The Castle Group, Inc. (CAGU) 10-Q 2010 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, 2010

[  ] 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 Registrant as spe cified in its charter)

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

500 Ala Moana Boulevard, 3 Waterfront Plaza, Suite 555

Honolulu, Hawaii 96813

(Address of Principal Executive Offices)

(808) 524-0900

(Registrant’s Telephone Number)

N/A

(Former name, former address and former fiscal year,

if changed since last report)

Indicate by check mark whether the Registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (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 [  ]

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [  ] No [  ]

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. (Check One):

Large accelerated filer [  ]      Accelerated filer [  ]       Non-accelerated filer [  ]      Smaller reporting company [X]

Indicate by check mark whether the Registrant 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

Indicate by check whether the Registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act subsequent to 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 Registrant’s classes of common equity, as of the latest practicable date:

November 15, 2010 - 10,026,392 shares of common stock.

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements.

THE CASTLE GROUP INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2010 (UNAUDITED) & DECEMBER 31, 2009
ASSETS
	September 30, 2010	December 31, 2009
Current Assets
Cash and cash equivalents	$            79,327	$          623,485
Accounts receivable, net of allowance for bad debts	2,045,938	1,710,449
Deferred tax asset	309,000	189,000
Prepaid and other current assets	359,328	288,952
Total Current Assets	2,793,593	2,811,886
Property plant & equipment, net	7,118,625	7,088,097
Goodwill	54,726	54,726
Deposits	24,477	24,477
Restricted cash	34,380	145,320
Investments	301,000	0
Deferred tax asset	1,770,297	2,008,088
TOTAL ASSETS	$     12,097,098	$     12,132,594
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities
Accounts payable	$       2,794,875	$       3,023,711
Payable to related parties	109,931	131,737
Deposits payable	&nb sp;525,074	289,488
Current portion of long term debt	421,994	494,162
Current portion of long term debt to related parties	6,250	&nbs p;          6,250
Accrued salaries and wages	698,255	763,488
Accrued taxes	106,068	139,542
Accrued interest	10,928	10,388
Other current liabilities	61,895	&n bsp; 8,734
Total Current Liabilities	&nbs p;        4,735,270	4,867,500
Non Current Liabilities
Long term debt, net of current portion	4,818,196	4,812,785
Deposits payable	393,605	369,804
Notes payable to related parties	146,483	151,170
& nbsp;Other long term obligations, net	3,103,178	3,015,368
Total Non Current Liabilities	8,461,462	8,349,127
Total Liabilities	13,196,732	13,216,627
Stockholders' Equity (Deficit)
Preferred stock, $100 par value, 50,000 shares authorized, 11,050
shares issued and outstanding in 2010 and 2009, respectively	1,105,000	1,105,000
Common stock, $.02 par value, 20,000,000 shares authorized, 10,026,392   and 9,946,392 shares issued and outstanding in 2010 & 2009, respectively	200,529	198,929
Additional paid in capital	4,372,709	&n bsp;         4,240,906
Retained deficit	(6,531,351)	(6,347,389)
Accumulated other comprehensive income (loss)	(246,521)	(281,479)
Total Stockholders' Equity (Deficit)	&n bsp;(1,099,634)	(1,084,033)
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)	$     12,097,098	&nb sp;$     12,132,594
The accompanying notes are an integral part of these consolidated financial statements

THE CASTLE GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010 & 2009
UNAUDITED
	Quarter Ended	Quarter Ended	Year to Date	Year to Date
	09/30/2010	09/30/2009	09/30/2010	09/30/2009
Revenues
Revenue attributed from properties	$       3,827,845	$       3,372,415	$     11,091,399	$       9,549,368
Management & Service	489,466	719,581	1,429,376	2,110,345
Other Income	301,000	240	301,000	20,233
Total Revenues	4,618,311	4,092,236	12,821,775	;     11,679,946
Operating Expenses
Attributed property expenses	3,670,861	3,251,802	10,574,604	9,654,689
Payroll and office expenses	382,973	570,330	1,410,368	1,675,124
Administrative and general	83,189	171,809	340,352	395,864
Depreciation	60,701	55,541	&nbs p;  178,886	147,500
Total Operating Expense	4,197,724	4,049,482	12,504,210	11,873,177
Operating Income (Loss)	420,587	42,754	317,565	(193,231)
Foreign Exchange Gain (Loss)	(177,300)	(294,520)	(87,810)	(580,638)
Interest Income	-	-	-	-
Interest Expense	(97,441)	(61,671)	(295,928)	(164,380)
Income (Loss) before taxes	145,846	(313,437)	(66,173)	(938,249)
Income (tax) benefit	(166,293)	62,435	(117,791)	121,122
Net Loss	$   &nb sp;       (20,447)	$         (251,002)	$         (183,964)	$         (817,127)
Other Comprehensive Income
Foreign currency translation adjustment	$          111,265	$          285,302	$             34,958	$          563,795
Total Comprehensive Income (Loss)	$            90,818	$            34,300	$         (149,006)	$         (253,332)
Earnings (Loss) Per Share				;
Basic	$               (0.00)	$               (0.03)	$   &nb sp;           (0.02)	$               (0.08)
Diluted	$               (0.00)	$               (0.03)	$               (0.02)	$               (0.08)
Weighted Average Shares
Basic	9,999,435	9,946,392	9,964,267	9,946,392
Diluted	9,999,435	9,946,392	9,964,267	9,946,392
The accompanying notes are an integral part of these consolidated financial statements

THE CASTLE GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2010 & 2009
UNAUDITED
		Year to Date	Year to Date
		09/30/2010	09/30/2009
Cash Flows from Operating Activities
Net income (loss)		$         (183,964)	$         (817,127)
Adjustmens to reconcile net loss to net cash from operating       activities:   Depreciation		178,387	146,643
Amortization of discount	;	117,771	99,792
Foreign exchange (gain) loss on guarantor obligation		&nb sp;            87,809	580,638
Interest on guarantor obligation		103,463	-
Issuance of equity-based compensation		29,940	-
Equity-based compensation income		(112,827)
(Increase) decrease in
Accounts receivable		(292,742)	131,554
Other current assets		(66,058)	(56,163)
Deposits and other assets		-	-
Restricted c ash		110,665	(51,210)
Deferred taxes		&nb sp;         117,791	(121,122)
Increase (decrease) in
Accounts payable and accrued expenses		(125,666)	(52,199)
Net Cash Flow From Operating Activities		(35,431)	(139,194)
Cash Flows from Investing Activities
Purchase of assets		(9,596)	(75,400)
Investment in Hotel		&nbs p;        (188,173)	-
Net Cash Flow from Investing Activities		(197,769)	(75,400)
Cash Flows from Financing Activities
Proceeds from notes		150,000	550,000
Pay ments on notes		(461,793)	(495,050)
Net Cash Flow from Financing Activities		(311,793)	54,950
Effect of exchange rate on changes in cash		835	(6,366)
Net Change in Cash		(544,158)	(166,010)
Beginning Balance		623,485	344,677
Ending Balance		$            79,327	$          178,667
Supplementary Information
Cash Paid for Interest		$            51,412	$            55,246
Cash Paid for Income Taxes		$                      -	$                      -
Non-cash investment in property		$        (112,827)	$                      -
The accompanying notes are an integral part of these consolidated financial statements

Notes to Condensed 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, 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 ac counts 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 prep ared 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 and nine month periods ended September 30, 2010, 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, 2009.

Revenue Recognition

The Company recognizes revenue 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 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.”  The portion of the revenues that represent the unit owners’ percentages are not recorded by the Company as revenue or expenses.  Under a 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 Revenue. 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 Company also provides consulting services which would include pre-opening services, acquisition due diligence consulting, renovation proj ect management and consulting, and other technical services that may from time to time be requested from both our current clients as well as prospective clients.  The Company recognized revenues from these services when the services are performed.

Note 2  New Accounting Pronouncements

In October 2009, the FASB issued authoritative guidance on multiple-deliverable revenue arrangements, which is effective for the Company on January 1, 2011 for new revenue arrangements or material modifications to existing agreements. The guidance amends the criteria for separating consideration in multiple-deliverable arrangements. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (a) vendor-specific objective evide nce; (b) third-party evidence; or (c) estimates. This guidance also eliminates the residual method of allocation and

requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. In addition, this guidance significantly expands required disclosures related to a vendor’s multiple-deliverable revenue arrangements. The Company is currently evaluating the effect the adoption of the guidance will have on its financial position, results of operations, cash flows and related disclosures.

In July 2010, the FASB issued authoritative guidance on disclosures about the credit quality of financing receivables and the allowance for credit losses, which is effecti ve for the Company on December 31, 2010. The guidance requires additional disclosures that facilitate financial statement users’ evaluation of: (a) the nature of credit risk inherent in the entity’s portfolio of financing receivables; (b) how that risk is analyzed and assessed in arriving at the allowance for credit losses; and (c) the changes and reasons for those changes in the allowance for credit losses. In addition, the guidance amends current requirements to include additional disclosures about financing receivables, including: (a) credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables; (b) the aging of past due financing receivables at the end of the reporting period by class of financing receivables; and (c) the nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses. The Company is curr ently evaluating the effect the adoption of the guidance will have on its financial position, results of operations, cash flows and related disclosures.

Note 3 Foreign Currency Transaction Gain / Loss

As part of the Company’s purchase of real estate in New Zealand, the Company has guaranteed an amount of up to $3,018,000 to the seller of the real estate and the Company recorded this guaranty as “Other Long Term Obligations” on its balance sheet.  The loan issued upon the purchase of the New Zealand real estate is payable in New Zealand dollars.  Due to the strengthening of the New Zealand dollar against the US dollar, the obligation has been increased to $3,103,178, with the difference of $177,300 and $87,810 recorded as a loss for the three and nine months ended September 30, 2010.

Note 4 Income Taxes

Income tax expense reflects the expense or benefit only on the Company’s domestic taxable income. Income tax expense and benefit from the Company’s foreign operations are not recognized as they have been fully reserved.

Note 5 Equity-Based Compensation

In August of 2010, the non-employee board of directors received a total of 80,000 shares of common stock (10,000 shares each) together with one warrant for each share grant ed which allows the holder of the warrant to purchase one share of common stock for $1.00.  The stock and warrants were issued as compensation to the board members for their time and efforts in assisting the Company.  The warrants expire at the earlier of five years or 60 days after the Company’s common stock trades for an average price of $3.00 per share for 20 consecutive days.  The common stock was valued using trading prices at $.25 per share or $20,000 and the warrants 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%.

Note 6 Acquisition of Equity Interest

On July 23, 2010 the Company acquired a 7% interest in the owne rship of a hotel located in Hawaii.  The Company received the interest in exchange for the CEO of the Company and the Company assisting the buyers of the hotel in negotiating the purchase, performing due diligence work and other consulting work performed by the CEO and the Company.  The hotel was purchased for $17,300,000, of which $13,000,000 was financed through a first mortgage on the hotel.  The Company recognized $301,000 in revenues resulting from the fair value of the ownership interest received.  The amount recognized comprises $188,173 of cash received from the stated amounts of finders and consulting fees and the remaining $112,827 represents the incremental fair value received in connection with the ownership interest.

Note 7 Subsequent Events

None

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operation.

Forward Looking Statements

Statements made in this Quarterly Report of the Castle Group, Inc. (“Castle” or the “Company”) which are not purely historical are forward-looking statements with respect to the goals, plan objectives, intentions, expect ations, 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 conduc ts 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 signifi cant 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 Opera tion

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,” which is 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 marketi ng; 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.

Marketing Strategy

Most of our marketing efforts are focused towards acquiring and retaining guests for the properties we manage. Castle does n ot own any hotels or resorts; however, it has made real estate investments in the properties that it manages in Hilo, Hawaii and 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.  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.

Our website (www.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 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, and lodging accommodations throughou t Hawaii, as well as in Saipan and New Zealand.   

In Hawaii, Castle is the only lodging chain that represents properties on all of the five major Hawaiian Islands of Oahu (Waikiki), Maui, Kauai, Molokai and Hawaii, (Big Island).  This allows customers the option to island-hop, and provides Castle cross-selling opportunities.  Our Honolulu headquarters serves as the epicenter for our international operations in Saipan and New Zealand.  Our diverse destinations offer customers the opportunity to discover new experiences and varying geographic areas and 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 hotel s with up to 450 guest rooms.  Our collection of all-suites condominium resorts, hotels, 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 unique strengths.  Our strategy is that we do not promote Castle as a brand name but instead, we focus on our customers, who are the owners of the properties we manage.  As Castle does represent a diverse range of properties it represents, its brand strategy is that one size does not fit all.  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 manageme nt, 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.  

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 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:  

·

Travelers seek personalized recognition, attention, and service.

·

Guests desire hotel and condominium accommodations that impart a sense of place and provide a

unique guest experience.

·

Customers demand 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 a number of 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.

Growth Strategy

The majority of the properties presently managed by Castle are located within the state of Hawaii.  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.  In addition, Castle manages properties in New Zealand and Saipan, while at the same time keeping the option to strategically expand operations into Thailand and Guam.  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.

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 Fina ncial 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 increased by 13% to $4,618,311 and 10% to $12,821,775 for the three and nine months ended September 30, 2010, from $4,092,236 and $11,679,946, respectively, for the comparable periods in 2009.  The increase reflects an increase in revenue from our New Zealand operations of 20%, from $1,739,115 to $2,089,188 for the three months ended September 30, 2010 and 31%, from $4,529,013 to $5,929,371 for the nine months ended September 30, 2010.  Domestic operations experienced a 7% increase in revenues for the three months ended September 30, 2010, from $2,353,121 to $2,529, 123 and a

decrease of 6% for the nine months ended September 30, 2010, from $3,008,877 to $2,821,366.  The increase from New Zealand is attributed to increased demand and a recovery of the travel industry of New Zealand and a strengthening of the New Zealand dollar against the US dollar.  Both domestic and international operations in 2010 were affected by the decreasing room rates in the markets in which our properties are located.  In response to the worldwide weakening of the economy in 2009, the hospitality business experienced severe discounting as travel companies compete to re-capture market share that was substantially reduced during to the worldwide financial crisis.  The trend of decreasing travelers has subsided, and now companies have used a volume strategy to entice travelers to book rooms in order to increase and in some cases maintain market share.

Revenues Attributed from Properties increased from $3,372,415 to $3,827,845, an increase of $455,430 or 14% for the three months ended September 30, 2010 compared to 2009.  For the nine months ended September 30, 2010, Revenues Attributed from Properties increased by $1,542,031 or 16%, from $9,549,368 to $11,091,399.  The increase for the quarter is attributed to an increase in demand in both our domestic and international operations.  Management and Service Revenues decreased by 32% during the third quarter to $489,466 in 2010 from $719,581 in 2009; for the nine months ended September 2010, Management and Service Revenues decreased by 32% to $1,429,376 from $2,110,345.  This decrease is primarily due to lower daily rates leading to decreased revenues at the properties we manage under net contracts, in addition to the loss of one property in the second quarter of 2009 and three properties in the fourth quarter of 2009, partially offset with the addition of three properties in the second quarter of 2009.  

Other Income for the third quarter 2010 was $301,000 compared to $240 for the prior year.  Year to date, Other Income was $301,000 compared to $20,233 for the nine month period.  The increase is a result of the Company receiving a fee for the services it rendered to one of its hotel owners in acquiring a property that the Company had under management.  In exchange for these services, the Company received a 7% ownership interest in the entity that purchased the hotel.  Based on the net asset value of the hotel purchase, the 7% interest was valued at $301,000.

Guaranty

As part of the Company’s purchase of real estate in New Zealand, the Company has guaranteed an amount of up to $3,018,000 to the seller of the real estate and the Company recorded this guaranty as “Other Long Term Obligations” on its balance sheet.  The loan issued upon the purchase of the New Zealand real estate is payable in New Zealand dollars.  Due to the strengthening of the New Zealand dollar against the US dollar, the obligation has been increased to $3,103,178, with the difference of $177,300 and $87,810 recorded as a loss for the three and nine months ended September 30, 2010.

Expenses

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 increased by $419,059 or 13% to $3,670,861 from $3,251,802 for the three months ended September 30, 2010 compared to 2009.  For the nine months ended September 30, 2010 compared to 2009, Property expenses increased by $919,915, or 10% to $10,574,604 from $9,654,689.  These expense increases are in line with the revenue increases and reflect significant cost savings measures through staffing adjustments and other initiatives to match operational expenditures with the lower average rates at the properties we manage.

Compared to the prior year, for the third quarter, payroll and office expenses decreased by $187,357 or 33% to $382,973 from $570,330 and for the nine months ended September 30, 2010, payroll and office expenses decreased by $264,756 or 16% to $1,410,368 from $1,675,124 as the Company adjusted the number of operational and corporate staff positions to the new levels of revenue and activity.  These decreases were experienced despite an increase in Total Revenues of 13% for the quarter and 10% for the nine months ended September 30, 2010 as compared to prior year.

Administrative and general expenses decreased by 52% or $88,620 to $83,189 from $171,809 for the third quarter and 14% or $55,512  to $340,352 from $395,864 for the nine months ended September 2010 compared to prior year.  This decrease was due to variances in professional fees related to our audits and other miscellaneous legal fees; and refunds received related to insurance premiums for the policy period which ended in April 2010.  

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.  EBITDA totaled $481,288 and $ 496,451 for the three and nine months ended September 30, 2010, as compared to $98,295 and ($45,731) in the year earlier period, an increase of $382,993 or 390% for the quarter and an increase of $542,182 or 1,186% for the nine months ended September 30, 2010.   The increase for the third quarter and the nine month period is attributable to the Company receiving a 7% ownership interest in one of the properties it manages, and a leveling off of the deep discounting that occurred in Hawaii during the first and second quarter.

Comparison of Net Income to EBITDA:

	Three months ended Sep 30,		Nine months ended Sep 30,
	2010	2009	2010	2009
Net Income (Loss)	$           (20,447)	$         (251,002)	$          ;(183,964)	$         (817,127)
Add Back:
Income Tax (Benefit) Provision	166,293	(62,435)	117,791	&nbs p;         (121,122)
Net interest expense	97,441	61,671	295,928	164,380
Depreciation	60,701	55,541	178,886	&n bsp;       147,500
Foreign Exchange Loss	177,300	294,520	87,810	580,638
EBITDA-	$          481,288	$            98,295	$          496,451	$           (45,731)

Investments

On July 23, 2010 the Company acquired a 7% interest in the ownership of a hotel located in Hawaii.  The Company received the interest in exchange for the CEO of the Company and the Company assisting the buyers of the hotel in negotiating the purchase, performing due diligence work and other consulting work performed by the CEO and the Company.  The hotel was appraised at $24,000,000 in April of 2010 and was purchased at a discounted price of $17,300,000, of which $13,000,000 was financed through a first mortgage on the hotel.  The Company recognized $301,000 in revenues resulting from the fair value of the ownership interest rec eived.  The amount recognized comprises $188,173 of cash received from the stated amounts of finders and consulting fees and the remaining $112,827 represents the incremental fair value received in connection with the ownership interest.

Depreciation

Castle’s business does not require a great deal of capital expenditure for equipment or fixed assets.  As a result, depreciation expense was $60,701 and $178,886 for the three and nine months ended September 30, 2010, as compared to $55,541 and $147,500 for the same periods last year.

Interest Expense

Interest Expense was $97,441 and $295,928 for the three and nine months ended September 30, 2010, as compared to $61,671 and $164,380 for the same periods last year, and reflects imputed interest on the note payable which was issued in the purchase of real estate.  

Net Income (Loss)

Net loss for the three and nine months ending September 30, 2010, totaled $20,447 and $183,964 as compared to a net loss of $251,002 and $817,127 in the year earlier periods.

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 tot aled $111,265 and $34,958 for the three and nine months ended September 30, 2010, compared to $285,302 and $563,795 in the year earlier periods.

Total Comprehensive Income

Total Comprehensive Income (Loss) for the three and nine months ended September 30, 2010, totaled $90,818 and ($149,006) as compared to $34,300 and ($253,332) in the year earlier periods.  This is primarily a result of the changes in Revenue and Property and Operating Expenses and foreign exchange rates noted above.

Liquidity

Our primary source s of liquidity include available cash and cash equivalents, and borrowing under the credit facility which was secured in October 2008, consisting of a $500,000 term loan and a $200,000 line of credit.   As of September 30, 2010, the Company has utilized $50,000 of the line of credit.  Additionally, our New Zealand subsidiary has an available NZ$300,000 line of credit.  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.  The Company is in compliance with the terms and conditions of these borrowing 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.

Expected uses of cash in fis cal 2010 include funds required to support our operating activities, including continuing to opportunistically and selectively expand the number of properties under our management.   

We experienced a small net loss in the third quarter of fiscal 2010 of $20,447, and our Total Current Assets were maintained at $2.8 million at the end of September 2010 and 2009.  The third quarter of the year is typically the high season for the travel industry in Hawaii and we have established a trend of Operating Profitability in recent quarters as we reported Operating Profits in three of the four previous quarters.  We anticipate a slight increase in current occupancy levels, partially offset by average rate trends and levels for the properties currently under contract for the remainder of 2010.  We will continue our efforts to expand the number of properties under management th rough the remainder of 2010, which will increase the overall revenue stream in 2010. The specific impact of these additions on revenue depends on the timing of when new properties are added during the year.  More importantly, over the past two fiscal years we implemented a number of cost saving and efficiency programs that began to improve our profitability and cash flows.  We are beginning to see the results of our operational changes as we reported positive EBITDA in four of the last five quarters.  Through the third quarter of this year, EBITDA was a positive $496,451 compared to a $45,731 loss for the prior year period. We project that we will continue to improve the overall profitability, cash flows, and working capital liquidity through 2010. This view is based on the following assumptions:

·

An increase in occupancy levels as the global economy stabilizes rather than deteriorates resulting in increased visitor trends to Hawaii and New Zealand.

·

A leveling off of the negative impact on average daily rates at the properties we manage as compared to recent years.

·

Focusing on increasing our properties room revenue throug h increased sales, advertising and marketing efforts.

·

A continuation of the cost savings and efficiency measures put into place which will provide the basis for improved operating trends throughout 2010.  

·

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

Our plans to manage our liquidity position in fiscal 2010 include:

·

Continued improvement in our accounts receivable collection rates which will have a positive impact on our liquidity.

·

Accessing additional sources of debt or equity financing at competitive rates.

·

Continuing with only limited capital expenditures and projects.

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.  Based upon these analyses and evaluations, we expect that our anticipated sources of liquidity will be sufficient to meet our obligations without disposition of assets outside of the ordinary course of business or significant revisions of our planned operations through 2010.

Off-balance sheet arrangements

None; not applicable.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

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, 2010, 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 acting 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 acting 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 to be enumerated by smaller reporting companies.

Item 2. Unregistered Sales of E quity Securities and Use of Proceeds.

Recent Sales of Unregistered Securities

In August of 2010, the non-employee board of directors received a total of 80,000 shares of common stock (10,000 shares each) together with one warrant for each share granted which allows the holder of the warrant to purchase one share of common stock for $1.00.  The stock and warrants were issued as compensation to the board members for their time and efforts in assisting the Company.  The directors receiving stock and warrants abstained from voting on the issuance of the stock and warrants.  The warrants expire at the earlier of five years or 60 days after the Company’s common stock trades for an average price of $3.00 per share for 20 consecutive days.  

Use of Proceeds of Registered Securities

No proceeds were received from the sale of registered securities during the quarter or six month period ended June 30, 2010.

Purchases of Equity Securities by Us and Affiliated Purchasers

On July 23, 2010 the Company acquired a 7% interest in the ownership of a hotel located in Hawaii.  The Company received the interest in exchange for the CEO of the Company and the Company assisting the buyers of the hotel in negotiating the purchase, performing due diligence work and other consulting work performed by the CEO and the Company.  The hotel was appraised at $24,000,000 in April of 2010 and was purchased at a discounted price of $17,300,000, of which $13,000,000 was financed through a first mortgage on the hotel.  The Company recognized $301,000 in revenues resulting from the fair value of the ownership interest received.  The amount recognized comprises $188,173 of cash received from the stated amounts of finders and consulting fees and the remaining $112,827 represents the incremental fair value received in connection with the ownership interest.

Item 3. Defaults Upon Senior Securities.

None; not applicable.

Item 4. Removed and Reserved..

Item 5. Other Information.

(a) Committees of the board of directors

In August 2010 the board of directors reduced the number of members on the Audit Committee to one.  Mr. Rick Humphreys shall be the sole member of the Audit Committee.

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:	11/15/10	By:	/s/Rick Wall
			Rick Wall
			Chief Executive Officer and Chairman of the Board of Directors and Acting CFO