Turnaround Is In Full Swing At Castle Brands

By The Wall Street Fox Wednesday, February 19, 2014

Castle Brands (ROX), the alcohol distributor that markets the increasingly popular Gosling's Rum and Jefferson's Whiskey brands, released its quarterly earnings after hours on Friday, February 14, allowing investors a three-day weekend to fully digest the report. The Q3 2014 earnings clearly illustrated the continued progress of Castle Brand's turnaround efforts, and after turning EBITDA positive for the nine months ended FY 2014, prospective investors are presented with an unique opportunity to gain exposure to a company that is positioned for significant long-term growth and is on the brink of posting a profitable quarter for the first time in its history.

Castle Brands continues to clean up its balance sheet, and with the last of the non-cash warrant charges out of the way, the company is ready to put its foot on the pedal and drive into the green. Revenues and assets are up, expenses and liabilities are down, the company has a strong cash position, and the momentum behind Castle's two flagship brands continues to build. Castle Brand's risk/reward profile is compelling at current prices of approximately $0.80 per share, and the company is significantly undervalued on a fundamental basis. Below is a highlight of Castle Brand's recent earnings report and why it continues to be one of my largest "Phillip Frost" positions.

Quick Note

While it is typically a bad sign for a company to "sneak" its earnings report out after the closing bell on a Friday (hoping that few investors see the possibly negative report), especially right before a three day weekend, I believe it was a mere coincidence this year for Castle Brands. The company posts its earnings 45 days after a fiscal quarter ends, and for Q3's case, the quarter ended December 31, 2013. Add 45 days and you get February 14th, 2014. The company released its Q3 report on Valentines Day in 2011, 2012, and 2013. This year Valentines Day just so happened to fall on a Friday right before a three-day weekend. Once going through the report, you will see that there was nothing negative to hide, and a positive PR from Castle Brands should accompany the report some time this week.

Earnings Review

First the bad:

Castle Brands posted a quarterly loss of $2.1 million, compared to a loss of $477,000 year over year, and more than $4 million quarter over quarter. The losses posted in the past two quarters can be attributed to the conversion of warrants, which resulted in a $3.6 million non-cash charge last quarter, and a $1.6 million charge this quarter. With the warrant charges out of the way, the company has lifted a huge weight off its shoulders. It's telling to see these warrants converted years prior to their expiration date, signaling a high level of confidence among holders. Phillip Frost recently picked up more than 5.6 million shares of the company through the conversion of warrants, upping his total stake to nearly 40 million shares.

Sales of Boru Vodka continue to decline, as it attempts to compete in a highly competitive and saturated liquor segment. Case sales are down year over year, but up quarter over quarter, potentially signaling that a temporary bottom has occurred. Regardless if this is the case, vodka sales made up only 5.6% of Q3 revenue, so any decline in vodka sales should be offset by the strong performance of Castle Brand's rum, whiskey, and liqueur brands.

Castle Brands exited its Drink Pie venture (pie flavored liqueur) and incurred a loss of approximately $430,000 this quarter. This is Castle Brands trimming the fat and focusing on its core competencies. This loss is a short-term setback, but the decision to walk away from this failed investment will allow the company to devote more time and resources to grow its successful brands, and actively seek strategic acquisitions.

Now the good:

The demand for Gosling's branded products, such as the Dark'n Stormy cocktail, has spurred the company to expand the production of Gosling's Stormy Ginger Beer in Germany and the U.K. to better support international sales. This expansion will open up a number of new sales channels and help further fuel the growth of Castle Brand's most successful product.



Some of the growth figures for Castle Brand's case sales are through the roof. Quarterly case sales of Castle's non-alcoholic beverages (Ginger Beer) increased 80% on a yearly basis, and international sales of the beverage soared 480% higher. This sharp increase is due to the recent production expansion as noted above. Case sales of Gosling's Rum increased by a modest 7%, and whiskey case sales increased by an astounding 44% (+12% and +75% in revenue, respectively). The Jefferson's Whiskey brand has been a sleeper after years of development, and the company's recent convertible bond offering that was dedicated to purchasing whiskey in bulk is a testament to how strong the growth prospects are for this product.

Castle Brand's gross profit increased 26.3% in Q3 2014 to $4.8 million. Gross margins declined by less than a percent, which was attributed to high volume sales of Castle's lower margin products like Gosling's Stormy Ginger Beer and Clontarf Irish Whiskey. As the company expands and increases its overall sales volume, gross profit should increase as efficiency rises and economies of scale are reached.

Castle Brand's quarterly revenue continued to reach new highs, and the company is on track to record $50 million in revenue for 2014. The company posted a positive EBITDA of $220,000 for the quarter, and turned EBITDA positive for the nine months ended 2014.

Castle Brands now has a cleaned up balance sheet that will allow the company to achieve profitability with the current funds at hand. As of February 12th, the company had more than $3 million in the bank. From the company's 10-Q:
We believe our current cash and working capital, and the availability under the Keltic Facility (~$2 million available), the proceeds that have been raised, and additional funds to be raised, under the distribution agreement, and the cash from the expected exercise of certain of our 2011 Warrants, will enable us to fund our losses until we achieve profitability, ensure continuity of supply of our brands, and support new brand initiatives and marketing programs.
This is reassuring, and led me to a piece of information I overlooked in my previous write-ups. In November of 2013, Castle Brand's entered an Equity Distribution Agreement with Barrington Research Associates, which allows the company to issue up to $6 million worth of common shares via an "at-the-market" offering. This enables Castle to sell the shares at any time on the open market. This explains the massive seller that stepped in around the same time my last article on the company was released in mid January. Shares rallied in after hours trading, but were met by massive blocks of shares in the two following trading sessions.

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This sale in the open market, and others since the distribution agreement offering was established back in November, have allowed Castle Brand's to raise approximately $4.5 million. Shares are poised to run once the company depletes of all its shares under this agreement, but because they currently have plenty of cash, the company may not immediately exercise this option since the share price can move much higher, hence less dilution. With only $1.5 million of shares left to be offered in this distribution agreement, the stock price will not be restricted as much as it was when the company sold more than $3 million worth of stock in mid January.

Conclusion

Shares of Castle Brands have been trading sideways since its last earnings report was released in November. This small cap company is subject to a number of risks, including extreme price swings and future dilution, and the company's accumulated deficit stands at nearly $140 million.

However, the operating platform that has been built up after more than a decade of development is finally ready to turn a profit and continue its stellar growth. Utilizing the industry average P/S ratio, shares of Castle Brands should be trading at $1.58 if the company books revenue of $50 million for 2014 (likely), representing a near double from Friday's close. With strong support at $0.71, shares of Castle Brands offers downside risk of 7% and upside potential of 100% for any investor who sets a tight stop loss near $0.70.

While Castle Brands presents an opportunity for short-term swing traders looking for an earnings play, longs should rest easy knowing that the superb performance of Gosling's and Jefferson's is not letting up, and the improved financial health of the company will enable continuous growth and acquisitions that will generate significant shareholder value over time.
Information was sourced from SEC Filings.
The Wall Street Fox

The Wall Street Fox utilizes fundamental and technical analysis to generate investment ideas. TWSF holds a MBA, and is currently preparing for the Chartered Market Technician (CMT) designation.

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