Castle Brands Inc.
Castle Brands Inc (Form: 10-Q, Received: 11/09/2017 17:19:20)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington , D.C. 20549

 

FORM 10-Q

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2017

 

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)

 

Florida   41-2103550
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
122 East 42nd Street, Suite 5000 ,   10168
New York , New York   (Zip Code)
(Address of principal executive offices)    

 

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 [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 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 [X] No [  ]

 

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

 

[  ] Large accelerated filer [X] Accelerated filer
       
[  ] Non-accelerated filer (Do not check if a smaller reporting company) [  ] Smaller reporting company
       
    [  ] Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 [  ] No [X]

 

The Company had 164,305,883 shares of $.01 par value common stock outstanding at November 7, 2017.

 

 

 

 
 

 

CASTLE BRANDS INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED

SEPTEMBER 30, 2017

 

TABLE OF CONTENTS

 

  Page
   
PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements: 3
     
  Condensed Consolidated Balance Sheets as of September 30, 2017 (unaudited) and March 31, 2017 3
     
  Condensed Consolidated Statements of Operations for the three months and six months ended September 30, 2017 and 2016 (unaudited) 4
     
  Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months and six months ended September 30, 2017 and 2016 (unaudited) 5
     
  Condensed Consolidated Statement of Changes in Equity for the six months ended September 30, 2017 (unaudited) 6
     
  Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2017 and 2016 (unaudited) 7
     
  Notes to Unaudited Condensed Consolidated Financial Statements 8
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 19
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
     
Item 4. Controls and Procedures 30
     
PART II. OTHER INFORMATION  
     
Item 1. Legal Proceedings 31
     
Item 1A. Risk Factors 31
     
Item 6. Exhibits 32

 

2

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

CASTLE BRANDS INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

 

    September 30, 2017     March 31, 2017  
    (Unaudited)        
ASSETS            
Current Assets                
Cash and cash equivalents   $ 322,529     $ 611,048  
Accounts receivable — net of allowance for doubtful accounts of $302,855 and $302,275 at September 30 and March 31, 2017, respectively     10,735,309       11,460,432  
Inventories— net of allowance for obsolete and slow moving inventory of $348,010 and $312,711 at September 30 and March 31, 2017, respectively     34,178,071       29,801,080  
Prepaid expenses and other current assets     4,092,001       3,674,923  
                 
Total Current Assets     49,327,910       45,547,483  
                 
Equipment — net     832,407       909,780  
                 
Intangible assets — net of accumulated amortization of $8,258,613 and $8,035,018 at September 30 and March 31, 2017, respectively     6,186,000       6,387,330  
Goodwill     496,226       496,226  
Investment in non-consolidated affiliate, at equity     797,691       570,097  
Restricted cash     366,420       331,455  
Other assets     103,877       99,773  
                 
Total Assets   $ 58,110,531     $ 54,342,144  
                 
LIABILITIES AND EQUITY                
Current Liabilities                
Accounts payable   $ 11,730,622     $ 7,549,942  
Accrued expenses     3,396,087       4,668,708  
Due to shareholders and affiliates     2,459,762       2,158,318  
                 
Total Current Liabilities     17,586,471       14,376,968  
                 
Long-Term Liabilities                
Credit facility, net (including $369,131 and $412,269 of related-party participation at September 30 and March 31, 2017, respectively)     12,848,829       13,033,075  
Note payable – 11% Subordinated note     20,000,000       20,000,000  
Notes payable – 5% Convertible notes (including $1,100,000 of related party participation at September 30 and March 31, 2017)     1,650,000       1,675,000  
Notes payable – GCP Note     216,869       211,580  
Deferred tax liability     559,436       558,766  
Other     20,666       20,666  
                 
Total Liabilities     52,882,271       49,876,055  
                 
Commitments and Contingencies (Note 11)                
                 
Equity                
Preferred stock, $.01 par value, 25,000,000 shares authorized, no shares issued and outstanding at September 30 and March 31, 2017            
Common stock, $.01 par value, 300,000,000 shares authorized at September 30 and March 31, 2017, 164,305,883 and 162,945,805 shares issued and outstanding at September 30 and March 31, 2017, respectively     1,643,059       1,629,458  
Additional paid-in capital     152,062,967       150,889,613  
Accumulated deficit     (149,171,900 )     (148,223,822 )
Accumulated other comprehensive loss     (2,148,860 )     (2,308,672 )
                 
Total controlling shareholders’ equity     2,385,266       1,986,577  
                 
Noncontrolling interests     2,842,994       2,479,512  
                 
Total Equity     5,228,260       4,466,089  
                 
Total Liabilities and Equity   $ 58,110,531     $ 54,342,144  

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

3

 

 

CASTLE BRANDS INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(Unaudited)

 

    Three months ended
September 30,
    Six months ended
September 30,
 
    2017     2016     2017     2016  
Sales, net*   $ 20,894,150     $ 19,627,791     $ 41,746,437     $ 36,378,716  
Cost of sales*     12,350,901       11,900,531       24,624,569       21,935,341  
                                 
Gross profit     8,543,249       7,727,260       17,121,868       14,443,375  
                                 
Selling expense     4,899,208       5,031,597       10,955,407       9,662,512  
General and administrative expense     2,298,882       2,140,659       4,561,879       4,130,894  
Depreciation and amortization     186,283       253,463       391,235       507,097  
                                 
Income from operations     1,158,876       301,541       1,213,347       142,872  
                                 
Other expense, net     (59 )     (27 )     (59 )     (333 )
Income from equity investment in non-consolidated affiliate     29,846       18,837       71,595       23,320  
Foreign exchange gain (loss)     18,853       (3,375 )     (32,308 )     76,488  
Interest expense, net     (901,559 )     (328,868 )     (1,793,423 )     (639,129 )
                                 
Income (loss) before provision for income taxes     305,957       (11,892 )     (540,848 )     (396,782 )
Income tax expense, net     (25,335 )     (477,962 )     (43,748 )     (688,775 )
                                 
Net income (loss)     280,622       (489,854 )     (584,596 )     (1,085,557 )
Net income attributable to noncontrolling interests     (282,303 )     (210,856 )     (363,482 )     (380,972 )
                                 
Net loss attributable to common shareholders   $ (1,681 )   $ (700,710 )   $ (948,078 )   $ (1,466,529 )
                                 
Net loss per common share, basic and diluted, attributable to common shareholders   $ (0.00 )   $ (0.00 )   $ (0.01 )   $ (0.01 )
                                 
Weighted average shares used in computation, basic and diluted, attributable to common shareholders     163,209,562       160,698,696       163,138,853       160,610,804  

 

* Sales, net and Cost of sales include excise taxes of $1,759,630 and $1,912,740 for the three months ended September 30, 2017 and 2016, respectively, and $3,399,385 and $3,628,701 for the six months ended September 30, 2017 and 2016, respectively.

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

4

 

 

CASTLE BRANDS INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

 

    Three months ended
September 30,
    Six months ended
September 30,
 
    2017     2016     2017     2016  
Net income (loss)   $ 280,622     $ (489,854 )   $ (584,596 )   $ (1,085,557 )
Other comprehensive income (loss):                                
Foreign currency translation adjustment     55,697       19,627       159,812       (24,345 )
                                 
Total other comprehensive income (loss):     55,697       19,627       159,812       (24,345 )
                                 
Comprehensive income (loss)   $ 336,319     $ (470,227 )   $ (424,784 )   $ (1,109,902 )

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

5

 

 

CASTLE BRANDS INC. AND SUBSIDIARIES

Condensed Consolidated Statement of Changes in Equity

(Unaudited)

 

                            Accumulated              
    Common Stock     Additional
Paid-in
    Accumulated     Other
Comprehensive
    Noncontrolling     Total  
    Shares     Amount     Capital     Deficit     Loss     Interests     Equity  
BALANCE, MARCH 31, 2017     162,945,805     $ 1,629,458     $ 150,889,613     $ (148,223,822 )   $ (2,308,672 )   $ 2,479,512     $ 4,466,089  
                                                         
Net loss                             (948,078 )             363,482       (584,596 )
Foreign currency translation adjustment                                     159,812               159,812  
Exercise of common stock options     240,300       2,403       179,736                               182,139  
Restricted share grants     1,092,000       10,920       (10,920 )                              
Conversion of 5% Convertible Notes to common stock     27,778       278       24,722                               25,000  
Stock-based compensation                     979,816                               979,816  
                                                         
BALANCE, SEPTEMBER 30, 2017     164,305,883     $ 1,643,059     $ 152,062,967     $ (149,171,900 )   $ (2,148,860 )   $ 2,842,994     $ 5,228,260  

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

6

 

 

CASTLE BRANDS INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

    Six months ended September 30,  
    2017     2016  
CASH FLOWS FROM OPERATING ACTIVITIES:                
Net loss   $ (584,596 )   $ (1,085,557 )
Adjustments to reconcile net loss to net cash used in operating activities:                
Depreciation and amortization     391,235       507,097  
Provision for doubtful accounts     30,812       23,100  
Amortization of deferred financing costs     38,960       89,608  
Deferred income tax expense, net     670       (74,076 )
Net income from equity investment in non-consolidated affiliate     (71,595 )     (23,320 )
Effect of changes in foreign exchange     32,308       (76,488 )
Stock-based compensation expense     979,816       762,497  

Accrued interest included in note payable balance

   

5,289

     

5,289

 
Addition to provision for obsolete inventory     50,000       100,000  
Changes in operations, assets and liabilities:                
Accounts receivable     712,811       (1,235,903 )
Due from affiliates           531  
Inventory     (4,363,236 )     (828,416 )

Prepaid expenses and other current assets

    (409,020 )     (351,239 )
Other assets     (32,401 )     (43,725 )
Accounts payable and accrued expenses     2,891,322       700,370  
Due to shareholders and affiliates     301,444       543,796  
                 
Total adjustments     558,415       99,121  
                 
NET CASH USED IN OPERATING ACTIVITIES     (26,181 )     (986,436 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES:                
Purchase of equipment     (84,251 )     (164,840 )
Acquisition of intangible assets     (22,265 )      
Investment in non-consolidated affiliate, at equity     (156,000 )      
Change in restricted cash     (12 )     (7,190 )
                 
NET CASH USED IN INVESTING ACTIVITIES     (262,528 )     (172,030 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:                
Net payments (borrowings) on credit facility     (194,909 )     241,913  
Payments for costs of stock issuance           (14,355 )
Proceeds from exercise of common stock options     182,139       181,245  
                 
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES     (12,770 )     408,803  
                 
EFFECTS OF FOREIGN CURRENCY TRANSLATION     12,960       (1,286 )
NET DECREASE IN CASH AND CASH EQUIVALENTS     (288,519 )     (750,949 )
CASH AND CASH EQUIVALENTS — BEGINNING     611,048       1,430,532  
                 
CASH AND CASH EQUIVALENTS — ENDING   $ 322,529     $ 679,583  
                 
SUPPLEMENTAL DISCLOSURES:                
Schedule of non-cash financing activities                
Conversion of 5% convertible note to common stock   $

25,000

    $

 
                 
Interest paid   $ 1,685,662     $ 551,428  
Income taxes paid   $ 669,500     $ 1,010,780  

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

7

 

 

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, 2017 is derived from the March 31, 2017 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, 2017 included in the Company’s annual report on Form 10-K for the year ended March 31, 2017, as amended (“2017 Form 10-K”). Please refer to the notes to the audited consolidated financial statements included in the 2017 Form 10-K for additional disclosures and a description of accounting policies.

 

  A. Description of business — The consolidated financial statements include the accounts of the Company, its wholly-owned domestic subsidiaries, Castle Brands (USA) Corp. (“CB-USA”) and McLain & Kyne, Ltd. (“McLain & Kyne”), 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 80.1% 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. Liquidity – The Company believes that its current cash and working capital and the availability under the Credit Facility (as defined in Note 7C) will enable it to fund its obligations until it achieves profitability, ensure continuity of supply of its brands and support new brand initiatives and marketing programs through at least November 2018.
     
  C. Organization and operations — The Company is principally engaged in the importation, marketing and sale of premium and super premium rums, whiskey, liqueurs, vodka, tequila and related non-alcoholic beverage products in the United States, Canada, Europe and Asia.
     
  D. 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 equity investments as a component of net income or loss.
     
  E. 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.
     
  F. Impairment of long-lived assets — Under 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.
     
  G. 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 or other relevant jurisdiction 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.
     
  H. 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.

 

8

 

 

CASTLE BRANDS INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements - Continued

 

  I. 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.

 

  J. 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 adopted the provisions of ASC 740 and as of March 31, 2017, the Company had reserves for uncertain tax positions (including related interest and penalties) for various state and local tax issues of $20,666. The Company recognizes interest and penalties related to uncertain tax positions in general and administrative expense.

 

The Company’s income tax expense for the three months ended September 30, 2017 and 2016 consists of federal, state and local taxes. 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. For the three months ended September 30, 2017 and September 30, 2016, the Company recognized ($25,335) and ($477,962) of income tax expense, net, respectively, and ($43,748) and ($688,775) of income tax expense, net, respectively for the six months ended September 30, 2017 and September 30, 2016. GCP is currently under a tax audit by New York State for the tax year ended March 31, 2016.

     
  K. Recent accounting pronouncements — In May 2017, the FASB issued ASU 2017-09, “Compensation — Stock Compensation (Topic 718): Scope of Modification Accounting.” ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. This guidance is effective for the Company as of April 1, 2018, with early adoption permitted. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.
     
    In February 2017, the FASB issued ASU 2017-05, “Other Income — Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets.” ASU 2017-05 clarifies the scope and accounting of a financial asset that meets the definition of an “in-substance nonfinancial asset” and defines the term “in-substance nonfinancial asset.” ASU 2017-05 also adds guidance for partial sales of nonfinancial assets. This guidance is effective for the Company as of April 1, 2018, with early adoption permitted. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.
     
    In January 2017, the FASB issued ASU 2017-04, “Intangibles — Goodwill and Other: Simplifying the Test for Goodwill Impairment (Topic 350).” ASU 2017-04 removes Step 2 from the goodwill impairment test. This guidance is effective for the Company as of April 1, 2020, with early adoption permitted. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.

 

9

 

 

 

 In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business.” This ASU, which must be applied prospectively, provides a narrower framework to be used to determine if a set of assets and activities constitutes a business than under current guidance and is generally expected to result in greater consistency in the application of ASC Topic 805, Business Combinations. This guidance is effective for the Company as of April 1, 2018, with early adoption permitted. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.

 

In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash, a consensus of the FASB’s Emerging Issues Task Force (the “Task Force”).” The new standard requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Entities will also be required to reconcile such total to amounts on the balance sheet and disclose the nature of the restrictions. This guidance is effective for the Company as of April 1, 2018, with early adoption permitted. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.

 

In October 2016, the FASB issued ASU 2016-16, “Income Taxes: Intra-Entity Transfers of Assets Other than Inventory.” This ASU removes the prohibition against the immediate recognition of the current and deferred income tax effects of intra-entity transfers of assets other than inventory. This guidance is effective for the Company as of April 1, 2018, with early adoption permitted. Entities must apply a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.

 

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments”, which provides guidance on eight cash flow classification issues with the objective of reducing differences in practice. The new standard is effective for the Company as of April 1, 2018, with early adoption permitted. Adoption is required to be on a retrospective basis, unless impracticable for any of the amendments, in which case a prospective application is permitted. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.

 

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting”, which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes and statutory tax withholding requirements, as well as classification in the statement of cash flows. The new standard is effective for the Company as of April 1, 2017. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.

 

In February 2016, the FASB issued ASU 2016-02, “Leases.” The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for the Company as of April 1, 2019. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.

 

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities”, which amends the guidance in U.S. GAAP on the classification and measurement of financial instruments. Changes to the current guidance primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the ASU clarifies guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The new standard is effective for the Company as of April 1, 2018, and upon adoption, an entity should apply the amendments by means of a cumulative-effect adjustment to the balance sheet at the beginning of the first reporting period in which the guidance is effective. Early adoption is not permitted except for the provision to record fair value changes for financial liabilities under the fair value option resulting from instrument-specific credit risk in other comprehensive income. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.

 

In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory”, which changes the measurement principle for inventory from the lower of cost or market to the lower of cost and net realizable value. Net realizable value is defined as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new guidance must be applied on a prospective basis and is effective for the Company as of April 1, 2017, with early adoption permitted. The Company determined that the adoption of this guidance did not have a material effect on the Company’s results of operations, cash flows and financial condition.

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers”, to clarify the principles for recognizing revenue. This guidance includes the required steps to achieve the core principle that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance is effective for the Company as of April 1, 2018. The Company is currently evaluating the new guidance to determine the impact the adoption of this guidance will have on the Company’s results of operations, cash flows and financial condition.

 

The Company does not believe that any other recently issued, but not yet effective, accounting standards, if currently adopted, would have a material effect on the accompanying condensed consolidated financial statements.
     
  L.

Accounting standards adopted — In March 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting”, which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes and statutory tax withholding requirements, as well as classification in the statement of cash flows. The guidance became effective for the Company beginning April 1, 2017. The Company determined that the adoption of this guidance did not have a material effect on the Company’s results of operations, cash flows and financial condition.

 

In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory”, which changes the measurement principle for inventory from the lower of cost or market to the lower of cost and net realizable value. Net realizable value is defined as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new guidance has been applied on a prospective basis and became effective for the Company as of April 1, 2017. The Company determined that the adoption of this guidance did not have a material effect on the Company’s results of operations, cash flows and financial condition.

 

 

10

 

 

CASTLE BRANDS INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements - Continued

 

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 potentially dilutive common shares that were outstanding during the period that are not anti-dilutive. Potentially dilutive common shares consist of incremental shares issuable upon exercise of stock options, vesting of restricted shares or conversion of convertible notes outstanding. In computing diluted net loss per share for the three months ended September 30, 2017 and 2016, no adjustment has been made to the weighted average outstanding common shares as the assumed exercise of outstanding options and warrants, the assumed vesting of restricted shares and the assumed conversion of convertible notes is anti-dilutive.

 

Potential common shares not included in calculating diluted net loss per share are as follows:

 

    Three months ended September 30,  
    2017     2016  
Stock options     15,523,008       16,339,086  
Unvested restricted stock     1,092,000        
5% Convertible notes     1,833,333       1,861,111  
                 
Total     18,448,341       18,200,197  

 

NOTE 3 — INVENTORIES

 

    September 30, 2017     March 31, 2017  
Raw materials   $ 18,543,553     $ 16,714,225  
Finished goods – net     15,634,518       13,086,855  
                 
Total   $ 34,178,071     $ 29,801,080  

 

As of September 30, and March 31, 2017, 8% and 9%, respectively, of raw materials and 5% and 7%, respectively, of finished goods were located outside of the United States.

 

In the six months ended September 30, 2017, the Company acquired $3,583,686 of bulk bourbon whiskey in support of its anticipated near and mid-term needs.

 

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 Gosling-Castle Partners Inc., consolidated

 

In March 2017, the Company entered into a Stock Purchase Agreement (“Purchase Agreement”) with Gosling’s Limited (“GL”) and E. Malcolm B. Gosling (“Gosling,” and together with GL, the “Sellers”). Pursuant to the terms of the Purchase Agreement, the Company acquired an additional 201,000 shares (the “GCP Share Acquisition”) of the common stock of GCP, representing a 20.1% equity interest in GCP. GCP is a strategic global export venture between the Company and the Gosling family. As a result of the completion of the GCP Share Acquisition, the Company’s total equity interest in GCP increased to 80.1%. The consideration for the GCP Share Acquisition was (i) $20,000,000 in cash and (ii) 1,800,000 shares of common stock of the Company.

 

The Company accounted for this transaction in accordance with ASC 810 “Consolidation,” and in particular section 810-10-45. Under the relevant guidance, a parent accounts for such changes in its ownership interest in a subsidiary as equity transactions. The parent cannot recognize a gain or loss in consolidated net income or comprehensive income for such transactions and is not permitted to step up a portion of the subsidiary’s net assets to fair value for the additional interests acquired. Any difference between the fair value of the consideration paid and the amount by which the noncontrolling interest is adjusted shall be recognized in equity attributable to the parent. As a result, the Company reduced the carrying amount of the noncontrolling interest by $2,232,824, with the $20,215,176 excess of the cash and stock paid over the adjustment to the carrying amount of the noncontrolling interest recognized as a decrease in the Company’s additional paid-in capital.

 

11

 

 

For the three months ended September 30, 2017 and 2016, GCP had pretax net income on a stand-alone basis of $1,425,534 and $1,005,101, respectively. The Company allocated a portion of this net income, or $283,681 and $402,040, to non-controlling interest for the three months ended September 30, 2017 and 2016, respectively. For the six months ended September 30, 2017 and 2016, GCP had pretax net income on a stand-alone basis of $1,851,541 and $1,641,204, respectively. The Company allocated a portion of this net income, or $368,457 and $656,482, to non-controlling interest for the three months ended September 30, 2017 and 2016, respectively. The cumulative balance allocated to noncontrolling interests in GCP was $2,842,994 and $2,479,512 at September 30 and March 31, 2017, respectively, as shown on the accompanying condensed consolidated balance sheets.

 

Investment in Copperhead Distillery Company, equity method

 

In June 2015, CB-USA purchased 20% of Copperhead Distillery Company (“Copperhead”) for $500,000. Copperhead owns and operates the Kentucky Artisan Distillery. The investment was part of an agreement to build a new warehouse to store Jefferson’s bourbons, provide distilling capabilities using special mash-bills made from locally grown grains and create a visitor center and store to enhance the consumer experience for the Jefferson’s brand. The investment has been used for the construction of a new warehouse in Crestwood, Kentucky dedicated to the storage of Jefferson’s whiskies. In September 2017, CB-USA purchased an additional 5% of Copperhead for $156,000 from an existing shareholder. Copperhead owns and operates the Kentucky Artisan Distillery. The Company has accounted for this investment under the equity method of accounting. For the three months ended September 30, 2017 and 2016, the Company recognized $29,846 and $18,837 of income from this investment, respectively. For the six months ended September 30, 2017 and 2016, the Company recognized $71,595 and $23,320 of income from this investment, respectively. The investment balance was $797,691 and $570,097 at September 30 and March 31, 2017, respectively.

 

NOTE 5 — GOODWILL AND INTANGIBLE ASSETS

 

The carrying amount of goodwill was $496,226 at each of September 30 and March 31, 2017.

 

Intangible assets consist of the following:

 

    September 30, 2017     March 31, 2017  
Definite life brands   $ 170,000     $ 170,000  
Trademarks     641,693       631,693  
Rights     8,271,555       8,271,555  
Product development     198,933       186,668  
Patents     994,000       994,000  
Other     55,460       55,460  
                 
      10,331,641       10,309,376  
Less: accumulated amortization     8,258,613       8,035,018  
                 
Net     2,073,028       2,274,358  
Other identifiable intangible assets — indefinite lived*     4,112,972       4,112,972  
                 
    $ 6,186,000     $ 6,387,330  

 

* Other identifiable intangible assets — indefinite lived consists of product formulations and the Company’s relationships with its distillers.

 

Accumulated amortization consists of the following:

 

    September 30, 2017     March 31, 2017  
Definite life brands   $ 170,000     $ 170,000  
Trademarks     385,160       367,294  
Rights     6,785,683       6,617,062  
Product development     41,150       34,478  
Patents     876,320       843,184  
                 
Accumulated amortization   $ 8,258,613     $ 8,035,018  

 

NOTE 6 — RESTRICTED CASH

 

At September 30 and March 31, 2017, the Company had €310,315 or $366,420 (translated at the September 30, 2017 exchange rate) and €310,305 or $331,455 (translated at the March 31, 2017 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 as described in Note 7A below.

 

12

 

 

CASTLE BRANDS INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements - Continued

 

NOTE 7 — NOTES PAYABLE

 

    September 30, 2017     March 31, 2017  
Notes payable consist of the following:                
Foreign revolving credit facilities (A)   $     $  
Note payable – GCP note (B)     216,869       211,580  
Credit facility (C)     12,938,215       13,133,124  
5% Convertible notes (D)     1,650,000       1,675,000  
11% Subordinated Note (E)     20,000,000       20,000,000  
                 
Total   $ 34,805,084     $ 35,019,704  

 

  A. The Company has arranged various credit facilities aggregating €310,315 or $366,420 (translated at the September 30, 2017 exchange rate) with an Irish bank, including overdraft coverage, creditors’ insurance, customs and excise guaranty, a revolving credit facility and Company credit cards. These credit facilities are payable on demand, continue until terminated by either party, are subject to annual review, and call for interest at the lender’s AA1 Rate minus 1.70%. The balance on the credit facilities included in notes payable totaled €0 at each of September 30 and March 31, 2017.
     
  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. At March 31, 2017, $10,579 of accrued interest was converted to amounts due to affiliates. At September 30, 2017, $216,869, consisting of $211,580 of principal and $5,289 of accrued interest, due on the GCP Note is included in long-term liabilities. At March 31, 2017, $211,580 of principal due on the GCP Note is included in long-term liabilities.
     
  C. In August 2011, the Company and CB-USA entered into a loan agreement with Keltic Financial Partners II, LP (“Keltic”), which, as amended, provides for availability (subject to certain terms and conditions) of a facility of up to $19.0 million (the “Credit Facility”) for the purpose of providing the Company with working capital.

 

In September 2014, the Company and CB-USA entered into an Amended and Restated Loan and Security Agreement (as amended, the “Amended Agreement”) with ACF FinCo I LP (“ACF”), as successor in interest to Keltic, in order to amend certain terms of the Credit Facility and the Bourbon Term Loan (defined below). Among other changes, the Amended Agreement modified certain aspects of the existing Credit Facility, including increasing the maximum amount of the Credit Facility from $8,000,000 to $12,000,000 and increasing the inventory sub-limit from $4,000,000 to $6,000,000. In addition, the term of the Credit Facility was extended from December 31, 2016 to July 31, 2019. The Credit Facility interest rate is the rate that, when annualized, is the greatest of (a) the Prime Rate plus 3.00%, (b) the LIBOR Rate plus 5.50% and (c) 6.00%. As of September 30, 2017, the Credit Facility interest rate was 6.75%. The monthly facility fee is 0.75% per annum of the maximum Credit Facility. The Amended Agreement contains EBITDA targets allowing for further interest rate reductions in the future. The Company paid ACF an aggregate $120,000 amendment fee in connection with the execution of the Amended Agreement.

 

In connection with the amendment, the Company and CB-USA entered into the following ancillary agreements: (i) a Reaffirmation Agreement with (a) certain officers of the Company and CB-USA, including John Glover, the Company’s Chief Operating Officer, T. Kelley Spillane, the Company’s Senior Vice President - Global Sales, and Alfred J. Small, the Company’s Senior Vice President, Chief Financial Officer, Treasurer and Secretary, (b) certain participants in the Bourbon Term Loan and (c) certain junior lenders to the Company, including Frost Gamma Investments Trust, an entity affiliated with Phillip Frost, M.D., a director and principal shareholder of the Company, Mark E. Andrews, III, a director of the Company and the Company’s Chairman, an affiliate of Richard J. Lampen, a director of the Company and the Company’s President and Chief Executive Officer, an affiliate of Glenn Halpryn, a former director of the Company, Dennis Scholl, a former director of the Company, and Vector Group Ltd., a more than 5% shareholder of the Company, of which Richard Lampen is an executive officer, Henry Beinstein, a director of the Company, and Phillip Frost M.D., a principal shareholder and director, which, among other things, reaffirms the existing Validity and Support Agreements by and among each officer, the Company, CB-USA and ACF, as successor-in-interest to Keltic; (ii) an Amended and Restated Term Note; and (iii) an Amended and Restated Revolving Credit Note.

 

In connection with the Amended Agreement, on September 22, 2014, ACF entered into an amendment to that certain Subordination Agreement, dated as of August 7, 2013 (as amended, the “Subordination Agreement”), by and among ACF, as successor-in-interest to Keltic, and certain junior lenders to the Company; neither the Company nor CB-USA is a party to the Subordination Agreement.

 

13

 

 

In August 2015, the Company and CB-USA entered into a First Amendment (the “Loan Agreement Amendment”) to the Amended Agreement. Among other changes, the Loan Agreement Amendment increased the amount of the Credit Facility from $12,000,000 to $19,000,000, including a sublimit in the maximum principal amount of $7,000,000 to permit the Company to acquire aged whiskey inventory (the “Purchased Inventory Sublimit”) subject to certain conditions set forth in the Amended Agreement. The maturity date remained unchanged at July 31, 2019. The Company and CB-USA are permitted to prepay the Credit Facility in whole or the Purchased Inventory Sublimit, in whole or in part, subject to certain prepayment penalties as set forth in the Loan Agreement Amendment. The Purchased Inventory Sublimit replaces the Bourbon Term Loan, which was paid in full in the normal course of business. The Purchased Inventory Sublimit interest rate is the rate that, when annualized, is the greatest of (a) the Prime Rate plus 4.25%, (b) the LIBOR Rate plus 6.75% and (c) 7.50%. As of September 30, 2017, the interest rate applicable to the Purchased Inventory Sublimit was 8.5%. The monthly facility fee remains 0.75% per annum of the maximum principal amount of the Credit Facility (excluding the Purchased Inventory Sublimit). Also, the Company must pay a monthly facility fee of $2,000 with respect to the Purchased Inventory Sublimit until all obligations with respect thereof are fully paid and performed. The Company paid ACF an aggregate $45,000 commitment fee in connection with the Loan Agreement Amendment.

 

In connection with the Loan Agreement Amendment, the Company and CB-USA entered into the following ancillary agreements: (i) a Reaffirmation Agreement with (a) certain officers of the Company and CB-USA, including John Glover, T. Kelley Spillane and Alfred J. Small and (b) certain junior lenders to the Company, including Frost Gamma Investments Trust, Mark E. Andrews, III, an affiliate of Richard J. Lampen, an affiliate of Glenn Halpryn, Dennis Scholl and Vector Group Ltd., which, among other things, reaffirms the existing Validity and Support Agreements by and among each officer, the Company, CB-USA and ACF and (ii) an Amended and Restated Revolving Credit Note.

 

ACF also required as a condition to entering into the Loan Agreement Amendment that ACF enter into a participation agreement with certain related parties of the Company, including Frost Gamma Investments Trust, Mark E. Andrews, III, Richard J. Lampen and Alfred J. Small, to allow for the sale of participation interests in the Purchased Inventory Sublimit and the inventory purchased with the proceeds thereof. The participation agreement provides that ACF’s commitment to fund each advance of the Purchased Inventory Sublimit shall be limited to seventy percent (70%), up to an aggregate maximum principal amount for all advances equal to $4,900,000. Neither the Company nor CB-USA is a party to the participation agreement. However, the Company and CB-USA are party to a fee letter with the junior participants (including the related party junior participants) pursuant to which the Company and CB-USA were obligated to pay the junior participants a closing fee of $18,000 on the effective date of the Loan Agreement Amendment and are obligated to pay a commitment fee of $18,000 on each anniversary of the effective date until the junior participants’ obligations are terminated pursuant to the participation agreement.

 

The Company and CB-USA are referred to individually and collectively as the Borrower. Pursuant to the Loan Agreement Amendment, the Company and CB-USA may borrow up to the lesser of (x) $19,000,000 and (y) the sum of the borrowing base calculated in accordance with the Amended Agreement and the Purchased Inventory Sublimit. For the six months ended September 30, 2017, the Company paid interest at 6.5% through June 14, 2017, then 6.75% through September 30, 2017 on the Amended Agreement. For the six months ended September 30, 2017, the Company paid interest at 8.25% through June 14, 2017, and then at 8.5% through September 30, 2017 on the Purchased Inventory Sublimit. Interest is payable monthly in arrears, on the first day of every month on the average daily unpaid principal amount of the Credit Facility. After the occurrence and during the continuance of any “Default” or “Event of Default” (as defined under the Amended Agreement), the Borrower is required to pay interest at a rate that is 3.25% per annum above the then applicable Credit Facility interest rate. There have been no Events of Default under the Credit Facility. ACF also receives a collateral management fee of $1,000 per month (increased to $2,000 after the occurrence of and during the continuance of an Event of Default) in addition to the facility fee with respect to the Purchased Inventory Sublimit. The Amended Agreement contains standard borrower representations and warranties for asset-based borrowing and a number of reporting obligations and affirmative and negative covenants. The Amended Agreement includes negative covenants that, among other things, restrict the Borrower’s ability to create additional indebtedness, dispose of properties, incur liens and make distributions or cash dividends. The obligations of the Borrower under the Loan Agreement Amendment are secured by the grant of a pledge and security interest in all of the assets of the Borrower. At September 30, 2017, the Company was in compliance, in all respects, with the covenants under the Amended Agreement.

 

In August 2015, the Company used $3,000,000 of the Purchased Inventory Sublimit to acquire aged bourbon inventory. Frost Gamma Investments Trust ($150,000), Mark E. Andrews, III ($50,000), Richard J. Lampen ($100,000) and Alfred J. Small ($15,000) each acquired participation interests in the Purchased Inventory Sublimit and the inventory purchased with the proceeds thereof. In January 2017, the Company acquired $1,030,000 in aged bulk bourbon under the Purchased Inventory Sublimit with additional borrowings from certain related parties of the Company, including Frost Gamma Investments Trust ($51,500), Richard J. Lampen ($34,333), Mark E. Andrews, III ($17,167), Brian L. Heller ($14,592), and Alfred J. Small ($5,150), as junior participants in the Purchased Inventory Sublimit with respect to such purchase. Under the terms of the participation agreement, the participants receive interest at the rate of 11% per annum.

 

At September 30 and March 31, 2017, $12,938,215 and $13,133,124, respectively, due on the Credit Facility was included in long-term liabilities. At September 30 and March 31, 2017, there was $6,061,785 and $5,866,876, respectively, in potential availability under the Credit Facility. In connection with the adoption of ASU 2015-03, the Company included $89,386 and $100,049 of debt issuance costs at September 30 and March 31, 2017, respectively, as direct deductions from the carrying amount of the related debt liability.

 

In October 2017, the Company and CB-USA entered into a Third Amendment (the “Third Amendment”) to the Amended Agreement to amend certain terms of the Company’s existing Credit Facility with ACF. Among other changes, the Third Amendment increases the maximum amount of the Credit Facility from $19,000,000 to $21,000,000, and amends the definition of borrowing base to increase the amount of borrowing that can be collateralized by inventory. The Company and CB-USA paid ACF an aggregate $20,000 commitment fee in connection with the Amendment. In connection with the Amendment, the Company and CB-USA also entered into an Amended and Restated Revolving Credit Note.

 

14

 

 

  D. In October 2013, the Company entered into a 5% Convertible Subordinated Note Purchase Agreement (the “Note Purchase Agreement”) with the purchasers party thereto, under which the Company issued an aggregate initial principal amount of $2,125,000 of unsecured subordinated notes (the “Convertible Notes”). The Convertible Notes bear interest at a rate of 5% per annum, payable quarterly, until their maturity date of December 15, 2018. The Convertible Notes, and accrued but unpaid interest thereon, are convertible in whole or in part from time to time at the option of the holders thereof into shares of the Company’s common stock at a conversion price of $0.90 per share (the “Conversion Price”). The Convertible Notes may be prepaid in whole or in part at any time without penalty or premium, but with payment of accrued interest to the date of prepayment. The Convertible Notes contain customary events of default, which, if uncured, entitle each note holder to accelerate the due date of the unpaid principal amount of, and all accrued and unpaid interest on, the Convertible Notes.

 

The purchasers of the Convertible Notes included related parties of the Company, including an affiliate of Dr. Phillip Frost ($500,000), Mark E. Andrews, III ($50,000), an affiliate of Richard J. Lampen ($50,000), an affiliate of Glenn Halpryn ($200,000), Dennis Scholl ($100,000), and Vector Group Ltd. ($200,000).

 

The Company may forcibly convert all or any part of the Convertible Notes and all accrued but unpaid interest thereon if (i) the average daily volume of the Company’s common stock (as reported on the principal market or exchange on which the common stock is listed or quoted for trading) exceeds $50,000 per trading day and (ii) the volume weighted average price of the common stock for at least twenty (20) trading days during any thirty (30) consecutive trading day period exceeds 250% of the then-current Conversion Price. Any forced conversion will be applied ratably to the holders of all Convertible Notes issued pursuant to the Note Purchase Agreement based on each holder’s then-current note holdings.

 

In connection with the Note Purchase Agreement, each purchaser of the Convertible Notes was required to execute a joinder to the subordination agreement, by and among ACF and certain other junior lenders to the Company; the Company is not a party to the Subordination Agreement.

 

At September 30, and March 31, 2017, $1,650,000 and $1,675,000 of principal due on the Convertible Notes was included in long-term liabilities, respectively.

 

  E. In March 2017, the Company issued a promissory note to Frost Nevada Investments Trust (the “Holder”), an entity affiliated with Phillip Frost, M.D., in the aggregate principal amount of $20,000,000 (the “Subordinated Note”). The purpose of Company’s issuance of the Subordinated Note was to finance the GCP Share Acquisition. The Subordinated Note bears interest quarterly at the rate of 11% per annum. The principal and interest incurred thereon shall be due and payable in full on March 15, 2019. All claims of the Holder to principal, interest and any other amounts owed under the Subordinated Note are subordinated in right of payment to all indebtedness of the Company existing as of the date of the Subordinated Note. The Subordinated Note contains customary events of default and may be prepaid by the Company, in whole or in part, without penalty, at any time.

 

NOTE 8 — EQUITY

 

Equity distribution agreement - In November 2014, the Company entered into an Equity Distribution Agreement (the “2014 Distribution Agreement”) with Barrington Research Associates, Inc. (“Barrington”), as sales agent, under which the Company could issue and sell over time and from time to time, to or through Barrington, shares (the “Shares”) of its common stock having a gross sales price of up to $10,000,000.

 

The Company did not sell any Shares pursuant to the 2014 Distribution Agreement during the six months ended September 30, 2017. The Company did not sell any Shares pursuant to the 2014 Distribution Agreement during the six months ended September 30, 2016, but incurred $12,000 of issuance costs related to the 2014 Distribution Agreement.

 

The 2014 Distribution Agreement expired in August 2017 upon the expiration of the Company’s Registration Statement on Form S-3 under which the Shares were sold.

 

Convertible Notes conversion - In the six months ended September 30, 2017, a Convertible Note holder converted $25,000 of Convertible Notes into 27,778 shares of Common Stock.

 

GCP Acquisition - As described in Note 4, in March 2017, the Company issued 1,800,000 shares of Common Stock to the Sellers in connection with the GCP Acquisition.

 

15

 

 

CASTLE BRANDS INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements - Continued

 

NOTE 9 — 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 September 30 and March 31, 2017, the Company had no forward contracts outstanding.

 

NOTE 10 — STOCK-BASED COMPENSATION

 

In April 2017, the Company granted to employees, directors and certain consultants an aggregate of 1,092,000 restricted shares of the Company’s common stock under the Company’s 2013 Incentive Compensation Plan. The restricted shares vest 25% on each of the first four anniversaries of the grant date. The Company has valued the shares at $1,843,078.

 

Stock-based compensation expense for the three months ended September 30, 2017 and 2016 amounted to $504,490 and $410,097, respectively. Stock-based compensation expense for the six months ended September 30, 2017 and 2016 amounted to $979,816 and $762,497, respectively. At September 30, 2017, total unrecognized compensation cost amounted to $4,199,077, representing 4,226,500 unvested options and 1,092,000 unvested shares of restricted stock. This cost is expected to be recognized over a weighted-average vesting period of 2.32 years. There were 240,300 options exercised during the six months ended September 30, 2017 and 476,500 options exercised during the six months ended September 30, 2016. The Company did not recognize any related tax benefit for the three and six months ended September 30, 2017 and 2016 from option exercises, as the effects were de minimis.

 

NOTE 11 — COMMITMENTS AND CONTINGENCIES

 

  A. The Company has entered into a supply agreement with an Irish distiller (“Irish Distillery”), which provides for the production of blended Irish whiskeys for the Company until the contract is terminated by either party in accordance with the terms of the agreement. The Irish Distillery may terminate the contract if it provides at least six years prior notice to the Company, except for breach. Under this agreement, the Company provides the Irish Distillery with a forecast of the estimated amount of liters of pure alcohol it requires for the next four fiscal contract years and agrees to purchase 90% of that amount, subject to certain annual adjustments. For the contract year ending June 30, 2018, the Company has contracted to purchase approximately €1,017,189 or $1,201,097 (translated at the September 30, 2017 exchange rate) in bulk Irish whiskey, of which €355,700, or $420,010 (translated at the September 30, 2017 exchange rate), has been purchased as of September 30, 2017. The Company is not obligated to pay the Irish Distillery for any product not yet received. During the term of this supply agreement, the Irish Distillery has the right to limit additional purchases above the commitment amount.
     
  B. The Company has also entered into a supply agreement with the Irish Distillery, which provides for the production of single malt Irish whiskeys for the Company until the contract is terminated by either party in accordance with the terms of the agreement. The Irish Distillery may terminate the contract if it provides at least thirteen years prior notice to the Company, except for breach. Under this agreement, the Company provides the Irish Distillery with a forecast of the estimated amount of liters of pure alcohol it requires for the next twelve fiscal contract years and agrees to purchase 80% of that amount, subject to certain annual adjustments. For the year ending June 30, 2018, the Company has contracted to purchase approximately €442,274 or $522,238 (translated at the September 30, 2017 exchange rate) in bulk Irish whiskey, of which €124,421, or $146,916 (translated at the September 30, 2017 exchange rate), has been purchased as of September 30, 2017. The Company is not obligated to pay the Irish Distillery for any product not yet received. During the term of this supply agreement, the Irish Distillery has the right to limit additional purchases above the commitment amount.
     
  C. The Company has entered into a supply agreement with a bourbon distiller, which provides for the production of newly distilled bourbon whiskey through December 31, 2019. Under this agreement, the distiller provides the Company with an agreed upon amount of original proof gallons of newly distilled bourbon whiskey, subject to certain annual adjustments. For the contract year ended December 31, 2016, the Company contracted and purchased approximately $2,053,750 in newly distilled bourbon. For the contract year ending December 31, 2017, the Company originally contracted to purchase approximately $2,464,500 in newly distilled bourbon, $1,014,028 of which had been purchased as of September 30, 2017. The Company is not obligated to pay the distiller for any product not yet received. During the term of this supply agreement, the distiller has the right to limit additional purchases to ten percent above the commitment amount. In March 2017, the distiller notified the Company of its intent to terminate the contract under its terms after the 2017 contract year, and to limit the purchase amount for the 2017 contract year to the 2016 contract year amount. In October 2017, the Company entered into a new supply agreement with a different bourbon distiller.
     
  D. The Company leases office space in New York, NY, Dublin, Ireland and Houston, TX. The New York, NY lease began on May 1, 2010 and expires on February 29, 2020 and provides for monthly payments of $26,255. The Dublin lease commenced on March 1, 2009 and extends through October 31, 2019 and provides for monthly payments of €1,500 or $1,771 (translated at the September 30, 2017 exchange rate). The Houston, TX lease commenced on April 27, 2015 and extends through June 26, 2018 and provides for monthly payments of $3,440. The Company has also entered into non-cancelable operating leases for certain office equipment.

 

16

 

 

CASTLE BRANDS INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements - Continued

 

  E.

As described in Note 7C, in August 2011, the Company and CB-USA entered into the Credit Facility, as amended in July 2012, March 2013, August 2013, November 2013, August 2014, September 2014, August 2015 and October 2017.

     
  F. Except as set forth below, the Company believes that neither it, nor any of its subsidiaries, is currently subject to litigation which, in the opinion of management after consultation with counsel, is likely to have a material adverse effect on the Company.

 

The Company may become involved in litigation from time to time relating to claims arising in the ordinary course of its business. These claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources.

 

NOTE 12 — 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. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk.
     
  B. Customers — Sales to one customer, the Southern Glazer’s Wine and Spirits of America, Inc. family of companies (“SGWS”) accounted for approximately 36.3% and 35.7% of the Company’s net sales for the three months ended September 30, 2017 and 2016, respectively. Sales to SGWS accounted for approximately 38.0% and 34.5% of the Company’s net sales for the six months ended September 30, 2017 and 2016, respectively, and approximately 35.1% and 33.2% of accounts receivable at September 30 and March 31, 2017, respectively.

 

NOTE 13 — GEOGRAPHIC INFORMATION

 

The Company operates in one reportable segment — the sale of premium beverage alcohol. The Company’s product categories are rum, whiskey, liqueurs, vodka, tequila and ginger beer, a related non-alcoholic beverage product. 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 sales, net, consolidated income from operations, consolidated net income (loss) attributable to common shareholders, consolidated income tax expense and consolidated assets from the U.S. and foreign countries and consolidated sales, net by category.

 

    Three months ended September 30,  
    2017     2016  
Consolidated Sales, net:                                
International   $ 2,177,367       10.4 %   $ 2,060,044       10.5 %
United States     18,716,783       89.6 %     17,567,747       89.5 %
                                 
Total Consolidated Sales, net   $ 20,894,150       100.0 %   $ 19,627,791       100.0 %
                                 
Consolidated Income (Loss) from Operations:                                
International   $ 15,737       1.4 %   $ (6,843 )     (2.3 )%
United States     1,143,139       98.6 %     308,384       102.3 %
                                 
Total Consolidated Income from Operations   $ 1,158,876       100.0 %   $ 301,541       100.0 %
                                 
Consolidated Net Income (Loss) Attributable to Common Shareholders:                                
International   $ 47,470       2,822.9 %   $ 17,871       2.6 %
United States     (49,151 )     (2,922.9 )%     (718,581 )     (102.6 )%
                                 
Total Consolidated Net Loss Attributable to Common Shareholders   $ (1,681 )     100.0 %   $ (700,710 )     100.0 %
                                 
Income tax expense, net:                                
United States   $ 25,335       100.0 %   $ (477,962 )     100.0 %
                                 
 Consolidated Sales, net by category:                                
Whiskey   $ 7,335,290       35.2 %   $ 6,486,287       24.7 %
Rum     4,168,262       19.9 %     4,837,653       33.0 %
Liqueurs     2,579,437       12.3 %     2,560,819       13.0 %
Vodka     353,792       1.7 %     414,052       2.1 %
Tequila     84,560       0.4 %     68,731       0.4 %
Ginger beer     6,372,809       30.5 %     5,260,249       26.8 %
                                 
Total Consolidated Sales, net   $ 20,894,150       100.0 %   $ 19,627,791       100.0 %

 

17

 

 

    Six Months ended September 30,  
    2017     2016  
Consolidated Sales, net:                                
International   $ 4,442,146       10.6 %   $ 3,799,543       10.4 %
United States     37,304,291       89.4 %     32,579,173       89.6 %
                                 
Total Consolidated Sales, net   $ 41,746,437       100.0 %   $ 36,378,716       100.0 %
                                 
Consolidated Income (Loss) from Operations:                                
International   $ (13,261 )     (1.1 )%   $ (105,068 )     (73.5 )%
United States     1,226,608       101.1 %     247,940       173.5 %
                                 
Total Consolidated Income from Operations   $ 1,213,347       100.0 %   $ 142,872       100.0 %
                                 
Consolidated Net Income (Loss) Attributable to Common Shareholders:                                
International   $ 42,262       4.5 %   $ (62,134 )     4.2 %
United States     (990,340 )     (104.5 )%     (1,404,395 )     95.8 %
                                 
Total Consolidated Net Loss Attributable to Common Shareholders   $ (948,078 )     100.0 %   $ (1,466,529 )     100.0 %
                                 
Income tax expense, net:                                
United States     (43,748 )     100.0 %     (688,775 )     100.0 %
                                 
Consolidated Sales, net by category:                                
Whiskey   $ 14,505,777       34.8 %   $ 11,985,706       32.8 %
Rum     8,621,765       20.7 %     9,449,569       26.0 %
Liqueur     4,638,346       11.1 %     4,506,191       12.4 %
Vodka     643,255       1.5 %     791,637       2.2 %
Tequila     129,736       0.3 %     127,339       0.4 %

Ginger beer

    13,207,558       31.6 %     9,518,274       26.2 %
                                 
Total Consolidated Sales, net   $ 41,746,437       100.0 %   $ 36,378,716       100.0 %

 

    As of September 30, 2017     As of March 31, 2017  
Consolidated Assets:                                
International   $ 2,994,097       5.2 %   $ 3,234,536       6.0 %
United States     55,116,434       94.8 %     51,107,608       94.0 %
                                 
Total Consolidated Assets   $ 58,110,531       100.0 %   $ 54,342,144       100.0 %

 

*Includes related non-beverage alcohol products.

 

18

 

 

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

 

Overview

 

We develop and market premium and super premium brands in the following beverage alcohol categories: rum, whiskey, liqueurs, vodka and tequila. We also develop and market our related non-alcoholic beverage product, Goslings Stormy Ginger Beer. We distribute our products in all 50 U.S. states and the District of Columbia and in thirteen primary international markets, including Ireland, Great Britain, Northern Ireland, Germany, Canada, France, Finland, Norway, Sweden, Denmark, and the Duty-Free markets. We market the following brands, among others:

 

  Goslings rum ®
  Goslings Stormy Ginger Beer
  Goslings Dark ‘n Stormy ® ready-to-drink cocktail
  Jefferson’s ® bourbon
  Jefferson’s Reserve ®
  Jefferson’s Ocean Aged at Sea ®
  Jefferson’s Wine Finish Collection
  Jefferson’s The Manhattan: Barrel Finished Cocktail
  Jefferson’s Chef’s Collaboration
  Jefferson’s Wood Experiment
  Jefferson’s Presidential Select™
  Jefferson’s Straight Rye whiskey
  Pallini ® liqueurs
  Clontarf ® Irish whiskey
  Knappogue Castle Whiskey ®
  Brady’s ® Irish Cream
  Boru ® vodka
  Tierras™ tequila
  Celtic Honey ® liqueur
  Gozio ® amaretto
  The Arran Malt ® Single Malt Scotch Whisky
  The Robert Burns Scotch Whiskeys
  Machrie Moor Scotch Whiskeys

 

Our objective is to continue building Castle Brands into a profitable international spirits company, with a distinctive portfolio of premium and super premium brands. To achieve this, we continue to seek to:

 

  focus on our more profitable brands and markets. We continue to focus our distribution efforts, sales expertise and targeted marketing activities on our more profitable brands and markets;
  grow organically. We believe that continued organic growth will enable us to achieve long-term profitability. We focus on brands that have profitable growth potential and staying power, such as our rums, whiskies and ginger beer, sales of which have grown substantially in recent years;
  build consumer awareness. We use our existing assets, expertise and resources to build consumer awareness and market penetration for our brands;
  leverage our distribution network. Our established distribution network in all 50 U.S. states enables us to promote our brands nationally and makes us an attractive strategic partner for smaller companies seeking U.S. distribution; and
  selectively add new brand extensions and brands to our portfolio. We intend to continue to introduce new brand extensions and expressions. For example, we have leveraged our successful Jefferson’s portfolio by introducing a number of brand extensions. Additionally, we recently added the Arran Scotch whiskies to our portfolio as agency brands. We continue to explore strategic relationships, joint ventures and acquisitions to selectively expand our premium spirits portfolio. We expect that future acquisitions or agency relations, if any, would involve some combination of cash, debt and the issuance of our stock.

 

Recent Events

 

Additional Investment in Copperhead Distillery Company

 

In October, we purchased an additional 5% of Copperhead Distillery Company, which owns and operates the Kentucky Artisan Distillery, for $0.2 million. The additional investment brings our ownership of Copperhead Distillery Company to 25%. The Kentucky Artisan Distillery currently has three warehouses storing Jefferson’s bourbons, provides distilling using special mash-bills made from locally grown grains for Jefferson’s brands and houses the Jefferson’s Visitor Center and store, showcasing the Jefferson’s brand.

 

Expanded Credit Facility

 

In October, we entered into a Third Amendment to our existing Credit Facility with ACF FinCo I LP. Among other changes, the Third Amendment increased the maximum amount of the Credit Facility from $19,000,000 to $21,000,000, and amended the definition of borrowing base to increase the amount of borrowing that can be collateralized by inventory.

 

19

 

 

Currency Translation

 

The functional currencies for our foreign operations are the Euro in Ireland 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.

 

Where in this report we refer to amounts in Euros or British Pounds, 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 September 30, 2017, each as calculated from the Interbank exchange rates as reported by Oanda.com. On September 30, 2017, the exchange rate of the Euro and the British Pound in exchange for U.S. Dollars was €1.00 = U.S. $1.18080 (equivalent to U.S. $1.00 = €0.84722) and £1.00 = U.S. $1.33983 (equivalent to U.S. $1.00 = £0.74614).

 

These conversions should not be construed as representations that the Euro and British Pound 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, 2017, as amended, which we refer to as our 2017 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 spirits case sales for the periods presented based on nine-liter equivalent cases, which is a standard spirits industry metric (table excludes related non-alcoholic beverage products):

 

    Three months ended     Six months ended  
    September 30,     September 30,  
    2017     2016     2017     2016  
Cases                                
United States     80,777       88,181       157,243       165,021  
International     20,990       19,843       42,918       36,945  
                                 
Total     101,767       108,024       200,161       201,966  
                                 
Rum     41,718       46,510       84,358       90,793  
Whiskey     25,904       27,111       53,669       48,255  
Liqueur     27,695       25,950       49,398       46,388  
Vodka     6,027       8,084       12,079       15,849  
Tequila     423       369       657       681  
                                 
Total     101,767       108,024       200,161       201,966  
                                 
Percentage of Cases                                
United States     79.4 %     81.6 %     78.6 %     81.7 %
International     20.6 %     18.4 %     21.4 %     18.3 %
                                 
Total     100.0 %     100.0 %     100.0 %     100.0 %
                                 
Rum     41.0 %     43.1 %     42.2 %     45.0 %
Whiskey     25.5 %     25.1 %     26.8 %     23.9 %
Liqueur     27.2 %     24.0 %     24.7 %     23.0 %
Vodka     5.9 %     7.5 %     6.0 %     7.8 %
Tequila     0.4 %     0.3 %     0.3 %     0.3 %
                                 
Total     100.0 %     100.0 %     100.0 %     100.0 %

 

20

 

 

The following table provides information regarding our case sales of our related non-alcoholic beverage products, Goslings Stormy Ginger Beer, for the periods presented:

 

    Three months ended     Six months ended  
    September 30,     September 30,  
    2017     2016     2017     2016  
Cases                                
United States     439,075       344,132       877,429       620,297  
International     10,520       15,915       29,449       40,732  
                                 
Total     449,595       360,047       906,878       661,029  
                                 
Percentage of Cases                                
United States     97.7 %     95.6 %     96.8 %     93.8 %
International     2.3 %     4.4 %     3.2 %     6.2 %
                                 
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
September 30,
    Six months ended
September 30,
 
    2017     2016     2017     2016  
Sales, net     100.0 %     100.0 %     100.0 %     100.0 %
Cost of sales     59.1 %     60.6 %     59.0 %     60.3 %
                                 
Gross profit     40.9 %     39.4 %     41.0 %     39.7 %
                                 
Selling expense     23.4 %     25.7 %     26.2 %     26.6 %
General and administrative expense     11.0 %     10.9 %     10.9 %     11.4 %
Depreciation and amortization     0.9 %     1.3 %     1.0 %     1.4 %
                                 
Income from operations     5.6 %     1.5 %     2.9 %     0.3 %
                                 
Other expense, net     (0.0 )%     (0.0 )%     (0.0 )%     (0.0 )%
Foreign exchange gain (loss)     0.1 %     0.0 %     (0.1 )%     0.2 %
Income from equity investment in non-consolidated affiliate     0.1 %     0.1 %     0.2 %     0.1 %
Interest expense, net     (4.3 )%     (1.7 )%     (4.3 )%     (1.8 )%
                                 
Income (loss) before provision for income taxes     1.5 %     (0.1 )%     (1.3 )%     (1.1 )%
Income tax expense, net     (0.1 )%     (2.4 )%     (0.1 )%     (1.9 )%
                                 
Net income (loss)     1.4 %     (2.5 )%     (1.4 )%     (3.0 )%
Net income attributable to noncontrolling interests     (1.4 )%     (1.1 )%     (0.9 )%     (1.0 )%
Net loss attributable to common shareholders     0.0 %     (3.6 )%     (2.3 )%     (4.0 )%

 

 

21

 

 

The following is a reconciliation of net loss attributable to common shareholders to EBITDA, as adjusted:

 

    Three months ended     Six months ended  
    September 30,     September 30,  
    2017     2016     2017     2016  
Net loss attributable to common shareholders   $ (1,681 )   $ (700,710 )   $ (948,078 )   $ (1,466,529 )
Adjustments:                                
Interest expense, net     901,559       328,868       1,793,423       639,129  
Income tax expense, net     25,335       477,962       43,748       688,775  
Depreciation and amortization     186,283       253,463       391,235