Attached files

file filename
EX-31.1 - LIBERATOR MEDICAL HOLDINGS, INC.v218338_ex31-1.htm
EX-32.1 - LIBERATOR MEDICAL HOLDINGS, INC.v218338_ex32-1.htm
EX-31.2 - LIBERATOR MEDICAL HOLDINGS, INC.v218338_ex31-2.htm
EX-32.2 - LIBERATOR MEDICAL HOLDINGS, INC.v218338_ex32-2.htm

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

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

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

2979 SE Gran Park Way, Stuart, Florida 34997
(Address of principal executive offices) (Zip Code)

(772) 287-2414
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ     No o

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

Yes o     No o

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

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

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 12, 2010
Common Stock, $.001
 
44,568,208

 
 

 
 
TABLE OF CONTENTS

     
Page
       
Explanatory Note
3
   
PART I — FINANCIAL INFORMATION
4
       
Item 1.
 
Condensed Consolidated Financial Statements
4
       
   
Balance Sheets as of June 30, 2010 (unaudited) and September 30, 2009
4
       
   
Statements of Operations for the three and nine months ended June 30, 2010 and 2009 (unaudited)
5
       
   
Statement of Changes in Stockholders’ Equity for the nine months ended June 30, 2010 (unaudited)
6
       
   
Statements of Cash Flows for the nine months ended June 30, 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
24
       
Item 3.
 
Quantitative and Qualitative Disclosures about Market Risk
29
       
Item 4T.
 
Controls and Procedures
30
       
PART II — OTHER INFORMATION
32
       
Item 1.
 
Legal Proceedings
32
       
Item 1A.
 
Risk Factors
32
       
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
32
       
Item 3.
 
Defaults Upon Senior Securities
32
       
Item 4.
 
<Removed and Reserved>
 
       
Item 5.
 
Other Information
32
       
Item 6.
 
Exhibits
32
       
SIGNATURES
33
       
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 June 30, 2010, which was originally filed with the Securities and Exchange Commission (“SEC”) on August 16, 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 nine months ended June 30, 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 have been made in order to maintain consistency and comparability with our subsequent presentations in fiscal year 2010 on Form 10-K.

The revisions relate to non-operating and non-cash items for the interim period ended June 30, 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 nine months ended June 30, 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)

   
Restated
June 30,
   
September 30,
 
   
2010
   
2009
 
   
(unaudited)
         
Assets
               
Current Assets:
               
Cash
 
$
6,889
   
$
3,798
 
Restricted cash
   
1,060
     
500
 
Accounts receivable, net of allowances of $3,622 and $2,327, respectively
   
6,511
     
3,850
 
Inventory, net of allowance for obsolete inventory of $227 and $110, respectively
   
2,037
     
902
 
Deferred taxes, current portion
   
1,244
     
 
Other current assets
   
662
     
483
 
Total Current Assets
   
18,403
     
9,533
 
Property and equipment, net of accumulated depreciation of $1,384 and $1,021, respectively
   
1,912
     
1,041
 
Deferred advertising
   
8,522
     
3,755
 
Intangible assets, net of accumulated amortization of $3
   
204
     
 
Other noncurrent assets
   
226
     
130
 
Total Assets
 
$
29,267
   
$
14,459
 
                 
Liabilities and Stockholders’ Equity
               
Current Liabilities:
               
Accounts payable
 
$
5,606
   
$
2,089
 
Accrued liabilities
   
798
     
716
 
Stockholder loans
   
865
     
1,515
 
Convertible notes payable, net of unamortized discount of $137 and $292, respectively
   
2,382
     
3,893
 
Derivative liabilities
   
2,467
     
 
Other current liabilities
   
136
     
140
 
Total Current Liabilities
   
12,254
     
8,353
 
Convertible notes payable, net of unamortized discount of $0 and $90, respectively
   
     
2,447
 
Deferred tax liability
   
676
     
 
Other noncurrent liabilities
   
176
     
235
 
Total Liabilities
   
13,106
     
11,035
 
                 
Stockholders’ Equity:
               
Common stock, $.001 par value, 200,000 shares authorized; 44,637 and 32,462 shares issued, respectively; 44,547 and 32,377 shares outstanding at June 30, 2010, and September 30, 2009, respectively
   
45
     
32
 
Additional paid-in capital
   
28,763
     
11,705
 
Accumulated deficit
   
(12,597
)
   
(8,272
)
     
16,211
     
3,465
 
Less: Treasury stock, at cost; 89 and 85 shares at June 30, 2010, and September 30, 2009, respectively
   
(50
)
   
(41
)
Total Stockholders’ Equity
   
16,161
     
3,424
 
Total Liabilities and Stockholders’ Equity
 
$
29,267
   
$
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 nine months ended June 30, 2010 and 2009
(Unaudited)
(in thousands, except per share amounts)

   
Three Months Ended
   
Nine Months Ended
 
   
June 30,
   
June 30,
 
   
Restated
2010
   
2009
   
Restated
2010
   
2009
 
Sales
 
$
10,619
   
$
6,950
   
$
29,428
   
$
18,119
 
                                 
Cost of Sales
   
3,677
     
2,506
     
10,312
     
6,425
 
                                 
Gross Profit
   
6,942
     
4,444
     
19,116
     
11,694
 
                                 
Operating Expenses
                               
Payroll, taxes and benefits
   
2,569
     
1,518
     
7,357
     
3,857
 
Advertising
   
1,336
     
616
     
3,255
     
1,373
 
Bad debts
   
1,020
     
373
     
2,603
     
1,861
 
Depreciation and amortization
   
179
     
80
     
449
     
214
 
General and administrative
   
896
     
785
     
2,991
     
2,445
 
Total Operating Expenses
   
6,000
     
3,372
     
16,655
     
9,750
 
                                 
Income from Operations
   
942
     
1,072
     
2,461
     
1,944
 
                                 
Other Income (Expense)
                               
Interest Expense
   
(289
)
   
(267
)
   
(1,105
)
   
(812
)
Change in fair value of derivative liabilities
   
3,697
     
     
(1,460
)
   
 
Loss on disposal of assets
   
     
     
(2
)
   
 
Interest Income
   
8
     
3
     
16
     
17
 
Total Other Income (Expense)
   
3,416
     
(264
)
   
(2,551
)
   
(795
)
                                 
Income (Loss) before Income Taxes
   
4,358
     
808
     
(90
)
   
1,149
 
                                 
Provision for (benefit from) Income Taxes
   
413
     
14
     
(599
)
   
14
 
                                 
Net Income
 
$
3,945
   
$
794
   
$
509
   
$
1,135
 
                                 
Basic earnings per share:
                               
Weighted average shares outstanding
   
41,569
     
32,133
     
36,438
     
32,068
 
Earnings per share
 
$
0.09
   
$
0.02
   
$
0.01
   
$
0.04
 
                                 
Diluted earnings per share:
                               
Weighted average shares outstanding
   
54,797
     
37,334
     
44,809
     
35,990
 
Earnings per share
 
$
0.07
   
$
0.02
   
$
0.01
   
$
0.03
 

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 nine months ended June 30, 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
                    280                       280  
Common stock issued for interest on convertible debt
    19             45                       45  
Common stock issued upon conversion of debt
    5,578       6       8,908                       8,914  
Common stock issued for exercise of warrants
    1,749       2       1,554                       1,556  
Common stock issued for employee stock purchase plan
    162             73                       73  
Common stock issued for cash, net of issuance costs
    4,666       5       6,588                       6,593  
Purchase common treasury stock
    (4 )                             (9 )     (9 )
Net income
                            509               509  
                                                 
Balance at June 30, 2010
    44,547     $ 45     $ 28,763     $ (12,597 )   $ (50 )   $ 16,161  
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
6

 

Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
For the nine months ended June 30, 2010 and 2009
(Unaudited)
(in thousands)
   
Restated
2010
   
2009
 
Cash flow from operating activities:
               
Net Income
 
$
509
   
$
1,135
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Depreciation and amortization
   
3,670
     
1,458
 
Change in fair value of derivative liabilities
   
1,460
         
Equity based compensation
   
303
     
365
 
Provision for doubtful accounts and sales returns and adjustments
   
2,759
     
1,861
 
Non-cash interest related to convertible notes payable
   
886
     
565
 
Deferred income taxes
   
(566
)
   
 
Amortization of non-cash debt issuance costs
   
23
     
29
 
Loss on disposal of assets
   
2
     
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(5,420
)
   
(2,950
)
Deferred advertising
   
(7,988
)
   
(2,907
)
Inventory
   
(1,135
)
   
(449
)
Other assets
   
(320
)
   
294
 
Accounts payable
   
3,516
     
1,220
 
Accrued expenses
   
(51
)
   
112
 
Deferred rent
   
(3
)
   
(34
)
Net Cash Flow Provided by (Used in) Operating Activities
   
(2,355
)
   
699
 
                 
Cash flow from investing activities:
               
Purchase of property and equipment and other
   
(1,531
)
   
(369
)
Proceeds from the sale of assets
   
5
     
 
Purchase of certificates of deposit
   
(559
)
   
 
Net Cash Flow Used in Investing Activities
   
(2,085
)
   
(369
)
                 
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 issuance of convertible notes
   
     
2,500
 
Costs associated with issuance of convertible notes
   
     
(326
)
Proceeds from the exercise of warrants
   
1,556
     
 
Proceeds from employee stock purchase plan
   
102
     
 
Purchase of treasury stock
   
(9
)
   
(41
)
Payments of debt and capital lease obligations
   
(711
)
   
(148
)
Net Cash Flow Provided by Financing Activities
   
7,531
     
1,985
 
                 
Net increase in cash
   
3,091
     
2,315
 
                 
Cash at beginning of period
   
3,798
     
1,173
 
Cash at end of period
 
$
6,889
   
$
3,488
 
                 
Supplemental disclosure of cash flow information:
               
Cash paid for interest
 
$
323
   
$
290
 
Cash paid for income taxes
 
$
20
   
$
21
 
                 
Supplemental schedule of non-cash investing and financing activities:
               
Capital expenditures funded by capital lease borrowings
 
$
   
$
91
 
Common stock issued for interest expense
 
$
45
   
$
105
 
Common stock issued for conversion of debt
 
$
8,914
   
$
85
 

See accompanying notes to unaudited condensed consolidated financial statements.

 
7

 

Liberator Medical Holdings, Inc. and Subsidiaries
Notes To The Unaudited Condensed Consolidated Financial Statements
June 30, 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 nine months ended June 30, 2010, are not necessarily indicative of the results to be expected for the full year.

The unaudited condensed consolidated financial statements include the accounts of the Company, Liberator Medical Supply, Inc., Liberator Health and Education, Inc., Liberator Health and Wellness, Inc., and Practica Medical Manufacturing, Inc., its wholly-owned subsidiaries. Practica Medical Manufacturing, Inc. was formed in April 2010 as a wholly-owned subsidiary of the Company, carrying on similar business activity as the other 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 Pronouncements

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 10 below).

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, “Fair Value Measurements and Disclosures,” which amends the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires disclosure of transfers of assets and liabilities between Level 1 and Level 2 of the fair value measurement hierarchy, including the reasons and the timing of the transfers and information on purchases, sales, issuance, and settlements on a gross basis in the reconciliation of the assets and liabilities measured under Level 3 of the fair value measurement hierarchy. The guidance is effective for annual and interim reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual and interim periods beginning after December 15, 2010. The Company adopted these amendments in January 2010. The Company has outstanding convertible debt instruments that have embedded conversion features that are classified as derivative liabilities. The fair values of the derivative liabilities are disclosed in Note 4 - Fair Value Measurements.

In June 2009, the FASB issued ASU 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities, which changes various aspects of accounting for and disclosures of interests in variable interest entities. ASU 2009-17 is effective for interim and annual periods beginning after November 15, 2009. The Company adopted these amendments in January 2010 and the adoption did not have a material impact on the Company’s consolidated financial statements.

In June 2009, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance on accounting for transfers of financial assets. This guidance was issued to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. This guidance is effective for fiscal years and interim periods beginning after November 15, 2009. The adoption of this statement did not have a material effect on the Company’s consolidated financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

In July 2010, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance that will require additional disclosures about the credit quality of loans, lease receivables and other long-term receivables and the related allowance for credit losses. Certain additional disclosures in this new accounting guidance will be effective for the Company on December 31, 2010 with certain other additional disclosures that will be effective on March 31, 2011. The Company does not expect the adoption of this new accounting guidance to have a material impact on its consolidated financial statements.

In April 2010, the FASB issued 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 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.

 
9

 

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

In October 2009, the FASB issued 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 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.

In September 2009, the FASB issued certain amendments as codified in ASC Topic 605-25, “Revenue Recognition; Multiple-Element Arrangements.” These amendments provide clarification on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated. An entity is required to allocate revenue in an arrangement using estimated selling prices of deliverables in the absence of vendor-specific objective evidence or third-party evidence of selling price. These amendments also eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. The amendments significantly expand the disclosure requirements for multiple-deliverable revenue arrangements. These provisions are to be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. The Company will adopt the provisions of these amendments in its fiscal year 2011 and does not expect that these amendments to have a significant impact on its consolidated financial statements.

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

On December 9, 2010, the Company concluded that the Company’s previously issued unaudited financial statements as of and for the interim period ended June 30, 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 nine months ended June 30, 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 $545,000 in tax benefits during the nine months ended June 30, 2010.

 
10

 

·
In addition, certain reclassifications related to the accounting for deferred advertising costs has been made in order to maintain consistency and comparability with our subsequent presentations in fiscal year 2010 on Form 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 June 30, 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.

The following tables provide a summary of the amounts restated as of and for the three and nine months ended June 30, 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
    4,595       (4,595 )                  
Deferred taxes, current portion
    413                   831       1,244  
Total Current Assets
    22,167       (4,595 )           831       18,403  
Deferred advertising
    3,927       4,595                   8,522  
Total Assets
    28,436                   831       29,267  
                                         
Notes Payable, net
  $ 2,493           $ (596 )   $ 485     $ 2,382  
Derivative liabilities
                5,820       (3,353 )     2,467  
Total Current Liabilities
    9,898             5,224       (2,868 )     12,254  
Deferred tax liability
    457                   219       676  
Total Liabilities
    10,531             5,224       (2,649 )     13,106  
                                         
Additional Paid in Capital
    24,274             (390 )     4,879       28,763  
Accumulated Deficit
    (6,364 )           (4,834 )     (1,399 )     (12,597 )
Total Equity
  $ 17,905           $ (5,224 )   $ 3,480     $ 16,161  


   
For the three months ended
 June 30, 2010
   
For the nine months ended 
June 30, 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
    (150 )     (139 )     (289 )     (621 )     (484 )     (1,105 )
Change in fair value of derivative liabilities
          3,697       3,697             (1,460 )     (1,460 )
Total Other Income (Expense)
    (142 )     3,558       3,416       (607 )     (1,944 )     (2,551 )
Provision for (Benefit from) Income Taxes
    2       411       413       (54 )     (545 )     (599 )
Net Income
  $ 798     $ 3,147     $ 3,945     $ 1,908     $ (1,399 )   $ 509  
                                                 
Basic Earnings per Share
  $ 0.02     $ 0.07     $ 0.09     $ 0.05     $ (0.04 )   $ 0.01  
Diluted Earnings per Share
  $ 0.02     $ 0.05     $ 0.07     $ 0.04     $ (0.03 )   $ 0.01  
 
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:

 
11

 

 
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.

The summary of fair values of financial instruments as of June 30, 2010 (dollars in thousands):

June 30, 2010
Instrument
 
Fair Value
   
Carrying Value
   
Level
 
Valuation Methodology
Derivative liabilities (See Note 10 below)
  $ 2,467     $ 2,467       3  
Monte Carlo
Simulation model

The Company engaged an independent third party valuation expert to calculate the fair values of the embedded derivative liabilities. Please refer to Note 10 for disclosure of assumptions used to calculate the fair value of the derivative liabilities.

The following represents a reconciliation of the changes in fair value of financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended June 30, 2010 (dollars in thousands):
 
   
2010
 
Beginning balance: Derivative liabilities
 
$
 
Adoption of change in accounting principle
   
5,820
 
Total loss on change in derivative liabilities
   
1,460
 
Purchases, sales, issuances and settlements, net
   
(4,813
)
Ending balance: Derivative liabilities
 
$
2,467
 

Note 5 — Property and Equipment

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

 
Estimated
 
June 30,
   
September 30,
 
 
Life
 
2010
   
2009
 
Leased equipment
5 years
 
$
582
   
$
582
 
Transportation equipment
3 years
   
72
     
95
 
Warehouse equipment
5 years
   
98
     
56
 
Office furniture
5 years
   
473
     
150
 
Computer equipment
3 years
   
231
     
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
   
1,494
     
889
 
Signage
3 years
   
21
     
13
 
Total property and equipment
     
3,296
     
2,062
 
Less: accumulated depreciation
     
(1,384
)
   
(1,021
)
Property and equipment, net
   
$
1,912
   
$
1,041
 
 
 
12

 
 
The amounts charged to operations for depreciation for the nine months ended June 30, 2010 and 2009, were $446,000 and $214,000, respectively.
 
Note 6 — Acquired Intangible Assets

A summary of acquired intangible assets at June 30, 2010, is as follows (in thousands):

   
Gross Carrying
   
Accumulated
 
   
Amount
   
Amortization
 
Amortized intangible assets
               
Patented technology
 
$
207
     
(3
)

Amortization expense associated with intangible assets for the nine months ended June 30, 2010, was $3,000. The remaining net intangible assets of $204,000 are expected to be amortized over the next 13.3 years. Estimated amortization expense for intangible assets as of June 30, 2010, for the next five fiscal years is as follows (in thousands):
   
Amount
 
Year ending September 30:
       
2010
 
$
4
 
2011
   
15
 
2012
   
15
 
2013
   
15
 
2014
   
15
 
   
$
64
 

Note 7 — Stockholder Loan

The stockholder loans at June 30, 2010, and September 30, 2009, in the amounts of $865,000 and $1,515,000, respectively, consist of various 8% and 11% notes payable to the President and principal stockholder of the Company, Mark Libratore. The notes payable are non-collateralized and due on demand. However, the notes are subordinated to the senior, unsecured, convertible notes payable discussed below in Note 9. During the nine months ended June 30, 2010, $650,000 of principal was repaid to Mr. Libratore. As of June 30, 2010, the senior note holders have authorized the remaining balance of the stockholder loan to be repaid to Mr. Libratore in increments of $300,000 per quarter until the stockholder loan is paid in full. Interest expense related to the stockholder loan for the nine months ended June 30, 2010 and 2009 was $81,000, and $115,000, respectively.

Note 8 — Credit Line Facility

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

On November 2, 2009, the Company entered into a revised Credit Line Facility with the same lender discussed above. Under the revised loan agreement, the lender agreed to advance the Company a maximum of $1,000,000 secured by the 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 June 30, 2010, the Company had an outstanding balance of $0 under the Credit Line Facility. Interest expense related to the credit line for the nine months ended June 30, 2010, was $18,000.
 
Note 9 — Convertible Notes Payable (Restated)

April 2008 Convertible Notes
 
 
13

 
 
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 June 30, 2010, $711,000 of the notes has been converted into 1,422,000 shares of the Company’s common stock and $93,000 of the notes has been redeemed for cash.

Interest expense related to the April 2008 convertible notes was $22,000 and $65,000 for the nine months ended June 30, 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 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 would 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 had 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.

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 $201,000 was recorded as non-cash interest expense for the nine months ended June 30, 2010.

Interest expense related to the May 2008 convertible note was $558,000 and $437,000 for the nine months ended June 30, 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.

 
14

 
 

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 $283,000 was recorded as non-cash interest expense for the nine months ended June 30, 2010.

Interest expense related to the October 2008 convertible note was $411,000 and $117,000 for the nine months ended June 30, 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.

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

   
Oct08 Note
 
Notes Payable, face amount
  $ 2,500  
Discounts on Notes:
       
Initial valuation of Warrants
    (86 )
Initial valuation of Embedded Derivative
    (841 )
Accumulated Amortization
    790  
Total Discounts
    (137 )
Accrued Interest
    19  
Convertible Notes Payable, net
  $ 2,382  

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  
 
 
15

 

NOTE 10 — Derivative Liabilities (Restated)

The May 2008 and October 2008 convertible notes, discussed above in Note 9, contain embedded adjustment features whereby the conversion price will be adjusted if the Company issues additional shares of common stock or securities exercisable, exchangeable, or convertible into shares of common stock at a price per share less than both the conversion price then in effect and $0.75. Based on accounting principles, discussed above in Note 2, that became effective for the Company on October 1, 2009, the embedded adjustment features are not indexed to the Company’s own stock and, therefore, are embedded derivative financial liabilities (the “Embedded Derivatives”) that require bifurcation and separate accounting. Accordingly, the Company recorded a cumulative effect adjustment to the opening balance of paid in capital and accumulated deficit on October 1, 2009. The cumulative effect adjustment is the difference between the amounts recognized in the balance sheet for the conversion options of the notes payable before initial application of ASC 815-40-15 and the fair values of the Embedded Derivatives at initial application of ASC 815-40-15 on October 1, 2009. Subsequently, the Company adjusted the Embedded Derivatives to fair value at each interim period and recognized the changes in fair value as a charge or a benefit to earnings included in the Other Income (Expense) section of the Company’s Condensed Consolidated Statement of Operations.

The following is a summary of the cumulative effect adjustment recorded to the Company’s 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:

 
16

 

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

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

On May 11, 2010, the May 2008 Note for $3,500,000 was converted into 4,375,000 shares of the Company’s common stock at a conversion price of $0.80 per share. The fair value of the Embedded Derivative for the May 2008 Note as of the conversion date was $4,813,000, which was the intrinsic value of the conversion, based on the Company’s stock price as of the conversion date. The increase in fair value of $1,556,000 for the Embedded Derivative from October 1, 2009, to the conversion date of May 11, 2010, was recorded as a non-cash charge to Other Expenses for the nine months ended June 30, 2010.

As of June 30, 2010, the fair value of the Embedded Derivative for the October 2008 Note was $2,467,000. The decrease in fair value of $865,000 from October 1, 2009, was recorded as non-cash benefit to Other Income for the nine months ended June 30, 2010. The fair value as of June 30, 2010 was calculated using a simulation model with the following assumptions:

   
October 2008 Note
 
Risk-free interest rate:
    0.18 %
Expected term:
 
0.30 Years
 
Expected dividend yield:
    0.00 %
Expected volatility:
    47.66 %
Probability of triggering reset provision:
    0.01 %
Existing conversion price per share
  $ 0.75  
Company’s stock price per share
  $ 1.49  

Note 11 — Capital Lease Obligations

Capital lease obligations include eleven capitalized leases with interest rates ranging from 8.4% to 28.4%. The combined monthly payments of principal and interest are $9,000. The amount of equipment and furniture capitalized under the capital leases was $289,000. Accumulated depreciation recorded for the equipment and furniture under capital leases as of June 30, 2010, is $194,000. 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 June 30, 2010 (in thousands):

   
Amount
 
Year ending September 30:
     
2010
  $ 25  
2011
    62  
2012
    13  
Total minimum lease payments
    100  
Less: Interest on capitalized lease obligations
    (10 )
Present value of capitalized lease obligations
    90  
Less: Current portion
    (68 )
Capitalized lease obligations, net of current portion
  $ 22  

Interest expense on capitalized leases was $16,000 and $22,000 for nine months ended June 30, 2010 and 2009, respectively.
 
Note 12 — Stockholders’ Equity
 
17

 
 
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

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 June 30, 2010, 1,026,000 of these warrants have expired and 1,422,875 of these warrants have been exercised. The weighted-average exercise price for the remaining 368,750 warrants as of June 30, 2010, is $0.87 per share. The expiration dates of the outstanding warrants are as follows:

Shares
 
Expiration Date
  331,250  
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 June 30, 2010, 113,250 of these warrants have been exercised. The weighted-average exercise price for the remaining 573,417 warrants as of June 30, 2010, is $1.47 per share. The expiration dates of the outstanding warrants are as follows:

Shares
 
Expiration Date
  6,250  
July 2010
  139,875  
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 June 30, 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 %
 
 
18

 

In connection with the April 2008 Convertible Notes discussed above in Note 9, the Company issued warrants to purchase 829,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the note holders and 51,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the placement agent. As of June 30, 2010, 30,000 of these warrants have been exercised. The remaining 850,000 warrants will expire as follows:

Shares
 
Expiration Date
  263,000  
February 2013
  100,000  
March 2013
  487,000  
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 %

In connection with the convertible note payable issued in May 2008 and discussed above in Note 9, the Company issued warrants to purchase 4,375,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the note holder and 350,000 shares of the Company’s common stock at an exercise price of $1.00 per share to the placement agent. In October 2009, the placement agent exercised 350,000 warrants via a cashless exercise, in which the Company issued 192,873 shares of the Company’s common stock. The 4,375,000 warrants held by the note holder are still outstanding as of June 30, 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 9, the Company issued warrants to purchase 1,166,667 shares of the Company’s common stock at an exercise price of $1.25 per share to the note holders and 266,667 shares of the Company’s common stock at an exercise price of $1.25 per share to the placement agent. These warrants are still outstanding as of June 30, 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 June 30, 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 %
 
 
19

 

A summary of warrants issued, exercised and expired during the nine months ended June 30, 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
    (1,906,125 )     1.00  
Expired
    (826,467 )     1.00  
Balance at June 30, 2010
    7,958,834     $ 1.13  

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 June 30, 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 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 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.
 
 
20

 
 
On June 4, 2010, Morgan Duke was appointed to the Board of Directors of the Company. Mr. Duke’s appointment was made pursuant to the Purchase Agreement entered into by the Company on March 9, 2010, in association with the sale of common stock, discussed above, to a single institutional investor. As part of the compensation for Mr. Duke’s services as a director, the institutional investor was granted an option, vesting over two years, to purchase 50,000 shares of common stock at $1.55 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 nine months ended June 30, 2010 and 2009:

   
2010
   
2009
 
Risk-free interest rate:
    1.32 %     1.82 %
Expected term:
 
3 years
   
3 years
 
Expected dividend yield:
    0.00 %     0.00 %
Expected volatility:
    68.59 %     36.05 %

For the nine months ended June 30, 2010 and 2009, the Company recorded $188,000 and $58,000, respectively, of stock-based compensation expense, which has been classified as Operating expenses, sub-classification of Payroll, taxes and benefits. As of June 30, 2010, there is $331,000 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.

A summary of the stock options outstanding under the 2007 Stock Plan as of June 30, 2010, and activity for the nine 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
    200,000       2.00        
Exercised
                 
Expired or forfeited
                 
Options outstanding at June 30, 2010
    1,780,000     $ 0.95     $ 1,069,700  
Options exercisable at June 30, 2010
    900,000     $ 0.81     $ 635,000  

2009 Employee Stock Purchase Plan

The 2009 Employee Stock Purchase Plan (the “ESPP”) became effective June 10, 2009, the effective date of the registration statement filed on Form S-8 with the SEC. The ESPP provides a means by which employees of the Company are given an opportunity to purchase common stock of the Company through payroll deductions. The maximum number of shares to be offered under the ESPP is 500,000 shares of the Company’s common stock, subject to changes authorized by the Board of Directors of the Company. Shares are offered through consecutive offering periods with durations of approximately six (6) months, commencing on the first trading day on or after June 1st and November 30th of each year and terminating on the last trading day before the commencement of the next offering period. The ESPP is intended to qualify as an “employee stock purchase plan” within the meaning of Section 423 of the Internal Revenue Code. The ESPP allows employees to designate up to 15% of their cash compensation to purchase shares of the Company’s common stock at 85% of the lesser of the fair market value at the beginning of the offering period or the exercise date, which is the last trading day of the offering period. Employees who own stock possessing 5% or more of the total combined voting power or value of all classes of the Company’s common stock are not eligible to participate in the ESPP.

As of June 30, 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 nine months ended June 30, 2010, the Company received $102,000 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 nine months ended June 30, 2010, the Company recognized $92,000 of compensation expense related to the ESPP.

 
21

 

Note 13 — 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, 2010 and 2009 (in thousands, except per share amounts):

   
For the three months
   
For the nine months
 
   
ended June 30,
   
ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Numerator:
                       
Net income — basic
  $ 3,945     $ 794     $ 509     $ 1,135  
Effect of dilutive securities:
                               
Convertible debt
    31       19              
Net income — diluted
  $ 3,976     $ 813     $ 509     $ 1,135  
                                 
Denominator:
                               
Weighted average shares outstanding — basic
    41,569       32,133       36,438       32,068  
Effect of dilutive securities:
                               
Stock options and warrants
    7,765       3,922       8,371       3,922  
Convertible debt
    5,463       1,279              
Weighted average shares outstanding — diluted
    54,797       37,334       44,809       35,990  
                                 
Earnings per share — basic
  $ 0.09     $ 0.02     $ 0.01     $ 0.04  
Earnings per share — diluted
  $ 0.07     $ 0.02     $ 0.01     $ 0.03  

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 the nine months ended June 30, 2010 and 2009 (in thousands):

   
For the three months
   
For the nine months
 
   
ended June 30,
   
ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Stock options
    200       960       200       960  
Warrants
    358       10,468       233       10,468  
Convertible debt
          7,708       3,333       8,911  
Totals
    558       19,136       3,766       20,339  

Note 14 — Income Taxes (Restated)

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

The Company had a net income tax benefit for the nine months ended June 30, 2010, of $599,000. The Company recognized $1,437,000 in tax benefits due to a change in the valuation allowance as of June 30, 2010. The Company 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 $870,000 for the nine months ended June 30, 2010.

 
22

 

The Company’s effective tax rate was approximately 666% and 1% for the nine months ended June 30, 2010 and 2009, respectively, which differ 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.  The effective tax rate for the nine months ended June 30, 2009 reflects the utilization of net operating losses from previous years that were fully reserved by a valuation allowance at the time of utilization and an estimated alternative minimum tax liability of $14,000.

Note 15 — Commitments

The Company leases property and telephone equipment under operating leases that expire at various times through November 2014. Future minimal rental commitments under non-cancelable operating leases with terms in excess of one year as of June 30, 2010, are as follows (in thousands):

   
Amount
 
Year ending September 30:
     
2010
  $ 150  
2011
    676  
2012
    621  
2013
    271  
2014
    204  
    $ 1,922  

Rent expense for the nine months ended June 30, 2010 and 2009, was $463,000 and $365,000, respectively.

 
23

 

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 in Part II, Item 1A,”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

Our emphasis continues to be on top line sales growth while controlling our costs in order to sustain profitable growth. For the third quarter of fiscal year 2010, our sales increased by 53%, to $10.6 million, compared with the third quarter of fiscal year 2009. For the nine months ended June 30, 2010, our sales increased by 62%, to $29.4 million, compared with the nine months ended June 30, 2009.

We have been able to significantly grow our sales over the last three years through the downturn in the U.S. economy. Our growth has been driven by our direct response marketing campaign, primarily through television ads at remnant (discounted) rates. Based on information from our media buying agents, we believe that demand for television time slots within the direct response advertising market has increased over the last nine months, creating a more competitive environment within this medium. Although customer acquisition costs remain at acceptable levels, during the third quarter of fiscal year 2010 we increased our spending significantly in alternative media channels and plan to continue those efforts.

Over the last nine months, we have invested heavily in our infrastructure by adding both personnel and facilities, so that we continue to remain capable of supporting a much higher sales volume. We currently have approximately 50% of each of our facilities available for future growth. We have chosen to build our infrastructure ahead of our advertising spend, which helps us achieve compliance on many fronts and maintain the quality of our customer service. Our cost structure continues to remain flexible enough to adapt to changing market conditions. We can pulse our advertising spend and the expansion of our workforce relatively quickly based on the results of our marketing programs. While our sales have increased during the last nine months, we have been able to decrease our general and administrative costs as a percentage of sales.

We believe we are well positioned to continue to grow our sales and improve profitability over the long term.

 
24

 

Results of Operations

The following table summarizes the results of operations for the three and nine months ended June 30, 2010 and 2009, including percentage of sales (dollars in thousands):

   
For the three months
ended June 30,
   
For the nine months
ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
As 
Restated
Amount
   
%
   
Amount
   
%
   
As
Restated
Amount
   
%
   
Amount
   
%
 
Sales
  $ 10,619       100.0     $ 6,950       100.0     $ 29,428       100.0     $ 18,119       100.0  
Cost of Sales
    3,677       34.6       2,506       36.1       10,312       35.0       6,425       35.5  
Gross Profit
    6,942       65.4       4,444       63.9       19,116       65.0       11,694       64.5  
Operating Expenses
    6,000       56.5       3,372       48.5       16,655       56.6       9,750       53.8  
Income from Operations
    942       8.9       1,072       15.4       2,461       8.4       1,944       10.7  
Other Income (Expense)
    3,416       32.2       (264 )     (3.8 )     (2,551 )     (8.7 )     (795 )     (4.4 )
Income (loss) before Income Taxes
    4,358       41.1       808       11.6       (90 )     (0.3 )     1,149       6.3  
Income Tax Expense (Benefit)
    413       3.9       14       0.2       (599 )     (2.0 )     14       0.1  
Net Income
  $ 3,945       37.2     $ 794       11.4     $ 509       1.7     $ 1,135       6.3  

Revenues:

Sales for the three months ended June 30, 2010, increased by $3,669,000, or 52.8%, to $10,619,000, compared with sales of $6,950,000 for the three months ended June 30, 2009. The increase was due to our direct response advertising campaign to obtain new mail order customers. Sales for the nine months ended June 30, 2010, increased by $11,309,000, or 62.4%, to $29,428,000, compared with sales of $18,119,000 for the nine months ended June 30, 2009, as a result of the direct response advertising campaign.

Gross Profit:

Gross profit for the three months ended June 30, 2010, increased by $2,498,000, or 56.2%, to $6,942,000, compared with gross profit of $4,444,000 for the three months ended June 30, 2009. Gross profit for the nine months ended June 30, 2010, increased by $7,422,000, or 63.5%, to $19,116,000, compared to $11,694,000 for the nine months ended June 30, 2009. The increase was attributed to our increased sales volume for the three and nine months ended June 30, 2010, compared to the three and nine months ended June 30, 2009. As a percentage of sales, the increases in gross profit for the three and nine months ended June 30, 2010 are primarily attributed to product mix and, to a lesser extent, a reduction in freight costs compared to the three and nine months ended June 30, 2009.

Operating Expenses:

The following table provides a breakdown of our operating expenses for the three and nine months ended June 30, 2010 and 2009, including percentage of sales (dollars in thousands):

   
For the three months ended June 30,
   
For the nine months ended June 30,
 
   
2010
   
2009
   
2010
         
2009
       
   
As Restated
Amount
   
%
   
Amount
   
%
   
As Restated
Amount
   
%
   
Amount
   
%
 
Operating Expenses:
                                               
Payroll, taxes, & benefits
  $ 2,569       24.2     $ 1,518       21.8     $ 7,357       25.0     $ 3,857       21.3  
Advertising
    1,336       12.6       616       8.9       3,255       11.1       1,373       7.6  
Bad debts
    1,020