In May 2014, the FASB issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers, which is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. ASU 2014-09 may be applied using either a full retrospective or a modified retrospective approach and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is not permitted. We are in the early stages of evaluating the effect of the standard on our financial statements, upon adoption our financial statements will include expanded disclosures related to contracts with customers, we are continuing our assessment of other impacts on our financial statements at this time. We are still assessing our method of adoption.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company has $954,692 of operating lease obligations as of December 31, 2016 and upon adoption of this standard it will record a ROU asset and lease liability for present value of these leases which will have a material impact on the balance sheet. However, the statement of income recognition of lease expenses is not expected to change from the current methodology.

In March 2016, the FASB issued ASU 2016-09, Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The objective of this update is to simplify several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. We will adopt ASU 2016-09 effective January 1, 2017 and will provide the necessary disclosures with our Form 10-Q for the period ending March 31, 2017.  The adoption of ASU 2016-09 will not have a material impact on our financial condition or results of operations.

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In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). The objective of this update is to add or clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those annual periods and is to be applied utilizing a retrospective approach. Early adoption is permitted. The Company is currently evaluating the new guidance to determine the impact it may have on its consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other” ASU 2017-04 simplifies the accounting for goodwill impairment by eliminating Step 2 of the current goodwill impairment test, which required a hypothetical purchase price allocation.  Goodwill impairment will now be the amount by which the reporting unit’s carrying value exceeds its fair value, limited to the carrying value of the goodwill. ASU 2017-04 is effective for financial statements issued for fiscal years, and interim periods beginning after December 15, 2019. Upon adoption, we will follow the guidance in this standard for the goodwill impairment testing.

Note 3 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 4 Long Term Debt

The Company has a note dated December 31, 2004, payable in New Zealand dollars, with an original face value of NZ $8.6 million and secured by real estate in New Zealand and a general security agreement over the assets of the Company’s New Zealand subsidiary, with the Company as guarantor.   The holder of the note owns 0.7% of the issued and outstanding common stock of the Company.  The note calls for payments of NZ $20,000 (US $13,980 at 03/31/17) per month.  The maturity date is March 31, 2019 with an extension to March 31, 2024 available is the Company is not in default.  The agreement does not provide for interest to be paid on this note payable so the Company has imputed interest of $46,500 and $50,010 for the quarters ended March 31, 2017 and 2016, respectively.  The balance of this note was NZ $4,987,543 (US $3,486,293) and NZ$ 5,098,463 (US $3,531,705) as of March 31, 2017 and December 31, 2016, respectively.

The Company has a note payable dated December 31, 2004, payable to a New Zealand bank, Westpac, for a loan in favor of Mocles at the bank’s prime rate plus 2%. The note calls for monthly interest payments and payments against principal of NZ $20,000 (US $13,980). The maturity date is March 31, 2019 with an extension to March 31, 2024 available if the Company is not in default.  The balance of this note was NZ $2,125,000 (US $1,485,375) and NZ $2,185,000 (US $1,513,550) as of March 31, 2017 and December 31, 2016, respectively.

In June 2015, the Company received a term loan of $200,000 from a local bank which was used to fund upgrades to the property management and central reservation systems.  These outflows will be recouped by the Company through reimbursements from managed properties.  The loan is for a fixed interest rate of 5.875% with monthly payments of $3,855 and matures in June 2020.  The balance of this loan was $136,423 and $145,892 as of March 31, 2017 and December 31, 2016, respectively.

In March 2016, the Company received a loan of $40,178 to finance the purchase carts for one of its managed properties.  The loan is secured by the equipment purchased.  The loan is for a fixed interest rate of 4.43% with monthly payments of $749 and matures in March 2021.  The outstanding balance of this loan was $32,846 and $37,919 as of March 31, 2017 and December 31, 2016, respectively.

Note 5 Equity-Based Compensation

None issued for the three months ended March 31, 2017 and 2016.

Note 6 Basic and Dilutive Earnings Per Share

Basic earnings per share of common stock were computed by dividing income available to common stockholders by the weighted average number of common shares outstanding.  Diluted earnings per share were computed using the treasury stock method for vested warrants and the two-class method for redeemable preferred stock. The calculation of diluted earnings per share for 2017 and 2016 excludes 368,333 shares which would be issued upon conversion of the outstanding $100 par value redeemable preferred stock of the Company as they are considered to be anti-dilutive. The warrants for 600,000 shares outstanding at March 31, 2017 and December 31, 2016 are not included as they are considered to be anti-dilutive since the exercise price exceeded the average market price of the stock during the respective periods. As the preferred shares and the warrants are considered to be anti-dilutive, the Company employed the two-class method and basic and diluted earnings per share were the same.

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Note 7 Commitments and Contingencies

The Company owns the Podium unit in New Zealand, and there was a claim made against the contractor by the Body Corporate (that represents all the unit owners, similar to an association of apartment owners in the United States) for defective work on the outer waterproofing skin of the building.  A settlement was reached and the amounts recovered from the contractor were not sufficient to cure the waterproofing defect.  As a result the Body Corporate will be imposing a special assessment on all the owners of units in the building.  The Company has paid NZ $138,578 (US $96,866) as of March 31, 2017, and expects to make additional payments through July 2017 of NZ $184,770 (US $129,154).  The project is scheduled to commence in the first quarter of 2018.  These payments will be capitalized by the Company since the repairs are expected to improve the property.  Another claim has been filed by the Body Corporate against the law firm previously representing the Body Corporate to recover funds previously expended by the Company and other owners in the building and the amounts assessed against the Company’s Podium unit may or may not be recovered.  There could also be additional remedial work required once construction starts, which could increase the amount assessed against the Company’s Podium unit.  

The amounts paid through March 31, 2017 have been recorded as Construction in progress.  Once the project has been completed, the Company will capitalize the costs of the asset as improvements and shall commence depreciation upon complettion of the project.

Note 8 Related Party Transactions

The Company has a receivable of $561,742 and $598,689 from Hanalei Bay International Investors (“HBII”) as of March 31, 2017 and December 31, 2016. The receivable has been fully provided for.  The Chairman and CEO of the Company is the sole shareholder of HBII Management, Inc., the managing General Partner of HBII.  During the quarters ended March 31, 2017 and 2016, the Company collected $36,947 and $118,617, respectively, of the note.

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, expectations, financial condition, results of operations, future performance and business of the Company, including, without limitation, (i) Castle’s ability to raise capital, and (ii) statements preceded by, followed by or that include the words “may,” “would,” “could,” “should,” “expects,” “projects,” “anticipates,” “believes,” “estimates,” “plans,” “intends,” “targets” or similar expressions.

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

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

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Overview

Principal products or services and their markets

General

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

Marketing Strategy

Most of our marketing efforts are focused towards acquiring and retaining guests for the properties we manage. Castle does not own any hotels or resorts; however, it has made 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 as we believe that “one standard does not fit all.”  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 online 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. We represent hotels, resort condominiums, and lodging accommodations throughout Hawaii, and in New Zealand.   

In Hawaii, Castle 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 operation in 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 hotels with hundreds of 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.  

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Brand Strategy

Castle does not brand the properties under its management.  Each property Castle manages is individually marketed 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, 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 differentiates us from the high profile branded hospitality companies. When a hotel owner or developer is considering contracting a large worldwide hospitality company for possible hotel management, there are several considerations that must be assessed.  With major worldwide brands, usually come the high costs that the owner must bear to sustain the expensive marketing and operational expense that the brand demands to offset their marketing costs. The owner may also have to make a substantial investment in the property in order to fit into the “cookie cutter” mold that the brand desires.  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, operational and service programs to fit the specific demographics attracted to each of our properties.  Through our individual property 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 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 is also seen throughout the world tourism marketplace.  This increased demand is fueled by the following traveler’s expectations:  

· Travelers seek individualized recognition, attention, and service.

· Guests desire hotel and condominium accommodations that impart a sense of home and provide a unique, hospitable guest experience.

· Customers demand differing quality and personalized service and providing this creates high customer loyalty and repeat business.  

· Customers seek Hawaii due to the feeling of “Ohana,” or family, experiencing the unique feeling of Aloha imparted by the people of Hawaii.  

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 also 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 a property in New Zealand, and is keeping the option to strategically expand operations into Thailand, Saipan 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 we purchased the front desk, restaurant, bar, ballroom, board room, conference rooms, back of the house facilities and other areas (collectively the “Podium”) at our New Zealand property that are necessary for the hotel’s operation.  Through our ownership of the Podium and a ten year management contract for the Spencer on Byron hotel, Castle is assured of ongoing revenues in future years from this property.  In January of 2015, we

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purchased the front desk unit at one of our condominium resort properties located on the island of Kauai.  This ownership solidifies our on-site presence at the property, allowing us to better service both our guests and the condominium owners that we represent.

In addition to seeking new hotel and resort condominium management contracts, we will continue to seek investment opportunities with hotel developers and owners.

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

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

Revenues

Total revenues for the quarter ended March 31, 2017 were $6,581,515 a 2% increase over the $6,422,326 reported for the three months ended March 31, 2016.  The increase is attributed to the signing of a property under a Net Contract in February of 2016 and overall higher average rates from the rooms we manage.

Managed property revenue showed an increase of 2%, to $6,581,215, for the three months ended March 31, 2017 from $6,421,226 for the three months ended March 31, 2016.  This increase is again due to a slight improvement of our domestic and the signing of a property under a Net Contract in February of 2016.   

Other revenue was $300 for the three months ended March 31, 2017 compared to $1,100 for the three months ended March 31, 2016.  

Other revenue for the periods include transfer fees the Company owns for preparing documents necessary for the sale of units by our condominium owners.

The Company recorded income from an equity method investment of $13,000 and $14,000, for the three months ended March 31, 2017 and 2016, respectively, which represents the Company’s 7% share of the income from the limited liability company that owns one of the hotels managed by the Company.

Expenses

Managed property expenses are those expenses more directly related to the management of our hotels and resort condominium properties. Managed property expense for the three months ended March 31, 2017 compared to March 31, 2016 decreased by 1%, to $5,151,609 from $5,204,544.  The decrease is attributed to the Company converting some of its smaller rental programs to a more vacation rental operation where operating costs are minimized.

Administrative and general expenses increased by 27% to $1,174,937 from $926,994 for the three months ended March 31, 2017 as compared to March 31, 2016.  This increase was due to the Company expanding its corporate staffing in all departments in order to better serve the properties represented by the Company. Also contributing to the increase was the recovery of bad debts in the prior quarter ended March 31, 2016 of $118,617 compared to $36,947 for the quarter ended March 31, 2017.

Depreciation

Our business is to provide services to our clients and as such does not require a great deal of capital expenditure for equipment or fixed assets.  As a result, depreciation expense was $57,992 and $61,992 for the three months ended March 31, 2017 and 2016.

Equity Method Investment Income

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Interest Expense

Interest expense was $69,774 and $81,949 for the three months ended March 31, 2017 and 2016, respectively.  Included in interest expense is interest that is imputed on the mortgage note for our Podium located in New Zealand of $46,500 for the three months ended March 31, 2017 compared to $50,010 for the three months ended March 31 2016.  The decrease in interest expense is due to the Company making payments under the terms of its note payable obligations which reduce the principal balances upon which interest expense is calculated on.

Income Taxes

Income tax expense for the three months ended March 31, 2017 and March 31, 2016 was $98,110 and $79,949, respectively.  The increase is due to an increase in the net taxable income reported by our domestic operations.

Net Income  

Net income for the three months ended March 31, 2017 was $42,093 compared to $80,898 for the three months ended March 31, 2016.  The decrease in net income is attributed to the recovery of bad debts of $36,947 for the quarter ended March 31, 2017 as compared to $118,617 for the quarter ended March 31, 2016.

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 spot 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 Loss totaled $7,308 compared to $5,279 for the three months ended March 31, 2017 and 2016, respectively.

Total Comprehensive Income

Total comprehensive income for the three months ended March 31, 2017 was $34,785 as compared to $75,619 for the three months ended March 31, 2016.  This is primarily a result of the changes in revenue and operating expenses, investment income, and foreign exchange rates noted above.

Non-GAAP Measures

EBITDA reflects the Company’s earnings without the effect of depreciation, amortization, interest income or expense or income taxes. Castle’s management believes that EBITDA is a good alternative indicator of the Company’s financial performance because it removes the effects of non-cash depreciation and amortization of assets as well as the fluctuations of interest costs based on Castle’s borrowing history, and increases and decreases in tax expense brought about by changes in the provision for future tax effects rather than current income.  

EBITDA as presented in this quarterly report is a supplemental measure of our performance that are neither required by, nor presented in accordance with, generally accepted accounting principles (“GAAP”). EBITDA is not a measurement of our financial performance under GAAP and should not be considered as alternative to net income, operating income, or any other performance measures derived in accordance with GAAP, or as alternative to cash flow from operating activities as a measure of our liquidity. In addition, in evaluating EBITDA, you should be aware that in the future we will incur expenses or charges such as those added back to calculate EBITDA. Our presentation of EBITDA should not be construed as an inference that our future results will be unaffected by unusual or nonrecurring items.

EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as substitutes for analysis of our results as reported under GAAP. Some of these limitations are (i) it does not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments, (ii) they do not reflect changes in, or cash requirements for, our working capital needs, (iii) it does not reflect interest expense, or the cash requirements necessary to service interest or principal payments, on our debt, (iv) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA does not reflect any cash requirements for such replacements, (v) it does not adjust for all non-cash income or expense items that are reflected in our statements of cash flows, and (vi) other companies in our industry may calculate this measure differently than we do, limiting its usefulness as comparative measures.

We compensate for these limitations by providing specific information regarding the GAAP amounts excluded from such non-GAAP financial measures. We further compensate for the limitations in our use of non-GAAP financial measures by presenting comparable GAAP measures more prominently.

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We believe that EBITDA facilitates operating performance comparisons from period to period by isolating the effects of some items that vary from period to period without any correlation to core operating performance or that vary widely among similar companies. These potential differences may be caused by variations in capital structures (affecting interest expense), tax positions (such as the impact on periods or companies of changes in effective tax rates or net operating losses) and the age and book depreciation of facilities and equipment (affecting relative depreciation expense). We also present EBITDA because (i) we believe that this measure is frequently used by securities analysts, investors and other interested parties to evaluate companies in our industry, (ii) we believe that investors will find these measures useful in assessing our ability to service or incur indebtedness, and (iii) we use EBITDA internally as benchmark to compare our performance to that of our competitors.

Reconciliation of GAAP Net Income to EBITDA:

EBITDA totaled $267,969 as compared to $304,788 for the three months ended March 31, 2017 and 2016, respectively, representing a 12% decrease.  The decrease in EBITDA is attributable to an $81,670 decrease in our recovery of bad debts for the three months ended March 31, 2017 when compared to the three months ended March 31, 2016.

Liquidity

Our primary sources of liquidity include available cash and borrowing under the credit facility which was secured in October 2008, consisting of a $600,000 line of credit.   As of March 31, 2017 the full amount of the line of credit was available to use. Additionally, our New Zealand subsidiary has an available NZ$150,000 (US$105,850) line of credit which was also fully available as of March 31, 2017. 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.

In June 2015, the Company received a term loan of $200,000 from a local bank which was used to fund upgrades to the property management and central reservation systems.  These outflows will be recouped by the Company through reimbursements from managed properties.  The loan is for a fixed interest rate of 5.875% with monthly payments of $3,855 and matures in June 2020.  The outstanding balance of this loan was $136,423 and $145,892 as of March 31, 2017 and December 31, 2016, respectively.

In March 2016, the Company received a loan of $40,178 to finance the purchase carts for one of its managed properties.  The loan is secured by the equipment purchased.  The loan is for a fixed interest rate of 4.43% with monthly payments of $749 and matures in March, 2021.  The outstanding balance of this loan was $32,846 at March 31, 2017.

The Company has a related party note dated December 31, 2004, payable in New Zealand dollars, with an original face value of NZ $8.6 million and secured by real estate in New Zealand and a general security agreement over the assets of the Company’s New Zealand subsidiary, with the Company as guarantor.   The note calls for payments of NZ $20,000 (US $13,980 at 03/31/17) per month.  The maturity date is March 31, 2019 with an extension to March 31, 2024 available is the Company is not in default.  The agreement does not provide for interest to be paid on this note payable so the Company has imputed interest of $46,500 and $50,010 for the quarters ended March 31, 2017 and 2016, respectively.  The balance of the note at March 31, 2017 was NZ $4,987,543 (US $3,486,293).

The Company has a note payable dated December 31, 2004, payable to a New Zealand bank, Westpac, for a loan in favor of Mocles at the bank’s prime rate plus 2%. The note calls for monthly interest payments and payments against principal of NZ $20,000 (US $13,980). The maturity date is March 31, 2019 with an extension to March 31, 2024 available if the Company is not in default.  The balance of the note at March 31, 2017 was NZ $2,125,000 (US $1,485,375).

Expected uses of cash in fiscal 2017 include funds required to support our operating activities, including continuing to selectively expand the number of properties under our management.  We are also in the installation phase of upgrading our central reservations system, front office systems and ecommerce systems which will allow us to better compete with the growing vacation rental industry, allowing guests to book their stays by a specific individual unit rather than by unit category.

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We experienced net income of $42,093 for the three months ended March 31, 2017 compared to $80,898 for the three months ended March 31, 2016.  We have established a trend of operating profitability in recent quarters as we reported positive EBITDA in thirteen of our last fourteen quarters, and positive net income for our last six fiscal years.  We anticipate an increase in current occupancy levels, together with a slight increase in average rate trends and levels for the properties currently under contract for the remainder of 2017 when compared to 2016.  We will continue our efforts to expand the number of properties under management through the remainder of 2017, which will increase the overall revenue and profitability stream in 2017. The specific impact of these additions on revenue depends on the timing of when and if new properties are added during the year.  We have implemented a number of revenue enhancement and cost saving programs that will improve our profitability and cash flow.  We project that we will continue to improve the overall profitability, cash flow, and working capital liquidity through 2017. This view is based on the following assumptions:

· The increase in current occupancy levels in our Hawaii and New Zealand markets.

· A slight increase in average daily rates at the properties we manage as compared to recent years.

· Focus on increasing our properties room revenue through increased sales, advertising and marketing efforts.

· Maximizing other sources of revenue from our guests.

· Careful monitoring of our costs and expenses, providing the basis for improved operating margins throughout 2017.  

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

· A stabilization of the United States / New Zealand exchange rates.

· The successful installation of our new reservations platform, allowing us to effectively penetrate the vacation rental market.

Our plans to manage our liquidity position in fiscal 2017 include:

· Reducing our existing debt.

· Accessing our available sources of debt if needed and seeking additional debt or equity financing at competitive rates.

· Expenditures to replace and upgrade our existing technological equipment.

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 2017 and our foreseeable future.

None; not applicable.

Critical Accounting Policies and Estimates

A summary of our significant accounting policies and estimates is discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note 1 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016. There have been no material changes to those policies during the three months ended March 31, 2017.  The preparation of the financial statements in accordance with U.S. generally accepted accounting principles requires us to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities. Significant areas of uncertainty that require judgments, estimates and assumptions include the accounting for income taxes, asset impairment and collectability of accounts receivable. We use historical and other information that we consider to be relevant to make these judgments and estimates. However, actual results may differ from those estimates and assumptions that are used to prepare our financial statements.

New Accounting Pronouncements

See discussion under Note 2, New Accounting Pronouncements, to the Condensed Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q, for information on new accounting pronouncements.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Foreign Currency Exchange Risk

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

As currency exchange rates change, translation of the income statements of our international businesses into U.S. dollars affects year-over-year comparability of operating results. We have not hedged translation risks because cash flows from international operations were generally reinvested locally.

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

Item 4.  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 March 31, 2017, 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

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

Item 1A. Risk Factors.

Not required to be enumerated by smaller reporting companies.

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

Recent Sales of Unregistered Securities

None during the three months ended March 31, 2017.

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Use of Proceeds of Registered Securities

No proceeds were received from the sale of registered securities during the three months ended March 31, 2017.

Purchases of Equity Securities by Us and Affiliated Purchasers

None during the three months ended March 31, 2017.

Item 3. Defaults Upon Senior Securities.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None reported

Item 6. Exhibits.

(a) Exhibits and index of exhibits.

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.

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