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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission file number 1-10875

J. L. HALSEY CORPORATION
(Exact name of registrant as specified in its charter)

        Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 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 information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

Yes o    No ý

        As of December 31, 2003, the aggregate market value of the shares of common stock held by non-affiliates was approximately $10,566,638. (Determination of stock ownership by non-affiliates was made solely for the purpose of responding to this requirement and the Registrant is not bound by this determination for any other purpose.)

        There were 82,193,063 shares of the Registrant's common stock outstanding as of September 13, 2004.

DOCUMENTS INCORPORATED BY REFERENCE

        None

J. L. HALSEY CORPORATION AND SUBSIDIARIES

FORM 10-K—FISCAL YEAR ENDED JUNE 30, 2004

Contents and Cross Reference Sheet
Furnished Pursuant to General Instruction G(4) of Form 10-K

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PART I

ITEM 1. BUSINESS

Company

Overview

        J. L. Halsey Corporation, together with its subsidiaries ("Halsey" or the "Company", sometimes referred to as "we" or "us"), is a company in transition. In response to substantial cuts in reimbursement under the Medicare program in the late 1990's, Halsey's predecessor sold all four of its operating businesses to raise cash and succeeded in fully repaying all of its creditors. Halsey has no operating units, and the Company's principal assets include approximately $29 million in cash and net operating loss carryforwards ("NOLs") of approximately $184 million. The Company has considered several asset redeployment strategies, including the possible acquisition of an operating business. Our management has recommended to our board of directors (the "board") and our board has concurred, that the Company should pursue the acquisition of an operating business as the best way to attempt to increase the value of our existing assets.

Discontinued Operations

        Halsey is the successor to NovaCare, Inc. ("NovaCare"), which was a national leader in physical rehabilitation services, orthotics and prosthetics and employee services. The changes to Medicare reimbursement in the late 1990's had deleterious effects on NovaCare and its competitors and customers. The prior operating business most affected by the Medicare changes was the long-term care services segment in which NovaCare provided therapists to skilled nursing facilities. This business was disposed of in fiscal 1999 with the shutdown of certain of its operations in the Western United States during the third fiscal quarter and the sale of the remaining operations on June 1, 1999. NovaCare's former outpatient services segment was disposed of through the sales of its orthotics & prosthetics (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 Corporation in November of 1999. The Company's former employee services segment was disposed of through NovaCare's sale of its interest in NovaCare Employee Services ("NCES") in October of 1999 to a subsidiary of Plato Holdings, Inc. as part of a tender offer by Plato for all of NCES's outstanding shares. With cash raised from the sales of its businesses, the Company repaid all of its bank debt in the summer of 1999, and in January of 2000, the Company retired its publicly-traded subordinated debt.

        Recent and Current Activities

        NovaCare sold its name as part of the sale of the PROH business and subsequently changed its name to NAHC, Inc. ("NAHC"). On June 18, 2002, in a transaction approved by NAHC's stockholders at a special meeting, NAHC merged with and into Halsey, its wholly-owned subsidiary. As used herein, the "Company" refers to Halsey, NAHC and NovaCare. The purpose of the merger between NAHC and Halsey was to implement transfer restrictions on the Company's common stock in order to preserve the Company's net operating losses.

        For the past several years, the Company has tried to maximize the assets that it has retained, including old accounts receivable, Medicare receivables and appeals, and tax items and to minimize liabilities retained after the sales of the operating businesses. The Company has made significant progress on these matters. The Company has collected virtually all of its receivables other than amounts which are the subject of litigation or arbitration. A subsidiary of the Company has retained five employees and two consultants to carry out the general and administrative functions specified above. These resources have been supplemented with outside financial, tax, legal and systems resources

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when required by management and the board. No members of the current board were members prior to the Company selling its operating businesses.

        The Company has reflected substantially all of its results of operations and cash flows, for the current and all prior periods as discontinued operations except for its remaining general and administrative activities, which are treated as continuing operations. All of the Company's financial assets are in cash items as defined under the Investment Company Act of 1940 (the "40 Act"), which, the Company believes, should exclude it from the definition of an investment company.

Risk Factors

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

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

The Company may not be profitable from operations.

        The Company's ability to become profitable depends on management's ability to find and execute on a profitable asset redeployment strategy. The Company incurred substantial net losses from continuing operations in the previous three fiscal years ended June 30, 2004, 2003 and 2002. The Company has reported net income for the fiscal years ended June 30, 2004, 2003 and 2002; however, the Company currently has no operations and thus there can be no assurance that it will be profitable in future periods. Net income in fiscal year 2004 was due to gains on discontinued operations primarily related to federal income tax refunds. Net income in fiscal year 2003 was primarily due to gains on discontinued operations including changes in receivable reserves, the reversal of liability accruals and the release of reserves no longer necessary as a result of the settlement of various lawsuits and settlements with some state tax authorities. The net income in fiscal year 2002 was primarily due to the realization of certain receivables in excess of book value, the release of reserves no longer necessary as a result of the settlement of various lawsuits and a settlement with the Internal Revenue Service.

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

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

Uncertainties related to legacy assets and liabilities

        The Company continues to manage a relatively small number of legacy assets and liabilities remaining from the period prior to the discontinuance of its operations. These remaining legacy assets consist of old receivables that are the subject of litigation or arbitration, and appeals of Medicare billing denials. The Company has established significant reserves against these assets because of the

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uncertainty regarding their collectability. The Medicare changes in the late 1990's had deleterious effects on the entire industry, including the financial status of companies that owe us money. Also, the companies and Medicare have asserted defenses to our claims.

        The Company is defending two remaining suits against it. (See Item 3). Our management believes that we should prevail on each of these claims against us. However, there is uncertainty and cost related to the claims. If possible, the Company may try to settle the remaining claims. The outcome of these matters is not possible to predict and the current reserves include only estimates of potential settlements of certain material lawsuits and/or the costs of litigating, but do not reflect the possibility of a settlement, an adverse ruling or a judgment against the Company

The Company may be considered an Investment Company.

        The 40 Act requires registration as an investment company for companies that are engaged primarily in the business of investing, reinvesting, owning, holding or trading securities. Unless an exclusion or safe harbor applies, a company may be deemed to be an investment company if it owns "investment securities" with a value exceeding 40% of the value of its total assets on an unconsolidated basis, excluding government securities and cash items. A general exclusion is provided for companies that are engaged primarily in a business other than investing.

        From the time of its public offering until November 19, 1999, the Company continued to operate one or more of its healthcare or professional employment businesses and, therefore, was not an investment company because it was primarily engaged in a business other than investing. Since November 1999, the Company has been engaged in litigation (managing significant claims for and against the Company), arbitration and other activities as part of winding down the various liabilities and assets from its former operating businesses. The Company believes it has been involved primarily in a business other than investing since November 1999. There is a risk that the Securities and Exchange Commission ("SEC") may take a contrary view.

        The Company believes that there are several exclusions from the definition of an investment company available to it. First, the Company does not meet the 40% test with respect to the composition of its assets. Fewer than 40% of its assets are in categories that the Company believes could be considered to be "investment securities." Second, the Company has placed assets that could be considered "investment securities" into "cash items." All of the Company's holdings are in cash items. Cash items are excluded from the calculation to determine whether a company meets the 40% test.

        In the event that the SEC disagrees with the Company's analysis, the Company may be required to register as an investment company under the Investment Company Act of 1940 or seek an exemption from the SEC that would exclude the Company from the definition of an investment company.

This report contains forward-looking statements

        This Annual Report on Form 10-K contains forward-looking statements based on management's current expectations about the Company. These forward-looking statements can be identified by the use of words such as "expect," "anticipate," "estimate" and other similar expressions. The Company's actual results will likely differ materially from those anticipated by these forward-looking statements as a result of factors described in these "Risk Factors" and elsewhere in this report.

Insurance

        Although the Company purchased professional liability tail coverage insurance for periods prior to the sales of its respective businesses, the insurer, Phico Insurance Company, has been declared insolvent and is no longer able to pay claims on behalf of the Company (see "Legal Proceedings"). The

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Company currently purchases a small "all risk" insurance policy to cover the liability and property risks arising out of the current administrative operations.

Employees

        At June 30, 2004, subsidiaries of the Company had five employees. The Company's employees are not represented by any labor union and the Company is not aware of any current activity to organize any of its employees.

ITEM 2. PROPERTIES

        Halsey's principal office is located at 103 Foulk Rd, Suite 205Q, Wilmington, DE 19803 where Halsey leases approximately 112 square feet of office space. A subsidiary of Halsey leases approximately 2,600 square feet of office space in King of Prussia, PA, which expires in March 2005. See Note 6 of Notes to Consolidated Financial Statements for information concerning the Company's leases.

ITEM 3. LEGAL PROCEEDINGS

        Walmsley and Sullivan v. NAHC, Inc. et. al.    During the third quarter of fiscal 2002, this action was filed in the Court of Common Pleas for the County of Philadelphia, PA by Walmsley and Sullivan, two former employees against the Company and its officer and directors. The suit seeks damages in excess of $3 million as a result of alleged breaches of contracts to pay certain bonuses, and other claims. The Company strongly disagrees with the allegations in the complaint and intends to vigorously defend this action. The Company has sued both Walmsley and Sullivan in federal court in Arizona. This suit claims damages related to bonuses paid to Walmsley and Sullivan. During the third quarter of fiscal 2004 several depositions were completed in this case and more are expected in the near future. The Company now believes that there is a strong possibility that this case will go to trial and the Company has accrued for the estimated costs to defend this case in accordance with the Company's policies. The Company estimates that a potential trial in the Arizona action will occur sometime in 2005. A trial in the Pennsylvania action will likely not occur for several years after 2005 and there is still significant discovery to undertake in that action. The outcomes of these actions are not possible to predict and the Company has reserved estimates of the costs of litigating both of these actions, but we have not recorded a liability to reflect the possibility of an adverse ruling or a judgment against the Company or a settlement.

        NovaCare v. Stratford Nursing Home.    The Company filed this collection lawsuit over three years ago to collect on a receivable of approximately $145,000, which the Company has full reserved. Stratford counter-claimed with numerous theories asserting that the Company instead owed Stratford money. Although Stratford's principal claims were thrown out by the court, Stratford in the last quarter of fiscal year 2003 has quantified its remaining counter-claims at approximately $1 million. The Company believes that the theories on which these damages are based are inconsistent with the contract between the parties and with the conduct of each party. This case is pending in the U.S. District Court for the Southern District of New Jersey (Camden).

        Uninsured Professional Liability Claims.    The Company is a defendant in eight professional liability claims and had previously purchased professional liability insurance policies from PHICO Insurance Company. On February 2, 2002, a Pennsylvania court authorized state insurance regulators to liquidate the insolvent PHICO Insurance Company, which had provided professional liability insurance policies to the Company. As a result, PHICO will not be permitted to pay any claims on behalf of the Company. The Company believes, however, that various state insurance guaranty funds will pay most of the claims on the Company's behalf. Based on its discussion with the state guaranty funds and its review of claims during the third quarter of 2004, the Company now believes that a payment may be

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required to settle one professional liability claim that may exceed the amount available to the Company under the applicable state guaranty fund limits. The Company recorded an accrual and related expense in the third quarter of 2004 equal to the estimated cost to settle the claim less the amount that would be paid by the state guaranty fund. The Company believes that no other claims will exceed the amounts available to the Company under the applicable state guaranty fund limits. There is no assurance, however, that each claim will settle within those limits and there is no excess insurance policy in place that would pay settlements or awards in excess of those limits. Therefore, in the event that the Company's current assessment is incorrect, and the amounts required to pay on these claims are in excess of any amounts paid by guaranty funds, the Company will be required to fund these claims. The Company's management does not believe that any of these claims are material.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        At the Annual Meeting of the Company's stockholders held on March 25, 2004, (the "Annual Meeting"), the following nominee was elected to serve on Halsey's Board of Directors as a Class II Director until the Annual Meeting of the Company's Stockholders in 2006 or until his earlier death, resignation or removal from office.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

        The Company's common stock is traded on the Over-the-Counter Bulletin Board ("OTCBB") under the symbol JLHY. Trading of the Company's common stock on OTCBB commenced on December 3, 1999. The Company's common stock was traded on the New York Stock Exchange (the "NYSE") under the symbol NOV until November 22, 1999. The Company's common stock traded on the OTCBB under the symbol NAHC until June 17, 2002. On July 27, 2004 there were 1,409 holders of record of common stock.

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

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

EQUITY COMPENSATION PLAN INFORMATION

        The Company currently has no equity compensation plans.

ITEM 6. SELECTED FINANCIAL DATA

        The following selected financial data should be read in conjunction with the Company's consolidated financial statements and the accompanying notes presented elsewhere herein.

        The Company has disposed of all of its operating segments. The Company's remaining activities consist of managing the legal proceedings against the Company, attempting to realize its assets, general administrative matters and searching for potential acquisition candidates. Accordingly, the accompanying selected financial data reflect all the Company's assets and liabilities and results of operations as discontinued operations, except for its remaining general and administrative activities which are treated as continuing operations.

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J. L. HALSEY CORPORATION AND SUBSIDIARIES
FIVE YEAR FINANCIAL SUMMARY

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

J. L. HALSEY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

        J. L. Halsey Corporation, together with its subsidiaries ("Halsey" or the "Company", sometimes referred to as "we" or "us"), is a company in transition. In response to substantial cuts in reimbursement under the Medicare program in the late 1990's, Halsey's predecessor sold all four of its operating businesses to raise cash and succeeded in fully repaying all of its creditors. Halsey has no operating units, and the Company's principal assets include approximately $29 million in cash and net operating loss carryforwards ("NOLs") of approximately $184 million. The Company has considered several asset redeployment strategies, including the possible acquisition of an operating business. Our management has recommended to our board of directors (the "board") and our board has concurred, that the Company should pursue the acquisition of an operating business as the best way to attempt to increase the value of our existing assets.

        Discontinued Operations

        Halsey is the successor to NovaCare, Inc. ("NovaCare"), which was a national leader in physical rehabilitation services, orthotics and prosthetics and employee services. The changes to Medicare reimbursement in the late 1990's had deleterious effects on NovaCare and its competitors and customers. The prior operating business most affected by the Medicare changes was the long-term care services segment in which NovaCare provided therapists to skilled nursing facilities. This business was disposed of in fiscal 1999 with the shutdown of certain of its operations in the Western United States during the third fiscal quarter and the sale of the remaining operations on June 1, 1999. NovaCare's former outpatient services segment was disposed of through the sales of its orthotics & prosthetics (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 Corporation in November of 1999. The Company's former employee services segment was disposed of through NovaCare's sale of its interest in NovaCare Employee Services ("NCES") in October of 1999 to a subsidiary of Plato Holdings, Inc. as part of a tender offer by Plato for all of NCES's outstanding shares. With cash raised from the sales of its businesses, the Company repaid all of its bank debt in the summer of 1999, and in January of 2000, the Company retired its publicly-traded subordinated debt.

        Recent and Current Activities

        NovaCare sold its name as part of the sale of the PROH business and subsequently changed its name to NAHC, Inc. ("NAHC"). On June 18, 2002, in a transaction approved by NAHC's stockholders at a special meeting, NAHC merged with and into Halsey, its wholly-owned subsidiary. As used herein, the "Company" refers to Halsey, NAHC and NovaCare. The purpose of the merger between NAHC and Halsey was to implement transfer restrictions on the Company's common stock in order to preserve the Company's net operating losses.

        For the past several years, the Company has tried to maximize the assets that it has retained, including old accounts receivable, Medicare receivables and appeals, and tax items and to minimize liabilities retained after the sales of the operating businesses. The Company has made significant progress on these matters. The Company has collected virtually all of its receivables other than amounts which are the subject of litigation or arbitration. A subsidiary of the Company has retained five employees and two consultants to carry out the general and administrative functions specified above. These resources have been supplemented with outside financial, tax, legal and systems resources

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when required by management and the board. No members of the current board were members prior to the Company selling its operating businesses.

        The Company has reflected substantially all of its results of operations and cash flows, for the current and all prior periods as discontinued operations except for its remaining general and administrative activities, which are treated as continuing operations. All of the Company's financial assets are in cash items as defined under the Investment Company Act of 1940 (the "40 Act"), which, the Company believes, should exclude it from the definition of an investment company.

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

Continuing Operations

        Continuing Operations.    Continuing operations consist of general and administrative expenses and interest income. General and administrative 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 a public company.

        The loss before income taxes from continuing operations was $2.2 million for the year ended June 30, 2004 compared to $3.2 million for the prior year. The primary reason for the decrease in the loss was a decrease in general and administrative costs of approximately $1.1 million, offset by a reduction in interest and other income of approximately $100,000. The decrease in general and administrative expenses include reductions in salaries and wages of $637,000, document storage related costs of $137,000, legal expenses of $481,000, office rent of $50,000 and professional and consulting fees of $48,000 offset by a $250,000 recovery of legal fees from the Company's directors and officers insurance carrier. The decrease in salaries and wages includes a reduction of $574,000 of non-cash compensation that was recorded in fiscal year 2003. The decrease in general and administrative costs was primarily due to the settlement of legal matters and the general reduction of costs to operate the Company. The non-cash compensation charge was the result of a transaction between a principal stockholder and an officer of the Company.

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

Discontinued Operations

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

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        The gain on disposal of discontinued operations was $4.9 million, compared to $4.1 million for the prior year. These gains reflect adjustments to the $374.1 million loss on disposal of discontinued operations that was recorded in fiscal year 2000. The gain in fiscal year 2004 of $4.9 million, primarily relates to income tax related refunds totaling $6 million and decreases in reserves for certain receivables totaling $600,000 principally due to recovery of previously reserved receivables offset by increases in expense accruals of $1.7 million, to reflect additional legal costs, collection costs, and to adjust other liabilities remaining from our discontinued operations. The $6 million of income tax refunds consist of Federal Income tax carryback claims filed by the Company in July 2003 for the tax years ended June 1993 and 1996 as a result of the amendment of our 2001 tax year return. The Company received the tax refunds in the fourth quarter of the fiscal year 2004. The gain in fiscal year 2003 of $4.1 million, primarily relates to the realization of certain receivables in excess of book value totaling $2.7 million and the reversal of accruals of $1.4 million, net, to reflect the settlement of tax claims, lawsuits and to adjust other liabilities remaining from our discontinued operations.

Year Ended June 30, 2003 Compared with the Year Ended June 30, 2002

Continuing Operations

        The loss before income taxes from continuing operations was $3.2 million for the year ended June 30, 2003 compared to $3.1 million for the prior year. The primary reason for the increase in the loss was a decrease in general and administrative costs of approximately $500,000, offset by a reduction in the credit provision for restructuring in the amount of $213,000 and by a reduction in interest and other income of approximately $360,000. Reductions in legal expenses of $463,000, taxes and licenses of $229,000 and insurance expense of $250,000, offset by $570,000 of non-cash compensation in fiscal year 2003, accounted for the vast majority of the decrease in general and administrative costs. The decrease in general and administrative costs was primarily due to the settlement of legal matters and the general reduction of costs to operate the Company. The non-cash compensation charge was the result of a transaction between a principal stockholder and an officer of the Company. General and administrative expenses consisted primarily of employee wages and benefits, legal expenses, accounting, audit, tax and other professional services.

        There is no provision for or benefit from income taxes for the years ended June 30, 2003 and 2002, as the Company could not utilize, for financial reporting or income tax purposes, the loss incurred in the periods. The Company had NOLs of approximately $209 million as of June 30, 2003. The Company will not recognize an income statement benefit for any previously incurred or future operating losses or future tax deductions until such time as management believes it is more likely than not that the Company's future operations will generate sufficient taxable income to be able to realize such benefits. Accordingly, the Company has provided a full valuation allowance against the net deferred tax assets at June 30, 2003.

Discontinued Operations

        The gain on disposal of discontinued operations was $4.1 million, compared to $21.3 million for the prior year. These gains reflect adjustments to the $374.1 million loss on disposal of discontinued operations that was recorded in fiscal year 2000. The gain in fiscal year 2003 of $4.1 million, primarily relates to the realization of certain receivables in excess of book value totaling $2.7 million and the reversal of accruals of $1.4 million, net, to reflect the settlement of lawsuits, tax claims, and to adjust other liabilities remaining from our discontinued operations. The gain in fiscal year 2002 of $21.3 million primarily relates to a tax claim settlement with the Internal Revenue Service in the amount of $13 million, the realization of certain receivables in excess of book value totaling $8.1 million, and the reversal of accruals of $0.2 million, net, to reflect the settlement of a lawsuit and to adjust other liabilities remaining from our discontinued operations.

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Quarterly Financial Information (unaudited)

Liquidity and Capital Resources

Liquidity and Cash Flows

        At June 30, 2004, cash and cash equivalents totaled approximately $28.9 million compared to approximately $23.2 million at June 30, 2003. The increase in cash was mainly attributable to a refund collected from the Internal Revenue Service ("IRS") in the third quarter of approximately $6 million (including interest of approximately $729,000).

        In fiscal year 2003, the Company purchased 2 million shares of its own common stock at $0.12 per share and 200 shares at $0.11 per share for a total purchase price of $240,022. Both stock purchases by the Company were made at fair market value at the time of each transaction. This amount has been recorded as Treasury Stock in the equity section of the Company's balance sheet.

        Our primary source of cash in fiscal year 2004 was income tax refunds from the IRS, collection of old accounts receivables, Medicare receivables and appeals and interest income generated by our investment of cash and cash equivalents. We currently have invested our cash and cash equivalents in interest bearing accounts in banks. We expect to continue to have similar holdings exclusively until we acquire an operating business.

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        We have concentrated our efforts on conserving our cash while considering our strategic alternatives. However, our use of cash has fluctuated significantly from quarter to quarter and we anticipate that this pattern may continue.

        Our primary use of cash to date has been for costs in pursuit of the collection of accounts receivables, Medicare receivables and appeals as well as general and administrative expenses for operations and in evaluating and implementing strategic alternatives.

        We expect our current cash will fund our current operations for the foreseeable future. In the event that we decide to purchase an operating business, our capital requirements may exceed our current resources. In such a case, we would have to seek additional debt or equity financing from private or public sources. To the extent we raise additional capital by issuing equity securities, ownership dilution to existing stockholders will result, and future investors may be granted rights superior to those of existing stockholders. To the extent that we borrow funds, the lenders of such funds will have claims to our assets before there can be any distribution to our stockholders. There can be no assurance, however, that additional financing, either debt or equity, will be available from any source or, if available, will be available on terms acceptable to us.

        In July 2004, the Company received notification that a former customer had filed for Bankruptcy protection under the US Bankruptcy Code Chapter 11. The Company may or may not have to return some or all of the amounts that it has collected from this former customer over the past two years. The total amount collected by the Company over the past two years was $2 million. The Company has not recorded a liability at this time since it is not possible to determine if a potential liability is probable based on the information available to us at this time. If in fact the Company is notified in the future by the Bankruptcy Court that an amount must be repaid to the former customer, we believe that we may have legal defenses to support the retention of payments collected from our former customer.

Legal and Tax Claims

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

        The Company has settled a matter with the IRS in the amount of $25,000 in the second quarter of the current fiscal year and the amount was paid by the Company in the third quarter of the current fiscal year.

Off-Balance Sheet Arrangements

        The Company has no off-balance sheet arrangements.

Long-Term Contractual Obligations

        The Company has no long-term contractual obligations other than the run off of workers compensation insurance and professional liability insurance for its legacy businesses described below.

Uninsured Professional Liability Claims

        The Company is a defendant in eight professional liability claims and had previously purchased professional liability insurance policies from PHICO Insurance Company. On February 2, 2002, a Pennsylvania court authorized state insurance regulators to liquidate the insolvent PHICO Insurance Company, which had provided professional liability insurance policies to the Company. As a result,

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PHICO will not be permitted to pay any claims on behalf of the Company. The Company believes, however, that various state insurance guaranty funds will pay most of the claims on the Company's behalf. Based on its discussion with the state guaranty funds and its review of claims during the third quarter of 2004, the Company now believes that a payment may be required to settle one professional liability claim that may exceed the amount available to the Company under the applicable state guaranty fund limits. The Company recorded an accrual and related expense of $100,000 in the third quarter of 2004 equal to the estimated cost to settle the claim less the amount that would be paid by the state guaranty fund. The Company believes that no other claims will exceed the amounts available to the Company under the applicable state guaranty fund limits. There is no assurance, however, that each claim will settle within those limits and there is no excess insurance policy in place that would pay settlements or awards in excess of those limits. Therefore, in the event that the Company's current assessment is incorrect, and the amounts required to pay on these claims are in excess of any amounts paid by guaranty funds, the Company will be required to fund these claims. The Company's management does not believe that any of these claims are material individually or in aggregate.

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 required by NovaCare's insurance policy deductibles has defaulted on those payment obligations. The Purchaser has funds that have been prepaid to this insurance carrier for claim payments under deductibles 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 are sufficient to pay deductible obligations on the unrelated workers' compensation policies as well as the NovaCare policies.

Cautionary Statement

        Except for historical information, matters discussed above including, but not limited to, statements concerning litigation against the Company, are forward-looking statements that are based on management's estimates, assumptions and projections. Important factors that could cause results to differ materially from those expected by management include the outcome and costs of pending legal actions against the Company, and the Company's ability to identify potential acquisition targets and to successfully complete potential acquisitions.

Critical Accounting Policies and Estimates

        The Company has identified the accounting principles critical to our business and results of operations. We determined the critical principles to be those that involve the most complex or subjective decisions or assessments. We believe our most critical accounting policies include the following:

Reserves

        The Company maintains allowances for the collection of receivables remaining from discontinued operations. These allowances are the result of the inability or unwillingness of many of the Company's former customers to make payments. Several of the key industries in which the Company operated have been severely impacted by the Balanced Budget Act of 1997. As a result of the provisions of this Act, many of the Company's former customers went bankrupt and many are nearly insolvent. Currently, the Company has outstanding receivables from a few of its customers and has recorded 100% allowances against these receivables. The Company is pursuing collection from two of its former customers through litigation.

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        On a quarterly basis, the Company reviews the value of the reserves and adjusts the net value of the receivables to the estimated amount that management expects to realize. When facts and circumstances indicate that an account has been impaired below its current carrying value, the Company will adjust the reserve accordingly. When a customer files for bankruptcy or other facts and circumstances dictate that the associated receivable will not be collectible at any future period, the Company fully reserves the receivable. Generally when there has been a significant change in facts or circumstances and it is reasonably assured collectibility of a receivable, the Company will release the associated reserves to support the Company's change in estimate.

        There are currently a few accounts that make up the Company's total receivables, all of which are fully reserved because it is highly unlikely that we will collect the money that it is owed. As a result it is inherently difficult to estimate the amount that the Company will realize upon collection.

Legal Fees

        The Company accrues an estimate of the legal costs necessary to defend the Company against legal claims. The costs of litigation are difficult to estimate because of the high variability of possible outcomes. As a result, the actual costs could differ significantly from these estimates.

Income Taxes

        The Company has net operating loss carryforwards. The realization of any benefit of these loss carryforwards is dependent on future results and the actual amount of these loss carryforwards may change over time. The Company does not recognize any benefit on its financial statements for any previously incurred losses and will not until it determines that it is more likely than not that it will have taxable income to realize these benefits. Although the Company has reported net income in each of the last three years, it has not generated taxable income since 1996 and does not expect to generate significant taxable income until and unless it executes on an acquisition of a profitable operating business. The Company records income tax receivables only when the Company believes the collection is reasonably assured.

Loss Contingencies

        The Company records estimated loss contingencies when information is available that indicates that it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. When no accrual is made for a loss contingency because one or both of these conditions are not met, or if an exposure to loss exists in excess of the amount accrued, the Company discloses such contingencies when there is at least a reasonable possibility that a loss or an additional loss may have been incurred. Determining the likelihood of incurring a liability and estimating the amount of the liability involves significant judgement. If we had used different assumptions, the amount of loss contingencies recorded could have differed materially. In particular, the Company has estimated that the Walmsley case will not result in a judgment against the Company. If the outcome of the litigation is more adverse to the Company than management currently expects, then the Company may have to record additional charges in the future and such charges could be significant.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        The Company does not engage in trading market risk sensitive instruments and does not purchase as investments, as hedges or for purposes "other than trading," instruments that are likely to expose the Company to market risk, whether it be from interest rate, foreign currency exchange, or commodity price risk. The Company has entered into no forward or futures contracts, purchased no options and entered into no swap arrangements.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

J. L. HALSEY CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

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J. L. HALSEY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

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

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J. L. HALSEY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

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

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J. L. HALSEY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

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

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J. L. HALSEY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2004

1. Summary of Significant Accounting Policies

        Nature of Operations:    J. L. Halsey Corporation, together with its subsidiaries ("Halsey" or the "Company", sometimes referred to as "we" or "us"), is a company in transition. In response to substantial cuts in reimbursement under the Medicare program in the late 1990's, Halsey's predecessor sold all four of its operating businesses to raise cash and succeeded in fully repaying all of its creditors. Halsey has no operating units, and the Company's principal assets include approximately $29 million in cash and net operating loss carryforwards ("NOLs") of approximately $184 million. The Company has considered several asset redeployment strategies, including the possible acquisition of an operating business. Our management has recommended to our board of directors (the "board") and our board has concurred, that the Company should pursue the acquisition of an operating business as the best way to attempt to increase the value of our existing assets.

        The Company has disposed of all of its operating segments. The Company's activities consist of searching for one or more established businesses to acquire and managing the Company's remaining assets and liabilities. Accordingly, the accompanying consolidated financial statements reflect all the Company's assets and liabilities, results of operations and cash flows as discontinued operations, except for its remaining general and administrative activities which are treated as continuing operations. For the past several years, the Company has tried to maximize the assets that it has retained, including old accounts receivable, Medicare receivables and appeals, and tax items and to minimize liabilities retained after the sales of the operating businesses. The Company has made significant progress on these matters. The Company continues to minimize the few remaining claims against the Company.

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

        Use of Estimates:    The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. Management also uses estimates to report assets and liabilities remaining from discontinued operations. The Company estimates reserves against potential assets from discontinued operations as well as in the reporting of potential liabilities from discontinued operations. The Company adjusts these estimates as facts and circumstances require.

        Cash and Cash Equivalents:    The Company's holdings consist of cash in banks. These holdings are recorded on the Company's balance sheet at current value, which includes cost plus earned interest. The Company maintains cash balances with banks in excess of FDIC insured limits. The Company limits credit risk by maintaining accounts with financial institutions of high credit standing.

        Restricted cash balances consist of the following:

        The increase in the restricted cash balance represents interest income of $8,397.

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        Accounts and Notes Receivables Remaining from Discontinued Operations:    At June 30, 2004, the accounts and notes receivables remaining from discontinued operations primarily consist of trade accounts receivable and Medicare related receivables which were owed to the Company prior to the disposition of the Company's operating segments in 1999. The Company has reserved these receivables at 100% to reduce these assets to their net realizable value of zero as the Company believes that it is not likely to collect any of these amounts. Adjustments to reserves are charged or credited to gain (loss) on discontinued operations, net of tax.

VALUATION AND QUALIFYING ACCOUNTS
Years Ended June 30, 2004, 2003 and 2002

(1)

Primarily write-offs.

(2)

Primarily related to changes in reserve estimates for receivables remaining from discontinued operations.

        Accrued Expenses Remaining from Discontinued Operations:    At June 30, 2004, the accrued expenses remaining from discontinued operations primarily consist of liabilities which arose prior to or as a result of the disposition transactions. These liabilities include workers compensation, uninsured professional liability claims and credit and collection expenses. The Company adjusts these accrual amounts based on current information available to management and these adjustments are charged or credited to gain (loss) on discontinued operations, net of tax.

        Legal Fees:    The Company accrues for total estimated legal fees to defend itself in lawsuits.

        Income Taxes:    The Company records deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Valuation allowances are provided against deferred tax assets which are unlikely to be realized as of the end of relevant reporting period.

        Net Income (Loss) Per Share:    Basic net income (loss) per share ("EPS") is calculated using the weighted average number of common shares outstanding during each period. Diluted net income (loss)

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per share is calculated using basic EPS adjusted for the effects of stock options and convertible debt if such instruments are dilutive.

        Stock-Based Compensation:    Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") requires that companies either recognize compensation expense for grants of stock, stock options, and other equity instruments based on fair value, or provide pro forma disclosure of net income or loss and earnings or loss per share in the notes to the financial statements. The Company follows the disclosure provisions of SFAS 123 and applies Accounting Principles Board Opinion No. 25 ("APB 25") and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates as calculated in accordance with SFAS 123, the Company's net income and income per share for the years ended June 30, 2004, 2003 and 2002 would not be material to the company's financial statements.

        Comprehensive Income (Loss):    For fiscal years 2004, 2003 and 2002 the Company's comprehensive income or loss consists only of net income or loss.

2. Discontinued Operations

        At June 30, 2004 and 2003, assets and liabilities from discontinued operations consisted of:

        The accounts receivables remaining from discontinued operations as of June 30, 2003 consisted primarily of trade accounts receivable and Medicare related receivables which were owed to the Company prior to the disposition of the Company's long-term care services business in 1999. At June 30, 2004, the Company believes that the probability of collecting these receivables is low and the Company will most likely cease its collection efforts in the next few quarters, therefore the Company has fully reserved these receivables to reduce their net realizable value to zero. If any of these receivables are collected, the Company will record a gain in the period of collection. The accrued expenses remaining from discontinued operations primarily consist of liabilities, which arose prior to or as a result of the disposition transactions. These liabilities include costs for litigation, workers compensation claims, professional liability claims, and other liabilities.

        The $4.9 million gain on disposal of discontinued operations recorded in fiscal year 2004 relates to adjustments to the $374.1 million loss on disposal of discontinued operations which was originally

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recorded in fiscal year 2000. The adjustments consist of income tax related refunds totaling $6 million and decreases in reserves for certain receivables totaling $600,000 principally due to recovery of previously reserved receivables offset by increases in expense accruals of $1.7 million, to reflect additional costs related to collections, legal costs, lawsuits (See Note 9), and to adjust other liabilities remaining from our discontinued operations. The $6 million of income tax refunds consist of Federal Income tax carryback claims filed by the Company in July 2003 for the tax years ended June 1993 and 1996 as a result of the amendment of our 2001 tax year return. The Company received the tax refunds in the fourth quarter of the fiscal year 2004.

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

        The $21.3 million gain on disposal of discontinued operations recorded in fiscal year 2002 relates to adjustments to the $374.1 million loss on disposal of discontinued operations which was originally recorded in fiscal year 2000. The adjustments consist of a tax claim settlement with the Internal Revenue Service in the amount of $13 million, the realization of certain receivables in excess of book value totaling $8.1 million, and the reversal of accruals of $0.2 million, net, to reflect the settlement of a lawsuit and to adjust other liabilities remaining from our discontinued operations.

3. Net Income Per Share

        The following table sets forth the computation and reconciliation of net income per share—basic and net income per share—diluted:

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4. Fixed Assets, net

        Fixed assets consists of the following at June 30:

        Depreciation expense for the years ended June 30, 2004, 2003 and 2002 was $10,702, $2,218, and $0, respectively. Depreciation is based on the straight-line method over the estimated useful life of the assets of 2 years.

5. Accounts Payable and Accrued Expenses

        Accounts payable and accrued expenses are summarized as follows:

6. Operating Leases

        Halsey's principal office is located at 103 Foulk Rd, Suite 205Q, Wilmington, DE 19803, where it leases approximately 112 square feet of office space. A subsidiary of Halsey leases approximately 2,600 square feet of office space in King of Prussia, PA, under a lease which expires in March 2005. A subsidiary of the Company also leases space in North Andover, MA on a month to month basis. Total rent expense charged to operations was $96,227, $146,176 and $102,463 in fiscal 2004, 2003 and 2002, respectively. Total minimum lease payments under these leases as of June 30, 2004 are approximately $50,000.

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7. Income Taxes

        The components of net deferred tax assets (liabilities) as of June 30, 2004 and 2003 were as follows:

        The Company has recorded a valuation allowance to reflect the estimated amount of deferred tax assets which relate to Federal and state net operating loss carry forwards, in excess of amounts carried back to prior years, and tax credit carryforwards that may not be realized.

        The Company has Federal net operating loss carryforwards of approximately $184 million and a capital loss carryforward of approximately $48 million to offset future taxable income and taxable gains. The net operating loss carryforwards expire principally in 2018. The capital loss carryforwards expire in 2005, 2007, 2008 and 2009. In addition, the Company has state net operating loss carryforwards of approximately $32 million, which begin to expire in 2018. The Company has adjusted its deferred tax asset and respective valuation allowance to eliminate state net operating loss carryforwards that are no longer available to the Company. If the Company experiences a change of ownership 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.

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

        The amount of income taxes refunded during fiscal 2004, 2003 and 2002 amounted to $5,865,651, $13,374,065, and $0 respectively.

        The amount of income taxes paid during fiscal 2004 and 2003 totaled $38,040 and $45,300, respectively. There were no income taxes paid during fiscal 2002.

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8. Benefit Plans

Stock Option Plans

        All of the Company's stock option plans were terminated by the Company's Board of Directors on April 17, 2003. The Company's stock option plans prior to termination, as amended, provided for issuance of options to purchase up to 8,600,000 shares of common stock to employees, officers and directors. Under the plans, substantially all options were granted for a term of up to 10 years at prices equal to the fair market value at the date of grant and vest ratably over five years. In fiscal year 2003 the last two option holders sold their outstanding options back to the Company for $2,800 concurrent with the termination of the plans. The Company used the black-scholes method for determining the fair value of these options at $2,800 and recorded this amount in the statement of operations as a component of general and administrative expenses.

        The following summarizes the activity of the stock option plans:
(in thousands, except per share amounts)

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Other Stock Awards

        The following summarizes the other stock award activity:

        In September 2002, an officer and principal stockholder of the Company granted an option to a director and principal stockholder of the Company to purchase 4,170,000 shares of common stock of the J. L. Halsey Corporation from the officer for $0.04 per share. Under the guidance provided by the AICPA Accounting Interpretation No. 1 to APB 25, such transaction is viewed to be a transaction of the Company and would require the Company to record a charge for the excess, if any, of the market price of the shares 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 of operations.

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

Retirement Plans

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

9. Commitments and Contingencies

        Walmsley and Sullivan v. NAHC, Inc. et. al.    During the third quarter of fiscal 2002, this action was filed in the Court of Common Pleas for the County of Philadelphia, PA by Walmsley and Sullivan, two former employees against the Company and its officer and directors. The suit seeks damages in excess of $3 million as a result of alleged breaches of contracts to pay certain bonuses, and other claims. The Company strongly disagrees with the allegations in the complaint and intends to vigorously defend this action. The Company has sued both Walmsley and Sullivan in federal court in Arizona. This suit claims

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damages related to bonuses paid to Walmsley and Sullivan. During the third quarter of fiscal 2004 several depositions were completed in this case and more are expected in the near future. The Company now believes that there is a strong possibility that this case will go to trial and the Company has accrued for the estimated costs to defend this case in accordance with the Company's policies. The Company estimates that a potential trial in the Arizona action will occur sometime in 2005. A trial in the Pennsylvania action will likely not occur for several years after 2005 and there is still significant discovery to undertake in that action. The outcomes of these actions are not possible to predict and the Company has reserved estimates of the costs of litigating both of these actions, but these estimates do not reflect the possibility of an adverse ruling or a judgment against the Company or a settlement.

        NovaCare v. Stratford Nursing Home.    The Company filed this collection lawsuit over three years ago to collect on a receivable of approximately $145,000, which the Company has fully reserved. Stratford counter-claimed with numerous theories asserting that the Company instead owed Stratford money. Although Stratford's principal claims were thrown out by the court, Stratford in the last quarter of fiscal year 2003 has quantified its remaining counter-claims at approximately $1 million. The Company believes that the theories on which these damages are based are inconsistent with the contract between the parties and with the conduct of each party. This case is pending in the U.S. District Court for the Southern District of New Jersey (Camden).

Other Miscellaneous Cases and Claims

        Ronald Shostack v. Wasserstein, et. al.    Shostack has sued several former directors of the Company who were also directors of NCES, as well as other NCES officers and directors. Several of these individuals have notified the Company that they believe that the Company is legally obligated to indemnify them against any costs or liability as a result of this suit. The Company believes this analysis is incorrect and has not agreed to indemnify those individuals. In fiscal year 2004, the Company did however agree to pay Shostack $45,000 as a settlement on behalf of some of the Company's former directors. This amount was recorded as a liability and a related expense by the Company as of June 30, 2004 and was paid in July 2004.

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

Uninsured Professional Liability Claims

        The Company is a defendant in eight professional liability claims and had previously purchased professional liability insurance policies from PHICO Insurance Company. On February 2, 2002, a Pennsylvania court authorized state insurance regulators to liquidate the insolvent PHICO Insurance Company, which had provided professional liability insurance policies to the Company. As a result, PHICO will not be permitted to pay any claims on behalf of the Company. The Company believes, however, that various state insurance guaranty funds will pay most of the claims on the Company's behalf. Based on its discussion with the state guaranty funds and its review of claims during the third quarter of 2004, the Company now believes that a payment may be required to settle one professional liability claim that may exceed the amount available to the Company under the applicable state guaranty fund limits. The Company recorded an accrual and related expense of $100,000 in the third quarter of 2004 equal to the estimated cost to settle the claim less the amount that would be paid by the state guaranty fund. The Company believes that no other claims will exceed the amounts available to the Company under the applicable state guaranty fund limits. There is no assurance, however, that each claim will settle within those limits and there is no excess insurance policy in place that would pay

27

settlements or awards in excess of those limits. Therefore, in the event that the Company's current assessment is incorrect, and the amounts required to pay on these claims are in excess of any amounts paid by guaranty funds, the Company will be required to fund these claims. The Company's management does not believe that any of these claims are material.

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 required by NovaCare's insurance policy deductibles has defaulted on those payment obligations. The Purchaser has funds that have been prepaid to this insurance carrier for claim payments under deductibles 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 are sufficient to pay deductible obligations on the unrelated workers' compensation policies as well as the NovaCare policies.

Employment Agreements

        Effective as of May 5, 2000, the Company entered into an employment agreement with David R. Burt, to serve as the Company's Chief Executive Officer. The term of the agreement continues through May 5, 2005, subject to certain extensions. Pursuant to the agreement, Mr. Burt receives an annual base salary of $250,000 and an annual performance bonus of not less than $20,000. The agreement requires Mr. Burt to devote at least 50% of his business time and attention to the performance of the duties and responsibilities of Chief Executive Officer, in as much as Mr. Burt also served, until December 2003, as president, chief executive officer and a director of Ergo Science Corporation. Mr. Burt resigned from all positions with Ergo in December 2003 and now devotes all of his business time to his duties as an officer and director of the Company.

10. Quarterly Results (Unaudited)

        The following table sets forth unaudited selected financial information for the periods indicated. This information has been derived from unaudited consolidated financial statements, which, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments)

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necessary for a fair presentation of such information. The results of operations for any quarter are not necessarily indicative of the results to be expected for any future period.