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EX-31.1 - EXHIBIT 31.1 - LIBERATOR MEDICAL HOLDINGS, INC.v301626_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - LIBERATOR MEDICAL HOLDINGS, INC.v301626_ex32-1.htm
EX-32.2 - EXHIBIT 32.2 - LIBERATOR MEDICAL HOLDINGS, INC.v301626_ex32-2.htm
EX-31.2 - EXHIBIT 31.2 - LIBERATOR MEDICAL HOLDINGS, INC.v301626_ex31-2.htm

 

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, 2010

 

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 16, 2011
Common Stock, $.001   47,995,600

 

 
 

 

TABLE OF CONTENTS

 

        Page
      
Explanatory Note   3
     
PART I — FINANCIAL INFORMATION   4
         
Item 1.   Condensed Consolidated Financial Statements   4
         
    Notes to Condensed Consolidated Financial Statements   8
         
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   16
         
Item 3.   Quantitative and Qualitative Disclosures about Market Risk   22
         
Item 4.   Controls and Procedures   22
         
PART II — OTHER INFORMATION   26
         
Item 1.   Legal Proceedings   26
         
Item 1A.   Risk Factors   26
         
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds   26
         
Item 3.   Defaults Upon Senior Securities   26
         
Item 5.   Other Information   26
         
Item 6.   Exhibits   26
         
SIGNATURES   27
EX-31.1
EX-31.2
EX-32.1
EX-32.2

 

2
 

 

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, 2010, which was originally filed with the Securities and Exchange Commission (“SEC”) on February 22, 2011 (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, 2010, to correct the following errors:

 

·The journal entries to record the cost of goods sold each month contained errors due to unit of measure conversion issues with certain products. As a result, the Company's inventory balance was overstated and the cost of sales was understated for the interim period; and

 

·Partially offsetting the adjustments to inventory and cost of sales, the Company identified additional sales that were not properly submitted to insurance carriers due to the unit of measure issues identified.

 

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, 2010.

 

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 — 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, the Original Filing has not been amended or updated. 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. This Form 10-Q/A should be read in conjunction with the Company’s filings subsequent to the Original Filing with the SEC.

 

3
 

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
As of December 31, 2010 (unaudited) and September 30, 2010
(In thousands, except dollar per share amounts)

 

   As Restated     
   December 31,   September 30, 
   2010   2010 
Assets          
Current Assets:          
Cash  $7,430   $7,428 
Accounts receivable, net of allowance of $3,748 and $3,312, respectively   6,424    6,744 
Inventory, net of allowance for obsolete inventory of $110 and $110, respectively   2,368    1,985 
Deferred taxes, current portion   1,464    1,696 
Prepaid and other current assets   436    355 
Total Current Assets   18,122    18,208 
Property and equipment, net of accumulated depreciation of $1,648 and $1,527, respectively   1,769    1,862 
Deferred advertising   12,048    10,006 
Other assets   197    139 
Total Assets  $32,136   $30,215 
           
Liabilities and Stockholders’ Equity          
Current Liabilities:          
Accounts payable  $5,630   $3,826 
Accrued liabilities   839    1,077 
Derivative liabilities       1,698 
Stockholder loans       565 
Convertible notes payable, net of unamortized discount of $21       2,516 
Other current liabilities   142    146 
Total Current Liabilities   6,611    9,828 
Deferred tax liability   1,922    1,826 
Other long-term liabilities   109    145 
Total Liabilities   8,642    11,799 
           
Stockholders’ Equity:          
Common stock, $.001 par value, 200,000 shares authorized, 48,085 and 44,707 shares issued, respectively; 47,996 and 44,617 shares outstanding at December 31, 2010, and September 30, 2010, respectively   48    45 
Additional paid-in capital   34,204    28,927 
Accumulated deficit   (10,708)   (10,506)
Treasury stock, at cost; 89 shares at December 31, 2010, and September 30, 2010   (50)   (50)
Total Stockholders’ Equity   23,494    18,416 
Total Liabilities and Stockholders’ Equity  $32,136   $30,215 

 

See accompanying notes to consolidated financial statements.

4
 

 

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
For the three months ended December 31, 2010 and 2009
(Unaudited)
(in thousands, except per share amounts)

 

   Three Months Ended December 31, 
   As Restated
2010
   2009 
Sales  $12,220   $9,158 
           
Cost of Sales   4,439    3,248 
           
Gross Profit   7,781    5,910 
           
Operating Expenses          
Payroll, taxes and benefits   2,841    2,169 
Advertising   1,901    806 
Bad debts   892    655 
Depreciation   166    95 
General and administrative   925    1,025 
Total Operating Expenses   6,725    4,750 
           
Income from Operations   1,056    1,160 
           
Other Income (Expense)          
Interest expense   (31)   (416)
Change in fair value of derivative liabilities   (902)   (5,098)
Interest income   2    3 
Gain on sale of assets   2     
Total Other Income (Expense)   (929)   (5,511)
           
Income (Loss) before Income Taxes   127    (4,351)
           
Provision for (Benefit from) Income Taxes   329    (1,006)
           
Net Loss  $(202)  $(3,345)
           
Basic and Diluted earnings (loss) per share:          
Weighted average shares outstanding   47,419    32,848 
Earnings (loss) per share  $(0.00)  $(0.10)

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

5
 

 

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statement of Changes in Stockholders’ Equity
For the three months ended December 31, 2010 As Restated
(Unaudited)
(in thousands)

 

                       Total 
   Common   Common   Paid in   Accumulated   Treasury   Stockholders’ 
   Shares   Stock   Capital   Deficit   Stock   Equity 
Balance at October 1, 2010   44,617   $45   $28,927   $(10,506)  $(50)  $18,416 
                               
Options issued to employees and directors             128              128 
Common stock issued upon conversion of debt   3,333    3    5,097              5,100 
Common stock issued for employee stock purchase plan   46        52              52 
Net loss                  (202)        (202)
Balance at December 31, 2010   47,996   $48   $34,204   $(10,708)  $(50)  $23,494 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

6
 

 

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
For the three months ended December 31, 2010 and 2009
(Unaudited)
(in thousands)

 

   Three Months Ended December 31, 
   As Restated
2010
   2009 
Cash flow from operating activities:          
Net Loss  $(202)  $(3,345)
           
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:          
Depreciation and amortization   2,011    905 
Change in fair value of derivative liabilities   902    5,098 
Equity based compensation   128    133 
Provision for doubtful accounts and sales returns and adjustments   980    763 
Non-cash interest related to convertible notes payable   21    353 
Deferred income taxes   328    (1,009)
Amortization of non-cash debt issuance costs       9 
Gain on sale of assets   (2)    
Changes in operating assets and liabilities:          
Accounts receivable   (659)   (1,576)
Deferred advertising   (3,887)   (2,037)
Inventory   (383)   (31)
Other assets   (140)   (150)
Accounts payable   1,804    744 
Accrued expenses   (283)   (179)
Other liabilities   (21)   (2)
Net Cash Flow Provided by (Used in) Operating Activities   597    (324)
           
Cash flow from investing activities:          
Purchase of property and equipment   (75)   (780)
Proceeds from the sale of assets   3     
Purchase of certificates of deposit       (553)
Net Cash Flow Used in Investing Activities   (72)   (1,333)
           
Cash flow from financing activities:          
Proceeds from the exercise of warrants       163 
Proceeds from employee stock purchase plan   59    56 
Proceeds from credit line facility       750 
Purchase of treasury stock       (9)
Payments of debt and capital lease obligations   (582)   (220)
Net Cash Flow Provided by (Used in) Financing Activities   (523)   740 
           
Net increase (decrease) in cash   2    (917)
           
Cash at beginning of period   7,428    3,798 
Cash at end of period  $7,430   $2,881 
           
Supplemental disclosure of cash flow information:          
Cash paid for interest  $47   $105 
Cash paid for income taxes  $   $12 
           
Supplemental schedule of non-cash investing and financing activities:          
Common stock issued for interest expense  $   $45 
Common stock issued for conversion of debt  $5,100   $150 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

7
 

 

Liberator Medical Holdings, Inc. and Subsidiaries

Notes To The Unaudited Condensed Consolidated Financial Statements

December 31, 2009

 

Note 1 — Interim Financial Statements

 

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 Forms 10-K and 10-K/A for the year ended September 30, 2010 that were filed with the SEC on January 13, 2011, and January 28,2011, respectively. The results of operations for the three months ended December 31, 2010 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., Liberator Health and Wellness, Inc., and Practica Medical Manufacturing, Inc., its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation.

 

Note 2 — Summary of Significant Accounting Policies

 

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, 2010.

 

Recent Accounting Pronouncements

 

In January 2010, the FASB issued new guidance for fair value measurements and disclosures which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and 2 fair value measurements and describe the reasons for the transfers. The guidance also requires a reporting entity to present separately information about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs (Level 3). The guidance was effective on January 1, 2010, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The guidance adopted on January 1, 2010 did not have a material impact on the Company’s financial statements. Adoption of the remaining guidance is not expected to have a material impact on the Company’s financial statements.

 

Note 3 — Restatement of Previously Issued Financial Statements (Restated)

 

On December 1, 2011, the Company concluded that the Company's previously issued unaudited financial statements as of and for the interim period ended December 31, 2010, contained errors in the valuation of inventory and cost of goods sold. The Company has restated its previously issued condensed consolidated financial statements as of and for the three months ended December 31, 2010, to correct the following errors:

 

·During the reconciliation of the annual physical inventory count at fiscal year-end, the Company determined that the journal entries to record the cost of goods sold each month during fiscal year 2011 contained errors as a result of unit of measure conversion issues with certain products. As a result of the unit of measure errors, the Company's inventory balance was overstated and cost of sales was understated by $103,000 for the interim period ended December 31, 2010; and
8
 

 

·Partially offsetting the adjustments to inventory and cost of sales, the Company identified additional sales of $16,000 for the interim period ended December 31, 2010, that were not properly submitted to insurance carriers due to the unit of measure issues identified.

 

The following tables provide summary of amounts restated, including tax effects of adjustments, due to the unit of measure errors as of and for the three months ended December 31, 2010 (dollars in thousands, except per share amounts):

 

Balance Sheet Data:  As
Previously
Reported
   Current
Period
Effects
   As
Restated
 
Accounts receivable, net  $6,408   $16   $6,424 
Inventory, net   2,471    (103)   2,368 
Deferred taxes, current portion   1,462    2    1,464 
Current Assets   18,207    (85)   18,122 
Total Assets  $32,221   $(85)  $32,136 
                
Current Liabilities  $6,611   $   $6,611 
                
Deferred tax liability   1,963    (41)   1,922 
Total Liabilities   8,683    (41)   8,642 
Accumulated Deficit   (10,664)   (44)   (10,708)
Total Equity   23,538    (44)   23,494 
Total Liabilities and Equity  $32,221   $(85)  $32,136 

 

   For the three months ended December 31, 2010 
     
Statement of Operations Data:  As
Previously
Reported
   Current
Period
Effects
   As
Restated
 
Sales  $12,204   $16   $12,220 
Cost of Sales   4,336    103    4,439 
Gross Profit   7,868    (87)   7,781 
Total Operating Expenses   6,725        6,725 
Income from Operations   1,143    (87)   1,056 
Total Other Income (Expense)   (929)       (929)
Income before Income Taxes   214    (87)   127 
Provision for Income Taxes   372    (43)   329 
Net Income (Loss)  $(158)  $(44)  $(202)
                
Basic Earnings (Loss) per Share  $(0.00)  $(0.00)  $(0.00)
Diluted Earnings (Loss) per Share  $(0.00)  $(0.00)  $(0.00)

 

9
 

 

Note 4 — Stockholder Loans

 

The stockholder loans at September 30, 2010, in the amounts of $565,000 consist of various 8% and 11% notes payable to the President and principal stockholder of the Company, Mark Libratore. The notes payable were non-collateralized and due on demand. However, the notes were subordinated to the senior, unsecured, convertible notes payable discussed below in Note 6. During the three months ended December 31, 2010, $565,000 of principal was repaid to Mr. Libratore. Interest expense related to the stockholder loans for the three months ended December 31, 2010 and 2009 were $4,000, and $31,000, respectively.

 

Note 5 — 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 agreed to advance the Company a maximum of $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 agreed to advance the Company a maximum of $1,000,000 secured by the 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 expired on September 8, 2010. All other terms of the September 4, 2009 Credit Line Facility remained unchanged.

 

In November and December 2009, the Company borrowed $750,000 from the credit line facility. In June 2010, the Company repaid the $750,000 balance under the credit line facility.

 

In September 2010, the Company elected not to renew the credit line facility.

 

Interest expense related to the credit line facility for the three months ended December 31, 2010 and 2009, was $0 and $2,000, respectively.

 

Note 6 — Convertible Notes Payable

 

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 were cash proceeds and $206,000 were prior year debt exchanged for the convertible notes. The notes were convertible into shares of our common stock at an initial conversion price of $0.50 per share, subject to adjustment, and matured one year after issuance. The notes were senior unsecured obligations of our Company and accrued 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, 2010, $711,000 of the notes has been converted into 1,422,000 shares of the Company’s common stock and $93,000 of the notes has been redeemed for cash.

 

Interest expense related to the April 2008 convertible notes was $0 and $16,000 for the three months ended December 31, 2010 and 2009, respectively.

 

10
 

 

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 was convertible into shares of our common stock at an initial conversion price of $0.80 per share, subject to adjustment, and matured on May 22, 2010. The note was a senior unsecured obligation of ours and accrued interest at the rate of 3% per annum, paid semi-annually on each November 15 and May 15. The note was unconditionally guaranteed by Liberator Medical Supply and Liberator Health and Education Services, Inc. The conversion price of the note could have been reduced if, among other things, we issued shares of common stock or securities exercisable, exchangeable or convertible for or into shares of common stock at a price per share less than both the conversion price then in effect and $0.75, subject to certain exclusions. The Company concluded that the adjustment feature for the conversion price of the note was not indexed to the Company’s own stock and, therefore, was an embedded derivative financial liability that required 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.

 

In May 2009, the Company entered into a Waiver Agreement with the note holder of the May 2008 convertible notes discussed above. As part of the Waiver Agreement, the note holder agreed to accept 104,137 shares of the Company’s common stock, with a fair market value of $68,000, in lieu of the Company’s obligation to pay cash in the amount of $52,000 for interest payment that was due May 15, 2009 under the original terms of the notes. As a result of this transaction, the Company incurred an additional $16,000 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 were in all other respects unchanged.

 

On May 11, 2010, the $3,500,000 note was converted into 4,375,000 shares of the Company’s common stock at a conversion price of $0.80 per share.

 

Interest expense related to the May 2008 convertible note was $0 and $219,000 for the three months ended December 31, 2010 and 2009, 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 was convertible into shares of our common stock at an initial conversion price of $0.75 per share, subject to adjustment, and matured on October 17, 2010. The note was a senior unsecured obligation of ours and accrued interest at the rate of 3% per annum, paid semi-annually on each October 15 and April 15. The note was unconditionally guaranteed by Liberator Medical Supply and Liberator Health and Education Services, Inc. The conversion price of the note could have been reduced if, among other things, we issued 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 concluded that the adjustment feature for the conversion price of the note was not indexed to the Company’s own stock and, therefore, was an embedded derivative financial liability that required 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.

 

11
 

 

In May 2009, the Company entered into 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 67,808 shares of the Company’s common stock, with a fair market value of $37,000, in lieu of the Company’s obligation to pay cash in the amount of $34,000 for interest payments that were due April 15, 2009 under the original terms of the note. As a result of this transaction, the Company incurred an additional $3,000 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 were 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 were in all other respects unchanged.

 

On October 15, 2010, the $2,500,000 note was converted into 3,333,333 shares of the Company’s common stock at a conversion price of $0.75 per share.

 

Interest expense related to the October 2008 convertible note was $24,000 and $142,000 for the three months ended December 31, 2010 and 2009, respectively.

 

Short-term convertible notes payable consist of the following as of September 30, 2010 (in thousands):

 

   Oct’08 Note 
Notes Payable, face amount  $2,500 
      
Discounts on Notes:     
Initial valuation of Warrants   (86)
Initial valuation of Bifurcated Embedded Derivative   (841)
Accumulated Amortization   906 
Total Discounts   (21)
Accrued Interest   37 
Convertible Notes Payable, net  $2,516 

 

NOTE 7 — Derivative Liabilities

 

The May 2008 and October 2008 convertible notes, discussed above in Note 6, contained embedded adjustment features whereby the conversion price could have been adjusted if the Company had issued 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. The embedded adjustment features were not indexed to the Company’s own stock and, therefore, were embedded derivative financial liabilities (the “Embedded Derivatives”) that required bifurcation and separate accounting. Accordingly, the Company recorded a cumulative effect adjustment to the opening balance of retained earnings 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 Consolidated Statement of Operations.

 

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:

 

12
 

 

   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 

 

As of December 31, 2009, the fair values of the Embedded Derivatives for the May 2008 and October 2008 Notes 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 Monte Carlo 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 

 

On May 11, 2010, the May 2008 Note for $3,500,000 was converted into 4,375,000 shares of the Company’s common stock at a conversion price of $0.80 per share. The fair value of the Embedded Derivative for the May 2008 Note as of the conversion date was $4,813,000 and was transferred from derivative liabilities to additional paid-in capital.

 

As of September 30, 2010, the fair value of the Embedded Derivative for the October 2008 Note was $1,698,000. The fair value as of September 30, 2010 was calculated using a Monte Carlo simulation model with the following assumptions:

 

   October 2008 Note 
Risk-free interest rate:   0.14%
Expected term:   17 days 
Expected dividend yield:   0.00%
Expected volatility:   49.30%
Probability of triggering reset provision:   0.01%
Existing conversion price per share  $0.75 
Company’s stock price per share  $1.26 

 

On October 15, 2010, the $2.5 million convertible note was converted into shares of our common stock at a conversion price of $0.75 per share. The fair value of the embedded derivative on October 15, 2010, was $2,600,000, which was the intrinsic value of the conversion, based on the Company’s stock price as of the conversion date. As a result of the increase in fair value of the embedded derivative from September 30, 2010, to the date of conversion on October 15, 2010, $902,000 was recorded as an additional non-cash charge to earnings for the three months ended December 31, 2010. As a result of the conversion, $2,600,000 was transferred into additional paid in capital.

 

13
 

 

Note 8 — Stockholders’ Equity

 

Warrants

 

A summary of warrants issued, exercised and expired during the three months ended December 31, 2010, is as follows:

 

       Weighted 
       Avg. 
       Exercise 
Warrants:  Shares   Price 
Balance at September 30, 2010   7,393,334   $1.14 
Issued        
Exercised        
Expired   (370,417)   1.59 
Balance at December 31, 2010   7,022,917   $1.12 

 

Employee and Director Stock Options

 

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.

 

On October 21, 2010, Tyler Wick was appointed to the Board of Directors of the Company. As part of the compensation for his services as a director, Mr. Wick was granted an option, vesting over two years, to purchase 50,000 shares of common stock at $1.50 per share.

 

On December 29, 2010, the Board of Directors of the Company approved a grant of 450,000 stock options under the 2007 Stock Plan to employees with an exercise price of $1.20 per share for 375,000 shares of the grant and an exercise price of $1.32 per share for 75,000 shares of the grant. The options vest 25% on January 1, 2011, 25% on July 1, 2011, 25% on January 1, 2012, and 25% on July 1, 2012.

 

The weighted-average grant date fair value of options granted during the three months ended December 31, 2010 and 2009, was $0.40 and $1.03, respectively. There were no options exercised during the three months ended December 31, 2010 and 2009. The fair values of stock-based awards granted during the three months ended December 31, 2010 and 2009, were calculated with the following weighted-average assumptions:

 

   2010   2009 
           
Risk-free interest rate:   1.05%   1.38%
Expected term:   3 years    3 years 
Expected dividend yield:   0.00%   0.00%
Expected volatility:   48.91%   66.35%

 

For the three months ended December 31, 2010 and 2009, the Company recorded $118,000 and $55,000, respectively, of stock-based compensation expense, which has been classified as Operating expenses, sub-classification of Payroll, taxes and benefits, for the employees and General and administrative for the directors. As of December 31, 2010, there is $343,000 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 1.8 years.

 

Stock option activity for the three months ended December 31, 2010, is summarized as follows:

 

           Weighted     
       Weighted   Average     
       Average   Remaining   Aggregate 
       Exercise   Contractual   Intrinsic 
2007 Stock Plan:  Shares   Price   Life (Yrs)   Value 
                     
Options outstanding at September 30, 2010   1,655,000   $0.92    3.07   $671,850 
Granted   500,000    1.25           
Expired or forfeited                  
                     
Options outstanding at December 31, 2010   2,155,000   $1.00    3.51   $698,100 
                     
Options exercisable at December 31, 2010   1,143,750   $0.84    2.84   $524,813 
Options vested or expected to vest at December 31, 2010   2,155,000   $1.00    3.51   $698,100 

 

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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.

 

As of December 31, 2010, 237,840 shares of the Company’s common stock have been purchased through the ESPP, using $168,000 of proceeds received from employee payroll deductions. For the three months ended December 31, 2010 and 2009, the Company received $59,000 and $56,000, respectively, 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, 2010 and 2009, the Company recognized $9,000 and $70,000, respectively, of compensation expense related to the ESPP.

 

Note 9 — Income Taxes (Restated)

 

The Company had a net income tax provision for the quarter ended December 31, 2010, of $329,000. Although the Company had net operating loss carry-forwards which completely offsets regular taxable income, the Company incurred alternative minimum tax on its net alternative minimum taxable income of $1,000. In addition, the Company incurred deferred tax expense of $328,000.

 

The Company’s effective tax rate was approximately 260% and 23% for the three months ended December 31, 2010 and 2009, respectively, which differ from the federal statutory rate of 35% due to the effect of state income taxes and certain of the Company’s expenses that are not deductible for tax purposes, primarily consisting of expense related to 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 which management has determined will, more likely than not, be utilized.

 

Note 10 — Subsequent Event

 

On February 11, 2011, the Company entered into a Committed Line of Credit agreement (the “Line of Credit Agreement”) with PNC Bank, National Association (the “Lender”). Pursuant to the Line of Credit Agreement, the Lender will provide a maximum of Eight Million Five Hundred Thousand Dollars ($8,500,000) of revolving credit secured by the Company’s personal property, including inventory and accounts receivable Interest is payable on any advance at LIBOR plus 2.75%. Advances under the Line of Credit Agreement are subject to a Borrowing Base Rider, which establishes a maximum percentage amount of the Company’s accounts receivable and inventory that can constitute the permitted borrowing base. The Line of Credit Agreement expires in February 2013.


15
 

 

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 within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. When used in this quarterly report, in future filings by the Company with the Securities and Exchange Commission, in the Company’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are intended to identify “forward-looking statements.” The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak as of the date made, and to advise readers that various factors, including regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of manufacturing, distributing or marketing activities, competitive and regulatory factors, and those factors set forth in the Company’s Annual Report on Form 10-K for the year ended September 30, 2010, under the caption “Risk Factors,” could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from those anticipated by any forward-looking statements.

 

The following discussion should be read in conjunction with our unaudited consolidated financial statements and notes thereto included in this Form 10-Q/A and the audited financial statements of the Company included in our Annual Report on Forms 10-K and 10-K/A for the year ended September 30, 2010, and management’s discussion and analysis contained therein. The Company does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

 

Overview

 

We are a leading national direct-to-consumer provider of quality medical supplies to Medicare-eligible seniors. 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. An Exemplary Provider™ accredited by The Compliance Team, our Company’s unique combination of marketing, industry expertise and customer service has demonstrated success over a broad spectrum of chronic conditions. Liberator is recognized for offering a simple, reliable way to purchase medical supplies needed on a regular, ongoing, repeat-order basis, with the convenience of direct billing to Medicare and private insurance. Liberator’s revenue primarily comes from supplying products to meet the rapidly growing requirements of general medical supplies, primarily diabetes supplies, catheters, ostomy supplies and mastectomy fashions. Customers may purchase by phone, mail, or Internet, with repeat orders confirmed with the customer and shipped when needed.

 

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 payers and/or customers.

 

Results of Operations

 

The following table summarizes the results of operations for the three months ended December 31, 2010 and 2009, including percentage of sales (dollars in thousands):

 

   As Restated
2010
   2009 
   Amount   %   Amount   % 
Sales  $12,220    100.0   $9,158    100.0 
Cost of Sales   4,439    36.3    3,248    35.5 
Gross Profit   7,781    63.7    5,910    64.5 
Operating Expenses   6,725    55.0    4,750    51.9 
Income from Operations   1,056    8.6    1,160    12.7 
Other Income (Expense)   (929)   (7.6)   (5,511)   (60.2)
Income (Loss) Before Income Taxes   127    1.0    (4,351)   (47.5)
Provision for (benefit from) Income Taxes   329    2.7    (1,006)   (11.0)
Net Loss  $(202)   (1.7)  $(3,345)   (36.5)

 

16
 

 

Revenues:

 

Sales for the three months ended December 31, 2010, increased by $3,062,000, or 33.4%, to $12,220,000, compared with sales of $9,158,000 for the three months ended December 31, 2009. The increase in sales was primarily due to our continued emphasis on our direct response advertising campaign to obtain new customers and our dedication to customer service to retain our recurring customer base. Our direct-response advertising expenditures for the three months ended December 31, 2010, were $3,887,000 compared to $2,037,000 for the three months ended December 31, 2009.

 

Gross Profit:

 

Gross profit for the three months ended December 31, 2010, increased by $1,871,000, or 31.7%, to $7,781,000, compared with gross profit of $5,910,000 for the three months ended December 31, 2009. The increase was attributed to our increased sales volume for the three months ended December 31, 2010, compared to the three months ended December 31, 2009.

 

Operating Expenses:

 

The following table provides a breakdown of our operating expenses for the three months ended December 31, 2010 and 2009, including percentage of sales (dollars in thousands):

 

   2010   2009 
   Amount   %   Amount   % 
Operating Expenses:                    
Payroll, taxes and benefits  $2,841    23.2   $2,169    23.7 
Advertising   1,901    15.5    806    8.8 
Bad debts   892    7.3    655    7.2 
Depreciation   166    1.4    95    1.0 
General and administration   925    7.6    1,025    11.2 
Total Operating Expenses  $6,725    55.0   $4,750    51.9 

 

Payroll, taxes and benefits increased by $672,000, or 31.0%, to $2,841,000 for the three months ended December 31, 2010, compared to the three months ended December 31, 2009. The increase is primarily attributed to an increase in the number of employees to support our increased sales volume. We have chosen to invest in recruiting, hiring, and training additional staff ahead of our advertising schedule, which helps us achieve compliance on many fronts and maintain the quality of our customer service. As of December 31, 2010, we had 223 active employees compared to 187 at December 31, 2009.

 

Advertising expenses increased by $1,095,000, or 135.9%, to $1,901,000 for the three months ended December 31, 2010, compared to the three months ended December 31, 2009. The majority of our advertising expenses are associated with the amortization of previously capitalized direct response advertising costs. The rest of our advertising expenses are for costs that do not qualify as direct response advertising and are expensed as incurred. The following table shows a breakdown of our advertising expenses for the three months ended December 31, 2010, and 2009 (dollars in thousands):

 

   2010   2009 
Advertising Expenses:          
Amortization of direct-response costs  $1,845   $809 
Other advertising expenses   56    (3)
Total Advertising Expenses  $1,901   $806 

 

17
 

 

As of December 31, 2010, we have $12,048,000 of deferred advertising costs that will be expensed over a period between four and six years based on probable future net revenues updated at each reporting period and expected to result directly from such advertising.

 

Bad debt expenses increased by $237,000, or 36.2%, to $892,000 for the three months ended December 31, 2010, compared to the three months ended December 31, 2009. The increases in bad debt expenses are due primarily to our increased sales levels.

 

Depreciation expense increased by $71,000, or 74.7%, to $166,000 for the three months ended December 31, 2010, compared to the three months ended December 31, 2009. The increase in depreciation expense is primarily attributed to the build out of an additional 24,000 square foot facility during the first six months of fiscal year 2010 to house our expanding workforce and provide the capacity necessary to support our future sales growth. Purchases of property and equipment totaled $75,000 and $780,000 during the three months ended December 31, 2010 and 2009, respectively.

 

General and administrative expenses decreased by $100,000, or 9.8%, to $925,000 for the three months ended December 31, 2010 compared to the three months ended December 31, 2009. The decreases are due to the reduction of amortization costs associated with debt issuance costs, professional fees, and office expense; partially offset by increases in software costs, equipment lease payments, and compensation for the board of directors. As a percentage of sales, general and administrative expenses have decreased from 11.2% for the three months ended December 31, 2009, to 7.6% for the three months ended December 31, 2010.

 

Income from Operations:

 

Income from operations for the three months ended December 31, 2010, decreased by $104,000 to $1,056,000, compared to the three months ended December 31, 2009. The decrease in operating income is attributed to our increased investments in payroll, facilities, and advertising costs, partially offset by a reduction in general and administrative costs.

 

Other Income (Expense):

 

The following table shows a breakdown of other income (expense) for the three months ended December 31, 2010 and 2009 (dollars in thousands):

 

   2010   2009 
Other Income (Expense):          
Interest Expense  $(31)  $(416)
Change in fair value of derivative liabilities   (902)   (5,098)
Gain on sale of assets   2     
Interest income   2    3 
Total Other Income (Expense)  $(929)  $(5,511)

 

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, 2010 and 2009, respectively, totaled $923,000 and $5,406,000.

 

Interest expense decreased by $384,000 to $31,000 for the three months ended December 31, 2010, compared to the three months ended December 31, 2009. The decrease in interest expense was due to reduced levels of debt during the three months ended December 31, 2010, as a result of the conversion of $6,452,000 of notes into shares of our common stock and $1,315,000 of principal payments towards shareholder loans since December 31, 2009.

18
 

 

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 and the three months ended December 31, 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 ended:          
September 30, 2009, Q4 FY 2009  $1.45   $ n/a 
December 31, 2009, Q1 FY 2010   2.18    (5,098)
March 31, 2010, Q2 FY 2010   2.20    (59)
June 30, 2010, Q3 FY 2010   1.49    3,698 
September 30, 2010, Q4 FY 2010   1.26    768 
October 15, 2010, Q1 FY 2011 (Conversion Date of $2.5 million note)   1.53    (902)
Total change in fair value of derivative liabilities       $(1,593)

 

As a result of the increase in fair value of the embedded derivatives from October 1, 2009, to December 31, 2009, $5,098,000 was recorded as a non-cash charge to earnings for the three months ended December 31, 2009.

On May 11, 2010, the $3.5 million convertible note issued in May 2008 was converted into shares of our common stock at a conversion price of $0.80 per share. As of September 30, 2010, derivatives liabilities had a remaining balance of $1,698,000, which is related to the embedded derivative contained in the $2.5 million convertible note due October 17, 2010.

 

On October 15, 2010, the $2.5 million convertible note was converted into shares of our common stock at a conversion price of $0.75 per share. The fair value of the embedded derivative on October 15, 2010, was $2,600,000. As a result of the increase in fair value of the embedded derivative from September 30, 2010, to the date of conversion on October 15, 2010, $902,000 was recorded as an additional non-cash charge to earnings for the three months ended December 31, 2010. As a result of the conversion, $5.1 million, which is the balance of the derivative liabilities plus the face value of the convertible note, was transferred into additional paid in capital, eliminating any additional exposure to changes in fair value of the derivative liabilities associated with the convertible debt issued in May and October 2008 since the notes have been converted into shares of our common stock.

 

Income Taxes:

 

The provision for income taxes was $329,000 for the three months ended December 31, 2010. The effective tax rate was approximately 260% of the income before income taxes of $127,000, which differs from the federal statutory rate of 35% due to the effect of state income taxes and certain of the Company’s expenses that are not deductible for tax purposes, primarily consisting of $902,000 of expense related to the change in fair value of derivative liabilities recorded for the three months ended December 31, 2010.

 

The benefit for income taxes was $1,006,000 for the three months ended December 31, 2009. The effective tax rate was approximately 23% of the loss before income taxes of $4,351,000, which differs from the federal statutory rate of 35% due to the effect of state income taxes, a $1,438,000 decrease to the valuation allowance for deferred tax assets that management has determined will, more likely than not, be utilized, 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.

19
 

 

Liquidity and Capital Resources

 

The following table summarizes our cash flows from operating, investing, and financing activities for the three months ended December 31, 2010 and 2009 (dollars in thousands):

 

   For the Three Months Ended 
   December 31, 
   2010   2009 
Cash Flows:          
Net cash provided by (used in) operating activities  $597   $(324)
Net cash used in investing activities   (72)   (1,333)
Net cash provided by (used in) financing activities   (523)   740 
Net increase (decrease) in cash   2    (917)
Cash at beginning of period   7,428    3,798 
Cash at end of period  $7,430   $2,881 

 

The Company had cash of $7,430,000 at December 31, 2010, compared to cash of $7,428,000 at September 30, 2010, an increase of $2,000. The increase in cash for the three months ended December 31, 2010, is primarily due to $597,000 of cash generated from operating activities and $59,000 of proceeds from the employee stock purchase plan, partially offset by payments of $582,000 on our debt obligations and $75,000 for purchases of property and equipment.

 

Operating Activities

 

During the three months ended December 31, 2010, cash provided by operations was $597,000, which was the result of a net loss of $202,000 plus non-cash charges of $4,368,000 less changes in operating assets and liabilities of $3,569,000. The non-cash charges consist primarily of $1,845,000 for amortization of deferred advertising costs, $902,000 for the change in fair value of derivative liabilities, $892,000 for bad debt expense, $328,000 for deferred income taxes, $166,000 for depreciation, $128,000 for equity based compensation associated with employee and director stock options, and $87,000 for increase in reserve for returns and adjustments. The changes in operating assets and liabilities for the three months ended December 31, 2010 consist of $3,887,000 of deferred advertising expenditures related to our direct response advertising efforts, increases for accounts receivable of $659,000 and inventory of $383,000 as a result of our increased sales, and a decrease of $283,000 for accrued expenses primarily related to the payment of management incentives in October 2010, partially offset by an increase in accounts payable of $1,804,000 due to increased purchases and improved vendor payment terms for our higher volume items.

 

During the three months ended December 31, 2009, cash used in operations was $324,000, which was the result of a net loss of $3,345,000 plus non-cash charges of $6,252,000 less changes in operating assets and liabilities of $3,231,000. The non-cash charges consist primarily of $5,098,000 for the change in fair value of derivative liabilities, $809,000 for amortization of deferred advertising costs, $655,000 for bad debt expense, $353,000 for non-cash interest expense related to convertible notes payable, $133,000 for equity based compensation associated with employee and director stock options, $107,000 for increase in the reserve for returns and adjustments, and $95,000 for depreciation; less, $1,009,000 for deferred income taxes. The changes in operating assets and liabilities for the three months ended December 31, 2009, consist of $2,037,000 of deferred advertising expenditures related to our direct response advertising efforts, increases for accounts receivable of $1,576,000 and inventory of $31,000 as a result of our increased sales, and a decrease of $179,000 for accrued expenses primarily related to the payment of management incentives in October 2009, partially offset by an increase in accounts payable of $744,000 due to increased purchases.

 

Investing Activities

 

During the three months ended December 31, 2010, we purchased $75,000 of property and equipment to support our continued growth.

 

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, into which we moved 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 5 of the unaudited condensed consolidated financial statements.

 

20
 

 

Financing Activities

 

During the three months ended December 31, 2010, cash used in financing activities was $523,000, which included payments of $582,000 towards our debt obligations, partially offset by $59,000 of proceeds from our employee stock purchase plan.

 

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.

 

Outlook

 

The Company has experienced substantial growth over the past three fiscal years despite the downturn in the U.S. economy. We have increased sales for eleven consecutive quarters. Our growth has been driven by our direct response marketing campaign, primarily through television ads at remnant (discounted) rates. Based on information from our media buying agents, we believe that demand for television time slots within the direct response advertising market has increased over the last fiscal year, creating a more competitive environment within this medium. Although customer acquisition costs remain at acceptable levels, during fiscal year 2010 and the first three months of fiscal year 2011, we increased our spending in alternative media channels and plan to continue those efforts during the remainder of fiscal year 2011. In addition, we have invested heavily in our infrastructure by adding both personnel and facilities, so that we continue to remain capable of supporting a much higher sales volume. We currently have approximately 50% of each of our facilities available for future growth. We have chosen to build our infrastructure ahead of our advertising spend, which helps us achieve compliance on many fronts and maintain the quality of our customer service. Our cost structure continues to remain flexible enough to adapt to changing market conditions. We can pulse our advertising spend and the expansion of our workforce relatively quickly based on the results of our marketing programs. We believe we are well positioned to continue to grow our sales and improve profitability over the long term.

 

We plan to continue our advertising efforts over the next twelve months to attract new customers and expand 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 grow over the next three quarters of fiscal year 2011 due to our advertising and marketing programs. The Company does not anticipate any major changes affecting the Company in Medicare reimbursement in 2011, nor in any other reimbursement programs available from other third-party payers.

 

Due to our emphasis on sales growth through our direct-response advertising efforts, we may be required to raise additional cash, preferably through debt facilities versus the sale of additional equity, in order to maintain our current growth rates. As of December 31, 2010, we had $7.4 million of cash available to fund our operations. 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.

 

At December 31, 2010, our current assets of $18,122,000 exceeded our current liabilities of $6,611,000 by $11,511,000.

 

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;

 

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Continue to invest in the expansion of our infrastructure; and

 

Increase our accounts receivable collection efforts.

 

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;

 

Expanded our Board of Directors to include five directors, four of whom are non-employee directors, and formed an Audit Committee, a Compensation Committee, and a Governance and Nominating Committee;

 

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;

 

Leased an additional 24,000 square foot facility to house our expanding workforce and support our continued growth. We completed the build out of this facility to house our call center and other administrative functions and moved into the new facility in January, 2010.

 

Created a HIPAA 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 adapt to changing market conditions; and

 

Established methods of testing our current and new advertising methods to meet 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 chronically ill patients.

 

Off-Balance Sheet Arrangements

 

As of December 31, 2010, we had no off-balance sheet arrangements.

 

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/A for the year ended September 30, 2010, 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.

 

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Item 4. 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, 2010. 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.

 

Management’s Report on 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.

 

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our internal control over financial reporting as of December 31, 2010, as required by Securities Exchange Act Rule 13a-15(c). In making our assessment, we have utilized the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control —Integrated Framework. We concluded that based on our evaluation, our internal control over financial reporting was not effective as of December 31, 2010 due to material weaknesses identified as follows:

 

·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.

 

·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.

 

·Inventory Controls: Management has identified a material weakness related to the Company’s procedures to account for inventory. During the reconciliation of the annual physical inventory count at fiscal year-end, the Company determined that the journal entries to record the cost of goods sold each month contained errors as a result of unit of measure conversion issues with certain products that were sold in each month of fiscal year 2011. As a result, the Company has amended its Report on Form 10-Q for the first quarter of fiscal year 2011 and will amend its Reports on Form 10-Q for the second and third quarters of fiscal year 2011.

 

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Change in Internal Control over Financial Reporting

 

During the three months ended December 31, 2010, the Company remediated the following material weaknesses previously disclosed in the Company’s Annual Report for fiscal year 2010 filed with the SEC on Form 10-K:

 

·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.

 

Remediation: The Company engaged an independent third party valuation expert to calculate the fair values of the embedded derivative liabilities and correctly accounted for the embedded derivatives contained in certain convertible notes payable. The Company has restated 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.

 

·Accounting for Deferred 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.

 

Remediation: During the first quarter of fiscal year 2011 and before we filed our Annual Report for fiscal year 2010 with the SEC on Form 10-K, management completed the above analysis as required, including defining separate stand-alone cost pools. In addition, management determined that no restatements of prior period financial statements were required as a result of the above analysis.

 

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 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

 

·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.

 

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·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.

 

·The Company plans on evaluating new inventory systems during fiscal year 2012. Until a new perpetual inventory system is implemented and the appropriate controls are put in place, the Company will conduct quarterly physical inventories for each future reporting period. During the first quarter of fiscal year 2012, additional analytical procedures will be implemented for the Company's monthly cost of goods sold journal entries and additional testing of cut-off controls will be performed at each interim period.

 

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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/A for the fiscal year ended September 30, 2010. 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

 

During the three months ended December 31, 2010, the Company issued 3,333,333 shares of common stock upon the conversion of convertible notes payable. The securities were issued in reliance upon the exemptions from registration provided by Regulation D, Rule 506, and Section 4(2) of the Securities Act of 1933, as amended.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 5. Other Information

 

None.

 

Item 6. 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

 

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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 President February 13, 2012
Mark A. Libratore    
     
/s/ Robert J. Davis Chief Financial Officer February 13, 2012
Robert J. Davis    

 

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