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EX-32.2 - EXHIBIT 32.2 - Luvu Brands, Inc.v237025_ex32-2.htm
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EX-10.20 - EXHIBIT 10.20 - Luvu Brands, Inc.v237025_ex10-20.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549


Form 10-K


x
 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2011
or
¨
 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 000-53314
 
Liberator, Inc.
(Exact name of Company as specified in its charter)
 
Florida
 
59-3581576
(State of incorporation)
 
(IRS Employer Identification No.)

2745 Bankers Industrial Drive, Atlanta, Georgia 30360
(Address of principal executive offices) (Zip Code)

Company's telephone number: (770) 246-6400

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  Common Stock, $.01 par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  ¨  YES     x  NO

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  ¨  YES  x NO

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.  x  YES     ¨  NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files)    ¨ YES   ¨   NO

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act
 
Large accelerated filer  ¨
 
Accelerated filer  ¨
 
Non-accelerated filer  ¨
 
Smaller reporting company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ¨  YES     x  NO

The aggregate market value of the common stock held by non−affiliates of the registrant computed by reference to the closing price of the common stock on December 31, 2010, the last trading day of the registrant’s most recently completed second fiscal quarter, was $1,256,807.

The number of shares of Common Stock, $.01 par value, outstanding as of the close of business on September 30, 2011 was 91,947,047.

 
 

 

Liberator, Inc.
Annual Report on Form 10-K
Year Ended June 30, 2011

TABLE OF CONTENTS
 
 
  
PAGE
     
FORWARD-LOOKING STATEMENTS
  1
     
PART I
  
 
     
ITEM 1.
  
Business
  
2
         
ITEM 2.
  
Properties
  
12
         
ITEM 3.
  
Legal Proceedings
  
13
         
PART II
  
 
     
ITEM 5.
  
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
  
13
         
ITEM 7.
  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
  
14
         
ITEM 8.
  
Financial Statements and Supplementary Data
  
22
         
ITEM 9.
  
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
  
23
         
ITEM 9A.
  
Controls and Procedures
  
23
         
ITEM 9B.
  
Other Information
  
24
     
PART III
  
 
     
ITEM 10.
  
Directors, Executive Officers and Corporate Governance
  
25
         
ITEM 11.
  
Executive Compensation
  
27
         
ITEM 12.
  
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
  
28
         
ITEM 13.
  
Certain Relationships and Related Transactions, and Director Independence
  
30
         
ITEM 14.
  
Principal Accounting Fees and Services
  
30
         
PART IV
  
 
     
ITEM 15.
  
Exhibits, Financial Statement Schedules
  
32
         
SIGNATURES
      34
 
 
i

 
 
 FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (“Annual Report”) for Liberator, Inc. (“Liberator” the “Company””we” “our” or “us”) may contain forward-looking statements, which include statements that are predictive in nature, depend upon or refer to future events or conditions, and usually include words such as "expects," "anticipates," "intends," "plan," "believes," "predicts", "estimates" or similar expressions. In addition, any statement concerning future financial performance, ongoing business strategies or prospects and possible future actions are also forward-looking statements. Forward-looking statements are based upon current expectations and projections about future events and are subject to risks, uncertainties and the accuracy of assumptions concerning the Company, the performance of the industry in which they do business and economic and market factors, among other things. These forward-looking statements are not guarantees of future performance.

Forward-looking statements speak only as of the date of this report, presentation or filing in which they are made. Except to the extent required by federal securities laws, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Our forward-looking statements in this report include, but are not limited to:
 
 
·
Statements relating to our business strategy;
 
 
·
Statements relating to our business objectives; and
 
 
·
Expectations concerning future operations, profitability, liquidity and financial resources.

These forward-looking statements are subject to risk, uncertainties and assumptions about us and our operations that are subject to change based on various important factors, some of which are beyond our control. The following factors, among others, could cause our financial performance to differ significantly from the goals, plans, objectives, intentions and expectations expressed in our forward-looking statements:
 
 
·
competition from other sexual wellness retailers and adult-oriented websites;
 
 
·
our ability to extend, renew or refinance our existing debt;
 
 
·
our ability to generate significant sales revenue from magazine, internet and radio advertising;
 
 
·
our plan to make continued investments in advertising and marketing;
 
 
·
our ability to maintain our brands;
 
 
·
unfavorable economic and market conditions and the impact on our leveraged financial position;
 
 
·
our reliance on credit cards as a form of payment;
 
 
·
our ability to keep up with new technologies and remain competitive;
 
 
·
our ability to continue as a going concern;
 
 
·
our history of operating losses and the risk of incurring additional losses in the future;
 
 
·
security breaches may cause harm to our systems;
 
 
·
supply interruptions from raw material vendors:
 
 
·
our ability to improve manufacturing efficiency at our production facility;
 
 
·
trends in raw material costs and other costs both in the industry and specific to the Company;
 
 
·
our ability to enforce and protect our intellectual property rights;

 
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·
we may be subject to claims that we have violated the intellectual property rights of others;
 
 
·
the loss of our main data center or other parts of our infrastructure;
 
 
·
systems failures and interruptions in our ability to provide access to our websites and content;
 
 
·
companies providing products and services on which we rely may refuse to do business with us;
 
 
·
changes in government laws affecting our business;
 
 
·
we may not be successful in integrating any acquisitions we make;
 
 
·
our dependence on the experience and competence of our executive officers and other key employees;
 
 
·
restrictions to access on the internet affecting traffic to our websites;
 
 
·
risks associated with currency fluctuations;
 
 
·
anticipated worsening US deficit and a rise in inflation in coming years that would put further stress on consumer spending;
 
 
·
management’s goals and plans for future operations;
 
 
·
risks associated with litigation and legal proceedings; and
 
 
·
other risks or uncertainties described elsewhere in this report and in other periodic reports previously and subsequently filed by the Company with the Securities and Exchange Commission.

PART I.
  ITEM 1.        Business

Our Business

We are a vertically integrated manufacturer that designs, develops and markets products and accessories that enhance intimacy. Liberator is also a nationally recognized brand trademark, brand category and a patented line of products commonly referred to as sexual positioning shapes and sex furniture. We are an integrated multi-channel, multi-brand direct-to-consumer retailer, distributor and wholesaler that also operate the Liberator brand website. We conduct our manufacturing, distribution and all administrative functions from a 140,000 square foot facility in Atlanta, Georgia.
 
We believe our Liberator customer base consists primarily of affluent, college educated couples that buy Liberator to enhance bedroom play and/or to improve sexual performance which may be inhibited by age and/or physical limitations.
 
The Company conducts direct to consumer business through its owned and managed website URL’s www.liberator.com and www.edenfantasys.com and the Liberator exhibition and concept store within our factory.

Through our wholly-owned subsidiary, OneUp Innovations Inc. (“OneUp”), we conduct wholesale business for Liberator products through five primary channels: (1) adult and female friendly retailers and specialty boutiques, (2) e-tailers who sell our products through adult, mass market, drug and other sites offering sexual wellness products, (3) adult “toy” home party businesses, (4) mail order catalogers, and (5) distributors of adult / sexual wellness products. These wholesale accounts have approximately 1,000 retail locations and/or websites in the United States and Canada. We have a growing number of retailers who are also adding a dedicated Liberator exhibition concept to their merchandising space. We also sell internationally under exclusive license and manufacturing agreements.
 
Under OneUp, we also function as an exclusive resale distributor of Tenga and Booty Parlor brands sold through the same wholesale and direct-to-consumer channels as branded Liberator products. For the year ended June 30, 2011, these product lines represented approximately fourteen percent of our consolidated net sales.

 
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In addition, the Company sells a line of contemporary beanbag seating under the Jaxx brand. Jaxx is an offshoot from Liberator manufacturing as it provides additional revenue from repurposing our polyurethane foam trim into shredded beanbag fill. The Jaxx product line and accessory products are sold through the following four wholesale channels: (1) beanbag e-tailers, (2) mass market and drug, (3) mail order catalogers, and (4) retail furniture stores. The Company also owns and manages a website under the URL www.studiooneup.com for direct to consumer sales. For the year ended June 30, 2011, this product line represented approximately ten percent of our consolidated net sales.
 
Unless the context requires otherwise, all references in this report to the “Company,” “Liberator,” “we,” “our,” and “us” refers to Liberator, Inc. and its subsidiaries.

Our executive offices are located at 2745 Bankers Industrial Dr., Atlanta, GA 30360; our telephone number is +1-770-246-6400.

Recent Developments – Entry Into a Material Definitive Agreement.

Stock Purchase Agreement

On October 6, 2011, the Company announced the signing of a definitive Stock Purchase Agreement (the “WMI Sale Agreement”) for the sale of our subsidiary, Web Merchants Inc. (“WMI”) to Web Merchants Atlanta, LLC (“WMA”), an entity controlled by the President and former majority shareholder of WMI, Fred Petrenko. Under the WMI Sale Agreement, the Company will receive the 25.4 million shares of Liberator common stock owned by Mr. Petrenko and a cash payment of $700,000 in exchange for the issued and outstanding stock of WMI currently owned by the Company. The Company received $150,000 upon the signing of the WMI Sale Agreement, with the balance due upon the closing of the transaction.
 
Upon the closing of the transaction, Fred Petrenko will resign as a director and Executive Vice President of the Company, and Rufina Bulatova will resign as Vice President – Online Marketing of the Company.
 
The above descriptions of the Stock Purchase Agreement are qualified in their entirety by the terms and conditions of the Stock Purchase Agreement, a copy of which is filed as Exhibit 10.26 hereto.

Escrow Agreement

As part of the WMI Sale Agreement, the Company will also enter into an Escrow Agreement with WMA (the “WMA Escrow Agreement”) covering the 25.4 million shares of Liberator common stock that will be transferred as part of the WMI Sale Agreement. Under the WMA Escrow Agreement, the 25.4 million shares of Liberator common stock will be held in escrow until outstanding loans from Advance Financial Corporation and Credit Cash LLC (see Notes to Consolidated Financial Statements – Note K-Line of Credit and Note L-Credit Card Advance) are either satisfied or WMI and Mr. Petrenko have been provided with a written release of any liability as a guarantor. Under the agreement, the Company shall obtain such releases no later than August 1, 2012, at which time the Liberator common stock shall be released to the Company. If by August 1, 2012, the Company has not satisfied the loans from Advance Financial Corporation and Credit Cash LLC and WMI and Mr. Petrenko have not been provided with written releases of liability, then the 25.4 million shares of Liberator common stock will be delivered from escrow to WMA who may use them to satisfy such loans. The above descriptions of the WMA Escrow Agreement are qualified in their entirety by the terms and conditions of the Escrow Agreement, a copy of which is filed as Exhibit 10.27 hereto.

Lease Agreement

The Company also entered into a month-to-month Lease Agreement whereby WMI will rent space in the Company’s facility for $12,000 per month. This Lease Agreement may be terminated by either party upon 30 days written notice. The above descriptions of the Lease Agreement are qualified in their entirety by the terms and conditions of the Lease Agreement, a copy of which is filed as Exhibit 10.28 hereto.

The transaction is expected to close no later than October 21, 2011 and will be effective October 1, 2011, the first day of the Company’s second fiscal quarter.

 
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Corporate History

Liberator, Inc. (the “Company”), located in Atlanta, Georgia, was incorporated in the State of Florida on February 25, 1999, under the name of WES Consulting, Inc. to provide consulting and commercial property management services. On October 19, 2009, the Company entered into a Merger and Recapitalization Agreement (the “Merger Agreement”) with Liberator, Inc. (f/k/a Remark Enterprises Inc.), a Nevada corporation (“Old Liberator”).  Pursuant to the Merger Agreement, Old Liberator merged with and into the Company, with the Company surviving as the sole remaining entity (the “Merger”). References to the “Company” in this Annual Report includes the Company and its wholly owned subsidiaries, Web Merchants, Inc, OneUp Innovations, Inc. and Foam Labs, Inc.

As a result of the Merger, each issued and outstanding share of the common stock of Old Liberator (the “Old Liberator Common Shares”) were converted into one share of the Company’s common stock, $0.01 par value, which, after giving effect to the Merger, equaled, in the aggregate, 98.4% of the total issued and outstanding common stock of the Company (the “Liberator Common Stock”).  Pursuant to the Merger Agreement, each issued and outstanding share of preferred stock of Old Liberator (the “Liberator Preferred Shares”) was to be converted into one share of the Company’s preferred stock with the provisions, rights, and designations set forth in the Merger Agreement (the “Liberator Preferred Stock”).  On the execution date of the Merger Agreement, the Company was not authorized to issue any preferred stock. On February 11, 2011 the Company filed an amendment to its Articles of Incorporation authorizing the issuance of the Liberator Preferred Stock, and at that time the Liberator Preferred Stock was exchanged pursuant to the terms of the Merger Agreement.  As of the execution date of the Merger Agreement, Old Liberator owned 80.7% of the issued and outstanding shares of the Company’s common stock.  Upon the consummation of the Merger, the shares of Liberator Common Stock owned by Old Liberator prior to the Merger were cancelled.

On January 27, 2011, the Company entered into a Stock Purchase Agreement (the “Purchase Agreement”) with Web Merchants, Inc., a Delaware corporation (“WMI”) and Fyodor Petrenko and Dmitrii Spetetchii, the holders of 100% of WMI’s capital stock (the “WMI Shareholders”), to acquire 100% of WMI’s issued and outstanding equity ownership in exchange for 28,394,400 shares of our common stock to the WMI Shareholders.  Dmitrii Spetetchii also received $100,000 in cash, which represented $79,000 for the repayment of a loan he made to WMI and $21,000 in consideration for him signing a non-compete agreement with the Company.  Pursuant to the Purchase Agreement, WMI will continue to operate as a wholly owned subsidiary of the Company.  
 
On February 28, 2011, the Company name was changed from WES Consulting, Inc. to Liberator, Inc.
 
Liberator, Inc. (formerly known as Remark Enterprises, Inc), a Nevada Corporation (“Old Liberator”)

Old Liberator, Inc. was incorporated in the State of Nevada on October 31, 2007 under the name “Remark Enterprises Inc.”  Since inception, Old Liberator was engaged in organizational efforts and obtaining initial financing. Old Liberator was formed as a vehicle to pursue a business combination. On March 11, 2009, Old Liberator formed OneUp Acquisition, Inc., a Georgia corporation as a wholly owned subsidiary (the “Subsidiary”).  On April 3, 2009, Old Liberator entered into a Stock Purchase and Recapitalization Agreement with OneUp Innovations, Inc., a privately held Georgia corporation (“OneUp”), and the Subsidiary.  On June 26, 2009, Old Liberator consummated the transactions contemplated by the agreement, as amended.  Pursuant to the agreement, the Subsidiary and OneUp merged, and all of the issued and outstanding common stock of OneUp was exchanged for an aggregate of 45,000,000 shares of Old Liberator’s common stock (90% of the total issued and outstanding shares of common stock of Old Liberator).  In addition, all of the issued and outstanding shares of preferred stock of OneUp was exchanged for 4,300,000 shares of preferred stock of Old Liberator.  After the merger, OneUp became Old Liberator’s wholly owned subsidiary, and Old Liberator’s business operations were conducted through OneUp.  On July 2, 2009, Remark Enterprises, Inc. changed its name to “Liberator, Inc.”

OneUp Innovations, Inc.

Founded in Atlanta, Georgia in 2000, OneUp is a provider of goods to customers who believe that sensual pleasure and fulfillment are essential to a well-lived and healthy life.

Under OneUp Innovations, Liberator is a growing consumer brand that enhances intimacy by inspiring romantic imagination. Established with this conviction, Liberator Bedroom Adventure Gear® empowers exploration, fantasy and the communication of desire, no matter the person’s shape, size and orientation. Liberator may also be assistive to individuals who might have intimacy limitations due to age, weight, back problems and a myriad of other physical disorders. Products include the original Liberator shapes, sex furniture and accessory products. The company is also a wholesaler and distributor of other sexual wellness products from other manufacturers including vibrators, pleasure objects and related products.
 
As a brand, Liberator Bedroom Adventure Gear exists in a space where the act of love meets art and invention. Not prurient enough to be an “adult” product, yet too sexy to be considered mainstream, we created a retail category and brand called “Liberator” that defines ourselves in a marketplace that is rapidly gaining in popularity and acceptance.

 
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Since we shipped our first product in 2002, OneUp has evolved into a community of approximately 120 people that create, develop, manufacture, market and promote Liberator products that allow couples to have a fuller sexual experience for themselves and each other.

OneUp is primarily focused on building, developing and marketing its Liberator brand of Bedroom Adventure Gear products. Since inception, we have spent just under nine million dollars building awareness of the brand, primarily through magazine advertisements. We now intend to broaden our marketing reach by expanding our advertising to radio, internet and TV.
 
OneUp currently occupies 140,000 square feet in a vertically integrated manufacturing facility on eight acres in a suburb of Atlanta, Georgia. Our products are sold directly to consumers and through approximately one thousand domestic resellers and six international resellers, 1,400 internet marketing affiliates, and several dozen independent sales consultants within the United States. Other than the six international resellers, none of our customers are subject to a written agreement or are required to purchase or sell a specific amount of our products. Marketing affiliates are companies that operate websites that market our products on their websites. These marketing affiliates direct visitor traffic to our websites by using our technology to place banners or links on their websites to our website.

Web Merchants, Inc.

In January, 2011, the Company acquired Web Merchants Inc. (“WMI”) for $100,000 and the issuance of 28,524,400 shares of common stock. WMI was incorporated in Delaware on July 12, 2002 and is an online retailer offering a full range of products for the sexual wellness market. WMI sells its products through an internet website located at www.EdenFantasys.com. Sales are generated through organic search, social communities, over 1,000 marketing affiliates, and internet advertising which funnel traffic to the EdenFantasys.com website.
 
From the acquisition date through June 30, 2011, WMI had net sales of $4.5 million and net income of approximately $76,000.

See Recent Developments – Entry Into a Material Definitive Agreement, above, regarding information on the signing of a definitive agreement for the sale of WMI.

Industry Background

The Company participates in the rapidly growing worldwide market of sexual wellness. What was once called Family Planning has evolved over the last decade into a new category called Sexual Wellness, a growing worldwide movement toward sexual health. Many of the major health and wellness retailers, pharmacies and on-line retailers have started embracing this movement, especially over the last two to three years. A Google search of the term ‘Sexual Wellness” returns over 9 million entries, with the first three entries in organic search being Amazon.com, Walgreens.com, and Overstock.com.
 
Major consumer brands are rapidly entering the Sexual Wellness market, with either new products or repackaged existing products. Such brands include:

 
·
K-Y® : the personal lubricant first introduced in 1917, now offers 10 products including products marketed as climax enhancers, for massage and foreplay, lubricants with sensation and vaginal moisturizers.
 
 
·
Trojan Condoms®, the leading condom in North America, now offers a line of eight vibrators and vibrating products. A recent quote from the Trojan Condom website - “vibrators are increasingly becoming as common in Americans’ bedrooms as coffee makers are in their kitchens.”

 
·
Durex Condoms® (a division of £8.4 billion UK-based Reckitt Benckiser) now offers a selection of vibrating products in addition to condoms.

We believe that the category of Sexual Wellness is in the early stages of consumer awareness and that it will continue to grow and gain consumer acceptance to become a major trend in society.

Core Business Strengths

We believe we have the following core business strengths that we can leverage to implement our strategy:

 
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Design Vision

Our in-house design group continues to reinforce our constantly evolving brand image. Our products are designed to reflect utility and sensuality as well as be room décor that incorporates high quality fabrics and construction with comfort and performance in the bedroom. Evolving from our iconic Liberator shapes, we combined form with function to launch contemporary furniture and accessories for sex play, as well as products for mainstream and mass market retailers which embrace the sexual wellness category of products.
 
Advertising and Branding

The Liberator.com website is the primary branding and advertising vehicle for the Liberator brand. We believe our website reinforces the Liberator mission and brand image while driving sales to all of our wholesale channels. We also believe we have distinguished ourselves from other web e-tailers in the adult and sexual wellness space by using edgy photography, instructional videos and exceptional art direction combined with an entertainment bent.Liberator attracts customers to its website and other retailers and e-tailers through internally developed print ads, and radio and television advertising during holiday periods. These provocative advertising campaigns communicate a distinctive image that differentiates us and creates a connection and following with our customers. Since inception, over $8.7 million has been spent building brand awareness. We have also aligned the brand with the entertainment industry appearing in Meet the Fockers, Burn after Reading and numerous TV and media events.
 
Diverse Mainstream Appeal

The Liberator brand is marketed and distributed through diverse wholesale mass market channels, specialty retailers and web stores. We estimate that approximately 50% of our purchases are made jointly by couples, varying in ages from 30 to 55 years old, who view sexual expression and experimentation as essential to a well-lived life. Liberator, as a company, also understands and supports sexuality as a potentially positive force in everyone’s life, and celebrates sexual diversity, differing desires, relationships structures, and individual choices based on consent. We offer our customers a broad range of Liberator styles and designs. By offering such a broad range of products, including higher priced luxury items, we believe it elevates the perception of the brand while providing more accessible price points for every customer and budget.
 
Flexible and Vertically Integrated Model

Our vertically integrated business model, with manufacturing, distribution, product development and marketing in-house, allows us to create new products with reduced lead times at a lower cost while enabling us to quickly respond to market and customer demands for new product releases. For our wholesale accounts, being able to fulfill large orders with shorter turnaround times allows us to capture business during December and February when wholesale customers make just-in-time holiday purchases.
 
American Manufacturing and Sourcing

We implemented a state-of-the-art conveyor-based sewing system to manufacture sewn products at the lowest possible cost in the United States. Because all cutting, sewing, foam contouring, assembly and packaging are performed in-house, we believe we can exercise greater control over product quality and respond faster to changing customer demands, which gives us a competitive advantage over companies that utilize out-sourced sewing services. Liberator can source raw materials from multiple domestic suppliers and we have supply contracts in place to produce our specialty fabrics under specific quality control and performance standards with just-in-time deliveries.
 
Management Information Systems

Our Enterprise Resource Planning software is designed specifically for the sewn products industry to provide comprehensive inventory, order processing, production planning, accounting and management information for the marketing, manufacturing, finance and distribution functions of our business. Item level replenishment and real time inventory is directly linked to our website feeds and online wholesale order portals. We continue to expand and upgrade our information systems, networks and infrastructure to support recent and future growth. To support our internal information technology infrastructure, we have agreements with third party providers for hosting services and administration support.
 
During fiscal 2009, we implemented an enterprise level e-commerce platform and have made continued improvements and upgrades since then. We have agreements with our e-commerce and network providers to manage our data center with 24/7 response time and uptime guarantees.

 
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Business Strategy

As one of the few recognized brands in the sexual wellness market, our goals are to achieve long-term growth and profitability and diversify our sales base. We plan to achieve these goals using the following strategies:

 
·
Manufacturing. To improve our business results, we constantly look for ways to reduce the impact of rising raw material costs by improving the productivity of our manufacturing processes. We recently implemented modest price increases for certain products, but are unable to predict if we will be able to successfully pass on recent raw material cost increases to our wholesale and retail customers.
 
 
·
Wholesale Operations. Our goal is to increase consumer demand through advertising and public relations while our wholesale operations expands our offering to distributors, retailers and e-tailers across every channel of adult, mass market drug and specialty accounts. For wholesalers thinking about adding sexual wellness products to their retail or online store, Liberator is typically one of the first “safer” products presented as it can be promoted as an assistive aid to sexual positioning. As the mainstream demand for sexual wellness products grows, our sales staff is training and educating new resellers on how to get started in this space. For retail display, we offer mainstream packaging in a variety of sizes and price points to meet their customers particular demographic. For e-tailers, we maintain brand continuity by providing rich product content, photography and instructional videos for use on their websites. We also provide fulfillment services and can drop-ship orders directly to their customer, typically the same day the order is received. The distribution of other brands like Tenga and Booty Parlor further extends the reach of Liberator products beyond our core channels.
 
 
·
Product Development. This past year we strategically expanded our Liberator offering by introducing several product line extensions, including Liberator Décor Series (shapes that coordinate with bedding), Liberator Contemporary Chaise and Massage Bench, Liberator Sex Toy Mounts and the Liberator Collection featuring exclusive, limited-edition accessories with artisan level details. We also introduced the Liberator “Jaz series”, an offering of smaller-sized shapes designed for easier retail display at lower price points.
 
We are designing products for both form and function, crafting them with quality materials that define a new class of products that we call “Erotic Luxury”. We have developed a product growth strategy to capitalize on our strengths and core competencies of manufacturing and marketing. As a vertically integrated company, we plan to continue the development of new products in-house. This results in lower development costs and quicker sales execution to our established adult and sexual wellness channels, where the Liberator brand is often asked for by name. We also feel the Liberator brand name can be extended to a variety of other products including vibrators, pleasure objects and consumables like massage oils and lubricants.
 
Our customers are our source of inspiration for product development and they are sophisticated, creative and independent-minded when it comes to trying and buying new Liberator products. Our ability to grow the Liberator brand and develop new growth opportunities depends in part on our ability to appropriately identify and execute our strategies and initiatives. Implementation of these plans may be delayed or may not be successful for a variety of reasons.

 
·
Liberator Concept Store. Our 2,500 square foot Liberator exhibition store is the retail extension of our Liberator.com website. Located at our Atlanta factory, it is a gallery-like setting for sensual and erotic discovery, offering a presentation of products that celebrate intimacy and romantic imagination.
 
In our opinion, Liberator and luxury pleasure objects are meant to go together. Our concept store is a destination where customers can learn about, touch and purchase the Liberator products they have only been able to see online. In addition to Liberator branded shapes, furniture and accessories, the store features a range of better brands from around the globe including: designer sex toys, lounge-wear and lingerie collections, masks, cuffs and intimate accessories, erotic décor homewares, and bath and body essentials. Also included are limited addition hand-made items in glass, leather, latex and a collection of romantic gifts.
 
We are dedicated to bringing our customers a compelling in-store experience through knowledgeable associates, interactive media displays and a high level of service, quality and innovation. The store also serves as a laboratory to listen and observe consumer reaction to new products and evaluate price points and merchandising techniques.Our concept store has demonstrated the power of the Liberator brand as customers, both singles and couples want to feel and experience our products and, although we are located in an industrial park, they are willing to travel to the store, return repeatedly and refer friends. We believe that a Liberator branded retail concept is ready to be expanded beyond our single location to large metropolitan areas, providing an upscale experience in-sync with the overall mainstreaming of sexual wellness.

 
7

 

 
·
Jaxx and Contract Manufacturing. The Jaxx beanbag product line was originally started in 2007 with the idea that we could create higher value from using our polyurethane foam trim as beanbag fill verses recycling this material as carpet pad regrind. Since then, the Jaxx product line has developed into a wide variety of styles, sizes and fabric choices including those designed for children. Our wholesale and mass market distribution channels are established mostly as drop-ship accounts and are seasonally busy during November and December. Further growth is expected to come from Jaxx as we expand sales into retail stores. We also expect to develop higher priced modern design seating and private labeled products, and offer contract production services around our core competency in manufacturing.
 
The beanbag retail business is highly competitive. We believe we can compete effectively on the basis of product quality, design, customer service and price. We believe that our primary competitive advantages are consumer recognition of the Jaxx brand, as well as the multiple sale channels customers prefer to buy in. However, our plans to expand this product offering and sales channels may not be successful and implementation may hamper our operational and managerial resources.
 
Products and Services

Liberator Products

We developed a product category which we call “Liberator Bedroom Adventure Gear”. They are positioning props that elevate, rock and create surfaces and textures that expand the sexual repertoire and make the act of love more exciting.

Liberator Shapes are manufactured in a variety of heights and widths to accommodate variations in the human body. They consist of differently shaped cushions and props that are available in an assortment of fabric colors and prints to add to the visual excitement. Each of the product profiles of the Liberator Shapes is unique, designed to introduce positions to the sexual experience that were previously difficult to achieve or impossible to achieve with standard pillows or cushions. Liberator Gear is manufactured from structured polyurethane foam, cut at various angles, platforms and profiles. The foam base is encased in a tight, fluid resistant polyester shell, helping the cushions to maintain their shape.  The original offering of the Liberator Wedge and Ramp, sold as a set, are our best-selling items. All of the Liberator Shapes are also available in our Black Label Series which includes blindfolds and snap-on Velcro cuffs.
 
We have also developed larger profile designs that are commonly referred to as “sex furniture”. Three of the sex furniture pieces are made from contoured urethane foam and covered in a variety of fabrics and colors. These items are marketed as the Esse®, Esse Stage, and the Equus®. Other larger designs include products based on shredded polyurethane foam encased in a wide range of fabric types and colors and sold under our Zeppelin® product offering. The Liberator larger profile designs can also be used as seating when not being used for relaxed interaction and creative sex.
 
The products sold under the Liberator line provided 33.1% and 59.1% of our revenues for our fiscal years ended June 30, 2011 and 2010, respectively.  The decrease from 2010 to 2011, as a percentage of total revenue, is primarily due to the inclusion of the WMI revenues since the acquisition date and, to a lesser extent, lower sales of the products.
 
Studio OneUp Products

In addition to the Liberator product line, we also produce a line of casual foam-based furniture sold under the “Jaxx” brand. These products are primarily offered directly to consumers through our Studio OneUp web site and to e-Merchants under drop-ship arrangements where we ship directly to customers and to other resellers.  Our Studio OneUp products provided 9.3% and17.2% of our revenues for our fiscal years ended June 30, 2011and 2010, respectively.

Resale Products including Web Merchants, Inc.

Beginning in 2006, we began importing high-quality pleasure objects and erotica from around the world. With the acquisition of WMI in January, 2011, we significantly expanded the range of sexual wellness products offered. These resale products provided 48.5% and 17.1% of our revenues for our fiscal years ended June 30, 2011 and 2010, respectively. The primary reason for the significant increase from 2010 to 2011 is the inclusion of WMI revenues from the acquisition date and, to a lesser extent, an increase in sales of the Tenga products.
 
See Recent Developments – Entry Into a Material Definitive Agreement, above, regarding information on the signing of a definitive agreement for the sale of WMI.

 
8

 
 
Miscellaneous Products and Contract Manufacturing
 
We also manufacture couture lingerie, latex garments, fetish wear, and a line of boudoir bedding items that are sold under the Fascinator line.  The Fascinator line provided an immaterial portion of our revenues during the last 3 fiscal years. Beginning in early fiscal 2007, we began providing contract manufacturing services to companies seeking private label specialty products made from fabric and foam. These products are typically designed by the client companies and manufactured to their specifications and, to date, have not been a material part of our business.

Competition

Competition among retailers of adult products and web based marketers is high. We too compete with retail, catalog, and internet businesses and now mass and drug retailers that sell sexual wellness products including vibrators, pleasure objects, accessories and similar merchandise. We believe we are able to compete favorably as our Liberator products are unique, are couple-centric, and are assistive devices for couples with sexual limitations.
 
We believe that our primary competitive advantage is consumer recognition of our brand. Since we sell through multiple sales channels, we provide consumers with the ability to shop for intimacy products in an environment or website that they are most comfortable in. In fact, many e-tailer websites refer to Liberator as a product category and not as a discrete product. We also believe that we differentiate ourselves from conventional sex toys based on our utility of design and overall customer satisfaction as it relates to enhanced intimacy.
 
Our range of retail product price points places us in the 50th percentile of the average adult retail pleasure object purchased. We believe our success depends, in large part, on our ability to create and market products that enhance intimacy and provide consumers with on-going value which will lead them to purchase other Liberator styles and designs.
 
For the Liberator e-commerce website, other competitive factors include the effectiveness of our customer mailing lists, maintaining natural search listing, advertising response rates, website design and functionality. The broad range of designs, color choice, fabrics and essential accessories that we offer helps to differentiate us and allows us to compete favorably against many other adult or sexual wellness websites. Liberator.com also competes against numerous mainstream websites, many of which have a greater volume of web traffic, greater financial strength and marketing resources.
 
Intellectual Property

The Liberator trademark is registered with the United States Patent and Trademark office and with the registries of many foreign countries. In addition we were issued approximately 20 other product name trademarks and trade names including: “Bedroom Adventure Gear”, “Explore More”, Ramp, Wedge, Stage, Esse, Zeppelin, Hipster, Wing, Equus, and Bonbon. In August 2005, we were issued utility patent number US 6,925,669 “Support Cushion and System of Cushions” Additionally, for Jaxx, a United States Trademark was issued in 2009. We believe our trademarks and patent have significant value and we intend to continue to vigorously protect them against infringement.
 
Sales and Distribution

Our sales personnel are organized by geographic market and by customer type. In addition, in North America, we have sales personnel who routinely visit sexual wellness retailers to assist in product training, merchandising and stocking of selling areas. Through our in-house wholesale sales organization, we engage retailers directly and then either ship to them on a wholesale basis or provide fulfillment services by drop-shipping directly to their customers.

As is customary in the sexual wellness and casual furniture industry, sales to customers are generally made pursuant to purchase orders, and we do not have long-term or exclusive contracts with any of our retail customers or wholesale distributors. We believe that our continuing relationships with our customers are based upon our ability to provide a wide selection and reliable source of sexual wellness and casual furniture products, combined with our expertise in marketing and new product introduction.
 
Our ten largest customers (excluding our own e-commerce sites) accounted for approximately 14% of net sales for the year ended June 30, 2011. No single customer accounted for more than 10% of our net sales during that period. However, the loss of, or a significant adverse change in our relationship with, any of our largest customers could have a material adverse effect on our business, prospects, results of operations, financial condition or cash flows.

 
9

 

Marketing

Our marketing strategy is designed to increase brand awareness and drive highly targeted new and repeat customers to our websites, our e-merchants websites and our retail customers’ stores. We use a multi-channel approach which includes search engine marketing, print advertising, email campaigns, and affiliate programs to acquire and retain our customer base.
 
Online Marketing — We promote our websites via keywords and shopping feeds on internet search engines including but not limited to Google, Bing and Yahoo. Banner advertisements on display networks are also used to drive traffic to our websites. In addition, we operate affiliate programs aimed at creating brand awareness through websites who promote our products.
 
Email Campaigns — Our weekly email marketing campaigns distribute information on new products, promotional discounts and product information to registered e-commerce customers.
 
Direct Mail — WMI uses direct mail marketing initiatives which are focused on creating a social community and to further develop their EdenFantasys brand.

Print Advertising — For Liberator and Studio OneUp products, we place advertisements in a broad range of national magazines and consumers are directed to one of our primary e-commerce websites to learn more about our products and place their orders. We intend to expand our advertising efforts beyond magazines to reach broader segments of the population and increase our consumer base. These initiatives may include television and radio advertising.

Manufacturing Facilities
 
Our 140,000 square foot facility on eight acres is located in metro Atlanta, Georgia and includes manufacturing and distribution, sales and marketing, product development, customer service and administrative staff.

Our manufacturing operation has CAD controlled fabric cutting and foam contouring equipment and two state-of-the-art conveyor unit production sewing systems. Our in-house manufacturing capabilities have enabled us to achieve greater efficiencies and cost savings, as well as strict control over the entire manufacturing cycle including raw material procurement, finished goods production and logistics optimization. In addition to providing us with greater production flexibility, our in-house manufacturing provides us with the opportunity to improve market response time, reduces the risk of out-of-stock situations, limits finished goods obsolescence and improves overall operating margins.
 
Technology and Operations
 
Our websites are supported by a technology infrastructure that is designed to provide a superior customer experience, including speed, ease of use and security. Our technology infrastructure uses highly scalable, fully fault tolerant enterprise-class technology and provides a high-availability system that we believe rival those of larger companies. We maintain strategic partnerships with vendors to ensure that we can rapidly deploy new products and information technology solutions that we believe are key to our success.
 
We follow rigorous industry standards to protect our internal operations and the personal information we collect from our customers. We do not sell or disclose the personal information of our customers. We continue to maintain and upgrade our technology framework that can support high levels of security while meeting the compliance requirements of Payment Card Industry (“PCI”) security standards. We are considered a “sender” under the CAN-SPAM Act and comply with the applicable aspects thereof.
 
WMI has installed a technologically advanced finished goods inventory control system to track finished goods from receipt through shipment. All WMI items are bar-coded to facilitate electronic tracking, allowing us to tie each stock keeping unit (“SKU”) number back to our inventory control, shipping and sales systems. The WMI inventory control system analyzes and automatically reorders a majority of the products we sell, minimizing out-of-stock situations. We consistently evaluate low volume items in order to minimize losses due to obsolescence as well as to efficiently manage our capital and warehouse space.
 
See Recent Developments – Entry Into a Material Definitive Agreement, above, regarding information on the signing of a definitive agreement for the sale of WMI.

 
10

 

Licenses

In mid-2008, we launched an international expansion program through a licensing program. Through a co-manufacturing arrangement whereby the foam is contoured in the local country, the Company has created a way for local partners to launch the brand quickly and aggressively. Each licensee has the full capability to sell directly to consumers and traditional resellers, and has made significant financial commitments to marketing the Liberator brand through country specific advertising channels which include print, television, and radio. These licensees are also empowered to interpret the brand so as to be culturally sensitive to their respective territories.

Since September 2008, we have issued six license agreements that cover 11 countries around the world including the UK, Germany, Netherlands, Belgium, France, Italy, Australia / New Zealand, Singapore, Indonesia, and Malaysia (with a combined population greater than 250 million residents.) All territories will have, if not already, a fully functional consumer website, and in some cases, our partners intend to develop Liberator Lovestyle retail stores.

International websites are now offering Liberator products in Singapore, the United Kingdom, the Netherlands, Germany, Belgium, France, and Australia/New Zealand.

These international licensees are expected to eventually be distribution pipelines which will market the Liberator branded products, ranging from consumables and toys to shapes and furniture. Under the licensing agreements, the licensees are encouraged to open all sales channels within their territories including big box retailers, drugstores, and other retail channels. Sales to licensees consist of an initial license fee plus recurring product sales. Product sales and license fees from international licensees was less than 3% of total net sales in fiscal 2009 and less than 1% of total net sales during fiscal 2010 and 2011. The international license agreements, which have a term of three to six years, appoint the companies or individuals as exclusive distributors in their respective territories (with no minimum annual purchase requirements) and require the licensees to spend specific amounts on advertising in their local markets. The international license agreements may be terminated at any time upon the mutual written agreement of the parties, and upon the occurrence of any event of default, as defined in the agreements.

Sales Channels

We conduct our business through two primary sales channels: Direct (consisting of our Internet websites) and Wholesale (consisting of our stocking reseller, drop-ship, contract manufacturing and distributor accounts). The following is a summary of our revenues:

(Dollars in thousands)
 
Fiscal
2009
   
Fiscal
2010
   
Fiscal
2011
 
Direct
  $ 5,144     $ 5,355     $ 9,738  
Wholesale
    4,022       4,736       6,450  
Other
    1,095       989       1,136  
Total Net Sales
  $ 10,261     $ 11,080     $ 17,324  

Net sales in the Other channel consists of shipping and handling fees derived from our Direct business.

Direct

The following is a summary of our Direct business net sales and the percentage relationship to total revenues:

(Dollars in thousands)
 
Fiscal
2009
   
Fiscal
2010
   
Fiscal
2011
 
Direct sales channel net sales
  $ 5,144     $ 5,355     $ 9,738  
Direct net sales as a percentage of total revenues
    50.1 %     48.3 %     56.2 %

Wholesale

The following is a summary of our net sales to Wholesale customers and the percentage relationship to total revenues:

(Dollars in thousands)
 
Fiscal
2009
   
Fiscal
2010
   
Fiscal
2011
 
Wholesale sales channel net sales
  $ 4,022     $ 4,736     $ 6,450  
Wholesale net sales as a percentage of total revenues
    39.2 %     42.7 %     37.2 %

As of June 30, 2011, the Company has approximately 650 active wholesale accounts, most of which are located in the United States.

 
11

 


Internet Websites

Since 2002, our Liberator website located at www.Liberator.com has allowed our customers to purchase our Liberator merchandise over the Internet.  We design and operate our websites using an in-house technical and creative staff.

Our www.Liberator.com website is intended to be an entertainment and educational venue where consumers can watch product demonstration videos, videos on sexual wellness topics and humorous videos on the many facets of human sexuality. EdenFantasys.com is the only adult website that leverages community to provide a unique shopping experience in the sexual wellness sector.  We believe that peer-to-peer customer introduction to the adult products leads to higher conversions, deeper satisfaction with the purchase and therefore increased repeat business. The product offering on EdenFantasys.com is over 10,000 SKUs that feature 42,000 peer reviews, 1,500 videos, and over 2,000 educational articles contributed by 35,000 active community members.  See Recent Developments – Entry Into a Material Definitive Agreement, above, regarding information on the signing of a definitive agreement for the sale of WMI.

Government Regulation

We are subject to customs, truth-in-advertising and other laws, including consumer protection regulations that regulate the promotion and sale of merchandise and the operation of warehouse facilities. We monitor changes in these laws and believe that we are in material compliance with applicable laws.

Seasonality

Our business is seasonal and, as a result, revenues will vary from quarter to quarter. During the past three years, we have realized an average of approximately 28% of our annual revenues in our second quarter, which includes Christmas, and an average of approximately 28% of our revenues in the third quarter, which includes Valentine’s Day.

Geographic Information

During our last two years, substantially all of our revenue was generated within North America, and all of our long-lived assets are located within the United States.

Employees and Labor Relations

As of September 25, 2011, we had 119 employees.  Additional staffing is typically required for peak holiday periods through Valentine’s Day.  None of our employees are represented by a union. We have had no labor-related work stoppages, and we believe our relationships with our employees are good.

Available Information

We are required to file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). These filings are available to the public via the Internet at the SEC’s website located at http://www.sec.gov. You may also read and copy any document we file with the SEC at the SEC’s public reference room located at 100 F Street, N.E., Washington, D.C. 20549. For more information, please call the SEC at 1-800-SEC-0330.

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports and the Proxy Statement for our Annual Meeting of Stockholders are made available, free of charge, on our website, http://www.liberator.com, as soon as reasonably practicable after such reports have been filed with or furnished to the SEC.  Information on this website is not a part of this Report.

ITEM 2.
Properties

We are headquartered in Atlanta, Georgia. Our mailing address is 2745 Bankers Industrial Drive, Atlanta, GA 30360. We lease a 140,000 square feet building on eight acres which we believe allows for expansion when needed. Our facility houses manufacturing, distribution and fulfillment, call center, in-house advertising and creative departments, product design group, administrative offices and a 2,500 square foot factory concept store. The lease is on an escalating schedule with the final year on the lease at $34,358 per month.  The lease for this facility expires on December 31, 2015.

We believe our facilities are currently adequate for their intended purposes and are adequately maintained.

See Recent Developments – Entry Into a Material Definitive Agreement, above, regarding information on the signing of a definitive agreement for the sale of WMI and other actions, including the signing of a month-to-month lease agreement with WMI.

 
12

 

ITEM 3.
Legal Proceedings

As of the date of this Annual Report, there are no material pending legal or governmental proceedings relating to our company or properties to which we are a party, and to our knowledge there are no material proceedings to which any of our directors, executive officers or affiliates are a party adverse to us or which have a material interest adverse to us, except that on September 1, 2010, Donald Cohen, a former officer, director and independent sales representative of Liberator, Inc., commenced an action against the Company and other defendants including certain current officers and directors, under the caption Cohen v. WES Consulting, Inc., OneUp Innovations, Inc., OneUp Acquisitions, Inc., Liberator, Inc., f/k/a Remark Enterprises, Inc., Remark Enterprises, Inc., Belmont Partners LLC, Louis Friedman, Ronald Scott and Leslie Vogelman, Civil Action File No. 100V10590-8. in the Superior Court of Dekalb County, Georgia.  The plaintiff seeks repayment of a shareholder loan in the amount of $29,948 and unspecified amounts of compensatory, punitive, and statutorily trebled damages. The plaintiff alleges breach of fiduciary duty, breach of contract, fraud, and violation of the Georgia Securities Act, among other claims.  The Company intends to vigorously contest the case and filed a motion to dismiss the lawsuit on October 15, 2010. The motion was converted to a motion for summary judgment, and the Court held a hearing on that motion on April 12, 2011. The Court has not ruled on the motion for summary judgment and stayed discovery until a ruling is issued.  Although we believe that we have meritorious defenses to Mr. Cohen’s claims, this matter is still at a preliminary stage, and we are not in a position to predict or assess the likely outcome of these proceedings.  Accordingly, other than the amount of the shareholder loan, we have not reserved for any future loss that may arise as a result of an adverse outcome in this litigation.

PART II.
 
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock is quoted on the Over-the-Counter Bulletin Board (“OTCQB”) under the symbol “LUVU.”  The following table sets forth, for the periods indicated, the reported high and low closing bid quotations for our common stock as reported on the OTCBB.  The bid prices reflect inter-dealer quotations, do not include retail markups, markdowns, or commissions, and do not necessarily reflect actual transactions.

Fiscal Year
           
2011
 
High Bid
   
Low Bid
 
Fourth Quarter: 4/1/11 to 6/30/11
    0.21       0.15  
Third Quarter: 1/1/11 to 3/31/11
    0.28       0.05  
Second Quarter: 10/1/10 to 12/31/10
    0.15       0.05  
First Quarter: 7/1/10 to 9/30/10
    0.28       0.15  

Fiscal Year
           
2010
 
High Bid
   
Low Bid
 
Fourth Quarter: 4/1/10 to 6/30/10
    0.34       0.25  
Third Quarter: 1/1/10 to 3/31/10
    *       *  
Second Quarter: 10/1/09 to 12/31/09
    *       *  
First Quarter: 7/1/09 to 9/30/09
    *       *  
  

* Our common stock commenced trading on the OTCBB in May 3, 2010.

Holders

As of October 7, 2011, we had approximately 87 stockholders of record of our common stock.

Transfer Agent

The transfer agent and registrar for our common stock is Transfer Online, Inc., 512 SE Salmon Street, Portland, OR 97214.

 
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Dividend Policy
 
We have not paid dividends.  We plan to retain all earnings generated by our operations, if any, for use in our business. We do not anticipate paying any cash dividends to our shareholders in the foreseeable future. The payment of future dividends on the common stock and the rate of such dividends, if any, and when not restricted, will be determined by our board of directors in light of our earnings, financial condition, capital requirements, and other factors. Additionally, under the terms of our credit facility, we are precluded from paying a dividend and we may in the future issue preferred stock and/or other securities that provides for preferences over holders of common stock in the payment of dividends.

Securities Authorized for Issuance under Equity Compensation Plans

The following table sets forth information regarding securities authorized for issuance under our equity compensation plans as of June 30, 2011.

   
Number of securities
to be issued upon
exercise of
outstanding options
   
Weighted
average
exercise price
of outstanding
options
   
Number of securities
remaining, available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column (a))
 
   
(a)
   
(b)
   
(c)
 
Equity compensation plans approved by security holders (1)
    1,692,498     $ .194       3,307,502 (2)
Equity compensation plans not approved by security holders (3)
    438,456       .228       -0-  
                         
Total
    2,130,954     $ .201       3,307,502  
 
(1)
Includes option awards outstanding under our 2009 Stock Option Plan.
(2)
Includes shares remaining available for future issuance under our 2009 Stock Option Plan.
(3)
Non-qualified stock option issued to the Company’s Chief Financial Officer, Ronald Scott.

Recent Sales of Unregistered Securities
 
None.
  
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion summarizes the significant factors affecting the results of operations and financial condition of the Company during the fiscal years ended June 30, 2011 and 2010 and should be read in conjunction with our financial statements and accompanying notes thereto included elsewhere herein. Certain information contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are “forward-looking statements.”  Statements that are not historical in nature and which may be identified by the use of words like “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could be” and other words of similar meaning, are forward-looking statements.  These statements are based on management’s expectations and assumptions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed. Our actual results may differ materially from the results discussed in this section because of various factors, including those set forth elsewhere herein. See “Forward-Looking Statements” included in this report.

See Recent Developments – Entry Into a Material Definitive Agreement, above, regarding information on the signing of a definitive agreement for the sale of WMI.

Critical Accounting Policies and Estimates

Our consolidated financial statements included under Item 8 in this report have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). Our significant accounting policies are described in the notes to our consolidated financial statements. The preparation of financial statements in accordance with GAAP requires that we make estimates and assumptions that affect the amounts reported in our financial statements and their accompanying notes. We have identified certain policies that we believe are important to the portrayal of our financial condition and results of operations. These policies require the application of significant judgment by our management. We base our estimates on our historical experience, industry standards, and various other assumptions that we believe are reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions. An adverse effect on our financial condition, changes in financial condition, and results of operations could occur if circumstances change that alter the various assumptions or conditions used in such estimates or assumptions. Our critical accounting policies include those listed below.

 
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Revenue Recognition 

To recognize revenue, four basic criteria must be met: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectability is reasonably assured. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale; (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller; (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (6) the amount of future returns can be reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from shipments where title passes upon delivery is deferred until the shipment has been delivered.

Net sales are comprised of the total product sales billed during the period plus amounts paid for shipping and handling, less the actual returns, customer allowances, and customer discounts.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts to reflect our estimate of current and past due receivable balances that may not be collected. The allowance for doubtful accounts is based upon our assessment of the collectability of specific customer accounts, the aging of accounts receivable and our history of bad debts. We believe that the allowance for doubtful accounts is adequate to cover anticipated losses in the receivable balance under current conditions. However, significant deterioration in the financial condition of our customers, resulting in an impairment of their ability to make payments, could materially change these expectations and an additional allowance may be required.

Inventories

We value inventory at the lower of cost or market on an item-by-item basis and establish reserves equal to all or a portion of the related inventory to reflect situations in which the cost of the inventory is not expected to be recovered. This requires us to make estimates regarding the market value of our inventory, including an assessment for excess and obsolete inventory. Once we establish an inventory reserve amount in a fiscal period, the reduced inventory value is maintained until the inventory is sold or otherwise disposed of. In evaluating whether inventory is stated at the lower of cost or market, management considers such factors as the amount of inventory on hand, the estimated time required to sell such inventory, the foreseeable demand within a specified time horizon and current and expected market conditions. Based on this evaluation, we record adjustments to cost of goods sold to adjust inventory to its net realizable value. These adjustments are estimates, which could vary significantly, either favorably or unfavorably, from actual requirements if future economic conditions, customer demand or other factors differ from expectations.   Finished goods and goods in process include a provision for manufacturing overhead, including depreciation. 
 
Accounting for Income Taxes

We utilize the asset and liability method of accounting for income taxes. We recognize deferred tax liabilities or assets for the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities. We regularly assess the likelihood that our deferred tax assets will be recovered from future taxable income. We consider projected future taxable income and ongoing tax planning strategies in assessing the amount of the valuation allowance necessary to offset our deferred tax assets that will not be recoverable. We have recorded and continue to carry a full valuation allowance against our gross deferred tax assets that will not reverse against deferred tax liabilities within the scheduled reversal period. If we determine in the future that it is more likely than not that we will realize all or a portion of our deferred tax assets, we will adjust our valuation allowance in the period we make the determination. We expect to provide a full valuation allowance on our future tax benefits until we can sustain a level of profitability that demonstrates our ability to realize these assets. At June 30, 2011, we carried a valuation allowance of $2 million against our net deferred tax assets.

 
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Impairment of Long-Lived Assets

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An asset or asset group is considered impaired if its carrying amount exceeds the undiscounted future net cash flows the asset or asset group is expected to generate. If an asset or asset group is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. If estimated fair value is less than the book value, the asset is written down to the estimated fair value and an impairment loss is recognized.

In fiscal year 2011, we did not generate positive cash flows from operations. If our long-term future plans do not yield positive cash flows in excess of the carrying amount of our long-lived assets, we would anticipate possible future impairments of those assets.

Considerable management judgment is necessary in estimating future cash flows and other factors affecting the valuation of long-lived assets, including the operating and macroeconomic factors that may affect them. We use historical financial information, internal plans and projections and industry information in making such estimates.

New Accounting Pronouncements

Please refer to Note C, “Summary of Significant Accounting Policies—Recent Accounting Pronouncements” to our financial statements included in this report for a discussion on the impact of the adoption of new accounting pronouncements.

Results of Operations

Overview

Comparisons of selected consolidated statements of operations data as reported herein follow for the periods indicated:

   
Year Ended
June 30, 2011
   
Year Ended
June 30, 2010
   
%
Change
 
Total Company:
                 
Net sales
  $ 17,323,689     $ 11,079,760       56 %
Gross profit
  $ 5,708,722     $ 3,680,399       55 %
Loss from operations
  $ (304,318 )   $ (624,258 )      
Diluted (loss) per share
  $ (0.01 )   $ (0.02 )      

   
Year Ended
June 30, 2011
   
Year Ended
June 30, 2010
   
%
Change
 
Net Sales by Channel:
                 
Direct
  $ 9,737,660     $ 5,354,622       82 %
Wholesale
  $ 6,449,701     $ 4,735,789       36 %
Other
  $ 1,136,328     $ 989,349       15 %
Total Net Sales
  $ 17,323,689     $ 11,079,760       56 %

Other revenues consist principally of shipping and handling fees derived from our Direct business.  

   
Year Ended
   
Margin
   
Year Ended
   
Margin
   
%
 
   
June 30, 2011
   
%
   
June 30, 2010
   
%
   
Change
 
Gross Profit by Channel:
                             
Direct
  $ 5,173,444       53 %   $ 2,601,700       49 %     99 %
Wholesale
  $ 1,440,421       22 %   $ 1,177,732       25 %     22 %
Other
  $ (905,143 )     (80 )%   $ (99,033 )     (10 )%     (814 )%
Total Gross Profit
  $ 5,708,722       33 %   $ 3,680,399       33 %     55 %

Fiscal Year ended June 30, 2011 Compared to the Fiscal Year Ended June 30, 2010

Net sales for the twelve months ended June 30, 2011 increased from the comparable prior year period by $6.2 million, or 56%.  The increase in total net sales was substantially due to an increase in sales through the Direct channel which resulted from the inclusion of WMI revenues from January 27, 2011 (the “Acquisition Date”) and, to a lesser extent, higher sales of Tenga products through the Wholesale channel.  The Direct sales channel, which consists of consumer sales through our three websites and, to a lesser extent, our single retail store, increased from approximately $5.4 million in the twelve months ended June 30, 2010 to approximately $9.7 million in the twelve months ended June 30, 2011, an increase of approximately 82%.  As previously discussed, this increase resulted primarily from the inclusion of WMI revenues from the Acquisition Date and was partially offset by slightly lower aggregate sales through the OneUp Innovations websites.  As a result of an ongoing focus on our Wholesale business, sales to wholesale customers increased approximately 36% from the prior year to approximately $6.4 million. The Wholesale sales channel includes products sold under exclusive distribution agreements (like the Tenga product line), Liberator products sold to distributors and retailers, and private label items sold to other resellers. The Wholesale sales channel also includes contract manufacturing services which consists of specialty items that are manufactured in small quantities for certain customers, and which, to date, has not been a material part of our business. The Other sales channel increased 15% to $1.1 million in the twelve months ended June 30, 2011.  The Other sales channel consists principally of shipping and handling fees derived from our Direct sales channel.  The percentage increase in the Other sales channel was significantly less than the percentage increase in the Direct sales channel for the year ended June 30, 2011, because the majority of the WMI shipments are sold with free shipping and handling.

 
16

 

Gross profit, derived from net sales less the cost of product sales, includes the cost of materials, direct labor, manufacturing overhead and depreciation.  Total gross profit as a percentage of sales for the year ended June 30, 2011 was unchanged from the prior year at 33%.   During the year ended June 30, 2011, the gross profit on sales through the Direct sales channel increased to 53% from 49% in the prior year.  This increase is primarily due to the inclusion of the higher margin WMI sales from the Acquisition Date.  The gross profit from the Wholesale sales channel during the year ended June 30, 2011 decreased to 22% from 25% in the prior year. This decrease during fiscal 2011was due to a change in product mix to a greater percentage of non-Liberator products sold during the year.  The gross profit from the Other sales channel decreased to a negative $905,143 during the year ended June 30, 2011 from the prior year due to the inclusion of the WMI results from the Acquisition Date and the fact that most of their shipments are sent with “free” or significantly reduced shipping and handling.  Because product gross profit margins for all products in a given distribution channel are comparable, we analyze and manage our business based on changes in distribution channels and not by product mix.

Total operating expenses for the year ended June 30, 2011 were 35% of net sales, or $6,013,040, compared to 39% of sales, or $4,304,656, for the year ended June 30, 2010. Operating expenses increased 40% from fiscal 2010 to fiscal 2011 and was primarily the result of the inclusion of the WMI operating expenses from the Acquisition Date through June 30, 2011.  Total operating expenses for WMI during the period totaled $1,736,491.  Advertising and promotion expense increased by $321,614 to $1,003,946 during the year ended June 30, 2011, with $611,193 attributable to WMI.  Other selling and marketing expense increased by $797,581, with $603,485 attributable to WMI and the remaining increase being attributable to higher personnel related costs including salaries, commission expense and travel expense.  General and administrative expense increased by $510,978, with $501,040 being WMI general and administrative expense. Total legal expense during the year ended June 30, 2011, excluding acquisition related legal expense, was $258,689.

Other income (expense) increased from expense of ($409,695) in fiscal 2010 to expense of ($496,934) in fiscal 2011.  Interest expense and financing costs in the current year included $49,028 from the amortization of the debt discount on the convertible notes, additional interest expense on higher debt balances, and $96,000 relating to the up-front finance charges on the two credit card advances. Expenses related to merger ($52,500) in the current year consist of the fair market value of the 350,000 shares issued to Belmont Partners, LLC in connection with a Settlement Agreement and General Release we entered into on October 13, 2010.  Expenses related to merger in the prior year consists of $192,167 for the discounted face value of the $250,000 convertible note payable to Hope Capital, Inc., a shareholder of the Company.

No expense or benefit from income taxes was recorded in the twelve months ended June 30, 2011 or 2010. We do not expect any U.S. federal or state income taxes to be recorded for the current fiscal year because of available net operating loss carry-forwards.

We had a net loss of $801,252, or ($0.01) per diluted share, for the twelve months ended June 30, 2011 compared with a net loss of $1,033,952, or $(0.02) per diluted share, for the twelve months ended June 30, 2010.

Variability of Results
 
We have experienced significant quarterly fluctuations in operating results and anticipate that these fluctuations may continue in future periods. As described in previous paragraphs, operating results have fluctuated as a result of changes in sales levels to consumers and wholesalers, competition, costs associated with new product introductions, and increases in raw material costs. In addition, future operating results may fluctuate as a result of factors beyond our control such as foreign exchange fluctuation, changes in government regulations, and economic changes in the regions in which we operate and sell.  A portion of our operating expenses are relatively fixed and the timing of increases in expense levels is based in large part on forecasts of future sales. Therefore, if net sales are below expectations in any given period, the adverse impact on results of operations may be magnified by our inability to meaningfully adjust spending in certain areas, or the inability to adjust spending quickly enough, as in personnel and administrative costs, to compensate for a sales shortfall. We may also choose to reduce prices or increase spending in response to market conditions, and these decisions may have a material adverse effect on financial condition and results of operations.

 
17

 

Liquidity and Capital Resources

   
Year Ended
 
The following table summarizes our cash flows:
 
June 30,
 
   
2011
   
2010
 
Cash flow data:
           
Cash used in operating activities
  $ (564,339 )   $ (1,661,640 )
Cash provided by (used in) investing activities
    35,518       (189,178 )
Cash provided by financing activities
  $ 654,210     $ 423,844  
    
As of June 30, 2011, our cash and cash equivalents totaled $514,048, compared to $388,659 in cash and cash equivalents as of June 30, 2010.

Operating Activities

Net cash used in operating activities primarily consists of net loss adjusted for certain non-cash items, including depreciation, amortization, stock-based compensation, expenses related to the merger, and the effect of changes in working capital. Net cash used in operating activities was $564,339 and $1,661,640 in the years ended June 30, 2011 and 2010, respectively.

Investing Activities

Cash provided by investing activities in the year ended June 30, 2011 of $35,518 was attributable to capital expenditures of $94,635 for the purchase of production equipment, leasehold improvements and computer equipment, less the net cash acquired of $130,153 in Web Merchants, Inc.

Cash used in investing activities in the year ended June 30, 2010 of $189,178 was primarily attributable to the purchase of production equipment, computer equipment and capitalized software development costs.

Financing Activities

Cash provided by financing activities in the year ended June 30, 2011 of $654,210 was primarily attributable to borrowings from unsecured notes payable, proceeds from the credit card advances, and net borrowings under our line of credit, partially offset by the repayment of the notes and lease payable and the credit card advances.

Cash provided financing activities in the year ended June 30, 2010 of $423,844 was primarily attributable to the sale of common stock, net borrowings under the line of credit and borrowings from unsecured notes payable, partially offset by the repayment of the line of credit and other obligations.
 
Sufficiency of Liquidity
 
The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles, which contemplates continuation of the Company as a going concern. We incurred a net loss of $801,252 for the year ended June 30, 2011 and a net loss of $1,033,952 for the year ended June 30, 2010. As of June 30, 2011, we have an accumulated deficit of $6,976,783 and a working capital deficit of $984,937.

In view of these matters, realization of a major portion of the assets in the accompanying balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon our ability to meet our financing requirements, and the success of our future operations. Management believes that actions presently being taken to revise our operating and financial requirements provide the opportunity for the Company to continue as a going concern.

These actions include an ongoing initiative to increase gross profit margins through improved production controls and reporting. To that end, the Company implemented a new Enterprise Resource Planning (ERP) software system during the first quarter of fiscal 2010. We also plan to manage discretionary expense levels to be better aligned with current and expected revenue levels. Furthermore, our plan of operation during the next twelve months continues a strategy for growth within our existing lines of business with an on-going focus on growing domestic sales. We estimate that the operational and strategic growth plans we have identified will require approximately $1,800,000 of funding. We expect to invest approximately $1,800,000 on sales and marketing programs, primarily sexual wellness advertising in magazines, on the internet and on cable television. We will also be exploring the opportunity to acquire other compatible businesses.

 
18

 

We plan to finance the required $1,800,000 with a combination of cash flow from operations as well as cash on hand and cash raised through equity and debt financings.

Capital Resources

We do not currently have any material commitments for capital expenditures. We expect total capital expenditures for fiscal 2012 to be under $75,000 and to be funded by capital leases and, to a lesser extent, anticipated operating cash flows and borrowings under the line of credit. This includes capital expenditures in support of our normal operations and the integration of Web Merchants, Inc., a Delaware corporation that we acquired on January 27, 2011 and expenditures that we may incur in conjunction with initiatives to further upgrade our e-commerce platform, ERP system and computer infrastructure.

If our business plans and cost estimates are inaccurate and our operations require additional cash or if we deviate from our current plans, we could be required to seek additional debt financing for particular projects or for ongoing operational needs.  This indebtedness could harm our business if we are unable to obtain additional financing on reasonable terms.  In addition, any indebtedness we incur in the future could subject us to restrictive covenants limiting our flexibility in planning for, or reacting to changes in, our business.  If we do not comply with such covenants, our lenders could accelerate repayment of our debt or restrict our access to further borrowings, which in turn could restrict our operating flexibility and endanger our ability to continue operations.

At June 30, 2011, we had $460,758 outstanding on our line of credit, compared to an outstanding balance of $320,184 at June 30, 2010.
 
On May 24, 2011, the Company’s wholly owned subsidiary, OneUp Innovations, Inc. (“OneUp”), and OneUp’s wholly owned subsidiary, Foam Labs, Inc. (“Foam Labs”) entered into a credit facility with a finance company, Advance Financial Corporation, to provide it with an asset based line of credit of up to $750,000 against 85% of eligible accounts receivable (as defined in the agreement) for the purpose of improving working capital.  The term of the agreement is one year, renewable for additional one-year terms unless either party provides written notice of non-renewal at least 90 days prior to the end of the current financing period. The credit facility is secured by our accounts receivable and other rights to payment, general intangibles, inventory and equipment, and are subject to eligibility requirements for current accounts receivable. Advances under the agreement bear interest at a rate of 2.5% over the lenders Index Rate (as of June 30, 2011 the lenders Index Rate was 4.75%.)  In addition there is a Monthly Service Fee (as defined in the agreement) of up to 1.25% per month. The Company’s CEO, Louis Friedman, and the Company’s Executive Vice President, Fred Petrenko, have personally guaranteed the repayment of the loan obligation. In addition, the loan has a corporate guarantee from the parent, Liberator, Inc., and Web Merchants, Inc.  On June 30, 2011, the balance owed under this line of credit was $460,758.  On June 30, 2011, we were in substantial compliance with all of the material financial and other covenants required under this credit facility.

On May 19, 2011, OneUp and Foam Labs entered into a receivable advance agreement with CC Funding, LLC (“Credit Cash”), a division of Credit Cash NJ, LLC whereby Credit Cash agreed to loan OneUp and Foam Labs a total of $400,000. The loan is secured by OneUp’s and Foam Lab’s existing and future credit card collections. Terms of the loan call for a repayment of $448,000, which includes a one-time finance charge of $48,000, by March 19, 2012.  This will be accomplished by Credit Cash withholding a fixed amount each business day of $2,074 from OneUp’s credit card receipts until full repayment is made.  The loan is guaranteed by the Company and is personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman, and the Company’s CFO, Ronald P. Scott.

On November 4, 2010, OneUp and Foam Labs entered into a receivable advance agreement with Credit Cash, whereby Credit Cash agreed to loan OneUp and Foam Labs a total of $400,000. The loan is secured by OneUp’s and Foam Lab’s existing and future credit card collections. Terms of the loan call for a repayment of $448,000, which includes a one-time finance charge of $48,000, by May 4, 2011.  This will be accomplished by Credit Cash withholding a fixed amount each business day of $3,446 from OneUp’s credit card receipts until full repayment is made.  The loan is guaranteed by the Company and is personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman, and the Company’s CFO, Ronald P. Scott.  On May 5, 2011 this advance was repaid.

 
19

 

On May 17, 2010, OneUp and Foam Labs entered into a financing agreement with an “asset-based” lender, Summit Financial Resources LLC, for the purpose of improving working capital.  The agreement provided for up to $600,000 and was secured primarily by accounts receivable, inventory, equipment, and all general intangibles. Under the financing agreement, the lender agreed to make loans at our request and in the lender’s discretion (a) based on purchases of our Accounts by the lender, with recourse against us and an advance rate of 80% (or such other percentage determined by the lender in its discretion), and (b) based on Acceptable Inventory not to exceed certain amounts, including an aggregate maximum of $200,000, not to exceed 50% of the aggregate amount of outstanding Accounts on which an Advance has been made.  The inventory component of the financing agreement is available to the Company, at the discretion of the lender and based upon Acceptable Inventory, from October 1 through November 30 of each year.  The term of the agreement was one year, renewable for additional one-year terms unless either party provides written notice of non-renewal at least 60 days prior to the end of the current financing period. Advances under the agreement bear interest at a rate of 2% over the prime rate (as published in the Wall Street Journal) for the accounts receivable portion of the advances and the inventory portion of the borrowings. The prime rate (3.25% as of June 30, 2010) adjusts with changes to the rate. In addition there are collateral management fees of 0.4% for each 10-day period that an advance on an accounts receivable invoice remains outstanding and a 1.9% collateral management fee on the average monthly loan outstanding on the inventory portion of any advance. The agreement provided that no change in control concerning us or any of our active subsidiaries shall occur except with the prior written consent of the lender. Events of default include, but are not limited to, the failure to make a payment when due or a default occurring on any indebtedness of ours.  The financing agreement was personally guaranteed by the Company’s CEO and majority shareholder, Louis Friedman and by the Company.  The balance owed under this line of credit was repaid on May 27, 2011.

Off-Balance Sheet Arrangements

We do not use off-balance sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off-balance sheet arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities. As of June 30, 2011, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

We have entered into operating leases primarily for certain equipment and our facilities in the normal course of business. These arrangements are often referred to as a form of off-balance-sheet financing. Future minimum lease payments under our operating leases as of June 30, 2011 are detailed in section entitled “Contractual Obligations.”

Inflation

During fiscal 2011, we experienced increases in various raw material costs, and increases in costs impacted by increases in fuel prices, such as freight and transportation costs. We believe these pricing pressures have not stabilized and will continue to increase throughout fiscal 2012, although there is no assurance this will occur. Inflation can harm our margins and profitability if we are unable to increase prices or cut costs enough to offset the effects of inflation in our cost base. Furthermore, if our customers reduce their levels of spending in response to increases in retail prices and/or we are unable to pass such cost increases to our customers, our revenues and our profit margins may decrease. 

Non-GAAP Financial Measures

Reconciliation of net loss to Adjusted EBITDA loss for the years ended June 30, 2011 and 2010:
 
   
Year ended June 30,
 
   
2011
   
2010
 
Net loss
  $ (801,252 )   $ (1,033,952 )
                 
Less interest income
    (752 )     (4,543 )
                 
Plus interest expense
    396,158       176,256  
                 
Plus income tax expense
    -       -  
                 
Plus depreciation and amortization expense
    246,405       249,380  
                 
Plus merger related non-cash expense
    52,500       192,167  
                 
Plus common stock issued for services
    5,600       -  
                 
Plus stock-based compensation
    18,310       9,955  
                 
Plus amortization of debt issuance costs
    49,028       45,815  
                 
Adjusted EBITDA loss
  $ (34,003 )   $ (364,922 )

 
20

 

As used herein, Adjusted EBITDA represents net loss before interest income, interest expense, income taxes, depreciation, amortization, amortization of debt issuance costs, stock-based compensation expense and common stock issued for services. We have excluded the non-operating item, amortization of debt issuance costs, because it represents a non-cash charge that is not related to the Company’s operations. We have excluded the non-cash expenses, stock-based compensation and common stock issued for services, as they do not reflect the cash-based operations of the Company. Adjusted EBITDA is a non-GAAP financial measure which is not required by or defined under GAAP (Generally Accepted Accounting Principles). The presentation of this financial measure is not intended to be considered in isolation or as a substitute for the financial measures prepared and presented in accordance with GAAP, including the net loss of the Company or net cash used in operating activities. Management recognizes that non-GAAP financial measures have limitations in that they do not reflect all of the items associated with the Company’s net income or net loss as determined in accordance with GAAP, and are not a substitute for or a measure of the Company’s profitability or net earnings. Adjusted EBITDA is presented because we believe it is useful to investors as a measure of comparative operating performance and liquidity, and because it is less susceptible to variances in actual performance resulting from depreciation and amortization and non-cash charges for amortization of debt issuance costs, stock-based compensation expense and common stock issued for services.

 
21

 

ITEM 8.
Financial Statements and Supplementary Data
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
Page
Consolidated Financial Statements:
 
   
Report of Independent Registered Public Accounting Firm
F-1
   
Consolidated Balance Sheets as of June 30, 2011 and 2010
F-2
   
Consolidated Statements of Operations for the years ended June 30, 2011 and 2010
F-3
   
Consolidated Statements of Changes in Stockholders’ Equity (Deficit) from July 1, 2009 to June 30, 2011
F-4
   
Consolidated Statements of Cash Flows for the years ended June 30, 2011 and 2010
F-5
   
Notes to Consolidated Financial Statements
F-6

 
22

 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Liberator, Inc.

We have audited the accompanying consolidated balance sheets of Liberator, Inc. as of June 30, 2011 and 2010, and the related consolidated statements of operations, changes in stockholders’ equity (deficit), and cash flows for each of the years in the two year period ended June 30, 2011.  Liberator, Inc.’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Liberator, Inc. as of June 30, 2011 and 2010, and the results of its consolidated operations and its consolidated cash flows for each of the years in the two year period ended June 30, 2011, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note B to the financial statements, conditions exist which raise substantial doubt about the Company’s ability to continue as a going concern unless it is able to generate sufficient cash flows to meet its financing requirements and attain profitable operations. Management’s plans in regard to these matters are also described in Note B.  The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Gruber & Company, LLC

/s/ Gruber & Company, LLC

Lake Saint Louis, Missouri
September 26, 2011

 
F-1

 

Liberator, Inc. and Subsidiaries
Consolidated Balance Sheets

   
June 30,
2011
   
June 30,
2010
 
Assets:
           
Current assets:
           
Cash and cash equivalents
  $ 514,048     $ 388,659  
Accounts receivable, net of allowance for doubtful accounts of $14,055 in 2011 and $14,143 in 2010
    761,380       562,872  
Inventories, net
    2,068,735       908,851  
Prepaid expenses
    77,728       212,438  
Total current assets
    3,421,891       2,072,820  
                 
Equipment and leasehold improvements, net
    981,499       1,075,315  
Intangible Assets, net
    847,082        
Goodwill
    1,633,592        
Other Assets
    5,341        
Total assets
  $ 6,889,405     $ 3,148,135  
Liabilities and stockholders’ equity:
               
Current liabilities:
               
Accounts payable
  $ 2,391,339     $ 1,579,138  
Accrued compensation
    243,155       284,796  
Accrued expenses and interest
    187,716       125,869  
Line of credit
    460,758       320,184  
Short-term unsecured notes payable
    699,961       362,812  
Current portion of lease payable
    33,973       77,010  
Credit card advance
    389,926        
Total current liabilities
    4,406,828       2,749,809  
Long-term liabilities:
               
Note payable – equipment
          12,136  
Leases payable
    63,739       140,749  
Notes payable – related party
    145,948       105,948  
Convertible notes payable – shareholder (net)
    572,759       523,731  
Unsecured lines of credit
    71,393       99,664  
Deferred rent payable
    296,192       331,570  
Less: current portion of leases payable
    (33,973 )     (77,010 )
Total long-term liabilities
    1,116,058       1,136,788  
Total Liabilities
    5,522,886       3,886,597  
Commitments and contingencies
               
Stockholders’ equity (deficit):
               
Series A Convertible Preferred stock, 10,000,000 shares authorized, 4,300,000 shares issued and outstanding with a liquidation preference of $1,000,000 as of June 30, 2011 and  4,300,000 shares obligated to be issued as of June 30, 2010
    430        
Common stock, $0.01 par value, 175,000,000 shares authorized, 91,947,047 and 63,182,647 shares issued and outstanding in 2011 and 2010, respectively
    919,470       631,826  
Additional paid-in capital
    7,423,401       4,805,243  
Retained deficit
    (6,976,783 )     (6,175,531 )
Total stockholders’ equity (deficit)
    1,366,518       (738,462 )
Total liabilities and stockholders’ equity
  $ 6,889,405     $ 3,148,135  

The accompanying notes are an integral part of these consolidated financial statements.

 
F-2

 
 
Liberator, Inc. and Subsidiaries
Consolidated Statements of Operations
Years Ended June 30, 2011 and 2010

   
2011
   
2010
 
             
Net Sales
  $ 17,323,689     $ 11,079,760  
Cost of goods sold
    11,614,967       7,399,361  
Gross profit
    5,708,722       3,680,399  
Operating expenses
               
Advertising and promotion
    1,003,946       682,332  
Other selling and marketing
    1,981,972       1,184,391  
General and administrative
    2,699,532       2,188,554  
Depreciation
    246,405       249,380  
Acquisition-related costs
    81,185        
Total operating expenses
    6,013,040       4,304,657  
Loss from operations
    (304,318 )     (624,258 )
                 
Other Income (Expense):
               
Debt issuance costs
    (49,028 )     (45,815 )
Interest income
    752       4,543  
Interest expense and financing costs
    (396,158 )     (176,256 )
Expenses related to merger
    (52,500 )     (192,167 )
Total Other Income (Expense)
    (496,934 )     (409,695 )
Net Loss Before Income taxes
    (801,252 )     (1,033,952 )
Provision for Income Taxes
           
Net Loss
  $ (801,252 )   $ (1,033,952 )
Loss per share:
               
Basic
  $ (0.01 )   $ (0.02 )
Diluted
  $ (0.01 )   $ (0.02 )
Weighted-average number of common shares outstanding:
               
Basic
    75,396,312       62,103,434  
Diluted
    75,396,312       62,103,434  

The accompanying notes are an integral part of these consolidated financial statements.

 
F-3

 
 
Liberator, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity (Deficit)
From July 1, 2009 to June 30, 2011

                            
Total
 
   
Series A Preferred
         
Additional
         
Stockholders’
 
  
 
Stock
   
Common Stock
   
Paid-in
   
Accumulated
   
Equity
 
   
Shares
   
$
   
Shares
   
$
   
Capital
   
Deficit
   
(Deficit)
 
                                               
Balance, July 1, 2009
   
4,300,000 
   
 $
430 
     
60,932,981
   
 $
609,330
   
 $
4,515,854
   
(5,141,579
)
 
 $
(15,965
)
                                                         
Obligation to issue preferred stock
   
(4,300,000
   
(430
                   
430
     
-
         
Recapitalization in connection
with merger with Old Liberator, Inc.
   
-
   
 
-
     
983,000
     
9,830
     
(9,830
   
-
     
-
 
Common stock issued in private placement, net of $48,500 in issuance costs, fees and expenses
   
-
     
-
     
1,000,000
     
10,000
     
241,500
     
-
     
251,500
 
Shares issued for services in connection with the private placement
   
-
     
-
     
100,000
     
1,000
     
(1,000
)
   
-
     
-
 
Common stock issued in private
placement
   
     
 -
     
166,666
     
 1,666
     
48,334
             
50,000
 
Stock-based compensation
   
-
     
-
     
-
     
-
     
9,955
     
-
     
9,955
 
Net loss
   
-
     
-
     
-
     
-
     
-
     
(1,033,952
   
(1,033,952
Ending balance, June 30, 2010
   
-
   
$
-
     
63,182,647
   
$
631,826
   
$
4,805,243
   
$
(6,175,531
)
 
$
(738,462
)
           
 
             
 
     
 
     
 
 
 
 
 
 
 
Settlement of obligation to issue
preferred stock
   
4,300,000
     
430
                     
(430
)
               
Stock issuance in connection
with merger with Old Liberator,
Inc.
   
-
     
-
     
350,000
     
3,500
     
 
49,000
             
52,500
 
Common stock issued for
acquisition of Web Merchants,
Inc.
   
-
     
-
     
28,394,400
     
283,944
     
2,545,878
     
-
     
2,829,822
 
Shares issued for services
   
-
     
-
     
20,000
     
200
     
5,400
     
-
     
5,600
 
Stock-based compensation
   
-
     
-
     
-
     
-
     
18,310
     
-
     
18,310
 
Net loss
   
-
     
-
     
-
     
-
     
-
     
(801,252
)
   
(801,252
)
Ending balance, June 30, 2011
   
4,300,000
   
$
430
     
91,947,047
   
$
919,470
   
$
7,423,401
   
$
(6,976,783
)
 
$
1,366,518
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-4

 
 
Liberator, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended June 30, 2011 and 2010
 
  
 
2011
   
2010
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net loss
 
$
(801,252
)
 
$
(1,033,952
)
Adjustments to reconcile net loss to net cash provided by (used in) operating
        activities:
               
Depreciation and amortization
   
246,405
     
249,380
 
Stock-based compensation expense
   
18,310
     
9,955
 
Expenses related to merger
   
52,500
     
192,167
 
Common stock issued for services
   
5,600
     
-
 
Amortization of debt issuance costs
   
49,028
     
45,815
 
Change in operating assets and liabilities:
               
Accounts receivable
   
(198,420
   
(216,442
)
Provision for (reduction of) allowance for doubtful accounts
   
(88
   
-
 
Inventory
   
(537,572
   
(208,448
)
Provision for inventory reserve
   
139,931
     
-
 
Prepaid expenses
   
136,470
     
(116,547
)
Accounts payable
   
339,921
     
(668,707
)
Accrued expenses
   
61,847
     
(19,924
Accrued payroll and related
   
(41,641
   
129,802
 
Deferred rent payable
   
(35,378
   
(24,738
Net cash used in operating activities from continuing operations
   
(564,339
   
(1,661,640
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Cash investment in Web Merchants, Inc., net of cash acquired
   
130,153
     
-
 
Investment in equipment and leasehold improvements
   
(94,635
)
   
(189,178
)
Net cash provided by (used in) investing
   
35,518
 
   
(189,178
)
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net proceeds from sale of common stock
   
-
     
301,500
 
Borrowings under line of credit
   
5,076,351
     
2,056,071
 
Repayment of line of credit
   
(4,935,777
)
   
(1,907,320
)
Borrowings from related party loans
   
160,000
     
-
 
Repayment of related party loans
   
(79,000
)
   
(20,000
)
Repayment of unsecured line of credit
   
(85,294
)
   
-
 
Proceeds from credit card advance
   
896,000
     
-
 
Repayment of credit card advance
   
(506,074
)
   
(198,935
Proceeds from unsecured notes payable
   
530,000
     
465,000
 
Repayment of unsecured notes payable
   
(312,850
)
   
(127,513
Principle payments on note payable and capital leases
   
(89,146
)
   
(144,959
)
Net cash provided by financing
   
654,210
     
423,844
 
NET INCREASE/(DECREASE) IN CASH AND EQUIVALENTS
   
125,389
     
(1,426,974
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
   
388,659
     
1,815,633
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
514,048
   
$
388,659
 
                 
Supplemental Disclosure of Cash Flow Information:
               
Non cash items:
               
Note payable issued in acquisition of majority control
 
$
   
192,167
 
Stock issuance in the acquisition of Web Merchants, Inc.
   
2,839,440
     
 
Stock issuance in connection with the Merger of Old Liberator, Inc.
   
52,500
     
 
Cash paid during the year for:
               
Interest
 
$
295,646
   
$
153,763
 

The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-5

 

Liberator, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
 
NOTE A – ORGANIZATION AND NATURE OF BUSINESS
 
Overview Liberator, Inc. (the “Company”) was incorporated in the State of Florida on February 25, 1999, under the name of WES Consulting, Inc. to provide consulting and commercial property management services.  On October 19, 2009, the Company entered into a Merger and Recapitalization Agreement (the “Merger Agreement”) with Liberator, Inc. (fka Remark Enterprises Inc.), a Nevada corporation (“Old Liberator”).  Pursuant to the Merger Agreement, Old Liberator merged with and into the Company, with the Company surviving as the sole remaining entity (the “Merger”).  References to the “Company” in these notes include the Company and its wholly owned subsidiaries, Web Merchants, Inc, OneUp Innovations, Inc. and Foam Labs, Inc.

As a result of the Merger, each issued and outstanding share of the common stock of Old Liberator (the “Old Liberator Common Shares”) were converted into one share of the Company’s common stock, $0.01 par value, which, after giving effect to the Merger, equaled, in the aggregate, 98.4% of the total issued and outstanding common stock of the Company (the “Liberator Common Stock”).  Pursuant to the Merger Agreement, each issued and outstanding share of preferred stock of Old Liberator (the “Liberator Preferred Shares”) was to be converted into one share of the Company’s preferred stock with the provisions, rights, and designations set forth in the Merger Agreement (the “Liberator Preferred Stock”).  On the execution date of the Merger Agreement, the Company was not authorized to issue any preferred stock.  The parties agreed that the Company will file an amendment to its Articles of Incorporation authorizing the issuance of the Liberator Preferred Stock, and at such time the Liberator Preferred Stock will be exchanged pursuant to the terms of the Merger Agreement.  On February 18, 2011, the Company filed an Article of Amendment to its Articles of Incorporation, effective February 9, 2011, to increase the number of shares of capital stock to 185,000,000 of which 10,000,000 shares shall be designated Preferred Stock, $0.0001 par value.  In addition, the Company filed a Certificate of Designation to create a class of preferred stock titled Series A Convertible Preferred Stock.  These actions were both approved by the Board of Directors and a majority vote of the shareholders on October 20, 2009. As of the execution date of the Merger Agreement, Old Liberator owned 80.7% of the issued and outstanding shares of the Company’s common stock.  Upon the consummation of the Merger, the shares of Liberator Common Stock owned by Old Liberator prior to the Merger were cancelled.

On January 27, 2011,the Company entered into a Stock Purchase Agreement (the “Purchase Agreement”) with Web Merchants, Inc., a Delaware corporation (“WMI”) and Fyodor Petrenko and Dmitrii Spetetchii, the holders of 100% of WMI’s capital stock (the “WMI Shareholders”), to acquire 100% of WMI’s issued and outstanding equity ownership in exchange for 28,394,400 shares of our common stock to the WMI Shareholders.  Dmitrii Spetetchii also received $100,000 in cash, which represented $79,000 for the repayment of a loan to WMI and $21,000 in consideration for signing a non-compete agreement with the Company.  Pursuant to the Purchase Agreement, WMI will continue to operate as a wholly owned subsidiary of the Company. The foregoing summary of the acquisition of WMI does not purport to be complete and is qualified in its entirety by reference to the Current Report on Form 8-K filed on February 2, 2011.  In connection with the acquisition of WMI, the board of directors appointed Fyodor Petrenko, the President of WMI, as Executive Vice President of the Company and to the board of directors, filling a vacancy.  See Recent Developments – Entry Into a Material Definitive Agreement, above, regarding information on the signing of a definitive agreement for the sale of WMI.

Effective February 28, 2011, the Company changed its name to “Liberator, Inc.” by filing an Articles of Amendment to its Articles of Incorporation with the Florida Department of State.  A copy of the Articles of Amendment were included as an exhibit to the Company’s Current Report on Form 8-K filed on March 3, 2011. 

The Company is a designer and manufacturer of various specialty furnishings for the sexual wellness market.  Since the acquisition of WMI, the Company has also become an online retailer offering a full range of products for the sexual wellness market.  The Company’s sales and manufacturing operation are located in the same facility in Atlanta, Georgia.  Sales are generated through internet and print advertisements.  We have a diversified customer base with no one customer accounting for 10% or more of consolidated net sales in the most recently completed quarter and no particular concentration of credit risk in one economic sector.  Foreign operations and foreign net sales are not material.

NOTE B – GOING CONCERN

The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles, which contemplates continuation of the Company as a going concern. The Company incurred a net loss of $801,252 and $1,033,952 for the years ended June 30, 2011 and 2010, respectively, and as of June 30, 2011 the Company has an accumulated deficit of $6,976,783 and a working capital deficit of $984,937.

In view of these matters, realization of a major portion of the assets in the accompanying balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company’s ability to meet its financing requirements, and the success of its future operations.  Management believes that actions presently being taken to revise the Company’s operating and financial requirements provide the opportunity for the Company to continue as a going concern.
 
 
F-6

 
 
These actions include initiatives to increase gross profit margins through improved production controls and reporting. To that end, the Company recently implemented a new Enterprise Resource Planning (ERP) software system. We also plan to reduce discretionary expense levels to be better in line with current revenue levels.  Furthermore, our plan of operation in the next twelve months continues a strategy for growth within our existing lines of business with an on-going focus on growing domestic sales. We estimate that the operational and strategic development plans we have identified will require approximately $2,300,000 of funding. We expect to invest approximately $500,000 for additional inventory of sexual wellness products and $1,800,000 on sales and marketing programs, primarily sexual wellness advertising in magazines and on cable television. We will also be exploring the opportunity to acquire other compatible businesses.
 
We plan to finance the required $2,300,000 with a combination of cash flow from operations as well as cash on hand and cash raised through future equity and debt financings.

The ability of the Company to continue as a going concern is dependent upon its ability to successfully accomplish the plans described in the preceding paragraph and eventually secure other sources of financing and attain profitable operations.  However, management cannot provide any assurances that the Company will be successful in accomplishing these plans.  The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
 
NOTE C – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Presentation
      
These consolidated financial statements include the accounts and operations of our wholly owned operating subsidiaries, OneUp Innovations, Inc., Web Merchants, Inc. and Foam Labs, Inc.  Intercompany accounts and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current year presentation.

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in determining the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period.  Significant estimates in these consolidated financial statements include estimates of: asset impairment; income taxes; tax valuation reserves; restructuring reserve; loss contingencies; allowances for doubtful accounts; share-based compensation; and useful lives for depreciation and amortization.  Actual results could differ materially from these estimates.

Revenue Recognition
    
The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition.” (“SAB No. 104”).  SAB No. 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) title has transferred; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured.  The Company uses contracts and customer purchase orders to determine the existence of an arrangement. The Company uses shipping documents and third-party proof of delivery to verify that title has transferred. The Company assesses whether the fee is fixed or determinable based upon the terms of the agreement associated with the transaction. To determine whether collection is probable, the Company assesses a number of factors, including past transaction history with the customer and the creditworthiness of the customer. If the Company determines that collection is not reasonably assured, then the recognition of revenue is deferred until collection becomes reasonably assured, which is generally upon receipt of payment.
 
The Company records product sales net of estimated product returns and discounts from the list prices for its products. The amounts of product returns and the discount amounts have not been material to date. The Company includes shipping and handling costs in cost of product sales.

Cash and Cash Equivalents

For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
 
 
F-7

 
 
Allowance for Doubtful Accounts

The allowance for doubtful accounts reflects management’s best estimate of probable credit losses inherent in the accounts receivable balance.  The Company determines the allowance based on historical experience, specifically identified nonpaying accounts and other currently available evidence.  The Company reviews its allowance for doubtful accounts monthly with a focus on significant individual past due balances over 90 days.  Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance sheet credit exposure related to its customers.  At June 30, 2011, accounts receivable totaled $761,380 net of $14,055 in the allowance for doubtful accounts.

Inventories and Inventory Reserves

Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method. Market is defined as sales price less cost to dispose and a normal profit margin.  Inventory costs include materials, labor, depreciation and overhead. The company establishes reserves for excess and obsolete inventory, based on prevailing circumstances and judgment for consideration of current events, such as economic conditions, that may affect inventory. The reserve required to record inventory at lower of cost or market may be adjusted in response to changing conditions.

Concentration of Credit Risk

Financial instruments that potentially subject us to significant concentration of credit risk consist primarily of cash, cash equivalents, and accounts receivable.  As of June 30, 2011, substantially all of our cash and cash equivalents were held at a single financial institution.  As of June 30, 2011 none of our cash and cash equivalents exceeded the FDIC insured limits.  Accounts receivable are typically unsecured and are derived from revenue earned from customers primarily located in the United States and Europe.

Fair Value of Financial Instruments

At June 30, 2011, our financial instruments included cash and cash equivalents, accounts receivable, accounts payable, and other long-term debt.

The fair values of these financial instruments approximated their carrying values based on either their short maturity or current terms for similar instruments.

Advertising Costs

Advertising costs are expensed in the period when the advertisements are first aired or distributed to the public. Prepaid advertising (included in prepaid expenses) was $13,635 at June 30, 2011 and $60,427 at June 30, 2010. Advertising expense for the years ended June 30, 2011 and 2010 was $1,003,946 and $682,332, respectively.

Research and Development

Research and development expenses for new products are expensed as they are incurred.  Expenses for new product development totaled $132,638 for the year ended June 30, 2011 and $143,736 for the year ended June 30, 2010.

Property and Equipment

Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over estimated service lives for financial reporting purposes.

Expenditures for major renewals and betterments which extend the useful lives of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. When properties are disposed of, the related costs and accumulated depreciation are removed from the respective accounts, and any gain or loss is recognized currently.

Operating Leases

The Company leases its facility under a ten year operating lease which was signed in September 2005 and expires December 31, 2015.  The lease is on an escalating schedule with the final year on the lease at $34,358 per month.  The liability for this difference in the monthly payments is accounted for as a deferred rent liability and the balance in this account at June 30, 2011 is $296,192.  The rent expense under this lease for each of the years ended June 30, 2011 and 2010 was $323,722.
 
 
F-8

 
 
Segment Information

During fiscal 2011 and 2010, the Company only operated in one segment; therefore, segment information has not been presented.
 
Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-06, “Improving Disclosures about Fair Value Measurements,” an amendment to Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures.” The standard requires disclosure for transfers in and out of Level 1 and Level 2, as well as the disclosure of Level 3 activity on a gross, rather than net, basis. The guidance also requires enhancements to certain existing disclosures. The amendments are effective as of the beginning of our fiscal year 2011, or July 1, 2010, except for the new requirements regarding Level 3 activity, which is deferred until the beginning of fiscal year 2012. The guidance is not expected to have an impact on the Company’s consolidated financial statements.

In December 2010, the FASB issued guidance to clarify disclosure requirements for pro-forma information on revenues and earnings for business combinations. This guidance clarifies that where comparative financial statements are presented, revenue and earnings of the combined entity should be disclosed as though the business combination(s) that occurred during the current reporting period had occurred as of the beginning of the comparable prior annual reporting period. This guidance also expands disclosure requirements to include a description of the nature and amount of material, non-recurring pro-forma adjustments directly attributable to the business combination included in the reported pro-forma revenue and earnings. The Company adopted the provisions of this guidance effective January 1, 2011 and there was no impact on the consolidated condensed financial statements resulting from the adoption of this guidance.

In December 2010, the FASB issued amended goodwill impairment testing guidance for reporting units with an overall nil or negative carrying amount, but a positive goodwill balance. This amended guidance requires that for these reporting units, the second stage of goodwill impairment testing should be performed when it is considered more likely than not that goodwill impairment exists. This assessment should be made by considering whether there are any adverse qualitative factors indicating impairment of the goodwill. The standard is effective for our fiscal year beginning July 1, 2011 and is not expected to have an impact on the Company’s consolidated financial statements.

We have determined that all other recently issued accounting standards will not have a material impact on our Consolidated Financial Statements, or do not apply to our operations.

Basic and Diluted Earnings Per Share

Basic earnings per share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted-average number of common shares outstanding during the period, plus the dilutive effect of outstanding options and warrants, using the treasury stock method and the average market price of our common stock during the applicable period.  All outstanding stock options and warrants were excluded from the computation of diluted earnings per share because they were antidilutive in the periods presented, but could be dilutive in the future.

 
  
Years Ended   
June 30,
 
 
  
2011
 
  
2010
 
Basic
               
Net Loss
  
$
(801,252
)  
  
$
(1,033,952
)  
Weighted-average common shares outstanding
  
 
75,396,312
  
  
 
62,103,434
  
Loss per share, basic
  
$
(0.01
)  
  
$
(0.02
Diluted
  
     
  
     
Net Loss
 
$
(801,252
)  
  
$
(1,033,952
)  
Weighted-average common shares outstanding, basic
  
 
75,396,312
  
  
 
62,103,434
  
Weighted-average effect of dilutive securities:
  
     
  
     
Stock options
  
 
-
  
  
 
-
  
Warrants
  
 
-
  
  
 
-
  
Effect of assumed exercise of stock options and warrants
  
 
-
  
  
 
-
  
Weighted-average common shares outstanding, diluted
  
 
75,396,312
  
  
 
62,103,434
  
Loss per share, diluted
  
$
(0.01
)  
  
$
(0.02
)  
Outstanding options and warrants excluded as impact would be antidilutive
  
 
2,943,239
  
  
 
3,337,849
  
 
 
F-9

 
 
Basic and diluted earnings per share are the same in periods of a net loss thus there is no effect of dilutive securities when a net loss is recorded.
 
Income Taxes

We utilize the asset and liability method of accounting for income taxes. We recognize deferred tax liabilities or assets for the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities. We regularly assess the likelihood that our deferred tax assets will be recovered from future taxable income. We consider projected future taxable income and ongoing tax planning strategies in assessing the amount of the valuation allowance necessary to offset our deferred tax assets that will not be recoverable. We have recorded and continue to carry a full valuation allowance against our gross deferred tax assets that will not reverse against deferred tax liabilities within the scheduled reversal period. If we determine in the future that it is more likely than not that we will realize all or a portion of our deferred tax assets, we will adjust our valuation allowance in the period we make the determination. We expect to provide a full valuation allowance on our future tax benefits until we can sustain a level of profitability that demonstrates our ability to realize these assets. At June 30, 2011, we carried a valuation allowance of $2 million against our net deferred tax assets.

Stock Based Compensation

We account for stock-based compensation in accordance with FASB ASC 718, Compensation – Stock Compensation. We measure the cost of each stock option and restricted stock award at its fair value on the grant date. Each award vests over the subsequent period during which the recipient is required to provide service in exchange for the award (the vesting period). The cost of each award is recognized as expense in the financial statements over the respective vesting period. The expense recognized reflects an estimated forfeiture rate for unvested awards of 25%.

NOTE D – ACQUISITION
 
On January 27, 2011, the Company entered into a Stock Purchase Agreement (the “Purchase Agreement”) with Web Merchants, Inc., a privately-held company organized under the laws of Delaware (“WMI”) and Fyodor Petrenko and Dmitrii Spetetchii, the holders of 100% of WMI’s capital stock (the “WMI Shareholders”), to acquire 100% of WMI’s issued and outstanding equity ownership in exchange for 28,394,400 shares of our common stock to the WMI Shareholders.  One of the WMI Shareholders also received $100,000 in cash, which represented $79,000 for the repayment of a loan to WMI and $21,000 in consideration for signing a non-compete agreement with the Company.  Pursuant to the Purchase Agreement, WMI will continue to operate as a wholly owned subsidiary of the Company. 

The total purchase price of $2,860,440 consisted of 28,394,400 shares of the Company’s common stock at a fair value of $2,839,000 and $21,000 in cash.

The purchase price allocation is not finalized and the valuations of all tangible and intangible assets, including customer relationships, trade name and intellectual property, have not been completed.  Management’s estimates and assumptions are subject to change upon the finalization of the valuation and may be adjusted in accordance with FASB ASC Topic 805, Business Combinations.
 
 
F-10

 
 
The following table presents the allocation of the purchase price to the assets acquired and liabilities assumed based on their estimated fair values on January 27, 2011, the date of acquisition: 

   
Provisional
Purchase Price
Allocation
 
Current assets
  $ 863,819  
Fixed assets
    56,755  
Goodwill
    1,633,592  
Intangible assets:
       
Customer list
    300,000  
Trade names
    500,000  
Proprietary technology
    65,000  
Total assets acquired
    3,419,166  
Acquired liabilities
    (841,743
Acquired additional paid in capital
    283,017  
Net assets acquired
    2,860,440  
Less cash acquired
    (128,577 )
Purchase price at closing, net of cash acquired
  $ 2,731,863  
         
 
The preliminary valuation of the acquired assets and liabilities resulted in goodwill of $1,916,609 and identifiable intangible assets of $865,000. We identified and valued intangible assets related to trade names, customer relationships, and certain other intangible assets. The detail by category of identifiable intangible assets is as follows:
 
Category
  
Amount
 
Average
Life (Years)
Trade names
 
$
500,000
  
Indefinite
Customer relationships
  
 
300,000
  
4-15
Proprietary technology
  
 
65,000
  
5
 
  
 
 
  
 
Total intangible assets acquired
  
$
865,000
  
 
 
Acquisition Related Costs
 
We classify costs incurred in connection with acquisitions as acquisition related costs. These costs consist primarily of transaction costs and integration costs. Transaction costs are incurred during the initial evaluation of a potential targeted acquisition and primarily relate to costs to analyze, negotiate and consummate the transaction as well as financial and legal due diligence activities. Integration costs relate to activities needed to combine the operations of an acquired enterprise into our operations.  Expenses of $81,185 were recognized in connection with this acquisition and are included in Operating Expenses for the fiscal year ended June 30, 2011.

See Recent Developments – Entry Into a Material Definitive Agreement, above, regarding information on the signing of a definitive agreement for the sale of WMI.

NOTE E – GOODWILL AND OTHER INTANGIBLE ASSETS

The Company acquired goodwill and certain identifiable intangible assets as part of the acquisition in January 2011.

The changes in the carrying amount of goodwill for the six months ended June 30, 2011 were as follows:
 
Balance as of December 31, 2010
 
$
-
 
Goodwill acquired
   
1,633,592
 
Balance as of June 30, 2011
 
$
1,633,592
 
 
 
F-11

 
 
A summary of intangible assets as of June 30, 2011:
 
   
June 30, 2011
 
   
Weighted Average
 
Gross Carrying
   
Accumulated
   
Net Carrying
 
   
Amortization Period
 
Amount
   
Amortization
   
Amount
 
Acquired technology
 
5 years
 
$
65,000
   
$
(5,418
)
 
$
59,582
 
Customer relationships
 
10 years
   
300,000
     
(12,500
)
   
287,500
 
Trade names
       
500,000
     
-
     
500,000
 
                       
Total
     
$
865,000
   
$
(17,918
)
 
$
847,082
 

Amortization expense of intangible assets was $17,918 for the six months ended June 30, 2011.

The Company estimates the following amortization expense related to its intangible assets for the years ended June 30:
 
2012
 
 $
43,002
 
2013
   
43,002
 
2014
   
43,002
 
2015
   
43,002
 
Thereafter
   
175,074
 
   
$
347,082
 

See Recent Developments – Entry Into a Material Definitive Agreement, above, regarding information on the signing of a definitive agreement for the sale of WMI.

NOTE F – IMPAIRMENT OF LONG-LIVED ASSETS
 
We follow Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 360, Property, Plant, and Equipment, regarding impairment of our other long-lived assets (property, plant and equipment). Our policy is to assess our long-lived assets for impairment annually in the fourth quarter of each year or more frequently if events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable.
 
An impairment loss is recognized only if the carrying value of a long-lived asset is not recoverable and is measured as the excess of its carrying value over its fair value. The carrying amount of a long-lived asset is considered not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of long-lived asset.

Assets to be disposed of and related liabilities would be separately presented in the consolidated balance sheet. Assets to be disposed of would be reported at the lower of the carrying value or fair value less costs to sell and would not be depreciated.  There was no impairment as of June 30, 2011 or 2010.
 
NOTE G – INVENTORIES
 
All inventories are stated at the lower of cost or market using the first-in, first-out method of valuation.
 
The Company’s inventories consist of the following components at June 30, 2011 and 2010:
 
   
2011
   
2010
 
Raw materials
 
$
416,675
   
$
443,043
 
Work in Process
   
165,054
     
170,996
 
Finished Goods
   
1,487,006
     
294,812
 
   
$
2,068,735
   
$
908,851
 

At June 30, 2011 and 2010 our inventory reserves were $139,931 and $0, respectively.
 
 
F-12

 
 
NOTE H – PROPERTY AND EQUIPMENT, NET
 
Property and equipment at June 30, 2011 and 2010 consisted of the following:
 
 
2011
 
2010
 
Estimated
Useful Life 
Factory Equipment
 
$
1,782,969
   
$
1,531,734
 
7-10 years
Computer Equipment and Software
   
842,852
     
819,870
 
5-7 years
Office Equipment and Furniture
   
166,996
     
166,996
 
5-7 years
Automobile
   
24,320
     
-
 
5-7 years
Leasehold Improvements
   
330,961
     
321,288
 
15 years
Subtotal
   
3,148,098
     
2,839,888
   
Accumulated Depreciation
   
(2,166,599
)
   
(1,764,573
)
 
   
$
981,499
   
$
1,075,315
   
 
Depreciation expense was $228,343 and $249,380 for the years ended June 30, 2011 and 2010, respectively.
 
NOTE I– SHORT TERM UNSECURED NOTES PAYABLE

Unsecured notes payable at June 30, 2011 and 2010 consisted of the following:
   
2011
   
2010
 
Unsecured note payable to an individual, with interest at 20%, principal and interest paid bi-weekly, maturing July 22, 2011
 
$
4,210
   
$
-
 
                 
Unsecured note payable to an individual, with interest at 20%, principal and interest paid bi-weekly, maturing July 22, 2011 
   
1,258
     
-
 
                 
Unsecured note payable to an individual, with interest at %, principal and interest paid bi-weekly, maturing February 17, 2012
   
34,000
     
-
 
                 
Unsecured note payable to Hope Capital, Inc. with interest at 20%, principal and interest paid bi-weekly, maturing December 23, 2011
   
62,986
     
-
 
                 
Unsecured note payable to Hope Capital, Inc. with interest at 20%, principal and interest paid bi-weekly, maturing March 16, 2012
   
97,507
     
-
 
                 
Unsecured note payable to an individual, with interest at 16%, principal and interest originally due on January 3, 2011, extended to May 1, 2012. Beginning May 31, 2011, the interest rate is increased to 20%, with interest due monthly, and the principal due in full on May 1, 2012
   
200,000
     
200,000
 
                 
Unsecured note payable to an individual, with interest at 20%, principal and interest paid bi-weekly, maturing April 16, 2011
   
-
     
78,659
 
                 
Unsecured note payable to an individual, with interest at 20%, principal and interest paid bi-weekly, maturing January 19, 2011
   
-
     
60,109
 
                 
Unsecured note payable to an individual, with interest at 20%, principal and interest paid bi-weekly, maturing January 13, 2011
   
-
     
24,044
 
                 
Unsecured note payable to an individual, with interest at 20%, principal and interest due in full on  January 3, 2012 
   
300,000
     
-
 
                 
Total Short Term Unsecured Notes Payable
 
$
699,961
   
$
362,812
 
 
 
F-13

 
 
NOTE J– NOTE PAYABLE – EQUIPMENT
 
Note payable – equipment, at June 30, 2011 and 2010 consisted of the following: 
 
   
2011
   
2010
 
Note payable to Fidelity Bank in monthly installments of $5,364 including
           
Interest at 8%, maturing October 25, 2010, secured by equipment
 
$
-
   
$
12,136
 
Long term debt portion
 
$
-
   
$
-
 
 
NOTE K – LINE OF CREDIT
 
On May 24, 2011, the Company’s wholly owned subsidiary, OneUp Innovations, Inc. (“OneUp”), and OneUp’s wholly owned subsidiary, Foam Labs, Inc. (“Foam Labs”) entered into a credit facility with a finance company, Advance Financial Corporation, to provide it with an asset based line of credit of up to $750,000 against 85% of eligible accounts receivable (as defined in the agreement) for the purpose of improving working capital.  The term of the agreement is one year, renewable for additional one-year terms unless either party provides written notice of non-renewal at least 90 days prior to the end of the current financing period. The credit facility is secured by our accounts receivable and other rights to payment, general intangibles, inventory and equipment, and are subject to eligibility requirements for current accounts receivable. Advances under the agreement bear interest at a rate of 2.5% over the lenders Index Rate (as of June 30, 2011 the lenders Index Rate was 4.75%).  In addition there is a Monthly Service Fee (as defined in the agreement) of up to 1.25% per month. The Company’s CEO, Louis Friedman, and the Company’s Executive Vice President, Fred Petrenko, have personally guaranteed the repayment of the facility.  In addition, Liberator, Inc., and Web Merchants, Inc. have provided their corporate guarantees of the credit facility.  On June 30, 2011, the balance owed under this line of credit was $460,758.  On June 30, 2011, we were in substantial compliance with all of the material financial and other covenants required under this credit facility.

On May 17, 2010, our wholly owned subsidiary, OneUp Innovations, Inc., entered into a financing agreement with an “asset-based” lender, Summit Financial Resources LLC, for the purpose of improving working capital.  The agreement provides for up to $600,000 and is secured primarily by accounts receivable, inventory, equipment, and all general intangibles. Under the financing agreement, the lender will make loans at our request and in the lender’s discretion (a) based on purchases of our Accounts by the lender, with recourse against us and an advance rate of 80% (or such other percentage determined by the lender in its discretion), and (b) based on Acceptable Inventory not to exceed certain amounts, including an aggregate maximum of $200,000, not to exceed 50% of the aggregate amount of outstanding Accounts on which an Advance has been made.  The inventory component of the financing agreement is available to the Company, at the discretion of the lender and based upon Acceptable Inventory, from October 1 through November 30 of each year.  The term of the agreement is one year, renewable for additional one-year terms unless either party provides written notice of non-renewal at least 60 days prior to the end of the current financing period. Advances under the agreement bear interest at a rate of 2% over the prime rate (as published in the Wall Street Journal) for the accounts receivable portion of the advances and the inventory portion of the borrowings. The prime rate (3.25% as of June 30, 2010) adjusts with changes to the rate. In addition there are collateral management fees of 0.4% for each 10-day period that an advance on an accounts receivable invoice remains outstanding and a 1.9% collateral management fee on the average monthly loan outstanding on the inventory portion of any advance. The agreement provides that no change in control concerning us or any of our active subsidiaries shall occur except with the prior written consent of the lender. Events of default include, but are not limited to, the failure to make a payment when due or a default occurring on any indebtedness of ours.  The financing agreement was personally guaranteed by the Company’s CEO and majority shareholder, Louis Friedman and Liberator, Inc. has provided its corporate guarantee of the credit facility.  The balance owed under this line of credit was repaid on May 27, 2011.

Management believes cash flows generated from operations, along with current cash and investments as well as borrowing capacity under the line of credit should be sufficient to finance capital requirements required by operations. If new business opportunities do arise, additional outside funding may be required.

NOTE L – CREDIT CARD ADVANCE
 
On May 19, 2011, the Company’s wholly owned subsidiary, OneUp Innovations, Inc. (“OneUp”), and OneUp’s wholly owned subsidiary, Foam Labs, Inc. (“Foam Labs”) entered into a receivable advance agreement with CC Funding, LLC (“Credit Cash”), a division of Credit Cash NJ, LLC whereby Credit Cash agreed to loan OneUp and Foam Labs a total of $400,000. The loan is secured by OneUp’s and Foam Lab’s existing and future credit card collections. Terms of the loan call for a repayment of $448,000, which includes a one-time finance charge of $48,000, by March 19, 2012.  This will be accomplished by Credit Cash withholding a fixed amount each business day of $2,074 from OneUp’s credit card receipts until full repayment is made.  The loan is guaranteed by the Company and is personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman, and the Company’s CFO, Ronald P. Scott.  As of June 30, 2011, $389,926 was owed under this agreement.
 
 
F-14

 
 
On November 4, 2010, the Company’s wholly owned subsidiary, OneUp Innovations, Inc. (“OneUp”), and OneUp’s wholly owned subsidiary, Foam Labs, Inc. (“Foam Labs”) entered into a receivable advance agreement with CC Funding, LLC (“Credit Cash”), a division of Credit Cash NJ, LLC whereby Credit Cash agreed to loan OneUp and Foam Labs a total of $400,000. The loan is secured by OneUp’s and Foam Lab’s existing and future credit card collections. Terms of the loan call for a repayment of $448,000, which includes a one-time finance charge of $48,000, by May 4, 2011.  This will be accomplished by Credit Cash withholding a fixed amount each business day of $3,446 from OneUp’s credit card receipts until full repayment is made.  The loan is guaranteed by the Company and is personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman, and the Company’s CFO, Ronald P. Scott.  On May 5, 2011 this advance was repaid.
 
NOTE M – CONVERTIBLE NOTES PAYABLE – SHAREHOLDER

On June 24, 2009, the Company issued a 3% convertible note payable to Hope Capital with a face amount of $375,000. The note is convertible, at the holder’s option, into common stock at $.25 per share and may be converted at any time prior to the maturity date of August 15, 2012. Upon maturity, the issuer has the option to either repay the note plus accrued interest in cash or issue the equivalent number of shares of common stock at $.25 per share. As of June 30, 2011, the 3% Convertible Note Payable is carried net of the fair market value of the embedded conversion feature of $29,750.  This amount will be amortized over the remaining life of the note as additional interest expense.

On September 2, 2009, the Company issued a 3% convertible note payable to Hope Capital with a face amount of $250,000. The note is convertible, at the holder’s option, into common stock at $.25 per share and may be converted at any time prior to the maturity date of September 2, 2012. As of June 30, 2011, the 3% Convertible Note Payable is carried net of the fair market value of the embedded conversion feature of $22,491.  This amount will be amortized over the life of the note as additional interest expense.

NOTE N – UNSECURED LINES OF CREDIT
 
The Company has drawn cash advances on three unsecured lines of credit that are in the name of the Company and Louis S. Friedman. The terms of these unsecured lines of credit call for monthly payments of principal and interest, with interest rates ranging from 12% to 18%. The aggregate amount owed on the three unsecured lines of credit was $71,393 at June 30, 2011 and $99,664 at June 30, 2010.

NOTE O – COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company leases its facility under a ten year operating lease which was signed in September 2005 and expires December 31, 2015. The lease is on an escalating schedule with the final year on the lease at $34,358 per month. The liability for this difference in the monthly payments is accounted for as a deferred rent liability and the balance in this account at June 30, 2011 and 2010 is $296,192 and $331,570. The rent expense under this lease for the years ended June 30, 2011 and 2010 was $323,722.

The Company leases certain material handling equipment under an operating lease.  The monthly lease amount is $4,082 per month and expires September 2012.

The Company also leases certain postage equipment under an operating lease.  The monthly lease is $144 per month and expires January 2013.

The Company entered into an operating lease for certain material handling equipment in September 2010.  The monthly lease amount is $1,587 per month and expires in September 2015.

Future minimum lease payments under non-cancelable operating leases at June 30, 2011 are as follows:

Year ending June 30,
     
2012
 
$
439,492
 
2013
   
415,013
 
2014
   
410,729
 
2015
   
424,029
 
2016
   
209,324
 
Thereafter through 2017
   
-
 
Total minimum lease payments
 
$
1,898,587
 
 
 
F-15

 
 
Capital Leases

The Company has acquired equipment under the provisions of long-term leases. For financial reporting purposes, minimum lease payments relating to the equipment have been capitalized. The leased properties under these capital leases have a total cost of $349,205. These assets are included in the fixed assets listed in Note 1 and include computers, software, furniture, and equipment. The capital leases have stated or imputed interest rates ranging from 7% to 21%.

The following is an analysis of the minimum future lease payments subsequent to the year ended June 30, 2011:

Year ending June 30,
     
2012
 
 $
43,843
 
2013
   
27,178
 
2014
   
7,601
 
2015
   
-
 
Future Minimum Lease Payments
 
$
78,622
 
Less Amount Representing Interest
   
(14,883
)
Present Value of Minimum Lease Payments
   
63,739
 
Less Current Portion
   
(33,973
Long-Term Obligations under Leases Payable
 
$
29,766
 
 
Employment Agreements
 
The Company has entered into employment agreements with Louis Friedman, President and Chief Executive Officer and Fred Petrenko, Executive Vice President and President, Web Merchants, Inc.  Each of the agreements provide for an annual base salary of $150,000 and eligibility to receive a bonus.   Under the agreements, these executive employees may be terminated at any time with or without cause, or by reason of death or disability.  In certain termination situations, the Company is liable to pay severance compensation to these executives for up to 9 months at their current salary.

Legal Proceedings

As of the date of this Annual Report, there are no material pending legal or governmental proceedings relating to our company or properties to which we are a party, and to our knowledge there are no material proceedings to which any of our directors, executive officers or affiliates are a party adverse to us or which have a material interest adverse to us, except that on September 1, 2010, Donald Cohen, a former officer, director and independent sales representative of Liberator, Inc., commenced an action against the Company and other defendants including certain current officers and directors, under the caption Cohen v. WES Consulting, Inc., OneUp Innovations, Inc., OneUp Acquisitions, Inc., Liberator, Inc., f/k/a Remark Enterprises, Inc., Remark Enterprises, Inc., Belmont Partners LLC, Louis Friedman, Ronald Scott and Leslie Vogelman, Civil Action File No. 100V10590-8. in the Superior Court of Dekalb County, Georgia.  The plaintiff seeks repayment of a shareholder loan in the amount of $29,948 and unspecified amounts of compensatory, punitive, and statutorily trebled damages. The plaintiff alleges breach of fiduciary duty, breach of contract, fraud, and violation of the Georgia Securities Act, among other claims.  The Company intends to vigorously contest the case and filed a motion to dismiss the lawsuit on October 15, 2010. The motion was converted to a motion for summary judgment, and the Court held a hearing on that motion on April 12, 2011. The Court has not ruled on the motion for summary judgment and stayed discovery until a ruling is issued.  Although we believe that we have meritorious defenses to Mr. Cohen’s claims, this matter is still at a preliminary stage, and we are not in a position to predict or assess the likely outcome of these proceedings.  Accordingly, other than the amount of the shareholder loan, we have not reserved for any future loss that may arise as a result of an adverse outcome in this litigation.

NOTE P – RELATED PARTY TRANSACTIONS
 
The Company’s CEO, Louis Friedman, and the Company’s Executive Vice President, Fred Petrenko, have personally guaranteed the repayment of the loan obligation to Advance Financial Corporation (see Note K – Line of Credit).  In addition, Liberator, Inc., and Web Merchants, Inc. have provided their corporate guarantees of the credit facility.  On June 30, 2011, the balance owed under this line of credit was $460,758.  On June 30, 2011, we were in substantial compliance with all of the material financial and other covenants required under this credit facility.
 
 
F-16

 
 
The loan from Credit Cash (see Note L – Credit Card Advance) is guaranteed by the Company (including OneUp, Foam Labs, and WMI) and is personally guaranteed by the Company’s CEO and controlling shareholder, Louis S. Friedman, and the Company’s CFO, Ronald P. Scott.  As of June 30, 2011, $389,926 was owed under this agreement.

On March 17, 2011, the Company issued an unsecured promissory note to Hope Capital, Inc. for $130,000. Terms of the note call for bi-weekly principal and interest payments of $5,536 with the note due in full on March 16, 2012. Mr. Friedman and Mr. Petrenko personally guaranteed the repayment of the loan obligation.

On December 23, 2010, the Company issued an unsecured promissory note to Hope Capital, Inc. for $120,000. Terms of the note call for bi-weekly principal and interest payments of $5,110 with the note due in full on December 23, 2011. Mr. Friedman personally guaranteed the repayment of the loan obligation.

On October 30, 2010, Mr. Friedman, loaned the Company $40,000. Interest on the loan will accrue at the prevailing prime rate (which was 3.25% on June 30, 2011) until paid and totaled $925 as of June 30, 2011.

On September 2, 2009, the Company issued a 3% convertible note payable to Hope Capital.  The note is convertible, at the holder’s option, into common stock at $.25 per share and may be converted at any time prior to the maturity date of September 2, 2012. As of June 30, 2011, the 3% Convertible Note Payable is carried net of the fair market value of the embedded conversion feature of $22,491.  This amount will be amortized over the life of the note as additional interest expense.

On June 24, 2009, the Company issued a 3% convertible note payable to Hope Capital with a face amount of $375,000. Hope Capital is a shareholder of the Company and was the majority shareholder of the Company before the merger with OneUp Innovations.  The note is convertible, at the holder’s option, into common stock at $.25 per share and may be converted at any time prior to the maturity date of August 15, 2012. Upon maturity, the Company has the option to either repay the note plus accrued interest in cash or issue the equivalent number of shares of common stock at $.25 per share.  At June 30, 2011, the 3% convertible note payable is carried net of the fair market value of the embedded conversion feature of $29,750.  This amount will be amortized over the life of the note as additional interest.

On June 30, 2008, the Company had a subordinated note payable to the majority shareholder and CEO in the amount of $310,000 and the majority shareholder’s wife in the amount of $395,000. During fiscal 2009, the majority shareholder loaned the Company an additional $91,000 and a director loaned the Company $29,948.  In connection with the Company’s June 26, 2009 merger, the majority shareholder and his wife agreed to convert $700,000 of principal balance and $132,120 of accrued but unpaid interest to Series A Convertible Preferred Stock.  Interest on the notes during fiscal 2010 and 2011 was accrued by the Company at the prevailing prime rate (which is currently at 3.25%) and totaled $3,607 and $3,443, respectively.  The accrued interest balance on