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EX-32.1 - EXHIBIT 32.1 - LYRIS, INC.v358561_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - LYRIS, INC.v358561_ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - LYRIS, INC.v358561_ex32-2.htm
EX-31.2 - EXHIBIT 31.2 - LYRIS, INC.v358561_ex31-2.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM 10-Q
 
   
þ   QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2013
 
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 of incorporation)
 
(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)
 
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 x 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 pursuant to Rule 405 of Regulation S-T (§232.405 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 x No ¨
 
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
x
 
Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨ No x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
9,567,864 shares of $.01 Par Value Common Stock as of November 7, 2013
 
 
 
LYRIS, INC. AND SUBSIDIARIES
 
Quarterly Report on Form 10-Q
 
For Quarter Ended September 30, 2013
 
Item No.
 
Description
 
Page
Number
 
 
 
 
 
 
 
PART I – FINANCIAL INFORMATION
 
 
 
 
 
 
 
Item 1.
 
Financial Statements
 
3
 
 
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2013
and June 30, 2013
 
3
 
 
Unaudited Condensed Consolidated Statements of Operations for the three months ended September 30, 2013 and September 30, 2012
 
4
 
 
Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three months ended September 30, 2013 and September 30, 2012
 
5
 
 
Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended
September 30, 2013 and September 30, 2012
 
6
 
 
Notes to Unaudited Condensed Consolidated Financial Statements
 
7
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
16
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
 
25
Item 4.
 
Controls and Procedures
 
25
 
 
 
 
 
 
 
PART II – OTHER INFORMATION
 
 
 
 
 
 
 
Item 1.
 
Legal Proceedings
 
26
Item 1A.
 
Risk Factors
 
26
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
26
Item 3.
 
Defaults Upon Senior Securities
 
26
Item 4.
 
Mine Safety Disclosures
 
26
Item 5.
 
Other Information
 
26
Item 6.
 
Exhibits
 
27
Signatures
 
 
 
 
 
PART I.  FINANCIAL INFORMATION
 
ITEM 1.      Financial Statements
 
LYRIS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except per share data)
 
 
 
September 30,
 
June 30,
 
 
 
2013
 
2013 (1)
 
ASSETS
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
1,898
 
$
2,318
 
Accounts receivable, less allowances of $436 and $510, respectively
 
 
3,848
 
 
4,103
 
Prepaid expenses and other current assets
 
 
788
 
 
722
 
Deferred income taxes
 
 
954
 
 
942
 
Total current assets
 
 
7,488
 
 
8,085
 
Property and equipment, net
 
 
9,499
 
 
9,354
 
Intangible assets, net
 
 
4,967
 
 
5,014
 
Goodwill
 
 
9,791
 
 
9,791
 
Other long-term assets
 
 
667
 
 
663
 
TOTAL ASSETS
 
$
32,412
 
$
32,907
 
 
 
 
 
 
 
 
 
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
Revolving line of credit
 
$
2,265
 
$
2,260
 
Accounts payable and accrued expenses
 
 
3,356
 
 
3,458
 
Capital lease obligations - short-term
 
 
835
 
 
827
 
Income taxes payable
 
 
187
 
 
203
 
Deferred revenue
 
 
3,267
 
 
3,220
 
Total current liabilities
 
 
9,910
 
 
9,968
 
Other long-term liabilities
 
 
516
 
 
436
 
Capital lease obligations - long-term
 
 
318
 
 
504
 
TOTAL LIABILITIES
 
 
10,744
 
 
10,908
 
Commitments and contingencies (Note 11)
 
 
 
 
 
 
 
Redeemable convertible Series A preferred stock: $0.01 par value per share, 2,000 shares authorized, issued and outstanding, liquidation preference $5,000, as of September 30, 2013 and June 30, 2013
 
 
5,000
 
 
5,000
 
 
 
 
 
 
 
 
 
Stockholders' equity:
 
 
 
 
 
 
 
Preferred stock, $0.01 par value per share, 2,000 shares authorized September 30, 2013 and June 30, 2013; no shares issued and outstanding
 
 
-
 
 
-
 
Common stock, $0.01 par value; 40,000 shares authorized; 9,579 shares issued and outstanding as of September 30, 2013 and June 30, 2013
 
 
1,415
 
 
1,415
 
Additional paid-in capital
 
 
268,323
 
 
268,209
 
Accumulated deficit
 
 
(253,102)
 
 
(252,608)
 
Treasury stock, at cost; 11 shares held at September 30, 2013 and June 30, 2013
 
 
(56)
 
 
(56)
 
Accumulated other comprehensive income
 
 
88
 
 
39
 
Total stockholders' equity
 
 
16,668
 
 
16,999
 
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
 
$
32,412
 
$
32,907
 
 
(1) Derived from the consolidated audited financial statements included in our annual report on Form 10-K for the year ended June 30, 2013 filed with the Securities and Exchange Commission.
 
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
 
 
3

 
LYRIS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)
 
 
 
Three Months Ended
September 30,
 
 
 
2013
 
2012
 
Revenue:
 
 
 
 
 
 
 
Subscription
 
$
6,343
 
$
7,128
 
Support and maintenance
 
 
997
 
 
931
 
Professional services
 
 
594
 
 
670
 
Software
 
 
297
 
 
243
 
Total revenue
 
 
8,231
 
 
8,972
 
Cost of revenue:
 
 
 
 
 
 
 
Subscription, support and maintenance, professional services, and software
 
 
2,637
 
 
3,574
 
Amortization of developed technology
 
 
439
 
 
229
 
Total cost of revenue
 
 
3,076
 
 
3,803
 
Gross Profit
 
 
5,155
 
 
5,169
 
Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
 
 
2,832
 
 
2,275
 
General and administrative
 
 
1,673
 
 
2,306
 
Research and development
 
 
1,038
 
 
1,161
 
Amortization of customer relationships and trade names
 
 
50
 
 
50
 
Total operating expenses
 
 
5,593
 
 
5,792
 
Loss from operations
 
 
(438)
 
 
(623)
 
Interest expense
 
 
(38)
 
 
(125)
 
Interest income
 
 
-
 
 
2
 
Other (expense) income, net
 
 
(7)
 
 
29
 
Loss from operations before income tax provision
 
 
(483)
 
 
(717)
 
Income tax provision
 
 
10
 
 
79
 
Net loss
 
 
(493)
 
 
(796)
 
Less: income attributable to noncontrolling interest, net of tax
 
 
-
 
 
20
 
Net loss attributable to Lyris, Inc.
 
$
(493)
 
$
(816)
 
 
 
 
 
 
 
 
 
Net loss per share
 
 
 
 
 
 
 
Basic
 
$
(0.05)
 
$
(0.08)
 
Diluted
 
$
(0.05)
 
$
(0.08)
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
 
 
 
 
 
 
Basic
 
 
9,568
 
 
9,441
 
Diluted
 
 
9,568
 
 
9,441
 
 
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
 
 
4

 
LYRIS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited; in thousands)
 
 
 
 
Three Months Ended
September 30,
 
 
 
2013
 
2012
 
Net loss
 
$
(493)
 
$
(796)
 
Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Foreign currency translation gain (loss)
 
 
49
 
 
(86)
 
Comprehensive loss attributable to Lyris, Inc.
 
 
(444)
 
 
(882)
 
less: Comprehensive income attributable to noncontrolling interest
 
 
-
 
 
20
 
Comprehensive loss attributable to Lyris, Inc.
 
$
(444)
 
$
(902)
 
 
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
 
 
5

 
LYRIS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)
 
 
 
 
Three Months Ended
September 30,
 
 
 
2013
 
2012
 
Cash Flows from Operating Activities:
 
 
 
 
 
 
 
Net loss
 
$
(493)
 
$
(796)
 
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
 
 
 
Stock-based compensation expense
 
 
115
 
 
206
 
Depreciation
 
 
369
 
 
251
 
Amortization of intangible assets
 
 
50
 
 
81
 
Amortization of capitalized development costs
 
 
439
 
 
229
 
Provision for bad debts
 
 
1
 
 
146
 
Deferred income taxes
 
 
(12)
 
 
12
 
Changes in assets and liabilities:
 
 
 
 
 
 
 
Accounts receivable
 
 
255
 
 
276
 
Prepaid expenses and other current assets
 
 
(71)
 
 
(95)
 
Accounts payable and accrued expenses
 
 
(106)
 
 
1,082
 
Deferred revenue
 
 
47
 
 
(225)
 
Income taxes payable
 
 
-
 
 
80
 
Net cash provided by operating activities
 
 
594
 
 
1,247
 
Cash Flows from Investing Activities:
 
 
 
 
 
 
 
Purchases of property and equipment, net
 
 
(68)
 
 
(366)
 
Capitalized software expenditures
 
 
(790)
 
 
(1,242)
 
Net cash used in investing activities
 
 
(858)
 
 
(1,608)
 
Cash Flows from Financing Activities:
 
 
 
 
 
 
 
Payments from common stock issuances
 
 
-
 
 
(18)
 
Proceeds (payments) from short-term credit arrangements, net
 
 
5
 
 
(291)
 
Payments under capital lease obligations
 
 
(213)
 
 
(190)
 
Net cash used in financing activities
 
 
(208)
 
 
(499)
 
Net effect of exchange rate changes on cash and cash equivalents
 
 
52
 
 
1
 
Net decrease in cash and cash equivalents
 
 
(420)
 
 
(859)
 
Cash and cash equivalents, beginning of period
 
 
2,318
 
 
1,602
 
Cash and cash equivalents, end of period
 
$
1,898
 
$
743
 
 
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
 
 
6

 
LYRIS INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERLY PERIOD ENDED September 30, 2013
 
Note 1 - Nature of Business and Basis of Presentation
 
Lyris, Inc. ("Lyris", "we", or "us") is a leading internet marketing technology company. Our Software-as-a-Service ("SaaS") or cloud-based online marketing solutions and services provide customers the ability to build, deliver and manage, permission-based, online direct marketing programs and other communications to customers that use online and mobile channels to communicate to their respective customers and members. Our software products are offered to customers primarily on a subscription and license basis.
 
We were incorporated under the laws of the state of Delaware as J.L. Halsey Corporation and changed our name to Lyris, Inc. in October 2007. We have principal offices in Emeryville, California and conduct our business worldwide, with wholly owned subsidiaries in Canada, United Kingdom, Argentina, Brazil and Australia. Our foreign subsidiaries are generally engaged in providing sales, account management and support.
 
We announced a new SaaS product platform, Lyris ONE in September 2012. Since announcing Lyris ONE, we have worked to connect Lyris product capabilities on a common enterprise service bus (“ESB”) framework, allowing marketers to responsibly migrate customer, campaign, and transactional data while enabling next generation drag-and-drop integration capabilities. We extended our delivery timelines for the Lyris ONE platform in order to execute against our expanded vision, and achieve the significant and needed benefits of a flexible and extensible platform that that the market has uniformly validated as critical.
 
Fiscal Year
 
Our fiscal year ends on June 30th. References to fiscal year 2014, for example, refer to the fiscal year ending June 30, 2014.
 
Basis of Presentation and Consolidation
 
The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements and prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations; however we believe that the disclosures included are adequate.
 
These interim unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with our consolidated financial statements and notes thereto filed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2013, or fiscal year 2013, filed with the SEC on September 19, 2013. Interim information presented in the unaudited condensed consolidated financial statements has been prepared by management. In the opinion of management, statements include all adjustments necessary for a fair presentation and that all such adjustments are of a normal, recurring nature and necessary for the fair statement of the financial position, results of operations and cash flows for the periods presented in accordance with GAAP. There are certain reclassifications that have been made to the prior year condensed consolidated financial statements to conform to the current year presentation. These reclassifications had no impact on net loss, total assets or stockholders’ equity. Interim results of operations for the three months ended September 30, 2013 are not necessarily indicative of results to be expected for the year ending June 30, 2014, or fiscal year 2014, or for any future period.
 
The preparation of financial statements in conformity with GAAP 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. 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.
 
The condensed consolidated financial statements include the accounts of Lyris and our wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
 
 
7

 
In April 2010, we acquired interest in an Australian reseller, Cogent Online PTY Ltd (‘‘Cogent’’) to assist us with our sales efforts and global expansion in Australia. During June 2011, we acquired additional shares of Cogent and increased our ownership from 33.3 percent to 80 percent. In December 2012, we acquired the remaining shares of Cogent and obtained 100 percent ownership.
 
On July 23, 2010, we entered into a Strategic Partnership Agreement and a Stock Purchase Agreement (together, the “SiteWit Agreements”) with SiteWit Corp. (“SiteWit”), a privately held company that provides an online marketing search engine to its customers. We invested in 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. Pursuant to the SiteWit Agreements, we had invested $750,000 in SiteWit and owned less than 50% of SiteWit’s outstanding stock. In fiscal year 2012, we entered into a Termination Agreement (the “Termination Agreement”) with SiteWit. Pursuant to the Termination Agreement, the SiteWit Agreements were terminated effective as of August 17, 2011. From our termination agreement we returned to SiteWit approximately 75% of the SiteWit shares that were issued to us pursuant to the Sitewit Agreements.  We will have a one-time right to require SiteWit to repurchase all the remaining SiteWit shares that we hold when Sitewit enters into a Qualified Financing of $6.0 million. We plan on exercising this right when these circumstances occur.
 
Fair Value of Financial Instruments
 
The carrying amounts of certain financial instruments, including cash, 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 us 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 in an orderly transaction between market participants at the measurement date. The Financial Accounting Standards Board (“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 September 30, 2013, we used Level 1 assumptions for our cash equivalents which were $0.3 million at September 30, 2013 and June 30, 2013. 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 September 30, 2013 we do 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 September 30, 2013, we did not have any significant Level 3 financial assets or liabilities.
 
Revenue Recognition
 
We recognize revenue from providing hosting and professional services and licensing our software products to our 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.
 
 
8

 
Subscription and Other Service Revenue
 
We generate service 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.
 
We follow Accounting Standards Update 2009-13, Multiple-Deliverable Revenue Arrangements (“ASU No. 2009-13”) 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 vendor-specific objective evidence (“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 estimate of selling price (“ESP”) to determine fair value for our subscription services when sold in a multiple-element arrangement and recognize revenue based on ASU No. 2009-13. Third-party evidence (“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 have defined processes and controls to ensure our 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.
 
We defer 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, we recognize 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.
 
Software Revenue
 
We enter into certain revenue arrangements for which we are obligated to deliver multiple products and/or services (multiple elements).  For these arrangements, which generally include software products and technical support (maintenance), 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. In the event that VSOE cannot be established, we defer the entire amount until all elements of the arrangements have been delivered.
 
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 the established price list to ensure that the prices charged on the invoices align with the prices per price list.
 
 
9

 
We perform a quarterly analysis of the actual sales for standalone maintenance to establish the VSOE. We consider VSOE established if prices charged per invoice of least 75% of all standalone deals for maintenance fall within +/-20% of the prices charged per price list. If the condition is satisfied, the price list is considered to represent VSOE as prices charged per majority of the invoices agree to the established price list. Software is then recognized based on a residual method (As per ASU 985-605-25-10e) unless the price for maintenance exceeds the price for price list (which rarely happens), in which case portion of maintenance fee would be allocated to SW.

Note 2 – Recent Accounting Standards
 
In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (ASU 2013-11) to provide guidance on the presentation of unrecognized tax benefits. ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. ASU 2013-11 is effective for us in our first quarter of fiscal year 2015 with earlier adoption permitted. ASU 2013-11 should be applied prospectively with retroactive application permitted. We are currently evaluating the impact of our pending adoption of ASU 2013-11 on our condensed consolidated financial statements.

Note 3 – Stock Acquisition
 
                Pursuant to the provisions of the Stock Purchase Agreement dated June 1, 2011(“SPA”) with Cogent, Lyris exercised our option to purchase an aggregate of 66 shares at a price of $1 per share from Cogent’s minority Shareholders (as that term is defined in the SPA). We made a determination to purchase these shares equally from the shareholdings of Damien Saunders and Lucid Online Pty Ltd (an entity controlled by Adrian Saunders). After the exercise, Damian Saunders continued to own 66.7 shares and Lucid Online Pty Ltd, continued to own 66.7 shares. Damian Saunders transferred the remaining 66.7 shares held by him to us in exchange for the satisfaction of $15 thousand owed by Damian Saunders to us. Adrian Saunders’ employment terminated with Lyris on July 19, 2012 and Lyris purchased the remaining shares held by Lucid Online Pty Ltd for an aggregate purchase price of $67. On December 3, 2012, the transfer of Damien and Adrian Saunders’ remaining shares was completed and we obtained 100 percent ownership of Cogent.

Note 4 – Other Long-term Assets
 
 
 
As of
September 30, 2013
 
As of
June 30, 2013
 
 
 
(In thousands)
 
Other long-term assets
 
$
667
 
$
663
 
 
During the first quarter of fiscal year 2012, we changed our accounting in SiteWit from the equity method to the cost method due to the decrease in ownership that resulted from the Termination Agreement. Periodically, we assess whether this investment has been other-than-temporarily impaired by considering factors such as trends and future prospects of the investee, ability to pay dividends annually, general market conditions, and other economic factors. When a decline in fair value is judged to be other than temporary, the cost basis of the security is written down to fair value as a new cost basis and the amount of the other-than-temporary impairment is included in earnings.
 
During the third quarter of fiscal year 2013, we performed an impairment analysis for our SiteWit investment. First we compared our carrying value to the estimated fair value of SiteWit. Since our carrying value exceeds the estimated fair value it was an indicator of impairment. Second, we deemed the impairment is other-than-temporary from the series of net loss in our investment and the substantial decrease in our carrying value. Based on our results, we conclude to impair and write down $0.3 million from our investment, SiteWit, during the third quarter of fiscal year 2013.
 
In June 30, 2012, we had $0.1 million in irrevocable letter of credit issued by Comerica Bank, in favor of the Hartford Insurance Company (“Hartford”) for workers’ compensation insurance obligations. The Hartford LOC is held by Hartford as collateral for deductible payments that may become due under a worker’s compensation insurance policy. During the fourth quarter of fiscal year 2013, we fully repaid the outstanding line of credit with Comerica Bank and entered into a Loan and Security agreement with Silicon Valley Bank. As such, we cancelled the line of credit with Comerica Bank and issued $0.1 million to Hartford as Hartford LOC and is held by as collateral for deductible payments that may become due under a worker’s compensation insurance policy. We classify Hartford LOC as a restricted cash account of $0.1 million. Any amounts drawn on the account will be expensed during that fiscal year.
 
 
10

 
Other assets at September 30, 2013 included $0.4 million related to the investment in SiteWit, and $0.2 million related to security deposits for leases entered in by us and $0.1 million in restricted cash. Other assets at June 30, 2013 included $0.4 million related to the SiteWit investment, $0.2 million related to security deposits for leases entered in by us, and $0.1 million related restricted cash.

Note 5 – Goodwill
 
Goodwill represents the excess of the purchase price over the fair value of net assets acquired in connection with our business combinations accounted for using the acquisition method of accounting.
 
There was no change in goodwill activity during the three months ended September 31, 2013. The following table outlines our goodwill, by acquisition:
 
 
 
As of
September 30, 2013
 
As of
June 30, 2013
 
 
 
(In thousands)
 
Lyris Technologies
 
$
9,707
 
$
9,707
 
Cogent
 
 
84
 
 
84
 
Total
 
$
9,791
 
$
9,791
 
 
We considered various events and circumstances when we evaluated whether it is more likely than not that the fair value of our reporting unit is less than our carrying value. We considered events and circumstances such as macroeconomic conditions, industry and market considerations, overall financial performance, entity-specific events, and our share price relative to our peers. Based on our assessment of relevant events and circumstances conducted, we concluded that there was no impairment of goodwill for the three months ended September 30, 2013.

Note 6 – Credit Facility
 
On May 6, 2013 Lyris, Inc. and our wholly owned subsidiaries, Lyris Technologies, Inc. and Commodore Resources (Nevada), Inc. (each a “Borrower” and collectively, the “Borrowers”), entered into a Loan and Security Agreement (“SVB Agreement”) with Silicon Valley Bank (“Bank”). The Agreement provides the Company with a revolving line of credit (“SVB Revolving Line”) of up to $5,000,000. The amount available under the SVB Revolving Line is limited by a borrowing base formula based on each Borrower’s recurring revenue and customer retention rate. The SVB Revolving Line matures on May 6, 2015.
 
Advances under the SVB Revolving Line will accrue interest at a per annum floating rate equal to the greater of 6.25% or the Bank’s prime rate plus 3%. Interest is due monthly, and all unpaid principal and accrued but unpaid interest is due upon maturity.
 
The SVB Agreement contains typical negative covenants for a credit facility of this size and type, including covenants that prevent or restrict our and our subsidiaries’ ability to take certain actions, including, without limitation, changing principal executive offices, entering into mergers and acquisitions, disposing of property or other assets, and incurring additional indebtedness. Under the SVB Agreement, we are required to comply with financial covenants to maintain a liquidity ratio of not less than 1.25 to 1.00, and to maintain a minimum EBITDA (maximum loss) for the trailing three month period according to the following schedule:
 
 
11

 
Trailing Three Month Period
Ending
 
Minimum EBITDA
(maximum loss)
 
 
 
 
June 30, 2013, July 31, 2013 and August 31, 2013
 
$
(400,000)
 
 
 
 
September 30, 2013, October 31, 2013 and November 30, 2013
 
$
(350,000)
 
 
 
 
December 31, 2013, January 31, 2014 and February 28, 2014
 
$
(150,000)
 
 
 
 
March 31, 2014, April 30, 2014 and May 31, 2014
 
$
(400,000)
 
 
 
 
June 30, 2014, July 31, 2014 and August 31, 2014
 
$
(350,000)
 
 
 
 
September 30, 2014, October 31, 2014 and November 30, 2014
 
$
(200,000)
 
 
 
 
December 31, 2014, January 31, 2015 and February 28, 2015
 
$
75,000
 
Payment and performance of our obligations with respect to the SVB Revolving Line is secured by a security interest in substantially all of our assets and the assets of the additional Borrowers, including our and their intellectual property.
 
The SVB Agreement contains typical default provisions for a credit facility of this size and type, that include, among others, defaults in the event of non-payment or non-performance of covenants, a material adverse change, an attachment of our assets or entry of an injunction against doing business, occurrence of certain bankruptcy and insolvency events, cross-defaults to certain other material indebtedness, entry of material judgment and inaccuracy of representations and warranties. The occurrence of an event of default could result in, among other things, acceleration of all obligations under the SVB Revolving Line, Bank ceasing to advance money or extending credit under the SVB Revolving Line, and a right by Bank to exercise all remedies available to it under the SVB Agreement, including the disposition of any or all collateral.
 
                On May 6, 2013, in connection with entering into the Agreement, Lyris paid all amounts outstanding and owed under its Amended and Restated Loan and Security Agreement with Comerica Bank, which terminated on April 30, 2013 according to its terms.
 
As of September 30, 2013, we are in compliance with all of the covenants of the SVB Agreement for all applicable measurement periods in the first quarter of fiscal year 2014. Our outstanding borrowings totaled $2.3 million with $1.5 million and $2.0 million in available credit remaining as of September 30, 2013 and June 30, 2013. 

Note 7 - Income Taxes
 
Our effective tax rates for the three months ended September 30, 2013 and 2012 were (2.0%) and (10.6%), respectively. The following table provides a reconciliation of the income tax provision (benefit) at the statutory U.S. federal rate to our actual income tax provisions for the three months ended September 30, 2013 and 2012:
 
 
12

 
 
 
Three Months Ended September 30,
 
 
 
 
2013
 
%
 
 
2012
 
%
 
 
 
 
(In thousands)
 
 
Income tax expense (benefit) at the
    statutory rate
 
$
(169)
 
 
35.0
%
 
$
(256)
 
 
35.0
%
 
State income taxes, net of federal
    benefit
 
 
3
 
 
(0.6)
%
 
 
49
 
 
(6.7)
%
 
Amortization of intangible assets
 
 
18
 
 
(3.6)
%
 
 
21
 
 
(2.8)
%
 
Impact of Foreign Operations
 
 
5
 
 
(1.1)
%
 
 
70
 
 
(9.6)
%
 
Difference between AMT and
    statutory federal income tax rates
 
 
53
 
 
(11.0)
%
 
 
140
 
 
(19.1)
%
 
Change in valuation reserve
 
 
30
 
 
(6.2)
%
 
 
40
 
 
(5.4)
%
 
Permanent difference
 
 
2
 
 
(0.3)
%
 
 
5
 
 
(0.6)
%
 
Other, net
 
 
68
 
 
(14.2)
%
 
 
10
 
 
(1.4)
%
 
Income tax provision
 
$
10
 
 
(2.0)
%
 
$
79
 
 
(10.6)
%
 
 
In accordance with FASB standards, we establishes 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, 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. 

Note 8 – Net Loss
 
Accounting standards established by the FASB require 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 for all periods.
 
The following table sets forth the computation and reconciliation of net loss per share:
 
 
 
Three Months Ended
September 30,
 
 
 
2013
 
2012
 
 
 
(In thousands)
 
Net Loss
 
$
(493)
 
$
(796)
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic and diluted
 
 
9,568
 
 
9,441
 
Net loss per share
 
 
 
 
 
 
 
Basic and diluted
 
$
(0.05)
 
$
(0.08)
 
 
Potentially anti-dilutive stock options to purchase 24,118 and 803,730 shares of common stock were excluded in the dilutive loss per common share calculation for the three months ended September 30, 2013 and 2012, respectively.

Note 9 - Stock-Based Compensation
 
Stock Options
 
We recognize stock-based compensation costs, including employee stock awards and purchases under stock purchase plans, at the grant date fair value of the award. Determining the fair value of stock-based awards at the grant date requires judgment. Judgment is also required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be impacted.
 
 
13

 
The following table summarizes the allocation of stock-based compensation expense included in the Unaudited Condensed Consolidated Statements of Operations for the three months ended September 30, 2013 and 2012:
 
 
 
Three Months Ended
September 30,
 
 
 
2013
 
2012
 
 
 
(In thousands)
 
Cost of revenues
 
$
5
 
$
34
 
General and administrative
 
 
61
 
 
152
 
Research and development
 
 
13
 
 
8
 
Sales and marketing
 
 
36
 
 
12
 
Total
 
$
115
 
$
206
 
 
For the three months ended September 30, 2013, total stock-based compensation was $0.1 million. For the three months September 30, 2012, total stock-based compensation expense of $0.1 million related to stock options and $0.1 million in expense related to restricted stock units. We determine the fair value of each option grant using a Black-Scholes model. The Black-Scholes model utilizes multiple assumptions including expected volatility, expected life, expected dividends and interest rates. 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 Lyris’ peer group as well as the options’ contractual terms. Expected volatilities are based on implied volatilities from traded options on Lyris’ peer group’s common stock, Lyris’ 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 we have no intention of paying dividends in the near term.
 
We recognize stock-based compensation expense on a straight-line basis over the requisite service period of the award, which is typically the option vesting term of four years.
 
Stock-based compensation expense as part of capitalized software development costs was not significant for the quarter ended September 30, 2013.
 
As of September 30, 2013, unamortized stock-based compensation expense associated with common stock options was $1.8 million which we expect to recognize over a weighted-average period of 3.1 years.
 
The following table summarizes stock option activity from July 1, 2013 to September 30, 2013:
 
 
 
Number of
options
 
Weighted-
Average Fair
Value
 
Weighted-Average
Remaining Contractual
Life in Years
 
 
 
(In thousands)
 
 
 
 
 
 
 
Outstanding at July 1, 2013
 
 
1,663
 
$
2.10
 
 
8.5
 
Granted
 
 
274
 
$
1.79
 
 
 
 
Forfeited/expired
 
 
(100)
 
$
1.91
 
 
 
 
Outanding at September 30, 2013
 
 
1,837
 
$
2.06
 
 
8.5
 
Vested and expected to vest at September 30, 2013
 
 
1,342
 
$
2.01
 
 
8.1
 
Exercisable at September 30, 2013
 
 
371
 
$
2.01
 
 
5.3
 
 
As of September 30, 2013, the calculated aggregate intrinsic value of options outstanding and options exercisable was $123,988. The intrinsic value represents the pre-tax intrinsic value, based on our closing stock price on September 30, 2013 which would have been received by the option holders had all option holders exercised their options as of that date.
 
274,370, options to purchase our common stock were granted under our equity compensation plan for the three months ended September 30, 2013. The weighted-average fair value of the options granted under the equity compensation plan was $1.79 per option and $2.52 per option for the three months ended September 30, 2013 and 2012, respectively.
 
 
14

 
Reserved Shares of Common Stock
 
On August 8, 2012, we amended our 2005 Equity-Based Compensation Plan (“Plan”) to increase the number of shares available under the Plan by an additional 775,000 shares. As of September 30, 2013, we had 738,186 shares of common stock under our Plan reserved for future equity awards.

Note 10 – Segment Information
 
ASC 280 “Segment Reporting,” (“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. We 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 our solutions and services. Our Chief Executive Officer has been identified as the Chief Operating Decision Maker as defined by ASC 280.

Note 11 - Commitments and Contingencies
 
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 have also entered into capital leases in connection with acquiring computer equipment for our data center operations which is included in property and equipment. We used an average of 6.78% 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.
 
 
 
Operating Leases
 
 
 
 
 
 
 
 
 
Facilities
 
Co-location
Hosting
Facilities
 
Other
 
Total
Operating
 
Capital
Leases
 
Total
 
 
 
(In thousands)
 
Fiscal Year 2014
 
 
871
 
 
422
 
 
25
 
 
1,318
 
 
685
 
 
2,003
 
Fiscal Year 2015
 
 
1,031
 
 
185
 
 
16
 
 
1,232
 
 
437
 
 
1,669
 
Fiscal Year 2016
 
 
713
 
 
-
 
 
-
 
 
713
 
 
89
 
 
802
 
Fiscal Year 2017
 
 
190
 
 
-
 
 
 
 
 
190
 
 
9
 
 
199
 
Total
 
$
2,805
 
$
607
 
$
41
 
$
3,453
 
$
1,220
 
$
4,673
 
Less: amounts representing interest
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(67)
 
 
 
 
Present value minimum lease payments
 
 
 
 
 
 
 
 
 
 
 
 
 
$
1,153
 
 
 
 
Less: short-term portion
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(835)
 
 
 
 
Long-term portion
 
 
 
 
 
 
 
 
 
 
 
 
 
$
318
 
 
 
 
 
We entered into capital leases of $0.1 million in the first quarter of fiscal year 2014 in connection with acquiring computer equipment for our data center operations.
 
Legal claims
 
On February 14, 2012, David R. and Janet H. Burt filed suit against Wolfgang Maasberg, our former Chief Executive Officer, one other employee, several current or former directors, and certain of our stockholders in the U.S. District Court for the District of Maryland, Baltimore Division. The plaintiffs alleged various facts and make claims of federal and state securities law violations, as well as breach of fiduciary duty under Delaware law and intentional infliction of emotional distress. The plaintiffs sought unspecified damages, punitive damages, costs, and injunctive relief. The lawsuit was dismissed in April, 2013 however; the Burts filed an amended complaint in May 2013. As of September 30, 2013 we are awaiting a ruling from the court.

Note 12 – Subsequent Events
 
  On October 7, 2013, our Board of Directors appointed John Philpin as the Company’s President and Chief Executive Officer and a member of the Board, effective immediately. Roy Camblin, the Company’s former President and Chief Executive Officer and member of the Board resigned from all officer, employee and director positions at the Company, also effective immediately.
 
 
15

 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the fiscal year ended June 30, 2013, or fiscal year 2013, included in our Annual Report on Form 10-K for fiscal year 2013, filed with the SEC on September 19, 2013 .
 
This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements identify prospective information, particularly statements referencing our expectations regarding revenue and operating expenses, cost of revenue, tax and accounting estimates, cash, cash equivalents and cash provided by operating activities, the demand and expansion opportunities for our products, our customer base, our competitive position and the impact of the current economic environment on our business. In some cases, forward-looking statements can be identified by the use of words such as “may,” “could,” “would,” “might,” “will,” “should,” “expect,” “forecast,” “predict,” “potential,” “continue,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “is scheduled for,” “targeted,” and variations of such words and similar expressions. Such forward-looking statements are based on current expectations, estimates, and projections about our industry, management’s beliefs, and assumptions made by management. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include those set forth herein under “Risk Factors” or included elsewhere in our Annual Report on Form 10-K for the fiscal year ended June 30, 2013. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
 
Overview
 
We are a leading provider of digital marketing software solutions that help organizations engage with their customers across multiple interactive channels. Our solutions empower marketers to design, automate and optimize data-driven campaigns that generate superior engagement, increased business value through greater customer conversions and measurable return on marketing investment. Our Lyris HQ, Lyris ONE and Lyris ListManager solutions improve marketing efficiency by providing campaign management and automated message delivery, using robust segmentation and analytics driven by real-time social, mobile and web interactions. Lyris HQ and Lyris ONE are offered as an in-the-cloud solution for enterprises while Lyris ListManager is offered as an on-premises solution primarily for the mid to large sized business market.
 
Lyris ONE is our next-generation cloud-based platform for data-driven digital marketing automation released in September 2012. Lyris ONE analyzes customer interactive data from structured and unstructured sources, including social, email, mobile and hundreds of enterprise applications, to power digital marketing campaigns that facilitate superior customer engagement and drive revenue. By natively integrating deep customer analytics with real-time data processing and campaign automation, Lyris ONE maximizes the relevancy and value of every customer interaction. Lyris ONE is targeted at the enterprise market.
 
Lyris HQ is our proven cloud-based digital marketing solution that combines enterprise-class email marketing with web analytics. Lyris HQ helps marketers manage complex email marketing campaigns and provides real-time access to revenue and conversion events to inform message targeting, relevancy, and timeliness. Lyris HQ is targeted at mid-to-large size enterprise companies.
 
Lyris ListManager is our on-premises solution for advanced email marketing. It includes powerful automation features and reporting capabilities, and its flexible and configurable architecture integrates seamlessly with in-house databases so that digital marketers can leverage existing data stores to target customers and prospects more effectively. Lyris ListManager is targeted at the mid-to-large size business market.
 
Our solutions help companies increase customer conversions and grow revenues. Real-time customer data defines and automates targeted message flows that facilitate superior customer experiences. Our private cloud technology stack is architected for “big data” to consolidate and analyze large amounts of vital behavioral and transactional information from online activities in order to increase the relevance of every customer message. With more than fifteen years' experience and billions of digital messages processed by our solutions, we are continuously expanding ways companies deliver value to their customers.
 
The majority of our revenues are recurring, comprised of subscription revenue and support and maintenance revenue. We derive revenue from subscriptions to our SaaS solutions (Lyris HQ and Lyris ONE), software (Lyris ListManager), support and maintenance, and related professional services.
 
 
16

 
Critical Accounting Policies and Use of Estimates
 
Our unaudited condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). The preparation of these condensed 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. Accordingly, actual results could differ significantly from the estimates made by our management. 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 our 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 with our audit committee, these critical accounting policies, our use of estimates and any related disclosures.
 
Revenue Recognition
 
We recognize revenue from providing hosting and professional services and licensing our software products to our 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 Service Revenue
 
We follow Accounting Standards Update 2009-13, Multiple-Deliverable Revenue Arrangements (“ASU No. 2009-13”) 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 vendor-specific objective evidence (“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 estimate of selling price (“ESP”) to determine fair value for our subscription services when sold in a multiple-element arrangement and recognize revenue based on ASU No. 2009-13. Third-party evidence (“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 have defined processes and controls to ensure our 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.
 
      
17

 
We defer 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, we recognize 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.
 
Software Revenue
 
We enter into certain revenue arrangements for which we are obligated to deliver multiple products and/or services (multiple elements).  For these arrangements, which generally include software products and technical support (maintenance), 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. In the event that VSOE cannot be established, we defer the entire amount until all elements of the arrangements have been delivered.
 
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 compare to the established price list to ensure that the prices charged on the invoices align with the prices per price list.
 
We perform a quarterly analysis of the actual sales for standalone maintenance to establish the VSOE. We consider VSOE established if prices charged per invoice of least 75% of all standalone deals for maintenance fall within +/-20% of the prices charged per price list. If the condition is satisfied, the price list is considered to represent VSOE as prices charged per majority of the invoices agree to the established price list. Software is then recognized based on a residual method (As per ASU 985-605-25-10e) unless the price for maintenance exceeds the price for price list (which rarely happens), in which case portion of maintenance fee would be allocated to SW.
 
 
18

 
Financial Results of Operations 
 
Three Months Ended September 30, 2013 Compared to Three Months Ended September 30, 2012 
 
The following tables set forth our condensed consolidated statements of operations data as a percentage of total revenue for the three months ended September 30, 2013 and 2012:
 
 
 
 
Three Months Ended
September 30,
 
 
 
 
2013
 
 
2012
 
 
Revenue:
 
 
 
 
 
 
 
Subscription
 
77
%
 
79
%
 
Support and maintenance
 
12
%
 
10
%
 
Professional services
 
7
%
 
8
%
 
Software
 
4
%
 
3
%
 
Total revenue
 
100
%
 
100
%
 
Cost of revenue
 
37
%
 
42
%
 
Gross profit
 
63
%
 
58
%
 
Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
 
34
%
 
25
%
 
General and administrative
 
20
%
 
26
%
 
Research and development
 
13
%
 
13
%
 
Amortization of customer relationships and trade names
 
1
%
 
1
%
 
Total operating expenses
 
68
%
 
65
%
 
Loss from operations
 
-5
%
 
-7
%
 
Interest expense
 
0
%
 
-1
%
 
Interest income
 
0
%
 
0
%
 
Other (expense) income, net
 
0
%
 
0
%
 
Loss from operations before income taxes
 
-5
%
 
-8
%
 
Income tax (benefit) provision
 
0
%
 
-1
%
 
Net loss
 
-5
%
 
-9
%
 
 
Revenue
 
 
 
Three Months Ended
September 30
 
Change
 
 
 
 
 
2013
 
 
2012
 
$
 
Percent
 
 
 
 
(In thousands, except percentages)
 
 
Subscription:
 
 
 
 
 
 
 
 
 
 
 
 
 
Lyris HQ
 
$
4,955
 
$
5,425
 
$
(470)
 
(9)
%
 
Legacy
 
 
1,388
 
 
1,703
 
 
(315)
 
(18)
%
 
Total subscription
 
 
6,343
 
 
7,128
 
 
(785)
 
(11)
%
 
Support and maintenance
 
 
997
 
 
931
 
 
66
 
7
%
 
Professional services
 
 
594
 
 
670
 
 
(76)
 
(11)
%
 
Software
 
 
297
 
 
243
 
 
54
 
22
%
 
Total revenue
 
$
8,231
 
$
8,972
 
$
(741)
 
(8)
%
 
 
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. Our subscription revenue includes revenue from our Lyris ONE, Lyris HQ product, and a variety of legacy products which are in the process of reaching their end of life. We did not recognize material amounts of revenue from Lyris ONE, which was introduced in September 2012. Subscription revenue was $6.3 million or 77% of our total revenue for the three months ended September 30, 2013, compared to $7.1 million or 79% of our total revenue for the three months ended September 30, 2012, a decrease of $0.8 million or 11%.
 
Subscription revenue related to Lyris HQ for the three months ended September 30, 2013 decreased compared to the same period in fiscal year 2013, primarily as a result of existing customer turnover and decrease in new sales. Subscription revenue related to legacy products decreased for the three months ended September 30, 2013 compared to the same period in fiscal year 2013, primarily due to termination of contracts with low priced subscriptions and management’s decision to phase out low margin legacy products.
 
 
19

 
Support and maintenance revenue
 
Support and maintenance revenue is primarily comprised of customer service and support for our products. Support and maintenance revenue was $1.0 million or 12% of our total revenue for the three months ended September 30, 2013 compared to $0.9 million or 10% of our total revenue for the three months ended September 30, 2012, an increase of $0.1 million or 7%. The slight increase for the three months ended in support and maintenance revenue is a result of our proactive effort to update customer support, new customers and customer upsells.
 
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 $0.6 million or 7% of our total revenue for the three months ended September 30, 2013, compared to $0.7 million or 8% of our total revenue for three months ended September 30, 2012, a decrease of $0.1 million or 11%.
 
Professional services revenue decreased for the three months ended September 30, 2013 compared to the same periods in fiscal year 2012 primarily due to management’s decision to terminate our low margin list building service from our Cogent acquisition in June 2011, customer turnover, and customers migrating from professional to subscription based service.
 
Software revenue
 
Software revenue is derived from perpetual licensing rights of our software that we sell to our customers. Software revenue was $0.3 million or 4% of our total revenue for the three months ended September 30, 2013 compared to $0.2 million and 3% of our total revenue for the three months ended September 30, 2012, an increase of $0.1 million or 22%.
 
Software revenue increased for the three months ended September 30, 2013 as compared to the same period in fiscal year 2012 primarily due to a slight increase in new sales.
 
Cost of revenue
 
Cost of revenue consists primarily of the amortization of intangible assets related to internally developed software to support our cloud-based marketing products, amortization of our intangibles and software acquired from our strategic acquisitions, payroll-related expenses related to our engineers assigned to product and revenue-support projects, data center and depreciation costs associated with our supporting hardware, various support costs such as website development, processing fees, and allocated overhead.
 
 
 
Three Months Ended
September 30,
 
Change
 
 
 
 
 
2013
 
 
2012
 
$
 
Percent
 
 
 
 
 
(In thousands, except percentages)
 
 
Cost of revenue
 
$
3,076
 
$
3,803
 
$
(727)
 
(19)
%
 
 
Cost of revenue was $3.1 million for the three months ended September 30, 2013 and compared to $3.8 million for the same period in fiscal year 2013. As a percentage of total revenue, cost of revenue decreased to 37% for the three months ended September, 2013 from 42% for the three months ended September 30, 2012. Cost of revenue for the three months ended September 30, 2013 compared to the same period in fiscal year 2013 decreased due to a decrease in headcount. The decrease consisted of a $0.2 million in compensation expense, $0.2 million in consultant expenses, $0.2 million in facilities expenses, $0.2 million in overhead expense and $0.1 million in recruiting expenses. The decrease is offset by an increase in amortization of our internally developed software of $0.2 million associated with internally developed software.
 
 
20

 
Gross profit
 
 
 
Three Months Ended
September 30,
 
Change
 
 
 
 
2013
 
2012
 
$
 
Percent
 
 
 
 
(In thousands, except percentages)
 
 
Gross profit
 
$
5,155
 
$
5,169
 
$
(14)
 
(0)
%
 
 
 
Gross profit was $5.2 million for the three months ended September 30, 2013, compared to $5.2 million for the three months ended September 30, 2012. As a percentage of net revenue, gross profit increased to 63% for the three months ended September 30, 2013 from 58% for the three month ended, September 30, 2012. .
 
Operating expenses
 
 
 
Three Months Ended
September 30,
 
Change
 
 
 
 
 
2013
 
 
2012
 
$
 
Percent
 
 
 
 
(In thousands, except percentages)
 
 
Sales and marketing
 
$
2,832
 
$
2,275
 
$
557
 
24
%
 
General and administrative
 
 
1,673
 
 
2,306
 
 
(633)
 
(27)
%
 
Research and development
 
 
1,038
 
 
1,161
 
 
(123)
 
(11)
%
 
Amortization of customer relationships
    and trade names
 
 
50
 
 
50
 
 
-
 
0
%
 
Total operating expenses
 
$
5,593
 
$
5,792
 
$
(199)
 
(3)
%
 
 
Sales and marketing
 
Sales and marketing includes expenses primarily related to employee salaries and related costs, costs associated with advertising and other promotional programs, and allocated facilities costs.
 
Sales and marketing expense was $2.8 million for the three months ended September 30, 2013, compared to $2.3 million for the three months ended September 30, 2012, an increase of $0.5 million or 24%. As a percentage of total revenue, sales and marketing expense increased to 34% for the three months ended September 30, 2013 from 25% for same period in fiscal year 2013. The increase in sales and marketing expense was primarily due to a $0.5 million increase in our sales and marketing compensation due to an increase in headcount in the sales and marketing department.
 
General and administrative
 
General and administrative expense consists primarily of salaries and related costs 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.
 
General and administrative expense was $1.7 million for the three months ended September 30, 2013, compared to $2.3 million for the three months ended September 30, 2012, a decrease of $0.6 million or 27%. As a percentage of total revenue, general and administrative expense decreased to 20% for the three months ended September 30, 2013 from 26% for the three months ended September 30, 2012. The decrease in general and administrative expense was primarily due to $0.2 million decrease in our salary expenses and decrease of $0.1 million in our overhead expenses due to a decrease in headcount. Additionally, we had decrease of $0.2 million in finance fees for the filing and subsequent withdrawal of the registration statement and $0.1 million decrease in bad debt expense as a result of our improvement in collection.
 
Research and development
 
Research and development expense consists of salaries and related costs for engineering personnel, stock-based compensation and other headcount-related expenses associated with development of our next generation product line and increasing the functionality of current lines. We capitalize product development expenses incurred during the application development stage until the product is available for general release, provided we can ascertain that there is future economic value. We expense engineering costs in cost of revenue if the expense is related to supporting on-going platforms and is more related to product support activities. Management’s judgment is used to determine the allocation between these three categories, and we refer to these three categories in aggregate as ‘‘product investment’’.
 
 
21

 
Research and development expense was $1.0 million for the three months ended September 30, 2013, compared to $1.2 million for the three months ended September 30, 2012, a decrease of $0.2 million or 11%. As a percentage of total revenue, research and development expense remained at 13% for the three months ended September 30, 2013 and 2012.The decrease in research and development expense for the three months ended September 30, 2013 compared to the same period in fiscal year 2012 was primarily due to a $0.1 million decrease in engineering compensation and benefits as we capitalized internally developed software.
 
Amortization of customer relationships and trade names
 
Amortization of customer relationships and trade names expenses consist of intangibles that we obtained through the acquisition of other businesses.
 
Amortization of customer relationships and trade names expense was $50 thousand for the three months ended September 30, 2013 and 2012. As a percentage of total revenue, amortization of customer relationships and trade names expense remained at 1% for the three months ended September 30, 2013 and 2012.
 
Interest expense
 
 
 
Three Months Ended
September 30,
 
Change
 
 
 
 
2013
 
2012
 
$
 
Percent
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(In thousands, except percentages)
 
 
Interest expense
 
$
(38)
 
$
(125)
 
$
87
 
(70)
%
 
 
Interest expense relates to our revolving line of credit with Silicon Valley 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 was $38 thousand for the three months ended September 30, 2013, compared to $0.1 million for the three months ended September 30, 2012, a decrease of $87 thousand or 70%. The decrease in interest expense for the three months ended September 30, 2013 compared to the same period in fiscal year 2012 was primarily due to a lower average balance in our revolving line of credit of $2.0 million at September 30, 2013 compared to an average balance of $4.4 million at September 30, 2012.
 
Income Tax Provision
 
Our effective tax rates for the three months ended September 30, 2013 and 2012 were (2.0%) and (10.6%), respectively. For additional information about income taxes, refer to Note 7 of the Notes to Unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
 
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.
 
ASU No. 2011-08 “Intangibles - Goodwill and Other (Topic 350) Testing Goodwill for Impairment” provides an entity the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test for goodwill impairment. If an entity believes, as a result of our qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than our carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required.
 
We adopted ASU No. 2011-08 in the first quarter of fiscal year 2012 and considered various events and circumstances when we evaluated whether it is more likely than not that the fair value of our reporting unit is less than our carrying value. We considered events and circumstances such as macroeconomic conditions, industry and market considerations, overall financial performance, entity-specific events, and our share price relative to our peers. Based on our assessment of relevant events and circumstances conducted on September 30, 2013, we concluded that there was no impairment of goodwill for the three months ended for fiscal year 2014.
 
 
22

 
Liquidity, Capital Resources and Financial Condition
 
Our primary sources of liquidity to fund our operations as of September 30, 2013 were 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 available a revolving line of credit with Silicon Valley Bank which matures on May 6, 2015, (refer to Note 6 of the Notes to Unaudited Condensed Consolidated Financial Statements for detail information). As of September 30, 2013, our availability under this credit facility was approximately $1.5 million. As of September 30, 2013, our cash and cash equivalents totaled $1.9 million compared to $0.7 million at September 30, 2012. As of September 30, 2013, our accounts receivable, less allowances, totaled $3.8 million compared to $4.1 million at June 30, 2013.
 
 
 
 
 
 
 
 
 
Change
 
 
 
 
September 30, 2013
 
June 30, 2013
 
$
 
Percent
 
 
 
 
(In thousands, except percentages)
 
 
Accounts Receivable
 
$
4,284
 
$
4,613
 
$
(329)
 
(7)
%
 
Allowance for Doubtful Accounts
 
 
(436)
 
 
(510)
 
 
74
 
(15)
%
 
Total - Accounts receivable
 
$
3,848
 
$
4,103
 
$
(255)
 
(6)
%
 
 
Accounts receivables decreased $0.3 million or 7% for the three months ended September 30, 2013 due to decreased sales in our subscription, professional service and software. Allowance for Doubtful Accounts (“Allowance”) decreased by $0.1 million or 15% for the three months ended September 30, 2013 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 September 30, 2013, our existing cash and cash equivalents, cash flow from operations, and the availability from our revolving credit facility, provides sufficient liquidity to fund our projected working capital requirements, and capital spending for at least the next 12 months at our current growth and spending rate. We anticipate that we will continue to improve our cash flow from operations through both expense reductions and stabilization of our customer base, and we intend to continue building our cash reserves. See Notes 6 and “Credit Facility” of the Notes to Unaudited Condensed Consolidated Financial Statements.
 
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 the first quarter of fiscal year 2014 had its challenges, we still expect to maintain long-term growth in our hosted revenue offerings through the marketing of our products, Lyris ONE, Lyris HQ and Lyris ListManager, and to increase efficiency through aggressive management of our operating expenses in order to generate available cash to satisfy our capital needs and debt obligations. To the extent that existing cash, 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.
 
 
23

 
Our cash flows were as follows for the three months ended September 30, 2013 and 2012 (in thousands):
 
 
 
Three Months Ended
September 30,
 
 
 
 
2013
 
 
2012
 
 
 
(In thousands)
 
Net cash provided by operating activities
 
$
594
 
$
1,247
 
Net cash used in investing activities
 
 
(858)
 
 
(1,608)
 
Net cash used in financing activities
 
 
(208)
 
 
(499)
 
Effect of exchange rate changes on cash
 
 
52
 
 
1
 
Net decrease in cash and cash equivalents
 
$
(420)
 
$
(859)
 
 
Cash Flows for the Three Months Ended September 30, 2013 Compared to the Three Months Ended September 30, 2012
 
Operating Activities
 
Net cash flows provided by operating activities was $0.6 million for the three months ended September 30, 2013 compared to net cash flows provided by operating activities of $1.2 million for the three months ended September 30, 2012.
 
Adjustments had a $1.0 million positive effect on cash flows from operating activities for the three months ended September 30, 2013 including $0.1 million stock-based compensations and $.9 million of depreciation and amortization. Changes in assets and liabilities had a $0.1 million positive effect on cash flows provided by operating activities for the three months ended September 30, 2013 due to $0.3 million in accounts receivable and is offset by $0.1 million decrease in prepaid expenses and other assets and $0.1 million decrease in accounts payable and accrued expenses.
 
Investing Activities
 
Net cash flows used in investing activities were $0.9 million for the three months ended September 30, 2013 compared to $1.6 million for the three months ended September 30, 2012. Net cash flows used in investing activities primarily reflects capitalized software expenditures. The net cash flow used in investing activities for the three months ended September 30, 2013 consisted of a $0.8 million in capitalized software expenditures, $0.1 million used in purchasing property and equipment.
 
Financing Activities
 
Net cash flows used in financing activities was $0.2 million for the three months ended September 30, 2013 compared to net cash flows provided by financing activities of $0.5 million for the three months ended September 30, 2012. Financing cash flows for the three months ended September 30, 2013 consisted primarily of $0.2 million payments under our capital lease obligations in connection with acquiring computer equipment for our data center operations.
 
Off-Balance Sheet Arrangements
 
As of September 30, 2013, we have a $40 thousand irrevocable letter of credit (“LOC”) issued by Silicon Valley Bank in favor of Legacy Partners I SJ North Second, LLC (“Legacy”), for obligations under our San Jose, California office lease.
 
We issued $0.1 million to Hartford as Hartford LOC which is held by as collateral for deductible payments that may become due under a worker’s compensation insurance policy. We classify Hartford LOC as a restricted cash account of $0.1 million. Any amounts drawn on the account will be expensed during that fiscal year. As of September 30, 2013 no amount was drawn under the account.
 
We do not have any interest in entities referred to as variable interest entities, which include special purpose entities and other structured finance activities.
 
Revolving Line of Credit
 
For summary description of our revolving credit facility with Silicon Valley Bank, please refer to Note 6 of the Notes to Unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
 
 
24

 
ITEM 3.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Not applicable.
 
ITEM 4.         CONTROLS AND PROCEDURES
 
(a) Disclosure Controls and Procedures
 
As of September 30, 2013, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934 ( “Exchange Act”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded at that time that our disclosure controls and procedures are effective to ensure that the information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
 
 (b) Changes in Internal Control over Financial Reporting
 
There were no changes in our internal control over financial reporting during the third quarter of fiscal year 2014, which were identified in connection with management’s evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
25

 
 
PART II.  OTHER INFORMATION
 
ITEM 1.    LEGAL PROCEEDINGS
 
The Company is involved in litigation as discussed under the caption “Legal claims” in Note 11 of the Notes to Unaudited Condensed Consolidated Financial Statements disclosed in this Quarterly Report on Form 10-Q and incorporated herein by reference.
 
In addition, from time to time, we are subject to legal proceedings and claims with respect to such matters as patents, intellectual property rights, and contractual disputes with customers, marketing service providers, and others, arising out of the normal course of business.  Litigating claims of these types, whether or not ultimately determined in our favor or settled by us, is costly and diverts the efforts of management and other personnel from normal business operations.  The results of legal proceedings cannot be predicted with certainty. We do not believe the final disposition of these matters will have a material effect on our financial statements and future cash flows. 
 
ITEM 1A.   RISK FACTORS
 
Careful consideration should be given to the risk factors discussed under the caption “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2013.  This Quarterly Report on Form 10-Q is qualified in its entirety by these risks. This Form 10-Q 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 in the Form 10-K and elsewhere in this Form 10-Q. The market price of our common stock could decline due to any of these risks and uncertainties, or for other reasons, and a stockholder may lose part or all of its investment.
 
There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for fiscal year ended June 30, 2013.
 
ITEM 2.     UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
None
 
ITEM 3.     DEFAULTS UPON SENIOR SECURITIES
 
None
 
ITEM 4.    MINE SAFETY DISCLOSURES
 
                   None
 
ITEM 5.    OTHER INFORMATION
 
None
 
 
26

 
ITEM 6.      EXHIBITS
   
 
 
 
 
 
 
Incorporated by Reference
 
   
Exhibit
No.
 
Description
 
Form
 
Date of First
Filing
 
Exhibit
Number
 
Filed Herewith  
 
 
 
 
 
 
 
 
 
 
   
3.1
 
Certificate of Incorporation of the Company.
 
10-K
 
9/26/07
 
3(a)(i)
 
   
 
 
 
 
 
 
 
 
 
 
   
3.2
 
Certificate of Amendment to Certificate of Incorporation of the Company.
 
10-K
 
9/26/07
 
3(a)(ii)
 
   
 
 
 
 
 
 
 
 
 
 
   
3.3
 
Certificate of Amendment to Certificate of Incorporation of the Company.
 
8-K
 
3/5/12
 
3.1
 
   
 
 
 
 
 
 
 
 
 
 
   
3.4
 
Certificate of Ownership and Merger, merging NAHC, Inc. with and into J.L. Halsey Corporation.
 
10-K
 
9/26/07
 
3(a)(iii)
 
    
 
 
 
 
 
 
 
 
 
 
   
3.5
 
Certificate of Ownership and Merger, merging Lyris, Inc., with and into J.L. Halsey Corporation.
 
8-K
 
10/31/07
 
3.2
 
   
 
 
 
 
 
 
 
 
 
 
   
3.6
 
First Amended and Restated Bylaws of the Company
 
8-K
 
2/21/07
 
3.3
 
   
 
 
 
 
 
 
 
 
 
 
   
3.7
 
Amendments to First Amended and Restated Bylaws of the Company
 
8-K
 
2/21/07
 
3.1
 
   
 
 
 
 
 
 
 
 
 
 
   
3.8
 
Amendments No.2 to First Amended and Restated Bylaws of the Company
 
8-K
 
9/17/13
 
3.1
 
   
 
 
 
 
 
 
 
 
 
 
   
4.1
 
Certificate of Designation, as filed with the Delaware Secretary of State on October 17, 2012.
 
8-K
 
10/18/12
 
4.1
 
   
 
 
 
 
 
 
 
 
 
 
   
31.1
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a)
 
 
 
 
 
 
 
X  
 
 
 
 
 
 
 
 
 
 
   
31.2
 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a)
 
 
 
 
 
 
 
X  
 
 
 
 
 
 
 
 
 
 
   
32.1
 
Section 1350 Certification of Chief Executive Officer
 
 
 
 
 
 
 
X  
 
 
 
 
 
 
 
 
 
 
   
32.2
 
Section 1350 Certification of Chief Financial Officer
 
 
 
 
 
 
 
X  
 
 
 
 
 
 
 
 
 
 
   
101.INS
 
XBRL Taxonomy Extension Schema
 
 
 
 
 
 
 
X  
 
 
 
 
 
 
 
 
 
 
   
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase
 
 
 
 
 
 
 
X  
 
 
 
 
 
 
 
 
 
 
   
101.LAB
 
XBRL Taxonomy Extension Label Linkbase
 
 
 
 
 
 
 
X  
 
 
 
 
 
 
 
 
 
 
   
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase
 
 
 
 
 
 
 
X  
 
 
27

 
SIGNATURE
 
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: November 7, 2013
 
 
By:  /s/ John Philpin
 
John Philpin
 
Chief Executive Officer and President
 
 
 
By:  /s/ Deborah Eudaley
 
Deborah Eudaley
 
Chief Financial Officer and Chief Operating Officer
 
 
28