The Castle Group, Inc. (CAGU) 10-Q 2008 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

[  ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from ____________ to____________

Commission File No. 000-23338

THE CASTLE GROUP, INC.

(Exact name of small business issuer as specified in its charter)

Utah	99-0307845
(State or Other Jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

500 Ala Moana Boulevard, 3 Waterfront Plaza, Suite 555

Honolulu, Hawaii 96813

(Address of Principal Executive Offices)

(808) 524-0900

(Issuer’s Telephone Number)

N/A

(Former name, former address and former fiscal year,

if changed since last report)

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 Issuer 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 Issuer 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  [ ]                                                                             Smaller reporting company [X]

Indicate by check mark whether the Issuer is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes [  ] No [X]

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS

Not applicable.

Check whether the Issuer 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

Indicate the number of shares outstanding of each of the Issuer’s classes of common equity, as of the latest practicable date: September 30, 2008 – 9,946,392 shares of common stock.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

	THE CASTLE GROUP INC.
	CONSOLIDATED BALANCE SHEETS
	SEPTEMBER 30, 2008 & DECEMBER 31, 2007
	ASSETS
		September 30, 2008	December 31, 2007
		(UNAUDITED)
Current Assets
Cash and cash equivalents		550,224	494,089
Accounts receivable, net of allowance for bad debts		2,289,675	3,262,058
Deferred tax asset		50,000	642,000
Prepaids and other current assets		427,200	339,620
Total Current Assets		3,317,099	4,737,767
Property plant & equipment, net		6,974,433	8,050,563
Goodwill		54,726	54,726
Deposits		29,316	28,070
Restricted cash		205,989	163,157
Deferred tax asset		2,321,492	1,319,475
TOTAL ASSETS		$12,903,055	$14,353,758
	LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities
Accounts payable		3,060,799	3,489,311
Deposits payable		871,613	386,359
Current portion of long term debt		920,755	1,308,262
Current portion of long term debt to related parties		64,818	110,850
Accrued salaries and wages		989,532	944,459
Accrued taxes		62,905	158,948
Accrued interest		50,985	66,250
Other current liabilities		43,654	8,267
Total Current Liabilities		6,065,061	6,472,706
Non Current Liabilities
Long term debt, net of current portion		4,218,151	4,916,997
Deposits payable		205,989	163,157
Notes payable to related parties		117,316	223,770
Other long term obligations, net		3,018,000	3,018,000
Total Non Current Liabilities		7,559,456	8,321,924
Total Liabilities		$13,624,517	$14,794,630
Stockholders' Equity (Deficit)
Preferred stock, $100 par value, 50,000 shares authorized, 11,050		1,105,000	1,105,000
shares issued and outstanding at 9/30/08 & 12/31/07 respectively
Common stock, $.02 par value, 20,000,000 shares authorized, 9,946,392 &		198,929	190,761
9,538,055 shares issued and outstanding at 9/30/08 & 12/31/07 respectively
Additional paid in capital		3,942,255	3,366,928
Retained deficit		(5,601,673)	(5,034,930)
Accumulated other comprehensive income (loss)		(365,973)	(68,631)
Total Stockholders' Equity (Deficit)		(721,462)	(440,872)
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)		$12,903,055	$14,353,758

The accompanying notes are an integral part of these consolidated financial statements

	THE CASTLE GROUP INC.
	CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
	THREE AND NINE MONTHS ENDED  SEPTEMBER 30, 2008 & 2007
	(UNAUDITED)
			Quarter End		Year to Date
			30-Sep-08	30-Sep-07	30-Sep-08	30-Sep-07
Revenues
Revenue attributed from properties		$4,122,324		$4,860,380	$13,298,127	$13,739,347
Management & Service			$570,368	$609,688	$1,974,861	$1,513,212
Other Income			3,652	$105,814	$51,907	$267,998
Total Revenues			$4,696,344	$5,575,882	$15,324,895	$15,520,557
Operating Expenses
Attributed property expenses			$4,019,335	$4,421,530	$12,935,490	$12,815,286
Payroll and office expenses			$596,036	$548,060	$1,966,451	$1,601,321
Administrative and general			$172,024	$411,130	$950,601	$868,000
Depreciation			$51,579	$59,968	$163,505	$175,828
Total Operating Expense			$4,838,974	$5,440,688	$16,016,047	$15,460,435
Operating Income (Loss)			($142,630)	$135,194	($691,152)	$60,122
Interest Income			$2,755	$37,873	$5,321	$112,181
Interest Expense			($88,187)	($134,471)	($290,929)	($403,857)
Income (loss) before taxes			($228,062)	$38,596	($976,760)	($231,554)
Income tax (expense) benefit			$107,543	($23,273)	$410,017	$97,197
Net Income (Loss)			($120,519)	$15,323	($566,743)	($134,357)
Other Comprehensive Income
Foreign currency translation adjustment		($365,173)		($44,053)	($357,114)	($77,575)
Total Comprehensive Income (Loss)		($485,692)		($28,730)	($923,857)	($211,932)
Earnings (Loss) Per Share
Basic			($0.01)	$0.00	($0.06)	($0.01)
Diluted			($0.01)	$0.00	($0.06)	($0.01)
Weighted Average Shares
Basic			9,946,392	9,538,055	9,716,889	9,538,055
Diluted			9,946,392	9,538,055	9,716,889	9,538,055
The accompanying notes are an integral part of these consolidated financial statements

	THE CASTLE GROUP INC.
	CONSOLIDATED STATEMENTS OF CASH FLOWS
	NINE MONTHS ENDED SEPTEMBER 30, 2008 & 2007
	(UNAUDITED)
		2008	2007
Cash Flows from Operating Activities
Net income (loss)		($566,743)	($134,357)
Depreciation		$163,505	$175,828
Amortization of discount		$188,348	$177,470
Stock issued for compensation		$131,250	$0
(Increase) decrease in
Accounts receivable		$777,837	($543,676)
Other current assets		($98,965)	($351,071)
Deposits and other assets		($1,392)	$0
Restricted cash		($69,950)	$339,571
Deferred taxes		($410,017)	($97,197)
Increase (decrease) in
Accounts payable and accrued expenses		$276,552	$602,353
Net Cash From Operating Activities		$390,425	$168,921
Cash Flows from Investing Activities
Purchase of assets		($48,970)	($106,457)
Net Cash from Investing Activities		($48,970)	($106,457)
Cash Flows from Financing Activities
Private placement of stock		$224,744	$0
Payments on notes		($448,087)	($714,887)
Net Cash from Financing Activities		($223,343)	($714,887)
Effect of exchange rate on changes in cash		($61,977)	$14,012
Net Change in Cash		$56,135	($638,411)
Beginning Balance		$494,089	$1,100,302
Ending Balance		$550,224	$461,891
Non-Cash Transactions
Coversion of debt to equity		$227,500	$0
Supplementary Information
Cash Paid for Interest		$93,242	$86,130
Cash Paid for Income Taxes		$0	$0
The accompanying notes are an integral part of these consolidated financial statements

Notes to Consolidated Financial Statements:

Summary of Significant Accounting Policies

Organization

The Castle Group, Inc. was incorporated under the laws of the State of Utah on August 21, 1981. The Castle Group, Inc. operates in the hotel and resort management industry in the State of Hawaii, New Zealand, Thailand, The Federated States of Micronesia, the Territory of Guam and the Commonwealth of Saipan under the trade name “Castle Resorts and Hotels.”  The accounting and reporting policies of The Castle Group, Inc. (the “Company” or “Castle”) conform with generally accepted accounting principles and practices within the hotel and resort management industry.

Principles of Consolidation

The consolidated financial statements of the Company include the accounts of The Castle Group, Inc. and its wholly-owned subsidiaries, Hawaii Reservations Center Corp., HPR Advertising, Inc., Castle Resorts & Hotels, Inc., Castle Resorts & Hotels Thailand Ltd., NZ Castle Resorts and Hotels Limited (a New Zealand Corporation), and NZ Castle Resorts and Hotels’ wholly-owned subsidiary, Mocles Holdings Limited (a New Zealand Corporation).  All significant inter-company transactions have been eliminated in the consolidated financial statements.

Note 1  Basis of Presentation

The accompanying consolidated financial statements have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.  In the opinion of management, the accompanying interim financial statements contain all adjustments, consisting of normal recurring accruals, necessary for a fair presentation.  The results of operations for the three-month and nine-month periods ended September 30, 2008, are not necessarily indicative of the results for a full-year period.  It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in Castle’s annual audited financial statements for the year ended December 31, 2007.

Income Recognition

The Company recognizes income from the management of resort properties according to terms of its various management contracts.

The Company has two basic types of agreements.  Under a “Gross Contract” the Company records income 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.” The portion of the revenues that represent the unit owners’ percentages are not recorded by the Company as income or expenses.  Under the Gross Contract, the 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.  Under a Net Contract, the Company also typically receives an incentive management fee, which is based on the net operating profit of the covered property.  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.

The financial statements presented for the periods ended September 30 2007, have been adjusted to reflect a change in the accounting methodology which the Company adopted in the fourth quarter of 2007 ended December 31, 2007. The Company previously recorded “Management and Service Fees” from its properties that were operated under a Gross Contract as described above, and an offsetting amount was recorded as an expense under “Property” operating expenses.  Financial results for the 12 months ending December 31, 2007, as reported in the Company’s Form 10-KSB as filed were prepared using the new accounting methodology.  The financial statements for the quarter and nine months ended September 30 2007, have been adjusted to conform to the new accounting methodology  by reducing both “Management & Service” revenues and “Payroll & Office Expense” by $431,215 and $1,220,578 respectively, which reflects the amount of Management & Service fees that were recorded for properties operated under a Gross Contact as described above.  The Company believes that this method properly allocates the corporate office overhead costs to the Gross Contract properties.  The adjustment is not material and did not affect net income, operating income, EBITDA or any balance sheet account balances in any period.

Note 2 New Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.”  SFAS No. 141(R) changes the accounting for and reporting of business combination transactions in the following way:  Recognition with certain exceptions, of 100% of the fair values of assets acquired, liabilities assumed, and non controlling interests of acquired businesses; measurement of all acquirer shares issued in consideration for a business combination at fair value on the acquisition date; recognition of contingent consideration arrangements at their acquisition date fair values, with subsequent changes in fair value generally reflected in earnings; recognition of pre-acquisition gain and loss contingencies at their acquisition date fair value; capitalization of in-process research and development (IPR&D) assets acquired at acquisition date fair value; recognition of acquisition-related transaction costs as expense when incurred; recognition of acquisition-related restructuring cost accruals in acquisition accounting only if the criteria in Statement No. 146 are met as of the acquisition date; and recognition of changes in the acquirer’s income tax valuation allowance resulting from the business combination separately from the business combination as adjustments to income tax expense.  SFAS No. 141(R) is effective for the first annual reporting period beginning on or after December 15, 2008, with earlier adoption prohibited.  The adoption of SFAS No. 141(R) will affect valuation of business acquisitions made in 2009 and forward.   

In December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interest in Consolidated Financial Statements – an Amendment of ARB 51” (SFAS 160).  SFAS 160 clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements.  It also requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest, and requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest.  SAFS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008.  Earlier adoption is prohibited.  We do not anticipate a material impact upon adoption.

In March 2008, the FSAB issued FASS No. 161, “Disclosures about Derivative Instruments and Hedging Activities.”  SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows.  SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged.  We do not anticipate a material impact upon adoption.

Note 3 Common Stock Transactions

In April, 2008, the Company raised additional capital from the completion of a Unit offering which resulted in the issuance of   333,334 Units at a price of $1.50 per Unit.  Each unit consists of one a of the Company’s common stock and a warrant to purchase an additional share of the Company’s common stock at a price of $3.50 for a period of three years, subject to certain restrictions.  Through this financing the Company raised a net amount of $224,744 for use as working capital and converted $227,500 in outstanding debt and short term obligations.

During the quarter ended June 30, 2008, the Company issued 75,000 shares of its common stock to one of its directors for services rendered to the Company.

Item 2. Management’s Discussion and Analysis or Plan of Operation.

Forward Looking Statements

Statements made in this Quarterly Report which are not purely historical are forward-looking statements with respect to the goals, plan objectives, intentions, expectations, financial condition, results of operations, future performance and business of the Company, including, without limitation, (i) Castle’s ability to raise capital, and (ii) statements preceded by, followed by or that include the words “may,” “would,” “could,” “should,” “expects,” “projects,” “anticipates,” “believes,” “estimates,” “plans,” “intends,” “targets” or similar expressions.

Forward-looking statements involve inherent risks and uncertainties, and important factors (many of which are beyond the Company’s control) that could cause actual results to differ materially from those set forth in the forward-looking statements, including the following, general economic or industry conditions, nationally and/or in the communities in which the Company conducts business, changes in the interest rate environment, legislation or regulatory requirements, conditions of the securities markets, the Company’s ability to raise capital, changes in accounting principles, policies or guidelines, financial or political instability, acts of war or terrorism, other economic, competitive, governmental, regulatory and technical factors affecting Castle’s operations, products, services and prices.

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 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.

Plan of Operation

Principal products or services and their markets

General

Castle is a hospitality and hotel management company that prides itself on its ability to be both “Flexible and Focused,” the Company’s 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.  Castle earns its 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.  In addition, Castle provides design services to properties that are furnishing, refurnishing or remodeling, as well as, pre-opening technical services for new hotel and resort properties being planned or under construction.  Castle’s revenues are derived primarily from two sources: (1) the rental of hotel rooms and condominium accommodations; and food and beverage sales at the properties it manages and; (2) fees paid for services it provides to property owners.  Castle also derives revenues from commissions and incentive payments, based on sales and performance criteria at each property.

In September, Castle began managing the new Halii Kai at Waikoloa resort property on the Big Island of Hawaii.  This is Castle’s first entry into the Waikoloa Resort which is located north of the Kona area.  The Halii Kai is made up of 192 luxury two and three bedroom Oceanfront luxury villas which range in size from 1,204 to 1,930 square feet and marks an important addition to Castle’s portfolio of properties as a destination for luxury oriented travelers.

Corporate Culture

Castle’s corporate culture has been internally branded as “F & F,” which meansFlexibility 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. Castle does not own any hotels or resorts; however, it has made an investment in the property that it manages in New Zealand. Marketing is done through a variety of distribution channels including direct Internet sales, wholesalers, online and traditional travel agencies and group tour operators.  Recently, Castle has expanded its sales and marketing staff and implemented a redesign of its interactive web site (www.Castleresorts.com).  Unlike many other hotel and resort operators, we do not market the properties we manage under the Castle brand. Instead of emphasizing the “Flag” or chain name, Castle’s strategy is to promote the name and reputation of the individual properties under management.  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.

In late 2007, we launched our redesigned website which has a customized proprietary booking engine and intuitive functionality, which we believe sets us apart from our competitors.   Our website (CastleResorts.com) offers state-of-the-art functionalities, user-friendly navigation, interactive features and rich content, while offering attractive rates and a travel booking engine that can handle rate conversions for over 100 foreign currencies. Castle’s proprietary online booking engine supports a dynamic pricing model which maximizes revenues for all of our properties under management.  We intend to continue to invest in optimizing our on-line presence directed specifically towards our own website, since revenue derived through our own branded website yields a higher margin utilizing retail rates.

Castle supports its online presence with its own full service, reservation call center that provides a wide range of services from tour reservation processing and rooms control, to handling group bookings.  The reservation center electronically connects resort property inventory and rates to the four major Global Distribution Systems (“GDS”). This connectivity displays rates and inventory of Castle’s properties to over 500,000 travel agents worldwide as well as Internet connectivity to over 1,200 travel websites worldwide.

For customer convenience, we offer direct to consumer online booking reservations of guest rooms at resort and condominium properties under contract and also vacation packages with attractions and activities related to our hotels and condominiums through Castle’s interactive web site at www.CastleResorts.com.  

Diversity

Castle has a diverse portfolio of properties located in desired island resort destinations throughout the Pacific Region and beyond.  We represent hotels, resort condominiums, luxury villas and lodging accommodations throughout Hawaii, Micronesia, New Zealand and Thailand.   

In Hawaii, Castle is the only lodging chain that represents properties on the five major Hawaiian Islands of Oahu/Waikiki, Maui, Kauai, Molokai and Hawaii, which allows customers the option to island-hop, and provides Castle cross-selling opportunities.  Our Honolulu headquarters serves as the epicenter for international operations in Saipan, Guam, New Zealand and in Thailand, and positions us for expansion in Southeast Asia as well as throughout the Pacific.  Our diverse destinations offer customers the opportunity to discover new experiences and varying cultures.

Castle offers 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 600 guest rooms.  Our collection of all-suites 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 Castle manages is individually branded in order to extract maximum value from its strengths. The Castle brand stays in the background and 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 marketing resources, channel distribution, resort management expertise, industry partnerships and networks.

Castle’s brand strategy is one of the areas that clearly differentiate 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 marketing and operational expense that the brand demands to offset their marketing costs.  There are also some tangible differences from the guest’s or customer’s perspective as well.  At Castle, we believe that one size does not fit all.

Castle markets each property with its own independent brand identity and deploys customized marketing programs to fit the specific demographics attracted to each of our properties.  Through our brand building efforts, we begin the process of positioning each of our resort brands 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.  This ongoing trend towards smaller, independent hotels, as opposed to the familiar mid-range chains, is not only occurring in Hawaii, but seen throughout the world tourism marketplace.  This increased demand is fueled by the following traveler’s expectations:  

·

Seeking personalized recognition, attention, and service.

·

Desiring hotel and condominium accommodations that impart a sense of place and provides a unique guest experience.  

·

Demanding quality and personalized service, which creates high retention and repeat customers.  

Marketing Programs and Promotions

Castle has implemented numerous marketing programs and promotions directed towards both the consumer and trade markets to generate incremental revenue and market loyalty for the individual properties.  We have developed a wide range of programs designed specifically to reflect the unique attributes of each of our resort properties, while providing various incentives.  At any given time, we may have up to 50 ongoing marketing programs and promotions in place, some of which are seasonal to drive incremental room night revenues during valley or shoulder periods and some of which are ongoing throughout the year.

Guest Relations and Quality Assurance

Rather than a generic approach to the guest experience, Castle provides customized guest relations programs that focus on the uniqueness of each resort property and the host culture.  Each aspect of the guest touch points is given careful consideration from the welcome through to the farewell, as well as the in-room experience.  Castle’s Guest Relations Committee along with the feedback from each properties staff and owners, customizes the program; establishes standards; provides staff training; conducts periodic inspections and on-going basis reviews; all of which evolves the program for continual improvement.  This effort is driven from within our operations team and the primary objective is to positively differentiate the Castle guest’s experience, from its competitors. Castle’s quality assurance program helps monitor and ensure that we deliver the highest level of service.  Our guest satisfaction program gives us the feedback from the guest’s perspective, which is reflected in our hospitality report card. Utilizing a third-party research and polling firm, we are able to benchmark our service levels and compare them to Castle’s aggregate.  We share the quarterly reports with our owners and use this quantifiable data to help us determine what areas we are doing well in and what areas need attention.  This guest satisfaction program is tied into the general manager’s responsibilities and bonus plan.  As a hotel management company, our guest satisfaction is our highest priority and focus, alongside with our owners’ satisfaction and favorable financial returns.

Growth Strategy

The majority of the properties presently managed by Castle are located within the state of Hawaii.  In addition, Castle manages properties in New Zealand, Guam, Micronesia, and most recently in Thailand.  We believe that there are significant opportunities to expand Castle’s operations both in the markets it currently serves, as well as other Pacific Basin and Asian vacation destinations including Vietnam.  Consequently over the last several quarters we have positioned Castle for significant growth within our current markets and to capitalize on the emerging growth opportunities particularly within the Asian markets.  In 2007, Castle formed its Thailand division to support its new business initiatives in Thailand and in 2008 Castle formed a new subsidiary in Vietnam to forward its development efforts there.

Also as a part of our growth initiatives, we have formed an experienced acquisition team and have engaged in strategic alliances with various hospitality development companies and prominent investment banks, who wish to team up with us in pursuing growth opportunities within our key targeted markets.  Significant opportunities for Castle to obtain additional contracts within the State of Hawaii are also available to us due to a myriad of factors that include sales of properties, foreclosures, underperformance, and dissatisfaction with the current management of our competitors.  

As part of Castle’s strategies 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, Castle is assured of ongoing revenues in future years from this property

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Certain statements contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Plan of Operation” 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 Operation.”

Revenues

Total Revenues for the three and nine months ended September 30 2008, decreased by $879,538, or 16% and by $195,662, or 1%, respectively.  The decrease for the quarter reflects the effects of the closure of two major airlines that service the State of Hawaii in April, 2008 as well as the overall trend of a decreasing number of travelers to Hawaii as compared to previous years during the same periods.  This trend has been brought about by weakening general economic conditions and consumer confidence and substantially increased airfares to Hawaii from the Mainland.    

Revenues Attributed from Properties decreased by 15% or $738,056 and by $441,220 or 3%, compared to prior year for the three and nine month periods ended September 30 2008, respectively.  The decrease for the quarter is attributed to the weakening of the Hawaii tourism market due to the airline closures and weakened overall economic conditions as mentioned above.  Management and Service Revenues decreased by $39,320, or 6% during the three month period and increased by $461,649, or 31% for the nine month periods ended September 30 2008, when compared to the same periods in 2007.  The increases during the first and second quarter are primarily due to incremental of revenues from additional management and service contracts initiated in 2007.  The decrease in the most recent quarter reflects the significant decrease in the number of vacationers to Hawaii and to a softening of the travel markets generally.  

Other income decreased by $102,162, or 97%, and $216,091, or 81%, respectively, for the three and nine month periods ended September 30 2008, when compared to prior year.  This decrease is due to decreased revenues from the Castle Design Group and decreased timeshare activity commissions in 2008 as compared to 2007.

Property Expenses are those expenses related to the management of the resort and condominium properties which are operated on a Gross Revenue contract basis.  Property expenses decreased by $402,195, or 9%, and increased by $120,204, or 1%, for the three and nine months ended September 30 2008, when compared to prior year.  These expense decreases in the most current quarter are the result of the significant cost reductions made by the Company in response to the decreased number of travelers and resulting decreases in revenues.  The cost increases for the nine month period are attributed to the increased cost of energy and other operating cost drivers  in 2008 as compared to 2007, and expenses related to the new management and service contracts initiated during 2007 which were recorded in the first two quarters.   Comparing the three and nine months ending  September 30 2008, and 2007, payroll and office expenses increased by $47,976, or 9%, and $365,130, or 23%, respectively.  Castle added operational positions in the first and second quarter to improve the services provided by the additional properties contracts and the previously existing portfolio of properties under contract.  Staffing levels were realigned during the third quarter in response to the decreased revenues and visitor counts.

Administrative and general expenses decreased by $239,106 or 58% during the third quarter as compared to 2007 in response to decreased revenue and visitors.  Administrative and general expenses increased $82,601 or 10% for the nine months ended September 30 2008, compared to 2007.  This increase is primarily a result of professional fees and travel expenses incurred and business development efforts during the first quarter. EBITDA (Earnings before Interest, Depreciation, Taxes and Amortization) reflects the Company’s earnings without the effect of depreciation, interest income or expense or taxes.  Castle’s management believes that in many ways it is a good alternative indicator of the Company’s financial performance.  It removes the effects of non cash depreciation and amortization of assets, as well as the fluctuations of interest costs based on the Company’s borrowing history 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 is shown below.  EBIDTA decreased by $286,213 and $763,597 for the three and nine months ended September 30 2008, when compared to prior year, respectively.  These changes are primarily a result of decreases in Total Revenue Attributed to Properties and increases in Administrative and general expenses related to the Company’s expansion and business development efforts in the early quarters which have been offset by cost savings programs initiated during the second and third quarters in response to decreased revenues.

Comparison of Net Income to  EBITDA	For the Three Months Ended September 30		For the Nine Months Ended September 30
	2008	2007	2008	2007
Net Income	($120,519)	$15,323	($566,743)	($134,357)
Add Back:    Income Taxes	($107,543)	$23,273	($410,017)	($97,197)

Net Interest Expense	$85,432	$96,598	$285,608	$291,676
Depreciation	$51,579	$59,968	$163,505	$175,828
EBITDA	($91,051)	$195,162	($527,647)	$235,950

Depreciation and Amortization

Castle’s business does not require a great deal of capital expenditure for equipment or fixed assets.  As a result, Depreciation expense was $51,579 and $163,505 for the three and nine months ended September 30 2008, as compared to $59,968 and $175,828 for the same periods last year.

Interest Income and Expense

Interest income of $2,755 and $5,321 for the three and nine months ended September 30 2008, as compared to $37,873 and $112,181 in the same periods last year reflects lower invested cash balances in the first three quarters of 2008 as compared to the comparable period in 2007.

Interest Expense of $88,187 and $290,929 for the three and nine months ended September 30 2008, as compared to $134,471 and $403,857, respectively, for the same periods last year, is a result of lower long term debt due to principle repayments and the lowering of the interest rate charged on various loans with banks that the Company has.

Income Taxes

Income tax benefits were $107,543 for the three months ended September 30 2008, compared to an income tax expense of $23,273 during the third quarter of last year.  The Company recorded an  income tax benefit of $410,017 for the nine months ended September 30, 2008 as compared to $97,197 during the  same period last year.

Net Income (Loss)

Net loss for the three and nine months ended September 30 2008, was $120,519 and $566,743, compared to net income of $15,323 and a loss of  $134,357 for the same periods last year.

Foreign Currency Translation Adjustment

For consolidated entities whose functional currency is not the U.S. dollar, Castle translates their financial statements into U.S. dollars.  Assets and liabilities are translated at the exchange rate currently 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. Changes in the carrying value of the assets and liabilities of the consolidated entities outside of the United States due to foreign exchange changes are reflected as Foreign Currency Adjustments.  Foreign Currency Translation adjustments totaled ($365,173) and ($357,114) for the three and nine months ended September 30 2008, compared to ($44,053) and ($77,575) in the year earlier periods.

Total Comprehensive Income

Total Comprehensive Loss for the three and nine months ended September 30 2008, totaled $485,692 and $923,857, as compared to $28,730 and $211,932 in the year earlier periods.  This is primarily a result of the changes in Revenue and Property and Operating Expenses noted above and the changes in Income Tax expense and Foreign Currency Translation adjustments also noted above.

Off-balance sheet arrangements

None; not applicable.

Financing

In September 2008 the Company modified and increased its debt arrangements through a new relationship with a local bank.  The Company added a $500,000, 5 year term loan secured by a security interest in the Company’s property, contracts, and equipment with interest at the bank’s base rate plus 1%.  The Company also secured a $250,000 revolving credit agreement, secured by the Company’s property, contracts and equipment, with interest at the bank’s base rate plus 1%.  The revolving credit agreement expires in one year and is renewable.  The balance due on the revolving credit agreement must be reduced to zero for at least 30 days each year. The outstanding amounts due under the prior revolving credit agreement were paid in full.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The primary market risk that the Company may be impacted by is the fluctuation of the exchange rate of the U.S. dollar relative to foreign currencies.  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 its 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.  Changes in exchange rates of the US Dollar to other foreign currencies may have a significant impact on the financial and operating results of the Company in future periods.

Item 4T.  Controls and Procedures.

Evaluation of disclosure controls and procedures

Our management, with the participation of our chief executive officer (and acting chief financial officer), evaluated the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act as of the end of the period covered by this Quarterly Report on Form 10-Q.  In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.  In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.  The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based on that evaluation, our chief executive officer (and acting chief financial officer)  concluded that, as of September 30 2008, our disclosure controls and procedures were, subject to the limitations noted above, effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules, regulations and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting

Our management, with the participation of the chief executive officer and chief financial officer, has concluded there were no significant changes in our internal controls over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

None.

Item 1A. Risk Factors.

Not required; however, there have been no material changes from our risk factors as previously disclosed in our 10-KSB Annual Report for the calendar year ended December 31, 2007.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Recent Sales of Unregistered Securities

None. Not applicable.

Use of Proceeds Registered Securities

None; not applicable.

Purchases of Equity Securities by Us and Affiliated Purchasers

None; not applicable.  

Item 3. Defaults Upon Senior Securities.

None; not applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

None; not applicable.

Item 5. Other Information.

None; not applicable.

Item 6. Exhibits

(a) Exhibits and index of exhibits.

31.1 302 Certification of Rick Wall, Chief Executive Officer

32    Section 906 Certification

SIGNATURES

In accordance with the requirements of the Exchange Act, the Registrant has caused this Quarterly Report to be signed on its behalf by the undersigned, thereunto duly authorized.

THE CASTLE GROUP, INC.

Date:	11/14/2008	By:	/s/Rick Wall
			Rick Wall
			Chief Executive Officer and Chairman of the Board of Directors and Acting CFO