U.S. Securities And Exchange Commission
Washington, D.C. 20549
Form 10-QSB
(check one)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2008
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE EXCHANGE ACT OF 1934
Commission File Number 000-30486
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLY ADVANCED
COMMUNICATIONS TECHNOLOGIES, INC.)
(Exact name of small business issuer as specified in its charter)
Florida
(State or other jurisdiction
of incorporation or organization)
65-0738251
(IRS Employer Identification No.)
420 Lexington Avenue, New York, NY 10170
(Address of principal executive offices)
(646)-227-1600
(Issuer’s telephone number)
Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
As of May 12, 2008, there were 5,077,711,570 shares of the registrant’s no par value
common stock issued and outstanding.
Transmittal Small Business Disclosure Format (check one):
Yes o No x
Part I-Financial Information
Item 1. | Financial Statements |
| | |
| | Condensed Consolidated Balance Sheets As Of March 31, 2008 (Unaudited) and June 30, 2007 |
| | |
| | Condensed Consolidated Statements Of Operations For The Three and Nine Months Ended March 31, 2008 and 2007 (Unaudited) |
| | |
| | Condensed Consolidated Statement Of Stockholders’ Equity (Deficiency) For The Nine Months Ended March 31, 2008 (Unaudited) |
| | |
| | Condensed Consolidated Statements Of Cash Flows For The Nine Months Ended March 31, 2008 and 2007 (Unaudited) |
| | |
| | Notes To Condensed Consolidated Financial Statements As Of March 31, 2008 (Unaudited) |
| | |
Item 2. | Management’s Discussion And Analysis Or Plan Of Operation |
| | |
Item 3. | Controls And Procedures |
Part II-Other Information
Item 1. | Legal Proceedings |
| | |
Item 2. | Unregistered Sales of Equity Securities And Use Of Proceeds |
| | |
Item 3. | Defaults Upon Senior Securities |
| | |
Item 4. | Submission Of Matters To A Vote Of Security Holders |
| | |
Item 5. | Other Information |
| | |
Item 6. | Exhibits |
As used herein, the terms the “Company,” “Encompass Group Affiliates,” ”Encompass,” “we,” “us” or “our” refer to Encompass Group Affiliates, Inc., a Florida corporation, formerly Advanced Communications Technologies, Inc.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in the "Management’s Discussion and Analysis or Plan of Operation" and elsewhere in this quarterly report constitute "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act")) relating to us and our business, which represent our current expectations or beliefs including, but not limited to, statements concerning our operations, performance, financial condition and growth. All statements, other than statements of historical facts, included in this quarterly report that address activities, events or developments that we expect or anticipate will or may occur in the future, including such matters as our projections, future capital expenditures, business strategy, competitive strengths, goals, expansion, market and industry developments and the growth of our businesses and operations are forward-looking statements. Without limiting the generality of the foregoing, words such as "may,” “believes,” ”expects,” "anticipates,” "could,” "estimates,” “grow,” “plan,” "continue," “will,” “seek,” “scheduled,” “goal” or “future” or the negative or other comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, such as credit losses, dependence on management and key personnel, variability of quarterly results, our ability to continue our growth strategy and competition, certain of which are beyond our control. Any or all of our forward-looking statements may turn out to be wrong. They may be affected by inaccurate assumptions that we might make or by known or unknown risks or uncertainties. Should one or more of these risks or uncertainties materialize or should the underlying assumptions prove incorrect, actual outcomes and results could differ materially from those indicated in the forward-looking statements.
Because of the risks and uncertainties associated with forward-looking statements, you should not place undo reliance on them. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLY ADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
| | | March 31, 2008 | | June 30, 2007 | |
| | | (Unaudited) | | (Note 1) | |
ASSETS |
| Current Assets | | | | | | | |
| Cash and cash equivalents | | $ | 2,677,636 | | $ | 843,721 | |
| Restricted cash | | | 766,651 | | | -- | |
| Accounts receivable, net of allowance for doubtful | | | | | | | |
| accounts of $81,027 and $6,919, respectively | | | 7,189,282 | | | 429,105 | |
| Inventory | | | 3,253,337 | | | -- | |
| Replacement parts and equipment | | | 679,321 | | | 371,353 | |
| Due from vendors | | | 1,106,927 | | | -- | |
| Prepaid expenses and other current assets | | | 723,830 | | | 84,083 | |
| Total Current Assets | | | 16,396,984 | | | 1,728,262 | |
| Property and equipment, net | | | 529,643 | | | 261,849 | |
| Other Assets | | | | | | | |
| Deferred financing costs, net | | | 365,514 | | | -- | |
| Deferred acquisition costs | | | 411,225 | | | 885,364 | |
| Intangible assets, net | | | 9,874,665 | | | -- | |
| Goodwill | | | 14,074,521 | | | 2,624,388 | |
| Other assets | | | 78,143 | | | 7,960 | |
| Total Other Assets | | | 24,804,068 | | | 3,517,712 | |
| | | | | | | | |
TOTAL ASSETS | | $ | 41,730,695 | | $ | 5,507,823 | |
| |
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) |
LIABILITIES | | | | | | | |
| Current Liabilities | | | | | | | |
| Accounts payable | | $ | 5,970,909 | | $ | 2,197,344 | |
| Accrued expenses | | | 2,269,223 | | | 1,375,363 | |
| Escrow liability | | | 766,651 | | | -- | |
| Notes payable, current portion | | | 507,614 | | | 617,068 | |
| Capitalized lease obligation, current portion | | | 33,750 | | | 15,341 | |
| Total Current Liabilities | | | 9,548,147 | | | 4,205,116 | |
| Long Term Liabilities | | | | | | | |
| Senior Notes, net of unamortized original issue discount and current portion | | | 11,764,859 | | | -- | |
| Senior Subordinated Notes, net of unamortized original issue discount | | | 11,542,728 | | | -- | |
| Convertible notes payable | | | 1,206,146 | | | -- | |
| Note payable, officer | | | 310,000 | | | -- | |
| Capitalized lease obligation, less current portion | | | 49,068 | | | | |
| Convertible preferred stock | | | | | | | |
| Series A convertible preferred stock, $.01 par value | | | -- | | | 3,006,200 | |
| Series B convertible preferred stock, $.01 par value | | | -- | | | 40,000 | |
| Series A-1 convertible preferred stock, $.01 par value | | | -- | | | 340,000 | |
| Total Long Term Liabilities | | | 24,872,801 | | | 3,386,200 | |
TOTAL LIABILITIES | | | 34,420,948 | | | 7,591,316 | |
COMMITMENTS AND CONTINGENCIES | | | | | | | |
STOCKHOLDERS' EQUITY (DEFICIENCY) | | | | | | | |
Series A-2 convertible preferred stock, $.01 par value, 8,413 shares authorized, 8,412 shares issued and outstanding (liquidation value of $3,388,200) | | | 84 | | | -- | |
Series C convertible preferred stock, $.01 par value, 1,000 shares authorized, 1,000 shares issued and outstanding (liquidation value of $6,300,000) | | | 10 | | | -- | |
Series D convertible preferred stock, $.01 par value, 1,000 shares authorized, 1,000 shares issued and outstanding (liquidation value of $633,962) | | | 10 | | | -- | |
| Common stock, no par value, 5,000,000,000 shares authorized, | | | | | | | |
| 4,997,711,570 shares issued and outstanding | | | 31,092,290 | | | 31,092,290 | |
| Additional paid-in capital | | | 11,929,837 | | | 1,280,374 | |
| Accumulated deficit | | | (35,712,484 | ) | | (34,456,157 | ) |
| Total Stockholders' Equity (Deficiency) | | | 7,309,747 | | | (2,083,493 | ) |
| | | | | | | | |
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) | | $ | 41,730,695 | | $ | 5,507,823 | |
See accompany notes to condensed consolidated financial statements
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLY ADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
| | | For The Three Months Ended | | For The Nine Months Ended | |
| | | March 31, | | March 31, | |
| | | 2008 | | 2007 | | 2008 | | 2007 | |
| | | | | | | | | | |
NET SALES | | $ | 19,474,380 | | $ | 2,617,443 | | $ | 45,107,525 | | $ | 6,776,813 | |
COST OF SALES | | | 15,386,864 | | | 1,802,159 | | | 35,391,253 | | | 4,521,989 | |
GROSS PROFIT | | | 4,087,516 | | | 815,284 | | | 9,716,272 | | | 2,254,824 | |
| | | | | | | | | | | | | | |
OPERATING EXPENSES | | | | | | | | | | | | | |
| Depreciation and amortization | | | 316,960 | | | 16,990 | | | 905,677 | | | 53,773 | |
| Selling, general and administrative expenses | | | 2,603,281 | | | 1,072,912 | | | 7,307,516 | | | 2,752,361 | |
TOTAL OPERATING EXPENSES | | | 2,920,241 | | | 1,089,902 | | | 8,213,193 | | | 2,806,134 | |
| | | | | | | | | | | | | | |
| Income (Loss) From Operations | | | 1,167,275 | | | (274,618 | ) | | 1,503,079 | | | (551,310 | ) |
| | | | | | | | | | | | | | |
OTHER INCOME (EXPENSE) | | | | | | | | | | | | | |
| Other income (expense), net | | | -- | | | (50,000 | ) | | 73,846 | | | (50,000 | ) |
| Interest expense, net | | | (804,238 | ) | | (19,401 | ) | | (2,013,347 | ) | | (39,050 | ) |
TOTAL OTHER (EXPENSE) | | | (804,238 | ) | | (69,401 | ) | | (1,939,501 | ) | | (89,050 | ) |
| | | | | | | | | | | | | | |
NET INCOME (LOSS) | | | 363,037 | | | (344,019 | ) | | (436,422 | ) | | (640,360 | ) |
| | | | | | | | | | | | | | |
| Deemed dividend on preferred stock | | | -- | | | -- | | | (819,905 | ) | | -- | |
| | | | | | | | | | | | | | |
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS | | $ | 363,037 | | $ | (344,019 | ) | $ | (1,256,327 | ) | $ | (640,360 | ) |
| | | | | | | | | | | | | | |
| Net Income (loss) per share - basic | | $ | - | | $ | - | | $ | - | | $ | - | |
| | | | | | | | | | | | | | |
| Weighted average number of shares | | | | | | | | | | | | | |
| outstanding during the period - basic | | | 4,997,711,570 | | | 4,976,626,376 | | | 4,997,711,570 | | | 4,763,625,689 | |
See accompany notes to condensed consolidated financial statements
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLY ADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIENCY)
FOR THE NINE MONTHS ENDED MARCH 31, 2008
(UNAUDITED)
| | | COMMON STOCK | | PREFERRED STOCK | | ADDITIONAL PAID IN | | ACCUMULATED | | | |
| | | SHARES | | AMOUNT | | SHARES | | AMOUNT | | CAPITAL | | DEFICIT | | TOTAL | |
BALANCE AT JULY 1, 2007 | | | 4,997,711,570 | | $ | 31,092,290 | | | -- | | $ | -- | | $ | 1,280,374 | | $ | (34,456,157 | ) | $ | (2,083,493 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
| Issuance of Series A-2, Series C and Series D convertible preferred stock | | | | | | | | | 10,412 | | | 104 | | | 10,649,463 | | | -- | | | 10,649,567 | |
| Deemed dividend on preferred stock | | | -- | | | -- | | | -- | | | -- | | | -- | | | (819,905 | ) | | (819,905 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
| Net loss for the period | | | | | | | | | | | | | | | | | | (436,422 | ) | | (436,422 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
BALANCE AT MARCH 31, 2008 | | | 4,997,711,570 | | $ | 31,092,290 | | | 10,412 | | $ | 104 | | $ | 11,929,837 | | $ | (35,712,484 | ) | $ | 7,309,747 | |
See accompany notes to condensed consolidated financial statements
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLY ADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
| | | For the Nine Months Ended | |
| | | March 31, | |
| | | 2008 | | 2007 | |
CASH FLOWS USED IN OPERATIONS: | | | | | |
| | | | | | |
| Net loss | | $ | (436,422 | ) | $ | (640,360 | ) |
| Adjustments to reconcile net loss to net cash used in operating activities | | | | | | | |
| Depreciation and amortization | | | 905,677 | | | 53,773 | |
| Provision for doubtful accounts | | | 18,155 | | | 4,785 | |
| Stock-based compensation | | | 590,976 | | | 31,500 | |
| Loss on sale of marketable securities | | | -- | | | 4,859 | |
| Stock distribution from Herborium | | | -- | | | (1,464 | ) |
| Changes in operating assets and liabilities: | | | | | | | |
| (Increase) decrease in assets: | | | | | | | |
| Accounts receivable | | | (979,272 | ) | | (223,102 | ) |
| Inventory | | | (267,234 | ) | | -- | |
| Replacement parts and equipment | | | (307,968 | ) | | (9,550 | ) |
| Credits due from vendors | | | (341,659 | ) | | -- | |
| Prepaid expense and other current assets | | | (64,193 | ) | | 1,626 | |
| Increase (decrease) in liabilities: | | | | | | | |
| Accounts payable | | | 40,189 | | | 143,904 | |
| Accrued expenses | | | (587,178 | ) | | 553,927 | |
| Net cash used in operating activities | | | (1,428,929 | ) | | (80,102 | ) |
| | | | | | | | |
CASH FLOWS USED IN INVESTING ACTIVITIES: | | | | | | | |
| Purchase of business, net of cash acquired | | | (22,320,755 | ) | | -- | |
| Increase in acquisition costs | | | (2,769,582 | ) | | (126,473 | ) |
| Purchase of property and equipment | | | (160,655 | ) | | (41,310 | ) |
| Reimbursement of costs from PMIC bankruptcy proceedings | | | -- | | | 26,500 | |
| Decrease (increase) in other assets | | | (32,810 | ) | | 12,641 | |
| Net cash used in investing activities | | | (25,283,802 | ) | | (128,642 | ) |
| | | | | | | | |
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES: | | | | | | | |
| Principal payments on notes payable and capitalized lease | | | (891,432 | ) | | (342,600 | ) |
| Proceeds from sale of preferred stock | | | 6,300,000 | | | -- | |
| Proceeds from sale of senior and subordinated notes | | | 24,039,137 | | | -- | |
| Payment of debt and equity issuance costs | | | (901,059 | ) | | -- | |
| Proceeds from sale of Series A-1 preferred stock | | | -- | | | 340,000 | |
| Net cash provided by (used in) financing activities | | | 28,546,646 | | | (2,600 | ) |
| | | | | | | | |
| Net increase (decrease) in cash and cash equivalents | | | 1,833,915 | | | (211,344 | ) |
| | | | | | | | |
| Cash and cash equivalents at beginning of period | | | 843,721 | | | 756,093 | |
| | | | | | | | |
CASH AND CASH EQUIVALENTS AT END OF PERIOD | | $ | 2,677,636 | | $ | 544,749 | |
See accompany notes to condensed consolidated financial statements
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLYADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2008
(UNAUDITED)
| NOTE 1. | ORGANIZATION, BASIS OF CONSOLIDATION AND SIGNIFICANT ACCOUNTING POLICIES |
(A) Organization
Unless the context requires otherwise, “we”, “us”, “our” “Encompass” or the “Company” refers to Encompass Group Affiliates, Inc., a Florida corporation, and its wholly owned subsidiaries on a consolidated basis. The Company’s shareholders approved its proxy solicitation that closed May 5, 2008 to, among other actions, amended the company Articles of Incorporation to change its name to Encompass Group Affiliates, Inc. from Advanced Communications Technologies, Inc.
We are a New York-based company that specializes in the consumer electronic after-market service and supply chain, known as reverse logistics. Through our principal operating subsidiary Encompass Group Affiliates, Inc. ("Encompass-Delaware"), a Delaware corporation, we address the full scope of this multi-billion market - including the end-user driven product support and repair industry, as well as the manufacturer-driven recovery and e-Waste industry. We provide single-source lifecycle management services for technology products, currently in the North American market, with accelerating growth towards a global presence. On June 2, 2004, Encompass-Delaware acquired Cyber-Test, Inc., a Delaware corporation ("Cyber-Test"). Cyber-Test, which had been our principal operating business, is an established electronic equipment repair facility located in Orlando, Florida, specializing in the repair and exchange of consumer and office electronic equipment, providing board-level and whole-unit repair to third-party warranty compa-nies, OEMs, national retailers and national office equipment dealers. On August 17, 2007, Encompass-Delaware completed the acquisition of Vance Baldwin, Inc., an industry leading Original Equipment Manufacturer Parts Distributor. For more than fifty years, Vance Baldwin operated in south Florida and recently opened a distribution facility in suburban Atlanta. Vance Baldwin distributes more than 30,000 parts annually for consumer electronics, computers, printers and office equipment. Vance Baldwin also provides service aids and industrial products such as cable, tools, test equipment, cleaners and other installation equipment. (See Notes 1(I) and 2 for further information concerning this acquisition and the related financing transactions.)
(B) Financial Statement Presentation and Principles of Consolidation
The Company consolidates all wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.
(C) Interim Financial Statements
The condensed consolidated financial statements as of and for the three and nine months ended March 31, 2008 and 2007 are unaudited but in the opinion of management the condensed consolidated financial statements include all adjustments consisting of normal accruals necessary for a fair presentation of financial position and the comparative results of operations and cash flows. Results of operations for interim periods are not necessarily indicative of those to be achieved or expected for the entire year. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-KSB for the fiscal year ended June 30, 2007. The June 30, 2007 balance sheet presented herein has been derived from the audited financial statements as of that date.
(D) Use of Estimates
The preparation of the condensed consolidated financial statements of the Company in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the period. Accordingly, actual results could vary from those estimates.
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLYADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2008
(UNAUDITED)
(E) Allowance for Doubtful Accounts
We make judgments as to our ability to collect outstanding trade receivables and provide allowances for the portion of receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding invoices. For those invoices not specifically reviewed, provisions are provided at differing rates, based upon the age of the receivable. In determining these percentages, we analyze our historical collection experience and current economic trends. If the historical data we use to calculate the allowance provided for doubtful accounts does not reflect our future ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed and the future results of operations could be materially affected.
(F) Inventory, Replacement Parts and Equipment
Inventory of OEM parts purchased for resale within the reverse logistics industry, which consists solely of finished goods, is valued at the lower of cost (first-in, first-out basis) or market.
Replacement parts and equipment consist primarily of repair parts, as well as consumable supplies for resale and used machines that are held for resale, that are stated at the lower of weighted average cost or market. The weighted average cost of replacement parts and equipment approximates the first-in, first-out (“FIFO”) method.
Management performs periodic assessments to determine the existence of obsolete, slow-moving and non-usable inventory, replacement parts and equipment and records necessary provisions to reduce such inventory, replacement parts and equipment to net realizable value.
(G) Core Charges
The vendors of products distributed by the Company frequently add a "core charge" to the cost of individual inventory items that the Company distributes as a means of encouraging the return of certain replaced components, most frequently circuit boards, which are defective. These defective replaced components are ultimately repaired and re-enter the distribution channel.
Core charges borne by the Company associated with goods in inventory are not included in inventory, but are classified in prepaid expenses and other current assets. At March 31, 2008, core charges classified in prepaid expenses and other current assets amounted to $508,000. Customers either receive a credit for cores when returned, or are obligated to pay the billed core charge in the event a core is not returned. This payment effectively compensates the Company for the core charge it is obligated to pay vendors. The Company returns cores to its vendors for credit, with the aggregate amount of credits due classified separately, as due from vendors, and included in current assets.
(H) Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation. When equipment is sold or otherwise disposed of, the cost and related accumulated depreciation are eliminated from the accounts and any resulting gain or loss is reflected in operations. Assets are depreciated using the straight-line method based on the following estimated useful lives:
| Machinery and equipment | 3 to 7 years |
| Furniture and fixtures | 5 to 7 years |
| Leasehold improvements | Estimated useful life or length of the lease, whichever is shorter |
The Company leases certain equipment and software under agreements that are classified as capital leases and are included in the accompanying balance sheet under property and equipment. Amortization of equipment held under capital leases is included in depreciation expense. Accumulated amortization of items under capital leases at March 31, 2008 amounted to $82,000. Maintenance and repairs are charged to expense when incurred.
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLYADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2008
(UNAUDITED)
(I) Goodwill and Intangibles
In accordance with SFAS No. 141, the Company allocates the purchase price of its acquisitions to the tangible assets, liabilities and intangible assets acquired based on their estimated fair values. The excess purchase price over those fair values is recorded as “Goodwill.” The fair value assigned to intangible assets acquired is based on valuations prepared by an independent appraisal firm or by management using certain estimates and assumptions, or the values negotiated at arms-length between the Company and the seller of the acquired assets. In accordance with SFAS No. 142, goodwill and purchased intangibles with indefinite lives acquired after June 30, 2001 are not amortized, but are reviewed periodically for impairment. Purchased intangibles with finite lives are amortized over the pattern in which the economic benefit is to be consumed, or, on a straight-line basis over their respective useful lives if that pattern cannot be determined.
As described in Note 2, on August 17, 2007, the Company acquired 100% of the outstanding common stock of Vance Baldwin, Inc. The business acquired is a recognized leader in its industry, has had long-term relationships with its major vendors and customers, a history of increasing levels of annual sales and earnings, and introduces a number of favorable strategic opportunities to the Company; accordingly, the Company believes that the excess of purchase price over net assets acquired is justified.
Goodwill and intangible assets consisted of the following:
| | | March 31, | | June 30, | |
| | | 2008 | | 2007 | |
| Goodwill | | $ | 14,074,521 | | $ | 2,624,388 | |
| | | | | | | | |
| Intangible assets, primarily consisting of customer lists | | $ | 10,580,000 | | | -- | |
| Less accumulated amortization | | | (705,335 | ) | | -- | |
| Total net intangible assets | | $ | 9,874,665 | | | -- | |
Amortization expense for intangible assets, which are being amortized over 10 years based on the straight line method, amounted to $705,000 for the nine months ended March 31, 2008. Based on the carrying value of intangible assets as of March 31, 2008, future amortization expense will amount to the following:
| For the year ending June 30, 2008 | | $ | 970,000 | |
| June 30, 2009 | | $ | 1,058,000 | |
| June 30, 2010 | | $ | 1,058,000 | |
| June 30, 2011 | | $ | 1,058,000 | |
| June 30, 2012 | | $ | 1,058,000 | |
(J) Revenue Recognition
The Company recognizes revenue upon delivery of goods to a common carrier for delivery to the customer, at which point title passes, at a sales price that is fixed and determinable and collectability is reasonably assured. Provisions for product returns are accounted for as sales reductions in determining sales in the same period that the related sales are recorded. The Company recognizes revenue from the sale of refurbished computer equipment and related products upon delivery of goods to a common carrier for delivery to the customer. Revenue for the repair of customer-owned equipment is recognized upon completion of the repair. The Company assumes the risk of loss due to damage or loss of refurbished products during shipment and is reimbursed by the common carriers for shipping damage and lost products.
The Company includes shipping costs in cost of sales. Total shipping costs included in cost of sales for the three months ended March 31, 2008 and 2007 were $1,492,329 and $407,714, respectively. Total shipping costs included in cost of sales for the nine months ended March 31, 2008 and 2007 were $3,407,125 and $1,100,377 respectively.
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLYADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2008
(UNAUDITED)
(K) Net Income (Loss) per Share
Basic net income (loss) per share is computed by dividing loss available to common stockholders by the weighted average number of common shares outstanding for the period. During the three months ended March 31, 2007 and nine months ended March 31, 2008 and 2007, potentially dilutive securities that could have been issued were excluded from the calculation of diluted loss per share as their effect would have been anti-dilutive. During the three months ended March 31, 2008, potentially dilutive securities totalling 114,052,000,000 were included in the calculation of diluted loss per share but had no effect. At March 31, 2008 and 2007, potentially dilutive securities totalled 127,462,000,000 and 5,841,667,000, respectively.
(L) Concentration of Sales and Credit Risk
Sales to two customers accounted for approximately 25.8% and 10.0% of consolidated sales for the three months ended March 31, 2008, and approximately 42.8% and 39.8% of consolidated sales for the three months ended March 31, 2007. Sales to two customers accounted for approximately 24.5% and 9.6% of consolidated sales for the nine months ended March 31, 2008, and approximately 44.7% and 41.7% of consolidated sales for the nine months ended March 31, 2007.
We have certain financial instruments that potentially subject us to significant concentrations of credit risk which consist principally of cash and cash equivalents and accounts receivable. We maintain cash and cash equivalents in short-term money market accounts with high quality financial institutions and in short-term, investment grade commercial paper. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and therefore bear minimal risk. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.
(M) Restricted Cash, Cash and Cash Equivalents
Restricted cash consists of funds representing a portion of the purchase price that is held in escrow in connection with the purchase of Vance Baldwin until earlier of the completion of an audit of the financial statements of Vance Baldwin as of and for the year ending December 31, 2007, or August 17, 2008, and the subsequent determination as to the existence of claims to be made against the escrow fund. On April 24, 2008, the Company agreed to an early release of $375,000 of the escrowed funds.
The Company considers all other short-term investments with an original maturity date of three months or less to be cash equivalents. Cash equivalents include commercial paper, money market funds and certain certificates of deposit.
(N) Stock Based Compensation
The Company determines the value of grants of restricted common stock to employees and others based on the closing price per share at the date of grant and amortizes the cost as compensation expense over the period of vesting. The exercise price of stock options granted is based on fair market value as determined by the closing price per share at the date of grant. The fair value of stock option grants is calculated using the Black-Scholes Option Pricing Model.
(O) Deferred Finance Costs
Costs associated with the Company’s debt obligations are capitalized and amortized, using the interest method. over the life of the related debt obligation.
(P) Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007; however, in February 2008, the FASB decided that an entity need not apply this standard to nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis until fiscal years beginning after November 15, 2008.. Management does not expect this pronouncement will have a material impact on the financial statements of the Company.
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLYADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2008
(UNAUDITED)
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115.” This Standard allows entities to voluntarily choose, at specified election dates, to measure many financial assets and financial liabilities (as well as certain non-financial instruments that are similar to financial instruments) at fair value. The election is made on an instrument-by-instrument basis and is irrevocable. If the fair value option is elected for an instrument, the Statement specifies that all subsequent changes in fair value for that instrument shall be reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2008. Management does not expect this pronouncement to have a significant impact on the financial statements of the Company.
The Financial Accounting Standards Board has issued Statement No. 141 (R), “Business Combinations”. This statement retains the fundamental requirements in Statement No. 141 that the acquisition method of accounting (which Statement No. 141 called the “purchase method”) be used, and applies to the all business entities, including mutual entities that previously used the pooling of interest method of accounting for some business combinations. The statement is effective for transactions within the annual reporting period beginning on or after December 15, 2008. Management is currently evaluating the impact that this new standard would have on the Company’s financial position and results of operations.
The Financial Accounting Standards Board has issued Statement No. 160, “Non-controlling Interests in Consolidated Financial Statements.” This statement changes the way the consolidated income statement is presented when non-controlling interests are present. It requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest, and is effective for periods beginning on or after December 15, 2008. Management is currently evaluating the impact that this new standard would have on the Company’s financial position and results of operations.
In April 2008, the Financial Accounting Standards Board has issued Final FASB Staff Position (FSP) No. FAS 142-3, “Determination of the Useful Life of Intangible Assets”. The guidance is intended to improve the consistency between the useful life of a recognized intangible asset under Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets”, and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R), Business Combinations, and other guidance under accounting principles generally accepted in the United States of America. FSP No. FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. Early adoption is prohibited. Paragraph 11(d) of SFAS No. 142 requires entities to base assumptions for determining the useful life of a recognized intangible asset on the legal, regulatory, or contractual provisions that permit extending the asset’s useful life without appreciably adding to its cost. FSP No. FAS 142-3, requires that an entity must consider its own experience with similar arrangements in developing its assumptions. If an entity has had no similar arrangements, then it should consider the assumptions other market participants use. Management does not expect this pronouncement to have a significant impact on the financial statements of the Company.
| NOTE 2. | RECAPITALIZATION AND ACQUISITION OF VANCE BALDWIN, INC. |
On August 17, 2007 (the “Closing Date”), the Company entered into a series of transactions to effect a recapitalization which included the acquisition of a new operating subsidiary for an aggregate purchase price of $27.9 million (including transaction costs), the completion of a significant preferred stock issuance of $6,300,000, the issuance of $23.4 million in senior and subordinated notes and the settlement of substantially all of the Company’s notes payable, accounts payable and accrued expenses. On the Closing Date, the Company acquired all of the outstanding equity interests in Vance Baldwin, Inc., a privately-held Florida subchapter S corporation doing business as Vance Baldwin Electronics and engaged in distribution and shipping of parts for consumer electronics, printers, appliances, and computers (“Vance Baldwin”). Management believes that the business and operations of Vance Baldwin, which has its headquarters in Ft. Lauderdale, Florida and a substantial distribution facility in Lawrenceville, Georgia, will complement the business and operations offered by Cyber-Test and significantly expand the Company’s presence in the reverse logistics business.
The following unaudited pro forma financial information presents the results of operations of the Company as if the acquisition had occurred at the beginning of fiscal 2008 and fiscal 2007. Adjustments to the combined financial information related to the acquisition that affect the results of operations include the interest expense associated with the debt issued in conjunction with the acquisition, amortization of the fair value of intangible assets and deferred debt financing costs and stock-based compensation. This pro forma information does not purport to be indicative of what would have occurred had the acquisition occurred as of July 1, 2007 and 2006 or of results of operations that may occur in the future.
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLYADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2008
(UNAUDITED)
| | | For the three | | | | | |
| | | months ended | | For the nine months ended | |
| | | March 31 | | March 31 | |
| | | 2007 | | 2008 | | 2007 | |
| Net sales | | $ | 16,520,398 | | $ | 51,532,045 | | $ | 44,937,527 | |
| Operating income (loss) | | | 723,072 | | | 1,655,656 | | | 882,514 | |
| Net income (loss) | | | (74,936 | ) | | (773,168 | ) | | (1,382,297 | ) |
| Net loss basic and diluted per common share | | | 0.00 | | | 0.00 | | | 0.00 | |
| NOTE 3. | NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS |
In connection with the recapitalization described in Note 2 and below, all of the notes (with the exception of the capitalized lease obligation) and related accrued interest outstanding as of the time of the recapitalization were satisfied in full.
Notes payable and capital lease obligations consisted of the following at March 31, 2008 and June 30, 2007:
| | | March 31, | | June 30, | |
| | | 2008 | | 2007 | |
| 12% Note payable | | $ | -- | | $ | 57,832 | |
| Note payable to officer | | | 310,000 | | | 35,000 | |
| Note payable to Cornell Capital | | | -- | | | 275,000 | |
| 6% Unsecured Note | | | -- | | | 249,236 | |
| Senior notes | | | 12,272,473 | | | -- | |
| Senior subordinated notes | | | 11,542,728 | | | -- | |
| Convertible notes | | | 1,206,146 | | | -- | |
| Capitalized leases | | | 82,818 | | | __15,341 | |
| Total notes payable and capital lease | | | 25,414,165 | | | 632,409 | |
| Less: current portion | | | (541,364 | ) | | (632,409 | ) |
| Long term notes payable and capital lease obligations | | $ | 24,872,801 | | $ | — | |
The Company may borrow up to $2,500,000 from Sankaty Advisors, LLC by issuing additional Senior Notes and/or Senior Subordinated Notes. Such notes will be Senior Notes, Subordinated Notes, or a combination thereof, depending upon the Company’s performance measured against the Maximum Total Leverage Ratio financial covenant. On September 27, 2007, the Company issued an additional $1,020,048 of Senior Subordinated Notes for a purchase price of $1,000,000 under the same terms as the Senior Subordinated Notes sold in connection with the August 17, 2007 transactions described above.
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLYADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2008
(UNAUDITED)
| NOTE 4. | PREFERRED AND COMMON STOCK |
Shares of Series C Preferred may, at the election of the Series C Preferred stockholders, be converted into shares of common stock upon the requisite state filing of a charter amendment (the “Charter Amendment”) that increases the number of authorized shares of common stock to an amount sufficient for the conversion of Series C Preferred into a fixed amount of shares of common stock at the Series C Conversion Rate. Shareholder approval is needed in order to file the Charter Amendment. The Company filed a Proxy Statement Pursuant to Schedule 14(a) of the Securities Exchange Act of 1934 (“Proxy Statement”) with the Securities and Exchange Commission (“SEC”) on November 8, 2007, which, among other matters, requested stockholder approval of an amendment to the Articles of Incorporation to increase the number of authorized shares of common stock. The Company received comment letters from the SEC on December 6, 2007 and January 14, 2008. The Company responded to both comment letters and other comments received verbally and filed Amendment No. 2 to the Proxy Statement on February 5, 2008. On March 21, 2008, the Company received a letter from the SEC stating that it would have no further comment. See Note 7.
The Company’s shareholders approved its proxy solicitation that closed May 5, 2008 to, among other actions, amended the company Articles of Incorporation to increase the number of authorized shares of common stock. Accordingly, the Company’s Series A-2, Series C and Series D convertible preferred stock is classified in Stockholders’ Equity (Deficiency) on the accompanying consolidated balance sheet at March 31, 2008. Previously, since there was an insufficient number of authorized shares of common stock for the conversion of convertible preferred stock, the Company was required to classify such stock as long-term liabilities on its consolidated balance sheets.
The Company recorded a 100% valuation allowance against its net deferred tax assets, including its federal and state net operating loss, for the periods ended March 31, 2008 and 2007. There was no tax benefit recorded relating to the increase in deferred tax assets. The Company has total net operating loss carryforwards (NOL) available to offset future federal taxable income of approximately $32,000,000 expiring in the fiscal years from 2016 through 2027. As a result of the change in control arising from the recapitalization, the Company will be limited to utilizing approximately $3.5 million of its NOL carryforward annually in future years to offset taxable income. The Company did not record a provision for income taxes for the three months ended March 31, 2008 due to this NOL carryforward which offset taxable income in the period. The Company did not record a provision or benefit for income taxes for the three months ended March 31, 2007 and the nine months ended March 31, 2008 and 2007 as the Company recorded net losses in each period.
The Company made a Section 338(h)(10) election which treats the acquisition of Vance Baldwin as an asset purchase; accordingly, purchased goodwill and other intangible assets acquired will be deductible for tax purposes for an estimated annual tax deduction of approximately $1.8 million.
| NOTE 6. | SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION |
The following are the payments made during the nine months ended March 31, 2008 and 2007 for income taxes and interest:
| | | 2008 | | 2007 | |
| | | | | | | | |
| Income taxes | | $ | 24,319 | | $ | 8,831 | |
| | | | | | | | |
| Interest | �� | $ | 1,356,219 | | $ | 3,329 | |
Non-cash investing and financing activities:
Nine Months Ended March 31, 2008:
| | (1) | In connection with the recapitalization and acquisition transactions, the Company issued: (i) a non-cash unsecured note of $310,000 to an officer in settlement of outstanding obligations, (ii) a noncash unsecured convertible note of $206,000 to a creditor in settlement of outstanding obligations, (iii) a noncash unsecured convertible note of $1 million to the stockholder of Vance Baldwin as part of the purchase price, (iv) Series A-2 convertible preferred stock in exchange for all outstanding shares of Series A, Series A-1 and Series B convertible preferred stock with liquidation values of $3,006,000, $40,000 and $340,000, respectively, resulting in a deemed dividend of $819,905 attributable to Series A-2 having a fair market value higher than the carrying value of the exchanged issues, (v) Series D convertible preferred stock of $198,113 to the stockholder of Vance Baldwin as part of the purchase price, and (vi) Series D convertible preferred stock of $435,849 in satisfaction of an assumed obligation of Vance Baldwin. |
ENCOMPASS GROUP AFFILIATES, INC. (FORMERLYADVANCED COMMUNICATIONS
TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2008
(UNAUDITED)
| | (2) | In connection with the recapitalization and acquisition transactions and the issuance of additional Senior Subordinated Notes on September 27, 2007, the Company incurred Original Issue Discounts of $190,335 on Senior Notes and $234,491 on Senior Subordinated Notes. |
| | (3) | As described in Note 4, the Company’s classified its Series A-2, Series C and Series D convertible preferred stock in Stockholders’ Equity (Deficiency) on the consolidated balance sheet at March 31, 2008; in prior periods such stock was classified as long-term liabilities. |
Nine Months Ended March 31, 2007:
| | (1) | 559 shares of Series A Preferred Shares and 20 shares of Series B Preferred Shares with liquidation values of $559,000 and $20,000, respectively, were converted into 789,784,564 shares and 20,000,000 shares, respectively, of the Company’s common stock. |
| | (2) | 20,000,000 shares of the Company’s common stock were issued to certain officers of the Company in pursuant of the employment contracts with the Company. |
In April and through May 5, 2008, the Company solicited and received sufficient affirmative written consents from common and preferred stockholders (voting on an as-converted basis) approving amendments to the Company’s Articles of Incorporation to, among other things, (i) change the name of the Company to Encompass Group Affiliates, Inc. and (ii) increase the number of authorized shares of common stock from 5,000,000,000 to 230,000,000,000. Shareholders also approved an amendment of the Company’s 2005 Stock Plan to increase the number of shares of common stock available for issuance under such plan from 700,000,000 to 15,000,000,000.
With the approved increase in the number of authorized shares of common stock, the Company has sufficient common shares for (i) the automatic conversion of Series A-2 Preferred into 8,412,206,677 shares of common stock, (ii) the issuance of 80,000,000 shares of restricted stock to two executives per terms of employment agreements, (iii) the effect of future conversions of Series C Preferred, Series D Preferred and Convertible Notes and (iv) the effect of future exercises of stock options. With the authorization of a sufficient number of shares for the conversion of preferred stock into common stock, the Company has reclassified the Series A-2, Series C and Series D Preferred stock from liabilities to stockholders’ equity in the accompanying balance sheet. Upon the issuance of shares of common stock to holders of Series A-2 preferred stock, shares of such issue will be cancelled and the aggregate of par value and related additional paid in capital associated with the cancelled Series A-2 preferred stock will be classified as common stock on subsequent consolidated balance sheets.
Item 2. Management’s Discussion And Analysis Or Plan Of Operation
The following discussion should be read in conjunction with our financial statements and the related notes and the other financial information appearing elsewhere in this report. In addition to historical information, the following discussion and other parts of this quarterly report contain words such as “may,” "estimates," "expects," "anticipates," "believes," “plan,” "grow," "will," “could,” "seek," “continue,” “future,” “goal,” “scheduled” and other similar expressions that are intended to identify forward-looking information that involves risks and uncertainties. In addition, any statements that refer to expectations or other characterizations of future events or circumstances are forward-looking statements. Actual results and outcomes could differ materially as a result of important factors including, among other things, general economic conditions, the Company's ability to renew or replace key supply and credit agreements, fluctuations in operating results, committed backlog, public market and trading issues, risks associated with dependence on key personnel, competitive market conditions in the Company's existing lines of business and technological obsolescence, as well as other risks and uncertainties.
The following discussion should be read in conjunction with the information contained in Part I, Item 6 in our Annual Report on Form 10-KSB for the year ended June 30, 2007, as amended, under the headings “Risks Related to Our Business” and “Risks Related to Our Stock.” These factors materially affect our business, financial condition or future results of operations. The risks, uncertainties and other factors described in our Annual Report on Form 10-KSB are not the only ones facing our company. Additional risks, uncertainties and other factors not presently known to us or that we currently deem immaterial may also impair our business operations, financial condition or operating results. Any of the risks, uncertainties and other factors could cause the trading price of our common stock to decline substantially.
General
We are a New York-based company specializing in the technology after-market service and supply chain, known as reverse logistics. Through our wholly-owned subsidiary and principal operating unit, Encompass Group Affiliates, Inc. ("Encompass-Delaware"), our strategy is to acquire and operate businesses that provide computer and electron-ics replacement parts, repair and refurbishment services and end-of-life cycle services for such products as flat screen TVs, laptop computers, monitors, multi-function units and high-end consumer elec-tronics such as PDAs and digital cameras, as well as office equip-ment such as fax machines, printers, copiers and scanners. Encompass owns Vance Baldwin, Inc. (“Vance Baldwin”) and Cyber-Test, Inc. ("Cyber-Test"), which, respectively, primarily distribute replacement parts and repair electronic equipment. Vance Baldwin is headquartered in Florida, with its sole warehouse facility located in Lawrenceville, Georgia. Cyber-Test’s headquarters and operating facilities are based in Florida. The Company operates as one segment in the reverse logistics industry serving the electronics industry.
Financial Condition
We incurred a net loss of $436,000 for the nine months ended March 31, 2008, and in our prior two fiscal years we incurred net losses of $1,250,000 and $574,000, respectively. However, as a result of the transactions described below, we earned net income of $363,000 in the quarter ended March 31, 2008, and had, as of March 31, 2008, current assets in excess of current liabilities of $6,849,000 and stockholders’ equity of $7,310,000.
On August 17, 2007, the Company entered into a series of transactions to effect a recapitalization in connection with the acquisition of a new operating subsidiary which included (i) the completion of a preferred stock investment of $6,300,000, (ii) the issuance of $23.4 million in senior and subordinated notes, (iii) the liquidation of substantially all of the Company’s current liabilities, including notes payable, by cash payment or conversion into Series A-2 Convertible Preferred Stock or a note, and (iv) the exchange of substantially all of the Company’s convertible preferred stock into Series A-2 Convertible Preferred Stock, which automatically converts into common stock following stockholder approval to increase the number of authorized shares of common stock, which approval has been obtained as described in Note 7 to the accompanying consolidated financial statements. Also on August 17, 2007, the Company acquired all of the outstanding equity interests in Vance Baldwin, another entity serving in the reverse logistics industry engaged primarily in the distribution of parts for consumer electronics, printers, appliances, and computers. Revenue and net income for Vance Baldwin for the year ended December 31, 2006 amounted to $48,690,000 and $4,558,000, respectively.
We believe that our present and future sales levels will, for the foreseeable future, generate cash flows that will, together with the remaining $1.5 million in available borrowing capacity under our senior and senior subordinated debt facility, be sufficient to fund our operating working capital needs, as well as capital expenditures and quarterly interest and principal payments that are required under our debt facility. We intend to seek significant business acquisitions in the future which will likely require additional borrowings and, in all likelihood, additional equity. Our debt agreement requires an annual sweep of excess cash flow, as defined, which may limit our ability to use operating cash flow to fund acquisitions.
RESULTS OF OPERATIONS - COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2008 TO THE THREE MONTHS ENDED MARCH 31, 2007
Summary of Results of Operations
Primarily as a result of the acquisition of Vance Baldwin, net sales for the three months ended March 31, 2008 were $19,474,000 as compared to net sales of $2,617,000 for the three months ended March 31, 2007, an increase of $16,857,000, or 644%. Further, gross profit increased from $815,000 to $4,088,000 from the earlier period to the current period as a result of the acquisition. The company had a net income of $363,000 for the three months ended March 31, 2008 compared to a net loss of $344,000 for the three months ended March 31, 2007. Current period expenses include net interest expense of $804,000 and noncash items including stock-based compensation expense of $84,000, depreciation and amortization expense of $317,000, for an aggregate of $1,205,000.
The following table sets forth certain selected financial data as a percentage of sales for the three months ended March 31, 2008 and 2007:
| | | 2008 | | 2007 | |
| | | | | | |
| Net sales | | | 100.0 | % | | 100.0 | % |
| Cost of sales | | | 79.0 | | | 68.9 | |
| Gross margin | | | 21.0 | | | 31.1 | |
| Operating expenses | | | 15.0 | | | 41.6 | |
| Income (loss) from operations before other expenses | | | 6.0 | | | (10.5 | ) |
| Other expenses | | | (4.1 | ) | | (2.7 | ) |
| Net income (loss) | | | 1.9 | % | | (13.1 | )% |
Net Sales
Net sales for the three months ended March 31, 2008 were $19,474,000 as compared to net sales of $2,617,000 for the three months ended March 31, 2007, an increase of $16,857,000, or 644%. The increase in net sales was primarily due to the inclusion of Vance Baldwin, acquired August 17, 2007, for the three months ended March 31, 2008 and an increase in net sales by Cyber-Test for the three months ended March 31, 2008. The increase in Cyber-Test’s net sales was primarily due to an increase in repair orders from its two major customers, as well as an increase in repair orders from several recently-added customers, during the period ended March 31, 2008, compared to the same period in 2007.
Cost of Sales and Gross Profit
Our cost of sales totaled $15,387,000 for the three months ended March 31, 2008, as compared to $1,802,000 for the three months ended March 31, 2007, an increase of $13,585,000, or 754%. Our gross profit increased to $4,088,000 for the three months ended March 31, 2008 as compared to $815,000 for the three months ended March 31, 2007, with gross margins declining to 21.0% from 31.1% for the comparable periods.
The increase in cost of sales and gross profit was primarily due to the inclusion of Vance Baldwin in the period.
The overall decrease in gross margin is primarily attributable to the effect of the inclusion of net sales and cost of sales of Vance Baldwin, which operates at a lower gross margin than Cyber-Test. Cyber-Test experienced a decrease in gross margin due to a change in product mix and price adjustments for certain recurring work.
Operating Expenses
Total operating expenses for the three months ended March 31, 2008 and 2007 were $2,920,000 and $1,090,000, respectively, representing an increase of 1,830,000, or 168%. The increase was primarily due to the inclusion of expenses of Vance Baldwin in the current period only.
Depreciation and amortization for the three months ended March 31, 2008 amounted to $317,000 compared to $17,000 for the three months ended March 31, 2007. The increase is primarily attributable to amortization expense associated with intangible assets acquired in connection with the acquisition of Vance Baldwin.
Selling, general and administrative expenses increased to $2,603,000 for the three months ended March 31, 2008 from $1,073,000 for the three months ended March 31, 2007, principally due to (i) the inclusion of Vance Baldwin for the period following its acquisition, (ii) an increase in stock-based compensation expense in the current period compared to the earlier period attributable to the expense associated with stock option grants made by the Company contemporaneously with the closing of the recapitalization and the acquisition of Vance Baldwin, and (iii) an increase in expenses incurred by Cyber-Test to support a higher level of sales volume.
Other Expense
Other expense amounted to $804,000 for the three months ended March 31, 2008, compared to $69,000 for the three months ended March 31, 2007. Interest expense, net, for the three months ended March 31, 2008 was $804,000 compared to $19,000 for the three months ended March 31, 2007, with the increase due to the inclusion of interest on the debt financing entered into in connection with the recapitalization and the acquisition of Vance Baldwin. In the three months ended March 31, 2007, the Company incurred a one-time expense of $50,000 in connection with the PMIC bankruptcy proceeding and litigation settlement.
RESULTS OF OPERATIONS - COMPARISON OF THE NINE MONTHS ENDED MARCH 31, 2008 TO THE NINE MONTHS ENDED MARCH 31, 2007
Summary of Results of Operations
Primarily as a result of the acquisition of Vance Baldwin, net sales for the nine months ended March 31, 2008 were $45,108,000 as compared to net sales of $6,777,000 for the nine months ended March 31, 2007, an increase of $38,331,000, or 566%. Further, gross profit increased from $2,255,000 to $9,716,000 from the earlier period to the current period as a result of the acquisition. The net loss decreased from $640,000 for the nine months ended March 31, 2007 to $436,000 for the nine months ended March 31, 2008. The net loss was reduced despite the current period net interest expense of $2,013,000 and noncash items including stock-based compensation expense of $591,000, depreciation and amortization expense of $906,000, for an aggregate of $3,510,000, compared to approximately $130,000 of such expenses in the nine months ended March 31, 2007.
The following table sets forth certain selected financial data as a percentage of sales for the nine months ended March 31, 2008 and 2007:
| | | 2008 | | 2007 | |
| | | | | | |
| Net sales | | | 100.0 | % | | 100.0 | % |
| Cost of sales | | | 78.5 | | | 66.7 | |
| Gross margin | | | 21.5 | | | 33.3 | |
| Operating expenses | | | 18.2 | | | 41.4 | |
| Income (loss) from operations before other expenses | | | 3.3 | | | (8.1 | ) |
| Other expenses | | | (4.3 | ) | | (1.3 | ) |
| Net loss | | | (1.0 | )% | | (9.4 | )% |
Net Sales
Net sales for the nine months ended March 31, 2008 were $45,108,000 as compared to net sales of $6,777,000 for the nine months ended March 31, 2007, an increase of $38,331,000, or 566%. The increase in net sales was primarily due to the inclusion of Vance Baldwin sales generated in the period following the August 17, 2007 acquisition, and an increase in net sales by Cyber-Test for the nine months ended March 31, 2008 over the comparable prior year period. The increase in Cyber-Test’s net sales during the period ended March 31, 2008 compared to the same period in 2007 was primarily due to an increase in repair orders from its two major customers, as well as an increase in repair orders from several recently-added customers.
Cost of Sales and Gross Profit
Our cost of sales totaled $35,391,000 for the nine months ended March 31, 2008, as compared to $4,522,000 for the nine months ended March 31, 2007, an increase of $30,869,000, or 683%. Our gross profit increased to $9,716,000 for the nine months ended March 31, 2008 as compared to $2,255,000 for the nine months ended March 31, 2007, with gross margins declining to 21.5% from 33.3% for the comparable periods.
The increase in cost of sales and gross profit was primarily due to the inclusion of Vance Baldwin in the nine months ended March 31, 2008 for the period following its acquisition.
The overall decrease in gross margin is primarily attributable to the effect of the inclusion of net sales and cost of sales of Vance Baldwin, which operates at a lower gross margin than Cyber-Test. Cyber-Test experienced a slight decrease in gross margin in the current period compared to the year ago period principally due to a change in product mix.
Operating Expenses
Total operating expenses for the nine months ended March 31, 2008 and 2007 were $8,213,000 and $2,806,000, respectively, representing an increase of $5,407,000, or 193%. The increases were primarily due to the inclusion of expenses of Vance Baldwin in the nine months ended March 31, 2008 for the period following its acquisition.
Depreciation and amortization for the nine months ended March 31, 2008 amounted to $906,000 compared to $54,000 for the nine months ended March 31, 2007. The increase is primarily attributable to amortization expense associated with intangible assets acquired in connection with the acquisition of Vance Baldwin.
Selling, general and administrative expenses increased to $7,308,000 for the nine months ended March 31, 2008 from $2,752,000 for the nine months ended March 31, 2007, principally due to (i) the inclusion of Vance Baldwin in the current year for the period following its acquisition, (ii) an increase in stock-based compensation expense in the current period compared to the earlier period attributable to the expense associated with stock option grants made by the Company contemporaneously with the closing of the recapitalization and acquisition of Vance Baldwin, (iii) an increase in compensation expense at the corporate level and (iv) an increase in expenses incurred by Cyber-Test to support a higher level of sales volume.
The amount expensed for stock-based compensation in the nine months ended March 31, 2008 was substantially greater than the expense that will be recorded in succeeding periods for this option grant since a substantial portion of the options granted vested immediately.
Other Income (Expense)
Other expense amounted to $1,940,000 for the nine months ended March 31, 2008, compared to $89,000 for the nine months ended March 31, 2007. Other income amounted to $74,000 for the nine months ended March 31, 2008, compared to $50,000 of expenses for the nine months ended March 31, 2007, and includes a $75,000 gain on settlement of an amount due to a creditor as a part of the recapitalization for 2008. Other expense for 2007 includes $50,000 for payments in connection with PMIC bankruptcy proceeding and litigation settlement. Interest expense for the nine months ended March 31, 2008 was $2,013,000 compared to $41,000 for the nine months ended March 31, 2007, with the increase due to the inclusion of interest on the debt financing entered into in connection with the recapitalization and the acquisition of Vance Baldwin.
LIQUIDITY AND CAPITAL RESOURCES
The Company incurred a net loss of $436,000 for the nine months ended March 31, 2008, and in our prior two fiscal years we incurred net losses of $1,250,000 and $574,000, respectively. However, as a result of the transactions described below, we earned net income of $363,000 in the quarter ended March 31, 2008, and we had, as of March 31, 2008, a cash balance of $2,678,000, current assets in excess of current liabilities of $6,849,000 and stockholders’ equity of $7,310,000.
On August 17, 2007, the Company entered into a series of transactions to effect a recapitalization in connection with the acquisition of a new operating subsidiary which included (i) the completion of a preferred stock investment of $6,300,000, (ii) the issuance of $23.4 million in senior and subordinated notes, (iii) the liquidation of substantially all of the Company’s current liabilities, including notes payable, by cash payment or conversion into Series A-2 Convertible Preferred Stock or a note, and (iv) the exchange of substantially all of the Company’s convertible preferred stock into Series A-2 Convertible Preferred Stock, which automatically convert into common stock upon stockholder approval to increase the number of authorized shares of common stock, which approval has been obtained as described in Note 7 to the accompanying consolidated financial statements. Also on August 17, 2007, the Company acquired all of the outstanding equity interests in Vance Baldwin, Inc., another entity serving in the reverse logistics industry engaged primarily in the distribution of parts for consumer electronics, printers, appliances, and computers (“Vance Baldwin”). Revenue and net income for Vance Baldwin for the year ended December 31, 2007 amounted to $48,690,000 and $4,558,000, respectively.
We believe that our present and future sales levels will, for the foreseeable future, generate cash flows that will, together with the remaining $1.5 million in available borrowing capacity under our senior and senior subordinated debt facility, be sufficient to fund our operating working capital needs, as well as capital expenditures and quarterly interest and principal payments that are required by our debt facility. We intend to seek significant business acquisitions in the future which will likely require additional borrowings and, in all likelihood, additional equity. Our debt agreement requires an annual sweep of excess cash flow, as defined, which may limit our ability to use operating cash flow to fund acquisitions.
We have total contractual obligations of $25,771,000 as of March 31, 2008. These contractual obligations, along with the dates on which such payments are due, are described below:
| | | Contractual Obligations | |
| | | Total | | 1 Year or Less | | More Than 1 Year | |
| | | | | | | | |
| Unsecured note | | $ | 310,000 | | $ | -- | | $ | 310,000 | |
| Senior notes | | | 12,437,000 | | | 508,000 | | | 11,929,000 | |
| Senior subordinated notes | | | 11,735,000 | | | -- | | | 11,735,000 | |
| Convertible notes | | | 1,206,000 | | | -- | | | 1,206,000 | |
| Capitalized lease obligations | | | 83,000 | | | 34,000 | | | 49,000 | |
| | | | | | | | | | | |
| Total Contractual Obligations | | $ | 25,771,000 | | $ | 542,000 | | $ | 25,229,000 | |
Net Cash Used In Operating Activities
Net cash used in operating activities was $1,429,000 for the nine months ended March 31, 2008, compared to net cash used in operating activities of $80,000 for the nine months ended March 31, 2007. Net cash used in operating activities for the nine months ended March 31, 2008 was principally due to the loss from operations of $436,000, increases in inventory of $267,000 and accounts receivable of $979,000 and a decrease in accrued expenses of $587,000 in connection with the recapitalization that liquidated substantially all of the Company’s liabilities, offset by non-cash expenses of $1,515,000.
Net cash used in operating activities for the nine months ended March 31, 2007 was principally due to the loss from operations of $640,000, and an increase in accounts receivable of $223,000, partially offset by increases in accounts payable of $144,000 and accrued expenses of $554,000, and non-cash expenses of $93,000.
Net Cash Used In Investing Activities
Net cash used in investing activities of $25,284,000 for the nine months ended March 31, 2008 was attributable almost entirely to the acquisition of Vance Baldwin for $22,321,000; net of cash acquired, plus related transaction costs of $2,770,000.
Net cash used in investing activities of $129,000 for the nine months ended March 31, 2007 was attributable to an increase in deferred acquisition costs of $126,000 incurred in connection with planned acquisition in process and purchases of fixed assets of $41,000.
Net Cash Provided By Financing Activities
Net cash provided by financing activities of $28,547,000 for the nine months ended March 31, 2008 was principally attributable to proceeds of $6,300,000 and $24,039,000 from the sale of Series C Preferred Stock and senior and subordinated notes, respectively, in connection with the recapitalization and the acquisition of Vance Baldwin, offset by principal payments of $891,000 to repay all notes payable outstanding at closing, as well as principal payments for the senior debt and monthly capital lease payments. In addition, transaction costs of $901,000 were incurred in connection with the equity and debt issued in connection with the recapitalization and acquisition transactions.
Net cash used by financing activities of $3,000 for the nine months ended March 31, 2007 was attributable to proceeds of $340,000 from the sale of our Series A-1 preferred stock, offset by principal payments of $343,000 on notes payable and capital leases.
Off-Balance Sheet Arrangements
There are no off-balance sheet arrangements between the Company and any other entity that have, or are reasonably likely to have, a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources. The Company does not have any non-consolidated special purpose entities.
Item 3. Controls And Procedures
(A) Evaluation Of Disclosure Controls And Procedures
Prior to the filing of this Report on Form 10-QSB, an evaluation was performed under the supervision of and with the participation of the Company’s management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on the evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of March 31, 2008, our Chief Executive Officer and our Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to the Company’s management, as appropriate, to allow timely decisions regarding required disclosure. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
(B) Changes In Internal Controls
During the three months ended March 31, 2008, there were no significant changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Unregistered Sales of equity Securities And Use Of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission Of Matters To A Vote Of Security Holders
None.
Item 5. Other Information
As previously disclosed, we have established a Code of Business Conduct and Ethics (the "Code") applicable to all of our employees, including our principal executive, accounting and financial officers, and we intend to satisfy our disclosure requirement under Item 5.05 of Form 8-K regarding certain amendments to, or waivers of, any provision of the Code by posting such information on our corporate website. In connection with our name change effective May 6, 2008, our Internet website address has changed and is now http://www.encompassgroup.com.
We have previously filed the Code as Exhibit 14.1 to our Form 10-KSB filed with the Securities and Exchange Commission on November 3, 2004. In addition, we will provide a copy of the Code, without charge, upon written requests to our corporate office located at 420 Lexington Avenue, Suite 2739, New York, NY 10170.
Item 6. Exhibits
Exhibits are incorporated herein by reference or are filed with this Quarterly Report as set forth in the Exhibit Index beginning on page 20 hereof.
Signatures
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | ENCOMPASS GROUP AFFILIATES, INC. |
| | | |
| | By: | /s/ Wayne I. Danson |
| | Name: | Wayne I. Danson |
| | Title: | President, Chief Executive Officer (Principal Executive Officer) and Director |
| | Date: | May 14, 2008 |
| | | |
| | By: | /s/ John E. Donahue |
| | Name: | John E. Donahue |
| | Title: | Chief Financial Officer (Principal Accounting Officer) |
| | Date: | May 14, 2008 |
EXHIBIT INDEX
Exhibit No. | | Description | | Location (1) |
| | | | | |
2.1 | | Stock Purchase Agreement entered into by and between Encompass Group Affiliates, Inc. and Fred V. Baldwin, dated as of August 17, 2007 | | Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 21, 2007 |
| | | | | |
3(i)(a) | | Restated Articles of Incorporation of Advanced Communications Technologies, Inc. | | Incorporated by reference to Exhibit 3(i) to the Company’s Annual Report on Form 10-KSB filed with the SEC on September 28, 2007 |
| | | | | |
3(i)(b) | | Articles of Amendment to the Articles of Incorporation of Advanced Communications Technologies, Inc. filed with the Secretary of State of Florida on May 6, 2008 | | Filed herewith |
| | | | | |
3(ii) | | Amended Bylaws of Advanced Communications Technologies, Inc. | | Incorporated by reference to Exhibit 3(ii) to the Company’s Current Report on Form 8-K filed with the SEC on August 21, 2007 |
| | | | | |
4.1 | | Form of Convertible Promissory Note issued in connection with Exhibit 2.1 | | Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 21, 2007 |
| | | | | |
4.2 | | Note Purchase Agreement, dated as of August 17, 2007, by and among Encompass Group Affiliates, Inc. as Issuer, and Advanced Communications Technologies, Inc., Cyber-Test, Inc., Vance Baldwin, Inc., Hudson Street Investments, Inc. and SpectruCell, Inc. as Guarantors, the Note Purchasers listed therein, and Sankaty Advisors, LLC | | Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed with the SEC on August 21, 2007 |
| | | | | |
4.3 | | Form of Senior Note issued in connection with Exhibit 4.16 | | Incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed with the SEC on August 21, 2007 |
| | | | | |
4.4 | | Form of Subordinated Note issued in connection with Exhibit 4.16 | | Incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed with the SEC on August 21, 2007 |
| | | | | |
4.5 | | First Lien Pledge and Security Agreement, dated as of August 17, 2007, between Encompass Group Affiliates, Inc., Advanced Communications Technologies, Inc., SpectruCell, Inc., Hudson Street Investments, Inc., Cyber-Test, Inc., Vance Baldwin, Inc. and Sankaty Advisors, LLC | | Incorporated by reference to Exhibit 4.5 to the Company’s Current Report on Form 8-K filed with the SEC on August 21, 2007 |
| | | | | |
4.6 | | Second Lien Pledge and Security Agreement , dated August 17, 2007, between Encompass Group Affiliates, Inc., Advanced Communications Technologies, Inc., SpectruCell, Inc., Hudson Street Investments, Inc., Cyber-Test, Inc., Vance Baldwin, Inc. and Sankaty Advisors, LLC | | Incorporated by reference to Exhibit 4.6 to the Company’s Current Report on Form 8-K filed with the SEC on August 21, 2007 |
| | | | | |
31.1 | | Certification by Chief Executive Officer pursuant to Sarbanes-Oxley Section 302 | | Filed herewith |
| | | | | |
31.2 | | Certification by Chief Financial Officer pursuant to Sarbanes-Oxley Section 302 | | Filed herewith |
| | | | | |
32.1 | | Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350 | | Filed herewith |
| | | | | |
32.2 | | Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350 | | Filed herewith |
(1) In the case of incorporation by reference to documents filed by the Company under the Exchange Act, the Company’s file number under the Exchange Act is 000-30486. |
