated balance sheet, net of an allowance for doubtfulaccounts of $450 and $365 at June 30, 2008 and June 30, 2007,respectively.

 

***LossContingencies***

 

We record estimated losscontingencies when information is available that indicates that it is probablethat a material loss has been incurred or an asset has been impaired and theamount of the loss can be reasonably estimated. We disclose if the assessment indicates that a potentially material losscontingency is not probable but is reasonably possible, or is probable butcannot be estimated, or if an exposure to loss exists in excess of the amountaccrued.  Loss contingencies consideredremote are generally not disclosed unless they arise from guarantees, in whichcase the guarantees would be disclosed. Determining the likelihood of incurring a liability and estimating theamount of the liability involves an exercise of judgment.  If the outcome of the litigation is moreadverse to us than management currently expects, then we may have to recordadditional charges in the future.  SeeNote 19 to our Consolidated Financial Statements for details on commitments andcontingencies.

 

***Stock-BasedCompensation***

 

Effective July 1,2005, we adopted the provisions of Statement of Financial Accounting Standards(“SFAS”) No. 123 (Revised 2004), “*Shared-Based Payments*”(“SFAS No. 123(R)”), and selected the modified prospective method toinitially report stock-based compensation amounts in the consolidated financialstatements.  Under the fair valuerecognition provisions of this statement, share-based compensation cost ismeasured at the grant date based on the fair value of the award and isrecognized as expense over the applicable vesting period of the stock award(generally four years) using the straight-line method.

 

  Prior to adoption of SFAS No. 123(R),we provided the disclosures required under SFAS No. 123, “*Accounting for Stock-Based Compensation*,” as amended by SFASNo. 148, “*Accounting for Stock-Based Compensation —Transition and Disclosures*.”  Under this method, we recordedcompensation expense only if the market price of the underlying stock on thedate of grant exceeded the exercise price. Previously reported amounts have not been restated.

 

***Goodwill,Long-lived Assets and Other Intangible Assets***

 

We classify ourintangible assets into three categories: (1) intangible assets withdefinite lives subject to amortization, (2) intangible assets withindefinite lives not subject to amortization, and (3) goodwill.

 

We evaluate our fixedassets and intangible assets with definite lives in accordance with SFAS No. 144,“*Accounting for the Impairment or Disposal ofLong-lived Assets,”*for impairment. Under SFAS 144, if the carrying amount of an asset or asset group (inuse or under development) is evaluated and found not to be recoverable(carrying amount exceeds the gross, undiscounted cash flows from use anddisposition), then an impairment loss must be recognized.  The impairment loss is measured as the excessof the carrying amount over the assets’ fair value.  In addition, the potential impairment offinite life intangibles is assessed whenever events or a change incircumstances indicate the carrying value may not be recoverable.

 

We test goodwill and ourintangible with indefinite lives not subject to amortization under theprovision of SFAS No. 142, “*Goodwill and Other IntangibleAssets.*” for annual impairment testing.  In addition, we consider the followingsignificant factors that could trigger an impairment review prior to annualtesting:

 

a.               asignificant underperformance relative to historical or expected projected futureoperating results;

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

c.               significantnegative industry or economic trends;

d.              asignificant decline in our stock price for a sustained period of time;

e.               ourmarket capitalization relative to net book value; and

f.                 asignificant adverse change in legal factors or in the business climate thatcould affect the value of the asset.

 

When we determine thatthe carrying value of intangible assets, long-lived assets or goodwill may notbe recoverable based upon the existence of one or more of the above indicatorsof impairment, we measure any potential impairment based on a projecteddiscounted cash flow method using a discount rate determined by our managementto be commensurate with the risk inherent in our current business model.

 

During fiscal year 2008,we determined that the carrying value of some our intangibles with definitelives might not be recoverable due to the second quarter unexpected revenuereduction and projected lower operating results from some of our software 

 

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(In thousands,except per share and percent data)

 

revenues.  Accordingly, we performed an impairmenttesting of our intangible assets related to the ClickTracks and Hot Bananaacquisitions.  As are result, we incurreda $4.1 million impairment loss.  See Note5, Intangible Assets.

 

During the fourth quarterof fiscal year 2008, we completed the annual impairment test for our goodwill,intangibles with definite lives and intangibles with indefinite lives.  We determined that the carrying amount of ourgoodwill and intangibles with indefinite lives were not impaired.

 

***Accounts andNotes Receivables Remaining from Discontinued Operations***

 

At June 30, 2008, wehave a remaining $233 in the accounts and notes receivables from discontinuedoperations, primarily consist of outstanding trade accounts receivable andMedicare related receivables, prior to the disposition of NovaCare’s healthcareoperating segments in 1999.  We havereserved these receivables at 100% to reduce these assets to their netrealizable value of zero as we believe that we are not likely to collect any ofthese amounts.  Adjustments to reservesare charged or credited to gain (loss) on discontinued operations, net oftax.  We received $125 payments for thefiscal year ended June 30, 2008. Refer to Note 12, Discontinued Operations

 

***AccruedExpenses Remaining from Discontinued Operations***

 

At June 30, 2008, wehave a remaining $471 in the accrued expenses from discontinued operationsprimarily consist of liabilities which arose prior to or as a result of thedisposition transactions. These liabilities include workers compensation,uninsured professional liability claims and credit and collection expenses. Weadjust these accrual amounts based on current information available tomanagement and these adjustments are charged or credited to gain (loss) ondiscontinued operations, net of tax. Refer to Note 12, Discontinued Operations.

 

***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 determinethe fair value of the non-compete agreements, customer relationships anddeveloped technology includes the use of estimates including: the potentialimpact on operating results if the non-compete agreements were not in place;revenue estimates for customers acquired through the acquisition based on anassumed customer attrition rate; estimated costs to be incurred to purchase thecapabilities gained through the developed technology model; and appropriatediscount rates based on the particular business’s weighted average cost of capital.  Our estimates of an entity’s growth and costsare based on historical data, various internal estimates and a variety ofexternal sources, and are developed as part of our planning process.  Refer to Note 4, Acquisitions.

 

***Income Taxes***

 

We account for incometaxes under the provisions of SFAS No. 109,*“Accounting for Income Taxes.” *Under this method, deferred taxassets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases.  Deferred tax assets, including tax loss andcredit carryforwards, and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled.  The effect on deferred tax assets andliabilities of a change in tax rates is recognized in income in the period thatincludes the enactment date.  Deferredincome tax expense represents the change during the period in the deferred taxassets and deferred tax liabilities.  Thecomponents of the deferred tax assets and liabilities are individuallyclassified as current and non-current based on their characteristics.  Deferred tax assets are reduced by avaluation allowance when, in the opinion of management, it is more likely thannot that some portion or all of the deferred tax assets will not be realized

 

We utilize certain taxstrategies to lower taxable income.  We believe that we will be able toestablish with state tax authorities that we are entitled to all or most of thebenefits from these strategies.  However, these tax strategies are subjectto certain assumptions and interpretations of the relevant legislation andjudicial history that may or may not be accepted by the tax authorities. Based on our assessment on any challenges from state tax authorities, werecognize a liability on uncertain tax positions.

 

On July 1, 2007, weadopted the provisions of FASB Interpretation No. 48, “*Accounting for Uncertainty in Income Taxes,*” (FIN 48).  FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, “*Accountingfor Income Taxes*,” (SFAS 109).  FIN 48 prescribes a recognition thresholdand measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a taxreturn.  Interpretation No. 48 alsoprovides guidance on derecognition, classification, interest and penalties,accounting in interim 

 

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periods, disclosure andtransition.  In addition, FIN 48prescribes a two-step process to determine the amount of tax benefit to berecognized.  First, the tax position mustbe evaluated to determine the likelihood that it will be sustained uponexternal examination. If the tax position is deemed “more-likely-than-not” tobe sustained, the tax position is then assessed to determine the amount ofbenefit to recognize in the financial statements.  The amount of the benefit that may berecognized is the largest amount that has a greater than 50% likelihood ofbeing realized upon ultimate settlement. Refer to Note 14, Income Taxes.

 

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

 

Basic net income (loss)per share is computed by dividing net income by the weighted average number ofcommon shares outstanding during the reporting period.  Diluted net income (loss) per share iscomputed similarly to basic net income per share except that it includes thepotential dilution that could occur if dilutive securities were exercised.

 

***New AccountingPronouncements***

 

 In December 2007, the FASB issued SFAS No. 141(Revised 2007) (SFAS 141R), “*BusinessCombinations*,” which replaces SFAS 141, “*Business Combinations*.” The new Statement will significantly change the accounting for businesscombinations and will impact financial statements both on the acquisition dateand in subsequent periods.  Under SFAS141R, an acquiring entity will be required to recognize the assets acquired,the liabilities assumed, and any noncontrolling interest in the acquireemeasured at their fair values as of the acquisition date, with limitedexceptions.  SFAS 141R also includes asubstantial number of new disclosure requirements.  SFAS 141R applies *prospectively* to business combinations for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008.  We are currently evaluating the potentialimpact that the provisions of SFAS 141R may have on our consolidated financialstatements.

 

In December 2007,the FASB issued SFAS No. 160 (SFAS 160),*Noncontrolling Interests in Consolidated Financial Statements—An Amendment ofARB No. 51. *The newStatement establishes new accounting and reporting standards for thenoncontrolling interest in a subsidiary and for the deconsolidation of asubsidiary.  Among other matters, it alsorequires the recognition of a noncontrolling interest (sometimes called “minorityinterest”) as equity in the consolidated financial statements and separate fromthe parent’s equity.  The amount of netincome attributable to the noncontrolling interest will be included inconsolidated net income on the face of the income statement.  SFAS 160 is effective for fiscal years, andinterim periods within those fiscal years, beginning on or after December 15,2008.  We are currently evaluating thepotential impact that the provisions of SFAS 160 may have on our consolidatedfinancial statements.

 

In February 2007,the FASB issued SFAS No. 159, “*The FairValue Option for Financial Assets & Financial Liabilities — Includingan Amendment of SFAS No. 115,”* (SFAS 159). SFAS 159 permitscompanies to choose to measure certain financial instruments and other items atfair value. The standard requires that unrealized gains and losses are reportedin earnings for items measured using the fair value option.  SFAS 159 will become effective for fiscalyears beginning after November 15, 2007. We are currently evaluating the potential impact that the provisions ofSFAS 159 may have on our consolidated financial statements.

 

In September 2006,the FASB issued SFAS No. 157,*FairValue Measurements*, which defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. This statement does notrequire any new fair value measurements, but provides guidance on how tomeasure fair value by providing a fair value hierarchy used to classify the sourceof the information. In February 2008, the FASB issued FASB Staff Position(“FSP”) 157-2,*  Effective Date of FASB Statement No. 157,*  which delays the effective date of SFAS No. 157for all nonfinancial assets and nonfinancial liabilities, except for items thatare recognized or disclosed at fair value in the financial statements on arecurring basis (at least annually). SFAS No. 157 is effective for us beginning July 1, 2008;  However, FSP 157-2 delays the effective datefor certain items to July 1, 2009.  Weare currently evaluating the potential impact that the provisions of SFAS 157may have on our consolidated financial statements.

 

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 Act stipulates that public companiesmust take responsibility for maintaining an effective system of internalcontrol.  The Sarbanes-Oxley Act requires public companies to report onthe effectiveness of their control over financial reporting and obtain anattestation report from their independent registered public accounting firmabout management’s report.  The Securities and Exchange Commission (the “SEC”)has extended the compliance date for non-accelerated filers to include a reporton effectiveness of controls over financial reporting to the year ending on orafter December 15, 2007, and has extended the date by whichnon-accelerated filers must file an auditor’s attestation report on internalcontrols over financial reporting in their annual reports until the firstannual report for a fiscal year ending on or after December 15,2009.  We currently are a smaller reporting company (and thus, anon-accelerated filer) and we expect to be able to comply with these filingrequirements.

 

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**3.**                   **Restricted Cash**

 

Our restricted cashbalances consist of the following:

 

| ** **                                                                | ** ** | **As of June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(In thousands)**                                                   | ** ** | **2008**                          | ** ** | **2007** | ** ** |
| Cash balance in  support of self-insured workers compensation liabilities |       | $                                 | —     |   | $ | 200 |   |
| Certificate of  deposit in support of operating lease agreement           |       | —                            |       | 96 |   |
|                                                                           |            |                                   |            |  |  |  |  |

 

At June 30, 2008, wehad no restricted cash.  The change inthe restricted cash balance represents $200 of restricted cash associated withour discontinued operations, in support of workers’ compensation liabilities,was returned to us in October 2007. The cash deposit was replaced by an irrevocable letter of credit withComerica Bank (“Comerica” or the “Bank”).

 

The certificate ofdeposit was required by the terms of the lease for the headquarters ofEmailLabs.  The lease ended and therestricted cash was returned to us in April 2008.

 

**4.****                   Acquisitions**

 

The agreements that weused to acquire the Lyris Technologies; EmailLabs; ClickTracks; and Hot Bananaincluded provisions for the payment of contingent consideration subject to eachbusiness achieving specified revenue targets (revenue-based earnoutagreements).

 

***2005Acquisitions***

 

***Lyris Technologies Acquisition***. On May 12, 2005, we acquired all of the outstanding capital stock of LyrisTechnologies for $30.7 million, which included cash payments of $25,100(including acquisition costs and working capital adjustments of $1,200) and$5,600 in the form of a promissory note payable, subject to Lyris Technologiesachieving specified revenue, on May 12, 2007, with interest accruing at10% per annum and due at the maturity date.  The specified revenue targetsstated in the promissory note were attained.  As of March 31, 2007,principal on the promissory note had been reduced to approximately $5,400 andthe note was amended and restated (“Amended and Restated Note” to require thefollowing payments (constituting both principal and interest): (a) $1,000due May 12, 2007; (b) $1,500 due February 12, 2008; and (c) $4,700due November 12, 2008.  We paid the $1,000 on May 14, 2007.

 

On January 23, 2008,LDN Stuyvie Partnership (“LDN Stuyvie”), which is controlled by thenon-executive chairman of our board of directors (the “Board of Directors”),William T. Comfort III, purchased the Amended and Restated Note from the Trustfrom the sellers of Lyris Technologies, at a discount of 10% for a totalpurchase price of $5,200.  On February 12, 2008, the Amended andRestated Note was amended to extend the due date of the next payment thereunderto November 12, 2008, the maturity date of the Amended and Restated Note.

 

On March 5, 2008, weentered into a Subscription Agreement (the “LDN Stuyvie Subscription Agreement”)with LDN Stuyvie. Pursuant to the LDN Stuyvie Subscription Agreement, LDNStuyvie purchased 6,520,374 shares of our common stock at a purchase price of$1.05 per share or $6,800  in theaggregate. The aggregate purchase price was satisfied by LDN Stuyvie asfollows: (a) payment of $1,000 in cash, and (b) termination of ourobligations under the Amended and Restated Note.

 

***EmailLabs Acquisition*.** On October 11, 2005, we acquired all of the outstanding capital stock ofEmailLabs for $24,500 (including acquisition costs and working capitaladjustments of $612).  The acquisition of EmailLabs also called for twocontingent payments of $1,700 each subject to EmailLabs achieving specifiedrevenue targets by the first and second anniversary of the closing date. Additionally, $500 was held back from the former stockholders of EmailLabssubject to EmailLabs meeting specified working capital requirements.  Wemade the first $1,700 payment to the former EmailLabs’ stockholders on October 13,2006, and we made the second $1,700 payment to the former EmailLabs’stockholders on October 11, 2007.  The $500 holdback and the workingcapital adjustment were paid in January 2006.  The former stockholders of EmailLabs alsoreceived the proceeds of tax refunds related to the period prior to the closingdate.  These refunds were paid in September 2006.

 

***2006Acquisitions***

 

***ClickTracks Acquisition***.  On August 18,2006, we acquired all of the outstanding capital stock of ClickTracks forapproximately $8,500 in cash, $2,800 of our common stock (2,799,636 shares)issued to certain security holders of ClickTracks and 

 

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NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

$337 of acquisitioncosts.  The acquisition originally called for additional contingentpayments totaling approximately $3,800 in the event ClickTracks achieved futurerevenue targets.  Pursuant to ouragreements with John Marshall, dated March 13, 2007, and June 8,2007, respectively, Mr. Marshall (acting in his capacity as therepresentative of the former stockholders of ClickTracks) acknowledged andagreed that the initial targets would not be met and waived all rights to anyfuture payments under the purchase agreement.

 

***Hot Banana Acquisition*.** On August 18, 2006, we also acquired all of the outstanding capital stockof Hot Banana for approximately $1,900 Canadian ($1,800 U.S. based on thethen-applicable exchange rate), with additional installments of up to $750Canadian if Hot Banana achieves specified revenue and technology integrationtargets, and up to an additional $500 Canadian payable subject to workingcapital and other adjustments.  In March 2007, we paid $94 Canadian($81 U.S.) for the first phase of the technology integration, in addition to$336 Canadian ($299 U.S.) for the working capital adjustment in April 2007.  Additionally, we paid $94 Canadian ($86 U.S.)for the second phase of the technology integration in May 2007.

 

On October 4, 2007,we paid $375 Canadian ($377 U.S.) to the former owners of Hot Banana for thefirst installment of the revenue earnouts.

 

**5.****              Intangible Assets**

 

The components ofintangible assets are consists of the following:

 

| ** **                                    | ** ** | **As of June 30,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|
| **(in thousands)**                       | ** ** | **2008**                          | ** ** | **2007** | ** ** |
| Depreciable  intangibles:                     |       |                              |       |   |   |
| Customer  relationships                       |       | $                                 | 9,536      |   | $ | 9,512 |   |
| Developed  technology                         |       | 12,041                            |       | 12,008 |   |
| Tradenames                                    |       | 1,498                             |       | — |   |
|                                          |       | 23,075                            |       | 21,520 |   |
| Less:  accumulated amortization               |       | (10,664                           | )          | (6,880 | ) |
| Less: impairment                              |       | (4,086                            | )          | — |   |
|                                          |       | 8,325                             |       | 14,640 |   |
| Non-depreciable  intangibles:                 |       |                              |       |   |   |
| Trade names                                   |       | 6,289                             |       | 7,774 |   |
| Total intangible  assets, net of amortization |       | $                                 | 14,614     |   | $ | 22,414 |   |

 

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(In thousands,except per share and percent data)

 

Thefollowing table outlines our intangible assets, by acquisition, as of June 30,2008:

 

| **(in thousands)**                         | ** ** | **Gross amount** | ** ** | **Accumulated  amortization** | ** ** | **Impairment** | ** ** | **Balance at  June 30,  2008** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|-------------------------------|------------|----------------|------------|------------------------------------------|------------|
| Lyris  Technologies:                            |       |                  |       |                          |       |           |       |                                     |       |
| Customer  relationships                         |       | $                     | 4,113      |                          | $          | (2,244         | )          | $                                        | —     |   | $ | 1,869 |   |
| Developed  technology                           |       | 4,078                 |       | (2,563                        | )          | —         |       | 1,515                                    |       |
| Tradenames                                      |       | 4,720                 |       | —                        |       | —         |       | 4,720                                    |       |
| Subtotal                                        |       | 12,911                |       | (4,807                        | )          | —         |       | 8,104                                    |       |
|                                            |       |                  |       |                          |       |           |       |                                     |       |
| EmailLabs:                                      |       |                  |       |                          |       |           |       |                                     |       |
| Customer  relationships                         |       | 3,260                 |       | (1,776                        | )          | —         |       | 1,484                                    |       |
| Developed  technology                           |       | 4,080                 |       | (2,222                        | )          | —         |       | 1,858                                    |       |
| Tradenames                                      |       | 1,569                 |       | —                        |       | —         |       | 1,569                                    |       |
| Subtotal                                        |       | 8,909                 |       | (3,998                        | )          | —         |       | 4,911                                    |       |
|                                            |       |                  |       |                          |       |           |       |                                     |       |
| ClickTracks:                                    |       |                  |       |                          |       |           |       |                                     |       |
| Customer  relationships                         |       | 1,600                 |       | (520                          | )          | (520           | )          | 560                                      |       |
| Developed  technology                           |       | 3,100                 |       | (960                          | )          | (1,598         | )          | 542                                      |       |
| Tradenames                                      |       | 1,200                 |       | (19                           | )          | (1,050         | )          | 131                                      |       |
| Subtotal                                        |       | 5,900                 |       | (1,499                        | )          | (3,168         | )          | 1,233                                    |       |
|                                            |       |                  |       |                          |       |           |       |                                     |       |
| Hot Banana:                                     |       |                  |       |                          |       |           |       |                                     |       |
| Customer  relationships                         |       | 510                   |       | (128                          | )          | (207           | )          | 175                                      |       |
| Developed  technology                           |       | 710                   |       | (234                          | )          | (308           | )          | 168                                      |       |
| Tradenames                                      |       | 270                   |       | (5                            | )          | (230           | )          | 35                                       |       |
| Cumulative  foreign currency translation effect |       | 154                   |       | 7                             |       | (173           | )          | (12                                      | )          |
| Subtotal                                        |       | 1,644                 |       | (360                          | )          | (918           | )          | 366                                      |       |
|                                            |       |                  |       |                          |       |           |       |                                     |       |
| Total of all  acquired intangibles              |       | $                     | 29,364     |                          | $          | (10,664        | )          | $                                        | (4,086     | ) | $ | 14,614 |   |

 

Total amortization andimpairment expense for the fiscal years ended June 30, 2008, 2007 and 2006was $7,890, $4,042 and $2,627, respectively. For fiscal years ended June 30, 2008, 2007 and 2006, amortizationand impairment expense of developed technology, classified as cost of revenuewas $4,148, $2,301 and $1,410, respectively.

 

Customerrelationship-based intangible assets have a weighted average amortizationperiod of 5.44 years and developed technology-based intangible assets have aweighted average amortization period of 4.6 years.

 

The estimated futureamortization expense related to intangible assets, assuming no futureimpairment of the underlying assets as of June 30, 2008, is as follows:

 
| **(in thousands)  Fiscal Year** | ** ** | **Customer  Relationships** | ** ** | **Developed  Technology** | ** ** | **Tradenames** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|---------------------------|------------|----------------|------------|-----------|------------|
| 2009                                      |       | $                           | 1,511      |                      | $          | 1,917          |       | $         | 47         |   | $ | 3,475 |   |
| 2010                                      |       | 1,511                       |       | 1,792                     |       | 47             |       | 3,350     |       |
| 2011                                      |       | 958                         |       | 367                       |       | 47             |       | 1,372     |       |
| 2012                                      |       | 104                         |       | —                    |       | 24             |       | 128       |       |
| Total                                     |       | $                           | 4,084      |                      | $          | 4,076          |       | $         | 165        |   | $ | 8,325 |   |

 

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NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

The rollforward of theintangible assets for June 30, 2007, through June 30, 2008, is asfollows:

 

| ** **                                                         | ** ** | **Amount**              | ** ** |
|--------------------------------------------------------------------|------------|-------------------------|------------|
|                                                               |       | **(in thousands)** |       |
|                                                               |       | ** **              |       |
| Beginning  balance at June 30, 2007                           |       | $                       | 22,414     |   |
| Amortization for  the twelve month period ended June 30, 2008 |       | (3,805                  | )          |
| Impairment  charge                                                 |       | (4,086                  | )          |
| Foreign currency  translation adjustment                           |       | 91                      |       |
|                                                               |       |                    |       |
| Ending balance  at June 30, 2008                              |       | $                       | 14,614     |   |

 

Foreign currencytranslation adjustment of $91 increased net intangible assets as a result ofchanges in the foreign currency exchange rate between the U.S. dollar andCanadian dollar.

 

During fiscal year 2008,we determined that the carrying value of some our intangibles with definitelives might not be recoverable due to the second quarter unexpected revenuereduction and projected lower operating results from some of our softwarerevenues.  Accordingly, we performed animpairment testing of our intangible assets related to the ClickTracks and HotBanana acquisitions.  As a result, weincurred following impairment losses:

 

| **Intangible Asset** | ** ** | **Amount**              | ** ** |
|---------------------------|------------|-------------------------|------------|
| ** **                | ** ** | **(in thousands)** | ** ** |
| Customer  relationships   |       | $                       | 786        |   |
| Developed  technology     |       | 1,983                   |       |
| Tradenames                |       | 1,317                   |       |
|                      |       |                    |       |
| Total                     |       | $                       | 4,086      |   |

 

Thefair value of the intangible assets were measured based on a projecteddiscounted cash flow method using a discount rate determined by management tobe commensurate with the risk inherent in our current business model. Theimpairment was recorded to reflect the significant decrease in revenue andprofitability due to the fact that neither ClickTracks nor Hot Banana hasgenerated the amount of revenue and profits that were anticipated at the timeof their acquisitions in August of 2006. In addition, as part of our long-term business strategy, we have alsoshifted our revenue focus from software to hosting services, resulting to anadverse effect on the revenue and profits of ClickTracks and Hot Banana.  The impairment charges are recorded as “Amortizationand impairment of developed technology” and “Amortization and impairment ofcustomer relationships and tradenames” in our Consolidated Statements ofOperations.

 

**6.****              Goodwill**

 

Goodwill is calculated asthe difference between the cost of acquisition and the fair value of the netassets acquired of any business that is acquired.  Hot Banana operates inCanada and uses the Canadian dollar as its functional currency. Consequently goodwill related to the acquisition of Hot Banana is accounted foras a Canadian dollar functional currency asset.  Each financial period,all assets, including goodwill, and liabilities of group entities with a nonU.S. dollar functional currency are translated into U.S. dollars, Lyris’reporting currency, using the closing rate method.

 

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(In thousands,except per share and percent data)

 

The following tableoutlines our goodwill, by acquisition:

 
| ** **                            | ** ** | **As of June 30,** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|
| **(in thousands)**               | ** ** | **2008**                          | ** ** | **2007** | ** ** |
|                                  |       |                              |       |   |   |
| Lyris  Technologies                   |       | $                                 | 17,491     |   | $ | 17,491 |   |
| EmailLabs                             |       | 10,680                            |       | 10,680 |   |
| ClickTracks                           |       | 5,891                             |       | 5,891 |   |
| Hot Banana                            |       | 1,862                             |       | 1,959 |   |
|                                  |       |                              |       |   |   |
| Ending balance  at June 30, 2008 |       | $                                 | 35,924     |   | $ | 36,021 |   |

 

The roll-forward ofgoodwill for June 30, 2007, through June 30, 2008, is as follows:

 
| ** **                               | ** ** | **Amount**              | ** ** |
|------------------------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **(in thousands)** | ** ** |
| Beginning  balance at June 30, 2007 |       | $                       | 36,021     |   |
| Reversal of Hot  Banana revenue earnouts |       | (162                    | )(1)       |
| Foreign currency  translation adjustment |       | 65                      |       |
|                                     |       |                    |       |
| Ending balance  at June 30, 2008    |       | $                       | 35,924     |   |

----

(1)** **Under the Hot Banana acquisitionagreement dated August 16, 2006, Hot Banana is subject to a contingentconsideration payment  provision that isbased on achieving a specified revenue target (revenue-based earnoutagreements) in order to received payment. For the fiscal year ended June 30, 2008, Hot Banana did not meetthe specified revenue target of $1,800. Accordingly, we reversed the unpaid accrued deferred acquisitionconsideration.

 

**7.****              Property andEquipment**

 

Property and equipmentconsists of the following:

 
| ** **                      | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|---------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Computers                       |       | $          | 3,776      |       | $          | 2,912 |   |
| Furniture and  fixtures         |       | 553        |       | 264        |       |
| Leasehold  improvements         |       | 663        |       | 52         |       |
| Software                        |       | 110        |       | 357        |       |
| Other equipment                 |       | 360        |       | 135        |       |
|                            |       | 5,462      |       | 3,720      |       |
| Less:  accumulated depreciation |       | (2,136     | )          | (1,268     | )          |
| Property and  equipment, net    |       | $          | 3,326      |       | $          | 2,452 |   |

 

Depreciation expense forthe Fiscal 2008, 2007 and 2006 was approximately $1,005, $807 and $417,respectively.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

**8.****              Operating Leases**

 

We have variousnon-cancelable operating leases for office space that expire at various timesthrough 2013.

 
| **Fiscal Year Ended June 30,** | ** ** | **Amount**              | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **(in thousands)** | ** ** |
| 2009                                               |       | $                       | 927        |   |
| 2010                                               |       | 679                     |       |
| 2011                                               |       | 454                     |       |
| 2012                                               |       | 468                     |       |
| 2013                                               |       | 118                     |       |
| Total                                              |       | $                       | 2,646      |   |

 

Total rent expensecharged to operations was approximately $1,076, $967, and $662 in fiscal 2008,2007 and 2006, respectively.

 

**9.****              Note Payable**

 

Commodore Resources(Nevada), Inc. (“Commodore”), one of our wholly-owned subsidiaries,executed a promissory note in favor of The John Buckman and Jan Hanford Trust(the “Trust”) in the amount of $5,600 as part of the acquisition of LyrisTechnologies on May 12, 2005.  Thenote bore interest at the rate of 10% per annum.  The note and accrued interest were to becomedue on May 12, 2007, subject to the satisfaction of the followingconditions:

 

·                     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 $24,000.  The total revenue of Lyris Technologies forthe twenty-four month period ended March 31, 2007 was approximately$36,300, which exceeds the specified revenue target of $24,000 as stated in thenote;

 

·                     The amountsdue on the note are reduced by certain royalty payments that we are required tomake.  During fiscal years 2006 and 2007,we made $204 and $95 royalty payments, respectively.

 

On March 31,2007, we executed the Amended and Restated Note, effective as of May 12,2005, in the principal amount of $5,600 (the “Amended and Restated Note”)payable to the Trust.  Under the terms of the Amended and Restated Note,the maturity of the obligation was extended to November 12, 2008, and webecame obligated to make the following payments (constituting both principaland interest, in accordance with the terms of the Amended and Restated  Note) to the Trust: (a) $1,000 due May 12,2007; (b) $1,500 due February 12, 2008; (c) $4,700 due November 12,2008.  We paid $1,000 to the Trust on May 14,2007.

 

On January 23,2008, LDN Stuyvie Partnership (“LDN Stuyvie”), which is controlled by thenon-executive chairman of our board of directors, William T. Comfort III,purchased the Amended and Restated Note from the Trust at a discount of 10% fora total purchase price of $5,200.  On February 12,2008, the Amended and Restated Note was amended to extend the due date of thenext payment thereunder to November 12, 2008, the maturity date of theAmended and Restated Note.

 

On March 5,2008, we entered into a Subscription Agreement (the “LDN Stuyvie SubscriptionAgreement”) with LDN Stuyvie. Pursuant to the LDN Stuyvie SubscriptionAgreement, LDN Stuyvie purchased 6,520,374 shares of our common stock at apurchase price of $1.05 per share or $6,846,392.37 in the aggregate. Theaggregate purchase price was satisfied by LDN Stuyvie as follows: (1) paymentof $1,000 in cash; and (2) termination of our obligations under theAmended and Restated Note.

 

We recorded a net gain of$919 as gain on debt extinguishment in the consolidated statement of operationsto the extent the carrying value of our obligations under the Amended andRestated Note exceeded the fair value of common stock issued to LDN Stuyvie.  During the fiscal year ended June 30,2008, we expensed $367 of interest on the Amended and Restated Note in theconsolidated statement of operations.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

**10.****       Convertible Bridge Loan,Rights Offering**

 

The ClickTracks and HotBanana acquisitions were financed primarily with a $10,000 bridge loan made byour largest stockholder, LDN Stuyvie Partnership.  LDN Stuyvie iscontrolled by the Company’s Chairman, William T. Comfort III.  The bridgeloan from LDN Stuyvie was evidenced by a promissory note (the “LDN Stuyvie Note”)bearing interest at the rate of 9.5% per annum, or 11.5% per annum.

 

On January 31, 2007,the LDN Stuyvie Note became due and payable and, in accordance with its terms,the Company issued to LDN Stuyvie a total of 12,279,130 shares of common stockas payment in full of the principal and accrued interest on the LDN StuyvieNote.  In accordance with the terms ofthe LDN Stuyvie Note, the common stock was valued at $0.85 per share for anaggregate price of $10,437, representing $10,000for the principal and $437 forthe accrued interest under the LDN Stuyvie Note.  The shares of commonstock were issued in a private placement in reliance on Rule 506 under theSecurities Act of 1933.

 

In connection with theLDN Stuyvie Note, the Company and LDN Stuyvie entered into a backstopagreement, pursuant to which LDN Stuyvie agreed to purchase an amount of theCompany’s common stock at $0.85 per share so that, together with all shares ofcommon stock sold by the Company in a proposed rights offering at the sameprice, the Company would receive at least $10,000 in proceeds (the “BackstopAgreement”).  Also, pursuant to theBackstop Agreement, the Company granted to LDN Stuyvie the exclusive right topurchase up to an additional $10,000 of common stock at a price of $0.85 pershare in respect of each right granted to the Company’s stockholders pursuantto the proposed rights offering which remained unexercised.

 

The conversion price of$0.85 per common share contained a beneficial conversion feature of $0.11 pershare to the August 16, 2006 closing price of $0.96.  The aggregateamount of this beneficial conversion feature was approximately $1,294 and thisamount was fully amortized though interest expense during fiscal year2007.  A corresponding amount was credited to stockholders’ additionalpaid in capital.

 

On February 5, 2007,the Company issued a press release announcing repayment of the LDN StuyvieNote, termination of the Backstop Agreement in accordance with its terms andcancellation of the previously announced rights offering.

 

**11.****       Revolving Line of Credit**

 

On October 11, 2005,we entered into a Loan and Security Agreement with Comerica, (the “Loan andSecurity Agreement”), an asset-based revolving line of credit.  Theinitial borrowings under the Loan and Security Agreement were used toconsummate the acquisition of EmailLabs and for general corporatepurposes.  Under the original Loan and Security Agreement, interest onoutstanding balances was charged at a floating rate equal to Comerica’s baserate plus 0.75% or Comerica’s LIBOR rate plus 3.75%.  The original amount available to us was$18,500 and that amount was reduced monthly beginning October 31,2005.  Monthly reductions were $250 through September 30, 2007 and$347, thereafter through the maturity date.  In addition, the Loan andSecurity Agreement contains certain financial covenants and requires us tomaintain certain financial ratios.  Failure to meet these financialcovenants and ratios constitute an event of default.

 

From April 2006through January 2007, we entered into four amendments to the Security andLoan Agreement.  These amendmentsadjusted Comerica’s lending commitment, adjusted the rate at which outstandingborrowings bear interest and revised existing financial and other covenants.

 

Effective as of March 31,2007, we entered into a Fifth Amendment to the Loan and Security Agreement (the“Fifth Amendment”) with Comerica.  TheFifth Amendment increased the amounts available under the revolving line ofcredit to fifteen million dollars ($15,000), extended the term to five yearsfrom the date of the Fifth Amendment and provided that the amounts availableunder the line are reduced in equal monthly installments of $208.  The Amendment modified the definition ofEBITDA to allow for adjustments related to discontinued operations, subject tocertain limitations, and also modified the financial covenants.

 

On March 6,2008, we entered into an Amended and Restated Loan and Security Agreement (the “NewCredit Agreement”) with Comerica.  TheNew Credit Agreement amends and restates in its entirety the Loan and SecurityAgreement. The Bank’s commitment and interest rate under the New CreditAgreement are essentially unchanged.  Therevolving line of credit is in the amount of approximately $12,700 as of  March 6, 2008, which is reduced on thelast day of each of the following months as follows: (i) $208 per monthfor each month from April 2008 through July 2008, (ii) $312 for December 2008,(iii) $417 per month for each month from January 2009 through March 2009,(iv) $312 for April 2009, and (v) $208  per month for each month from May 2009through March 31, 2012, the maturity date. The New Credit Agreement contains certain financial covenants andrequires us to maintain certain financial ratios.  Failure to meet thesefinancial covenants and ratios constitutes an event of default.  Thecommitment is secured by essentially all of the assets of the Company and itssubsidiaries including intellectual property.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

The financialcovenant requirements, measured on a monthly basis, are as follows: (a) fixedcharge coverage of at least 1.25 to 1.00 (except for the period September 1,2008, to November 3, 2008, when it is 1:15:1.00), calculated as the ratioof annualized rolling three-month EBITDA minus cash taxes and capitalizedexpenditures to the sum of cash interest expense plus the current portion ofall indebtedness to Comerica; (b) minimum EBITDA, on a rolling three-monthbasis, of at least (i) $800 for the three-month period ended March 31,2008,  (ii) $0 for the three-monthperiod ending June 30, 2008 (iii) $250 for the three months ending September 30,2008, (iv) $1,500 for each three-month period ending December 31,2008 through February 28, 2009 and (v) $2,000 for the three monthperiod ending March 1, 2009 and thereafter; (c) ratio of senior debtto EBITDA, calculated on an annualized rolling three-month basis, of notgreater than: (i) 2.50 to 1.00 for the measuring periods through June 30,2008, (ii) 3.25:1.00 for the measuring periods July 1, 2008 to November 30,2008 and (iii) 2.00 to 1.00 at all times thereafter; (d) Liquidity,defined as cash held at Comerica plus availability under the revolving line, ofnot less than (i) $500 for the measuring periods ended March 31,2008, and (ii) $250 for the measuring periods April 1, 2008 through June 30,2008.

 

The New Credit Agreementcontains customary events of default provisions giving the Bank the right todemand immediate payment of all principal, interest and other obligationsoutstanding thereunder in the event of certain occurrences, and typicalnegative covenants preventing or restricting our ability to take certainactions, including, without limitation, changing our principal executiveoffices, changing our names, disposing of property or other assets, andincurring additional indebtedness.

 

As of June 30, 2008,we have $11.9 million revolving line of credit facility, less $9.9 millionoutstanding balance, and $240 used for letters of credit.  Accordingly, the availability under thisrevolving line of credit was $1.7 million at the end of fiscal year 2008.

 

**The aggregate maturities of line of credit by fiscal year as of June 30,2008 are as follows:**

 
| **Fiscal Year Ended June 30,** | ** ** | **Amount**              | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **(in thousands)** | ** ** |
| ** **                                         | ** ** | ** **              | ** ** |
| 2009                                               |       | $                       | 555        |   |
| 2010                                               |       | 2,500                   |       |
| 2011                                               |       | 2,500                   |       |
| 2012                                               |       | 4,375                   |       |
| Total                                              |       | $                       | 9,930      |   |

 

On July 30, 2008, weentered into First Amendment to Amended and Restated Loan Security Agreementwith Comerica Bank.

 

During the course of theCompany’s year-end audit, our independent auditors requested and we agreed tomake certain accounting entries to reverse a previously recognized softwarelicense sale of approximately $73 thousand. The effect was to reduce our EBITDA to a negative $-478 thousand whichwas below the amount required by the financial covenant with Comerica, for thequarterly measurement period ending June 30, 2008.  On September 12, 2008, we obtained awaiver for this quarterly measurement period requirement.  Refer to Note 21, Subsequent Events relatedto our revolving line of credit with Comerica.

 

**12.****       Discontinued Operations**

 

We maintain allowancesfor the collection of receivables remaining from discontinued healthcareoperations.  These allowances are theresult of the inability of unwillingness of many of the former healthcarecustomers to make payments.

 

Results for discontinuedoperations consist of gains or losses as a result of adjustments to the$374,100 loss on disposal of discontinued operations which was originallyrecorded in fiscal year 2000. Gains primarily include amounts received inexcess of book value for trade accounts receivable and Medicare relatedindemnification receivables that were owed to us prior to the disposition ofour long-term care services business in 1999. Losses primarily include expensesincurred or adjustments to liabilities which were owed by us prior to thedisposition of our long-term care services business in fiscal year 2000.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

The remaining assets andliabilities from discontinued operations consisted of the following:

 
| ** **                                                              | ** ** | **As of June 30,** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                              | ** ** | **2008**                          | ** ** | **2007** | ** ** |
|                                                                    |       |                              |       |   |   |
| Restricted cash  in support of workers’ compensation liabilities   |       | $                                 | —     |   | $ | 200 |   |
| Prepaid expenses  pertaining to insurance deposits                      |       | 6                                 |       | 6 |   |
| Accounts  receivable remaining from discontinued operations             |       | 233                               |       | 583 |   |
| Allowance for  doubtful accounts remaining from discontinued operations |       | (233                              | )          | (583 | ) |
| Total assets  related to discontinued operations                        |       | $                                 | 6          |   | $ | 206 |   |
|                                                                    |       |                              |       |   |   |
| Accrued expenses  remaining from discontinued operations                |       | $                                 | 471        |   | $ | 722 |   |
| Total  liabilities related to discontinued operations                   |       | $                                 | 471        |   | $ | 722 |   |

 

As of June 30, 2008,we believe that more likely than not these receivables are uncollectible.  Thus, we have fully reserved thesereceivables to reduce their net realizable value to zero.  If any of these receivables are collected, wewill record a gain in the period of collection.

 

The change in therestricted cash balance represents $200 of restricted cash that was returned tous in October 2007.  The cashdeposit was replaced by an irrevocable letter of credit with Comerica.

 

The accrued expensesremaining from discontinued operations primarily consist of liabilities, whicharose prior to or as a result of the disposition transactions. Theseliabilities include costs for litigation, workers’ compensation claims,professional liability claims and other liabilities.

 

We accrue an estimate ofthe legal costs necessary to defend ourselves against legal claims related toour discontinued operations. The costs of litigation are difficult to estimatebecause of the high variability of possible outcomes. As a result, the actualcosts could differ significantly from these estimates.

 

For fiscal years 2008,2007 and 2006, gain on disposal of discontinued operations, net of taxes,was  $29, $1,670 and $407.  The $29 gain recorded in fiscal year 2008consist primarily of, approximately  $143collection of accounts receivable that was previously written off by us offsetby additional expenses of approximately $114, primarily related to litigationcosts and legacy insurance expenses.

 

**13.****       Accounts Payable andAccrued Expenses**

 

Accounts payable andaccrued expenses are summarized as follows:

 
| ** **                         | ** ** | **June 30,** | ** ** |
|------------------------------------|------------|-------------------|------------|
| ** **                         | ** ** | **2008**          | ** ** | **2007** | ** ** |
| Accounts payable                   |       | $                 | 748        |   | $ | 1,217 |   |
| Accrued  compensation and benefits |       | 1,192             |       | 1,087 |   |
| Accrued other                      |       | 782               |       | 276 |   |
|                               |       |              |       |   |   |
|                               |       | $                 | 2,722      |   | $ | 2,580 |   |

 

As of June 30, 2008, $506 increase in accrued other representsincreases in accrued marketing  and othermiscellaneous costs, offset by decreases in deferred rent and accrued taxespayable.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

**14. Income Taxes**

 

The components of theprovision for income taxes were as follows:

 
| ** **                  | ** ** | **Year Ended June 30,** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|
| ** **                  | ** ** | **2008**                               | ** ** | **2007** | ** ** | **2006** | ** ** |
| Current:                    | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal                     |       | $                                      | 118        |   | $ | 119 |   | $ | 121 |   |
| State                       |       | 320                                    |       | 525 |   | 740 |   |
|                        |       | 438                                    |       | 644 |   | 861 |   |
| Deferred:                   | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal                     |       | —                                 |       | — |   | 15 |   |
| State                       |       | 2                                      |       | (100 | ) | (49 | ) |
|                        |       | 2                                      |       | (100 | ) | (34 | ) |
|                        |       |                                   |       |   |   |   |   |
| Total income tax  provision |       | $                                      | 440        |   | $ | 544 |   | $ | 827 |   |

 

The components of netdeferred tax assets (liabilities) were as follows:

 
| ** **                                                       | ** ** | **As of June 30,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                       | ** ** | **2008**                          | ** ** | **2007** | ** ** |
| Accruals and  reserves not currently deductible for tax purposes |       | $                                 | 3,378      |   | $ | 3,426 |   |
| Net operating  loss, capital loss and tax credit carryforwards   |       | 63,418                            |       | 69,544 |   |
| Gross deferred  tax assets                                       |       | 66,796                            |       | 72,970 |   |
| Valuation  allowance                                             |       | (66,177                           | )          | (72,390 | ) |
| Net deferred tax  asset                                          |       | $                                 | 619        |   | $ | 580 |   |

 

Deferred income taxbalances reflect the effects of temporary differences between the carryingamounts of assets and liabilities and their tax basis and are stated at enactedtax rates expected to be in effect when taxes are actually paid or recovered,in addition to, estimated amount related to net operating loss, capital lossand tax credit carryforwards.

 

We have recorded avaluation 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.

 

We have federal netoperating loss carryforwards of approximately $168,434 to offset future taxableincome and taxable gains.  The net operating loss carryforwards start toexpire in 2019. The change in the valuation allowance was a decrease ofapproximately $6,213, and $1,700, for the fiscal year ended June 30, 2008and June 30, 2007.  The reason for this change was the utilization ofnet operating loss carryfowards, offsetting the estimated tax income ascalculated per tax purposes, If we experience a change of ownership within themeaning of Section 382 of the Internal Revenue Code of 1986, as amended,we may have limitations on our ability to realize the benefit of our netoperating loss, capital loss and tax credit carryforwards.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

The items accounting forthe difference between expected tax (benefit) computed at the federal statutoryrate of 35% and the provision of income taxes were as follows:

 
| ** **                                                           | ** ** | **Years Ended June 30,** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                | ** ** | **%** | ** ** | **2007** | ** ** | **%** | ** ** | **2006** | ** ** | **%** | ** ** |
| Expected federal  income tax expense (benefit) at the statutory rate |       | $                                       | (807       | ) | (35.0 | )% | $ | (271 | ) | (35.0 | )% | $ | 1,045 |   | 35.0 | % |
| State income  taxes, net of federal benefit                          |       | 209                                     |       | 22.6 | % | 219 |   | 28.3 | % | 341 |   | 11.4 | % |
| Utilization of  NOL carryover                                        |       | (1,514                                  | )          | (195.4 | )% | (1,905 | ) | (245.8 | )% | (1,446 | ) | (48.4 | )% |
| Amortization of  intangible assets                                   |       | 2,377                                   |       | 306.7 | % | 1,350 |   | 174.2 | % | 920 |   | 30.8 | % |
| Beneficial  conversion feature within convertible note               |       | —                                  |       | 0.0 | % | 453 |   | 58.4 | % | — |   | 0.0 | % |
| Other, net                                                           |       | 175                                     |       | 47.4 | % | 698 |   | 90.1 | % | (33 | ) | (1.1 | )% |
|                                                                 |       | $                                       | 440        |   | 146.3 | % | $ | 544 |   | 70.2 | % | $ | 827 |   | 27.7 | % |

 

The amount of incometaxes refunded during fiscal 2008, 2007 and 2006 amounted to approximately $6,$179, and $0 respectively.  The amount ofincome taxes paid during fiscal 2008, 2007 and 2006 was approximately $699,$862 and $565, respectively.

 

**Adoption of FIN 48**

 

On July 1, 2007, weadopted the provisions of FASB Interpretation No. 48, “*Accounting for Uncertainty in Income Taxes,*” (FIN 48).  FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, “*Accountingfor Income Taxes*,” (SFAS 109). FIN 48 prescribes a recognition threshold and measurement attributefor the financial statement recognition and measurement of a tax position takenor expected to be taken in a tax return. Interpretation No. 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition.  In addition,FIN 48 prescribes two-steps process to determine the amount of tax benefit tobe recognized.  First, the tax positionmust be evaluated to determine the likelihood that it will be sustained uponexternal examination. If the tax position is deemed “more-likely-than-not” tobe sustained, the tax position is then assessed to determine the amount ofbenefit to recognize in the financial statements.  The amount of the benefit that may berecognized is the largest amount that has a greater than 50% likelihood ofbeing realized upon ultimate settlement.

 

As a result ofimplementation of FIN 48, we had approximately $158 in unrecognized taxbenefits, if recognized would reduce tax expense and our effective tax rate.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

The aggregate changes inthe balance of unrecognized tax benefits were as follows:

 
| **Year Ended June 30,**               | ** ** | **2008** | ** ** |
|------------------------------------------------------|------------|----------|------------|
|                                                 |       |     |       |
| Balance,  beginning of year                          |       | 105      |       |
|                                                 |       |     |       |
| Increases for  tax positions related to prior year   |       | —   |       |
| Increases for  tax positions related to current year |       | 53       |       |
| Decreases  related to settlements                    |       | —   |       |
| Reductions due  to lapsed statute of limitations     |       | —   |       |
|                                                 |       |     |       |
| Balance, end of  year                                |       | 158      |       |

 

TheCompany recognizes interest accrued and penalties related to unrecognized taxbenefits in its income tax provision. As of June 30, 2008, the Companyaccrued no penalties and an insignificant amount of interest was recorded inincome tax expense.

 

Taxpositions for the Company and its subsidiaries are subject to income taxaudits.  Tax returns for all tax yearssince fiscal year 2005 remain open to examination by the Internal RevenueService and since 2001 for state income tax purposes.  As of June 30, 2008, there are nocurrent federal or state income tax audits in progress.  We do not believe it is reasonably possiblethat the total amount of unrecognized tax benefits will significantly increaseor decrease within the next 12 months.

 

We aresubject to income tax in some jurisdictions outside the United States, none ofwhich are individually material to our financial position, cash flows, orresult of operations.

 

**15.****       Comprehensive (Loss) Income**

 

The following table showsthe computation of comprehensive (loss) income:

 
| ** **                                | ** ** | **As of June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|
| **(in thousands)**                   | ** ** | **2008**                          | ** ** | **2007** | ** ** |
| ** **                                | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Net (loss)  income                        |       | $                                 | (5,502     | ) | $ | 351 |   |
| Other  comprehensive income:              |       |                              |       |   |   |
| Foreign currency  translation adjustments |       | 162                               |       | 228 |   |
| Total  comprehensive (loss) income        |       | $                                 | (5,340     | ) | $ | 579 |   |

 

Other comprehensiveincome is primarily related to gains and losses on the translation of foreigncurrency denominated financial statements. Adjustments resulting from these translations are accumulated andreported as a component of other comprehensive income in stockholders’ equitysection of the balance sheet.

 

**16.****       Net (Loss) Income per Share**

 

SFASNo. 128, *Earnings Per Share,*requires thepresentation of the basic net income (loss) per common share and diluted netincome (loss) per common share.  Basicnet income (loss) per common share excludes any dilutive effects of options andconvertible securities.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

The following table setsforth the computation and reconciliation of net income (loss) per share:

 
| ** **                                                                                  | ** ** | **Years Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| **(in thousands)**                                                                     | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                                  | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| (Loss) income  from continuing operations                                                   |       | $                                       | (5,531     | ) | $ | (1,319 | ) | $ | 2,159 |   |
| Gain on disposal  of discontinued operations, net of income tax benefit (expense) per share |       | 29                                      |       | 1,670 |   | 407 |   |
| Net income  (loss) per share                                                                |       | $                                       | (5,502     | ) | $ | 351 |   | $ | 2,566 |   |
|                                                                                        |       |                                    |       |   |   |   |   |
| Weighted average  shares outstanding:                                                       |       |                                    |       |   |   |   |   |
| **Basic**                                                                                   | ** ** | **98,604**                              | ** ** | **90,706** | ** ** | **83,127** | ** ** |
| Effective of  dilutive securities:                                                          |       |                                    |       |   |   |   |   |
| Stock options                                                                               |       |                                    |       | 2,198 |   | 1,359 |   |
|                                                                                        |       |                                    |       |   |   |   |   |
| **Diluted  shares**                                                                         | ** ** | **98,604**                              | ** ** | **92,904** | ** ** | **84,486** | ** ** |
|                                                                                        |       |                                    |       |   |   |   |   |
| **Basic**                                                                                   |       |                                    |       |   |   |   |   |
| (Loss) income  per share from continuing operations                                         |       | (0.06                                   | )          | (0.01 | ) | 0.03 |   |
| Gain on disposal  of discontinued operations, net of income tax benefit (expense) per share |       | 0.00                                    |       | 0.02 |   | 0.00 |   |
| Net income  (loss) per share                                                                |       | (0.06                                   | )          | 0.00 |   | 0.03 |   |
|                                                                                        |       |                                    |       |   |   |   |   |
| **Diluted**                                                                                 |       |                                    |       |   |   |   |   |
| (Loss) income  per share from continuing operations                                         |       | (0.06                                   | )          | (0.01 | ) | 0.03 |   |
| Gain on disposal  of discontinued operations, net of income tax benefit (expense) per share |       | 0.00                                    |       | 0.02 |   | 0.00 |   |
| Net income  (loss) per share                                                                |       | (0.06                                   | )          | 0.00 |   | 0.03 |   |

 

For the fiscal year endedJune 30, we incurred a $5,502 net loss, therefore, our 11,047 outstandingshares were treated as anti-dilutive shares. The dilutive loss per common share calculated for the fiscal years endedJune 30, 2007, and 2006 excludes the effect of 3,300, and 2,100 optionsoutstanding, respectively.  These amountswere excluded since their inclusion would be anti-dilutive.

 

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NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

**17.****       Stockholders’ Equity**

 

Sharesof common stock outstanding were as follows:

 
| **Year Ended June 30,**                    | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                      |       |     |       |     |       |     |       |
| Balance,  beginning of year                               |       | 98,431   |       | 83,208   |       | 82,966   |       |
| Shares issued  for exercise options                       |       | 492      |       | 144      |       | —   |       |
| Shares issued to  related party for additional investment |       | 952      |       | —   |       | —   |       |
| Shares issued  related to acquisitions                    |       | —   |       | 2,800    | (1)        | —   |       |
| Shares issued to  related party for promissory note       |       | 5,568    | (3)        | 12,279   | (2)        | —   |       |
| Shares  repurchased                                       |       | (2,226   | )(4)       | —   |       |     |       |
| Shares issued  for board members services                 |       | —   |       | —   |       | 121      |       |
| Shares purchased  by a board member                       |       | —   |       | —   |       | 121      |       |
|                                                      |       | 103,217  |       | 98,431   |       | 83,208   |       |

 

----

(1)On August 18, 2006, we acquired all of the outstanding capital stock ofClickTracks.  Refer to Note 4.

(2)On February 1, 2007, we issued stocks to LDN Stuyvie Partnership, arelated party convertible bridge loan. Refer to Note 10.

(3)On March 5, 2008, we entered into a Subscription Agreement with LDNStuyvie Partnership.  Refer to Note 9.

(4)July 2, 2007, we purchased 2,226,006 shares of our common stock ata purchase price of $0.75 per share, (or $1,700 in the aggregate) from JohnMarshall, the former president of ClickTracks in accordance with an Agreementthat was entered into between us and Mr. Marshall on June 8, 2007.  These shares represented the number of sharesMr. Marshall received from us on August 18, 2006, as part of ouracquisition of ClickTracks.

 

***Treasury Stock***

 

Repurchased shares of ourcommon stock are held as treasury shares until they are reissued. When wereissue treasury stock, if the proceeds from the sale are more than the averageprice we paid to acquire the shares we record an increase in additional paid-incapital.  Conversely, if the proceedsfrom the sale are less than the average price we paid to acquire the shares, werecord a decrease in additional paid-in capital to the extent of increasespreviously recorded for similar transactions and a decrease in retainedearnings for any remaining amount.

 

**18.****       Stock Compensation Plans**

 

Effective July 1,2005, we adopted the fair value recognition provisions of SFAS No. 123(R),“*Shared-Based Payments*.”  We selected the modified prospective methodto initially report stock-based compensation amounts in the consolidatedfinancial statements and therefore previously reported amounts have not beenrestated.  The adoption of SFAS No. 123Rdid not have a material impact on our stock-based compensation expense for thefiscal year ended June 30, 2005.  Prior to adoption of SFAS No. 123(R), weaccounted for stock option plan under the fair value recognition and disclosureof SFAS No. 123, “*Accounting for Stock-BasedCompensation*,” as amended by SFAS No. 148, “*Accounting for Stock-Based Compensation — Transition and Disclosures*.”  Under this method, compensation expense wasrecorded only if the market price of the underlying stock on the date of grantexceeded the exercise price.

 

***StockOptions Plan***

 

On May 6,2005, we established the J.L. Halsey Corporation Equity Based CompensationPlan, which we subsequently amended and restated (the “Equity BasedCompensation Plan”).  The Equity BasedCompensation Plan authorizes the granting of stock options and stock-basedawards to employees, directors, and our consultants.  Stock options issued in connection with theEquity Based Compensation Plan are granted with an exercise price per shareequal to the fair market value of a share of our common stock at the date ofgrant.  All stock options generallybecame exercisable over 4.5 years vesting period and expire 10 years from thedate of the grant.  Under this plan amaximum 13.2 million shares of our common stock was approved to be issued ortransferred to certain officers and employees pursuant to stock options grantprovision.  At June 30, 2008, therewere 1,396,921 million shares 

 

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NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

available for future issuance under the Equity BasedCompensation Plan.

 

The fairvalue of each option grant was estimated on the date of grant using theBlack-Scholes option pricing model that uses the assumptions noted in thefollowing table:

 
| ** **                                            | ** ** | **Fiscal Year Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                            | ** ** | **2008**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
| Weighted average  fair value of options at grant date |       | $0.43                                              |       | $0.43 |   | $0.32 |   |
| Expected  dividends                                   |       | —                                             |       | — |   | — |   |
| Expected  Volatility                                  |       | 47-52%                                             |       | 47-50% |   | 50-55% |   |
| Expected term of  the option                          |       | 4.5 years                                          |       | 4.5 years |   | 4.5 years |   |
| Risk-free  interest rates                             |       | 2.19 - 4.76%                                       |       | 4.51 - 4.94% |   | 3.82-5.23% |   |

 

The expected term of theoptions is based on the period of time that options are expected to beoutstanding and is derived by analyzing historical exercise behavior ofemployees in our peer group and the options’ contractual terms.  Expected volatilities are based on impliedvolatilities from traded options on our common stock, its historical volatilityand other factors.  The risk-free ratesare for the period matching the expected term of the option is based on theU.S. Treasury yield curve rates as published by the Federal Reserve in effectat the time of grant.  The dividend yieldis zero based on the fact that we have no intention of paying dividends in thenear term.

 

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NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

The following tablesummarizes stock option activity from July 1, 2005 to June 30, 2008:

 
| ** **                         | ** ** | **Shares**              | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Weighted-Average  Remaining  Contractual Life** | ** ** |
|------------------------------------|------------|-------------------------|------------|-------------------------------------------|------------|--------------------------------------------------------|------------|
|                               |       | **(In thousands)** |       |                                      |       |                                                   |       |
| Outstanding on  July 1, 2005  |       | 6,370                   |       | 0.31                                      |       |                                                   |       |
| Granted                            |       | 3,699                   |       | 0.64                                      |       |                                                   |       |
| Exercised                          |       | —                  |       | 0.00                                      |       |                                                   |       |
| Forfeited/expired                  |       | (820                    | )          | 0.54                                      |       |                                                   |       |
| Outstanding on  June 30, 2006 |       | 9,249                   |       | 0.42                                      |       |                                                   |       |
| Exercisable on  June 30, 2006 |       | 1,668                   |       | 0.30                                      |       |                                                   |       |

 
| ** **                         | ** ** | **Shares**              | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Weighted-Average  Remaining  Contractual Life** | ** ** |
|------------------------------------|------------|-------------------------|------------|-------------------------------------------|------------|--------------------------------------------------------|------------|
|                               |       | **(In thousands)** |       |                                      |       |                                                   |       |
| Outstanding on  July 1, 2006  |       | 9,249                   |       | 0.42                                      |       |                                                   |       |
| Granted                            |       | 4,469                   |       | 0.92                                      |       |                                                   |       |
| Exercised                          |       | (143                    | )          | 0.61                                      |       |                                                   |       |
| Forfeited/expired                  |       | (2,648                  | )          | 0.80                                      |       |                                                   |       |
| Outstanding on  June 30, 2007 |       | 10,927                  |       | 0.53                                      |       | 8.38                                                   |       |
| Exercisable on  June 30, 2007 |       | 3,878                   |       | 0.37                                      |       |                                                   |       |

 
| ** **                         | ** ** | **Shares**              | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Weighted-Average  Remaining  Contractual Life** | ** ** |
|------------------------------------|------------|-------------------------|------------|-------------------------------------------|------------|--------------------------------------------------------|------------|
|                               |       | **(In thousands)** |       |                                      |       |                                                   |       |
| Outstanding on  July 1, 2007  |       | 10,927                  |       | 0.53                                      |       | 8.38                                                   |       |
| Granted                            |       | 3,065                   |       | 0.97                                      |       |                                                   |       |
| Exercised                          |       | (492                    | )          | 0.42                                      |       |                                                   |       |
| Forfeited/expired                  |       | (2,453                  | )          | 0.78                                      |       |                                                   |       |
| Outstanding on  June 30, 2008 |       | 11,047                  |       | 0.60                                      |       | 7.88                                                   |       |
| Exercisable on  June 30, 2008 |       | 5,384                   |       | 0.40                                      |       |                                                   |       |

 

The total intrinsic valueof the options exercised during fiscal 2008, 2007 and 2006 were approximately,$358, $34 and $0, respectively.

 

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NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

The following tablesummarizes information concerning option outstanding and exercisable optionactivity as of June 30, 2008:

 
| **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** | ** ** |
|                                        |       | **(in thousands)**      |       |   |   |   |   | **(****in thousands)** |   |   |   |
| $.30 - $.30                                 |       | 5,325                        |       | 6.85 |   | $ | 0.30 |   | 4,127 |   | $ | 0.30 |   |
| $.46 - $.66                                 |       | 1,163                        |       | 7.77 |   | 0.60 |   | 580 |   | 0.59 |   |
| $.68 - $.83                                 |       | 1,190                        |       | 9.3 |   | 0.80 |   | 236 |   | 0.76 |   |
| $.85 - $.90                                 |       | 1,458                        |       | 9.39 |   | 0.89 |   | 121 |   | 0.89 |   |
| $.91 - $.91                                 |       | 117                          |       | 8.63 |   | 0.91 |   | 32 |   | 0.91 |   |
| $.95 - $.95                                 |       | 89                           |       | 9.09 |   | 0.95 |   | 4 |   | 0.95 |   |
| $.96 - $.96                                 |       | 865                          |       | 8.13 |   | 0.96 |   | 279 |   | 0.96 |   |
| $1.05 - $1.05                               |       | 15                           |       | 9.59 |   | 1.05 |   | 0 |   | 1.05 |   |
| $1.23 - $1.23                               |       | 103                          |       | 9.44 |   | 1.23 |   | 3 |   | 1.23 |   |
| $1.30 - $1.30                               |       | 721                          |       | 9.39 |   | 1.30 |   | 2 |   | 1.30 |   |
|                                        |       |                         |       |   |   |   |   |   |   |   |   |
| Total                                       |       | 11,046                       |       | 7.88 |   | $ | 0.60 |   | 5,384 |   | $ | 0.40 |   |

 

We recognize stock-basedcompensation expenses on a straight-line basis over the requisite serviceperiod of the award, which is the option vesting term of 4.5 years.   Our total stock-based compensation expensewas approximately $750, $694, $343 for the fiscal years 2008, 2007, and 2006, respectively.

 

The following tablesummarizes the allocation of stock-based compensation expense:

 
| ** **                              | ** ** | **Fiscal year Ended June 30,** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------|------------|
| ** **                              | ** ** | **2008**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
| Cost of revenues                        |       | 139                                                |       | 132 |   | 71 |   |
| General and  administrative             |       | 370                                                |       | 382 |   | 199 |   |
| Research and  development               |       | 40                                                 |       | 18 |   | 0 |   |
| Sales and  marketing                    |       | 201                                                |       | 162 |   | 73 |   |
|                                    |       |                                               |       |   |   |   |   |
| Total  stock-based compensation expense |       | 750                                                |       | 694 |   | 343 |   |

 

As of June 30, 2008,the unrecorded deferred stock-based compensation balance related to stockoptions was approximately $2.8 million before estimated forfeitures and will berecognized over an estimated weighted average 2.5 years.

 

As of June 30, 2008and 2007, the aggregate intrinsic value of stock options outstanding andexercisable was approximately $2.0 million and $1.6 million, respectively.  The intrinsic value represents the pre-taxintrinsic value, based on our closing stock price on June 30, 2008, whichwould have been received by the option holders had all option holders exercisedtheir options as of that date.

 

During fiscal year ended June 30,2008 and 2007, we granted 3,064,900 stock options with an estimated totalgrant-date fair value of $1,300.  Of this amount, we estimated that thestock-based compensation for awards not expected to vest was approximately$328.

 

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NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

***Retirement Plans***

 

We have a definedcontribution 401(k) Plan covering substantially all of our employees.  Beginning September 2006 we began makingmatching contributions to the 401(k) Plan. Contributions during fiscal 2008 and 2007 were approximately $290 and$174, respectively.

 

***AnnualIncentive Bonus***

 

On August 1, 2008,Annual Incentive Bonus plan (the “Bonus Plan”) was approved by our CompensationCommittee of the Board of Directors. Under this Bonus Plan certain key employees, including the namedexecutive officers are eligible to receive cash bonus payments following eachfiscal quarter. The objectives of the Bonus Plan include aligning the eligibleparticipants’ performance with the Company’s business goals to reward andretain high performing key employees, and to attract high quality employees tothe Company.    Refer to Note 21,Subsequent Events.

 

**19.****      ****Commitments and Contingencies**

 

*NovaCarev. Stratford Nursing Home**.** * We filed this collection lawsuit inAugust, 1999 to collect on a receivable of approximately $146, which we havefully reserved.  Stratford counter-claimed with numerous theoriesasserting that we instead owed Stratford money.  Although Stratford’sprincipal claims were dismissed by the court, Stratford, in the last quarter offiscal year 2003, had quantified its remaining counter-claims at approximately$1,000.  We believe that the theories on which these damages are based areinconsistent with the contract between the parties and with the conduct of eachparty.  As of June 30, 2008, this case is pending in the U.S.District Court for the Southern District of New Jersey (Camden).  Theoutcome of this action is not possible to predict and we have reserved anestimate of the cost of litigating this action; however, this estimate does notreflect the possibility of an adverse ruling or a judgment against us or asettlement.

 

***Other Cases and Claims***

 

*O’Learyv. Joyner Sports Medicine.** *We are a defendant in one professionalliability claim and had previously purchased professional liability insurancepolicies from PHICO Insurance Company.  On February 2, 2002, aPennsylvania court authorized state insurance regulators to liquidate theinsolvent PHICO Insurance Company, which had provided professional liabilityinsurance policies to us. As a result, PHICO will not be permitted to pay anyclaims on our behalf; however, the remaining claims were transferred to variousstate guaranty funds.  Since 2002, state insurance guaranty funds havepaid the amounts due for liability claims settlements on our behalf.  Basedon our discussion with the state guaranty funds and a review of claims duringthe third quarter of 2004, we now believe that a payment may be required tosettle the professional liability claim that may exceed the amount available tous under the applicable state guaranty fund limits.  We recorded anaccrual and related expense in the third quarter of 2004 equal to the estimatedcost to settle that claim less the amount that would be paid by the stateguaranty fund.  We are undertaking negotiations to settle our liability onthis claim and have recently increased our reserve for this liabilityclaim.  There is no insurance policy in place that would pay anysettlement or award for this claim; therefore, in the event that our currentreserve assessment is incorrect, we will be required to fund any amount inexcess of the reserve amount.

 

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NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

**20.****      ****Quarterly Results (Unaudited)**

 

The following table setsforth unaudited selected financial information for the periods indicated. Thisinformation has been derived from unaudited consolidated financial statements,which, in the opinion of management, include all adjustments (consisting onlyof normal recurring adjustments) necessary for a fair presentation of suchinformation. The results of operations for any quarter are not necessarilyindicative of the results to be expected for any future period.

 
| ** **                                                                       | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** | ** **         | ** ** |
|----------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|--------------------|------------|
| ** **                                                                       | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Full Year** | ** ** |
| **Year  Ended June 30, 2008:**                                              |       |        |       |        |       |        |       |        |       |               |       |
| Software  revenues                                                               |       | $           | 1,851      |        | $          | 1,419       |       | $           | 1,455      |               | $          | 1,222 |   | $ | 5,947 |   |
| Services  revenues                                                               |       | 8,849       |       | 9,480       |       | 9,395       |       | 9,529       |       | 37,253             |       |
| Total Revenues                                                                   |       | 10,700      |       | 10,899      |       | 10,850      |       | 10,751      |       | 43,200             |       |
| Cost of revenues                                                                 |       | 3,716       |       | 5,795       |       | 3,970       |       | 4,118       |       | 17,599             |       |
| Gross Profit                                                                     |       | 6,984       |       | 5,104       |       | 6,880       |       | 6,633       |       | 25,601             |       |
| Operating  expenses                                                              |       | 6,766       |       | 8,967       |       | 6,271       |       | 8,688       |       | 30,692             |       |
| Income (loss)  from continuing operations before income taxes                    |       | 218         |       | (3,863      | )          | 609         |       | (2,055      | )          | (5,091             | )          |
| Income tax  provision                                                            |       | 190         |       | 153         |       | 188         |       | (91         | )          | 440                |       |
| Income (loss)  from continuing operations                                        |       | 28          |       | (4,016      | )          | 421         |       | (1,964      | )          | (5,531             | )          |
| (Loss) gain on  disposal of discontinued operations, net of tax                  |       | (52         | )          | 75          |       | 2           |       | 4           |       | 29                 |       |
| Net (loss)  income                                                               |       | $           | (24        | )           | $          | (3,941      | )          | $           | 423        |               | $          | (1,960 | ) | $ | (5,502 | ) |
| (Loss) income  per share from continuing operations: basic and diluted           |       | $           | 0.00       |        | $          | (0.04       | )          | $           | 0.00       |               | $          | (0.02 | ) | $ | (0.06 | ) |
| (Loss) gain per  share on disposal of discontinued operations: basic and diluted |       | $           | (0.00      | )           | $          | 0.00        |       | $           | 0.00       |               | $          | 0.00 |   | $ | 0.00 |   |
| Net (loss)  income per share: basic and diluted                                  |       | $           | (0.00      | )           | $          | (0.04       | )          | $           | 0.00       |               | $          | (0.02 | ) | $ | (0.06 | ) |

 

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NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 
| ** **                                                                       | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** | ** **         | ** ** |
|----------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|--------------------|------------|
| ** **                                                                       | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Full Year** | ** ** |
| **Year  Ended June 30, 2007:**                                              |       |        |       |        |       |        |       |        |       |               |       |
| Software  revenues                                                               |       | $           | 1,538      |        | $          | 2,070       |       | $           | 2,288      |               | $          | 2,149 |   | $ | 8,045 |   |
| Services  revenues                                                               |       | 6,838       |       | 7,433       |       | 8,060       |       | 8,629       |       | 30,960             |       |
| Total Revenues                                                                   |       | 8,376       |       | 9,503       |       | 10,348      |       | 10,778      |       | 39,005             |       |
| Cost of revenues                                                                 |       | 2,549       |       | 3,126       |       | 3,224       |       | 3,141       |       | 12,040             |       |
| Gross Profit                                                                     |       | 5,827       |       | 6,377       |       | 7,124       |       | 7,637       |       | 26,965             |       |
| Operating expenses                                                               |       | 6,504       |       | 8,145       |       | 6,637       |       | 6,454       |       | 27,740             |       |
| (Loss) income  from continuing operations before income taxes                    |       | (677        | )          | (1,768      | )          | 487         |       | 1,183       |       | (775               | )          |
| Income tax  provision                                                            |       | 62          |       | 91          |       | 174         |       | 217         |       | 544                |       |
| (Loss) income  from continuing operations                                        |       | (739        | )          | (1,859      | )          | 313         |       | 966         |       | (1,319             | )          |
| (Loss) gain on  disposal of discontinued operations, net of tax                  |       | (35         | )          | 522         |       | 73          |       | 1,110       |       | 1,670              |       |
| Net (loss)  income                                                               |       | $           | (774       | )           | $          | (1,337      | )          | $           | 386        |               | $          | 2,076 |   | $ | 351 |   |
| (Loss) income  per share from continuing operations: basic and diluted           |       | $           | (0.01      | )           | $          | (0.02       | )          | $           | 0.00       |               | $          | 0.01 |   | $ | (0.01 | ) |
| (Loss) gain per  share on disposal of discontinued operations: basic and diluted |       | $           | (0.00      | )           | $          | 0.01        |       | $           | 0.00       |               | $          | 0.01 |   | $ | 0.02 |   |
| Net (loss)  income per share: basic and diluted                                  |       | $           | (0.01      | )           | $          | (0.02       | )          | $           | 0.00       |               | $          | 0.02 |   | $ | 0.00 |   |

 

**21.****      ****Subsequent Events**

 

**On July 30, 2008, we entered into First Amendment toAmended and Restated Loan and Security Agreement (the “Amendment”) withComerica.   The Amendment amends andrestates the financial covenant related to measuring our EBITDA, which is theearnings before interest, taxes, depreciation, amortization and non-cash stockcompensations plus any cash or non-cash expenses related to discontinuedoperations (such as expenses capped at $200).**

 

**As amended, the covenant requires the following minimumEBITDA calculations, as measured on a rolling three-month basis, as follows: (i) measuredquarterly, not less than eight hundred thousand dollars ($800) for thequarterly measuring period ending March 31, 2008, (ii) measured quarterly,not less than negative four hundred thousand ten dollars ($-410)  for the quarterly measuring period ending June 30,2008, (iii) measured quarterly, not less than two hundred fifty thousanddollars ($250) for the quarterly measuring period ending September 30,2008, (iv) measured monthly, one million five hundred thousand dollars($1,500) for the monthly measuring periods ending December 30, 2008through February 28, 2009, and (v) measure monthly, two milliondollars ($2,00) for each monthly measuring period thereafter.  Our failure to meet the modified financialcovenant stated in the Amendment constitutes an event of default.**

 

During the course of theCompany’s year-end audit, our independent auditors requested and we agreed tomake certain accounting entries to reverse a previously recognized softwarelicense sale of approximately $73 thousand. The effect was to reduce our EBITDA to a negative $-478 thousand whichwas below the amount required by the financial covenant with Comerica, for thequarterly measurement period ending June 30, 2008.  On September 12, 2008, we obtained awaiver for this quarterly measurement period requirement.

 

On August 1, 2008,the Compensation Committee of the Board of Directors (the “Committee”) approvedthe Annual Incentive Bonus plan (the “Bonus Plan”).  Under this Bonus Plan certain key employees,including the named executive officers are eligible to receive cash bonuspayments following each fiscal quarter. The objectives of the Bonus Planinclude aligning the eligible participants’ performance with the Company’sbusiness goals to reward and retain high performing key employees, and toattract high quality employees to the Company.

 

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NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data)

 

Under the Bonus Plan,participants are eligible to receive bonuses during each bonus year based onindividual performance and Company performance.   With respect to bonuses based on individualperformance, all or a portion of a bonus may be based on the participant’sattainment of individual performance objectives, as may be determined by theCommittee.    Participants are alsoeligible to receive all or a portion of their bonuses based on the followingCompany performance criteria: (1) net new monthly rate of revenue; (2) totalrevenue; and (3) corporate earnings before interest, taxes, depreciationand amortization (the “Company Performance Bonus”).   The plan shall be administered under thedirection of the Compensation Committee, therefore, may select additionalcriteria for the Company Performance Bonus.  For each bonus plan year, the Committee will establish the percentage touse for each of the criteria that comprise the Company Performance Bonus, suchthat participants are aware of the relative importance of each criterion indetermining any Company Performance Bonuses. To the extent the Company exceeds performance targets, participants areeligible for additional bonus awards.

 

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LYRIS INC., ANDSUBSIDIARIES

NOTES TO THECONSOLIDATED FINANCIAL STATEMENTS

(In thousands,except per share and percent data

 

**Appendix A**

 

**VALUATIONAND QUALIFYING ACCOUNTS(In thousands)**

 
| **Description**                                                              | ** ** | **Balance at  Beginning of  Period** | ** ** | **Charges to  Costs and  Expenses** | ** ** | **Other** | ** ** | **Net  Deductions** | ** ** | **Balance  at End of  Period** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|-----------|------------|---------------------|------------|------------------------------------------|------------|
| Year ended  June 30, 2008                                               |       |                                           |       |                                          |       |      |       |                |       |                                     |       |
| Allowance for  uncollectible accounts                                        |       | $                                              | 365        |                                          | $          | 580       |       | $                   | 119        |                                     | $          | (614 | )(1) | $ | 450 |   |
| Allowance for  uncollectible accounts remaining from discontinued operations |       | 583                                            |       | —                                        |       | (125      | )          | (225                | )(1)       | 233                                      |       |
| Deferred tax  asset valuation allowance                                      |       | 72,390                                         |       | —                                        |       |      |       | (6,213              | )(2)       | 66,177                                   |       |
|                                                                         |       |                                           |       |                                          |       |      |       |                |       |                                     |       |
| Year ended  June 30, 2007                                               |       |                                           |       |                                          |       |      |       |                |       |                                     |       |
| Allowance for  uncollectible accounts                                        |       | 181                                            |       | 638                                           |       | 140       |       | (594                | )(1)       | 365                                      |       |
| Allowance for  uncollectible accounts remaining from discontinued operations |       | 583                                            |       | —                                        |       |      |       | —              |       | 583                                      |       |
| Deferred tax  asset valuation allowance                                      |       | 73,506                                         |       | —                                        |       | 52        |       | (1,168              | )(2)       | 72,390                                   |       |
|                                                                         |       |                                           |       |                                          |       |      |       |                |       |                                     |       |
| Year ended  June 30, 2006                                               |       |                                           |       |                                          |       |      |       |                |       |                                     |       |
| Allowance for  uncollectible accounts                                        |       | 10                                             |       | 328                                           |       | 68        |       | (225                | )(1)       | 181                                      |       |
| Allowance for  uncollectible accounts remaining from discontinued operations |       | 1,109                                          |       | —                                        |       | —    |       | (526                | )          | 583                                      |       |
| Deferred tax asset  valuation allowance                                      |       | $                                              | 74,714     |                                          | $          | —    |       | $                   | 995        |                                     | $          | (2,203 | )(2) | $ | 73,506 |   |

 

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(1) Primarily write-offs

(2)Utilization of net operating loss carryforwards at minimum tax rates

 

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**ITEM 9.****CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES**

 

**None**

 

**ITEM 9A. CONTROLS AND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

Asof the end of the period covered by this annual report on Form 10-K, weevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures.  This evaluationwas performed under the supervision and with the participation of ourmanagement, including our Chief Executive Officer (CEO) and Chief FinancialOfficer (CFO).

 

OurCEO and CFO have concluded that our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the Exchange Act), are effective to providereasonable assurance that information required to be disclosed by us in reportsthat we file or submit under the Exchange Act is recorded, processed, andreported within the time periods specified in Securities and ExchangeCommission ( the “SEC”) rules and forms, and is accumulated andcommunicated to management, including our principal executive officer andprincipal financial officer, as appropriate to allow timely decisions regardingrequired disclosure.

 

**Management’s Annual report on Internal Control overFinancial Reporting**

 

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting (as defined in Rule 13a-15(f) and15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to providereasonable assurance regarding the reliability of our financial reporting andthe preparation of financial statements for external reporting purposes inaccordance with U.S. generally accepted accounting principles.  We reviewed the results of management’sassessment with our Audit Committee of our Board of Directors.

 

Managementassessed our internal control over financial reporting as of June 30,2008, the end of our fiscal year. Management based its assessment on criteria established by the Committeeof Sponsoring Organizations of the Treadway Commission in (COSO).  Management’s assessment included evaluation of elements such as thedesign and operating effectiveness of key financial reporting controls, processdocumentation, accounting policies, and our overall control environment.

 

Based on our assessment of our internal controlover financial reporting as of June 30, 2008, management has concludedthat our internal control financial reporting was effective as of the end ofthe fiscal year to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with U.S. generally accepted accounting principles.

 

**Changesin Internal Control over Financial Reporting**

 

Wetook the following actions during the quarter ended June 30, 2008:

 

·                  Hired appropriate personnel with strongtechnical accounting experience commensurate with responsibilities, includingappointment of a new Chief Financial Officer and hiring Sr. Manager ExternalReporting & Technical Accounting.

 

·                  Improved documentation and communication inestablishing and implementing applicable and complex accounting policiesincluding proactive review of recent accounting pronouncements that may affectour financial reporting.

 

·                  Implemented process improvements includingexternal reporting checklists, regular scheduled staff meetings to discussaccounting and operational issues.

 

·                  Continued use of outside technical experts onsuch complex areas as taxes, intangible asset evaluation and stock optionaccounting.

 

Management intends to reviewand evaluate the design and effectiveness of its disclosure controls andprocedures on an ongoing basis and to improve its controls and procedures andto correct deficiencies that may be discovered in the future in order to ensurethat we have timely access to all material financial and non-financialinformation concerning our business. However, while the present design of our disclosure controls andprocedures is effective, future events affecting our business may cause ourmanagement to modify its disclosure and procedures.

 

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**InherentLimitations on Effectiveness of Controls**

 

Our management includingour CEO and CFO does not expect that our disclosure controls or our internalcontrol over financial reporting will prevent or detect all error and allfraud. A control system, no matter how well designed and operated, can provideonly reasonable, not absolute, assurance that the control system’s objectiveswill be met. The design of a control system must reflect the fact that thereare resource constraints, and the benefits of controls must be consideredrelative to their costs. Further, because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatmisstatements due to error or fraud will not occur or that all control issuesand instances of fraud, if any, within the company have been detected. These inherentlimitations include the realities that judgments in decision-making can befaulty and that breakdowns can occur because of simple error or mistake.Controls can also be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the controls. Thedesign of any system of controls is based in part on certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions. Projections of any evaluation of controls effectiveness to futureperiods are subject to risks. Over time, controls may become inadequate becauseof changes in conditions or deterioration in the degree of compliance withpolicies or procedures.

 

** ITEM 9B. OTHER INFORMATION**

 

**None**

 

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**PART III**

 

**ITEM 10. Directors, Executive Officers and CorporateGovernance.**

 

**DIRECTORS**

 

Our directors are as follows:

 
| **Name  of Director**        | ** ** | **Age**    | ** ** | **Title**                                                    | ** ** | **Annual Meeting at  which Term Ends** |
|------------------------------|------------|------------|------------|--------------------------------------------------------------|------------|---------------------------------------------|
| ** **                   | ** ** | ** ** | ** ** | ** **                                                   | ** ** | ** **                                  |
| Andrew Richard Blair         |       | 74         |       | Class I Director                                        |       | 2008                                        |
|                         |       |       |       |                                                         |       |                                        |
| William T. Comfort, III |       | 42         |       | Class III Director, Chairman of the Board of  Directors |       | 2010                                        |
|                         |       |       |       |                                                         |       |                                        |
| Nicolas De Santis Cuadra     |       | 41         |       | Class I Director                                        |       | 2008                                        |
|                         |       |       |       |                                                         |       |                                        |
| Luis A. Rivera               |       | 37         |       | Class II Director                                       |       | 2009                                        |
|                         |       |       |       |                                                         |       |                                        |
| James A. Urry                |       | 53         |       | Class II Director                                       |       | 2009                                        |
|                         |       |       |       |                                                         |       |                                        |
| Robb Wilson                  | ** ** | 39         |       | Class III Director                                      |       | 2010                                        |

 

*Andrew Richard Blair*has been a member of our Board since November 12, 2002. He is a founder ofFreimark Blair & Company, Inc., a broker-dealer research boutiquelocated at One Rice Bluff Road, Pawley’s Island, South Carolina.  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.

 

*William T. Comfort*, IIIhas served as a member of our Board since May 2002, and as Chairman of theBoard since November 12, 2002. He was a private equity investmentprofessional with CVC Capital Partners, a leading private equity firm based inLondon, England, from February 1995 until December 2000. From February 2001to February 2003 he served as a consultant to Citicorp Venture Capital (“CVC”).  He is now principal of Conversion CapitalPartners Limited, an investment fund headquartered at 4th Floor,Liscartan House, 127 Sloane Street, London, England.  Mr. Comfort also has served as adirector of numerous public and private companies as a representative of CVCCapital Partners and CVC, from all of which he has resigned.  Mr. Comfort is currently a director ofKofax, Inc.  Mr. Comfortreceived his J.D. and L.L.M. in tax law from New York University School of Law.

 

*Nicolas De Santis Cuadra*hasbeen a member of our Board since January 16, 2003. Mr. De SantisCuadra has served since January 2003 as the Chief Executive Officer ofLondon-based Twelve Stars Communications, an international brand businessconsulting firm, located at 13 Chesterfield Street, Mayfair, London, which Mr. DeSantis Cuadra founded in 1994. He previously served as the Chief ExecutiveOfficer of Twelve Stars from 1994 until December 1998. From December 2000until January 2003, Mr. De Santis Cuadra served as the marketingdirector of OPODO Ltd., an online travel portal owned by several European-basedairlines. From January 1999 until December 2000, Mr. De SantisCuadra served as Senior Vice President and Chief Marketing Officer ofBeenz.com, the Internet currency website.

 

*Luis A. Rivera* wasappointed our Chief Executive Officer on May 11, 2007.  He has been a director since June 25,2007.  He previously served as ourInterim Chief Executive Officer and President beginning on January 29,2007.  From May 2005 until hisappointment as Interim Chief Executive Officer, Mr. Rivera served as ourChief Operating Officer.  Mr. Riveracontinues to serve as President and Chief Executive Officer of LyrisTechnologies, Inc. and Uptilt, Inc., positions he has held since May 2005and October 2005, respectively. From May 2003 through May 2005, Mr. Rivera was theGeneral Manager of Lyris.  From May 2001through April 2003, Mr. Rivera was the Director of Sales ofLyris.  From November 1999 through May 2001,Mr. Rivera served as Director of International Sales of Turbolinx, an opensource technology company.  Mr. Riverais a graduate of Claremont McKenna College.

 

*James A. Urry* hasbeen a member of our Board since June 25, 2007.  Mr. Urry is a partner at Court SquareCapital Management L.P., a private equity firm located at Park Avenue Plaza, 55East 52nd Street, 34th Floor, New York, New York.  Prior to joining Court Square, he was apartner at Citigroup Venture Capital Equity Partners from 1989 to 2006.  Mr. Urry also serves as a member of theboard of directors of Intersil Corporation, a semiconductor company.  Mr. Urryis the brother-in-law of William T. Comfort, III, one of our directors.

 

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*Robb Wilson*resigned as an officer and employee of the Company on July 1, 2008 and wasappointed a director of the Company on that date.  Mr. Wilson was appointed our VicePresident of Technology on January 19, 2006.  From December 15, 2004 until July 1,2008, Mr. Wilson served as Vice President of Development andDeliverability for Lyris.  Prior tojoining Lyris, Mr. Wilson served as President and founder of PiperSoftware, a pioneer in the development of email deliverability solutions, from October 1,2004 to December 15, 2004.  Lyrisacquired Piper Software in November 2004. Prior to his tenure at Piper Software, Mr. Wilson served as VicePresident of Software Development for Quris, Inc., the online marketingfirm, from March 1, 2001 to October 1, 2001.

 

Our Certificate of Incorporation provides that the Board of Directorsshall be divided into three classes, designated Class I, Class II andClass III. Directors serve for staggered terms of three years each.  Messrs. Blair and De Santis Cuadracurrently serve as Class I directors, whose terms expire at the AnnualMeeting of Stockholders following the 2008 fiscal year. Messrs. Rivera andUrry currently serve as Class II directors whose terms expire at theAnnual Meeting of Stockholders following the 2009 fiscal year. Messrs. Comfortand Wilson currently serve as Class III directors, whose terms expire atthe Annual Meeting of Stockholders following the 2010 fiscal year.

 

**EXECUTIVE OFFICERS**

 

Our executive officers are as follows:

 
| **Name**             | ** ** | **Age**    | ** ** | **Title**                                          |
|----------------------|------------|------------|------------|----------------------------------------------------|
| ** **           | ** ** | ** ** | ** ** | ** **                                         |
| Luis A. Rivera       |       | 37         |       | President and  Chief Executive Officer             |
| Heidi L.  Mackintosh |       | 38         |       | Chief Financial  Officer, Treasurer and Secretary  |
| Blaine Mathieu       |       | 41         |       | Senior Vice  President and Chief Marketing Officer |
| Sean Ryan            |       | 42         |       | Senior Vice  President, Engineering                |
| Jason Han            |       | 37         |       | Vice President,  Sales                             |
| Ray Polanco          |       | 41         |       | Vice President,  Client Services                   |

 

The Executive Officers named above were appointed by the Board ofDirectors to serve in such capacities until their respective successors havebeen duly appointed and qualified, or until their earlier death, resignation orremoval from office.

 

Biographical information on Mr. Rivera is set forth above.  See “Directors.”

 

*Heidi Mackintosh*wasappointed our Chief Financial Officer, Secretary and Treasurer on May 1,2008. Prior to joining us, Ms. Mackintosh served as Vice President andCorporate Controller for BenefitStreet, Inc., an unbundled provider of 401(k) recordkeepingsolutions and services since March 2007. From August 2004 until January 2007, Ms. Mackintosh wasthe Corporate Controller for OSIsoft, Inc., a performance managemententerprise software company.  From July 2002until August 2004, Ms. Mackintosh was employed as Senior Manager ofTechnical Accounting at Apple Computer, Inc.  Ms. Mackintosh is a CPA and received herB.A. in Business Administration from the California State University, Hayward.

 

*Blaine Mathieu*wasappointed our Chief Marketing Officer on April 21, 2008 after havingjoined us in November 2007 as Senior Vice President, Marketing. Prior tojoining us, Mr. Mathieu was general manager and vice president of productand marketing at Corel Corp. He was responsible for creating global marketingand product strategies for a wide range of software products targeted atconsumers, businesses and professionals. Mr. Mathieu also held a varietyof senior management positions at Adobe Systems, Gartner Group and othercompanies. He received his MBA from Athabasca University in Canada and hisbachelor of commerce degree from the University of Alberta in 1989.

 

*Sean Ryan*wasappointed our Vice President of Engineering on May 21, 2007.  Since January of 2005, Mr. Ryan hasbeen providing SaaS consulting services and assisted early stage companies inraising investment capital. Notably, he assisted eSchoolware, a provider ofhosted assessment services to the educational market, acting as their interimCTO and helping them raise capital.  FromJanuary 2004 to December 2004, he acted as the CTO/COO of Booksurge,LLC an online provider of print-on-demand services. In December of 2004BookSurge was acquired by Amazon.com. From January 2000 to December 2003Mr. Ryan was a founder and the CTO of ExactTarget, a hosted emailsolutions provider.

 

*Jason Han*wasappointed our Vice President of Sales on July 1, 2007.  From April of 2002 to June of 2007,Mr. Han has served as Director of ASP Operations for Lyris.  Prior to joining Lyris, Mr. Han servedin various sales management positions with enterprise software companiesTurbolinux, Siebel Systems and Netscape Communications.  Mr. Han received a bachelor degree fromUniversity of California, Berkeley.

 

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*Ray Polanco* wasappointed our Vice President of Client Services in January 2008. From May 2007to January 2008, Mr. Polanco was the Director of Service and Supportfor Lyris. Prior to May 2007 Mr. Polanco held similar director levelclient services positions at Avid Technology, Zhone Technology, and Lucent. Mr. Polancostudied business administration at San Jose State University.

 

**COMPLIANCE WITH SECTION 16(a) OFTHE EXCHANGE ACT**

 

Section 16(a) of the Exchange Act requires our directors,executive officers and holders of more than 10% of our shares of Common Stockto file with the SEC initial reports of ownership of shares of Common Stock andreports of changes in such ownership. The SEC’s rules require such personsto furnish us with copies of all Section 16(a) reports that theyfile. Based on a review of these reports and on written representations fromthe reporting persons that no other reports were required, we believe that theapplicable Section 16(a) reporting requirements were complied withfor all transactions which occurred in the fiscal year ended June 30,2008.

 

**CODE OF ETHICS**

 

We adopted our Code of Business Conduct and Ethics on September 25,2003, and it was filed with the SEC as an exhibit to our Annual Report on Form 10-Kfor the year ended June 30, 2003.

 

**STOCKHOLDER NOMINATION**

 

There have been no material changes to the procedures by whichstockholders may recommend nominees to the board of directors, since thedisclosure in our last proxy statement.

 

**AUDIT COMMITTEE**

 

The Audit Committee is appointed by the Board of Directors to assistthe Board of Directors with carrying out its duties.  The primary functions of the Audit Committeeare to oversee:

 

·                                          ouraccounting and financial reporting process;

 

·                                          the qualityand integrity of the financial statements and other financial information thatwe provide to any governmental body or the public;

 

·                                          ourcompliance with legal and regulatory requirements;

 

·                                          theindependent auditors’ qualifications and independence; and

 

·                                          theperformance of our internal audit function and independent auditors.

 

The role and other responsibilities of the Audit Committee are setforth in the Audit Committee Charter. The Audit Committee Charter is not available on our website.  A copy of the Audit Committee Charter waslast provided to stockholders as an exhibit to the proxy statement for ourannual meeting for fiscal year 2005, which was originally filed with the SEC onJune 20, 2006.

 

The members of the Audit Committee are Messrs. Blair and De SantisCuadra, with Mr. Blair serving as chairman.  The Board of Directors has affirmativelydetermined that all members of the Audit Committee meet the currentindependence requirements of the NASDAQ Stock Market listing standards andapplicable rules and regulations of the SEC.  Those standards require that, in addition tomeeting the independence standards set forth under “Certain Relationship andRelated Transactions – Director Independence,”****each member of the Audit Committee must not be an affiliate of oursand must not receive from us, directly or indirectly, any consulting, advisoryor other compensatory fees except for fees for services as a director.  The Board of Directors also has determinedthat Mr. Blair satisfies the requirements for an “audit committeefinancial expert” and has designated Mr. Blair as our audit committeefinancial expert.

 

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**ITEM 11.  EXECUTIVECOMPENSATION.**

 

**SUMMARY COMPENSATION TABLE**

 

The following table summarizes, with respect to our Chief ExecutiveOfficer and each of our other named executive officers, information relating tothe compensation earned for services rendered in all capacities during fiscalyear 2008.

 

**Summary Compensation Table ForFiscal-Year End 2008 and 2007**

 
| **Name and  Principal Position** | ** ** | **Year** | ** ** | **Salary  ($)** | ** ** | **Bonus  ($) ****(1)** | ** ** | **Option  Awards  $ ****(2)** | ** ** | **All Other  Compensation  ($)** | ** ** | **Total  ($)** | ** ** |
|--------------------------------------------|------------|----------|------------|-----------------|------------|-----------------------------|------------|------------------------------------|------------|---------------------------------------|------------|----------------|------------|
|                                       |       |     |       |            |       |                        |       |                               |       |                                  |       |           |       |
| Luis A. Rivera                             |       |     |       |            |       |                        |       |                               |       |                                  |       |           |       |
| President and  Chief                       |       | 2008     |       | 200,000         |       | 165,625                     |       | 137,532                            |       | 30,215                                | (3)        | 533,372        |       |
| Executive  Officer                         |       | 2007     |       | 200,000         |       | 250,000                     |       | 137,156                            |       |                                  |       | 587,156        |       |
|                                       |       |     |       |            |       |                        |       |                               |       |                                  |       |           |       |
| Peter Biro (4)                             |       |     |       |            |       |                        |       |                               |       |                                  |       |           |       |
| Former Chief  Operating                    |       | 2008     |       | 108,641         |       | 35,100                      |       | 116,698                            |       | 58,438                                | (5)        | 318,877        |       |
| Officer                                    |       | 2007     |       | 165,519         |       | 23,010                      |       | 81,082                             |       |                                  |       | 269,611        |       |
|                                       |       |     |       |            |       |                        |       |                               |       |                                  |       |           |       |
| Sean Ryan                                  |       |     |       |            |       |                        |       |                               |       |                                  |       |           |       |
| Senior Vice  President,                    |       | 2008     |       | 211,875         |       | 21,630                      |       | 53,084                             | ** ** | 6,813                                 | (6)        | 293,402        |       |
| Engineering                                |       | 2007     |       | 24,769          |       |                        |       | 3,339                              | ** ** |                                  |       | 28,108         |       |
|                                       |       |     |       |            |       |                        |       |                               | ** ** |                                  |       |           |       |
| Jason Han                                  |       | 2008     |       | 233,617         |       | 13,950                      |       | 30,521                             | ** ** | 6,116                                 | (6)        | 284,204        |       |
| Vice President,  Sales                     |       | 2007     |       | 327,635         |       | 5,938                       |       | 15,240                             |       |                                  |       | 348,813        |       |

 

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| (1)    |       | Performance objectives for bonuses are based on  individual criteria related to those areas where that executive can influence  business outcomes. The CEO, former COO and VP, Sales also had performance  objectives based on the company achieving budgeted revenue targets. The  bonuses earned by the named executive officers for FY 2008 were in a range of  66% to 88% of their bonus potential. Our annual bonus plan is discussed in  greater detail in the narrative following the Summary Compensation Table.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (2)    |       | We account for the cost of stock-based compensation  awarded under the 2005 Equity-Based Compensation Plan (the “2005 Plan”) in  accordance with the Financial Accounting Standards Board Statement of  Financial Accounting Standards No. 123 (revised 2004) Share Based  Payment (“SFAS 123(R)”), under which the cost of equity awards to employees  is measured by the fair value of the awards on their grant date and is  recognized over the vesting periods of the awards, whether or not the awards  had any intrinsic value during the period. Amounts shown in the table above  reflect the dollar amount recognized for financial statement reporting  purposes for fiscal years 2007 and 2008 in accordance with SFAS  123(R) of awards granted under the 2005 Plan and thus may include  amounts from awards granted in and prior to fiscal year 2008. All awards are  based on the closing market price of our common stock on the date of grant.  Assumptions used in calculation of these amounts are included in Note 18 to  our consolidated audited financial statements for the fiscal year ended  June 30, 2008, included in the Original Form 10-K. The vesting  provisions of these options are described in the footnotes to the 2008  Outstanding Equity Awards at Fiscal Year-End table below. Mr. Biro’s  700,000 options were forfeited and cancelled on June 30, 2008 but no  portion of the accounting expense related to his stock based compensation was  reversed. |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (3)    |       | In FY 2008 we initiated a revised policy to limit  the number of days of vacation that employees may accrue before those days  must be used or forfeited. There was a companywide one-time payout of unused  vacation days in excess of that maximum that were forfeited.. Mr. Rivera  was paid $17,303 as compensation for the forfeiture of those unused vacation  days. Pursuant to Mr. Rivera’s employment agreement, the Company paid  the employee portion of his healthcare benefit premiums an amount equal to $6,299. In addition, Mr Rivera received $6,613 as the company’s matching  contribution to his individual 401 (k) plan contribution.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (4)    | ** ** | The Company paid Mr. Biro $108,641 for salary  and $35,100 as bonus prior to Mr. Biro’s resignation on January 28,  2008, as an employee and Chief Operating Officer. In connection with his  resignation, we entered into an agreement with Mr. Biro to provide  severance in the amount of $47,500 as follows: (i) $23,750 to be paid  immediately and (ii) $23,750 payable on June 30, 2008. In addition,  we also agreed that, (a) options for a total of 100,000 shares granted  under the Non-Statutory Stock Option Agreement dated August 17, 2006,  between the Company and Mr. Biro, would vest and become exercisable  following his resignation, with half vesting on February 17, 2008, and  half vesting on May 17, 2008, (b) options for 75,000 shares granted  under the Non-Statutory Stock Option Agreement dated May 8, 2007,  between the Company and Mr. Biro, would vest on May 8, 2008, and  (c) all options granted to Mr. Biro that had vested prior to the  effectiveness of his resignation or that vest and become exercisable pursuant  to clauses (a) and (b) above would remain exercisable until  June 30, 2008. Mr. Biro did not exercise any of his options and his  700,000 options have been forfeited and cancelled.                                                                                                                                                                                |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (5)    |       | In addition to severance in the amount of $47,500,  Mr. Biro received $7,313 as compensation for accrued but unused vacation  days at the time of his resignation and $3,625 as the company’s matching  portion to his individual 401 (k) plan contribution.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (6)    |       | Represents the company’s matching portion to their  individual 401 (k) plan contributions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |

 

**Compensation Philosophy andObjectives**

 

Since the acquisition of our operating subsidiaries, our compensationprograms and policies have focused mainly on the areas of retaining andattracting employees necessary to operate the acquired subsidiaries and growour respective businesses. Historically, the Compensation Committee of ourBoard of Directors (the “Compensation Committee”) has not utilized a formalcompensation policy. Rather, compensation of executives, including the namedexecutive officers, has been established on a more informal, ad-hoc basis. Todate, the Company has not undertaken a formal study to determine whethercompensation paid to our executives is competitive with that of our competitors.Instead, the Compensation Committee has focused on one-on-one negotiations withour executives at the 

 

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time of hire forthe purpose of recruiting the executive in order to assemble an executive teamthat will develop and implement our long-term strategic goals.

 

***Annual Bonus Plan***

 

In the fourth quarter of the fiscal year ended June 30, 2007, webegan implementing formal procedures to ensure that short term incentivebonuses and annual salary increases are tied to individual performance. All ofthe named executive officers had specific objectives required to beaccomplished in order to achieve their bonus.  Specifically, individual and business objectives established for ournamed executives were as follows:

 
| **Named  Executive   Officer** | ** ** | **Performance Objectives**                                                                                                                                                                                                                                                              | ** ** | **Percentage of  Bonus Potential** | ** ** |
|--------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | ** **                                                                                                                                                                                                                                                                              | ** ** | ** **                         | ** ** |
| Luis Rivera                    |       | Key performance  objectives included meeting or exceeding EBITDA targets, achieving budgeted  revenue targets and development of the executive team.                                                                                                                                    |       | 66                                 | %          |
|                           |       |                                                                                                                                                                                                                                                                                    |       |                               |       |
| Peter Biro                     |       | Key performance  objectives included achieving budgeted revenue targets, achieving staffing  targets, certain improvements to hosted customer service and certain specific  integration goals.                                                                                          |       | 78                                 | %          |
|                           |       |                                                                                                                                                                                                                                                                                    |       |                               |       |
| Sean Ryan                      |       | Key performance  objectives included engineering and architectural plan implementation for  point solutions and *Lyris HQ*,  integration and direction of engineering organization in support of  organizational goals, developing of certain metrics and achieving of staffing  goals. |       | 86                                 | %          |
|                           |       |                                                                                                                                                                                                                                                                                    |       |                               |       |
| Jason Han                      |       | Key performance  objectives included achieving budgeted revenue targets, achieving budgeted  increases to hosted monthly revenue run rates, and achieving of staffing  goals.                                                                                                           |       | 78                                 | %          |

 

On August 1, 2008, the Compensation Committee approved an annualincentive bonus plan. Under this bonus plan, certain key employees, includingthe named executive officers are eligible to receive cash bonus paymentsfollowing each fiscal quarter. The objectives of the bonus plan includealigning the eligible participants’ performance with the Company’s businessgoals to reward and retain high performing key employees, and to attract highquality employees to the Company.

 

Under the bonus plan, participants are eligible to receive bonuses duringeach bonus year based on individual performance and our company’s performance.With respect to bonuses based on individual performance, all or a portion of abonus may be based on the participant’s attainment of individual performanceobjectives, as may be determined by the Compensation Committee. Participantsare also eligible to receive all or a portion of their bonuses based on thefollowing Company performance criteria: (1) net new monthly hosted revenueadditions (2) total revenue; and (3) corporate earnings beforeinterest, taxes, depreciation and amortization (the “Company Performance Bonus”).The bonus plan is to be administered under the direction of the CompensationCommittee and, therefore, the Compensation Committee may select additionalcriteria for the Company Performance Bonus. For each bonus plan year, theCompensation Committee will establish the percentage to use for each of thecriteria that comprise the Company Performance Bonus, such that participantsare aware of the relative importance of each criterion in determining anyCompany Performance Bonuses. To the extent the Company exceeds performancetargets, participants are eligible for additional bonus awards.

 

**Employment Agreements/Arrangements**

 

We have entered into employment agreements with our named executiveofficers.  The employment agreements havethe following general terms.

 

*Luis A. Rivera*.Effective May 12, 2005, Lyris Technologies, Inc., our wholly ownedsubsidiary, entered into an employment agreement with Luis A. Rivera, to serveas President and Chief Executive Officer. The term of the agreement is for fiveyears and expires on May 12, 2010. The initial annual base salary underthe agreement was and continues to be $200,000 and Mr. Rivera is eligibleto receive a quarterly performance bonus based on our profitability. Inaddition, Mr. Rivera received an award of options to purchase 3,600,000shares of our Common Stock at an exercise price of $0.30 per share that vestratably on a quarterly basis over four years from the date of grant.  Mr. Rivera is also eligible toparticipate in any “Investment Plans” and “Welfare Plans” (as defined in theemployment agreement) to the extent applicable generally to our otheremployees.

 

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The employment agreement also provides for certain severance paymentsto Mr. Rivera described in greater detail below in the section titled “PotentialPayments upon Termination or Change in Control.”

 

Additionally, following termination Mr. Rivera will be subject tonon-competition and non-solicitation provisions for a twelve month period followinghis termination and ongoing confidentiality and non-disparagement obligations.

 

*Peter Biro*. On August 17,2006, we entered into an employment agreement with Peter Biro to serve as VicePresident of Corporate Development and Planning. The term of the agreement wasfor four years and expires on August 16, 2010. The initial annual basesalary under the agreement was $190,000 (subject to adjustment by our board ofdirectors), and Mr. Biro was eligible to receive an annual bonus asdetermined by our board of directors, provided that such annual bonus is notless than $15,000. In addition, Mr. Biro received an award of options topurchase 400,000 shares of our Common Stock at an exercise price of $0.95, 50percent of which vested on August 17, 2007 and the remaining 50 percent ofwhich vested (or would have vested had he remained in employment) in four equalinstallments on the last day of each quarter of the period beginning on August 18,2007, and ending on August 17, 2008. On May 8, 2007, Mr. Birowas also granted an award of options to purchase 300,000 shares of our CommonStock at an exercise price of $0.83 per share, which will vest in four equalannual installments beginning May 8, 2008.** **As indicated above innote 4 to the Summary Compensation Table, Mr. Biro did not exercise any ofhis options following his termination of employment and they have beenforfeited and cancelled.  Mr. Birowas also eligible to participate in any “Investment Plans” and “Welfare Plans”(as defined in the employment agreement) to the extent applicable generally toour other employees.  We also agreed toreimburse Mr. Biro for monthly premiums incurred by Mr. Biro formedical, prescription drug, dental and/or vision insurance for himself and hisimmediate family, not to exceed $1,200 per month.

 

The employment agreement also provided for certain severance paymentsto Mr. Biro described in greater detail below in the section titled “PotentialPayments upon Termination or Change in Control.”

 

Additionally,following his termination Mr. Biro will be subject to non-competition andnon-solicitation provisions for a twelve month period following his terminationand ongoing confidentiality and non-disparagement obligations.

 

*SeanRyan*. Effective May 29, 2007, Lyris Technologies, Inc.entered into an agreement with Sean Ryan, to serve as Vice President ofEngineering. The initial base salary under the agreement was $210,000 and hewas also eligible for an incentive bonus of up to $20,000. In addition, Mr. Ryanreceived an award of options to purchase 400,000 shares of our Common Stock atan exercise price of $0.90 per share, which will vest ratably on an annualbasis over four years from the date of grant. Mr. Ryan is also eligible toparticipate in the company’s benefit plans to the extent applicable generallyto our other employees. Mr. Ryan also received a relocation allowance ofup to $20,000 as well as certain travel and temporary housing costs. On February 19,2008, Mr. Ryan was granted an award of options to purchase 250,000 sharesof our Common Stock at an exercise price of $0.89 per share, which will vest infour equal annual installments beginning February 19, 2009.

 

The employment agreement also provided for certain severance paymentsto Mr. Ryan described in greater detail below in the section titled “PotentialPayments upon Termination or Change of Control.”

 

*Jason Han*.Effective May 12, 2005, Lyris Technologies, Inc. entered into anemployment agreement with Jason Han, to serve as Director of Sales Operations.The term of the agreement is for five years and expires on May 12, 2010.The initial base salary under the agreement was $70,000 and he is also eligiblefor both incentive bonuses and sales commissions, both on mutual agreed termsbetween Mr. Han and the Chief Executive Officer. In addition, Mr. Hanreceived an award of options to purchase 400,000 shares of our Common Stock atan exercise price of $0.30 per share, which will vest ratably on an annualbasis over four years from the date of grant. Mr. Han is also eligible toparticipate in any “Investment Plans” and “Welfare Plans” (as defined in theemployment agreement) to the extent applicable generally to our otheremployees. Mr. Han is not entitled to severance upon termination of hisemployment.

 

The employment agreement also provided for certain severance paymentsto Mr. Han described in greater detail below in the section titled “PotentialPayments upon Termination or Change in Control.”

 

Additionally,following termination Mr. Han will be subject to non-competition and non-solicitationprovisions for a twelve month period following his termination and ongoingconfidentiality.  On July 1, 2007, Mr. Hanwas appointed our Vice President, Sales.

 

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**OUTSTANDING EQUITY AWARDS AT FISCAL YEAREND**

 

The following table reflects outstanding stock optionsheld by the Named Executive Officers as of June 30, 2008.

 
| ** **              | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#)** | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#)** | ** ** | **Option  Exercise  Price** | ** ** | **Option  Expiration** | ** ** |
|-------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------|------------|------------------------|------------|
| **Name**                | ** ** | **Exercisable**                                                       | ** ** | **Unexercisable**                                                     | ** ** | **($)**                     | ** ** | **Date**               | ** ** |
| ** **              | ** ** | ** **                                                            | ** ** | ** **                                                            | ** ** | ** **                  | ** ** | ** **             | ** ** |
| Luis A. Rivera          |       |                                                                  |       |                                                                  |       |                        |       |                   |       |
| President and  Chief    |       | 1,935,612                                                             |       | 1,664,388                                                             | (1)        | 0.30                        |       | 5/6/2015               |       |
| Executive  Officer      |       |                                                                  |       |                                                                  |       |                        |       |                   |       |
|                    |       |                                                                  |       |                                                                  |       |                        |       |                   |       |
| Peter Biro (2)          |       |                                                                  |       |                                                                  |       |                        |       |                   |       |
| Former Chief  Operating |       |                                                                  |       |                                                                  |       |                        |       |                   |       |
| Officer                 |       |                                                                  |       |                                                                  |       |                        |       |                   |       |
|                    |       |                                                                  |       |                                                                  |       |                        |       |                   |       |
| Sean Ryan               |       |                                                                  |       |                                                                  |       |                        |       |                   |       |
| Senior Vice  President, |       | 100,000                                                               |       | 300,000                                                               | (3)        | 0.90                        |       | 5/31/2017              |       |
| Engineering             |       |                                                                  |       | 250,000                                                               | (4)        | 0.89                        |       | 2/19/2018              |       |
|                    |       |                                                                  |       |                                                                  |       |                        |       |                   |       |
| Jason Han               |       |                                                                  |       |                                                                  |       |                        |       |                   |       |
| Vice President,  Sales  |       | 300,000                                                               |       | 100,000                                                               | (5)        | 0.30                        |       | 5/6/2015               |       |

 

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| (1)    |   | The Compensation Committee granted these options to  Mr. Rivera on May 6, 2005. The awards vest and become exercisable  in equal quarterly installments over a four year period beginning  June 30, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (2)    |   | Mr Biro resigned from the Company on January 28,  2008 as an employee and Chief Operating Officer. In connection with his  resignation, Mr. Biro entered into an agreement that awarded him among  other things, options for a total of 100,000 shares granted under the  Non-Statutory Stock Option Agreement dated August 17, 2006, between the  Company and Mr. Biro, that would vest and become exercisable following  his resignation, with half vesting on February 17, 2008, and half  vesting on May 17, 2008, (b) options for 75,000 shares granted  under the Non-Statutory Stock Option Agreement dated May 8, 2007,  between the Company and Mr. Biro, would vest on May 8, 2008, and  (c) all options granted to Mr. Biro that had vested prior to the  effectiveness of his resignation or that vest and become exercisable pursuant  to clauses (a) and (b) above would remain exercisable until  June 30, 2008. Mr. Biro did not exercise any of his options and his  options on 700,000 shares have been forfeited and cancelled. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (3)    |   | The Compensation Committee granted this option to  Mr. Ryan on May 31, 2007. The award vests and becomes exercisable  in four equal annual installments beginning May 31, 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (4)    |   | The Compensation Committee granted these options to  Mr. Ryan on February 19, 2008. The awards vest and become  exercisable in four equal annual installments beginning on February 19,  2009.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (5)    |   | The Compensation Committee granted these options to  Mr. Han on May 6, 2005. The awards vest and become exercisable in  four equal annual installments beginning May 31, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

 

**PENSION BENEFITS, NONQUALIFIED DEFERRED COMPENSATION ANDOTHER BENEFITS**

 

We do not sponsor or maintain either a defined benefit plan or anonqualified deferred compensation plan for the benefit of our employees.

 

All executive officers are eligible to participate in our 401(k) planand other benefit programs as described below. All executive officers are eligible to participate in the group healthand 401(k) plans under the same terms and conditions as all otheremployees with the exception that, by the terms of his employment contract, theemployee contribution of the Chief Executive Officer Luis Rivera, under ourhealthcare plan is paid by us.  Theseamounts are disclosed in the Summary Compensation Table above.

 

Our 401(k) plan provides for employer matching funds of up to 50percent of the first six percent of an employee’s salary for all qualifyingemployees including executive officers. We do not provide any other retirementbenefits or tax-qualified deferred compensation plans or programs for ourexecutive officers, nor do we provide a nonqualified deferred compensationplan.

 

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**POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL**

 

*Mr. Rivera*.Pursuant to his employment agreement, in the event Mr. Rivera’s employmentis terminated for good reason or without cause, Mr. Rivera will beentitled to the following:

 

A lump sum severance payment equal to 1.5 times his thencurrent base salary;

 

Any annual bonus awarded to Mr. Rivera prior to thedate of termination but not yet paid;

 

Mr. Rivera’s annual base salary through the date oftermination to the extent not yet paid;

 

Any compensation previously deferred by Mr. Rivera;

 

Any unreimbursed business expenses;

 

Any “accrued investments” (as defined in the employmentagreement); and

 

Any “accrued welfare benefits”, including any amounts owedas a result of accrued vacation.

 

At the end of fiscal year 2008, these provisions would have entitled Mr. Riverato $300,000 plus any other amounts accrued but not yet paid.  Mr. Rivera’s agreement also providesthat any amounts, payments, entitlements and benefits earned, accrued or owingbut not yet paid will be made in the event of his death or disability or if hisemployment is terminated for cause. Mr. Rivera’s agreement does notcontain a provision for additional payment based on a change of control;however, we will require any successor to us to assume expressly and agree toperform this employment agreement in the same manner and to the same extentthat we would be required to perform.

 

Under the terms of the agreement: (i) “cause” means (a) thefailure of Mr. Rivera to materially perform his obligations and dutieshereunder to our satisfaction, which failure is not remedied within 45 daysafter receipt of written notice from us, (b) commission by Mr. Riveraof an act of fraud upon, or willful gross misconduct toward, us or any of ouraffiliates, (c) a material breach by Employee of certain sections of theagreement, which in either case is not remedied within 15 business days afterreceipt of written notice from us or our Board of Directors , (d) theconviction of Mr. Rivera of any felony (or a plea of nolocontenderethereto) or any crime involving moral turpitude, or (e) the failure of Mr. Riverato carry out, or comply with, in any material respect any directive of theBoard of Directors consistent with the terms of the agreement, which is notremedied within 30 business days after receipt of written notice from us or ourBoard of Directors; and (ii) “good reason” shall mean any material breachby us of any provision of the agreement, and shall also include our (or oursuccessors and assigns) substantially altering the position, geographiclocation, or responsibilities of Mr. Rivera during the term of hisemployment.

 

*Mr. Biro*. Mr. Biro’semployment agreement provided that, in the event his employment is terminatedfor good reason or without cause, Mr. Biro was entitled to the following:

 

A lump sum severance payment equal to his then current basesalary;

 

Any annual bonus awarded to Mr. Biro prior to the dateof termination but not yet paid;

 

Mr. Biro’s annual base salary through the date oftermination to the extent not yet paid;

 

Any compensation previously deferred by Mr. Biro;

 

Any unreimbursed business expenses;

 

Any “accrued investments” (as defined in the employmentagreement); and

 

Any “accrued welfare benefits”, including any amounts owedas a result of accrued vacation.

 

At the end of fiscal year 2008, these provisions would have entitled Mr. Biro(had he remained employed) to $190,000 (subject to mitigation) plus any otheramounts accrued but not yet paid.  Mr. Biro’sagreement also provided that any amounts, payments, entitlements and benefitsearned, accrued or owing but not yet paid will be made in the event of hisdeath or disability or if his employment is terminated for cause.  Mr. Biro’s agreement did not contain aprovision for additional payment based on a change of control; however, we willrequire any successor to us to assume expressly and agree to perform thisemployment agreement in the same manner and to the same extent that we would berequired to perform.

 

Under the terms of the agreement: (i) “cause” meant (a) thefailure of Mr. Biro to perform his obligations and duties hereunder to oursatisfaction, which failure is not remedied within fifteen (15) days afterreceipt of written notice from us, (b) commission by Mr. Biro of anact of fraud upon, or willful misconduct toward, us or any of our affiliates, (c) amaterial breach by Mr. Biro of certain sections of the agreement, which ineither case is not remedied within fifteen (15) days after receipt of writtennotice from us or our 

 

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Board ofDirectors; (iv) the conviction of Mr. Biro of any felony (or a pleaof nolo contendere thereto) or any crime involving moral turpitude; or (v) thefailure of Mr. Biro to carry out, or comply with, in any material respectany directive of the Board consistent with the terms of this Agreement, whichis not remedied within fifteen (15) days after receipt of written notice fromus or our Board of Directors; and (ii) “good reason” means (w) amaterial reduction in the nature or scope of Mr. Biro’s responsibilitiesor authorities that is not consented to or approved by him, (x) anyfailure by us to comply in any material respect with the compensationprovisions of the agreement that is not consented to or approved by Mr. Biro,(y) failure by us to comply with any other material term or provision ofthe agreement, or (z) the relocation or transfer of Mr. Biro’sprincipal office to a location more than 50 miles from the city of Boston,Massachusetts.

 

As described above, Mr. Biro resigned from his position asemployee and Chief Operating Officer on January 28, 2008.  Mr. Biro was not entitled to severancepursuant to his employment agreement as described above, however, in connectionwith his resignation we entered into an agreement with Mr. Biro to provideseverance in the amount of $47,500 as follows: (i) $23,750 to be paidimmediately and (ii) $23,750 payable on June 30, 2008. In addition,the we also agreed that, (a) options for a total of 100,000 shares grantedunder the Non-Statutory Stock Option Agreement dated August 17, 2006,between the Company and Mr. Biro, would vest and become exercisablefollowing his resignation, with half vesting on February 17, 2008, andhalf vesting on May 17, 2008, (b) options for 75,000 shares grantedunder the Non-Statutory Stock Option Agreement dated May 8, 2007, betweenthe Company and Mr. Biro, would vest on May 8, 2008, and (c) alloptions granted to Mr. Biro that had vested prior to the effectiveness ofhis resignation or that vest and become exercisable pursuant to clauses (a) and(b) above would remain exercisable until June 30, 2008. Mr. Birodid not exercise any of his options and they have been forfeited and cancelled.

 

*Mr. Ryan*Mr. Ryan’sagreement provides that, in the event his employment is terminated withoutcause, we shall pay to Mr. Ryan an amount equal to six months of hiscurrent annual base salary at the time of termination.  At the end of fiscal year 2008 this provisionwould have entitled Mr. Ryan to $112,500 plus any other amounts accruedbut not yet paid.  Mr. Ryan’sagreement does not contain a provision for additional payment based on a changeof control; however, we will require any successor to us to assume expresslyand agree to perform this employment agreement in the same manner and to thesame extent that we would be required to perform.

 

Under the terms of the agreement: “cause” means (a) the failure ofMr. Ryan to perform his obligations and duties hereunder to thesatisfaction of us, which failure is not remedied within 15 days after receiptof written notice from us, (b) commission by Mr. Ryan of an act offraud upon, or willful misconduct toward, us or any of our affiliates, (c) amaterial. breach by Mr. Ryan of certain sections of our ProprietaryInformation and Inventions Agreement (“PIAA”), which in either case is notremedied within 15 days after receipt of written notice from us or our Board ofDirectors, (d) the conviction of the executive of any felony (or a plea ofnolocontendere thereto) or any crime involving moral turpitude,or (e) the failure of Mr. Ryan to carry out, or comply with, in anymaterial respect any directive of the Board of Directors consistent with theterms of the PIAA, which is not remedied within 15 days after receipt ofwritten notice from us or our Board of Directors.

 

*Mr. Han*. Mr. Han’semployment agreement provides that, in the event his employment is terminatedfor good reason or without cause, Mr. Han will be entitled to thefollowing:

 

A lump sum severance payment equal to his then current basesalary:

 

Any annual bonus awarded to Mr. Han prior to the dateof termination but not yet paid;

 

Mr. Han’s annual base salary through the date oftermination to the extent not yet paid;

 

Any compensation previously deferred by Mr. Han;

 

Any unreimbursed business expenses;

 

Any “accrued investments” (as defined in the employmentagreement); and

 

Any “accrued welfare benefits”, including any amounts owedas a result of accrued vacation.

 

At the end of fiscal year 2008, these provisions would have entitled Mr. Hanto $170,000 plus any other amounts accrued but not yet paid.  Mr. Han’s agreement also provides thatany amounts, payments, entitlements and benefits earned, accrued or owing butnot yet paid will be made in the event of his death or disability or if hisemployment is terminated for cause. Mr. Han’s agreement does not contain aprovision for additional payment based on a change of control; however, we willrequire any successor to us to assume expressly and agree to perform thisemployment agreement in the same manner and to the same extent that we would berequired to perform.

 

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Under the terms of the agreement: (i) “cause” means (a) thefailure of Mr. Han to perform his obligations and duties hereunder to thesatisfaction of us, which failure is not remedied within 15 days after receiptof written notice from us, (b) commission by Mr. Han of an act offraud upon, or willful misconduct toward, us or any of our affiliates, (c) amaterial. breach by Mr. Han of certain sections of the agreement, which ineither case is not remedied within 15 days after receipt of written notice fromus or our Board of Directors, (d) the conviction of the executive of anyfelony (or a plea of nolocontendere thereto) or any crimeinvolving moral turpitude, or (e) the failure of Mr. Han to carryout, or comply with, in any material respect any directive of the Board ofDirectors consistent with the terms of the agreement, which is not remediedwithin 15 days after receipt of written notice from us or our Board ofDirectors; and (ii) “good reason” shall mean any material breach by us ofany provision of the agreement.

 

Additionally, the 2005 Plan gives the Compensation Committee thediscretion (but does not require it) to vest options outstanding under the 2005Plan upon us having a change in control. The option agreements for each of the named executive officers providethat within one year following us having a change in control, if the executive’semployment is terminated without cause by us, or with good reason by theexecutive (in each case as defined in the option agreement), any options thatwould have become exercisable on or prior to the one year anniversary followingthe termination shall become immediately exercisable and shall remainexercisable until the earlier of the first anniversary of the termination ofemployment or the earlier expiration of the option in accordance with its terms.  With respect to each of the named executiveofficers (other than Mr. Biro) such accelerated vesting, assuming aqualifying termination on June 30, 2008, would have resulted in thevesting of an additional 900,000 shares for Mr. Rivera (with a value of $333,000),137,500 shares for Mr. Ryan, and an additional 100,000 shares for Mr. Han(with a value of $37,000).  The valueassociated with this accelerated vesting was calculated utilizing thedifference between the exercise price of the option shares being acceleratedand the closing price of our common stock of $0.67 on June 30, 2008.  The exercise price of each of Mr. Ryan’soptions exceeds $0.67 and, therefore, no value has been assigned to hispotential vesting acceleration.  Mr. Biro’soption agreements provided that all of his options would become exercisableimmediately prior to us having a change in control, however, his optionsterminated on June 20, 2008 as described above.

 

**COMPENSATION OF DIRECTORS**

 

We provide each non-employee director with an annual retainer of$25,000. Each director receives a fee of $1,000 per meeting attended, plusout-of-pocket expenses. In addition, members of board committees receive a feeof $1,000, plus out-of-pocket expenses, for each non-telephonic committeemeeting attended that is not scheduled in conjunction with a meeting of thefull Board of Directors, and a fee of $500, plus out-of-pocket expenses, foreach non-telephonic committee meeting attended in conjunction with a meeting ofthe full Board of Directors and for each telephonic meeting of any committee ofthe Board of Directors.  Our executiveofficers do not receive additional compensation for serving on the Board ofDirectors.  Mr. Comfort, ourChairman of the Board, and Mr. Urry have waived all retainers and fees fortheir services.  On October 11,2005, Mr. DeSantis Cuadra was granted 120,968 restricted shares of CommonStock under the J. L. Halsey Corporation 2005 Equity-Based Compensation Plan,which began vesting ratably on a quarterly basis on January 11, 2006 andcontinues vesting through October 11, 2008.  Mr. DeSantis Cuadra’s shares weregranted in lieu of $75,000 to be received in future annual director retainerfees over the three-year period following the date of grant.

 

**Director Compensation Table**

 

The table below summarizes the compensation paid to our independentdirectors for the fiscal year ended June 30, 2008.

 
| **Name**                    | ** ** | **Fees Earned or  Paid in Cash   ($)** | ** ** | **Stock Awards  ($)** | ** ** | **Total  ($)** | ** ** |
|-----------------------------|------------|-----------------------------------------------------------------|------------|----------------------------|------------|----------------|------------|
| ** **                  | ** ** | ** **                                                      | ** ** | ** **                 | ** ** | ** **     | ** ** |
| Andrew Richard  Blair       |       | 27,000                                                          | (1)        | —                     |       | 27,000         |       |
| William T.  Comfort III (2) |       | —                                                          |       | —                     |       | —         |       |
| Nicolas De  Santis Cuadra   |       | 2,000                                                           | (3)        | 26,397                     | (4)        | 28,397         |       |
| James A. Urry (2)           |       | —                                                          |       | —                     |       | —         |       |

 

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| (1)    |   | Fees are for $25,000 annual retainer and four telephonic  Audit Committee meetings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
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| (2)    |   | Messrs. Comfort and Urry have waived all retainers  and fees.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
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| (3)    |   | Fees are for four telephonic Audit Committee meetings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (4)    |   | On October 11, 2005, Mr. DeSantis Cuadra  was granted 120,968 restricted shares of Common Stock under the J. L. Halsey  Corporation 2005 Equity-Based Compensation Plan, which began vesting ratably  on a quarterly basis on January 11, 2006, and continues through  October 11, 2008. Mr. DeSantis Cuadra’s shares were granted in lieu  of $75,000 to be received in future annual director retainer fees over the  three-year period following the date of grant. As of the end of fiscal year  2008, 20,165****of these shares  remain unvested. We account for the cost of stock-based compensation in  accordance with FAS 123(R), under which the cost of equity awards to  employees and directors is measured by the fair value of the awards on their  grant date and is recognized over the vesting periods of the awards, whether  or not the awards had any intrinsic value during the period. The grant date  fair value of the restricted stock granted to Mr. DeSantis Cuadra was  $78,629.  Amounts shown in the table  above reflect the dollar amount recognized for financial statement reporting  purposes for fiscal year 2008 in accordance with SFAS 123(R) and thus  may include amounts from awards granted in and prior to fiscal year 2008. Mr. DeSantis  Cuadra is entitled to receive dividends on the restricted stock underlying  this grant along with our other stockholders, although we do not expect to  declare dividends on our common stock in the foreseeable future. |

 

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**ITEM 12.  SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS.**

 

The following table sets forth information with respect to thebeneficial ownership of the Common Stock as of September 2**,**2008 by:

 

·each stockholder known by us to beneficially own more than five percent of theCommon Stock;

 

·each of our directors;

 

·each of our named executive officers; and

 

·all directors and executive officers as a group.

 

We have determined beneficial ownership in accordance with the rules ofthe SEC. Unless otherwise indicated, the persons included in this table havesole voting and investment power with respect to all the shares of Common Stockbeneficially owned by them, subject to applicable community property laws.

 
| **Name of Beneficial Owner (a)** | ** ** | **Amount and Nature  of Beneficial  Ownership** | ** ** | **Percentage of  Outstanding Shares** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | ** **                                                     | ** ** | ** **                                      | ** ** |
| LDN Stuyvie  Partnership                             |       | 42,353,126                                                     | (b)        | 39.5                                            | %          |
| David R. Burt                                        |       | 8,010,000                                                      | (c)        | 7.5                                             | %          |
| Luis A. Rivera                                       |       | 3,230,612                                                      | (d)        | 3.0                                             | %          |
| Andrew Richard  Blair                                |       | 1,002,200                                                      | (e)        | *                                               |       |
| Robb Wilson                                          |       | 451,500                                                        | (f)        | *                                               |       |
| Jason Han                                            |       | 400,000                                                        | (g)        | *                                               |       |
| Nicolas De  Santis Cuadra                            |       | 120,968                                                        | ** ** | *****                                           | ** ** |
| Sean Ryan                                            |       | 100,000                                                        |       | *                                               |       |
| James A. Urry                                        |       | 0                                                              | (h)        | *                                               |       |
| Peter Biro                                           |       | 0                                                              |       | *                                               |       |
| Directors and  Officers as a group (12 persons)      |       | 55,668,406                                                     |       | 52.0                                            | %          |

 

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| *      |   | Represents  beneficial ownership of less than 1%.                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (a)    |   | Information  as to the interests of the directors and officers has been furnished in part  by them. The inclusion of information concerning shares held by or for their  spouses or children or by corporations or other entities in which they have  an interest does not constitute an admission by such persons of beneficial  ownership thereof. Unless otherwise indicated, the address of each director  and officer listed is 103 Foulk Rd., Suite 205Q, Wilmington, Delaware  19803. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (b)    |   | LDN  Stuyvie Partnership is a limited partnership, the sole general partner of  which is William T. Comfort III, our Chairman of the Board. The address of  LDN Stuyvie Partnership is 127-131 Sloane St., 4th Floor, Liscartan  House, SWIX 9AS, London, UK.                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (c)    |   | Consists  entirely of shares held by a family limited partnership, the general partner  of which is controlled by Mr. Burt.                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (d)    |   | Includes  3,060,612 shares of common stock subject to stock options held by Mr. Rivera  on September 2, 2008 and exercisable within 60 days thereafter.                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (e)    |   | The  shares reported by Mr. Blair consist of 825,000 shares owned by  Mr. Blair and his wife, 60,000 owned by Freimark, Blair & Co.  pension fund and 117,200 owned by the Blair Family Trust.                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (f)    |   | Includes  450,000 shares of common stock subject to stock options held by  Mr. Wilson on September 2, 2008 and exercisable within 60 days  thereafter.                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (g)    |   | Includes  300,000 shares of common stock subject to stock options held by Mr. Han  on September 2, 2008 and exercisable within 60 days thereafter.                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (h)    |   | Does  not include the 42,353,126 shares beneficially owned by LDN Stuyvie  Partnership, of which Mr. Urry’s spouse is a partner. Mr. Urry’s  spouse has no dispositive or voting authority with respect to the shares  beneficially owned by LDN Stuyvie Partnership, and Mr. Urry disclaims  beneficial ownership of such shares.                                                                                                                                       |

 

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**Equity Compensation Plan Information**

 
| **Plan  Category**                                          | ** ** | **Number  of securities to be   issued upon exercise of  outstanding options, warrants  and rights  (a)** | ** ** | **Weighted-average  exercise of  outstanding options, warrants  and rights  (b)** | ** ** | **Number  of securities   remaining available for future  issuance under compensation  plans (excluding securities  related in (a))  (c)** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                        |       |                                                                                                      |       |                                                                              |       |                                                                                                                                       |       |
| Equity  compensation plans approved by security holders     |       | 11,046,700                                                                                                |       | $                                                                                 | 0.60       |                                                                                                                                       | 1,396,921  |   |
| Equity  compensation plans not approved by security holders |       |                                                                                                      |       | —                                                                            |       | —                                                                                                                                     |       |
|                                                        |       |                                                                                                      |       |                                                                              |       |                                                                                                                                       |       |
| Total                                                       |       | 11,046,700                                                                                                |       | $                                                                                 | 0.60       |                                                                                                                                       | 1,396,921  |   |

 

We established the EquityBased Compensation Plan on May 6, 2005. The Equity Based Compensation Planprovides for grants of stock options and stock-based awards to our employees,directors, and consultants. Stock options issued in connection with the EquityBased Compensation Plan are granted with an exercise price per share equal tothe fair market value of a share of our common stock at the date of grant. Allstock options have ten-year maximum terms and vest, either quarterly orannually and all within four years of grant date. The total number of shares ofcommon stock issuable under the Equity Based Compensation Plan is 13,200,000.At June 30, 2008, there were 1,396,921 shares available for grant underthe Equity Based Compensation Plan.

 

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**ITEM13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS.**

 

**TRANSACTIONS AND AGREEMENTS**

 

**NotePayable**

 

Commodore Resources(Nevada), Inc. (“Commodore”), one of our wholly-owned subsidiaries,executed a promissory note in favor of The John Buckman and Jan Hanford Trust(the “Trust”) in the amount of $5.6 million as part of the acquisition ofLyris Technologies on May 12, 2005. The note bore interest at the rate of10% per annum. The note and accrued interest were to become due on May 12,2007, subject to the satisfaction of the following conditions:

 

·                     Total revenue of LyrisTechnologies for the twelve month periods ended March 31, 2006 and 2007,taken in the aggregate, must be equal to or greater than $24.0 million.  The total revenue of Lyris Technologies forthe twenty-four month period ended March 31, 2007 was approximately $36.3million, which exceeds the specified revenue target of $24.0 million as statedin the note.

 

·                     The amountsdue on the note are reduced by certain royalty payments that we are required tomake.  In the quarter ended June 30, 2006 we reduced the note by$103,760, in the quarter ended December 31, 2006 we reduced the note by$99,756 and in the quarter ended March 31, 2007 we reduced the note by$94,953 related to these payments.

 

On March 31,2007, we executed an amended and restated promissory note, effective as of May 12,2005, in the principal amount of $5.6 million (the “Amended and Restated Note”)payable to the Trust.  Under the terms of the Amended and Restated Note,the maturity of the obligation was extended to November 12, 2008, and webecame obligated to make the following payments (constituting both principaland interest, in accordance with the terms of the Amended and Restated Note) tothe Trust: (a) $1,000,000 due May 12, 2007; (b) $1,453,447 due February 12,2008; (c) $4,687,666 due November 12, 2008. We paid $1,000,000 to theTrust on May 14, 2007.

 

On January 23,2008, LDN Stuyvie Partnership (“LDN Stuyvie”), which is controlled by thenon-executive chairman of our board of directors, William T. Comfort III,purchased the Amended and Restated Note from the Trust from the sellers ofLyris Technologies, at a discount of 10% for a total purchase price of $5.2million.  On February 12, 2008, theAmended and Restated Note was amended to extend the due date of the nextpayment thereunder to November 12, 2008, the maturity date of the Amendedand Restated Note.

 

On March 5, 2008, weentered into a Subscription Agreement (the “LDN Stuyvie Subscription Agreement”)with LDN Stuyvie. Pursuant to the LDN Stuyvie Subscription Agreement, LDNStuyvie purchased 6,520,374 shares of our common stock at a purchase price of$1.05 per share or $6,846,392.37 in the aggregate. The aggregate purchase pricewas satisfied by LDN Stuyvie as follows: (1) payment of $1.0 million in cash;and (2) termination of our obligations under the Amended and RestatedNote.

 

**Resignation of Former Director**

 

On March 7, 2007,the Board of Directors accepted the resignation of David R. Burt, our directorand former Chief Executive Officer (“Burt”).  In connection with theresignation, we, Burt, Texas Addison Limited Partnership (“Addison”), LDNStuyvie and Andrew Richard Blair (“Blair”), entered into an Agreement andMutual Release, dated March 8, 2007 (the “Release”).   Blair is a member of our Board of Directorsand LDN Stuyvie is controlled by Mr. Comfort, the chairman of our Board ofDirectors.

 

Pursuant to the Release,Addison, which is controlled by Burt, agreed to sell (A) to LDN, and LDNagreed to purchase from Addison, 4,166,667 shares (the “LDN Sale Shares”) ofCommon Stock and (B) to Blair, and Blair agreed to purchase from Addison,333,333 shares (the “Blair Sale Shares” and together with the LDN Sale Shares,the “Sale Shares”) of Common Stock.  The purchase price paid by LDN andBlair for the Sale Shares was $0.75 per share, or an aggregate of$3,375,000.  The closing of the purchase of the Sale Shares by LDN andBlair occurred on March 16, 2007.  In addition, we waived thetransfer restrictions on the remaining Common Stock owned by Burt and Addisonin order to permit them to sell such Common Stock on the open market; provided,that (A) the amount of Common Stock sold in any 90-day period shall notexceed 300,000 shares (or such greater or lesser number to appropriatelyreflect adjustments for stock splits, stock dividends, or similar actions by uswith respect to the Common Stock), (B) all sales of Common Stock sold byAddison or Burt pursuant to this provision are to be effected through theDesignated Brokerage Firm (defined below) and (C) neither Burt nor Addisonwill undertake a sale of Common Stock to any Person (defined below) whereby, tothe knowledge of Burt or Addison, such sale would (1) cause the Transferee(defined below) to have a Prohibited Ownership Percentage or (2) increasethe ownership percentage of any Person already having a Prohibited OwnershipPercentage (defined below).  For purposes of the Release, the “DesignatedBrokerage Firm” means (a) Freimark Blair & Company, Inc. (“Freimark

 

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Blair”), an entitycontrolled by Blair, or (b) any office of Smith Barney; provided, however,**that Smith Barney may only be used in theevent (1) Blair retires or terminates his relationship with FreimarkBlair; (2) Freimark Blair is unable for any reason whatsoever to providethe brokerage services necessary for Burt and/or Addison to sell the sharespermitted under this provision of the Agreement; or (3) Blair or FreimarkBlair engage or propose to engage in conduct that is outside the reasonablenorms of the brokerage industry.  For purposes of the Release, the terms “Transferee”,“Prohibited Ownership Percentage” and “Person” have the meanings given suchterms in Article Fifth of our Certificate of Incorporation.  Once thenumber of shares of Common Stock owned by Burt falls below a ProhibitedOwnership Percentage, Burt and Addison shall be free to sell shares of CommonStock without restriction, other than restrictions imposed by law.

 

Also in connection withBurt’s resignation and pursuant to the terms of the Release, we and Burtprovided general releases of claims (other than certain types of claimsspecified in the Agreement) to each other and their respectiveaffiliates.  In addition, we agreed to pay to Burt a total of $359,000representing bonuses earned by Burt at the time he was employed by us as anofficer.  The exact amount of bonuses earned by Burt was in dispute andthe amount agreed upon represented a settlement between the parties.  Such bonus amount is to be paid as follows: (i) $30,000on the first business day of each month beginning in March 2007 (providedthat the payment due in March 2007 shall be made concurrently with theclosing of the sale of the Sale Shares to LDN and Blair) and ending on thefirst business day of January 2008, and (ii) $29,000 on the firstbusiness day of February 2008.

 

**Indemnification Agreements**

 

We have entered intoindemnification agreements with our directors other than Mr. Urry and Mr. Rivera.Under these agreements, we are obligated to indemnify the directors to thefullest extent permitted under the Delaware General Corporation Law forexpenses, including attorneys’ fees, judgments, fines and settlement amountsincurred by them in any action or proceeding arising out of their services as adirector.  We believe that theseindemnification agreements are helpful in attracting and retaining qualifieddirectors, and intend to enter into such agreements with Messrs. Urry andRivera in the near future.

 

**Policiesand Procedures**

 

Under SEC rules, publicissuers such as us must disclose certain transactions with related persons.These are transactions in which we are a participant where the amount involvedexceeds $120,000, and a member of our Board of Directors, an executive officeror a holder of more than 5% of our common stock has a direct or indirectmaterial interest.

 

To date we have notadopted a formal written policy with respect to such related-party transactions.  However, an informal, unwritten policy hasbeen in place whereby all such related-party transactions are reported to, andapproved by, the full Board of Directors (other than any interested director).  Factors considered by the Board of Directorswhen deliberating such transactions include:

 

·                  whether theterms of such transaction are fair to us;

 

·                  whether thetransaction are consistent with, and contribute to, our growth strategy; and

 

·                  what impact,if any, such transaction will have on the transfer restrictions currently inplace with respect to our Common Stock.

 

The agreements andtransactions listed above (other than the indemnification agreements) were allapproved by the full Board of Directors (other than those directors withinterests in the transactions).

 

Given the SEC’s reportingrequirements, the Board of Directors is considering whether to adopt a formalwritten policy with respect to related-party transactions.

 

**DIRECTOR INDEPENDENCE**

 

We have adopted theNASDAQ Stock Market’s standards for determining the independence of directors.  Under these standards, an independentdirector means a person other than an executive officer or one of our employeesor any other individual 

 

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having a relationshipwhich, in the opinion of the Board of Directors, would interfere with theexercise of independent judgment in carrying out the responsibilities of adirector.  In addition, the followingpersons shall not be considered independent:

 

·                  A director who is, or at any time during the pastthree years was, employed by us;

 

·                  a director who accepted or who has a family memberwho accepted any compensation from us in excess of $100,000 during any periodof twelve consecutive months within the three years preceding the determinationof independence, other than the following:

 

·      compensationfor service on the Board of Directors or any committee thereof;

 

·      compensationpaid to a family member who is one of our employees (other than an executiveofficer); or

 

·      under atax-qualified retirement plan, or non-discretionary compensation;

 

·                  a director who is a family member of an individualwho is, or at any time during the past three years was, employed by us as anexecutive officer;

 

·                  a director who is, or has a family member who is, apartner in, or a controlling shareholder or an executive officer of, anyorganization to which we made, or from which we received, payments for propertyor services in the current or any of the past three fiscal years that exceed 5%of the recipient’s consolidated gross revenues for that year, or $200,000,whichever is more, other than the following:

 

·      paymentsarising solely from investments in our securities; or

 

·      paymentsunder non-discretionary charitable contribution matching programs;

 

·                  a director who is, or has a family member who is,employed as an executive officer of another entity where at any time during thepast three years any of our executive officers serve on the compensationcommittee of such other entity; or

 

·                  a director who is, or has a family member who is, acurrent partner of our outside auditor, or was a partner or employee of ouroutside auditor who worked on our audit at any time during any of the past threeyears.

 

For purposes of theNASDAQ independence standards, the term “family member” means a person’sspouse, parents, children and siblings, whether by blood, marriage or adoption,or anyone residing in such person’s home.

 

The Board of Directorshas assessed the independence of each non-employee director under theindependence standards of the NASDAQ Stock Market set forth above, and hasaffirmatively determined that all four non-employee directors (Messrs. Blair,Comfort, De Santis Cuadra and Urry) are independent.

 

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**ITEM 14. PRINCIPAL ACCOUNTINGFEES AND SERVICES.**

 

# **AUDIT FEES**

# ** **

The following table setsforth the fees paid to Burr, Pilger & Mayer LLP andPricewaterhouseCoopers LLP for services provided during fiscal 2008 and 2007:

 
| **(In thousands)**  | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Audit Fees (1) |       | $        |  409  |     | $          |  348 |   |
| Audit-Related  Fees (2)  |       | 5        |       | 150      |       |
|                     |       |     |       |     |       |
| Total                    |       | $        | 414        |     | $          | 498 |   |

 

----

(1) Represents fees for professional services rendered in connectionwith the audit of our annual financial statements and review of our quarterlyfinancial statements.

 

(2) Represents fees for professional services rendered in connectionwith the acquisitions of Lyris Technologies, Inc., Uptilt, Inc.,ClickTracks Analytics, Inc. and Hot Banana Software, Inc.

 

The Audit Committee hasadopted 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.  In situations where it is impractical to waituntil the regularly scheduled quarterly meeting, the Audit Committee maydelegate authority to approve the audit, audit-related, tax and other servicesto a member of the committee up to a certain pre-determined level as approvedby the Audit Committee.  During fiscalyears 2007 and 2008, 14 percent and 0% percent, respectively, of theAudit-Related fees described above were not pre-approved by the Audit Committee.

 

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**PART IV**

 

**ITEM 15. EXHIBITS AND FINANCIALSTATEMENT SCHEDULES**

 

a)              The financialstatements filed as part of this Annual Report at Item 8 are listed in theFinancial Statements and Supplementary Data on page 41 of this AnnualReport.  All other consolidated financialschedules are omitted because they are inapplicable, not required, or theinformation is included elsewhere in the consolidated financial statements or thenotes thereto.

b)             See Schedule II:  Appendix A – Valuation and QualifyingAccounts, on Page 71

c)              The followingdocuments are filed or incorporated by reference as exhibits to this Report:

 

**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 2(a)                 |       | 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 filed with  the Securities and Exchange Commission on May 12, 2005).                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 2(b)                 |       | Agreement and  Plan of Merger by and among Commodore Resources (Nevada), Inc., Halsey  Acquisition Delaware, Inc, Uptilt Inc., David Sousa, in his capacity as  Representative, and the Company, dated October 3, 2005 (incorporated by  reference to the Company’s Current Report on Form 8-K filed with the  Securities and Exchange Commission on October 14, 2005).                                                                                                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 2(c)                 |       | Agreement and  Plan of Merger, dated as of August 16, 2006, by and among the Company,  Commodore Resources (Nevada), Inc., Halsey Acquisition  California, Inc., ClickTracks Analytics, Inc., the Shareholders  listed therein and John Marshall (as representative) (incorporated by  reference to Exhibit 2.1 to the Company’s Current Report on  Form 8-K filed with the Securities and Exchange Commission on  August 22, 2006).                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 2(d)                 |       | Share Purchase  Agreement, dated August 18, 2006, by and among 1254412 Alberta ULC, an  unlimited liability company formed under the laws of the Province of Alberta,  the Company, Krista Lariviere, Chris Adams, 1706379 Ontario Inc., a  corporation formed under the laws of the Province of Ontario and 1706380  Ontario Inc., a corporation formed under the laws of the Province of Ontario  (incorporated by reference to Exhibit 2.2 to the Company’s Current  Report on Form 8-K filed with the Securities and Exchange Commission on  August 22, 2006). |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3(a)(i)              |       | Certificate of  Incorporation of the Company (incorporated by reference to Exhibit 3(a)(i) to  the Company’s Annual Report on Form 10-K for the year ended June 30,2007).                                                                                                                                                                                                                                                                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3(a)(ii)             |       | Certificate of  Amendment to Certificate of Incorporation of the Company (incorporated by  reference to Exhibit 3(a)(ii) to the Company’s Annual Report on Form 10-K  for the year ended June 30,2007).                                                                                                                                                                                                                                                                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3(a)(iii)            |       | Certificate of  Ownership and Merger, merging NAHC, Inc. with and into J. L. Halsey  Corporation (incorporated by reference to Exhibit 3(a)(iii) to the  Company’s Annual Report on Form 10-K for the year ended June 30,2007).                                                                                                                                                                                                                                                                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3(b)                 |       | First Amended  and Restated Bylaws of the Company, as amended as of February 14, 2007  (incorporated by reference to Exhibit 3.2 to the Company’s Current  Report on Form 8-K filed with the Securities and Exchange Commission on  February 21, 2007).                                                                                                                                                                                                                                                                                                            |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(a)(i)†        |       | 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 filed with  the Securities and Exchange Commission on May 12, 2005).                                                                                                                                                                                                                                                                                                                                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4(a)(ii)†       |       | First Amendment  to the J. L. Halsey Corporation 2005 Equity-Based Compensation Plan (incorporated  by reference to Exhibit 4(a)(ii) to the Company’s Annual Report on Form 10-K  for the year ended June 30,2007).                                                                                                                                                                                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10(a)†          |       | Amended and  Restated Employment Agreement dated as of September 27, 2000, between  NAHC Inc. and David R. Burt (incorporated by reference to  Exhibit 10(k)(i) to NAHC, Inc.’s Annual Report on  Form 10-K for the year ended June 30, 2000).                                                                                                                                                                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10(b)†          |       | Convertible  Subordinated Note dated as of September 27, 2000, issued by NAHC Inc. to  David R. Burt (incorporated by reference to  Exhibit 10(k)(ii) to NAHC, Inc.’s Annual Report on  Form 10-K for the year ended June 30, 2000).                                                                                                                                                                                                                                                                                                                |

 

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                              |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                         |
| 10(c)(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(c)(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(d)†          |       | 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(e)                |       | Stock Purchase  Agreement, dated as of December 13, 2002, by and between the Company and  The University of Chicago Law School (incorporated by reference to  Exhibit 10(h) to the Company’s Annual Report on Form 10-K for  the year ended June 30, 2004).                                                                                                    |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                         |
| 10(f)†          |       | 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 filed with  the Securities and Exchange Commission on May 12, 2005).                                                                                   |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                         |
| 10(g)(i)             |       | Promissory Note  from Commodore Resources, Inc., a subsidiary of the Company, in favor of  The John Buckman and Jan Hanford Trust, dated May 12, 2005 (incorporated  by reference to Exhibit 10(j) to the Company’s Annual Report on  Form 10-K for the year ended June 30, 2005).                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                         |
| 10(g)(ii)            |       | Amended and  Restated Promissory Note dated March 31, 2007, by Commodore  Resources, Inc. in favor of The John Buckman and Jan Hanford Trust  (incorporated by reference to Exhibit 10.2 to the Company’s Current  Report on Form 8-K filed with the Securities and Exchange Commission on  April 5, 2007).                                                    |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                         |
| 10(g)(iii)           |       | Subordination  Agreement dated March 31, 2007, by and between The John Buckman and Jan  Hanford Trust and Comerica Bank (incorporated by reference to  Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with  the Securities and Exchange Commission on April 5, 2007).                                                                               |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                         |
| 10(h)                |       | Guaranty,  entered into by the Company on May 12, 2005, guaranteeing payment by  Commodore Resources, Inc. to The John Buckman and Jan Hanford Trust of  the amount specified in the Promissory Note dated May 12, 2005  (incorporated by reference to Exhibit 10(k) to the Company’s Annual  Report on Form 10-K for the year ended June 30, 2005). |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                         |
| 10(i)†          |       | Employment  Agreement effective May 12, 2005, between Lyris and Luis A. Rivera  (incorporated by reference to Exhibit 10(l) to the Company’s Annual  Report on Form 10-K for the year ended June 30, 2005).                                                                                                                                                    |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                         |
| 10(j)†          |       | Employment  Agreement effective May 12, 2005, between Lyris and Robb Wilson (incorporated  by reference to Exhibit 10(j) to the Company’s Annual Report on Form 10-K  for the year ended June 30,2007).                                                                                                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                         |
| 10(k)†          |       | Employment  Agreement dated as of August 29, 2005, between Lyris and Joseph Lambert  (incorporated by reference to Exhibit 10(m) to the Company’s Annual  Report on Form 10-K for the year ended June 30, 2005).                                                                                                                                               |

 

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|----------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(l)*†         |       | Employment  Agreement effective August 17, 2006, between the Company and Peter  Biro(incorporated by reference to Exhibit 10(n) to the Company’s  Annual Report on Form 10-K for the year ended June 30, 2006).                                                                                                                                                                                                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(m) *†   |       | Agreement and  Release effective January 28, 2008 between the Company and Peter Biro  (incorporated by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K filed with the Securities and Exchange Commission on  January 30, 2008).                                                                                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(m)(ii)            |       | First Amendment  to Loan and Security Agreement, effective as of April 25, 2006, by and  among Comerica Bank and Commodore Resources (Nevada), Inc., Lyris  Technologies, Inc. and Uptilt Inc. (incorporated by reference to  Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the  quarter ended March 31, 2006).                                                                                                                                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(m)(iii)           |       | Second Amendment  to Loan and Security Agreement, effective as of August 18, 2006, by and  among Comerica Bank and Commodore Resources (Nevada), Inc., Lyris  Technologies, Inc. and Uptilt Inc. (incorporated by reference to  Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the  quarter ended September 30, 2006).                                                                                                                                                     |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(m)(iv)            |       | Third Amendment  to Loan and Security Agreement, effective as of November 30, 2006, by  and among Comerica Bank, Commodore Resources (Nevada), Inc., Lyris  Technologies, Uptilt Inc., MCC Nevada, Inc. and ClickTracks  Analytics, Inc. (incorporated by reference to Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the Securities and Exchange  Commission on December 6, 2006).                                                                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(m)(v)             |       | Fourth Amendment  to Loan and Security Agreement, effective as of January 30, 2007, by and  among Comerica Bank and Commodore Resources (Nevada), Inc., Lyris  Technologies, Inc., Uptilt, Inc., MCC Nevada, Inc. and  ClickTracks Analytics, Inc. (incorporated by reference to  Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with  the Securities and Exchange Commission on March 5, 2007).                                                             |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(m)(vi)            |       | Fifth Amendment  to Loan and Security Agreement, effective as of March 31, 2007, by and  among Comerica Bank and Commodore Resources (Nevada), Inc., Lyris  Technologies, Inc., Uptilt, Inc., MCC Nevada, Inc.,  ClickTracks Analytics, Inc., Admiral Management Company and the Company  (incorporated by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K filed with the Securities and Exchange Commission on  April 5, 2007).                      |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(m)(vii)           |       | Amended and  Restated Loan and Security Agreement effective as of March 6, 2008, by  and among Comerica Bank and Lyris, Inc., Lyris Technologies, Inc.  and Commodore Resources (Nevada), Inc. (incorporated by reference to  Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with  the Securities and Exchange Commission on March 11, 2008).                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(m)(viii)          |       | First Amendment  to Amended and Restated Loan and Security Agreement effective as of  July 30, 2008, by and among Comerica Bank and Lyris, Inc., Lyris  Technologies, Inc. and Commodore Resources (Nevada), Inc.  (incorporated by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K filed with the Securities and Exchange Commission on  August 4, 2008).                                                                                                      |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(m)(vix)           |       | Waiver Letter from Comerica Bank, dated September 12, 2008, related  to a violation of Section 6.7(b)(ii) of the Amended and Restated  Loan and Security Agreement, dated as of March 6, 2008, by and among  Comerica Bank, Lyris, Inc., Lyris Technologies, Inc and Commodore  Resources (Nevada), Inc., (incorporated by reference to Exhibit 10.1  to the Company’s Current Report on Form 8-K filed with the Securities  and Exchange Commission on September 15, 2008). |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(o)†          |       | Restricted Stock  Award Agreement, dated October 11, 2005, by and between the Company and  Nicolas DeSantis Cuadra (incorporated by reference to Exhibit 10.1 to  the Company’s Current Report on Form 8-K filed with the Securities and  Exchange Commission on October 14, 2005).                                                                                                                                                                                                                   |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10(p)                |       | Promissory Note,  dated August 16, 2006, in the amount of $10,000,000 from the Company to  LDN Stuyvie Partnership (incorporated by reference to Exhibit 2.3 to the  Company’s Current Report on Form 8-K filed with the Securities and  Exchange Commission on August 22, 2006).                                                                                                                                                                                                                     |

 

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                      |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10(q)(i)             |       | Backstop  Agreement, dated August 16, 2006, by and between the Company and LDN  Stuyvie Partnership (incorporated by reference to Exhibit 2.4 to the  Company’s Current Report on Form 8-K filed with the Securities and  Exchange Commission on August 22, 2006).                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10(q)(ii)            |       | First Amendment  to Backstop Agreement, dated as of December 5, 2006, by and between the  Company and LDN Stuyvie Partnership (incorporated by reference to  Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with  the Securities and Exchange Commission on December 6, 2006).                                                                                              |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10(r)†          |       | Agreement and  Mutual Release, dated March 8, 2007, by and among the Company, LDN  Stuyvie Partnership, Texas Addison Limited Partnership, David R. Burt and  Andrew Richard Blair (incorporated by reference to Exhibit 10.1 to the  Company’s Current Report on Form 8-K filed with the Securities and  Exchange Commission on March 12, 2007).                                           |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10(s)                |       | Agreement and  Waiver, entered into as of June 8, 2007, by and among the Company,  Commodore Resources (Nevada), Inc., Lyris Technologies, Inc.,  ClickTracks Analytics, Inc., John Marshall and Lisa Deverse  (incorporated by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K filed with the Securities and Exchange Commission on  June 14, 2007). |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 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, 2003).                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 21*                  |       | Subsidiaries of  the Company.                                                                                                                                                                                                                                                                                                                                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 31.1*                |       | Certification of  Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a)                                                                                                                                                                                                                                                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 31.2*                |       | Certification of  Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a)                                                                                                                                                                                                                                                                                                                                  |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 32.1*                |       | Section 1350  Certification                                                                                                                                                                                                                                                                                                                                                                                     |

 

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| *      | Filed herewith                                                                                                                                   |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|
| † | Indicates  management contracts or compensatory plans, contracts or arrangements in  which any director or named executive officer participates. |

 

Copies of the exhibits filed with this Annual Report on Form 10-Kor incorporated by reference herein do not accompany copies hereof fordistribution to our stockholders. We will furnish a copy of any of suchexhibits to any stockholder requesting the same.

 

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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 16,2008

 
|   | LYRIS, INC. |
|--------|-------------|
|   |        |
|   | By:         | /s/ Luis A. Rivera |
|   |        | LUIS A. RIVERA |
|   |        | Chief  Executive Officer and President |

 

 

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 16,  2008 |
| (WILLIAM T.  COMFORT, III)   |       |                                                     |       |                     |
|                              |       |                                                     |       |                     |
| /s/ Luis A. Rivera                |       | Chief Executive  Officer, President (Principal Executive |       | September 16,  2008 |
| (LUIS A. RIVERA)                  |       | Officer) and Director                                    |       |                     |
|                              |       |                                                     |       |                     |
| /s/ Andrew Richard  Blair         |       | Director                                                 |       | September 16,  2008 |
| (ANDREW RICHARD BLAIR)            |       |                                                     |       |                     |
|                              |       |                                                     |       |                     |
| /s/ Nicolas DeSantis  Cuadra      |       | Director                                                 |       | September 16,  2008 |
| (NICOLAS DESANTIS  CUADRA)        |       |                                                     |       |                     |
|                              |       |                                                     |       |                     |
| /s/ James A. Urry                 |       | Director                                                 |       | September 16,  2008 |
| (JAMES A. URRY)                   |       |                                                     |       |                     |
|                              |       |                                                     |       |                     |
| /s/ Heidi L. Mackintosh           |       | Chief Financial Officer  (Principal Financial and        |       | September16,  2008       |
| (HEIDI L. MACKINTOSH)             |       | Accounting Officer),  Secretary and Treasurer            |       |                     |

 

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