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ROX > SEC Filings for ROX > Form 10-Q on 14-Aug-2013All Recent SEC Filings

Show all filings for CASTLE BRANDS INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for CASTLE BRANDS INC


14-Aug-2013

Quarterly Report


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 distribute our products in all 50 U.S. states and the District of Columbia, in thirteen primary international markets, including Ireland, Great Britain, Northern Ireland, Germany, Canada, South Africa, Bulgaria, France, Russia, Finland, Norway, Sweden, China and the Duty Free markets, and in a number of other countries in continental Europe and Latin America. We market the following brands, among others, Gosling's Rum®, Gosling's Stormy Ginger Beer, Gosling's Dark 'n Stormy® ready-to-drink cocktail, Jefferson's®, Jefferson's Reserve® and Jefferson's Presidential SelectTM bourbons, Jefferson's Rye whiskey, Pallini® liqueurs, Clontarf® Irish whiskey, Knappogue Castle Whiskey®, Brady's® Irish Cream, Boru® vodka, TierrasTM tequila, Celtic Honey® liqueur, Castello MioTM sambucas, Travis Hasse's Original® Pie liqueurs and Gozio® amaretto.

Our objective is to continue building a distinctive portfolio of global premium and super premium spirits brands as we move towards profitability. To achieve this, we continue to seek to:

§ increase revenues from our more profitable brands. We continue to focus our distribution relationships, sales expertise and targeted marketing activities on our more profitable brands;

§ improve value chain and manage cost structure. We continue to review and analyze our supply chains and cost structures both on a company-wide and brand-by-brand basis, as well as control general and administrative costs in an effort to further control costs; and

§ selectively add new premium brands to our portfolio.We intend to continue developing new brands and pursuing strategic relationships, joint ventures and acquisitions to selectively expand our premium spirits portfolio, particularly by capitalizing on and expanding our partnering capabilities. Our criteria for new brands focuses on underserved areas of the beverage alcohol marketplace, while examining the potential for direct financial contribution to our company and the potential for future growth based on development and maturation of agency brands. We evaluate future acquisitions and agency relationships on the basis of their potential to be immediately accretive and their potential contributions to our objectives of becoming profitable and further expanding our product offerings. We expect that future acquisitions, if consummated, would involve some combination of cash, debt and the issuance of our stock.

Recent Events

Keltic Facility

In August 2013, we entered into a Third Amendment (the "Amendment") to our loan agreement with Keltic Financial Partners II, L.P. ("Keltic"), in order to amend certain terms of our existing $8.0 million revolving credit facility (the "Keltic Facility") and the term loan to finance purchases of aged whiskies ("Bourbon Term Loan").

The Amendment modifies certain aspects of the borrowing base calculation and covenants with respect to the Keltic Facility and permits us to make regularly scheduled payments of principal and interest and voluntary prepayments on the Junior Loan (as defined below), subject to certain conditions set forth in the Amendment. In addition, the Amendment provides us with the ability to increase the maximum aggregate principal amount of the Bourbon Term Loan from $2.5 million to up to $4.0 million following the identification of junior participants to purchase a portion of the increased Bourbon Term Loan amount. We paid Keltic an aggregate $0.025 million amendment fee in connection with the execution of the Amendment.

In connection with the Amendment, we entered into the following ancillary agreements with Keltic: (i) a Reaffirmation Agreement with certain of our officers, including John Glover, T. Kelley Spillane and Alfred J. Small, which reaffirms the existing Validity and Support Agreements by and among each officer, us and Keltic (the "Reaffirmation Agreement"); and (ii) an Amended and Restated Term Note (the "Keltic Note").

Also in connection with the Amendment, Keltic entered into an amended and restated participation agreement with certain related parties of the Company as junior participants, including Frost Gamma Investments Trust, an entity affiliated with Phillip Frost, M.D., a director and principal shareholder of ours, Mark E. Andrews, III, a director and our Chairman and an affiliate of Richard J. Lampen, a director and our President and Chief Executive Officer, to allow for the sale of participation interests in the additional tranches of the Bourbon Term Loan, if any. The amended and restated participation agreement provides that additional tranches of the Bourbon Term Loan, if any, are to be funded in increments of $0.5 million and that Keltic will fund 15% of each tranche. We are not party to the amended and restated participation agreement.

Also in August 2013, we entered into a Loan Agreement (the "Junior Loan Agreement"), by and between us and the lending parties thereto (the "Junior Lenders"), which provides for an aggregate $1.25 million unsecured loan (the "Junior Loan") to us. The Junior Loan bears interest at a rate of 11% per annum, payable quarterly in arrears commencing November 1, 2013, and matures on October 15, 2015. The Junior Loan 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 Junior Loan Agreement contains customary events of default, which, if uncured, entitle each Junior Lender to accelerate the due date of the unpaid principal amount of, and all accrued and unpaid interest on, the portion of the Junior Loan made by such Junior Lender. The Junior Loan Agreement provides for a funding fee of 2% per annum on the then outstanding Junior Loan balance (pro-rated for any period of less than one year), payable pro rata among the Junior Lenders on the date of the Junior Loan Agreement and on the first and second anniversaries thereof. The Junior Lenders include Frost Gamma Investments Trust, Mark E. Andrews, III and an affiliate of Richard J. Lampen. In connection with the Junior Loan Agreement, the Junior Lenders entered into a subordination agreement with Keltic; we are not a party to the subordination agreement.

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 June 30, 2013, each as calculated from the Interbank exchange rates as reported by Oanda.com. On June 30, 2013, the exchange rate of the Euro and the British Pound in exchange for U.S. Dollars was €1.00 = U.S. $1.30071 (equivalent to U.S. $1.00 = €0.76881) and £1.00 = U.S. $1.52084 (equivalent to U.S. $1.00 = £0.65753).

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, 2013, as amended, which we refer to as our 2013 Annual Report. Please refer to that section for disclosures regarding the critical accounting policies related to our business.

Financial performance overview

The following table provides information regarding our case sales for the periods presented based on nine-liter equivalent cases, which is a standard spirits industry metric (table excludes related non-beverage alcohol products):

Three months ended

                             June 30,
                         2013          2012
Cases
United States             67,689       70,170
International             20,653       15,960

Total                     88,342       86,130

Rum                       43,980       42,442
Whiskey                   14,123        9,388
Liqueurs                  18,068       15,085
Vodka                     10,694       17,080
Tequila                      319          536
Wine                       1,155        1,449
Other                          3          150

Total                     88,342       86,130

Percentage of Cases
United States               76.6 %       81.5 %
International               23.4 %       18.5 %

Total                      100.0 %      100.0 %

Rum                         49.7 %       49.3 %
Whiskey                     16.0 %       10.9 %
Liqueurs                    20.5 %       17.5 %
Vodka                       12.1 %       19.8 %
Tequila                      0.4 %        0.6 %
Wine                         1.3 %        1.7 %
Other                        0.0 %        0.2 %

Total                      100.0 %      100.0 %

The following table provides information regarding our case sales of non-beverage alcohol products for the periods presented:

Three months ended
June 30,

                   2013           2012
Cases
United States        97,682       63,630
International         6,607        5,726

Total               104,289       69,356

United States          93.7 %       91.7 %
International           6.3 %        8.3 %

Total                 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
                                                             June 30,
                                                        2013           2012
Sales, net                                                100.0 %       100.0 %
Cost of sales                                              62.4 %        64.7 %

Gross profit                                               37.6 %        35.3 %

Selling expense                                            27.8 %        27.0 %
General and administrative expense                         12.1 %        13.7 %
Depreciation and amortization                               2.0 %         2.4 %

Loss from operations                                       (4.4 )%       (7.7 )%

Foreign exchange gain                                       0.6 %         2.0 %
Interest expense, net                                      (2.2 )%       (1.1 )%
Net change in fair value of warrant liability              (4.3 )%       (0.9 )%
Income tax benefit                                          0.4 %         0.4 %

Net loss                                                  (10.0 )%       (7.4 )%
Net income attributable to noncontrolling interests        (2.4 )%       (1.1 )%

Net loss attributable to controlling interests            (12.4 )%       (8.5 )%

Dividend to preferred shareholders                         (1.8 )%       (1.9 )%

Net loss attributable to common shareholders              (14.2 )%      (10.4 )%

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

                                                                  Three months ended
                                                                       June 30,
                                                                 2013             2012
Net loss attributable to common shareholders                 $ (1,482,765 )   $ (1,009,452 )
Adjustments:
Interest expense, net                                             228,819          111,020
Income tax benefit                                                (37,038 )        (37,038 )
Depreciation and amortization                                     213,124          231,082
EBITDA (loss)                                                  (1,077,860 )       (704,388 )
Allowance for doubtful accounts                                    10,500            6,000
Stock-based compensation expense                                   72,533           59,180
Loss (gain) from equity investment in non-consolidated
affiliate                                                           6,121             (348 )
Foreign exchange gain                                             (60,340 )       (195,941 )
Net change in fair value of warrant liability                     447,251           91,328
Net income attributable to noncontrolling interests               252,372          110,458
Dividend to preferred shareholders                                189,932          179,951
EBITDA, as adjusted                                              (159,491 )       (453,760 )

Earnings before interest, taxes, depreciation and amortization, or EBITDA, adjusted for allowances for doubtful accounts, non-cash compensation expense, loss from equity investment in non-consolidated affiliate, foreign exchange, net change in fair value of warrant liability, net income attributable to noncontrolling interests and dividend to preferred shareholders is a key metric we use in evaluating our financial performance. EBITDA is considered a non-GAAP financial measure as defined by Regulation G promulgated by the SEC under the Securities Act of 1933, as amended. We consider EBITDA, as adjusted, important in evaluating our performance on a consistent basis across various periods. Due to the significance of non-cash and non-recurring items, EBITDA, as adjusted, enables our Board of Directors and management to monitor and evaluate the business on a consistent basis. We use EBITDA, as adjusted, as a primary measure, among others, to analyze and evaluate financial and strategic planning decisions regarding future operating investments and allocation of capital resources. We believe that EBITDA, as adjusted, eliminates items that are not indicative of our core operating performance or are based on management's estimates, such as allowance accounts, are due to changes in valuation, such as the effects of changes in foreign exchange or fair value of warrant liability, or do not involve a cash outlay, such as stock-based compensation expense. Our presentation of EBITDA, as adjusted, should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items or by non-cash items, such as non-cash compensation, which is expected to remain a key element in our long-term incentive compensation program. EBITDA, as adjusted, should be considered in addition to, rather than as a substitute for, income from operations, net income and cash flows from operating activities.

Our EBITDA, as adjusted, improved 54.9% to ($0.2) million for the three months ended June 30, 2013, as compared to ($0.5) million for the comparable prior-year period, primarily as a result of increased sales.

Three months ended June 30, 2013 compared with three months ended June 30, 2012

Net sales. Net sales increased 7.2% to $10.4 million for the three months ended June 30, 2013, as compared to $9.7 million for the comparable prior-year period. Our International case sales as a percentage of total case sales increased to 23.4% for the three months ended June 30, 2013 from 18.5% for the comparable prior-year period due to strong growth in Gosling's rum and Irish whiskey sales in international markets. The overall sales growth was partially offset by a decrease in vodka sales due to continued price competition. We continue to focus on our faster growing brands and markets, both in the U.S. and internationally.

The table below presents the increase or decrease, as applicable, in case sales by product category for the three months ended June 30, 2013 as compared to the three months ended June 30, 2012:

            Increase/(decrease)               Percentage
               in case sales             increase/(decrease)
            Overall         U.S.        Overall          U.S.
Rum             1,538       (1,090 )          3.6 %        (3.4 )%
Whiskey         4,735        1,620           50.4 %        25.4 %
Liqueur         2,984        3,212           19.8 %        21.7 %
Vodka          (6,386 )     (5,564 )        (37.4 )%      (36.7 )%
Tequila          (217 )       (217 )        (40.5 )%      (40.5 )%
Wine             (294 )       (294 )        (20.3 )%      (20.3 )%
Other            (147 )       (147 )        (97.9 )%      (97.9 )%

Total           2,213       (2,480 )          2.6 %        (3.5 )%

Gross profit. Gross profit increased 14.2% to $3.9 million for the three months ended June 30, 2013 from $3.4 million for the comparable prior-year period, while our gross margin increased to 37.6% for the three months ended June 30, 2013 compared to 35.3% for the comparable prior-year period. The increase in gross profit was primarily due to increased sales in the current period, while the increase in gross margin was due to an increase in sales of our more profitable brands, in particular the Jefferson's brands.

Selling expense. Selling expense increased 10.4% to $2.9 million for the three months ended June 30, 2013 from $2.6 million for the comparable prior-year period, primarily due a $0.2 million increase in advertising, marketing and promotion expense in support of our overall volume growth. The increase in sales resulted in a net increase of selling expense as a percentage of net sales to 27.8% for the three months ended June 30, 2013 as compared to 27.0% for the comparable prior-year period.

General and administrative expense.General and administrative expense decreased 4.7% to $1.27 million for the three months ended June 30, 2013 from $1.33 million for the comparable prior-year period, primarily due to a $0.1 million decrease in professional fees. The increase in sales in the current period resulted in general and administrative expense as a percentage of net sales decreasing to 12.1% for the three months ended June 30, 2013 as compared to 13.7% for the comparable prior-year period.

Depreciation and amortization. Depreciation and amortization was $0.2 million for each of the three-month periods ended June 30, 2013 and 2012.

Loss from operations. As a result of the foregoing, loss from operations improved 39.2% to ($0.5) million for the three months ended June 30, 2013 from ($0.8) million for the comparable prior-year period. As a result of our focus on our stronger growth markets and better performing brands, and expected growth from our existing brands, we anticipate improved results of operations in the near term as compared to comparable prior-year periods, although there is no assurance that we will attain such results.

Net change in fair value of warrant liability. We recorded the fair market value of the warrants issued in connection with the June 2011 private placement at their initial fair value. Changes in the fair value of the warrants are recognized in earnings for each reporting period. For the three months ended June 30, 2013, we recorded a loss on the change in the value of the warrants of ($0.4) million, as compared to a loss of ($0.1) million for the comparable prior-year period, due to the changes in the Black-Scholes valuation.

Loss (gain) from equity investment in non-consolidated affiliate. We have accounted for our investment in DP Castle Partners, LLC on the equity method of accounting. Results from this investment were de minimis in each of the three-month periods ended June 30, 2013 and 2012.

Foreign exchange gain. Foreign exchange gain for the three months ended June 30, 2013 was $0.1 million as compared to a gain of $0.2 million for the comparable prior year period due to the net effects of fluctuations of the U.S. dollar against the Euro and their effects on our Euro-denominated intercompany balances due to our foreign subsidiaries for inventory purchases.

Interest expense, net. We had interest expense, net of ($0.2) million for the three months ended June 30, 2013 as compared to ($0.1) million for the comparable prior year period due to increased balances outstanding under our credit facilities. Due to expected balances on the Keltic Facility and other indebtedness, we expect interest expense, net to increase in the near term as compared to prior-year periods.

Net income attributable to noncontrolling interests. Net income attributable to noncontrolling interests during the three months ended June 30, 2013 was ($0.3) million as compared to ($0.1) million for the comparable prior-year period, both the result of allocated net income recorded by our 60%-owned subsidiary, Gosling-Castle Partners, Inc.

Dividend to preferred shareholders.For each of the three-month periods ended June 30, 2013 and 2012, we recognized a dividend on our Series A Preferred Stock of $0.2 million, as required by the terms of the preferred stock. Accrued dividends on our Series A Preferred Stock are only payable in common stock upon conversion or liquidation.

Net loss attributable to common shareholders.As a result of the net effects of the foregoing, net loss attributable to common shareholders increased 46.9% to
($1.5) million for the three months ended June 30, 2013 as compared to ($1.0)
million for the comparable prior-year period. Net loss per common share, basic and diluted, was ($0.01) per share for each of the three-month periods ended June 30, 2013 and 2012.

Liquidity and capital resources

Overview

Since our inception, we have incurred significant operating and net losses and have not generated positive cash flows from operations prior to this quarter ended June 30, 2013. For the three months ended June 30, 2013, we had a net loss of $1.5 million, and operating activities provided cash of $0.03 million. As of June 30, 2013, we had cash and cash equivalents of $0.3 million and had an accumulated deficit of $131.8 million.

Existing Financing

In August 2013, we entered into the Amendment to our loan agreement with Keltic in order to amend certain terms of the Keltic Facility and the Bourbon Term Loan.

The Amendment modifies certain aspects of the borrowing base calculation and covenants with respect to the Keltic Facility and permits us to make regularly scheduled payments of principal and interest and voluntary prepayments on the Junior Loan, subject to certain conditions set forth in the Amendment. In addition, the Amendment provides us with the ability to increase the maximum aggregate principal amount of the Bourbon Term Loan from $2.5 million to up to $4.0 million following the identification of junior participants to purchase a portion of the increased Bourbon Term Loan amount. We paid Keltic an aggregate $0.025 million amendment fee in connection with the execution of the Amendment.

In connection with the Amendment, we also entered into the Reaffirmation Agreement and the Keltic Note.

Also in connection with the Amendment, Keltic entered into an amended and restated participation agreement with certain related parties of the Company as junior participants, including Frost Gamma Investments Trust, Mark E. Andrews, III and an affiliate of Richard J. Lampen, to allow for the sale of participation interests in the additional tranches of the Bourbon Term Loan, if any. The amended and restated participation agreement provides that additional tranches of the Bourbon Term Loan, if any, are to be funded in increments of $0.5 million and that Keltic will fund 15% of each tranche. We are not party to the amended and restated participation agreement.

Also in August 2013, we entered into the Junior Loan Agreement, which provides for the aggregate $1.25 million Junior Loan to us. The Junior Loan bears interest at a rate of 11% per annum, payable quarterly in arrears commencing November 1, 2013, and matures on October 15, 2015. The Junior Loan 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 Junior Loan Agreement contains customary events of default, which, if uncured, entitle each Junior Lender to accelerate the due date of the unpaid principal amount of, and all accrued and unpaid interest on, the portion of the Junior Loan made by such Junior Lender. The Junior Loan Agreement provides for a funding fee of 2% per annum on the then outstanding Junior Loan balance (pro-rated for any period of less than one year), payable pro rata among the Junior Lenders on the date of the Junior Loan Agreement and on the first and second anniversaries thereof. The Junior Lenders include Frost Gamma Investments Trust, Mark E. Andrews, III and an affiliate of Richard J. Lampen. In connection with the Junior Loan Agreement, the Junior Lenders entered into a subordination agreement with Keltic; we are not a party to the subordination agreement.

In March 2013, we entered into a Second Amendment to the Keltic Facility, providing for an increase in available borrowings (subject to certain terms and conditions) under the Keltic Facility for working capital purposes from $7.0 million to $8.0 million and the Bourbon Term Loan in the initial aggregate principal amount of $2.5 million, which was used for the purchase of bourbon inventory on March 11, 2013. Unless sooner terminated in accordance with their respective terms, the Keltic Facility and Bourbon Term Loan expire on December 31, 2016 (the "Maturity Date"). We may borrow up to the maximum amount of the Keltic Facility, provided that we have a sufficient borrowing base (as defined in the loan agreement). The Keltic Facility interest rate is the rate that, when annualized, is the greatest of (a) the Prime Rate plus 3.25%, (b) the LIBOR Rate plus 5.75% and (c) 6.50%. The Bourbon Term Loan 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%. Interest is payable monthly in arrears, on the first day of every month on the average daily unpaid principal amount of the Keltic Facility and the Bourbon Term Loan. After the occurrence and during the continuance of any "Default" or "Event of Default" (as defined under the loan agreement) we are required to pay interest at a rate that is 3.25% per annum above the then applicable Keltic Facility or Bourbon Term Loan, as applicable, interest rate. The Keltic Facility currently bears interest at 6.50% and the Bourbon Term Loan currently bears interest at 7.50%. We are required to pay down the principal balance of the Bourbon Term Loan within 15 banking days from the completion of a bottling run of bourbon from our bourbon inventory stock purchased on or about the date of the Bourbon Term Loan in an amount equal to the purchase price of such bourbon. The unpaid principal balance of the Bourbon Term Loan, all accrued and unpaid interest thereon, all fees, costs and expenses payable in connection with the Bourbon Term Loan are due and payable in full on the Maturity Date. Upon execution of the second loan amendment, we paid Keltic a $70,000 closing and commitment fee, and Keltic will also continue to receive an annual facility fee and a collateral management fee (each as set forth in the loan agreement).

The loan agreement contains standard borrower representations and warranties for asset-based borrowing and a number of reporting obligations and affirmative and negative covenants. The loan agreement includes negative covenants that, among other things, restrict our ability to create additional indebtedness, dispose of . . .

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