UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2007
OR
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission File Number 001-32849
CASTLE BRANDS INC.
(Exact name of registrant as specified in its charter)
incorporation or organization)
Identification No.)
570 Lexington Avenue, 29th Floor,
New York, New YorkRegistrant’s telephone number, including area code: (646) 356-0200
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Act). See definition of ‘‘accelerated filer and large accelerated filer’’ in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
The Company had 15,629,776 shares of $0.01 par value common stock outstanding at November 13, 2007.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
2007
2007See accompanying notes to the condensed consolidated financial statements.
1
CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
September 30,
September 30,See accompanying notes to the condensed consolidated financial statements.
2
CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(Unaudited)
Paid in
Capital
Deficiency
Other
Comprehensive
Loss
Stockholders’
EquitySee accompanying notes to the condensed consolidated financial statements.
3
CASTLE BRANDS INC. and SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
See accompanying notes to the condensed consolidated financial statements.
4
CASTLE BRANDS INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial StatementsNOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying condensed consolidated financial statements do not include all of the information and footnote disclosures normally included in financial statements prepared in accordance with the rules and regulations of the Securities and Exchange Commission and U.S. generally accepted accounting principles (‘‘GAAP’’) and in the opinion of management, contain all adjustments (which consist of only normal recurring adjustments) necessary for a fair presentation of such financial information. Results of operations for interim periods are not necessarily indicative of those to be achieved for full fiscal years. The Condensed Consolidated Balance Sheet as of March 31, 2007 is derived from the March 31, 2007 audited financial statements. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the fiscal year ended March 31, 2007 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.
In February 2005, Castle Brands Inc. acquired 60% of the shares of Gosling-Castle Partners Inc. (‘‘GCP’’), which holds the worldwide distribution rights (excluding Bermuda) to Gosling’s rum and related products.
In October 2006, Castle Brands Inc. acquired all of the outstanding capital stock of McLain & Kyne, Ltd. (‘‘McLain & Kyne’’) pursuant to a Stock Purchase Agreement. McLain & Kyne is a Louisville, Kentucky based developer and marketer of three premium small batch bourbons: Jefferson’s Reserve, Jefferson’s and Sam Houston.
As used herein, the ‘‘Company’’ refers to Castle Brands Inc. and, where appropriate, it also refers collectively to Castle Brands Inc. and its direct and indirect subsidiaries, including its majority owned GCP subsidiary.
5
6
September 30,
September 30,7
In February 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 159, ‘‘The Fair Value Option for Financial Assets and Financial Liabilities’’ (SFAS 159), which allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. Subsequent changes in fair value of these financial assets and liabilities would be recognized in earnings when they occur. SFAS 159 further establishes certain additional disclosure requirements. SFAS 159 is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. Management is currently evaluating the impact and timing of the adoption of SFAS 159 on the Company’s consolidated financial statements.
NOTE 2 — BASIC AND DILUTED NET LOSS PER COMMON SHARE
Basic net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is computed giving effect to all dilutive potential common shares that were outstanding during the period. Diluted potential common shares consist of incremental shares issuable upon exercise of stock options and warrants and contingent conversion of debentures. In computing diluted net loss per share for the six-months ended September 30, 2007 and 2006, no adjustment has been made to the weighted average outstanding common shares as the assumed exercise of outstanding options and warrants and the assumed conversion of convertible debentures is anti-dilutive.
Potential common shares not included in calculating diluted net loss per share are as follows:
2007
2006 Stock options8
NOTE 3 — INVESTMENTS
The following is a summary of available-for-sale securities:
Fair Value September 30, 2007The cost of the Company’s short-term investments approximates their fair-values.
NOTE 4 — INVENTORIES
2007
2007 Raw materialsAs of September 30, and March 31, 2007, 78.5% and 99.1%, respectively, of the raw materials and 10.6% and 13.0%, respectively, of finished goods were located outside of the United States.
Inventories are stated at the lower of weighted average cost or market.
NOTE 5 — INVESTMENTS AND ACQUISITIONS
Acquisition of McLain & Kyne, Ltd.
On October 12, 2006, the Company acquired all of the outstanding capital stock of McLain & Kyne, Ltd. pursuant to a Stock Purchase Agreement (the ‘‘Agreement’’). McLain & Kyne is a Louisville, Kentucky-based developer and marketer of three premium small batch bourbons: Jefferson’s Reserve, Jefferson’s and Sam Houston. As consideration for the acquisition, the Company has paid $2,000,000, consisting of $1,294,800 in cash and issued 100,000 shares of its common stock, valued at $705,200. The Company will also pay an earn-out to the sellers based on the financial performance of the acquired business. The aggregate amount of such earn-out payments, which shall not exceed $4,000,000, will be determined by a calculation based on the gross margin (as defined in the Agreement) recognized by the Company from the sales of McLain & Kyne’s bourbons through March 31, 2011. As a result of the purchase price allocation, the Company recorded goodwill of $768,805. Under the purchase method of accounting, tangible and identifiable intangible assets acquired and liabilities assumed are recorded at their estimated fair values. The estimated fair values and useful lives of intangible assets acquired are tentative and have been supported by a preliminary third party valuation based on weighted average cost of capital vs. return on invested capital. The fair values allocated to McLain & Kyne’s net tangible and intangible assets are as follows: current assets of $100,021, inventory of $53,866, tradenames of $941,000, and customer relationships of $169,000 and current liabilities of $32,692. The tradenames have been determined to have indefinite useful lives and accordingly, consistent with FAS 142, no amortization will be recorded in the Company’s consolidated income statements. Instead, the related intangible asset will be tested for impairment at least annually, with any related impairment charge recorded to the statement of operations at the time of determining such impairment. The customer relationships are being amortized on a straight-line basis over a period of 15 years.
The operating results of the McLain & Kyne business are reflected in the accompanying consolidated financial statements from the date of acquisition and were not material.
The Agreement also provides for, among other things, representations, warranties, indemnities and ‘‘piggyback’’ registration rights for the shares issued.
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The following table presents unaudited pro forma information about sales and net loss had the operations of the above described acquisition been combined with the Company’s business as of the first day of the period shown.
Ended
September 30,
2006
Ended
September 30,
2006 Net salesIn management’s opinion, the unaudited pro forma results of operations are not indicative of the actual results that would have occurred had the above acquisitions been consummated at the beginning of the periods presented or of future operations of the combined companies under the Company’s management.
Investment in Gosling-Castle Partners Inc.
In February 2005, the Company entered into a stock subscription agreement for 60% of the stock of Gosling Partners, Inc., whose name was subsequently changed to Gosling-Castle Partners Inc.
NOTE 6 — INTANGIBLE ASSETS
Intangible assets consist of the following:
2007
2007 Definite life brands10
Accumulated amortization consists of the following:
2007
2007 BrandsAmortization expense for the three-months ended September 30, 2007 and 2006 totaled $238,176 and $203,954 respectively, and $453,418 and $402,002 for the six-months ended September 30, 2007 and 2006, respectively.
On September 1, 2006, the Company delivered notice to a certain distributor that it was terminating its distribution agreement. As a result of the delivery of the notice, the distribution agreement has been terminated, as provided for by its terms, as of September 15, 2007. The Company has adjusted the estimated useful life of the underlying intangible asset to agree to the termination date.
Estimated aggregate amortization expense for each of the five succeeding years is as follows:
NOTE 7 — RESTRICTED CASH
The Company has cash collateral on deposit for creditors insurance in Ireland of €501,935, or $716,362 (as translated at the exchange rate in effect on September 30, 2007).
NOTE 8 — OVERDRAFT ACCOUNTS
CB-IRL and CB-UK maintain overdraft coverage with a financial institution in Ireland of up to €400,000 ($570,880) and £20,000 ($40,954), respectively. Overdraft balances included in notes payable totaled $459,830 and $380,334 at September 30, and March 31, 2007, respectively.
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NOTE 9 — SENIOR NOTES PAYABLE, NOTES PAYABLE AND CAPITAL LEASE
2007
2007 Notes payable consist of the following:Principal payments due over the next five years for the above listed notes payable and capital lease are due as follows (as translated at the exchange rate in effect on September 30, 2007):
NOTE 10 — COMMON STOCK
Unregistered Sales of Equity Securities – On April 18, 2007, the Company entered into a Securities Purchase Agreement (the ‘‘Securities Purchase Agreement’’) with selected investors (each an ‘‘Investor’’ and collectively, the ‘‘Investors’’). Pursuant to the terms of the Securities Purchase Agreement, the Company has sold in a private placement a total of 3,520,035 shares of its common stock, (the ‘‘Common Stock’’), for aggregate gross proceeds of $21,014,609. Net proceeds to the Company after offering costs were $19,618,484. The transaction closed on May 8, 2007. The Investors included, among others, Frederick M. R. Smith and Phillip Frost, MD, each a director of the Company, and CNF Investments II, LLC, of which Robert J. Flanagan, a director of the Company, is a manager.
As part of the transaction, investors received warrants to purchase approximately 1,408,014 additional shares at an exercise price of $6.57 per share (the ‘‘Warrants’’). The Warrants will remain exercisable for a period of five years from the closing of the offering. The Warrants contain anti-dilution protection for stock splits and similar events, but do not contain any price-based anti-dilution adjustments. In connection with the transaction, Piper Jaffray & Co., as placement agent was issued a warrant to purchase 35,200 shares of Common Stock at an exercise price of $5.97 per share, exercisable within five years following the issuance of the warrant (the ‘‘Agent Warrant’’). The Agent Warrant is otherwise on the same terms and conditions as the Warrants.
Registration Rights Agreement – On April 18, 2007, the Company entered into a Registration Rights Agreement (the ‘‘Registration Rights Agreement’’) with the Investors. Pursuant to the Registration Rights Agreement, the Company has agreed to register the resale of the shares of Common Stock sold to the Investors pursuant to the Securities Purchase Agreement, including the shares issuable upon exercise of the Warrants. The Company agreed to file with the SEC a registration statement with respect to this registration within 30 days after closing. The Company filed such registration statement on May 31, 2007, within this 30 day timeframe. The registration statement was declared effective as of July 9, 2007.
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NOTE 11 — FOREIGN CURRENCY FORWARD CONTRACTS
The Company enters into forward contracts to attempt to limit its exposure to foreign currency fluctuations. The Company recognizes in the balance sheet derivative contracts at fair value, and reflects any net gains and losses currently in earnings. At September 30, 2007, the Company held outstanding forward exchange positions for the purchase of euros, expiring through December 2007, in the amount of $855,140 with a weighted average conversion rate of €1 = $1.4252 as compared to the spot rate at September 30, 2007 of €1 = $1.4272. Gain or loss on foreign transactions related to the foreign currency forward contracts, which was de minimis, is included in other income and expense.
NOTE 12 — PROVISION FOR INCOME TAXES
On January 1, 2007, the Company adopted the provisions of FIN 48 – ‘‘Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109’’. FIN 48 clarifies and sets forth consistent rules for accounting for uncertain tax positions in accordance with FAS 109, ‘‘Accounting for Income Taxes.’’
As a result of the implementation of FIN 48, the Company made a review of its portfolio of uncertain tax positions in accordance with recognition standards established by FIN 48. In this regard, an uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. As a result of this review, the Company determined that it had no material uncertain tax positions and, therefore, it has not recorded unrecognized tax benefits. The Company does not expect any material changes to its uncertain tax positions.
The tax years 2004 through 2007 remain open to examination by federal and state tax jurisdictions.
The Company has various foreign subsidiaries for which tax years 2001 through 2007 remain open to examination in certain foreign tax jurisdictions.
The Company’s income tax benefit for the three-months and six months ended September 30, 2007 and 2006 consists of federal and state and local taxes attributable to Gosling-Castle Partners Inc. (‘‘GCP’’) which does not file a consolidated income tax return with the Company. In connection with the investment in GCP, the Company recorded a deferred tax liability on the ascribed value of the acquired intangible assets of $2,222,222, increasing the value of the asset. The deferred tax liability is being reversed and a deferred tax benefit is being recognized over the amortization period of the intangible asset (15 years). For the three-months ended September 30, 2007 and 2006, the Company recognized $37,038 and $37,038 of deferred tax benefits, respectively, and $74,076 and $74,076 for the six-months ended September 30, 2007 and 2006, respectively.
On December 1, 2003, the Company recorded a deferred tax liability of $629,444 as the amount ascribed to the difference between the book and tax basis of the tangible and intangible assets acquired as additional goodwill.
Pursuant to FIN 48, the Company recognizes interest and penalties related to uncertain tax positions in the provision for income taxes. The Company did not recognize any such interest and/or penalties during the six-months ended September 30, 2007 and 2006.
NOTE 13 — STOCK OPTIONS AND WARRANTS
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At September 30, 2007 total unrecognized compensation cost amounted to approximately $2,140,868, representing 628,050 unvested options. There were no options exercised under the share-based payment arrangements during the six-months ended September 30, 2007 and 2006.
The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model and is affected by assumptions regarding a number of highly complex and subjective variables. The use of an option pricing model also requires the use of a number of complex assumptions, including expected volatility, risk-free interest rate, expected dividends, and expected term. Expected volatility is based on the historical volatility of a peer group of companies over the expected life of the option as the Company does not have enough history trading as a public company to calculate its own stock price volatility. The expected term and vesting of the options represents the estimated period of time until exercise and is based on historical experience of similar awards, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option. The Company has not paid dividends in the past and does not plan to pay any dividends in the near future. SFAS 123R also requires the Company to estimate forfeitures at the time of grant and revise these estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company estimates forfeitures based on its expectation of future experience while considering its historical experience.
A summary of the options outstanding under the stock option plan is as follows:
Average
Exercise
Price
Average
Exercise
Price Outstanding at beginning of period14
The following table represents information relating to stock options outstanding at September 30, 2007:
Average
Remaining
Life in
Years
Average
Exercise
Price
Intrinsic
value $5.00 – $6.00The fair value of options at date of grant was estimated using the Black-Scholes option-pricing model utilizing the following weighted average assumptions:
2007
2006 Risk-free interest ratesThe following summarizes the activity of the Company’s stock options that have not vested for the three-months and six-months ended September 30, 2007:
Average
Exercise
Price Nonvested at April 1, 2007As of September 30, 2007, there was $2,140,868 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under existing stock option plans. This cost is expected to be recognized over a weighted-average period of 3.41 years. The total fair value of shares vested during the three-months ended September 30, 2007 and 2006 was $266,708 and $276,921, respectively, and $536,896 and $771,415 for the six-months ended September 30, 2007 and 2006, respectively.
Since no options were exercised, the Company did not recognize any tax benefit for the six-months ended September 30, 2007 and 2006.
B. Stock Warrants – The Company has entered into various warrant agreements.
Common Stock Warrant Issued to the Financing Agent
On August 29, 2002, in connection with a revolving credit facility, the Company granted to the lender, Keltic Financial Partners, LP (‘‘Keltic’’), a warrant to acquire 100,000 shares of the Company’s
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common stock at an exercise price of $6.00. The warrant is subject to anti-dilution provisions, upon the occurrence of certain events such as stock splits and stock dividends, vests immediately and is exercisable through September 1, 2014. The warrant is exercisable at any time and includes a cashless exercise provision. The Company was not obligated to register the warrant or the underlying shares, except to the extent that, if the Company elected to file a registration statement, Keltic could have the shares underlying its warrant included in that registration statement and the Company would assume all registration costs and other expenses in connection with such registration.
On September 27, 2005, the warrant was amended to eliminate the cash put feature and replace it with certain penalties (up to $200,000) if the shares underlying the warrant were not been registered by June 1, 2007 and June 1, 2008. The Company agreed that if on either June 1, 2007 or June 1, 2008 (a) there were shares of common stock received or issuable upon the exercise of the warrant that have not been registered, and (b) it had not filed a registration statement with respect to which Keltic had the opportunity to register the unregistered shares, the Company would pay Keltic $100,000 within ten (10) days of such dates. The Company filed such registration statement on May 31, 2007, and Keltic elected to have the shares underlying its warrant included in such registration statement.
Effective with the Company’s registration statement (Reg. no. 333-143422), as amended, filed with the SEC on June 29, 2007 and effective as of July 9, 2007, the registration rights penalty was eliminated. The Company has reflected the fair value of the combined instrument at March 31, 2007 included in the balance sheet caption accrued expenses, put warrants payable and derivative instrument of approximately $189,397.
Common Stock Warrants Issued to Senior Note Holders
In connection with the issuance of the latest tranche of senior notes in November 2006, the Company entered into a warrant agreement to grant the right to purchase 213,600 shares of the Company’s common stock at an exercise price of $8.00 per share at any time through May 31, 2009. These warrants were recorded at relative fair value and accounted for as a discount to the face value of the senior notes and a credit to additional paid-in capital in the amount of $706,944. This discount will be recognized over the adjusted term of the senior notes with a charge to interest expense and a credit to senior notes payable. For the three-months ended September 30, 2007 and 2006, the Company recorded $73,562 and $5,148 respectively of senior note accretion as interest expense, and $147,124 and $10,296 for the six-months ended September 30, 2007 and 2006 respectively.
Common Stock Warrants Issued to Financial Advisor
In July 2005, the Company granted to a financial advisor warrants to purchase up to 100,000 shares of common stock at $8.00 per share. The warrants are subject to anti-dilution provisions, such as stock splits and stock dividends, and vested upon the completion of the initial public offering in April 2006. The Company fair valued the warrant at $283,727 and recorded a charge upon vesting. The charge is included in interest expense for the six-months ended September 30, 2006 on the accompanying condensed consolidated statements of operations.
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The following is a summary of the company’s outstanding warrants for the six-months ended September 30, 2007:
Average
Exercise
Price Per
Warrant Warrants outstanding and exercisable, March 31, 2007NOTE 14 — RELATED PARTY TRANSACTIONS
Pursuant to the MHW distribution agreement, MHW receives sales orders from the Company’s domestic wholesalers at prices agreed upon with the Company. MHW simultaneously purchases Company inventory necessary to fill those orders and ships that inventory to the various wholesalers. MHW then invoices, collects, and deposits remittances from those wholesalers into an MHW bank account designated for the Company. The funds are remitted to the Company on a bi-weekly basis. Although MHW is responsible for the billing function, the collected funds are the property of the Company and MHW is not liable to the Company for any unpaid balances due from wholesalers.
In addition to the distribution services provided for the Company, MHW also provides administrative and support services on behalf of the Company. For the three-months ended September 30, 2007 and 2006, aggregate charges recorded for all services provided were approximately $95,390 and $64,651, respectively and were $169,413 and $124,358 for the six-months ended September 30, 2007 and 2006, respectively. These charges have been included in general and administrative expenses on the accompanying condensed consolidated statements of operations.
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NOTE 15 — COMMITMENTS AND CONTINGENCIES
Under this agreement, Castle Brands is permitted to import Pallini Limoncello and its flavor extensions at a set price, updated annually, and is obligated to set aside a portion of the gross margin toward a marketing fund for Pallini. The agreement also encompasses the hiring of a Pallini Brand Manager at Castle Brands with Pallini reimbursing the costs of this position up to a stipulated annual amount. These reimbursements are included in the accompanying condensed consolidated financial statements as a reduction in selling expense.
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CB-USA will receive a stipulated commission per case, subject to adjustment, provided certain case sales are achieved, for all sales in calendar years under the distribution agreement. The sales commission is net of agreed reimbursements, including taxes and payments to the marketing affiliate, GCP. This distribution agreement is for fifteen years, subject to extension.
The Gosling’s global distribution agreement, which excludes Bermuda, commenced on April 1, 2005 and has a 15 year term. It is renewable for additional 15 year terms as long as GCP meets certain case sale targets during the initial term as set forth in the agreement. The Company ascribed the entire purchase of $5,000,000 to the Gosling global distribution agreement described above. In conjunction with this transaction the Company recorded a deferred tax liability of $2,222,222 to reflect the difference between the adjusted book value and tax basis. This deferred tax liability was recorded as an increase to the value of the distribution agreement and is included in intangible assets.
Castle Brands Inc. has agreed to fund certain operating losses of GCP. The balance funded at September 30, 2007 is approximately $3,275,000.
Future minimum lease payments are as follows:
In addition to the above annual rental payments, the Company is obligated to pay its pro-rata share of utility and maintenance expenses on the leased premises. Rent expense under operating leases amounted to approximately $109,299 and $105,026 for the three-months ended September 30, 2007 and 2006, respectively, and $214,411 and $197,983 for the six-months ended and September 30, 2007 and 2006, respectively, and is included in general and administrative expense on the accompanying condensed consolidated statements of operations.
In the event of the sale of the brand rights by either the Company or Gaelic, the non-selling party shall have the right of first refusal to purchase the interest at the same price as the proposed sale and the right to sell alongside the other party.
Pursuant to the agreement, the Company is required to pay royalties to Gaelic for each case purchased, such royalties are included within cost of sales in the accompanying consolidated statements of operations.
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NOTE 16 — CONCENTRATIONS
The Company has entered into a distribution agreement with Gaelic Heritage Corporation, Ltd. (‘‘Gaelic’’), an international supplier, to be the sole-producer of Celtic Crossing, one of the Company’s products, for an indefinite period.
The Company has entered into a distribution agreement with ILAR, S.p.A to be the sole-producer of the Pallini premium Italian liqueurs, expiring December 31, 2009, subject to a three or five year renewal, depending on case purchase.
The Company has entered into a distribution agreement with Gosling’s Export (Bermuda) limited, an international supplier, to be the sole-producer of the Gosling’s family of rum products for 15 years.
The Company has entered into a supplier agreement with Carbery Milk Products Limited, an international supplier, which provides for the production of the Company’s vodka and cream products through December 31, 2008.
The Company has entered into a bottling and services agreement with Terra Limited which provides for the bottling of the Company’s vodka, whiskey and cream products through February 28, 2009.
NOTE 17 — LEGAL PROCEDINGS
The Company’s subsidiary, Castle Brands Spirits Company Limited, is the holder of a trademark registration for the mark ‘‘BORU’’ with the United States Patent and Trademark Office. On May 9, 2007, Distillerie Stock U.S.A. Ltd. filed a Petition for Cancellation with the United States Patent and Trademark Office for the cancellation of the trademark registration for BORU on several grounds, including potential confusion between BORU and its existing registered trademark ‘‘BORA’’. The Company has filed a response presenting various defenses on the merits as well as procedural defenses in a timely manner against Distillerie Stock’s claims. The Company intends to vigorously pursue these defenses as appropriate. Currently, the matter is pending at the United States Patent and Trademark Office before the Trademark Trial and Appeal Board. While matters before the Trademark Trial and Appeal Board cannot result in monetary damages or directly affect the right to use a trademark, they can result in the cancellation of a trademark registration. Thus, it is possible this matter could result in
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the cancellation of the Company’s trademark registration for BORU in the United States. As a result, it is not feasible to predict the final outcome, and there can be no assurance that these claims might not be finally resolved adversely to the Company, resulting in material liability to its operations.
On September 6, 2007 the Company was served with a lawsuit, International Brands USA, Inc. v. Castle Brands, Inc., now pending in Supreme Court, New York County, New York. The complaint alleges several claims relating to the Company’s decision not to proceed with the acquisition of a privately-held spirits importing business. The Company believes the claims have no legal or factual merit and is vigorously defending the matter.
NOTE 18 — GEOGRAPHIC INFORMATION
The Company operates in one business – premium branded spirits. The Company’s product categories are vodka, rum, liqueurs/cordials, and whiskey and reports its operations in two geographic areas: International and United States.
The condensed consolidated financial statements include revenues and assets generated in or held in the U.S. and foreign countries. The following table sets forth the percentage of consolidated revenue and consolidated assets from the U.S. and foreign countries.
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NOTE 19 — SUBSEQUENT EVENTS
On October 22, 2007, the Company entered into a credit agreement with Frost Nevada Investments Trust, which is controlled by Dr. Phillip Frost, a former director of the Company, which enables the Company to borrow up to $5,000,000. The Company does not presently anticipate borrowing any advances under this credit facility. Any amounts outstanding under the credit facility bear interest at a rate of 10% per annum. Interest is payable quarterly. The maturity date of any amounts outstanding is the earlier of one business day after the closing of a financing transaction which results in gross proceeds to the Company of at least $10,000,000 and February 28, 2009.
Upon entering into the credit agreement, the Company paid the lender a facility fee of $175,000. If the Company draws down on the credit facility, upon receiving its first advance, it would have to pay the lender an additional facility fee of $200,000. As additional consideration for entering into the credit facility, the Company issued to the Lender a warrant to purchase 50,000 shares of common stock, par value $0.1 per share, at an exercise price of $4 per share.
An event of default under the credit facility occurs if the Company (a) fails to make payment of principal or interest on the maturity date, (b) fails to make payment of any fees or quarterly interest payments when due and after 10 business days of prior written notice to the Company by the lender of the failure to pay, (c) breach the affirmative covenants contained in the credit agreement and fail to cure the breach generally within 30 days of the breach or (d) becomes insolvent or begins an insolvency proceeding or one is begun against the Company and is not dismissed or stayed within 90 days. If an event of default occurs, the lender could declare all principal and interest immediately due and payable and the interest rate will increase by 200 basis points above the current interest rate.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Note Regarding Forward Looking Statements
This Quarterly Report on Form 10-Q includes statements of our expectations, intentions, plans and beliefs that constitute ‘‘forward-looking statements’’ within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are intended to come within the safe harbor protection provided by those sections. These statements, which involve risks and uncertainties, relate to the discussion of our business strategies and our expectations concerning future operations, margins, profitability, liquidity and capital resources and to analyses and other information that are based on forecasts of future results and estimates of amounts not yet determinable. We have used words such as ‘‘may,’’ ‘‘will,’’ ‘‘should,’’ ‘‘expects,’’ ‘‘intends,’’ ‘‘plans,’’ ‘‘anticipates,’’ ‘‘believes,’’ ‘‘thinks,’’ ‘‘estimates,’’ ‘‘seeks,’’ ‘‘expects,’’ ‘‘predicts,’’ ‘‘could,’’ ‘‘projects,’’ ‘‘potential’’ and other similar terms and phrases, including references to assumptions, in this report to identify forward-looking statements. These forward-looking statements are made based on expectations and beliefs concerning future events affecting us and are subject to uncertainties, risks and factors relating to our operations and business environments, all of which are difficult to predict and many of which are beyond our control, that could cause our actual results to differ materially from those matters expressed or implied by these forward-looking statements. These risks and other factors include those listed under ‘‘Risk Factors’’ in our Annual Report on Form 10-K for the year ended March 31, 2007 and elsewhere in this report. The following factors, among others, could cause our actual results and performance to differ materially from the results and performance projected in, or implied by, the forward-looking statements:
We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in, or implied by, these forward-looking statements, even if new information becomes available in the future.
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Currency Translation
The functional currencies for our foreign operations are the euro in Ireland and continental Europe, the British pound in the United Kingdom and the Canadian dollar in Canada. With respect to our condensed consolidated financial statements, the translation from the applicable foreign currencies to U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. The resulting translation adjustments are recorded as a component of other comprehensive income. Gains or losses resulting from foreign currency transactions are included in other income/expenses.
Where in this quarterly report we refer to amounts in euros, British pounds or Canadian dollars we have for your convenience also in certain cases provided a translation of those amounts to U.S. dollars in parenthesis. Where the numbers refer to a specific balance sheet account date or financial statement account period, we have used the exchange rate that was used to perform the translations in connection with the applicable financial statement. In all other instances, unless otherwise indicated, the translations have been made using the exchange rates as of September 30, 2007, each as calculated from the Interbank exchange rates as reported by Oanda.com. On September 30, 2007, the exchange rate of the euro, the British pound and the Canadian dollar in exchange for U.S. dollars were €1.00 = U.S. $1.4272 (equivalent to U.S. $1.00 = €0.7012) for euros, £1.00 = U.S. $2.0477 (equivalent to U.S. $1.00 = £0.4886) for British Pounds, and CAN $1.00 = U.S. $0.9929 (equivalent to U.S. $1.00 = CAN $1.0081) for Canadian dollars, respectively.
These translations should not be construed as representations that the euro, British pound and Canadian dollar amounts actually represent U.S. dollar amounts or could be converted into U.S. dollars at the rates indicated.
The following information should be read in conjunction with ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ and the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended March 31, 2007, as well as in conjunction with the condensed consolidated financial statements and related notes appearing elsewhere in this Form 10-Q.
Overview
We develop and market premium branded spirits in several growing market categories, including vodka, rum, whiskey and liqueurs, and we distribute these spirits in all 50 U.S. states and the District of Columbia, in six key international markets, including Ireland, Great Britain, Northern Ireland, Germany, Canada and the Duty Free markets, and in a number of other countries in continental Europe. The brands we market include, among others, Boru vodka, Gosling’s rum, Clontarf Irish Whiskey, Knappogue Castle Whiskey, Jefferson’s, Jefferson’s Reserve and Sam Houston bourbons, Celtic Crossing and the Pallini liqueurs.
Our current growth strategy focuses on: (a) aggressive brand development to encourage case sale and revenue growth of our existing portfolio of brands through significant investment in sales and marketing activities, including advertising, promotion and direct sales personnel expense; and (b) the selective addition of complementary premium brands through a combination of strategic initiatives, including acquisitions, joint ventures and long-term exclusive distribution arrangements.
Historically, our sales in Ireland have been made ‘‘in-bond’’, net of excise taxes. In September 2007, we made an initial sale to our new distributor in Ireland ‘‘ex-bond’’ that included $1.9 million in excise taxes and VAT. These taxes are reflected in both our revenues and cost of sales as an equal increase to both. While the inclusion of $1.9 million dollars in both revenues and cost of sales has no net effect in gross margin, the inclusion did have a negative effect on our gross margin percent, purely as a mathematical consequence of increasing the denominator in the calculation.
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Financial performance overview
The following table sets forth certain information regarding our case sales for the three and six-month periods ended September 30, 2007 and 2006. The data in the following table is based on nine-liter equivalent cases, which is a standard spirits industry metric.
September 30,
September 30, Case SalesCritical accounting policies and estimates
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires us to make a number of 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. Such estimates and assumptions affect the reported amounts of sales and expenses during the reporting period. On an ongoing basis, we evaluate these estimates and assumptions based upon historical experience and various other factors and circumstances. We believe our estimates and assumptions are reasonable under the circumstances; however, actual results may differ from these estimates under different future conditions.
We believe that the estimates and assumptions discussed below are most important to the portrayal of our financial condition and results of operations in that they require our most difficult, subjective or complex judgments and form the basis for the accounting policies deemed to be most critical to our operations.
Revenue recognition
We recognize revenue from product sales when the product is shipped to a customer (generally upon shipment to a distributor or to a control state entity), title and risk of loss has passed to the customer in accordance with the terms of sale (FOB shipping point or FOB destination) and collection is reasonably assured. We do not offer a right of return but will accept returns if we shipped the wrong product or wrong quantity.
Accounts receivable
We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the trade accounts
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receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on our history of write-offs, level of past due accounts based on contractual terms of the receivables and our relationships with, and economic status of, our customers.
Inventory
Our inventory, which consists of distilled spirits, packaging and finished goods, is valued at the lower of cost or market, using the weighted average cost method. We assess the valuation of our inventories and reduce the carrying value of those inventories that are obsolete or in excess of our forecasted usage to their estimated realizable value. We estimate the net realizable value of such inventories based on analyses and assumptions including, but not limited to, historical usage, future demand and market requirements. Reduction to the carrying value of inventories is recorded in cost of goods sold.
Goodwill and other intangible assets
Goodwill represents the excess of purchase price and related costs over the value assigned to the net tangible and other intangible assets of businesses acquired. As of September 30, and March 31, 2007, goodwill and other intangible assets that arose from acquisitions were $12.5 million and $13.0 million, respectively. Goodwill and other intangible assets with indefinite lives are not amortized, but instead, are tested for impairment annually or, more frequently, if circumstances indicate a possible impairment may exist.
We evaluate the recoverability of goodwill and indefinite lived intangible assets using a two-step impairment test approach at the reporting unit level. In the first step the fair value of the reporting unit is compared to its book value including goodwill. In the case that the fair value of the reporting unit is less than the book value, a second step is performed which compares the implied fair value of the reporting unit’s goodwill to the book value of the goodwill. The fair value for the goodwill is determined based on the difference between the fair values of the reporting units and the net fair values of the identifiable assets and liabilities of such reporting units. If the fair value of the goodwill is less than the book value, the difference is recognized as an impairment.
SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to the estimated residual values and reviewed for impairment in accordance with SFAS No. 144, ‘‘Accounting for the Impairment or Disposal of Long-Lived Assets.’’
Stock-based compensation
We follow Statement of Financial Accounting Standards (‘‘SFAS’’) No. 123R, ‘‘Share Based Payment’’ with respect to accounting for stock-based compensation. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense over the service period (generally the vesting period) in the consolidated financial statements based on their fair values. The impact of forfeitures that may occur prior to vesting is also estimated and considered in the amount recognized. In addition, the realization of tax benefits in excess of amounts recognized for financial reporting purposes will be recognized as a financing activity in accordance with SFAS 123R.
No tax benefits were attributed to the stock-based compensation expense in this quarter because a valuation allowance was maintained for substantially all net deferred tax assets. We follow the alternative method of calculating the historical pool of windfall tax benefits as permitted by FASB Staff Position (FSP) No. SFAS 123R, ‘‘Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.’’ This is a simplified method to determine the pool of windfall tax benefits that is used in determining the tax effects of stock compensation in the results of operations and cash flow reporting for outstanding awards.
Stock based compensation for the three-months ended September 30, 2007 and 2006 was $0.3 million and $0.3 million, respectively, and $0.5 million and $0.8 million, respectively, for the six-months ended September 30, 2007 and 2006. We used the Black-Scholes option-pricing model to
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estimate the fair value of options granted. The assumptions used in valuing the options granted during the six-months ended September 30, 2007 and 2006 are included in Note 13 to the condensed consolidated financial statements.
Fair value of financial instruments
SFAS No. 107, ‘‘Disclosures About Fair Value of Financial Instruments,’’ defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties and requires disclosure of the fair value of certain financial instruments. We believe that there is no material difference between the fair value and the reported amounts of financial instruments in the balance sheets due to the short-term maturity of these instruments, or with respect to the debt, as compared to the current borrowing rates available to us.
Results of operations
The following table sets forth, for the periods indicated, the percentage of net sales of certain items in our financial statements.
September 30,
September 30,Three-months Ended September 30, 2007 Compared With Three-months Ended September 30, 2006
Net sales. Net sales increased $2.7 million, or 42.7%, to $8.9 million in the three-months ended September 30, 2007 from $6.3 million in the comparable prior period. As described in the ‘‘Overview’’ section above, included in the current period net sales is $1.9 million dollars of excise tax on the initial sale to our new distributor in Ireland. In addition to the effects of this one time increase to net sales, net sales during the three-months ended September 30, 2007, were also positively affected by our continuing to increase the price of certain of our products as a part of our overall pricing strategy. Our increase in net sales also reflects an increase in overall case sales, primarily from existing brands. The
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weakening dollar vis-à-vis the euro and the British pound also positively impacted our net sales as our international sales which are denominated in euros and British pounds translated to U.S. dollars at a higher rate. However, some of these net sales gains were offset by reduced net sales from direct imports into the U.S. In a direct import sale, whereby federal excise taxes are paid directly by the distributor and not included in our revenue and cost of sales, resulting in lower revenue and cost per case, ending in an increase in gross margin percent.
Our U.S. case sales as a percentage of total case increased to 61.8% during the three-months ended September 30, 2007 as compared to 60.1% in the comparable period in 2006. This percentage of total case sales sold in the U.S. continues to reflect the momentum of our portfolio in the U.S., particularly for Boru vodka and the Pallini liqueurs.
The table below presents the increase or decrease, as applicable, in our case sales by product category for the three-months ended September 30, 2007 as compared to the prior year period. Current period Whiskey case sales include sales of bourbon products following our acquisition of McLain & Kyne on October 12, 2006. The decrease in rum case sales was primarily due to a significant buy-in by our distributors in the quarter ended March 31, 2007 in anticipation of Gosling’s rum price increases later in the year. Although this buy-in has negatively affected year-over-year rum case sales, we view this as further indication of the continuing strength of the brand, as the distributors are willing to carry the cost of the additional inventory.
case sales
increaseGross profit. Gross profit increased 22.9% to $2.5 million during the three-months ended September 30, 2007 from $2.0 million in the comparable prior period, while our gross margin decreased to 27.8% during the three-months ended September 30, 2007 compared to 32.3% for the comparable prior period.
The absolute increase in gross profit reflected our increased level of case sales. As described in the ‘‘Overview’’ section above, the decrease in gross margin percentage is a result of the effects of the $1.9 million of excise tax included in the current period from our initial sale to our new distributor in Ireland. The effect of this one-time event was partially offset by the positive effects of price increases on certain of our products as part of an overall pricing strategy, coupled with a change in product mix of some of our higher margin products, including shifts in both brands and sizes and the effects of an increase in direct imports. These increases were partially offset by the adverse effects of the weakening dollar vis-à-vis the euro and the resulting increase in real U.S. dollar costs of our euro billed production.
Selling expense. Selling expense decreased 5.5% to $4.4 million in the three-months ended September 30, 2007 from $4.7 million in the comparable prior year period. This decrease in selling expense was largely attributable to a combination of reduced overall spending and the timing of certain advertising promotional programs, including decreases in distributor incentives and sales support costs of $0.2 million. The decrease of these costs was offset in part by an increase in personnel to strengthen our sales and marketing team. We added new personnel, which resulted in an increase in consultancy and compensation expense of $0.4 million. Stock-based compensation expense attributable to sales and marketing personnel remained flat at $0.1 million in the three-months ended June 30, 2007 when compared to the comparable prior period. As a result of the foregoing, selling expense as a percentage of net sales decreased to 49.7% in the three-months ended September 30, 2007 as compared to 75.1% for the comparable prior year period.
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General and administrative expense. General and administrative expense increased 10.1% to $2.1 million in the three-months ended September 30, 2007 from $1.9 million in the comparable prior year period. The increase in general and administrative expense was primarily attributable to $0.1 million of increases in compensation expense and $0.1 million in capital based taxes. As a result of the foregoing, general and administrative expense as a percentage of net sales decreased to 23.4% in the three-months ended September 30, 2007 compared to 30.4% for the comparable prior year period.
Depreciation and amortization. Depreciation and amortization during the quarter ended September 30, 2007 was approximately the same as the comparable prior year quarter at $0.3 million.
Other Income/(Expense), Net. Other income/(expense), net, increased 74.6% to $1.0 million during the three-months ended September 30, 2007 from $0.6 million in the comparable prior period. The major components of this category include a change in foreign exchange, net interest income/(expense) and minority interest.
The foreign exchange gain during the three-months ended September 30, 2007 increased to $1.1 million as compared to $0.3 million in the comparable prior period. The increased gain in the current period is attributable to the strengthening of the euro and the British pound against the dollar, as compared to the comparable prior year period, on our intercompany loans to our foreign subsidiaries.
Interest income during the three-months ended September 30, 2007 increased to $0.3 million from $0.2 million in the comparable prior year period. The source of this income is the investment of our excess cash. Interest expense during the three-months ended September 30, 2007 was $0.5 million versus $0.3 million in the comparable prior year period. The increase in interest expense is primarily attributable to the expansion of our senior notes in November 2006.
Minority interest during the three-months ended September 30, 2007 amounted to a credit of $0.3 million as compared to a credit of $0.4 million in the comparable prior year period as a result of improving operations recorded by our 60%-owned subsidiary, Gosling-Castle Partners, Inc.
Net loss attributable to common stockholders. The net loss attributable to common stockholders for the three-months ended September 30, 2007 decreased 22.2% to $3.3 million from $4.2 million in the comparable prior year period. Net loss per common share basic and diluted was positively affected by the increase in shares outstanding resulting from the shares issued in our private placement completed in May 2007. The net loss per common share for the three-months ended September 30, 2007 and 2006 include no preferred dividends.
Six-months Ended September 30, 2007 Compared With Six-months Ended September 30, 2006
Net sales. Net sales increased $2.8 million, or 24.2%, to $14.5 million in the six-months ended September 30, 2007 from $11.7 million in the comparable prior period. As described in the ‘‘Overview’’ section above, included in the current period net sales is $1.9 million dollars of excise tax on the initial sale to our new distributor in Ireland. In addition to the effects of this one time increase to net sales, net sales during the six-months ended September 30, 2007, were also positively affected by our continuing to increase the price of certain of our products as a part of our overall pricing strategy. Our increase in net sales also reflects an increase in overall case sales, primarily from existing brands. The weakening dollar vis-à-vis the euro and the British pound also positively impacted our net sales as our international sales which are denominated in euros and British pounds translated to U.S. dollars at a higher rate. However, some of these net sales gains were offset by reduced net sales from direct imports into the U.S. In a direct import sale, federal excise taxes are paid directly by the distributor, resulting in lower revenue and cost per case, ending in an increase in gross margin percent.
Our U.S. case sales as a percentage of total cases increased to 61.2% during the six-months ended September 30, 2007 as compared to 60.2% in the comparable period in 2006. This percentage of total case sales sold in the U.S. continues to reflect the momentum of our portfolio in the U.S., particularly for Boru vodka and the Pallini liqueurs.
The table below presents the increase or decrease, as applicable, in our case sales by product category for the six-months ended September 30, 2007 as compared to the prior year period. Current
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period Whiskey case sales include sales of bourbon products following our acquisition of McLain & Kyne on October 12, 2006. The decrease in rum case sales was primarily due to a significant buy-in by our distributors in the quarter ended March 31, 2007 in anticipation of Gosling’s rum price increases later in the year. Although this buy-in has negatively affected year-over-year rum case sales, we view this as further indication of the continuing strength of the brand, as the distributors are willing to carry the cost of the additional inventory.
case sales
increaseGross profit. Gross profit increased 17.5% to $4.6 million during the six-months ended September 30, 2007 from $3.9 million in the comparable prior period, while our gross margin decreased to 31.7% during the six-months ended September 30, 2007 compared to 33.4% for the comparable prior period.
The absolute increase in gross profit reflected our increased level of case sales. As described in the ‘‘Overview’’ section above, the decrease in gross margin percentage is a result of the effects of the $1.9 million of excise tax included in the current period from our initial sale to our new distributor in Ireland. The effect of this one-time event was partially offset by the positive effects of price increases on certain of our products as part of an overall pricing strategy, coupled with a change in product mix of some of our higher margin products, including shifts in both brands and sizes and the effects of an increase in direct imports. These increases were partially offset by the adverse effects of the weakening dollar vis-à-vis the euro and the resulting increase in real U.S. dollar costs of our euro billed production.
Selling expense. Selling expense increased 5.3% to $8.7 million in the six-months ended September 30, 2007 from $8.2 million in the comparable prior year period. A decrease in certain marketing programs of $0.6 million in the six-months ended September 30, 2007 was offset by primarily by the addition of new personnel, which resulted in an increase in consultancy, compensation and related expenses of $1.1 million. Stock-based compensation expense attributable to sales and marketing personnel remained flat at $0.2 million in the six-months ended September 30, 2007 when compared to the comparable prior period. As a result of the foregoing, selling expense as a percentage of net sales decreased to 59.6% in the six-months ended September 30, 2007 as compared to 70.3% for the comparable prior year period.
General and administrative expense. General and administrative expense increased 0.1% to $4.2 million in the six-months ended September 30, 2007 from $4.1 million in the comparable prior year period. The increase in general and administrative expense was primarily attributable to $0.2 million of increases in compensation expense and $0.1 million in capital based taxes and other public company expenses. As a result of the foregoing, general and administrative expense as a percentage of net sales decreased to 28.5% in the six-months ended September 30, 2007 compared to 35.3% for the comparable prior year period.
Depreciation and amortization. Depreciation and amortization increased 15.7% to $0.6 million during the six-months ended September 30, 2007 from $0.5 million in the comparable prior year period. This increase is primarily due to increased assets.
Other Income/(Expense), Net. Other income/(expense), net, increased to 67.5% to $1.1 million during the six-months ended September 30, 2007 from $0.7 million in the comparable prior period. The major components of this category include a change in foreign exchange, net interest income/(expense) and minority interest.
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The foreign exchange gain during the six-months ended September 30, 2007 increased to $1.2 million as compared to $0.7 million in the comparable prior period. The increased gain in the current period is attributable to the strengthening of the euro and the British pound against the dollar, as compared to the comparable prior year period, on our intercompany loans to our foreign subsidiaries.
Interest income during the six-months ended September 30, 2007 was $.3 million as compared to $0.5 in the comparable prior year period. The source of this income is the investment of the proceeds of our excess cash. Interest expense during the six-months ended September 30, 2007 increased to $1.1 million from $1.0 million in the comparable prior year period. The increase in interest expense is primarily attributable to the expansion of our Senior Notes in November 2006.
Minority interest during the six-months ended September 30, 2007 amounted to a credit of $0.5 million as compared to a credit of $0.7 million in the comparable prior year period as a result of improving operations recorded by our 60%-owned subsidiary, Gosling-Castle Partners, Inc.
Net loss attributable to common stockholders. The net loss attributable to common stockholders for the six-months ended September 30, 2007 decreased 7.7% to ($7.7) million from ($8.3) million in the comparable prior year period. Net loss per common share basic and diluted was positively affected by the increase in shares outstanding resulting from the shares issued in our private placement completed in May 2007. The net loss per common share for the six-months ended September 30, 2007 and 2006 included $0.0 and $0.1 of preferred dividends, respectively.
EBITDA. EBITDA increased 7.0% to ($5.9) million for the six-months ended September 30, 2007 from ($6.2) million the comparable prior year period. EBITDA represents net income before deducting interest expense (including expensing of deferred financing costs), income taxes, depreciation and amortization and the impact of the non-cash charge for stock-based compensation reported under SFAS 123(R). We use EBITDA as the primary internal management measure for evaluating performance on a period over period analysis, when comparing actual results to budgeted performance and when allocating additional resources. This non-GAAP financial measure is presented in order to assist industry analysts and investors in assessing our liquidity, our ability to incur and service debt, make capital expenditures and meet working capital requirements. EBITDA should not be considered as an alternative to operating income as an indicator of our performance, as an alternative to cash flows from operating activities as a measure of liquidity, or as an alternative to any other measure determined in accordance with GAAP. Unlike net income, EBITDA does not include depreciation or interest expense and therefore does not reflect current or future capital expenditures or the cost of capital. We compensate for these limitations by using EBITDA as only one of several comparative tools, together with GAAP measurements, to assist in the evaluation of operating performance. Such GAAP measurements include operating income (loss), net income (loss), cash flows from operations and cash flow data. We have significant uses of cash flows, including interest payments, debt principal repayments, and other non-recurring charges, which are not reflected in EBITDA. Because EBITDA as determined by us excludes some, but not all, items that affect net income, it may not be comparable to EBITDA or similarly titled measures used by other companies.
The following table sets forth our reconciliation of EBITDA to net loss (the most directly comparable financial measure):
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September 30, (Dollars in thousands)Liquidity and capital resources
Since our inception, we have incurred significant operating and net losses and, in addition, have not generated positive cash flows from operations. As of September 30, 2007, we had stockholders’ equity of $35.3 million and working capital of $28.8 million as compared to $23.6 million and $17.1 million, respectively, at March 31, 2007. These increases are primarily the result of our May 2007 private placement, which raised net proceeds of $19.6 million upon the sale of 3,520,035 common shares at the offering price of $5.97 per share. The proceeds have been and will continue to be used for working capital and general corporate purposes, including, without limitation, sales and marketing activities.
At September 30, 2007, we had cash and cash equivalents and short-term investments of approximately $11.6 million as compared to $6.9 million at March 31, 2007. This $4.7 million increase is primarily attributable to our May 2007 private placement, net of our operating and capital uses. In addition, at September 30, 2007, we had approximately $0.7 million of cash restricted from withdrawal and held by a bank in Ireland as collateral for a line of credit.
We believe that we will be able to fund our operations for the next twelve months from our projected cash flow from operations, improvements in our working capital, the $5.0 million available from our 10% credit facility with Frost Nevada Investments Trust, and current cash and cash equivalents and short term investments. Beyond the next twelve months, we anticipate additional financing will be needed to fund working capital and other requirements. Changes in our operating plans, acquisitions or other additions of brands, lower than anticipated sales, increased expenses, or other events, including those described in our Annual Report on Form 10-K for the year ended March 31, 2007, under the caption ‘‘Risk Factors,’’ may require us to seek additional debt or equity financing on an accelerated basis. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could impact negatively our growth plans, financial condition and results of operations. Additional equity financing may be dilutive to the holders of our common stock, and debt financing, if available, may involve significant cash payment obligations or financial covenants and ratios that restrict our ability to operate our business.
The following trends are reasonably likely to result in a material decrease in our liquidity over the near-to-mid term:
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We expect that we will require increasing amounts of working capital to finance our inventory levels in the United States. Except for Gosling’s rums and our bourbon products, which are bottled in the United States, all of our products are imported from Europe. In the case of our internationally produced brands, there is a three-to-four month production and shipping lead time between the time of order placement and the time the product is available for sale. This lead time has required us to maintain sufficient inventories to properly service our customers.
We expect to experience a lengthening of the revenue collection cycle due to the need to extend payment terms as an incentive to encourage customers to make container-sized purchases of our products on which title passes to the customer at the shipping point in Ireland. A lengthening of the revenue collection cycle will require a significant amount of working capital.
Cash flows
The following table summarizes our primary sources and uses of cash during the periods presented (in thousands):
September 30,Operating activities. A substantial portion of our available cash has been used to fund our operating activities. In general, these cash funding requirements are based on operating losses, driven chiefly by our investment in our selling and marketing efforts. With increases in our overall sales volumes, we have also utilized cash to fund our receivables and inventories. In general, these increases are only partially offset by increases in our accounts payable to our suppliers and accrued expenses. Our business has incurred significant losses since inception.
On average, the production cycle for our owned brands can take as long as four months from the time we obtain the distilled spirits and other materials needed to bottle and package our products to the time we receive products available for sale, which is impacted by the international nature of our business. With respect to Gosling’s rums and Pallini liqueurs, we do not produce the finished product and, instead, receive the finished product directly from the owners of such brands. From the time we have products available for sale, an additional three to four months may be required before we sell our inventory and collect payment from our customers.
In the six-months ended September 30, 2007, net cash used in operating activities was $14.6 million, consisting primarily of losses from our operations of $7.7 million, increases in accounts receivable and inventories of $3.9 million and $2.7 million, respectively, $1.0 million resulting from the effect of changes in foreign currency rates, and minority interest in the net loss of our 60%-owned subsidiary Gosling-Castle Partners of $0.5 million. These uses of cash were offset, in part, by $0.3 in written off deferred financing charges, and by non-cash charges for depreciation and amortization and stock-based compensation expense of $0.6 million and $0.5 million, respectively.
Investing activities. We fund certain acquisitions and operating activities primarily with cash and short-term investments. Net cash used in investing activities was $2.4 million during the six-months ended September 30, 2007, consisting of the proceeds from sale of certain short-term investments of $10.1 million, which was offset by the purchase of $8.0 million of short-term investments.
Financing activities. Net cash provided by financing activities during the six-months ended September 30, 2007 was $19.5 million and consisted of $21.0 million of common stock issued in our
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May 2007 private placement, less $1.4 million in payments for the costs of stock issuance and a $0.2 million increase in restricted cash.
Contractual obligations
The following table sets forth our contractual commitments as of September 30, 2007 for each of the following years:
Recent accounting pronouncements
In September 2006, the FASB issued SFAS No. 157, ‘‘Fair Value Measurements,’’ to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles, and expand disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, the beginning of our 2008 fiscal year. We are assessing the impact the adoption of SFAS No. 157 will have on our financial position and results of operations.
In February 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 159, ‘‘The Fair Value Option for Financial Assets and Financial Liabilities’’ (SFAS 159), which allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. Subsequent changes in fair value of these financial assets and liabilities would be recognized in earnings when they occur. SFAS 159 further establishes certain additional disclosure requirements. SFAS 159 is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. Management is currently evaluating the impact and timing of the adoption of SFAS 159 on our consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
As of September 30, 2007, we did not participate in any derivative financial instruments, or other financial or commodity instruments for which fair value disclosure would be required under SFAS No. 107, ‘‘Disclosure About Fair Value of Financial Investments.’’ We hold no investment securities that would require disclosure of market risk.
Our short-term investments consist primarily of mutual funds that are highly liquid in nature and represent the investment of cash that is available for current operations. These short-term investments are carried at fair market value.
We do participate in certain foreign exchange currency future contracts programs to limit our risk and the potential impact of currency fluctuations on our product costs. When placing a product order, we attempt to lock in its cost by buying forward contracts on euros coinciding with the projected payment dates for such purchases. At September 30, 2007 total forward contracts outstanding amounted to €600,000 ($856,320), calculated at the weighted average conversion rate in such contracts). Depending upon the term of the contract, the cost of these transactions can vary between approximately 50 to 150 basis points.
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Item 4. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Security Exchange Act of 1934, as amended (the ‘‘Exchange Act’’)) that are designed to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Security Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer, and President, Chief Operating Officer and Principal Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As of September 30, 2007, we carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and President, Chief Operating Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. This type of disclosure controls evaluation is performed on a quarterly basis so that the conclusions of management, including the Chief Executive Officer and President, Chief Operating Officer and Principal Financial Officer, concerning the effectiveness of controls can be reported in our Quarterly Reports on Form 10-Q and in our Annual Reports on Form 10-K. Many of the components of our Disclosure Controls are also evaluated on an ongoing basis by other personnel in our accounting, finance and legal functions. The overall goals of these various evaluation activities are to monitor our Disclosure Controls and to modify them on an ongoing basis as necessary. Based upon the evaluation of our Disclosure Controls, our Chief Executive Officer and President, Chief Operating Officer and Principal Financial Officer concluded that our Disclosure Controls were effective as of September 30, 2007 to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during the period covered by this Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Except as described below, we believe that neither we nor any of our wholly owned subsidiaries is currently subject to litigation which, in the opinion of our management, is likely to have a material adverse effect on us.
Our subsidiary, Castle Brands Spirits Company Limited, is the holder of a trademark registration for the mark ‘‘BORU’’ with the United States Patent and Trademark Office. On May 9, 2007, Distillerie Stock U.S.A. Ltd. filed a Petition for Cancellation with the United States Patent and Trademark Office for the cancellation of the trademark registration for BORU on several grounds, including potential confusion between BORU and its existing registered trademark ‘‘BORA’’. We have filed a response presenting various defenses on the merits as well as procedural defenses in a timely manner against Distillerie Stock’s claims. We intend to vigorously pursue these defenses as appropriate. Currently, the matter is pending at the United States Patent and Trademark Office before the Trademark Trial and Appeal Board. While matters before the Trademark Trial and Appeal Board cannot result in monetary damages or directly affect the right to use a trademark, they can result in the cancellation of a trademark registration. Thus, it is possible this matter could result in the cancellation of our trademark registration for BORU in the United States. As a result, it is not feasible to predict the final outcome, and there can be no assurance that these claims might not be finally resolved adversely to us, resulting in material liability to our operations.
On September 6, 2007 we were served with a lawsuit, International Brands USA, Inc. v. Castle Brands, Inc., now pending in Supreme Court, New York County, New York. The complaint alleges several claims relating to our decision not to proceed with the acquisition of a privately-held spirits importing business. We believe the claims have no legal or factual merit and are vigorously defending the matter.
Furthermore, we may become involved in litigation from time to time relating to claims arising in the ordinary course of our business. These claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources.
Item 1A. Risk Factors
Not applicable.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sales of Equity Securities
Not applicable.
Use of proceeds from registered securities
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
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Item 4. Submission of Matters to a Vote of Security Holders
(a) We held our Annual Meeting of Stockholders on September 12, 2007.
(b) Proxies for the meeting were solicited pursuant to Regulation 14 under the Exchange Act; there was no solicitation in opposition to the Board of Directors Nominating Committee’s nominees listed in the Proxy Statement, and all such nominees were elected. Directors elected were Mark Andrews, Keith A. Bellinger, John F. Beaudette, Robert J. Flanagan, Gill Jefferson, Colm Leen, Richard C. Morrison, Frederick M. R. Smith and Kevin Tighe.
The results of the election of directors were as follows:
(c) The appointment of Eisner LLP, independent registered public accounting firm, to audit our consolidated financial statements for the 2008 fiscal year was ratified by the following vote:
Item 5. Other Information
Not applicable.
Item 6. Exhibits
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
and Principal Financial Officer)
EXHIBIT INDEX