October 30, 2000
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Plan of Operations" including statements regarding the anticipated development
and expansion of the Company's business, the intent, belief or current expectations of the performance of the Company
and the products and/or services it expects to offer and other statements contained herein regarding matters that
are not historical facts, are "forward-looking" statements. Because such statements include risks and
uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements.
Factors that could cause actual results to differ materially from those expressed or implied by such forward-looking
statements include, but are not limited to, the factors set forth in "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Plan of Operations."
GENERAL
The Company is a Utah corporation that earns its revenues primarily by providing management, reservations, and
sales and marketing services to hotels and resorts. The Company primarily operates within the State of Hawaii under
the trade names "Hawaiian Pacific Resorts" and "Castle Resorts and Hotels."
The Company's revenues are derived from management fees, sales & marketing fees, reservation fees, accounting
fees, commissions, incentive fees and other fees from the properties it represents pursuant to the terms and conditions
of its management contracts. The revenues of the properties that are managed by the Company are generally not recorded
as revenues of the Company. The revenues of the Royal Orchid Hotel, however, are recorded as revenues belonging
to the Company. As of July 31, 2000 the Company had a lease agreement for the Royal Orchid Guam Hotel and therefore,
the Company is credited for all of the revenues received by the Royal Orchid Guam, and is also responsible for
all of the operating expenses of the Royal Orchid. The Company is in the final stages of renegotiations with the
owner of the Royal Orchid Hotel, which will limit the Company's financial exposure for any operating losses incurred
by the property.
The Company's operating expenses are comprised of labor, reservations fees and other costs associated with operating
as a management company. The expenses of the properties that are managed by the Company are not recorded as expenses
of the Company, except for the operating expenses of the Royal Orchid Guam, which is operated under a lease agreement
As of July 31, 2000, the Company had 27 management or sales, marketing and reservations contracts covering 2,900
rooms, all except 580 rooms located in four properties, which are situated in Micronesia, being situated within
the State of Hawaii. Under the management contracts, the Company is typically responsible for the supervision and
day-to- day operations of the property in exchange for a base management fee based on gross revenues. In some cases,
the Company also participates in the profitability of the properties it manages and may earn an incentive fee based
on the net operating profits of the property managed. Sales, marketing and reservation fees earned from the properties
are based on the gross revenues of the property. The Company is also reimbursed for direct advertising and marketing
expenditures it makes on behalf of the property, all in accordance with the terms and conditions of the management
contracts. The Company also earns commissions and other fees from the properties managed by providing centralized
purchasing services to the hotel owners. Under these arrangements, the net savings to the property owner from centralized
purchasing are shared between the Company in the form of commissions and to the property owner in the form of cost
savings.
OVERVIEW
The tourism industry has been, historically, seasonal in nature. The Company generally reflects higher revenues
from the fees generated by its properties in the first and third quarters of its operating year, which may cause
expected fluctuations in the Company's quarterly revenues and net earnings. The majority of the Company's properties
under contract are located in Hawaii. The tourism economy of the State of Hawaii has been in a downward trend over
the past few years. The economic crisis in Asia, upon whom Hawaii depends upon for its tourist market has resulted
in a decrease in the eastbound traveler. Although no assurances can be given, management believes that the economy
of the mainland United States will continue to improve, and that the economic crisis in Asia will also show signs
of improvement in the near future. Management also believes that the convention center recently completed in Waikiki
shall allow the State to capture a portion of the lucrative convention travel market, further increasing the demand
for guest rooms.
Revenues grew at a compound annual rate of 24.6% from 1994 through 2000, from $1,118,386 to $4,189,369. The growth
in revenues attained by the Company over the past six years has been substantial, however management gives no assurances
that these increases shall continue in future periods.
The increase in revenues together with smaller increases in operating expenses resulted in the Company being able
to reduce net losses from 1994 through 1996, and record a profit in 1997 and 1998. The loss for 1999 and 2000 is
attributable to the expenses attributable to the Company's expansion efforts in the Pacific Basin and the overall
decline in the tourism industry for the Hawaiian operations. Net losses increased from $922,644 for the nine months
ended July 31, 1994 to a net loss of $1,374,223 for the fiscal year ended July 31, 2000, with the Company reporting
profits in 1997 and 1998. Management is confident that future improvements in operating income through the growth
in revenues coupled with effective cost controls will be obtained, but there can be no assurance that these improvements
to operating income will be realized in future periods.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED JULY 31, 2000 AND 1999
SALES
For the years ended July 31, 2000 and 1999, the Company had total revenues of $4,189,369 and $4,337,283, respectively,
representing a decrease of $147,914 or 3%. The decrease in revenue is attributed to the loss of three management
contracts during the year, which caused management fees to decrease by $789,671, or 22%. This was offset by an
increase in hotel related revenues of $839,666, as the Company opened its lease property located in Guam. At July
31, 2000, the Royal Orchid in Guam was operated under a lease agreement and therefore, the revenues received by
the hotel are recorded as revenues of the Company.
COSTS AND EXPENSES
Operating expenses were $5,484,041 for the year ended July 31, 2000 as compared to $4,696,037 for the prior year,
an increase of $788,004 or 17%. The increase in operating expenses is attributed to the expenses of the Company's
leased property, The Royal Orchid, located in Guam. As of July 31, 2000, the property was operated under a lease
agreement and therefore, the operating expenses of the Royal Orchid are recorded as operating expenses of the Company.
Operating expenses attributed to the Royal Orchid were $1,625,405. Operating expenses for the Company's core business,
management operations, decreased by $837,401, or 18%, from $4,696,037 to $3,858,636.
The following table summarizes the increases and decreases in operating expenses for the fiscal year 2000 as compared
to the prior year by management related operations and hotel related operations:
(In Thousands)
Management Hotel
Operation Operation
Expense Increase(Decrease) Increase
Payroll & Benefits $( 422 ) $ 637
Rent ( 17 ) 138
Reservations Expense ( 140 ) 0
Repairs & Maintenance ( 3 ) 47
Taxes ( 44 ) 12
Advertising ( 68 ) 150
Travel & Entertainment ( 144 ) 13
Professional Fees ( 30 ) 26
Insurance 37 129
Utilities ( 6 ) 309
Office & Supplies ( 3 ) 124
Depreciation & Amortization 23 5
Other Expenses ( 20 ) 35
---------- --------
$( 837 ) $ 1,625
========== ========
As mentioned above, the operations of the Royal Orchid, located in Tumon, Guam commenced in late October of 1999,
and expenses incurred by the Company from opening to July 31, 2000 was $1,625,405. Operating expenses for the Royal
Orchid did not exist for the fiscal year ended July 31, 1999 and therefore, all of the costs incurred during the
fiscal year ended July 31, 2000 represented an increase in operating expenses for the prior year.
Operating expenses for the Company's management operations as compared to the prior year are as follows:
Payroll and benefits decreased by $422,000 as a result of management restructuring its workforce during the fiscal
year and eliminating six positions. In addition, during the year ended July 31, 1999, the Company issued stock
as compensation to an officer of the Company and recorded an expense of $41,000.
Reservations expense decreased by $140,000 due to the Company purchasing all of the outstanding stock of Hawaii
Reservations Center Corp. in April of 2000, and due to the decrease in the number of rooms represented by the Company.
Taxes decreased by $44,000 as a result of the Company's revenues from management related activities decreasing
by $1,080,000. The taxes represent sales taxes imposed by the State of Hawaii on all gross income received from
sources within the State of Hawaii.
Advertising and Marketing expenses decreased by $68,000 as a result of the renegotiation of the Company's foreign
sales offices. The Company has three offices in Europe and one in Japan, and was successful in renegotiating the
compensation paid to these offices to be based more on performance rather than a flat fee.
Travel and Entertainment expenses decreased by $144,000, as the Company completed the opening of its Micronesian
properties during the prior fiscal year. The opening of properties located in Chuuk, Saipan and Guam entailed increased
travel to these destinations for pre- opening related matters during the fiscal year ended July 31, 1999. For the
fiscal year ended July 31, 2000, travel to these areas was limited.
Professional fees decreased by $30,000 as during the prior fiscal year ended July 31, 1999 the Company recorded
an expense of $31,000 for the exercise of warrants previously issued to Van Kasper & Company.
Insurance expenses increased by $37,000 as a result of increases in premiums paid by the Company for its insurance
coverage. The insurance coverage includes foreign liability premiums for the Company's operations at three properties
in Micronesia.
Depreciation & Amortization expense increased by $23,000 due to the Company amortizing the cost of acquiring
a contract through the issuance of 130,000 shares of its common stock. The common stock was issued as consideration
for a new management contract and is being amortized over the five-year life of the contract. In addition, the
Company recorded goodwill of $366,817 related to its acquisition of Hawaii Reservations Center Corp. that is being
amortized over a twenty-year period.
Other expenses decreased by $20,000 as the Company reduced the amount of dues, subscriptions and membership fees
paid to various organizations and associations. In addition, the Company experienced decreases in computer service
expenses of $8,000 as it installed its computer network systems during the prior fiscal year ended July 31, 1999.
NET LOSS
The Company reported a net loss of $1,374,241 and $487,458 for the fiscal years ended July 31, 2000 and 1999, respectively.
Included in the losses for the fiscal year ending July 31, 2000 is a loss of $690,995 that the Company incurred
for its leased property located in Guam that opened in late October of 1999. The Company has elected to expense
all of these costs rather than capitalize them as pre-opening expenses.
FOR THE YEARS ENDED JULY 31, 1999 AND 1998
SALES
For the years ended July 31, 1999 and 1998, the Company had total revenues of $4,337,283 and $5,609,619, respectively,
representing a decrease of $1,272,336 or 23%. The decrease in revenue was attributable to a decrease of $1,247,320
in hotel revenues, and a decrease of $25,016 in management and other management related income. The decrease in
hotel revenues is due to the Company terminating its lease of 167 rooms operated as a hotel in April of 1998. The
decrease in management related income is due to the loss of $75,000 in fees on the management contracts for two
of the Company's properties in December of 1998. The Company was successful in increasing its total fees from the
management contracts of its other properties.
COSTS AND EXPENSES
Operating expenses were $4,696,037 for the year ended July 31, 1999 as compared to $5,480,813 for the prior year,
a decrease of $784,776 or 14.3%. Operating expenses for management related operations increased by $529,506 or
12.7% while operating expenses for hotel operations decreased by $1,314,284 due to the Company terminating its
lease on a hotel property in April 1998.
Payroll and related costs for management operations increased by $257,000 as a result of the Company increasing
it's staffing to service the expansion and anticipated future growth of the Company into the Pacific Basin region.
Reservation Expenses increased by $130,000 as a result of an increase in the room revenues from the properties
represented by the Company. Reservations expenses are based upon the room revenues of the hotels and resorts managed
by the Company. Total room revenues increased by $4.8 million during the fiscal year ended July 1999 when compared
to the prior year.
Rent expense decreased by $605,000 or 61.9% when compared to the prior year due to the Company terminating its
lease on a 167-room hotel effective April 1998 and the renegotiation of the monthly lease rents on the Company's
corporate offices. Rents related to the lease of the hotel decreased by $554,200.
Sales & Marketing expense increased by $142,000 as the Company increased its presence in the international
marketplace through the opening of foreign offices. The Company opened offices in Japan and Europe during the fiscal
year ended July 31, 1998 in order to secure additional sources of international business for the properties it
represents. Additionally, the Company expended $20,000 in pre-opening marketing efforts for properties that the
Company will represent in the future but have not yet opened as they are in the process of being constructed.
Taxes decreased by $38,000 as a result of the Company terminating its lease on a 167-unit hotel in April of 1998.
The Company incurred taxes of $42,656 on the property for the fiscal year ended July 31, 1998.
Travel and entertainment expenses increased by $40,000 when compared to the prior year as a result of the Company's
expansion into the Pacific Basin region. Travel costs associated with the acquisition and pre-opening of the properties
located within the Pacific Basin was $60,000 for the fiscal year ended July 31, 1999.
Repairs and maintenance expenses decreased by $242,000 as a result of the non-existence of the repair & maintenance
expenses associated with the Company's lease of a 167-room hotel in fiscal 1998. The lease was terminated in April
of 1998 and in the fiscal year ended July 31, 1998, incurred repairs and maintenance expenses of $233,347.
Other expenses decreased by $72,000 as a result of the non-existence of the other expenses associated with the
Company's lease of a 167- room hotel in fiscal 1998. The lease was terminated in April of 1998 and in the fiscal
year ended July 31, 1998, incurred other expenses of $82,545.
Interest expense increased by $58,000 for the year ended July 31, 1999 as compared to the prior year. The increase
in interest expense is attributed to the Company securing and drawing on an additional bank loan and line of credit
during fiscal 1999. (See Note 5 to the consolidated financial statements).
NET INCOME (LOSS)
The Company reported a net loss of $487,458 and a net income of $58,133 for the fiscal years ended July 31, 1999
and 1998, respectively.
Included in the losses for the fiscal year ending July 31, 1999 were non-operational and pre-opening costs of $174,400
which were a result of the issuance of common stock, travel and other pre-opening costs and expenses related to
the Company's unsuccessful underwriting of its common stock.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of working capital are cash flows from operations and borrowings. Net cash used for
operations was $537,003 in fiscal 2000 and $606,906 in fiscal 1999. The Company had unrestricted cash of $120,681
and $93,440 at July 31, 2000 and 1999, respectively.
At July 31, 2000, the Company's balance sheet reflected $120,681 of cash representing an increase of $27,241 from
July 31, 1999. During the year ended July 31, 2000, cash used in operating activities exceeded cash provided by
operating activities by $537,003. Cash used in investing activities was $785,067 and cash provided by financing
activities was $1,349,311.
During the fiscal year ended July 1999, the Company sold 8,550 shares of Preferred Stock at a gross price of $100
per share through private placements. Dividends are cumulative from the date of original issue and are payable
semi-annually, beginning July 15, 1999 at a rate of $7.50 per annum per share. During the fiscal year ended July
2000, the Company sold an additional 2,500 shares. Dividends of $16,715 were paid to holders of the Preferred Stock
during the fiscal year ended July 2000. The shares are nonvoting and are convertible to the Company's common stock
at $3.00 per share.
The Company has a $200,000 line of credit with a bank dated May 25, 1999, which is secured by the Company's accounts
receivable, furniture, fixtures and equipment and is personally guaranteed by the Company's Chief Executive Officer.
The Company made draws against the line of credit of $100,000 during the fiscal year ended July 31, 1999. The line
of credit bears interest at 3% above the bank s base rate and is the due on the line has been extended to November
30, 2000.
The Company has a $400,000 term loan with a bank dated May 25, 1999, which is secured by the Company's accounts
receivable, furniture, fixtures and equipment and is personally guaranteed by the Company's Chief Executive Officer.
The term loan bears interest at the rate of 9.25% with monthly payments of $8,352 and is due on May 25, 2004.
The Company had a net working capital deficit of $1,232,566 as of July 31, 2000 and net working capital of $122,413
as of July 31, 1999.
As of July 31, 2000, net working capital included liabilities due to related parties in the amount of $273,460
consisting of $159,960 in notes and interest payable to former stockholders of KRI, Inc. (representing the undistributed
cost on the acquisition of the stock of KRI, Inc.), and $113,500 in notes payable to officers who advanced funds
to the Company. Also included in net working capital is $94,691 in unamortized deferred revenues related to a signing
bonus paid in cash to the Company by one of its vendors in May of 1998 as a result of the Company entering into
a three year contract with the vendor and a tenant improvement allowance received upon the renegotiation of the
lease rent for the Company's principal office. The deferred revenues related to the signing bonus are being amortized
over three years and the tenant improvement allowance is being amortized over the length of the office lease.
At July 31, 2000, accounts payable increased by $1,096,654 over the prior fiscal year, to $2,012,748. The increase
in accounts payable is attributable to the Company commencing operations at the Royal Orchid located in Guam, which
as of July 31, 2000 had accounts payable of $743,771. The balance of the expenses are related to legal and other
fees related to the Company's exploring and negotiating the potential acquisition of other management companies
At July 31, 1999, the Company's accounts receivable consisted of $1,198,652 in management related revenues and
reimbursements, and $533,293 of hotel related revenues. Fifty one percent (51%) of the total accounts receivable
was current, twenty percent (20%) was 30 to 60 days past due, nine percent (9%) was 60 to 90 days past due, and
twenty percent (20%) was more than 90 days past due.
At July 31, 2000, the Company had a receivable balance of $1,105,001 from Hanalei Bay International Investors ("HBII"),
representing fees and reimbursed expenses charged to HBII through March of 1999. HBII sold its principal asset,
the Hanalei Bay Resort in March of 1999. Upon the closing of the sale, the Company received $468,000, which was
applied to the $435,000 note receivable and accrued interest due from HBII (see Note 3 to the Consolidated Financial
Statements). The funds received by HBII upon the closing of the sale were insufficient to make full payment to
the Company for its accounts receivable balance. Under the terms of the sale, in addition to the sale proceeds
to be received, HBII shall share in the future cashflows generated by timeshare unit sales located within the Hanalei
Bay Resort, after certain secured and preferential payments are made. HBII shall make payments to the Company through
the funds received from the future cashflows generated by the timeshare sales of the Hanalei Bay Resort units (see
Note 2 to the Consolidated Financial Statements). Although no assurances can be given, management is confident
that the Company shall receive payment in full of its accounts receivable balance from HBII. Certain members of
the Board of Directors of the Company have a direct or indirect financial interest in HBII (See Item 12).
Subsequent to July 31, 2000, HBII executed two assignments of its interest in the future cashflows generated by
the timeshare unit sales of the Hanalei Bay Resort. The first assignment is for $1,105,001, which represents the
outstanding receivable balance due to the Company by HBII. The second assignment is for $3,315,003, which represents
an additional amount negotiated between the Company and HBII, in exchange for the Company allowing the sale of
the Hanalei Bay Resort to proceed even though the Company was not paid in full from the cash proceeds received
at closing. Although no assurance can be given, the Company expects to begin collecting funds from the assignment
within the next twelve to eighteen months.
In January of 1998, two officers loaned the Company $50,000 and $60,000, respectively and the Company executed
a note that called for interest at the rate of 8.5% and a due date of April 15, 1998. In July of 1998, one of the
officers advanced an additional $60,000 to the Company. In April of 1999, the note to one of the officers was fully
repaid. The note to the other officer was refinanced into a new note that included the portion of the undistributed
sales proceeds to the former KRI, Inc. stockholders (see Item 1-Description of Business, "Development of Business").
The terms of the new note call for monthly payments of $2,000 per month and interest at the rate of ten percent
(10%) per annum. The note was due and payable on August 15, 2000, and was extended for an additional year to August
15, 2001.
In July of 1998, the Company funded a loan of $435,000 to Hanalei Bay International Investors ("HBII").
The terms of the loan called for interest at the rate of 12% per annum and a percentage of the future cashflows
received from timeshare sales by the partners of HBII. The loan was due on or before March 31, 1999 and was fully
retired in March of 1999 through the payment of $468,000 from the sale proceeds received by HBII.
In July of 1998, a director of the Company advanced $175,000 and the Company executed a note, which called for
interest at the rate of 10% per annum and a due date of March 31, 1999. The note was fully paid in March of 1999.
In addition to the return of principal plus interest, warrants on the Company's common stock was issued to the
director. (See Item 11, Security Ownership of Certain Beneficial Owners and Management).
In July of 1998, the Company received loans of $200,000 from four unrelated parties. The terms of the notes call
for interest at the rate of 10% per annum and a due date of March 31, 1999. The loans were fully paid in March
of 1999. In addition to the return of principal plus interest, warrants on the Company's common stock were also
issued. (See Item 11, Security Ownership of Certain Beneficial Owners and Management).
In July 1999, the Company issued 61,157 shares of restricted common stock to the lessor of a hotel as part of a
security deposit. The lessor is prohibited from selling these shares in public trading and will return the shares
to the Company at the termination of the lease agreement in the year 2004. The Company recorded the common stock
held by the lessor as a contra equity item in the Consolidated Balance Sheet.
In April of 2000, an officer funded a note of $300,000 to the Company, and the proceeds were used for the acquisition
of Hawaii Reservations Center Corp. and for working capital. The terms of the note call for interest at 10% per
annum and monthly payments of $9,642.03. The note and any unpaid interest is due in full on March 31, 2003.
In April of 2000, the company received funds of $125,000 from an unrelated party and entered into a promissory
note, with the proceeds being used to fund the acquisition of Hawaii Reservations Center Corp. The terms of the
note call for interest of one-third of the profits generated by Hawaii Reservations Center Corp. Interest is payable
quarterly, and the principal and any unpaid interest is due on December 31, 2003.
During the fiscal year ended July 31, 1999, the Company issued 8,550 shares of its convertible preferred stock.
The preferred stock calls for a cumulative dividend of 7.5%, payable semi-annually, when and if, declared by the
board of directors of the Company. Certain officers and directors of the Company purchased shares of the preferred
stock, either directly or indirectly through other entities or family members, during fiscal 1999; Mr. Thomas Blankley,
Jr., 1,500 shares; Mr. Judhvir Parmar, 1,000 shares; and Mr. K. Roger Moses, 300 shares.
During the fiscal year ended July 31, 2000, the Company declared and paid a dividend of $16,715 to holders of record
as of January 15, 2000. During the fiscal year ended July 31, 2000, the Company issued an additional 2,500 shares
of preferred stock. Of the shares issued during fiscal 2000, 2,000 shares were issued as consideration for the
outstanding balances due to HRCC prior to the Company's purchase of HRCC in April of 2000. An officer of the Company,
Mr. Thomas Blankley, Jr., purchased the remaining 500 shares issued.
During the fiscal year ended July 31, 2000, the Company issued 130,000 shares of its common "unregistered"
and "restricted" common stock to the owner of one of its properties in exchange for a five-year management
contract. The management contract took effect on January 1, 2000 and the Company's stock was issued and valued
as of that date at $1.75 per share, which was the closing price on December 31, 1999. The value of the shares was
recorded as an intangible asset on the books of the Company and is being amortized over the five-year life of the
management contract.
During the fiscal year ended July 31, 2000, the Company issued 391,024 shares of its common "unregistered"
and "restricted" common stock to various individuals and entities for $1.25 per share. In addition to
the shared, the Company granted a warrant for each share purchased under the private placement, which entitles
the purchasers to purchase on additional share of the Company's common stock for $1.50 per share, exercisable at
any time prior to July 15, 2002. Under the private placement, certain directors of the Company purchased shares
of the Company's common stock either directly or indirectly: Mr. Judhvir Parmar, 120,000 shared; Mr. K. Roger Moses,
20,000 shares; Mr. Roy Tokujo, 80,000 shares; and Mr. Stanley Mukai, 40,000 shares.
The Company has, in the past, met its financial obligations through borrowings from banks and related parties and
the issuance of preferred and common stock. The Company will continue in its efforts to raise additional equity
through the issuance of its common stock through private placements in order to fund its operations and expansion
plans. The Company believes, although no assurance may be given, that it shall begin to collect its receivable
balance from HBII within the next twelve to eighteen months. Management also believes that the Company shall have
sufficient cash flows for its business operations during fiscal 2001.
The Company has done preliminary research and due diligence in attaining growth through the acquisition of other
management companies throughout the Pacific Basin.
PLAN OF OPERATIONS
The Company is one of the leading regional hotel and resort management companies within the State of Hawaii. At
July 31, 2000, the Company had 27 management or sales, reservations and marketing contracts covering 2,900 rooms.
The Company has a wide range of product available to the leisure traveler, from luxury condominium resorts with
room rates exceeding $1,500 per night to the small budget inns with a rates under $40. The Company has also expanded
its base to include other Pacific Basin destinations such as Saipan, Guam, Chuuk and most recently, New Zealand.
The Company believes that the availability of differing product lines and provides appeal to more levels of business
or leisure traveler, while the diversity of geographic locations helps by not making the Company dependent upon
the economies of one particular region.
The Company has experienced successful growth in the past, almost doubling the number of rooms under management
since it began in 1994. During the fiscal year ended July 31, 2000, the Company lost management contracts on three
of its properties, representing approximately 500 rooms. It is common in the management industry to acquire and
lose management contracts on an annual basis, and it should be noted that all three of the properties that it lost
during the fiscal year were due to changes in the use of the properties; two of the properties converted to long
term rental use and the other shifted its focus on strictly timeshare interval sales. Since 1994, the Company has
acquired the bulk of its contracts from its competitors and has only lost only two over the Company's six years.
The Company plans to expand by entering into various types of agreements with properties which is not limited to
a "full" management agreement under which the day to day operations as a whole of the property is the
responsibility of the Company. The Company has the flexibility to tailor its services based upon the needs and
desires of each property owner. Agreements may take the form of full management contracts or sales & marketing
contracts or reservation agreements. With the acquisition of Hawaii Reservations Center Corp. the Company intends
to aggressively seek independent properties in need of an efficient central reservations department.
On August 1, 1997, the Company was successful in entering the foreign market of the Pacific Basin when it signed
a management agreement with the Aquarius Beach Tower, a 68-unit luxury condominium resort located in Saipan. On
January 1, 1999, the Company acquired the management contract for a 56-unit hotel located in Chuuk. In March of
1999 the Company entered into a lease agreement for the Royal Orchid Hotel, a five star 205-unit hotel located
on Tumon Bay, Guam. In January of 1999, the Company signed an agreement as co-lessee for an uncompleted 200 unit
hotel located in the Cook Islands. In May of 2000, the Company signed an agreement to manage a 249-unit condominium
project in Takapuna, New Zealand, which is currently under construction and scheduled to open in May of 2001. Management
will continue to seek expansion in the Pacific Rim area through the assistance of its geographically diverse board
of directors.
Although no assurance can be given, the Company plans to expand its portfolio of management contracts both within
the State of Hawaii and outside of Hawaii and to increase its exposure in Micronesia and other Pacific Basin destinations.
In addition to Hawaii, management believes that there are many opportunities to expand its client base in the emerging
markets of the Pacific Basin. In addition to signing on independent hotels and resorts, the Company may achieve
its desired goals through joint venture investments, leases and/or acquisitions of management contracts and/or
companies. Currently, the Company is engaged in various stages of discussions for management of several properties
located both within Hawaii and the Pacific Basin area, as well as exploring the possibility of the acquisition
of other management companies in the region.
The Company finalized a contract for a management agreement on a brand new 249-unit condominium projects to be
constructed in Takapuna, New Zealand. The terms of the lease call for the Company to pay a lease determined by
a percentage of the total cost of developing the property, estimated to be NZ $56 million. The property recently
broke ground and construction is ongoing on the project, with opening currently scheduled for May of 2001. Although
no assurance can be given, management is confident that the Company shall attain acceptable profit levels from
the management of this property.
The Company continues to negotiate with other properties located in Hawaii and the Pacific Basin and is optimistic
that it will be successful in securing additional contracts during the coming fiscal year.
The Company experienced losses during the fiscal year July 2000 as expenses and overhead were incurred in anticipation
of the commencement of operations in Guam and other projects that will be coming on-line within the next twelve
to eighteen months.
The Company is in the final stages of renegotiations with the owner of the Royal Orchid Hotel and management is
confident, although no assurance may be given that it will be successful in finalizing an agreement that will limit
the Company's financial exposure for any operating losses incurred by the property.
Although no assurances can be given, management is optimistic that the Company will attain profitability once the
renegotiation is finalized, the operations of the property in Guam mature, and the New Zealand property opens.
With the increase in the number of management contracts, the number of hotel and resort employees that the Company
will supervise may increase significantly. The Company is presently negotiating for both small budget hotels and
large luxury condominium resorts and therefore, it is impossible at this time to predict the number of additional
employees that it will supervise or that it will be required to hire for the hotels and resorts during the next
fiscal year.
On July 31, 1995, the Company invested $100,000 into a reorganization plan instituted by HBII. Under terms of the
HBII reorganization plan, the eighty-seven units owned by HBII will be sold under a timeshare plan and investors
in the timeshare plan may receive up to four times their investment over the life of the timeshare plan. As of
July 31, 2000, the Company has received a total of $175,516 from this investment. Of the funds received, $43,879
represents a return of the initial investment and $131,637 represents a gain to the Company. At July 31, 1999,
the balance of the investment was $56,121. The Company has classified the remaining principal balance as a due
from related party as the principal asset of HBII, the units located in Hanalei Bay Resort, was sold in 1999.
Subsequent to July 31, 2000, HBII executed two assignments of its interest in the future cashflows generated by
the timeshare unit sales of the Hanalei Bay Resort. The first assignment is for $1,105,001, which represents the
outstanding receivable balance due to the Company by HBII. The second assignment is for $3,315,003, which represents
an additional amount negotiated between the Company and HBII, in exchange for the Company allowing the sale of
the Hanalei Bay Resort to proceed even though the Company was not paid in full from the cash proceeds received
at closing. Although no assurance can be given, the Company expects to begin collecting funds from the assignment
within the next twelve to eighteen months.
In March of 1999, HBII sold its principal asset, the Hanalei Bay Resort and the sale proceeds received at closing
was insufficient to retire the investment by the Company. Under the terms of the sale, in addition to the sale
proceeds received at closing, the current HBII partners shall share in the future cashflows generated by timeshare
sales of the units located within the Hanalei Bay Resort, after certain secured and preferential payments are made.
HBII shall make payments to the Company through the funds received from the future cashflows generated by the timeshare
sales of the Hanalei Bay Resort units (see Note 2 to the Consolidated Financial Statements). Although no assurances
can be given, management is confident that the Company shall receive payment in full of its receivable balance
from HBII. Certain members of the Board of Directors of the Company have a direct or indirect financial interest
in HBII (See Item 12).
On August 1, 1994, the Company entered into a contract with Hawaii Reservations Center Corp. ("HRCC"),
a company controlled by Charles M. McGee, pursuant to which HRCC shall provide reservation services for hotels
and resorts managed by the Company. At the time of entering into the contract, Mr. McGee was a director of the
Company. Mr. McGee tendered his resignation as a member of the board of directors on February 16, 1999. Since the
purchase of KRI, reservation services have been provided by KRI. The fees to be paid by the Company include a fixed
monthly fee plus commissions. The Company also agreed to sell to HRCC the assets of the reservation offices of
KRI, which consisted of office equipment. As consideration for the equipment, HRCC agreed to employ the reservation
department employees of KRI and to assume the liability for the accrued vacation of such employees. KRI realized
a gain of $4,372 on the transaction, as the value of the accrued vacation exceeded the net book value of the office
equipment sold. In May of 1997, the Company renegotiated its contract with
HRCC with regard to the fees charged. Under the renegotiated agreement, the fees paid to HRCC is based upon the
monthly room revenues of the properties managed by the Company, subject to a minimum monthly fee. It is management's
belief that the contract with HRCC are on terms which are no less favorable than those which could be negotiated
with companies not affiliated with the Company.
On April 30, 2000, the Company purchased all of the outstanding stock of Hawaii Reservations Center Corp. ("HRCC")
from Mr. Charles McGee, a former director of the Company. Immediately prior to the Company's purchase of HRCC,
the assets of HRCC except for accounts receivable of $12,400 and furniture & equipment were distributed to
Mr. McGee. Under the terms of the purchase agreement, the Company paid as consideration $350,000 for 100% of the
outstanding stock of HRCC and assumed liabilities of $26,817. The Company allocated $10,000 of the purchase price
to the value of the furniture and equipment of HRCC, and recorded $366,817 of goodwill, which shall be written
off over 20 years. In addition, prior to the acquisition of the stock of HRCC, the Company issued 2,000 shares
of its $100 par value Preferred Stock to Mr. McGee in settlement of the accounts payable of the Company due to
HRCC for past reservation services.
THE TOURISM INDUSTRY
The majority of the Company's properties under contract are located in Hawaii. According to WTTC Hawaii Tourism
Report 1999 published by the World Travel and Tourism Council, tourism is Hawaii's largest industry, providing
26.3% of the Gross State Product. It is estimated that in 1998, tourism accounted for approximately 32.1% of the
State's total work force. The outlook for 1999 is forecasted to be relatively flat due to the economic prospects
in the Asian visitor market, with a projected decrease in visitors of 2.6% from Japan and 11.6% from Korea. The
outlook for the calendar year 2000 and beyond, however, is a forecasted average growth of 4.3% per annum over the
next twelve years, which exceeds U.S. expectations of 2.6% and worldwide expectations of 3.4%. The World Travel
and Tourism Council is also projecting that the recently completed Hawaii Convention Center will have a positive
impact on the Hawaii tourism market. Projections call for the Hawaii Convention Center attendees and delegates
to add $126 million in visitor exports in 1999, increasing to $362 million annually by the year 2004. Management
believes that the economy of the mainland United States will continue to improve, the recently completed Hawaii
Convention Center shall attract new business to the State of Hawaii and that the recent economic crisis in Asia
will improve in the near future and, therefore, that the tourism industry of Hawaii as a whole will experience
future growth in earnings.
GROWTH STRATEGY
The Company believes that the improving tourism industry together with the current economic environment will provide
excellent opportunities for future growth. Under the current economy of the Hawaii hotel industry, the Company
is able to provide more benefits to the owners of properties which are under performing in the form of economies
of scale in advertising, reservations, sales and marketing which should translate to higher revenues and profitability
for the property.
Since the Company allocates the cost of expenditures to all of the managed properties, property owners would enjoy
a substantial increase in the exposure to the general public, travel agents and wholesalers than an independent
hotel could accomplish. The Company also provides this at a much lower cost than an independent hotel could. The
operational expertise provided by the Company would also assist the property owner in reducing operating expenses
in the areas of staffing and central purchasing. Other contributing factors to the future growth of the Company
over the next few years are:
Existing Contracts. The Company has been successful in improving or maintaining the performance for its properties
over the past few years in spite of the decrease in the Hawaii tourist market. Further improvements in revenues
and net operating profits for the Company's current portfolio of properties will result in higher management fees
for the Company. The additional fees from the Company's current portfolio of properties would generally not entail
additional incremental expenses to the Company. Instead, an expansion of the Company's management contract portfolio
would provide better savings to the existing properties, which in certain contracts would translate into higher
management incentive fees.
Additional Contracts. Although no assurance can be given, management believes that it will be successful in attaining
additional management contracts in the future. Opportunities for additional contracts may arise from a myriad of
factors that include sales of properties, foreclosures, underperformance and dissatisfaction with current management.
A number of properties in Hawaii are under performing and cannot generate the cashflow necessary to service the
debts of the properties. Many of these properties were purchased by Japanese investors at the height of the Asian
bubble of the mid to late 1980s. Management has a proven track record over the past six years in improving the
performance of the properties it manages. Management is constantly looking for properties in need of the Company's
services.
Emerging Markets. The Company currently has the majority of its contracts located within the State of Hawaii. Management
believes that there are emerging markets in which the services provided by the Company will be needed. These areas
include Guam, Saipan, Chuuk, New Zealand and other Pacific Basin regions. Management has been successful in securing
management contracts for four properties throughout the Pacific Basin, on of which is scheduled to open within
the next eight months. Although no assurance can be given, management is confident that it will be able to continue
to be successful in acquiring additional management contracts in the Pacific Basin and enhance the profitability
of these properties through the services it provides.
Acquisitions. The Company may also seek opportunities to acquire other hotel management contracts and/or companies
that would result in further synergies for the Company and its managed properties. The Company has had preliminary
discussions and investigated and researched the potential acquisition of other management companies throughout
the Pacific Basin.
ITEM 7. FINANCIAL STATEMENTS
The financial statements of the Company have not been audited as of this filing date due to a change in the independent
auditors of the Company. The Company shall file Form 10K-SB/A and include the audited financial statements upon
the completion of the audit.
FINANCIAL STATEMENTS Page No.
Consolidated Balance Sheets - July 31, 2000 and 1999 31
Consolidated Statements of Operations for the years ended July 31, 2000 and 1999 33
Consolidated Statements of Stockholder's Equity for the years ended July 31, 2000 and 1999 34
Consolidated Statements of Cash Flows for the years ended July 31, 2000 and 1999 35
Notes to Consolidated Financial Statements 37
The Castle Group, Inc. and Subsidiary Consolidated Balance Sheets For the years ended July 31, 2000 and 1999 (Unaudited)
ASSETS
2000 1999
-----------------------
Current Assets
Cash $ 120,682 $ 93,440
Accounts receivable, less allowance for
doubtful accounts of $28,612 & $60,311
in 2000 and 1999, respectively 1,703,333 1,285,448
Due from related parties,
current (Note 2) 0 428,316
Notes receivable, current (Note 3) 70,184 110,300
Prepaid Expenses 189,029 164,667
Restricted Cash 19,941 19,941
-----------------------
Total current assets 2,103,169 2,102,112
Furniture, Fixtures and Equipment,
net (Note 1) 66,786 46,475
Due from related party,
noncurrent (Note 2) 1,105,001 635,537
Notes Receivable, Noncurrent (Note 3) 0 35,900
Deposits 324,970 183,281
Investment in HBII Timeshare Program 0 56,121
Intangible Assets, net (Note 1) 563,190 0
-----------------------
Total assets $ 4,163,116 $3,059,426
=======================
The accompanying notes are an integral part of the consolidated financial statements
The Castle Group, Inc. and Subsidiary Consolidated Balance Sheets For the years ended July 31, 2000 and 1999 (Unaudited)
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIENCY)
2000 1999
-----------------------
Current Liabilities:
Accounts payable $ 2,012,748 $ 916,094
Vacation payable 101,729 107,349
Wages payable 114,589 82,771
Taxes payable 77,977 25,629
Due to related parties,
current (Note 2) 257,100 162,299
Notes payable, current (Note 5) 273,400 173,300
Deferred income (Note 1) 94,691 91,008
Other accrued liabilities 403,501 421,249
-----------------------
Total current liabilities 3,335,735 1,979,699
Due to Related Parties,
noncurrent (Note 2) 199,352 42,975
Notes Payable, noncurrent (Note 5) 375,062 322,606
Deferred Income (Note 1) 37,856 70,368
-----------------------
Total liabilities 3,948,005 2,415,648
-----------------------
Commitments and Contingencies (Note 4)
Redeemable Preferred Stock, $100 par
value, 50,000 shares authorized, 8,550
shares issued & outstanding in 1999
(see Note 7) 0 871,715
Stockholders' Equity
Preferred Stock, $100 par value, 50,000
shares authorized, 11,020 & 8,500 shares
issued and outstanding,in 2000 & 1999,
respectively (Note 7) 1,105,000 0
Stockholders' Equity (Deficiency) (Note 8):
Common stock, $.02 par value, 20,000,000
Shares authorized, 5,928,055 & 5,407,031
issued and outstanding in 2000 and
1999, respectively 118,561 108,141
Common stock held by lessor (111,641) (111,641)
Capital in excess of par 3,370,828 2,668,956
Accumulated deficit (4,267,637) (2,893,393)
----------------------
Total stockholders' equity (deficiency) 215,111 ( 227,937)
----------------------
Total liabilities and stockholders'
equity (deficiency) $4,163,116 $3,059,426
======================
The accompanying notes are an integral part of the consolidated financial statements
The Castle Group, Inc. and Subsidiary Consolidated Statements of Operations For the years ended July 31, 2000 and
1999 (Unaudited)
2000 1999
Revenues:
Hotel revenue and management fees
(includes excise tax of $130,345 and
$173,005 in 2000 and 1999 $ 3,773,806 $ 4,032,122
Other income 415,563 305,161
-----------------------
Total revenues 4,189,369 4,337,283
-----------------------
Expenses:
Payroll and benefits 2,460,603 2,291,910
Reservations services 839,595 979,759
Rent 493,538 372,078
Sales and marketing 434,021 352,346
Taxes 142,133 174,058
Travel and entertainment 30,994 157,405
Professional fees 147,072 106,266
Insurance 234,591 68,825
Office & Supplies 169,882 49,003
Utilities 350,437 47,505
Depreciation and amortization 55,797 28,192
Repairs and maintenance 64,424 20,073
Other 60,954 48,617
----------------------
Total expenses 5,484,041 4,696,037
----------------------
Income (Loss) from Operations (1,314,672) (358,754)
Other Expenses:
Interest expense 79,569 128,704
-----------------------
Net Income (Loss) $(1,374,241)$( 487,458)
=======================
Per Common Share Data (Note 8):
Basic earnings (loss) $ (0.23) $ (0.09)
Diluted earnings (loss) $ (0.23) $ (0.09)
The accompanying notes are an integral part of the consolidated financial statements
The Castle Group, Inc. and Subsidiary Consolidated Statements of Stockholders' Equity (Deficiency) For the years
ended July 31, 2000 and 1999 (Unaudited)
Stock
Subscribed Stock Capital in
Stock and Held By Excess of Accumulated
Shares Amount Unissued Lessor Par Deficit Total
Balance July 31, 1998 5,311,130 106,223 - - 2,539,175 (2,405,938) 239,460
Exercise of common stock
warrants 12,244 245 - - 30,559 - 30,804
Issuance of common stock
as compensation 22,500 450 - - 40,331 - 40,781
Costs related to issuance
of redeemable preferred
stock (Note 7) - - - - (34,812) - (34,812)
Redeemable preferred stock
dividend accrual (Note 7) - - - - (16,715) - (16,715)
Issuance of common stock
to lessor (Note 8) 61,157 1,223 - (111,641) 110,418 - -
Net loss for the year
ended July 31, 1999 - - - - - (487,458) (487,458)
---------------------------------------------------------------------------
Balance July 31, 1999 5,407,031 $108,141 $ - $(111,641) $2,668,956 $(2,893,396) $ (227,941)
Common Stock Sold 391,024 7,820 - - 476,972 - 484,792
Issuance of common stock
For contract 130,000 2,600 - - 224,900 - 227,500
Net loss for the year
Ended July 31, 2000 - - - - - (1,374,241) (1,374,241)
---------------------------------------------------------------------------
Balance July 31, 2000 5,928,055 118,561 - $(111,641) 3,370,828 (4,267,637) ( 889,889)
---------------------------------------------------------------------------
Preferred Stock at
July 31, 1999 8,550 855,000 - - - - 855,000
Accrued Dividends on
Preferred Stock - - - - - - 16,715
--------------------------------------------------------------------------
Balance July 31, 1999 8,550 855,000 - - - - 871,715
Issuance of preferred
Stock 2,500 250,000 - - - - 250,000
Payment of dividends
On preferred stock - - - - - - (16,715)
---------------------------------------------------------------------------
Preferred stock at
July 31, 2000 11,050 1,105,000 - - - - 1,105,000
---------------------------------------------------------------------------
Stockholders' Equity
At July 31, 2000 n/a n/a - - - - 215,111
===========================================================================
The accompanying notes are an integral part of the consolidated
financial statements
The Castle Group, Inc. and Subsidiary Consolidated Statements of Cash Flows For the Years ended July 31, 2000 and
1999 (Unadited)
2000 1999
Cash Flows from Operating Activities:
Net Income (loss) $(1,374,241) $( 487,458)
Adjustments to reconcile net loss to
net cash used in operating activities-
Depreciation and amortization 59,877 28,192
Issue of common stock as compensation - 40,781
Changes in assets and liabilities-
Increase in accounts receivable (417,889) (272,030)
Increase (decrease) in due from related parties 14,973 (219,055)
Decrease (increase) in prepaid expenses (24,362) (142,593)
Decrease (increase) in notes receivable 76,016 103,800
Increase (decrease) in deferred income (28,829) 81,376
Increase in accounts payable 1,096,654 26,687
Increase (decrease) in wages payable 31,818 6,286
Decrease in vacation payable (5,620) (1,506)
Decrease in taxes payable 52,348 (730)
Increase in other accrued liabilities (17,748) 139,344
----------------------------
Net cash used in operating activities (537,003) (696,906)
Cashflows from Investing Activities: ----------------------------
Repayment of loan by Hanalei Bay Int'l Investors - 435,000
Purchase of furniture, fixtures & equipment (49,061) ( 10,946)
Decrease in investment in HBII Time Share Program - 2,785
Receipt (payment) of deposits (141,689) (157,634)
Purchase of Hawaii Reservations Center (366,817) -
Purchase of management contract (227,500) -
Net cash provided by (used in) ----------------------------
investing activities (785,067) 269,205
Cashflows from Financing Activities: ----------------------------
Proceeds from exercise of common stock warrants - 30,804
Proceeds from issuance of preferred stock, net of
issuance cost 250,000 820,188
Proceeds from issuance of common stock 712,292 -
Payment of dividends on preferred stock ( 16,715) -
Repayment to related parties ( 48,822) (321,726)
Proceeds from related parties 300,000 -
Repayment of notes payable (172,444) (700,000)
Proceeds from notes payable 325,000 445,906
----------------------------
Net cash provided by financing activities 1,349,311 275,172
----------------------------
Net Increase (Decrease) in Cash 27,241 (152,529)
Cash at Beginning of Year 93,440 245,969
----------------------------
Cash at End of Year 120,681 93,440
============================
The accompanying notes are an integral part of the consolidated
financial statements
35
The Castle Group, Inc. and Subsidiary Consolidated Statements of Cash Flows (Continued) For the Years ended July
31, 2000 and 1999 (Unaudited)
2000 1999
Supplemental Disclosures:
Cash paid during the year for interest $ 79,569 $ 145,070
========== =========
Supplemental Schedule of Noncash Investing and Financing Activities:
Isuance of common stock to lessor $ - $ 111,641
Redeemable preferred stock dividend accrual - 16,715
The accompanying notes are an integral part of the consolidated financial statements
The Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
1. 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, Guam, The Federated
States of Micronesia and the Commonwealth of Saipan under the trade names "Hawaiian Pacific Resorts"
and "Castle Resorts and Hotels."
The accounting and reporting policies of The Castle Group, Inc. and Subsidiary (the "Company") 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., KRI, Inc. and KRI, Inc.'s wholly-
owned subsidiary, HPR Advertising, Inc. All significant inter-company transactions have been eliminated in the
consolidated financial statements.
New Accounting Pronouncements Effective August 1, 1998, the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS
No. 131 establishes standards for reporting operating segments and requires certain other disclosures about products
and services, geographic areas and major customers. The adoption of this statement did not have a material effect
on the Company's consolidated financial statements, as management does not evaluate the Company based on the performance
of operating segments.
Effective August 1, 1998, the Company adopted SFAS No. 132, "Employers Disclosures about Pensions and Other
Postretirement Benefits," which standardized the disclosure requirements for pensions and other postretirement
benefits. Since the Company does not have a pension plan or other postretirement plan, the adoption of this statement
did not have an effect on the Company's consolidated financial statements.
The Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
In June 1998, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards
for derivative instruments and hedging activities. SFAS No. 133 requires the recognition of all derivative instruments
in the statement of financial position as either assets or liabilities and the measurement of derivative instruments
at fair value. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133." The original effective date for SFAS
No. 133 was for all fiscal years beginning after June 15, 1999. As a result of SFAS No. 137, the effective date
for SFAS No. 133 is for all fiscal quarters of all fiscal years beginning after June 15, 2000. As the Company does
not invest in derivative instruments or participate in hedging activities, the adoption of SFAS No. 133, as amended
by SFAS No. 137, is not expected to have a material effect on the Company's consolidated financial statements.
Reclassifications Certain reclassifications were made to the 1999 consolidated financial statements to conform
to the 2000 presentation. Such reclassifications did not have an effect on net income as previously reported.
Income Taxes The Company records deferred tax assets and liabilities for expected future tax consequences of events
that have been recognized in the Company's consolidated financial statements or tax returns. Under this method,
deferred tax assets and liabilities are determined based on the difference between the financial statement carrying
amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences
are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the
amount expected to be realized.
Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or
less when purchased to be cash equivalents.
Restricted Cash Restricted cash consists of cash held in client trust accounts and cash pledged as collateral for
an equipment lease.
Furniture, Fixtures and Equipment Furniture, fixtures and equipment are recorded at cost. When assets are retired
or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounting records,
and any resulting gain or loss is reflected in the Consolidated Statement of Operations for the period.
The Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
The cost of maintenance and repairs are charged to income as incurred. Renewals and betterments are capitalized
and depreciated over their estimated useful lives.
At July 31, 2000 and 1999, furniture, fixtures and equipment consisted of the following:
2000 1999
Office equipment $ 270,019 $ 220,959
Less accumulated depreciation 203,233 174,484
---------------------
$ 66,786 $ 46,475
=====================
Depreciation is computed using the declining balance and straight-line methods over the estimated useful life of
the assets (5 to 7 years). For the years ended July 31, 2000 1999 depreciation expense was $28,750 and $25,607
respectively.
Intangibles Intangible assets consist of contract acquisition costs and goodwill. The contract acquisition cost
is being amortized over the life of the contract acquired (5 years) on a straight-line basis. Goodwill costs are
being amortized on a straight-line basis over 20 years. At July 31, 2000 and 1999, the balances of those intangibles
were as follows:
2000 1999
Contract Acquisition Costs $ 227,500 $ -
Goodwill 366,817 -
-------------------------
594,317 -
Less Accumulated Amortization ( 31,127) -
-------------------------
$ 563,190 -
=========================
Income Recognition The Company recognizes income from the management of resort properties according to terms of
its various management contracts.
Deferred Income During the year ended July 31, 1999, the Company renegotiated its office lease. In connection with
this renegotiation, the Company received six months of free office rent and a tenant improvement allowance of $56,785.
The free office rent and tenant improvement allowance is recorded as deferred income and is recognized on the straight-line
method over the term of the lease agreement.
The Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
During the year ended July 31, 1998, the Company received a signing bonus of $80,000 as a result of a contract
entered into with a vendor to provide services over a three-year period. Income is recognized on the straight-line
method over the term of the contract.
Sales and Marketing Expenses The Company incurs sales and marketing expenses in conjunction with the production
of promotional materials, trade shows, retainers for out-of-state sales agents, and related travel costs. Such
costs are expensed as incurred. During the years ended July 31, 2000 and 1999, the Company incurred sales and marketing
expenses of $434,021 and $352,346, respectively.
Concentration of Credit Risks The Company maintains its cash with several financial institutions in Hawaii. Balances
maintained with these institutions are occasionally in excess of federally insured limits.
Concentration in Market Area The Company manages hotel properties primarily in Hawaii and is dependent on the state's
visitor industry. During the years ended July 31, 2000 and 1999, the Company expanded its operation to Guam, New
Zealand and Saipan, respectively. The Company is also contemplating expansion into other areas in the Pacific.
Use of Management Estimates in Financial Statements The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Fair Value of Financial Instruments The carrying value of notes receivable and notes payable approximates fair
values as these notes have interest rates at which similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities. The fair value of the Company's investment in Hanalei Bay International
Investors ("HBII") Time Share Program is estimated based on future cash flow projections.
Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
2. Related Party Transactions
Hanalei Bay International Investors The Company had a hotel management agreement with HBII to manage the Hanalei
Bay Resort ("HBR"). The managing general partner of HBII is also the chairman and chief executive officer
of the Company. Under the management agreement with HBII, the Company was to receive management and incentive fees
based on a percentage of gross total revenue and net income, respectively. The Company also received reservation
and marketing fees based on a percentage of room revenue. During the year ended July 31, 1999, total fee income
from HBR amounted to $739,346.
In March 1999, HBII consummated the sale of its interest in HBR to an unrelated third party. The proceeds from
the sale of HBR were not sufficient to satisfy all claims of HBR's creditors. At July 31, 2000 and 1999, the Company's
receivable from HBR amounted to $1,119,974 (including the principal balance of the Company's timeshare investment)
and $1,105,001, respectively. Under the terms and conditions of the agreement to sell HBR, HBII is entitled to
receive a percentage of the future cash flows from HBR s hotel operations and the sale of certain time-share units.
The current portion of the receivable of $428,316 as of July 31, 1999 represents the projected available cash flow
of HBII to repay the Company during fiscal 2000. The Company has received updated projections from the current
owner of HBR and based on those projections, HBII shall receive distributions in the calendar year 2002. Based
on this, the entire receivable from HBII has been reclassified as a non-current asset as of July 31, 2000. Management
expects that such proceeds will be sufficient to allow HBII to repay its debt to the Company.
HBII Time Share Program In July 1995, the Company invested $100,000 in the HBII Time Share Program of Hanalei Bay
Resort. The Company receives moneys based on a percentage of timesharing unit sales. The Company records proceeds
from the investment on the installment method, whereby a portion of the proceeds represents a return of initial
investment and a portion represents gains.
During 1999, the Company received $11,100 from this investment of which $2,800 represents a return of initial investment
and $8,400 represents a gain recognized by the Company. At July 31, 1999, the investment in the HBII Time Share
Program was $56,121.
As of July 31, 2000, the Company reclassified the remaining principal balance of $56,121 as a "Due from Related
Party".
Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
Reservations Services Reservations services were provided by Hawaii Reservation Center Corporation ("HRCC"),
wholly owned by a former director of the Company. The Company had a payable balance to Hawaii Reservation Center
Corporation of $78,684 as of July 31, 1999.
In April of 2000, the Company purchased all of the outstanding stock of HRCC for $350,000 in cash and the assumption
of $26,817 of liabilities, and HRCC became a wholly owned subsidiary of the Company.
Reservations services expense related to Hawaii Reservation Center Corporation is included in the Reservations
Services caption in the Consolidated Statements of Operations. Through July 31, 2000, HRCC recorded a net profit
of $3,045 that is also included in the Reservations Services caption in the Consolidated Statements of Operations.
Due to Related Parties The Company had the following related party loan balances as of July 31, 2000 and 1999:
2000 1999
6% loans from stockholders, due
August 31, 1998 $ 143,600 $ 143,600
10% loans from Officer, due 03/31/2003 269,851 -
10% loans from Officer, due 08/15/2001 43,001 61,674
-------------------
456,452 205,274
Less current portion 257,100 162,299
-------------------
Due to related parties, non-current $ 199,352 $ 42,975
===================
In June 1998, the Company issued warrants to acquire up to 87,500 shares of common stock for $2.00 per share, exercisable
through June 2003 in exchange for the $175,000 loan made by a Director. No warrants were exercised during 2000
or 1999.
In July 2000, the Company issued warrants to acquire up to 391,024 shares of Common Stock for $1.50 per share,
exercisable through July 15, 2002 in exchange for participation in a private placement of the Company's common
stock at $1.25 per share. Four directors of the Company invested $208,000 in the aggregate through the private
placement and were issued warrants to acquire up to 260,000 shares of the Company's Common Stock.
In February of 2000, an officer of the Company purchased 500 shares of the Company's $100 par value preferred stock.
Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
3. Notes Receivable
At July 31, 2000 and 1999, notes receivable consisted of the following:
2000 1999
Notes receivable from third party in
Monthly installments of $10,000,
including interest at 10% per annum.
Balance of principal and interest is
due September 1, 2000. Real estate is
pledged as collateral. 70,184 146,200
Less current portion 70,184 110,300
----------------------
Notes receivable, non-current $ - $ 35,900
======================
4. Commitments and Contingencies
Leases The Company leases office space, vehicles and equipment expiring at various dates through 2004. The office
lease may be renewed for an additional five years.
In March 1999, the Company signed an agreement to lease and manage a newly constructed hotel in Guam through December
2004. The Company began leasing and managing this resort property in October 1999.
At July 31, 2000, the future minimum rental commitments under these leases was as follows:
Schedule of future minimum lease payments
2001 $ 2,655,000
2002 2,799,000
2003 2,894,000
2004 2,909,000
2005 1,139,000
--------------
$ 13,804,000
==============
Rent expense under these leases amounted to approximately $317,000 for the years ended July 31, 2000 and 1998,
respectively.
Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
Management Contracts The Company manages several hotels and resorts under management agreements expiring at various
dates through December 2004. Several of these management agreements contain automatic extensions for periods of
1 to 10 years. Management fees received are based on the revenues and net available cash flows of the hotels operations
as defined in the respective management agreements.
In addition, the Company has sales, marketing and reservations agreements with other hotels and resorts expiring
at various dates through December 2000. Several of these agreements contain automatic extensions for periods of
one month to three years. Fees received are based on revenues, net available cash flows or commissions as defined
in the respective agreements.
Lease of Real Property in Cook Islands In January 1999, the Company signed an agreement as a co-lessee for certain
real property located in the Cook Islands, upon which is situated an uncompleted hotel development that is approximately
85% completed. Under terms of the agreement with the lessor, the lessees collectively are to complete construction
of the hotel and open substantially all of the rooms of the hotel for business not later than June 30, 2000. If
substantially all of the rooms of the hotel are not open for business by June 30, 2000, the lessor of the property
is entitled to compensation in an amount to be determined by arbitration. Funding for the completion of the hotel
development was to be provided by the Company's co-lessee. However, as of July 31, 2000, the Company's co-lessee
has been unable to fund the completion of the hotel development. The Company's co-lessee is responsible for any
compensation awarded to the lessor and the Company has no responsibility to contribute to any compensation paid
to the lessor. The Company attempted to secure a replacement for the co-lessee but was unsuccessful and therefore,
considers its involvement in the Cook Islands project to be terminated.
Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
5. Notes Payable
At July 31, 2000 and 1999, notes payable consisted of the following:
2000 1999 Term loan payable to a bank at an interest rate of 9.25% with monthly payments of $8,352. The balance and any unpaid interest is due on May 24, 2004. The Company's accounts receivable, furniture, fixtures and equipment are pledged as collateral and the Company's Chief Executive Officer is a guarantor $ 323,462 $ 395,906
$200,000 line of credit from a bank dated May 25, 1999. Drawings are due on September 30, 2000, with interest (11%
at July 31, 2000) at 3% above the bank's base rate. The Company's accounts receivable, furniture, fixtures and
equipment are pledged as collateral and the Company's Chief Executive Officer is
a guarantor on the line of credit 200,000 100,000
Note payable to unrelated party with interest determined based on 1/3 the profits of the Company's wholly owned
subsidiary, HRCC. Principal and any
unpaid interest due on December 31, 2001 125,000 0
----------------------
647,635 495,906
Less current portion 273,400 173,300
----------------------
Notes payable, non-current $ 375,062 $ 322,606
======================
6. Employee Benefits
The Company has a 401(k) Profit Sharing Plan (the "Plan") available for its employees. Under the terms
of the Plan, the Company may match 50% of the compensation reduction of the participants in the Plan up to 1% of
compensation. Any employee with one-year service and 1,000 credit hours of service, who is at least twenty-one
years old, is eligible to participate. For the years ended July 31, 2000 and 1999, the Company made no contributions.
Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
The Company also has a Flexible Benefits Plan (the "Benefits Plan"). The participants in the Benefits
Plan are allowed to make pre-tax premium elections which are intended to be excluded from income as provided by
Section 125 of the Internal Revenue Code of 1986. To be eligible, an employee must have been employed for 90 days.
The benefits include group medical insurance, vision care insurance, disability insurance, cancer insurance, group
dental coverage, group term life insurance and accident insurance.
7. Redeemable Preferred Stock
In March and April of 1999, the Company issued a total of 8,550 shares of $100 par value redeemable preferred stock
to certain officers and directors. Dividends are cumulative from the date of original issue and are payable semi-annually,
when, and if declared by the board of directors beginning July 15, 1999 at a rate of $7.50 per annum per share.
During the fiscal year ended July 31, 2000, the Company paid dividends to holder of record as of July 15, 2000
in the amount of $16,715. At July 31, 1999, accrued dividends on these shares of $16,715 ($1.95 per share), is
included in redeemable preferred stock in the accompanying Consolidated Balance Sheet. The shares are nonvoting,
and are convertible into the Company's common stock at an exercise price of $3 per share. As of January 15, 2001,
the redeemable preferred stock will be redeemable at the option of the Company at a redemption price of $100 per
share plus accrued and unpaid dividends. In February and April of 2000, the Company issued an additional 2,500
shares.
Of the shares issued during the fiscal year ended July 31, 2000, 2,000 shares were issued to the former sole stockholder
of HRCC in settlement of amounts due to HRCC for past reservation services performed through April 30, 2000. An
additional 500 shares were issued to an officer of the Company.
8. Common Stock
Restricted Common Stock In July 1999, the Company issued 22,500 shares of restricted common stock as compensation
to an employee. The Company recorded payroll and benefits expense of approximately $40,781 based on the fair market
value of the Company's stock on the date of issuance ($1.8125 per share at July 30, 1999). The holder of these
shares is prohibited from selling these shares in normal public trading.
During the fiscal year ended July 31, 2000, the Company issued 521,024 shares of restricted common stock. 130,000
shares were issued to the owner of one of the properties managed by the Company in exchange for a new five-year
management agreement. The shares were valued as of the date of the new management contract, January 1, 2000, at
$1.75 per
Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
share. The remaining 391,024 shares were issued to various individuals and entities through private placements
of stock at a price of $1.25 per share. The purchasers of the 391,024 shares also received a warrant for each share
purchased. The warrants entitle the holder to purchase one additional share of the Company's common stock for $1.50
per share, exercisable anytime prior to July 15, 2002. Directors of the Company purchased, directly or indirectly,
260,000 of the 391,024 shares issued.
Common Stock Held by Lessor In July 1999, the Company issued 61,157 shares of restricted common stock to the lessor
of a hotel as part of a security deposit. The lessor is prohibited from selling these shares in public trading
and will return the shares to the Company at the termination of the lease agreement in the year 2004. The Company
recorded the common stock held by the lessor as a contra equity item in the Consolidated Balance Sheet.
Common Stock Warrants In June 1998, the Company issued common stock warrants to acquire up to 187,500 shares of
common stock for $2.00 per share, exercisable through June 2003 in exchange for certain loans made to the Company.
No common stock warrants were exercised during 1999 and 1998. A director of the Company was issued warrants for
87,500 shares in exchange for a loan made to the Company.
In May 1994, the Company issued common stock warrants to acquire up to 25,000 shares of common stock for $1.25
per share, exercisable through May 1999 in exchange for consulting services rendered. During 1999, these common
stock warrants were exercised on a net basis, resulting in the issuance of 12,244 shares of the Company's common
stock.
During the fiscal year ended July 31, 2000, the Company issued warrants to acquire up to 391,024 shares of common
stock for $1.50 per share, exercisable through July 15, 2002, in exchange for the purchase of common stock at a
price of $1.25 per share. Directors of the Company were issued, directly or indirectly, warrants to acquire 260,000
shares of the Company's common stock.
Common Stock Options In May 1997, the Company, as part of a renegotiation of its reservation services agreement,
granted an option to purchase 50,000 shares of the Company's common stock at a price of $2 per share to Hawaii
Reservation Center Corporation ("HRCC"), which is wholly-owned by a stockholder/director of the Company.
The options are exercisable at any time between May 1997 and 2002 and no options were exercised as of July 31,
2000 or 1999. In April of 2000, immediately prior to the Company's acquisition of HRCC, HRCC assigned the option
to its sole shareholder, a former director of the Company.
Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
No other stock options were issued during the years ended July 31, 2000 or 1999.
Per Common Share Data The following is a reconciliation of the numerators and denominators of the basic and diluted
common earnings (loss) per share:
-------------------------------------------
Per Common
Income Shares Share
(Numerator) (Denominator) Amount
BASIC:
Net Income $(1,374,241) 5,928,055 $ (0.23)
Effect of dilutive securities:
Stock subscriptions, options
and warrants - - -
-------------------------------------------
DILUTED:
Net Income and assumed conversions $(1,374,241) 5,928,055 $ (0.23)
===========================================
-------------------------------------------
Per Common
Income Shares Share
(Numerator) (Denominator) Amount
Net Loss $ (487,458)
Less: Redeemable preferred
stock dividend accrual ( 16,715)
-----------
BASIC:
Loss available to common
stockholders (504,173) $ 5,313,912 $ (0.09)
Effect of dilutive securities:
Redeemable preferred stock,
Stock subscriptions, options
and warrants - - -
-------------------------------------------
DILUTED:
Loss available to common
Stockholders and assumed
Conversions $ (504,173) $ 5,313,912 $ (0.09)
===========================================
Castle Group, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited)
In 2000, 1,105 shares of preferred stock, 578,524 shares covered under stock warrants and 50,000 common stock options
were not considered common stock equivalents since they had an anti-dilutive effect on basic loss per share.
In 1999, 8,550 shares of preferred stock, 187,500 common stock warrants, and 50,000 common stock options were not
considered common stock equivalents since they had an anti-dilutive effect on basic loss per share.
9. Income Taxes
Significant components of the Company's deferred tax assets and liabilities as of July 31, 2000 and 1999 are as
follows:
2000 1999
Deferred Tax Assets:
Net operating loss carryforward $1,500,000 920,000
Noncompetition agreement 176,000 197,000
Deferred income 10,000 21,000
Vacation pay 6,000 8,000
-----------------------
$1,692,000 $1,146,000
Deferred Tax Liability:
Furniture, fixtures and equipment (5,000) (5,000)
-----------------------
Net Deferred Tax Asset 1,687,000 1,141,000
Valuation Allowance (1,687,000) (1,141,000)
-----------------------
$ 0 $ 0
=======================
The net change during 2000 and 1999 in the valuation allowance was an increase of $546,000 and a decrease of $218,000,
respectively.
The Company has a net operating loss carryforward for income tax purposes of $3,746,000 at July 31, 2000, which
expires at various dates through fiscal year 2020.
Litigation There are various claims and lawsuits pending against the Company involving complaints, which are normal
and reasonably foreseeable in light of the nature of the Company's business. The ultimate liability of the Company,
if any, cannot be determined at this time. Based upon consultation with counsel, management does not expect that
the aggregate liability, if any, resulting from these proceedings would have a material effect on the Company's
consolidated financial position, results of operations or liquidity.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
The Company dismissed PricewaterhouseCoopers LLP as its principal accountant during the fiscal year ended July
31, 2000. There were no disagreements with PricewaterhouseCoopers LLP.
The Company is in the process of finalizing an agreement with its new accountants and therefore, the financial
statements included in this filing have not been audited. The Company shall file Form 10K-SB/A upon the completion
of its audit for the fiscal year ended July 31, 2000.