SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934|
For the quarterly period ended September 30, 2007
|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)
(State or other jurisdiction of
incorporation or organization)
570 Lexington Avenue, 29th Floor,
New York, New York
|(Address of principal executive offices)||(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 No
Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Act). See definition of ‘‘accelerated filer and large accelerated filer’’ in Rule 12b-2 of the Exchange Act.
|Large accelerated filer||Accelerated filer||Non-accelerated filer|
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No
The Company had 15,629,776 shares of $0.01 par value common stock outstanding at November 13, 2007.
TABLE OF CONTENTS
|PART I.||FINANCIAL INFORMATION|
|Item 1.||Condensed Consolidated Financial Statements:|
|Condensed Consolidated Balance Sheets as of September 30, 2007 (unaudited) and March 31, 2007||1|
|Condensed Consolidated Statements of Operations for the Three Month and Six Month Periods ended September 30, 2007 and 2006 (unaudited)||2|
|Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Six Months ended September 30, 2007 (unaudited)||3|
|Condensed Consolidated Statements of Cash Flows for the Six Month Periods ended September 30, 2007 and 2006 (unaudited)||4|
|Notes to Unaudited Condensed Consolidated Financial Statements||5|
|Item 2.||Management’s Discussion and Analysis of Financial Condition and Results of Operations||23|
|Item 3.||Quantitative and Qualitative Disclosures About Market Risk||34|
|Item 4.||Controls and Procedures||35|
|PART II.||OTHER INFORMATION|
|Item 1.||Legal Proceedings||36|
|Item 1A.||Risk Factors||36|
|Item 2.||Unregistered Sales of Equity Securities and Use of Proceeds||36|
|Item 3.||Defaults Upon Senior Securities||36|
|Item 4.||Submission of Matters to a Vote of Security Holders||37|
|Item 5.||Other Information||37|
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
|Cash and cash equivalents||$||3,545,013||$||1,004,957|
|Accounts receivable – net of allowance for doubtful accounts of $196,135 and $352,458||10,669,957||6,503,449|
|Due from affiliates||11,054||10,328|
|Prepaid expenses and other current assets||1,645,507||1,585,901|
|TOTAL CURRENT ASSETS||37,560,487||25,734,082|
|EQUIPMENT – net||759,529||643,753|
|Intangible assets – net of accumulated amortization of $2,276,630 and $2,233,808||13,951,694||13,813,596|
|LIABILITIES AND STOCKHOLDERS’ EQUITY|
|Current maturities of notes payable and capital leases||$||464,327||$||419,308|
|Accrued expenses, put warrant payable and derivative instrument||2,793,368||1,987,669|
|Due to stockholders and affiliates||1,433,810||1,092,755|
|TOTAL CURRENT LIABILITIES||8,787,842||8,650,267|
|LONG TERM LIABILITIES|
|Senior notes payable||9,501,985||9,354,861|
|Notes payable and capital leases, less current maturities||9,003,296||9,005,207|
|Deferred tax liability||2,481,292||2,555,368|
|COMMITMENTS AND CONTINGENCIES (Note 15)|
|Preferred stock, $.01 par value, 5,000,000 shares authorized, none outstanding||—||—|
|Common stock, $.01 par value, 45,000,000 shares authorized; 15,629,776 and 12,109,741 shares issued and outstanding at September 30, and March 31, 2007, respectively||156,298||121,098|
|Additional paid in capital||104,210,150||84,086,710|
|Accumulated other comprehensive loss||(1,452,558||)||(692,958||)|
|TOTAL STOCKHOLDERS’ EQUITY||35,265,991||23,552,613|
|TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY||$||65,956,661||$||54,525,961|
See accompanying notes to the condensed consolidated financial statements.
CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
|Cost of sales||6,436,721||4,231,445||9,941,259||7,795,504|
|Selling expense (Note 1L)||4,436,622||4,694,074||8,674,230||8,236,646|
|General and administrative expense (Note 1L)||2,091,109||1,898,702||4,152,029||4,134,493|
|Depreciation and amortization||284,274||245,794||555,701||480,288|
|Net operating loss||(4,327,774||)||(4,817,953||)||(8,778,182||)||(8,934,464||)|
|Foreign exchange gain/(loss)||1,082,609||262,377||1,159,935||659,789|
|Interest expense, net||(313,354||)||(75,931||)||(800,814||)||(498,607||)|
|Write-off of deferred financing costs in connection with conversion of 6% subordinated convertible notes||—||—||—||(295,368||)|
|Current (charge)/credit on derivative financial instrument||—||(8,666||)||189,397||(10,858||)|
|Income tax benefit||37,038||37,038||74,076||74,076|
|Preferred stock dividends||—||—||—||48,238|
|Net loss attributable to common stockholders||$||(3,280,758||)||$||(4,218,194||)||$||(7,685,662||)||$||(8,330,378||)|
|Net loss attributable to common stockholders per common share, basic and diluted||$||(0.21||)||$||(0.35||)||$||(0.52||)||$||(0.71||)|
|Weighted average shares used in computation, basic and diluted|
|Weighted average shares used in computation, basic and diluted||15,629,776||12,009,741||14,898,083||11,716,233|
See accompanying notes to the condensed consolidated financial statements.
CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Changes in Stockholders’ Equity
|BALANCE, MARCH 31, 2007||12,109,741||$||121,098||$||84,086,710||$||(59,962,237||)||$||(692,958||)||$||23,552,613|
|Foreign currency translation adjustment||(759,600||)||(759,600||)|
|Total comprehensive loss||(8,445,262||)|
|Issuance of common stock in private placement, net of issuance costs||3,520,035||35,200||19,583,286||19,618,486|
|Vesting of stock options as compensation||3,258||3,258|
|BALANCE, SEPTMEBER 30, 2007||15,629,776||$||156,298||$||104,210,150||$||(67,647,899||)||$||(1,452,558||)||$||35,265,991|
See accompanying notes to the condensed consolidated financial statements.
CASTLE BRANDS INC. and SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
|Six-months Ended September 30,|
|CASH FLOWS FROM OPERATING ACTIVITIES|
|Adjustments to reconcile net loss to net cash used in operating activities|
|Depreciation and amortization||555,701||480,288|
|Change in allowance for doubtful accounts||36,343||48,591|
|Minority interest in net loss of consolidated subsidiary||(491,390||)||(735,214||)|
|Loss on disposal of fixed assets||1,051||—|
|Write-off of deferred financing costs||321,197||167,196|
|Current (credit)/charge on derivative financial instrument||(189,397||)||10,858|
|Deferred tax benefit||(74,076||)||(74,076||)|
|Effect of changes in foreign currency rate||(1,038,734||)||(533,720||)|
|Stock-based compensation expense||536,896||771,415|
|Non-cash interest charge||—||283,727|
|Write-off of deferred financing costs in connection with conversion of 6% subordinated convertible notes||—||295,368|
|Changes in operations, assets and liabilities|
|Increase in accounts receivable||(3,933,607||)||(2,895,645||)|
|Increase in due from affiliates||—||(78,199||)|
|Increase in inventory||(2,726,693||)||(1,957,665||)|
|Increase in prepaid expenses and supplies||(53,338||)||(278,636||)|
|Decrease/(increase) in other assets||151,191||(15,491||)|
|Decrease in accounts payable and accrued expenses||(248,353||)||(933,385||)|
|Decrease in due to related parties||281,747||254,691|
|NET CASH USED IN OPERATING ACTIVITIES||(14,557,124||)||(13,472,037||)|
|CASH FLOWS FROM INVESTING ACTIVITIES|
|Acquisition of property and equipment||(212,655||)||(117,938||)|
|Acquisition of intangible assets||(12,029||)||(111,931||)|
|Purchase of short-term investments||(8,000,000||)||—|
|Proceeds from sale of short-term investments||5,859,358||—|
|NET CASH USED IN INVESTING ACTIVITIES||(2,365,326||)||(229,869||)|
|CASH FLOWS FROM FINANCING ACTIVITIES|
|Repayment of notes payable||(10,761,738||)||(13,541,011||)|
|Proceeds from notes payable and warrants||10,776,732||10,855,070|
|Payments of obligations under capital leases||(1,817||)||(1,729||)|
|Increase in restricted cash||(170,164||)||(94,938||)|
|Issuance of common stock||21,014,609||31,500,000|
|Payments for costs of stock issuances||(1,396,123||)||(2,898,063||)|
|NET CASH PROVIDED BY FINANCING ACTIVITIES||19,461,499||25,819,329|
|EFFECTS OF FOREIGN CURRENCY TRANSLATION||1,007||32|
|NET INCREASE IN CASH AND CASH EQUIVALENTS||2,540,056||12,117,455|
|CASH AND CASH EQUIVALENTS – BEGINNING||1,004,957||1,392,016|
|CASH AND CASH EQUIVALENTS – ENDING||$||3,545,013||$||13,509,471|
|Schedule of non-cash investing and financing activities|
|Conversion of redeemable convertible preferred stock, net of fractional shares, by issuance of common stock||$||—||$||28,447,667|
|Issuance of common stock in payment of accrued dividends||$||—||$||1,389,765|
|Conversion of 5% euro denominated convertible subordinated notes by issuance of common stock||$||—||$||1,663,173|
|Conversion of 40% of 6% convertible subordinated notes by issuance of common stock||$||—||$||6,000,000|
|Income taxes paid||$||—||$||—|
See accompanying notes to the condensed consolidated financial statements.
CASTLE BRANDS INC. AND SUBSIDIARIES
NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying condensed consolidated financial statements do not include all of the information and footnote disclosures normally included in financial statements prepared in accordance with the rules and regulations of the Securities and Exchange Commission and U.S. generally accepted accounting principles (‘‘GAAP’’) and in the opinion of management, contain all adjustments (which consist of only normal recurring adjustments) necessary for a fair presentation of such financial information. Results of operations for interim periods are not necessarily indicative of those to be achieved for full fiscal years. The Condensed Consolidated Balance Sheet as of March 31, 2007 is derived from the March 31, 2007 audited financial statements. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the fiscal year ended March 31, 2007 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.
|A.||Description of business and business combination – Castle Brands Inc. is the successor to Great Spirits Company, LLC, a Delaware limited liability company (‘‘GSC’’). GSC was formed in February 1998. In May 2003, Great Spirits (Ireland) Limited (‘‘GSI’’), a wholly owned subsidiary of GSC, began operations in Ireland to market GSC’s products internationally. GSI has been an inactive entity since December 2003 and was dissolved as of September 30, 2006. In July 2003, GSRWB, Inc. (renamed Castle Brands Inc.) and its wholly owned subsidiary, Great Spirits Corp. (renamed Castle Brands (USA) Corp.) (‘‘CB-USA’’), were formed under the laws of Delaware in contemplation of a pending acquisition. On December 1, 2003, Castle Brands Inc. acquired The Roaring Water Bay Spirits Group Limited and The Roaring Water Bay Spirits Marketing and Sales Company Limited and their related entities (collectively, ‘‘Roaring Water Bay’’). The acquisition has been accounted for under purchase accounting. Simultaneously, GSC was merged into CB-USA, and Castle Brands Inc. issued stock to GSC’s members in exchange for their membership interests in GSC. Subsequent to the acquisition, The Roaring Water Bay Spirits Group Limited was renamed Castle Brands Spirits Group Limited (‘‘CB-IRL’’) and The Roaring Water Bay Spirits Marketing and Sales Company Limited was renamed Castle Brands Spirits Marketing and Sales Company Limited (‘‘CB-UK’’).|
In February 2005, Castle Brands Inc. acquired 60% of the shares of Gosling-Castle Partners Inc. (‘‘GCP’’), which holds the worldwide distribution rights (excluding Bermuda) to Gosling’s rum and related products.
In October 2006, Castle Brands Inc. acquired all of the outstanding capital stock of McLain & Kyne, Ltd. (‘‘McLain & Kyne’’) pursuant to a Stock Purchase Agreement. McLain & Kyne is a Louisville, Kentucky based developer and marketer of three premium small batch bourbons: Jefferson’s Reserve, Jefferson’s and Sam Houston.
As used herein, the ‘‘Company’’ refers to Castle Brands Inc. and, where appropriate, it also refers collectively to Castle Brands Inc. and its direct and indirect subsidiaries, including its majority owned GCP subsidiary.
|B.||Principles of consolidation – The consolidated financial statements include the accounts of Castle Brands Inc., its wholly-owned subsidiaries, CB-USA and McLain and Kyne, Castle Brands Inc. wholly-owned foreign subsidiaries, CB-IRL and CB-UK, and its majority owned subsidiary, Gosling-Castle Partners, Inc. 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.|
|C.||Organization and operations – The Company is principally engaged in the manufacture, marketing and sale of fine spirit brands of vodka, whiskey, rums and liqueurs (the ‘‘products’’) in the United States, Canada, Europe, and the Caribbean. Except for Gosling’s rums and bourbon products, which are bottled in the United States, all of the Company’s products are imported from Europe. The vodka, Irish whiskies and certain liqueurs are produced by CB-IRL, billed in euros and imported into the United States. The risk of changes in F/X is borne by the U.S. entities.|
|D.||Cash and cash equivalents – The Company considers all highly liquid instruments with a maturity date at acquisition of three-months or less to be cash and cash equivalents.|
|E.||Investments – The Company follows Statement of Financial Accounting Standards (‘‘SFAS’’) No. 115, Accounting for Certain Investments in Debt and Equity Securities, classifying its investments based on the intended holding period. The Company currently classifies its investments as available-for-sale. Available-for-sale securities are carried at estimated fair value, based on available market information, with unrealized gains and losses, if any, reported as a component of stockholders’ equity. Investments consist primarily of auction rate corporate debt, auction rate municipal securities, government bonds, mutual funds and preferred stock that are highly liquid in nature and represent the investment of cash that is available for current operations. Although original maturities of the Company’s auction rate securities are generally longer than one year, the Company has the right to sell these securities each auction date subject to the availability of buyers. Interest rates on these securities reset at every auction date, generally every twenty eight days.|
|F.||Trade accounts receivable – The Company records trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect anticipated losses on the trade accounts receivable balances. The Company calculates this allowance based on its history of write-offs, level of past due accounts based on contractual terms of the receivables and its relationships with, and economic status of, the Company’s customers.|
|G.||Revenue recognition – Revenue from product sales is recognized when the product is shipped to a customer (generally a distributor), title and risk of loss has passed to the customer in accordance with the terms of sale (FOB shipping point or FOB destination), and collection is reasonably assured. Revenue is not recognized on shipments to control states in the United States until such time as product is sold through to the retail channel.|
|H.||Inventories – Inventories, which comprise distilled spirits, raw materials (bulk spirits, bottles, labels and caps), packaging and finished goods, is valued at the lower of cost or market, using the weighted average cost method. The Company assesses the valuation of its inventories and reduces the carrying value of those inventories that are obsolete or in excess of the Company’s forecasted usage to their estimated net realizable value. The Company estimates the net realizable value of such inventories based on analyses and assumptions including, but not limited to, historical usage, expected future demand and market requirements. Reductions to the carrying value of inventories are recorded in cost of goods sold.|
|I.||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. As of September 30, and March 31, 2007, goodwill and other indefinite lived intangible assets that arose from acquisitions were $12.5 million and $13.6 million, respectively. Goodwill and other intangible assets with indefinite lives are not amortized, but instead are tested for impairment annually or more frequently if circumstances indicate a possible impairment may exist. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to the estimated residual values and reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Company performed its annual impairment assessment on long-lived assets, including indefinite lived intangible assets and goodwill, and concluded that no impairment existed.|
|J.||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 Great Britain 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. Historically, the Company’s sales in Ireland have been made ‘‘in-bond’’, net of excise taxes. In September 2007, the Company made an initial sale to its new distributor in Ireland ‘‘ex-bond’’ that included $1,861,995 million in excise taxes and VAT. These taxes are reflected in both our revenues and cost of sales as an equal increase to both. During the three-month and six-month periods ended September 30, 2007 and 2006, the captions for the Company’s revenues and cost of sales included the amounts of excise tax and duties presented in the table below:|
|K.||Foreign currency – The functional currency for the Company’s foreign operations is the euro in Europe, excluding the United Kingdom, the British pound in the United Kingdom, and the Canadian dollar in Canada. The translation from the applicable foreign currencies to U.S. dollars is performed for balance sheet accounts using current 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 accompanying consolidated statements of operations. As indicated in Note 1C, the vodka, Irish whiskies and certain liqueurs are produced by CB-IRL and billed in euros to the U.S. entities, with the risk of foreign exchange gain/loss resting with CB-US. In addition, CBI has funded the continuing operations off the international subsidiaries. At each balance sheet date, the euro denominated balances included on the books of CB-IRL are translated into U.S. dollars at the exchange rate in effect at the balance sheet date, and the resulting foreign currency transaction gain or loss included in net income.|
|L.||Stock-based compensation – Incremental compensation expense for the three-months ended September 30, 2007 and 2006 amounted to $266,708 and $276,921, respectively, of which $115,417 and $136,603 are included in selling expense, respectively, and $151,291 and $140,318 are in general and administrative expense, respectively, in the accompanying condensed consolidated statements of operations. Incremental compensation expense for the six-months ended September 30, 2007 and 2006 amounted to $536,896 and $771,415, respectively, of which $229,579 and $221,472 are included in selling expense, respectively, and $307,317 and $549,943 are in general and administrative expense, respectively, in the accompanying condensed consolidated statements of operations.|
|M.||Stock warrants – The Company accounted for the warrant and the put option rights as a compound financial instrument in the consolidated financial statements at fair value following the guidelines of EITF 00-19, paragraphs 44 and 45, and paragraphs 11 and 24 of SFAS 150. Changes in the fair value of the compound instrument are recognized in earnings for each reporting period. For the three-months ended September 30, 2007 and 2006, the Company recorded a (credit)/charge for the change in the value of the compound financial instrument of $0 and $8,666 respectively, and a (credit)/charge for the change in the value of the compound financial instrument of $(189,397) and $10,858, for the six-months ended September 30, 2007 and 2006, respectively.|
|N.||Advertising – Advertising costs are expensed when the advertising first appears in its respective medium. Advertising expense, which is included in selling expense, for the three-months ended September 30, 2007 and 2006 was $920,222 and $1,462,782, and $1,772,023 and $2,528,900 for the six-months ended September 30, 2007 and 2006, respectively.|
|O.||Use of estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates include the accounting for items such as evaluating annual impairment tests, allowance for doubtful accounts, inventory, depreciation, amortization and expense accruals.|
|P.||Recent accounting pronouncements – In September 2006, the Financial Accounts Standards Board (‘‘FASB’’) issued SFAS No. 157, ‘‘ Fair Value Measurements ,’’ to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles, and expand disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, the beginning of the Company’s 2008 fiscal year. The Company is assessing the impact the adoption of SFAS No. 157 will have on the Company’s financial position and results of operations.|
In February 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 159, ‘‘ The Fair Value Option for Financial Assets and Financial Liabilities ’’ (SFAS 159), which allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. Subsequent changes in fair value of these financial assets and liabilities would be recognized in earnings when they occur. SFAS 159 further establishes certain additional disclosure requirements. SFAS 159 is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. Management is currently evaluating the impact and timing of the adoption of SFAS 159 on the Company’s consolidated financial statements.
|Q.||Reclassifications – Certain prior year balances have been reclassified to conform to the current period classification.|
NOTE 2 — BASIC AND DILUTED NET LOSS PER COMMON SHARE
Basic net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is computed giving effect to all dilutive potential common shares that were outstanding during the period. Diluted potential common shares consist of incremental shares issuable upon exercise of stock options and warrants and contingent conversion of debentures. In computing diluted net loss per share for the six-months ended September 30, 2007 and 2006, no adjustment has been made to the weighted average outstanding common shares as the assumed exercise of outstanding options and warrants and the assumed conversion of convertible debentures is anti-dilutive.
Potential common shares not included in calculating diluted net loss per share are as follows:
NOTE 3 — INVESTMENTS
The following is a summary of available-for-sale securities:
|September 30, 2007|
The cost of the Company’s short-term investments approximates their fair-values.
NOTE 4 — INVENTORIES
As of September 30, and March 31, 2007, 78.5% and 99.1%, respectively, of the raw materials and 10.6% and 13.0%, respectively, of finished goods were located outside of the United States.
Inventories are stated at the lower of weighted average cost or market.
NOTE 5 — INVESTMENTS AND ACQUISITIONS
Acquisition of McLain & Kyne, Ltd.
On October 12, 2006, the Company acquired all of the outstanding capital stock of McLain & Kyne, Ltd. pursuant to a Stock Purchase Agreement (the ‘‘Agreement’’). McLain & Kyne is a Louisville, Kentucky-based developer and marketer of three premium small batch bourbons: Jefferson’s Reserve, Jefferson’s and Sam Houston. As consideration for the acquisition, the Company has paid $2,000,000, consisting of $1,294,800 in cash and issued 100,000 shares of its common stock, valued at $705,200. The Company will also pay an earn-out to the sellers based on the financial performance of the acquired business. The aggregate amount of such earn-out payments, which shall not exceed $4,000,000, will be determined by a calculation based on the gross margin (as defined in the Agreement) recognized by the Company from the sales of McLain & Kyne’s bourbons through March 31, 2011. As a result of the purchase price allocation, the Company recorded goodwill of $768,805. Under the purchase method of accounting, tangible and identifiable intangible assets acquired and liabilities assumed are recorded at their estimated fair values. The estimated fair values and useful lives of intangible assets acquired are tentative and have been supported by a preliminary third party valuation based on weighted average cost of capital vs. return on invested capital. The fair values allocated to McLain & Kyne’s net tangible and intangible assets are as follows: current assets of $100,021, inventory of $53,866, tradenames of $941,000, and customer relationships of $169,000 and current liabilities of $32,692. The tradenames have been determined to have indefinite useful lives and accordingly, consistent with FAS 142, no amortization will be recorded in the Company’s consolidated income statements. Instead, the related intangible asset will be tested for impairment at least annually, with any related impairment charge recorded to the statement of operations at the time of determining such impairment. The customer relationships are being amortized on a straight-line basis over a period of 15 years.
The operating results of the McLain & Kyne business are reflected in the accompanying consolidated financial statements from the date of acquisition and were not material.
The Agreement also provides for, among other things, representations, warranties, indemnities and ‘‘piggyback’’ registration rights for the shares issued.
The following table presents unaudited pro forma information about sales and net loss had the operations of the above described acquisition been combined with the Company’s business as of the first day of the period shown.
|Earnings per share:|
|Weighted average shares:|
In management’s opinion, the unaudited pro forma results of operations are not indicative of the actual results that would have occurred had the above acquisitions been consummated at the beginning of the periods presented or of future operations of the combined companies under the Company’s management.
Investment in Gosling-Castle Partners Inc.
In February 2005, the Company entered into a stock subscription agreement for 60% of the stock of Gosling Partners, Inc., whose name was subsequently changed to Gosling-Castle Partners Inc.
NOTE 6 — INTANGIBLE ASSETS
Intangible assets consist of the following:
|Definite life brands||$||296,886||$||308,909|
|Less: accumulated amortization||2,276,630||2,233,808|
|Other identifiable intangible assets – indefinite life Trade names and formulations||4,664,363||4,292,000|
Accumulated amortization consists of the following:
Amortization expense for the three-months ended September 30, 2007 and 2006 totaled $238,176 and $203,954 respectively, and $453,418 and $402,002 for the six-months ended September 30, 2007 and 2006, respectively.
On September 1, 2006, the Company delivered notice to a certain distributor that it was terminating its distribution agreement. As a result of the delivery of the notice, the distribution agreement has been terminated, as provided for by its terms, as of September 15, 2007. The Company has adjusted the estimated useful life of the underlying intangible asset to agree to the termination date.
Estimated aggregate amortization expense for each of the five succeeding years is as follows:
NOTE 7 — RESTRICTED CASH
The Company has cash collateral on deposit for creditors insurance in Ireland of €501,935, or $716,362 (as translated at the exchange rate in effect on September 30, 2007).
NOTE 8 — OVERDRAFT ACCOUNTS
CB-IRL and CB-UK maintain overdraft coverage with a financial institution in Ireland of up to €400,000 ($570,880) and £20,000 ($40,954), respectively. Overdraft balances included in notes payable totaled $459,830 and $380,334 at September 30, and March 31, 2007, respectively.
NOTE 9 — SENIOR NOTES PAYABLE, NOTES PAYABLE AND CAPITAL LEASE
|Notes payable consist of the following:|
|Revolving credit facilities||$||460,550||$||407,261|
|Revolving credit facilities||—||8,363|
|Subordinated convertible notes||9,000,000||9,000,000|
Principal payments due over the next five years for the above listed notes payable and capital lease are due as follows (as translated at the exchange rate in effect on September 30, 2007):
|For the years ending September 30,|
|Less current portion||464,327|
|Non current portion||$||18,505,281|
NOTE 10 — COMMON STOCK
Unregistered Sales of Equity Securities – On April 18, 2007, the Company entered into a Securities Purchase Agreement (the ‘‘Securities Purchase Agreement’’) with selected investors (each an ‘‘Investor’’ and collectively, the ‘‘Investors’’). Pursuant to the terms of the Securities Purchase Agreement, the Company has sold in a private placement a total of 3,520,035 shares of its common stock, (the ‘‘Common Stock’’), for aggregate gross proceeds of $21,014,609. Net proceeds to the Company after offering costs were $19,618,484. The transaction closed on May 8, 2007. The Investors included, among others, Frederick M. R. Smith and Phillip Frost, MD, each a director of the Company, and CNF Investments II, LLC, of which Robert J. Flanagan, a director of the Company, is a manager.
As part of the transaction, investors received warrants to purchase approximately 1,408,014 additional shares at an exercise price of $6.57 per share (the ‘‘Warrants’’). The Warrants will remain exercisable for a period of five years from the closing of the offering. The Warrants contain anti-dilution protection for stock splits and similar events, but do not contain any price-based anti-dilution adjustments. In connection with the transaction, Piper Jaffray & Co., as placement agent was issued a warrant to purchase 35,200 shares of Common Stock at an exercise price of $5.97 per share, exercisable within five years following the issuance of the warrant (the ‘‘Agent Warrant’’). The Agent Warrant is otherwise on the same terms and conditions as the Warrants.
Registration Rights Agreement – On April 18, 2007, the Company entered into a Registration Rights Agreement (the ‘‘Registration Rights Agreement’’) with the Investors. Pursuant to the Registration Rights Agreement, the Company has agreed to register the resale of the shares of Common Stock sold to the Investors pursuant to the Securities Purchase Agreement, including the shares issuable upon exercise of the Warrants. The Company agreed to file with the SEC a registration statement with respect to this registration within 30 days after closing. The Company filed such registration statement on May 31, 2007, within this 30 day timeframe. The registration statement was declared effective as of July 9, 2007.
NOTE 11 — FOREIGN CURRENCY FORWARD CONTRACTS
The Company enters into forward contracts to attempt to limit its exposure to foreign currency fluctuations. The Company recognizes in the balance sheet derivative contracts at fair value, and reflects any net gains and losses currently in earnings. At September 30, 2007, the Company held outstanding forward exchange positions for the purchase of euros, expiring through December 2007, in the amount of $855,140 with a weighted average conversion rate of €1 = $1.4252 as compared to the spot rate at September 30, 2007 of €1 = $1.4272. Gain or loss on foreign transactions related to the foreign currency forward contracts, which was de minimis, is included in other income and expense.
NOTE 12 — PROVISION FOR INCOME TAXES
On January 1, 2007, the Company adopted the provisions of FIN 48 – ‘‘ Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 ’’. FIN 48 clarifies and sets forth consistent rules for accounting for uncertain tax positions in accordance with FAS 109, ‘‘ Accounting for Income Taxes .’’
As a result of the implementation of FIN 48, the Company made a review of its portfolio of uncertain tax positions in accordance with recognition standards established by FIN 48. In this regard, an uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. As a result of this review, the Company determined that it had no material uncertain tax positions and, therefore, it has not recorded unrecognized tax benefits. The Company does not expect any material changes to its uncertain tax positions.
The tax years 2004 through 2007 remain open to examination by federal and state tax jurisdictions.
The Company has various foreign subsidiaries for which tax years 2001 through 2007 remain open to examination in certain foreign tax jurisdictions.
The Company’s income tax benefit for the three-months and six months ended September 30, 2007 and 2006 consists of federal and state and local taxes attributable to Gosling-Castle Partners Inc. (‘‘GCP’’) which does not file a consolidated income tax return with the Company. In connection with the investment in GCP, the Company recorded a deferred tax liability on the ascribed value of the acquired intangible assets of $2,222,222, increasing the value of the asset. The deferred tax liability is being reversed and a deferred tax benefit is being recognized over the amortization period of the intangible asset (15 years). For the three-months ended September 30, 2007 and 2006, the Company recognized $37,038 and $37,038 of deferred tax benefits, respectively, and $74,076 and $74,076 for the six-months ended September 30, 2007 and 2006, respectively.
On December 1, 2003, the Company recorded a deferred tax liability of $629,444 as the amount ascribed to the difference between the book and tax basis of the tangible and intangible assets acquired as additional goodwill.
Pursuant to FIN 48, the Company recognizes interest and penalties related to uncertain tax positions in the provision for income taxes. The Company did not recognize any such interest and/or penalties during the six-months ended September 30, 2007 and 2006.
NOTE 13 — STOCK OPTIONS AND WARRANTS
|A.||Stock Options – In July 2003, the Company implemented the 2003 Stock Incentive Plan (‘‘the Plan’’) which provides for awards of incentive and non-qualified stock options, restricted stock and stock appreciation rights for its officers, employees, consultants and directors in order to attract and retain such individuals who contribute to the Company’s success by their ability, ingenuity and industry knowledge, and to enable such individuals to participate in the long-term success and growth of the Company by giving them an equity interest in the|
|Company. There are 2,000,000 common shares reserved and available for distribution under the Plan, of which 692,375 remain available. Stock options granted under the Plan are granted with an exercise price at or above the fair market value of the underlying common stock at the date of grant, generally vest over a four or five year period and expire ten years after the grant date.|
At September 30, 2007 total unrecognized compensation cost amounted to approximately $2,140,868, representing 628,050 unvested options. There were no options exercised under the share-based payment arrangements during the six-months ended September 30, 2007 and 2006.
The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model and is affected by assumptions regarding a number of highly complex and subjective variables. The use of an option pricing model also requires the use of a number of complex assumptions, including expected volatility, risk-free interest rate, expected dividends, and expected term. Expected volatility is based on the historical volatility of a peer group of companies over the expected life of the option as the Company does not have enough history trading as a public company to calculate its own stock price volatility. The expected term and vesting of the options represents the estimated period of time until exercise and is based on historical experience of similar awards, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option. The Company has not paid dividends in the past and does not plan to pay any dividends in the near future. SFAS 123R also requires the Company to estimate forfeitures at the time of grant and revise these estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company estimates forfeitures based on its expectation of future experience while considering its historical experience.
A summary of the options outstanding under the stock option plan is as follows:
|Six-months ended September 30,|
|Outstanding at beginning of period||1,294,125||$||7.19||888,500||$||6.82|
|Outstanding at end of period||1,307,625||7.20||1,328,500||7.18|
|Options exercisable at period end||679,575||7.10||409,267||$||6,63|
|Weighted average fair value of options gr|