UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q/A

(Amendment No. 2)

(Mark One)

 

þ

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 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		87-0267292
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		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 þ 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 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 August 11, 2011
Common Stock, $.001		48,046,650

 

 

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	18
Item 3.		Quantitative and Qualitative Disclosures about Market Risk	25
Item 4.		Controls and Procedures	25
PART II — OTHER INFORMATION
Item 1.		Legal Proceedings	27
Item 1A.		Risk Factors	27
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.		Defaults Upon Senior Securities	27
Item 5.		Other Information	27
Item 6.		Exhibits	27
SIGNATURES			27
EX-31.1
EX-31.2			28
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 Reports on Form 10-Q for the interim period ended June 30, 2011, which was originally filed with the Securities and Exchange Commission (“SEC”) on August 15, 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 nine months ended June 30, 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;

 

·

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; and

 

·

Reclassified the outstanding balance on the Company’s credit line facility from current liabilities to long-term liabilities since the expiration date of the credit line facility as of June 30, 2011, was February 11, 2013.

 

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 nine months ended June 30, 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 June 30, 2011 (unaudited) and September 30, 2010

(In thousands, except dollar per share amounts)

 

		As Restated
		June 30,				September
		2011				30, 2010
Assets
Current Assets:
Cash		$	2,452			$	7,428
Accounts receivable, net of allowances of $4,111 and $3,312, respectively			8,012				6,744
Inventory, net of allowance for obsolete inventory of $137 and $110, respectively			2,612				1,985
Deferred taxes, current portion			1,749				1,696
Prepaid and other current assets			366				355
Total Current Assets			15,191				18,208
Property and equipment, net of accumulated depreciation of $1,997 and $1,527, respectively			1,708				1,862
Deferred advertising			16,841				10,006
Intangible assets, net of accumulated amortization of $12			470				—
Other assets			215				139
Total Assets		$	34,425			$	30,215
Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable		$	5,493			$	3,826
Accrued liabilities			1,145				1,077
Derivative liabilities			—				1,698
Stockholder loans			—				565
Notes payable, net of unamortized discount of $0 and $21, respectively			107				2,516
Other current liabilities			124				146
Total Current Liabilities			6,869				9,828
Deferred tax liability			2,861				1,826
Credit line facility			500				—
Other long-term liabilities			59				145
Total Liabilities			10,289				11,799
Stockholders’ Equity:
Common stock, $.001 par value, 200,000 shares authorized, 48,135 and 44,706 shares issued, respectively; 48,046 and 44,617 shares outstanding at June 30, 2011, and September 30, 2010, respectively			48				45
Additional paid-in capital			34,447				28,927
Accumulated deficit			(10,309	)			(10,506	)
Treasury stock, at cost; 89 shares at June 30, 2011, and September 30, 2010			(50	)			(50	)
Total Stockholders’ Equity			24,136				18,416
Total Liabilities and Stockholders’ Equity		$	34,425			$	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 nine months ended June 30, 2011 and 2010

(Unaudited)

(in thousands, except per share amounts)

 

		Three Months Ended June 30,								Nine Months Ended June 30,
		As Restated								As Restated
		2011				2010				2011				2010
Sales		$	13,319			$	10,619			$	38,203			$	29.428
Cost of Sales			5,237				3,677				14,450				10,312
Gross Profit			8,082				6,942				23,753				19,116
Operating Expenses
Payroll, taxes and benefits			3,072				2,569				8,843				7,357
Advertising			2,132				1,336				6,052				3,255
Bad debts			1,098				1,020				2,867				2,603
Depreciation			191				179				528				449
General and administrative			1,205				896				3,354				2,991
Total Operating Expenses			7,698				6,000				21,644				16,655
Income from Operations			384				942				2,109				2,461
Other Income (Expense)
Interest expense			(3	)			(289	)			(35	)			(1,105	)
Change in fair value of derivative liabilities			—				3,697				(902	)			(1,460	)
Gain (Loss) on disposal of assets			—				—				2				(2	)
Interest income			1				8				5				16
Total Other Income (Expense)			(2	)			3,416				(930	)			(2,551	)
Income (Loss) before Income Taxes			382				4,358				1,179				(90	)
Provision for (Benefit from) Income Taxes			292				413				982				(599	)
Net Income		$	90			$	3,945			$	197			$	509
Basic earnings per share:
Weighted average shares outstanding			48,018				41,569				47,809				36,438
Earnings per share		$	0.00			$	0.09			$	0.00			$	0.01
Diluted earnings per share:
Weighted average shares outstanding			54,175				54,797				53,751				44,809
Earnings per share		$	0.00			$	0.07			$	0.00			$	0.01

 

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 nine months ended June 30, 2011 As Restated

(Unaudited)

(in thousands)

 

										Additional												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			—				—				328				—				—				328
Common stock issued upon conversion of debt			3,333				3				5,097				—				—				5,100
Common stock issued for employee stock purchase plan			82				—				95				—				—				95
Common stock issued for cashless exercise of warrants			14				—				—				—				—				—
Net income			—				—				—				197				—				197
Balance at June 30, 2011			48,046			$	48			$	34,447			$	(10,309	)		$	(50	)		$	24,136

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

Liberator Medical Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For the nine months ended June 30, 2011 and 2010

(Unaudited)

(in thousands)

 

		Nine Months Ended June 30,
		As Restated 2011				2010
Cash flow from operating activities:
Net Income		$	197			$	509
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization			6,458				3,670
Change in fair value of derivative liabilities			902				1,460
Equity based compensation			328				303
Provision for doubtful accounts and sales returns and adjustments			3,059				2,759
Non-cash interest related to convertible notes payable			21				886
Deferred income taxes			982				(566	)
Amortization of non-cash debt issuance costs			—				23
Reserve for inventory obsolescence			28				—
Loss (Gain) on disposal of assets			(2	)			2
Changes in operating assets and liabilities:
Accounts receivable			(4,326	)			(5,420	)
Deferred advertising			(12,765	)			(7,988	)
Inventory			(622	)			(1,135	)
Other assets			(36	)			(320	)
Accounts payable			1,667				3,516
Accrued liabilities			60				(51	)
Other liabilities			(58	)			(3	)
Net Cash Flow Used in Operating Activities			(4,107	)			(2,355	)
Cash flow from investing activities:
Purchase of property and equipment and other			(306	)			(1,531	)
Acquisition of SGV Medical Supplies (see Note 4)			(466	)			—
Proceeds from the sale of assets			3				5
Purchase of certificates of deposit			—				(559	)
Net Cash Flow Used in Investing Activities			(769	)			(2,085	)
Cash flow from financing activities:
Proceeds from the sale of common stock			—				7,000
Costs associated with the sale of common stock			—				(407	)
Proceeds from the exercise of warrants			—				1,556
Proceeds from employee stock purchase plan			64				102
Proceeds from credit line facility			500				—
Costs associated with new credit line facility			(51	)			—
Purchase of treasury stock			—				(9	)
Payments of debt and capital lease obligations			(613	)			(711	)
Net Cash Flow Provided by (Used in) Financing Activities			(100	)			7,531
Net increase (decrease) in cash			(4,976	)			3,091
Cash at beginning of period			7,428				3,798
Cash at end of period		$	2,452			$	6,889
Supplemental disclosure of cash flow information:
Cash paid for interest		$	51			$	323
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			$	8,914
Promissory note issued for acquisition of SGV Medical Supplies (see Note 4)		$	107			$	—

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

Liberator Medical Holdings, Inc. and Subsidiaries

Notes To The Unaudited Condensed Consolidated Financial Statements

June 30, 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 nine months ended June 30, 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 July 2011, the Financial Accounting Standards Board (“FASB”) issued accounting guidance that requires health care entities to present the provision for bad debts related to patient service revenue as a deduction from patient service revenue in the statement of operations rather than as an operating expense. Additional disclosures relating to a company’s sources of patient revenue and its allowance for doubtful accounts related to patient accounts receivable will also be required. The guidance is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2011. Upon adoption of this guidance on October 1, 2012, we will reclassify the provision for bad debts related to prior period patient service revenue as a deduction from patient service revenue as required by this guidance. The adoption of this guidance is not expected to have a material impact on our financial condition, overall results of operations or cash flows.

 

In May 2011, the FASB issued amendments to its accounting guidance related to fair value measurements in order to more closely align its disclosure requirements with those in the International Financial Reporting Standards. This guidance clarifies the application of existing fair value measurement and disclosure requirements and also changes certain principles or requirements for measuring fair value or for disclosing information about fair value measurements. The guidance is effective for interim and annual periods beginning after December 15, 2011. The adoption of this guidance is not expected to have a material impact on our financial position or results of operations.

 

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 October 1, 2011, 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 June 30, 2011, contained errors in the valuation of inventory and cost of goods sold and the classification of the outstanding balance under the credit line facility. The Company has restated its previously issued condensed consolidated financial statements as of and for the three and nine months ended June 30, 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 $300,000 as of June 30, 2011, and cost of sales was understated by $95,000 and $300,000, respectively, for the three and nine months ended June 30, 2011; and

 

·

Partially offsetting the adjustments to inventory and cost of sales, the Company identified additional sales of $10,000 and $47,000, respectively, for the three and nine months ended June 30, 2011, that were not properly submitted to insurance carriers due to the unit of measure issues identified.

 

·

Reclassified the outstanding balance of $500,000 on the Company’s credit line facility from current liabilities to long-term liabilities since the expiration date of the credit line facility as of June 30, 2011, was February 11, 2013.

 

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 nine months ended June 30, 2011 (dollars in thousands, except per share amounts):

 

		As				Current
		Previously				Period				As
Balance Sheet Data:		Reported				Effects				Restated
Accounts receivable, net		$	7,965			$	47			$	8,012
Inventory, net			2,912				(300	)			2,612
Deferred taxes, current portion			1,775				(26	)			1,749
Current Assets			15,470				(279	)			15,191
Total Assets		$	34,704			$	(279	)		$	34,425
Credit line facility – short-term		$	500			$	(500	)		$	—
Current Liabilities			7,369				(500	)			6,869
Credit line facility – long-term			—				500				500
Deferred tax liability			3,006				(145	)			2,861
Total Liabilities			10,434				(145	)			10,289
Accumulated Deficit			(10,175	)			(134	)			(10,309	)
Total Stockholders’ Equity			24,270				(134	)			24,136
Total Liabilities and Stockholders’ Equity		$	34,704			$	(279	)		$	34,425

 

 

		For the three months ended												For the nine months ended
Statement of Operations Data:		June 30, 2011												June 30, 2011
		As				Current								As				Current
		Previously				Period				As				Previously				Period				As
		Reported				Effects				Restated				Reported				Effects				Restated
Sales		$	13,309			$	10			$	13,319			$	38,156			$	47			$	38,203
Cost of Sales			5,142				95				5,237				14,150				300				14,450
Gross Profit			8,167				(85	)			8,082				24,006				(253	)			23,753
Total Operating Expenses			7,698				—				7,698				21,644				—				21,644
Income from Operations			469				(85	)			384				2,362				(253	)			2,109
Total Other Income (Expense)			(2	)			—				(2	)			(930	)			—				(930	)
Income before Income Taxes			467				(85	)			382				1,432				(253	)			1,179
Provision for Income Taxes			329				(37	)			292				1,101				(119	)			982
Net Income		$	138			$	(48	)		$	90				331				(134	)			197
Basic Earnings per Share		$	0.00			$	(0.00	)		$	0.00				0.01				(0.01	)			0.00
Diluted Earnings per Share		$	0.00			$	(0.00	)		$	0.00				0.01				(0.01	)			0.00

 

Note 4 — Acquisition

 

On May 13, 2011, the Company entered into an Asset Purchase Agreement with Kruin Medical Products, Inc., a California corporation, which had been doing business as SGV Medical Supplies ("SGV"), and its sole shareholder. Under the Asset Purchase Agreement, the Company purchased SGV's customer list, inventory, and website (the "Purchased Assets") used in its ostomy supply business. The purchase price for the Purchased Assets was $716,000, of which the Company paid $466,000 in cash and $250,000 pursuant to a non-interest bearing promissory note due on November 13, 2011, subject to the Company's right of setoff based on the number of SGV customers that purchase ostomy supplies from the Company within six months following the acquisition date.

 

With the acquisition of SGV's ostomy supply customers, the Company was able to acquire new customers at a cost that was below the Company's advertising costs per acquired customer, which is consistent with the Company's growth strategy.

 

As of June 30, 2011, the estimated fair values of the contingent consideration, that is, the promissory note due on November 13, 2011, and the assets acquired are provisional and are based on the information that was available as of the acquisition date to estimate the fair value of the contingent consideration and of the assets acquired. The Company believes that the information provides a reasonable basis for estimating the fair values of assets and is obtaining additional information necessary to finalize those fair values. Therefore, the provisional measurements of fair value reflected are subject to change and such changes could be significant. The Company expects to finalize the valuation and complete the purchase price allocation as soon as practicable but no later than one year from the acquisition date.

 

The following table summarizes the estimated fair value of consideration paid and the preliminary allocation of purchase price to the fair value of assets acquired as of the date of the acquisition (in thousands):

 

Preliminary Purchase Price Consideration:
Cash		$	466
Promissory note, net of right of setoff			107
Total fair value of consideration		$	573
Preliminary Purchase Price Allocation:
Intangible assets (customer list)		$	482
Inventory			33
Property and equipment (website)			58
Total assets acquired		$	573

 

 

The fair value of the promissory note was calculated based on an estimate of the number of SGV customers expected to purchase ostomy supplies from the Company within six months from the date of the acquisition. The range of potential amounts due pursuant to the terms of the promissory note is between $0 and $250,000. The fair values of the customer list and the website acquired were estimated using an income approach and incorporate significant inputs not observable in the market, which are Level 3 fair value inputs. Key assumptions in the estimated valuation included: (1) a discount rate of 18.92%; (2) the number of SGV customers expected to place orders with the Company; and (3) net cash flow projections over the projected life of the assets.

 

For the nine months ended June 30, 2011, the Company recognized $271,000 of revenue and approximately $12,000 of earnings generated from customers acquired from SGV since the acquisition date. Disclosure of supplemental pro forma information for revenue and earnings related to the acquired assets, assuming the acquisition was made at the beginning of the earliest period presented, has not been disclosed since the effects of the acquisition would not have been material to the results of operation for the periods presented.

 

Note 5 — Stockholder Loans

 

The stockholder loans at September 30, 2010, in the amounts of $565,000 consisted 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 7. 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 nine months ended June 30, 2011 and 2010 was $4,000, and $81,000, respectively.

 

Note 6 — 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 nine months ended June 30, 2011 and 2010, was $0 and $18,000, 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 June 30, 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 June 30, 2011, the Company was in compliance with all applicable financial covenants pursuant to the PNC Credit Line Facility. The permitted borrowing base as of June 30, 2011, was $6,857,000. As of June 30, 2011, the Company had an outstanding principal balance of $500,000 with $6,357,000 available to borrow from the PNC Credit Line Facility.

 

Interest expense related to the PNC Credit Line Facility for the nine months ended June 30, 2011 and 2010, was $1,000 and $0, respectively.

 

Note 7 — 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 $558,000 for the nine months ended June 30, 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 $411,000 for the nine months ended June 30, 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 8 — Derivative Liabilities

 

The May 2008 and October 2008 convertible notes, discussed above in Note 7, 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 nine months ended June 30, 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 nine months ended June 30, 2011 (dollars in thousands):

 

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

 

Note 9 — Stockholders’ Equity

 

Warrants

 

A summary of warrants issued, exercised and expired during the nine months ended June 30, 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 June 30, 2011			6,965,667			$	1.12

 

 

Employee and Director Stock Options

 

The weighted-average grant date fair value of options granted during the nine months ended June 30, 2011 and 2010, was $0.40 and $0.93, respectively. There were no options exercised during the nine months ended June 30, 2011 and 2010. The fair values of stock-based awards granted during the nine months ended June 30, 2011 and 2010, were calculated with the following weighted-average assumptions:

 

		2011				2010
Risk-free interest rate:			1.05	%			1.32	%
Expected term:			3 years				3 years
Expected dividend yield:			0.00	%			0.00	%
Expected volatility:			48.91	%			68.59	%

 

For the nine months ended June 30, 2011 and 2010 the Company recorded $305,000 and $188,000, 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 June 30, 2011, there is $157,000 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 1.3 years.

 

Stock option activity for the nine months ended June 30, 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				2.58			$	792,250
Granted			500,000				1.25
Expired or forfeited			(70,000	)			1.03
Options outstanding at June 30, 2011			2,085,000			$	0.99				3.01			$	828,250
Options exercisable at June 30, 2011			1,515,000			$	0.90				2.61			$	738,750
Options vested or expected to vest at June 30, 2011			2,085,000			$	0.99				3.01			$	828,250

 

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 June 30, 2011, 274,581 shares of the Company’s common stock have been purchased through the ESPP, using $211,000 of proceeds received from employee payroll deductions. For the nine months ended June 30, 2011 and 2010, the Company received $64,000 and $102,000, 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 nine months ended June 30, 2011 and 2010, the Company recognized $23,000 and $92,000, respectively, of compensation expense related to the ESPP.

 

Note 10 — Basic and Diluted Earnings 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 nine months ended June 30, 2011 and 2010 (in thousands, except per share amounts):

 

		For the three months ended								For the nine months ended
		June 30,								June 30,
		Restated								Restated
		2011				2010				2011				2010
Numerator:
Net income  — basic		$	90			$	3,945			$	197			$	509
Effect of dilutive securities:
Convertible debt			—				31				—				—
Net income  — diluted			90				3,976				197				509
Denominator:
Weighted average shares outstanding — basic			48,018				41,569				47,809				36,438
Effect of dilutive securities:
Stock options and warrants			6,157				7,765				5,942				8,371
Convertible debt			—				5,463				—				—
Weighted average shares outstanding — diluted			54,175				54,797				53,751				44,809
Earnings per share — basic		$	0.00			$	0.09			$	0.00			$	0.01
Earnings per share — diluted		$	0.00			$	0.07			$	0.00			$	0.01

 

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 nine months ended June 30, 2011 and 2010 (in thousands):

 

		For the three months								For the nine months
		ended June 30,								ended June 30,
		2011				2010				2011				2010
Stock options			640				200				640				200
Warrants			358				358				358				233
Convertible debt			—				—				—				3,333
Totals			998				558				998				3,766

 

Note 11 — Income Taxes (Restated)

 

The provision for income taxes was $292,000 for the three months ended June 30, 2011. The effective tax rate was approximately 76% of the income before income taxes of $382,000, 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.

 

 

The provision for income taxes was $982,000 for the nine months ended June 30, 2011. The effective tax rate was approximately 83% of the income before income taxes of $1,179,000, 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 nine months ended June 30, 2011.

 

The provision for income taxes was $413,000 for the three months ended June 30, 2010. The effective tax rate was 9% of the income before income taxes of $4,358,000, which differs from the federal statutory rate of 35% due to the effect of state income taxes and certain of the Company’s income that is not taxable for income tax purposes, primarily consisting of $3,697,000 of income for the change in fair value of the derivative liabilities recorded for the three months ended June 30, 2010.

 

The benefit for income taxes was $599,000 for the nine months ended June 30, 2010. The effective tax rate was 666% of the loss before income taxes of $90,000, which differs from the federal statutory rate of 35% due to the effect of state income taxes, the reduction in valuation allowance, and certain of the Company’s expenses that are not deductible for income tax purposes, primarily consisting of $1,460,000 of expense for the change in fair value of the derivative liabilities recorded for the nine months ended June 30, 2010.

 

 

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 condensed 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 nine months ended June 30, 2011 and 2010, including percentage of sales (dollars in thousands):

 

		For the three months ended June 30,																For the nine months ended June 30,
		As Restated																As Restated
		2011								2010								2011								2010
		Amount				%				Amount				%				Amount				%				Amount				%
Sales		$	13,319				100.0			$	10,619				100.0			$	38,203				100.0			$	29,428				100.0
Cost of Sales			5,237				39.3				3,677				34.6				14,450				37.8				10,312				35.0
Gross Profit			8,082				60.7				6,942				65.4				23,753				62.2				19,116				65.0
Operating Expenses			7,698				57.8				6,000				56.5				21,644				56.7				16,655				56.6
Income from Operations			384				2.9				942				8.9				2,109				5.5				2,461				8.4
Other Income (Expense)			(2	)			0.0				3,416				32.2				(930	)			(2.4	)			(2,551	))			(8.7	)
Income (loss) before Income Taxes			382				2.9				4,358				41.0				1,179				3.1				(90	)			(0.3	)
Income Tax Expense (Benefit)			292				2.2				413				3.9				982				2.6				(599	)			(2.0	)
Net Income		$	90				0.7			$	3,945				37.2			$	197				0.5			$	509				1.7

 

Revenues:

 

Sales for the three months ended June 30, 2011, increased by $2,700,000, or 25.4%, to $13,319,000, compared with sales of $10,619,000 for the three months ended June 30, 2010. Sales for the nine months ended June 30, 2011, increased by $8,775,000, or 29.8%, to $38,203,000, compared with sales of $29,428,000 for the nine months ended June 30, 2010. The increase in sales was primarily due to our continued emphasis on our direct response advertising campaign to acquire new customers and our emphasis on customer service to retain our recurring customer base. Our direct-response advertising expenditures for the nine months ended June 30, 2011, were $12,765,000 compared with $7,988,000 for the nine months ended June 30, 2010. While our revenues have not increased proportionally to our increased advertising expenditures, we believe that the incremental costs associated with acquiring new customers through our increased advertising expenditures will be more than offset by the recurring revenues generated from the new customers acquired as a result of our advertising efforts.

 

Our increased advertising efforts do not represent an effort to target new markets or sell new products, but are a continuation of our efforts to acquire new customers in the markets we currently serve.

 

In addition to our direct response advertising efforts, on May 13, 2011, we acquired the ostomy supply customers of SGV Medical Supplies (see Note 4 of the condensed consolidated financial statements above). The customers from SGV generated $271,000 of sales from the date of acquisition to June 30, 2011.

 

Gross Profit:

 

Gross profit for the three months ended June 30, 2011, increased by $1,140,000, or 16.4%, to $8,082,000, compared with gross profit of $6,942,000 for the three months ended June 30, 2010. For the nine months ended June 30, 2011, gross profit increased by $4,637,000, or 24.3%, to $23,753,000, compared with gross profit of $19,116,000. The increase was attributed to our increased sales volume for the three and nine months ended June 30, 2011, compared with the three and nine months ended June 30, 2010.

 

As a percentage of sales, gross profit decreased by 4.7% and 2.8%, respectively, for the three and nine months ended June 30, 2011, compared with the three and nine months ended June 30, 2010. The decrease in gross profit as a percentage of sales was primarily attributed to an increase in our ostomy supply sales, which have lower gross margins than our other product lines, as a percentage of our total sales and, to a lesser extent, an increase in shipping costs for fiscal year 2011 versus fiscal year 2010.

 

Operating Expenses:

 

The following table provides a breakdown of our operating expenses for the three and nine months ended June 30, 2011 and 2010, including percentage of sales (dollars in thousands):

 

		For the three months ended June 30,																For the nine months ended June 30,
		As Restated																As Restated
		2011								2010								2011								2010
		Amount				%				Amount				%				Amount				%				Amount				%
Operating Expenses:
Payroll, taxes, & benefits		$	3,072				23.1			$	2,569				24.2			$	8,843				23.1			$	7,357				25.0
Advertising			2,132				16.0				1,336				12.6				6,052				15.9				3,255				11.1
Bad debts			1,098				8.3				1,020				9.6				2,867				7.5				2,603				8.8
Depreciation			191				1.4				179				1.7				528				1.4				449				1.5
General and administration			1,205				9.0				896				8.4				3,354				8.8				2,991				10.2
Total Operating Expenses		$	7,698				57.8			$	6,000				56.5			$	21,644				56.7			$	16,655				56.6

 

 

Payroll, taxes and benefits increased by $503,000, or 19.6%, to $3,072,000 for the three months ended June 30, 2011, compared with the three months ended June 30, 2010. Payroll, taxes and benefits increased by $1,486,000, or 20.2%, to $8,843,000 for the nine months ended June 30, 2011, compared with the nine months ended June 30, 2010. The increase was due to an increase in the number of employees to support our increased sales volume. As of June 30, 2011, we had 277 active employees compared with 213 at June 30, 2010.

 

Advertising expenses increased by $796,000, or 59.6%, to $2,132,000 for the three months ended June 30, 2011, compared with the three months ended June 30, 2010. For the nine months ended June 30, 2011, advertising expenses increased by $2,797,000, or 85.9%, to $6,052,000, compared with the nine months ended June 30, 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 nine months ended June 30, 2011 and 2010 (dollars in thousands):

 

 

		For the three months								For the nine months
		Ended June 30,								Ended June 30,
		2011				2010				2011				2010
Advertising Expenses:
Amortization of direct-response advertising costs		$	2,095			$	1,334			$	5,929			$	3,221
Other advertising expenses			37				2				123				34
Total Advertising Expenses		$	2,132			$	1,336			$	6,052			$	3,255

 

As of June 30, 2011, we had $16,841,000 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.

 

Over the last three fiscal years, as we have increased our direct response advertising efforts, our cost per acquired customer has increased proportionally to our increased advertising spend. As a result of our increased costs to acquire new customers, our advertising expense, as a percentage of sales, has increased by 3.4% and 4.8%, respectively, for the three and nine months ended June 30, 2011, compared with the three and nine months ended June 30, 2010. As stated above, we believe that the incremental costs associated with acquiring new customers through our increased advertising expenditures will be more than offset by the recurring revenues generated from the new customers acquired as a result of our advertising efforts.

 

Bad debt expenses increased by $78,000, or 7.6%, to $1,098,000 for the three months ended June 30, 2011, compared with the three months ended June 30, 2010. For the nine months ended June 30, 2011, bad debt expenses increased by $264,000, or 10.1%, compared with the nine months ended June 30, 2010. The increase in bad debt expenses for the three and nine months ended June 30, 2011, is due to our increased sales levels, partially offset by improvements in our collection efforts during the nine months ended June 30, 2011.

 

Depreciation expense increased by $12,000, or 6.7%, to $191,000 for the three months ended June 30, 2011, compared with the three months ended June 30, 2010. For the nine months ended June 30, 2011, depreciation expense increased by $79,000, or 17.6%, compared with the nine months ended June 30, 2010. The increase in depreciation expense is primarily attributed to the build out of an additional 24,000 square foot facility during the first nine 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 $306,000 and $1,324,000 during the nine months ended June 30, 2011 and 2010, respectively.

 

 

General and administrative expenses increased by $309,000, or 34.5%, to $1,205,000 for the three months ended June 30, 2011 compared with the three months ended June 30, 2010. For the nine months ended June 30, 2011, general and administrative costs increased by $363,000, or 12.1%, compared with the nine months ended June 30, 2010. The increase is due to increases in software costs, professional fees, 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.

 

Income from Operations:

 

Income from operations for the three months ended June 30, 2011, decreased by $558,000, or 59.2%, to $384,000, compared with the three months ended June 30, 2011. For the nine months ended June 30, 2011, income from operations decreased by $352,000, or 14.3%, to $2,109,000, compared with the nine months ended June 30, 2010. The decrease in operating income was due to our reduced gross profit margins as a result of our increased ostomy supply sales, our increased shipping costs, and our increased operating expenses, primarily our increased advertising expenses, during the three and nine months ended June 30, 2011.

 

Other Income (Expense):

 

The following table shows a breakdown of other income (expense) for the three and nine months ended June 30, 2011 and 2010 (dollars in thousands):

 

		For the three months								For the nine months
		ended June 30,								ended June 30
		2011				2010				2011				2010
Other Income (Expense):
Interest Expense		$	(3	)		$	(289	)		$	(35	)		$	(1,105	)
Change in fair value of derivative liabilities			—				3,697				(902	)			(1,460	)
Gain (Loss) on disposal of assets			—				—				2				(2	)
Interest income			1				8				5				16
Total Other Income (Expense)		$	(2	)		$	3,416			$	(930	)		$	(2,551	)

 

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 convertible debt that has been converted into common shares. Non-cash charges to other income (expense) for the nine months ended June 30, 2011 and 2010, respectively, totaled $923,000 and $2,300,000.

 

Interest expense decreased by $286,000 and $1,070,000, respectively, for the three and nine months ended June 30, 2011, compared with the three and nine months ended June 30, 2010. The decrease in interest expense was due to reduced levels of debt during the nine months ended June 30, 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 nine months ended June 30, 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 ending:
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 June 30, 2010, $1,460,000 was recorded as a non-cash charge to earnings for the nine months ended June 30, 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 nine months ended June 30, 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 $292,000 for the three months ended June 30, 2011. The effective tax rate was approximately 76% of the income before income taxes of $382,000, 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.

 

The provision for income taxes was $982,000 for the nine months ended June 30, 2011. The effective tax rate was approximately 83% of the income before income taxes of $1,179,000, 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 nine months ended June 30, 2011.

 

The provision for income taxes was $413,000 for the three months ended June 30, 2010. The effective tax rate was 9% of the income before income taxes of $4,358,000, which differs from the federal statutory rate of 35% due to the effect of state income taxes and certain of the Company’s income that is not taxable for income tax purposes, primarily consisting of $3,697,000 of income for the change in fair value of the derivative liabilities recorded for the three months ended June 30, 2010.

 

The benefit for income taxes was $599,000 for the nine months ended June 30, 2010. The effective tax rate was 666% of the loss before income taxes of $90,000, which differs from the federal statutory rate of 35% due to the effect of state income taxes, the reduction in valuation allowance, and certain of the Company’s expenses that are not deductible for income tax purposes, primarily consisting of $1,460,000 of expense for the change in fair value of the derivative liabilities recorded for the nine months ended June 30, 2010.

 

 

Liquidity and Capital Resources

 

The following table summarizes our cash flows from operating, investing, and financing activities for the nine months ended June 30, 2011 and 2010 (dollars in thousands):

 

		For the nine months
		ended June 30,
		2011				2010
Cash Flows:
Net cash used in operating activities		$	(4,107	)		$	(2,355	)
Net cash used in investing activities			(769	)			(2,085	)
Net cash provided by (used in) financing activities			(100	)			7,531
Net increase (decrease) in cash			(4,976	)			3,091
Cash at beginning of period			7,428				3,798
Cash at end of period		$	2,452			$	6,889

 

The Company had cash of $2,452,000 at June 30, 2011, compared with cash of $7,428,000 at September 30, 2010, a decrease of $4,976,000. The decrease in cash for the nine months ended June 30, 2011, is primarily due to $4,107,000 of cash used in operating activities, payments of $614,000 for our debt obligations, and $466,000 of cash used for the acquisition of SGV Medical Supplies.

 

Operating Activities

 

During the nine months ended June 30, 2011, cash used in operations was $4,107,000, which was the result of $12,765,000 of direct response advertising expenditures and increases of $4,948,000 for accounts receivable and inventory, partially offset by net income of $197,000, non-cash charges of $11,776,000, and an increase in accounts payable of $1,667,000.

 

During the nine months ended June 30, 2010, cash used in operations was $2,355,000, which was the result of $7,988,000 of direct response advertising expenditures and increases of $6,555,000 for accounts receivable and inventory, partially offset by net income of $509,000, non-cash charges of $8,537,000, and an increase in accounts payable of $3,516,000.

 

Investing Activities

 

During the nine months ended June 30, 2011, we used $466,000 of cash for the acquisition of SGV Medical Supplies. In addition, we purchased $306,000 of property and equipment, primarily computer equipments and software, to support our continued growth.

 

During the nine months ended June 30, 2010, we purchased $1,531,000 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 6 of the unaudited condensed consolidated financial statements.

 

Financing Activities

 

During the nine months ended June 30, 2011, cash used in financing activities was $101,000, which included payments of $614,000 towards our debt obligations and payment of $51,000 for costs associated with a new PNC Credit Line Facility discussed above in Note 6, partially offset by $500,000 of proceeds from the new credit line facility and $64,000 of proceeds from our employee stock purchase plan.

 

During the nine months ended June 30, 2010, cash provided by financing activities was $7,531,000, which included net proceeds of $6,593,000 from the sale of common stock to a single institutional investor, $1,556,000 of proceeds from the exercise of warrants, and $102,000 of proceeds from our employee stock purchase plan, partially offset by payments of $711,000 for our debt and capital lease obligations.

 

 

Outlook

 

We increased our sales for the thirteenth consecutive quarter, driven by our direct response marketing campaign, primarily through television ads at remnant (discounted) rates and "pay-per-click" ads on the Internet. During the second quarter of fiscal year 2011, based on buying opportunities within the direct response advertising markets, we increased our advertising spend across both media channels. As a result of the increased advertising spend during the second quarter, we had a backlog of customer leads at the end of the second quarter, of which a portion of these customer leads were converted into sales during the third quarter of fiscal year 2011. Consistent with past results from our advertising efforts, we expect to continue to generate sales from these customer leads during the fourth quarter of fiscal year 2011.

 

During the third quarter of fiscal year 2011, we decreased our television advertising expenditures from the previous quarter levels, which generated less customer leads from television ads. However, the decrease in our television advertising expenditures resulted in lower costs per lead. The decrease in television ad spend was partially offset by increased advertising expenditures within the Internet media channel. We also completed the acquisition of SGV's ostomy supply customers in the third quarter of fiscal year 2011. With the customer leads generated from our advertising efforts and the customers acquired through the SGV acquisition, we expect to acquire new customers at reduced levels of costs during the fourth quarter of fiscal year 2011.

 

During the nine months ended June 30, 2011, we invested in new software programs, specifically a new dialer system and contact management program, to improve our productivity and generate increased levels of sales at reduced levels of operating expenses. As of June 30, 2011, we were still in the process of implementing these new software packages, which has increased our general and administrative operating expenses over the last six months of fiscal year 2011. We expect to complete the implementation of these new systems during the next six months.

 

The outlook for demand for our products and services continues to be 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 in the last quarter of fiscal year 2011 due to our advertising campaign and the SGV acquisition. The Company does not anticipate any major changes affecting the Company for Medicare reimbursement in 2011.

 

As of June 30, 2011, we had $2.5 million of cash and $6.4 million available from our credit line facility to fund our operations. We believe that the existing cash and the availability of funds through our credit line, 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 June 30, 2011, our current assets of $15,191,000 exceeded our current liabilities of $6,869,000 by $8,322,000.

 

Our plan for the next twelve months includes the following:

 

•

Continue our advertising and marketing efforts;

 

•

Explore potential acquisition opportunities that produce customers at acquisition costs below our current advertising costs per acquired customer;

 

•

Increase our customer base;

 

•

Continue to service our current customer base and increase the retention rate;

 

•

Complete the implementation of our new dialer and contact management systems

 

•

Continue to invest in the expansion of our infrastructure; and

 

•

Increase our accounts receivable collection efforts.

 

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 June 30, 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 June 30, 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 June 30, 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 June 30, 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 three quarters of fiscal year 2011.

 

Change in Internal Control over Financial Reporting

 

During the three months ended June 30, 2011, the Company made the following changes in our internal controls over financial reporting:

 

·

Implemented a revised review and approval process to ensure that all account reconciliations and journal entries are reviewed and approved on a timely basis with supporting documentation to support the review and approval processes.

 

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 fourth quarter of fiscal year 2011 as follows:

 

·

Complete the testing and documentation of the internal controls implemented during the third quarter of fiscal year 2011 related to the reported inadequate documented review and approval of certain aspects of the accounting process.

 

·

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 nine months ended June 30, 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		March 5, 2012
Mark A. Libratore
/s/ Robert J. Davis		Chief Financial Officer		March 5, 2012
Robert J. Davis