Castle Brands Inc.
Castle Brands Inc (Form: 10-Q, Received: 02/14/2007 06:39:09)

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 December 31, 2006

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)


Delaware 41-2103550
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
570 Lexington Avenue
New York, New York
10022
(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 [X]     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).


         [ ] Large accelerated filer [ ] Accelerated filer [X] 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 [X]

The Company had 12,122,241 shares of $0.01 par value common stock outstanding at February 12, 2007.




TABLE OF CONTENTS


PART I.    FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements:  
  Condensed Consolidated Balance Sheets as of December 31, 2006 (unaudited) and March 31, 2006 1
  Condensed Consolidated Statements of Operations for the Three-Month and Nine-Month Periods ended December 31, 2006 (unaudited) and 2005 2
  Condensed Consolidated Statements of Changes in Shareholders’ Equity (Deficiency) for the Nine-Month Periods ended December 31, 2006 (unaudited) 3
  Condensed Consolidated Statements of Cash Flows for the Nine-Month Periods ended December 31, 2006 (unaudited) and 2005 4
  Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 23
Item 3. Quantitative and Qualitative Disclosures About Market Risk 35
Item 4. Controls and Procedures 35
PART II.    OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 1A. Risk Factors 37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 37
Item 3. Defaults Upon Senior Securities 38
Item 4. Submission of Matters to a Vote of Security Holders 38
Item 5. Other Information 38
Item 6. Exhibits 40
SIGNATURE



PART I.    FINANCIAL INFORMATION

Item 1.    Consolidated Financial Statements

CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets


  December 31, 2006 March 31, 2006
  (unaudited)  
ASSETS  
 
CURRENT ASSETS  
 
Cash and cash equivalents $ 11,031,765
$ 1,392,016
Accounts receivable – net of allowance for doubtful accounts of $463,351 and $395,207 8,632,373
3,511,215
Due from affiliates 1,048,359
953,616
Inventories 9,514,110
6,673,235
Prepaid expenses and other current assets 1,232,904
1,021,369
TOTAL CURRENT ASSETS 31,459,511
13,551,451
EQUIPMENT – net 538,749
407,983
OTHER ASSETS  
 
Intangible assets – net of accumulated amortization of $2,013,125 and $1,379,389 13,428,433
13,936,427
Goodwill 13,636,650
11,649,430
Deferred registration costs
2,823,594
Restricted cash 497,667
362,293
Other assets 635,379
913,032
TOTAL ASSETS $ 60,196,389
$ 43,644,210
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIENCY)  
 
CURRENT LIABILITIES  
 
Current maturities of notes payable and capital leases $ 1,088,007
$ 3,678,547
Accounts payable 3,173,466
3,757,515
Accrued expenses, put warrant payable and derivative instrument 3,268,496
2,986,188
Due to stockholders and affiliates 2,353,982
2,121,334
Convertible stockholder notes payable
1,660,148
Stockholder notes payable
147,113
TOTAL CURRENT LIABILITIES 9,883,951
14,350,845
LONG TERM LIABILITIES  
 
Senior notes payable 9,287,098
4,594,791
Notes payable and capital leases, less current maturities 9,006,148
15,350,640
Preferred stock and preferred membership units dividends payable
1,546,480
Deferred tax liability 2,592,406
2,703,515
  30,769,603
38,546,271
REDEEMABLE CONVERTIBLE PREFERRED STOCK  
 
Redeemable convertible preferred stock Series A, B, C; 4,103,750 shares designated; 4,089,463 shares outstanding at March 31, 2006, liquidation preference of $33,326,484
28,447,683
COMMITMENTS AND CONTINGENCIES (Note 14)  
 
MINORITY INTERESTS 1,573,309
2,674,731
   
 
STOCKHOLDERS’ EQUITY (DEFICIENCY)  
 
Preferred stock, $.01 par value, 5,000,000 shares authorized, none outstanding  
 
Common stock, $.01 par value, 45,000,000 shares authorized, 12,109,741 and 3,106,666 shares issued and outstanding at December 31, 2006 and March 31, 2006, respectively 121,098
31,067
Additional paid in capital 83,751,040
17,182,405
Accumulated deficiency (55,417,539
)
(43,404,887
)
Accumulated other comprehensive (loss)/income (601,122
)
166,940
TOTAL STOCKHOLDERS’ EQUITY (DEFICIENCY) 27,853,477
(26,024,475
)
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIENCY) $ 60,196,389
$ 43,644,210

See accompanying notes to the condensed consolidated financial statements.

1




CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(unaudited)


  Three Months Ended
December 31,
Nine Months Ended
December 31,
  2006 2005 2006 2005
Sales, net $ 7,380,605
$ 7,359,281
$ 19,093,072
$ 17,450,819
Cost of sales 4,938,243
4,997,850
12,733,747
11,313,126
Gross profit 2,442,362
2,361,431
6,359,325
6,137,693
Selling expense (Note 1K) 4,599,783
3,616,145
12,836,429
9,965,930
General and administrative expense
(Note 1K)
2,101,331
1,659,034
6,235,824
4,032,304
Depreciation and amortization 262,926
232,920
743,214
674,748
Operating loss (4,521,678
)
(3,146,668
)
(13,456,142
)
(8,535,289
)
Other income 1,096
(30,624
)
5,040
3,508
Other expense (21,132
)
(9,468
)
(36,998
)
(28,077
)
Foreign exchange gain/(loss) 483,799
(258,868
)
1,143,588
(556,592
)
Interest expense, net (208,093
)
(413,317
)
(706,700
)
(1,037,521
)
Write-off of deferred financing costs in connection with conversion of 6% subordinated convertible notes
(295,368
)
Current credit on derivative financial instrument 132,255
3,702
121,397
18,752
Income tax benefit 37,033
37,037
111,109
111,113
Minority interests 366,208
204,385
1,101,422
428,442
Net loss $ (3,730,512
)
$ (3,613,821
)
$ (12,012,652
)
$ (9,595,664
)
Preferred stock dividends
421,890
48,238
1,113,652
Net loss attributable to common stockholders $ (3,730,512
)
$ (4,035,711
)
$ (12,060,890
)
(10,709,316
)
Net loss attributable to common stockholders per common share  
 
 
 
Basic $ (0.31
)
$ (1.30
)
$ (1.02
)
$ (3.45
)
Diluted $ (0.31
)
$ (1.30
)
$ (1.02
)
$ (3.45
)
Weighted average shares used in computation  
 
 
 
Basic 12,051,045
3,106,666
11,827,837
3,106,666
Diluted 12,051,045
3,106,666
11,827,837
3,106,666

See accompanying notes to the condensed consolidated financial statements.

2




CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Changes in Stockholders’ Equity (Deficiency)
(Unaudited)


  Common Stock Additional
Paid in
Capital
Accumulated
Deficiency
Accumulated
Other
Comprehensive
Income/(Loss)
Total
Stockholders’
Equity/
(Deficiency)
  Shares Amount
BALANCE, MARCH 31, 2006 3,106,666
$ 31,067
$ 17,182,405
$ (43,404,887
)
$ 166,940
$ (26,024,475
)
Comprehensive loss  
 
 
 
 
 
Net loss  
 
 
(12,012,652
)
 
(12,012,652
)
Foreign currency translation adjustment  
 
 
 
(768,062
)
(768,062
)
Total comprehensive loss  
 
 
 
 
(12,780,714
)
Accrued preferred stock dividends  
 
(48,238
)
 
 
(48,238
)
Issuance of common stock in initial public offering, net of issuance costs 3,500,000
35,000
26,393,889
 
 
26,428,889
Conversion of redeemable convertible preferred stock, net of fractional shares 4,089,463
40,895
28,406,772
 
 
28,447,667
Issuance of common stock in payment of accrued dividends 193,107
1,931
1,387,834
 
 
1,389,765
Conversion of 5% euro denominated convertible subordinated notes 263,362
2,634
1,660,539
 
 
1,663,173
Conversion of 40% of 6% convertible subordinated notes 857,143
8,571
5,991,429
 
 
6,000,000
Issuance of common stock in connection with acquisition of McLain & Kyne, Ltd. 100,000
1,000
704,200
 
 
705,200
Vesting of stock options as compensation  
 
24,143
 
 
24,143
Estimated fair value ascribed to warrants issued to financial consultant  
 
283,727
 
 
283,727
Estimated fair value ascribed to warrants issued in connection with issuance of senior notes  
 
706,944
 
 
706,944
Stock-based compensation  
 
1,057,396
 
 
1,057,396
BALANCE, DECEMBER 31, 2006 12,109,741
$ 121,098
$ 83,751,040
$ (55,417,539
)
$ (601,122
)
$ 27,853,477

See accompanying notes to the condensed consolidated financial statements.

3




CASTLE BRANDS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited)


  Nine Months Ended December 31,
  2006 2005
    (audited)
CASH FLOWS FROM OPERATING ACTIVITIES  
 
Net loss $ (12,012,652
)
$ (9,595,664
)
Adjustments to reconcile net loss to net cash used in operating activities  
 
Depreciation and amortization 743,214
674,748
Minority interest in net loss of consolidated subsidiary (1,101,422
)
(428,442
)
Loss on disposal of fixed assets
1,159
Write-off of deferred financing costs 390,756
373,956
Current charge/(credit) on derivative financial instrument (121,397
)
(18,752
)
Deferred tax benefit (111,109
)
(111,113
)
Effect of changes in foreign currency rate (997,604
)
(269,403
)
Stock-based compensation expense 1,057,396
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 (4,872,125
)
(2,389,002
)
Increase in due from related parties – GXB (92,715
)
(688,339
)
Increase in inventory (2,607,467
)
(1,018,343
)
Increase in prepaid expenses and supplies (198,592
)
(401,550
)
Increase in other assets (139,590
)
(370,744
)
(Decrease)/increase in accounts payable, accrued expenses, put warrant payable and derivative instrument (58,528
)
449,518
Increase in due to related parties 175,720
1,944,221
Total adjustments (7,354,368
)
(2,252,086
)
NET CASH USED IN OPERATING ACTIVITIES (19,367,020
)
(11,847,750
)
CASH FLOWS FROM INVESTING ACTIVITIES  
 
Acquisition of property and equipment (221,631
)
(157,188
)
Acquisition of intangible assets (129,144
)
(98,219
)
Business acquisitions – net of cash acquired (1,282,021
)
(13,379
)
NET CASH USED IN INVESTING ACTIVITIES (1,632,796
)
(268,786
)
CASH FLOWS FROM FINANCING ACTIVITIES  
 
Repayment of notes payable (18,538,838
)
(17,335,098
)
Proceeds from notes payable and warrants 20,677,017
25,233,423
Payments of obligations under capital leases (2,609
)
(2,755
)
Increase in restricted cash (97,985
)
Issuance of redeemable convertible preferred stock
2,900,000
Payments for costs of stock issuances
(247,466
)
Issuance of common stock 31,500,000
Payments for costs of stock issuances (2,898,063
)
(560,224
)
NET CASH PROVIDED BY FINANCING ACTIVITIES 30,639,522
9,987,880
EFFECTS OF FOREIGN CURRENCY TRANSLATION 43
(1,443
)

4





  Nine Months Ended December 31,
  2006 2005
    (audited)
NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS 9,639,749
(2,130,099
)
CASH AND CASH EQUIVALENTS – BEGINNING 1,392,016
5,676,398
CASH AND CASH EQUIVALENTS – ENDING $ 11,031,765
$ 3,546,299
SUPPLEMENTAL DISCLOSURES  
 
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 initial public offering $ 28,447,667
$
Issuance of common stock in payment of accrued dividends $ (1,389,765
)
$
Issuance of common stock in initial public offering $ 1,389,765
$
Conversion of 5% euro denominated convertible subordinated notes by issuance of common stock $ (1,663,173
)
$
Issuance of common stock in initial public offering $ 1,663,173
$
Conversion of 40% of 6% convertible subordinated notes by issuance of common stock $ (6,000,000
)
$
Issuance of common stock in initial public offering $ 6,000,000
$
Business acquisition-net of cash acquired $ (705,200
)
$
Issuance of common stock $ 705,200
$
Increase in deferred registration costs $
$ (1,053,238
)
Increase in accounts payable, accrued expenses, put warrant payable and derivative instrument $
$ 1,053,238
Interest paid $ 1,000,963
$ 921,951

See accompanying notes to the condensed consolidated financial statements.

5




Table of Contents

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

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 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, 2006 is derived from the March 31, 2006 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, 2006 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. A loss on F/X of $17,659 was realized upon the dissolution. 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 Ireland’’) 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 its wholly-owned foreign subsidiaries, CB Ireland and CB-UK, and its majority owned 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.

6




Table of Contents
C.  Cash equivalents – The Company considers all highly liquid instruments with a maturity at date of acquisition of three-months or less to be cash equivalents.
D.  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.
E.  Revenue recognition – Revenue from product sales is recognized when the product is shipped to a customer (generally a distributor or a control state), 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.
F.  Inventories – Inventories, which comprise distilled spirits, raw materials (bulk spirits, bottles, labels and caps), packaging and finished goods, are 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.
H.  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 December 31, 2006 and March 31, 2006, goodwill and other indefinite lived intangible assets that arose from acquisitions were $13.6 million and $11.6 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 intangible assets and goodwill. The Company concluded that no impairment existed at March 31, 2006.
I.  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. During the three-month and nine-month periods ended December 31, 2006 and 2005, the line items for the Company’s revenues and cost of sales included the amounts of excise tax and duties presented in the table below:

  Three-months ended
December 31,
Nine-months ended
December 31,
  2006 2005 2006 2005
Sales, net $ 1,809,820
$ 1,096,510
$ 4,431,836
$ 2,991,267
Cost of Sales $ 1,809,820
$ 1,096,510
$ 4,431,836
$ 2,991,267

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Table of Contents
J.  Foreign currency translation – 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 condensed consolidated statements of operations.
K.  Stock-based compensation – Effective April 1, 2006, the Company began recording compensation expense associated with stock options and other forms of equity compensation in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004 ), Share-Based Payment (SFAS 123R), as interpreted by SEC Staff Accounting Bulletin No. 107. Prior to April 1, 2006, the Company accounted for stock options according to the provisions of Accounting Principles Board Opinion No. 25 , Accounting for Stock Issued to Employees (APB 25), and related interpretations, and therefore no related compensation expense was recorded for awards granted with no intrinsic value. The Company adopted the modified prospective transition method provided for under SFAS 123R, and consequently, had not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with stock options recognized in the three-month and nine-month periods ended December 31, 2006 includes: 1) amortization related to the remaining unvested portion of all stock option awards granted prior to April 1, 2006 over the requisite service period based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123 , Accounting for Stock-Based Compensation ; and 2) amortization related to all stock option awards granted on or subsequent to April 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. A compensation charge is recorded when it is probable that performance or service conditions will be satisfied. The probability of vesting is updated annually and compensation is adjusted via a cumulative catch-up adjustment or prospectively depending upon the nature of the change.

As a result of the adoption of SFAS 123R, incremental compensation expense for the three-month and nine-month periods ended December 31, 2006 amounted to $285,981 and $1,057,396, respectively, of which $136,604 and $358,076 is included in selling expense, respectively, and $149,377 and $699,320 in general and administrative expense, respectively, in the accompanying condensed consolidated statements of operations. At December 31, 2006 total unrecognized compensation cost amounted to approximately $3,480,225, representing 1,012,033 unvested options.

For stock options granted prior to the adoption of SFAS 123R, if compensation expense for the Company’s stock option plan had been determined based upon estimated fair values at the grant dates in accordance with SFAS No. 123, the Company’s pro forma net loss and pro forma basic and diluted net loss per common share would have been as follows:


  For the three-months
ended December 31,
2005
For the nine-months
ended December 31,
2005
Net loss attributable to common stockholders, as reported $ (4,035,711
)
$ (10,709,316
)
Stock-based compensation expense determined
(60,966
)
Pro forma net loss attributable to common stockholders $ (4,035,711
)
$ (10,770,282
)
Loss per share: Basic and diluted – as reported $ (1.30
)
$ (3.45
)
Basic and diluted – pro forma $ (1.30
)
$ (3.47
)

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Table of Contents
L.  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 December 31, 2006 and 2005 was $946,124 and $622,296, respectively and was $3,475,024 and $2,626,061 for the nine-months ended December 31, 2006 and 2005, respectively.
M.  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, fair value of put warrants, derivative instruments and other equity issuances, allowance for doubtful accounts, depreciation, amortization and expense accruals.
N.  Recent accounting pronouncements – In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, ‘‘Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109’’ (‘‘FIN 48’’), which clarifies the accounting and disclosure for uncertainty in tax positions, as defined. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. This interpretation will apply to the Company’s fiscal year beginning April 1, 2007. The Company does not expect the interpretation will have a material impact on its financial position, results from operations or cash flows.

In September 2006, the Securities and Exchange Commission (‘‘SEC’’) issued Staff Accounting Bulletin 108, ‘‘Considering the Effects on Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,’’ (‘‘SAB 108’’). SAB 108 requires registrants to quantify errors using both the income statement method (i.e. iron curtain method) and the rollover method and requires adjustment if either method indicates a material error. If a correction in the current year relating to prior year errors is material to the current year, then the prior year financial information needs to be corrected. A correction to the prior year results that are not material to those years would not require a ‘‘restatement process’’ where prior financials would be amended. SAB 108 is effective for fiscal years ending after November 15, 2006. The Company does not anticipate that SAB 108 will have a material effect on its financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157, ‘‘Fair Value Measurements,’’ to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles, and expand disclosures about fair value measurements. SFAS No. 157 will be 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, results of operations or cash flows.

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, contingent conversion of debentures and convertible preferred stock outstanding. In computing diluted net loss per share for the three-month and nine-month periods ended December 31, 2006 and 2005, 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 preferred stock and convertible debentures is anti-dilutive.

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


  December,
  2006 2005
Stock options 1,428,500
915,500
Stock warrants 812,218
598,618
Convertible debentures 1,125,000
2,245,505
Convertible preferred stock
4,089,465
Total 3,365,718
7,849,088

NOTE 3 — INVENTORIES


  December 31,
2006
March 31,
2006
Raw materials $ 863,551
$ 1,339,697
Finished goods 8,650,559
5,333,538
Total $ 9,541,110
$ 6,673,235

As of December 31, and March 31, 2006, 100% of the raw materials and 14.1% and 23.5%, respectively, of finished goods were located outside of the United States.

Inventories are stated at the lower of average cost or market. 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.

NOTE 4 — INVESTMENTS AND ACQUISITIONS

Acquisition of McLain & Kyne, Ltd.

A.  On October 12, 2006, the Company acquired all of the outstanding capital stock of McLain & Kyne, Ltd., pursuant to a Stock Purchase Agreement among Chester F. Zoeller III, Brittany Lynn Zoeller Carlson, Beth Allison Zoeller Willis (collectively, the ‘‘Sellers’’) and the Company (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 to the Sellers and issued to the Sellers 100,000 shares of its common stock with a value of $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 initial purchase price allocation, we recorded goodwill of $1,987,220 million at December 31, 2006 in connection with this acquisition. The purchase price allocation for this acquisition is preliminary and may be revised as additional information becomes available. Any change in the fair value of the net assets acquired will change the amount of the purchase price allocable to goodwill. Management is currently developing integration plans which may result in additional costs which will be accrued as a liability in conjunction with recording the purchase of the McLain & Kyne, Ltd. business and which will result in an increase to goodwill. The operating results of the McLain & Kyne, Ltd. business are reflected in the accompanying condensed consolidated financial statements from the date of acquisition and were not material.

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

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$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. Any payments made pursuant to this earn-out will be treated as additional goodwill.

The Agreement also provides for, among other things, representations, warranties, indemnities and ‘‘piggyback’’ registration rights to the Sellers.

The following table presents unaudited pro forma information about sales and net income had the operations of the above described acquisition been combined with the Company’s business as of the first day of the period shown. This information has not been adjusted to reflect any changes in the operations of McLain & Kyne, Ltd. subsequent to its acquisition by the Company. Changes in operations of the acquired business includes, but are not limited to, discontinuation of products changes in trade practices, application of the Company’s credit policies, changes in manufacturing processes or locations, changes in marketing and advertising programs and integration of systems and personnel. Had any of these changes been implemented by the former management of the business acquired prior to acquisition by the Company, the sales and net income information might have been materially different than the actual results achieved and from the pro forma information provided below.


  Three months ended
December 31
Nine months ended
December 31,
  2006 2005 2006 2005
Net sales $ 7,380,605
$ 7,467,281
$ 19,398,143
$ 17,721,479
Net loss attributable to common stock holders $ (3,730,512
)
$ (4,035,271
)
$ (12,022,231
)
$ (10,708,217
)
Net loss attributable to common stock holders per common share  
 
 
 
Basic $ (0.31
)
$ (1.30
)
$ (1.02
)
$ (3.45
)
Diluted $ (0.31
)
$ (1.30
)
$ (1.02
)
$ (3.45
)
Weighted average shares:
Basic
12,051,045
3,106,666
11,827,837
3,106,666
Diluted 12,051,045
3,106,666
11,827,837
3,106,666

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 our management.

B.  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.

The Company agreed to pay GCP $5,000,000 for its 60% interest: $100,000 in cash and issuance of a promissory note of $4,900,000 to GCP for the balance owed. The promissory note was payable in five installments with one remaining payment of $750,000 due April 1, 2007.

Effective with the payment of the second installment on October 1, 2005, this promissory note began accruing interest on the unpaid principal amount at the rate of 4% per annum until the note is repaid in full. As of December 31 and March 31, 2006, $97,500 and $55,000, respectively, in interest on this note has been accrued and remains unpaid.

The global distribution agreement commenced on April 1, 2005 and has a 15 year term. It is renewable for additional 15 year terms as long as GCP meets certain case sale targets during the initial term as set forth in the agreement. (See Note 16 — Gosling-Castle Partners Inc. Export

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Agreement with Gosling’s Export (Bermuda) Limited). The Company ascribed the entire purchase of $5,000,000 to the Gosling global distribution agreement described above. In conjunction with this transaction the Company recorded a deferred tax liability of $2,222,222 to reflect the difference between the adjusted book value and tax basis. This deferred tax liability was recorded as an increase to the value of the distribution agreement and is included in intangible assets.

Castle Brands Inc. has agreed to fund certain operating losses of GCP. The balance of this funding at December 31, 2006 is approximately $1,600,000.

NOTE 5 — GOODWILL AND INTANGIBLE ASSETS

The changes in the carrying amount of goodwill for nine-months ended December 31, 2006 were as follows:


  Amount
Balance as of March 31, 2006 11,649,430
Acquisition of McLain & Kyne, Ltd 1,987,220
Balance as of December 31, 2006 $ 13,636,650