Encompass Holdings, Inc. - Form 10QSB for the period ended September 30, 2006
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-QSB



(Mark One)

[X]
Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2006

[   ]
Transition report under Section 13 or 15(d) of the Exchange Act for the transition period from __________ to __________.

Commission File Number: 000-31451
 

ENCOMPASS HOLDINGS, INC.
(Exact name of small business issuer as specified in its charter)

NEVADA
  
95-4756822
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer
Identification No.)


1005 Terminal Way, Suite 110, Reno, Nevada 89502
(Address of principal executive office) (Zip Code)

(775) 324-8531
(Issuer's telephone number)

Indicate by checking the box below, whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act.
Yes [   ] No [X]


Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [   ]


As of November 8, 2006, the number of outstanding shares of the issuer's common stock, $0.001 par value, was 44,629,481 shares.


TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT: Yes [   ] No [X]



1




TABLE OF CONTENTS

ITEM 1.
FINANCIAL STATEMENTS
3
     
 
3
     
 
4
     
 
5
     
 
6
     
ITEM 2.
 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
10
     
ITEM 3.
12
     
PART II - OTHER INFORMATION
     
ITEM 2.
12
     
ITEM 6.
12
   
13





2


ENCOMPASS HOLDINGS, INC.
Consolidated Condensed Balance Sheets

   
September 30,
2006
  
June 30,
2006
  
Assets
  
 
          
Current assets:
          
    Cash
  
$
53,373
  
$
146,935
  
    Accounts receivable, less allowance for uncollectible accounts
    
394,732
    
405,545
  
    Receivable from related party
    
-
    
-
  
    Prepaid expenses
    
353,294
    
335,063
  
    Other current assets
    
-
    
-
  
               
        Total current assets
    
801,399
    
887,543
  
               
Equipment, net
    
13,116,602
    
13,363,914
  
Other assets:
              
    Note receivable
    
-
    
-
  
    Deposits & other
    
403,084
    
403,084
  
     Other assets
    
4,503,664
    
4,497,308
  
               
        Total other assets
    
4,906,748
    
4,900,392
  
   
$
18,824,749
  
$
19,151,849
  
               
Liabilities and Stockholders' Equity
 
              
Current liabilities:
              
    Accounts payable
  
$
1,918,072
  
$
2,019,394
  
    Accrued liabilities
    
2,157,345
    
1,879,280
  
    Unearned revenue
    
264,039
    
286,318
  
    Notes payable and accrued interest subject to conversion into
        an indeterminable number of shares of common stock
    
1,035,906
    
995,851
  
    Derivative liabilities
    
981
    
6,371
  
    Long-term debt due within one year
    
3,800,505
    
3,803,666
  
    Other current liabilities
    
-
    
-
  
        Total current liabilities
    
9,176,850
    
8,990,880
  
               
Long-term debt to related parties
    
84,464
    
84,464
  
Long-term debt
    
2,691,300
    
1,911,313
  
Accrued Interest
          
71,847
  
Minority interest
    
5,307,065
    
5,306,746
  
Stockholders' equity:
              
    Preferred stock; $.001 par value; authorized 200,000 shares;
        outstanding 200,000 shares
    
200
    
200
  
    Common stock; $.001 par value; authorized 500,000,000
        shares; issued and outstanding 29,570,035 shares (28,820,035
        shares at June 30, 2006)
    
29,570
    
28,820
  
    Common stock to be issued
    
-
    
-
  
    Convertible promissory note and accrued interest
    
107,140
    
107,140
  
    Additional paid in capital
    
34,829,923
    
34,810,660
  
    Retained deficit
    
(33,401,764
)
  
(32,160,221
)
        Total stockholders' equity
    
1,565,069
    
2,786,599
  
   
$
18,824,749
  
$
19,151,849
  
See accompanying notes.
3




ENCOMPASS HOLDINGS, INC.
Consolidated Condensed Statements of Operations


   
Three months ended
September 30
  
   
2006
  
2005
  
           
           
Revenues
  
$
791,319
  
$
1,119,416
  
               
Cost of goods sold
    
275,977
    
276,039
  
               
Gross profit
    
515,342
    
843,377
  
               
General and administrative expenses
    
1,634,776
    
1,685,593
  
Research and development expenses
    
53,823
    
647
  
               
Net loss from operations
    
(1,173,257
)
  
(842,863
)
               
Other income (expenses):
              
    Change in fair value of derivative liabilities
    
5,390
    
(8,808
)
    Interest expense
    
(153,676
)
  
(22,684
)
    Other income
    
80,000
    
-
  
        Total other income (expenses)
    
(68,286
)
  
(31,492
)
               
Net loss from operations before provision for income taxes
    
(1,241,543
)
  
(874,355
)
               
Provision for income taxes - State of California
              
               
Net loss
    
(1,241,543
)
$
(874,355
)
Net loss per common share
    
(.043
)
$
(.145
)


See accompanying notes.
4




ENCOMPASS HOLDINGS, INC.
Consolidated Condensed Statements of Cash Flows

   
Three months ended
September 30
  
   
2006
  
2005
  
           
Cash flows from operating activities:
          
    Net loss
  
$
(1,241,543
)
$
(874,355
)
    Adjustment to reconcile net loss to net cash provided by
              
    (used in) operating activities:
              
        Depreciation & amortization
    
296,077
    
295,017
  
        Shares issued in exchange for compensation & services
          
226,056
  
        Change in fair value of derivative liabilities
    
(5,390
)
  
8,808
  
        Unearned revenue
    
(22,279
)
  
(70,893
)
        Provision for bad debts
    
21,000
    
-
  
        Minority interest in subsidiaries
    
319
        
        Changes in assets and liabilities:
              
            Receivables
    
(10,187
)
  
43,323
  
            Prepaid expenses
    
(18,231
)
  
16,299
  
 
              
            Accounts payable
    
(101,319
)
  
383,600
  
            Accrued liabilities
    
210,904
    
387,242
  
     
(870,649
)
  
415,097
  
 
              
Cash flows from investing activities:
              
    Capital expenditures
    
(55,121
)
  
(351,937
)
    Repayment of advances to related parties
          
7,113
  
    Net advances to related parties
    
(17,792
)
  
(80,653
)
     
(943,562
)
  
(425,477
)
               
Cash flows from financing activities:
              
    Proceeds from long-term debt
    
800,000
        
    Proceeds from notes payable
   
50,000
    
-
  
    Repayment to related parties
          
(45,916
)
    Proceeds from convertible notes payable
          
10,000
  
     
850,000
    
(35,916
)
               
Net change in cash
    
(93,562
)
  
(46,296
)
               
Cash at beginning of period
    
146,935
    
46,296
  
               
Cash at end of period
    
53,373
  
$
-
  
               
Supplemental schedule of noncash financing activities:
              
               
    Notes and accrued interest converted into common stock
        
$
9,774
  



See accompanying notes.
5






ENCOMPASS HOLDINGS, INC.

Consolidated Notes to Financial Statements
September 30, 2006

1.
Summary of significant accounting policies

BUSINESS COMBINATIONS AND BASIS OF CONSOLIDATION: The consolidated condensed financial statements include the accounts of Encompass Holdings, Inc., Aqua Xtremes, Inc., Xtreme Engines, Inc., Rotary Technologies, Inc., Nacio Systems, Inc., and Interactive Holding Group, Inc. since their acquisitions. All intercompany accounts and transactions have been eliminated.
 
On August 30, 2004, the Company acquired 51% of Realized Development, Inc. which changed its name to Aqua Xtremes, Inc. (“Aqua”) in December 2004. On May 9, 2005, the Company acquired the remaining 49% of Aqua.
 
In December 2004, Aqua formed Xtreme Engines, Inc. ("Engines") and owns 100% of its common stock.

Effective April 1, 2005, the Company acquired 100% of Nacio Systems, Inc. ("Nacio"). Nacio owns 100% of Interactive Holding Group, Inc. ("IHG").
 
INTERIM REPORTING: The Company's year-end for accounting purposes is June 30. In the opinion of Management, the accompanying consolidated condensed financial statements as of September 30, 2006 and 2005 and for the three months then ended, consisting of only normal recurring adjustments, except as noted elsewhere in the notes to the consolidated condensed financial statements, necessary to present fairly its financial position, results of its operations and cash flows. The results of operations for the three months ended September 30, 2006 and 2005 are not necessarily indicative of the results to be expected for the full year.

RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS TO REFLECT DERIVATIVE ACCOUNTING: The Company has restated its previously issued interim financial statements to reflect additional non-operating gains related to the classification of and accounting for certain financial instruments with embedded derivative features.

The Company determined that it had not correctly accounted for the embedded conversion feature of its convertible notes payable as a derivative instrument pursuant to SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, and Financial Accounting Standards Board's Emerging Issues Task Force ("EITF") Issue No. 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in A Company's Own Stock".

The Company estimated the fair value of the conversion feature of its notes payable to be $981 as of September 30, 2006 and is reported in the accompanying consolidated balance sheet as derivative liabilities. Under EITF No. 00-19, this

6




ENCOMPASS HOLDINGS, INC.

Consolidated Notes to Condensed Financial Statements
September 30, 2006


1.
Summary of significant accounting policies (continued)

RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS TO REFLECT DERIVATIVE ACCOUNTING (CONTINUED): amount is reported separate from the convertible notes payable as derivative liabilities. Further, under SFAS No. 133, any change in fair value of derivative liabilities during the period is reported as other income or expense in the statement of operations. The Company recognized other income for the change in fair value of derivative liabilities in the consolidated statement of operations of $5,390 for the three months ended September 30, 2006.

DERIVATIVE INSTRUMENTS: In connection with the issuance of convertible notes payable, the terms of certain notes payable provide for principal and interest to be converted into an indeterminable number of shares of the Company's common stock. This variable conversion feature is determined to be an embedded derivative instrument and the Company has accounted for these derivatives pursuant to SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended and Financial Accounting Standards Board's Emerging Issues Task Force ("EITF") Issue No. 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in A Company's Own Stock". Under EITF No. 00-19, the estimated fair value of the embedded derivative instrument is reported separate from the notes payable on the date of issuance as derivative liabilities.

Derivative liabilities are reported at fair value as of the balance sheet date and any change in fair value during the period is reported as other income or expense in the statement of operations.

Revenue recognition: Revenues for Nacio consist of dedicated Internet access fees; hosting, co-location and other fees; sales of third party hardware and software; fees for systems and technical integration and administration; fees for power and server connection and connectivity services.

Monthly service revenue related to Internet access, hosting, co-location and ESF is recognized over the period services are provided. Service and equipment installation revenue is recognized at completion of installation and upon commencement of services. Payments received in advance of providing services are deferred until the period such services are provided, except in the case of non-refundable payments including last-month deposits, which are recognized when service is initiated. Equipment sales and installation revenue is recognized when installation is completed.

Revenues also consists of computer software compliance monitoring services and products. Service revenues related to software compliance monitoring are generally billed annually and recognized ratably over the period services are provided. Software product sales are recognized when software is provided and payment has been received.

7




ENCOMPASS HOLDINGS, INC.

Consolidated Notes to Condensed Financial Statements
September 30, 2006


1.
Summary of significant accounting policies (continued)

REVENUE RECOGNITION (CONTINUED): Revenue for Aqua consists of the sale of XBoards and is recognized when the product is shipped.

NET LOSS PER COMMON SHARE: Net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period. The weighted average number of common stock shares outstanding was 28,993,112 for the three months ended September 30, 2006 (6,048,177 for the three months ended September 30, 2005). Common stock to be issued is not considered to be a common stock equivalent as the effect on net loss per common share would be dilutive.

2.
Operations

The Company's operating strategies focus on the development of recreational water sports products, rotary engines and operating and managing its enterprise server facilities.

The Company has begun selling distributorships for its recreational water sports products and expects to begin manufacturing and selling those products in 2006.

Management of the Company believes that operations from the sale of these products will be profitable by the first quarter of 2007 and that the Company will recover its development costs within five years.

The Company purchased Nacio effective April 1, 2005. Since its acquisition, management has pursued aggressive cost cutting programs and eliminated unprofitable products. An aggressive marketing campaign focusing on Governement services as well as e-commerce hosting and web site development has been undertaken and added to Nacio’s product offerings. Management believes these actions will enable Nacio to achieve profitable operations.

The Company is dependent upon its ability to obtain additional capital and debt financing until the Company ultimately achieves profitability, if ever.

The consolidated financial statements do not reflect adjustments relating to the recorded asset amounts, or the amounts of liabilities that would be necessary should the Company not be able to continue in existence.

3.
Notes payable subject to conversion into an indeterminable number of shares of common stock

Notes payable were due one year from the issuance date of the note with interest at rates ranging from 8% to 20% per annum. The notes, including unpaid interest, are convertible, in whole or in part, at any time after six months from the date of the note at the option of the holder. The notes are convertible at the option of the Company upon

8




ENCOMPASS HOLDINGS, INC.

Consolidated Notes to Condensed Financial Statements
September 30, 2006


3.
Notes payable subject to conversion into an indeterminable number of shares of common stock (continued)

ten days written notice after six months and one year from the date of the note or at the time of any public offering by the Company in an aggregate amount of no less than $10,000,000, or upon any merger or acquisition to which the Company is a party. The notes may be converted at prices per share ranging from 70% to 90% of the closing bid price of the Company's common stock on the date of the notice of conversion. There is no limit on the number of shares of common stock that would be required to by issued upon conversion of the notes payable and the number of shares required to be issued could exceed the number of shares of the Company's common stock currently authorized. The Company would have been required to issue 2,959,225 shares of its common stock if the principal and accrued interest of the notes were converted as of September 30, 2006.

4.
Long Term Obligations

 
Included in long term debit is $2,500,000 of notes payable to AJW Offshore, Ltd; AJW Partners, LLC AJW Qualified Partners, LLC; and Millennium Capital Partners II., LLC. The entire amount is convertible in whole or in part into shares of common stock of the Company at the option of the Company at a conversion price equal to the average of the three lowest closing bid prices of the Company’s common stock during the 20 trading days prior to the date of conversion at a discount of 45%.

 
The Company also granted AJW Offshore, Ltd; AJW Partners, LLC; AJW Qualified Partners, LLC; and New Millennium Capital Partners II, LLC warrants for the purchase of an aggregate of 3,500,000 shares of common stock of the Company at an exercise price equal to $.50 per share. The warrants are exercisable in whole or in part and warrants for the purchase of up to 1,400,000 shares expire on November 29, 2009; warrants for the purchase of up to 979,380 shares expire on January 17, 2010 if not exercised: and warrants for the purchase of 1,120,620 shares shall expire on August 8, 2010. The Company has reserved 3,500,000 shares of its common stock for issuance to these warrant holders.

 
During the three months ending, September 30, 2006, as partial repayment of the cash advances received from AJW Partners, LLC, AJW Qualified Partners, LLC, and New Millennium Capital Partners II, LLC, the company issued 750,000 shares of its common stock in return for a principle reduction of $20,012.50. Subsequent to September 30, 2006 the Company has issued an additional 1,250,000 common shares for a further reduction of $25,342.50.


5.
Common stock

During the three months ended September 30, 2006, the Company issued 750,000 shares of common stock as partial repayment of its long term debt. The amount of debt reduction was recorded at an average share price of $.023 per share. Subsequent to September 30, 2006 the Company issued 1,309,446 common shares to pay for engineering services. 309,446 of the shares were record at a cost of $.04 per share; 1,000,000 shares were recorded at a cost of $.05 per share. Subsequent to September 30, 2006, the Company also issued 2,500,000 shares to liquidate its obligations under a previously signed loan agreement. Those shares were recorded at a cost of $.07 per share.

Also subsequent to September 30, 2006, the Company sold 10,000,000 shares, to one entity, for the cash amount of $260,000.

 
9




ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's discussion and analysis contains various forward-looking statements within the meaning of the Securities and Exchange Act of 1934. These statements consist of any statement other than a recitation of historical fact and can be identified by the use of forward looking terminology such as "may", "expect", "anticipate", "estimates", or "continue" or use of negative or other variations of comparable terminology. We caution that these statements are further qualified by important factors that could cause actual results to differ materially from those contained in our forward looking statements, that these forward looking statements are necessarily speculative, and there are certain risks and uncertainties that could cause actual events or results to differ materially from those referred to in our forward looking statements.

Management's discussion and analysis should be read in conjunction with the financial statements and the notes thereto.

EXECUTIVE LEVEL OVERVIEW

The Company's operating strategies focus on the development of recreational water sports products, Rotary Engines and the management of its enterprise server facilities. The Company has begun selling distributorships for its recreational water sports products and expects to begin manufacturing and selling those products in 2006.

Management has also devoted substantial efforts in the operations of Nacio by pursuing aggressive cost cutting programs and eliminated unprofitable products.

Revenues for Nacio consist of hosting, co-location and related fees; sales of third party hardware and software; fees for systems and technical integration and administration; fees for power and server connectivity services, and the sale of computer software compliance monitoring services and products.

Revenues for Aqua to date consist of the sale of dealerships and the sale of XBoards.
 
Encompass Holdings, Inc. presently has executive offices at 1005 Terminal Way, Reno, NV. Nacio's enterprise server facilities are located at 55 Leveroni Court, Novato, CA. Currently, the only significant business risk of Nacio's operations is that the electricity to power the Electronic Enterprise Servers is obtained from a single-source supplier, Pacific Gas & Electric. Nacio has available back-up power generators sufficient to continue to power their enterprise server facilities in the event of short-term power losses. However, if the supply of power to Nacio by Pacific Gas & Electric were delayed or curtailed, the ability of Nacio to provide services to its customers could be adversely affected.

 
10




RESULTS OF OPERATIONS

Three months ended September 30, 2006 compared to the three months ended September 30, 2005:

 
Three months ended September 30:
 
2006
  
2005
  
Decrease
  
%
Sales
$ 791,319
  
$ 1,119,416
  
($ 328,097)
 
(29.31%)

The decrease in sales was attributable to reduce revenue at Nacio.

 
 
Three months ended September 30:
 
2006
  
2005
  
Decrease
  
%
Cost of sales
$ 275,978
  
$ 276,039
  
($ 61)
  
-%

Because Nacio’s direct costs are fixed, there were no saving of direct cost as a result of decreased revenue.

 
Three months ended September 30:
 
2006
  
2005
  
Decrease
  
%
General and administrative expenses
$ 1,634,776
  
$ 1,686,240
  
($ 51,464)
  
(3.05%)

The decrease in selling, general & administrative expenses was attributable to cost cutting measures taken at Nacio.

FINANCIAL POSITION & LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2006 compared to September 30, 2005:

 
September 30,
2006
  
September 30,
2005
  
Decrease
  
%
Accounts receivable, net
$ 394,732
  
$ 405,585
  
($ 10,853)
 
(2.68%)

The change in accounts receivable was attributed to the reduction of revenue at Nacio.

11



ITEM 3.  CONTROLS AND PROCEDURES

As required by Rule 13a-15 under the Exchange Act, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our management, including our President and Chief Executive Officer. Based upon that evaluation, we concluded that our disclosure controls and procedures are effective in ensuring that material information related to us, required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the rules and regulations of the SEC. There have been no significant changes in our internal controls subsequent to the date we carried out our evaluation.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.


PART II - OTHER INFORMATION

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

No unregistered sales of equity securities occurred during the period covered by this report. Subsequent to September 30, 2006, the Company issued 1,154,723 common shares as compensation for engineering services, of which 1,000,000 shares were record at a cost of $.05 per share and the remaining 154,723 shares were record at a cost of $.04 per share. Subsequent to September 30, 2006, the Company also issued 2,500,000 common shares, record at a cost of $.07 per share to settle an obligation to a lender that had obtained a judgment against the Company.

The Company’s registration statement on Form SB-2 was declared effective August 8, 2006. The registration statement covered the sale of shares of the Company’s common stock by certain shareholders upon the conversion of outstanding debentures and the exercise of outstanding warrants. The Company did not realize any proceeds from the sales by the shareholders. The principle expense incurred by the Company in connection with the registration statement was legal fees of $51,666.00.
 
ITEM 6.  EXHIBITS

(a)  Exhibits.
 
Exhibit
Number
  
Description of Document
     
3.1
  
Articles of Incorporation as Amended *
3.2
  
By laws *
31.1
  
31.2
  
32.1
  
32.2
  
     
*
Filed by reference to a prior filing of the Registrant.




12



SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

November 15, 2006
ENCOMPASS HOLDINGS, INC.
   
 
By:
/s/ ARTHUR N. ROBINS
Arthur N. Robins
Chief Executive Officer
     
 
By:
/s/ LESLIE I. HANDLER
Leslie I. Handler, President




13