##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2010
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from  to
 Commission file number: 000-05663
 LIBERATOR MEDICAL HOLDINGS, INC.
  NEVADA(State or other jurisdiction of 
incorporation or organization)
    
    87-0267292(I.R.S. Employer
Identification No.)
 2979 SE Gran Park Way, Stuart, Florida 34997  (Address of principal executive offices) (Zip Code)
 (772) 287-2414  (Registrants telephone number, including area code)
  þ o
  o o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer o
    
    Smaller reporting company þ(Do not check if a smaller reporting company)
  o þ
   Class
    
    Outstanding as of February 16, 2011Common Stock, $.001
    
    47,995,600




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##### 



TABLE OF CONTENTS
 PagePART I  FINANCIAL INFORMATION
    
    
    3Item 1.
    
    Condensed Consolidated Financial Statements
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    20Item 4.
    
    Controls and Procedures
    
    
    21PART II  OTHER INFORMATION
    
    
    23Item 1.
    
    Legal Proceedings
    
    
    23Item 1A.
    
    Risk Factors
    
    
    23Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    23Item 3.
    
    Defaults Upon Senior Securities
    
    
    23Item 5.
    
    Other Information
    
    
    23Item 6.
    
    Exhibits
    
    
    23SIGNATURES
    
    
    24EX-31.1EX-31.2EX-32.1EX-32.2
   
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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
As of December 31, 2010 (unaudited) and September 30, 2010
 December
    
    
    September31, 2010
    
    
    30, 2010AssetsCurrent Assets:Cash
    
    $
    7,430
    
    
    $
    7,428Accounts receivable, net of allowance of $3,748 and $3,312, respectively
    
    
    6,408
    
    
    
    6,744Inventory, net of allowance for obsolete inventory of $110 and $110, respectively
    
    
    2,471
    
    
    
    1,985Deferred taxes, current portion
    
    
    1,462
    
    
    
    1,696Prepaid and other current assets
    
    
    436
    
    
    
    355Total Current Assets
    
    
    18,207
    
    
    
    18,208Property and equipment, net of accumulated depreciation of $1,648 and $1,527,
respectively
    
    
    1,769
    
    
    
    1,862Deferred advertising
    
    
    12,048
    
    
    
    10,006Other assets
    
    
    197
    
    
    
    139Total Assets
    
    $
    32,221
    
    
    $
    30,215Liabilities and Stockholders EquityCurrent Liabilities:Accounts payable
    
    $
    5,630
    
    
    $
    3,826Accrued liabilities
    
    
    839
    
    
    
    1,077Derivative liabilities
    
    
    
    
    
    
    1,698Stockholder loans
    
    
    
    
    
    
    565Convertible notes payable, net of unamortized discount of $21
    
    
    
    
    
    
    2,516Other current liabilities
    
    
    142
    
    
    
    146Total Current Liabilities
    
    
    6,611
    
    
    
    9,828Deferred tax liability
    
    
    1,963
    
    
    
    1,826Other long-term liabilities
    
    
    109
    
    
    
    145Total Liabilities
    
    
    8,683
    
    
    
    11,799Stockholders Equity:Common stock, $.001 par value, 200,000 shares authorized, 48,085 and 44,707 shares
issued, respectively; 47,996 and 44,617 shares outstanding at December 31, 2010, and
September 30, 2010, respectively
    
    
    48
    
    
    
    45Additional paid-in capital
    
    
    34,204
    
    
    
    28,927Accumulated deficit
    
    
    (10,664
    )
    
    
    (10,506
    )Treasury stock, at cost; 89 shares at December 31, 2010, and September 30, 2010
    
    
    (50
    )
    
    
    (50
    )Total Stockholders Equity
    
    
    23,538
    
    
    
    18,416Total Liabilities and Stockholders Equity
    
    $
    32,221
    
    
    $
    30,215
  3




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Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
For the three months ended December 31, 2010 and 2009
(Unaudited)
 Three Months Ended December 31,2010
    
    
    2009Sales
    
    $
    12,204
    
    
    $
    9,158Cost of Sales
    
    
    4,336
    
    
    
    3,248Gross Profit
    
    
    7,868
    
    
    
    5,910Operating ExpensesPayroll, taxes and benefits
    
    
    2,841
    
    
    
    2,169Advertising
    
    
    1,901
    
    
    
    806Bad debts
    
    
    892
    
    
    
    655Depreciation
    
    
    166
    
    
    
    95General and administrative
    
    
    925
    
    
    
    1,025Total Operating Expenses
    
    
    6,725
    
    
    
    4,750Income from Operations
    
    
    1,143
    
    
    
    1,160Other Income (Expense)Interest expense
    
    
    (31
    )
    
    
    (416
    )Change in fair value of derivative liabilities
    
    
    (902
    )
    
    
    (5,098
    )Interest income
    
    
    2
    
    
    
    3Gain on sale of assets
    
    
    2
    
    
    
    --Total Other Income (Expense)
    
    
    (929
    )
    
    
    (5,511
    )Income (Loss) before Income Taxes
    
    
    214
    
    
    
    (4,351
    )Provision for (Benefit from) Income Taxes
    
    
    372
    
    
    
    (1,006
    )Net Loss
    
    $
    (158
    )
    
    $
    (3,345
    )Basic and Diluted earnings (loss) per share:Weighted average shares outstanding
    
    
    47,419
    
    
    
    32,848Earnings (loss) per share
    
    $
    (0.00
    )
    
    $
    (0.10
    )
  4




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Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statement of Changes in Stockholders Equity
For the three months ended December 31, 2010
(Unaudited)
 TotalCommon
    
    
    Common
    
    
    Paid in
    
    
    Accumulated
    
    
    Treasury
    
    
    StockholdersShares
    
    
    Stock
    
    
    Capital
    
    
    Deficit
    
    
    Stock
    
    
    EquityBalance at October 1, 2010
    
    
    44,617
    
    
    $
    45
    
    
    $
    28,927
    
    
    $
    (10,506
    )
    
    $
    (50
    )
    
    $
    18,416Options issued to employees and directors
    
    
    
    
    
    
    
    
    
    
    128
    
    
    
    
    
    
    
    
    
    
    
    128Common stock issued upon conversion of debt
    
    
    3,333
    
    
    
    3
    
    
    
    5,097
    
    
    
    
    
    
    
    
    
    
    
    5,100Common stock issued for employee stock purchase plan
    
    
    46
    
    
    
    
    
    
    
    52
    
    
    
    
    
    
    
    
    
    
    
    52Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (158
    )
    
    
    
    
    
    
    (158
    )Balance at December 31, 2010
    
    
    47,996
    
    
    $
    48
    
    
    $
    34,204
    
    
    $
    (10,664
    )
    
    $
    (50
    )
    
    $
    23,538
  5




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Liberator Medical Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
For the three months ended December 31, 2010 and 2009
(Unaudited)
 Three Months EndedDecember 31,2010
    
    
    2009Cash flow from operating activities:Net Loss
    
    $
    (158
    )
    
    $
    (3,345
    )Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:Depreciation and amortization
    
    
    2,011
    
    
    
    905Change in fair value of derivative liabilities
    
    
    902
    
    
    
    5,098Equity based compensation
    
    
    128
    
    
    
    133Provision for doubtful accounts and sales returns and adjustments
    
    
    980
    
    
    
    763Non-cash interest related to convertible notes payable
    
    
    21
    
    
    
    353Deferred income taxes
    
    
    371
    
    
    
    (1,009
    )Amortization of non-cash debt issuance costs
    
    
    
    
    
    
    9Gain on sale of assets
    
    
    (2
    )
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    (643
    )
    
    
    (1,576
    )Deferred advertising
    
    
    (3,887
    )
    
    
    (2,037
    )Inventory
    
    
    (486
    )
    
    
    (31
    )Other assets
    
    
    (140
    )
    
    
    (150
    )Accounts payable
    
    
    1,804
    
    
    
    744Accrued expenses
    
    
    (283
    )
    
    
    (179
    )Other liabilities
    
    
    (21
    )
    
    
    (2
    )Net Cash Flow Provided by (Used in) Operating Activities
    
    
    597
    
    
    
    (324
    )Cash flow from investing activities:Purchase of property and equipment
    
    
    (75
    )
    
    
    (780
    )Proceeds from the sale of assets
    
    
    3
    
    
    
    Purchase of certificates of deposit
    
    
    
    
    
    
    (553
    )Net Cash Flow Used in Investing Activities
    
    
    (72
    )
    
    
    (1,333
    )Cash flow from financing activities:Proceeds from the exercise of warrants
    
    
    
    
    
    
    163Proceeds from employee stock purchase plan
    
    
    59
    
    
    
    56Proceeds from credit line facility
    
    
    
    
    
    
    750Purchase of treasury stock
    
    
    
    
    
    
    (9
    )Payments of debt and capital lease obligations
    
    
    (582
    )
    
    
    (220
    )Net Cash Flow Provided by (Used in) Financing Activities
    
    
    (523
    )
    
    
    740Net increase (decrease) in cash
    
    
    2
    
    
    
    (917
    )Cash at beginning of period
    
    
    7,428
    
    
    
    3,798Cash at end of period
    
    $
    7,430
    
    
    $
    2,881Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    47
    
    
    $
    105Cash paid for income taxes
    
    $
    
    
    
    $
    12Supplemental schedule of non-cash investing and financing activities:Common stock issued for interest expense
    
    $
    
    
    
    $
    45Common stock issued for conversion of debt
    
    $
    5,100
    
    
    $
    150
  6




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Liberator Medical Holdings, Inc. and Subsidiaries
 
 Notes To The Unaudited Condensed Consolidated Financial Statements
 December 31, 2009
 Note 1  Interim Financial Statements
   Note 2  Summary of Significant Accounting Policies
  Recent Accounting Pronouncements
  Note 3  Stockholder Loans
  Note 4  Credit Line Facility
  7




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Note 5  Convertible Notes Payable
 April 2008 Convertible Notes
    May 2008 Convertible Note
  8




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October 2008 Convertible Note
    9




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Oct08 NoteNotes Payable, face amount
    
    $
    2,500Discounts on Notes:Initial valuation of Warrants
    
    
    (86
    )Initial valuation of Bifurcated Embedded Derivative
    
    
    (841
    )Accumulated Amortization
    
    
    906Total Discounts
    
    
    (21
    )Accrued Interest
    
    
    37Convertible Notes Payable, net
    
    $
    2,516
 NOTE 6  Derivative Liabilities
   May 2008 Note
    
    October 2008 NoteRisk-free interest rate:
    
    
    0.40
    %
    
    
    0.40
    %Expected term:
    
    0.64 years
    
    1.05 yearsExpected dividend yield:
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility:
    
    
    56.03
    %
    
    
    56.03
    %Probability of triggering reset provision:
    
    
    22.42
    %
    
    
    19.18
    %Existing conversion price per share
    
    $
    0.80
    
    
    $
    0.75Companys stock price per share
    
    $
    1.45
    
    
    $
    1.45
  May 2008 Note
    
    October 2008 NoteRisk-free interest rate:
    
    
    0.47
    %
    
    
    0.47
    %Expected term:
    
    0.39 years
    
    0.79 yearsExpected dividend yield:
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility:
    
    
    51.99
    %
    
    
    51.99
    %Probability of triggering reset provision:
    
    
    2.91
    %
    
    
    2.11
    %Existing conversion price per share
    
    $
    0.80
    
    
    $
    0.75Companys stock price per share
    
    $
    2.18
    
    
    $
    2.18
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October 2008 NoteRisk-free interest rate:
    
    
    0.14
    %Expected term:
    
    17 daysExpected dividend yield:
    
    
    0.00
    %Expected volatility:
    
    
    49.30
    %Probability of triggering reset provision:
    
    
    0.01
    %Existing conversion price per share
    
    $
    0.75Companys stock price per share
    
    $
    1.26
  Note 7  Stockholders Equity
 Warrants
  WeightedAvg.ExerciseWarrants:
    
    Shares
    
    
    PriceBalance at September 30, 2010
    
    
    7,393,334
    
    
    $
    1.14Issued
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Expired
    
    
    (370,417
    )
    
    
    1.59Balance at December 31, 2010
    
    
    7,022,917
    
    
    $
    1.12
 Employee & Director Stock Options
  11




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2010
    
    
    2009Risk-free interest rate:
    
    
    1.05
    %
    
    
    1.38
    %Expected term:
    
    3 years
    
    3 yearsExpected dividend yield:
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility:
    
    
    48.91
    %
    
    
    66.35
    %
   WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    Intrinsic2007 Stock Plan:
    
    Shares
    
    
    Price
    
    
    Life (Years)
    
    
    ValueOptions outstanding at September 30, 2010
    
    
    1,655,000
    
    
    $
    0.92
    
    
    
    3.07
    
    
    $
    671,850Granted
    
    
    500,000
    
    
    
    1.25Expired or forfeited
    
    
    
    
    
    
    Options outstanding at December 31, 2010
    
    
    2,155,000
    
    
    $
    1.00
    
    
    
    3.51
    
    
    $
    698,100Options exercisable at December 31, 2010
    
    
    1,143,750
    
    
    $
    0.84
    
    
    
    2.84
    
    
    $
    524,813Options vested or expected to vest at December 31, 2010
    
    
    2,155,000
    
    
    $
    1.00
    
    
    
    3.51
    
    
    $
    698,100
 2009 Employee Stock Purchase Plan
 st th
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Note 8  Income Taxes
   Note 9  Subsequent Event
  13




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 This Managements Discussion and Analysis of Financial Condition and Results of Operations and
other parts of this quarterly report on Form 10-Q contain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide
current expectations of future events based on certain assumptions and include any statement that
does not directly relate to any historical or current fact. When used in this quarterly report, in
future filings by the Company with the Securities and Exchange Commission, in the Companys press
releases or other public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases will likely result, are
expected to, will continue, is anticipated, estimate, project, or similar expressions are
intended to identify forward-looking statements. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak as of the date made, and
to advise readers that various factors, including regional and national economic conditions,
substantial changes in levels of market interest rates, credit and other risks of manufacturing,
distributing or marketing activities, competitive and regulatory factors, and those factors set
forth in the Companys Annual Report on Form 10-K for the year ended September 30, 2010, under the
caption Risk Factors, could affect the Companys financial performance and could cause the
Companys actual results for future periods to differ materially from those anticipated by any
forward-looking statements.
 The following discussion should be read in conjunction with our unaudited consolidated financial
statements and notes thereto included in this Form 10-Q and the audited financial statements of the
Company, included in our Annual Report on Forms 10-K and 10-K/A for the year ended September 30,
2010, filed with the Securities and Exchange Commission and managements discussion and analysis
contained therein. The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect the occurrence of anticipated or unanticipated
events or circumstances after the date of such statements.
 Overview
   Results of Operations
  2010
    
    
    2009Amount
    
    
    %
    
    
    Amount
    
    
    %Sales
    
    $
    12,204
    
    
    
    100.0
    
    
    $
    9,158
    
    
    
    100.0Cost of Sales
    
    
    4,336
    
    
    
    35.5
    
    
    
    3,248
    
    
    
    35.5Gross Profit
    
    
    7,868
    
    
    
    64.5
    
    
    
    5,910
    
    
    
    64.5Operating Expenses
    
    
    6,725
    
    
    
    55.1
    
    
    
    4,750
    
    
    
    51.9Income from Operations
    
    
    1,143
    
    
    
    9.4
    
    
    
    1,160
    
    
    
    12.7Other Income (Expense)
    
    
    (929
    )
    
    
    (7.6
    )
    
    
    (5,511
    )
    
    
    (60.2
    )Income (Loss) Before Income Taxes
    
    
    214
    
    
    
    1.8
    
    
    
    (4,351
    )
    
    
    (47.5
    )Provision for (benefit from) Income Taxes
    
    
    372
    
    
    
    3.1
    
    
    
    (1,006
    )
    
    
    (11.0
    )Net Loss
    
    $
    (158
    )
    
    
    (1.3
    )
    
    $
    (3,345
    )
    
    
    (36.5
    )
 14




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Revenues:
  Gross Profit:
  Operating Expenses:
  2010
    
    
    2009Amount
    
    
    %
    
    
    Amount
    
    
    %Operating Expenses:Payroll, taxes and benefits
    
    $
    2,841
    
    
    
    23.3
    
    
    $
    2,169
    
    
    
    23.7Advertising
    
    
    1,901
    
    
    
    15.6
    
    
    
    806
    
    
    
    8.8Bad debts
    
    
    892
    
    
    
    7.3
    
    
    
    655
    
    
    
    7.2Depreciation
    
    
    166
    
    
    
    1.4
    
    
    
    95
    
    
    
    1.0General and administration
    
    
    925
    
    
    
    7.6
    
    
    
    1,025
    
    
    
    11.2Total Operating Expenses
    
    $
    6,725
    
    
    
    55.1
    
    
    $
    4,750
    
    
    
    51.9
   2010
    
    
    2009Advertising Expenses:Amortization of direct-response costs
    
    $
    1,845
    
    
    $
    809Other advertising expenses
    
    
    56
    
    
    
    (3
    )Total Advertising Expenses
    
    $
    1,901
    
    
    $
    806
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Income from Operations:
  Other Income (Expense)
  2010
    
    
    2009Other Income (Expense):Interest Expense
    
    $
    (31
    )
    
    $
    (416
    )Change in fair value of derivative liabilities
    
    
    (902
    )
    
    
    (5,098
    )Gain on sale of assets
    
    
    2
    
    
    
    Interest income
    
    
    2
    
    
    
    3Total Other Income (Expense)
    
    $
    (929
    )
    
    $
    (5,511
    )
   16




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Change inClosing
    
    
    Fair Value ofMarket
    
    
    DerivativePrice of
    
    
    LiabilitiesCommon
    
    
    Income /Stock
    
    
    (Expense)Interim period ending:September 30, 2009, Q4 FY 2009
    
    $
    1.45
    
    
    $
    n/aDecember 31, 2009, Q1 FY 2010
    
    
    2.18
    
    
    
    (5,098
    )March 31, 2010, Q2 FY 2010
    
    
    2.20
    
    
    
    (59
    )June 30, 2010, Q3 FY 2010
    
    
    1.49
    
    
    
    3,698September 30, 2010, Q4 FY 2010
    
    
    1.26
    
    
    
    768October 15, 2010, Q1 FY 2011 (Conversion Date of $2.5 million note)
    
    
    1.53
    
    
    
    (902
    )Total change in fair value of derivative liabilities
    
    
    
    
    
    $
    (1,593
    )
    Income Taxes:
   17




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Liquidity and Capital Resources
  For the Three Months EndedDecember 31,2010
    
    
    2009Cash Flows:Net cash provided by (used in) operating activities
    
    $
    597
    
    
    $
    (324
    )Net cash used in investing activities
    
    
    (72
    )
    
    
    (1,333
    )Net cash provided by (used in) financing activities
    
    
    (523
    )
    
    
    740Net increase (decrease) in cash
    
    
    2
    
    
    
    (917
    )Cash at beginning of period
    
    
    7,428
    
    
    
    3,798Cash at end of period
    
    $
    7,430
    
    
    $
    2,881
  Operating Activities
   Investing Activities
   18




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##### Table of Contents



Financing Activities
   Outlook
      
    
    Continue our advertising and marketing efforts;
    
    Increase our customer base;
    
    Continue to service our current customer base and increase the retention rate;
 19




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
    
    Continue to invest in the expansion of our infrastructure; and
    
    Increase our accounts receivable collection efforts.
  
    
    Identified and presented to many large funding sources, soliciting terms for long-term capital
in the form of debt, equity or a combination of both;
    
    Expanded our Board of Directors to include five directors, four of whom are non-employee
directors, and formed an Audit Committee, a Compensation Committee, and a Governance and
Nominating Committee;
    
    Identified products and related target customers through extensive market research;
    
    Established efficient and cost-effective methods to reach qualified customers;
    
    Established an infrastructure of management and knowledgeable staff to support substantial
growth in sales with a minimal amount of additional staff members, maximizing our revenue per
employee;
    
    Leased an additional 24,000 square foot facility to house our expanding workforce and support
our continued growth. We completed the build out of this facility to house our call center and
other administrative functions and moved into the new facility in January, 2010.
    
    Created a HIPAA compliant IT infrastructure and staff to accommodate additional growth in sales;
    
    Established a marketing plan that can be monitored for effectiveness and is flexible enough to
adapt to changing market conditions; and
    
    Established methods of testing our current and new advertising methods to meet changing market
conditions.
  Off-Balance Sheet Arrangements
  Critical Accounting Policies
  Effect of Inflation
  
 Item 3. Qualitative and Quantitative Disclosure about Market Risk
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Item 4. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures
   Managements Report on Internal Control Over Financial Reporting
   
    
    Assess and Identify the Impact of Recently Issued Accounting Pronouncements:The
Companys procedures to assess and identify the impact of Recently Issued Accounting
Pronouncements were not sufficient, as evidenced by the Companys failure to timely
identify the impact of ASC 815-40-15, Derivatives and Hedging  Contracts in Entitys
Own Equity (Scope and Scope Exceptions), which became effective for the Company on
October 1, 2009. The Company did not become aware of the new guidance until June 2010, and
the impacts of the accounting guidance were not properly identified by the Company until
December 2010. As a result, the Company determined that the previously issued interim
financial statements for fiscal year 2010 should no longer be relied upon, which resulted
in the restatement of the interim financial statements for the interim period ending
December 31, 2009. The Company plans to file restated interim financial statements for the
interim periods ending March 31, 2010, and June 30, 2010.
 
    
    Documentation of Accounting Review and Approval Process:In connection with the audit
of our consolidated financial statements for the fiscal year ended September 30, 2010, our
independent registered accounting firm reported to our Board of Directors that they
observed inadequate documented review and approval of certain aspects of the accounting
process including the documented review of accounting reconciliations and journal entries
that they considered to be a material weakness in internal control. After a review of our
current review and approval of certain aspects of the accounting process, management
concluded that the inadequate documented review and approval process represented a
material weakness.
 Change in Internal Control over Financial Reporting
  
    
    Accounting for Derivative Financial Instruments:Management has identified a material
weakness related to accounting for embedded derivatives included in certain convertible
notes payable that were outstanding when ASC 815-40-15 became effective for the Company on
October 1, 2009. When the Company first
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assessed the impacts of ASC 815-40-15, management erred in its conclusion that certain
embedded derivatives met the scope exceptions of ASC 815-40-15 and did not require
adjustments to its accounting. The Company lacked a technical review process which might
have enabled the Company to identify the error and prevent a misstatement of the Companys
interim financial statements.Remediation:The Company engaged an independent third party valuation expert to calculate
the fair values of the embedded derivative liabilities and correctly accounted for the
embedded derivatives contained in certain convertible notes payable. The Company has
restated the interim financial statements for the interim period ending December 31, 2009.
The Company plans to file restated interim financial statements for the interim periods
ending March 31, 2010, and June 30, 2010.
    
    Accounting for Deferred Direct-Response Advertising Costs:Management has identified a
material weakness related to the classification and measurement of our capitalized
direct-response advertising costs due to the following:
 
    
    The Company had not previously defined what constituted a separate
stand-alone cost pool as defined by ASC 340-20-35-1.
 
    
    The amortization of capitalized direct-response advertising costs was
not calculated by taking the ratio of current period revenues over the total period
revenues associated with each cost pool as required by ASC 340-20-35-3.
 
    
    Prior to September 30, 2010, the Company had reflected both a current
and long term portion of the assets on the consolidated balance sheet. In
accordance with an SEC interpretation (SPCH.T.1995.22.Glynn), the SEC would object
to the classification of any unamortized cost of advertising as a current asset.
This resulted in the Company reclassifying the fiscal year 2009 comparative balance
to conform to the current fiscal year classification.
 Remediation:During the first quarter of fiscal year 2011 and before we filed our Annual
Report for fiscal year 2010 with the SEC on Form 10-k, management completed the above
analysis as required, including defining separate stand-alone cost pools. In addition,
management determined that no restatements of prior period financial statements were
required as a result of the above analysis.
 Remediation of Material Weaknesses in Internal Control over Financial Reporting
  
    
    Subscribe to an outside service that provides the Companys Chief Financial Officer and
Controller with timely guidance on Recently Issued Accounting Pronouncements. In addition,
the Company intends to supplement its current interim and annual financial reporting
processes with documentation of the Controllers and Chief Financial Officers review and
assessment of the timing and impacts, if any, that the new accounting pronouncements will
have on the Companys financial statements; and
    
    Document all significant accounting policies and ensure that the accounting policies are
in accordance with accounting principles generally accepted in the United States and that
internal controls are designed effectively to ensure that the financial information is
properly reported. Management will engage independent accounting specialists to ensure that
there is an independent verification of the accounting positions taken.
    
    In connection with the reported inadequate documented review and approval of certain
aspects of the accounting process, management has plans to review the current review and
approval processes and implement changes to ensure that all accounting reconciliations and
journal entries are reviewed and approved on a timely basis and that this review is
documented by a member of management separate from the preparer.
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PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 5. Other Information
  
 Item 6. Exhibits
 
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SIGNATURES
   
  /s/ Mark A. Libratore

Mark A. Libratore
    
    President
    
    February 22, 2011/s/ Robert J. Davis

Robert J. Davis
    
    Chief Financial
Officer
    
    February 22, 2011
 24