UNITED
STATES


SECURITIES
EXCHANGE COMMISSION


WASHINGTON,
DC 20549





FORM
10-K


ý
            
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
      EXCHANGE ACT OF 1934For
      the fiscal year ended June 30, 2009ORo
            
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
      EXCHANGE ACT OF 1934


For the
transition period from ____________ to ____________





Commission
file number:  000-30486










ENCOMPASS
GROUP AFFILIATES, INC.


(Exact
name of registrant as specified in its charter)





FLORIDA
            65-0738251State or other
      jurisdiction of incorporation or organization
            (I.R.S.
      Employer Identification No.)420
      Lexington Avenue, Suite 2739,
            10170New
      York, NY
            (Zip
      Code)(Address
      of principal executive offices)




Registrant’s
telephone number, including area code (646) 227-1600





Securities
registered pursuant to Section 12(b) of the Act:




Title
      of each class
            
            Name
      of each exchange on which registeredNone
            
            None





Securities
registered pursuant to Section 12(g) of the Act:  Common Stock, No Par
Value per Share





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.Yes o No þ





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange
Act.    Yes o No þ





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes þ No o




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files). Yes o No o





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





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





Large
      accelerated filer  o
            Accelerated
      filer  oNon-accelerated
      filer  o
            Smaller
      reporting company  þ




(Do not
check if a smaller reporting company)





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes o No þ





As of
December 31, 2008, the aggregate market value of the registrant’s common stock
held by non-affiliates of the registrant was $3,048,330 based on the average of
the bid and asked prices as quoted on the OTC Bulletin Board.





Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.





Class
            
            Outstanding
      at September 25, 2009[Common
      Stock, No par value per share]
            
            13,286,151,226
      shares





DOCUMENTS
INCORPORATED BY REFERENCE


None





Encompass
Group Affiliates, Inc. and Subsidiaries


Form
10-K


Table
of Contents


Page




Part
I




Item
      1.
            Business
            1-9Item
      1.a.
            Risk
      Factors
            9-13Item
      1.b.
            Unresolved
      Staff Comments
            13Item
      2.
            Properties
            13Item
      3.
            Legal
      Proceedings
            13Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            13





Part
II




Item
      5.
            Market
      for Registrant’s Common Equity, Related Stockholder Matters
      andIssuer
      Purchases of Equity Securities
            14-15Item
      6.
            Selected
      Financial Data
            15Item
      7.
            Management's
      Discussion and Analysis of Financial Condition andResults
      of Operations
            15-29Item
      7.a.
            Quantitative
      and Qualitative Disclosures about Market Risk
            29Item
      8.
            Financial
      Statements and Supplementary Data
            29Item
      9.
            Changes
      In and Disagreements with Accountants on Accounting andFinancial
      Disclosure
            29Item
      9a(t).
            Controls
      and Procedures
            29-30Item
      9b.
            Other
      Information
            30


Part
III




Item
      10.
            Directors,
      Executive Officers and Corporate Governance
            31-35Item
      11.
            Executive
      Compensation
            35-40Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Managementand Related
      Stockholder Matters
            40-44Item
      13.
            Certain
      Relationships and Related Transactions, and Director
      Independence
            45-47Item
      14.
            Principal
      Accountant Fees and Service
            47-58





Part
IV




Item
      15.
            Exhibits
      and Financial Statement Schedules
            48-54




Signatures

















As used
herein, the terms the “Company,” “Encompass Group Affiliates,” “we,” “us,” or
“our” refer to Encompass Group Affiliates, Inc., a Florida corporation. Unless
otherwise noted herein, dollars are presented in thousands, except for per share
amounts.




Forward-Looking
Statements




Certain
statements in  Item 1 - Business, Item 1A – Risk Factors, Item 7 -
Management’s Discussion and Analysis of Financial Condition and Results of
Operation and elsewhere in this Annual Report on Form 10-K 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 Annual Report on Form 10-K 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,” "anticipation,” "intend,” "could,” "estimate,” or "continue" or
the negative or other comparable terminologies 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.




Additional factors that could affect
future results are set forth throughout Item 1 - Business and Item 1A – Risk
Factors and elsewhere in this Annual Report on Form 10-K.  Because of
the risks and uncertainties associated with forward-looking statements, you
should not place undue 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.














Part
I




Item
1.  Business




Encompass
Group Affiliates, Inc., a Florida corporation ("we," "us," "our," “Encompass” or
the "Company"), is a public company specializing in the technology
after­market service and supply chain known as reverse logistics. Our
wholly-owned subsidiaries and principal operating units, Encompass Parts
Distribution, Inc., a Delaware corporation ("Encompass Parts"), and Encompass
Service Solutions, Inc (also known as Cyber-Test, Inc) collectively operate
businesses that, on a national  level, provide parts procurement and
distribution services, depot repair of consumer electron­ics, computer and
peripheral equipment, board level repair, de-manufacturing and reclamation
services for flat panel display and computer products, returns management
services, and anticipates providing end-of-life cycle services for all such
products.





We are a
market leader in the consumer electronics segment of the reverse logistics
industry providing original equipment manufacturers (“OEMs”), retailers, third
party administrators (“TPAs”) and end-users with single-source, integrated life
cycle reverse logistic professional management services for technology
products.  Our strategy addresses the overall market from both the
end-user driven product support and repair industry and from the
manufacturer-driven e-Waste recovery industry.  While these two
industries have different characteristics, they have significant operational
synergies.  We are focused on becoming a full-service provider of
repair, refurbishment, parts distribution and end-of-life cycle services in
other industries. To that end and to augment our growth, we intend to continue
to acquire additional businesses that either repair and refurbish equipment or
distribute parts typically used in the repair and refurbishment process, as well
as those that provide e-Waste recovery services. We presently provide single
source life cycle professional management services for technology products to
businesses and consumers in the North American market initially, and expect to
commence full-scale operations in Mexico to serve the Latin America market and
Canada within the next 60 days.





Encompass
Parts owns Cyber-Test, Inc., a Delaware corporation acquired in June 2004
("Cyber-Test"), which is headquartered in Florida and currently operating as
Encompass Service Solutions, Inc.  Encompass Service Solutions
operates as an independent service organization with the expertise to provide
board-level repair of technical products to third-party warranty companies,
OEMs, national retailers and national office equipment dealers. Service options
include advance exchange, depot repair, call center support, parts supply and
warranty management.  Encompass Service Solutions' technical
competency extends from office equipment and fax machines to printers, scanners,
laptop computers, monitors, multi-function units and high-end consumer
elec­tronics such as GPS devices, PDAs and digital cameras and
de-manufacturing and reclamation services for flat-panel display products.
Services are delivered nationwide through proprietary systems that feature
real-time electronic data interchange (“EDI”), flexible analysis tools and
repair tracking.  Encompass Service Solutions expanded in fiscal 2009
by opening a service center in one of our suburban Atlanta parts distribution
warehouses to perform board repair and other reverse logistics functions
enabling us to offer a full range of integrated services to
customers.  We intend to open additional service centers in more of
our distribution facilities to become the only company in the industry to offer
fully integrated services on a nation-wide basis.





On August
17, 2007, Encompass Parts completed the acquisition of Vance Baldwin, Inc., a
consumer electronics parts distributor that has been a leader in the industry
for over fifty years.  Vance Baldwin had operations in southern
Florida and suburban Atlanta, and now an operation in Las Vegas, and distributes
tens of thousands of different parts (i.e., SKU’s) ranging from consumer
electronics, computers, printers, appliances and office supplies carried in
stock or special ordered from the five million parts that it has access to for
distribution.  In addition, Vance Baldwin provides service aids and
industrial products such as cable, tools, test equipment, cleaners and other
installation equipment.





On July
14, 2008, Vance Baldwin entered into an agreement with Philips Consumer
Lifestyle North America (“Philips”), a division of Philips Electronics North
America Corporation.  Under the terms of the agreement, Vance Baldwin,
as single primary authorized distributor, assumed the management and execution
responsibilities for operational and order fulfillment of the replacement parts
business for Philips’ digital flat panel display products.  In this
role the Company sells replacement parts to independent service centers as well
as other parts distributors with whom it competes.  Under terms of
this agreement, the Company purchased approximately $4,200 of inventory directly
from Philips.




1





On August
1, 2008, Encompass Parts completed the acquisition of Tritronics, Inc., an
OEM-authorized consumer electronics parts distributor that has been in business
since 1975 and has operations in suburban Baltimore and
Miami.  Tritronics similarly distributes tens of thousands of
different parts (i.e., SKU’s) ranging from consumer electronics, computers,
printers, appliances and office supplies carried in stock or special ordered
from the five million parts that it has access to for
distribution.  In addition, as with Vance Baldwin, Tritronics also
provides service aids and industrial products such as cable, tools, test
equipment, cleaners and other installation
equipment.   Tritronics is a distributor of replacement parts in
the U.S. for substantially all of the major OEM manufacturers, with a
particularly strong market presence selling to the extensive network of
independent service centers that operate nationwide.  During fiscal
2009, Encompass Parts Distribution formed subsidiaries in Mexico and Canada in
anticipation of commencing operations in each of those countries in fiscal
2010.





As a key
component of our rebranding initiative that began in fiscal 2009, Vance Baldwin
and Tritronics, now operating on an integrated single technology platform, are
known throughout the industry as Encompass Parts Distribution.





The
Reverse Logistics Industry





Reverse
logistics was first implemented in the electronics industry (computing, office
automation, telecommunications process, etc.) in the early 1980s as a result of
miniaturization and modularization design, with the repair of a product or piece
of equipment performed in the field (i.e., fix in place).  More
recently, the proliferation of large-scale, sophisticated, integrated digital
circuits and circuit boards, carrying built in diagnostics and defined test
points, have led to increased reliability of the subsystems and components,
reducing repair time through the pull-and-replacement of modules rather than
field repair.  As the value of these components continuously
increases, so does the demand for solutions that monetize and extend the life of
components through repair and reallocation.  Larger high-cost
products, not well suited for off-site repair, such as DLP and LCD televisions,
continue to drive demand for a field repair solution.





Historical
growth in sales of consumer electronics and computer and peripheral equipment,
partly fueled by the continuing introduction of new products, is driving the
need for reverse logistics and repair services as offered by the
Company.  There remains significant opportunity for above average
company growth within the industry by continuing to increase capabilities across
the product life cycle.  While the demand for reverse logistics and
repair services is adversely impacted by economic downturn cycles we believe the
long-term need for such services may not be as severely impacted as retail sales
levels may be since consumers generally are more likely to repair currently
owned equipment if a new product purchase is deferred.





The
consumer electronics (including high-tech home appliances), computer and
computer peripherals segment of the reverse logistics industry can be broken
down into five segments which span the industry lifecycle, including: parts
suppliers; repair, refurbishment and returns management companies; remote/onsite
repair management and service dispatch providers; warranty administrators; and
e-Waste recovery organizations.  These constituencies provide services
to the participants at various points along the product life-cycle continuum,
from the OEMs who manufacture the products and original parts to the retailers
engaged in marketing and selling of the end-products to the TPAs which
underwrite the extended service plans.





The
reverse logistics industry has traditionally been generally comprised of
businesses that are either parts suppliers or repair, refurbishment and returns
management operations; our strategy is to offer, on a nation-wide basis, all
such services on an integrated value-added basis.





Parts
Suppliers




Historically,
parts suppliers tended to be regionally focused and lack the ability to provide
customers with a national solution, therefore only serving the network of repair
centers and onsite service technicians in their surrounding
areas.  Today, part suppliers are still regionally based, and struggle
with the cost of supporting customers nationally due to the minimum service
requirement of two-day delivery, forcing them to resort to expensive freight
methods such as two-day air delivery.  Some parts suppliers have
vertically integrated repair operations, leveraging the sourcing of parts from
their own inventory.  Parts distribution companies tend to specialize
around certain product categories, and/or specific OEMs.  OEMs control
parts access and in some cases (for example, Apple and Sony for certain product
lines) make it virtually impossible for independent service or parts providers
to gain direct access to their parts.    To extend the life
of products and to prevent inefficient post-manufacturing parts production
(after a product line is closed), OEMs will apply core charges to circuit boards
and other high mortality items to extend product life.




2





Repair,
Refurbishment and Returns Management Companies




Historic
repair and refurbishment activities for technology products have been organized
based on the proximity of the repair center to the end-user.  Examples
include the independent service dealer handling in-warranty authorized repairs
for OEMs or out-of-warranty repairs for end consumers (all walk-in
driven).  The industry has witnessed consolidation in service repair
centers, as well as groups aligning together to create a national network for
OEMs.  Over the last 20 years, much of the growth of the service
contract business has been driven by large insurance agencies that have acquired
a sizeable portion of the former out-of-warranty repair business and placing it
under the service plans they underwrite.




The
larger scale operations have historically been run by
OEMs.  Integrated circuitry, power source improvements and lifestyle
changes are driving products toward smaller dimensions.  As a result,
price pressures from imports, fickle consumer demand and manufacturer
consolidation have forced OEMs to close these large scale facilities and
outsource work to external service providers or cobble together a network to
replicate this operation.  The influx of Asian OEMs, many of which are
Chinese manufacturers historically focused on private label manufacturing for
major US brands (e.g., Panasonic, Sony, etc), have been aggressively selling
into the U.S. with extremely cost-competitive products.  However,
these OEMs do not possess the requisite US-based service infrastructures and,
therefore, are driving additional demand toward a group of smaller external
service providers.  In addition to pure service delivery, the repair
and refurbishment companies are broadening their offerings to include level II
and III technical support, diagnosing and potentially repairing equipment
directly over the phone with the end user.  (Level II support is
typically a technical representative advising a consumer.  Level III
support is typically a more highly trained technical representative advising a
technical person.)   As equipment becomes more integrated with
other systems and software, it has become necessary for the repair centers to
offer this value added service.   An industry trend is the rise
of so-called “Big Box” retailers entering into this area, such as Best Buy
through its “Geek Squad” group and formerly Circuit City through its “Firedog”
group.





The
Equipment Warranty/Repair Management Industry





Warranty
periods, including product warranties issued by manufacturers and extended life
warranties issued by third-party insurers, as well as longer product life
cycles, demand a maintenance/repair commitment that can typically support a
product for up to ten years.  In addition, the industry relationship
among OEMs, TPS’s and similar organizations, and the third- and fourth-party
service providers has become more complex.  The end-user, or consumer,
must have assurance that products are supported by an after-sales service system
capable of providing preventive maintenance and/or an immediate remedy upon
equipment failure.





With the
technological advances and associated cost reductions in shipping, the warranty
provider’s challenge is to meet and exceed customer’s expectations with respect
to speed of response.  The repair/warranty industry has seen a shift
towards outsourcing warranty service to companies whose primary purpose and core
strength is to manage complex demands of the repair/warranty chain
process.  Warranty service companies are expected to be able
to:





·
            offer
      one-stop / turnkey service;




·
            have
      the technical ability to repair multi-products for
      multi-vendors;




·
            offer
      advance exchange of office equipment computer peripheral
      products;




·
            offer
      distribution logistics from call management through delivery;
      and




·
            demonstrate
      supply-line parts management logistics
  efficiencies.





Ultimately,
the success or failure of meeting warranty commitments will depend on the
ability of the warrantor or its service provider to have the right component in
the right place, at the right time, and the right skills, to affect the
necessary repair at the most cost-effective price.




3





Our Products and
Services





Encompass
Parts Distribution





Parts and
Sales.Formerly two of the nation’s largest distributors of
parts for consumer electronics products, computers, printers and fax machines as
well as office supplies, Vance Baldwin and Tritronics, now operating as one
entity, Encompass Parts Distribution, currently sell from stock and have access
to over five million parts for distribution.  Customers can view a
full listing of parts inventoried parts at all five Encompass Parts Distribution
warehouses through its website and, if any part is not in stock, it can usually
be made available in one business day.  Encompass Parts Distribution’s
unique parts ordering system affords the capability to search, order, and buy
parts without an OEM part number, and its search feature will cross-reference to
other OEMs or parts manufacturers that may fit the desired
part.  Parts and products sold are typically backed with a full OEM
warranty.





Traditionally,
Encompass Parts Distribution as Vance Baldwin and Tritronics served customers in
the Eastern half of the country, although Tritronics had more of a nationwide
presence as it typically focused more on the smaller independent service centers
than Vance Baldwin and the Company’s one other major competitor. Vance Baldwin
had a strong market presence with national “big box” retailers and rental
organizations, hence it focused more on the Eastern half of the
country.  Freight costs make it prohibitively costly to supply
customers on a nation-wide basis, hence, all competitors, with the exception of
one other major competitor, are substantially smaller and serve smaller
regions.  In March 2009, Encompass Parts Distribution opened a
warehouse in Las Vegas to become the first parts distributor to offer
nation-wide services with two-day ground shipping capability to virtually any of
the lower 48 states.





Encompass
Parts Distribution, through Vance Baldwin, has now entered into contractual
agreements with virtually all of the country’s largest providers of extended
warranty plans to consumers for an innovative program described
below.  (Extended warranty plans are purchased in approximately 15% of
product purchases that consumers make at “big box” and other retailers for flat
screen TV’s, cell phones, PDA’s, printers and laptop
computers.)  Under the program, which includes internally developed
proprietary technical information systems, Encompass Parts Distribution supplies
parts to the thousands of repair businesses, like Encompass Service Solutions,
that provide repair services on behalf of the extended warranty
providers.  The advantage of the program to the extended warranty
provider is (a) standard pricing for parts and (b) a system that offers control
over the repair cycle so that the extended warranty provider has the ability to
monitor both the repair cycle status and associated cost for hundreds of
thousands of open repair jobs, an ability that did not previously exist to any
meaningful degree.  As a result of this program, Encompass Parts
Distribution has increased the volume of parts sales made directly to extended
warranty providers.





Encompass
Parts Distribution is a major distributor for the largest, well-known OEMs in
the world, such as Panasonic, Samsung, Toshiba, RCA, JVC, Sony, Philips, and
many others, as well as the predominant supplier to the largest retailers, such
as Best Buy and Rent-a-Center.





Call Center Technical
Support.  Encompass Parts Distribution offers customer support
through their Call Centers, averaging approximately 59,000 calls per
month.  The principal service provided by the Call Centers is
assisting customers with parts searches and purchases.





Encompass
Service Solutions





Repair and Exchange.Encompass Service
Solutions operates in the reverse logistics industry within the office equipment
and computer peripheral products repair/warranty management industry, with its
primary focus on facsimile machines, printers, scanners, PDAs, laptop computers,
monitors, and multi-function units.  The following describes the
individual components that make up the current Encompass Service Solutions
family of products and services.





Encompass
Service Solutions has offered board-level repair of technical products for more
than 20 years, and offers service programs for equipment dealers, OEMs, extended
warranty companies, retail outlets and end-users.  The service
programs include:





·
            return
      to depot repair of office equipment and computer peripheral
      products;




·
            advance
      exchange of office equipment and computer peripheral
    products;




4




·
            board-level
      repair of circuit boards and sub
assemblies;




·
            return
      to depot repair for component-level circuit
  boards;




·
            OEM
      warranty exchange and repair
programs;




·
            large
      volume repair and refurbishment;
and




·
            call
      center technical support.





Encompass
Service Solutions’ repair and exchange service is managed by an internally
designed and developed proprietary information system internally  with
software-tracking that allows customers or the call center function (whether it
is onsite at Encompass Service Solutions’ facilities or at the customer’s
facility) to track on a real-time basis the repair status of any given unit,
including a date of return delivery to the end-user, while at the same time
allowing Encompass Service Solutions to manage the output volume and quality of
the repair process. This software allows its clients to view their inventory,
parts, parts used per unit, and the status of all equipment on a real-time basis
via its secure website.  Clients may also change priorities and
accelerate orders directly from this proprietary, customized web
portal.  Repair work is principally performed for OEM’s, retailers and
TPAs under warranty programs.





Parts and
Sales.Encompass Service Solutions stocks a line of parts,
accessories, and consumables for its in-house repair needs and offers these
parts for sale as well.  Encompass Service Solutions stocks over
30,000 parts for printers, facsimile machines, scanners, laptops, monitors and
PDAs.  A customer can view a full listing of parts at Encompass
Service Solutions’ website and, if any part is not in stock, it can usually be
made available in one business day.  Encompass Service Solutions'
unique parts ordering system affords the capability to search, order, and buy
parts without an OEM part number, and its search feature will cross-reference to
other OEMs or parts manufacturers that may fit the desired part.





Further,
Encompass Service Solutions stocks an extensive inventory of new and refurbished
equipment available for purchase.  New equipment is backed with a full
OEM warranty, and 90-day warranties are offered by Encompass Service Solutions
for refurbished units.





Call Center Technical
Support.  Encompass Service Solutions offers partial or full
(turnkey) Help Desk support through its Call Center.  The Call Center
has handled as many as 25,000 calls per month from its customers and currently
averages approximately 9,000 calls per month.  The Call Center has a
phone-fix rate of approximately 69%, which significantly reduces costs to again
service a product that Encompass Service Solutions repaired and guaranteed under
a 90-day warranty.  Encompass Service Solutions' Call Center is the
sole technical help line for selected Xerox printers and fax
machines.





Logistics and
Outsourcing.Encompass Service Solutions offers its customers
an outsourcing service of inventory, warehousing, and shipping of parts and end
products for warranty fulfillment, with full refurbishing and inspection
programs including "A" and "B" goods logistics.  OEMs can direct all
store returns to Encompass Service Solutions for inspection.  If units
have not been taken out of the box, those items can be inspected and resold out
as "A" goods.  Products that have been used or are defective are
processed through the refurbishment process and repackaged and resold as "B"
goods.  Encompass Service Solutions can assist the OEM with "B" goods
distribution and resale.





Encompass
Service Solutions also has a salvage division that receives extended warranty
products that were "bought out" by the warranty provider. Products are received,
sorted and palletized for resale to wholesalers worldwide.





Service
Contracts.Encompass Service Solutions has established
relationships with a number of insurance companies and third-party service
providers to provide full repair and call center support
service.  Extended manufacturer’s warranties sold at retail stores are
typically backed by a third party insurance company.  In other cases,
the extended warranty is managed by the retailer itself.  If a product
covered in a service contract is determined to be in need of repair by the Call
Center, a replacement unit may be sent directly to the end-user in exchange for
the unit needing repairs.  Encompass Service Solutions manages the
process from call receipt and receiving the defective product back from the
customer, to tracking the product, repairing the returned units, and managing
against customer fraud.  In fiscal 2009, Encompass Service Solutions
lost a contract to repair laptops with one of its two major
customers.




5





Encompass
Service Solutions also offers an "Advance Exchange" program, known as ADVANCEXTM,
which provides same day service to its customers on all products Encompass
Service Solutions repairs.  With the ADVANCEXTM program, Encompass
Service Solutions can ship an equivalent-to-new ("ETN") replacement product
directly to the customer if phone support fails to correct the
problem.  The customer then returns the defective unit to Encompass
Service Solutions for repair and refurbishment and subsequent use for another
customer.  A special capability of Encompass Service Solutions’
proprietary system is that it allows the OEM to gather failure analysis and
failure trends critical to the release of new products.  This
information is collected online while Encompass Service Solutions is providing
Level II and III technical support directly to the
customer.    The ADVANCEXTM program has resulted in decreased
product returns and increased customer satisfaction.





Competition





Encompass
Parts Distribution





Encompass Parts
Distribution’s business (formerlyVance
Baldwin and Tritronics operating as competitors) is highly competitive within
the geographic area in which it operates, which recently expanded from
predominately being in the Eastern half of the country to that of a national
capability.  It competes with numerous smaller, more regionally
restricted firms in the Eastern half of the country, while in the Western half
of the country if primarily competes against one large distributor.





Competition
within the parts distribution segment of the reverse logistics industry is based
on service, price, availability of parts (“fill rate”), speed and accuracy of
delivery, depth of technical know-how and the ability to tailor specific
solutions to customer needs.  Encompass Parts
Distribution is very proficient in forging technological links with
suppliers and customers to streamline the exchange of information for ordering,
shipping and paying, something which has provided a clear competitive advantage
over other parts distributors.





As
mentioned above, freight cost is a major expense component affecting all parts
distributors.  With the relocation of its warehouse operation to a
larger facility in April 2006, Vance Baldwin lowered freight costs and gained
the ability to ship to more customers by two-day land delivery, thereby reducing
its reliance on more costly air shipping.  Presently, with five
warehouses located in Georgia, Florida, Maryland and Nevada, the Company enjoys
competitive advantage over its regional competitors.





Competitors
of Encompass Parts include MTI/Andrews Electronics, Herman Electronics, Fox
International, Union Electronics, Cumberland and Partsearch.





Encompass
Service Solutions





Encompass
Service Solutions' business is highly competitive in each area from which it
derives revenue.  It competes with some larger and numerous smaller
companies that provide repair services for office equipment and computer
peripheral products, that supply parts and consumables to end-users and other
repair companies of such equipment and products, and with other sellers of new
equipment and resellers of refurbished equipment and products.





Competition
within the office equipment and computer peripheral products service and repair
industry is based on quality of service, depth of technical know-how, price,
availability of parts, speed and accuracy of delivery, and the ability to tailor
specific solutions to customer needs.  In the U.S., there are
hundreds of manufacturers of technical products of the type Encompass Service
Solutions repairs, hundreds of independent companies that repair products in a
manner similar to Encompass Service Solutions, as well as hundreds of companies
that supply parts and components for use in repair, and thousands of independent
service technicians that do on-site repair.  In addition, there are
thousands of companies that sell technical products that may need repair, and
many of these do their own repair or service work.





Many
of Encompass Service Solutions' competitors are larger in terms of
revenue, customers and employees, such as privately-held companies DEX and
Nexicore.  Encompass Service Solutions also competes with OEMs and
major retailers that do their own repair work.




6





Customers




Encompass
Parts Distribution





Encompass
Parts Distribution currently sells to approximately 20,000 active customers,
many for a decade or more.  With the acquisition of Tritronics in
August 2008, the concentration of Vance Baldwin’s business among three specific
customers was diminished as approximately 75% of Tritronics’ sales volume is
derived from sales to the nationwide network of thousands of independent service
contractors.  During the fiscal years ended June 30, 2009 and 2008,
sales to these three customers accounted for approximately 25% and 52% of its
total sales, respectively.  In March 2009, one of these three
customers went out of business after an unsuccessful effort to reorganize under
bankruptcy protection.





Encompass Service
Solutions





Encompass
Service Solutions currently generates a significant portion of its revenues from
two large customers.  During the fiscal years ended June 30, 2009 and
2008, sales to these two customers accounted for approximately 69% and 74% of
its total sales, respectively.In the third
quarter of fiscal 2009,Encompass Service Solutions’ was notified that it
lost its contract to perform laptop repair work for itslargest
customer.  This repair work, which accounted for 36.9% and 40.2% of
revenue in fiscal 2009 and fiscal 2008, respectively, will end by September
2009.





In fiscal
2009, Encompass Service Solutions opened a board repair and parts reclamation
facility in an Encompass Parts Distribution warehouse operation in Georgia, and
plans to open another such facility in the Las Vegas warehouse
operation.  Its ability to expand service, locations and customer base
is dependent upon many variables including its ability to successfully attract
and retain technicians that are capable of performing repair on all brands and
models of office equipment and computer peripherals at prices which remain
competitive.





Encompass
Parts DistributionandEncompass Service
Solutions have many customers in common, which will increase as the Company
sells not just parts or repair services on a standalone basis, but comprehensive
programs integrating parts supply, repair services, parts reclamation and asset
recovery services, etc.





Principal
Suppliers





Encompass
Parts Distribution is an authorized distributor for the largest, well-known OEMs
of consumer electronic products in the world, such as Panasonic, Samsung,
Toshiba, RCA, JVC, Sony, Sharp, Visio and Philips, the principal suppliers of
the products it sells.





Intellectual
Property





The
Company utilized and owns several domain names.  The Company uses the
name "Green Choice Parts" to identify certain goods and services, and has
applied for federal trademark registration of Green Choice Parts.  We
also use the name "Encompass" and our logo in various forms, such as “Encompass
Parts Distribution” and “Encompass Service Solutions”, in connection with our
goods and services.





As an
authorized distributor for the largest, well-known OEMs of consumer electronic
products in the world, Encompass Parts Distribution has contracts with each of
the OEMs that typically are one year in duration.  Through Vance
Baldwin and Tritronics, Encompass Parts Distribution enjoys long-term
relationships with each OEM.  As mentioned above, the OEMs are
restrictive in terms of granting authorization to additional
distributors.  In fact, many have not named any new distributors in a
number of years.





The
Company has entered into contracts with some of its customers; however, such are
typically cancellable upon a relatively short notice period by either party for
convenience.  With the majority of its customers, there is no written
contractual arrangement.





Encompass Parts
Distribution andEncompass Service Solutions have developed proprietary
IT systems that are integral part of the business and, management believes,
afford it a competitive advantage.




7





Government
Approval/Regulation





The
Company does not presently require government approvals to conduct its core
business, nor is its core business subject to existing or probable governmental
regulations.





Research
and Development Activities





The
Company currently conducts no research and development activities.





Environmental
Laws




The
Company’s operations do not involve activities that are subject to comprehensive
environmental laws.  To the extent that the Company’s operations are
subject to local, state and federal environmental laws, regulations and
ordinances, including waste disposal activities, the Company is in material
compliance with such laws, regulations and ordinances.


Company
History





We were
incorporated in Florida on April 30, 1998 under the name Media Forum
International, Inc. ("Media Forum") and were inactive from April 1998 to June
1998, except for the issuance of founders’ shares during such time
period.  On April 7, 1999, Advanced Communications Technologies, Inc.,
a Nevada corporation ("Advanced Communications (Nevada)") merged with and into
us.  Pursuant to this merger, the shareholders of Advanced
Communications (Nevada) received 90% of our outstanding common stock and we
received all of Advanced Communications (Nevada)’s assets.  These
assets included all of the North and South American rights to market and
distribute SpectruCell, a wireless software-defined radio ("SDR")-based
communications platform under development in Australia by entities related to a
founding shareholder, to offer mobile communications network providers the
flexibility of processing and transmitting multiple wireless communications
signals through one base station.  We subsequently changed our name
from Media Forum to Advanced Communications Technologies, Inc.  Upon
completion of the merger, we changed our trading symbol to "ADVC."  As
a result of the merger, Advanced Communications (Nevada) ceased to exist as a
separate entity.




On
January 31, 2000, we acquired Smart Investments.com, Inc. through a stock
exchange with Smart Investments’ sole shareholder.  Immediately upon
completion of that acquisition, we elected successor issuer status in accordance
with Rule 12g-3 promulgated under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”), and consequently became a "reporting company"
under the Exchange Act.




In 2002,
we closed operations relating to SpectruCell, significantly reduced our
expenses, and shifted to a holding company structure, as it became uncertain
whether SpectruCell’s development would ever be completed and brought to market
in the U.S.  On December 17, 2003, we formed SpectruCell, Inc., a
wholly owned Delaware subsidiary, and transferred all of our rights in the
SpectruCell technology to this subsidiary.  SpectruCell, Inc. is
presently inactive and the technology, to the best of our knowledge, has never
been commercially developed and/or tested.




On April
13, 2004, we formed Encompass Group Affiliates, Inc., a Delaware corporation,
currently known as Encompass Parts, to be our wholly-owned subsidiary for the
purpose of becoming our principal operating unit.  Encompass Parts is
the direct parent company to Cyber-Test, Vance Baldwin and Tritronics, our core
operating businesses.




On June
3, 2004, pursuant to the terms of an asset purchase agreement dated May 27,
2004, Encompass Parts acquired 100% of the assets and business of
Cyber-Test.




On
December 30, 2004, we acquired a controlling interest in Pacific Magtron
International Corp. (“PMIC”) PMIC engaged in the wholesale distribution of
electronics products, computer components, and computer peripheral equipment
throughout the United States.  On May 11, 2005, PMIC and its
subsidiaries filed voluntary petitions to reorganize their businesses under
Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy
Court for the Southern District of Nevada.  Due to the bankruptcy
filing of PMIC and its subsidiaries on May 11, 2005, and as of that date, the
Company was no longer able to exercise management control over PMIC’s business
operations.  Consequently, as of June 30, 2005, the Company accounted
for the investment in PMIC under the cost method of accounting.  PMIC
and its operating subsidiaries have been liquidated under Chapter 11 of the
bankruptcy code pursuant to plans confirmed by the Bankruptcy Court in August
2005 and January 2006.




8




On August
17, 2007 Encompass Parts entered into a series of transactions to effect a
recapitalization which, among other transactions, included the
following:




•           the
acquisition of Vance Baldwin for cash, a convertible note and shares of our
Series D Convertible Preferred Stock;




•           the
offer and sale of a significant preferred stock investment of $6.3 million to
ACT-DE, LLC, an affiliate of H.I.G. Capital, LLC, which, together with certain
other parties, received newly designated Series C Convertible Preferred Stock,
par value $.01, constituting approximately 79.5% (if converted) of the ownership
interest in the Company (before dilution for stock options issued to management
as described herein); and




•           the
issuance of approximately $23.4 million in senior and subordinated notes
pursuant to a Note Purchase Agreement, for which Sankaty Advisors, LLC is the
collateral agent.




In
connection with the above-described recapitalization, the Company offered the
holders of the Company’s Series A Convertible Preferred Stock, par value $.01
per share, Series A-1 Convertible Preferred Stock, par value $.01 per share, and
Series B Convertible Preferred Stock, par value $.01 per share, the right to
exchange such stock for the newly designated Series A-2 Preferred (the
“Exchange”).  In the Exchange, the existing preferred stockholders
provided a full release of any claims against the Company, but were not required
to provide any other consideration other than the surrender of their outstanding
shares of preferred stock.  In connection with the recapitalization,
the Company also paid off outstanding debts to certain creditors with an
aggregate payment of approximately $3,600,000 in cash.  One creditor
received a convertible promissory note in addition to a cash
payment.  Certain of these creditors then purchased shares of the
Series A-2 Preferred from one of the stockholders receiving such stock pursuant
to the exchange.  In May 2008, following an increase in the number of
authorized shares of our common stock, all shares of Series A-2 Preferred
automatically converted into shares of common stock.




Effective
May, 5, 2008, we changed our name to Encompass Group Affiliates, Inc. and our
trading symbol to "ECGA”.




On August 1, 2008 Encompass Parts
entered into a series of transactions which included:





·           the
acquisition of Tritronics, Inc. as a new operating subsidiary, for cash, a
promissory note and shares of our common stock;





·           the
offer and sale of shares of Series E Preferred Stock, for an aggregate purchase
price of $4,166,672 to ACT-DE, LLC and the other holders of its Series C
Preferred; and





·           the
issuance of approximately $13.2 million in additional subordinated notes under
an Amended and Restated Note Purchase Agreement with our existing
lender.





On
January 15, 2009, the Company formed Encompass Service Solutions, Inc., a
Delaware corporation.




On
January 15, 2009, the Company formed Encompass Parts Distribution, S. de R.L. de
C.V., a Mexican corporation, in connection with the contemplated expansion of
its operations into Mexico.




On June
18, 2009, the Company formed Encompass Distribution Canada, Inc., an Ontario,
Canada corporation, in connection with the contemplated expansion of its
operations into Canada.




Employees




As of
June 30, 2009, the Company had 305 full-time equivalent employees.




Item
1.A.  Risk Factors




Our
business is subject to the following risk factors:




We
Will Need Additional Capital to Achieve Our Business Plans.





We will
need capital to fund transactions with potential acquisition
candidates.  Any inability in obtaining this funding for further
acquisitions will delay or inhibit our progress in achieving our
goals.




9





Our
ability to secure additional financing for future strategic acquisitions will
depend upon a number of factors such as then prevailing general economic and
credit market conditions, including interest rate levels and the availability of
credit generally, many of which are beyond our control.  The prolonged
continuation or worsening of current credit market conditions could have a
material adverse effect on our ability to secure financing on favorable terms,
if at all.  If financing is not available when needed, or is available
on unfavorable terms, we may be unable to complete acquisitions at the pace or
on the scale that we have contemplated, or otherwise take advantage of business
opportunities or respond to competitive pressures, any of which could have a
material adverse effect on our business, financial condition and results of
operations.





Making
and Integrating Acquisitions Could Impair the Company’s Operating
Results.





A
component of our strategy for growth and expansion include the acquisition of
businesses that will complement or expand upon our current suite of
services.  Acquisitions involve a number of risks, including diversion
of management’s attention from current operations; disruption of the Company’s
ongoing business; difficulties in integrating and retaining all or part of the
acquired business, its customers and its personnel; and the effectiveness of the
acquired company’s internal controls and procedures.  The individual
or combined effect of these risks could have an adverse effect on the Company’s
business.  In paying for an acquisition, the Company may deplete its
cash resources or issue additional debt or equity
securities.  Furthermore, there is the risk that the Company’s
valuation assumptions, customer retention expectations and its models for an
acquired product or business may be erroneous or inappropriate due to foreseen
or unforeseen circumstances and thereby cause the Company to overvalue an
acquisition target.  There is also the risk that the contemplated
benefits of an acquisition may not materialize as planned or may not materialize
within the time period or to the extent anticipated.  The occurrence
of one or more of the foregoing risks associated with an acquisition could have
a material adverse effect on our results of operations.





There can
be no assurance that the Company will be able to successfully integrate any
future acquisition with the Company’s existing business. The Company could have
difficulty retaining and assimilating new personnel, retaining vendors of the
acquired business, and assimilating the services of the acquired business into
the Company’s overall operations. These difficulties could disrupt the Company’s
business, distract its management and employees, increase expenses and adversely
affect the Company’s business, results of operations and financial condition.
The Company did not, however, experience any integration or assimilation issues
with the acquisition of the Tritronics business and personnel with and into the
Encompass Parts brand during the current fiscal year.





To
Service Our Indebtedness, We Will Require A Significant Amount Of Cash; Our
Ability To Generate Cash Depends On Many Factors Beyond Our
Control.





Our
ability to make payments on the indebtedness that we have incurred to fund our
recent acquisitions and may incur in respect of future acquisitions will depend
on our ability to generate cash from our operations in the future. This, to a
certain extent, is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond our
control.  We cannot provide any assurances that we will have
sufficient cash flow to fund our debt service and other liquidity needs. We may
need to refinance or restructure all or a portion of our indebtedness on or
before maturity.  We cannot make any assurances that we will be able
to refinance any of our indebtedness on commercially reasonable terms or at
all.  If we cannot service our indebtedness, we may have to take
actions such as selling assets, seeking additional equity or reducing or
delaying capital expenditures, a sale of our business, strategic acquisitions,
investments and alliances. We cannot make any assurances that any such actions,
if necessary, could be effected on commercially reasonable terms, or at
all.





The
Company has not experienced any difficulty in the past two years in satisfying
its quarterly principal and interest debt service payments nor the one-time
principal prepayment on its senior debt.





Failure
To Meet Certain Financial Covenant Tests required By Our Debt Agreements Would
Result In An Event Of Default.





Our
ability to meet certain financial covenants will depend on our ability to
generate earnings from our operations in the future. This, to a certain extent,
is subject to general economic, financial, competitive, legislative, regulatory
and other factors that are beyond our control.  We cannot provide any
assurances that we will have sufficient earnings to meet our financial covenant
tests.




10




New
Equity Financing Could Dilute Current Stockholders.





If we
raise additional funds through equity financing to meet the needs discussed
above, it may have a further dilutive effect on existing holders of our shares
by reducing their percentage ownership. The shares may be sold at a time when
the market price is low because we need the funds. This will dilute existing
holders more than if our stock price was higher. In addition, equity financings
often involve shares sold at a discount to the current market
price.





The
Loss Of Any One Of our Key Customers Could Have A Material Adverse Effect On Our
Business.





We rely
heavily on the business of a limited number of key customers. While some of
these key customers are contractually committed, these contracts are terminable
within 60 to 90 days.  If two or more of these key customers terminate
their relationships with us, it could have a material adverse effect on our
business.





Our
Business Could Suffer If There Is A Prolonged Economic Downturn.





We
believe the need for reverse logistics and repair services may not be as
severely impacted by economic downturn cycles to the extent that retail sales
levels may decline since consumers are more likely to repair currently owned
equipment if a new product purchase is deferred.  Nevertheless, there
is no assurance that a prolonged national or regional economic downturn will not
have a material adverse effect on our businesses.





Fluctuations
In The Price Or Availability Of Office Equipment Parts And Computer Peripheral
Products Could Materially Adversely Affect Us.





The price
of office equipment parts and computer peripheral products that Encompass
Service Solutions purchases and the parts for consumer electronics, printers,
appliances, and computers that Encompass Parts purchases for resale may
fluctuate significantly in the future. Changes in the supply of or demand for
such parts and products could affect delivery times and prices. We cannot
provide any assurances that  Encompass Parts and Encompass Service
Solutions will continue to have access to such parts and products in the
necessary amounts or at reasonable prices or that any increases in the cost of
such parts and products will not have a material adverse effect on our
business.





We
Could Be Materially Affected By Turnover Among Our Service Qualified Technical
and Other Personnel.





Encompass
Parts and Encompass Service Solutions depend on their ability to identify, hire,
train, and retain qualified technical and other personnel as well as a
management team to oversee the services that each provide. A loss of a
significant number of these experienced personnel would likely result in reduced
revenues for and could materially affect our business. Our ability to attract
and retain qualified personnel depends on numerous factors, including factors we
cannot control, such as conditions in the local employment markets in which it
operates. We cannot provide any assurances that Encompass Parts and Encompass
Service Solutions will be able to hire or retain a sufficient number of
qualified personnel to achieve their financial objectives.





We
Could Fail To Attract Or Retain Key Personnel.





Our
success largely depends on the efforts and abilities of key corporate executives
as well as key executives at  Encompass Parts and Encompass Service
Solutions. The loss of the services of these key executives could materially
adversely affect our business because of the cost and time necessary to replace
and train a replacement. Such a loss would also divert management’s attention
away from operational issues.





The
Company’s Issuances of Preferred Stock Has Significantly Diluted the Equity
Ownership of our Stockholders and the Future Conversion of our Outstanding
Preferred Stock will also Cause Significant Dilution to our Existing
Stockholders.





The
Company’s issuances of preferred stock in August 2007 in connection with our
recapitalization and acquisition of Vance Baldwin significantly diluted the
equity ownership of our stockholders.  The significant dilution of the
common stock ownership of existing stockholders could have an adverse effect on
the price of the shares of common stock and on the future volume of the shares
of common stock traded.




11





The
Price of Our Common Stock May Be Affected By A Limited Trading Volume And May
Fluctuate Significantly and May Not Reflect the Actual Value of Our
Business.





There is
a very limited public market for our common stock, and there can be no assurance
that an active trading market will continue. An absence of an active trading
market could adversely affect our stockholders’ ability to sell our common stock
in short time periods, or at all. Our common stock has experienced, and is
likely to experience in the future, significant price and volume fluctuations
that could adversely affect the market price of our common stock without regard
to our operating performance. In addition, we believe that factors, such as
possible quarterly fluctuations in our financial results, changes in the overall
economy and the volatility of the financial markets, could cause the price of
our common stock to fluctuate substantially.





As a
result of the significant preferred stock issuances we have undertaken,
outstanding shares of our common stock represent only a small portion of our
fully diluted equity.  The price at which shares of our common stock
may trade from time to time may not reflect the actual value of our business or
the actual value of our common stock.





Our
Common Stock Is Deemed To Be "Penny Stock," Which May Make It More Difficult For
Investors To Sell Their Shares Due To Suitability Requirements.





Our
common stock is deemed to be "penny stock" as that term is defined in Rule
3a51-1 promulgated under the Exchange Act. These requirements may reduce the
potential market for our common stock by reducing the number of potential
investors. This may make it more difficult for investors in our common stock to
sell shares to third parties or to otherwise dispose of them. This could also
cause our stock price to decline. Penny stocks:





·
            have
      a price of less than $5.00 per
share;


·
            are
      not traded on a "recognized" national
exchange;


·
            are
      not quoted on the NASDAQ automated quotation system (NASDAQ listed stock
      must still have a price of not less than $5.00 per share);
    or


·
            include
      stock in issuers with net tangible assets of less than $2.0 million (if
      the issuer has been in continuous operation for at least three years) or
      $5.0 million (if in continuous operation for less than three years), or
      with average revenues of less than $6.0 million for the last three
      years.





Broker/dealers
dealing in penny stocks are required to provide potential investors with a
document disclosing the risks of penny stocks. Moreover, broker/dealers are
required to determine whether an investment in a penny stock is a suitable
investment for a prospective investor.





The
Holders of Preferred Stock are Entitled to Rights and Preferences that are
Significantly Greater than the Rights and Preferences of the Holders of our
Common Stock, Including Preferential Payments Upon a Sale or Liquidation of the
Company.





Holders
of our preferred stock are entitled to a number of rights and preferences which
holders of shares of our outstanding common stock do not and will not
have.  Among these rights and preferences is a preference on a sale or
liquidation of the Company, which means that holders of preferred stock will be
entitled to receive the proceeds out of any sale or liquidation of the Company
before any such proceeds are paid to holders of our common stock.  In
general, if the proceeds received upon any sale or liquidation do not exceed the
total liquidation proceeds payable to the holders of preferred stock, holders of
common stock would receive no value for their shares upon such sale or
liquidation.





Certain
Private Stockholders, such as ACT-DE, LLC and Some of Our Directors and
Officers, Control a Substantial Interest in the Company and thus may Influence
Certain Actions, Including Actions Requiring a Shareholder Vote.





ACT-DE,
LLC and our officers and directors own approximately 72.78% of our outstanding
common stock in the aggregate on a fully diluted basis.  As a result,
these shareholders have the ability to influence certain actions requiring a
shareholder vote, including the election of directors.  In connection
with our recapitalization in August 2007, we entered into a Stockholder
Agreement with, among other parties, ACT-DE, LLC.  The Stockholder
Agreement includes provisions regarding the election of certain individuals, or
individuals nominated by certain parties, to our Board of
Directors.  As a result, certain private stockholders and some of our
officers and directors may have the ability to influence certain actions,
including actions requiring a shareholder vote.




12




Item
1.B.  Unresolved Staff Comments




Not
applicable.




Item
2.  Properties




The
Company’s principal executive office is located at 420 Lexington Avenue, Suite
2739, New York, New York 10170.  The Company, through a license
agreement effective August 15, 2007 with Danson Partners, LLC, a party related
to our chief executive officer, effectively assumed the Danson Partners’ lease
obligation for a total of approximately 2,300 square feet of office space
through May 31, 2010, and licenses for its use all the furniture, fixtures,
filing cabinets, computers, servers, office equipment, etc. that it needs to
conduct its business.




Encompass
Service Solutions leases an aggregate of approximately 37,300 square feet in
office/shop/warehouse facility space in three separate buildings in the same
building complex in Longwood, Florida, generally under one-year triple net lease
that carries a one-year option renewal option.




Encompass
Parts Distribution, through Vance Baldwin, leases a 55,985 square foot
office/warehouse facility in Lawrenceville, Georgia under a lease that commenced
February 15, 2006 with a termination date of June 30, 2011, and carries a
one-year option.  Encompass Parts Distribution entered into a lease
for a second 50,900 square foot office/warehouse facility, also in
Lawrenceville, Georgia, under a lease that commenced August 1, 2008 with a
termination date of October 10, 2013.  On December 1, 2008, Encompass
Parts Distribution entered into an amendment of the latter lease for an
additional 100,300 square feet of contiguous space, for a total of 151,200
square feet at that facility.  The original termination date of
October 10, 2013 was extended and modified to be May 31, 2014 for the total of
151,200 square feet.  Vance Baldwin also leases a 10,010 square foot
office facility in Ft. Lauderdale, Florida under a lease that commenced May 1,
2008 and ends on May 1, 2011.




Encompass Parts, throughTritronics, leases a
43,100 square foot office/warehouse facility located in Abingdon, Maryland and a
13,500 square foot office/warehouse facility located in Miami,
Florida.  The Abingdon Lease, which has a five-year term with an
option for one additional five-year period, also contains an opt out provision
whereby the Company can terminate the lease if it does not meet certain
financial targets.  The Miami Lease has a two-year term with no
renewal option.





Encompass Parts leases a 38,400
square foot office/warehouse facility located in North Las Vegas, Nevada, under
a lease that commenced February 1, 2009 and ends on March 31, 2012.




Item
3.  LegalProceedings




The
Company from time-to-time is involved in litigation incidental to the conduct of
its business. Currently, there are no pending legal proceedings to which the
Company or any of its subsidiaries is a party, or to which any of their
respective properties is subject, for which any material adverse judgment is
considered probable.




Item
4.  Submission Of Matters To A Vote Of Security Holders




None.




13





Part
II




Item
5.  Market For Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities


Price
Range Of Common Stock




Our
common stock is currently traded on the Over-the-Counter Bulletin Board
("OTCBB") under the symbol “ECGA.”  As of September XX, 2009, there
were 13,286,151,226 common shares issued and outstanding and approximately 550
holders of record.  The number of beneficial owners is substantially
greater than the number of record holders because a large portion of our common
stock is held in "broker" or "street names".  There are approximately
6,500 such holders of common stock




The
following table sets forth, for the fiscal periods indicated, the bid price
range of our common stock:




High
      Bid
            
            
            Low
      BidFiscal
      Year 2009Quarter
      Ended September 30, 2008
            
            $
            .0005
            
            
            $
            .0003Quarter
      Ended December 31, 2008
            
            
            .0004
            
            
            
            .0001Quarter
      Ended March 31, 2009
            
            
            .0002
            
            
            
            .0001Quarter
      Ended June 30, 2009
            
            
            .0004
            
            
            
            .0002Fiscal
      Year 2008Quarter
      Ended September 30, 2007
            
            $
            .0008
            
            
            $
            .0006Quarter
      Ended December 31, 2007
            
            
            .0014
            
            
            
            .0006Quarter
      Ended March 31, 2008
            
            
            .0009
            
            
            
            .0004Quarter
      Ended June 30, 2008
            
            
            .0008
            
            
            
            .0005




Such
market quotations reflect inter-dealer prices, without retail mark-up, mark-down
or commissions and may not represent actual transactions.




We did
not pay any dividends during fiscal 2009 and have never paid any dividends on
our capital stock.  We currently expect that we will retain future
earnings for use in the operation and expansion of our business and do not
anticipate paying any cash dividends in the foreseeable future.  Any
decision on the future payment of dividends will depend on our earnings and
financial position at that time and such other factors as our Board of Directors
deems relevant.  Our agreements with the holders of our Senior and
Subordinated Notes restrict the payment of dividends.  The provisions
of our Series C Convertible Preferred Stock prohibit the payment of dividends on
common stock, or other capital stock ranking junior to the Series C Preferred
Stock, without the consent of a the holders of a majority of the Series C
Preferred Stock.  In addition, so long as any shares of Series E
Preferred are outstanding, no dividends may be paid or distributions made on the
common stock or any class of preferred stock ranking junior to the Series E
Preferred until all accrued but unpaid dividends, if any, on the Series E
Preferred have been paid, unless:






            the
      Company obtains the written consent of the holders of a majority of the
      outstanding shares of the Series E Preferred; or
            the
      Company is a party to an agreement with any officer, employee or director
      of the Company pursuant to which the Company is entitled or required to
      repurchase shares of common stock or any preferred stock (or options
      therefore) from such officer, employee or
  director.




Recent
Sales Of Unregistered Securities




On August
17, 2007, we engaged in the recapitalization and acquisition of Vance Baldwin
described above under Item 1,
Description of Business - Company History, and issued certain shares of
our Series C, Series D and Series A-2 Preferred Stock, as well as certain
notes.  On August 1, 2008, we engaged in the financing and acquisition
of Tritronics described above under Item 1, Description of Business -
Company History, and issued certain shares of our Series E Preferred
Stock and common stock, as well as certain notes.  For a further
description of these transactions, reference is made to our Current Reports on
Form 8-K filed with the SEC on August 21, 2007, August 7, 2008 and August 18,
2008.




14




With
respect to the sale of unregistered securities referenced above, all
transactions were exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933 (the "Securities Act").  These offerings may
have qualified for other exemptions as well.  In each instance, the
purchaser had access to sufficient information regarding the Company so as to
make an informed investment decision.  More specifically, the Company
had a reasonable basis to believe that each purchaser was an "accredited
investor" as defined in Regulation D under the Securities Act, which information
was based on representations received from such investors, and otherwise had the
requisite sophistication to make an investment in the Company's
securities.




Issuer
Purchases of Equity Securities




We did
not make any purchases of equity securities during the fourth quarter of fiscal
year ended June 30, 2009.




Item
6.  Selected Financial Data




As a
smaller reporting company, the Company has elected scaled disclosure reporting
and therefore is not required to provide information required by this Item
6.




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





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 Annual Report contain forward-looking
information that involves risks and uncertainties including the use of words
such as "estimates," "expects," "anticipates," "believes," "intends," "will,"
"seek" and other similar expressions, 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.




General




We
specialize in the technology after­market service and supply chain known as
reverse logistics. Our wholly-owned subsidiaries and principal operating units,
Encompass Parts Distribution, Inc., a Delaware corporation ("Encompass Parts"),
and Encompass Service Solutions, Inc. (a Delaware corporation, also known as
Cyber-Test, Inc.) collectively operate businesses that, on a
national  level, provide parts procurement and distribution services,
depot repair of consumer electron­ics, computer and peripheral equipment,
board level repair, de-manufacturing and reclamation services for flat panel
display and computer products, returns management services, and anticipates
providing end-of-life cycle services for all such products.





We are a
market leader in reverse logistics for the consumer electronics industry by
providing original equipment manufacturers (“OEMs”), retailers, third party
administrators (“TPAs”) and end-users with single-source, integrated life cycle
reverse logistic professional management services for technology
products.





Encompass
Parts owns Vance Baldwin, Inc., Tritronics, Inc. and Cyber-Test, Inc. dba
Encompass Service Solutions, which collectively engage in the distribution of
replacement parts for electronic equipment and the repair of such
equipment.  Vance Baldwin is headquartered in Ft. Lauderdale, FL, and
operates out of two warehouse facilities located in Lawrenceville, Georgia and
one in Las Vegas, Nevada; Tritronics is headquartered in Abington, MD, near
Baltimore, MD, with its warehouse facilities located in Abington and Miami, FL;
and Encompass Service Solutions’ headquarters and operating facilities are based
in Longwood, Fl, near Orlando, FL.  The Company operates as one
segment in the reverse logistics industry serving the electronics
industry.




15




Critical
Accounting Policies, Estimates and Judgments





The
Company’s significant accounting policies are described in Note 1 in the Notes to Consolidated Financial
Statements included in Item 8 – Financial Statements
and Supplementary Data in this Annual Report on Form 10-K for the year
ended June 30, 2009.  The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions to apply certain of these
critical accounting policies.  Actual results may differ from
estimates.  Critical accounting policies requiring the use of
estimates and assumptions include the following:




Financial
Statement Presentation and Principles of Consolidation





The
consolidated financial statements include the Company and all of its
wholly-owned subsidiaries.  All significant inter-company transactions
have been eliminated in consolidation. The Company consolidates all
majority-owned and controlled subsidiaries, uses the equity method of accounting
for investments in which the Company is able to exercise significant influence,
and uses the cost method for all other investments.





Use
of Estimates




The
preparation of the 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.  In particular, significant estimates are required to
determine reserves for excess and obsolete inventory.  If the actual
amounts differ from these estimates, the Company’s operating results could be
adversely impacted.




Long-Lived
Assets




Long-lived
assets to be held and used are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable.  If such review indicates that the asset is impaired
when the carrying amount of an asset exceeds the sum of its expected future cash
flows, on an undiscounted basis, the asset’s carrying amount is written down to
fair value.  Long-lived assets to be disposed of are reported at the
lower of carrying amount or fair value, net of disposal costs.




Goodwill
and Intangible Assets





In
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141,
“Business Combinations” (“SFAS No. 141”), the Company allocates the purchase
price of its acquisitions to the tangible assets, liabilities and identifiable
intangible assets acquired based on their estimated fair values.  The
excess purchase price over those fair values is recorded as
“Goodwill”.  Historically, in accordance with SFAS No. 141, the
Company has included transaction costs such as investment banking fees,
accounting fees, legal fees, appraisal fees and Company-incurred direct
out-of-pocket costs as part of the purchase price of its
acquisitions.  As described below in “Recent Accounting
Pronouncements”, under SFAS Statement No. 141(R), effective July 1,
2009,the Company will be required to expense such costs as
incurred.  At June 30, 2009, the Company had $1,111 of deferred
transaction costs which it will be required to write off in the quarter ending
September 30, 2009.





In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets” (“SFAS No. 144”), purchased intangibles with finite lives are
reviewed for impairment whenever events or changes in circumstances indicate the
carrying value may not be recoverable.  The Company amortizes such
intangible assets on a straight-line basis (which approximates consumption of
economic value) over their respective useful lives.  In accordance
with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”),
goodwill and purchased intangibles with indefinite lives are not amortized, but
are reviewed periodically for impairment.





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 (average cost
basis) or market, using the first-in, first-out (“FIFO”) method.




16





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 inventory and non-usable replacement parts and equipment and records
necessary provisions to reduce such inventory and replacement parts and
equipment to net realizable value.





Core
Charges




The
vendors of products distributed by the Company frequently add a "core charge" to
the cost of certain high value 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 as cost, but are classified separately in prepaid expenses and
other current assets in the consolidated balance sheets.  Core charges
associated with goods in inventory in the amount of $1,702 and $749 are included
in prepaid expenses and other current assets as of June 30, 2009 and 2008,
respectively.





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.  Upon shipping a returned core to a vendor, the Company
records an asset for the amount due from the vendor.





Property
and Equipment




Property
and equipment are stated at cost, less 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 yearsFurniture
      and fixtures
            5
      to 7 yearsLeasehold
      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.





Fair
Value of Financial Instruments




The
carrying amounts of the Company’s cash and cash equivalents, accounts
receivable, accounts payable and accrued liabilities approximate fair value due
to the relatively short period to maturity for these instruments.  The
fair value of the Company’s long-term debt is estimated based on the rates
currently available to the Company for debt of the same remaining
maturities.  The carrying amounts of the Company’s long-term debt
obligations approximate its fair value.




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 and core returns are
accounted for as sales reductions in determining sales in the same period that
the related sales are recorded.  The Company also 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.




17





Income
Taxes




The
Company accounts for income taxes under SFAS No. 109 "Accounting for Income
Taxes".  Under SFAS No. 109, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases.  Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled.  Under SFAS No. 109, the effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date.




Stock
Based Compensation




The fair
value of stock option grants is calculated using the Black-Scholes Option
Pricing Model.  The exercise price of stock options granted is equal
to or greater than fair market value at the date of grant as determined by the
closing price per share.  The Company recognizes compensation expense
for the entire award over the period of vesting.  Performance based
compensation is recorded when the underlying criteria is considered probable of
being met.




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 on a straight-line basis over the
period which services are to be performed or the period of vesting.




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.




COMPARISON
OF THE FISCAL YEAR ENDED JUNE 30, 2009 TO THE FISCAL YEAR ENDED JUNE 30,
2008





Financial
Condition





We
believe that our present and future sales levels will, notwithstanding current
poor economic conditions, generate cash flows that will 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 have implemented and continue to implement internal
growth initiatives to expand our sales levels, increase profitability, and to
seek significant future business acquisitions, the latter 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 therein), which may limit our ability to use operating cash
flow to fund acquisitions.




18




Summary
of Results of Operations





The
following table sets forth certain selected financial data as a percentage of
sales for the years ended June 30, 2009 and 2008:





2009
            
            
            2008Net
      sales
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of sales
            
            
            74.1
            
            
            
            78.6Gross
      profit
            
            
            25.9
            
            
            
            21.4Operating
      expenses
            
            
            18.8
            
            
            
            17.9Income
      from operations before other expenses
            
            
            7.1
            
            
            
            3.5Interest
      expense, net of other income
            
            
            (5.7
            )
            
            
            (4.1
            )Income
      (loss) before tax benefit
            
            
            1.4
            
            
            
            (0.6)Income
      tax benefit
            
            
            1.2
            
            
            
            6.9Net
      income
            
            
            2.6
            %
            
            
            6.3
            %





Net
Sales





Net sales
for the fiscal year ended June 30, 2009 amounted to $110,084 as compared to net
sales of $64,327 for the fiscal year ended June 30, 2008, an increase of
$45,757, or 71.1%.  The increase in net sales for Encompass Parts was
attributable to (i) for Vance Baldwin, the effect of new customer additions and
a distribution agreement entered into with a major producer of digital flat
panel display products, and, to a lesser extent, the inclusion of Vance
Baldwin’s net sales in the fiscal year ended June 30, 2008 only since August 17,
2007, the date of its acquisition, and (ii) for Tritronics, the inclusion of
Tritronics’ net sales in the fiscal year ended June 30, 2009, since August 1,
2008, the date of its acquisition, compared to $0 in the fiscal year ended June
30, 2008.




Cost
of sales




Our cost
of sales totaled $81,562 for the fiscal year ended June 30, 2009 as compared to
$50,543 for the fiscal year ended June 30, 2008, an increase of $31,019, or
61.4%.  Our gross profit increased to $28,522 for the fiscal year
ended June 30, 2009 as compared to $13,784 for the fiscal year ended June 30,
2008, with gross margins increasing to 25.9% from 21.4% for the comparable
periods.




The
increase in cost of sales and gross profit and improvement in gross margin were
primarily due to the inclusion of Vance Baldwin and Tritronics in the current
period following their acquisitions as described above, as well as from the
current year increase in sales recorded by Vance Baldwin for the reasons
described above.  The increase in gross margin is attributable to
changes in customer and product mix.




Operating
Expenses




Operating
expenses for the fiscal years ended June 30, 2009 and 2008 were $20,687 and
$11,544, respectively, representing a $9,143, or 79.2%, increase.  The
net change was primarily attributable to an increase of $8,264 selling, general
and administrative expenses for the fiscal year ended June 30, 2009 as compared
to the fiscal year ended June 30, 2008.  This increase was primarily
due to the inclusion of expenses of Vance Baldwin and Tritronics for twelve and
eleven months in the current period, respectively, and for ten and a half and
zero months in the earlier period, respectively, following their acquisitions in
fiscal 2008 and 2009, respectively, and increased expenses incurred by Encompass
Parts in line with its growth in sales volume.




Depreciation
and amortization for the fiscal year ended June 30, 2009 amounted to $2,124
compared to $1,245 for the fiscal year ended June 30, 2008.  The
increase is primarily attributable to amortization expense associated with
intangible assets acquired in connection with the acquisition of
Tritronics.




Selling,
general and administrative expenses increased to $18,563 for the fiscal year
ended June 30, 2009 from $10,299 for the fiscal year ended June 30,
2008.  This increase was primarily due to the inclusion of expenses of
Vance Baldwin and Tritronics for twelve and eleven months in the current period,
respectively, and for ten and a half and zero months in the earlier period,
respectively, following their acquisitions in fiscal 2008 and 2009,
respectively, and increased expenses incurred by Encompass Parts Distribution in
line with its growth in sales volume.




19




Other
Income and Expenses




Other
expense amounted to $6,227 for the fiscal year ended June 30, 2009, compared to
$2,693 for the fiscal year ended June 30, 2008.  Interest expense,
net, for the fiscal year ended June 30, 2009 was $6,390 compared to $2,752 for
the fiscal year ended June 30, 2008, an increase of $3,638 due to interest on
higher average amounts of senior and subordinated debt financing entered into in
connection with the recapitalization and acquisitions of Vance Baldwin and
Tritronics as described above, and an increase in interest expense recorded for
the dividend on the Series E Preferred Stock (that is required to be classified
as a liability) and to amortize additional deferred financing costs incurred in
connection with such debt.




Income
tax benefit





For the fiscal yearsended June 30, 2009and 2008, we realized an income tax benefit of
$1,250and $4,500, respectively,
fromthe reversal of a
portion of our deferred tax asset valuation allowance.







COMPARISON
OF THE FISCAL YEAR ENDED JUNE 30, 2008 TO THE FISCAL YEAR ENDED JUNE 30,
2007





Summary
of Results of Operations





The
following table sets forth certain selected financial data as a percentage of
sales for the years ended June 30, 2008 and 2007:





2008
            
            
            2007Net
      sales
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of sales
            
            
            78.6
            
            
            
            66.3Gross
      profit
            
            
            21.4
            
            
            
            33.7Operating
      expenses
            
            
            17.9
            
            
            
            45.73.5
            
            
            
            (12.0
            )Interest
      expense, net of other income
            
            
            (4.1
            )
            
            
            (1.5
            )Net
      income (loss) before tax benefit
            
            
            (0.6
            )
            
            
            (13.5
            )Income
      tax benefit
            
            
            6.9
            
            
            
            —Net
      income (loss)
            
            
            6.3
            %
            
            
            (13.5
            )%





Net
Sales





Net sales
for the fiscal year ended June 30, 2008 amounted to $64,327 as compared to net
sales of $9,244 for the fiscal year ended June 30, 2007, an increase of $55,083,
or 596%.  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 Encompass Service Solutions for the
fiscal year ended June 30, 2008 over the prior year.   The
increase in Encompass Service Solutions’ net sales during fiscal 2008 compared
to fiscal 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 customers
added in fiscal 2008.




Cost
of sales




Our cost
of sales totaled $50,543 for the fiscal year ended June 30, 2008 as compared to
$6,133 for the fiscal year ended June 30, 2007, an increase of $44,410, or
724%.  Our gross profit increased to $13,784 for the fiscal year ended
June 30, 2008 as compared to $3,111 for the fiscal year ended June 30, 2007,
with gross margins declining to 21.4% from 33.7% for the comparable
periods.




The
increase in cost of sales and gross profit was primarily due to the inclusion of
Vance Baldwin’s results 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
Encompass Service Solutions.  Encompass Service Solutions experienced
a decrease in gross margin due to a change in product mix and price adjustments
for certain recurring work.




20




Operating
Expenses




Operating
expenses for the fiscal years ended June 30, 2008 and 2007 were $11,544 and
$4,218, respectively, representing a $7,326, or 174%, increase compared to the
fiscal year ended June 30, 2007.  The increase was primarily due to
the inclusion of expenses of Vance Baldwin in the current period.




Depreciation
and amortization for the fiscal year ended June 30, 2008 amounted to $1,245
compared to $75 for the fiscal year ended June 30, 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 $10,299 for the fiscal year
ended June 30, 2008 from $3,743 for the fiscal year ended June 30, 2007,
principally due to (i) the inclusion of Vance Baldwin’s expenses for the period
following its acquisition, (ii) an increase in stock-based compensation expense
in the current period compared to the earlier period, which increase is
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
Encompass Service Solutions to support a higher level of sales
volume.




Other
Income and Expenses




Other
expense amounted to $2,693 for the fiscal year ended June 30, 2008, compared to
$143 for the fiscal year ended June 30, 2007.  Other income amounted
to $59 for the fiscal year ended June 30, 2008, compared to $0 for the fiscal
year ended June 30, 2007, and includes a $75 gain on settlement of an amount due
to a creditor as a part of the recapitalization on August 17,
2007.  Interest expense, net, for the fiscal year ended June 30, 2008
was $2,752 compared to $143 for the fiscal year ended June 30, 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.




As
described further above, in fiscal 2008 we realized an income tax benefit of
$4,500 from the reversal of a portion of our deferred tax asset valuation
allowance.




Inflation
and Changing Prices





The
company’s net sales and revenues and income from continuing operations were not
impacted by inflation or prices changes instituted by its suppliers during the
fiscal years ended June 30, 2009 and 2008.  Typically changes in
prices charged by the major OEMs that are the Company’s principal suppliers are
passed on to customers, this enabling the Company to maintain its gross margin.
Historically, the Company has experienced minimal inflationary effects as the
prices charged for the products it purchases for resale more frequently decrease
due to technological advances and producers’ economies of scale.




Liquidity
and Capital Resources




Sources
of Liquidity




At June 30, 2009, the Company had cash
and liquid cash equivalents of $5,536 available to meet its working capital and
operational needs.




Net Cash Provided By (Used In) Operating
Activities





Net cash
used in operating activities was $(3,816) for the fiscal year ended June 30,
2009 compared to $152 provided for the year ended June 30, 2008.





Cash
provided by operating activities in the year ended June 30, 2009 was principally
due to net income of $2,858, non-cash charges of $3,358, for depreciation,
amortization, provision for bad debt and stock-based compensation expense, an
increase in accounts payable and accrued expenses of $2,367, a decrease in
replacement parts and equipment of $358, which were more than offset by an
increase in accounts receivable of $2,471 and increases in inventory of $6,706,
amounts due from vendors of $1,089 and prepaid expenses and other assets of
$1,241.  Recognition of a deferred tax asset in the amount of $1.25
million is included in net income for the fiscal year ended June 30, 2009, which
represents a non-cash income component.





Cash
provided by operating activities in the year ended June 30, 2008 was principally
due net income of $4,047,  non-cash charges of $1,926 for
depreciation, amortization, provision for bad debts and stock-based compensation
expense, a decrease in accounts receivable of $315 and an increase in accounts
payable and accrued expenses of $311, which were partially offset by increases
in inventory of $820, replacement parts and equipment of $284, amounts due from
vendors of $337 and prepaid expenses and other assets of
$506.  Recognition of a deferred tax asset in the amount of $4.5
million is included in net income for the fiscal year ended June 30, 2008, which
represents a non-cash income component.




21





Net
Cash Used In Investing Activities





Net cash
used in investing activities was $10,358 for the fiscal year ended June 30, 2009
compared to $25,361 for the year ended June 30, 2008.





Net cash
used in investing activities for the fiscal year ended June 30, 2009 was
attributable almost entirely to the acquisition of Tritronics for $8,296, net of
cash acquired, plus related transaction costs of $865, and purchases of property
and equipment for $871.





Net cash
used in investing activities for the fiscal year ended June 30, 2008 was
attributable almost entirely to the acquisition of Vance Baldwin for $22,321,
net of cash acquired, plus related transaction costs of $2,769.








Net
Cash Provided By Financing Activities





Net cash
provided by financing activities was $15,702 for the year ended June 30, 2009
compared to cash used in financing activities of $28,373 for the year ended June
30, 2008.





Net cash
provided by financing activities for the year ended June 30, 2009 was
principally attributable to proceeds of $4,167 and $13,000 from the sale of
Series E Preferred Stock and subordinated notes, respectively, in connection
with the acquisition of Tritronics and the Philips transaction, offset by
principal payments of $876 on senior debt and capital lease
payments.  In addition, transaction costs of $272 were incurred in
connection with the debt issuance and company purchased treasury stock of
$317.





Net cash
provided by financing activities for the year ended June 30, 2008 was
principally attributable to proceeds of $6,300 and $24,000 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 $1,026 to repay all notes payable outstanding at
the August 17, 2007 closing, as well as principal payments for the senior debt
and monthly capital lease payments.  In addition, transaction costs of
$901 were incurred in connection with the equity and debt issued in connection
with the recapitalization and acquisition transactions..





Senior
Notes and Senior Subordinated Notes and Senior Secured Credit
Facility





On August 17, 2007, in connection with
the recapitalization and the acquisition of Vance Baldwin, we entered into a
series of transactions which included the completion of a preferred stock
investment of $6,300, the issuance of $24,000 in senior and subordinated notes,
the liquidation of substantially all of the Company’s current liabilities,
including notes payable, by cash payment or conversion into Series A-2
Preferred, and the conversion of substantially all of the Company’s convertible
preferred stock, by cash payment or conversion into Series A-2
Preferred.





On that
date, we entered into a Note Purchase Agreement (the “Note Purchase Agreement”)
with Sankaty Advisors, LLC (“Sankaty”) and other “Note Purchasers”, Encompass
Parts as issuer, and SpectruCell, Inc., Hudson Street Investments, Inc.,
Encompass Service Solutions and Vance Baldwin, as guarantors (the “Guarantors”).
Pursuant to the Note Purchase Agreement, we issued $12,690 in aggregate
principal amount of our senior secured notes for an aggregate purchase price of
$12,500,000 (the “Senior Notes”) and $10,714 in aggregate principal amount of
Series A senior subordinated notes for an aggregate purchase price of $10,500
(the “Series A Subordinated Notes”).  Under the Note Purchase
Agreement, we could issue up to an additional $2,500 in Senior Notes and/or
Series A Subordinated Notes if the Company met a certain financial
covenant.  On September 27, 2007, we issued an additional $1,020 in
principal amount of Series A Senior Subordinated Notes for a purchase price of
$1,000 under the terms described below for Series A Senior Subordinated
Notes.




22





The
Senior Notes bear interest at LIBOR plus 3.75%, per annum payable quarterly, in
arrears, and have a five-year term through August 17, 2012 (the “Maturity
Date”). They are repayable in consecutive quarterly installments in an amount
equal to 1%, or approximately $127, through August 17, 2012.  At the
Maturity Date the remaining principal amount and any unpaid and accrued interest
on the Senior Notes shall be due.  We are required to prepay the
Senior Notes from any new equity or debt financing, certain excess cash flow or
the cash proceeds of asset sales and casualty events, subject to stipulated
exceptions.  We may redeem the Senior Notes at any time, subject to a
redemption premium, as defined.  The Senior Notes are secured by a
first priority security interest in substantially all of our assets and are
guaranteed by our direct or indirect wholly-owned subsidiaries.





The
Series A Subordinated Notes bear interest, payable quarterly, in arrears, at 13%
per annum, plus an increment of up to 4% based on the debt to equity leverage
ratio.  The Series A Subordinated Notes have a six-year term through
August 17, 2013.  Redemption of the Series A Subordinated Notes was
permitted but only following repayment of the Senior Notes in full, subject to a
redemption premium.  The Series A Subordinated Notes are secured by a
second priority security interest in substantially all of our assets and are
guaranteed by our direct or indirect wholly-owned subsidiaries.





On August
1, 2008, we amended and restated the Note Purchase Agreement (the “Amended and
Restated Note Purchase Agreement”), with Sankaty and other “Note Purchasers”,
Encompass Parts, as issuer, and us, Tritronics, SpectruCell, Inc., Hudson Street
Investments, Inc., Encompass Service Solutions and Vance Baldwin, as guarantors
(the “Guarantors”).  Pursuant to the Amended and Restated Note
Purchase Agreement, Encompass Parts issued an additional $13,265 in aggregate
principal amount of its Series B senior subordinated notes for an aggregate
purchase price of $13,000 (the “Series B Subordinated Notes” and, collectively
with the Series A Subordinated Notes, the “Subordinated Notes”).





Under the Amended and Restated Note
Purchase Agreement, the terms and conditions of the Senior Notes are
substantially similar to those in the Note Purchase Agreement as described
above.  The Senior Notes are guaranteed by us and the other
Guarantors, each a direct or indirect wholly-owned subsidiary of the Company.
The Senior Notes are subject to events of default customary for a secured
financing.




The
Subordinated Notes, including the newly issued Series B Subordinated Notes, bear
interest, payable quarterly, in arrears, at 13% per annum, plus an increment
based on the debt to EBITDA leverage ratio. The increment will amount to 0% to
4% as the ratio ranges from 2.5:1 or below to 3.5:1 or higher. The Subordinated
Notes have a term through August 17, 2013.  The EBITDA leverage ratio
as of June 30, 2009 was less than 3.5:1; accordingly, the increment decreased to
2% from 4% commencing July 1, 2009.   We may redeem the
Subordinated Notes only following repayment of the Senior Notes in full, subject
to a 3% redemption premium for both the Series A Subordinated Notes and Series B
Subordinated Notes, if the redemption occurs prior to the first anniversary date
of their respective issuances, and a 2% redemption premium for both the Series A
and Series B Subordinated Notes if the redemption occurs between the first and
second anniversary dates of their respective issuances, and a 1% redemption
premium for both the Series A and Series B Subordinated Notes if the redemption
occurs between the second and third anniversary dates of their respective
issuances. The Series B Subordinated Notes will have an additional 2% redemption
premium (in addition to the premium described above) through maturity.  In
certain circumstances in which Note Purchasers are not provided with rights of
first refusal and rights of first offer (as described below), including in
connection with a prepayment of the Series A Subordinated Notes within 18 months
of August 17, 2007 that occurs in connection with a purchase of a potential
acquisition target, the Subordinated Notes may also be subject to a 10%
redemption premium.  The Subordinated Notes are secured by a second
priority security interest in our assets and those of our subsidiaries pursuant
to an amended and restated Second Lien Pledge and Security Agreement among the
Guarantors and Sankaty, as the Second Lien Collateral Agent.  The
Subordinated Notes are guaranteed by the Guarantors pursuant to the Amended and
Restated Note Purchase Agreement. The Subordinated Notes are subject to events
of default customary for a secured financing.




If, on
August 1, 2009, the Senior Notes and Subordinated Notes have not been repaid or
refinanced and the debt to EBITDA leverage ratio for the twelve months prior to
August 1, 2009 exceeds 3.50:1, the Note Purchasers will be entitled to receive
warrants, for no or nominal additional consideration, to purchase 3.5% of the
shares of our outstanding common stock on a fully diluted basis (the “Initial
Warrants”).  The debt to EBITDA leverage ratio for the twelve months
prior to August 1, 2009 did not exceed 3.50:1.  If, on each of
February 1, 2010 and August 1, 2010, the Senior Notes and Subordinated Notes
have not been repaid or refinanced and the debt to EBITDA leverage ratio for the
twelve month period prior to February 1, 2010 or August 1, 2010, as applicable,
exceeds 3.50:1, the Note Purchasers will be entitled to receive on each such
date, for no or nominal additional consideration, warrants to purchase 5.5% and
7.5% (in each case minus the percentage of warrants previously issued to the
Note Purchasers pursuant to this provision) of the shares of our outstanding
common stock on a fully diluted basis (“Additional Warrants” and, together with
the Initial Warrants, the “Warrants”) on each such date. The Warrants expire on
the first anniversary of their issuance, have anti-dilution protections and
benefit from other customary protections.
  23




Under the
terms of the Senior Notes and the Subordinated Notes, we are permitted to incur
purchase money secured indebtedness to suppliers of up to certain agreed
amounts. We are not permitted to make any mandatory or optional dividends or
distributions, and are not permitted to redeem any capital
stock.




Under
certain circumstances, holders of the Senior Notes and the Subordinated Notes
have a right of first refusal and first offer to purchase debt securities and
certain types of preferred stock in connection with the financing of additional
acquisitions by us.




Preferred
Stock





Series C Preferred





As of
June 30, 2009, we had 1,000 shares of our Series C Convertible Preferred Stock,
par value of $0.01 per share (“Series C Preferred”).  Dividends accrue
on a cumulative basis on the Series C Preferred at a rate per annum of 12%
through the date of a sale of assets, merger, liquidation, dissolution or
winding up of the Company.  The right to dividends on the Series C
Preferred will extinguish upon conversion of the Series C
Preferred.





In the
event of a sale of assets, merger, liquidation, dissolution or winding up of the
Company, the holders of shares of Series C Preferred will be entitled to receive
payment (the “Series C Liquidation Value”) equal to the greater of (i) $6,300
(the “Series C Preference Amount”) plus all accrued and unpaid dividends thereon
or (ii) the Assumed Conversion Amount (as defined below). The Series C
Liquidation Value will be paid before any payment or distribution of the assets
of the Company, or proceeds therefrom, to the holders of shares of any Junior
Stock. The “Assumed Conversion Amount” means the total amount of proceeds that
would be payable to the holder of a share of Series C Preferred upon the
liquidation, dissolution or winding up of the Company if, immediately prior to
such event, each outstanding share of Series C Preferred were deemed to be
converted into a number of shares of Common Stock at the applicable “Series C
Conversion Rate.”





Pursuant to the formula for determining
the Series C Conversion Rate set forth in the Certificate of Designation for the
Series C Preferred, the holders of the Series C Preferred, in the aggregate,
will be entitled to receive shares of Common Stock equal to 79.5% (before
dilution for stock options issued to management in connection with the
recapitalization) of (A) the number of issued and outstanding shares of common
stock as of the recapitalization, plus (B) the total number of shares of common
stock issuable upon conversion of all of the shares of Series C Preferred and
Series D Preferred outstanding as of the recapitalization, plus (C) 80,000,000
shares of restricted common stock issuable to Messrs. Donahue and Miller under
their prior employment agreements with us, plus (D) any shares of common stock
issued pursuant to the convertible promissory notes of $1,000 and $206 described
under the captionOther
Indebtedness/Promissory Notes below (collectively, the “Outstanding
Amount”). The foregoing conversion rate will be subject to further adjustment
(downward to a floor of 72.5% of the Outstanding Amount) if the return, or
deemed return, per share of Series C Preferred meets certain targets (as further
described in the Certificate of Designation for the Series C
Preferred).  In the event that the number of shares of outstanding
Common Stock is changed by any stock dividend, stock split, reclassification or
recapitalization at any time shares of Series C Preferred are outstanding, the
Series C Conversion Rate will be proportionately adjusted.





Series
D Preferred





As of June 30, 2009, we had 1,000
shares of our Series D Convertible Preferred Stock, par value $0.01 per share
(“Series D Preferred”) outstanding.  Dividends accrue on a cumulative
basis on the Series D Preferred at a rate per annum of 12% through the date of a
sale of assets, merger, liquidation, dissolution or winding up of the
Company.  The right to dividends on the Series D Preferred will
extinguish upon conversion of the Series D Preferred.




24





In the
event of  a sale of assets, merger, liquidation, dissolution or
winding up of the Company, before any distribution or payment shall be made to
any of the holders of the common stock or any series of preferred stock ranking
junior to the Series D Preferred and subject to the rights of the holders of
Series C Preferred, the holders of Series D Preferred will be entitled to
receive out of the assets of the Company a liquidation amount per share of
Series D Preferred equal to the greater of (i) $634 (the “Series D Preference
Amount”) or (ii) the “Assumed Conversion Amount.” The Assumed Conversion Amount
means the total amount of proceeds that would be payable to the holder of a
share of Series D Preferred on any liquidation, dissolution or winding up of the
Company, if, immediately prior to such event, each outstanding share of Series D
Preferred were deemed to be converted into a number of shares of Common Stock at
the applicable Series D Conversion Rate.





Pursuant to the formula for determining
the Series D Conversion Rate as set forth in the Certificate of Designation for
the Series D Preferred, the holders of the Series D Preferred, in the aggregate,
will be entitled to receive shares of Common Stock equal to 8% of the
Outstanding Amount.  In the event that the number of shares of
outstanding Common Stock is changed by any stock dividend, stock split,
reclassification or recapitalization at any time shares of Series D Preferred
are outstanding, the Series D Preferred conversion rate will be proportionately
adjusted.  At any time after August 17, 2009, the holders of shares of
the Series D Preferred have the right to elect to convert all, but not less than
all, of his, her or its shares of Series D Preferred into shares of common stock
at the applicable Series D Conversion Rate.  All outstanding shares of
Series D Preferred will automatically convert into shares of common stock at the
applicable Series D Conversion Rate upon any conversion of the Series C
Preferred into common stock whereby less than 50% of the shares of Series C
Preferred outstanding on August 17, 2007 remain outstanding.





The
Series C and Series D Preferred shares both rank junior to the Series E
Preferred shares as described below.





Series E Preferred





On August 1, 2008, we sold 908.57
shares of our newly designated Series E Preferred Stock, par value of $0.01 per
share (“Series E Preferred”).  On August 13, 2008, we completed a
subsequent closing of the sale of Series E Preferred and sold an additional
91.43 shares of Series E Preferred.  As of June 30, 2009, we had an
aggregate of 1,000 shares of Series E Preferred outstanding.





Dividends accrue cumulatively on a
daily basis on the Series E Base Amount (as defined below) for each share of
Series E Preferred at a rate per annum of 20% until February 28, 2010 and 30%
thereafter. Dividends accrue from the date of issuance through the date of
redemption, liquidation, dissolution or winding up of the
Company.   The Series E Preferred is not convertible into the
Company’s common stock.





In the event of the liquidation,
dissolution or winding up of the Company or sale of substantially all of the
assets of the Company, the holders of shares of Series E Preferred will be
entitled to receive the Series E Redemption Value (as defined below) for those
shares. In the event of such a liquidation event, the Series E Redemption Value
will be paid before any payment or distribution of the assets of the Company, or
proceeds therefrom, to the holders of shares of common stock or any class of
preferred stock ranking junior to the Series E Preferred.





At the option of the Board of
Directors, the Company may, at any time, redeem all but not less than all of the
Series E Preferred by paying to the holders of the Series E Preferred in cash an
amount equal to the Series E Redemption Value. In addition, the Company must
redeem all of the outstanding Series E Preferred upon the (i) refinancing,
repayment, redemption or other discharge in full of the Company’s senior notes
and subordinated notes issued pursuant to the Amended and Restated Note Purchase
Agreement or (ii) consolidation or merger of the Company with or into any other
person or entity in which less than a majority of the outstanding voting power
of the surviving entity is held by persons who were shareholders of the Company
prior to the event (each a “Mandatory Redemption Event”). Upon a Mandatory
Redemption Event, the holders of the Series E Preferred will be entitled to be
paid the Series E Redemption Value.





The “Series E Redemption Value” means a
payment per share equal to (i) $4,166.66 per share (the “Series E Base Amount”)
plus all accrued and unpaid dividends thereon multiplied by (ii) the Redemption
Percentage. The “Redemption Percentage” shall be (i) 100% until July 31, 2009,
(ii) 105% from August 1, 2009 until February 28, 2010 and (iii) 110% from March
1, 2010 until July 31, 2010. The Redemption Percentage shall increase by another
5% each March 1 and August 1 thereafter. By way of example, the Redemption
Percentage will increase to be 115% on August 1, 2010 and 120% on March 1,
2011.




25





The holders of Series E Preferred have
agreed that in the event that (i) the Board of Directors of the Company, (ii) an
independent committee comprised of disinterested members of the Board of
Directors of the Company and (iii) a majority of the holders of the Series E
Preferred agree to convert or redeem or refinance the Series E Preferred (an
“Exchange Transaction”), then each holder of the Series E Preferred shall agree
to enter into such transaction.





The Company accrues dividends for the
Series E Preferred stock.




The order
of liquidation preference of the Company’s outstanding preferred stock, from
senior to junior, is Series E, Series C and Series D.  Each of the
Certificates of Designation governing the Series C and E Preferred prohibits the
Company from declaring or paying dividends or any other distribution on the
common stock or any other class of stock ranking junior as to dividends and upon
liquidation unless all dividends on the senior series of preferred stock for the
dividend payment date immediately prior to or concurrent with the dividend or
distribution as to the junior securities are paid unless:





·
            The
      Company obtains the written consent of the holders of a majority of the
      outstanding shares of the senior series of preferred stock;
    or·
            The
      Company is a party to an agreement with any officer, employee or director
      of the Company pursuant to which the Company is entitled or required to
      repurchase shares of common stock or any preferred stock (or options
      therefore) from such officer, employee or
  director.





As of June 30, 2009, we had no shares
of any other class of preferred stock outstanding with the exception of the
Series C, D and E preferred stock.





Other
Indebtedness/Promissory Notes





On August 17, 2007, we incurred other
debt obligations as follows:





·
            We
      entered into a new agreement with the consulting company of our Chief
      Executive Officer, Wayne I. Danson, to pay the consulting company $310,
      plus interest accruing at the rate of 7% per annum, upon the earlier of a
      change of control of the Company or August 17, 2013 for unpaid
      compensation under a now-terminated consulting
  agreement.




·
            We
      entered into an agreement with Mr. Danson to restructure a potential $250
      bonus until such time as the Company satisfies certain milestones as
      described in Mr. Danson’s employment
agreement.




·
            We
      issued unsecured convertible promissory notes in the amount of $1,000 to
      then sole stockholder of Vance Baldwin and $206 to a creditor. The notes
      will accrue interest at the rate of 7% per annum, payable semi-annually,
      in arrears, on each January 30 and July 30, and are due and payable on
      October 17, 2012 to the extent the holders have not exercised their
      conversion rights thereunder.  During the year ended June 30,
      2009, we incurred $74 of interest expense related to these
      notes.  Scheduled semi-annual interest payments to date have
      been made.




On August 1, 2008, we issued a
subordinated promissory note issued in favor of Tritronics with an original
principal amount of $1,000.  This note will accrue interest at the
rate of 7% per annum, payable semi-annually, in arrears, on each January 31 and
July 31. The outstanding principal balance under the note and any accrued but
unpaid interest thereon is due and payable on August 1, 2014, subject to
extension under certain circumstances if the Company’s senior indebtedness (as
described above) is not paid in full as of August 1, 2014. During the year ended
June 30, 2009, we incurred $64 of interest expense related to this
note.





Capital
Expenditures





Capital
expenditures during the year ended June 30, 2009 amounted to $871 for equipment,
computer hardware and software and leasehold improvements.  Management
expects future capital expenditures will include purchases for equipment,
computer hardware and software and leasehold improvements.




26




Cash
Balances




The
Company’s cash balances may be diminished over 2010 due to many factors,
including the use of cash for operations, changes in working capital, capital
expenditures, quarterly interest and principal payments and annual cash flow
sweep required by our debt facility, additional acquisitions of businesses and
other factors. Despite these factors, the Company believes that available funds
and cash flows expected to be generated by current operations will be sufficient
to meet its anticipated cash needs for working capital and capital expenditures
for its existing operations for at least the next twelve months.





Funding
Requirements





We
believe that our present and future sales levels will, for the foreseeable
future, generate cash flows that will 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 implement internal growth initiatives to increase sales levels and 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 therein)
which may limit our ability to use operating cash flow to fund
acquisitions.  We cannot be certain that additional funding will be
available on acceptable terms, or at all.





Certain
Related Party Transactions





In
addition to the transactions described above under the caption Liquidity and Capital Resources –
Sources of Liquidity -Senior Notes and Senior Subordinated
Notes and Senior Secured Credit Facility,see Part III, Item 12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters – Changes in Control and Part III, Item 13 – Certain
Relationships and Related Transactions, and Directors Independence below
for further descriptions of the Company’s transactions with related parties
during fiscal 2009 and 2008.





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 that is material to investors.  The Company does not have
any non-consolidated special purpose entities.




Recent
Accounting Pronouncements




The
Company adopted the provisions of SFAS No. 157 – Fair Value Measurements for its
financial assets and liabilities for which it has recognized or disclosed at
fair value on a recurring basis effective July 1, 2008. In February 2008, the
Financial Accounting Standards Board issued FASB Staff Position (“FSP”) No.
157-2, “Effective Date of FASB
No. 157,”which delays the effective date for non-financial assets and
non-financial liabilities to fiscal years beginning after November 15, 2008,
except for items that are measured at fair value in the financial statements on
a recurring basis (at least annually).  As provided by FSP No. 157-2,
the Company has elected to defer the adoption of SFAS No. 157 for certain of its
non-financial assets and non-financial liabilities, primarily goodwill and
intangible assets, until July 1, 2009.  Management does not expect
this pronouncement will have a material impact on the consolidated financial
statements of the Company.





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 years beginning after November 15,
2008.  Management does not expect this pronouncement will have a
material impact on the consolidated financial statements of the
Company.





The FASB
has issued SFAS No. 141 (R), “Business Combinations”. This statement retains the
fundamental requirements in SFAS No. 141 that the acquisition method of
accounting (which Statement No. 141 called the “purchase method”) be used, and
applies to all business entities, including mutual entities that previously used
the pooling of interest method of accounting for some business
combinations.  SFAS No. 141 (R) requires that typical transaction
costs such as investment banking fees, accounting fees, legal fees, appraisal
fees and Company-incurred direct out-of-pocket costs be expensed as incurred and
no longer be effectively accounted for as part of excess purchase price and
intangible assets. The statement is effective for transactions within the annual
reporting period beginning after December 15, 2008; accordingly, management is
evaluating the impact this new standard will have on the Company’s financial
position and results of operations, including the prospective write off of
capitalized transaction costs included in other non-current assets associated
with potential acquisitions in process. At June 30, 2009, such capitalized
transaction costs amount to $1,111.




27





In April
2009, the FASB issued FSP No. FAS 141(R)-1, “Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from Contingencies” to
amend the provisions SFAS No. 141 (R) for the initial recognition and
measurement, subsequent measurement and accounting, and disclosures for assets
and liabilities arising from contingencies in business combinations. The FSP
eliminates the distinction between contractual and non-contractual
contingencies, including the initial recognition and measurement criteria in
SFAS No. 141 (R) and instead carries forward most of the provisions in SFAS No.
141 for acquired contingencies.  (FSP) No. FAS141(R)-1 is effective
for contingent assets and contingent liabilities acquired in business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning after December 15, 2008. Management
is currently evaluating the impact of this new standard, but the nature and
magnitude of the specific effects will depend upon the nature, term and size of
the acquired contingencies.





In April
2008, the FASB 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 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 is currently evaluating the impact this new standard
could have on the Company’s financial position and results of
operations.





On June
16, 2008, the FASB issued final Staff Position ("FSP") No. EITF 03-6-1,
"Determining Whether  Instruments Granted in Share-Based Payment
Transactions Are Participating Securities", to address the question
of  whether instruments granted in share-based payment transactions
are participating securities prior to vesting. The FSP determines that unvested
share-based payment awards that contain rights to dividend payments should be
included in earnings per share calculations. The guidance will be effective for
fiscal years beginning after December 15, 2008.  We do not expect the
adoption of this FSP to have a significant impact on our financial position,
results of operations or cash flows.





In
May 2009, the FASB issued SFAS No. 165, Subsequent Events(“SFAS
165”). This standard requires the disclosure of the date through which an entity
has evaluated subsequent events and whether that represents the date the
financial statements were issued or were available to be issued. This standard
is not expected to result in significant changes in the subsequent events that
an entity reports, either through recognition or disclosure, in its financial
statements. The provisions for SFAS 165 were effective for interim or annual
financial periods ending after June 15, 2009, and shall be applied
prospectively. The Company adopted this standard on June 30, 2009, and the
impact of the adoption was not significant.





In June
2009, FASB issued Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation
No. 46 (R)(“SFAS 167”).  SFAS 167 amends FASB’s Interpretation
(FIN) No. 46(R) , Consolidation of Variable Interest
Entities, mainly to (1) require an enterprise to conduct a qualitative
analysis for the purpose of determining whether, based on its variable
interests, it also has a controlling interest in a variable interest entity
(VIE), and (2) make the consequential changes resulting from elimination of the
concept of a qualifying special-purpose entity (QSPE) in SFAS No. 140 , Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, thus
subjecting an entity previously designated as a QSPE to the same evaluation as
that of any other VIE for consolidation purposes. Amended FIN No. 46(R) is
effective as of the start of the first annual reporting period beginning after
November 15, 2009, for interim periods within the first annual reporting period,
and for all subsequent annual and interim reporting periods. Earlier application
is not permitted, but retrospective application to previously issued financial
statements for previous years is allowed but, not required.  We do not
expect the adoption of SFAS 167 to have a significant impact on our financial
position, results of operations or cash flows.




28





In June
2009, FASB issued Statement of Financial Accounting Standards No. 168, The FASB Codification and the
Hierarchy of Generally Accepted Accounting Principles (“SFAS 168” or
“Codification”).  When it becomes effective for financial statements
covering periods ending after September 15, 2009, the Codification will be the
single source of authoritative U.S. GAAP applicable to all non-governmental
entities and will supersede all existing FASB, AICPA, and Emerging Issues Task
Force (EITF) pronouncements and related literature (i.e. all codified literature
will carry the same level of authority and non-codified GAAP literature will
become non-authoritative). The Codification will also
include relevant portions of authoritative SEC content relating to matters
within the basic financial statements, which are considered as sources of
authoritative GAAP for SEC registrants.  As of July 1, 2009, the FASB
no longer issues Statements, Interpretations, Staff Positions, or EITF
abstracts.  Irrespective of how they would have been issued under the
previous structure, all changes to GAAP will henceforth be only in the form of
Accounting Standards Updates, which will serve to update the Codification itself. When the
Codification becomes
effective, SFAS No. 162, The
Hierarchy of Generally Accepted Accounting Principles, will be rendered
irrelevant to give effect to the new GAAP hierarchy established in the Codification.  SFAS 168
is effective for our fiscal quarter beginning July 1, 2009.  Other than
modifications to the currently required disclosures, we do not expect the
adoption of SFAS 168 to have a significant impact on our financial position,
results of operations or cash flows.




Item
7.A.  Quantitative and Qualitative Disclosures about Market
Risk




As a smaller reporting company, the
Company has elected scaled disclosure reporting obligations and therefore is not
required to provide the information requested by this Item 7A.




Item  8.  Financial
Statements and Supplementary Data




The
financial statements required by Item 8 are included in this Annual Report on
Form 10-K beginning on page F-1.





Item
9. Changes in and Disagreements With Accountants on Accounting and Financial
Disclosure.





None.




Item
9.A (T).  Controls And Procedures




Evaluation
Of Disclosure Controls And Procedures




Prior to
the filing of this Report on Form 10-K, an evaluation was performed under the
supervision of and with the participation of the Company’s management, including
the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the
effectiveness of the Company’s disclosure controls and procedures. Based on the
evaluation, the CEO and CFO have concluded that, as of June 30, 2009, the
Company’s disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act, 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.




Changes
In Internal Control Over Financial Reporting




There
were no changes in the Company's internal control over financial
reporting  (as defined in Section 240.13a-15(f) or 240.15d-15(f) of
the Exchange Act) during our fourth fiscal quarter ended June 30, 2009 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.




29




MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING




The
management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in Rules 13a-15(f)
and 15d-15(f) under the Securities Exchange Act. The Company’s internal control
over financial reporting is designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles. The Company’s internal control over financial reporting
includes those policies and procedures that:




(i)
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of the assets of the
      Company;




(ii)
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with U.S. generally
      accepted accounting principles, and that receipts and expenditures of the
      Company are being made only in accordance with authorizations of
      management and directors of the Company;
and




(iii)
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of the Company’s assets that
      could have a material effect on the financial
  statements.




Because
of inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.




The
Company’s management assessed the effectiveness of the Company’s internal
control over financial reporting as of June 30, 2009.  In making
this assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal
Control-Integrated Framework. Based on management’s assessment and those
criteria, management has concluded that the Company’s internal control over
financial reporting was effective as of June 30, 2009.




This
Annual Report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting.  The Company’s internal control over financial reporting
was not subject to attestation by the Company’s registered public accounting
firm pursuant to temporary rules of the Securities and Exchange Commission that
permit the Company to provide only management’s report in this Annual
Report.




Item
9.B.  Other
Information




Not
applicable.




30




Part
III




Item 10. Directors, Executive Officers and Corporate
Governance.





Executive
Officers and Directors





Name
            
            Age
            
            Position
      Held with the CompanyWayne
      I. Danson
            
            56
            
            President,
      Chief Executive Officer and DirectorJohn
      E. Donahue
            
            60
            
            Vice
      President and Chief Financial OfficerSteven
      J. Miller
            
            51
            
            Chief
      Operating OfficerWilbank
      J. Roche
            
            63
            
            DirectorJohn
      G. Ball
            
            70
            
            DirectorJohn
      R. Black
            
            45
            
            DirectorThomas
      R. Ketteler
            
            66
            
            DirectorWilliam
      J. Nolan IV
            
            35
            
            DirectorGerald
      E. Wedren
            
            72
            
            Director





All directors are elected to hold
office until the next annual meeting of stockholders following election and
until their successors are duly elected and qualified. Executive officers are
appointed by the Board of Directors and serve at the discretion of the
Board.  Our Board now consists of seven directors, six of whom are
independent of Company management.  There is no family relationship
between any director and any executive officer.





Wayne I. Danson.Mr.
Danson has served as a Director since January 3, 2000, as President since April
30, 2002, and as Chief Executive Officer since June 7, 2005.  He
served as our Chief Financial Officer from December 1, 1999 until September 25,
2006.  Mr. Danson also serves as Chief Executive Officer and Chairman
of the Board of Encompass Parts and a director of Encompass Service Solutions,
Inc.  Mr. Danson was the Managing Director and Founder of Danson
Partners, LLC, a financial advisory firm that specialized in middle market
companies in the real estate and technology industries.  Prior to
forming Danson Partners, LLC in May 1999, Mr. Danson was Managing Director of
PricewaterhouseCoopers LLP’s Real Estate Capital Markets Group.  Prior
to rejoining PricewaterhouseCoopers in 1996, Mr. Danson was a Managing Tax
Partner with Kenneth Leventhal & Company in New York and Washington D.C.,
where he was also Kenneth Leventhal’s National Director of its International and
Debt Restructure Tax Practices.  Prior to his involvement with Kenneth
Leventhal in 1988, Mr. Danson was a Managing Director with Wolper Ross &
Co., Ltd. in New York, a closely held financial services company specializing in
financial tax, pension consulting, designing financial instruments and providing
venture capital and investment banking services.  Mr. Danson graduated
with honors from Bernard M. Baruch College with a BBA in Accounting and an MBA
in Taxation.  He is a certified public accountant and a member of the
AICPA and the New York State Society of CPAs.





Steven J.
Miller.  Mr. Miller has served as our Chief Operating Officer
since September 25, 2006.  For the prior ten years, Mr. Miller served
as Senior Director of Service Operations for N.E.W. Customer Service Companies,
Inc., the nation’s largest privately-held third-party administrator/reinsurer
providing warranty policies for consumer electronic goods. There, Mr. Miller
built and managed the team that developed new service offerings and delivered
more than 3 million service events per year, representing $400 million in claims
payments.  Prior to that, he was the Director of North American
Service Operations with Sharp Electronics with responsibility for all North
American parts distribution, board level repairs and product refurbishment
operations at Sharp’s headquarters in Romeoville, IL.  Previously, for
ten years he was responsible for shop and field service as well as parts
inventory and parts sales for several large-market locations for General
Electric/RCA, where he was Area Manager for GE Consumer Services.  Mr.
Miller is a past Board Member of NESDA (National Servicing Dealers Association
of America) recently completing a three-year revolving membership.  He
earned his Bachelor’s Degree in Business Administration from The Detroit
Institute of Technology.




31





John E.
Donahue.  Mr. Donahue has served as our Vice President and
Chief Financial Officer since September 25, 2006 and as a director of Encompass
Parts Distribution, Inc and Encompass Service Solutions, Inc..  Mr.
Donahue served as Vice President and Chief Financial Officer of Online Benefits
Inc., (a privately held HR solutions firm that provides Internet based
applications for administering, communicating and presenting HR related
information and data) from August 1999 until joining us.  Prior to
that, Mr. Donahue served as an Executive Vice President and Chief Financial
Officer of Lead America, a marketer of insurance products to customers of
financial institutions, Managing Director of Oxbridge Incorporated, a boutique
investment banking firm, Chief Financial Officer at Mast Resources Inc., a
merchant bank, and Chief Financial Officer at Catalyst Energy Corp., a
NYSE-listed independent power producer.  Mr. Donahue was with Price
Waterhouse from September 1972 to March 1985, including serving as a Senior
Audit Manager.  He holds a B.A. in Economics from Holy Cross College
and an MBA from Rutgers University.  Mr. Donahue is a former member of
the Board of Directors of Pacific Magtron International Corp.  Pacific
Magtron and its subsidiaries filed for bankruptcy protection in May 2005, prior
to the date Mr. Donahue became a Director.





Wilbank J.
Roche.  Mr. Roche was appointed a Director on March 25, 1999
and is currently a principal with the law firm of Roche & Holt in Los
Angeles, California.  Mr. Roche was an honors graduate from the
University of Southern California in 1976, as well as from Loyola University
School of Law, Los Angeles, in 1979.  He was admitted to the
California State Bar in 1979 and has been practicing law actively since that
time.  Mr. Roche worked for law firms in the Los Angeles area from
1976 to 1983, when he opened his own office.  In 1985, he formed Roche
& Holt.  Mr. Roche’s law practice has revolved largely around
representing small businesses and their owners.  In that regard, he
has provided legal services in connection with the formation, purchase, sale,
and dissolution of numerous entities, as well as in connection with their
on-going operations.





John G. Ball.  Mr.
Ball has served as a Director since August 2007.  He is a cofounder
and principal of XRoads Solutions Group, a professional services firm formed in
1997, where he leads the services and manufacturing practices.  While
at XRoads, he was involved in leading and advising a number of temporary
staffing firms. Prior to XRoads, Mr. Ball was a partner of High Performance
Partners, a firm of financial, strategic planning, marketing and turnaround
consultants, from 1989 to 1997.




John R. Black.  Mr.
Black has served as a Director since August 2007.  He is currently a
managing director with H.I.G. Capital, a private equity firm headquartered in
Miami with offices in Atlanta, Boston, San Francisco, London, Paris and Hamburg.
He has 11 years of experience investing in middle market transactions. Prior to
H.I.G. Capital, Mr. Black was a senior professional with several leading
consulting firms, including Ernst & Young, where he began his business
career. He sits on the boards of several portfolio companies of H.I.G. Capital
as well as Westaff, a publicly traded light industrial staffing business based
in California.  Mr. Black graduated from Harvard University in 1987
with a dual degree in applied mathematics and economics.




Thomas R.
Ketteler.  Mr. Ketteler has served as a Director since August
2007.  He is currently a consultant to Schottenstein Stores
Corporation ("SSC") and a special advisor to the independent directors of
American Eagle Outfitters.  Previously, Mr. Ketteler served as
Executive Vice President of Finance and Treasurer of Schottenstein Stores
Corporation ("SSC"), a private company owned by the Schottenstein-Deshe-Diamond
families.  Mr. Ketteler served SSC as Chief Operating Officer from
April 1995 through 2000, as a Director since 1985 and Vice President of Finance
since 1981. Prior to SSC, he was a partner in the firm of Alexander Grant and
Company, Certified Public Accountants. Mr. Ketteler has served as an officer and
director of various other corporations owned or controlled by the Schottenstein
family, the members of which beneficially own over ten percent of the common
stock of American Eagle Outfitters, Inc.  From 1994 through 2003, Mr.
Ketteler served as a director of American Eagle Outfitters, Inc., the common
stock of which is listed on the New York Stock Exchange.




William J. Nolan
IV.  Mr. Nolan has served as a Director since August
2007.  He is currently a principal with H.I.G. Capital, a private
equity firm headquartered in Miami with offices in Atlanta, Boston, San
Francisco, London, Paris and Hamburg.  Prior to joining H.I.G. in
2003, he worked as a management consultant with Bain & Company in its
private equity and consumer product practices.  He sits on the boards
of directors for several of H.I.G. Capital’s portfolio companies.  Mr.
Nolan earned an M.B.A. from Harvard Business School with High Honors in 2001 and
a B.Cp.E from Villanova University in 1996.




32




Gerald E.
Wedren.  Mr. Wedren has served as a Director since August
2007.  He is currently the owner and President of Craig Capital Co., a
Washington D.C. and Miami based firm concentrating on mergers and acquisitions,
business turnarounds and liquidations since 1972. Since 1960, he has been
associated with several firms in both business and legal
capacities.  Mr. Wedren was the owner and President of Little Tavern
Shops, a chain of approximately 30 fast food restaurants in the Washington, D.C.
and Baltimore, M.D. areas from 1981 to 1988.  He currently is a
director of American Eagle Outfitters, Inc., having served since 1998, and he
served as chairman of the Compensation Committee until June 2008.  In
May 2007, Mr. Wedren was appointed as a director of Westaff, Inc., a
publicly-traded light industrial staffing business based in California, and
serves as a member of its Audit Committee and Nominating and Governance
Committee.





Other
Significant Employees





Lisa A. Welton, President and Chief
Executive Officer of Cyber-Test, Inc.  From 1990 to June 3,
2004, Ms. Welton served as President and Chief Executive Officer of Cyber-Test,
where she was responsible for overseeing the company’s operational, marketing,
contractual, and communications efforts, including business development and
growth.  Upon our acquisition of Cyber-Test's assets in June 2004, Ms.
Welton was appointed to the same offices and given the same responsibilities
with Cyber-Test. From 1987 to 1989, Ms. Welton served as the National Director
of Business Development for Charlan Brock and Associates, an International
architectural firm specializing in hotels and high-end custom home developments,
where she secured architectural contracts for the firm’s clients in the United
States and Europe.  From 1985 to 1987, Ms. Welton was Senior Account
Manager at Robison, Yesawich and Pepperdine, an advertising and public relations
firm, where she coordinated hotel property grand openings and all subsequent
press events.  Ms.
Welton’s contract as President and Chief Executive Officer of Cyber-Test will
expire September 30, 2009 when Thomas Sutlive, Sr., who is currently Interim
President and Chief Operating Officer, will be appointed President and Chief
Executive Officer of Cyber-Test.




Thomas Sutlive, Sr. Interim
President and Chief Operating Officer of Encompass Service Solutions,
Inc.  From August 1995 to June 3, 2004, Mr. Sutlive was
employed by Cyber-Test, where he served as Vice President, since January 2004,
and was responsible for the overall service structure and establishment of
purchasing policies and procedures.  Upon our acquisition of
Cyber-Test's assets in June 2004, Mr. Sutlive was appointed to the same offices
and given the same responsibilities with Cyber-Test. Effective August 1, 2009,
Mr. Sutlive was appointed Interim President and Chief Operating
Officer. Prior to Mr. Sutlive’s appointment to Vice President, he served as
Cyber-Test’s Director of Operations from September 1999 to January 2004 and
Purchasing Manager from August 1995 to September 1999.  From 1989 to
1995, Mr. Sutlive was Lead Electric Technician with Sprague Electric, where he
handled the operational readiness of specialized precision manufacturing
equipment.  Mr. Sutlive previously held the position of Systems
Analyst with Dyncorp, a defense contractor, where he was responsible for
generating failure analyses for naval missile tracking systems.  Mr.
Sutlive earned a bachelors degree from the University of Georgia and served six
honorable years with the United States Navy.




Robert Coolidge, President and Chief
Executive Officer of Vance Baldwin, Inc.  Since August 1990,
Mr. Coolidge has been employed by Vance Baldwin, Inc, where he served as General
Manager, since 1994, he has assumed responsibility for business development and
marketing.  In 2001, Mr. Coolidge was promoted to Vice President and
subsequently he was promoted to Senior Vice President responsible for business
development, national sales and vendor relations, IT management and development,
as well as integration management.  Upon our acquisition of the stock
of Vance Baldwin on August 17, 2007, Mr. Coolidge was appointed as the President
of Vance Baldwin and effective August 17, 2008 Mr. Coolidge assumed the role of
Chief Executive Officer.  Mr. Coolidge graduated from Western Carolina
University in 1990 with a Bachelor of Science in Business Administration with a
concentration in marketing and computer science.




Fred Baldwin, Chief Executive
Officer-Emeritus of Vance Baldwin, Inc.  Since 1973, Mr.
Baldwin has been employed by Vance Baldwin, Inc. and, in 1984, he was appointed
President and Chief Executive Officer.  Upon our acquisition of the
stock of Vance Baldwin on August 17, 2007, Mr. Baldwin resigned as President of
Vance Baldwin.  Effective August 17, 2008, Mr. Baldwin became Chief
Executive Officer-Emeritus. Mr. Baldwin graduated from Florida State University
with a Bachelor's degree in Marketing and Finance.




Kim Wagner, President/CEO of
Tritronics, Inc.From 1982 to 1986, Ms.
Wagner was employed by Tritronics in the Customer Service
Department.  After almost three years in the law firm of Smith,
Somerville and Case, she returned to Tritronics in 1989 to oversee the call
center and business development.  She was promoted to Vice President
in 1990 and continued in that capacity, overseeing administration, business
development and the call center until the acquisition of Tritronics by Encompass
on August 1, 2008, when she was promoted to President and CEO.  Ms.
Wagner graduated cum laude from Towson University in 1985 with a BS dual major
in Political Science and Mass Communications, and earned a JD from the
University of Baltimore, School of Law in 1988 and an MBA, with a concentration
in International Business, from the Sellinger School of Business, Loyola
College.  Ms. Wagner received her Certified Service Manager
designation from the National Electronic Service Dealers Association and is
serving her second term on their Advisory Board.




33





Jim Scarff, Executive Vice President
of Tritronics, Inc.From 1979 to 1985, Mr. Scarff worked for
the Marriott Corporation where he served as Room Service Supervisor, Assistant
Manager and then Restaurant Manager.  He joined Tritronics in 1985 and
worked in all aspects of the operations and purchasing
departments.  In 1990, he was promoted to Vice President and oversaw
warehouse operations, purchasing, marketing, IT and the Florida branch at
various times.  He was promoted to Executive Vice President for
Operations when Tritronics was acquired by Encompass on August 1, 2008. Mr.
Scarff also serves as Vice President-Operations of the Company





Randy Williams, Executive Vice
President of Tritronics, Inc.Mr. Williams joined
Tritronics as Secretary and Director in 1982, after spending a brief career in
the restaurant industry.  He oversaw many aspects of this family owned
and operated business, including warehouse operations, sales and
purchasing.  In 1990, Mr. Williams was promoted to Vice President and
continued to share all aspects of managing the business, especially purchasing,
warehouse operations and business development.  He was promoted to
Executive Vice President for Purchasing when Tritronics’ stock was acquired by
Encompass on August 1, 2008.





Section
16(a) Beneficial Ownership Reporting Compliance





Section
16(a) of the Exchange Act requires that our directors and executive officers,
and any persons who own more than ten percent of our common stock, file with the
SEC initial reports of ownership and reports of changes in ownership of our
common stock and other equity securities. Such persons are required by SEC
regulations to furnish us with copies of all such reports that they file. To our
knowledge, based upon our review of these reports, all Section 16 reports
required to be filed by our directors, executive officers and ten percent
beneficial owners during the fiscal year ended June 30, 2009 were filed on a
timely basis.





Code
of Ethics





In April
2004, we established a Code of Business Conduct and Ethics (the "Code"),
applicable to all of our employees, including our principal executive,
accounting and financial officers, which states that we are committed to the
highest standards of legal and ethical conduct.  This Code sets forth
our policies with respect to the way we conduct ourselves individually and
operate our business.  The provisions of this Code are designed to
deter wrongdoing and to promote honest and ethical conduct among our employees,
officers and directors.  The Code is incorporated by reference to
Exhibit 14.1 to the Company’s Form 10-KSB filed with the SEC on November 3,
2004.  We will satisfy our disclosure requirement under Item 5.05 of
Form 8-K regarding certain amendments to, or waivers of, any provision of our
Code by posting such information on our corporate website,
www.encompassgroup.com.  We will provide a copy of the Code, without
charge, upon request.  Anyone may request a copy of the Code by
writing to our corporate office located at 420 Lexington Avenue, Suite 2739, New
York, NY 10170.





Corporate
Governance





Procedures
for Nomination of Directors by Security Holders





There were no material changes to the
procedures for nomination of directors by Encompass’s security holders during
the year ended June 30, 2009.





Audit
Committee





Encompass has a separately-designated
standing Audit Committee, which was established on May 15, 2001 in accordance
with Section 3(a)(58)(a) of the Exchange Act.  During fiscal year
2009, Messrs. Ball, Ketteler and Wedren were appointed to our Audit Committee,
each of whom met such independence criteria.  Mr. Ketteler has served
as the Chairman of the Audit Committee since his appointment.




34





Audit
Committee Financial Expert





The Board of Directors has determined
that Mr. Ketteler is an “audit committee financial expert” as defined under Item
407(d)(5)(ii) of Regulation S.K.  Mr. Ketteler, a member of the Audit
Committee and its chairman, is “independent,” as that term is defined under
applicable SEC and NASDAQ rules.





Item 11. Executive Compensation.





As a
“smaller reporting company,” the Company has elected to follow scaled disclosure
requirements for smaller reporting companies with respect to Part III, Item 11 – Executive
Compensation. Under the scaled disclosure obligations, the Company is not
required to provide Compensation Discussion and Analysis and certain other
tabular and narrative disclosures relating to executive compensation. Nor is the
company required to quantify payments due to the named executives upon
termination of employment.





Summary
Compensation of Executive Officers





The table below sets forth information
concerning compensation paid to Wayne I. Danson, Steven J. Miller and John E.
Donahue in the fiscal years ended June 30, 2008 and June 30,
2009.  None of our named executive officers other than Messrs. Danson,
Donahue and Miller received compensation of $100,000 or more in fiscal 2008 or
fiscal 2009.   As set forth below, our compensation program for
our named executive officers consists of base salary and stock option
awards.





Summary
Compensation Table




Name
      and Principal Position
            Year
            
            Salary
              ($)
            
            
            Bonus
              ($)
            
            
            Stock
      Awards
              ($)
            
            
            Option
      Awards
              ($)
            
            
            Non-Equity
      Incentive Plan Compen-sation
              ($)
            
            
            Nonqualified
      Deferred Compensa-tion
              Earnings
              ($)
            
            
            All
      Other Compensa-tion
              ($)
            
            
            Total
              ($)(a)
            (b)
            
            (c)
            
            
            (d)
            
            
            (e)
            
            
            (f)
            
            
            (g)
            
            
            (h)
            
            
            (i)
            
            
            (j)Wayne
      I. Danson
            2009
            
            $
            300
            
            
            $
            126
            (2)
            
            $
            0
            
            
            $
            332
            (4)
            
            $
            0
            
            
            $
            0
            
            
            $
            12
            (5)
            
            $
            770President,
      Chief Executive Officer and Director
            2008
            
            $
            306
            
            
            $
            60
            (2)
            
            $
            0
            
            
            $
            283
            (4)
            
            $
            0
            
            
            $
            0
            
            
            $
            12
            (5)
            
            $
            661Steven
      J. Miller
            2009
            
            $
            213
            
            
            $
            74
            (2)
            
            $
            0
            
            
            $
            258
            (4)
            
            $
            0
            
            
            $
            0
            
            
            $
            15
            (5)
            
            $
            560Chief
      Operating Officer
            2008
            
            $
            192
            
            
            $
            50
            (2)
            
            $
            26
            (3)
            
            $
            220
            (4)
            
            $
            0
            
            
            $
            0
            
            
            $
            15
            (5)
            
            $
            503John
      E. Donahue
            2009
            
            $
            237
            
            
            $
            96
            (2)
            
            $
            0
            
            
            $
            148
            (4)
            
            $
            0
            
            
            $
            0
            
            
            $
            17
            (5)
            
            $
            498Vice
      President and Chief Financial Officer
            2008
            
            $
            239
            
            
            $
            50
            (2)
            
            $
            26
            (3)
            
            $
            126
            (4)
            
            $
            0
            
            
            $
            0
            
            
            $
            17
            (5)
            
            $
            458





(1)           The
amounts in column (d) for fiscal year 2009 represent “performance bonuses” with
respect to fiscal 2009 pursuant to their respective employment agreements with
us and discretionary cash bonuses awarded by the Compensation Committee
to Messrs. Danson and Donahue in the amount of $21 and $13,
respectively, for their contributions in fiscal 2009.





(2)           The
amounts in column (d) for fiscal year 2008 represent discretionary cash bonuses
awarded by the Compensation Committee to the named executive officers for their
respective contributions in fiscal 2008.  The named executives earned
no “performance bonuses” with respect to fiscal 2008 pursuant to their
respective employment agreements with us.




35





(3)           The
amounts in column (e) reflect the dollar amounts recognized for financial
statement reporting purposes in accordance with SFAS 123(R) for the fiscal years
ended June 30, 2009 and 2008 with respect to stock awards granted in and prior
to fiscal 2007, specifically 50,000,000 shares of restricted common stock which
were granted to each of Messrs. Donahue and Miller on September 25, 2006,
10,000,000 shares of which vested immediately, and 40,000,000 shares the vesting
of which was fully accelerated in connection with our recapitalization in August
2007 as described in more details in the section “Employment Agreements and
Post-Termination or Change-of-Control Payments” of this Annual
Report.  The 40,000,000 shares that did not vest immediately were to
vest 30% on September 26, 2007 and 50% on September 26, 2008.  The
fair value was calculated using the closing price of Encompass stock on the date
of grant.   Assumptions used in the calculation of this amount
are included Note 9 of our audited financial statements for the fiscal year
ended June 30, 2009 included in Part II, Item 8 – Financial
Statements and Supplementary Data of this Annual Report.  This
amount reflects our accounting expense for these awards, and does not correspond
to the actual value that will be recognized by the named
executives.





(4)           The
amounts in column (f) reflect the dollar amount recognized for financial
statement reporting purposes for the fiscal years ended June 30, 2009 and 2008,
in accordance with SFAS No. 123R, of awards of stock
options.  Specifically, the terms of the option awards are discussed
below in this Part III, Item
11 – Executive Compensation - Employment Agreements and Post –Termination or
Change-of-Control Payments – Equity Awards.  The Company
utilizes a closed-form model (Black-Scholes) to estimate the fair value of stock
option grants on the date of grant.  Assumptions used in the
calculation of this amount are included in Note 9 of our audited financial
statements for the fiscal year ended June 30, 2009 included in Part II, Item 8 – Financial
Statements and Supplementary Data of this Annual Report.  This
amount reflects our accounting expense for these awards, and does not correspond
to the actual value that will be recognized by the named
executives.





(5)           Messrs.
Danson, Miller and Donahue each receive a car allowance with an estimated value
of $.75 per month to compensate each of them for the use of their respective car
for business purposes, and
receive a term life insurance policy in the amount of $2,000.  The
dollar value of premiums for such policies for Messrs. Danson, Miller and
Donahue in each of the fiscal years amounted to $3, $6 and $8,
respectively.




Employment
Agreements and Post –Termination or Change-of-Control Payments





Employment-Related
Matters





Prior to
the recapitalization, we were obligated to pay approximately $1,048 for accrued
and unpaid management compensation, unreimbursed business expenses and the
outstanding principal balance and accrued interest with respect to an unsecured
promissory note dated April 24, 2006 issued by us to Wayne Danson.  We
satisfied the outstanding debts with management with an aggregate payment of
approximately $488 and an agreement with Mr. Danson’s consulting company to pay
the consulting company $310, plus interest accruing at the rate of 7% per annum,
upon the earlier of a change of control of us or  the six-year
anniversary of the closing of the transactions described herein.  Mr.
Danson also agreed to restructure a potential $250 bonus until such time as we
satisfy certain milestones as described in Mr. Danson’s employment agreement
(described below).  In addition, each of Messrs. Danson, Miller and
Donahue exchanged, in the aggregate, 275 (or $275) shares of our Series A-1
Preferred for our Series A-2 Preferred which on May 6, 2008, converted
automatically into an aggregate 572,916,667 shares of common stock.





On August
17, 2007, and in connection with the recapitalization, we entered into a new
employment agreement with Wayne I. Danson to serve as our Chief Executive
Officer and President.  Under this agreement, we agreed to cause Mr.
Danson to continue as one of our directors, and Mr. Danson agreed to serve as a
director. In addition, at the request of our Board of Directors he will serve as
a director or officer of any of our subsidiaries without additional
compensation.  Mr. Danson received a base salary of $300 per year; if
he earned a “success bonus” (as defined below), his base salary would have been
increased to $325 for the remaining employment term.  Among other
benefits, Mr. Danson receives an auto allowance of $.75 per month.  In
addition, Mr. Danson was eligible to receive (i) a “success bonus,” which
represents his deferred existing bonus in the amount of $250 to which he will be
entitled if certain milestones, as specified in the agreement, are met, and (ii)
an “exit bonus” to which, subject to certain conditions, he will be entitled if
a change of control occurs while he is employed by us.  In the event
certain conditions are satisfied and a change of control occurs after Mr.
Danson’s employment is terminated without “cause” or he resigns for “good
reason”, Mr. Danson will be entitled to 50% of the “exit bonus”.




36





Also on
the August 17, 2007, and in connection with the recapitalization, we entered
into employment agreements with John E. Donahue to serve as our Vice President
and Chief Financial Officer and Steven J. Miller to serve as our Chief Operating
Officer.  Under their respective agreements, Mr. Donahue’s base salary
was $238 per year, and Mr. Miller’s base salary was $188 per year, which
increased to $210 effective September 1, 2008.  Among other benefits,
Messrs. Donahue and Miller receive an auto allowance of $.75 per
month.  In addition, to the extent a “success bonus” was earned,
Messrs Donahue and Miller’s base salary would have increased to $250 and $225,
respectively.   No such “success bonus” was earned prior to
August 17, 2009, the expiration of the eligibility period.





Proposed
amendments to each executive’s employment agreement to be effective August 17,
2009 would replace the one-year option period and among other
items provide for additional two-year employment periods and a one-year
option at the Company’s election.  Under the terms of the proposed
amendments, the Company would be obligated to pay base salaries to Messrs
Danson, Donahue and Miller of $315, $250 and $250, respectively, in each of the
first and second years.  Amendments effective July 31,
2009 modified the provisions of the employments agreements that define the
parameters by which “performance” bonuses would be earned.





Certain
terms of the employment agreements of Messrs. Danson, Donahue and Miller are
identical and are set forth below:




·
            Each
      executive is eligible to receive a “performance bonus.”  A
      “performance bonus” is equal to a variable percentage of the executive’s
      base salary, determined by measuring actual EBITDA (as defined therein)
      against the target EBITDA (as defined therein) of any fiscal year during
      which the executive was employed for any portion of that
      year.  For fiscal 2009, target EBITDA was $13,000. The
      revised definition of
      performance bonus is set forth in Amendment No. 1 to each of the
      employment agreements of Messrs. Danson, Donahue and Miller, copies of
      which are filed herewith as Exhibits 10.22, 10.23 and 10.24,
      respectively.




·
            Subject
      to certain conditions, the executive will receive a one-time “exit bonus”,
      which will be payable to the executive in cash not later than 30 days
      after a “Disposition Event” (as defined therein).  The amount of
      the exit bonus will be determined pursuant to a formula set forth in the
      respective employment agreement, and will depend on executive’s current
      employment with us or the circumstances of executive’s termination of
      employment with us, but in no event will exceed $2,500 in the aggregate
      for Messrs. Danson, Donahue and Miller.  In no event will the
      sum of the exit bonus and any other amounts required to be taken into
      account under Section 280G of the Code in connection with the Disposition
      Event exceed 299% of the executive’s “Base Amount” as determined pursuant
      to Section 280G of the Code.




·
            The
      employment agreement contains restrictive covenants prohibiting the
      executive from competing with us or soliciting our employees or customers
      for another business during the term of the agreement and for a period of
      2 years after termination or the end of the employment term.  In
      the event the Severance Period (as defined below) is equal to six months,
      such restrictive covenants will survive for a period of 1 year after
      termination or the end of
employment.




·
            We
      are obligated to provide a $2,000 term life insurance policy on the
      executives’ life, with a beneficiary of his choosing, and, at our option,
      may insure the executive under a key man life insurance
      policy.




·
            We may terminate the employment
      agreements for “cause” as defined therein or in the event that the
      respective executive becomes “Permanently Disabled” as defined therein.
      The executive may terminate his agreement for “Good Reason” as defined
      therein. The employment agreement will automatically terminate upon the
      executive’s death.




The agreements provide for the
following post-termination and change-in-control payments to Messrs. Danson,
Donahue and Miller:





·
            In
      the event that we terminate the executive’s employment without cause, we
      will pay to the executive (i) any accrued base salary and reimbursement
      for business expenses and, if applicable, auto expenses incurred prior to
      the termination date, (ii) any unpaid success and/or performance bonus, to
      the extent such bonus has been earned and (iii) a severance payment (the
      “Severance Payment”) equal to the additional amount of base salary which
      would have been payable to the executive during the six-month period
      immediately following the termination date or, if the executive earned a
      success bonus prior to termination, the twelve-month period immediately
      following the termination date (the “Severance Period”), which Severance
      Payment will be paid in accordance with our standard payroll practices
      over the course of the Severance Period after the date on which the
      executive incurs a “separation from service,” as such term is defined in
      Internal Revenue Code.




37




·
            In
      the event that the executive’s employment is terminated for any reason, we
      will pay to the executive any accrued base salary and reimbursement for
      business expenses and, if applicable, auto expenses incurred prior to the
      termination date and any accrued unpaid success and/or performance bonus,
      to the extent such bonus has been earned, which amounts shall be payable
      in cash to the executive in a lump sum no later than 30 days after the
      termination date.  In addition, if we terminate the executive’s
      employment for any reason other than for Cause or by the executive for
      Good Reason, the executive will be deemed to have earned (i) a performance
      bonus if 270 days have passed in any fiscal year, which performance bonus
      will be paid on a pro rata basis for the period of time the executive was
      employed prior to termination and (ii) a success bonus if the conditions
      set forth in the agreement occur within three months of such
      termination.




·
            We will indemnify the executive
      for any losses, damages, claims, costs and expenses incurred by the
      executive resulting from any act or omission of us or from our failure to
      perform any of our obligations under the respective agreement.




Specific EBITDA target levels are set
forth in each of our employment agreements with Messrs. Danson, Donahue and
Miller for the fiscal years ended June 30, 2008, 2009 and 2010 for purposes of
determining an annual “Performance Bonus”; however, these targets are adjusted
annually for the effect of such matters as an acquisition and the annual
budget. The
dollar amounts of the Company’s projected EBITDA established as executive
compensation incentives for prior fiscal years were as follows:


·
              the
      FY Target EBITDA for the fiscal years ended June 30, 2008 and 2009 were
      $8,100 and $9,500, respectively;
 
 ·
              the
      EBITDA target for any twelve consecutive fiscal month period ending
      prior to the second anniversary of the Employment Agreements was $13,000;
      and
 
 ·
              the
      Special Bonus Target EBITDA for the five month period ending December 31,
      2007 was $2,900.
 
 As set
forth in the amendments to each of the employment agreements with Messrs.
Danson, Donahue and Miller effective as of July 31, 2009, the Compensation
Committee will determine the FY Target EBITDA for each subsequent complete
fiscal year during the term of the agreement no later than 30 days after the
Board's approval of the Company’s budget for such year.  In the event
that the Company or any of its subsidiaries in any fiscal year enters into any
extraordinary transaction, such as a business acquisition or disposition, the
Compensation Committee in the exercise of its sole discretion may, at any time
during such fiscal year, adjust upward or downward the Target EBITDA for
such fiscal year to take into account such extraordinary
transaction.  The Compensation Committee shall notify each executive
officer of the Target EBITDA for any such fiscal year promptly after determining
such Target EBITDA.


Upon achieving a minimum of 80%
(revised to 90% for fiscal 2009 and thereafter) of the FY Target EBITDA for the
fiscal years ended June 30, 2008, 2009 and 2010, or achieving the Special Bonus
Target EBITDA, each of the Company’s executive officers is entitled to receive
an annual Performance Bonus which represent a varying percentage of each such
officer’s base salary as set forth in his respective employment
agreement.





Equity
Awards




During fiscal year 2008, our
Compensation Committee recommended, and our full Board of Directors approved,
stock awards to each of Mr. Donahue and Mr. Miller of 40,000,000 shares of
restricted stock pursuant to the terms of their prior employment agreements
under which a “change of control” occurred with HIG’s investment and purchase of
the Series C Preferred shares.





In connection with the recapitalization
described herein, our Board of Directors also approved the issuance of options
representing an aggregate of 10.0% of the available pool under our amended and
restated 2005 Stock Plan to the following named executive officers pursuant to
the terms of separate option agreements:





Wayne
      I. Danson,
              President
      and CEO
            
            
            4.5%John
      E. Donahue
              VP
      and CFO
            
            
            2.0%Steven
      J. Miller
              COO
            
            
            3.5%




38





Messrs. Danson’s, Miller’s and
Donahue’s options will vest according to the following schedule:





•
            25%
      of the options awarded will be vested
  immediately,





•
            37.5%
      of the options awarded will vest quarterly in equal increments over three
      years, and





•
            37.5%
      of the options awarded over three years if certain EBITDA targets are
      met.





The
above-referenced EBITDA targets refer to the “Base EBITDA Targets” set forth in
each of the named executive’s stock option agreements with us.  The
full satisfaction of the Base EBITDA Targets in each of our fiscal years ending
June 30, 2008, 2009 and 2010 will cause one-third of the options designated as
“Performance Optioned Shares” in each stock option agreement to become
vested.  For our fiscal years ending June 30, 2008 and 2009 the EBITDA
targets were $6,500 and $7,600, respectively.  The EBITDA
target for the fiscal year ending June 30, 2010 is $9,500. The fiscal
year 2008 EBITDA target of $6,500 was not attained; however, the fiscal year
2009 EBITDA target of $7,600 was met and, furthermore, cumulative EBITDA for the
two year period was such that Performance Optioned Shares for fiscal 2008 also
have vested per terms of the Company’s Stock Option Plan.




Outstanding
Equity Awards at 2009 Fiscal Year-End




The
following table and its notes provide information concerning outstanding equity
awards in the form of stock options, a portion of which constitute equity
incentive plan awards, for each of the named executives at June 30,
2009.  No options or related stock appreciation rights were exercised
in fiscal 2009. No
named executive held unvested stock awards at the end of fiscal year
2009.








Option
      awardsName
            
            Option
      Grant Date
              (1)
            
            
            Number
      of securities underlying unexercised options (#)
    exercisable
            
            
            Number
      of securities underlying unexercised options
      (#) unexercisable
            
            
            Equity
      incentive plan awards: Number of securities underlying unexercised
      unearned options (#)
            
            
            Option
      exercise price($)
            
            
            Option
      expiration dateWayne
      I. Danson
            
            
            8-17-07
            
            
            
            2,997,452,818
            
            
            
            499,575,470
            
            
            
            499,575,470
            
            
            $
            .0075
            
            
            
            8-17-17Steven
      J. Miller
            
            
            8-17-07
            
            
            
            2,331,352,191
            
            
            
            388,558,699
            
            
            
            388,558,699
            
            
            $
            .0075
            
            
            
            8-17-17John
      E. Donahue
            
            
            8-17-07
            
            
            
            1,332,201,252
            
            
            
            222,033,542
            
            
            
            222,033,542
            
            
            $
            00.75
            
            
            
            8-17-17(1)
      These options vest according to the following schedule: 25% of the options
      vested immediately as of August 17, 2007, 37.5% of the options will vest
      quarterly in equal increments over three years, and 37.5% of the options
      will vest over three years if certain EBITDA targets are
    met.





Director
Compensation




Director
Compensation Policy





Following the recapitalization in
August 2007, we adopted new standards for the compensation of our independent
directors.  Our credit agreement with Sankaty Advisors limits our
aggregate outside board fees to $60 if our EBITDA for such fiscal year is below
$5,800 whereby each independent director would receive an annual retainer of $10
per year and a committee retainer (for participation in one or multiple
committees) of $2 per year.  Such retainers are to be increased if we
meet higher EBITDA targets, with a maximum of $100 in aggregate outside board
fees authorized under our credit agreement if EBITDA exceeds
$6,200.  Under this policy, each independent director would receive an
annual retainer of $15 per year and a committee retainer (for participation in
one or multiple committees) of $5 per year.  Regardless of our EBITDA
for any fiscal year, we will also pay our independent directors $.5 per meeting
for in-person attendance at a Board meeting and $.25 per meeting for attendance
at a Board meeting via teleconference.   During the fiscal year
ended June 30, 2009, independent board members were entitled to receive
aggregate board fees in the amount of $100 under the terms of our credit
agreement.




39





In addition to the cash compensation
described above and in connection with the recapitalization, Wilbank Roche, John
G. Ball, Thomas R. Ketteler and Gerald E. Wedren, our independent directors,
each received a one-time grant of stock options to purchase 50,000,000 shares of
our common stock at an exercise price of $.00075 per share.  These
options, which vested on August 17, 2008, were granted under the amended and
restated 2005 Stock Plan.





The Director Compensation table below
summarizes the compensation that we paid to non-employee directors for the
fiscal year ended June 30, 2009.





2009
Director Compensation Table




Name
              (a)
            
            Fees
      Earned or Paid in Cash ($)
              (b)
            
            
            Stock
      Awards ($)
              (c)
            
            
            Option
      Awards ($)
              (1)
      (2)
              (d)
            
            
            Non-Equity
      Incentive Plan Compensation ($)
              (e)
            
            
            Nonqualified
      Deferred Compensation Earnings
              ($)
              (f)
            
            
            All
      Other Compensation ($)
              (g)
            
            
            Total
      ($)
              (h)Wilbank
      J. Roche
            
            $
            20
            
            
            
            —
            
            
            $
            1
            
            
            $
            0
            
            
            
            —
            
            
            $
            0
            
            
            $
            21John
      G. Ball
            
            $
            20
            
            
            
            —
            
            
            $
            1
            
            
            $
            0
            
            
            
            —
            
            
            $
            0
            
            
            $
            21John
      R. Black
            
            $
            0
            
            
            
            —
            
            
            $
            0
            
            
            $
            0
            
            
            
            —
            
            
            $
            0
            
            
            $
            0Thomas
      Ketteler
            
            $
            20
            
            
            
            —
            
            
            $
            1
            
            
            $
            0
            
            
            
            —
            
            
            $
            0
            
            
            $
            21William
      J. Nolan
            
            $
            0
            
            
            
            —
            
            
            $
            0
            
            
            $
            0
            
            
            
            —
            
            
            $
            0
            
            
            $
            0Gerald
      E. Wedren
            
            $
            20
            
            
            
            —
            
            
            $
            1
            
            
            $
            0
            
            
            
            —
            
            
            $
            0
            
            
            $
            21







(1)           As
of June 30, 2009, the aggregate number of option awards outstanding for the
directors were 50,000,000 each for Messrs. Roche, Ball, Ketteler and
Wedren.  These options vested on August 17, 2008.  There are
no stock awards outstanding for the directors.





(2)           The
amounts in this column reflect the dollar amount recognized for financial
statement reporting purposes for the fiscal year ended June 30, 2009, in
accordance with SFAS 123(R) of awards of stock options. The expense included in
the table represents pro-rata portions of the total expense for each grant
related to the portion of the vesting period included in FY 2009. The total fair
value of the option grants are being expensed over their respective one-year
vesting periods. The Company utilizes a closed-form model (Black-Scholes) to
estimate the fair value of stock option grants on the dates of
grant.  Assumptions used in the calculation of this amount are
included in Note 9 of our audited financial statements for the fiscal year ended
June 30, 2009 included in Part
II,  Item 8 – Financial Statements and Supplementary Data of
this Annual Report.




40








Item
12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.





As of
September 15, 2009, we had 13,286,151,226 shares of common stock, no shares of
Series A-2 Preferred, 1,000 shares of Series C Preferred, 1,000 shares of Series
D Preferred and 1,000 shares of Series E Preferred outstanding. The Series E
Preferred is not convertible into shares of our common stock, and the holders of
Series E Preferred are not entitled to any voting rights. The following table
sets forth information concerning the ownership of our common and preferred
stock except for Series E Preferred as of such date by each person known to us
to be the beneficial owner of more than five percent of a class of our voting
capital stock, by each of our directors and executive officers, and by our
directors and executive officers, as a group. Due to certain factors relating to
our convertible securities, the principles of the presentation below vary from
the mechanics specified in Rule 13d-3 under the Exchange Act as described in
Note 2 below.





Common Stock Beneficially
              Owned (2)
            
            
            Series C Preferred Stock
              Beneficially Owned
            
            
            Series D Preferred Stock
              Beneficially OwnedName and Address
              of Beneficial
              Owner(1)
            
            # of Shares
            
            
            
            % of
              Class
            
            
            # of Shares
            
            
            % of
              Class
            
            
            # of Shares
            
            
            % of
              Class5% Beneficial OwnersACT-DE
      LLC(3)
            
            
            78,399,417,172
            (6
            )
            
            
            72.79
            %
            
            
            913.79
            
            
            
            91.379
            %Sankaty
      Entities(4)
            
            
            7,322,678,357
            (7
            )
            
            
            6.14
            %
            
            
            85.35
            
            
            
            8.535
            %Fred
      Baldwin
            
            
            4,364,650,314
            (8
            )
            
            
            3.66
            %
            
            
            —
            
            
            
            —
            
            
            
            312.5
            
            
            
            31.25
            %Robert
      Coolidge
            
            
            5,189,420,878
            (9
            )
            
            
            4.35
            %
            
            
            —
            
            
            
            —
            
            
            
            562.5
            
            
            
            56.25
            %Scott
      Cameron
            
            
            1,079,193,459
            (10
            )
            
            
            *
            
            
            
            —
            
            
            
            —
            
            
            
            125.0
            
            
            
            12.50
            %Tritronics,
      LLC(5)
            
            
            2,796,232,989
            
            
            
            
            2.34
            %Officers and
      DirectorsWayne
      I. Danson President, CEO & Director
            
            
            3,306,778,317
            (11
            )
            
            
            2.77
            %
            
            
            
            
            
            
            
            
            
            
            —
            
            
            
            —Steven
      J. Miller
              Chief
      Operating Officer
            
            
            2,693,852,191
            (12
            )
            
            
            2.26
            %John
      E. Donahue
              VP
      & Chief Financial Officer
            
            
            1,538,451,252
            (13
            )
            
            
            1.29
            %
            
            
            
            
            
            
            
            
            
            
            —
            
            
            
            —Wilbank
      J. Roche
              Director
            
            
            216,423,810
            (14
            )
            
            
            *
            
            
            
            
            
            
            
            
            
            
            
            —
            
            
            
            —John
      G. Ball
              Director
            
            
            50,000,000
            (15
            )
            
            
            *
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —John
      R. Black
              Director
            
            
            78,399,417,172
            (16
            )
            
            
            72.79
            %
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Thomas
      R. Ketteler
              Director
            
            
            50,000,000
            (17
            )
            
            
            *
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —William
      J. Nolan IV
              Director
            
            
            —
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Gerald
      E. Wedren
              Director
            
            
            50,000,000
            (18
            )
            
            
            *
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Executive
      Officers and Directors as a group
              (9
      persons)
            
            
            86,304,922,742
            
            
            
            
            79.10
            %
            
            
            
            
            
            
            
            
            
            
            —
            
            
            
            —




41




* Less
than one percent (1%)


1
            
            Except
      as otherwise indicated, the address of each person named in the above
      table is c/o Encompass Group Affiliates, Inc., 420 Lexington Avenue, New
      York, NY 10170.2
            
            Common
      Stock which is issuable upon the exercise of a stock option which is
      presently exercisable or which becomes exercisable within sixty days is
      considered outstanding for the purpose of computing the percentage
      ownership (x) of persons holding such options, and (y) of officers and
      directors as a group with respect to all options held by officers and
      directors. The number of shares of common stock and the percent of the
      class in the table and these notes to the table have been calculated in
      accordance with Rule 13d-3 under the Exchange Act, except as described in
      this Note 2. The percentage calculations assume that each stockholder has
      converted all securities he owned that are convertible into common stock
      at the option of the holder currently or within 60 days of September 22,
      2008, and, for all beneficial owners, that all shares of the Series C and
      Series D Preferred Stock have been converted to Common Stock. This varies
      from the provisions of Rule 13d-3 which generally requires the
      calculations to be made on the assumption that the stockholder for whom
      the calculation is being made has converted his convertible securities but
      that none of the other stockholders have converted convertible securities.
      We believe that our presentation is more meaningful than the presentation
      specified in Rule 13d-3 as the conversion rates on our Series C Preferred
      and Series D Preferred are interrelated with each other, and because the
      Series C Preferred and Series D Preferred vote, on an as-converted basis,
      together with the common stock as one class.  Information is
      provided in the footnotes below for each holder as to the number of shares
      of common stock included in the table for conversion of securities.
      .
              
              For
      purposes of this presentation, all shares of Series C Preferred Stock may
      currently be converted into 85,795,879,985 shares of common stock. All
      shares of Series D Preferred Stock may currently be converted into
      8,633,547,671 shares of common stock.  The conversion rate for
      the Series C Preferred Stock is subject to downward adjustment if the
      return, or deemed return, per share of Series C Preferred Stock meets
      certain targets over a period of years described in the Certificate of
      Designation for the Series C Preferred Stock.  If the conversion
      rate for the Series C Preferred Stock is adjusted, the conversion rate for
      the Series D Preferred Stock will also adjust.  The number of
      shares issuable upon conversion of the Series C Preferred Stock and Series
      D Preferred Stock used in this presentation assume no downward adjustment
      of the conversion rates.
              
              The
      information presented in the table assumes full conversion of the
      convertible note held by Mr. Baldwin, only for the purposes of Mr.
      Baldwin’s beneficial ownership.  The conversion rates for the
      Series C and Series D Preferred Stock depend in part on whether Mr.
      Baldwin has converted this note.3
            
            As
      reported in a Schedule 13D/A filed with the Securities and Exchange
      Commission on March 25, 2009, H.I.G.-ACT, Ltd., a Cayman Islands
      corporation (“HIG ACT”), is the sole member of ACT-DE LLC, a Delaware
      limited liability company (“ACT LLC”). As the sole member of ACT LLC, HIG
      ACT has the power to vote and dispose of the shares of our capital stock
      owned by the ACT LLC and, accordingly, may be deemed the beneficial owner
      of such shares. H.I.G. Capital Partners III, L.P., a Delaware limited
      partnership (“HIG CP III”), is a shareholder of HIG ACT. As a shareholder
      of HIG ACT, HIG CP III has the power to vote and dispose of the shares of
      our capital stock owned by ACT LLC and, accordingly, may be deemed the
      beneficial owner of such shares. H.I.G. Advisors III, L.L.C., a Delaware
      limited liability company (“HIG LLC”), is the general partner of HIG CP
      III. As the general partner of HIG CP III, HIG LLC has the power to vote
      and dispose of the shares of our capital stock owned by ACT LLC and,
      accordingly, may be deemed the beneficial owner of such shares. H.I.G.
      Investment Group III, L.P., a Cayman Islands limited partnership (“HIG IG
      III”) is a shareholder of HIG ACT. As a shareholder of HIG ACT, HIG IG III
      has the power to vote and dispose of the shares of our capital stock owned
      by ACT LLC and, accordingly, may be deemed the beneficial owner of such
      shares. H.I.G. Associates III, L.P., a Cayman Island limited partnership
      (“HIG Associates”) is the general partner of HIG IG III. As the general
      partner of HIG IG III, HIG Associates has the power to vote and dispose of
      the shares of our capital stock owned by ACT LLC and, accordingly, may be
      deemed the beneficial owner of such shares. H.I.G.-GPII, Inc., a Delaware
      corporation (“HIG GP”) is the manager of HIG LLC and the general partner
      of HIG Associates. As the manager of HIG LLC and the general partner of
      HIG Associates, HIG GP has the power to vote and dispose of the shares of
      our capital stock owned by ACT LLC and, accordingly, may be deemed the
      beneficial owner of such shares. Anthony Tamer and Sami Mnaymneh are the
      Co-Presidents of HIG GP, and in that capacity direct its operations.
      Therefore, Anthony Tamer and Sami Mnaymneh may be deemed to be beneficial
      owners of shares beneficially owned by HIG GP. Each of HIG Act, HIG CP
      III, HIG LLC, HIG IG III, HIG Associates, HIG GP, Mr. Tamer and Mr.
      Mnaymneh disclaim beneficial ownership except to the extent of their
      pecuniary interest in the shares. The address for HIG-DE LLC is c/o H.I.G.
      Capital L.L.C., 855 Boylston St., 11th
      Floor, Boston, MA 02116. ACT-DE LLC also owns 840 shares of our Series E
      Preferred, which represents 84% of the outstanding shares of Series E
      Preferred.




42




4
            
            Includes
      Sankaty Credit Opportunity (Offshore Master) IV, L.P. and Sankaty Credit
      Opportunities IV, L.P. The address of the Sankaty entities is 111
      Huntington Avenue, Boston, MA 02199. These entities also own 160 shares of
      our Series E Preferred, which represents 16% of the outstanding shares of
      Series E Preferred.





5.
            
            Kimberly
      Wagner, Randy Williams and James Scarff each hold 10% of the ownership
      interests in Tritronics, LLC. The address of these three individuals is
      c/o Tritronics, Inc., 1306 Continental Drive, Abingdon, MD 210096
            
            The
      number of common shares in the table includes 78,399,417,171 shares of
      common stock that may be acquired upon conversion of Series C
      Preferred.7
            
            The
      number of common shares in the table includes 7,322,678,357 shares of
      common stock that may be acquired upon conversion of Series C
      Preferred.8
            
            The
      number of common shares in the table includes 2,697,983,647 shares of
      common stock that may be acquired upon conversion of Series D Preferred
      and 1,666,666,667 shares of common stock which may be acquired upon
      conversion of a convertible note.  .9
            
            The
      number of common shares in the table includes 4,856,370,565 shares of
      common stock that may be acquired upon conversion of Series D Preferred
      and 333,050,313 shares which Mr. Coolidge may acquire by exercising
      options he holds.10
            
            The
      number of common shares in the table includes 1,079,193,459 shares of
      common stock that may be acquired upon conversion of Series D
      Preferred.11
            
            The
      number of common shares in the table includes 309,325,499 shares of common
      stock held by Mr. Danson and 2,997,452,818 shares which Mr. Danson may
      acquire by exercising options he holds.12
            
            The
      number of common shares in the table includes 362,500,000 shares of common
      stock held by Mr. Miller, including 50,000,000 shares of restricted stock
      previously granted to Mr. Miller, and 2,331,352,191 shares which Mr.
      Miller may acquire by exercising options he holds.13
            
            The
      number of common shares in the table includes 206,250,000 shares of common
      stock held by Mr. Donahue, including 50,000,000 shares of restricted stock
      previously granted to Mr. Donahue, and 1,332,201,252 shares which Mr.
      Donahue may acquire by exercising options he holds.14
            
            The
      number of common shares in the table includes 166,423,810 shares of common
      stock held by Mr. Roche and 50,000,000 shares of common stock which Mr.
      Roche may acquire by exercising options he holds.15
            
            The
      number of common shares in the table includes 50,000,000 shares of common
      stock which Mr. Ball may acquire by exercising options he
      holds.16
            
            The
      number of common shares in the table includes 78,399,417,171 shares that
      may be acquired upon conversion of 913.79 shares of Series C Preferred
      held by ACT-DE, LLC. Mr. Black is a Managing Director of H.I.G. Capital,
      L.L.C., an affiliate of ACT-DE, LLC and, as such, may be deemed to
      beneficially own shares of Series C Preferred Stock held by ACT-DE, LLC.
      In addition, Mr. Black may be deemed to beneficially own 840 shares of
      Series E Preferred held by ACT-DE, LLC. Mr. Black disclaims beneficial
      ownership of such shares.17
            
            The
      number of common shares in the table includes 50,000,000 shares of common
      stock which Mr. Ketteler may acquire by exercising options he
      holds.18
            
            The
      number of common shares in the table includes 50,000,000 shares of common
      stock which Mr. Wedren may acquire by exercising options he
      holds.




43




Changes
in Control





There are
no arrangements known to us the operation of which may result in a change in
control of Encompass.




Equity
Compensation Plan Information





The
following table sets forth information as of June 30, 2009 regarding all of our
existing compensation plans and individual compensation arrangements pursuant to
which equity securities are authorized for issuance to employees, non-employee
directors or non-employees (such as directors, consultants and advisors) in
exchange for consideration in the form of services:





Plan Category
            Number of
              securities to be
              issued upon
              exercise of
              outstanding
              options, warrants
              and rights
            
            Weighted-average
              exercise price of
              outstanding
              options, warrants
              and rights
            
            Number of
              securities
              remaining
              available for future
              issuance under
              equity
              compensation
              plans (excluding
              securities reflected
              in column (a))(a)
            
            (b)
            
            (c)Equity
      compensation plans approved by security holders: 2005 Stock
      Plan
            
            
            10,923,525,261
            
            
            $
            .00075
            
            
            
            4,076,474,739Equity
      compensation plans not approved by security holders:
            
            
            0
            
            
            
            0
            
            
            
            0Total
            
            
            10,923,525,261
            
            
            $
            .00075
            
            
            
            4,076,474,739





Our 2005
Stock Plan was adopted by the Board of Directors on June 26, 2005. In connection
with the recapitalization described herein, our Board of Directors voted to
amend and restate our 2005 Stock Plan (the “2005 Plan”) on August 16, 2007. The
material revision to the 2005 Plan was an increase in the number of shares of
common stock available for issuance under the 2005 Plan from 700,000,000 shares
to 15,000,000,000 shares. Our stockholders approved the amendments to the 2005
Stock Plan pursuant to a consent solicitation that concluded on May 5,
2008.




At
September 25, 2009, there were approximately 305 Employees, Non-Employee
Directors and Key Advisors of Encompass and its subsidiaries eligible to
participate in the 2005 Plan.





The
aggregate number of shares of our common stock, which may be issued under the
2005 Plan, is 15,000,000,000 shares, subject to proportionate adjustment in the
event of stock splits and similar events. There is no limitation on the number
of shares which may be issued to any individual under the 2005 Plan, including
any officer or director. No awards may be granted under the 2005 Plan on or
after June 26, 2015. If any award granted under the 2005 Plan is canceled or
terminates, expires or lapses for any reason, the number of shares subject to
the award will again be available for purposes of the 2005 Plan.




44





Item 13. Certain
Relationships and Related Transactions, and Director
Independence.





Certain Relationships and Related
Transactions





During the last two fiscal years, we
have not entered into any material transactions or series of transactions in
which any officer, director or beneficial owner of 5% or more of any class of
our capital stock, or any immediate family member of any of the preceding
persons, had a direct or indirect material interest and in which the amount
involved exceeds the lesser of (i) $120 or (ii) one percent of the average of
our total assets at 2009 and 2008 fiscal year end ($61,540), nor are any such
transactions presently proposed, except as follows:





·
            In
      connection with the recapitalization described under Part III, Item 12. Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters – Changes in Control, we
      entered into a five-year management agreement with H.I.G.
      Capital.   H.I.G Capital is an affiliate of ACT-DE, LLC,
      which owns shares entitled to cast approximately 72% of the votes which
      may be cast by all of our stockholders. Under the management agreement,
      H.I.G Capital provides management and consulting services to us and our
      subsidiaries, subject to the supervision of the our Board of Directors. We
      pay a cash consulting and management fee to H.I.G Capital, currently not
      to exceed $500 per annum. The fee is payable only to the extent permitted
      under a Note Purchase Agreement, for which Sankaty Advisors, LLC is the
      collateral agent, and the amount of the fee depends on whether we have met
      certain financial objectives. If payment of the fee is prohibited by the
      Note Purchase Agreement, the unpaid amount will accrue interest at the
      rate of 5% per annum, compounded annually. In addition, we have agreed to
      reimburse HIG Capital for expenses incurred in connection with the
      performance of management and consulting services with respect to
      us.   At the same time, we also entered into a five-year
      investment advisory services agreement with H.I.G. Capital, pursuant to
      which H.I.G Capital will provide certain financial advisory services to us
      and our subsidiaries, subject to the supervision of our Board of
      Directors. In connection with any transaction introduced, arranged,
      managed and/or negotiated by H.I.G. Capital, including an acquisition,
      disposition, sale of us, or financing, we will pay H.I.G. Capital an
      investment banking fee and a supplemental management fee, each equal to a
      percentage of (i) the enterprise value of an acquisition or disposition,
      (ii) the financing amount, in connection with a debt or equity financing,
      or (iii) the benefit value, in connection with any other transaction not
      in the ordinary course of business. The investment banking fee and
      supplemental management fee with respect to future transactions will be
      payable only to the extent permitted under the Note Purchase Agreement. If
      payment of the fees is prohibited by the Note Purchase Agreement, the
      unpaid amount will accrue interest at the rate of 5% per annum, compounded
      annually. We paid H.I.G. Capital a combined investment banking and
      supplemental management fee of $525 in connection with the purchase by
      certain investors, including H.I.G. Capital, of Series C Preferred Stock
      pursuant to a Series C Purchase Agreement.   We paid H.I.G.
      Capital a combined investment banking and supplemental management fee of
      $200 in connection with the purchase by certain investors of Series E
      Preferred Stock pursuant to a Series E Purchase
      Agreement.  Under both the management agreement and the
      investment advisory services agreement, we will reimburse H.I.G. Capital
      for expenses incurred in performance of its duties thereunder. Both
      agreements require us to indemnify H.I.G. Capital and its affiliates with
      respect to losses or claims arising from H.I.G. Capital’s performance of
      services, except as a result of its gross negligence or willful
      misconduct. Either party may terminate the management agreement or the
      investment advisory services agreement in the event of a breach of
      material terms by the other party, and H.I.G. Capital is entitled to
      recover damages in the event of such a breach by
  us.




·
            Our
      principal executive office is located at 420 Lexington Avenue, Suite 2739,
      New York, New York 10170.  We, through a license agreement
      effective August 15, 2007 with Danson Partners, LLC, a party related to
      our chief executive officer, effectively assumed the Danson Partners’
      lease obligation for a total of approximately 2,300 square feet of office
      space through May 31, 2010, and licenses for its use all the furniture,
      fixtures, filing cabinets, computers, servers, office equipment, etc. that
      it needs to conduct its business.




45




·
            On
      August 17, 2007, we satisfied outstanding debts to our Chief Executive
      Officer, Vice President and Chief Operating Officer and Chief Financial
      Officer, to whom we were obligated to pay approximately $1,048 for accrued
      and unpaid compensation, unreimbursed business expenses and the
      outstanding principal balance and accrued interest with respect to an
      unsecured promissory note dated April 24, 2006 issued by us to our Chief
      Executive Officer.  We satisfied the outstanding debts with
      management with an aggregate payment of approximately $488 and the
      issuance of a note to Mr. Danson’s consulting company, Danson Partners,
      LLC, in the aggregate principal amount of $310,000, plus interest accruing
      at the rate of 7% per annum, upon the earlier of a change of control of us
      or August 17, 2013.  Mr. Danson also agreed to restructure a
      potential $250 bonus until such time as we satisfy certain milestones as
      described in Mr. Danson’s employment agreement. Effective
      August 17, 2009, Mr. Danson’s potential bonus amount was not earned and
      therefore expired.




·
            Upon
      the closing of the recapitalization, the four pre-closing directors of the
      Company, which included Mr. Roche, received an aggregate of $365 for
      accrued directors’ and special committee fees of which $175 was used by
      the directors to purchase shares of Series A-2
  Preferred.




·
            Pursuant
      to agreement entered into on March 7, 2006 by and between John E. Donahue,
      currently our Vice President and Chief Financial Officer, and Montgomery
      Scott, LLC (“Janney”), that served as our financial advisor and investment
      banker in connection with the recapitalization and acquisition of Vance
      Baldwin, Janney agreed to pay 5% of its advisory fees to Mr. Donahue as a
      finder’s fee.  Janney paid this amount of Mr. Donahue in
      September 2007.  Mr. Donahue entered into the agreement with
      Janney approximately six months prior to his joining the Company and prior
      to the Company discussing the possibility of Mr. Donahue joining the
      Company.




·
            On
      August 1, 2008, we sold 908.57 shares of our newly designated Series E
      Preferred for an aggregate purchase price of $3,786 in immediately
      available funds to ACT-DE, LLC and the other holders of its Series C
      Preferred (the “Other Series C Stockholders), pursuant to a Purchase
      Agreement (the “Series E Purchase Agreement”). We used the proceeds from
      the sale of the Series E Preferred, in conjunction with the debt proceeds
      described below, to fund the acquisition of Tritronics, Inc. and for
      working capital needs related to an agreement entered into with Philips
      Consumer Lifestyle North America as described on the Company's Form 8-K
      filed with the SEC on July 18, 2008.  On August 13, 2008, we
      completed a subsequent closing of the sale of shares of our Series E
      Preferred as contemplated by the Series E Stock Purchase Agreement at
      which we sold an additional 91.43 shares of our Series E Preferred, at a
      price of $4,167 per share, to the holders of its Series C Preferred Stock,
      other than ACT-DE, LLC, for an aggregate cash purchase price of
      $381.




·
            On
      August 1, 2008, Encompass Parts entered into the Amended and Restated Note
      Purchase Agreement  with Sankaty Advisors, LLC and other “Note
      Purchasers”, Encompass Parts Distribution, Inc., a Delaware corporation
      (“Encompass-DE”), as issuer, and us, Tritronics, SpectruCell, Inc., Hudson
      Street Investments, Inc., Cyber-Test and Vance Baldwin, as guarantors (the
      “Guarantors”).  See Part II, Management’s
      Discussion and Analysis of Financial Condition and Results of Operations -
      Liquidity and Capital Resources – Source of Liquidity – SeniorNotes and Senior
      Subordinated Notes and Senior Secured Credit Facility above for a
      detailed description of the Amended and Restated Note Purchase
      Agreement.  Certain affiliates of Sankaty are holders of our
      Series C and Series E Preferred.  On August 1, 2008, we and the
      holders of Series C Preferred Stock entered into Amendment No. 1 to the
      Stockholder Agreement, dated August 17, 2007 (the “Amended Series C
      Stockholder Agreement”) originally entered into between such
      parties.  Pursuant to the amendment, the shares of Series E
      Preferred issued to holders of Series C Preferred Stock are subject to the
      Series C Stockholder Agreement, including for purposes of transfer
      restrictions as well as co-sale rights on sales of preferred stock by the
      major Series C Preferred Stockholder in favor of the other Series C
      Stockholders.  The Series C Stockholder Agreement was also
      amended to provide that we may not agree to an Exchange Transaction (as
      defined therein) without the prior written consent of the major Series C
      Preferred Stockholder and the prior written consent of holders of a
      majority of the outstanding shares of Series C Preferred held by the other
      Series C Stockholders.




46




·
            On
      January 12, 2009, the Company and Sankaty Advisors, LLC entered into
      Amendment No. 1 to the Amended and Restated Note Purchase Agreement which
      incorporated a minimum payment of $1 million for the fiscal year ending
      June 30, 2009 under an annual sweep of excess cash flow, as defined, and
      increased the amount of permitted annual capital
    expenditures.




·
            On
      March 20, 2009 the Company and Sankaty Advisors, LLC entered into an
      Equity Repurchase Waiver Agreement whereby the Company agreed to a
      prepayment of Senior Notes in the principal amount of $300 in connection
      with the purchase of 3,000,000,000 shares of its common stock from an
      institutional investor for a price of $308 including
    expenses.




Director
Independence





During fiscal 2009, the following
members of our Board of Directors were independent under the relevant
Marketplace Rules of The NASDAQ Stock Market LLC:  Messrs. Ball,
Black, Ketteler, Nolan, Roche and Wedren.  During fiscal year 2009 and
currently the members of the Audit Committee, Messrs. Ball, Ketteler and Wedren,
satisfy both the separate independence requirements of NASDAQ and the SEC for
members of the Audit Committee.  Messrs. Nolan, Roche and Wedren
currently serve on the Compensation Committee.





The Board of Directors did not consider
any transaction, relationship or arrangement not otherwise disclosed above under
the heading “Certain Relationships and Related Transactions” in determining the
independence of Messrs. Ball, Black, Ketteler, Nolan, Roche and
Wedren.





Item 14. Principal Accounting
Fees and Services.





J.H. Cohn
LLP (“JH Cohn”) served as our independent auditors for the fiscal years ended
June 30, 2009 and June 30, 2008.  We have been or will be billed the
fees set forth below in connection with services rendered by the independent
auditors to us:





Fee Category
            
            Fiscal 2009
            
            
            Fiscal 2008Audit
      Fees1
            
            $
            337
            
            
            $
            284Audit-Related
      Fees2
            
            $
            —
            
            
            $
            —Tax
      Fees3
            
            $
            27
            
            
            $
            16All
      Other Fees4
            
            $
            72
            
            
            $
            156TOTAL
            
            $
            436
            
            
            $
            456








1 Audit
fees consisted of fees for the audit of our annual financial statements, review
of quarterly financial statements as well as services normally provided in
connection with statutory and regulatory filings or engagements, comfort
letters, consents and assistance with and review of our documents filed with the
SEC.  This category includes (i) $170 billed by JH Cohn for the audit
of our annual consolidated financial statements for the fiscal year ended June
30, 2008 and the review of our Form 10-K for the fiscal year ended June 30,
2008, $91 by JH Cohn for the reviews of our consolidated financial statements
included in our Forms 10-QSB for the quarters ended September 30, 2007, December
31, 2007 and March 31, 2008 and $22 billed in connection with a Form 8K/A filed
with the SEC and (ii)  $225 billed or to be billed by JH Cohn for
the audit of our annual consolidated financial statements for the fiscal year
ended June 30, 2009 and the review of our Form 10-K for the fiscal year ended
June 30, 2009, $84 billed by JH Cohn for the reviews of our consolidated
financial statements included in our Forms 10-Q for the quarters ended September
30, 2008, December 31, 2008 and March 31, 2009 and $28 billed in connection with
a Form 8K/A filed with the SEC.




2Audit-related
fees consisted of fees for assurance and related services, including primarily
employee benefit plan audits, due diligence related to acquisitions, accounting
consultations in connection with acquisitions, consultation concerning financial
accounting and reporting standards and consultation concerning matters related
to Section 404 of the Sarbanes Oxley Act of 2002.





3Tax fees
consisted primarily of fees for tax compliance, tax advice and tax planning
services.





4Other
than the services described above, the aggregate fees billed for services
rendered by JH Cohn were $72 and $156 for the fiscal years ended June 30, 2009
and 2008. These fees were related to the audits and due diligence services for
acquiring certain business targets.




47




Policy
for Pre-Approval of Audit and Non-Audit Services




The
policy of the Company’s Audit Committee is to pre-approve audit, audit-related,
tax and other permissible services to be performed by the Company’s principal
accountant. The need for pre-approval of any services to be performed by the
principal accountant is considered in setting the agendas for Audit Committee
meetings, and review and approval of proposed fees is undertaken at the Audit
Committee meetings as needed.  In cases where pre-approval of services
is necessary prior to the next scheduled Audit Committee meeting, approval will
be determined by communication with Audit Committee members and documented
through written consents in lieu of meetings.
  The Audit
Committee’s pre-approval policy was implemented as of September 20, 2007, as
required by applicable regulations.


During the fiscal years ended June 30,
2009, 2008 and 2007, all engagements of our independent auditor to perform any
audit services and non-audit services were approved by the Audit Committee in
accordance with its policy to pre-approve all such services to be performed for
us under applicable federal securities regulations.





Part
IV





Item
15.  Exhibits and Financial Statement Schedules





a)
Financial Statements.




The
Financial Statements and Supplementary Data are listed or are presented in Item
8 of this Report on Form 10K.




(b)
Financial Statement Schedules.





(c)
Exhibits.




48




See Index
to Exhibits which appears on Pages 51-56 of this Report on Form
10K.





Exhibit
      No.
            Description
            Location
      (1)2.1
            Asset
      Purchase Agreement dated May 27, 2004, by and between Cyber-Test, Inc., a
      Delaware corporation, and Cyber-Test, Inc., a Florida
      corporation.
            Incorporated
      by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K
      filed with the SEC on June18,
      20042.2
            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, 20072.3
            Stock
      Purchase Agreement entered into by and between Encompass Group Affiliates,
      Inc., a Florida corporation, Encompass Group Affiliates, Inc., a Delaware
      corporation, Tritronics, Inc., Tritronics, LLC and the members of
      Tritronics, LLC listed on Schedule 2 thereto, dated as of August 1,
      2008
            Incorporated
      by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 7, 20083(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, 20073(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
            Incorporated
      by reference to Exhibit 3(i)(b) to the Company’s Annual Report on Form
      10-KSB filed with the SEC on September 28, 20073(i)(c)
            Articles
      of Amendment to the Articles of Incorporation of Advanced Communications
      Technologies, Inc. filed with the Secretary of State of Florida on August
      1, 2008
            Incorporated
      by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 7, 20083(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, 20074.1
            Form
      of Exchange Agreement, dated June 24, 2004, by and among Advanced
      Communications Technologies, Inc. and certain debenture holders of Hy-Tech
      Technology Group, Inc.
            Incorporated
      by reference to Exhibit 10.40 to the Company’s Annual Report on Form
      10-KSB filed with the SEC on November 3, 20044.2
            Form
      of Convertible Promissory Note issued in connection with Exhibit
      2.2
            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




49




4.3.1
            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, 20074.3.2
            Form
      of Senior Note issued in connection with Exhibit 4.3.1
            Incorporated
      by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 21, 20074.3.3
            Form
      of Subordinated Note issued in connection with Exhibit
    4.3.1
            Incorporated
      by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 21, 20074.3.4
            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, 20074.3.5
            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, 20074.4
            Form
      of Subordinated Promissory Note issued in connection with Exhibit
      2.3
            Incorporated
      by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 7, 20084.5.1
            Amended
      and Restated Note Purchase Agreement, dated as of August 1, 2008, by and
      among Encompass Group Affiliates, Inc., a Delaware corporation as Issuer,
      Encompass Group Affiliates, Inc., a Florida corporation, Tritronics, 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 7,
2008




50




4.5.2
            Form
      of Series B Subordinated Note issued in connection with Exhibit
      4.5.1
            Incorporated
      by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 7, 20084.5.3
            Amended
      and Restated First Lien Pledge and Security Agreement, dated as of August
      1, 2008, between Encompass Group Affiliates, Inc., a Delaware corporation,
      Encompass Group Affiliates, Inc., a Florida corporation, Tritronics, Inc.,
      SpectruCell, Inc., Hudson Street Investments, Inc., Cyber-Test, Inc.,
      Vance Baldwin, Inc. and Sankaty Advisors, LLC
            Incorporated
      by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 7, 20084.5.4
            Amended
      and Restated Second Lien Pledge and Security Agreement, dated August 1,
      2008, between Encompass Group Affiliates, Inc., a Delaware corporation,
      Encompass Group Affiliates, Inc., a Florida corporation, Tritronics, 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 7, 20084.5.5
            Amendment
      No. 1 to the Amended and Restated Note Purchase Agreement, dated as of
      August 1, 2008, by and among Encompass Group Affiliates, Inc., a Delaware
      corporation as Issuer, Encompass Group Affiliates, Inc., a Florida
      corporation, Tritronics, 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, dated January
      12, 2009.
            Incorporated
      by reference to Exhibit 4.5.5  to the Company’s Quarterly Report
      on Form 10-Q filed with the SEC on February 13, 200910.1
            Employment
      Agreement, dated June 3, 2004, by and between Cyber-Test, Inc., a Delaware
      corporation, and Lisa Welton.
            Incorporated
      by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K
      filed with the SEC on June 18, 200410.2
            Employment
      Agreement, dated June 3, 2004, by and between Cyber-Test, Inc., a Delaware
      corporation, and Thomas Sutlive.
            Incorporated
      by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K
      filed with the SEC on June 18, 200410.3
            Stockholders
      Agreement by and among Advanced Communications Technologies, Inc., the
      holders of the Series C Convertible Preferred Stock and the holders of the
      Series D Convertible Preferred Stock, dated as of August 17,
      2007
            Incorporated
      by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 21,
2007




51




10.4.1
            Purchase
      Agreement entered into by and among Advanced Communications Technologies,
      Inc., ACT-DE, LLC and the other Buyers identified on Schedule 1 thereto,
      dated as of August 17, 2007
            Incorporated
      by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 21, 200710.4.2
            Registration
      Rights Agreement entered into by and among Advanced Communications
      Technologies, Inc., ACT-DE, LLC and the persons and entities identified on
      Schedule 1 thereto, dated as of August 17, 2007
            Incorporated
      by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 21, 200710.4.3
            Stockholders
      Agreement by and among Advanced Communications Technologies, Inc., ACT-DE,
      LLC and the persons and entities identified on Schedule 1 thereto, dated
      as of August 17, 2007
            Incorporated
      by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 21, 200710.6.1*
            Amended
      and Restated 2005 Stock Plan
            Incorporated
      by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 21, 200710.6.2*
            Form
      of Option Agreement for Executive Officers under the Amended and Restated
      2005 Stock Plan
            Incorporated
      by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 21, 200710.7
            Management
      Agreement entered into by Advanced Communications Technologies, Inc. and
      H.I.G. Capital L.L.C., dated as of August 17, 2007
            Incorporated
      by reference to Exhibit 10.33 to the Company’s Annual Report on Form
      10-KSB filed with the SEC on September 28, 200710.8
            Investment
      Advisory Services Agreement entered into by Advanced Communications
      Technologies, Inc. and H.I.G. Capital L.L.C., dated as of August 17,
      2007
            Incorporated
      by reference to Exhibit 10.34 to the Company’s Annual Report on Form
      10-KSB filed with the SEC on September 28, 200710.9*
            Letter
      Agreement among Wayne I. Danson, Danson Partners LLC and Advanced
      Communications Technologies, Inc. dated as of  August 17,
      2007
            Incorporated
      by reference to Exhibit 10.36 to the Company’s Annual Report on Form
      10-KSB filed with the SEC on September 28, 200710.10*
            Employment
      Agreement between Wayne Danson and Advanced Communications Technologies,
      Inc., dated as of August 17, 2007
            Incorporated
      by reference to Exhibit 10.37 to the Company’s Annual Report on Form
      10-KSB filed with the SEC on September 28, 200710.11*
            Employment
      Agreement between John Donahue and Advanced Communications Technologies,
      Inc. dated as of August 17, 2007
            Incorporated
      by reference to Exhibit 10.38 to the Company’s Annual Report on Form
      10-KSB filed with the SEC on September 28,
2007




52




10.12*
                        Employment
      Agreement between Steven Miller and Advanced Communications Technologies,
      Inc. dated as of August 17, 2007
                        Incorporated
      by reference to Exhibit 10.39 to the Company’s Annual Report on Form
      10-KSB filed with the SEC on September 28, 200710.13*
                        Stock
      Option Agreement between Wayne Danson and Advanced Communications
      Technologies, Inc., dated as of August 17, 2007
                        Filed
      herewith10.14*
                        Stock
      Option Agreement between John Donahue and Advanced Communications
      Technologies, Inc., dated as of August 17, 2007
                        Filed
      herewith10.15*
                        Stock
      Option Agreement between Steven Miller and Advanced Communications
      Technologies, Inc., dated as of August 17, 2007
                        Filed
      herewith10.16
                        Side
      Letter between H.I.G. Capital L.L.C. and Sankaty Advisors, LLC, dated as
      of August 17, 2007
                        Incorporated
      by reference to Exhibit 3(i)(b) to the Company’s Annual Report on Form
      10-KSB filed with the SEC on September 28, 200710.17
                        Stock
      Purchase Agreement entered into by and among Encompass Group Affiliates,
      Inc., ACT-DE, LLC and the persons and entities identified on Schedule 1
      thereto, dated August 1, 2008.
                        Incorporated
      by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 7, 200810.18
                        Amendment
      No. 1 to Stockholder Agreement, among Encompass Group Affiliates, Inc.,
      ACT-DE, LLC, and the persons and entities identified on Schedule 1
      thereto, dated August 1, 2008.
                        Incorporated
      by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K
      filed with the SEC on August 7, 200810.19
                        Spare
      Parts Agreement between Vance Baldwin Electronics, a wholly-owned
      subsidiary of Encompass Group Affiliates, Inc. and Philips Consumer
      Lifestyle North America, a division of Philips Electronics North America
      Corporation, dated July 14, 2008.
                        Filed
      herewith (subject to request for confidential
treatment)10.20
                        Stock
      Purchase Agreement with YA Global Investments, L.P, dated March 23.
      2009
                        Incorporated
      by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K
      filed with the SEC on March 24, 200910.21
                        Equity
      Repurchase Waiver Agreement with Sankaty Advisors LLC, dated March 20,
      2009.
                        Incorporated
      by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form
      10-Q filed with the SEC on May 12, 200910.22*
                        Amendment to Employment
      Agreement between Wayne Danson and Encompass Group Affiliates, Inc., dated
      September 28, 2009, effective as of July
    31, 2009
                        Filed
      herewith10.23*
                        Amendment to Employment
      Agreement between John Donahue and Encompass Group Affiliates, Inc., dated
      September 28, 2009, effective as of July 31, 2009
                        Filed
      herewith10.24*
                        Amendment to Employment
      Agreement between Steven Miller and Encompass Group Affiliates, Inc.,
      dated September 28, 2009, effective as of July 31,
    2009
                        Filed
      herewith




53




14
            Code
      of Business Conduct and Ethics for Advanced Communications Technologies,
      Inc.
            Incorporated
      by reference to Exhibit 14.1 to the Company’s Annual Report on Form 10-KSB
      filed with the SEC on November 3, 200421
            Subsidiaries
      of Advanced Communications Technologies, Inc.
            Filed
      herewith31.1
            Certification
      by Chief Executive Officer pursuant to Sarbanes–Oxley Section
      302
            Filed
      herewith31.2
            Certification
      by Chief Financial Officer pursuant to Sarbanes-Oxley Section
      302
            Filed
      herewith32.1
            Certification
      by Chief Executive Officer pursuant to 18 U.S.C. Section
    1350
            Filed
      herewith32.2
            Certification
      by Chief Financial Officer pursuant to 18 U.S.C. Section
    1350
            Filed
      herewith*
      Management contract or management compensatory plan or
      arrangement.
              (1) In the case of incorporationby
      reference to documents filed by the Company under the Exchange Act, the
      Company’s file number under the Exchange Act is
      000-30486.




54




Signatures




In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this amended report to be signed on its behalf by the undersigned, thereunto
duly authorized.




Encompass
      Group Affiliates, Inc.By:  /s/
      Wayne I.
      DansonName:   Wayne
      I. DansonTitle:     President
      and Chief Executive OfficerDate:     September
      28, 2009


In
accordance with the Exchange Act, this amended report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.




Signature
            
            Title
            
            Date/s/ Wayne I. DansonWayne
      I. Danson
            
            President
      and Chief Executive Officer
              (Principal
      Executive Officer) and Director
            
            September
      28, 2009/s/ John E. DonahueJohn
      E. Donahue
            
            Vice
      President and Chief Financial Officer
              (Principal
      Accounting Officer)
            
            September
      28, 2009/s/ John BlackJohn
      Black
            
            Director
            
            September
      28, 2009/s/ J.G. (Pete) BallJ.G. (Pete) Ball
            
            Director
            
            September
      28, 2009/s/ Thomas R. KettelerThomas
      R. Ketteler
            
            Director
            
            September
      28, 2009/s/ Wilbank J. RocheWilbank
      J. Roche
            
            Director
            
            September
      28, 2009/s/ William J. NolanWilliam
      J. Nolan
            
            Director
            
            September
      28, 2009/s/ Gerald E. WedrenGerald E. Wedren
            
            Director
            
            September
      28, 2009




55




Encompass
Group Affiliates, Inc. And Subsidiaries




Contents





PageF-1
            Report
      of independent registered public accounting firmF-2
            Consolidated
      balance sheets as of June 30, 2009 and 2008F-3
            Consolidated
      statements of operations for the years ended June 30, 2009, 2008 and
      2007F-4
            Consolidated
      statements of changes in stockholders’ equity (deficiency) for the years
      ended June 30, 2009, 2008 and 2007F-5
            Consolidated
      statements of cash flows for the years ended June 30, 2009, 2008 and
      2007F6
      – F-30
            Notes
      to consolidated financial
statements





i





REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors:


Encompass
Group Affiliates, Inc.





We have
audited the accompanying consolidated balance sheets of Encompass Group
Affiliates, Inc. and subsidiaries as of June 30, 2009 and 2008 and the related
consolidated statements of operations, changes in stockholders' equity
(deficiency) and cash flows for each of the years in the three-year period ended
June 30, 2009. These consolidated financial statements are the responsibility of
the Company's management.  Our responsibility is to express an opinion
on these consolidated financial statements based on our audits.





We
conducted our audits in accordance with the auditing standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material   respects,
the   financial   position of Encompass Group
Affiliates, Inc. and subsidiaries as of June 30, 2009 and 2008, and their
results of operations and cash flows for each of the years in the three-year
period ended June 30, 2009 in conformity with accounting principles generally
accepted in the United States of America.





J.H. COHN
LLP


New York,
New York


September
28, 2009




F-1





ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 CONSOLIDATED
BALANCE SHEETS
 (Dollars
in thousands, except per share data)




June
      30,2009
                                      
                                      
                                      2008ASSETSCurrent
      AssetsCash
      and cash equivalents
                                      
                                      $
                                      5,536
                                      
                                      
                                      $
                                      4,008Restricted
      cash
                                      
                                      
                                      1,509
                                      
                                      
                                      
                                      394Accounts
      receivable, net of allowance for doubtful accounts of $441and
      $74 at June 30, 2009 and 2008, respectively
                                      
                                      
                                      9,677
                                      
                                      
                                      
                                      5,908Inventory
                                      
                                      
                                      12,267
                                      
                                      
                                      
                                      3,806Replacement
      parts and equipment
                                      
                                      
                                      297
                                      
                                      
                                      
                                      655Due
      from vendors
                                      
                                      
                                      2,487
                                      
                                      
                                      
                                      1,103Deferred
      tax asset
                                      
                                      
                                      1,400
                                      
                                      
                                      
                                      1,100Prepaid
      expenses and other current assets
                                      
                                      
                                      2,089
                                      
                                      
                                      
                                      870Total
      Current Assets
                                      
                                      
                                      35,262
                                      
                                      
                                      
                                      17,844Property
      and equipment, net
                                      
                                      
                                      1,227
                                      
                                      
                                      
                                      550Other
      AssetsIntangible
      assets, net
                                      
                                      
                                      13,248
                                      
                                      
                                      
                                      9,610Goodwill
                                      
                                      
                                      20,627
                                      
                                      
                                      
                                      14,075Deferred
      tax asset
                                      
                                      
                                      4,170
                                      
                                      
                                      
                                      3,400Other
      assets
                                      
                                      
                                      1,836
                                      
                                      
                                      
                                      1,133Total
      Other Assets
                                      
                                      
                                      39,881
                                      
                                      
                                      
                                      28,218TOTAL
      ASSETS
                                      
                                      $
                                      76,370
                                      
                                      
                                      $
                                      46,612LIABILITIES
      AND STOCKHOLDERS' EQUITYLIABILITIESCurrent
      LiabilitiesAccounts
      payable and accrued expenses
                                      
                                      $
                                      11,766
                                      
                                      
                                      $
                                      8,450Escrow
      liability
                                      
                                      
                                      1,509
                                      
                                      
                                      
                                      394Senior
      notes payable, current portion
                                      
                                      
                                      1,508
                                      
                                      
                                      
                                      507Other
      notes payable, current portion
                                      
                                      
                                      88
                                      
                                      
                                      
                                      34Total
      Current Liabilities
                                      
                                      
                                      14,871
                                      
                                      
                                      
                                      9,385Long
      Term LiabilitiesSenior
      notes payable, net of unamortized original issue discount and less current
      portion
                                      
                                      
                                      9,883
                                      
                                      
                                      
                                      11,649Senior
      subordinated notes payable, net of unamortized original issue
      discount
                                      
                                      
                                      24,636
                                      
                                      
                                      
                                      11,552Convertible
      notes payable
                                      
                                      
                                      1,206
                                      
                                      
                                      
                                      1,206Note
      payable, officer
                                      
                                      
                                      310
                                      
                                      
                                      
                                      310Other notes payable, less current
      portion
                                      
                                      
                                      1,327
                                      
                                      
                                      
                                      42Deferred
      tax liability
                                      
                                      
                                      1,836
                                      
                                      
                                      
                                      —Series
      E preferred stock
                                      
                                      
                                      5,360
                                      
                                      
                                      
                                      —Total
      Long Term Liabilities
                                      
                                      
                                      44,558
                                      
                                      
                                      
                                      24,759TOTAL
      LIABILITIES
                                      
                                      
                                      59,429
                                      
                                      
                                      
                                      34,144COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      EQUITYPreferred
      stock, $.01 par value, 25,000 authorized, 3,000 shares issued and
      outstanding in 2009 for Series C, Series D and Series E and 2,000 in 2008
      for Series C and Series D:Series
      C convertible preferred stock, $.01 par value, 1,000 shares authorized,
      1,000 shares issued and outstanding (liquidation value of $7,713 and
      $6,957 in 2009 and 2008, respectively)
                                      
                                      
                                      —
                                      
                                      
                                      
                                      —Series
      D convertible preferred stock, $.01 par value, 1,000 shares authorized,
      1,000 shares issued and outstanding (liquidation value of $776 and $700 in
      2009 and 2008, respectively)
                                      
                                      
                                      —
                                      
                                      
                                      
                                      —Common
      stock, no par value, 230,000,000,000 shares authorized in 2009 and
      5,000,000,000 in 2008, 13,286,151,000 and 13,489,918,000  shares
      issued and outstanding in 2009 and 2008, respectively
                                      
                                      
                                      36,152
                                      
                                      
                                      
                                      35,350Additional
      paid-in capital
                                      
                                      
                                      9,160
                                      
                                      
                                      
                                      8,347Accumulated
      deficit
                                      
                                      
                                      (28,371
                                      )
                                      
                                      
                                      (31,229
                                      )Total
      Stockholders' Equity
                                      
                                      
                                      16,941
                                      
                                      
                                      
                                      12,468TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                                      
                                      $
                                      76,370
                                      
                                      
                                      $
                                      46,612




See
accompanying notes to consolidated financial statements


F-2




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 (Dollars
in thousands, except per share data)




For
      The Years Ended June 30,2009
            
            
            2008
            
            
            2007NET
      SALES
            
            $
            110,084
            
            
            $
            64,327
            
            
            $
            9,244COST
      OF SALES
            
            
            81,562
            
            
            
            50,543
            
            
            
            6,133GROSS
      PROFIT
            
            
            28,522
            
            
            
            13,784
            
            
            
            3,111OPERATING
      EXPENSESDepreciation
      and amortization
            
            
            2,124
            
            
            
            1,245
            
            
            
            75Selling,
      general and administrative expenses
            
            
            18,563
            
            
            
            10,299
            
            
            
            3,743Asset
      impairment charge
            
            
            —
            
            
            
            —
            
            
            
            400TOTAL
      OPERATING EXPENSES
            
            
            20,687
            
            
            
            11,544
            
            
            
            4,218Income
      (Loss) From Operations
            
            
            7,835
            
            
            
            2,240
            
            
            
            (1,107
            )OTHER
      INCOME (EXPENSE)Other
      income
            
            
            163
            
            
            
            59
            
            
            
            —Interest
      expense, net
            
            
            (6,390
            )
            
            
            (2,752
            )
            
            
            (143
            )TOTAL
      OTHER INCOME (EXPENSE), NET
            
            
            (6,227
            )
            
            
            (2,693
            )
            
            
            (143
            )Income
      (loss)  before income tax benefit
            
            
            1,608
            
            
            
            (453
            )
            
            
            (1,250
            )Income
      tax benefit
            
            
            1,250
            
            
            
            4,500
            
            
            
            —NET
      INCOME (LOSS)
            
            
            2,858
            
            
            
            4,047
            
            
            
            (1,250
            )Deemed
      dividend on  preferred stock
            
            
            —
            
            
            
            (820
            )
            
            
            —Cumulative
      preferred stock dividend
            
            
            (832
            )
            
            
            (723
            )
            
            
            —NET
      INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS
            
            $
            2,026
            
            
            $
            2,504
            
            
            $
            (1,250
            )Basic
      net income (loss) per common share
            
            $
            —
            
            
            $
            —
            
            
            $
            —Basic weighted average number ofcommon sharesoutstanding
            
            
            15,234,964,325
            
            
            
            6,300,625,470
            
            
            
            4,821,987,000Diluted
      net income (loss) per common share
            
            $
            —
            
            
            $
            —
            
            
            $
            —Diluted weighted average number
      ofcommon shares outstanding
            
            
            125,746,338,315
            
            
            
            116,811,998,990
            
            
            
            4,821,987,000




See
accompanying notes to consolidated financial statements
  F-3
 
  ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)
 FOR
THE YEARS ENDED JUNE 30, 2009, 2008 AND 2007
 (Dollars
in thousands)


PREFERRED
                            STOCK
                          
                          
                          COMMON
      STOCK
                          
                          
                          ADDITIONAL
      PAID-IN
                          
                          
                          ACCUMULATEDSHARES
                          
                          
                          AMOUNT
                          
                          
                          SHARES
                          
                          
                          AMOUNT
                          
                          
                          CAPTIAL
                          
                          
                          DEFICIT
                          
                          
                          TOTALBALANCE
      AT JULY 1, 2006
                          
                          
                          —
                          
                          
                          $
                          —
                          
                          
                          
                          4,167,927,000
                          
                          
                          $
                          30,475
                          
                          
                          $
                          1,195
                          
                          
                          $
                          (33,045
                          )
                          
                          $
                          (1,375
                          )Stock
      issued on conversion of Series A preferred stock
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          789,785,000
                          
                          
                          
                          559
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          559Stock
      issued on conversion of Series B preferred stock
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          20,000,000
                          
                          
                          
                          20
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          20Common
      stock issued to officers
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          20,000,000
                          
                          
                          
                          38
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          38Accrued
      distribution of Herborium Inc.'s common shares to
    shareholders
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (161
                          )
                          
                          
                          (161
                          )Beneficial
      conversion feature attributable to Series A-1 preferred
    stock
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          85
                          
                          
                          
                          —
                          
                          
                          
                          85Net
      loss for the year
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (1,250
                          )
                          
                          
                          (1,250
                          )BALANCE
      AT JUNE 30, 2007
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          4,997,712,000
                          
                          
                          
                          31,092
                          
                          
                          
                          1,280
                          
                          
                          
                          (34,456
                          )
                          
                          
                          (2,084
                          )Exchange
      of Series A, Series B and Series A-1 convertible preferred stock for
      Series A-2 convertible preferred stock, resulting in a deemed
      dividend
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (820
                          )
                          
                          
                          (820
                          )Issuance
      of Series C and Series D convertible preferred stock
                          
                          
                          2,000
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          6,443
                          
                          
                          
                          —
                          
                          
                          
                          6,443Reclassification
      of Series A-2 convertible preferred stock from debt  to
      stockholders’ equity
                          
                          
                          8,412
                          
                          
                          
                          4,206
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          4,206Conversion
      of Series A-2 convertible preferred stock into common
stock
                          
                          
                          (8,412
                          )
                          
                          
                          (4,206
                          )
                          
                          
                          8,412,206,000
                          
                          
                          
                          4,206
                          
                          
                          
                          —
                          
                          
                          
                          —Stock-based
      compensation - issuance of common shares to officers
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          80,000,000
                          
                          
                          
                          52
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          52Stock-based
      compensation
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          624
                          
                          
                          
                          
                          
                          
                          
                          624Net
      income for the year
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          4,047
                          
                          
                          
                          4,047BALANCE
      AT JUNE 30, 2008
                          
                          
                          2,000
                          
                          
                          
                          —
                          
                          
                          
                          13,489,918,000
                          
                          
                          
                          35,350
                          
                          
                          
                          8,347
                          
                          
                          
                          (31,229
                          )
                          
                          
                          12,468Issuance
      of common stock
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          2,796,233,000
                          
                          
                          
                          1,119
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          1,119Redemption
      and cancellation of common
                            stock
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (3,000,000,000
                          )
                          
                          
                          (317
                          )
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (317
                          )Stock-based
      compensation
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          813
                          
                          
                          
                          
                          
                          
                          
                          813Net
      income for the year
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          2,858
                          
                          
                          
                          2,858BALANCE
      AT JUNE 30, 2009
                          
                          
                          2,000
                          
                          
                          $
                          —
                          
                          
                          
                          13,286,151,000
                          
                          
                          $
                          36,152
                          
                          
                          $
                          9,160
                          
                          
                          $
                          (28,371
                          )
                          
                          $
                          16,941








F-4




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (Dollars
in thousands)


For
      the Years Ended June 30,2009
                                
                                
                                2008
                                
                                
                                2007CASH
      FLOWS PROVIDED BY OPERATIONS:Net
      income (loss)
                                
                                $
                                2,858
                                
                                
                                $
                                4,047
                                
                                
                                $
                                (1,250
                                )Adjustments
      to reconcile net income (loss) to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                                
                                
                                2,287
                                
                                
                                
                                1,245
                                
                                
                                
                                77Deferred
      income taxes
                                
                                
                                (1,250
                                )
                                
                                
                                (4,500
                                )
                                
                                
                                —Provision
      for doubtful accounts
                                
                                
                                258
                                
                                
                                
                                5Stock-based
      compensation
                                
                                
                                813
                                
                                
                                
                                676
                                
                                
                                
                                38Beneficial
      conversion feature of Series A-1 preferred stock
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                85Asset
      impairment charge
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                400Loss
      on sale of marketable securities
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                5Changes
      in operating assets and liabilities:(Increase)
      decrease in assets:Accounts
      receivable
                                
                                
                                (2,471
                                )
                                
                                
                                315
                                
                                
                                
                                (59
                                )Inventory
                                
                                
                                (6,706
                                )
                                
                                
                                (820
                                )
                                
                                
                                —Replacement
      parts and equipment
                                
                                
                                358
                                
                                
                                
                                (284
                                )
                                
                                
                                43Due
      from vendors
                                
                                
                                (1,089
                                )
                                
                                
                                (337
                                )
                                
                                
                                —Prepaid
      expense and other assets
                                
                                
                                (1,241
                                )
                                
                                
                                (506
                                )
                                
                                
                                20Increase
      in liabilities:Accounts
      payable and accrued expenses
                                
                                
                                2,367
                                
                                
                                
                                311
                                
                                
                                
                                983Net
      cash provided by (used in) operating activities
                                
                                
                                (3,816
                                )
                                
                                
                                152
                                
                                
                                
                                342CASH
      FLOWS USED IN INVESTING ACTIVITIES:Purchase
      of business, net of cash acquired
                                
                                
                                (8,296
                                )
                                
                                
                                (22,321
                                )
                                
                                
                                —Increase
      in acquisition costs
                                
                                
                                (865
                                )
                                
                                
                                (2,769
                                )
                                
                                
                                (176
                                )Purchase
      of property and equipment
                                
                                
                                (871
                                )
                                
                                
                                (238
                                )
                                
                                
                                (108
                                )Funds
      received from PMIC bankruptcy trustee
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                27Decrease
      (increase) in other assets
                                
                                
                                (326
                                )
                                
                                
                                (33
                                )
                                
                                
                                12Net
      cash used in investing activities
                                
                                
                                (10,358
                                )
                                
                                
                                (25,361
                                )
                                
                                
                                (245
                                )CASH
      FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:Principal
      payments on notes payable and capitalized leases
                                
                                
                                (876
                                )
                                
                                
                                (1,026
                                )
                                
                                
                                (349
                                )Redemption
      of common stock
                                
                                
                                (317
                                )Proceeds
      from issuance of preferred stock
                                
                                
                                4,167
                                
                                
                                
                                6,300
                                
                                
                                
                                —Proceeds
      from issuance of senior and subordinated notes
                                
                                
                                13,000
                                
                                
                                
                                24,000
                                
                                
                                
                                —Payment
      of debt and equity issuance costs
                                
                                
                                (272
                                )
                                
                                
                                (901
                                )
                                
                                
                                —Proceeds
      from sale of Series A-1 preferred stock
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                340Net
      cash provided by (used in) financing activities
                                
                                
                                15,702
                                
                                
                                
                                28,373
                                
                                
                                
                                (9
                                )Net
      increase in cash and cash equivalents
                                
                                
                                1,528
                                
                                
                                
                                3,164
                                
                                
                                
                                88Cash
      and cash equivalents at beginning of year
                                
                                
                                4,008
                                
                                
                                
                                844
                                
                                
                                
                                756CASH
      AND CASH EQUIVALENTS AT END OF YEAR
                                
                                $
                                5,536
                                
                                
                                $
                                4,008
                                
                                
                                $
                                844








F-5






ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)




NOTE
1.                      BASIS
OF CONSOLIDATION AND SIGNIFICANT ACCOUNTING POLICIES






Organization




Encompass
Group Affiliates, Inc., a Florida corporation ("we," "us," "our," “Encompass” or
the "Company"), specializes in the technology after­market service and
supply chain known as reverse logistics.  Our wholly-owned
subsidiaries and principal operating units, Encompass Parts Distribution, Inc.
("Encompass Parts"), and Encompass Service Solutions, Inc operates businesses
that provide parts procurement and distribution services, depot repair of
consumer electron­ics, computers and peripheral equipment, de-manufacturing
and reclamation services for flat panel display products,  returns
management services and anticipates providing end-of-life cycle services for all
such products.








We are a
market leader in the consumer electronics segment of the reverse logistics
industry providing original equipment manufacturers (“OEMs”), retailers, third
party administrators (“TPAs”) and end-users with single-source, integrated life
cycle reverse logistic professional management services for technology
products.  Our strategy addresses the overall market from both the
end-user driven product support and repair industry and from the
manufacturer-driven e-Waste recovery industry.  While these two
industries have different characteristics, they have significant back-end
operational synergies.  We are also focused on becoming a full-service
provider of repair, refurbishment, parts distribution and end-of-life cycle
services in other complimentary industries. To that end and to augment our
growth, we intend to continue to acquire additional businesses that either
repair and refurbish equipment or distribute parts typically used in the repair
and refurbishment process, as well as those that provide e-Waste recovery
services. We presently provide single source, value-added life cycle
professional management services for technology products to businesses and
consumers in the North American market, and expect to commence full-scale
operations in Mexico to serve the Latin American and Canadian markets within the
next 60 days.





On August
17, 2007, Encompass Parts completed the acquisition of Vance Baldwin, Inc.
(“Vance Baldwin”), d/b/a Vance Baldwin Electronics, an OEM parts distributor
that has been a leader in the industry for over fifty years.  Vance
Baldwin has operations in southern Florida, suburban Atlanta and Las Vegas and
distributes tens of thousands of different parts (i.e., SKU’s) ranging from
consumer electronics, computers, printers, appliances and office supplies
carried in stock or special ordered from the five million parts that it has
access to for distribution.  In addition, Vance Baldwin provides
service aids and industrial products such as cable, tools, test equipment,
cleaners and other installation equipment.





On July
14, 2008, Vance Baldwin entered into an agreement with Philips Consumer
Lifestyle North America (“Philips”), a division of Philips Electronics North
America Corporation.  Under the terms of the agreement, Vance Baldwin,
as single primary authorized distributor, will assume the management and
execution responsibilities for operational and order fulfillment of the
replacement parts business for Philips’ digital flat panel display
products.  In this role the Company sells replacement parts to
independent service centers as well as other parts distributors with whom it
competes.  Under the terms of this agreement, the Company purchased
approximately $4,200 of inventory directly from Philips.





On August
1, 2008, Encompass Parts completed the acquisition of Tritronics, Inc.,
(“Tritronics”) an OEM parts distributor that has been in business since 1975 and
has operations in suburban Baltimore and Miami.  Tritronics similarly
distributes tens of thousands of different parts (i.e., SKU’s) ranging from
consumer electronics, computers, printers, appliances and office supplies
carried in stock or special ordered from the five million parts that it has
access to for distribution.  In addition, as with Vance Baldwin,
Tritronics also provides service aids and industrial products such as cable,
tools, test equipment, cleaners and other installation
equipment.   Tritronics is a distributor of replacement parts in
the U.S. for substantially all of the major OEM manufacturers, with a
particularly strong market presence selling to the extensive network of
independent service centers that operate nationwide.




F-6




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)




In
addition, Encompass Parts has, since June 2004, owned Cyber-Test, Inc., a
Delaware corporation ("Cyber-Test").  Cyber-Test, dba Encompass
Service Solutions, Inc. (“Encompass Service”), a depot repair and refurbishment
company based in Florida, operates as an independent service organization with
the expertise to provide board-level repair of technical products to third-party
warranty companies, OEMs, national retailers and national office equipment
dealers. Service options include advance exchange, depot repair, call center
support, parts supply and warranty management.  Encompass Service's
technical competency extends from office equipment and fax machines to printers,
scanners, laptop computers, monitors, multi-function units and high-end consumer
elec­tronics such as GPS devices, PDAs and digital cameras and
de-manufacturing and reclamation services for flat-panel display products.
Services are delivered nationwide through proprietary systems that feature
real-time electronic data interchange (“EDI”), flexible analysis tools and
repair tracking.





In
connection with its strategy of expanding internationally, Encompass Parts
Distribution has formed subsidiaries in Mexico and Canada, the operations of
which have not commenced as of June 30, 2009.





Principles
of Consolidation





The
consolidated financial statements include the Company and all of its
wholly-owned subsidiaries.  All significant inter-company transactions
have been eliminated in consolidation.





Use
of Estimates




The
preparation of the 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.




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.




Long-Lived
Assets




Long-lived
assets to be held and used are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable.  If such review indicates that the asset is impaired
when the carrying amount of an asset exceeds the sum of its expected future cash
flows, on an undiscounted basis, the asset’s carrying amount is written down to
fair value.  Long-lived assets to be disposed of are reported at the
lower of carrying amount or fair value, net of disposal costs.





Goodwill
and Intangible Assets





In
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141,
“Business Combinations” (“SFAS No. 141”), the Company allocates the purchase
price of its acquisitions to the tangible assets, liabilities and identifiable
intangible assets acquired based on their estimated fair values.  The
excess purchase price over those fair values is recorded as
“Goodwill”.  Historically, in accordance with SFAS No. 141, the
Company has included transaction costs such as investment banking fees,
accounting fees, legal fees, appraisal fees and Company-incurred direct
out-of-pocket costs as part of the purchase price of its
acquisitions.  As described below in “Recent Accounting
Pronouncements”, under SFAS Statement No. 141(R), effective July 1,
2009,the Company will be required to expense such costs as
incurred.  At June 30, 2009, the Company had $1,111 of deferred
transaction costs which it will be required to write off in the quarter ending
September 30, 2009.




F-7




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)




In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets” (“SFAS No. 144”), purchased intangibles with finite lives are
reviewed for impairment whenever events or changes in circumstances indicate the
carrying value may not be recoverable.  The Company amortizes such
intangible assets on a straight-line basis over their respective useful
lives.  In accordance with SFAS No. 142, “Goodwill and Other
Intangible Assets” (“SFAS No. 142”), goodwill and purchased intangibles with
indefinite lives are not amortized, but are reviewed periodically for
impairment.





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 (average cost
basis) or market, using the first-in, first-out (“FIFO”)method.





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
method.





Management
performs periodic assessments to determine the existence of obsolete,
slow-moving inventory and non-usable replacement parts and equipment and records
necessary provisions to reduce such inventory and replacement parts and
equipment to net realizable value.





Income
(Loss) Per Share




Net
income (loss) per share is computed in accordance with SFAS No. 128,
“Earnings Per Share.”  Basic net income (loss) per share is computed
by dividing income (loss) available to common stockholders by the weighted
average number of common shares outstanding for the period.  Diluted
net income per share is based upon the addition of the effect of common stock
equivalents (convertible preferred stock and convertible notes
payable, potentially dilutive stock options and warrants) to the
denominator of the basic net income per share calculation using the treasury
stock method, if their effect is dilutive. The computation of net income per
share for the fiscal years ended June 30, 2009 and 2008 is as
follows:




Year
      ended June 30, 2009Income
            
            
            Shares
            
            
            Per
      Share AmountBasic
      EPSNet
      income available to common stockholders
            
            $
            2,026
            
            
            
            15,234,964,000
            
            
            $
            —Effect
      of Dilutive SecuritiesConvertible
      preferred stock
            
            
            832
            
            
            
            108,501,131,000Convertible
      notes
            
            
            148
            
            
            
            2,010,243,000Diluted
      EPSNet
      income available to common stockholders
            
            $
            3,006
            
            
            
            125,746,338,000
            
            
            $
            —







Year
      ended June 30, 2008Income
            
            
            Shares
            
            
            Per
      Share AmountBasic
      EPSNet
      income available to common stockholders
            
            $
            2,504
            
            
            
            6,300,625,000
            
            
            $
            —Effect
      of Dilutive SecuritiesConvertible
      preferred stock
            
            
            723
            
            
            
            108,501,131,000Convertible
      notes
            
            
            74
            
            
            
            2,010,243,000Diluted
      EPSNet
      income available to common stockholders
            
            $
            3,301
            
            
            
            116,811,999,000
            
            
            $
            —




F-8




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)




The above
diluted EPS calculations are based on the maximum possible amount of dilutive
shares, which may not actually occur.  Actual results from the
conversion of Series C Preferred may result in the issuance of fewer common
shares if the return, or deemed return, per share of Series C Preferred meets
certain targets (see Note 8).





During
the fiscal year ended June 30, 2007, potentially dilutive securities totalling
5,841,667,000 that could have been issued upon conversion of convertible
preferred stock were excluded from the calculation of diluted loss per share as
their effect would have been anti-dilutive.   There were no
options to purchase shares of common stock outstanding as of June 30,
2007.  At June 30, 2009 and 2008, potentially dilutive securities
attributable to stock option grants totalled 10,923,525,000 and 9,325,409,000
respectively.





Options
to purchase 10,923,525,000 and 9,325,409,000 shares of common stock at $.00075
were outstanding as of June 30, 2009 and 2008, but were not include in the
computation of diluted EPS for the years then ended because the options’
exercise price was greater than the average market price of the common
shares.





Core
Charges




The
vendors of products distributed by the Company frequently add a "core charge" to
the cost of individual replacement parts 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 as cost, but are classified separately in prepaid expenses and
other current assets in the consolidated balance sheets.  Core charges
associated with goods in inventory in the amount of $1,702 and $749 are included
in prepaid expenses and other current assets as of June 30, 2009 and 2008,
respectively.





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.  Upon shipping a returned core to a vendor, the Company
records an asset for the amount due from the vendor.





Property
      and Equipment




Property
and equipment are stated at cost, less 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 yearsFurniture
      and
      fixtures
            5
      to 7 yearsLeasehold
      improvements
            Estimated
      useful life or length of the lease, whichever is
  shorter




F-9




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


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.  Maintenance and
repairs are charged to expense when incurred.




Warranty
Reserve





Refurbished
peripheral computer equipment sold to customers and the repair of customer owned
equipment is guaranteed for a period of ninety days and a period of 12 months
for the repair of circuit boards.  Any defective refurbished equipment
is replaced free of charge and customer owned equipment is repaired without
charge during the warranty period.  Encompass Service Solutions
provides a reserve for warranty repairs based on historical failure rates and
the estimated cost to repair.  During fiscal 2009, 2008 and 2007, the
provision for warranty costs and costs charged against the reserve were as
follows:




2009
                
                
                2008
                
                
                2007Balance
      at beginning of year
                
                $
                86
                
                
                $
                72
                
                
                $
                64Provision
      recorded
                
                
                751
                
                
                
                774
                
                
                
                646Warranty
      costs incurred
                
                
                747
                
                
                
                760
                
                
                
                638Balance
      at end of year
                
                $
                90
                
                
                $
                86
                
                
                $
                72




Fair
Value of Financial Instruments




The
carrying amounts of the Company’s financial instruments including cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities
approximate fair value due to the relatively short period to maturity for these
instruments.  The fair value of the Company’s long-term debt is
estimated based on the rates currently available to the Company for debt of the
same remaining maturities.  The carrying amounts of the Company’s
long-term debt obligations approximate its fair value.




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 and core returns are
accounted for as sales reductions in determining sales in the same period that
the related sales are recorded.  The Company also 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.





Shipping
and Handling Costs





The
Company includes shipping costs, associated with outbound freight, in cost of
sales.  Total shipping costs included in cost of sales for the years
ended June 30, 2009, 2008 and 2007 were approximately $7,336, $4,959 and $1,621,
respectively.




Income
Taxes




The
Company accounts for income taxes under SFAS No. 109, "Accounting for Income
Taxes".  Under SFAS No. 109, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases.  Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled.  Under SFAS No. 109, the effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date.  A valuation allowance
has been used to partially offset the recognition of any deferred tax assets
arising from net operating loss carryforwards due to the uncertainty of future
realization.  The use of any tax loss carryforward benefits may also
be limited as a result of changes in control of Company.




F-10




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


The
amount of income taxes a Company pays is subject to periodic audits by federal
and state tax authorities and these audits may result in proposed deficiency
assessments.   In June 2006, the Financial Accounting Standards
Board (“FASB”) issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an interpretation of SFAS Statement No. 109
(“FIN 48”) which clarifies the accounting for uncertainty in income taxes in an
enterprise’s financial statements in accordance with SFAS
No. 109.  FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition.  The Company
recognizes interest and penalties, if any, related to uncertain tax positions in
income tax expense.  The Company adopted FIN 48 as of July 1,
2007, with no impact on the consolidated financial statements.





The
Company defines the federal jurisdiction as well as various multi-state
jurisdictions as “major” jurisdictions (within the meaning of FIN
48).  The Company is currently undergoing an examination of its
Federal returns for fiscal 2006-2008.





Concentration
of Credit Risk




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.  Certain deposits held with banks may exceed the amount
of insurance provided on such deposits; at June 30, 2009, the amount of deposits
in excess of insurance provided was $520.  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.





Cash,
Cash Equivalents and Restricted Cash




The
Company considers all short-term investments with a maturity date of three
months or less when acquired to be cash equivalents.  Cash equivalents
include commercial paper, money market funds and certain certificates of
deposit.




Restricted cash consists of funds
representing a portion of the purchase price that is held in escrow in
connection with the acquisitions described in Note 3 to satisfy possible
indemnification obligations.




Stock-Based
      Compensation




The fair
value of stock option grants is calculated using the Black-Scholes Option
Pricing Model.  The exercise price of stock options granted is equal
to or greater than fair market value at the date of grant as determined by the
closing price per share.  The Company recognizes compensation expense
for the entire award over the period of vesting.  Performance based
compensation is recorded when the underlying criteria are considered probable of
being met.




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 on a straight-line basis over the
period which services are to be performed or the period of vesting.




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.  As of June 30, 2009 and 2008, $682 and $390,
respectively, of such costs were capitalized, or $433 and $347, respectively,
net of amortization.




F-11




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


Classification
      of Preferred Stock




In
accordance with SFAS No. 150, “Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity” (“SFAS No. 150”) a company is
required to classify preferred stock as a liability rather than as a component
of stockholders’ equity if there is an unconditional obligation requiring the
issuer to redeem it at a specified or determinable date (or dates) or upon the
occurrence of an event that is certain to occur.  The Series E
Certificate of Designation provides for the redemption of all outstanding shares
of Series E Preferred Stock upon, among other events, any refinancing or
repayment in full, redemption or other discharge or satisfaction in full of the
Senior Notes and Series A and Series B Senior Subordinated Notes (Note
7).  As of June 30, 2009, the Company was required to classify its
Series E Preferred Stock as a liability rather than as a component of
stockholders’ equity for this reason, however remote.   Dividends
on the Series E Preferred Stock are included in interest expense since the issue
is classified as a liability rather than equity, with the related liability
included in the preferred stock redemption balance included in long-term
liabilities as of June 30, 2009.




Subsequent
Events




The
Company performed its evaluation of subsequent events through September 28,
2009, the date that these consolidated financial statements were
issued.




Recent
      Accounting Pronouncements




The
Company adopted the provisions of SFAS No. 157 – Fair Value Measurements for its
financial assets and liabilities for which it has recognized or disclosed at
fair value on a recurring basis effective July 1, 2008. In February 2008, the
FASB issued Staff Position (“FSP”) No. 157-2, “Effective Date of FASB No. 157,”which delays the effective date for non-financial assets and
non-financial liabilities to fiscal years beginning after November 15, 2008,
except for items that are measured at fair value in the financial statements on
a recurring basis (at least annually).  As provided by FSP No. 157-2,
the Company has elected to defer the adoption of SFAS No. 157 for certain of its
non-financial assets and non-financial liabilities, primarily goodwill and
intangible assets, until July 1, 2009.  Management does not expect
this pronouncement will have a material impact on the consolidated financial
statements of the Company.





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 years beginning after November 15,
2008.  Management does not expect this pronouncement will have a
material impact on the consolidated financial statements of the
Company.





The FASB
has issued SFAS No. 141 (R), “Business Combinations”. This statement retains the
fundamental requirements in SFAS No. 141 that the acquisition method of
accounting (which Statement No. 141 called the “purchase method”) be used, and
applies to all business entities, including mutual entities that previously used
the pooling of interest method of accounting for some business
combinations.  SFAS No. 141 (R) requires that typical transaction
costs such as investment banking fees, accounting fees, legal fees, appraisal
fees and Company-incurred direct out-of-pocket costs be expensed as incurred and
no longer be effectively accounted for as part of excess purchase price and
intangible assets. The statement is effective for transactions within the annual
reporting period beginning after December 15, 2008; accordingly, management is
evaluating the impact this new standard will have on the Company’s financial
position and results of operations, including the prospective write off of
capitalized transaction costs included in other non-current assets associated
with potential acquisitions in process. At June 30, 2009, such capitalized
transaction costs amount to $1,111.




F-12




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


In April
2009, the FASB issued FSP No. FAS 141(R)-1, “Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from Contingencies” to
amend the provisions SFAS No. 141 (R) for the initial recognition and
measurement, subsequent measurement and accounting, and disclosures for assets
and liabilities arising from contingencies in business combinations. The FSP
eliminates the distinction between contractual and non-contractual
contingencies, including the initial recognition and measurement criteria in
SFAS No. 141 (R) and instead carries forward most of the provisions in SFAS No.
141 for acquired contingencies.  (FSP) No. FAS141(R)-1 is effective
for contingent assets and contingent liabilities acquired in business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning after December 15, 2008. Management
is currently evaluating the impact of this new standard, but the nature and
magnitude of the specific effects will depend upon the nature, term and size of
the acquired contingencies.





In April
2008, the FASB 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 underSFAS No. 142, “Goodwill and Other Intangible Assets”,
and the period of expected cash flows used to measure the fair value of the
asset underSFAS 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 is currently evaluating the
impact this new standard could have on the Company’s financial position and
results of operations.





On June
16, 2008, the FASB issued final Staff Position ("FSP") No. EITF 03-6-1,
"Determining Whether  Instruments Granted in Share-Based Payment
Transactions Are Participating Securities", to address the question
of  whether instruments granted in share-based payment transactions
are participating securities prior to vesting. The FSP determines that unvested
share-based payment awards that contain rights to dividend payments should be
included in earnings per share calculations. The guidance will be effective for
fiscal years beginning after December 15, 2008.  We do not expect the
adoption of this FSP to have a significant impact on our financial position,
results of operations or cash flows.





In
May 2009, the FASB issued SFAS No. 165, Subsequent Events(“SFAS
165”). This standard requires the disclosure of the date through which an entity
has evaluated subsequent events and whether that represents the date the
financial statements were issued or were available to be issued. This standard
is not expected to result in significant changes in the subsequent events that
an entity reports, either through recognition or disclosure, in its financial
statements. The provisions for SFAS 165 were effective for interim or annual
financial periods ending after June 15, 2009, and shall be applied
prospectively. The Company adopted this standard on June 30, 2009, and the
impact of the adoption was not significant.





In June
2009, FASB issued SFAS No. 167, Amendments to FASB Interpretation
No. 46 (R)(“SFAS 167”).  SFAS 167 amends FASB’s Interpretation
(FIN) No. 46(R) , Consolidation of Variable Interest
Entities, mainly to (1) require an enterprise to conduct a qualitative
analysis for the purpose of determining whether, based on its variable
interests, it also has a controlling interest in a variable interest entity
(VIE), and (2) make the consequential changes resulting from elimination of the
concept of a qualifying special-purpose entity (QSPE) in SFAS No. 140 , Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, thus
subjecting an entity previously designated as a QSPE to the same evaluation as
that of any other VIE for consolidation purposes. Amended FIN No. 46(R) is
effective as of the start of the first annual reporting period beginning after
November 15, 2009, for interim periods within the first annual reporting period,
and for all subsequent annual and interim reporting periods. Earlier application
is not permitted, but retrospective application to previously issued financial
statements for previous years is allowed but, not required.  We do not
expect the adoption of SFAS 167 to have a significant impact on our financial
position, results of operations or cash flows.




F-13




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)




In June
2009, FASB issued SFAS No. 168, The FASB Codification and the
Hierarchy of Generally Accepted Accounting Principles (“SFAS 168” or
“Codification”).  When it becomes effective for financial statements
covering periods ending after September 15, 2009, the Codification will be the
single source of authoritative U.S. GAAP applicable to all non-governmental
entities and will supersede all existing FASB, AICPA, and Emerging Issues Task
Force (EITF) pronouncements and related literature (i.e. all codified literature
will carry the same level of authority and non-codified GAAP literature will
become non-authoritative). The Codification will also
include relevant portions of authoritative SEC content relating to matters
within the basic financial statements, which are considered as sources of
authoritative GAAP for SEC registrants.  As of July 1, 2009, the FASB
no longer issues Statements, Interpretations, Staff Positions, or EITF
abstracts.  Irrespective of how they would have been issued under the
previous structure, all changes to GAAP will henceforth be only in the form of
Accounting Standards Updates, which will serve to update the Codification itself. When the
Codification becomes
effective, SFAS No. 162, The
Hierarchy of Generally Accepted Accounting Principles, will be rendered
irrelevant to give effect to the new GAAP hierarchy established in the Codification.  SFAS 168
is effective for our fiscal quarter beginning July 1, 2009.  Other than
modifications to the currently required disclosures, we do not expect the
adoption of SFAS 168 to have a significant impact on our financial position,
results of operations or cash flows.




NOTE
2.                      PROPERTY AND
EQUIPMENT




The
following is a summary of property and equipment as of June 30, 2009 and
2008:





2009
            
            
            2008Computer,
      office equipment and fixtures
            
            $
            1,562
            
            
            $
            546Machinery
      and equipment
            
            
            292
            
            
            
            256Leasehold
      improvements
            
            
            178
            
            
            
            1142,032
            
            
            
            916Less:    Accumulated
      depreciation
            
            
            805
            
            
            
            366Property
      and equipment, net
            
            $
            1,227
            
            
            $
            550




Depreciation expense for the years
ended June 30, 2009, 2008 and 2007 was $443, $197 and $75,
respectively.




NOTE
3.RECAPITALIZATION;
ACQUISITION OF VANCE BALDWIN, INC. AND TRITRONICS,
INC.




On August
17, 2007 (the “Recapitalization 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 $27,900 (including
transaction costs), the completion of a significant preferred stock issuance of
$6,300, the issuance of $23,400 in senior and subordinated notes and the
settlement of substantially all of the Company’s notes payable, accounts payable
and accrued expenses.  On the Recapitalization 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
substantial distribution facilities in Lawrenceville, Georgia, complements the
business and operations offered by Cyber-Test and significantly expands the
Company’s presence in the reverse logistics business.  Results of
operations include Vance Baldwin since the Recapitalization Date.




F-14




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


Consideration
consisted of the following:  (i) $23,921 in cash, $750 of which was
placed into an escrow account to serve as a source of funds to satisfy any
indemnification obligations under the VB Purchase Agreement, (ii) 312.50 shares
of the Company’s newly designated Series D Convertible Preferred Stock, par
value $0.01 per share (“Series D Preferred”), and a convertible promissory note
in the amount of $1,000.  The convertible note accrues interest at the
rate of 7% per annum, payable semi-annually, in arrears, on each January 30 and
July 30, and is due and payable on October 17, 2012  to the extent the
holder has not exercised its conversion rights thereunder.  The fair
value of the Series D Convertible Preferred Stock was determined based on the
implicit value of the Series C Convertible Preferred Stock based on the ratio of
the amount received for the sale of shares of such issue to the equity interest
sold.





On August
1, 2008 (the “Acquisition Date”), the Company acquired all of the outstanding
equity interests in Tritronics, Inc., a privately-held Maryland C corporation
engaged in the distribution of replacement parts and accessories for consumer
electronics products (“Tritronics”).  Management believes that the
business and operations of Tritronics, which has its headquarters and principal
facility in Abingdon, Maryland and a second facility in Miami, Florida,
complements the business and operations offered by the Company’s two current
operating subsidiaries, Cyber-Test and Vance Baldwin
Electronics.  Tritronics sales for the fiscal year ended April 30,
2008 amounted to $21,983.  The results of operations include
Tritronics since the Acquisition date.





Consideration
consisted of the following: (i) $9,000 in cash less seller transaction expenses
and certain indebtedness, $1,500 of which was placed in an escrow account to
satisfy any indemnification obligations under the Tritronics Purchase Agreement,
(ii) a subordinated promissory note in the amount of $1,000 (the “Tritronics
Note”) and (iii) 2,796,232,989 shares of the Company’s common stock for an
aggregate purchase price of $11,068, before transaction costs.  The
Tritronics Note will accrue interest at the rate of 7% per annum, payable
semi-annually, in arrears, on each January 31 and July 31. The outstanding
principal balance under the Tritronics Note and any accrued but unpaid interest
thereon is due and payable on August 1, 2014 (subject to extension under certain
circumstances if the Company’s senior indebtedness is not paid in full as of
August 1, 2014).





The
purchase prices of the acquisitions are set forth below:





Vance
      Baldwin
            
            
            TritronicsCash
      paid to seller
            
            $
            23,921
            
            
            $
            8,949Issuance
      of Series D convertible preferred stock to seller
            
            
            198
            
            
            
            —Issuance
      of common stock to seller
            
            
            —
            
            
            
            1,119Issuance
      of convertible note to seller
            
            
            1,000
            
            
            
            —Issuance
      of note to seller
            
            
            —
            
            
            
            1,000Total
      consideration paid to seller
            
            
            25,119
            
            
            
            11,068Additional
      cash paid for transaction costs
            
            
            2,769
            
            
            
            865Total
      purchase price
            
            
            27,888
            
            
            
            11,933Less:
      noncash item of issuance of Series D convertible preferred stock to
      seller
            
            
            (198
            )
            
            
            —Less:
      noncash item of issuance of stock to seller
            
            
            —
            
            
            
            (1,119
            )Less:
      noncash item of note issued to seller
            
            
            (1,000
            )
            
            
            (1,000
            )Less:
      cash acquired in the acquisition
            
            
            (1,600
            )
            
            
            (653
            )Net
      cash paid for acquisition
            
            $
            25,090
            
            
            $
            9,161





The
allocations of the total purchase price considerations of the assets acquired
and liabilities assumed are based upon appraisals of the fair market value of
the acquired assets and liabilities assumed in accordance with FAS
141.  The businesses acquired are recognized leaders in its industry,
have had long-term relationships with major vendors and customers, histories of
increasing levels of annual sales and earnings, and introduce a number of
favorable strategic opportunities to the Company; accordingly, the Company
believes that the excess of purchase price over net assets acquired in both
acquisitions is justified.




F-15




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


The fair
value of the a ssets
acquired and liabilities assumed is set forth below:




Vance
      Baldwin
            
            
            TritronicsAssets
      acquired:Current
      assets
            
            $
            11,349
            
            
            $
            4,360Property
      and equipment
            
            
            247
            
            
            
            248Intangible
      assets
            
            
            10,580
            
            
            
            5,170Long-term
      assets
            
            
            37
            
            
            
            17Total
      assets acquired
            
            
            22,213
            
            
            
            9,795Liabilities
      assumed:Current
      liabilities
            
            
            5,712
            
            
            
            2,352Deferred
      tax liability
            
            
            —
            
            
            
            2,016Non-current
      liabilities
            
            
            63
            
            
            
            47Total
      liabilities assumed
            
            
            5,775
            
            
            
            4,415Net
      identifiable assets acquired
            
            
            16,438
            
            
            
            5,380Costs
      in excess of net identifiable assets acquired (recorded
      goodwill)
            
            
            11,450
            
            
            
            6,553Total
      fair value of net identifiable assets acquired and
goodwill
            
            $
            27,888
            
            
            $
            11,933




Intangible
assets principally consist of customer lists which are being amortized over a
ten year period, which is evaluated annually.  The Company, based on
its annual assessment of customer attrition rates, records amortization on a
straight-line basis .  Goodwill and intangible assets arising from the
acquisition of Vance Baldwin are deductible for income tax purposes; however,
goodwill and intangible assets arising from the acquisition of Tritronics are
not deductible for income tax purposes.





The following unaudited pro forma
financial information presents the results of operations of the Company as if
the acquisitions had occurred at the beginning of fiscal 2009 and fiscal
2008.  Adjustments to the financial information related to the
acquisition that affect the results of operations include the increase on cost
of sales from the fair valuation of inventory acquired, 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 unaudited pro forma
information does not purport to be indicative of what would have occurred had
the acquisitions occurred as of July 1, 2009 and 2008 or of results of
operations that may occur in the future.




For
      the year ended
              June
      30,2009
            
            
            2008(unaudited)
            
            
            (unaudited)Net
      sales
            
            $
            111,974
            
            
            $
            92,417Operating
      income
            
            
            7,975
            
            
            
            4,492Net
      income
            
            
            2,691
            
            
            
            1,128Net
      income (loss) basic and diluted per common share
            
            $
            0.00
            
            
            $
            0.00




NOTE
4.                      GOODWILL
AND INTANGIBLE ASSETS




Goodwill
and intangible assets consisted of the following:





June
      30, 2009
                  
                  
                  June
      30, 2008Goodwill
                  
                  $
                  20,627
                  
                  
                  $
                  14,075Intangible
      assets, primarily consisting of customer lists
                  
                  $
                  15,750
                  
                  
                  $
                  10,580Less
      accumulated amortization
                  
                  
                  (2,502
                  )
                  
                  
                  (970
                  )Total
      net intangible assets
                  
                  $
                  13,248
                  
                  
                  $
                  9,610




F-16




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


Amortization
expense for intangible assets, which are being amortized over 10 years based on
the straight line method (which approximates the period in which the economic
benefits are consumed), amounted to $1,532 and $970 for the years ended June 30,
2009 and June 30, 2008.  Based on the carrying value of intangible
assets as of June 30, 2009, amortization expense for the next five fiscal years
will amount to the following:


For
      the year ending
                June
      30, 2010
                $1,575June
      30, 2011
                $1,575June
      30, 2012
                $1,575June
      30, 2013
                $1,575June
      30, 2014
                $1,575




NOTE
5.                      DEFERRED
ACQUISITION COSTS




The
Company has incurred and deferred certain legal, accounting, advisory and
consulting costs relating to acquiring certain targeted
businesses.  Upon the closing of an acquisition, such deferred costs
are included with the purchase price in determining the total cost of acquiring
the assets or capital stock of the acquired business.  As of June 30,
2009 and 2008, $1,111 and $617, respectively, of these deferred costs relating
to active potential acquisitions ongoing at each date have been deferred by the
Company and included in other assets.  As described in Note 1, the
Company will be required to write off such deferred transaction costs in the
quarter ending September 30, 2009.




NOTE
6.                      ASSET
IMPAIRMENT




On May
27, 2004, Encompass entered into an Agreement with Hy-Tech Technology Group, Inc
and Hy-Tech Computer Systems, Inc (collectively “Hy-Tech”) to license and use on
an exclusive, worldwide, royalty-free, perpetual, non-terminable and irrevocable
right basis, various intangible assets of Hy-Tech including its customer lists
and corporate web addresses.  The Company originally recorded $400 for
these licensed intangibles.  During the year ended June 30, 2007,
these intangible assets were tested for impairment and, as a result of a
determination that these assets were impaired, an impairment charge in the
amount of $400 was recorded in fiscal 2007.  There was no impairment
charge recorded in fiscal 2009 or 2008.







NOTE
7.                      NOTES
PAYABLE AND CAPITAL LEASE OBLIGATIONS




Notes
payable and capital lease obligations consist of the following at June 30, 2009
and 2008:




2009
            
            
            2008Note
      payable to officer
            
            $
            310
            
            
            $
            310Senior
      notes (net of unamortized discount   of $112 and $154,
      respectively)
            
            
            11,391
            
            
            
            12,156Senior
      subordinated notes (net of unamortized   discount of $364
      and $183, respectively)
            
            
            24,636
            
            
            
            11,552Convertible
      notes
            
            
            1,206
            
            
            
            1,206Other
      notes payable
            
            
            1,415
            
            
            
            7638,958
            
            
            
            25,300Total
      notes payable and capital lease obligations Less: current
      portion
            
            
            (1,596
            )
            
            
            (541
            )Notes
      payable and capital lease obligations,  less current
      portion
            
            $
            37,362
            
            
            $
            24,759




F-17




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


Recapitalization
and Acquisition of Vance Baldwin




In
connection with the recapitalization effective August 17, 2007 described in
Note 3 and below,
substantially all of the then outstanding notes payable and related accrued
interest were satisfied in full as of that date.




The
Company entered intoan unsecured note with a
consulting company controlled by its Chief Executive Officer to pay the
consulting company $310, plus interest accruing at the rate of 7% per annum,
upon the earlier of a change of control of the Company or the six-year
anniversary of the closing of the transactions described herein, for unpaid
compensation under a now-terminated consulting agreement.  Our Chief
Executive Officer also agreed to restructure a potential $250 bonus until such
time as the Company satisfies certain milestones as described in his employment
agreement.




On the
Recapitalization Date, the Company entered into a Note Purchase Agreement with
Sankaty Advisors, LLC (“Sankaty”).  Pursuant to the Note Purchase
Agreement, the Company issued $12,690 in aggregate principal amount of Senior
Notes for an aggregate purchase price of $12,500 and $10,714 in aggregate
principal amount of Subordinated Notes for an aggregate purchase price of
$10,500.  The aggregate discount of $405, or $259 net of accumulated
amortization as of June 30, 2009, is being amortized using the interest method
over the terms of the notes.  Net proceeds amounted to $22,609 after
related transaction expenses of $391, which is being amortized using the
interest method over the terms of the notes. Under the Note Purchase Agreement,
the Company is required to meet a Minimum Fixed Charge Coverage Ratio, a Maximum
Total Leverage Ratio and a Minimum Adjusted EBITDA level, as
defined.   Further, the Company is subject to an annual Excess
Cash Flow Sweep whereby it is required to apply an amount equal to 50% of Excess
Cash Flow (as defined) to the prepayment of Senior Notes.  The defined
Excess Cash Flow formula did not require an amount to be paid for the year ended
June 30, 2009; however, a $1,000 payment will be paid within 90 days of June 30,
2009, in accordance with provisions of the First Amendment to the Amended and
Restated Note Purchase Agreement entered into on January 12, 2009.





The
Senior Notes bear interest at LIBOR, with a 2.5% floor, plus 3.75%, per annum
payable quarterly, in arrears, and have a five-year term through August 17, 2012
(the “Maturity Date”). As of June 30, 2009, the interest rate for the Senior
Notes was 6.25%.  They are repayable in consecutive quarterly
installments of 1% of the original principal amount, or approximately $127,
through August 17, 2012.  At the Maturity Date the remaining principal
amount and any unpaid and accrued interest on the Senior Notes shall be due. The
Company is required to prepay the Senior Notes from any new equity or debt
financing, certain excess cash flow or the cash proceeds of asset sales and
casualty events, subject to stipulated exceptions. The Company may redeem the
Senior Notes at any time, subject to a redemption premium, as
defined.  The Senior Notes are secured by a first priority security
interest in the assets of the Company and its subsidiaries and are guaranteed by
the direct or indirect wholly-owned subsidiaries of the Company.





The
Subordinated Notes bear interest, payable quarterly, in arrears, at 13% per
annum, plus an increment of up to 4% based on a Maximum Total Leverage Ratio
financial covenant.  The Subordinated Notes have a six-year term
through August 17, 2013.  The Company may redeem the Subordinated
Notes only following repayment of the Senior Notes in full, subject to a
redemption premium, as defined.  The Subordinated Notes are secured by
a second priority security interest in the assets of the Company and its
subsidiaries and are guaranteed by the direct or indirect wholly-owned
subsidiaries of the Company.  Interest, including the increment, was
payable at 17% through June 30, 2009; effective July 1, 2009, interest,
including the increment, is payable at 15% based on the then effective Leverage
Ratio (as defined).





Under the
Note Purchase Agreement, the Company was able to borrow up to $2,500 from
Sankaty 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 in principal amount of Senior
Subordinated Notes for a purchase price of $1,000 under the terms described
above for Senior Subordinated Notes.  No further borrowings are
available under this line of credit.




F-18




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


Also on
the Recapitalization Date, the Company issued an unsecured convertible
promissory notes in the amount of $1,000 to the seller and $206 to a
creditor.  The notes accrue interest at the rate of 7% per annum,
payable semi-annually, in arrears, on each January 30 and July 30, and are due
and payable on October 17, 2012 to the extent the holders have not exercised
their conversion rights thereunder.





Acquisition
of Tritronics





In
connection with the acquisition of Tritronics on August 1, 2008, the Company
amended and restated the Note Purchase Agreement entered into on August 17, 2007
(the “Amended and Restated Note Purchase Agreement”) with Sankaty Advisors, LLC
(“Sankaty”).  Pursuant to the Note Purchase Agreement, the Company
previously issued $12,690 in aggregate principal amount of its Senior Notes for
an aggregate purchase price of $12,500 and $10,714 in aggregate principal amount
of Series A senior subordinated notes for an aggregate purchase price of $10,500
(the “Series A Subordinated Notes”).  Pursuant to the Amended and
Restated Note Purchase Agreement, the Company issued an additional $13,265 in
aggregate principal amount of its Series B senior subordinated notes for an
aggregate purchase price of $13,000 (the “Series B Subordinated Notes” and,
collectively with the Series A Subordinated Notes, the “Subordinated
Notes”).  The aggregate discount of $265, or $217 net of accumulated
amortization as of June 30, 2009, is being amortized using the interest method
over the terms of the notes.  Net proceeds amounted to $12,869 after
related transaction expenses of $141, which is being amortized using the
interest method over the terms of the notes. Certain affiliates of Sankaty
Advisors, LLC are holders of the Company’s Series C and Series E Preferred
Stock.





With
regards to the Senior Notes, the terms of the Amended and Restated Note Purchase
Agreement are substantially similar to those in the August 17, 2007 Note
Purchase Agreement.





The
Series B Subordinated Notes have an additional 2% prepayment penalty compared to
the Series A Subordinated Notes through maturity.  In certain circumstances
in which Note Purchasers are not provided with rights of first refusal and
rights of first offer (as described below), including in connection with a
prepayment of the Series A Subordinated Notes within 18 months of August 17,
2007 that occurs in connection with a purchase of a potential acquisition
target, the Subordinated Notes may also be subject to a 10% redemption
premium.





If, on
August 1, 2009, the Senior Notes and Subordinated Notes have not been repaid or
refinanced and the debt to EBITDA leverage ratio for the twelve months prior to
August 1, 2009 exceeds 3.50:1, the Note Purchasers will be entitled to receive
warrants, for no or nominal additional consideration, to purchase 3.5% of the
shares of the Company’s outstanding common stock on a fully diluted basis; the
ratio was not exceeded.  If, on each of February 1, 2010 and August 1,
2010, the Senior Notes and Subordinated Notes have not been repaid or refinanced
and the debt to EBITDA leverage ratio for the twelve month period prior to
February 1, 2010 or August 1, 2010, as applicable, exceeds 3.50:1, the Note
Purchasers will be entitled to receive on each such date, for no or nominal
additional consideration, warrants to purchase 5.5% and 7.5% (in each case minus
the percentage of warrants previously issued to the Note Purchasers pursuant to
this provision) of the shares of the Company’s outstanding common stock on a
fully diluted basis (the “Warrants”) on each such date.  The Warrants
expire on the first anniversary of their issuance, have anti-dilution
protections and benefit from other customary protections.





Under the
terms of the Senior Notes and the Subordinated Notes, the Company is permitted
to incur purchase money secured indebtedness to suppliers of up to certain
agreed amounts. The Company is not permitted to pay any dividends or
distributions, and is not permitted to redeem any capital stock.





Under
certain circumstances, holders of the Senior Notes and the Subordinated Notes
have a right of first refusal and first offer to purchase debt securities and
certain types of preferred stock in connection with the financing of additional
acquisitions by the Company.




F-19




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


On
January 12, 2009, the Company and Sankaty Advisors, LLC entered into Amendment
No. 1 to the Amended and Restated Note Purchase Agreement which incorporated a
minimum payment of $1 million for the fiscal year ended June 30, 2009 under an
annual sweep of excess cash flow, as defined, and increased the amount of
permitted annual capital expenditures.





As
described in Note 8, on March 20, 2009 the Company entered into an Equity
Repurchase Waiver Agreement with Sankaty whereby it agreed to a prepayment of
Senior Notes in the principal amount of $300.





The
future minimum scheduled maturities of notes payable for each of the next five
years are as follows:





Year
      ending June 30,
            2010
            
            $
            1,5962011
            
            
            6112012
            
            
            5712013
            
            
            10,1642014
            
            
            25,016Thereafter
            
            
            1,000







NOTE
8.                      PREFERRED
STOCK




Series
C and Series D Convertible Preferred Stock




On August
17, 2007, the Company sold 1,000 shares of its newly designated Series C
Convertible Preferred Stock, having a par value of $0.01 per share (“Series C
Preferred”), for an aggregate purchase price of $6,300 in immediately available
funds, net proceeds of $5,809 after related transaction expenses of $491, to
certain accredited investors, principally including ACT-DE, LLC, an affiliate of
H.I.G. Capital, LLC (“HIG”), pursuant to a Purchase Agreement.  Also
on that date, the Company and the holders of the Series C Preferred entered into
a Registration Rights Agreement and a Stockholders Agreement.  HIG and
certain other holders have certain demand registration rights with respect to
shares of common stock that it may hold, subject to certain limitations, and HIG
and certain other stockholders, including the holders of Series D Preferred,
have piggy-back registration rights with respect to shares of common stock that
they may hold.  The Series C Preferred rank senior to the common stock
and all other currently designated series of preferred stock of the Company
(with the exception of Series E Preferred issued in August 2008).





Pursuant
to the formula for determining the Series C Conversion Rate set forth in the
Certificate of Designation for the Series C Preferred, the holders of the Series
C Preferred, in the aggregate, will be entitled to receive shares of common
stock equal to 79.5% of common stock on a fully diluted basis except for
dilution for stock options issued to management as described in Note 9 (the “Outstanding
Amount”).  This conversion rate will be subject to adjustment downward
to a floor of 72.5% if the return, or deemed return, per share of Series C
Preferred meets certain targets.  These ranges could change if there
are new issuances of convertible preferred and common stock, excluding stock
options exercised.





The
Series D Preferred Stock, having a par value of $0.01 per share (“Series D
Preferred”), issued in the amount of $634 rank senior to the common stock and
all other currently designated series of preferred stock of the Company with the
exception of the Series C Preferred and the subsequently issued Series E
Preferred.  Pursuant to the formula for determining the Series D
Conversion Rate as set forth in the Certificate of Designation for the Series D
Preferred, the holders of the Series D Preferred, in the aggregate, will be
entitled to receive shares of common stock equal to 8% of the Outstanding
Amount.  This interest could change if there were new issuances of
equity, excluding current stock options granted.  The shares of Series
D Preferred are convertible into a fixed amount of shares of common stock at the
Series D Conversion Rate, subject to certain limitations during a two-year
period.





Dividends
on the Series C and Series D Preferred, which accrue cumulatively at the rate of
12%, are only payable upon a sale of assets, merger, liquidation, dissolution or
winding up of the Company.  The right to such will extinguish upon
conversion of the Series C and Series D Preferred.  As of June 30,
2009, cumulative, undeclared dividends, accrued but not recorded amounted to
$1,413 and $142 for the Series C and Series D Preferred, respectively, or $1,413
and $142 per share, respectively.  As of June 30, 2008, cumulative,
undeclared dividends, accrued but not recorded amounted to $657 and $66 for the
Series C and Series D Preferred, respectively, or $657 and $66 per share,
respectively.




F-20




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


Series
E Preferred Stock




On August
1, 2008, in connection with the financing of the Tritronics acquisition, the
Company sold 1,000 shares of its newly designated Series E Preferred Stock,
having a par value of $0.01 per share (“Series E Preferred”), for an aggregate
purchase price of $4,167, net proceeds of $4,036 after related transaction costs
of $131, to the holders of Series C Preferred pursuant to a Purchase Agreement
(the “Series E Purchase Agreement”). The Company used the proceeds from the sale
of the Series E Preferred Stock, in conjunction with the debt proceeds described
above, to fund the acquisition of Tritronics and for working capital needs
related to an agreement entered into with Philips.





The
holders of Series E Preferred have agreed that in the event that (i) the Board
of Directors of the Company, (ii) an independent committee comprised of
disinterested members of the Board of Directors of the Company and (iii) a
majority of the holders of the Series E Preferred agree to convert or redeem or
refinance the Series E Preferred, then each holder of the Series E Preferred
shall enter into such transaction.





The
Series E Preferred ranks senior to the common stock and all other currently
designated series of preferred stock of the Company.  Dividends shall
accrue cumulatively on a daily basis on the Series E Base Amount (as defined
below) for each share of Series E Preferred at a rate per annum of 20% until
February 28, 2010 and 30% thereafter.  Dividends shall accrue from the
date of issuance through the date of redemption, liquidation, dissolution or
winding up of the Company.  The Series E Preferred is not convertible
into the Company’s common stock.  So long as any shares of Series E
Preferred are outstanding, no dividends may be paid or distributions made on the
common stock or any class of preferred stock ranking junior to the Series E
Preferred (collectively, “Junior Stock”) until all accrued but unpaid dividends,
if any, on the Series E Preferred have been paid, unless:





·
            the
      Company obtains the written consent of the holders of a majority of the
      outstanding shares of the Series E Preferred; or·
            the
      Company is a party to an agreement with any officer, employee or director
      of the Company pursuant to which the Company is entitled or required to
      repurchase shares of common stock or any preferred stock (or options
      therefore) from such officer, employee or
  director.





At the
option of the board of directors, the Company may, at any time, redeem all but
not less than all of the Series E Preferred by paying to the holders of the
Series E Preferred in cash an amount equal to the Series E Redemption
Value.  In addition, the Company must redeem all of the outstanding
Series E Preferred upon the (i) consolidation or merger of the Company with or
into any other person or entity in which less than a majority of the outstanding
voting power of the surviving entity is held by persons who were shareholders of
the Company prior to the event or (ii) refinancing, repayment, redemption or
other discharge in full of the Company’s senior notes and subordinated notes
issued pursuant to the Amended and Restated Note Purchase Agreement which the
Company entered into in connection with the Acquisition (each a “Mandatory
Redemption Event”).  Upon a Mandatory Redemption Event, the holders of
the Series E Preferred will be entitled to be paid the Series E Redemption
Value. Holders of the Series E Preferred have priority in respect of any payment
or distribution of the assets of the Company, or proceeds therefrom, to the
holders of shares of any Junior Stock.





The
“Series E Redemption Value” means a payment per share equal to (i) $4,167 per
share (the “Series E Base Amount”) plus all accrued and unpaid dividends thereon
multiplied by (ii) the Redemption Percentage.  The “Redemption
Percentage” shall be (i) 100% until July 31, 2009, (ii) 105% from August 1, 2009
until February 28, 2010 and (iii) 110% from March 1, 2010 until July 31, 2010.
The Redemption Percentage shall increase by another 5% each March 1 and August 1
thereafter.  By way of example, the Redemption Percentage will
increase to 115% on August 1, 2010 and 120% on March 1, 2011.




F-21




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


The
holders of Series E Preferred are not entitled to any voting
rights.  However, the consent of the holders of at least a majority of
the outstanding shares of Series E Preferred, voting as a class, will be
required for certain corporate actions, as defined.





On August
1, 2008, in connection with the financing of the Tritronics acquisition, the
Company and the holders of Series C Preferred entered into Amendment No. 1 to
the Stockholder Agreement, dated August 17, 2007 (the “Amended Series C
Stockholder Agreement”) originally entered into between such
parties.  Pursuant to the amendment, the shares of Series E Preferred
issued to holders of Series C Preferred are subject to the Series C Stockholder
Agreement, including for purposes of transfer restrictions as well as co-sale
rights on sales of preferred stock by the major Series C Preferred Stockholder
in favor of the other Series C Stockholders.  The Series C Stockholder
Agreement was also amended to provide that the Company may not agree to an
Exchange Transaction (as defined therein) without the prior written consent of
the major Series C Preferred Stockholder and the prior written consent of
holders of a majority of the outstanding shares of Series C Preferred held by
the other Series C Stockholders.




In
accordance with SFAS No. 150, the Company is required to classify the Series E
Preferred as a liability rather than as a component of stockholders’ equity,
and, accordingly, dividends thereon are classified as interest expense on the
consolidated statement of operations.   Total incurred and unpaid
interest expense for the year ended June 30, 2009, which includes the
amortization of the aforementioned redemption premium, amounted to
$1,193.  The average interest rate of 31.2% for the year ended June
30, 2009 included an average dividend rate of 26.5% and average redemption
premium rate of 4.7% based on an assumed redemption date of August 17,
2013.




Recapitalization





Also on
August 17, 2007, the Company entered into a series of transactions with the
holders of the Company’s Series A Convertible Preferred Stock, Series A-1
Convertible Preferred Stock, Series B Convertible Preferred Stock and certain
trade creditors and note holders of the Company (the “Creditors”) pursuant to
which the following transactions were effected:  (i) the holders of
the Series A Preferred, the Series A-1 Preferred and Series B Preferred
exchanged such preferred stock for (a) an aggregate of 8,412.21 shares of the
Company’s newly designated Series A-2 Convertible Preferred Stock, par value
$0.01 per share (the “Series A-2 Preferred”) valued at $4.1 million, and (b) a
full release of all claims against the Company; (ii) the Company satisfied the
outstanding debts to the Creditors with an aggregate payment of approximately
$3,600 in cash and the issuance of a convertible promissory note in the
approximate principal amount of $206.  The terms and conditions of
this note are substantially the same as those of the convertible promissory note
discussed above.  The value of the Series A-2 Convertible Preferred
Stock was determined based on the market price per share of the Company’s common
stock on August 16, 2007.  The exchange of Series A Convertible
Preferred Stock, Series A-1 Convertible Preferred Stock and Series B Convertible
Preferred Stock and certain obligations for shares of Series A-2 Convertible
Preferred Stock resulted in a deemed dividend in the amount of $820 for the year
ended June 30, 2008.





The
holders of the Series A-2 Preferred include the Company’s Chief Executive
Officer and President, Chief Operating Officer and Vice President and Chief
Financial Officer who formerly held 275 shares (or $275,000) of the Series A-1
Preferred.  Additionally, the Company’s Creditors also included the
aforementioned officers, to whom the Company was obligated to pay approximately
$1,048 for accrued and unpaid compensation, unreimbursed business expenses and
the outstanding principal balance and accrued interest with respect to an
unsecured promissory note dated April 24, 2006 issued by the Company to its
Chief Executive Officer and President.  The Company satisfied the
outstanding debts with management with an aggregate payment of approximately
$488 and an agreement with Mr. Danson’s consulting company to pay the consulting
company $310, plus interest accruing at the rate of 7% per annum, upon the
earlier of a change of control of the Company or the six-year anniversary of the
closing of the transactions described herein.  The Chief Executive
Officer and President also agreed to restructure a potential $250 bonus until
such time as the Company satisfies certain milestones as described in his
employment agreement.




F-22




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


Pursuant
to separate agreements between certain of the Creditors and the former majority
holder of the Series A Preferred, certain of the Creditors purchased an
aggregate of 1,136.69 shares of Series A-2 Preferred from the former holder of
the Series A Preferred for an aggregate purchase price of $682.





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.  Accordingly, the Company has classified Series C and
Series D Preferred stock in stockholders’ equity in the accompanying balance
sheet.




Redemption
of Common Stock




On March
23, 2009, the Company acquired 3,000,000,000 shares of its common stock from an
institutional stockholder for a price of $317 including
expenses.  Under Florida law, such shares are deemed to be immediately
canceled and, accordingly, are excluded from the total of issued and outstanding
shares of common stock at June 30, 2009.   In connection with
this transaction, on March 20, 2009 the Company entered into an Equity
Repurchase Waiver Agreement with Sankaty whereby it agreed to a prepayment of
its Senior Notes in the principal amount of $300 in exchange for a waiver of a
provision of the Amended and Restated Note Purchase Agreement otherwise
prohibiting such purchase.  Such prepayment occurred prior to the June
30, 2009 balance sheet date.




NOTE
9. STOCK-BASED
COMPENSATION





In
connection with the recapitalization effective August 17, 2007 as described in
Note 3, the Company’s
2005 Stock Plan was amended and restated as of that date. The material revision
to the plan was an increase in the number of shares of common stock available
for issuance under the Stock Plan from 700,000,000 shares to 15,000,000,000
shares.





On August
17, 2007, the Board of Directors of the Company approved the issuance of options
to certain executive and subsidiary officers of the Company and independent
directors to purchase 9,325,000,000 and 200,000,000 shares, respectively, of the
Company’s common stock under the amended and restated Stock Plan pursuant to the
terms of separate option agreements.  On August 1, 2008, the Board of
Directors of the Company approved the issuance of options to certain subsidiary
officers of Tritronics to purchase 1,398,117,000 of the Company’s common stock
under the amended and restated Stock Plan pursuant to the terms of separate
option agreements.  The exercise price of these options is $.00075 per
share, a price that was greater than fair market value at the date of
grant.  The aggregate intrinsic value at date of grant was
$0.  The options have a term of 10 years and vest according to the
following schedule:





•
            25%
      of the options awarded vested
immediately,


•
            37.5%
      of the options awarded vest quarterly in equal increments over three
      years, and


•
            37.5%
      of the options awarded vest over three years if certain EBITDA targets are
      met.




F-23




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


The
following table summarizes stock option activity for the year ended June 30,
2009:





Shares
                    
                    
                    Exercise
      Price
                    
                    Weighted
                      Average
                      Remaining
                      Contractual
      Term
                    
                    Aggregate
      Intrinsic ValueOutstanding
      at July 1, 2008
                    
                    
                    9,525,409,000
                    
                    
                    $
                    0.00075Granted
                    
                    
                    1,398,116,000
                    
                    
                    $
                    0.00075Exercised
                    
                    
                    —
                    
                    
                    
                    —Canceled
      or expired
                    
                    
                    —
                    
                    
                    
                    —Outstanding
      at June 30, 2009
                    
                    
                    10,923,525,000
                    
                    
                    $
                    0.00075
                    
                    8.3
      years
                    
                    $
                    —Exercisable
      at June 30, 2009
                    
                    
                    7,893,115,000
                    
                    
                    $
                    0.00075
                    
                    8.2
      years
                    
                    $
                    —Expected
      to vest at June 30, 2009
                    
                    
                    3,030,410,000
                    
                    
                    $
                    0.00075
                    
                    8.4
      years
                    
                    $
                    —





Future
stock compensation expense for unvested shares at June 30, 2009, which amount
to  3,030,410,000 shares of which all are expected to vest, will
amount to $667.  That cost is expected to be recognized over a
weighted-average period of 1.2 years.





The
Black-Scholes Option Pricing Model (which models the value over time of
financial instruments)was used to estimate the fair value of the options at an
assumed measurement date. The Black-ScholesOption Pricing Model uses several
assumptions to value an option. We used the following assumptions:




Expected
Dividend Yield--because we do not currently pay dividends, our expected dividend
yield is zero.




Expected
Volatility in Stock Price--reflects the historical change in our stock price
over the expected term of the   stock option.




Risk-free
Interest Rate--reflects the average rate on a United States Treasury bond with
maturity equal to the expected term of the option.




Expected
Life of Stock Awards--reflects the simplified method to calculate an expected
life based on the midpoint between the vesting date and the end of the
contractual term of the stock award.




The
weighted-average assumptions used in the option pricing model for stock option
grants were as follows:






Year
      Ended
            
            
            Year
      EndedJune 30, 2009
            
            
            June 30, 2008Expected
      Volatility in Stock Price
            
            
            26.6
            %
            
            
            25.7
            %Risk-Free
      Interest Rate
            
            
            4.39
            %
            
            
            4.39
            %Expected
      Life of Stock Awards—Years
            
            
            6
            
            
            
            6Weighted
      Average Fair Value at Grant Date
            
            $
            .00005
            
            
            $
            .0002




Under now
superseded employment agreements the Company entered into with two executives on
September 25, 2006, the Company awarded an aggregate of 100,000,000 restricted
shares of common stock of which 20% vested immediately, with 30% and 50% to vest
on September 26, 2007 and September 26, 2008, respectively, subject to continued
employment.  The award had a fair market value of $90 based on the
closing price of the Company’s common stock on the date of grant.  In
connection with this restricted stock grant, $52 was charged to stock-based
compensation expense during the year ended June 30, 2008, including $50 for
unvested restricted shares that vested on an accelerated basis due to the August
17, 2007 recapitalization and change in control.




F-24




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


Stock-based
compensation expense for the years ended June 30, 2009, 2008 and 2007 amounted
to $813, $676 and $38, respectively.




NOTE
      10.
            INCOME
      TAXES










Year
      ended June 30,2009
            
            
            2008
            
            
            2007Current
      tax expense (benefit):Federal
            
            $
            80
            
            
            $
            —
            
            
            $
            —State
            
            
            —
            
            
            
            —
            
            
            
            —Total
            
            
            80
            
            
            
            —
            
            
            
            —Deferred
      tax expenseFederal
            
            
            1,921
            
            
            
            882
            
            
            
            (510
            )State
            
            
            —
            
            
            
            —
            
            
            
            —Utilization
      of net operating loss carryforward
            
            
            (1,100
            )
            
            
            (955
            )Change
      valuation allowance
            
            
            (2,151
            )
            
            
            (4,427
            )
            
            
            510Total
            
            
            (1,330
            )
            
            
            (4,500
            )
            
            
            —Income  tax
      benefit
            
            $
            (1,250
            )
            
            $
            (4,500
            )
            
            $
            -





The
following summarizes the differences between the income tax (benefit) expense
and the amount computed by applying the federal income tax rate of 35% in the
fiscal ended June 30, 2009 and 34% in fiscal years ended June 30, 2008 and 2007,
to income/loss before income taxes:




Year ended June
      30,2009
            
            
            
            
            
            2008
            
            
            
            
            
            2007Tax
      rate reconciliation:Computed
      "expected” federal  tax expense (benefit)
            
            $
            563
            
            
            
            35
            %
            
            $
            (154
            )
            
            
            (34
            )%
            
            $
            (425
            )
            
            
            (34
            %)State
      taxes, net of federal benefit
            
            
            —
            
            
            
            —
            %
            
            
            —
            
            
            
            —
            %
            
            
            —
            
            
            
            —
            %Nondeductible
      interest
            
            
            417
            
            
            
            26
            %
            
            
            —
            
            
            
            —
            %
            
            
            —
            
            
            
            —
            %Purchase
      accounting adjustment
            
            
            (83
            )
            
            
            (5
            %)
            
            
            81
            
            
            
            18
            %
            
            
            —
            
            
            
            —
            %Other
      permanent differences, net
            
            
            4
            
            
            
            —
            %
            
            
            —
            
            
            
            —
            %
            
            
            (85
            )
            
            
            (7
            %)Total
            
            
            901
            
            
            
            56
            %
            
            
            (73
            )
            
            
            (16
            %)
            
            
            (510
            )
            
            
            (41
            %)Change
      in valuation allowance
            
            
            (2,151
            )
            
            
            (134
            %)
            
            
            (4,427
            )
            
            
            (977
            %)
            
            
            510
            
            
            
            41
            %Income
      tax benefit
            
            $
            (1,250
            )
            
            
            (78
            %)
            
            $
            (4,500
            )
            
            
            (993
            %)
            
            $
            0
            
            
            
            0
            %





The
Company recorded a valuation allowance for its net deferred tax assets,
including its federal and state net operating loss, as of June 30, 2009, 2008
and 2007.





As of June 30, 2009, the Company had
total net operating loss carryforwards (NOL) available to offset future Federal
taxable income of approximately $23,000,000 expiring in the fiscal years from
2020 through 2027. As of June 30, 2009, the Company also had approximately
$200,000 of capital loss carryforwards, expiring in fiscal 2010 that could be
used to offset future federal taxable income.  As of June 30, 2009,
the Company had NOLs available for various state jurisdictions that will expire
from fiscal year 2022 through 2027. Due to the August 17, 2007 recapitalization
and change in control, the Company is subject to an annual Section 382
limitation regarding its loss carryforward that can be utilized to offset
taxable income.




F-25




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)




Deferred
tax assets and liabilities as of June 30, 2009 and 2008 were comprised of the
following:




2009
            
            
            2008Deferred
      tax assets (liabilities):Capital  loss
      carryover
            
            $
            69
            
            
            $
            69Stock-based
      compensation
            
            
            509
            
            
            
            105Inventory
            
            
            326
            
            
            
            —Other
      expenses deducted for book, not yet for tax
            
            
            221
            
            
            
            84Net
      operating loss carryover
            
            
            8,112
            
            
            
            14,3189,237
            
            
            
            14,576Valuation
      allowance
            
            
            (3,256
            )
            
            
            (9,728
            )5,981
            
            
            
            4,848Property
      and equipment
            
            
            (124
            )
            
            
            (9
            )Intangible
      assets
            
            
            (2,123
            )
            
            
            (339
            )Net
      deferred tax asset
            
            $
            3,734
            
            
            $
            4,500




The
Company periodically assesses its ability to realize its deferred tax
assets by considering whether it is more likely than not that some portion or
all of deferred tax assets will be realized.  Several factors are
evaluated, including the amount and timing of the scheduled expiration and
reversals of net operating loss carry forwards (NOLs) and deferred tax items,
respectively, as well as potential generation of future taxable income over the
periods for which the NOLs are applicable.  Certain estimates used in this
analysis are based on the current beliefs and expectations of management, as
well as assumptions made by, and information currently available to, management.
Although the Company believes the expectations reflected in these estimates are
based upon reasonable assumptions, there can be no assurance that actual results
will not differ materially from these expectations.  Accordingly, as of
June 30, 2009 and 2008, the Company re-evaluated its net deferred tax asset
balance and determined that $1,330 and $4,500, respectively, should be
recognized.  The recognition of the asset is reflected as an income tax
benefit included in net income for the fiscal years ended June 30, 2009 and
2008.  As a result of the company's analysis, during the year ended
June 30, 2009, the NOL carry forward and valuation allowance were
adjusted downward by $4,321.




NOTE
11.                  
   MAJOR CUSTOMERS





Sales to
the Company’s three largest customers during the fiscal years ended June 30,
2009 and 2008 accounted for approximately 11%, 10% and 4%, and 23%, 19% and 10%,
respectively, of total sales. Sales to the Company’s two largest customers
during the fiscal year ended June 30, 2007 accounted for approximately 44% and
41% respectively, of total sales.




NOTE
12.                      LITIGATION
SETTLEMENT




On May
11, 2005, Pacific Magtron International Corp. (“PMIC”), a then majority owned
subsidiary, and its subsidiaries filed voluntary petitions to reorganize their
businesses under Chapter 11 of the United States Bankruptcy
Code.  Also, on that date the Company filed a complaint in the United
States District Court against the former officers and principal shareholders of
PMIC, for the recovery of damages and costs for securities fraud, breach of
contract and other counts in connection with the Stock Purchase Agreement dated
December 10, 2004 among the Company and the former officers and principal
shareholders of PMIC.




The
bankruptcy court approved a Mutual Settlement Agreement and Release with respect
to the settlement of this litigation on August 11, 2006.  Under
PMIC’s Plan of Reorganization, the Company contributed $50,000 on behalf of
PMIC’s stockholders to effectuate the plan of reorganization and paid $325,000
in cash to the former officers and principal shareholders of
PMIC.  The Company recorded a charge to accumulated deficit in fiscal
2007 in the amount of $161,000 for this distribution.




F-26




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


NOTE
13.                      COMMITMENTS
AND CONTINGENCIES





Employment
Agreements





On the
Recapitalization Date, the Company entered into three separate, two-year
employment agreements with certain executive officers, with each agreement
having a one-year option at the Company’s election and replacing prior
employment agreements.  Under the terms of the agreements, the Company
is obligated to pay aggregate base salaries of $725 in the first year, $750 in
the second year and $750 in the option year.  The executives are
eligible to receive cash “performance” bonuses, equal to a percent of the base
salaries, determined by measuring actual EBITDA against the target EBITDA
established for a fiscal year and “exit” bonuses after a “Disposition Event”, as
defined, restricted shares of common stock, or options under the employment
agreements, with a vesting schedule and other terms established by the Company’s
Compensation Committee in its sole discretion.   In fiscal 2009,
“performance” bonuses were achieved; in fiscal 2008, no “performance” bonuses
were achieved. Amendments
effective July 31, 2009 modified the provisions of the employment agreements
defining the parameters by which “performance” bonuses would be earned.Proposed amendments to each executive’s employment agreement to be
effective August 17, 2009, would, among other items, replace the one-year option
period and provide for additional two-year employment periods and a one-year
option at the Company’s election.  Under the terms of the proposed
amendments, the Company would be obligated to pay aggregate base salaries of
$815 in each of the first and second years.





In addition, as a result of the change
in control that occurred in connection with the recapitalization, the vesting of
an aggregate of 80,000,000 shares of restricted stock previously issued to
Messrs. Donahue and Miller as a bonus was accelerated in the three months ended
September 30, 2007.  (See Note 9.)  Such
shares were issued following shareholder approval of an increase in the number
of authorized shares of common stock in May 2008.





Also on the Recapitalization Date, the
Company entered into separate, two- or three-year employment agreements with
certain officers of Vance Baldwin, with the three-year agreement having a
one-year option at the Company’s election.  Effective August 17, 2008,
the Company amended one of the executive’s employment contract to reduce the
annual compensation to that executive to reflect a reduction in working
days. The Company agreed to a proposed amendment one of the executive’s
employment contract to be effective August 17, 2009, to increase the annual
compensation to that executive, and to make this employee eligible for an annual
“performance” bonus.  Under the terms of the agreements and proposed
amendments, the Company was obligated to pay aggregate base salaries of $590 in
the first year and $535 in the second year, and would be obligated to pay
aggregate base salaries of $545 in the third year.  Two of the
employees are eligible to receive cash “performance” bonuses determined by
measuring actual EBITDA against the target EBITDA established for a fiscal year,
and restricted shares of common stock, or options under the employment
agreements, with a vesting schedule and other terms established by the Company’s
Compensation Committee in its sole discretion.  Further, also on the
Recapitalization Date, these two employees received an aggregate of 687.5 shares
of Series D Preferred Stock with a value of $435.





Operating
Lease Commitments




The
Company is obligated under leases for warehouse facilities expiring at various
dates through 2014.    For the fiscal years ended June 30,
2009, 2008 and 2007, rent expense amounted to $1,499, $796 and $231,
respectively.




Future
minimum aggregate lease payments as of June 30, 2009 are approximately as
follows:




For
      the year ending June 30, 2010
                    
                    $
                    1,7772011
                    
                    
                    1,3932012
                    
                    
                    9492013
                    
                    
                    7762014
                    
                    
                    531Total
                    
                    $
                    5,426




F-27




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


Legal
Matters




The
Company has been, and may in the future be involved as, a party to various legal
proceedings, which are incidental to the ordinary course of its
business.  Management regularly analyzes current information and, as
necessary, provides accruals for probable liabilities on the eventual
disposition of these matters.  In the opinion of management, as of
June 30, 2009, there were no threatened or pending legal matters that would have
a material impact on the Company's consolidated results of operations, financial
position or cash flows.  See Note 12 for a description of
certain legal proceeding settled in fiscal 2007.




Advisory
Agreements







Pursuant
to a financial advisory agreement between Janney Montgomery Scott, LLC
(“Janney”) and the Company, as amended, Janney served as financial advisor and
investment banker for the Company in connection with the acquisition of Vance
Baldwin, the sale of the Series C Preferred and the related transactions.
Pursuant to the amended agreement, Janney received total fees of $560 in cash,
$100 of which was used to purchase 166.7 shares of formerly outstanding Series
A-2 Preferred, which agreement also provides for additional fees upon the
consummation of certain types of transactions in the future.  The
Janney agreement expired prior to June 30, 2009 and has not been
renewed.





On the
Recapitalization Date, the Company entered into a five-year Management Agreement
with H.I.G. pursuant to which it will provide management and consulting services
to the Company and its subsidiaries.  The Company will pay a cash
consulting and management fee to H.I.G., currently not to exceed $500 per
annum.  The Company also entered into a five-year Investment Advisory
Services Agreement with H.I.G. pursuant to which it will provide certain
financial advisory services to the Company and its subsidiaries.  The
Company paid HIG a combined investment banking and supplemental management fee
of $525 in connection with the August 17, 2007 acquisition financing and
recapitalization, and a similar fee of $200 in connection with the August 1,
2008 acquisition financing.




NOTE
14.                      RELATED
PARTIES




As
described in Note 13,
on August 17, 2007, the Company entered into a Management Agreement and
Investment Advisory Services Agreement with H.I.G. During the fiscal years ended
June 30, 2009 and 2008, payments to H.I.G. for management and investment
advisory services were $523 and $250, respectively.





As
described in Note 7, on
August 17, 2007, the Company entered into a note agreement for $310, plus
interest at 7% per annum accruing but not paid, with Danson Partners, LLC (DPL),
the consulting firm of its Chief Executive Officer, for compensatory services
and reimbursable expenses under a prior Service Agreement that terminated
December 31, 2005.




F-28




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


In
connection with the recapitalization effective August 17, 2007 as described in
Note 3, the Company and
DPL entered into a new license agreement whereby the Company effectively assumed
the Danson Partners’ lease obligation for a total of approximately 2,300 square
feet of office space, as well as agreed to lease certain furniture, fixtures
computers, servers and software, for a monthly fee of approximately $10.. The
license agreement is co-terminus with the underlying office lease that expires
May 31, 2010.  Prior thereto, the Company, through a license agreement
with DPL that commenced December 1, 2004, licensed a portion of the office
facility.  The term of this license agreement was month-to-month and
the license payment was at fair value.




Pursuant
to an agreement dated March 7, 2006 between Janney, who served as financial
advisor and investment banker for the Company in connection with the
recapitalization and acquisition of Vance Baldwin, and the Company’s Chief
Financial Officer, approximately six months prior to his joining the Company
(and prior to the Company discussing the possibility of this individual joining
the Company), Janney agreed to pay 5% of its advisory fees to Company’s Chief
Financial Officer as a finder’s fee.




NOTE
15.                      SEGMENT
INFORMATION





The
Company applies Statement of Financial Accounting Standards No. 131 “Disclosures
about Segments of an Enterprise and Related Information”.  For the
fiscal year ended June 30, 2009, 2008 and 2007, the Company primarily operated
in one segment, the reverse logistics industry, involving the repair of office
and consumer electronic products and the supplying of replacement parts for such
repairs, which expanded with the acquisition of Vance Baldwin and
Tritronics.





NOTE
16.                      SUPPLEMENTAL
DISCLOSURE OF CASH FLOWS INFORMATION





The
following are the payments made during the fiscal years ended June 30, 2009,
2008 and 2007 for income taxes and interest:


2009
            
            
            2008
            
            
            2007Income
      taxes
            
            $
            25
            
            
            $
            —
            
            
            $
            —Interest
            
            $
            2,503
            
            
            $
            2,135
            
            
            $
            4





Fiscal
Year Ended June 30, 2009:





(1)
            In
      connection with the Tritronics acquisition transaction, the Company
      issued: (i) a noncash unsecured note of $1,000 to the stockholder of
      Tritronics as part of the purchase price and  (ii) 2,796,233,000
      shares of common stock having a value of $1,119 to the stockholder of
      Tritronics as part of the purchase
price.


(2)
            In
      connection with the debt financing for the acquisition of Tritronics, the
      Company incurred original issue discounts of $265 on Series B subordinated
      notes.


(3)
            The
      Company repurchased from a stockholder 3,000,000,000 shares of its common
      stock for the amount of $308.  Such shares are considered
      retired under Florida law and are reflected as a reduction of shares of
      common stock issued and
outstanding.





Fiscal
Year Ended June 30, 2008:





(1)
            The
      Company issued 80,000,000 restricted shares of common stock to the Chief
      Operating Officer and Chief Financial Officer in accordance with the
      provisions of employment agreements with the
  Company.


(2)
            In
      connection with the recapitalization and acquisition of Vance Baldwin, the
      Company issued: (i) a non-cash unsecured note of $310 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, $40 and $340, 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 to the stockholder of Vance
      Baldwin as part of the purchase price, and (vi) Series D convertible
      preferred stock of $436 in satisfaction of an assumed obligation of Vance
      Baldwin.




F-29




ENCOMPASS
GROUP AFFILIATES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 AS
OF JUNE 30, 2009
 (Dollars
in thousands, except per share amounts)


(3)
            8,412
      shares of Series A-2 Preferred Shares were converted into 8,412,206,607
      shares of the Company’s common
stock.





Fiscal
Year Ended June 30, 2007:





(1)
            The
      Company issued 20,000,000 restricted shares of common stock to a Chief
      Operating Officer and Chief Financial Officer in accordance with the
      provisions of employment agreements with the
      Company.


(2)
            615
      shares of Series A Preferred Shares and 20 shares of Series B Preferred
      Shares were converted into 789,884,564 shares and 20,000,000 shares,
      respectively, of the Company’s common
stock.


(3)
            The Company recorded a charge in
      the amount of $85 for the beneficial conversion feature associated with
      the Series A-1 Convertible Preferred
  Stock.


















~
end of filing ~




F-30