**FORM 10-K**

**SECURITIES ANDEXCHANGE COMMISSION**Washington, D.C. 20549

**ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(d) ofthe SECURITIES EXCHANGE ACT OF 1934**

**For the fiscalyear ended June 30, 2006**

**Commission file number 1-10875**

**J. L. HALSEY CORPORATION******(exact name ofregistrant as specified in its charter)

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

 

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

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

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

Indicate by check mark if the Registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o    No  x

Indicated by check mark if the Registrant is not required to file reportspursuant to Section 13 or Section 15(d) of the Act.  Yes  o    No  x

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.  Yes  x    No  o

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of Registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. x

Indicate bycheckmark whether the Registrant is a larger accelerated filer, an acceleratedfiler, or a non-accelerated filer. See definition of “accelerated filer andlarger accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)

Large Acceleratedfiler  o                                  Acceleratedfiler  o                                             Non-accelerated filer  x

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

As of December 30, 2005, the aggregate market value of the shares ofcommon stock held by non-affiliates was approximately $29,012,691(Determination of stock ownership by non-affiliates was made solely for thepurpose of responding to this requirement and the Registrant is not bound bythis determination for any other purpose.)

There were 85,387,095 shares of the Registrant’s common stock outstandingas of September 15, 2006.

DOCUMENTS INCORPORATED BY REFERENCE

None

 

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**J. L. HALSEY CORPORATION ANDSUBSIDIARIES**

**FORM 10-K – FISCAL YEAR ENDED JUNE30, 2006**

**Contents and Cross Reference SheetFurnished Pursuant to General Instruction G(4) of Form 10-K**
| Item No.   | ** ** | **Description**                                                                             | ** ** | ** ** |
|------------|------------|---------------------------------------------------------------------------------------------|------------|------------|
|       |       |                                                                                        |       |       |
|       |       | PART I                                                                                      |       |       |
|       |       |                                                                                        |       |       |
| Item  1.   |       | Business                                                                                    |       |       |
| Item  2.   |       | Properties                                                                                  |       |       |
| Item 3.    |       | Legal Proceedings                                                                           |       |       |
| Item 4.    |       | Submission of  Matters to a Vote of Security Holders                                        |       |       |
|       |       |                                                                                        |       |       |
|       |       | PART II                                                                                     |       |       |
|       |       |                                                                                        |       |       |
| Item 5.    |       | Market for  Registrant’s Common Equity and Related Stockholder Matters                 |       |       |
| Item 6.    |       | Selected Financial  Data                                                                    |       |       |
| Item 7.    |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       |       |
| Item 7A.   |       | Quantitative  and Qualitative Disclosures about Market Risk                                 |       |       |
| Item 8.    |       | Financial  Statements and Supplementary Data                                                |       |       |
| Item 9.    |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosures      |       |       |
| Item 9A.   |       | Controls and  Procedures                                                                    |       |       |
| Item 9B.   |       | Other Information                                                                           |       |       |
|       |       |                                                                                        |       |       |
|       |       | PART III                                                                                    |       |       |
|       |       |                                                                                        |       |       |
| Item 10.   |       | Directors and  Executive Officers of the Registrant                                         |       |       |
| Item 11.   |       | Executive  Compensation                                                                     |       |       |
| Item 12.   |       | Security  Ownership of Certain Beneficial Owners                                            |       |       |
| Item 13.   |       | Certain  Relationships and Related Transactions                                             |       |       |
| Item 14.   |       | Principal  Accountant Fees and Services                                                     |       |       |
|       |       |                                                                                        |       |       |
|       |       | PART IV                                                                                     |       |       |
|       |       |                                                                                        |       |       |
| Item 15.   |       | Exhibits,  Financial Statement Schedules                                                    |       |       |
|       |       |                                                                                        |       |       |
| Signatures |       |                                                                                        |

 

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**PART I**

**Forward-LookingInformation**

*This Annual Report includes forward-looking statementsrelated to future events and our future performance within the meaning ofSection 27A of 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 the business, financial condition and resultsof operations of the Company as well as the value of the Company’s common stock.We undertake no obligation to publicly release any revisions to theseforward-looking statements that may be made to reflect events or circumstancesafter the date hereof or to reflect the occurrence of unanticipated events.Readers are urged, however, to review the factors set forth in reports that wefile from time to time with the Securities and Exchange Commission. Unless thecontext requires otherwise in this Annual Report the terms “Halsey,” the “Company,”“we,” “us” and “our” refer to J.L Halsey Corporation and its subsidiaries.*

**ITEM 1.**                    BUSINESS

**Overview**

J. L. Halsey Corporation,through its wholly-owned subsidiaries, Lyris Technologies, Inc. (“Lyris”),Uptilt, Inc. (d/b/a “EmailLabs”), ClickTracks, Inc. (“ClickTracks”) and HotBanana Software Inc. (“Hot Banana) is a leading marketing technology andservices firm.  Lyris and EmailLabsdevelop and sell email marketing technology and solutions.  ClickTracks develops and sells WebAnalyticstechnology and solutions.  Hot Bananadevelops and sells web content management solutions for marketers.  Our primary customers are people engaged inonline marketing at small and medium-sized organizations or subsidiaries oflarge enterprises.  The Company’s emailmarketing software and services provide clients with leading solutions forcreating, managing and delivering online permission-based direct marketingprograms, newsletters, discussion groups and other digital communications toclients whose email lists require specialized technology in order to effectivelycommunicate with their members and customers. The Company offers its emailsolutions in two forms:  as software thatis downloaded and installed on a customer’s computers, and as a hosted solutionin which the customer uses the Company’s software through an internetconnection.

In August 2006, theCompany acquired ClickTracks and Hot Banana (see Note 19 to the CondensedConsolidated Financial Statements).  Eachof the ClickTracks and Hot Banana acquisitions occurred after the Company’sfiscal year end and therefore financial results relating to these subsidiariesare not included in the Condensed Consolidated Financial Statements.

ClickTracks is aWeb analytics provider based in Santa Cruz, California and Hot Banana is ane-marketing Web content management company based in Ontario, Canada.  Clicktracks’ web analytics software andservices provide clients with leading solutions for analyzing the behavior ofvisitors to their websites and managing pay-per-click (PPC) campaigns.  The Company offers its analytics solutions intwo forms:  as software that isdownloaded and installed on a customer’s computers, and as a hosted solution inwhich the customer uses the Company’s software through an internetconnection.  Clicktracks offers webanalytics software and hosting to 8,000 customers worldwide.

Hot Banana is aWeb Content Management Suite (Web CMS) that assists marketers in managing a Website’s content creation, publishing and optimization process.  Clients use Hot Banana to achieve greaterefficiencies and realize more revenue through more efficient control of theircorporate web sites, intranets, extranets, landing pages and micro marketingsites.  Hot Banana sells their softwareon an installed basis and as a hosted solution in which the customer uses the Company’ssoftware through an internet connection. The Company serves more than 200 companies worldwide in more than 16languages.

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***OurProducts and Services***

***ListManager***.  Corporations, governments, not-for-profitorganizations, political campaigns, universities, and other groups andorganizations have large lists of people with whom they want to communicate byemail.  These lists can range fromhundreds to thousands to millions of email addresses.  For the past ten years, Lyris has developedand licensed software, called *ListManager*,which can manage these email address lists. This software enables customers todevelop, send and monitor complex email mailings reliably.  The software also permits organizations todesign email campaigns that are customized to their members’ preferences.Customers can obtain the benefits of the *ListManager*functionality in two ways: first by installing software on their own computer;or second, by logging onto Lyris’ servers via the internet on a hosted basis.

Lyris offers hostedemail marketing solutions based on the *ListManager*platformunder two brands: *ListHosting*and *SparkList*.  Theseservices enable clients to create, send and monitor email campaigns with only aweb browser and without the need for their own engineering and equipmentsupport.  For these clients, emailadministration and security are outsourced and they can manage mailing lists,as well as direct marketing campaigns, newsletters and discussion groups whilesupported by Lyris’ data facility and technical staff.

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

***EmailLabs***.  For the past seven years, EmailLabs hasdeveloped and licensed software called EmailLabs, which manages email listssimilar to those managed by Lyris.  Thissoftware enables customers to develop, send and monitor complex email mailingsreliably, and to customize the design of the mailings to their members’preferences.  Customers obtain thebenefits of EmailLabs functionality primarily by logging onto EmailLabs’ seversvia the internet on a hosted basis.

Over ninety-seven percent (97%) of EmailLabs’ revenue comefrom the sale of the use of EmailLabs on a hosted basis, and from relatedsupport and maintenance services.

***Clicktracks. ***For the past four years, Clicktracks has developed andlicensed web analytics software. Clicktracks offers four different types of products, all of which enablecustomers to track and report on basic statistics about the behavior ofvisitors to their websites.  Theseproducts are based on the same code base and are branded Analyzer, Optimizer,Professional, and JDC.  Clicktracks alsosells software to agencies and ISPs, who run the software on behalf of othercustomers.  Most of Clicktracks revenuecomes from the sale of installed software.

***Hot Banana.*** Hot Banana is the successor organization to a company founded in 2001and sells two products.  The first is HotBanana Web Content Management Suite, which enables customers to manage moreeasily content across their different web properties, including corporate websites, intranets, extranets, landing pages and micro marketing sites.  The second is branded Hot Banana ActiveMarketing Suite, which integrates several features including contentmanagement, web analytics, e-mail marketing, and event registration to enable amarketing person to effectively plan and execute web-centric marketing campaigns.  Most of Hot Banana’s revenue comes from thesale of software on an installed basis together with professional servicesincluding creative design, content creation, and other web site developmentservices.

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

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

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Lyris offersanother software product called *MailEngine*.  *MailEngine* isan SMTP Mail Transfer Agent (“MTA”). This is the software that actually sends the email out through theinternet’s mail system.  Companiespartner *MailEngine* with their own internalsystems to send high volumes of email.

***Customers***

Over 4,000 customers have purchased *ListManager*software and more than 1,600 customers use our software on a hosted basis.  Our customers include several departments ofthe U.S. government, national political campaigns, local governments andpolitical campaigns, Fortune 500 and smaller companies including many topsoftware companies, and some of the largest and most reputable academicorganizations, charitable organizations and athletic teams.

***Strategy***

Our primary goalis to create value for our stockholders by creating and delivering efficientlyand profitably a leading set of products to our customers.  We hope to sell products and services atquality and price points that deliver value for our customers.  To accomplish these goals and objectives ouraim is to become a leader in developing and selling technology solutions fordigital marketers.  Our primary focus ison digital marketers at small and medium size organizations.  We intend to achieve this objective byimproving and diversifying our current product offerings through research anddevelopment as well as through strategic acquisitions. In particular, webelieve there is an opportunity to provide a wider array of services to ourclients, and in particular, provide more integrated solutions that satisfy theneeds of our customers.  Because weoperate in a fragmented market, characterized by a large number of smallcompetitors and a handful of medium-sized competitors, we believe there may bean opportunity to create stockholder value by acquiring competing andcomplementary businesses.  Throughacquisitions, we endeavor to expand our customer base and diversify and deepenour technology offerings. We are currently seeking acquisitions and as notedabove, on August 18, 2006, we acquired ClickTracks and Hot Banana.

***Salesand Marketing***

Lyris’ sales andmarketing activities are based in its Emeryville, California headquarters.  The sales team is structured by product, withone team focused exclusively on software and the other on hosted solutions.  As of June 30, 2006, Lyris’ sales andmarketing organization consisted of 11 employees.  Lyris’ marketing efforts consist of tradeshows, limited print advertising, and Internet advertising including “pay-per-click”(PPC) marketing on major search engines including Google and Yahoo!.

EmailLabs’ salesand marketing activities are based in its Menlo Park headquarters.  The sales team is structuredgeographically.  As of June 30, 2006,EmailLabs’ sale and marketing organization consisted of 14 employees.  EmailLabs’ marketing efforts consist of tradeshows, limited print advertising, and Internet advertising including PPC onmajor search engines including Google and Yahoo!.

ClickTrack’s salesand marketing activities are based in its Santa Cruz headquarters.  The sales team is structuredgeographically.  As of August 18, 2006,ClickTrack’s sales and marketing organization consisted of 10 employees.  ClickTracks marketing efforts consist oftrade shows, limited print advertising, and Internet advertising including PPCmarketing on major search engines including Google and Yahoo!.

Hot Banana’ssales, marketing and software development activities are based in its Barrie,Ontario headquarters.  The sales team isstructured by direct and channel sales. As of August 18, 2006, Hot Banana’s sales, marketing and softwaredevelopment organization consisted of 9 employees.  Hot Banana’s marketing efforts consist oftrade shows, limited print advertising, and Internet advertising including PPCmarketing on major search engines including Google and Yahoo!.

***CustomerService and Support***

We believe thatcustomer service and support are important components in successfully sellingsoftware and hosting services.

Lyris providescustomer service and support in three levels. First, all *ListManager* customers receive “includedsupport,” which provides free web access to our online support databases andthirty days of email assistance.  Second,

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customers may purchasetwo levels of paid support.  The firstlevel, referred to as Essential Support, provides email assistance and freeaccess to minor upgrades during the term of the support contract.  Customers also have the option of purchasingComprehensive Support, which includes email and telephone support (subject tocertain limits) and free access to minor and major upgrades for a period of oneyear.

For *SparkList* and Lyris *ListHosting*, weoffer free access to our online support databases as well as web seminars onthe fundamentals of our hosted products as well as on the basics of emailmarketing and communication. Additionally, upgrades are automatically deployed to clients since theservice is provided using Lyris’ servers on a hosted basis.

EmailLabs provides application support forphone and email queries to all clients. Other online help tools are provided. Its standard contract allows for 2 hours of support per month, with afee for additional hours as used.  Eachclient goes through a standard one to two-hour personalized trainingsession.  Additional customized trainingsessions are available at a charge.  Aswith the Lyris hosted products, upgrades to the EmailLabs product are alsoautomatically deployed to clients since it is a hosted service.

Clicktracks provides technical support via anonline ticketing system to all existing customers under a current maintenancecontract (based on named key contacts) as well as and prospectivecustomers.  Normal support hours are 7amto 6pm US Pacific Time, and 8am to 5pm in the UK.  Clicktracks typically responds on the sameday that questions are received. Clicktracks periodically releases software updates with basic productimprovements.  All customers can downloadthese updates, free of charge, through Clicktracks’ website.  Major upgrades are included in the regularyearly maintenance contract.  Majorupgrades include all new features and enhancements to the program (beyond theproduct updates available to all users). Customers who require more personalized technical support can alsopurchase the Premium Support package. Premium Support guarantees four hour response time and priority routingof issues to an engineer.  PremiumSupport is 30% of the license price per year.

Hot Banana provides applications support forphone and email queries to all clients. Other online help tools are provided. Each client goes through an implementation process for a fee, andadditional customization training sessions are also available at a charge.  Upgrades to the Hot Banana product areautomatically deployed to clients at no charge since it is delivered as a hostedservice.

***Technology***

Our products are written in several computinglanguages, including C, C++, C#, and TCL, among others.  They are designed to run in conjunction witha number of different commercial database servers, including mySQL, MicrosoftSQL Server and Oracle.  Lyris’ andEmailLabs’ platforms are designed to handle hundreds of thousands of emails perhour, while emphasizing reliability, availability and security.  They automatically handle bounces due toinvalid email addresses, and track user activity after reception of the emails,such as open detection, clickthrough tracking and purchase tracking.  The information gathered from user activitiesis digested into reports, and can be used for initiating further emailcampaigns.

Our companies’ security systems control access tointernal systems and data via the Internet. Internally, log-ins and passwordsare maintained for all systems, with access control granted on an individualbasis to only the required areas for which the recipient is responsible.  Firewalls prevent unauthorized access fromoutside or access to confidential data on the inside.  We rely on certain encryption andauthentication technologies licensed from third parties to provide securetransmission of confidential information.

***Researchand Development***

Because we competein technology markets, we must try to continually innovate as fast as or fasterthan our competition. We are committed to supporting and updating our coretechnology and to expanding our product offerings to offer a leading set ofproducts which meet the needs of our customers. We are continually investing our resources in product development.

Historically, bothLyris and EmailLabs have released major upgrades to their flagship productsevery 12 to 16 months and have augmented these offerings with periodic minorupgrades.  As of June 30, 2006, we haveapproximately 42 engineers who are engaged in maintaining our current productsand researching, developing, testing and deploying new versions of Lyris andEmailLabs 

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software.  With the acquisitions of ClickTracks and HotBanana, we have added 12 engineers involved in product development.

***Operations***

Continuous datacenter operations are crucial to our success. We currently lease space andservices in secure co-location data facilities in Fremont, CA, Santa Clara, CA,Parsippany, NJ, and Menlo Park, CA.  Wealso lease space in a secure co-location data facility in Novato, California.These facilities have redundant electrical generators and UPS power suppliesthat protect the facilities, fire suppression systems, and 24x7 physicalsecurity.  All data center locations arecurrently processing outbound email.

Our networksoftware constantly monitors our systems and notifies systems engineers if anyunexpected conditions arise.

***Competition***

***General***.  We operate in extremely competitivetechnology markets.  Many of ourcompetitors have significantly greater resources (financial, technical,marketing, human capital and other resources) than we do.  We must continue to innovate as well and asfast as or faster than our competitors or we may be left behind in thecompetition for customers.  In general,the barriers to entry in software and hosting markets are considered to below.  New competitors can and will enterthe 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;

·                  Performanceand scalability;

·                  Priceand total cost of ownership;

·                  Stabilityand reliability;

·                  Qualityof the customer service and support;

·                  Brandname and reputation; and

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

***EmailMarketing Markets***

The market foremail marketing software and hosted email marketing services is fragmented withmany participants and we have several types of competitors in the emailmarket.  Some of these competitors offeran on-premise software solution, others offer a hosted service, and stillothers offer both, as we do.

There are manysmall, privately-held competitors, particularly on the hosted side.  Many competitors price their products belowour prices.  At the higher end of theemail marketing market, there are a number of large companies that compete witheither an integrated offering or that compete with large staffs of people whohelp customize the applications for their customers’ needs.  Among the companies that include emailmarketing in an integrated offering are CRM software vendors such as Siebel,EMM software vendors such as Unica, outsourced e-commerce solution providerssuch as Digital River, database marketers such as Experian (which ownsCheetahMail), Axciom (which owns Digital Impact) and Harte Hanks (which ownsPostFuture).  BigFoot Interactive andDoubleClick’s DartMail business were recently purchased 

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by Alliance Data Systems’Epsilon division, which will enable them to sell an integrated solution.  Other competitors include Silverpop,Responsys, Exact Target, Constant Contact and SubscriberMail.

***EmailSecurity and Anti-Spam Markets***

In the emailsecurity and anti-spam markets, there are a number of very large competitorsand several well-funded start-up competitors. Large companies who operate in this market include Symantec, McAfee,Microsoft, Tumbleweed and Trend Micro. Additionally, many other privately held companies compete in this space,many of whom have raised significant funding from private investors.  Some of the larger privately-held companiesinclude IronPort, Proofpoint, MXLogic, Sophos, Kaspersky Labs, andCloudmark.  Other competitors provideenabling anti-spam technology rather than an end-user solution.  Examples of such companies include Mailshell,Commtouch and MailFrontier (acquired by SonicWall).  Email security and anti-spam markets areamong the most competitive of all technology markets.

***Web Analytics Market***

In the webanalytics market, there are a number of large competitors and severalwell-funded start-up competitors.  Largecompanies who operate in this market include WebSideStory, Digital River(through its Fireclick subsidiary), Unica Software (thorough its acquisition ofSane Solutions), WebTrends, Omniture, and CoreMetrics.  Additionally, many other smaller privatelyheld companies compete in this space, including Indextools, OneStat, andManticore Technology.  The web analyticsmarket is among the 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.  Largecompanies who operate in this market include EMC (through its Documentumsubsidiary), Interwoven, Silver Lake Software, Hummingbird, and VignetteSoftware.  Additionally, many othersmaller privately held companies compete in this space, including CrownPeak,Clickability, Ektron, PaperThin, and FatWire.

***IntellectualProperty***

We have filed onepatent application that covers some of the technology developed for *EmailAdvisor*.  Weenter into confidentiality and proprietary rights agreements with ouremployees, consultants, and other third parties in order to try to protect ourtrade secrets and intellectual property. In recent years, many software companies have filed patents coveringtheir technologies.  Many of thesepatents have yet to be litigated.  Othersmay develop technologies that are similar or superior to our technology and mayreceive and enforce patents on such technology. We are aware of several issued or pending patents that may be assertedagainst us.

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

Email has been the subjectof regulation by local, state, federal and foreign governments.  In 2003, the US Congress passed the CAN-SPAMAct.  The CAN-SPAM Act of 2003 establishesthe United States’ first national standards for the sending of commercial emailand requires the Federal Trade Commission (FTC) to enforce 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).” It exempts “transactionalor relationship messages.” The bill permits email marketers to send unsolicitedcommercial email as long as it contains all of the following: an opt-outmechanism; a valid subject line and header (routing) information; and thelegitimate physical address of the mailer, among other requirements.

If a user opts out, asender has ten days to remove the address. The legislation also prohibits thesale or other transfer of an email address after an opt-out request.

We believestrongly that emailers should send email only to those who have requested orgiven permission (twice) for email to be sent. We do not permit any of its hosted customers to send SPAM, and requireby contract that our

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

***CorporateBackground***

***Acquisitionof Lyris***

On May 12, 2005,Halsey acquired all of the outstanding capital stock of Lyris.  The purchase price was $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’ achieving specified revenue targets,on the second anniversary of the closing date with interest equal to 10% perannum. With this acquisition, Halsey became a leading email marketing companywith over 5,000 customers worldwide.

***Acquisitionof EmailLabs***

On October 11,2005, Halsey acquired all of the outstanding capital stock of EmailLabs, anemail marketing technology company based in Menlo Park, California, for $24.5million (including acquisition costs and working capital adjustments of$612,000).  Of this purchase price, $19.5million was paid in cash at closing of which $2.3 million was funded byEmailLabs’ available cash.  $500,000 ofthe purchase price was held back as security against EmailLabs meeting certainagreed upon minimum working capital requirements.  This holdback, less the final working capitaladjustment was paid during the quarter ended March 31, 2006.  The agreement also includes contingent mergerconsideration consisting of two equal earn-out payments of $1.725 million dueon the first and second anniversary of the closing date if EmailLabs achievesspecified revenue targets.  With thisacquisition, Halsey extended its role in the email marketing market.

***Acquisitionof ClickTracks***

On August 18,2006, Halsey acquired all of the outstanding capital stock of ClickTracks, aWeb analytics provider based in Santa Cruz, California, for approximately $7.7million in cash and $2.9 million in common stock of the Company issued tocertain securityholders of ClickTracks. Additional payments totaling approximately $3.8 million may be made inthe event ClickTracks achieves future revenue targets and working capitaladjustments.

***Acquisitionof Hot Banana***

On August 18, 2006,Halsey acquired all of the outstanding capital stock of Hot Banana, a Webcontent management company based in Ontario, Canada, for approximately $1.9million Canadian ($1.7 million U.S. based on the then-applicable exchangerate), with additional installments of up to $750,000 Canadian ($670,661 U.S.)if Hot Banana achieves specified revenue and technology integration targets,and up to an additional $500,000 Canadian ($447,107 U.S.) payable subject toworking capital and other adjustments.

***Discontinuedoperations***

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

NovaCare sold its name aspart of the sale of the PROH business and subsequently changed its name toNAHC, Inc. (“NAHC”).  On June 18, 2002,in a transaction approved by NAHC’s stockholders at a special meeting, NAHCmerged

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with and intoHalsey, its wholly-owned subsidiary. The purpose of the merger between NAHC andHalsey was to implement transfer restrictions on the Company’s common stock inorder to preserve the Company’s net operating losses.

Prior to theacquisitions noted above, the Company spent several years maximizing the assetsthat it retained, including old accounts receivable, Medicare receivables andappeals, and tax items and to minimize liabilities retained after the sales ofthe operating businesses.  The Companyhas collected virtually all of its receivables other than amounts which are thesubject of litigation or arbitration or that have been written off.  No members of the current board were membersprior to, or at the time of, the Company selling its healthcare operatingbusinesses in 1999.

**RISKFACTORS**

*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 ourcompany. Additional risks not currently known to us or that we currently deemimmaterial may also impair our business operations. Our business, financialcondition or results of operations could be materially adversely affected byany of these risks.  This Annual Report****is qualified in its entirety by these risks.  ThisAnnual Report also contains forward-looking statements that involve risks anduncertainties. Our actual results could differ materially from thoseanticipated in these forward-looking statements as a result of certain factors,including the risks faced by us described below and elsewhere in thisreport.  The market price of our commonstock could decline due to any of these risks and uncertainties, or for otherreasons, and you may lose part or all of your investment.*

**Risks Related to Our Business and Industry**

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

More than 80% ofthe Company’s revenues come from the email marketing market – from thelicensing of**software, the saleof support and maintenance contracts related to our software, and from the sale of hosted services.  Theremainder of our revenue, with the acquisitions of ClickTracks and Hot Banana,comes from Web analytics and content management.  The markets for email marketing, web analytics,marketing content management and related services is relatively new and stillevolving.  There is no certainty regarding how or whether these marketswill develop, or whether they will experience any contractions.

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

The traditionaldirect marketing industry has typically generated lower revenues during thesummer months and higher revenues during the calendar year-end months. We believeour business may be affected by similar revenue fluctuations, but our limitedoperating history is insufficient to isolate and predict the magnitude of theseeffects. Because we may experience these effects, investors (and, possibly,securities analysts) may not be able to predict our quarterly or annualoperating results. If we fail to meet expectations of securities analysts andinvestors, our stock price could decline.

***If businesses and consumers fail to accept online directmarketing as a means to attract new customers, demand for our services may notdevelop and the price of our stock could decline.***

The market foronline direct marketing services is relatively new, rapidly evolving and ourbusiness may be harmed if sufficient demand for our services does not develop.Our current and planned services are very different from the traditionalmethods that many of our clients have historically used to attract newcustomers and maintain customer relationships.  As a result, customers andpotential customers may be reticent to try new technologies and new solutions,and the demand for our services may not develop or may decline, which couldcause 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 andplanned services enable customers to use email and the internet to increaserevenue and traffic from, and communication with, their online audiences,customers and members. Our ability to serve these customers therefore dependson their audiences continuing to use both email and the Internet ascommunications media.  If consumer adoption of either technology declines,demand for our services may not develop or may decline.

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

Adoption of emailas a communications 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 unwanted messagesbefore they reach customers’ mailboxes.  In response, spammers have becomemore sophisticated 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 foronline direct marketing is highly competitive, rapidly evolving andexperiencing rapid technological change. Intense competition may result inprice reductions, reduced sales, gross margins and operating margins, and lossof market share. Our principal competitors include providers of online directmarketing solutions such as DoubleClick, Responsys, Experian, Silverpop,Bigfoot Interactive, Exact Target, Constant Contact and InfoUSA, as well as thein-house information technology departments of our existing and prospectiveclients. The loss of a client due to service quality or technology problemscould result in reputational harm to us and, as a result, increase the effectof competition and negatively impact our ability to attract new clients.

Many of thesepotential competitors have broad distribution channels and they may bundlecomplementary products or services. Such bundled products include, but are notlimited to, web analytics, data mining, customer relationship management (CRM)systems and professional services.  If we are not able to bundlecomplementary services or continue to expand our distribution capabilities, ourresults may suffer.

In addition, weexpect competition 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 businessescould develop, market or resell a number of online direct marketing solutions.These potential competitors may also choose to enter, or have already entered,the market for online direct marketing by acquiring one of our existingcompetitors or by forming strategic alliances with a competitor. As a result offuture competition, the demand for our services could substantially decline.Any of these occurrences could harm our ability to compete effectively.

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

Our email securitybusiness faces competition from businesses that develop their own anti-spam andother messaging security technology.  These competitors vary fromenterprise software vendors such as Oracle and SAP to online service providerswho develop or bundle anti-spam, anti-virus and other messaging securitytechnology with their other products such as Symantec and NetworkAssociates.  We also face competition from large enterprise networkinfrastructure and software vendors such as Cisco Systems and Microsoft as theydiversify their product offerings.  Many of these competitors havebroad distribution channels and can bundle competing products or services. Thiscompetition poses a significant risk for us.

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

The markets forour products and services are characterized by rapid technological advances,changes in client 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 retain existingrevenue 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.***

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The development ofproprietary technology and service enhancements and the migration of customersto new technology entail significant technical and business risks and requiresubstantial expenditures and lead-time. We might not be successful in marketingand supporting recently released versions of our technology and services on atimely or cost-effective basis. In addition, even if new technology andservices are developed and released, they might not achieve market acceptance.Also, if we are not successful in a smooth migration of customers to new orenhanced technology and services, we could lose customers.

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

Barriers to entryin software 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.

***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, ourhosted services are sold pursuant to short-term subscription agreements, whichare generally six months to one year in length, with no obligation to renewthese agreements. 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 ourproducts and services are complex, they may have errors or defects that usersidentify after they begin using them, which could harm our reputation andbusiness.  In particular, our anti-spam products may identify somelegitimate emails as unwanted or unsolicited spam, or we may not be able tofilter out a sufficiently high percentage of unsolicited or unwanted messagessent to the email accounts of customers.  Complex software products likeours frequently contain undetected errors when first introduced or when newversions or enhancements are released.  In addition, we may be unable torespond in a prompt manner, or at all, to new methods of attacking a messagingsystem, such as new spamming techniques.  We have from time to time founddefects in 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 thedelivery of 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 onthe efficient 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 direct

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marketing campaigns untilthe damage is repaired, and may accordingly lose clients and revenues. Inaddition, subject to applicable insurance coverage, we may incur substantialcosts 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 tointerruptions in customer service include:  operator negligence; improperoperation by, or supervision of, employees; physical and electronic break-ins;misappropriation; computer viruses and similar events; power loss;computer systems failures; and Internet and telecommunications failures. We donot carry sufficient business interruption insurance to fully compensate us forlosses that may occur.

***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 serverscould result in the misappropriation of confidential customer information orcause interruptions in our services. It is also possible that one of ouremployees could attempt to misuse confidential customer information, exposingus to liability. In addition, our reputation may be harmed if we lose customerinformation maintained in our data warehouse due to systems interruptions orother reasons.

***If we are unable to protect our intellectual property or 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. Policingunauthorized use of our proprietary information is difficult, and we cannot becertain that the steps we have taken will prevent misappropriation,particularly in foreign countries where the laws may not protect ourproprietary rights as fully as in the United States.

We are one ofseveral companies rapidly building new technologies in this industry.  Itis possible 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 ofseveral patents that may be asserted against 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 onnon-exclusive software license rights from third parties in technologies thatare incorporated 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 license to, or the inability tosupport, maintain and enhance, software products we license from third partiescould result in our customers having to upgrade their Lyris or EmailLabsproducts. 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, ourmargins, market share and operating results could be significantly harmed. Ifany of these events occurs, our business and operating results could be harmed.

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***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 softwareand Internet industries are characterized by the existence of a large number ofpatents, trademarks and copyrights and by frequent litigation based onallegations of infringement or other violations of intellectual propertyrights. Third parties may assert patent and other intellectual propertyinfringement claims against us in the form of lawsuits, letters or other formsof communication. If a third party successfully asserts a claim that we areinfringing their proprietary rights, royalty or licensing agreements might notbe available on terms we find acceptable or at all. Because currently pendingpatent applications are not publicly available for certain periods of time, wecannot anticipate all such claims or know with certainty whether our technologyinfringes the intellectual property rights of third parties.  As a generalmatter, we do not search patent office files for patents or patent applicationsthat we may possibly infringe.  We are awareof several patents that may be asserted against us.

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

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

·                  divertmanagement’s attention;

·                  result in costlyand time-consuming litigation;

·                  require us toenter into royalty or licensing agreements, which may not be available onacceptable terms, or at all; or

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

Our servicesinvolve the transmission of information through the Internet. These servicescould be used to transmit harmful applications, negative messages, unauthorizedreproduction of copyrighted material, inaccurate data or computer viruses toend-users in the course of delivery. Any transmission of this kind could 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.

***Regulation of, and uncertainties regarding the applicationof existing laws and regulations to, online direct marketing and the Internetcould prohibit, limit or increase the cost of  our business.***

In December 2003,Congress enacted the CAN-SPAM Act of 2003, which regulates the sending ofcommercial email and pre-empts state laws regulating commercial email. The effect of this legislation on marketers is difficult to predict.  Wecannot assure you that this or future legislation regarding commercial emailwill not harm our business.  In addition, many states have passed lawsthat are significantly more punitive and difficult to comply with thanCAN-SPAM, particularly Utah and Michigan.  It is not clear to what extentthese state laws will in fact be preempted by CAN-SPAM.

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

***We have acquired all our operating businesses since May2005, and we  may continue to expandthrough acquisitions of, or investments in, other companies or through businessrelationships, all of which may divert our management’s attention, resulting inadditional dilution to our stockholders and consumption of resources that arenecessary to sustain our business.***

One of ourbusiness strategies is to acquire competing or complementary services,technologies or businesses. We also may enter into relationships with otherbusinesses in order to expand our service offerings, which could involvepreferred or exclusive licenses, additional channels of distribution ordiscount pricing or investments in other companies.

Our completedacquisitions and any future acquisition, investment or business relationshipmay result in unforeseen operating difficulties and expenditures. Inparticular, we may encounter difficulties assimilating or integrating theacquired businesses, technologies, products, personnel or operations of the acquiredcompanies, particularly if the key personnel of the acquired company choose notto work for us and we may have difficulty retaining the customers of anyacquired business due to changes in management and ownership. Acquisitions mayalso disrupt 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 benefitsof any acquisition, investment or business relationship would be realized orthat we would not be exposed to unknown liabilities, nor can we assure you thatwe will be able to complete any acquisitions on favorable terms or at all. Inconnection with one or more of those transactions, we may:

·                  issue additionalequity securities that would dilute our stockholders;

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

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

·                  incur largecharges or substantial liabilities;

·                  encounterdifficulties retaining key employees of the acquired company or integratingdiverse business cultures;

·                  become subjectto adverse tax consequences, substantial depreciation or deferred compensationcharges; and

·                  encounterunfavorable reactions from investment banking market analysts who disapprove ofour 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 existingand implement new operational, financial and management controls, reportingsystems and procedures;

·                  install newmanagement information systems; and

·                  train, motivate,retain and manage our employees.

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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 toexecute our 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 we have.In addition, in making employment decisions, particularly in the Internet andhigh-technology industries, job candidates often consider the value of thestock options they are to receive in connection with their employment.Volatility in the price of our stock may, therefore, adversely affect ourability to attract or retain key employees. Furthermore, the new requirement toexpense stock options may discourage us from granting the size or type of stockoption awards that job candidates require in order to join the Company. If wefail to attract new personnel or fail to retain and motivate our currentpersonnel, our business and future growth prospects could be severely harmed.

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

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

Our technologycurrently uses cookies, which are small files of information placed on anInternet user’s computer, to collect information about the user’s visits to thewebsites of our customers. Third-party software and our own technology make iteasy for users to block or delete our cookies. Several software programs,sometimes marketed as ad-ware or spyware detectors, block our cookies bydefault or prompt users to delete or block our cookies. If a large proportion,such as a majority, of users delete or block our cookies, this could undermine thevalue of the data that we collect for our customers and could negatively impactour ability to deliver accurate reports to our customers, which would harm ourbusiness.

Changes in webbrowsers may also encourage users to block our cookies. Microsoft, for example,frequently modifies its Internet Explorer web browser. Some modifications byMicrosoft could substantially impair our ability to use cookies for datacollection purposes. If that happens and we are unable to adapt our technologyand practices adequately in response to changes in Microsoft’s technology, thenthe value of our services will be substantially impaired. Additionally,

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other technologies couldbe developed that impede the operation of our services. These developmentscould prevent us from providing our services to our customers or reduce thevalue 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.

***We may not realize expected benefits from our acquisitions.***

We expect ouracquisitions to result in additional net revenues for the Company. Achieving the benefits of these acquisitions will depend in part on ourdemonstration to customers that the acquisitions will not result in adversechanges in client service standards.

With respect tothe integration of personnel, despite our efforts to retain the key employeesof acquired 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.

***Exposureto risks associated with our international operations could unfavorably affectour performance.***

We recentlycompleted the acquisition of Hot Banana, which is based in Ontario, Canada andwhich has significant revenues there. The success and profitability of these international operations may beadversely affected by risks associated with international activities, includingeconomic and labor conditions, tax laws and changes in the value of the U.S.dollar versus the local currencies in which Hot Banana’s business may bedenominated.  Specifically with currencyrisks, we do not currently utilize derivative instruments to hedge an exposureto fluctuation in foreign currency, including the Canadian dollar, and ourrevenues may decrease as a result of such fluctuations.

***Our operating subsidiaries are relatively young companieswith limited histories of operating results****.*

Our operatingsubsidiaries are both relatively young companies with no long-term history ofdeveloping their internal management and administration processes.  Ifeither cannot continue to develop these internal processes, its long-termresults may suffer.

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

We may requireadditional capital to fund our business. If capital requirements varymaterially from those currently planned, we may require additional financing soonerthan anticipated. Our capital requirements depend on several factors, includingthe rate of market acceptance of our products, the ability to expand our clientbase and the growth of sales and marketing. Additional financing may not beavailable when needed, on terms favorable to us or at all. If adequate fundsare not available or are not available on acceptable terms, we may be unable todevelop or enhance our services, take advantage of future opportunities orrespond to competitive pressures, which would harm our operating results andadversely affect our ability to sustain profitability.  See Note 19 on our proposed rights offeringand bridge loan.

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***MoneyBorrowed to Fund Acquisitions***

We borrowed moneyto purchase EmailLabs, ClickTracks, and Hot Banana.  (Lyris was purchased with cash onhand.).  We borrowed from Comerica, N.A.and from LDN Stuyvie Partnership.  Copiesof our agreements with these lenders have been filed with the Securities andExchange and are also described elsewhere herein.  (See Notes 6 and 19).  Our agreements with these lenders placecertain restrictions on us, including restrictions on our total borrowings, ourdebt to EBITDA ratios, and our ability to buy additional businesses, amongother restrictions.

***FutureEarn-out Payments***

Each of our fouracquisitions we have made requires us to make additional earn-out payments tothe sellers of the businesses if certain conditions are met.  Copies of the acquisition agreements havebeen filed with the SEC and are discussed elsewhere herein.  (See Notes 6, 11 and 19).  We believe that some of these conditions arelikely to be met, and, therefore, have classified specified earn-outs on ourbalance sheet as short-term or long-term debt. Our principal use of cash in the future will be the payment of earn-outsand the pay down of debt.  Based on itscurrent projections, the Company believes that it will be able to make thesepayments with its available resources. If however, operating results deteriorate or other adverse events occur,the Company will not have adequate resources to make these payments.  The Company may be forced to seek additionalresources and the cost of these resources, if available at all, may beprohibitive.

**Risksrelated to our Company 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 marketand the trading prices of Internet-related companies in particular, have beennotably volatile. This volatility is likely to continue in the short-term andis not necessarily related to the operating performance of affected companies.This broad market and industry volatility could significantly reduce the priceof our common stock at any time, without regard to our operating performance.Factors that could cause our stock price in particular to fluctuate include,but are not limited to:

·                  actual oranticipated variations in quarterly operating results;

·                  announcements oftechnological innovations by others or us;

·                  acceptance byconsumers of technologies of companies other than us;

·                  the ability tosign new clients and the retention of existing clients;

·                  new products orservices that we offer;

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

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

·                  changes infinancial estimates by securities analysts;

·                  conditions ortrends in the Internet and online commerce industries;

·                  global unrestand terrorist activities;

·            changes in theeconomic performance and/or market valuations of other Internet or onlinee-commerce  companies;

·                  required changesin generally accepted accounting principles and disclosures;

·                  our announcementof significant acquisitions, strategic partnerships, joint ventures or capitalcommitments or results of operations or other developments related to thoseacquisitions;

·                  additions ordepartures of key personnel; and

·                  sales or othertransactions involving our common stock.

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***Our executive officers and directors have control over ouraffairs.***

As of June 30,2006, our executive officers and directors and entities affiliated with thembeneficially own, in the aggregate, approximately 40% of our commonstock.  As a group they control and they will likely be able to continueto control our business. These stockholders have the ability to exertsubstantial influence over all matters requiring approval by our stockholders,including the election and removal of directors and any merger, consolidationor sale of all or substantially all of our assets. This concentration ofownership could have the effect of delaying, deferring or preventing a changeof control or impeding a merger or consolidation, takeover or other businesscombination.  See Note 19 on our proposedrights offering and bridge loan.

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

Trading markets for common stock rely in part on theresearch and reports that industry or financial analysts would publish about usor our business. Currently, no securities analysts cover our stock.  As aresult, we lack visibility in the market.  In addition, if one or moreanalysts initiate coverage with an unattractive rating, our stock price wouldlikely decline rapidly.  There is also little liquidity in the trading ofour stock and therefore it may be more difficult for investors to sell commonstock in our company.  Sales of large blocks of stock may have asignificantly greater negative impact because of the lack of liquidity.

***The stock transfer restrictions implemented in the merger ofNAHC, Inc. and J. L. Halsey Corporation may delay or prevent takeover bidsby third parties and may delay or frustrate any attempt by stockholders toreplace or remove the current management.***

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

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

Our ability to useour potential tax benefits in future years will depend upon the amount of ourotherwise taxable income. If Lyris and EmailLabs generate insufficient taxableincome in future years, the NOLs will not be needed or used and therefore willprovide no benefit to the Company. If the Company experiences a change ofownership within the meaning of Section 382 of the Internal Revenue Code,the Company will not be able to realize the benefit of its net operating loss,capital loss and tax credit carryforwards.

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

The Companycontinues to manage a relatively small number of legacy assets and liabilitiesremaining from the period prior to the sale of its operating businesses in1999.  These remaining legacy assets consist of restricted cash, oldreceivables that are the subject of litigation or arbitration, and appeals ofMedicare related claims.  The Company has established significant reservesagainst these assets because of the uncertainty regarding our ability tocollect on these assets.

The Company isdefending one remaining lawsuit against us. Our management believes that weshould prevail in this case.  However, there is uncertainty and costrelated to the claims.  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 the Company. For more information regarding thislawsuit, please see Note 16 to the Condensed Consolidated Financial Statements.

***Provisions in our certificate of incorporation and bylawsmight discourage, delay or prevent a change of control of the Company orchanges in our management and, therefore, depress the trading price of ourcommon stock.***

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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 a change ofcontrol of the Company or changes in our management that the stockholders ofour company may deem advantageous. These provisions:

·                  establish aclassified board of directors so that not all members of our board are electedat one time;

·                  provide thatdirectors may only be removed “for cause” and only with the approval of 66 2/3%of our stockholders;

·                  requiresuper-majority voting to amend some provisions in our amended and restatedcertificate of incorporation;

·                  authorize theissuance of “blank check” preferred stock that our board of directors couldissue to increase the number of outstanding shares to discourage a takeover attempt;

·                  provide that theboard of directors is expressly authorized to make, alter or repeal our bylaws;and

·                  establishadvance notice requirements for nominations for elections to our board or forproposing matters that can be acted upon by stockholders at stockholdermeetings.

***We incur significant costs as a result of being a publiccompany****.*

As a publiccompany, we incur significant legal, accounting and other expenses that thebusinesses which we have acquired did not incur as private companies. In addition,the Sarbanes-Oxley Act of 2002, as well as new rules implemented by theSEC require changes in corporate governance practices of public companies. Weexpect these new rules and regulations to significantly increase our legaland financial costs.

***New accounting standards or interpretations of existingaccounting standards could adversely affect our operating results****.*

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

For example, werecognize software license revenue in accordance with Statement of Position, orSOP 97-2,*“Software Revenue Recognition,”*as amended by SOP 98-9,*“SoftwareRevenue Recognition with Respect to Certain Transactions*.” TheAmerican Institute of Certified Public Accountants and the SEC continue toissue interpretations and guidance for applying the relevant accountingstandards to a wide range of sales contract terms and business arrangementsthat are prevalent in software licensing arrangements. As a result of futureinterpretations or applications of existing accounting standards, includingSOP 97-2 and SOP 98-9, by regulators or our internal or independentaccountants, we could be required to delay revenue recognition into futureperiods, which would adversely affect our operating results.

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

In December 2004,the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123R), “*Share-Based Payment.” *SFASNo. 123 (R) replaces SFAS No. 123,” *Accounting for Stock-BasedCompensation”*and supersedes APB Opinion No. 25.  Generally, the approach in SFAS No. 123(R) issimilar to the approach described in SFAS No. 123 for fair value. However, SFASNo. 123(R) requires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the financial statements based ontheir fair values and prohibits pro forma disclosure as an alternative tofinancial statement recognition.  SFASNo. 123(R) became effective and was adopted by the Company beginning in thefirst quarter of fiscal 2006.  Theadoption of SFAS 123(R) has had an impact on our financial statements.

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In September 2006, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (SFAS) No. 157, *“FairValue Measurements,”*(“SFAS No. 157”).  This Statement defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles (GAAP), and expands disclosures about fair valuemeasurements.  This Statement iseffective for financial statements issued for fiscal years beginning after November15, 2007, and interim periods within those fiscal years.  The Company is currently evaluating theimpact of SFAS No. 157 on the Company’s consolidated financial statements.

In February 2006, theFASB issued SFAS No. 155, *“Accounting forCertain Hybrid Financial Instruments”* (“SFAS No. 155”) which amendsSFAS No. 133, *“Accounting for DerivativeInstruments and Hedging Activities”* (SFAS No. 133”) and SFAS No.140, *“Accounting for Transfers and Servicingof Financial Assets and Extinguishments of Liabilities”* (“SFAS No.140”).  SFAS No. 155 simplifies theaccounting for certain derivatives embedded in other financial instruments byallowing them to be accounted for as a whole if the holder elects to accountfor the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFASNo. 133 and SFAS No. 140.  SFAS No. 155is effective for all financial instruments acquired, issued or subject to aremeasurement event occurring in fiscal years beginning after September 15,2006.  Management believes that theadoption of SFAS No. 155 will not have a material impact on our financialstatements.

In June 2005, the FASBissued SFAS No. 154 *“Accounting Changes andError Corrections,”* (“SFAS No. 154”).  SFAS No. 154 replaces Accounting PrinciplesBoard Option No. 20 (“APB 20) and SFAS No. 3, *“ReportingAccounting Changes in Interim Financial Statements,”* and applies toall voluntary changes in accounting principle, and changes the requirements foraccounting for and reporting of a change in accounting principle.  APB 20 previously required that mostvoluntary changes in accounting principle be recognized by including in netincome of the period of change a cumulative effect of changing to the newaccounting principle whereas SFAS No. 154 requires retroactive application toprior periods’ financial statements unless it is impracticable.  SFAS No. 154 enhances the consistency offinancial information between periods. SFAS No. 154 is effective for fiscal years beginning after December 15,2005, and is required to be adopted by the Company in the first quarter offiscal year 2007.  Management believesthat the adoption of SFAS No. 154 will not have a material impact on ourfinancial statements.

In June 2006, theFASB issued Interpretation No. 48, “*Accountingfor Uncertainty in Income Taxes - an interpretation of FASB Statement 109*,’’(“FIN 48”).  FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with SFAS 109, *``Accounting for Income Taxes.”*FIN 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. FIN 48 is effective for fiscal years beginning after December 15,2006.  Management is currently assessingin the impact of FIN 48 on the Company’s consolidated financial statements.

In March 2005, theFASB issued Interpretation No. 47, *``Accountingfor Conditional Asset Retirement Obligations,”*(“FIN 47”).* *FIN 47provides clarification regarding the meaning of the term ``conditional assetretirement obligation’’ as used in SFAS No. 143,*“Accounting for Asset Retirement Obligations,”*(“SFAS 143”).This Interpretation is effective no later than the end of fiscal years endingafter December 15, 2005. The adoption of FIN 47 did not have a material impacton the Company’s consolidated financial statements.

In July 2002, *The Public Company Accounting Reform and Investor Protection Act of2002*(the Sarbanes-Oxley Act) was enacted.  Section 404 of the Sarbanes-Oxley Actstipulates that public companies must take responsibility for maintaining aneffective system of internal control. The act requires public companies to report on the effectiveness oftheir control over financial reporting and obtain an attestation report fromtheir independent registered public accounting firm about management’sreport.  The act requires acceleratedfilers to report on the company’s internal control over financial reporting foryears ending on or after November 15, 2004. Other public companies (non-accelerated filers) must begin to complywith the new requirements related to internal control over financial reportingfor their first year ending on or after July 15, 2007 under the latestextension granted by the SEC.  The SECrecently has proposed extending the compliance date for non-accelerated filersto include a report on effectiveness of controls over financial reporting tothe year ending on or after December 15, 2007. In addition, the SEC has proposed extending the date by whichnon-accelerated filers must file an auditor’s attestation report on internalcontrols over financial reporting in their annual reports.  Under the proposed extension, the attestationreport would not be due until the first annual report for a fiscal year endingon or after December 15, 2008.  J.L.Halsey is a non-accelerated filer and expects to be able to comply with thesefiling requirements, either as proposed or as currently in effect.

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**Insurance**

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

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

**Employees**

At June 30, 2006,the Company had 113 employees, of which 62 were employed by Lyris, 48 wereemployed by EmailLabs, and 3 were employed by other subsidiaries of theCompany. The Company’s employees are not represented by any labor union and theCompany is not aware of any current activity to organize any of its employees.

**ITEM 2.**                    PROPERTIES

Halsey’s principaloffice is located at 103 Foulk Rd, Suite 205Q, Wilmington, DE 19803 where Halsey leases approximately 112 squarefeet of office space. Our subsidiaries lease office space in California,Delaware, Pennsylvania and Nevada.

A summary of oursignificant leased office facilities at June 30, 2006 are as follows:
| Location                      | ** ** | **Approximate Number of  Square Feet Leased** | ** ** | **Expiration of Lease** | ** ** |
|-------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------|------------|
|                          |       |                                                              |       |                              |       |
| Emeryville,  California       |       | 19,491                                                            |       | October  2009                     |       |
| Menlo Park,  California       |       | 14,534                                                            |       | April  2008                       |       |
| Wayne,  Pennsylvania          |       | 770                                                               |       | January  2007                     |       |
| Loveland,  Colorado           |       | 945                                                               |       | November  2006                    |       |
| North Andover,  Massachusetts |       | 400                                                               |       | September  2007                   |       |
| Wilmington, Delaware          |       | 112                                                               |       | September 2006                    |       |

 

Our remaining leaseobligations as of June 30, 2006 for all of our facilities are $1.6 million.

**ITEM 3.**                    LEGALPROCEEDINGS

*NovaCare v. Stratford Nursing Home*.  TheCompany filed this collection lawsuit over four years ago to collect on areceivable of approximately $146,000, which the Company has fullyreserved.  Stratford counter-claimed withnumerous theories asserting that the Company instead owed Stratford money.  Although Stratford’s principal claims weredismissed by the court, Stratford, in the last quarter of fiscal year 2003, hadquantified its remaining counter-claims at approximately $1 million.  The Company believes that the theories onwhich these damages are based are inconsistent with the contract between theparties and with the conduct of each party. As of June 30, 2006, this case is pending in the U.S. District Court forthe Southern District of New Jersey (Camden). The outcome of thisaction is not possible to predict and the Company has reserved an estimate ofthe cost of litigating this action; however, this estimate does not reflect thepossibility of an adverse ruling or a judgment against the Company or asettlement.

Uninsured ProfessionalLiability Claims.* *The Company is adefendant in one professional liability claim and had previously purchasedprofessional liability insurance policies from PHICO Insurance Company.  On February 2, 2002, a Pennsylvania courtauthorized state insurance regulators to liquidate the insolvent PHICO InsuranceCompany, which had provided professional liability insurance policies to theCompany. As a result, PHICO will not be permitted to pay any claims on behalfof the Company; however, the remaining claims were transferred to various stateguaranty funds.  State insurance guarantyfunds have over the last four years paid the amounts due for liability claimssettlements on the Company’s behalf. Based on its discussion with the state guaranty funds and its review ofclaims during the third quarter of 2004, the Company now believes that apayment may be required to settle one professional liability claim that mayexceed the amount available to the Company under the applicable state guarantyfund limits.  The Company recorded anaccrual 

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and relatedexpense in the third quarter of 2004 equal to the estimated cost to settle thatclaim less the amount that would be paid by the state guaranty fund.  A recent ruling by the Superior Court of NewJersey may free this state guarantee fund from contributing their limit to anysettlement on behalf of the Company. Because of this ruling, the Company has increased its reserve for thisliability claim.  There is no insurancepolicy in place that would pay any settlement or award for this claim;therefore, in the event that the Company’s current reserve assessment isincorrect, the Company will be required to fund any amount in excess of thereserve amount.

Community Eldercare ServiceLLC v. NovaCare Holdings, Inc.  In July 2004, the Companyreceived notification that a former healthcare customer had filed for Bankruptcyprotection under the U.S. Bankruptcy Code Chapter 11.  An action may be filed asserting that theCompany may have to return some or all of the amounts that it has collectedfrom this former customer over the two years ended June 30, 2004. The total amountcollected by the Company over that time was $2 million. We believe that we mayhave legal defenses to support the retention of payments collected from ourformer customer.

**ITEM 4.**                    SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submittedto a vote of stockholders of J.L. Halsey during the fourth quarter of fiscalyear 2006.

**PART II**

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

The Company’s commonstock is traded on the Over-the-Counter Bulletin Board (“OTCBB”) under thesymbol JLHY.  Trading of the Company’scommon stock on OTCBB commenced on December 3, 1999.  The Company’s common stock was traded on theNew York Stock Exchange (the “NYSE”) under the symbol NOV until November 22,1999.  The Company’s common stock tradedon the OTCBB under the symbol NAHC until June 17, 2002.  On June 8, 2006 there were 488 holders ofrecord of common stock.

Thefollowing table sets forth the high and low bids per share of common stock onthe OTCBB for the relevant periods, and reflect inter-dealer prices, withoutretail mark-up, mark-down or commission and thus may not necessarily representactual transactions.
|                                | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------------|------------|----------|------------|---------|------------|
|                           |       |     |       |    |       |
| **Year  Ended June 30, 2006:** |       |     |       |    |       |
| First Quarter                  |       | $        | 0.79       |    | $          | 0.50 |   |
| Second Quarter                 |       | 0.73     |       | 0.51    |       |
| Third Quarter                  |       | 0.76     |       | 0.53    |       |
| Fourth Quarter                 |       | 0.96     |       | 0.67    |       |
|                           |       |     |       |    |       |
| **Year  Ended June 30, 2005:** |       |     |       |    |       |
| First Quarter                  |       | $        | 0.35       |    | $          | 0.25 |   |
| Second Quarter                 |       | 0.38     |       | 0.29    |       |
| Third Quarter                  |       | 0.35     |       | 0.30    |       |
| Fourth Quarter                 |       | 0.68     |       | 0.27    |       |

 

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 or declared oncommon stock since the Company’s initial public offering on November 5,1986.  The Company does not expect todeclare any cash dividends on common stock in the foreseeable future.

During the quarterended December 31, 2005, in reliance upon the exemption provided under Section4 (2) of the Securities Act of 1933, the Company sold 120,968 shares of its owncommon stock held in treasury to Andrew Richard Blair at the then-currentmarket price of $0.62.  Mr. Blair, adirector of the Company, and is a sophisticated businessman with knowledge andextensive experience in financial matters. This resulted in a cash inflow to the Company in the amount of $75,000which was recorded as a reduction to Treasury Stock in the equity section ofthe Company’s balance sheet.

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**ITEM 6.**                    SELECTEDFINANCIAL DATA

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

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

Our results of operationsfor the year ended June 30, 2006 include the results of the acquisition ofEmailLabs on October 11, 2005.  Ourresults of operations for the year ended June 30, 2005 includes the results ofthe acquisition of Lyris on May 12, 2005. The selected financial data belowincludes data of Lyris beginning from May 12, 2005 and data of EmailLabsbeginning from October 11, 2005. Accordingly, the accompanying selectedfinancial data for periods prior to May 12, 2005 reflects only the Company’sassets and liabilities and results of operations as discontinued operationsexcept for its remaining general and administrative activities which weretreated as continuing operations.  Noresults from ClickTracks or Hot Banana are included in the tables below asthese acquisitions were not completed until August 18, 2006.

**J. L. HALSEY CORPORATION ANDSUBSIDIARIESFIVE YEAR FINANCIAL SUMMARY****(In thousands, exceptshare and per share amounts)**
| ** **                                                     | ** ** | **Years Ended June 30,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                     | ** ** | **2006 (2)**                       | ** ** | **2005 (1)** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                           |       |                                    |       |   |   |   |   |   |   |   |   |
| **Statement  of Operations Data:**                             |       |                                    |       |   |   |   |   |   |   |   |   |
| Software and services revenues                                 |       | $                                       | 24,353     |   | $ | 2,207 |   | $ | — |   | $ | — |   | $ | — |   |
| Gross Profit                                                   |       | 17,597                                  |       | 1,760 |   | — |   | — |   | — |   |
| Income (loss) from continuing operations                       |       | 2,986                                   |       | (434 | ) | (2,186 | ) | (3,189 | ) | (3,066 | ) |
| Income tax provision                                           |       | 827                                     |       | 77 |   | — |   | — |   | — |   |
| Gain on disposal of discontinued operations, net of tax   |       | 407                                     |       | 281 |   | 4,941 |   | 4,067 |   | 21,255 |   |
| Net income (loss)                                              |       | 2,566                                   |       | (230 | ) | 2,755 |   | 878 |   | 18,189 |   |
| Gain (loss) per share from continuing operations               |       |                                    |       |   |   |   |   |   |   |   |   |
| Basic and diluted                                              |       | 0.03                                    |       | (0.01 | ) | (0.03 | ) | (0.04 | ) | (0.05 | ) |
| Net income (loss) per share:                                   |       |                                    |       |   |   |   |   |   |   |   |   |
| Basic and diluted                                              |       | 0.03                                    |       | (0.00 | ) | 0.03 |   | 0.01 |   | 0.28 |   |
| Weighted average shares used in basic per share  calculation   |       | 83,126,803                              |       | 82,296,880 |   | 82,193,063 |   | 83,097,263 |   | 65,306,280 |   |
| Weighted average shares used in diluted per share  calculation |       | 84,485,747                              |       | 82,296,880 |   | 82,193,063 |   | 83,097,263 |   | 65,306,280 |   |
|                                                                |            |                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                       | ** ** | **As of June 30,** | ** ** |
|----------------------------------|------------|--------------------|------------|
| ** **                       | ** ** | **2006**           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Balance  Sheet Data:**         |       |               |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents        |       | $                  | 255        |   | $ | 3,102 |   | $ | 28,880 |   | $ | 23,219 |   | $ | 11,632 |   |
| Intangibles, net of amortization |       | 19,776             |       | 12,714 |   | — |   | — |   | — |   |
| Goodwill                         |       | 27,390             |       | 17,749 |   |   |   |   |   |   |   |
| Total assets                     |       | 57,719             |       | 38,824 |   | 31,643 |   | 29,142 |   | 34,502 |   |
| Long term debt (3)               |       | 11,592             |       | 5,600 |   | — |   | — |   | — |   |
| Stockholders’  equity       |       | 30,066             |       | 27,082 |   | 27,080 |   | 24,325 |   | 23,114 |   |
|                                  |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)            Includesinformation from Lyris Technologies Inc. as of the acquisition date of May 12,2005 through June 30, 2005

(2)            Includesinformation from EmailLabs as of the acquisition date of October 11, 2005through June 30, 2006.

(3)            Representsrevolving line of credit and contingent payment incurred as part of theacquisition of EmailLabs on October 11, 2005 (See Note 4) in Fiscal 2006 andcontingent note payable incurred as part of the acquisition of LyrisTechnologies on May 12, 2005 in Fiscal 2005 (See Note 3).

**ITEM 7.**                    MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

*Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with our Condensed Consolidated Financial Statementsand the notes to those statements included elsewhere in this annualreport.  The discussion and analysisbelow includes certain forward-looking statements that are subject to risks,uncertainties and other factors, as described in “Risk Factors” and elsewherein this quarterly report, that could cause our actual growth, results ofoperations, performance, financial position and business prospects andopportunities for this quarter and the periods that follow to differ materiallyfrom those expressed in, or implied by, those forward-looking statements.*

**Overview**

J.L. HalseyCorporation (“Halsey” or “Company”), through its wholly owned subsidiaries,Lyris Technologies, Inc. (“Lyris”), and Uptilt, Inc. (d/b/a “EmailLabs”) is aleading marketing technology and services firm. The Company’s email marketing software and services provide clients withsolutions for creating, managing and delivering online permission-based directmarketing programs, newsletters, discussion groups and other digitalcommunications to clients whose email lists require specialized technology inorder to effectively communicate with their members and customers.  The Company offers its email solutions in twoforms: as software that is downloaded and installed on a customer’s computers,and as a hosted solution in which the customer uses the Company’s softwarethrough an internet connection.

On May 12, 2005,Halsey acquired all of the outstanding capital stock of Lyris for $30.7million, which included cash payments of $25.1 million (including acquisitioncosts and working capital adjustments of $1.2 million) and $5.6 million in theform of a promissory note payable, subject to Lyris achieving specified revenuetargets, on the second anniversary of the closing date with interest equal to10% per annum.  Halsey believes that itis probable that the specified revenue targets stated in the promissory notewill be attained on or before the second anniversary of the closing date. As aresult, we have recorded the note payable as a current liability on our BalanceSheet as of June 30, 2006. With this acquisition, Halsey became a leading emailmarketing company with over 5,000 customers worldwide.

On October 11,2005, Halsey acquired all of the outstanding capital stock of EmailLabs, anemail marketing and technology company based in Menlo Park, California, for$24.5 million (including acquisition costs and working capital adjustments of$612,000).  Of this purchase price, $19.5million was paid in cash at closing, of which $2.3 million was funded byEmailLabs’ available cash.  $500,000 ofthe purchase price was held back pursuant to minimum working capitalrequirements.  This holdback and thefinal working capital adjustment were paid during the quarter ended March 31,2006.  The agreement also includescontingent consideration consisting of two equal earn-out payments of $1.7million due on the first and second anniversary of the closing date ifEmailLabs achieves specified revenue targets. Halsey believes that it is probable that the specified revenue targetswill be attained and has accrued these liabilities in the current andnon-current portions of our Balance Sheet at June 30, 2006.  Additionally, any income tax refund relatedto the period ending on and including the closing date will be paid to theformer stockholders of EmailLabs.  AtJune 30, 2006 these refunds have been estimated at $482,000 and are included inthe current portion of our Balance Sheet. The remainder of the purchase price was funded with the proceeds of theLoan and Security Agreement between Halsey and Comerica Bank.

On August 18,2006, Halsey acquired all of the outstanding capital stock of ClickTracks, aWeb analytics provider based in Santa Cruz, California, for approximately $7.7million in cash and $2.9 million in common stock of the Company issued tocertain security holders of ClickTracks. Additional payments totaling approximately $3.8 million may be made inthe event ClickTracks achieves future revenue targets and working capitaladjustments.

On August 18,2006, Halsey acquired all of the outstanding capital stock of Hot Banana, ane-marketing Web content management company based in Ontario, Canada, forapproximately $1.9 million Canadian ($1.7 million U.S. based on thethen-applicable exchange rate), with additional installments of up to $750,000Canadian ($670,661 U.S.) if Hot 

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Banana achieves specifiedrevenue and technology integration targets, and up to an additional $500,000Canadian ($447,107 U.S.) payable subject to working capital and otheradjustments.

Halsey is the successorto NovaCare, which was a national leader in physical rehabilitation services,orthotics and prosthetics and employee services. The changes to Medicarereimbursement in the late 1990’s had deleterious effects on NovaCare and itscompetitors and customers.  

The prior operatingbusiness most affected by the Medicare changes was the long-term care servicessegment in which NovaCare provided therapists to skilled nursingfacilities.  This business was disposedof in fiscal 1999 with the shutdown of certain of its operations in the WesternUnited States during the third fiscal quarter and the sale of the remainingoperations on June 1, 1999. NovaCare’s former outpatient services segment wasdisposed of through the sales of its orthotics and prosthetics (“O&P”) andphysical rehabilitation and occupational health (“PROH”) businesses. TheO&P business was sold to Hangar Orthopedic Group, Inc. in July of 1999 andthe PROH business was sold to Select Medical Corporation in November of1999.  The Company’s former employeeservices segment was disposed of through NovaCare’s sale of its interest inNovaCare Employee Services (“NCES”) in October of 1999 to a subsidiary of PlatoHoldings, Inc. as part of a tender offer by Plato for all of NCES’s outstandingshares.  With cash raised from the salesof its businesses, the Company repaid all of its bank debt in the summer of1999, and in January of 2000, the Company retired its publicly-tradedsubordinated debt.

NovaCare sold its name aspart of the sale of the PROH business and subsequently changed its name toNAHC, Inc.  On June 18, 2002, in atransaction approved by NAHC’s stockholders at a special meeting, NAHC mergedwith and into Halsey, its wholly-owned subsidiary.  The purpose of the merger between NAHC andHalsey was to implement transfer restrictions on the Company’s common stock inorder to preserve the Company’s federal income tax net operating losses.

Prior to theacquisitions noted above, the Company spent several years maximizing the assetsthat it had retained, including old accounts receivable, Medicare receivablesand appeals and tax items, and minimizing liabilities retained after the salesof the operating businesses.  The Companymade significant progress on these matters. The Company has collected virtually all of its receivables, other thanamounts which are the subject of litigation or arbitration or that have beenwritten off, and also resolved all but one litigation matter remaining from theprior operations of NovaCare. A subsidiary of the Company has retained three****employees and two consultants to carry out the general andadministrative functions specified above. These resources have beensupplemented with outside financial, tax and legal resources when required bymanagement and the board of directors. No members of the current board of directors were members prior to theCompany selling its previous healthcare operating businesses.

***Acquisition of Lyris and EmailLabs and Comparabilityof Operations***

Our results of operationsfor the year ended June 30, 2006 includes the results of the acquisition ofEmailLabs on October 11, 2005. Our results of operations for the year endedJune 30, 2005 includes the results of the acquisition of Lyris on May 12, 2005.  The results of these acquisitions must befactored into any comparison of our 2006 results to the results of 2005 and2004.

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

Our financial statementsare prepared in accordance with accounting principles generally accepted in theUnited States, or GAAP.  The applicationof GAAP requires that we make estimates that affect our reported amounts ofassets and liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenue andexpenses during the reporting period.  Webase our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances.  We evaluate our estimates and assumptions onan ongoing basis.  Our actual results maydiffer significantly from these estimates.

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

·                  revenuerecognition

·                  valuationallowances and reserves

·                  legalfees

·                  losscontingencies

·                  accountingfor acquisitions

·                  accountingfor stock-based compensation

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

·                  accountingfor income taxes

**Revenue Recognition**

The Companyrecognizes revenue from the following primary sources:  (1) hosting software for use by customers;(2) licensing software products; and (3) providing customers technical support(maintenance).

The Companygenerally recognizes revenue when all of the following conditions aresatisfied:  (1) there is persuasiveevidence of an arrangement; (2) the service has been provided to the customer(in the case of software licenses, revenue is recognized when the customer isgiven electronic access to the licensed software); (3) the amount of fees to bepaid by the customer is fixed or determinable; and (4) the collection of feesis probable.

The Company’shosted software arrangements are considered service arrangements in accordancewith Emerging Issues Task Force (“EITF”) Issue No. 00-3, *“Applicationof AICPA Statement of Position 97-2, Software Revenue Recognition, toArrangements That Include the Right to Use Software Stored on Another Entity’sHardware”*, and with multiple deliverables under EITF 00-21, “*Accounting for Revenue Arrangements with Multiple Deliverables.”*  In addition, because the Company provides itsapplications as a service, the Company follows the provisions of Securities andExchange Commission Staff Accounting Bulletin No. 104, *RevenueRecognition*.  Hosting revenueis recognized monthly based on the usage defined in the agreement.  Excess usage is billed and recognized asrevenue is incurred.

The Companyrecognizes software license revenue in accordance with the provisions of SOP97-2, *“SoftwareRevenue Recognition*I and SOP 98-9 *“Modification of SOP 97-2, Software RevenueRecognition with Respect to Certain Transactions.” *We enter into certain revenue arrangements for which we are obligatedto deliver multiple products and/or services (multiple elements).  For these arrangements, which generallyinclude software products and maintenance, we allocate and defer revenue forthe undelivered elements based on their vendor-specific objective evidence offair value (“VSOE”).  Future discounts onunspecified items are considered post-contract customer support, which areincluded in VSOE for undelivered elements. Since VSOE exists for all elements (delivered and undelivered), weallocate the total revenue to be earned under the arrangement among the variouselements, based on their relative fair value. Maintenance revenues, including revenues included in multipleelement arrangements, are deferred and recognized ratably over the relatedcontract period, generally twelve months.

**Deferred Revenue**

Deferred revenuerepresents customer billings made in advance for annual support contracts andbulk purchases of emails to be delivered in the future. Maintenance istypically billed on a per annum basis in advance and revenue is recognizedratably over the maintenance period. Bulk purchases are typically billed in advance and revenue is recognizedin the periods in which emails are delivered.

**Allowance for Doubtful Accounts**

The Company’spolicies for allowances for doubtful accounts for its current operations (Lyrisand EmailLabs) and its previous healthcare discontinued operations are asfollows:

Continuingoperations

We regularlyassess our ability to collect outstanding customer invoices and in so doingmust make estimates of the collectibility of accounts receivable.  We provide an allowance for doubtful accountswhen we determine that the collection of an outstanding customer receivable isnot probable.  We specifically analyzeaccounts receivable and historical bad debts experience, and changes in ourcustomer payment history when evaluating the adequacy of the allowance fordoubtful accounts.  If any of thesefactors change, our estimates may also change, which could affect the level ofour future provision for doubtful accounts.

Discontinuedoperations

The Company maintainsallowances for the collection of its healthcare receivables remaining fromdiscontinued healthcare operations. These allowances are the result of the inability or unwillingness ofmany of the Company’s former 

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healthcarecustomers to make payments.  Several ofthe key industries in which the Company previously operated were severelyimpacted by the Balanced Budget Act of 1997. As a result of the provisions of this Act, many of the Company’s formerhealthcare customers went bankrupt and many are nearly insolvent. Currently,the Company has outstanding receivables from a few of these customers and hasrecorded 100% allowances against these receivables. The Company is pursuingcollection from two of its former healthcare customers through litigation.

On a quarterly basis, theCompany reviews the value of the reserves and adjusts the net value of thereceivables to the estimated amount that management expects to realize. Whenfacts and circumstances indicate that an account has been impaired below itscurrent carrying value, the Company will adjust the reserve accordingly.  When a healthcare customer files forbankruptcy or other facts and circumstances dictate that the associatedreceivable will not be collectible at any future period, the Company fullyreserves the receivable.  Generally whenthere has been a significant change in facts or circumstances and it isreasonably assured collectibility of a receivable, the Company will release theassociated reserves to support the Company’s change in estimate.

There are a few accountsthat make up the Company’s receivables remaining from discontinued healthcareoperations, all of which are fully reserved because of the difficulty incollection the money that is owed.

**LossContingencies**

The Company recordsestimated loss contingencies when information is available that indicates thatit is probable that an asset has been impaired or a liability has been incurredand the amount of the loss can be reasonably estimated.  When no accrual is made for a loss contingencybecause one or both of these conditions are not met, or if an exposure to lossexists in excess of the amount accrued, the Company discloses suchcontingencies when there is at least a reasonable possibility that a loss or anadditional loss may have been incurred. Determining the likelihood of incurring a liability and estimating theamount of the liability involves significant judgment.  If the outcome of the litigation is moreadverse to the Company than management currently expects, then the Company mayhave to record additional charges in the future.

**Accounting for Acquisitions**

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

**Stock-Based Compensation**

We account forstock-based compensation in accordance with the provisions of SFAS 123R, I*Share-Based Payment.”* Under the fair value recognition provisions of SFAS 123R, stock-basedcompensation cost is estimated at the grant date based on the fair value of theaward and is recognized as expense ratably over the requisite service period ofthe award.  Determining the appropriatefair value model and calculating the value of stock-based awards, whichincludes estimates of stock price volatility, forfeiture rates and expectedlives, requires judgment that could materially impact our operating results.

**Goodwill, Long-Lived Assets and Other IntangibleAssets**

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

·                  significant underperformance relativeto historical or expected projected future operating results;

·                  significant changes in the manner ofour use of the acquired assets or the strategy for our overall business;

·                  significant negative industry oreconomic trends;

·                  significant decline in our stockprice for a sustained period of time; and

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·                  our marketcapitalization relative to net book value

When we determine that the carrying value ofintangible assets, long-lived assets or goodwill may not be recoverable basedupon the existence of one or more of the above indicators of impairment, wemeasure any potential impairment based on a projected discounted cash flowmethod using a discount rate determined by our management to be commensurate withthe risk inherent in our current business model.

**Income Taxes**

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

The Company has netoperating loss carryforwards.  Therealization of any benefit of these loss carryforwards is dependent on futureresults and the actual amount of these loss carryforwards may change overtime.  The Company does not recognize anybenefit on its financial statements for any previously incurred losses and willnot until it determines that it is more likely than not that it will havetaxable income to realize these benefits. Although the Company has reported netincome in fiscal years 2006 and 2005 it has not generated taxable income since1996.

**Year Ended June30, 2006 Compared with the Year Ended June 30, 2005**

Our results of operationsfor the year ended June 30, 2006 include the results of the acquisition ofEmailLabs on October 11, 2005.  Ourresults of operations for the year ended June 30, 2005 include the results ofthe acquisition of Lyris on May 12, 2005. The financial data below includes dataof Lyris beginning from May 12, 2005 and data of EmailLabs beginning fromOctober 11, 2005.

*Revenue*

*Totalrevenue was approximately $24.4 million for the year ended June 30, 2006compared to $2.2 million for the year ended June 30, 2005.  The increase in revenue of approximately$22.2 million is due to our acquisitions of Lyris and EmailLabs.*

*Costof revenue*

*Cost ofrevenue was $6.8 million for the year ended June 30, 2006, compared to $447,000for the year ended June 30, 2005. The increase in cost of revenue ofapproximately $6.4 million is due to our acquisitions of Lyris andEmailLabs.  Cost of revenue primarilyincludes salary and personnel costs attributable to our hosting business andsupport services. Other costs allocated to cost of revenue include amortizationof intangibles of $1.4 million related to developed technology, and computerand internet bandwidth costs associated with providing our support and hostingservices to our customers.*

*Salesand marketing*

Sales andmarketing expenses were $5.1 million for the year ended June 30, 2006, comparedto $290,000 for the year ended June 30, 2005. The increase in sales andmarketing expenses of approximately $4.8 million is due to our acquisitions ofLyris and EmailLabs.  Sales and marketingexpenses consist primarily of salaries and related expenses for personneldedicated entirely to the sales and marketing efforts of the Company. Othersales and marketing costs include advertising costs and costs associated withexhibits and tradeshows.

*Generaland administrative*

General andadministrative expenses were $7.1 million for the year ended June 30, 2006,compared to $2.2 million for the year ended June 30, 2005.  The primary reasons for the increase ofapproximately $4.9 million are due to our acquisitions of Lyris and EmailLabsand increases in operating expenses by the parent company.  Increases at the parent 

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company include increasesin professional and consulting fees, legal fees, accounting fees, merger andacquisition related costs and other administrative operating expensesassociated with integrating the newly-acquired companies.  General and administrative expenses consistprimarily of compensation for personnel, professional services, which includeconsultants, legal fees and accounting, audit and tax fees, and administrativeexpenses associated with operating as a public company.

*Amortizationof intangibles*

Amortization ofintangibles was $1.2 million for the year ended June 30, 2006, compared to $94,000for the year ended June 30, 2005. The increase reflects amortization expenserelated to intangible assets of customer relationships that are recorded asintangible assets on our balance sheet as a result of the acquisition of Lyrison May 12, 2005 and the acquisition of EmailLabs on October 11, 2005. See Note5 to the Condensed Consolidated Financial Statements for details on intangibleassets.

*Provision for income taxes*

During the yearended June 30, 2006, the Company recorded an income tax provision of $827,000which consisted primarily of a provision for state income taxes on the earningsof two of our subsidiaries in the amount of $691,000 and a provision forfederal alternative minimum income taxes of $136,000. The Company recorded anincome tax provision of $77,000 for state income taxes on the earnings of Lyrisfor the year ended June 30, 2005.  SeeNote 13 to the Condensed Consolidated Financial Statements for details onincome taxes.

*Net income (loss)*

Net income was$2.6 million for the year ended June 30, 2006, compared to a net loss of ($230,000)for the year ended June 30, 2005. The primary reasons for this increase of $2.8million are the acquisitions of Lyris and EmailLabs.

*DiscontinuedOperations*

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

The gain ondisposal of discontinued operations was $407,000 compared to $281,000 for theprior year. These gains reflect adjustments to the $374.1 million loss ondisposal of discontinued operations that was recorded in fiscal year 2000.  The gain of $407,000 in fiscal year 2006consist primarily of a refund from a state insurance guarantee fund in theamount of $53,000, a gain of $31,000 resulting from the collection of accountsreceivable that were previously written off by the Company and reductions ofexpense accruals of $348,000 to adjust other liabilities remaining fromdiscontinued operations offset by a provision for federal alternative minimumtaxes of $25,000. The reductions in expense accruals include amounts forlitigation related costs and legacy insurance expenses. The gain in fiscal year2005 of $281,000 primarily relates to the collection of previously reservedreceivables in the amount of $460,000 and the collection of a federal incometax refund of $400,000, offset by increases in expense accruals of $579,000, toreflect additional legal costs, collection costs and to adjust otherliabilities remaining from discontinued operations.

**Year Ended June30, 2005 Compared with the Year Ended June 30, 2004**

*Revenue*

*Totalrevenue was approximately $2.2 million for the year ended June 30, 2005compared to none for the year ended June 30, 2004.  All of the revenue for the fiscal year endedJune 30, 2005 represents revenue attributable to Lyris for the period May 12,2005 (acquisition date) through June 30, 2005. The Company had no revenue infiscal 2004.*

*Costof revenue*

*Cost ofrevenue was $447,000 for the year ended June 30, 2005 compared to none for theyear ended June 30, 2004. All of the Cost of revenue is a result of theacquisition of Lyris on May 12, 2005. Cost of revenue primarily includes*

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*salary and personnel costsattributable to our support services and hosting business. Other costsallocated to cost of revenue include amortization of intangibles of $103,000related to developed technology and computer and internet bandwidth costsassociated with providing our support and hosting services to our customers.*

*Salesand marketing*

Sales andmarketing expenses consist primarily of salaries and related expenses forpersonnel dedicated entirely to the sales and marketing efforts of the Company.Other sales and marketing costs include costs associated with exhibits andtradeshows. Sales and marketing expenses were $290,000 for the year ended June30, 2005 compared to none for the year ended June 30, 2004. All sales andmarketing expenses were incurred by Lyris. The Company had no sales andmarketing expenses in fiscal 2004.

*Generaland administrative*

General andadministrative expenses consist primarily of compensation for personnel,professional services, which include consultants, legal fees and accounting,audit and tax fees, and administrative expenses associated with operating as apublic company. General and administrative expenses were $2.2 million for theyear ended June 30, 2005 compared to $2.4 million for the prior year.  The primary reason for the decrease ofapproximately $201,000 included increases of $327,000 in general and administrativeexpenses for Lyris Technologies from the acquisition date of May 12, 2005through June 30, 2005, offset by decreases in operating expenses by the parentcompany of approximately $528,000 primarily as a result of decreases inprofessional and consulting fees, legal fees, insurance expense and otheradministrative operating expenses.

*Amortizationof intangibles*

Amortization ofintangibles was $94,000 in fiscal year 2005 and none in the previous year. Theincrease reflects amortization expense related to intangible assets of customerrelations that are recorded as intangible assets on our balance sheet as aresult of the acquisition of Lyris on May 12, 2005. See Note 5 for details onintangible assets.

*Provision for income taxes*

During the yearended June 30, 2005, the Company recorded an income tax provision for the yearended June 30, 2005 of $77,000 which consists of state income taxes on theearnings of one of our subsidiaries. The company has not recorded a provisionfor federal income taxes due to our federal net operating loss carryforwards ofapproximately $184 million. See Note 13 for more details regarding our taxcarryforwards.

*Net income (loss)*

Net income (loss)was $(230,000) for the year ended June 30, 2005 compared to $2.7 million forthe previous year. The net loss in 2005 includes net income from LyrisTechnologies of $704,000 and a net loss from J.L. Halsey of $(934,000). The netincome in fiscal year 2004 of $2.7 million was primarily the result of afederal income tax refund received by the Company in the fourth quarter of  fiscal year 2004.

*DiscontinuedOperations*

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

The gain ondisposal of discontinued operations was $281,000 compared to $4.9 million forthe prior year. These gains reflect adjustments to the $374.1 million loss ondisposal of discontinued operations that was recorded in fiscal year 2000.  The gain in fiscal year 2005 of $281,000primarily relates to the collection of previously reserved receivables in theamount of $460,000 and the collection of a federal income tax refund of $400,000,offset by increases in expense accruals of $579,000, to reflect additionallegal costs, collection costs and to adjust other liabilities remaining fromdiscontinued operations. The gain in fiscal year 2004 of $4.9 million,primarily relates to income tax related refunds totaling $6.0 million

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and decreases in reserves for certain receivables totaling $600,000principally due to recovery of previously reserved receivables offset byincreases in expense accruals of $1.7 million, to reflect additional legalcosts, collection costs, and to adjust other liabilities remaining from ourdiscontinued operations. The $6.0 million of income tax refunds consist ofFederal Income tax carryback claims filed by the Company in July 2003 for thetax years ended June 1993 and 1996 as a result of the amendment of our 2001 taxyear return. The Company received the tax refunds in the fourth quarter of thefiscal year 2004.

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**QuarterlyFinancial Information (unaudited)Year Ended June 30, 2006:**
| **(in thousands)**                                                          | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                                                       | ** ** | ** **         | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** |
| Software and services  revenues                                                  |       | $                  | 3,527      |                | $          | 6,175              |       | $                   | 6,995      |   | $ | 7,656 |   |
| Cost of revenues                                                                 |       | 988                |       | 1,680               |       | 1,811              |       | 2,277               |       |
| Gross Profit                                                                     |       | 2,539              |       | 4,495               |       | 5,184              |       | 5,379               |       |
| Operating expenses                                                               |       | 2,020              |       | 3,750               |       | 4,171              |       | 4,670               |       |
| Income from continuing  operations before income taxes                           |       | 519                |       | 745                 |       | 1,013              |       | 709                 |       |
| Income tax provision                                                             |       | 123                |       | 154                 |       | 246                |       | 304                 |       |
| Income from continuing  operations                                               |       | 396                |       | 591                 |       | 767                |       | 405                 |       |
| Gain (loss) on disposal  of discontinued operations, net of tax                  |       | 130                |       | 210                 |       | 108                |       | (41                 | )          |
| Net income                                                                       |       | $                  | 526        |                | $          | 801                |       | $                   | 875        |   | $ | 364 |   |
| Income per share from  continuing operations: basic and diluted                  |       | $                  | 0.01       |                | $          | 0.01               |       | $                   | 0.01       |   | $ | 0.00 |   |
| Gain (loss) per share  on disposal of discontinued operations: basic and diluted |       | $                  | 0.00       |                | $          | 0.00               |       | $                   | 0.00       |   | $ | (0.00 | ) |
| Net income per share: basic and diluted                                          |       | $                  | 0.01       |                | $          | 0.01               |       | $                   | 0.01       |   | $ | 0.00 |   |

 

**Year Ended June 30, 2005:**

 
| **(in thousands)**                                                          | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                                                       | ** ** | ** **         | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** |
| Software and services  revenues                                                  |       | $                  | —     |                | $          | —             |       | $                   | —     |   | $ | 2,207 |   |
| Cost of revenues                                                                 |       | —             |       | —              |       | —             |       | 447                 |       |
| Gross Profit                                                                     |       | —             |       | —              |       | —             |       | 1,760               |       |
| Operating expenses                                                               |       | 297                |       | 257                 |       | 320                |       | 1,320               |       |
| (Loss) income from  continuing operations before income taxes                    |       | (297               | )          | (257                | )          | (320               | )          | 440                 |       |
| Income tax provision                                                             |       | —             |       | —              |       | —             |       | 77                  |       |
| (Loss) income from  continuing operations                                        |       | (297               | )          | (257                | )          | (320               | )          | 363                 |       |
| Gain (loss) on disposal  of discontinued operations, net of tax                  |       | 142                |       | 117                 |       | (297               | )          | 319                 |       |
| Net (loss) income                                                                |       | $                  | (155       | )                   | $          | (140               | )          | $                   | (617       | ) | $ | 682 |   |
| (Loss) income per share  from continuing operations: basic and diluted           |       | $                  | (0.00      | )                   | $          | (0.00              | )          | $                   | (0.00      | ) | $ | 0.01 |   |
| Gain (loss) per share  on disposal of discontinued operations: basic and diluted |       | $                  | 0.00       |                | $          | 0.00               |       | $                   | (0.00      | ) | $ | 0.00 |   |
| Net (loss) income per share: basic and diluted                                   |       | $                  | (0.00      | )                   | $          | (0.00              | )          | $                   | (0.01      | ) | $ | 0.01 |   |

 

**Liquidity andCapital Resources**

*Liquidity andCash Flows*

***Cash and cash equivalents***

At June 30, 2006, cash and cash equivalents totaledapproximately $255,000 compared to approximately $3.1 million at June 30, 2005.The decrease in cash was mainly attributable to the acquisition of EmailLabs onOctober 11, 2005.

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***Net Cash Flow from OperatingActivities***

Net cash from operating activities was approximately$5.5 million for the year ended June 30, 2006. This amount includes a positivecash flow from operations from Lyris and EmailLabs of $7.8 million, offset by anegative cash flow from operations from the parent company of ($2.3) million.On a consolidated basis, the $5.5 million in net cash resulted from a netincome of $2.6 million, add back of non-cash items of $3.0 million related todepreciation and amortization and $343,000 related to stock-based compensation,$328,000 related to provision for bad debt offset by ($102,000) related todeferred income tax, changes in working capital assets and liabilities of($246,000) and add-back of gain on disposal of discontinued operations of($407,000).

Net cash from operating activities was approximately($656,000) for the year ended June 30, 2005. This amount includes a positivecash flow from operations from our Lyris subsidiary of $813,000 for the periodMay 12, 2005 — June 30, 2005, offset by a negative cash flow from operationsfrom the parent company of ($1,469,000). The net cash used resulted from a netloss of ($230,000), changes in working capital assets and liabilities of($381,000), add-back of gain on disposal of discontinued operations of($281,000), offset by-non cash items of $236,000 related to depreciation andamortization.

Net cash from operating activities was approximately($2.3) million for the year ended June 30, 2004. The net cash used resultedfrom net income of $2.7 million, changes in working capital assets andliabilities of $7,000, add-back of gain on disposal of discontinued operationsof ($4.9) million, reversal of income tax payable of ($187,000), offset by-noncash items of $11,000.

The Company isdeveloping a next generation emarketing application.  The Company is currently evaluating whatresources to devote to this potential new product.  The company may dedicate a portion of itsfuture operating cash flow to the development, marketing and sale of this newproduct.

***Net Cash Flow from InvestingActivities***

Net cash used in investing activities wasapproximately $17.8 million for the year ended June 30, 2006, which representedcash paid for the acquisition of EmailLabs of $17.4 million and $854,000 usedfor capital expenditures.  Theseexpenditures were partially offset by the collection of $600,000 of restrictedcash that was paid to Halsey by one of its workers’ compensation insurancecarriers.

Net cash used in investing activities wasapproximately $24.6 million, for the year ended June 30, 2005, whichrepresented cash paid for the acquisition of Lyris of $24.6 million and thepurchase of property and equipment of $20,000. Net cash used in investingactivities was approximately $6,000 for the year ended June 30, 2004, whichrepresented the purchase of property and equipment.

***Net Cash Flow from FinancingActivities***

Net cash provided by financing activities was $9.8million for the year ended June 30, 2006, which represented proceeds of $22.4million from Comerica Bank (“Comerica”). This amount was offset by repayments of $12.5 million.

Net cash provided by financing activities was$232,000, for the year ended June 30, 2005, which represented cash received asthe result of the sale of 773,333 shares of the Company’s common stock held intreasury.

On October 11,2005, the Company entered into a Loan and Security Agreement (the “Loan andSecurityAgreement”) with Comerica providing a revolving line of credit to theCompany.  The initial borrowings underthe Agreement were used to consummate the acquisition of EmailLabs and forgeneral corporate purposes.  Under theoriginal Agreement, interest on outstanding balances was charged at a floatingrate equal to either Comerica’s base rate plus 0.75% or Comerica’s LIBOR rateplus 3.75%.  The original amountavailable to the Company was $18.5 million and that amount was reduced monthlybeginning October 31, 2005.  Monthlyreductions were $250,000 through September 30, 2007 and $347,222 thereafterthrough the maturity date.  In addition,the Agreement contains certain financial covenants and requires the Company tomaintain certain financial ratios.

Effective April25, 2006, the Company entered into a First Amendment (“First Amendment”) to theLoan and Security Agreement.  The FirstAmendment reduces Comerica’s lending commitment to $13.5 million and resets themonthly reduction amounts on the lending commitment to $175,000 per month forthe period April 30, 2006 through May 31, 2007, $250,000 per month throughSeptember 30, 2007, and $347,222 per month thereafter until the maturity dateof February 28, 2010.  In addition, theFirst Amendment decreases the rate at which outstanding borrowings under the

32

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agreementbear interest to a rate that fluctuates dependent upon a ratio of senior debtto EBITDA, as calculated from time to time, and revises existing financial andother covenants.

TheLoan and Security Agreement, as amended, contains certain financial covenantsand requires the Company to maintain certain financial ratios.  At June 30, 2006, the Company was incompliance with all provisions of the Agreement, including the financialcovenants and ratios.  In addition, themonthly reductions reduce the amount available to the Company at June 30, 2007to $10.8 million.  Current borrowings areless than the amount available to the Company at June 30, 2007 and thereforethe Company has classified the entire outstanding balance as a long termliability.

Effectiveas of August 18, 2006, the Company entered into a Second Amendment to Loan andSecurity Agreement (the “Second Amendment”) with Comerica.  The Second Amendment also amends the Loan andSecurity Agreement and revises existing financial and other covenants.

*Rights Offering, Future CashRequirements and Sources*

The Company’sBoard of Directors has authorized the filing of a registration statement withthe SEC to raise $20 million in a common stock rights offering at a price pershare of $0.85.  LDN Stuyvie provided $10million to the Company pursuant to a Bridge Loan to provide funds to purchaseClickTracks.  The first $10 millionraised in the rights offering will be used to repay the Bridge Loan.  LDN Stuyvie has agreed to backstop at least$10 million of the stock offering in the rights offering.

As noted on ourBalance Sheet, the Company believes it will likely be required to pay certainearn-outs to sellers of the Lyris and EmailLabs businesses.  A payment to the sellers of EmailLabs in theamount of $1.725 million is due on October 11, 2006.  In addition, we believe that it is likely thatthe Company will be required to pay in May 2007 approximately $6.6 million tothe sellers of the Lyris business pursuant to the earn-out provisions.  Based on its current projections, the Companycurrently anticipates that it will be able to meet these obligations fromavailable resources.

*Legal Claims*

*The Company is currently defending one lawsuit (NovaCare v. Stratford,see Item 3) and management believes the Company will prevail in this case. TheCompany has accrued for the potential costs of litigating this claim, but theCompany does not, and has not, accrued for the payments that could result froman adverse ruling, judgment or a settlement of this claim until the Companybelieves that it is probable that such a payment will be made.*

In July 2004, theCompany received notification that a former healthcare customer had filed forBankruptcy protection under the U.S. Bankruptcy Code Chapter 11.  A claim may be filed asserting that theCompany may or may not have to return some or all of the amounts that it hascollected from this former customer over the two years ended June 30, 2004. Thetotal amount collected by the Company over that time was $2 million. We believethat we may have legal defenses to support the retention of payments collectedfrom our former customer

*Off-BalanceSheet Arrangements*

Asa result of the acquisitions made by the Company on August 18, 2006 and in theevent that certain milestones are reached over the next two years, the Companywill be obligated to pay the sellers of ClickTracks an additional $3,300,000 inearn-out payments and an additional $510,000 subject to working capitaladjustments. The Company will make installments totaling up to approximately$750,000 Canadian dollars (approximately $670,661 US dollars) to the sellers ofHot Banana if they achieve specified revenue and technology integration targetsin the first and second year following the closing as well as an additional$500,000 Canadian dollars (approximately $447,107 US dollars) will be paidsubject to working capital and other adjustments.

*Long-TermContractual Obligations*

The following is asummary of future minimum long-term contractual obligations for the years endedJune 30,
|                                  | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Total** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|-----------|------------|
| Property lease obligations       |       | $        | 622        |     | $          | 567      |       | $        | 345        |     | $          | 102       |       | $ | — |   | $ | 1,636 |   |
| Note payable                     |       | 5,496    |       | —   |       | —   |       | —   |       | —   |       | 5,496     |       |
| Contingent merger  consideration |       | 2,207    |       | 1,725    |       | —   |       | —   |       | —   |       | 3,932     |       |
| Revolving line  of credit        |       | —   |       | 2,942    |       | 4,167    |       | 2,758    |       | —   |       | 9,867     |       |
| Total                            |       | $        | 8,325      |     | $          | 5,234    |       | $        | 4,512      |     | $          | 2,860     |       | $ | — |   | $ | 20,931 |   |

 

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***FuturePayments on recent acquisitions***

TheCompany believes it will likely be required to pay certain earn-outs to sellersof the Lyris, EmailLabs, ClickTracks and Hot Banana businesses.  A payment to the sellers of EmailLabs in theamount of $1.725 million is due on October 11, 2007 and a payment to thesellers of Lyris will be required to be paid of approximately $6.6 millionwhich is due in May 2007 pursuant to the earn-out provisions of thoseacquisitions.

Asa result of the acquisitions made by the Company on August 18, 2006 and in theevent that certain milestones are reached over the next two years, the Companywill be obligated to pay the sellers of ClickTracks an additional $3,300,000 inearn-out payments and an additional $510,000 subject to working capitaladjustments. The Company will make installments totaling up to approximately$750,000 Canadian dollars (approximately $670,661 US dollars) to the sellers ofHot Banana if they achieve specified revenue and technology integration targetsin the first and second year following the closing as well as an additional$500,000 Canadian dollars (approximately $447,107 US dollars) will be paidsubject to working capital and other adjustments.

***RevolvingLine of Credit***

On October 11,2005, the Company entered into a Loan and Security Agreement (“the Agreement”)with Comerica Bank (“Comerica”) providing a revolving line of credit to theCompany.  The initial borrowings underthe Agreement were used to consummate the acquisition of EmailLabs and for generalcorporate purposes.  Under the originalAgreement interest on outstanding balances was charged at a floating rate equalto the Comerica Bank base rate plus 0.75% or Comerica’s LIBOR rate plus3.75%.  The original amount available tothe Company was $18.5 million and that amount was reduced monthly beginningOctober 31, 2005.  Monthly reductions onloan were required in the amount of $250,000 through September 30, 2007 and$347,222 thereafter through the maturity date. In addition, the Agreement contains certain financial covenants andrequires the Company to maintain certain financial ratios.  Effective April 25, 2006, the Company enteredinto a First Amendment (“First Amendment”) to the Agreement.

TheFirst Amendment reduces Comerica’s lending commitment to $13.5 million andresets the monthly reduction amounts on the lending commitment to $175,000 permonth for the period April 30, 2006 through May 31, 2007, $250,000 per monththrough September 30, 2007, and $347,222 per month thereafter until the maturitydate of February 28, 2010.  In addition,the First Amendment decreases the rate at which outstanding borrowings underthe agreement bear interest to a rate that fluctuates dependent upon a ratio ofsenior debt to EBITDA, as calculated from time to time, and revises existingfinancial and other covenants.

TheLoan and Security Agreement, as amended, contains certain financial covenantsand requires the Company to maintain certain financial ratios.  At June 30, 2006, the Company was incompliance with all provisions of the Agreement, including the financialcovenants and ratios.  In addition, themonthly reductions reduce the amount available to the Company at June 30, 2007to $10.8 million.  Current borrowings areless than the amount available to the Company at June 30, 2007 and thereforethe Company has classified the entire outstanding balance as a long termliability.

Effectiveas of August 18, 2006, the Company entered into a Second Amendment to Loan andSecurity Agreement (the “Second Amendment”) with Comerica.  The Second Amendment also amends the Loan andSecurity Agreement and revises existing financial and other covenants.

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UninsuredProfessional Liability Claims

The Company isa defendant in one professional liability claim and had previously purchasedprofessional liability insurance policies from PHICO Insurance Company.  On February 2, 2002, a Pennsylvania courtauthorized state insurance regulators to liquidate the insolvent PHICOInsurance Company, which had provided professional liability insurance policiesto the Company. As a result, PHICO was not permitted to pay any claims onbehalf of the Company; however, the remaining claims were transferred tovarious state insurance guaranty funds. State insurance guaranty funds have over the last four years paid theamounts due for liability claims settlements on the Company’s behalf.  Based on its discussion with the stateguaranty funds and its review of claims during the third quarter of 2004, theCompany now believes that a payment may be required to settle one professionalliability claim that may exceed the amount available to the Company under theapplicable state guaranty fund limits. The Company recorded an accrual and related expense in the third quarterof 2004 equal to the estimated cost to settle that claim less the amount thatwould be paid by the state guaranty fund. A recent ruling by the Superior Court of New Jersey may free this stateguarantee fund from contributing their limit to any settlement on behalf of theCompany.  Because of this ruling, theCompany has increased its reserve for this liability claim.  There is no insurance policy in place thatwould pay any settlement or award for this claim; therefore, in the event thatthe Company’s current reserve assessment is incorrect, the Company will berequired to fund any amount in excess of the reserve amount.

*Workers’ Compensation Loss Payments*

*During the first quarter of fiscal year 2003, the NovaCare workers’compensation insurance carrier notified the Company that the purchaser of NCES(the “Purchaser”) who is responsible for making certain claim payments requiredby NovaCare’s insurance policy deductibles has defaulted on those paymentobligations.  The Purchaser has fundsthat have been prepaid to this insurance carrier for claim payments underdeductibles on the NovaCare policies as well as other unrelated workers’compensation policies of the Purchaser. In management’s opinion, the deposits held by the insurance carrier aresufficient to pay deductible obligations on the unrelated workers’ compensationpolicies as well as the NovaCare policies.*

**CautionaryStatement**

Except forhistorical information, matters discussed above including, but not limited to,statements concerning litigation against the Company, are forward-lookingstatements that are based on management’s estimates, assumptions andprojections.  Important factors thatcould cause results to differ materially from those expected by managementinclude the outcome and costs of pending legal actions against the Company, andthe Company’s ability to identify potential acquisition targets and tosuccessfully complete potential acquisitions.

**RecentAccounting Pronouncements**

In September2006, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards (SFAS) No. 157, *“FairValue Measurements,”*(“SFAS No. 157”).  This Statement defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles (GAAP), and expands disclosures about fair valuemeasurements.  This Statement iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007, and interim periods within those fiscal years.  The Company is currently evaluating theimpact of SFAS No. 157 on the Company’s consolidated financial statements.

In February2006, the FASB issued SFAS No. 155, *“Accountingfor Certain Hybrid Financial Instruments”* (“SFAS No. 155”) whichamends SFAS No. 133, *“Accounting forDerivative Instruments and Hedging Activities”* (SFAS No. 133”) andSFAS No. 140, *“Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities”* (“SFASNo. 140”).  SFAS No. 155 simplifies theaccounting for certain derivatives embedded in other financial instruments byallowing them to be accounted for as a whole if the holder elects to accountfor the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of  SFAS No. 133 and SFAS No. 140.  SFAS No. 155 is effective for all financialinstruments acquired, issued or subject to a remeasurement event occurring infiscal years beginning after September 15, 2006.  Management believes that the adoption of SFASNo. 155 will not have a material impact on our financial statements.

In June 2005,the FASB issued SFAS No. 154 *“AccountingChanges and Error Corrections,”* (“SFAS No. 154”).  SFAS No. 154 replaces Accounting PrinciplesBoard Option No. 20 (“APB 20) and SFAS No. 3, *“ReportingAccounting Changes in Interim Financial Statements,”* and applies toall voluntary changes in accounting principle, and changes the 

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requirementsfor accounting for and reporting of a change in accounting principle.  APB 20 previously required that mostvoluntary changes in accounting principle be recognized by including in netincome of the period of change a cumulative effect of changing to the newaccounting principle whereas SFAS No. 154 requires retroactive application toprior periods’ financial statements unless it is impracticable.  SFAS No. 154 enhances the consistency offinancial information between periods. SFAS No. 154 is effective for fiscal years beginning after December 15,2005, and is required to be adopted by the Company in the first quarter offiscal year 2007.

In June 2006, theFASB issued Interpretation No. 48, ``*Accountingfor Uncertainty in Income Taxes - an interpretation of FASB Statement 109*,’’(“FIN 48”).  FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with SFAS 109, *``Accounting for Income Taxes.’’*FIN 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. FIN 48 is effective for fiscal years beginning after December 15,2006. The Company is currently evaluating the impact of FIN 48 on the Company’sconsolidated financial statements.

In March 2005, theFASB issued Interpretation No. 47, *``Accountingfor Conditional Asset Retirement Obligations,”*(“FIN 47”).* *FIN 47provides clarification regarding the meaning of the term ``conditional assetretirement obligation’’ as used in SFAS No. 143,*“Accounting for Asset Retirement Obligations,”*(“SFAS 143”).This Interpretation is effective no later than the end of fiscal years endingafter December 15, 2005. The adoption of FIN 47 did not have a material impacton the Company’s consolidated financial statements.

InJuly 2002, *The Public Company Accounting Reform and InvestorProtection Act of 2002*(the Sarbanes-Oxley Act) was enacted.  Section 404 of the Sarbanes-Oxley Actstipulates that public companies must take responsibility for maintaining aneffective system of internal control. The act requires public companies to report on the effectiveness oftheir control over financial reporting and obtain an attestation report fromtheir independent registered public accounting firm about management’sreport.  The act requires most publiccompanies (accelerated filers) to report on the company’s internal control overfinancial reporting for years ending on or after November 15, 2004.  Other public companies (non-acceleratedfilers) must begin to comply with the new requirements related to internalcontrol over financial reporting for their first year ending on or after July15, 2007 under the latest extension granted by the SEC.  The SEC recently has proposed extending thecompliance date for non-accelerated filers to include a report on effectivenessof controls over financial reporting to the year ending on or after December15, 2007.  In addition, the SEC hasproposed extending the date by which non-accelerated filers must file anauditor’s attestation report on internal controls over financial reporting intheir annual reports.  Under the proposedextension, the attestation report would not be due until the first annualreport for a fiscal year ending on or after December 15, 2008.  J.L. Halsey is a non-accelerated filer andexpects to be able to comply with these filing requirements, either as proposedor as currently in effect.

**ITEM 7A.**                    QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Companydoes not engage in trading market risk sensitive instruments and does notpurchase as investments, as hedges or for purposes “other than trading,”instruments that are likely to expose the Company to market risk, whether it befrom interest rate, foreign currency exchange, or commodity price risk. TheCompany has entered into no forward or futures contracts, purchased no optionsand entered into no swap arrangements.

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**ITEM 8.**                             FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA
| **Index to Consolidated Financial Statements**                                                              |   |   |   |
|-------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| ** **                                                                                                  |   |   |   |
| Report  of Independent Registered Public Accounting Firm – Burr, Pilger & Mayer  LLP               |   |   |   |
|                                                                                                        |   |   |   |
| Report  of Independent Registered Public Accounting Firm – PricewaterhouseCoopers LLP                  |   |   |   |
|                                                                                                        |   |   |   |
| Consolidated  Balance Sheets as of June 30, 2006 and 2005                                                   |   |   |   |
|                                                                                                        |   |   |   |
| Consolidated Statements of Operations for the years  ended June 30, 2006, 2005 and 2004                |   |   |   |
|                                                                                                        |   |   |   |
| Consolidated Statements of Stockholders’ Equity for  the years ended June 30, 2006, 2005 and 2004 |   |   |   |
|                                                                                                        |   |   |   |
| Consolidated Statements of Cash Flows for the years  ended June 30, 2006, 2005 and 2004                |   |   |   |
|                                                                                                        |   |   |   |
| Notes to Consolidated Financial Statements                                                                  |   |   |   |

 

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**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directorsand Stockholders of J.L. Halsey Corporation:

We have auditedthe accompanying consolidated balance sheet of J.L. Halsey Corporation andSubsidiaries as of June 30, 2006 and 2005 and the related consolidatedstatements of operations, stockholders’ equity and cash flows for the yearsthen ended.  These consolidated financialstatements and financial statement schedule are the responsibility of theCompany’s management.  Our responsibilityis to express an opinion on these consolidated financial statements based onour audit.

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. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of J.L. Halsey Corporation andSubsidiaries as of June 30, 2006 and 2005, and the results of their operationsand their cash flows for the years then ended, in conformity with accountingprinciples generally accepted in the United States of America.

As discussed inNote 15 to the financial statements, the Company changed the manner inwhich it accounts for share-based compensation in fiscal year 2006.
| /s/ Burr, Pilger & Mayer  LLP |   |
|-----------------------------------|--------|
| San Francisco,  California        |
| September 19,  2006               |

 

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### **REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To****theBoard of Directors and Stockholders of J.L. Halsey Corporation:

In our opinion,the consolidated statements of operations, stockholders’ equity, and cash flowsfor the year ended June 30, 2004, present fairly, in all materialrespects, the results of operations and cash flows of J.L. Halsey Corporationand its subsidiaries for the year ended June 30, 2004, in conformity withaccounting principles generally accepted in the United States of America.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audit.  Weconducted our audit of these statements in accordance with the standards of thePublic Company Accounting Oversight 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. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements, assessing the accountingprinciples used and significant estimates made by management, and evaluatingthe overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
| /s/ PRICEWATERHOUSECOOPERS  LLP |   |
|---------------------------------|--------|
| Boston,  Massachusetts          |
| September 8,  2004              |

 

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

**CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share amounts)**

 
| ** **                                                                                                        | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                        | ** ** | **2006**          | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                        |       |              |       |   |   |
| Current assets:                                                                                                   |       |              |       |   |   |
| Cash and cash  equivalents                                                                                        |       | $                 | 255        |   | $ | 3,102 |   |
| Accounts  receivable, net of allowance of $181 and $10 respectively at June 30, 2006  and 2005                    |       | 4,661             |       | 1,878 |   |
| Prepaid expenses                                                                                                  |       | 1,160             |       | 231 |   |
| Deferred  acquisition costs                                                                                       |       | 231               |       | — |   |
| Deferred income  taxes                                                                                            |       | 492               |       | 95 |   |
| Deferred  financing fees                                                                                          |       | 97                |       | — |   |
| Prepaid expenses  related to discontinued operations                                                              |       | 213               |       | 270 |   |
| Total current  assets                                                                                             |       | 7,109             |       | 5,576 |   |
| Restricted cash related  to discontinued operations                                                               |       | 1,675             |       | 2,234 |   |
| Restricted cash                                                                                                   |       | 94                |       | — |   |
| Fixed assets, net                                                                                                 |       | 1,675             |       | 551 |   |
| Intangible assets, net                                                                                            |       | 19,776            |       | 12,714 |   |
| Goodwill                                                                                                          |       | 27,390            |       | 17,749 |   |
| Total assets                                                                                                      |       | $                 | 57,719     |   | $ | 38,824 |   |
|                                                                                                              |       |              |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                    |       |              |       |   |   |
| Current liabilities:                                                                                              |       |              |       |   |   |
| Accounts payable  and accrued expenses                                                                            |       | $                 | 2,126      |   | $ | 1,093 |   |
| Contingent  acquisition consideration – short-term                                                           |       | 2,207             |       | — |   |
| Note payable                                                                                                      |       | 5,496             |       | — |   |
| Accrued interest                                                                                                  |       | 634               |       | — |   |
| Income taxes  payable                                                                                             |       | 433               |       | 77 |   |
| Accrued expenses  remaining from discontinued operations                                                          |       | 2,310             |       | 3,113 |   |
| Deferred revenue                                                                                                  |       | 2,664             |       | 1,687 |   |
| Total current  liabilities                                                                                        |       | 15,870            |       | 5,970 |   |
| Revolving line of  credit                                                                                         |       | 9,867             |       | — |   |
| Note payable –  long-term                                                                                    |       | —            |       | 5,600 |   |
| Contingent acquisition  consideration – long-term                                                            |       | 1,725             |       | — |   |
| Accrued interest–  long-term                                                                                 |       | —            |       | 77 |   |
| Deferred income taxes                                                                                             |       | 98                |       | 95 |   |
| Other long-term  liabilities                                                                                      |       | 93                |       | — |   |
| Total  liabilities                                                                                                |       | 27,653            |       | 11,742 |   |
| Commitments and  contingencies (Note 16)                                                                          |       | —            |       | — |   |
| Stockholders’ equity:                                                                                        |       |              |       |   |   |
| Common stock,  $.01 par value; authorized 200,000,000 shares; issued 89,522,280 shares at  June 30, 2006 and 2005 |       | 895               |       | 895 |   |
| Additional  paid-in capital                                                                                       |       | 274,064           |       | 275,064 |   |
| Accumulated  deficit                                                                                              |       | (207,929          | )          | (210,495 | ) |
| Treasury stock  (at cost), 6,313,948 and 6,555,884 shares respectively, at June 30, 2006 and  2005                |       | (36,964           | )          | (38,382 | ) |
| Total  stockholders’ equity                                                                                  |       | 30,066            |       | 27,082 |   |
| Total liabilities and  stockholders’ equity                                                                  |       | $                 | 57,719     |   | $ | 38,824 |   |

 

The accompanying notesare an integral part of these financial statements.

 

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Inthousands, except share and per share amounts)**

 
| ** **                                                                                                                        | ** ** | **Years Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                                        | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                              |       |                                    |       |   |   |   |   |
| Software and  services revenues                                                                                                   |       | $                                       | 24,353     |   | $ | 2,207 |   | $ | — |   |
| Cost of  revenues:                                                                                                                |       |                                    |       |   |   |   |   |
| Software and services                                                                                                             |       | 5,346                                   |       | 344 |   | — |   |
| Amortization of intangibles                                                                                                       |       | 1,410                                   |       | 103 |   | — |   |
| Total cost of  revenues                                                                                                           |       | 6,756                                   |       | 447 |   | — |   |
| Gross profit                                                                                                                      |       | 17,597                                  |       | 1,760 |   | — |   |
| Operating  expenses:                                                                                                              |       |                                    |       |   |   |   |   |
| General and administrative expenses                                                                                               |       | 7,111                                   |       | 2,223 |   | 2,424 |   |
| Sales & marketing                                                                                                             |       | 5,097                                   |       | 290 |   | — |   |
| Amortization of intangibles                                                                                                       |       | 1,217                                   |       | 94 |   | — |   |
| Income (loss) from operations                                                                                                     |       | 4,172                                   |       | (847 | ) | (2,424 | ) |
| Interest income                                                                                                                   |       | 98                                      |       | 490 |   | 238 |   |
| Interest expense                                                                                                                  |       | (1,268                                  | )          | (77 | ) | — |   |
| Loss on sale of  assets                                                                                                           |       | (16                                     | )          | — |   | — |   |
| Income (loss) from continuing operations before  income taxes                                                                     |       | 2,986                                   |       | (434 | ) | (2,186 | ) |
| Income tax  provision                                                                                                             |       | 827                                     |       | 77 |   | — |   |
| Net income (loss) from continuing operations                                                                                      |       | 2,159                                   |       | (511 | ) | (2,186 | ) |
| Gain on disposal  of discontinued operations, net of income taxes of $25, $0 and $0  respectively at June 30, 2006, 2005 and 2004 |       | 407                                     |       | 281 |   | 4,941 |   |
| Net income (loss)                                                                                                                 |       | $                                       | 2,566      |   | $ | (230 | ) | $ | 2,755 |   |
| Income (loss)  per share from continuing operations – basic and diluted                                                      |       | $                                       | 0.03       |   | $ | (0.01 | ) | $ | (0.03 | ) |
| Income (loss)  per share - basic and diluted                                                                                      |       | $                                       | 0.03       |   | $ | (0.00 | ) | $ | 0.03 |   |
| Weighted average  number of shares outstanding – basic                                                                       |       | 83,126,803                              |       | 82,296,880 |   | 82,193,063 |   |
| Weighted average number  of shares outstanding – diluted                                                                     |       | 84,485,747                              |       | 82,296,880 |   | 82,193,063 |   |

 

The accompanying notesare an integral part of these financial statements.

 

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

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**(Inthousands, except share amounts)**

 
| ** **                | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated** | ** ** | **Treasury Stock** | ** ** | **Total  Stockholders’** | ** ** |
|---------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------|------------|-------------------------|------------|-------------------------------|------------|
| ** **                | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Deficit**             | ** ** | **Shares**                    | ** ** | **Amount** | ** ** | **Equity** | ** ** |
|                      |       |                  |       |                    |       |            |       |                    |       |                          |       |   |   |   |   |
| Balance at June  30, 2003 |       | 89,522,280            |       | $                       | 895        |            | $          | 275,064                 |       | $                             | (208,720   | ) | (7,329,217 | ) | $ | (42,914 | ) | $ | 24,325 |   |
|                      |       |                  |       |                    |       |            |       |                    |       |                          |       |   |   |   |   |
| Net income                |       | —                |       | —                  |       | —          |       | 2,755                   |       | —                        |       | — |   | 2,755 |   |
|                      |       |                  |       |                    |       |            |       |                    |       |                          |       |   |   |   |   |
| Balance at June  30, 2004 |       | 89,522,280            |       | 895                     |       | 275,064         |       | (205,965                | )          | (7,329,217                    | )          | (42,914 | ) | 27,080 |   |
|                      |       |                  |       |                    |       |            |       |                    |       |                          |       |   |   |   |   |
| Treasury stock  sale      |       | —                |       | —                  |       | —          |       | (4,300                  | )          | 773,333                       |       | 4,532 |   | 232 |   |
|                      |       |                  |       |                    |       |            |       |                    |       |                          |       |   |   |   |   |
| Net loss                  |       | —                |       | —                  |       | —          |       | (230                    | )          | —                        |       | — |   | (230 | ) |
|                      |       |                  |       |                    |       |            |       |                    |       |                          |       |   |   |   |   |
| Balance at June  30, 2005 |       | 89,522,280            |       | 895                     |       | 275,064         |       | (210,495                | )          | (6,555,884                    | )          | (38,382 | ) | 27,082 |   |
|                      |       |                  |       |                    |       |            |       |                    |       |                          |       |   |   |   |   |
| Treasury stock  sale      |       | —                |       | —                  |       | (1,343          | )          | —                  |       | 241,936                       |       | 1,418 |   | 75 |   |
|                      |       |                  |       |                    |       |            |       |                    |       |                          |       |   |   |   |   |
| Stock based  compensation |       | —                |       | —                  |       | 343             |       | —                  |       | —                        |       | — |   | 343 |   |
|                      |       |                  |       |                    |       |            |       |                    |       |                          |       |   |   |   |   |
| Net income                |       | —                |       | —                  |       | —          |       | 2,566                   |       | —                        |       | — |   | 2,566 |   |
|                      |       |                  |       |                    |       |            |       |                    |       |                          |       |   |   |   |   |
| Balance at June 30,  2006 |       | 89,522,280            |       | $                       | 895        |            | $          | 274,064                 |       | $                             | (207,929   | ) | (6,313,948 | ) | $ | (36,964 | ) | $ | 30,066 |   |

 

The accompanyingnotes are an integral part of these financial statements.

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

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

 
| ** **                                                                                                        | ** ** | **For the Years Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **2006**                                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Cash  Flow from Operating Activities:**                                                                         | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                                 |       | $                                                         | 2,566      |   | $ | (230 | ) | $ | 2,755 |   |
| Adjustments to reconcile net income (loss) to net  cash flows from operating activities of continuing operations: |       |                                                      |       |   |   |   |   |
| Gain on disposal of discontinued operations, net of  tax                                                          |       | (407                                                      | )          | (281 | ) | (4,941 | ) |
| Stock-based compensation expense                                                                                  |       | 343                                                       |       | — |   | — |   |
| Depreciation and amortization                                                                                     |       | 3,045                                                     |       | 236 |   | 11 |   |
| Provision for bad debt                                                                                            |       | 328                                                       |       | — |   | — |   |
| Deferred income tax benefit                                                                                       |       | (102                                                      | )          | — |   | — |   |
| Loss on sale of assets                                                                                            |       | 16                                                        |       | — |   | — |   |
| Changes in assets and liabilities:                                                                                |       |                                                      |       |   |   |   |   |
| Accounts receivable                                                                                               |       | (1,739                                                    | )          | (526 | ) | — |   |
| Prepaid expenses                                                                                                  |       | (328                                                      | )          | (126 | ) | 46 |   |
| Accounts payable and accrued expenses                                                                             |       | 176                                                       |       | 157 |   | (39 | ) |
| Accrued interest                                                                                                  |       | 557                                                       |       | 77 |   | — |   |
| Deferred revenue                                                                                                  |       | 679                                                       |       | (40 | ) | — |   |
| Income taxes payable                                                                                              |       | 409                                                       |       | 77 |   | (187 | ) |
| Net cash flows provided by (used in) continuing  operations                                                       |       | 5,543                                                     |       | (656 | ) | (2,355 | ) |
| Net cash flows (used in) provided by discontinued  operations                                                     |       | (380                                                      | )          | (714 | ) | 8,022 |   |
| Net cash flows provided by (used in) operating  activities                                                        |       | 5,163                                                     |       | (1,370 | ) | 5,667 |   |
| **Cash  Flows from Investing Activities:**                                                                        | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Continuing operations:                                                                                            |       |                                                      |       |   |   |   |   |
| Acquisition costs                                                                                                 |       | (32                                                       | )          | — |   | — |   |
| Reduction of note payable                                                                                         |       | (104                                                      | )          | — |   | — |   |
| Additions to property and equipment                                                                               |       | (854                                                      | )          | (20 | ) | (6 | ) |
| Payment for businesses acquired, net of cash  acquired                                                            |       | (17,450                                                   | )          | (24,620 | ) | — |   |
| Discontinued operations:                                                                                          |       |                                                      |       |   |   |   |   |
| Release of restricted cash                                                                                        |       | 600                                                       |       | — |   | — |   |
| Net cash flows used in investing activities                                                                       |       | (17,840                                                   | )          | (24,640 | ) | (6 | ) |
| **Cash  Flows from Financing Activities:**                                                                        | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from sale of treasury stock                                                                              |       | 75                                                        |       | 232 |   | — |   |
| Financing fees                                                                                                    |       | (112                                                      | )          | — |   | — |   |
| Proceeds from debt and credit arrangements                                                                        |       | 22,384                                                    |       | — |   | — |   |
| Payment of debt and credit arrangements                                                                           |       | (12,517                                                   | )          | — |   | — |   |
| Net cash flows provided by financing activities                                                                   |       | 9,830                                                     |       | 232 |   | — |   |
| Net (decrease)  increase in cash and cash equivalents                                                             |       | (2,847                                                    | )          | (25,778 | ) | 5,661 |   |
| Cash and cash  equivalents, beginning of year                                                                     |       | 3,102                                                     |       | 28,880 |   | 23,219 |   |
| Cash and cash  equivalents, end of year                                                                           |       | $                                                         | 255        |   | $ | 3,102 |   | $ | 28,880 |   |
|                                                                                                              |       |                                                      |       |   |   |   |   |
| Supplemental  disclosure of cash flow information:                                                                |       |                                                      |       |   |   |   |   |
| Cash paid for  interest                                                                                           |       | $                                                         | 709        |   | $ | — |   | $ | — |   |
| Cash paid for taxes                                                                                               |       | $                                                         | 565        |   | $ | — |   | $ | — |   |

 

The accompanying notesare an integral part of these financial statements.

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

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**June 30, 2006**

**1.     TheCompany**

J.L.Halsey Corporation (“Halsey” or “Company”), through its wholly-ownedsubsidiaries, Lyris Technologies, Inc. (“Lyris”) and Uptilt, Inc. (d/b/a “EmailLabs”),is a leading marketing technology and services firm.  The Company’s email marketing software andservices provide clients with leading solutions for creating, managing anddelivering online permission-based direct marketing programs, newsletters,discussion groups and other digital communications to clients whose email listsrequire specialized technology in order to effectively communicate with theirmembers and customers.  The Companyoffers its email solutions in two forms: as software that is downloaded andinstalled on a customer’s computers, and as a hosted solution in which thecustomer uses the Company’s software through an internet connection.

OnMay 12, 2005, Halsey acquired all of the outstanding capital stock of Lyris for$30.7 million, which included cash payments of $25.1 million (includingacquisition costs and working capital adjustments of $1.2 million) and $5.6million in the form of a promissory note payable, subject to Lyris achievingspecified revenue targets, on the second anniversary of the closing date withinterest equal to 10% per annum.  Halseybelieves that it is probable that the specified revenue targets stated in thepromissory note will be attained on or before the second anniversary of theclosing date. As a result, we have recorded the note payable of $5.5 million asa current liability on our Balance Sheet as of June 30, 2006. With thisacquisition, Halsey became a leading email marketing company with over 5,000customers worldwide.

OnOctober 11, 2005, Halsey acquired all of the outstanding capital stock ofEmailLabs, an email marketing technology company based in Menlo Park,California, for $24.3 million (including acquisition costs and working capitaladjustments of $541,000).  Of thispurchase price, $19.5 million was paid in cash at closing, of which $2.3million was funded by EmailLabs’ available cash.  $500,000 of the purchase price was held backpursuant to minimum working capital requirements.  This holdback and the final working capitaladjustment were paid during the quarter ended March 31, 2006.  The agreement also includes contingentconsideration consisting of two equal earn-out payments of $1.7 million due onthe first and second anniversary of the closing date if EmailLabs achievesspecified revenue targets.  Halseybelieves that it is probable that the specified revenue targets will beattained and has accrued these liabilities in the current and non-currentportions of our Balance Sheet at June 30, 2006. Additionally, any income tax refund related to the period ending on andincluding the closing date will be paid to the stockholders of EmailLabs.  At June 30, 2006, these refunds and theassociated liabilities have been estimated at approximately $482,000 and areincluded in the current portion of our Balance Sheet.  The remainder of the purchase price wasfunded with the proceeds of the Loan and Security Agreement between Halsey andComerica Bank.  With this acquisition wecontinued to expand our customer base and diversify and deepen our technologyofferings.

OnAugust 18, 2006, Halsey acquired all of the outstanding capital stock ofClickTracks, a Web analytics provider based in Santa Cruz, California, forapproximately $7.7 million in cash and $2.9 million in common stock of theCompany issued to certain security holders of ClickTracks.  Additional payments totaling approximately$3.8 million may be made in the event ClickTracks achieves future revenuetargets and working capital adjustments.

OnAugust 18, 2006, Halsey acquired all of the outstanding capital stock of HotBanana, an e-marketing Web content management company based in Ontario, Canada,for approximately $1.9 million Canadian ($1.7 million U.S. based on thethen-applicable exchange rate), with additional installments of up to $750,000Canadian ($670,661 U.S.) if Hot Banana achieves specified revenue andtechnology integration targets, and up to an additional $500,000 Canadian($447,107 U.S.) payable subject to working capital and other adjustments.

Eachof our four acquisitions we have made requires us to make additional earn-outpayments to the sellers of the businesses if certain conditions are met.  Copies of the acquisition agreements havebeen filed with the SEC and are discussed elsewhere herein.  (See Notes 6, 11 and 19).  We believe that some of these conditions arelikely to be met, and, therefore, have classified specified earn-outs on ourbalance sheet as short-term or long-term debt. Our principal use of cash in thefuture will be the payment of earn-outs and the pay down of debt. Based on itscurrent projections, the Company believes that it will be able to make thesepayments with its available resources. If however, operating resultsdeteriorate or other adverse events occur, the Company will not have adequateresources to make these payments.  TheCompany may be forced to seek additional resources and the cost of theseresources, if available at all, may be prohibitive.

Halsey is thesuccessor to NovaCare, which at one time was a national leader in physicalrehabilitation services, orthotics and prosthetics and employee services. Thechanges to Medicare reimbursement in the late 1990’s had deleterious effects onNovaCare and its competitors and customers. The prior operating business most affected by the Medicare changes wasthe long-term care services segment in which NovaCare provided therapists toskilled nursing facilities.  Thisbusiness was disposed of in fiscal 1999 with the shutdown of certain of itsoperations in the Western United States during the third fiscal quarter and thesale of the remaining operations on June 1, 1999.  NovaCare’s former outpatient services segmentwas disposed of through the sales of its orthotics and prosthetics (“O&P”)and physical rehabilitation and occupational health (“PROH”) businesses. TheO&P business was sold to Hangar Orthopedic Group, Inc. in July of 1999 andthe PROH business was sold to Select Medical Corporation in November of1999.  The Company’s former employee

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servicessegment was disposed of through NovaCare’s sale of its interest in NovaCareEmployee Services (“NCES”) in October of 1999 to a subsidiary of PlatoHoldings, Inc. as part of a tender offer by Plato for all of NCES’s outstandingshares.  With cash raised from the salesof its businesses, the Company repaid all of its bank debt in the summer of1999, and in January of 2000, the Company retired its publicly-tradedsubordinated debt.

NovaCare soldits name as part of the sale of the PROH business and subsequently changed itsname to NAHC, Inc.  On June 18, 2002, ina transaction approved by NAHC’s stockholders at a special meeting, NAHC mergedwith and into Halsey, its wholly-owned subsidiary.  The purpose of the merger between NAHC andHalsey was to implement transfer restrictions on the Company’s common stock inorder to preserve the Company’s net operating losses.

Priorto the  acquisitions noted above, theCompany spent several years maximizing the assets that it had retained,including old accounts receivable, Medicare receivables and appeals and taxitems, and minimizing liabilities retained after the sales of the operatingbusinesses.  The Company made significantprogress on these matters.  The Companyhas collected virtually all of its receivables, other than amounts which arethe subject of litigation or arbitration or that have been written off, andalso resolved all but one litigation matter remaining from the prior operationsof NovaCare. A subsidiary of the Company has retained three****employeesand two consultants to carry out the general and administrative functionsspecified above. These resources have been supplemented with outside financial,tax and legal resources when required by management and the board ofdirectors.  No members of the currentboard of directors were members prior to the Company selling its previoushealthcare operating businesses.

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

*Principles of Consolidation*

Theconsolidated financial statements include the accounts of the Company and itswholly-owned subsidiaries. All significant intercompany accounts andtransactions have been eliminated.

*Use of Estimates*

The preparationof financial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of expenses during the reporting period. Actual results could differfrom those estimates. Management also uses estimates to report assets andliabilities remaining from discontinued operations. The Company estimatesreserves against potential assets from discontinued operations as well as inthe reporting of potential liabilities from discontinued operations. TheCompany adjusts these estimates as facts and circumstances require.

*Certain Significant Risks and Uncertainties*

*TheCompany operates in a highly competitive and dynamic market and accordingly,can be affected by a variety of factors. For example, management of the Company believes that any of thefollowing could have a negative effect on the Company in terms of its futurefinancial position and results of operations; ability to obtain rights to orprotect our intellectual property; changes in regulations; ability to developnew products accepted in the marketplace; competition including, but notlimited to, pricing and products or product features and services; litigationor claims against the Company; and the hiring, training and retention of keyemployees.*

*Concentration of Credit Risk*

*FinancialInstruments that potentially subject the Company to a concentration of creditrisk consist primarily of cash and trade receivables.  The Company sells its products primarily tocustomers throughout the United States. The Company monitors the credit status of its customers on an ongoingbasis and does not require its customers to provide collateral for purchases oncredit.  No single customer or vendoraccounts for greater than 10% of the Company’s trade receivables.*

*Fair Value of Financial Instruments*

*Thefair value of certain of the Company’s financial instruments, including cashand cash equivalents, accounts receivable and accounts payable, and certainother accrued liabilities, approximate cost because of their short maturities.*

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*Cash and Cash Equivalents*

The Companyconsiders cash on hand, cash in banks, and cash investments with maturities ofthree months or less when purchased as cash and cash equivalents.  The Company’s holdings consist of cash inbanks. These holdings are recorded on the Company’s balance sheet at currentvalue, which includes cost plus earned interest.  The Company maintains cash balances withbanks in excess of FDIC insured limits. The Company limits credit risk bymaintaining accounts with financial institutions of high credit standing.

*Restricted Cash*

The Company’srestricted cash balances consist of the following:
| (in thousands)                                                       | ** ** | **June 30, 2006** | ** ** | **June 30, 2005** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Cash balance in  support of self-insured workers compensation liabilities |       | $                           | 1,675      |                        | $          | 2,234 |   |
| Certificate of  deposit in support of operating lease agreement           |       | 94                          |       | —                      |       |
| Total restricted cash                                                     |       | $                           | 1,769      |                        | $          | 2,234 |   |

 

*Therestricted cash accounts are a result of an agreement between Halsey and itsprevious workers compensation insurance carriers from our previous healthcarediscontinued operations and are restricted at the discretion of the insurancecarriers. The Company has been working with the insurance carriers to settlethe eight remaining workers compensation claims. The change in the restrictedcash balance represents a release of the restricted cash that was received bythe Company in fiscal year 2006 in the amount of $600,000 offset by interestincome of $41,000.   The certificate ofdeposit is required by the terms of the lease for the headquarters ofEmailLabs.*

# *Propertyand Equipment*

Propertyand equipment are stated at cost, less accumulated depreciation andamortization.  Depreciation andamortization is computed using the straight-line method over the shorter of theestimated useful lives of the assets, generally two years to seven years, orthe lease term including any lease term extensions that the Company has theright and intention to execute, if applicable. Repair and maintenance costs areexpensed in the period incurred.

# *RevenueRecognition*

The Companyrecognizes revenue from the following primary sources:  (1) hosting software for use by customers;(2) licensing software products; and (3) providing customers technical support(maintenance).

TheCompany generally recognizes revenue when all of the following conditions aresatisfied:  (1) there is persuasiveevidence of an arrangement; (2) the service has been provided to the customer(in the case of software licenses, revenue is recognized when the customer isgiven electronic access to the licensed software); (3) the amount of fees to bepaid by the customer is fixed or determinable; and (4) the collection of feesis probable.

The Company’shosted software arrangements are considered service arrangements in accordancewith Emerging Issues Task Force (“EITF”) Issue No. 00-3, *Applicationof AICPA Statement of Position 97-2, Software Revenue Recognition, toArrangements That Include the Right to Use Software Stored on Another Entity’sHardware*, and with multiple deliverables under EITF 00-21, *Accounting for Revenue Arrangements with Multiple Deliverables*.  In addition, because the Company provides itsapplications as a service, the Company follows the provisions of Securities andExchange Commission Staff Accounting Bulletin No. 104, *RevenueRecognition*.  Hosting revenueis recognized monthly based on the usage defined in the agreement.  Excess usage is billed and recognized asrevenue is incurred.

TheCompany recognizes software license revenue in accordance with the provisionsof SOP 97-2, *Software Revenue Recognition*,and SOP 98-9 *Modification of 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).  For these arrangements, which generallyinclude software products and maintenance, we allocate and defer revenue forthe undelivered elements based on their vendor-specific objective evidence offair value (“VSOE”).  Future discounts onunspecified items are considered post-contract customer support, which areincluded in VSOE for undelivered elements. Since VSOE exists for all elements (delivered and undelivered), weallocate the total revenue to be earned under the arrangement among the variouselements, based on their relative fair value. Maintenance

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revenues,including revenues included in multiple element arrangements, are deferred andrecognized ratably over the related contract period, generally twelve months.

# *DeferredRevenue*

Deferredrevenue represents customer billings made in advance for annual supportcontracts and bulk purchases of emails to be delivered in the future.Maintenance is typically billed on a per annum basis in advance and revenue isrecognized ratably over the maintenance period. Bulk purchases are typically billed in advance and revenue is recognizedin the periods in which emails are delivered.

# *AdvertisingCosts*

Advertisingcosts are expensed as incurred or the first time the advertising takesplace.  Advertising costs for the yearsended June 30, 2006, 2005 and 2004 were approximately $1.5 million, $90,000 and$0, respectively.

*Researchand Development Costs*

Researchand development costs are expensed as incurred. Research and development costs for the years ended June 30, 2006, 2005and 2004 were approximately $210,000, $0 and $0, respectively.  Research and development costs are includedin general and administrative expenses.

*Significant Customer Information andSegment Reporting*

**SFASNo.  131, *“Disclosureabout Segments of an Enterprise and Related Information*,*”* establishes standards for the reporting by businessenterprises of information about operating segments, products and services,geographic areas and major customers. The method for determining what information to report is based on theway that management organizes the operating segments within Halsey for makingoperational decisions and assessments of financial performance.**

Halsey’schief executive officer (CEO) is considered to be the chief operatingdecision-maker.  The CEO reviewsfinancial information presented on a consolidated basis for purposes of makingoperating decisions and assessing financial performance.  Halsey has determined that it operates in asingle operating segment, specifically, email marketing technology andservices, and has no significant customers.

***Allowance for Doubtful Accounts***

TheCompany’s policies for allowances for doubtful accounts for its currentoperations (Lyris and EmailLabs) and its previous healthcare discontinuedoperations are as follows:

Continuingoperations

Weregularly assess our ability to collect outstanding customer invoices and in sodoing must make estimates of the collectibility of accounts receivable.  We provide an allowance for doubtful accountswhen we determine that the collection of an outstanding customer receivable isnot probable.  We specifically analyzeaccounts receivable and historical bad debts experience, and changes in ourcustomer payment history when evaluating the adequacy of the allowance fordoubtful accounts.  If any of thesefactors change, our estimates may also change, which could affect the level ofour future provision for doubtful accounts.

Discontinuedoperations

The Companymaintains allowances for the collection of its receivables remaining fromdiscontinued healthcare operations. These allowances are the result of the inability or unwillingness ofmany of the Company’s former healthcare customers to make payments.  Several of the key industries in which theCompany previously operated were severely impacted by the Balanced Budget Actof 1997.  As a result of the provisionsof this Act, many of the Company’s former customers went bankrupt and many arenearly insolvent. Currently, the Company has outstanding receivables from a fewof these customers and has recorded 100% allowances against these receivables.The Company is pursuing collection from two of its former customers throughlitigation.

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On a quarterlybasis, the Company reviews the value of the reserves and adjusts the net valueof the receivables to the estimated amount that management expects to realize.When facts and circumstances indicate that an account has been impaired belowits current carrying value, the Company will adjust the reserveaccordingly.  When a customer files forbankruptcy or other facts and circumstances dictate that the associatedreceivable will not be collectible at any future period, the Company fullyreserves the receivable.  If any of thesereceivables are collected, the Company will record a gain in the period ofcollection.

*Loss Contingencies*

*The Company records estimated losscontingencies when information is available that indicates that it is probablethat an asset has been impaired or a liability has been incurred and the amountof the loss can be reasonably estimated. When no accrual is made for a loss contingency because one or both ofthese conditions are not met, or if an exposure to loss exists in excess of theamount accrued, the Company discloses such contingencies when there is at leasta reasonable possibility that a loss or an additional loss may have beenincurred.  Determining the likelihood ofincurring a liability and estimating the amount of the liability involvessignificant judgment.  If we had useddifferent assumptions, the amount of loss contingencies recorded could havediffered materially.  If the outcome ofthe litigation is more adverse to the Company than management currentlyexpects, then the Company may have to record additional charges in the futureand such charges could be significant. See Note 16 for details oncontingencies.*

*Accountingfor Acquisitions*

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

*Stock-Based Compensation*

Weaccount for stock-based compensation in accordance with the provisions of SFASNo. 123(R), *“Share-Based Payment*.*”*  Under the fairvalue recognition provisions of SFAS No. 123(R), stock-based compensation costis estimated at the grant date based on the fair value of the award and isrecognized as expense ratably over the requisite service period of theaward.  Determining the appropriate fairvalue model and calculating the value of stock-based awards, which includesestimates of stock price volatility, forfeiture rates and expected lives,requires judgment that could materially impact our operating results.

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

**In accordance with the provisions of Statement of SFAS No. 141, *“Business Combinations”*(“SFAS 141”), the purchase price of an acquired company is allocatedbetween tangible and intangible assets acquired and liabilities assumed fromthe acquired business based on their estimated fair values, with the residualof the purchase price recorded as goodwill.**

**We assess the impairment of identified intangibles, long-lived assets andgoodwill at least annually and whenever events or a change in circumstancesindicate the carrying value may not be recoverable. Factors we considerimportant which could trigger an impairment review include the following:**

·                  significant underperformance relativeto historical or expected projected future operating results;

·                  significant changes in the manner ofour use of the acquired assets or the strategy for our overall business;

·                  significant negative industry oreconomic trends;

·                  significant decline in our stock pricefor a sustained period of time; and

·                  our marketcapitalization relative to net book value

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     When we determine that the carrying value of intangible assets, long-livedassets or goodwill may not be recoverable based upon the existence of one or moreof the above indicators of impairment, we measure any potential impairmentbased on a projected discounted cash flow method using a discount ratedetermined by our management to be commensurate with the risk inherent in ourcurrent business model.

The Companycompleted annual goodwill impairment tests during the fourth quarter of 2006and determined that the carrying amount of goodwill was not impaired.

*Accounts and Notes Receivables Remaining from DiscontinuedOperations*

At June 30,2006, the accounts and notes receivables remaining from discontinued operationsprimarily consist of trade accounts receivable and Medicare related receivableswhich were owed to the Company prior to the disposition of the Company’shealthcare operating segments in 1999. The Company has reserved these receivables at 100% to reduce theseassets to their net realizable value of zero as the Company believes that it isnot likely to collect any of these amounts. Adjustments to reserves are chargedor credited to gain (loss) on discontinued operations, net of tax.

*AccruedExpenses Remaining from Discontinued Operations*

At June 30, 2006, the accrued expenses remaining fromdiscontinued operations primarily consist of liabilities which arose prior toor as a result of the disposition transactions. These liabilities includeworkers compensation, uninsured professional liability claims and credit andcollection expenses. The Company adjusts these accrual amounts based on currentinformation available to management and these adjustments are charged orcredited to gain (loss) on discontinued operations, net of tax.

*Interest Expense*

*The Companyrecords interest expense related to its revolving line of credit and notepayable.  All interest expense is relatedto continuing operations therefore no interest expense is allocated todiscontinued operations.*

*Income Taxes*

*TheCompany accounts for income taxes under the provisions of SFAS No. 109,**“Accounting for Income Taxes.”**  Under this method, deferred tax assets andliabilities are determined based on the differences between the financialstatements carrying amounts of existing assets and liabilities and theirrespective tax basis.*

The Companyrecords deferred tax assets and liabilities for the expected future taxconsequences of events that have been recognized in the Company’s financialstatements or tax returns.  Due to theCompany’s rapid growth through acquisitions, the Company can not currentlydetermine when its more likely than not that deferred taxes will be realized infuture periods.  As a result, we aremaintaining a valuation allowance on significantly all the future federal taxbenefits.  As the Company developsreliable revenue projections and determines that the future benefits willlikely be utilized, we will adjust the valuation reserve.

The Companyutilizes certain tax strategies to lower taxable income.  We believe that we will be able to establishwith state tax authorities that we are entitled to all or most of the benefitsfrom these strategies.  However, thesetax strategies are subject to certain assumptions and interpretations of therelevant legislation and judicial history that may or may not be accepted bythe tax authorities.  Based on ourassessment on any challenges from state tax authorities, we recognize aliability on uncertain tax positions.

*Net Income (Loss) Per Share*

Basic netincome (loss) per share (“EPS”) is calculated using the weighted average numberof common shares outstanding during each period. Diluted net income (loss) pershare is calculated using basic EPS adjusted for the effects of stock optionsand convertible debt if such instruments are dilutive.

*Comprehensive Income (Loss)*

For fiscalyears 2006, 2005 and 2004 the Company’s comprehensive income or loss consistsonly of net income or loss.

49

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*NewAccounting Pronouncements*

In September2006, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards (SFAS) No. 157, *“FairValue Measurements,”*(“SFAS No. 157”).  This Statement defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles (GAAP), and expands disclosures about fair valuemeasurements.  This Statement iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007, and interim periods within those fiscal years.  The Company is currently evaluating theimpact of SFAS No. 157 on the Company’s consolidated financial statements.

In February2006, the FASB issued SFAS No. 155, *“Accountingfor Certain Hybrid Financial Instruments”* (“SFAS No. 155”) whichamends SFAS No. 133, *“Accounting forDerivative Instruments and Hedging Activities”* (SFAS No. 133”) andSFAS No. 140, *“Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities”* (“SFASNo. 140”).  SFAS No. 155 simplifies theaccounting for certain derivatives embedded in other financial instruments byallowing them to be accounted for as a whole if the holder elects to accountfor the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of  SFAS No. 133 and SFAS No. 140.  SFAS No. 155 is effective for all financialinstruments acquired, issued or subject to a remeasurement event occurring infiscal years beginning after September 15, 2006.  Management believes that the adoption of SFASNo. 155 will not have a material impact on our financial statements.

In June 2005,the FASB issued SFAS No. 154 *“AccountingChanges and Error Corrections,”* (“SFAS No. 154”).  SFAS No. 154 replaces Accounting PrinciplesBoard Option No. 20 (“APB 20) and SFAS No. 3, *“ReportingAccounting Changes in Interim Financial Statements,”* and applies toall voluntary changes in accounting principle, and changes the requirements foraccounting for and reporting of a change in accounting principle.  APB 20 previously required that mostvoluntary changes in accounting principle be recognized by including in netincome of the period of change a cumulative effect of changing to the new accountingprinciple whereas SFAS No. 154 requires retroactive application to priorperiods’ financial statements unless it is impracticable.  SFAS No. 154 enhances the consistency offinancial information between periods. SFAS No. 154 is effective for fiscal years beginning after December 15,2005, and is required to be adopted by the Company in the first quarter offiscal year 2007.

In June 2006, theFASB issued Interpretation No. 48, ``*Accountingfor Uncertainty in Income Taxes - an interpretation of FASB Statement 109*,’’(“FIN 48”).  FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with SFAS 109, *``Accounting for Income Taxes.’’*FIN 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. FIN 48 is effective for fiscal years beginning after December 15,2006. The Company is currently evaluating the impact of FIN 48 on the Company’sconsolidated financial statements.

In March 2005, theFASB issued Interpretation No. 47, *``Accountingfor Conditional Asset Retirement Obligations,”*(“FIN 47”).* *FIN 47provides clarification regarding the meaning of the term ``conditional assetretirement obligation’’ as used in SFAS No. 143,*“Accounting for Asset Retirement Obligations,”*(“SFAS 143”).This Interpretation is effective no later than the end of fiscal years endingafter December 15, 2005. The adoption of FIN 47 did not have a material impacton the Company’s consolidated financial statements.

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

As discussed in Note 1, on May 12, 2005 the Company acquired Lyris Technologies, Inc. The acquisition was accounted for as a purchase and, accordingly, the results of operations of Lyris have been included in the consolidated financial statements commencing on the date of acquisition. During the fourth quarter of fiscal year 2006, the Company determined that a deferred tax asset of approximately $257,000 existed at the date of the acquisition.  This adjustment resulted in increase in other current assets with an offsetting decrease to goodwill.  In connection with the acquisition, the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition were as follows:
| (in thousands)                        | ** ** | ** **                 | ** ** |
|---------------------------------------|------------|----------------------------|------------|
| Description                           | ** ** | **May 12, 2005** | ** ** |
| Assets:                               |       |                       |       |
| Cash                                  |       | $                          | 86         |   |
| Trade receivables                     |       | 1,039                      |       |
| Other current assets                  |       | 620                        |       |
| Property and equipment                |       | 559                        |       |
| Goodwill                              |       | 17,491                     |       |
| Trademarks and intangible assets      |       | 12,911                     |       |
| Total assets acquired                 |       | 32,706                     |       |
| Liabilities:                          |       |                       |       |
| Accounts payable and accrued expenses |       | 321                        |       |
| Deferred revenue                      |       | 1,727                      |       |
| Total liabilities                     |       | 2,048                      |       |
| Net assets  acquired                  |       | $                          | 30,658     |   |

 
| Represented by:            |   |   |   |
|----------------------------|--------|--------|--------|
| Cash paid at closing       |   | $      | 23,900 |   |
| Acquisition costs          |   | 1,023  |   |
| Working capital adjustment |   | 135    |   |
| Note payable               |   | 5,600  |   |
|                       |   | $      | 30,658 |   |

 

The followingtable represents unaudited pro-forma financial information as if theacquisition took place on the first day of the fiscal year in which theacquisition occurred and the first day of the fiscal year prior to the actualfiscal year of acquisition.
|                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Total revenue                        |       | $        | 12,562     |     | $          | 10,815 |   |
| Net income  (loss)                   |       | 1,657    |       | 4,495    |       |
| Basic net income  (loss) per share   |       | $        | 0.02       |     | $          | 0.05 |   |
| Diluted net income  (loss) per share |       | $        | 0.02       |     | $          | 0.05 |   |

 

**4.Acquisition of EmailLabs**

As discussed in Note 1, on October 11, 2005 the Company acquired EmailLabs.  The acquisition was accounted for as a purchase, and, accordingly, the results of operations of EmailLabs have been included in the consolidated financial statements commencing on the date of acquisition. In connection with the acquisition, the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition were as follows:
| **(in thousands)**                    | ** ** | ** **                     | ** ** |
|---------------------------------------|------------|--------------------------------|------------|
| Description                           | ** ** | **October 11, 2005** | ** ** |
| Assets:                               |       |                           |       |
| Cash                                  |       | $                              | 3,075      |   |
| Trade receivables                     |       | 1,368                          |       |
| Other current assets                  |       | 624                            |       |
| Property and equipment                |       | 703                            |       |
| Other non-current assets              |       | 94                             |       |
| Goodwill                              |       | 9,899                          |       |
| Trademarks and intangible assets      |       | 9,690                          |       |
| Total assets acquired                 |       | 25,453                         |       |
| Liabilities:                          |       |                           |       |
| Accounts payable and accrued expenses |       | 683                            |       |
| Deferred revenue                      |       | 297                            |       |
| Other liabilities                     |       | 16                             |       |
| Total liabilities                     |       | 996                            |       |
| Net assets  acquired                  |       | $                              | 24,457     |   |

 
| Represented by:                         |   |   |   |
|-----------------------------------------|--------|--------|--------|
| Cash paid at closing                    |   | $      | 19,484 |   |
| Acquisition costs                       |   | 429    |   |
| Holdback and working capital adjustment |   | 612    |   |
| Estimated income tax refund             |   | 482    |   |
| Contingent consideration                |   | 3,450  |   |
|                                    |   | $      | 24,457 |   |

 

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Upon completionof EmailLabs’ 2005 tax returns during the fourth quarter of fiscal year 2006,the Company increased the fair value of other current assets by approximately$175,000 to reflect addition tax refunds due the Company.  This increase was offset by an increase inour payable to the former shareholders of EmailLabs since they receive thebenefit of these refunds.   Also duringthe fourth quarter of fiscal year 2006, the Company determined that a deferred taxasset of approximately $35,000 existed at the date of the acquisition.  This adjustment resulted in increase in othercurrent assets with an offsetting decrease to goodwill.

The followingtable represents unaudited pro-forma financial information as if theacquisition took place on the first day of the fiscal year in which theacquisition occurred and the first day of the fiscal year prior to the actualfiscal year of acquisition.
| (in thousands)                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Total revenue                        |       | $        | 26,698     |     | $          | 9,607 |   |
| Net income  (loss)                   |       | 2,513    |       | (844     | )          |
| Basic net income  (loss) per share   |       | $        | 0.03       |     | $          | (0.01 | ) |
| Diluted net income  (loss) per share |       | $        | 0.03       |     | $          | (0.01 | ) |

 

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

Intangible assets consist of thefollowing: 
| (in thousands)             | ** ** | **June 30, 2006** | ** ** | **June 30, 2005** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|
| Customer  relationships         |       | $                 | 7,373      |              | $          | 4,113 |   |
| Developed  technology           |       | 8,158             |       | 4,078             |       |
|                            |       | 15,531            |       | 8,191             |       |
| Less:  accumulated amortization |       | (2,825            | )          | (197              | )          |
|                            |       | 12,706            |       | 7,994             |       |
| Trade names                     |       | 7,070             |       | 4,720             |       |
|                            |       |              |       |              |       |
| Total intangible  assets        |       | $                 | 19,776     |              | $          | 12,714 |   |

 

The following tableoutlines the Company’s intangible assets, by acquisition, as of June 30, 2006:
| (in thousands)    | ** ** | **Gross amount** | ** ** | **Accumulated  amortization** | ** ** | **Balance at  June 30, 2006** | ** ** |
|------------------------|------------|-----------------------|------------|-------------------------------|------------|----------------------------------------------|------------|
| Lyris  Technologies:   |       |                  |       |                          |       |                                         |       |
| Customer relationships |       | $                     | 4,113      |                          | $          | (840                                         | )          | $ | 3,273 |   |
| Developed technology   |       | 4,078                 |       | (923                          | )          | 3,155                                        |       |
| Tradenames             |       | 4,720                 |       | —                        |       | 4,720                                        |       |
| Subtotal               |       | 12,911                |       | (1,763                        | )          | 11,148                                       |       |
|                   |       |                  |       |                          |       |                                         |       |
| EmailLabs:             |       |                  |       |                          |       |                                         |       |
| Customer relationships |       | 3,260                 |       | (472                          | )          | 2,788                                        |       |
| Developed technology   |       | 4,080                 |       | (590                          | )          | 3,490                                        |       |
| Tradenames             |       | 2,350                 |       | —                        |       | 2,350                                        |       |
| Subtotal               |       | 9,690                 |       | (1,062                        | )          | 8,628                                        |       |
|                   |       |                  |       |                          |       |                                         |       |
| Grand Total            |       | $                     | 22,601     |                          | $          | (2,825                                       | )          | $ | 19,776 |   |

 

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Amortizationexpense for the years ended June 30, 2006, 2005 and 2004 was $2.6 million, $197,000and $0, respectively. During the years ended June 30, 2006, 2005 and 2004,amortization expense classified as cost of revenue and related to amortizationof developed technology was $1.4 million, $103,000 and $0, respectively.

Customerrelationship-based intangible assets have a weighted average amortizationperiod of 5.95 years and developed technology-based intangible assets have aweighted average amortization period of 5 years.

Theestimated future amortization expense related to intangible assets, assuming nofuture impairment of the underlying assets as of June 30, 2006 is as follows:
| (in thousands)  Fiscal Year | ** ** | **Customer  Relationships** | ** ** | **Developed  Technology** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|---------------------------|------------|-----------|------------|
| 2007                                  |       | $                           | 1,398      |                      | $          | 1,636     |       | $ | 3,034 |   |
| 2008                                  |       | 1,310                       |       | 1,636                     |       | 2,946     |       |
| 2009                                  |       | 1,302                       |       | 1,636                     |       | 2,938     |       |
| 2010                                  |       | 1,302                       |       | 1,511                     |       | 2,813     |       |
| 2011                                  |       | 749                         |       | 226                       |       | 975       |       |
| Total                                 |       | $                           | 6,061      |                      | $          | 6,645     |       | $ | 12,706 |   |

 

The following table outlines the Company’s goodwill,by acquisition, as of June 30, 2006:
| **(in thousands)**Description | ** ** | **Goodwill  Amount** | ** ** |
|-------------------------------|------------|----------------------|------------|
|                          |       |                 |       |
| Lyris Technologies            |       | $                    | 17,491     |   |
| EmailLabs                     |       | 9,899                |       |
|                          |       |                 |       |
| Total                         |       | $                    | 27,390     |   |

 

**6.****             ****Note Payable and Revolving Lineof Credit**

NotePayble

CommodoreResources, (Nevada) Inc, a wholly-owned subsidiary of the Company, executed asubordinated promissory note with The John Buckman and Jan Hanford Trust in theamount of $5.6 million as part of the acquisition of Lyris Technologies on May12, 2005.  The note bears interest at therate of 10% per annum. The note and accrued interest become due on May 12, 2007subject to the following conditions:

·                  Total Revenue of LyrisTechnologies for the twelve month periods ended March 31, 2006 and 2007, takenin the aggregate, must be equal to or greater than $24 million.

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

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

·                  The amount due on this noteshall also be reduced for any royalty payments that the Company is required tomake under the terms of the License Agreement between the Company and DigitalImpact, Inc.  In the quarter ended June30, 2006 the Company paid $103,760 to Digital Impact, Inc. and reduced the notepayable by this amount.

·                  The Company has accrued $634,000of interest owed on this note as of June 30, 2006.  During the fiscal year the Company accrued$557,000 of interest on this note and recorded this amount as interest expensein the statement of operations for the year ended June 30, 2006.

RevolvingLine of Credit

On October 11,2005, the Company entered into a Loan and Security Agreement (“the Agreement”)with Comerica Bank (“Comerica”) providing a revolving line of credit to theCompany.  The initial borrowings underthe Agreement were used to consummate the acquisition of EmailLabs and forgeneral corporate purposes.  Under theoriginal Agreement interest on outstanding balances was charged at a floatingrate equal to either Comerica’s base rate plus 0.75% or Comerica’s LIBOR rateplus 3.75%.  The original amountavailable to the Company was $18.5 million and that amount was reduced monthlybeginning October 31, 2005.  Monthlyreductions were $250,000 through September 30, 2007 and $347,222 thereafterthrough the maturity date.  In addition,the Agreement contains certain financial covenants and requires the Company tomaintain certain financial ratios. Effective April 25, 2006, the Company entered into a First Amendment (“FirstAmendment”) to the Agreement.

TheFirst Amendment reduces Comerica’s lending commitment to $13.5 million and resetsthe monthly reduction amounts on the lending commitment to $175,000 per monthfor the period April 30, 2006 through May 31, 2007, $250,000 per month throughSeptember 30, 2007, and $347,222 per month thereafter until the maturity dateof February 28, 2010.  In addition, theFirst Amendment decreases the rate at which outstanding borrowings under theagreement bear interest to a rate that fluctuates dependent upon a ratio ofsenior debt to EBITDA, as calculated from time to time, and revises existing financialand other covenants.

TheLoan and Security Agreement, as amended, contains certain financial covenantsand requires the Company to maintain certain financial ratios.  At June 30, 2006, the Company was incompliance with all provisions of the Agreement, including the financialcovenants and ratios.  In addition, themonthly reductions reduce the amount available to the Company at June 30, 2007to $10.8 million.  Current borrowings areless than the amount available to the Company at June 30, 2007 and thereforethe Company has classified the entire outstanding balance as a long termliability.

Effectiveas of August 18, 2006, the Company entered into a Second Amendment to Loan andSecurity Agreement (the “Second Amendment”) with Comerica.  The Second Amendment also amends the Loan andSecurity Agreement and revises existing financial and other covenants.  Substantially all of the Company’s assets arepledged against the note.

Theaggregate maturities of debt by fiscal year as of June 30, 2006 are as follows(in thousands)
| 2007   |   | $      | 5,496  |   |
|--------|--------|--------|--------|--------|
| 2008   |   | 2,942  |   |
| 2009   |   | 4,167  |   |
| 2010   |   | 2,758  |   |
| 2011   |   | — |   |
|   |   | $      | 15,363 |   |

 

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**7.     Discontinued Operations**

**At June 30, 2006 and 2005, assets andliabilities from discontinued operations consisted of:**

| (in thousands)                                                     | ** ** | **June 30, 2006** | ** ** | **June 30, 2005** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Restricted cash in  support of workers compensation liabilities         |       | $                           | 1,675      |                        | $          | 2,234 |   |
| Prepaid expenses  pertaining to insurance deposits                      |       | 213                         |       | 270                         |       |
| Accounts receivable  remaining from discontinued operations             |       | 583                         |       | 1,109                       |       |
| Allowance for doubtful  accounts remaining from discontinued operations |       | (583                        | )          | (1,109                      | )          |
| Total assets  related to discontinued operations                        |       | $                           | 1,888      |                        | $          | 2,504 |   |
|                                                                    |       |                        |       |                        |       |
| Accrued expenses  remaining from discontinued operations                |       | 2,310                       |       | 3,113                       |       |
| Taxes payable related  to discontinued operations                       |       | —                      |       | —                      |       |
| Total liabilities  related to discontinued operations                   |       | $                           | 2,310      |                        | $          | 3,113 |   |

 

The accountsreceivables remaining from discontinued operations as of June 30, 2006consisted primarily of trade accounts receivable and Medicare relatedreceivables which were owed to the Company prior to the disposition of theCompany’s long-term care services business in 1999. At June 30, 2006, theCompany believes that the probability of collecting these receivables is lowand the Company will most likely cease its collection efforts in the next fewquarters, therefore the Company has fully reserved these receivables to reducetheir net realizable value to zero. If any of these receivables are collected,the Company will record a gain in the period of collection.

The decrease inaccounts receivable remaining from discontinued operations and its relatedallowance was due to a receivable assigned to the plaintiffs in the settlementof Walmsley and Sullivan v. NAHC, Inc. et. al.  (See Note 16).

The accruedexpenses remaining from discontinued operations primarily consist ofliabilities, which arose prior to or as a result of the dispositiontransactions.  These liabilities includecosts for litigation, workers compensation claims, professional liabilityclaims, and other liabilities.

The Companyaccrues an estimate of the legal costs necessary to defend itself against legalclaims related to its discontinued operations. The costs of litigation aredifficult to estimate because of the high variability of possible outcomes. Asa result, the actual costs could differ significantly from these estimates.

The $407,000gain on disposal of discontinued operations recorded in fiscal year 2006relates to adjustments to the $374.1 million loss on disposal of discontinuedoperations which was originally recorded in fiscal year 2000.  The adjustments consist primarily of a refundfrom a state insurance guarantee fund in the amount of $53,000, a gain of$31,000 resulting from the collection of accounts receivable that werepreviously written off by the Company and reductions of expense accruals of$348,000 to adjust other liabilities remaining from discontinued operationsoffset by a provision for federal alternative minimum income taxes of $25,000.The reductions in expense accruals include amounts for litigation related costsand legacy insurance expenses.

The $281,000gain on disposal of discontinued operations recorded in fiscal year 2005relates to adjustments to the $374.1 million loss on disposal of discontinuedoperations which was originally recorded in fiscal year 2000.  The adjustments consist of decreases inreserves for certain receivables totaling $460,000 and income tax refundstotaling $400,000, offset by increases in expense accruals of $579,000, toreflect additional costs related to collections, legal costs, lawsuits (seeNote 16), and to adjust other liabilities remaining from discontinuedoperations.

The $4.9million gain on disposal of discontinued operations recorded in fiscal year2004 relates to adjustments to the $374.1 million loss on disposal ofdiscontinued operations which was originally recorded in fiscal year 2000. Theadjustments consist of income tax related refunds totaling $6.0 million anddecreases in reserves for certain receivables totaling $600,000 principally dueto recovery of previously reserved receivables, offset by increases in expenseaccruals of $1.7 million, to reflect additional costs related to collections,legal costs, lawsuits (See Note 16), and to adjust other liabilities remainingfrom our discontinued operations. The $6.0 million of income tax refundsconsist of federal income tax carryback claims filed by the Company in July2003 for the tax years ended June 1993 and 1996 as a result of the amendment ofour 2001 tax year return. The Company received the tax refunds in the fourthquarter of the fiscal year 2004.

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** **

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

Thefollowing table sets forth the computation and reconciliation of net income(loss) per share:

|                                                                           | ** ** | **Years Ended June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| **(in thousands)**                                                   | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Software and services  revenues                                           |       | $                                       | 24,353     |   | $ | 2,207 |   | $ | — |   |
| Cost of revenues                                                          |       | 6,756                                   |       | 447 |   | — |   |
| Gross profit                                                              |       | 17,597                                  |       | 1,760 |   | — |   |
| Income (loss) from  continuing operations before income taxes             |       | 2,986                                   |       | (434 | ) | (2,186 | ) |
| Income tax provision                                                      |       | (827                                    | )          | (77 | ) | — |   |
| Income (loss) from  continuing operations                                 |       | 2,159                                   |       | (511 | ) | (2,186 | ) |
| Gain on disposal of  discontinued operations, net of tax                  |       | 407                                     |       | 281 |   | 4,941 |   |
| Net income  (loss)                                                        |       | $                                       | 2,566      |   | $ | (230 | ) | $ | 2,755 |   |
|                                                                      |       |                                    |       |   |   |   |   |
| Weighted average shares  outstanding:                                     |       |                                    |       |   |   |   |   |
|                                                                      |       |                                    |       |   |   |   |   |
| basic                                                                     |       | 83,126,803                              |       | 82,296,880 |   | 82,193,063 |   |
| **Effect of dilutive securities:**                                        |       |                                    |       |   |   |   |   |
| stock options                                                             |       | 1,358,944                               |       | — |   | — |   |
|                                                                      |       |                                    |       |   |   |   |   |
| diluted                                                                   |       | 84,485,747                              |       | 82,296,880 |   | 82,193,063 |   |
|                                                                      |       |                                    |       |   |   |   |   |
| Income (loss) per share  from continuing operations: basic and diluted    |       | $                                       | 0.03       |   | $ | (0.01 | ) | $ | (0.03 | ) |
| Gain per share on  disposal of discontinued operations: basic and diluted |       | 0.00                                    |       | 0.01 |   | 0.06 |   |
|                                                                      |       |                                    |       |   |   |   |   |
| Net income (loss) per share: basic and diluted                            |       | $                                       | 0.03       |   | $ | (0.00 | ) | $ | 0.03 |   |

 

The dilutiveloss per common share calculated for the years ended June 30, 2006, 2005, and2004  excludes the effect of 2.1 million,6.4 million, and zero options outstanding. These amounts were excluded sincetheir inclusion would be anti-dilutive. There were no stock options outstanding at June 30, 2004.

**9.      Property and Equipment**

Fixed assets consist of the followingat June 30: 

| (in thousands)             | ** ** | **2006** | ** ** | **2005** | ** ** | **Estimated  Useful Lives  (Years)** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|-------------------------------------------|------------|
| Computers                       |       | $        | 1,708      |     | $          | 502                                       |       | 5 |   |
| Furniture and fixtures          |       | 123      |       | 16       |       | 3 - 4                                     |       |
| Leasehold improvements          |       | 17       |       | 6        |       | 4                                         |       |
| Software                        |       | 175      |       | 61       |       | 3                                         |       |
| Other equipment                 |       | 113      |       | 18       |       | 2 - 5                                     |       |
| Total Cost                      |       | 2,136    |       | 603      |       |                                      |       |
| Less: accumulated  depreciation |       | (461     | )          | (52      | )          |                                      |       |
| Net property and  equipment     |       | $        | 1,675      |     | $          | 551                                       |       |   |   |

 

Theincrease in property and equipment is primarily due to the acquisition ofEmailLabs on October 10, 2005. Depreciation expense for the years ended June30, 2006, 2005 and 2004 was approximately $417,000, $39,000, and $11,000,respectively.  In addition, the Companyretired equipment with a historical cost of approximately $24,000 resulting ina loss on disposal of approximately $16,000.

**10.  Accounts Payable and Accrued Expenses**

(in thousands**)**

Accountspayable and accrued expenses are summarized as follows:

|                                    | ** ** | **As of June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------|------------|
| ** **                         | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Accounts payable                   |       | $                                 | 1,039      |   | $ | 827 |   |
| Accrued  compensation and benefits |       | 882                               |       | 266 |   |
| Other                              |       | 205                               |       | — |   |
| Total                              |       | $                                 | 2,126      |   | $ | 1,093 |   |

** **

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** **

**11.  Contingent Consideration**

**(in thousands)**

**As discussed in Note 1, on October 11,2005 Halsey acquired all of the outstanding capital stock of EmailLabs.  The agreement includes contingentconsideration consisting of two equal earn-out payments of $1.7 million due onthe first and second anniversary of the closing date if EmailLabs achievesspecified revenue targets.  The Companybelieves that it is probable that these will be attained and has accrued theseliabilities in the current and non-current portions of our Balance Sheet atJune 30, 2006.  Additionally, any incometax refunds related to the period ended on and including the closing date willbe paid to the shareholders of EmailLabs. At June 30, 2006 these refunds have been estimated at approximately$482,000 and have been included in the current portion of our Balance Sheet atJune 30, 2006.**

**Contingent consideration is summarized asfollows at June 30, 2006:**

| Current:                                   |   |   |   |
|--------------------------------------------|--------|--------|--------|
| Earn-out payment                           |   | $      | 1,725  |   |
| Income tax refunds                         |   | 482    |   |
| Total current  contingent consideration    |   | $      | 2,207  |   |
|                                       |   |   |   |
| Non-current:                               |   |   |   |
| Earn-out payment                           |   | $      | 1,725  |   |
| Total non-current contingent consideration |   | $      | 1,725  |   |

** **

**12.  Operating Leases**

(in thousands**)**

The Company has variousnon-cancelable operating leases for office space that expire at various timesthrough 2010.

 

| 2007  |   | $      | 622    |   |
|-------|--------|--------|--------|--------|
| 2008  |   | 567    |   |
| 2009  |   | 345    |   |
| 2010  |   | 102    |   |
| 2011  |   | — |   |
| Total |   | $      | 1,636  |   |

 

Total rentexpense charged to operations was approximately $662,000, $147,000, and $96,000in fiscal 2006, 2005 and 2004, respectively.

**13.  Income Taxes**

(in thousands**)**

The componentsof federal and state income tax expense as of June 30, 2006, 2005 and 2004 wereas follows:

|                          | ** ** | **Years ended June 30,** | ** ** |
|--------------------------|------------|-----------------------------------------|------------|
| ** **               | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Current                  |       |                                    |       |   |   |   |   |
| Federal                  |       | $                                       | 146        |   | $ | — |   | $ | — |   |
| State                    |       | 740                                     |       | 111 |   | — |   |
|                     |       |                                    |       |   |   |   |   |
| Deferred                 |       |                                    |       |   |   |   |   |
| Federal                  |       | 15                                      |       | — |   | — |   |
| State                    |       | (49                                     | )          | (34 | ) | — |   |
|                     |       |                                    |       |   |   |   |   |
| Total income tax expense |       | $                                       | 852        |   | $ | 77 |   | $ | — |   |

 

57

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The componentsof net deferred tax assets (liabilities) as of June 30, 2006 and 2005 were asfollows:

|                                                                  | ** ** | **As of June 30,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                       | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Accruals and reserves  not currently deductible for tax purposes |       | $                                 | 3,286      |   | $ | 1,867 |   |
| Net operating loss,  capital loss and tax credit carryforwards   |       | 70,712                            |       | 72,942 |   |
| Gross deferred tax  assets                                       |       | 73,998                            |       | 74,809 |   |
| Valuation allowance                                              |       | (73,506                           | )          | (74,714 | ) |
| Net deferred tax assets                                          |       | 492                               |       | 95 |   |
| Other, net                                                       |       | (98                               | )          | (95 | ) |
| Gross deferred tax  liabilities                                  |       | (98                               | )          | (95 | ) |
| Net deferred tax asset (liability)                               |       | $                                 | 394        |   | $ | — |   |

 

The Company hasrecorded a valuation allowance to reflect the estimated amount of deferred taxassets which relate to federal and state net operating loss carry forwards, inexcess of amounts carried back to prior years, and tax credit carryforwardsthat may not be realized.

The Company hasfederal net operating loss carryforwards of approximately $177.0 million and acapital loss carryforward of approximately $11.0 million to offset futuretaxable income and taxable gains.  Thenet operating loss carryforwards expire principally in 2018. The capital losscarryforwards expire in 2007 and 2008. In addition, the Company has state netoperating loss carryforwards of approximately $10.0 million, which begin toexpire in 2018. The change in the valuation allowance was a decrease ofapproximately $1.2 million for the year ended June 30, 2006 and an increase ofapproximately $1,000 for the year ended June 30, 2005.  If the Company experiences a change of ownershipwithin the meaning of Section 382 of the Internal Revenue Code, the Company mayhave limitations on its ability to realize the benefit of its net operatingloss, capital loss and tax credit carryforwards.

Thereconciliation of the expected tax (benefit) expense (for income fromcontinuing operations before income taxes) to actual tax (benefit) expense wasas follows:
| ** **                                                       | ** ** | **Years Ended June 30,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                             |       |                                    |       |   |   |   |   |
| Expected federal income  tax expense (benefit) at statutory rate |       | $                                       | 994        |   | $ | (92 | ) | $ | (765 | ) |
| State income taxes, net  of federal benefit                      |       | 341                                     |       | 77 |   | (57 | ) |
| Utilization of NOL  carryover                                    |       | (1,446                                  | )          | — |   | — |   |
| Expiration of capital  loss carryover                            |       | —                                  |       | (12,763 | ) | — |   |
| Reduction in state NOL  carryover                                |       | —                                  |       | (1,296 | ) | — |   |
| Nondeductible  stock-based compensation                          |       | —                                  |       | — |   | — |   |
| Effect of valuation  allowance on current year losses            |       | —                                  |       | 14,734 |   | 822 |   |
| Amortization of  intangible assets                               |       | 920                                     |       | 81 |   | — |   |
| Refund of federal  income tax                                    |       | —                                  |       | (151 | ) | — |   |
| Other, net                                                       |       | 43                                      |       | (513 | ) | — |   |
|                                                             |       | $                                       | 852        |   | $ | 77 |   | $ | — |   |

 

The amount ofincome taxes refunded during fiscal 2006, 2005 and 2004 amounted toapproximately $0, $368,000, and $5.9 million respectively. The amount of incometaxes paid during fiscal 2006, 2005 and 2004 was approximately $565,000, $0 and$0 respectively.

**14.      Stockholders Equity**

**CommonStock**

**On June 19, 2002, NAHC, Inc. (“NAHC”) merged with and intoits wholly owned subsidiary J.L. Halsey, with Halsey being the survivingcorporation.  At the time of this mergerall outstanding shares of NAHC were cancelled and converted into the right toreceive one (1) share of Halsey common stock. At June 30, 2006, 620,873 shares of NAHC have not been exchanged forshares of Halsey.  These unredeemedshares are included as outstanding in the Company’s financial statements.**

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**TreasuryStock**

Repurchased sharesof our common stock are held as treasury shares until they are reissued orretired. When we reissue treasury stock, if the proceeds from the sale are morethan the average price we paid to acquire the shares we record an increase inadditional paid-in capital. Conversely, if the proceeds from the sale are lessthan the average price we paid to acquire the shares, we record a decrease inadditional paid-in capital to the extent of increases previously recorded forsimilar transactions and a decrease in retained earnings for any remainingamount.

**15.  Benefit Plans**

*Stock OptionPlan*

Effective July 1,2005, the Company adopted the provisions of Statement of Financials AccountingStandards (“SFAS”) No. 123(R), “Shared-Based Payments” (“SFAS No. 123(R)”), andselected the modified prospective method to initially report stock-basedcompensation amounts in the consolidated financial statements.  Prior to adoption of SFAS No. 123(R), theCompany provided the disclosures required under SFAS No. 123, “Accounting forStock-Based Compensation,” as amended by SFAS No. 148, “Accounting forStock-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.  Previouslyreported amounts have not been restated.

The Companyestablished the J.L. Halsey Corporation 2005 Equity Based Compensation Plan (“EquityBased Compensation Plan”) on May 6, 2005. The Equity Based Compensation Planprovides for grants of stock options and stock-based awards to employees,directors, and consultants of the Company. Stock options issued in connectionwith the Equity Based Compensation Plan are granted with an exercise price pershare equal to the fair market value of a share of Company common stock at thedate of grant. All stock options have ten-year maximum terms and vest, eitherquarterly or annually, and all within four years of grant date. The totalnumber of shares of common stock issuable under the Equity Based CompensationPlan is 13,200,000. At June 30, 2006, there were 3,709,064 shares available forgrant under the Equity Based Compensation Plan. If the Company would have expensed stock-based awards in the fiscal year2005, the total expense would have been approximately $40,000.

The Company is currently using the Black-Scholesoption pricing model to determine the fair value of all option grants. Foroption grants issued in the year ended June 30, 2006, the following weightedaverage assumptions were used:

| Risk-free rate range             |   | 3.82% -5.23%  |
|----------------------------------|--------|---------------|
| Expected dividends               |   | $             | — |
| Expected market price volatility |   | 50.0% - 55.0% |
| Expected years until exercise    |   | 4.5 years     |

 

Expectedvolatility is based on the historical volatility of the Company’s common stockto estimate future volatility.  Therisk-free rates are taken from the Federal Yield Curve Rates as published bythe Federal Reserve and represent the yields on actively traded treasurysecurities for terms equal or approximately equal to the expected term of theoptions.  The expected term calculationis based on observed historical exercise behavior of employees in the Company’speer group and the options’ contractual terms. The dividend yield is zero based on the fact that the Company has nointention of paying dividends in the near term.

59

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The following tablesummarizes stock option activity from July 1, 2005 to June 30, 2006:
|                                       | ** ** | **Options  Granted**    | ** ** | **Weighted Average  Contractual Term** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|---------------------------------------|------------|-------------------------|------------|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **(in thousands)** | ** ** | ** **                                       | ** ** | ** **                                 | ** ** |
| Options  outstanding at June, 30 2004 |       | —                  |       |                                             |       | $                                          | —     |   |
| Options granted                       |       | 6,370                   |       |                                             |       | 0.31                                       |       |
| Options  exercised                    |       | —                  |       |                                             |       | —                                     |       |
| Forfeited,  Cancelled                 |       | —                  |       |                                             |       | —                                     |       |
| Options  outstanding at June 30, 2005 |       | 6,370                   |       |                                             |       | $                                          | 0.31       |   |
| Options granted                       |       | 3,699                   |       |                                             |       | 0.64                                       |       |
| Options  exercised                    |       | —                  |       |                                             |       | —                                     |       |
| Forfeited,  Cancelled                 |       | (820                    | )          |                                             |       | 0.54                                       |       |
| Balance, June 30, 2006                |       | 9,249                   |       | 9.03                                             |       | $                                          | 0.42       |   |
|                                  |       |                    |       |                                             |       |                                       |       |
| Options exercisable at  June 30, 2006 |       | 1,668                   |       |                                             |       | $                                          | 0.30       |   |
|                                  |       |                    |       |                                             |       |                                       |       |
| Options exercisable at  July 1, 2005  |       | 136                     |       |                                             |       | $                                          | 0.30       |   |

 

The adoption of SFAS no.123(R) increased compensation expense by approximately $343,000 (per-tax) inthe year ended June 30, 2006.  Thefollowing table summarizes the allocation of stock-based compensation expense:
| (in thousands)                     | ** ** | **For the Twelve Months  Ended June 30, 2006** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------------------------------|------------|
| Cost of revenues                        |       | $                                                                            | 71         |   |
| Sales and  marketing                    |       | 73                                                                           |       |
| General and  administrative             |       | 199                                                                          |       |
| Total stock-based  compensation expense |       | $                                                                            | 343        |   |

 

Asof June 30, 2006, the unrecorded deferred stock-based compensation balance relatedto stock options was approximately $1.7 million before estimated forfeituresand will be recognized over an estimated weighted average 3.31 years.

Asof June 30, 2006, the aggregate intrinsic value of stock options outstandingand exercisable was approximately $4.6 million and $1.0 million, respectively.

Duringthe twelve months ended June 30, 2006, the Company granted 3,699,000 stockoptions with an estimated total grant-date fair value of $1.2 million.  Of this amount, the Company estimated thatthe stock-based compensation for awards not expected to vest was approximately$305,000.

The following table summarizes information about stockoptions outstanding at June 30, 2006:
| **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)** | ** ** | ** ** | ** ** |
| $0.30 to 0.30                           |       |                    | 5,950      |   | 8.85 years |   | $ | 0.30 |   | 1,623 |   | $ | 0.30 |   |
| $0.46 to 0.71                           |       |                    | 3,049      |   | 9.29 years |   | $ | 0.61 |   | 45 |   | $ | 0.46 |   |
| $0.85 to 0.85                           |       |                    | 250        |   | 9.99 years |   | $ | 0.85 |   | — |   | $ | — |   |
|                                    |       |                    | 9,249      |   | 9.03          |   | $ | 0.42 |   | 1,668 |   | $ | 0.30 |   |

 

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

InJanuary 2003, the same two individuals entered into a transaction whereby thedirector directly purchased 4,170,000 shares of common stock from an officerand principal stockholder of the Company. Pursuant to Interpretation No. 1 toAPB 25, this is treated as a transaction of the Company and, as a result, the excessof the purchase price over the market value, as measured by the quoted marketprice on the date of transaction, is recorded as stock-based compensationexpense. On the date of the transaction, the Company’s market price per sharewas $0.13 per share and the officer paid $0.2676 per share. Accordingly, theCompany recorded $574,000 of non-cash, stock-based compensation expense and acorresponding increase in additional paid-in capital for this transaction.

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*RetirementPlans*

TheCompany has a defined contribution 401(k) plan covering substantially all ofits employees. The Company does not provide any matching contributions underthe terms of the plan.

**16.      Commitments and Contingencies**

Walmsley andSullivan v. NAHC, Inc. et. al.  During the third quarter of fiscal 2002, thisaction was filed in the Court of Common Pleas for the County of Philadelphia,Pennsylvania by Messrs. Walmsley and Sullivan, two former employees of theCompany, against the Company and its officer and directors.  The suit sought damages in excess of $3million as a result of alleged breaches of contracts to pay certain bonuses andother claims.  The Company sued bothMessrs. Walmsley and Sullivan in federal court in Arizona.  This suit claimed damages related to bonusespaid to Messrs. Walmsley and Sullivan.  **The Company receivednotice on May 6, 2005 that the presiding judge issued an order transferring thematter from the District of Arizona to the Eastern District of Pennsylvania forthe convenience of the witnesses. In addition, the order denied the Company’spartial motion for summary judgment on its fraud,negligent misrepresentation and breach of fiduciary duty claim againstMessrs. Walmsley and Sullivan due to a material issue of fact to be resolved attrial.**  This casewas settled on October 24, 2005.  Thesettlement assigned a receivable remaining from the Company’s discontinuedoperations to Messrs. Walmsley and Sullivan. The receivable had been fully reserved by the Company, so there was nofinancial impact related to this settlement.

NovaCare v. StratfordNursing Home.  TheCompany filed this collection lawsuit over four years ago to collect on areceivable of approximately $146,000, which the Company has fullyreserved.  Stratford counter-claimed withnumerous theories asserting that the Company instead owed Stratford money.  Although Stratford’s principal claims weredismissed by the court, Stratford, in the last quarter of fiscal year 2003, hadquantified its remaining counter-claims at approximately $1 million.  The Company believes that the theories onwhich these damages are based are inconsistent with the contract between theparties and with the conduct of each party. As of June 30, 2006, this case is pending in the U.S. District Court forthe Southern District of New Jersey (Camden). The outcome of this action is not possible to predict and the Companyhas reserved an estimate of the cost of litigating this action; however, thisestimate does not reflect the possibility of an adverse ruling or a judgmentagainst the Company or a settlement.

 

*Other Miscellaneous Cases andClaims*

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

UninsuredProfessional Liability Claims.**TheCompany is a defendant in one professional liability claim and had previouslypurchased professional liability insurance policies from PHICO InsuranceCompany.  On February 2, 2002, aPennsylvania court authorized state insurance regulators to liquidate theinsolvent PHICO Insurance Company, which had provided professional liabilityinsurance policies to the Company. As a result, PHICO was not permitted to payany claims on behalf of the Company; however, the remaining claims weretransferred to various state insurance guaranty funds.  State insurance guaranty funds have over thelast four years paid the amounts due for liability claims settlements on theCompany’s behalf.  Based on itsdiscussion with the state guaranty funds and its review of claims during thethird quarter of 2004, the Company now believes that a payment may be requiredto settle one professional liability claim that may exceed the amount availableto the Company under the applicable state guaranty fund limits.  The Company recorded an accrual and relatedexpense in the third quarter of 2004 equal to the estimated cost to settle thatclaim less the amount that would be paid by the state guaranty fund.  A recent ruling by the Superior Court of NewJersey may free this state guarantee fund from contributing their limit to anysettlement on behalf of the Company. Because of this ruling, the Company has increased its reserve for thisliability claim.  There is no insurancepolicy in place that would pay any settlement or award for this claim;therefore, in the event that the Company’s current reserve assessment isincorrect, the Company will be required to fund any amount in excess of thereserve amount.

*Workers’ Compensation Loss Payments*

During thefirst quarter of fiscal year 2003, the NovaCare workers’ compensation insurancecarrier notified the Company that the purchaser of NCES (“the Purchaser”) whois responsible for making certain claim payments required by NovaCare’sinsurance policy deductibles had defaulted on those payment obligations.  The Purchaser has funds that have

61

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beenprepaid to this insurance carrier for claim payments under deductibles on theNovaCare policies as well as other unrelated workers’ compensation policies ofthe Purchaser.  In management’s opinion,the deposits held by the insurance carrier are sufficient to pay deductibleobligations on the NovaCare policies as well as the unrelated workers’compensation policies. 

**EmploymentAgreements**

Effective as ofMay 5, 2000, the Company entered into an employment agreement with David R.Burt, to serve as the Chief Executive Officer. The original term of theagreement continued through May 5, 2005, subject to certain extensions.  Pursuant to the agreement, Mr. Burt receives anannual base salary of $250,000 and an annual performance bonus of not less than$20,000.  Mr. Burt’s agreement providesfor additional bonuses of 10% of the amount the Company collects on certain ofthe Company’s delinquent receivables in excess of the amount booked for suchreceivables on the Company’s balance sheet, subject to a specified cap, and 10%of the difference between the amount at which certain on the Company’sliabilities are booked on the Company’s balance sheet and the actual amountsthe Company pays.  As consideration for,among other things, his efforts in obtaining settlements on certain disputes inJuly 2000, the Company granted Mr. Burt a convertible promissory note in theprincipal amount of $60,000. Mr. Burt subsequently transferred the note to afamily limited partnership controlled by him. On or about May 28, 2002, the holder of the note converted $52,125of principal on the note into 20,850,000 shares of Common Stock.  The remaining $7,875 in principal and $9,500in accrued interest were redeemed by the Company.  On September 19, 2002, the family limitedpartnership granted an option to purchase 4,170,000 shares of the Common Stockacquired upon conversion of the note to Mr. William T. Comfort III, a directorof the Company, at $0.04 per share which was later exercised.  On January 8, 2003, the partnership sold anadditional 4,170,000 shares of the Common Stock to LDN Stuyvie Partnership, ofwhich Mr. Comfort is the sole general partner, for $0.02676 per share. Mr. Burt’semployment agreement also provides him certain registration rights with respectto the shares of the Common Stock acquired upon conversion of the note.  On the date of the transaction, the Company’smarket price per share was $0.13 per share and the officer paid $0.2676 pershare resulting in the recording of a non-cash, stock-based compensation chargeof approximately $574,000 in the quarter ended March 31, 2003.

Effective May 12, 2005, Lyris entered into an employment agreement withLuis A. Rivera, to serve as President and Chief Executive Officer. The term ofthe agreement is for five years and expires on May 12, 2010. Pursuant to theagreement, Mr. Rivera receives an annual base salary of $200,000 and willbe eligible to receive a quarterly performance bonus based on the profitabilityof the Company. In addition, Mr. Rivera received an award of options topurchase 3,600,000 shares of Company Common Stock that vest ratably on aquarterly basis over four years. Effective May 12, 2005, Lyris enteredinto an employment agreement with Robb Wilson, to serve as Vice President. Theterm of the agreement is for five years and expires on May 12, 2010. Pursuantto the agreement, Mr. Wilson receives an annual base salary of $175,000.In addition, Mr. Wilson received an award of options to purchase 600,000shares of Company Common Stock, which will vest ratably on an annual basis overfour years.

On August 29, 2005, Joseph Lambert joined the Company as VicePresident and Controller and on November 14, 2005 he was appointed Chief AccountingOfficer of the Company.  Mr. Lambert will receive an annual basesalary of $125,000 and will be eligible to receive an annual merit bonus of upto 25% of his base salary.  In addition, Mr. Lambert will receive anaward of options to purchase 250,000 shares of Company Common Stock optionsthat vest ratably on an annual basis over four years.  The terms ofMr. Lambert’s employment are contained in an offer letter, datedAugust 2, 2005 from Lyris, and an employment agreement between Lyris andMr. Lambert dated August 29, 2005.

On June 26, 2006, Loren McDonald joined the Company as Vice President andChief Marketing Officer.  Mr McDonaldwill receive an annual base salary of $175,000 and will be eligible to receivean annual merit bonus of up to $25,000. In addition, Mr. McDonald received an award of options to purchase250,000 shares of Company Common Stock, which will vest ratably each quarterover four years.

On August 17, 2006, Peter Biro joined the Company asVice President of Corporate Development and Planning. Mr. Biro will receive anannual base salary of $190,000 (subject to adjustment by the board of directorsof the Company) and will be eligible to receive an annual bonus as determinedby the board of directors of the Company, provided that such annual bonus willnot be less than $15,000.  In addition,Mr. Biro received an award of options to purchase 400,000 shares of CompanyCommon Stock, fifty percent (50%) of which shall vest on August 17, 2007 and theremaining fifty percent (50%) shall vest in four (4) equal installments on thelast day of each quarter of the year that begins on August 18, 2007, and endson August 17, 2008.

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**17.  Quarterly Results (Unaudited)**

The followingtable sets forth unaudited selected financial information for the periodsindicated. This information has been derived from unaudited consolidatedfinancial statements, which, in the opinion of management, include alladjustments (consisting only of normal recurring adjustments) necessary for afair presentation of such information. The results of operations for anyquarter are not necessarily indicative of the results to be expected for anyfuture period.
|                                                                                  | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter(1)** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|------------------------|------------|
| **Year  Ended June 30, 2006:**                                                   |       |               |       |                |       |               |       |                   |       |
| Software and services revenues                                                   |       | $                  | 3,527      |                | $          | 6,175              |       | $                      | 6,995      |   | $ | 7,656 |   |
| Cost of revenues                                                                 |       | 988                |       | 1,680               |       | 1,811              |       | 2,277                  |       |
| Gross Profit                                                                     |       | 2,539              |       | 4,495               |       | 5,184              |       | 5,379                  |       |
| Operating expenses                                                               |       | 2,020              |       | 3,750               |       | 4,171              |       | 4,670                  |       |
| Income from continuing operations before income  taxes                           |       | 519                |       | 745                 |       | 1,013              |       | 709                    |       |
| Income tax provision                                                             |       | 123                |       | 154                 |       | 246                |       | 304                    |       |
| Income from continuing operations                                                |       | 396                |       | 591                 |       | 767                |       | 405                    |       |
| Gain (loss) on disposal of discontinued operations,  net of tax                  |       | 130                |       | 210                 |       | 108                |       | (41                    | )          |
| Net income                                                                       |       | $                  | 526        |                | $          | 801                |       | $                      | 875        |   | $ | 364 |   |
| Income per share from continuing operations: basic  and diluted                  |       | $                  | 0.01       |                | $          | 0.01               |       | $                      | 0.01       |   | $ | 0.00 |   |
| Gain (loss) per share on disposal of discontinued  operations: basic and diluted |       | $                  | 0.00       |                | $          | 0.00               |       | $                      | 0.00       |   | $ | (0.00 | ) |
| Net income per  share: basic and diluted                                         |       | $                  | 0.01       |                | $          | 0.01               |       | $                      | 0.01       |   | $ | 0.00 |   |

 
|                                                                                  | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter(2)** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|------------------------|------------|
| **Year Ended  June 30, 2005:**                                                   |       |               |       |                |       |               |       |                   |       |
| Software and services revenue                                                    |       | $                  | —     |                | $          | —             |       | $                      | —     |   | $ | 2,207 |   |
| Cost of revenues                                                                 |       | —             |       | —              |       | —             |       | 447                    |       |
| Gross Profit                                                                     |       | —             |       | —              |       | —             |       | 1,760                  |       |
| Operating expenses                                                               |       | 297                |       | 257                 |       | 320                |       | 1,320                  |       |
| (Loss) income from continuing operations before  income taxes                    |       | (297               | )          | (257                | )          | (320               | )          | 440                    |       |
| Income tax provision                                                             |       | —             |       | —              |       | —             |       | 77                     |       |
| (Loss) income from continuing operations                                         |       | (297               | )          | (257                | )          | (320               | )          | 363                    |       |
| Gain (loss) on disposal of discontinued operations,  net of tax                  |       | 142                |       | 117                 |       | (297               | )          | 319                    |       |
| Net (loss) income                                                                |       | $                  | (155       | )                   | $          | (140               | )          | $                      | (617       | ) | $ | 682 |   |
| (Loss) income per share from continuing operations:  basic and diluted           |       | $                  | (0.00      | )                   | $          | (0.00              | )          | $                      | (0.00      | ) | $ | 0.01 |   |
| Gain (loss) per share on disposal of discontinued  operations: basic and diluted |       | $                  | 0.00       |                | $          | 0.00               |       | $                      | (0.00      | ) | $ | 0.00 |   |
| Net (loss) income  per share: basic and diluted                                  |       | $                  | (0.00      | )                   | $          | (0.00              | )          | $                      | (0.01      | ) | $ | 0.01 |   |

 

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(1)          Includes fourth quarter 2006gains (losses) on disposal of discontinued operations of:

·                  $20,000 to reduce othermiscellaneous accruals.

·                  $(3,000) to increase liabilityaccruals pertaining to costs associated with lawsuits.

·                  $(9,000) to increase accrualspertaining to the Company’s workers compensation liability.

·                  $(2,000) to increase liabilityaccruals pertaining to the Company’s collection related costs.

·                  $(25,000) to record provisionfor federal alternative minimum income taxes.

·                  $(22,000) relating to othermiscellaneous expenses.

(2)          Includes fourth quarter 2005gains (losses) on disposal of discontinued operations of:

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·                  $425,000 to reduce reserves forcollection of receivables

·                  $8,000 to reduce liabilityaccruals pertaining to the Company’s professional liability insuranceliabilities.

·                  $(44,000) to increase liabilityaccruals pertaining to costs associated with lawsuits.

·                  $(30,000) to increase accrualspertaining to the Company’s workers compensation liability.

·                  $(13,000) to increase liabilityaccruals pertaining to the Company’s collection related costs.

·                  $(27,000) relating to othermiscellaneous expenses.

**18.      Valuation and qualifying accounts**

**VALUATIONAND QUALIFYING ACCOUNTSYears Ended June 30, 2006, 2005 and 2004**

**(in thousands)**
| Description                           | ** ** | **Balance At  Beginning of  Period** | ** ** | **Charged To  Costs and  Expenses** | ** ** | **Other** | ** ** | **Deductions** | ** ** | **Balance At End  of Period** | ** ** |
|---------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|-----------|------------|----------------|------------|----------------------------------------------|------------|
|                                  |       |                                           |       |                                          |       |      |       |           |       |                                         |       |
| Year ended June 30,  2006:            |       |                                           |       |                                          |       |      |       |           |       |                                         |       |
| Allowance for  uncollectible accounts |       | $                                              | 1,119      |                                          | $          | 328       |       | $              | 68         |                                         | $          | (751) | (3) | $ | 764 | (5) |
|                                  |       |                                           |       |                                          |       |      |       |           |       |                                         |       |
| Year ended June 30,  2005:            |       |                                           |       |                                          |       |      |       |           |       |                                         |       |
| Allowance for  uncollectible accounts |       | $                                              | 1,689      |                                          | $          | 12        |       | $              | (400)      | (1)                                          | $          | (182) | (3) | $ | 1,119 | (4) |
|                                  |       |                                           |       |                                          |       |      |       |           |       |                                         |       |
| Year ended June 30,  2004:            |       |                                           |       |                                          |       |      |       |           |       |                                         |       |
| Allowance for  uncollectible accounts |       | $                                              | 2,386      |                                          | —     |      | $          | (553)          | (2)        | $                                            | (144)      | (3) | $ | 1,689 |   |

 

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(1)           Primarily the collection of previously reserved amounts.

(2)           Primarily related to changes in reserve estimates forreceivables remaining from discontinued operations.

(3)           Primarily write-offs.

(4)                                  Includes allowances foruncollectible accounts for Lyris of $10,000 and for the Halsey discontinuedoperations of $1.1 million

(5)                                  Includes allowances foruncollectible accounts for Lyris of $54,000, Uptilt of $127,000 and for theHalsey discontinued operations of $583,000

**19.  Subsequent Events**

On August 18, 2006, Halsey acquired all of the outstandingcapital stock of ClickTracks, a Web analytics provider based in Santa Cruz,California, for approximately $7.7 million in cash and $2.9 million in commonstock of the Company issued to certain security holders of ClickTracks.  Additional payments totaling approximately$3.8 million may be made in the event ClickTracks achieves future revenuetargets and working capital adjustments.

On August 18, 2006, Halsey acquired all of the outstandingcapital stock of Hot Banana, an e-marketing Web content management companybased in Ontario, Canada, for approximately $1.9 million Canadian ($1.7 millionU.S. based on the then-applicable exchange rate), with additional installmentsof up to $750,000 Canadian ($670,661 U.S.) if Hot Banana achieves specifiedrevenue and technology integration targets, and up to an additional $500,000Canadian ($447,107 U.S.) payable subject to working capital and otheradjustments.

TheClickTracks and Hot Banana acquisitions were financed primarily with a $10million loan made by our largest stockholder, LDN Stuyvie Partnership.  LDN Stuyvie is controlled by our Chairman,William T. Comfort, III.  The loan fromLDN Stuyvie is evidenced by a promissory note, which bears interest at the rateof 9.5% per annum, or 11.5% per annum in the event of default, and isdue upon the first to occur of:

(i)            Theclosing under the Backstop Agreement (discussed below);

(ii)           Thedate on which our board of directors resolves to abandon the rights offering;

(iii)          Thedate on which any order issued by a governmental entity of competentjurisdiction or any other legal restraint prohibits the consummation of therights offering;

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(iv)          Thedate on which any law or order by any governmental entity of competentjurisdiction makes the rights offering illegal;

(v)           February1, 2007, if the registration statement filed in connection with rights offeringhas not been declared effective by the Securities and Exchange Commission by5:30 p.m. ET on January 31, 2007; or

(vi)          April1, 2007, if the registration statement filed in connection with rights offeringhas been declared effective by Securities and Exchange Commission by 5:30 p.m.ET on January 31, 2007, but the rights offering has not expired by 11:59 p.m.ET on March 31, 2007.

If the rights offering isnot completed for any of the reasons set forth in (i) through (vi) above, theoutstanding principal balance of the note shall be paid in shares of our commonstock valued at $0.85 per share, for a total of approximately 11,764,706 sharesof common stock.  If the rights offeringis completed, the aggregate purchase price of the common stock purchased by LDNStuyvie pursuant to the rights offering and/or the Backstop Agreement shall beoffset against the principal amount of the LDN Stuyvie note.  If the value of the stock purchased by LDNStuyvie pursuant to the rights offering and/or the Backstop Agreement is lessthan the principal amount outstanding under the LDN Stuyvie note and allaccrued but unpaid interest thereon, we will pay such remaining balance to LDNStuyvie in cash and the LDN Stuyvie note shall be cancelled; provided, that ifwe are prevented from making any such payment under the terms of any agreementgoverning our senior indebtedness, such payment shall be made in shares of ourcommon stock valued at $0.85 per share. In the event of default, LDN Stuyvie may elect to have accrued butunpaid interest paid in cash or in shares of our common stock, which sharesshall be valued at $0.85 per share.

In connection with the LDN Stuyvie note, we and LDN Stuyvie enteredinto a Backstop Agreement, dated August 16, 2006, pursuant to which LDN Stuyvieagreed to purchase our common stock. Under the terms of the Backstop Agreement, LDN Stuyvie will purchase ata price of $0.85 per share, outside of the rights offering, a number of sharesof our common stock so that, together with all rights subscribed for andexercised in the rights offering (including any rights subscribed for by LDNStuyvie), we will receive gross proceeds (including offsets against the LDNStuyvie note as discussed below) of at least $10 million. In partialconsideration for making the $10 million loan to us and agreeing to backstopthe rights offering up to $10 million, we also granted to LDN Stuyvie theexclusive right to purchase up to an additional $10 million of common stock atthe subscription price of $0.85 per share in respect of each right granted toour stockholders which is unexercised at the expiration of the rightsoffering.  Any shares purchased by LDNStuyvie pursuant to the Backstop Agreement will be done so in a privateoffering and will not be registered under the Securities of 1933.  Any shares purchased by LDN Stuyvie in therights offering or pursuant to the Backstop Agreement will be paid for by firstoffsetting the principal amount of the LDN Stuyvie note.  The Backstop Agreement provides that, withoutfirst obtaining the consent of LDN Stuyvie, we cannot amend certain terms ofthe rights offering, including the aggregate and per share offering price, thenumber of shares offered and the non-transferability of the rights.  The Backstop Agreement terminatesautomatically if (i) the registration statement for the rights offering has notbeen declared effective by the SEC by 5:30 p.m. ET on January 1, 2007, or (ii)even if the registration statement has been declared effective, the rightsoffering has not expired by 11:59 p.m. on March 31, 2007.

**ITEM 9.**                             CHANGES INAND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES

On June 8, 2005,the Audit Committee of the Board of Directors of Halsey announced that it hadappointed Burr, Pilger & Mayer LLP as its new independent registeredaccounting firm to audit its financial statements for the year ending June 30,2005.

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

The report issuedby PricewaterhouseCoopers LLP on Halsey’s financial statements for the fiscalyear ended June 30, 2004 did not contain any adverse opinion or a disclaimer ofopinion, or any qualification or modification as to uncertainty, audit scope oraccounting principles.

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As reported in theCompany’s Report on Form 8-K filed on June 14, 2005, during Halsey’s fiscalyears ended June 30, 2004 and 2003 and through June 8, 2005, there were nodisagreements with PricewaterhouseCoopers LLP on any matter of accountingprinciples or practices, financial statement disclosure, or auditing scope orprocedure, which, if not resolved to the satisfaction of PricewaterhouseCoopersLLP, would have caused PricewaterhouseCoopers LLP to make reference to thesubject matter of the disagreement in connection with its reports.

**ITEM 9A.**                    CONTROLS ANDPROCEDURES

*Evaluationof disclosure controls and procedures*

Based on anevaluation as of the end of the period covered by this annual report on Form 10-K,the Company’s principal executive officer and acting principal financialofficer has concluded that the Company’s disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) of the Securities ExchangeAct of 1934 (the “Exchange Act”) are effective in timely providing managementwith material information required to be disclosed by the Company in itsfilings under the Exchange Act.

*Changesin internal controls*

There have been nochanges in the Company’s internal controls or in other factors that havematerially affected, or are reasonably likely to materially affect, itsinternal controls during the fourth quarter, including any corrective actionswith regard to significant deficiencies and material weaknesses.

**ITEM 9B.**                    OTHERINFORMATION

**None**

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**PART III**

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

The directorsand executive officers of the Company are as follows:
| Name                     | ** ** | **Age** | ** ** | **Title**                                                                                               | ** ** |
|--------------------------|------------|---------|------------|---------------------------------------------------------------------------------------------------------|------------|
| William T.  Comfort, III |       | 40      |       | Chairman  of the Board of Directors and Director                                                        |       |
| David R. Burt.           |       | 43      |       | Chief  Executive Officer, President, Acting Chief Financial Officer, Secretary,  Treasurer and Director |       |
| Andrew Richard  Blair    |       | 73      |       | Director                                                                                                |       |
| Nicolas DeSantis  Cuadra |       | 40      |       | Director                                                                                                |       |
| Luis A. Rivera           |       | 35      |       | Chief  Operating Officer                                                                                |       |
| Joseph Lambert           |       | 45      |       | Vice  President and Controller                                                                          |       |
| Robb Wilson              |       | 37      |       | Vice  President of Technology                                                                           |       |
| Loren T.  McDonald       |       | 49      |       | Vice  President and Chief Marketing Officer                                                             |       |
| Peter Biro               |       | 36      |       | Vice President of  Corporate Development and Planning                                                   |       |

 

Nofamily relationships exist among any of the directors or executive officer ofthe Company.  Executive officers serve atthe discretion of the Company’s Board of Directors.

*WilliamT. Comfort, III*has served as a director of the Company since June 2002, and Chairman of theBoard since November 12, 2002.  Mr.Comfort was a private equity investor with CVC Capital Partners, a leadingprivate equity firm based in London, England, from February 1995 until December2000.  From February 2001 to February2003 he served as a consultant to Citicorp Venture Capital (“CVC”).  He is now principal of Conversion CapitalPartners Limited, an investment fund headquartered in London, England.  Mr. Comfort has served as a member of theboard of directors of Ergo Science Corporation since January 2001.  Mr. Comfort also served as a director ofnumerous public and private companies as a representative of CVC Capital Partnersand CVC from which he has resigned.  Mr.Comfort received his J.D. and L.L.M. in tax from New York University School ofLaw.

*DavidR. Burt*has been Chief Executive Officer, President and Secretary of the Company andits predecessor since May 4, 2000, Treasurer since January 14, 2002, and adirector since June 7, 2000.  Mr. Burtpreviously served as a Class III director of the Company until January 31,2004, when he resigned that position and was reappointed as a Class II directorto fill the vacancy on the Board of Directors created by the resignation ofCharles E. Finelli.  Mr. Burt was alsoPresident, Chief Executive Officer, Secretary, and a director of Ergo ScienceCorporation, a biopharmaceutical company, until his resignation in December2003.  Mr. Burt had served in variouscapacities with Ergo since joining that company in March 1993.  Mr. Burt received a B.A. in government fromDartmouth College and a J.D. from the University of Maryland Law School.  Before attending law school, Mr. Burt workedon the staff of United States Senator Paul S. Sarbanes.

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

*NicolasDeSantis Cuadra*has been a director of the Company since January 16, 2003.  Mr. DeSantis has served since January 2003 asthe Chief Executive Officer of London-based Twelve Stars Communications, aninternational brand business consulting firm, which Mr. DeSantis founded in1994.  He previously served as the ChiefExecutive Officer of Twelve Star from 1994 until December 1998.  From December 2000 until January 2003, Mr.DeSantis served as the marketing director of OPODO Ltd., an online travelportal owned by several European-based airlines.  From January 1999 until December 2000 Mr.DeSantis served as Senior Vice President and Chief Marketing Officer ofBeenz.com.

*Luis A. Rivera* was elected to the office ofChief Operating Officer of the Company effective as of our acquisition of Lyrisin May 2005.  At the same time, Mr.Rivera was named President and Chief Executive Officer of Lyris.  From May 2003 through May 2005, Mr. Riverawas the General Manager of Lyris.  FromMay 2001 through April 2003, Mr. Rivera

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wasthe Director of Sales of Lyris.  FromNovember 1999 through May 2001, Mr. Rivera served as Director of InternationalSales of Turbolinx, an open source technology company.  Mr. Rivera is a graduate of Claremont McKennaCollege.

*Joseph Lambert* joined the Companyon August 29, 2005 as Vice President and Controller.  Prior to joining the Company,Mr. Lambert served as Director of Operational Accounting for Dreyer’sGrand Ice Cream, Inc. from December 2001 to August 2005. From March 2001 through June 2001, Mr. Lambert was a consultantand served as Interim Controller of Equilibrium Technologies.  FromJune 2001 through October 2001, Mr. Lambert was employed by NewBoston Select Group, Inc., in which capacity he continued to serve asInterim Controller of Equilibrium Technologies.  Prior to his work withEquilibrium Technologies, Mr. Lambert served as Controller of 1stUp.comCorporation from 1999 to 2001.  Mr. Lambert holds a B.A. in Economicsfrom the University of California Los Angeles.

*Robb Wilson* was appointed VicePresident of Technology of the Company on January 19, 2006.  Since December 15, 2004, Mr. Wilson hasserved as Vice President of Development and Deliverability for Lyris.  Prior to joining Lyris, Mr. Wilson served asPresident and founder of Piper Software, a pioneer in development of emaildeliverability solutions, from October 1, 2004 to December 14, 2004.  Lyris acquired Piper Software in November,2004.  Prior to his tenure at PiperSoftware, Mr. Wilson served as Vice President of Software Development forQuiris, Inc., the online marketing firm, from March 1, 2001 to October 1, 2001.

*Loren McDonald* was appointed VicePresident and Chief Marketing Office on June 26, 2006.  Prior to joining the Company Mr. McDonald wasvice president of marketing for EmailLabs beginning in March 2003.  EmailLabs is a leading email serviceprovider, which was acquired by J.L. Halsey in October of 2005.  From January 2002 through March 2003, Mr.McDonald was founder and president of Intevation, an e-marketing servicesconsulting firm specializing in email and search engine marketingservices.  From December 2000 throughJanuary 2002 Mr. McDonald was Chief Marketing Officer of NetStruxr.n.

*Peter Biro* was appointed VicePresident of Corporate Development and Planning of the Company on August 17,2006.  From July 2001 until joining theCompany, Mr. Biro was founder and managing partner of The Cowper Group, aBoston-based corporate development consulting firm focused on buy-side mergersand acquisitions for small to mid-market technology companies.  Working with both venture-backed and publiccompanies, including the Company, Mr. Biro consulted on the use of mergers andacquisitions as a core part of business strategy and actively assisted clientswith transaction sourcing and execution. Mr. Biro received an M.B.A from Stanford University and both a B.S. inelectrical engineering and B.A. in computer science and history from DukeUniversity.

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

Section16(a) of the Exchange Act requires the Company’s directors, executive officersand holders of more than 10% of its shares of common stock to file with the SECinitial reports of ownership of shares of common stock and reports of changesin such ownership. The SEC’s rules require such persons to furnish the Companywith copies of all Section 16(a) reports that they file.  Based on a review of these reports and onwritten representations from the reporting persons that no other reports wererequired, the Company believes that the applicable Section 16(a) reportingrequirements were complied with for all transactions which occurred in thefiscal year ended June 30, 2006

**Code of Ethics**

On September 25, 2003, the Company adopted a Code of Conductapplicable to all employees, including the principal executive officer,principal financial officer and principal accounting officer. A copy of theCode of Conduct was included as an exhibit in the Company’s 2003 Form 10-K asfiled with the Securities and Exchange Commission and is incorporated byreference.  See Item 15, Exhibits andFinancial Statement Schedules.

**Audit CommitteeMembers and Financial Expert**

The audit committee of the boardof directors is comprised of Andrew Richard Blair, who serves as chairman, andNicolas DeSantis Cuadra.  The AuditCommittee does not include a financial expert within the meaning of theapplicable rules of the Securities and Exchange Commission. The board ofdirectors has not appointed a financial expert to the Audit Committee becauseof the Company’s current size and the difficulty and expense of locating aperson with such expertise who is willing to join the board of directors.

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**StockholderNomination**

Therehave been no material changes to the procedures by which stockholders mayrecommend nominees to the board of directors, since the disclosure in theCompany’s last proxy statement.

**ITEM 11.**                      EXECUTIVECOMPENSATION

Thefollowing table sets forth certain information for the fiscal years ended June30, 2006, 2005 and 2004 concerning the compensation of Messers. Burt, Riviera,Lambert, Wilson and McDonald.  Theseindividuals are referred to herein as “Named Executive Officers.”

**SummaryCompensation Table**
|                                    | ** ** | ** ** | ** ** | ** **          | ** ** | ** **         | ** ** | **Other**           | ** ** |
|------------------------------------|------------|------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| **Name and**                  | ** ** | ** ** | ** ** | ** **          | ** ** | ** **         | ** ** | **Annual**          | ** ** |
| **Principal Position**        | ** ** | **Year**   | ** ** | **Salary ($)** | ** ** | **Bonus ($)** | ** ** | **Compensation($)** | ** ** |
| David R. Burt,                     |       | 2006       |       | 250,000             |       | 20,000             | (1)        | —              |       |
| Chief Executive                    |       | 2005       |       | 250,000             |       | 20,000             | (2)        | —              |       |
| Officer, President,                |       | 2004       |       | 250,000             |       | 20,000             | (3)        |                |       |
| Secretary,                         |       |       |       |                |       |               |       |                |       |
| Treasurer and Director             |       |       |       |                |       |               |       |                |       |
| Luis A. Rivera,                    |       |       |       |                |       |               |       |                |       |
| Chief Operating                    |       | 2006       |       | 200,000             |       | 250,000            |       | —              |       |
| Officer of JL                      |       | 2005       |       | 28,875              |       | 34,341             | (4)        |                |       |
| Halsey and                         |       |       |       |                |       |               |       |                |       |
| President and                      |       |       |       |                |       |               |       |                |       |
| Chief Executive Officer  of Lyris. |       |       |       |                |       |               |       |                |       |
| Joseph Lambert,                    |       | 2006       |       | 105,609             |       | 26,042             |       | —              |       |
| VP Controller                      |       | 2005       |       | —              | (5)        |               |       |                |       |
| Robb Wilson,                       |       | 2006       |       | 162,500             |       |               |       | —              |       |
| Vice President  of                 |       | 2005       |       | 20,667              | (6)        |               |       |                |       |
| Technology                         |       |       |       |                |       |               |       |                |       |
| Loren McDonald,                    |       |       |       |                |       |               |       |                |       |
| Vice President                     |       | 2006       |       | 2,885               |       |               |       |                |       |
| and Chief Marketing Officer        |       | 2005       |       | (7)                 |       |               |       |                |       |

 

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(1)       Thisamount represents the amount earned and paid in fiscal year 2006.

(2)   This amount represents the amountearned and paid in fiscal year 2005.

(3)        This amountrepresents the amount earned and paid in fiscal year 2004.

 (4)     Mr. Rivera became an officer of the Company on May 12, 2005when the Company acquired Lyris Technologies, Inc.  Salary and bonus only includes amounts earnedfrom the period May 12, 2005 through June 30, 2005. The bonus amount was earnedin fiscal 2005 and paid in fiscal 2006.

(5)   Mr. Lambert joined the Company on August 28,2005 and therefore did not receive any compensation in fiscal year 2005.

(6)          Mr. Wilson joined the Company onMay 12, 2005 when the Company acquired Lyris Technologies, Inc.  Salary only includes amounts earned from theperiod of May 12, 2005 through June 30, 2005.

(7)  Mr. McDonald joined the Company on June 26,2006.  Salary includes amounts earnedfrom June 26, 2006 through June 30, 2006 only.

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**Option Grantsin Last Fiscal Year**

During fiscal year 2006, Mr. Lambert was granted options to purchase250,000 shares of Common Stock under the J.L. Halsey 2005 Equity-BasedCompensation Plan at an exercise price of $0.70.  These options vest ratably on an annual basisover four years.

During fiscal year 2006, Mr. McDonald was granted options to purchase400,000 share of Common Stock under the J.L. Halsey 2005 Equity-BasedCompensation Plan at an exercise price of $0.85.  These options vest ratably on a quarterlybasis over four years.

**Aggregate Option Exercises in Last Fiscal Year**

**and Fiscal YearEnd Option Values**
|                | ** ** | **Shares**   | ** ** | ** **   | ** ** | **Number of Securities Underlying** | ** ** | **Value of the Unexercised** | ** ** |
|----------------|------------|--------------|------------|--------------|------------|----------------------------------------------------|------------|---------------------------------------------|------------|
| ** **     | ** ** | **Acquired** | ** ** | ** **   | ** ** | **Unexercised Options**                       | ** ** | **In-The-Money Options**               | ** ** |
| ** **     | ** ** | **on**       | ** ** | **Value**    | ** ** | **At Fiscal Year-End**                   | ** ** | **at Fiscal Year-End (1)**   | ** ** |
| **Name**       | ** ** | **Exercise** | ** ** | **Realized** | ** ** | **Exercisable**                                    | ** ** | **Unexercisable**                           | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Luis A. Rivera |       | —       |       | $            | —     |                                               | 810,612    |                                        | 2,789,388  |   | $ | 502,579 |   | $ | 1 ,729,421 |   |
| Joseph Lambert |       | —       |       | $            | —     |                                               | —     |                                        | 250,000    |   | $ | — |   | $ | 55,000 |   |
| Robb Wilson    |       | —       |       | $            | —     |                                               | 100,000    |                                        | 500,000    |   | $ | 62,000 |   | $ | 250,000 |   |
| Loren McDonald |       | —       |       | $            | —     |                                               | —     |                                        | 600,000    |   | $ | — |   | $ | 122,500 |   |

 

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(1)                                  Thevalue of unexercised in-the-money options at fiscal year end assumes a fairmarket value for our Common Stock of $0.92, the closing sale price per share ofour Common Stock as reported in the OTCBB on Friday, June 30, 2006 and exerciseprices to the officers of $0.30 to $0.85

**Compensation ofDirectors of Halsey**

TheCompany provides each non-employee director with an annual retainer of$25,000.  Each director receives a fee of$1,000 per meeting attended, plus out-of-pocket expenses.  In addition, members of board committeesreceive a fee of $1,000, plus out-of-pocket expenses, for each non-telephoniccommittee meeting attended that is not scheduled in conjunction with a meetingof the full board, and a fee of $500, plus out-of-pocket expenses, for eachnon-telephonic committee meeting attended in conjunction with a meeting of thefull board and for each telephonic meeting of any committee of the board.  Executive officers of the Company do notreceive additional compensation for serving on the board of directors. WilliamT. Comfort, III, the Company’s Chairman of the Board, has waived all retainersand fees for his services.

**EmploymentAgreements**

Effective as of May 5, 2000, theCompany entered into an employment agreement with David R. Burt, to serve asthe Chief Executive Officer. The original term of the agreement Continuedthrough May 5, 2005, subject to certain extensions.  Pursuant to the agreement, Mr. Burt receivesan annual base salary of $250,000 and an annual performance bonus of not lessthan $20,000.  The agreement requires Mr.Burt to devote at least 50% of his business time and attention to theperformance of the duties and responsibilities of Chief Executive Officer,inasmuch as Mr. Burt also served, until December 2003, as president, chiefexecutive officer and a director of Ergo. Mr. Burt now devotes all of his time and attention to his duties as anofficer of the Company.  Mr. Burt’sagreement provides for additional bonuses of 10% of the amount the Companycollects on certain of the Company’s delinquent receivables in excess of theamount booked for such receivables on the Company’s balance sheet, subject to aspecified cap, and 10% of the difference between the amount at which certain onthe Company’s liabilities are booked on the Company’s balance sheet and theactual amounts the Company pays.  Asconsideration for, among other things, his efforts in obtaining settlements oncertain disputes in July 2000, the Company granted Mr. Burt a convertiblepromissory note in the principal amount of $60,000. Mr. Burt subsequentlytransferred the note to a family limited partnership controlled by him.  On or about May 28, 2002, the holder ofthe note converted $52,125 of principal on the note into 20,850,000 shares ofCommon Stock.  The remaining $7,875 inprincipal and $9,500 in accrued interest were redeemed by the Company.  On September 19, 2002, the family limited

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partnership granted an option to purchase 4,170,000 sharesof the Common Stock acquired upon conversion of the note to Mr. William T.Comfort III, a director of the Company, at $0.04 per share which was laterexercised.  On January 8, 2003, thepartnership sold an additional 4,170,000 shares of the Common Stock to LDNStuyvie Partnership, of which Mr. Comfort is the sole general partner, for $0.02676per share. Mr. Burt’s employment agreement also provides him certainregistration rights with respect to the shares of the Common Stock acquiredupon conversion of the note. Because the exercise price of the options and theselling price of the shares were at or above market price in effect at the timeof the transactions, there was no effect on the Company’s results ofoperations.

Effective May 12, 2005, Lyris entered into anemployment agreement with Luis A. Rivera, to serve as President and ChiefExecutive Officer. The term of the agreement is for five years and expires onMay 12, 2010. Pursuant to the agreement, Mr. Rivera receives an annualbase salary of $200,000 and will be eligible to receive a quarterly performancebonus based on the profitability of the Company. In addition, Mr. Riverareceived an award of options to purchase 3,600,000 shares of Company CommonStock that vest ratably on a quarterly basis over four years.

Effective May 12, 2005, Lyris entered into anemployment agreement with Robb Wilson, to serve as Vice President. The term ofthe agreement is for five years and expires on May 12, 2010. Pursuant to theagreement, Mr. Wilson receives an annual base salary of $175,000. Inaddition, Mr. Wilson received an award of options to purchase 600,000shares of Company Common Stock, which will vest ratably on an annual basis overfour years.

On August 29, 2005, Joseph Lambert joined theCompany as Vice President and Controller and on November 14, 2005 he wasappointed Chief Accounting Officer of the Company.  Mr. Lambert willreceive an annual base salary of $125,000 and will be eligible to receive anannual merit bonus of up to 25% of his base salary.  In addition,Mr. Lambert will receive an award of options to purchase 250,000 shares ofCompany Common Stock options that vest ratably on an annual basis over fouryears.  The terms of Mr. Lambert’s employment are contained in anoffer letter, dated August 2, 2005 from Lyris, and an employment agreementbetween Lyris and Mr. Lambert dated August 29, 2005.

On June 26, 2006, the Company entered into anemployment agreement with Loren McDonald to serve as Vice President and ChiefMarketing Officer.  Mr. McDonald willreceive an annual base salary of $175,000 and will be eligible to receive anannual merit bonus of up to $25,000.  Inaddition, Mr. McDonald will receive an award of options to purchase 250,000shares of Company Common Stock that vest ratably each quarter over four years.

**On August 17, 2006, the Company entered intoan employment agreement with Peter Biro to serve as Vice President of CorporateDevelopment and Planning.  The term ofthe agreement is for four years and expires on August 16, 2006.  Pursuant to the agreement, Mr. Biro receivesan annual base salary of $190,000 (subject to adjustment by the board ofdirectors of the Company) and will be eligible to receive an annual bonus asdetermined by the board of directors of the Company, provided that such annualbonus will not be less than $15,000.  Inaddition, Mr. Biro received an award of options to purchase 400,000 shares ofCompany Common Stock, fifty percent (50%) of which shall vest on August 17,2007 and the remaining fifty percent (50%) shall vest in four (4) equalinstallments on the last day of each quarter of the year that begins on August18, 2007, and ends on August 17, 2008.**

**CompensationCommittee Interlocks and Insider Participation**

TheCompensation Committee of the Company during 2006 consisted of William T.Comfort, III. No executive officer of the Company serves as a member of thecompensation committee or board of directors of another company of which anexecutive officer serves on the Compensation Committee of the Company.

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

Thefollowing table sets forth information with respect to the beneficial ownershipof the Company’s common stock as of September 25, 2006 by:

·                                          each stockholder known by theCompany to beneficially own more than five percent of the common stock;

·                                          each of the Company’s directors;

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·                                          each of the Company’s namedexecutive officers; and

·                                          all directors and executiveofficers as a group.

The Company has determined beneficial ownership inaccordance with the rules of the Securities and Exchange Commission.  Unless otherwise indicated, the personsincluded in this table have sole voting and investment power with respect toall the shares of common stock beneficially owned by them, subject toapplicable community property laws. 
| Name of Beneficial Owner (a) | ** ** | **Amount and Nature of  Beneficial Ownership** | ** ** | **Percentage of  Outstanding Shares** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------|------------|
|                                             |       |                                                               |       |                                            |       |
| LDN Stuyvie  Partnership                         |       | 15,216,955                                                         | (b)        | 17.7                                            | %          |
| William T.  Comfort III                          |       | 19,386,955                                                         | (c)        | 22.5                                            | %          |
| David R. Burt                                    |       | 12,510,000                                                         | (d)        | 14.5                                            | %          |
| Luis A. Rivera                                   |       | 1,430,612                                                          | (e)        | 1.4                                             | %          |
| Joseph Lambert                                   |       | 62,500                                                             | (f)        | *                                               |       |
| Robb Wilson                                      |       | 101,500                                                            | (g)        | *                                               |       |
| Andrew Richard  Blair                            |       | 495,300                                                            | (h)        | *                                               |       |
| Nicolas De  Santis Cuadra                        |       | 120,968                                                            |       | *                                               |       |
| Loren McDonald                                   |       | 140,000                                                            | (i)        | *                                               |       |
| Peter Biro                                       |       | 100,000                                                            | (j)        | *                                               |       |
| Directors and Officers  as a group (9 persons)   |       | 34,331,835                                                         |       | 39.9                                            | %          |

 

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*                      Representsbeneficial ownership of less than 1% of the Company’s outstanding shares ofcommon stock.

 (a)            Information as to the interestsof the directors and officers has been furnished in part by them.  The inclusion of information concerningshares held by or for their spouses or children or by corporations or otherentities in which they have an interest does not constitute an admission bysuch persons of beneficial ownership thereof. Unless otherwise indicated, the address of each director and officerlisted is 103 Foulk Rd. Suite 205Q, Wilmington, DE 89119. Unless otherwiseindicated, all persons have sole voting and dispositive power as to all sharesthey are shown as owning.

(b)              LDN Stuyvie Partnership is a partnershipcontrolled by William T. Comfort III, the Company’s Chairman of the Board. Theaddress of LDN Stuyvie Partnership is 30 Cheyne Walk, SW3 5HH London, UNITEDKINGDOM.

(c)               Includes the shares held by LDNStuyvie Partnership, of which Mr. Comfort is the sole general partner.

(d)              Consists entirely of shares heldby a family limited partnership, the general partner of which is controlled byMr. Burt.

(e)               Includes 1,260,612 shares ofcommon stock subject to stock options held by Mr. Rivera on September 25,2006 and exercisable within 60 days thereafter.

(f)                 Includes 62,500 shares of commonstock subject to stock options held by Mr. Lambert on September 25, 2006and exercisable within 60 days thereafter.

(g)              Includes 100,000 shares ofcommon stock subject to stock options held by Mr. Wilson on September 25,2006 and exercisable within 60 days thereafter.

(h)              The shares reported by Mr. Blairconsist of 417,300 shares owned by Mr. Blair and his wife, 30,000 owned byFreimark, Blair & Co. pension fund and 48,000 owned by the Blair FamilyTrust.

(i)                  Includes 104,000 shares ofcommon stock subject to stock options held by Mr. McDonald on September 25,2006 and exercisable within 60 days thereafter.

(j)                The shares reported by Mr. Biroconsist of 100,000 shares owned by Mr. Biro and his wife.

## ***Equity Compensation Plan Information***

The following tablefurnishes information with respect to compensation plans under which equitysecurities of the Company are authorized for issuance as of June 30, 2006.

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| Plan category                                          | ** ** | **Number of securities to be  issued upon exercise of  outstanding options,  warrants and rights  (a)** | ** ** | **Weighted-average exercise  price of outstanding options,  warrants and rights  (b)** | ** ** | **Number of securities  remaining available for  issuance under equity  compensation plans  (excluding securities  reflected in column (a))  (c)** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation  plans approved by security holders     |       |                                                                                                                                                      |       |                                                                                                                 |       |                                                                                                                                                                                                      |       |
| Equity compensation  plans not approved by security holders |       | 9,249,000                                                                                                                                                 |       | $                                                                                                                    | 0.42       |                                                                                                                                                                                                      | 3,709,064  |   |
| Total                                                       |       | 9,249,000                                                                                                                                                 |       | $                                                                                                                    | 0.42       |                                                                                                                                                                                                      | 3,709,064  |   |

 

TheCompany established the Equity Based Compensation Plan on May 6, 2005.****The Equity Based Compensation Planprovides for grants of stock options and stock-based awards to employees,directors, and consultants of the Company. Stock options issued in connectionwith the Equity Based Compensation Plan are granted with an exercise price pershare equal to the fair market value of a share of Company common stock at thedate of grant. All stock options have ten-year maximum terms and vest, eitherquarterly, or annually and all within four years of grant date. The totalnumber of shares of common stock issuable under the Equity Based CompensationPlan is 13,200,000. At June 30, 2006, there were 3,709,064 shares available forgrant under the Equity Based Compensation Plan.

**ITEM 13.               CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

Onor about May 28, 2002, a family limited partnership controlled by David Burt,our Chief Executive Officer, converted $52,125 of the $60,000 note originallyissued to Mr. Burt in September 2000 for 20,850,000 shares of Common Stock.  The remaining $7,875 of principal and $9,500of interest accrued on the note was redeemed by the Company at the time of theconversion.  On September 19, 2002, thefamily limited partnership granted an option to purchase 4,170,000 shares ofthe Common Stock acquired upon conversion of the note to Mr. William T. ComfortIII, a director of the Company, at $0.04 per share, which was later exercised.On January 8, 2003, the partnership sold an additional 4,170,000 shares to LDNStuyvie Partnership, of which Mr. Comfort is the sole general partner, for$0.2676 per share.

**ITEM 14.**                      PRINCIPALACCOUNTANT FEES AND SERVICES

(in thousands)

| Fee Type      | ** ** | **Fiscal Year  2006** | ** ** | **Fiscal Year  2005** | ** ** |
|--------------------|------------|----------------------------|------------|----------------------------|------------|
|               |       |                       |       |                       |       |
| Audit fees (1)     |       | $                          | 233        |                       | $          | 164 |   |
| Audit-related fees |       | —                     |       | —                     |       |
| Tax fees           |       | —                     |       | —                     |       |
| All other fees (2) |       | 138                        |       | 117                        |       |
| Total (3)          |       | $                          | 371        |                       | $          | 281 |   |

 

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

(2)          Includes fees for professionalservices rendered in connection with the acquisition EmailLabs in Fiscal Year2006 and the acquisition of Lyris Technologies in Fiscal Year 2005.

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

*Board of Directors Pre-Approval Policy:*

**Our Audit Committee has adopted a policy to pre-approve all audit,audit-related, tax and other services proposed to be provided by ourindependent auditor prior to engaging the auditor for that purpose.  Consideration and approval of such servicesgenerally will occur at the Audit Committee’s regularly scheduled quarterlymeetings.**

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**PART IV**

**ITEM 15.**                      EXHIBITS ANDFINANCIAL STATEMENT SCHEDULES

(a) The financialstatements filed as part of this Annual Report at Item 8 are listed in theFinancial Statements and Supplementary Data on page 35****ofthis Annual Report.

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

**EXHIBIT INDEX**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                       | ** ** | ** ** |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|        |       |                                                                                                                                                                                                                                                                                                                                  |       |       |
| 2(a)(i)     |       | Stock Purchase Agreement dated as of April 2, 1999  by and among NovaCare, Inc., NC Resources, Inc., Hanger Orthopedic Group,  Inc. and HPO Acquisition Corp. (incorporated by reference to Exhibit 2(a) to  the Company’s Current Report on Form 8-K dated July 1, 1999).                                                       |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                  |       |       |
| 2(a)(ii)    |       | Amendment No. 1 to Stock Purchase Agreement made as  of May 19, 1999 by and among NovaCare, Inc., NC Resources, Inc., Hanger  Orthopedic Group, Inc. and HPO Acquisition Corp. (incorporated by reference  to the Exhibit 2 (b) to the Company’s Current Report on Form 8-K dated July  1, 1999).                                |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                  |       |       |
| 2(a)(iii)   |       | Amendment No. 2 to Stock Purchase Agreement made as  of June 30, 1999 by and among NovaCare, Inc., NC Resources, Inc., Hanger  Orthopedic Group, Inc. and HPO Acquisition Corp. (incorporated by reference  to Exhibit 2(c) to the Company’s Current Report on Form 8-K dated July 1,  1999).                                    |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                  |       |       |
| 2(b)(i)     |       | Stock Purchase Agreement dated as of June 1, 1999 by  and among NovaCare, Inc., NC Resources, Inc. and Chance Murphy, Inc.  (incorporated by reference to Exhibit 2(a) to the Company’s Current Report on  Form 8-K dated June 1, 1999).                                                                                         |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                  |       |       |
| 2(b)(ii)    |       | Amendment No. 1 to Stock Purchase Agreement made as  of June 1, 1999 by and among NovaCare, Inc., NC Resources, Inc. and Chance  Murphy, Inc. (incorporated by reference to Exhibit 2(b) to the Company’s  Current Report on Form 8-K dated June 1, 1999).                                                                       |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                  |       |       |
| 2(c)        |       | Stockholder Agreement dated as of September 8, 1999  among Plato Holdings, Inc., New Plato Acquisition, Inc., NC Resources, Inc.  and NovaCare, Inc. (incorporated by reference to Exhibit 2((a) to the  Company’s Current Report on Form 8-K dated October 14, 1999).                                                           |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                  |       |       |
| 2(d)(i)     |       | Stock Purchase Agreement dated as of October 1, 1999  by and among NovaCare, Inc. NC Resources, Inc. and Select Medical Corporation  (incorporated by reference to Exhibit 2(b) to the Company’s Current Report on  Form 8-K dated October 14, 1999).                                                                            |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                  |       |       |
| 2(d)(ii)    |       | First Amendment dated November 19, 1999 to the Stock  Purchase Agreement dated October 1, 1999 among NovaCare, Inc., NC Resources,  Inc. and Select Medical Corporation (incorporated by reference to Exhibit  2(b) to the Company’s Current Report on Form 8-K dated December 6, 1999).                                         |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                  |       |       |
| 2(d)(iii)   |       | Opinion of Warburg Dillon Read LLC dated as of  October 1, 1999 (incorporated by reference to Exhibit 99(a) to the Company’s  Current Report on Form 8-K dated October 14, 1999).                                                                                                                                                |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                  |       |       |
| 2(e)        |       | Stock Purchase Agreement by and among Commodore  Resources, Inc., Lyris Technologies, Inc., John Buckman, Jan Hanford, The  John Buckman and Jan Hanford Trust and the Company, for certain limited  purposes contained therein, dated May 6, 2005 (incorporated by reference to  Exhibit 2.1 to the Company’s Current Report on |       | —     |

 

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| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | ** ** | ** ** |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|        |       | Form 8-K dated May 12, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 2(f)        |       | 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 dated October 14, 2005).                                                                                                                                                                                                                                                               |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 2(g)        |       | 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(h)        |       | 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 Caririere,  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, as  amended (incorporated by reference to Exhibit 3.1 to the Company’s  Registration Statement on Form S-4 filed with the Securities and Exchange  Commission on February 5, 2002, file no. 333-82154).                                                                                                                                                                                                                                                                                                                                  |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 3(a)(ii)    |       | Certificate of Ownership and Merger of NAHC, Inc.  with and into J. L. Halsey Corporation (incorporated by reference to Exhibit  2.1 to the Company’s Registration Statement on Form S-4 filed with the  Securities and Exchange Commission on February 5, 2002, file no. 333-82154).                                                                                                                                                                                                                                                                                                 |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 3(b)        |       | First Amended and Restated Bylaws of the Company  (incorporated by reference to Exhibit 3(b) to the Company’s Annual Report on  Form 10-K for the year ended June 30, 2002).                                                                                                                                                                                                                                                                                                                                                                                                          |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 4(a)(ii)    |       | Amendment No. 2 to 1986 Stock Option Plan (incorporated  by reference to Exhibit 4(a)(ii) to the Company’s Annual Report on Form 10-K  for the year ended June 30, 2002).                                                                                                                                                                                                                                                                                                                                                                                                             |       |       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 4(b)(i)     |       | 1998 Stock Option Plan (incorporated by reference to  Exhibit 4 to Registration Statement Form S-8 filed with the Securities and  Exchange Commission on January 15, 1999, File No. 333-70653).                                                                                                                                                                                                                                                                                                                                                                                            |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 4(b)(ii)    |       | Amendment No. 1 to 1998 Stock Option Plan  (incorporated by reference to Exhibit 4(c)(ii) to the Company’s Annual Report  on Form 10-K for the year ended June 30, 2002).                                                                                                                                                                                                                                                                                                                                                                                                             |       |       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 4(c)        |       | J. L. Halsey Corporation Executive Stock Option Plan  (incorporated by reference to Exhibit 4(d) to the Company’s Annual Report on  Form 10-K for the year ended June 30, 2002).                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 4(d)        |       | J. L. Halsey Corporation 2005 Equity-Based Compensation  Plan (incorporated by reference to Exhibit 10.1 to the Company’s current  report on Form 8-K dated May 12, 2005).                                                                                                                                                                                                                                                                                                                                                                                                            |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 10(a)       |       | Stock Purchase Agreement dated as of May 1, 1997  between NovaCare Employee Services, Inc. and James W. McLane (incorporated by  reference to Exhibit 10(i) to the Company’s Annual Report on Form 10-K for  the year ended June 30, 1998).                                                                                                                                                                                                                                                                                                                                           |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 10(b)       |       | Subscriber Services Agreement dated as of July 1,  1999 between NovaCare, Inc. and NovaCare Employee Services, Inc. (incorporated  by reference to Exhibit 10(b) to the Company’s Current Report on Form 8-K  dated November 2, 1999).                                                                                                                                                                                                                                                                                                                                                |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 10(c)       |       | Amended and Restated Employment Agreement dated as  of September 27, 2000 between the Company and David R. Burt (incorporated by  reference to Exhibit 10(k)(i) to the Company’s Annual Report on Form 10-K  for the year ended June 30, 2000).                                                                                                                                                                                                                                                                                                                             |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       |       |
| 10(d)       |       | Convertible Subordinated Note dated as of  September 27, 2000 issued by the Company to David R. Burt  (incorporated by reference to Exhibit 10(k)(ii) to the Company’s Annual  Report on Form 10-K for the year ended June 30, 2000).                                                                                                                                                                                                                                                                                                                        |       | —     |

 

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| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                 | ** ** | ** ** |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(f)(i)    |       | Indemnification Agreement, dated May 4, 2000, by and  between NAHC, Inc. and David R. Burt (the “Burt Indemnification  Agreement”) (incorporated by reference to Exhibit 10(f)(i) to the Company’s  Annual Report on Form 10-K for the year ended June 30, 2002).                                                                                                           |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(f)(ii)   |       | Assignment and Assumption Agreement, dated as of  June 1, 2002, by and between NAHC, Inc. and J. L. Halsey Corporation,  assigning the obligations of NAHC under the Burt Indemnification Agreement to  Halsey (incorporated by reference to Exhibit 10(f)(ii) to the Company’s  Annual Report on Form 10-K for the year ended June 30, 2002).                                             |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(g)       |       | Form of Indemnification Agreement entered into by  and between the Company and each of Charles E. Finelli, William T.  Comfort, III, Andrew Richard Blair and Nicolas DeSantis Cuadra (incorporated  by reference to Exhibit 10(g) to the Company’s Annual Report on Form 10-K for  the year ended June 30, 2002).                                                               |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(h)       |       | Stock Purchase Agreement by and between the Company  and the University of Chicago Law School. (incorporated by reference to  Exhibit 10(h) to the Company’s Annual Report on Form 10-K for the year ended  June 30, 2004).                                                                                                                                                                |       | X          |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(i)       |       | Form of Nonstatutory Stock Option Agreement under  the J. L. Halsey Corporation 2005 Equity-Based Compensation Plan  (incorporated by reference to Exhibit 10.2 to the Company’s current report on  Form 8-K dated May 12, 2005).                                                                                                                                                          |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(j)       |       | Promissory Note, from Commodore Resources, Inc., a  subsidiary of the Company, to The John Buckman and Jan Hanford Trust dated  May 12, 2005. (incorporated by reference to Exhibit 10(j) to the Company’s  Annual Report on Form 10-K for the year ended June 30, 2005).                                                                                                                  |       | X          |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(k)       |       | Guaranty, entered into by the Company on May 12,  2005, to guaranteeing the payment by Commodore Resources, Inc., a subsidiary  of the Company, to The John Buckman and Jan Hanford Trust of the amount  specified in the Promissory Note dated May 12, 2005. (incorporated by  reference to Exhibit 10(k) to the Company’s Annual Report on Form 10-K for  the year ended June 30, 2005). |       | X          |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(l)       |       | Employment Agreement effective May 12, 2005 between  the Company 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(m)       |       | 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).                                                                                                                                                                            |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(n)       |       | Employment Agreement effective August 17, 2006  between the Company and Peter Biro.                                                                                                                                                                                                                                                                                                             |       |       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(o)       |       | 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 16, 2006)                                                                                      |       |       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 10(p)       |       | 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 16, 2006)                                                                                                      |       |       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 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.                                                                                                                                                                                                                                                                                                                                                                    |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 24          |       | Power of Attorney (see “Power of Attorney” in Form  10-K)                                                                                                                                                                                                                                                                                                                             |       | —     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 31.1        |       | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                                                                                                                                          |       |       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 32.1        |       | Section 1350 Certification                                                                                                                                                                                                                                                                                                                                                                      |       |       |

 

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

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** **

**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.
| Dated:  September 28, 2006 |                           |
|----------------------------|--------------------------------|
|                       | J. L. HALSEY CORPORATION, INC. |
|                       |                           |   |
|                       | By:                            | /s/ David R. Burt |   |
|                       |                           | DAVID R. BURT |
|                       |                           |   | Chief Executive Officer, President, Secretary and  Principal  Financial Officer |
|                            |                                |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated.
| Signature                    | ** ** | **Title**                    | ** **                                         | **Date** |
|------------------------------|------------|------------------------------|----------------------------------------------------|----------|
|                         |       |                         |                                               |     |
| /S/ William T. Comfort,  III |       |                         | Chairman of the Board  and Director                |     | September  28, 2006 |
| (WILLIAM T. COMFORT,  III)   |       |                         |                                               |     |
|                         |       |                         |                                               |     |
| /S/ David R. Burt            |       |                         | Chief Executive  Officer, President, Secretary and |     | September  28, 2006 |
| (DAVID R. BURT)              |       | Principal Financial  Officer |                                               |     |
|                         |       |                         |                                               |     |
| /S/ Andrew Richard  Blair    |       |                         | Director                                           |     | September  28, 2006 |
| (ANDREW RICHARD BLAIR)       |       |                         |                                               |     |
|                         |       |                         |                                               |     |
| /S/ Nicolas DeSantis  Cuadra |       |                         | Director                                           |     | September  28, 2006 |
| (NICOLAS DESANTIS  CUADRA)   |       |                         |                                               |     |
|                         |       |                         |                                               |     |
| /S/ Joseph Lambert           |       |                         | Vice President and  Controller, (Chief Accounting  |     | September  28, 2006 |
| (JOSEPH LAMBERT)             |       | Officer)                     |                                               |     |
|                              |            |                              |                                                    |          |  |  |  |  |  |

 

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