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PART I

Item 1.  Business.

Forward-looking Statements.

The Private Securities Litigation Reform Act of 1995 (the “Act”) provides a safe harbor for forward-looking statements made by or on behalf of Castle.  Castle and its representatives may from time to time make written or oral statements that are “forward-looking,” including statements contained in this Annual Report and other filings with the Securities and Exchange Commission, and in reports to Castle’s stockholders.  Management believes that all statements that express expectations and projections with respect to future matters, as well as from developments beyond Castle’s control, including changes in global economic conditions, are forward-looking statements within the meaning of the Act.  These statements are made on the basis of management’s views and assumptions, as of the time the statements are made, regarding future events and business performance. There can be no assurance; however, that management’s expectations will necessarily come to pass.

Factors that may affect forward-looking statements include a wide range of factors that could materially affect future developments and performance, including the following: Changes in company-wide strategies, which may result in changes in the types or mix of businesses in which Castle is involved or chooses to invest; changes in U.S., global or regional economic conditions; changes in U.S. and global financial and equity markets; including significant interest rate fluctuations; which may impede Castle’s access to, or increase the cost of, external financing  for its operations and investments; increased competitive pressures, both domestically and internationally; legal and regulatory developments, such as regulatory actions affecting environmental activities; the imposition by foreign countries of trade restrictions and changes in international tax laws or currency controls; adverse weather conditions or natural disasters, such as hurricanes and earthquakes; and labor disputes, which may lead to increased costs or disruption of operations.  This list of factors that may affect future performance and the accuracy of forward-looking statements are illustrative, but by no means exhaustive.  Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty.

Description of the Business

The Castle Group, Inc. (“the Company,” “Castle,” “we,” or ‘us”) through its subsidiaries manages luxury and mid-range resort condominiums and hotels on all of the major islands within the state of Hawaii, and resorts located in Saipan, and New Zealand. The Company was incorporated in Utah on August 21, 1981 and on June 4, 1993 the name of the Company was changed to The Castle Group, Inc.  

Principal Products or Services and Their Markets

General

Castle is a full service hospitality and hotel management company that prides itself on its ability to be both “Flexible and Focused,” the Company’s operations motto.  Flexible, to meet the specific needs of property condo owners at the properties that it manages; and Focused, in its efforts to achieve enhanced rental income and profitability for those owners.  Castle earns its revenues by providing several types of services to property owners including, hotel and resort management and operations; reservations staffing and operations; sales and marketing; and accounting.  Castle’s revenues are derived primarily from two sources: (1) the rental of hotel rooms and condominium accommodations along with food and beverage sales at the properties it manages and; (2) fees paid for services it provides to property owners.  Castle also derives revenues from commissions and incentive payments, based on sales and performance criteria at each property.

Corporate Culture

Castle’s corporate culture has been internally branded as “F & F,” which means Flexibility and Focus.  The organization and infrastructure is solid; and designed for maximum flexibility to react to any and all marketplace dynamics; while at the same time, allowing us to remain focused on our objectives and overall strategy without losing focus or perspective.

Marketing Strategy

Most of our marketing efforts are focused towards acquiring and retaining guests for the properties we manage.  Castle has made investments in two of the properties that it manages, as it owns the lobby and food and beverage areas in its New Zealand property, and a minority interest in one of the properties it manages in Hawaii.  Marketing is done through a variety of distribution channels including direct internet sales, wholesalers, online and traditional travel agencies and group tour operators.   Castle also manages and operates an interactive web site (www.Castleresorts.com) for customers to view information about the properties we manage and make reservations to stay at the properties.  The website offers user friendly navigation, interactive features and rich content, while offering attractive rates and a travel booking engine that can handle rate conversions for over 100 foreign currencies.  The proprietary online booking and reservations engine supports a dynamic pricing model which maximizes revenues for all of our properties under management.  

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Castle supports its online presence with its own full service, reservation call center that provides a wide range of services from tour reservation processing and rooms control, to handling group bookings.  The reservation center electronically connects resort property inventory and rates to the four major Global Distribution Systems (“GDS”).  This connectivity displays rates and inventory of Castle’s properties to over 500,000 travel agents worldwide as well as Internet connectivity to over 1,200 travel websites around the globe.

Diversity

Castle has a diverse portfolio of properties located in desired island resort destinations throughout the Pacific Region and beyond. We represent hotels, resort condominiums, luxury villas and lodging accommodations throughout Hawaii, in Saipan, and in New Zealand.

In Hawaii, Castle is the only lodging chain that represents properties on the five major Hawaiian Islands of Oahu, Maui, Kauai, Molokai and Hawaii, which allows customers the option to island-hop, and provides Castle with cross-selling opportunities. Our Honolulu headquarters serves as the epicenter for our international operations in Saipan and New Zealand.  Our diverse destinations offer customers the opportunity to discover new experiences and varying cultures in the areas we represent.

Castle offers a wide range of accommodations at various price points from exclusive private villas, full-service all-suites hotels, oceanfront resort condominiums, to modestly priced hotels with up to 450 guest rooms.  Our collection of all-suites condominium resorts, hotels, villas, lodges and vacation rentals allows customers to select the best accommodation to suit their individual style and budget.    

Our ability to deliver consistent financial returns to our property owners demonstrates Castle’s competency in managing and marketing a wide range of accommodations to our customers via multiple channels of distribution.  

Brand Strategy

Each property Castle manages is individually branded in order to extract maximum value from its strengths.  The Castle brand stays in the background and our focus is on marketing the uniqueness of each property, while satisfying the needs and expectations of our owners.  Each property we manage maintains its own brand identity and personality, while utilizing the Castle advantage of our powerful marketing resources, channel distribution, resort management expertise, industry partnerships and networks.

Castle’s brand strategy is one of the areas that clearly differentiate us from the high profile branded hospitality companies.  When a hotel owner or developer is considering contracting a large worldwide hospitality company for possible hotel management, there are several considerations that must be assessed.  With major worldwide brands, usually come the high costs that the owner must bear to sustain the expensive marketing and operational expense that the brand demands to offset their marketing costs. There are also some tangible differences from the guest’s or customer’s perspective as well.  At Castle, we believe that one size does not fit all and we also believe that marketing efforts should be focused on the individual property instead of the brand name.

Castle markets each property with its own independent brand identity and deploys customized marketing programs to fit the specific demographics attracted to each of our properties.  Through our brand building efforts, we begin the process of positioning each of our resort brands to our key market segments, niche targeted customers and distribution channels.

We also do not flag our properties with the Castle name.  The advantages of doing so are several.  There is a high demand for the independent smaller boutique hotels and condominiums, as travelers favor a more individualized and unique travel experience. We believe that this allows the consumer to better choose the specific type of vacation experience desired based upon the specific attributes of the property selected.  This ongoing trend towards smaller, independent hotels, as opposed to the familiar mid-range chains has been seen in recent years throughout the world tourism marketplace.

Marketing Programs and Promotions

Castle has implemented numerous marketing programs and promotions directed towards both the consumer and trade markets to generate incremental revenue and market loyalty for the individual properties.  We have developed a wide range of programs designed specifically to reflect the unique attributes of each of our resort properties, while providing various incentives.  We manage a number of marketing programs and promotions, some of which are seasonal to drive incremental room night revenues during valley or shoulder periods, and some of which are ongoing throughout the year.  During the past year we have emphasized programs relating to value travel and accommodations as well as increased consumer direct booking at the luxury properties we manage.

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Growth Strategy

The majority of the properties presently managed by Castle are located within the state of Hawaii.  In addition, Castle manages properties in New Zealand and Saipan.

During the course of 2009 and through 2010, as a result of the declines in world economic conditions and decreasing revenues from our existing operations, Castle has temporarily halted its expansion plans and efforts aimed at the Far East Asian region.  While we believe that significant opportunities for Castle exist there, we have chosen to focus on obtaining additional contracts within the State of Hawaii due to the opportunities afforded by the economic downturn including sales of properties, foreclosures, underperformance of certain properties, and dissatisfaction with the current management of our competitors.  Castle will explore expansion again into the Asian region when it determines that the economic conditions would make it profitable to enter these regions.

As part of Castle’s strategies to secure long term, multi-year management contracts, from time to time, we have found it advantageous to purchase or lease selected real property within a resort or condominium project.  This occurred in 2004, when Castle’s wholly owned subsidiary, NZ Castle Resorts and Hotels Limited, entered into an agreement to purchase all of the shares of Mocles Holdings Limited (“Mocles”), a New Zealand Corporation.  Mocles owns the Podium levels (“Podium”) of the Spencer on Byron Hotel in Auckland, New Zealand, which includes the front desk, restaurant, bar, ballroom, board room, conference rooms, back of the house facilities and other areas necessary for the hotel’s operation.  Through our ownership of the Podium and a multi-year management contract for the Spencer on Byron hotel, Castle is assured of ongoing revenues in future years from this property.  

In 2010 Castle took a major step forward in the domestic market as it secured an ownership interest in a Hawaii property that it manages.  In addition to focusing on growing our portfolio of properties, Castle will also concentrate on securing additional equity ownership interests in properties in both the domestic and international markets as well.

Item 1A.  Risk Factors

Item 2.  Property.

Castle leases office space for its principal executive offices.  The current lease expires on October 31, 2011 at a rental cost that averages $9,928 per month, plus the cost of common area maintenance.  Castle has an option to renew the leases for an additional three years at the then prevailing rental rates.

Castle leases additional office space at a rental cost of $5,472 per month, plus the cost of common area maintenance, this lease expires on February 28, 2011.  In 2011, Castle renewed this lease for an additional three year period, with a reduced rental cost for the first year with the remaining two years at our current rental rate.

In July, 2001, Castle entered into lease agreements (in lieu of a traditional management agreements) with each of the owners of approximately 250 investment units of the Spencer on Byron condominium project for the purpose of having those units be part of the rental program at the Spencer on Byron Hotel.  The leases are for a period of ten years expiring on July 18, 2011, and Castle has the option to extend these leases for an additional 20 years.  Monthly lease rent through 2011 is calculated as a percentage of the purchase price paid by the original owner of each condominium.  Monthly lease rent for the option period after July 18, 2011 will be based on the net profits of the rental program at the Spencer on Byron Hotel.  Management intends to exercise its option to continue to manage the rental of the individual condominiums.

On December 24, 2004, the Company, through its wholly owned subsidiary NZ Castle Resorts and Hotels Limited, entered into an agreement to purchase all of the shares of Mocles Holdings Limited (“Mocles”), a New Zealand Corporation.  The purchase price for Mocles was $7,455,213 (NZ$10,367,048), net of imputed interest $1,164,699 (NZ$1,632,952).  The face value of the purchase price was $8,619,912 (NZ$12,000,000).   Details of this purchase and residual amounts due are more fully described in Note 11 of the Notes to Financial Statements.  

Item 3.  Legal Proceedings.

The Company is subject to various claims and lawsuits which are normal and reasonably foreseeable in light of the nature of the Company’s business and the growth in the Company’s business.  In the opinion of management, although no assurances can be given, the resolution of these claims will not have a material adverse effect on the Company’s financial position, results of operations and liquidity.  Further, to the knowledge of management, no director, officer, affiliate, or record of beneficial owner of more than 5% of the common voting stock of the Company is a party adverse to the Company or has a material adverse interest to the Company in any material proceeding.

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Item 4.  (Removed and Reserved).

PART II

Item 5.  Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Castle’s common stock began trading on December 31, 2007 under the trading symbol CAGU.  Prior to that time, it traded sporadically on the “pink sheets.”  The OTC Bulletin Board is an over the counter market quotation system and as such, all stock prices reflect as noted by the system are inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.  

Price Range of Common Stock

The price range per share of common stock presented below represents the highest and lowest sales prices for the Company’s common stock on the OTC Bulletin Board during each quarter of the two most recent fiscal years.

Holders of Record

There were approximately 280 owners of record of Castle’s common stock as of March 30, 2011.

Dividends

Castle has not paid any dividends with respect to its common stock, and does not intend to pay dividends on its common stock in the foreseeable future.  As more fully described in Note 7 to Castle’s consolidated financial statements included herein, in 1999 and 2000, the Company issued a total of 11,050 shares of $100 par value redeemable preferred stock.  Dividends are cumulative from the date of original issue and are payable semi-annually, when, and if declared by the board of directors beginning July 15, 1999, at a rate of $7.50 per annum, per share.  During the fiscal year ended July 31, 2000, the Company paid dividends to holders of record as of July 15, 2000, in the amount of $16,715.  At December 31, 2010, undeclared and unpaid dividends on these shares totaled $953,069 or $86.25 per preferred share. These dividends are not accrued as a liability, since no dividends have been declared.  Castle cannot pay dividends on its common stock until it declares and pays the dividends on its preferred stock.  It is the present intention of management to utilize all available funds for the development and expansion of Castle’s business, rather than for common stock dividend payments.  

Securities Authorized for Issuance under Equity Compensation Plans

Castle does not have any equity compensation plans and as such no securities have been authorized for issuance subject to such a plan.

Recent Sales of Unregistered Securities

During the last three years, we issued the following unregistered securities:

In 2008 the Company raised additional capital from the completion of a Unit offering which resulted in the issuance of 333,337 Units at a price of $1.50 per Unit.  Each Unit consists of one of the Company’s common stock and a warrant to purchase an additional share of the Company’s common stock at a price of $3.50 for a period of three years, subject to certain restrictions.  Through this financing the Company raised a net amount of $224,745 for use as working capital and converted $227,500 in outstanding debt and short term obligations.  Members of management and certain directors purchased 260,003 Units at the offering price.

In 2008, the Company issued 75,000 shares of its common stock to one of its directors for services rendered to the Company. These shares were valued at $1.75 per share which equals the closing price of the common stock on the date of issuance and the entire valuation was recorded as compensation expense on that date.

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During 2009, there were no new issuances of registered or unregistered securities.

During 2010 the Company issued 80,000 of its common stock to non-employee directors of the Company.  The shares were valued at $.20 per share which equaled the closing price of the common stock on the date of issuance and the entire valuation was recorded as compensation expense on that date.  In addition to the shares, the non-employee directors also received, for every share issued, a warrant to purchase an additional share of the Company’s common stock at a price of $1.00.  The warrants expire at the earlier of five years or 60 days after the Company’s common stock trades for an average price of $3.00 per share for 20 consecutive days and were valued using the Black-Scholes pricing model at $.12 per share or $9,440. The inputs for the pricing model included an expected term of 2.5 years and volatility of 131%.

Castle issued all of these securities to persons who were “accredited investors” or “sophisticated investors,” as those terms are defined in Regulation D of the Securities and Exchange Commission; and each such person had prior access to all material information about us.  We believe that the offer and sale of these securities were exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), pursuant to Sections 4(2) and 4(6) thereof, and Rule 506 of Regulation D of the Securities and Exchange Commission.  Sales to “accredited investors” are preempted from state regulation.

Use of Proceeds of Registered Securities.

There were no proceeds received by Castle from the sale of registered securities during the 12 months ending December 31, 2010.

Purchases of Equity Securities by Us and Affiliated Purchasers.

On July 23, 2010 the Company acquired a 7% common series interest in the ownership of a hotel located in Hawaii.  The Company received a finder’s fee in exchange for the Company’s assistance to the buyers of the hotel in negotiating the purchase, performing due diligence work and other consulting work.  The hotel was purchased for $17,300,000, of which $13,000,000 was financed through a first mortgage on the hotel.  The Company recognized $188,173 in revenue resulting from cash received in finder’s fees and consulting fees and then used those funds to acquire the 7% common series interest.

Item 6.  Selected Financial Data and Supplementary Financial Information.

Not Applicable

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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Plan of Operations” including statements regarding the anticipated development and expansion of Castle’s business, the intent, belief or current expectations of the performance of Castle, and the products and/or services it expects to offer and other statements contained herein regarding matters that are not historical facts, are “forward-looking” statements.  Because such statements include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements.  Factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements include, but are not limited to, the factors set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Plan of Operations.”

Factors that may affect forward- looking statements include a wide range of factors that could materially affect future developments and performance, including the following: Changes in company-wide strategies, which may result in changes in the types or mix of businesses in which Castle is involved or chooses to invest; changes in U.S., global or regional economic conditions, changes in U.S. and global financial and equity markets, including significant interest rate fluctuations, which may impede Castle’s access to, or increase the cost of, external financing  for its operations and investments; increased competitive pressures, both domestically and internationally, legal and regulatory developments, such as regulatory actions affecting environmental activities, the imposition by foreign countries of trade restrictions and changes in international tax laws or currency controls; adverse weather conditions or natural disasters, such as hurricanes and earthquakes, labor disputes, which may lead to increased costs or disruption of operations.  This list of factors that may affect future performance and the accuracy of forward-looking statements are illustrative, but by no means exhaustive.  Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty.

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RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2010 and 2009

For added clarity in the discussion below the Company’s Quarterly Statement of Operations for 2010 and 2009 are presented as reported in the Company’s Form 10-Q Quarterly Reports with the Securities and Exchange Commission:

Revenue

For 2010, our revenue trend is reflective of a recovery in the tourism industry of Hawaii.  The Hawaii State Department of Business, Economic Development, and Tourism (DBEDT) announced that overall there was a 4.1% increase in visitor arrivals, an 8.2% increase in visitor days, and a 14.8% increase in visitor spending in Hawaii for 2010 as compared to 2009. ¹   Total airline seat capacity to Hawaii also reflected this trend with an increase of 5.8% in 2010 as compared to 2009. ²

¹ Hawaii State Department of Business, Economic Development and Tourism (http://hawaii.gov/dbedt/info/economic/data_reports/qser/outlook-economy)

² Hawaii Tourism Authority http://www.hawaiitourismauthority.org/documents_upload_path/tr_documents/December%202010%20Visitor%20Stats%20PR%20 (FINAL).pdf)

Castle’s Revenues totaled $17,327,901 for the year ended December 31, 2010, representing an 8% increase from $16,031,926 in 2009. Castle’s quarterly revenues increased 8%, 9%, 13% and 4% for the first through fourth quarters, respectively, in 2010 as compared 2009. Total revenue for the fourth quarter of 2010 totaled $4,506,126 as compared to $4,351,980 in the fourth quarter of 2009.

The Company has two basic types of agreements.  Under a “Gross Contract” the Company records revenue which is based on a percentage of the gross rental proceeds received from the rental of hotel or condominium units.   Under a “Gross Contract” the Company pays a portion of the gross rental proceeds to the owner of the rental unit.  The Company only records the difference between the gross rental proceeds and the amount paid to the owner of the rental unit as “Revenue Attributed from Properties.”  Under the Gross Contract, the Company is responsible for all of the operating expenses for the hotel or condominium unit.  Under a “Net Contract”, the Company receives a management fee that is based on a percentage of the gross rental proceeds received from the rental of hotel or condominium units. Under the Net Contract, the owner of the hotel or condominium unit is responsible for all of the operating expenses of the rental program covering the owner’s unit.  Under the Net Contract, the Company also typically receives an incentive management fee, which is based on the net operating profit of the covered property. Revenues received under the net contract are recorded as Management and Service Income. Under both types of agreements, revenues are recognized after services have been rendered.  A liability is recognized for any deposits received for which services have not yet been rendered.

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Revenues attributed from Properties increased 14% to $15,159,427 for the year ended December 31, 2010, as compared to $13,259,906 in 2009.  Revenues attributed to Castle’s New Zealand operation increased a total of 23% in 2010 to $8,224,794, as compared to $6,679,355 in 2009.  Management and Service Revenues decreased 28% to $1,971,913 in 2010 from $2,751,068 in 2009.  This decrease is due to the loss of three Net Contract properties in 2010 and the modification of one additional contract in 2010 upon the sale of the property.  

Other income increased 838%, from $20,952 in 2009 to $196,561 in 2010 as the Company received $188,173 for services rendered in connection with the sale of one of the properties managed by the Company.  The Company retained management of the property following the sale, and invested the fees received in return for a 7% common series ownership interest in the hotel.

The Company reported investment income of $87,226 during 2010, which represents the Company’s 7% share of the income attributable to common ownership generated by the hotel.

Costs and Expenses

Total Operating Expenses were $16,942,208 for the 12 months ending December 31, 2010.  This represents a 5% increase from the Total Operating Expenses of $16,139,870 in 2009.  The increase of 5% was due to the reasons explained below.

Attributed Property Expenses increased 10% to $14,398,550 in 2010, as compared to $13,062,203 in 2009.  Attributed Property Expenses include the operating expenses of the properties which are managed under Gross Contracts.  The increase in expenses is a result of higher occupancy in 2010, with attributed property revenues increasing by 14%.  In addition, the Company continued to institute other measures to better match costs and expenses and this allowed our gross profit margin on Attributed Property Revenues (Attributed Property Revenues – Attributed Property Expenses) to increase to 5% in 2010 as compared to 1% in 2009.  

Payroll and office expense totaled $1,858,812 in 2010, as compared to $2,291,247 in the year earlier period. This decrease is primarily related to salary and wage reductions in 2010 as compared to 2009.  The Company reduced its staffing through attrition, and pay rate decreases in 2010.

Administrative and general expense totaled $441,591 in 2010, a reduction of 16% as compared to $525,383 for 2009.  The reduction in administrative and general expenses is due to a $62,517 decrease in insurance costs.  In addition travel expenses decreased by $28,090 as the Company did not travel to the Far East areas for expansion purposes.

EBITDA reflects the Company’s earnings without the effect of depreciation, interest income or expense or taxes.  Castle’s management believes that EBITDA is a good alternative indicator of the Company’s financial performance, because it removes the effects of non-cash depreciation and amortization of assets as well as the fluctuations of interest costs based on Castle’s borrowing history along with increases and decreases in tax expense brought about by changes in the provision for future tax effects rather than current income.  A comparison of EBITDA and Net Income for 2010 and 2009 is shown below.  For the year ended 2010, EBITDA was $716,174 as compared to $153,093 for 2009, an increase of $563,081, or 368%.  EBITDA for the Fourth quarter of 2010 was $219,722 as compared to an EBITDA of $142,575 in the fourth quarter of 2009, an increase of $77,147 or 54%.   EBITDA is not a measure that is recognized within generally accepted accounting principles (GAAP).

Comparison of Net Income to EBITDA:

Depreciation expense in 2010 decreased by $17,782, to $243,255 when compared to 2009.  This was due to limited capital expenditures made during 2010 and various assets became fully depreciated during 2009.

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A foreign exchange loss of $215,534 was recognized in 2010 which resulted from the impact of an increase of the Guarantor Obligation of the Company that is payable in New Zealand Dollars (see note 4 of the Notes to Consolidated Financial Statements).   In 2009, the Company recorded a foreign exchange loss of $582,318. These exchange losses were a result of the weakening of the US Dollar exchange rate against the New Zealand Dollar.

Interest expense for 2010 totaled $346,315 for 2010, a decrease of $24,868 as compared to 2009’s total of $371,183.  This decrease is due to the reductions made during the year in the Company’s long term debt, and also reductions in interest on loans payable to banks.

The Company provides for a deferred tax asset on its United States taxable income.  Although the Company also has net operating losses that are available to carryforward from its non-US operations, due to the uncertainty of those tax benefits being used in future years, the Company has set up a provision for 100% of those tax benefits.  Income tax expense for 2010 totaled $151,611, an increase of $190,626 when compared to 2009s’ Income Tax Benefit of $39,015.  The Company’s deferred tax asset balance of $2,045,477 on December 31, 2010 is derived primarily from its taxable losses in recent years.  This reflects the Company’s estimate of the amount which will offset tax liabilities from expected taxable income in future years.  The Company expects to be profitable in 2011, and in future years as the benefits of the cost savings measures noted above are realized and additional properties and management contracts are added.  We believe that it is likely that the current portion of the deferred tax asset will be utilized in 2011 and the remainder will be utilized in subsequent years.  Since the majority of these losses occurred in recent years, the useful life of the tax asset extends well into the projected taxable periods.  Further, the nature of the derivation of the tax asset is directly applicable to the nature of the expected tax liability in future periods; as such the ‘quality’ of the tax asset in relation to the expected utilization is high.  (see note 9 of the Notes to Consolidated Financial Statements.)  The Company’s US based net operating losses available for future use are as follows:

        Available

Year

Net Operating Loss

Expires

1999

$             

1,556,403

2019

2002

1,461,310

2022

2007

   138,950

2027

2008

   669,081

2028

Total Available

$

3,825,744

Net Loss for the year ended December 31, 2010, was ($240,541), an improvement of $781,889 compared to the Net Loss of ($1,022,430) for the year ended December 31, 2009.   The net loss for 2010 includes an exchange loss of $215,534 as compared to a loss of $582,318 in 2009.  Excluding the effects of the foreign exchange gains & losses, we were successful in reducing our Net Loss for the year 2010 as compared to 2009 by $415,015.

Liquidity:

Our primary sources of liquidity include available cash and cash equivalents, and borrowing under the credit facility which was secured in October 2008 and further modified in 2009 and 2010, consisting of a $500,000 term loan and a $150,000 line of credit for our US operations and a NZ$300,000 line of credit for our New Zealand operations.  These facilities contain representations and warranties, conditions, covenants and events of default that are customary for this type of credit facility but do not contain financial covenants.  We do not believe the limitations contained in the credit facility will, in the foreseeable future, adversely affect our ability to use the credit facility and execute our business plan.

Expected uses of cash in fiscal 2011 include funds required to support our operating activities, including continuing to opportunistically and selectively expand the number of properties under our management.   

We experienced a loss in 2010 of $240,541.  The trend towards continued losses due to the economic downturn has reversed during 2010, as our loss in 2009 was $1,022,430 and the Company reported positive EBITDA in six of the last eight quarters, and five of the last six quarters.  We anticipate a continuation of the improvement in occupancy and average room rates for the properties currently under contract for the remainder of 2011.  We plan to expand the number of properties under management, which will increase the overall revenue stream in 2011.  The specific impact of these additions on revenue depends on the timing of when and if new properties are added during the year. More importantly, since 2008 we  implemented a number of cost saving and efficiency programs that began to improve the Company’s profitability and cash flows which resulted in EBITDA of $716,174 in 2010 and $153,093 in 2009 as compared to an EBITDA loss of $418,085 in 2008.  We believe that it represents a significant turnaround during these difficult times as our EBITDA continued to improve since our programs went into effect.  We project that the Company will significantly improve the overall profitability, cash flows, and working capital liquidity through 2011 as compared to 2010.  This view is based on the following assumptions:

·

Continued slight improvements in global macroeconomic trends in consumer spending and especially travel spending by consumers, and the resulting visitation trends to Hawaii and New Zealand particularly in the first half of the fiscal year.

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·

An increase in occupancy levels and slight increases in average daily rates at the properties we manage as compared to recent years.

·

A continuation of the cost savings and efficiency measures and reduction in business development and investor relations costs.  This will provide the basis for improved operating trends throughout 2010.  

·

Expansion of the number of properties under management, with emphasis on Hawaii and New Zealand.

·

A stabilization of the exchange rate between the US and New Zealand currency.

·

The change in our contract for our New Zealand Property in mid July of 2011 from a gross contract to a net contract.

·

The World Rugby Cup tournament which will be held in New Zealand in the last quarter of 2011.

·

A minimal impact on occupancy and average rates as a result of the recent tragedy in Japan, since the Company does not rely heavily on the eastbound market from Japan.

Based on current revenue forecasts and operating projections we anticipate recording an Operating Profit for the first quarter of 2011, and our current forecasts and projections anticipate that the Company will be profitable in 2011.  Our plans to manage our liquidity position in fiscal 2011 include:

·

Maintaining an intense focus on controlling expenses; while maintaining strong relationships with our owners and travel wholesalers and partners to ensure continuity and good communication.  

·

Continued improvement in our accounts receivable collection rates which will have a positive impact on working capital and liquidity.

·

Continuing with only limited capital expenditures and projects.

·

Maintain our relationships with banks and other institutions and through improved profitability and financial stability increase our borrowing availability under our credit facility.

We have considered the impact of the financial outlook on our liquidity and have performed an analysis of the key assumptions in our forecast such as sales, gross margin and expenses; an evaluation of our relationships with our travel partners and property owners and an analysis of cash requirements, other working capital changes, capital expenditures and borrowing availability under our credit facility. Based upon these analyses and evaluations, we expect that our anticipated sources of liquidity will be sufficient to meet our obligations without disposition of assets outside of the ordinary course of business or significant revisions of our planned operations through 2011.  

Other Borrowings

In October 2010, the Company extended its available credit facilities by renewing its line of credit with a local bank in Hawaii. As of March 31, 2011, the Company has the full $150,000 line of credit available for use.  During 2009, the Company drew in the aggregate $350,000 against its line of credit and repaid $300,000; during 2010, the Company drew and repaid in the aggregate $150,000 against the line, leaving a balance of $50,000 owing as of December 31, 2010.

In 2009, the Company renewed and increased its NZ$100,000 line of credit with a bank.  The Company now has a NZ$300,000 line of credit with a New Zealand bank to finance its general working capital flows in New Zealand.  As of December 31, 2010 and March 31, 2011 there were no borrowings against this line of credit.  

In May 2009, the Company received a loan of $200,000 from an unrelated party.  The loan calls for monthly payments plus interest and is due on or before June 30, 2011.

In December of 2010, the Company received a short term loan of $50,000 from an officer of one of its domestic subsidiaries.

Off-Balance Sheet Arrangements

As of December 31, 2007, the Company had an available lease line of credit with a bank for up to $250,000.  In December of 2007, as part of the Company acquiring a new hotel management agreement, the Company allowed the hotel owner to purchase computer hardware using the Company’s equipment lease line of credit in the amount of $76,501.  The hotel owner shall be responsible for making the operating lease payments to the bank, and also agreed to assume, refinance or retire the lease should the management agreement between the Company and the hotel be terminated.  On October 24, 2008, the lease line of credit was terminated by the bank upon the Company

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refinancing its term loan and revolving line of credit with another bank.  Refer to Note 4 of the Financial Statements, and in December 2009, the outstanding balance due under the lease line of credit was assigned over to the hotel owner.

Foreign Currency

The U.S. dollar is the functional currency of our consolidated entities operating in the United States.  The functional currency for our consolidated entities operating outside of the United States is generally the currency of the country in which the entity primarily generates and expends cash.  For consolidated entities whose functional currency is not the U.S. dollar, Castle translates its financial statements into U.S. dollars.  Assets and liabilities are translated at the exchange rate in effect as of the financial statement date, and results of operations are translated using the weighted average exchange rate for the period.  Translation adjustments from foreign exchange are included as a separate component of stockholders’ equity.

Item 7A.  Quantitative and Qualitative Disclosure About Market Risk

Foreign Currency Exchange Risk

In addition to our US operations, we conduct business in New Zealand. Our foreign currency risk primarily relates to our New Zealand loan guaranty and investments in foreign subsidiaries that transact business in a functional currency other than the U.S. Dollar. The exposure to this risk is minimized as we have generally reinvested profits or funded operations via local currencies for our international operations. In addition, we are exposed to foreign currency risk related to our assets and liabilities denominated in a currency other than the functional currency.

As currency exchange rates change, translation of the income statements of our international businesses into U.S. dollars affects year-over-year comparability of operating results. We have not hedged translation risks because cash flows from international operations were generally reinvested locally. Non-operating foreign exchange net loss for 2010 was $215,534 and $582,318 for 2009 attributable to the guaranty of debts in currency other than the functional currency. This was principally driven by U.S. dollar positions held at December 31, 2010 and 2009 affected by the fluctuation in the value of the US dollar to the New Zealand dollar.

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Item 8.  Financial Statements

The Castle Group, Inc. and Subsidiaries

Table of Contents

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

The Castle Group, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of The Castle Group, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations and comprehensive income, cash flows, and stockholders’ deficit, for the years ended December 31, 2010 and 2009.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audit.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Castle Group, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the results of operations and cash flows for the years ended December 31, 2010 and 2009, in conformity with accounting principles generally accepted in the United States of America.

/s/Mantyla McReynolds LLC

Mantyla McReynolds LLC

Salt Lake City, Utah

March 30, 2011

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The Castle Group, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   Summary of Significant Accounting Policies

Organization

The Castle Group, Inc. was incorporated under the laws of the State of Utah on August 21, 1981.  The Castle Group, Inc. operates in the hotel and resort management industry in the State of Hawaii, New Zealand, and the Commonwealth of Saipan under the trade name “Castle Resorts and Hotels.”  The accounting and reporting policies of The Castle Group, Inc. (the “Company”) conform with generally accepted accounting principles and practices within the hotel and resort management industry.

Principles of Consolidation

The consolidated financial statements of the Company include the accounts of The Castle Group, Inc. and its wholly-owned subsidiaries, Hawaii Reservations Center Corp., HPR Advertising, Inc., Castle Resorts & Hotels, Inc., Castle Resorts & Hotels Thailand Ltd., NZ Castle Resorts and Hotels Limited (a New Zealand Corporation),  NZ Castle Resorts and Hotels’ wholly-owned subsidiary, Mocles Holdings Limited (a New Zealand Corporation), Castle Resorts & Hotels NZ Ltd., Castle Group LLC (Guam), Castle Resorts & Hotels Guam Inc. and KRI Inc. dba Hawaiian Pacific Resorts (Interactive).  All significant inter-company transactions have been eliminated in the consolidated financial statements.

Use of Management Estimates in Financial Statements

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

Restricted Cash

The Company holds funds on behalf of the unit owners for one of the properties it manages.  These funds are to be used only for the replacement and refurbishment of the furniture and equipment within the rooms owned by the unit owner.  As of December 31, 2010 and 2009, the Company had $191,501 and $145,320 respectively, of funds held for this purpose.  The Company recorded an offsetting liability as a long term deposit payable on its balance sheet.  As of December 31, 2010, the Company held $151,975 in deposits for room rentals in New Zealand, which the New Zealand government required to be kept in a separate bank account that the Company would not be able to use until the World Rugby Cup event held in the fall of 2011.  The room deposits are classified as current deposits payable on its balance sheet.

Accounts Receivable

The Company records an account receivable for revenue earned but net yet collected.  If the Company determines any account to be uncollectible based on significant delinquency or other factors, it is immediately written off.  An allowance for bad debts has been provided based on estimated losses amounting to $134,257 and $185,749 as of December 31, 2010 and 2009, respectively.    

Property, Plant, and Equipment

Property, furniture, and equipment are recorded at cost.  When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounting records, and any resulting gain or loss is reflected in the Consolidated Statement of Operations for the period.  The cost of maintenance and repairs is expensed as incurred.  Renewals and betterments are capitalized and depreciated over their estimated useful lives.

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At December 31, 2010 and 2009, property, furniture, and equipment consisted of the following:

         2010                  2009           

     Real estate - Podium (see Note 11)

                 $  7,972,228        $ 7,440,400

     Equipment and furnishings

                     1,537,135           1,427,281

     Less accumulated depreciation

    (2,160,020)        (1,779,584)

 $  7,349,343        $ 7,088,097  

Depreciation is computed using the declining balance and straight-line methods over the estimated useful life of the assets (Equipment and furnishings 5 to 7 years, Podium 50 years).  For the years ended December 31, 2010 and 2009, depreciation expense was $243,255 and $261,037, respectively.  

Goodwill and Intangibles

Goodwill related to our historical acquisitions is not amortized, but is subject to annual review for impairment or upon the occurrence of certain events, and, if impaired, is written down to its fair value.  The Company has not recognized any impairment losses during the periods presented.

Revenue Recognition

The Company recognizes revenue from the management of resort properties according to terms of its various management contracts.

The Company has two basic types of agreements.  Under a “Gross Contract” the Company records revenue which is based on a percentage of the gross rental proceeds received from the rental of hotel or condominium units.   Under a “Gross Contract” the Company pays a portion of the gross rental proceeds to the owner of the rental unit.  The Company only records the difference between the gross rental proceeds and the amount paid to the owner of the rental unit as “Revenue Attributed from Properties.”  Under the Gross Contract, the Company is responsible for all of the operating expenses for the hotel or condominium unit.  Under a “Net Contract”, the Company receives a management fee that is based on a percentage of the gross rental proceeds received from the rental of hotel or condominium units. Under the Net Contract, the owner of the hotel or condominium unit is responsible for all of the operating expenses of the rental program covering the owner’s unit.  Under the Net Contract, the Company also typically receives an incentive management fee, which is based on the net operating profit of the covered property. Revenues received under the net contract are recorded as Management and Service Income. Under both types of agreements, revenues are recognized after services have been rendered.  A liability is recognized for any deposits received for which services have not yet been rendered.

Under a Gross Contract, the Company records the expenses of operating the rental program at the property covered by the agreement. These expenses include housekeeping, food & beverage, maintenance, front desk, sales & marketing, advertising and all other operating costs at the property covered by the agreement.  Under a Net Contract, the Company does not record the operating expenses of the property covered by the agreement.  The difference between the Gross and Net contracts is that under a Gross Contract, all expenses, and therefore the ownership of any profits or the covering of any operating loss, belong to and is the responsibility of the Company; under a Net Contract, all expenses, and therefore the ownership or any profits or the covering of any operating loss belong to and is the responsibility of the owner of the property.  The operating expenses of properties managed under a Gross Contract are recorded as “Attributed Property Expenses.”

Advertising, Sales and Marketing Expenses

The Company incurs sales and marketing expenses in conjunction with the production of promotional materials, trade shows, and retainers for out-of-state sales agents, and related travel costs.  The Company expenses advertising and marketing costs as incurred or as the advertising takes place.  For the years ended December 31, 2010 and 2009, total advertising expense was $936,865 and $975,171 respectively.

Stock-Based Compensation

The Company has accounted for stock-based compensation by recording an expense associated with the fair value of stock-based compensation.  The Company currently uses the Black-Scholes option valuation model to calculate the valuation of stock options and warrants at the date of grant.  Option pricing models require the input of highly subjective assumptions, including the expected price volatility.  Changes in these assumptions can materially affect the fair value estimate.

Income Taxes

Deferred income tax assets and liabilities are determined based upon differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.  Tax

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benefits are recognized only for tax positions that are more likely than not to be sustained upon examination by tax authorities.  We have recorded tax benefits for our US based operations as these benefits have been used in the past, and are likely to be used in the future.  We do not recognize any tax benefits from our net operating losses from our foreign operations, as it is not certain that these tax benefits will be realized in the future.  The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate settlement.  Unrecognized tax benefits are tax benefits claimed in our tax returns that do not meet these recognition and measurement standards.  Our policy is to recognize potential interest and penalties accrued related to unrecognized tax benefits within income tax expense.  For the years ended December 31, 2010 and 2009, the Company did not recognize any interest or penalties in its Statement of Operations, nor did it have any interest or penalties accrued in its Balance Sheet at December 31, 2010 and 2009, relating to unrecognized benefits.

Basic and Diluted Earnings per Share

Basic earnings per share of common stock were computed by dividing income available to common stockholders, by the weighted average number of common shares outstanding.  Diluted earnings per share were computed using the “treasury stock method”. The calculation of Basic and Diluted earnings per share for 2010 and 2009 did not include 368,335 shares which would be issued upon conversion of the outstanding $100 par value redeemable preferred stock of the Company, nor does it include 583,337shares issuable pursuant to the exercise of vested warrants as of December 31, 2009 and 663,337 vested warrants as of December 31, 2010 as the effect would be anti-dilutive.

Concentration of Credit Risks

The Company maintains its cash with several financial institutions in Hawaii and New Zealand.  Balances maintained with these institutions are occasionally in excess of federally, insured limits.  As of December 31, 2010 and 2009, the Company had balances of $0 and $221,782, respectively, in excess of US federally insured, limits of $250,000 per financial institution.    

Concentration in Market Area

The Company manages hotel properties in Hawaii, New Zealand and Saipan, and is dependent on the visitor industries in these geographic areas.

Fair Value of Financial Instruments

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.  A fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, may be used to measure fair value.  The carrying value of notes receivable and notes payable approximates fair values as these notes have interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Long-Lived Assets

We regularly evaluate whether events or circumstances have occurred that indicate the carrying value of our long-lived assets may not be recoverable.  When factors indicate the asset may not be recoverable, we compare the related undiscounted future net cash flows to the carrying value of the asset to determine if impairment exists.  If the expected future net cash flows are less than the carrying value, an impairment charge is recognized based on the fair value of the asset.  An evaluation of our intangible assets was conducted utilizing the two step impairment analysis. No impairments were indicated or recorded during the years ended December 31, 2010 and 2009.

Guarantees 

We record a liability for the fair value of a guarantee on the date a guarantee is issued or modified.  The offsetting entry depends on the circumstances in which the guarantee was issued.  Funding under the guarantee reduces the recorded liability.  When no funding is forecasted, the liability is amortized into income on a straight-line basis over the remaining term of the guarantee. Guarantees are presented as other long term obligations on the balance sheet.  

Investment in Limited Liability Company

On July 23, 2010 the Company acquired a 7% common series interest in the ownership of a hotel located in Hawaii.  The Company received a finder’s fee in exchange for the Company’s assistance to the buyers of the hotel in negotiating the purchase, performing due diligence work and other consulting work.  The hotel was purchased for $17,300,000, of which $13,000,000 was financed through a first mortgage on the hotel.  The Company recognized $188,173 in revenue resulting from cash received in finder’s fees and consulting fees and then used those funds to acquire the 7% common series interest.  The investment is accounted for as an equity method investment and

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during the year ended December 31, 2010, the Company recognized $87,226 in other income resulting from their portion of the net income attributable to the common series ownership interest.

Foreign Currency Translation and Transaction Gains/Losses 

The U.S. dollar is the functional currency of our consolidated entities operating in the United States.  The functional currency for our consolidated entities operating outside of the United States is generally the currency of the country in which the entity primarily generates and expends cash.  For consolidated entities whose functional currency is not the U.S. dollar, we translate their financial statements into U.S. dollars.  Assets and liabilities are translated at the exchange rate in effect as of the financial statement date, and the line items of the results of operations are translated using the weighted average exchange rate for the year. Translation adjustments from foreign exchange are included as a separate component of shareholders’ equity.  Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations.

New Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (FASB) issued amended standards that require additional fair value disclosures. These amended standards require disclosures about inputs and valuation techniques used to measure fair value, as well as disclosures about significant transfers, beginning in the first quarter of 2010.  This amendment did not have an impact on our financial statements.  Additionally, these amended standards require presentation of disaggregated activity within the reconciliation for fair value measurements using significant unobservable inputs (Level 3), beginning in the first quarter of 2011.  These additional requirements are not expected to have a material impact on the financial statements.

In October 2009, the FASB issued Accounting Standards Update No. 2009-13 for Revenue Recognition – Multiple Deliverable Revenue Arrangements (Subtopic 605-25) “Subtopic”. This accounting standard update establishes the accounting and reporting guidance for arrangements under which the vendor will perform multiple revenue – generating activities. Vendors often provide multiple products or services to their customers. Those deliverables often are provided at different points in time or over different time periods. Specifically, this Subtopic addresses how to separate deliverables and how to measure and allocate arrangement consideration to one or more units of accounting.  The amendments in this guidance will affect the accounting and reporting for all vendors that enter into multiple-deliverable arrangements with their customers when those arrangements are within the scope of this Subtopic.  This Statement is effective for fiscal years beginning on or after June 15, 2010. Earlier adoption is permitted. If a vendor elects early adoption and the period of adoption is not the beginning of the entity’s fiscal year, the entity will apply the amendments under this Subtopic retrospectively from the beginning of the entity’s fiscal year.  The presentation and disclosure requirements shall be applied retrospectively for all periods presented. Currently, Management believes this Statement will have no impact on the financial statements of the Company once adopted.

In December 2010, the FASB issued Accounting Standards Update No. 2010-28, Intangibles – Goodwill and Other (Topic 350):  When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (ASU 2010-28).  ASU 2010-28 modifies Step 1 of the goodwill impairment test so that for those reporting units with zero or negative carrying amounts, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not based on an assessment of qualitative indicators that a goodwill impairment exists.  In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist.  ASU 2010-28 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010.  The Company does not expect adoption of this standard to have a material impact on its consolidated results of operations and financial condition.

2.   Related Party Transactions

Hanalei Bay International Investors (“HBII”)

The Chairman and CEO of the Company is the sole shareholder of HBII Management, Inc., the managing General Partner of Hanalei Bay International Investors (“HBII”).  In March 1999, HBII consummated the sale of its interest in Hanalei Bay Resort to an unrelated third party.  The cash proceeds received by HBII on the closing of the sale were not sufficient to satisfy all claims of HBII’s creditors, including the Company, and the Company accepted a note receivable in the amount of $4,420,003 as settlement for its account receivable balance of $1,105,001 at the time of the sale.  The excess amount $3,315,002 over the receivable balance was accounted for as a shareholder contribution.  Under the terms and conditions of the agreement to sell Hanalei Bay Resort, HBII was entitled to receive a percentage of the future cash flows from the resort’s hotel operations and the sale of certain time-share units.    

As part of the Company’s purchase of real estate in New Zealand (see Note 11), an assignment of $3,018,000 of the total note receivable from HBII was made to the seller of the real estate, with the Company remaining as guarantor should the note receivable not be collected before December 24, 2010 (See Note 3).  The Company extended the maturity date of this liability to December 31, 2012.

During 2006, the purchaser of Hanalei Bay Resort (“HBR”), disputed the amount that it was indebted to HBII, and HBII filed a lawsuit to collect the amounts owed by HBR.  In March 2008, HBII and Quintus Resorts, LLC (“Quintus”), the parent company of HBR, entered

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into a settlement to resolve the litigation by Quintus issuing a 19.9% membership interest in Quintus to HBII or its designee, which included a preferred return as to the first $6.2 million of future distributions of available cash flow.

Quintus is the owner of a timeshare resort project in Genoa, Nevada, near Lake Tahoe.  Quintus has not yet completed its financial statements for 2010 but the latest unaudited financial statements received from Quintus showed a net equity of approximately $1.6 million. Neither Quintus’ estimates as to the fair market value of its assets nor its projections have been verified or reviewed by Management or any independent third party.  

For at least the next year, Quintus will be required to use all of its available cash flow to pay down the substantial indebtedness it incurred in purchasing the resort.  Based on Quintus’s financial projection, HBII’s management believes that it is likely to receive in excess of $6,000,000 from its ownership interest in Quintus and that it will utilize these funds to pay its indebtedness to the Company.  In that the distributions from HBII will likely not be realized for a number of years and are subject to uncertainty and risks over which the Company has no control, there can be no assurance that the Company will receive any distributions from HBII’s ownership interest in Quintus within the next ten years, if at all.  In light of such uncertainties, as required by Generally Accepted Accounting Principles (“GAAP”) the Company has established a reserve for uncollectible amounts equal to the entire amount of the receivable.  

Investment in LLC

In July 2010, the Company acquired a minority interest in a limited liability company that purchased one of the properties managed by the Company.  After the purchase, the chief financial officer of Castle Resorts & Hotels, Inc. was appointed treasurer of a subsidiary of the limited liability company that owns the property.

Related Party Loans

In June, 2004, a director loaned the Company $125,000 with interest at the rate of 8% per annum and monthly payments of interest plus $521, and a maturity date of January 1, 2012.

Through December 2010, the Company has accrued but not paid the Chairman and CEO a total of $27,808 for expenses incurred on behalf of the Company, and $61,014 for interest accrued on a note payable.

Through December 2010, the Company has accrued but not paid the Company’s COO a total of $642 for expenses incurred on behalf of the Company.

In December 2010, the Company received a $50,000 short term loan from an officer of the Company’s domestic subsidiary.  This short term loan bears no interest and is payable on demand.

During 2002, the Company’s CEO advanced $117,316 to the Company for general working capital.  The note bears interest at 10% and is due on or before January 1, 2012.

During 2004, the Company’s CEO advanced $125,000 to the Company for general working capital.  The note calls for monthly payments of $2,544, including interest at prime plus 2.5%, with the remaining principle balance due on 4/26/09.  In April 2009, the note was paid in full.

3.   Notes Receivable

Notes receivable consisted of the following:

       2010               2009

Note receivable from Hanalei Bay International Investors,

secured by a direct assignment of Hanalei Bay International

Investors right to receive future proceeds from HBII’s

ownership interest in Quintus. (Assigned to third parties- see Note 2)

$ 4,269,151       $ 4,269,151

Less Reserve for Uncollectible Notes

   4,269,151          4,269,151

Notes Receivable, Non-current

$              0       $               0

See Note 2 above. Pursuant to GAAP, the Company has established a reserve for uncollectible amounts.  The Company recorded an expense during 2007 for $954,459, and reduced additional paid in capital for $3,315,002 in providing for the reserve. This is a reflection of the nature of the original accounting treatment.  This line item does not appear on the balance sheet due to its $0 carrying value.

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4.   Commitments and Contingencies

Leases

The Company leases two office spaces expiring February 28, 2011 and October 31, 2011 and for the years ended December 31, 2010 and 2009, the Company paid $372,484 and $379,358, respectively, in lease expense for these leases. As of December 31, 2010, the future minimum rental commitment under these leases was $193,948.

In July, 2001, Castle entered into lease agreements (in lieu of a traditional management agreements) with each of the owners of approximately 250 investment units of the Spencer on Byron condominium project for the purpose of having those units be part of the rental program at the Spencer on Byron Hotel.  The leases are for a period of ten years expiring on July 18, 2011, and Castle has the option to extend these leases for an additional 20 years.  Monthly lease rent through 2011 is calculated as a percentage of the purchase price paid by the original owner of each condominium. Total lease expense for the year ending December 31, 2010 and 2009 was $2,258,221 and $2,037,292, respectively.  

As of December 31, 2010, the future lease commitments are as follows:

  Year

        Amount     

  2011

   $    1,631,795

  2012 and beyond

                       0

  Total

   $    1,631,795

The purchase of Mocles Holdings Limited (see Note 11) includes a requirement for monthly payments of the greater of $15,380 (NZ$20,000) or Surplus Profits, as defined at Note 11.  Using the monthly rate of $15,380, total annual payments are approximately $184,560 per year, beginning in 2005 and continuing through 2012 at that amount.  The Company has not yet determined whether the Surplus Profits will be greater than $184,560 for 2011.  The approximate term is 2 years.  

As of December 31, 2007, the Company had an available lease line of credit with a bank for up to $250,000.  In December of 2007, as part of the Company acquiring a new hotel management agreement, the Company allowed the hotel owner to purchase computer hardware using the Company’s equipment lease line of credit in the amount of $76,501.  The hotel owner is responsible for making the operating lease payments to the bank, and also agreed to assume, refinance or retire the lease should the management agreement between the Company and the hotel be terminated.  On October 24, 2008, the lease line of credit was terminated by the bank upon the Company refinancing its term loan and revolving line of credit with another bank.  In December 2009, the balance due on the lease line of credit was assigned over to the hotel owner.

Guaranty

As part of the Company’s purchase of real estate in New Zealand (see Note 11), an assignment of $3,018,000 of the total note receivable from HBII was made to the seller of the real estate, with the Company remaining as guarantor should the note receivable not be collected before December 31, 2012 (see Note 2).  In 2009, due to the strengthening of the New Zealand dollar against the US dollar, the amount recorded as “Other long term obligations” on the Company’s balance sheet was increased to $3,015,368; with the difference of $582,318 recorded as a foreign exchange loss as of December 31, 2009.   In 2010, the New Zealand dollar strengthened against the US dollar, and the Company recorded a foreign exchange loss of $215,534, and increased the amount recorded as “Other long term obligations” to $3,230,902.

The assignment does not have a provision for interest and in 2007, the Company had fully amortized the imputed interest on the assignment.  For 2010 and 2009, the Company recorded interest expense of $159,238 and $140,206, respectively, based on 5.25% on the guaranty of NZ$ 4,201,433 assignment and an increase in Additional Paid in Capital for the same amount.

The Company has recognized a guarantor liability for these assignments, amounting to $3,230,902 as of December 31, 2010, and $3,015,368 as of December 31, 2009, which represents the present fair value of the obligation undertaken in becoming a guarantor of the payment of the assigned receivables.  In March 2010, the Company extended the due date such that if the Company remains current with its obligations in connection with the purchase of the New Zealand Real Estate, an extension to December 31, 2012 is available.

Management Contracts

The Company manages several hotels and resorts under management agreements expiring at various dates.  Several of these management agreements contain automatic extensions for periods of 1 to 10 years.  

In addition, the Company has sales, marketing and reservations agreements with other hotels and resorts expiring at various dates through March 2014.  Several of these agreements contain automatic extensions for periods of one month to three years.  Fees received are based on revenues, net available cash flows or commissions as defined in the respective agreements.

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Litigation

There are various claims and lawsuits pending against the Company involving complaints, which are normal and reasonably foreseeable in light of the nature of the Company’s business.  The ultimate liability of the Company, if any, cannot be determined at this time.  Based upon consultation with counsel, management does not expect that the aggregate liability, if any, resulting from these proceedings would have a material effect on the Company’s consolidated financial position, results of operations or liquidity.

5. Employee Benefits

The Company has a 401(k) Profit Sharing Plan (the “Plan”) available for its employees.  Under the terms of the Plan, the Company may match 50% of the compensation reduction of the participants in the Plan up to 1% of compensation.  On March 1, 2009, the Company terminated its matching contribution.  Employees may continue to contribute a portion of their compensation into the plan however the Company will not make a matching contribution.  Matching contributions for the years ended December 31, 2010, and 2009 were $0 and $2,660, respectively.  Any employee with one-year of continuous service and 1,000 credit hours of service, who is at least twenty-one years old, is eligible to participate.  For the years ended December 31, 2010 and 2009, the Company made no profit contributions.   

The Company also has a Flexible Benefits Plan (the “Benefits Plan”).  The participants in the Benefits Plan are allowed to make pre-tax premium elections which are intended to be excluded from income as provided by Section 125 of the Internal Revenue Code of 1986.  To be eligible, an employee must have been employed for 90 days.  The benefits include group medical insurance, vision care insurance, disability insurance, cancer insurance, group dental coverage, group term life insurance, and accident insurance.

6. Notes Payable

Notes payable consisted of the following

         2010  

          2009

Note dated 6/6/04 to a director, with interest at the rate

of 8%, monthly payments of interest plus $521,

balance due 1/1/12, unsecured

$          33,855     

$          40,104

Note dated 6/16/04 to unrelated party with interest at the

rate of 15% due on 1/1/12 with monthly payments of

NZ$3,225 (US$2,315), unsecured     

          198,402       

          185,167

Note dated 7/31/95 to former stockholders, due 8/31/98

with interest at 6%, unsecured.  No formal demand has

been made on the Company.   

                           12,000

                   12,000

Note dated 12/31/02 from the Company’s CEO, with

interest at 10%, due on or before 1/1/12, unsecured

         117,316

         117,316

Note dated 12/31/04, payable in New Zealand, net of discount of $.072 and

$0.158 million, as of 2010 and 2009, respectively, with an original face

value of $8.6 million and which is secured by real estate in New Zealand and

a general security agreement including an assignment of $3.018 million of the

note receivable due from HBII.  The Company acts as a guarantor for the

payment of the assigned receivable, and therefore, the obligation undertaken

as a guarantor is included in this amount.  The guarantor obligation is referred

to as “Other long term obligations” on the Balance Sheet (See Note 4).  The

effective interest rate at December 31, 2010 is 5.25% per annum.  The maturity

date is December 31, 2012 (See Notes 2 and 11).

     7,947,837

     7,483,447

Note dated 12/31/04 payable to unrelated party, with interest

at 10% due 3/01/12 with monthly payments of $2,975, unsecured

          33,810

                    64,445

Note dated 10/20/08 payable to a bank, with interest at the bank’s

prime rate plus 1%, secured by a security interest in all personal

property of the Company and by the personal guaranty of the Company’s

Chairman & CEO, with monthly payments of $8,333 plus interest.

The note is due on or before 10/20/2013.

        283,342

                 383,338

26

Revolving line of credit with a bank for up to $150,000.

The line is secured by a general security interest in the

Company’s assets.  Draws against the line will bear interest

at the bank’s base lending rate plus 2%.  The line has a

termination date of October 31, 2011.                     

                                         50,000

                  50,000

Revolving line of credit with a bank for up to NZ $300,000.

The line is secured by a general security interest in the Company’s

assets in New Zealand.  Draws against the line will bear interest at

the bank’s base lending rate plus 2%.  The line is cancellable at

any time by the bank.

                  0

                            0

Note dated 5/15/09 payable to unrelated party, unsecured, with

interest at 10% and monthly payments of $4,946.  The note

is due on or before June 15, 2011.

        28,828

                   143,918

Subtotal

$ 8,705,390

$ 8,479,735

Less Current Portion

      415,448

                   500,412

Notes payable, non-current

$ 8,289,942

$ 7,979,323

The five year payout schedule for notes payable is as follows:

 Year

       Amount   

2011

   $    415,448

2012

      8,206,600  

2013

           83,342

Thereafter  

    0

Total

   $ 8,705,390

7. Redeemable Preferred Stock

In 1999 and 2000, the Company issued a total of 11,050 shares of $100 par value redeemable preferred stock to certain officers and directors.  Dividends are cumulative from the date of original issue and are payable semi-annually, when, and if declared by the board of directors beginning July 15, 1999, at a rate of $7.50 per annum per share.  During the fiscal year ended July 31, 2000, the Company paid dividends to holders of record as of July 15, 2000, in the amount of $16,715.  At December 31, 2010, undeclared and unpaid dividends on these shares were $983,069 or $86.25 per preferred share.  These dividends are not accrued as a liability, as no declaration has occurred. The shares are nonvoting, and are convertible into the Company’s common stock at an exercise price of $3.00 per share.  As of January 15, 2001, the redeemable preferred stock is redeemable at the option of the Company at a redemption price of $100 per share plus accrued and unpaid dividends.

8.  Common Stock

During 2010 the Company issued 80,000 shares of its common stock to non-employee directors of the Company.  The shares were valued at $.20 per share which equaled the closing price of the common stock on the date of issuance and the entire valuation was recorded as compensation expense of $16,000 on that date.  In addition to the shares, the non-employee directors also received, for every share issued, a warrant to purchase an additional share of the Company’s common stock at a price of $1.00.  The warrants expire at the earlier of five years or 60 days after the Company’s common stock trades for an average price of $3.00 per share for 20 consecutive days.  The warrants were valued using the Black-Scholes pricing model at $.12 per share or $9,440. The inputs for the pricing model included an expected term of 2.5 years, .27% risk free interest rate, and volatility of 131%.

The Company has a guarantor obligation of NZ$ 4,201,433 related to the purchase of real estate (see Note 11).  The terms of the agreement do not provide for interest to be paid to the holder of this debt and therefore in 2010 and 2009, the Company recorded interest expense of $159,238 and $140,206, respectively, representing 5.25% of the obligation and increased Additional Paid in Capital for the amount of interest expense recorded on the obligation.

Common Stock Options and Warrants

The Company does not have Stock Based Incentive, Stock Purchase or Stock Option or Warrant Plans.  No options or warrants were outstanding prior to January 1, 2007.

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The average risk-free interest rate is determined using the U.S. Treasury rate in effect as of the date of grant, based on the expected term of the stock warrant.  The Company determined the expected term of the stock warrants as being equal to one half of the contractual term of the warrants due to a lack of exercise and forfeiture history and the thinly traded volume of the Company’s common stock.   

Changes in warrants for the years ended December 31, 2010 and 2009 were as follows: 

The following table summarizes information about compensatory warrants outstanding at December 31, 2010:

9.            Income Taxes

The provision for income taxes consists of the following:

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The components of the Company’s deferred tax assets and liabilities are as follows:

As of December 31, 2010, the Company had net operating loss carry forwards amounting to $3,825,744 and $404,058 for domestic and foreign, jurisdictions, respectively, which expire on various dates through 2029, except for our foreign jurisdictions which do not expire. The Company expects to utilize $105,045 of the loss carryforward for the year ended December 31, 2011, and has therefore classified the deferred tax asset associated with the loss carryforward as a current asset on the Company’s consolidated balance sheet.  

The Company’s US based net operating losses available for future use are as follows:

        Available

Year

Net Operating Loss

Expires

1999

$             

1,556,403

2019

2002

1,461,310

2022

2007

   138,950

2027

2008

   669,081

2028

Total Available

$

3,825,744

Income tax expense differs from amounts computed by applying the statutory Federal rate to pretax income as follows:

The Company has evaluated its uncertain tax positions and determined that any required adjustments would not have a material impact on the Company's balance sheet, income statement, or statement of cash flows.

A reconciliation of the unrecognized tax benefits for the years ending December 31, 2010 and 2009 is presented in the table below:

The tax years 2001 through 2010 remain open to examination for federal income tax purposes and by other major taxing jurisdictions to which we are subject.

10.Business Segments

As stated in Note 1, the Company has two basic types of hotel management agreements:  Gross Contracts and Net Contracts. As described in Note 1, the revenues and expenses are disclosed separately on the statements of operations for each type of agreement.  The assets included in the consolidated financial statements only consist of assets owned in relation to the Gross Contract agreements and other assets used for general corporate purposes.  The financial statements do not include any assets the Company manages under the Net Contract agreements, since the Company does not have the same level of responsibility that it has under Gross Contracts.

The consolidated financial statements include the following related to international operations (which are predominately in New Zealand and related to Gross Contract agreements):  Revenues of $8,224,794 in 2010 and $6,679,508 in 2009; net loss of ($89,432) in 2010 and ($525,876) in 2009; and net fixed assets of $7,341,390 in 2010 and $7,070,019 in 2009.   The consolidated financial statements also include the following related to our operations in Thailand:  Revenues of $0 in 2010 and $374,499 in 2009 net loss of $0 in 2010 and ($111,831) in 2009; and fixed assets of $0 in 2010 and 2009.

11. Purchase of Mocles Holdings Limited

On December 24, 2004, the Company, through its wholly owned subsidiary NZ Castle Resorts and Hotels Limited, entered into an agreement to purchase all of the shares of Mocles Holdings Limited (“Mocles”), a New Zealand Corporation.  Following are the significant provisions of this agreement (with modifications according to a “Deed of Variation” dated April 15, 2005):

Mocles owns the Podium levels (“Podium”) of the Spencer on Byron Hotel in Auckland, New Zealand.

The purchase price for Mocles was $7,972,260 (NZ$10,367,048), net of imputed interest $1,255,740 (NZ$1,632,952).  The face value of the purchase price was $9,228,000 (NZ$12,000,000).   

The purchase price is to be paid as follows:

Partial assignment of the Company’s receivables from Hanalei Bay International Investors (“HBII”) in the amount of US$3,018,000.  In the event that this amount is not realized from HBII, the Company is obligated to make up the difference by December 31, 2012.

Monthly payments of the greater of NZ$20,000 (US$15,380), or Surplus Profits defined as 50% of net profits, whichever is higher, calculated in accordance with New Zealand’s Generally Accepted Accounting Principles or International Reporting Standards.  Beginning on August 1, 2011, monthly payments will be increased by NZ$20,000 (US$15,380), which represents interest on the outstanding obligation.  The vendor has the right to increase the interest payable on the then outstanding balance of the purchase price provided that the interest rate does not exceed the Westpac Banking Corporation indicator lending rate plus a margin of 3%.

At the time of purchase, Mocles had additional debts, namely:

(1)

Bank Mortgage – There is $2,273,502 payable to a bank which is secured by the Podium.  The liability to the bank must be refinanced, paid in full, or renegotiated to the extent that the current guarantors are released from all obligations associated therewith, by December 31, 2012.

(2)

Advances from parties heretofore related to Mocles in the amount of $1,509,768.  The entire amount is due and payable by December 31, 2012 (See Note 2).  There is no interest associated with this liability through 2010.

The purchase price is deemed to be satisfied in part by NZ Castle procuring repayment of Mocles additional debts.  After NZ Castle has procured repayment of the additional debts by or on behalf of Mocles, the total payable to the seller of the Mocles shares under 1 and 2 above is $4,836,642.

Mocles shares are being held legally by the seller of such shares until such time as all obligations associated with this transaction are satisfied.

An amount equal to the interest payable by Mocles to the bank is to be paid annually to Mocles by the Company as rental for the Podium.

A replacement fund is to be established from 50% of the net profits from the operation of the Podium, until such time as there is NZ$175,000 (US$134,575) regularly available for the replacement of furniture, fixtures and equipment installed in the Podium.  If and to the extent that the balance in the replacement fund would exceed NZ$175,000 (US$134,575), the 50% share of the net profits must be paid

30

towards the purchase price rather than being accumulated.  As of December 31, 2010 and 2009, there was NZ$1,474 (US$1,134) and NZ$1,801 (US$1,385) in the replacement fund.

12. Subsequent Event

The Company is negotiating a settlement with the owner of a property previously managed by the Company with regard to contract guaranty.  The Company does not anticipate paying out a net settlement to the owner due to various circumstances regarding the property, including a force majeur clause in the management contract.  Since the Company does not anticipate paying out any net settlement, and also cannot estimate the amount of this net settlement, no liability for this claim has been recorded as of December 31, 2010.

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

None.

Item 9A. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The Company’s management conducted an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer (who is also the Acting Chief Financial Officer), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2010.  Our Chief Executive Officer has concluded that all disclosure controls and procedures were effective as of December 31, 2010, in providing reasonable assurance that information required to be disclosed by us in the reports we file under the Exchange Act are recorded, processed, summarized, and reported as specified in the Securities and Exchange Commission’s rules, regulations, and forms.   

The design and evaluation of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.  Management has determined that any identified deficiencies, in the aggregate, do not constitute material weaknesses in the design and operation of our internal controls in effect prior to December 31, 2010.

Changes in Internal Control over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, during its fourth fiscal quarter of 2010 that have materially affected, or are reasonably likely to materially affect its internal control over financial reporting.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting.  Our internal control system is intended to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements and that we have controls and procedures designed to ensure that the information required to be disclosed by us in our reports that we are required to file under the Exchange Act is accumulated and communicated to our management, including our principal executive and our principal financial officers or persons performing similar functions, as appropriate to allow timely decisions regarding financial disclosure.   

Management’s assessment of the effectiveness of our internal controls is based principally on our financial reporting as of December 31, 2010.  In making our assessment of internal control over financial reporting, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework.  Our management, with the participation of our Chief Executive Officer (who is also the Acting Chief Financial Officer), has evaluated the effectiveness of our internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, as of December 31, 2010.  Those rules define internal control over financial reporting as a process 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 (“GAAP”) and includes those policies and procedures that:

·

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;

·

Provide reasonable assurance that the transactions are recorded as necessary to permit the preparation of financial statements in accordance with GAAP, and the receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

·

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.

Based on our assessment and those criteria, management believes that, as of December 31, 2010, the Company’s internal control over financial reporting is effective.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  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 policies or procedures may deteriorate.

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This Annual Report does not include an attestation report of the Company’s registered public accounting firm due to rules established by the Securities and Exchange Commission for Smaller Reporting Companies.  Our auditors have not advised us of any material weaknesses in our internal controls in connection with auditing our consolidated financial statements for the years ended December 31, 2010, and 2009. 

Item 9B. Other Information.

In 2009, the Company discontinued its matching contribution on the Company’s 401k pension plan (see note 5 to the consolidated financial statement).

PART III

Item 10.  Directors, Executive Officers and Corporate Governance.

The following table sets forth certain information concerning the directors and executive officers of Castle as of December 31, 2010.  Except as otherwise stated below, the directors will serve until the next annual meeting of stockholders or until their successors are elected or appointed, and the executive officers will serve until their successors are appointed by the Board of Directors.

Director and Officer Backgrounds

Rick Wall. - Mr. Wall was appointed Castle’s Chief Executive Officer and Chairman of the Board in 1993.  Mr. Wall is the founder of Castle, and has served on the board of directors, and the executive committee of the Hawaii Visitors and Convention Bureau.  

Alan Mattson – Mr. Mattson possesses over 25 years of executive level hospitality and travel industry experience.  Mr. Mattson was formerly vice president of sales and marketing for Dollar Rent a Car, responsible for all sales and marketing efforts for Hawaii, Asia, and the Pacific.  Prior to that, he was director of marketing for Avis Car Rental, operating out of the Avis worldwide headquarters in New York and responsible for the marketing within the US rental car division.  In addition, Mr. Mattson has seven years of sales and marketing experience with Hilton Hotels Corporation, performing in a variety of senior level sales and marketing positions in Hawaii and the domestic United States.  He joined Castle in September 1999, as senior vice president of sales and marketing and was later promoted to President in July, 2005.  Mr. Mattson was appointed to the position of Chief Operating Officer of the Castle Group, Inc., in June, 2007.  

John Brogan - Mr. Brogan is a well-respected and recognized leader in the hotel industry, Mr. Brogan’s last position before retirement was President of Starwood Hotels and Resorts - Hawaii.  Previously, he chaired various boards, including Hawaii Visitors & Convention Bureau, Hawaii Hotel Association, American Heart Association-Hawaii, Blood Bank of Hawaii, Waikiki Improvement Association, and Chaminade University.

Rick Humphreys - Mr. Humphreys has almost 40 years of financial expertise.  He started his career with Bank of California, and was formerly president of both First Federal S & L and Hawaiian Trust Company.  He also served as chairman of Bank of America in Hawaii.  Mr. Humphreys is currently the President of Hawaii Receivables Management, LLC.  Additionally, he is a trustee of Pacific Capital Funds, and also a board member of the Bishop Museum, and Cancer Research Center of Hawaii.

Mike Irish - Mr. Irish has been a successful businessman in Hawaii for over 30 years.  Mr. Irish began his career in hotel management, but moved to real estate and business acquisitions during the 1980s.  He became part of the Hawaii food service industry with the purchase of Parks Brand Products in 1985, Halm’s Kim Chee in 1986, and Diamond Head Seafood in 1995, where he continues to serve as CEO.  

33

Stanley Mukai - Mr. Mukai is a partner practicing commercial and tax law in the Hawaii law firm of McCorriston, Miller, Mukai, MacKinnon.  He holds a law degree from the Harvard Law School.  He is a member of the Board of Directors of Waterhouse, Inc., AIG Hawaii, and on the Board of Governors of Iolani School.  Mr. Mukai has also served as Chairman of the Board of Regents of the University of Hawaii and on the Board of Governors of the East-West Center.  

Motoko Takahashi - Ms. Takahashi was appointed Secretary of Castle in August of 2010, and as director in March of 1995. Ms. Takahashi had previously served as director for various Japanese investment companies in the United States.  She also holds the position as Vice President of N.K.C. Hawaii, Inc.  Ms. Takahashi was born in Tokyo, Japan where she completed her education and has resided in the United States for more than thirty years.

Roy Tokujo - Mr. Tokujo was elected to the board of directors in March 2000.  Mr. Tokujo has over 45 years of experience in the hotel, restaurant and entertainment business in Hawaii, and he is the President and CEO of Cove Enterprises and Cove Marketing.  Mr. Tokujo was a founding member of the Hawaii Tourism Authority and is managing partner of Ko Olina Activities, LLC and Ko Olina Marketing & Licensing, LLC.

Tony Vericella - Mr. Vericella is the Managing Director of Island Partners Hawaii, a premier destination management company servicing the meeting and incentive travel needs of corporations and organizations, primarily from North America, Asia/Pacific and Europe.  He has 30 years of extensive leadership experience in all aspects of the travel and tourism industry.  His career in Hawaii began with Hawaiian Airlines and evolved to American Express Travel Related Services, Budget Rent a Car-Asia/Pacific and the Hawaii Visitors and Convention Bureau.

Robert Wu- Mr. Wu currently serves as Executive Vice President for Asian development for Castle Resorts & Hotels a subsidiary of the Castle Group, Inc.  He joined the Company in January 2008 and became an integral part of Castle’s business development in the Asia region.  Mr. Wu serves as the Chief Executive Officer for the Wu Group, a Hawaii based firm that specializes in Asia imports, management of several Hawaii businesses and business consultation services for the Asia-Pacific region.

Significant Employees

None, not applicable.

Family Relationships

There are no family relationships between any Castle officers and directors.

Involvement in Certain Legal Proceedings

During the past five years, no current director, person nominated to become a director, executive officer, promoter or control person of Castle:

(1)

 was a general partner or executive officer of any business against which any bankruptcy petition was filed, either at the time of the bankruptcy or two years prior to that time;

(2)

 was convicted in a criminal proceeding or named subject to a pending criminal proceeding (excluding traffic violations and other minor offenses);

(3)

 was subject to any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities; or

(4)

was found by a court of competent jurisdiction (in a civil action), the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.

Compliance with Section 16(a) of the Securities Exchange Act.

Section 16 of the Securities Exchange Act of 1934 requires Castle’s directors and executive officers and persons who own more than 10% of a registered class of Castle’s equity securities to file with the Securities and Exchange Commission initial reports of beneficial ownership (Form 3) and reports of changes in beneficial ownership (Forms 4 and 5) of Castle’s common stock and other equity securities of Castle. Officers, directors and greater than 10% shareholders are required by SEC regulation to furnish Castle with copies of all Section 16(a) reports they file. Appropriate beneficial ownership forms have been filed with the Securities and Exchange Commission and may be found at (www.sec.gov).

34

To Castle’s knowledge, as of the date hereof, all directors, officers and holders of more than 10% of Castle’s common stock, have filed all reports required of Section 16(a) of the Securities Exchange Act of 1934.

Code of Ethics

Castle has adopted a Code of Ethics that applies to all of its directors and executive officers serving in any capacity, including our principal executive officer, principal financial officer, and principal accounting officer or controller or persons performing similar functions.  See Part III, Item 13.

Nominating Committee

The Board of Directors has not established a Nominating and Corporate Governance Committee because Castle management believes that the Board of Directors is able to effectively manage the issues normally considered by a Nominating and Corporate Governance Committee.

Audit Committee

The Board of Directors has appointed Richard Humphreys as the sole member of the Audit Committee.  Mr. Humphreys, is independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act.

Item 11. Executive Compensation.

Executive Compensation

The following table shows for the fiscal years ended December 31, 2010 and 2009 the aggregate annual remuneration of the highly paid persons who are executive officers of Castle:

SUMMARY COMPENSATION TABLE

Mr. Wall earns salary commensurate with his Employment Agreement dated July 1, 2004, however, in 2009; Mr. Wall declined his salary for the calendar year 2009.

Mr. Mattson earns salary commensurate with his Employment Agreement January 1, 2006.  

In addition, both Mr. Wall and Mr. Mattson participate in Castle’s 401(k) benefit plan.

(1)

All Other Compensation consists of Company contributions to the Company’s qualified 401(k) plan

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END

None as the Company does not have, nor has it has in the past, an equity compensation program.  

35

Compensation of Directors

DIRECTOR COMPENSATION  

*Directors who are employees of the Company

In May, 2009, the members of the Board decided to forego compensation for attending meetings of the Board.  Prior to this, non-employee Directors were paid $500 for each meeting of the Board which they attend.  Members of the Executive Committee, Compensation Committee and Audit Committee were paid $250 for each meeting of the respective committees which they attend. Castle does not presently have a stock option or similar compensation or incentive plan for members of the Board of Directors

During 2010 the Company issued 80,000 shares of its common stock to non-employee directors of the Company.  The shares were valued at $.20 per share which equaled the closing price of the common stock on the date of issuance and the entire valuation was recorded as compensation expense on that date.  In addition to the shares, the non-employee directors also received, for every share issued, a warrant to purchase an additional share of the Company’s common stock at a price of $1.00.  The warrants expire at the earlier of five years or 60 days after the Company’s common stock trades for an average price of $3.00 per share for 20 consecutive days and the were valued using the Black-Scholes pricing model at $.12 per share or $9,440. The inputs for the pricing model included an expected term of 2.5 years and volatility of 131%.

36

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

Security Ownership of Certain Beneficial Owners

The following table sets forth the number of shares of Castle’s common stock beneficially owned as of March 31, 2011 by:  (i) each of the two highest paid persons who were officers and directors of Castle, (ii) all officers and directors of Castle as a Group, and (iii) each shareholder who owned more than 5% of Castle’s common stock, including those shares subject to outstanding options, warrants and other convertible items.  Amounts also reflect shares held both directly and indirectly by the persons named.

(1)

Except as otherwise noted, Castle believes the persons named in the table have sole voting and investment power with respect to the shares of Castle’s common stock set forth opposite such persons names.  Amounts shown include the shares owned directly by the holder and shares held indirectly by family members of the holder or entities controlled by the holder.

(2)

Includes 310,000 shares owned by HBII Management.

(3)

Includes 180,344 shares held by a family foundation and pension plan.

(4)

Determined on the basis of 10,026,392 shares outstanding.  

Changes in Control

There are no current or planned transactions that would or are expected to result in a change of control of Castle.

37

Securities Authorized for Issuance under Equity Compensation Plans

There are no current of planned issuances of securities under any equity compensation plan.

Options, Warrants and Rights

In 1999 and 2000, Castle issued 11,105 shares of Castle’s $100 par value redeemable Preferred Stock through a private placement for a gross consideration of $1,105,000.  The stock bears cumulative dividends at the rate of $7.50 per annum for each share of stock.  Upon certain tender offers to acquire substantially all of Castle’s common stock, the holders of the Redeemable Preferred Stock may require that the shares be redeemed at a redemption price of $100 per share plus accrued and unpaid dividends.  The shares are nonvoting and entitle the holder to convert each share of Preferred Stock into 33.33 shares of Castle’s common stock.  Dividends are cumulative from the date of original issue and are payable, semi-annually, when, and if, declared by the board of directors.  At December 31, 2010, undeclared and unpaid dividends on these shares were $953,069 or $86.25 per preferred share.

In April, 2008, the Company raised additional capital from the completion of a Unit offering which resulted in the issuance of 333,337 Units at a price of $1.50 per Unit.  Each unit consists of one share of the Company’s common stock and a warrant to purchase an additional share of the Company’s common stock at a price of $3.50 for a period of three years, subject to certain restrictions.  Through this financing the Company raised a net amount of $224,744 for use as working capital and converted $227,500 in outstanding debt and short term obligations.

In August of 2010, the Company issued 80,000 shares of its common stock and 80,000 warrants to purchase one share of the Company’s common stock at a price of $1.00 for a period of three years.  The stock and warrants were issued in blocks of 10,000 to each of the non-employee directors of the Company.  

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

Transactions with Related Persons

Hanalei Bay International Investors (“HBII”)

The Chairman and CEO of the Company is the sole shareholder of HBII Management, Inc, the managing General Partner of HBII.  In March 1999, HBII consummated the sale of its interest in Hanalei Bay Resort to an unrelated third party.  The cash proceeds received by HBII on the closing of the sale were not sufficient to satisfy all claims of HBII’s creditors, including the Company, and the Company accepted a note receivable in the amount of $4,420,003 as settlement for its account receivable balance of $1,105,001 at the time of the sale. The excess amount ($3.315M) over the receivable balance was accounted for as a shareholder contribution.  Under the terms and conditions of the agreement to sell Hanalei Bay Resort, HBII is entitled to receive a percentage of the future cash flows from the resort’s hotel operations and the sale of certain time-share units.    

As part of the Company’s purchase of real estate in New Zealand (see Note 11), an assignment of $3,018,000 of the total note receivable from HBII was made to the seller of the real estate, with the Company remaining as guarantor should the note receivable not be collected before December 31, 2012 (See Note 2 to the Consolidated Financial Statements).

Castle has recorded a note receivable from Hanalei Bay International Investors (“HBII”) which amounted to $4,269,151 including interest as of December 31, 2008.  In March 2008, HBII and Quintus Resorts, LLC (“Quintus”), the parent company of HBR, entered into a settlement to resolve the litigation by Quintus issuing a twenty percent (19.9%) membership interest in Quintus to HBII or its designee, which included a preferred return as to the first $6.2 million of future distributions of available cash flow.

For at least the next two or three years, Quintus will be required to use all of its available cash flow to pay down the substantial indebtedness it incurred in purchasing the resort.  Based on Quintus’s financial projection, HBII’s management believes that it is likely to receive in excess of $6,000,000 from its ownership interest in Quintus and that it will utilize these funds to pay its indebtedness to Castle. In that the distributions from HBII will likely not be realized for a number of years and are subject to uncertainty and risks over which Castle has no control, there can be no assurance that Castle will receive any distributions from HBII’s ownership interest in Quintus within the next ten years, if at all.  As required by Generally Accepted Accounting Principles (“GAAP”) the Company has established a reserve of $4,269,141 for uncollectible notes relating to this transaction.  

In October 2008, the Company secured a line of credit with a local bank for up to $250,000.  The line is secured by the personal guaranty of the Company’s Chairman and CEO, and a general security interest in the Company’s assets.  In October 2009, the line of credit was renewed for $200,000 and the personal guaranty of the Company’s Chairman and CEO was removed.  The line is due in October 2011.

In April, 2008, the Company raised additional capital from the completion of a Unit offering which resulted in the issuance of 333,337 Units at a price of $1.50 per Unit.  Each unit consists of one a of the Company’s common stock and a warrant to purchase an additional share of the Company’s common stock at a price of $3.50 for a period of three years, subject to certain restrictions.  Through this financing

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the Company raised a net amount of $224,744 for use as working capital and converted $227,500 in outstanding debt and short term obligations.  Directors and Officers of the Company purchased a total of 260,003 Units in this offering.

Related Party Loans

In June, 2004, a director loaned the Company $125,000 with interest at the rate of 8% per annum and monthly payments of interest plus $521, and a maturity date of January 1, 2012.  In March 2008, $50,000 of the principle balance was converted to common stock and warrants as part of the Company’s 2008 unit offering.

During 2002, the Company’s CEO advanced $117,316 to the Company for general working capital.  The note bears interest at 10% and is due on or before January 1, 2012.

During 2004, the Company’s CEO advanced $125,000 to the Company for general working capital.  The note calls for monthly payments of $2,544, including interest at prime plus 2.5%, with the remaining principle balance due on 4/26/09.  In April 2009, the note was paid in full.

Through December 2009, the Company has accrued but not paid the Chairman and CEO a total of $27,808 for expenses incurred on behalf of the Company, and $61,014 for interest accrued on a note payable.

Through December 2009, the Company has accrued but not paid the Company’s COO a total of $642 for expenses incurred on behalf of the Company. 

In December 2010, an officer of the Company’s domestic subsidiary gave the Company a short term advance of $50,000.

Except for the transactions with HBII, the issuance of stock and warrants described above, the financing guarantee arrangement, the related party loans and unpaid fees, and the employment agreements with Rick Wall and Alan Mattson, there were no transactions, proposed transactions or outstanding transactions to which Castle or any of its subsidiaries was or is to be a party, in which the amount involved exceeds $50,000 and in which any director or executive officer, or any shareholder who is known to Castle to own of record or beneficially more than 10% of Castle’s common stock, or any member of the immediate family of any of the foregoing persons, had a direct or indirect material interest.

Parents of the Issuer:  

Not applicable.

Transactions with Promoters and Control Persons

Except as indicated under the heading “Transactions with Related Persons” of this Item 12, above, there were no material transactions, or series of similar transactions, during Castle’s last five fiscal years, or any currently proposed transactions, or series of similar transactions, to which we or any of our subsidiaries was or is to be a party, in which the amount involved exceeded $120,000 and in which any promoter or founder of ours or any member of the immediate family of any of the foregoing persons, had an interest.

Item 14. Principal Accounting Fees and Services.

AUDIT FEES

The aggregate fees billed by Castle’s auditors for professional services rendered in connection with the audit of Castle’s annual consolidated financial statements and reviews of the interim consolidated financial statements for 2010 and 2009 were $98,480 and $95,217, respectively.

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AUDIT-RELATED FEES

There were no aggregate fees billed by Castle’s auditors for any additional fees for assurance and related services that are reasonably related to the performance of the audit or review of Castle’s financial statements and are not reported under “Audit Fees” above for 2010 and 2009

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TAX FEES

The aggregate fees billed by Castle’s auditors for professional services for tax compliance, tax advice, and tax planning for 2010 and 2009 were $4,914 and $10,333, respectively.

ALL OTHER FEES

The aggregate fees billed by Castle’s auditors for all other non-audit services rendered to Castle, such as attending meetings and other miscellaneous financial consulting, for 2010 and 2009 were $3,516 and $4,063, respectively.

PART IV.

Item 15. Exhibits and Financial Statement Schedules.

Exhibit Index

* Incorporated herein by reference and Filed as exhibit to Form 10KSB for the year ended December 31, 2006 on September 19, 2007.

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SIGNATURES

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

THE CASTLE GROUP, INC.

March 31, 2011

By  /s/ Rick Wall

Rick Wall, Chief Executive Officer

and Chairman of the Board

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

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