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EX-32.2 - LIBERATOR MEDICAL HOLDINGS, INC.v218337_ex32-2.htm
EX-31.2 - LIBERATOR MEDICAL HOLDINGS, INC.v218337_ex31-2.htm
EX-32.1 - LIBERATOR MEDICAL HOLDINGS, INC.v218337_ex32-1.htm
EX-31.1 - LIBERATOR MEDICAL HOLDINGS, INC.v218337_ex31-1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q/A
(Amendment No. 1)
(Mark One)

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2010

or

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

Commission file number: 000-05663

LIBERATOR MEDICAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

NEVADA
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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o     No o

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

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company þ
 
(Do not check if a smaller reporting company)

Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o     No þ

APPLICABLE TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class
 
Outstanding as of May 5, 2010
Common Stock, $.001
 
39,198,333

 
 

 


TABLE OF CONTENTS

   
Page
Explanatory Note
3
     
PART I — FINANCIAL INFORMATION
4
     
Item 1.
Condensed Consolidated Financial Statements
4
     
 
Balance Sheets as of March 31, 2010 (unaudited) and September 30, 2009
4
     
 
Statements of Operations for the three and six months ended March 31, 2010 and 2009 (unaudited)
5
     
 
Statement of Changes in Stockholders’ Equity for the six months ended March 31, 2010 (unaudited)
6
     
 
Statements of Cash Flows for the six months ended March 31, 2010 and 2009 (unaudited)
7
     
 
Notes to Unaudited Condensed Consolidated Financial Statements
8
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
25
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
31
     
Item 4T.
Controls and Procedures
31
     
PART II — OTHER INFORMATION
34
     
Item 1.
Legal Proceedings
34
     
Item 1A.
Risk Factors
34
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
34
     
Item 3.
Defaults Upon Senior Securities
34
     
Item 4.
<Removed and Reserved>
34
     
Item 5.
Other Information
34
     
Item 6.
Exhibits
35
     
SIGNATURES
36
  EX-31.1
   
  EX-31.2
   
  EX-32.1
   
  EX-32.2
   

 
2

 

Explanatory Note – Restatement of Previously Issued Financial Statements

Liberator Medical Holdings, Inc. (the “Company”) is filing this amendment to its Quarterly Report on Form 10-Q for the interim period ended March 31, 2010, which was originally filed with the Securities and Exchange Commission (“SEC”) on May 11, 2010 (the “Original Filing”), to include restated financial statements as described in Note 3 to the condensed consolidated financial statements. The Company has restated its previously issued condensed consolidated financial statements as of and for the three and six months ended March 31, 2010, to properly account for the following:

 
·
The Company’s adoption of accounting principles related to embedded conversion features included in certain convertible notes payable issued in May and October 2008 that became effective for the Company on October 1, 2009.

 
·
The effect of a change in a valuation allowance that resulted from a change in judgment about the realizability of the related deferred tax asset in future years.

 
·
In addition, certain reclassifications related to the accounting for deferred advertising costs and deferred income taxes have been made in order to maintain consistency and comparability with our subsequent presentations in fiscal year 2010 on Forms 10-Q and 10-K.

The revisions relate to non-operating and non-cash items for the interim period ended March 31, 2010, and do not impact reported revenues, operating income, or the Company’s cash position. Please refer to Note 3 of the condensed consolidated financial statements below for a detailed analysis of the effects of the restatements on our condensed consolidated financial statements for the three and six months ended March 31, 2010.

This Form 10-Q/A amends the following items in the Company’s Original Filing:

 
·
Part I – Item 1 – Condensed Consolidated Financial Statements

 
·
Part I – Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

 
·
Part I – Item 4T – Controls and Procedures

 
·
Part II – Item 6 – Exhibits

For the convenience of the reader, this Form 10-Q/A sets forth the Quarterly Report on Form 10-Q in its entirety. Other than as described above, none of the other disclosures in the Original Filing have been amended or updated. Among other things, forward-looking statements made in the Original Filing have not been revised to reflect events that occurred or facts that became known to the Company after the filing of the Original Filing, and such forward-looking statements should be read in their historical context. Accordingly, this Form 10-Q/A should be read in conjunction with the Company’s subsequent filings to the Original Filing with the SEC.

 
3

 

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in thousands, except per share amounts)

   
As Restated
March 31,
   
September 30,
 
   
2010
   
2009
 
   
(unaudited)
       
Assets
           
Current Assets
           
Cash
  $ 7,961     $ 3,798  
Restricted cash
    1,056       500  
Accounts receivable, net of allowances of $3,232 and $2,327, respectively
    5,744       3,850  
Inventory, net of allowance for obsolete inventory of $110 and $110, respectively
    1,552       902  
Deferred taxes, current portion
    1,206        
Other current assets
    429       483  
Total Current Assets
    17,948       9,533  
Property and Equipment, net of accumulated depreciation of $1,207 and $1,021, respectively
    1,982       1,041  
Deferred advertising
    6,499       3,755  
Deposits and other
    201       130  
Total Assets
  $ 26,630     $ 14,459  
                 
Liabilities and Stockholders’ Equity
               
Current Liabilities
               
Accounts payable
  $ 3,569     $ 2,089  
Accrued liabilities
    907       716  
Credit line facility
    750        
Stockholder loans
    1,315       1,515  
Convertible notes payable, net of unamortized discount of $361 and $292, respectively
    5,787       3,893  
Derivative liabilities
    10,977        
Capital lease obligations, current portion
    73       80  
Deferred rent liability, current portion
    46       60  
Total Current Liabilities
    23,424       8,353  
Convertible notes payable, net of unamortized discount of $0 and $90, respectively
          2,447  
Capital lease obligations, net of current portion
    37       70  
Deferred rent liability, net of current portion
    176       165  
Deferred tax liability
    223        
Total Liabilities
    23,860       11,035  
                 
Stockholders’ Equity
               
Common stock, $.001 par value, 200,000 shares authorized; 39,118 and 32,462 shares issued, respectively; 39,029 and 32,377 shares outstanding at March 31, 2010 and September 30, 2009, respectively
    39       32  
Additional paid-in capital
    19,324       11,705  
Accumulated deficit
    (16,543 )     (8,272 )
      2,820       3,465  
Less: Treasury stock, at cost; 89 and 85 shares at March 31, 2010 and September 30, 2009, respectively
    (50 )     (41 )
Total Stockholders’ Equity
    2,770       3,424  
Total Liabilities and Stockholders’ Equity
  $ 26,630     $ 14,459  

See accompanying notes to unaudited condensed consolidated financial statements.

 
4

 

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

   
Three Months Ended March 31,
   
Six Months Ended March 31,
 
   
As Restated
2010
   
2009
   
As Restated
2010
   
2009
 
Sales
  $ 9,650     $ 5,827     $ 18,808     $ 11,169  
                                 
Cost of Sales
    3,386       2,078       6,633       3,919  
                                 
Gross Profit
    6,264       3,749       12,175       7,250  
                                 
Operating Expenses
                               
Payroll, taxes and benefits
    2,618       1,274       4,787       2,339  
Advertising
    1,114       459       1,920       757  
Bad debts
    928       809       1,583       1,488  
Depreciation
    174       67       270       134  
General and administrative
    1,070       778       2,094       1,660  
Total Operating Expenses
    5,904       3,387       10,654       6,378  
                                 
Income from Operations
    360       362       1,521       872  
                                 
Other Income (Expense)
                               
Interest Expense
    (402 )     (273 )     (819 )     (545 )
Change in fair value of derivative liabilities
    (59 )           (5,157 )      
Loss on disposal of assets
    (2 )           (2 )      
Interest Income
    5       6       8       14  
Total Other Income (Expense)
    (458 )     (267 )     (5,970 )     (531 )
                                 
Income (Loss) before Income Taxes
    (98 )     95       (4,449 )     341  
                                 
Benefit from Income Taxes
    (6 )           (1,012 )      
                                 
Net Income (Loss)
  $ (92 )   $ 95     $ (3,437 )   $ 341  
                                 
Basic earnings (loss) per share:
                               
Weighted average shares outstanding
    34,921       32,021       33,873       32,035  
Earnings (loss) per share
  $ 0.00     $ 0.00     $ (0.10 )   $ 0.01  
                                 
Diluted earnings (loss) per share:
                               
Weighted average shares outstanding
    34,921       35,941       33,873       35,955  
Earnings (loss) per share
  $ 0.00     $ 0.00     $ (0.10 )   $ 0.01  

See accompanying notes to unaudited condensed consolidated financial statements.

 
5

 

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

                                 
Total
 
   
Common
   
Common
   
Paid in
   
Accumulated
   
Treasury
   
Stockholders’
 
   
Shares
   
Stock
   
Capital
   
Deficit
   
Stock
   
Equity
 
Balance at September 30, 2009
    32,377     $ 32     $ 11,705     $ (8,272 )   $ (41 )   $ 3,424  
                                                 
Cumulative effect of change in accounting principle
                    (390 )     (4,834 )             (5,224 )
Options issued to employees
                    208                       208  
Common stock issued for interest on convertible debt
    19             45                       45  
Common stock issued upon conversion of debt
    1,086       1       542                       543  
Common stock issued for exercise of warrants
    723       1       529                       530  
Common stock issued for employee stock purchase plan
    162             72                       72  
Common stock issued for cash, net of issuance costs
    4,666       5       6,613                       6,618  
Purchase common treasury stock
    (4 )                             (9 )     (9 )
Net loss
                            (3,437 )             (3,437 )
                                                 
Balance at March 31, 2010
    39,029     $ 39     $ 19,324     $ (16,543 )   $ (50 )   $ 2,770  

See accompanying notes to unaudited condensed consolidated financial statements.

 
6

 

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
For the six months ended March 31, 2010 and 2009
(Unaudited)
(in thousands)
   
Restated
2010
   
2009
 
Cash flow from operating activities:
           
Net Income (Loss)
  $ (3,437 )   $ 341  
Adjustments to reconcile net income (loss) to net cash used in operating activities:
               
Depreciation and amortization
    2,156       838  
Change in fair value of derivative liabilities
    5,157        
Equity based compensation
    223       272  
Provision for doubtful accounts and sales returns and adjustments
    1,728       1,488  
Non-cash interest related to convertible notes payable
    662       322  
Deferred income taxes
    (982 )      
Amortization of non-cash debt issuance costs
    17       20  
Loss on disposal of assets
    2        
Changes in operating assets and liabilities:
               
Accounts receivable
    (3,621 )     (2,483 )
Deferred advertising
    (4,630 )     (1,918 )
Inventory
    (650 )     (181 )
Other assets
    (50 )     174  
Accounts payable
    1,479       929  
Accrued expenses
    128       140  
Deferred rent
    (3 )     (24 )
Net Cash Flow Used in Operating Activities
    (1,821 )     (82 )
                 
Cash flow from investing activities:
               
Purchase of property and equipment
    (1,217 )     (224 )
Proceeds from the sale of assets
    5        
Purchase of certificates of deposit
    (556 )      
Net Cash Flow Used in Investing Activities
    (1,768 )     (224 )
                 
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 issuance of convertible notes
          2,500  
Costs associated with issuance of convertible notes
          (326 )
Proceeds from the exercise of warrants
    530        
Proceeds from employee stock purchase plan
    104        
Proceeds from credit line facility
    750        
Purchase of treasury stock
    (9 )     (29 )
Payments of debt and capital lease obligations
    (241 )     (67 )
Net Cash Flow Provided by Financing Activities
    7,752       2,078  
                 
Net increase in cash
    4,163       1,772  
                 
Cash at beginning of period
    3,798       1,173  
Cash at end of period
  $ 7,961     $ 2,945  
                 
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $ 185     $ 179  
Cash paid for income taxes
  $ 20     $  
                 
Supplemental schedule of non-cash investing and financing activities:
               
Capital expenditures funded by capital lease borrowings
  $     $ 48  
Common stock issued for interest expense
  $ 45     $  
Common stock issued for conversion of debt
  $ 543     $  

See accompanying notes to unaudited condensed consolidated financial statements.

 
7

 

Liberator Medical Holdings, Inc. and Subsidiaries
Notes To The Unaudited Condensed Consolidated Financial Statements
March 31, 2010

Note 1 — Basis of Presentation (Restated)

The accompanying unaudited condensed consolidated financial statements of Liberator Medical Holdings, Inc. (the “Company”) and the notes thereto have been prepared in accordance with instructions for Form 10-Q and Article 8 of Regulation S-X of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. However, in the opinion of the Company, such information includes all adjustments (consisting only of normal recurring adjustments) which are necessary for a fair presentation of the financial position and results of operations for the interim periods presented. The unaudited condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and the notes thereto that are included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2009, that was filed with the SEC on December 17, 2009. The results of operations for the three and six months ended March 31, 2010, are not necessarily indicative of the results to be expected for the full year.

The unaudited condensed consolidated financial statements include the accounts of the Company, Liberator Medical Supply, Inc., Liberator Health and Education, Inc., and Liberator Health and Wellness, Inc., its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation.

Certain reclassifications of amounts previously reported have been made to the accompanying condensed consolidated financial statements in order to maintain consistency and comparability between the periods presented. The following reclassification was made to the fiscal year 2009 financial statements to be consistent with the fiscal year 2010 financial statements presented:

 
·
On the Consolidated Balance Sheet as of September 30, 2009, $2,016,000 of Deferred Advertising was reclassified from Current Assets to Non-current Assets in order to be consistent with accounting guidance issued for deferred advertising costs.

Note 2 — Summary of Significant Accounting Policies (Restated)

The significant accounting policies followed by the Company for interim reporting are consistent with those included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2009, except for the accounting policy related to Derivative Financial Instruments discussed below.

Derivative Financial Instruments

We do not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks. However, we have entered into certain other financial instruments and contracts with embedded conversion features on convertible debt instruments that must be separated from the host instrument and are not afforded equity classification. These instruments are required to be carried as derivative liabilities, at fair value, in our condensed consolidated financial statements.

Derivative financial instruments consist of financial instruments or other contracts that contain a notional amount and one or more underlying variables (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as assets or liabilities. The changes in fair values at each reporting period, or interim period, are recorded as a charge or a benefit to earnings included in the Other Income (Expense) section of the Company’s Condensed Consolidated Statement of Operations.
 
 
8

 

We estimate fair values of derivative financial instruments using various techniques that are considered to be consistent with the objective measurement of fair values. In selecting the appropriate technique, we consider, among other factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques are highly volatile and sensitive to changes in the trading market price of our common stock. Since derivative financial instruments are initially and subsequently carried at fair values, our income or loss will reflect the volatility in changes to these estimates and assumptions.

Recently Adopted Accounting Standards

ASC 815-40-15, “Derivatives and Hedging - Contracts in Entity's Own Equity (Scope and Scope Exceptions)" (“ASC 815-40-15”)

On October 1, 2009, we adopted ASC 815-40-15, which requires that we apply a two-step approach in evaluating whether an equity-linked financial instrument (or embedded feature) is indexed to our own stock, including evaluating the instrument's contingent exercise and settlement provisions. Upon adoption of ASC 815-40-15 on October 1, 2009, we reclassified $5,820,000 from stockholders’ equity to derivative liabilities. Additionally, the fair value of the derivative liabilities are adjusted to fair market value at the end of each reporting period (See Notes 4 and 9 below).

ASU No. 2009-17, “Consolidations (Topic 810) — Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.” (“ASU 2009-17”)

ASU 2009-17 amends prior guidance to change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. ASU 2009-17 requires additional disclosures about the reporting entity’s involvement with variable-interest entities and any significant changes in risk exposure due to that involvement as well as its affect on the entity’s financial statements. The provisions of ASU 2009-17 became effective on January 1, 2010 and did not have a significant impact on the Company’s consolidated financial statements.

ASU No. 2010-06, “Fair Value Measurements and Disclosures — Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”)

ASU 2010-06 amends ASC Subtopic 820-10, “Fair Value Measurements and Disclosures — Overall”, and requires reporting entities to disclose (1) the amount of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers, and (2) separate information about purchases, sales, issuance and settlements in the reconciliation of fair value measurements using significant unobservable inputs (Level 3). ASU 2010-06 also requires reporting entities to provide fair value measurement disclosures for each class of assets and liabilities and disclose the inputs and valuation techniques for fair value measurements that fall within Levels 2 and 3 of the fair value hierarchy. These disclosures and clarification are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuance, 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 provisions of ASU 2010-06 became effective on January 1, 2010 and did not have a significant impact on the Company’s consolidated financial statements.

ASU No. 2010-09, “Subsequent Events — Amendments to Certain Recognition and Disclosure Requirements” (“ASU 2010-09”)

ASU 2010-09 amends ASC Subtopic 855-10, “Subsequent Events — Overall” (“ASC 855-10”) and requires an SEC filer to evaluate subsequent events through the date that the financial statements are issued but removed the requirement to disclose this date in the notes to the entity’s financial statements. The amendments are effective upon issuance of the final update and accordingly, the Company has adopted the provisions of ASU 2010-09 during the quarter ended March 31, 2010. The adoption of these provisions did not have a significant impact on the Company’s consolidated financial statements.

 
9

 

ASU No. 2009-16, “Transfers and Servicing (Topic 860) — Accounting for Transfers of Financial Assets.” (“ASU 2009-16”)

ASU 2009-16 amends prior accounting guidance to enhance reporting about transfers of financial assets, including securitizations, and where companies have continuing exposure to the risks related to transferred financial assets. ASU 2009-16 eliminates the concept of a “qualifying special-purpose entity” and changes the requirements for derecognizing financial assets. ASU 2009-16 also requires additional disclosures about all continuing involvements with transferred financial assets including information about gains and losses resulting from transfers during the period. The provisions of ASU 2009-16 became effective on January 1, 2010 and did not have a significant impact on the Company’s consolidated financial statements.

Recent Accounting Standards

ASU No. 2009-13, “Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements (A Consensus of the FASB Emerging Issues Task Force)” (“ASU 2009-13”)

ASU 2009-13 requires the use of the relative selling price method when allocating revenue in these types of arrangements. This method allows a vendor to use its best estimate of selling price if neither vendor specific objective evidence nor third party evidence of selling price exists when evaluating multiple deliverable arrangements. This standard update is effective January 1, 2011 and may be adopted prospectively for revenue arrangements entered into or materially modified after the date of adoption or retrospectively for all revenue arrangements for all periods presented. The Company does not expect that this standard update will have a significant impact on its consolidated financial statements.

ASU No. 2009-14, “Software (Topic 985) — Certain Revenue Arrangements That Include Software Elements (A Consensus of the FASB Emerging Issues Task Force)” (“ASU 2009-14”)

ASU 2009-14 requires tangible products that contain software and non-software elements that work together to deliver the products essential functionality to be evaluated under the accounting standard regarding multiple deliverable arrangements. This standard update is effective January 1, 2011 and may be adopted prospectively for revenue arrangements entered into or materially modified after the date of adoption or retrospectively for all revenue arrangements for all periods presented. The Company does not expect that this standard update will have a significant impact on its consolidated financial statements.

ASU No. 2010-11, “Derivatives and Hedging (Topic 815) — Scope Exception Related to Embedded Credit Derivatives.” (“ASU 2010-11”)

ASU 2010-11 clarifies that the only form of an embedded credit derivative that is exempt from embedded derivative bifurcation requirements are those that relate to the subordination of one financial instrument to another. As a result, entities that have contracts containing an embedded credit derivative feature in a form other than such subordination may need to separately account for the embedded credit derivative feature. The provisions of ASU 2010-11 will be effective on July 1, 2010 and are not expected to have a significant impact on the Company’s consolidated financial statements.

ASU 2010-13, “Compensation — Stock Compensation (Topic 718) — Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades.” (“ASU 2010-13”)

ASU 2010-13 provides amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in ASU 2010-13 are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010 and are not expected to have a significant impact on the Company’s consolidated financial statements.

 
10

 

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

On December 9, 2010, the Company concluded that the Company’s previously issued unaudited financial statements as of and for the interim period ended March 31, 2010, contained errors in the application of certain generally accepted accounting principles. The Company has restated its previously issued condensed consolidated financial statements as of and for the three and six months ended March 31, 2010, to properly account for the following:

·
Previously, the Company had concluded that embedded anti-dilution provisions included in certain convertible notes payable issued in May and October 2008 were indexed to the Company’s own stock under accounting principles that became effective for the Company on October 1, 2009, and did not change the accounting treatment for the embedded conversion features when the guidance became effective for the Company on October 1, 2009. However, after re-evaluating the accounting principles issued and our accounting treatment for the embedded conversion features, the Company concluded that an error was made in the application of the accounting principles, that the embedded anti-dilution provisions are not indexed to the Company’s own stock, and, therefore, they are embedded derivative financial liabilities (the “Embedded Derivatives”) that require bifurcation and separate accounting. Accordingly, the Company should have recorded a cumulative effect adjustment to the opening balance of paid in capital and accumulated deficit on October 1, 2009. In addition, the Company is required to adjust the Embedded Derivatives to fair value at each balance sheet date, or interim period, and recognize the changes in fair value as a non-cash charge or benefit to earnings, recorded as a component of other income (expense) in the Company’s condensed consolidated statement of operations.

·
Previously, the Company included a change in the valuation allowance as an adjustment to the estimated annual tax rate used in the calculation of interim period deferred taxes, which allocated the tax benefits proportionately throughout the four quarters of fiscal year 2010. Based on a re-evaluation of generally accepted accounting principles, the Company recorded the effect of the change in the valuation allowance as a discrete event, which resulted in an additional $956,000 in tax benefits during the six months ended March 31, 2010.

·
In addition, certain reclassifications related to the accounting for deferred advertising costs and deferred income taxes have been made in order to maintain consistency and comparability with our subsequent presentations in fiscal year 2010 on Forms 10-Q and 10-K. The Company had reflected both a current and long term portion of the deferred advertising assets on the condensed consolidated balance sheet as of March 31, 2010. In accordance with an SEC interpretation (SPCH.T.1995.22.Glynn), the SEC would object to the classification of any unamortized cost of advertising as a current asset. As a result, the Company reclassified the amount previously recorded as current assets to non-current assets. Also, the Company had reported its non-current deferred tax assets and deferred tax liabilities separately on the condensed consolidated balance sheet as of March 31, 2010. The Company has consolidated the non-current portion of the deferred tax assets and the deferred tax liabilities and reported the non-current portion of the deferred taxes as a consolidated deferred tax liability in accordance with generally accepted accounting principles.
 
 
11

 
 
The following tables provide a summary of the amounts restated as of and for the three and six months ended March 31, 2010 (dollars in thousands, except per share amounts):

Balance Sheet Data:
 
As
Previously
Reported
   
Reclassifications
   
Cumulative
Effect
Adjustment
as of
10/1/2009
   
Current
Period
Effect
   
As
Restated
 
                               
Deferred advertising, current portion
    3,499       (3,499 )                  
Deferred taxes, current portion
    555                   651       1,206  
Total Current Assets
    20,796       (3,499 )           651       17,948  
Deferred advertising
    3,000       3,499                   6,499  
Deferred taxes, net of current
    545       (545 )                  
Total Assets
    26,524       (545 )           651       26,630  
                                         
Notes Payable, net
  $ 6,037           $ (596 )   $ 346     $ 5,787  
Derivative liabilities
                5,820       5,157       10,977  
Total Current Liabilities
    12,697             5,224       5,503       23,424  
Deferred tax liability
    1,495       545             (1,817 )     223  
Total Liabilities
    14,405       545       5,224       3,686       23,860  
                                         
Additional Paid in Capital
    19,291             (390 )     423       19,324  
Accumulated Deficit
    (7,161 )           (4,834 )     (4,548 )     (16,543 )
Total Equity (Deficit)
  $ 12,119           $ (5,224 )   $ (4,125 )   $ 2,770  

   
For the three months ended
 March 31, 2010
   
For the six months ended
March 31, 2010
 
Statement of Operations Data:
 
As
Previously
Reported
   
Current
Period
Effect
   
As
Restated
   
As
Previously
Reported
   
Current
Period
Effect
   
As
Restated
 
                                     
Other Income (Expense):
                                   
Interest Expense
    (229 )     (173 )     (402 )     (472 )     (347 )     (819 )
Change in fair value of derivative liabilities
          (59 )     (59 )           (5,157 )     (5,157 )
Total Other Income (Expense)
    (226 )     (232 )     (458 )     (466 )     (5,504 )     (5,970 )
                                                 
Provision for (Benefit from) Income Taxes
    (122 )     116       (6 )     (56 )     (956 )     (1,012 )
Net Income (Loss)
  $ 256     $ (348 )   $ (92 )   $ 1,111     $ (4,548 )   $ (3,437 )
                                                 
Basic Earnings (Loss) per Share
  $ 0.01     $ (0.01 )   $ (0.00 )   $ 0.03     $ (0.13 )   $ (0.10 )
Diluted Earnings (Loss) per Share
  $ 0.01     $ (0.01 )   $ (0.00 )   $ 0.02     $ (0.12 )   $ (0.10 )

Note 4 - Fair Value Measurements (Restated)

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. Inputs may be observable or unobservable. Observable inputs are based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s own assumptions based on the best information available in the circumstances. The fair value hierarchy prioritizes the inputs used to measure fair value into three broad levels. The three levels of the fair value hierarchy are defined as follows:
 
Level 1
Inputs are quoted prices in active markets for identical assets or liabilities as of the reporting date.
     
Level 2
Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, as of the reporting date.
     
Level 3
Unobservable inputs for the asset or liability that reflect management’s own assumptions about the assumptions that market participants would use in pricing the asset or liability as of the reporting date.
 
 
12

 

The summary of fair values of financial instruments as of March 31, 2010 (dollars in thousands):

March 31, 2010
Instrument
 
Fair Value
   
Carrying Value
   
Level
 
Valuation Methodology
Derivative liabilities (See Note 9 below)
  $ 10,977     $ 10,977       3  
Monte Carlo
Simulation model
 
The Company engaged an independent third party valuation expert to calculate the fair values of the embedded derivative liabilities. Please refer to Note 9 for disclosure of assumptions used to calculate the fair value of the derivative liabilities.

The following represents a reconciliation of the changes in fair value of financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended March 31, 2010 (dollars in thousands):
 
   
2010
 
Beginning balance: Derivative liabilities
  $  
Adoption of change in accounting principle
    5,820  
Total loss on change in derivative liabilities
    5,157  
Purchases, sales, issuances and settlements, net
     
Ending balance: Derivative liabilities
  $ 10,977  

Note 5 — Property and Equipment

A summary of property and equipment at March 31, 2010 and September 30, 2009 is as follows (in thousands):

 
Estimated
 
March 31,
   
September 30,
 
 
Life
 
2010
   
2009
 
Leased equipment
5 years
  $ 582     $ 582  
Transportation equipment
3 years
    72       95  
Warehouse equipment
5 years
    64       56  
Office furniture
5 years
    450       150  
Computer equipment
3 years
    204       87  
Telephone equipment
5 years
    77       33  
Rental equipment
7 years
    18       18  
Web Site
3 years
    6       6  
Software
3 years
    222       130  
Training guides
3 years
    3       3  
Leasehold improvements
5 years
    1,470       889  
Signage
3 years
    21       13  
Total property and equipment
      3,189       2,062  
Less: accumulated depreciation
      (1,207 )     (1,021 )
Property and equipment, net
    $ 1,982     $ 1,041  

The amounts charged to operations for depreciation for the six months ended March 31, 2010 and 2009 were $270,000 and $134,000, respectively.

Note 6 — Stockholder Loan

The stockholder loans at March 31, 2010, and September 30, 2009, in the amounts of $1,315,000 and $1,515,000, respectively, consist of various 8% and 11% notes payable to the President and principal stockholder of the Company, Mark Libratore. The notes payable are non-collateralized and due on demand. However, the notes are subordinated to the senior, unsecured, convertible notes payable discussed below in Note 8. During the six months ended March 31, 2010, $200,000 of principal was repaid to Mr. Libratore. As of March 31, 2010, an additional $150,000 has been authorized by the senior note holders, but not paid to Mr. Libratore. Interest expense related to the stockholder loan for the six months ended March 31, 2010 and 2009 was $60,000, and $77,000, respectively.
 
Note 7 — Credit Line Facility
 
13

 
 
On September 4, 2009, the Company entered into a one-year Business Loan Agreement, Promissory Note and Assignment of Deposit (collectively, the “Credit Line Facility”) with a lender. Pursuant to the Credit Line Facility, the lender agreed to advance the Company a maximum of Five Hundred Thousand Dollars ($500,000) secured by the Company’s $500,000 certificate of deposit held by the lender. Interest is payable on any advance under the Credit Line Facility at a rate of 1.000 percentage point under the corporate loan base rate index published by the Wall Street Journal, with a minimum interest rate of 4.750% per annum.

On November 2, 2009, the Company entered into a revised Credit Line Facility with the same lender discussed above. Under the revised loan agreement, the lender agreed to advance the Company a maximum of One Million Dollars ($1,000,000) secured by the Company’s existing $500,000 certificate of deposit held by the lender plus an additional $550,000 certificate of deposit to be held by the lender. The revised Credit Line Facility expires on September 8, 2010. All other terms of the September 4, 2009 Credit Line Facility remain unchanged.

As of March 31, 2010, the Company had an outstanding balance of $750,000 under the Credit Line Facility. Interest expense related to the credit line for the six months ended March 31, 2010, was $11,000.

Note 8 — Convertible Notes Payable (Restated)

April 2008 Convertible Notes

On April 11, 2008, the Company closed a private placement consisting of convertible notes and warrants for $804,000, of which $598,000 were cash proceeds and $206,000 were prior year debt exchanged for the convertible notes. The notes are convertible into shares of our common stock at an initial conversion price of $0.50 per share, subject to adjustment, and mature one year after issuance. The notes are senior unsecured obligations of our Company and accrue interest at an annual rate of twelve percent (12%) per annum, payable at maturity. The warrants have a term of five years and are exercisable from the date of their issuance until their expiration at a price of $1.00 per share. In addition, we issued a warrant to the placement agent exercisable for up to 51,000 shares of our common stock on terms substantially similar to the warrant issued in connection with the note described above. As of March 31, 2010, $653,000 of the notes has been converted into 1,306,000 shares of the Company’s common stock and $93,000 of the notes has been redeemed for cash. During fiscal year 2009, the maturity dates for the remaining $58,000 of notes were extended for one year from the original date of maturity. The maturity dates and amounts for the outstanding notes as of March 31, 2010, are as follows (in thousands):

   
Amount Due
 
April 2010
    58  
Total April 2008 Convertible Notes Due
  $ 58  

Interest expense related to the April 2008 convertible notes was $22,000 and $46,000 for the six months ended March 31, 2010 and 2009, respectively.

May 2008 Convertible Note

On May 22, 2008, the Company closed a private placement consisting of a convertible note and a warrant for gross proceeds of $3,500,000. The note is convertible into shares of our common stock at an initial conversion price of $0.80 per share, subject to adjustment, and matures on May 22, 2010. The note is a senior unsecured obligation of ours and accrues interest at the rate of 3% per annum, paid semi-annually on each November 15 and May 15. The note is unconditionally guaranteed by Liberator Medical Supply and Liberator Health and Education Services, Inc. The conversion price of the note will be reduced if, among other things, we issue shares of common stock or securities exercisable, exchangeable or convertible for or into shares of common stock (“common stock equivalents”) at a price per share less than both the conversion price then in effect and $0.75, subject to certain exclusions. The Company has concluded that the adjustment feature for the conversion price of the note is not indexed to the Company’s own stock and, therefore, is an embedded derivative financial liability that requires bifurcation and separate accounting. The warrants have a term of 5 years and are exercisable for up to 4,375,000 shares of our common stock at an exercise price of $1.00 per share. The exercise price of the warrants will be reduced if, among other things, we issue shares of our common stock or common stock equivalents at a price per share less than both the exercise price then in effect and the closing sale price of our common stock for any of the 10 consecutive trading days immediately preceding such issuance, subject to certain exclusions. The Company has concluded that the adjustment feature for the exercise price of the warrants is indexed to the Company’s own stock, and, accordingly, has classified the warrants as equity instruments. In addition, we issued a warrant to the placement agent exercisable for up to 350,000 shares of our common stock on terms substantially similar to the warrant issued in connection with the note described above.

 
14

 

As a result of the cumulative effect adjustment recorded for the Embedded Derivatives, described above in Note 3, the net discounts on the May 2008 note increased by $201,000. Due to the increased discounts on the note, an additional $157,000 was recorded as non-cash interest expense for the six months ended March 31, 2010.

Interest expense related to the May 2008 convertible note was $437,000 and $281,000 for the six months ended March 31, 2010 and 2009, respectively.

October 2008 Convertible Note

On October 17, 2008, the Company closed a private placement consisting of a convertible note and a warrant for gross proceeds of $2,500,000. The note is convertible into shares of our common stock at an initial conversion price of $0.75 per share, subject to adjustment, and matures on October 17, 2010. The note is a senior unsecured obligation of ours and accrues interest at the rate of 3% per annum, paid semi-annually on each October 15 and April 15. The note is unconditionally guaranteed by Liberator Medical Supply and Liberator Health and Education Services, Inc. The conversion price of the note will be reduced if, among other things, we issue shares of common stock or securities exercisable, exchangeable or convertible for or into shares of common stock (“common stock equivalents”) at a price per share less than both the conversion price then in effect and $0.75, subject to certain exclusions. The Company has concluded that the adjustment feature for the conversion price of the note is not indexed to the Company’s own stock and, therefore, is an embedded derivative financial liability that requires bifurcation and separate accounting. The warrants have a term of 3 years and are exercisable for up to 1,166,667 shares of our common stock at an exercise price $1.25 per share. The exercise price of the warrants will be reduced if, among other things, we issue shares of our common stock or common stock equivalents at a price per share less than both the exercise price then in effect and the closing sale price of our common stock for any of the 10 consecutive trading days immediately preceding such issuance, subject to certain exclusions. The Company has concluded that the adjustment feature for the exercise price of the warrants is indexed to the Company’s own stock, and, accordingly, has classified the warrants as equity instruments. In addition, we issued a warrant to the placement agent exercisable for up to 266,667 shares of our common stock on terms substantially similar to the warrants issued in connection with the note described above.

As a result of the cumulative effect adjustment recorded for the Embedded Derivatives, described above in Note 3, the net discounts on the October 2008 note increased by $395,000. Due to the increased discounts on the note, an additional $190,000 was recorded as non-cash interest expense for the six months ended March 31, 2010.

Interest expense related to the October 2008 convertible note was $276,000 and $73,000 for the six months ended March 31, 2010 and 2009, respectively.

In October 2009, the Company entered into a Waiver Agreement with the holder of the October 2008 convertible note discussed above. As part of the Waiver Agreement, the note holder agreed to accept 18,101 shares of the Company’s common stock, with a fair market value of $45,000, in lieu of the Company’s obligation to pay cash in the amount of $38,000 for an interest payments that was due October 15, 2009, under the original terms of the note. As a result of this transaction, the Company incurred an additional $7,000 of interest expense that would not have been incurred if the Company had paid the interest due in cash. The rights and obligations of the note holder and the Company with respect to any future interest payments and the other terms of the note are in all other respects unchanged.
 
 
15

 


Short-term convertible notes payable consist of the following as of March 31, 2010 (in thousands):

   
April’08 Notes
   
May’08 Note
   
Oct’08 Note
   
Totals
 
Notes Payable, face amount
  $ 58     $ 3,500     $ 2,500     $ 6,058  
Discounts on Notes:
                               
Initial valuation of Warrants
    (126 )     (610 )     (86 )     (822 )
Initial valuation of Embedded Derivative
          (930 )     (841 )     (1,771 )
Accumulated Amortization
    126       1,432       674       2,232  
Total Discounts
          (108 )     (253 )     (361 )
Accrued Interest
    10       43       37       90  
Convertible Notes Payable, net
  $ 68     $ 3,435     $ 2,284     $ 5,787  

Short-term convertible notes payable consist of the following as of September 30, 2009 (in thousands):

   
April’08 Notes
   
May’08 Note
   
Totals
 
Notes Payable, face amount
  $ 601     $ 3,500     $ 4,101  
Discounts on Notes:
                       
Initial valuation of Warrants
    (126 )     (610 )     (736 )
Initial valuation of Beneficial Conversion Option
          (303 )     (303 )
Accumulated Amortization
    126       621       747  
Total Discounts
          (292 )     (292 )
Accrued Interest
    40       44       84  
Convertible Notes Payable, net
  $ 641     $ 3,252     $ 3,893  

Long-term Convertible notes payable consist of the following at September 30, 2009 (in thousands):

   
Oct’08 Note
 
Notes Payable, face amount
  $ 2,500  
Discounts on Notes:
       
Initial valuation of Warrants
    (86 )
Initial valuation of Beneficial Conversion Option
    (86 )
Accumulated Amortization
    82  
Total Discounts
    (90 )
Accrued Interest
    37  
Convertible Notes Payable, net
  $ 2,447  

NOTE 9 — Derivative Liabilities (Restated)

The May 2008 and October 2008 convertible notes, discussed above in Note 8, contain embedded adjustment features whereby the conversion price will be adjusted if the Company issues additional shares of common stock or securities exercisable, exchangeable, or convertible into shares of common stock at a price per share less than both the conversion price then in effect and $0.75. Based on accounting principles, discussed above in Note 2, that became effective for the Company on October 1, 2009, the embedded adjustment features are not indexed to the Company’s own stock and, therefore, are embedded derivative financial liabilities (the “Embedded Derivatives”) that require bifurcation and separate accounting. Accordingly, the Company recorded a cumulative effect adjustment to the opening balance of paid in capital and accumulated deficit on October 1, 2009. The cumulative effect adjustment is the difference between the amounts recognized in the balance sheet for the conversion options of the notes payable before initial application of ASC 815-40-15 and the fair values of the Embedded Derivatives at initial application of ASC 815-40-15 on October 1, 2009. Subsequently, the Company adjusted the Embedded Derivatives to fair value at each interim period and recognized the changes in fair value as a charge or a benefit to earnings included in the Other Income (Expense) section of the Company’s Condensed Consolidated Statement of Operations.

 
16

 
 
The following is a summary of the cumulative effect adjustment recorded to the Company’s Consolidated Balance Sheet on October 1, 2009 (in thousands):

   
Balance
September 30,
2009
   
Cumulative
Effect of
Adjustment
   
Balance
October 1,
2009
 
Derivative liabilities
  $     $ 5,820     $ 5,820  
Convertible Notes Payable, net
    6,340       (596 )     5,744  
Additional paid-in capital
    11,705       (390 )     11,315  
Accumulated deficit
    (8,272 )     (4,834 )     (13,106 )

When the convertible notes were originally issued in May 2008 and October 2008, beneficial conversion features of $390,000 were recorded to additional paid-in capital. As a result of reclassifying the embedded conversion features from equity to liabilities, the cumulative effect of the adjustment was a reduction of additional paid-in capital of $390,000.

The fair values of the Embedded Derivatives at the issuance dates (May 2008 and October 2008) of the convertible notes were $1,771,000. The increase in the convertible note discounts of $1,381,000 less the accretion of an additional $785,000 in discounts to the convertible notes resulting from the bifurcation of the Embedded Derivatives was booked as a reduction of $596,000 to the Convertible Notes Payable as of October 1, 2009. The fair values at the issuance dates were calculated using a simulation model with the following assumptions:

   
May 2008 Note
   
October 2008 Note
 
Risk-free interest rate:
    2.56 %     1.64 %
Expected term:
 
2 years
   
2 years
 
Expected dividend yield:
    0.00 %     0.00 %
Expected volatility:
    45.29 %     50.87 %
Probability of triggering reset provision:
    64.17 %     61.62 %
Existing conversion price per share
  $ 0.80     $ 0.75  
Company’s stock price per share
  $ 0.73     $ 0.75  

The fair values of the Embedded Derivatives at the transition date, October 1, 2009, were $5,820,000, which was booked as a Derivative Liability on October 1, 2009. The fair values as of October 1, 2009, were calculated using a Monte Carlo simulation model with the following assumptions:

   
May 2008 Note
   
October 2008 Note
 
Risk-free interest rate:
    0.40 %     0.40 %
Expected term:
 
0.64 years
   
1.05 years
 
Expected dividend yield:
    0.00 %     0.00 %
Expected volatility:
    56.03 %     56.03 %
Probability of triggering reset provision:
    22.42 %     19.18 %
Existing conversion price per share
  $ 0.80     $ 0.75  
Company’s stock price per share
  $ 1.45     $ 1.45  

The cumulative effect of these adjustments was recorded as a decrease to total stockholders’ equity of $5,224,000 as of October 1, 2009.

As of March 31, 2010, the fair values of the Embedded Derivatives for the May 2008 and October 2008 Notes were $10,977,000. The increase in fair value of $5,157,000 from October 1, 2009, was recorded as non-cash charge to Other Expenses for the six months ended March 31, 2010. The fair values as of March 31, 2010, were calculated using a simulation model with the following assumptions:

   
May 2008 Note
   
October 2008 Note
 
Risk-free interest rate:
    0.24 %     0.24 %
Expected term:
 
0.14 years
   
0.55 years
 
Expected dividend yield:
    0.00 %     0.00 %
Expected volatility:
    48.58 %     48.58 %
Probability of triggering reset provision:
    0.01 %     0.03 %
Existing conversion price per share
  $ 0.80     $ 0.75  
Company’s stock price per share
  $ 2.20     $ 2.20  
 
 
17

 

 
Note 10 — Capital Lease Obligations

Capital lease obligations include eleven capitalized leases with interest rates ranging from 8.4% to 28.4%. The combined monthly payments of principal and interest are $9,000. The amount of equipment and furniture capitalized under the capital leases was $289,000. Accumulated depreciation recorded for the equipment and furniture under capital leases as of March 31, 2010 is $173,000. The payment terms of the capital leases expire between August 2010 and May 2012.

The following is a schedule by years of future minimum lease payments under capital leases together with the present value of the net minimum lease payments as of March 31, 2010 (in thousands):

   
Amount
 
Year ending September 30:
     
2010
  $ 50  
2011
    62  
2012
    13  
Total minimum lease payments
    125  
Less: Interest on capitalized lease obligations
    (15 )
Present value of capitalized lease obligations
    110  
Less: Current portion
    (73 )
Capitalized lease obligations, net of current portion
  $ 37  

Interest expense on capitalized leases was $12,000 and $14,000 for six months ended March 31, 2010 and 2009, respectively.

Note 11 — Stockholders’ Equity

Sale of Common Stock

On March 9, 2010, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) pursuant to which the Company issued and sold to a single institutional investor (the “Investor”) an aggregate of 4,666,667 shares of the Company’s common stock, par value $.001 per share, in a private placement at a price of $1.50 per share, resulting in aggregate gross proceeds to the Company of $7.0 million. Pursuant to the terms of the Purchase Agreement, the Company has provided the Investor certain demand registration rights covering the resale of all of the shares issued in the private placement, as well as piggy-back registration rights in certain circumstances. The securities were issued in reliance upon the exemptions from registration under the Securities Act of 1933, as amended, provided by Regulation D and Section 4(2). The securities were issued directly by the Company and did not involve a public offering or general solicitation. The Investor in the private placement is an “Accredited Investor,” as that term is defined in Rule 501 of Regulation D.

At closing of the Purchase Agreement, Mark A. Libratore, the Company’s President, Chairman and Chief Executive Officer, entered into a Stockholders Agreement with the Investor. Pursuant to the Stockholders Agreement, Mr. Libratore agreed to vote his shares of common stock of the Company in favor of the election of a director to be designated by the Investor.

On February 5, 2010, the Company entered into an Investment Banking Agreement (the “Investment Banking Agreement”) with Littlebanc Advisors LLC, securities through Wilmington Capital Securities, LLC (the “Placement Agent”), pursuant to which the Company engaged the Placement Agent to act as its agent. As compensation for the Placement Agent’s services, the Placement Agent received an aggregate of $350,000 in commissions and a five-year warrant to purchase 233,333 shares of the Company’s common stock at an exercise price of $2.50 per share.
 
Warrants
 
18

 
The Company issued warrants to the stockholders of Liberator Medical Supply, Inc. to purchase 2,818,092 shares of the Company’s common stock in conjunction with the reverse merger in 2007. As of March 31, 2010, 200,000 of these warrants have expired and 426,250 of these warrants have been exercised. The weighted-average exercise price for the remaining 2,191,842 warrants as of March 31, 2010, is $0.98 per share. The expiration dates of the outstanding warrants are as follows:

Shares
 
Expiration Date
7,188
 
April 2010
31,250
 
May 2010
1,778,404
 
June 2010
337,500
 
July 2010
12,500
 
August 2010
25,000
 
November 2010

From July 2007 to January 2008, in connection with sales of the Company’s common stock, the Company issued warrants to purchase an additional 686,667 shares of the Company’s common stock at a weighted-average exercise price of $1.40 per share. As of March 31, 2010, 93,750 of these warrants have been exercised. The weighted-average exercise price for the remaining 592,917 warrants as of March 31, 2010, is $1.46 per share. The expiration dates of the outstanding warrants are as follows:

Shares
 
Expiration Date
6,250
 
July 2010
159,375
 
August 2010
75,625
 
September 2010
169,167
 
October 2010
145,000
 
November 2010
31,250
 
December 2010
6,250
 
January 2011

In November 2007, the Company issued warrants to purchase 125,000 shares of the Company’s common stock at an exercise price of $2.00 per share as compensation for consulting services. These warrants are still outstanding as of March 31, 2010 and expire in November 2012. The fair value of these warrants of $24,000 was determined using the Black-Scholes option pricing model with the assumptions listed below:

Risk-free interest rate:
    4.11 %
Expected term:
 
5 years
 
Expected dividend yield:
    0.00 %
Expected volatility:
    27.97 %

In connection with the April 2008 Convertible Notes discussed above in Note 8, the Company issued warrants to purchase 829,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the note holders and 51,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the placement agent. As of March 31, 2010, 20,000 of these warrants have been exercised. The remaining 860,000 warrants will expire as follows:

Shares
 
Expiration Date
263,000
 
February 2013
100,000
 
March 2013
497,000
 
April 2013

The fair value of these warrants of $126,000 and $7,000, respectively, was determined using the Black-Scholes option pricing model with the assumptions listed below:

Risk-free interest rate:
 
Range of 2.39% to 2.93
%
Expected term:
 
5 years
 
Expected dividend yield:
    0.00 %
Expected volatility:
    27.97 %
 
 
19

 

In connection with the convertible note payable issued in May 2008 and discussed above in Note 8, the Company issued warrants to purchase 4,375,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the note holder and 350,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the placement agent. In October 2009, the placement agent exercised 350,000 warrants via a cashless exercise, in which the Company issued 192,873 shares of the Company’s common stock. The 4,375,000 warrants held by the note holder are still outstanding as of March 31, 2010, and expire in May 2013.

The fair value of these warrants of $610,000 and $49,000, respectively, was determined using the Black-Scholes option pricing model with the assumptions listed below:

Risk-free interest rate:
    3.24 %
Expected term:
5 years
 
Expected dividend yield:
    0.00 %
Expected volatility:
    27.97 %

In connection with the long-term convertible notes payable issued in October 2008 and discussed above in Note 8, the Company issued warrants to purchase 1,166,667 shares of the Company’s common stock at an exercise price of $1.25 per share to the note holders and 266,667 shares of the Company’s common stock at an exercise price of $1.25 per share to the placement agent. These warrants are still outstanding as of March 31, 2010, and expire in October 2011. The fair value of these warrants of $86,264 and $19,717, respectively, was determined using the Black-Scholes option pricing model with the assumptions listed below:

Risk-free interest rate:
    1.90 %
Expected term:
   
3 years
 
Expected dividend yield:
    0.00 %
Expected volatility:
    35.19 %

In connection with the sale of common stock on March 9, 2010, for gross proceeds of $7 million and discussed above, the Company issued warrants to purchase 233,333 shares of the Company’s common stock at an exercise price of $2.50 per share to the placement agent. These warrants are still outstanding as of March 31, 2010, and expire in October 2015. The fair value of these warrants of $228,961 was determined using the Black-Scholes option pricing model with the assumptions listed below:

Risk-free interest rate:
    2.34 %
Expected term:
 
5 years
 
Expected dividend yield:
    0.00 %
Expected volatility:
    63.66 %

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

       
Weighted
 
       
Avg.
 
       
Exercise
 
Warrants:
 
Shares
 
Price
 
Balance at September 30, 2009
    10,458,093     $ 1.07  
Issued
    233,333       2.50  
Exercised
    (880,000 )     1.00  
Expired
           
Balance at March 31, 2010
    9,811,426     $ 1.11  
 
 
20

 
 
Options
 
In connection with conversion of $1,589,000 of debt to equity and under the terms of the reverse merger in 2007, Mr. Libratore, the Company’s founder, principal shareholder and President, received options to purchase 4,541,009 shares of the Company’s common stock at an exercise price of $0.0001. As of March 31, 2010, a total of 3,921,009 options were outstanding.

Employee and Director Stock Options

On September 14, 2007, the Board of Directors adopted the Company’s 2007 Stock Plan with an aggregate of 1,000,000 shares of the Company’s unissued common stock. The Plan was approved by the shareholders at the Company’s annual meeting in September 2008. The 1,000,000 shares authorized under the 2007 Stock Plan are reserved for issuance to officers, directors, employees, prospective employees and consultants as incentive stock options, non-qualified stock options, restricted stock awards, other equity awards and performance based stock incentives. The option price, number of shares and grant date are determined at the discretion of the Company’s board of directors or the committee overseeing the 2007 Stock Plan.

On July 13, 2009, the Board of Directors of the Company approved an amendment to the 2007 Stock Plan to increase the number of shares authorized under the plan from 1,000,000 to 2,000,000 shares. The amendment was approved at the Company’s annual shareholders meeting on September 4, 2009.

On September 14, 2007 the Company adopted the provisions of ASC Topic 718, Compensation — Stock Compensation,” which requires the Company to recognize expense related to the fair value of stock-based compensation awards. The Company elected the modified prospective transition method as permitted by Topic 718, under which stock-based compensation for the years ended September 30, 2009 and 2008 is based on grant date fair value estimated in accordance with the provisions of Topic 718 and compensation expense for all stock-based compensation awards granted subsequent to January 1, 2006, as well as the unvested portion of previously granted awards that remained outstanding as of January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of Topic 718.

On October 30, 2008, the Board of Directors of the Company approved a grant of 480,000 stock options under the 2007 Stock Plan to employees with an exercise price of $0.60 per share. The options vest 25% on October 1, 2009, 25% on April 1, 2010, 25% on October 1, 2010, and 25% on April 1, 2011.

On October 29, 2009, Joseph D. Farish, Jr. was appointed to the Board of Directors of the Company. As part of the compensation for his services as a director, Mr. Farish was granted an option, vesting over two years, to purchase 50,000 shares of common stock at $2.35 per share.

On December 3, 2009, Robert Cuillo was appointed to the Board of Directors of the Company. As part of the compensation for his services as a director, Mr. Cuillo was granted an option, vesting over two years, to purchase 50,000 shares of common stock at $2.18 per share.

On February 26, 2010, Jeannette Corbett was appointed to the Board of Directors of the Company. As part of the compensation for her services as a director, Ms. Corbett was granted an option, vesting over two years, to purchase 50,000 shares of common stock at $1.90 per share.

The fair values of share-based payments are estimated on the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the six months ended March 31, 2010 and 2009:

   
2010
   
2009
 
Risk-free interest rate:
   
1.37
%
   
1.82
%
Expected term:
 
3 years
 
3 years
Expected dividend yield:
   
0.00
%
   
0.00
%
Expected volatility:
   
67.67
%
   
36.05
%

For the six months ended March 31, 2010 and 2009, the Company recorded $119,000 and $49,000, respectively, of stock-based compensation expense, which has been classified as Operating expenses, sub-classification of Payroll, taxes and benefits. As of March 31, 2010, there is $363,000 in total unrecognized compensation expense related to non-vested employee stock options granted under the 2007 Stock Plan, which is expected to be recognized over 1.9 years.

 
21

 

 
A summary of the stock options outstanding under the 2007 Stock Plan as of March 31, 2010, and activity for the six months then ended is as follows:

           
Weighted
       
           
Avg.
   
Aggregate
 
           
Exercise
   
Intrinsic
 
2007 Stock Plan:
 
Shares
   
Price
   
Value
 
Options outstanding at September 30, 2009
   
1,580,000
   
$
0.81
         
Granted
   
150,000
     
2.14
         
Exercised
   
     
         
Expired or forfeited
   
     
         
Options outstanding at March 31, 2010
   
1,730,000
   
$
0.93
   
$
2,144,100
 
Options exercisable at March 31, 2010
   
755,000
   
$
0.79
   
$
1,064,250
 

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 1st and November 30th of each year and terminating on the last trading day before the commencement of the next offering period. The ESPP is intended to qualify as an “employee stock purchase plan” within the meaning of Section 423 of the Internal Revenue Code. The ESPP allows employees to designate up to 15% of their cash compensation to purchase shares of the Company’s common stock at 85% of the lesser of the fair market value at the beginning of the offering period or the exercise date, which is the last trading day of the offering period. Employees who own stock possessing 5% or more of the total combined voting power or value of all classes of the Company’s common stock are not eligible to participate in the ESPP.

The first offering period of the ESPP commenced on June 10, 2009, and ended on November 30, 2009. The second offering period commenced on December 1, 2009, and will end on May 31, 2010. As of March 31, 2010, 161,781 shares of the Company’s common stock have been purchased through the ESPP, using $73,000 of proceeds received from employee payroll deductions. For the six months ended March 31, 2010, the Company received $104,000 through payroll deductions under the ESPP.

The Company uses the Black-Scholes option pricing model to estimate the fair value of the shares expected to be issued under the ESPP at the grant date, the beginning date of the offering period, and recognizes compensation expense ratably over the offering period. If an employee elects to increase their payroll withholdings during the offering period, the increase is treated as a modification to the original option granted under the ESPP. As a result of the modification, the incremental fair value, if any, associated with the modified award is recognized as compensation expense at the date of the modification. Compensation expense is recognized only for shares that vest under the ESPP. For the six months ended March 31, 2010, the Company recognized $89,000 of compensation expense related to the ESPP.

Note 12 — 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, 2010 and 2009 (in thousands, except per share amounts):

 
22

 
 
   
For the three months ended
   
For the six months ended
 
   
March 31,
   
March 31,
 
   
2010
   
2009
   
2010
   
2009
 
Numerator:
                               
Net income (loss) — basic
 
$
(92
)
 
$
95
   
$
(3,437
)
 
$
341
 
                                 
Denominator:
                               
Weighted average shares outstanding — basic
   
34,921
     
32,021
     
33,873
     
32,035
 
Effect of dilutive securities:
                               
Stock options and warrants
   
     
3,920
     
     
3,920
 
Weighted average shares outstanding — diluted
   
34,921
     
35,941
     
33,873
     
35,955
 
                                 
Earnings (loss) per share — basic
 
$
(0.00
)
 
$
0.00
   
$
(0.10
)
 
$
0.01
 
Earnings (loss) per share — diluted
 
$
(0.00
)
 
$
0.00
   
$
(0.10
)
 
$
0.01
 

The following tables summarize 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/or six months ended March 31, 2010 and 2009 (in thousands):

   
For the three and/or six months
 
   
ended March 31,
 
   
2010
   
2009
 
Stock options
   
5,651
     
975
 
Warrants
   
9,811
     
10,468
 
Convertible debt
   
 7,825
     
9,193
 
Net income — diluted
   
23,287
     
20,636
 

Note 13 — Income Taxes (Restated)

Income taxes are accounted for under the asset and liability method.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  A valuation allowance on deferred tax assets is established when management considers it is more likely than not that some portion or all of the deferred tax assets will not be realized.  The Company files consolidated federal and state income tax returns.

The Company had a net income tax benefit for the six months ended March 31, 2010, of $1,012,000. The Company recognized $1,436,000 in tax benefits due to a change in the valuation allowance as of March 31, 2010. Although the Company had net operating loss carryforwards that completely offset regular taxable income, the Company incurred alternative minimum tax of $3,000 on its net alternative minimum taxable income. The Company also recorded a current federal income tax benefit of $32,000 to adjust for prior year income tax return. In addition, the Company incurred deferred tax expense of $453,000.

The Company’s effective tax rate was approximately 23% and 0% for the six months ended March 31, 2010 and 2009, respectively, which differs from the federal statutory rate of 35% due to the effect of state income taxes, the reduction in valuation allowance, and certain of the Company’s expenses that are not deductible for income tax purposes, primarily consisting of $5,157,000 of expense for the change in fair value of derivative liabilities. The effective tax rate for the six months ended March 31, 2009, reflects the utilization of net operating losses from previous years that were fully reserved by a valuation allowance at the time of utilization.
 
Note 14 — Commitments
 
23

 
The Company leases property and telephone equipment under operating leases that expire at various times through June 2014. Future minimal rental commitments under non-cancelable operating leases with terms in excess of one year as of March 31, 2010, are as follows (in thousands):

   
Amount
 
Year ending September 30:
       
2010
 
$
289
 
2011
   
661
 
2012
   
608
 
2013
   
271
 
2014
   
204
 
   
$
2,033
 

Rent expense for the six months ended March 31, 2010 and 2009 was $309,000 and $237,000, respectively.

Note 15 — Subsequent Event (Restated)

On May 11, 2010, the Company issued 4,375,000 shares of the Company’s common stock upon conversion of the $3,500,000 convertible note due May 22, 2010, at a conversion price of $0.80 per share. The shares were issued on reliance from the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. As a result of the note conversion, the Company’s current liabilities were reduced by $3,500,000 for the face value of the convertible note and $4,813,000 for the fair value of the embedded derivative as of the conversion date. In addition, $1,326,000 was recorded as a non-cash benefit to Other Income due to the decrease in fair value of the embedded derivative from March 31, 2010, to the conversion date of the note on May 11, 2010.

 
24

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other parts of this quarterly report on Form 10-Q contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can also be identified by words such as “intends,” “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those set forth below under “Certain Risk Factors.” The following discussion should be read in conjunction with our unaudited consolidated financial statements and notes thereto included in this Form 10-Q and the audited financial statements of the Company, included in our Report on Form 10-K for the year ended September 30, 2009, filed with the Securities and Exchange Commission and management’s discussion and analysis contained therein. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law.

Overview

Liberator Medical Supply, Inc. (“LMS”), a wholly-owned subsidiary of the Company, is a federally licensed, direct-to-consumer, provider of Medicare Part B Benefits focused on providing medical supplies in a retail environment and via the Internet in the United States. LMS distributes a full range of medical products which address the healthcare needs of our customers.

We market our products directly to consumers primarily through targeted media and direct response television advertising. Our customer service representatives are specifically trained to communicate with Medicare-eligible beneficiaries. Our operating platforms enable us to collect and process required documents from physicians and customers, bill and collect amounts due from Medicare and/or other government agencies and/or third party payors and/or customers.

Executive Summary

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 grow our sales by 66%, to $9.65 million, during the second quarter of 2010 compared with the second quarter of 2009, primarily as a result of new customers generated from our direct response advertising efforts. Consistent with last year’s seasonality, our quarterly customer retention rates during the second quarter dropped 7% lower than the other three quarters of the year.

Even though we have been able to significantly grow our sales over the last three fiscal years during the downturn of the U.S. economy, we have experienced increased costs associated with our direct response advertising efforts over the first six months of fiscal year 2010 compared with the first six months of fiscal year 2009. Based on information we are receiving from our media buying agents, we believe that due to the economic conditions, the larger “branded” type companies have turned to direct response television advertising to market their products and reduce their advertising costs. As a result, demand for television time slots within the direct response advertising market has increased dramatically over the last six months to a year, causing a decrease in available inventory. Our media buying agents believe that this trend has peaked and advertising opportunities will improve over the next several quarters. In April 2010, we experienced an increase in available time slots and a reduction in our advertising costs associated with these time slots. We will continue to invest in direct response television advertising campaigns for our products in order to grow our business while continuing to closely monitor the success rates of these television campaigns.

During the first and second quarters of fiscal year 2010, we increased our spending in alternative media and plan to continue those efforts. We are highly optimistic by the results we are seeing within the alternative media channels and confident that significant gains can be made and that we can lower customer acquisition costs through these new channels.

 
25

 
 
In January 2010, we completed the build out of an additional 24,000 square foot facility to house our expanding workforce and provide the infrastructure necessary to support future growth of our business. The continuous growth of our recurring business requires regular increases in staff. We have chosen to invest in recruiting, hiring, and training additional staff ahead of our advertising schedule, which helps us achieve compliance on many fronts and maintain the quality of our customer service. During the first six months of fiscal year 2010, we added eighty-one employees. Of these additional employees, we added several key management positions to focus on new product opportunities, increased sales within our existing product lines, additional distribution channels within the insurance industry, and improved productivity within our operations, lead management, and accounting groups.

Our biggest asset and resource is our employees. In an effort to recognize their considerable contributions to our growth and reduce attrition, effective December 2009 we modified our employee benefits plan to cover 100% of the employees’ portion of their health insurance plan. This provides every one of our employees an opportunity to obtain health insurance at no cost to them. As a result of this change, we experienced an increase in health insurance costs during the second quarter due to increased enrollment and the higher portion of the premiums paid for by us. Although this change temporarily reduced earnings, we expect the increased health insurance costs to be offset by improved employee turnover rates, improved customer service, reduced training costs, and improved efficiency. This decision to improve employee benefits is consistent with our mission to attract and retain talented, highly skilled employees with entrepreneurial spirit.

In March 2010, we completed the sale of 4,666,667 shares of our common stock to a single institutional investor for gross proceeds of $7.0 million. As a result of the proceeds from this private placement and the investments we have made in our infrastructure and employees, we believe we are well positioned to grow our business in the future.

Results of Operations

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

   
For the three months ended March 31,
   
For the six months ended March 31,
 
   
2010
   
2009
   
2010
   
2009
 
   
As Restated
Amount
   
%
   
Amount
   
%
   
As Restated
Amount
   
%
   
Amount
   
%
 
Sales
 
$
9,650
     
100.0
   
$
5,827
     
100.0
   
$
18,808
     
100.0
   
$
11,169
     
100.0
 
Cost of Sales
   
3,386
     
35.1
     
2,078
     
35.7
     
6,633
     
35.3
     
3,919
     
35.1
 
Gross Profit
   
6,264
     
64.9
     
3,749
     
64.3
     
12,175
     
64.7
     
7,250
     
64.9
 
Operating Expenses
   
5,904
     
61.2
     
3,387
     
58.1
     
10,654
     
56.6
     
6,378
     
57.1
 
Income from Operations
   
360
     
3.7
     
362
     
6.2
     
1,521
     
8.1
     
872
     
7.8
 
Other Income (Expense)
   
(458
)
   
(4.7
)
   
(267
)
   
(4.6
)
   
(5,970
)
   
(31.7
)
   
(531
)
   
(4.8
)
Income (loss) before Income Taxes
   
(98
)
   
(1.0
)
   
95
     
1.6
     
(4,449
)
   
(23.7
)
   
341
     
3.1
 
Benefits from Income Taxes
   
(6
)
   
(0.0
)
   
     
0.0
     
(1,012
)
   
(5.4
)
   
     
0.0
 
Net Income (Loss)
 
$
(92
   
(1.0
)
 
$
95
     
1.6
   
$
(3,437
)
   
(18.3
)
 
$
341
     
3.1
 

Revenues:

Sales for the three months ended March 31, 2010, increased by $3,823,000, or 65.6%, to $9,650,000, compared with sales of $5,827,000 for the three months ended March 31, 2009. The increase was due to our direct response advertising campaign to obtain new mail order customers. Sales for the six months ended March 31, 2010, increased by $7,639,000, or 68.4%, to $18,808,000, compared with sales of $11,169,000 for the six months ended March 31, 2009, as a result of the direct response advertising campaign.

Gross Profit:

Gross profit for the three months ended March 31, 2010, increased by $2,515,000, or 67.1%, to $6,264,000, compared with gross profit of $3,749,000 for the three months ended March 31, 2009. Gross profit for the six months ended March 31, 2010, increased by $4,925,000, or 67.9%, to $12,175,000, compared to $7,250,000 for the six months ended March 31, 2009. The increase was attributed to our increased sales volume for the three and six months ended March 31, 2010, compared to the three and six months ended March 31, 2009.

 
26

 
 
Operating Expenses:

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

   
For the three months ended March 31,
   
For the six months ended March 31,
 
   
2010
   
2009
   
2010
   
2009
 
   
As Restated
Amount
   
%
   
Amount
   
%
   
As Restated
Amount
   
%
   
Amount
   
%
 
Operating Expenses:
                                                               
Payroll, taxes, & benefits
 
$
2,618
     
27.1
   
$
1,274
     
21.9
   
$
4,787
     
25.5
   
$
2,339
     
20.9
 
Advertising
   
1,114
     
11.6
     
459
     
7.9
     
1,920
     
10.2
     
757
     
6.8
 
Bad debts
   
928
     
9.6
     
809
     
13.9
     
1,583