UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q/A

(Amendment No. 1)

(Mark One)

 

R

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2011

 

or

 

£

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from                      to

 

Commission file number: 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 ¨

 

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 ¨   No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨		Accelerated filer ¨		Non-accelerated filer ¨		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 ¨   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 May 10, 2011
Common Stock, $.001		48,009,909

 

 

TABLE OF CONTENTS

 

		Page
Explanatory Note		3
PART I — FINANCIAL INFORMATION
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	23
Item 4.	Controls and Procedures	23
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	25
Item 1A.	Risk Factors	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 3.	Defaults Upon Senior Securities	25
Item 5.	Other Information	25
Item 6.	Exhibits	25
SIGNATURES		26
EX-31.1
EX-31.2
EX-32.1
EX-32.2

 

 

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 March 31, 2011, which was originally filed with the Securities and Exchange Commission (“SEC”) on May 12, 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 and six months ended March 31, 2011, 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 and six months ended March 31, 2011.

 

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 4 — 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, 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.

 

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
As of March 31, 2011 (unaudited) and September 30, 2010
(In thousands, except dollar per share amounts)

 

		As Restated
		March				September
		31, 2011				30, 2010
Assets
Current Assets:
Cash		$	4,594			$	7,428
Accounts receivable, net of allowance of $3,740 and $3,312, respectively			7,439				6,744
Inventory, net of allowance for obsolete inventory of $137 and $110, respectively			2,416				1,985
Deferred taxes, current portion			1,541				1,696
Prepaid and other current assets			504				355
Total Current Assets			16,494				18,208
Property and equipment, net of accumulated depreciation of $1,818 and $1,527, respectively			1,686				1,862
Deferred advertising			15,126				10,006
Other assets			218				139
Total Assets		$	33,524			$	30,215
Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable		$	6,234			$	3,826
Accrued liabilities			799				1,077
Derivative liabilities			—				1,698
Stockholder loans			—				565
Convertible notes payable, net of unamortized discount of $21			—				2,516
Other current liabilities			132				146
Total Current Liabilities			7,165				9,828
Deferred tax liability			2,361				1,826
Other long-term liabilities			87				145
Total Liabilities			9,613				11,799
Stockholders’ Equity:
Common stock, $.001 par value, 200,000 shares authorized, 48,100 and 44,707 shares issued, respectively; 48,010 and 44,617 shares outstanding at March 31, 2011, and September 30, 2010, respectively			48				45
Additional paid-in capital			34,312				28,927
Accumulated deficit			(10,399	)			(10,506	)
Treasury stock, at cost; 89 shares at March 31, 2011, and September 30, 2010			(50	)			(50	)
Total Stockholders’ Equity			23,911				18,416
Total Liabilities and Stockholders’ Equity		$	33,524			$	30,215

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
For the three and six months ended March 31, 2011 and 2010
(Unaudited)
(in thousands, except per share amounts)

 

		Three Months Ended March 31,								Six Months Ended March 31,
		As Restated 2011				2010				As Restated 2011				2010
Sales		$	12,664			$	9,650			$	24,884			$	18,808
Cost of Sales			4,774				3,386				9,213				6,633
Gross Profit			7,890				6,264				15,671				12,175
Operating Expenses
Payroll, taxes and benefits			2,930				2,618				5,771				4,787
Advertising			2,019				1,114				3,920				1,920
Bad debts			877				928				1,769				1,583
Depreciation			171				174				337				270
General and administrative			1,224				1,070				2,149				2,094
Total Operating Expenses			7,221				5,904				13,946				10,654
Income from Operations			669				360				1,725				1,521
Other Income (Expense)
Interest expense			(1	)			(402	)			(32	)			(819	)
Change in fair value of derivative liabilities			—				(59	)			(902	)			(5,157	)
Gain (Loss) on disposal of assets			—				(2	)			2				(2	)
Interest income			2				5				4				8
Total Other Income (Expense)			1				(458	)			(928	)			(5,970	)
Income (Loss) before Income Taxes			670				(98	)			797				(4,449	)
Provision for (Benefit from) Income Taxes			361				(6	)			690				(1,012	)
Net Income (Loss)		$	309			$	(92	)		$	107			$	(3,437	)
Basic earnings (loss) per share:
Weighted average shares outstanding			47,996				34,921				47,704				33,873
Earnings (loss) per share		$	0.01			$	(0.00	)		$	0.00			$	(0.10	)
Diluted earnings (loss) per share:
Weighted average shares outstanding			53,773				34,921				53,502				33,873
Earnings (loss) per share		$	0.01			$	(0.00	)		$	0.00			$	(0.10	)

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statement of Changes in Stockholders’ Equity
For the six months ended March 31, 2011 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											236												236
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
Common stock issued for cashless exercise of warrants			14				—				—												—
Net income															107								107
Balance at March 31, 2011			48,010			$	48			$	34,312			$	(10,399	)		$	(50	)		$	23,911

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
For the six months ended March 31, 2011 and 2010
(Unaudited)
(in thousands)

		Six Months Ended
		March 31,
		As Restated 2011				2010
Cash flow from operating activities:
Net Income (Loss)		$	107			$	(3,437	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization			4,172				2,156
Change in fair value of derivative liabilities			902				5,157
Equity based compensation			236				223
Provision for doubtful accounts and sales returns and adjustments			1,865				1,728
Non-cash interest related to convertible notes payable			21				662
Deferred income taxes			690				(982	)
Amortization of non-cash debt issuance costs			—				17
Reserve for inventory obsolescence			28				—
Loss (Gain) on disposal of assets			(2	)			2
Changes in operating assets and liabilities:
Accounts receivable			(2,561	)			(3,621	)
Deferred advertising			(8,954	)			(4,630	)
Inventory			(458	)			(650	)
Other assets			(179	)			(50	)
Accounts payable			2,409				1,479
Accrued liabilities			(308	)			128
Other liabilities			(37	)			(3	)
Net Cash Flow Used in Operating Activities			(2,069	)			(1,821	)
Cash flow from investing activities:
Purchase of property and equipment			(163	)			(1,217	)
Proceeds from the sale of assets			3				5
Purchase of certificates of deposit			—				(556	)
Net Cash Flow Used in Investing Activities			(160	)			(1,768	)
Cash flow from financing activities:
Proceeds from the sale of common stock			—				7,000
Costs associated with the sale of common stock			—				(382	)
Proceeds from the exercise of warrants			—				530
Proceeds from employee stock purchase plan			44				104
Proceeds from credit line facility			—				750
Costs associated with new credit line facility			(51	)			—
Purchase of treasury stock			—				(9	)
Payments of debt and capital lease obligations			(598	)			(241	)
Net Cash Flow Provided by (Used in) Financing Activities			(605	)			7,752
Net increase (decrease) in cash			(2,834	)			4,163
Cash at beginning of period			7,428				3,798
Cash at end of period		$	4,594			$	7,961
Supplemental disclosure of cash flow information:
Cash paid for interest		$	49			$	185
Cash paid for income taxes		$	5			$	20
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			$	543

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

Liberator Medical Holdings, Inc. and Subsidiaries

 

Notes To The Unaudited Condensed Consolidated Financial Statements

March 31, 2011

 

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 six months ended March 31, 2011 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 on January 1, 2011 did not 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 March 31, 2011, 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 and six months ended March 31, 2011, 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 by $205,000 as of March 31, 2011, and cost of sales was understated by $102,000 and $205,000, respectively, for the three and six months ended March 31, 2011; and

 

 

·

Partially offsetting the adjustments to inventory and cost of sales, the Company identified additional sales of $21,000 and $37,000, respectively, for the three and six months ended March 31, 2011, that were not properly submitted to insurance carriers due to the unit of measure issues identified.

 

The following tables provide a summary of amounts restated, including tax effects of adjustments, due to the unit of measure errors as of and for the three and six months ended March 31, 2011 (dollars in thousands, except per share amounts):

 

Balance Sheet Data:		As Previously Reported				Current Period Effects				As Restated
Accounts receivable, net		$	7,402			$	37			$	7,439
Inventory, net			2,621				(205	)			2,416
Deferred taxes, current portion			1,557				(16	)			1,541
Current Assets			16,678				(184	)			16,494
Total Assets		$	33,708			$	(184	)		$	33,524
Current Liabilities		$	7,165			$	—			$	7,165
Deferred tax liability			2,459				(98	)			2,361
Total Liabilities			9,711				(98	)			9,613
Accumulated Deficit			(10,313	)			(86	)			(10,399	)
Total Stockholders’ Equity			23,997				(86	)			23,911
Total Liabilities and Stockholders’ Equity		$	33,708			$	(184	)		$	33,524

  

 

 

Statement of Operations Data:		For the three months ended  March 31, 2011												For the six months ended  March 31, 2011
		As Previously Reported				Current Period Effects				As Restated				As Previously Reported				Current Period Effects				As Restated
Sales		$	12,643			$	21			$	12,664			$	24,847			$	37			$	24,884
Cost of Sales			4,672				102				4,774				9,008				205				9,213
Gross Profit			7,971				(81	)			7,890				15,839				(168	)			15,671
Total Operating Expenses			7,221				—				7,221				13,946				—				13,946
Income from Operations			750				(81	)			669				1,893				(168	)			1,725
Total Other Income (Expense)			1				—				1				(928	)			—				(928	)
Income before Income Taxes			751				(81	)			670				965				(168	)			797
Provision for Income Taxes			400				(39	)			361				772				(82	)			690
Net Income		$	351			$	(42	)		$	309				193				(86	)			107
Basic Earnings per Share		$	0.01			$	(0.00	)		$	0.01				0.00				(0.00	)			0.00
Diluted Earnings per Share		$	0.01			$	(0.00	)		$	0.01				0.00				(0.00	)			0.00

 

 

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 first quarter of fiscal year 2011, the balance of the notes was repaid to Mr. Libratore. Interest expense related to the stockholder loans for the six months ended March 31, 2011 and 2010 was $4,000, and $60,000, respectively.

 

Note 5 — Credit Line Facility

 

Gulfstream 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 “Gulfstream Credit Line Facility”) with a lender. Pursuant to the Gulfstream 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 was payable on any advance under the Gulfstream 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 Gulfstream 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 Gulfstream 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 Gulfstream Credit Line Facility.

 

Interest expense related to the Gulfstream Credit Line Facility for the six months ended March 31, 2011 and 2010, was $0 and $11,000, respectively.

 

PNC Credit Line Facility

 

On February 11, 2011, the Company entered into a Committed Line of Credit agreement (the “PNC Credit Line Facility”) with PNC Bank, National Association ("PNC"). Pursuant to the PNC Credit Line Facility, the PNC will provide a maximum of $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 PNC Credit Line Facility 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 PNC Credit Line Facility expires in February 2013.

 

The PNC Credit Line Facility requires the Company to comply with certain financial covenants which are defined in the credit agreement. As of March 31, 2011, these financial covenants included:

 

·

The Company will maintain as of the end of each fiscal quarter, on a rolling four quarter basis, a ratio of Senior Funded Debt to EBITDA of less than 2.0 to 1; and

 

·

The Company will maintain as of the end of each fiscal quarter, on a rolling four quarters basis, a Fixed Charge Coverage Ratio of at least 1.25 to 1.

 

As of March 31, 2011, the Company was in compliance with all applicable financial covenants pursuant to the PNC Credit Line Facility. The permitted borrowing base as of March 31, 2011, was $5,858,000. As of March 31, 2011, the Company has not borrowed any funds or incurred any interest expense from the PNC Credit Line Facility.

 

 

Note 6 — Convertible Notes Payable

 

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.

 

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 $437,000 for the six months ended March 31, 2011 and 2010, 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.

 

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 $276,000 for the six months ended March 31, 2011 and 2010, 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.

 

On May 11, 2010, the May 2008 convertible note was converted into 4,375,000 shares of the Company’s common stock at a conversion price of $0.80 per share.

 

As of September 30, 2010, the fair value of the Embedded Derivative for the October 2008 convertible 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 October 2008 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, $902,000 was recorded as an additional non-cash charge to earnings for the six months ended March 31, 2011. As a result of the conversion, $2,600,000 was transferred from derivative liabilities into additional paid in capital.

 

 

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 six months ended March 31, 2011 (dollars in thousands):

 

		2011
Beginning balance: Derivative liabilities		$	1,698
Total (gains) losses			902
Settlements			(2,600	)
Ending balance: Derivative liabilities		$	—

 

Note 8 — Stockholders’ Equity

 

Warrants

 

A summary of warrants issued, exercised and expired during the six months ended March 31, 2011, is as follows:

 

						Weighted
						Avg.
						Exercise
Warrants:		Shares				Price
Balance at October 1, 2010			7,393,334			$	1.14
Issued			—				—
Exercised			(51,000	)			1.00
Expired			(376,667	)			1.59
Balance at March 31, 2011			6,965,667			$	1.12

 

Employee & Director Stock Options

 

The weighted-average grant date fair value of options granted during the six months ended March 31, 2011 and 2010, was $0.40 and $0.99, respectively. There were no options exercised during the six months ended March 31, 2011 and 2010. The fair values of stock-based awards granted during the six months ended March 31, 2011 and 2010, were calculated with the following weighted-average assumptions:

 

		2011				2010
Risk-free interest rate:			1.05	%			1.37	%
Expected term:			3 years				3 years
Expected dividend yield:			0.00	%			0.00	%
Expected volatility:			48.91	%			67.67	%

 

For the six months ended March 31, 2011 and 2010 the Company recorded $216,000 and $119,000, 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 March 31, 2011, there is $246,000 in total unrecognized compensation expense related to non-vested employee and director stock options granted under the 2007 Stock Plan, which is expected to be recognized over 1.6 years.

 

Stock option activity for the six months ended March 31, 2011, is summarized as follows:

 

										Weighted
						Weighted				Average
						Average				Remaining				Aggregate
						Exercise				Contractual				Intrinsic
2007 Stock Plan:		Shares				Price				Life (Years)				Value
Options outstanding at October 1, 2010			1,655,000			$	0.92				2.82			$	942,750
Granted			500,000				1.25
Expired or forfeited			(70,000	)			1.03
Options outstanding at March 31, 2011			2,085,000			$	0.99				3.26			$	1,016,750
Options exercisable at March 31, 2011			1,376,250			$	0.90				2.84			$	794,188
Options vested or expected to vest at March 31, 2011			2,085,000			$	0.99				3.26			$	1,016,750

 

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 1 and November 30 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 March 31, 2011, 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 six months ended March 31, 2011 and 2010, the Company received $44,000 and $104,000, 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 six months ended March 31, 2011 and 2010, the Company recognized $19,000 and $105,000, respectively, of compensation expense related to the ESPP.

 

Note 9 — 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 and six months ended March 31, 2011 and 2010 (in thousands, except per share amounts):

 

		For the three months								For the six months
		ended March 31,								ended March 31,
		2011				2010				2011				2010
Numerator:
Net income (loss) — basic		$	309			$	(92	)		$	107			$	(3,437	)
Denominator:
Weighted average shares outstanding — basic			47,966				34,921				47,704				33,873
Effect of dilutive securities:
Stock options and warrants			5,777				—				5,798				—
Weighted average shares outstanding — diluted			53,773				34,921				53,502				33,873
Earnings (loss) per share — basic		$	0.01			$	(0.00	)		$	0.00			$	(0.10	)
Earnings (loss) per share — diluted		$	0.01			$	(0.00	)		$	0.00			$	(0.10	)

 

 

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 per share because the impact would have been anti-dilutive for the three and six months ended March 31, 2011 and 2010 (in thousands):

 

		For the three and six months
		ended March 31,
		2011				2010
Stock options			640				5,651
Warrants			358				9,811
Convertible debt			—				7,825
			998				23,287

 

Note 10 — Income Taxes (Restated)

 

The provision for income taxes was $690,000 for the six months ended March 31, 2011. The effective tax rate was approximately 87% of the income before income taxes of $797,000, 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 six months ended March 31, 2011.

 

The benefit for income taxes was $1,012,000 for the six months ended March 31, 2010. The effective tax rate was approximately 23% of the loss before income taxes of $4,449,000, 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 $5,157,000 of expense for the change in fair value of derivative liabilities.

 

 

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/A 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 and six months ended March 31, 2011 and 2010, including percentage of sales (dollars in thousands):

 

		For the three months ended March 31,																For the six months ended March 31,
		As Restated 2011								2010								As Restated 2011								2010
		Amount				%				Amount				%				Amount				%				Amount				%
Sales		$	12,664				100.0			$	9,650				100.0			$	24,884				100.0			$	18,808				100.0
Cost of Sales			4,774				37.7				3,386				35.1				9,213				37.0				6,633				35.3
Gross Profit			7,890				62.3				6,264				64.9				15,671				63.0				12,175				64.7
Operating Expenses			7,221				57.0				5,904				61.2				13,946				56.1				10,654				56.6
Income from Operations			669				5.3				360				3.7				1,725				6.9				1,521				8.1
Other Income (Expense)			1				0.0				(458	)			(4.7	)			(928	)			(3.7	)			(5,970	)			(31.7	)
Income (loss) before Income Taxes			670				5.3				(98	)			(1.0	)			797				3.2				(4,449	)			(23.7	)
Income Tax Expense (Benefit)			361				2.9				(6	)			(0.0	)			690				2.8				(1,012	)			(5.4	)
Net Income (Loss)		$	309				2.4			$	(92	)			(1.0	)		$	107				0.4			$	(3,437	)			(18.3	)

 

 

Revenues:

 

Sales for the three months ended March 31, 2011, increased by $3,014,000, or 31.2%, to $12,664,000, compared with sales of $9,650,000 for the three months ended March 31, 2010. Sales for the six months ended March 31, 2011, increased by $6,076,000, or 32.3%, to $24,884,000, compared with sales of $18,808,000 for the six months ended March 31, 2010. 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 six months ended March 31, 2011, were $8,954,000 compared with $4,630,000 for the six months ended March 31, 2010.

 

Gross Profit:

 

Gross profit for the three months ended March 31, 2011, increased by $1,626,000, or 26.0%, to $7,890,000, compared with gross profit of $6,264,000 for the three months ended March 31, 2010. For the six months ended March 31, 2011, gross profit increased by $3,497,000, or 28.7%, to $15,671,000, compared with gross profit of $12,175,000. The increase was attributed to our increased sales volume for the three and six months ended March 31, 2011, compared with the three and six months ended March 31, 2010.

 

As a percentage of sales, gross profit decreased by 2.6% and 1.7%, respectively, for the three and six months ended March 31, 2011, compared with the three and six months ended March 31, 2010. The decrease in gross profit as a percentage of sales was due to $100,000 of additional costs associated with a product recall and product mix during the three and six months ended March 31, 2011.

 

Operating Expenses:

 

The following table provides a breakdown of our operating expenses for the three and six months ended March 31, 2011 and 2010, including percentage of sales (dollars in thousands):

 

		For the three months ended March 31,																For the six months ended March 31,
		As Restated 2011								2010								As Restated 2011								2010
		Amount				%				Amount				%				Amount				%				Amount				%
Operating Expenses:
Payroll, taxes, & benefits		$	2,930				23.1			$	2,618				27.1			$	5,771				23.2			$	4,787				25.5
Advertising			2,019				15.9				1,114				11.6				3,920				15.7				1,920				10.2
Bad debts			877				6.9				928				9.6				1,769				7.1				1,583				8.4
Depreciation			171				1.4				174				1.8				337				1.4				270				1.4
General and administration			1,224				9.7				1,070				11.1				2,149				8.6				2,094				11.1
Total Operating Expenses		$	7,221				57.0			$	5,904				61.2			$	13,946				56.0			$	10,654				56.6

 

Payroll, taxes and benefits increased by $312,000, or 11.9%, to $2,930,000 for the three months ended March 31, 2011, compared with the three months ended March 31, 2010. Payroll, taxes and benefits increased by $984,000, or 20.6%, to $5,771,000 for the six months ended March 31, 2011, compared with the six months ended March 31, 2010. The increase was due to an increase in the number of employees to support our increased sales volume. As of March 31, 2011, we had 250 active employees compared with 220 at March 31, 2010.

 

 

 

Advertising expenses increased by $905,000, or 81.2%, to $2,019,000 for the three months ended March 31, 2011, compared with the three months ended March 31, 2010. For the six months ended March 31, 2011, advertising expenses increased by $2,000,000, or 104.2%, to $3,920,000, compared with the six months ended March 31, 2010. The majority of our advertising expenses are associated with the amortization of previously capitalized direct response advertising costs. The balance of our advertising expenses is 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 and six months ended March 31, 2011 and 2010 (dollars in thousands):

 

		For the three months Ended March 31,								For the six months Ended March 31,
		2011				2010				2011				2010
Advertising Expenses:
Amortization of direct-response costs		$	1,990			$	1,077			$	3,835			$	1,887
Other advertising expenses			29				37				85				33
Total Advertising Expenses		$	2,019			$	1,114			$	3,920			$	1,920

 

As of March 31, 2011, we had $15,126,000 of deferred advertising costs that will be expensed over a period between four and six years based on estimated future revenues for each cost pool, updated at each reporting period and expected to result directly from such advertising.

 

As a percentage of sales, advertising expenses increased by 4.4% and 5.5%, respectively, for the three and six months ended March 31, 2011, compared with the three and six months ended March 31, 2010. The increase in advertising expenses as a percentage of sales was primarily attributed to higher amortization expense associated with increased costs incurred over the last twelve months to place our direct response advertisements.

 

Bad debt expenses decreased by $51,000, or 5.5%, to $877,000 for the three months ended March 31, 2011, compared with the three months ended March 31, 2010. For the six months ended March 31, 2011, bad debt expenses increased by $186,000, or 11.7%, compared with the six months ended March 31, 2010. The increase in bad debt expenses for the six months ended March 31, 2011, is due to our increased sales levels, partially offset by improvements in our collection efforts during the six months ended March 31, 2011.

 

Depreciation expense increased by $67,000, or 24.8%, to $337,000 for the six months ended March 31, 2011, compared with the six months ended March 31, 2010. 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 $163,000 and $1,217,000 during the six months ended March 31, 2011 and 2010, respectively.

 

General and administrative expenses increased by $154,000, or 14.4%, to $1,224,000 for the three months ended March 31, 2011 compared with the three months ended March 31, 2010. For the six months ended March 31, 2011, general and administrative costs increased by $55,000, or 2.6%, compared with the six months ended March 31, 2010. The increase is due to increases in software costs, equipment lease payments, and compensation for the board of directors; partially offset by the reduction of amortization costs associated with debt issuance costs and office expenses. As a percentage of sales, general and administrative expenses have decreased by 1.4% and 2.5%, respectively, for the three and six months ended March 31, 2011, compared with the three and six months ended March 31, 2010.

 

Income from Operations:

 

Income from operations for the three months ended March 31, 2011, increased by $309,000, or 85.8%, to $669,000, compared with the three months ended March 31, 2010. For the six months ended March 31, 2011, income from operations increased by $206,000, or 13.6%, to $1,725,000, compared with the six months ended March 31, 2010. The increase in operating income is primarily attributed to our increased sales volumes with a reduction as a percentage of sales in payroll costs, bad debt expenses, and administrative costs; partially offset by increases in our advertising costs.

 

 

Other Income (Expense):

 

The following table shows a breakdown of other income (expense) for the three and six months ended March 31, 2011 and 2010 (dollars in thousands):

 

		For the three months ended March 31,								For the six months ended March 31,
		2011				2010				2011				2010
Other Income (Expense):
Interest Expense		$	(1	)		$	(402	)		$	(32	)		$	(819	)
Change in fair value of derivative liabilities			—				(59	)			(902	)			(5,157	)
Gain (Loss) on disposal of assets			—				(2	)			2				(2	)
Interest income			2				5				4				8
Total Other Income (Expense)		$	1			$	(458	)		$	(928	)		$	(5,970	)

 

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 six months ended March 31, 2011 and 2010, respectively, totaled $923,000 and $5,774,000.

 

Interest expense decreased by $401,000 and $784,000, respectively, for the six months ended March 31, 2011, compared with the three and six months ended March 31, 2010. The decrease in interest expense was due to reduced levels of debt during the six months ended March 31, 2011, 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.

 

We were 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 six months ended March 31, 2011 (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 March 31, 2010, $5,157,000 was recorded as a non-cash charge to earnings for the six months ended March 31, 2010.

 

 

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 six months ended March 31, 2011. 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 $690,000 for the six months ended March 31, 2011. The effective tax rate was approximately 87% of the income before income taxes of $797,000, 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 six months ended March 31, 2011.

 

The benefit from income taxes was $1,012,000 for the six months ended March 31, 2010. The effective tax rate was approximately 23% of the loss before income taxes of $4,449,000, 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 $5,157,000 of expense for the change in fair value of derivative liabilities.

 

Liquidity and Capital Resources

 

The following table summarizes our cash flows from operating, investing, and financing activities for the six months ended March 31, 2011 and 2010 (dollars in thousands):

 

		For the Six Months Ended
		March 31,
		2011				2010
Cash Flows:
Net cash used in operating activities		$	(2,069	)		$	(1,821	)
Net cash used in investing activities			(160	)			(1,768	)
Net cash provided by (used in) financing activities			(605	)			7,752
Net increase (decrease) in cash			(2,834	)			4,163	)
Cash at beginning of period			7,428				3,798
Cash at end of period		$	4,594			$	7,961

 

The Company had cash of $4,594,000 at March 31, 2011, compared with cash of $7,428,000 at September 30, 2010, a decrease of $2,834,000. The decrease in cash for the six months ended March 31, 2011, is primarily due to $2,069,000 of cash used in operating activities and payments of $598,000 on our debt obligations.

 

Operating Activities

 

During the six months ended March 31, 2011, cash used in operations was $2,069,000, which was the result of net income of $107,000 plus non-cash charges of $7,912, 000 less changes in operating assets and liabilities of $10,088,000. The non-cash charges consist primarily of $3,835,000 for amortization of deferred advertising costs, $1,769,000 for bad debt expense, $902,000 for the change in fair value of derivative liabilities, $690,000 for deferred income taxes, $337,000 for depreciation, $236,000 for equity based compensation associated with employee and director stock options, and $96,000 for increase in reserve for sales returns and adjustments. The changes in operating assets and liabilities for the six months ended March 31, 2011, consist of $8,954,000 of deferred advertising expenditures related to our direct response advertising efforts, increases for accounts receivable of $2,561,000 and inventory of $458,000 as a result of our increased sales, and a decrease of $308,000 for accrued expenses primarily related to the payment of management incentives in October 2010, partially offset by an increase in accounts payable of $2,409,000 due to increased purchases and improved vendor payment terms for our higher volume items.

 

 

During the six months ended March 31, 2010, cash used in operations was $1,821,000, which was the result of a net loss of $3,437,000 plus non-cash charges of $8,963,000 less changes in operating assets and liabilities of $7,347,000. The non-cash charges consist primarily of $5,157,000 for the change in fair value of derivative liabilities, $1,887,000 for amortization of deferred advertising costs, $1,583,000 for bad debt expense, $662,000 for non-cash interest expense related to convertible notes payable, $223,000 for equity based compensation associated with employee and director stock options, $145,000 for increase in the reserve for sales returns and adjustments, and $270,000 for depreciation; less, $982,000 for deferred income taxes. The changes in operating assets and liabilities for the six months ended March 31, 2010, consist of $4,630,000 of deferred advertising expenditures related to our direct response advertising efforts, increases for accounts receivable of $3,621,000 and inventory of $650,000 as a result of our increased sales, partially offset by an increase in accounts payable of $1,479,000 due to increased purchases.

 

Investing Activities

 

During the six months ended March 31, 2011, we purchased $163,000 of property and equipment to support our continued growth.

 

During the six months ended March 31, 2010, we purchased $1,217,000 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.

 

Financing Activities

 

During the six months ended March 31, 2011, cash used in financing activities was $605,000, which included payments of $598,000 towards our debt obligations and payment of $51,000 for costs associated with a new PNC Credit Line Facility discussed above in Note 5, partially offset by $44,000 of proceeds from our employee stock purchase plan.

 

During the six months ended March 31, 2010, cash provided by financing activities was $7,752,000, which included net proceeds of $6,618,000 from the sale of common stock to a single institutional investor, borrowings of $750,000 from our credit line facility, $530,000 of proceeds from the exercise of warrants, and $104,000 of proceeds from our employee stock purchase plan, partially offset by payments of $241,000 to pay down a portion of our outstanding debt and capital lease obligations.

 

Outlook

 

The second quarter of our fiscal year is typically a challenging quarter for us each year due to the annual renewal of our customers’ insurance coverage, primarily Medicare Part B coverage, and calendar year deductibles that must be met by the majority of our customers at the beginning of each calendar year. In spite of these challenges, we were able to increase our sales for the twelfth consecutive quarter. Our growth over the last three years has been driven by our direct response marketing campaign, primarily through television ads at remnant (discounted) rates. During the second quarter of fiscal year 2011, based on buying opportunities within the direct response advertising markets, we increased our advertising spend across all media channels. As a result of the increased advertising spend and the seasonal challenges that we encountered during the second quarter of fiscal year 2011, we have a backlog of customer leads, of which a portion of these leads will be converted into closed customer sales during the third quarter of fiscal year 2011, consistent with past quarters that have resulted in similar build-ups of customer leads.

 

 

Demand for television time slots within the direct response advertising market continues to be competitive, increasing the costs of our direct-response advertising efforts. We plan to decrease our television advertising spend from second quarter levels for the remainder of fiscal year 2011. Based on results of our advertising efforts within alternate media channels, we plan to continue those efforts and increase our spend within specific areas during fiscal year 2011. 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.

 

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 two 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.

 

As of March 31, 2011, we had $4.6 million of cash available and a credit line available to fund our operations. We believe that existing cash and the availability of funds through our credit line, if necessary, 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 March 31, 2011, our current assets of $16,494,000 exceeded our current liabilities of $7,165,000 by $9,329,000.

 

Our plan for the next twelve months includes the following:

 

	•	Continue our advertising and marketing efforts at reduced spending levels;
	•	Explore potential acquisition opportunities;
	•	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.

 

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;
	•	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;
	•	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 March 31, 2011, 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 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. Quantitative and Qualitative Disclosures 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 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 March 31, 2011. 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 March 31, 2011, 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 March  31, 2011, due to the material weakness identified as follows:

 

·

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 Reports on Form 10-Q for the first and second quarters of fiscal year 2011 and will amend its Report on Form 10-Q for the third quarter of fiscal year 2011.

 

Change in Internal Control over Financial Reporting

 

During the three months ended March 31, 2011, the Company remediated the following material weakness previously disclosed in the Company’s Annual Report for fiscal year 2010 and Interim Report for period ending December 31, 2010, filed with the SEC on Forms 10-K and 10-Q:

 

·

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 periods ending December 31, 2009, March 31, 2010, and June 30, 2010.

 

Remediation: During the second quarter of fiscal year 2011, the Company subscribed 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 supplemented its current interim 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.

 

Remediation of Material Weaknesses in Internal Control over Financial Reporting

 

In order to remediate the material weakness in internal control over financial reporting, the Company, under the direction of the Company’s Audit Committee, intends to implement improvements during the remainder of fiscal year 2011 as follows:

 

·

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.

 

·

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.

 

 

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, 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 six months ended March 31, 2011, 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

 

 

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 21, 2012
Mark A. Libratore
/s/ Robert J. Davis		Chief Financial Officer		February 21, 2012
Robert J. Davis