Friday, August 24, 2007

J.L. Halsey -- The Biggest Story Never Told!

In July 2001, J.L. Halsey (JLHY-$1.05) was just a shell of a public company, with nothing much to offer potential investors, save for about $135 million in net operating loss carryforwards. However, anyone drunk enough—oh! prescient enough—to have bought just $100 worth of this penny stock would have witnessed their investment grow to more than $35,000 by June 2006!

Halsey is the successor to NovaCare, which was a national leader in physical rehabilitation services, orthotics and prosthetics and employee services. The changes to Medicare reimbursement in the late 1990’s (due to the Balanced Budget Act of 1997) had deleterious effects on NovaCare and its competitors and customers. The prior operating business most affected by the Medicare changes was the long-term care services segment in which NovaCare provided therapists to skilled nursing facilities.

This business was disposed of in fiscal 1999 with the shutdown of certain of NovaCare’s operations in the Western United States during the third fiscal quarter and the sale of the remaining operations on June 1, 1999.

Subsequently, NovaCare sold off its other segments, and on June 18, 2002, the shell merged with and into Halsey, its remaining wholly owned subsidiary.

Shares rocketed in price after Halsey acquired four Emarketing software companies during the past two years:
Lyris Technologies (March 2005, Email marketing software & Hosting services), EmailLabs (October 2005, Email marketing software), ClickTracks (August 2006, Web Site Analysis Tools), and Hot Banana (August 2006, Web Content Management Software Suite).

In July 2007, Ziff Davis Media's IT publication, Baseline Magazine, ranked the company No. 1 on its list of the fastest-growing, publicly-traded software companies with sales of less than $150 million. J.L. Halsey landed at the top with 1003 percent 2006 sales growth to $24.4 million in sales, from $2.2 million in 2005.

More than 80% of Halsey’s revenue comes from the email marketing market — from the licensing of software, the sale of support and maintenance contracts related to its software, and from the sale of hosted services. The remainder of its revenue, with the acquisitions of ClickTracks and Hot Banana, comes from Web analytics (the ability to monitor and understand visitor behavior, funnel paths, track conversions and optimize pay-per-click (PPC) programs) and content management.

In our view, despite its torrid sales growth, the current valuation of Halsey discounts the price performance potential over the next 12-months. Granted, the Company is focused on high-growth technologies—and management’s ability to execute on successfully completing the integration of its acquisitions could drive sales and earnings higher. However, our confidence in Halsey forward earnings’ visibility dissipated after a quantitative look at growth, profitability, and capital strength metrics.


Total revenue was $28.2 million for the nine months ended March 31, 2007, compared to $16.7 million for the prior year. Lyris’ hosted revenue increased to approximately $6.8 million for the nine months ended March 31, 2007, from approximately $4.7 million for the nine months ended March 31, 2006. In addition, the acquisitions of EmailLabs and ClickTracks kicked in incremental sales of $5.5 million and $2.5 million, respectively.

Halsey reported a net loss of $(430,000), or $0.00 per share, for the nine months ended March 31, 2007, compared to net income of $2.2 million, or share-net of $0.03, last year. The primary reasons for the decrease of approximately $2.6 million were increases in research and development of $1.2 million and interest expense of $576,000.

“Some people find fault as if it were buried treasure.”

Doing what we do best, the 10Q dug into Halsey’s Income statement and found some interred accounting gems. To wit:

  • Discontinued Operations – Management is boosting its bottom line by annual changes to discontinued adjustments ($374.1 million loss on disposal of operations, which were originally recorded in fiscal year 2000).

The Company maintains allowances for the collection of its receivables remaining from its erstwhile healthcare operations. These allowances resulted from the purported inability or unwillingness of many of the Company’s former healthcare customers to make payments and Medicare related indemnification receivables. At March 31, 2007, the Company believed that “the probability of collecting the $563,000 in receivables was low” and accordingly, has fully reserved these receivables to reduce their net realizable value to zero. However, if any of these receivables are collected, the Company will record a gain in the period of collection.

Halsey also maintains $1.54 million (down from $2.31 million in 2006) in accrued expenses (still remaining from the 2000 discontinued operations, primarily consisting of liabilities that arose prior to or as a result of the disposed transactions). These liabilities include costs for litigation (necessary to defend itself against legal claims related to its discontinued operations), workers’ compensation claims, professional liability claims and other liabilities.

Management claims that the actual collections of assets or actual costs of liabilities are difficult to estimate because of the high variability of possible outcomes: “As a result, the actual costs could differ significantly from [prior] estimates.”

Of interest, management has consistently erred on its estimates (to the Company’s benefit) of its legacy assets and liabilities. For the nine-months ended March 31, 2007, management reversed a previously booked loss of $560,000. As such, the nine-month loss shrank by $0.01 per share. And, in the same period for fiscal 2006, there was a reversal of $448,000, boosting share-net by one-cent.

  • Income Tax Provision – Halsey continues to utilize its net operating loss carryforwards to lower taxable income. For federal income tax purposes, 90% of the Company’s consolidated year to date income was offset by prior cumulative NOLs. For state income tax purposes, the company pays at the statutory rate of 8.84 percent (the statutory rate in California).

For the nine-months ended March 31, 2007, Halsey’s effective income tax rate was 23.5 percent, compared to 24.3% in the prior year. In 2006, the U.S. average statutory rate was 39.3 percent.

  • Contingent acquisition payments – The Company spent about $54 million in payments for the four most recent acquisitions. In addition, each of the four foregoing acquisitions requires Halsey to make additional earn-out payments to the sellers of the businesses if certain conditions are met (specified revenue targets) totaling $13.7 million. A principle use of cash in the future will be the payment of these earn-outs (and the pay down of debt). C

Cash on hand, cash flow, and borrowing capacity under its credit facility currently are insufficient to pay these earn outs. As of March 31, 2007, the Company had only $346,000 in cash.

In addition, the Company has a current account deficit of about $(208.4) million.

  1. Lyris achieved its specified revenue targets, and was owed $6.6 million in May 2007. Halsey extended the maturity date, with interest accruing at 10% per annum, to November 12, 2008. [est. total due—with interest--$7.2 million]
  2. EmailLabs achieved its specific revenue targets, too, and is owed $1.72 million (due on October 11, 2007).
  3. Additional payments totaling approximately $4.0 million may be made in the event ClickTracks achieves future revenue targets. Halsey does not believe it is probable that ClickTracks will achieve the specified targets and accordingly has not recorded a liability as of (March 31, 2007).
  4. Halsey believes it is probable that Hot Banana’s performance will result in contingent payments for revenue targets and the second installment of a technology integration target to the sellers of Hot Banana and, as a result, the Company has accrued $882,488 in liabilities (as of March 31, 2007).

Halsey carries a market capitalization of only $103.3 million, which belies an air of ‘undervaluation.’ In our view, the trailing twelve-month ROA and ROE of 2.24% and (1.61)%, respectively, speak more to the problematic growth prospects ahead.

Investors ought note, too, that the existing capital structure can no longer support new acquisitions: intangible assets (e.g. customer relations, developed technology) and goodwill of $23.3 million and $35.8 million, collectively represented approximately 84% of total assets; and, the Company has revolving line of with Comerca Bank with some
restrictive financial covenants, including fixed charge coverage ratio and senior debt to EBITDA.

J.L. Halsey said that it will seek stockholder approval
to change its name to Lyris Solutions, Inc., at the company's annual stockholder meeting, which is expected to take place on September 12, 2007.

Editor David J. Phillips does not hold a financial position in J.L. Halsey. The 10Q Detective has a Full Disclosure Policy.


Anonymous said...

David - Do you have any thoughts / comments in general about the use of shell companies to bring companies private? Is it truly a pyramid-type scheme, or can it be a real financing alternative?

David J. Phillips said...

In general, financial experts would tell investors to steer clear of reverse mergers (w. a shell company. For legitimate businessmen, however, there are merits in going public via a shell, including lower costs (than an IPO). Ted Turner & Muriel Siebert--to name a few--successfully made millions for investors after initially going public via reverse mergers w. shell companies.

Anonymous said...

If you are concerned about the 10Q it might be helpful to speak with a few customers which comprise some of the new receivables. Then the concerns will accelerate.