UNITED STATES

 SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-K

[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 20122013

[  ] 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: 000-23338

THE CASTLE GROUP, INC.

(Exact name of registrant as specified in its charter)

500 Ala Moana Boulevard, 3 Waterfront Plaza, Suite 555, Honolulu HI 96813

(Address of principal executive office)

Registrant’s telephone number: (808) 524-0900

Securities registered under Section 12(b) of the Exchange Act:  None

Securities registered under Section 12(g) of the Exchange Act:

Common Stock, $0.02 par value

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. 

Yes [ ] No [X]

Check whether the Issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. [  ]

Check whether the Issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 [  ]

Check if there is no disclosure of delinquent filers in response to Item 405 of regulation S-K contained in this form, and no disclosure will be contained, to the best of Issuer’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]

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

Large accelerated filer  [   ]

Accelerated filer            [   ]

Non-accelerated filer      [   ]  

(Do not check if a smaller reporting company)

Smaller reporting company  [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  

[   ] Yes   [X] No

Aggregate Market Value of Non-Voting Common Stock Held by Non-Affiliates

As of June 30, 2012,2013, there were approximately 4,889,9895,805,324 shares of common voting stock of the Issuer held by non-affiliates. As of June 30, 2012,2013, the closing price of the common stock on the OTC Bulletin board was $.12$.30 per share or an aggregate value of $586,799.$1,741,597.

Issuers Involved in Bankruptcy Proceedings During the Past Five Years

Not applicable.

Check whether the Issuer has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court.

Not applicable. 

Applicable Only to Corporate Issuers

Number of shares outstanding of the Issuer’s common stock as of March 22, 2013:28, 2014:   10,026,392

Documents Incorporated by Reference

See Part IV, Item 15.  The Exhibit Index appears on page 37.36.

TABLE OF CONTENTS

PART I

Item 1.  

Business.

 4

Item 1A.  

Risk Factors.

 6

Item 1B.

Unresolved Staff Comments

 6

Item 2.  

Property.

 6

Item 3.  

Legal Proceedings.

 7

Item 4.  

Submission of Matters to a Vote of Security Holders.Mine Safety Disclosures

 7

PART II

Item 5.  

Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 7

Item 6.  

Selected Financial Data and Supplementary Financial Information.

 8

Item 7.   

Management’s Discussion and Analysis of Financial Condition and Results of Operation.

 8

Item 7A.

Quantitative and Qualitative Disclosure about Market RiskRisk.

13

Item 8.  

Consolidated Financial Statements.

14

Item 9.   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

30

Item 9A(T).

Controls and Procedures.

30

Item 9B.

Other Information.

31

PART III

Item 10.  

Directors, Executive Officers and Corporate Governance.

31

Item 11.

Executive Compensation.

33

Item 12 .

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

34

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

35

Item 14.

Principal Accounting Fees and Services.

36

PART IV.

Item 15.

Exhibits and Consolidated Financial Statement Schedules.

37

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PART I

Item 1.  Business.

Forward-looking Statements.

The Private Securities Litigation Reform Act of 1995 (the “Act”) provides a safe harbor for forward-looking statements made by or on behalf of Castle.  Castle and its representatives may from time to time make written or oral statements that are “forward-looking,” including statements contained in this Annual Report and other filings with the Securities and Exchange Commission, and in reports to Castle’s stockholders.  Management believes that all statements that express expectations and projections with respect to future matters, as well as from developments beyond Castle’s control, including changes in global economic conditions, are forward-looking statements within the meaning of the Act.  These statements are made on the basis of management’s views and assumptions, as of the time the statements are made, regarding future events and business performance. There can be no assurance; however, that management’s expectations will necessarily come to pass.

Factors that may affect forward-looking statements include a wide range of factors that could materially affect future developments and performance, including the following: Changes in company-wide strategies, which may result in changes in the types or mix of businesses in which Castle is involved or chooses to invest; changes in U.S., global or regional economic conditions; changes in U.S. and global financial and equity markets; including significant interest and foreign exchange rate fluctuations; which may impede Castle’s access to, or increase the cost of, external financing  for its operations and investments; increased competitive pressures, both domestically and internationally; legal and regulatory developments, such as regulatory actions affecting environmental activities; the imposition by foreign countries of trade restrictions and changes in international tax laws or currency controls; adverse weather conditions or natural disasters, such as hurricanes and earthquakes; and labor disputes, which may lead to increased costs or disruption of operations.  This list of factors that may affect future performance and the accuracy of forward-looking statements are illustrative, but by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty.

Description of the Business

The Castle Group, Inc. (“the Company,” “Castle,” “we,” “our” or “us”) through its subsidiaries manages luxury and mid-range resort condominiums and hotels on all of the major islands within the state of Hawaii, and resortsa premier property located in Saipan, and New Zealand. The Company was incorporated in Utah on August 21, 1981 and on June 4, 1993 the name of the Company was changed to The Castle Group, Inc.  

Principal Products or Services and Their Markets

General

We are a full service hospitality and hotel management company that prides itself on its ability to be both “Flexible and Focused,” our operations motto.  Flexible, to meet the specific needs of property condo owners at the properties that it manages; and Focused, in its efforts to achieve enhanced rental income and profitability for those owners.  We earn our revenues by providing several types of services to property owners including, hotel and resort management and operations; reservations staffing and operations; sales and marketing; and accounting.  Our revenues are derived primarily from two sources: (1) the rental of hotel rooms and condominium accommodations along with food and beverage sales at the properties we manage and; (2) fees paid for services we provide to property owners.  We also derive revenues from commissions at certain of our properties, rental of real estate owned in New Zealand, and investment income through our ownership of a minority interest in a domestic hotel property.

Corporate Culture

Our corporate culture has been internally branded as “F & F,” which means Flexibility and Focus.  The organization and infrastructure is solid; and designed for maximum flexibility to react to any and all marketplace dynamics; while at the same time, allowing us to remain focused on our objectives and overall strategy without losing focus or perspective.

Marketing Strategy

Most of our marketing efforts are focused towards acquiring and retaining guests for the properties we manage.  We have made investments in two of the properties that we manage, as we own the lobby and food and beverage areas in our New Zealand property, and have a minority interest in a property in Hawaii.  Sales, advertising and marketing is handled by our sales staff and is done through various distribution channels including direct internet sales, wholesalers, online and traditional travel agencies, corporate and frequent traveler accounts, and group tour operators.   We also manage and operate an interactive web site (www.Castleresorts.com) for customers to view information about the properties we manage and make reservations to stay at the properties.  The website offers user friendly navigation,

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interactive features and rich content, while offering attractive rates and a travel booking engine that can handle rate conversions for over

100 foreign currencies.  The proprietary online booking and reservations engine supports a dynamic pricing model which maximizes revenues for all of our properties under management.  

We support our online presence with a full service, reservation call center that provides a wide range of services from tour reservation processing and rooms control, to handling group bookings.  Our reservation center electronically connects resort property inventory and rates to the four major Global Distribution Systems (“GDS”).  This connectivity displays rates and inventory of our properties to over 500,000 travel agents worldwide as well as providing internet connectivity to over 1,200 travel websites around the globe.

Diversity

We have a diverse portfolio of properties located in desired island resort destinations throughoutin the Pacific Region. We represent hotels, resort condominiums, luxury villas and lodging accommodations throughout Hawaii in Saipan, and in New Zealand.

In Hawaii, we are the only lodging chain that representsrepresent properties on the five major Hawaiian Islands of Oahu, Maui, Kauai, Molokai and Hawaii, allowing our customers the option to island-hop which provides us with cross-selling advantages. Our Honolulu headquarters serve as the epicenter for our international operations in Saipan and New Zealand.operations.  Our diverse destinations offer customers the opportunity to discover new experiences and varying cultures in the areas we represent.

We offer a wide range of accommodations at various price points from exclusive private villas, full-service all-suites hotels, oceanfront resort condominiums, to modestly priced hotels with up to 300 guest rooms.  Our collection of all-suite condominium resorts, hotels, villas, lodges and vacation rentals allows customers to select the best accommodation to suit their individual style and budget.    

Our ability to deliver consistent financial returns to our property owners demonstrates Castle’s competency in managing and marketing a wide range of accommodations to our customers via multiple channels of distribution.  

Brand Strategy

Each property we manage is individually branded in order to extract maximum value from its strengths.  The Castle brandname stays in the background andas our focus is on marketing the uniqueness of each property while satisfying the needs and expectations of our owners.  Each property we manage maintains its own brand identity and personality, while utilizing the Castle advantage of our powerful sales and marketing resources, channel distribution, resort management expertise, industry partnerships and networks.

Our brand strategy is one of the areas that clearly differentiatedifferentiates us from the high profile branded hospitality companies.  When a hotel owner or developer is considering contracting a large worldwide hospitality company for possible hotel management, there are several considerations that must be assessed.  With major worldwide brands usually come the high costs that the owner must bear to sustain the expensive plant, marketing and operational costs that the brand demands in order to fall into the brandsbrand’s cookie cutter image. There are also some tangible differences from the guest’s or customer’s perspective as well.perspective.  At Castle, we believe that one size and one guest experience model does not fit all and we also believe that marketing efforts should be focused on the individual property with its unique culture instead of concentrating dollars on the advancement of the brand name instead of the individual property.

We market each property with its own independent brand identity and deploy customized marketing programs to target the specific demographics attracted to each of our unique properties.  Through our property brand building efforts, we begin the process of positioning each of our resorts to our key market segments, niche targeted customers and distribution channels.

We also do not flag our properties with the Castle name.  The advantages of doing so are several.  There is a high demand for the independent smaller boutique hotels and condominiums, as travelers favor a more individualized and unique travel experience. We believe that this allows the consumer to better choose the specific type of vacation experience desired based upon the specific attributes of the property selected.  This ongoing trend towards smaller, independent hotels, as opposed to the familiar mid-range chains has been seen in recent years throughout the world tourism marketplace.

Marketing Programs and Promotions

We have implemented numerous marketing programs and promotions directed towards both the consumer and trade markets to generate incremental revenue and customer loyalty for each of our properties.  We have developed a wide range of programs designed specifically to reflect the unique attributes of each of our resort properties, which also includes providing various incentives.  We manage a number of marketing programs and promotions, some of which are seasonal to drive incremental room night revenues during valley periods, and some of which are ongoing throughout the year.  During the past year we have emphasized programs relating to value travel and vacation rental accommodations as well as increased consumer direct booking at the luxury properties we manage.

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Growth Strategy

The majority of the properties we presently manage are located within the state of Hawaii, with one property each in New Zealand and Saipan.Zealand.

During the course of 2008 and 2009, as a resultWe also have subsidiary companies set up in other regions of the declines in world economic conditionsPacific Basin and the associated decrease in consumer expendable wealth, we have temporarily halted our expansion plans and efforts aimed at the Far East Asian region.  Whilewhile we believe that there are significant opportunities in this region, we have chosen to focus on obtaining additional contracts within our current markets due to the opportunities afforded by the economic downturn including sales of properties, foreclosures, underperformance of certain properties, and dissatisfaction with the current management of our competitors.  Management will explore expansion again into the Asian region when we determine that the economic conditions would make it once again economically feasible to enter these regions.

As part of our strategy to secure long term, multi-year management contracts, from time to time, we have found it advantageous to purchase or lease selected real property within a resort or condominium project.  This occurred in 2004, when Castle’s wholly owned subsidiary, NZ Castle Resorts and Hotels Limited, entered into an agreement to purchase all of the shares of Mocles Holdings Limited (“Mocles”), a New Zealand Corporation.  Mocles owns the Podium levels (“Podium”) of the Spencer on Byron Hotel in Auckland, New Zealand, which includes the front desk, restaurant, bar, ballroom, board room, conference rooms, back of the house facilities and other areas necessary for the hotel’s operation.  Through our ownership of the Podium and a multi-year management contract for the Spencer on Byron hotel, we are assured of ongoing revenues in future years from this property.  

In 2010 we took a major step forward in the domestic market as we secured an ownership interest in a Hawaii property that we manage.  

In addition to focusing on growing our portfolio of managed properties, we will continue to focus efforts on securing additional equity ownership interests in properties in both the domestic and international markets.

ItemItem 1A.  Risk Factors

Not required for smaller reporting companies.

Item 1B.  Unresolved Staff Comments

None.

Item 2.  Property.

We lease office space for our principal executive offices.  This lease expires on October 31, 2014 at a rental cost that averages $8,558 per month, plus the cost of common area maintenance.

We also lease additional office space for our finance and accounting operations.  This lease expiresoperations, which expired on February 28, 20142014.  We were successful in obtaining a three year extension, through February 28, 2017 at aour current rental costrate that averages $5,606 per month, plus the cost of common area maintenance.

In July 2001, we entered into lease agreements (in lieu of a traditional management agreements) with each of the owners of approximately 250 investment units of the Spencer on Byron condominium project for the purpose of having those units be part of the rental program at the Spencer on Byron Hotel.  The leases were for a period of ten years expiring on July 18, 2011.  Monthly lease rents were calculated as a percentage of the purchase price paid by the original owner of each condominium.  This lease was extended to July 31, 2011 and upon expiration, we entered into a new management contract with the unit owners under a Net Contract arrangement through January 31, 2012.

In February 2012, the Company entered into a long term contract (10 years) with approximately 200 unit owners of our New Zealand property.  Under the terms of the new contract, there is no guaranteed return to the unit owners of the property.  

We continue our ownership (through Mocles) of certain common areas of the property which includes the lobby, restaurant and bar; therefore, we will continue to own and operate the food and beverage operation.  The lobby area owned by us is also rented out to the rental program.  Over the previous ten years, we had operated the room operations at a loss as in addition to our lease obligations to the owners, the property was brand new and hadwas not established itself in the marketplace.  The property is now well known in the area, especially after the hosting of various teams that participated in the World Rugby Cup, and has a mature base of customers.  Additionally, our food and beverage operations have won various culinary awards in the area and we believe that this combination of a net contract for the room operations and the profitable food & beverage operations will ensure future profitability for our New Zealand operation.  

On December 24, 2004, Castle, through its wholly owned subsidiary NZ Castle Resorts and Hotels Limited, entered into an agreement to purchase all of the shares of Mocles Holdings Limited (“Mocles”), a New Zealand Corporation.  The purchase price for Mocles was $8,024,095 (NZ$10,367,048), net of imputed interest $1,263,905 (NZ$1,632,952).  The face value of the purchase price was $9,288,000 (NZ$12,000,000).   Mocles owns the lobby, bar and restaurant areas in the Spencer on Byron Hotel.

In July 2010, we acquired a 7% common series ownership interest in one of the Hawaii-based hotels which we manage as compensation for consulting and due diligence work done during the acquisition of the property by a third party.  

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Item 3.  Legal Proceedings.

We are subject to various claims and lawsuits which are normal and reasonably foreseeable in light of the nature of our business.  In the opinion of management, although no assurances can be given, the resolution of these claims will not have a material adverse effect on our financial position, results of operations and liquidity. Further, to the knowledge of management, no director, officer, affiliate, or record of beneficial owner of more than 5% of the common voting stock of the Company is a party adverse to the Company or has a material adverse interest to the Company in any material proceeding.

Item 4.  Submission of Matters to a Vote of Security Holders.Mine Safety Disclosures.

No matter was submitted to a vote of the security holders of record during 2012.None.

PART II

Item 5.  Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.Securities.

Our common stock began trading on December 31, 2007 under the trading symbol CAGU.  Prior to that time, it traded sporadically on the “pink sheets.”  The OTC Bulletin Board is an over the counter market quotation system and as such, all stock prices reflect as noted by the system are inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.  

Price Range of Common Stock

The price range per share of common stock presented below represents the highest and lowest sales prices for our common stock on the OTC Bulletin Board during each quarter of the two most recent fiscal years.

Holders of Record

There were approximately 280 owners of record of Castle’s common stock as of March 15, 2013.2014.

Dividends

We have not paid any dividends with respect to our common stock, and do not intend to pay dividends on our common stock in the foreseeable future.  As more fully described in Note 7 to Castle’s consolidated financial statements included herein, in 1999 and 2000, we issued a total of 11,050 shares of $100 par value redeemable preferred stock.  Dividends are cumulative from the date of original issue and are payable semi-annually, when, and if declared by the board of directors beginning July 15, 1999, at a rate of $7.50 per annum, per share. During the fiscal year ended July 31, 2000, we paid dividends to holders of record as of July 15, 2000, in the amount of $16,715.  At December 31, 2012,2013, undeclared and unpaid dividends on these shares totaled $1,119,035$1,201,904 or $101.27$108.77 per preferred share. These dividends are not accrued as a liability, since no dividends have been declared.  We cannot pay dividends on our common stock until we declare and pay the dividends on our preferred stock.  It is the intention of management to utilize and reinvest all discretionary available funds into the development and expansion of our business, rather than for common stock dividend payments.  

Securities Authorized for Issuance under Equity Compensation Plans

We do not have any equity compensation plans and as such no securities have been authorized for issuance subject to such a plan.

Recent Sales of Unregistered Securities

During the last three years, we issued the followingthere were no issuances of unregistered securities:securities.

During 2010 we issued 80,000 of our common stock to non-employee directors of the Company.  The shares were valued at $.20 per share which equaled the closing price of the common stock on the date of issuance and the entire valuation was recorded as compensation

expense on that date.  In addition to the shares, the non-employee directors also received, for every share issued, a warrant to purchase an additional share of our common stock at a price of $1.00.  The warrants expire at the earlier of five years or 60 days after our common stock trades for an average price of $3.00 per share for 20 consecutive days and were valued using the Black-Scholes pricing model at $.12 per share or $9,440. The inputs for the pricing model included an expected term of 2.5 years and volatility of 131%.7

We issued all of these securities to persons who were “accredited investors” or “sophisticated investors,” as those terms are defined in Regulation D of the Securities and Exchange Commission; and each such person had prior access to all material information about us.  We believe that the offer and sale of these securities were exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), pursuant to Sections 4(2) and 4(6) thereof, and Rule 506 of Regulation D of the Securities and Exchange Commission.  Sales to “accredited investors” are preempted from state regulation.

During 2011 and 2012, there were no new issuances of registered or unregistered securities.

Use of Proceeds of Registered Securities.

There were no proceeds received by us from the sale of registered securities during the 12 months ending December 31, 2012.2013.

Purchases of Equity Securities by Us and Affiliated Purchasers.

On July 23, 2010 the Company acquired a 7% common series interest in the ownership of a hotel located in Hawaii.   The Company recognized $188,173 in revenue resulting from cash received in finder’s fees and consulting fees and then used those funds to acquire the 7% common series interest.

On September 22, 2011, the Company acquired a minority ownership interest in a hotel for consulting work done during the acquisition of the hotel units by another third party.  The Company recorded $180,000 of consulting fee income as the value of the 2% ownership interest.  The interest was subsequently sold in 2012.

Item 6.  Selected Financial Data and Supplementary Financial Information.

Not Applicable

Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operation.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Plan of Operations” including statements regarding the anticipated development and expansion of Castle’s business, the intent, belief or current expectations of the performance of Castle, and the products and/or services it expects to offer and other statements contained herein regarding matters that are not historical facts, are “forward-looking” statements.  Because such statements include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements.  Factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements include, but are not limited to, the factors set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Plan of Operations.”

Factors that may affect forward- looking statements include a wide range of factors that could materially affect future developments and performance, including the following: Changes in company-wide strategies, which may result in changes in the types or mix of businesses in which Castle is involved or chooses to invest; changes in U.S., global or regional economic conditions, changes in U.S. and global financial and equity markets, including significant interest rate or exchange rate fluctuations, which may impede Castle’s access to, or increase the cost of, external financing  for its operations and investments; increased competitive pressures, both domestically and internationally, legal and regulatory developments, such as regulatory actions affecting environmental activities, the imposition by foreign countries of trade restrictions and changes in international tax laws or currency controls; adverse weather conditions or natural disasters, such as hurricanes and earthquakes, labor disputes, which may lead to increased costs or disruption of operations.  This list of factors that may affect future performance and the accuracy of forward-looking statements are illustrative, but by no means exhaustive.  Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty.

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RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012 and 2011

For added clarity in the discussion below the Company’s Quarterly Statement of Operations for 20122013 and 20112012 are presented as reported in the Company’s Form 10-Q Quarterly Reports with the Securities and Exchange Commission:

Revenue

For 2012,2013, our revenue trend is reflective of a recovery in the tourism industry of Hawaii.  The Hawaii State Department of Business, Economic Development, and Tourism (DBEDT)Authority (HTA) announced that a record 8.2 million visitors to Hawaii in 2013, with an overall there was an 8.9%1.2% increase in visitor days, a 9.2%2.6% increase in visitor arrivals, and a 5.6%2.0% increase in visitor spending in Hawaii for 20122013 as compared to 2011.2012. ¹   Total airline seat capacityseats to Hawaii also reflected this trend with an increase of 8.7%5.6% in 20122013 as compared to 2011.2012. ¹

¹ Hawaii State Department of Business, Economic Development and Tourism (http:Authority:

 http://hawaii.gov/dbedt/info/vistors-stats/tourism/2012/Dec12.pdf).www.hawaiitourismauthority.org/default/assets/File/research/monthly-visitors/December%202013%20Visitor%20Stats%20(Final).pdf

The Company has two basic types of agreements.  Under a “Gross Contract” the Company records revenue which is based on a percentage of the gross rental proceeds received from the rental of hotel or condominium units.   Under a “Gross Contract” the Company pays a portion of the gross rental proceeds to the owner of the rental unit.  The Company only records the difference between the gross rental proceeds and the amount paid to the owner of the rental unit as “Revenue Attributed from Properties.”  Under the Gross Contract, the

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Company is responsible for all of the operating expenses for the hotel or condominium unit.  Under a “Net Contract”, the Company receives a management fee that is based on a percentage of the gross rental proceeds received from the rental of hotel or condominium units.  Under the Net Contract, the owner of the hotel or condominium unit is responsible for all of the operating expenses of the rental program covering the owner’s unit and the Company also typically receives an incentive management fee, which is based on the net operating profit of the covered property. Additionally, under a net contract, in most cases we employ on-site personnel to provide services such as housekeeping, maintenance and administration to property owners under our management agreements and for such services, we recognize revenue in an amount equal to the expenses incurred.  Revenues received under the net contract are recorded as Management and Service Income.  Under both types of agreements, revenues are recognized after services have been rendered.  A liability is recognized for any deposits received for which services have not yet been rendered.

Castle’s Revenues totaled $22,774,487$23,877,726 for the year ended December 31, 2012,2013, representing a 12% decrease5% increase from $25,888,733$22,774,487 in 2011.2012.  This decreaseincrease is attributed to the changeoverall improvement in our New Zealand management contract.  Effective August 1, 2011, our contract for our New Zealand property changed from a gross to a net contract and therefore room revenues after that date belonged to the owners and were no longer reported as our revenue.  Room revenues for our New Zealand property between January 1 and August 1, 2011, were $3,850,174.  If these revenues were excluded from our 2011 results, total revenues on a same store basis for 2011 would have been $22,038,559 and 2012 revenues would represent an increasetourism industry, especially in Hawaii where all of 3% over 2011.  the Company’s domestic operations are situated.

Our quarterly revenues decreased 18%, 3%increased 13% and 16%9% during the first second and third quarters of 20122013 compared to 2011, again as a result2012, and decreased by 1% and 1% during the second and fourth quarters of our reporting the New Zealand room revenues in our financial statements through August 1, 2011.  Total revenue for the fourth quarter of 2012 totaled $5,833,790 as2013 compared to $5,804,3672012.  The tourism industry in Hawaii is highly seasonal, and the results reflected the industry where the first and third quarters of the year are shoulder periods while the second and fourth quarter of 2011, representing a slight increase of 1%.quarters are typically valley periods.

Revenues attributed from Properties decreased 23%increased 2% to $11,895,796$12,124,316 for the year ended December 31, 2012,2013, as compared to $15,409,947$11,895,796 in 2011,2012, again as a result of the change in our New Zealand contract.  Excludingimprovement of the room revenues from our New Zealand property from our 2011 results would bring 2011 revenues down to $11,559,773 on a same store basis and 2012 results would represent an increase of 3% over prior year.Hawaii tourism industry.  

Management and Service Revenues increased 6%8% to $11,724,143 in 2013 from $10,865,044 in 2012 from $10,287,337 in 2011.2012.  This increase was attained as a result of the increase in occupancy for both our domestic and foreign operations and was attained despite the sale of one of our Hawaii based contracts in June of 2012.  The increase is attributed to the improvement in the overall world tourism economy.economy, which resulted in increased management and incentive fees from our domestic based net management contracts.

Other income was $29,267 in 2013 compared to $13,647 in 2012 compared2012.  The increase is attributed to $191,449 in 2011.  In 2011additional cancellation fees we received an ownership interestfor a management contract which terminated in a hotel which was valued at $180,000.2011.

The Company reported investment income of $37,164 in 2013 compared to $175,145 in 2012, compared to $14,160 in 2011, which represents the Company’s share of the income attributable to its minority ownership in a domestic hotel.  The decrease in investment income is due to the hotel undergoing a major renovation project for most of 2013.

Costs and Expenses

Total Operating Expenses were $21,867,788$23,204,687 in 2012, a decrease2013, an increase of 13%6% when compared to $25,130,259$21,867,788 in 2011.  Similar2012.  In addition to revenues, the decrease is attributableincreased revenue, the Company increased its marketing staff in 2013 and expanded its marketing channels in the resort condominium market to approximately $2,800,000 of room departmental expenses we recorded in 2011 under our gross contract in New Zealand.  Excluding these expenses in 2011, Total Operating Expenses on a same store basis in 2011 would be $22,330,259effectively compete with individual owners that are more and 2012 results would represent a decrease of 2% despite the increase in revenue.  more renting their resort condominium units directly to guests via various websites that promote rentals by owners.

Attributed Property Expenses decreased 25%increased 5% to $11,019,541 in 2013, as compared to $10,531,679 in 2012, as compared to $14,076,386 in 2011.2012.  Attributed Property Expenses include the operating expenses of the properties which are managed under Gross Contracts.  The decreaseincrease in expenses is a result of the changeincrease in Revenue Attributed From Properties of 2%, changes in some of our New Zealand management contract.  Similarly with Attributed Property Revenues, asGross Contracts where the Company absorbs additional costs of August 1, 2011, we do not include the operating expenses for our room operationsrental programs, and the acquisition in New Zealand.  Attributed Property Expenses from our New Zealand contract in 2011 were approximately $2,800,000September 2013 of a Gross Contract by the Company and excluding this from our 2011 expenses would translate to a same store expense of $11,276,386 and 2012 results would represent a decrease of 7%.the related start up costs.

Payroll and office expense totaled $10,667,646$11,487,772 in 2012,2013, as compared to $10,378,464$10,667,646 in the year earlier period, an increase of 3%8%. This increase is primarily related to additional salary and wages for our sales and marketing corporate headquarters that were previously unfilled in 2011.2012, and hiring additional staff to increase the marketing of our properties.

Administrative and general expense totaled $445,935$475,404 in 2012,2013, an increase of 3%7% as compared to $431,708$445,935 for 2011.2012.  The increase is due to a general increase in insurance premiums, increased travel expenses as our corporate headquarters performed more operational visitssales taxes attributed to our properties.the increased revenues the Company experienced, and increased repairs and maintenance costs related to the Company’s furniture.

Depreciation expense of $221,970 in 2012 decreased by $21,172, to $222,5282013 showed a slight decrease when compared to $243,700$222,528 in 2011.2012.   This was due to the Company making only limited capital expenditures during 2012.2013.

A foreign exchange lossgain of $191,585$14,284 was recognized in 20122013 which resulted from the impact of an increasea decrease of the Guarantor Obligation of the Company that is payable in New Zealand Dollars (see Note 4 of the Notes to Consolidated Financial Statements).   In 2011,2012, the

Company recorded a foreign exchange loss of $21,007. These$191,585. The exchange losses wereloss was a result of the weakening of the US Dollar exchange rate against the New Zealand Dollar.Dollar in 2012.

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Interest expense totaled $374,996$379,176 for 2012,2013, an increase of 4%1% as compared to 2011’s2012’s total of $359,557.$374,996.  This increase is due to the refinancing of our real estate loanNZ dollar strengthening from .81 to .82 per 1USD, or 1% from 2012 to 2013.  Total interest expense includes non-cash imputed interest amounting to $200,030 and $0 for the years ended December 31, 2013 and 2012, respectively.  Effective January 1, 2013, the note payable in New Zealand whereby effective August 1, 2011, we commenced paying interestcalled for payments of NZ$20,00040,000 per month (US$16,392)to be applied to the principle balance plus interest payments to Westpac on the loan.debt that was assumed as part of the purchase price of the Podium.  The agreement does not provide for interest to be paid on the balance of the note and therefore, we have imputed interest on the non-Westpac portion of the note payable so that the combined interest rate paid on the note payable is approximately 4.5%.  The amount of imputed interest we recorded was offset with an increase in additional paid in capital on our balance sheet.

The Company provides for a deferred tax asset on its United States taxable income.  Although the Company also has net operating losses that are available to carryforward from its non-US operations, due to the uncertainty of those tax benefits being used in future years, the Company has set up a provision for 100% of those tax benefits.  Income tax expense for 20122013 totaled $413,227, an increase$143,444, a decrease of $281,672$269,783 when compared to 2011’s $131,555.2012’s $413,227.  The Company’s deferred tax asset balance of $1,500,695$1,369,154 on December 31, 20122013 is derived from its taxable losses in previous years.  This reflects the Company’s estimate of the amount which will offset tax liabilities from expected taxable income in future years.  The Company expects to be profitable again in 2013,2014 and in future years as the benefits of the cost savings measures noted above are realized and additional properties and management contracts are added.  We have established a history of profitability, reporting net income for the past three years.  We believe that it is likely that the $431,000 current portion of the deferred tax asset as of December 31, 20122013 will be utilized in 20132014 and the remainder will be utilized in subsequent years.  Since the majority of these losses occurred in recent years, the useful life of the tax asset extends well into the projected taxable periods.  Further, the nature of the derivation of the tax asset is directly applicable to the nature of the expected tax liability in future periods; as such the ‘quality’ of the tax asset in relation to the expected utilization is high.  (See Note 9 of the Notes to Consolidated Financial Statements.)  The Company’s US based net operating losses available for future use are as follows:

        Available

Year

Net Operating Loss

Expires

1999

$             

   320,713

2019

2002

1,461,310

2022

2007

   138,950

2027

2008

   669,081

2028

Total Available

$

2,590,054

Net income for the year ended December 31, 2012,2013, was $497,036, an improvement$201,867 a decrease of $236,521$295,169 compared to Net Incomenet income of $260,515$497,036 for the year ended December 31, 2011.2012.   Net income for 2012 includesincluded a gain of $395,000 on the sale of an investment and a management contract.  Net income for 2013 included an exchange gain of $14,284 compared to an exchange loss of $191,585 as compared to a loss of $21,007 in 2011. Excluding the effects of the foreign exchange gains & losses, we were successful in achieving Net income of $688,621 for the year 2012 as compared to $281,522 for 2011, an improvement of $407,099, or a 145% increase in Net income.2012.  

EBITDA reflects the Company’s earnings without the effect of depreciation, interest income or expense or taxes.  Castle’s management believes that EBITDA is a good alternative indicator of the Company’s financial performance, because it removes the effects of non-cash depreciation and amortization of assets as well as the fluctuations of interest costs based on Castle’s borrowing history, fluctuations of foreign exchange rates, and increases and decreases in tax expense brought about by changes in the provision for future tax effects rather than current income.  A comparison of EBITDA and Net Income for 20122013 and 20112012 is shown below.  For the year ended 2012,2013, EBITDA was $1,699,372$946,457 as compared to $1,016,334$1,507,787 for 2011, an increase2012, a decrease of $683,038$561,330 or 67%37%.  EBITDA for the Fourth quarter of 20122013 was $616,625$275,273 as compared to an EBITDA of $510,767$659,900 in the fourth quarter of 2011, an increase2012, a decrease of $105,858$384,627 or 21%58%.  The decrease in EBITDA is attributed to the sale of investments and a contract in 2012 for $395,000.  In addition, the Company reported lower earnings ($37,164 in 2013 and $175,145 in 2012) from its ownership in a hotel due to the hotel being under renovation for most of 2013.   The renovation project for the hotel was completed in November 2013 and the hotel will enter 2014 with a fully renovated product.  EBITDA is not a measure that is recognized within generally accepted accounting principles (GAAP).

Comparison of Net Income to EBITDA:

Liquidity:

Our primary sources of liquidity include available cash and cash equivalents, and borrowing under the credit facility which was secured in October 2008 and further modified in 2012,2013, consisting of a $500,000 term loan and a $200,000 line of credit for our US operations and a NZ$300,000 line of credit for our New Zealand operations.  These facilities contain representations and warranties, conditions, covenants and events of default that are customary for this type of credit facility but do not contain financial covenants.  We do not believe the limitations contained in the credit facility will, in the foreseeable future, adversely affect our ability to use the credit facility and execute our business plan.  As of December

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31, 2012,2013, the balance of our termUS line of credit was $150,000 and the NZ line was fully available.  The $150,000 line was fully paid off in January 2014.

We were also successful in extending the due date for our New Zealand loan was $83,350(see note 6 to the Consolidated Financial Statements), from December 31, 2014 to March 31, 2018.  Although no assurance can be given, management is confident that the Company will be able to generate the operating cashflow necessary to service the loan payment requirements through the due date of the loan, and our US and NZ lines were fully available.also that management will be able to refinance this debt in 2018, should there be any outstanding balance on the loan.

Expected uses of cash in fiscal 20132014 include funds required to support our operating activities, including continuing to opportunistically and selectively expand the number of properties under our management.   Management is confident that it will be able to generate sufficient operating cashflow to meet these expected uses of cash in fiscal 2014 and beyond.

The trend towards continued improvement in our bottom line is due to the improvement in the tourism industry that we have experienced since the economic downturn that occurred in 2008, together with various cost control initiatives undertaken by the Company since 2008. We experienced Net income of $497,036$201,867 in 20122013 and net income in 20112012 of $260,515.$497,036. The Company has reported positive EBITDA in nine of the last ten quarters, and positive net income in six of the last eight quarters.  We anticipate a continuation of the improvement in occupancy and average room rates for the properties currently under contract for the remainder of 20132014 with more emphasis on increased average room rates.  The Company also signed on another property in September of 2013, and will enter 2014 with one property that has been through an extensive renovation project.  We also plan to expand the number of properties under management, which will increase the overall revenue stream in 2013.2014.  The specific impact of these additions on revenue depends on the timing of when and if new properties are added during the year.  

More importantly, since the recession of 2008-2009 we implemented a number of cost saving and efficiency programs that together with increases in revenue, continually improved our profitability and cash flows which resulted in EBITDA of $1,699,372$946,457 in 2013, $1,507,787 in 2012, $1,016,334$1,033,327 in 2011, $716,174and $678,500 in 2010 and $153,093 in 2009 as compared to an EBITDA loss of $418,085$429,225 in 2008.2009. We believe that this represents a significant turnaround during these difficult timessince the recession years as our EBITDA continued to improve sinceas the tourism industry improved and our cost saving programs went into effect and have remained as our operating model through 2012.effect.  We project that the Company will continue to improve the overall profitability, cash flows, and working capital liquidity through 20132014 as compared to 2012.2013. This view is based on the following assumptions:

·

Continued improvement in global macroeconomic trends in consumer spending and especially travel spending by consumers, and the resulting visitation trends to Hawaii and New Zealand.

·

A slight increase in occupancy levels and higher increases in average daily rates at the properties we manage as compared to recent years.

·

A continuation of the reduction in business development in other geographic regions.  

·

Expansion of the number of properties under management, with emphasis on Hawaii and New Zealand.

·

A stabilization of the exchange rate between the US and New Zealand currency.

·

The change in ourbenefits of the contract for our New Zealand Property changing in August of 2011 from a gross contract to a net contract.

·

The emergence of travelers from China, Korea and other Asian countries as airlines add more flights from these destinations.

·

An increase in air capacity to Hawaii and the introduction of direct flights from foreign destinations in 20132014 such as from Taiwan which implemented a VISA waiver program, Japan and New Zealand.

Based on current revenue forecasts and operating projections we anticipate recording an Operating Profit for the first quarter of 2013,2014, and our current forecasts and projections anticipate that the Company will be profitable in 2013.2014.  Our plans to manage our liquidity position in fiscal 20132014 include:

·

Maintaining our operating plan for controlling expenses; while maintaining strong relationships with our owners and travel wholesalers and partners to ensure continuity and good communication.  

·

Continuing with only limited capital expenditures and projects.

·

MaintainMaintaining our relationships with banks and other institutions and through improved profitability and financial stability increase our borrowing availability under our credit facility.

·

Modifying our operating models for some of our resort condominium properties to more closely mirror the vacation rental market with its limited services and lower costs.

We have considered the impact of the financial outlook on our liquidity and have performed an analysis of the key assumptions in our forecast such as sales, gross margin and expenses; an evaluation of our relationships with our travel partners and property owners and an

analysis of cash requirements, other working capital changes, capital expenditures and borrowing availability under our credit facility. facilities.

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Based upon these analyses and evaluations, we expect that our anticipated sources of liquidity will be sufficient to meet

both our short term and long term obligations without disposition of assets outside of the ordinary course of business or significant revisions of our planned operations through 2013.operations.    

Other Borrowings

In October 2012,2013, the Company extended, for another year, its available credit facilities by renewing its $200,000 line of credit with a local bank in Hawaii. In addition to the extension, the Company also increased the funds available through this facility from $150,000 to $200,000.  As of March 15, 2013,28, 2014, the Company has the full $200,000 line of credit available for use.  During 2012,2013, the Company drew in the aggregate $150,000 against its line of credit andwhich was fully repaid in January 2014; during 2012, the Company drew $150,000 repaid $300,000 against the line, leaving the full linebalance of credit$200,000 available as of as of December 31, 2012; during 2011, the Company drew $250,000 repaid $150,000 against the line, leaving a balance of $150,000 owing as of December 31, 2011.2012.

We have a NZ$300,000 line of credit with a New Zealand bank to finance its general working capital flows in New Zealand. As of December 31, 2011, we utilized NZ$184,842 of this line and as of December 31, 2012 and 2013, and March 25, 201328, 2014 there were no borrowings against this line of credit.  

In December of 2011, the Company received a short term loan of $50,000 from an officer of one of its domestic subsidiaries which was fully paid off in 2012.

Off-Balance Sheet Arrangements

None

Foreign Currency

The U.S. dollar is the functional currency of our consolidated entities operating in the United States.  The functional currency for our consolidated entities operating outside of the United States is generally the currency of the country in which the entity primarily generates and expends cash.  For consolidated entities whose functional currency is not the U.S. dollar, Castle translates itswe translate their financial statements into U.S. dollars.  Assets and liabilities are translated at the exchange rate in effect as of the financial statement date, and results of operations are translated using the weighted average exchange rate for the period.  Translation adjustments from foreign exchange are included as a separate component of stockholders’ equity.

Item 7A.  Quantitative and Qualitative Disclosure About Market Risk

Foreign Currency Exchange Risk

In addition to our US operations, we conduct business in New Zealand. Our foreign currency risk primarily relates to our New Zealand loan guaranty and investments in foreign subsidiaries that transact business in a functional currency other than the U.S. Dollar. The exposure to this risk is minimized as we have generally reinvested profits or funded operations via local currencies for our international operations. In addition, we are exposed to foreign currency risk related to our assets and liabilities denominated in a currency other than the functional currency.

As currency exchange rates change, translation of the income statements of our international businesses into U.S. dollars affects year-over-year comparability of operating results. We have not hedged translation risks because cash flows from international operations were generally reinvested locally. Non-operating foreign transaction exchange net gain for 2013 was $14,284 and a net loss of $191,585 for 2012 was $191,585 and $21,007 for 2011 attributable to the guaranty of debts in currency other than the functional currency. This was principally driven by U.S. dollar positions held at December 31, 20122013 and 20112012 affected by the fluctuation in the value of the US dollar to the New Zealand dollar.

Our operations are affected by potentially volatile movements in currency exchange rates. The economic impact of currency exchange rate movements on us is often linked to macroeconomic factors such as GDP growth, inflation, interest rates, governmental actions and other factors. These changes, if material, could cause us to adjust our financing, operating and hedging strategies.  We have not made any changes to our currency exchange risk exposures between the current and preceding fiscal years.

Item 8.  Financial Statements

The Castle Group, Inc. and Subsidiaries

Table of Contents

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Mantyla McReynolds LLC [letterhead]

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

The Castle Group, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of The Castle Group, Inc. and Subsidiaries as of December 31, 20122013 and 2011,2012, and the related consolidated statements of operations and comprehensive income, cash flows, and stockholders’ deficit, for the years ended December 31, 20122013 and 2011.2012.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Castle Group, Inc. and Subsidiaries as of December 31, 20122013 and 2011,2012, and the consolidated results of operations and cash flows for the years ended December 31, 20122013 and 2011,2012, in conformity with accounting principles generally accepted in the United States of America.

/s/ Mantyla McReynolds LLC

Mantyla McReynolds LLC

Salt Lake City, Utah

March 25, 201331, 2014

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