Attached files

file filename
EX-32.1 - EX-32.1 - LIBERATOR MEDICAL HOLDINGS, INC.g26197exv32w1.htm
EX-31.2 - EX-31.2 - LIBERATOR MEDICAL HOLDINGS, INC.g26197exv31w2.htm
EX-32.2 - EX-32.2 - LIBERATOR MEDICAL HOLDINGS, INC.g26197exv32w2.htm
EX-31.1 - EX-31.1 - LIBERATOR MEDICAL HOLDINGS, INC.g26197exv31w1.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
(Amendment No. 1)
(Mark One)
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2009
or
o   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: 000-05663
LIBERATOR MEDICAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
     
NEVADA
(State or other jurisdiction of
incorporation or organization)
  87-0267292
(I.R.S. Employer
Identification No.)
2979 SE Gran Park Way, Stuart, Florida 34997
(Address of principal executive offices) (Zip Code)
(772) 287-2414
(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 þ   No o
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 o   No o
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 o   Accelerated filer o   Non-accelerated filer o   Smaller reporting company þ
        (Do not check if a smaller reporting company)    
Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o   No þ
APPLICABLE TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
Class   Outstanding as of February 10, 2010
     
Common Stock, $.001   33,933,666
 
 

 


 

TABLE OF CONTENTS
             
        Page
Explanatory Note     3  
   
 
       
PART I — FINANCIAL INFORMATION     4  
   
 
       
Item 1.       4  
   
 
       
        4  
   
 
       
        5  
   
 
       
        6  
   
 
       
        7  
   
 
       
        8  
   
 
       
Item 2.       23  
   
 
       
Item 3.       28  
   
 
       
Item 4T.       28  
   
 
       
PART II — OTHER INFORMATION     30  
   
 
       
Item 1.       30  
   
 
       
Item 1A.       30  
   
 
       
Item 2.       30  
   
 
       
Item 3.       30  
   
 
       
Item 4.       30  
   
 
       
Item 5.       30  
   
 
       
SIGNATURES  
 
    31  
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2

2


Table of Contents

Explanatory Note — Restatement of Previously Issued Financial Statements
Liberator Medical Holdings, Inc. (the “Company”) is filing this amendment to its Quarterly Report on Form 10-Q for the interim period ended December 31, 2009, which was originally filed with the Securities and Exchange Commission (“SEC”) on February 11, 2010 (the “Original Filing”), to include restated financial statements as described in Note 3 to the condensed consolidated financial statements. The Company has restated its previously issued condensed consolidated financial statements as of and for the three months ended December 31, 2009, to properly account for the following:
    The Company’s adoption of accounting principles related to embedded conversion features included in certain convertible notes payable issued in May and October 2008 that became effective for the Company on October 1, 2009.
 
    The effect of a change in a valuation allowance that resulted from a change in judgment about the realizability of the related deferred tax asset in future years.
 
    In addition, certain reclassifications related to the accounting for deferred advertising costs and deferred income taxes have been made in order to maintain consistency and comparability with our subsequent presentations in fiscal year 2010 on Forms 10-Q and 10-K.
The revisions relate to non-operating and non-cash items for the interim period ended December 31, 2009, and do not impact reported revenues, operating income, or the Company’s cash position. Please refer to Note 3 of the condensed consolidated financial statements below for a detailed analysis of the effects of the restatements on our condensed consolidated financial statements for the three months ended December 31, 2009.
This Form 10-Q/A amends the following items in the Company’s Original Filing:
    Part I — Item 1 — Condensed Consolidated Financial Statements
 
    Part I — Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
    Part I — Item 4T — Controls and Procedures
 
    Part II — Item 6 — Exhibits
For the convenience of the reader, this Form 10-Q/A sets forth the Quarterly Report on Form 10-Q in its entirety. Other than as described above, none of the other disclosures in the Original Filing have been amended or updated. Among other things, forward-looking statements made in the Original Filing have not been revised to reflect events that occurred or facts that became known to the Company after the filing of the Original Filing, and such forward-looking statements should be read in their historical context. Accordingly, this Form 10-Q/A should be read in conjunction with the Company’s filings subsequent to the Original Filing with the SEC.

3


Table of Contents

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in thousands, except per share amounts)
                 
    As Restated        
    December 31,     September 30,  
    2009     2009  
    (unaudited)          
Assets
               
Current Assets
               
Cash
  $ 2,881     $ 3,798  
Restricted cash
    1,053       500  
Accounts receivable, net of allowances of $2,717 and $2,327, respectively
    4,664       3,850  
Inventory, net of allowance for obsolete inventory of $110 and $110, respectively
    933       902  
Deferred taxes, current portion
    1,073        
Debt issuance costs, current portion
    242       347  
Other current assets
    246       136  
 
           
Total Current Assets
    11,092       9,533  
Property and equipment, net of accumulated depreciation of $1,116 and $1,021, respectively
    1,726       1,041  
Deferred advertising
    4,983       3,755  
Debt issuance costs, net of current portion
          7  
Deposits
    258       123  
 
           
Total Assets
  $ 18,059     $ 14,459  
 
           
 
               
Liabilities and Stockholders’ Equity
               
Current Liabilities
               
Accounts payable
  $ 2,834     $ 2,089  
Accrued liabilities
    560       716  
Credit line facility
    750        
Stockholder loans
    1,315       1,515  
Convertible notes payable, net of unamortized discount of $670 and $292, respectively
    5,863       3,893  
Derivative liabilities
    10,918        
Capital lease obligations, current portion
    77       80  
Deferred rent liability, current portion
    38       60  
 
           
Total Current Liabilities
    22,355       8,353  
Convertible notes payable, net of unamortized discount of $0 and $90, respectively
          2,447  
Capital lease obligations, net of current portion
    53       70  
Deferred rent liability, net of current portion
    185       165  
Deferred tax liability
    64        
 
           
Total Liabilities
    22,657       11,035  
 
           
 
               
Stockholders’ Equity (Deficit)
               
Common stock, $.001 par value, 200,000 shares authorized; 33,298 and 32,462 shares issued, respectively; 33,209 and 32,377 shares outstanding at December 31, 2009 and September 30, 2009, respectively
    33       32  
Additional paid-in capital
    11,870       11,705  
Accumulated deficit
    (16,451 )     (8,272 )
 
           
 
    (4,548 )     3,465  
Less: Treasury stock, at cost; 89 and 85 shares at December 31, 2009 and September 30, 2009, respectively
    (50 )     (41 )
 
           
Total Stockholders’ Equity (Deficit)
    (4,598 )     3,424  
 
           
Total Liabilities and Stockholders’ Equity (Deficit)
  $ 18,059     $ 14,459  
 
           
See accompanying notes to unaudited condensed consolidated financial statements.

4


Table of Contents

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
For the three months ended December 31, 2009 and 2008
(Unaudited)
(in thousands, except per share amounts)
                 
    As Restated        
    2009     2008  
Sales
  $ 9,158     $ 5,342  
 
               
Cost of Sales
    3,248       1,841  
 
           
 
               
Gross Profit
    5,910       3,501  
 
           
 
               
Operating Expenses
               
Payroll, taxes and benefits
    2,169       1,065  
Advertising
    806       298  
Bad debts
    655       679  
Depreciation
    95       66  
General and administrative
    1,025       882  
 
           
Total Operating Expenses
    4,750       2,990  
 
           
 
               
Income from Operations
    1,160       511  
 
           
 
               
Other Income (Expense)
               
Interest expense
    (416 )     (273 )
Change in fair value of derivative liabilities
    (5,098 )      
Interest income
    3       8  
 
           
Total Other Income (Expense)
    (5,511 )     (265 )
 
           
 
               
Income (Loss) before Income Taxes
    (4,351 )     246  
 
               
Benefit from Income Taxes
    (1,006 )      
 
           
 
               
Net Income (Loss)
  $ (3,345 )   $ 246  
 
           
 
               
Basic earnings (loss) per share:
               
Weighted average shares outstanding
    32,848       32,049  
Earnings (Loss) per share
  $ (0.10 )   $ 0.01  
 
               
Diluted earnings (loss) per share:
               
Weighted average shares outstanding
    32,848       35,970  
Earnings (Loss) per share
  $ (0.10 )   $ 0.01  
See accompanying notes to unaudited condensed consolidated financial statements.

5


Table of Contents

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statement of Changes in Stockholders’ Equity (Deficit)
For the three months ended December 31, 2009 As Restated
(Unaudited)
(in thousands)
                                                 
                                            Total  
    Common     Common     Paid in     Accumulated     Treasury     Stockholders’  
    Shares     Stock     Capital     Deficit     Stock     Equity (Deficit)  
Balance at September 30, 2009
    32,377     $ 32     $ 11,705     $ (8,272 )   $ (41 )   $ 3,424  
 
                                               
Cumulative effect of change in accounting principle
                    (390 )     (4,834 )             (5,224 )
Options issued to employees
                    125                       125  
Common stock issued for interest on convertible debt
    19             45                       45  
Common stock issued upon conversion of debt
    300             150                       150  
Common stock issued for exercise of warrants
    355       1       162                       163  
Common stock issued for employee stock purchase plan
    162             73                       73  
Purchase common treasury stock
    (4 )                             (9 )     (9 )
Net loss
                            (3,345 )             (3,345 )
 
                                   
Balance at December 31, 2009
    33,209     $ 33     $ 11,870     $ (16,451 )   $ (50 )   $ (4,598 )
 
                                   
See accompanying notes to unaudited condensed consolidated financial statements.

6


Table of Contents

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
For the three months ended December 31, 2009 and 2008
(Unaudited)

(in thousands)
                 
    Restated        
    2009     2008  
Cash flow from operating activities:
               
Net Income (Loss)
  $ (3,345 )   $ 246  
 
               
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Depreciation and amortization
    905       357  
Change in fair value of derivative liabilities
    5,098        
Equity based compensation
    133       136  
Provision for doubtful accounts and sales returns and adjustments
    763       679  
Non-cash interest related to convertible notes payable
    353       162  
Deferred income taxes
    (1,009 )      
Amortization of non-cash debt issuance costs
    9       10  
Changes in operating assets and liabilities:
               
Accounts receivable
    (1,576 )     (1,190 )
Deferred advertising
    (2,037 )     (680 )
Inventory
    (31 )     (275 )
Other assets
    (150 )     80  
Accounts payable
    744       928  
Accrued expenses
    (179 )     6  
Deferred rent
    (2 )     (12 )
 
           
Net Cash Flow Provided by (Used in) Operating Activities
    (324 )     447  
 
           
 
               
Cash flow from investing activities:
               
Purchase of property and equipment
    (780 )     (29 )
Purchase of certificates of deposit
    (553 )      
 
           
Net Cash Flow Used in Investing Activities
    (1,333 )     (29 )
 
           
 
               
Cash flow from financing activities:
               
Proceeds from issuance of convertible notes
          2,500  
Costs associated with issuance of convertible notes
          (310 )
Proceeds from the exercise of warrants
    163        
Proceeds from employee stock purchase plan
    56        
Proceeds from credit line facility
    750        
Purchase of treasury stock
    (9 )     (3 )
Payments of debt and capital lease obligations
    (220 )     (16 )
 
           
Net Cash Flow Provided by Financing Activities
    740       2,171  
 
           
 
               
Net increase (decrease) in cash
    (917 )     2,589  
 
               
Cash at beginning of period
    3,798       1,173  
 
           
Cash at end of period
  $ 2,881     $ 3,762  
 
           
 
               
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $ 105     $ 93  
Cash paid for income taxes
  $ 12     $  
 
               
Supplemental schedule of non-cash investing and financing activities:
               
Capital expenditures funded by capital lease borrowings
  $     $ 17  
Common stock issued for interest expense
  $ 45     $  
Common stock issued for conversion of debt
  $ 150     $  
See accompanying notes to unaudited condensed consolidated financial statements.

7


Table of Contents

Liberator Medical Holdings, Inc. and Subsidiaries
Notes To The Unaudited Condensed Consolidated Financial Statements
December 31, 2009
Note 1 — Basis of Presentation (Restated)
The accompanying unaudited condensed consolidated financial statements of Liberator Medical Holdings, Inc. (the “Company”) and the notes thereto have been prepared in accordance with instructions for Form 10-Q and Article 8 of Regulation S-X of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. However, in the opinion of the Company, such information includes all adjustments (consisting only of normal recurring adjustments) which are necessary for a fair presentation of the financial position and results of operations for the interim periods presented. The unaudited condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and the notes thereto that are included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2009 that was filed with the SEC on December 17, 2009. The results of operations for the three months ended December 31, 2009 are not necessarily indicative of the results to be expected for the full year.
The unaudited condensed consolidated financial statements include the accounts of the Company, Liberator Medical Supply, Inc., Liberator Health and Education, Inc., and Liberator Health and Wellness, Inc., its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation.
Certain reclassifications of amounts previously reported have been made to the accompanying condensed consolidated financial statements in order to maintain consistency and comparability between the periods presented. The following reclassification was made to the fiscal year 2009 financial statements to be consistent with the fiscal year 2010 financial statements presented:
    On the Consolidated Balance Sheet as of September 30, 2009, $2,016,000 of Deferred Advertising was reclassified from Current Assets to Non-current Assets in order to be consistent with accounting guidance issued for deferred advertising costs.
Note 2 — Summary of Significant Accounting Policies (Restated)
The significant accounting policies followed by the Company for interim reporting are consistent with those included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2009, except for the accounting policy related to Derivative Financial Instruments discussed below.
Derivative Financial Instruments
We do not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks. However, we have entered into certain other financial instruments and contracts with embedded conversion features on convertible debt instruments that must be separated from the host instrument and are not afforded equity classification. These instruments are required to be carried as derivative liabilities, at fair value, in our condensed consolidated financial statements.
Derivative financial instruments consist of financial instruments or other contracts that contain a notional amount and one or more underlying variables (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as assets or liabilities. The changes in fair values at each reporting period, or interim period, are recorded as a charge or a benefit to earnings included in the Other Income (Expense) section of the Company’s Condensed Consolidated Statement of Operations.

8


Table of Contents

We estimate fair values of derivative financial instruments using various techniques that are considered to be consistent with the objective measurement of fair values. In selecting the appropriate technique, we consider, among other factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques are highly volatile and sensitive to changes in the trading market price of our common stock. Since derivative financial instruments are initially and subsequently carried at fair values, our income or loss will reflect the volatility in changes to these estimates and assumptions.
Recent Accounting Pronouncements
In September 2009, Accounting Standards Codification (“ASC”) became the source of authoritative U.S. Generally Accepted Accounting Principles (“GAAP”) recognized by the Financial Accounting Standards Board (“FASB”) for nongovernmental entities, except for certain FASB Statements not yet incorporated into ASC. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative U.S. GAAP for registrants. The discussion below includes the applicable ASC reference.
On October 1, 2009, we adopted Accounting Standards Codification (“ASC”) 815-40-15, “Derivatives and Hedging — Contracts in Entity’s Own Equity (Scope and Scope Exceptions)” (“ASC 815-40-15”), which requires that we apply a two-step approach in evaluating whether an equity-linked financial instrument (or embedded feature) is indexed to our own stock, including evaluating the instrument’s contingent exercise and settlement provisions. Upon adoption of ASC 815-40-15 on October 1, 2009, we reclassified $5,820,000 from stockholders’ equity to derivative liabilities. Additionally, the fair value of the derivative liabilities are adjusted to fair market value at the end of each reporting period. (See Notes 4 and 10 below).
The Company adopted ASC Topic 825-10 Financial Instruments, which requires quarterly disclosure of information about the fair value of financial instruments within the scope of Topic 825-10. The Company adopted this pronouncement effective April 1, 2009 with no material impact on its condensed consolidated financial statements. The carrying value of financial instruments including cash, receivables, accounts payable, accrued expenses and debt, approximates their fair value at December 31, 2009 and September 30, 2009 due to the relatively short-term nature of these instruments. The carrying value of long-term debt approximates its fair value as it bears variable interest rate which reflects the current market yield level for comparable loans.
In April 2009, the Company adopted ASC Topic 820-10-65 Fair Value Measurements and Disclosures. The standard provides additional guidance for estimating fair value in accordance with Topic 820-10-65 when the volume and level of activity for the asset or liability have significantly decreased and includes guidance on identifying circumstances that indicate if a transaction is not orderly. The Company adopted this pronouncement effective April 1, 2009 with no material impact on its condensed consolidated financial statements.
The Company adopted, ASC Topic 855-10 Subsequent Events effective April 1, 2009. This pronouncement changes the general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The Company has evaluated subsequent events through the time it filed its original interim report on Form 10-Q on February 11, 2010.
In July 2009, the FASB issued SFAS No. 168, The Hierarchy of Generally Accepted Accounting Principles. SFAS 168 codified all previously issued accounting pronouncements, eliminating the prior hierarchy of accounting literature, in a single source for authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. SFAS 168, now ASC Topic 105-10 Generally Accepted Accounting Principles, is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of this pronouncement did not have a material effect on the condensed consolidated financial statements.
In August 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-05, Measuring Liabilities at Fair Value, which clarifies, among other things, that when a quoted price in an active market for the identical liability is not available, an entity must measure fair value using one or more specified techniques. The Company adopted the pronouncement effective July 1, 2009 with no material impact on its condensed consolidated financial statements.

9


Table of Contents

In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements, which revises the existing multiple-element revenue arrangements guidance and changes the determination of when the individual deliverables included in a multiple-element revenue arrangement may be treated as separate units of accounting, modifies the manner in which the transaction consideration is allocated across the separately identified deliverables and expands the disclosures required for multiple-element revenue arrangements. The pronouncement is effective for financial statements issued after December 31, 2010. The Company does not expect the pronouncement to have a material effect on its condensed consolidated financial statements.
Note 3 — Restatement of Previously Issued Financial Statements (Restated)
On December 9, 2010, the Company concluded that the Company’s previously issued unaudited financial statements as of and for the interim period ended December 31, 2009, contained errors in the application of certain generally accepted accounting principles. The Company has restated its previously issued condensed consolidated financial statements as of and for the three months ended December 31, 2009, to properly account for the following:
  Previously, the Company had concluded that embedded anti-dilution provisions included in certain convertible notes payable issued in May and October 2008 were indexed to the Company’s own stock under accounting principles that became effective for the Company on October 1, 2009 and did not change the accounting treatment for the embedded conversion features when the guidance became effective for the Company on October 1, 2009. However, after re-evaluating the accounting principles issued and our accounting treatment for the embedded conversion features, the Company concluded that an error was made in the application of the accounting principles, that the embedded anti-dilution provisions are not indexed to the Company’s own stock, and, therefore, they are embedded derivative financial liabilities (the “Embedded Derivatives”) that require bifurcation and separate accounting. Accordingly, the Company should have recorded a cumulative effect adjustment to the opening balance of paid in capital and accumulated deficit on October 1, 2009. In addition, the Company is required to adjust the Embedded Derivatives to fair value at each balance sheet date, or interim period, and recognize the changes in fair value as a non-cash charge or benefit to earnings, recorded as a component of other income (expense) in the Company’s condensed consolidated statement of operations.
  Previously, the Company included a change in the valuation allowance as an adjustment to the estimated annual tax rate used in the calculation of interim period deferred taxes, which allocated the tax benefits proportionately throughout the four quarters of fiscal year 2010. Based on a re-evaluation of generally accepted accounting principles, the Company recorded the effect of the change in the valuation allowance as a discrete event, which resulted in an additional $1,072,000 in tax benefits during the interim period ending December 31, 2009.
  In addition, certain reclassifications related to the accounting for deferred advertising costs and deferred income taxes have been made in order to maintain consistency and comparability with our subsequent presentations in fiscal year 2010 on Forms 10-Q and 10-K. The Company had reflected both a current and long term portion of the deferred advertising assets on the condensed consolidated balance sheet as of December 31, 2009. In accordance with an SEC interpretation (SPCH.T.1995.22.Glynn), the SEC would object to the classification of any unamortized cost of advertising as a current asset. As a result, the Company reclassified the amount previously recorded as current assets to non-current assets. The Company had reflected its deferred tax assets and deferred tax liabilities as a consolidated deferred tax liability amount on the condensed consolidated balance sheet as of December 31, 2009. The Company has reclassified the current portion of the deferred tax assets from the consolidated deferred tax liability and presented the amounts separately in accordance with generally accepted accounting principles.

10


Table of Contents

The following tables provide a summary of the amounts restated as of and for the three months ended December 31, 2009 (dollars in thousands, except per share amounts):
                                 
            Cumulative              
            Effect              
    As     Adjustment     Current        
    Previously     as of     Period     As  
Balance Sheet Data:   Reported     10/1/2009     Effect     Restated  
Deferred advertising, current portion
    2,678             (2,678 )      
Deferred taxes, current portion
                1,073       1,073  
 
                       
Current Assets
    12,697             (1,605 )     11,092  
Deferred advertising
    2,305             2,678       4,983  
 
                       
Total Assets
    16,986             1,073       18,059  
 
                       
 
Notes payable, net
  $ 6,286     $ (596 )   $ 173     $ 5,863  
Derivative liabilities
          5,820       5,098       10,918  
 
                       
Current Liabilities
    11,860       5,224       5,271       22,355  
Deferred tax liability
    503             (439 )     64  
 
                       
Total Liabilities
    12,601       5,224       4,832       22,657  
 
                       
 
Additional Paid in Capital
    11,820       (390 )     440       11,870  
Accumulated Deficit
    (7,418 )     (4,834 )     (5,268 )     (16,451 )
 
                       
Total Equity (Deficit)
  $ 4,385     $ (5,224 )   $ (3,759 )   $ (4,598 )
 
                       
                         
    For the three months ended December 31, 2009  
    As     Current        
    Previously     Period     As  
Statement of Operations Data:   Reported     Effect     Restated  
Other Income (Expense):
                       
Interest Expense
  $ (243 )   $ (173 )   $ (416 )
Change in fair value of derivative liabilities
          (5,098 )     (5,098 )
 
                 
Total Other Income (Expense)
    (240 )     (5,271 )     (5,511 )
 
                 
 
                       
 
                 
Provision for (Benefit from) Income Taxes
    66       (1,072 )     (1,006 )
 
                 
 
 
                 
Net Income (Loss)
  $ 854     $ (4,199 )   $ (3,345 )
 
                 
 
                       
Basic Earnings (Loss) per Share
  $ 0.03     $ (0.13 )     (0.10 )
Diluted Earnings (Loss) per Share
  $ 0.02     $ (0.12 )     (0.10 )
Note 4 — Fair Value Measurements (Restated)
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. Inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. Inputs may be observable or unobservable. Observable inputs are based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s own assumptions based on the best information available in the circumstances. The fair value hierarchy prioritizes the inputs used to measure fair value into three broad levels. The three levels of the fair value hierarchy are defined as follows:
         
Level 1
    Inputs are quoted prices in active markets for identical assets or liabilities as of the reporting date.
 
       
Level 2
    Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, as of the reporting date.
 
       
Level 3
    Unobservable inputs for the asset or liability that reflect management’s own assumptions about the assumptions that market participants would use in pricing the asset or liability as of the reporting date.

11


Table of Contents

The summary of fair values of financial instruments as of December 31, 2009 (dollars in thousands):
                             
December 31, 2009
Instrument   Fair Value   Carrying Value   Level   Valuation Methodology
Derivative liabilities (See Note 10 below)
  $ 10,918     $ 10,918       3     Monte Carlo
Simulation model
The Company engaged an independent third party valuation expert to calculate the fair values of the embedded derivative liabilities. Please refer to Note 10 for disclosure of assumptions used to calculate the fair value of the derivative liabilities.
The following represents a reconciliation of the changes in fair value of financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended December 31, 2009 (dollars in thousands):
         
    FY 2010  
Beginning balance: Derivative liabilities
  $  
Adoption of change in accounting principle
    5,820  
Total loss on change in derivative liabilities
    5,098  
Purchases, sales, issuances and settlements, net
     
 
     
Ending balance: Derivative liabilities
  $ 10,918  
 
     
Note 5 — Property and Equipment
A summary of property and equipment at December 31, 2009 and September 30, 2009 is as follows (in thousands):
                         
    Estimated     December 31,     September 30,  
    Life     2009     2009  
Leased equipment
  5 years   $ 582     $ 582  
Transportation equipment
  3 years     95       95  
Warehouse equipment
  5 years     64       56  
Office furniture
  5 years     339       150  
Computer equipment
  3 years     150       87  
Telephone equipment
  5 years     33       33  
Rental equipment
  7 years     18       18  
Web site
  3 years     6       6  
Server software
  3 years     158       130  
Training guides
  3 years     3       3  
Leasehold improvements
  5 years     901       889  
Signage
  3 years     13       13  
Fixed assets under construction
            480        
 
                   
Total property and equipment
            2,842       2,062  
Less: accumulated depreciation
            (1,116 )     (1,021 )
 
                   
Property and equipment, net
          $ 1,726     $ 1,04  
 
                   
The amounts charged to operations for depreciation for the three months ended December 31, 2009 and 2008 were $95,000 and $66,000, respectively.
Note 6 — Deposits
Deposits at December 31, 2009 and September 30, 2009 consist of the following (in thousands):
                 
    December 31,     September 30,  
    2009     2009  
Deposits on leased equipment
  $ 14     $ 9  
Building rent deposits
    64       67  
Utility deposits
    9       9  
Deposits on software consulting
    25       25  
Deposits for building expansion
    66       3  
Deposits for professional fees
    80       10  
 
           
Total deposits
  $ 258     $ 123  
 
           

12


Table of Contents

Note 7 — Stockholder Loan
The stockholder loan at December 31, 2009 and September 30, 2009 in the amounts of $1,315,000 and $1,515,000, respectively, consist of various 8% and 11% notes payable to the President and principal stockholder of the Company, Mark Libratore. The notes payable are non-collateralized and due on demand. However, the notes are subordinated to the senior, unsecured, convertible notes payable discussed below in Note 9. During the three months ended December 31, 2009, $200,000 was paid to Mr. Libratore. As of December 31, 2009, an additional $150,000 has been authorized by the senior note holders, but not paid to Mr. Libratore. Interest expense related to the stockholder loan for the three months ended December 31, 2009 and 2008 were $31,000, and $38,000, respectively.
Note 8 — Credit Line Facility
On September 4, 2009, the Company entered into a one-year Business Loan Agreement, Promissory Note and Assignment of Deposit (collectively, the “Credit Line Facility”) with a lender. Pursuant to the Credit Line Facility, the lender has agreed to advance the Company a maximum of Five Hundred Thousand Dollars ($500,000) secured by the Company’s $500,000 certificate of deposit held by the lender. Interest is payable on any advance under the Credit Line Facility at a rate of 1.000 percentage point under the corporate loan base rate index published by the Wall Street Journal, with a minimum interest rate of 4.750% per annum.
On November 2, 2009, the Company entered into a revised Credit Line Facility with the same lender discussed above. Under the revised loan agreement, the lender has agreed to advance the Company a maximum of One Million Dollars ($1,000,000) secured by the Company’s existing $500,000 certificate of deposit held by the lender plus an additional $550,000 certificate of deposit to be held by the lender. The revised Credit Line Facility expires on September 8, 2010. All other terms of the September 4, 2009 Credit Line Facility remain unchanged.
As of December 31, 2009, the Company had an outstanding balance of $750,000 under the Credit Line Facility.
Note 9 — Convertible Notes Payable (Restated)
April 2008 Convertible Notes
On April 11, 2008, the Company closed a private placement consisting of convertible notes and warrants for $804,000, of which $598,000 was cash proceeds and $206,000 was prior year debt exchanged for the convertible notes. The notes are convertible into shares of our common stock at an initial conversion price of $0.50 per share, subject to adjustment, and mature one year after issuance. The notes are senior unsecured obligations of our Company and accrue interest at an annual rate of twelve percent (12%) per annum, payable at maturity. The warrants have a term of five years and are exercisable from the date of their issuance until their expiration at a price of $1.00 per share. In addition, we issued a warrant to the placement agent exercisable for up to 51,000 shares of our common stock on terms substantially similar to the warrant issued in connection with the note described above. As of December 31, 2009, $260,000 of the notes has been converted into 520,000 shares of the Company’s common stock and $93,000 of the notes has been redeemed for cash. During fiscal year 2009, the maturity dates for the remaining $451,000 of notes were extended for one year from the original date of maturity. The maturity dates and amounts for the outstanding notes as of December 31, 2009 are as follows (in thousands):
         
    Amount Due  
February 2010
  $ 263  
March 2010
    50  
April 2010
    138  
 
     
Total April 2008 Convertible Notes Due
  $ 451  
 
     

13


Table of Contents

Interest expense related to the April 2008 convertible notes was $16,000 and $23,000 for the three months ended December 31, 2009 and 2008, respectively.
May 2008 Convertible Note
On May 22, 2008, the Company closed a private placement consisting of a convertible note and a warrant for gross proceeds of $3,500,000. The note is convertible into shares of our common stock at an initial conversion price of $0.80 per share, subject to adjustment, and matures on May 22, 2010. The note is a senior unsecured obligation of ours and accrues interest at the rate of 3% per annum, paid semi-annually on each November 15 and May 15. The note is unconditionally guaranteed by Liberator Medical Supply and Liberator Health and Education Services, Inc. The conversion price of the note will be reduced if, among other things, we issue shares of common stock or securities exercisable, exchangeable or convertible for or into shares of common stock (“common stock equivalents”) at a price per share less than both the conversion price then in effect and $0.75, subject to certain exclusions. The Company has concluded that the adjustment feature for the conversion price of the note is not indexed to the Company’s own stock and, therefore, is an embedded derivative financial liability that requires bifurcation and separate accounting. The warrants have a term of 5 years and are exercisable for up to 4,375,000 shares of our common stock at an exercise price of $1.00 per share. The exercise price of the warrants will be reduced if, among other things, we issue shares of our common stock or common stock equivalents at a price per share less than both the exercise price then in effect and the closing sale price of our common stock for any of the 10 consecutive trading days immediately preceding such issuance, subject to certain exclusions. The Company has concluded that the adjustment feature for the exercise price of the warrants is indexed to the Company’s own stock, and, accordingly, has classified the warrants as equity instruments. In addition, we issued a warrant to the placement agent exercisable for up to 350,000 shares of our common stock on terms substantially similar to the warrant issued in connection with the note described above.
As a result of the cumulative effect adjustment recorded for the Embedded Derivatives, described above in Note 3, the net discounts on the May 2008 note increased by $201,000. Due to the increased discounts on the note, an additional $78,000 was recorded as non-cash interest expense.
Interest expense related to the May 2008 convertible note was $219,000 and $141,000 for the three months ended December 31, 2009 and 2008, respectively.
October 2008 Convertible Note
On October 17, 2008, the Company closed a private placement consisting of a convertible note and a warrant for gross proceeds of $2,500,000. The note is convertible into shares of our common stock at an initial conversion price of $0.75 per share, subject to adjustment, and matures on October 17, 2010. The note is a senior unsecured obligation of ours and accrues interest at the rate of 3% per annum, paid semi-annually on each October 15 and April 15. The note is unconditionally guaranteed by Liberator Medical Supply and Liberator Health and Education Services, Inc. The conversion price of the note will be reduced if, among other things, we issue shares of common stock or securities exercisable, exchangeable or convertible for or into shares of common stock (“common stock equivalents”) at a price per share less than both the conversion price then in effect and $0.75, subject to certain exclusions. The Company has concluded that the adjustment feature for the conversion price of the note is not indexed to the Company’s own stock and, therefore, is an embedded derivative financial liability that requires bifurcation and separate accounting. The warrants have a term of 3 years and are exercisable for up to 1,166,667 shares of our common stock at an exercise price $1.25 per share. The exercise price of the warrants will be reduced if, among other things, we issue shares of our common stock or common stock equivalents at a price per share less than both the exercise price then in effect and the closing sale price of our common stock for any of the 10 consecutive trading days immediately preceding such issuance, subject to certain exclusions. The Company has concluded that the adjustment feature for the exercise price of the warrants is indexed to the Company’s own stock, and, accordingly, has classified the warrants as equity instruments. In addition, we issued a warrant to the placement agent exercisable for up to 266,667 shares of our common stock on terms substantially similar to the warrants issued in connection with the note described above.

14


Table of Contents

As a result of the cumulative effect adjustment recorded for the Embedded Derivatives, described above in Note 3, the net discounts on the October 2008 note increased by $395,000. Due to the increased discounts on the note, an additional $95,000 was recorded as non-cash interest expense.
Interest expense related to the October 2008 convertible note was $142,000 and $33,000 for the three months ended December 31, 2009 and 2008, respectively.
In May 2009, the Company entered into Waiver Agreements with the note holder of the May 2008 and October 2008 convertible notes discussed above. As part of the Waiver Agreements, the note holder agreed to accept 171,945 shares of the Company’s common stock, with a fair market value of $105,000, in lieu of the Company’s obligation to pay cash in the amount of $86,000 for interest payments that were due April 15, 2009 and May 15, 2009 under the original terms of the notes. As a result of this transaction, the Company incurred an additional $19,000 of interest expense that would not have been incurred if the Company had paid the interest due in cash. The rights and obligations of the note holder and the Company with respect to any future interest payments and the other terms of the notes are in all other respects unchanged.
In October 2009, the Company entered into a Waiver Agreement with the note holder of the October 2008 convertible note discussed above. As part of the Waiver Agreement, the note holder agreed to accept 18,101 shares of the Company’s common stock, with a fair market value of $45,000, in lieu of the Company’s obligation to pay cash in the amount of $38,000 for an interest payments that was due October 15, 2009 under the original terms of the note. As a result of this transaction, the Company incurred an additional $7,000 of interest expense that would not have been incurred if the Company had paid the interest due in cash. The rights and obligations of the note holder and the Company with respect to any future interest payments and the other terms of the note are in all other respects unchanged.
Short-term convertible notes payable consist of the following as of December 31, 2009 (in thousands):
                                 
    April’08     May’08     Oct’08        
    Notes     Note     Note     Totals  
Notes Payable, face amount
  $ 452     $ 3,500     $ 2,500     $ 6,452  
 
                       
Discounts on Notes:
                               
Initial valuation of Warrants
    (126 )     (610 )     (86 )     (822 )
Initial valuation of Embedded Derivative
          (930 )     (841 )     (1,771 )
Accumulated Amortization
    126       1,239       558       1,923  
 
                       
Total Discounts
          (301 )     (369 )     (670 )
Accrued Interest
    45       17       19       81  
 
                       
Convertible Notes Payable, net
  $ 497     $ 3,216     $ 2,150     $ 5,863  
 
                       
Short-term convertible notes payable consist of the following as of September 30, 2009 (in thousands):
                         
    April’08 Notes     May’08 Note     Totals  
Notes Payable, face amount
  $ 601     $ 3,500     $ 4,101  
 
                 
Discounts on Notes:
                       
Initial valuation of Warrants
    (126 )     (610 )     (736 )
Initial valuation of Beneficial Conversion Options
          (303 )     (303 )
Accumulated Amortization
    126       621       747  
 
                 
Total Discounts
          (292 )     (292 )
Accrued Interest
    40       44       84  
 
                 
Convertible Notes Payable, net
  $ 641     $ 3,252     $ 3,893  
 
                 

15


Table of Contents

Long-term Convertible notes payable consist of the following at September 30, 2009 (in thousands):
         
    Oct’08 Note  
Notes Payable, face amount
  $ 2,500  
 
     
Discounts on Notes:
       
Initial valuation of Warrants
    (86 )
Initial valuation of Beneficial Conversion Option
    (86 )
Accumulated Amortization
    82  
 
     
Total Discounts
    (90 )
Accrued Interest
    37  
 
     
Convertible Notes Payable, net
  $ 2,447  
 
     
NOTE 10 — Derivative Liabilities (Restated)
The May 2008 and October 2008 convertible notes, discussed above in Note 9, contain embedded adjustment features whereby the conversion price will be adjusted if the Company issues additional shares of common stock or securities exercisable, exchangeable, or convertible into shares of common stock at a price per share less than both the conversion price then in effect and $0.75. Based on accounting principles, discussed above in Note 2, that became effective for the Company on October 1, 2009, the embedded adjustment features are not indexed to the Company’s own stock and, therefore, are embedded derivative financial liabilities (the “Embedded Derivatives”) that require bifurcation and separate accounting. Accordingly, the Company recorded a cumulative effect adjustment to the opening balance of paid in capital and accumulated deficit on October 1, 2009. The cumulative effect adjustment is the difference between the amounts recognized in the balance sheet for the conversion options of the notes payable before initial application of ASC 815-40-15 and the fair values of the Embedded Derivatives at initial application of ASC 815-40-15 on October 1, 2009. Subsequently, the Company adjusted the Embedded Derivatives to fair value at each interim period and recognized the changes in fair value as a charge or a benefit to earnings included in the Other Income (Expense) section of the Company’s Condensed Consolidated Statement of Operations.
The following is a summary of the cumulative effect adjustment recorded to the Company’s Condensed Consolidated Balance Sheet on October 1, 2009 (in thousands):
                         
    Balance     Cumulative        
    September     Effect of     Balance  
    30, 2009     Adjustment     October 1, 2009  
Derivative liabilities
  $     $ 5,820     $ 5,820  
Convertible Notes Payable, net
    6,340       (596 )     5,744  
Additional paid-in capital
    11,705       (390 )     11,315  
Accumulated deficit
    (8,272 )     (4,834 )     (13,106 )
When the convertible notes were originally issued in May 2008 and October 2008, beneficial conversion features of $390,000 were recorded to additional paid-in capital. As a result of reclassifying the embedded conversion features from equity to liabilities, the cumulative effect of the adjustment was a reduction of additional paid-in capital of $390,000.
The fair values of the Embedded Derivatives at the issuance dates (May 2008 and October 2008) of the convertible notes were $1,771,000. The increase in the convertible note discounts of $1,381,000 less the accretion of an additional $785,000 in discounts to the convertible notes resulting from the bifurcation of the Embedded Derivatives was booked as a reduction of $596,000 to the Convertible Notes Payable as of October 1, 2009. The fair values at the issuance dates were calculated using a Monte Carlo simulation model with the following assumptions:
                 
    May 2008 Note   October 2008 Note
Risk-free interest rate:
    2.56 %     1.64 %
Expected term:
  2 years   2 years
Expected dividend yield:
    0.00 %     0.00 %
Expected volatility:
    45.29 %     50.87 %
Probability of triggering reset provision:
    64.17 %     61.62 %
Existing conversion price per share
  $ 0.80     $ 0.75  
Company’s stock price per share
  $ 0.73     $ 0.75  

16


Table of Contents

The fair values of the Embedded Derivatives at the transition date, October 1, 2009, were $5,820,000, which was booked as a Derivative Liability on October 1, 2009. The fair values as of October 1, 2009, were calculated using a Monte Carlo simulation model with the following assumptions:
                 
    May 2008 Note   October 2008 Note
Risk-free interest rate:
    0.40 %     0.40 %
Expected term:
  0.64 years   1.05 years
Expected dividend yield:
    0.00 %     0.00 %
Expected volatility:
    56.03 %     56.03 %
Probability of triggering reset provision:
    22.42 %     19.18 %
Existing conversion price per share
  $ 0.80     $ 0.75  
Company’s stock price per share
  $ 1.45     $ 1.45  
The cumulative effect of these adjustments was recorded as an increase to total stockholders’ deficit of $5,224,000 as of October 1, 2009.
As of December 31, 2009, the fair values of the Embedded Derivatives for the May 2008 and October 2008 Note were $10,918,000. The increase in fair value of $5,098,000 from October 1, 2009, was recorded as non-cash charge to Other Expenses for the three months ended December 31, 2009. The fair values as of December 31, 2009, were calculated using a simulation model with the following assumptions:
                 
    May 2008 Note   October 2008 Note
Risk-free interest rate:
    0.47 %     0.47 %
Expected term:
  0.39 years   0.79 years
Expected dividend yield:
    0.00 %     0.00 %
Expected volatility:
    51.99 %     51.99 %
Probability of triggering reset provision:
    2.91 %     2.11 %
Existing conversion price per share
  $ 0.80     $ 0.75  
Company’s stock price per share
  $ 2.18     $ 2.18  
Note 11 — Capital Lease Obligations
Capital lease obligations include eleven capitalized leases with interest rates ranging from 8.4% to 28.4%. The combined monthly payments of principal and interest are $9,000. The amount of equipment and furniture capitalized under the capital leases was $289,000. Accumulated depreciation recorded for the equipment and furniture under capital leases as of December 31, 2009 is $152,000. The payment terms of the capital leases expire between August 2010 and May 2012.
The following is a schedule by years of future minimum lease payments under capital leases together with the present value of the net minimum lease payments as of December 31, 2009 (in thousands):
         
    Amount  
Year ending September 30:
       
2010
  $ 75  
2011
    62  
2012
    13  
 
     
Total minimum lease payments
    150  
Less: Interest on capitalized lease obligations
    (20 )
 
     
Present value of capitalized lease obligations
    130  
Less: Current portion
    (77 )
 
     
Capitalized lease obligations, net of current portion
  $ 53  
 
     

17


Table of Contents

Interest expense on capitalized leases was $6,000 and $7,000 for three months ended December 31, 2009 and 2008, respectively.
Note 12 — Stockholders’ Equity
Warrants
The Company issued warrants to the stockholders of LMS to purchase 2,818,092 shares of the Company’s common stock in conjunction with the merger in 2007. As of December 31, 2009, 200,000 of these warrants have expired and 133,750 of these warrants have been exercised. The weighted-average exercise price for the remaining 2,484,342 warrants as of December 31, 2009 is $0.98 per share. The expiration dates of the outstanding warrants are as follows:
     
 
   
Shares   Expiration Date
     
7,188   April 2010
31,250   May 2010
2,070,904   June 2010
337,500   July 2010
12,500   August 2010
25,000   November 2010
From July 2007 to January 2008, in connection with sales of the Company’s common stock, the Company issued warrants to purchase an additional 686,667 shares of the Company’s common stock at a weighted-average exercise price of $1.40 per share. The weighted-average exercise price for the remaining 667,917 warrants as of December 31, 2009 is $1.41 per share. The expiration dates of the outstanding warrants are as follows:
     
     
Shares   Expiration Date
     
6,250   July 2010
234,375   August 2010
75,625   September 2010
169,167   October 2010
145,000   November 2010
31,250   December 2010
6,250   January 2011
In November 2007, the Company issued warrants to purchase 125,000 shares of the Company’s common stock at an exercise price of $2.00 per share as compensation for consulting services. These warrants are still outstanding as of December 31, 2009 and expire in November 2012. The fair value of these warrants of $24,000 was determined using the Black-Scholes option pricing model with the assumptions listed below:
         
Risk-free interest rate:
    4.11 %
Expected term:
  5  years
Expected dividend yield:
    0.00 %
Expected volatility:
    27.97 %
In connection with the April 2008 Convertible Notes discussed above in Note 9, the Company issued warrants to purchase 829,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the note holders and 51,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the placement agent. As of December 31, 2009, 20,000 of these warrants have been exercised. These remaining 860,000 warrants will expire as follows:
     
 
   
Shares   Expiration Date
     
263,000   February 2013
100,000   March 2013
497,000   April 2013

18


Table of Contents

The fair value of these warrants of $126,000 and $7,000, respectively, was determined using the Black-Scholes option pricing model with the assumptions listed below:
         
Risk-free interest rate:
  Range of 2.39% to 2.93%
Expected term:
  5 years
Expected dividend yield:
    0.00 %
Expected volatility:
    27.97 %
In connection with the convertible note payable issued in May 2008 and discussed above in Note 9, the Company issued warrants to purchase 4,375,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the note holder and 350,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the placement agent. In October 2009, the placement agent exercised 350,000 warrants via a cashless exercise, in which the Company issued 192,873 shares of the Company’s common stock. The 4,375,000 warrants held by the note holder are still outstanding as of December 31, 2009 and expire in May 2013.
The fair value of these warrants of $610,000 and $49,000, respectively, was determined using the Black-Scholes option pricing model with the assumptions listed below:
         
Risk-free interest rate:
    3.24 %
Expected term:
  5  years
Expected dividend yield:
    0.00 %
Expected volatility:
    27.97 %
In connection with the long-term convertible notes payable issued in October 2008 and discussed above in Note 9, the Company issued warrants to purchase 1,166,667 shares of the Company’s common stock at an exercise price of $1.25 per share to the note holders and 266,667 shares of the Company’s common stock at an exercise price of $1.25 per share to the placement agent. These warrants are still outstanding as of December 31, 2009, and expire in October 2011. The fair value of these warrants of $86,264 and $19,717, respectively, was determined using the Black-Scholes option pricing model with the assumptions listed below:
         
Risk-free interest rate:
    1.90 %
Expected term:
  3  years
Expected dividend yield:
    0.00 %
Expected volatility:
    35.19 %
A summary of warrants issued, exercised and expired during the three months ended December 31, 2009, is as follows:
                 
            Weighted  
            Avg.  
            Exercise  
Warrants:   Shares     Price  
Balance at September 30, 2009
    10,458,093     $ 1.07  
Issued
           
Exercised
    (512,500 )     1.00  
Expired
           
 
           
Balance at December 31, 2009
    9,945,593     $ 1.07  
 
           
Options
In connection with conversion of $1,589,000 of debt to equity and under the terms of the Private Placement and Merger Agreement, Mr. Libratore, the Company’s founder, principal shareholder and President, received and exercised 620,000 options in March 2007 and beginning on June 1, 2007, 356,455 options monthly until a total number of 4,541,009 options are received. The exercise price of the options is $0.0001. As of December 31, 2009, a total of 3,921,009 options were outstanding.

19


Table of Contents

Employee & Director Stock Options
On September 14, 2007 the Board of Directors adopted the Company’s 2007 Stock Plan with an aggregate of 1,000,000 shares of the Company’s unissued common stock. The Plan was approved by the shareholders at the Company’s annual meeting in September 2008. The 1,000,000 shares authorized under the 2007 Stock Plan are reserved for issuance to officers, directors, employees, prospective employees and consultants as incentive stock options, non-qualified stock options, restricted stock awards, other equity awards and performance based stock incentives. The option price, number of shares and grant date are determined at the discretion of the Company’s board of directors or the committee overseeing the 2007 Stock Plan.
On July 13, 2009, the Board of Directors of the Company approved an amendment to the 2007 Stock Plan to increase the number shares authorized under the plan from 1,000,000 to 2,000,000 shares. The amendment was approved at the Company’s annual shareholders meeting on September 4, 2009.
On September 14, 2007 the Company adopted the provisions of ASC Topic 718, Compensation — Stock Compensation,” which requires the Company to recognize expense related to the fair value of stock-based compensation awards. The Company elected the modified prospective transition method as permitted by Topic 718, under which stock-based compensation for the years ended September 30, 2009 and 2008 is based on grant date fair value estimated in accordance with the provisions of Topic 718 and compensation expense for all stock-based compensation awards granted subsequent to January 1, 2006, as well as the unvested portion of previously granted awards that remained outstanding as of January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of Topic 718.
On October 30, 2008, the Board of Directors of the Company approved a grant of 480,000 stock options under the 2007 Stock Plan to employees with an exercise price of $0.60 per share. The options vest 25% on October 1, 2009, 25% on April 1, 2010, 25% on October 1, 2010, and 25% on April 1, 2011.
On October 29, 2009, Joseph D. Farish, Jr. was appointed to the Board of Directors of the Company. As part of the compensation for his services as a director, Mr. Farish was granted an option, vesting over two years, to purchase 50,000 shares of common stock at $2.35 per share.
On December 3, 2009, Robert Cuillo was appointed to the Board of Directors of the Company. As part of the compensation for his services as a director, Mr. Cuillo was granted an option, vesting over two years, to purchase 50,000 shares of common stock at $2.18 per share.
The fair values of share-based payments are estimated on the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the three months ended December 31, 2009 and 2008:
                 
    2009     2008  
Risk-free interest rate:
    1.38 %     1.82 %
Expected term:
  3  years   3  years
Expected dividend yield:
    0.00 %     0.00 %
Expected volatility:
    66.35 %     36.05 %
For the three months ended December 31, 2009 and 2008 the Company recorded $55,000 and $44,000, respectively, of stock-based compensation expense which has been classified as Operating expenses, sub-classification of Payroll, taxes and benefits. As of December 31, 2009, there is $381,000 in total unrecognized compensation expense related to non-vested employee stock options granted under the 2007 Stock Plan, which is expected to be recognized over 1.9 years.

20


Table of Contents

A summary of the stock options outstanding under the 2007 Stock Plan as of December 31, 2009, and activity for the three months then ended is as follows:
                         
            Weighted        
            Avg.     Aggregate  
            Exercise     Intrinsic  
2007 Stock Plan:   Shares     Price     Value  
Options outstanding at September 30, 2009
    1,580,000     $ 0.81          
Granted
    100,000       2.27          
Exercised
                   
Expired or forfeited
                   
 
                 
Options outstanding at December 31, 2009
    1,680,000     $ 0.90     $ 2,144,100  
 
                 
Options exercisable at December 31, 2009
    600,000     $ 0.73     $ 862,500  
 
                 
2009 Employee Stock Purchase Plan
The 2009 Employee Stock Purchase Plan (the “ESPP”) became effective June 10, 2009, the effective date of the registration statement filed on Form S-8 with the SEC. The ESPP provides a means by which employees of the Company are given an opportunity to purchase common stock of the Company through payroll deductions. The maximum number of shares to be offered under the ESPP is 500,000 shares of the Company’s common stock, subject to changes authorized by the Board of Directors of the Company. Shares are offered through consecutive offering periods with durations of approximately six (6) months, commencing on the first trading day on or after June 1st and November 30th of each year and terminating on the last trading day before the commencement of the next offering period. The ESPP is intended to qualify as an “employee stock purchase plan” within the meaning of Section 423 of the Internal Revenue Code. The ESPP allows employees to designate up to 15% of their cash compensation to purchase shares of the Company’s common stock at 85% of the lesser of the fair market value at the beginning of the offering period or the exercise date, which is the last trading day of the offering period. Employees who own stock possessing 5% or more of the total combined voting power or value of all classes of the Company’s common stock are not eligible to participate in the ESPP.
The first offering period of the ESPP commenced on June 10, 2009 and ended on November 30, 2009. The second offering period commenced on December 1, 2009 and will end on May 31, 2009. As of December 31, 2009 161,781 shares of the Company’s common stock have been purchased through the ESPP. For the three months ended December 31, 2009, the Company received $56,000 through payroll deductions under the ESPP.
The Company uses the Black-Scholes option pricing model to estimate the fair value of the shares expected to be issued under the ESPP at the grant date, the beginning date of the offering period, and recognizes compensation expense ratably over the offering period. If an employee elects to increase their payroll withholdings during the offering period, the increase is treated as a modification to the original option granted under the ESPP. As a result of the modification, the incremental fair value, if any, associated with the modified award is recognized as compensation expense at the date of the modification. Compensation expense is recognized only for shares that vest under the ESPP. For the three months ended December 31, 2009, the Company recognized $70,000 of compensation expense related to the ESPP.
Note 13 — Basic and Diluted Earnings (Loss) per Common Share (Restated)
The following is a reconciliation of the numerator and denominator used in the computation of basic and diluted earnings per share for the three months ended December 30, 2009 and 2008 (in thousands, except per share amounts):
                 
    For the Quarters Ended  
    December 31,  
    2009     2008  
Numerator:
               
 
               
Net income (loss) — basic
  $ (3,345 )   $ 246  
Effect of dilutive securities:
               
Convertible debt
           
 
           
Net income (loss) — diluted
  $ (3,345 )   $ 246  
 
           
 
               
Denominator:
               
 
               
Weighted average shares outstanding — basic
    32,848       32,049  
Effect of dilutive securities:
               
Stock options
          3,921  
Convertible debt
           
 
           
Weighted average shares outstanding — diluted
    32,848       35,970  
 
           
 
               
Earnings per share — basic
  $ (0.10 )   $ 0.01  
Earnings per share — diluted
  $ (0.10 )   $ 0.01  

21


Table of Contents

The following table summarizes the number of weighted shares outstanding for each of the periods presented, but not included in the calculation of diluted income (loss) per share because the impact would have been anti-dilutive for the three months ended December 31, 2009 and 2008 (in thousands):
                 
    2009     2008  
Stock options
    5,601       975  
Warrants
    9,946       10,668  
Convertible Debt
    8,611       8,650  
 
           
Totals
    24,158       20,293  
 
           
Note 14 — Income Taxes (Restated)
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance on deferred tax assets is established when management considers it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company files consolidated federal and state income tax returns.
The Company had a net income tax benefit for the quarter ended December 31, 2009, of $1,006,000. The Company recognized $1,438,000 in tax benefits due to a change in the valuation allowance as of December 31, 2009. Although the Company had net operating loss carryforwards that completely offsets regular taxable income, the Company incurred alternative minimum tax on its net alternative minimum taxable income of $3,000. In addition, the Company incurred deferred tax expense of $429,000.
The Company’s effective tax rate was approximately 23% and 0% for the three months ended December 31, 2009 and 2008, respectively, which differs from the federal statutory rate of 35% due to the effect of state income taxes, the reduction in valuation allowance, and certain of the Company’s expenses that are not deductible for income tax purposes, primarily consisting of $5,098,000 of expense for the change in fair value of derivative liabilities. The effective tax rate for the three months ended December 31, 2009, also reflects a $1,438,000 decrease to the valuation allowance for deferred tax assets that management has determined will, more likely than not, be utilized. The effective tax rate for the three months ended December 31, 2008, reflects the utilization of net operating losses from previous years.
Note 15 — Commitments
The Company leases property and telephone equipment under operating leases that expire at various times through June 2014. Future minimal rental commitments under non-cancelable operating leases with terms in excess of one year as of December 31, 2009 are as follows (in thousands):
         
    Amount  
Fiscal year ending September 30:
       
2010
  $ 432  
2011
    661  
2012
    608  
2013
    161  
2014
    121  
 
     
 
  $ 1,983  
 
     
Rent expense for the three months ended December 31, 2009 and 2008 was $164,000 and $120,000, respectively.

22


Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other parts of this quarterly report on Form 10-Q contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can also be identified by words such as “intends,” “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those set forth below under “Certain Risk Factors.” The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and notes thereto included in this Form 10-Q and the audited financial statements of the Company, included in our Report on Form 10-K for the year ended September 30, 2009, filed with the Securities and Exchange Commission and management’s discussion and analysis contained therein. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law.
Overview
Liberator Medical Supply, Inc. (“LMS”), a wholly-owned subsidiary of the Company, is a federally licensed, direct-to-consumer, provider of Medicare Part B Benefits focused on providing medical supplies in a retail environment, and via the Internet in the United States. LMS distributes a full range of medical products which address the healthcare needs of our customers.
We market our products directly to consumers primarily through targeted media and direct response television advertising. Our customer service representatives are specifically trained to communicate with Medicare-eligible beneficiaries. Our operating platforms enable us to collect and process required documents from physicians and customers, bill and collect amounts due from Medicare and/or other government agencies and/or third party payors and/or customers.
Results of Operations
The following table summarizes the results of operations for the three months ended December 31, 2009 and 2008, including percentage of sales (dollars in thousands):
                                 
    As Restated        
    2009     2008  
    Amount     %     Amount     %  
Sales
  $ 9,158       100.0     $ 5,342       100.0  
Cost of Sales
    3,248       35.5       1,841       34.5  
 
                       
Gross Profit
    5,910       64.5       3,501       65.5  
Operating Expenses
    4,750       51.9       2,990       56.0  
 
                       
Income from Operations
    1,160       12.7       511       9.6  
Other Income (Expense)
    (5,511 )     (60.2 )     (265 )     (5.0 )
 
                       
Income (Loss) Before Income Taxes
    (4,351 )     (47.5 )     246       4.6  
Benefit from Income Taxes
    (1,006 )     (11.0 )            
 
                       
Net Income (Loss)
  $ (3,345 )     (36.5 )   $ 246       4.6  
 
                       
Revenues:
Sales for the three months ended December 31, 2009, increased by $3,816,000, or 71.4%, to $9,158,000, compared with sales of $5,342,000 for the three months ended December 31, 2008. The increase was due to our direct-response advertising campaign to obtain new mail order customers. Our direct-response advertising costs for the three months ended December 31, 2009, were $2,037,000 compared to $713,000 for the three months ended December 31, 2008.

23


Table of Contents

Gross Profit:
Gross profit for the three months ended December 31, 2009, increased by $2,409,000, or 68.8%, to $5,910,000, compared with gross profit of $3,501,000 for the three months ended December 31, 2008. The increase was attributed to our increased sales volume for the three months ended December 31, 2009 compared to the three months ended December 31, 2008. As a percentage of sales, gross profit decreased by 1.0% to 64.5% of sales for the three months ended December 31, 2009, compared to 65.5% of sales for the three months ended December 31, 2008. The 1.0% decrease in profit margins is primarily the result of product mix.
Operating Expenses:
The following table provides a breakdown of our operating expenses for the three months ended December 31, 2009 and 2008, including percentage of sales (dollars in thousands):
                                 
    As Restated        
    2009     2008  
    Amount     %     Amount     %  
Operating Expenses:
                               
Payroll, taxes and benefits
  $ 2,169       23.7     $ 1,065       20.0  
Advertising
    806       8.8       298       5.6  
Bad debts
    655       7.2       679       12.7  
Depreciation
    95       1.0       66       1.2  
General and administration
    1,025       11.2       882       16.5  
 
                       
Total Operating Expenses
  $ 4,750       51.9     $ 2,990       56.0  
 
                       
Operating expenses for the three months ended December 31, 2009, were $4,750,000, or 51.9% of revenue, compared with $2,990,000, or 56.0% of revenue for the three months ended December 31, 2008. The increase in operating expenses is primarily attributed to increased spending levels for additional employees, advertising costs, rent and other administration costs to support our sales growth.
Income from Operations:
Income from operations for the three months ended December 31, 2009, increased $649,000 to $1,160,000, compared with $511,000 for the three months ended December 31, 2008. As a percentage of sales, operating income improved by 3.1% to 12.7% of sales for the three months ended December 31, 2009, compared to 9.6% of sales for the three months ended December 31, 2008. The increase in operating income and margins for the three months ended December 31, 2009, is attributed to our increased sales volumes at lower levels of incremental operating expenses, as a percentage of sales.
Other Income (Expense):
The following table shows a breakdown of other income (expense) for the three months ended December 31, 2009 and 2008 (dollars in thousands):
                 
    As Restated        
    2009     2008  
Other Income (Expense):
               
Interest Expense
  $ (416 )   $ (273 )
Change in fair value of derivative liabilities
    (5,098 )      
Interest income
    3       8  
 
           
Total Other Income (Expense)
  $ (5,511 )   $ (265 )
Other income (expense) is predominantly non-cash charges associated with the amortization of discounts on our convertible debt, recorded as interest expense, and non-cash charges associated with the change in fair value of derivative liabilities embedded within our convertible debt. Non-cash charges to other income (expense) for the three months ended December 31, 2009 and 2008, respectively, totaled $5,407,000 and $162,000.

24


Table of Contents

Interest expense increased by $143,000 to $416,000 for the three months ended December 31, 2009, compared to the three months ended December 31, 2008. As a result of accounting guidance that became effective for us on October 1, 2009, we are required to bifurcate and separately account for embedded anti-dilution provisions contained in certain convertible notes issued in May and October 2008 as derivative liabilities. Accordingly, on October 1, 2009, we recorded a cumulative effect adjustment that increased the value of the discounts on our convertible debt issued in May and October 2008, which resulted in an additional $173,000 of non-cash interest expense for the three months ended December 31, 2009.
In addition to the cumulative effect adjustment recorded on October 1, 2009, we are required to adjust the embedded derivative liabilities to fair value at each balance sheet date, or interim period, and recognize the changes in fair value as a non-cash charge or benefit to earnings. The changes in fair value of the derivative liabilities at each interim period are very sensitive to changes in the market price for our common stock. When the market price of our common stock increases, the fair value of the embedded derivatives increases, resulting in additional non-cash charges to our earnings. Conversely, when the market price for our common stock declines, the fair value of the embedded derivatives decreases, resulting in non-cash benefits to our earnings. The following table illustrates the changes in the market price of our common stock and the changes in fair value of the derivative liabilities recorded in fiscal year 2010 (dollars in thousands, except per share amounts):
                 
            Change in
    Closing   Fair Value of
    Market   Derivative
    Price of   Liabilities
    Common   Income /
    Stock   (Expense)
Interim period ending:
               
September 30, 2009, Q4 2009
  $ 1.45     $ n/a  
December 31, 2009, Q1 2010
    2.18       (5,098 )
Liquidity and Capital Resources
The following table summarizes our cash flows from operating, investing, and financing activities for the three months ended December 31, 2009 and 2008 (dollars in thousands):
                 
    For the Quarters Ended  
    December 31,  
    As Restated        
    2009     2008  
Cash Flows:
               
Net cash provided by (used in) operating activities
  $ (324 )   $ 447  
Net cash used in investing activities
    (1,333 )     (29 )
Net cash provided by financing activities
    740       2,171  
 
           
Net increase (decrease) in cash
    (917 )     2,589  
Cash at beginning of period
    3,798       1,173  
 
           
Cash at end of period
  $ 2,881     $ 3,762  
 
           
The Company had cash of $2,881,000 at December 31, 2009, compared to cash of $3,798,000 at September 30, 2009, a decrease of $917,000. The decrease in cash for the three months ended December 31, 2009, is primarily due to our accelerated direct-response advertising campaign and the build out of our new 24,000 square foot facility during the quarter, partially offset by borrowings from our credit line facility.
In order to maintain our accelerated sales growth through our direct-response advertising efforts, we may be required to raise additional cash through the sale of our securities, whether on a debt or equity basis. As of December 31, 2009, we had 2.8 million of outstanding warrants at an average exercise price of $1.00 that expire during fiscal year 2010. We have already received telephone inquiries from several of the warrant holders over the last few months and expect a majority of these warrant holders to exercise these “in-the-money” warrants before expiration. There can be no assurance, of course, as to the amount or timing of the proceeds we may receive from the sale of our securities. However, we believe that existing cash and cash equivalents, together with cash generated from the collection of accounts receivable and the sale of products will be sufficient to meet our cash requirements during the next twelve months, but at reduced levels of sales growth if we are unable to raise additional capital.

25


Table of Contents

Operating Activities
Net cash used in operating activities decreased to $324,000 during the three months ended December 31, 2009, as compared to net cash provided by operating activities of $447,000 during the three months ended December 31, 2008. The decrease is primarily a result of our increased direct-response advertising spend.
Investing Activities
During the three months ended December 31, 2009, we purchased $780,000 of property and equipment primarily related to the build out of our new 24,000 square foot facility, which we moved into in January 2010. In addition, we purchased a $550,000 certificate of deposit as additional security for a $1,000,000 credit line facility discussed above in Note 6 of the unaudited condensed consolidated financial statements. The certificate matures in September 2010 and bears interest at a rate of 1.242%.
Financing Activities
During the three months ended December 31, 2009, cash provided by financing activities was $740,000, which included borrowings of $750,000 from our credit line facility used to finance the build out of our new facility discussed above, $163,000 of proceeds from the exercise of warrants, and $56,000 of proceeds from our employee stock purchase plan, partially offset by payments of $220,000 to pay down a portion of our outstanding debt and capital lease obligations.
During the three months ended December 31, 2008, cash provided by financing activities was $2,171,000, which was the result of a $2,500,000 convertible debt offering in October 2008, partially offset by $310,000 of debt issuance costs associated with the debt offering.
Outlook
The Company has experienced tremendous growth over the past two and a half years. We have built an infrastructure and business model that are capable of generating a substantially higher sales volume at reduced levels of incremental cost. In an effort to continue our growth, we have accelerated our advertising efforts to attract new customers and expanded our operations to service our new and existing customers. The outlook for demand for our products and services is favorable, as there should be an increase in newly-diagnosed patients requiring the medical supplies that we provide. We expect our revenues to continue to increase over the next nine months due to our advertising and marketing programs. The Company does not anticipate any major changes in Medicare reimbursement in 2010, nor in any other reimbursement programs available from other third-party payers.
Our plan for the next twelve months includes the following:
    Continue our advertising and marketing efforts;
 
    Increase our customer base;
 
    Continue to service our current customer base and increase the retention rate;
 
    Continue to invest in the expansion of our infrastructure; and
 
    Increase our accounts receivable collection efforts.

26


Table of Contents

In order to implement our current business model, we have completed the following:
    Identified and presented to many large funding sources, soliciting terms for long-term capital in the form of debt, equity or a combination of both;
 
    Retained an investor relations firm to further enhance our exposure and opportunities for long-term capital requirements;
 
    Identified products and related target customers through extensive market research;
 
    Established efficient and cost effective methods to reach qualified customers;
 
    Established an infrastructure of management and knowledgeable staff to support substantial growth in sales with a minimal amount of additional staff members, maximizing our revenue per employee;
 
    Completed the build out of an additional 24,000 square foot facility to house our expanding workforce and support our continued growth;
 
    Created a HIPPA compliant IT infrastructure and staff to accommodate additional growth in sales;
 
    Established a marketing plan that can be monitored for effectiveness and is flexible enough to adjust to changing market conditions; and
 
    Tested our advertising methods and established methods of testing additional advertising methods to meet with changing market conditions.
We will continue to operate as a federally licensed, direct-to-consumer, Part B Benefits Provider, primarily focused on supplying medical supplies to the chronically ill patients
Contractual Obligations
A summary of our contractual obligations for convertible debt obligations, capital lease obligations, minimum lease payments under non-cancelable operating leases, and minimum purchase commitments as of December 31, 2009 is presented in the following table (dollars in thousands):
                                                 
    Payments due by period  
    Totals     FY 2010     FY 2011     FY 2012     FY 2013     FY 2014  
Convertible debt obligations (1)
  $ 6,642     $ 4,101     $ 2,541     $     $     $  
Operating leases
    1,983       432       661       608       161       121  
Capital lease obligations
    150       75       62       13              
Purchase commitment (2)
    514       84       120       120       120       70  
 
                                   
Total contractual obligations
  $ 9,289     $ 4,692     $ 3,384     $ 741     $ 281       191  
 
                                   
 
(1)   The convertible debt obligations that are due in fiscal year 2010 include $452,000 of convertible notes that are convertible into shares of our common stock at a conversion price of $0.50 per share and $3,500,000 of convertible notes that are convertible into shares of our common stock at a conversion price of $0.80 per share. Based on the current price of our common stock, we anticipate that the majority of this debt will be converted into shares of common stock at some point during fiscal year 2010. If for some reason the notes are not converted, we believe we have sufficient financial resources to meet our debt obligations.
 
(2)   The purchase commitment consists of a long distance service agreement that requires us to purchase a minimum of $10,000 per month, partially offset by rebates for the first five months of calendar year 2010, of long distance service through April 2014.
Off-Balance Sheet Arrangements
As of December 31, 2009, we had no off-balance sheet arrangements.

27


Table of Contents

Critical Accounting Policies
See “Summary of Significant Accounting Policies” in the Notes to the unaudited condensed consolidated financial statements and our current annual report on Form 10-K for the year ended September 30, 2009, for discussion of significant accounting policies, recent accounting pronouncements and their effect, if any, on the Company.
Effect of Inflation
We do not believe that inflation has had a material effect on our business, results of operations or financial condition during the past two years.
Item 3. Qualitative and Quantitative Disclosure about Market Risk
We have not entered into any hedging agreements or swap agreements. Our principal market risk is the risk related to our customers and Medicare.
Item 4T. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Principal Financial Officer, to allow timely decisions regarding required disclosure.
We carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of December 31, 2009. Based upon that evaluation, our Chief Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were not effective due to material weaknesses identified in the Company’s internal control over financial reporting described below.
Change in Internal Control over Financial Reporting
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
As a result of the restatement of our financial statements for the interim periods ending December 31, 2009, March 31, 2010, and June 30, 2010, our Chief Executive Officer and Principal Financial Officer re-assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. Based on that assessment, management identified the following material weaknesses:
    Assess and Identify the Impact of Recently Issued Accounting Pronouncements: The Company’s procedures to assess and identify the impact of Recently Issued Accounting Pronouncements were not sufficient, as evidenced by the Company’s failure to timely identify the impact of ASC 815-40-15, “Derivatives and Hedging — Contracts in Entity’s Own Equity (Scope and Scope Exceptions),“which became effective for the Company on October 1, 2009. The Company did not become aware of the new guidance until June 2010, and the impacts of the accounting guidance were not properly identified by the Company until December 2010. As a result, the Company determined that the previously issued interim financial statements for fiscal year 2010 should no longer be relied upon, which resulted in the restatement of the interim financial statements for the interim period ending December 31, 2009. The Company plans to file restated interim financial statements for the interim periods ending March 31, 2010, and June 30, 2010.

28


Table of Contents

    Accounting for Derivative Financial Instruments: Management has identified a material weakness related to accounting for embedded derivatives included in certain convertible notes payable that were outstanding when ASC 815-40-15 became effective for the Company on October 1, 2009. When the Company first assessed the impacts of ASC 815-40-15, management erred in its conclusion that certain embedded derivatives met the scope exceptions of ASC 815-40-15 and did not require adjustments to its accounting. The Company lacked a technical review process which might have enabled the Company to identify the error and prevent a misstatement of the Company’s interim financial statements.
 
    Accounting for Direct-Response Advertising Costs: Management has identified a material weakness related to the classification and measurement of our capitalized direct-response advertising costs due to the following:
    The Company had not previously defined what constituted a “separate stand-alone cost pool” as defined by ASC 340-20-35-1.
 
    The amortization of capitalized direct-response advertising costs was not calculated by taking the ratio of current period revenues over the total period revenues associated with each cost pool as required by ASC 340-20-35-3.
 
    Prior to September 30, 2010, the Company had reflected both a current and long term portion of the assets on the consolidated balance sheet. In accordance with an SEC interpretation (SPCH.T.1995.22.Glynn), the SEC would object to the classification of any unamortized cost of advertising as a current asset. This resulted in the Company reclassifying the fiscal year 2009 comparative balance to conform to the current fiscal year classification.
      In the fourth quarter of fiscal year 2010, management completed the above analysis as required, including defining a separate stand-alone cost pool. In addition, management determined that no restatements of prior period financial statements were required as a result of the above analysis.
 
    Documentation of Accounting Review and Approval Process: In connection with the audit of our consolidated financial statements for the fiscal year ended September 30, 2010, our independent registered accounting firm reported to our Board of Directors that they observed inadequate documented review and approval of certain aspects of the accounting process including the documented review of accounting reconciliations and journal entries that they considered to be a material weakness in internal control. After a review of our current review and approval of certain aspects of the accounting process, management concluded that the inadequate documented review and approval process represented a material weakness.
During the three months ended December 31, 2009, there were no changes in the Company’s internal controls over financial reporting that have materially affected or are reasonably likely to materially affect such internal controls over financial reporting.
Remediation of Material Weaknesses in Internal Control over Financial Reporting
In order to remediate the material weaknesses in internal control over financial reporting, the Company is in the process of finalizing a remediation plan, under the direction of the Company’s Audit Committee, and intends to implement improvements during the first half of fiscal year 2011 as follows:
    Subscribe to an outside service that provides the Company’s Chief Financial Officer and Controller with timely guidance on Recently Issued Accounting Pronouncements. In addition, the Company intends to supplement its current interim and annual financial reporting processes with documentation of the Controller’s and Chief Financial Officer’s review and assessment of the timing and impacts, if any, that the new accounting pronouncements will have on the Company’s financial statements; and
 
    Engage outside experts, as needed, to provide counsel and guidance on non-routine technical accounting issues that can be associated with future financial instruments. The Company has determined that it is not economically feasible for the Company to maintain the required expertise internally due to the limited number of complex transactions that the Company may undertake and the current size of the Company. As the Company continues to grow, management will continually re-assess its staffing levels, particularly within the accounting and finance areas, required to maintain effective internal controls over financial reporting.
 
    Document all significant accounting policies and ensure that the accounting policies are in accordance with accounting principles generally accepted in the United States and that internal controls are designed effectively to ensure that the financial information is properly reported. Management will engage independent accounting specialists to ensure that there is an independent verification of the accounting positions taken.
 
    In connection with the reported inadequate documented review and approval of certain aspects of the accounting process, management has plans to review the current review and approval processes and implement changes to ensure that all accounting reconciliations and journal entries are reviewed and approved on a timely basis and that this review is documented by a member of management separate from the preparer.

29


Table of Contents

PART II — OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2009. Please refer to the “Risks Factors” section in our Annual Report for a discussion of risks to which our business, financial condition, results of operations and cash flows are subject.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Under a stock repurchase program approved by our Board of Directors in December 2008, we are authorized to repurchase up to $500,000 of our Common Stock through December 2009. The authorization enables the Company to purchase shares through open market transactions at management’s discretion. We intend to retain any common shares which we repurchase as treasury shares or use them in connection with our employee stock option program. Our shares repurchased for the three months ended December 31, 2009 were as follows:
                                 
                    Total Number of     Approximate Dollar  
    Total             Shares Purchased as     Value of Shares that  
    Number of     Average     Part of Publicly     May Yet Be  
    Shares     Price Paid     Announced Plans or     Purchased Under the  
    Purchased     per Share     Programs(2)     Plans or Programs(2)  
October 1—31, 2009(1)
        $                  
November 1—30, 2009(1)
    4,000     $ 2.26                  
December 1—31, 2009(1)
        $                  
 
                       
Total
    4,000     $ 2.26       89,600     $ 0  
 
                       
 
(1)   In December 2008, we opened a separate money market account with an investment bank pursuant to which we transferred $50,000 into the account, of which $9,055 was used to purchase 4,000 shares during the three months ended December 31, 2009.
 
(2)   As of December 31, 2009, 89,600 cumulative shares have been purchased under our stock repurchase program for $49,634. The stock repurchase program ended on December 31, 2009 and no additional shares have been authorized to be repurchased.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Other Information
None.
Item 5. Exhibits
Exhibit 31.1 — Section 302 Certificate of Chief Executive Officer
Exhibit 31.2 — Section 302 Certificate of Chief Financial Officer
Exhibit 32.1 — Section 906 Certificate of Chief Executive Officer
Exhibit 32.2 — Section 906 Certificate of Chief Financial Officer

30


Table of Contents

SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, duly authorized.
/s/ LIBERATOR MEDICAL HOLDINGS, INC.
 
Registrant
         
/s/ Mark A. Libratore
 
Mark A. Libratore
  President   February 22, 2011
/s/ Robert J. Davis
 
Robert J. Davis
  Chief Financial Officer   February 22, 2011

31