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EX-21 - EXHIBIT 21 - LYRIS, INC.v235344_ex21.htm
EX-31.1 - EXHIBIT 31.1 - LYRIS, INC.v235344_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - LYRIS, INC.v235344_ex32-1.htm
EX-23.1 - EXHIBIT 23.1 - LYRIS, INC.v235344_ex23-1.htm

  
United States Securities and Exchange Commission
Washington, D.C. 20549
   

 
FORM 10-K
 
R ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED JUNE 30, 2011
 
OR
 
£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE TRANSITION PERIOD FROM              TO_________
 
COMMISSION FILE NUMBER 333-82154
 
Lyris, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
01-0579490
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
6401 Hollis Street, Suite 125, Emeryville, CA 94608
(Address of principal executive office, including zip Code)
 
(800) 768-2929
(Registrant’s telephone number, including area code)
 

Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
 
 
    
Common Stock, par value $.01 per share
 
OTCBB
 
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes ¨    No R
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes ¨    No R
 
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  R     No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ¨     No  ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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.  ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ¨
 
Accelerated filer ¨
 
Non-accelerated filer £
(Do not check if a smaller reporting Company)
 
Smaller reporting company R
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  £ No R
 
Based on the closing price of the Registrant’s common stock on the last business day of the Registrant’s most recently completed second fiscal quarter, which was December 31, 2010, the aggregate market value of its shares (based on a closing price of $0.25 per share as reported on the OTCBB National Market System) held by non-affiliates was $14,118,897 (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 of any other purpose). As of September 21, 2011, there were 121,233,700 shares of common stock outstanding.

 
 

 
 
LYRIS, INC. AND SUBSIDIARIES
FORM 10-K – FISCAL YEAR ENDED JUNE 30, 2011
 
Contents and Cross Reference Sheet
Furnished Pursuant to General Instruction G(4) of Form 10-K
 
Item No.
 
Description
 
Page
Number
         
   
PART I
   
         
Item 1.
 
Business
 
3
Item 1A.
 
Risk Factors
 
11
Item 1B.
 
Unresolved Staff Comments
 
24
Item 2.
 
Properties
 
25
Item 3.
 
Legal Proceedings
 
26
Item 4.
 
Reserved
 
27
         
   
PART II
   
         
Item 5.
 
Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities
 
28
Item 6.
 
Reserved
 
29
Item 7.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
30
Item 7A.
 
Reserved
 
46
Item 8.
 
Financial Statements and Supplementary Data
 
47
Item 9.
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
 
74
Item 9A.
 
Controls and Procedures
 
75
Item 9B.
 
Other Information
 
76
         
   
PART III
   
         
Item 10.
 
Directors, Executive Officers and Corporate Governance
 
77
Item 11.
 
Executive Compensation
 
81
Item 12.
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
90
Item 13.
 
Certain Relationships and Related Transactions and Director Independence
 
92
Item 14.
 
Principal Accounting Fees and Services
 
94
         
   
PART IV
   
         
Item 15.
 
Exhibits and Financial Statement Schedules
 
95
         
Signatures
 
99
 
 
2

 

PART I

Forward-Looking Information

This annual report on Form 10-K (this “Annual Report” or this “Form 10-K”), including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) in Item 7, contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements may also be included from time to time in our other public filings, press releases, our website and oral and written presentations by management.  Specific forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and include, without limitation, words such as “may,” “will,” “expects,” “believes,” “anticipates,” “plans,” “estimates,” “projects,” “predicts,” “targets,” “seeks,” “could,” “intends,” “foresees” or the negative of such terms or other variations on such terms or comparable terminology.  Similarly, statements that describe our strategies, initiatives, objectives, plans or goals are forward-looking.

These forward-looking statements are based on management’s current intent, belief, expectations, estimates and projections regarding our Company and our industry. These statements are not guarantees of future performance and involve risks, uncertainties, assumptions and other factors that are difficult to predict.  Therefore, actual results may vary materially from what is expressed in or indicated by the forward-looking statements. The risk factors set forth below under “Item 1A. Risk Factors,” and other matters discussed from time to time in subsequent filings with the Securities and Exchange Commission, including the “Risk Factors” sections of our Quarterly Reports on Form 10-Q, among others, could affect future results, causing these results to differ materially from those expressed in our forward-looking statements. In that event, our business, financial condition, results of operations or liquidity could be materially adversely affected and investors in our securities could lose part or all of their investments.  Accordingly, our investors are cautioned not to place undue reliance on these forward-looking statements because, while we believe the assumptions on which the forward-looking statements are based are reasonable, there can be no assurance that these forward-looking statements will prove to be accurate.

Further, the forward-looking statements included in this Form 10-K and those included from time to time in our other public filings, press releases, our website and oral and written presentations by management are only made as of the respective dates thereof. We undertake no obligation to update publicly any forward-looking statement in this Form 10-K or in other documents, our website or oral statements for any reason, even if new information becomes available or other events occur in the future.  Readers are urged, however, to review the factors set forth in reports that we file from time to time with the Securities and Exchange Commission.  Unless the context requires otherwise in this Annual Report the terms “we,” “us” and “our” refer to Lyris, Inc. and its subsidiaries.

ITEM 1.  BUSINESS

Overview

Lyris, Inc., ( the “Company” or “Lyris” or “we”), formerly J.L. Halsey Corporation, is a leading Online marketing technology company serving a wide range of customers from the Fortune 500 to the small and medium-sized business market. We offer the industry’s first on-demand, integrated marketing solution, Lyris HQ.  As of June 30, 2011, approximately 4,500 customers worldwide use our online marketing technology to manage their marketing programs.

Our SaaS-based (“software-as-a-service”) online marketing solutions and services provide customers with solutions for creating, delivering and managing online, permission-based direct marketing programs and other communications to customers who use online and mobile channels to communicate with their customers and members.  Our solutions include:

 
·
Email marketing software that enables customers to create, deliver and manage email marketing programs, newsletters, discussion groups and other digital communications;
 
·
Web analytics software that enables customers to analyze and manage the behavior of visitors to their websites;
 
·
Email delivery tools that build email deliverability features right into the message-creation process, so that marketers can automatically find and fix deliverability issues before they release their email marketing campaigns;
 
·
Search marketing software that enables companies to better manage and optimize pay-per-click (“PPC”) campaigns;
 
·
Web content management software that enables customers to manage a website, landing page or email content creation;  
 
·
Social media marketing software that enables marketers to extend their email marketing initiatives to reach customers via social networking sites, such as Twitter or Facebook;
 
·
Mobile marketing software that allows marketers to send targeted, opt-in text messages; and
 
·
Online marketing professional services and support.

 
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We offer our marketing software solutions as licensed software that customers purchase and download on their computers and as a hosted service that customers use on a subscription basis through an Internet connection.

Prior to August 2006, Lyris was a provider of hosted and licensed email marketing software through its wholly-owned subsidiaries, Lyris Technologies, Inc. and Uptilt, Inc. (d/b/a “EmailLabs”).  On August 18, 2006, the Company acquired ClickTracks Analytics, Inc. (“ClickTracks”), a Web analytics provider, and Hot Banana Software, Inc. (“Hot Banana”), an e-marketing Web content management company.  Both EmailLabs and ClickTracks were merged into Lyris Technologies, Inc. in late 2007. In connection with this merger, we integrated our software offerings, those companies’ software offerings and our hosted EmailLabs email marketing offering into our on-demand, integrated marketing solution, Lyris HQ

In addition to Lyris HQ, we continue to offer the following separate individual online marketing solutions: Lyris ListManager, our licensed software product for email marketing; EmailLabs, our hosted email marketing software; and EmailAdvisor, our deliverability monitoring tool.  We also offer as separate products ClickTracks, our Web analytics product and Lyris Hot Banana, our Web content management software.

Business Strategy

Our primary goal is to achieve long-term sustainable growth, create value for our stockholders and improve customer satisfaction.  Our business strategy is based on our commitment to providing the best on-demand Web-based marketing platform and services.  Our platform is a full-suite of integrated online marketing solutions with superior ease of use and convenience.  Our objective is to expand our offerings globally to effectively reach more of our targeted customers and provide them with high quality online marketing solutions and professional services and support.  We believe that continued investment in research and development is critical to our ability to develop and enhance our products and technologies. 

To achieve our vision, we are focused on the following key initiatives that will drive our future performance:

 
·
Developing and strengthening our products and services:  We intend to continue to develop innovative software applications and marketing solutions that deliver value for our customers.  In November 2007, we began to offer Lyris HQ, an integrated on-demand marketing suite that consolidates our full suite of digital marketing technologies into a single sign-on dashboard interface, as our premier core product. We plan to invest in Lyris HQ with the goal of making it the best on-demand integrated marketing solution in the market. In February 2011, we introduced our new mobility application that extends the Lyris HQ platform to the iPhone, iTouch and iPad. In April 2011, we introduced our new tabbed user interface for Lyris HQ.

 
·
Being a leader in digital marketing technology and related services:  We intend to strengthen our position in the digital marketing space.  Becoming a leader involves product awareness and creation of key offerings.   We plan to extend our marketing knowledge to new and existing Lyris customers worldwide.

 
·
People: We plan to continue to create a great place to work where people are inspired to give their best efforts towards Lyris’ success.  We hire and retain a highly talented and diverse workforce to establish a productive working environment.  In addition, we intend to improve training opportunities and identify visible career paths for our employees.

 
·
Business Partners: We plan to continue to nurture a winning network of business partners and build mutual trust and loyalty.

 
·
Profitability: We continue to strive to maximize returns to shareholders, while being mindful of our overall financial responsibilities.

We operate in the highly competitive online and email marketing industry and meet strong competition from other email marketing companies.  Our financial results, like those of other companies, are being impacted by the current economic pressures as businesses cut back on spending.  We believe that Lyris is well-positioned to weather the current economic pressures based on our ongoing technological innovations and implementation of an across-the-board cost reduction initiative.

During fiscal year 2011, we continued to expand our offerings, specifically Lyris HQ, in Europe, Latin America, Asia Pacific and other international markets.  We believe there is a significant market opportunity in Europe, Latin America, Asia Pacific and we expect to aggressively market to these regions.  We intend to extend our marketing knowledge resources to new and existing Lyris customers worldwide.

 
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Our Products and Services

Lyris HQ

In November 2007, we introduced Lyris HQ, our premier offering which provides customers an integrated online suite of marketing solutions that enables a 360-degree view of campaigns, from email, to search-engine keyword management, to web content management and analytics.  Its competitive price allows the marketing department to put an integrated, on-demand toolset in the hands of everyday marketers to simplify their processes, unify their marketing efforts and improve return on investment (“ROI”).  For fiscal year 2011, we had approximately 912 Lyris HQ subscription customers, down from 964 in the prior fiscal year.

Lyris HQ is a robust hosted email marketing platform that helps professional online marketers manage and maximize the effectiveness of complex campaigns with high volume.  Lyris HQ allows users to write email messages, create segments, edit lists, manage landing pages, track Web analytics and gain insights from data and reports.  Lyris HQ integrates social, mobile, search and analytics to connect our clients to their customers across digital channels. Lyris HQ is cloud-based, so customers do not need to purchase any hardware or upgrades. Lyris HQ primarily targets small and mid-sized businesses (“SMB”) and mid-market companies that use the Internet to market and sell their goods and services.

In February 2011, we introduced our new mobility application that extends the Lyris HQ platform to the iPhone, iTouch and iPad. Lyris HQ Mobile provides marketers real-time campaign insights and the ability to manage and view campaigns on their mobile devices.  Lyris HQ customers can now actively engage and manage campaigns, including the previewing, scheduling and cancelling of email messages from their mobile devices.

In April 2011, we introduced our new tabbed user interface for Lyris HQ.  Our tabbed user interface enables marketers to multitask within email campaign development and facilitates increased productivity and workflow. This new user interface is designed to facilitate multitasking by marketers and make the platform more user-friendly.  Leveraging broadly available next generation browser capabilities, marketers are able to develop, run and view all aspects of their campaign simultaneously.

Email Marketing Software

Lyris ListManager is our email marketing licensed software product. Lyris ListManager provides IT and marketing departments with a time-tested, powerful email marketing engine to manage and execute campaigns.  Lyris ListManager gives IT managers a secure, trustworthy, on-premise platform to deliver a reliable, cost-effective solution for marketing teams.  And for marketers, Lyris ListManager delivers a platform to create high-volume, customized email campaigns that ensure the timely delivery of messages to the appropriate email recipients.  For IT managers, Lyris ListManager delivers software that can be integrated into other enterprise software solutions.  Lyris ListManager’s open architecture enables IT managers to modify, configure and integrate the application quickly and easily.  It cost-effectively helps marketers nurture their customer base and convert prospects into customers, while smoothly integrating with other applications and solutions.  Lyris ListManager’s powerful delivery engine which has proven to be effective in diverse industries, allows users to conduct email campaigns ranging in size from small to large scale.

In January 2011, we introduced ListManager 11, providing improved campaign planning and end-to-end performance tracking capabilities to facilitate improved campaign effectiveness. It offers new interactive marketing calendaring - a visual calendar that provides visibility of all campaign mailings and events. Enhanced navigation and new analytics enable marketers to more effectively drive campaign success. The fully integrated offering also allows customers without HTML experience to easily create and edit personalized messages and track and manage campaigns. In addition, it offers a click-through heat map that provides visual user data for specific campaigns.

EmailLabs is our brand of hosted email marketing software, which also manages email campaigns and communications.     EmailLabs is the email marketing software that is integrated into the Lyris HQ platform and provides the email campaign capabilities within this software suite.

EmailAdvisor is our deliverability monitoring tool that helps facilitate the delivery of legitimate email while taking into account the complexity of different email viewing applications.  With the email difficulties that can be caused by spam (see “U.S. and Foreign Government Regulation” below), many ISPs (Internet service providers), network administrators and others now deploy anti-spam filters to prevent spam from entering their email inbox.  Many of these anti-spam filters unfortunately block legitimate emails that people want to receive.  EmailAdvisor helps email senders design their messages and campaigns to minimize the chance that legitimate email is wrongly blocked.  EmailAdvisor is also integrated into Lyris HQ and provides this email deliverability monitoring capability.

 
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Web Analytics Software
 
 ClickTracks is our Web analytics product. ClickTracks is integrated into the Lyris HQ platform and provides the Web analytics capabilities within the integrated application. Web analytics software uses cookies and simple java-script to track and report on the activity of visitors to a website or landing page. This software then allows the user to analyze the behavior of those visitors and report on basic statistics about this behavior. ClickTracks is used by marketing agencies and ISPs to support their customers.

Web Content Management Software

 Hot Banana is our software product that enables customers to manage content across their different Web properties more easily, including corporate websites, intranets, extranets, landing pages and micro marketing sites.  Hot Banana assists customers in optimizing their sites in a manner that allows search engines to find relevant content more easily and increase traffic to their site.  Many of Hot Banana’s features have been integrated into our other products. Hot Banana customers have been migrated to our other platforms when appropriate and we have announced that we will end support for Hot Banana on or near December 2011.

Online Marketing Professional Services and Support

Our Professional Services team provides full-service online marketing services and support to assist our customers in developing the best email marketing strategy to meet their goals and objectives.  Whether our customers are trying to kick start their email marketing campaign strategy, troubleshoot an email deliverability issue, catch up on best practices or just use our online or email marketing software more efficiently, our Professional Services team is available to offer guidance, expertise and solutions to help our customers achieve world-class email marketing.

We understand that each customer’s business is unique, and that is how we approach our engagement with each of our customers. We begin by understanding the specifics of our customers’ email program, and then we benchmark, develop and execute initiatives and review outcomes. Since the goal is our customers’ ongoing improvement, we optimize the approach and begin again. As a result, our customers achieve a comprehensive email marketing strategy that increases their efficiency, conversion and ultimately revenue.

Strategic Services. We offer strategic services to analyze, benchmark and build a results-oriented plan to increase the value of our customer’s email marketing program.

Dedicated Account Management. We offer strategic guidance to improve our customers’ email marketing performance.

Campaign Management. We plan, build, create, test, send and optimize our customers’ email marketing campaigns from start to finish.  We also offer this as a value-added service to our product.

Deliverability. We ensure optimal delivery of our customers’ emails to their clients’ inbox. We assist in authentication settings, develop tools, education and services for building best practices for our customers’ with their email campaigns.

Training. We offer online, instructor-led and private courses to help our customers’ get the most out of our Lyris solution.

Technical Services. We offer customized system designs and implementation based on our customers’ specifications and security requirements.

Customers may purchase our Professional Services and Support a-la carte, or take advantage of comprehensive service offerings which bundle these services into packages.

Customer Service and Support

Our hosted service offerings include access to our online support knowledgebase and maintenance upgrades to our SaaS solution.  Lyris’ offers telephone support (6:00 am - 6:00 pm Pacific Time for US customers and 9:00 am - 9:00 pm Greenwich Mean Time for Europe, Middle East and Africa customers).  24/7 telephone support is also available for critical issues.

For our licensed software customers, we offer multiple levels of customer service and support.  Our “Core” offering provides online self service assistance, telephone support (6:00 a.m. - 6:00 p.m. Pacific time for US customers and 9:00 a.m. – 9:00 p.m. Greenwich Mean Time for Europe, Middle East and Africa customers) as well as access to minor and major upgrades during the term of the support contract. The second level, referred to as “Core Premium”, includes all “Core” services along with 24/7 after hours support for critical issues.

 
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Customers

We serve a wide range of customers from Fortune 500 companies to small and medium-sized businesses to government entities.  We also serve several departments of the U.S. government, national and local political campaigns, academic institutions, charitable organizations, major retail stores and athletic teams.

Sales and Marketing

Our sales and marketing activities are based in our Emeryville, California operating headquarters with additional personnel throughout the United States; Barrie, Ontario, Canada; Buenos Aires, Argentina; Sao Paulo, Brazil; Ultimo, Australia, and London, England. The sales team is focused on selling a suite of solutions including licensed software, primarily Lyris ListManager and Lyris HQ. Our main sales channels are direct and indirect sales.  Direct sales are primarily by phone and field sales personnel who are assigned to a region or country.  Our inside sales team is principally responsible for generating and identifying qualified leads.  Indirect sales are referrals from existing business partners who introduce us to potential customers.  Our sales teams incorporate account managers who focus on retention of existing customers and engagement managers that develop additional business from our largest customers.

We employ integrated marketing campaigns that combine the Internet and offline media.  Our marketing strategy includes attending periodic trade shows and events and seeking promotional partners through business development activities, including technology, agency and referral partnerships.  As part of our marketing strategy, we use cross-media advertising methodology, which includes limited print advertising, with significant Internet advertising including “pay-per-click” marketing on major search engines such as Google and Yahoo. 

Operations

We believe that continuous data center operations are crucial to our success in selling hosted services.   We currently lease space and services in secure co-location data facilities in Milpitas, Fremont, Sunnyvale and Emeryville, California and London, England.  These facilities house the servers that our hosted customers use to access our services.  In addition, these facilities have redundant electrical generators and uninterruptible power supplies, fire suppression systems and 24/7 physical securities that protect the facilities.  

We continuously monitor the performance of our service.  Our monitoring features include centralized performance consoles, automated load distribution tools and various self-diagnostic tools and programs that constantly monitor our systems and notify systems engineers if any unexpected conditions arise.  Those system engineers and our dedicated operations team are committed to ensuring that our customers have access to our hosted network to enable delivery of marketing solutions on a real time basis.

Technology

Lyris HQ, our premier product, is the integrated user front-end for our individual point applications backends, is written in Adobe Flex and delivered as a Web-based Flash application. This allows us to provide a Rich Internet Application to our customers.  Lyris HQ communicates and integrates with the individual point applications using a RESTful XML API library.

Our independent point applications are written in several computing languages, including Flex, Cold Fusion, C, C++, C# and TCL, among others.  We design these applications to run in conjunction with a number of different commercial database servers, including mySQL, Microsoft SQL Server and Oracle.  Lyris’ and EmailLabs’ platforms are designed to handle hundreds of thousands of emails per hour, while emphasizing reliability, availability and security.  These platforms automatically handle bounces due to invalid email addresses and track user activity after receipt of the emails, such as open detection, clickthrough tracking and purchase tracking.  The information gathered from user activities is digested into reports and can be used for initiating further email campaigns.

Our security systems control access to internal systems and data via the Internet.  Internally, we maintain log-ins and passwords for all systems, which grant access control on an individual basis to only the areas each individual is required to access.  Firewalls prevent unauthorized access externally, as well as unauthorized access to confidential data internally.  We combine certain encryption and authentication technologies licensed from third parties with our own technologies to provide secure transmission of confidential information.

Research and Development
 
We believe that investment in research and development is a critical factor in strengthening our product offerings.  Accordingly, we are continually reinvesting resources in product development.  We believe that to succeed in technology markets, we must have a broad focus on innovation with a long-term approach to new markets.  Additionally, we are committed to supporting and updating our core technology and to expanding our product offerings to provide a leading set of products that meet customer needs.   As we continue to build out our services platform, we will bring a broad range of new products and service offerings to market that target the needs of small and medium-sized businesses, as well as large enterprises.

 
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Historically, we have released major upgrades to our software products every 12 to 16 months.  With our premier product, Lyris HQ, we have been implementing an Agile/SCRUM methodology for our releases which allows for shorter development cycles and faster releases.  As of June 30, 2011, we had approximately 55 engineers who are engaged in maintaining our current products and researching, developing, testing and deploying new versions of our software.  We continue to invest resources for significant new research and development to develop new and innovative products, and we are constantly adding or enhancing features within our existing applications.  Our main research and development facilities are located in Emeryville and San Jose, California.

During fiscal years 2011 and 2010, research and development expenses were $2.0 million and $3.2 million, respectively.  We plan to continue to make significant investments in a broad range of research and product development efforts to further our product and service offerings.

Competition

General.  The market for email marketing products and services is highly fragmented, competitive and rapidly evolving, and there are relatively low barriers to entry into this market. With the introduction of new technologies and the influx of new entrants to the market, we expect competition to persist and intensify in the future, which could harm our ability to increase sales and maintain our prices. Our current and potential competitors may have significantly more financial, technical, marketing and other resources than we have, be able to devote greater resources to the development, promotion, sale and support of their products and services, have more extensive customer bases and broader customer relationships than we have, and may have longer operating histories and greater name recognition than we have. As a result, these competitors may be better able to respond quickly to new technologies and to undertake more extensive marketing campaigns. In some cases, these vendors may also be able to offer interactive marketing applications at little or no additional cost by bundling them with their existing applications. If we are unable to compete with such companies, the demand for products and services could substantially decline.

We believe the following factors are important or may become important in the competition for customers:

 
·
Product feature set, effectiveness, interoperability, stability and reliability;
 
·
Ease of use of the products;
 
·
Ability to integrate with other applications that our customers use to interact with their customers such as Customer Relationship Management (“CRM”), enterprise marketing management (“EMM”), Web analytics, Enterprise Resource Planning packages and consumer and business databases;
 
·
A competitor’s introduction of an integrated digital marketing software suite to compete directly with Lyris HQ in performance and scalability;
 
·
Price and total cost of ownership;
 
·
Cross-channel integration,
 
·
Pace of innovation and product roadmap;
 
·
Return on investment;
 
·
Quality of customer service and support;
 
·
Strength of professional services organization;
 
·
Brand name and reputation; and
 
·
Ability to provide services in a secure environment and maintain the confidentiality of customer data.
 
Email Marketing Markets.  The market for email marketing software and hosted email marketing services is fragmented and includes numerous competitors.  We have several types of competitors, some of whom offer an on-premise licensed software solution, while others offer a hosted service.

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

Our competitors also include many small, privately-held, companies that compete with us on the hosted side, as well as in the SMB marketplace.  Our larger competitors in this marketplace include Silverpop, Responsys, ExactTarget, CheetahMail and StrongMail.

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

Web Analytics Market.  In the Web analytics market, there are a number of large competitors and several well-funded start-ups.  Large companies who operate in this market include WebTrends, Omniture (owned by Adobe), CoreMetrics (owned by IBM), IndexTools (owned by Yahoo) and Google Analytics (owned by Google). Additionally, many smaller, privately held companies compete in this space, including OneStat and Manticore Technology. The Web analytics market is among the most competitive of all technology markets.

Search (PPC) Marketing Market. In the Search Marketing market, often referred to as PPC or Pay-Per-Click marketing, there are a significant number of competitors, particularly startups or small private companies such as Clickable, Acquisio and Marin Software. In addition, most Web Analytics firms offer some level of Search Marketing capabilities in their products.

Web Content Management Market.  In the Web content management market, there are a number of very large competitors and several well-funded start-ups.  Large companies who operate in this market include EMC (through its Documentum subsidiary), Interwoven, Silver Lake Software and OpenText.  Additionally, many smaller privately-held companies compete in this space, including CrownPeak, Clickability, Ektron, PaperThin and FatWire.

We believe our products compete effectively with these vendors based on our strategy and our comprehensive on-demand marketing platform that consolidates our full suite of digital marketing technologies into a single sign-on dashboard interface.

Intellectual Property

We have filed several patent applications.  One application covers technology developed for EmailAdvisor and four other applications relate to technology and processes developed for ClickTracks. We were awarded a patent on ClickTracks technology that covers the display of statistical data overlaid on the website as well as the automatic parameter masking used to define relevant page identifying URLs. This patent expires in 2024.  This technology displays metrics about website visitors directly onto the site itself, allowing easy analysis and interpretation.

We enter into confidentiality and proprietary rights agreements with our employees, consultants and other third parties in order to try to protect our trade secrets and intellectual property.

In recent years, many software companies have filed applications for patents covering their technologies.  Many of these patents have yet to be litigated.  Other competitors may develop technologies that are similar or superior to our technology and may receive and enforce patents on such technology.  We are not aware of any issued or pending patents that may be asserted against us.

Employees

As of June 30, 2011, we had 233 employees. Our employees are not represented by any labor union and we are not aware of any current activity to organize any of our employees.

Insurance

We currently purchase insurance policies to cover the ongoing liability and property risks arising out of our current operations.
 
U.S. and Foreign Government Regulation

Email has been the subject of regulation by local, state, federal and foreign governments.  The CAN-SPAM Act of 2003 (“CAN-SPAM”) established national standards in the U.S. for commercial email.  The Federal Trade Commission (FTC) enforces the provisions of CAN-SPAM.

CAN-SPAM defines spam as “any electronic mail message the primary purpose of which is the commercial advertisement or promotion of a commercial product or service (including content on an Internet website operated for a commercial purpose).” CAN-SPAM exempts “transactional or relationship messages.” The provision permits email marketers to send unsolicited commercial email that contain, among other requirements, the following: an opt-out mechanism; a valid subject line and header (routing) information; and the legitimate physical address of the mailer.

 
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Under CAN-SPAM, if a recipient of permitted email marketing opts out, a sender has ten days to remove the address. The legislation also prohibits the sale or other transfer of an email address after an opt-out request.  We believe strongly that emailers should send email only to those who have requested or given permission (twice) for email to be sent.  We do not permit any of our hosted customers to send spam, and our customer contracts require that our software purchasers and hosted customers comply with CAN-SPAM. 

Available Information

We are subject to the information requirements of the Securities Exchange Act of 1934. Therefore, we file periodic reports, proxy statements and other information with the Securities and Exchange Commission, (“SEC”). Such reports, proxy statements and other information may be obtained by visiting the Public Reference Room of the SEC at 100 F Street, NE, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330, by sending an electronic message to the SEC at publicinfo@sec.gov or by sending a fax to the SEC at 1-202-772-9295. In addition, the SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.

We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, available (free of charge) on or through the investor relations section our website located at www.lyris.com, as soon as reasonably practicable after they are filed with or furnished to the SEC. Information contained on or accessible through our website or contained on other websites is not deemed to be part of this Form 10-K.
 
 
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ITEM 1A.   RISK FACTORS

The following section describes risks and uncertainties that we believe may adversely affect our business, financial condition or results of operations.  The risks described below are not the only risks facing us. Additional risks not currently known to us or that we currently deem immaterial may also impair our business operations. Our business, financial condition or results of operations could be materially adversely affected by any of these risks.  This Annual Report is qualified in its entirety by these risks.  This Annual Report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced by us described below and elsewhere in this report.   The market price of our common stock could decline due to any of these risks and uncertainties, or for other reasons, and you may lose part or all of your investment.

Risks Related to Our Business and Industry

We were not profitable in fiscal year 2011 or 2010 and there can be no assurance that we will generate net income in subsequent periods.

We incurred net losses of $7.0 million and $2.7 million for fiscal years 2011 and 2010, respectively and there can be no assurance that we will be cash flow positive or generate net income in fiscal year 2012 or future years.  At June 30, 2011, our existing cash and cash equivalents cash flow from operations and the availability from our revolving credit facility, did not provide sufficient liquidity to fund our current obligations, projected working capital requirements and capital spending for the next 12 months.  While our amended credit facility entered into on August 31, 2011 improves our liquidity position, we may be unable to improve our cash flow from operations and to build our cash reserves in order to obtain sufficient liquidity.

We must generate increased revenue to attain profitability and sufficient liquidity.  We may be unable to generate sufficient revenue to reach profitability in fiscal year 2012, or our revenue could further decline. We also may incur significant losses in the future for a number of reasons, including due to the other risks described in this report, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown developments. Accordingly, we may not be able to generate net income and subsequent periods, and we may continue to incur net losses in the future.  If we continue to incur net losses in future periods we may be forced to further restructure our business to reduce costs or liquidate our business.

We may need to raise additional capital to achieve our business objectives, which could result in dilution to existing investors or increase our debt obligations.

Our capital requirements depend on several factors, including the rate of market acceptance of our products, the ability to expand our client base and the growth of sales and marketing.  In fiscal year 2011, we had a current account deficit and may continue to have a deficit through fiscal year 2012.  There is no certainty that we will be able to raise additional equity or other capital, or that the terms on which such capital may be raised will be favorable to us.  The terms of any new capital may be superior to, or dilutive to, the existing common shareholders.  Our common stock is traded on the OTC Bulletin Board, and the trading volume is low.  This may limit our ability to raise funds in the public markets.

We may not be able to obtain funding, obtain funding on acceptable terms or obtain funding under our current credit facility because of the deterioration of the credit and capital markets. This may hinder or prevent us from meeting our future capital needs and may inhibit our ability to grow.

Global financial markets and economic conditions have been, and continue to be, disrupted and volatile, making it difficult for us to obtain funding on advantageous terms.

Our agreement with Comerica Bank places certain restrictions on us, including restrictions on our total borrowings, our debt to EBITDA, certain minimum monthly thresholds our EBITDA must exceed, liquidity requirements that our cash balance must meet and our ability to buy additional businesses, among other restrictions. We cannot be certain that we will continue to be in compliance with these requirements. Our failure to meet the financial covenants under existing agreements, would constitute an event of default. If funding is not available when needed, or is available only on unfavorable terms, we may be unable to meet our obligations as they come due or be required to post collateral to support our obligations, or we may be unable to implement our business development plans, enhance our existing business, complete acquisitions or otherwise take advantage of business opportunities or respond to competitive pressures any of which could have a material adverse effect on our revenues and results of operations.

 
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Our business is substantially dependent on the market for email marketing, which is in an early stage of development, and if it does not develop or develops more slowly than we expect, our business may be harmed.

More than 90% of our revenue comes from email marketing:  from the licensing of software, the sale of support and maintenance contracts related to our software and from the sale of hosted services.  The markets for digital marketing software, including email marketing, Web analytics, marketing content management and related services are relatively new and still evolving and it is uncertain whether the software and services that we offer will achieve and sustain high levels of demand and market acceptance.  It is uncertain whether businesses will make significant investments in email and digital marketing software, and if they do, whether they will purchase our software or subscriptions to our hosted services for this function.  Our success will substantially depend on the willingness of businesses to increase their use of email and digital marketing software.  If businesses do not perceive the overall benefits of e-mail and digital marketing software, then the market may develop more slowly than we expect, either of which would significantly and adversely affect our operating results and our business may be harmed.

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

The market for online direct marketing is highly competitive and is experiencing rapid technological change. Intense competition may result in price reductions, reduced sales, reduced gross margins and operating margins and loss of market share. Our principal competitors include providers of online direct marketing solutions such as Responsys, Silverpop, Exact Target, Constant Contact, Cheetahmail, Strongmail, and among others; Web analytics providers such as Omniture (owned by Adobe), Coremetrics (owned by IBM); and search engine marketing providers such as Acquisio, Clickable and Marin Software.  The loss of a client due to service quality or technology problems could result in reputational harm to us and, as a result, increase the effect of competition and negatively affect our ability to attract new customers.

Many of these potential competitors have broad distribution channels and may bundle complementary products or services. Such bundled products include, but are not limited to, Web analytics, data mining, customer relationship management systems and professional services.  If we are not able to bundle complementary services or continue to expand our distribution capabilities, current and potential customers may choose to work with our competitors and our results may suffer.

Barriers to entry in software markets generally, and the online direct marketing industry in particular, are low.  Privately-backed and public companies could choose to enter our market and compete directly with us, or compete indirectly by offering substitute solutions.  This could result in decreased demand or pricing for our services, longer sales cycles, or a requirement to make significant incremental investments in research and development to match these entrants’ new technologies, which could in turn cause us to suffer a decline in revenues and profitability.

We expect competition to persist and intensify in the future, which could harm our ability to increase sales and maintain our prices. In the future, we may experience competition from Internet service providers, advertising and direct marketing agencies and other large established businesses possessing large, existing customer bases, substantial financial resources and established distribution channels.  These businesses could 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 existing competitors or by forming strategic alliances with a competitor. As a result of future competition, the demand for our services could substantially decline. Any of these occurrences could harm our ability to compete effectively.

 
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Our operating results fluctuate due to many factors that make our future results difficult to predict and could cause our operating results to fall below expectations.

Our operating results may fluctuate significantly as a result of a variety of factors, many of which are outside of our control.  These factors include:

 
·
fluctuations in demand for, and sales of, our products and services;
 
·
introduction of new products and services by us or our competitors;
 
·
competitive pressures that result in pricing fluctuations;
 
·
variations in the timing of orders for and delivery of our products and services;
 
·
seasonality;
 
·
changes in the mix of products and services that we sell and the resulting impact on our gross margins; and
 
·
costs associated with litigation and intellectual property claims.

Our operating expenses are based on current expectations of our future revenues and are relatively fixed in the short term.  Customer purchasing behavior can be difficult to forecast, and if we have lower revenues than expected, we may not be able to quickly reduce our expenses in response.  Consequently, our operating results for a particular period could be adversely impacted, and this could in turn negatively affect the market price of our common stock.

 
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Our results depend on consumer use of email and the Internet, and the acceptance of online direct marketing as a means to attract and retain new customers. 

Our current and planned services enable customers to use email, SMS and the Internet to increase revenue and traffic from, and communication with, their online audiences, customers and members. Our ability to serve these customers therefore depends on their audiences continuing to use email, SMS and the Internet as communications media.  If consumer adoption of either technology declines, demand for our services may not develop or may decline.

Moreover, our services are relatively new, rapidly evolving, and are very different from the traditional methods that many of our customers have historically used to attract new customers and maintain customer relationships.  As a result, customers and potential customers may be reluctant to try new technologies and new solutions, and the demand for our services may not develop or may decline, which could cause our stock price to decline.

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

The development of proprietary technology (e.g., Lyris HQ), service enhancements and the migration of customers to new technology entail significant technical and business risks and require substantial expenditures and lead-time. We might not be successful in marketing and supporting recently released versions of our technology and services on a timely or cost-effective basis. In addition, even if we develop and release new technology and services, they might not achieve market acceptance, and if we are unable to recover the costs associated with the research and development activities, our business, financial condition and results of operations may be adversely affected.  Also, if we are not successful in a smooth migration of customers to new or enhanced technology and services, we could lose customers or fail to maximize profits resulting from customers who continue to use older products [or services] rather than our newest offerings.

System failures could reduce the attractiveness of our service offerings.

We provide email marketing and delivery services to our customers and end-users through our proprietary technology and client management systems. The satisfactory performance, reliability and availability of the technology and the underlying network infrastructure are critical to our operations, level of client service, reputation and ability to attract and retain customers. We have experienced periodic interruptions, affecting all or a portion of our systems, which we believe will continue to occur from time to time. Any systems damage or interruption that impairs our ability to accept and fill client orders could result in an immediate loss of revenue to us and could cause some customers to purchase services offered by our competitors. In addition, frequent systems failures could harm our reputation.  Some factors that could lead to interruptions in customer service include: operator negligence; improper operation 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.

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

Adoption of email as 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 messages before they reach customers’ mailboxes.  In response, spammers have become more sophisticated and have also begun using junk messages as a means for fraud.  Email protection companies in turn have evolved to address this new threat.  However, if their products fail to be effective against spam, adoption of email as a communications tool may decline, which would adversely affect the market for our services.

We have acquired a number of operating businesses in recent years, and we may continue to expand through acquisitions of, or investments in, other companies or through business relationships, all of which may divert our management’s attention, result in additional dilution to our stockholders, consume resources that are necessary to sustain our business and furthermore, we may not realize expected benefits from any of these acquisitions.

One of our business strategies is to acquire competing or complementary services, technologies or businesses. We also may enter into relationships with other businesses in order to introduce new and/or expand our existing product and service offerings, which could involve preferred or exclusive licenses, additional channels of distribution or discount pricing or investments in other companies.

 
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Our completed acquisitions and any future acquisition, investment or business relationship may result in unforeseen operating difficulties and expenditures. In particular, we may encounter difficulties assimilating or integrating the acquired businesses, technologies, products, personnel or operations of the acquired companies, and such challenges may be compounded if the key personnel of the acquired company choose not to work for us and management and ownership changes negatively affect customer retention.  Acquisitions may also disrupt our ongoing business, divert our resources and require significant management attention that would otherwise be available for ongoing development of our business. Moreover, we cannot assure you that we will recognize the anticipated benefits of, or that we would not be exposed to unknown liabilities as a result of, any acquisition, investment or business relationship.  While we expect our acquisitions to result in additional net revenues for us, we cannot guarantee that will be the case.  We have already seen significant decreases in revenue and profitability due to the fact that neither ClickTracks nor Hot Banana has generated the revenues anticipated at the time we acquired those companies.

We cannot assure you that we will be able to complete any acquisitions on favorable terms or at all.  In connection with one or more of those transactions, we may:
 
 
·
issue additional equity securities that would dilute our stockholders’ percentage of ownership;
 
·
use cash that we may need in the future to operate our business;
 
·
incur debt on terms unfavorable to us or that we are unable to repay;
 
·
incur large charges or substantial liabilities;
 
·
encounter difficulties retaining key employees of the acquired company or integrating diverse business cultures;
 
·
become subject to adverse tax consequences, substantial depreciation or deferred compensation charges;
 
·
encounter undiscovered and unknown problems, defects or other issues related to any acquisition that become known to us only after the acquisition;
 
·
encounter  potential conflicts in distribution, marketing or other important relationships, or poor acceptance by our customers;
 
·
face difficulties caused by entering geographic and business markets in which we have no or only limited prior experience;
 
·
face risks that the acquired products and services may not attract consumers;
 
·
encounter difficulties in implementation of uniform standards, controls, policies and procedures;
 
·
fail to achieve anticipated levels of revenue, profitability or productivity;
 
·
face poor acceptance of our business model and strategies; and/or
 
·
encounter unfavorable reactions from investment banking market analysts who disapprove of our completed acquisitions.

If we fail to respond to rapidly changing technology or evolving industry standards, our products and services may become obsolete or less competitive.

Rapid technological advances, changes in client requirements, changes in protocols and evolving industry standards characterize the market for our products and services.  If we are unable to develop enhancements to, and new features for, our existing products and services, or develop entirely new products and services, our products and services may become obsolete, less marketable or less competitive, and our business may be harmed.  The ability to add new enhancements, new features and new services depends on several factors, including having sufficient financial, technical and human resources, management focus on these efforts and the ability to complete such work in a timely and cost-effective manner.  Failure to produce timely new features in response to or anticipation of customer demands will significantly impair our ability to retain existing revenue and earn new revenue.

We will also need to continually improve our computer network and infrastructure to avoid service interruptions or slower system performance.  As usage of our products grow and as customers use it for more complicated tasks, we will need to devote additional resources to improving our computer network, our application architecture and our infrastructure in order to maintain the performance of our products. Any failure or delays in our computer systems could cause service interruptions or slower system performance. If sustained or repeated, these performance issues could reduce the attractiveness of our products to customers. This could result in lost customer opportunities and lower renewal rates, any of which could hurt our revenue growth, customer loyalty and our reputation. We may need to incur additional costs to upgrade or expand our computer systems and architecture in order to accommodate increased demand if our systems cannot handle current or higher volumes of usage.

Changes in technology may also affect consumer preferences, business environment and market share.   We may not accurately predict customer or business partner behavior and may not recognize or respond to emerging trends, changing preferences or competitive factors, and, therefore, we may fail to make accurate financial forecasts.  

Qualifying and supporting our products on multiple computer platforms is time consuming and expensive.

We devote time and resources to qualify and support our software products on specific computer platforms, such as Microsoft operating systems.  The pace at which existing platforms are being modified and new platforms are being adopted has increased rapidly over time.  To the extent that existing platforms are modified or upgraded, or customers adopt new platforms, we could be required to expend additional engineering time and resources to qualify and support our products on such modified or new platforms, or we could lose customers to competitors who respond more quickly to platform changes, which could add significantly to our development expenses, decrease our revenues and adversely affect our operating results.

 
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The majority of our hosted services are sold pursuant to short-term subscription agreements, and if we are unable to retain existing customers or to grow our customer base by adding new customers, our operating results will be adversely affected.

Our growth strategy is in part driven by our ability to retain our existing customers and grow our customer base by adding new customers. Customers cancel their accounts for many reasons, including economic concerns, business failure or a perception that they do not use our product effectively, the service is not a good value and that they can manage their email campaigns without our product.  Typically, our hosted services are sold pursuant to short-term subscription agreements, which are generally one year in length, with no obligation to renew these agreements. Our renewal rates may decline due to a variety of factors, including the services and prices offered by our competitors, new technologies offered by others, consolidation in our customer base or cessation of operations of some of our customers.  We must continually add new customers to replace customers whose accounts are cancelled, terminated or not renewed, which may involve significantly higher marketing expenditures than we currently anticipate. If too many of our customers cancel or do not renew our service, or if we are unable to attract new customers in numbers sufficient to grow our business, our operating results would be adversely affected.
 
Defects in our products could diminish demand for our products and services and cause us to lose customers.

Because our products and services are complex, they may have errors or defects that users identify after they begin using them, which could harm our reputation and business.  In particular, our anti-spam products may identify some legitimate emails as unwanted or unsolicited spam, or we may not be able to filter out a sufficiently high percentage of unsolicited or unwanted messages sent to the email accounts of customers, which could result in customers’ dissatisfaction.  Complex software products like ours frequently contain undetected errors when first introduced or when new versions or enhancements are released. Failure to achieve acceptance could results in a delay in, or inability to receive payment. In addition, we may be unable to respond in a prompt manner, or at all, to new methods of attacking a messaging system, such as new spamming techniques, which could result in increased service and warranty costs and related litigation expenses, and potential liability to third parties, any of which could harm our business. We have from time to time found defects in our products, and we may detect errors in existing products in the future.  Any such errors, defects or other performance problems could affect the perceived reliability of our products and services and damage our reputation.  If that occurs, customers could elect not to renew or terminate their subscriptions and we could lose potential future sales.

Our facilities and systems are vulnerable to natural disasters and other unexpected events and any of these events could result in an interruption of our ability to execute customers’ online direct marketing campaigns.

We depend on the efficient and uninterrupted operations of our data centers and hardware systems. Our data centers and hardware systems are located in California, an area susceptible to earthquakes. Our data centers and hardware systems are also vulnerable to damage from fire, floods, power loss, telecommunications failures and similar events. If any of these events results in damage to our data centers or systems, we may be unable to execute customers’ hosted online direct marketing campaigns until the damage is repaired and may accordingly lose customers and revenues. In addition, subject to applicable insurance coverage, we may incur substantial costs in repairing any damage.

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

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

If we are unable to safeguard the confidential information in our data warehouse, our reputation may be harmed and we may be exposed to liability.

We currently store confidential customer information, including customers’ proprietary email distribution lists, credit card information and other critical data, in a secure data warehouse owned by a third party. Any accidental or willful security breaches or other unauthorized access could expose us to liability for the loss of such information, adverse regulatory action by federal and state governments, time-consuming and expensive litigation and other possible liabilities as well as negative publicity, which could severely damage our reputation. Any unauthorized access to our servers could result in the misappropriation of confidential customer information or cause interruptions in our services. It is also possible that one of our employees could attempt to misuse confidential customer information, exposing us to liability. In addition, our reputation may be harmed if we lose customer information maintained in our data warehouse due to systems interruptions or other reasons.

 
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Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until they are launched against a target, we and our third-party hosting facilities may be unable to anticipate these techniques or to implement adequate preventative measures. In addition, as we continue to grow our customer base and our brand becomes more widely known and recognized, we may become a more inviting target for third parties seeking to compromise our security systems. Many states have enacted laws requiring companies to notify individuals of data security breaches involving certain types of personal data. These mandatory disclosures regarding a security breach often lead to widespread negative publicity, which may cause our customers to lose confidence in the effectiveness of our data security measures. Any security breach, whether actual or perceived, would harm our reputation, and we could lose customers and fail to acquire new customers. In addition, if we fail to maintain our compliance with the data protection policy standards adopted by the major credit card issuers, we could lose our ability to offer our customers a credit card payment option. Any loss of our ability to offer our customers a credit card payment option would harm our reputation and make our products less attractive to many small organizations by negatively impacting our customer experience and significantly increasing our administrative costs related to customer payment processing. Our existing general liability insurance may not cover any, or only a portion of any potential claims to which we are exposed or may not be adequate to indemnify us for all or any portion of liabilities that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of insurance coverage would increase our operating losses and reduce our net worth and working capital.

We may not be able to protect our intellectual property or gain access to third party intellectual property necessary to the operation of our business.

Unlicensed copying and use of our intellectual property or illegal infringements of our intellectual property rights represent losses of revenue to us. Our products and services include internally developed technology and intellectual property, which we protect through a combination of patent, copyright, trade secret and trademark law, as well as contractual obligations.  Because these measures only provide limited protection, we may not be able to protect our proprietary rights. Unauthorized parties may attempt to obtain and use our intellectual property without authorization. Policing unauthorized use of our proprietary information is difficult, and we cannot be certain that the steps we have taken will prevent misappropriation. Further, effective patent, copyright, trade secrets and trademark law may not be available in every country in which our products and services are offered, marketed, distributed, sold or used.

We are one of several companies rapidly building new technologies in this industry. Our competitors may develop similar technology independently and design products and services that address this market. It is possible that a third party could be awarded a patent that applies to some portion of our business.  If this occurs, we may be required to incur substantial legal fees, cease using the technology or pay significant licensing fees for such use. 

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

The software and Internet industries are characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. Third parties may assert patent and other intellectual property infringement claims against us in the form of lawsuits, letters or other forms of communication. These events could be costly, could divert technical resources and management time and, result in the invalidation of our intellectual property.  Unfavorable litigation outcomes may subject us to substantial damage claims, cause product enhancement delays and require us to cease development of certain products, terminate the use of certain technology, develop alternative technology or enter into license agreements to continue using certain technology.  Such licensing agreements might not be available on terms we find acceptable or at all and could harm our business. Existing lawsuits against others in this industry, as well as any future assertions or prosecutions of claims like these, could also result in an unfavorable outcome for us, potentially leading to proprietary rights infringements claims against us.
 
From time to time, we may be named as a defendant in lawsuits claiming that we have, in some way, violated the intellectual property rights of others. Because currently pending patent applications are not publicly available for certain periods of time, we cannot anticipate all such claims or know with certainty whether our technology infringes the intellectual property rights of third parties.  As a general matter, we do not search patent office files for patents or patent applications that we may possibly infringe.  We are aware of several patents for which patent infringement potentially may be asserted against us.

As technology evolves and the number of competitors in our industry increases, we may face an increasing number of third party claims related to potential patent infringement. In addition, many of our subscription agreements require us to indemnify our customers for third-party intellectual property infringement claims.  These indemnification requirements would increase our costs in the event of an adverse ruling in potential infringement claims. Even if we have not infringed any third parties’ intellectual property rights, we cannot be sure our legal defenses will be successful, and even if we are successful in defending against such claims, our legal defense could result in significant costs and diversion of company resources. As a result, any third-party intellectual property claims against us could adversely affect our results of operations, projected growth and revenues.

 
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Activities of customers could damage our reputation or give rise to legal claims against us.

Customers’ promotion of their products and services may not comply with federal, state and local laws. We cannot predict whether our role in facilitating these marketing activities would expose us to liability under these laws. Any claims made against us could be costly and time-consuming to defend. If we are exposed to this kind of liability, we could be required to pay fines or penalties, redesign business methods, discontinue some services or otherwise expend resources to avoid liability.

Our services involve the transmission of information through the Internet. These services could be used to transmit harmful applications, negative messages, unauthorized reproduction of copyrighted material, inaccurate data or computer viruses to end-users in the course of delivery. Any transmission of this kind could damage our reputation or could give rise to legal claims against us. We could spend a significant amount of time and money defending against these types of potential legal claims.

Our executive officers and other key personnel are critical to our business, and because there is significant competition for personnel in our industry, it may not be able to attract and retain qualified personnel.

Our success depends on the continued contributions of our executive management team, our technical, marketing, sales, customer support and product development personnel.  The loss of key individuals or significant numbers of such personnel, or our failure to continue to attract or retain such personnel in the future could significantly harm our business, financial condition and results of operations.  Competition for these personnel is intense, especially for engineers with high levels of experience in designing and developing software and Internet-related services and for direct sales personnel with the advanced sales skills and technical knowledge we need.  We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. Many of the companies with which we compete for experienced personnel have greater resources than we have. In addition, in making employment decisions, particularly in the Internet and high-technology industries, job candidates often consider the value of the stock options they are to receive in connection with their employment. Volatility in the price and low trading volume of our stock may, therefore, adversely affect our ability to attract or retain key employees. Furthermore, the requirement to expense stock options may discourage us from granting the size or type of stock option awards that job candidates require in order to join us.

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

Internet service providers are able to block messages from reaching their users. Recent releases of Internet service provider software and the implementation of stringent new policies by Internet service providers make it more difficult to deliver emails on behalf of customers. We continually improve our own technology and work with Internet service providers to improve our ability to successfully deliver emails. However, if Internet service providers materially limit or halt the delivery of our emails, or if we fail to deliver emails in such a way as to be compatible with these companies’ email handling or authentication technologies, then the amount we may be able to charge customers for producing and sending their online direct marketing campaigns may be reduced and /or customers may discontinue their use of our services.  In addition, the effectiveness of email marketing may decrease as a result of increased customer resistance to email marketing in general.

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

Our technology currently uses cookies, which are small files of information placed on an Internet user’s computer, to collect information about the user’s visits to the websites of our customers. Third-party software and our own technology make it easy for users to block or delete our cookies. Several software programs, sometimes marketed as ad-ware or spyware detectors, block our cookies by default or prompt users to delete or block our cookies. If a large proportion of users delete or block our cookies, this could undermine the value of the data that we collect for our customers and could negatively impact our ability to deliver accurate reports to our customers, which would harm our business.

Changes in Web browsers may also encourage users to block cookies. Microsoft, for example, frequently modifies its Internet Explorer Web browser. Some modifications by Microsoft could substantially impair our ability to use cookies for data collection purposes. If that happens and we are unable to adapt our technology and practices adequately in response to changes in Microsoft’s technology, then the value of our services will be substantially impaired. Additionally, other technologies could be developed that impede the operation of our services. These developments could prevent us from providing our services to our customers or reduce the value of our services.

 
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In addition, laws regulating the use of cookies by us and our customers could also prevent us from providing our services to our customers or require us to employ alternative technology. A European Union Directive implemented by member countries requires us to tell users about cookies placed on their computers, describe how we and our customers will use the information collected and offer users the right to refuse a cookie. Although no European country currently requires consent prior to delivery of a cookie, one or more European countries may do so in the future. If we were required to obtain consent before delivering a cookie or if the use or effectiveness of cookies is limited, we would be required to switch to alternative technologies to collect user profile information, which may not be done on a timely basis, at a reasonable cost or at all.  Moreover, laws in the areas of privacy and behavioral tracking are likely to be passed in the future, which could result in significant limitations on or changes to the way in which we can collect, use, store or transmit users’ personal information and deliver products and services.
 
The standards that private entities use to regulate the use of email have in the past interfered with, and may in the future interfere with, the effectiveness of our on-demand software and our ability to conduct business.
 
Our customers rely on email to communicate with their customers. Various private entities attempt to regulate the use of email for commercial solicitation. These entities often advocate standards of conduct or practice that significantly exceed current legal requirements and classify certain email solicitations that comply with current legal requirements as spam. Some of these entities maintain “blacklists” of companies and individuals, and the websites, ISPs and Internet protocol addresses associated with those entities or individuals, who do not adhere to those standards of conduct or practices for commercial email solicitations that the blacklisting entity believes are appropriate. If a company’s Internet protocol addresses are listed by a blacklisting entity, emails sent from those addresses may be blocked if they are sent to any Internet domain or Internet address that subscribes to the blacklisting entity’s service or purchases its blacklist.
 
From time to time, some of our Internet protocol addresses may become listed with one or more blacklisting entities due to the messaging practices of our customers. There can be no guarantee that we will be able to successfully remove ourselves from those lists. Blacklisting of this type could interfere with our ability to market our on-demand software and services and communicate with our customers and, because we fulfill email delivery on behalf of our customers, could undermine the effectiveness of our customers’ email marketing campaigns, all of which could have a material negative impact on our business and results of operations.

Adverse global economic conditions may continue to decrease our customers’ activity levels and spending for our products and services.

Current adverse global economic conditions have had, and may continue to have, a negative impact on our customers.   The tightening in the credit markets, a low level of liquidity in many financial markets and extreme volatility of in fixed income, credit and equity markets may have negatively affected our customers’ equity values, reduced their cash flow and/or limited their access to debt or equity financing, and therefore may result in a significant reduction in our customers’ spending for our products and services. To the extent our customers reduce their capital expenditure budgets for the remainder of 2010 or beyond, this reduction in spending and decrease in demand for our products and services could have a material adverse effect on our operations.

An impairment loss could have a material adverse impact on our financial condition and results of operations.

The continued global economic crisis, resulting in, among other things, sharply lower demand for our offerings and disruption of capital and credit markets could significantly affect our market capitalization and result in an impairment loss.  We did not recognize a goodwill impairment loss in fiscal year 2011 and 2010; however, in fiscal year 2009, we recognized a goodwill impairment loss of $17.0 million.  It is possible that further decline of economic conditions would result in additional impairment loss that could have a material adverse impact on our financial condition and results of operations.
 
Because we recognize subscription revenue from our customers over the term of their agreements, downturns or upturns in sales may not be immediately reflected in our operating results.
 
We recognize subscription revenue over the term of our customer agreements, which are typically one year. As a result, most of our monthly subscription revenue results from agreements entered into during previous months. Consequently, a shortfall in demand for our on-demand software and related services in any quarter may not significantly reduce our subscription revenue for that quarter, but could negatively affect subscription revenue in future quarters. We may be unable to adjust our cost structure to compensate for this potential shortfall in subscription revenue. Accordingly, the effect of significant downturns in sales of subscriptions to our on-demand software and related services may not be fully reflected in our results of operations until future periods. Our subscription model also makes it difficult for us to rapidly increase our subscription revenue through additional sales in any period, as subscription revenue from new customers must be recognized over the applicable subscription terms.

 
19

 

 
Exposure to risks associated with our international operations could unfavorably affect our performance.

We derive revenues through our international operations.  The success and profitability of our international operations may be adversely affected by risks associated with international activities, including economic and labor conditions, tax laws and changes in the value of the U.S. dollar versus the local currencies in which our foreign operations may be denominated.  Specifically with currency risks, we do not currently utilize derivative instruments to hedge an exposure to fluctuations in foreign currencies and our revenues may decrease as a result of such fluctuations.

Our operating results are subject to volatility resulting from fluctuations in foreign currency exchange rates, including:

 
·
currency movements in which the U.S. dollar becomes stronger with respect to foreign currencies, thereby reducing relative demand for our products and services outside the United States; and
 
·
currency movements in which a foreign currency in which we have incurred expenses becomes stronger in relation to the U.S. dollar, thereby raising our expenses for the same level of operating activity.

Our international operations expose us to additional risks, which could adversely affect our business, financial condition and results of operations, including, but not limited to:

 
·
trade restrictions and duties, including tariffs, quotas and other barriers;
 
·
delays resulting from difficulty in obtaining trade licenses for certain technology, foreign regulatory requirements, such as safety or radio frequency emissions regulations;
 
·
liquidity problems in various foreign markets;
 
·
uncertainties and liabilities associated with foreign tax laws;
 
·
burdens of complying with a variety of foreign laws, including more stringent consumer and data protection laws;
 
·
unexpected changes in, or impositions of, foreign legislative or regulatory requirements;
 
·
difficulties in coordinating the activities of our geographically dispersed and culturally diverse operations;
 
·
difficulties in staffing, managing and operating our international operations;
 
·
potential loss of proprietary information due to misappropriation or laws that may be less protective of our intellectual property rights than U.S. law;
 
·
political and economic instability;
 
·
changes in diplomatic and trade relationships; and
 
·
other factors beyond our control including terrorism, war, natural disasters and diseases, particularly in areas in which we have facilities.

As Internet commerce develops, federal, state and foreign governments may adopt new laws to regulate Internet commerce, which may negatively affect our business.
 
As Internet commerce continues to evolve, increasing regulation by federal, state or foreign governments becomes more likely. Our business could be negatively impacted by the application of existing laws and regulations or the enactment of new laws applicable to our products or our business. The cost to comply with such laws or regulations could be significant and would increase our operating expenses, and we may be unable to pass along those costs to our customers in the form of increased subscription fees. In addition, federal, state and foreign governmental or regulatory agencies may decide to impose taxes on services provided over the Internet or via email. Such taxes could discourage the use of the Internet and email as a means of commercial marketing, which would adversely affect the viability of our products.  States and some local taxing jurisdictions also have differing rules and regulations governing sales and use taxes, and these rules and regulations are subject to varying interpretations that may change over time. In particular, the applicability of sales taxes to our subscription services in various jurisdictions is unclear.  At present, we do not collect sales or other similar taxes with respect to our subscription services.  However, various other states may seek to impose sales tax obligations on our subscription services in the future. A number of proposals have been made at the state and local levels that would impose additional taxes on the sale of goods and services through the Internet. A successful assertion by one or more states that we should have collected or be collecting sales taxes on the sale of products could have a material adverse effect on our results of operations.

 
20

 
 
Evolving regulations concerning data privacy may restrict our customers’ ability to solicit, collect, process, disclose and use data necessary to conduct effective marketing campaigns and analyze the results or may increase their costs, which could harm our business.
 
Federal, state and foreign governments have enacted, and may in the future enact, laws and regulations concerning the solicitation, collection, processing, disclosure or use of consumers’ personal information. Such laws and regulations may require companies to implement privacy and security policies, permit users to access, correct and delete personal information stored or maintained by such companies, inform individuals of security breaches that affect their personal information, and, in some cases, obtain individuals’ consent to use personal information for certain purposes. Other proposed legislation could, if enacted, impose additional requirements and prohibit the use of certain technologies that track individuals’ activities on web pages or that record when individuals click through to an Internet address contained in an email message. Such laws and regulations could restrict our customers’ ability to collect and use email addresses, page viewing data and personal information, which may reduce demand for our solution. For example, Directive 2009/136/EC of the European Parliament and of the Council concerning the processing of personal data and the protection of privacy in the electronic communications sector requires that users be provided with information and offered the right to refuse when a third party wishes to store information on a user’s equipment, such as by placing a cookie on the user’s computer, or to access information already stored. In other words, Directive 2009/136/EC appears to require consumers to “opt-in” in order for cookies to be used as part of marketing efforts. Directive 2009/136/EC required EU member states to adopt and publish by May 25, 2011 laws, regulations and administrative provisions necessary to comply with the Directive. While some EU member states have done so, others have not, and there remains considerable uncertainty regarding what types of procedures and mechanisms are legally sufficient to comply with the Directive. Because it is not yet clear how this directive will be implemented by the member states, it is possible that our customers may need to evolve their business practices if they wish to continue to utilize interactive marketing with their customers. These changes may have the effect of reducing demand for our services in the European Union.
 
Our applications collect, store and report personal information, which raises privacy concerns and could result in liability to us or inhibit sales of subscriptions to our products.
 
Many federal, state and foreign government bodies and agencies have adopted or are considering adopting laws and regulations regarding the collection, use and disclosure of personal information. Because many of the features of our applications use, store and report on personal information from our customers, any inability to adequately address privacy concerns, even if unfounded, or comply with applicable privacy laws, regulations and policies, could result in liability to us, damage our reputation, inhibit sales and harm our business. Furthermore, the costs of compliance with, and other burdens imposed by, such laws, regulations and policies that are applicable to the businesses of our customers may limit the use and adoption of our products and services and reduce overall demand for it. Privacy concerns, whether or not valid, may inhibit market adoption of our solutions.
 
If our products are perceived to cause or is otherwise unfavorably associated with invasions of privacy, whether or not illegal, it may subject us or our customers to public criticism. Existing and potential future privacy laws and increasing sensitivity of consumers to unauthorized disclosures and use of personal information may create negative public reactions related to interactive marketing, including marketing practices of our customers. Public concerns regarding data collection, privacy and security may cause some of our customers’ customers to be less likely to visit their websites or otherwise interact with them. If enough consumers choose not to visit our customers’ websites or otherwise interact with them, our customers could stop using our products. This, in turn, would reduce the value of our service and inhibit or reverse the growth of our business.
 
Failure to effectively expand our sales and marketing capabilities could harm our ability to increase our customer base and achieve broader market acceptance of our on-demand software.

Increasing our customer base and achieving broader market acceptance of our solutions will depend to a significant extent on our ability to expand our sales and marketing operations and activities. We expect to be substantially dependent on our direct sales force to obtain new customers. We plan to continue to expand our direct sales force both domestically and internationally. We believe that there is significant competition for direct sales personnel with the sales skills and technical knowledge that we require. Our ability to achieve significant growth in revenue in the future will depend, in large part, on our success in recruiting, training and retaining sufficient numbers of direct sales personnel. New hires require significant training and time before they achieve full productivity. Our recent hires and planned hires may not become as productive as quickly as we would like, and we may be unable to hire or retain sufficient numbers of qualified individuals in the future in the markets where we do business. Our business will be seriously harmed if these expansion efforts do not generate a corresponding significant increase in revenue.

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

We believe that developing and maintaining awareness of our brands in a cost-effective manner is critical to achieving widespread acceptance of our current and future services and is an important element in attracting new customers. Furthermore, we believe that the importance of brand recognition will increase as competition in our market develops. Successful promotion of our brands will depend largely on the effectiveness of our marketing efforts and on our ability to provide reliable and useful services at competitive prices. Brand promotion activities may not yield increased revenue, and even if they do, any increased revenue may not offset the expenses we incur in building our brands. If we fail to successfully promote and maintain our brands, or incur substantial expenses in an unsuccessful attempt to promote and maintain our brands, we may fail to attract enough new customers or retain our existing customers to the extent necessary to realize a sufficient return on our brand-building efforts, and our business and results of operations could suffer.
 
21

 
  
We may use third parties to grow our business. If we are unable to maintain successful relationships with them, our business could be harmed.
 
In addition to our direct sales force, we may use third parties such as resellers to help promote our solutions. Although we do not currently derive a significant amount of revenue through third parties, we may in the future seek to expand sales of subscriptions of our solutions through these and other indirect sales channels.
 
These third parties may offer customers the solutions of several different companies, including solutions that compete with ours. We also expect that these third parties will not have an exclusive relationship with us. Thus, we will not be certain that they will prioritize or provide adequate resources for selling our solutions. In addition, establishing and retaining qualified third parties and training them in our products and services require significant time and resources. If we are unable to maintain successful relationships with any of these third parties, our business could be harmed.
 
Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported results of operations.
 
A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, we have recently adopted a new revenue recognition standard, which may in the future be subject to varying interpretations that could materially impact how we recognize revenue. Accounting for revenue from sales of subscriptions to software is particularly complex, is often the subject of intense scrutiny by the SEC, and will evolve as the Financial Accounting Standards Board, or FASB, continues to consider applicable accounting standards in this area.

We are subject to evolving and expensive corporate governance regulations and requirements.  Our failure to adequately meet such requirements could harm our business.

Because we are a publicly-traded company, we are subject to certain federal, state and other rules and regulations, including those required by the Sarbanes-Oxley Act of 2002.   Compliance with these evolving regulations is costly and requires a significant amount of management time and attention, particularly with regard to our disclosure controls and procedures and our internal control over financial reporting.  Although we have reviewed and continue to review our disclosure and internal controls and procedures for effectiveness, our controls and procedures may not be able to prevent fraud or other errors.

Risks Related to Investment in our Common Stock

Our executive officers and directors beneficially own a significant amount of our common stock.

As of June 30, 2011, our executive officers and directors and entities affiliated with them beneficially own or have options exercisable within 60 days to purchase, in the aggregate, approximately 59% of our common stock.  The chairman of our board of directors (the “Board”), Mr. William T. Comfort, III, as controlling partner of LDN Stuyvie Partnership, beneficially owns approximately 48% of our common stock.  Mr. Comfort’s brother-in-law, James A. Urry, is also on our Board and beneficially owns approximately 8% of our common stock.  These stockholders together have, and Mr. Comfort himself has, the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets. This concentration of ownership could have the effect of delaying, deferring or preventing a change of control or impeding a merger or consolidation, takeover or other business combination.

There is a limited market for our common stock.

Our common stock is subject to a limited trading market on the OTC Bulletin Board, and an active trading market may not develop.  Moreover, sales of large blocks of stock may have a significantly greater negative impact because of the low trading volume.  If a more active public market for our stock is not sustained, it may be difficult for stockholders to sell shares of our common stock.  Because we do not anticipate paying cash dividends on our common stock for the foreseeable future, stockholders will not be able to receive a return on their shares unless they are able to sell them.

The transfer restrictions on our common stock 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 us in the merger with our former parent company, NAHC, Inc, are subject to transfer restrictions that, in general, prevent any individual stockholder or group of stockholders from acquiring in excess of 5% of our outstanding common stock. The types of acquisition transactions that we may undertake will be limited unless our Board 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 our outstanding shares of common stock, unless that stockholder held more than 5% of our common stock before the merger or our Board specifically authorizes the acquisition of more than 5% of our common stock.
   
 
22

 
     
We may not be able to realize the benefits of our net operating loss carryforwards.

Our ability to use our potential tax benefits derived from our net operating loss carryforwards in future years will depend upon the amount of our otherwise taxable income. If we generate insufficient taxable income in future years, the net operating losses will not be needed or used and therefore will provide no benefit to us. If we experience a change of ownership within the meaning of Section 382 of the Internal Revenue Code, we will not be able to realize the benefit of our net operating loss carryforwards and tax credit carryforwards. Our net operating loss carryforwards at June 30, 2011 and 2010 were $62.4 million and $61.2 million, respectively.

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

In addition to the provisions to protect our NOLs, our amended and restated certificate of incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent us from having a change of control or changes in our management that our stockholders may deem advantageous. These provisions:

 
·
establish a classified board of directors so that not all members of our board are elected at one time;
 
·
provide that directors may only be removed “for cause” and only with the approval of 66 2/3% of our stockholders;
 
·
require super-majority voting to amend some provisions in our amended and restated certificate of incorporation;
 
·
authorize the issuance of “blank check” preferred stock that our board of directors could issue to increase the number of outstanding shares to discourage a takeover attempt;
 
·
provide that the board of directors is expressly authorized to make, alter or repeal our bylaws; and
 
·
establish advance notice requirements for nominations for elections to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings.
   
 
23

 
   
ITEM 1B. 
UNRESOLVED STAFF COMMENTS
 
None
    
 
24

 
ITEM 2. 
PROPERTIES

Our principal office and corporate headquarters is located at 6401 Hollis Street Suite 125, Emeryville, CA 94608, where we lease 31,186 square feet of office space.  We also maintain an office in San Jose, California.  Our subsidiaries lease office space in London, England; Barrie, Ontario, Canada; Buenos Aires, Argentina; and Ultimo, Australia.

A summary of our significant leased office facilities at June 30, 2011 are as follows:

Location
 
Square Feet
 
Lease Expiration Date
Emeryville, California
  31,186  
March 2016
San Jose, California
  17,120  
September 2012
Barrie, Ontario, Canada
  6,400  
December 2013
London, England
  2,260  
May 2014
Buenos Aires, Argentina
  1,076  
February 2014
Ultimo, Australia
  2,960  
December 2012

Our leased facilities are fully used by us and our subsidiaries operations.

We believe that our current operating leases are suitable and adequate to provide our current and near-term requirements.   Our remaining facility lease obligation as of June 30, 2011 for all of our facilities is approximately $4.3 million.
  
 
25

 

ITEM 3. 
LEGAL PROCEEDINGS

From time to time, we are a party to litigation and subject to claims which are incidental to the ordinary course of business, including customer disputes, breach of contract claims and other matters.  Although the results of such litigation and claims cannot be predicted with certainty, we believe that the final outcome of such litigation and claims will not have a material adverse effect on our business, consolidated financial position, results of operations and cash flows.  Due to the inherent uncertainties of such litigation and claims, our view of such matters may change in the future.
   
 
26

 
  
ITEM 4. 
RESERVED
   
 
27

 
   
PART II

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

Our common stock, par value $0.01 per share is traded on the Over-the-Counter Bulletin Board (“OTCBB”) under the symbol LYRI.OB.  Trading of our common stock on OTCBB commenced on December 3, 1999.  As of August 31, 2011 there were 478 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.

   
High
   
Low
 
             
Year Ended June 30, 2011:
           
First Quarter
  $ 0.39     $ 0.31  
Second Quarter
    0.35       0.23  
Third Quarter
    0.30       0.19  
Fourth Quarter
    0.30       0.22  
                 
Year Ended June 30, 2010:
               
First Quarter
  $ 0.50     $ 0.25  
Second Quarter
    0.45       0.26  
Third Quarter
    0.40       0.27  
Fourth Quarter
    0.44       0.32  

In August 2010, Luis Rivera resigned from his positions as President and Chief Executive Officer of the Company. In accordance with the terms of his termination agreement, the Company repurchased 170,000 shares of common stock from Mr. Rivera at the then market price of $0.33 for a total payment of $56 thousand. The cost of these treasury shares were recorded as a reduction to stockholders’ equity and represent the total treasury stock held by the Company as of September 30, 2010. 
 
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 our initial public offering on November 5, 1986.  We do not expect to declare any cash dividends on common stock in the foreseeable future.

See disclosure under the heading entitled “Equity Compensation Plan Information” in Item 12 – Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters – for disclosure related to the securities authorized for issuance under our equity compensation plans.
 
28

 
  
ITEM 6. 
RESERVED
   
 
29

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

Overview

The discussion and analysis below includes certain forward-looking statements that are subject to risks, uncertainties and other factors, as described in “Risk Factors” and elsewhere in this Annual Report, that could cause our actual growth, results of operations, performance, financial position and business prospects and opportunities to differ materially from what is expressed in, or implied by, those forward-looking statements.

The following discussion and analysis addresses our results of operations and financial condition; it should be read in conjunction with our consolidated financial statements and the accompanying notes to consolidated financial statements included in Part II, Item 8 of this Annual Report.

General

We are a leading online marketing technology company serving a wide range of customers from the Fortune 500 to the small and medium-sized business market. We offer the industry’s first on-demand, integrated marketing solution, Lyris HQ.  Our customers use our online marketing technology to manage their marketing programs.

Our SaaS-based (“software-as-a-service”) online marketing solutions and services provide customers with solutions for creating, delivering and managing online, permission-based direct marketing programs and other communications to customers who use online and mobile channels to communicate with their customers and members.

On August 18, 2006, we acquired ClickTracks and Hot Banana.  ClickTracks was a Web analytics provider and Hot Banana was an e-marketing Web content management company, and both were merged into Lyris Technologies, Inc. in late 2007.  We integrated Hot Banana, our Web content management system, and ClickTracks, our Web analytics solution, with our hosted EmailLabs email marketing offering, to create our Lyris HQ offering. 

We continue to offer the following separate individual online marketing solutions: Lyris ListManager, our licensed software product for email marketing; EmailLabs, our brand for hosted email marketing software; and EmailAdvisor, our deliverability monitoring tool.  In addition, we provide online marketing professional services and support to assist our customers in developing the best email marketing strategy to meet their goals and objectives.

We derive revenue from subscriptions to our hosted services application (Lyris HQ), software (Lyris ListManager), support, maintenance and related professional services. As part of a subscription, a customer commits to a minimum monthly, quarterly, or yearly fee that permits a customer to send up to a specified number of email messages. Subscription revenue is primarily comprised of subscription fees from customers accessing our hosted services application and from customers purchasing additional offerings that are not included in the standard hosting agreement.  Software revenue is derived from perpetual licensing rights of our software that we sell to our customers.  Support and maintenance revenue is primarily comprised of customer service and support for our products. Professional services revenue is primarily comprised of training, custom product implementation and integration, which includes web analytics and reporting, web design, email deliverability and search engine marketing.

In fiscal year 2011, we faced many challenges as an organization. We appointed Mr. Wolfgang Maasberg as our new Chief Executive Officer, and in subsequent months we also  replaced all of our former executive officers. As a result of this executive reorganization, we incurred a variety of related expenses.

In fiscal year 2011, we incurred net losses of $7.0 million,  and there can be no assurance that we will be cash flow positive or generate net income in fiscal year 2012 or in future years.  At June 30, 2011, our existing cash and cash equivalents, cash flow from operations and the availability from our revolving credit facility, did not provide sufficient liquidity to fund our current obligations, projected working capital requirements and capital spending for the next 12 months.  While the amended credit facility entered into on August 31, 2011 improves our liquidity position, we may be unable to improve our cash flow from operations and to build our cash reserves in order to obtain sufficient liquidity to continue as a going concern.

Fiscal Year 2012 Outlook

We believe that our relative market position, our innovative products and planned upgrades position us for growth in fiscal year 2012. However, we have to date been unable to project our revenue growth accurately, and the current challenging economic conditions may make growth difficult for us. We are continuing to invest in our technology and upgrades to Lyris HQ are ongoing. Later in fiscal year 2012, a planned upgrade to our on premises software solution, ListManager, will occur and could increase our revenues.
   
 
30

 

Other key elements of our business plans include investments in the core technology of our platform that will enhance delivery of our services and customer service initiatives to address customer churn. We also expect to aggressively manage our operating expenses as we seek to improve our profitability.

We will continue to seek international expansion in Asia Pacific, Latin America and EMEA, to take advantage of opportunities to enter new markets that demonstrate strong market acceptance of our solutions and accretive revenue and operational opportunities. As a major step in this effort, in June 2011 we acquired a majority stake in Cogent Online PTY Ltd (“Cogent”), one of the most experienced marketing services providers in Australia. Lyris first invested in Cogent in 2010 and this investment established Lyris as the majority owner of Cogent, which is now known as Lyris APAC.
  
 
31

 
   
Financial Results of Operations for Fiscal Years 2011 and 2010

The following table summarizes our consolidated statements of operations data as a percentage of total revenue for the periods presented:

   
Fiscal Year Ended June 30,
 
   
2011
   
2010
 
Subscription revenue
    76 %     77 %
Professional services revenue
    10 %     8 %
Support and maintenance revenue
    9 %     9 %
Software revenue
    5 %     6 %
Total revenue
    100 %     100 %
Cost of revenue
    52 %     47 %
Gross profit
    48 %     53 %
Operating expenses:
               
Sales and marketing
    36 %     30 %
General and administrative
    21 %     16 %
Research and development
    5 %     7 %
Amortization of customer relationships and trade names
    4 %     5 %
Impairment of capitalized software
    1 %     0 %
Total operating expenses
    67 %     58 %
Loss from operations
    -19 %     -5 %
Interest income
    0 %     0 %
Interest expense
    0 %     -1 %
Other income
    1 %     0 %
Loss before income taxes and noncontrolling interest
    -18 %     -6 %
                 
Income tax provision (benefit)
    0 %     1 %
Net loss
    -18 %     -7 %
Less: Net loss attributable to noncontrolling interest
    0 %     0 %
Net loss attributable to Lyris, Inc.
    -18 %     -7 %
 
Financial Summary

Our financial results during fiscal year 2011 were impacted by the following significant items:

 
·
10% decrease in subscription revenue compared to fiscal year 2010 due to pricing pressures received from our customers on our subscription renewals due in part to the difficult economic environment.
 
·
19% increase in professional services revenue compared to fiscal year 2010 due to one-time revenue recognized from a specific customer and sustained service offerings to customers.
 
·
13% decrease in support and maintenance revenue compared to fiscal year 2010 due to decrease in sales of our legacy products which requires maintenance and customer support as the Company’s business strategy has been focusing on developing and selling the integrated flagship product, Lyris HQ.
 
·
30% decrease in software sales compared to fiscal year 2010 resulting from continued lower sales volume compared to fiscal year 2010 due to changes in our business model beginning in 2008 where we shifted focus to invest our resources to expand our premier offering, Lyris HQ.
 
·
Cost of revenue remains approximately even compared to fiscal year 2010.
 
·
4% increase in operating expenses compared to fiscal year 2010 primarily due to our corporate reorganization of our Company, the investment to rebuild our business with new hires in the executive staff and other key levels, and several projects and initiatives were launched to improve our operational systems and processes. All expenses are considered unusual one-time expenses.
 
·
65% decrease in interest expense compared to fiscal year 2010 as a result of a lower average outstanding debt balance.
       
 
32

 
  
   
Fiscal Year Ended June 30,
   
Change
 
   
2011
   
2010
   
Dollars
   
Percent
 
   
(In thousands, except percentages)
 
Subscription revenue
  $ 30,434     $ 33,883     $ (3,449 )     (10 )%
Professional services revenue
    4,150       3,491       659       19 %
Support and maintenance revenue
    3,649       4,185       (536 )     (13 )%
Software revenue
  $ 1,892     $ 2,687     $ (795 )     (30 )%
Total revenue
  $ 40,125     $ 44,246     $ (4,121 )     (9 )%
  
Subscription Revenue

Subscription revenue is primarily comprised of subscription fees from customers accessing our hosted services application and from customers purchasing additional offerings that are not included in the standard hosting agreement.  Subscription revenue was $30.4 million or 76% of our total revenue for fiscal year 2011, compared to $33.9 million or 77% of our total revenue for fiscal year 2010, a decrease of $3.4 million or 10%.  Subscription revenue decreased primarily because we continued to experience pricing pressures from our customers on our subscription renewals due in part to the difficult economic environment.

Professional Services Revenue

Professional services revenue is primarily comprised of training, custom product implementation and integration, which includes web analytics and reporting, web design, email deliverability and search engine marketing. Professional services revenue was $4.2 million or 10% of our total revenue for fiscal year 2011, compared to $3.5 million or 8% of our total revenue for fiscal year 2010, an increase of $0.7 million or 19%. The increase in revenue was attributable to $0.6 million in one-time revenue recognized from a specific customer and $0.1 million based on overall growth in this area.

Support and Maintenance Revenue

Support and maintenance revenue is primarily comprised of customer service and support for our products. Support and maintenance revenue was $3.6 million or 9% of our total revenue for fiscal year 2011, compared to $4.2 million or 9% of our total revenue for fiscal year 2010, a decrease of $0.6 million or 13%. The decrease was attributable to the continued decrease of our legacy products which required such maintenance and customer support, as well as the reduction of sales of ListManager licenses. Our business strategy has been focused on developing and selling the integrated flagship product, Lyris HQ.

Software Revenue

Software revenue is derived from perpetual licensing rights of our software that we sell to our customers.  Software revenue was $1.9 million or 5% of our total revenue for fiscal year 2011, compared to $2.7 million or 6% of our total revenue for fiscal year 2010, a decrease of $0.8 million or 30%. The decrease was attributable to our continued focus on sales of our SaaS-based solutions and services throughout fiscal year 2011. However, we plan on increasing our efforts in selling our List Manager 11 software in fiscal year 2012, as an alternative to our Lyris HQ product for customers who prefer an on-premise solution.

Cost of Revenue

Cost of revenue includes expenses primarily related to engineering employee salaries and related costs, support and hosting of our services, data center costs, amortization of developed technology, depreciation of computer equipment, website development costs, credit card fees and overhead allocated costs.

   
Fiscal Year Ended June 30,
   
Change
 
   
2011
   
2010
   
Dollars
   
Percent
 
   
(In thousands, except percentages)
 
Cost of revenue
  $ 20,705     $ 20,632     $ 73       0 %

Cost of revenue for fiscal year 2011 and 2010 was $20.7 million and $20.6 million, respectively, a decrease of $0.1 million. As a percentage of net revenue, cost of revenue increased to 52% for fiscal year 2011 from 47% for fiscal year 2010. The slight increase in cost of revenue for fiscal year 2011 compared to fiscal year 2010 was attributable to $1.0 million increase in costs associated with our subscription, software and services, $0.3 million increase in amortization of capitalized software and offset in part by $1.2 million decrease in amortization of developed technologies as they became fully amortized during the period.
    
 
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Gross Profit

   
Fiscal Year Ended June 30,
   
Change
 
   
2011
   
2010
   
Dollars
   
Percent
 
   
(In thousands, except percentages)
 
Gross profit
  $ 19,420     $ 23,614     $ (4,194 )     (18 )%

Gross profit for fiscal year 2011 and 2010 was $19.4 million and $23.6 million, respectively, a decrease of $4.2 million or 18%. As a percentage of net revenue, gross profit decreased to 48% for fiscal year 2011 from 53% for fiscal year 2010. The decrease in gross profit for fiscal year 2011 compared to fiscal year 2010 was attributable to $3.4 million decrease in subscription revenue, $0.8 million decrease in software revenue, $0.6 million decrease in support and maintenance revenue, $1.0 million increase related to cost associated with our subscription, software and services and an increase of $0.3 million in amortization of capitalized software and offset in part by $1.2 million decrease in amortization of certain developed technologies as they became fully amortized during the period and $0.7 million increase in professional service revenue.

The overall decline in revenues coupled with an increase in spending to strengthen operational efficiencies in our co-location facilities and data center operations, caused the dip. Gross profit should improve as we continue to focus on improving the scalability and efficiency of our data center and co-location facilities by upgrading our capital equipment with leading edge hardware and software technologies.  This will reduce our cost of operations and at the same time provide better overall reliability, scalability and throughput performance; all at a lower overall total cost of ownership and sustainability.

Overall in the industry, software revenue typically has higher gross margins than subscription revenues. We plan on increasing our efforts in selling our List Manager 11 software in fiscal year 2012, as an alternative to our Lyris HQ product for customers who prefer an on-premise solution. This in effect should improve our overall gross profit.

Operating Expenses

   
Fiscal Year Ended June 30,
   
Change
 
   
2011
   
2010
   
Dollars
   
Percent
 
   
(In thousands, except percentages)
 
Sales and marketing
  $ 14,584     $ 13,484     $ 1,100       8 %
General and administrative
    8,233       6,921       1,312       19 %
Research and development
    2,032       3,246       (1,214 )     (37 )%
Amortization and impairment of customer relationships and trade names
    1,449       1,999       (550 )     (28 )%
Impairment of capitalized software
    408       -       408       -  
Total operating expenses
  $ 26,706     $ 25,650     $ 1,056       4 %

Sales and marketing

Sales and marketing expense consists of payroll, employee benefits, stock-based compensation and other headcount-related expenses associated with advertising, promotions, trade shows, seminars and other marketing programs.

Sales and marketing expense for fiscal year 2011 and 2010 was $14.6 million and $13.5 million, respectively, an increase of $1.1 million or 8%. As a percentage of net revenue, sales and marketing expense increased to 36% for fiscal year 2011from 30% for fiscal year 2010.

The increase in sales and marketing expense for fiscal year 2011 compared to fiscal year 2010 was attributable to $0.8 million increase in payroll and related taxes and benefits due to increased in headcount for the department, $0.4 million in one-time severance related expenses in connection with a corporate reorganization, $0.3 million increase in outsourced services, $0.2 million increase in recruiting fees for our new Senior Vice President of Marketing and Senior Vice President of Sales and $0.2 million increase in reimbursable employee expenses, offset in part by $0.8 million decrease in advertising and related expenses. The severance and recruiting fees are considered one-time expenses.

General and administrative

General and administrative expense consists primarily of compensation and benefits for administrative personnel, professional services such as consultants, legal fees and accounting, audit and tax fees, and related allocation of overhead including stock-based compensation and other corporate development costs.
  
 
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General and administrative expense for fiscal year 2011 and 2010 was $8.2 million and $6.9 million, respectively, an increase of $1.3 million or 19%. As a percentage of net revenue, general and administrative expense increased to 21% for fiscal year 2011 from 16% for fiscal year 2010.

The increase in general and administrative expense for fiscal year 2011 compared to fiscal year 2010 was attributable to $0.6 million increase due to severance expenses incurred for a corporate reorganization, $0.6 million increase in stock compensation expenses, $0.4 million increase in recruiting fees, $0.3 million increase in outside services to help us launch several projects and initiatives to improve our operational systems and processes, $0.1 million increase in acquisition related costs associated with our acquisition of Cogent Online PTY Ltd. (“Cogent”) and $0.1 million increase in reimbursable employee expenses, offset in part by $0.6 million decrease in bad debt due to our improved collection process and $0.2 million decrease in payroll and related taxes and benefits due to the decrease in headcount for the department. The severance and recruiting fees are considered one-time expenses.

Research and development

Research and development expense consists of payroll, employee benefits, stock-based compensation and other headcount-related expenses associated with product development.

Research and development expense for fiscal year 2011 and 2010 was $2.0 million and $3.2 million, respectively, a decrease of $1.2 million or 37%. As a percentage of net revenue, research and development expense decreased to 5% for fiscal year 2011 from 7% for fiscal year 2010.

The decrease in research and development expense for fiscal year 2011 compared to fiscal year 2010 was primarily attributable to a shift in focus of engineering resources from product development to the production environment.  Over the past year, we achieved certain product development milestones and made the related product functionality available to our customers resulting in a reduction of research and development costs. As of June 30, 2011 and 2010, we had approximately 55 and 71, respectively, engineers who are engaged in maintaining our current products and researching, developing, testing and deploying new versions of our software

Amortization of customer relationships and trade names

Amortization of customer relationships and trade names expense consists of intangibles that we obtained through the acquisition of other businesses.

Amortization of customer relationships and trade names expense for fiscal year 2011 and 2010 was $1.4 and $2.0 million, respectively, a decrease of $0.6 million or 28%. As a percentage of net revenue, amortization of customer relationships and trade names expense decreased to 4% for fiscal year 2011 from 5% for fiscal year 2010.

The decrease in amortization of customer relationships and trade names expense for fiscal year 2011 compared to fiscal year 2010 was primarily due to one customer relationship reached full amortization in October 2010. We acquired customer relationships from the Cogent Acquisition in fiscal year 2011 and will amortize this over a six year period.

Interest expense

   
Fiscal Year Ended June 30,
   
Change
 
   
2011
   
2010
   
Dollars
   
Percent
 
   
(In thousands, except percentages)
 
Interest expense
  $ (94 )   $ (268 )   $ 174       65 %

Interest expense relates to our revolving line of credit with Comerica Bank and our short and long-term capital lease obligations in connection with acquiring computer equipment for our data center operations which is included in property and equipment.

Interest expense for fiscal year 2011 and 2010 was $94 thousand and $268 thousand, respectively, a decrease of $174 thousand or 65%. The decrease in interest expense was primarily attributable to a lower average balance of $1.7 million in our revolving line of credit for fiscal year 2011 compared to an average balance of $4.7 million for fiscal year 2010.

Provision for income taxes

Our effective tax rates for fiscal year 2011 and 2010 were 2.3% and (20.9)%, respectively.  For additional information about income taxes, refer to Note 10 of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K.
  
 
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Impairment of goodwill

We performed our annual impairment testing of goodwill at June 30, 2011 and 2010 and determined that the estimated fair value of our reporting unit was in excess of its carrying value; therefore no impairment charge was recorded in fiscal year 2011 and 2010.

Refer to Goodwill, Long-lived Assets and Other Intangible Assets herein Item 7 of the Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 5 of the Notes to Consolidated Financial Statements for detail information.

Liquidity, Capital Resources and Financial Condition

Our primary sources of liquidity to fund our operations during fiscal year 2011 was from the collection of accounts receivable balances generated from net sales and proceeds from our revolving line of credit.  For additional operational funds requirements, we have an available revolving line of credit with Comerica Bank which matures on April 30, 2012, (refer to Notes 8 and17 of the Notes to Consolidated Financial Statements for detail information).  As of June 30, 2011, our availability under this credit facility was approximately $0.2 million.  As of June 30, 2011, our cash and cash equivalents totaled $244 thousand compared to $492 thousand at the fiscal year ended June 30, 2010. As of June 30, 2011, our accounts receivable, less allowances, totaled $6.3 million compared to $7.2 million at the fiscal year ended June 30, 2010.

   
Fiscal Year Ended June 30,
   
Change
 
   
2011
   
2010
   
Dollars
   
Percent
 
   
(In thousands, except percentages)
 
Accounts Receivable
  $ 7,264     $ 7,941     $ (677 )     (9 )%
Allowance for Doubtful Accounts
    (936 )     (768 )     (168 )     22 %
Total - Accounts receivable
  $ 6,328     $ 7,173     $ (845 )     (12 )%

Accounts receivables decreased $0.7 million or 9% for fiscal year 2011 due to $0.3 million decrease in accounts receivable as a result of higher collections relative to amounts invoiced resulting from improved collection processes and procedures and $0.4 million decrease due to potential and known customer issues. Allowance for Doubtful Accounts (“Allowance”) increased $0.2 million or 22% for fiscal year 2011 as a result of our routine evaluation of customer balances. We adjusted the Allowance as appropriate based upon the collectability of the receivables in light of historical trends, adverse situations that may affect our customers’ ability to repay and prevailing economic conditions. This evaluation was done in order to identify issues which may impact the collectability of receivables and reserve estimates. Revisions to the Allowance are recorded as an adjustment to bad debt expense.  After appropriate collection efforts are exhausted, specific receivables deemed to be uncollectible are charged against the Allowance in the period they are deemed uncollectible. Recoveries of receivables previously written-off are recorded as credits to the Allowance.

Our short-term and long-term liquidity requirements primarily arise from: (i) interest and principal payments related to our debt obligations, (ii) working capital requirements and (iii) capital expenditures, including periodic acquisitions.

 At June 30, 2011, our existing cash and cash equivalents cash flow from operations and the availability from our revolving credit facility, did not provide sufficient liquidity to fund our current obligations, projected working capital requirements and capital spending for at least the next 12 months.  However, on August 31, 2011 we entered into an amendment to our revolving credit facility which improves our liquidity position. Previously, our $5.0 million commitment from the bank was based on eligible receivables, which limited our borrowings to between $3.5 million to $4.3 million during the fiscal year. Our amended credit facility provides for only $2.5 million to be limited by eligible receivables while a second $2.5 million credit line is not limited by eligible receivables, which increases our available borrowings. This increased availability under our revolving credit facility coupled with our cash flow from operations, will provide us sufficient liquidity to fund our current obligations, projected working capital requirements and capital spending for fiscal year 2012. We anticipate that we will continue to improve our cash flow from operations through both expense reductions and stabilization of our customer base and will continue building our cash reserves. Refer to Note 8 and 17 of the Notes to Consolidated Financial Statements for discussion regarding our amended credit facility.

Significant costs incurred in fiscal year 2011 were one-time charges associated with a corporate reorganization. We do not expect to incur these costs in the near future.  Throughout fiscal year 2011, we had to draw upon our revolving line of credit to fund our operations.  At June 30, 2011, our outstanding borrowings totaled $3.3 million compared to no outstanding borrowings at June 30, 2010 due to $6.0 million in proceeds received from the issuance of stock through a private placement with members of our Board. We used a significant portion of the private placement proceeds to repay our entire outstanding term loan with Comerica bank during fiscal year 2010.
   
 
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Our ability to service any indebtedness we incur under our revolving credit facility will depend on our ability to generate cash in the future. We may not have significant cash available to meet any large unanticipated liquidity requirements, other than from available borrowings, if any, under our revolving credit facility. As a result, we may not retain a sufficient amount of cash to finance growth opportunities, including acquisitions, or unanticipated capital expenditures or to fund our operations. If we do not have sufficient cash for these purposes, our financial condition and our business could suffer.

While fiscal year 2011 had its challenges, we still expect we will maintain long-term growth in our hosted revenue offerings, particularly with Lyris HQ, and increase efficiency within our operating expenses to generate available cash to satisfy our capital needs and debt obligations.  To the extent that existing cash and cash equivalents and cash from operations are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing.  Additionally, we may enter into agreements or letters of intent with respect to potential investments in, or acquisitions of, complementary businesses, applications or technologies in the future, which could also require us to seek additional equity or debt financing.

Cash Flows

In summary, our cash flows were as follows for the fiscal year ended June 30, 2011 and 2010 (in thousands):

   
Fiscal Year Ended June 30,
 
   
2011
   
2010
 
   
(In thousands, except percentages)
 
Net cash provided by (used in) operating activities
  $ (529 )   $ 2,896  
Net cash provided by (used in) investing activities
    (2,520 )     (2,254 )
Net cash provided by (used in) financing activities
    2,867       (747 )
Effect of exchange rate changes on cash
    (66 )     (22 )
Increase (decrease) in cash and cash equivalents
  $ (248 )   $ (127 )

Cash Flows for fiscal year 2011 compared to fiscal year 2010

Operating Activities

Net cash flows used in operating activities was $0.5 million for fiscal year 2011 as compared to net cash flows provided by operating activities of $2.9 million for fiscal year 2010. The deterioration in cash flow for fiscal year 2011 was primarily due to the one-time charges associated with a corporate reorganization.  Net cash flow provided by in operating activities for fiscal year 2011 consisted of contributions from working capital of $1.4 million and non-cash charges of $5.1 million, partially offset by net loss of $7.0 million. The contribution from working capital accounts was primarily due to an increase in accounts payable and accrued expenses of $0.8 million, $0.3 million in prepaid expenses and other assets, $0.2 million in income taxes payable, $0.2 million in accounts receivable, offset by $0.1 million in deferred revenue. The non-cash charges consisted of depreciation and amortization of $3.6 million, stock-based compensation of $0.9 million, provision for bad debt of $0.6 million, $0.2 million in impairment of capitalized software, $0.1 million in equity in earnings of unconsolidated affiliates, offset by $0.2 million in deferred income tax benefits and $0.2 million in gain on equity interest in Cogent. Net cash flow used in operating activities for fiscal year 2010 consisted of non-cash charges of $6.4 million partially offset by net loss of $2.7 million and contributions from working capital of $0.8 million. The non-cash charges primarily consisted of depreciation and amortization of $4.8 million, stock-based compensation of $0.4 million and provision for bad debt of $1.2 million. The contribution from working capital accounts was primarily due to a decrease in accounts receivable of $1.9 million offset by $0.6 million in accounts payable and accrued expenses, $0.3 million in deferred revenue and $0.2 million in prepaid expenses and other assets.

Investing Activities

Net cash flows used in investing activities was $2.5 million for fiscal year 2011 as compared to net cash flows used in investing activities of $2.3 million for fiscal year 2010. The deterioration in cash flow for fiscal year 2011 was primarily due to the investment in Cogent.  The net cash flow used in investing activities for fiscal year 2011 consisted of $0.8 million payment for equity investments in SiteWit, $0.7 million used in purchasing property and equipment consisting of computer equipment for its data center operations, $0.6 million in capitalized software expenditures and $0.4 million in costs related to the acquisition of Cogent. Net cash flow used in investing activities for fiscal year 2010 consisted of $1.3 million in capitalized software expenditures, $0.7 million used in purchasing property and equipment consisting of computer equipment for its data center operations, computer equipment for our employees and equipment and leasehold improvements for our office locations and $0.3 million for the initial investment in Cogent. Refer to Note 3 of the Notes to Consolidated Financial Statements.
    
 
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Financing Activities

Net cash flows provided by financing activities was $2.9 million for fiscal year 2011 as compared to net cash flows used in financing activities of $0.7 million for fiscal year 2010. The improvement in cash flow for fiscal year 2011 was primarily due to net proceeds over payments from our revolving line of credit with Comerica Bank. Net cash flow provided by financing activities for fiscal year 2011 consisted of $3.4 million in net proceeds over payment from our revolving line of credit with Comerica Bank offset by $0.1 million in purchases of treasury stock from our former CEO, Mr. Luis Rivera, in accordance with the terms of his termination agreement, $0.2 million related to noncontrolling interest related to Cogent and $0.2 million in payments under our capital lease obligations in connection with acquiring computer equipment for our data center operations. Net cash flow used in financing activities for fiscal year 2010 consisted of $6.6 million in net payments over proceeds from our revolving line of credit with Comerica Bank, $0.1 million in payments under our capital lease obligations in connection with acquiring computer equipment for our data center operations, offset by $6.0 million from proceeds from sale of stock.

Off-Balance Sheet Arrangements

As of June 30, 2011, we had $140 thousand in irrevocable letters of credit (“LOC”) issued by Comerica Bank, consisting of a $100 thousand LOC in favor of the Hartford Insurance Company (“Hartford”) and a $40 thousand LOC in favor of Legacy Partners I SJ North Second, LLC (“Legacy”).

The Hartford LOC is held by Hartford as collateral for deductible payments that may become due under a worker’s compensation insurance policy. Under the terms of the Hartford LOC, any amount drawn down by Hartford on this LOC would be added to our existing debt as part of our line of credit with Comerica Bank. The Hartford LOC was originally entered into on September 5, 2007 with an expiration date of September 1, 2008 and will automatically renew annually unless we are notified by Comerica Bank thirty (30) days prior to the annual expiration date that they have chosen not to extend the Hartford LOC for the next year. The current expiration of the letter of credit is September 1, 2012. As of the date of this report, there have been no draw downs on this LOC by Hartford.

The Legacy LOC is held by Legacy in connection with our lease dated January 31, 2008 for our offices in San Jose, California.

We do not have any interest in entities referred to as variable interest entities, which include special purpose entities and other structured finance activities.

Long-Term Contractual Obligations

Our commitments consist of obligations under operating leases for corporate office space and co-location facilities for data center capacity for research and test data centers.  We entered into capital leases in connection with acquiring computer equipment for our data center operations which is included in property and equipment. We used a 5.25% interest rate to calculate the present value of the future principal payments and interest expense related to our capital leases. Additionally, in the ordinary course of business, we enter into contractual purchase obligations and other agreements that are legally binding and specify certain minimum payment terms.

The following table summarizes by period the payments due for contractual obligations estimated as of June 30, 2011:

   
Operating Leases
             
   
Facilities (1)
   
Co-location
Hosting
Facilities (2)
   
Other (3)
   
Total
Operating
   
Capital
Leases (4)
   
Total
 
   
(In thousands)
 
Fiscal Year 2012
    1,387       1,060       77       2,524       206       2,730  
Fiscal Year 2013
    1,000       155       14       1,169       138       1,307  
Fiscal Year 2014
    774       -       1       775       29       804  
Fiscal Year 2015
    658       -       -       658       5       663  
Thereafter
    506       -       -       506       -       506  
Total
  $ 4,325     $ 1,215     $ 92     $ 5,632     $ 378     $ 6,010  

 
(1)
Represents our significant leased office facilities.
 
(2)
Represents our co-location facilities for data center capacity for research and test data centers.
 
(3)
Represents our software contracts used in our production environment.
       
 
38

 
 
(4)
Represents our capital leases in connection with acquiring computer equipments for our data center operations which is included in property and equipment in our Consolidated Balance Sheets. Capital lease payments include interest.
   
Revolving Line of Credit

On September 15, 2010, we entered into the Sixth Amendment (the “Sixth Amendment”) to the Amended and Restated Loan and Security Agreement with Comerica Bank (“Bank”). The Sixth Amendment revises the terms of the Amended and Restated Loan and Security Agreement (“Loan Agreement”) between the Bank and us.

The Sixth Amendment (1) changed the definition of EBITDA to include in EBITDA severance and related expenses of $1.1 million incurred in August 2010; (2) waived compliance with the EBITDA financial covenant under the Loan Agreement for the August 2010 measuring period, the terms of which we were not in compliance with due to severance and related expenses incurred in August 2010; and (3) required us to maintain EBITDA not less than specified amounts. The new EBITDA minimum requirements, which are measured on a trailing six months basis, are as follows, with no minimum EBITDA requirement for months after March 31, 2011:

Measurment Period Ending
 
Minimum Trailing
Six Month EBITDA
 
9/30/2010
  $ (850,000 )
10/31/2010
  $ (1,125,000 )
11/30/2010
  $ (1,200,000 )
12/31/2010
  $ (1,150,000 )
1/31/2011
  $ (850,000 )
2/28/2011
  $ (500,000 )
3/31/2011
  $ 1  

On August 31, 2011, we entered into a Seventh Amendment (“Seventh Amendment”) to the Loan Agreement with Comerica Bank (“Bank”). The Seventh Amendment revises the terms of the Loan Agreement.

The Seventh Amendment reduced our existing revolving line of credit from $5,000,000 to $2,500,000 (“Existing Line”).  The amount available under the Existing Line is limited by a borrowing base, which is 80% of the amount of the aggregate of our accounts receivable, less certain exclusions. The Seventh Amendment also extends us to a second revolving line of credit of $2,500,000 (“Non-Formula Line,” and together with the Existing Line, the “Revolving Lines”).  The Revolving Lines mature on April 30, 2012.

Advances under the Revolving Lines will accrue interest at a variable rate calculated as the Bank’s prime rate plus a margin of 2.5% for the Existing Line and the Bank’s prime rate plus a margin of 0.5% for the Non-Formula Line.  Interest is payable monthly, and principal is payable upon maturity.

The Seventh Amendment contains additional covenants from us, including that we will raise $2,000,000 in new equity prior to February 28, 2012 and will maintain the following minimum amounts of EBITDA (measured on a trailing three months basis):

Measurment Period Ending
 
Minimum Trailing
Six Month EBITDA
 
7/31/2011
  $ (1,500,000 )
8/31/2011
  $ (1,400,000 )
9/30/2011
  $ (1,350,000 )
10/31/2011
  $ (750,000 )
11/30/2011
  $ (350,000 )
12/31/2011
  $ 50,000  

Repayment of the Revolving Lines is secured by a security interest in substantially all of our assets.  In addition, Mr. William T. Comfort, III, our Chairman of the Board, agreed to guarantee our repayment of indebtedness under the Seventh Amendment (the “Limited Guaranty”).  Mr. Comfort also entered into a Pledge and Security Agreement with the Bank (“Pledge Agreement”), a Reimbursement and Security Agreement with the Borrowers (“Reimbursement and Security Agreement”), and a Subordination Agreement with the Bank and the Company (“Subordination Agreement”).  Under the Pledge Agreement, Mr. Comfort granted the Bank a security interest in cash collateral maintained at the bank, as security for the performance of Mr. Comfort’s obligations under the Limited Guaranty. The Company also agreed to reimburse Mr. Comfort for all amounts paid to the Bank and all costs, fees and expenses incurred by Mr. Comfort under the Limited Guaranty and Pledge Agreement.  As security for the Company’s reimbursement obligations, the Company granted Mr. Comfort a security interest in the same property which secures its obligations under the Loan Agreement.  Under the Subordination Agreement, the Company’s indebtedness and obligations to Mr. Comfort are subordinated to the Company’s indebtedness and obligations to the Bank.
  
 
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As of June 30, 2011 and July 31, 2011, we were not in compliance with the terms of the Loan Amendment as we did not meet our liquidity covenant which requires us to have $1.0 million in liquidity. Our liquidity is determined by our unrestricted cash at Bank and unused availability under our revolving line of credit.  As part of the Seventh Amendment, the Bank waived compliance with our liquidity covenant for the June and July 2011 measurement period. We were in compliance with all of our covenants for the August 2011 measurement period.

Our outstanding borrowings totaled $3.3 million with $0.2 million in available credit remaining as of June 30, 2011. We had no outstanding borrowings at June 30, 2010. Borrowings under the line of credit are secured by our assets.

Critical Accounting Policies and Use of Estimates

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”).  The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances.  In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period to period.  Our accounting estimates and assumptions bear the risk of change due to the uncertainty attached to the estimates and assumptions, or some estimates and assumptions may be difficult to measure or value. Accordingly, actual results could differ significantly from the estimates made by our management.  On an ongoing basis, we evaluate these estimates, judgments and assumptions, including those related to revenue recognition, stock-based compensation, goodwill and acquired intangible assets, capitalization of software, allowances for bad debt and income taxes. We base these estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities and recorded revenue and expenses that are not readily apparent from other sources. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions.  Our management has reviewed these critical accounting policies, our use of estimates and the related disclosures with our audit committee.

In October 2009, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update 2009-13, Multiple-Deliverable Revenue Arrangements (“ASU No. 2009-13”), which addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services separately rather than as a combined unit and modifies the manner in which the transaction consideration is allocated across the separately identified deliverables.  The ASU significantly expands the disclosure requirements for multiple-deliverable revenue arrangements.  We adopted ASU No. 2009-13 in the first quarter of fiscal year 2011 and are described in detail below.

Revenue Recognition

We recognize revenue from providing hosting and professional services and licensing its software products to its customers.

We generally recognize revenue when all of the following conditions are satisfied:  (1) there is persuasive evidence of an arrangement; (2) the service has been provided to the customer (for software licenses, revenue is recognized when the customer is given electronic access to the licensed software); (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of fees is probable.

Subscription and Other Services Revenue
 
We generate services revenue from several sources, including hosted software services bundled with technical support (maintenance) services and professional services.  We recognize subscription revenue in two ways: (1) based on the subscription plan defined in the agreement with specified monthly volume, and (2) based on actual usages at rates specified in the agreement. Additionally, we invoice excess usage and recognize it as revenue when incurred.
  
 
40

 
 
 
In October 2009, ASU No. 2009-13 amended the accounting standards for revenue recognition for multiple deliverable revenue arrangements to:
 
 
·
Provide updated guidance on how the deliverables of an arrangement should be separated, and how the consideration should be allocated;
 
·
Eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method; and
 
·
Require an entity to allocate revenue to an arrangement using the estimated selling prices (“ESP”) of deliverables if it does not have vendor-specific objective evidence (“VSOE”) of fair value or third-party evidence (“TPE”) of selling price.
 
Valuation terms are defined as set forth below:

 
·
VSOE — the price at which the element is sold in a separate stand-alone transaction
 
·
TPE — evidence from us or other companies of the value of a largely interchangeable element in a transaction
 
·
ESP — our best estimate of the selling price of an element in a transaction
 
We adopted ASU No. 2009-13 for the current fiscal year ending June 30, 2011 on a prospective basis for multiple-element arrangements that include subscription services bundled with technical support and professional services.  The implementation resulted in an immaterial difference in revenue recognized and additional disclosures that are included below.

We follow accounting guidance for revenue recognition of multiple-element arrangements to determine whether such arrangements contain more than one unit of accounting.  Multiple-element arrangements require the delivery or performance of multiple products, services and/or rights to use assets.  Although our professional services that are a part of multiple element arrangement have standalone value to the customer, such services could not be accounted as separate units of accounting under the previous guidance, as VSOE did not exist for the undelivered element. The VSOE for subscription services could not be established based on the historical pricing trends to date, which indicate that the price of the majority of standalone sales does not yet fall within a narrow range around the median price.  Since our subscription services have standalone value as such services are often sold separately, but do not have VSOE, we use ESP to determine fair value for its subscription services when sold in a multiple-element arrangement and recognize revenue based on ASU No. 2009-13. For the year ended, June 30, 2011, TPE was concluded to be an impractical alternative due to differences in features and functionality of other companies’ offerings and lack of access to the actual selling price of competitor standalone sales.  If new subscription service products are acquired or developed that require significant professional services in order to deliver the subscription service and the subscription service and professional services cannot support standalone value, then such subscription services and professional services will be evaluated as one unit of accounting.  We determined ESP of fair value for subscription services based on the following:
 
 
 ·
We defined processes and controls to ensure its pricing integrity.  Such controls include oversight by a cross-functional team and members of executive management.  Significant factors considered when establishing pricing include market conditions, underlying costs, promotions and pricing history of similar services.  Based on this information and actual pricing trends, management establishes or modifies the pricing.
 
 
 
 ·
We identified the population of transactions to serve as the basis for establishing ESP, including subscription services and professional services pricing history in transactions with multiple-element arrangements and those sold on a standalone basis.
 
 
 
 ·
We analyzed the population of items sold by stratifying the population by product type and level and considered several data points, such as (1) average price charged, (2) weighted average price to incorporate the frequency of each item sold at any given price, and (3) the median price charged. These three price points were then compared with the existing price list that is used as a point of reference to negotiate contracts and does not represent fair value.  Additionally, we gathered and analyzed sales’ team feedback gained from interaction with customers and similar activities.  This feedback included consideration of current market trends for pricing charged by companies offering similar services, competitive advantage of the products we offer and recent economic pressures that have resulted in lower spending on marketing activities. ESP for each item in the population was established based on the factors noted above and was reviewed by management.
 
For transactions entered into or materially modified after July 1, 2010, we allocate consideration in multiple-element arrangements based on the relative selling prices.  Revenue is then recognized as appropriate for each separate element based on its fair value.  For the year ended June 30, 2011, the impact on our revenue under the new accounting guidance as compared to the previous methodology resulted in an immaterial difference in revenue recognized as compared to that which would have previously been deferred and recognized ratably. The immaterial impact is primarily a result of the limited population of transactions subject to newly adopted guidance, as it includes only those arrangements entered into or materially modified within fiscal year 2011. The accounting treatment for arrangements entered into prior to July 1, 2010 continues to follow legacy accounting rules and the revenue recognition method applied to certain types of arrangements has not changed upon adopting new guidance and does not affect the revenue recognized. The adoption of new guidance did not result in a material impact to the financial statements for fiscal year 2011.

 
41

 

However, new guidance may result in a material impact in the future, due to the change in other factors affecting the revenue recognition method, as the impact on the timing and pattern of revenue will vary depending on the nature and volume of new or materially modified contracts in any given period. We expect that the new accounting guidance will facilitate our efforts to optimize the sales and marketing of our offerings due to better alignment between the economics of an arrangement and the accounting for that arrangement.  Such optimization may lead us to modify our pricing practices, which could result in changes in the relative selling prices of our elements, including both VSOE and ESP, and therefore change the allocation of the sales price between multiple elements within an arrangement. However, this will not change the total revenue recognized with respect to the arrangement.

Software Revenue
 
We enter into certain revenue arrangements for which it is obligated to deliver multiple products and/or services (multiple elements).  For these arrangements, which generally include software products, technical support (maintenance) and professional services, we allocate and defer revenue for the undelivered elements based on their VSOE.  We allocate total earned revenue under the agreement among the various elements based on their relative fair value. VSOE exists for all elements of multiple element arrangements.   In the event that VSOE cannot be established for one of the elements of multiple element arrangement, we will apply the residual method to determine how much revenue for the delivered elements (software licenses) can be recognized upon delivery by assigning VSOE to other elements in multiple element arrangements.
 
We determine VSOE based on actual prices charged for standalone sales of maintenance.  To accomplish this, we track sales for the maintenance product when sold on a standalone basis for a one year term and compares to sales of the associated licensed software product.
 
We perform a quarterly analysis of the actual sales for standalone maintenance and licensed software to establish the percentage of sales relationships for each level of maintenance and licensed software.  The result of this analysis has historically been a tight range of percentage of sales relationships centered on a mid-point.  Renewal rates, expressed as a consistent percentage of the license fee at each level, represent VSOE of fair value for the maintenance element of the arrangements.
 
We recognize revenue from its professional services as rendered.  VSOE for professional services is based on the use of a consistent rate per hour when similar services are sold separately on a time-and-material basis.  In cases where VSOE has not been established, we defer the full value of the arrangement and recognize it ratably over the term of the agreement.

Deferred Revenue

Deferred revenue represents customer billings made in advance for annual support or hosting contracts, professional consulting services to be delivered in the future, and bulk purchases of emails to be delivered in the future.  We typically bill maintenance on a per annum basis in advance for software and recognize the revenue ratably over the maintenance period.  Some hosted contracts are prepaid for monthly, quarterly or annually and recognized monthly after the service has been provided.  Bulk purchases are typically billed in advance, ranging from monthly to annually, and we recognize the revenue in the periods in which emails are delivered.
 
Valuation Allowances and Reserves

We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts.

We use the aged receivable and specific-identification methods of estimating our allowance for doubtful accounts.  During the monthly accounts receivable analysis, we apply the aged receivable method by categorizing each customer’s balance by the number of days or months the underlying invoices have remained outstanding.  Based on historical collection experience, changes in our customer payment history and a review of the current status of a customer’s trade accounts receivable, historical bad debts percentages are applied to each of these aggregate amounts, with larger percentages being applied to the older accounts. The computed total dollar amount is compared to the balance in the valuation account and an adjustment is made for the difference.  On a quarterly basis, we use the specific-identification method by categorizing each customer’s balance based on all outstanding receivables greater than 90 days in the following uncollectible categories: (1) receivables sent to collection agency; (2) receivables under legal determination; and (3) receivables in higher collection risk.   Consequently, our quarterly allowance for doubtful accounts adjustment is determined by comparing the difference of the total of the uncollectible amounts as identified from the uncollectible categories with the pre-adjusted allowance provision.

 
42

 

Accounts receivable is presented in our consolidated balance sheet, net of an allowance for doubtful accounts of $0.9 million and $0.8 million at June 30, 2011 and June 30, 2010, respectively.  During fiscal year 2011, bad debt expense was approximately $0.7 million compared to $1.2 million for fiscal year 2010 due to better collection processes.

Loss Contingencies and Commitments

We record an estimated loss contingency when information is available that indicates that it is probable that a material loss has been incurred or an asset has been impaired and the amount of the loss can be reasonably estimated.   We disclose if the assessment indicates that a potentially material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, or if an exposure to loss exists in excess of the amount accrued.   Loss contingencies considered remote are generally not disclosed unless they arise from guarantees, in which case the guarantees would be disclosed.  Determining the likelihood of incurring a liability and estimating the amount of the liability involves an exercise of judgment.   If the litigation results in an outcome that has greater adverse consequences to us than management currently expects, then we may have to record additional charges in the future.  As of June 30, 2011, there was no probable material losses incurred that could be reasonably estimated.

Our commitments consist of obligations under operating leases for corporate office space, co-location facilities for data center capacity for research and test data centers, software contracts used in our production environment and capital leases.  See Long-term Contractual Obligations table above.

Goodwill, Long-lived Assets and Other Intangible Assets

We classify our intangible assets into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill.
 
Periodically, we evaluate our fixed assets and intangible assets with definite lives for impairment. If the carrying amount of an asset or asset group (in use or under development) is evaluated and found not to be recoverable (carrying amount exceeds the gross, undiscounted cash flows from use and disposition), then an impairment loss must be recognized. The impairment loss is measured as the excess of the carrying amount over the asset’s or asset group’s fair value. In addition, the potential impairment of finite life intangibles is assessed whenever events or a change in circumstances indicate the carrying value may not be recoverable.
 
We conduct a test for the impairment of goodwill on at least an annual basis.  We have one reporting unit, Lyris, Inc. We adopted June 30th as the date of the annual impairment test, but will conduct the test at an earlier date if indicators of possible impairment arise that would cause a triggering event. Due to the triggering event of the decline of our stock price from $0.34 as of the date of our annual impairment test at June 30, 2010, to lesser amounts at each quarter end in fiscal year 2011, we tested the impairment of our goodwill during each quarter ended for fiscal year 2011. The impairment test first compares the fair value of our reporting unit to its carrying amount, including goodwill, to assess whether impairment is present. The fair values calculated in our impairment test are determined using the weight of two methods: Public Company Market Multiple Method and the Income Approach.

At June 30, 2011 we determined that the estimated fair value of our reporting unit was in excess of its carrying value. The carrying value of our reporting unit was approximately $28.1 million at June 30, 2011. The fair value of our reporting unit under the Public Company Market Multiple Method was approximately $39.7 million at June 30, 2011 based on a comparison of us to other publicly traded companies within the same industry and market; and similar product lines, growth, margins and risk. Our comparison is based on published data regarding the public companies’ stock price and earnings, sales and/or revenues. This method resulted in an excess of fair value under the Public Company Market Multiple Method over the carrying value of approximately $11.6 million or 41%.

The fair value of our reporting unit under the Income Approach, specifically utilizing the Discounted Cash Flow Method, was approximately $35.2 million at June 30, 2011. This resulted in an excess of fair value under the Income Approach over the carrying value of approximately $7.1 million or 25%. The Discounted Cash Flow Method under the Income Approach utilized several assumptions and estimates. The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions. We base these estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities and recorded revenue and expenses that are not readily apparent from other sources. Actual results could differ from those estimates, and such differences could affect the results of operations reported in future periods. These assumptions and estimates include, but are not limited to, anticipated operating income growth rates, our long-term anticipated operating income growth rate, and the discount rate, including a specific reporting unit risk premium. The assumptions used are based upon what we believe a hypothetical marketplace participant would use in estimating fair value. Our accounting estimates and assumptions bear the risk of change due to the degree of uncertainty attached to the estimates and assumptions, or some estimates and assumptions may be difficult to measure or value. Accordingly, actual results could differ significantly from the estimates made by our management. For example, if our revenue projections, expected growth rate and economic upturn do not materialize, this will negatively affect our key assumptions.

 
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Based on our impairment test conducted at June 30, 2011, we concluded that there was no impairment of goodwill or intangible assets for fiscal year 2011.
 
Capitalized Software Costs
 
Software licensing.  We expense internal costs incurred in researching and developing computer software products designed for sale or licensing until technological feasibility has been established for the product.  Once technological feasibility is established, applicable development software costs are capitalized until the product is available for general release to customers.  Judgment is required in determining when technological feasibility of a product is established.  We determined that technological feasibility is established when we have completed all necessary planning and designing and after we have resolved all high-risk development issues through coding and testing.  Moreover, these activities are necessary to establish that the product can meet our design specifications including functions, features and technical performance requirements.  We discontinue capitalization when the product is available for general release to customers.
 
SaaS software costs.  We capitalize the direct costs associated with the software we develop for use in providing software-as-a-service to our customers during its application development stage, primarily consisting of employee-related costs.  The types of activities performed during the application development stage create probable future economic benefits. Once the software is available for use in providing services to customers, we amortize the capitalized amount over three years with the amortization charged to cost of revenues.  We expense activities performed during the preliminary project stage which are analogous to research and development activities. In addition, we expense the types of activities performed during the post-implementation / operation stage.  These activities are likely to include release ready and release launch activities.
 
Total capitalized hosting software costs were approximately $1.5 million and $1.3 million during fiscal years 2011 and 2010, respectively.  During the fourth quarter of fiscal year 2011, we fully impaired $0.4 million of internal-use hosting software developed for its EmailLabs application as it was deem to not provide substantive service potential. We started to capitalize this software in the fourth quarter of fiscal year 2010 as it was probable that those expenditures will result in additional functionality to the EmailLabs application.

Stock-Based Compensation

We amortize stock-based compensation expense based on the fair value of stock-based awards on a straight-line basis over the requisite vesting period as defined in the applicable plan documents which is typically four years.  We determine the fair value of each option grant using the Black-Scholes model.  The Black-Scholes model utilizes the expected volatility, the term which the option is expected to be outstanding and the risk free interest rate to calculate the fair value of an option.

Due to the global economic downturn, on July 9, 2009, our Compensation Committee modified the exercise price of 3,429,499 outstanding stock option awards granted to 178 employees, including executives, by exchanging each employee stock option with an exercise price greater than $0.50 for a stock option with a $0.50 exercise price on a one share-to-one share basis.  The other terms of the stock option awards such as the commencement date and vesting schedule remained unchanged.  We used the binomial lattice pricing model to determine the fair value of the repriced options.  Total additional stock-based compensation expense associated with the modification was $99 thousand of which $69 thousand was recognized in fiscal year 2010.  There was no modification to the exercise price during fiscal year 2011.

Accounting for Income Taxes

We recognize deferred tax assets and liabilities for the future tax consequences of temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  We measure deferred tax assets, including tax loss and credit carryforwards and liabilities using enacted tax rates expected to be applicable to taxable income in the years in which we expect those temporary differences to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities.  The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics.

We establish a valuation allowance if we believe that it is more likely than not that some or all of our deferred tax assets will not be realized.  We do not recognize a tax benefit unless we determine that it is more likely than not that the benefit will be sustained upon external examination, such as an audit by a taxing authority.  The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement.  Refer to Note 10 of the Notes to Consolidated Financial Statements.
 
 
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Recent Accounting Pronouncements

Refer to Note 2 to our consolidated financial statements for a discussion of recent accounting standards and pronouncements.
 
 
45

 

ITEM 7A.    RESERVED

 
46

 
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA      
       
Index to Consolidated Financial Statements
     
       
Report of Independent Registered Public Accounting Firm – Burr Pilger Mayer, Inc.
     
       
Consolidated Balance Sheets as of June 30, 2011 and 2010
     
       
Consolidated Statements of Operations for the years ended June 30, 2011 and 2010
     
       
Consolidated Statements of Stockholders' Equity and Comprehensive Loss for the years ended June 30, 2011 and 2010
     
       
Consolidated Statements of Cash Flows for the years ended June 30, 2011 and 2010
     
       
Notes to Consolidated Financial Statements
     

 
47

 

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Lyris, Inc:

We have audited the accompanying consolidated balance sheets of Lyris, Inc. and Subsidiaries (the “Company”) as of June 30, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the two years in the period ended June 30, 2011.  These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of the Company’s internal control over financial reporting.  Our audits include consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstance, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lyris, Inc. and Subsidiaries as of June 30, 2011 and 2010, and the results of their operations and their cash flows for each of the two years in the period ended June 30, 2011, in conformity with accounting principles generally accepted in the United States of America.

/s/Burr Pilger Mayer, Inc.
San Francisco, California
September 21, 2011

 
48

 

LYRIS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)

   
June 30,
 
   
2011
   
2010
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 244     $ 492  
Accounts receivable, less allowances of  $936 and $768, respectively
    6,328       7,173  
Prepaid expenses and other current assets
    842       965  
Deferred income taxes
    882       750  
Deferred financing fees
    10       23  
Total current assets
    8,306       9,403  
Property and equipment, net
    3,139       3,738  
Intangible assets, net
    6,701       7,635  
Goodwill
    18,791       18,707  
Other long-term assets
    899       352  
TOTAL ASSETS
  $ 37,836     $ 39,835  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
Accounts payable and accrued expenses
  $ 4,628     $ 3,593  
Revolving line of credit - short-term
    3,285       -  
Capital lease obligations - short-term
    192       138  
Income taxes payable
    231       47  
Deferred revenue
    4,388       4,274  
Total current liabilities
    12,724       8,052  
Other long-term liabilities
    539       835  
Capital lease obligations - long-term
    165       223  
TOTAL LIABILITIES
    13,428       9,110  
Commitments and contingencies (Note 15)
               
Stockholders' equity:
               
Common stock, $0.01 par value; authorized 200,000 shares; 121,234 and 121,404 issued and outstanding shares at June 30, 2011 and 2010, respectively
    1,214       1,214  
Additional paid-in capital
    265,075       264,222  
Accumulated deficit
    (241,812 )     (234,841 )
Treasury stock, at cost 170 and 0 shares held at June 30, 2011 and 2010, respectively
    (56 )     -  
Accumulated Other Comprehensive Income
    159       130  
Total stockholders’ equity controlling interest
    24,580       30,725  
Total stockholders’ equity noncontrolling interest
    (172 )     -  
Total stockholders' equity
    24,408       30,725  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 37,836     $ 39,835  

See accompanying Notes to Consolidated Financial Statements.

 
49

 

LYRIS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

   
Years Ended June 30,
 
   
2011
   
2010
 
Revenues:
           
Subscription revenue
  $ 30,434     $ 33,883  
Professional services revenue
    4,150       3,491  
Support and maintenance revenue
    3,649       4,185  
Software revenue
    1,892       2,687  
Total revenues
    40,125       44,246  
Cost of revenues:
               
Subscription, software and other services
    19,890       18,880  
Amortization of developed technology
    815       1,752  
Total cost of revenues
    20,705       20,632  
Gross profit
    19,420       23,614  
Operating expenses:
               
Sales and marketing
    14,584       13,484  
General and administrative
    8,233       6,921  
Research and development
    2,032       3,246  
Amortization of customer relationships and trade names
    1,449       1,999  
Impairment of capitalized software
    408       -  
Total operating expenses
    26,706       25,650  
Loss from operations
    (7,286 )     (2,036 )
Interest income
    16       1  
Interest expense
    (94 )     (268 )
Other income
    228       41  
Loss on debt extinguishment
    -       (5 )
Loss before income taxes and noncontrolling interest
    (7,136 )     (2,267 )
Income tax provision (benefit)
    (161 )     474  
Net loss
  $ (6,975 )   $ (2,741 )
Less: Net loss attributable to noncontrolling interest
  $ (2 )   $ -  
Net loss attributable to Lyris, Inc.
  $ (6,973 )   $ (2,741 )
                 
Basic and diluted:
               
Net loss per share
  $ (0.06 )   $ (0.03 )
                 
Weighted average shares used in calculating net loss per common share
    121,259       106,460  

See accompanying Notes to Consolidated Financial Statements.

 
50

 

LYRIS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS
(In thousands, except share data)

                                             
Total
   
Total
       
                                       
Accumulated
   
Stockholders'
   
Stockholders'
       
          Additional                
Other
    Equity    
Deficit
   
Total
 
   
Common Stock
    Paid-In    
(Accumulated
   
Treasury Stock
   
Comprehensive
   
Controlling
   
Noncontrolling
   
Stockholders'
 
   
Shares
   
Amount
   
Capital
   
Deficit)
   
Shares
   
Amount
   
Income
   
Interest
   
Interest
   
Equity
 
Balances at June 30, 2009
    103,221,882     $ 1,032     $ 257,959     $ (232,100 )     -     $ -     $ 123     $ 27,014     $ -     $ 27,014  
Common stock sale
    18,181,818       182       5,818       -       -       -       -       6,000       -       6,000  
Stock-based compensation
    -       -       445       -       -       -       -       445       -       445  
Comprehensive loss, net of tax:
                                                                               
Cumulative translation adjustment
    -       -       -       -       -       -       7       7       -       7  
Net loss
    -       -       -       (2,741 )     -       -       -       (2,741 )     -       (2,741 )
Total comprehensive loss
    -       -       -       -       -       -       -       (2,734 )     -       (2,734 )
Balances at June 30, 2010
    121,403,700     $ 1,214     $ 264,222     $ (234,841 )     -     $ -     $ 130     $ 30,725     $ -     $ 30,725  
Stock-based compensation
    -       -       853       -       -       -       -       853       -       853  
Purchase of treasury shares
    -       -       -       -       (170,000 )     (56 )     -       (56 )     -       (56 )
Noncontrolling Interest
    -       -       -       -       -       -       -       -       (170 )     (170 )
Comprehensive loss, net of tax:
                                                                            -  
Cumulative translation adjustment
    -       -       -       -       -       -       29       29       -       29  
Net loss
    -       -       -       (6,973 )     -       -       -       (6,973 )     (2 )     (6,975 )
Total comprehensive loss
    -       -       -       -       -       -       -       (6,944 )     (2 )     (6,946 )
Balances at June 30, 2011
    121,403,700     $ 1,214     $ 265,075     $ (241,814 )     (170,000 )   $ (56 )   $ 159     $ 24,578     $ (172 )   $ 24,406  
 
See accompanying Notes to Consolidated Financial Statements.

 
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LYRIS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

   
Years Ended June 30
 
   
2011
   
2010
 
             
Cash Flows from Operating Activities:
           
Net loss
  $ (6,975 )   $ (2,741 )
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
               
Gain on equity interest in Cogent
    (190 )     -  
Equity in earnings of unconsolidated affiliates
    71       -  
Stock-based compensation expense
    853       445  
Depreciation
    1,563       1,085  
Amortization and impairments of intangible assets
    1,803       3,638  
Amortization of capitalized development cost
    260       113  
Impairment of capitalized development cost
    202       -  
Provision for bad debt
    654       1,219  
Deferred income tax benefit
    (132 )     (36 )
Gain on debt restructuring
    -       (5 )
Changes in assets and liabilities:
               
Accounts receivable
    244       (1,934 )
Prepaid expenses and other assets
    309       217  
Accounts payable and accrued expenses
    784       625  
Deferred revenue
    (138 )     270  
Income taxes payable
    163       -  
Net cash provided by (used in) operating activities
    (529 )     2,896  
Cash Flows from Investing Activities:
               
Business acquisition, net of cash acquired
    (440 )     -  
Purchases of property and equipment
    (730 )     (685 )
Capitalized software expenditures
    (600 )     (1,294 )
Payment for equity investments
    (750 )     (275 )
Net cash provided by (used in) investing activities
    (2,520 )     (2,254 )
Cash Flows from Financing Activities:
               
Proceeds from sale of stock
    -       6,000  
Purchases of treasury stock
    (56 )     -  
Financing fees
    -       (25 )
Proceeds from debt and credit arrangements
    20,541       8,418  
Payments of debt and credit arrangements
    (17,257 )     (15,076 )
Payments under capital lease obligations
    (189 )     (64 )
Noncontrolling Interest
    (172 )     -  
Net cash provided by (used in) financing activities
    2,867       (747 )
Net effect of exchange rate changes on cash and cash equivalents
    (66 )     (22 )
Net decrease in cash and cash equivalents
    (248 )     (127 )
Cash and cash equivalents, beginning of period
    492       619  
Cash and cash equivalents, end of period
  $ 244     $ 492  
                 
Supplemental cash flow information:
               
Cash paid for interest
  $ 94     $ 210  
Cash paid for taxes
  $ 128     $ 442  
                 
Supplemental disclosure of non-cash transactions:
               
Property and equipment acquired under capital lease
  $ 144     $ 425  

See accompanying Notes to Consolidated Financial Statements.

 
52

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1.
Overview and Basis of Presentation

Overview

Lyris, Inc. and its wholly-owned subsidiaries (collectively “Lyris” or the “Company”) is a leading online marketing technology company. Its software-as-a-service, or SaaS-based online marketing solutions and services provide customers the ability to build, deliver and manage online, permission-based direct marketing programs and other communications to customers that use online and mobile channels to communicate to their respective customers and members. The Company’s software products are offered to customers primarily on a subscription and license basis.

The Company was incorporated under the laws of the state of Delaware as J.L. Halsey Corporation and changed its name to Lyris, Inc. in October 2007. The Company has principal offices in Emeryville, California and conducts its business worldwide, with wholly owned subsidiaries in Canada, the United Kingdom, and subsidiaries in Argentina and Australia. The Company’s foreign subsidiaries are generally engaged in providing sales, account management and support, with some product development provided through its Canadian subsidiary.

Basis of Presentation

Fiscal Periods

The Company’s fiscal year ends on June 30.  References to fiscal year 2011, for example, refer to the fiscal year ended June 30, 2011.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly and majority owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

In April 2010, the Company acquired interest in an Australian reseller, Cogent Online PTY Ltd (“Cogent”) to assist the Company with its sales efforts and global expansion in Australia.  During June 2011, the Company acquired new shares issued from Cogent and increased the Company’s ownership from 33.3 percent to 80 percent.

As the Company does not have 100 percent ownership of Cogent, the Company recorded a noncontrolling interest in the consolidated balance sheet for the noncontrolling investors’ interests in the net assets and operations of Cogent. Noncontrolling interest of $0.2 million as of June 30, 2011 is reflected in stockholders’ equity. Refer to Note 3 of the Notes to the Consolidated Financial Statements.

2.
Summary of Significant Accounting Policies

Use of Estimates and Assumptions

The preparation of financial statements in conformity with U.S. GAAP, for a fair presentation of the periods presented, requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and related disclosures at the date of the financial statements and the reported amounts of revenues, expenses and related disclosures during the reporting period. On an ongoing basis, management evaluates these estimates, judgments and assumptions, including those related to revenue recognition, stock-based compensation, goodwill and acquired intangible assets, capitalization of software, allowances for bad debt and income taxes. The Company bases these estimates on historical and anticipated results and trends and on various other assumptions that the Company believes are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities and recorded revenue and expenses that are not readily apparent from other sources. Actual results could differ from those estimates, and such differences could affect the results of operations reported in future periods.

Foreign currency translation

The Company records assets, liabilities and the results of its operations outside of the United States based on their functional currency.   On consolidation, the Company translates all assets and liabilities using the exchange rates in effect as of the balance sheet date.  The Company translates revenues and expenses using the monthly average exchange rates that were in effect during the period.  The Company recognizes the resulting adjustments as a separate component of equity in other comprehensive loss or gain.  Foreign currency transaction gains and losses are included in income as incurred for that period.

 
53

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
 
The Company’s European, Canadian, Latin American and Australian subsidiaries represented approximately 8% of its consolidated net operating revenues and consolidated long-lived assets at June 30, 2011.  The Company will continue to manage its foreign currency exposure to mitigate, over time, a portion of the impact of exchange rate fluctuation on net income and earnings per share.  The fluctuation in the exchange rates resulted in foreign currency translation gains reflected as a component of comprehensive income in stockholders’ equity of $29 thousand and $7 thousand at June 30, 2011 and 2010, respectively.

Certain Risks and Uncertainties

The Company operates in a highly competitive and dynamic market.  Accordingly, there are factors that could adversely impact the Company's current and future operations or financial results including, but not limited to, the following:  its ability to obtain rights to or protect intellectual property; changes in regulations; its ability to develop new products accepted in the marketplace; future impairment charges; competition including, but not limited to, product pricing, product features and services; litigation or claims against the Company; and the hiring, training and retention of key employees.

Financial instruments that potentially subject the Company to a concentration of credit risk consist primarily of cash and trade receivables.  The Company sells its products primarily to customers throughout the United States.  The Company monitors the credit status of its customers on an ongoing basis and does not require its customers to provide collateral for purchases on credit.  No sales to an individual customer accounted for more than 10% of revenue for fiscal year ended June 30, 2011 and 2010. Moreover, there was no single customer or supplier that accounted for more than 10% of the Company’s trade receivables for the same periods.

Segment Reporting

The Company operates in one segment. Refer to Note 16 of the Notes to the Consolidated Financial Statements.
 
Fair Value of Financial Instruments

The carrying amounts of certain financial instruments, including cash and cash equivalents, accounts receivable and accounts payable and certain other accrued liabilities approximate their fair values, due to their short maturities.  Based on borrowing rates currently available to the Company for loans with similar terms, the carrying amounts of capital lease obligations approximate their fair value.  The revolving line of credit approximates fair value due to its market interest rate and short-term nature.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (“exit price”) in an orderly transaction between market participants at the measurement date.  The FASB has established a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).  The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).

The three levels of the fair value hierarchy under the guidance for fair value measurement are described below:

Level 1:  Pricing inputs are based upon quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.  As of June 30, 2011, the Company used Level 1 assumptions for its cash equivalents, which were $244 thousand and $492 thousand at June 30, 2011 and June 30, 2010, respectively.  The valuations are based on quoted prices of the underlying security that are readily and regularly available in an active market, and accordingly, a significant degree of judgment is not required.

Level 2:  Pricing inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.  As of June 30, 2011, the Company did not have any Level 2 financial assets or liabilities.

Level 3:  Pricing inputs are generally unobservable for the assets or liabilities and include situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require management’s judgment or estimation of assumptions that market participants would use in pricing the assets or liabilities. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models and similar techniques.  As of June 30, 2011, the Company did not have any significant Level 3 financial assets or liabilities.
 
 
54

 
 
LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

Cash and Cash Equivalents

     The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.  Cash and cash equivalents, primarily consisting of cash on deposit with banks and money market funds, are stated at cost, which approximates fair value.   At certain times, the Company maintains cash balances with banks in excess of FDIC insured limits.   The Company limits its credit risk by maintaining accounts with financial institutions of high credit standing. As of June 30, 2011, the Company’s cash and cash equivalents were $244 thousand and $492 thousand at June 30, 2011 and June 30, 2010, respectively.

Property and Equipment

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

Refer to Note 6 of the Notes to Consolidated Financial Statements.

Revenue Recognition

The Company recognizes revenue from providing hosting and professional services and licensing its software products to its customers.

The Company generally recognizes revenue when all of the following conditions are satisfied:  (1) there is persuasive evidence of an arrangement; (2) the service has been provided to the customer (for software licenses, revenue is recognized when the customer is given electronic access to the licensed software); (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of fees is probable.

Subscription and Other Services Revenue
 
The Company generates services revenue from several sources, including hosted software services bundled with technical support (maintenance) services and professional services.  The Company recognizes subscription revenue in two ways: (1) based on the subscription plan defined in the agreement with specified monthly volume, and (2) based on actual usages at rates specified in the agreement. Additionally, the Company invoices excess usage and recognizes it as revenue when incurred.
 
In October 2009, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update 2009-13, Multiple-Deliverable Revenue Arrangements a consensus of the of the FASB Emerging Issues Task Force (“ASU No. 2009-13”) which amended the accounting standards for revenue recognition for multiple deliverable revenue arrangements to:
 
 
·
Provide updated guidance on how the deliverables of an arrangement should be separated and how the consideration should be allocated;
 
·
Eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method; and
 
·
Require an entity to allocate revenue to an arrangement using the estimated selling prices (“ESP”) of deliverables if it does not have vendor-specific objective evidence (“VSOE”) of fair value or third-party evidence (“TPE”) of selling price.
 
Valuation terms are defined as set forth below:
 
 
·
VSOE — the price at which the element is sold in a separate stand-alone transaction
 
·
TPE — evidence from the Company or other companies of the value of a largely interchangeable element in a transaction
 
·
ESP — the Company’s best estimate of the selling price of an element in a transaction
 
The Company adopted ASU No. 2009-13 for the current fiscal year ending June 30, 2011 on a prospective basis for multiple-element arrangements that include subscription services bundled with technical support and professional services.  The implementation resulted in an immaterial difference in revenue recognized and additional disclosures that are included below.

 
55

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

The Company follows accounting guidance for revenue recognition of multiple-element arrangements to determine whether such arrangements contain more than one unit of accounting.  Multiple-element arrangements require the delivery or performance of multiple products, services and/or rights to use assets.  Although the Company’s professional services that are a part of multiple element arrangement have standalone value to the customer, such services could not be accounted as separate units of accounting under the previous guidance, as VSOE did not exist for the undelivered element. The VSOE for subscription services could not be established based on the historical pricing trends to date, which indicate that the price of the majority of standalone sales does not yet fall within a narrow range around the median price.  Since the Company’s subscription services have standalone value as such services are often sold separately, but do not have VSOE, the Company uses ESP to determine fair value for its subscription services when sold in a multiple-element arrangement and recognize revenue based on ASU No. 2009-13. For the fiscal year ended, June 30, 2011, TPE was concluded to be an impractical alternative due to differences in features and functionality of other companies’ offerings and lack of access to the actual selling price of competitor standalone sales.  If new subscription service products are acquired or developed that require significant professional services in order to deliver the subscription service and the subscription service and professional services cannot support standalone value, then such subscription services and professional services will be evaluated as one unit of accounting.  The Company determined ESP of fair value for subscription services based on the following:
 
 
·
The Company has defined processes and controls to ensure its pricing integrity.  Such controls include oversight by a cross-functional team and members of executive management.  Significant factors considered when establishing pricing include market conditions, underlying costs, promotions and pricing history of similar services.  Based on this information and actual pricing trends, management establishes or modifies the pricing.
 
 
·
The Company identified the population of transactions to serve as the basis for establishing ESP, including subscription services and professional services pricing history in transactions with multiple-element arrangements and those sold on a standalone basis.
 
 
·
The Company analyzed the population of items sold by stratifying the population by product type and level and considered several data points, such as (1) average price charged, (2) weighted average price to incorporate the frequency of each item sold at any given price, and (3) the median price charged. These three price points were then compared with the existing price list that is used as a point of reference to negotiate contracts and does not represent fair value.  Additionally, the Company gathered and analyzed sales’ team feedback gained from interaction with customers and similar activities.  This feedback included consideration of current market trends for pricing charged by companies offering similar services, competitive advantage of the products we offer and recent economic pressures that have resulted in lower spending on marketing activities. ESP for each item in the population was established based on the factors noted above and was reviewed by management.
 
For transactions entered into or materially modified after July 1, 2010, the Company allocates consideration in multiple-element arrangements based on the relative selling prices.  Revenue is then recognized as appropriate for each separate element based on its fair value.  For the year ended, June 30, 2011, the impact on the Company’s revenue under the new accounting guidance as compared to the previous methodology resulted in an immaterial difference in revenue recognized as compared to that which would have previously been deferred and recognized ratably. The immaterial impact is primarily a result of the limited population of transactions subject to newly adopted guidance, as it includes only those arrangements entered into or materially modified within the year ended fiscal year 2011. The accounting treatment for arrangements entered into prior to July 1, 2010 continues to follow legacy accounting rules and the revenue recognition method applied to certain types of arrangements has not changed upon adopting new guidance and does not affect the revenue recognized. The adoption of new guidance did not result in a material impact to the financial statements for fiscal year 2011.
 
However, new guidance may result in a material impact in the future, due to the change in other factors affecting the revenue recognition method, as the impact on the timing and pattern of revenue will vary depending on the nature and volume of new or materially modified contracts in any given period. The Company expects that the new accounting guidance will facilitate its efforts to optimize the sales and marketing of its offerings due to better alignment between the economics of an arrangement and the accounting for that arrangement.  Such optimization may lead the Company to modify its pricing practices, which could result in changes in the relative selling prices of its elements, including both VSOE and ESP, and therefore change the allocation of the sales price between multiple elements within an arrangement. However, this will not change the total revenue recognized with respect to the arrangement.
 
The Company defers technical support (maintenance) revenue, including revenue that is part of a multiple element arrangement, and recognizes it ratably over the term of the agreement, which is generally one year.
 
For professional services sold separately from subscription services, the Company recognizes professional service revenues as delivered.  Expenses associated with delivering all professional services are recognized as incurred when the services are performed.  Associated out-of-pocket travel costs and expenses related to the delivery of professional services are typically reimbursed by the customer and are accounted for as both revenue and expense in the period the cost is incurred.
 
 
56

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
 
For multiple element arrangements entered into prior to July 1, 2010 that include both subscription and professional services and did not meet the separability criteria under the previous guidance, the Company has accounted for as a single unit of accounting. Consistent with the revenue recognition method applied prior to the adoption of ASU No. 2009-13, revenue for these arrangements continues to be recognized ratably over the term of the related subscription arrangement. If the multi-element arrangement is materially modified, the transaction is evaluated in accordance with the new accounting guidance which will most likely result in any deferred services revenue being recognized at the time of the material modification.
 
Software Revenue
 
The Company enters into certain revenue arrangements for which it is obligated to deliver multiple products and/or services (multiple elements).  For these arrangements, which generally include software products, technical (maintenance) support and professional services, the Company allocates and defers revenue for the undelivered elements based on their VSOE.  The Company allocates total earned revenue under the agreement among the various elements based on their relative fair value. VSOE exists for all elements of multiple element arrangements.   In the event that VSOE cannot be established for one of the elements of multiple element arrangement, the Company will apply the residual method to determine how much revenue for the delivered elements (software licenses) can be recognized upon delivery by assigning VSOE to other elements in multiple element arrangements.
 
The Company determines VSOE based on actual prices charged for standalone sales of maintenance.  To accomplish this, the Company tracks sales for the maintenance product when sold on a standalone basis for a one year term and compares to sales of the associated licensed software product.
 
The Company performs a quarterly analysis of the actual sales for standalone maintenance and licensed software to establish the percentage of sales relationships for each level of maintenance and licensed software.  The result of this analysis has historically been a tight range of percentage of sales relationships centered on a mid-point.  Renewal rates, expressed as a consistent percentage of the license fee at each level, represent VSOE of fair value for the maintenance element of the arrangements.
 
The Company recognizes revenue from its professional services as rendered.  VSOE for professional services is based on the use of a consistent rate per hour when similar services are sold separately on a time-and-material basis.  In cases where VSOE has not been established, the Company defers the full value of the arrangement and recognizes it ratably over the term of the agreement.

 Deferred Revenue

Deferred revenue represents customer billings made in advance for annual support or hosting contracts, professional consulting services to be delivered in the future and bulk purchases of emails to be delivered in the future.  The Company typically bills maintenance on a per annum basis in advance for software and recognizes the revenue ratably over the maintenance period.  Some hosted contracts are prepaid monthly, quarterly or annually and recognized monthly after the service has been provided.  Bulk purchases are typically billed in advance, ranging from monthly to annually and the Company recognizes revenue in the periods in which emails are delivered.
 
Advertising Costs

Advertising costs are expensed as incurred or the first time the advertising takes place.  Advertising costs were $4.3 million and $5.1 million for fiscal years 2011 and 2010, respectively.

Allowance for Doubtful Accounts

The Company records trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts.

The Company provides an allowance for doubtful accounts equal to the estimated uncollectible amounts.  Its estimate is based on historical collection experience, changes in customer payment history and a review of the current status of trade accounts receivable.  If any of these factors change, it is reasonably possible that the estimate of the allowance for doubtful accounts will change.

 
57

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
 
  The following is a summary of the activity in the allowance for doubtful accounts:

   
Years Ended June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Balance at July 1,
  $ 768     $ 899  
Charge to cost and expenses
    654       1,219  
Write-offs charge against allowance
    (486 )     (1,350 )
Balance at June 30,
  $ 936     $ 768  

Loss Contingencies and Commitments

The Company records estimated loss contingencies when information is available that indicates that it is probable that a material loss has been incurred or an asset has been impaired and the amount of the loss can be reasonably estimated.   The Company discloses if the assessment indicates that a potentially material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, or if an exposure to loss exists in excess of the amount accrued.  Loss contingencies considered remote are generally not disclosed unless they arise from guarantees, in which case the guarantees would be disclosed.  Determining the likelihood of incurring a liability and estimating the amount of the liability involves an exercise of judgment.   If the litigation results in an outcome that has greater adverse consequences to the Company than management currently expects, then the Company may have to record additional charges in the future.  As of June 30, 2011, there were neither material changes to the Company commitments and obligations, nor were there any probable material losses incurred that could be reasonably estimated.

The Company’s commitments consist of obligations under operating leases for corporate office space and co-location facilities for data center capacity for research and test data centers.  The Company also enters into contractual purchase obligations, capital leases and other agreements that are legally binding and specify certain minimum payment terms.

Goodwill, Long-lived Assets and Other Intangible Assets

The Company classifies its intangible assets into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill.

The Company evaluates its fixed assets and intangible assets with definite lives for impairment.  If the carrying amount of an asset or asset group (in use or under development) is evaluated and found not to be recoverable (carrying amount exceeds the gross, undiscounted cash flows from use and disposition), then an impairment loss must be recognized.  The impairment loss is measured as the excess of the carrying amount over the asset’s or asset group’s fair value.  In addition, the potential impairment of finite life intangibles is assessed whenever events or a change in circumstances indicate the carrying value may not be recoverable.

The Company tests goodwill and its intangible assets with indefinite lives not subject to amortization annually on June 30th for impairment.  In addition, the Company considers the following significant factors that could trigger an impairment review prior to annual testing:

 
a.
a significant underperformance relative to historical or expected projected future operating results;
 
b.
a significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
 
c.
significant negative industry or economic trends;
 
d.
a significant decline in our stock price for a sustained period of time; 
 
e.
a significant change in our market capitalization relative to net book value; and
 
f.
a significant adverse change in legal factors or in the business climate that could affect the value of the asset.

Impairment Testing
 
If the Company determines that the carrying value of intangible assets, long-lived assets or goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, it measures any potential impairment based on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in our current business model.  The fair values calculated in the Company’s impairment tests are determined using discounted cash flow models involving several assumptions. These assumptions include, but are not limited to, anticipated operating income growth rates, the Company’s long-term anticipated operating income growth rate and the discount rate (including a specific reporting unit risk premium).  The assumptions that are used are based upon what the Company believes a hypothetical marketplace participant would use in estimating fair value. In developing these assumptions, the Company compares the resulting estimated enterprise value to its observable market enterprise value at the time the analysis is performed.  Based on the most recent impairment test conducted on June 30, 2011, the Company has concluded that there was no impairment of goodwill or intangible assets during fiscal year 2011. Refer to Note 5 of the Notes to Consolidated Financial Statements.

 
58

 
 
LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
 
Capitalized Software Costs
 
Software licensing.  The Company expenses internal costs incurred in researching and developing computer software products designed for sale or licensing until technological feasibility has been established for the product. Once technological feasibility is established, applicable development software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. The Company determined that technological feasibility is established when it has completed all necessary planning and designing and after it has resolved all high-risk development issues through coding and testing. Moreover, these activities are necessary to establish that the product can meet its design specifications including functions, features and technical performance requirements. The Company discontinues capitalization when the product is available for general release to customers.
 
SaaS software costs. The Company capitalizes the direct costs associated with the software it develops for use in providing software-as-a-service to its customers during its application development stage. The types of activities performed during the application development stage create probable future economic benefits. Once the software is available for use in providing services to customers, the Company amortizes the capitalized amount over three years with the amortization charged to cost of revenues. The Company expenses activities performed during the preliminary project stage which are analogous to research and development activities. In addition, the Company expenses the types of activities performed during the post-implementation / operation stage. These activities are likely to include release ready and release launch activities.  Refer to Note 6 of the Notes to Consolidated Financial Statements.

Stock-Based Compensation

The Company amortizes stock-based compensation expense based upon the fair value of stock-based awards on a straight-line basis over the requisite vesting period as defined in the applicable plan documents.  Refer to Note 14 of the Notes to Consolidated Financial Statements.

Accounting for Income Taxes

The Company accounts for income taxes in accordance with standards established by the FASB.  The Company recognizes deferred tax assets and liabilities for the future tax consequences of temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets, including tax loss and credit carryforwards and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the rate enactment date.  Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities.  The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics.

In accordance with FASB standards, the Company establishes a valuation allowance if it believes that it is more likely than not that some or all of its deferred tax assets will not be realized.  The Company does not recognize a tax benefit unless it determines that it is more likely than not that the benefit will be sustained upon external examination, an audit by taxing authority.  The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement.  Refer to Note 10 of the Notes to Consolidated Financial Statements.

Acquisition

Significant judgment is required to estimate the fair value of purchased assets and liabilities at the date of acquisition, including estimating future cash flows from the acquired business, determining appropriate discount rates, asset lives and other assumptions.  The Company’s process to determine the fair value of the non-compete agreements, customer relationships and developed technology includes the use of estimates including: the potential impact on operating results if the non-compete agreements were not in place; revenue estimates for customers acquired through the acquisition based on an assumed customer attrition rate; estimated costs to be incurred to purchase the capabilities gained through the developed technology model; and appropriate discount rates based on a particular business’ weighted average cost of capital. The Company’s estimates of an entity’s growth and costs are based on historical data, various internal estimates and a variety of external sources and are developed as part of our planning process.  Refer to Note 3 of the Notes to Consolidated Financial Statements.

 
59

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
 
Net Loss per Share

Basic net income (loss) per share is computed by dividing net income by the weighted average number of common shares outstanding during the reporting period.  Diluted net income (loss) per share is computed similarly to basic net income (loss) per share except that it includes the potential dilution that could occur if dilutive securities were exercised.  Refer to Note 12 of the Notes to Consolidated Financial Statements.
 
New Accounting Pronouncements

In October 2009, the FASB issued Accounting Standard Update No. 2009-13, “Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-13”). It updates the existing multiple-element revenue arrangements guidance currently included under ASC 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”). The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) requires the use of the relative selling price method to allocate the entire arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. The Company adopted this guidance in fiscal year 2011. The adoption of this guidance did not have a material impact on our results of operations and financial position.
 
In December 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2010-29, Business Combinations Topic (805): Disclosure of Supplementary Pro Forma Information for Business Combinations (“ASU 2010-29”). ASU 2010-29 provides clarification on the presentation of pro forma information for business combinations and applies to public entities. ASU 2010-29 specifies that the pro forma disclosure should include revenue and earnings of the combined entity as though the business combination(s) during the current year had occurred as of the beginning of the comparable prior annual reporting period only if comparative financial statements are presented. ASU 2010-29 also expands the supplemental pro forma disclosures to include a description of the nature and amount of the material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective on a prospective basis for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company adopted this update as of January 1, 2011, and its adoption did not result in additional disclosures over its business combination acquisition of Cogent Online PTY Ltd. that was completed in June 2011, as that was not material on an individual or aggregate basis.
 
Recently Issued Accounting Standards
        
In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), which is intended to result in convergence between U.S. GAAP and International Financial Reporting Standards requirements for measurement of, and disclosures about, fair value. ASU 2011-04 clarifies or changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements. This pronouncement is effective for reporting periods beginning after December 15, 2011, with early adoption prohibited for public companies. The new guidance will require prospective application. The Company will adopt this pronouncement in the third quarter of 2012 and does not expect its adoption to have a material effect on its financial position or results of operations.

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”), which will require companies to present the components of net income and other comprehensive income either in a single continuous statement or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The pronouncement does not change the current option for presenting components of other comprehensive income, gross, or net of the effect of income taxes, provided that such tax effects are presented in the statement in which other comprehensive income is presented or disclosed in the notes to the financial statements. Additionally, the pronouncement does not affect the calculation or reporting of earnings per share. The pronouncement also does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. This standard is effective for reporting periods beginning after December 15, 2011. Early application is permitted. The Company will adopt this pronouncement in the third quarter of 2012, and it will have no effect on its financial position or results of operations but it will impact the way it presents comprehensive income.
 
 
60

 


LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

3.
Acquisition

In April 2010, the Company acquired interest in an Australian reseller, Cogent Online PTY Ltd (“Cogent”) to assist the Company with its sales efforts and global expansion in Australia.  During June 2011, the Company acquired other shareholders’ interest in Cogent for a total cash consideration of approximately $0.4 million and increased the Company’s ownership from 33.3 percent to 80 percent.  Cogent is a privately held company, with its headquarters in Ultimo, Australia.  Cogent was a marketing representative and reseller for the Company. The Company accounted for the initial investment with the equity method of accounting and changed to the consolidated method of accounting with the additional shares purchased. Additionally, the Company recorded a noncontrolling interest in the consolidated statement of operations for the noncontrolling investors’ interests in the net assets and operations of Cogent. Noncontrolling interest of $0.2 million as of June 30, 2011 is reflected in stockholders’ equity. Additionally, the Company recorded goodwill of $0.1 million, intangibles of $0.9 million and net liabilities of $0.1 million associated with this transaction. Furthermore, the Company recorded a gain on the initial investment of $0.2 million and is reflected in other income in the Consolidated Statements of Operations. The Company incurred related expenses associated with this acquisition of $0.1 million. Subsequent to the acquisition, Cogent was renamed to Lyris APAC PTY Ltd.

4.
Intangible Assets

The components of intangible assets consist of the following:

   
As of June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Amortizable intangibles:
           
Customer relationships
  $ 10,518     $ 9,604  
Developed technology
    11,805       11,741  
Trade names
    314       2,178  
      22,637       23,523  
Less: accumulated amortization
    (22,225 )     (20,288 )
Less: impairment and write-downs
    -       -  
      412       3,235  
Non-amortizable intangibles:
               
Trade names
    6,289       4,400  
Total intangible assets, net of amortization
  $ 6,701     $ 7,635  

The activity for intangible assets for fiscal years 2011 and 2010 consisted of the following:

   
Amount
 
   
(In thousands)
 
Ending balance at July 1, 2009
  $ 11,252  
Amortization
    (3,638 )
Foreign currency translation adjustment
    21  
Ending balance at June 30, 2010
  $ 7,635  
Customer relationships acquired from Cogent Acquisitions
    850  
Amortization
    (1,803 )
Foreign currency translation adjustment
    19  
Ending balance at June 30, 2011
  $ 6,701  

The Company acquired customer relationships from the Cogent Acquisition of $0.9 million in fiscal year 2011 and will amortize this over a six year period.

For fiscal years 2011 and 2010 foreign currency translation adjustments were $19 thousand and $21 thousand, respectively.  The change in net intangible assets is primarily a result of changes in the foreign currency exchange rate between the U.S. dollar and Canadian dollar.

 
61

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

Total intangible asset amortization and impairment expense for fiscal years 2011 and 2010 were $1.8 million and $3.6 million.  For fiscal years 2011 and 2010, total intangible asset amortization and impairment expense of developed technology classified as cost of revenue were $0.9 million and $1.6 million, respectively.  As of June 30, 2010, accumulated amortization includes the $4.2 million impairment write-down recorded in fiscal year 2009.  Additionally, during fiscal year 2011 and 2010, the Company eliminated approximately $1.0 million and $1.7 million, respectively, in fully amortized intangible assets from its net intangible assets.

Customer relationship-based intangible assets have a remaining weighted average amortization period of 4.68 years and developed technology-based intangible assets have a remaining weighted average amortization period of 5.00 years.

The estimated future amortization expense related to intangible assets, assuming no future impairment of the underlying assets as of June 30, 2011, is as follows:

Fiscal Year
 
Customer
Relationships
   
Developed
Technology
   
Trade
Names
   
Total
 
   
(In thousands)
 
2012
  $ 318     $ 96     $ 417     $ 831  
2013
    202       48       314       564  
2014
    202       -       288       490  
2015
    147       -       -       147  
2016
    142       -       -       142  
2017
    127       -       -       127  
Total estimated future amortization expense
  $ 1,138     $ 144     $ 1,019     $ 2,301  
                                 
Intangible asset with indefinite life
  $ -     $ -     $ 4,400     $ 4,400  
                                 
Total Intangible asset
  $ 1,138     $ 144     $ 5,419     $ 6,701  

5.
Goodwill

Goodwill represents the excess of the purchase price over the fair value of net assets acquired in connection with the Company’s business combinations accounted for using the acquisition method of accounting.

The following table outlines the Company’s goodwill, by acquisition:

   
As of June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Lyris Technologies
  $ 16,505     $ 16,505  
EmailLabs
    2,202       2,202  
Cogent
    84       -  
Total
  $ 18,791     $ 18,707  

The Company recorded goodwill of $0.1 million associated with the Cogent acquisition. Refer to Note 3 of the Notes to Consolidated Financial Statements. The Company had no goodwill activity in fiscal year 2010.

   
Amount 
(in thousands)
 
Beginning balance at July 1, 2010
  $ 18,707  
Goodwill Impairment
    -  
Ending balance at June 30, 2010
  $ 18,707  
Goodwill
    84  
Goodwill Impairment
    -  
Ending balance at June 30, 2011
  $ 18,791  

 
62

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
 
The Company conducts a test for the impairment of goodwill on its reporting unit on at least an annual basis. The Company has one reporting unit, Lyris, Inc. The Company adopted June 30th as the date of the annual impairment test, but will conduct the test at an earlier date if indicators of possible impairment arise that would cause a triggering event. Due to the triggering event of the decline of the Company’s stock price from $0.34 as of the date of its annual impairment test at June 30, 2010, to lesser amounts at each quarter end in fiscal year 2011, we tested the impairment of our goodwill during each quarter ended for fiscal year 2011. The impairment test first compares the fair value of our reporting unit to its carrying amount, including goodwill, to assess whether impairment is present. The fair values calculated in our impairment test are determined using the weight of two methods: Public Company Market Multiple Method and the Income Approach.

At June 30, 2011 we determined that the estimated fair value of the Company’s reporting unit was in excess of its carrying value. The carrying value of our reporting unit was approximately $28.1 million at June 30, 2011. The fair value of our reporting unit under the Public Company Market Multiple Method was approximately $39.7 million at June 30, 2011 based on a comparison of the Company to other publicly traded companies within the same industry and market; and similar product lines, growth, margins and risk. The Company comparison is based on published data regarding the public companies’ stock price and earnings, sales and/or revenues. This method resulted in an excess of fair value under the Public Company Market Multiple Method over the carrying value of approximately $11.6 million or 41%.

The fair value of the Company reporting unit under the Income Approach, specifically utilizing the Discounted Cash Flow Method, was approximately $35.2 million at June 30, 2011. This resulted in an excess of fair value under the Income Approach over the carrying value of approximately $7.1 million or 25%. The Discounted Cash Flow Method under the Income Approach utilized several assumptions and estimates. The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions. The Company bases these estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities and recorded revenue and expenses that are not readily apparent from other sources. Actual results could differ from those estimates and such differences could affect the results of operations reported in future periods. These assumptions and estimates include, but are not limited to, anticipated operating income growth rates, our long-term anticipated operating income growth rate, and the discount rate, including a specific reporting unit risk premium. The assumptions used are based upon what the Company believes a hypothetical marketplace participant would use in estimating fair value. The Company accounting estimates and assumptions bear the risk of change due to the degree of uncertainty attached to the estimates and assumptions, or some estimates and assumptions may be difficult to measure or value. Accordingly, actual results could differ significantly from the estimates made by the Company’s management. For example, if the Company’s revenue projections, expected growth rate and economic upturn do not materialize, this will negatively affect our key assumptions.

Based on our impairment test conducted at June 30, 2011, the Company concluded that there was no impairment of goodwill or intangible assets for fiscal year 2011.

6.
Property and Equipment

The components of property and equipment were as follows:

   
As of June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Computers
  $ 4,745     $ 4,088  
Furniture and fixtures
    548       584  
Leasehold improvements
    263       253  
Software
    3,001       2,310  
Other equipment
    491       483  
      9,048       7,718  
Less: accumulated depreciation and amortization
    (5,909 )     (3,980 )
Total
  $ 3,139     $ 3,738  

For fiscal year 2011 and 2010, the Company acquired $0.7 million and $0.7 million, respectively, of new property and equipment.  Total depreciation expense related to property and equipment for fiscal years 2011 and 2010 was approximately $1.6 million and $1.1 million, respectively. 

For fiscal year 2011 and 2010, the Company entered into capital leases totaling approximately $0.4 million and $0.4 million, respectively, for computer equipment associated with its data centers. Accumulated depreciation related to property and equipment under capital leases total $0.2 million as of June 30, 2011 and $38 thousand as of June 30, 2010.

 
63

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

During the fourth quarter of fiscal year 2011, the Company changed their accounting estimate on the service lives of their computer and data processing equipment from five to three years based on industry standards and best practices, resulting in an additional depreciation expense of $0.4 million for fiscal year 2011. Net loss increased by approximately $0.4 million for fiscal year 2011.
 
Also during fiscal year 2011, the Company continued to capitalize hosting software costs.  Total capitalized hosting software costs were approximately $1.5 million and $1.3 million during fiscal years 2011 and 2010, respectively.  Capitalized hosting software costs primarily consist of employee-related costs. Total amortization related to capitalized hosting software costs in fiscal year 2011 and 2010 was approximately $0.5 million and $0.1 million, respectively, in amortization expense being recorded as cost of revenue.

During the fourth quarter of fiscal year 2011, the Company fully impaired $0.4 million of internal-use hosting software developed for its EmailLabs application as it was deem to not provide substantive service potential. The Company started to capitalize this software in the fourth quarter of fiscal year 2010 as it was probable that those expenditures will result in additional functionality to the EmailLabs application. Net loss increased by approximately $0.4 million for fiscal year 2011.

7.
Other Long-term Assets

   
As of June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Other long-term assets
  $ 899     $ 352  

During the first quarter of fiscal year 2011, the Company entered into a Stock Purchase Agreement (the “SiteWit Agreement”) with SiteWit Corp. (“SiteWit”), a privately held company that provides an online marketing search engine to its customers.  The Company invested in SiteWit to secure the right to use SiteWit’s online marketing search engine technology.  The Company also entered into a Strategic Partnership Agreement with SiteWit regarding the development and marketing of other services.  Pursuant to the SiteWit Agreement, the Company will acquire up to 30% of SiteWit’s outstanding stock on a fully diluted basis, based upon the achievement by SiteWit of product development milestones through fiscal year 2011. As of June 30, 2011, the Company owns 22.5% of SiteWit’s outstanding stock on a fully diluted basis. The Company paid $0.5 million in cash at the signing of the SiteWit Agreement and will invest an additional $0.5 million upon the achievement of the milestones. Certain milestones were reached and $0.25 million was invested during the second quarter of fiscal year 2011.  As part of the SiteWit agreement, the Company received the right to designate one of SiteWit’s board members and has designated Wolfgang Maasberg, its Chief Executive Officer and President, to that position.  The Company recorded the SiteWit investment at cost and uses the equity method of accounting to account for any future activity associated with this investment. The Company does not have a controlling interest in SiteWit. Subsequent to the fiscal 2011 year end, on August 17, 2011 the Company entered into a Termination Agreement with SiteWit. Refer to Note 17 of the Notes to Consolidated Financial Statements for subsequent details.

Other assets included here at June 30, 2011 were $221 thousand, of which $126 thousand were related to security deposits related to leases entered in by the Company and $95 thousand were related to notes receivables acquired from Cogent acquisition. At June 30, 2010, the entire balance of $352 thousand was related to the Company’s initial investment in Cogent. This investment was accounted for under the equity method of accounting. Refer to Note 3 of the Notes to Consolidated Financial Statements.

Investments are accounted for using the equity method of accounting if the investment gives the Company the ability to exercise significant influence, but not control, over an investee. The Company classifies its investments in equity-method investees on its condensed consolidated balance sheets as “Other long-term assets” and its share of the investees’ earnings or losses as “Other income” on its condensed consolidated statements of operations.

8.
Revolving Line of Credit

On September 15, 2010, the Company entered into the Sixth Amendment (the “Amendment”) to the Amended and Restated Loan and Security Agreement with Comerica Bank (“Bank”). The Amendment revises the terms of the Amended and Restated Loan and Security Agreement (“Loan Agreement”) between the Bank and the Company.

 
64

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

The Amendment (1) changed the definition of EBITDA to include in EBITDA severance and related expenses of $1.1 million incurred in August 2010; (2) waived compliance with the EBITDA financial covenant under the Loan Agreement for the August 2010 measuring period, the terms of which the Company was not in compliance with due to severance and related expenses incurred in August 2010; and (3) required the Company to maintain EBITDA not less than specified amounts. The new EBITDA minimum requirements, which are measured on a trailing six months basis, are as follows, with no minimum EBITDA requirement for months after March 31, 2011:

Measurment Period Ending
 
Minimum Trailing
Six Month EBITDA
 
9/30/2010
  $ (850,000 )
10/31/2010
  $ (1,125,000 )
11/30/2010
  $ (1,200,000 )
12/31/2010
  $ (1,150,000 )
1/31/2011
  $ (850,000 )
2/28/2011
  $ (500,000 )
3/31/2011
  $ 1  

As of June 30, 2011 and July 31, 2011, the Company was not in compliance with the terms of the Loan Amendment as the Company did not meet its liquidity covenant which requires us to have $1.0 million in liquidity. The Company’s liquidity is determined by its unrestricted cash at bank and unused availability under its revolving line of credit.  As part of the amendment to the Company’s credit facility that the Company entered into on August 31, 2011, the Bank waived compliance with the Company’s liquidity covenant for the June and July 2011 measurement period. Refer to Note 17 of the Notes to Consolidated Financial Statements for Seventh Amendment entered into subsequent to June 30, 2011.

The Company’s outstanding borrowings totaled $3.3 million with $0.2 million in available credit remaining as of June 30, 2011. The Company had no outstanding borrowings at June 30, 2010. Borrowings under the line of credit are secured by the Company’s assets.

9.
Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses are summarized as follows:

   
As of June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Accounts payable
  $ 1,928     $ 948  
Accrued compensation and benefits
    1,433       1,405  
Other current liabilities
    1,267       1,240  
Total
  $ 4,628     $ 3,593  

Accounts payable is comprised of the Company’s trade accounts payable and credit card charges incurred during the normal course of business.

Accrued compensation and benefits are comprised of the Company’s employee salaries, commissions, bonuses, vacation, payroll taxes and related benefits.

Other current liabilities are comprised of the Company’s accrued expenses related to the operation of the normal course of business and other onetime charges.

 
65

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

10.
Income Taxes

The components of the provision for income taxes were as follows:

   
Fiscal Year Ended June 30,
 
   
2011
   
2010
 
   
(In Thousands)
 
Current:
           
Federal
  $ -     $ 25  
State
    17       480  
Foreign
    (46 )     5  
      (29 )     510  
Deferred:
               
State
    (132 )     (36 )
      (132 )     (36 )
                 
Total income tax provision
  $ (161 )   $ 474  

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

   
As of June 30,
 
   
2011
   
2010
 
   
(In Thousands)
 
                 
Accruals and reserves not currently deductible for tax purposes
  $ 4,342     $ 3,969  
Net operating loss and tax credit carry forwards
    62,439       61,201  
Gross deferred tax assets
    66,781       65,170  
Valuation allowance
    (65,899 )     (64,420 )
Net deferred tax assets
  $ 882     $ 750  

Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax basis and are stated at enacted tax rates expected to be in effect when taxes are actually paid or recovered, in addition to estimated amounts related to net operating loss, capital loss and tax credits carry forwards.  We have recorded a valuation allowance to reflect the estimated amount of deferred tax assets which relate to federal net operating loss carry forwards, in excess of amounts carried back to prior years, and tax credit carry forwards that may not be realized.
 
As of June 30, 2011, the Company has approximately $0.2 million in U.S. federal net operating loss ("NOL") carry forwards that will start to expire in 2019.  The Company has approximately $5.2 million in Canadian net operating loss carry forwards that will start to expire in 2028.  Also, the Company has approximately $0.4 million in state NOLs which expire at various times between 5 and 20 years.  These NOL's offset future taxable income and taxable gains.

The change in the valuation allowance was an increase of approximately $1.5 million and a decrease of $0.5 million for the fiscal year ended June 30, 2011 and June 30, 2010 respectively.  The reason for this change was the generation and utilization of net operating carry forwards, offsetting the estimated tax income as calculated per tax purposes.  If the Company experiences a change in ownership within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended, it may have limitations on our ability to realize the benefit of our net operating loss and tax credit carryovers.

In addition to the net operating loss carryovers, the Company has alternative minimum tax credit carryovers of $4.4 million.
The alternative minimum tax credit may be applied to regular federal income tax once the NOLs expired or the Company has regular federal taxable income.  There is no expiration date on alternative minimum tax credit carryovers.

 
66

 
 
LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
 
The items accounting for the difference between expected tax (benefit) computed at the federal statutory rate of 35% and the provision of income taxes were as follows:

   
Years Ended June 30,
 
   
2011
   
%
   
2010
   
%
 
                         
Expected federal income tax expense (benefit) at statutory rate
  $ (2,497 )     35.0 %   $ (793 )     35.0 %
State income taxes (benefit), net of federal benefit
    (75 )     1.0 %     289       -12.7 %
Utilization of NOL carryover
    -       0.0 %     (1,033 )     45.6 %
Goodwill Impairment
    -       0.0 %     -       0.0 %
Amortization of intangible assets
    901       -12.6 %     1,273       -56.2 %
Impact of Foreign Operations
    726       -10.2 %     607       -26.8 %
Difference between AMT and statutory federal income tax rates
    1,070       -15.0 %     340       -15.0 %
Other, net
    (287 )     4.0 %     (209 )     9.2 %
                                 
    $ (161 )     2.3 %   $ 474       -20.9 %

The amount of income taxes refunded during fiscal years 2011 and 2010 amounted to approximately $22 thousand and $6 thousand, respectively.  The amount of income tax cash payments during fiscal years 2011 and 2010 were approximately $128 thousand and $442 thousand, respectively.

In accordance with FASB Interpretation No. 48, "Accounting for Uncertainly in Income Taxes, ("FIN 48"), the Company establishes a valuation allowance if it believes that it is more likely than not that some or all of our deferred tax assets will not be realized.  The Company does not recognize a tax benefit unless it determines that it is more likely than not that the benefit will be sustained upon external examination, which is an audit by taxing authority.  The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement.  As of June 30, 2011, the Company had approximately $0.4 million in unrecognized tax benefits recorded in other long-term liabilities on its Consolidated Balance Sheet, which, if recognized would reduce tax expense and its effective tax rate.

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

   
Fiscal Year Ended June 30,
 
   
2011
   
2010
 
   
(In Thousands)
 
             
Balance, beginning of year
    362       211  
                 
Increases for tax positions related to prior year
    -       95  
Increases for tax positions related to current year
    60       56  
Decreases related to settlements
    -       -  
Reductions due to lapsed statute of limitations
    (53 )     -  
                 
Balance, end of year
    369       362  

The Company recognizes interest accrued and penalties related to unrecognized tax benefits in its income tax provision. As of June 30, 2011, the Company accrued no penalties and an insignificant amount of interest was recorded in income tax expense.

Tax positions for the Company and its subsidiaries are subject to income tax audits.  Tax returns for all tax years since fiscal year 2008 remain open to examination by the Internal Revenue Service and since 2004 for state income tax purposes.  As of June 30, 2011, there are no current federal or state income tax audits in progress.

The Company is subject to income tax in some jurisdictions outside the United States, none of which are individually material to its financial position, cash flows, or result of operations.

 
67

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

11.  Comprehensive Loss

The following table shows the computation of comprehensive:

   
Fiscal Year Ended June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Consolidated Net loss
  $ (6,975 )   $ (2,741 )
Foreign currency translation adjustments
    29       7  
Total comprehensive loss
  $ (6,946 )   $ (2,734 )

Other comprehensive loss includes gains and (losses) on the translation of foreign currency denominated financial statements.  Adjustments resulting from these translations are accumulated and reported as a component of other comprehensive income in stockholders’ equity section of the balance sheet.

12.  Net Loss per Share

Accounting standards established by the FASB requires the presentation of the basic net income (loss) per common share and diluted net income (loss) per common share.  Basic net income (loss) per common share excludes any dilutive effects of options and convertible securities. Dilutive net (loss) per common share is the same as basic net (loss) per common share since the effect of potentially dilutive securities are antidilutive.

The following table sets forth the computation and reconciliation of net loss per share:

   
Fiscal Year Ended June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Consolidated Net loss
  $ (6,975 )   $ (2,741 )
                 
Basic and dilutive:
               
Weighted average shares outstanding:
    121,259       106,460  
                 
Basic and diluted:
               
Net loss per share
  $ (0.06 )   $ (0.03 )

Potentially anti-dilutive stock options were excluded in the dilutive loss per common share calculation for the year ended June 30, 2011 and 2010.

13.  Stockholders’ Equity

Shares of common stock outstanding were as follows:

   
Fiscal Year Ended June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Beginning Balance at July 1,
    121,404       103,222  
Shares issued for exercised options
    -       -  
Shares issued to related party for additional investment
    -       18,182  
Shares issued to related party for promissory note
    -       -  
Shares repurchased
    (170 )     -  
Ending balance at June 30,
    121,234       121,404  

On August 18, 2010, Luis Rivera resigned from his positions as President and Chief Executive Officer of the Company. The Company repurchased 170,000 shares of common stock from Mr. Rivera at a purchase price of $0.33 per share.

 
68

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

On April 12, 2010, the Company entered into subscription agreements with each of (a) William T. Comfort, III, Chairman of the Company’s Board, and (b) Meudon Investments, a New York limited partnership whose general partner, James A. Urry, is another of the Company’s Board. Pursuant to the subscription agreements, Mr. Comfort purchased 12,121,212 shares of the Company’s common stock at a purchase price of $0.33 per share or $4.0 million in total and Meudon Investments purchased 6,060,606 shares of the Company’s common stock at a purchase price of $0.33 per share or $2.0 million in total.  Upon closing the deal on April 26, 2010, the Company issued 18,181,818 of its common stock and received all of the total proceeds of $6.0 million in total proceeds.  Transaction costs associated with the private placement were immaterial.

Reverse Stock Split

At the June 7, 2011 Annual Meeting for fiscal year 2010, the stockholders of the Company approved and adopted an amendment to the Company’s Certificate of Incorporation to effect the Reverse Stock Split at a ratio of not less than one for ten and not more than one for thirty and a grant of discretionary authority to the Board of Directors to effect the Reverse Stock Split at any time prior to the Annual Meeting of the Company’s stockholders for the fiscal year 2011.  As of June 30, 2011, the Company’s Board of Directors has not authorized a Reverse Stock Split.

Treasury Stock

Repurchased shares of the Company’s common stock are held as treasury shares and at cost until they are reissued. When the Company reissues treasury stock, if the proceeds from the sale are more than the average price the Company paid to acquire the shares, the Company records an increase in additional paid-in capital.  Conversely, if the proceeds from the sale are less than the average price the Company paid to acquire the shares, the Company records a decrease in additional paid-in capital to the extent of increases previously recorded for similar transactions and a decrease in retained earnings for any remaining amount.  The Company holds 170,000 shares at $56 thousand as of June 30, 2011; and 0 treasury shares as of June 30, 2010.

14.  Stock Compensation Plans

Stock Options Plan
 
On May 6, 2005, the Company established the J.L. Halsey Corporation 2005 Equity Based Compensation Plan, which it amended with the First Amendment, effective as of May 6, 2005 (together, the “Original Equity-Based Compensation Plan”).  Subsequently, the Board adopted the Second Amendment to the Original Equity-Based Compensation Plan (the “Second Amendment”) and, on May 13, 2009, the Company’s stockholders ratified the Second Amendment (the Second Amendment, together with the Original Equity-Based Compensation Plan, the “Equity-Based Compensation Plan”).  The Equity-Based Compensation Plan authorizes the granting of stock options and stock-based awards to employees, directors and certain consultants.   Stock options issued in connection with the Equity-Based Compensation Plan are granted with an exercise price per share equal to the fair market value of a share of the Company’s common stock at the date of grant.   Stock options generally become exercisable over a four year vesting period and expire 10 years from the date of the grant.   The effect of the Second Amendment was to increase the number of shares of Common Stock that may be issued in connection with awards granted under the Equity-Based Compensation Plan from 13,200,000 shares to 17,200,000 shares, thereby increasing the number of shares available for future awards under the Equity Based Compensation Plan by 4,000,000 shares.  At June 30, 2011, there were 4.6 million shares available for future issuance under the Equity-Based Compensation Plan.

The following table summarizes stock option activity from July 1, 2009 to June 30, 2011

   
Number of
options
   
Weighted-
Average
Exercise
Price
 
   
(In thousands)
 
Outstanding at July 1, 2009
    10,585     $ 0.52  
Granted
    4,244     $ 0.46  
Forfeited/expired
    (3,224 )   $ 0.47  
Outstanding at June 30, 2010
    11,605     $ 0.41  
Granted
    8,298     $ 0.34  
Forfeited/expired
    (7,193 )   $ 0.44  
Outstanding at June 30, 2011
        12,710     $ 0.34  

 
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LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

As of June 30, 2011, the calculated aggregate intrinsic value of options outstanding and options exercisable was immaterial for disclosure. The intrinsic value represents the pre-tax intrinsic value, based on the Company’s closing stock price on June 30, 2011 which would have been received by the option holders had all option holders exercised their options as of that date.  As of June 30, 2011, the Company had 10,230,000 options vested or expected to vest with a weighted average exercise price of $0.34 and a weighted average remaining contractual term of 5.9 years.  As of June 30, 2011, unamortized compensation cost related to stock options was $1.8 million.  The cost is expected to be recognized over a weighted-average period of 3.4 years.

The following table summarizes stock options outstanding and exercisable options as of June 30, 2011:
 
Exercise Prices
 
Number of
Options
Outstanding
   
Weighted-
Average
Remaining
Contractual
Life (Years)
   
Number of
Options
Exercisable
 
   
(In thousands)
         
(In thousands)
 
 $0.30 - 0.46
    11,009       6.45       3,633  
 $0.47 - 0.50
    1,701       7.66       833  
Total
    12,710               4,466  
                         
Weighted average exercise price per share
            $ 0.34  

 The Company recognizes total stock-based compensation expenses, including employee stock awards and purchases under stock purchase plans, in accordance with the standards established by FASB.

The following table summarizes the allocation of stock-based compensation expense:
 
   
Fiscal Year Ended June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Cost of revenues
  $ 140     $ 231  
General and administrative
    564       70  
Research and development
    -       15  
Sales and marketing
    149       129  
Total
  $ 853     $ 445  

The Company recognizes stock-based compensation expenses on a straight-line basis over the requisite service period of the award which is generally four years.

The weighted average fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model that uses the assumptions noted in the following table:
 
   
Fiscal Year Ended June 30,
 
   
2011
   
2010
 
Weighted average fair value of options at grant date
  $ 0.19     $ 0.19  
Expected Volatility
    77 - 79 %     78 - 79 %
Expected term of the option
 
4.5 years
   
4.5 years
 
Risk-free interest rates
    1.06 - 1.99 %     1.97 - 2.35 %
Expected dividends
    -       -  

The expected term of the options is based on the period of time that options are expected to be outstanding and is derived by analyzing historical exercise behavior of employees in the Company’s peer group as well as the options’ contractual terms.  Expected volatilities are based on implied volatilities from traded options on the Company’s peer group’s common stock, the Company’s historical volatility and other factors.  The risk-free rates are for the period matching the expected term of the option and are based on the U.S. Treasury yield curve rates as published by the Federal Reserve in effect at the time of grant.  The dividend yield is zero based on the fact the Company has no intention of paying dividends in the near term.

 
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LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
 
On July 9, 2009, the Company’s Compensation Committee modified the exercise price of 3,429,499 outstanding stock option awards granted to 178 employees, including executives, by exchanging each employee stock option with an exercise price greater than $0.50 for a stock option with a $0.50 exercise price on a one share-to-one share basis.  The other terms of the stock option awards such as the commencement date and vesting schedule remained unchanged.  The Company used the binomial lattice pricing model and the following assumptions to determine the fair value of the repriced options:

Expected Volatility
    78 %
Expected term of the option
 
4.5 years
 
Risk-free interest rates
    0.47 - 3.44 %
Expected dividends
    -  
 
Total additional stock-based compensation expense associated with the modification was $99 thousand of which $69 thousand was recognized in fiscal year 2010.  The remaining $30 thousand in unamortized stock-based compensation expense will be recognized over the remaining vesting period of the unvested stock options.

Retirement Plans

The Company has a defined contribution 401(k) Plan covering substantially all of its employees.  Beginning September 2006, the Company began making matching contributions to the 401(k) Plan.  During fiscal year 2009, due to difficult business conditions and the economic downturn, the Company discontinued the 401(k) matching plan program.  As such, in fiscal year 2011 and 2010, there was no employee related expense associated with the Company’s 401(k) contribution match program.

Annual Incentive Bonus

On August 1, 2008, the Annual Incentive Bonus plan (the “Bonus Plan”) was approved by the Company’s Compensation Committee of the Board of Directors (the “Compensation Committee”).  Under this Bonus Plan certain key employees, including the named executive officers are eligible to receive cash bonus payments following each fiscal quarter.  The objectives of the Bonus Plan include aligning the eligible participants’ performance with the Company’s business goals to reward and retain high performing key employees and to attract high quality employees to the Company.

15.
Commitments and Contingencies

The Company’s commitments consist of obligations under operating leases for corporate office space and co-location facilities for data center capacity for research and test data centers.  The Company has also entered into capital leases in connection with acquiring computer equipment for its data center operations which is included in property and equipment.  The Company used a 5.25% interest rate to calculate the present value of the future principal payments and interest expense related to its capital leases. Additionally, in the ordinary course of business, the Company enters into contractual purchase obligations and other agreements that are legally binding and specify certain minimum payment terms.

During the third quarter of fiscal year 2011, the Company entered into a lease agreement for an average of $2,250 per month for the next 36 months plus a value added tax which is currently at 21%, for a new facility in Buenos Aires, Argentina.

From the acquisition of Cogent in the fourth quarter of fiscal year 2011, the Company assumed the lease agreement of its acquiree for an average of $9,600 per month for the next 18 months, for a facility in Ultimo, Australia. Refer to Note 3 of the Notes to Consolidated Financial Statements.

 
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LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

   
Operating Leases
             
   
Facilities
   
Co-location
Hosting
Facilities
   
Other
   
Total
Operating
   
Capital
Leases
   
Total
 
   
(In thousands)
 
Fiscal Year 2012
    1,387       1,060       77       2,524       206       2,730  
Fiscal Year 2013
    1,000       155       14       1,169       138       1,307  
Fiscal Year 2014
    774       -       1       775       29       804  
Fiscal Year 2015
    658       -       -       658       5       663  
Thereafter
    506       -       -       506       -       506  
Total
  $ 4,325     $ 1,215     $ 92     $ 5,632     $ 378     $ 6,010  
Less amounts representing interest
                                    (21 )        
Present value minimum lease payments
                                  $ 357          
Less short-term portion
                                    (192 )        
Long-term portion
                                  $ 165          

The Company occupies the majority of its facilities under non-cancellable operating leases with lease terms in excess of one year. Such facility leases generally provide for annual increases based upon the Consumer Price Index or fixed increments. Rent expense under operating leases totaled $1.2 million and $1.4 million during fiscal years 2011 and 2010, respectively.

Legal claims
   
From time to time, the Company is a party to litigation and subject to claims incident to the ordinary course of business, including customer disputes, breach of contract claims and other matters.  Although the results of such litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of such litigation and claims will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.  Due to the inherent uncertainties of such litigation and claims, the Company’s view of such matters may change in the future.

16.
Segment Reporting

ASC 280 “Segment Reporting,” or ASC 280, establishes standards for the way public business enterprises report information about operating segments in annual consolidated financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. ASC 280 also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company concluded that there is only one reportable segment as it is a SaaS-based online marketing solutions and service provider and uses an integrated approach in developing and selling its solutions and services. The Company’s Chief Executive Officer has been identified as the Chief Operating Decision Maker as defined by ASC 280.
 
17.
Subsequent Events

On August 17, 2011 the Company entered into a Termination Agreement (the “Agreement”) with SiteWit Corp. (“SiteWit”), a privately held company that provides an online marketing search engine to its customers. Pursuant to the Agreement, the Strategic Partnership Agreement dated July 23, 2010, as amended, by and between SiteWit and the Company and the Stock Purchase Agreement dated July 23, 2010 by and between SiteWit and the Company (together, the “Prior Agreements”) were terminated effective as of August 17, 2011.
 
The Company entered into the Prior Agreements with SiteWit to secure the right to use SiteWit’s online marketing search engine technology and to develop and market certain services related to SiteWit’s product. To date, the Company has invested $750,000 in SiteWit and owns a minority of SiteWit’s outstanding stock.

Due to a disagreement regarding the parties’ respective rights and obligations under the agreements, the parties have mutually agreed to terminate the Prior Agreements and release one another from all rights and obligations thereunder. Pursuant to the Agreement, the Company will make no further investments in SiteWit, the right of the Company to designate one of the members of SiteWit’s board of directors was terminated and the Company has returned to SiteWit approximately 75% of the SiteWit shares that were issued to the Company pursuant to the Prior Agreements. For a period of 18 months commencing on August 17, 2011, the Company’s remaining SiteWit shares are subject to a right of repurchase by SiteWit or SiteWit’s shareholders for the original aggregate purchase price, and under some circumstances the Company would have a one-time right to require SiteWit to repurchase all the remaining SiteWit shares that the Company holds.

 
72

 

LYRIS INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

On August 31, 2011, James A. Urry informed the Company of his resignation from the board of directors of the Company, effective immediately.

On August 31, 2011, the Company entered into a Seventh Amendment (“Seventh Amendment”) to the Loan Agreement with Comerica Bank (“Bank”). The Seventh Amendment revises the terms of the Loan Agreement.

The Seventh Amendment reduced the Company’s existing revolving line of credit from $5,000,000 to $2,500,000 (“Existing Line”).  The amount available under the Existing Line is limited by a borrowing base, which is 80% of the amount of the aggregate of our accounts receivable, less certain exclusions. The Seventh Amendment also extends the Company to a second revolving line of credit of $2,500,000 (“Non-Formula Line,” and together with the Existing Line, the “Revolving Lines”).  The Revolving Lines mature on April 30, 2012.

Advances under the Revolving Lines will accrue interest at a variable rate calculated as the Bank’s prime rate plus a margin of 2.5% for the Existing Line and the Bank’s prime rate plus a margin of 0.5% for the Non-Formula Line.  Interest is payable monthly, and principal is payable upon maturity.

The Seventh Amendment contains additional covenants for the Company, including that the Company will raise $2,000,000 in new equity prior to February 28, 2012 and will maintain the following minimum amounts of EBITDA (measured on a trailing three months basis):

Measurment Period Ending
 
Minimum Trailing
Six Month EBITDA
 
7/31/2011
  $ (1,500,000 )
8/31/2011
  $ (1,400,000 )
9/30/2011
  $ (1,350,000 )
10/31/2011
  $ (750,000 )
11/30/2011
  $ (350,000 )
12/31/2011
  $ 50,000  

Repayment of the Revolving Lines is secured by a security interest in substantially all of the Company’s assets.  In addition, Mr. William T. Comfort, III, the Company’s Chairman of the Board, agreed to guarantee its repayment of indebtedness under the Seventh Amendment (the “Limited Guaranty”).  Mr. Comfort also entered into a Pledge and Security Agreement with the Bank (“Pledge Agreement”), a Reimbursement and Security Agreement with the Borrowers (“Reimbursement and Security Agreement”), and a Subordination Agreement with the Bank and the Company (“Subordination Agreement”).  Under the Pledge Agreement, Mr. Comfort granted the Bank a security interest in cash collateral maintained at the bank, as security for the performance of Mr. Comfort’s obligations under the Limited Guaranty. The Company also agreed to reimburse Mr. Comfort for all amounts paid to the Bank and all costs, fees and expenses incurred by Mr. Comfort under the Limited Guaranty and Pledge Agreement.  As security for the Company’s reimbursement obligations, the Company granted Mr. Comfort a security interest in the same property which secures its obligations under the Loan Agreement.  Under the Subordination Agreement, the Company’s indebtedness and obligations to Mr. Comfort are subordinated to the Company’s indebtedness and obligations to the Bank

As of June 30, 2011 and July 31, 2011, the Company was not in compliance with the terms of the Loan Amendment as the Company did not meet its liquidity covenant which requires the Company to have $1.0 million in liquidity. The Company’s liquidity is determined by its unrestricted cash at Bank and unused availability under its revolving line of credit.  As part of the Seventh Amendment, the Bank waived compliance with the Company’s liquidity covenant for the June and July 2011 measurement period. The Company was in compliance with all of its covenants for the August 2011 measurement period.

On September 19, 2011, Keith Taylor, the Company’s Chief Financial Officer, Treasurer and Secretary, unexpectedly passed away.  The Company’s Board of Directors called a meeting on September 20, 2011 and named its President and Chief Executive Officer, Wolfgang Maasberg as Interim Chief Financial Officer, Treasurer and Secretary.

 
73

 

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

None

 
74

 

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934 (the “Exchange Act”).  This evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer.   Based on the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this Form 10-K, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

As of June 30, 2011, there were no changes in our internal control over financial reporting during the fourth quarter of fiscal year 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management’s Annual report on Internal Control over Financial Reporting

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

Management assessed our internal control over financial reporting as of June 30, 2011, the end of our fiscal year.  Management based its assessment on criteria established by the Committee of Sponsoring Organizations of the Treadway Commission in (COSO).   Management’s assessment included evaluation of elements such as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies and our overall control environment.

Based on our assessment of our internal control over financial reporting as of June 30, 2011, management has concluded that our internal control over financial reporting was effective as of the end of the fiscal year to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

This report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to the temporary rules of the SEC that permit the Company to provide only management’s report in this Annual report.

Inherent Limitations on Effectiveness of Controls

Our management, including our Chief Executive Officer and Interim Chief Financial Officer, believe that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives, and our Chief Executive Officer and Interim Chief Financial Officer have concluded that these controls and procedures are effective at the “reasonable assurance” level. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

 
75

 

ITEM 9B. OTHER INFORMATION

None

 
76

 

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS and CORPORATE GOVERNANCE

DIRECTORS

Our directors as of August 31, 2011 are as follows:

Name of Director
 
Age
 
Title
 
Annual Meeting at
 which Term Ends
             
Andrew Richard Blair
 
78
 
Director
 
2012
             
William T. Comfort, III
 
45
 
Director, Chairman of the Board of Directors
 
2014
             
Nicolas De Santis Cuadra
 
45
 
Director
 
2012
             
Wolfgang Maasberg
 
39
 
Director, Chief Executive Officer
 
2014

Andrew Richard Blair has been a member of our Board since November 12, 2002. He is a founder of Freimark Blair & Company, Inc., a broker-dealer research boutique.  Mr. Blair has served as President, Chief Executive Officer, Chief Financial Officer and as a director of Freimark Blair since January 1983.  Mr. Blair received his B.S. in Science and Business Administration from Wake Forest University. We believe that Mr. Blair possesses specific attributes that qualify him to serve as a member of our Board of Directors and to serve as chair of our audit committee, including his financial and accounting expertise and his substantial knowledge of financial markets.

William T. Comfort, III has served as a member of our Board since May 2002 and as Chairman of the Board since November 12, 2002. He was a private equity investment professional with CVC Capital Partners, a leading private equity firm based in London, England, from February 1995 until December 2000. From February 2001 to February 2003 he served as a consultant to Citicorp Venture Capital (“CVC”).  He is now principal of Conversion Capital Partners Limited, an investment fund headquartered in London.  Mr. Comfort also has served as a director of numerous public and private companies as a representative of CVC Capital Partners and CVC, from all of which he has resigned.  Mr. Comfort is currently a director of Kofax, Inc.  Mr. Comfort received his J.D. and L.L.M. in tax law from New York University School of Law. We believe Mr. Comfort should serve as a member of our board of directors based on the important perspective he brings to our board of directors and management team from his extensive experience as a investor in a numerous businesses, both public and privately held, providing guidance and counsel to a wide variety of companies and service on the boards of directors of numerous private and publicly-held companies.

Nicolas De Santis Cuadra has been a member of our Board since January 16, 2003. Mr. De Santis Cuadra has served since January 2003 as the Chief Executive Officer of London-based Twelve Stars Communications (now called Corporate Vision Strategists), an international strategic vision and brand business consulting firm, located in London, England, which Mr. De Santis Cuadra founded in 1994. He previously served as the Chief Executive Officer of Twelve Stars Communications from 1994 until December 1998. From December 2000 until January 2003, Mr. De Santis Cuadra served as the marketing director of OPODO Ltd., an online travel portal owned by British Airways, Lufthansa, Air France and several other European-based airlines. From January 1999 until December 2000, Mr. De Santis Cuadra served as Senior Vice President and Chief Marketing Officer of Beenz.com, the Internet currency website sold to Carlson Marketing the U.S.A based global marketing services company. We believe that Mr. De Santis’ should serve as a member of our Board of Directors because his substantial strategic planning and marketing experience and his executive experience at several Internet related businesses.

Wolfgang Maasberg joined our Company as Chief Executive Officer and our Board on August 18, 2010. Prior to joining our Board, he served as Vice President Sales, Americas, of the Omniture business unit at Adobe Systems since its January 2010 acquisition of Omniture.  From May 2005 to January 2010, Mr. Maasberg served in various senior sales management positions at Omniture, including most recently as Senior Vice President Sales, Americas. Mr. Maasberg began his career at Dell Computer in 1997.  In 2000 he joined FIT Technologies as Vice President of Sales. Prior to Omniture he held sales and sales leadership responsibilities at Coremetrics (recently acquired by IBM) where he finished as Regional Vice President of Sales, North America. We believe that Mr. Maasberg should serve as a member of our Board of Directors because of his substantial leadership experience with Internet marketing companies as well as his position as the senior executive of our Company.

 
77

 

Our certificate of incorporation provides that the Board is divided into three classes, designated Class I, Class II and Class III.  Directors serve for staggered terms of three years each.  Messrs. Blair and De Santis Cuadra currently serve as Class I directors, whose terms expire at the 2012 Annual Meeting of Stockholders. Due to the resignation of James A. Urry from our Board effective as of August 31, 2011, there are currently no Class II directors.  Mr. Comfort and Mr. Maasberg currently serve as Class III directors, whose term expires at the 2014 Annual Meeting of Stockholders.

EXECUTIVE OFFICERS

Our executive officers as of September 20, 2011 are as follows:

Name
 
Age
 
Title
         
Wolfgang Maasberg
 
39
 
President, Chief Executive Officer,
       
Interim Chief Financial Officer, Treasurer and Secretary
Phil Sakakihara
 
68
 
Chief Technology Officer
Nello Franco
 
45
 
Senior Vice President of Customer Success
Jim Lovelady
 
48
 
Senior Vice President of Sales
Tina Stewart
 
46
 
Senior Vice President of Marketing

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

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

Philip Sakakihara joined our Company as Chief Technology Officer in January, 2011. Most recently, he was founder and CTO of OnVideon, a provider of SaaS-cloud computing solutions since January 2008 and also founder and principal of Global Mountain Software, a full service software development and program management consulting business since 2006. Mr. Sakakihara prior experience includes CTO of Enterprise Products at Fidelity National Financial and at Hewlett Packard, where he began his career and was eventually General Manager for Distributed Computing Products. Mr. Sakakihara has both a BS and a MS in applied mathematics and served as a full time visiting professor at the University of California, Davis in networks, database and object based systems.
 
Nello Franco who joined us in February, 2011 is the Company’s Senior Vice President of Customer Success responsible for all aspects of our portfolio of client services, including client relations and account implementation and management. Most recently, Mr. Franco was VP Field Operations for SCOPIX, a provider of technology solutions for retail store management since October 2009 and was previously with W-5 Networks since July 2005 where he was VP Marketing and Field Operations. From 2001-2005, Mr. Franco was VP, Services and Support for Tacit Software.  Franco holds a BA degree in Political Science and International Relations from the University of California, Los Angeles.
 
Jim Lovelady is our Senior Vice President of Sales and joined the Company in October 2010. Prior to joining Lyris, he was Vice President of Sales for Production Services Associates LLC, a marketing supply chain management company during 2010 and Vice President, Retail Sales at Cellfire, Inc., a digital mobile marketing services provider from 2007 thru 2009.  He also worked for Epsilon, a provider of marketing automation technologies as Vice President, Sales from 2006 thru 2007; Yesmail, an email services provider, from 2002 thru 2005 as Vice President, Sales; and, Digital Impact, a digital marketing and services company, as Regional Vice President, Sales. Lovelady holds a bachelor of business administration degree from Cleary University, Ann Arbor, Michigan.

Tina Stewart is our Senior Vice President of Marketing and joined the Company in November 2010. Prior to joining our Company, she worked for Juniper Networks a networking, security and software company from October 2006 to September 2010 where most recently she served as Senior Director of Web and Online Strategy. Previous to that, she was Vice President of Worldwide Marketing for Arbor Networks from September 2005 to September 2006 and has also held senior marketing roles at several other technology companies. Stewart holds a bachelor of science degree in public relations and a master of science degree in mass communications from San Jose State University, San Jose, California.

Keith Taylor was appointed our Chief Financial Officer in January 2011 and unexpectedly passed away on September 19, 2011.  Our board of directors called a meeting on September 20, 2011 and named our President and Chief Executive Officer, Wolfgang Maasberg as Interim Chief Financial Officer, Treasurer and Secretary.

 
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COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

Section 16(a) of the Exchange Act requires our directors, executive officers and holders of more than 10% of our shares of common stock to file with the SEC initial reports of ownership and reports of changes in such ownership.  SEC rules require such persons to furnish us with copies of all Section 16(a) reports that they file. Based on a review of these reports and on written representations from the reporting persons that no other reports were required, we believe that the applicable Section 16(a) reporting requirements were complied with for all of the transactions which occurred in the fiscal year ended June 30, 2011 with the following exception.  In November 2010 a Form 3 reporting no ownership of shares or options for Tina Stewart was not filed in a timely basis. In February 2011 a Form 4 for Nello Franco for an award of options was not filed on a timely basis.
 
CODE OF ETHICS

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

STOCKHOLDER NOMINATION

Our Bylaws contain provisions addressing the process by which a stockholder may nominate an individual to stand for election to the Board of Directors at our Annual Meeting.  Historically, we have not had a formal policy concerning stockholder recommendations for nominees. Given our size, the Board of Directors does not feel that such a formal policy is warranted at this time.  The absence of such a policy, however, does not mean that a reasonable stockholder recommendation will not be considered, in light of our particular needs and the policies and procedures set forth above. Procedures for submitting such stockholder recommendations are set forth under “Stockholder Communications with the Board” below. The Board of Directors will reconsider this matter at such time as it believes that our circumstances, including our operations and prospects, warrant the adoption of such a policy.
 
Stockholder Communications with the Board
 
We have no formal process by which stockholders may communicate directly with directors.  However stockholders may direct communications intended for the Board of Directors to the Secretary of the Company, at 6401 Hollis St., Suite 125, Emeryville, California 94608.  The envelope containing such communication must contain a clear notation indicating that the enclosed letter is a “Stockholder-Board Communication” or “Stockholder-Director Communication” or similar statement that clearly and unmistakably indicates the communication is intended for the Board of Directors.  All such communications must clearly indicate the author as a stockholder and state whether the intended recipients are all members of the Board of Directors or just certain specified directors.  The Secretary of the Company will make copies of all such communications and circulate them to the appropriate director or directors.

AUDIT COMMITTEE

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

 
·
our accounting and financial reporting process;

 
·
the quality and integrity of the financial statements and other financial information that we provide to any governmental body or the public;

 
·
our compliance with legal and regulatory requirements;

 
·
the independent auditors’ qualifications and independence; and

 
·
the performance of our internal audit function and independent auditors.

The role and other responsibilities of the Audit Committee are set forth in the Audit Committee Charter.  The Audit Committee Charter is not available on our website.  A copy of the First Amended and Restated Audit Committee Charter was last provided to stockholders as an exhibit to the proxy statement for our annual meeting for fiscal year 2010, which was originally filed with the SEC on April 25, 2011.

The members of the Audit Committee are Messrs. Blair and De Santis Cuadra, with Mr. Blair serving as chairman.  The Board has affirmatively determined that all members of the Audit Committee meet the current independence requirements of the NASDAQ Stock Market listing standards and applicable rules and regulations of the SEC.  Those standards require that, in addition to meeting the independence standards set forth under “Certain Relationship and Related Transactions – Director Independence,” each member of the Audit Committee must not be an affiliate of ours and must not receive from us, directly or indirectly, any consulting, advisory or other compensatory fees except for fees for services as a director.  The Board also has determined that Mr. Blair satisfies the requirements for an “audit committee financial expert” and has designated Mr. Blair as our audit committee financial expert.

 
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Compensation Committee
 
The Compensation Committee’s purpose is to assist the Board of Directors in determining the compensation of senior management and administering our benefit plans.  The Compensation Committee of our Board of Directors (the “Compensation Committee”) currently is composed of Mr. Comfort. Mr. Urry served on the Committee during fiscal year 2011, but resigned in August 31, 2011.  During fiscal year 2011, the Compensation Committee held two meetings.
 
The Compensation Committee currently does not have a charter.  The Compensation Committee establishes the salaries of all corporate officers, including the named executive officers set forth in the Summary Compensation Table under “Executive Compensation,” and directs and administers our incentive compensation plans. The Compensation Committee also reviews with the Board of Directors its recommendations relating to the future direction of corporate compensation practices and benefit programs.  The Compensation Committee does not have the authority to delegate any of its responsibilities.  The Compensation Committee may receive recommendations from our Chief Executive Officer or other officers regarding executive compensation and benefits and may secure the services of our accounting and human resources department in fulfilling its responsibilities.  To date, the Compensation Committee has not retained independent advisors in the fulfillment of its responsibilities.
 
The Board of Directors has determined that all of the members of the Compensation Committee satisfy the independence requirements of the listing standards of The NASDAQ Stock Market.  Additionally, Mr. Urry qualified as a “non-employee director” under applicable SEC rules, and Mr. Comfort qualifies and Mr. Urry qualified as “outside directors” under Section 162(m) of the Code.

 
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ITEM 11.  EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

The following table summarizes, with respect to our Chief Executive Officer and each of our other named executive officers, information relating to the compensation earned for services rendered in all capacities during fiscal year 2011.

Name and
Principal Position
 
Year
 
Salary
$
   
Bonus
$
   
 
Stock
Awards
$
   
Option
Grants (1)
$
   
Non-Equity
Incentive Plan
Compensation (2)
$
   
All Other
Compensation
$
   
Total
$
 
Wolfgang Maasberg (3)
                                             
President and Chief Executive Officer
 
2011
    303,782       100,000       1,485,000       186,652       100,000       30,000       2,205,434  
                                                             
Luis A. Rivera (4)
                                                           
Former President and Chief Executive Officer
 
2011
    34,134                                       402,876       437,010  
   
2010
    204,167                               161,144       14,615       379,926  
                                                             
Keith Taylor (5)
                                                           
Former Chief Financial Officer
 
2011
    115,641       25,000               191,347       19,701       2,500       354,189  
                                                             
Heidi Mackintosh (6)
                                                           
Former Chief Financial Officer
 
2011
    142,723       25,901                               155,081       323,705  
   
2010
    220,000                               31,280               251,280  
                                                             
Jim Lovelady (7)
                                                           
SVP of Sales
 
2011
    151,284       30,000               55,627               41,582       278,493  
                                                             
Tina Stewart (8)
                                                           
SVP of Marketing
 
2011
    147,407                       46,952       26,612       3,000       223,971  
 
(1)
Reflects the grant date fair value of the awards made in fiscal 2011 in accordance with the ASC 718. The assumptions used in the valuation of these awards are set forth in Note 14 to our consolidated audited financial statements for the fiscal year ended June 30, 2011, included in this Annual Report on Form 10-K and do not purport to reflect the value that will be recognized by the named executive officers upon the sale of the underlying securities. The vesting provisions of these options are also described in the footnotes to the 2011 Outstanding Equity Awards at Fiscal Year-End table below.

(2)
These compensation awards were awarded by the Compensation Committee as Company Performance Bonus awards under our bonus plan (our bonus plan is discussed in greater detail in the narrative following the Summary Compensation Table) for fiscal year 2011.

(3)
Pursuant to the terms of Mr. Maasberg’s employment agreement, $100,000 of his bonus was a sign on bonus and $30,000 of his performance bonus was guaranteed. Also pursuant to the terms of that agreement, Mr Maasberg was paid $30,000 in fiscal 2011 to offset the cost of living increase associated with his relocation. Mr. Maasberg’s compensation under Option Grants above consists of $186,652 as the grant date fair value for options granted in fiscal year 2011. Mr. Maasberg’s compensation under Bonus above consists of $1,485,000 as the grant date fair value for restricted stock units granted in fiscal year 2011.

(4)
Mr. Rivera resigned from his positions as President and Chief Executive Officer on August 18, 2010. Additional amounts included above in All Other Compensation for fiscal 2011 are severance payments of $375,000 and payout of accrued vacation of $27,876.

(5)
Mr. Taylor unexpectedly passed away on September 19, 2011.  Pursuant to the terms of Mr. Taylor’s employment agreement, $25,000 of his bonus was paid as a sign on bonus for his first five months of employment. Mr. Taylor also received $2,500 to offset commuting expenses. Mr. Taylor’s compensation under Option Grants above consists of $191,347 as the grant date fair value for options granted in fiscal year 2011.
 
 
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(6)
Ms Mackintosh resigned from her positions as Chief Financial Officer, Secretary and Treasurer effective January 31, 2011. In fiscal 2011, the amounts included above in All Other Compensation are severance payments of $125,000, payout of accrued vacation of $22,842 and COBRA reimbursements of $7,239.

(7)
Pursuant to the terms of Mr. Lovelady’s employment agreement, $30,000 of his bonus was a sign on bonus. Mr. Lovelady also received sales commissions of $41,582. Mr. Lovelady’s compensation under Option Grants above consists of $55,627 as the grant date fair value for options granted in fiscal year 2011.

(8)
Pursuant to the terms of Ms. Stewart’s employment agreement, she was reimbursed $3,000 for relocation expense.  Ms. Stewart’s compensation under Option Grants above consists of $46,952 as the grant date fair value for options granted in fiscal year 2011.

Compensation Philosophy and Objectives

Our compensation programs and policies focus mainly on retaining and attracting employees necessary to operate the acquired subsidiaries and grow our business.  To date, we have not undertaken a formal study to determine whether compensation paid to our executives is competitive with that of our competitors.  Instead, the Compensation Committee has focused on one-on-one negotiations with our executives at the time of hire for the purpose of recruiting the executive in order to assemble an executive team that will develop and implement our long-term strategic goals.

Employment Agreements/Arrangements

We have entered into employment agreements with our named executive officers.  The employment agreements have the following general terms.

Wolfgang Maasberg. Effective August 18, 2010, we entered into an employment agreement with Wolfgang Maasberg in connection with his appointment to serve as our President and Chief Executive Officer.  The term of the agreement is for three years and will automatically extend for one year at the end the initial term of the agreement and at the end of each annual extension term unless 90 days prior written notice is given prior to the end of the term.  The initial base salary under the agreement is $350,000 and Mr. Maasberg is eligible to receive an annual cash bonus of up to $100,000, $30,000 of which is guaranteed for fiscal 2011.  We agreed to pay Mr. Maasberg a sign on bonus of $10,000 per month for each month he remains an employee for up to 18 months.  In addition, Mr. Maasberg received an award of options to purchase 1,500,000 shares of our common stock, par value $0.01 per share, at an exercise price of $0.33 per share that vest over four years, with 25% of the total number of shares subject to the option vesting on August 18, 2011, and the remainder vesting in equal installments of 1/12 of the total number of shares subject to the option on each three-month anniversary thereafter.  We awarded Mr. Maasberg 4,500,000 restricted stock units (“RSUs”) that vest over four years, with 25% vesting on August 18, 2011, and the remainder vesting in equal installments of 1/12 of the total number of shares subject to the RSU on each three-month anniversary thereafter.  Additionally, we agreed to pay Mr. Maasberg relocation payments not to exceed $94,500.  Mr. Maasberg is eligible to participate in any of the Company’s employee benefit plans to the extent applicable generally to our other employees.

The employment agreement also provides for certain payments to Mr. Maasberg described in greater detail below in the section titled “Potential Payments upon Termination or Change in Control.”

Luis A. Rivera. Effective May 12, 2005, Lyris Technologies, Inc., our wholly owned subsidiary, entered into an employment agreement with Luis A. Rivera, to serve as President and Chief Executive Officer. The term of the agreement was for five years and expired on May 12, 2010.  The initial annual base salary under the agreement was $200,000, which was raised to $250,000 on May 27, 2010 and Mr. Rivera was eligible to receive a quarterly performance bonus based on our profitability.  In addition, Mr. Rivera received an award of options to purchase 3,600,000 shares of our Common Stock, par value $0.01 per share, at an exercise price of $0.30 per share that vested ratably on a quarterly basis over four years from the date of grant.  Mr. Rivera was also eligible to participate in any “Investment Plans” and “Welfare Plans” (as defined in the employment agreement) to the extent applicable generally to our other employees.

Mr. Rivera resigned from the Company effective August 18, 2010 and was entitled to certain severance payments under the terms of his employment agreement.  The severance payments to Mr. Rivera are described in greater detail below in the section titled “Potential Payments upon Termination or Change in Control.”

Mr. Rivera is subject to non-competition and non-solicitation provisions for a twelve month period following his termination and ongoing confidentiality and non-disparagement obligations.
 
 
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Keith Taylor. Effective January 31, 2011, we entered into an agreement with Keith Taylor to serve as Chief Financial Officer.  The annual base salary under the agreement is $275,000 and he is eligible for an incentive bonus of up to 25%.  Mr. Taylor also received a sign on bonus of $60,000 payable monthly at a rate of $5,000 per month for his first twelve months of employment subject to repayment of one hundred percent of the bonus if he is terminated for cause or voluntarily terminated with in the first twelve months of his employment.  Mr. Taylor is also eligible for a relocation allowance of up to $25,000 during his second year of employment subject to repayment of one hundred percent of this allowance if he is terminated for cause or voluntarily terminated within twelve months of the payment date of this allowance. Unless and until Mr. Taylor would relocate, he will be paid a commute expense allowance of $500 per month.  Mr. Taylor received an award of options to purchase 1,250,000 shares of our Common Stock at an exercise price of $0.33 per share.  Twenty-five percent of the shares underlying the option vest on January 31, 2012, which is the first anniversary of his date of hire and the remaining 75% vest in equal installments of 1/12 of the total number of shares subject to the option on each three month anniversary of his date of hire thereafter.  Mr. Taylor is also eligible to participate in the Company’s benefit plans to the extent applicable generally to our other employees. The employment agreement also provided for certain severance payments to Mr. Taylor described in greater detail below in the section titled “Potential Payments upon Termination or Change of Control.” Mr. Taylor unexpectedly passed away on September 19, 2011.
 
Heidi Mackintosh.  Effective April 15, 2008, we entered into an agreement with Heidi Mackintosh to serve as Chief Financial Officer.  The initial base salary under the agreement was $220,000 and she was also eligible for an incentive bonus of up to $49,500. In addition, Ms. Mackintosh received an award of options to purchase 400,000 shares of our Common Stock at an exercise price of $0.83 per share.  Twenty-five percent of the shares underlying option vested on May14, 2009, which was the first anniversary of her employment starting date and the remaining 75% vested in equal quarterly installments on the last day of each calendar quarter, provided that the fourth anniversary of her starting date was considered the last day of the quarter for vesting purposes.  Ms. Mackintosh was also eligible to participate in the Company’s benefit plans to the extent applicable generally to our other employees.  On January 19, 2010, Ms. Mackintosh was granted an award of options to purchase 150,000 shares of our Common Stock at an exercise price of $0.50 per share, which vested 25% on January 19, 2011 and the remaining 75% in equal quarterly installments on the last day of each calendar quarter provided that the fourth anniversary of the grant date shall be deemed to be the last day of the calendar quarter for vesting purposes.  On May 24, 2010 Ms. Mackintosh was granted an award of options to purchase 100,000 shares of our Common Stock at an exercise price of $0.40 per share, which would vest in four equal annual installments beginning May 24, 2011.

Ms. Mackintosh resigned from the Company effective January 31, 2011 and her unvested options were forfeited and she had 90 days to exercise her vested options, which she did not exercise.  She was also entitled to certain severance payments under the terms of her employment agreement.  The severance payments to Ms. Mackintosh are described in greater detail below in the section titled “Potential Payments upon Termination or Change in Control.”

Jim Lovelady.  Effective October 25, 2010, we entered into an agreement with Jim Lovelady to serve as Senior Vice President of Sales.  The initial base salary under the agreement is $185,000 and he is also eligible for an annual variable salary targeted at $95,000 paid monthly against quota performance. Mr. Lovelady also received a sign on bonus of $30,000 payable monthly at a rate of $5,000 per month for his first six months of employment subject to repayment of one hundred percent of the bonus if he voluntarily terminates within the first twelve months of his employment.  In addition, Mr. Lovelady received an award of options to purchase 300,000 shares of our Common Stock at an exercise price of $0.33 per share.  Twenty-five percent of the shares underlying the option vest on October 25, 2011, which is the first anniversary of his date of hire and the remaining 75% vest in equal installments of 1/12 of the total number of shares subject to the option on each three month anniversary of his date of hire thereafter.  Mr. Lovelady is also eligible to participate in the Company’s benefit plans to the extent applicable generally to our other employees. The employment agreement also provided for certain severance payments to Mr. Lovelady described in greater detail below in the section titled “Potential Payments upon Termination or Change of Control.”

Tina Stewart.  Effective November 15, 2010, we entered into an agreement with Tina Stewart to serve as Senior Vice President of Marketing.  The initial base salary under the agreement is $236,000 and she is also eligible for an annual bonus of up to $56,000. Ms. Stewart was also eligible for reimbursement of hotel and living expenses of up to $15,000 during the first six months of her employment subject to repayment of one hundred percent of the expense reimbursement if she was terminated for cause or voluntarily terminated with in the first twelve months of his employment.  In addition, Ms. Stewart received an award of options to purchase 500,000 shares of our Common Stock at an exercise price of $0.33 per share.  Twenty-five percent of the shares underlying the option vest on November 24, 2011, which is the first anniversary of the date of the option grant and the remaining 75% vest in equal installments of 1/12 of the total number of shares subject to the option on each three month anniversary of the date of the option grant thereafter.  Ms. Stewart is also eligible to participate in the Company’s benefit plans to the extent applicable generally to our other employees. The employment agreement also provided for certain severance payments to Ms. Stewart described in greater detail below in the section titled “Potential Payments upon Termination or Change of Control.”

Annual Bonus Plan

On August 1, 2008, the Compensation Committee approved an annual incentive bonus plan, under which key employees, including our named executive officers, are eligible to receive quarterly cash bonus payments.  The objectives of the bonus plan are to align participants’ incentives with Lyris’ business goals and to reward and retain high performing key employees.
 
 
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Under the bonus plan, participants are eligible to receive bonuses based on individual performance and our Company’s performance.  Individual performance objectives may be established by the Compensation Committee.  Company performance (the “Company Performance Bonus”) is based on the following criteria: (1) net new monthly hosted revenue additions (“net new MRR”); (2) total revenue; and (3) corporate earnings before interest, taxes, depreciation and amortization (“EBITDA”).  The Compensation Committee may select additional criteria for the Company Performance Bonus. For each bonus plan year, the Compensation Committee will establish the percentage to use for each of the criteria that comprise the Company Performance Bonus, such that participants are aware of the relative importance of each criterion in determining any Company Performance Bonuses.  To the extent the Company exceeds performance targets participants are eligible for additional bonus awards.

In the first and second quarters of fiscal 2011 the Compensation Committee determined not to set performance targets under this bonus plan due to the difficult economic environment and the executive turnover.  However, the Compensation Committee believed that bonuses also serve an important retention purpose, so it decided to award discretionary bonuses to the named executives based on the Committee’s judgment about the Company’s financial resources that were available for this purpose and their evaluation of the individual performance of the executive. In the first and second quarters, only Ms. Mackintosh was an employee for both quarters and was awarded a bonus equal to 100% of her bonus potential. Mr. Maasberg joined the company midway through the first quarter and was awarded the guaranteed bonuses discussed above under “Employment Agreements/Arrangements” for the first and second quarters. Ms. Stewart joined the company midway through the second quarter and was awarded a bonus equal to 100% of her bonus potential prorated for that quarter.

For the third and fourth quarters of fiscal 2011, the Compensation Committee established Company performance criteria under the bonus plan and no individual performance measures.  The Company performance criteria were weighted as follows: 50% based on committed annual value of new contracts (ACV) and 50% on the contract value of cancelled contracts (churn).

   
% Weighting
   
3rd Quarter
   
4th Quarter
 
New contract ACV
    50       2,688,000       2,765,000  
Churn
    50       3,060,000       2,880,000  

Target bonus amounts for our named executive officers in fiscal 2011 were; 25% of annual base salary for Mr. Taylor; prorated for his start date in the third quarter and 24% of annual base salary for Ms. Stewart. Mr. Lovelady is paid commissions on achieving certain sales quotas and does not participate in the bonus plan.

Mr. Maasberg’s performance bonus potential is $100,000 although for fiscal 2011, $30,000 of that bonus was guaranteed. His performance bonus is based on specific criteria negotiated between Mr. Maasberg and the Compensation Committee. For fiscal 2011, those objectives were: (1) restructure executive management team; stabilize existing product platforms; (3) develop and initiate next generation product strategy; (4) restructure the company’s technology investments; and (5) stabilize customer churn.

Aggregate bonus amounts paid to our named executive officers in fiscal 2011 were: $100,000 for Mr. Maasberg; $19,701 for Mr. Taylor; and $26,612 for Ms. Stewart.  These amounts were 100% for Mr. Maasberg, 95% for Mr. Taylor and 95% for Ms. Stewart.
 
 
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OUTSTANDING EQUITY AWARDS AT FISCAL YEAR END

The following table reflects outstanding stock options held by the named executive officers as of June 30, 2011.

   
Number of
Securities
Underlying
Unexercised
Options
(#)
   
Number of
Securities
Underlying
Unexercised
Options
(#)
   
Option
Exercise
Price
 
Option
Expiration
 
Number of
Shares or Units
of Stock That
Have Not
Vested
   
Market Value of
Shares or Units
of Stock
That Have Not
Vested
 
Name
 
Exercisable
   
Unexercisable
   
($)
 
Date
  #    
($)
 
Wolfgang Maasberg President and Chief Executive Officer
          1,500,000 (1)     0.33  
8/18/2020
    4,500,000 (2)     855,000 (3)
                                         
Luis A. Rivera
Former President and Chief Executive Officer
    3,600,000 (4)             0.30  
8/18/2011
               
                                           
Keith Taylor
Former Chief Financial Officer
            1,250,000 (5)                          
                                           
Heidi Mackintosh
Former Chief Financial Officer (6)
                                         
                                           
Jim Lovelady
SVP of Sales
            300,000 (7)                          
              200,000 (8)                          
                                           
Tina Stewart
SVP of Marketing
            500,000 (9)                          
 
(1)
The Compensation Committee granted these options to Mr. Maasberg on August 18, 2010.  The awards will vest over four years, with 25% of the total number of shares vesting on August 18, 2011, and the remainder vesting in equal installments of 1/12 of the total number of shares subject to the option on each three-month anniversary thereafter.

(2)
Mr. Maasberg was awarded 4,500,000 Restricted Stock Units (“RSUs”) as part of his employment agreement.  The RSUs will vest over four years, with 25% of the total number of shares subject to the RSU vesting on August 18, 2011, and the remainder vesting in equal installments of 1/12 of the total number of shares subject to the RSU on each three-month anniversary thereafter.

(3)
Value is calculated by multiplying the number of restricted stock units that have not vested by the closing market price of our stock ($0.19) as of the close of trading on August 19, 2011.

(4)
The Compensation Committee granted this option to Mr. Rivera on May 6, 2005 and was fully vested.  As part of his terms of resignation, Mr. Rivera had until August 18, 2011 to exercise this option. He did not exercise his option and the option is now forfeit.

(5)
The Compensation Committee granted this option to Mr. Taylor on January 31, 2011.  The awards will vest over four years, with 25% of the total number of shares vesting on January 31, 2011, and the remainder vesting in equal installments of 1/12 of the total number of shares subject to the option on each three-month anniversary thereafter.

(6)
In accordance with the terms of her option agreement, Ms. Mackintosh’s unvested options were forfeited and she had 90 days to exercise her vested options, which she did not exercise.

(7)
The Compensation Committee granted this option to Mr. Lovelady on October 25, 2010.  The awards will vest over four years, with 25% of the total number of shares vesting on October 25, 2011, and the remainder vesting in equal installments of 1/12 of the total number of shares subject to the option on each three-month anniversary thereafter.
 
 
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(8)
The Compensation Committee granted this option to Mr. Lovelady on November 24, 2010.  The awards will vest over four years, with 25% of the total number of shares vesting on November 24, 2012, and the remainder vesting in equal installments of 1/12 of the total number of shares subject to the option on each three-month anniversary thereafter.

(9)
The Compensation Committee granted this option to Ms. Stewart on November 24, 2010.  The awards will vest over four years, with 25% of the total number of shares vesting on November 24, 2011, and the remainder vesting in equal installments of 1/12 of the total number of shares subject to the option on each three-month anniversary thereafter.

PENSION BENEFITS, NONQUALIFIED DEFERRED COMPENSATION AND OTHER RETIREMENT BENEFITS

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

All executive officers are eligible to participate in our 401(k) plan and other benefit programs as described below.  All executive officers are eligible to participate in the group health and 401(k) plans under the same terms and conditions as all other employees with the exception that, by the terms of his employment contract, the Company pays the employee contribution under our healthcare plan for our Chief Executive Officer, Wolfgang Maasberg.  We disclose the amounts paid by the Company in the Summary Compensation Table and the related footnotes above.

POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL

Mr. Maasberg. Pursuant to his employment agreement, the event Mr. Maasberg’s employment is terminated for Cause or is separated from service to the Company for any reason other than his resignation for Good Reason, Mr. Maasberg will be to be entitled to the following:

 
· 
any unearned but unpaid base salary;
 
· 
Other unpaid vested amounts or benefits under the compensation, incentive and benefit plans of the Company in which he participates; and
 
· 
Any unreimbursed business expenses.

Mr. Maasberg’s agreement also provides for additional payments in the event of a change of control of the Company, as more specifically defined in his employment agreement.  In the event of his separation from employment by the Company without Cause or for Good Reason within six months prior to a change in control and provided that Mr. Maasberg delivers a general release of claims in favor of the Company, Mr. Maasberg would receive the following benefits in addition to the items mentioned above:

 
· 
Lump sum payment equal to twelve months of his then-current base salary;
 
· 
Lump sum payment equal to his target bonus, prorated based on the number of days out of the applicable year he was employed by the Company prior to his separation from service.;
 
· 
Lump sum payment of his guaranteed bonus of $30,000 for fiscal year 2011;
 
· 
Reimbursement for any monthly COBRA premium payments made by him for himself and his dependents in the twelve months following his separation from service; provided however, that such COBRA reimbursements will terminate when he becomes eligible for substantially equivalent health insurance coverage in connection with new employment or self-employment; and
 
· 
Immediate vesting of 50% of all then-unvested shares subject to his option agreement and the RSUs provided, however, that this will cease to apply after August 18, 2012.

In the event of Mr. Maasberg’s separation of employment by the Company without Cause or for good Reason within six months prior to and twelve months following a change of control, also subject to Mr. Maasberg’s delivery of a general release, Mr. Maasberg will receive all the termination payments set forth above (other than the 50% vesting acceleration) and 100% of his then unvested shares subject to his option agreement and the RSUs shall immediately accelerate and become exercisable or be settled, as applicable.

Upon a change in control, 100% of Mr. Maasberg’s then unvested shares subject to his option agreement and 50% of the then unvested shares subject to the RSUs shall immediately accelerate and become exercisable or be settled, as applicable.
 
 
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Cause” is defined in Mr. Maasberg’s employment agreement to mean (i) his continued failure to perform (other than by reason of death or illness or other physical or mental incapacity) his duties and responsibilities as assigned by the Board, which is not remedied within 30 days’ written notice from the Company, (ii) a material breach by Mr. Maasberg of the employment agreement or the Proprietary Information and Inventions Agreement , which is not cured within 10 days’ written notice from the Company (if such breach is susceptible to cure), (iii) Mr. Maasberg’s gross negligence or willful misconduct, which is injurious to the Company or its reputation, (iv)  Mr. Maasberg’s material violation of a material Company policy including its Code of Business Conduct, which is not cured within 10 days’ written notice from the Company (if such violation is susceptible to cure), (v) fraud, embezzlement or other material dishonesty with respect to the Company, (vi) conviction of a crime constituting a felony or conviction of any other crime involving fraud, dishonesty or moral turpitude or (vii) failing or refusing to cooperate, as reasonably requested in writing by the Company, in any internal or external investigation of any matter in which the Company has a material interest (financial or otherwise) in the outcome of the investigation.

“Change in Control” is defined in Mr. Maasberg’s employment agreement to mean (i) a sale, conveyance, exchange or transfer  in which any non-current stockholder becomes the beneficial owner of more than fifty (50%) percent of the total voting power of all the then outstanding voting securities; (ii) a merger, consolidation or reorganization of the Company;  (iii) a sale of substantially all of the assets of the Company or a liquidation or dissolution of the Company; (iv) a change in the composition of the Board occurring within a one-year period, as a result of which fewer than a majority of the directors are incumbent directors; or (v) any other transactions or series of related transactions occur which have substantially the same effect as the transactions specified in any of the preceding subsections (i)-(iv).

“Good Reason” is defined in Mr. Maasberg’s employment agreement to mean any material breach of this Agreement by the Company or the occurrence of any one or more of the following without Mr. Maasberg’s prior express written consent: (i) a material diminution in his authority, duties or responsibilities;  (ii)  a diminution in his base salary other than a reduction which is part of an across-the board reduction in the salaries of all senior executives of the Company; or (iii) the Company moves its primary location more than fifty (50) miles from its Emeryville headquarters.

The above description is a summary of the potential payments upon termination or change of control and is fully qualified by the full text of the employment agreement, which has been filed with the SEC.

Mr. Rivera. Pursuant to his employment agreement, in the event Mr. Rivera’s employment is terminated for good reason or without cause, Mr. Rivera was to be entitled to the following

 
· 
A lump sum severance payment equal to 1.5 times his then current base salary;
 
· 
Any annual bonus awarded to Mr. Rivera prior to the date of termination but not yet paid;
 
· 
Mr. Rivera’s annual base salary through the date of termination to the extent not yet paid;
 
· 
Any compensation previously deferred by Mr. Rivera;
 
· 
Any unreimbursed business expenses;
 
· 
Any “accrued investments” (as defined in the employment agreement); and
 
· 
Any “accrued welfare benefits”, including any amounts owed as a result of accrued vacation.

Mr. Rivera’s agreement also provides that any amounts, payments, entitlements and benefits earned, accrued or owing but not yet paid will be made in the event of his death or disability or if his employment is terminated for cause. Mr. Rivera’s agreement did not contain a provision for additional payment based on a change of control.

Under the terms of the agreement: (i) “cause” means (a) the failure of Mr. Rivera to materially perform his obligations and duties thereunder to our satisfaction, which failure is not remedied within 45 days after receipt of written notice from us, (b) commission by Mr. Rivera of an act of fraud upon, or willful gross misconduct toward, us or any of our affiliates, (c) a material breach by Mr. Rivera of certain sections of the agreement, which, in either case, is not remedied within 15 business days after receipt of written notice from us or our Board , (d) the conviction of Mr. Rivera of any felony (or a plea of nolo contendere thereto) or any crime involving moral turpitude, or (e) the failure of Mr. Rivera to carry out, or comply with, in any material respect, any directive of the Board consistent with the terms of the agreement, which is not remedied within 30 business days after receipt of written notice from us or our Board; and (ii) “good reason” shall mean any material breach by us of any provision of the agreement and shall also include our (or our successors and assigns) substantially altering the position, geographic location or responsibilities of Mr. Rivera during the term of his employment.

Mr. Rivera resigned as President and Chief Executive Officer effective August 18, 2010. Under the terms of Mr. Rivera’s separation and release agreement, he was paid all wages, salary, bonuses and reimbursable expenses that were owed as well as $27,876 of accrued vacation. In addition, Mr. Rivera was paid $375,000 (1.5 times his base salary) in accordance with the terms of his employment agreement. The Company repurchased 170,000 shares of common stock from Mr. Rivera at the then market price of $0.33 for a total payment of $56,100. The Company also amended Mr. Rivera’s stock option agreement to extend the period in which he may exercise unexercised vested shares from ninety (90) days to one year following the date of his resignation.
 
 
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Mr. Taylor. Pursuant to his employment agreement, in the event Mr. Taylor’s employment is terminated without cause, we will pay to Mr. Taylor an amount equal to six months of his current annual base salary at the time of termination.  At the end of fiscal year 2011, this provision would have entitled Mr. Taylor to $137,500, plus any other amounts accrued but not yet paid. If the Company is acquired of undergoes a change of control and Mr. Taylor is terminated without Cause within two years following the change of control he will be entitled to one year of his then base salary as severance. Mr. Taylor’s agreement also provides that if the Company is acquired or undergoes a change of control and his employment is terminated without Cause, any unvested options shall immediately vest. Mr. Taylor unexpectedly passed away on September 19, 2011.

Under the terms of the agreement: “Cause” means (a) the failure of Mr. Taylor to perform his obligations and duties to the satisfaction of us, which failure is not remedied with in fifteen days after receipt of written notice, (b) commission by Mr. Taylor of an act of fraud upon, or willful misconduct toward, us or any of our affiliates, (c) a material breach by Mr. Taylor of certain sections of our Proprietary Information and Inventions Agreement (“PIAA”), (d) the failure of Mr. Taylor to carry out, or comply with, in any material respect, any directive of the Board consistent with the terms of the PIAA, which in the case of each situation above is not remedied within 15 days after receipt of written notice from us or our Board, or (e) the conviction of Mr. Taylor of (or a plea of nolo contendere to) any felony or any crime involving moral turpitude.

Ms. Mackintosh. Ms. Mackintosh’s agreement provided that, in the event her employment is terminated without Cause, we shall pay to Ms. Mackintosh an amount equal to six months of her current annual base salary at the time of termination.  Ms. Mackintosh’s agreement did not contain a provision for additional payment based on a change of control; however, we would have required any successor to us to assume expressly and agree to perform this employment agreement in the same manner and to the same extent that we would be required to perform.

Under the terms of the agreement: “Cause” means (a) the failure of Ms. Mackintosh to perform her obligations and duties to the satisfaction of us, which failure is not remedied with in fifteen days after receipt of written notice, (b) commission by Ms. Mackintosh of an act of fraud upon, or willful misconduct toward, us or any of our affiliates, (c) a material breach by Ms. Mackintosh of certain sections of our PIAA, (d) the failure of Ms. Mackintosh to carry out, or comply with, in any material respect, any directive of the Board consistent with the terms of the PIAA, which in the case of each situation above is not remedied within 15 days after receipt of written notice from us or our Board, or (e) the conviction of Ms. Mackintosh of (or a plea of nolo contendere to) any felony or any crime involving moral turpitude.

Ms. Mackintosh resigned as Chief Financial Officer effective January 31, 2011. Under the terms of her termination agreement, in addition to all wages, salary, bonuses and reimbursable expenses that were owed, she was paid 125,000 of severance (0.5 times her base salary of 250,000) as well as $22,842 of accrued vacation. In addition, the Company paid $7,239 for COBRA benefits for her and her family.

Mr. Lovelady. Pursuant to his employment agreement, in the event Mr. Lovelady’s employment is terminated without cause after six months of employment, we will pay to Mr. Lovelady an amount equal to six months of his current annual base salary at the time of termination.  At the end of fiscal year 2011, this provision would have entitled Mr. Lovelady to $112,500, plus any other amounts accrued but not yet paid. Mr. Lovelady’s agreement does not contain a provision for additional payment based on a change of control; however, we will require any successor to us to assume expressly and agree to perform this employment agreement in the same manner and to the same extent that we would be required to perform.

Under the terms of the agreement: “cause” means (a) the failure of Mr. Lovelady to perform his obligations and duties to the satisfaction of us, which failure is not remedied with in fifteen days after receipt of written notice, (b) commission by Mr. Lovelady of an act of fraud upon, or willful misconduct toward, us or any of our affiliates, (c) a material breach by Mr. Lovelady of certain sections of our Proprietary Information and Inventions Agreement (“PIAA”), (d) the failure of Mr. Lovelady to carry out, or comply with, in any material respect, any directive of the Board consistent with the terms of the PIAA, which in the case of each situation above is not remedied within 15 days after receipt of written notice from us or our Board, or (e) the conviction of Mr. Lovelady of (or a plea of nolo contendere to) any felony or any crime involving moral turpitude.

Ms. Stewart. Pursuant to her employment agreement, in the event Ms. Stewart’s employment is terminated without cause after 90 days of employment, we will pay to Ms. Stewart an amount equal to six months of her current annual base salary at the time of termination.  At the end of fiscal year 2011, this provision would have entitled Ms. Stewart to $118,000, plus any other amounts accrued but not yet paid. If the Company is acquired of undergoes a change of control and Ms. Stewart is terminated without Cause within two years following the change of control she will be entitled to one year of her then base salary as severance and one year of COBRA benefits for her and her family. Ms. Stewart’s agreement also provides that if the Company is acquired or undergoes a change of control and her employment is terminated without Cause, any unvested options shall immediately vest.

Under the terms of the agreement: “cause” means (a) the failure of Ms. Stewart to perform his obligations and duties to the satisfaction of us, which failure is not remedied with in fifteen days after receipt of written notice, (b) commission by Ms. Stewart of an act of fraud upon, or willful misconduct toward, us or any of our affiliates, (c) a material breach by Ms. Stewart of certain sections of our Proprietary Information and Inventions Agreement (“PIAA”), (d) the failure of Ms. Stewart to carry out, or comply with, in any material respect, any directive of the Board consistent with the terms of the PIAA, which in the case of each situation above is not remedied within 15 days after receipt of written notice from us or our Board, or (e) the conviction of Ms. Stewart of (or a plea of nolo contendere to) any felony or any crime involving moral turpitude.
 
 
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The 2005 Plan, described below under “Equity Compensation Plan Information”, gives the Compensation Committee the discretion to vest options outstanding under the 2005 Plan upon the occurrence of a change in control. In addition to the accelerated vesting described above for Mr Maasberg, Mr. Taylor, Mr. Lovelady and Ms. Stewart, the option agreements for each of the named executive officers provide that within one year following the occurrence of a change in control, if the executive’s employment is terminated without cause by us, or with good reason by the executive (in each case, as defined in the option agreement), any options that would have become exercisable on or prior to the one year anniversary following the termination shall become immediately exercisable and shall remain exercisable until the earlier of the first anniversary of the termination of employment or the earlier expiration of the option in accordance with its terms.  If a qualifying termination had occurred on June 30, 2011, such an acceleration of vesting would have resulted in the following for our named executive officers: no additional shares for Mr. Rivera; 1,500,000 shares for Mr. Maasberg; 1,250,000 shares for Mr. Taylor, 208,334 shares for Mr. Lovelady and 500,000 shares for Ms. Stewart. There are no shares associated with accelerated vesting relating to Mr Rivera since his options vested prior to June 30, 2011. No value has been assigned to such a potential vesting acceleration for Mr. Maasberg, Mr. Taylor, Mr. Lovelady or Ms. Stewart because the exercise price of each of  their options exceeds the $0.28 closing price of our common stock on June 30, 2011.

COMPENSATION OF DIRECTORS

We provide each non-employee director with an annual retainer of $25,000. Each non-employee director receives a fee of $1,000 per meeting attended, plus out-of-pocket expenses. In addition, non-employee members of Board committees receive a fee of $1,000, plus out-of-pocket expenses, for each non-telephonic committee meeting attended that is not scheduled in conjunction with a meeting of the full Board and a fee of $500, plus out-of-pocket expenses, for each non-telephonic committee meeting attended in conjunction with a meeting of the full Board and for each telephonic meeting of any committee of the Board.  Our executive officers do not receive additional compensation for serving on the Board.  Mr. Comfort has and Mr. Urry had waived all retainers and fees for their services.

Director Compensation Table

The table below summarizes the compensation paid to our independent directors for the fiscal year ended June 30, 2011.

Name
 
Fees Earned or
Paid in Cash 
($)
   
Stock Compensation
($)
   
Total
($)
 
                   
Andrew Richard Blair (1)
    27,000             27,000  
William T. Comfort III (2)
                 
Nicolas De Santis Cuadra (1)
    27,000               27,000  
James A. Urry (2)
                 
Luis Rivera (3)
                 
 
 
(1)
Fees consist of a $25,000 annual retainer and additional payments for four telephonic Audit Committee meetings.

 
(2)
Messrs. Comfort and Urry have waived all retainers and fees.

 
(3)
Mr. Rivera was an employee until August 18, 2010 and therefore received no compensation for his service as a director. He remained a director after resigning his positions as an employee and waived all retainers and fees until his resignation from the board on November 7, 2010.
 
 
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ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Equity Compensation Plan Information

Plan Category
 
Number of securities to be
issued upon exercise of
outstanding options, warrants
and rights
(a)
  
Weighted-average exercise of
outstanding options, warrants
and rights
(b)
  
Number of securities
remaining available for future
issuance under compensation
plans (excluding securities
related in (a))
(c)
             
Equity compensation plans approved by security holders
 
12,709,892
 
$
0.35
 
4,490,108
Equity compensation plans not approved by security holders
     
 
             
Total
 
12,709,892
 
$
0.35
 
4,490,108

We established the 2005 Plan on May 6, 2005. The 2005 Plan provides for grants of stock options and stock-based awards to our employees, directors and consultants. Stock options issued in connection with the 2005 Plan are granted with an exercise price per share equal to the fair market value of a share of our Common Stock at the date of grant. All stock options have ten-year maximum terms and vest, either quarterly or annually and all within four years of grant date. The total number of shares of common stock issuable under the Equity Based Compensation Plan is 17,200,000. At June 30, 2011, there were 4,490,108 shares available for grant under the 2005 Plan.

The following table sets forth information with respect to the beneficial ownership of the Common Stock as of August 31, 2011 by:

 
· 
each stockholder known by us to beneficially own more than five percent of the Common Stock;
 
· 
each of our directors;
 
· 
each of our named executive officers; and
 
· 
all directors and executive officers as a group.

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

Name of Beneficial Owner (a)
 
Amount and Nature
of Beneficial
Ownership
   
Percentage of
Outstanding Shares
 
             
LDN Stuyvie Partnership (b)
    42,453,126       35.0 %
William T. Comfort, III (c)
    58,574,338       48.3 %
James A. Urry (d)
    10,060,606       8.3 %
Wolfgang Maasberg(e)
    1,827,438       1.5 %
Andrew Richard Blair (f)
    1,002,200       *  
Jim Lovelady (g)
    125,000       *  
Nicolas De Santis Cuadra
    120,968       *  
Keith Taylor
    25,000       *  
Tina Stewart
    25,000       *  
Luis Rivera (h)
    -       *  
Heidi Mackintosh (h)
    -       *  
All directors and executive officers as a group (10 persons)(i)
    71,885,550       59.1 %
 

*
Represents beneficial ownership of less than 1%.

(a)
Information as to the interests of the directors and officers has been furnished in part by them. The inclusion of information concerning shares held by or for their spouses or children or by corporations or other entities in which they have an interest does not constitute an admission by such persons of beneficial ownership thereof. Unless otherwise indicated, the address of each director and officer listed is 6401 Hollis St., Suite 125, Emeryville, CA  94608.
 
 
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(b)
LDN Stuyvie Partnership is a limited partnership, the sole general partner of which is William T. Comfort III, our Chairman of the Board. The address of LDN Stuyvie Partnership is 127-131 Sloane St., 4th Floor, Liscartan House, SWIX 9AS, London, UK.

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

(d)
Does not include the 42,453,126 shares beneficially owned by LDN Stuyvie Partnership, of which Mr. Urry’s spouse is a partner. Mr. Urry’s spouse has no dispositive or voting authority with respect to the shares beneficially owned by LDN Stuyvie Partnership, and Mr. Urry disclaims beneficial ownership of such shares.

(e)
Includes 375,000 shares of Common Stock subject to stock options held by Mr. Maasberg on August 31, 2011 and exercisable within 60 days thereafter.

(f)
The shares reported by Mr. Blair consist of 825,000 shares owned by Mr. Blair and his wife, 60,000 owned by the Freimark, Blair & Co. pension fund and 117,200 owned by the Blair Family Trust.  Mr. Blair disclaims beneficial ownership of 27,600 of the shares owned by the Freimark, Blair & Co. pension fund and the entire 117,200 shares are owned by the Blair Family Trust.

(g)
Includes 75,000 shares of Common Stock subject to stock options held by Mr. Lovelady on August 31, 2011 and exercisable within 60 days thereafter.
 
(h)
Mr. Rivera and Ms. Mackintosh have resigned from the Company and their options have been forfeited.

(i)
Represents the shares of common stock owned and shares of common stock subject to stock options that are exercisable within 60 days after August 31, 2011 for the 8 directors and officers in the table above. They also include an additional 125,000 shares of common stock held by two other executive officers.  The denominator used to calculate percentage of outstanding shares has been adjusted for the fore mentioned options.
 
 
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ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Employment Agreement

Effective August 18, 2010, the Company entered into an employment agreement with Wolfgang Maasberg to serve as President and Chief Executive Officer and as a director of the Company.  See “Item 11. Executive Compensation – Employment Agreements/Arrangements” for a summary of the terms of this agreement.  The employment agreement also provides for certain severance payments to Mr. Maasberg described in greater detail above in “Item 11. Executive Compensation – Potential Payments upon Termination or Change in Control”.

Effective January 31, 2011, the Company entered into an employment agreement with Keith Taylor to serve as Chief Financial Officer of the Company.  See “Item 11. Executive Compensation – Employment Agreements/Arrangements” for a summary of the terms of this agreement.  The employment agreement also provides for certain severance payments to Mr. Taylor described in greater detail above in “Item 11. Executive Compensation – Potential Payments upon Termination or Change in Control”.

Separation Agreement

On August 18, 2010 the Company entered into a separation agreement and release agreement with Luis Rivera. Mr Rivera resigned from his positions as President and Chief Executive Officer. See “Item 11: Executive Compensation - Potential Payments upon Termination or Change in Control” for a summary of the terms of the separation agreement.
 
On February 4, 2011 the Company entered into a separation agreement and release agreement with Heidi Mackintosh, effective January 31, 2011. Mrs. Mackintosh resigned from her position as Chief Financial Offer. See “Item 11: Executive Compensation - Potential Payments upon Termination or Change in Control” for a summary of the terms of the separation agreement.

Guaranty to Loan Agreement and Related Agreements

In connection with the Seventh Amendment, Mr. William T. Comfort, III, entered into a Limited Guaranty, dated as of August 31, 2011 (“Limited Guaranty”), to guarantee the Company’s repayment of indebtedness under the Seventh Amendment. Mr. Comfort’s liability under the Limited Guaranty is limited to $1,000,000 with respect to advances made under the Existing Line and $2,500,000 with respect to advances made under the Non-Formula Line.  Mr. Comfort also entered into a Pledge and Security Agreement with the Bank (“Pledge Agreement”), a Reimbursement and Security Agreement with the Borrowers (“Reimbursement and Security Agreement”), and a Subordination Agreement with the Bank and the Company (“Subordination Agreement”).  Under the Pledge Agreement, Mr. Comfort granted the Bank a security interest in cash collateral maintained at the bank, as security for the performance of Mr. Comfort’s obligations under the Limited Guaranty. The Company also agreed to reimburse Mr. Comfort for all amounts paid to the Bank and all costs, fees and expenses incurred by Mr. Comfort under the Limited Guaranty and Pledge Agreement.  As security for the Company’s reimbursement obligations, the Company granted Mr. Comfort a security interest in the same property which secures its obligations under the Loan Agreement.  Under the Subordination Agreement, the Company’s indebtedness and obligations to Mr. Comfort are subordinated to the Company’s indebtedness and obligations to the Bank.

Indemnification Agreements

We have entered into indemnification agreements with each of our directors. Under these agreements, we are obligated to indemnify the directors to the fullest extent permitted under the Delaware General Corporation Law for expenses, including attorneys’ fees, judgments, fines and settlement amounts incurred by them in any action or proceeding arising out of their services as a director.  We believe that these indemnification agreements are helpful in attracting and retaining qualified directors.

Related Person Transaction Procedures

Related person transactions are transactions in which we are a participant where the amount involved exceeds $120,000, and a member of our Board, an executive officer or a holder of more than 5% of our common stock has a direct or indirect material interest.

To date we have not adopted a formal written policy with respect to review and approval of such related-party transactions.  However, in practice all such related-party transactions are reported to, and approved by, the full Board.  Factors considered by the Board when deliberating such transactions include:

 
· 
whether the terms of such transaction are fair to us;
 
· 
whether the transaction are consistent with, and contribute to, our growth strategy; and
 
· 
what impact, if any, such transaction will have on the transfer restrictions currently in place with respect to our Common Stock.
 
 
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The agreements and transactions listed above (other than the indemnification agreements) were all approved by the full Board.

DIRECTOR INDEPENDENCE

We have adopted the NASDAQ Stock Market’s standards for determining the independence of directors.  Under these standards, an independent director means a person other than an executive officer or one of our employees or any other individual having a relationship which, in the opinion of the Board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.  In addition, the following persons shall not be considered independent:

 
· 
A director who is, or at any time during the past three years was, employed by us;
 
· 
a director who accepted or who has a family member who accepted any compensation from us in excess of $120,000 during any period of twelve consecutive months within the three years preceding the determination of independence, other than the following:
 
·
compensation for service on the Board or any committee thereof;
 
·
compensation paid to a family member who is one of our employees (other than an executive officer); or
 
·
under a tax-qualified retirement plan, or non-discretionary compensation;
 
· 
a director who is a family member of an individual who is, or at any time during the past three years was, employed by us as an executive officer;
 
· 
a director who is, or has a family member who is, a partner in, or a controlling shareholder or an executive officer of, any organization to which we made, or from which we received, payments for property or services in the current or any of the past three fiscal years that exceed 5% of the recipient’s consolidated gross revenues for that year, or $200,000, whichever is more, other than the following:
 
·
payments arising solely from investments in our securities; or
 
·
payments under non-discretionary charitable contribution matching programs;
 
· 
a director who is, or has a family member who is, employed as an executive officer of another entity where at any time during the past three years any of our executive officers serve on the compensation committee of such other entity; or
 
· 
a director who is, or has a family member who is, a current partner of our outside auditor, or was a partner or employee of our outside auditor who worked on our audit at any time during any of the past three years.

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

The Board has assessed the independence of each non-employee director under the independence standards of the NASDAQ Stock Market set forth above and has affirmatively determined that the following non-employee directors are independent: Messrs. Blair, Comfort andDe Santis Cuadra.

 
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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

AUDIT FEES

The following table sets forth the fees billed for professional audit services rendered to Lyris, Inc. by an independent accountant, Burr Pilger Mayer, Inc., during fiscal year 2011 and 2010:

   
Fiscal Year Ended June 30,
 
   
2011
   
2010
 
   
(In thousands)
 
Audit fees (1)
  $ 166     $ 225  
Audit related fees (2)
    11       15  
Total
  $ 177     $ 240  
 
(1)
Represents fees for professional services rendered in connection with the audit of our annual financial statements and review of our quarterly financial statements.

(2)
Represents fees for professional services rendered in connection with the audit of our 401(k) benefit plan annual financial statements.

The Audit Committee of the Board of Directors has adopted a policy to pre-approve all audit, audit-related, tax and other services proposed to be provided by our independent auditor prior to engaging the auditor for that purpose.  Consideration and approval of such services generally will occur at the Audit Committee’s regularly scheduled quarterly meetings.  In situations where it is impractical to wait until the regularly scheduled quarterly meeting, the Audit Committee may delegate authority to approve the audit, audit-related, tax and other services to a member of the committee up to a certain pre-determined level as approved by the Audit Committee.  During fiscal years 2011 and 2010, respectively, our Audit-Related fees as described above were not pre-approved by the Audit Committee.
 
 
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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

a)  
The financial statements filed as part of this Annual Report at Item 8 are listed in the Financial Statements and Supplementary Data on page 47 of this Annual Report.  All other consolidated financial schedules are omitted because they are inapplicable, not required, or the information is included elsewhere in the consolidated financial statements or the notes thereto.
b)  
The following documents are filed or incorporated by reference as exhibits to this Report:
 
EXHIBIT INDEX
 
Exhibit
No.
 
Description
 
Form
 
Date of First
Filing
 
Exhibit
Number
2(a)
 
Stock Purchase Agreement by and among Commodore Resources, Inc., Lyris Technologies, Inc., John Buckman, Jan Hanford, The John Buckman and Jan Hanford Trust and the Company, for certain limited purposes contained therein, dated May 6, 2005.
 
8-K
 
5/12/05
 
2.1
2(b)
 
Agreement and Plan of Merger by and among Commodore Resources (Nevada), Inc., Halsey Acquisition Delaware, Inc, Uptilt Inc., David Sousa, in his capacity as Representative and the Company, dated October 3, 2005.
 
8-K
 
10/14/05
   
2(c)
 
Agreement and Plan of Merger, dated as of August 16, 2006, by and among the Company, Commodore Resources (Nevada), Inc., Halsey Acquisition California, Inc., ClickTracks Analytics, Inc., the Shareholders listed therein and John Marshall (as representative)
 
8-K
 
8/22/06
 
2.1
2(d)
 
Share Purchase Agreement, dated August 18, 2006, by and among 1254412 Alberta ULC, an unlimited liability company formed under the laws of the Province of Alberta, the Company, Krista Lariviere, Chris Adams, 1706379 Ontario Inc., a corporation formed under the laws of the Province of Ontario and 1706380 Ontario Inc., a corporation formed under the laws of the Province of Ontario.
 
8-K
 
8/22/06
 
2.2
3(a)(i)
 
Certificate of Incorporation of the Company.
 
10-K
 
9/26/07
 
3(a)(i)
3(a)(ii)
 
Certificate of Amendment to Certificate of Incorporation of the Company.
 
10-K
 
9/26/07
 
3(a)(ii)
                 
3(a)(iii)
 
Certificate of Ownership and Merger, merging NAHC, Inc. with and into J. L. Halsey Corporation.
 
10-K
 
9/26/07
 
3(a)(iii)
                 
 3(a)(iv)
 
Certificate of Ownership and Merger, merging Lyris, Inc. with and into J.L. Halsey Corporation .
 
8-K
 
10/31/07
 
3.1
 
 
95

 
 
Exhibit
No.
 
Description
 
Form
 
Date of First
Filing
 
Exhibit
Number
3(b)(i)
 
First Amended and Restated Bylaws of the Company, as amended as of February 14, 2007.
 
8-K
 
2/21/07
 
3.2
3(b)(ii)
 
Amendment to the First Amended and Restated Bylaws of the Company, effective February 14, 2007.
 
8-K
 
2/21/07
 
3.1
10(a)(i)
 
J. L. Halsey Corporation 2005 Equity-Based Compensation Plan.
 
8-K
 
5/12/05
 
10.1
10(a)(ii)
 
First Amendment to the J. L. Halsey Corporation 2005 Equity-Based Compensation Plan.
 
10-K
 
9/26/07
 
4(a)(ii)
10(a)(iii)
 
Second Amendment to the J. L. Halsey Corporation 2005 Equity-Based Compensation Plan.
 
8-K
 
6/22/09
 
10.1
10(b)(i)
 
Form of Nonstatutory Stock Option Agreement under the J. L. Halsey Corporation 2005 Equity-Based Compensation Plan.
 
8-K
 
5/12/05
 
10.2
10(b)(ii)
 
Form of Notice of Restricted Stock Unit Award and Award Agreement (Restricted Stock Units) to the Lyris, Inc. 2005 Equity-Based Compensation Plan.
 
8-K
 
9/20/10
 
99.3
10(c)
 
Employment Agreement effective May 12, 2005, between Lyris and Luis A. Rivera.
 
10-K
 
9/28/05
 
10(l)
10(d)
 
Employment Agreement effective May 12, 2005, between Lyris and Robb Wilson.
 
10-K
 
9/26/07
 
10(j)
10(e)
 
Executive Employment Agreement effective August 18, 2010, between Lyris and Wolfgang Maasberg.
 
8-K
 
9/20/10
   
10(f)
 
Agreement effective August 18, 2010, between Lyris and Luis Rivera
 
8-K
 
9/20/10
 
99.2
10(g)(i)
 
Subscription Agreement effective April 12, 2010 by and between Lyris, Inc. and Meudon Investments.
 
8-K
 
4/13/2010
 
10.1
10(g)(ii)
 
Subscription Agreement effective April 12, 2010 by and between Lyris, Inc. and William Ty Comfort, III.
 
8-K
 
4/13/2010
 
10.2
10(h)
 
Form of Indemnification Agreement.
 
8-K
 
3/30/09
 
10.1
                 
10(i)
 
Stock Purchase Agreement effective as of July 23, 2010, by and between SiteWit Corp. and Lyris, Inc.
           
10(j)(i)
 
Amended and Restated Loan and Security Agreement effective as of March 6, 2008, by and among Comerica Bank and Lyris, Inc., Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc.
 
8-K
 
3/11/08
 
10.1
10(j)(ii)
 
First Amendment to Amended and Restated Loan and Security Agreement effective as of July 30, 2008, by and among Comerica Bank and Lyris, Inc., Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc.
 
8-K
 
8/4/08
 
10.1
10(j)(iii)
 
Waiver Letter from Comerica Bank, dated September 12, 2008, related to a violation of Section 6.7(b)(ii) of the Amended and Restated Loan and Security Agreement, dated as of March 6, 2008, by and among Comerica Bank, Lyris, Inc., Lyris Technologies, Inc and Commodore Resources (Nevada), Inc.
 
8-K
 
9/15/08
 
10.1
 
 
96

 
 
Exhibit
No.
 
Description
 
Form
 
Date of First
Filing
 
Exhibit
Number
10(j)(iv)
 
Second Amendment to Amended and Restated Loan and Security Agreement effective as of December 31, 2008, by and among Comerica Bank and Lyris, Inc., Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc.
 
8-K
 
1/6/09
 
10.1
10(j)(v)
 
Third Amendment to Amended and Restated Loan and Security Agreement effective as of June 19, 2009, by and among Comerica Bank and Lyris, Inc., Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc.
 
8-K
 
6/22/09
 
10.1
10(j)(vi)
 
Fourth Amendment to Amended and Restated Loan and Security Agreement effective as of October 23, 2009, by and among Comerica Bank and Lyris, Inc., Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc.
 
8-K
 
10/27/09
 
10.1
10(j)(vii)
 
Fifth Amendment to Amended and Restated Loan and Security Agreement effective as of May 6, 2010, by and among Comerica Bank and Lyris, Inc., Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc.
 
8-K
 
5/7/10
 
10.1
10(j)(viii)
 
Sixth Amendment to Amended and Restated Loan and Security Agreement effective as of September 15, 2010, by and among Comerica Bank and Lyris, Inc., Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc.
 
8-K
 
9/16/10
 
10.1
10(j)(ix)
 
Offer letter between the Company and Keith D. Taylor, dated January 5, 2011
 
10-Q
 
5/11/11
 
10.1
10(j)(x)
 
Termination agreement between the Company and Heidi Mackintosh, dated February 4, 2011
 
10-Q
 
5/11/11
 
10.2
10(j)(xi)
 
Seventh Amendment to Amended and Restated Loan and Security Agreement effective as of August 31, 2011, by and among Comerica Bank and Lyris, Inc., Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc.
 
8-K
 
9/6/11
 
99.1
10(j)(xii)
 
Limited Guaranty by William T. Comfort, III, dated as of August 31, 2011
 
8-K
 
9/6/11
 
99.2
10(j)(xiii)
 
Pledge and Security Agreement entered into as of August 31, 2011by and among Comerica Bank and Lyris, Inc., Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc.
 
8-K
 
9/6/11
 
99.3
10(j)(xiv)
 
Reimbursement and Security Agreement entered into as of August 31, 2011, by and among William T. Comfort  III and Lyris, Inc., Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc.
 
8-K
 
9/6/11
 
99.4
 
 
97

 
 
Exhibit
No.
 
Description
 
Form
 
Date of First
Filing
 
Exhibit
Number
10(j)(xv)
 
Subordination Agreement entered into as of August 31, 2011, by and among William T. Comfort  III and Comerica Bank
 
8-K
 
9/6/11
 
99.5
10(k)
 
Restricted Stock Award Agreement, dated October 11, 2005, by and between the Company and Nicolas DeSantis Cuadra.
 
8-K
 
10/14/05
 
10.1
14
 
Code of Business Conduct and Ethics, adopted by the Company on September 25, 2003.
 
10-K
 
9/29/03
 
14
21*
 
Subsidiaries of the Company.
           
                 
23.1*
 
Consent of Burr Pilger Mayer, Inc., Independent Registered Public Accounting Firm
           
31.1*
 
Certification of Chief Executive Officer and Interim Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a)
           
32.1*
 
Section 1350 Certification
           

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

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

 
98

 

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated:  September 21, 2011
 
 
LYRIS, INC.
     
 
By:
/s/Wolfgang Maasberg
   
Wolfgang Maasberg
   
Chief Executive Officer, President, Interim Chief Financial
Officer, Secretary and Treasurer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.


Signature
 
Title
 
Date
         
/s/ William T. Comfort, III
 
Chairman of the Board and Director
 
September 21, 2011
(WILLIAM T. COMFORT, III)
       
         
/s/ Andrew Richard Blair
 
Director
 
September 21, 2011
(ANDREW RICHARD BLAIR)
       
         
/s/ Nicolas Desantis Cuadra
 
Director
 
September 21, 2011
(NICOLAS DESANTIS CUADRA)
       
         
/s/ Wolfgang Maasberg
 
Chief Executive Officer (Principal Executive Officer),
 
September 21, 2011
(WOLFGANG MAASBERG)  
 
President, Interim Chief Financial Officer (Principal
Financial and Accounting Officer), Secretary and
Treasurer
   
 
 
99