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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


 [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

[  ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from ____________ to____________

Commission File No. 000-23338

THE CASTLE GROUP, INC.

(Exact name of Registrant as specified in its charter)


 

 

 

 

Utah

99-0307845

(State or Other Jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)


500 Ala Moana Boulevard, 3 Waterfront Plaza, Suite 555

Honolulu, Hawaii 96813

(Address of Principal Executive Offices)


(808) 524-0900

(Registrant’s Telephone Number)


N/A

(Former name, former address and former fiscal year,

if changed since last report)


Indicate by check mark whether the Registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.


Yes [X]   No [  ]

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [  ] No [  ]


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


Large accelerated filer [  ]      Accelerated filer [  ]       Non-accelerated filer [  ]      Smaller reporting company [X]


Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).


Yes [  ]   No [X]




APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS


Indicate by check whether the Registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act subsequent to the distribution of securities under a plan confirmed by a court.  


Not applicable.


APPLICABLE ONLY TO CORPORATE ISSUERS


Indicate the number of shares outstanding of each of the Registrant’s classes of common equity, as of the latest practicable date:


August 12, 2011 - 10,026,392 shares of common stock.




2




PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements.


THE CASTLE GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

JUNE 30, 2011 (UNAUDITED) & DECEMBER 31, 2010

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

Jun 30, 2011

Dec 31, 2010

Current Assets

 

 

 

 

 

 

  Cash and cash equivalents

 

 

 

 

 $      823,448

 $      539,701

  Accounts receivable, net of allowance for bad debts

 

 

 

      1,761,022

      2,038,211

  Deferred tax asset

 

 

 

 

         217,500

         217,500

  Restricted cash

 

 

 

 

         925,124

         151,975

  Prepaids and other current assets

 

 

 

 

         384,759

         279,890

Total Current Assets

 

 

 

 

      4,111,853

      3,227,277

Property plant & equipment, net

 

 

 

 

      7,694,609

      7,349,343

Goodwill

 

 

 

 

           54,726

           54,726

Deposits

 

 

 

 

           24,477

           24,477

Restricted cash

 

 

 

 

         140,652

         191,501

Investment in limited liability company

 

 

 

 

         260,885

         270,399

Deferred tax asset

 

 

 

 

      1,929,045

      1,827,977

 

 

 

 

 

 

 

TOTAL ASSETS

 

 

 

 

 $ 14,216,247

 $ 12,945,700

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' DEFICIT

Current Liabilities

 

 

 

 

 

 

  Accounts payable

 

 

 

 

 $   3,382,060

 $   3,136,776

  Payable to related parties

 

 

 

 

           94,873

         139,464

  Deposits payable

 

 

 

 

      1,824,499

         676,635

  Current portion of long term debt

 

 

 

 

         425,462

         409,198

  Current portion of long term debt to related parties

 

 

 

             6,250

             6,250

  Accrued salaries and wages

 

 

 

 

         802,952

         720,926

  Accrued taxes

 

 

 

 

           53,515

         199,693

  Accrued interest

 

 

 

 

           11,468

           11,108

  Other current liabilities

 

 

 

 

           12,219

           13,107

Total Current Liabilities

 

 

 

 

      6,613,298

      5,313,157

Non Current Liabilities

 

 

 

 

 

 

  Long term debt, net of current portion

 

 

 

 

      5,137,935

      4,914,119

  Deposits payable

 

 

 

 

         115,640

         354,337

  Notes payable to related parties, net of current portion

 

 

 

 

         141,795

         144,921

  Other long term obligations, net

 

 

 

 

      3,433,831

      3,230,902

Total Non Current Liabilities

 

 

 

 

      8,829,201

      8,644,279

Total Liabilities

 

 

 

 

    15,442,499

    13,957,436

Stockholders' Deficit

 

 

 

 

 

 

  Preferred stock, $100 par value, 50,000 shares authorized, 11,050

 

 

      1,105,000

      1,105,000

    shares issued and outstanding in 2011 and 2010, respectively

 

 

 

 

 

  Common stock, $.02 par value, 20,000,000 shares authorized, 10,026,392

 

 

         200,529

         200,529

    shares issued and outstanding in 2011 and 2010, respectively

 

 

 

 

 

  Additional paid in capital

 

 

 

 

      4,509,777

      4,423,984

  Retained deficit

 

 

 

 

    (7,089,138)

    (6,587,930)

  Accumulated other comprehensive income (loss)

 

 

 

           47,580

       (153,319)

Total Stockholders' Deficit

 

 

 

 

    (1,226,252)

    (1,011,736)

 

 

 

 

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT

 

 

 

 $ 14,216,247

 $ 12,945,700

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements



THE CASTLE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

THREE AND SIX MONTHS ENDED JUNE 30, 2011 & 2010

(UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quarter Ended

Quarter Ended

Year to Date

Year to Date

 

 

 

06/30/2011

06/30/2010

06/30/2011

06/30/2010

Revenues

 

 

 

 

 

 

  Revenue attributed from properties

 

 $      4,021,755

 $      3,474,227

 $      8,365,564

 $      7,263,555

  Management & Service

 

 

            197,106

            404,551

            749,509

            939,910

  Other Revenue

 

 

                   300

                       -

                   301

                       -

Total Revenues

 

 

         4,219,161

         3,878,778

         9,115,374

         8,203,465

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

 

  Attributed property expenses

 

 

         4,127,139

         3,516,379

         8,008,934

         6,903,742

  Payroll and office expenses

 

 

            489,623

            472,941

            973,734

         1,027,395

  Administrative and general

 

 

              74,637

              80,506

            236,129

            257,164

  Depreciation

 

 

              60,885

              58,548

            117,942

            118,185

Total Operating Expense

 

 

         4,752,284

         4,128,374

         9,336,739

         8,306,486

Operating Income

 

 

          (533,123)

          (249,596)

          (221,365)

          (103,021)

Foreign Currency Transaction Gain (Loss)

          (242,843)

              61,761

          (202,929)

              89,490

Investment Income (Loss)

 

 

            (32,514)

                       -

              (9,514)

                       -

Interest Expense

 

 

            (86,278)

            (98,208)

          (168,468)

          (198,487)

Loss before taxes

 

 

          (894,758)

          (286,043)

          (602,276)

          (212,018)

Income tax benefit

 

 

            151,743

              65,113

            101,068

              48,502

Net Loss

 

 

 $       (743,015)

 $       (220,930)

 $       (501,208)

 $       (163,516)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Comprehensive Income

 

 

 

 

 

 

  Foreign currency translation adjustment

 

            184,702

            (45,884)

            200,899

            (76,307)

Total Comprehensive Income

 

 

 $       (558,313)

 $       (266,814)

 $       (300,309)

 $       (239,823)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (Loss) Per Share

 

 

 

 

 

 

  Basic

 

 

 $             (0.07)

 $             (0.02)

 $             (0.05)

 $             (0.02)

  Diluted

 

 

 $             (0.07)

 $             (0.02)

 $             (0.05)

 $             (0.02)

Weighted Average Shares

 

 

 

 

 

 

  Basic

 

 

       10,026,392

         9,946,392

       10,026,392

         9,946,392

  Diluted

 

 

       10,026,392

         9,946,392

       10,026,392

         9,946,392

 

 

 

 

 

 

 




 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements






4





THE CASTLE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2011 & 2010

(UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year to Date

06/30/2011

Year to Date

06/30/2010

Cash Flows from Operating Activities

 

 

 

 

 

 

  Net loss

 

 

 

 

 $          (501,208)

 $          (163,516)

  Adjustments to reconcile from net income (loss) to net cash

   from operating activities:

 

 

 

 

  Depreciation

 

 

 

 

               117,942

               118,185

  Amortization of discount

 

 

 

 

                 48,204

                 78,076

  Foreign exchange (gain) loss on guarantor obligation

 

 

 

               202,929

               (89,490)

  Deferred taxes

 

 

 

 

             (101,068)

               (48,502)

  Interest on guarantor obligation

 

 

 

 

                 85,793

                 77,804

  (Increase) decrease in

 

 

 

 

 

 

    Accounts receivable

 

 

 

 

               353,063

               256,955

    Other current assets

 

 

 

 

               (98,907)

             (110,253)

    Restricted cash

 

 

 

 

             (666,946)

                 59,298

  Increase (decrease) in

 

 

 

 

 

 

    Accounts payable and accrued expenses

 

 

 

                 82,013

             (306,765)

    Customer advance deposits

 

 

 

 

            1,080,169

               192,802

Net Change From Operating Activities

 

 

 

 

               601,984

                 64,594

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

 

  Purchase of assets

 

 

 

 

                 (7,563)

                 (7,610)

Net Change from Investing Activities

 

 

 

 

                 (7,563)

                 (7,610)

 

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

 

  Proceeds from notes

 

 

 

 

               150,000

               150,000

  Payments on related party notes payable

 

 

 

                          -

                 (1,563)

  Payments on notes

 

 

 

 

             (473,980)

             (389,891)

Net Change from Financing Activities

 

 

 

 

             (323,980)

             (241,454)

 

 

 

 

 

 

 

Effect of exchange rate on changes in cash

 

 

 

                 13,306

                 (2,658)

 

 

 

 

 

 

 

Net Change in Cash

 

 

 

 

               283,747

             (187,128)

Beginning Balance

 

 

 

 

               539,701

               623,485

Ending Balance

 

 

 

 

 $            823,448

 $            436,357

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supplementary Information

 

 

 

 

 

 

 Cash Paid for Interest

 

 

 

 

 $            (28,241)

 $            (36,379)

 Cash Paid for Income Taxes

 

 

 

 

 $                       -

 $                       -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

5


Notes to Condensed Consolidated Financial Statements (Unaudited):


Note 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” or “Castle”) 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), and NZ Castle Resorts and Hotels’ wholly-owned subsidiary, Mocles Holdings Limited (a New Zealand Corporation).  All significant inter-company transactions have been eliminated in the consolidated financial statements.


Basis of Presentation


The accompanying condensed consolidated financial statements have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.  In the opinion of management, the accompanying interim financial statements contain all adjustments, consisting of normal recurring accruals, necessary for a fair presentation.  The results of operations for the three and six month periods ended June 30, 2011, are not necessarily indicative of the results for a full-year period.  It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in Castle’s annual audited financial statements for the year ended December 31, 2010.


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.”  The portion of the revenues that represent the unit owners’ percentages are not recorded by the Company as revenue or expenses.  Under a 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 a 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 Revenue. 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.


The Company also provides consulting services which would include pre-opening services, acquisition due diligence consulting, renovation project management and consulting, and other technical services that may from time to time be requested from both our current clients as well as prospective clients.  The Company recognizes revenues from these services when the services are performed.

 




6




Note 2 New Accounting Pronouncements


From time to time, new accounting pronouncements are issued by FASB that are adopted by the Company as of the specified effective date.  If not discussed, management believes that the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company’s financial statements upon adoption.


Note 3 Foreign Currency Transaction Gain / Loss


As part of the Company’s purchase of real estate in New Zealand, the Company has guaranteed an amount of up to $3,018,000 to the seller of the real estate and the Company recorded this guaranty as “Other Long Term Obligations” on its balance sheet.  The loan issued upon the purchase of the New Zealand real estate is payable in New Zealand dollars.  Due to the strengthening in the exchange rate of the New Zealand dollar against the US dollar, the obligation has been increased to $3,433,831 as of June 30, 2011.  For the three months ended June 30, 2011 and 2010, the Company recorded foreign currency transaction (losses)/gains of ($242,843) and $61,761, and for the six months ended June 30, 2011 and 2010, ($202,929) and $89,490 respectively.


Note 4 Income Taxes


Income tax expense reflects the expense or benefit only on the Company’s domestic taxable income. Income tax expense and benefit from the Company’s foreign operations are not recognized as they have been fully reserved.


Note 5 Equity-Based Compensation


None issued during the quarters ended June 30, 2011 or 2010.


Note 6 Subsequent Events


The Company managed a property in New Zealand under a Gross Contract through July 31, 2011.  Effective August 1, 2011, the contract with the property expired and the Company entered into a new management contract with the unit owners under a Net Contract arrangement.  Under the Net Contract, the Company will receive fees based on the revenue and net operating profits of the properties room operations.  Previously, the Company collected room revenues and paid a fixed amount to the unit owners; any room revenue remaining after this fixed payment was used to cover room operating expenses and any remaining profits belonged to the Company while shortfalls were funded by the Company.


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operation.


Forward Looking Statements


Statements made in this Quarterly Report of the Castle Group, Inc. (“Castle” or the “Company”) which are not purely historical are forward-looking statements with respect to the goals, plan objectives, intentions, expectations, financial condition, results of operations, future performance and business of the Company, including, without limitation, (i) Castle’s ability to raise capital, and (ii) statements preceded by, followed by or that include the words “may,” “would,” “could,” “should,” “expects,” “projects,” “anticipates,” “believes,” “estimates,” “plans,” “intends,” “targets” or similar expressions.


Forward-looking statements involve inherent risks and uncertainties, and important factors (many of which are beyond the Company’s control) that could cause actual results to differ materially from those set forth in the forward-looking statements, including the following, general economic or industry conditions, nationally and/or in the communities in which the Company conducts business, changes in the interest rate environment, legislation or regulatory requirements, conditions of the securities markets, the Company’s ability to raise capital, changes in accounting principles, policies or guidelines, financial or political instability, acts of war or terrorism, other economic, competitive, governmental, regulatory and technical factors affecting Castle’s operations, products, services and prices.





7




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. or New Zealand global and/or regional economic conditions, changes in U.S. and New Zealand global financial and/or 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.


Plan of Operation


Principal products or services and their markets


General


Castle is a hospitality and hotel management company that prides itself on its ability to be both “Flexible and Focused,” which is 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. In addition, Castle provides design services to properties that are furnishing, refurnishing or remodeling, as well as, pre-opening technical services for new hotel and resort properties being planned or under construction.  Castle’s revenues are derived primarily from two sources: (1) the rental of hotel rooms and condominium accommodations; and 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/or incentive payments, based on sales and performance criteria at various properties.  Castle also receives investment income through its subsidiary in New Zealand and through its minority ownership of real estate located in Hawaii.


Marketing Strategy


Most of our marketing efforts are focused towards acquiring and retaining guests for the properties we manage. Castle does not own any hotels or resorts; however, it has made real estate investments in the properties that it manages in Hilo, Hawaii and New Zealand.  Marketing is done through a variety of distribution channels including direct internet sales, wholesalers, online and traditional travel agencies, and group tour operators.  Unlike many other hotel and resort operators, we do not market the properties we manage under the Castle brand.  Instead of emphasizing the “Flag” or “Chain” name, Castle’s strategy is to promote the name and reputation of the individual properties under management. 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.


Our website (www.CastleResorts.com) offers state-of-the-art functionalities, user-friendly navigation, interactive features and rich content, while offering attractive rates and a travel booking engine that supports a dynamic pricing model which maximizes revenues for all of our properties under management.  We intend to continue to invest in optimizing our online presence directed specifically towards our own website, since revenue derived through our own branded website yields a higher margin utilizing retail rates. 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 worldwide.


For customer convenience, we offer direct to consumer online booking reservations of guest rooms at resort and condominium properties under contract and also vacation packages with attractions and activities related to our hotels and condominiums through Castle’s interactive web site at www.CastleResorts.com.  




8





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, and lodging accommodations throughout Hawaii, as well as in Saipan and New Zealand.   


In Hawaii, Castle is the only lodging chain that represents properties on all of the five major Hawaiian Islands of Oahu (Waikiki), Maui, Kauai, Molokai and Hawaii (Big Island).  This allows customers the option to island-hop, and provides Castle 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 geographic areas and cultures.


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, 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 unique strengths.  Our strategy is that we do not promote Castle as a brand name but instead, we focus on our customers, who are the owners of the properties we manage.  As Castle does represent a diverse range of properties, its brand strategy is that one size does not fit all.  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.  

 

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.  This ongoing trend towards smaller, independent hotels, as opposed to the familiar chains, is not only occurring in Hawaii, but seen throughout the world tourism marketplace.  This increased demand is fueled by the following travelers expectations:  


·

Travelers seek personalized recognition, attention, and service.


·

Guests desire hotel and condominium accommodations that impart a sense of place and provide a

unique guest experience.


·

Customers demand quality and personalized service, which creates high retention and repeat customers.  





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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.  At any given time, we may have a number of ongoing marketing programs and promotions in place, 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.


Growth Strategy


The majority of the properties presently managed by Castle are located within the state of Hawaii.  Significant opportunities for Castle to obtain additional contracts within the State of Hawaii are also available to us due to a myriad of factors that include sales of properties, foreclosures, underperformance, and dissatisfaction with the current management of our competitors.  In addition, Castle manages properties in New Zealand and Saipan, while at the same time keeping the option to strategically expand operations into Thailand and Guam.  We believe that there are significant opportunities to expand Castle’s operations both in the markets it currently serves, as well as other Pacific Basin and Asian vacation destinations.


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.


In July 2010, the Company acquired a 7% common series ownership interest in one of the hotels managed by the Company as compensation for consulting work done during the acquisition of the property by a third party.  Castle will continue to pursue these types of arrangements in which the Company will receive a partial real estate ownership in a property, in addition to a long term management contract.


Profitability


The second quarter of the calendar year is the typical slow period for the travel industry in Hawaii.  The Company did anticipate a loss during the quarter; however this was further exacerbated by various items which included:


1.     The Company agreed to rebate $200,000 of fees to the owners of a property previously managed by

the Company, in order to preserve goodwill with the property ownership.


2.       The New Zealand dollar strengthened during the second quarter, resulting in an exchange loss of $242,843.

Fluctuations in the currency exchange rates are outside of the control of the Company and due to the volatility in the currency exchange rates, large gains and losses shall continue to occur.  As an example, between August 1, and August 8, the New Zealand dollar devalued from .88 to .83, which represents an exchange gain to the Company of $204,000 to the Company over only an eight day period.


The Company managed a property in New Zealand under a Gross Contract through July 31, 2011.  Effective August 1, 2011, the contract with the property expired and the Company entered into a new management contract with the unit owners under a Net Contract arrangement.  Under the Net Contract, the Company will receive fees based on the revenue and net operating profits of the properties room operations.  Previously, the Company collected room revenues and paid a fixed amount to the unit owners; any room revenue remaining after this fixed payment was used to cover room operating expenses and any remaining profits belonged to the Company while shortfalls were funded by the Company.  Since the Company owns the common areas of the property which includes the lobby, restaurant and bar, the Company will continue to own and operate the food and beverage operation.  Over the previous ten years, the Company had operated the room operations at a loss.  The property is now well known in the area with a mature base of customers and additionally, its food and beverage operations




10




have won various culinary awards.  The Company believes that this combination of a net contract for the room operations and the profitable food & beverage operations will ensure future profitability for our New Zealand operation.


The Company also anticipates that it will receive a minority interest in another property, which is in escrow and is scheduled to close in the third quarter of 2011.  The property currently has a large rental program and should be profitable.    Additionally, the Company is in talks with the ownership of two additional properties for full management contracts.


The Company anticipates that it will be profitable for calendar 2011 due to the change in our contract in New Zealand, the World Rugby Cup which will be hosted by New Zealand in the fall, and the new property that it anticipates managing in the third quarter of 2011.  


Management’s Discussion and Analysis of Financial Condition and Results of Operations


Certain statements contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Plan of Operation” 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 Operation.”


Revenues


Total Revenues increased over the prior year by 9% to $4,219,161 from $3,878,778 for the quarter and by 11% to $9,115,374 from $8,203,465 for the six months ended June 30, 2011.  The increase reflects an increase over prior year in revenue from our New Zealand operations of 22%, from $1,840,510 to $2,238,926 for the three months ended June 30, 2011, and 21%, from $3,840,183 to $4,635,117 for the six months ended June 30, 2011.  Domestic operations experienced a 3% decrease in revenues for the three months ended June 30, 2011, from $2,038,268 to $1,980,235, and a 3% increase, from $4,363,282 to $4,480,257 for the six months ended June 30, 2011.  Included in our domestic operation for the quarter ending June 2011 was a fee rebate of $200,000 to the owners of a previously managed property.  Without this rebate, revenues for our domestic operations would have increased by 7% for the three and six months ended June 30, 2011.   The increases are attributed to increased demand and a recovery of the travel industries of New Zealand and Hawaii, and a strengthening of the New Zealand dollar against the US dollar.  Both domestic and international operations in 2010 were affected by the decreasing room rates in the markets in which our properties are located.  In response to the worldwide weakening of the economy in 2009, the hospitality business experienced severe discounting as travel companies compete to re-capture market share that was substantially reduced during to the worldwide financial crisis.  The trend of decreasing travelers has subsided, and now companies are focusing on increased average daily rates and have refrained from using discounted rates in order to increase market share.


Revenues Attributed from Properties increased from $3,474,227 to $4,021,755, an increase of 16% for the three months ended June 30, 2011 compared to 2010, and increased by 15% from $7,263,555 to $8,365,564 for the six months ended June 30, 2011.  The increase is attributed to an increase in demand in both our domestic and international operations, and a 3% and 8% appreciation in the value of the New Zealand Dollar against the US Dollar for the three and six months ended June 2011. Management and Service Revenues from our domestic operations decreased by 51%, from $404,551 to $197,106 during the quarter, and by 20% from $939,910 to $749,509 for the six months ended June 30, 2011.  The decrease in domestic operations is due to a $200,000 rebate of fees to the owners of a previously managed property during the quarter ended June 30, 2011.  Excluding this rebate, Management and Service Revenues would have decreased by 2% for the quarter and increased by 1% for the six months ended June 30, 2011.


Guaranty


As part of the Company’s purchase of real estate in New Zealand, the Company has guaranteed an amount of up to $3,018,000 to the seller of the real estate and the Company recorded this guaranty as “Other Long Term Obligations” on its




11




balance sheet.  The loan issued upon the purchase of the New Zealand real estate is payable in New Zealand dollars.  Due to the strengthening in the exchange rate of the New Zealand dollar against the US dollar, the obligation has been increased to $3,433,831 as of June 30, 2011.  For the three months ended June 30, 2011 and 2010, the Company recorded foreign currency transaction (losses)/gains of ($242,843) and $61,761, and for the six months ended June 30, 2011 and 2010, ($202,929) and $89,490, respectively.


Expenses


Attributed Property Expenses are those expenses related to the management of the resort and condominium properties which are operated on a Gross Revenue contract basis.  Property expenses increased by 17%, from $3,516,379 to $4,127,139 for the quarter ended June 30, 2011 compared to 2010, and by 16%, from $6,903,742 to $8,008,934 for the six months ended June 30, 2011 compared to 2010.  These expense increases are attributed to the strengthening of the New Zealand Dollar against the US Dollar and the 15% and 16% increase in Revenue Attributed From Properties for the three and six months ended June 30, 2011 compared to prior year.


Compared to the prior year, payroll and office expenses increased over prior year by 4% from $472,941 to $489,623 for the quarter and decreased by 5% from $1,027,395 to $973,734 for the six months ended June 30, 2011.  The decrease in cost is a result of the Company making operational efficiency adjustments to the number of operational and corporate staff positions. The 5% decrease in expenses for the six month period was experienced despite an increase in Total Revenues of 11%.


Administrative and general expenses decreased by 7% from $80,506 to $74,637 for the quarter and by 8% from $257,164 to $236,129 for the six months ended June 30, 2011 as compared to 2010.  This decrease was due to reductions instituted by the Company for professional fees, travel costs and a decrease in our insurance rates as compared to the prior year.


EBITDA (Earnings before Interest, Depreciation, Taxes and Amortization) reflects the Company’s earnings without the effect of depreciation, interest income or expense, or taxes.  EBITDA is a non-GAAP measure.  Castle’s management believes that in many ways it is a good alternative indicator of the Company’s financial performance.  It removes the effects of non-cash depreciation and amortization of assets, as well as the fluctuations of interest costs based on the Company’s borrowing history and 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 is shown below.  EBITDA totaled ($472,239) and ($191,048) for the three months ended June 30, 2011 and 2010.  EBITDA totaled ($103,423) and $15,164 for the six months ended June 30, 2011 and 2010.  The decrease for the quarter is attributable to the Company recording a rebate of $200,000 of management fees to the owner of a previously managed hotel, and an increase in EBITDA loss of $93,837 from our New Zealand operations.  


Comparison of Net Income to EBITDA:


 

 

Three months ended Jun 30

Six Months Jun 30

 

 

2011

2010

2011

2010

Net Income (Loss)

 $          (743,015)

 $        (220,930)

 $         (501,208)

 $          (163,516)

Add Back:

 

 

 

 

 

Income Tax Benefit

             (151,743)

             (65,113)

            (101,068)

               (48,502)

Net interest expense

               118,791

              98,208

              177,982

               198,487

Depreciation

 

                60,885  

              58,548  

              117,942  

               118,185  

Foreign Exchange (Gain) Loss

               242,843

             (61,761)

              202,929

               (89,490)

EBITDA-

 

 $          (472,239)

 $        (191,048)

 $         (103,423)

 $              15,164

 

 

 

 

 

 


Investments


On July 23, 2010 the Company acquired a 7% common series interest in the ownership of a hotel located in Hawaii.  The Company received the interest in exchange for the Company’s assistance to the buyers of the hotel in negotiating the purchase, performing due diligence work and other consulting services.  The hotel was purchased for $17,300,000, of which




12




$13,000,000 was financed through a first mortgage on the hotel.  The Company recognized $188,173 in revenue resulting from cash received for consulting fees and used those funds to acquire the 7% common series interest.  The Company recorded investment income of $15,000 and $38,000 for the quarter and six months ending  June 30, 2011, which represents the Company’s 7% share of the income from the limited liability company that owns one of the hotels managed by the Company. In addition, during the current quarter, the Company recorded a reduction adjustment of $47,514 to reconcile its share of the 2010 investment income upon receipt of the final financial statement and IRS form K-1 from the limited liability company.


Depreciation


Castle’s business does not require a great deal of capital expenditure for equipment or fixed assets.  As a result, depreciation expense was $60,885 and $58,548 for the three months ended June 30, 2011 and 2010, and $117,942 and $118,185 for the six months ended June 30, 2011 and 2010 respectively.


Interest Expense


Interest Expense was $86,278 and $98,208 for the three months ended June 30, 2011 & 2010 and $168,468 and $198,487 respectively for the six months ended June 30, 2011 and 2010.  Interest expense includes imputed interest on the note payable which was issued in the purchase of real estate and interest imputed on the guaranty of the note.  


Net Income  


Net loss for the three and six months ending June 30, 2011 was $743,015 and $501,208, respectively.  Net loss for the three and six months ending June 30, 2010 was $220,930 and $163,516, respectively.


Foreign Currency Translation Adjustment


For consolidated entities whose functional currency is not the U.S. dollar, Castle translates their financial statements into U.S. dollars.  Assets and liabilities are translated at the exchange rate currently 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. Changes in the carrying value of the assets and liabilities of the consolidated entities outside of the United States due to foreign exchange changes are reflected as Foreign Currency Adjustments.  Foreign Currency Translation adjustments totaled $184,702 and ($45,884) for the three months ended June 30, 2011 and 2010, respectively; Foreign Currency Translation adjustments for the six months ended June 30, 2011 and 2010 totaled $200,899 and ($76,307), respectively.

 

Total Comprehensive Income (Loss)


Total Comprehensive Income (Loss) for the three months ended June 30, 2011 was ($558,313) as compared to ($266,814) for the prior year period.  For the six months ended June 30, 2011, Total Comprehensive Income (Loss) was ($300,309) as compared to ($239,823) for the prior year.  This is primarily a result of the changes in Revenue and Property and Operating Expenses, Investment Income, and foreign exchange rates noted above.


Liquidity


Our primary sources of liquidity include available cash and cash equivalents, and borrowing under the credit facility which was secured in October 2008, consisting of a $500,000 term loan and a $150,000 line of credit.   As of June 30, 2011, the Company has utilized $100,000 of the line of credit.  Additionally, our New Zealand subsidiary has an available NZ$300,000 (US$245,190) line of credit of which NZ$85,090 (US$69,544) was utilized as of June 30, 2011.  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.  The Company is in compliance with the terms and conditions of these borrowing 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.





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The Company manages a property in New Zealand, where the World Rugby Cup will be held during the fall of 2011.  Room rentals are in very high demand during this period, and all reservations require a deposit or full prepayment in order to secure accommodation reservations.  Our New Zealand property has received advance deposits for this period of $925,124 and $151,975 as of June 30, 2011 and December 31, 2010, respectively.  New Zealand law requires that these funds be held in a separate trust account and not be used by the property until services have been rendered; accordingly, the Company has recorded these cash deposits as Restricted Cash on its balance sheet.


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 net loss of $743,015 for the second quarter of 2011 and a net loss of $501,208 for the six months ended June 30, 2011.  Total Current Assets were maintained at $4.1 million at the end of June 2011.  The second quarter of the year is typically the low season for the travel industry in Hawaii which was also magnified by the rebate of $200,000 during the quarter to the owner of a previously managed property.  Additionally, we recorded exchange losses of $242,843 and $202,929 for the three and six months ended June 30, 2011.  The Company has established a trend of Operating Profitability in recent quarters as we reported Operating Profits in three of our four previous quarters.  We anticipate that occupancy levels will show a slight increase over prior year, together with increases in average room rates for the properties currently under contract for the remainder of 2011.  We will continue our efforts to expand the number of properties under management through the remainder of 2011, which will increase the overall revenue stream in 2011. The specific impact of these additions on revenue depends on the timing of when new properties are added during the year.  More importantly, over the past two fiscal years we implemented a number of cost saving and efficiency programs that began to improve our profitability and cash flows.  We are beginning to see the results of our operational changes as we reported operating profits in six of the last seven quarters.  We project that we will continue to improve the overall profitability, cash flow, and working capital liquidity through 2011. This view is based on the following assumptions:


· An increase in occupancy levels as the global economy stabilizes rather than deteriorates resulting in increased visitor

   trends to Hawaii and New Zealand.


·A slight increase in average daily rates at the properties we manage as compared to recent years.


·Focusing on increasing our properties room revenue through increased sales, advertising and marketing efforts.


·A continuation of the cost savings and efficiency measures put into place which will provide the basis for improved

  operating trends throughout 2011.  


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


·The World Rugby Cup being held in New Zealand during the third quarter of 2011


·The conversion of our management contract in New Zealand from a gross contract to a net contract in August of 2011.


Our plans to manage our liquidity position in fiscal 2011 include:


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


·Accessing additional sources of debt or equity financing at competitive rates.


·Continuing with only limited capital expenditures and projects.


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




14




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.


Off-balance sheet arrangements


None; not applicable.


Item 3. Quantitative and Qualitative Disclosures about Market Risk


Not applicable.


Item 4.  Controls and Procedures.


Evaluation of disclosure controls and procedures


Our management, with the participation of our chief executive officer (and acting chief financial officer), evaluated the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act as of the end of the period covered by this Quarterly Report on Form 10-Q.  In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.  In addition, the design 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.  The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.


Based on that evaluation, our chief executive officer (and acting chief financial officer)  concluded that, as of June 30, 2011, our disclosure controls and procedures were effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules, regulations and forms, and that such information is accumulated and communicated to our management, including our chief executive officer (and acting chief financial officer), as appropriate, to allow timely decisions regarding required disclosure.


Changes in internal control over financial reporting


Our management, with the participation of the chief executive officer (and acting chief financial officer), has concluded there were no significant changes in our internal controls over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


PART II - OTHER INFORMATION


Item 1. Legal Proceedings.


None during the quarter ended June 30, 2011


Item 1A. Risk Factors.


Not required to be enumerated by smaller reporting companies.


Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.


Recent Sales of Unregistered Securities


None during the quarter ended June 30, 2011.





15




Use of Proceeds of Registered Securities


No proceeds were received from the sale of registered securities during the quarter ended June 30, 2011.


Purchases of Equity Securities by Us and Affiliated Purchasers


None during the quarter ended June 30, 2011.


Item 3. Defaults Upon Senior Securities.


None; not applicable.


Item 4. Removed and Reserved.


Item 5. Other Information.


None reported


Item 6. Exhibits.


(a) Exhibits and index of exhibits.


31.1   302 Certification of Rick Wall, Chief Executive Officer


32    Section 906 Certification



SIGNATURES


In accordance with the requirements of the Exchange Act, the Registrant has caused this Quarterly Report to be signed on its behalf by the undersigned, thereunto duly authorized.



THE CASTLE GROUP, INC.


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Date:

08/15/2011

 

By:

/s/Rick Wall

 

 

 

 

Rick Wall

 

 

 

 

Chief Executive Officer and Chairman of the Board of Directors and Acting CFO







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