Castle Brands Inc.
Castle Brands Inc (Form: 10-Q, Received: 02/14/2011 19:36:18)
 

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2010

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number 001-32849
 
CASTLE BRANDS INC.
(Exact name of registrant as specified in its charter)

Florida
 
41-2103550
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
     
122 East 42nd Street, Suite 4700,
New York, New York
(Address of principal executive offices)
 
10168
(Zip Code)
 
Registrant’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 þ    No o
 
   Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o    No o
 
   Indicate by check mark 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):

o Large accelerated filer
 
o Accelerated filer
o Non-accelerated filer (Do not check if a smaller reporting company)
 
þ Smaller reporting company
 
   Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o    No þ
 
   The Company had 107,202,145 shares of $.01 par value common stock outstanding at February 14, 2011.    
        

 
TABLE OF CONTENTS
 
   
       
Financial Statements:
   
       
 
Condensed Consolidated Balance Sheets as of December 31, 2010 (unaudited) and March 31, 2010
   
       
 
Condensed Consolidated Statements of Operations for the three months and nine months ended December 31, 2010 and 2009 (unaudited)
   
       
 
Condensed Consolidated Statement of Changes in Equity for the nine months ended December 31, 2010 (unaudited)
   
       
 
Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2010 and 2009 (unaudited)
   
       
 
Notes to Unaudited Condensed Consolidated Financial Statements
   
       
Management’s Discussion and Analysis of Financial Condition and Results of Operations
   
       
Controls and Procedures
   
       
   
       
Legal Proceedings
   
       
Exhibits
   
 

 
PART I. FINANCIAL INFORMATION
Item 1.            Financial Statements
 
CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
 
   
December 31, 2010
   
March 31, 2010
 
   
(Unaudited)
       
ASSETS:
           
Current Assets
           
Cash and cash equivalents
 
$
581,887
   
$
1,281,141
 
Accounts receivable — net of allowance for doubtful accounts of $468,847 and $807,438, respectively
   
6,184,835
     
5,394,019
 
Due from affiliates
   
188,750
     
2,192
 
Inventories— net of allowance for obsolete and slow moving inventory of $220,838 and $370,869, respectively
   
10,611,022
     
9,243,801
 
Prepaid expenses and other current assets
   
967,762
     
960,033
 
                 
Total Current Assets
   
18,534,256
     
16,881,186
 
                 
Equipment net
   
469,431
     
482,025
 
Other Assets
               
Investment in non-consolidated affiliate, at equity
   
175,614
     
--
 
Intangible assets — net of accumulated amortization of $3,988,582 and $3,437,237, respectively
   
11,125,935
     
11,669,432
 
Goodwill
   
1,063,392
     
994,044
 
Restricted cash
   
439,554
     
693,966
 
Other assets
   
73,312
     
169,134
 
                 
Total Assets
 
$
31,881,494
   
$
30,889,787
 
                 
LIABILITIES AND EQUITY:
               
Current Liabilities
               
Current maturities of notes payable
 
$
422,270
   
$
425,435
 
Accounts payable
   
3,270,055
     
3,826,705
 
Accrued expenses
   
595,574
     
657,934
 
Due to shareholders and affiliates
   
1,677,738
     
676,028
 
                 
Total Current Liabilities
   
5,965,637
     
5,586,102
 
                 
Long-Term Liabilities
               
Notes payable
   
5,834,426
     
434,034
 
Deferred tax liability
   
1,999,798
     
2,110,912
 
                 
Total Liabilities
   
13,799,861
     
8,131,048
 
                 
Commitments and Contingencies (Note 12)
               
                 
Equity
               
Preferred stock, $.01 par value, 25,000,000 shares authorized, none outstanding
   
     
 
Common stock, $.01 par value, 225,000,000 shares authorized, 107,202,145 and 107,955,207 shares issued and outstanding at December 31, and March 31, 2010, respectively
   
1,072,021
     
1,079,552
 
Additional paid-in capital
   
135,430,953
     
135,466,448
 
Accumulated deficit
   
(116,950,055
)
   
(112,105,964
)
Accumulated other comprehensive loss
   
(1,799,651
)
   
(1,768,531
)
                 
Total controlling shareholders’ equity
   
17,753,268
     
22,671,505
 
                 
Noncontrolling interests
   
328,365
     
87,234
 
                 
Total equity
   
18,081,633
     
22,758,739
 
                 
Total Liabilities and Equity
 
$
31,881,494
   
$
30,889,787
 
 
See accompanying notes to the unaudited condensed consolidated financial statements.
 

 
CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
 
   
Three months ended December 31,
   
Nine months ended December 31,
 
   
2010
   
2009
   
2010
   
2009
 
Sales, net*
 
$
8,719,754
   
$
7,490,526
   
$
23,048,823
   
$
22,052,321
 
Cost of sales*
   
5,994,034
     
5,009,483
     
15,073,438
     
14,809,907
 
Reversal of provision for obsolete inventory
   
     
(84,660
)
   
(24,589
)
   
(589,930
)
                                 
Gross profit
   
2,725,720
     
2,565,703
     
7,999,974
     
7,832,344
 
                                 
Selling expense
   
2,645,359
     
2,265,354
     
7,963,367
     
7,363,067
 
General and administrative expense
   
1,067,801
     
1,308,248
     
3,655,837
     
4,057,956
 
Depreciation and amortization
   
229,569
     
240,774
     
695,045
     
687,506
 
                                 
Loss from operations
   
(1,217,009
)
   
(1,248,673
)
   
(4,314,275
)
   
(4,276,185
)
                                 
Other income
   
     
     
957
     
145
 
Other expense
   
--
     
(26,376
)
   
(300
)
   
(48,057
)
Income from equity investment in non-consolidated affiliate
   
17,214
     
--
     
17,214
     
--
 
Foreign exchange (loss) gain
   
(118,578
)
   
628,436
     
(172,824
)
   
2,212,933
 
Interest (expense) income, net
   
(147,606
)
   
1,408
     
(244,846
)
   
28,265
 
Gain on sale of intangible asset
   
--
     
405,900
     
--
     
405,900
 
Gain on exchange of note payable
   
     
     
     
270,275
 
Income tax benefit
   
37,038
     
37,038
     
111,114
     
111,114
 
                                 
Net loss
   
(1,428,941
)
   
(202,267
)
   
(4,602,960
)
   
(1,295,610
)
Net (income) loss attributable to noncontrolling interests
   
(55,155
)
   
(34,963
)
   
(241,131
)
   
27,926
 
                                 
Net loss attributable to common shareholders
 
$
(1,484,096
)
 
$
(237,230
)
 
$
(4,844,091
)
 
$
(1,267,684
)
                                 
Net loss per common share, basic and diluted, attributable to common shareholders
 
$
(0.01
)
 
$
(0.00
)
 
$
(0.05
)
 
$
(0.01
)
                                 
Weighted average shares used in computation, basic and diluted, attributable to common shareholders
   
107,202,145
     
107,955,207
     
107,500,417
     
103,623,882
 
                                 
 
* Sales, net and Cost of sales include excise taxes of $1,229,257 and $1,146,624 for the three months ended December 31, 2010 and 2009, respectively, and $3,522,510 and $3,851,410 for the nine months ended December 31, 2010 and 2009, respectively.
 
See accompanying notes to the unaudited condensed consolidated financial statements.
 

 
CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Changes in Equity
(Unaudited)
 
                           
Accumulated
             
               
Additional
         
Other
             
   
Common Stock
   
Paid-in
   
Accumulated
   
Comprehensive
   
Noncontrolling
   
Total
 
   
Shares
   
Amount
   
Capital
   
Deficit
   
Loss
   
Interests
   
Equity
 
BALANCE,
MARCH 31, 2010
   
107,955,207
   
$
1,079,552
   
$
135,466,448
   
$
(112,105,964
)
 
$
(1,768,531
)
 
$
87,234
   
$
22,758,739
 
                                                         
Comprehensive loss
                                                       
Net (loss) income
                           
(4,844,091
)
           
241,131
     
(4,602,960
)
Foreign currency translation adjustment
                                   
(31,120
)
           
(31,120
)
                                                         
Total comprehensive
loss
                                                   
(4,634,080
)
                                                         
Repurchase and retirement of common stock
   
(3,790,562
)
   
(37,906
)
   
(985,569
)
                           
(1,023,475
)
Issuance of common stock in exchange for fine wine inventory
   
3,000,000
     
30,000
     
810,000
                             
840,000
 
Issuance of common stock in connection with stock option exercises
   
37,500
     
375
     
7,500
                             
7,875
 
Stock-based compensation
                   
132,574
                             
132,574
 
                                                         
BALANCE, DECEMBER 31, 2010
   
107,202,145
   
$
1,072,021
   
$
135,430,953
   
$
(116,950,055
)
 
$
(1,799,651
)
 
$
328,365
   
$
18,081,633
 
 
See accompanying notes to the unaudited condensed consolidated financial statements.
 

 
CASTLE BRANDS INC. and SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
   
Nine months ended December 31,
 
   
2010
   
2009
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net loss
 
$
(4,602,960
)
 
$
(1,295,610
)
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
   
695,045
     
687,506
 
Gain on sale of intangible asset
   
--
     
(405,900
)
Provision for doubtful accounts
   
(23,165
)
   
46,398
 
Amortization of deferred financing costs
   
7,292
     
 
Deferred tax benefit
   
(111,114
)
   
(111,114
)
Income from equity investment in non-consolidated affiliate
   
(17,214
)
   
--
 
Effect of changes in foreign exchange
   
(10,383
)
   
(2,383,647
Stock-based compensation expense
   
132,574
     
125,321
 
Reversal of provision for obsolete inventories
   
(24,589
)
   
(589,930
)
Non-cash interest charge
   
101,097
     
--
 
Gain on exchange of note payable
   
     
(270,275
)
Changes in operations, assets and liabilities:
               
Accounts receivable
   
(778,346
)
   
170,964
 
Due from affiliates
   
(186,558
)
   
73,767
 
Inventory
   
(519,425
)
   
406,589
 
Prepaid expenses and supplies
   
(7,966
)
   
(29,630
)
Other assets
   
88,530
     
35,000
 
Accounts payable and accrued expenses
   
(590,842
)
   
(2,669,678
)
Due to related parties
   
1,001,710
     
254,891
 
                 
Total adjustments
   
(243,354
)
   
(4,659,738
)
                 
NET CASH USED IN OPERATING ACTIVITIES
   
(4,846,314
)
   
(5,955,348
)
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of equipment
   
(135,128
)
   
(63,092
)
Acquisition of intangible assets
   
(7,848
)
   
 
Investment in non-consolidated affiliate, at equity
   
(150,000)
     
--
 
Proceeds from sale of intangible asset
   
--
     
500,000
 
Payments under contingent consideration agreements
   
(69,348
)
   
(65,643
)
Short-term investments — net
   
     
2,954,164
 
                 
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES
   
(362,324
)
   
3,325,429
 
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Credit facilities — net
   
2,500,000
     
(127,263
)
Note payable — Betts & Scholl, LLC
   
(212,271
)
   
(355,406
)
Promissory note – Frost Gamma Investments Trust
   
2,000,000
     
 
Promissory notes – $1.0 million December 2010 financing
   
1,000,000
     
--
 
Notes payable – Gosling’s Export (Bermuda) Limited
   
--
     
223,492
 
Payments of obligations under capital leases
   
     
(928
)
Change in restricted cash
   
241,044
     
(4,673
)
Proceeds from stock option exercises
   
7,875
     
 
Repurchase of common stock
   
(1,023,475
)
   
(180,000
)
                 
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
   
4,513,173
     
(444,778
)
                 
EFFECTS OF FOREIGN CURRENCY TRANSLATION
   
(3,789
)
   
925
 
NET DECREASE IN CASH AND CASH EQUIVALENTS
   
(699,254
)
   
(3,073,772
)
CASH AND CASH EQUIVALENTS — BEGINNING
   
1,281,141
     
4,011,777
 
                 
CASH AND CASH EQUIVALENTS — ENDING
 
$
581,887
   
$
938,005
 
                 
SUPPLEMENTAL DISCLOSURES:
               
Schedule of non-cash investing and financing activities:
               
Issuance of common stock in exchange for fine wine inventory in June 2010
 
$
840,000
   
$
 
                 
Exchange of $314,275 of 3% note payable, including all interest, by issuance of common stock for $44,000 in May 2009
 
$
   
$
314,275
 
Acquisition of Betts & Scholl, LLC assets by issuance of common stock in September 2009
 
$
   
$
1,928,572
 
Acquisition of Betts & Scholl, LLC assets by issuance of note payable in September 2009
 
$
   
$
844,541
 
                 
Interest paid
 
$
121,949
   
$
10,689
 
 
See accompanying notes to the unaudited condensed consolidated financial statements.
 

  
CASTLE BRANDS INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements

NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Presentation
 
The accompanying unaudited 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 (“SEC”) 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, 2010 is derived from the March 31, 2010 audited financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with Castle Brands Inc.’s (the “Company”) audited consolidated financial statements for the fiscal year ended March 31, 2010 included in the Company’s annual report on Form 10-K for the year ended March 31, 2010, as amended (“2010 Form 10-K”). Please refer to the notes to the audited consolidated financial statements included in the 2010 Form 10-K for additional disclosures and a description of accounting policies.
 
The Company has incurred significant operating losses and has not generated positive cash flows from its operating activities since inception. For the nine months ended December 31, 2010, the Company had a net loss of $4,602,960 and used cash of $4,846,314 in operating activities. As of December 31, 2010, the Company had cash and cash equivalents of $581,887 and an accumulated deficiency of $116,950,055. In addition, as described in Note 8, the Company is obligated to pay $0.4 million in principal pertaining to a promissory note maturing in September 2011.

The Company is continuing to implement a plan supporting the continued growth of existing brands that will be supported by a variety of sales and marketing initiatives that the Company expects will generate cash flows from operations. As part of this plan, the Company intends to grow its business through continued expansion to new markets and within existing markets, as well as strengthening distributor relationships. The Company is also seeking additional brands and agency relationships to leverage the existing distribution platform, as well as a systematic approach to inventory and expense reduction, improvements in routes to market and production cost containment to improve existing cash flow. Additionally, the Company is actively seeking additional sources of capital. The terms of such potential financing have not been determined at this time and may include the conversion of existing debt into equity, an increase in availability under the Company’s revolving credit facility, modification to existing debt, including a change in maturity dates, and/or new equity issuances.  No assurance can be provided that any such financings will be completed. Failure to consummate any such financings may impact the Company's ability to implement its planned sales and marketing initiatives and expansion into new and existing markets, and may require the Company to limit its activities, including reduction of personnel, market contraction and sales of inventory and/or brands below market value.

A.   
Description of business and business combination — The unaudited condensed consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, Castle Brands (USA) Corp. (“CB-USA”), and McLain & Kyne, Ltd. (“McLain & Kyne”), and the Company’s wholly-owned foreign subsidiaries, Castle Brands Spirits Group Limited (“CB-IRL”) and Castle Brands Spirits Marketing and Sales Company Limited, and the Company’s 60% ownership interest in Gosling-Castle Partners, Inc. (“GCP”), with adjustments for income or loss allocated based upon percentage of ownership. The accounts of the subsidiaries have been included as of the date of acquisition. All significant intercompany transactions and balances have been eliminated.

B.   
Organization and operations — The Company is principally engaged in the importation, marketing and sale of premium and super premium brands of vodka, whiskey, rums, tequila, liqueurs and fine wine in the United States, Canada, Europe, Latin America and the Caribbean. The vodka, Irish whiskeys and certain liqueurs are procured by CB-IRL, billed in Euros and imported from Europe into the United States. The risk of fluctuations in foreign currency is borne by the U.S. entities.

C.  
Equity investments - Equity investments are carried at original cost adjusted for the Company’s proportionate share of the investees’ income, losses and distributions. The Company assesses the carrying value of its equity investments when an indicator of a loss in value is present and records a loss in value of the investment when the assessment indicates that an other-than-temporary decline in the investment exists. The Company classifies its equity earnings of non-consolidated affiliate equity investment as a component of net income or loss.

D.   
Goodwill and other intangible assets — Goodwill represents the excess of purchase price including related costs over the value assigned to the net tangible and identifiable intangible assets of businesses acquired. Goodwill and other identifiable 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. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives, generally on a straight-line basis, and are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

E.   
Impairment of long-lived assets — Under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310, “Accounting for the Impairment or Disposal of Long-lived Assets”, the Company periodically reviews whether changes have occurred that would require revisions to the carrying amounts of its definite lived, long-lived assets. When the sum of the expected future cash flows is less than the carrying amount of the asset, an impairment loss is recognized based on the fair value of the asset.

 
F.   
Excise taxes and duty — Excise taxes and duty are computed at standard rates based on alcohol proof per gallon/liter and are paid after finished goods are imported into the United States and then transferred out of “bond.” Excise taxes and duty are recorded to inventory as a component of the cost of the underlying finished goods. When the underlying products are sold “ex warehouse”, the sales price reflects the taxes paid and the inventoried excise taxes and duties are charged to cost of sales.

G.   
Foreign currency — The functional currency for the Company’s foreign operations is the Euro in Ireland and the British Pound in the United Kingdom. Under ASC 830, “Foreign Currency Matters”, 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 shown as a separate line item in the consolidated statements of operations. The Company’s vodka, Irish whiskeys and certain liqueurs are procured by CB-IRL and billed in Euros to CB-USA, with the risk of foreign exchange gain or loss resting with CB-USA. Also, the Company has funded the continuing operations of the international subsidiaries. The Company previously considered these transactions to be trading balances and short-term funding subject to transaction adjustment under ASC 830. As such, at each balance sheet date, the Euro denominated intercompany balances included on the books of the foreign subsidiaries were restated in U.S. Dollars at the exchange rate in effect at the balance sheet date, with the resulting foreign currency transaction gain or loss included in net loss. In November 2009, to improve the liquidity of the foreign subsidiaries, the Company converted $17,481,169 in intercompany balances due from the foreign subsidiaries into an additional investment in the subsidiaries. Beginning December 1, 2009, the translation gain or loss from the restatement of any investment in the foreign subsidiaries will be included in other comprehensive income.

H.   
Fair value of financial instruments — ASC 825, “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. The Company believes that there is no material difference between the fair-value and the reported amounts of financial instruments in the Company’s balance sheets due to the short term maturity of these instruments, or with respect to the Company’s debt, as compared to the current borrowing rates available to the Company.

The Company’s investments are reported at fair value in accordance with authoritative guidance, which accomplishes the following key objectives:
·   
Defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date;
·   
Establishes a three-level hierarchy (“valuation hierarchy”) for fair value measurements;
·   
Requires consideration of the Company’s creditworthiness when valuing liabilities; and
·   
Expands disclosures about instruments measured at fair value.

The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the valuation hierarchy are as follows:
·   
Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
·   
Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are directly or indirectly observable for the asset or liability for substantially the full term of the financial instrument.
·   
Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value measurement.

I.   
Income taxes — Under ASC 740, “Income Taxes”, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. A valuation allowance is provided to the extent a deferred tax asset is not considered recoverable.

The Company has not recognized any adjustments for uncertain tax provisions. The Company recognizes interest and penalties related to uncertain tax positions in general and administrative expense; however, no such provisions for accrued interest and penalties related to uncertain tax positions have been recorded as of December 31, 2010 or 2009.
 
The Company’s income tax benefit for the three months and nine months ended December 31, 2010 and 2009 consists of federal, state and local taxes attributable to 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 difference between the book basis and tax basis created a deferred tax liability that is being amortized over a period of 15 years (the life of the licensing agreement) on a straight-line basis. For each of the three-month and nine-month periods ended December 31, 2010 and 2009, the Company recognized $37,038 and $111,114 of deferred tax benefits, respectively.
 


J.  
Accounting standards adopted — In July 2010, the FASB issued authoritative guidance which requires expanded disclosures to help financial statement users understand the nature of credit risks inherent in a creditor’s portfolio of financing receivables; how that risk is analyzed and assessed in arriving at the allowance for credit losses; and the changes, and reasons for those changes, in both the receivables and the allowance for credit losses. The disclosures should be prepared on a disaggregated basis and provide a roll-forward schedule of the allowance for credit losses and detailed information on financing receivables including, among other things, recorded balances, nonaccrual status, impairments, credit quality indicators, details for troubled debt restructurings and an aging of past due financing receivables.  The guidance became effective for the Company beginning December 15, 2010. The adoption of the standard did not have a material impact on the Company’s results of operations, cash flows or financial condition.

In February 2010, the FASB issued authoritative guidance which eliminated as of February 2010 the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated. The adoption of this guidance did not have a material impact on the Company’s results of operations, cash flows or financial condition.

In January 2010, the FASB issued authoritative guidance intended to improve disclosure about fair value measurements. The guidance requires entities to disclose significant transfers in and out of fair value hierarchy levels and the reasons for the transfers and to present information about purchases, sales, issuances, and settlements separately in the reconciliation of fair value measurements using significant unobservable inputs (Level 3). Also, the guidance clarifies that a reporting entity should provide fair value measurements for each class of assets and liabilities and disclose the inputs and valuation techniques used for fair value measurements using significant other observable inputs (Level 2) and significant unobservable inputs (Level 3). This guidance is effective for interim and annual periods beginning after December 15, 2009, except for the disclosure about purchases, sales, issuances and settlements in the Level 3 reconciliation, which will be effective for interim and annual periods beginning after December 15, 2010. As this guidance provides only disclosure requirements, the adoption of this guidance did not have a material impact on the Company’s results of operations, cash flows or financial condition.
 
In June 2009, the FASB issued authoritative guidance which eliminates the concept of a qualifying special-purpose entity, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria, and changes the initial measurement of a transferor’s interest in transferred financial assets. This guidance became effective for the Company on April 1, 2010. The adoption of the standard did not have a material impact on the Company’s results of operations, cash flows or financial condition.
 
In June 2009, the FASB issued authoritative guidance which eliminates exceptions to consolidating qualifying special-purpose entities, contains new criteria for determining the primary beneficiary, and increases the frequency of required reassessments to determine whether a company is the primary beneficiary of a variable interest entity. This guidance also contains a new requirement that any term, transaction, or arrangement that does not have a substantive effect on an entity’s status as a variable interest entity, a company’s power over a variable interest entity, or a company’s obligation to absorb losses or its right to receive benefits of an entity must be disregarded. The elimination of the qualifying special-purpose entity concept and its consolidation exceptions means more entities will be subject to consolidation assessments and reassessments. This guidance became effective for the Company on April 1, 2010. The adoption of the standard did not have a material impact on the Company’s results of operations, cash flows or financial condition.
 
In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for the consolidation of variable interest entities. The guidance affects the overall consolidation analysis and requires enhanced disclosures on involvement with variable interest entities. This guidance became effective for the Company on April 1, 2010. The adoption of the standard did not have a material impact on the Company’s results of operations, cash flows or financial condition.

K.   
Recent accounting pronouncements — No new accounting pronouncements issued during the current period are expected to have a material impact on the Company’s results of operations, cash flows or financial condition.
 
  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 that are not anti-dilutive. Diluted potential common shares consist of incremental shares issuable upon exercise of stock options and warrants outstanding. In computing diluted net loss per share for the three months and nine months ended December 31, 2010 and 2009, no adjustment has been made to the weighted average outstanding common shares as the assumed exercise of outstanding options and warrants is anti-dilutive.
 

 
Potential common shares not included in calculating diluted net loss per share are as follows:
 
   
Nine months ended
December 31,
 
   
2010
   
2009
 
Stock options
   
4,570,850
     
3,224,900
 
Warrants to purchase common stock
   
1,926,814
     
2,016,814
 
                 
Total
   
6,497,664
     
5,241,714
 
 
NOTE 3 — INVENTORIES

   
December 31,
2010
   
March 31,
2010
 
Raw materials
 
$
3,777,653
   
$
2,961,887
 
Finished goods – net
   
6,833,369
     
6,281,914
 
                 
Total
 
$
10,611,022
   
$
9,243,801
 

  As of December 31, and March 31, 2010, 66% and 47%, respectively, of raw materials and 3% and 4%, respectively, of finished goods were located outside of the United States.
 
The Company recorded reversals of its allowance for obsolete and slow moving inventory of $84,660 during the three months ended December 2009, and $24,589 and $589,930 during the nine months ended December 31, 2010 and 2009, respectively. These reversals were recorded as the Company was able to sell certain of the goods included in the allowance recorded during previous fiscal years. The Company did not record any reversal during the three months ended December 31, 2010. The Company estimates the allowance for obsolete and slow moving inventory based on analyses and assumptions including, but not limited to, historical usage, expected future demand and market requirements.
 
Inventories are stated at the lower of weighted average cost or market.

NOTE 4 — EQUITY INVESTMENT

Investment in DP Castle Partners, LLC

In August 2010, CB-USA formed DP Castle Partners, LLC (“DPCP”) with Drink Pie, LLC to manage the manufacturing and marketing of Travis Hasse’s Original Apple Pie Liqueur, Cherry Pie Liqueur and any future line extensions of the brand. DPCP has the exclusive global rights to produce and market Travis Hasse’s Original Pie Liqueurs and CB-USA has the global distribution rights for this brand. DPCP pays a per case royalty fee to Drink Pie, LLC under a licensing agreement. CB-USA purchases the finished product from DPCP at a pre-determined margin and then uses its existing infrastructure, sales force and distributor network to sell the product and promote the brands. Finished goods are sold to CB-USA FOB – Production and CB-USA bears the risk of loss on both inventory and third-party receivables. Revenues and cost of sales are recorded at their respective gross amounts on the books and records of CB-USA. For the three and nine months ended December 31, 2010, the CB-USA purchased $620,731 in finished goods from DPCP under the distribution agreement. As of December 31, 2010, CB-USA was indebted to DPCP in the amount of $98,881 which is included in due to shareholders and affiliates on the accompanying condensed consolidated balance sheet. Under the terms of the agreement, CB-USA initially owns 20% of the entity and will increase its stake in DPCP based on achieving case sale targets. The Company has accounted for this investment under the equity method of accounting. This investment balance was $175,614 at December 31, 2010.

  NOTE 5 — ACQUISITIONS

  Acquisition of McLain & Kyne  
 
On October 12, 2006, the Company acquired all of the outstanding capital stock of McLain & Kyne, pursuant to a stock purchase agreement. As consideration for the acquisition, the Company paid $2,000,000, consisting of $1,294,800 in cash and 100,000 shares of its common stock, valued at $705,200, at closing. Under the McLain & Kyne agreement, as amended, the Company will also pay an earn-out, not to exceed $4,000,000, to the sellers based on the financial performance of the acquired business through March 31, 2011. For the nine months ended December 31, 2010 and 2009, the sellers earned $69,348 and $65,643, respectively,  under this agreement. The earn-out payments have been recorded as an increase to goodwill.
 
NOTE 6 — GOODWILL AND INTANGIBLE ASSETS
 
The changes in the carrying amount of goodwill for the nine months ended December 31, 2010 were as follows:
 

 
   
Amount
 
Balance as of March 31, 2010
 
$
994,044
 
         
Payments under McLain and Kyne agreement
   
69,348
 
         
Balance as of December 31, 2010
 
$
1,063,392
 
 
Intangible assets consist of the following:
 
   
December 31,
2010
   
March 31, 
2010
 
Definite life brands
 
$
170,000
   
$
170,000
 
Trademarks
   
479,248
     
479,248
 
Rights
   
8,271,555
     
8,271,555
 
Distributor relationships
   
664,000
     
664,000
 
Product development
   
28,262
     
20,350
 
Trade secrets, formulations and patents
   
994,000
     
994,000
 
Other
   
28,480
     
28,544
 
             
     
10,635,545
     
10,627,697
 
Less: accumulated amortization
   
3,988,582
     
3,437,237
 
             
Net
   
6,646,963
     
7,190,460
 
Other identifiable intangible assets — indefinite lived*
   
4,478,972
     
4,478,972
 
             
   
$
11,125,935
   
$
11,669,432
 
Accumulated amortization consists of the following:
 
   
December 31,
2010
   
March 31,
2010
 
Definite life brands
 
$
146,385
   
$
137,885
 
Trademarks
   
155,720
     
130,834
 
Rights
   
3,167,334
     
2,751,928
 
Distributor relationships
   
83,000
     
33,200
 
Product development
   
7,123
     
4,070
 
Trade secrets, formulations and patents
   
429,020
     
379,320
 
                 
Accumulated amortization
 
$
3,988,582
   
$
3,437,237
 
 
* Other identifiable intangible assets — indefinite lived consists of product formulations.
 
NOTE 7 — RESTRICTED CASH
 
At December 31, and March 31, 2010, the Company had €331,701 or $439,554 (translated at the December 31, 2010 exchange rate) and €515,845 or $693,966 (translated at the March 31, 2010 exchange rate), respectively, of cash restricted from withdrawal and held by a bank in Ireland as collateral for overdraft coverage, creditors’ insurance, customs and excise guaranty, and a revolving credit facility. In April 2010, the Company reduced the aggregate amount of the credit facilities, and the commensurate cash restricted from withdrawal, by €185,000 or $236,654 (translated at the exchange rate then in effect).
 
NOTE 8 — NOTES PAYABLE
 
   
December 31,
2010
   
March 31,
2010
 
Notes payable consist of the following:
               
Note payable (A)
 
 $
422,270
   
 $
633,332
 
Note payable (B)
   
219,513
     
226,137
 
Credit agreement (C)
   
2,500,000
     
 
Note payable (D)
   
2,114,913
     
 
Notes payable (E)
   
1,000,000
     
 
             
Total
 
$
6,256,696
   
$
859,469
 
 

 
A.   
In connection with the Betts & Scholl asset acquisition in September 2009, the Company issued a secured promissory note in the aggregate principal amount of $1,094,541 to Betts & Scholl, LLC, an entity affiliated with Dennis Scholl, who became a director of the Company at the time of the acquisition. This note is secured by the Betts & Scholl inventory acquired by the Company under a security agreement. This note provides for an initial payment of $250,000, paid at closing, and for eight equal quarterly payments of principal and interest, with the final payment due on September 21, 2011. Interest under this note accrues at an annual rate of 0.84%, compounded quarterly. This note contains customary events of default, which if uncured, entitle the holder to accelerate the due date of the unpaid principal amount of, and all accrued and unpaid interest on, the note. In December 2010, the Company entered into a letter agreement amending the terms of the note with Betts & Scholl, LLC, that provides that the quarterly installment payments of principal and interest due December 21, 2010 and March 21, 2011, each in the amount of approximately $107,000, will not be due and payable until the maturity date of such note and that such installment payments will bear interest, payable on such maturity date, at the rate of 11% per annum, compounded quarterly. At December 31, 2010, $422,270, consisting of $421,062 of principal and $1,208 of accrued interest, due on this note is included in current liabilities.

B.   
In December 2009, GCP issued a promissory note (the “GCP Note”) in the aggregate principal amount of $211,580 to Gosling's Export (Bermuda) Limited in exchange for credits issued on certain inventory purchases. The GCP Note matures on April 1, 2020, is payable at maturity, subject to certain acceleration events, and calls for annual interest of 5%, to be accrued and paid at maturity. Interest has been recorded retroactive to November 15, 2008. At December 31, 2010, $219,513, consisting of $211,580 of principal and $7,933 of accrued interest, due on the GCP Note is included in long-term liabilities.

C.   
In December 2009, the Company entered into a $2,500,000 revolving credit agreement with, among others, Frost Gamma Investments Trust, an entity affiliated with Phillip Frost, M.D., a director and principal shareholder of the Company, Vector Group Ltd., a principal shareholder of the Company, Lafferty Ltd., a principal shareholder of the Company, IVC Investors, LLLP, an entity affiliated with Glenn Halpryn, a Company director, Mark E. Andrews, III, the Company’s Chairman, and Richard J. Lampen, the Company’s President and Chief Executive Officer. Under the credit agreement, the Company may borrow from time to time up to $2,500,000 to be used for working capital or general corporate purposes. Borrowings under the credit agreement mature on April 1, 2013 and bear interest at a rate of 11% per annum, payable quarterly. The credit agreement provides for the payment of an aggregate commitment fee of $75,000 payable to the lenders over the three-year period. The note issued under the credit agreement contains customary events of default, which if uncured, entitle the holders to accelerate the due date of the unpaid principal amount of, and all accrued and unpaid interest on, such note. Amounts may be repaid and reborrowed under the revolving credit agreement without penalty. The note is secured by the inventory and trade accounts receivable of CB-USA, subject to certain exceptions, pursuant to a security agreement. Borrowings under this facility occurred as follows: $1,000,000 on April 23, 2010, $1,000,000 on September 14, 2010 and $500,000 on October 22, 2010. At December 31, 2010, $2,500,000 of principal due on this credit agreement was outstanding and is included in long-term liabilities.

D.   
In June 2010, the Company issued a $2,000,000 promissory note to Frost Gamma Investments Trust. Borrowings under the note mature on June 21, 2012 and bear interest at a rate of 11% per annum. Interest accrues quarterly and is payable at maturity. The note may be prepaid in whole or in part at any time prior to maturity without penalty, but with payment of accrued interest to the date of prepayment. At December 31, 2010, $2,114,913, consisting of $2,000,000 of principal and $114,913 of accrued interest is included in long-term liabilities in respect of the Frost Note.

E.   
In December 2010, the Company issued promissory notes in the aggregate principal amount of $1,000,000 to Frost Gamma Investments Trust, Vector Group Ltd., IVC Investors, LLLP, Mark E. Andrews, III and Richard J. Lampen. Borrowings under these notes mature on June 21, 2012 and bear interest at a rate of 11% per annum. Interest accrues quarterly and is payable at maturity. These notes may be prepaid in whole or in part at any time prior to maturity without penalty, but with payment of accrued interest to the date of prepayment. At December 31, 2010, $1,000,000 of principal is included in long-term liabilities in respect of these promissory notes.

NOTE 9 — EQUITY
 
Common stock — In June 2010, the Company issued 3,000,000 shares of its common stock in exchange for fine wine inventory. The inventory was valued at $840,000 based on the closing price of the common stock on the date of the transaction.
 
Share repurchase – In June 2010, the Company repurchased 3,790,562 shares of its common stock at a price of $0.27 per share in a privately-negotiated transaction. Also, the Company’s board of directors approved a stock repurchase program authorizing the Company to repurchase up to an additional 2,500,000 shares of its common stock. As of December 31, 2010, no shares of the Company’s common stock had been repurchased under the repurchase program.
 

 
NOTE 10 — FOREIGN CURRENCY FORWARD CONTRACTS  
 
The Company enters into forward contracts from time to time to reduce 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 December 31, 2010 and March 31, 2010, the Company had no forward contracts outstanding. Gain or loss on foreign currency forward contracts, which was de minimis during the periods presented, is included in other income and expense.
 
NOTE 11 — STOCK-BASED COMPENSATION
 
In December 2010, the Company granted to certain employees options to purchase an aggregate of 41,850 shares of the Company’s common stock at an exercise price of $0.35 per share under the Company’s 2003 Stock Incentive Plan. The options, which expire in December 2020, vest 33.3% on each of the first three anniversaries of the grant date. The Company has valued the options at $8,810 using the Black-Scholes option pricing model.

In June 2010, the Company granted to employees, directors and certain consultants options to purchase an aggregate of 1,500,000 shares of the Company’s common stock at an exercise price of $0.35 per share under the Company’s 2003 Stock Incentive Plan. The options, which expire in June 2020, vest 25% on each of the first four anniversaries of the grant date. The Company has valued the options at $250,020 using the Black-Scholes option pricing model. 

Stock-based compensation expense for the three months ended December 31, 2010 and 2009 and for the nine months ended December 31, 2010 and 2009 amounted to $47,881 and $42,947, respectively and $132,574 and $125,321, respectively. At December 31, 2010, total unrecognized compensation cost amounted to $361,234, representing 2,955,600 unvested options. This cost is expected to be recognized over a weighted-average period of 2.63 years. There were 37,500 shares exercised during the nine months ended December 31, 2010 and none exercised during the nine months ended December 31, 2009. The Company did not recognize any related tax benefit for the three and nine months ended December 31, 2010 and 2009 from these option exercises.
 
NOTE 12 — COMMITMENTS AND CONTINGENCIES

A.   
The Company has entered into a supply agreement with Irish Distillers Limited (“Irish Distillers”), which provides for the production of Irish whiskeys for the Company through 2015, subject to annual extensions thereafter, provided that the Company and Irish Distillers agree on the amount of liters of pure alcohol to be provided in the following year. Irish Distillers may terminate this agreement at the end of its term in 2014. Under this agreement, the Company is obligated to notify Irish Distillers annually of the amount of liters of pure alcohol it requires for the current contract year and contracts to purchase that amount. For the contract year ending June 30, 2011, the Company has contracted to purchase approximately €803,844 or $1,065,214 (translated at the December 31, 2010 exchange rate) in bulk Irish whiskey. The Company has purchased €344,021 or $455,879 (translated at the December 31, 2010 exchange rate) in bulk Irish whiskey through December 31, 2010 under the current contract year. The Company is not obligated to pay Irish Distillers for any product not yet received. During the term of this supply agreement, Irish Distillers has the right to limit additional purchases above the commitment amount.

B.   
The Company leases office space in New York, NY, Dublin, Ireland and Houston, TX. The New York, NY lease began on April 1, 2010 and expires on April 1, 2012 and provides for monthly payments of $16,779. The Dublin lease commenced on March 1, 2009 and extends through November 30, 2013 and calls for monthly payments of €1,394 or $1,847 (translated at the December 31, 2010 exchange rate). The Houston, TX lease commenced on February 24, 2000 and extends through January 31, 2012 and calls for monthly payments of $1,693. The Company has also entered into non-cancelable operating leases for certain office equipment.

NOTE 13 — CONCENTRATIONS

A.   
Credit Risk — The Company maintains its cash and cash equivalents balances at various large financial institutions that, at times, may exceed federally and internationally insured limits. As of December 31, and March 31, 2010, the Company exceeded the insured limit by approximately $325,000 and $760,000, respectively.

B.   
Customers — Sales to three customers accounted for approximately 37.9% and 43.1% of the Company’s revenues for the three months ended December 31, 2010 and 2009, respectively, (of which one customer accounted for 27.6% and 31.8%, respectively, of total sales). Sales to three customers accounted for approximately 41.5% and 44.5% of the Company’s revenues for the nine months ended December 31, 2010 and 2009, respectively, (of which one customer accounted for 27.9% and 31.5%, respectively, of total sales).  Sales to three customers accounted for approximately 34.9% of accounts receivable at December 31, 2010.
 
NOTE 14 — GEOGRAPHIC INFORMATION
 
The Company operates in one reportable segment — the sale of premium beverage alcohol. The Company’s product categories are vodka, rum, liqueurs, whiskey, tequila and fine wine. The Company reports its operations in two geographic areas: International and United States.
 
The consolidated financial statements include revenues and assets generated in or held in the U.S. and foreign countries. The following table sets forth the amounts and percentage of consolidated revenue, consolidated results from operations, consolidated net loss attributable to common shareholders, consolidated income tax benefit and consolidated assets from the U.S. and foreign countries and consolidated revenue by category:
 

 
   
Three months ended December 31,
 
   
2010
   
2009
 
Consolidated Revenue:
                               
International
 
$
1,432,696
     
16.4
%
 
$
1,431,247
     
19.1
%
United States
   
7,287,058
     
83.6
%
   
6,059,279
     
80.9
%
                         
 Total Consolidated Revenue
 
$
8,719,754
     
100.0
%
 
$
7,490,526
     
100
%
                         
Consolidated Results from Operations:
                               
International
 
$
(35,746
)
   
2.9
%
 
$
27,386
     
(2.2)
%
United States
   
(1,181,263
)
   
97.1
%
   
(1,276,059
   
102.2
%
                         
Total Consolidated Results from Operations
 
$
(1,217,009
   
100.0
%
 
$
(1,248,673
   
100.0
%
                         
Consolidated Net Loss Attributable to Common Shareholders:
                               
International
 
$
(210,172
)
   
14.2
%
 
$
15,350
     
6.5
%
United States
   
(1,273,924
   
85.8
%
   
(252,580
   
106.5
%
                         
Total Consolidated Net Loss Attributable to Common Shareholders
 
$
(1,484,096
   
100.0
%
 
$
(237,230
   
100.0
%
                         
Income tax benefit:
                               
United States
   
37,038
     
100.0
%
   
37,038
     
100.0
%
                         
 Consolidated Revenue by category:
                               
Rum
 
$
2,248,611
     
25.8
%
 
$
2,134,876
     
28.5
%
Liqueurs
   
2,609,008
     
29.9
%
   
2,097,431
     
28.0
%
Whiskey
   
1,728,988
     
19.8
%
   
1,812,346
     
24.2
%
Vodka
   
1,103,244
     
12.7
%
   
1,065,276
     
14.2
%
Tequila
   
41,076
     
0.5
%
   
89,367
     
1.2
%
Fine Wine
   
701,536
     
8.0
%
   
150,550
     
2.0
%
Other*
   
287,291
     
3.3
%
   
140,679
     
1.9
%
                         
Total Consolidated Revenue
 
$
8,719,754
     
100.0
%
 
$
7,490,526
     
100
%
 

 
   
Nine months ended December 31,
 
   
2010
   
2009
 
Consolidated Revenue:
                               
International
 
$
2,953,867
     
12.8
%
 
$
3,339,657
     
15.1
%
United States
   
20,094,956
     
87.2
%
   
18,712,664
     
84.9
%
                         
 Total Consolidated Revenue
 
$
23,048,823
     
100.0
%
 
$
22,052,321
     
100
%
                         
Consolidated Results from Operations:
                               
International
 
$
(112,952
   
2.6
%
 
$
(143,154
   
3.3
%
United States
   
(4,201,323
)
   
97.45
%
   
(4,133,031
   
96.7
%
                         
Total Consolidated Results from Operations
 
$
(4,314,275
   
100.0
%
 
$
(4,276,185
   
100.0
%
                         
Consolidated Net Loss Attributable to Common Shareholders:
                               
International
 
$
(419,243
)
   
8.7
%
 
$
(501,750
)
   
39.6
%
United States
   
(4,424,848
   
91.3
%
   
(765,934
   
60.4
%
                         
Total Consolidated Net Loss Attributable to Common Shareholders
 
$
(4,844,091
   
100.0
%
 
$
(1,267,684
   
100.0
%
                         
Income tax benefit:
                               
United States
   
111,114
     
100.0
%
   
111,114
     
100.0
%
                         
 Consolidated Revenue by category:
                               
Rum
 
$
7,942,544
     
34.5
%
 
$
7,109,472
     
32.2
%
Liqueurs
   
6,016,024
     
26.1
%
   
5,507,523
     
25.0
%
Whiskey
   
3,736,977
     
16.2
%
   
4,272,817
     
19.4
%
Vodka
   
2,914,777
     
12.6
%
   
3,909,406
     
17.7
%
Tequila
   
210,071
     
0.9
%
   
428,773
     
1.9
%
Fine Wine
   
1,161,610
     
5.0
%
   
150,550
     
0.7
%
Other*
   
1,066,820
     
4.7
%
   
673,780
     
3.1
%
                         
Total Consolidated Revenue
 
$
23,048,823
     
100.0
%
 
$
22,052,321
     
100
%
 
 
   
As of December 31,   2010
   
As of March 31,   2010
 
Consolidated Assets:
                               
International
 
$
2,846,153
     
8.9
%
   
3,167,893
     
10.3
%
United States
   
29,035,340
     
91.1
%
   
27,721,894
     
89.7
%
                                 
 Total Consolidated Assets
 
$
31,881,493
     
100.0
%
   
30,889,787
     
100.0
 

 
*Includes related non-beverage alcohol products.

NOTE 15 — SUBSEQUENT EVENTS

In January 2011, CB-USA entered into an agreement ("New Agreement") with Pallini Internazionale S.r.l. ("Pallini"), as successor in interest to I.L.A.R. S.p.A, regarding the importation and distribution of certain Pallini brand products. The New Agreement supersedes that certain Agreement dated as of August 27, 2004 between I.L.A.R. S.p.A and CB-USA ("Original Agreement"). The terms of the New Agreement are effective as of April 1, 2010.

The New Agreement expires on March 31, 2016, subject to successive five year renewals unless either party delivers a notice of non-renewal six months prior to the end of the term. The Original Agreement had an expiration date of December 31, 2012. Under the New Agreement, if minimum volume targets are not achieved and not cured, Pallini has the right to terminate the agreement without payment of termination fees to CB-USA. However, if such targets are met, CB-USA has the right under the New Agreement to receive certain termination payments and other payments upon the non-renewal of the agreement, certain terminations of the agreement or the sale of the brand. CB-USA has modified reporting requirements under the New Agreement as compared to the Original Agreement. The exclusive territory under the New Agreement is the fifty states of the United States of America and the District of Columbia, but does not include Puerto Rico, overseas territories or military bases of the United States that were included in the Original Agreement.
 

 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Overview
 
We develop and market premium brands in the following beverage alcohol categories: vodka, rum, whiskey, liqueurs, tequila and fine wine. We distribute these spirits in all 50 U.S. states and the District of Columbia, in twelve primary international markets, including Ireland, Great Britain, Northern Ireland, Germany, Canada, Bulgaria, France, Russia, Finland, Norway, Sweden, China and the Duty Free markets, and in a number of other countries in continental Europe and Latin America. We market the following brands, among others, Gosling’s Rum® , Jefferson’s TM , Jefferson’s Reserve® and Jefferson's Presidential Select TM bourbons, Clontarf® Irish Whiskey, Pallini® liqueurs, Boru® vodka, Knappogue Castle whiskey® , Tierras TM tequila, Travis Hasse’s Original® Pie Liqueurs, A. de Fussigny ® cognacs and Betts & Scholl TM wines, including the CC: line of wines.
 
Our objective is to continue building a distinctive portfolio of global premium and super premium spirits and fine wine brands as we move towards profitability. To achieve this, we continue to seek to:

·   
increase revenues from our more profitable brands. We have focused, and continue to focus, our distribution relationships, sales expertise and targeted marketing activities on our more profitable brands;
·   
improve value chain and manage cost structure. We have undergone a comprehensive review and analysis of our supply chains and cost structures both on a company-wide and brand-by-brand basis. This included personnel reductions throughout our company; restructuring our international distribution system; reducing inventory levels; changing distributor relationships in certain markets; moving production of certain products to a lower cost facility in the U.S.; and reducing general and administrative costs. We continue to review costs and seek to reduce expense; and
·   
selectively add new premium brands to our portfolio. We intend to continue developing new brands and pursuing strategic relationships, joint ventures and acquisitions to selectively expand our premium spirits and fine wine portfolio, particularly by capitalizing on and expanding our already demonstrated partnering capabilities. Our criteria for new brands focuses on underserved areas of the beverage alcohol marketplace, while examining the potential for direct financial contribution to our company and the potential for future growth based on development and maturation of agency brands. We will evaluate future acquisitions and agency relationships on the basis of their potential to be immediately accretive and their potential contributions to our objectives of becoming profitable and further expanding our product offerings. We expect that future acquisitions, if consummated, would involve some combination of cash, debt and the issuance of our stock.
 
  Recent Events
 
Pallini Agreement

In January 2011, we entered into an agreement ("New Agreement") with Pallini Internazionale S.r.l. ("Pallini"), as successor in interest to I.L.A.R. S.p.A, regarding the importation and distribution of certain Pallini brand products. The New Agreement supersedes that certain Agreement dated as of August 27, 2004 with I.L.A.R. S.p.A ("Original Agreement"). The terms of the New Agreement are effective as of April 1, 2010.

The New Agreement expires on March 31, 2016, subject to successive five year renewals unless either party delivers a notice of non-renewal six months prior to the end of the term. The Original Agreement had an expiration date of December 31, 2012. Under the New Agreement, if minimum volume targets are not achieved and not cured, Pallini has the right to terminate the agreement without payment of termination fees to us. However, if such targets are met, we have the right under the New Agreement to receive certain termination payments and other payments upon the non-renewal of the agreement, certain terminations of the agreement or the sale of the brand. We have modified reporting requirements under the New Agreement as compared to the Original Agreement. The exclusive territory under the New Agreement is the fifty states of the United States of America and the District of Columbia, but does not include Puerto Rico, overseas territories or military bases of the United States that were included in the Original Agreement.

December 2010  Promissory Notes

In December 2010, we issued promissory notes in the aggregate principal amount of $1.0 million to Frost Gamma Investments Trust, an entity affiliated with Phillip Frost, M.D., a director and principal shareholder of our company, Vector Group Ltd., a principal shareholder of our company, IVC Investors, LLLP, an entity affiliated with Glenn Halpryn, a director of our company, Mark E. Andrews, III, our chairman, and Richard J. Lampen, our president and chief executive officer. Borrowings under the notes mature on June 21, 2012 and bear interest at a rate of 11% per annum. Interest accrues quarterly and is due at maturity. The notes may be prepaid in whole or in part at any time prior to maturity without penalty, but with payment of accrued interest to the date of prepayment.
 


DP Castle Partners, LLC

In August 2010, we formed DP Castle Partners, LLC (“DPCP”) with Drink Pie, LLC to manage the manufacturing and marketing of Travis Hasse’s Original® Apple Pie Liqueur, Cherry Pie Liqueur and any future line extensions of the brand. DPCP has the exclusive global rights to produce and market Travis Hasse’s Original® Pie Liqueurs and we have the global distribution rights for this brand. We purchase the finished product from DPCP at a pre-determined margin and then use our existing infrastructure, sales force and distributor network to sell the product and promote the brands. Under the terms of the agreement, we own 20% of DPCP and will acquire an increasing stake in the brand based on achieving certain case sale targets.

Revolving Credit Facility  

In December 2009, we entered into a $2.5 million revolving credit agreement with, among others, Frost Gamma Investments Trust, Vector Group Ltd., Lafferty Ltd., a principal shareholder of our company, IVC Investors, LLLP, Mark E. Andrews, III and Richard J. Lampen. Under the credit agreement, we may borrow from time to time up to $2.5 million to be used for working capital or general corporate purposes. Borrowings under the credit agreement mature on April 1, 2013 and bear interest at a rate of 11% per annum, payable quarterly. At December 31, 2010, the note was secured by $10.2 million of inventory and $4.5 million in trade accounts receivable of Castle Brands (USA) Corp. under a security agreement. We have borrowed the full $2.5 million available under the credit agreement as of the date of this filing.
 
June 2010 Promissory Note  

In June 2010, we issued a $2.0 million promissory note to Frost Gamma Investments Trust, which we refer to as the Frost Note. Borrowings under the Frost Note mature on June 21, 2012 and bear interest at a rate of 11% per annum. Interest accrues quarterly and is due at maturity. The Frost Note may be prepaid in whole or in part at any time prior to maturity without penalty, but with payment of accrued interest to the date of prepayment.
 
Share Repurchase  
 
In June 2010, we repurchased 3,790,562 shares of our common stock at a price of $0.27 per share in a privately-negotiated transaction. Also, our board of directors approved a stock repurchase program authorizing us to repurchase up to an additional 2.5 million shares of our common stock. As of the date of this report, no shares of our common stock had been repurchased under the repurchase program.

Currency Translation
 
The functional currencies for our foreign operations are the Euro in Ireland and continental Europe and the British Pound in the United Kingdom. With respect to our 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. Previously, gains or losses resulting from balances due from funding our international subsidiaries were included in other income (expenses). In November 2009, to improve the liquidity of our foreign subsidiaries, we converted our intercompany balances due from our foreign subsidiaries into an additional investment in these subsidiaries. Beginning December 1, 2009, the translation gain or loss from the restatement of any investment in our foreign subsidiaries will be included in other comprehensive income. Prior to this conversion, we considered these transactions to be trading balances and short-term funding subject to transaction adjustment. As such, at each balance sheet date, we restated the Euro denominated intercompany balances included on the books of the foreign subsidiaries in U.S. Dollars at the exchange rate in effect at the balance sheet date, with the resulting foreign currency transaction gain or loss included in net loss.
 
Where in this report we refer to amounts in Euros, we have for your convenience also in certain cases provided a conversion of those amounts to U.S. Dollars in parentheses. 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 conversions in connection with the applicable financial statement. In all other instances, unless otherwise indicated, the conversions have been made using the exchange rates as of December 31, 2010, each as calculated from the Interbank exchange rates as reported by Oanda.com. On December 31, 2010, the exchange rate of the Euro in exchange for U.S. Dollars was €1.00 = U.S. $1.32515 (equivalent to U.S. $1.00 = €0.75455).
 
These conversions should not be construed as representations that the Euro amounts actually represent U.S. Dollar amounts or could be converted into U.S. Dollars at the rates indicated.
 
Critical Accounting Policies
 
There are no material changes from the critical accounting policies set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our annual report on Form 10-K for the year ended March 31, 2010, as amended, which we refer to as our 2010 Annual Report. Please refer to that section for disclosures regarding the critical accounting policies related to our business.
 

 
Financial performance overview
 
The following table provides information regarding our case sales for the periods presented based on nine-liter equivalent cases, which is a standard spirits industry metric (table excludes related non-beverage alcohol products): 
 
   
Three months ended
   
Nine months ended
 
   
December 31,
   
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
Cases
                               
United States
   
65,644
     
52,355
     
177,311
     
167,583
 
International
   
19,856
     
21,045
     
45,452
     
53,780
 
                                 
Total
   
85,500
     
73,400
     
222,763
     
221,363
 
                                 
Rum
   
22,942
     
22,782
     
81,054
     
73,381
 
Vodka
   
19,743
     
20,675
     
52,684
     
73,027
 
Liqueurs
   
25,466
     
18,294
     
55,992
     
47,069
 
Whiskey
   
11,758
     
10,727
     
24,007
     
25,750
 
Tequila
   
303
     
299
     
937
     
1,513
 
Fine Wine
   
5,129
     
623
     
7,644
     
623
 
Other
   
159
     
     
445
     
 
                                 
Total
   
85,500
     
73,400
     
222,763
     
221,363
 
                                 
Percentage of Cases
                               
United States
   
76.8
%
   
71.3
%
   
79.6
%
   
75.7
%
International
   
23.2
%
   
28.7
%
   
20.4
%
   
24.3
%
                                 
Total
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
                                 
Rum
   
26.7
%
   
31.1
%
   
36.4
%
   
33.1
%
Vodka
   
23.1
%
   
28.2
%
   
23.7
%
   
33.0
%
Liqueurs
   
29.8
%
   
24.9
%
   
25.1
%
   
21.3
%
Whiskey
   
13.8
%
   
14.6
%
   
10.8
%
   
11.6
%
Tequila
   
0.4
%
   
0.4
%
   
0.4
%
   
0.7
%
Fine Wine
   
6.0
%
   
0.8
%
   
3.4
%
   
0.3
%
Other
   
0.2
%
   
0.0
%
   
0.2
%
   
0.0
%
                                 
Total
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
 

 
Results of operations
 
   The table below provides, for the periods indicated, the percentage of net sales of certain items in our consolidated financial statements:
 
   
Three months ended December 31,
   
Nine months ended December 31,
 
   
2010
   
2009
   
2010
   
2009
 
Sales, net
   
100.0
%
   
100.0
%
   
100.0
%
   
100.00
%
Cost of sales
   
68.7
%
   
66.9
%
   
65.4
%
   
67.2
%
Reversal of provision for obsolete inventory
   
0.0
   
(1.1
)% 
   
(0.1
)% 
   
(2.7
)%
                                 
Gross profit
   
31.3
%
   
34.3
%
   
34.7
%
   
35.5
%
                                 
Selling expense
   
30.3
%
   
30.2
%
   
34.5
%
   
33.4
%
General and administrative expense
   
12.2
%
   
17.5
%
   
15.9
%
   
18.4
%
Depreciation and amortization
   
2.6
%
   
3.2
%
   
3.0
%
   
3.1
%
                                 
Loss from operations
   
(14.0
)%
   
(16.7
)%
   
(18.7
)%
   
(19.4
)%
                                 
Other income
   
0.0
%
   
0.0
%
   
0.0
%
   
0.0
%
Other expense
   
0.0
%
   
(0.4
)%
   
0.0
%
   
(0.2
)%
Income from equity investment in non-consolidated affiliate
   
0.2
%
   
0.0
%
   
0.1
%
   
0.0
%
Foreign exchange (loss) gain
   
(1.4
)%
   
8.4
%
   
(0.7
)%
   
10.0
%
Interest (expense) income, net
   
(1.7
)%
   
0.0
%
   
(1.1
)%
   
0.1
%
Gain on exchange of note payable
   
0.0
%
   
0.0
%
   
0.0
%
   
1.2
%
Gain on sale of intangible asset
   
0.0
%
   
5.4
%
   
0.0
%
   
1.8
%
Income tax benefit
   
0.4
%
   
0.5
%
   
0.5
%
   
0.5
%
                                 
Net loss
   
(16.4
)%
   
(2.7
)%